Thin Film Electronics

R2R game changers

Q216 results

Tech hardware & equipment

17 August 2016

Price	NOK4.47
Market cap	NOK3,041m
NOK8.2050/US$
Net cash ($m) at end-Q216		36.8

Shares in issue	680.4m
Free float	84.9%
Code	THIN

Primary exchange	Oslo
Secondary exchange	OTCQX

Share price performance

%	1m	3m	12m
Abs	(5.5)	1.6	27.0
Rel (local)	(3.7)	(0.5)	32.6

52-week high/low

NOK5.7

NOK2.2

Business description

Thin Film Electronics (Thinfilm) commercialises printed electronics and owns key patents for printing rewritable, non-volatile memory and printable NFC circuits. It also licenses technology from others to develop complete printed systems.

Next events

Q316 results	4 November 2016
Q416 results	24 February 2017

Analysts

Anna Bossong	+44 (0)20 3077 5737
Katherine Thompson	+44 (0)20 3077 5730

tech@edisongroup.com

Edison profile page

Thin Film Electronics is a research client of Edison Investment Research Limited

During Q216 Thin Film Electronics (Thinfilm) continued to build on the list of top brands looking to incorporate its NFC tags into their products. New partners include craft beer seller Hopsy, an Italian luxury bag producer and a Fortune 500 pharma producer. Helped by a trial product order for medical devices for the latter, Thinfilm reported 25% y-o-y sales revenue growth in Q2. For us, the one area of disappointment was that the growth in partnerships has not yet translated into volume orders capable of filling the expanded capacity of the plant (fab). Does it matter? Most probably not – the prize for investors is what happens from 2018 onwards. Here we believe that our forecasts could significantly understate earnings, especially if Thinfilm can leverage its expanded salesforce and reduced price points, enabled by low R2R manufacturing costs, into a major slice of the burgeoning NFC market.

Year end	Revenue ($m)	PBT* ($m)	EPS* (c)	DPS (c)	EV/Sales (x)	EV/EBITDA (x)	Yield (%)
12/14	4.5	(24.2)	(4.9)	0.0	74.2	N/A	N/A
12/15	4.4	(28.3)	(5.3)	0.0	75.9	N/A	N/A
12/16e	6.0	(35.6)	(5.8)	0.0	55.6	N/A	N/A
12/17e	38.6	(33.7)	(4.9)	0.0	8.6	N/A	N/A
12/18e	196.2	15.2	2.2	0.0	1.7	15.2	N/A

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, share-based payments

Thinfilm focuses on R&D and sales expansion in Q2

In Q2 Thinfilm’s strategic focus switched to boosting the group’s sales capabilities and moving forward with R&D and the transition to R2R manufacturing. It ploughed $5.2m into expensed R&D (vs $2.6m in Q116) and increased staff (particularly sales staff) numbers in the US. This increased cash burn to $12.8m in Q2, compared with $8-9.5m in the previous four quarters. Nevertheless, the group finished the quarter with a still healthy $36.8m cash balance.

R2R plant capacity potential uprated

Management’s current guidance for the construction of a 1bn unit capacity roll-to-roll (R2R) plant in 2017 is for capex of $20-25m plus $8m in capitalised opex. It is now looking at potentially trebling the bed width of the facility to enable the construction of a 2bn unit plant for $18m cost or a 7bn unit plant for $32m, which we believe would be positive for the group valuation. With a 50x increase in batch sizes and thinner substrates, management is indicating that front-end production costs may be cut by c 90% from current levels. Lower price points and higher production capacity could lead to a step change in earnings from 2018.

Valuation: Forecast revisions reduce valuation

Thinfilm shares have outperformed the NASDAQ Composite by 27% over the last year, helped by positive newsflow from major customer signings and increased focus globally on NFC products. Our DCF valuation has fallen NOK0.08 to NOK7.44 per share following revisions to our forecasts.

Q2 results and forecasts update

Interim results: Focus on boosting R&D and sales team

The key points from the Q2 results are:

■

Product sales became a driver of growth in Q2, with sales revenues growing 25% to $597k. Revenues were boosted by trial product deliveries under a new agreement with a global pharmaceutical company, as well as delivery of the final 1.8m units from the 13m unit Nedap electronic article surveillance (EAS) order from 2015. Lumpy government grant revenues kept headline revenue growth to a more moderate 10%.

■

Management took advantage of increased equity funding to accelerate expensed R&D, which is currently focused on the development of printed batteries and displays and R2R printing processes. Running the fab at full capacity to test these processes resulted in $5.3m in expensed R&D in Q2 (equal to 50% of total costs) compared with $2.7m in Q1.

■

Payroll costs also rose sharply in Q2, up 35% y-o-y, reflecting increased uptake of higher-cost staff in the US. The main focus was a boost to the sales and business development teams which we see as key to monetising the recent 24m unit increase in annual production.

■

Cash burn in Q2 increased to $12.8m from $8.4m in Q1, principally due to the above-mentioned increase in R&D spending and employee hiring. We forecast that cash on the balance sheet at the mid-year point of $36.8m should be sufficient to fund the company through to at least Q117, after which time another equity raising is likely to be sought.

Exhibit 1: Interim results summary

US$000s	Q216	Q215	Change y-o-y (%)	H116	H115	Change y-o-y (%)	Q116
Sales revenue	597	478	25.0	747	731	2.2	150
Other Operating revenue	483	492	(1.7)	1,040	872	19.3	557
Other Income	105	107	(1.9)	209	172	21.5	104
Total revenue	1,186	1,077	10.1	1,997	1,775	12.5	811
Payroll	(5,146)	(3,797)	35.5	(9,794)	(8,021)	22.1	(4,648)
Share-based payments	(413)	(352)	17.3	(599)	(393)	52.4	(186)
Premises, supplies	(2,507)	(1,557)	61.0	(4,986)	(2,945)	69.3	(2,479)
Other operating costs	(2,492)	(2,032)	22.6	(4,408)	(3,521)	25.2	(1,916)
Total operating costs	(10,558)	(7,738)	36.4	(19,787)	(14,880)	33.0	(9,229)
of which expensed R&D	(5,266)	(2,646)	99.0	(7,916)	(4,084)	93.8	(2,650)
EBITDA	(9,372)	(6,661)	40.7	(17,790)	(13,105)	35.8	(8,418)
EBITDA (normalised)	(8,959)	(6,309)	42.0	(17,191)	(12,712)	35.2	(8,232)
D&A	(684)	(308)	122.1	(1,236)	(652)	89.6	(552)
Reported operating profit	(10,056)	(6,969)	44.3	(19,026)	(13,757)	38.3	(8,970)
Net financial items	(454)	53	NA	0	0	NA	(967)
PBT	(10,510)	(6,916)	52.0	(20,447)	(13,644)	49.9	(9,937)
Tax	(1)	0	NA	0	0	NA	(299)
Profit (loss) for the period	(10,511)	(6,916)	52.0	(20,747)	(13,644)	52.1	(10,236)
Normalised profit (loss) for the period	(10,098)	(6,564)	53.8	(20,148)	(13,251)	52.1	(10,050)
Normalised loss per share ($)	0.015	0.012	22.1	0.031	0.025	24.1	0.016
Net cash	36,809	36,291	1.4	36,809	36,291	1.4	49,122
Cash flow from operations	(11,516)	(6,817)	68.9	(17,769)	(12,111)	46.7	(6,253)
Cash burn (CF from ops and investments)	(12,827)	(8,406)	52.6	(20,852)	(14,094)	48.0	(8,024)
Purchases of PPE	(945)	(1,055)	(10.5)	(2,645)	(1,497)	76.7	(1,700)

Source: Thin Film Electronics

Our view

In our original 2016 forecast we had looked for a sharper ramp-up in sales in Q2 to $880k on increased field sample sales and new order inflows, particularly from Nedap for EAS tags. With Q2 sales revenue a shade below $600k and the order book light of volume orders that the company could use to generate sharply higher revenues in H2, we have reduced our 2016 and 2017 revenue and earnings forecasts (see below).

We are not concerned by the increased cost levels. We see the R&D spend and increased outlays on sales staff, in particular, as important building blocks to secure the group’s future.

Change in forecasts: Trimming H216 production ramp outlook

We have cut our revenue and earnings expectations for 2016, reflecting delays to volume order inflows. While we believe this may have to be reversed if major orders materialise in the next few weeks – not least from the many leading companies currently trialling the product (Diageo, Constantia, Jones Packaging, Ypsomed, Ferngrove, etc) – we have for now reduced our 2016 revenue forecast for NFC OpenSense products from $4.6m to $1m. For 2017 we have cut our NFC OpenSense unit sales and revenues forecast by 25%, to 82m and $29.8m respectively reflecting the delay in volume ramp-up.

Similarly, whereas we had assumed a 10m unit follow-up order for (EAS) tags from Nedap from Q316, we now assume a follow-up order later this quarter, with 4m sales in Q4 after the 1.8m in Q2, reducing our full year EAS sales expectation from $2.3m to $0.4m.

Additionally, with Xerox label sales having no material impact on Q2 sales, we have cut our sales assumption for 2016 from 180m to 120m units, reducing revenues from $1.1m to $720k. For 2017, we have maintained our assumption of 1bn unit sales, giving rise to licence fee revenues of $4.5m.

With the high level of interest from brands and packaging companies and lower potential pricing points from the new R2R plant, we expect higher order flows to put revenues and earnings back on track in 2018, with a 0.3% higher operating margin assumed on the back of the additional cost savings now envisaged by the new R2R line configuration.

Exhibit 2: Change in earnings forecast

	Revenue ($m)			EBITDA* ($m)			EPS (c)
	Old	New	% chg.	Old	New	% chg.	Old	New	% chg.
2015	4.4			(29.2)			(5.3)
2016e	12.0	6.0	(50.1)	(30.6)	(33.8)	10.3	(5.3)	(5.8)	9.6
2017e	48.3	38.6	(20.0)	(24.2)	(29.2)	20.3	(4.3)	(4.9)	16.4
2018e	196.2	196.2	(0.0)	21.0	21.9	3.9	2.2	2.2	3.7

Source: Edison Investment Research, Thin Film Electronics. Note: *Normalised.

Valuation sensitivity

Exhibit 3: DCF sensitivity analysis – forecast revenue from 2018 and WACC (NOK/share)

		Actual revenue as % of current forecast revenue
		60	70	80	90	100	110	120	130
WACC	12%	4.03	5.73	7.42	9.11	10.81	12.50	14.19	15.88
	13%	3.45	4.95	6.45	7.95	9.45	10.95	12.45	13.95
	14%	2.99	4.33	5.67	7.01	8.35	9.69	11.03	12.37
	15%	2.60	3.81	5.02	6.23	7.44	8.65	9.86	11.07
	16%	2.28	3.38	4.48	5.58	6.68	7.78	8.88	9.98
	17%	2.01	3.02	4.02	5.03	6.03	7.04	8.04	9.05

Source: Edison Investment Research

Our DCF valuation for Thinfilm was not significantly affected by the reduction in our 2016 and 2017 revenue forecasts, as in our model the bulk of Thinfilm’s DCF value lies in cash flows generated post 2017. In view of the significant uncertainty about the timing and volume of future order flows, we show above a sensitivity table showing the impact on our DCF value of alternative revenue and WACC assumptions, assuming fixed cash costs at 13% of total. This shows that the DCF of the company would fall 32% on a 20% shortfall in forecast revenues, but a 3pp reduction in WACC to 12%, potentially on greater confidence about revenue outcomes, would largely offset this impact.

Exhibit 4: Financial summary

	US$000s	2013	2014	2015	2016e	2017e	2018e
Year-end December		IFRS	IFRS	IFRS	IFRS	IFRS	IFRS
PROFIT & LOSS
Revenue		1,897	4,479	4,413	6,003	38,623	196,150
EBITDA		(10,420)	(23,550)	(29,187)	(33,756)	(29,154)	21,851
Operating Profit (before amort. and except.)		(10,688)	(24,855)	(30,724)	(35,943)	(32,868)	17,098
Intangible Amortisation		0	0	0	0	0	0
Exceptionals		(2,154)	0	0	0	0	0
Share-based payments		(847)	(941)	(1,064)	(1,092)	(1,359)	(1,506)
Operating Profit		(13,689)	(25,796)	(31,788)	(37,035)	(34,227)	15,592
Net Interest		274	701	2,406	329	(795)	(1,874)
Profit Before Tax (norm)		(10,415)	(24,155)	(28,318)	(35,614)	(33,663)	15,223
Profit Before Tax (FRS 3)		(13,416)	(25,096)	(29,382)	(36,705)	(35,022)	13,718
Tax		0	0	0	0	0	0
Profit After Tax (norm)		(10,415)	(24,155)	(28,318)	(35,614)	(33,663)	15,223
Profit After Tax (FRS 3)		(13,416)	(25,096)	(29,382)	(36,705)	(35,022)	13,718

Average Number of Shares Outstanding (m)		412.7	493.5	535.4	617.9	680.3	680.3
EPS - normalised (c)		(2.5)	(4.9)	(5.3)	(5.8)	(4.9)	2.2
EPS - (IFRS) (c)		(3.3)	(5.1)	(5.5)	(5.9)	(5.1)	2.0
Dividend per share (c)		0.0	0.0	0.0	0.0	0.0	0.0

EBITDA Margin (%)		N/A	N/A	N/A	N/A	N/A	11.1
Operating Margin (before GW and except.) (%)		N/A	N/A	N/A	N/A	N/A	8.7

BALANCE SHEET
Fixed Assets		3,112	7,189	10,390	24,320	37,606	40,853
Intangible Assets		0	2,319	2,602	2,720	2,720	2,720
Tangible Assets		3,112	4,870	7,788	21,601	34,887	38,134
Investments		0	0	0	0	0	0
Current Assets		45,121	33,870	19,425	12,840	20,109	40,674
Stocks		0	451	367	499	1,207	1,290
Debtors		1,318	2,565	3,118	3,393	10,582	37,618
Cash		43,803	30,854	15,940	8,947	8,321	1,766
Other		0	0	0	0	0	0
Current Liabilities		(5,865)	(4,748)	(5,170)	(6,093)	(60,311)	(68,899)
Creditors		(5,865)	(4,748)	(5,170)	(6,093)	(10,311)	(28,899)
Short term borrowings		0	0	0	0	(50,000)	(40,000)
Long Term Liabilities		0	0	0	0	0	0
Long term borrowings		0	0	0	0	0	0
Other long term liabilities		0	0	0	0	0	0
Net Assets		42,367	36,311	24,645	31,067	(2,596)	12,627

CASH FLOW
Operating Cash Flow		(7,905)	(24,079)	(26,036)	(33,240)	(32,831)	13,319
Net Interest		234	569	146	570	(795)	(1,874)
Tax		0	0	0	0	0	0
Capex		(2,487)	(3,217)	(4,751)	(16,118)	(17,000)	(8,000)
Acquisitions/disposals		0	(2,700)	(799)	0	0	0
Financing		48,560	16,477	16,527	41,796	0	0
Dividends		0	0	0	0	0	0
Net Cash Flow		38,402	(12,949)	(14,914)	(6,993)	(50,626)	3,445
Opening net debt/(cash)		(5,401)	(43,803)	(30,854)	(15,940)	(8,947)	41,679
HP finance leases initiated		0	0	0	0	0	0
Other		0	0	0	0	0	(0)
Closing net debt/(cash)		(43,803)	(30,854)	(15,940)	(8,947)	41,679	38,234

Source: Thin Film Electronics accounts, Edison Investment Research

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