Elmos Semiconductor SE (ELG) Earnings Call Transcript & Summary

Hello, ladies and gentlemen. And welcome to the extraordinary conference call of Elmos Semiconductor SE. At this time, all participants have been placed on a listen-only mode. The floor will be open for questions following the presentation. Let me now turn the floor over to your host, Dr. Arne Schneider, CEO. Please go ahead.

Ladies and gentlemen, welcome to this extraordinary conference call, and thank you very much for participating on such short notice. So the wait has finally come to an end, and I'm very happy to present very good news to you today. We have signed contracts actually early this morning. with a publicly listed U.S. technology corporation, Littelfuse for the sale of our wafer fab and have agreed on a long-term supply agreement at least until the year 2029. We are very happy that we now have a new and strong partner on board who will secure and expand wafer production in Dortmund in the long term. After the very disappointing provision in November last year, we have now found a very good new solution in a short period of time. With today's agreement, Elmos can now implement the important structural transformation into a fabless company as planned. And it also provides a sustainable and long-term perspective for the Dortmund wafer fab and all of its employees. So before we go into the details of the transaction, let me briefly recap why we have decided to sell a fab and become a fabless company. At the Elmos wafer fab in Dortmund, semiconductors are manufactured in the long time proven 350-nanometer technology, primarily for automotive customers. In the coming years, the demand for these Elmos 350-nanometer products will shrink because new and more powerful products, successor products partly with a higher performance are designed in newer or smaller technology nodes. And these, we cannot manufacture at the Elmos wafer fab. This development would have led to a critical underutilization of the fab in the medium or long term. The associated fixed cost burden would have led to a considerable product cost increase and a significant competitive disadvantage for Elmos. In the final consequence when the load is virtually completely gone. This would have resulted in the closure of the fab and the loss of jobs, including considerable restructuring costs. Therefore, the sale of the fab to a leading corporation capable of enabling high capacity utilization with new technologies and products is the best option to secure the Dortmund location and the jobs in the long term. So let me summarize this important transaction and give you some information about our new partner. Elmos Semiconductor SE and the German subsidiary of Littelfuse signed an SPA for the sale of the Dortmund wafer fab for a net purchase price of EUR 93 million. A payment of around EUR 37 million, 40% and will be transferred after regulatory approvals already. And the rest of the purchase price is viewed at the final closing. In addition, Elmos and Littelfuse have agreed to enter into a long-term supply agreement until 2029 with almost buying a certain volume of the processed wafers produced at the Dortmund fab. The share of our product is higher in the beginning and has a tail, of course, towards 2029, and maybe we even continue something beyond 2029. The supply of sufficient wafers from Dortmund is therefore secured without interruption for a very long time. Initially, for the first years, Elmos will take virtually all of the capacity. This is the reason why we have also agreed with Littlefuse that the closing is expected to be effective on December 31, 2024. So in 1.5 years from now. With the plant closing only towards the end of 2024, Elmos retains full operational control of the wafer fab for the time being. And at the same time, Littlefuse will have sufficient time to prepare the transformation of the fab with new technologies and products. The closing of the transaction is subject to certain closing conditions and regulatory approvals. Among them, the foreign trade clearance by the German ministry for the economy and climate action. As Littlefuse the U.S. parent of the actual acquiring entity is a non-EU cooperation. However, we do not expect headwinds from politics or the ministry in Berlin. The sale to a technology leader from the United States opens up new prospects for the wafer fab with power semiconductors for climate technology and renewable energies and in secure semiconductor production in Dortmund and the associated jobs in the long term. At closing, the German subsidiary of Littelfuse will take over 100% of the shares in the Dortmund semiconductor GmbH, which is, as you will, for sure, know the carve-out entity of the Elmos wafer fab, including the direct and indirect personnel. Littelfuse will acquire the wafer front end processes only. Elmos will continue to conduct all testing activities, wafer testing and final power testing in-house and in cooperation with our external testing partners in East Asia. The transaction will have no material effect on the EBIT in the fiscal year 2023. Since closing is not expected, as I told you, to be effective until December 31, 2024. Therefore, the current forecast for our EBIT margin in the year 2023 is unchanged at 25% plus or minus 2 percentage points. The cash flow in fiscal year 2023 will be positively impacted possibly at least likely, by the payment of around EUR 37 million after regulatory approvals. Independent of this transaction, we have also reviewed the guidance and decided to intensify once again the expansion of test capacities for our future growth. And we now expect capital expenditures of around 19% plus or minus 2 percentage points of sales for the fiscal year 2023. Previously, just as a reminder, it was 17% plus or minus 2%. As a result, Elmos now expect a negative operating free cash flow and operating, meaning without effects from the transaction in 2023. So ladies and gentlemen, we are now able to transform Elmos into an even more agile fabless company. We will be fully flexible to access a wide range of state-of-the-art wafer technologies, and we can continue to focus on utilizing our strong growth potential with highly innovative automotive IC applications. We can continue to build on our core strengths of IC design and systems and software understanding and will be able to tap into new fields of growth. So I think we will be more innovative, we will be faster, we will be more efficient. So then who is the owner of the Dortmund wafer fab. Founded in 1927. So this is, I mean, 1927, just to -- Littelfuse is a global leading U.S. tech corporation today, headquartered in Chicago. Littelfuse develops, manufactures and sells circuit protection, power control and sensing products and operates in the electronics, transportation and industrial segments. In 2022, Littelfuse generated group revenues of approximately USD 2.5 billion. Littelfuse shares are listed on the NASDAQ. The shareholder structure is very broadly diversified also with no known significant shareholders from China or other critical countries. So I guess this is an important information at least we closed it off. In Germany, Littelfuse operates in several R&D sales and manufacturing locations already, including a 6-inch wafer fab in Lampertheim near Frankfurt am Main. With the acquisition of the Elmos fab, Littelfuse invest in the expansion of the existing manufacturing network in Germany and in the expansion of capabilities and capacities for power semiconductors for industrial application especially in the area of climate technology, renewable energies and electro mobility. The Elmos fab is an important milestone in their strategy as they need additional capacity to realize the growth potential in power semiconductors and also it's an 8-inch facility, which is good and adds to their portfolio. In the first years, the Dortmund fab is still very well utilized with the traditional Elmos products. With the gradual phaseout of these products, Littelfuse will realign and structurally develop the fab. The existing CMOS manufacturing technology will be replaced. The power semiconductors produced in the Dortmund fab will be used primarily in the industrial applications in fields like renewable energy and electro mobility, as I mentioned. This will give the semiconductor location in Dortmund, an even more important role in digitization and energy transition in the future. Ladies and gentlemen, this transaction and our new partnership with Littelfuse is a major milestone for Elmos, our employees, customers and investors. We have found a new partner for the -- our fab in Dortmund and secured the supply of our 350-nanometer product for a long period of time. Today marks the start of an excellent foundation for an even more successful future for Elmos and all of our employees. So thank you very much for your attention. And I'm now looking forward to your questions.

[Operator Instructions] And the first question comes from Malte Schaumann.

Closer to the view. Then just my first question is, are there further material conditions that have to be met to each conclusion by the end of next year? Or is this just a timing component and then kind of an automated process?

Well, we do have good pricing conditions. We do have typical closing conditions, but these are in the hands of the parties. And the key external things if I remember correctly, on the one hand, FDI, so clearance from the Bundes Wirtschaft Ministerium and [indiscernible] And then there's customary others. But we actually do not perceive that there is a huge risk amount.

Right. So like in the final approval appears to be very high.

Well, I mean this is a deal that is very good for Dortmund, for Germany, for technology. Coming into Germany, a little bit again, but it is a deal where technology comes to Dortmund and a bunch of technology comes to Dortmund. There is no intention to use the existing 350-nanometer technology. Unsurprisingly, of course, this is not of interest. Of interest is the capacity of interest is our highly experienced team of interest is not the technology of Elmos. There is going to be a technology inflow and an inspiration and a shift of focus, of course. We do mixed signal semiconductors. It's going to be power semiconductors and these are, of course, very different in the future. Luckily, they are largely compatible in production. So the switchover can happen over a certain period of time. This is really good.

Okay. Next question is on margin impact. I think with the site you said that you expect the transaction to be more or less neutral to the pre-margin levels. Is this still valid th. En also for the year with uncertainties?

Yes. This is again true. I mean the -- we will only see, of course, the margin impact after closing or anything significant after closing and then there won't be too much.

And you have always agreed on the price in wafer for the part you buy from them until 2029.

Well, it's we agreed on a price finding mechanism.

On current trading. I mean you can maybe comment on current trading, is that changed in the demand pattern. And then secondly, to the increased CapEx. Is that coming from higher volumes you're seeing in maybe that towards 2024 reason for stepping up.

Yes, the CapEx is actually mostly linked to next year because anything that we newly decide to acquire as machines only has a very limited impact on this year. But we see good momentum generally. And that is why it is necessary to step up our investment in testers.

Right and this momentum kind of accelerated because you had to raise your investment levels?

I mean whenever something changes, you have to adjust to it. We do feel a very strong obligation to deliver to our customers what they really need. And that, of course, may at some point in time require more test machines.

Yes. Okay. Maybe can you comment on discussion about inventory, the supply chain. What's your view?

Well, I believe we're in the normalization phase. People cannot buy everything they want and everything immediately, but it's not as bad as it was. And I believe that in 2024, will be out of the woods for quite a number of products and segments. At least if there are no kind of big ramps or big kind of new requirements that also sometimes happens. But generally, I believe we are on our way towards normalization.

Okay. Good.

[Operator Instructions] And the next question comes from Robert Sanders.

From Deutsche Bank. I just had a first question. Just can you remind us how much of the cost of goods sold or how much of your foundry supply so your manufacturing supply comes from the Dortmund fab? And I've got a couple of follow-ups.

It's somewhere around 1/3 Rob, first, thank you for your question. It's somewhere around 1/3.

Okay. And just remind me, the mechanism when this thing comes off the balance sheet, there's no depreciation to come off, but you will have to pay a cost plus kind of setup. Is that right? So I'm just trying to work through the mechanics on the P&L. Could you just be a bit more detailed about that gross margin, EBIT margin, et cetera?

Yes. I mean we will, of course, only see that in '25. Just to remind everyone of the -- at least the schedule for closing. So what will happen? We see less assets. We see less depreciation. We see more buying. So we see more third party. We see less personnel costs because that goes into the wafers that we buy and you're right, we are kind of -- our price finding mechanisms. It could resemble a model that you would use within a group for cost plus pricing. And it's reasonably similar.

And let's say it's cost plus 25%. Would that -- how would that compare to market pricing for 0.35-micron foundry wafers.

Our cost plus 25% sounds wrong. We can't really tell you the number, but the number 25% sounds outrageous. This is, I cannot afford such things. No, no, we still want to buy them at -- and then we have reasonable arrangements. One other thing that, of course, happens when we have closing is that we have some extra ordinary income.

Got it. So in conclusion, will there be any impact in '25 on gross margin and EBIT margin?

There will theoretically be a little impact, but honestly, it is so small that a lot of other factors will be bigger.

Okay. And just following up on the current trading. So it sounds like the -- is it fair to say your demand outlook today is better than it was in early May when you last reported? Because that's why you're intensifying your CapEx investment in testers? Or is it just -- or do you think it may be more just Elmos-specific design win pipeline that is just a function of new products, et cetera?

Well, since we last kind of reviewed the guidance, we looked at our customers and our customer orders for this year, but also for '24 and have some serious discussions with customers on what the demand for '24 will be and what we need to do. And that's a little bit what comes out of it. So yes, there is an update and we need to reflect the additional demand, particularly in the new year. I mean, as you know, we've got this horribly long value chains. And we have lead times for the investment. So we have to look a little bit into the future and then react accordingly.

Got it. Just last question would be, there have been some stories about founderies increasing pricing again next year. Have you had any indications yet about what the pricing for foundries will be flat or up next year and whether you can pass that on to your customers?

Well, the last thing I read in the press, and it doesn't seem inconsistent to the general news situation is that it looks like flattish. Let's see what comes out. I mean it's still not time for yearly price negotiations. But I believe TSMC is somewhere in the flattish range. though they haven't or they have been -- they followed a very sensible and kind of less volatile pricing strategy. Some of the others had a more, I believe, volatile or aggressive pricing strategy. So this might -- may, of course, again, be prone to more change than, say, the Taiwanese approach where they have a very sensible, moderated and kind of long-term view on how things should go.

Got it. Congrats on the deal.

And the next question comes from Hugo Moss.

Yes, I would have two follow-up questions regarding the impact for you of the Dortmund Divestment when it comes to the CapEx and the amortization, could you help us to assess what kind of CapEx in the last years? And do you allocate to Dortmund every year? And same thing for amortization, how much of amortization are dedicated for Dortmund, please?

We had a little less than 2% or percentage points of our CapEx going into the wafer fabrication recently. And that then, of course, goes away. So that is good. The depreciation, of course, also goes away. I believe it's in about that range. So it's not a huge impact. But of course, if we look at this transaction, we see a very substantial cash inflow we will see a very substantial extraordinary income. So that is what makes it for us very attractive combined with the fact that the kind of looming threat of restructuring or I mean, I believe some people wrote or thought that after the provision, we now have to sell the fab for kind of a pitiful price or so. We are happy to come to the conclusion that, that is not right. But we haven't added pricing. We will even see a substantial extra income. Of course, at closing, right? This is not a cost earnings this year. There's only likely that not going to be a cash income.

Okay. Okay. And then on the utilization of this cash, until you have already an idea of what could be the cash inflow.

Yes. Part of it will, of course, go into our beloved test machines. But on the others, I can't tell you. We should wait for the regulatory -- I mean we're a little bit like a burnt child, right? I mean we should wait for the regulatory approval to before we really discuss it. We kind of started discussions when we had the other deal a little bit before and kind of thought what should we do. But I believe this time, everyone is waiting for the money to be there before we actually kind of decide on how we are going to distribute or use or do whatever.

Okay. Very clear. And just the last one. Could you give us some details on the visibility that you have at this moment for 2024? Do you offer some contracts that are running in to this time frame? And is it a big part of your order backlog that is related to 2024? It's small part and do you guess you have, over time, a more contract on the long term on basis? Could you state how many -- how much does it represent of your backlog, maybe second term contract...

Well, we, of course, do contracts that -- or these days, we do contracts that cover many or multiple years. We wouldn't disclose how much that is. But it is not that such contracts insulate us from whatever the business cycle adopted just kind of gives a lot of stability in certain customer relationships into certain products, which is good. And I mean, it's especially important for ramp projects. where we do have to do a lot of new investments, then we, of course, like to do a multiyear contract such that we secure that investment, but we also can do the ramp operationally. We try to get as much visibility into '24 as we can, discussing with our customers because the normalization phase, I believe, should also be a joint effort between us and our customers. We all need to settle on what it should be, not too much and not too little. And this is what we, together with our customers, try to achieve.

And we have a follow-up question from Mr. Schaumann.

Asking for. I think with the Silex deal you mentioned to or you accounted for about EUR 5 million in transaction costs. Are these expected to kind of reach for a similar level? And are these [indiscernible] units [indiscernible] big items?

Well, I believe our guidance kind of holds and we will have to pay some money to lawyers and these types of people. That is true. You can now try to attribute some cost to the one deal, some cost to the other deals. So this is an exercise we haven't really done. So after we kind of attributed something to the different deals, we can be a little bit more precise on transaction costs. But it's kind of the very normal things that you always have to pay, and it's not going to affect the guidance.

Ladies and gentlemen, we didn't receive any further questions. So let me hand over to Dr. Schneider for some closing remarks.

So everyone, thank you very much for your participation and your interest in Elmos. I would -- the last thing I like to remind you that we will publish our half year 2023 report on July 27, 2023. So with that, goodbye from Dortmund, stay confident See you then.

Thank you.