Earnings Call Transcript - PLAB Q4 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Photronics Q4 Fiscal Year 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ remarks, there will be a question-and-answer session. Please be advised that today’s conference is being recorded, Wednesday, December 9, 2020. I would now like to hand the conference over to Troy Dewar, Vice President of Investor Relations.

Troy Dewar, Vice President of Investor Relations

Thank you, Jimmy. Good morning everyone. Welcome to our review of Photronics 2020 fourth quarter financial results. Joining me this morning are Peter Kirlin, our Chief Executive Officer; John Jordan, our Chief Financial Officer; and Chris Progler, our Chief Technology Officer. The press release we issued earlier this morning, along with the presentation material which accompanies our remarks, are available on the Investors section of our web page. Comments made by any participants on today's call may include forward-looking statements, words such as anticipate, believe, estimate, expect, and forecast. 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. Lastly, before turning the call over to Peter, I invite you all to join us next Monday, December 14, at 10:00 a.m. Eastern for our 2020 Investor Analyst Day. The event, which will be webcast, will include an update on our long-term strategy and outlook. More details are available on our website, where you may contact me with any questions. At this time, I will turn the call over to Peter.

Peter Kirlin, CEO

Thank you, Troy, and good morning, everyone. Despite operating in a very challenging environment, full year revenue in 2020 was $610 million, the highest ever in the third consecutive year of record revenue. FPD achieved record revenue for the second year in a row, surpassing last year's record level by an impressive 32%. IC revenue in 2020 was the second highest ever, just shy of a record established in 2015. We also achieved record revenue of products shipped to customers in China on a consolidated basis, as well as for both IC and FPD. It was a great year for Photronics, marked by many significant milestones. For the fourth quarter, revenue was lower as typical seasonality was worsened by geopolitical factors, primarily in FPD, where mobile display demand was constrained by U.S. trade sanctions against Huawei. In IC, we saw strengthening trends among some logic/foundry customers in the U.S. and Asia. However, memory demand was weaker. Due to a combination of these factors, our revenue was down 5% sequentially. The quarterly decrease in revenue and the high amount of operating leverage in our business led to a contraction in profit margin. Operating expenses stayed under control as we maintained cost discipline amid challenging circumstances, allowing us to deliver $0.10 in diluted earnings per share. We ended the year with $279 million in cash, an increase of $72 million from last year, accomplished even while we spent $71 million on CapEx, investing in future growth, and $34 million on share repurchases, returning cash to our shareholders. I believe these achievements demonstrate that our investment strategy is working, and we are on the path to improving long-term shareholder returns. Looking back on 2020, the challenges we faced were unlike any in my 35-year career, primarily among them were significant supply chain and customer design team disruption, as governments around the world placed restrictions on travel, working conditions, and commercial activity to limit the spread of the coronavirus. Additionally, trade restrictions implemented by the U.S. federal government against certain companies in China created their own set of market dislocations. Fortunately, with the development and approval of effective vaccines, and the expected impact of the U.S. election results, it appears these challenges will diminish as we move through 2021. Regarding the challenges of 2020, I am proud of the way our team responded. They worked tremendously hard to take care of our customers and seize every opportunity in the market. Due to their efforts, we achieved record revenue, and I'm confident that we have gained market share. Our 2020 revenue came within just a few percentage points of the target we set three years ago. While we formally rescinded the $630 million goal in May during the height of the COVID-driven market uncertainty, we continue to pursue this target to maximize our growth. There are no moral victories, and we recognize there is room for improvement, but I am truly proud of our performance. Furthermore, I like our position in the market and the long-term outlook for our business. Next week, we will host an Investor Day, and let me preview some key points we will discuss during that event. Photronics represents a compelling investment thesis. We are the largest merchant photomask manufacturer with 11 global facilities, something none of our competitors can match. We invest in technology to align our operations with secular market trends, such as the industry's geographic expansion into China, the growth of high-end display technologies, such as AMOLED for mobile applications, and enabling our customers' technology roadmap to continue introducing new semiconductor nodes and pursue the continuation of Moore's law. We have invested in models that enable us to invest in growth, which expands our cash flow and strengthens our balance sheet, positioning us to consolidate our market or return cash to shareholders. We believe these efforts will lead to greater shareholder returns. We have performed well since our last Investor Day in 2018, delivering on the main commitments we made then, such as constructing, equipping, staffing, qualifying, and ramping two new manufacturing facilities in China. Additionally, we have made further progress against our key initiatives to diversify our business by growing our China revenue, increasing our share of business with customers and growing our sales of high-end products. We have achieved this despite the challenges in 2020 by staying true to our core competency of being a low-cost producer, employing operational excellence in everything we do, prioritizing customer intimacy to become our customers' trusted photomask partner, and maintaining technological leadership to ensure we can meet all of our customers' needs. These attributes have served us well for over 50 years, and we remain committed to them heading into the future. Looking forward, we are increasingly optimistic regarding our long-term outlook and have positioned the business for sustained growth. By delivering the right technology to the right customer at the right time, we intend to expand our leadership position. With plans to increase profit margins and enhance cash generation, we expect to deliver even greater shareholder value. We have much more to say next week, and I hope you can join us. Before turning the call over to John to provide additional commentary on our performance and outlook, I would like to thank all the Photronics employees for their commitment and hard work and wish everyone a wonderful holiday season.

John Jordan, CFO

Thank you, Peter. Good morning, everyone. As Peter mentioned, 2020 was a record revenue year. The year began on a run rate in Q1 well in excess of the $630 million target we set almost three years ago. After the COVID-related disruption in Q2, we recovered to a run rate still in excess of this target. Q4 was again impacted by geopolitical influences when the trade sanctions against Huawei suppressed the FPD business while the supply chain reset. Nonetheless, $610 million in fiscal year 2020 revenue exceeded the fiscal year 2019 record by 11%, setting the third consecutive annual revenue record. During the fourth quarter, our business typically sees a slight seasonal decrease in demand as the design cycle winds down from recent introductions of new consumer electronics products. Our fourth-quarter decline was exacerbated by pockets of softness in some sectors and a negative impact from U.S. trade sanctions against Huawei. Revenue for the quarter was up 5% compared with last quarter and $0.04 compared with the same quarter last year. IC revenue was particularly strong in China, which received a record level of product delivery. Foundry and logic demand drove the increase as the region continued to be a healthy location for new design activity. In other geographies, Korea and Taiwan also saw strong foundry logic demand, while U.S. logic revenue benefited from emerging opportunities for defense applications. The area of weakness for high-end IC was memory, where recovery is not expected until sometime during 2021. FPD mask demand was negatively impacted by two factors. First, as we discussed during our third-quarter call, U.S. trade restrictions against Huawei had a dramatic impact on the China mobile supply chain. As Huawei was effectively prohibited from buying leading-edge semiconductors, their ability to release new mobile phones was severely limited. This reduced their demand for new display panels, which in turn reduced demand for masks from their panel producers. This supply chain is in the process of resetting to meet the demand, especially in China, and we've seen the market shift away from Huawei to other China mobile phone manufacturers. Huawei recently sold their low-end to mid-price phone division to separate and insulate that business from the U.S. trade restrictions. Since Huawei was one of the largest suppliers of smartphones by units, the ripple effect of these moves is being felt throughout the supply chain, significantly impacting our business. Consequently, our revenue for AMOLED mask sets was down 21% sequentially. The second display trend was the improving profitability of panel producers. Strong unit demand and higher pricing for TV and IT products created incentives for them to continue production runs of existing products to maximize short-term profit. This resulted in a delay of new design releases, negatively affecting mask demand for G10.5 and smaller form factors. Consequently, demand for LCD masks decreased for the quarter, negatively impacting both high-end and mainstream revenue. Profit margins on the gross and operating line were lower due to the impact of operating leverage on the results. Our continued focus on margin expansion should yield improved results next year as we complete the ramp of our IC phase one investment in China and implement our next phase of FPD investment. We will elaborate more on our long-term margin targets during our investor event next Monday. Below the operating line, other expense of $2.9 million included interest expense and primarily the unrealized effect of the re-measurement of U.S. dollar-denominated balance sheet items of our foreign subsidiaries. Tax provision and non-controlling interests were in line with expectations, resulting in earnings of $0.10 per diluted share for the quarter. Our cash balance at the end of 2020 was $279 million, an increase of $72 million during the year and $18 million during the quarter. Significant cash events during the quarter included $63 million generated from operating activities, $34 million of capital expenditures, and $18 million returned to shareholders via share repurchases. We repurchased 1.7 million shares of Photronics stock during the quarter and $13 million in net proceeds from debt. Additionally, we paid $16 million in dividends to our Taiwan JV partner. These dividends are generally contributed back to our China JV in future periods. Total CapEx in 2020 was $71 million, less than our $80 million target. For next year, we forecast CapEx of about $100 million as we complete the phase one investment in Xiamen and execute the next phase of our FPD investment in Asia. Our strong balance sheet has enabled us to invest in China and return $79 million through share repurchases since 2018. Looking forward, we have plotted a course that will generate sufficient cash from operations to continue investing in organic growth and return cash to shareholders. In parallel, we will be actively open to M&A opportunities in the photomask space to extend our market and technology leadership, which we will share more about on Monday. Before I provide first-quarter 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 high, and as this segment of the business grows, relatively few high-end orders can significantly impact our quarterly revenue and earnings. Geopolitical risks related to government actions to address health concerns or trade policies may also affect our operations, those of our customers and suppliers, or end-market demand, potentially resulting in adverse impacts on our industry and, consequently, our results. I will also mention that our first-quarter will have two more days than the fourth quarter. Given those caveats, we expect first-quarter revenue to be in the range of $145 million to $155 million. Underlying market demand in many sectors is healthy and improving, driven by trends in remote work and education, although geopolitical headwinds remain due to trade restrictions and government actions to limit travel and business activity. The midpoint of our guidance implies revenue essentially flat with Q4. Based on our revenue expectations and current operating model, we estimate earnings for the first quarter to be in the range of $0.07 to $0.14 per diluted share. 2020 was a challenging year, and it appears many of these challenges are carrying into 2021. However, our workforce has responded well globally, and we are in a solid financial position to continue investing in capabilities and technology to drive growth while making meaningful improvements to profit margins and optimizing returns. Our initial outlook for fiscal year 2021 suggests that revenue growth will be in the high single-digit percent range, with operating profit growth similar to the 23% growth we achieved in 2020. Again, please join us on Monday to learn more. I will now turn the call over to the operator for your questions.

Operator, Operator

Our first question comes from Patrick Ho with Stifel. Your line is now open.

Patrick Ho, Analyst

Maybe first off, Peter, in terms of the mainstream IC marketplace. Can you just help reconcile a little bit of the commentary I've been getting in terms of high utilization rates for many market segments within the trailing edge geometries, and I guess just the kind of mixed outlook you're talking about on that side of things?

Peter Kirlin, CEO

Yes. So if you look at our mainstream business this year, Patrick, from a high-level view, it's been pretty stable quarter-to-quarter, right? Revenues were in the high 60s, around $67 million, $68 million, maybe approaching $70 million. If you peel back that remarkably stable trend, what has happened during the year is a rotation of the business from the U.S. and Europe into primarily Taiwan and China. So, our mainstream business's demand profile is shifting, with the West seeing the market diminish and growth in the Far East. We believe that rotation is more or less complete, and we see upward demand in the foundry logic business in Asia. We expect this trend to continue and strengthen as we move through next year and into the following year. So, we’re really optimistic about the market opportunity in China and Taiwan, and you’ll hear more about that next week as well.

Patrick Ho, Analyst

Fair enough. And maybe as my follow-up question on the memory side of things. I concur that the current environment for most of the memory market continues to be soft. But at the same time, you do hear of the industry transitions, both in terms of DRAM as well as NAND towards next-generation devices. Can you reconcile a little bit of the typical shift to next-generation nodes and layer counts, as that’s usually a positive driver for Photronics in terms of design wins? Can you help me understand what's happening there versus some of the softness you're seeing in the near term?

Peter Kirlin, CEO

Yes, it's interesting because, again, if you look at our IC business, year-over-year, we've had a lot of fluctuations, characterized by what I would describe as pretty healthy quarters in Q1 and Q3, each at about a $640 million run rate, which is great. However, we've seen declines in Q2 and Q4, driven by COVID impacts and trade war influences, respectively. This means our business has fluctuated between strong and profoundly impacted by external factors. Our memory business has similarly been sold through, with ups and downs; ultimately, however, our memory business is down year-over-year, reflecting the overall state of the memory industry. From our customers’ perspective, we expect our memory business to ramp up significantly next year, particularly as we head into early spring. We view this as a near-term dip, with optimism for a rebound in the memory business as our customers have aggressive plans for new transitions next year, which typically drive revenue in the industry.

Operator, Operator

And I'm showing no further questions in the queue at this time. I'd like to turn the call back to Peter Kirlin for closing comments.

Peter Kirlin, CEO

Okay. Thank you for joining us this morning, and we look forward to reconnecting next Monday during our Investor Day.

Operator, Operator

Before we sign off, speakers, I do see two other participants join the Q&A queue. Would you like to continue to take their questions?

Peter Kirlin, CEO

Of course, yes.

Operator, Operator

Understand. Our next question comes from Tom Diffely with D.A. Davidson. Your line is open.

Unidentified Analyst, Analyst

This is [indiscernible] for Tom this morning. I guess I wanted to ask how much conservatism you, I guess, are including in your first-quarter outlook? I understand that right now, obviously, the geopolitical headwinds are difficult to ascertain, but any color on the actual quantifiable specificity number?

Peter Kirlin, CEO

Yes. Typically, in our business, Q1 seasonally sees a decline of about 5% compared to Q4. The midpoint of our guidance reflects a flat quarter as we believe market conditions are improving and that improvement offsets the seasonal decline. If you look at our IC business, first demand trends in Asia are solid. In terms of the FPD, last quarter we estimated that our industry's photomedicine utilization was around 70%, which is the worst quarter I can remember. November continued to show weakness, but around Thanksgiving, the FPD market began to rebound, and we continue to see improvements. So, we’re navigating between a normal market and what was an extremely weak quarter. Our utilization last quarter was likely 15% above the industry average, but it’s the first quarter in several years where we haven’t been sold out. That illustrates our current market conditions, which inform our guidance.

Unidentified Analyst, Analyst

Thank you so much for the color there.

Peter Kirlin, CEO

Yes, I would also add that unlike prior years, following new revenue recognition rules, each item we have in production has a percent completion associated with it. Our business is a direct reflection of market conditions. We're not a capital equipment company that operates with a backlog that can ship some tools into this quarter, so the market dictates our actual performance.

Operator, Operator

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

Gus Richard, Analyst

Real quick on SMIC, which has just gotten banned. Are you seeing customers migrate their business to other foundries? And is that helping the mainstream?

Peter Kirlin, CEO

Well, to the extent that happens over time, yes. First of all, SMIC is a customer of ours, though not a large one because they have their own internal fabrication. Anything that harms a customer is a negative. We don't like to see any customer negatively impacted by external factors not driven by market conditions. That said, if market demand shifts away from a customer that builds a significant fraction of its own photomasks to customers buying them from the merchant market, that can create demand for Photronics, but it’s not an ideal way to see our market expand.

Gus Richard, Analyst

Got it. And then, there have been a number of companies that have planned to list on the star market where valuations for semiconductor-related companies are significantly higher than those in the U.S. Is that something you guys might consider? Or do you have any thoughts there?

Peter Kirlin, CEO

We are continuously seeking ways to enhance shareholder value, and this is one of many possibilities we’re considering. However, there are potential upsides and downsides depending on geopolitical factors. While we are aware and assessing this option, we are a company that has been around for 50 years and are typically conservative regarding new trends, preferring to evaluate potential outcomes based on past experiences before making informed decisions. However, we are aggressive in pursuing growth, especially in markets like China, which we see as a growth opportunity for our industry. From an execution perspective, we are aggressive, but typically cautious regarding broader market trends.

Gus Richard, Analyst

Okay, thank you for that.

Peter Kirlin, CEO

Yes, it looks interesting, but it’s early in the game.

Gus Richard, Analyst

Yes. Okay, this is it for me. Thanks so much.

Operator, Operator

Thank you, and I'm now showing no further questions in the queue at this time.

Peter Kirlin, CEO

Okay, so thank you for joining us this morning, and we look forward to reconnecting next Monday.

Operator, Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes your program. You may now disconnect.