Photronics Inc (PLAB) Q1 2024 Earnings Call Transcript

Good day, ladies and gentlemen. Thank you for standing by. Welcome to Photronics First Quarter Fiscal 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. As a reminder, this conference is being recorded today, Wednesday, February 21st, 2024. I would now like to turn the conference over to Richelle Burr, Chief Administrative Officer. Please go ahead.

Thank you, Lilian. Good morning, everyone. Welcome to our review of Photronics Fiscal 2024 First Quarter Results. Joining me this morning are Frank Lee, our Chief Executive Officer; Chris Progler, our Chief Technology Officer; John Jordan, our Chief Financial Officer; and Eric Rivera, our Chief Accounting Officer and Corporate Controller. 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 web page. Comments made by any participants on today's call may include forward-looking statements and 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. We achieved sales growth compared with last year and both IC and FPD increased, with high-end growth being partially offset by soft mainstream demand in both sectors. Compared with the fourth quarter, sales were down due to seasonal trends and four fewer days in the first quarter. Demand was weaker, and sales were softer than we expected during the first month of the quarter for both IC and FPD. Demand improved during the quarter, increasing our revenue run rate and giving us confidence that revenue will improve in the second quarter. Earnings improved over last year as operational leverage drove higher gross margins. In our quarter-over-quarter comparison, no varying costs caused gross margin to fall. Once again, our team has managed to control expenses and deliver solid margins, even with lower sales compared with the fourth quarter. The first quarter earnings were $0.42 per share on a GAAP basis and $0.48 per share on a non-GAAP basis. Operational cash flow improved from the first quarter of last year, allowing us to further strengthen our balance sheet to support our growth plans. I would now like to offer some comments on the overall market, mass market, and demand environment. As I stated earlier, mass demand was soft at the start of the first quarter for both IC and FPD. Demand improved through the quarter, including the US spike in orders we saw ahead of the Chinese New Year, which started on February 9th. While still early following the holiday break, we do expect the demand trends we saw prior to the Chinese New Year to continue in Q2. For IC, we are seeing a growing trend in customer migration from Asia as they move to 28 and 22 nanometers to improve performance. This trend is driving tap-out demand for our high-end businesses. In memory, the industry is seeing a recovery in demand. Our memory exposure is with Tier 2 providers, now typically aligned with high-value applications. They are seeing encouraging demand trends as well. For FPD, our business outlook looks good even as the overall display industry remains soft. As a technology leader with a strong market presence in the more advanced AMOLED displays, we have a competitive advantage that keeps demand high for our display mask. Displays for premium smartphones are continually asked to add new features, and panel makers are innovating to gain market share. This benefits us as we have strong relationships with large panel makers and can provide high-quality masks to help them achieve their goals. With the momentum during the second half of the first quarter, we expect our revenue to grow in the second quarter. As this happens, we will remain focused on controlling costs to increase margins and increasing cash flow to support growth investments. I'm optimistic about the rest of the year, expecting the semiconductor industry to transition to the next phase of growth, leading to an increase in photomask demand during our second to third fiscal quarters. We believe our technology, strong customer relations, and global presence will position us to continue to perform well. Before turning the call over to John to review Q1 results, I would like to publicly congratulate John on his upcoming retirement. John has been an important member of our executive team since joining Photronics in 2017 and has been a great partner to me throughout this time, especially during my tenure as CEO. He has led us through tremendous growth and geographic expansion. On behalf of the entire organization, I wish him well in retirement. John, the floor is yours.

Thank you, Frank, for those kind words. I am looking forward to retirement and spending more time with my family and some favorite projects. Although I'm leaving, I'm confident in the company's continued success. The CFO role in any company is a challenging position. In our case, I believe we have met that challenge with the strong support of an excellent finance organization. Eric, our Corporate Controller, will assume the role of Interim CFO, along with one of our Treasurers and both their staffs and our international CFOs and their staffs. The Photronics Board is demanding and supportive, and the cohesiveness and commitment of the leadership team to a well-defined strategy of targeted investment and consistent execution will help ensure that success. Now turning to first quarter results. Revenue was $216.3 million, up 2% year-over-year and down 5% from last quarter. As Frank mentioned, our first quarter began slowly, but gained momentum as end market demand seemed to recover. The first quarter is typically the seasonally slowest quarter in our fiscal year. Slower demand at the beginning of the first quarter exacerbated the seasonal decrease, and there were four fewer days than the previous quarter, all combining to create the sequential decrease. First quarter IC revenue was $157.6 million, up 1% year-over-year and down 4% sequentially. High-end revenue increased, led by strong foundry logic demand in Asia and high-end revenue in the US. Mainstream revenue was lower due to softness in Asia, partly related to the stronger high-end demand resulting from customers' migration to the more advanced nodes. The long-term growth drivers remain intact as we support customers' technology road maps and investments as they expand capacity to support supply chain regionalization. FPD revenue of $58.7 million improved 8% compared with last year but was down 7% from Q4's record level. High-end FPD revenue improved year-over-year due to increased demand for AMOLED displays used in mobile applications, although it was lower sequentially due to normal seasonal softness. The mainstream FPD decline was attributable to the slow start to Q1 that we alluded to earlier. We remain the technology leader, which gives us confidence in our ability to continue to outgrow the market as panel makers release innovative products to gain market share. Gross margin was 36.6%, slightly higher year-over-year and slightly lower quarter-over-quarter, consistent with changes in revenue and the effect of high operating leverage in both directions. Operating expenses were higher this quarter primarily related to increased employee compensation expenses. The resulting operating margin was 26.6%. Net income in the quarter was $26.2 million or $0.42 per diluted share. Adjusted for the non-operating loss, net income was $29.9 million or $0.48 per diluted share, an improvement from last year and somewhat lower than our very strong Q4 earnings. We generated $41.5 million in operating cash flow, which is 50% higher than last year due to higher net income and effective working capital management. Our CapEx investments for growth were $43.3 million in the quarter. Our CapEx guidance for the year will remain at $140 million, primarily in both high-end and mainstream IC to address anticipated demand. We ended the quarter with a cash balance of $508.5 million, short-term investments of $13 million, and debt of $23.4 million, providing us with ample liquidity to fund investments in organic growth. Before I provide guidance, I'll remind you that our visibility is always limited as our backlog is typically only one to three weeks, and demand for some of our products is inherently uneven and difficult to predict. Additionally, the ASPs for high-end mask sets are substantial, 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 second quarter revenue to be in the range of $226 million to $236 million. We believe the momentum that built during the first quarter will continue into Q2, driven by solid long-term demand drivers across our markets. Our pricing environment has stabilized around the mid to high 30s percentage gross margin level. At the midpoint of our guidance for Q2, we anticipate gross margin in the 38% range, somewhat better than the margin in Q1. Based on those revenue expectations and our current operating model, we estimate non-GAAP earnings per share for the second quarter to be in the range of $0.50 to $0.58 per diluted share. After a slow start to the year, we're encouraged by strengthening demand during the quarter and into the second quarter. We anticipate the continuation of these trends, along with the performance of our global team to provide sequential improvement in the second quarter and continued growth through 2024. I will now turn the call over to the operator for your questions.

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

Yeah, good morning, and thank you for taking my question. First of all, John, it's been a pleasure working with you, and I wish you well on your retirement. And then I guess I'd like to just kind of back up here and hopefully ask a little bit about just the health of the mainstream business and how you see that playing out in terms of pricing, supply-demand, seasonality, just focused on the mainstream, if you could.

Yes. Tom, thank you. In the mainstream sector, the season is low, especially in the China and Taiwan markets. In terms of pricing, there are still some newcomers in the market in the mainstream. However, we don't see the mainstream business impacted by this new competition in areas outside of China and Taiwan. So the impact on mainstream pricing has some pressure in the Greater China area. However, our main business has been migrating to 40 and 22, 28 nanometers. Therefore, the portion of mainstream business in our Asia operation is not significant. So the increase in product mix has offset the mainstream price pressure in terms of overall branded ASPs.

Okay. So when you look at the last few years, you had the nice ramp-up in first demand? And then because there were supply constraints in the industry, you had nice pricing, nice margins. And then it seemed like the margin got a little saturated. At this point, it feels like the pricing or the margins from the mainstream is in a kind of stable area where if you look at over the next few quarters, it feels pretty stable for you? Or are we going back to kind of the historical pattern in mainstream when we have a seasonal or yearly decline in pricing?

Actually, the pricing I mentioned went up in 2021 and '22. So even if we adjust the price a little bit right now, they are still much higher than before. But at this moment, the pricing of mainstream has stabilized, and we are not trying to adjust the price because the market in high-end of the mainstream, especially in the 40-nanometer area, are growing. So that is consuming a lot of our capacity. We have no need to further adjust our price in mainstream. So going forward, we will keep our mainstream pricing stable. Of course, the premium charge at this moment has disappeared. However, as I mentioned, we are focusing on the branded ASP, which primarily depends on the product mix.

Okay. No, it sounds good. It's encouraging. Moving over to the flat panel business, you talked about some OLED strength and how that helped your advance. I'm curious, what are you seeing in the Gen 10.5 range? Is that still fairly light or fairly soft for you?

It's still very light. Most customers are focusing on AMOLED products and the total cap of Gen 10.5 remains very low. So actually, in terms of profit margin and overall production output, it's more beneficial for us to focus on AMOLED products instead of Gen 10.5.

Okay. Great. I'm not certain if Chris Progler is on the line, but I have a question about how the introduction of mini and micro LEDs for flat panel displays influences the photomask market.

Let's say, so the mini LEDs are just a more sophisticated backlight. There's not a big impact on those in the photomask market except for the switching layer or the transistor layer. Those mini LEDs let you take advantage of more advanced TFTs or the transistor level. So it's driving a more sophisticated advanced switching layer. Thanks to mini LEDs, although the formation of the mini LEDs is not particularly photomask intensive. For micro LEDs, it started off as a relatively simple technology to integrate that is relatively few patterning steps. What we're seeing in most of those products are in the prototype or early production phase. Actually, there's a fairly dense set of photomask and patterning requirements to build those micro LEDs. They're proving to be a little harder to control than initially anticipated. So I think it's a good trend, a positive trend on the micro LED side for photomask, especially if it drives more applications for displays. It's not a game-changer by any means or a tremendous driver, but I think it should be viewed as a positive trend for display mask making.

All right. Thanks, Chris. And since I have you on the line, any update on activity that's going on with you and EUV? I know you've been part of some consortiums. But curious if there's any what we call regular business in that space at all for you?

Yes. So I think in '23 and '24 our EUV customer base expanded modestly. There are a couple of more companies we work with that are starting to dip their toes in the water on EUV using pilot masks and things like that. So we see the customer base expanding. We're doing a few demonstrations on running flows with EUV masks versus optical masks for one memory customer to compare what the yields might be under EUV. So I think the customer base is starting to expand a bit. The strongest part of that business for us has been our primary customer who is an OEM. That business has been very strong, consistent with what their OEM products and the take-up in the industry. And then as far as the advanced nodes, we did develop one new relationship on EUV, which we should not have the liberty to talk about on this call, but it's so far been a fruitful interaction and maybe we'll have a little more to say about it over the next few calls.

Great. I appreciate it, Chris. And then last question for John. When you look at the capital spending of $140 million this year, how much of that is, I guess, sponsored or do you have contracts to kind of guarantee a certain level of production if you're going to spend that level of money?

Yes. So as we've discussed over the last several years, Tom, for every major capital investment we get, first of all, we have an investment analysis that supports at least our threshold IRR. We drill down on the revenue line and those analyses to ensure that the revenues are not just numbers on an Excel spreadsheet. They're supported by either customer commitments or strong assurances that that business is going to be there, the requests from customers for us to increase capacity and not promises, but assurances of future orders to support the investments. As you've seen, our ROIC from 2017 at about 1.5% has increased to 13% to 14% over the last several years. So that strategy of supporting the investments and ensuring that we've got the revenues to support them has been effective in the total turnaround in our ROIC.

Great. Well, thank all three of you for your time today. And John, once again, congratulations.

Thanks, Tom. Thanks for coming and calling for the questions.

Thanks.

Thank you. And there are no further questions in the queue at this time. I will now turn the call over to Frank Lee for any closing comments.

Thank you for joining us this morning. We are entering the second quarter from a strong position with demand growing across our markets and a solid financial position to support our growth investments. We have a great market position with leading share and technology. We expect to continue growing market share and improving profit margins. I'm proud of our team's performance and confident we are on the way to another new record year in 2024. Thank you.

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