Pivotal Systems Corp

ASX:PVS

Earnings Call Transcript

[Operator]

Thank you for standing by and welcome to the Pivotal Systems Fourth Quarter 2020 Investor Conference Call. [Operator Instructions] I'd 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 you in regards our fourth quarter 2020 4C and the results. As I've mentioned in the past, we provide commentary each quarter to keep you apprised of our progress as well as answer any questions you may have. The fourth quarter of 2020 was quite solid for Pivotal Systems as we were able to continue our strategic development programs with 2 leading original equipment companies while leveraging our new Korean transformation center to achieve significant gross margin improvement as we had expected. The company was able to leverage material cost reductions on many of our GFC common components, and this aided in our gross margin improvements. Dennis Mahoney, our CFO, will spend time providing you with more specific details in this regard. Most importantly, our standard etch GFC continued to take market share in the fourth quarter as more OEMs move over to Pivotal's industry-leading technology. We see that trend continuing well into 2021. Here are some of the fourth quarter highlights. Our unaudited Q4 revenue was $6.06 million, which was up from our Q3 revenue and down from the same period a year ago. Our second half of 2020 unaudited revenue growth was 18.3% versus our first half 2020 revenue of $12.1 million. This was consistent with our guidance for sequential second half growth over the first half. Our unaudited 2020 overall revenue of $22.1 million was up 44% from the previous period in 2019, which was $15.3 million and up 8.5% from the 2018 $20.3 million as well. 2020 revenue represents an all-time high for Pivotal. Our unaudited gross margins of 29.6% were up 22% in the prior -- from the prior period and up 8.7% from Q3 of 2020. During the quarter, we also had a $4 million share placement undertaking to strengthen our balance sheet ahead of expected increasing demand for Pivotal products in 2021. We also received a progress payment of USD 480,000 for our atomic layer deposition GFC development program that we've agreed to with a leading Japanese equipment company in Q3 of 2020. We also qualified the remote GFC with a second OEM that is based in Korea. We qualified the standard GFC with a new U.S.-based foundry. We continue the qualification of the 2-channel flow ratio controller and a leading U.S. equipment company. Our backlog at the end of December 31 was left at $3.5 million. And despite the ongoing pandemic, Pivotal maintained all of our manufacturing activity in China, Korea and the United States during the reported period. We also reduced material costs on our standard GFC by approximately 10% in 2020. Specifically, looking at our products. The sales of the standard low-flow GFC commonly used in etch application continued its momentum in Q4, driven primarily by U.S. OEMs and both IDMs and OEMs in Korea, China and Japan. Management estimates that we grew our etch market share from approximately 5% at the end of 2019 to approximately 10% in 2020. We based this on strategic OEMs in Korea and China as well as IDM wins in Taiwan, Europe and China. The high-temperature GFC fan-out continued in the fourth quarter with multiple repeat orders, including on the newly qualified gases we spoke about during our Q3 call. The momentum in this product area is expected to accelerate in 2021. Also in the fourth quarter, we qualified and sold a high-temperature GFC with a second original equipment company, which demonstrates the continuing acceptance that the market is moving to higher temperatures on newly developed processes, especially in deposition. Our strategic partnerships with a leading OEM in the U.S. and a leading OEM in Japan both remained on track in the fourth quarter as we work diligently on new ALD flow applications. They're high temperature, and we also worked on specific flow ratio controller applications for both etch and deposition. Overall, Pivotal maintains its commitment to a pipeline of new products as our history continues to demonstrate. We strive to maintain 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 that as the semiconductor industry continues to advance to smaller and smaller geometries, our superior performance of the flow control product family becomes even more compelling, and the market continues to show that with our growth. At this time, I'll pass it over to Dennis to discuss operations and finance.

[Dennis R. Mahoney, Chief Financial Officer]

Thank you, John. We are pleased to report our preliminary unaudited results for the fourth quarter and full year of 2020. Please note that all dollar amounts that I will be providing will be stated in U.S. dollars. As John highlighted, we had a solid finish to 2020, producing strong year-over-year growth in revenue; sequential gains in gross margin, culminating in margins of 29.6% for Q4; important advances in product development and customer penetration as well as discipline and execution in worldwide operations. The company completed an equity investment of $4 million in December, as John mentioned, strengthening its cash position to $7.5 million at December 31, 2020. This cash balance included a $1.7 million balance outstanding on the term loan with Bridge Bank and the first tranche of $10 million on the RBI preferred stock financing from Anzu, which was completed in February of 2020. The $4 million strategic share placement was closed with Viburnum Funds, an Australian high conviction, active ownership investment manager and recent investor in Pivotal. These funds will provide the company with additional financial flexibility to further capitalize on the strength of the global semiconductor capital equipment market expected during 2021. Placement proceeds will be deployed in funding increased inventories based on expected increases in product demand from customers, along with capital expenditures related to additional tooling required to manufacture Pivotal's next-generation gas flow controllers to service the fast-growing atomic layer deposition and etch markets. Cash receipts from customers for the period were $5.7 million, up 4.7% from $5.5 million in Q3 2020, evidencing stability and receivables management. Cash payments for product manufacturing were $4.8 million, down 15% from $5.6 million in Q3 2020, reflecting operating improvements in inventory management and contract manufacturing as well as reductions in labor costs and utilities while still fully supporting production schedules. Pivotal continued to invest in product development with $680,000 in capitalized product development costs incurred during the fourth quarter. During the fourth quarter, the company made salary and related payments of $210,000 to related parties and their associates, including executive directors' salary payments, nonexecutive director fees and fees for consulting services provided by a director-related entity. Our fourth quarter full-time headcount was 45 employees, unchanged from the previous quarter. All of the achievements we are reporting were accomplished with no increases in our workforce. During Q4 2020, Pivotal optimized production operations with a combination of standard products produced in volume at the Korean contract manufacturer facility, while the advanced and specialty products were produced at the Pivotal Fremont, California facility. Combined, this global scalability drove our operation to higher volume thresholds and increased efficiency. Overall, material cost reductions for the year came in slightly better than planned at near 10% overall reductions. Our Korea transformation strategy significantly reduced importation duties paid to the United States Customs and Border Control with transformation now being performed in Korea rather than California. Duty expense paid to the U.S. in Q4 2020 decreased by 37% over Q4 2019. Total duty paid to U.S. Customs in fiscal year 2020 was $1.6 million, of which we have already received drawback or refunds totaling $1.2 million. Additionally, manufacturing overhead decreased approximately 50% from Q1 2020 to Q4 2020. These significant cost reductions and duty drawback, when combined with lower freight costs and reduced labor costs, were significant drivers of our gross margin improvements. These improvements are sustainable in 2021, and we'll continue to work with our suppliers to gain even more savings.Pivotal surged manufacturing during December and achieved a production record of over 1,000 units produced in 1 week. This high utilization, coupled with operational efficiency, effectively validated our factory strategy and demonstrated a current capability of over 40,000 units in production in 2021. This is a strategic milestone as we demonstrate our production readiness in a sustained industry ramp. All in all, we are pleased with our business results and forward progress on many fronts in 2020. At this time, I'll hand back to John.

[John P. Hoffman, Executive Chairman & CEO]

Thank you, Dennis. We're very pleased with our performance in the fourth quarter, and we expect continued improved conditions in 2021 as the semiconductor industry moves forward. The unaudited revenue growth of over 44% in 2020, coupled with the company's gross margin improvement, validates the market differentiation of our superior products. I would add that based on our research, our leading Japanese competitor's reporting, we are growing at more than twice as fast at 44% versus 18%, and we're achieving higher gross margins. Most significantly, Pivotal is going into 2021 with our advanced products being designed into the next generation of process tools at 2 of the 3 strategic equipment companies. This is truly a tipping point in that it enables the company to ship its flow control solutions to all IDM customers around the world through our equipment company partners. As we mentioned at the end of our third quarter, we expect this to further accelerate our growth in 2021 and beyond. Once again, our strategies are not changed. We want to take market share in the markets that we serve. We want to expand our served available market with our new product introduction, and we want to develop recurring revenue streams in the market we currently compete in. As we mentioned in our market release, the semi-virtual meeting held on the week of January 11, also known as ISS, was very heartwarming for the company. They reported the return to economic growth in 2021 is expected to spark a continued expansion of the semiconductor industry. Worldwide semiconductor revenue is set to rise 7% to 8% as stated by various industry forecasters. 5G deployment and PCs for remote work and learning are among the key drivers, coupled with accelerating spending across the board in the information communication technology segment. This would include mobile handsets, Internet of Things, cloud computing, big data analytics, robotics, security, artificial intelligence. And specifically called out was cloud computing, which will be a key force behind the chip industry growth in 2021 as cloud infrastructure build-outs drive higher server demand stemming from the pandemic-inspired surge in online shopping and increasing adoption of the public cloud. One other item of note. 5G smartphones have 50% more silicon content than 4G smartphones. Pivotal Systems remains absolutely focused on our customers in providing them with advanced technology that they will require today and in the future. Our market share gains in 2020 indicate that we're making significant progress to that goal. The company expects the first half of 2021 revenues to continue to improve as our customer find increasing value in our products and strong industry tailwinds. We also see continued improvement in our gross margins as we reduce our cost and leverage increasing volumes at all of our factories. At this time, Dennis and I would be happy to take questions.

[Operator]

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

[Unknown Attendee]

John, I was wondering to find these qualifications that you've gotten here, the one -- the Korean OEM and the foundry. If you can outline what this means in terms of -- I mean, revenues for 2021. Are we, in fact, an assumed revenues? Or is this going to take some time to generate revenues?

[John P. Hoffman, Executive Chairman & CEO]

Yes. Good question, [ Mark ]. The -- it's very interesting. The U.S.-based foundry actually has already begun purchasing GFCs during the fourth quarter. The qualification they used was, I suppose, expedited, and I thought that was quite interesting. On the OEM front, I believe you'll start to see revenues there in the first half. As this typically goes with the equipment companies, it can take several quarters or even a year or so to ramp that up to large volumes as we've seen, say, with the Korean OEM in the qualification we did during 2020. But that did exceed our expectations as well as the year went on. So part of it is the technology gives them advantages and part of it is where they're going to spend their dollars and how potentially they can leverage that into more revenue. And I think it's dependent on each individual situation.

[Unknown Attendee]

And is the foundry going back and retrofitting? Or is it just on new tools at the foundry stations?

[John P. Hoffman, Executive Chairman & CEO]

Yes. They're retrofitting now to prove that they can get the process performance gained. And then as we've seen, they'll then stipulate the GFC potentially on new tools or refer tools as they procure. And it just depends on what their strategy is on equipment procurement, but they can do both, and they have done both.

[Unknown Attendee]

Okay. And the ALD effort at this point, is that a revenue generator in 2021?

[John P. Hoffman, Executive Chairman & CEO]

Yes. We believe it is. As we've said in the release, that partnership has already yielded. There was a progress payment, I believe, of about $480,000 in 2020. We have more of those coming in 2021. The total engagement was $1 million, if you recall, from our -- I believe it was Q2 -- Q3 release, excuse me. So you'll see more of that. And then as we said before, this is interesting in that, in the past, Pivotal would be working directly with the device manufacturers. We become qualified. They would then start retrofitting their installed base around the world in some instances with GFCs. And that would turn on relatively quick because they control it. When you're talking about equipment companies, first, you've got to get through the gambit of getting qualified on their tool. And as you know, the qualification on an ALD tool at one of the larger equipment companies would mean they'd have to be doing -- able to do logic. They have to do ASIC, they'd have to do memory, and they do memory both on flash as well as DRAM because they would sell to all those customers. So the -- what we generally see is the qualification ramp at an equipment company may take a little longer because they've got to run a lot of wafers and qualify a lot of processes. But then the fan out of that technology would be quite accelerated, if that makes sense. And one thing to keep in mind always is that if we look at the total flow control spend on an annual basis, 95% of it is coming from the equipment companies, whether that's Applied Materials, Lam Research or Tokyo Electron in most instances. So the fan out there is not only quick, but it's large because they're going to be selling across their installed base. So I hope that helps.

[Dennis R. Mahoney, Chief Financial Officer]

And then John, can I add one point to [ Mark's ] question?

[John P. Hoffman, Executive Chairman & CEO]

Sure, Dennis.

[Dennis R. Mahoney, Chief Financial Officer]

Mark, would that be okay to give you a bit more color on your question as well on -- so...

[Unknown Attendee]

Yes, absolutely.

[Dennis R. Mahoney, Chief Financial Officer]

You mentioned about revenue in the ALD business. So where we are with that project right now is that we are -- we structured it as a milestone arrangement or agreements. And as we perform on milestones, we recognize the revenue associated with it. We've been doing that since the inception of that contract, and we're in compliance with all the accounting literature guidance on after the accounting treatment and as well as with the thoughts of our outside auditors. So yes, revenue is beginning, and I'm expecting it's going to increase as we get further into this.

[Unknown Attendee]

All right. And is there -- the reserve that you have for the account receivable, the China account that -- [ been paid ]. Is there any opportunity to recapture any of that?

[John P. Hoffman, Executive Chairman & CEO]

Yes. So we've been working on that. The reserve has been there, I think, probably for getting close to a year. And what's happened in China is rather interesting. A lot of the factories that were buying equipment in, say, 2019 basically put those in barns in Taiwan and awaited government funding. Many of those factories, we're seeing probably 20%, 30%, somewhere in that regard, either go under or they reorganize. And so then in this specific case, they did receive their funding, and we've been working with them on that, and we think we can recover all, if not a very sizable portion of that, as we get through here 2021.

[Operator]

[Operator Instructions] Your next question comes from [ Ron Tanna ] of [ Triple M H ].

[Unknown Analyst]

Good results and very pleased to see the progress. One question -- first question is, what was the increase in the customer base compared between 2019 and 2020? I realize there's a number of types of customers. But just in numbers because one of the things we do track, I remember is -- and part of the strategy of the company is actually to go wide. So are you able to give any color on the number of customer growth or perhaps the percentage increase in customer growth?

[John P. Hoffman, Executive Chairman & CEO]

Yes. Good question, [ Ron ]. And it's also nice to speak with you again. We're going to give you the full deck as we normally would at the year-end, and we give you the full color around how many new customers qualified, were they device manufacturers, were they equipment companies and potentially research in other universities as well. I believe in the fourth quarter, it was specifically one, which was this brand-new foundry that we started working with. But we'll give you an update on the whole second half year-over-year, if that's okay, at the end of February.

[Unknown Analyst]

Okay. That's all right. I had one more question.

[John P. Hoffman, Executive Chairman & CEO]

I do want to point out -- I do want to put out one thing is that I believe that we said it at the beginning of the second half when we sent out the deck. It's getting more difficult for us to get more new customers because we've pretty much gotten qualified everywhere. And that's important. There are equipment companies we're still qualifying with because they're the smaller ones, and we kind of worked our way from the larger ones to the, let's say, the smaller ones as a strategy, but some pulls quicker than others. In terms of the device manufacturing side of it, right, the large companies, the Samsungs, right? Those have been qualified or are qualified in 2020. And there's just not a whole lot left for us to attack individually. But I will say, there are 2 very large customers that are device manufacturers, that being Intel and TSMC, that prefer to go through the equipment companies. And so we're working on those strategies as well, and I'll talk more about that in 2021.

[Unknown Analyst]

Okay. I had another question. A couple of years ago, you set up, I think, the remanufacture or the repurposing, recycling center in Korea. And can you just give some color on how that's gone?

[John P. Hoffman, Executive Chairman & CEO]

Yes. So it's the repair and upgrade center. We do upgrades to the devices that is sent back from either the equipment companies or the device manufacturers themselves. What they would generally do is potentially take, let's say, an MSC that's flowing oxygen and they may change it from flowing 20 SCCMs per minute, or standard cubic centimeters per minute, to 200, or they may change it from an oxygen to an argon as an example. What that does is it's the software upgrade. So it's a great opportunity for Pivotal to upgrade the software. And then in some instances, they'll send -- companies will send in their devices after x number of years to get them cleaned up and refurbished and we'll send those back. I believe we're close to getting that to $1 million run rate in 2020. Dennis might have specifics on it. But the net of it is it's accelerating because our installed base is large and it's getting larger as you'd imagine. And as these units come out of warranty, then these companies look at them and say, okay, we can go take this back and get it changed from a gas or speed it up or whatever they'd like to do. As we've said, our products generally do not fail. The way Dr. Monkowski has designed this is that the valve itself is never exceeding its elastic limits at any point. And the materials themselves are noncorrosive. So it really would be maybe there's a PCB issue, which can last -- these PCBs will last over 20 years. It's really more upgrades than it is repair, if that makes sense, Ron.

[Unknown Analyst]

Good, good. And finally, that's an interesting number that you've got a current capacity of 40,000 units in 2021. What -- if that's -- I kind of reduce some numbers, would that equate -- if you sold all those units, would that equate to a revenue of approximately $50 million?

[John P. Hoffman, Executive Chairman & CEO]

No. Our ASPs are higher. And I generally don't talk about ASPs and there's a number of reasons for that. But I would suggest that there's probably enough capacity there to do well over $100 million.

[Unknown Analyst]

Okay. Okay. So we're not going to run out of capacity in the next couple of years out of that plant?

[John P. Hoffman, Executive Chairman & CEO]

I didn't say that. I said I've got the capacity to probably do enough for, let's say, 40,000 this year. What we -- in this flow space, just in semiconductor, there's -- we guessed there's probably 380,000 of these built every year. And our goal is to get to 30% or more of that. So what I think the message there is, is that to many people listening to our calls, including our customers, one of the things we want to know is, we do have capacity. Despite our growth, despite the fact we've grown twice as fast as our competitors, we have plenty of capacity because we plan. And I think the ops team has done an amazing job. I think the finance team has done an amazing job as well to get the capacity ready so that when more and more business keeps coming Pivotal's way, we're ready for it.

[Unknown Analyst]

And one quick final question, a finance question, is that I think you mentioned that you got a payback loan originally during COVID. Did that get written off because in January because you kept all the employees?

[John P. Hoffman, Executive Chairman & CEO]

Yes, it was forgiven, and I believe Dennis and his team did a release earlier this week on that.

[Unknown Analyst]

Okay. Great.

[Dennis R. Mahoney, Chief Financial Officer]

Correct.

[John P. Hoffman, Executive Chairman & CEO]

That's correct.

[Unknown Analyst]

Okay. That's all. You're doing -- I mean this is a great report. This is well done, guys. It sounds like it's turning the corner. I mean -- and the confidence of the share placement from the fund obviously says that they know they've obviously done a lot of research and they're backing you. So I'm very happy.

[John P. Hoffman, Executive Chairman & CEO]

Thanks, [ Ron ].

[Operator]

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