Electro Scientific Industries' (ESIO) CEO Ed Grady on Q3 2016 Results - Earnings Call Transcript

| About: Electro Scientific (ESIO)

Electro Scientific Industries, Inc. (NASDAQ:ESIO)

Q3 2016 Results Earnings Conference Call

February 02, 2016, 05:00 PM ET

Executives

Brian Smith - Director, IR

Ed Grady - CEO

Paul Oldham - CFO

Analysts

Jim Ricchiuti - Needham and Company

Tom Diffely - D.A. Davidson

Operator

Good day, ladies and gentlemen, and welcome to the ESI Fiscal 2016 Third Quarter Earnings Call. My name is Stephanie, and I'll be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session toward the end of this conference. [Operator Instructions] As a reminder, this call is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Brian Smith. You may proceed.

Brian Smith

Thank you, Stephanie, and good afternoon, everyone. My name is Brian Smith, Director of Investor Relations for ESI. With me today are Ed Grady, our CEO; and Paul Oldham, our Chief Financial Officer. This call will cover our fiscal 2016 third quarter results.

Before we go into the details of the call, I would like to remind you that some of what we say on this call will include forward-looking statements concerning customer orders, shipments, revenue, gross margins, expenses and earnings. These statements are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements include a number of risks and uncertainties that are discussed in more detail in today's press release and our filings with the SEC. Actual results may differ materially from those forward-looking statements.

This call also contains time-sensitive information that we believe to be accurate as of today, February 02, 2016, and which could change in the future. This call is the property of ESI.

Now, I’d like to turn the call over to Ed.

Ed Grady

Thank you, Brian. Good afternoon and welcome to our third quarter conference call. This was a good quarter for ESI as we took more steps advancing our corporate turnaround. We grew our orders, increased gross margin, lowered our expense base, generated cash from operations and delivered positive earnings on an adjusted basis. We also introduced new products and earned key customer wins that will drive growth as we move forward. Paul will go into the financial details in a few minute.

Looking at Q3 and our near term outlook in the component processing space, GemStone continues to win in the Flex via drilling market and its momentum is building. It is wining on both industry leading performance and cost of ownership driven by our internally developed laser.

Looking forward, smaller vias, higher via densities and more complex flexible circuit designs should continue to grow demand for GemStone. While the overall growth in smartphones may be slowing, the use of flexible circuit is expanding to broader applications and becoming more complex that we believe we are well positioned in this market to capitalize on this growth.

We're leveraging our capability in flex circuits to expand into adjacent market. We achieved a key milestone in our strategy this quarter with the order received for our CornerStone IC Series 2 via drilling system. The selection of this tool by a large semiconductor manufacturer following an extensive evaluation period demonstrates this systems industry leading capability and speed and accuracy or current and next generation packaging application.

Its attribute to the ESI team that we won this business with our first offering in the IC Package market and I believe it positions us well to win additional business in this customer supply chain and alternative substrate packaging design.

Another exciting event in the third quarter was our entry into the HDI or High Density Interconnect market with the introduction of our nViant CO2 based via drilling platform.

HDI printed circuit boards are becoming more prevalent and represent the largest segment in the printed circuit board laser drilling market. We believe we can leverage our capability; industry knowledge and service footprint to grow our share in this large mainstream via drilling segment and expect multiple nViant product placements over the next few months.

With our broader footprint in GemStone and introduction of CornerStone and nViant, we have in the past year more than tripled our addressable market in the PCB space.

Moving into our Micromachining Group, we continue to see good activity on our Lumen platform and received a nice follow-on order from a previous design win. In addition, we’re building out our application stat for our Jade platform and are working hard to be positioned to win new business in the next year with this product.

In addition to Jade, we expect to announce another platform this quarter to address larger format applications in this mid-range value segment. As we build out these lower cost platforms and continue to invest in our local channel and applications capability, we see significant opportunity to grow our business in the large China market for micromachining tools.

Finally, in the quarter we completed the consolidation of our Chelmsford facility and continue to see benefits of our ongoing lean programs to reduce waste, improve efficiency and lower cost. In summary, our market expansion strategy is working, the market segments we’ve entered with our new products over the past 18 months represent a significant market opportunity for share and revenue growth.

The initial products we introduced Lumen and GemStone are driving solid revenue growth. As our more recent introduction, CornerStone, Jade, Ultrus and nViant completed valuations and begin to see traction in the market over the next few quarters, we expect to see growth to continue and expand.

Our efforts to improve our gross margin and cost structure will translate this growth to improve profitability, while economic uncertainty and slowing growth in consumer electronics and in China may impact the pace of capacity vias and the adoption rate of our new products we believe we are investing in the right markets and are seeing the benefit in our result.

With that, I’ll turn the call over to Paul for an overview of our financial results.

Paul Oldham

Thank you, Ed and good afternoon everyone. The following information includes results from our third quarter of fiscal 2016, which ended January 2 and represented a 14 week quarter as compared to 13 weeks last quarter and last year.

To improve comparability, we're also providing earnings per share and related income statement results on a non-GAAP or adjusted basis excluding the impact of purchase accounting, equity compensation, inventory write-downs, restructuring and other items.

For the quarter, bookings were $52.6 million, up 2% from last quarter and 30% from last year. This represented our highest third quarter bookings in five years in what is normally a seasonally softer quarter.

Bookings in our component processing segment grew 6% over the previous quarter. Within this segment, demand for interconnect products grew almost 10% sequentially with sequential growth in GemStone and strengthened service.

Bookings for our semiconductor products group were strong again on higher demand for wafer trim plus the receipt of a follow-on order for our legacy memory repair products. Orders for component test products increased from last quarter on higher system demand. Based on recent customer activity, we expect to see some improvement in this business over the next several quarters.

Orders in our micromachining segment were solid but down slightly from last quarter. We received a follow-on order for our Lumen series but not as large as in Q2. Adoption of our new Jade platform and the Topwin line of products were both slow. However we are building out the applications for these platforms as Ed mentioned in order to demonstrate through a broader set of Chinese contract manufacturers via advantage of the ESI Solution.

Shipments were $38.8 million, backlog increased to $12.9 million to $52.3 million. And our book-to-bill ratio was 1.4. The third revenue decreased by nearly $5 million as we received acceptance on several new products.

Revenue for the quarter was $43.3 million and was impacted by the timing of customer sight readiness resulting in delayed shipments of several tools. We expect these to largely ship in the next two quarters.

Even with this delay, we saw sequential growth in the component processing segment, more than offset by a decline in micromachining. Micromachining was down due to the timing of shipments. The Lumen series order received in Q2 shipped in the same quarter, while the order in Q3 will not shipped until Q4.

Systems revenue was $31.3million down 12% from last quarter, service revenue increased sequentially to $12.1 million. GAAP gross margin was 14.9% and included about $370,000 of purchase accounting and equity compensation in cost of sales. Also in cost of sales was a $1.4 million charge to reserve inventory associated with the discontinuation of our large format glass cutting product.

On a non-GAAP basis gross margin was 44.9% compared to 40.6% last quarter. The higher gross margin was due to very favorable product mix including legacy memory repair tools, new products and service contract timing.

In addition, we're seeing benefit from lower material cost and more efficient manufacturing operations following closure of our Chelmsford facility. Looking forward, we expect to continued favorable product mix for the next couple of quarters with margins down slightly from current levels. Over time however, we would expect a more normalized mix with margins in the low 40% range but on higher volumes.

GAAP operating expenses were $22.2 million, about $750,000 higher than last quarter and included 1.3 million of purchased accounting and stock compensation. In addition, we recognize $1.9 million of cost associated with previously announced pre structuring activities. Most of these were related to the closure of our Chelmsford facility.

On a non-GAAP basis operating expenses in Q3 were just under $19 million, down more than $600,000 from last quarter. These lower expenses reflect our ongoing efforts to optimize our cost structure including the Chelmsford closure. Expenses came in lower despite the fact that Q3 contained a 14th week.

For Q4, we expect operating expenses to increase slightly but remain in the low $19 million range driven by a significant new product launch in placement activity. On a GAAP basis operating loss was $4.5 million. Non-GAAP operating income was approximately $0.5 million compared to a loss of $0.8 million in the prior quarter. On a non-GAAP basis, income tax expense was $160,000 reflecting foreign taxes. We expect Q4 tax expense to remain in this range.

Our GAAP net loss was $4.6 million or $0.15 per share. That included approximately $3.3 million of one-time charges associated with inventory in the site closure I mentioned previously. This compares to a loss of $0.10 per share last quarter.

On an adjusted basis, net earnings were $0.4 million or $0.01 per diluted share compared to a loss of $1 million or $0.03 per share last quarter.

Turning now to our balance sheet. Cash and investments increased $2.6 million to $62.8 million. We generated $3.5 million of operating cash during the quarter, primarily on positive EBITDA and good cash collections. Total accounts receivable decreased by $12.6 million to $37.3 million. DSO improved to 79 days on timing of shipments in the quarter and improved turns.

Inventories increased by about $2.8 million primarily as a result of the delayed shipments I mentioned earlier and investment to support new product placements and revenue. Inventory turns were approximately 1.7x.

Accounts payable decreased by $3 million on the timing of inventory receipts and payments. Capital expenditures were $555,000, down from $840,000 last quarter on reduced purchases of test equipment. Depreciation and amortization, excluding purchase accounting, was $1.9 million.

Looking forward, we expect to see cash down in the fourth quarter, but about flat from the beginning of the year as improved EBITDA will be offset by investments and working capital or inventory at accounts receivable.

In summary, while there is more work to do, we believe that we are generally on track with our turnaround plan and are beginning to see this in our financial results. Year-to-date we've grown orders 12%, increased revenue 9%. Achieved positive EBITDA and generated positive cash flow each quarter. This quarter we were non-GAAP operating income positive for the first time in over two years.

As we look forward, we continue to see some headwinds related to macroeconomic factors, slowing growth in China and timing in the spending of capital budget. However, we believe that we are investing in the right market and that the technology trends around smaller vias, higher complexity and increased use of flex material and advance packaging are moving in our direction.

Although we saw some impact from timing of shipments in our third quarter, we believe that onbalance, our business is strengthening in the near term and that we are well positioned as we move into next fiscal year.

As a result, we expect fourth quarter revenues to be between $47 million and $53 million and non-GAAP earnings per share between $0.03 and $0.08. While we are not providing specific guidance for next fiscal year, we are generally comfortable with current street expectation.

Now, I'll turn the call back to Ed.

Ed Grady

Thanks, Paul. During Q3 we grew our bookings, increased our cash balance, generated positive cash from operation, lowered our expenses and delivered positive adjusted earnings. We are very pleased with these results and the progress we made to our goals of introducing new products, entering new market segments, growing our served addressable market.

Our global team is highly motivated, enthusiastic and energized as we continue the success and drive sustainable long-term revenue and earnings growth. My personal thanks to all the ESIO team for your contribution at our success.

This concludes our prepared remarks. At this time, we would be pleased to take your questions. Stephanie?

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Jim Ricchiuti. You may proceed.

Jim Ricchiuti

Thank you. Good afternoon. I wonder, Ed, if you could talk a little bit about the new products. I know you can't be specific about expectations, but there you've had a fairly active role out of new products and how people should think about the acceptance, potentially the contribution of some of these over the next two to three quarters.

Clearly, you're making some headway in the IC area but maybe if you could just talk about CornerStone and maybe your expectations for some of the other products.

A – Ed Grady

Sure, Jim. I guess what I would say is, the first thing is CornerStone being selected as a POR is a big deal because it’s not just a POR for the single customer but it has leverage to a broader supply chain. So that’s a big deal in terms of that supply chain in that application we have multiple applications with multiple people right now on the - in the packaging space.

In the flex space GemStone has continued to perform in Q3 and we see it very strong going forward. I'd say the Lumen series is a - is in place and we are doing fine with that. It's targeted as specific market segment and we think that that market segment is much more cost sensitive so, the introduction of Jade and our new product that we’ll introduce this quarter will actually broaden the portfolio.

nViant that was just introduced in December. The impact of that on revenues is clearly going to be out a couple of quarters because it will take time to get the qualifications in place but we do expect nViant and CornerStone to be the drivers of incremental growth as throughout FY17.

Jim Ricchiuti

And with respect to CornerStone, can you say how many qualification orders are out there, I may have missed it in your overview?

Ed Grady

We have several.

Paul Oldham

We have valuations in process, one qualification where we have been selected and received the order.

Ed Grady

Right.

Jim Ricchiuti

Okay. And just with respect to the flex via drilling market, it just seems like we are still hearing some mix reports but it sounds like your characterization of demand is fairly healthy. In other words you are not seeing much of an impact from the macro headwinds.

Ed Grady

No as a matter of fact, it’s interesting that the key driver there is as I said the smaller vias, the higher density and the more complex boards, more complex stacks within the flex is actually - we have found our product is preferred because it actually gets better yields and higher throughputs and has lower cost.

So we are extremely well positioned in that market right now with GemStone with the 53.35 with the 35 XI and so with the broad product portfolio we have on the space we can kind of do anything, anybody wants at the right cost point.

Then obviously the benefit at any company is that having the ESI toolset means that there is service cost and support cost are less because we can service their tools onsite across the board with at a very low cost.

Jim Ricchiuti

Okay, thanks very much. Congratulations on the quarter.

Ed Grady

Thanks Jim. Appreciate it very much.

Operator

And your next question comes from the line of Tom Diffely. Please proceed.

Tom Diffely

Yes, good afternoon. Maybe another question on the Lumen, it sounds like you think it might not be the right product for the market right now and then the market is more set up for a Jade type product?

Ed Grady

I'd say Lumen has its application, it's more - it’s a higher end more I guess more capable tool, the Jade and the other tool in the space, the Topwin tools as well, they just have a different cost point. So if you’re in the China market which a lot of these tools go into the China market, that’s where these other tools Jade and our other tools are more fitted to that market.

What we’re seeing is continued demand for Lumen, I’ll call it the higher end applications and that as I said earlier in the remarks Tom is where we won orders in over the last several quarters at a customer that requires much more stringent application.

Tom Diffely

Okay. That makes sense. And then Paul you mentioned that there was a one-off memory repair order as well. What is the driver behind that, is that capacity requirements or is this something unique that requires a new tool?

Paul Oldham

There is a little bit of capacity. I wouldn't call it broad, but there are some designs that still require the laser used process. And so we're seeing a small incremental demand there. This is in the very few units. So nothing we would expect over a long period of time, but its good business in the meantime when we can get it. And we would expect to see a couple of units here and there, probably for a little while still.

Ed Grady

Okay. I think Tom, we went through kind of a dry spell, because when some of that newer applications went away from laser fuse, there was a lot of used equipment on the market for several years. And that used equipment has pretty much dried up now.

So the underlying demand that was masked for a while is still there. It's never going to be a big growing business for us, but it's nice business and we have a great customer base that we serve with that product.

Tom Diffely

Okay. Is it a certain type of DRAM chip then?

Ed Grady

Yes. It's specific DRAM applications.

Tom Diffely

Okay. All right. And then, Paul, you mentioned that there were a few delays during the quarter, may be just a little more on that was the facility that wasn't ready or just demand push up by the end customer?

Paul Oldham

Yes. We mentioned in our call last quarter that we could see some impact from timing. And in fact we did have two customers who - sites weren't quite ready and we saw those push out. In the case of one, they took a portion of the tools, but didn't have the balance or the facility ready.

In the case of the other, they push the tools out, because of the size it was not quite ready to go yet. So shipments, we would still expect to see over the next several weeks here. But it did impact our topline and we thought that could happen and we did see that come in the quarter.

Tom Diffely

Okay. So, is your arrange of revenue in the fourth calendar fiscal quarter kind of represents if I guess push out again?

Paul Oldham

I'd say not specifically. I think that's just more broadly that there is a lot of moving pieces and the timing of when shipments will actually go out the door there is little bit of risk around that. But as we mentioned, I think we fell generally that our business is strengthening and that's reflected in the guidance. But there could be some impact in timing just quarter-to-quarter.

Tom Diffely

Okay. And then I couldn't quite make out what you were saying on the OpEx side after it came down this quarter when you did the consolidation. What is your expectation going forward?

Paul Oldham

Yes, we would expect to see OpEx in generally in the $19 million to $20 million range depending on our volume and variable cost. But for this coming quarter, it will be in the very low end of that $19 million range.

It's up a little from this quarter particularly when you consider the extra week, because we have a lot of activity in the market. We're getting our new products placed and the cost of being out there with the various installations and other activity.

So it's up a little bit even on one last week, but it should be in the very low $19 million range. And that's generally where we'd expect it outside of variable costs that are driven by volume.

Tom Diffely

Okay. And then as revenues ramp over the next couple of years, how much overhead absorption impact is there as certain incremental gross margin we could look at?

Paul Oldham

Well, the way we think about it, Tom, a little bit broadly is around our model that we would expect to see about $0.35 to $0.40 of what we call leverage or drop through to the operating income line. That contemplates both absorption and manufacturing, but also the fact that we don't need to add fixed cost in the expense line.

There will be some variable cost around selling and other volume related things. But for the most part, we've been able to keep our expenses fairly flat. So that's really the way to think of it is around this 35% to 40% of leverage.

Tom Diffely

Okay. You said to the operating -

Paul Oldham

The operating income line, yes.

Tom Diffely

Perfect. Okay. Well, great. Thank you.

Paul Oldham

You're welcome.

Operator

[Operator Instructions] And we have no questions in queue. Now, I'd like to turn the conference over to Ed Grady for final remarks.

Ed Grady

Great. Thank you very much for joining us. You're welcome to call Paul, Brian or me if you have any further questions. Thanks for attending and this concludes our call for today.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect and have a great day.

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