Kulicke & Soffa Industries Inc Q2 FY2020 Earnings Call

Greetings, and welcome to Kulicke and Soffa's Second Quarter Fiscal 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Joe Elgindy. Please go ahead, Joe.

Thank you. Welcome, everyone, to Kulicke and Soffa's Second Quarter Fiscal 2020 Conference Call. Joining us on the call today are Fusen Chen, President and Chief Executive Officer; and Lester Wong, Chief Financial Officer. For those of you who have not received a copy of today's results, the release as well as the latest investor presentation are both available in the Investor Relations section of our website at investor.kns.com. In addition to historical statements, today's remarks will contain statements relating to future events and our future results. These statements are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Our actual results and financial condition may differ materially from what is indicated in those forward-looking statements. For a complete discussion of the risks associated with Kulicke and Soffa that could affect our future results and financial condition, please refer to our recent SEC filings, specifically the 10-K for the year ended September 28, 2019, and the 8-K filed yesterday. Before moving on to our prepared comments, I'd like to make an additional announcement. Beginning on today's call, we will provide additional details and updates to our end market categorization. These end market categories will now refer only to our capital equipment segment and will isolate the general and advanced LED market from the general semiconductor end markets and advanced packaging IC market. Additional information regarding these end market categories are available within the latest investor presentation and will be reported in the Management Discussion & Analysis section of our quarterly and year-end SEC filings. With that said, I would like to turn the call over to Fusen Chen for the business overview. Please go ahead, Fusen.

Thank you, Joe. This is clearly an unprecedented period for our industry and the world. First, I hope your family, friends, and colleagues remain safe and healthy through this unique period. Before reviewing our quarterly business update, I would like to briefly discuss our response and the status regarding the global COVID-19 situation. Over the past 6 years, our global development and manufacturing teams have designed and carried out detailed business continuity planning and testing exercises. This effort has streamlined and prioritized critical communication flow and allowed our individual site management teams in affected areas to operate in the best interest of employees, customers, and business partners, while allowing for decisive responses to local and regional guidelines and orders. More recently, over the past few months, we have also taken many precautionary steps, including significant travel reductions, increased site cleaning, social distancing practices, visitor limitations, and increased use of virtual collaboration tools and software. Where it is in the best interest of employees and the local community where we operate, we have also reduced our physical presence in the office and facilities to provide a safe working environment for essential staff. Our IT infrastructure has provided adequate bandwidth to support the needs of this temporary remote working environment. Despite this working from home transition, we continue to make progress on our development initiatives and do not anticipate significant disruption to critical customer commitments. From a manufacturing standpoint, all operational sites in Singapore, Europe, and China remain fully operational. Our operation in China returned to 100% capacity within the March quarter. Regarding supply chain, there continues to be disruption in many parts of the world, although we believe the situation remains manageable. We experienced temporary disruption from suppliers within China, although production gradually recovered in March. Therefore, US and European vendors are operating at reduced capacity. Currently, the situation in Malaysia may create additional disruption in the June quarter. Again, we believe this current situation is manageable, and that we are mitigating these identified supply chain risks through close partnership with customers and also with new and existing suppliers. Overall, I am very proud of our organization's resilience, dedication, and effort in navigating this unique situation. Turning to our business dynamics, demand challenges and uncertainty were triggered by mandated customer shutdowns early in the quarter. Demand has recovered rapidly in certain areas like China and has softened in other regions currently implementing social distancing practices, such as Europe, Southeast Asia, and the U.S. During the March quarter, revenue came in at $150.7 million, a sequential increase from the December quarter. We generated $11.9 million of net income and earnings per share of $0.19. On the December quarter, the capital equipment segment revenue increased by 11%, with stronger demand for our high-volume ball and wedge bonding systems. The APS segment decreased by roughly 11% sequentially. This change was largely due to the lower customer utilization rate in the week following the Chinese New Year. Considering a higher portion of capital equipment sales, gross margin of 46% came in better than expected, generating $69.3 million of gross profit. Within capital equipment, general semiconductor increased the most dramatically by nearly $17 million, over 33% from the December quarter. Automotive and industrial also improved, while LED, advanced packaging, and memory declined sequentially. During the June quarter, we continue to anticipate demand improvement to stem primarily from the general semiconductor and the LED market, although we anticipate ongoing shelter-in-place orders to create regional demand disruptions. I would now like to turn the call over to Lester Wong, who will cover this quarter's financial overview in greater detail. Lester?

Thank you, Fusen. My remarks today will refer to GAAP results unless noted. Net revenue for the quarter was $150.7 million. Gross margins of 46% generated $69.3 million of gross profit, and net income of $11.9 million, or $0.19 per diluted share. As Fusen mentioned, despite the lower relative APS contribution, gross margins of 46% were stronger than expected. This stronger performance is largely due to product mix within equipment and a higher proportion of feature-rich equipment. Looking into the June quarter, we anticipate gross margins to be lower due to an increased demand for LED wire bonding systems. Operating expenses again came in more favorably than our expected target range. This is largely due to a sustained focus on cost control, prior restructuring efforts, and also due to lower travel expenses. Travel expenses were approximately $550,000 lower in the March quarter versus the December quarter. As we continue to prioritize order fulfillment and near-term project development, we expect June quarter operating expenses to, again, fall on the lower side of our target operating expense range. As a reminder, this GAAP operating expense target range consists of $53 million of fixed expenses plus 5% to 7% of variable expenses tied to revenue. Turning to tax, we booked a net tax expense of $1.2 million. We continue to target a long-term average effective tax rate of approximately 18%, although we anticipate our fiscal 2020 period to come in below that long-term target. Regarding the balance sheet, we ended the March quarter with a total net cash and investment position of $524.7 million or $8.17 on a diluted share basis. Considering our long-term perspective on the repurchase program, we view the recent market dynamics as an opportunity. During the March quarter, we increased our repurchase activity by over three times and deployed $18.5 million to repurchase 872,000 shares. Over the trailing two years, we deployed roughly $191 million to repurchase 8.5 million shares. Since initiating the program in 2014, we have repurchased 18.3 million shares, which is equivalent to over 28% of our diluted share count in the March quarter. We continue to take a long-term and very structural approach to this repurchase program. At the end of the March quarter, we had approximately $73.3 million remaining under the existing share repurchase authorization. On a book value per share basis, we closed the March quarter with $11.89. Working capital, defined as accounts receivable plus inventory, less accounts payable, increased slightly to $255.4 million. From a DSO perspective, our days sales outstanding decreased from 124 days to 119 days. Our days sales of inventory increased from 116 days to 117 days, and days of accounts payable increased from 55 days to 56 days. This concludes the financial review portion of our call. I will now turn the discussion back over to Fusen for the June quarter's business outlook.

Thanks, Lester. This is clearly a unique and dynamic period in our history. While we cannot predict the future, our strong fundamental position, expectations of core business improvements, and the growing market prospects for our new products provide confidence and optimism as we look ahead. Fundamentally, we continue to have adequate cash on hand to support our operational ramp, maintain the path of development, while supporting shareholder returns through the dividend and our opportunistic repurchase activity. Also, our served market has diversified over the years, and we continue to aggressively expand our market reach. Despite supply chain challenges throughout the world and the ongoing uncertainty, there continue to be pockets of strong demand for our core high-volume systems. After several low-volume quarters, many customers are beginning to demand incremental capacity. This is primarily evident in the general semiconductor and the LED market, although we continue to anticipate gradual improvement in automotive and memory as well. Finally, I'm happy to report the adoption and progress of all APAMA and Katalyst, our advanced packaging system, and PIXALUX, our advanced LED system, continue as planned. Customer feedback continues to be positive, and we are aggressively working toward increasing production and additional customer acceptance. This new product that enables new packaging capabilities is an additional layer of diversification to our business. I will provide a brief update for each of these new systems. Katalyst, our High Accuracy Flip Chip tool, continues to be in several payroll evaluations, which are progressing according to plan. We have attained the first Katalyst PO and acceptance from our OSAT in April, supporting high-volume logic applications. This first market acceptance of Katalyst highlights our ability to rapidly develop a competitive flip-chip solution and expand our market reach further into the leading-edge logic market, a market where wire bonding has historically been less dominant. We are currently building multiple Katalyst tools to be shipped over the coming quarters. APAMA, our Thermo-compression system, is qualified for production for several high-end mobile chipsets at a major OSAT, and we are also actively working towards several additional qualifications supporting new features in mobile sensor applications. Our progress and expectations on PIXALUX, our advanced mini and micro LED system, remain consistent and optimistic. We expect higher volume production to begin in the June quarter, and the majority of the calendar year sales to ship in the September and December quarters. We anticipate consistent demand for PIXALUX through fiscal year 2021, largely driven by backlighting applications in the display market. Despite a challenging working environment globally, we have maintained focus on our longer-term market expanding development efforts. These initiatives are increasing our prospects for next-generation displays and also leading-edge logic integration. Considering the current dynamic environment and the ongoing impact of regional, state, and home orders on semiconductor assembly production and our customers' equipment capacity plans, we are guiding June quarter revenue of $140 million to $160 million. While this production challenge across the industry may linger, we are reassured by the resilience of the general semiconductor and the LED market in areas like China, which are not significantly affected by the current global pandemic. Again, we believe the recovery is partially due to ongoing demand improvement within select end markets, but also achieved a relatively strong and improving utilization rate we have seen in the December quarters. Utilization rates recovered quickly in China, and we are hopeful other regions will resume a higher level of productivity once social distancing practices begin to ease. Longer-term, ongoing technology transitions within the automotive market, display market, and within advanced packaging are driving the need for new equipment capabilities. Ongoing progress in this technology transition will further diversify our unit-driven businesses. We continue to believe this improving condition and the longer-term opportunity will be much more meaningful to our business than the near-term headwinds. In summary, the strength of our fundamental resilience of our core market and the progress of new growth initiatives provide a positive outlook and ongoing confidence as we look ahead. I am very proud of the dedication and adaptability of our employees through this dynamic period. I am confident we will exit this current environment as a stronger and better-positioned organization. This concludes our prepared remarks. Operator, we will now be happy to take the questions.

Our first question today is coming from Craig Ellis from B. Riley FBR.

Gentlemen, congratulations on the execution in the quarter despite a very dynamic environment. Fusen, I just wanted to start by following up on some of the trends in the quarter. I think I heard you say that memory was down quarter-on-quarter, but auto was up. We've heard from some other companies that memory utilization rose through the quarter. So can you give us your view of how memory looks as we move into the latter part of April? And secondly, on auto, there are a lot of concerns about auto units sequentially in the second quarter. What's your view of the automotive market as it stands today?

Okay. So Craig, let's talk about, I think you asked about memory and auto, right? So let me talk about memory first. I think in the recent months, we see actually a price of both NAND and DRAM start to firm up. So I do believe recovery is ongoing and will go even stronger in the next couple of months and quarters. I think memory is a very important component for the whole supply chain. And I am optimistic that it’s going to go bigger compared to our current level because of 5G, AI, and many other technologies. So for us, I think we're a little bit slow. Our quarterly revenue compared to average revenue is still low; that's why I think we say it's a little bit softer. But I do believe the recovery is ongoing. I think in the next couple of months and quarters, we will see stronger revenue contributions from memory. So that's a question about memory.

Okay. And then on the automotive market?

So automotive, I think for us, we still have room to grow. Relatively, I think the whole quarter was still a little bit low. But I think auto is also going through some revolution, right? It's like electric vehicles and a lot of changes, with information and memory content in the auto continuing to increase. So hopefully, I think we're going to see that recover in the next couple of quarters as well. But relatively for us, I think it's a little bit slow. We see upside in the memory and auto.

Great. That's helpful. The next question is really a follow-up on a point in the press release and an artifact of the guidance range. So I think a quarter ago, the guidance range was $30 million. It's back to $20 million. So does that signal just increased confidence with the way the supply chain is working? And I noticed from the release, backlog ending the fiscal second quarter was $136 million, so about 90% of the guidance midpoint. How would you characterize the strength of the backlog? And would you expect to be building backlog as you go through the fiscal third quarter given the view for gradual sequential growth through the year?

Okay. So, Craig, let me put it this way. We believe our customers are under-indexed in 2019, right? So currently, I think the utilization rate in the industry is quite healthy, and we see many technology drivers like 5G and AI. And we already experienced a few quarters of sequential growth, right? So we can see that fundamental demand for our core business is very strong. Coupling this with our new product introductions in AP and LED and also new customers we are engaging, I think that we are quite optimistic for 2020 and beyond. However, I think that we have this pandemic situation, and it's just not practical for some of our customers to give us a PO and for us to enable the systems and then service the systems in their fabs. So this pandemic actually weakened a little bit of our outlook. But fundamentally, I think the situation will improve and our growth will resume. So at the beginning of this coronavirus, which probably started in China at the end of January, actually LED was much more than we expected. So that's why I think we gave a little bit wider range. Fortunately, with a lot of effort, we almost hit the center point, right? So with a lot of effort from the team, we believe we know how to respond to many dynamics much better. So I think this time, we actually tightened the range.

Craig, it's Lester. Just to give you a little more specificity around the backlog. We are seeing backlog growing over the last couple of quarters. So if you look at the last 4 quarters, the backlog of capital has increased.

That's great color on both fronts, guys. And then my last question before I hop back in the queue. Fusen, it was really helpful to get your perspective on some of the emerging product growth drivers for the company, Katalyst, APAMA, and PIXALUX. I know we've had a view that PIXALUX could potentially generate $50 million to $100 million in revenue. So the two-part question is, first, is that still a reasonable revenue expectation for PIXALUX this year and next year? And if you look at the 3 new products, Katalyst, APAMA, and PIXALUX, which would be the most significant growth drivers this year and next year? Thanks so much for your help, guys.

Okay. So I think I talked about a piece of that in my script. Currently, I think we expect about $40 million for the calendar year revenue, so roughly $40 million. Some of the systems are going to be shipped in June, but the majority of the systems are going to be shipped in September and December. So altogether, I think we are looking at roughly $40 million because we only have half of the year to run these products. So the number is due to the shipment schedules and is not a change in end demand. We continue to expect the demand for PIXALUX to increase further in fiscal 2021, right? So compared to a lot of global market disruptions, this performance of $40 million is very good. So in summary, I think that piece is on track and on schedule, and we are quite happy with it. So that's PIXALUX. For the AP system, we are also quite confident. Increasing transistor density is very important, right? Most of them actually increased the transistor taking density at the wafer level, but AP actually increased taking density in transition level, making it much more affordable and effective. This is very favorable for our TCB and free chip. We are aiming at high-performance logic, high bandwidth in memory, and also the next generation of imaging sensors. So AP, I think, many players are competitive, and we are actually a little bit late, but we are quite confident. So we're in the process of gaining market shares and establishing a good foundation. So we expect AP to grow significantly, probably in 2021, and we're quite confident that 2022 will be much bigger. The APS is where we are much stronger, putting more focus. I hope to see from now to 2022, we can contribute probably close to $200 million in AP plus advanced LED and maybe an additional $50 million for the APS.

Our next question is coming from Krish Sankar from Cowen and Company.

I had a few of them. First one, Fusen, you spoke about supply constraints, which seems to be a common theme across most companies. Just curious, if you did not have any supply constraints, what would the June quarter guidance have been?

Okay. So actually, Krish, the June quarter has constraints both on supply chain and also the shelter-in-place orders, right? So I mentioned it's also not practical to expect some of the customers to place a PO during this period of time, and for us to deliver systems in their fabs when they are shut down. So I think we are impacted by both supply chain disruption and also the shelter-in-place orders. I would say shelter-in-place has probably impacted more than the supply chain disruption. Our operating team has done a very good job. If you want me to quantify, these two factors together probably account for about 15% of our total revenue outlook. But I think this is temporary. This order did not disappear; I think it's going to show up in the next couple of quarters in our revenue.

Got it. That's helpful, Fusen. And then I think you mentioned about auto coming back. I'm just curious, is that a function of what your customers are telling you or is it just the fact that auto has been weak for a while so it's expected to have a cyclical rebound?

Well, Krish, let me rephrase it. Actually, memory will come back much faster than auto, right? With the current financial situation, I think auto will actually be weak for a while. So this will be a longer-term opportunity. But I'm quite confident there will be a lot of innovation, and electric vehicles will become much larger. In the B2B area, there are many things, with information, the display, the semiconductor content. So the auto will come back, but let me modify a little bit. I think this will take a while to come back. So this will be our longer-term opportunity.

Got it. Got it. All right. And then just a final housekeeping question for Lester. I might have missed it in the prepared comments. What did you say in March quarter for the semiconductor revenues, auto revenues, and China exposure?

Sorry. I don't think I specifically said that. Are you asking for regional sales in China? Is that your question, Krish?

Yes. Regional sales in China. And also, out of the total sales, how much was semi and auto in March?

So out of total sales in China for the quarter, it's about 63%. For capital equipment sales, auto and industrial together account for about 80% of total capital equipment sales. What was the other question you had?

Semiconductor, like your general semi exposure?

The general semi is about 60%.

Our next question is coming from David Duley from Steelhead Securities.

Could you just repeat what you said? Was China 63% of revenue in the quarter? Is that what you said, Lester?

Yes. 6-3.

63, okay. And general semi was 60%. So therefore, advanced packaging would be the other 40%?

No, no, no. We break it out: general semi, LED, advanced packaging, memory, as well as auto industrial.

Okay. And could you just review those percentages?

Sure. So general semi was 60%. LED was about 9% to 10%. AP is around 6% to 8% or so. Memory was around 8% to 10%. Auto industrial is about 18% to 20%.

Okay. And what do you think the overall utilization rates are now? And I'm assuming utilization rates in China are higher than in other regions. If you could help us understand what the difference is, that would be great.

Sure. I'll take that, Fusen. So utilization rate is actually quite healthy. I would say globally, it's close to 80%. In China, we see it above 90%. Obviously, it's much softer in Europe as well as in the U.S., and Korea and Japan. So in general, I think Taiwan is also pretty strong right now in utilization.

Okay. And did you mention what the specific supply disruptions are that you're seeing, I guess, in Malaysia? If you could just help us understand what it is that's in short supply for you?

I think for us, we're still, as Fusen indicated, working with our partners, our suppliers throughout the world, first in China, now Malaysia as well as in the U.S., to manage the supply chain disruption. We're also looking for new partners, second sources, and so on. But I think for Malaysia, yes, obviously, there's a loss of control order in place. Even though some of the semiconductor companies have gotten exceptions as well as suppliers, it's always being renewed every 2 weeks in terms of the MCO. So I think for us, right now, it's definitely manageable. It didn't have a huge effect on the March quarter, but I think it will have some effect in the June quarter, as Fusen says, with both shelter in place and control orders.

Okay. My final question is about the LED product moving forward. You mentioned aiming for $40 million in the second half of this calendar year. Can you clarify how many customers that involves and what end market products you anticipate contributing to this growth?

Okay. So I think I mentioned this in my script last time. Actually, we have a part with LED mini. We also identify our customers, and they have a networking, for example, in consumer electronics, auto industry, and the display industry. So actually, we have numerous customers, about 4 sizable customers; I think we could have 2 or 3 sizable customers. And at this moment, yes, it's quite concentrated on a few other customers, but we do have multiple customers.

Thank you. Our next question is coming from Tom Diffely from D.A. Davidson. Your line is now live.

Yes. Good morning and good evening. Following up on Dave's mini LED question. We've been talking about a $30 million to $70 million market, midpoint of $50 million. Now you're saying it's $40 million. Is it just the timing of when the shipments happen in the second half that's gone, and you have changed the midpoint of that guide?

Okay. So I think, first, I think we talked about this probably a long time ago, a year ago. Personally, I'm quite happy with the program. We talked about maybe starting to ramp in the second half of this year. So actually, the demand was actually originally expected. And the revenue really depends on the shipment schedule, which is mainly when the customer needs the system. And due to a recent customers' request, I think we are seeing about $40 million from now until the end of the year. We see next year, our demand will be stronger than the current level. So it’s really not a demand issue. It’s really about the shipment schedule. We need to make a system and according to customers' requests, and when the system reaches the customer side, we will ship out from there.

Okay, so the shipment schedule is dictated by the customer, not your supply capabilities?

That's correct. I don't think it's our manufacturing constraint or a demand constraint. I think demand is very healthy.

Great. And then, Lester, I was hoping to get a little color on the utilization rates and how they've changed over the last quarter. Because I remember going into the year, China was really strong at the end of last year, maybe dipped up in the beginning of this year. But curious, as this quarter has gone on, how have the different utilization rates changed?

I believe the utilization rate has likely remained relatively stable. It may see more changes in the June quarter, especially as more shelter-in-place orders are lifted. China performed well even in the first quarter and appears to be stronger in the second quarter. Taiwan has also shown consistent strength. Southeast Asia has experienced some fluctuations, but overall, Europe and the U.S. were weak previously and continue to show weakness now.

Okay, that's helpful. And then finally, when you look at the operating expenses, obviously, some very good cost controls going on right now. Are those just temporary measures? Or has anything changed structurally that would change the operating expense equation going forward?

Well, Tom, cost control is a subject near and dear to Fusen's heart, so we always look at it. But I think, as I indicated, some of the reductions are due to, for example, reduction in travel because of COVID-19. Our rate of hiring has also slowed down a little given the difficulties of hiring. So I would say, at this point, I would not say it's structural in the model. I think $53 million plus 5% to 7% is still what we're seeing. But we are coming in on the low side of that, both for last quarter, this quarter, and as I guide, probably for next quarter as well.

Our next question is coming from Christian Schwab from Craig-Hallum.

Great. Fusen, I just want to make sure I understand on the supply chain with disruptions. That's really like movement controls and shelter-in-place that's causing supply chain disruptions, correct? There are not components that you're waiting for that are in short supply somewhere in the supply chain. Is that correct?

Yes. It's many things. Sometimes, they cannot go to the office to make a part for us. So this is really a lot of things tied together. Sometimes, we are short on parts. We continue to find a second supplier, so this is quite time-consuming to manage all of the disruptions.

Okay. Okay. And would you say that given the economic dislocation due to the COVID-19 environment, that the business, a couple of quarters here, we're kind of stable at $150 million, should we begin to reopen successfully globally? Can you give us any idea about how big a recovery or snapback in your revenue could be 2 to 3 quarters out?

So we don't guide more than 1 quarter. But if you ask my feeling, I can tell you my feeling. I believe our customers are under-indexed in 2019. At this moment, if you look at the utilization rate, it's quite healthy. We already have a few quarters of sequential growth. Unfortunately, I think we really want to guide higher, but we need to avoid the risks related to the pandemic. Fundamentally, I think the demand is there. Hopefully, this will not extend for more than 2 quarters. I think we can see some better data for Q4. If you look at it, all customers are concentrated in China and in Asia, such as Europe. So Europe has already been impacted, and the U.S. has already been impacted, and they are opening up now. This quarter, Southeast Asia has impacted us a lot. I really don't think this will be more than another quarter. All semiconductor companies appear to be somewhat impacted already. If there is no second wave of the infection, hopefully, we can see better results in Q4 and bigger revenue.

Thank you. We’ve reached the end of our question-and-answer session. I'd like to turn the floor back over for any further or closing comments.

Thank you, Kevin. Thank you all for your time today. As always, please feel free to follow up directly with any additional questions. Have a great day, everyone. Operator, this concludes our call.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.