Kulicke and Soffa (NASDAQ:KLIC) Q2 Sales Beat Estimates But Quarterly Guidance Underwhelms

Semiconductor production equipment company Kulicke & Soffa (NASDAQ: KLIC) reported Q2 FY2023 results topping analyst expectations, with revenue down 55% year on year to $173 million. However, guidance for the next quarter was less impressive, coming in at $190 million at the midpoint, being 8.94% below analyst estimates. Kulicke and Soffa made a GAAP profit of $15 million, down on its profit of $116 million, in the same quarter last year.

Headquartered in Singapore, Kulicke & Soffa (NASDAQ: KLIC) is a provider of production equipment and tools used to assemble semiconductor devices

Kulicke & Soffa was founded in 1951 by Frederick Kulicke Jr. and Albert Soffa, and the company was incorporated in 1956. With a 1971 NASDAQ listing, Kulicke & Soffa became one of the first technology companies on the exchange.

The company’s key products are equipment and tools used in the interconnect processes of semiconductor manufacturing. The interconnect process is the wiring system that connects transistors and other components on a chip. This step in manufacturing is important because these connections can be a limiting factor to chip performance, as electrical resistance of wires increases as they are made smaller and thinner to accommodate more transistors.

KLIC’s products therefore aim to improve performance and increase power efficiency amid smaller form factors. One example is the company’s ball bonder, which enables precise electrical interconnections between a bare silicon die and the lead frame of the package it is placed in during semiconductor fabrication. Another example is the company’s wedge bonder, which uses ultrasonic power and force to form resilient bonds.

Competitors offering semiconductor equipment and packaging materials products include ASM Pacific Technology (SEHK:522), BE Semiconductor Industries (ENXTAM:BESI), and Hanwha Precision Machinery.

Sales Growth

Kulicke and Soffa's revenue growth over the last three years has been impressive, averaging 43.9% annually. But as you can see below, last year quarterly revenue declined from $384.3 million to $173 million. Semiconductors are a cyclical industry and long-term investors should be prepared for periods of high growth, followed by periods of revenue contractions (which can sometimes offer opportune times to buy).

Despite Kulicke and Soffa revenues beating analyst estimates, this was still a slow quarter with a 55% revenue decline.

Kulicke and Soffa's looks headed into the trough of the semi cycle, as it is guiding to revenue declines of 48.9% YoY next quarter, and analysts are estimating 0.16% declines over the next twelve months.

Product Demand & Outstanding Inventory

Days Inventory Outstanding (DIO) are an important metric for chipmakers, as it reflects the capital intensity of the business and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise the company may have to downsize production.

This quarter, Kulicke and Soffa’s inventory days came in at 229, 115 days above the five year average, suggesting that that inventory has grown to higher levels than what we used to see in the past.

Pricing Power

Kulicke and Soffa's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 48.6% in Q2, down 3.9 percentage points year on year.

Kulicke and Soffa' gross margins have been trending up over the past year, averaging 49.1%. This is a welcome development, as Kulicke and Soffa's margins are slightly below the group average, potentially pointing to improved demand and pricing.

Profitability

Kulicke and Soffa reported an operating margin of 11.8% in Q2, down 23.4 percentage points year on year. Operating margins are one of the best measures of profitability, telling us how much the company gets to keep after paying the costs of manufacturing the product, selling and marketing it and most importantly, keeping products relevant through research and development spending.

Operating margins have been trending down over the last year, averaging 20.9%. Not a great indicator for Kulicke and Soffa, whose operating margins are already a bit below average for semiconductors, driven by only modest pricing power and cost controls.

Earnings, Cash & Competitive Moat

Analysts covering the company are expecting earnings per share to be fairly flat over the next twelve months, although estimates are likely to change post earnings.

Earnings are important, but we believe cash is king as you cannot pay bills with accounting profits. Kulicke and Soffa's free cash flow came in at $62.7 million in Q2, down 10.7% year on year.

Kulicke and Soffa has generated $337.8 million in free cash flow over the last twelve months, translating to 33.5% of revenues. This is a great result; Kulicke and Soffa's free cash flow conversion was very high compared to most semiconductor companies, in the last year. This high cash conversion, if maintained, puts it in a great position to invest in new products, while also remaining resilient during industry down cycles.

Kulicke and Soffa’s average return on invested capital (ROIC) over the last 5 years of 61.9% implies it has a strong competitive position and is able to invest in profitable growth over the long term.

Key Takeaways from Kulicke and Soffa's Q2 Results

With a market capitalization of $2.71 billion Kulicke and Soffa is among smaller companies, but its more than $734.1 million in cash and positive free cash flow over the last twelve months give us confidence that Kulicke and Soffa has the resources it needs to pursue a high growth business strategy.

We were impressed by how strongly Kulicke and Soffa outperformed analysts’ earnings expectations this quarter. And we were also happy to see it topped analysts’ revenue expectations, even if just narrowly. On the other hand, it was less good to see that the revenue growth was quite weak and both revenue and EPS guidance for the next quarter missed analysts' expectations. Overall, this quarter's results could have been better. The company is up 1.87% on the results and currently trades at $48 per share.

Is Now The Time?

Kulicke and Soffa may have had a bad quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. We think Kulicke and Soffa is a good business. We would expect growth rates to moderate from here, but its revenue growth has been exceptional, over the last three years. And while its operating margins are below average vs. semiconductor peers, the good news is its powerful free cash generation enables it to sustainably invest in growth initiatives while maintaining an ample cash cushion, and its high return on invested capital suggests it is well run and in a strong position for profit growth.

Kulicke and Soffa's price to earnings ratio based on the next twelve months is 20.8x. There is definitely a lot of things to like about Kulicke and Soffa and looking at the semiconductors landscape right now, it seems that the company trades at a pretty interesting price point.

The Wall St analysts covering the company had a one year price target of $63.8 per share right before these results, implying that they saw upside in buying Kulicke and Soffa even in the short term.

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