Executives
Brenda Ropoulos – Investor Relations
Lavi A. Lev President, Chief Executive Officer & Director
Kevin C. Eichler - Chief Financial Officer, Senior Vice President & Secretary
Analysts
Christopher Blansett – J. P. Morgan
Analyst Timothy Arcuri – Citigroup
Patrick Ho – Stifel Nicolaus & Company, Inc.
Analyst for Satya Kumar – Credit Suisse
Nickolay Tishchenko – Global Crown Capital
Credence Systems Corp. (CMOS) F1Q08 Earnings Call March 3, 2008 5:00 PM ET
Operator
Good day ladies and gentlemen and welcome to the first quarter 2008 Credence Systems Corporation earnings conference call. My name is Akia and I’ll be your operator for today. At this time all participants are on a listen only mode. We will conduct a question-and-answer session toward the end of the conference. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Miss Brenda Ropoulos.
Brenda Ropoulos
Good afternoon everyone and welcome to our discussion of the Credence first quarter fiscal 2008 results. With me today are Lavi Lev, President and Chief Executive Officer and K.C. Eichler, Chief Financial Officer. The press release announcing our financial results is on the Credence website under Investor Relations.
Before we begin our prepared remarks I’d like to cover some guidelines for the call. It’s our objective that this call will comply with the requirements of SEC Regulation FD. This call also includes and constitutes the company’s official guidance for the second quarter of fiscal 2008. If at any time after this call we communicate any material changes to this guidance we intend that such updates will be done using a public forum such as a press release or publicly announced conference call. Investors should note that only the Chief Executive Officer and the Chief Financial Officer are authorized to supply company guidance. The matters that we discuss today other than historical information include forward-looking statements relating to our future financial performance and other performance expectations. Investors are cautioned that forward-looking statements are neither promises nor guarantees but involve risks and uncertainties that may cause actual results to differ materially from those projected in the forward-looking statements. Some of those risks and uncertainties are detailed in our filings with the Securities & Exchange Commission including our Form 10K filed in January 2008 and our quarterly reports on Form 10Q. The company disclaims any obligation to publicly update or revise any such forward-looking statements to reflect events or circumstances that occur after this call.
In addition, we want to make clear to investors that our prepared remarks will be presented with the requirements of the SEC Regulation G regarding Generally Accepted Accounting Principles or GAAP. Some financial information presented by us during the call is provided on both a GAAP and non-GAAP basis. By disclosing certain non-GAAP information which may exclude certain changes and credits management intends to provide investors with additional information to permit further analysis of the company’s performance, core results and underlying trends. Management uses non-GAAP measures to better assess operating performance and to establish operational goals. Non-GAAP information should not be viewed by investors as a substitute for nor superior to data prepared in accordance with GAAP and is not necessarily comparable to financial metrics used by other companies. If we use any non-GAAP financial measure during the call you will find the required presentation of and reconciliation to the most directly comparable GAAP financial measure on the company’s website at www.Credence.com by clicking on Investors, Fundamental Data and then selection the Non-GAAP Reconciliation tab. Finally this call is being simultaneously webcast on our website. A telephone replay and webcast play will be available approximately one hour following the conclusion of the call.
And now it’s my pleasure to turn the call over to Lavi.
Lavi A. Lev
Good afternoon and welcome. Let me briefly outline the agenda for this call. First I’ll provide an overview of the first quarter and give you a progress report on our growth plans. Then our CFO, K.C. Eichler will give you detailed financial review of the first quarter and provide guidance for the second quarter.
Here are the key points of our first quarter of fiscal 2008. Overall we had a strong first quarter. Revenue of $63.2 million exceeded our guidance range of $58 to $62 million in the first quarter which is typically our weakest revenue period for the year. Our book to bill ratio was 1.3 showing a sharp recovery and a sign of decreased demands for our products. Then we maintained a strong cash position closing the quarter with a cash balance of $241 million. Despite the challenging economic environment I am pleased to say that Credence products had good traction in the quarter as our strategy to provide unique value to customers in the consumer semi-conductor market began to take hold. Let me give you a few highlights.
ASL continues to be the most widely deployed commercial test platform in the analog linear consumer market. This quarter our business for ASL came from existing customers who selected the platform for capacity expansion. We saw continued demand for ASL in North America and Europe where ASL maintained its strong foothold in key accounts who added capacity to address their current and next generation linear test requirements.
In Taiwan where ASL is the number one tester we are seeing additional business as a result of our existing customers winning new consumer business. As an example a large fabless company that has a successful business developing power management solutions for PCs has just won significant business delivering power management solutions for the LCD market. As a result they have increased their own inventory of ASL 1000 platforms and will also drive larger amount of ASL production business into the OCEPs. As for Diamond, this quarter we had two major design wins in the area of mixed signal SOC and digital consumer markets where both a North American fabless company as well as a major Japanese IDM selected Diamond for its unique cost, performance and versatility advantages.
In addition we were encouraged to see the beginning of capacity expansion with existing fabless and OCEPs companies in Asia. Sapphire, in the high end consumer business we saw capacity expansion with both our HDMI and DTV customers, specifically a fabless North American company added additional capacity for testing graphics processors. In the MMPU space Sapphire continues to be the plan of record for MPU testing at AMD where we expanded our position in Q1 with both new systems and instrument upgrades. We expect to see our position strengthening with this customer throughout the year as we meet their current test requirements and partner with them to develop the next generation lower cost instruments which are also being required by our high end consumer customers.
As for competitive landscape, we did not see competitive traction in any of our key accounts across our product line. Having stabilized the company in fiscal 2007 and delivering the first profitable year in six years we now have set our sights on achieving long term growth and sustained profitability during industry cycles. To reach these goals we announced last quarter a restructuring of operations that sets us on a new path. With the restructuring actions now mostly behind us we believe we’ve set the stage for financial recovery to unfold during the course of fiscal 2008.
Before I close, I’d like to review our plans for growth and sustained profitability. First we are sharpening our focus on the consumer semi-conductor markets where our growth engines, Diamond, ASL and Sapphire are positioned extremely well. Second every tester and instrument that we develop must be targeted at the broad range of customers and applications. It will be built, deployed and supported in a way that satisfies real customer needs and can be done profitably by us. And third, Diamond and ASL will be targeted at the mainstream consumer market and Sapphire will be configured and deployed into both the high end consumer and MPU markets. I want to clarify the Sapphire market positioning. From a test solution point of view MPU and high end consumer devices have the same ATE development and deployment needs. Therefore, Sapphire addresses both market needs with the same exact tester configuration. In conclusion last year we stabilized the financial condition of Credence, now we’ve dramatically lowered our cost structure and aligned our resources to focus on the consumer markets in order to achieve the goals of growth and sustained profitability during industry cycles. We’ve gone through a painful process to get here, but it was necessary and we are very encouraged by the early signs of progress. With the bulk of our company transformation behind us we are moving forward with a focused product portfolio and a more efficient and cost effective infrastructure.
With that, I’ll turn the call over to K.C.
Kevin C. Eichler
Lavi has already covered the highlights of Q1 so let me get into the details. It’s been a very active quarter. We’re in the middle of a major restructuring, we’ve completed a sale leaseback of our Hillsboro facility and divested the diagnostics and characterization product line or DCG. There’s a lot we’re trying to get done here so I’ll call out these activities on how they impacted our first quarter.
Revenue for the first quarter was $63.2 million a decrease of $34.5 million from the prior quarter or $55.6 million when compared to the first quarter of fiscal 2007. Orders were $82.3 million reflecting a book to bill ratio of 1.3. Product revenues were $41.1 million a decrease of $31.7 million or 44% when compared to the prior quarter. Product revenues represented 65% of total revenue. Service and application revenue was $22.1 million a decrease of $2.8 million or 11% when compared to the prior quarter. Service and application revenue represented 35% of total revenue. Revenue from the high end consumer and MPU business was $17.4 million a decrease of $3.2 million or 15.5% when compared to the prior quarter. Revenue for the mainstream consumer business was $21.5 million a decrease of $21.2 million or 49.7% when compared to the prior quarter. Revenue from our DCG business was $2.2 million a decrease of $7.3 million or 77% when compared to the prior quarter. As previously reported we signed an agreement in February to sell the DCG business. This transaction was closed in the second quarter. The top 10 customers represented 65% of revenue with three customers contributing greater than 10% of revenue. IDM and fabless customers accounted for 83% with the remaining 17% coming from OCEPs. North America accounted for 32% of revenue, Europe 14% and Asia including Japan 54%. Gross margin for the quarter was 41.2% compared to 49.2% in the prior quarter. Included in gross margin was a $2.8 million restructuring charge. Gross margin was 45.6% excluding the restructuring charge.
Total operating expense were $74.6 million an increase of $32.1 million or 72% compared to the prior quarter. Operating expenses in Q1 fiscal year 08 included a $10.7 million restructuring charge and a $23 million non-cash impairment charge related to the divestiture of DCG. Excluding these charges operating expenses were $43.2 million down 4% from the prior quarter. Research and development expenses were $17.2 million an increase of $300,000 essentially flat with the prior quarter. SG&A expenses were $21.5 million a decrease of $2 million or 8% from the prior quarter. Amortization and stock option compensation expenses were $4.5 million and $1.1 million respectively. Other income and expense was $4.6 million an increase of $4.4 million compared to the prior quarter. Included in other income and expense was a $3.5 million charge related to the sale leaseback of our Hillsboro facility previously discussed and completed in the quarter. Income tax expense for the quarter was $700,000. Net loss for the quarter was $56.1 million or $0.55 per share.
So let me recap the one-time and extraordinary charges for the quarter. Cost of goods sold included a $2.8 million charge for restructuring. Operating expenses included a $10.7 million for restructuring. In addition operating expenses included a $23 million non-cash impairment charge related to the divestiture of DCG. Finally other income and expense includes a $3.5 million charge for the sale leaseback of our Hillsboro facility. Excluding these one-time and extraordinary charges net loss was $16 million or $0.16 per share.
Now let’s turn our focus to the balance sheet. Cash and short term investments were approximately $241 million compared to $242 million in the prior quarter. Accounts receivable was approximately $58 million compared to $64 million in the prior quarter. DSOs were 84 days compared to 60 days in the prior quarter and inventory was $51.3 million compared to $62.5 million in the prior quarter. Our full time and temporary headcount at the end of the first quarter was 1,250 employees.
Before I review our guidance I’d like to remind you that our guidance is based on current expectations. These statements are forward looking and actual results may differ materially based on a number of factors as stated at the beginning of the call. Here’s the guidance for the second quarter of fiscal 2008. Revenue is expected to be in the range of $64 to $68 million. Gross margin is expected to be 46 to 48%. Gross margin will include a $1 million charge for restructuring. Operating expenses are expected to be $39 to $43 million and will include a $1 million charge for restructuring and a $3.3 million charge for amortization. Net loss for the quarter is expected to be $9 to $11 million or $0.09 to $0.11 per share.
Now I’d like to turn the call back over to the moderator to be able to start Q&A.
Question-and-Answer Session
Operator
(Operator Instructions) Your first question comes from the line of Chris Blansett of JP Morgan. Please proceed.
Christopher Blansett – J.P. Morgan
Real quick starting off, when you look at your guidance if you gave that on a pro forma basis, K.C., could you tell us what that would be?
Kevin C. Eichler
Well I called out the restructuring which was $1 million in gross margin and $1 million in operating expense. I also have the $3.3 million of amortization that I know that several people pro forma out and I’ve also called out what the stock option charge was last quarter and I would think it’s relatively comparable this quarter as well. So those are really the charges we’re looking at that would be comparable to the one-time charges for this quarter.
Christopher Blansett – J.P. Morgan
And then is the second quarter pretty much going to be the end of these charges or will they kind of trickle on for a while?
Kevin C. Eichler
We announced it was going to be about $16 million when we announced the restructuring at the beginning of the year and as you can see we’ve taken about $13.5 this quarter, I’ve just talked about another $2 million. So fundamentally most of the charges have been taken in Q1 and in Q2. There will be some that will come through in Q3 and Q4 but you’ve seen the majority of the charges related to the restructuring that we’ve already announced.
Christopher Blansett – J.P. Morgan
One more quick one, looking at your book to bill it’s pretty good. Your guidance doesn’t quite reflect I guess a comparable level of turns in business so it sounds like some of your clients are booking in advance. Why is this tied to maybe your manufacturing being more quickly transitioned to China? Just trying to understand the dynamic there?
Lavi A. Lev
We are not providing guidance for book to bill. Obviously the revenue this quarter was the result of booking of the last quarter or two and we are guiding up, we see the business starting to pick up a bit after a pretty slow start in Q1 and we’re pretty comfortable with that.
Kevin C. Eichler
The other thing I’d point out is we had some DCG revenue in the first quarter and we will not have any DCG revenue in the second quarter so we’re actually having a little stronger growth than is reflected in the numbers because of DCG being in the first quarter.
Christopher Blansett – J.P. Morgan
I guess the only thing I was asking is you have a pretty high book-to-bill but your guidance doesn’t reflect the direct correlation with the book-to-bill number. Are some of your customers like, why are they looking at longer lead times before shipments given the short lead times of the products?
Lavi A. Lev
We are, according to the way we recognize revenue and bookings we expect this thing to revenue within the next two quarters or so, so you will see this number plus whatever comes this quarter coming in.
Operator
Your next question comes from the line of Timothy Arcuri. Please proceed.
Analyst Timothy Arcuri – Citigroup
I had a couple of items. The first one, can you kind of go into a little more detail on the strategic rationale for divesting the debug business? I had thought this was a business that was doing close to $10 million a quarter in revenues over the past couple of years. I know it’s depressed and it’s also, if I’m correct, one of your higher margin businesses so I’m wondering first why it was sold and then why it was sold at what appears to be a fairly low valuation?
Lavi A. Lev
Let me talk it. The diagnostic and characterization business, the DCG is really a very highly specialized business and was losing money throughout 2007. As you saw we reported $2.2 million revenue this last quarter. And, our first priority there was our customers and our employees to make sure that those who bought this equipment from us will continue to get served well. We had difficult, because it’s a specialized business we had difficulty running it and attracting people to run it profitably and develop products for the future. So, what we want to do is focus on our customers to make sure that they’re taking care of and we’re really pleased that we managed to attract Dr. Israel Niv to run it, he ran it before, he’s an excellent leader, took it over and I’m sure it’s in the best hands and we are very comfortable for the outcome for Credence and its shareholders with the sizeable deal that we cut here.
Analyst Timothy Arcuri – Citigroup
Okay, great. Maybe as a follow up, was that a business where maybe one to two customers accounted for most of the revenues and kind of part of that base has deteriorated recently?
Lavi A. Lev
No, if you’re talking about DCG, this is not the case, no.
Analyst Timothy Arcuri – Citigroup
Okay. So, that was a pretty diversified customer base you were dealing with?
Lavi A. Lev
It was a diversified customer base the needed highly specialized skills and obviously, this does not comply with our consumer focus strategy all together. So, this just aggravated the situation even more so we are really not the right place for this to be.
Analyst Timothy Arcuri – Citigroup
Okay. That’s helpful. Maybe one last one for me and I’ll go away. Is the breakeven target for Q208 still $70 to $73? Because, if I run the numbers and I kind of assume maybe a mid 50s incremental drop through to the gross line, it looks like you’ll have to cut $10 million in op ex to reach that target. So, is that a fair assumption or is the breakeven target changing here?
Kevin C. Eichler
Again, we didn’t give guidance on the breakeven or update the breakeven from the first quarter. I think assuming a $10 million reduction in operating expense is – we didn’t give guidance that would indicate that we have a $10 million drop so I don’t know if that would be a great assumption.
Analyst Timothy Arcuri – Citigroup
Okay. So, is maybe my incremental gross margin assumption too low? I guess I’m trying to see where the disconnect is here with the numbers and you not changing the breakeven. Or, is the breakeven without explicitly stating a new one sort of pushing out a little bit here?
Lavi A. Lev
I just want to pop it up a little because we might get mixed up here a little bit on the call on the details. In general, what we guided is for us exiting 2008 as profitable with the business plan that we showed you, that we disclosed last time, we are not changing that. We said that Q1 would be bottom line wise the lowest quarter for the year, we are not changing that. So, definitely on the right trajectory to be profitable exiting the year. While we do that obviously we need to cross a breakeven period so that’s the thing we are focusing on at this point. There are a lot of good points that you made here but there are quite a lot of moving parts with such a large restructuring so it will be hard to dissect them here on the call.
Analyst Timothy Arcuri – Citigroup
Okay. So, bottom line the year end targets haven’t changed but maybe the trajectory to getting to them has moved a little bit?
Lavi A. Lev
Yeah. Especially on the bottom line being profitable and with the profit margins that we are talking about, yes.
Operator
Your next question comes from the line of Patrick Ho of Stifel Nicolaus. Please proceed.
Patrick Ho – Stifel Nicolaus & Company, Inc.
First, just a housekeeping question, what was your cash flow from operations this quarter?
Kevin C. Eichler
We didn’t get into the cash flow from operations for the current quarter. Again, as you can see we weren’t burning a lot of cash this quarter. So, if that gives you any indication of how we did from a cash flow basis.
Patrick Ho – Stifel Nicolaus & Company, Inc.
I guess then should I assume it was just neutral during the quarter?
Kevin C. Eichler
Yeah, it was basically neutral.
Patrick Ho – Stifel Nicolaus & Company, Inc.
Can you also then provide an update on your outsourcing strategy? What’s some of the milestones that you met this quarter and what do you expect over the next three or six months?
Lavi A. Lev
Yeah. We are meeting all of our goals and some of them are ahead of our schedule a little bit. We said that we will start this quarter drop shipping diamonds from Asia; we did that. And, we are comfortably on our plan to outsource at least 80% so far of our manufacturing capabilities of Asia by Q4 this year. We’re very comfortable with that.
Patrick Ho – Stifel Nicolaus & Company, Inc.
So basically everything remains on track?
Lavi A. Lev
Oh yeah.
Patrick Ho – Stifel Nicolaus & Company, Inc.
Okay. A more strategic question in terms of your customer base and the target markets you’re going to be focused on going forward. It sounds like the majority of your orders came from your existing customer base which obviously was pretty strong. What are some of the strategic initiatives you’re going to do to expand off of this existing customer base? How are you going to convince new customers to take your new products? And I guess importantly, the test environment always being competitive, what are you going to take on the pricing front to get new market share?
Lavi A. Lev
So in general the main focus that we have is obviously in Asia when we already announced last quarter that we are increasing our headcount there to support the growing consumer market. So, this is from a geography point of view. The main area that we’re going to hit on is obviously the cost of test both diamond, ASL and sapphire are correspondingly in their areas we believe provide the best cost of test for customers and perspective customers and we are going to continue to present those solutions to them. You know that this quarter obviously we had most of the growth was with existing customers. The fact that we had healthy business this quarter was very rewarding for us. This quarter was really bad for most companies and economies. Obviously, the larger volume increase you get from existing customers who are already comfortable with you and they have the infrastructure associated with your machines and they tend to buy more machines, new customers tend to buy less. But, the short answer for your question is Asia focus and cost of test reduction for customers for diamond, ASL and sapphire.
Patrick Ho – Stifel Nicolaus & Company, Inc.
Alright. And a final question for me, can you provide a little bit of a breakdown or some qualitative breakdown between products and services for your orders? Because typically, isn’t the January quarter tilted somewhat more to service renewals?
Lavi A. Lev
For the whole year it is roughly the ratio of 75 to 25%.
Patrick Ho – Stifel Nicolaus & Company, Inc.
Okay. What about this current quarter? Is the ratio a little bit different?
Kevin C. Eichler
We don’t
Okay. What about this current quarter? Is the ratio a little bit different?
Kevin C. Eichler
We don’t get in to the bookings detail or the orders detail by a quarter-by-quarter basis.
Operator
Your next question comes from the line of Satya Kumar of Credit Suisse. Please proceed.
Analyst for Satya Kumar – Credit Suisse
The question I have is regarding can you talk about the out of market and your participation in that. I assume one of your products for the ASL [inaudible] RF you are very strong in the ASL gateway. So, I just want to find your outlook for opportunity for Credence and you’re position in this?
Lavi A. Lev
So, the RF market is a market that is growing pretty rapidly. We have in the ASL, as you said and also in diamond, D40RF which both of them are pretty sizable opportunities for us. We think that roughly in the diamond space it’s about something close to, I’m not really accurate here, anywhere between $400 to $500 million, if I’m not mistaken but I don’t have my notes with me here so maybe I’ll just quantify. Due to the fact that everything is now starting to integrate into one chip and most of those to systems that are wirelessly connected with something we see the RF being deployed into the broad range of where our testers are deployed especially in the ASL [inaudible] and the diamond D40RF when we find a lot of interest with customers to use those testers.
Analyst for Satya Kumar – Credit Suisse
Okay. Another thing is you have about, what I think 17%, that’s what you mentioned as the OSAT percent of revenues. How do you see an increase in that as you keep getting solid traction with your existing customers?
Lavi A. Lev
Well, the figure that you are quoting here is the overall for all of Credence products. OSAT are very important target for us for all of our testers, diamond is starting to get quite a lot of traction there, ASL is the number one tester in Taiwan already and sapphire is starting to get already some traction. OSAT is our critical, critical target for all of us in the ATE industry as people are starting to outsource their test operations.
Operator
Your next question comes from the line of Nick Tishchenko of Global Crown Capital. Please proceed.
Nickolay Tishchenko – Global Crown Capital
I have a couple of questions. During prepared remarks you mentioned couple of times magic words capacity expansion. Would you please liberate where this is happening, what applications are driving this capacity expansion and what type of customers you are talking about here.
Lavi A. Lev
The application expansion is mainly in mixed signal SOCs when it comes to diamond and [inaudible] related applications when it comes to ASL and actually also power management when it comes to ASL.
Nickolay Tishchenko – Global Crown Capital
And the locations of these customers?
Lavi A. Lev
One of them was in the diamond space it was North America fabless customer and Japanese IDM customer and the rest in ASL it was mainly in Taiwan a fabless company and OSAT.
Operator
Your next question is a follow up from the line of Chris Blansett of JP Morgan. Please proceed.
Christopher Blansett – J. P. Morgan
I’m trying to kind of understand that outlook here a little better. So, when you look at your guidance, how are you looking at the different weights of demand you’re seeing from the OSATs versus the IDMs? Any kind of change on the outlook there?
Lavi A. Lev
We see more traction with the OSAT as we are starting to focus on Asia more and more and again, the general trend of people trying to reduce the cost of test but also [inaudible] OSAT. But, in diamond we are roughly targeting about 70% of our business will come from OSAT by the end of the year. With ASL we’re trying to – the OSAT is highly populated already with ASLs and we’re trying to get roughly 50% of the revenue of ASL to come from OSAT.
Christopher Blansett – J. P. Morgan
Right. Now, when you look at your equipment in the field, what’s an idea of the utilization rate you’re seeing on that equipment? And, if there’s a difference between the IDMs versus the OSATs?
Lavi A. Lev
The utilization rate, the number that we normally have is from the OSATs and last quarter it was slightly lower, it’s about 70 to 75% or so. It was a slow quarter for everybody.
Christopher Blansett – J. P. Morgan
Okay. Last question here for me is how did the orders trend for the quarter? Was it more back end loaded or was it pretty linear?
Lavi A. Lev
Each quarter is very different. Some quarters are – this current quarter that we’re in was pretty active already, the very beginning of the quarter, some quarters you just hold on to your seat and the business comes in the last two weeks of the quarter. It’s kind of nerve racking and then there’s anywhere in between. I mean, there’s nothing that can characterize the nature of the business.
Operator
(Operator Instructions) Your next question is a follow up from the line of Patrick Ho of Stifel Nicolaus. Please proceed.
Patrick Ho – Stifel Nicolaus & Company, Inc.
Can you tell me what the level of turns you had this past quarter and what your outlook is going forward?
Kevin C. Eichler
We don’t go into turns. So, we don’t typically comment in the past and we’re not going to this quarter.
Operator
(Operator Instructions) I show there are no more audio questions at this time.
Brenda Ropoulos – Investor Relations
The Credence press release announcing the financial results for the first quarter fiscal 2008 was sent out by market wire and is posted on our website under investor relations prior to the opening of market today. If you do not have access to the Internet and would like a copy of the press release please contact me at 408-635-4309. A replay of the call will be provided on our website later today. You can also access an audio replay of the call by dialing 1-88-286-8010 in North America or 1-617-801-6888 internationally and use passcode 69122182. Replays from both sources will be available through April 3, 2008. I want to thank everyone for joining us today.
Operator
Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a great day.
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