VAT Group AG

SIX:VACN

Earnings Call Transcript 2018-Q3

[Operator]

Ladies and Gentlemen, welcome to the VAT Q3 2018 Tradings Update Conference Call. I'm Sherry, the Chorus Call operator. [Operator Instructions] And the conference is being recorded. The presentation will be followed by Q&A session. [Operator Instructions] The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Mr. Michel Gerber, Head of Investor Relations. You will now be joined into the conference room. Thank you.

[Michel R. Gerber]

Okay. Good morning, everybody. Welcome to VAT's third quarter trading update conference call. My name is Michel Gerber, Head of Investor Relations. And with me today are Mike Allison, Chief Executive Officer; and Andreas Leutenegger, Chief Financial Officer. During today's call, Mike will quickly review our order and sales development during the third quarter of 2018, share reviews on where we see the industry in general and update you on our expectation for the rest of the year. The media release detailing our third quarter development was released at 7 a.m. this morning and can be also found on the Investor Relations section of the VAT website. Today's prepared remarks and the following Q&A include forward-looking statements that are subject to risks and uncertainty reflected in the forward-looking statement paragraph at the end of the media release. As a reminder, the reply (sic) [ replay ] of this call will be available later this afternoon on our website. With that, let me hand the call over to Mike.

[Michael Allison]

So thank you, Michel, and good morning everybody. Thank you for joining us today on the call. Demand for VAT's high-vacuum valves softened, as expected, during the third quarter of 2018, really reflecting a pushout of new semiconductor fab projects. Our end customers, especially in the memory segment, built up quite a bit of capacity, as you know, during the last 2.5 years. And at the moment, we have a slight supply-demand imbalance. Customers are managing their CapEx budgets very tightly to control the situation. And although, this is a little bit painful in the short term with the lower CapEx numbers, I think overall, they're doing a good job managing the future of the business, preventing a wider problem. The situation in Foundry and Logic is a little bit healthier, and there has been a lot of positive announcements from TSMC, et cetera, as they expand the 7-nanometer production. But this isn't able to make up for the shortfall we've seen in memory. As I mentioned in my first half year result, we are managing the parameters available to us, that is market share and our cost basis.Let me look first at market share. We're continuing to track around 25 to 30 share gain and share retention projects. And most of these were either won or are on track to win. So we have a huge focus on continuing to build our market share. Some of these projects are fairly significant and will result in CHF 20 million per year new business in the late 2019, 2020 time frame as it takes some time to get them qualified. But this laser focus on our core products is strengthening our market position and laying foundation for strong future growth.The second is cost, and as you know, we have a pretty experienced management team here at VAT. And we've had a very fast reaction to the difficult business environment compared to the first 6 months of the year.If you remember back to about a year ago, we were putting the infrastructure in place to support another 20% plus year. And then around midyear, we were faced with substantial reduction in that forecast. So as a management team, we very quickly implemented many measures, it's not just 1 measure, but many measures, short-, medium-, long-term measures to manage the situation and reduce our cost base in order to retain the appropriate profitability, while continuing to invest in innovation, business and our people. I'd also take this opportunity to thank the global VA (sic) [ VAT ] team for the very significant efforts in doing this. They reacted very fast, professionally and really together as 1 team. And in doing so, they still managed to continue the strong performance for our customers.Looking a little bit longer term, I think the overall demand for semiconductors remains robust and we still see that in some of the top line numbers from the large IC makers. And this is driven by the well-documented industry trends, such as autonomous vehicles and Internet of Things, and I think, everyone is well aware of them.As a result, the mid- to long-term demand trend for semi investments and therefore our VAT's high-vacuum valves remains positive. And we stay committed to continue to invest in the innovation and adequate production capacity to ensure we accelerate the success of our customers both in the semi and display and other sectors.So looking at the 9-month numbers, sales for the company increased 11% to CHF 550 million compared to the first 9 months a year ago. Orders is a leading indicator, however, turned negative, and we have a decline of about 7% year-on-year. For the third quarter of 2018, orders declined 26% year-on-year to CHF 133 million and about 20% sequentially. This order intake headwind was driven mostly by the weakness in semi and was further accentuated by some overstocking at some of the key OEMs. Group net sales amounted to CHF 163 million, a decrease of 3% year-on-year and some 14% quarter-on-quarter.These trends are broadly in line with management expectations and the result of a moderation demand in semiconductors and the fact that the third quarter of 2017 saw some very high volumes, making the comparison quite difficult. As a consequence of the slowdown in our order entry, VAT order backlog at the end of the third quarter declined to CHF 128 million, down about at -- down about 19% compared with the end of June 2018.Let's take a look at the individual business segments now. And not all areas are affected by the moderation to the same extent, and service and industry continue to show positive trends.Year-on-year, net sales in the third quarter grew in the Global Service segment by 3% to CHF 28 million and industry improved sales by 2% to CHF 10 million. This was, as mentioned, more than offset by the Valves segment, which declined 4% in the third quarter to CHF 125 million.Looking a little bit more detail in the Valves segment, the business unit Display & Solar recorded its second highest level of net sales driven by the demand for Gen 10.5 transfer valves used in LCD display manufacturing and also some favorable order environment in Solar. Segment also recorded specification wins for Gen 8.6 tools from a Chinese display manufacturer, which would drive net sales growth in future quarters. Sales also grew in the business unit General Vacuum, which benefited from both strong demands for valves used in R&D projects, as well as resolution of supply chain bottlenecks that we experienced in 2017 and early 2018. However, the gains in these 2 business units within the Valves segment were really offset by the slowdown in customer investments in semiconductor.On the positive side, however, we have seen a continuation of the high level of specification wins with major OEMs, reflected -- reflecting continued technology innovations that will support the future sales growth in the business unit.In Modules, our fourth business unit within the Valves segment, sales were also negatively impacted by the general slowdown in semiconductor fabrication sector. But again, significant specification wins and successful factory acceptance tests for some new prototypes confirmed the strategic direction of the business.In the Global Service segment, sales grew 3% in the third quarter despite the overall moderation in semiconductor. The decline in orders, on the other hand, reflect the inventory adjustment of our key OEMs as they have inventory of spare parts and consumables. Cooperation with these OEMs and end users for upgrades and retrofits continue to increase, although, this is not yet reflected in the order numbers.In the industry segment, lower net sales in bellows used in semiconductor fabrication was more than offset by increased sales in the mechanical components business.So that's the summary of the individual business units. At this point, I'm very happy to announce our new CFO, Stephan Bergamin, who was just appointed by the VAT Board of Directors. As Stephan succeeds Andreas Leutenegger, who, as previously announced, will be leaving the company at the end of the year. Stephan will start effective 1st of January 2019. Stephan comes from Gearbulk Group, a specialized global cargo shipping company, where he was CFO from 2015 to 2018. Prior management positions include CFO roles at Goldbach, Cofely and the Steiner Group and also Swissair e-commerce startup. He also worked in the Corporate Finance department, M&A and private equity transactions at Crédit Suisse as a Financial Consultant and Project Leader. Stephan is a very experienced individual, and has successfully navigated a number of complex and strategic business environments in a variety of industry sectors and brings a critically important skill set to VAT, including costs management and M&A. Stephan will make a strong business partner for me, as we continue the various growth strategies of VAT. Stephan holds a PhD in Economics from the University of St. Gallen, specialized in Corporate Finance. So let me welcome Stephan to the VAT Group, and we're really looking forward to working with him on our exciting future.Okay. So let me have a look now at the full year 2018 outlook. Looking at the recent news flow coming from the semiconductor industry, it can be expected that the moderation of business activities experienced in the third quarter will not reverse substantially during the rest of 2018. While we still think that the last quarter could have been the trough in the semi industry, it looks like we may be dealing with a slightly longer moderation. However, I think, it is worth pointing out that just as things change fast in the way down, they can change equally fast in the way up. And the cost management strategies we've put in place allow us to react very quickly should the business come back. And we'll be ready to take full advantage of that when that happens.While the overall investment activities in semiconductor remain at a historical high level, the medium- to longer-term investment needs and additional capacities remain undisputed. But we currently see the OEMs continue to adjust their inventory levels further, which is leading to a reduction in new orders. As a result of this, we now expect to reach at least prior year's net sales at constant foreign exchange rates. The midterm EBITDA margin target that we have of 33% is still in place, and I think the cost actions we're putting in place will further solidify that as the business comes back. However, the forecast for 2018 is EBITDA to be maintained at around last year's level.Full year net income and earnings per share are still expect to be substantially exceed 2017 levels. This is mainly driven by the absence of a special finance charge from the recycling of noncash translation reserves recorded in the fourth quarter of 2017. Capital expenditure is foreseen to be around 8% of net sales before returning to about 4% of net sales in the following years, and free cash flow is expected to exceed 2017 amount.So this concludes my prepared remarks, and I'd like to turn now to the operator to open the lines for any Q&A. Thank you.

[Operator]

[Operator Instructions] The first question is from Sandeep Deshpande, JPMorgan.

[Sandeep Sudhir Deshpande, Research Analyst]

My first question is regarding, I mean, the overall environment in the display market. I mean, there have been previous comments that OLED investments into 2019 are going to be weaker. I mean, how do you see the display market behaving going forward from here? And then secondly, regarding the semiconductor market, I mean, what are you hearing at this point from your customers regarding 2019? I mean, from some semiconductor equipment companies, we've already heard that they see slightly better trends in the first half of 2019 versus the second half of this year. Do you see that sort of trend? Or do you not have that visibility at this point? And then finally, a quick question on how you see your market share trending in clearly in a very difficult market environment?

[Michael Allison]

Okay. Thank you for them. Display market, I think, we've been doing pretty well on market share, as I mentioned. We've had a couple of key wins, which is certainly helping us in this period. I think, again, it's very tough to look at 2019 and give an accurate forecast. We're not seeing any real recovery in OLED for sure. But LCD spending still seems to be robust in places. And we have pretty strong market share there. So I think the overall consensus in the market that the capital spending is going to be down. The question is how much? But we're really focused there on market share, and there are several key OEMs in the display area, where we have quite low market share that we're really attacking. So that we can, over the short to medium term, outperform the CapEx levels in the industry. But I think to give an accurate number at this point is very difficult. And that same applies for semi. I think we forecast back in July that we'd see a slight recovery in Q4, and there was signs of that early on, but the volatility is still pretty high. As you probably saw from MKS earlier in the week, the range they gave on their Q4 number was pretty significant, again, showing the volatility that we're seeing. So there's a lot of projects being discussed and a lot of projects the OEMs are getting ready for, but which ones actually happen is really quite difficult to project at this point. Going into '19, I've really heard so many different signals at this point that we're planning on being ready for a slight up, and also if things deteriorate, we're also ready. That's really the key thing is to make sure our operations are flexible, we can drive the right cost and profitability performance. And we'll deal with the market situations we have, but I think there's so much misinformation out there that we are just trying to stay close to the OEMs and the end users to be ready with the right capacity at the right time. On market share, I mentioned, we're doing extremely well. We've had no loss in market share during this period. And you probably know is market share semiconductor takes quite a bit of time to build, the OEMs don't change dramatically, the type of valves they build on a piece of equipment. So when you're installed on that equipment, you generally continue that share. So we're focused on all the latest generation of equipment for 7 nanometers, et cetera, and as I mentioned, we're following all the key new platforms in the industry. And we're very well positioned to continue that very high level of share and probably exceed that level of share in the future.

[Operator]

The next question is from Jörn Iffert, UBS.

[Jörn Iffert, Director and Analyst]

And the first one would be please on the inventory issue, then, for example, LAM Research, one of your key customers, is guiding sales to be up next quarter. You, MKS, INFICON are guiding sales to be down around 10% next quarter. Shall we read that the inventory issue for you is in between CHF 20 million to CHF 30 million on sales to explain this divergence? Or how shall we think about this? Second question would be please in terms of order trends. Are you already seeing, in September, October, some stabilization month-over-month? Or is it still in the declining mode? And the last question would be please on the capacity planning for 2019. Given the point in time, do you think you will extend your short-time working into Q1, Q2 2019? And also what are you planning on headcounts in general for 2019 first half?

[Michael Allison]

Okay, thank you for that. First one, I think you got to be very careful when you listen to OEM guidance on revenue. They have a lot of deferred revenue projects with customers, and you've really got to look at their individual demand on a product-by-product basis. So I don't think their guidance really reflects what we're seeing. I think there's a little bit of an inventory buildup in the supply chain, some OEMs are higher and lower than others. To give a number on it is quite tricky, but I'd say, by the end of the fourth quarter, we'll be back to fairly normal levels. In terms of order performance right now, I'd say, we're fairly flat. So I think we've seen that trough and we're trading at a fairly flat level. In terms of capacity, we're not going to make any future decision on the short-term working till closer to the end of the year, until we see visibility into the first quarter of 2019. We built up, I think, a tremendous capability with the new fab in Malaysia. It's fully ready to go. So we're able to take any volume that comes back within 2019. And also to take share gains if those opportunities come up. So in terms of headcount, we'll manage that as time goes on. And you really got to be pretty dynamic when it comes to managing that from a quarter-to-quarter and year-on-year. But I also want to make sure I'm putting headcount into our growth areas like service and general vacuum. So we'll try to manage the cost to allow us to invest in those sectors, while keeping semiconductor ready to ramp when the business comes back.

[Operator]

Next question is from Michael Foeth, Vontobel.

[Michael Foeth, Head of Industrials Team]

Follow-up basically on the previous one. How are you dealing with the Malaysia plant in the current context? What is the -- what is sort of the output or the utilization rate, if you can give any numbers on that? And the same goes for the Swiss plant. What sort of capacity utilization, if that number makes sense, are you currently running on? And yes, that -- that's would be my question.

[Michael Allison]

Yes. We're not going to give any exact numbers out on capacity in any of our plants. What I would say is that we targeted our high-volume semiconductor products to be ramped up in Malaysia. So a lot of the qualification work was done on those new products. Now obviously, with semi pushing back, that's had a pretty significant impact on the output of Malaysia. So all I would say is we're managing that situation, but the good news is we're ready to ramp those new products when semiconductor comes back. What we're also doing is any new product in semi and display that we're bringing to market, we're ensuring that's qualified within Malaysia. So that gives us the ability to ramp there. It also gives us strong business continuity story for our key OEMs as well. So we're managing really the capacity dynamically across the 2 plants to get the right level of cost performance.

[Michael Foeth, Head of Industrials Team]

So maybe following up on that. So when -- assuming the market demand picks up again, are you going to ramp Malaysia faster than Switzerland in order to have a more balanced setup?

[Michael Allison]

Yes. Well, I think, Switzerland still remains a core production site for us. We have a huge mix of products here. And that will remain that way. I think as semi ramps back up though, we will see a sizable amount come out of Malaysia, but that's kind of our latest-generation products and some of the high-volume semi products. But the exact numbers at this point, it's -- is too early to say.

[Operator]

Next question is from [ Jorg Rune ], [ AWP ].

[Unknown Analyst]

This is [ Jorg Rune ], [ AWP ]. The outlook and the weakness in the semiconductor market, it was strong -- the weakness was stronger than you anticipated in August. How -- I mean, do you see the bottom of the trough? Or is there no visibility at all?

[Michael Allison]

I think there is visibility in terms of the number of new fab projects that are happening across the world. I think LAM Research commented on there was a high number of new facilities getting built. The key question is, is when they are populated with equipment. So we expect to see a good portion of them happening in 2019. So the CapEx level will still remain at a high level, maybe not at the high level we'd like it to be obviously. In terms of our guidance, we guided mid-single digit, and we put a lot of thought into that in the July time frame. And we're not far off that guidance. We say we're going to exceed last year's number. So I think we did a reasonable job in forecasting where the second half would be. Just the fourth quarter is a little bit weaker than I was expecting. We expected a little bit more in the memory sector, which just didn't materialize. So it's very hard in semi to get it absolutely right. And I think, overall, our estimates were pretty close, and we'll continue to watch every signal in the market, as I mentioned, between the OEMs. And the good news for VAT, we have a very strong network across all the OEMs. So it's quite easy for us to triangulate what is happening. As soon as the OEMs hear about the projects, we get very fast visibility into that. So we can react quickly.

[Operator]

[Operator Instructions] The next question is from Paul Moran, Northern Trust.

[Paul Moran, Partner and Head of Research]

Two questions on inventory. I think, Mike, you mentioned last time that there was 1 OEM on a consignment basis. Has there been any change to that? And the second question is, also you mentioned that in terms of where the inventory runout will come, you're thinking towards the end of the fourth quarter being back down to the normal basis. When you say normal, do you mean normal for a market that's currently flat or normal versus a good market?

[Michael Allison]

Okay. Yes, challenging question. I think we now have, I'd say, 2 out of 3 of our key customers on consignment inventory. And we are managing that very dynamically with them. As I said back in July, we built up quite a strong inventory position with them expecting higher growth. So it's taken a little bit of time to burn that down, but we're working that very dynamically with them and they are extremely cooperative with us in how we manage that. By the end of the year, I would say, we'd be down to basically, at their run rate, whatever that run rate is going to be. But we won't have, I'd say, excess capacity above the run rate that they will be seeing in the fourth quarter. But exactly, where that run rate is, is pretty hard to tell still at this point.

[Paul Moran, Partner and Head of Research]

Okay. I appreciate that. And is that -- does that mean that there has been a change from the first half to the third quarter in terms of who's on consignment? You said 2 OEMs now. Was that the case in the first half of the year as well?

[Michael Allison]

No, I think when we last talked, we've been running a consignment program with 1 OEM for quite a long period of time and we were transitioning another OEM to a much more formal consignment program. We also hold stock for other OEMs around the world, that's just not in a formalized consignment program. So we're supporting all our OEMs very heavily with stock.

[Operator]

There are no more questions at this time.

[Michael Allison]

I'd like to pass, at this point, to Andreas, who has a few comments to make.

[Andreas Leutenegger, Chief Financial Officer]

Thank you, Mike. I have 1 specific comment to make with regards to the EBITDA margin guidance for the rest of the year. We said we will stay around last year's figure, which is, of course, the normalized figure. So some have picked it up not normalized, which was 30.6% last year, but of course, we talk around, again, the trusted or normalized figure, which is around 31.1%, just to clarify that. So we talk in terms of year-on-year guidance at the normalized figure. So back to Mike.

[Michael Allison]

Okay. Thank you. I think that concludes the call from the VAT side. I thank you for participation. Thank you.

[Operator]

Ladies and gentlemen, the conference is now over. Thank you for choosing Chorus Call, and thank you for participating in the conference. You may now disconnect your lines. Goodbye.