Power issues
Meanwhile, Shi found it necessary to explain what caused the 1HFY2021 earnings to drop. To recap, the company is organised into three business units. The largest contributor in terms of revenue and operating profit is that of advanced materials, which provides the coating services to the parts that are then used by other manufacturers. In 1HFY2021, revenue increased by 18% y-o-y to $76 million, but adjusted ebitda fell 4% y-o-y to $28 million. ebitda margins also fell to 37% for 1HFY2021 from 46% in 1HFY2020.
While demand increased from the so-called 3C (computer, communications and consumer electronics) and automotive sub-segments, supply chain disruptions caused by a global shortage of semiconductors, hampered production. If Nanofilm’s customers could not secure sufficient chips in time, then they would not require much of other components as well.
Nanofilm also incurred higher costs related to the equipment qualification process for a new plant in Shanghai. Shi explains that the new machines being installed use high-tension power lines instead of normal power supply lines. Besides having to get relevant approvals from the city authorities, the installation had to be carried out by a government-approved contractor. This, coupled with Covid-19-related curbs, led to delays. Furthermore, Shi also reveals there was a “timely and pressing demand” from Nanofilm’s customer to qualify 60 new pieces of equipment coating equipment in the new plant. To meet the project delivery deadline, the company rented diesel generators to supply the power needed, thereby incurring extra one-off costs in terms of fuel and equipment rental fees.
In addition, there were costs involved from new projects that have yet to enter mass production and the mix of products sold during the half-year happened to offer lower margins too.
During 2HFY2020 and 1HFY2021, the company added 64 coating machines, making it a total of 186 units. While that increased total production capacity by more than half, the utilisation rate for 1HFY2021 did not increase in tandem but instead dropped from 73% for 1HFY2020 to 61%, which is lower than its own long-term utilisation rate target of around 80%.
The second significant business unit is called industrial equipment, which makes the coating machines for both Nanofilm itself and external customers, where the services business model “may not be feasible”.
Relative to the advanced materials business unit, sales figures for this business unit tend to be lumpier and smaller. Revenue for 1HFY2021 was up 81% y-o-y to $19 million, with a total of 16 machines produced, down from 23 in 1HFY2020.Out of the 16, external sales increased to six from four in 1HFY2020 as customers’ capital expenditure increased, especially from those in the glass lens mould and precision engineering industries. The business unit’s adjusted ebitda for 1HFY2021 was $5.9 million, up 67% from $3.5 million recorded in 1HFY2020.
The third and smallest business unit is called the nanofabrication, described by Shi as the “new baby in the family”. This unit underperformed because a customer, which had been placing orders since the second half last year, halted volume production early this year and the replacement to take up the freed capacity could not be found in time. For 1HFY2021, revenue for this business unit dropped y-o-y from $3.4 million to $1.8 million, registering an adjusted loss before interest, tax, depreciation and amortisation of $0.9 million.
Nevertheless, Shi says there is a “very strong product pipeline” for multiple projects to make “high volume, high margin” parts for two major customers. The first will start by the end of the last quarter this year and another to follow early next year. “We expect to start a very good business with nanofabrication,” he says.
More often than not, when companies launch their IPOs, their top honchos would be most eager to meet up with both investors and the media to drum up interest in their offering with a rousing presentation.
However, when Nanofilm Technologies International launched its IPO last October, the company’s management skipped the meet-and-greet with the media, presumably confident that the issue is well supported by a long list of cornerstone investors with many more other institutional investors queuing up, eager to get their hands on some shares as well.
Indeed, the issue was 23 times subscribed and from the offer price of $2.59, the share price climbed steadily, helped along by a growing number of sell-side coverage with ever-higher target prices. On July 26, Nanofilm’s share price hit an all-time of $6.76, valuing the company at more than $4.4 billion. Along the way, company founder and executive chairman Shi Xu earned a place among Singapore’s wealthiest, thanks to his total direct and deemed interest of around 54% of the company.
However, things started to unravel quickly within weeks. On Aug 13, the company announced earnings for 1HFY2021 ended June 30 fell 3.1% y-o-y to $17.9 million instead of registering a steep trajectory as expected. As KGI analysts put it, Nanofilm missed estimates by “a mile”. Other analysts had predicted full-year earnings of around $80 million. The company’s 1HFY2021 revenue grew 24.2% y-o-y to $97 million, which was also a slower pace than expected.
At an earnings call on Aug 16, Nanofilm’s two deputy CEOs, Gary Ho and Gian Yi Hsen said they expected the second half to be better. They also maintained that the recent resignation of COO Ricky Tan, which came less than two months after CEO Lee Liang Huang quit, was not a cause for concern.
In reaction, analysts who were previously bullish on Nanofilm slashed their price targets by about a third. The market was swift to punish the stock too. From its Aug 13 closing price of $5.97 before the earnings were announced, Nanofilm’s share price plunged by a third to close at $4.25 at the end of Aug 16 after the weekend break. And investors were not done yet. The following day, the stock dropped by another 10% to as low as $3.80 before closing the day at $3.82. More than $1.4 billion in Nanofilm’s market value was wiped out over the two days.
In the face of a wave of downgrades and a big drop in its share price, the company launched a share buyback for the first time. On Aug 16, when its share price dropped by a third, the company spent around $6.8 million in total to scoop up 1.55 million shares at between $4.21 and $4.52. With selling continuing the following day, Nanofilm spent another $5.8 million to buy nearly 1.5 million shares at between $3.81 and $4.07. On Aug 18, another $3.48 million was spent buying even more shares at between $3.93 and $3.97. In the end, a total of more than $16 million was spent buying back the shares. This is larger than the $6.61 million dividend of one cent per share Nanofilm had planned to distribute.
This was when Shi, who is currently holding the interim CEO position, decided it was time for him to explain to the investment community with a follow-up call. “We didn’t expect such a drastic reaction. So, there was obviously a gap between our thoughts and intentions and market reality,” said Shi in the briefing held over video on Aug 18.
The lower earnings, according to Nanofilm, was due to higher costs related to getting new capacity ready in one of its plants in Shanghai. On the other hand, revenue growth was lower than expected because supply chain issues affected the volume of parts its key customer could secure.
On reflection, Shi realises the company could have done better managing expectations. Internally, the management has been mulling if quarterly updates should be given even though Nanofilm is not required to do so. “We need to have a better sense and a pulse of the market sentiment. We also need to make the market better known of our views and positions, [as well as] the company’s performance,” he adds.
New markets, new risks?
Indeed, things weren’t all that smooth sailing for Nanofilm even before the earnings surprise.
On June 7, the company announced it was suing a customer Advanced Solar Power (Hangzhou) (ASP) in China in a Shanghai court to claim an amount equivalent to $5.9 million for equipment constructed and delivered.
The suit was filed by one of the company’s subsidiaries, Nanofilm Vacuum Coating (Shanghai) (NVC), which was contracted by ASP to supply two Cadmium Telluride (CdTe) thin-film surface solution and production in-line equipment for solar cell panels.
“After the delivery and installation of the equipment which were carried out in stages, ASP refused to give factory acceptance for some of the equipment that were delivered,” said Nanofilm in its June 7 announcement.
Instead, the customer made demands which Nanofilm said were beyond the contractual obligations. NVC then tried to address the demands. “The company regrets that NVC’s goodwill gesture and efforts did not produce a positive outcome. While at the same time putting the equipment into operation for its own production, ASP persistently refused to give factory acceptance for some of those equipment that were delivered,” says Nanofilm.
On June 2, NVC was counter-claimed by ASP for around RMB11.3 million ($2.4 million) on grounds of quality issues in the equipment, which ASP alleged had resulted in a loss of $1 million in value of products and $1.4 million in production capacity.
Thus far, Nanofilm has received $20.9 million in payment out of the $23 million in total sales recorded from ASP as of Dec 31, 2020.
However, Nanofilm says the suit is not expected to have any “material adverse impact” on its FY2021 earnings. “The company is confident of the claim and believes that the counter-claim has no sufficient basis and could be tactical in nature,” adds Nanofilm.
According to Shi on Aug 18, the customer has been using NVC’s equipment in production for several years. “We did give them ample time to come up with a payment in a regular way. But since we are a public company, we need to be responsible to the public. We should not drag this issue further. That’s why we started the suit and, hopefully, that will bring a close to this event as soon as possible,” he says. In any case, this episode shows some of the risks involved when a company like Nanofilm tries to win over new customers in new markets.
