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Amkor Technology, Inc. (NASDAQ:AMKR)

Q3 2011 Earnings Call

October 27, 2011 05:00 PM ET

Executives

Kenneth Joyce – President and CEO

Joanne Solomon – CFO

Analysts

Wenge Yang – Citigroup

Eric Reubel – MTR Securities

Operator

Good afternoon, ladies and gentlemen, and welcome to the Third Quarter 2011 Amkor Technology Earnings Conference Call. My name is Camille, and I’ll be your conference operator for today’s call. (Operator Instructions) Following the presentation, the conference will be opened for questions. This conference call is being recorded today, Thursday, October 27, 2011, and will run for up to one hour.

Before we begin this conference call, Amkor would like to remind you that there will be forward-looking statements made during the course of this conference. These statements represent current view of Amkor management. Actual results could vary materially from such statements.

Prior to the conference call, Amkor’s third quarter 2011 earnings release was filed with the SEC on Form 8-K. The earnings release together with Amkor’s other SEC filings contain information on risk factors, uncertainties and exceptions that could cause actual results to differ materially from Amkor’s current expectations.

I would now like to turn the conference over to Mr. Ken Joyce, Amkor’s President and Chief Executive Officer. Please go ahead, sir.

Ken Joyce

Thank you, Camille, and good afternoon, everyone. With me today is Joanne Solomon, our Chief Financial Officer.

Today I’ll talk about third quarter results, some steps we are taking to mitigate the challenges to profitability that we’ve been experiencing in 2011 and guidance for the fourth quarter. Joanne will then discuss our financial performance in more detail and finally we’ll open up the call for your questions.

To begin, third quarter sales of $740 million were close to the midpoint of our guidance while gross margin of 17% and earnings per share of $0.11 were at the low end. Sequentially sales were up 8% driven by solid demand in communications, particularly for smartphones and tablets, and the seasonal increase in the consumer area led by our strong position in gaming.

Turning to our other end markets, networking and computing held steady and we saw a slight decline in automotive and industrial as some customers adjusted inventory levels in the face of an uncertain demand environment.

Our gross margins have been under pressure throughout 2011 with the principle contributors being unfavorable foreign exchange rates, higher gold prices and pockets of underutilized capacity. The accelerated migration of gold wire bond products to flip chip has opened up wire bond capacity faster than we’ve been able to redeploy these assets. And this has been one of the primary contributors to our 2011 utilization gap.

We are committed to addressing these challenges to profitability and are currently focused on rationalizing our cost structure and improving utilization. These efforts are already underway and during the third quarter we implemented an 8% reduction in force in our Philippines manufacturing operation. We expect to improve our labor cost by about $2 million on a quarterly basis through this action.

We are also looking at other areas for improving our cost structure, including further alignment of our work force with customer demand, investing in operating efficiency initiatives in our factories and achieving greater cost savings on material and equipment through our continued focus on supply chain management.

Although the shift of packages out of wire bond and into flip chip has led to some gaps in utilization of our wire bond assets, this migration is a positive story overall from a revenue and return perspective. This quarter about 40% of our revenues came from flip chip applications, up from about 30% in Q3 of last year. And Amkor has the largest share of flip chip market in the OSAT industry. Our flip chip packages generally both a better margin and a higher return than our wire bond packages.

In addition, we are working on a number of initiatives to improve the utilization of our wire bond assets. Our efforts include ramping NAND memory production in our China facility, promoting the adoption of our copper wire bond solutions, and increasing penetration of IDMs as they pursue asset-light business strategies.

Looking ahead to the fourth quarter, we expect sales to decline between 5% and 12% from the third quarter. Based on the current level of demand for smartphones and tablets, our wireless communications business is expected to remain strong. However we see a general softening in demand in other areas, driven by the uncertain macro-economic environment coupled with the seasonal decline in gaming.

As I mentioned earlier, we continue to see solid demand and high returns from our newest and most advanced interconnect technologies for wireless communications packages and for flip chip packaging overall. To support this demand and to meet the capacity requirements of our leading customers, we spent $123 million on capital additions in the third quarter and we are currently planning additions of $100 million to $125 million for the fourth quarter for a total of $425 million to $450 million for the full year. These investments primarily support smartphones and tablets, leadframe efficiency improvements through high-density matrix packaging and research and development initiatives including next generation interconnect technology such as wafer level fan out and Through Silicon Via.

Fourth quarter gross margin is expected to be in the range of 15% to 18% as we expect to see some margin pressure from lower utilization commensurate with the decline in revenues. Our gross margin guidance does not include any additional restructuring charges. That said, we are evaluating adjustments in our cost structure in light of our current demand expectations.

Turning to cash flow, I’m pleased to say that we expect 2011 to be our sixth consecutive year of positive free cash flow. So even with the downturn in revenues, gross margin pressures and significant investments in capacity for our customers and research and development we should again be free cash flow positive for the year. With that I’ll now turn the call over to Joanne.

Joanne Solomon

Thank you, Ken. Good afternoon everyone. To begin, we grew our revenues to $740 million in the third quarter, which was up 8% from Q2. Strong demand for our communications products supporting smartphones and tablets drove our chip scale package sales up 17%. Our ball grid array packages were up 16% due to the seasonal boost in gaming. A slight decline in auto and industrial end markets caused a 4% decline in our leadframe packages and our Test business was also down slightly in conjunction with the decline in our leadframe products. Our sales to integrated device manufacturers were 48% in Q3, essentially flat with the second quarter. The pricing environment has become increasingly competitive as industry utilization softens.

That said, price aversion was in a normal range at around 1% for Q3. Gross margin for the third quarter was 17%, down from 19% in the second quarter. The restructuring charge, together with higher gold prices drove around half of the margin decline from the second quarter. The other drivers of the sequentially lower gross margin were price erosion and higher manufacturing costs which more than offset the benefit of the higher utilization we saw. The restructuring charge in total was $4.8 million of which $4.4 million was charged cost of sale and the rest went to SG&A.

Our operating expenses of $78 million were slightly higher than the second quarter and our expectations. The increase is primarily driven by legal fees for our ongoing patent arbitration. We expect operating expenses for the fourth quarter to be back down at the levels we incurred in the second quarter. Our other expenses decreased $24 million from the second quarter primarily due to three items. As a reminder, our second quarter other expenses included $16 million of premiums we paid to retire a debt. Second we had a favorable spring in foreign currency from a $3 million loss in Q2 to a $3 million gain in Q3 which was primarily attributed to the depreciation of the Korean won and Taiwan dollar and the resulting re-measurement of the balance sheet items denoted in those currencies.

Finally, we saw lower interest by our successful refinancing efforts earlier this year. Income taxes were lower than our expectations. We had an effective tax rate of 8% versus expectations of 13%. The lower rate was due to additional Korean tax incentives with retroactive effect back to the beginning of 2011. We expect and effective tax rate of 21% for the fourth quarter and 14% for the full year.

On August 30, 2011, our board of directors authorized the repurchase of up to 150 million of our common stock. As of yesterday we repurchased 17 million shares for a total of $77 million dollars. We believe this investment in our company enhances stockholder value and reflects our confidence in Amkor’s future.

We ended the quarter with a cash balance of $483 million, total debt of $1.3 billion and net debt of $843 million. Additional we are free cash flow positive again in the third quarter and as Ken mentioned, expect to be free cash flow positive for the full year.

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

Question-and-Answer Session

Operator

Thank you ma’am. Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions) Our first question is from the line of (inaudible) Kumar with Credit Suisse. Please go ahead.

Unidentified Analyst

Hi. This is (inaudible) Kumar. I had a question regarding your flip chip business. You reported it as part of CSP, right? Is that correct?

Joanne Solomon

So it’s in actually a couple places. Part of it is in CSP with a lot of our communications packages are in principally in CSP so part of flip chip is in CSP, but it’s also in BGA. When we looked at BGA, flip chip BGA goes into things like gaming, high end servers and that’s a component of BGA. And then some of the bumping is actually in other packaging. So it’s combined in the three areas is where you would get the total and overall it’s a 40% of our packaging.

Unidentified Analyst

Okay. And how are the utilizations in the flip chip portion of your business? Is that better than your overall utilization? And what kind of level are you seeing there?

Ken Joyce

The flip chip utilization is very strong. It’s in the wire bond area in particular that we’ve been seeing some pockets of open capacity as things transition from wire bond into the flip chip area.

Unidentified Analyst

Okay. And when you say strong, is it like more than 90%? Is that reasonable?

Ken Joyce

I don’t have that number right in front of me but I doubt that it’s that high.

Joanne Solomon

Yeah, it’s high 80s.

Unidentified Analyst

Okay. Okay. So when you look at the utilization levels for your Amkor and compare it to your peers, it seems like your utilizations are a little bit lower than your competitors. What’s the main reason? And even though you seem to have like lesser exposure to leadframe than some of the other competitors, is it like you’re less aggressive about pursuing the leadframe business? Or what’s going on?

Joanne Solomon

Yeah, there’s no industry standard way of calculating utilization and especially when you have a very diverse mix of packages. Sometimes the units get to be very deceiving. As an example, units for leadframes, we have 1.5 billion units for leadframes and a half of billion of units for chip scale packaging and chip scale packaging is a more significant piece of our puzzle. So sometimes the utilizations aren’t very comparable between industry partners because of mix and depending on how they calculate. Generally what I always recommend is that you can sequentially compare our utilization to discern a good trend but when you start trying to compare our utilization to our competitors’, it gets to be a little bit more challenged.

Unidentified Analyst

Then I have another question related to your gross margins and basically the effect that gold prices are having on it. Can you mention how much of your total revenues are coming from, I mean basically how much is gold as a percentage of your revenue? Is it, like 13.5%?

Joanne Solomon

Yeah. Sure, sure, sure. Our gold spend is about 13% of our revenues. And as a reminder we do recover a large percentage of that gold spend either directly within price or as a separate adder. It’s about 85% is what we estimate that we recover of those gold costs. But that still has a very significant impact on our gross margins because a lot of that has very little markup associated with it and just as a general rule of thumb, about $100 change of gold will impact us about 25 to 30 basis points of gross margin.

Unidentified Analyst

Right. So in terms of your guidance, what kind of assumptions are you building in for the gold prices? Like the gold prices went up quite sharply in third quarter. Now is that something that you would see in the fourth quarter, or is it all being reflected in third quarter?

Joanne Solomon

Yeah. You know our posture with respect to posturing both gold and FX is we try not to speculate too heavily where prices are going to be so we tend to heavily weight where they are as of today. So based on gold prices trading around $1,700 I would say that, that’s what we would have included in our forecast. I know today it’s gone up above the $1,700 but so I would say right around $1,700 is for our forecast.

Unidentified Analyst

Okay. But in terms of the gold cost that you incur, is there a lag time in it? Like he gold that would go into parts as, say, a delay like it was bought like a quarter ago?

Joanne Solomon

Yeah. There’s some lag. I would suggest it’s probably no more than two or three weeks. We tend to operate very heavily with some vendor-managed inventory with respect to gold. So there’s not that much of a lag but it is about two to three weeks of a lag.

Unidentified Analyst

Right. Then one more question I have is related to this year compared to other. It seems like the fourth quarter guidance for this year, overall in general is lower compared to the previous years. Typically fourth quarter is the stronger so just want to hear your thoughts on what is the...

Ken Joyce

I think that’s a reflection of the overall macro economy and the softening of demand that you’re seeing.

Unidentified Analyst

Okay. And is that across all sectors, barring communication? Is that a fair way to think about it? Or even communications you would...

Ken Joyce

No communications remains very strong and very solid so that part but I think other than communications the overall macro economy seems to have some uncertainty and it’s causing some weakness, some softness in demand.

Joanne Solomon

The only other thing I would highlight is with respect to the seasonality of our gaming. We have a very strong and dominant position in gaming. Gaming tends to peak Q3 and we tend to see October begin okay gaming and then November, depending on how big of a gaming season it is, you may see some gaming sales in November. This year our gaming season ended a little bit earlier than we expected so that’s also driving part of the, I would say, more than seasonal adjustment to our fourth quarter. So Q3 had a good benefit of gaming but then it’s going away largely for Q4. So that has some impact in addition to what Ken has mentioned about just the general macro environment impacting some of our more wire bond packages and the bright spot being smartphones and tablets, which we expect to continue for Q4.

Operator

Thank you. And our next question is from the line of Wenge Yang with Citigroup. Please go ahead.

Wenge Yang – Citigroup

Hi. Thank you for taking my questions. First question is regarding your customers’ behavior. What’s their inventory level right now? And is there any destocking activities still going on at this point?

Ken Joyce

Wenge, I think that the customers are adjusting inventories. We saw some of that clearly in the automotive sector and once again I think it’s a reflection of the softening in the macro economy.

Wenge Yang – Citigroup

Okay. So TSMC actually mentioned last night that they saw customers’ inventory actually below the seasonal levels, could be seven to eight days below seasonal average in the past years. So is that a similar thing you saw in your customer base?

Ken Joyce

Once again, I can only speak to our customer base and, as we said, communications for us and smartphones and the tablets, I think the inventories are being well managed and it’s been solid for us. If you look in the areas of the end markets of networking, I think inventories are being very closely managed there. Automotive, industrial, it looks like there is some correction going on. So it depends on the end markets, I think, that you’re looking at.

Wenge Yang – Citigroup

Okay. Question on CapEx. In the last earnings call you guided CapEx to be, I think, around 425 level and this time the Q4 cash has actually moving up so make the whole year closer to 450. Considering the utilization rate is relatively low, could you justify why you actually continuous span in terms of CapEx?

Ken Joyce

Absolutely. I believe we’re spending in the right areas and a lot of our spend has gone into the flip chip in support of communications and tablets that’s been a heavy part of our investment this year for communications. But we’ve also been spending incrementally on cost reduction activities that hopefully we’ll see the benefits of in improved utilization in the future. And one of the areas very important to us is that we continue to invest into some of the R&D initiatives for next generation packaging, and that’s in wafer level fan out and TSV initiatives that we have that we think are very, very important. The easy thing to do would be pull back in this slower environment but it’s our future so we have to invest in those R&D areas.

Joanne Solomon

The only other piece I would add is that Ken mentioned in his script about the ramping for NAND memory in China. That is taking some facilities clean room space that we need to expand and that is driving some of the spend as well in the fourth quarter.

Wenge Yang – Citigroup

Okay. Because technology is going to continue to evolve so is it safe to say that you’re going to continue to spend at this level just to sustain your technology leadership?

Joanne Solomon

You know I would say with respect to investments in R&D I think they’ve been particularly heavy with respect to Through Silicon Via as well as wafer level fan out. I believe that will start to moderate and you know, with respect to capacity it was a big transition year to the flip chip so ramping both for flip chip CSP as well as our fine pitch copper pillar. So I think some of the capacity investments that we’re making, maybe we can start to moderate and some of the R&D investments will start to moderate. But we’re very much focused on matching up the CapEx dollars with the revenue opportunities. We invested very heavily in support of our communications customers, two in particular that grew with us this year. You know, 20% to 25% so as Ken mentioned we’re investing for the guys that are bringing the demand in. And then we’re also setting up for the future.

Wenge Yang – Citigroup

That’s helpful. Just couple of questions regarding some specific events. First one is the Thailand flooding. I understand you don’t have factories in Thailand. Do you see any impact on your business or any actually opportunities if customers shifting from Thailand to other regions?

Ken Joyce

Well, first and foremost, our condolences and sympathy go out to the people of Thailand and this is certainly an ongoing tragedy. As you mentioned, we don’t have facilities in Thailand and it’s really hard to tell what the impact of this is going to be on the border electronics industry. That being said, we have a number of customers with operations in Thailand. We’ve been working very closely with them. There could be some upside opportunities to help them out, particularly some of the IDM customers, to help them get through and prevent any kind of disruptions in their business. Yeah, we do see some opportunities as a result of this but once again, it really is a tragic circumstance and we’ll do whatever we can do to help those people of Thailand as well as our customers.

Wenge Yang – Citigroup

Would it be safe to say that it’s still too early to say that those potential opportunities are not factored into your guidance for Q4?

Ken Joyce

They are not factored into our guidance right now.

Wenge Yang – Citigroup

Okay. One last question regarding your acquisition of Toshiba factory in Malaysia. Could you give us some justification on why do you acquire their factory? And also what P&L impact will that be after you took over the operation?

Ken Joyce

Sure. Look, Toshiba is an industry-leading player in many areas, power discretes in particular. It’s a great way for Amkor to gain scale in this business. Toshiba has some excellent IP in this area and it plays along the lines of an extension, if you will, product line extension of some of our leadframe business. So we’re really, really very excited about it. In terms of what the impact, we can’t comment at this point in time because we’re currently in due diligence on the project.

Joanne Solomon

And just as a reminder, it’s a non-binding MOU at this stage and to the extent we have any changes, we’ll update accordingly.

Wenge Yang – Citigroup

Is it okay to comment on what revenues they generated last year from that factory’s operation?

Joanne Solomon

We’re bound by confidentiality provisions at this point with Toshiba so when we get to the point where we can make further announcements, we’re very excited about this opportunity and we’ll give that detail for you.

Wenge Yang – Citigroup

Any timelines on when the deal will be closed?

Joanne Solomon

Our expectation is that it will be sometime during the first quarter is that we would close the deal.

Operator

Thank you. (Operator Instructions) Our next question is from the line of Eric Reubel with MTR Securities. Please go ahead.

Eric Reubel – MTR Securities

Hey, good afternoon. Ken in your prepared remarks you talked about excess capacity in fine pitch wire bond and you also mentioned I thought that you were starting the NAND flash business to sort of fill in on capacity. Joan you mentioned that you’re spending also to support the NAND flash. So help me understand how you’re approaching the business, how large it could be. Historically I think you’ve stayed away from kind of the real commodity memory programs?

Ken Joyce

Well, Eric, you are right. We haven’t participated in a big way in DRAM. With respect to NAND we’ve been doing NAND for different customers: Samsung and Micron and others. So we’ve been doing NAND. We currently have some really large opportunities with some customers in Japan, some IDMs. We’ve been ramping for them very vigorously in China operations and that’s what Joan was talking to earlier when we talked about some of the investments in facility. It’s also given us the opportunity to redeploy some of our existing wire bond assets from some of our other locations into China to use some of those. So it’s a great opportunity in a lot of ways: first one, redeploying some underutilized assets in other locations; and two is to build, I think, a significant opportunity with I think a good return potential for us in our China operations.

Joanne Solomon

Just my comment with effect to the facilities. As a reminder, we have a very large building in China, in Shanghai, in the Waigaoqiao Free Trade Zone. The building itself is a shell and as we need clean-room space we keep expanding the clean room. So because of the redeployment of some of these assets that Ken talked about into China, we did have to expand some of the clean-room space within the building. So we’re not building a building as much as if we are expanding out the internal clean-room space.

Eric Reubel – MTR Securities

If you’re consolidating equipment from the Philippines where you’re reducing the workforce eventually. How much capacity could this be and if the program is successful is there something that we could expect to see as margin positive and how many quarters would that take?

Joanne Solomon

So with respect to the NAND opportunity, as a general reminder we have a large wire bond presence in both Korea as well as the Philippines. The Philippines tends to have more of the leadframe assets, a lot more of the advanced wire bonding is in Korea. So a lot of the assets that we’re redeploying or actually coming from Korea. The opportunity could be very significant. We’ve redeployed some of the existing wire assets that Ken mentioned already from communication. Samsung has been a big consumer of our NAND memory so far in Korea and we’re starting to ramp with Toshiba as well largely in China but we also do some in Japan for them. So the full impact on growth margins it will be over last when we helped create some contribution margin for us but I don’t have any specific numbers to share with you at this time.

Eric Reubel – MTR Securities

Okay. Ken, in the past you’ve talked about sort of customer shipments to customer forecast sort of delivery of guide to forecast. And I was wondering if you could comment in the current environment if you’re seeing any slippage with respect to sort of shipments to forecast?

Ken Joyce

Eric, the die support in support of customers forecast in communications has been solid, has been strong right up to today. We are seeing some softness in the wire bond areas and that once again we think is partially a reflection as transition from wire bond into flip chips and part of it is the overall macroeconomic environment.

Operator

Thank you. And there are no further questions at this time. I would now like to turn the call back over to management for closing remarks.

Ken Joyce

We thank, everyone, for participating in the call with us here today. So good afternoon.

Operator

Ladies and gentlemen, this concludes the third quarter 2011 Amkor Technology earnings conference call. If you’d like to listen to a replay of today’s conference please dial 1-800-406-7325 or 303-590-3030 with the access code of 4478852. AT&T would like to thank you for your participation. You may now disconnect.

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