Thin Film Electronics — Cloud portal launch strengthens NFC proposition

Thinfilm reported slightly higher than expected revenues of $3.8m in 2016, albeit 13% down on the previous year. The y-o-y decline was principally due to lower sales revenues of $1.5m (2015: $2.2m) derived from product development projects, prototype deliveries and sales of EAS tags. Orders for EAS tags were interrupted by the need to add a glue layer, then delays in re-initiation of orders from Thinfilm’s go-to-market partner. Revenues were supported by government grants and other funded projects of $2.0m ($1.8m in 2015) and $0.4m ($0.4m) from sub-leasing part of the San Jose production site.

Reported operating losses in 2016 rose to $41.5m (2015: $31.8m). A major factor in the rise was 39% growth in uncapitalized R&D costs to $15.1m, relating to the development of roll-to-roll printing processes, printed batteries and displays. The cost was contained within a number of lines, including payroll costs, which grew 24% to $20.7m on the back of a 26% increase in employee numbers during 2016 to 134.

Another cost pressure related to the planned ramp up in production was a greater build-up of front-end buffer stock than we had forecast, ahead of the expected disruption to production from the planned move to group’s new Junction Avenue site in Q217. The company did not release exact figures for this, but we understand that the bulk of the stock build-up was expensed rather than capitalized and contained in the premises and supplies line, which grew 58% to $12.0m in 2016.

Thinfilm management put significant effort into marketing during the year, with notable successes in new partnership agreements and field trials. Part of this was reflected in rising personnel costs but marketing costs rose only moderately from $2.8m in 2015 to $3.0m.

Capital issues had a negative impact on financial costs during the year. The group reported a $2.7m expense (2015: $2.4m profit) in 2016. Of this $869k in Q1 was related to fees for the private placement to Woodford. Nevertheless, we understand that the high $1.4m expense in the fourth quarter was principally due to depreciation in the value of the NOK, which led to FX losses on the funds raised from the $61.7m capital issue in December and the costs of the capital issue in December were capitalized.

Local taxes resulted in a small $0.3m tax burden, which resulted in net post-tax losses rising from $29.4m to $44.5m and normalized post-tax losses rising from $28.3m to $43.1m after a $0.3m rise in share-based remuneration to $1.4m.

Revenues in the fourth quarter fell 36% y-o-y to $1.0m, but were above our $0.9m forecast due to higher than expected technology access and development fees.

The inventory build-up mentioned above had a particularly strong impact on the Q4 results and contributed to a 59% y-o-y increase in Q416 premises and supplies costs to $4.3m. This cost line was also affected by the take-up of the lease over the new Junction Avenue site in November, which resulted in additional ancillary costs relating to insurance etc, alongside the costs incurred by the existing Zanker Road site. These costs will continue until the move in Q217, with the lease cost extending until June. Further pressure from 18% employee cost growth contributed to a 30% widening in Q4 operating losses to $12.7m ($12.4m normalized).

The new lease over the Junction Avenue site (where the R2R plant will be built) began in November but, being deemed a financial lease (as opposed to the operational lease designation for the existing site), the charge was reflected in the D&A and finance cost lines rather than in the premises/supplies line. We have restated our forecasts to account for this change (see Exhibit 4).

Cash flow from operations rose to $37.5m in 2016 from $26.0m the previous year. During Q4 the outflow was increased to $10.4m (Q415: $7.8m) by the stock-piling of front-end buffer stock and the additional premises costs discussed above. Including investments, cash burn reached $42.8m (2015: $31.4m), which was funded principally by equity issues totaling $101.1m, which resulted in cash levels rising from $15.9m to $74.2m (in line with our forecast of $74.0m). Netting off debt and the new $12.6m financial lease discussed above, net cash reserves at end 2016 were $61.6m.

The group completed the purchase of the EAS label-producing equipment for the R2R plant during December. The purchase cost comprises approximately one-third of the total $32m outlay planned for the entire plant including the Near Field Communication (NFC) transistor segment, which will be procured later this year. Based on the costs incurred in this purchase, management expects the final capex outlay for the R2R plant should be within 10% of the budgeted total amount of $32m.

Thinfilm’s new software portal, which first went live in China in Q416, was launched internationally on 22 February. The portal primarily supports brand owners, enabling them to store and manage tag data, execute marketing campaigns, and track real-time consumer tapping activity. Consumers can also authenticate products via the portal with an integrated app.

The portal was designed to be accessed via a range of devices, using android and IoS systems. Functionality includes tracking the location of products, viewing real-time data on the number and location of consumers accessing the labels using interactive maps and charts. In addition, the brands are able to alter the messages accessed by consumers such that they can launch specific marketing campaigns or alter the message to suit specific consumer events, holidays or geographic locations.

Thinfilm is offering two versions, one in a Thinfilm skin and one that can be customized for brands. An application protocol interface (API) and software development kit (SDK) also allows third-party integrators to develop their own applications.

Thinfilm management is very bullish about the prospects for an acceleration in field trial orders in upcoming months helped by the launch of the portal internationally (after it was launched in China in Q416) and the launch of go-to-market activities with hang-tag specialist, Bedford Industries. The latter’s elasticized “smart hang-tag” labels are being marketed as a low-cost, high-impact method of attaching Thinfilm’s NFC labels to bottles and other packaging.

We have restated our earnings forecasts to account for the classification of Thinfilm’s 12-year lease over the new group’s new headquarters in the US as a financial, rather than operating, lease. A significant impact of this is that the lease liability of $12.6m at end-2016 has had to be treated like debt (unlike the existing lease on the Zanker Road site), so has had to be included in our net cash calculation, reducing the net cash figure for end 2016 to $61.6m. As we had assumed that the lease would be an operating lease, we have also had to adjust our forecast net cash/debt levels accordingly.

In the P&L we have had to transfer our forecast of lease costs on this site from premises and services and increase in depreciation and interest costs to reflect the creation of the lease property asset in the accounts under IFRS standards. Our revised forecast for 2017 reflects this with a $1.3m reduction in premises and services costs and $1.1m and $0.2m increases in D&A costs and interest expenses, respectively. By shifting expenses down the P&L, our otherwise unchanged forecasts of 2017 EBITDA, operating loss and net loss are reduced by 3%, 1% and 0.2%, respectively (see Exhibit 4).