VAT Group AG (VACN) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the VAT Q3 2022 Trading Update Conference Call. I am Sandra, the Chorus Call operator. I would like to remind you is being recorded [Operator Instructions]. The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Mr. Mike Allison, Chief VAT Group. Please go ahead, sir.

Thank you. Ladies and gentlemen. Good morning, and welcome to VAT's Third Quarter 2022 Trading Update Conference Call. With me this morning are our CFO, Fabian Chiozza and our Head of Investor Relations, Michel Gerber. After my introductory remarks, we will start the Q&A session. The call moderator will take the questions in the order you enter them. So I trust that you've both seen the media release we issued this morning at 6:30. And I'd like to point out that we are very pleased with the way the third quarter of 2022 has developed. Geopolitical uncertainties, the persisting supply chain challenges, and more recently, weakening customer demand have not prevented VAT from posting another set of very strong results. Record quarterly sales levels were achieved in the Global Service business in semiconductors as well as in our Advanced Industrial business. To achieve these record sales level, it was crucial that the whole operations team from procurement to machining and assembly was able to further increase our factory output not only in Malaysia but also here at Switzerland. This great effort allowed VAT to satisfy the customer requirements for products and services. And I'm proud again to be able to say that VAT has not been the bottleneck for our customers. So a big thank you goes out to all of our 2,900 employees around the world have made such a strong result possible in the third quarter. At the same time, VAT is aware of the challenges that we're still dealing with in [indiscernible] the challenging supply chain with regard to cost inflation or the need to further increase our factory output. Here, we have gained invaluable experience over the last 2 years. We are confident that VAT is best positioned to deal with these challenges. Now let me turn to our business performance in the third quarter. Demand in the third quarter of 2022 remained at a healthy level as investments in the semiconductor industry continued, driven by technology advances and ongoing capacity increases in the lagging edge products. At the same time, demand for service offerings continue to grow as persistent high utilization rates in the semiconductor fabs require high levels of maintenance to prevent shutdowns and to further increase the productivity of those assets. This led to record quarterly sales in Semi and the Global Service businesses. And also the Advanced Industrial business unit contribute to VAT's strong Q3 performance with record sales by continuing to expand its activities in targeted growth sectors such as industrial coatings, crystal pulling used to produce silicon and Silicon Carbide and medical equipment devices. The Display & Solar business reported higher Q3 sales versus prior year period on the execution of orders received back in 2021. The further ramp of the factory output in Malaysia and Switzerland continues as planned. And as already mentioned, thanks to the capabilities of VAT's global supply chain organization enabling the company to provide uninterrupted product deliveries and services to all its customers despite supply and logistical uncertainties. As a result, the Group's Q3 net sales reached CHF 306 million, a 33% increase compared with the same quarter in 2021 and above the midpoint of the Q3 guidance of CHF 290 million to CHF 310 million. Foreign exchange movements, especially the U.S. dollar against the Swiss franc had no impact on reported Q3 sales growth. Orders in the third quarter grew 4.5% to CHF 312 million compared to a year earlier. And the Q3 book-to-bill ratio stood at 1.02. Sequentially, however, orders did not reach the very high level seen in the second quarter of 2022. And while we expect the order activity to remain at a robust level in the fourth quarter, we do anticipate a moderation of order activity during 2023. And I'll come back to that in the outlook. Turning to our businesses in a bit more detail. The Valves segment reported Q3 orders of CHF 244 million, down 16.1% sequentially compared to the very strong order levels seen in Q2 of 2022. Year-on-year order intake was down 2.1%. However, net sales increased 35.4% to CHF 251 million compared with the same period in 2021. Year-on-year, Q3 order development was mainly driven by the Semiconductor business unit, where orders increased 0.5% to CHF 187 million. Business unit Semiconductors net sales in the quarter amounted to a record of CHF 192 million, up 40.4% compared to the third quarter in 2021. End-users continue to invest in new technologies to manufacture the next generation of chips, which plays into VAT's technology leadership. VAT's capabilities to deliver the required products and solutions has further strengthened the company's market position. In addition, the growth initiatives in adjacencies continue to bear fruit. Semiconductors also reported 9 specification wins in the third quarter bringing the total for the first 9 months to 27 with 7 of them resulting from the company's growth initiatives to develop new adjacent products that complement its core Valves business. Orders in the Display & Solar business unit decreased to CHF 20 million, down 3.2% year-on-year, continuing a trend already witnessed in the first 2 quarters of 2022. Sales in Q3 increased by 14.7% to CHF 18 million from execution of orders won in 2021. Fading LCD investments in display can still not be offset by increasing OLED investments. In solar, however, other trends continue both in the PERC and the Heterojunction technologies. Orders in the Advanced Industrial business unit declined in Q3 year-on-year by 13% to CHF 37 million, mainly due to the project nature of some of its businesses. Sales, however, continued to grow in Q3 year-on-year by 24.3% to CHF 41 million in a variety of key markets. Asia, for the first time, became the biggest market region, surpassing Europe in that capacity with many key spec wins in Advanced Industrials business unit but notable were several advanced assembly prototypes into the Scientific Instrument sector, which demonstrates our ability to compete the successful semi adjacency methodology into this segment. The Global Service sector reported Q3 orders of CHF 68.1 million or 7.5% higher than in Q2 and 38.1% higher year-on-year. Sales reached another record volume of CHF 55 million, up 24.2% compared to the same period last year. Strong demand was seen across the entire services portfolio with fab utilization remaining very high, driving spares and consumables and a ramp-up of new fab buildouts driving subfab valve growth. High capacity utilization is expected to continue into 2023, while the increasing installed base generates a solid stream of service opportunities. Now let me turn to the outlook for the fourth quarter of 2022 and what this means for our full year expectations. We expect growth to continue in both our Valves and Global Services segments during the remainder of 2022 as we execute orders at hand while tapping further into significant opportunities offered by various attractive markets. Our continued success is driven by the unparalleled market and technology leadership positions, coupled with the successful execution of our proven strategy for profitable growth. In the Valves segment, we expect further high demand for additional semiconductor manufacturing equipment, driven by technology advances in the leading-edge areas in logic. Memory investments which peaked in the first half of 2022 are expected to show a softer development, mainly driven by reduced general consumer industrial spending. This situation is expected to affect our Semiconductor business growth during 2023. Based on orders on hand for delivery in '22, we expect Display sales to grow compared to 2021 however, the soft order intake in 2022 indicates a lower level of activity in 2023. Further growth is expected in the Solar market as positive trends continue both in the PERC and the Heterojunction technologies. Forecast for vacuum-related equipment sales in Advanced Industrial market point to continued growth as the business unit executes a strategic focus in selected growth areas. VAT expects the market for its Global Service segment to grow further in 2022 as semiconductor manufacturers continue to invest in both new capacity and upgrading their existing vacuum equipment assets. The high capacity utilization rates drive strong ongoing demand for all our service products as the installed base continues to grow and semi investment, which took place several years back are now entering a period of higher maintenance or upgrade requirements. VAT expects Q4 2020 net sales of CHF 285 million to CHF 350 million as the supply chain situation remains challenging. As a result, we expect net sales in 2022 between CHF 1.14 billion to CHF 1.17 billion or nearly 30% higher at midpoint than in 2021. In the last few days, the U.S. has implemented new sanctions against China, targeting at reducing their access to semiconductor technology. These new regulations will restrict the shipment of U.S. semiconductor process equipment into China for leading-edge and MID technology nodes. These are complex new sanctions, and we expect it will take some time for the implication on WFE to be defined. If we see any material impact on our Q4 guidance, we will issue a formal statement in due course. We expect these issues to be short to midterm orientated as the robust demand for chips will ensure the appropriate amount that WFE is allocating to meet the long-term market demand and we also expect more of this to be in Europe and the U.S. In the meantime, we will continue to build our flexible global footprint and strengthening our natural hedge against foreign exchange impacts by further ramping up our production facility in Malaysia, increasing sourcing from best-cost countries, gaining greater economies of scale and global supply chains and driving further operational excellence measures by getting closer to our customers. At the same time, we remain dedicated to technology innovation. Investments in research, development and productivity improvements will therefore remain at the heart of our strategy also in 2023. Furthermore, we expect our 2022 EBITDA to increase substantially in the full year 2022 EBITDA margin to be around half-year level of 35%, driven by higher volume and better cost absorption as well as the ongoing focus on costs, offsetting the cost inflation seen in raw materials, logistics and energy costs. Because of the expected higher sales, EBITDA and EBITDA margin, we also expect our 2022 net income to increase significantly compared with 2021. Stronger operational performance and is related free cash flow will partially be offset by higher CapEx compared to 2021 and the elevated working capital levels, which are needed to maintain production and delivery continuity. Full-year free cash flow is expected to be substantially above the 2021 level despite these higher working capital requirements and our overall CapEx of around CHF 75 million. We will give you more details on how we see 2023 evolving together with our midterm expectations out to 2027 during our Capital Markets Day that we will host on December 2 in Zurich. It is planned to do this event in person, but it will also be broadcast live. Invitations to this event will be sent out in the coming weeks. This concludes my prepared remarks, and I'm now turning the call back to the operator for the Q&A session. Thank you.

[Operator Instructions] The first question comes from Sebastian Kuenne from RBC.

My first question is regarding AMAT's cup of revenue guidance in Q4. I mean that would indicate that China is accounting for some 11% of their revenues. How big is China for VAT at the moment? That will be my first question. Secondly, do you expect cancellations from direct Chinese orders for order cancellations from your book or just deferrals? And then thirdly, on operating leverage, if we do have a slowdown next year and maybe second half of next year, that also reflects in your revenues, how big is your operating leverage? If you lose 10% of revenue, what do you think your margin will do?

Yes. Thank you for that. Yes, the AMAT guidance came out last night. So obviously, we're taking into that. I think VAT is a pretty good proxy for overall WFE spending. And if you look at China in recent times, makes up around 20% of WFE. Now half of that goes to foreign companies investing in China like Samsung, Hynix, TSMC and the other half goes to the indigenous semi manufacturers. So I think, as I said in my comments, it's going to take a little bit of time for this to play out because there's a good chance that the foreign investments in China will be directed to other assets within the foreign companies fab portfolio. And then the overall allocation of that will come back to what's happening in the consumer markets. The big question is obviously the 10% going into China. And a big part of that is still made up by U.S. and Japanese OEMs, also European. So there's still, I think, a lot of understanding on what the sanctions are going to mean exactly for those shipments, what percent are going to be over the 15 to 18-nanometer geometry level where the sanctions kick in. And I think it's going to take at least a quarter to understand that. So for VAT, I think roughly, our numbers play into that total WFE allocation to China. As yet, we haven't seen any cancellations. We are -- we've got plan A, B and C, obviously, we're confident we can navigate any challenges. We've done it successfully before. And cancellations are always possible. We have mechanisms in place to get reimbursement for some of that depending on how far away the cancellations are from the delivery time. And again, deferrals is something we work with in the semiconductor industry lots. So we're very experienced in dealing with that. On the operational leverage, I'll ask Fabian to comment on that.

As you have seen from our results recently, we do benefit quite a bit from the operational leverage, thanks to our flexible operating model. And the same way that we can grow, we can also reduce our costs in a potential correction. Now you there must expect a certain lead time, I would say, between 3 to maximum 4, 5 months up until we have our costs adjusted. But if you compare this also to historical levels, I would say, that we are here still quite solid in our conversion rate in a potential correction.

If the lead time is 3 to 5 months, and you already -- and you have the order book. You know when you have to deliver the revenue, so you can plan your production 6 months ahead. That means you can adjust your capacity just when the orders drop, right? Because the order book is so long.

Yes, that's right. Therefore, we are realistic about that. We are on the pulse. And as Mike said, we have our plans already in place. And as soon as we see the need to execute on them, then we would also then start with the respective measures being put in place.

2 more brief questions. If you had to adjust capacity, would you start in Switzerland or Malaysia? And were you surprised by TSMC's cut off CapEx plan this year?

Where we can really depends on where the product is going to which market because we have different products in different facilities. So really, it's a mix. We probably have to make reductions in both factories. I think what we're going to see realistically in the short term is the OEMs are still running pretty heavy backlogs and they're going to be looking at the China situation and adjusting shipments to go to other customers in other regions. So there's going to be a lot of reflow of capacity into different areas. So it's going to be quite a challenging couple of quarters coming out as things are reallocated there. I think the Semiconductor business is dynamic. We all know that. TSMC as well as Samsung, I think, will adjust to changes in consumer spending and industrial spending. The latest estimates I've seen for WFE are maybe down 10% to 15% in 2023. We'll continue to monitor that. We have to work carefully what that means for VAT because we have things like spec wins that are growing our market share and growing the adjacency business. So the final outcome we're still working on. We hope we're going to have a better idea of both the China situation as well as the WFE outlook for 2023 by the time we do our Capital Markets Day at the beginning of December.

Before we go to the next caller because there are more callers on the line, please do keep to the 2 questions initially. If we have time at the end, we can still come back, but it will be nice to give everybody a chance to ask a question.

The next question comes from Marta Bruska from Berenberg.

I have a quick clarification. Have I heard that correctly that you said for 2023 semi CapEx forecast of the moment stands at 10% to 15% down. Is that correct?

Yes, approximately, and that's from both estimates. One is from semi.org and one is from [ VAT ] insights.

And then the actual question is, so back in 2020, you mentioned that there were 2x the normal level of the new greenfield project for fabs being announced in anticipation of Chip Acts and they came then the financing came earlier this year, both in Europe and in the U.S. So I was wondering at what stage are those projects now? And when would you expect them to trigger new orders for VAT?

Yes. The whole industry works on a kind of a risk portfolio of assets when you look at what you're going to need over, say, a 5-year period, and VAT acts in the same way. So our customers are building shelves and they speed them up as demand looks more promising or slow them down if they see slight declines. So there's no change, I think, to the number of assets. The speed of which they come online will really be dependent on the growth. One thing I think we will see is a lot of those SaaS assets will come online as planned, but maybe with lower wafer stops because the qualification time to get the most advanced processes up and running is increasing. So I think you'll see the major investments from, say, TSMC, Intel, Samsung continuing. But maybe the build-out of total wafer demand will be staggered a bit longer if we see a sluggish demand in the short term. There's still going to be more announcements. There's a lot of rumors right now that TSMC are going to announce in Reston. And I mentioned in my remarks that I think we'll see this rebalancing effect of more fabs coming into U.S. and Europe as a result of the sanctions in China.

All right. Thank you. That answers my question. Very helpful.

The next question comes from Timm Schulze-Melander from Redburn.

Two quick questions. If I could start, please, Mike, with what consignment inventory pools you've seen in recent weeks? That would be really helpful color, please.

Yes. I would say pretty normal. Our consignment levels are sitting pretty much exactly where we want them to be. We adjust these very dynamically. We have min-max levels on all our key products. I would say we're selling exactly where the OEM forecast demand them to be. I do expect we're going to see coming up a significant volatility in them as our customers rebalance the short to midterm to account for the shipments into China. And I think it was obvious from the announcement last night that Applied Materials looked like they stop shipments until they understand the overall sanction framework with China. So we expect to see our portfolio of products changing a little bit as that portfolio is rebalanced. The reduction from AMAT last night looks like it was about 10%, but I'll let you guys analyze that. So I think over the next month, through the announcement season, we'll gain a little more insight into what that means. But again, we're very experienced at dealing with this. We have our teams ready to manage any change in that. It could lead to a little bit more inventory in the short term as we rebalance things. But these products have very long life times. I think that's another key thing is that even if we ran with a bit more working capital, we can deal with that in the longer term. So we're pretty confident we can deal with any situation that's thrown out at us.

Got it. And then my second question, I'm going to sneak in a 2-parter, if I may. You mentioned Applied halting their China activities, I think ASML and KLA-Tencor are reported to have done the same. So at VAT Group, are you pulling back any of your people, activities? And the sub-question, have you made any changes to your existing hiring plans?

Yes. We haven't made any change right now to China. There's no restrictions in any of our products shipping to China. I would also highlight that we ship more of our standard product portfolio into China which is a lot more generic than a lot of the customized products we ship to our more advanced technology customers. So I think there will be less restrictions on them, but that's going to be -- we've got to play that through and see what happens in the long term. At the moment, there's no comment from the European authorities or the Swiss authorities on potential sanctions. There's still no official statement from Japanese, although Tokyo Electron have said that they will follow the U.S. sanctions. So again, I think a lot is going to play out in the next month. Some of the IC actual chip shipments are actually economically far further reaching and their impact, for example, the ability to ship latest microprocessors from TSMC and Intel into China, kind of a massive impact on the electronic shipments. So I think that's going to become a bigger economic question. But for us, we're just looking at what our customers stop telling us in the next few weeks and also we're mostly in touch with local and regional authorities.

The next question comes from Sandeep Deshpande from JPMorgan.

The industry has been substantially backed up in being able to supply tools which is why -- I mean if there is going to be any weakness in demand, it will take some time to be seen. How do you see -- I mean what you are supplying today to your customers? Is this what you are supplying today to your customers going to go into tools, which they're going to ship well into next year? Or does it go into tools whether within 3 months after you ship? So how do you see that timing? And I have 1 quick follow-up on that.

Yes. I think that's exactly right. There is a lot of backlog within the industry. So our customers will be juggling that backlog as we go through the fourth quarter and the first quarter in order to linearize and manage their shipments. At the moment, we're running roughly about a 5-month backlog when you look at our numbers. So we still got close to -- when you look at the numbers, roughly CHF 300 million in backlog for this quarter. Hence, our guidance. Now some of that could change obviously with the China situation, but that may be rebalanced by other tools, and that's the big question what we have at this time is how are customers going to rebalance things. But our current order book roughly goes through the first half of the first quarter in '23.

And in terms of the order book, I mean, since you're planning for -- that there could be some risks in the scenario going forward. How does your order book run? I mean, can customers push out or cancel at will or is it that you enforce some kind of 3 months, you can't cancel after -- 3 months before you're going to take the product or any other such restrictions that you have, which means that you can prepare for a downturn through revenues that you ensure that occur?

Yes. It's a huge mix. Our smaller customers, obviously, we have tighter constraints on the order. And if they're close to the manufacturing date, we will ensure those products ship. With our larger customers where we have consignment inventories, there is flexibility on when they can pull that. Ultimately, they have to take the product that's on consignment, but there's different windows within that consignment inventory period in which they are allowed to defer parts of that. So it really is a mixed bag. The most important thing is, and we've learned this in previous cycles, is partnering with our customers to fix these issues is really important, just like partnering with our own supply chain because the most important thing is to maintain the customer trust, build those relationships and you come out of the cycle with the maximum upward potential. So if we harm any of our supply chains, we wouldn't have that ability to bounce back. And that's what we're going to be looking at is how do we optimize that overall supply chain with our customers to ensure when demand comes back strong, which we know it will, that we're ready to ramp the way we did in 2020 and '21.

The next question comes from Michael Foeth from Vontobel.

Two questions. The first one is you said that you were still constrained by supply in the quarter. So my question would be where does that -- where do these constraints come from at this point? And how much approximately of sales growth did it hold back? And the second question would be regarding the pretty wide range in your Q4 sales guidance. I think it's a bit wider than usual, and that does not yet include any uncertainty from the U.S. restrictions, obviously. So what explains that increased uncertainty in your guidance, please?