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Aehr Test Systems (NASDAQ:AEHR)

F1Q09 Earnings Call

September 25, 2008 5:00 pm ET

Executives

Tricia Ross - Financial Relations Board

Gary Larson - Vice President and Chief Financial Officer

Rhea Posedel - Chairman and Chief Executive Officer

Analysts

Vernon Essi - Needham & Company

Jeffrey Scott - Scott Asset Management

Joey Mcurgie – State of Wisconsin Investment Board

Robert Moses - RGM Capital

Operator

Welcome everyone to the Aehr Systems first quarter 2009 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host Trisha Ross of Financial Relations Board.

Tricia Ross

Good afternoon and thanks for joining us to discuss Aehr Test Systems results for the first quarter of fiscal 2009. By now you should have all received a copy of today’s press release. If not you can call my office at 213-486-6540 and we will get one to you right away.

With us today from Aehr Test are Rhea Posedel, Chairman and Chief Executive Officer and Gary Larson, Vice President of Finance and Chief Financial Officer. Management will review its operating performance for the quarter before opening the call to your questions.

I would now like to turn the call over to Gary Larson.

Gary Larson

Before we begin I would like to make a few comments about forward-looking statements. Please be advised that during the course of our discussion today we may make forward-looking statements that involve risks and uncertainties relating to projections regarding industry growth and customer demand for Aehr Test products as well as projections regarding Aehr Test’s future financial performance. Actual results may differ materially from projected results and should not be considered as an indication of future performance.

These risks and uncertainties include without limitation economic conditions in Asia and elsewhere, world events; acceptance by customers of our Fox, ABTS, MTX, MAX, and DiePak technologies and conversion of quote activity to purchase orders and acceptance by customers of products shipped upon receipt of a purchase order; the ability of new products to meet customer needs or performance described; the company’s development and manufacture of a commercially successful wafer level test and burning system; and the potential emergence of alternative technologies, each of which could adversely affect demand for Aehr Test products in fiscal year 2009.

We refer you to our most recent 10-K report and other reports filed from time to time with the US Securities and Exchange Commission for a more detailed description of the risks facing our business and factors that could cause actual results to differ materially from projected results.

The company disclaims any obligation to update information contained in any forward-looking statements to reflect events or circumstances occurring after the date of this conference call.

Now I would like to introduce our chairman and CEO Rhea Posedel.

Rhea Posedel

We are pleased to report that we had a solid first quarter to start fiscal 2009 on a high note. Revenue was $9.7 million up 27% over the same quarter of the prior year. Most importantly, we did an excellent job in managing our cost to deliver higher year-over-year operating profits. Our operating profit increased to $1.4 million, an increase of 89% over the same quarter of the prior year. It was a pretty good first quarter considering the weakness in our industry.

We had a number of accomplishments since our last conference call. Our major accomplishment last quarter is that we designed and shipped a record number of Fox-1 WaferPak contactors. A special thanks to our design and manufacturing team for making this happen. These WaferPaks’ are a key part of the enabling technologies that allows the Fox-1 system to test thousands of die in a single touchdown.

Last quarter we shipped new WaferPak designs for contacting over 2,500 die per wafer, which we believe could be an industry high water mark. Our challenge will be to stay on this trajectory so we can keep up with customer road maps showing the number of die increasing to over 3,000 die per wafer near term. We expect shipments of WaferPaks’ to grow this fiscal year to support our increasing installed base of Fox-1 and Fox-15 full-wafered test and burn-in systems. Additionally, since a new custom designed WaferPak is required for each new design device type, we believe WaferPak will provide a significant revenue stream over the long-term.

Another highlight was receiving a significant follow on order from our Fox-1 system customer. On September 11 we announced receiving over $7 million in orders for our Fox-1 WaferPaks’ and system upgrades. Our customer is upgrading most of their remaining 200-millimeter Fox-1 systems to 300-millimeter configurations to support their new 300-millimeter FAB capacity ramp. We expect our customer to start adding additional Fox-1 system capacity in the first half of calendar year 2009, which is the second half of our fiscal year.

Now that our Fox-1 systems have been used in high volume manufacturing for more than a year we believe our customer has significantly reduced test costs and capital expenditures by using our Fox-1. This is reflected by their continuing commitment to the Fox-1 system as they ramp capacity. We continue to be encouraged by the level of interest and activity in our Fox products from other IC manufacturers, but we believe the slow down in the semi-conductor industry has delayed capital spending and our ability to penetrate new accounts. Our management team and sales force remains positive and is focused on adding new Fox accounts this fiscal year.

We have seen a slow-down in sales of our core max and MTX parallel test and burn in products for packaged ICs during this industry contraction; however, we remain positive about the market opportunities for our core products and will aggressively invest in R&D this fiscal year to grow market share.

We are planning to introduce a family of products in our core markets using our new ABTS general-purpose test electronics. We believe we can grow our core business by targeting the growing market segments for high power logic burn and massively parallel testers for DRAMs and flash memory. These are significant market segments that we currently don’t competitively address.

In July we announced receiving our initial ABTS L-36 system order from integrated service technology or IST, a leading Taiwan test house. This is our first ABTS system roll out and it’s targeting test and burn in of a wide range of logic and mixed signal devices which we believe is ideal for a test house. Our ABTS platform offers significant competitive advantages in cost of ownership and system flexibility to test a wide range of devices. Additionally the innovative ABTS architecture offers significant footprint and energy savings over competitive products. The energy savings will be attractive to our customers who are increasingly interested in green products.

We are seeing increased coating activity in our new ATBS products and expect to announce new orders this fiscal year.

In closing, with the strength of our FOX and new ABTS products we are positive on the long-term growth prospects and we are encouraged that fiscal 2009 has gotten off to a good start.

Now I would like to turn the call over to Gary and he will add some color on the first quarter financials.

Gary Larson

Net sales were $9.7 million in the first quarter of fiscal 2009, an increase of 27% from $7.7 million in the first quarter of fiscal 2008. In the first quarter of 2009 FOX-1 WaferPak contactors represented the large majority of our net sales. Gross margin was 51% for the first quarter, compared with 55% in the year ago quarter. The declining gross margin reflects the increased costs associated with ramping up production of WaferPaks’. Given the current mix of products we continue to believe that our typical gross margin will be about 50%. SG&A was $2.1 million in the first quarter compared with $1.8 million in the prior year period. The increase in SG&A dollars is primarily attributable to an increase in head count as we added sales and support staff to help drive the growth in our business.

First quarter 2009 R&D expense was $1.5 million, slightly lower than $1.6 million in the first quarter of last year. R&D spending varies from quarter to quarter depending on the level of development of new products. We would expect R&D spending to increase somewhat from this level.

Pre-tax income was $1.4 million in the first quarter of fiscal 2009, an increase of 78% from the $794,000.00 in pre-tax income in the first quarter of last year. The significant increase in pre-tax income is attributable to our effective expense management while continuing to scale the business and drive revenue growth. Our effective tax rate was 39% in the first quarter compared to 2% in the first quarter last year. As we indicated on our last call, on a going forward basis we expect to accrue tax expense at close to the statutory rates for the countries we generate income in, namely the United States, Japan, and Germany. This rate is expected to be in the upper 30% to 40% range.

Our net income for the first quarter was $865,000.00 or $0.10 per diluted share compared with net income of $779,000.00 or $0.09 per diluted share a year ago. Excluding stock compensation expense in these periods pro forma net income in the first quarter of 2009 was $1 million or $0.12 per diluted share compared to $1 million or $0.12 per diluted share in the same period of the prior year.

Our cash, cash equivalents, and short-term investments stood at $9.5 million at August 31. 2008. This is down from the end of last quarter as we had a significant investment required in accounts receivable. Our inventory was $10.8 million at August 31. 2008, a slight increase from the end of the prior quarter.

Shareholders equity increased to $38.9 million or $4.63 per share outstanding at August 31, 2008 and we continue to have no outstanding debt. Based on expected shipment schedules for FOX products, we believe our net sales in the second quarter of fiscal 2009 will be higher on both the sequential quarter and year-over-year basis.

We are now ready to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Vernon Essi of Needham & Company.

Vernon Essi - Needham & Company

Rhea, I was wondering if you could comment, we are hearing indications that of course the budgets are potentially slipping in some of your year-end customers. Can you share with us any anecdotal color you might have had over the last couple of weeks and what you’ve been hearing from your customers?

Rhea Posedel

As I mentioned, we saw that the opportunities for our core products, our MAX and MTX have been reduced during this past slow down in the industry. But I think the industry not adding capacity type systems, but we are seeing activity for new products in terms of the FOX and the ABTS and these are for new requirements, so I think we haven’t seen any change in the last few weeks or last few months that has gotten us concerned about the industry being in a worse state than it was prior to that, so I think we’re cautiously optimistic that in 2009 we will see increased orders for some of our core products along with FOX products.

Vernon Essi - Needham & Company

Also, I mean I appreciate your market share. You are in a situation where you will be gaining market share, so I’m sort of trying to take it to the 30,000-foot view here and I know that it’s very difficult with —.

Rhea Posedel

Well what I read is pretty much here, that I would say the DRAM business and the NAN flash business seems to be hit the hardest in terms of them adding FAB capacity and things of that sort.

Vernon Essi - Needham & Company

Right of course the challenge is always trying to figure out how hard. Then also, just to switch gears here, Gary I was wondering just on the balance sheet, I know you went through some of the items there, but could you walk us through the build up in receivables and sort of how that’s going to be taken care of over the next couple quarters?

Gary Larson

The receivables balance has actually been fluctuating quite a bit. Our current receivables level is just under $17 million, up from $11 million at the end of the fiscal year. But if you looked a quarter back it was actually a little higher than that, it was $17 million in change, so as we have noted in our queues we do have one customer that is doing a significant portion of our business and so what we’re seeing is the receivables levels do vary depending on the particular collection activities with that customer. So, we have been at a higher level than we are right now, we were successful in bringing that down at the end of the fiscal year and we would anticipate being able to bring it down a little further also now.

Operator

Your next question comes from Jeffrey Scott of Scott Asset Management.

Jeffrey Scott - Scott Asset Management

On the last call you said that the most likely next new customer would be for a FOX-15. Is that still your thinking?

Gary Larson

That’s correct.

Jeffrey Scott - Scott Asset Management

Rather than a FOX-1, okay.

Gary Larson

But it could be either. I think there is some potential FOX-1 customers from either Taiwan or China for, these would be contract test houses that might be interested, so there is a possibility we could either over the next few months or quarters book a FOX-1 or a FOX-15.

Jeffrey Scott - Scott Asset Management

Okay the decrease in R&D Gary, was that salaries moving from R&D to cost of goods sold as they did less R&D and more production work?

Gary Larson

Really the big fluctuation that we see in R&D is historically in the materials area. So as the level of development changes from one quarter to the next you’ll see higher levels of engineering materials. As a product gets closer to completion and commercialization then you’ll see some of those costs instead of being written off as engineering expenses you’ll see some of them go into inventory just prior to shipment of those systems, so that’s really where you’re seeing most of the variability. You’re not really seeing any swings in staffing or anything like that.

Jeffrey Scott - Scott Asset Management

At year-end you decided that you would account for a portion of the tax valuation allowance rather than all of it and it was going to be on a quarterly review. You did not decrease the evaluation allowance at the end of this quarter. What was the reason for that view?

Gary Larson

I don’t think we said we were going to be evaluating in each quarter, I think we said we would be evaluating it over time, but there wasn’t any commitment that that would be done quarterly.

Jeffrey Scott - Scott Asset Management

I thought the 10-K said that it would be a quarterly review. Am I —?

Gary Larson

Again, that was not our intent to have a quarterly review. Periodically we will do a review and as appropriate we will make those changes to the deferred tax asset.

Jeffrey Scott - Scott Asset Management

Is there anything that the semi conductor test consortium is doing with their open star software open standards which would in any way impact your ability to compete in new markets?

Rhea Posedel

That’s a good question Jeff. I mean that consortia was basically started by Intel pushing Von test to have an open architecture on their testers that they purchased and I think that was done, for the generation of tester that was sold to Intel, but I as far as I know that consortium is going away. I don’t think it was successful so I don’t think it is anything we need to worry about.

Jeffrey Scott - Scott Asset Management

So it is not causing any problems with potential customers that…

Rhea Posedel

I mean that whole strategy, it just hasn’t materialized. I think Intel pushed it on the Von test for the generation of testers that they bought for their microprocessor, but I don’t think it covers any other product in the industry and it’s not going to affect us or really anyone else anymore. I think that whole consortium has been or will be disbanded.

Jeffrey Scott - Scott Asset Management

In the last conference call you suggested that revenue would be higher than a year ago and you came in about $2 million higher than a year ago. What happened during the course of the quarter that pushed it up so much, or were you just being unduly conservative three months ago?

Rhea Posedel

That’s a fair question. I think when I look back at a previous conference call, before I was preparing this conference call, I did mention that there was concern that we had a number of new wafer pack designs. As I mentioned, we’ve increased the dye count up to over 2,500 dye per wafer, so we were doing a little bit of maybe invention and development that I was a little bit cautious of and I think our development team and manufacturing team did a super job to design and manufacture these WaferPacs and hit our schedule, so I was —.

Jeffrey Scott - Scott Asset Management

If I gather what you’re saying, it was not a pull in of existing orders, it was not new customers, it was your ability to produce to an existing order that got it out the door in this quarter rather than next quarter.

Rhea Posedel

Existing orders, right. So they were able to execute and did a great job doing it.

Jeffrey Scott - Scott Asset Management

Progress on the ABTS, you sent a beta out there; it has now been accepted for production. What else do you think you need to do to that to broaden the appeal or are you there?

Rhea Posedel

The ABTS in our mind at an air test is a hardware/software platform that can be configured to produce a number of products, to go after a number of different markets. The first product that we sold was the ABTS low power logic system to IST, so we shipped them a prototype to evaluate it, they bought a production system; so what we need to do to expand that market now is to ship that production system so it’s accepted and they buy additional production systems.

What we talked about to grow the market further would be to roll out new products based on this ABTS platform of hardware where we go after different markets and one of them being massively parallel test for DRAMs and flash memories, another one is for high power logic, up to 75 watts per device; so these would be two new market opportunities and two new systems that would address these markets.

Jeffrey Scott - Scott Asset Management

How much new engineering is required to fully develop a machine for those markets?

Rhea Posedel

Not a huge amount because if you look at our systems, most of the engineering is developing the hardware, the printed circuit boards and pattern generators, the software. All of these systems really use the same boards, the same operation system, so it’s more a matter of configuring different ovens and different interfaces so we can interface to different burn in boards. So I would say it’s more incremental engineering, which tends to be more predictable than R&D type engineering. So the engineering efforts aren’t that significant to roll out these products.

Jeffrey Scott - Scott Asset Management

This was the first quarter when your e-soft was able to sell shares. Were any shares sold during that three-month period?

Gary Larson

You are right, this is the first time that diversification is allowed to the members of the e-soft plan. We announced in our first quarter the opportunity for people to diversify and some of them did take advantage of that and then we had during our second quarter to actually implement that diversification.

Jeffrey Scott - Scott Asset Management

So as I understand it no shares were actually sold in the first quarter, but they are available for sale in the second quarter.

Gary Larson

That’s correct.

Jeffrey Scott - Scott Asset Management

Does that take care of the entire for sale allotment for fiscal ’09 or will it more become available on a quarterly basis?

Gary Larson

No, it would just be once a year.

Operator

Your next question comes from Joy Mcurgie from the State of Wisconsin Investment Board.

Joey Mcurgie - State of Wisconsin Investment Board

You talked about the incremental market opportunities. Could you give us some quantification of, you know, how big the new market opportunities will be for you with the ABTS product?

Rhea Posedel

Yes that is a good question. I guess I would look at the overall market in a good year for package point burn in and parallel tests being around $200 million and I would expect the market for the logic segment and the memory segment to be about half of that; so probably around $60 million for memory and maybe $40 million for high power logic. Roughly it would give about $100 market opportunities for these two segments.

Joey Mcurgie - State of Wisconsin Investment Board

Then for the next quarter around, the incremental revenues, is that still coming from your largest customer or is that coming from something else?

Gary Larson

We don’t give guidance as far as which customers are included in the forward-looking guidance but I can tell you that in the quarter just ended the customer that we’ve been reporting continues to be a large contributor. Also, the order which was recently announced was also a follow on order from our FOX-1 customer.

Joey Mcurgie - State of Wisconsin Investment Board

I guess you already addressed the accounts receivable. You are expecting that to come down in the coming quarter?

Gary Larson

Yes we are.

Joey Mcurgie - State of Wisconsin Investment Board

Could you give us an idea of what the installed base now is of your FOX systems?

Gary Larson

Roughly around 125.

Operator

Your last question comes from Robert Moses of RGM Capital.

Robert Moses - RGM Capital

Gary in terms of cash rate and cash taxes, I think you were very specific about a 40% tax rate, so it shouldn’t be too surprising. Could you just talk to me about kind of the cash taxes, if you would pay on that versus what you are actually accruing on the P&L?

Gary Larson

Cash taxes, because we have substantial NOLs we wouldn’t expect to be paying cash taxes for some time.

Robert Moses - RGM Capital

Some time being years?

Gary Larson

Well again, that would be then trying to forecast what our business is going to be doing for the next years, but it is at least a year yes.

Robert Moses - RGM Capital

Okay so that would be just basically an add back in your cash flow statement in deferred tax assets.

Robert Moses - RGM Capital

Rhea you gave us some detail on detail on the ABTS and kind of the size that you expect. Would you expect to run into new competition? I remember kind of Ando and others in kind of the traditional max and MTX and as you are kind of moving up the technology chain and entering these new markets are you also potentially counting new competition or the same type of wafer that same type of burn in customers and competitions that you’ve had in the past?

Gary Larson

There is competition in that space. I think if we address the ABTS memory opportunity. This system allows us to go after the competitors in Asia, like the Ando competitor and others in Taiwan, so yes there will be competitors, but we believe our system offers advantages in cost of ownership and also a footprint in and capability. So we believe we are well positioned to address these competitors.

In terms of the high power logic system, there is a limited number of competitors in that arena, so we think we will have an easier chance in that area to gain market share.

Robert Moses - RGM Capital

You also have the capability to sell into your existing customer base the people that have bought kind of traditional packaged burn in systems or is it largely these new opportunities and new markets, new customers?

Gary Larson

I think it’s both. I think we would expect to sell our ABTS into our historic customers IETI. They are looking at the ABTS because of its capabilities and we would hope that they would purchase a system over the next three to six months for evaluation. But, I think the real take away on the ABTS is that it allows us to address a broader market that we haven’t been able to address before with the MTX and that allows us to configure the system to adapt to other competitive burn in boards, so it makes it very seamless to sell that system into automated factories that exist for other products.

Robert Moses - RGM Capital

You talked about the second half of the year. Just to kind of understand the mind set, I guess the WaferPacs’ continuing that certainly helped the first quarter and will help the second quarter. Hopefully that continues with the installed base that you have. Your hope is that kind of in the second half of your fiscal year that this large FOX-1 customer adds some capacity and do we think it’s also possible that we’ll actually get some ABTS revenue or do you think more orders for ABTS in the second half of the year?

Rhea Posedel

I think the key for us with the ABTS is to penetrate new accounts, so basically we would probably see more orders and more new accounts than revenue, although it’s possible that we can get some ABTS revenue if we can ship early enough and get acceptance. But, what investors should look for is new penetrations, new accounts and I think the volume shipments of ABTS products will come in the following fiscal year.

What I mentioned in terms of the FOX-1, I think the upside potential for us is that our FOX0-1 customer places additional orders in calendar 2009 and that’s what they’re telling us their ramp comes in that year, so if that happens we would see additional purchases for FOX-1 systems.

Robert Moses - RGM Capital

Okay and I think you mentioned either in a question or prepared remarks about a FOX-1 or FOX-15 I guess it was in the Q&A and think you reiterated that you had hoped to, in your fiscal ’09, this would be probably a contactor type of development order similar to other situations over the past three years?

Rhea Posedel

On the FOX-15, right now it looks like not the first customer, but the next customer for the FOX-15 more than likely will purchase a contactor for evaluation, but we would hope to finish that evaluation this fiscal year and book an order.

Operator

There are no further questions.

Rhea Posedel

I would like to thank you all for joining us this afternoon and we look forward to next quarters conference call.

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