inTest Corporation's (INTT) CEO Robert Matthiessen on Q2 2017 Results - Earnings Call Transcript

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About: inTest Corporation (INTT)
by: SA Transcripts

inTest Corporation (NYSEMKT:INTT) Q2 2017 Earnings Conference Call August 3, 2017 5:00 PM ET

Executives

Laura J. Guerrant - Principal, Guerrant Associates Investor Relations, IR Consultant

Robert E. Matthiessen - President, CEO and Executive Chairman

Hugh T. Regan, Jr. - Secretary, Treasurer and CFO

James Pelrin - EVP and COO

Analysts

Tomer Cohen - Five Roads Capital

George Melas-Kyriazi - MKH Management Company

Operator

Welcome to inTEST Corporation's 2017 Second Quarter Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded today and a replay will be accessible at www.intest.com.

I would now turn the call over turn the call over to inTEST's Investor Relations consultant, Laura Guerrant, please go ahead.

Laura J. Guerrant

Thank you, operator, and thank you for joining us for inTEST's 2017 second quarter financial results conference call.

Before we begin, please be aware that our press release was issued today with an error. The wires service issued the release without the reconciliation of GAAP to non-GAAP net earnings table. Instead, it was issued with duplicate condensed consolidated balance sheet data table. The correct release is in the process of being issued. If you need a copy of the corrected release, please contact me directly via email at lguerrant@guerrantir.com.

With us today are Robert Matthiessen, inTEST's Chairman, President and CEO, Hugh Regan, Treasurer and Chief Financial Officer and Jim Pelrin, Executive Vice President and Chief Operating Officer. Bob will briefly review highlights from the second quarter as well as the current business trends, followed by an update on our recent acquisition of Ambrell by Jim. Hugh will then review inTEST's detailed financial results and discussed guidance for 2017 third quarter. We'll then have time for any questions.

Before we begin the formal remarks, the company's attorneys advise 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 and the economy; changes in the demand for semiconductors; changes in the rates of and timing of capital expenditures by our customers; our ability to integrate Ambrell corporation into our business successfully or operate Ambrell profitably; 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.

During today's call, we will make reference to non-GAAP financial measures. We have provided additional information concerning these non-GAAP measures including the 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 with that, let me now turn the call over to Bob Matthiessen, please go ahead, Bob.

Robert E. Matthiessen

Thanks, Laura. I'd like to welcome everyone to our 2017 second quarter conference call. We are very pleased with our results for the quarter. We continue to see strong demand for our broad-based solutions.

On the heels of an exceptionally strong first quarter, second quarter revenue increased 33% year-over-year, excluding the impact of Ambrell Corporation, which we acquired on May 24, 2017, and we mark the company's 31st consecutive quarter of profitability. It should be noted that these results include only five weeks post-acquisition contribution from Ambrell's operations during the quarter.

Our Thermal segment, which is now composed of the combined business of inTEST Thermal solutions, or ITS, and Ambrell, delivered solid results during the quarter. ITS provides thermal products for test and development applications, while Ambrell provides thermal induction heating products for industrial manufacturing applications.

We have strategically diversified this segment, resulting in new opportunities in industrial manufacturing through both OEM and end-user applications. This diversification complements our broad penetration into electronic test markets, broadening inTEST's footprint as a provider of highly-engineered Thermal Products, now for both test and industrial applications.

Thermal segment bookings for the second quarter were a $8.8 million, which included $2.3 million in bookings for Ambrell, compared with first quarter bookings of $7.3 million. Q2 thermal segment revenues were $9.2 million, which included $2 million of revenues for Ambrell, compared with $7.8 million in the first quarter. Customers for Mil/Aero and telecom continued with strong orders in North America and telecom in Asia and our chiller systems remain strong with increased business over Q1. There was a slight decrease in Asia business due to the drop off in the semi market.

Thermal segment highlights for the quarter, included a large Mil/Aero customers purchased variety of ThermoStreams cryoplates and chambers; a major supplier of military communication systems purchased four large thermal platforms for satellite communication, system test and development; a major supplier of optical transceivers purchased six ThermoStreams for product development in the U.S.; a semiconductor OEM purchased two additional systems for MEMS testing; telecom companies in Asia purchased 41 ThermoStream systems valued at more than $1 million as telecoms continue production demands for broadband optical components; a new OEM manufacturer of custom pumping systems purchased their first fluid chiller industrial pump system; a semiconductor OEM purchased four additional fluid chiller systems and IDM purchased an additional fluid chiller system and an instrument manufacturer purchased a gas chiller for laser inspection systems.

Turning to our EMS Product segment, and as a reminder, we have combined electrical and mechanical segments to create the EMS Product segment. Q2 EMS segments bookings were $5.8 million compared with $7.8 million in Q1, and EMS revenues were $6.7 million compared with $6.4 million in the first quarter. While EMS bookings were lower than Q1, business remains strong and Q2 was higher than any other quarter in the previous year.

Business in the second quarter, was fueled by end-users, IDMs and OEMs continued ramp up of new production. The heaviest ramps originated from companies supplying parts to the automotive industry. Demand for the Internet of Things, industrial and consumer electronics also continued to drive Q2 business. We also added a sales resource in Asia resulting in significant new business from this region.

EMS highlights for the quarter, include a large subcontractor purchased 24 docking systems for final test handlers and a large IDM purchased 22 sets of docking and interface hardware another IDM purchased 15 test interfaces for a mix signal tester, a new customer in China purchased two interfaces and a new OEM in Japan purchased a Cobalt 500 class manipulator for a new tester platform, now being introduced to the market.

So looking forward, we continue to see significant opportunities. Key drivers for inTEST include the surging use of sophisticated electronics and automobiles, continued growth of telecommunications and Internet backbone, the drive for improved semi-device packaging and the growth of applications for the Internet of Things. As we continue to execute our differentiated product strategy, we believe the conditions for our long-term success remain firmly in place and we're solidly on track for a strong 2017.

And with that, I'd like to turn the call over to Jim. Jim?

James Pelrin

Thank you, Bob. I'd just like to reiterate the significance of our Ambrell acquisition. Ambrell's induction heating technology complements our current thermal technologies and establishes our position in industrial markets with a diverse customer base and the broad manufacturing space, including many emerging markets, consumer product packaging, fiber optics, automotives and other markets.

In the coming quarters, we'll be sharing highlights from Ambrell detailing its important contributions to the Thermal segment and inTEST as a whole. Ambrell's outlook for Q3 and Q4 is upbeat with continued activity from OEM partners and major customers operating in a wide range of markets.

And with that, I'll turn the call over to you Hugh to discuss our second quarter results in detail. Hugh?

Hugh T. Regan, Jr.

Thank you, Jim. Second quarter 2017 end-user net revenues were $15.1 million, or 95% of net revenues, compared to $12.5 million, or 88% of net revenues in the first quarter. OEM net revenues were $762,000 or 5% of net revenues, down from $1.7 million or 12% for the first quarter. Net revenues from markets outside of the ATE market were $5.7 million or 36% of net revenues, compared with $3.7 million or 26% of net revenues in the first quarter.

As noted earlier in this call, Ambrell net revenues for the second quarter were $2 million and our net revenues for markets outside of the ATE market, excluding Ambrell, were $3.7 million or 24% of net revenues. So clearly Ambrell does further diversify our served markets. We expect that revenues from markets outside of the ATE market will equal or exceed our ATE market revenues going forward.

Our second quarter gross margin was $8.4 million or 53% as compared with $7.7 million or 55% in the first quarter. The reduction in gross margin was primarily the result of an increase in our fixed manufacturing costs and a less favorable absorption of these costs, partially offset by a decrease in our consolidated component material costs, which declined from 33.2% in the first quarter to 32.8% in the second quarter.

Our manufacturing -- excuse me, our fixed manufacturing costs increased by $444,000 or 31% sequentially, and represented 12% of our net revenues in the second quarter compared to 10% in the first quarter. Ambrell's fixed manufacturing costs were $404,000, and excluding the impact of Ambrell, our fixed manufacturing costs would have only increased $40,000 or 3% sequentially, and would represent 9% of our net revenues for the second quarter.

The increase in second quarter fixed manufacturing costs was primarily the result of increased cost for insurance. The decrease in our component material cost -- was driven by a reduction in the component material costs of our EMS segment, which declined from 35.1% in the first quarter to 32.7% in the second quarter due to a more favorable product mix, which reflected a much higher level of docking hardware sales in the second quarter as compared to the first.

The improvement or this improvement was partially offset by an increase in the component material cost of our Thermal segment, which grew from 31.7% in the first quarter to 32.9% in the second quarter. This increase was due to a less favorable product mix in the second quarter as compared to the first. Excluding the impact of the acquisition of Ambrell, our second quarter gross margin would have been $7.5 million or 54%. Ambrell second quarter 2017 gross margin was 49%.

Selling expense was $1.9 million for the second quarter compared to $1.7 million in the first quarter, an increase of $203,000 or 12%. Second quarter selling expense included a $317,000 for Ambrell. Excluding this amount, our second quarter selling expense would've been $1.6 million, which was $114,000 or 7%, sequential decrease. The reductions were primary related to lower levels of sales travel and commissions.

Engineering and product development expense was $982,000 for the second quarter compared to $935,000 for the first quarter, an increase of $47,000 or 5% sequentially. Second quarter engineering and product development expense included $82,000 for Ambrell, excluding this amount our second quarter engineering development expense would've been $900,000, which was a $35,000 or 4% decrease, sequentially. The reduction was primarily related to lower levels of salary and benefit costs in our EMS segment and reduced patent legal costs, which were partially offset by increased spending on development materials by our Thermal segment.

General and administrative expenses grew from $2 million in the first quarter to $3.3 million in the second quarter, an increase of $1.3 million or 65%. Included in second quarter G&A expense was $849,000 of transaction costs related to the acquisition of Ambrell and $536,000 of G&A costs for Ambrell. Excluding these amounts, our second quarter G&A expense would've been $1.9 million, which was a $92,000 or 5% sequential decrease. The decrease was primarily the result of lower levels of salary and benefit cost in our corporate segment and reduced travel costs. These reductions were partially offset by increases in officer and staff bonus accruals.

Other income was $54,000 in the second quarter compared to $41,000 in the first quarter, an increase of $13,000 or 32%. Included in other income for the second quarter was $12,000 of ForEx transaction gains for Ambrell. Excluding this amount, second quarter other income would've been $42,000, which was an increase of 1% -- excuse me, $1,000 or 2% sequentially. We accrued and income tax expense of $891,000 in the second quarter compared to $1.1 million accrued in the first quarter.

Our effective tax rate increased to 38% in the second quarter from 35% in the first quarter. The increase in our effective tax rate primarily reflects, not recording tax benefits on losses incurred in Ambrell's European operations, as we don't expect to be able to utilize them due to expected changes in our operating structure.

At June 30, 2017, we had a deferred tax liability of $4.1 million compared to a deferred tax asset of $1.1 million as of March 31, 2017. The acquisition of Ambrell brought over $1.8 million of deferred tax liabilities which we are in the process of evaluating as part of our purchase price allocation work, which is ongoing.

In connection with our second quarter closing and the estimates we have created for Ambrell, we established a 3.$4 million deferred tax liability related to the estimated intangible assets we have preliminarily determined for Ambrell.

Offsetting these deferred tax liabilities was a $1.1 million deferred tax asset. We expect our tax rate for the balance of 2017 to be in the range of 35% to 37%. On a GAAP basis, second quarter net earnings were $1.4 million or $0.14 per diluted share, compared with first quarter net earnings of $2.1 million or $0.20 per diluted share.

On a non-GAAP basis, second quarter adjusted net earnings were $1.7 million or $0.16 per diluted share, compared with first quarter adjusted net earnings of $2.1 million or $0.21 per diluted share. Diluted average shares outstanding were 10,334,894 at June 30. During the second quarter, we did not issue or repurchase any shares.

As of June 30, 2017, we've repurchased accumulative total of 297,020 shares an approximately -- or approximately 2.8% of our outstanding common stock at a net cost of $1.2 million or $4 per share. Amortization and depreciation expense was $373,000 for the second quarter compared to $150,000 in the first quarter.

Acquired intangible amortization was $249,000 in the second quarter, an increase of $196,000 from the first quarter, and the Increase intangible amortization was related to the acquisition of Ambrell. As I noted previously, we have not yet completed our purchase price allocation for Ambrell and we are expecting that of quarterly amortization to increase in the third quarter as we reflect a full quarter of Ambrell's operations.

EBITDA was $2.7 million for the second quarter, down $614,000 or 18% from the $3.3 million in EBITDA reported for the first quarter. Consolidated headcount at the end of June, which includes temporary staff was 217, an increase of 123 staff from the level we had at March 31. Included in the June total, with 93 Ambrell's staff and adjusted for this amount, our staff would be 124 at the end of June, up 1 from the end of March. I will now turn to our balance sheet.

Cash and cash equivalents at the end of second quarter were $7.6 million, down $19.6 million from March 31. We used $23.2 million in cash for the Ambrell transaction to fund the purchase price and pay transaction-related expenses. We currently expect cash and cash equivalents to increase throughout the balance of 2017.

Accounts receivable increased to $11.9 million at June 30, an increase of $2.1 million sequentially, included in this amount was $3.4 million for Ambrell. Adjusted to exclude this amount, accounts receivable would've been $8.6 million, an increase of $3.2 million or 59% sequentially. The increase in receivables was related to increased sales into Asia where credit terms are longer than in other parts of the world.

Inventory increased $2.3 million to $6.2 million at the quarter-end. Included in this amount was $1.9 million for Ambrell. Adjusted to exclude this amount, inventories would have been $4.3 million, an increase of $608,000 or 17% sequentially. The growth in inventories was in response to expected shipments in the third quarter.

Capital expenditures during the second quarter were $89,000, down from $114,000 in the first quarter. Included in the second quarter capital expenditures was $7, 000 for Ambrell. Bob provided consolidated and segment revenues and booking data earlier. The backlog at the end of June was $11.1 million, up from $8.2 million at the end of March. Included in June 30 backlog was $4.4 million for Ambrell. Excluding this amount backlog would've been $6.6 million, down $1.6 million from the end of March.

In terms of our financial outlook, as noted in our earnings release, we expect that net revenue for the quarter ended September 30, 2017, we'll be in the range of $17.5 million to $18.5 million and that net earnings will range from $0.12 to $0.16 per diluted share. We currently expect that our Q3, 2017 product mix will be less favorable as compared with the second quarter and the third quarter gross margin will range from 48% to 50%. Operator, that concludes our formal remarks, we can now take questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Tomer Cohen with Five Roads Capital.

Tomer Cohen

Good afternoon. Congrats on another good quarter.

Hugh T. Regan, Jr.

Thank you, Tomer.

Tomer Cohen

I've got a couple of questions about Ambrell's business. Maybe we could just start by help me understand, who are the competitors that Ambrell faces off against?

Hugh T. Regan, Jr.

Jim, would you like to respond to that?

James Pelrin

Certainly Ambrell -- the induction heating market can be looked upon in two sectors. One is from 1 to 500-kilowatt products and the other is above 500-kilowatt products. Ambrell does not offer products above 500 kilowatts. Those are generally for heavy machinery, smelting and that type of thing. Instead, they are in the manufacturing process realm, which is 500 watts and below, and we view that market as being about a $400 million market and it's composed of about 20 -- 20 competitors of that, four or five of them are about double Ambrell's size. There's a couple that are equivalent and all the rest are $15 million or less in revenue.

So Ambrell is -- it's a strange market in that there is not a single large dominant player. Now I might add that several of their competitors, like Ajax Tocco and Inductotherm are much larger companies. But if you look at only that induction heating component of their revenue, that's management's best guess.

Tomer Cohen

Okay, that's helpful. And then maybe if you could help me to understand what are your competitive advantages? And how you differ from the rest of the market?

James Pelrin

Well, the Ambrell specializes in their application engineering and they actually customize their products to suit whatever the application might be. They do a lot of work with Tier 1 automotive companies that are actually embedding Ambrell's product in their manufacturing process. They do a lot of work with integrators all of the major integrators that serve at several different industries, because Ambrell's application engineering and application labs, worldwide, are able to provide a customized solution that, not only provides the heating component, but also a fit for the manufacturing process.

Tomer Cohen

And I saw that some of your revenues come from a large electric car manufacturer. Can you give me a rough sense of what percentage of revenues are for that manufacturer? Is it half the business, is it a much smaller amount? Can you give a rough sense?

James Pelrin

It's a much smaller amount. It's very significant but it's much smaller and it's business that has occurred over a couple of years, and it seems to be occurring in the future as well. What's really significant is that the application to the electric car manufacturer is -- Ambrell is looking to proliferate that through all of the other electric car manufacturers that are emerging on the market place, because induction heating is really the way to go when you're joining parts, when you're joining metal parts. And that's the use in this particular case where each electric motor that drives each wheel, the axle is actually inserted into the motor by expanding it through induction heating very, very quickly and then inserting in the shaft and then allowing it to cool and it heat seals and heat -- and contracts around it.

It's stronger than a weld, but most importantly, it's perfectly balanced. If you used mechanical connectors, you have a lot of welding, you have a lot of opportunity for imprecise balance. So this is something that Ambrell sees as an emerging market for them.

Tomer Cohen

Yeah, and would you expect that as the electric car manufacturing grows, you would capture all that market? Are you the only induction manufacturer who can sell to that market or do you think you'll be one of many players there?

James Pelrin

Well, I think that Ambrell has a strong leg up because they were the first in there. They have a -- their customer base is well respected, and so I think that they are in a very favorable position but it's hard for anybody to say that they're going to capture a market entirely, when you're talking about automotive manufacturing.

Tomer Cohen

Yes, that makes sense. All right, I am going to -- I have more questions but I am going to hop in line. Let somebody else ask questions and I'll come back. Thank you.

Hugh T. Regan, Jr.

Thank you, Tomer.

Operator

[Operator Instructions] We have a follow-up question from Tomer Cohen with Five Roads Capital.

Tomer Cohen

Looks like, I don't have to wait long.

Hugh T. Regan, Jr.

No, you don't Tomer. Keep going.

Tomer Cohen

So I'm just curious, the management of Ambrell, they had a lot of equity in the business before you bought them. And I'm curious, did you buyout their equity or did that roll over? How did that work?

Hugh T. Regan, Jr.

We actually -- we purchased all of the equity of Ambrell Corporation, so we bought out management and that was determined in advance. In other words, we wanted to own a 100% of the company. We do plan to clearly incentivize some key players in management with restricted stock awards but we did purchase all of the equity.

Tomer Cohen

I see. And did that management team have to commit to stay with you for a certain period? Or are you worried about turnover the management now that you acquired them?

Hugh T. Regan, Jr.

They did not -- for instance, they're not bound to us with employment, other than the CEO is bound to us with an employment agreement. His direct reports are not. It's a very strong team. They seem to be very focused and driven and we're putting incentives in place to make sure to keep them there. So I think the situation is being well handled but the only one who's tied up for a period of time is the CEO.

James Pelrin

Let me also add that they were owned by APEG and they all knew what that meant. They were looking forward to being acquired and they very much have welcomed inTEST with open arms.

Tomer Cohen

Yes, [indiscernible]. And that actually touches on another question I had, can you say anything publicly about why Graylog [ph] wanted to sell Ambrell? Was it just, there holding period was up and they needed to return money to investors or was there something else there?

Hugh T. Regan, Jr.

Well it was actually -- it's Graycliff is the name of the private equity firm, and they were about 2.5 years into a plan, four to five year hold. We had approached them about the opportunity as we were looking at -- across the industry and many industries for opportunities. And we began a dialogue with them and were able to convince them that it was appropriate for them to sell the business prior to their planned execution. So it's not an auction situation. We find, we do better where we approach companies that are not in play and speak with them about joining inTEST.

Tomer Cohen

Yes, that makes sense, okay. And then I guess the last set of questions have to do with Alan Hold's passing. I was sorry to see that. I'm just curious, how much work do you need to replace the value he was bringing to the Board and how much was he able to do before he passed away?

Robert E. Matthiessen

Hey, Tomer, this is Bob Matthiessen. Since I'm replacing him, I guess I should answer it. Alan was actually on a path of retirement when he passed away. We had gradually been moving the things he'd been doing onto my plate and we were almost there. So it really has no impact on us from that direction.

Tomer Cohen

Okay, well. Lot of great things happening at the company and things probably have worked.

Robert E. Matthiessen

We appreciate your thoughts and comments. Thank you, Tomer.

Operator

And your next question comes from the line of George Melas with MKH Management.

George Melas-Kyriazi

Good afternoon, guys. Congratulations.

Hugh T. Regan, Jr.

Hey, George.

George Melas-Kyriazi

Quick question on the non-ATE inTEST business. Can you give us a little bit of color by vertical? Yes, that's basically it.

Hugh T. Regan, Jr.

Sure. For the quarter-ended June 30, non-ATE revenues were $5.7 million and the largest market -- there's split really between two large markets which are telecom, wholly driven by the optical transceiver business and that represented just about $2.2 million and then another $2.2 million in the industrial market, which is basically the Ambrell business that we acquired during the quarter and that will remind people that it is only five weeks of business as opposed to a full quarter and we also had strength during the quarter in the automotive sector as well as the mil/aero sector both of which were right around $0.5 million mark.

George Melas-Kyriazi

Okay, great. That's it for me. Congratulations again.

Hugh T. Regan, Jr.

Thank you, George.

Operator

Mr. Regan, were there any questions that were submitted in advance. If there were please go ahead and address those now.

Hugh T. Regan, Jr.

Sure, thank you, Operator. The one other question that we did receive that we'll speak to right now is what you expect to pay for the earn-out related to Ambrell. And we have established a liability on our books relative to Ambrell and that liability that was established, was $2.3 million. I would expect we'll pay more than that because that's the present valued rate. We can pay up to $18 million.

I think when we closed the deal APEG was very optimistic that Ambrell would hit certain targets. While if it hits those targets, we'll be thrilled to pay the $18 million. My gut says to me the answer lies probably somewhere in the middle, and my expectation is that we'll pay probably somewhere between $5 million and $9 million at the end of the day. That's it for questions, operator?

Operator

That does conclude our question-and-answer session. I would now like to turn the call back over to Mr. Matthiessen for any closing remarks or final statements.

Robert E. Matthiessen

Thank you, operator, and thank you for your interest in inTEST. We look forward to seeing many of you at the investor conferences we'll be attending in September. And to updating you on our progress when we report our third quarter results in November. Good evening.

Operator

Ladies and gentlemen, that does conclude our call. We thank you for participation and that, that you please disconnect your lines.