Richard Blickman - Chief Executive Officer Cor te Hennepe - Senior Vice President, Finance

Nigel van Putten - Kempen Peter Olofsen - Kepler Cheuvreux Robert Sanders - Deutsche Bank Trion Reid - Berenberg

Good morning, good afternoon, ladies and gentlemen. And welcome to Besi’s Quarterly Conference Call and Audio Webcast to discuss the company’s 2018 Second Quarter Results. You can log in to the audio webcast via Besi’s website, www.besi.com. Joining us today are Mr. Richard Blickman, Chief Executive Officer; and Mr. Cor te Hennepe, Senior Vice President, Finance. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. As a reminder, ladies and gentlemen, this conference is being recorded and cannot be reproduced in whole or in part without written permission from the company. I would now like to turn the call over to Mr. Richard Blickman. Please go ahead, sir.

Thank you. Thank you all for joining us today. We will begin by making a few comments in connection with the press release we issued earlier today and then take your questions. I would like to remind you that some of the comments made during this call and some of the answers in response to your questions by management may contain forward-looking statements. Such statements may involve uncertainties and risks as described in the earnings release and reports filed with the AFM. For today’s call, we would like to review the key highlights of our second quarter and first half year, and also spend some time updating you on the market, our strategy and outlook. First, some overall thoughts on the past quarter and the first half year. Besi’s second quarter financial results were favorably with sequential revenue up 4% versus Q1, gross margin at the high-end of the guidance, net income growing sequentially by 27.2% and a net margin of 29.3%. Revenue was in line with revised guidance, while operating profit exceeded guidance due to lower than anticipated operating expense levels. As is usually the case, net cash declined significantly in Q2 from Q1 due primarily to the payment of cash dividends to shareholders during the quarter, which this year aggregated to €174 million. Besi’s first half 2018 results showed continued year-over-year improvement in revenue and net income of 12.8% and 9.9%, respectively. The solid results reflected the extension of favorable industry trends from 2017, additions to advanced packaging capacity by customers and Besi’s ongoing execution of strategic initiatives. Revenue growth in the first half 2018 was broad based, with contributions from each of our principal end-user markets. First half net income of €84.3 million, combined with peer leading gross and net margins of 56.5% and 26.7%, highlighted the success of Besi’s products in the marketplace and the efficiency of our business model. Order rates by Besi’s end-user applications varied during the first half year. During the second quarter, we experienced a sharp decline in orders for high-end smartphone applications, including a €28 million order cancellation at quarter end from a single customer via its Asian subcontractors. This reflected both a digestion by customers of the substantial capacity out of last year and in Q1 2018, as well as a delay in the rollout of certain high-end mobile features. Customer order preference for assembly equipment can adjust quickly depending on economic conditions, capacity utilization rates and the timing and success of new product introductions, particularly for mobile applications. Fluctuations in high-end smartphone orders overshadowed positive trends in some of our other end-user markets, such as automotive, computing, and our spares and service business. They also overshadowed notable orders from Chinese subcontractors for mainstream electronics applications during the second quarter. Further, they have skewed the significant opportunities ahead to leverage Besi’s technology for demands of the new digital society such as Internet of Things, 5G connectivity, expanded data and memory needs and increased automotive electronic content. As these needs are realized the assembly equipment market will become an ever more critical step in the semiconductor value chain, for which we believe Besi has the premier advanced packaging portfolio and market position. We continue to maintain a solid liquidity position with cash and deposits of €395.5 million and a net cash of €110.2 million at the end of the second quarter. The decrease in our net cash position versus the first quarter was primarily due to a high level of distributions in the form of €174 million dividend payment and €6 million share repurchases. Cash flow from operations was €7 million in the second quarter, a decrease of €22.5 million versus the second quarter last year, due mostly to higher receivable levels outstanding. We expect the third quarter 2018 cash flow generation to rebound significantly versus the second quarter as working capital needs reduce. Beginning in 2011, Besi adopted the shareholder friendly capital allocation program. Since that date, we have made total distributions of €454.9 million, including the 2017 dividend and share repurchases to-date in 2018. In recent years, the mix between dividend and share repurchases has skewed towards dividends, with dividend payouts at the higher end of our 40% to 100% range relative to net income. As announced today, we are initiating a new €75 million share repurchase program through October 26, 2019. It will replace our current €2 million share repurchase program, which is 80% completed. As a result, we will approximately double quarterly repurchase activity from €6 million per quarter currently to approximately €12 million per quarter now -- from now on. As such, we anticipate that share repurchase will represent a higher percentage of capital allocation mix in the near-term. Now let me take a few moments to discuss some of the revenue and cost reduction opportunities we have over the next 12 months to 18 months. Besi’s product strategy focuses on delivering customers the most reliable, stable and accurate assembly systems for 24 hours, 7 days a week production environment, which lowers cost of ownership. In addition, we aim to leverage Besi’s technology’s position to gain share in each new investment round, as well as in the highest growth geographic markets. Looking through to 2019, we see a number of growth opportunities. One is the rollout of 3D imaging and other advanced features to a broader group of mobile platforms and other electronics applications. Other opportunities play on the secular growth of our industry due to the explosion of data and computing requirements from the cloud, as well as higher levels of automotive electronics content and safety requirements. In addition, we are well-positioned to gain further ground in the Chinese market, not just from the government governing of investments over the next five years, but also from an ever growing number of Besi products produced and sold directly in the local market. Finally, we see renewed customer interest this year in emerging process technologies, such as TCB wafer level and panel wafer level assembly for the next-generation devices. The last major investment round was in 2015, ‘16. In December 2016, we adopted a new five-year cost plan, the goal of which was to generate €15 million to €20 million of annualized cost savings by 2021. We are on target with this plan. The main components of which involve further reducing European overhead and bringing additional efficiencies from current platform developments and our Asian supply chain. In this regard, we have began the transfer of additional 100 European personnel functions to Asia over the next two years in the areas of supply chain, administration, IT and R&D support. In addition, we have become ever more flexible and scalable in recent years to deal with the industry’s inherent order volatility. We reviewed production and inventory levels weekly and took immediate action to reduce temporary production headcount and scale back the supply chain as soon as we saw order rates decline. This vigilance has helped sustain gross margins in the mid-50 levels. Now a few words about our third quarter guidance, we estimate that revenue will decline by 25% to 30% sequentially versus the second quarter due to soft conditions continuing in the high-end mobile market, typical H2 seasonal patterns and some weakness we are seeing from Chinese and Taiwanese subcontractors, who guesstimate high performance computing applications. Even with the sequential revenue decline, we anticipate that Besi’s gross margins should remain relatively strong within the range of 54% to 56%. We also anticipate relatively flat OpEx developments sequentially, as we align the business model with current order rates. For the nine months, Q3 guidance indicates revenue roughly flat or slightly down versus the comparable period of 2017 and gross margins staying in an attractive range of 55% to 57%, OpEx will increase by approximately 8% year-over-year, due mostly to higher share-based compensation expense. That ends my prepared remarks. I would like to open the call to questions. Operator?

Thank you, sir. [Operator Instructions] Our first question is from Mr. Nigel van Putten of Kempen.

Hi. Good afternoon. I have got a couple of questions, first on the notable orders from Chinese subcontractors for mainstream electronics applications. Could you elaborate a bit on the outlook for the segment, because it seems like it has the potential of becoming quite substantial driver of revenue growth? And then already also on the outlook for automotive and computing, you’ve indicated year-on-year strength so far this year. How is the outlook for those segments going into the second half of the year and especially the fourth quarter?

Well, Chinese subcontractors for really many, many years we have been successfully growing the business with major Chinese subcontractors focusing on the broad spectrum of applications. So, for the computer applications also mobile phones, Chinese high-end phones and also automotive. And as said, we have received in the second quarter notable orders once again from several of the subcontractors and with our capability to build those systems in China and deliver them in China, our position becomes very strong. On the outlook for automotive and computer, well, our visibility is always around the quarter. So what we have seen in the second quarter, lower orders then affecting lower revenue in Q3. It is too early to tell how the tide will continue in the foreseeable future.

Okay. May I just clarify on the first point, I think, you’ve said in the past that you see big opportunity in the mid-market segment that has been traditionally more of a wire bonding segment. I kind of maybe mistaken that comment as to pertaining a bit more towards that market. But it’s the China business as it was, but it’s doing well, maybe that’s the better explanation. And then, I guess, also just at the end of your prepared remarks, you have mentioned, 3D sensing for a broader group of platforms. Could you give us any indication of how many models or at least manufacturers you are thinking about or you have indications of interest for next year?

Well, it can be expected that in the next-generation of the leading high-end smartphones all of the mobiles will be equipped with 3D sensing facial recognition and that should also further penetrate in the other part of the Android world. How fast it will go and what the volumes are is hard to predict. But after, let’s say, a somewhat slower start last year, it becomes more clear with several data points that had rolled out is happening.

And then maybe my final question, so are you then, also following the -- your -- the companies you supply to for the leading edge platform you already supply to, like maybe northern company and a French company? As those move towards the Android base, you are following them, you are still supplying through them to this new end-markets?

No one is ever sure about anything. But it looks quite promising.

Great. Thank you.

Next question is from Mr. Peter Olofsen of Kepler Cheuvreux. Go ahead. Your line is open.

Yes. Thank you. Good afternoon, gentlemen. Two clarification questions, in your press release and also in your remarks you referred to the delay of the rollout of a new high-end mobile feature. I guess you re referring to 3D sensing. Is this limited to the one particular client that canceled the big order in Q2 or actually you are seeing a multiple clients delaying the adoption?

Well, it’s best explained by comparing the first fingerprint sensors entry into the smartphone world and other features. Cameras was the same, but then a bit further back, even these introductions don’t have a straight lineup. They are first introduced in a high-end mobile and don’t forget, there are issues always with technical features, especially in the very high-end. So once you think about yield, one should think about other process-related issues and that causes a longer period before mass volume introduction and further penetration into other mobiles. So we see it not unusual. It is a pattern we have seen in many, many years, in many generations. So time will tell what the trajectory will be for the mobiles end of this year and well into 2019.

Okay. And then coming back on your answer on the question from Nigel on automotive, did I understand it correctly, that also in automotive you did see a somewhat weaker order intake in 3Q, is it what you said?

No, no, no. No, no, no. There is a couple of -- and I didn’t say it correctly. No, we saw very healthy strong orders in the second quarter. But my comment was that you cannot forecast longer than one quarter how it may look like further down the road. Automotive is, yes, less cyclical than the other two main areas and the computing world and the mobile Internet devices. But still -- and there is a cycle, whether we are entering into a slower period, I cannot forecast.

Okay. But Q3 is also still looking well?

Yeah.

Okay. Yeah. That’s great. Thank you.

But in overall perspective, as I try to mention, the third quarter apart from 2017 and for other back there was another year as well. But usually we are always first half year stronger than the second half year. That does not automatically point towards a recession. It’s hard to tell. And on the other hand, we have had eight quarters of growth, so many forecasted that the industry will have in the near-term future a more difficult time, whether that will happen, no one knows. So there are two elements you have to certainly be looking at.

Okay. That’s helpful. Thank you.

The next question is from Mr. Robert Sanders, Deutsche Bank. Go ahead, sir. Your line is open.

Good afternoon, gentlemen. And my first question would just be around at the high performance computing weakness that you saw in -- from Chinese and Taiwanese subcons. I’d love to get some more feeling about which sub-segment within this area you think this was coming from and what was driving it, whether it was crypto or something else. And then I have got a couple of follow-ups.

Well, we think it’s crypto. But you can see that from other indicators as well and hard to tell if the market will further develop, but that certainly was last year an additional part of our growth in the second half of last year. Does that answer your question?

Okay. Yeah. Great. And then just looking a bit further ahead, I mean, it looks like you are going to go through a bit of a softer phase, but in terms of getting back to growth, do you see any projects of the size of the 3D sensing project that really boosted your revenue last year and even beginning of this year upcoming that can get you back to more than a €600 million kind of run rate of revenue. I am thinking of maybe [inaudible], maybe a company like Samsung would use your equipment or subcontractors to Samsung or something else, whether it’s [inaudible] or something else that you can see bringing yourself back to a positive growth trajectory?

Well, first of all, as we explained in earlier calls, it’s not only 3D sensing. There is this slide in our presentation, slide 22, which explains all of the components where we are involved in, in a major way in internet devices since many years, both in the OS world and in the Android world. So it’s not just a 3D sensing question. It is a nice new feature but it’s only a fraction. So, that said, yes, there are new generations on the shorter horizon. There are several new models announced for this year. There are more models to come next year and there are certainly things which are expected to move the needle dramatically, even more so than the growth we have had in the past two years. So, yes, that’s a big driver. But then you mentioned quickly some others and our market position, and we have explained that in some detail in the analyst meeting mid-June, has improved step-by-step, year-by-year significantly, whether that is in the computer environment and there is a lot happening in that world, the cloud server world and the -- also the integrated world on processors and memories. We mentioned the -- you mentioned the [inaudible] is a very important new technology where we are deeply involved in and moving in general, the accuracy is down from a 3-micron environment to even below 1-micron accuracy and then in panel size and these are for next-generation processors but also other applications. So will we ever reach €600 million revenue again, because that is your question and maybe you have significant doubts, but it is not our world.

Got it. And my last few questions would just be around, I know you can’t guide on Q4, you have such a short lead time. But just be interested to know if you think that the -- you said it was typical H2 seasonality, so if you can just remind me what typical seasonality is Q3 on Q4 growth-wise? And then just related to that, if there was any gross margin negative impact to think about or should we just assume that you can hold the gross margin as part of your third quarter guidance? Thank you.

Well, you gave the answer yourself. We are talking about the third quarter guidance and not about the fourth quarter. So we will not comment on that.

Okay. And on the gross margin, it is too early to say basically as well?

Well, what do you want to hear?

Well, I mean, obviously, I guess, the context of my question…

We are guiding on the third quarter, let’s make it very clear. You’re trying to set us up for a trap again. We are not going to tell Mr. Sanders.

Okay.

Good-bye.

And -- okay. Thanks.

[Operator Instructions] We have a question coming through from Mr. Trion Reid of Berenberg. Go ahead, sir. Your line is open.

Hi, there. Yeah. Thanks for taking my question. I got cut-off midway through the Q&A, so apologies if this has been asked before. But just mentioned from the order intake in Q2, it seems if your orders from IDMs held up reasonably well, but I see the weakness was coming from the subcontractors, whereas actually in a downturn we maybe expect that to be other way around. I just wondered, do you have any comments on that or what is something that we can read from this? And then just secondly, can you make any comment on your order intake so far in July, that would be useful? Thanks.

Well, the big subcon impact was the major cancellation, which we issued the press release early July. So, I mentioned also in the comments and in the press release that has impacted the amount from the subcontractors. And you’re right, the IDMs are positively continuing, moving along and so you have to take into account the €28 million cancellation. On the order intake so far, we have not given any specifics. Our guidance is what it is in the quarter and that is where we stand.

Okay. Thank you. Thanks.

[Operator Instructions] There is no question coming through. Please continue, sir.

Well, thank you very much for listening to this call. If you have any further questions don’t hesitate to contact us directly. Bye-bye.

This concludes this conference. On behalf of Besi thank you for attending. You may disconnect your line now.