（6890） | Publish:Tue, Jul 09, 2013 IR「BRIDGE REPORT」

BRIDGE REPORT
（6890）

スタンダード

Ferrotec Corporation (6890)

President
Akira Yamamura

Company	Ferrotec Corporation
Code No.	6890
Exchange	JASDAQ
Industry	Electric Equipment (Manufacturing)
President	Akira Yamamura
HQ Address	Nihonbashi Plaza Building, Nihonbashi 2-3-4, Chuo-ku, Tokyo
Year-end	March
URL	http://www.ferrotec.co.jp/english/

Share Price	Shares Outstanding		Market Cap.	ROE (actual)	Trading Unit
¥426	30,810,278 shares		¥13.125 billion	-	100 shares
DPS (Est.)	Dividend Yield (Est.)	EPS (Est.)	PER (Est.)	BPS (actual)	PBR (actual)
¥5.00	1.2%	¥14.61	29.2x	¥966.10	0.4x

* Stock price as of closing on June 10, 2013. Number of shares issued at the end of the most recent quarter excluding treasury shares.

Fiscal Year	Net Sales	Operating Income	Ordinary Income	Net Income	EPS	Dividend (¥)
March 2010	31,541	703	524	156	6.58	12.00
March 2011	57,880	6,931	6,290	4,483	180.63	20.00
March 2012	60,088	4,124	3,287	1,715	59.18	20.00
March 2013	38,424	-3,608	-3,465	-6,532	-	5.00
March 2014 Est.	42,000	1,000	700	450	14.61	5.00

* Estimates are those of the Company.

This Bridge Report reviews the earnings results for fiscal year March 2013.

Key Points

Company Overview

Ferrotec manufactures and sells silicon single crystal pulling equipment, consumable products used in the silicon single crystal manufacturing process including crucibles (the number one manufacturer in the world) in the photovoltaic business category, semiconductor manufacturing equipment and flat panel display (FPD) manufacturing equipment parts, semiconductor materials, and various thermoelectric temperature controllers. While most of these products may not be visible to consumers, they are widely used in personal computers, cellular telephones, and devices using liquid crystal and plasma technologies. In addition to Ferrotec Corporation, Ferrotec Group is comprised of 24 consolidated subsidiaries, which conduct manufacturing and other business activities in China, Europe, North America, Russia, and Taiwan, and five equity method affiliates.

Ferrotec's operations can be divided into the equipment related business segment where vacuum seals, crucibles, and other ceramics products used in semiconductor, FPD, and LED related manufacturing equipment are manufactured, electronic device business segment where thermoelectric module application products are made, and photovoltaic business segment where silicon single crystal manufacturing equipment and crucibles used in devices are produced. In fiscal year March 2013, sales of the equipment related business, electronic device business, and photovoltaic related business segments accounted for 49.1%, 11.9% and 32.1% of total sales respectively, while saw blades, equipment part cleansing, machine tool, and other products not included in reported segments accounted for 6.9%. Ferrotec leverages its knowhow and technologies for vacuum seals, which are the main product of the equipment related business segment, in its silicon crystal manufacturing equipment.

Management Strategy

The promotion of a "Business Restructuring Plan" was able to rectify the issues causing a bleeding of profits in a short period of time. From fiscal year March 2014 onwards, Ferrotec management is expected to make a shift from its current defensive strategy to a more offensive strategy that includes efforts to fortify its product lineup, broaden its customer base, and develop overseas markets.

(1) Equipment Related Business Segment

With regards to vacuum seals, Ferrotec is expected to make a transition from the simple parts business model to a higher value added business model that provides modules, subassemblies, and engineering after services, in addition to pursuing synergies with its surface processing and cleansing operations. Furthermore, the Company will endeavor to develop applications in foods, pharmaceuticals, and medical equipment areas, while at the same time fortifying applications other than semiconductors and FPD. In the area of quartz products, Ferrotec will fortify its marketing operations to pursue synergies and sell its cleansing services to the Chinese factories of high profile customers from the United States and Taiwan.

(2) Electronic Device Business Segment

Ferrotec is implementing measures to fortify development of thermoelectric module products to meet customers' needs for diversified applications. At the same time in overseas markets, efforts to develop optical communications related field in China and Korea, and the cleansing equipment field in Korea are being implemented. Furthermore, Ferrotec's marketing function will also be fortified to cultivate the high functionality market in the United States. Efforts to automate production lines and reduce fixed costs are also being implemented.

(3) Photovoltaic Related Business Segment

Ferrotec will create a structure that can produce stable profits based on consumable products including quartz crucibles and multiple crystal square tanks, and photovoltaic cell silicon.

Quartz Crucibles, Multiple Crystal Square Tanks

In the photovoltaic cell related market in China, the new leadership has taken steps to restrict supplies. Therefore, stagnant capital investments and curtailed production have contributed to bankruptcies of some of the large panel makers. Consequently, quartz crucible manufacturers and multiple crystal square tank manufacturers have also been impacted, and there are currently only five crucible manufacturers and three multiple crystal square tank manufacturers operating in China. The photovoltaic cell market is expected to grow by 10% to 15% per annum and therefore supply shortages of quartz crucibles and multiple crystal square tanks are expected. In addition, Ferrotec is expected to cultivate demand from quartz crucibles for semiconductor circuits (future target is to achieve two thirds of sales from photovoltaic cells and one third from semiconductor applications), and to strengthen its position in Taiwan where it has 60% share in the multiple crystal square tank market with a high conversion rate and low pricing.

Photovoltaic Cell Use Silicon

Ferrotec will endeavor to expand its OEM supply of its P type wafers, which have attained a high conversion rate of over 19% using its unique technologies, and advanced N type wafers. Compared with loose abrasive grain (grinding and polishing abrasive grains used by mixing with water), Ferrotec's wafers sliced by using fixed abrasive grain diamond wire (core piano wire coated with diamond gains) are highly regarded by Japanese photovoltaic cell makers.

Production Devices

With regards to the photovoltaic cell related realm, Ferrotec will adopt a selective strategy for taking orders in view of profitability, and leverage its advanced technologies in glass processing, general use polishing, core drill, NC lathe and other equipment, and develop applications for its general use equipment in general industries other than photovoltaic cells.

Fiscal Year March 2013 Earnings Results

Sales Fall 36.1%, Ordinary Loss of ¥3.465 Billion (¥3.287 Billion Ordinary Income in Previous Term)

Sales fell by 36.1% year-over-year to ¥38.424 billion during fiscal year March 2013. Difficult operating conditions of the photovoltaic cell panel makers contributed to a 54.9% year-over-year decline in sales of the photovoltaic related business segment. Declines in capital investments and production of the semiconductor and FPD industries contributed to a 24.2% fall in sales of the equipment related business segment, and weak demand for thermo modules led to a 14.5% year-over-year decline in electronic device business segment.

Operating loss of ¥3.608 billion was recorded (compared with an operating income of ¥4.124 billion in the previous term). Silicon crystal manufacturing equipment parts inventory evaluation losses arising from a contraction in this business and lower of cost or market evaluation losses arising from price declines in poly-silicon materials contributed to a ¥1.884 billion increase in materials costs and a 9.3% point increase in cost of sales margin to 81.8%. While successful promotion of cost reduction measures and declines in variable costs allowed sales, general and administrative expenses (recorded ¥853 million as the bad debt provision) to fall by 14.6% year-over-year, they were not enough to offset the lower gross income. The booking of a foreign exchange translation gain of ¥870 million (compared with a loss of ¥139 million in the previous term) contributed to an improvement in non-operating income. Despite the booking of ¥1.548 billion in profit from the sale of real estate as extraordinary income, the total extraordinary loss of ¥4.330 billion was realized due to ¥3.656 billion from business restructuring costs and ¥458 million from impairment loss and contributed to a net loss of ¥6.532 billion.

The average foreign exchange rate assumptions during the current term were ¥80.1 per Dollar, and ¥12.7 per Chinese Yuan (compares with ¥79.6 and ¥12.3 respectively during the previous term). Capital investments and depreciation of ¥3.706 and ¥3.321 billion were recorded (compared with ¥7.877 and ¥2.825 billion in the previous term).

Most of the losses on non-cash item, the promotion of inventory reductions and a decline in tax expenses allowed the net cash inflow of operating activities to rise from ¥642 million in the previous term to ¥1.584 billion in the current term. Furthermore the quarterly sales appear to have bottomed out.

Equipment Related Business

Sales and operating income declined by 24.2% and 94.5% year-over-year to ¥18.867 and ¥0.137 billion respectively. Overall demand stagnated despite favorable trends for quartz and ceramics products used in semiconductor and FPD manufacturing processes and in applications for smartphone semiconductors. The growing request for price reduction since the mid-year also contributed to the fall in sales. Furthermore, sales of vacuum seals used as semiconductors and FPD manufacturing equipment parts also fell due to weak capital investments. However, silicon wafer processing for small diameter wafers maintained robust sales.

Electronic Device Business

Sales and operating income declined by 14.5% and 53.7% year-over-year to ¥4.563 and ¥0.257 billion respectively. Demand for thermoelectric modules from testing devices and biotechnology related equipment applications proved resilient. However, a difficult operating environment continued until the mid-year, which led to a decline in sales of temperature controller for automobile seats. Weak consumer spending also contributed to declines in shipments to consumer equipment applications. At the same time, strong automobile sales in developing countries contributed to an increase in sales of magnetic fluid used in automobile speakers.

Photovoltaic Related Business

Sales declined by 54.9% year-over-year to ¥12.345 billion and an operating loss of ¥3.934 billion was incurred (compared with an operating income of ¥775 million in the previous term). Increases in the use of photovoltaic cells in Japan, China and the United States were offset by declines in Europe and worldwide demand remained flat with the previous term. At the same time, the price of photovoltaic panel declined due to an oversupply primarily by Chinese manufacturers. Subsequently, these conditions led to deterioration in profits of the panel makers and caused their capital investments to freeze. Against this backdrop, demand for silicon ingots and wafers, and silicon crystal manufacturing equipment declined, causing sales of crucibles, square tanks and other consumable goods to decline as customers adjusted their production schedules.

Large declines in sales and inventory evaluation losses on silicon crystal manufacturing equipment parts (review of inventories associated with the contraction in this business) contributed to a large loss. Furthermore, the lower of cost or market accounting method for the price declines of silicon ingots and wafers led to the booking of a ¥1.884 billion evaluation loss as cost of goods sold, and the implementation of more conservative assumptions for the possibility of collection of accounts receivables led to the booking of bad debt provision of ¥853 million to sales, general and administrative costs.

Progress in a "Business Restructuring Plan" contributed to a ¥6.227 billion decline in total assets from the end of the previous fiscal year to ¥66.343 billion. In February 2013, Ferrotec signed agreements with various financial institutions to extend their short term commitment lines, and the sale of a vacant lot of its headquarters allowed the Company to secure the cash expected to be used for the foreseeable future. In addition, the "Business Restructuring Plan" calls for the retreat from unprofitable businesses and reduction of fixed costs, as well as the promotion of activities to fortify existing businesses and effectively utilize corporate facilities as part of a strategy to improve the Ferrotec's earnings structure. Capital adequacy ratio stood at 44.9%.

With regards to cash flow, the large net loss caused in large part by a number of losses that did not require cash payments, and a progress in inventory reductions and a decline in tax expense (fell from ¥1.482 billion to ¥492 million) allowed the net cash inflow in operating activities to rise from ¥642 million in the previous term to ¥1.584 billion in the current term. At the same time, large reductions in capital investments and the sale of a vacant lot of its headquarter contributed to a large reduction in the net cash outflow in investing activities, and allowed free cash flow to improve from a net outflow of ¥7.850 billion in the previous term to a net inflow of ¥1.182 billion in the current term.

Fiscal Year March 2014 Earnings Estimates

Sales to Rise 9.3%, Ordinary Income of ¥700 Million

While difficulties in the silicon crystal manufacturing equipment are expected to contribute to a 9.5% year-over-year decline in sales of the photovoltaic related business, investments for miniaturization of semiconductors and for mobile applications of FPDs should boost sales of the equipment related business by 18.2% year-over-year. At the same time, an increase in the sales of thermoelectric modules on the back of recoveries in consumer products and temperature controllers for automobile seats is expected to allow sales of electronic devices to rise by 15.8% year-over-year.

With regards to profits, the disappearance of unprofitable business and cost reductions are expected to contribute to declines in ratios of both cost of sales and sales, general and administrative expenses. Consequently, operating income is expected to improve by ¥4.6 billion from the current term and allow operating income of ¥1.0 billion to be recorded.

Ferrotec's assumptions for foreign exchange rates are ¥95.0 per Dollar and ¥15.0 per Chinese Yuan (¥80.1 and ¥12.7 in fiscal year March 2013 respectively). Also, the Company is expected to spend ¥1.5 billion on capital investments and record ¥3.6 billion in depreciation (¥3.706 and ¥3.321 billion in fiscal year March 2013 respectively). Moreover, Ferrotec is not planning any large new investments and this figure is based on the Company's cash flow position at the end of the current term including equipment costs payable.

Equipment Related Business: Sales Rise 18.2% to ¥22.305 Billion

Vacuum seals sales are expected to rise by 14.0% year-over-year to ¥5.340 billion. At the moment, in addition to the restart of investments primarily by large semiconductor companies, investments on FPD for large LCD television, small and medium sized high resolution LCDs for mobile handsets, and organic EL manufacturing equipments in China are expected to recover as well. Furthermore, signs of a recovery in robot manufacturers have also been observed. In addition, Ferrotec is implementing efforts to expand its customer base by providing engineering after services, and cultivating demand for equipment sub-assemblies and chambers from general industries.

Quartz product sales are expected to rise by 19.5% year-over-year to ¥4.087 billion. The company is expecting a recovery of sales after the latter of the first half, on the basis that the orders from major OEM customers in the United States have bottomed out and the orders from companies in Japan and other parts of Asia have also started to increase as they resumed capital investments (56% of quartz crucible sales were OEM during fiscal year March 2013). Chinese plants of United States and Taiwanese companies are potential customers, and Ferrotec is increasing its production in China as a means of cultivating this latent demand and reducing costs. In addition, sales growth is expected to be derived by pursuing synergies with the cleansing business. The Company will also promote efforts to acquire certification quickly, customize products, ensure consistent quality, achieve short delivery periods, and fortify marketing in the Taiwan market.

Ceramics sales are expected to rise by 5.9% year-over-year to ¥4.350 billion. Orders for fine ceramics products used in semiconductor manufacturing equipment have been recovering because some of the Japanese and Taiwanese manufacturers resumed their investments for miniaturization. In addition, efforts to develop new clients and expand applications for wafer circuit testing equipment are being undertaken in the realm of machine-able ceramic products for semiconductor testing equipment. Furthermore, the Company tries to expand sales and improve its competitiveness in marketing by developing new materials for both products.

Also, overall market conditions for wafer processing have begun to recover, with expectations of a strong expansion of in-house brands. At the same time, LED investments have completed and EB gun and deposition equipment market is expected to recover from the second half onwards.

Electronic Device Business: Sales Rise 15.8% to ¥5.282 Billion

Sales of the core product of thermoelectric modules are expected to rise by 15.5% year-over-year to ¥4.764 billion. Sales to automobile heated seat applications are expected to grow on the back of the adoption of new product models. In addition, consumer products, biotechnology equipment, semiconductor, and optical applications are expected to keep strong trend. Also, new product applications for electric shavers and water purifying equipment are being developed. Ferrotec is implementing measures to expand its share of the United States and China optical communications markets, and to increase profitability through the sale and certification of power device boards. In particular, the Company is fortifying it marketing capabilities in the high functionality market in the United States. In addition to these moves, automation of production lines is being promoted as a means of reducing fixed costs.

Photovoltaic Related Business: Sales Fall 9.5% to ¥11.173 Billion

Sales of quartz crucibles, including multiple crystal and square tank products, are expected to rise by 13.8% year-over-year to ¥6.268 billion. Volumes are expected to increase on a bottoming in photovoltaic cell demand. Efforts to raise the share of semiconductor applications to overall sales are also being considered. At the same time, Ferrotec is now enjoying the benefit from competitors' withdrawal from the multiple crystal square tanks and its capacity utilization rate is currently trending around 90%. In addition to differentiation by getting certified as heat resistant products for a long period of time, efforts to recycle materials and extract cost reductions in the refining process are being implemented at the Yinchuan Plant. Moreover, Ferrotec seeks to expand its share by quickly acquiring certification for eight inch applications for semiconductor use.

Photovoltaic cell use silicon sales are expected to grow by 13.8% year-over-year to ¥6.268 billion. Evaluation losses arising from fluctuations in the raw material polysilicon market have already been accounted for, and Ferrotec's shift to manufacture of products only on an OEM basis has been completed with the withdrawal from its own in-house products during the previous term. While growth in Europe has halted, strong demand from India, Eastern Europe, the Middle East, South America and other emerging regions is anticipated, and demand from Japan, China and the United States remains strong. Prices are expected to trend around the current levels. Ferrotec is endeavoring to increase its market share by meeting customers' demands for products with better conversion rates and lower prices. In addition, the Company seeks to reduce costs by producing crystals at its Yinchuan Plant, and differentiate itself by using its fixed abrasive grain sliced wafers.

Silicon crystal manufacturing equipment sales are expected to decline by 93.4% year-over-year to ¥150 million, based on the assumption of no new orders and booking of maintenance expenses. For the foreseeable future, production facilities for glass processing, general polishing, core drill and other general use equipment for general industries are expected to be maintained. Ferrotec will also implement other rationalization measures along with efforts to cultivate orders for the CMS business with a view to its recovery.

Conclusions

At the time of Ferrotec's listing on the JASDAQ (formerly known as the Over-The-Counter Market), the Company had sales and operating income of only ¥4.0 and ¥0.3 to ¥0.4 billion, respectively, derived primarily from hard disc drive computer seals using magnetic fluids. After the start of the 2000s, hard disc drives shifted from the use of ball bearings to fluid bearings and the market for traditional computer seals completely disappeared. However, Ferrotec successfully fortified its equipment related business by cultivating new clients for both in-house and OEM products and fortifying its quartz crucible and ceramic product lineup. Furthermore its expansion of the thermoelectric module business and launch of newer business including the CMS and photovoltaic related businesses enabled it to achieve sales and operating income of ¥60.0 and ¥6.9 billion respectively in fiscal year March 2011. Although extremely difficult operating conditions continued since the second quarter of fiscal year March 2012, both the business environment and earnings appear to have bottomed out now. If Ferrotec makes earnest efforts to fortify its business and to implement proactive investor relations, it may take little time before investor confidence in the Company can be restored. At the same time, a decline in Ferrotec's share price from its recent high of ¥694 on May 22 to its current level of the low ¥400 range may be an opportune time for investors to consider the positive long term potential of the Company.

Disclaimer

This report is intended solely for information purposes, and is not intended as a solicitation to invest in the shares of this company. The information and opinions contained within this report are based on data made publicly available by the Company, and comes from sources that we judge to be reliable. However we cannot guarantee the accuracy or completeness of the data. This report is not a guarantee of the accuracy, completeness or validity of said information and or opinions, nor do we bear any responsibility for the same. All rights pertaining to this report belong to Investment Bridge Co., Ltd., which may change the contents thereof at any time without prior notice. All investment decisions are the responsibility of the individual and should be made only after proper consideration.

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