Earnings Call: Q3 2020

Oct 21, 2020

Ladies and gentlemen, welcome to the Inticon's Q3 Results Conference Call. I am Alessandro, with Coruscalo Perito. I would like to remind you that all participants will be in listen only mode and the conference is being recorded. This presentation will be followed by a Q and A session. The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Mr. Lukas Zinkler, Chief Executive Officer of Intercom. Please go ahead, sir. Thank you, Alessandra, Christian, good morning, everyone, and thanks for joining us today to review our results for the Q3 of 2020. The Q3 can be summarized with 5 bullet points. First of all, the ongoing COVID-nineteen 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 Q2 of 2020. 4th bullet point is a disappointing cross profit margin due to several reasons, we'll come to that later. And last but not least, we expect a strong last quarter supported by a good order momentum. As always, you can find a PowerPoint presentation on the Investor Relations tab on our website. Please go to Slide number 3, where we start with key figures for the current reporting quarter. We closed the Q3 1.3% below last year's Q3 and reached €92,000,000 Organically, this reflects a 3.4 percent decrease compared and compared to the Q2 of this year, a reduction of 4.4%. On the positive side, the order intake is picking up in our quarterly as well as our year to date book to bill ratio is clearly above 1. With a disappointing low gross profit margin and stable operating expenses, we finished the quarter with operating income of US10.5 million dollars after US16.3 million dollars a year ago. This is onethree less than a quarter ago. Our net income was US7.9 million dollars or 8.6 percent of sales. Later on, Matthias Trendle will go with you through detailed figures. And now I go to the development of in our target markets. Now please turn to next Slide number 4, where you see the breakdown of our sales into the 4 markets that we serve. We've sequentially improved contribution from the REC, 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. Now let's do a quick analysis market by market. We start with the smallest one in the security and energy market on Slide number 5. Sales decreased more than 25% year over year. The sequential increase of 74% looks impressive, but it's compared to a very low Q2 of this year. So 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. And secondly, we are about to launch a brand new Hebside 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 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. Now moving to the Refrigeration, Air Conditioning and Automotive market on Slide number 6, with sales of US19 $1,000,000 which represents a sales decrease of 5.5 percent year over year, but enjoyed a 13.8% increase REC and refrigeration manufacturers started slowly to but REC 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, the e cars and ZCIM un 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 check 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 2 years on an annual basis. Now let's go to the semi and vacuum coating market, which includes solar display optics and semiconductor applications on Slide number 7, where sales increased 5.7% year over year and decreased 20.9 percent sequentially and reached US42.4 million dollars 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 2 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 profit low gross profit margins, since we decided strategically to win the majority of all Chinese chip manufacturers. And secondly, the U. S.-China trade issues as well as the war and the bond technology led to some shipment and installation delays as well as a continuation of enforced import tariffs for U. S. Goods, which has a negative gross profit margin impact as well. Outside of China, high end semiconductor companies invest in new sub-ten 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 and D cost 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 4th 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 8 with sales of US25.9 million dollars which is 3% below last year's Q3, but 11.6% of the weak Q2 of this year. As you know, we sell analysis, measurement and control products for many different industrial applications through 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-nineteen 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 show have been canceled. But 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 close my part of the presentation with an outlook on Slide number 9. 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 Given the positive order momentum and the current backlog, we leave our top line guidance unchanged at between $370,000,000 $390,000,000 And on the operating income, we expect to finish the year between 15% 16% of sales. With that, I'd like to turn over to Matthias, who will give you more details of financial performance. Thank you, Lucas. Good morning, everyone, to our Q3 2020 conference I will cover, as usual, our Q3 financial results and also commend 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 Q3 of 2020 came out at €92,000,000 compared with $93,200,000 in our Q3 of last year. Total sales decreased by a minimal $1,100,000 or 1.3%. Due to the weak US 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 €2,300,000 or approximately 6%, while the sales to the other end markets declined. On a sequential basis and shown in the chart on Page 11, sales in the Q3 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 in 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% and Asia Pacific ended with 41% of total 3rd quarter sales. As you can see in the chart, Europe and Asia developed more or less stable, and 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 Q3 of 2020 reached 45% compared to 49.6 percent in the same quarter of last year. The margin percentage decreased significantly by 4 66 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 in the current and the current price pressure in China did drive the gross margin down. Moving on to our operating expenses. R and D expense in the 3rd quarter reached 9,700,000 We continue to invest to support future product launches and push ahead with our strategic projects. The costs increased by 10.2%. SG and A expense did develop stable and ended at $21,100,000 As a percentage of sales, this represents 23%. Let's turn to the bottom line. For the Q3 of 2020, we achieved income from operations of 10,500,000 dollars or 11.4 percent of sales. This compares with income from operations of $16,300,000 17.5 percent in last year's Q3, which means the result decreased clearly by 35 percent compared to last year. Let's go to the next slide. For the Q3, we recorded tax expense of $2,400,000 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 $7,900,000 or 8.6 percent compared to $12,400,000 or 13.3 percent in the same quarter last year. The 3rd 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 $25,700,000 This compares with $50,100,000 at the end of last year, which means a decrease of about $24,400,000 Main driver for the decrease is the $45,000,000 dividend payment we had in April this year. As a better comparison, last year's Q3 net cash was at 29.1 $1,000,000 a difference of minus $3,400,000 The slightly lower cash flow generation due to higher working capital balances is the main driver for this slightly lower cash flow. 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 $15,500,000 a solid level. For the Q3, our accounts receivable ratio, day sales outstanding, reached 50.9 days and was better than the end of last year, also better than in our previous Q2. Payment morale and behavior of our customers continue to stay good despite these 10 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 our higher accounts payables. Looking at the balance sheet structure, the equity ratio reached approximately 65% in Q3 after 76% in Q4. And as another comparison more or less at the same level as 1 year ago in Q3 'nineteen where we had 66% ratio. We have no material long term liabilities and a net cash position of $26,000,000 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 Q4, I would like to commend the guidance. Many things in the world are still moving around and our fragile business environment, global trade and the pandemic are still hard to predict. But due to improved weather situation, the strength of the semiconductor market, we assess the outlook for the coming quarter, cautiously optimistic. Based on that, we expect sales of $370,000,000 to $390,000,000 with an operating income margin of 15% to 16%. The last slide shows our corporate calendar and the upcoming dates. And this concludes the formal part of the presentation, and we are ready to take your questions. The first question comes from the line of Jurgen Ivester 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, it's reflecting a significant improvement on EBIT margins versus Q3. Can you tell us where this is coming from? Is this really already a strong gross profit margin recovery or is it more SG and A cost discipline? 2nd question would be, please, on your overall gross profit margin impact. We have seen now in 20 20 of around $10,000,000 Can you split this in the tariff impact, in the pricing pressure impact and some extra cost you have and how fast you can recover this in 2021, 2022? And then 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 'twenty one looking on newer and feedback you get from the sales teams on the ground? Many thanks. Thank you, Jorgen. It looks like you're always the first one who is allowed to ask questions. Why that's the case, I don't know. Now let me go into your questions. Gross profit margin outlook for the last quarter Our operating income outlook is clearly based on improvements on the gross profit margin side, not on the operating expense side. So we are looking to finish the to end the last quarter with gross profit margin closer to the 50%, not reaching 50%, but closer to 50%, and that's what we see currently. And as you know, we had several impacts while we had this gross profit margin drop, and that's main part of your second question, how can the EUR 10,000,000 or roughly EUR 10,000,000 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 €1,000,000 impacts on tariffs, on the price pressure, on some COVID-nineteen issues, especially on the material side and some inefficiencies in our processes going to 2nd shift and then special shift payments. And if you add up all that, you 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, and only number 3 are the COVID-nineteen inefficiencies. And so the 3rd part of the question, what can we expect in the memory market? We don't know exactly, but what we see is that there is at least some movement going on. Even Samsung announced they first pushed out some investment into 2021. But now it looks like they are really serious about doing it in 2021. So we might see some recovery in the memory market in 2021. And as you know, especially the Chinese manufacturer will continue to make memories. And now they're even looking to go into some of the foundry business, which is a little bit more complex. But on the memory side, the Chinese manufacturers will continue to invest. So 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? I mean, your gross profit margins are right 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? And is this 50% or close to 50% gross profit margin level now also sustainable going into 2021? First of all, it's I think there are 2 effects that we see. 1 is clearly product mix with more revenue coming from the semiconductor market in the last quarter. The profit product mix goes to a higher gross profit margin products, 1st of all. And secondly, we had some one, I would then call them kind of small onetime impact 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. And so not having those onetime 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%. And I think with some of the new products that we will launch in 2021, which clearly has 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 Ford from Vontobel. Please go ahead. Yes, good morning, gentlemen. And a few questions from my side. The first one is 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 Q3? And then 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 Q4. That would be the first one, so explaining that swing. And 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 your within that sort of end market? And the last question would be regarding your sales guidance, dollars 3.70 to $390,000,000 that's still a pretty huge range when you consider just 1 quarter. So 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 start now with the customer type and then going back to the what product is used there. It's driven by the our end user business more than on the OEM side. And 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 into 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. And 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. And even the shipments to our lithography customer remained at the high level but flat. And now exposure into China, as you 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 this the war on technology. And therefore, the exposure overall in the 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. But if you look into some of the press releases from Specialty Applied Materials or Land Research, you can see that their exposure into China is starting to get larger as well. And so indirectly, our exposure to China is even more than what we what we see direct in our books. Now coming to your 3rd questions, what why do we have this relatively large range? And there are 2 main reasons. 1, 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. And 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. And 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. And this process became much more cumbersome over the last few months. And 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. And the customers are listed on the U. S. Export control restrictions and we have to get licenses even for some leak detector for refrigeration market and that creates this big kind of range between $370,000,000 $390,000,000 Very helpful. Thanks a lot. You're very welcome. The next question comes from Marta Brusca 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 suffers in the gross margin? And is it basically hardware, software or a combination of both? And 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? And what was the reason that they appeared at that particular point in time, please? Thank you. Okay. Thank you, Martha. Those product lines that we sell are not simple plug in 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 SAC. So we always talk about a few million per fab line. It's not just a few 1,000. And that's what we sell. So it's primarily around gas analysis for high pressure, low pressure based on either a mass spectrometer or optical sensing technology together with some very advanced software packages and, as I mentioned, on-site engineering support. Now you call it a problematic cross profit margin. Yes, it is a very low, but from our point of view, it was a clear strategic decision to participate in those auctions, and 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. And in fact, we have already seen that at least in one case, not in all cases yet. And why did it happen so, let's say, dominant in Q3? Because now we make those shipments. The auctions took place much earlier, of course. But in Q3, we had 2 large shop installation shipments that we made that went through this auction. So it was a kind of an initial shipment that we made in both cases. And I cannot disclose the name of the customers, but there are not that many in China, so you can maybe guess. And does it 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. But beyond that, we have a follow-up orders now, which has already a higher gross profit margin than the initial setup that we offer. So therefore, this was a clear strategic move, and we knew that we will suffer on the cross profit side. And 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, it sounds like those solutions are very specific for China and very specific for those customers. Is that basically as a new product altogether? Is that the right way of thinking about it? No, 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. Okay. And why this started in 2019 versus when you sell to China before and we somehow didn't hear about this sort of more condensed auction issue. So I just wanted understand what triggered this change basically? It was a clear decision that we made. Okay. So we wanted to come more aggressive and we wanted to get to 80% market share in China, and that's what we believe we can reach. Yes. Okay. That sounds very good actually. Thank you very much. You're very welcome. The next question comes from Perksen Oskar, Company, please go ahead. Yes. Good morning, gentlemen. I have 2 quick ones. The first one is about last year, you also reiterated its guidance at the same time, but at that time you said it's uncertain whether all orders will come and at the end of the day, you missed the guidance. Then for the question, how sure are you that you really can deliver and if there are no postponements or whatever? This is the first question. We can, of course, not give you a full guarantee, but you can there are two facts basically that we that makes us feel very, very confident. First of all, the range is quite large. And secondly, the order momentum is very positive. And so 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. But the fact that our order momentum is very positive, first of all, and as I said, the range is quite large. We should be within that, with a high certainty, be within this 370 to 390 range. Okay. It's not dependent on 1 or 2 single bulk orders in that case, yes, like last year? No, it's we have of course always a few of them, but they are not as huge as last year. Okay, got it. And then probably we are a little bit early in the year, but the consensus is expecting growth of about 12% to 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 year? Is it more the recovery of the non semi divisions? Or do you believe still in a strong growth in semi looking into your crystal ball? It's my crystal ball tells me that the semiconductor will continue to behave well. And on top of that, as I mentioned in the at the beginning of the call, we have a bunch of new products that are new, so 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. So the growth in the semi has two sites, new applications as well as market growth itself. And I expect certainly a recovery in the security market. Okay, got it. Many thanks. You're welcome. The next question comes from Ron Sverdrup from Helvea. Please go ahead. Yes. Good morning, gentlemen. I have three questions. One is what you mentioned on the war on technology. And in that respect, you 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? So is it like 30% to 40% semi China? I did not say 27%. I said above 20%. That's correct, yes. Within the semi exposure, it's more than 20% goes to China directly. And indirectly, we don't know exactly. But 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 the everything that we ship to the extreme ultraviolet lithography market does not go to China. That's understood. Because several articles have been indicating that because of this go wrong technology, the Chinese have been stockpiling or hamstring 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 the stockpiling. We don't know how much, but I share that concerns with some of these articles. Okay. Thank you. And then 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, but 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 it will be let's say that I don't in other words, it's not just depending on semi. Our markets are recovering very clear. Okay. Thank you. And then on the Security segment, when do you so 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 in not before 2022. Okay, great. And no further questions. Thank you. Have a good Q4. Thank you, Rolf. We can always use the good wishes. Ladies and gentlemen, this was the last question. Okay. There are no more questions. Then 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. Ladies and gentlemen, the conference is now over. Thank you for choosing Chorus Call and thank you for participating in the conference. You may now disconnect your lines. Goodbye.