Ladies and gentlemen, welcome to the INFICON's Q3 Results Conference Call. I am Alessandro, your call's co-operator. I would like to remind you that all participants will be in listen-only mode, and the conference is being recorded. The presentation will be followed by a Q&A session. You can register for questions at any time by pressing star and one on your telephone. For operator assistance, please press star and zero. The conference must not be recorded for publication or broadcast. At this time, it is my pleasure to hand over to Mr. Lukas Winkler, Chief Executive Officer of INFICON. Please go ahead, sir.
Thank you, Alessandro. Good morning, everyone, and thanks for joining us today to review our results for the third quarter of 2020. The third quarter can be summarized with five bullet points. First of all, the ongoing COVID-19 impact on how we do business. Secondly, semiconductor market development, but still at a higher level than 2019. Third, the rebound in all other served target markets after a relatively weak second quarter of 2020. Fourth bullet point is a disappointing gross profit margin due to several reasons. We come to that later. Last but not least, we expect a strong last quarter supported by a good order momentum. As always, you can find the PowerPoint presentation on the investor relations tab on our website. Please go to slide number three, where we start with key figures for the current reporting quarter.
We closed the third quarter 1.3% below last year's third quarter and reached $92 million. Organically, this reflects a 3.4% decrease, and compared to the second quarter of this year, a reduction of 4.4%. On the positive side, the order intake is picking up and our quarterly as well as our year-to-date book-to-bill ratio is clearly above one. With a disappointing low gross profit margin and stable operating expenses, we finished the quarter with operating income of $10.5 million after $16.3 million a year ago. This is one third less than a quarter ago. Our net income was $7.9 million or 8.6% of sales. Later on, Matthias Troendle will go with you through detailed figures. Now I go to the development in our target markets. Now, please turn to next slide number four, where you see the breakdown of our sales into the four markets that we serve.
With sequentially improved contribution from the RAC auto as well as general vacuum markets, the pie chart looks very similar to the same pie chart a year ago, with one exception. The expected lower contribution from the security and energy market has been compensated with higher sales primarily to semiconductor customers. The quarterly regional sales trends on the right-hand side shows lower sales to Asian customers, again, primarily driven by the sequential lower shipments into the semiconductor market. Europe and Americas remained stable. Let's do a quick analysis market by market. We start with the smallest one in the security and energy market on slide number five. Sales decreased more than 25% year-over-year. The sequential increase of 74% looks impressive, but it's compared to a very low second quarter of this year.
Overall, we are far behind our normal sales level, which has been expected and communicated since the beginning of this year. Our main customer in this market, the American Department of Defense, had no specific program for portable on-site chemical warfare detection instrument this year. Secondly, we are about to launch a brand new HAPSITE product family at the beginning of next year and expect the U.S. government to be first customer for this next generation chemical warfare detection unit. We do also face some headwind in China with this product due to the fact that Chinese agencies are not allowed to buy American-made products. As a consequence, we started to work with a Chinese system integrator who is using a OEM module to be built into a Chinese-made system.
This quarter, again, we sold the majority of our products into the energy and environment market and enjoyed a nice sales growth with gas detection instruments in the biomethane and landfill monitoring applications. Looking ahead, we expect a further improvement, especially outside of the main security applications, but we will end this year far behind the sales level of 2019. Moving to the refrigeration air conditioning automotive market on slide number six, with sales of $19 million, which represents a sales decrease of 5.5% year-over-year, but enjoyed a 13.8% increase compared to the second quarter of this year, which has been hit by COVID-19 measures. Sales to traditional car manufacturers remained low, but RAC and refrigeration manufacturers started slowly to invest in additional capacity again, and the revenue of our after-sales service instruments even recuperated from some of the losses in Q1 and Q2.
Last but not least, our e-cars and lithium-ion battery testing remained at an attractive level. As the preferred number one supplier in this market, we are able to keep our high market share and expand into new operator independent robotic leak-checking applications, as well as new ways to test the leak integrity of a variety of different lithium-ion cartridges. We expect a strong last quarter, but we will miss the record levels of the last years on an annual basis. Let's go to the semi and vacuum coating market, which includes solar display optics and semiconductor applications on slide number seven, where sales increased 5.7% year-over-year and decreased 20.9% sequentially and reached $42.4 million. As in the previous quarters, the vast majority of our shipments went to semiconductor customers, while sales to OLED and optics customers are still behind 2019.
Although the activities in China remain at a high level, we face two main issues with chip manufacturers in China. First of all, going through a public auction process for our process monitoring solutions led to the current initial low gross profit margins, since we decided strategically to win the majority of all Chinese chip manufacturers. Secondly, the U.S.-China trade issues as well as the war on technology, led to some shipment and installation delays, as well as a continuation of enforced import tariffs for U.S. goods, which had a negative gross profit margin impact as well. Outside of China, high-end semiconductor companies invest in new sub-10 nanometer technology that can only be reached with extreme ultraviolet lithography technology. Companies in the U.S., Korea, and Taiwan are at the forefront of this latest technology node.
These new chips, new materials, and manufacturing processes are asking for more accurate process control and monitoring. We continue to work very closely with OEMs and end users to develop new sensors, solutions, and software. The high level of R&D costs will lead to a large number of new products and instruments going into 2021 and will drive our sales to semiconductor customers to new levels. The fourth quarter is expected to be a strong quarter, and we push at all levels to get systems installed and accepted. Finally, we had a sequentially improved quarter in the general vacuum market on slide number eight, with sales of $25.9 million, which is 3% below last year's third quarter, but 11.6% above the weak second quarter of this year.
As you know, we sell analysis, measurement, and control products for many different industrial applications through private label partners, primarily vacuum pump manufacturers and via direct sales channels to industrial OEMs and distributors. Especially in Europe, we saw a recovery after the first COVID-19 shock during springtime. During the lockdown, it was also quite difficult to acquire new customers in the food packaging market since most of the trade shows have been canceled. We have been able to increase our sales with existing customers, especially within the coffee packaging market in Europe. Before I turn over to Matthias, I’d like to close my part of the presentation with an outlook on slide number nine. 2020 will remain a very special and challenging year with only one stable element, the uncertainty.
Being able to adjust quickly, use agile and flexible methods, and see every uncertainty as an opportunity to gain market share is what we do. Thanks to a healthy semiconductor market and the recovery of some other markets that we serve, we will end this challenging year with a strong last quarter. We cannot influence the global geopolitics, but we will do our best to keep our customers happy and successful. Given the positive order momentum and the current backlog, we leave our top-line guidance unchanged at between $370 million and $390 million. On the operating income, we expect to finish the year between 15% and 16% of sales. With that, I'd like to turn over to Matthias, who will give you more details about financial performance.
Thank you, Lukas. Good morning, everyone, to our third quarter 2020 conference call. I will cover, as usual, our Q3 financial results and also comment our guidance for 2020. As always, let me begin with our revenue segmentation in the September quarter. You find this on slide number 11. Revenues for the third quarter of 2020 came out at $92 million, compared with $93.2 million in our third quarter of last year. Total sales decreased by a minimal $1.1 million or 1.3%. Due to the weak U.S. dollar, we had a positive exchange rate effect of 2.2%, which means we had an organic sales decrease of 3.4%. Looking at the end market development, the semi and vacuum coating market had a good performance and increased by $2.3 million or approximately 6%, while the sales to the other end markets declined.
Shown in the chart on page 11, sales in the third quarter decreased by 4.4% compared to the sales level in previous quarter, Q2. The decrease is exclusively caused by lower sales to the semi and vacuum coating market after the strong 26% increase and the record level we had in Q2. All other markets recovered from Q2 levels, an increase between 12% in general vacuum and 74% in security and energy. On a geographic basis, Europe reached 30%, North America 29%, Asia Pacific ended with 41% of total third-quarter sales. As you can see in the chart, Europe and Asia developed more or less stable, North America did drop by approximately 4%. Compared to previous quarter, Q2, all markets except semi and vacuum coating did grow in Europe and Americas. Let's go to slide number 13.
The gross margin for the third quarter of 2020 reached 45% compared to 49.6% in the same quarter of last year. The margin percentage decreased significantly by 466 basis points. Besides various COVID-driven inefficiencies in materials productions with some process changes we had to do and logistics, the product and market mix and the current price pressure in China did drive the gross margin down. Moving on to our operating expenses, R&D expense in the third quarter reached $9.7 million. We continue to invest to support future product launches and push ahead with our strategic projects. The cost increased by 10.2%. SG&A expense did develop stable and ended at $21.1 million. As a percentage of sales, this represents 23%. Let's turn to the bottom line. For the third quarter of 2020, we achieved income from operations of $10.5 million or 11.4% of sales.
This compares with income from operations of $16.3 million or 17.5% in last year's third quarter, which means the result did decrease clearly by 35% compared to last year. Let's go to the next slide. For the third quarter, we recorded tax expense of $2.4 million, which represents an average tax rate of 23.4%, stable compared to last year's tax rate of 22.7%. As a result, the net income reached $7.9 million or 8.6%, compared to $12.4 million or 13.3% in the same quarter last year. The third quarter income equates to earnings of $3.24 per diluted share, compared with net income of $5.10 per diluted share in the same period last year. The decrease for both net income and EPS is caused by the decline in operating income. Now let's move to the balance sheet highlights on slide number 15. Our net cash position was $25.7 million.
This compares with $15.1 million at the end of last year, which means a decrease of about $24.4 million. Main driver for the decrease is the $45 million dividend payment we had in April this year. As a better comparison, last year's Q3 net cash was at $29.1 million, a difference of -$3.4 million. The slightly lower cash flow generation due to higher working capital balances is the main driver for this slightly lower cash. The operating cash flow, which you can also see on the slide, did improve versus previous year and also did improve versus previous quarter and reached with $15.5 million a solid level. For the third quarter, our accounts receivable ratio, days sales outstanding, reached 50.9 days and was better than the end of last year, also better than in our previous quarter, too.
Payment morale and behavior of our customers continued to stay good despite these tense times with the pandemic and other influence factors. Inventory reached 2.7 turns. The working capital level increased mainly due to higher accounts receivables and inventory numbers, partially compensated by higher accounts payables. Looking at the balance sheet structure, the equity ratio reached approximately 65% in Q3 after 76% in Q4. As another comparison, more or less at the same level as one year ago in Q3 2019, where we had 66% ratio. We have no material long-term liabilities and a net cash position of $26 million, which confirms a solid balance sheet structure. With that, I covered our current quarter results. I conclude my portion of the call with the guidance. Finally, as we move ahead now in the fourth quarter, I would like to comment the guidance.
Many things in the world are still moving around in our fragile business environment. Global trade and the pandemic are still hard to predict, but due to improved order situation, the strength of the semiconductor market, we assess the outlook for the coming quarter cautiously optimistic. Based on that, we expect sales of $370 million-$390 million with an operating income margin of 15%-16%. The last slide shows our corporate calendar and the upcoming dates. This concludes our part of the presentation, and we are ready to take your questions.
We will now begin the question and answer session. Anyone who wishes to ask a question may press star and one on their touchtone telephone. You will hear a tone to confirm that you have entered the queue. If you wish to remove yourself from the question queue, you may press star and two. Participants are requested to use only handsets when asking a question. Anyone who has a question may press star and one at this time. The first question comes from the line of Joern Iffert from UBS. Please go ahead.
Yes, good morning, Lukas. Good morning, Matthias. Thanks for taking my questions. The first one would be please on your profitability outlook for Q4, and in the lower end is reflecting a significant improvement on EBIT margins versus Q3. Can you tell us where this is coming from? Is it really already a strong gross profit margin recovery or is it more SG&A cost discipline? Second question would be, please, on your overall gross profit margin impact. We have seen now in 2020 of around $10 million. Can you split this in the tariff impact, in the pricing pressure impact as an extra cost you had, and how fast you can recover this in 2021, 2022? Third question, please, on semi. You mentioned you see the memory market to be more volatile or you see mixed signals.
What do you expect here for 2021, looking on your end feed that you get from your sales teams on the ground? Many thanks.
Thank you, Joern. It looks like you're always the first one who is allowed to ask questions. Why that's the case, I don't know. Let me go into your questions. Gross profit margin outlook for the last quarter or operating income outlook is clearly based on improvements on the gross profit margin side, not on the operating expense side. We are looking to end the last quarter with gross profit margin closer to 50%, not reaching 50%, but closer to 50%. That's what we see currently. As you know, we had several impacts why we had this gross profit margin drop. That's main part of your second question, how can the roughly $10 million be split?
I do not know the exact figures, but at least can tell you that for all impacts, we are talking about more than 1 million impacts on tariffs, on the price pressure, on some COVID-19 issues, especially on the material side and some inefficiencies in our processes going to second shift and then the special shift payments. If you add up all that, you get close that you mentioned and what had the single biggest impact? I'm not 100% sure, but I would assume it's the maybe Matthias knows it better. He usually has the figures. It's the China impact on tariffs and on price pressure. Only number three are the COVID-19 inefficiencies. Your third part of the question, what can we expect in the memory market? We don't know exactly. What we see is that there is at least some movement going on.
Even Samsung announced they first pushed out some investments into 2021. Now it looks like they are really serious about doing it in 2021. We might see some recovery in the memory market in 2021. As you know, especially the Chinese manufacturer will continue to make memories. Now they're even looking to go into some of the foundry business, which is a little bit more complex. On the memory side, the Chinese manufacturers will continue to invest. From that point of view, I assume, or at least we assume that the memory market in 2021 will be above 2020.
Many thanks. May I follow up, please, on the gross profit margin question for Q4? Your gross profit margin is suffering now in Q2, Q3. How is it possible that you so quickly can recover in Q4? Have you increased price points or are the tariffs falling away or what is really happening here? Is it 50% or close to 50% gross profit margin level now also sustainable going into 2021?
First of all, I think there are two effects that we see. One is a clearly product mix with more revenue coming from the semiconductor market in the last quarter. The product mix goes to a higher gross profit margin products, first of all. Secondly, we had some one, I would then call them kind of small one-time impacts in Q3 with some cleanup activities that we went through in order to improve the gross profit margin. You also find some things that you have to clean first, and that's what we did. Not having those one-time impacts anymore and the better product mix will lead to a better gross profit margin. Yes, we believe that we can keep a certain level close to the 50% mark, but it's still our target to, again, get over the 50%.
I think with some of the new products that we will launch in 2021, which clearly have an above average gross profit margin, we should be able to get closer to 50% again and keep that level on a sustainable level.
Thanks a lot.
You're very welcome.
The next question comes from Michael Foeth, from Vontobel. Please go ahead.
Yes, good morning gentlemen, and a few questions from my side. The first one's regarding semiconductor as well.
This big swing that you had between Q2 and Q3 in the semi space, and this inventory replenishment or catch-up that you talked about, which products were mostly affected, and which products sort of are the reason that you had this drop in the third quarter? Leading to the next question, which type of products, or let's say, which type of customers are expecting to generate the higher sales in the fourth quarter? That would be the first one, so explaining that swing. The second one would be if you could actually give some rough idea on the exposure that you actually have to the Chinese semiconductor market within that sort of end market. The last question would be regarding your sales guidance, $370-$390, that's still a pretty huge range when you consider just one quarter.
My question would be, what are the swing factors between the lower and upper end of the guidance?
Okay. Thank you, Michael. Let me try to explain as best as I can. The swing that you mentioned between Q2, Q3 can be clearly allocated to, I think we start now with the customer type and then going back to what product is used there. It's driven by our end user business more than on the OEM side. Having said that, it's primarily in the end user business in China, with some delays due to some hurdles in the administrative kind of approval process to get imports and exports in and out China and had some, I would call them end of quarter effects that led to some, I would say, delays in acceptance tests, primarily in China.
Having said that, because we talk about end user business, it's the product line that deals with those yield enhancement solutions that we sell to the end user chip manufacturers. On the OEM side, the business was basically flat. No improvements, just flat. Even the shipments to our lithography customer remained at a high level, but flat. Now exposure into China, based on our answer on the first question already, you can see it's going up. It's going up very quickly on the end user side, but it's also growing on the OEM side. We see now competitors of companies such as Applied Materials and Lam and so on, starting to generate revenue in China in order to get around the war on technology.
Therefore, the exposure overall to the Chinese semiconductor market, I do not know exactly the figure, but it's probably in the neighborhood of reaching more than 20% of our semiconductor business goes directly to China. Indirectly, it's even higher because we do not know exactly where our OEM customers ship their products. If you look into some of the press releases from, especially Applied Materials or Lam Research, you can see that their exposure into China is starting to get larger as well. Indirectly, our exposure to China is even more than what we see direct in our books. Coming to your third questions, why do we have this relatively large range? There are two main reasons. One, again, coming to the semiconductor end user business in China, where we depend heavily on acceptance tests and on revenue recognition timing and doing the installations.
That's true for all semiconductor end users, but it's most critical in Taiwan and in China, where our revenue recognition depends very much on the acceptance test at the end user side. Not so much with Korea and not so much with Europe and the U.S. That's the first big swing factor. The second swing factor comes from some other activities in China, where we depend on getting export licenses, primarily in conjunction with some security-related products that we have in the books but have not recognized revenue yet and have not even get export licenses for all products. This process became much more cumbersome over the last few months. So we have to apply for export license, not just for security products, but also some customers in the refrigeration markets are listed on this strange, how do they call it?
We call it internally the blacklist, but the official title is differently. The customers are listed on the US export control restrictions, and we have to get licenses even for some leak detector for refrigeration market. That creates this big range between $370 and $390.
Very helpful. Thanks a lot.
You are very welcome.
As a reminder, if you wish to register for a question, please press star and one. The next question comes from Marta Bruska from Berenberg. Please go ahead.
Hello, good morning. I would like to ask you if you could please explain a little bit more about what are those process monitoring solutions that you sell into China that suffered in the gross margin. Is it basically hardware, software, or a combination of both? Could you also remind us, please, if I remember correctly, was that since 2019 when these tenders appeared and started to become a problem for the gross margin? What was the reason that they appeared at that particular point in time, please? Thank you.
Thank you, Marta. Those product lines that we sell are not simple plug and play products. Those are typical systems or solutions, which is a combination of a couple of different sensors, a lot of software, and application support that we do on site. We always talk about a few million per fab line. It's not just a few thousand. That's what we sell, though it's primarily around gas analysis for high pressure, low pressure based on either mass spectrometer or optical sensing technology, together with some very advanced software packages and, as I mentioned, on-site engineering support. You call it a problematic gross profit margin. Yes, it is very low, from our point of view, it was a clear strategic decision to participate in those auctions.
We did win the majority of the bets, and we believe that this initial low gross profit margin will ease the price to get into the account, and that the follow-up orders will not have that low gross profit margin anymore. In fact, we have already seen that at least in one case, not in all cases yet. Why did it happen let's say dominant in Q3? Because now we made those shipments. The auctions took place much earlier, of course, but in Q3, we had two larger installation shipments that we made that went through this auction. It was a kind of an initial shipment that we made in both cases. I cannot disclose the name of the customers, but there are not that many in China, so you can maybe guess. Will it occur later on? We assume not.
We know that we have still one of those larger accounts in the books that probably will be shipped in Q4. Beyond that, we have follow-up orders now, which has already a higher gross profit margin than the initial setup that we offered. Therefore, this was a clear strategic move, and we knew that we will suffer on the gross profit side. We assume that based on the history with those customers, that it will go back to normal levels of gross profit margins once we have win the account.
Thank you. That's very helpful. Just that I understand that correctly, that sounds like those solutions are very specific for China and very specific for those customers. It's just basically a new product altogether. Is that the right way of thinking about it?
No, that's not correct. It's a very similar solution that we offer also to the non-Chinese semiconductor customers. It's just that those customers are brand new customer for us, so it's always the first installation that we had to go through an auction.
Okay. Why this started in 2019 versus when you sell to China before, and we somehow didn't hear about this sort of a more condensed auction issue. I just wanted to understand what triggered this change, basically.
It was a clear decision that we made.
Okay, you wanted to become more aggressive and you just wanted to-
Absolutely.
Okay, now I get it .
All to get to a 80% market share in China, and that's what we believe we can reach.
Yeah. Okay. That sounds very good, actually. Thank you very much.
You're very welcome.
The next question comes from [inaudible] . Please go ahead.
Yes, good morning, gentlemen. I have two quick ones. The first one is about last year, you also reiterated its guidance the same time. At that time you said it's uncertain whether all orders will come, and at the end of the day, you missed the guidance. Therefore, the question, how sure are you that you really can deliver and that there are no postponements or whatever? This is the first question.
We can, of course, not give you a full guarantee, but there are two facts basically, that makes us feel very confident. First of all, the range is quite large, and secondly, all the momentum is very positive. Based on those two facts, we are very certain that we are within the range. Where exactly we end up really depends on the timing of shipments and revenue recognition. The fact that our order momentum is very positive, first of all, and as I said, the range is quite large, w e should be within that, with a high certainty, be within this $370-$390 range.
Okay. It's not dependent on one or two single bulk orders in that case, like last year?
No. We have, of course, always a few of them, but they are not as huge as last year.
Okay, got it. Probably we are a little bit early in the year, but the consensus is expecting growth of about 12%-13% for next year. I know that you can't comment that, but probably in general, as you're a little bit prudent on memory, where is growth coming from next? Is it more the recovery of the non-semi divisions? Do you believe still in a strong growth in semi, looking into your crystal ball?
My crystal ball tells me that the semiconductor will continue to behave well, and on top of that, as I mentioned at the beginning of the call, we have a bunch of new products that are new, which are not depending on market growth, which are really depending on new applications and further enhancements in the range of processes that we can cover with our instruments. The growth in the semi has two sides, new applications as well as market growth itself. I expect certainly a recovery in the security market.
Okay, got it. Many thanks.
You're welcome.
Once again, to ask a question, please press star and one. The next question comes from [Rolf Swendenberg] from Helvea. Please go ahead.
Yes, good morning, gentlemen. I have three questions. One is what you mentioned on the war on technology. In that respect, can I just first check a number? You mentioned something of semi exposure in China, 27%, but then on top comes the indirect part. Is that right? Is it like 30%-40% semi China?
I did not say 27%. I said above 20%. That's correct. Yeah. Within the semi exposure, it's more than 20% goes to China directly, and indirectly we don't know exactly. Assuming that from the indirect part, a good percentage goes to China as well, it could be as high as 30%.
Okay, thank you.
There's one large exception maybe, that's everything that we ship to the extreme ultraviolet lithography market does not go to China.
That's understood. Several articles have been indicating that because of this war on technology, the Chinese have been stockpiling or hamstering products. What's your view on that? Do you recognize that, or is it outside of what you are doing?
We believe that a part of the growth is coming from this stockpiling. We don't know how much, but I share that concerns with some of these articles.
Okay, thank you. You indicated to expect a strong Q4 in semis. Is that similar strong then as the past Q2, which was extremely strong?
I don't know the exact details. I would have to dig in the figures to give you a better and a clear answer. I don't know yet at this point in time, but let's say that in other words, it's not just depending on semi. Other markets are recovered very clearly.
Okay, thank you. On the security segment, it's now for logical reasons in the U.S., low and there's new product launch to come. When do you expect it to be around the levels we've seen in 2018, 2019?
Probably not before 2022.
Okay, great. Yeah, no further questions. Thank you. Have a good fourth quarter.
Thank you, [Rolf]. We always could use the good wishes.
Ladies and gentlemen, this was the last question.
In case there are no more questions, I simply like to thank you all for being very active in this conference call, and I like to talk to you again once we have finished our last quarter, hopefully on a very positive note. Thank you very much and have a great day. Bye-bye.
Thank you.
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