Amkor Technology Inc

NASDAQ:AMKR

Earnings Call Transcript 2018-Q4

[Operator]

Good day, ladies and gentlemen, and welcome to the Amkor Technology Fourth Quarter and Full Year 2018 Earnings Conference Call. My name is Valerie, and I will be your conference facilitator today. At this time, all participants are in listen-only mode. After the speakers’ remarks, we will conduct the question-and-answer session. As a reminder, this conference is being recorded.

I would now like to turn the call over to your host Mr. Vincent Keenan, Vice President of Investor Relations. Mr. Keenan, please go ahead.

[Vincent Keenan, Vice President-Investor Relations]

Good afternoon, everyone and thank you for joining us for Amkor’s fourth quarter and full year 2018 earnings conference call. Joining me today are Steve Kelley, our Chief Executive Officer; and Megan Faust, our Chief Financial Officer.

Our earnings press release was filed with the SEC this afternoon and is available on our website. During this conference call, we will use non-GAAP financial measures, and you can find the reconciliation to the U.S. GAAP equivalent on our website.

We will also make forward-looking statements about our expectations for Amkor’s future performance based on the environment as we currently see it. Of course, actual results could be different. Please refer to our press release and other SEC filings for information on risk factors, uncertainties and exceptions that could cause actual results to differ materially from these expectations.

Please note that financial results discussed today are preliminary and final data will be included in our Form 10-K.

And now I would like to turn the call over to Steve.

[Steve Kelley, Chief Executive Officer]

Good afternoon. Thanks for joining the call. Today, I will discuss our fourth quarter and full year 2018 performance, our first quarter outlook and priorities for 2019.

In the fourth quarter, all of our end market performed better than expected. Pushing revenue to more than $20 million above midpoint guidance, this additional revenue together with the favorable product mix drove improved profitability. For the year, we grew total revenue of 3% to $4.3 billion, a record high for Amkor. In addition, we delivered free cash flow of $120 million, our fourth consecutive year of positive free cash flow.

Revenue was up 5% in communications, up 2% in automotive and industrial, up 3% in computing and down 3% in consumer. The 2% automotive and industrial growth consisted of double-digit growth outside Japan, largely offset by a customer specific inventory correction in Japan.

Our capital spending in 2018 was $547 million, most of those CapEx dollars we use to expand capability and capacity for advanced packages, including wafer-level, system and package and flip chip technologies. Wafer-level and SIP, our backbone technologies for space constrained, performance sensitive applications. Flip chip package are used by a broad base of customers for communications, computing and automotive applications. They were a popular choice for high pin count products.

Our investments in advance technologies are driving growth, with advanced product revenue of 8% in 2018 after going 15% in 2017. Our sales in advance packages into the automotive market grew nearly 50% in 2018, largely due to new data intensive applications. The high pin count and performance requirements of these products dictate the use of advanced rather than wire bond packages.

The most popular advanced packages for automotive are flip chip BGA, SIP and wafer-level fan-out. Typical applications include ADAS, infotainment and connectivity. Automotive IC customers expect their manufacturing partners to maintain qualified factories for at least 10 years after product launch to support long product life cycles. So they tend to gravitate towards stable manufacturers such as Amkor.

After all, we’ve been in the assembly and test business for over 50 years and for most of that time, we’ve been serving the automotive market. We understand that serving this market means continuously upgrading our factories and quality systems to keep pace with stringent automotive requirements.

Now, I would like to say a few words about 5G technology, a key driver of future growth for the industry and for Amkor. We are involved in many 5G development projects and expect to see significant ramps in 2020 as 5G capable handsets hit the market and volume. 5G phones will require more silicon and more capable batteries, a key challenge for designers will be fitting these new ICs, modules and batteries into a relatively small space, and that’s where Amkor can add value, deploying innovative, reliable and efficient packages to help our customers miniaturize, optimize performance and manage power consumption. Our technology strength is together with our long-term participation in the smartphone market, position as well for the transition to 5G.

Now let’s move to our first quarter forecast. At the midpoint of guidance, we expect revenue of $880 million. This is more than our typical first quarter seasonal decline and reflects the inventory correction currently underway in the smartphone market. We estimate that 75% of our sequential revenue decline is tied to reductions in smartphone related demand.

The remainder is, due to a lackluster general market is a continuation of the weakness, which started in the third quarter of 2018. We believe that the general market is going through normal, cyclical correction after over two years of strong demand. Based on the aggregate forecast from our customers, we believe that the first quarter will be our trough revenue quarter and expect that the second half of the year will be stronger than the first.

In this dynamic market environment, we think it prudent to restrain spending, to help us reach our goal of a fifth consecutive year of positive free cash flow. Our target capital spending for 2019 is $475 million down, roughly $75 million from 2018. We will minimize spending on incremental capacity, but continue to spend on strategic programs, which improve our competitive position.

We have also taken other general measures to reduce spending throughout the company. Looking forward, our long-term objective remains the same, balanced revenue growth. To achieve that goal, we will continue to focus on the basics, reducing cycle time, improving quality, ramping new products, maximizing yields and developing innovative, reliable technology for our customers.

Megan will now provide more detail in financial information.

[Megan Faust, Chief Financial Officer]

Thank you, Steve, and good afternoon, everyone. Today, I will review our fourth quarter and full year results. Then provide some comments about our first quarter outlook.

Fourth quarter sales of $1.08 billion or 2% above the midpoint of guidance. Gross margin of 16.9%, with nearly 200 basis points above the high end of guidance, primarily, as a result of higher sales and favorable product mix. The better than expected gross profit drove operating income margin of 7%.

Net income of $0.12 per share in the quarter was also well above the midpoint of guidance. Net income for the quarter was reduced by a net $17 million discrete income tax charge or $0.07 per diluted share, primarily due to a one-time true up for U.S. tax reform.

Overall 2018 was a solid year. Sales increased 3% over 2017 to a record $4.3 billion. We generated $258 million of operating income and operating income margin of 6%. CapEx of $547 million represented 13% capital intensity consistent with 2017.

We redeem $200 million of our 6 5/8% senior notes, with the proceeds from the new term loan with a fixed rate of 1.3%. The refinancing lowered our interest expense by $11 million annually. We delivered strong cash flow with EBITDA of $837 million. Cash flow from operations of $663 million and free cash flow of $120 million. Excluding the one-time proceeds from the sale of our K1 Factory in 2017, free cash flow increased nearly 50% in 2018, our fourth consecutive year of positive free cash flow.

Over the past four years, we generated more than $500 million in free cash flow. We significantly strengthened our balance sheet in 2018, ending the year with $682 million of cash on hand and over $1 billion of total liquidity. Debt stands at $1.3 billion and we reduced our net debt by over $100 million from 2017. We expect Q1 to be the trough quarter in 2019 with gross margin of between 9% and 13%.

As a reminder, a large portion of our manufacturing costs are fixed resulting in high operating leverage for our business. This leverage benefits us when sales increased, where we generally see $0.40 to $0.50 of every incremental revenue dollar fall through to gross profit. Conversely, we get a negative effect on gross margin when revenue goes down as gross profit decreases at a faster rate than revenue.

Operating expenses are expected to be around $115 million for the first quarter, well below Q1 2018 level. We expect a net loss in Q1 between $64 million and $16 million or $0.27 to $0.07 per share. Generally, our effective tax rate is around 25%, subject to a minimum level of taxes not dependent on our income. Our 2019 forecast for capital expenditures is $475 million. We’ve experienced many cycles like this in the past, and we expect sales to improve in the second half of the year. In the meantime, our strong balance sheet and liquidity allows us to continue to invest for the future while executing our balance growth strategy.

With that, we will now open the call up for your questions. Operator?

[Operator]

Thank you. [Operator Instructions]. Our first question comes from Sidney Ho of Deutsche Bank. Your line is open.

[Sidney Ho, Deutsche Bank]

Thanks for taking my question. I have a few. If I take your guidance for Q1, that three quarters of the declines tied to the smartphone market, that would imply a quarter-over-quarter –it’s probably down more than 30%. And that’s even lower than what you guys did in the March of 2017. How should we think about the recovery from the Q1 level and are you still expecting comps revenue to grow this year?

[Steve Kelley, Chief Executive Officer]

Okay, Sidney. Yes, I think your calculation is correct that we saw the revenue down by more than 30% right in smartphones. That’s an accurate observation. And I think what’s going on this year, which is a little bit different, is we’re seeing a slowdown in both the android and the iOS markets. So, I think you’ve seen a pullback in both the markets and that’s hitting us in Q1, and it’ll probably bleed in Q2 a bit. It’s hard to predict how fast the inventory will burn off.

[Sidney Ho, Deutsche Bank]

Okay. Maybe switching over to the automotive market, did you talk about one customer is going through inventory digestion, but outside of that, maybe related to that, is that particular customer stopped ordering more normally now, and maybe broadly speaking, how does the automotive market, how do you see the rest of the year that play out?

[Steve Kelley, Chief Executive Officer]

Sure. Yes, that particular customer that went through the inventory problems in 2018 is still digesting inventory. So, we don’t see that situation improving anytime soon. It could improve in the second half, but probably not the first half for that particular customer. More broadly, you look at the automotive market; we look at it in two parts. One part is the more advanced packaging, which is tied to the new systems like ADAS and connectivity, safety infotainment and we continue to see that market growing pretty rapidly. We are in very good position there, because we’re the number one OSAT for automotive in particularly for advanced packages.

The other part of the automotive market, you may want to characterize it as classical automotive, where you’re looking at, body electronics, engine control, those types of things. I think that market’s a little bit under pressure and will be until automotive sales pickup.

[Sidney Ho, Deutsche Bank]

Okay. My follow-up is that if you look at your gross margin guidance for Q1, if you assume a typical incremental margin, understand what revenue goes down, your margin goes down. But it would suggest gross margin to be could be less than 10%. But if you look at where gross margin was historically when the last time revenue wasn’t a similar level. I have to go back to Q1 of 2016. I think at that time, the gross margin was closer to 14%. Can you just help understand what are the moving parts between the 10% and the 14% as well as you guys talk about higher material content in the past – related to advance SiP programs? Has that had one go away yet?

[Megan Faust, Chief Financial Officer]

Sidney, I’ll take that question. So, it sounds like you understand the model with respect to the incremental margin aspect. So, as it relates to looking back, I believe you’re pointing to Q1 2017, where we had a similar amount of revenue kind of bit higher margin. So, the puts and takes there, it’s really that now we’re operating with lower capacity utilization. So, over the past two years, we have increased our revenue generating capacity, which at the same level of revenue would not allow us to achieve a similar level of gross margin. As it relates to the high material content products you mentioned, that’s having less of an impact in our Q1 2019 guidance.

[Sidney Ho, Deutsche Bank]

Okay, great. Thank you very much.

[Operator]

Thank you. [Operator Instructions]. Our next question comes from Randy Abrams of Credit Suisse. Your line is open.

[Randy Abrams, Credit Suisse]

Okay. Yes. thank you. Yes, I have a couple of questions, some in follow-up to Sidney. The first one just in some of the comments about driving the trough in first quarter. Could you talk maybe a little more about the order patterns and behavior you’re seeing now from customers? If they’re giving you indication inventory exiting Q1 is back to normal levels and that’s driving pickup or you’re starting to see some signs that demand and maybe give kind of a feel on what you’re seeing in the last few weeks, if you’re starting to get any better signals from customers?

[Steve Kelley, Chief Executive Officer]

Yes, Randy. I’ll make a few comments. Obviously, we’re just guiding for Q1 today, but I think your question is more towards what gives us confidence that Q1 is the trough quarter. And what we do is we do aggregate customer forecast. We have forecasts that go through Q2 and right now those forecasts show improvement and some moderate growth in Q2. But this is a dynamic forecast environment as we have experienced over the last couple of months. So, right now, we’re in a wait-and-see mode to see how revenue develops in March and what our momentum into going April. But nearly, all of our customers have expressed the belief that Q2 will be better than Q1 and the second half will be better than first half.

[Randy Abrams, Credit Suisse]

Okay, great. And it sounds like a couple of applications you’re expecting or maybe not banking on too much yet. So, the Japan automotive. and so is it the right assumption, there’s areas of Japan autos, smartphones, maybe more second halfway did and you’re seeing it in some of the other areas. So, like the non-Japan auto or some of the consumer networking. So, it’s kind of an uneven recovery is how we should think about and then picks up hopefully more into second half across applications.

[Steve Kelley, Chief Executive Officer]

Yes. Again, I divide the market into two parts. We have the smartphone-related demand and then we have everything else which you call it general market. And in the general market, we expect to see recovery starting in Q3, because that will mark the fifth quarter after we saw the beginning of the downturn in Q3 of last year. So, our experience is it takes about four quarters for these cycles to work themselves out in the general market.

In the smartphone part of the business, we do expect the seasonal surge in the second half, primarily driven by the iOS ecosystem. So, what we noticed every year, no matter what the market conditions are, we do see that upturn in second half based on the launch of flagship phones. So that’s what’s driving in our optimism for the second half and in addition to that, all of our customers are optimistic about the second half.

[Randy Abrams, Credit Suisse]

Okay. And you mentioned in some of the prepared remarks on 5G as a driver, is it early to see, I guess when you look at both the RF and SiP, and the main chip. is there a way to think about content where the mobile business kind of on upper phoned or a content opportunity or is it, I don’t know if you have enough signals yet on how your opportunity changes, like moving 4G to 5G as that rolls out?

[Steve Kelley, Chief Executive Officer]

Yes. Randy, it’s hard to quantify, but certainly, there’s more silicon in a 5G phones. So, I think the best way to think about it is the 5G phone is additive, as everything your 4G phone is plus more. And obviously, the biggest opportunity for us is helping our customers squeeze all that additional circuitry into the same amount of space essentially, because in all likelihood, the batteries will need to be bigger, because 5G phones will consume more power, so that, that reduces the board space. And then you have an incremental silicon. So, it puts a lot of pressure on our customers to really shrink the size of their designs to make use of the real estate.

[Randy Abrams, Credit Suisse]

Okay. And I just have two other questions; one on the CapEx. If you could talk maybe a bit more on, it looks like spending more toward technology or strategic priorities. If – maybe if you could elaborate a bit more kind of where some of the investments are being prioritized for this year.

[Steve Kelley, Chief Executive Officer]

Yes. Randy for this year, we’re going to have a budget right now is $475 million for CapEx, which is done about $75 million from last year and where we’re directing most of that spend is to advanced products. And we see opportunities in fan-out, in SiP and those two areas in particular, where we’re spending money to broaden our capacities in some cases, build new capacity. So, I’d say that’s – those are the two main focus areas for us.

[Randy Abrams, Credit Suisse]

Okay. And last question is maybe a bit more on sales margins if there’s a way to think for full year, just given the low base to start the earth if you expect, we could get some above seasonal – Amkor specific projects to get back to kind of a flat year overall types of target, and then a way to think about gross margins, I guess relative to a few years ago. Kind of on a follow-up to Sidney’s question, but if there’s a way to think about getting back to 20% gross margin with the capacity you have in place now, like what type of revenue level you need to get to?

[Steve Kelley, Chief Executive Officer]

Okay, Randy. I’ll answer the first half of your question then turn it over to Megan for the second half. So the way we’re looking at 2019 right now is a tale of two halves. I think the first half is going to be a challenge with the smartphone correction and the fact that we’re in the tailend of the general market slowed down. But the second half, we see as you know a different business environment, because of the recovery we think in the general market and also because the smart phone market will pick up.

[Megan Faust, Chief Financial Officer]

And then Randy, with respect to your question about profitability, as far as previously, we’ve given some target sales to achieve a 20% margin, we’ve come off that, because there’s several factors that impact that, recently was the product mix and then of course, now it’s impacting us as utilization. So, to give you another figure, we’ve looked at our model and to break-even bottom line that would take about $915 million of quarterly revenue run rate. And so with that, and then the function of increasing utilization, that’s where we would see margin expansion.

[Randy Abrams, Credit Suisse]

Okay. All right. Great. Thanks a lot. Yes. that’s all my questions. Thank you. Thanks Megan and Steve.

[Steve Kelley, Chief Executive Officer]

Thanks, Randy.

[Operator]

Thanks. Our next question comes from Sidney Ho of Deutsche Bank. your line is open.

[Sidney Ho, Deutsche Bank]

Thanks for taking my follow-up. I have two follow-up questions. The first one is, I think last quarter you talk about, looking at the factory footprint in Japan and try to figure out what’s the right thing to do. Can you give us an update on that and if there’s anything – is there anything we should think about margin benefit that you expect, both on the gross margin line and the operating expenses side?

[Steve Kelley, Chief Executive Officer]

Sure. As a reminder for listeners, I mentioned last quarter that we’ve seen a decrease in demand within Japan for a wirebond packages. So factory network in Japan is totally focused on wirebond and these are older packages. So, the demand is steadily declining and we need to reduce our fixed costs. We made a substantial progress over the past few months putting together a plan to do just that, which involves reducing our footprint and reducing our overhead in Japan. I’m not prepared to discuss the details today, but I hope to be able to provide more details in our next earnings call.

[Sidney Ho, Deutsche Bank]

Okay. That’s helpful. Maybe, my follow-up to that is to Randy’s question about the CapEx. You haven’t really talked too much about SWIFT and NANIUM, those fan-out products. Can you maybe talk about what kind of capacity increase are you expecting within that $475 million of CapEx and maybe, what kind of revenue expectations do you have for those products this year?

[Steve Kelley, Chief Executive Officer]

Yes. So the fan-out investment we’ll be making will be focused primarily on a low density fan-out. So, these are the NANIUM technologies. So, we’re investing in both Porto in Portugal factory as well as in a K5 in Korea. So, we’re quite happy with the way that’s going – that NANIUM acquisition worked out very well for us. The technology we think is best-in-class for fan-out, from both a yield standpoint and a quality standpoint. We’re also very happy with the people that joined Amkor after that acquisition. And we see a lot of opportunities to grow that business. In addition we’re seeing opportunities within Europe to engage more broadly with European customers, who want a European supply chain. So, we’re building another capabilities in Porto, including tests, including MEMS and some other packages that we’re moving into Europe at the request of European customers.

[Sidney Ho, Deutsche Bank]

All right. Thank you very much.

[Steve Kelley, Chief Executive Officer]

Thanks, Sidney.

[Megan Faust, Chief Financial Officer]

Thank you.

[Operator]

Our next question comes from Ed Roesch of Sidoti & Company. Your line is open.

[Ed Roesch, Sidoti & Company]

Yes. Hi, a lot of my questions have been answered already, but I wanted to check in on operating expenses, which declined by about 2% when you combine SG&A with R&D in 2018 versus 2017 and that’s with revenue up. So, I was just wondering Megan, you mentioned some efforts maybe to curb spending, who would be driving towards another 2% decline over the course of 2019.

[Megan Faust, Chief Financial Officer]

Yes. We’re not giving guidance on OpEx and – but I would expect that with our efforts, we will be able to reduce our OpEx lower in 2019 compared to 2018.

[Ed Roesch, Sidoti & Company]

Okay. All right. Very good. And then I think the question was already answered pretty well. So, on the gross margin, there’s no effect of the higher material content, affecting that Q1 outlook, is that the right message?

[Megan Faust, Chief Financial Officer]

Right. That’s correct.

[Ed Roesch, Sidoti & Company]

Okay. All right. So, I think that covers it for me. Thanks for your time.

[Steve Kelley, Chief Executive Officer]

Thank you, Ed.

[Operator]

Thank you. I’m showing no questions at this time. I’d like to try to turn the conference back over to Vincent Keenan for any closing remarks.

[Vincent Keenan, Vice President-Investor Relations]

Thank you, Valerie. This ends the question-and-answer portion of our call. I will now turn the call back to Steve for his closing remarks.

[Steve Kelley, Chief Executive Officer]

I’d like to recap our key messages. First, 2018 was a good year for Amkor technology. We grew revenue 3% and generated $120 million of positive free cash flow. Second, we expect Q1 2019 revenues of approximately $880 million more than our typical first quarter decline due largely to an inventory correction underway in the smartphone market. Finally, we’re optimistic about the second half of the year when we expect more favorable market conditions. Thank you for joining the call today.

[Operator]

Ladies and gentlemen, this concludes today’s conference. You may now disconnect.