Pivotal Systems Corp

ASX:PVS

Earnings Call Transcript

[Operator]

Thank you for standing by and welcome to the Pivotal Systems Second Quarter Cash Flow Report Investor Conference Call. [Operator Instructions]I would now like to hand the conference over to Mr. John Hoffman, Chairman and CEO. Please go ahead.

[John P. Hoffman, Executive Chairman & CEO]

Good morning, everyone. It's a pleasure to speak with everyone today regarding our second quarter 2020 4C. As I've mentioned in the past, we provide commentary each quarter to keep you appraised of our progress and answer your questions. The second quarter 2020 was quite eventful for Pivotal as we made a great deal of progress on several meaningful fronts. As everyone knows, the current COVID-19 situation has made running a global business a bit more challenging as we continue to operate in an environment of restricted travel and no face-to-face meeting with our customers or our suppliers.In Q1, Pivotal continued to operate as an essential business, and we were able to meet all of our customer commitments and shipments as well as new product development milestones. This operating environment continued through the second quarter as well. However, Pivotal was once again able to meet all of our key business requirements with both our customers as well as our suppliers.On July 21, SEMI, the semiconductor industry consortium, improved their 2020 CapEx forecast or capital spending by the device manufacturers and indicated that the 2020 spending would now grow 6%, up from 2019 spending levels. SEMI once again maintained that 2021 would be a double-digit growth CapEx year, and they added that CapEx from memory spending would be up over 20% for both DRAM as well as NAND flash. Based on our current business levels and the forecast we are receiving from our customers, we remain very optimistic as we move into the second half of 2020.Last night, Samsung reported Q2 results with a positive outlook, especially for memory products. Evercore II, the leading global independent investment bank, reported that at a high level Samsung saw solid memory demand in both data center and the PC market, which helped offset businesses hit by the pandemic like mobile. Stifel reported that Samsung was constructively positive on memory fundamentals, but citing further strength in work-from-home and in gaming.Let's move to some of Pivotal's specific Q2 highlights. They include: the GFC transformation or software loading of our products was transferred back to our new Korea contract manufacturing per our operating plan. This will effectively eliminate U.S. duty drawback for the second half of 2020. GFC production at our China-based contract manufacturer and our Fremont, California facility was maintained during the challenging COVID-19 period. Unaudited first half 2020 revenue of $10.1 million was up 26% from first half of 2019 revenue of $8 million. Unaudited Q2 revenue of $5.8 million was up 32% from Q1 2020 revenue of $4.4 million. Pivotal shipped the agreed-upon final product to the leading Japanese equipment company, as covered in the customer development agreement we signed in 2018. We achieved qualification and multiple repeat orders for the standard GFC used for etch applications at the #1 Korean etch OEM. We received multiple repeat orders at multiple Chinese IDMs and at the leading Chinese etch OEM. We successfully demonstrated the 2-channel flow ratio controller at a leading U.S.-based OEM for deposition applications. Also, we appointed Mr. Dennis Mahoney as our Chief Financial Officer on June 5. We also appointed Mr. Kevin Hill as our Chief Operating Officer on June 1. Our backlog, which is confirmed orders not yet shipped at 30 June, was $3.2 million.In the area of products, the standard low-flow GFC commonly used for etch application continued to gain market share at leading device manufacturers in Europe, Taiwan and Japan. Significant wins includes the qualification of a standard GFC at a leading Korean etch OEM. This has already generated multiple repeat orders and numerous fan-outs to various etch process tools in this OEM's fleet. As a reminder, we were demonstrating the GFC on the SmartStik architecture as we initiated this engagement in Q1 of 2020.Also, we were able to qualify the standard GFC with a leading Chinese etch equipment company, once again leveraging the SmartStik architecture. This has generated multiple repeat orders and a continued fan-out of the GFC technology across China by this OEM. At this time, the GFC is being selectively requested by 6 leading Chinese semiconductor device manufacturers. It should be apparent that the resources we placed in China in 2018 and 2019 continue to drive our business forward as they're making a material impact on our ability to sell advanced technology.If you recall, we introduced the remote electronics, which is for higher gas temperatures, GFC, during the first half of 2019. This GFC was developed in partnership with a leading Japanese equipment company in order to function in a heated gas box at approximately 65 degrees centigrade. We believe that as the semiconductor industry continues to migrate to advanced technology nodes, new materials will be required that will require low-vapor pressure gases. These vapor pressures will require the gases to be heated in order to provide the prerequisite gas flows required in advanced wafer processing. In 2019, we thought that the remote GFC would become required in future advanced technology wafer processing environments. In the second quarter of 2020, we once again saw multiple repeat orders, and we also had a request to qualify the remote GFC on additional processed gases with this leading equipment company. This has given us renewed confidence in our technology road map.Both the 3-zone flow ratio controllers or FRCs, both of them continued their excellent performance in production at a leading Korea IDM. Also, the newly introduced 2-zone flow ratio controller continued its testing and qualification at a leading U.S. OEM for deposition. As a reminder, as gases leave the Pivotal gas flow controllers in a process tool gas box, the gas flows are often mixed and then split by flow ratio controllers to provide equal gas concentrations in various zones in a process chamber. Without a very fast and accurate flow ratio controller, the advantages of Pivotal GFC may be compromised. Both our OEM and IDM customers require the speed and precision in the future, and we have discussed this in previous releases.Overall, Pivotal System maintains its commitment to a pipeline of new products as our history demonstrates. We strive to maintain the technology leadership we have achieved in the flow control markets by being the go-to technology partner for both leading device manufacturers and leading equipment companies. We believe as the semiconductor industry continues to advance to smaller and smaller geometries, the superior performance of our flow control product family becomes even more compelling.At this time, I will pass it over to Dennis Mahoney to discuss finance and operations.

[Dennis R. Mahoney, Chief Financial Officer]

Thank you, John. Good morning, everyone.I will be reporting on our second quarter financial performance. For unaudited profit and loss, we will be comparing against the first half of 2019. For the balance sheet, we will be comparing June of 2020 versus December 2019. Investors should note that all numbers are stated in U.S. dollars. Further details can be found in our Appendix 4C, which was lodged with the ASX this morning.I will first summarize our unaudited revenues for the quarter and the half year. As John mentioned, unaudited Q2 2020 revenue of USD 5.8 million was up 32% from Q1 2020 revenue of USD 4.4 million. Unaudited first half 2020 revenue of USD 10.1 million was up 26% on the previous corresponding period.This was a particularly pleasing result for the company and highlights the resilience of our business despite global uncertainty across manufacturing and supply chains. Our innovative GFCs are used in critical industries such as semiconductor manufacturing and medical devices, where substantial growth continues to be forecast for 2021 and beyond. I will now turn to our Appendix 4C quarterly cash flow highlights. The company finished the second quarter of 2020 with a cash balance of USD 9.1 million, which included USD 2.5 million of outstanding balance drawn against our term loan with Bridge Bank as well as the first tranche of the USD 10 million RBI preferred stock funding from Anzu Partners.In addition, on the 21st of April 2020, the company signed loan documents with Western Alliance Bank and received funding of USD 970,000 from the United States Government Small Business Administration, or SBA, Payroll Protection Program, which is part of the National Fiscal Relief Program created by the Coronavirus Aid Relief and Economic Security Act or the CARES Act, which provides financial relief from the COVID-19 pandemic. This loan bears interest at a fixed rate of 1% per annum and is payable monthly beginning December 2020 and matures in 2 years. The SBA may forgive this loan if all covered employees are kept on payroll for 8 weeks and the loan proceeds were used for payroll, rent and utilities. The company fully expects to qualify forgiveness of the loan or full forgiveness of the loan and will commence and submit its application in the coming months.Cash receipts from customers for the period were USD 4.9 million, up from USD 4.8 million from the first quarter of 2020, highlighting the stability in our receivables management. Cash payments for product manufacturing were USD 4.9 million, down 12% from USD 5.6 million in the first quarter of 2020, reflecting a decrease in payments to key suppliers, contract manufacturers, labor and utilities to support production schedules. Pivotal continued to invest in product development with USD 692,000 of capitalized R&D costs incurred during the quarter.I'll now turn to operational highlights. I am pleased to report that during the quarter, Pivotal's Korea contract manufacturer launched its newly established transformation center. Transformation manufacturing activity was transferred from Fremont, California during the second quarter to our Korea contract manufacturer, and this transfer was completed in July. Both the CM's production line and its personnel have also now been qualified. Pleasingly, Pivotal has commenced product shipments from this center in July 2020. Pivotal's Fremont, California facility will continue as an auxiliary capability to our Korea CM.A significant financial benefit to Pivotal will result from this transfer of transformation from Fremont, California to our Korea CM, specifically by the substantial elimination of the United States Customs Duty that would otherwise continue to have been levied on shipments from our China CM of partially finished product to Fremont, California for the final transformation steps. Regarding the duty that has already been levied by U.S. Customs and paid by Pivotal in prior periods, Pivotal is in the process of claiming duty drawback or refunds from the United States Customs Office. We are expecting refunds, which potentially will be in excess of USD 1 million, to begin in late Q4 2020. The United States Government cash disbursement process is slow and unpredictable, so we cannot predict with full accuracy the timing of these cash receipts. I will update you in future calls.Pivotal also fully qualified the repair and upgrade center in Korea, which is operated by the same contract manufacturer. This center provides both repair and software upgrades to IDM and OEM customers globally. During the second quarter, the company experienced 91% growth in repair revenue to USD 231,000 versus USD 121,000 in Q1 2020. As Pivotal's large global installed base continues to grow over time, an increasing number of GFCs will progressively come out of warranty and require both repair and upsell features for customers. Pivotal expects this business to continue to scale over time. We closed the second quarter with a full-time headcount of 45 employees. As John mentioned, despite the impacts of COVID-19 across a number of manufacturing sectors in California in mid- to late Q1 and into Q2, Pivotal's designation as an essential business has allowed us to meet all of our customer commitments and shipments as well as new product development.At this time, I'll hand back to John.

[John P. Hoffman, Executive Chairman & CEO]

Thanks, Dennis. Before I summarize, I want to take a moment to talk about Dennis, our new CFO; and Mr. Kevin Hill, our new Chief Operating Officer.First, Dennis has been with Pivotal since February and took over when Tim Welch retired. Dennis brings over 30 years of CFO experience to Pivotal, including scaling publicly traded and private companies, raising over $500 million in equity and debt, negotiating and closing M&A transaction in both the U.S. and Europe, and establishing joint ventures and leading international expansions. Dennis' experience includes manufacturing, fabless semi, solar, medical devices and other adjacent industries. His experience will prove valuable as we continue to expand our product portfolio and the markets we serve, and I really look forward to bringing Dennis over to meet with each of you soon.Second, Kevin Hill joined Pivotal Systems from Apple. At Apple, Kevin successfully managed the worldwide supply chain and was the new product introduction manager for the iPad. His prior experience included time with Applied Materials, where he and I worked together. Kevin also was an executive at Flextronics, a leading global contract manufacturer. He's a graduate of the United States Military Academy and has an MBA from Boston University. He's brought us up to the latest global operating principles and he's already making a significant difference in our daily operations and supply chain. His leadership was instrumental in bringing up our Korean CM at a time of global no travel and quarantines. I also look forward to bringing him over to meet you.Finally, we're pleased with our performance for the second quarter and we expect continued growth in the second half of 2020 as the semiconductor industry continues forward in the middle of this pandemic. As I've mentioned in numerous past investor calls, in times of global crisis, technology continues to move forward as it improves operating efficiency. Fortunately, Pivotal uses and leverages leading technology with our partners and our customers, and the level of trust we have with them is unsurpassed. So far, in 2020, our global sales team has been working remotely and yet meaningful customer interactions are actually accelerating.Once again, we continue to execute to our growth strategy of taking market share in the markets we serve, expanding our served available market and developing recurring revenue streams like the one Dennis spoke of in the markets that we currently compete in. Currently, it appears the fundamentals underpinning the global semiconductor industry continue to be strong and improving. Pivotal Systems remains absolutely focused on our customers and providing them with the advanced technology they will require today and in the future. Our market share gains in the first half of 2020 indicate that we're making significant progress to that goal. The company expects second half 2020 revenues to continue to improve as our customers continue to find increasing value in our products. We see positive signs that the industry is doing quite well and will maintain strong momentum going into 2021.At this time, Dennis and I would be happy to take your questions.

[Operator]

[Operator Instructions] Your first question comes from Brendon Kelly with Moelis.

[Brendon Kelly, Analyst]

A couple from me. Firstly, just on the product mix. Can you just give a sense for the product mix, whether it was just a standard low flow, the high temperature and high flow and how that compared to the previous half?

[John P. Hoffman, Executive Chairman & CEO]

Yes. Hi, Brendon. First, I think we can get into more specifics on it, but it pretty much stayed the way it was. The lion's share of the business is the standard etch product for lower flows and most of the gains were with that etch product, as we talked about, with the Korean etch OEM as well as the Chinese etch OEM. And most of the production lines that are ramping, especially in memory or -- as you know, we have a leading market share there, so it's pretty much driven by that. And then some of the gains on high flow and the remote GFC were about the same as in percentage as we've seen in the past.

[Brendon Kelly, Analyst]

Okay. And so with the high temperature and the high flow increases, is that still mostly within memory? Or is there any kind of movement into logic?

[John P. Hoffman, Executive Chairman & CEO]

No. I think we have a -- to recall, there's a slide, I believe, in the first half of 2000 -- or second half 2019 results where we walked through the demographics of the spend, and it's about 50-50 in terms of foundry, logic and memory in terms of the number of accounts qualified. I think, obviously, our revenue, because we've been working at it longer, is much stronger in memory for all aspects of the product line, but we're seeing improvements based on foundry spending in other regions besides, let's say, Korea. And as you -- we've said in the past that, generally, you introduce a new product, it takes time for it to track upwards, the history of the standard GFC, I think, 2015 versus the amount of time we scaled it up to the large business it is today. Hopefully, that answered your question.

[Brendon Kelly, Analyst]

Yes, that answers it really well. And then just with the transition of the manufacturing operations back to Korea, I'm just wanting to understand how the gross margins were in the first half and how we can expect that to trend into the second half?

[John P. Hoffman, Executive Chairman & CEO]

Well, I'll pass that one over to Dennis.

[Dennis R. Mahoney, Chief Financial Officer]

Yes. Hi, Brendon. Sure, I'll be pleased to answer that question. And in fact, how about if I give you a bit of a trend line so you can see the picture? First, for the -- I'll start with the first half and then share with you the first and second quarter as well as the month of June so you can see the trends that appear to be shaping up. So for the first half -- and I'd like to tell you, the actual gross margin, as recorded, which includes everything in such as duty to the U.S. Customs as well as a pro forma number where we say what would it have been if we wasn't -- we're not incurring U.S. duty and the higher labor costs in the United States.So in the first half, the actual gross margin was 1.46%, so about 1.5%, but on a pro forma basis, we're as close to 22%. In the first quarter or the first half, gross margins were negative at negative 3.9% with the pro forma just below 17%. The second half, we saw improvements. Now among the things that started happening in the second half were we had resolved a historical negotiation with our China CM, which affected the cost to us of our, what I'll call, our base blocks, and we also started seeing reductions in duty and reductions in individual components of our product as we're trying to drive costs down. So in Q2, gross margins increased from negative 3.9% to 5.5% and the pro forma was about 21%. So the overall pro forma is about similar to the first half.In the month of June, we had 16.7% gross margins and 31% on a pro forma basis. We expect that trend to continue because now that we have the duty, which is -- will be effectively gone as well as the incremental shipping costs and the higher labor costs for manufacturing here in the United States.

[Brendon Kelly, Analyst]

Sure. Sorry, I just missed the June number. Can you please repeat that one?

[John P. Hoffman, Executive Chairman & CEO]

Which number? June?

[Dennis R. Mahoney, Chief Financial Officer]

June number? Yes, sure. So June, the actual number was 16.7%. On a pro forma basis, it was 30.7% after adjusting for duty and higher labor costs in the United States. So we benefited from reduction in duty that were beginning to ship out of June. We are also benefiting from cost reductions, which we had achieved in some of the components which make our product. And of course, we started to see the fall-off or fall-away of the duty charges.

[Brendon Kelly, Analyst]

Yes, understood. And then just lastly for me, just in terms of that sequential improvement that you're expecting in the second half, can you just give us a bit of a sense for what that might look like Q3 versus Q4? Like is there going to be -- like are we waiting for a late calendar year ramp-up? Or is there an ongoing positive trend here which we should start to see in Q3?

[John P. Hoffman, Executive Chairman & CEO]

Yes. So as we -- I think, as you know, Brendon, we always look at our second half. And there's some good news in that we're getting really good forecasts from both of our -- all 3 of the equipment companies and the integrators that we deal with as well as we do fairly detailed bottoms-up from many of the meaningful IDMs like a Samsung or a hynix, for example. So not only do we see what the OEMs are telling us, we actually validate what the IDMs are actually thinking they're going to install.And so at this particular point, I will say Q3 is improved -- is better, slightly maybe, but it's better, but I think we'll see, based on what the planning is, better improvement even in Q4. But it's not a hockey stick, so to speak. It's more of a gradual trend line.

[Operator]

[Operator Instructions] Your next question comes from [ Mark Fitzgerald ], a private investor.

[Unknown Shareholder]

I've got a couple of questions here for you. First, can you give us a sense of how Japan is doing for you at this point?

[John P. Hoffman, Executive Chairman & CEO]

[ Mark ], thanks. I think we're starting to see some green shoots coming out of those Japanese factories, [ Mark ], in terms of demand from the IDMs, which is good. As you know, Japan has been in a bit of a trough for quite a few years and the amount of real CapEx spending for new technology has been pretty low, right? They've added capacity in older factories, but we're actually starting to hear some discussion now about adding new tools and technology, which is good.I would suggest that our activity with one of the leading Japanese OEMs is absolutely fantastic. They're a great partner with Pivotal, that continues. And I think that's quite meaningful as the company knows or as we've discussed, right, 3 of the major equipment companies really cover a large percentage of the MFC spend in the world. So it's really important strategically for the company to continue to partner with those OEMs. So we're also seeing really good work in that regard.

[Unknown Shareholder]

Okay. And the other question has to do with the SmartStik. Just tracking your comments here, it seems that most of the activity is happening in Asia at this point that -- I think you mentioned the Korean OEM and then some Chinese IDMs. Is that, in fact, the case? And if -- I'm curious why we're not seeing more interest at the U.S. OEMs.

[John P. Hoffman, Executive Chairman & CEO]

Yes. It's a really good question. First, we've already -- if you think it through, like there's a pretty strong penetration activity in the major U.S. OEMs. And so what we've seen as we go into Asia and especially China, many of the IDMs and effectively the equipment companies are cost-driven. And so for Pivotal, if you're selling into non-advanced fabs, say a 3-nanometer, 7-nanometer line fabs, you really have to go back and talk about how you save money. And the purpose of that SmartStik architecture, as you know, is -- and we're able to do live demos of this on the road now in conference rooms, although in the COVID world we live in, we're not doing that right now, but what we're able to do is actually demonstrate the specs that the GFC can meet with the elimination of a number of components in that gas box, which the competitors have to have. If they don't have all the braces and straps, their product can't perform to the spec. So when you're dealing with engineers, you generally have to show them and provide a lot of data around it when you're going to pull things that they've built into their equipment for years and years off the tool.And so I think that was the whole thesis we had with SmartStik, which is, hey, we want to be able to go in here and demonstrate to people that what we're telling them is real. And so I think you've seen that, and those penetrations were very successful so far. But just as importantly, there are no SmartStiks running in fabs. And so when 6 leading IDMs in China are asking for GFCs for select application, that's because they need advanced technology.So hopefully, I want to get across that the product is not only good in terms of meeting specs, and those are the best specs in the world, but it really has proven that it can save equipment companies money as they move in this direction. Did that help, [ Mark ]?

[Unknown Shareholder]

Yes. Yes. And another question on the FRC. The -- you've got something going with a large IDM in Korea and a U.S. company at this point. Is this, in terms of a revenue story, converting these -- I assume what we're talking about here is a valuation level interest at this point. But are we going to see a take-off in revenues at some point here in the next 6 to 12 months on this product?

[John P. Hoffman, Executive Chairman & CEO]

I think -- yes, I think in both instances, the standard product we're using for the etch applications in Korea will probably be a revenue story possibly in the period you talked about, right? And we're talking about meaningful revenue, not onesie-twosies.What we're seeing, though, on the deposition side is that this may have opened new opportunities in terms of different ways to apply that technology, and we'll see. I do think there will be deposition revenue, but in the future, we may be able to find new ways with the equipment companies to leverage Pivotal technology, and that may mean new tools and new architectures for flow.

[Unknown Shareholder]

Okay. And a question on the service side of the business. It was $120,000. I think I took my notes here for the second quarter -- or the second half. And if I recall, in Korea, that the Korean IDMs require that those gas flow controllers are refurbished every 2 years. And does that mean we're going to see a sharp increase here in refurbishing business coming out of Korea shortly, given what you've sold in the last couple of years?

[John P. Hoffman, Executive Chairman & CEO]

Yes. I think Dennis gave those numbers as -- I think we went from about $120,000 up to $200,000 and something, $240,000?

[Dennis R. Mahoney, Chief Financial Officer]

$240,000, yes.

[John P. Hoffman, Executive Chairman & CEO]

So I think 91% growth is sharp enough for me. We're -- that's a pretty solid ramp. And I think your thesis is correct. And we talked about it at the IPO. And we know how these businesses operate where once things start rolling off warranty, you've got to be prepared for it. And you're spot on. The software upgrade business is a good recurring revenue stream for the company. And so yes, the answer is we continue to see that as a growth opportunity.

[Unknown Shareholder]

Okay. And then just one kind of a bigger picture question here. I mean there's been a lot of news in the last couple of days about Intel and Intel's problem. It's 7 nanometers at this point. I'm curious if there's, given the problems that they're having in manufacturing, if there's a potential opportunity there. And are you working with anybody in the Portland Intel facility in their development labs?

[John P. Hoffman, Executive Chairman & CEO]

First off, if I was, I couldn't tell you, as you well know, based on nondisclosure agreements that Intel would and have required us to sign. I can suggest, though, that -- and I'm certainly not qualified to talk about Intel's production issues. But most of the work that any IDM does, right, any device manufacturer, they're going to leverage that back through the equipment companies, right, the Applieds, the Lams, the [ tels ], the ASML and others. And so in my view, it's important to service the needs of the equipment companies and make sure that we give them that value. And then as an IDM brings us problems, and they do, we need to resolve them quickly and efficiently.

[Operator]

[Operator Instructions] There are no further questions. I'll now hand back to Mr. Hoffman for closing remarks.

[John P. Hoffman, Executive Chairman & CEO]

First, thanks, everyone, for joining us for this call. And again, I really truly wish I was there to meet face-to-face. This pandemic has been problematic for all of us. And I certainly hope everyone is doing well and their families and everyone's health is remaining intact.Thank you very much for your time. And again, look forward to speaking with you again soon. Thank you.

[Operator]

That does conclude our conference for today. Thank you for participating. You may now disconnect.