Amkor Technology, Inc. (AMKR) Q1 2011 Earnings Report, Transcript and Summary

Good afternoon ladies and gentlemen and welcome to First Quarter 2011 Amkor Technology Incorporated Earnings Conference Call. My name is Jeremy and I will be your conference operator for today’s call. (Operator Instructions) This conference call is being recorded today, Thursday, April 28, 2011, and we’ll run for up to one hour. Before we begin this call, Amkor would like to remind you that there will be forward-looking statements made during the course of this conference call. These statements represent the current view of Amkor management. Actual results could vary materially from such statements. Prior to this conference call Amkor’s first quarter 2011 earnings release was filed with the SEC on Form 8K. The earnings release together with Amkor’s other SEC filing contain information on risk factors uncertainties and exceptions that could cause actual results to differ materially from Amkor’s current expectation. I would now like to turn the conference over Mr. Ken Joyce, Amkor’s President and Chief Executive Officer, please go ahead sir.

Thank you Jeremy, and good afternoon everyone. With me today is Joanne Solomon our Chief Financial Officer. Today I will talk about our first quarter performance, the situation in Japan and our expectations for the second quarter. Joanne will then discuss our first quarter financial results in more detail and finally we’ll open up the call for your questions. To begin our sales of $665 million were consistent with our expectations even though sales were reduced by approximately $6 million due to the impact of the Japan earthquake on our Kitakami operation. I will talk about Japan in more detail shortly, but first let's focus on the trends and patterns we saw in the first quarter. Looking at our performance in the first quarter we saw typical seasonal softness. Our strong position in gaming amplify the seasonal patterns, we also saw weakness in networking and certain consumer electronics due to inventory adjustments by some of our customers. Our gross margin came in at 19% and was at the top of our anticipate range. Now let's move on to the situation in Japan. First, we express our sympathies to the victims of the earthquake and tsunami as well as our Japanese colleagues in the nation as a whole. We’re all very relieved that all of our employees are safe and unharmed. Our factory in Kitakami is located more than 130 miles north of the Fukushima Daiichi Nuclear Power Plant. The factory suffered some minor damage and I’m happy to say that substantially all repairs are complete and the facility is back in operation, although we’re currently experiencing some wafer shortages. Kitakami is our smallest factory in both units and revenue generating around $10 million of monthly sales prior to the earthquake. And as I mentioned, the closure impacted our first quarter sales by about $6 million. Now, looking at the broader supply chain, Japan is a major supplier to the semiconductor industry. Since the earthquake we have been working closely with our customers and suppliers to analyze the situation, identify the potential exposure and mitigate the risk where possible. Despite these efforts we currently expect that supply chain disruption, particularly relating to the availability of substrates and wafers will negatively impact our second quarter results. As we look ahead to the second quarter, we anticipate that our sales will be in the range $650 million to $700 million or down 2% to up 5% sequentially. Because of the uncertainties in Japan we have reduced our sales outlook by $50 million. Our demand forecast was also reduced by $20 million due to the unexpected weakness for wireless base hinges by a single OEM. We expect our gross margin to be in the range of 16% to 20%. As we look at the second half of the year we’re anticipating a rebound in customer demand and solid growth, driven primarily by strength in wireless communications and consumer electronics. In support of this growth and to meet the capacity requirements of our leading customers we are currently planning capitalization of approximately $450 million for 2011. Consumers worldwide are seeking electronic devices that feature ever greater communication and computing capabilities and provide high-speed wireless access to data rich content. These devices increasingly require flip-chip interconnect technology. Insatiable demand is driving the migration from wire bond flip-chip packaging. We have been investing significant resources in our wafer bumps and flip-chip capability, and these investments are paying off. From 2005 to 2010, we grew our flip-chip and wafer level business by a CAGR of more than 60%, three times faster than the overall industry growth rate. Flip-chip and wafer level packages now account for over 30% of our packaging revenues and continue to grow. One of the key drivers of our outlook for growth in flip-chip is our Fine Pitch Copper Pillar Flip-Chip packages. Fine Pitch Copper Pillar enables reduced semiconductor chip size and cost while boosting performance. It is ideal for handheld high performance and low power devices precisely the kind of product most in demand with today’s global consumer. Last year, we developed and commercialized this proprietary technology in partnership with Texas Instruments. It has really taken hold and we expect it to generate sales of over $100 million this year. And we are fanning this out to other customers. In summary, we remain encouraged by the underlining demand trends we see in our business and end-markets. We certainly face near-term challenges associated with the Japan earthquake and its aftermath. However, we’re optimistic that this impact will be combined to the near term and we’re looking forward for a strong second half of the year. With that, I will now turn the call over to Joanne.

Thank you Ken, and good afternoon everyone. To begin our first quarter net sales of $665 million declined 11% sequentially and we’re in line with expectations. Our ball grid array packages were down 20% and chip-scale packages down 15% due to the expected seasonal declines and inventory adjustments in networking and consumer electronics. Lead frame packages and test services were nearly flat, the shutdown of our Kitakami factory and the $6 million sales impact mostly affected chip sale and lead frame packages. Our sales to integrated device manufacturers, our IDM customers were 47% in Q1, essentially flat with the fourth quarter. We anticipate that the revenue split between our IDM and fabless customers will remain around 50-50 for the second quarter of 2011. The pricing environment remains stable with very little price aversion this quarter. Gross margin for the first quarter was 19%, at the top end of our anticipated range and down from 21% in Q4. Given the sequential decline in business volume, we kept tight focus on our cost across the enterprise. Our assembly utilization is 71% created some headwinds as utilization is one of the critical drivers of gross margin performance. We also continue to face to face pressure from unfavorable foreign currency exchange rate movements and higher gold prices. Our operating expenses of $77 million were slightly higher than the fourth quarter and our expectations. For the second quarter of 2011, we expect operating expenses to remain generally consistent with Q1. Income taxes were consistent with our expectations and we anticipate that our expected tax rate for the second quarter and full year 2011 will be around 11%. Turning to the balance sheet. In January all $100 million of our outstanding 6.25 convertible notes through 2013 were converted into 13.4 million share of our common stock. We ended the quarter with a cash balance of $393 million, total debt of $1.2 billion and net debt of $851 million. This includes $250 million of convertible debt that we expect will be converted into equity rather than being paid at maturity. Additionally, we were free cash flow positive for the first quarter. Moving on to our capital spending activity, we spent $105 million on capital additions in the first quarter. Our spending was focused primarily on new capacity for flip-chip assembly and test services and supported communication. And to meet the capacity requirements of our leading customers, we are currently planning capital additions of around $125 million for the second quarter. In closing, we are anticipating some near-term impact form the Japan earthquake but we expect the second half of the year to be strong. With that we’ll now open the call up for your questions. Operator?

Thank you. We’ll now begin the question and answer session. (Operator Instructions) Our first question comes from the line of Timothy Arcuri with Citigroup. Please go ahead.

Hi this is Wanga (ph) for Tim. Thank you for taking my question. Two questions. First of all, the Japan impact in Q2 you mentioned about $15 million, what do you see as the future impact in Q3 and Q4?

We’re hopeful that this is going to clean itself up in Q2, but that has to be seen how the situation unfolds and resolves itself in Japan.

Okay. So, Q2 right now is shaping up to be less than seasonal, and you mentioned about some of the demand delays that could make second half stronger. So, is there any visibility on Q3 right now? Is it going to be stronger than seasonal or it’s hard to say at this point?

It looks to us as we look at our current demand forecast from our customers and our discussions with our customers that Q3 will be stronger than seasonal.

That’s encouraging. Okay. The second question is more focused on your investment in CapEx. You’ve been spending lot of CapEx to expand your advanced packaging technologies mostly flip chips and others. So, if you look at some of your competitors like ASC (ph) they spend quite a bit on the copper wire, as a result they again a lot of market share and also outperform compared to some of the lead frame players. So, on a flip chip side when can we actually see a major benefit of all those CapEx investment in terms of either gross margin all your market share?

It’s a good question, I mean with the price gold over $1500 an ounce, the migration from gold to flip chip and copper wire bond is definitely accelerating. Right now flip chip is over 30% of our assembly revenue. So you are seeing some of the benefits right now. We have invested substantial resources, as you say, a good example would be our fine pitch copper pillar flip chip. This new technology platform is going to generate over $100 million in revenue this year. We are in the process of fanning that out to other customers and that’s a very successful flip chip technology. So, the migration to copper wire bonding that’s also accelerating. And, but we think we have the great focus of where we are at, which is on the flip chip, and that’s where we put the most of our resources. So, to sum up again this year we will see over a $100 million just from the fine pitch copper pillar flip chip program as well as our other flip chip. So we are going to see some of it this year.

So do you expect to see a major uptick in either gross margin or market share, because so far we haven’t seen a concrete result out of those investments beyond the industry average I think.

Yeah, with respect to market share when you look at it in the aggregate Amkor maintained its share with respect to 2010. When you break it down by who has an industry leading position with respect to flip chip, fairly Amkor has a industry leading position with respect to flip chip assembly, with that flip chip assembly we do get strong attached to cash turnkey services. There really is very strong returns and that also translate into industry leading return on invested capital which is more than twice our WAC (ph). With respect to growth margin and the premium net you would get on advance package technology, as you are in a rampage for any of these advanced technologies, especially flip chip when we are investing significant dollars in bump, it does take time to bring up those bump operations to level scale, as bump is in its start up phase that operates a lower gross margin. But once it does reach economies of scale it has gross margins that are higher than the corporate average. So I would say 2010 was a strong ramp year for bump and flip chip, and we will start to 1brief some of those benefits in 2011. But that is one offering and with respect to the slow start this first half of the year gross margin will be challenged by the headwinds of our Q1 and Q2 results.

Great, thank you.

Thank you. And our next question comes from the line of C.J. Muse with Barclays Capital. Please go ahead. Olga Levinson – Barclays Capital: :

There are clearly a number of uncertainties, but a bulk of them rely around the substrate supply, substrate supply as you know are tied back to the availability of BT resins, and there are first other things such as copper foil, there is play of fabric, there is a epoxy, there is a whole series of supplies that come out of Japan that are critical, and it’s the timing of those and the timing of how fast the operations can be restored in Japan that will really dictate how this $50 million comes out. This $50 million there is a good deal of uncertainty in a sense that it’s a snapshot at this point in time of the inventory that we have on-hand, delivery date that literally change on a daily basis from your suppliers and whether or not they’re going to be able to fulfill those commitments. We’re optimistic from the standpoint that they – a number of these operations in Japan seems to be covering a little quicker than people had anticipated. We are focused on this every day with both our customers and our suppliers to make sure. So, we’re hopeful that the $50 million is the low side in the range on the impact and we’re going to be able to recover some of that in the quarter. Olga Levinson – Barclays Capital: Got you. And then within those component shortages which you discussed, can you talk about what sort of pricing trends you are seeing on those shortages and whether you are passing along any of that to your customers?

The pricing for the most part has been rational. We are seeing one or two where I think a supplier tends to tries to be a little opportunistic. We’re working with our customer and with the supplier coordinating back and forth. And we would obviously have to try to pass that cost onto our customers. But we think, the overall environment from the suppliers given the conditions has really pretty rational. Olga Levinson – Barclays Capital: Got it. Thank you.

Thank you. And our next question comes from the line Frank Jarman with Goldman Sachs. Please go ahead.

Thanks guys. My first question is just related to the weakness in demand on the wireless space band side. Could you proved a little bit more color around what you guys are seeing there with that single customer? Thank you.

We had a product that came to end of life actually in the second quarter. They came to end of life a little sooner than people anticipated. So, I think that’s a onetime event, you saw it in this quarter that’s what it’s a reflection of.

Okay, great. So, we shouldn’t really think about that as more a function of the market more so purely related to that that one contract?

Absolutely not, it’s related to that one contract.

Got it. Thanks. And then the second question I had was just about the capital structure. You had the 100 million of converge convert to equity. I think you have 9.25% call date coming up for those notes. And as I look at your cash structure you’re running with relatively low leverage today around one and half times. So, how are you thinking about your target capital structure down the road, what your view is as sort of appropriate leverage for the business and how are you guys thinking about taking steps towards achieving that?

Yeah. When we look at our capital structure, we certainly look at maturities and we feel very comfortable with how the maturities are allowed. From a public debt standpoint the first maturity we have out there beyond the covert that’s coming up here in May is the 2016 convert. We do have some amortizing debt in our foreign jurisdictions which is a great way for us to continue down the process delevering and reducing our debt further. We also manage our debt from a net debt position. We talked about our net debt being at $850 million. We also have converts that has a start price of just over $3, we see that as a – that’s very equity like right now. So you can even take that 250 off and I have put this at $600 million of net debt. We historically talked about a net debt goal of $500 million, so we’re very close to that already. So, people have different views on optimal capital structure, we feel very comfortable with our capital structure. Our debt to EBIDTA ratio is below 2.0 which would even suggest seeing a somewhat of an investment grade although we’re not rated investment grade. So, we’re well positioned with our capital structure and we give away our maturity status. With that said we continue to monitor the capital market and if there is transactions that make sense to further improve the capital structure we’ll certainly be opportunistic.

Okay, great, thanks very much guys.

(Operator Instructions) Our next question comes from the line of Sundar Varadarajan with Citadel Securities, please go ahead.

Thanks for taking my question. Just wanted to talk a little about your CapEx plan for the remainder of the year. You still have a $460 million budget. Can you talk about this being related to some of the demand you are seeing from customers. Would you characterize this demand as kind of net incremental revenue to you or is part of it just stuff moving from an older technology to a different technology, how should we think about the incremental revenue impact from the CapEx that you are putting in place?

Sure, I can give you some color to that. We talk about 60% of our investment goes to assembly, about 20% goes to facilities and R&E other infrastructure project. There is some level of replacement that happens, there is a piece of aging assets that roll off each year. And as you invest in new assets you get better utilizations and the like. Where we are spending our money is in support of flip-chip technologies largely and there I great turnkey opportunities with respect to flip-chip, and right now the investments are heavily focused in support of communications because that’s where we see the growth for the year. A lot of our flip-chip chip scale packaging assets are operating at high levels of utilization given the ongoing demand on the communication side. There is some seasonal softness with respect to communications in the first quarter, second quarter, but then it heats up 2Q into Q3. So that’s where we are investing, we are investing heavily in flip-chip chip scale packages. Passed some incremental bump investments to keep up with the fine chip copper pillar (inaudible) that Ken talked about in his prepared remarks, but there is some investment that just maintains the business. Historically what we have said is just from a – when we’re investing about a capital intensity of 10%, overall you don’t see a lot of growth. When we invest capital intensity of 14% is where you start to see growth and then we have from time to time been above the 14% cap on (inaudible) infrastructures or heavier levels of cap investments for specific opportunity.

Great. That was a very detailed answer, thank you. And then moving on to the base band weakness that you expect to see in Q2, are you kind of – you said that product has kind of reached the end of life. Are you transitioning to the newer products or would we see some form of a bounce back in Q3 with respect to that customer/product group or is that kind of like a onetime permanent change and then that doesn’t come back in Q3.

That was a onetime hit to Q2. That product as you say came to the end of life. There is additional business with that customer, but that will be – we are talking about an OEM here, so our customer will be driving business with them as we go forward.

Okay, great, thank you.

Thanks Sundar.

Yeah. The only thing else I would add is the – there is significant demand with respect to communications that this won’t have an impact overall for us for the year.

Thank you. And our next question comes from the line of Satya Kumar with Credit Suisse, please go ahead. Farhan Rizvi – Credit Suisse: Hi, this is Farhan calling in for Satya. Thanks for taking my question. I just had a question like in terms of your guidance, we see like other companies like some of your competitors are guiding up next quarter and we see that the guidance from you is actually down. Are you losing share or what do you think is the reason that you are guiding quarter down for the next quarter?

I think the guidance was minus two to up five. So I think that’s pretty much in line with what our competition seem, although I have to admit there is a great deal of uncertainty out there. Farhan Rizvi – Credit Suisse: Okay. And just another question, can you just elaborate a little bit on your share in smartphones versus feature phones, we have seen lot of weakness recently on feature phones whereas smartphones are doing quite well. Can you talk about like how some of these transitions for 4G and some of the transitions happening towards smartphone, how does that affect your share?

Well, when you look at who our customers are, you know, include the likes of Qualcomm and Texas Instruments, Infineon and others. So a lot of our customers compete very strongly and very significantly on the smartphone. So, we do see ourselves as being more closely tied to the smartphones and the demand trends that are happening with smartphones than we do with feature rich. I am not saying that we don’t support feature rich as well but our sweet spot is more on the smartphone side. Farhan Rizvi – Credit Suisse: Thank you, that’s all I have.

Thank you and our next question comes from the line of Ross Taylor (ph) with RBC Wealth Management. Please go ahead.

On your 50 million shortfall, is that going to other competitors or are they in the same boat too?

No that is going nowhere that’s a one OEM that’s…

Ken, sorry, it was 50 million relating to Japan.

Right.

No, Ross, that will be largely – hopefully we are going to recover that and it’s going to be delayed, possibly we can get some in this quarter but then some will move into Q3 and 4.

We don’t believe that that it’s an Amkor specific thing, we believe that’s an industry thing. We can’t obviously speak to our competitors. Only one of our competitors had a call, they did talk about some substrate impact as well. But we don’t see that we would somehow be more impacted by this than our competitors.

Okay. And then Joanne, also did you mention something that the consumer electronics are still not quite back yet, but you expect to be fully back by Q3, is that what you said?

You know, there is clear seasonal patterns with respect to consumer electronics. We did talk about some inventory adjustments in consumer electronics, a lot of that is relating to memory. So it’s not broadly impacting consumer electronics. A lot of that memories go into whether it’s a phone or a iPad that correction – those inventory adjustments are really Q1. Most acutely you would see it in our results, in our chip scale packaging results is – was pressured by those inventory adjustments. So we see those trends correcting Q2 and beyond and then strong Q3 in support of the holiday season is all over again.

Okay. So some of that has already, because in your last quarterly report I know that was the big problem for this quarter. So has a lot of that excess inventory now worked its way through.

Yeah, we are starting to see improvements to the utilization of our – as an example our chip sales are stacked, chip scale packaging line. So I would – based off of those increases in utilizations I feel comfortable that the inventories are working through.

Okay great. And then, in regards to the cost of gold you guys do any hedging?

We don’t hedge gold. Gold is a very significant impact for us. When you look at our gold spent as a percentage of revenue it's about 10%. So, our position on gold is that it’s a total part of the cost of the package and we look to recover from our customers either directly or indirectly on the incremental cost of gold. That said, even though we may be passing that through and stay neutral on a cash basis that gold price increases do compress our gross margins. We were at the top end of our gross margin guidance for Q1 and it was in line with our forecasted expectations of gold. But if there was about close to a 0.5 a point of gross margin that was relating to gold.

With gold continuing to go up, what are you doing now going forward? Are you just – is it involved in the pricing? Is it a variable price than what your customer is going for, is that how you do it?

So, with respect to mitigation of the gold exposure, you’re seeing two very significant trends that Ken talked about. You’re seeing the migration to flip chip packaging technologies which has a lot less gold. Some gold but not to the extent of a gold wire bond. So that’s one way. The other way is with respect to the migration to copper wire. With gold trading at over $1,500 an ounce, we’re seeing the migration to copper accelerating. We continue to qualify, more and more of our customers supported that migration and we are investing capital expenditures to bring up our capacity. We do see that as a significant trend also for 2011.

Okay. Great. Thank you very much. That’s all from me.

Thank you, Ross.

Thank you. And our next question comes from line of Raj Dave with Citigroup. Please go ahead.

Hi. This is Raj Dave from the principal strategies group. Could you on this – I wanted to follow up on a question that one of the other callers asked about the guidance relative to competitors. I’m just trying to reconcile whether you’re being a little bit more conservative. This still is looking at – guidance of up 3% to 7% in the second quarter and stats trip back at zero to mid single-digits up. So, if I take your low end clearly it’s an outlier and your midpoint is – your high end is in line. Could you maybe help us think though that? And then the second question was on the FX and currency, would the US dollar continue to trade lower and your cost structure denominated non-US dollars, are you doing anything on the hedging side or contemplating anything there?

Well, to answer the first question on the guidance, I think we're pretty much in line with where our competitors are with one exception. We have called out this $50 million that did impact or could impact, I should say, it impacted our guidance but could impact results. We're working on it daily and that could be an improvement over what’s listed in that guidance of minus 2 to up 5. So, we continue to work that and we think that’s a fair reflection of where we are.

On the FX side, FX impacted our gross margins adversely by about $4 million this quarter. So it is significant. We historically have relied on natural hedges. About 80% of our revenues are US dollar based revenues with the – and our costs are about 60% in US dollar. We do have some balance sheet exposures. We have the Korean severance plan and the Taiwan dollar that are local currency. We do evaluate from time to time whether hedging makes sense to avoid some of the balance sheet risks. And we do also carry cash balances in local currencies to help to phrase some of the currency exposures. But that’s kind of where we’re at. And the one thing I just want to correct myself, 90% of our sales are in US dollars, just to clarify that.

Okay. And my last question is on the Yen market. There has been conflicting reports from many types of (inaudible) seemed to be more negative than someone like the Qualcomm. And so, when you – as an investor put all that together, there isn’t a clear picture on yen demand and what I’m trying to figure out is; is there any crack in the Yen demand or is it just normal seasonal patterns that you have excess inventory channels that one company is involved in and less excess inventory and other. Can you help us maybe thinking through that?

On the communications side, the demand continues to be strong for us. I know you mentioned TI and Qualcomm, they are obviously two of Amkor’s large customers. TI was impacted obviously by some of the impacts in Japan in Q2. I don’t see that as an ongoing issue for them based on the results of their conference call which I read. So, I think in the communications sector the growth sector is still very strong. I think we're all very optimistic once again with some caveats around how Japan unfolds. In the other areas of gaming, it’s seasonal, very seasonal in fact, down for us in Q1. We see a coming back in Q2 but even stronger in Q3. So, there is the gaming which is part of the consumer market. On the networking, we have seen – we said we saw in Q4 there was a built-up in some inventories. We see some of that being worked down through the die banks at our factories at this time. So, that’s kind of an overview for those markets.

All right.

Yeah. The only thing I would add is the – when you look a little bit more granular at the diversification of the comm fliers I think that may swing things within a quarter. But the overall demand trend is solid, so they’re doing well.

Great. Thank you very much guys.

Thank you. Mr. Joyce, there are no further question at this time.

Well, we thank everyone for their participation in the call today. With that we’ll end the call. Thank you.