Earnings Call: Q3 2018

Oct 18, 2018

Ladies and gentlemen, welcome to the Insecon Third Quarter 2018 Results Conference Call. I'm Andrea, the Chorus Call 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 and A session. The conference must now be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Mr. Lucas Vinkla, Chief Executive Officer of Inficon. Please go ahead, sir. Thank you, Andrea. Good morning, everyone, and thanks for joining us today to review our results for the Q3 of 2018. After a very strong first half year twenty eighteen, we report now, as expected, and announced a somewhat sequentially weaker third quarter with sales of over US101 $1,000,000 which is more than 13% above last year's 3rd quarter, and we increased our year end guidance despite a weaker demand in our semi and vacuum coating target market. You can find, as always, a PowerPoint presentation on the Investor Relations tab on our website that supports our conference call. Please turn to Slide number 4, where we start with the key figures for the reporting quarter. We closed 3rd quarter with increased sales in all our target markets and all sales regions. Total quarterly sales reached $101,400,000 which reflects an organic growth of 14.3% above last year's Q3. As I mentioned before, sequentially, we had a decrease of 2.7% compared to the Q2 of this year, and our book to bill ratio was below 1, which is another indication of a weaker second half twenty eighteen. With an increased gross profit margin as well as a little bit higher operating expenses, we finished the quarter with operating income of exactly US20 $1,000,000 after US15 $100,000 a year ago and net income was US15.3 million or 15.1 percent of sales. Mattias Trendle will review the numbers with you in more details later, while I'll now highlight some important developments in our target markets first. Please turn to the Slide number 5, where you will see the breakdown of our sales into the 4 focus markets that we serve. The pie chart, which did not change much compared with the same quarter a year ago, actually shows the real breakdown of our 4 target markets. The graph on the right side shows the increased importance and the rebound of the Asian market, while the contribution from Europe and America declined again after a strong Q1 of this year. Now let's do a quick analysis market by market, and we start with the smallest one. In the Security and Energy market, Slide number 6, sales increased more than 50% again year over year and 5% sequentially and reached USD 7,700,000. The main contributor was still the HEP site, our main portable on-site detection instrument, and the 2 largest customers remained the same as well, U. S. And Chinese government agencies. Also, sales for the 1st 9 months in 2018 were much higher compared to last year. We expect the 4th quarter to be much lower than the last quarter of 2017. And the market trend is still hard to predict, and it will not become easier with the current geopolitical uncertainties. On the energy side in this market, which represents a smaller part of our business, we continue to see an increased interest in the new green energy technologies such as biomethane gas applications, especially in Europe. In the energy market, we do serve a much larger customer base. Therefore, our energy business is less lumpy compared to the security activities, and it's easier to predict. Now moving to the refrigeration, air conditioning and automotive market on Slide number 7, where we can report a sales increase of 15.1 percent year over year and even a small sequential increase of 1.9%. The total sales of CHF 21,300,000 represent a new quarterly record with growth in all regions and all applications. Being the preferred number one supplier in the pure RAC manufacturers market is a good starting point to expand our market reach into adjacent markets. We are gaining market share in the automotive market and the service business around the world. In addition to the traditional needs for the leak tight components for gasoline and diesel powered vehicles, we have been able to secure a pole position in the new market of lithium ion battery production, primarily used for e cars, e buses as well as e bikes. With tougher regulations around the world, even smaller rechargeable batteries for all kinds of mobile devices need to be checked for leaks. This new application will generate the next growth opportunity for our full line helium, hydrogen, refrigerant and multi gas leak detection instruments, sensors and modules. These more industrial type leak detection applications were one of the drivers for the increased sales in Asia, especially in China, where we enjoy a very high brand recognition supported by a loyal, well established long term market organization. Now let's go to the semi and vacuum coating market, which includes solar, display, optics and semiconductor applications on Slide number 8, where sales increased 11.6% year over year and reached US44.3 million dollars but decreased 6.7% compared to the Q2 of this year, mainly driven by lower investments in OLED flat panel display applications in Asia. Sales to the pure semiconductor market were flat, but the demand was weakening as well. Design wins for newer tools as well as the acceptance of the extreme ultraviolet lithography technology for below 10 nanometer nodes helped to offset the lower demand for traditional semiconductor activities. Nevertheless, we expect that this dip in demand for semiconductors will be short term only and that the business activities will come back in 2019. Since the need for new and existing applications, such as smart sensors for industrial, health and automotive applications as well as inside of things, big data and artificial intelligence applications will continue to grow. On top of that, China will stick to its 5 year investment plan to become one of the top ranked semiconductor countries. Further productivity gains require new design technologies and new manufacturing processes such as EUV, ALD and ALE. We work closely together with our key customers to develop the right products and services to help them realizing those productivity gains. That was one of the reasons why we acquired a small software company called Final Phase Systems, or FPS, based in Austin, Texas, to be able to provide a more powerful combined solution to small and midsized semiconductor manufacturers. Finally, we had another positive quarter in the general vacuum market on Slide number 9 with sales of US28.1 million dollars which resulted in a year over year increase of 7.7% and a small sequential decrease of 1.4%, mainly driven by the European summer vacations lump. 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. We gained market share with our direct channels as well as with new private label products and get slowly into new applications such as stabilization, analytical and life science markets. And as a positive last topic, the leak checking technology that is used in our Contura S400 leak detector has finally been approved as an accepted quality inspection measurement by 2 large food companies in Europe for food packaging leak detection applications. This is a breakthrough for our Contura S400 leak detector in the food packaging market. Before I turn over to Matthias, I'd like to close my part of the presentation with an outlook on Slide number 10. There were no dramatic changes in the view how we see the next 3 months for most of our markets compared to 3 months ago, except that we have no clear picture yet about the impact of the potential war on tariffs on our business. Nevertheless, and despite the already foreseen weaker semi and vacuum coating market, With only 3 months to go, the visibility obviously improves automatically. We increased our previously given guidance from sales being around $400,000,000 to now clearly above $400,000,000 and an operating income of around 20% instead of just above 19%. With that, I'd like to turn over to Matthias, who will give you more details about our financial performance. Thank you, Lukas, and good morning to everyone on our Q3 conference call. I will cover our Q3 results and comment also our guidance for 2018. My commentary starts with Slide 12 of the PowerPoint on our website. As communicated this morning in our press release, revenues for the Q3 of 2018 came out at $101,400,000 compared with $89,400,000 in the Q3 of last year. Total sales increased by US12 $1,000,000 or 13.4%. We had a negative exchange effect of minus 0.8%, which means we had an organic sales increase in Q3 of 14.3%. Looking at the end market developments, all markets increased and the refrigeration, air conditioning and automotive market reached a new quarterly record level. The semi and vacuum coating markets did grow by approximately 12%. The general vacuum market showed a growth of 8% and the security and energy market had a clearly better Q3 than last year and increased by roughly 51%. On a sequential basis, sales in the Q3 were lower by 2.7% compared to the sales level in the previous quarter Q2. This decrease was mainly driven by about 7% lower sales into the semi and vacuum coating market. Now how does regional sales performance look like? On a geographic basis, Europe reached 27% and a slightly higher share, North America 25% and Asia Pacific ended with 46% of total third quarter sales. As you can see from the chart, sales increase was in Asia by roughly 13%, where all markets increased except semi and vacuum coating. Europe did grow by 19% and North America did grow by approximately 8%. Compared to previous quarter Q2 sales did increase in Asia by 4%, while Europe and North America decreased by 5.5%, respectively, 7%. Now let's go to the next slide, Slide 14. The gross margin for the Q3 of 2018 reached 49.7% compared to 48.7% in the same quarter of last year. The margin percentage increased by 100 basis points and the absolute margin increased by $6,900,000 or 15.8%. Moving on to our operating expense. R and D expense in the 3rd quarter reached $7,900,000 and increased by 12.4%. As a percent of sales, this represents 7.8% after 7.9% last year. SG and A, selling, general and administrative expense in the Q3 was $22,500,000 or 22.2 percent of sales, an increase of $1,200,000 or 5.6 percent. The increase in both expense items, R and D and SG and A, is driven by development projects, research activities, headcount additions in various functions and also a higher variable compensation and commission spend. Now turning to the bottom line. For the Q3 of 2018, we achieved income from operations of $20,000,000 or 19.7 percent of sales. This compares with income from operations of $15,100,000 or 17% in last year's Q3, which means the result did improve by roughly $4,800,000 or 31.8 percent compared to last year. The increase is due to higher sales volume at a solid gross margin, while costs did increase under proportionally. Let's go to the next slide. For the Q3 of 2018, we recorded tax expense of $4,100,000 which represents an average tax rate of about 21.1 percent, lower than the 24.4% recorded in the 2017 period. The tax rate is lower due to the taxable income mix of our various entities in the different jurisdictions. The net income for this year's Q3 reached, therefore, $15,300,000 or 15.1% compared to $11,200,000 or 12.5 percent in the same quarter of last year. The increase of 37% compared to last year is driven by the higher operating income in combination with the lower tax rate. The 3rd quarter net income equates to earnings of 6.3 dollars per diluted share compared with net income of $4.61 per diluted share in the same period last year. This represents an increase of 36.7%, which is good in line with the net income development. Now let's move to the balance sheet highlights on the next slide. Our net cash position at the end of Q3 was $64,600,000 which represents roughly 22% of our total assets. This compares with $85,000,000 at the end of last year, which means a decrease of about $20,000,000 So why did the cash decrease? The decrease is heavily driven, of course, due to the $50,000,000 dividend payment in April this year, which is now partially, in the meantime, compensated by new cash flow generation. The operating cash flow, which you can also see on that slide, did increase from previous levels and reached good $22,500,000 For the Q3, our days sales outstanding slightly increased and reached point 4 days compared to 50.3 days at the end of last year. The inventory levels did increase and therefore the turns decreased to 3.7 turns. And as a consequence, the working capital ratio did increase to 26.1%. On the balance sheet graph, on the left side, you see structure and composition of assets and liabilities. The equity ratio reached 70.1% in Q3 after 77.1% in Q4 last year, at the end of last year. Low material long term liabilities and the cash position gross cash position, I must say, of €85,000,000 confirm a solid balance sheet structure. With that, I will cover our current quarter results. I conclude my portion of today's call with the guidance comment. After having passed our 3 quarters in 2018 and based on our assessment of our various end markets which we serve, we updated and increased our guidance for the full year 2018. Sales are now expected to exceed $400,000,000 and the operating income margin should be around 20%. And this compares to our old guidance where we said sales will be around €400,000,000 and operating income will be above 19%. So the last slide shows our corporate calendar and the upcoming dates. This concludes my part of the presentation and we are now ready to take your questions. The first question is from Reto Amstarden from Badriere. Please go ahead. Yes, good morning. A question regarding your guidance. Can you give here some more indication, a bit more precise? When we look now at the Q4, I would expect this to be lower than the Q3. And can you give me some indication, is it more like, let's say, minus 10% quarter on quarter or less? Then on the semi and display cycle here, you speak about in the Q4, which should perform below average, I think, in relation of group context. And when you look at your 3 main areas there in display, semi OEM and end user business, Are there some different trends here? And then with respect to 2019, I think especially on the display side, with the overcapacity in the market, it looks like this market will remain weak in terms of new CapEx investments. Would you expect this to be compensated by, let's say, already an improvement in the semi business throughout 2019? How do you see this weakness and sustainability in that in this place? Thank you. Okay. Good morning, Reto. I'll try to answer your question as good as I can. First question was regarding our guidance to have a little bit more clarity. What I like to refer to here is that it goes basically into 2 directions. One direction is, and you had mentioned it already, has to deal with the weaker demand in the semiconductor and display activities. And what we see is clearly that the level that we have reached now is clearly below the level of the 1st 6 months of this year. And especially on the OLED side, we have experienced a sharper drop compared with traditional semi business, but that has nothing to do with the market itself. It has to do with the fact that we ship a broader range of products to the OLED application than we do to the semi. And therefore, the impact from a weaker demand coming from the OLED has a larger impact basically on Inficon business than just semi. What we also experienced and give you a little guidance here is that the difference between the end user business in semi and the OEM business in semi is clearly tilting a little bit over to the OEM side. So we are have a little bit more exposure now into the OEM business than we used to have with design wins for newer products and also with the acceptance of the EUV lithography technology where we have a nice part of that OEM business as well that helps to offset a little bit the weakening part of the end user business. Now your question was how low can it go down? We don't know yet that part because it usually depends on some timing elements at the end of the year. And that refers me to my second detail about your question. We have also a relatively high uncertainty about the exact figure in our specialty security part of the market. As you know, usually we depend on some large government orders and we do not have a huge backlog anymore in that market environment unless we might get another large order for the remainder of the year, but we don't see that yet. So therefore, the uncertainty as a percentage of total volume for the security market is much bigger than the uncertainty in the semiconductor vacuum market as a percentage of total revenue. So those are the two main triggers that can make plusminus €5,000,000 at the end of the year very easily. The timing of shipments for semi and as well as the uncertainty in security market. Now you asked the question about already into 2019, we have not yet provided an official guidance, but I can give you at least my gut feeling on what we see so far. And to make it very clear, yes, we believe we can compensate the the weakening part of the OLED business with a bigger exposure into the traditional semiconductor market. Now, in order to give you some details here, the OLED market did already start to weaken at the end of the second quarter this year, not just in the Q3. And we don't believe that the OLED level will go below what we now would refer to the second half of twenty eighteen going into 2019, because we know that some of the investments simply have been postponed into 2019, but not canceled. So therefore, I don't expect the OLED business will go down further compared with the current level. And I clearly see a little uptick on our semi exposure, especially on the OEM side of the business, where we really have been able to get some nice design wins and some market share gains on the OEM side of the semiconductor business. Thank you. You're welcome. The next question comes from the line of Jorn Iffert from UBS. Please go ahead, sir. Yes, good morning. And thanks for taking my questions. The first one would be again on the guidance for 2018. Do you think it's fair to assume that your run rate for Q4 is in between €90,000,000 €95,000,000 or is it more skewed towards €90,000,000 €90,000,000 Just an update here would be appreciated. And second question would be please, if you look on your Q3 numbers, can you help us to understand a little bit better between OLED and semi? I mean, when the downturn is coming quarter on quarter from OLED, it's down 10%. And then when you say semi is down and you compensated its market share gains, does it mean that you have market share gains, new product launches incrementally benefiting by 2,000,000, 3,000,000 euros for Q3 in semi. Is this fair to assume? And here also then the question for 2019, when the semi market, for example, would be down 5% to 10%, hurting your revenues by around maybe €20,000,000 in 2019, what do you think is the incremental benefit from the new product launches and the market share gains? Are we speaking about €5,000,000 €10,000,000 €15,000,000 just to better understand how you can offset some end market weakness? And the last question, if I may, do you already see the significant decline of investments of your key customer in Korea? Or are you not seeing this yet? Thanks. Let me thank you, Jurgen, for very detailed questions. I'm not even sure if I can answer all of them, try to do my best. Q4 run rate, and since we changed a little bit our guidance to now exceeding SEK 400,000,000, you can easily assume that the run rate needs to be around €90,000,000 plus We are probably not reaching €100,000,000 So it will be something between €90,000,000 €100,000,000 Where exactly, as I mentioned before, there could be an easy swing of plusminus €5,000,000 both directions just depending on security market. Now in you made probably your modeling regarding expectation for 2019. And as I mentioned before, we believe we can compensate the additional market share gains and with new applications and new products and services in the semiconductor business to compensate the OLED weaknesses? And how much will it be in terms of new products versus a certain market share behavior. It will be probably in the higher single digit figure, million wise, that we believe we can maybe small double digit, but somewhere in that time, the net environment that we believe we can generate new revenue with new type of applications and products, including design wins. Now I wasn't so sure about your last question. I think it was regarding some key customers in Korea and usually a couple of one big one and a couple of smaller ones. And as I mentioned before, we don't see any cancellations of projects. We only see delayed and postponement of our push outs of projects, but not cancellations, which makes us not that pessimistic for 2019 because we know that the business will come, but it will not come this year, it will come next year. So therefore, we see a clear, I would say, slightly positive mood within our key customers in Korea, 2019 will come back, obviously not as high as the Q1 of 2018, but to a very reasonable good level of business activities throughout the year for both applications semi as well as some OLED activities. As you know, at least one customer will come pretty short with a foldable flip phone again, which means that now the flexible displays reached the level of market readiness. And that's an OLED technology as well, which might trigger another round of investments for flexible OLED displays next year. Okay. Understand. So to make sure that I get this 100% correctly, so with your large client in Korea, your momentum is already down significantly for Q3 and in particular for Q4. It's not the case because you are taking more late cyclical that you are suddenly seeing the low point in your semiconductor sales in Q1 2019? I think the low point will be around now. Okay. Understand. All right. Thank you very much. Thank you, too. The next question is from Marty Compeze from Berenberg. Please go ahead. Yes. Good morning. One or two questions from my side, maybe leaving the semiconductor or staying with semiconductors in a way. In some earlier earnings call, you mentioned already that you're working on a new product range with the sales potential of somewhere between $25,000,000 $50,000,000 where you already did some CapEx. Can you give us an update on the progress here? And whether you expect these earnings already to come through next year? And the second question would be, you've talked about the record numbers in Refrigeration and Automotive. Can you give us a bit a better feeling for where this comes from? Does it come from the classic automotive business? Or is it really predominantly triggered by the new lithium iron batteries? Thanks. Okay. Good. Your first question, thank you, Martin. First question regarding some of our new services and products for the semi industry. Yes, we will see some impact this year and yes, we will be seeing more impact even next year. This is one part of the reason why we are quite optimistic to be able to compensate semi weakness all its weaknesses with some semi additional market share gains. And it will probably be, as I mentioned before, close to the single digit million run rate. And so that helps clearly. And on the RSC side, it's predominantly the new lithium ion battery trend, especially in China. So that was the single biggest driver and followed by interestingly, I would call it, a kind of a rebound in the classical RIC Manufacturers Industries and the stable automotive business. But the single biggest driver was the installation for new lithium ion battery manufacturing, who needs to be leaked checked in several staging throughout the manufacturing process. All right. Thanks. You're welcome. There are no more questions sorry, there is a follow-up question from Jorn Iferd from UBS. Please go ahead. Yes, sorry again, sorry, Ben, when I missed this. On the gross profit margin, can you give us roughly what is your view here for the next couple of quarters also considering your product mix and your development? And if you have any initiatives how you can improve your gross profit margins due to automatization, new supply chain setup or anything like this? Thanks. Yes. Let me try to give you a feeling on the gross profit margin and what we see. And first of all, yes, we try always to improve the gross profit margin and our investments in the cost of sales areas through robotics or automation and even giving outsourcing various activities and concentrating on core activities. That's number 1. And of course, number 2 in the research and development activities that we design in an optimized way to get here some optimized margin as well. What can we expect? As you know and as you follow Inficon since quite some time, we typically we run about now to give you a high range between 45% and maybe 53%. And given our product structure and our end markets, we have ranges from gross margins from 30% up to 80%, right? And therefore, there is a high dependency where we sell, to whom we sell and what kind of products we sell. The past showed that we are somewhere in a narrower margin between 48% 52%, and something in that range I also would expect in the short term and midterm future. Okay. Thank you. The next question comes from Michael Inouell from Credit Suisse. Please go ahead. Yes. Thank you. Good morning, everyone. Sorry for the late questions. I don't want to hold anyone up. Just have 3 from my side on the semi, on the cyclicality, just to understand a little bit. I know you're a bit more skewed to OLED than to the traditional semi business, but when we look at semi OEMs like Lam Research that has reported just recently AMET is coming up, KLA. Just to understand a little bit the cyclicality because your sequential revenues in semi and vacuum were down about 7%, whereas we see Lam over the 20% down, others probably in the same area. Just to understand a little bit what are here the dynamics, is it possible that actually that we have to understand that Inficon, for example, will see a weaker Q4 compared to the industry, so to say, and potentially also suffers like a quarter longer than the general industries? Just to understand this a little bit because currently, it looks a little bit like that. And another one on the semi also, the confidence that you have, I understand your point with the new product, so with the new product range, but the overall confidence that you said it will be a short term dip, which I also believe. But where do you take this confidence from? Because Lam Research, for example, was not really able to give a clear outlook into 'nineteen. They said we can only give an outlook on wafer CapEx in January. So I was just wondering where your confidence comes from that we will see only a short term dip? And maybe one last one for Matthias, if you would be able to give us a little bit more color on the CapEx plans for 'eighteen and maybe also for 2019 as you are investing also into new product ranges just to kind of model maintenance? Sorry for that. Okay. We do our best. Thank you for your question, Michael. I think from the cyclical point of view, the easiest way to answer your question is that to understand that we have about a fifty-fifty exposure between OEM and end user. As you already indicated that there is a time lag between the 2 customer groups. The OEMs are usually early cycle or more early cycle and the end user a little bit more on the late side with a time lag of depends on the application between 3 6 months. And therefore, we usually are, as an average, a little bit behind the OEM cyclicality. And so we are kind of in between what you would consider the on the end user on the demand side and on the other hand side, the equipment manufacturer side. So fifty-fifty-fifty exposure. We flatten out a little bit the cyclicality, but the low point of the dip is usually, again, as an average, probably around 3 months behind the lowest point of the dip of companies such as Lam are applied. And therefore, our Q4, as you clearly indicated already, we are not going to go up with the semi business. A little bit on the OEM side, but end user will be, as I mentioned before, late cycle. Therefore, our Q4 for semiconductor vacuum coating will be clearly lower than Q3. And then with Q1, we might then come back to the normal trend. Now how are we why are we confident about what I mentioned before? I think there are 2 elements. First of all, it's a through our key account management, we know roughly what major end users such as Intel's, TSMC, Samsung's, Hynix and the Chinese, what plans they have to invest for the next 6 to 12 months. So that's one level. We are very close to those large accounts. So we know their plans. So we can make our own prediction and calculation about where we might end up with our business. That's one element of the competence. And the second element is more coming from the new product cycles. If most of our R and D investments go in applications that would be used in the newer type of products. And of course, most OEMs try to push the newer products versus the old ones. Therefore, the likelihood that we might gain some market share with new products is higher than the old products. And on the CapEx side, I think I referred to Mattias. He has a certain feeling about what we are going to use. Yes. We even have some actual numbers, so not feedings. That's typical for finance people. So to give you some insight, so last year, we spent about $14,000,000 in CapEx in fiscal year 2017. And in the first half, based on our half year results, you can see that we spent about $10,000,000 So for the full year, I expect to have a spend, let's say, about $17,000,000 to up to maybe up to $20,000,000 even in CapEx for this year, in that range. And for next year, I would expect a lower level, a little bit lower level, maybe in the range of EUR 10,000,000 to EUR 15,000,000. Perfect. Thank you very much. Welcome. There are no more questions at this time. There are no more questions. I simply like to thank all of you for your patience, and I'm looking forward to meet you again or talk to you soon within the next couple of months somewhere in the world. Thank you very much and have a nice day. Thank you. Thank you. Bye bye. Bye bye. 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.