VAT Group AG (VACN) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the VAT Q3 Results 2023 Conference Call. I'm Alice, the Chorus Call operator. [Operator Instructions] The conference 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, CEO of VAT Group. Please go ahead, sir.

Good morning, ladies and gentlemen, and welcome to VAT's Q3 2023 trading update conference call. With me this morning are our CFO, Fabian Chiozza; our CEO designate, Urs Gantner; and Investor Relations team with Michel Gerber and Christopher Wickli. After my introductory remarks, we'll start the Q&A session. The call moderator will take your questions in the order you enter them. So I welcome you to my last earnings call as CEO of VAT and thank you for your support and interactions during my tenure as CEO. I look back with fond memories of the past 6 years and at what we have achieved and I'm happy to see that I pass on VAT to such steady hands as Urs. I'm also happy to see that the team is reporting better days with positive signs that we have reached the bottom of the semi cycle and we're returning to more supportive markets. As you can see from the media release we issued this morning for the third quarter of 2023, semi cycle continues to be challenging, but there are signs across the board that the industry is emerging from the down cycle. Year-on-year we remain below the record results posted in 2022 as spending on capital equipment in the semiconductor industry remained on a low level. However, we're seeing continuous growth in our order flow from Q1 of this year onwards, which is encouraging and we enter the fourth quarter ahead of expected market recovery in 2024. Our third quarter orders amounted to CHF 164 million, 5.4% higher than Q2. Group net sales have decreased for Q3 slightly to CHF 210 million, which is slightly above the midpoint of the sales guidance we communicated at the half 1 results back in July. The FX impact of the strong U.S. dollar versus Swiss franc was approximately 8%. Nevertheless, our order numbers were down 48% year-over-year and sales number were down approximately 31% year-over-year. We maintain a healthy order backlog of approximately CHF 282 million, which equates to a book-to-bill of approximately 0.8. This was 0.7 at half 1 results so we see a slight improvement here as well. We have been using the lower utilization in both Switzerland and Malaysia to work through our backlog, but also to focus on innovation, cost and process efficiency. Across the 3 businesses, we saw the following performance. In the Valve segment, the Semiconductor business unit was impacted in the quarter by continued lower spending by chip manufacturers on wafer fabrication equipment. Geopolitics and trade restrictions increased uncertainty for our clients. However, we have observed our investments in lagging-edge chip manufacturing in China continued at a healthy level during the quarter. We're using the down cycle to work closely with our clients on next generation of tools and made progress on further spec wins and adjacency products. In the Advanced Industrial business unit, orders decreased for scientific instruments and high-vacuum valves used in industrial coatings. Some nuclear fusion project orders were pushed out to the fourth quarter of 2023, hence a slightly slower order recovery. However, Advanced Industrial business unit delivered a sequential increase in sales of 8% in the quarter versus Q2 of 2023 as the business executed on its order backlog. We also expect strong order momentum in this business in Q4. VAT Global Service segment continued to see relatively weak demand in the third quarter. This was mainly driven by lower capacity utilization in semiconductor fabs and, as a result, VAT customers continue to have elevated levels of consumables and spare parts. These levels are coming down, but not as fast as we had predicted especially in the memory segment. With the market slowdown also impacting the build-out of new fabs, demand has declined for subfab valves, an important growth driver for the Global Services business. Talking numbers. In the Semiconductor business unit, orders decreased 47% year-on-year to CHF 105 million. Net sales amounted to CHF 120 million, down 41% compared with the third quarter of 2022. Orders in the Advanced Industrial business unit declined in Q3 year-on-year by 31% to CHF 31 million due to the project nature of some of its businesses. Sales, however, increased in Q3 year-on-year by 13% to CHF 53 million. The Global Service segment reported Q3 orders of CHF 28 million, 20% lower than in Q2 2023 and 59% lower year-on-year. Sales reached CHF 37 million, down 19% compared to the same period last year. As we wrap up 2023 and look forward towards 2024, we believe the capital spending on semiconductor manufacturing equipment is expected to remain at relatively low levels over the rest of 2023. However, as OEM inventory levels are now normalizing, we're gaining confidence that order intake should improve in Q4 and into 2024. Based on these factors, VAT expects 2023 full year sales and EBITDA to be below the record set in 2022. Low capacity utilization and persistent foreign exchange headwinds are also negatively impacting the company's EBITDA margin, which is expected to be higher for the second half of 2023 compared to the first half, but slightly below the target range of 32% to 37%. Net income is also expected to be lower than in 2022. As I mentioned at the Q2 results, we are uncompromising in our approach to being ready for the next upcycle and VAT will continue to invest in both innovation and capacity expansion. Overall 2023 CapEx is forecast at CHF 75 million to CHF 80 million and while free cash flow is also expected to be below the 2022 record, it remains at an attractive level. As new leading-edge semiconductor technology is being developed and produced, we at VAT will support our clients at the forefront of the manufacturing process with our valves and advanced components. The AI revolution, further digitalization of industry and a move to a data-centric society will require further leading-edge hardware. Even a mass market product like the iPhone 15 runs on a 3-nanometer chip and we continue to see a growth in new advanced devices being rolled out. Finally, VAT continues to prepare the manufacturing and supply chain footprint in Malaysia for future growth opportunities. This will help us increase our natural foreign exchange hedge by sourcing from best cost countries and gaining greater economies of scale in global supply chains. Fabian was just last week in Malaysia and our preparations for getting factory 1b operational are well underway. In Switzerland, we had the groundbreaking ceremony in mid-September for our new Innovation Center and we are on track to open this site early 2025. For the final quarter of the year, we're guiding sales of CHP 200 million to CHF 230 million, which includes the ongoing impact of the current strength of the Swiss franc. So one more thing. We are happy to make the announcement that we're appointing Finn Felsberg as the new Executive Vice President, Semiconductor Solutions Group, a new member of the company's Group Executive Committee effective December 1, 2023. He is the successor to Urs Gantner in the SSG group and I would like to extend a warm welcome to him here. Finn has extensive experience in the semiconductor sector having worked over 20 years at Infineon. He served in a wide variety of important roles, including the Senior Vice President and General Manager of the Power Integration and Supply business in the automotive sector. We're all excited to have Finn join VAT and bring his experience into running the group and allow Urs to take over his duties as CEO. So this concludes my prepared introductory remarks and we're now turning the call back to the operator for the Q&A session. Thank you.

[Operator Instructions] Our first question comes from the line of Sandeep Deshpande with JPMorgan.

All the best, Mike, for your future endeavors. My first question to you is are you seeing any signs of revival in your order intake into next year? What are you hearing from customers in terms of revival? Because many other large semiconductor equipment companies are talking down 2024 and the recovery in early part of 2024. So I'm trying to understand whether you as a component supplier into them is seeing these orders because of changes in inventory situation or is it because the end demand is actually improving. And my second question is regarding all these new facilities coming onstream, how quickly will this capacity come onstream through the next 12 months? Because '24 may continue based on what some of these other companies are saying to remain fairly challenging.

I think there's different effects, Sandeep, happening across the layers of the supply chain. I think in the component sector, we're probably seeing a more positive sentiment because of the pretty high inventory levels that we're setting across the OEM companies. As you saw our order intake in the first half of the year, it was down considerably because of the high inventory level. So I think we will see an increase through the fourth quarter and into 2024 because of that effect. I think it's also quite difficult to gauge fully 2024 at this point. As you know, the market changes very quickly. Samsung were a bit more positive on memory outlook in their recent results and the situation is very changeable. I think consensus for next year is coming in somewhere around the high 80s in WFE, which is up sort of mid-single digits on this year. But I think for VAT, we'll see a faster return because of that inventory challenge that we've had in the first half of the year. When you were meaning facilities, are you talking about chip plants or are you talking about VAT facilities?

No, I'm talking about VAT facilities.

Yes. We're very flexible in our facilities. If you remember that we outsource about 75% of our supply chain. So we have a lot of ways of managing that capacity. The new facility in Malaysia, we're really only bringing up the machining capacity in that facility. We're not fully equipping all the assembly, clean rooms, et cetera. And the reason we want to bring on the machining is to give us some business continuity for a faster than expected ramp if that happens. Trying to get high quality machining components in Asia is harder than in Europe. So we'll probably reduce that [ cloud ] storage ratio and do a little bit more internal machining to give us more breathing space as we ramp the Malaysia facility. So it made a lot of sense for us to bring up that factory. It gives us tremendous expansion power in the future. And then through '24, '25, '26 as we see the market improve; we can start to bring in the additional assembly capacity, et cetera, within that facility. So I don't really have a concern that we're going to be sitting on underutilized assets. I think we can do a really good job to manage that and also give our customers tremendous confidence that VAT is ready to really absorb anything they can throw at us and that will give us a chance to take further market share.

The next question comes from the line of Sebastian Kuenne with RBC.

I have a few questions and I will ask them straight away so you have a bit of time to maybe prepare. First question is on year-on-year demand; if you could split this to volume, pricing, FX. You mentioned FX 8% tailwind you mentioned. Maybe you can give us the volume component. Secondly, service is what's surprisingly soft down 20% quarter-on-quarter. If you could quantify the destocking effect of it. It doesn't seem to be all just lower utilization. There seems to be a very strong destocking effect still going on and maybe it's a way to quantify? Third question is on China. You mentioned strong demand for lagging-edge equipment from those clients. What is the current share of China and how did it change over the last 12 months? And the last question is on profitability for the rest of the year. I think you mentioned earlier that you don't plan to cut staff in Malaysia. You have the short time labor in Switzerland, but you don't cut staff in Malaysia. What does that mean for utilization there and what does that mean for the margin in the second half?

Could you just -- on your first question, could you give me a little bit of color on exactly what you're looking for in that question?

Yes. Maybe to simplify, what is the volume component in demand? I mean you have the 50%-plus drop in total orders. But is there pricing? Is there volume? Is pricing coming down from the level or... If you can imply what do you expect for Q4 and going into 2024 if pricing drops?

I think on that topic, Sebastian, our pricing remains very stable. We have long-term contracts with all of our major customers and the pricing doesn't really change much during the cycle. So any impact is pure volume driven and FX driven so it's really not an issue on pricing. In fact you could even argue that pricing would certainly improve in a downturn because volume rebates will be less than expected. Service, I can't quantify the exact destocking. But I think when you reflect back on '23, the amount of additional stock that was added because of the supply chain crisis was probably quite considerable. We don't get visibility to what our customers are stocking. So I think some of that growth in 2023 was a little bit artificial driven by higher stocking levels and probably also the lead time went up, almost doubled in fact compared to historical levels. So as we bring our lead times down, that maybe pushes out recovery a little bit. We don't see any fundamental changes though in the service business. We don't see any encroachment from third parties and we expect the business to bounce back fairly quickly once these inventory levels reduce to more historical levels. We expected that to be really in the second half of the year. Possibility that could happen or start to happen in the fourth quarter; but if it doesn't, then we're into 2024. China, Fabian, do you want to comment on the percent in China?

We have seen bit an increase on the share of our business in China during this year. This was just about 20% I would say. They are now trading somewhere between 20% to 24%.

And just to come back to China briefly, is this -- in your best estimate, is this China stocking up on the valves that they might need for future WFE equipment or is that valves that China use today in equipment for solar display microchips?

Maybe I can step in, Urs speaking here, on the China topic. Now China, really they have a demand and so they have to build up their own infrastructure on the tool. So even though the wafer starts is not that high, but the share on the wafer starts from our Chinese customer is increasing a lot and this is driving our business with -- the components business with our Chinese customers quite significantly at the moment.

And finally, on Malaysia funding the utilization margin?

First of all, we do still see higher utilization coming out of Malaysia as in Switzerland. Secondly, we have also adjusted our workforce in Malaysia ahead of this downturn. And third, we are also now utilizing the, let's say, excess capacity that we have in plant 1a in order to bring 1b up. So overall, I think we do not see any effect of Malaysia not having such a short-time work scheme in our bottom line consolidated results.

The next question comes from the line of Jorn Iffert set with UBS.

First of all, Mike, thanks a lot for the good communication that we have from the capital market feedback and we'll miss you. So thanks a lot for the cooperation. Then maybe going into a couple of questions. The first one is I mean do you already see the September order run rate to be better versus August and July? And are you still sticking to your order intake target which you mentioned in the last earnings call that you can reach CHF 12 million plus in Q4? Is this an average you're looking for? Second question would be, please, on the R&D headcount and with all the spec wins you recently had. I mean this year I think the target are to add around 100 new R&D headcount, is this still valid? When will this happen? Have you identified the people? Have they signed contract already? And the third question is, please, on Finn Felsberg. Can you tell us why you choose this person? Was this happening with the headhunter or did you know him before? And why you are looking for an external candidate and not using somebody internal?

Order run rate I think in the third quarter was somewhat as we expected. Semicon I say was about the level we expected. Advanced Industrial was actually down a little bit. We were expecting some larger orders coming in, in the fusion area, which pushed out to the fourth quarter. And we have expected Service to be a bit more robust as I said in my last comment. So I think it was more or less on track. We expect in the fourth quarter the Advanced Industrial area to grow considerably and I think we'll see incremental improvements in semi. I wouldn't expect to see an explosion in the semiconductor area. And then Service is unpredictable, we still don't quite see. Because the service market is much more distributed than the OEM business where we're only dealing with really 7 or 8 large OEMs, the Service business is literally hundreds of fabs. So we don't get the same level of visibility to when that order intake is going to pick up. So that could really go both ways, it could remain fairly sluggish or we could start to see the recovery as we had expected. But I think we can safely say order intake will be up, it's just a question of how much at this point. On the R&D headcount, Fabian, do you want to comment?

Jorn, I think that the number that you have in mind is what we communicated in connection with the new Innovation Center and as we march towards the opening in 2025, we are gradually increasing our headcount. And if I just compare the numbers to the end of 2022, I can say that we have added about 20 positions already from that 100 and the remainder will now be identified during the course of the next, say, 15 to 18 months.

On Finn, I'll make some comments and maybe Urs can also make a few comments. But in summary, we were both very aligned on bringing Finn in. We've had a very intensive talent program in VAT over the last 5 years and we've really stepped up our actions there. Of course we're growing so fast that we really have no option, but to bring in some additional talent. But 50% of our internal promotions are now filled by internal candidates and that's up from the low 20s if you go back 5 years. So we're certainly generating a lot more talent from within our employee base, which is great and we make a very clear statement to our staff that our goal is to promote them. At the top level of the company as we grow, we have to bring in some additional talent. We have to bring in expertise. It's difficult in Europe to find top level semiconductor people and when we looked at the options we had with Urs moving into the top job, we decided that we did want to improve our bench strength a little bit within the company. But we do have a very solid level below Finn and Urs has strengthened the sort of sub-business unit structure under Finn to make sure we are bringing that next level of talent up. Finn is a professional, 20 years of experience in the semiconductor market. Coming from a bigger company, he knows how to grow. He knows how to get the process landscape and the engineering landscape in place to ensure we have consistency in the programs and grow in a systematic way. So we're coming from a smaller company growing fast and he's coming from a larger company so I think that marriage will be great for Urs to make sure we harness on the fantastic opportunities that exist in semi. So maybe, Urs, you can say a few comments on Finn.

You did a lot already, but I can maybe add just from the inside view of the SSG, right? So we have a very ambitious growth target as well and this we will not only do with our core, but mainly also with a change in products and new products which are in development for the future. And here of course we have a lot of opportunities for our internal staff to grow and move up in positions. But these new fields we want to enter, it's also very important that we also bring in expertise in SBUs and in that way also get this diversity in the teams. And I think we feel Finn coming from more of our customer side as well, it will open up quite a lot of opportunities and insights to be even a better supplier in this industry. So I'm very confident and looking forward to work with Finn. I think it will be exactly in line what we want to achieve in our mid- and long-term strategy.

Your next question comes from the line of Michael Foeth with Vontobel.

Also thank you, Mike, for what you've done for the company and for investors and all the best for the future. Just 2 follow-ups from me. One was on China, you mentioned the increased share of total revenues. I didn't do the math. But are your shipments to China actually growing right now? Do I understand that correctly? And the second question is on your CapEx guidance. It is I think slightly lower than what you guided before. I guess that's just pushed into 2024. Can you explain the dynamics behind those shifts?

Maybe let me take the first question on China. I would say sales are basically flat, but as everybody else is dropping, therefore the share increases. So CapEx guidance has been adjusted by about CHF 5 million at midpoint and that is in connection with the opening of the Innovation Center, which we have also pushed out by about 3 to 4 months, which is a result of some delays we have experienced with the, let's say, start of the construction.

The next question comes from the line of Nejc Lavric with Octavian.

Maybe my first question would be could you maybe expand on the geographic sales development? So you mentioned China is steady, but we see from the semiconductor sales that U.S. is also slowly picking up. So can you maybe expand on that? And on the utilization rate, you mentioned before that the logic segment is strong, but here we now see quite a decrease. So can you maybe expand on the logic side? And my final question would be on the spec wins on adjacencies you also mentioned for some new products. Could you maybe expand on that?

Okay. Let me talk first on the utilization. I think we see -- again you have to remember that we don't get direct feedback exactly where our product ends up, but we can kind of triangulate at a macro level. Logic does seem to be driving business right now and we see the OEMs are slightly more logic focused with slightly higher sales. We're very optimistic on the logic segment long term. Urs and I were just doing some work for a strategy process looking at the impact of Gate-All-Around at the 3-nanometer and 2-nanometer area. And with our position, we really see a pretty substantial increase in content that we see as the industry proliferates into those advanced nodes. So I think for VAT, that advanced logic growth is really a great thing and the OEMs that are winning in that space, we have a tremendous partnership and relationship with. The spec wins are going well. They're all a new platform so again it's back to how quickly these platforms make it into the market and start ramping up. We've seen for example kind of a mixed bag this year where some of the spec wins we have in our advanced modules and advanced assemblies have been growing very fast even through this downturn. But in areas where we had motion components, they were a little bit more memory-centric and we've seen them reduce year-on-year. So it really depends on which platforms are shifting. Looking at the geographic nature of the business, just checking here. I think as you would expect, the areas that are more memory focused like Japan and Korea are heavily down. I'd say the U.S. is slightly less, there's more logic coming out of the U.S. and Europe is fairly steady. In fact Europe is actually going to be slightly up on the back of the EUV growth that we're seeing there. But I would say it kind of goes along with what you would expect across the segmentation of the industry and where the OEMs are positioned with respect to those segments. So I'd say fairly consistent year-on-year.

Thank you and all the best, Mike.

The next question comes from the line of Didier Scemama with Bank of America.

It's all on China. So first, on the weight of your China business. Can you give us a sense of the amount of benefits you think or share gains, whatever you want to call that, you accrued from the export controls that have been effectively imposed on your U.S. competitors? So is that a key driver for you to gain share with domestic China semicon companies? And then related to that, I wanted to ask your opinion, Mike, educated opinion really on where your domestic China customers are in terms of competitiveness in leading-edge versus your non-China customers. Do you think that they are like 2 years behind or are they closer to them today?

I think our share gains, I'd say, probably are not dramatically different year-on-year. VAT already enjoys a very, very high market share in China. I think 1 area we have made some gains was in solar where one of our U.S. competitors had some business there and we've done a good job in capturing that business. But I think in the semi space, we were already very high in terms of share. I think over the last couple of years I've made comments where I saw China's technological capability was and where they focus and I think they're playing out quite accurately. I think their ability to compete in the leading-edge is obviously curtailed by the litho challenges they have. Litho is a monster for them to try to make progress when you see the complexity of technologies like EUV. That's just not going to happen within 10 years. So I think the focus on the China OEMs now is really about lagging and mid-technology range and they're really trying to make cost effective systems as well as performance systems. So I think they'll be successful there. It's easier for them to compete in the 25-nanometer to 50-nanometer segment and I think we'll see rapid growth there as they refocus their efforts into these mature areas. So I think that brings a challenge for the Western OEMs who like to compete in that area as well because obviously these tools in China will be cost effective. So I don't think the focus is really on leading-edge as much. I think in the last 6 months we've certainly seen more focus on cost, on improving their position in the mature technologies with less focus on pure technology. Now will that change again over the coming months? Hard to tell. I mean obviously they want to keep up some position on the 7-nanometers as we saw with the recent Huawei 7-nanometer chip. So I think there'll be some focus on technology, but I think an increasing focus on capacity and overall system efficiency in these mature nodes.

Okay. That's interesting color. Can I just ask maybe quickly on just your opinion. If the U.S. administration imposes additional export controls on China, let's say, a full immersion ban on China. I know you don't supply into ASM and immersion systems. But considering the use of emerging system in the sort of 28-nanometer to 64-nanometer node give or take, do you think that could have an indirect impact on your customers?

Well, I think as I mentioned before, there's very high determination to really exploit the whole lagging and mid-technology areas and to really own the whole segment of consumer and automotive segments especially. I think there's tremendous growth opportunity for the OEMs and the market in China plus a lot of the equipment serviced by these industries is already made in China. So they get the direct beneficial impact of having lower cost chips made in China. So I think the focus is really going to be in that area and I don't think it will be as much of a focus on immersion and DBV. I also feel that there's a lot of lobbying in Washington about the impact this is going to have on the Western OEM companies the fact that they're going to be losing now in China if they're not able to compete. So I'm not convinced we're going to see expanded sanctions. Let's wait and see how they react to that. But I think that there's going to be a realization that the U.S. OEMs will lose out if they're not able to compete there.

Super interesting. Thank you so much, Mike, and best of luck.

Your next question comes from the line of Thomas Pohl with awp.

I was just wondering if you could explain to me a little bit the importance of solar business for your company and what the developments and cycles are in this industry?

I'd say solar has been a fairly small part of our portfolio in the last 5 years. It had a big ramp-up in the mid sort of 2010 to 2015 time frame, but in recent years it's been a little bit more sluggish because of the capacity that was added in China back at that time. It's about 3% of our total business in '22. However, you can imagine there are a lot of forces driving solar. There's a lot of new technology coming to market. And I think the most recent solar efficiency numbers I've seen should mean that over the next 10 years we will see a refresh of that installed base where you can get between 30% to 50% improvement in solar efficiency, which makes it a pretty strong value proposition for industry and consumers to house that. So I think we'll see continued growth in that business. Our recent strategic plan shows our solar business growing quite significantly within China, but also a little bit more growth in other parts of Asia and even some in Europe and the U.S. I don't think it's going to be a dramatically large part of VAT in the future, probably remaining in that 3% to 5% area of sales. But these are nice segments to be part of. We can reuse our semiconductor portfolio. So it's pretty easy for us to play and harness that opportunity. Cycles are very different from semicon though. It's really connected to different markets and probably more connect to things like oil prices and the cost of fossil fuel. But I think we're at the start of a slight ramp-up in that business overall.

The next question comes from the line of Bhawin Thakker with Bloomberg Intelligence.