Photronics Inc (PLAB) Q2 2023 Earnings Call Transcript

Good day and thank you for standing by. Welcome to Photronics Second Quarter 2023 Earnings Conference Call. As a reminder, this conference is being recorded Wednesday, May 24, 2023. I would now like to turn the conference over to Richelle Burr, Chief Administrative Officer. Please go ahead.

Thank you, Kevin. Good morning, everyone. Welcome to our review of Photronics’ fiscal 2023 second quarter results. Joining me this morning are Frank Lee, our Chief Executive Officer; John Jordan, our Chief Financial Officer; Chris Progler, our Chief Technology Officer; and Eric Rivera, our Corporate Controller and Chief Accounting Officer. The press release we issued earlier this morning, together with the presentation material that accompanies our remarks, are available on the Investor Relations section of our webpage. Comments made by any participants on today’s call may include forward-looking statements that include such words as anticipate, believe, estimate, expect, forecast and in our view. These forward-looking statements are based upon a number of risks, uncertainties and other factors that are difficult to predict. Actual results may differ materially from those expressed or implied and we assume no obligation to update any forward-looking information. During the course of our discussion, we will refer to certain non-GAAP financial metrics. These numbers are useful for analysts, investors and management to evaluate ongoing performance. A reconciliation of these metrics to GAAP financial results is provided in our presentation materials. At this time, I will turn the call over to Frank.

Thank you, Richelle and good morning everyone. Second quarter results were strong as we achieved record revenue and profit. Demand for our products grew in both IC and FPD with sequential revenue growth in all regions. Our position as the largest merchant photomask supplier provides us broad exposure to global markets and makes us less dependent on any single sector or region. In addition, we have a talented and dedicated global team. Their performance has enabled Photronics to deliver record results in Q2. IC demand was strong again this quarter, especially for mainstream. This sector has been growing for the last several quarters. Demand for the advanced portion of mainstream in the 40 to 55-nanometer range is especially strong. On the other hand, we observed some softness in high-end. However, we expect this to recover in the next one to two quarters and to resume a growth trend. Within FPD, demand for AMOLED grew significantly. Our customers are releasing new designs for mobile displays as they try to gain market share in the next generation of smartphones, tablets and PCs. Demand for LCD has stabilized with good sequential growth. We expect this favorable trend to continue. Growth and operating margin benefited again this quarter from strong pricing and tight cost management across the organization. As a result, we earned $0.65 per share on a GAAP basis and $0.54 per share on a non-GAAP basis after excluding $0.11 per share gain from foreign exchange. This was an excellent quarter as we continue to see another record year. Photomask demand is driven mainly by new designs. Design activity often follows different demand cycles than capital equipment or wafer starts. For example, our customers often release new designs when their demand is soft and utilization is low, and that could be a better time to introduce new products into their operations. Another condition that drives photomask demand is capacity expansion, either through new fabs or new tools in existing fabs. This factor tends to make photomask demand more sustainable and even countercyclical. Since I was named CEO 1 year ago, I have spent a lot of time with our employees across the organization and helped enhance our drive to upgrade, which has contributed to our success. In addition, we have strategically invested in technology and developed advanced process know-how for our leading edge mask solutions. By working closely with our customers, we are able to fully support their technology and product enrollment. Our differentiated EUV product line continued to expand, achieving a number of important milestones, including our first EUV DRAM mask shipments in Q2. We have a great market position as a leading photomask supplier with 11 strategically located manufacturing sites. Based on data recently published by Tech Insight, we shipped approximately 30% of all photomask units globally. The leading providers of semiconductors and display panels trust us to supply their photomasks. This confirms our leading position and is an indication of our broad and diverse market exposure. Finally, we have a strong balance sheet to fund growth. Through cash flow generation and financial discipline, we have built a strong and flexible balance sheet that provides liquidity to invest in growth while also providing support should we see a decline in demand. We are on track to deliver another record year in 2023. Later on, John will provide our Q3 guidance in more detail. Photomask market demand is strong and our team is performing well. I am very optimistic about our future. With that, I will turn the call over to John.

Thank you, Frank. Good morning, everyone. Second quarter revenue of $229 million was another record, a 9% sequential increase and a 12% increase over last year’s second quarter. That represented the ninth consecutive quarter of year-over-year revenue growth. Demand remained robust across both IC and FPD, reflecting strong design activity from our customers releasing new products and expanding production capacity. Shipments within and into China represented 51% of second quarter revenue. We are the global market leader in merchant photomask and our customers partner with us to achieve their product roadmap objectives. IC revenue of $167.1 million was up 7% sequentially and 15% compared with last year. Demand was strong across all regions and mainstream growth more than offset some high-end softness. Pricing remains favorable as demand growth continues to outpace some increases in supply. We are seeing the strongest demand within the higher end of the mainstream technologies, which aligns well with the investments we have made to increase IC capacity. Our commercial teams are doing a great job of bringing those orders in and we believe new designs and increases in chip capacity driven by regionalization of the semiconductor supply chain will continue to drive long-term positive trends in the photomask sector. FPD revenue was also a record in the quarter, improving 14% quarter-over-quarter and 6% year-over-year. AMOLED panels used in advanced mobile displays continue to fuel healthy demand for high-end masks, which represented 83% of the FPD revenue in the quarter. Mainstream revenue also grew sequentially with increased capacity and stable LCD demand. Gross and operating margins increased quarter-over-quarter by more than 260 and 270 basis points, respectively, to 38.6% and 29.2%, which were 430 and 500 basis points more than the margins reported in the second quarter last year. The sustained strong margins benefited from volume leverage, pricing power, favorable mix and disciplined cost management. Operating expenses increased by 6%, but at 9.3% of revenue were lower as a percentage of revenue. Second quarter operating income of $67 million is the most the company has ever recorded in a quarter. The non-operating gain in the quarter of $13.6 million resulted primarily from the unrealized gain from remeasurement of U.S. dollar-denominated balance sheet items into the local functional currencies of our foreign operations. This compares with a loss of $14.4 million in the first quarter, resulting in a $28 million sequential tailwind due to changing FX rates. Similar to last quarter, we provided non-GAAP results that exclude the foreign exchange effect for better comparison of operating results. GAAP EPS was $0.65 a share. After eliminating the effects of foreign exchange and the related income tax on minority interest, adjusted EPS was $0.54 for Q2 compared with adjusted EPS of $0.40 last quarter and $0.38 in the same quarter last year. The strong net income performance and tight working capital management produced an outstanding $82 million in cash from operating activities. We invested $27 million in capital expenditures in the quarter, bringing year-to-date CapEx to $58 million. Our 2023 CapEx forecast remains approximately $130 million primarily for increased IC capacity. Our cash balance was $367 million at the end of the quarter, and we held an additional $45 million in short-term investments. We have $28 million of debt remaining consisting almost entirely of low-cost equipment leases. Our cash and short-term investments combined with funds available under the credit agreement, provide ample liquidity for our growth investments and resilience against uncertainties we could face in the future. Before I provide guidance, I’ll remind you that our visibility is always limited as our backlog is typically only 1 to 3 weeks, and demand for some of our products is inherently uneven and difficult to predict. Additionally, the ASPs for high-end mask sets are high. And as this segment of the business grows, a relatively low number of high-end orders can have a significant impact on our quarterly revenue and earnings. Given those caveats, we expect third quarter revenue to be in the range of $224 million to $234 million. We believe photomask demand will continue to do well in the current semiconductor environment, and we will continue to strive to increase our market-leading position. Based on those revenue expectations in our current operating model, we estimate non-GAAP earnings per share for the third quarter to be in the range of $0.48 to $0.54 per diluted share. Year-to-date, we have grown revenue 12% and expanded operating margins by 570 basis points. Demand remains strong, and our team is performing well. Our confidence that we can achieve our long-term targets and continue creating shareholder value is supported by our level of execution, strong balance sheet and positive outlook on continued strong design activity. I will now turn the call over to the operator for your questions.

Thank you. Our first question comes from Tom Diffely with D.A. Davidson. Your line is open.

Hi, good morning. This is Linda on behalf of Tom Diffely. Thank you for letting us ask a question. First of all, congratulations on a great quarter. So I guess my first question, in terms of the continued geopolitical issues we have seen in the past few days, Japan now tightening export controls to China, this coming after export restrictions by the U.S. And I believe you mentioned you had 51% shipments into China this quarter. So I’m wondering if you could quantify any headwinds that you’ve seen from China in terms of the macro headwinds and then the Japan development and maybe just compare it to your guide for next quarter?

Yes. Thanks for that, Linda. Good morning. Richelle, who’s our Chief Administrative Officer, will comment on that question.

Hey, Linda. Yes, so with respect to the geopolitical tensions, to date we have not received – we have not had a material impact in our quarter, because of the export control regulations and the geopolitical issues that are going on between China and the U.S. We are cognizant of Japan tightening the controls again, we monitor the controls very carefully. We are working closely with our suppliers so that they can get licenses or we get licenses for either the tools or the parts that we need to continue our operations in China.

Okay, thanks, Richelle. That’s helpful. And then I guess my second question in terms of the demand side of things. You noted strong demand in the quarter, but as memory demand remains sluggish and mature holding up well. What are you seeing on the memory front for you guys? And maybe discuss how this is impacting your pricing dynamics as well as your margin profile?

Hi, this is Chris. I think your question was related to particularly memory mask demand in the quarter, what the market kind of looks like and the dynamics. Did I get that correctly?

Correct. Yes, that’s correct.

Yes. So we have exposure to part of the memory market and those customers haven’t been as strong as they were in previous quarters, but particularly our most advanced DRAM customer is still doing fairly strong roadmap and development cycles, preparing for recovery of the markets. It looks like some of the memory pricing has started to stabilize. Maybe it’s at a bottom, maybe not, but the two or three primary customers we have on memory seem to be a bit more optimistic about what might unfold in the second half of 2023 calendar year, and we’re seeing pretty strong R&D cycles and pretty strong product development cycles still. So that hasn’t changed. So it was not strong in the quarter, but it looks like at least customers we serve are getting a bit more optimistic about the latter half of 2023.

Thank you for the color. And then my last question is on CapEx. Maybe John, I have missed it, but what are you thinking in terms of CapEx for this year, and maybe could you give us please for this year for FPD and IC?

Yes. Most of the $130 million that we’ve got planned for this year Linda is in IC. And it seems as though we’ve really targeted our CapEx well because the demand is in the high end of that mainstream business, which is where we’ve invested significantly in the past year.

And also some of our tools, we call end of life, so we are planning to replace certain old tools with more efficient and updated tools. So, some CapEx in IC is spending on the end-of-life tool replacement.

Got it. Thank you for your time.

Linda, just like to add on the geopolitical situation, Richelle’s comments are well placed and they relate only to IC because the FPD business is not impacted by...

Yes. FPD is not controlled, so control regulations yes, those impact IC, not FPD.

Got it. Thank you so much for your time.

Thank you, Linda.

Our next question comes from Gus Richard with Northland. Your line is open.

Yes. Thanks for taking my question.

Good morning Gus.

Good morning. Appreciate it. Real quick, could you talk a little bit about expedites, are you still seeing those in the mature side, or has that activity slowed?

Okay. Hi Gus. Thank you. The premium side has seen a slowdown in Taiwan. However, we still have some long-term agreements which we signed last year or early this year. And in those long-term agreements, the premium charge has been defined and will continue through the period of the agreement, and certain agreements are for 2 years, some agreements are for 3 years. So, we will maintain certain premium charges in this year and next year.

Got it. And then in terms of industry-wide capacity, it seems like particularly mature, it remains tight, and I am just wondering, as you look across the industry on the IC side of things, is it just tight in certain regions like China, or is it tight globally? Can you talk about how you see that evolving over the next couple of years?

In our industry, we do see some expansion, some new local manufacturers in China. And these new players, some are in a very early stage, some have started to get customer qualifications and enter the market. However, we believe that the impact will start on the low end of the business, and also for these new competitors to achieve certain economic scale, it will take several years. So, our business in China basically, we are focused on the higher end of the mainstream. Therefore, we will have some differentiation with the new competitors. Outside of China, IC photomask capacity expansion is not significant. As we just mentioned, we spent some CapEx, part of those, of course, is for capacity expansion, but some portions of those are for end-of-life replacement. This kind of end-of-life situation happens to every merchant, not only to us. Even if every merchant is doing CapEx, some tools will be at end-of-life. Overall, the capacity increase is still limited.

Okay. Got it. So basically, just to summarize overall you see the capacity remaining tight and the incremental CapEx is for replacement of all the tools that are no longer supported.

Correct.

Got it. And then over the last 40 years, IC photomask margins rarely have gotten into the 30s, and I am just kind of curious what gives you the confidence that that is a sustainable level, just given the history of the industry?

I think in the past, yes, as you mentioned, photomasks are not big players in the semi industry. A lot of companies are focusing on wafer fab capacity expansion and paid little attention to photomask supply. So, the supply demand was on the other side, more supply than demand. However, because most merchant photomasks are not making enough money to invest, the trend has gradually shifted between the supply and demand, especially in the past 2 years. A lot of new IC applications have created a lot of new wafer fab expansions. So, the combination of supply side of photomasks not expanding and the demand side having a lot of new wafer and new product demand is causing the supply and demand balance to worsen. In such situations, we believe we have some leverage in terms of pricing and also profit margin.

Got it. And just last one for me. Are you seeing an extension in the mature markets of lead times, or have they stabilized at this point for you guys, your lead times?

Yes. Our lead time was very low last year. Before the shortage, the lead time was like 7 days, 10 days at the longest. Last year, some lead times were as long as 90 days. At this moment, the lead time has improved, but still, it is much longer than the normal lead time before. We are still seeing some premium charges, but this lead time is different from node to node. Certain nodes remain very long lead times, while certain nodes have improved.

Got it. Thank you so much. I think that’s it for me.

Thank you, Gus.

Thanks very much.

I am not showing any further questions at this time. I would like to turn the call back over to Frank.

We are glad that you have chosen to join us this morning and appreciate your interest in Photronics. Our performance through the first half of 2023 has exceeded our expectations. Market demand is strong and financial metrics are improving. I am proud of the way our team has performed to serve our customers and continue to contribute to our achievements. We believe we are on our way to achieving our long-term targets and look forward to updating you again on our progress. Have a good day to everyone. Thank you.

Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation and ask that you disconnect your line.