Audio webcast to discuss the company's 2015 second quarter results. The audio webcast is available on Besi's website, www.besi.com. Joining us today are Mr. Richard Blickman, Chief Executive Officer, and Mr. Cor Haneke, Senior Vice President, Finance. At this time, all participants are in the listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. As a reminder, ladies and gentlemen, this conference is being recorded and cannot be reproduced in whole or in part without written permission from the company. I would now like to turn over the call to Mr. Richard Blickman. Go ahead.
Thank you very much. Thank you all for joining us today. I will begin by making a few comments in connection with the press release we issued earlier today. Then we'll take questions. I would like to remind everyone that some of the comments made during this call and some of the answers in response to your questions by management may contain forward-looking statements. Such statements may involve uncertainties and risks as described in the earnings release and other reports filed with the AFM. For today's call, we'd like to review the key highlights of our second quarter and first half year ended June 30, 2015. Also spend some time updating you on the market, our strategy, and outlook. First, some overall thoughts on the past quarter.
Besi recorded solid Q2 '15 results with sequential quarterly revenue and earnings growth of 9.9% and 9.2% respectively, ex restructuring benefits realized in the first quarter from our Swiss headcount reduction program. Quarterly sequential profit growth was limited by higher operating expenses, some of which were variable with higher sales levels and some of which were related to higher TCB development costs as we develop enhancements for additional end-user applications. We believe that our operating expense levels peaked in the second quarter and will reduce gradually over the coming quarters as our Swiss headcount reduction program is completed and other operating initiatives are realized. Besi had strong cash flow generation in the second quarter as net cash increased by EUR 28.9 million or 46.2% year-over-year, even after payment of EUR 56.9 million of cash dividends due to strong profit generation and improved working capital management.
We saw a general softening of customer order trends in the latter half of the second quarter as compared to last year's large capacity build, which masked growth in a number of our end-market applications. For the first half year 2015, Besi generated revenue growth in a variety of promising areas, such as high-end memory and cloud service and automotive, China handsets, and solar plating. Such growth could not compensate for reduced orders for high-end smartphones from the major supply chain networks as compared to exceptionally high levels last year. Despite such headwinds, the first half year 2015 revenue grew by 7% over the first half last year. Our net income, excluding restructuring benefits, was roughly equal to last year's strong first half levels. With that, I'll turn the presentation over to Cor, our Senior Vice President, Finance. Cor.
Okay. Thank you, Richard. Besi's 9.9% revenue growth versus Q1 2015 was due primarily to increased die test and packaging system sales for automotive, high-end server, and Chinese handset applications, as well as increased plating system shipments for solar applications. Sequential revenue growth was at the low end of guidance, primarily due to pushouts of deliveries for certain die test and molding systems in advanced packaging applications. The 10.2% revenue decline versus the second quarter of last year was due to decreased sales of die test systems for high-end smartphone applications. Orders decreased by 11.8% sequentially versus the first quarter 2015, due primarily to lower bookings for memory and smartphone applications and by customer pushouts into the second half of 2015 as a result of less favorable industry conditions in the latter half of the quarter.
Per customer, IDM orders decreased by EUR 8.8 million or 15.1%, while subcontractor orders decreased sequentially by EUR 3.5 million or 7.6%. Orders declined by 26% versus exceptionally strong Q2 2014 levels, which reflected a large first half year 2014 high-end smartphone capacity build. Besi's 7% revenue increase in the first half year of 2015 was due to growth in TCB die test shipments for memory applications, die sorting systems for high-end server applications, thermal forming epoxy die attach systems for automotive applications, and plating systems primarily for solar applications. The 16.7% order decrease versus the first half year of 2014 reflected similar trends.
For the next analysis of gross margins, OpEx, and net income trends, I plan to refer primarily to adjusted figures for all sequential comparisons as we booked a EUR 3.3 million net restructuring benefit in the first quarter of 2015, which makes our trends more difficult to compare without such adjustment. You see that Besi's 47.9% gross margin in the second quarter of 2015 decreased by 0.3% points versus Q1 2015 as adjusted and increased by 4.7 points versus the second quarter of last year. There was no material foreign exchange variance in comparing Q2 and Q1 2015 figures. As compared to the second quarter of 2014, gross margin improvement resulted primarily from net foreign exchange benefits from the decrease in the value of the euro versus the US dollar and increased materials and labor cost efficiencies.
Similarly, adjusted gross margins increased by 5.2% points between the comparable first half periods. Besi's Q2 2015 adjusted operating expenses increased by EUR 3.7 million and EUR 7.4 million compared to the first quarter of this year and the second quarter of last year, respectively. Sequential growth was due to a variety of factors, including EUR 0.9 million of higher TCB R&D-related development costs, EUR 1 million of higher warranty costs, mainly ForEx and TCB, EUR 900,000 of higher personnel expenses, and travel, mainly restructuring for Switzerland. They were higher than prior guidance due to a large number of small items which developed during the period, including lower R&D subsidies, higher warranty, and TCB material costs. Expense growth versus the second quarter of 2014 was due primarily to EUR 4.4 million of increased development costs, primarily related to TCB activities.
EUR 1.5 million of incremental expenses from the increase of the Swiss franc versus the euro and EUR 0.6 million related to increased incentive compensation expense. Such factors were principally responsible for the EUR 14.2 million increase in adjusted OpEx between the first half of 2014 and the first half of 2015. Given the influence of OpEx in our recent results, we thought it helpful to illustrate the development in our baseline operating expenses over the past six quarters, separate from other factors influencing their development on a quarterly sequential basis. The chart indicates that baseline operating expenses have ranged between roughly EUR 21 million and EUR 23 million over the past five quarters, with a jump to EUR 26.1 million in the second quarter of 2015. The largest factor in our Q2 '15 expense growth is from R&D, most of which is from higher TCB development costs, both on a cash and non-cash basis.
Cash costs relate to higher personnel and material costs to support existing customers and develop enhancements for new applications. You will also notice in other OpEx the influence of R&D capitalization and amortization according to IFRS. As such, we have amortized more capitalized development costs and capitalized less spending than last year, given volume shipments of TCB and new epoxy die bonding systems in 2015. The variance in this item between Q2 '14 and Q2 of this year was EUR 2 million. We expect net R&D amortization trends to continue for the balance of 2015 as TCB and epoxy die bonding sales growth continues. The other important influence in other operating expenses is the increase in the Swiss franc versus the euro, which has increased expenses by EUR 3.4 million in the first half year of 2015 as compared to the first half year of 2014.
We expect this influence to reduce significantly in Q1 2016 as we complete our Swiss headcount reduction program. You can see on this next chart that Besi's adjusted net income has been increasing on a sequential basis since Q4 2014 and grew by 9.2% in Q2 versus Q1 '15. The trajectory of our net income development is different in 2015 than 2014, given the significant spike we experienced last year from the first half high-end smartphone capacity build. The first half of 2015 net income was adversely affected by a slight rise in effective tax rate versus the first half of 2014 due to the absence of deferred tax benefit recorded in Q2 '14. Absent this benefit, the 2015 rate is just slightly higher than last year. Our liquidity has developed nicely this quarter and this year with a strong cash flow generation from operations.
As such, net cash increased by EUR 28.9 million at June 30, 2015, versus June 30, 2014, even after large Q2 dividend payments. Total net cash ended up at EUR 91.4 million at the end of Q2. Strong cash flow was principally due to our continued high level of profit generation and improved working capital management, including a reduction of DSO and inventories this quarter. We have a substantial cash base to finance our development programs and strategic initiatives and return to shareholders. With that, I'll turn the presentation back to Richard.
Now I'd like to spend a couple of moments updating you on the market and our strategic priorities. In general, the near-term market tone has softened since last quarter. Via SI now forecasts relatively flat assembly equipment market growth in 2015 and 2016, however, followed by a large upturn in 2017 and 2018 of approximately 24%. As in recent years, we anticipate quarterly and annual order fluctuations based on customer purchasing patterns and seasonal influences from retail-oriented applications such as smartphones, tablets, and automotive. We anticipate that assembly equipment spending over the next three to five years will be primarily focused on advanced packaging applications such as smartphones, the Internet of Things, wearable devices, high-end memory and cloud servers, and streaming video. Customer roadmaps are particularly focused on shrinking device geometries below 25 nanometers, as is evident in this next chart, courtesy of SEMI.
This trend plays to the sweet spot of Besi's product strategy and technological strength. As you know, we participate in a highly volatile industry with significant quarterly ebbs and flows. We think we're in a transitional period now after substantial growth in 2014. We have a variety of drivers which should power future revenue growth above current levels. Some are process-oriented, such as device shrinks, increased functionality, and new product introductions, which will increase the need for new equipment and the conversion from wirebond to flip chip die attach usage. Others are more Besi specific, such as increased market share and penetration of Asian electronics and smartphone supply chain networks, and the expansion of TCB sales and customer applications. Combined, they point to significant Besi revenue opportunities over the next couple of years.
As you've heard in this presentation today, we're investing significantly in our future, particularly in TCB, but also in next-generation packaging and die attach systems and redesign efforts to make our platforms more cost-efficient and scalable. In addition, we are highly engaged in operating initiatives designed to move operations closer to customers to further drive down cycle times and capture incremental revenue opportunities, such as transferring plating production to Malaysia and transferring certain die bonding production from Malaysia to China. We are also keenly focused on further reducing European-based costs and currency exposure via such initiatives as our supply chain transfer to Asia, our reduction of Swiss-based overhead costs, and additional European facility and personal cost decreases. Some of these initiatives are just underway and will be bearing fruit in 2016. A couple of words about our guidance for the next quarter.
Looking forward, we see Q3 this year, sequential revenue decreasing by 15%-20%, consistent with historical seasonal trends and reflecting less favorable industry conditions, which began at the end of the second quarter. Based on customer feedback, potential Q3 order trends are difficult to estimate currently and could be either up or down sequentially versus the second quarter. We anticipate that gross margins will range between 45% and 47% as revenue declines, and we operate in a more stable currency environment. We think that OpEx peaked in the second quarter and will start declining gradually in the coming quarters as we complete our Swiss headcount reduction program by year-end and other operating initiatives are realized. A 10% reduction is anticipated in the third quarter.
Based on our outlook, we anticipate generating strong levels of profit and cash flow in the second half of this year in an environment less favorable than 2014. Longer term, we are certainly excited about Besi's growth prospects and market share potential. A new technology cycle has started, wherein customers increasingly demand under 25 nanometer device geometries with increased chip complexity, functionality, and density for which new assembly equipment and solutions will be required. This trend plays to our strength as a technology leader in advanced packaging systems. We are also working to maintain high levels of through-cycle profitability and cash flow generation via operating initiatives to further reduce European structural and supply chain costs, move our operations closer to customers, and improve cycle times and inventory management. We anticipate generating significant excess cash flow again this year, which is available to enhance shareholder value. That ends my prepared remarks.
I would like to open the call for some questions. Operator?
Ladies and gentlemen, we will now start a question and answer session. To be registered for the question and answer session, please press star one. Your questions will be answered in the order that they are received. If you have a question, please press star one. The first question is from Mr. Pieter Olffsen, Kepler Cheuvreux. Please go ahead.
Good afternoon, gentlemen. A couple of questions, maybe starting with automotive, which has been quite strong in the first half. Do you expect that to continue going into the second half? Reason for asking is that recent end market data has been somewhat mixed. China seems to be slowing a bit, but car sales in Europe in June were actually pretty strong. Could you shed some light on what you see in automotive? My second question relates to the balance sheet and cash flow. You anticipate strong cash flow generation in the second half. You have a strong balance sheet with significant amount of cash. In the past, you have bought back shares. Would you consider buying back shares at current share price levels?
Okay. Well, first question first. Automotive is certainly in direct link to the economies in the world, we've seen a very strong pickup last year. Continued strong automotive power device, especially environment, in the first half of this year. Also a solid outlook for the second half of this year. Automotive looks pretty good. On the balance sheet, we have in the past bought back shares at times when the industry was in a significant downturn, we still were generating significant cash. What we would do at this point in time, we are still in very good industry environment. There's no reason for us to start to buy back shares to be competing with investors in our stock. At this moment, there are no plans to buy back shares.
Okay. Could I maybe ask a follow-up question on TCB and the opportunities in that particular area? I think you mentioned memory cubes during the meeting in June. In terms of other potential opportunities that you may or are already addressing, are FPGAs an application that you are addressing with TCB?
Well, the interesting thing with TCB is that it is, of course, heavily competing with further shrink capabilities of flip chip, flip chip is moving down the accuracy path from five micron to four micron, we now have even delivered production equipment for three micron. That should certainly hold off TCB developing more into logic applications. Single dies, simply because the cost of flip chip is significantly lower than the cost of TCB. For stacked applications like memory, it's a different story because it is a direct interconnect that is not possible with flip chip, that is made possible through TCB. That's the current landscape.
In terms of applications where you already see a decent amount of volumes. That includes the memory cubes, are there other applications or products?
No. It's fair to say that it is still early days and some very high-end applications, but simply because of cost and in low volumes, it is not yet ramping in any volumes.
Okay, that's clear. Thank you.
The next question is with Mr. Philip Scholte, Kempen & Co. Please go ahead.
Yes, good afternoon, everybody. Following up on those TCB questions, because in the press release, you are actually saying, "We are developing additional end-user applications." But from your remarks just now, I don't have the feeling that you are targeting real other applications beyond memory stacking. Is that the right way to look at it?
No, no. Of course, there are more applications, to develop reliable processes with high yields in production environments, that always takes a long time. Yes, the industry is preparing for ever tighter geometries where TCB could be the only interconnect solution. However, clearly customers are developing those solutions also using flip chip. You have to work on both fronts. Successfully, we moved the flip chip specs down to 3 micron. We successfully installed over 25 TCB machines for memory cube application. We also installed several TCB systems for single die applications. That development continues, which is an even greater effort on more applications.
At a certain point in time, that will become volume in a similar trend as we saw the introduction of flip chip in the late 1990s, being the successor of wire bond in certain applications where the dimensions forced the industry to move away from wire bond to flip chip.
Right. Thank you for that. A second question on market shares. Have you seen any changes in that in the last one or two quarters, or do you still believe you are gaining share?
Well, I think if you look at the revenue development year-over-year, also quarter-over-quarter, there's no reason to expect that we will not have gained market share. Also, if you look at our gross margins, our gross margins are now consistently at 48% in the last quarters. That is a clear indication of a very strong market position.
Sure. My third question is on the cost savings related to the Swiss restructuring. Are there already some savings in maybe the Q2 number or in your guidance for the Q3 number, or is the majority of that, I think it was EUR six and a half million, is the majority of that still to come?
Some is in Q3, a larger part in Q4, and a final part in Q1.
Right. Can you maybe quantify the amount already in the Q3 guidance?
In the Q3 guidance of the 10% reduction, about half of that is savings resulting from the Swiss move.
Right. Great. Thank you very much.
Okay.
The next question is from Mr. Hans Slob, Rabobank. Go ahead.
Yes, good afternoon. First, you're guiding for somewhat lower gross margins in the third quarter, while the US dollar is still quite, I think, favorable for the margin development. Is that due to the, let's say, the seasonal downturn, or is there a bit of a mix change that drives the lower margins for Q3? That is my first question. Second question is on the working capital. How much room is there to improve further on DSO and inventories? Third is for Cor on the tax rate. What are you guiding for the full year tax rate as H1 was up a little bit? Thanks.
Okay. Gross margins, with lower revenue, there's always an impact of adjustment to the lower revenue in operations. That typically leads to some under applied in your gross margins. Still the guidance is above 45%, which is, in this environment, very strong gross margin. The reason for the lower gross margins is because of lower revenue. On the DSO and also inventory, DSO has come down, could come down some more. However, also in times when the industry is hesitant, customers are also hesitant with payments. Usually in downturns, there's not a significant improvement. If you look at inventory has come down already. That also shows that managing our supply chain, we do that very direct. On a weekly basis, we adjust our forecasts going forward, and that should imply that going forward at somewhat lower revenue, also, our inventory should show that.
No big changes are to be expected there.
On the tax rate curve. Tax rate for the third quarter is expected to be in line with the second quarter, so around 12%. Depends a bit, of course, always on in which jurisdiction we do what. For the third quarter, we don't expect a significant change. The operational tax rate for the whole year is expected to be more or less in line with that. There's one topic we, let's say, value every year at the end of the year, so we don't know yet how that will go. Last year in Q4, we had a significant revaluation of tax loss carryforward. If you look in our annual report, you can see that in some jurisdictions, there is still some of it not valued.
However, the assessment of that we do at year-end, and we don't guide or don't exactly know yet what the effect would be, if any. An operational income tax rate will be around the 12% we've seen in Q2.
Okay, very clear. Thank you.
Ladies and gentlemen, if there are additional questions, please press star one. The first question is from Mr. Edwin de Jong and SNS. Please go ahead.
Hello, gentlemen. A couple of questions from my side regarding the dividend and the cash position. Is the EUR 80 million still a sort of threshold that you have for cash that you want to have in the corporation? Secondly, in the press release, you stated cash generation in H2 was strong. Should we then think or will be strong? Should we think of comparable to the H2 2014 of maybe H1 this year? In TCB, you're investing somewhat more. Could you maybe explain a little bit more about what the direction is that you are looking for in the TCB market? I think those are my main questions.
Excellent. Well, the EUR 80 million, you could say, baseline is still intact. The second question, how strong the cash generation will be in the second half, also depends on how the first half next year will look like. In general, or let's say the trend we indicated, it should be at least the cash generation of the first half of this year. On TCB, the direction is twofold. One is more applications, but the second is we have developed a twin system, and the first systems are running with a single bond head, but they will be upgraded to a dual bond head, and that will nearly double the capacity of these systems, which will reduce the cost for the customers significantly in order to make TCB more attractive in terms of cost.
The development efforts for both areas is causing the increase in the development cost for TCB.
If you look at the bonding pitches, say you are at around three now for flip chip. What are we now at for TCB?
Two.
Two. I guess like with flip chip, there's also room for improvement there to go below one.
No, no. If you reach consistently three.
Yeah
That definitely will answer a very large part of that market for the next cycle.
That will not be reached with the usual flip chip machines.
With the five, you will face some difficulties. With the three, you will be able to accomplish that would be for us an excellent coverage of the total next generation requirements. For stack dies and in memory, the specifications as mentioned using TCB, a tighter tolerance flip chip for many of the logic devices, single devices.
The bonding forces, that's still a factor?
Well, with the current process used, it is not an issue, in the future it could very well be, that is the next generation that we would need higher bond forces. Of course, every customer is interested to have a simple as possible process, that means the lower bond force, the more reliable a process.
Yeah, makes sense.
Those are technical issues, but they are quite easy to understand.
The 15 TCB systems that you mentioned that you had in order book at Q2, have they been delivered now, or are they recognized in the revenues for Q3?
The eight are shipped and others are still to come.
Shipped is also built, right?
Yes, that's right.
Yeah. In production.
Maybe a last one. I think I read somewhere in the media that in the high-end mobile phones, there's some sort of a two-year cadence, that 2016 with 2014 as the first half being very strong, that could be a force in 2016, a positive force for you in 2016. Is that the right assumption, or?
Well, if you look historically, then there's a typical two-year pattern. That is, if you have that same pattern, that would mean based on that, an upturn in 2016. However, today, Viavi expects equipment spending to be flat this year, next year, with a major upturn in 2017. We've seen many of these models pass by.
Absolutely.
We are ready for every model.
All right. Thank you very much.
Thanks, Edwin.
The next question is from Mr. Philip Scholte of Kempen & Co. Please go ahead.
Yes. Sorry to come back on the OpEx levels, but if you say that about half of the OpEx reduction in Q3 relates to the Swiss restructuring. Let's assume the decline is about EUR 3 million, so half is EUR a million and a half. On an annualized basis, that would be already EUR 6 million, which is the total saving you are targeting for Switzerland. That seems to imply that there will be no sequential additional savings after Q3, or am I wrong there?
Looking at the reduction we mentioned, we say, if all plans are redone, we are on an annual basis at a level of EUR 6.5 million. It will be Q3, Q4, part of Q1. Probably Q3, it is not EUR one and a half million, it is somewhat less. If everything is behind us and we are in the next Q3, then it will be, in total, on an annual basis, EUR six and a half. That will be somewhat more than EUR 1.5 million. In Q3, EUR 1.5 million, it is actually somewhat lower. That is correct.
Yeah, it is not a straight line.
No.
The biggest portion will be in Q4. Then a last smaller portion in Q1. That has also to do with ending of a lease. The cost is not simply a straight line.
It means also that the 10% decrease we are guiding for, that's not it. There's more to come in Q4 and also in Q1.
Yeah. Okay, because you're also guiding indeed for the total OpEx to go down sequentially beyond Q3.
Yeah.
That's right. Based on the current plans we have and we have announced, you may expect that OpEx will further reduce in Q4 and Q1.
Right. Okay. Thank you.
The next question is from Mr. Pieter Olffsen, Kempen. Please go ahead.
Yes. Thanks for the follow-up. Coming back on the flip-chip TCB discussion. You mentioned three micron, which you are currently able to do in flip-chip. Is the competition also capable of doing this, or are you ahead of competition here?
We are ahead of competition.
Okay. On TCB, I think in June, at the end of the session, you mentioned that your throughput is about double of the competition. What's the comparison there? Do you compare your dual bondhead with competitor's single bondhead, or how do you get to this claim?
Well, definitely with two bondheads, but also our heating up ramp capability and cooling down through our patented bondhead is much faster than what the competitors use. It depends on the application, by how much that is. On a single basis, we are faster, and in some instances that could be two times. In essence, our concept has more than two times the output advantage. Again, we would have to go in more detail. There's also a nice matrix where you see where the specific speed advantage is between a single and a multiple and a stacked. There's a variety.
Okay. Maybe final question on your outlook. In the press release, and I think also in your introduction, you mentioned that there have been some push outs in the second quarter. If I look at the guidance for Q3, the implicit sales guidance is above your backlog at the start of the quarter. Can I assume that the orders that were pushed out in Q2 will be booked in Q3 and will also contribute to the sales in Q3? Is that a way to read it?
No, they are already in the books.
Yeah
Have been pushed out are in the backlog, and hopefully they will be shipped in Q3, those of which have been pushed out to Q3. There are other not yet orders, projects, which should have been ordered in Q2 but have been pushed out to Q3. A typical pattern, as we said, the slowdown occurred in the last, you could say two weeks of June, because the start of June was very positive, and then all of a sudden we had some delays. Yeah, the question is, as we put it in the press release, but also in these comments, will that be temporary? Will that pick up in August, September, or will that stay more or less flat? That's not unusual. That is a typical pattern at this time in a cycle. One of them is very interesting, is of course the wearables.
The wearables, you can be sure, will do an enormous advertising effort for end-of-year sales. If those numbers pick up, more systems will be required. If it doesn't pick up, not more systems will be required.
Okay. Just to clarify what's in your Q3 guidance, the orders that were pushed out from Q2 into the second half, you need some of them to come in in Q3.
Yes
to meet your sales guidance. Yeah.
Yes.
Okay. Just to understand. Okay, that's clear then.
Some have come in in July.
Okay. That's good. Thank you.
Okay.
Ladies and gentlemen, if there are additional questions, please press star one. There are no further questions. Please continue.
Well, thank you everyone for joining us today on the call, and if you have any further questions, don't hesitate to contact us. Goodbye.
Ladies and gentlemen, this concludes the conference call. You may now disconnect your line. Thank you. The conference is no longer being recorded.