Pivotal Systems Corp

ASX:PVS

Earnings Call Transcript

[Operator]

Thank you for standing by, and welcome to the Pivotal Systems Corporation December 2019 Quarter Update 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. Thank you again for taking the time to join the call. It's a pleasure to speak with everyone following our December quarterly. As we mentioned during previous announcements, we remain committed to providing commentary with each of our 4C releases. The fourth quarter of 2019 was in line with our expectations of higher orders and improving revenue. However, as we mentioned in our January 20 release, fourth quarter revenues were impacted by approximately $825,000 due to a shipment of Pivotal GFCs being shipped from a third-party CM to Pivotal later than the committed shipment date. During the quarter, Pivotal experienced an increase in lead times from its CM as their end customer demand also increased. Revenue from the delayed shipments were subsequently recognized in January 2020.Let me spend a bit more time providing context on this matter. As the industry began to recover late in the third quarter, Pivotal operations conducted a ramp readiness exercise across our entire supply chain. This included all component and piece part suppliers as well as our integration and transformation centers. Our teams concluded that we were ready for the business growth from the prior period.However, as the quarter progressed, we saw lead time increases as well as missed commitments from our China-based CM. Pivotal operations management implemented a recovery plan, which included dispatching both management and technical resources to improve CM factory output. Unfortunately, due to several smaller issues, we were unable to fully recover until after the 4Q 2019 reporting period had ended. Pivotal is currently back on track with timely deliveries to all of our customers, and the impact of our late shipments were minimized. We continue to monitor all aspects of our supply chain, and we will dispatch operations executives and technical resources as required in the future.I would also like to mention several of the highlights around the fourth quarter. First, the company successfully passed a corporate-level audit from a major Japanese original equipment manufacturer and subsequent manufacturing audits by the same manufacturer in both our facilities in Shenzhen and in Fremont, California. Later in the quarter, the GFC was production-released by the same Japanese original equipment manufacturer. This means it can now be sold on both new tools as well as sold by this IDM as retrofits into the installed base. We view this as a significant accomplishment. We also received our first-ever production order from the same Japanese equipment company.We received repeat orders from a large Chinese integrated device manufacturer, or IDM, and repeated our 2019 Q2 100% market share at the same IDM in China. We successfully qualified the Standard GFC with a Korean etch OEM and received our first orders. We also received our first orders from our new sales representative in Japan. We qualified the GFC and received our first orders from a large European foundry. We had multiple repeat orders in Taiwan, multiple repeat orders in the United States. And this was actually the first quarter ever where Pivotal received orders from all geographic regions we target, which includes Europe, the United States, Taiwan, Korea, Japan and China.Diving into focus on the industry specifically, we saw the major Korean memory device manufacturers begin taking delivery of new semiconductor equipment in line with our expectations. During the quarter, the Pivotal Systems team met with key executives and engineers from Korean manufacturers, leading equipment companies from the U.S., Japan, Korea and China as well as semiconductor industry executives. As a result of these interactions, we understood that capital equipment or CapEx spending for the first half of 2020 would grow significantly from the 2019 run rate. This message was further reinforced in various industry meetings while I was at SEMICON Japan, which was held in Tokyo in mid-December.Turning specifically to the memory market and DRAM. We continue to believe that the spending increase will extend through this calendar year as customers seek continued growth in data center spending. In NAND or flash memory, recent data indicates that bit shipments were better than normal seasonal trends, and we continue to believe that this -- that market conditions are improving with 5G, smartphones and tablets spending.On the foundry and logic side, 2020 CapEx spending is slightly higher than our previous baseline as customers appear to be ramping leading-edge technology nodes faster than we previously had forecast, which we believe is partly due to increased semiconductor content in smartphones related to 5G. While predicting the exact timing of cyclical change is difficult, our confidence in long-term demand for Pivotal business is unchanged. Semiconductor drivers such as artificial intelligence, 5G and Internet of Things are creating compelling served available market expansion opportunities for all of the IDMs and all require innovation in the transmission, processing and storage of data using the minimum number of compute cycles at lower power and lower overall system cost.This is leading the changes in compute system architecture and driving demand in new on-chip and off-chip memory designs. Key trends include the use of high-bandwidth memory interfaces for leading accelerator designs, heterogeneous integration for system ownership solutions and the move to MRAM for embedded memory. In each of these changes, Pivotal's leading gas flow precision and speed becomes increasingly differentiated.In the area of products, the standard low flow GFC commonly used for etch continued qualification with a leading Japanese equipment company. At SEMICON Korea, we announced the new SmartStik architecture in 2019, and we will further leverage that at SEMICON Korea 2020 coming up. We believe that pressure and sensitivity, speed and intelligent signals provided by the Standard GFC can effectively eliminate the need for numerous components on a gas stick. This will ultimately allow the equipment companies to save money as they adopt the SmartStik architecture. The company also achieved new etch process gas qualifications with the Standard GFC at a leading U.S.-based equipment company.Finally, we have an ongoing development program with a leading Japanese equipment company for the next-generation GFC focused on advanced deposition requirements associated with 5-nanometer production. This program remains on schedule. Overall, we continue to maintain a consistent strategy of delivering upon our commitment of a pipeline of new products. We are being aggressive in maintaining the technology leadership we have achieved in the flow control markets by being the innovation leader for both device manufacturers and the equipment companies. We believe that the recent industry slowdown was a key enabler to allow the large equipment companies time to focus on our new technology and to partner with other technology leaders. We believe that our market share gains were enabled by our technology partnership with these same industry leaders.At this time, I'll pass it over to Tim Welch to discuss specifics covered in the 4C and the announcement in the ASX this morning of up to USD 13 million in additional funding for Pivotal, which is required for us to grow and expand our business.

[Timothy D. Welch, Chief Financial Officer]

Thanks, John, and good morning. I'm pleased to cover our fourth quarter 4C cash flow information. All financial numbers are in U.S. dollars and are unaudited. We will be releasing audited 2019 financials at the end of February.The company finished Q4 with a cash balance of $5.4 million, which included $2.8 million borrowed against the term loan with Bridge Bank. There are currently no borrowings against a $7 million revolving line of credit.Cash receipts from customers for the period was $3.1 million, which was down from Q3 due to low Q3 shipments. Cash payments for product manufacturing in Q4 were $4.8 million due to the increase in quarterly shipments and the cost while we temporarily transition certain manufacturing activities back to Fremont. Pivotal continues to invest in product development with $600,000 capitalized costs incurred during the quarter. As commented on previously, Pivotal has made this product development investment in response to 4 customer-led product initiatives along with an increased inventory build on a High Flow GFC and the new High Temp GFC, also called the Remote GFC. During Q4, the company experienced an increase in demand from IDM and OEM customers that have qualified the Standard GFC, the High Temp GFC and the High Flow GFC products.Moving to operations. Our fourth quarter full-time head count remained flat at 45 people. During the quarter, Pivotal made excellent progress in temporarily transitioning certain manufacturing activities and laying the groundwork for backfilling capacity in Korea. This resulted in final product transformation activities and product shipments from Pivotal's Fremont facility. The Fremont facility has sufficient capacity to meet expected customer demand for Pivotal GFCs commensurate with the improved outlook for the semiconductor manufacturing sector.Pivotal is currently bringing up a new transformation center in Korea and expects to activate this new facility in the first half of this year. Pivotal is also on track in establishing a repair and upgrade center in Korea. The facility, which will be operated but not owned by Pivotal, is expected to commence operations in Q1 of this year. In this facility, we will provide software upgrades to both IDMs and OEMs as well as repair business.As noted previously, Pivotal's large global installed base has an increasing number of units coming out of warranty. Pivotal therefore expects the repair and software upgrade business to grow over the coming quarters.As John has mentioned, our fourth quarter revenue was impacted by approximately $825,000 due to a late shipment from our third-party contract manufacturer. At this time, I'm pleased to report that Pivotal has cleared up past due shipments, and we continue to monitor our supply chain and grow the business.Turning now to the financing announcement. Today, we announced the signing of a definitive preferred stock investment agreement between Pivotal and Anzu Industrial RBI USA LLC, a fund organized by Anzu Partners. This financing provides the company with up to $13 million in additional funding required to grow and expand the business. Our investors will be familiar with Anzu as they are currently our second largest shareholder and have been an investor in the company since 2016. Anzu is a venture capital and private equity firm that invests in breakthrough industrial technologies and currently manages approximately $350 million in capital commitments. The funding of $13 million is available to be drawn down in 2 tranches: an initial funding of $10 million anticipated to close mid-February; and an optional $3 million, which would be drawn in conjunction with the replacement of the Bridge Bank senior loan. We currently anticipate the Bridge facility, including the $7 million revolving line of credit, will remain in place. We appreciate that for our investors, a revenue base preferred share structure is somewhat novel in the context of more traditional debt equity-style funding.In addition to the announcement, we have provided investors with additional information on the proposed Pivotal revenue-based preferred shares in the Notice of Special Meeting released to the ASX today. In essence, RBI preferred shares are an alternate source of financing versus ordinary equity and debt financing structures. The preferred stock is redeemable by the company based on percentage of revenue levels achieved during that period. Beyond typical contractual covenants pertaining to liquidation of the company, there are no other financial covenants, no warrants or option coverage, and the issue of RBI preferred shares is nondilutive to current common stock or CDI holders. The parties intend to treat the RBI preferred shares as preferred equity for financial and tax purposes. Pivotal has already carefully considered a range of additional financing alternatives for the company and believes the proposed transaction with Anzu, a long-time partner to Pivotal, is in the best interest of Pivotal shareholders and had unanimous Board support. The issue of preferred shares to Anzu is subject to Pivotal shareholder approval under ASX listing rule 10.11. We have reached out to certain shareholders about the RBI investment under a confidentiality and standstill agreement, and a majority of our shareholders have provided their approval of this financing transaction. Also lodged with the ASX today is a letter from John Hoffman to our shareholders and a Notice of Special Meeting of a shareholder meeting to be held in Fremont, California 4 p.m., Wednesday, February 12, which translates to 11 a.m., February 13 Sydney time.I will now pass it over to John for final comments.

[John P. Hoffman, Executive Chairman & CEO]

Thank you, Tim. To summarize, as we mentioned in the quarterly, SEMI recently announced the global semiconductor manufacturing and equipment sales is expected to increase 5.5% to USD 60.8 billion in 2020 and continue expansion into 2021 with record revenue estimates at $66.8 billion as leading device manufacturers invest in sub-10-nanometer equipment, especially for foundry and logic. SEMI expects the 2020 equipment market recovery to be fueled by advanced logic, foundry, new projects in China and memory. As expected, Pivotal saw the industry rebound in the fourth quarter of 2019, and this growth is continuing into the first half of 2020. Currently, we are optimistic about the business, so we are working very closely with our OEM partners to meet the required shipments. We continue to see the powerful advantages the semiconductor provides the global community especially in the areas of communication, artificial intelligence, biotech and automotive.As stated in the quarterly, we will keep the market informed about any updates to our outlook as we receive more visibility around material changes of the timing of orders and shipments from the major IDM customers. Based on current feedback around their spending plan together with Pivotal's increasing market share, we continue to expect first half 2020 to be an improving market. That said, we continue, though, to execute on our core strategies, take market share in the markets we serve, expand our served available markets and develop recurring revenue streams in the market we compete in. The underpinning of our strategy is maintaining our leadership as the #1 innovator in the flow control market. Innovation is the key to better ideas and increased value for our customers and our shareholders. Pivotal has positioned itself as the innovation leader in our markets, as evidenced by the increasing number of development programs and market share gain with our partners. We view this development as a critical step in achieving our overall objectives. Integral to our strategy, we believe the RBI preferred shares issue announced today provides Pivotal with the financial flexibility we require to meet the goals and objectives of our expanding customer base. As to momentum, our business experience in the latter part of the fourth quarter extends into 2020. We eagerly await shareholder approval for this important transaction. I'll be back in Australia in March as we will be beginning our planning for our Annual General Meeting, which will be in Sydney during the month of May, while in March, I hope to meet with all of our investors. And at this time, I'd be happy to answer any of your questions.

[Operator]

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

[Brendon Kelly, Analyst]

Couple of questions for me today. Just firstly, on the qualification. Just to the high level of qualifications, which you've been getting over the last couple of quarters. Are you starting to see any changes in the mix of end market demand of memory versus logic and foundry?

[John P. Hoffman, Executive Chairman & CEO]

Thanks, Brendon. It's John. When you say the mix, is that in terms of our orders or the overall market and the positions of, say, the IDMs?

[Brendon Kelly, Analyst]

Yes, just your end market exposure.

[John P. Hoffman, Executive Chairman & CEO]

Yes. What we -- as we said before, 2019 was a pretty rough year on the memory front. We've seen that recover significantly. Now as we, let's say, ended the fourth quarter, we see that continuing forward into 2020. In the past, we've talked about DRAM lagging slightly behind NAND. For sure, the NAND developments have happened as we had predicted. And actually, we're seeing a bit more out of DRAM than we had probably mentioned in the last call, which we see as good news. At the same time though, we're seeing strong demand in China. We're seeing strong demand coming out of Taiwan, which you would understand, of course, with the foundry activities and the overall moves in China to make semiconductor a more strategic part of their infrastructure. So I would say things have improved. And I think that's reflected as well in some of our orders. We're seeing more foundry business. We mentioned that is a very large customer in Europe is a foundry customer. The business in China was from a foundry customer, and some of the business in Taiwan were logic as opposed to memory, which also reinforces that. So I hope I answered your question.

[Brendon Kelly, Analyst]

Yes, that's great. And just in terms of your indications of demand now for -- on the memory side of things, you noted that you've seen a pretty strong first half. Can you just give us a sense, say, how much of revenue this year is going to be first half-weighted versus second half, do you think?

[John P. Hoffman, Executive Chairman & CEO]

Yes, that's a great question. First off, next week is SEMICON Korea, so we're getting ready for that. That's, of course, a very important set of meetings. As we've seen so far in the first quarter, 3 or 4 weeks of the first quarter, it appears to be balanced, which I think is good news. This is -- many years, we go into it, and we see kind of a hockey stick in the second half. We don't see that. We actually see the first half looking strong as we've said. And the second half, I would suggest, is balanced. I don't know if Tim has any follow-up on that.

[Timothy D. Welch, Chief Financial Officer]

Yes. Again, our visibility is a little bit better near term. But from what we've seen and from the forecast that we've seen from the OEMs, it appears fairly level for next year, first half, second half.

[Operator]

[Operator Instructions] There are no further questions at this time. That does conclude our conference for today. Thank you for participating. You may now disconnect.