FSI International, Inc. F3Q08 (Qtr End 05/31/08) Earnings Call Transcript

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 |  About: FSI International, Inc. (FSII)
by: SA Transcripts

FSI International, Inc. (NASDAQ:FSII)

F3Q08 Earnings Call

June 24, 2008 4:30 pm ET

Executives

Donald Mitchell – Chief Executive Officer

Patricia Hollister – Chief Financial Officer

Benno Sand – Executive Vice President, Business Development and Investor Relations

Analysts

Christian Schwab – Craig Hallum Capital group

Eric Appell - Appell Capital Management

Operator

Welcome to the FSI International Third Quarter Fiscal 2008 Financial Results Conference Call. (Operator Instructions) With us today is Benno Sand who will begin our call.

Benno Sand

With me today is Don Mitchell, Chief Executive Officer, and Pat Hollister, Chief Financial Officer. We will have a telephonic replay of this conference call available for the next several days. That phone number is 866-490-5922. Investors also have an opportunity to listen to the conference call over the internet through CCBN’s individual investor center. A webcast replay of this call will be available shortly after the call is completed and remains available for 30 days.

In compliance with Regulation FD, we have provided advance notice of this call, and the call is publicly available. Under the Securities Reform Act Safe Harbor provision, we will be making forward-looking statements during the call including expected fourth quarter fiscal 2008 financial performance.

Actual results may differ materially from those provided in the forward-looking statements. As you know, these statements involve various risks and uncertainties. Please refer to our press release from this afternoon and to our recently filed SEC documents, including the latest 10-K annual report and 10-Q quarterly report in which we discuss risk factors that could affect these forward-looking statements.

To begin the call, Don will summarize of third quarter performance, discuss current industry conditions, and review recent accomplishments. Pat will then provide a more detailed review of third quarter financial results and fourth quarter expectations. We will all be available for questions at the end of the call.

Now let me turn the call over to Don.

Don Mitchell

We continue to operate in an environment where it is difficult to forecast the timing of customer orders and deliveries. As a result of order delays from several customers, our third quarter order level came in below the guidance we had previously provided. However, on the technology introduction and acceptance front, we continue to make good progress.

Net orders for the third quarter were $16 million, which was below the guidance we gave on our March conference call. However, during the quarter we generated $1.7 million in cash from operations. We shipped an Orion single wafer wet cleaning system to a major US semiconductor manufacturer, and we delivered our first Zeta 200-mm system incorporating our proven 300-mm ViPR technology.

Third quarter sales were $20.3 million, slightly below our $21 to $24 million guidance, as compared to $25.2 million for the same period in fiscal 2007. The year-over-year revenue decrease occurred across all product lines reflecting the current weak order environment.

Our net loss for the quarter was $1.4 million, or $0.05 per share. This compares with a net loss of $5.6 million, or $0.19 per share in the third quarter of fiscal 2007. The 2007 third quarter net loss included a $500,000 or $0.02 per share asset impairment charge. Third quarter shipments were $20.5 million, as compared to $20.9 million for the same period in fiscal 2007. We entered the 2008 fourth quarter with $11.7 million of backlog and deferred revenue, and anticipate that the difficult order environment will last for another quarter. We anticipate fourth quarter orders of $18 to $21 million.

From an industry perspective, current macroeconomic conditions are having a dampening impact on 2008 semiconductor industry growth. Even though year over year semiconductor bit growth is forecasted by analysts to continue at a healthy pace and factory utilization remains near the 90% level, unit average selling prices remain under pressure for many device types. Recently a leading Gartner analyst increased the forecasted calendar 2008 semiconductor revenue growth from 3.4% to 4.6%, with other industry analysts in the 5% to 10% range.

In early June, at a semi-sponsored forum, several market research firms presented their longer-term outlook for semiconductor demand. The most optimistic analyst set the semiconductor compounded annual growth rate from 2007 through 2012 at 10%, while the least optimistic presenter was at approximately 5%. Even though most analysts appear to be aligned on unit volume assumptions, the key differentiator appeared to be the device ASP assumptions. We remain optimistic that the severe decline in calendar ’08 capital spending will result in a tightening of the supply-demand imbalance and lead to improving ASP as 2008 comes to an end and we enter 2009.

Analysts continue to have a mixed view on calendar 2008 forecasted equipment spending as the anticipated recovery in the memory space is delayed. Gartner is forecasting calendar ’08 capital spending to decrease 15-22% from the ’07 level, while other analysts are forecasting a decline of as much as 30%. Gartner is forecasting a 2009 recovery with capital spending growth of between 4% and 13%. It is still too difficult to predict the strength and timing of any recovery in equipment spending from customers in the segments we serve.

Bookings for the surface conditioning segment of the equipment industry have been bouncing along the bottom of the trough for the past 4 quarters. This is unprecedented over the past 10 years. Customers provide limited visibility on their capacity requirements when their unit pricing is under pressure. We remain optimistic based upon customer inputs that capital spending will begin a recovery cycle sometime in the second half in calendar 2008.

Now, I’ll provide a brief review of third quarter progress. If not for a customer-requested shipment delay near the end of the quarter and softer than anticipated spares and service requirements, we would have achieved our third quarter financial performance guidance. Once again, accounts receivable and inventory management enabled us to generate cash from operations for the quarter. During the quarter, we made incremental improvements to our Zeta ViPR process technology. We received initial orders and shipped the Zeta ViPR technology to customers in Korea, Japan, and Europe. These orders were received because we were able to demonstrate our ability to address critical advanced IT manufacturing costs and integration concerns during photo-resist stripping and silicide formation processes.

We are also seeing growing interest from 200-mm fabs seeking to upgrade their technology while lowering their manufacturing costs. In fact, the Korean customer order previously mentioned was for a 200-mm fab that is implanting the Zeta ViPR technology.

Recently we announced in a paper jointly presented by Hynix, Varian, Nanometrics, and FSI at the Seventeenth International Conference on Ion Implantation Technology that the Zeta Spray Cleaning System with ViPR technology was highlighted as a key step in the integration of ultra high-dose PLAD ion implantation. The ViPR process is uniquely capable of removing photo-resist hardened by exposure to high-dose ion bombardment without the surface damage and material loss caused by traditional techniques. The broader acceptance of the Zeta ViPR technology resulted from its ability to eliminate the ashing process from most photo-resist stripping sequences and to effectively remove residual metal following advanced silicide processes.

With photo-resist stripping, the unique chemical reactivity achieved by the Zeta ViPR process allows it to remove the photo-resist by wet chemical action alone for all but the most extreme in-plant conditions. Not only does this eliminate the time and cost associated with ashing, ViPR also eliminates asher-induced damage and dopant/material losses.

The metal stripping following the silicide process is that Zeta ViPR process removes unreacted metal without attacking the silicide. This technology has now been successfully qualified with logic, NAND, and NOR customers through the 32-nm node. In May, we shipped an ORION single wafer wet system to a major semiconductor manufacturer for the development of back-end-of-line cleaning capability for 32-nm integrated circuit manufacturing. Leading IC manufacturers are finding low-K materials and the metal film stacks used for the 32-nm devices are much more sensitive to wet cleaning than previous generations of back-end-of-line processes. FSI’s differentiated single wafer technology demonstrated highly efficient removal of etch and ash byproducts without altering the dielectric, changing metal film thickness, and avoiding corrosion. The tool has been installed, and it is now being process qualified, and we continue to see interest from other customers for this new product.

In addition to launching our ORION product, we remain focused on winning additional process tool record status with our top customers and expanding our presence at memory device manufacturers. Now, I’d like to turn the call over to Pat for a detailed review of our fiscal 2008 third quarter financial results and to provide our expectations for the fourth quarter of fiscal 2008.

Pat Hollister

International customers represented 69% of orders in the third quarter of fiscal 2008 as compared to 68% of orders in the prior year comparable period. Year to date, international customers accounted for 70% of all orders as compared to 68% for the first nine months of fiscal 2007. International customers represented 70% of sales in the third quarter of fiscal 2008 as compared to 75% of sales in the prior year comparable period. Year-to-date, international customers accounted for 76% of all sales as compared to 68% for the fiscal 2007 comparable period.

Our gross profit margins will fluctuate from quarter to quarter and year to year depending on the international-domestic sales mix and product mix. Other factors that impact gross margins are our manufacturing capacity utilization and the competitive pricing environment. Third quarter gross margins were 51.5% as compared to 37.2% in the prior year comparable period and 47.7% last quarter.

The increase in the gross profit margin percentage for the 2008 third quarter as compared to the prior year third quarter was due primarily to product mix. The fiscal 2008 quarter-over-quarter improvement was primarily due to product and regional mix.

SG&A expenses were $7.4 million in the third quarter of 2008 as compared to $8.6 million in the prior year comparable period and $6.9 million last quarter. The decrease from the prior year period related to the cost reductions implemented in the second half of fiscal 2007. The increase from last quarter resulted from a reduction in the utilization of our service floor personnel as customers managed their operating expense levels.

Third quarter ER&D expenses were $4.7 million as compared to $6.1 million in the prior year third quarter and $4.8 million last quarter. The decrease from the prior year period related to cost reductions. The majority of our ER&D resources are focused on broadening the applications capabilities and supporting demonstrations and evaluations for our flagship products.

Third quarter interest and other income was $130,000 of income as compared to $310,000 of expense in the prior year comparable period. The third quarter fiscal 2007 net expense included net charges related to the mFSI transaction of $488,000 and investment interest and other income of $178,000.

Now, I will briefly discuss the changes in key balance sheet items from the end of fiscal 2007 to the end of the third quarter of fiscal 2008. Cash, restricted cash, and marketable securities represented $25.2 million of our total assets at the end of the third quarter as compared to $24.5 million at the end of fiscal 2007.

Our investment portfolio at the end of the third quarter included approximately $8.3 million at par of auction-rate securities, which are investments with contractual maturities between 5 to 35 years. These securities are classified as long term as they are not trading and conditions in the debt markets have reduced the likelihood that these securities will successfully auction in the next 12 months. During the third quarter, we recorded based upon evaluation model we utilized $400,000 temporary impairment of these investments bringing the net value to $7.9 million. The majority of the auction-rate securities held by us are backed by student loans and are guaranteed by the United States Federal Department of Education. The remaining portion relates t o manufactured housing and is collateralized by the principal housing contract trust associated with the related loans and are insured by third parties.

During the last 90 days, of the original $1.5 million of manufactured housing auction-rate securities, $200,000 has been redeemed. In addition, all auction-rate securities held by us are rated by the major independent rating agencies as either AAA or Aaa. We determined that no permanent impairment losses existed as of May 31, 2008. However, if the issuer of the issuer of the auction-rate securities is unable to successfully close due to auction or does not redeem the auction-rate securities, or the United States Government fails to support its guarantee of obligation, we may be required to adjust the carrying value of the auction rate securities and record additional impairment changes in future periods which could materially affect the results of operations and financial condition.

The company’s net accounts receivable decreased to $15.9 million at the end of the third quarter as compared to $17.6 million at the prior fiscal year end. We remain focused on managing our accounts receivable to minimize the impact on our overall cash position.

Our net inventories decreased to $26.6 million at the end of the third quarter as compared to $29.6 million at the end of fiscal ’07, but represented a modest increase from the $24.3 million at the end of last quarter, primarily related to a customer-requested shipment delay and the placement of the ORION evaluation system. Given our current backlog and deferred revenue at the end of the third quarter and anticipated fourth quarter orders, we have limited visibility with respect to the fourth quarter revenues. As in the past quarters, included in our revenue guidance are several systems for which we need to book orders and ship during the quarter. Also, we have orders that will require customer acceptance to be included in revenue.

With that backdrop, we expect fourth quarter orders to be between $18 million and $21 million as compared to $16 million in third quarter. Given the cautious spending plans of our customers, we anticipate only technology and single-unit capacity orders during the fourth quarter. We expect fourth quarter revenues to be flat between $18 million and $21 million, as compared to the $20.3 million third quarter level. Keep in mind that a portion of the revenues are subject to obtaining new orders and timely acceptance from our customers for certain orders and that orders are subject to cancellation.

Gross profit margins are expected to be between 45% and 47% of revenues, reflecting a less favourable product and geographic mix. We expect SG&A expenses to be flat, between $7.3 million to $7.5 million as compared to $7.4 million in the third quarter. We expect fourth quarter ER&D expenses to remain in the $4.7 million to $4.9 million range. We continue to invest in new application and product development programs and provide support for product evaluations at customer locations along with lab demos.

Interest income should come in between $75,000 to $125,000 given our current cash position and anticipated interest rates. Assuming we can achieve the revenue, gross margin, and operating expense levels, we expect to report a net loss of $1.5 to $2.5 million for the fourth quarter of 2008.

We anticipate fourth quarter capital expenditures to be less than $250,000, and the fourth quarter depreciation and amortization expense to be between $1 million and $1.1 million. At the expected revenue and expense run-rate and given our commitment to more aggressively place Zeta and ORION tools with customers for evaluation, we anticipate using approximately $3 to $4 million of cash in the fourth quarter of fiscal 2008.

In summary, we are managing our expense levels based upon the assumptions that the industry spending for surface conditioning products will not deteriorate from the current $140 to $150 million monthly run-rate. In addition, we are building Zeta and ORION tools so that we can take advantage of sale and evaluation tool placement opportunities. If for any reason we determine that our assumptions are incorrect, we will manage our investments and spending to ensure that we are in a strong financial position when the industry recovery occurs.

Thank you. Now, Don, Benno, and I will take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Christian Schwab with Craig Hallum Capital group.

Christian Schwab – Craig Hallum Capital Group

The ORION product line, how did the evaluation go that you mentioned last quarter?

Benno Sand

The unit just shipped last quarter, and it’s just going through process qualification right now.

Christian Schwab – Craig Hallum Capital Group

So, we’re still excited about that product line, so maybe when the cycle improves, whether it will be sometime in 2009, we’ll have a new product set that could help drive growth?

Benno Sand

Yes, that’s the plan Christian. Our intention is to place several ORIONs between now and the end of the calendar year.

Christian Schwab – Craig Hallum Capital Group

We’ve got one out there, so several meaning one more or two?

Benno Sand

Well, actually this is our second one. This is the first prototyped product. The first was our beta unit, if you will, that’s generating data from the first customer. It was shipped a year ago. Now we have our final configuration product that we shipped this last quarter. We expect to ship another one this coming quarter.

Christian Schwab – Craig Hallum Capital Group

Perfect! When I crunch through the numbers, if I take a lower revenue stream towards the lower end of the range of $18 to $19 million, I get you losing a lot more than money than $2.5 million. Am I doing that wrong?

Benno Sand

Christian, no. If we come in at the low end of the range which we are trying avoid obviously, but as Don, I think, mentioned in the prepared comments that visibility on orders is less than clear at this point, and as in the past couple of quarters, we’ve got to book some orders and ship products and recognize revenue through acceptance on a couple of systems. The visibility isn’t really good, but yes if we think we are going to come in at the lower end of that range, then we will have to control and manage our expenses to a lower level than the guidance that we gave.

Christian Schwab – Craig Hallum Capital Group

Okay. So, if you come in $18 to $19 million revenues, then you will spend less money in SG&A and R&D to get there is what you are saying.

Benno Sand

That is the plan.

Operator

Our next question comes from Eric Appell with Appell Capital Management.

Eric Appell - Appell Capital Management

I have a question; it’s sort of a broad-based question. I’ve been asking this question to technology companies in our portfolio. We’ve got dozens of technology companies that are trading at far less than one times revenues, decent amount of cash but not a lot, and I’m curious, from a management’s perspective, how do you increase shareholder value at this point? Do we wait for the cycle to turn, are there other things that you could do to actually maximize shareholder value in a shorter period of time? Are you thinking along those lines? What are your thoughts?

Donald Mitchell

Yeah. We believe that we have to continue to make certain investments here at the bottom of the cycle. We are betting a lot on the success we’ve had with our Zeta ViPR technology at multiple customers, at least getting initial wins for specific cleaning applications, for developing the ORION product in the west, the fastest growing segment of the market, and so when industry conditions improve, the strategy is that we will grow at a faster rate than the industry, and we will start to see multiple-unit orders from customers, and that’s the way we create shareholder value over the long term. Obviously, given today’s prices, if we went out and aggressively shopped the company, hopefully we can get a valuation that’s higher than the current market value, but we don’t think that’s in the best interest of the shareholders long term.

Eric Appell - Appell Capital Management

Okay, but how do you measure that, because you spend money on research and development, you get ahead of the competition, why not seriously consider being aggressive in trying to find a buyer who wants to participate in growth that actually could consolidate the SG&A and enhance their earnings opportunity?

Donald Mitchell

It’s all based on the growth rate assumption in the Zeta product area and the ORION product area. If we don’t think we can grow at a faster rate than the market, then you’re correct. It would probably be best to look for a merger partner at this point and at this valuation.

Eric Appell - Appell Capital Management

So, it doesn’t make sense at this juncture given the larger opportunity and scope forwards as opposed to what actually you can do currently to actually sell yourself out to a competitor based on what you foresee as the potential market place for your products.

Donald Mitchell

That’s what we believe. Our board evaluates that at each quarterly meeting any options that we have in front of us, and the conclusion we’ve agreed to is that we believe we can generate more shareholder value by revenue growth than we can by selling out today.

Eric Appell - Appell Capital Management

If you were approached, obviously I guess the answer is usually the same. If you were approached, you’d probably look at the opportunity, but thus far, have you been approached by a competitor?

Donald Mitchell

I can’t answer that question. What I can tell you is that clearly our board has a fiduciary responsibility to evaluate any offer that would come in to the company.

Operator

I have no further questions, so I will turn the call back over to management.

Don Mitchell

Thank you. I’d like to thank everyone for participating on the call, and Benno and I look forward to seeing many of you during SEMICON/West to be held July 14-16 at Moscone Center in San Frisco. Thanks again.

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