Ladies and gentlemen, thank you all for standing by, welcome to today's Melexis Q3 2018 results conference call. At this time, all participants are in a listen-only mode. There will be a presentation followed by a question and answer session, at which time, if you wish to ask a question, you will need to press star and the number one on your telephone and wait for your name to be announced. I must advise you all that this conference is being recorded today, Wednesday the 24th of October, 2018. With that, I'd like to hand the conference over to our first speaker for today, Ms. Françoise Chombar. Please go ahead, ma'am.
Thank you, operator. Dear audience, welcome to the Melexis earnings call for the third quarter 2018. I'll begin with a business perspective update, after which our CFO, Karen Van Griensven, will carry on with the financial highlights. Of course, subsequently, we will be happy to answer all your questions. Where are we on the business and market side? Quarter three sales came out at 15% growth year-on-year, just south of EUR 147 million. There was no currency impact, geographical spread year-on-year was the same as well. Melexis year-to-date performance is in line with expectations. This is good growth related to both existing and new programs. We have key growth drivers in Q3, Magnetic Position Sensors, Embedded Motor Drivers, and Pressure Sensors. Let's dig a bit deeper into these three product lines. First, Magnetic Position Sensors.
Our new generation Triaxis, which was launched in April this year, is gaining traction while the previous generation upholds new design wins too. It reaffirms the number one position we enjoy in this field. Magnetic Position Sensors can be found mainly in the powertrain, in particular, also the new electrified powertrain, both hybrid and pure EV. Equally, in steering, pedal, and shifter applications, we see further ramps. Melexis products fulfill the higher demands in robustness, safety, integration, electrification in general, and added features are driving many of the integration activities. We see these trends to proceed as autonomous driving, electrified cars, and consumer demands for more comfort and ease of use maintain their course. It's also great to see our Embedded Motor Drivers picking up steam now. We call them embedded because they contain an MCU core and a flash memory.
For these products, the MCU core is proprietary to Melexis. These are complex, highly integrated products that enable our customers to achieve their targets on emissions, efficient electrification, and silent motors. Smart and small mechatronics in cars is an accelerating trend, Melexis is very well-positioned with a broad product portfolio. You'll find these Embedded Motor Drivers, for example, in Air Grille Shutters, Smart Valves, and all kinds of BLDC pumps and blowers. Finally, we want to highlight our Pressure Sensors getting popular. This product line makes also a significant contribution to developing highly efficient and cleaner vehicles, thereby lowering emissions and preserving the environment. Next to conventional applications such as braking and that's a universal need in all types of cars, we see uptake in two new areas, being Seat Lumbar, that is connected to the trend of personalized vehicles, and pumps.
All of this demonstrates that the long-term fundamentals of Melexis are intact. Short-term, though, our visibility is lower than anticipated before, and currently we see demand distorted by a mix of reasons. The main reason is the higher concern over the economic and geopolitical situation due to global trade tensions. The path the Trump administration has chosen isn't doing our industry any good. We notice our customers have suddenly turned much more cautious, and thus they are scrutinizing their costs, meaning in the first place, their inventories. We reflect this unusual demand distortion in our adjusted sales guidance for the full year. Our opinion today is that the extent of this weakness is likely to be moderate, and that it is likely to last for a brief period of time. However, at this point, it is very hard to make any predictions as to how this will play out.
Again, this is short-term, like some turbulence during a flight. Long-term is a different and positive story. When we look at our customer forecasts, which comprise a longer timeframe than purchase orders, and knowing what our design wins are, we have reasons to be confident mid and long term. This is on the back of both organic growth of existing products and of new products ramping up in 2019. Our content growth is on the rise with multiple product lines as they tick all the boxes on the secular trends: electrification, assisted drive, and personalization of the car. Key to Melexis is that there is no structural change going forward. Now I will hand the stage to Karen for the financial update.
Thank you, Françoise . Good afternoon, ladies and gentlemen. On the financial, the gross result was EUR 68.1 million or 46.4% of sales, an increase of 17% compared to the same quarter of last year, and an increase of 3% compared to the previous quarter. R&D expenses were 13.3% of sales. G&A was at 5.3% of sales, and selling was at 2.6% of sales in the third quarter. The operating result was EUR 36.9 million of 25.1% in the third quarter of sales, an increase of 15% compared to the same quarter of last year and an increase of 4% compared to the previous quarter. The net result was EUR 13.1 million or EUR 0.74 per share, an increase of 7% compared to EUR 28.1 million or EUR 0.70 per share in the third quarter of 2017, and an increase of 7% compared to the previous quarter.
I would like to open now the questions and answer session.
Thank you. Ladies and gentlemen joined over the phone line, should you wish to ask a question, you may press star and the number 1 on your telephone and wait for your name to be announced. Should you wish to cancel the request, you may press the pound or hash key. Once again, it is star and the number 1 should you wish to ask a question. We have got questions over the phone line. Your first question comes from the line of Francois-Xavier Bouvignies. Your line is now open. Please ask your question.
Hi. Thank you very much. I have a couple if I may. The first one is on the growth that you are seeing in Q4 and the impact of the inventory. Given that your lead times is roughly 16 weeks, if I remember correctly, you said in previous calls. How should we think about the beginning of 2019? I do not expect you to give the 2019 guidance, but given the visibility that you have, you mentioned a brief impact, just to get a sense of how we should think about H1 2019, especially given the comps that are if I remember Q1 2018 was particularly strong, you enter in a very tough comp environment as well.
Mm-hmm. Yeah. Thank you, Françoise. In fact, if you look at the sales that we guide for in the fourth quarter, it still equals a year-on-year sales growth of 6%. I think that is the first thing that we have to understand. Indeed, traditionally, we give only guidance for 2019 after full year publication. I cannot do that today. However, if you ask me how do you think that 2019 will begin? The honest answer is, for the time being, order behavior of customers is today quite different than usual. For the reasons like we mentioned in the press release and the reasons I mentioned before in the introduction. Current visibility is low. Customers seem to wait with putting in their purchase orders. They are indeed pushing out their orders that they had already put in.
Main reason as what they tell us is that they want to make sure that they do not have too high inventories at the end of the year. Some mentioned lower demand. Some mentioned lower visibility. We have a bit of everything, but in the end, they wait with ordering. If this trend continues, it could be that we will face a slow start of the year, because, of course, if, for example, a customer ships out parts that were ordered in December towards February, of course, they will not order new parts for January. I think you can see that. On the other hand, again, based on the customer forecasts that have a much longer time horizon than the purchase orders, based on the discussions we have, the awards we win with our customers, we have reasons to be confident mid and long term.
These are two different patterns. You have the short-term pattern, which is extremely volatile and with low visibility. The inventory corrections, the slow order intake. The waiting customers, let's say. That's the short-term pattern. You have the second pattern, which is a more structural pattern, with expected ramp-ups of new business, new products. They are superposed to each other. We will have to see how they will correlate, how one will trade off the other. That is today, very hard to say because of the volatility of the first pattern.
You mentioned in your remarks that you expect it to be brief, like short-term uncertainty. What makes you think that's going to be brief? Is there any data point that you could share with us to feel confident?
For the same reasons that I already mentioned before. When we talk to our customers, they are very busy with new programs. We are very busy with new programs together with them. There's a lot of work to do. There's good developments, there's good awards being discussed. That is the reason why we believe this is a correction for sure, but this is also a lot of uncertainty. There is no other reason than that.
Okay. Thank you. The second one I had is on your gross margin. Your level of inventory is still very high and is consistent with what you said last quarter, saying that you are comfortable with this kind of level, although it decreased slightly. The question I had is, if you wanted to deflate these inventories, what should we expect in terms of impact on gross margin, if any? Just to get a sense of your gross margin profile in a more challenging environment.
We don't expect major impact, if any, on the gross margin of depleting our inventory. As mentioned already, we are confident with the levels we are seeing. We are not counting on a huge depletion of our inventory levels in the shortest term.
Understood. That's all my questions. I will leave the floor to my peers. Thank you very much.
Thank you, Francois. Operator, could you see if there are any other questions?
The next question comes from the line of Janardan Menon. The line is now open. Please ask your question.
Hi. Good evening. Thanks for taking my question. When I look at your Q3 numbers, your non-automotive revenues fell very sharply, around 24% both quarter-over-quarter and year-over-year. While your automotive revenues actually seem to have done very well. They went up 6% or so. The weakness that you are seeing, some of your peers have talked about a lot of weakness in the distribution channel. TI talked about it, STMicro talked about it, and obviously your non-automotive is quite a lot into the distribution channel. Is most of the weakness that you're seeing in the distribution channel for non-automotive, and is that where we should expect much of the decline into Q4? Or are you also seeing quite a bit of weakness in the automotive side?
Yes. You are absolutely right that most of the adjacent, and what we call adjacent markets, are going through the distribution channel. Indeed, we see weakness there, and we see already some more weakness there in Q3 than with automotive. That is correct. Now, the uncertainty that we see seem to have been more pronounced with adjacent markets than with the automotive markets so far. Indeed, also in Q4, we do not expect this to change dramatically. It's not like the non-auto will suddenly be boosted and auto will suddenly drop. I think it will be more or less the same in Q4 as far as percentage is concerned.
In Q4 also, you will see more weakness in the adjacent markets, and less weakness in automotive. Is that what I'm getting from you?
No, what I mean is we now have 92% automotive.
That we think as far as we see today, again, we're in a very, very volatile situation. We see the same, like 92 or something for automotive in Q4. It might even increase a bit. We believe that the uncertainty that you see in adjacent markets, it's easier for end customers to delay, sorry, looking for the word. To delay their purchases. They say, "Oh, we'll wait to buy another washing machine or another," I don't know what
Oh no, I'm not going to buy that drone for my kid now. I'm going to wait until we're a bit more clear about the economy." I think, therefore, we do see a higher volatility in the adjacent markets. The second thing is that with adjacent markets, we're more exposed to China than with automotive.
Got it.
China also is influencing the lower adjacent market contribution in Q3 and in Q4.
Okay. In automotive, some of your peers are saying that there is not much weakness, or in fact, they're saying it's very strong. Again, STM today morning was saying that it's strong. Elmos came out after the quarter ended and said they're not seeing any weakness, and they are quite a close peer of yours. Infineon, at least when the last time they've said, again, after the quarter is completed, that they said everything in automotive is very strong. On the other hand, I agree, TI yesterday said that automotive has got some weakness as well. I'm just wondering your weakness. How do you explain this discrepancy between some suppliers who seem to be seeing a little bit more weakness, and especially in your case?
Is it that perhaps you have a higher level of exposure to someone like Volkswagen, which has seen a much bigger impact from WLTP than some of the other companies, and it's that end customer or OEM or Tier 1 exposure, which is resulting in this difference? Is there some other explanation for this?
Okay. Well, we communicate in a very transparent way on how we see the situation. We cannot speak for other companies. The only thing I can see is that in the last days, we've seen several Tier 1s and OEMs making business comments which support our view. To your comment that do we have a higher exposure to some OEMs, like VW? I don't think so because the situation that we're seeing is very spread over our customer base, and we are not more exposed to Volkswagen than to any other.
Got it. One last question from me. When you say brief period of time, I know this is a difficult question to answer, but I'm not going to hold you to it at all, but is one quarter brief or two quarters brief? I presume long would be like three to four quarters, but what would be brief around?
If I would be able to predict that, I would probably not be sitting here. I don't know. I think nobody knows. Honestly, if we're honest to ourselves, nobody knows because it's hard to predict, especially since the Trump administration seems to change course very quickly. What is valid today might not be valid tomorrow anymore or might be different tomorrow. What is important, I believe, is to look at the fundamentals of the industry, and the fundamentals of the industry is, and definitely so the automotive industry at large, is that the industry needs to innovate in order to bring to market those products that customers are looking for, namely cleaner vehicles.
There's a push both in China and Europe, definitely less in the U.S., but in China, which is the biggest market, and in Europe, there is a big push by the general public for cleaner environments. That means they want cleaner cars. For that, the industry must innovate. For that, the industry must also look at technology like the one supplied by Melexis. That's why we believe there is no need for, say, a big panic. Again, I cannot tell you how long this correction will last, but in the end, what we can tell you is that mid-long term, technologies provided by Melexis are needed in the industry.
Got it. Thank you very much.
You're welcome.
Thank you for your question. Your next question comes from the line of Guy Sips. Your line is now open. Please ask your question.
Yes, thank you. Most of my questions are already answered, but I have one question on your R&D going forward. Has the current turbulence any impact on your R&D spending as a percentage of sales? Can you give us some guidance into 2019 on this regard? Thank you.
Regarding the next quarter, the fourth quarter, I think we can say there that it's likely that as a percentage of sales, R&D will be at a higher component versus sales than we have in the third quarter. For next year, however, that will depend very heavily on the sales we will have next year and
It is too early to give an answer.
Okay, thank you. The second question is also related to the non-automotive growth, because if you put together then the 6% sales increase that you indicate for the fourth quarter and the 92% or even higher percentage of automotive sales in the fourth quarter, it actually indicates that the problem is especially in non-automotive more than in automotive sales. If you put all that together, isn't that the problem still has to come in automotive in the first quarter of next year? Is it a little bit too pessimistic?
Again, it's very hard for us to say in this very volatile environment. We have no reason to believe that what we're currently seeing short term is related to Melexis stand on its own. It's more an economically and geopolitically, or an effect of the economy and the geopolitical situation. Thus uncertainty does affect consumers, right? I don't think that there is any other reason, honestly speaking. Will automotive be worse in Q1 or will we see the hit coming in Q1 more? I honestly cannot predict that.
Okay. Thank you.
Thank you. Your next question comes from the line of Marc Hesselink. Your line is now open. Please ask the question.
Hello. Just one follow-up question on the R&D spend. In a hypothetical situation, if growth next year isn't, say, 10%, but it's 5%, would that make you reduce the R&D spend as you were planning for a 14% of sales kind of target there? Same, would you also slow down your CapEx plan for 2018 and 2019 in such a scenario, or would you say, well, 5% mid-single digit growth is still good enough to carry that?
It's difficult. A lot depends on the top line, and for the moment, certainly short term, the visibility is low. Our R&D spending is a long-term invest, and we will definitely We might be cautious on the one hand, but on the other hand, we will invest structurally where we feel we need to invest. If that answers your question.
All right. Thank you very much.
Marc, maybe I can add, and I second what Karen has said. If we look at all the discussions we have with customers, there is no reason to reduce our R&D spending because there's a lot to do. There's a lot of opportunities going forward. We also say that in our press release. There are so many opportunities. It would be very short-sighted to now suddenly, because of a short turbulence, suddenly start reducing heavily on long-term important R&D spend or investments that we need. In fact, in times when maybe there is a little bit less to do on the production side, it's nice to have some time to focus on some other stuff than focusing on getting production out the door as the customer wants. We're not worried about this.
Even if this is a slowdown, the opportunities going forward are more than enough to continue our investments.
Yeah. Just you will continue as if building the foundation for future growth.
Exactly, because that's what we see.
Perfect. Thank you very much.
Thank you. The next question comes from the line of Andreas. Your line is now open. Please ask your question.
Thank you. Well, my question has already been answered more or less. I would like to ask it a bit in a different way. When I consider your growth guidance and your EBIT margin, it looks to me that you have some flexibility in your SG&A costs to reduce overhead costs, so to say. Is that correct to assume?
You assume I'm not sure I understand the question.
Well, the question, I can put it more simple.
If I could just see in a.
Is the 25% margin really realistic given the slowdown in sales, or does that require a cost cut?
Again, it's too early. We haven't given any guidance yet for 2019.
I'm talking about 2018 because the fourth quarter could be.
Fourth quarter.
Quite a tough one.
For the fourth quarter, we can expect a lower EBIT than Q3, indeed. We still keep the EBIT margin for 2018 at around 25%.
Okay. Thank you.
Thank you. The next question comes from the line of Jeff Osborne. You're now live. Please ask your question.
Hey, good afternoon. As it relates to the working capital in 4Q as well as early 2019, can you just talk about the moving pieces there? It sounded like inventory wasn't going to improve. You've got a dividend payment in the fourth quarter. What I'm trying to get at, is there a minimum cash balance that you're comfortable with?
Okay. Maybe I can first answer the inventories. You can take over, Karen. The inventories are indeed higher than the same comparison of last year. It's not that today's inventories are too high. It is rather that the previous year inventories were too low because we were in an accelerating mode and with capacity shortages a bit everywhere in the supply chain. Which is now much more improved. We're working hard to move towards a normalized situation in the supply chain at year-end. The inventories today, as already mentioned, we feel okay with these. They are strategic also because we are still concerned with security of supply. Inventories are not a problem as long as they remain sellable, and ours are sellable. The risk of obsolescence is not more than usual.
In fact, excess inventories, as some people call them, they are really a blessing. They are a blessing, especially at a time when everyone has been in waiting mode to order and suddenly find out too late that their own inventories have depleted fast. At that moment in time, Melexis will be able to deliver and take advantage. If we look at the distribution also between the different stages in the inventory, so finished goods versus work in progress, it's not different than usual. Again, this is a strategic choice, and we feel well about it, and we have it well under control. I hand to Karen for the rest of the question. I hope that answers your question on inventory.
No, that's very helpful. I appreciate that. Is there a physical euro level of cash that you feel comfortable with or that are required by covenants?
Covenants-wise, we don't need to worry at all. We expect by year-end to come out, yeah, probably around zero. Might be a small net debt. More or less, yeah, a zero position.
Got it. It was alluded to on the prior question about CapEx for next year. Is there a specific target? I think it was EUR 75 million for this year. What are you thinking of for next year? It was unclear with some of your fab expansions, how much lingers into 2019 versus this year.
We don't give guidance yet today on that CapEx for next year. For 2018, we indeed reconfirmed the EUR 75 million. For the year, we said EUR 70 million to EUR 75 million. We will most likely end at around EUR 75 million for 2018. For next year, no specific guidance yet, but what we can say is that we have heavy investments in 2018 in equipment, and it's likely that this will slow down in 2019. On the other hand, we will heavily invest in facility, particularly in Sofia. There we will see an increase versus 2018.
The last question I had is just with the disruption in the market, in particular with European OEMs as well as the Chinese, is there any delays or push outs of RFPs or qualification process? I know you don't report bookings, but just in general, the new design wins, is there any deceleration of those awards given what's going on?
Not that we can see today, Jeff, no. No deceleration.
Perfect. Good to hear. Thank you. That's all I had.
Okay. Thank you.
Thank you for your question. We have got one last question on the line that comes from the line of Gaspar Reno. The line is now open. Please ask your question.
Hi. Good afternoon. Thank you for taking my questions. I have three, if I may. The first one is about the revenue growth on a regional basis in Q3. It is interesting to see that all regions have been growing at the same pace of 15%. I would like if you could please elaborate the implied revenue growth for Q4 of 6%. Can you elaborate on a regional basis, what you see there? That is the first question.
I am sorry, we did not really make that estimation at this time. From my gut feeling, I do not think there will be such a big difference. There might be some changes, but I do not think they will be major.
Honestly, we have not made that. We could have made that simulation. We have the data, of course, but we did not prepare for that here.
Okay. The second one is, if you could just please remind me, how much inventory do your customers typically hold? How long does de stocking, just to be more cautious if that's all, how long does it take?
How much inventory our customers keep? We're a component supplier. We have at least two of our customers downstream. If in the best case, we're the tier 2. We have the Tier 1, and then we have the OEM before it then goes to the consumer. We have at least two. In many cases, we have many more. We have sometimes distribution in between. We sometimes have subcontractors of our customers in between, sometimes even two subcontractors before it ends up at the tier 2, and then it has to still go to a Tier 1. It's very hard to give you now a figure like, "Our customers always keep x amount of months in stock." It's really very hard to estimate that.
What I can say is that it is typical in a supply chain that the further up you are upstream, and we're pretty much upstream in the end-
Yeah
the higher the swings will be. A brief ripple at the end of the stream-
Yeah
can mean pretty high swings at the other end, upstream. Depending on where we are in that stream, let's say, we have either very high swings or not so high swings. How long it takes is really dependent also on the information flow. The change in behavior came, in fact, very recently. It's just started, really. It takes some time before the information flows through the value chain as well. Today, because we're in the beginning, it's not so easy to estimate how long de stocking will continue.
Okay. Thank you. Maybe just two shorts more. On the CapEx, on the investment plans, can you please let me know how much as a whole of Melexis you're increasing capacity? How much capacity are you adding?
In 2018, we did not make a huge investment in capacity. Actually, most of the capacity will be made available in 2019. The Bulgarian investment is 2020. For the moment, we are not extending capacity or hardly increasing capacity. By 2020, we will have increased total capacity by around, I think, 40%, in that range.
Okay. Maybe I follow up on this one. Just maybe the last one, if I may. In a recent public conference, the head of automotive at Infineon said that over the medium to long term, he was seeing double-digit revenue growth for the semiconductors in the automotive market. I know you have said already that the long-term picture doesn't change, but is that something like a 10% they were guiding now for the long term, maybe the next five to 10 years. Is that a kind of a growth rate that you are comfortable with it over the next five to 10 years?
It's already difficult to explain the next three months, let's say, or next six months. Over the next 5-10 years, I would say that around 10% for the industry, for the semiconductor industry in auto, overall, is maybe on the high side. For us, our target has always been to do double digits. That is what we are striving for. That is what we will continue to strive for in the next years. We're not living in a vacuum, and there's always an economic situation that we will have to take care of.
Okay. Thank you very much.
Thank you for your question. We've got one last question on the line that comes from the line of Mr. Holfelder. The line is now open. Please ask the question.
Hi, it's Gunther Holfelder from Baader Helvea. I just had two questions on the timing of the automotive slowdown. Was this already reflected in your orders in the September quarter, like a book-to-bill?
We don't do book-to-bill. We don't disclose that. No, as I said before, it is very recent. It's very recent that we saw this slowdown coming to us.
Okay. The second question, you mentioned consumer cautiousness and slowdown in potential consumer demand with washing machines and other things. If I take your year-over-year growth, the 6% you mentioned for the December quarter, if at the same time your customers are reducing inventories, as you indicated, it does not sound to be too bad the situation from the end demand out there.
Well, thank you for your optimistic note, I would say.
Okay. It's indicating that it would be higher than 6%, yeah?
Sorry, come again.
Yeah. I would say it should indicate that the real end demand for your product is above the 6%, if there is an inventory correction component included.
Yeah, that could be a conclusion that you could take. Yes, I guess.
Okay. Many thanks.
You're welcome.
Thank you. No further question at this time, Diana. Please continue.
Thank you very much for your interest and your questions. We will be very happy to meet some of you in person at our upcoming Analyst Day, which is on December 5th, or else at our full year earnings call next year on February 6th. For now, goodbye, and have a good rest of the day.
Thank you. That does conclude our conference for the day. Thank you all for participating. You may all disconnect. Speakers, please stand by.