Good morning. Good afternoon, ladies and gentlemen, and welcome to the Besi's quarterly conference call and audio webcast to discuss the company's 2017 third quarter and nine-month results. The audio webcast is available on Besi's website, www.besi.com. Joining us today are Mr. Richard Blickman, Chief Executive Officer, and Mr. Cor ter Heurne, Senior Vice President, Finance. At this time, all participants are in listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. As a reminder, ladies and gentlemen, this conference is being recorded and cannot be reproduced in whole or in part without written permission from the company. I would now like to turn the call over to Mr. Richard Blickman. Go ahead, please, sir.
Thank you. Thank you all for joining us today. We will begin by making a few comments in connection with the press release we issued earlier, and then take questions. I would like to remind that some of the comments made during this call and some of the answers in response to your questions by management may contain forward-looking statements. Such statements may involve uncertainties and risks as described in the earnings release and other reports filed with the AFM. For today's call, we'd like to review the key highlights for our third quarter and nine months ended September 30, and update you on the market, strategic initiatives, and the outlook. First, some overall thoughts on the past quarter and nine months.
Besi's financial performance continued to improve in the third quarter, underscoring the strength and market position of our advanced packaging portfolio and the achievements of new benchmark levels of revenue and net income. For the quarter, revenue and net income reached EUR 159.3 million and EUR 52.9 million respectively, up 68.9% and 219% versus the third quarter last year. Similarly, for the nine months ended September 30, Besi's revenue and net income reached EUR 439.5 million and EUR 129.6 million respectively, up 55.7% and 167% versus the year-to-date period last year. The nine-month 2017 net income levels was almost double that recorded for the whole of 2016. Orders for semiconductor assembly equipment continued to develop positively in the third quarter, reflecting an uptrend which first commenced in the second half of last year.
Besi's orders grew strongly, reaching EUR 161.5 million in the third quarter and EUR 531.5 million for the first nine months of 2017, representing increases of 107% and 88.2% respectively versus the comparable periods of last year. In a quarter typically weaker than the second quarter, Q3 2017 orders actually grew sequentially by 24.1% versus the second quarter, primarily due to increased orders from Asian subcontractors for high-end computing and mobile applications and renewed capacity purchases by IDMs for advanced mobile applications. In general, our order growth this year has reflected market share gains as well as continued benefits from a new technology upgrade cycle, wherein customers are significantly building out their advanced packaging capacity for leading-edge smartphone, automotive, cloud server, memory, and computing applications. Market growth in 2017 has also been driven by new device introductions, many of which require new investments in assembly equipment.
Cash flow generation has also increased in 2017, with net cash and deposits at the end of the third quarter reaching EUR 165.4 million, a 25.4% increase versus the end of the third quarter last year, despite the return to shareholders of EUR 82.5 million so far this year in the form of dividends and share repurchases. The efficiency of Besi's operations has also improved this year. In the third quarter, gross margins and net margins reached new industry benchmark versus peers of 58.7% and 33.2% respectively. Similarly, gross margin and net margins rose to 57.4% and 29.5% respectively for the first nine months of this year. Enhanced margin levels reflect Besi's strong technology position, successful optimization of our Asian production strategy, and ongoing realization of cost control initiatives. With that, I'll turn the presentation over to Cor.
Okay. Thank you, Richard. Besi's 6.3% sequential revenue decline followed typical seasonal patterns and was within prior guidance of down 5%-15%. The strong year-over-year comparisons reflect the ongoing industry upturn, as well as increased market share in our addressable assembly equipment market. Besi revenue and order growth this year is also coming from increased customer demand for advanced packaging capacity from well-established process technologies, and not from emerging technologies such as Fan-Out Wafer Level processing or TCB. Per customer type, IDM and subcontractor orders represented 55% and 45%, respectively, of total Q3 '17 bookings, but were 69% and 31%, respectively, of Besi's total year-to-date '17 orders due to strong demand by IDMs and their respective supply chains this year for advanced packaging capacity.
Besi's gross margin of 58.7% in Q3 '17 increased by 1.4 points versus Q2 '17, despite the 6.3% sequential revenue decline and by 8.2 points versus Q3 '16. Continued gross margin improvement this year is primarily due to our market position and value proposition to customers, as well as production efficiencies realized from the successful scaling of our Asian production capacity. These favorable influences overcame a 9.1% average decline in the US dollar versus the euro since the start of 2017. Q3 '17 OpEx decreased by EUR 3.7 million, or 11% versus Q2 '17, and was slightly better than prior guidance of a 5%-10% decline. As a percentage of revenue, OpEx decreased to 19% versus 20% last quarter and 30% last year.
Baseline OpEx in Q3 '17 decreased by 8.8% sequentially to EUR 27 million and has stayed within a range of EUR 25 million-EUR 30 million this year, despite Besi's significant revenue growth. Operating expense growth in the Q3 and nine-month year-over-year comparisons was primarily associated with higher personnel and variable sales-related expenses to support our revenue ramp this year. Q3 '17 net income of EUR 52.9 million increased by half a million euro, or 1%, versus Q2 '17, and by EUR 36 million, or 290%, versus Q3 '16. Sequentially, net income grew principally as a result of continued gross margin improvement, cost control efforts, and a lower effective tax rate. Besi's nine-month 2017 growth of 167% versus 2016 reflected many of the same factors. Our effective tax rate has varied on a quarterly basis but has ranged between the 10%-15% as per guidance at the start of the year.
Our liquidity position continues to build nicely, which accommodates shareholder-friendly capital allocation policy. At the end of Q3 2017, Besi's cash and deposits aggregated EUR 298 million, and net cash and deposits increased by EUR 34 million versus Q2 2017 to reach EUR 165.4 million. Similarly, net cash and deposits increased by EUR 33.5 million or 25.4% versus Q3 2016. Regular share repurchases continued during the quarter, resulting in a total of 522,000 shares repurchased since program inception through quarter end for a total of EUR 21 million. This compares with a total of 1 million shares repurchased on the Besi's prior program, which expired on October 20, 2016, for a total of EUR 22.5 million. Besi has extended the current 1 million share repurchase program until October 30, 2018. With that, I'll turn the presentation back over to Richard.
Thanks, Cor. I'd like to update you on our strategy, the market, and the guidance for the fourth quarter. The disciplined execution of our product strategy, combined with focused initiatives to reduce structural costs, has contributed to Besi's success in recent years. Favorable momentum has continued into 2017, where we have experienced a further expansion of our revenue and profit potential, along with an increase in the share of our addressable markets to approximately 38% using current VLSI estimates. Another key to success has been the enhanced scalability of our production capacity via expanded Asian production and supply chain capabilities and a reduction of customer lead times. This year, Besi has increased production capacity to an annualized run rate of EUR 600 million with minimal additional CapEx.
Starting in Q4, Besi will invest approximately EUR 4.5 million in our Leshan, China facility, consistent with government plans to increase local production over the next five years. We anticipate total Asian production investments of about EUR 6 million to accommodate potential revenue growth 30%-40% above current levels. In addition, we continue to pursue revenue and cost initiatives established in the Q4 2016 to increase Besi's addressable market share, reduce structural costs, including further reductions to European overhead, and to accelerate common platform developments. These actions will help drive current business momentum into the future. We'd also like to highlight some of the strategic progress we've made to improve Besi's cash flow generation, which helps support organic growth and our capital allocation policy. In this regard, we've almost doubled our inventory turnover ratio over the past five years, and similarly reduced our cash conversion cycle by half.
We've achieved these results through constant attention on a weekly basis to inventory levels relative to projected order rates and some specific initiatives such as the qualification, expansion, and consolidation of our Asian supply chain and centralized management of global spares activities. A few words about the assembly market and our Q4 guidance. At present, the industry environment remains positive, with ongoing customer investment in a new technology upgrade cycle and specific applications such as smartphones, automotive, cloud server, and high-end memory. SEMI recently upgraded its 2017 assembly equipment market growth rate to 23%, up from 12% in May and 9% at the start of the year. It currently forecasts growth to continue into 2018 with an estimated growth rate of 5%.
Our fourth quarter guidance calls for revenue to decrease by 0%-10% versus the third quarter, consistent with seasonal trends, with gross margins anticipated to range between 55% and 57%, assuming current Forex rates. In addition, OpEx should increase by 5%-10% versus the third quarter, mostly due to higher projected development spending. The midpoint of Q4 2017 guidance indicates that Besi will post strong revenue and operating income growth versus the fourth quarter last year. That ends my prepared remarks. I would like to open the call now for some questions. Operator.
Ladies and gentlemen, we will start the question and answer session now. To be registered for the question and answer queue, you may press star 1. Your questions will be answered in the order that they are received. Star 1 for your questions. The first question is from Mr. Pieter Olofsen, Kepler Cheuvreux. Go ahead, please.
Good afternoon, gentlemen. A couple of questions from my side. Maybe first on some of your end markets, starting with automotive. Looking at the automotive market, we see some structural trends and drivers like advanced driver assistance, electrification, et cetera. I was wondering whether you already have some visibility on a further capacity build-out in that particular market for next year, and what that would mean for equipment spending. Then related to cloud server, could you shed some light on what type of chips your machines are used for? Is that hybrid memory, or what kind of products should I think of? Thank you.
Mr. Holt. Oh, Pieter, you had three questions. I noted two. Anyway, let me answer the first. Automotive expansion and what do we see in 2018. First of all, yes, there's a significant capacity expansion on the way, and also with new devices, which are part of either next-generation cars in general, but also hybrid cars and also electrical cars. That is always, in automotive, a longer-term investment than, for instance, for smartphones. Automotive has a longer production cycle and qualification cycle, so we can well look into the first half of next year already, and all the major electronics companies in that space are investing in new products and also capacity expansions. For Besi, around 20% of our revenue is in automotive, historically ranging between 15% and 20%. In a similar basis, this is expected to remain going forward. That's a very positive driver.
Cloud server, we are invested in many technologies, in the processors, in the memory part of the servers, also specific logics in that space. On a broader scale, we have a very consistent market position in that space, and that's usually around 25% of our revenue. Also this year, it has grown very much in line with the historical percentages.
Okay. Maybe to clarify then on memory. If I understand correctly, some of the more mainstream memory products are still using wire bonding. Your exposure to memory, that is mostly these type of hybrid memories that they use TSV technology?
Well, no, that's the very high-end. That's still a fraction of the volume. You have to think more in die-attached products using wire bond. Also certain flip chip, also stacked memory devices. There's a whole range, and the TCB arena is only the very high-end, which is still in early stages.
Okay. That means that your exposure to memory, it's quite broad.
Yeah.
Yeah. Okay.
As a percentage of revenue, I should add to that, we have never had market shares in our total revenue of more than 15% in memory. At this moment, it is not above that percentage.
Okay.
Memory is a very cyclical part of this industry. It's very cost-related, as opposed to the logic part of the business. You have to be careful in memory.
Okay. My final question that relates to your top line clearly outperforming the industry growth. I was curious whether you have a clear idea in which part of the market or which product you're clearly gaining market share. Are there some products that clearly stand out there?
No, it's actually across the board. It is in die attach, it is in packaging. Plating has a very strong investment cycle. That also ties to the gross margin development. If it would only be one of our products, it would not reach those levels. Asia is benefiting from a very successful product mix in the current upcycle.
Okay. That's helpful. Thank you.
Ladies and gentlemen, is there any additional questions, please press star one. Star one for any additional questions, please. The next question is from Mr. Robert Sanders, Deutsche Bank. Go ahead, please.
Yeah. Hi. Congrats on the quarter. I just had a quick question about, again, coming back to TSV, Chip-on-Wafer-on-Substrate, these trends. I know they represent a small proportion of your revenue, but have you seen any change in the environment, whether it's for TSV, Chip-on-Wafer-on-Substrate InFO that has been perhaps been a contributing factor to your orders?
No. If you look at current product mix, revenue development over the past quarters. Last year and in 2015, we had certain investment rounds for TCB, TSV, and also for fan-out wafer level. This year it is far less, I would say. The growth is coming from the current technology applications using substrates, and in automotive also lead frames. One would expect that is probably in the next round, more important. There is continued investment from the leaders in those new areas. The big growth, the volume growth, is not coming from those applications.
Got it. When you look at the market into next year, when you split between the OSATs, the couple of foundries and the IDMs, how would you compare your growth prospects across those three customer segments? Given what I assume you can probably see in terms of utilizations. In fact, some of the OSATs have reported quite lackluster numbers of late.
Yeah. What's interesting is, that is also history repeats itself. The key drivers for any new upcycle are always the IDMs. Certain IDMs, especially the fabless, they use more subcontractors. The big ones who are moving the needle, you see also contrary development where there's more in-house advanced packaging and assembly, as opposed to outsourcing. Probably because of the complexity, the CapEx involved, the critical nature of the specific end products. That's why you've seen with us the percentage of IDM versus subcon move more towards the IDMs. It's probably at some point, going again more towards the outsourcing, because that gives a higher flexibility. That's our read of how things are happening.
Got it. Just last question, would just be, in terms of those IDMs, which it sounds like they're quite broad-based across automotive and-
Yeah
logic and everything else. Given that those companies would rather do stuff in-house than use an OSAT, or you call it a subcon, I presume that's because they're in the system business, and they have specific needs that they would prefer to address than to rely on a third party. Does that mean then that their requirements are more stringent, and their demands on you are therefore higher, and therefore your margins are higher with IDMs than versus subcons?
In some cases, that probably is a good read. Because there are so many different package types, with some, you need far more development, and that can have a negative impact on the gross margins. It's hard to give an average. Also, in the first round of new technology rollout, there are many unknowns. There are still choices to be made on design specifics, also on materials, and that usually has a negative impact on the gross margin. Once it's all clear and it's also rolled out to the subcon or OSAT world, that is more predictable. We have, over the years, extended our support in the early stages, also out of Singapore with our design center and process development capabilities to address these first-round critical developments much closer to the end customers. That has increased the predictability.
Yeah, gross margins you would expect to be higher in the IDM world. With the risks and the uncertainties, historically, there also have been many unknowns which then have a negative effect on the gross margins.
Last follow-on from that, and otherwise, I'll jump back in the queue. In terms of what the largest logic IDM is talking about in terms of splitting up dies, in terms of creating modules of dies at multiple process geometries.
Yep
They see the cost of that as being less than the cost of shrinking, given the high cost of things like EUV. If that trend plays out as a global trend, and I would imagine Intel tends to lead the industry in this kind of thing, would that be great for a lot of your business or just the die bonding business? If you can just characterize that and how meaningful that would be if that became a mega trend.
Well, that's extremely positive for us because the critical nature of assembly, die attach, die placement, and subsequently, the packaging requirements for that are exactly into our advanced packaging strategy. Currently, we are very successful at that. That trend we have anticipated, and that's widely publicized. That is, from a cost point of view, also very much advantageous because the very high-end, using wafer level, is still a very expensive way of providing interconnect solutions. Being active on both technologies at the forefront with the winners in this industry is very beneficial.
Got it. This multi-die trend could actually be more meaningful than TSV and all of that, it sounds like.
Well, maybe it will be a mix because there's not one. You have to see this world as an ever-growing amount of different dies in different application, in different technologies, being the interconnect between the chip and an end application.
There is not going to be one final solution.
Got it. Okay, thank you very much.
Thank you.
The next question is from Mr. Pieter Olofsen, Kepler Cheuvreux. Go ahead, please.
Yes, I had two follow-ups on the outlook for Q4. Maybe first for Cor. Can you explain why OpEx is expected to be up while you're guiding for sales to be flat to down? Then on the sales guidance, if I take the low point of the range, it's EUR 143 million. That looks quite conservative given your backlog of EUR 168 million. Trying to understand the moving parts there, is that entirely related to timing of your customers, or are your lead times also playing a role there, and if you're able to reduce them, there might be some upside there?
Okay, well, if I look at OpEx, that's very much related to a technicality. Under IFRS, we have to build up a provision for holidays that are built up by our people, and Q3 is typically the quarter that, especially in Europe, everybody takes his holiday, then you book a release of this provision. Every third quarter, we see that's a normal pattern that has a lowering effect on our OpEx. That, of course, in Q4, we start to build up again. That's the main reason for this increase and other increases are a bit across the board, bits and pieces. This technicality, this, let's say, seasonal technicality, is the main driver here. Looking at sales and backlog. We always give a range, of course. Backlog is very much depending on the planning of the customer.
If you look at our ability to reach a quarter before that, EUR 170 million, we could basically deliver the whole backlog, but we are depending on the planning of customers there. If the planning would be beneficial, that could help. We always have to take into consideration a range, because the quarters are usually backloaded, so at the end of the quarter, a lot is happening. That's why we work with ranges. It's very much depending on the timing of our customer.
Okay. That's very clear. The final question from my side that relates to the plating business, where you're working on a solution for the solar market, where copper offers some cost benefits. Could you tell a bit more on what that means for the lifetime of these solar panels and whether there have already been some results from the test that your clients are doing in that field?
Yeah, there are some positive developments to note. We've received certain upgrade kits for the systems installed in the field. We've added another customer who is investing in Plating solar cells with our technology. There's a positive movement again. Still in the early days. The major uptick in Plating systems is again in the semiconductor arena, where we are, at this moment, involved in a very positive expansion and also the upgrading of the existing Plating lines in the field. Solar is moving in the right direction.
By adding a new customer, you now have three in this field?
Three major ones. We have many who are testing this in laboratory environment.
Okay.
Close to 10.
The opportunity is only getting bigger then.
Yeah.
Okay.
Yeah.
Thank you.
Ladies and gentlemen, for any additional questions, please press star one. For any additional questions, please press star one. There are no further questions, Mr. Blickman.
Okay. Thank you all very much for listening in to the call and also your questions. If you have any further questions, please contact us. Bye-bye.
Ladies and gentlemen, this concludes the Besi event call. Thank you for attending. You may now disconnect your line. Have a nice day.