Sumco Corp

TSE:3436

Earnings Call Transcript 2023-Q1

[Takayuki Komori]

Thank you for your participation today. This is the results briefing for Q1 of the Fiscal Year Ending December 2023, and I am Komori, General Manager of Public Relations and IR Department.

Before starting the presentation, allow me to confirm today's materials, which consists of three items: the brief statement on consolidated financial results for Q1 fiscal 2023; the announcement regarding revision to dividend forecast; and the presentation deck entitled Results for First Quarter of Fiscal Year 2023. This will be a roughly one-hour briefing, which will end at 5:00 p.m.

Next, a disclaimer. The estimates, expectations, forecasts and other future information discussed here and shown in today's materials were prepared based on the information available to the company as of today, and on certain assumptions and qualifications, including our subjective judgment. Actual financial performance or results may differ substantially from the future information contained in this material due to risk factors, including domestic and global economic conditions, trends in the semiconductor market and foreign exchange rates.

We will have presentations today from Representative Director, Chairman and CEO, Mayuki Hashimoto; and Vice President, CFO, Michiharu Takii. Hiroshi Itoh, General Manager of Accounting is also on hand.

Chairman and CEO, Hashimoto, will discuss our forecast and operating environment to be followed by an explanation of the financial results by CFO, Takii. We have set aside time for a Q&A session as well.

I will now hand over to Chairman, Hashimoto.

[Mayuki Hashimoto]

I am Chairman, Hashimoto. I will start with the overview on Slide 5 of the presentation. This is a summary of the Q1 results. Q1 sales exceeded our forecast by JPY 5 billion. Operating income and ordinary profits also exceeded forecast. However, net profit attributable to the owners of the parent fell short of our guidance. The shortfall is related to tax issues, which CFO, Takii will cover in detail later.

Turning to our Q2 forecast. We are guiding for sales of JPY 108 billion, which is a Q-on-Q decline of roughly JPY 2 billion. However, the sales forecast includes JPY 5 billion in sales of polysilicon as a result of the takeover of the Mitsubishi Materials polysilicon business. So the actual Q-on-Q decline for the wafer business, excluding this is JPY 7 billion.

We expect operating income of JPY 17 billion and ordinary income of JPY 16 billion. For net profit attributable to owners of the parent, we are guiding for JPY 9.5 billion. Our Q2 forecast called for both sales and profits to decline substantially on a Q-on-Q basis. The decline in profits is largely a function of lower sales and a large increase in costs, resulting in a significant impact.

Please turn to Page 6. This slide shows shareholder returns. Our guidance for the interim dividend is JPY 40 for a dividend payout ratio of 30.6%. We determined DPS based on net profits and our expected future cash needs. This fiscal year, we have a strong need for cash as this will be a significant year for greenfield capacity expansion investments. As such, our dividend payout ratio has reverted to the previous 30% level.

Last fiscal year, SUMCO generated significant profits and had abundant cash on hand, so we were able to raise the payout ratio to 40%. But this fiscal year, there will be large-scale outlays related to capacity expansion, hence the return to a 30% payout ratio. Additionally, in keeping with our policy to-date, we do not include the subsidy received from Saga Prefecture, which is ¥1.5 billion on a post-tax basis in calculating the dividend per share. We did not feel it was appropriate to use the subsidy for dividends.

Slide 7 shows the market environment for silicon wafers. First, looking back to Q1, the results were not bad. For 300-millimeter, a correction started in memory use wafers, but wafer demand for use in logic varied by customer. There were some logic customers that made no adjustments to wafer procurement, but others that did. That said, customer wafer inventory levels did increase during the quarter.

The situation for 200-millimeter wafers was as expected, with demand from the automotive sector still strong but weaker demand from consumer electronics and industrial applications. For 150-millimeter wafers, overall market conditions were soft, so demand was generally weaker.

In terms of pricing, SUMCO benefited from LTAs, all of some cost 300-millimeter wafers are covered by LTAs. On the outlook for Q2, given that customers have started to adjust wafer procurement, we expect to see some declines in 300-millimeter wafer volumes. This is why we are expecting Q2 sales to fall ¥7 billion.

For 200-millimeter, with the exception of auto-related demand, demand from consumer electronics and industrial applications are expected to remain weak. 150-millimeter will stay weak as well. Fortunately, customers are expected to respect LTA pricing. In Q1, prices for the majority of LTA customers rose, but all complied with the prices as set out in the LTA.

The issue is the outlook. Our view is that second half calendar year 2023 will be the bottom for 300-millimeter wafers. I expect this will also be the bottom for memory. Given the major production adjustments expected to be implemented by customers in the second half, we expect memory prices, such as for DRAM and NAND should see a solid recovery.

I will cover this in more detail later, but I expect a recovery in volumes for logic use wafers at the end of 2023. The recovery in volumes for memory use wafers is likely to come towards the end of first half calendar year 2024, such as June, reflecting the tougher situation for memory.

Next, slide 8 shows the wafer trend for 200-millimeter by quarter. As you can see, the ceiling for global capacity is 6 million wafers per month. Last year, the market was capped at this level throughout the year as was the case in the previous year.

This year, however, there has been a slight easing, although I do not expect to see a large-scale decline. I expect the trend to be relatively firm at solid levels. However, for 150 millimeter, which is not shown here, I would expect to see sizable declines.

This is the same chart for the all important 300-millimeter wafers. It is very rare to see a year-on-year decline in the trend. We did see it happen in Q1 2020, which is the blue cross line where it fell short of 2019, which is the gray triangle line, although the Q1 levels for both years were very close.

For 2023, represented by the Red Dot, however, we have started the year significantly lower year-on-year. I believe this is a reflection of the severity of the correction at this time.

Next slide, please. That said, the expectation of growth in semiconductors over time remains unchanged. Next slide, please. This shows trends in global data traffic volume. This may be obvious to investors, but given continued developments such as the emergence of ChatGPT, data traffic volumes can only increase. It has consistently been increasing over time. Higher data traffic will drive an increased need for semiconductors. Given this, I believe prospects for the semiconductor market remain promising.

Next slide, please. This shows trends in data center-related demand. Given the slight overbuilding of data centers, I do expect to see a modest pause in data center demand in 2023. On the back of this, there is likely to be a slight decline in related wafer volumes in 2023. Overall, I think 2023 is likely to be a tough year.

Next is smartphones on slide 13. Here again, we expect to see a dip in 2023. This reflects the combination of a number of factors, but the biggest is the absence of pandemic-driven work-from-home demand, which boosted smartphone, PC and tablet demand. The increase in remote working drove significant demand during the pandemic. However, more recently, we haven't seen replacement demand kick in, leading to a softer trend in 2023.

Smartphone sales have weakened as a result. Another major factor is geopolitics such as the invasion of Ukraine, which is indirectly led to inflation. The strain on consumers' finances as a result of rising consumer prices has dampened replacement demand for smartphones. That said, replacement of smartphones, PCs and tablets can't be put off indefinitely. So I would expect demand to recover over time.

Slide 14, please. This is also obvious, but we continue to see memory bit growth, although wafer input volumes have continued to grow as well. The reason for this is that while technological advances make it possible to keep pace with bit growth to a certain extent, advances in technology have not fully caught up to bid growth. This is the case even now, given this we expect a continuation of wafer growth going forward.

Next slide, please. This shows estimated customer inventory levels. Given the current situation, we have seen inventory levels peak, but this does not mean that we can expect sales to pick up immediately. Customers are adjusting production significantly and have been cutting back on procurements, leading to a peaking of inventories.

Next slide, please. This slide shows the same trend. Next slide, please. This chart plots trends for inventory, demand and price for 300-millimeter logic use epi wafers. Let's focus on inventory and demand. The blue line reflects trends in consumption or demand. If we track this line, you can see there were declines in demand in 2013, late 2015 into 2016, a modest dip in 2019 and then the current drop in 2023. The drops in 2013 and 2016 were relatively large.

If we then look at the same trend for polished wafers on the next page, the trend lines for inventory and demand are very different, but polished wafer also dipped in 2013, 2016, 2019 and 2023. In the case of PW, however, the declines in 2013 and 2016 were quite modest. On the other hand, PW saw a larger drop in demand than epi in 2019. This is also true of 2023 with the decline in PW demand much larger than epi.

What does this tell us? Going back to page 17, if you compare this trend to the trend line for inventory in orange, you can see that in the case of epi, when demand drops, you see an immediate jump up in inventory levels. When demand surges, inventory levels dropped rapidly. When demand hits a plateau, then inventory again surges. In other words, there is an immediate link between demand and inventory levels in epi.

The point I want to make is that epitaxial wafers for logic use are produced to order, as are the logic chips for which they are used. For instance, a customer will place an order on the launch of a new smartphone model, which will drive the rollout of a new generation of Snapdragon or other chips. The chips and wafers for such products are fabricated once an order has been received.

Jumping back to page 18. This contrasts with PW, where there is a significant delay between demand and inventory trends. This is because memory can be produced on spec. When the market is strong, memory makers get bullish in pushing up production volumes in anticipation of demand. So, if you look at 2014 and 2015, although production levels were high, inventory also increased. In other words, in these situations, memory makers wafer procurements exceed wafer consumption. This is why the trend in wafer procurement volumes is very volatile. So in PW, there is a lag between trends in demand and trends in inventory.

So, as I explained earlier, sometime at the end of this year, I expect to see a recovery in epi procurement volumes. I expect epi wafer consumption will also increase at around the same time. However, PW, I expect the trend to be weak in the first half of 2024, with volumes starting to recover in the second half of the year. So there is a lag between demand and procurements in PW and I would expect the recovery to be gradual. For that reason, when I think about our plans to expand capacity, the expansion at Imari [ph] is almost all for leading-edge epi, but there is more of a focus on PW for FST's capacity expansion. This is why I think the ramp-up of new capacity at FST may be slightly slower than planned.

Next, slide 19, please. This is the outlook for supply demand, including historical data, which we always share with you. Although there are many factors, growth over the longer term tends to revert to PPP GDP growth. We looked at a number of scenarios, but this time, we chose to revise our outlook. We may be slightly too conservative, but even if we are being a little conservative, we still expect overall 300-millimeter capacity utilization to be at 95% in 2025.

For the wafer industry, 2023 is likely to be the toughest year with 2024 as a year of recovery. We may well see some wafer shortages again in 2023. This is our view.

This completes my section of the presentation. I will hand over to CFO, Takii, to talk about details of our earnings.

[Michiharu Takii, Vice President & Chief Financial Officer]

I Takii will present the earnings in more detail. Please turn to page 21. As touched upon at the beginning of the presentation, these are the Q1 results. Sales and profit were up year-on-year. However, on a Q-on-Q basis, both sales and operating profits declined, reflecting the strong Q4 earnings performance.

We generated JPY20.1 billion in extraordinary profits as a result of the negative goodwill associated with the acquisition of the Mitsubishi Material's polysilicon business. At the previous earnings briefing, we indicated we expected extraordinary profit of around JPY30 billion. So the result was JPY10 billion short of this figure. In reviewing the asset valuation in more detail, we revised down the valuation by JPY3 billion.

With regard to the remaining JPY7 billion shortfall, our guidance was based on discussions with our accountants, but there appear to have been some misunderstandings in the calculation of deferred tax liabilities, resulting in a JPY7 billion increase in deferred tax liabilities. These factors depressed extraordinary profits by JPY10 billion.

Otherwise, we were able to exceed our forecast for both sales and operating income, although net profit was slightly lower than projected. CapEx was up dramatically. Q4 CapEx was around JPY50 billion, but with activity related to greenfield investments picking up, verified Q1 CapEx was around JPY91.6 billion. As this is the first quarter of the fiscal year as a result of progress on depreciation of facilities in the previous fiscal year, depreciation fell Q-on-Q but was up year-on-year. We were able to keep EBITDA above the JPY40 billion level in Q1.

With regard to ROE, which we do not show here, there are two factors to note. The JPY20.1 billion in negative goodwill incurred in Q1 and the JPY2.1 billion in subsidies from Saga Prefecture, which is included in the JPY1.4 billion in non-operating gains and losses, which we did not mention earlier. We did not feel it was appropriate to include these amounts in full in Q1. Instead, we have factored in one-quarter of these amounts in calculating Q1 ROE. This is the basis for the 15.8% figure shown here.

Please turn to the next slide. This is the analysis of changes in operating income. First, the sequential analysis, sales fell JPY7.5 billion and operating profit dropped JPY3.8 billion Q-on-Q. Costs rose JPY3 billion. We have seen costs consistently rising from last year. Materials costs continue to rise up around JPY2 billion Q-on-Q. Electric power unit costs increased for an impact of around JPY1 billion.

Depreciation fell Q-on-Q as a result of the start of a new fiscal year. Sales-related variance as noted previously was impacted by the rise in LTA prices from the start of a new fiscal year by a positive JPY5 billion, but volumes were down for a net positive impact of JPY1.4 billion. The yen was at its weakest in Q4, so there was a negative contribution from ForEx in Q1 of ¥4.6 billion.

On the right, we show the year-on-year change for Q1. Both sales and profits increased year-on-year. However, if you look at the waterfall chart, costs rose a significant ¥8 billion with materials unit prices and electric power unit costs up for an impact of ¥3 billion each and labor up ¥1.5 billion and maintenance repair costs up ¥0.5 billion.

Depreciation also increased year-on-year. On sales-related variance, the contribution from prices was slightly less than ¥7 billion, partly reflecting the impact of a creep up in prices over the course of last year. Volume decreased, however, by slightly more than ¥3 billion for a net positive of ¥4 billion. ForEx had a positive impact of ¥7.2 billion with the yen weakening by ¥18 to the US dollar.

Next slide, please. Slide 23 shows the balance sheet and cash flow statement. Cash and time deposits on the balance sheet fell ¥45.5 billion. I will explain this in more detail in talking about the cash flow statement. Raw materials and supplies rose a hefty ¥15.8 billion. Both polysilicon as well as some supplies increased.

As of the end of March, we integrated Mitsubishi Materials Polysilicon on the balance sheet, pushing up polysilicon by ¥2 billion. Supplies increased primarily at Sumco some of which reflects increases related to greenfield production expansion. Inventory also rose a significant ¥18 billion, of which roughly ¥13 billion is related to the consolidation of Mitsubishi Materials inventory.

Interest-bearing debt was virtually unchanged at but other liabilities increased. This is reflected in the cash flow statement with other facilities-related liabilities up roughly ¥25 billion. Earlier, we touched upon extraordinary profits. DTLs increased roughly ¥10 billion as a result of consolidating Mitsubishi Materials polysilicon business.

If we look at the capital account, retained earnings increased ¥21.9 billion, reflecting the impact of net profits after deducting the payment of dividends. At the bottom of the table, we show a number of metrics, which were largely unchanged.

On the cash flow statement to the right, operating cash flow was a positive ¥26.3 billion. Capital expenditures were $91.6 billion, although ¥24.9 billion will be paid in later quarters. Proceeds from the acquisition of shares of subsidiaries, which refers to cash and cash equivalents acquired through the acquisition of Mitsubishi Materials polysilicon business was a positive ¥9.9 billion.

Free cash flow was a negative ¥30 billion. After dividends paid and other adjustments, we get to the net decrease in cash and time deposited highlighted earlier of ¥45.5 billion. We chose not to increase borrowings, but paid dividends from the cash balance.

Next slide, please. On page 25, we show our forecast for Q2. As shown here, we project sales of ¥108 billion and operating income of ¥17 billion, net profit of ¥9.5 billion. The projected EBITDA margin is slightly lower at 31.6% but from Q2, the sales figures include contributions from external sales generated by Mitsubishi Materials polysilicon business. This is mainly sales of specialty gases for a contribution of around JPY5 billion. This increases the denominator for calculating the margin. We estimate the negative impact from this to be around two percentage points. If we calculate the EBITDA margin on only the wafer business, we estimate it would be around 33%.

Next slide, please. This is the analysis of change in operating profit. First, the sequential change. As noted earlier, if we look just at wafer sales, the forecast sales of JPY108 billion would be JPY103 billion, implying a top line decline in wafer sales of JPY7 billion, effectively a drop of slightly less than 7%.

Sequentially, ForEx rates are largely unchanged, so the decline in sales is effectively from volume gain wafers. And looking at change in operating profit, costs are continuing to rise. At the Kubara plant in Imari, the high voltage transmitting cables were short circuited by nesting crows using wire, which led to a deterioration in yield as a result of a blackout.

The negative impact is reflected here, we expect costs to increase JPY2.3 billion Q-on-Q. Labor costs are expected to increase JPY0.5 billion on the back of an average hike to base wages of 6.1%. Maintenance and repair costs are expected to rise JPY1 billion. Other expenses are also projected to increase for a total negative impact of JPY2.3 billion.

Depreciation is forecast to rise JPY3 billion Q-on-Q. Under sales related variance, as noted earlier, lower volume is expected to have a JPY7 billion impact at the top line for a JPY3.9 billion negative impact Q-on-Q.

Looking at the analysis of year-on-year change for Q2 on the right, at first glance, sales appears to be up significantly but reflects the impact of a weaker yen year-on-year as well as a JPY13 billion positive impact from higher prices. There is also a JPY5 billion contribution to the top line from the Mitsubishi Material's polysilicon business.

OP is expected to fall JPY6.8 billion year-on-year. The main factor is higher cost. Materials and supplies costs are expected to rise JPY6 billion year-on-year. We expect electric power costs to rise JPY6 billion. Labor costs will rise JPY3 billion year-on-year on higher unit costs and increased headcount for the greenfield expansion. Repair and maintenance costs are expected to increase JPY2.5 billion year-on-year. R&D costs are also up. Altogether, we expect cost to increase JPY18.2 billion year-on-year. Depreciation is also expected to increase.

For sales related variance, as mentioned earlier, we expect volumes to decline. As mentioned by Chairman Hashimoto, volumes are down for 200 millimeters and 300 millimeters year-on-year. As a result, while the impact of higher prices is around JPY13 billion, we expect a negative impact of around JPY8 billion from lower volumes. We expect a positive impact of more than JPY10 billion year-on-year from ForEx for Q2 given the weaker yen to the US dollar.

Next slide, please. As we show here, you can see that sales and EBITDA has declined recently. Also, the EBITDA margin, as mentioned earlier, includes the polysilicon business. If we exclude the polysilicon business, then we estimate the EBITDA margin should be 2% points higher. This completes my remarks.

[Takayuki Komori]

Thank you. We will now open the floor to questions. We'll start with Mr. Enomoto of BofA Securities. Mr. Enomoto.

[Takashi Enomoto, BofA Securities]

Please talk about your view on when the semiconductor wafer market will rebound. You indicated that you expect PW to recover in the second half of 2024. This seems to imply that there won't be any sort of recovery for wafers in 2023 and that you think a recovery in second half 2024 is perhaps the best we can hope for. I think that semiconductor chips will bottom earlier. Please share your view. Do you think that a recovery in second half 2023 is highly unlikely or is there a possibility of an early recovery in second half 2023.

[Mayuki Hashimoto]

With regard to the semiconductor chip market, my honest view would be that logic will recover from the end of this year, but it is likely to be mid-2024 before memory recovers. The issue is what happens with silicon wafers. As discussed earlier, there was a time lag between demand and shipments in PW but no delay between shipment and demand trends in epi in either direction. I expect logic use epi wafers to be weak until the end of 2023, but epi wafer volumes should start to recover from that point.

However, a recovery in PW wafer volumes is likely to take until mid-2024. Once we get into 2025, I think demand for both PW and epi will be strong. I think we will see more production cuts in second half 2023 for silicon wafers. However, logic use epi wafers are likely to recover earlier than PW because there is no lag. Also, the negative impact on logic chips appears to be relatively smaller.

[Takashi Enomoto, BofA Securities]

Can I follow up on one point, please? Did you say the silicon wafer market is likely to deteriorate further in the second half of 2023. Is that the correct way to interpret your comments?

[Mayuki Hashimoto]

Yes, that's correct.

[Takashi Enomoto, BofA Securities]

In the presentation, you compared epi to PW in previous downturns in 2013, 2016 and 2019, and -- but I think the level of inventory is very different to what it was at that time. I think it is much higher than it was in past downturns. Should this be viewed as a major negative factor for silicon wafer market demand this time around?

[Mayuki Hashimoto]

If you look at inventory months for logic use epi wafers, I have a sense that it isn't that high. However, if you look at memory, it is being significantly impacted by geopolitical factors such as the invasion of Ukraine, which has depressed the overall market. Smartphone sales have been weak. There are multiple geopolitical factors that have coincided. The US-China trade tension is another factor. The CHIPS Act is very restrictive, as you know.

If companies that accept subsidies from the US government under the CHIPS Act cannot sell into China, particularly to companies on the entity list, this would mean that it would be very challenging to fabricate memory in China. This begs the question of who will take up the slack in supplying memory if China cannot produce and makes it difficult to read the situation. From this perspective, it seems as if the damage to the memory market is severe.

[Takashi Enomoto, BofA Securities]

Understood. Thank you.

[Takayuki Komori]

Next is Mr. Watabe of Morgan Stanley.

[Takato Watabe, Morgan Stanley]

My question is about the LTAs and when you expect customers to catch up on deferred volume? Can I confirm that customers are respecting LTA prices and that you are not seeing cancellation of LTAs where customers are willing to pay penalties to terminate LTAs early. What is your view?

[Mayuki Hashimoto]

Customers have been very good about respecting LTA prices. The reason for this is because in the last few downturns, those customers that apparently chose not to respect LTA prices struggled to procure wafers anywhere when supply became tight. Given the cyclical nature of this business, there is a broad sense within the market that there are consequences in being overly aggressive when you have the upper hand.

So we have been able to maintain good price discipline with virtually no customers asking about price relief. On the issue of volume, if a customer says that they don't have the physical space to take more wafers, I think we must be supportive. So on the question of when customers catch up on deferred LTA volume for Epi, it will probably happen in 2024.

For PW, it may take a little longer. Probably customers will return to taking volume stipulated in LTAs in 2024 and catch up on deferred volume in 2025. I expect customers will respect the total volumes set out in the LTAs. They are respecting LTA prices, but there will be some rescheduling of deliveries.

[Takato Watabe, Morgan Stanley]

Understood. Thank you.

[Operator]

Next is Mr. Ikeda of Goldman Sachs.

[Atsushi Ikeda, Goldman Sachs]

I would like to ask about the demand and capacity expansion forecast you show on slide 19, as you mentioned in the presentation, ultimately, what we have seen in the past is that average growth of procurement capacity over time reverts to PPP GDP growth rates. I understand your projections for a decline in demand in 2023. But if I look at the forecast for 2024 and beyond, it is still well below the PPP GDP-based forecast. Does your forecast reflect the weak near-term recovery from the inventory corrections we are currently seeing? If I look at slide 14, both DRAM and NAND are expected to show growth based on bit growth or scaling and the start of the ramp of 3D NAND stacking of peripheral circuity at Kioxia [ph]. Given this, your forecast appears to be slightly conservative. Have you newly factored in geopolitical or other risk into your forecast? Also, this forecast would suggest that supply/demand will be very tough. Are you comfortable that such tough conditions will not lead to renegotiations of the LTAs?

[Mayuki Hashimoto]

On our forecast, I am generally confident in the 2023 and 2024 levels. However, there have been times in the past where we have seen a rapid rebound, so it's hard to say for 2025. It is true that we have factored in geopolitical risks, which have depressed our outlook simply because we don't know how things will play out. Our management plans are based on this outlook.

If your question is, will 2025 really be this low, I do think that the new capacity expected to come online will be running at close to full capacity. However, in talking about the future, what we show here is simply a forecast as of this point in time. If you look back at historical trends, getting to full capacity utilization in 2025 implies a very rapid ramp-up. That said, I do think we will eventually catch up to the dotted blue line, which means a rapid ramp-up, but there are also some challenges. This forecast is the result of intensive internal discussion. So you may be right, we may be taking a conservative view.

[Atsushi Ikeda, Goldman Sachs]

I have one follow-up. With regard to the correlation to the increase in the number of wafers, there are emerging technologies like 3D NAND, what impact will such technology have on demand?

[Mayuki Hashimoto]

I believe that carriers and interposers will definitely increase at some point, but we are not there yet. Everyone is in the red and struggling at the moment, particularly the memory players. We are still at the R&D stage. I would expect interposers to start to increase from 2025 or beyond. It's possible that this could be a driver that steepens the slope for demand in the future. This is why players in the process of expanding capacity cannot just simply stop investing now. They remain focused on continuing to grow capacity steadily. As well, our balance sheet is relatively robust, so I believe we will be able to weather the storm.

[Atsushi Ikeda, Goldman Sachs]

Thank you for the detailed explanation.

[Takayuki Komori]

Next is Mr. Nishiyama of Citi Group.

[Yuta Nishiyama, Citi Group]

If we look at slide 16, it appears that inventory levels are peaking. The largest memory player only announced significant production cuts of 20% in April. Given their estimated global share of production capacity of around 40%, this implies a 10% decline in wafer inputs for the overall memory industry. But if we look at wafer procurement volumes, the largest wafer player, which is known to have strengths in memory appears to expect shipments will recover slightly in the June quarter. If we take into account procurement volumes versus wafer input volumes, is it possible that we could see memory customer wafer inventory levels start to rise again?

[Mayuki Hashimoto]

Frankly speaking, I think wafer procurements will decline in the second half of 2023. A very large customer has already started to adjust its procurement. This customer had not adjusted its procurement much up to this point. I expect they will follow through on their announced plans.

Typically, the magnitude of the reduction in procurement is larger than the scale of production cuts. So I think second half of 2023 will be very tough. I would be very surprised to see a peer talking about a recovery in second half 2023 that would drive higher sales of wafers.

[Yuta Nishiyama, Citi Group]

So when should we expect customer wafer inventory levels will peak? If possible, could you comment on logic use epi wafers?

[Mayuki Hashimoto]

I think now is the peak. In the second half of the year, I would expect to see significant production cuts from customers and would expect the magnitude of cuts to procurement volumes to be larger than production cuts. So I think we are at the peak now. There is a difference between when the market is peaking and the timing of the peak for customer inventory. Inventory is up significantly because the market is weak. To address inventory levels, customers need to cut production, which will depress the market.

[Yuta Nishiyama, Citi Group]

Understood. Thank you.

[Takayuki Komori]

Next is Mr. Yoshida of CLSA Securities.

[Yu Yoshida, CLSA Securities]

Mr. Yoshida, I would like to ask about slide 19 and the supply-demand forecast. If I look at this chart from the previous results briefing, Sumco has adjusted down its forecast for both demand and supply. At the same time, you also said that the investment plans for capacity expansion are unchanged.

[Mayuki Hashimoto]

Perhaps there was a misunderstanding. Sumco will maintain its domestic investment plan as the focus is on leading-edge epi. However, the investment plan at FST is likely to be slightly slower as the main focus is PW.

[Yu Yoshida, CLSA Securities]

I see the graph shows capacity flat year-on-year for 2026. Is this because you have visibility into the industry as a whole, slowing down capacity expansion?

[Mayuki Hashimoto]

So there is no point in making product that you can't sell no matter how much effort you put in. The current correction in PW is very big. I think it is unlikely that our peers will continue to expand PW capacity at the same pace.

[Yu Yoshida, CLSA Securities]

And you can confirm this through trends at equipment makers, for instance?

[Mayuki Hashimoto]

I guess that is fair.

[Yu Yoshida, CLSA Securities]

Understood. Thank you.

[Mayuki Hashimoto]

I haven't seen others plan, so I can't say for sure, but that would be my view. I think my peers would have a similar view.

[Yu Yoshida, CLSA Securities]

Understood. Thank you.

[Takayuki Komori]

Next is Mr. Miyamoto of SMBC Nikko.

[Go Miyamoto, SMBC Nikko]

I have a question related to Slide 19 and the expected drop in demand in 2023 for a demand supply of 86%. This is a level that the market has not seen for 10 years and the lowest level since 2013. With demand supply easing to this level, are you expecting prices on non-LTA 300-millimeter wafers to decline? The chart does not show analysis of demand supply for 200-millimeter, but do you expect price drops for 200-millimeter, particularly given that the percentage of LTAs is not that high.

[Mayuki Hashimoto]

200-millimeter is relatively healthy, with automotive use demand doubling. The range of applications for 200-millimeter is very broad. Leading edge applications continue to be able to achieve higher prices. So I wouldn't expect the 200-millimeter market to deteriorate dramatically. Also, no one in the industry is increasing 200-millimeter wafer production capacity. As a result, I think prices should remain relatively stable.

On 300-millimeter spot prices, Sumco's domestic business in 300-millimeter is all on LTA, so I don't have much information on spot conditions. What I have heard related to test wafers is that spot prices are down significantly.

That said, although it is test wafers, they are also on LTAs. So spot for us is tiny. However, what we are seeing is that while our customers are pushing out delivery timing for volume, they are not buying in the spot market. So there aren't many customers that are buying wafers in the spot market because prices are cheaper now.

[Go Miyamoto, SMBC Nikko]

On a consolidated basis, I understand that there is slightly more spot business that you do through FST, what are the current trends?

[Mayuki Hashimoto]

For Taiwan, although, FST does have spot business, in fact, much of the business is done with long-standing customers, so prices are not off that much. The reason for this is if you lower spot prices significantly, that has negative implications for LTA customers. Also, there isn't that much volume available in the spot market, although, we do some spot business, although, it's very challenging.

[Go Miyamoto, SMBC Nikko]

I see. So basically, although, demand supply is eased, is it fair to say the limited availability of spot product has meant the price competition hasn't really intensified.

[Mayuki Hashimoto]

Yes. If you think about it, s sense for them to be buying in the spot market. The spot market is also very thin.

[Go Miyamoto, SMBC Nikko]

Thank you.

[Takayuki Komori]

Next is Mr. Okazaki of Nomura Securities.

[Shigeki Okazaki, Nomura Securities]

Mr. Okazaki I would like to ask about whether you expect depreciation to change. Three months ago, you indicated you expected to invest $200 billion for domestic capacity expansion and invest $100 billion for Taiwan in 2023 and with depreciation likely to rise £15 billion to £20 billion year-on-year. If you delay the completion of greenfield investment, expected to complete in 2024. Does that mean that the timing of depreciation will also get pushed out?

[Mayuki Hashimoto]

For the domestic investments, we are maintaining our planned schedule as the focus is on expanding capacity for leading-edge logic use, epi wafers. If the market recovers, we will be well positioned to respond to rising demand by doing so.

Also, as discussed earlier, if demand picks up, customers will buy wafers immediately. For Taiwan and PW, however, we will ramp up new capacity in line with the demand recovery -- although we have already bought the equipment, so there may be limits to how much we can slow things down.

Generally speaking, I don't expect a major divergence in terms of depreciation.

[Michiharu Takii, Vice President & Chief Financial Officer]

There isn't much change from our previous comments on depreciation. For this fiscal year, Q1 depreciation was $14 billion. We are guiding for £17 billion in depreciation for Q2. In Q3, we expect a further increase of £5 billion in depreciation and Q4 is likely to rise another £5 billion.

[Shigeki Okazaki, Nomura Securities]

So basically, for Epi, even if demand weakens, you will continue with your plans as scheduled to ramp up greenfield capacity from 2024?

[Mayuki Hashimoto]

The plan continues to be to ramp up epi production toward the end of second half 2024, so likely to be Q4.

[Takayuki Komori]

Next is Mr. Watanabe of MUFG Securities.

[Ryoichi Watanabe, MUFJ Securities]

I have a question about slide 18 and PW. If the correction continues until mid-2024 and demand remains weak, would you still expect LTA prices to rise in keeping with the terms of the contracts.

In this instance, volume could be significantly lower than initially expected. If that happens, would it be possible to raise prices further to mitigate the impact? What is your view at this time?

[Mayuki Hashimoto]

You are suggesting asking for further price increases in order to drive a recovery in profit if volumes fall off, that would be very tough to negotiate. However, it is unlikely that PW will see a rapid recovery.

There are many different types of products tends to be locked in to flat prices over long periods of time. So prices generally don't rise gradually overtime. I can't speak for other companies, but generally, customers tend to commit for long periods of time for a, with prices generally remaining steady.

[Ryoichi Watanabe, MUFJ Securities]

From that perspective, it sounds like the only area of concern would then be a decline in volumes. Is that fair?

[Mayuki Hashimoto]

There's no point in hiding volume declines. With customers making large-scale production adjustments, there's no way there won't be an impact. I don't know who it is in the industry that has suggested a recovery in the second half of 2023, but that doesn't seem realistic.

[Ryoichi Watanabe, MUFJ Securities]

Understood. Thank you.

[Takayuki Komori]

Our final question is from Mr. Yamada of Mizuho Securities.

[Mikiya Yamada, Mizuho Securities]

I was looking at the gray lines on Pages 17 and 18 and was encouraged to see that both went up in Q1. If we look at the graph on Page 16, inventory levels look very high. However, if we look at Pages 17 and 18, although inventory is intersecting with demand, it doesn't appear to be that high from a historical perspective. Based on these charts and if we assume that there will be a recovery in epi wafers in late 2023, there doesn't appear to be a need to be overly pessimistic about Sumco's earnings in 2024. Can you provide a qualitative view on this?

[Mayuki Hashimoto]

At Samco, Epi wafers account for close to half. This is different than our peers where epi wafers generally account for around 25%. And Sumco has the highest proportion of epi wafers within the industry, which is supportive in thinking about 2024. Also, Sumco has strength in IGBT and automotive use 300-millimeter wafers. Technologically, it is a very challenging and specialized product. Our share in this is also very high. So relatively speaking, this is supportive for our PW business. Although we are not talking about volumes in the hundreds of thousands here, volumes are relatively solid. Even now for this product, customers are asking for more volume for 2024. Given this, I don't see the need to be overly pessimistic about 2024 earnings. 2023 will be tough, but 2024 should be better. We don't disclose long-term forecast, but that would be my sense.

[Mikiya Yamada, Mizuho Securities]

If we only look at the graph on Pages 19 and 16, it seems to suggest that conditions will continue to be tough. But if you look at Pages 17 and 18, I think it suggests that conditions aren't actually that bad.

[Mayuki Hashimoto]

Slide 19 represents the overall market, but Sumco sales composition is slightly different than the overall industry average. Current conditions appear to favor a relatively earlier recovery for Sumco. Although the PW business is attractive when prices are rising, there is a lagging trend. Trying to navigate the volatility of this market segment is very challenging.

In contrast, epi is a leading-edge differentiated product where the number of players is limited. In addition, there is no lag because it is a made-to-order product and the product it is used for are also made to order. So, sales rise immediately on the back of an upturn in demand and vice versa. It is a product, where it is relatively easy to read the market environment. In the PW wafer market, even if you track market trends, it doesn't necessarily give you insight into customer behavior because of the lag.

For instance, in 2014, while the number of customers was rising strongly, inventory levels were also rising as well up to 2016. This is because customers were buying more than they needed, and we're letting inventory climb. This kind of behavior does not typically happen in the epi market. Mr. Yamada, I think that for PW, in addition to power semi apples, we are likely to see an increase in made-to-order products in GAA and other areas. I have high expectations for Sumco. Thank you.

[Hiroshi Itoh, General Manager, Accounting]

Mr. Komori. Thank you, everyone, for joining the Q1 2023 results briefing. We are grateful for your participation today. We will end the meeting here. Chairman, Hashimoto; and CFO, Takii, thank you.