Thin Film Electronics — Strong revenue growth outlook in coming quarters

Thinfilm has had a very strong last few months in terms of business development in its key areas of EAS (Electronic Article Surveillance for anti-theft purposes), NFC and sensor labels. EAS orders have resumed in volume after trailing off in H216 (on need for a new wet inlay layer) and prospects for further growth in coming quarters appear good based on the existing 16m order backlog and the potential for THIN’s EAS tags to qualify for inclusion in denim items with its go-to-market partner. The launch of the CNECT platform for NFC labels has enabled the group to tie its tags into a complete marketing suite, which is attracting significant interest from new brands. Management sees the potential to double and then redouble revenues from NFC tags over each of the next two quarters helped by the momentum already created. Also, after many delays in recent years, Thinfilm has launched its first hybrid commercial sensor product, using R2R technology to cheaply print displays in Sweden. Coming quarters should bring yet further developments in all three areas, with the launch of R2R printing of EAS tags later this year, signalling a new era for the group.

Thinfilm management has reported that capital expenditure on the new R2R facility is on track and on budget. CEO Davor Sutija has suggested that the programme may be accelerated if Thinfilm experiences strong order flows from current NFC pilot and field trial orders. No decisions have yet been taken but we understand that this would likely take the form of capex spending being brought forward by a quarter or so. This means that we would expect approximately one-quarter of 2018 capex to fall into the 2017 capex spend. If it does, however, then the total 2018 capex should be reduced by a similar amount. With our forecast of R2R capex at $14m in 2018 this could mean an additional spend of c $3-4m on PPE in 2017 (but then also the same reduction in 2018). Rather than bringing production schedules forward by a similar amount, we understand that management may decide to spend the extra few months on process development work to further improve start-up production yields. This could be expected to have a positive impact on production levels from the launch of NFC production in H218.

After a hiatus in late 2016 caused by the need to incorporate a wet inlay (glue layer) to its EAS (anti-theft) tags, there was a surge in EAS tag sales in the first quarter of this year. Unit sales increased 10-fold from Q416 to 5m as new orders flowed in from THIN’s go-to-market partner. The order backlog was increased by a further 11m to 16m units in April, which, assuming a unit sales price of 5 cents, should add approximately $0.8m to revenues in coming quarters.

At the same time THIN has reduced costs of EAS tag manufacture by a 500-600 fold increase in batch sizes, led by die (label size) shrinkage. Helped by lower price points there also appears to be good potential for THIN to qualify for denim apparel with the lead customer of its go-to-market partner. At the same time, we understand that this customer has indicated that it will roll out the use of printed electronic tags across its worldwide operations, which brings a further potential boost to order sizes. This comes at a good time, with THIN planning to transfer EAS production to its R2R facility in Q417, with a resulting increase in annual capacity to 1.2bn units, with substantially reduced unit costs.

Thinfilm launched its CNECT cloud-based NFC marketing platform on 22 February (see our note, Cloud portal launch strengthens NFC proposition, 6 March 2017), but has since announced that it now has four live field trials ongoing with CNECT, covering markets in the US, Europe, China and Canada. The trials consist of Coronado Brewery, a Fortune 500 pharmaceutical company, a medical marijuana dispensary, an Asian cosmetics firm and alcoholic beverage producer Northern Lights Spirits. Preparation for a further six to ten trials are also underway and the company is shortly to launch “IoT Connect in a Box”, which will provide brand managers with a set of different NFC tag types to test different configurations and the abilities of the CNECT platform. With the launch on 28 April of Thinfilm’s book, produced together with publisher John Wiley and Sons, NFC Mobile Marketing for Dummies (see Exhibit 2), the company has created a complete ecosystem for its NFC labels encompassing hardware, tracking, analytics and education.

It is worth noting that the Asian cosmetics company is trialling NFC OpenSense labels for a quite different use case than seen to date. It is looking to monitor assembly of its products in China to ensure that only authentic components that are still fresh are incorporated in its products.

Official launch of Thinfilm’s new temperature sensors is set to take place in Q417, but Thinfilm was able to deliver its first commercial shipment of the product to two distributor partners in the first quarter. Emerson (which acquired sensor label specialist PakSense in August 2016) is to market the labels to the perishable foods industry and Temptime will be used to distribute the product to the drug industry.

The company’s hybrid product (see display in Exhibit 1) contains standard silicon chip based electronics for the temperature sensing component, added to a printed electronics display produced-in-house using THIN technology. This enables the company to make the tags thinner and at a lower cost point than standard tags employing silicon chips. In comparison with the cheaper chemical alternatives, the clear display and on switch functionality enable users to quickly determine which stock has been compromised and to store the tags in their off state without regard to the temperature (which would trigger reactions in the chemical labels).

Thinfilm has been able to reduce the cost of producing these displays by printing them in volumes of 10s of millions using pre-existing R2R technology in its Linkoping plant in Sweden. In addition, given the more complex nature of back-end work in the sensor market, the company is very pleased to have partnered with a tier-two back-end operator in China, which has the capacity to assemble high volumes of the product, giving the product a high degree of scalability. Thinfilm expects, at least initially, to sell most of its products via its partners, which are established distributors in the sensor field. Price points are likely to be between those of chemical and electronic labels, ie in the $2-6 range before volume and distributor discounts (each potentially 30-40%).

Thinfilm is likely to add further sensor labels to its range in coming years featuring different combinations of sensors and features aimed at different verticals.

Thinfilm achieved a 38% increase in revenues to $1.1m in Q117, boosted by a revival of sales (over 5m units) of EAS anti-theft tags. Continued focus on process development ahead of the move to R2R printing resulted in an ongoing high level of raw material expenses, resulting in a 48% y-o-y increase in premises and supplies costs. At the same time, additional technical hires in the new US plant resulted in payroll rising 32%. This contributed to a 35% increase in EBITDA losses to $11.4m. FX gains resulted in a positive financial line and enabled net losses to rise only 12% to $11.5m.

Down payments for equipment orders for the new R2R plant absorbed a high $4.1m of working capital, with purchases of plant and equipment an additional $4.7m. Together with operating cash outflows this led to $21.9m outflows from operations and investment, leading to a $21.6m decline in cash balances to $52.6m.

EBITDA and pre-tax losses for the quarter were 29% and 26% of our full year forecast (the latter helped by non-cash FX gains). We see these figures as supportive of our full year estimates based on the company’s and our expectation that revenues from NFC and EAS product sales should increase in coming quarters. The cash burn in the quarter at $21.9m represents a high 39% of our full year expectation of $56.4m. Stripping out the $9.0m of cash absorbed by capex ($4.9m) and capex down-payments ($4.2m) reported in working capital in Q117 gives rise to $12.9m non-capex cash burn, which represents 33% of the full year $38.9m in forecast cash burn stripping out our assumption of $17.0m capex. In coming quarters, we assume that growth in operating revenues will boost operating cash flows from the Q117 level to enable the company to reach our full year expectations. If the mooted acceleration of R2R capex does take place we assume that the company will employ an additional $3-4m in capex this year with a corresponding increase in cash burn, offset by a corresponding reduction in 2018.

Apart from minor rounding differences in the 2018 P&L, we have made two changes to our model since our last report, both solely affecting the balance sheet. The first is a $269k reduction in the 2016 cash balance to $74.2m occurring as a result of an input error in our model. This reduction carries forward into our forecasts of cash balances.

The second is an adjustment to our cash balances of the $473k cash raised from share issues and the conversion of subscription rights thus far this year, the latest being the raising of $449k (NOK3.87m) from the exercise of employee subscription rights. This has resulted in the issue of 2.06m shares, to bring the number of shares in issue to 818.8m.

Netting these changes has resulted in a $0.2m increase in our forecast net cash balances at end-2017 to $5.9m and a $0.2m reduction in net debt in 2018 to $32.8m (including finance lease liabilities that are treated as debt of $11.0m).

These changes have not materially altered our per share DCF valuation, which in Norwegian krone terms has been strengthened by the 3.1% depreciation in the krone vs the dollar since our last update.