Foolish Forecast: Will Credence Clear Water?

Tic-tac-toe, investors want to know: Can semiconductor-tester Credence Systems (Nasdaq: CMOS) keep up its recent profitable trend, and make it three in a row for positive (pro forma only) earnings when it reports its fiscal third-quarter 2006 numbers on Thursday?

What analysts say:

• Buy, sell, or waffle? A dozen analysts rate Credence a hold; two actually say "sell it."
• Revenues. On average, analysts are looking for 4% revenue growth to $115.8 million.
• Earnings. And a pro forma loss of $0.03 per share.

What management says:
Two weeks ago, Credence sharply slashed its sales guidance, saying it no longer expected to make $125 million to $128 million in revenue, but something closer to $109 million. Citing "lower capacity utilization rates," management announced that a 14% reduction in its work force will accompany the 16% reduction in its sales estimates.

Perversely, this may turn out to be good news for shareholders in the quarters going forward, because it appears the company is drawing water to give itself a "big bath." Risking redundancy (see below), Credence warned that it's going to incur a net loss this quarter, and further warned (note the "additionally" language here): "Additionally. the Company believes it may be required to take a material non-cash charge to reduce the carrying amount of goodwill and intangible assets by approximately $300 million to $400 million."

Looks to this Fool like Credence is going to try and push an awful lot of non-cash charges into what was already shaping up to be a pretty lousy quarter (hence, the big bath), making future quarters' results look all the brighter for the charges' absence.

What management does:
Did you notice the "parenthetical" in the first paragraph of this column? Here's where we explain it: Data providers that track how well a firm does in relation to analyst estimates necessarily have to use the same standards the analysts put forward. In the case of Credence, that's a standard of "pro forma" profits -- because the company doesn't seem capable of earning any of the straight GAAP variety. As you can see reflected in the chart below, it has grown its gross margin and compressed the negativity of its operating and net margins for three quarters running.

But that doesn't change the fact that it has only netted a GAAP quarterly profit once (in April 2004) in the last five years.

One Fool says:
As you can probably tell from the above, I'm not too impressed with Credence's recent performance. The announcement of the "big bath" -- something American Standard (NYSE: ASD) shareholders can aver that I'm not fond of -- doesn't improve my opinion of the company. But let's try and make some lemonade out of this apparently sour quarter and see whether we can glean what it might tell us about the chipmaking industry in general.

Yesterday, we discussed Applied Materials (Nasdaq: AMAT), and its CEO's recent reticence about his earlier belief that demand was picking up among chipmakers. This week, we're likely to hear Credence tell of a slowdown in demand for testing of chips as well. Put the two together, and it's starting to look like the semiconductor industry is in for continued tough times.

Competitors:

• Agilent (NYSE: A)
• Teradyne (NYSE: TER)

Customers:

• AMD (NYSE: AMD)
• Intel (Nasdaq: INTC)

Read more about "big bath" accounting -- and why we aren't overly fond of it -- in "More Earnings Shenanigans."

Intel is a Motley Fool Inside Value recommendation. Are you looking for irresistible values? Check out Philip Durell's latest value picks by taking a 30-day free trial to Inside Value .

Fool contributor Rich Smith owns shares of Intel. The Fool has an ironclad disclosure policy.