Tic-tac-toe, investors want to know: When semiconductor tester Credence Systems (NASDAQ:CMOS) reports its Q4 and full-year 2006 earnings tomorrow afternoon, will this make for three quarters in a row of missing analyst projections? Or should we believe that Credence has turned the corner (if we define analysts' expectations as a "corner," that is)?

What analysts say:

  • Buy, sell, or waffle? A dozen analysts follow Credence, with one calling the stock a buy, nine more a hold, and two a sell.
  • Revenues. On average, analysts are looking for an 11% decline in quarterly sales to $107.8 million.
  • Earnings. A $0.02-per-share loss is predicted.

What management says:
Third-quarter 2006 was not at all kind to this company. As we advised in the Foolish Forecast preceding that report four months ago, "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," and so it did. In comparison to Q3 2005's $0.43-per-share loss, it stuffed into Q3 2006 a whopping $461 million worth of losses (more than twice the company's market cap at the time), including a $424 million goodwill writedown, $24 million to write down obsolete inventories, $2 million worth of restructuring charges, a million more for an impaired equity investment, two million more for stock options expensing, and to top it all off, another $4 million for unspecified "intangibles amortization."

I was wrong about one thing, however. Predicting that the third quarter's big bath would "mak[e] future quarters' results look all the brighter for the charges' absence" proved to be jumping the gun a bit. In giving its Q4 guidance, Credence advised that it still has $8 million to $10 million worth of charges to tack on, to account for the severance costs of its downsizing. After taking that into account, management predicts a GAAP loss of about $0.14 per share for tomorrow. (Reminder: The analyst estimates are pro forma, not GAAP numbers.)

What management does:
Last quarter's big bath didn't do much good for Credence's bottom line. In a single quarter, it managed to drive down its rolling net margin to negative triple digits; we'll be seeing these effects continue for three more quarters.

Margins %




























All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
Since the net margins are going to look lousy well into 2007, Fools would be better advised to focus on the upper lines of the income statement to see how Credence's business is really doing. Focus on the gross margin, for example, which -- although it dipped a bit last quarter -- generally seems to be trending upward. Focus on how dramatically the firm's downsizing has shrunk its operating loss, and is moving Credence closer and closer to breakeven on an operating basis. And focus on revenues -- they're expected to fall again tomorrow, but if the firm can find a way to turn that trend around and combine it with positive operating margins, it just might repeat its isolated success of the April 2004 quarter and actually earn a profit.


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

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Fool contributorRich Smithdoes not own shares of any company named above. The Fool's disclosure policy makes bath time lots of fun.