Ladies and gentlemen, thank you for standing by, and welcome to the Melexis Q3 2019 results conference call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone keypad. I must advise you that this conference is being recorded today. I would like now to hand the conference over to your speaker today, Françoise Chombar. Please go ahead.
Thank you, Andrea. Dear audience, thanks for joining the Melexis earnings call for the third quarter of 2019. Our CFO, Karen Van Griensven, will comment on the financials. I will begin with the business update. As said, we will welcome your questions afterwards. Third quarter sales stands at EUR 123.3 million, which is at the upper end of our guidance. Not much change in geographical split versus the previous quarter. Amidst the continuing downward trend in global car sales and the uncertain economic and geopolitical situation caused by global trade tensions, this is a solid performance. Still, it is a decrease of 16% compared to the same quarter of the previous year. We are not out of the woods yet. The bullwhip effect we have experienced in the last nine months is still at work, though the severe inventory corrections are clearly ebbing away.
Inventories at OEMs and at our customers seem to get into a more stable state. Customer order behavior also seems to be getting better step by step, and we expect a further sales increase in the last quarter of this year, bringing full year 2019 sales outlook to a fourth between €483 and €489 million. Next up to the economic uncertainty. Legislation uncertainties make people postpone decisions also on which type of car to buy. Pent-up replacement demand should be unleashed at some point in time, though. Looking where we are today, year-to-date car sales worldwide is still down by close to 5%, a little better than a quarter ago. With a combination of plus half a percent in Japan, a minus 1% in the U.S., a minus 2% of European car sales, but still a significant minus in China, with close to 11% year-to-date.
The month of September saw the opposite of a return to growth in China, despite a more benign comparison basis. As stated at our previous earnings conference, China's auto industry is suffering from the China-U.S. trade war, the recent electric car subsidy reductions, and the continued absence of government incentives. Visibility worldwide does remain low as uncertainty lingers on, even if there are signs of moderation in the U.S.-China trade negotiations. Let me take a deeper dive into three product lines that outperformed in the third quarter. Pressure, optical, and temperature sensors. The first one, pressure sensors. They outperformed linked to electrification content growth in cars.
A nice example of the innovation Melexis is bringing to market in this regard is our newly launched system and packaged MEMS solution for the reliable measurement of fuel vapor pressure suitable for evaporation systems, which are designed to capture, store, and responsibly dispose of the vapor, preventing it from escaping into the air. This is applied in both internal combustion engines and especially important in hybrid vehicles, as more regions introduce strict legislation which prohibits the venting of fuel vapor into the atmosphere. Melexis herewith contributes to a healthier environment. Number 2, our optical sensors include automotive rain light sensors, and also the Time-of-Flight 3D sensors, which grew nicely in the first 9 months versus the same period of last year. Also nice to see our adjacent optical products move up well again versus the previous quarter.
The latter are a family of products, near-infrared remote control for multiple consumer applications. Last but not least, our temperature sensors. They are a great example of how Melexis leverages its know-how and technology in order to grow in both its automotive and adjacent markets. Firstly, the thermocouple interface chips used as part of a system measuring very precisely temperature in exhaust systems, thereby helping again to reduce emissions of the combustion engine. Secondly, the infrared thermal arrays, where I'd like to highlight in particular one application. Infrared arrays can be used to detect heat sources quickly and precisely. When combining this feature with a classical smoke detector, this results in an advanced fire prevention system, which is currently being deployed in high-speed trains.
As you can tell from the previous three product examples or product line examples, Melexis sensor and driver components serve the long-term automotive content growth trend and new opportunities in adjacent markets. My conclusion today is pretty much the same as at the previous three quarters. We are realistic and not satisfied about the current situation, we remain positive and confident about our future as our long-term growth drivers remain intact. Karen, now over to you for the financials.
Thank you, Françoise. For the third quarter, sales came out at EUR 123.3 million, a decrease of 16% compared to the same quarter of the previous year, and an increase of 3% compared to the previous quarter. There was a euro-US dollar exchange rate effect in the magnitude of 2% compared with the same quarter of the last year, and a positive impact of 1% compared to the previous quarter. The gross result was EUR 49.3 million or 40% of sales, a decrease of 28% compared to the same quarter of last year, and a decrease of 1% compared to the previous quarter. Continued low utilization of test capacity and a less advantageous product mix compared to the previous quarter resulted in a slightly lower gross margin. R&D expenses were 16.1% of sales. G&A was at 6.2% of sales, and selling was at 3% of sales.
The operating result was EUR 18.2 million or 14.7% of sales, a decrease of 51% compared to the same quarter of last year and a decrease of 1% compared to the previous quarter. The net result was EUR 15.4 million or EUR 0.38 per share, a decrease of 49% compared to EUR 13.1 million or EUR 0.74 per share in the third quarter of 2018, and a decrease of 1% compared to the previous quarter. The outlook for Q4, Melexis expects sales in the fourth quarter of 2019 to be in the range of EUR 123 million-EUR 129 million, with a gross margin expectation of 40% and an EBIT margin for the year of around 15%. I think we can now start the Q&A session. Operator, please go ahead.
Yeah. Thank you. Ladies and gentlemen, we will now begin the question and answer session. As a reminder, if you wish to ask a question, please press star one on your telephone keypad and wait for your name to be announced. Please stand by while we compile the Q&A queue. This will only take a few moments. If you wish to cancel your request, please press the hash key. Once again, please press star one if you wish to ask a question. Your first question comes from the line of Marc Hesselink. Please ask your question.
Yeah. Hello? Can you hear me?
Yes, we can.
Yes. Hello. Good afternoon. Two questions from my end, actually. First is actually on the product mix effect. Can you elaborate just a little bit more what is actually driving this? It seems to me that it should be mainly magnetic sensors that are growing or still contracting. Can you just elaborate a little bit on what drives this? Are you seeing some changes there in the competitive environment, and then how is your market share holding up? That would be my first question. A second question would be on the visibility you're presently having. As inventory corrections or the effect of the inventory corrections abate, and the ordering behavior becomes a little bit more stable, do you also have better visibility and maybe also a little bit of visibility also in next year? How are your customers giving their views on next year?
That would be my second question. Thank you.
Okay. Thank you, [Marc]. On the product mix, because of the fact that we have quite some inventory effects, it's very hard to take any conclusion at all on this at this moment in time. What I can tell you is that the market share as such has not really changed. There are always things that we lose. There are always things that we win also against competition. We don't see a significant change of our positioning in the market. On the visibility, does the visibility get better? Well, I wish it would, but I'm sorry to say it is not. The only thing we can say today is, whereas in the last, let's say, nine months
We had and even already a little bit indications before, let's say certainly the last nine months, we've had quite some pushouts and hardly any pull-ins of deliveries. Today, the pushouts have greatly diminished in both number and value. The pull-ins, they are, let's say, up and down. There's no real trend to be derived from that yet. It does, in combination with the distribution inventory and the consignment stock inventory that we have, of course, both a better view on than with the other customers. When we look at that, we see that it's become more stable and it become a more normalized situation, which is another indication, and which is why we also are confident to say that we have the feeling that the inventory corrections are slowly ebbing away. That's all we can say right now. For the future, the visibility remains low.
The uncertainty is there. The car sales worldwide is not yet growing again, though, of course, the decline is a little bit less. You see that's also an indication, but that doesn't mean that it's getting better. It's just getting less worse or less bad. That wasn't good English, I think. Visibility into the next year, I think it's really much too soon to tell, and anyhow, we will give you that guidance in February as usual.
Okay. Understood. Thanks.
You're welcome.
Thank you for your question. Your next question comes from the line of Francois-Xavier Bouvignies. Please ask your question.
Thank you very much. My first question was on your comments on the order behavior that you are seeing and improving step by step, as you call it. If you compare that to Texas Instruments that published last night, I don't know if you had the chance to look at what they said, but it's quite contradictory with what you are saying. They are talking about macro uncertainty, weakness across the board, and automotive is one of the weak spots with a decline of revenues secondarily for the next quarter, possibly. I just wanted to explain or maybe understand how come the order behavior can be different for Melexis and Texas beyond the product difference, because I know you're not doing the same, but the order behavior should be the same because they said that the customers from 90 days ago is much more cautious.
It's just contradictory to what you're saying. I just wanted to understand how you can reconcile that.
Yeah. A very interesting question, Francois. If you would recall when it was a year ago, I think, we were also the first saying that we saw a decline coming ahead in Q4 last year. There is not only a difference in the products that we carry, there is also a difference in lead times. Our lead times are probably a little longer because we make quite complex products which have long cycles. We had been, that was also something we said already over the last year, we were somehow in allocation. When you are in allocation, when you get in allocation, you wait a long time, or every company waits a long time to tell their customers that they're going in allocation, because once you are there, then customers can be very unpredictable in their order behavior and start ordering more than they really need.
That's usually what you always see, which is why everybody in the industry is cautious and waits as long as possible to even speak about the words. It's like a bit recession, don't speak about it because then it's a self-fulfilling prophecy. Well, with allocation, it's a bit the same thing. Lead times allocation have an influence. That means if you have not spoken about this, then maybe there was not a need for customers to start ordering more than they need. Once you then do see a decline in your end markets, the delay in information takes you longer. That means that Texas Instruments is apparently only now seeing a decline in their orders. That could be another reason. We can only say what we see. We cannot speak for Texas Instruments.
Yes, we've read through their PR and the transcripts. It's not something that we became wiser of. You can read that as well. We don't have an explanation necessarily for that other than different product mix, maybe different customers, different lead times, different supply chains.
Okay. That's very clear. Thank you. The second question I had is on the inventory situation in the supply chain. If we look at the release, you mentioned that inventories are ebbing away. Do you expect this inventory reduction to be over by the end of the year, or do you think it's going to continue still in 2020?
With some customers, it might still continue, but as said, it's really diminished. We have the feeling that we are reaching the bottom in the last quarter. Again, the future is still very uncertain. We believe that inventories in our customer base and at OEMs are relatively stable. We keep our inventory also at, let's say, at the same level, more or less, as before because this is, for us, a strategic thing. It's strategic because of many factors, but definitely also because the industry allocation risk that we had in 2017 and 2018 is still there. Once the market picks up again, we will see the same thing happening, and we just want to be ready for that and keep our machine oiled and greased.
I see. If we just dig a bit more on your own inventory situation, if the market recovers and, obviously, I guess you're going to use your inventories to capture the market share, like your strategy. If it happens, should we expect your inventories to go down if we see a recovery?
Yeah, that could be, but that will very much depend on the steepness of the rise. We have seen a slow decline, and now maybe we will see a slow ramp-up, but I cannot predict anything there. In any case, our idea is to keep inventories at the same level because at some moment in time in the past, exactly because of that allocation and because with some customers, we were living hand to mouth, our inventories were too low in the end. We don't feel they are too high at this moment in time. We feel they are just at the right level for the market dynamics that we meanwhile know very well.
The low utilization rate that is impacting your gross margin in Q3 and I guess in Q4 as well, I guess you will need a much higher production to reduce this lower utilization rate. My point is, should we expect this low utilization rate to impact for a couple of quarters still, given the lack of strong recovery for now?
It's clear that sales growth indeed will increase the loads in our factory. There is a direct link, yes.
You still get for 40% gross margin next quarter, yeah?
In the short term, indeed, it will not play so significantly. Well, yeah. In the short term, not, but in the longer term, for sure, the utilization rate will increase. It also depends a bit how inventory will move up and down.
Okay. Can we know exactly the impact of underutilization charges this quarter on your gross margin?
The impact?
Yeah.
Yeah, versus a year ago, that's in the range, that's more than 3%.
Percentage point, yeah. Okay. Thank you very much.
Thank you for your question. Your next question comes from the line of Janardan Menon. Please ask your question.
Hi. Good evening. I just would like to go back to the recovery, and you're saying that orders are now sort of showing some improvement step by step, and the inventory severity has ebbed. In your experience, how does order behavior typically behave over the next few quarters, say a couple of quarters from this stage of the cycle? I completely agree that the cycle may be, or the shape of this recovery may be completely different from previous recoveries. If you were to generalize, is it that you would normally see quite a quick acceleration from this point onwards, say, over the next three or four months, where you sort of get back to the kind of revenue levels that you left before you started this slowdown, or would it take more time than that looking at past experience?
Yeah. You are right that every cycle has its own dynamics. What is clear is that as long as car sales is still in a downward trend, it is very hard to compensate that completely or even exceed it with content growth. I think a steep recovery could only be possible, in my humble opinion, it is only possible if there is a steep recovery of car sales. As I said in my introduction, car sales is still in a declining mode, though the decline in Q3 is a bit better, or is not as bad as it was before. Content growth goes much slower in the end. Content growth is much more robust as well over time. In that sense, I think we really have to see what comes to play now. It's hard to say.
Do you think to get a proper sort of strong recovery, you need to see car sales globally grow again, or is it enough if you reach sort of a zero level stabilization, and then the content plays in? Would that be a sufficient scenario for the industry to start showing a proper recovery? You may not necessarily get back to the same level of revenue if you've lost, I don't know, 6% of car volume over the course of the last year, but is that scenario good enough to sort of get you back to normal recovery mode acceleration?
In an ideal theoretical scenario, if you would say it's flat sales, of course you would see content growth increasing the demand. The problem is that it is not linear. It is not theoretical. It depends on so many factors, and as you know, the automotive industry has such a long value chain and a long supply chain, one of the most difficult ones or the most complex ones in the world, with a lot of back and forth shipping everywhere. The automotive industry adopts very slowly new programs because they do a lot of testing and qualification, et cetera. You have a lot of delay factors on the line.
Nevertheless, even if content growth is a long-term growth driver, and that remains definitely for Melexis, fully intact, you will need to see at least stabilization of the car sales or a slight growth in order to really set the whole machine in motion again. That's what we believe.
Regionally, one of your competitors recently said that they're seeing a stabilization in the U.S. and Europe, but still, it's quite a difficult situation from an inventory perspective in China and from an order perspective. Your current order book suggests that the recovery is sort of uniform in all regions of the world, is it?
Yeah, you could say that more or less, yes. I think that the recovery we're seeing today has more to do with inventory corrections than with demand corrections. Right? It's logical that it would be then across the board.
Okay. Just a last question on the gross margin development. You're guiding at 40% roughly into Q4 as well. Is that because the adverse mix continues into Q4? Otherwise, I would have thought that you would have got at least about 1% upside if the mix had sort of rectified itself into Q4.
Yeah, we assume today a more or less similar mix. Of course, it can always be different from what we assume today because it moves. The order behavior still can change somewhat, but that's our best assumption today.
Understood. Thank you very much.
Thank you for your question. Your next question comes from the line of Stephane Houri. Please ask your question.
Yes, hello, good afternoon. Yeah, well, some of the questions have been asked already, but sorry to come back on 2020 visibility. When we look at the market research analysis for next year, we see that at best, the car market will be flat. In your experience and given the description that you can have with your customers, do you think that growing double-digit next year is a possible assumption? Because this is what the consensus is looking for. That's the first question. Also, how do you see your CapEx budget for the end of the year? How do you evaluate your CapEx for next year with this lack of visibility? Thank you.
Okay. Well, I think that the analysts' predictions are as good as mine. If they say it will be a flat car market, I think they are probably right. That comes back to how much content growth will be ramping up, and we cannot provide that guidance at this moment in time. That is a bit too soon to tell. We see Q1 is maybe also not too bad, but again, it's really because of the low visibility, the high uncertainty, everyone being cautious, though positive. Customers are not negative at all.
It is too soon to tell what it's going to do. I cannot tell you whether it's going to be single-digit growth or double-digit growth or growth at all for the time being. On the CapEx, maybe I relate to Karen. On the CapEx, we assumed EUR 40 million, EUR 45 million. We only, after three quarters, we have now just above EUR 20 million. The main reason of delay is our expansion in Sofia, which has delay. That's the main reason. Also, we have a little bit less manufacturing investments due to the sales that came down throughout the year. It's clear that the investment for Bulgaria will move. Whatever is not spent this year, it will be then spent next year. That's a delay that's spread over two years now.
Okay. The expansion delay, it was because of a technical reason or its decision that you made?
Yeah, permitting, things like that.
Okay.
We didn't push, of course.
For next year, what do you foresee at the moment?
That's too early. We will give guidance on that when we give the guidance on the full year's 2020.
Okay. It means that in February this year, you will give a guidance for the full year, right?
Yes. Including CapEx.
Okay. Thank you very much.
Thank you for your question. Your next question comes from the line of Marc Hesselink. Please ask your question.
Yes. Thank you. First question, I would like to come back on the gross margin, on the mix comment. The change in the mix, is that something that is very temporary, or is it also to do with some of maybe your lower gross margin products have been growing a little bit faster and so that they might be the higher products in the future? What is it, simply a temporary thing?
Well, the guidance for next year, we will give in February. In general, there are so many items at play in the product mix and in the gross margin that it's difficult to give any further guidance on that. What is an item that is relatively new and that I do can add is that today we sell more EUR than in the past. This means that we are in absolute terms fully hedged today. That means that if the U.S. dollar goes up, it's beneficial for our sales, but it's a negative impact on our gross margin, and that is one effect that we see today as well. That is playing also on the gross margin today. If the U.S. dollar would further strengthen, our gross margin will be negatively impacted today.
Great. Thanks. Second question is also something you discussed in previous calls, is the relatively high level of R&D that you're doing for clients for new applications. Could you tell a little bit, what's the progression there? What are you seeing? Is that indicated that a relatively high number of applications are coming to the market in the coming quarters?
Well, we have continuously new applications ramping up, new products ramping up. That also plays, you are right, that also plays in the product mix in some quarters. From one quarter to the other, if you have a difficult product ramping up, yeah, it could be that there are some yield issues in the beginning, et cetera, that play in there. In fact, we rather continuously have new applications coming on board.
I don't know if that answers your question, Marc, or if you need more details.
Yeah, I saw that a little bit weird because if I look to your R&D costs, which I think you kind of paused at that you would not really spend less on that. I think in the last quarter, we discussed that you still continue to invest heavily in R&D, but you are more scrutinizing a bit on travel and stuff like that. That continues to be very much under control. Just looking if there is something that you're delaying there or there's nothing like that.
No, we're not delaying. I think we're keeping the costs under control. Of course, being very cautious in the choices we make. Indeed, we will not sacrifice the long term for the short term. Our R&D projects, they continue to go on. They are important for our long-term growth path.
Okay. That's clear. Thank you.
Thank you for your question. Your next question comes from the line of Jeff Osborne. Please ask your question.
Good evening. Most of them have been asked, but just two quick ones. As customers are getting re-engaged, is there any change in the discussions around pricing relative to three or four quarters ago?
In automotive industry, there is always pricing pressure, and the pricing pressure is high in good times, and it's equally high and sometimes higher in bad times. Yeah, pricing pressure will always be there and everybody has it difficult. Everybody is being squeezed, certainly with the tariffs that have come on board, with the disruption that these tariffs have created in the supply chains. New qualifications weigh sometimes heavily on the engineering resources that you have to spend, because if customers change their supply chains, they of course, have to re-qualify. What we see, certainly our customers who are global, they try to now with, let's say, this closing doors scenario, you could say, where they try to have in every region, their manufacturing to service the region in itself.
Of course, they come from a previous situation where the whole world was used, and with the tariffs, that has created quite some disruption. Yeah, there is cost pressure in the whole supply chain. Yeah, that creates tensions everywhere, for sure.
Makes sense. Several questioners asked about this for next year. I understand you're not giving guidance, but just as we think about what the pressures are on gross margins, you've obviously got pricing, you've got mix that was addressed. How do we think about Sofia ramping up and the impact of that new facility on margins?
Sofia ramping up, we will only take the factory into use in the second half of next year. The impact will still be relatively small.
Got it.
Furthermore, equipment will only be purchased at need basis. It's mainly infrastructure now that we invest in.
Got it. That's helpful. The last question I had is just you mentioned in the prepared remarks that the Time-of-Flight 3D sensors were up nicely. Can you just talk about what specific application those are being used for, that you saw the strength year-over-year that you called out?
Yeah, for this time, the Time-of-Flight, it's still gesture recognition in cars, mainly.
Got it. Thank you.
You're welcome.
Thank you. Your next question comes from the line of Jonathan Mertens. Please ask your question.
Hi. Thank you for taking the question. I have a question about the dividend yield. Even if the results do not improve materially in 2020, will you still increase the dividend next year?
Well, we will continue to pay out a high portion of our profits. We already set a high precedent with the interim dividend of EUR 1.3, which means that we have belief in the future anyway. Of course, we don't have a fixed rule of how much percentage we pay out. That is at the discretion and opportunistic decision for the board. At least for the interim dividend, we actually went along as we did before.
Okay. That's clear. Thanks.
Thank you for your question. There are no question at the moment, please, speaker, go ahead.
Okay, well, thank you everyone for your questions. Our next earnings conference for the full year 2019 will be on February 5, and we hope to welcome you all again then. Goodbye for now. Thank you. Operator?
That concludes the conference for today. Thank you for participating. You may all disconnect.