inTEST Corporation (INTT) Q2 2018 Earnings Report, Transcript and Summary

Welcome to the inTEST Corporation's 2018 Second Quarter Financial Results Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded today. A replay will be accessible at www.intest.com. I will now like to turn the call over to Laura Guerrant. Ma'am, you may proceed.

Thank you, Ian, and thank you for joining us for inTEST's 2018 Second Quarter Financial Results Conference Call. With us today are James Pelrin, inTEST's President and CEO; and Hugh Regan, Treasurer and Chief Financial Officer. Jim will briefly review highlights from the second quarter as well as current business trends. Hugh will then review inTEST's detailed financial results and discuss guidance for the 2018 third 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 attorneys advised that this conference call may contain 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, changes in business conditions in the economy; changes in the demand for semiconductors; changes in the rates of and timing of capital expenditures by our customers; the success of our strategy to diversify our business by entering markets outside the semiconductor or ATE markets; progress of product development program; increases in raw materials and fabrication cost 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 report 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 event. During today's call, we will make reference to non-GAAP financial measures. We have provided additional information concerning these non-GAAP measures, including a reconciliation to the directly comparable GAAP measure in our press release, which is posted on the investor page of our website, www.intest.com. And lastly, we'll be attending the following investor conferences in the next few months: The Canaccord Genuity Conference in Boston next week on August 8, and The Dougherty Conference in Minneapolis on September 6. We look forward to seeing many of you. And with that, let me now turn the call over to James Pelrin. Please go ahead, Jim.

Thank you, Laura. I'd would like to welcome everyone to over 2018 second quarter conference call. We continue to make progress in broadening our presence within the markets we serve as we diversify the company into a global world-class provider of thermal solutions for industrial manufacturing and electronic test. Operating results for the quarter were exceptionally strong, driven by orders for our broad-based solutions across test and industrial manufacturing. The robust demand associated with the semiconductor industry, with automotive sensors, mobility, technologies and the Internet of Things continues to benefit our semiconductor test business, while non-semi business drivers included solid demand from automotive, industrial, and defense aerospace markets. Q2 consolidated bookings of $19.3 million declined 6%, sequentially, but increased 32% year-over-year. Excluding Ambrell, the year-over-year increase would have been 11%. While consolidated net revenues of $21.1 million exceeded our guidance increasing 12% sequentially and 33% year-over-year, and again, excluding Ambrell year-over-year, increase would have been 5%. Gross margin increased from 50% to 52% quarter-over-quarter and GAAP net earnings per share increased by $0.35 sequentially, with non-GAAP adjusted net earnings per share up by $0.12. Both exceeding guidance. 38% of Q2, 2018 revenues were derived from non-semi compared with 36% a year ago. Our Thermal segment is the combined business of inTEST Thermal Solutions or iTS and Ambrell. We have strategically diversified this segment resulting in new opportunities in industrial manufacturing, through both OEM and end-user applications. This diversification complements our wide penetration into the electronics test market, broadening inTEST's footprint as a provider of highly engineered thermal products for both test and industrial applications. Our Thermal segment bookings of $13.1 million were down 8% sequentially and up 51% year-over-year. Excluding Ambrell, the year-over-year increase would have been 18%. While net revenues of $14 million increased 6% sequentially, and 52% year-over-year. And again, excluding Ambrell, the year-over-year increase would have been 5%. Breaking it down, Ambrell's Q2 bookings came in as expected at $5.7 million, and were down 19% sequentially, and up 13% year-over-year. Recall that this comes on the heels of Ambrell's Q1, 2018 record bookings. Major orders were driven by both semi and wire cable OEMs. End users in the automotive, energy and government sectors also provided significant orders. Revenue of $6.4 million increased 4% sequentially and 29% year-over-year driven by large orders from strategic customers in Europe. The quarter was driven by key OEMs serving a semiconductor market, where 2 customers combined ordered induction-heating systems valued at over $1.6 million. Ambrell brought back a long time absent customer in the electric motor market with the purchase of ECO heat systems valued at over $125,000 for preheated and [indiscernible] for a shrink fitting application. In other sectors, a major OEM is fiber optics purchased systems valued at over $500,000 for heating glass fiber. End users and automotive and energy combined to purchase Easy Heating Systems valued at over $275,000 for soldering and brazing respectively. Business for inTEST Thermal Solutions was solid with bookings of $7.6 million, up 2% sequentially and 18% year-over-year. Defense/aerospace drove strong sequential North American bookings, while the industrial sector with the uptick in energy production and the strength of the semi market drove our global bookings. These increases served to more than offset a reduction in telecom orders from optical transceiver companies, they tend to be placed in volume or not at all in particular, quarters. iTS's net revenue of $7.6 million increased 8% sequentially and 5% year-over-year. Bookings for temperature systems were driven by end users and defense/aerospace, industrial and semi sectors. A major defense company purchase 4 systems for their satellite development program, valued at over $150,000, a major supplier of RF and wireless devices purchased 8 systems for 2 facilities valued at over $250,000, and a major industrial supplier purchased 8 systems valued at $300,000 for testing components to be used in oilfields. Bookings for chiller systems, which is a growing line of iTS business reached the best quarter in the company's history. With the increase driven by orders from semi and industrial OEMs, along with defense/aerospace and industrial end users. iTS acquired a new OEM customer, that place chiller orders for their new platform of ATE systems, and bookings for fluid and gas chiller systems total 15 units, valued at over $600,000. The largest chiller quarter in iTS history. Our EMS Products business serves the automated test system market for the semiconductor industry. Strong Q2 EMS results followed and equally strong first quarter driven by the robust semiconductor industry, including a particularly large order from an IDM valued at over $2.5 million. As well as the automotive Internet of Things, industrial and consumer electronic markets. Bookings of $6 million declined by 2% sequentially and 3% year-over-year, while revenue was $7.1 million increased 26% sequentially and 6% year-over-year. A major IDM purchased over $2.5 million with multiple orders from manipulator dockings and interface equipment testing for 6 locations throughout North America, Europe and Asia. In other EMS news, bookings for 2 other end-user manufacturers were strong with a mix of docking systems and interface products valued at over $650,000, and a tester company purchased interface products valued at over $300,000. We continue to expand our customer base in the markets we serve, while growing our footprint in additional thermal test and industrial markets. Looking forward, our long-term drivers remain squarely in place and we see solid opportunities as we take advantage of the robust markets where we have a strong focus. For example, semi with its super cycle, IoT, automotive, including electric vehicles, optical transceivers and consumer markets. We will continue to direct our resources in those key markets to further grow market share and broaden our customer base. Our leadership in thermal continues to increase with greater opportunities at Ambrell, from our OEM partners and end-user projects. And iTS, we expect continued solid bookings in the semiconductor, defense/aerospace, and telecom market, as well as additional demand driven by increased investment by a key energy customer in the industrial market. And we expect demand for our semi-related products to remain brisk, which benefit both iTS and EMS divisions. Regarding EMS, we expect third quarter to reflect marginal softness in bookings, as a result of customer-related supply chain issues, specifically, some of our customers have been experiencing challenges in getting various components of their test cell in one place at the same time, which obviously translates into delaying orders to vendors like inTEST, whose lead times are less. Understandably, nobody wants to take delivery of material until they are going to use it. But that has a tendency to make orders fluctuate someway. We expect that it will take a quarter or 2 for this to work itself through. The success of our core business unit remains critical to ensuring a foundation of inTEST's continued success through maximizing the financial performance of these businesses. In addition, we continue to apply significant resources to our goal of diversified growth through acquisition. Specifically, these are synergistic acquisition opportunities that complement our current products and expertise, and we had the opportunities then to expand our market customers, adjacent products and geography. We plan to build on the 6 acquisitions we've made since 1977, which account for approximately 81% of our 2017 revenue. With the momentum of inTEST's solid performance in first half of this year, our commitment to focus resources in growth market areas, and globally overall positive economic climate, we are creating the conditions for long-term success and are well positioned to be on track for a strong 2018. And with that, I'd like to turn the call over to Hugh Regan. Hugh?

Thanks, Jim. Second quarter 2018 end-user net revenues were $18.2 million, or 86% of net revenues compared to $16.3 million or 87% of net revenues in the first quarter. Q2 OEM net revenues were $2.9 million or 14% of net revenues, up from $2.5 million or 13% for the first quarter. Net revenues for markets outside of the semiconductor market were $8.1 million or 38% of net revenues compared with $8.3 million or 44% of net revenues in the first quarter. The significant reduction in non-semi revenues in both the first and second quarters of 2018 was due to Ambrell having a large order from a customer in the semiconductor industry front end versus our usual back end. As noted earlier in the call, Ambrell's net revenues for the second quarter were $6.4 million. Excluding Ambrell, our net revenues from markets outside of the semiconductor market were $3.5 million or 24% of net revenues for Q2. So clearly, Ambrell continues to further diversify our served markets. Our second quarter gross margin was $10.9 million or 52% as compared with $9.4 million or 50% in the first quarter. The improvement in the gross margin was the result of decreases in our fixed manufacturing costs, both in absolute dollar terms, as well as, as a percentage of net revenues. This decrease was partially offset by an increase in our component material costs. Our fixed manufacturing cost declined by $76,000 or 3% sequentially, and they were more favorably absorbed in the second quarter due to the higher net revenues. As a result, these costs represented 13% of our net revenues in the second quarter as compared to 14% in the first quarter. The decrease in our second quarter fixed manufacturing costs was primarily the result of reduced facility costs for our Thermal segment in the second quarter compared to the first quarter. In addition, we had reductions in our Thermal segment's temporary workforce during the second quarter. Our consolidated component material cost increased slightly from 33.5% in Q1 to 33.7% in Q2, reflecting higher component material costs in our EMS segment. The increase in the component material costs in our EMS segment, which grew from 33.5% in the first quarter to 33.9% in the second quarter was due to a less favorable product mix in the second quarter as compared to the first. This increase was partially offset by reductions in the component material costs for both iTS and Ambrell. iTS saw its component material cost declined slightly from 33.8% in the first quarter to 33.5% in the second quarter, while Ambrell saw a reduction from 35.2% in the first quarter to 34.7% in the second quarter. In both cases reflecting a more favorable product and customer mix. Excluding the impact of the acquisition of Ambrell, our second quarter gross margin would have been $7.9 million or 54%. Ambrell's second quarter 2018 gross margin was $3.0 million or 47%. Selling expense was $2.5 million for each of the second and first quarters, but actually increased $62,000 or 3% sequentially. The increase was primarily related to higher levels of commission expense driven by the increased net revenues. To a lesser extent, there were also an increase in advertising costs. Engineering and product development expense was $1.2 million for the second quarter compared to $1.3 million for the first quarter, a decrease of $66,000 or 5% sequentially. The decrease was primarily related to lower levels of salary and benefits expense, and to a lesser extent reduced spending on product development materials in the second quarter. General and administrative expense grew from $3 million in the first quarter to $3.3 million in the second quarter, an increase of $345,000 or 12%. The increase in G&A expense was primarily the result of increased professional fees. To a lesser extent, there were also increases in amortization expense and bad debt expense. During the second quarter, we recorded a $710,000 reduction in our contingent consideration liability related to the earn-out for Ambrell compared to a $1.7 million increase in this liability during the first quarter. At June 30, 2018, we'd accrued $6.3 million for the 2018 earn-out payable. During the second quarter, we paid out $5.8 million for the 2017 earn-out payable. Our earn-out for Ambrell is based upon 8x adjusted EBITDA for both 2017 and 2018 capped at $18 million. We expect to have further variability in our financial results related to this item during the balance of 2018. Other expense was $121,000 in the second quarter compared to the other income of $75,000 in the first quarter, a sequential change of $196,000. The change from other income to other expense for the second quarter was the result of $124,000 in foreign exchange, transaction losses for the quarter, compared to $74,000 of foreign exchange gains booked in the first quarter. We accrued income tax expense of $382,000 for the second quarter compared to $601,000 in the first quarter. Our effective tax rate declined from 61% in the first quarter to 9% in the second quarter. The significant decrease in our effective tax rate as a result of the 2 factors: first, we reversed the $476,000 federal transition tax that had been accrued in the fourth quarter of 2017 as a result of the new tax legislation, when we determined that the accrual was no longer needed. The second factor is the impact of a contingent consideration liability adjustment not being tax deductible. When adjusted to remove the impact of the contingent consideration adjustment, and the reversal of the federal transition tax payable, our effective tax rates would've been 23% for the second quarter compared to 22% for the first quarter. At June 30, 2018, we had a deferred tax liability of $2.5 million, and we currently expect our effective tax rate for the balance of the 2018 to be in the range of 22% to 24%, excluding the impact of changes in the fair value of our contingent consideration liability, which as I mentioned, are not tax deductible. Our second quarter net earnings were $4 million, or $0.39 per diluted share, compared to $381,000, or $0.04 per diluted share for the first quarter of 2018. Adjusted net earnings for the second quarter were $3.5 million or $0.34 per diluted share compared with first quarter adjusted net earnings of $2.3 million or $0.22 per diluted share. The second quarter adjusted net earnings of $0.34 per diluted share included the aforementioned effect of the reversal of the $476,000 federal transition tax payable, which contributed $0.05 per diluted share. When adjusted to eliminate this item, second quarter 2018 adjusted earnings per diluted share would've been $0.29 per diluted share. Adjusted net earnings is a non-GAAP measure, which is derived by adding acquired intangible amortization adjusted for the related income tax expense to net earnings and removing any change in the fair value of our contingent consideration liability from net earnings. Adjusted net earnings per diluted share is derived by dividing adjusted net earnings by diluted weighted average shares outstanding. Diluted weighted average shares outstanding were $10,370,318 at June 30. During the second quarter, we issued 11,900 shares of restricted stock and options to purchase 35,700 shares at $7.25 per share. We did not repurchase any shares during the second quarter. Depreciation and amortization expense was $435,000 for the second quarter, up from $405,000 in the first quarter. Acquired intangible amortization of $247,000 in the second quarter was up from $216,000 for the first quarter. EBITDA was $4.8 million for the second quarter compared to $1.4 million reported for the first quarter. When adjusted for contingent consideration liability adjustments recorded during both periods, adjusted EBITDA would have been $4.1 million for Q2 compared to $3.1 million for Q1. Consolidated headcount at the end of June, which includes temporary staff, was 226, up 1 from the level we had at March 31. I will now turn to the balance sheet. Cash and cash equivalents at the end of the second quarter were $10.7 million, down $3.7 million from March 31, due to the payment of the $5.8 million, 2017 earn-out for Ambrell, as well as the final expenditures for tenant improvements for Ambrell's new Rochester facility, which opened on May 1. Cash today is at $12.7 million. During the third quarter, we expect to receive approximately $550,000 in grant funding to offset the cost of the $2.1 million tenant improvements for Ambrell's new facility. We do currently expect cash and cash equivalents to increase in the second half of 2018 prior to the impacts of any acquisition-related activities. Accounts receivable increased slightly to $11.6 million at June 30, included in the quarter-end receivables were $3.4 million for Ambrell. Inventory increased $191,000 sequentially to $6.9 million at the end of the second quarter and included in this amount was $2.1 million for Ambrell's inventory. Capital expenditures during the second quarter were $752,000, down from $1.2 million in the first quarter. Included in the first quarter capital expenditures was $1.1 million for the aforementioned Ambrell tenant improvements. Jim provided consolidated and segment revenue and booking data earlier on the call. The backlog at the end of June was $13.6 million, down from $15.4 million at the end of March. Included in the June 30 backlog was $5.5 million for Ambrell. In terms of our financial outlook, as noted in our earnings release, we expect that net revenue for the quarter ended September 30, 2018, will be in the range of $19 million to $20 million, net earnings will range from $0.19 to $0.23 per diluted share. We expect that adjusted net earnings will range from $0.21 to $0.25 per diluted share. We currently expect that our Q3, 2018 product mix will be less favorable as compared with the second quarter of 2018, and as the third quarter gross margin will range from 49% to 50%. Operator, that concludes our formal remarks. We can now take questions.

[Operator Instructions]. Our first question is from the line of Theodore O'Neill from Litchfield Hills Research.

Yes, just a couple questions. So there -- a couple of your peers are talking about and one of them just reported as you did, are reporting, I think, a slowdown in sort of the mobile side of the business. And I was wondering if you are seeing anything along those lines?

We really haven't experienced anything like that, and we don't foresee, we think the business is going to continue pretty much on track as it is at the present, at least for the next quarter. We haven't really seen any indicators from our customers as we said in our remarks earlier, EMS might see some softness in bookings because their customers are frankly, having trouble getting other products needed for their test cell.

That's a supply chain issue you talked about there.

That's correct.

Yes. and are you, either Ambrell or on the EMS side of the business, seeing any impact of either hedging or preordering? They are related to the potential tariffs?

No, we're not. That's an interesting question, in fact, I think, we had that question sent into us. We have not really seen, felt anything from potential tariffs, we continue to monitor our customers. They tell us that it's business as usual for them. Of course, things could always change quickly, but so far, it has not touched us.

Okay. Finally, what are your customers at Tesla, says they are going to double their production volume through the Model 3 sometime next year? Does that have an impact on the needed equipment that you sell them? Or the existing equipment they have, it's sufficient to ramp to double where they are right now?

We believe they will need expanded capacity, but we are not inside Tesla, so we can't say that definitively, but we believe that they will need to increase their production capability, which would be favorable for Ambrell.

[Operator Instructions]. Our next question is from the line of Edgar Roesch from Sidoti & Company.

First question, just a follow-up on the EMS potential slowdown of orders in Q3. Is that right to think that that's on the OSAT side that you're seeing there?

No, it's actually on the IDM side.

And then in the iTS business, you mentioned pretty good demand from the semi space right now, could you just speak a little bit, Jim, about which products you're seeing that materializing?

That would be our ThermoStream product, which is used in the product development and qualification in the engineering labs. That business has been very brisk, very strong.

Okay. So not chambers, it's more of the directed [indiscernible].

No, the chambers are more for the non-semi side of the business, when we talk about things like satellite -- used for satellite, products for satellite application and that kind of thing.

Okay. And then I don't know how relevant this is to you, but on optical transceiver side, some of the producers of those components are talking about 25 gigabyte data centers coming online in China, since that is kind of older technology, should we assume that there's no real incremental demand for your thermal products related to that type of build out? Or is that...

Well, not necessarily. The typical evolution of an optical transceiver manufacturer. This may require a new optical transceiver manufacturers coming online and we've seen that in the past. And they always have to start with a high-end products. So they have full chest capability. And then as they grow and mature, then they allocate that our high-end solution to their product development and state-of-the-art faster products that they are developing, while they use a lesser thermal solution for the -- everyday production chest be more simple transceivers. So it depends, certainly people in the business that are thoroughly entrenched, it won't create a demand for us there, but other new companies do come on the scene as a result of these things.

Okay. Yes, that's helpful. And then on the 400 gigabyte side, that next generation, that's still development phase, is that right?

That's correct. That's a long way from hitting production, they've got a lot to do to reduce the package, and to reduce the heat generated by the package.

And then, one for Hugh. You seeing any increase in aluminum or steel prices, driving part of the component cost increase?

Clearly, inflation is back in the mix, but we haven't -- I'm not seeing anything that's pushing significantly at this point, but we do expect cost to be going up in the new year. So -- but what's really been driving the issue more recently has been more of a customer mix issue and product mix issue as opposed to increases due to inflation, but we expect that to pick up to be honest with you.

Okay. And then last one. You mentioned key energy partner that sort of come back into the mix more recently. And do you see that as benefiting both Q2 and Q3? Or can you kind of parse that a bit?

We believe that this energy partner has kind of woken up. They were a long-term Sigma customer with major orders every year, and when the price of oil drops, they just stop purchasing, they slow their expansion efforts down. And now they seem to have kind of rightsized themselves and come to grips with the new energy economy, and so they are beginning to reinvest.

And our next question is from the line of Dick Ryan from Dougherty.

So Jim, now with the Ambrell a year under your belt, what's the current pipeline of opportunities look like maybe even addressing new customers or just the actual level of business that you see out there?

Well, Ambrell has been strong, it continues to be strong. Ambrell worked very hard to acquire some OEMs, particularly in the semi space because it's a good fit for their products and they've actually acquired some OEMs and displaced some competition, and that's driven quite a bit of business to date this year, and we expected to continue strong going into the second half of the year. And again, it's driven by the semi cycle. But they've also identified OEMs and working with OEMs and other areas. Their key to growth to significant growth is through large OEMs and end-users, and that's what they're working on. They're also working in the integrator market, they've got their first order from a first-tier automotive engineer, automotive integrator, and they're about to get another order from a second first-tier automotive integrator. So we think that's very exciting, but that's how they are going to grow.

Okay. Great. Hugh, I think on Q1 you guided for full year to the low $70 million range, $70 million range. With Q2 and the guidance for Q3.

I would say, the low $70 million range, I would say the mid-$70 million range now, I'd say quite frankly. Yes, I think, mostly it's...

Hopefully, we won't see a big drop off in Q4 to stick with that?

No. We're hoping seasonality does not come back that strong to us. So we're expecting mid now potentially even upper 70s.

Good. And do you have a stock-based comp for the quarter?

Yes. stock-based for Q2 was -- stay with me, $172,000, up from $121,000 in Q1.

Okay. And one last housekeeping. You said tax rate 22% to 24%, did you say for the next two quarters? Or is that the year?

That's what we expect the range for the next 2 quarters, and you could say, on an adjusted basis for the full year. Unfortunately, the contingent consideration adjustment is really skewing it. As I mentioned, Q1 adjusted is 22%, Q2 is 23%, when you back out the contingent consideration adjustment and we expect that, again, ex that number, we'll be in that range.

[Operator Instructions]. And at this time, I'm showing that there is no further questions in queue. I'd like to turn it back to Mr. Jim Pelrin, sir?

Well, thank you for your interest in inTEST. We look forward to seeing you at the conferences Laura noted, and to updating you on our progress when we report our third quarter results. Operator, the call is concluded.

Ladies and gentlemen, this does conclude today's conference call. We thank you greatly for joining us today. You may now disconnect.