inTEST Corporation (INTT) Q3 2016 Earnings Report, Transcript and Summary

Welcome to inTEST Corporation’s 2016 Third Quarter Financial Results Conference Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference call is being recorded today. A replay will be accessible at www.inTEST.com. I'll now turn the call over to inTEST’s Investor Relations Consultant, Laura Guerrant. Please go ahead.

Thank you, Laurie, sorry. And thank you for joining us for inTEST’s 2016 third quarter financial results conference call. With us today are Robert Matthiessen, President and CEO; Hugh Regan, Treasurer and Chief Financial Officer; and Jim Pelrin, Executive Vice President. Mr. Matthiessen will briefly review highlights from the third quarter as well as current business trends. Mr. Regan will then review inTEST’s detailed financial results and discuss guidance for the fourth quarter. We’ll then have time for any questions. If you’ve not yet received a copy of today’s release, a copy can be obtained on inTEST’s website, www.inTEST.com. Before we begin the formal remarks, the Company’s attorney’s advice that this conference call may contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements do not convey historical information, but relate to predicted or potential future events that are based upon management’s current expectations. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. Such risks and uncertainties include, but are not limited to, our ability to implement and execute the 2015 repurchase plan, changes in business conditions in the economy, changes in the demand for semiconductors, changes in the rates of and timing of capital expenditures by semiconductor manufacturers, the success of our strategy to diversify our business by entering markets outside the semiconductor or ATE markets, progress of product development programs, increases in raw material and fabrication costs associated with our products and other risk factors set forth from time-to-time in the Company’s SEC filings, including, but not limited to inTEST’s periodic reports on Form 10-K and Form 10-Q. The Company undertakes no obligation to update the information on today’s conference call to reflect events or circumstances after the date hereof or to reflect the occurrence of anticipated or unanticipated events. And with that, let me now turn the call over to Bob Matthiessen. Please go ahead, Bob.

Thanks for the interval, Laura. I'd like to welcome everyone to our 2016 third quarter conference call. I’ll review some of the highlights, our markets and what we are seeing in our customer base and then Hugh will review the financial results in detail. Q3 results were again strong, net revenue, gross margin, net earnings and earnings per share all increased on both the sequential basis as well as year-over-year and exceeded our guidance range. These results were fuelled predominantly by our thermal division which had revenue growth of nearly 20% sequentially. The telecom market was a significant component of our thermal division revenues with both bookings and net revenues increasing from the prior quarter. Outside of the semiconductor industry telecom has been the strongest sector for our business this year and lastly profitability remains the hallmark of our business and we continue to generate cash. At the end of the quarter cash and cash equivalents were at record levels. Now, let me look at the thermal products segment. As I just noted our thermal products segment which is our largest and most profitable division was the major contributor to the quarter's strong results. We strategically diversified this segment resulting in new opportunities in industrial testing and broadening our end market penetration into electronics test applications in various growth markets, including automotive, consumer electronics, military, aerospace, energy, industrial and telecommunications. In addition, new product offerings have opened industrial markets outside of this for both OEM and end user applications. Thermal product segment bookings for the third quarter were 7.3 million compared with second quarter bookings 8.2 million. Q3 thermal segment revenues were 6.6 million compared with 5.6 million for the second quarter. A few highlights of our thermal segment. We have a new U.S. customer in the medical industry with multiple locations that purchase three thermal platforms with additional systems expected. A major defense company purchased six thermal streams with customer closures and five thermal platforms. A major Korean semiconductor company purchase the thermal slide, which is the first direct contact system sold into Asia. We had seven customers in Indian semiconductor market that purchases our thermal streams and in addition, we required a new European customer serving in the automotive market with the purchase on a thermal stream. In process chiller systems, chiller bookings increased 52% over the second quarter, primarily from the defense market were a major defense organization purchased its first ambient chiller capping a successful multi-phase development project that should generate system orders over the next several years. Now let me turn to our EMS products division. The EMS business was down slightly compared to the previous quarter impacted by a robust first half year that satisfied high demand and the ongoing effects of customer consolidation. Automotive, consumer electronics and industrial markets continue to drive business in Q3 as it has throughout the year. Q3 mechanical product segment bookings were 1.7 million, compared with 2.4 million for the prior quarter and mechanical sales were 2.1 million, compared with 2.7 million in the second quarter. Q3 electrical product segment bookings were 2.3 million, compared with Q2 2.0 million and electrical revenues for the third quarter were 2.1 million, compared with 2.2 million reported in the second quarter. Some highlights from the EMS group for the quarter included a major sub-contractor in China who purchase production volume docking and interface products for the Teradyne Uflex test system. A major multi-national IDM purchase an MDI setup for a new tester platform with production volumes expected in 2017 and a new customer in the U.S. purchased Intellidock docking hardware. And a new major OEM customer purchased one of the latest interface products. So key drivers for inTEST or the surging use of sophisticated electronics in automobiles, continued growth of telecommunications and Internet backbone, the drive for improved semi-device packaging and the growth of the Internet of Things. By continually responding to the changes in our industry, we are well positioned to meet the needs of our customers in their technological roadmaps evolved. Our long-term objective is centered on diversified growth through acquisition and we continue to look for strategic opportunities. As we continue to execute on our differentiated product strategies, we believe the conditions for our long-term success remain firmly in place. And with that, I’d like to turn the call over to Hugh to discuss our third quarter results in detail. Hugh?

Thanks, Bob. Third quarter 2016 end-user net revenues were 10.4 million, or 97% of net revenues, compared to 9.7 million, or 93% of net revenues in the second quarter. OEM net revenues were $341,000, or 3% of net revenues, down from $770,000, or 7% for the second quarter. Net revenues from markets outside of semiconductor tests were $2.8 million, or 26% of net revenues, compared with $2.5 million, or 24% of net revenues in the second quarter. The Company’s third quarter gross margin was $5.6 million, or 52% as compared with $5.3 million, or 51% in the second quarter. The improvement in the gross margin was primarily the result of a reduction in our consolidated component material costs which was partially offset by an increased in our fixed manufacturing costs both in absolute dollar terms and as a percentage of our net revenues. Our consolidated component material costs were 33.0% in the third quarter down from 34.6% in the second quarter. The decrease in our consolidated component material costs was the result of decreases in the component material costs and our Thermal and Mechanical product segments. Our Thermal Products segments component material cost decreased from 32.4% in the second quarter to 30.7% in third quarter, while our Mechanical Products segment saw its component material costs decline from 37.5% to 36.4% sequentially. These improvements were the results of more favorable product and customer mix in the third quarter as compared to the second quarter. The component material cost in our Electrical Product segment were essentially unchanged going from 36.8% in the second quarter to 36.9% in the third quarter. Our manufacturing costs increased by 90,000 or 7% sequentially due to increased other and benefit cost in our Thermal Product segment and these costs as a percentage of our net revenues decreased from 12% in the Q2 -- increased from 12% in Q2 to 13% in Q3. Selling expense was $1.4 million for the third quarter compared to $1.5 million in the second quarter, a decrease of $77,000 or 5%. The decrease was driven by reductions in spending on advertising and sales related travel. Engineering and product development expense was $905,000 for the third quarter compared to $982,000 for the second quarter, a decrease of $77,000 or 8% sequentially. The decrease was related to reduced product development costs in our Thermal Products segment. General and administrative expense was $1.6 million for the third quarter compared with $2.1 million in the second quarter, a decrease of $571,000 or 27%. Our second quarter G&A expense included $456,000, or $0.04 per diluted share, in acquisition related expenses compared to $23,000 of acquisition related expenses in the third quarter. When adjusted to remove these items, third quarter G&A expenses decreased $138,000 or 8% sequentially. The decrease was primarily the result of lower levels of stock-based compensation expense related to restricted stock awards granted to our three independent directors, which fully vested upon their reelection to our board at the end of second quarter. In addition there were lower levels of profit related bonuses and reduced professional fees in the third quarter as compared to the second quarter. Other income was $17,000 for the third quarter, compared to $18,000 for the second quarter and we accrued income tax expense of $631,000 in the third quarter, compared to $263,000 accrued in the second quarter. Our effective tax rate increased to 37% in the third quarter from 35% in the second quarter and the increase in our effective tax rate was the result of the repatriation of the million dollars from our German operation during the quarter and the incremental U.S. income tax that needed to be accrued on that dividend. At September 30, 2016, our deferred tax assets were $1.1 million and our remaining net loss carry forward was $1.0 million for domestic state primarily California and $70,000 for foreign related to our German operation. We expect that our tax rate for the fourth quarter 2016 will be in the range of 34% to 36%. Third quarter net income was $1.1 million, or $0.11 per diluted share, compared with second quarter net income of $486,000, or $0.05 per diluted share. Diluted average shares outstanding were 10,319,000 at September 30. We resumed our stock buyback in early September and during the quarter we re-purchased 18,546 shares at a net of $72,000, or $3.85 per share. As of September 30, 2016, we had repurchased accumulative total of 215,603 shares or just under 2.5% of our outstanding common stock at a net cost of $997,000, or $3.95 per share. We had suspended our stock buyback in May 2016 as we commenced significant due diligence on an acquisition opportunity that had been expected to close on August 1, 2016. Amortization and depreciation expense was $148,000 for the third quarter and EBITDA was $1.9 million for the third quarter, up from $882,000 in EBITDA for the second quarter. Consolidated headcount at the end of September, which includes temporary step with 118, an increase of 1 from the step level we had at June 30. I'll now turn to our balance sheet. Cash and cash equivalents at the end of the second quarter were $26.3 million, up $1.3 million from June 30. We currently expect cash and cash equivalents to increase in the fourth quarter 2016. Accounts receivable was essentially unchanged sequentially at $6.7 million. Inventory increased slightly by $83,000 to $3.4 million at September 30. Capital expenditures during the third quarter were $118,000, down slightly from $126,000 in the second quarter and represented new computer hardware related to a companywide system upgrades and additions to our leased product inventory in our German operation. Bob provided a consolidated segment and revenue and booking data earlier on the call, the backlog at the end of September was $6.1 million, up from $5.7 million at the end of June. In terms of our financial outlook, as noted in our earnings release, we expect that net revenue for the quarter ended December 31, 2016 will be in the range of $9 million to $10 million and that net earnings will range from $0.02 to $0.06 per diluted share. We currently expect that our Q4 2016 product mix will be consistent with Q3 that the fourth quarter gross margin will range from 46% to 49%. Operator that concludes our formal remarks. We can now take questions.

[Operator Instructions] Mr. Regan there no questions at this time.

Thank you very much operator. We did have some question submitted in advance of the call. So I am going to bring those up now. The first one was "You have talked in the past about margin enhancement and your margins were up again, what specific actions have you taken in this regard?" I am happy to respond to that question. Our margin have been enhanced due to number of actions we have taken in our mechanical and EMS business, I mean its testimony to the hard work that this team has done. We now make dollars in the lower breakeven point due to the fact that we’ve been able to make these margin enhancements and cost cuts, which have primarily been involved in several areas, one some redesign of the products, two, some changes in the procurement operations, and three, the increase in product and prices for certain manipulated products. And as a result of this we've really been able to improve this margin. In addition our machine shop operations for this facility has been restructured and what was historically a cost center has turned into a profit center for this operation. So, this is just one example of an extreme focus on controlling costs while simultaneously looking at selective price increases to strengthen margins. We've another question, “You've spoken before about strong demand in the telecom market from customers who sell optical transceivers, can you describe the recent trends you're seeing in that sub market and how did that level of current business relate to prior quarters?” Bob?

Yes, that's true. Jim, I'm going to pass this question to you since it's from the thermal group, why don't you answer that.

Alright Bob, yes the optical transceiver market has certainly come to live in the second and third quarter of this year, in particular it has been historically in the last three years a very strong market for us from the major players, it then became somewhat soft for three quarters coming into this year and what's happened is that many emerging companies in the market are developing 40 gig to 100 gig products, primarily for data farms, and they have -- the demand from these smaller companies particularly in Asia has really taken hold and they've been feeding our results in the optical transceiver market and we expect though they're not going to be as strong as they were perhaps in the second quarter we expect it's going to continue at a very healthy clip.

This is the operator. We do have a question online from George Melas of MKH Management.

So, you had very strong bookings again in the non-semi space, and can you sort of talk a little bit about that, maybe Jim can you sort of elaborate on that, is it a new product that you have or have you sort of cracked the code, have you got more mine share in some of these verticals like Telco, and in a way is it sustainable?

Well regarding Telco, the major portion of Telco is the optical transceiver market. Our ThermoStreams product in the thermal division is the production tool of choice for providing a temperature environment in manufacturing for testing and tooling optical transceivers. That started many years ago and about 2009, with one of the larger companies that spread to the other three major players and now with as I had just said that same tool is being used by all of the emerging companies producing high speed transceivers. And yes we see that sustainable because the market -- the data farm market is really going to go -- we believe is going to continue to expand and expand and expand and expand. With IoT really starting to take hold in the next year or so, I think that the amount of data that's going to needed to be stored is going to absolutely mushroom over next three to five years. So, we continue to see this as a strong market. Now that the companies that we're dealing with now will probably eventually be saturated and we expect new companies to come onboard. So, that's really growth of the -- within the telecom market. Other non-semi markets are more opportunistic or non-semi growth. We have a significant amount of business with a Tier 1 government contractor for specialty product, several specialty products that I really can’t discussed in any detail, but that’s multi-million dollar proposition for us. And we’re finding and also a lot of business in satellite communication as well, that is a real strong market for us that we’ve been in the past, but not to the extent that we’re in now. So I hope that answers your question.

Yes. It’s definitely. Thank you. As a follow-up on that question, it seems like the long-term bookings peak somewhat longer than and the semi bookings to translate into revenue. Is that because, there is more development to be done or is there something particular by the nature of this [multiple speakers]?

Of bookings in semi, we have our standard, our thermal stream product line, which is pretty much standard product and that can be converted from booking to revenue very quickly. And all of the rest generally our custom products that required design and development. In fact we often receive NRE for this and that’s one of the reasons that takes longer.

Got it. And then it’s more the non-standard, it’s quite a bit of this standard in telecom, but in non-telecom non-semi, it’s more sort of non-standard order?

It’s almost all customs.

Okay, great. And can you Jim, can you elaborate just a little bit on your under resources that you have to go after the non-semi market. How many people you have or maybe that’s too granular?

Well, I will say this we -- over the past four or five years, we have transitions our sales channels to which was entirely semi-centric, to electronic test centric. And it’s, we are really spending a lot of time with the sales channel and they are spending a lot of time going outside of semi-market. Most of the trade shows we go to our non-semi trade shows. The reason that we have and so successful on the telecom market, which is non-semi is because of this refocus.

Okay. And do you have dedicated people who are dealing with telecom or are you still too small in way to have dedicated team?

We don’t have dedicated people, but we certainly our -- sales directors certainly go to every telecom personally several times a year.

Okay, great. Okay. Fantastic results. Thank you very much.

At this time, there are no further questions. I’ll now turn the call to Bob Matthiessen for any closing comments.

Thanks. Thank you for your interest in inTEST. We look forward to updating you on our progress when we report our fourth quarter results in January. Also a quick reminder that we will be participating in the LD Micro Conference in Los Angeles on December 6th and the Midtown CAP Summit in New York sitting on December 8th. We look forward to see you. Thank you.

Thank you. That does conclude the inTEST Corporation 2016 third quarter financial results conference call.