Elmos Semiconductor SE

XETRA:ELG

Earnings Call Transcript 2021-Q2

[Operator]

Good morning, ladies and gentlemen, and welcome to the Elmos Semiconductor SE Conference Call regarding the results of Q2 2021. [Operator Instructions] Let me now turn the floor over to your host, Dr. Arne Schneider, CEO. Go ahead.

[Arne Schneider, CEO & Member of the Management Board]

Good morning, ladies and gentlemen, and welcome to the Elmos Q2 Conference Call. I can, once again, present to you a solid performance with strong increases in sales and EBIT in the past quarter despite a challenging market environment characterized by an ongoing high demand for semiconductors and the corresponding allocation challenges. As usual, you have the opportunity to ask questions at the end of my presentation. Before I'm going to explain the current market situation and the financial results of Q2, I would like to give you a short update about the COVID-19 situation at Elmos. Since the outbreak of the pandemic in January 2020, we have introduced extensive protective measures at all Elmos sites. This has enabled us to maintain our own production and business operations until today without any major disruptions. Starting as early as April this year, Elmos has coordinated 3 vaccination rounds for our employees and their relatives. This campaign was very successful. At our Dortmund site alone, almost 600 people have been vaccinated by external physicians. Every Elmos employee received a vaccination offer with their vaccine of choice. I think this is a great success and important step for us in the fight against corona. Since July, we have now introduced first small steps to ease some of the corona-related measures at Elmos concerning small group meetings or business travel and we also started the gradual and partial return to the offices. However, we are prepared to tighten the protective measures immediately should it be necessary. Turning to the market environment we currently see. Since Q4 last year, we have witnessed a very high demand for semiconductors across all industries. The ongoing boom of office and consumer electronic products and the faster-than-expected recovery of the automotive market resulted in soaring demand levels for semiconductors, which could not be satisfied by the global IC manufacturing capacity. This led to a longer and also more severe than expected allocation situation, which is also by far from not over. The entire semiconductor supply chain, including wafer production, assembly and testing is still under a great deal of pressure. In addition to the increasing real car demand, all automotive OEMs and Tier 1s naturally want to rebuild their inventory levels and increase safety stocks after the reduction during the corona crisis last year. To secure as many ICs as possible and to avoid potential line shutdowns, the current order levels of some automotive customers are significantly higher than their real production demand, adding even more stress to the already tight value chain and leading to some heated discussions concerning how much can be obtained. More and more market participants now expect that the current situation most likely may get worse before it will get better. There's also extensive coverage on the topic in the newspapers. The capacity bottlenecks, especially for agent wafers, will continue in the next year, which could temporarily dampen growth in 2022. All IC companies, including Elmos are faced with the limited fab and foundry capacities, supply bottlenecks for key components, significant material price increases and logistical challenges, all leaving traces on the business performance. I will further comment on this later in my presentation. In this dynamic market environment, Elmos, once again, had a successful quarter. Group sales increased significantly by 34.2% in Q2 to EUR 78.9 million, again, a new record in quarterly sales. You may have noticed that a part of that sales, of course, came out of our inventory. The EBIT improved to EUR 12.5 million in the second quarter of 2021 based on higher volumes. The EBIT margin improved significantly to 15.9% compared to 5.4% in the previous corona-ridden year. Overall, the Q2 results are in line with our quarterly guidance. However, as I mentioned before, allocation-related effects, especially material price increases started to impact our results in the second quarter. Our R&D expenses continue to remain on a high level, supporting the numerous serial launches and new development projects in all application fields. After 6 months, we are still fully on track with our new design win activities and we're able to acquire new projects in all of our product segments. Despite the temporary allocation situation, we have significantly intensified our own CapEx program in the back-end area as already announced earlier this year. In Q2, we have invested EUR 17.3 million, mainly in the testing area to install the necessary capacities at the Dortmund site and at our partner sites in Asia to secure our delivery capabilities. Although we have further reduced our own inventories by around EUR 3 million in the second quarter, the cash flow from operations was lower compared to Q1, mainly due to seasonal effects. As a result of the current allocation and the lack of external foundry capacity, we have reduced our inventory by more than EUR 10 million to fulfill our delivery obligations in the first 6 months of 2021 alone. The significantly higher CapEx spending led to a slightly negative adjusted free cash flow of minus EUR 3.4 million in Q2. Our spending will continue in the next months, influencing free cash flow in the further course of the year. Accordingly, our net cash decreased to EUR 47.3 million at the balance sheet date due to the negative free cash flow and the dividend payment in May. Looking ahead to the third quarter. Based on the current order situation, we expect another successful quarter, which will continue to be notably influenced by the allocation situation. For Q3 2021, we expect sales of EUR 79 million, plus or minus EUR 5 million and an EBIT margin of 15.5%, plus or minus 2 percentage points. The wider range of our sales and EBIT guidance reflects the increasing uncertainties about the future course of the allocation situation, the pandemic and related challenges such as logistical delays. That's also why a reliable forecast for the full year is still not possible at the present time. As I mentioned before, we expect that the challenging market environment will continue for the time being. Looking ahead into the next year, we are currently in negotiations with our foundry partners to secure sufficient wafer capacities for 2022. As you can imagine, these negotiations are very tough, and it has become pretty obvious for everybody that the capacity tightness will continue into the next year, especially for 8-inch wafers. Although some foundries have announced that they will allocate more capacity to automotive products, we do not expect a significant increase in overall 8-inch capacity next year. As you may know, all Elmos ICs are manufactured on 8-inch wafers only. And since our own fab in Dortmund is fully loaded and cannot be expanded any further, our growth potential critically depends on external 8-inch foundry capacity. Our view regarding potential capacity constraints in the next year is supported by various announcements made by foundries or OEMs in the last weeks. For example, the DIGITIMES Asia published an article in early July, stating that, and I quote, " Foundry capacity supply could become even tighter in 2022, particularly at 8-inch fabs. And that again, capacity promised for 2022 can satisfy only 70% to 80% of demand. " This is status today a realistic reflection of the actual situation and the current state of our negotiations, and more and more market players expect that the global semiconductor shortage will continue into the next year. We, of course, work closely together with our wafer factories to ensure that Elmos is not the cause of any line down. We were not, of course, up to now, and we will do our utmost to keep it that way. However, despite these temporary growth numbers, the semiconductor market will continue to develop positively in the long term. And based on our innovative product portfolio and strong financial position, Elmos will be able to successfully participate in the positive development of our markets in the future. So far, thank you very much. I'm opening the floor for questions.

[Operator]

[Operator Instructions] And the first question comes from Stephane Houri from ODDO.

[Stephane Houri, Research Analyst]

I have a few questions on the outlook, obviously. What presents you from now to guide for Q4 already, what kind of order book do you have? We had some comments yesterday from Infineon saying that basically, they had years of order book. So I assume this is probably a problem of capacity and supply chain. But is, at this stage, a flat Q4, a good assumption. So that's the first question. Very long question, I admit. And also for 2022, how should we translate what you are currently saying? Are you calling for an inaugural year in 2022? Or do you think you can gain productivity or maybe price increases will provide you some growth? Or yes, if you can also describe the discussions with the foundry. You said it's very tough. But what can we expect at this stage?

[Arne Schneider, CEO & Member of the Management Board]

Thank you, Stephane. On your first question, we do see that we come into a situation where our inventory is basically empty. At the same time, we see the corona pandemic is not over. We see a partial or full factory shutdowns, sometimes for days, sometimes for weeks of some suppliers in Malaysia, in Thailand. And at the same time logistics gets less plannable. Also, there are some supply constraints such as lead frames at assembly houses. So overall, the key thing why there is volatility is not that our customers are not willing to take any amount of ICs and all amount of ICs that we can deliver. The key thing is that since we are living from hand to mouth basically, in the value chain, that is the hard thing to predict. So our order book, just as Infineon commented yesterday, I believe, is super full. So given on the orders, I guess, or I feel 120 million or 140 million cars could be built, but these are wish orders. When they are reduced to the allocation level that the customers get. So orders these days are nothing. You get an allocation. And that is what you can expect to get delivered. So the key in the volatility like in the value chain lies more in actually bringing it out. And it's stronger than it was in the past because -- as I said, we cannot just say, well, we have the inventory. We are sure that we have. No, we get it. We test it. It goes out. It's all a very continuous flow. If we lose the week due to whatever corona or material shortage, then it's just not there. And then it's no revenue with all the things linked to it. So that is the key concerning why we have a little difficulty being as precise as we have been over the years with our forecast. On 2022, we just -- we're in a very unclear situation. This is not finished. I mean in the current state, we have basically a flat wafer allocation from our foundry partners. And given that we delivered substantial volume out of inventory this year, this would lead not only to no growth but to worse next year. And obviously, it cannot stay that way. And I do expect it will not stay that way. However, these are intense difficult discussions that are going on. And they are key for our cost in 2022. So we just want to make you aware and also since -- I mean, you can read the newspaper basically every second day. I believe it would be foolish that we don't talk about it and just ignore the existence. These are discussions where we do not know the end of it. We are very much pushing for a good end for Elmos. But status today, is that it's unfinished.

[Stephane Houri, Research Analyst]

Okay. And can you just remind us how much of your inventories you sold in your revenue this year so far?

[Arne Schneider, CEO & Member of the Management Board]

Well, so far, we had EUR 10 million less inventories in the first half. So that is probably -- it's a very rough rule of thumb, double that in revenue because, of course, in inventories accounted at cost, with our gross margin, it's around double that in revenue.

[Stephane Houri, Research Analyst]

All right. And just a housekeeping question. Can you update us on the tax rate you're expecting for this year and for the coming years?

[Arne Schneider, CEO & Member of the Management Board]

Well, I would guess that our tax rate will fluctuate around 30%, not only this year, but also for the time being. We actually, some years ago, did a tax project to see whether we can somehow reduce that. But in Germany, it was the time of Mr. [ Schaller ] but under Mr. Schultz, things have not get -- or changed in any way. It is very hard to get to a lower tax rate. We would have to shift substantial business operations to Ireland or Singapore or somewhere where we just cannot shift very substantial operations. I mean it can shift a little bit, but then this has not the effect that we wish for. So I cannot give any up there. We will likely fluctuate around to 30%.

[Operator]

And the next question comes from Johannes Ries from Apus Capital.

[Johannes Ries, Founder]

Also some questions like always, maybe following the question from Stephane. Maybe you can be -- to repeat it. What about pricing? You talked about price increases in your supply chain. But I think you are also able, and Infineon has talked about also yesterday, that is able and the customers accept it and know about the situation to increase the prices at your customers, maybe with some time lag. But you said -- could that help in some regard to get at least stable or maybe revenues or growth next year. And like you said, although it's not clear if you stay with a stable capacity. I have a follow-on, but first, maybe with this -- let's start with this pricing question.

[Arne Schneider, CEO & Member of the Management Board]

Yes, concerning pricing. Of course, we do increase prices. We do negotiate around that. It's not all finished, but we have to ask our customers for their share of the burden concerning allocation-related costs because these are real and these are large. So we cannot just take that on our own shoulders. I believe it's a very fair approach to do a cost share when it comes to allocation related additional costs. Meaning that we have some burden, but we, for sure, have not all the burden. And we also have the growth, which somehow goes against that burden when it comes to profitability that are, of course, price increases, but they are not kind of huge. So theoretically, of course, yes, they do help to grow, but it's small growth.

[Johannes Ries, Founder]

And -- but it should help to at least hold the gross margin up? So to surpass your cost increases to the -- in the price? That's the idea?

[Arne Schneider, CEO & Member of the Management Board]

Yes. Well, the idea is, of course, to find a fair solution with our customers. If that means a really stable gross margin or slightly decreasing, but then we have OpEx effect and scale effect in the OpEx such that we can somehow keep the overall profitability, that would probably be okay. I mean we don't want to get rich by charging our customers in these difficult times unfair amounts of money. This is not us. Our policy is to share the burden with our customers in a fair way and that's what we ask of them, and that's where we also have to insist on because there is no other way.

[Johannes Ries, Founder]

Maybe on your own fab, how much of your sales are coming percentage wise around from your own fab? And you said you are fully loaded, it's clear, but there are not some efficiency measures possible to a little bit maybe in the low percentage-wise maybe increase the output next year? Or is it totally impossible because you are -- can't increase efficiency anymore?

[Arne Schneider, CEO & Member of the Management Board]

Yes, first of all, it's around half, half internally. I believe end of last year or beginning of this year, I asked Guido Meyer, my head of production, the Board member for production, for an additional maybe 15 or 20 wafers. And of course, that -- this is way not possible, maybe 5 a day and -- or maybe 8. And that's where you can see this is really limited but we try to squeeze out as much as we can.

[Johannes Ries, Founder]

So it's not a surprise, but thanks for the confirmation. Maybe another question. There is one H in fab, which is -- will still have capacity because it shifted to the foundry side now to more advanced solutions, but it's coming -- it's closely related to your main competitors, [indiscernible] . Therefore, could you say for maybe more general, are there other maybe potentials to go to a third foundry partner to get additional capacities, especially for new projects? I know this, you need this certification. Therefore, it's hard to move an old project to a new source. But is that a potential opportunity? And is this [H fab] solution totally out of any discussion because it's so close to Melexis?

[Arne Schneider, CEO & Member of the Management Board]

Well, the [ H fab ] discussions, we wouldn't entertain for the reason you mentioned, but also for a timing reason. I mean this would become online in 1.5 or 2 years and -- so this is no immediate relief. That would also concern every new foundry. However, what we do, we try to ramp our 130-nanometer project a little quicker. We asked some customers to take the newer product because then we get overall a little bit more wafers for next year. This is a very limited thing. But still, we try to find all the measures that there are to ensure that we deliver to the best of our abilities, including all additional measures one can think of.

[Johannes Ries, Founder]

That's clear. Finally, if I look to your CapEx in the back end, it's really high. Therefore, you don't invest in your testing capacities if you not see very interesting growth maybe after the year 2022. Is that right? This assumption?

[Arne Schneider, CEO & Member of the Management Board]

Yes. And then even in '22, I want to kind of quote the community. The only thing that we can currently say is an unsolved problem. However, with the lead times that exist on testing equipment, I can -- if I were to decide today that I only invest in testers where I have the wafers for, then we would need to invest a lot less. But these are open discussions, and they may be open for some time, and '22, for sure, will not be closed quickly. So we have to kind of go out on a limb there and make an assumption. The thing that we -- as the Board of Elmos cannot accept to happen is that Elmos is unable to deliver because we failed to invest in testers. That should never happen.

[Johannes Ries, Founder]

Great. Super. And it's also for the years after 2022 because you said very good design wins a very full order book and so on. So for...

[Arne Schneider, CEO & Member of the Management Board]

If we did it some months later because we -- I mean these are things that run for 15 years. It's not that the first few months -- I mean, in these days, we must be able to deliver. That is the key. And then it comes to optimization and efficiency. But the first thing is really the key that we are able to deliver.

[Operator]

And the next question comes from Malte Schaumann from Warburg Research.

[Malte Schaumann, Equity Analyst]

The first question, unsurprising, again, on 2022. From a timing perspective, I mean for the first quarter next year sales, wafer production has to start maybe 2 or 3 months. Would you say that this is more or less take the volume and the discussions are rather open than for the second to the fourth quarter? Or is there still any scope for even more capacity for the revenues you then require in the first quarter?

[Arne Schneider, CEO & Member of the Management Board]

Well, I think we will get decisions on our wafer allocation and what we finally get as wafers. I mean, not what we currently have, but what we finally get, which I hope is more than today because otherwise, the [ cars ] will be large. So it must be more than today, but we won't get it for the full year, generally, I would expect. I would expect we kind of have decisions that are relatively close to the time where you actually have to start the wafers at the foundries.

[Malte Schaumann, Equity Analyst]

Okay. And that will be kind of a monthly or quarterly thing probably?

[Arne Schneider, CEO & Member of the Management Board]

Well, there's no clear proceeds written down for these kind of procedures.

[Malte Schaumann, Equity Analyst]

Okay. So still for the first quarter of production late in Q4, so things are pretty fluid?

[Arne Schneider, CEO & Member of the Management Board]

As you said, in the next month, we have to get some sort of result out of that. That is what everyone is aware of. It's not today, but it's -- time is flowing forward. So -- yes.

[Malte Schaumann, Equity Analyst]

Okay. And do you have any insight in the [indiscernible] process in the sense that is your supplier keeping the capacity and then deciding on very short notice who's offering the highest price the scarcity issue to avoid line downs, as you said, and we need it the most from an urgency perspective to be flexible in that respect. Any insight which is the criteria the supplier faces this final decision on foundry?

[Arne Schneider, CEO & Member of the Management Board]

Yes. It's all those and with various ways at different suppliers. I mean some are less concerned about the reputation and more about money. Others are more concerned about doing the right thing. But of course, it is -- I mean, if you allocate all the capacity in 8-inch globally only to automotive and then the car guys, unconstrained, sit on high inventories after 2022, which would happen if you let it go totally unconstrained, then you also did the wrong thing. So there is no other way than to discuss what is really needed to keep everything rolling. And these are, of course, difficult discussions. And we hope that everyone is reasonable, and then we'll keep on rolling as good as we can.

[Malte Schaumann, Equity Analyst]

Yes. Sure. Okay. And then on the CapEx, the Q2 number, was that kind of a spike or should we expect kind of a similar level somewhat in the third or fourth quarter?

[Arne Schneider, CEO & Member of the Management Board]

We will actually invest quite a lot this year. There is potential volume, at least if we look at the demand from our customers that we need to prepare for because as I mentioned, I think it would be -- given that we got longer and longer lead times on machinery, we have to be careful that we're not caught an allocation there again. Such that we, ourselves, are the bottlenecks to delivery. That is currently not the case and we want to really make sure that it will not be the case in the future.

[Malte Schaumann, Equity Analyst]

Yes. I'm going to [indiscernible] anyway. So it doesn't matter. Okay. And then strategically, any -- is the current situation kind of accelerating your plans to products to 12-inch wafers? I understand that this is a lengthy process, but is there something in volumes that -- for the next generations, is it able to be moved to 12-inch?

[Arne Schneider, CEO & Member of the Management Board]

Well, today, no, concerning the next-generation technology after the one we just started with the 130-nanometer you can discuss many things. But until that comes into serious delivery, that is a long time. So we will, for the time being and for the next years, many years, we are an 8-inch. Also, we asked some foundries whether for them, it makes sense to transfer processes we are on right now to 12-inch, but they declined that. So we are, for the time being, on 8-inch.

[Malte Schaumann, Equity Analyst]

Yes. Okay. And then maybe a quick word on design wins, everything going to plan, strong [indiscernible]?

[Arne Schneider, CEO & Member of the Management Board]

Strong and on track. I mean, these are also the days where when you ask the customer for written confirmation of their design win, which may only come online in '24 or '25. But still, we have a climate where semiconductors are valued. And then if you want to close the deal, then it's not only the supplier that wants to close the deal, it's also the customer that at some point wants to close the deal and say, "Okay, now we agree we sign it." That's it. And that's, of course, the requirement for design wins. So design wins develop nicely.

[Operator]

And the last question comes from Robert Sanders from Deutsche Bank.

[Robert Duncan Cobban Sanders, Director]

My first question is about redesigning by OEMs and Tier 1s. Can OEMs or Tier 1s redesign with alternate suppliers if you're not able to deliver products? And which of your products are substitutable and which are just not because they are cell-specific and qualified that, that happens? And I have a follow-up.

[Arne Schneider, CEO & Member of the Management Board]

Well, I think it is rare that you get on anything in a reasonable -- I mean, of course, you can and you can do for everything. It only depends on timing. But within reasonable timing such that it has any effect, say, on 2022. This is a very hard thing to do. You can only do that if you are willing to take substantial risk of failure of such a product, such a new product. Because you will be unqualified, you will have no tests and you will just shoot in the dark. The thing that you can discuss is leaving things away, to restrict your customers or the end customers of a car that you just say, look, this is a feature, but it's unavailable. Say you have climate control and you say, look, this is a feature currently unavailable. You can only get it with 2-zone climate control because you say [indiscernible] that. That is a more realistic option, although, of course, I believe, the car manufacturers hate it. So we haven't seen that to any noticeable [indiscernible] to now.

[Robert Duncan Cobban Sanders, Director]

Got it. And if you get a flat wafer allocation in 2022, at what point do you think your would start to have the issue around line down? Because I guess this year, there will only be 80 million production units, but your demand today is probably 95 million. So there must be some inventory out there that they can absorb some kind of buffer inventory, but at some point, that will be exhausted. So do you think the line stock issue would materialize in '22 or might crystallize the year after?

[Arne Schneider, CEO & Member of the Management Board]

No. We are pretty sure it materializes in Q1 '22 because we did the exercise with the OEs and this feeds into our discussion with foundries.

[Robert Duncan Cobban Sanders, Director]

Got it. And then the last question is on the OEMs, they're all profit warning on the second half at the moment, BMW just yesterday talking they've exhausted their inventory and now selling shortage is really biting. But the thing I don't really understand is in first quarter, there was a lot of attention on NXP and [ Renesas ] because of the microcontroller issues, supply issues, and that led to the foundries going public and saying they were prioritizing automotive microcontrollers at the 40- to 65-nanometer nodes. Why has there not been a profit escalation process in the smaller value parts like sensors and power management chips? Why has there been a kind of breakdown of communication here in the industry, given -- as you say, there could be a line down in Q1 '22 caused by Elmos, heaven forbid.

[Arne Schneider, CEO & Member of the Management Board]

Yes. I mean there is a lot of communication to avoid that right now. So I believe we are kind of going forward as we go. So there is no great all-encompassing map of who needs semiconductors and how many and where they come from because it's just too complex. But as we go on, we need to discuss month by month, quarter by quarter, however, it will happen. What needs to be done. And that is what is currently happening. So it's a lot of -- it's a lot of dynamic in that situation. And we have a view on what needs to be done and the OEs have a view on what they definitely, lowest level possible need. And the foundries, of course, need to protect their other customers, but also I believe, fundamentally, they make their point, yes, we want to support. But of course, you also see that there's limited transparency concerning the whole world at the same time. So we...

[Robert Duncan Cobban Sanders, Director]

What incentive is there for CM1 to be transparent about their inventory when having inventory is now a [indiscernible] that now enables them to take market share. So why would I be transparent if I'm a Tier 1, for example?

[Arne Schneider, CEO & Member of the Management Board]

Well, if you -- there is just not that transparency from our side. I mean, if you have a certain product, it goes -- I mean we have a lot of product, and we are a small player. And we have a lot of customers. And they again have a lot of customers. So this is even for the pure Elmos thing, this would be a gigantic XL. And if you then add some of the others because it's an optimization not only for the little Elmos share, but also for all of our competitors that require foundry capacity. So that is just not there. There is no complete halfway real-time stock level plus IC level, plus lead times, plus end demand there. So we try to give as much transparency as we can get as the OEs can provide in addition. And then that's the basis for a discussion. And in the end, there have to be judgment calls, what can be done and what can't be done.

[Operator]

[Operator Instructions] There is another question from Johannes Ries.

[Johannes Ries, Founder]

Yes, a short follow-on to a more general topic. We discussed it even in the last call very briefly. Have you heard anything from politicians from the EU or say talking about maybe to build up own European capacities and to talk with the industry, have you heard anything about them?

[Arne Schneider, CEO & Member of the Management Board]

Yes. We will be part of an interest group just to be close to what goes on. However, I think these are more kind of very long-term things because building a fab, choosing a location, building it, getting it online, getting process transferred, we're not talking '22 or '23 there. We may talk '25 or '26, if it's applicable to Elmos at all. So what you sometimes read in the newspaper that the European fab will then immediately start to solve all the problems. I think this disregards the timing perspective of such efforts.

[Johannes Ries, Founder]

That's clear. That's clear. But there is some movement, but slowly and it's something for the long term if it happens. And I have a feeling the Americans are much faster seeing the recent announcements of [indiscernible] so it's not only my [indiscernible] also the U.S. government a little bit behind it. But okay, they know more about the industry. So that's a big advantage.

[Operator]

There are no more questions.

[Arne Schneider, CEO & Member of the Management Board]

Very good. Thank you very much for your participation and your interest in Elmos. I would also like to remind you that we will publish our Q3 results on Thursday, November 4, 2021. And finally, I would like to wish you all the best, stay healthy and confident. Goodbye from Dortmund.