Conference Transcript - PLAB 2026-01-14

Operator

Welcome, everyone, to the 28th Annual Needham Growth Conference. Today we have with us Filtronics, ticker PLAP, and we have Ted Murrow from Investor Relations doing your presentation. Please take it away.

Speaker 3

All right. Thank you. Appreciate it. Thanks for joining, everyone. Kind of a quick run-through of who Filtronics is. These numbers are, you know, we have an October fiscal year-end, and so these numbers are the fiscal year for 2025. Revenue was a little flattish, but obviously you can see from the numbers here, we generate really good operating profitability and cash flow. Market cap actually is a little stale. We had a nice reaction to our earnings call, which occurred on December 10th this past That was our fiscal Q4 earnings call. Stock actually really had a very strong move, was actually up almost about 50% that day. So our market cap today is more like $2.1, $2.2 billion. In the lower left-hand corner, we show revenue based off of geographic origin. So that's revenue produced out of those facilities in China, facilities in Taiwan. You can see Taiwan is about 33% of our total revenue. China represents about 26% of total revenue today. That is actually split. But for the first time, we broke this out, our exposure on our FPD business and our IC business. So you can see from that graph or that pie chart, 11% exposure for China FPD, 15% China IC. And the reason we did that is because of the competitive dynamics in the China market. Competitive intensity is a little bit greater on IC in China versus in FPD. We have technological advantages that keep us a little bit ahead. And so we can talk about that a little bit later if there's questions on that. But generally speaking, in the lower right-hand side, you can see we have two areas that we generate revenue. One is semiconductor integrated circuits, so that's typically 70% to 75% of total revenue. And then flat panel display, which makes up the remaining quarter of our business. I don't know if everybody knows what a photo mask is, but we basically take a semiconductor chip design and etch it onto a glass plate, ship it off to our customer base, typically is the semiconductor manufacturing site. So we don't really talk very much with R&D organizations, we tend to talk to manufacturing operations organizations. So our largest customers, we have three 10% customers that we disclose in our filings. You would see United Microelectronics, which is UMC. They're based in Taiwan. Samsung is a 10% plus customer. And they're actually split between IC and FPD. And then we have Semiconductor Manufacturing Incorporated, which is based in China. They're about a 10% customer, also known as SMIC. So we ship off the photo masks that have the semiconductor chip design that's etched into the glass plate, send those off to the manufacturing organization. The glass plates get inserted into a lithography tool. Light laser shines through. The glass plate projects the image onto the wafer. So therefore, we are at the very beginning of the front end of the semiconductor manufacturing line. So for every semiconductor chip that's out there, there is a set of photo masks. Every semiconductor chip has a number of layers that can vary from say 20 layers up to say 80 layers or 100 layers. For every layer requires one photo mask. And so when we ship off a set of photo masks, we call them a set. And we'll get into that in a little bit. Flat panel display market is very similar to the IC business, except in IC, the photo mask is typically six inches by six inches, except for in certain cases, we talked about a little bit on our most recent earnings call, some advanced packaging opportunities that we've been participating in. In that situation, the photo mask is actually a little bit bigger than six inches by six inches, but generally speaking, it's six inches square, and then on the flat panel display, it's similar technology, similar production process in our clean room facilities, except these photo masks are much bigger. They're several meters wide, several meters tall, because if you think about for a display, if you have a 70-inch screen TV, you need a photo mask that's 70 inches, right, or at least that size so you can fit the display within that, you know, piece of glass. So what are the trends that are, you know, hitting the industry and why, you know, is Photronics well positioned for trends that are coming down the pipeline? Obviously, we're tied into the semiconductor industry. So as semiconductor, you know, business, the market grows, generally speaking, we're going to grow along with it because the photomask market, which I'll talk about a little bit later, the photomask market typically is about 1% of the total semiconductor market. So as the semiconductor industry grows, we should generally grow along with it. But on top of that, we have seen, especially since the COVID timeframe, when supply chains were disrupted, much of the world realized, or much of the industry realized, hey, we're very dependent upon China and upon Taiwan to manufacture semiconductor chips. And so the industry took an initiative, obviously being a little geopolitically influenced more recently, but took the initiative to start diversifying itself geographically, starting to reshore semiconductor production into the United States. We're even seeing more semiconductor production occurring in Japan, in Korea, in Europe. There's even consideration Southeast Asia, Middle East. So the more semiconductor manufacturing locations that open up, the more opportunity there is for a company such as Photronics. and part of that reason is if you have one chip design but you're going to manufacture that chip design in maybe two locations, hypothetically speaking you would need two sets of photo masks one for each location so that would be a positive for us captives are outsourcing more so some of the captives in the market today Taiwan Semiconductor is going to be the biggest captive out there they're a very big company obviously. I think everybody's familiar with them. There's opportunities where they're looking to outsource a little bit more, and it's tied into their developmental work or their expansion into Arizona. Samsung's looking to outsource more. Semiconductor Manufacturing Incorporated, SMIC, they're looking to outsource a little bit more. So we are seeing just kind of a trend towards more outsourcing by the captives the next trend that's in our favor is no migration so and we'll get into this in a little bit but there will be a graph that you'll see in a couple of slides where you actually see a pretty significant hockey spike parabolic move on the dollar value of a mask set as you get into more leading-edge chip designs so that's you know very encouraging and And every year, you'll tend to see semiconductor chips move to, generally speaking, move to the next generation, or every release, next generation of geometries or next node. And every time they do so, they have to release a new chip design. We need a new photo mask set. So that's obviously something that works in our favor. And then on flat panel display, we really have a competitive advantage at higher end. in the in that market higher value photo masks for flat panel display so as you get into bigger mask sizes more advanced mask sizes that's where we have a competitive advantage and then obviously you know operational excellence you know we're very good at producing high quality photo masks it's one of the reasons why we are a market leader in the merchant part of the market and then generate a lot of cash flow as I showed on that on that opening slide so the semiconductor industry I think you know everybody's been talking about reaching a trillion dollars by 2030 maybe that timeline has moved up I'm hearing some rumblings that that some of those numbers are changing so maybe that that lower left-hand side of this map of this of this page is is maybe a little bit dated I don't know we'll see how that plays out but but hypothetically speaking let's say semiconductor market grows to a trillion dollars historically the photomask market's been about one percentage one percent of the semiconductor market so that says that you know this past year maybe where the the photomask market was you know six to six and a half billion dollars um and maybe growing to you know ten billion dollars over the next several years um feels as though it's you know if you think about how that plays out from a growth rate perspective. It feels as though it's like, you know, the industry is growing at about, you know, 9% CAGR over the next several years. The photomask market is broken up, and you'll kind of see this on the lower right-hand side, between the merchants, such as Fultronics, and the captives. A decade ago, a little bit more than a decade ago, the captives were a much lower percentage of the total photomask market at about 40%. They have grown to now, this past year, they were 63% of the total photomask market. And that's not to say that they're bringing more business in-house, and you'll see this on one of the upcoming slides, but it's really the value at the higher end, at least this is how we're interpreting it, is the value at the higher end of the market is increasing at such a rapid rate that it's causing the market share deficiencies to skew a little bit. One of the reasons why we win is because of the significant global footprint that we have. We have 11 cleanroom facilities throughout the world, three here in the United States. We have two in Europe, and then the rest are in Asia, across Korea, Taiwan, and China. We are actually undergoing a very significant expansion at our facility here in Dallas, or not here, in the United States at our facility in Dallas, Texas. I say here because I work out of the facility in Texas, so it's inherently kind of one of my thoughts. But we're expanding that facility down to 65 nanometers initially, and eventually we have plans to go to 40 nanometers. We see the opportunity there as being pretty meaningful with a number of customers giving us strong indications that they are going to use up that additional capacity that comes online and capabilities that come online in the coming years. We have said that we expect to start generating revenue out of that new facility in the late in fiscal 2026. So, again, we have an October fiscal year end, and so that's really the timeline there. And so, obviously, the United States probably would be a pretty good growth driver for the company in the fiscal 2027 timeline. As we expand and get this capacity and capabilities up and running at 65 nanometers, we're actually, what we're doing is we're going to transition some of our production out of our Boise, Idaho facility. Our Boise, Idaho facility is the only high-end facility commercial mask maker in the United States. It's also the only government-trusted high-end facility in the United States, and so we do governmental work there, but there is some programs we do at that facility that actually can produce masks down to seven nanometers today. We do have some production there at, say, 65 nanometers that we're going to transition over to Allen, Texas, therefore freeing up capacity at our Boise facility for other high-end opportunities. the other significant investment plan that we have coming you know that we've actually already committed to and we've started to work on is in our South Korea facility at that facility we have historically been producing masks at the higher end of our mainstream business but we are we've committed to progressing down to eight nanometers so really tackling the high end of the market obviously we have customers there that have been very supportive of this investment plan and so we're really optimistic you know about these two opportunities and I'll talk a little bit about why that's important and I mean because if you think about this will help diversify our geographic mix. You know, thinking back to that first slide, you know, about 80% of our revenue originates in the China, or I'm sorry, in the Asia markets that's split across China, Taiwan, and Korea. So this should help boost our Korea presence and our amount of revenue that we're generating out of Korea. And then the United States, obviously, you know, that's going to help with the reshoring. So both efforts should diversify the geographic mix a little bit more. These two facilities, so let me kind of step back a little bit. We have two joint venture facilities. I don't know if you're aware, but we have two joint venture facilities. One is in Xiamen, China, on the IC side, and the other one is in Taiwan, also on the IC side. So these investments will actually allow us to generate greater earnings power to shareholders because if you looked at our net income earnings per share we have earnings per share and then we have earnings per share to shareholders because because of these investments we will generate more revenue and therefore more product profitability that will benefit shareholders in the future and then it does also target these investments will help us target get more high-end opportunities down the road as these production comes online. So why is going after the high-end important? So as you can see from this graph, on the bottom line, the x-axis, you can see the different geometries, ranging from 130 nanometers down to more leading edge, two to three nanometers. And so as, and then on the y-axis, you see the mask value. So as we get into more leading edge, higher end geometries, the value of the mask set increases almost exponentially, almost parabolically. And then you can kind of see within this, you know, the background shade, we generate a lot of business at the 130 nanometers all the way down to 14 nanometers today, and a little bit of, you know, 12. We are striving to participate more in the very leading edge that's what the Korea facility is designed to do that is what our Boise facility is designed to do so we are going to be targeting more higher-end opportunities in the future you know and and you know but today a lot of that photo mask demand is actually being serviced by the captives and so this is where you know we are looking for looking towards some of these captives to outsource a little bit more to companies such as Fortronics. Many of the captives, as I said earlier, do business with us. A lot of the captives are customers for us today, and we're looking to expand with them. A lot of people ask, okay, well, so in the very leading edge, what are the applications That's typically your AI in the hyperscale data centers, or maybe it's an application processor for your smartphones, that sort of thing. That's typically, yes, you have a question?

Speaker 6

Yeah, I don't know you mentioned captive, but based on my understanding for a more advanced node, it's very complicated. They have to iterate and improve in-house. That's why they keep captive, right? And what they're also seeing are those more mature and easy process.

Speaker 3

I think what you're saying is absolutely true, generally speaking, that they want to focus more and more. They want to maintain concentrated production at the leading edge, though we do have indications. There is a reason why we are going down to 8 nanometers for Korea, right? So there are opportunities that are out there that we have identified that will allow us to participate in that part of the market. Well, I'm not going to get, you know, really don't want to get into exactly the specifics about that today. And I don't know if I ever will, but, you know, because we have agreements with customers and you don't really want to violate those agreements, right? And so I would just say, generally speaking, though, there are opportunities that are opening up. But to your point, the captives will continue to probably dominate the production of leading-edge photomask production. But there are opportunities here and there that we are going after to target, for sure. And then on the display side, again, this is a business that's very complementary to our IC business. We feel as though we have technological advantages in the display market that others cannot match. We were the first company to ship, and we believe still the only company to ship, photomasks for generation 8.6 AMOLED technologies. That is a technology that is in the very early stages of proliferating throughout the display market. We think that probably accelerates in the 2027 time frame. We also are very good at producing masks at larger screen sizes. And so if you looked at our high-end versus our mainstream mix on our display business, we were at about 85% for the high-end. So why do we win? I kind of referenced this a little bit earlier, but where global footprint is a very significant factor, you want to be partnered close to your customer locations, you want to reduce shipping time. So cycle time and delivery time becomes a very important factor. Obviously, you have to produce masks that are very of high quality with, you know, very few defects, you know, if any defects. I mean, you really can't actually have defects in your design, in your production of photo masks. But, you know, because you can't actually, I mean, if you think back to how, you know, what the utilization is of a photo mask, where the laser shines through to project the image onto a wafer, actually having, you know, a speck of dust or a speck of dirt on those glass, on the glass would show up on the wafer for print, right? And so you have to avoid those situations. So responsive delivery, high-quality masks, trusted supplier. We've become a very, very trusted supplier, particularly in the Asia markets, which is a factor at play as to why we are quite confident about our position in the China market and the Asian markets, despite some Chinese local players having entered into the market, we feel pretty good about our position because of our trusted supplier status. And then on the technology side, yes, I mentioned we are an innovator and a leader on the FPD side. In semiconductor IC, it's a little bit harder to differentiate on the technology side, though we do have advanced designs where some of our competitors are not able to do that, and we have equipment that we are able to utilize more efficiently than some of our peers. So I had talked earlier about the expansion in North America at our Texas facility and then our expansion in Korea. This is kind of a history of what our capital intensity ratio is on the graph on the left-hand side. You can see a spike that occurred in 2019. That was associated with our expansion into the China market. And then in the 2020 to 2024, we had kind of a standard capital intensity run rate of about 15%. We are now going through an investment cycle that's consisting of, obviously, U.S., Korea, plus end-of-life tool replacement costs. And so that's what caused the elevated capital intensity ratio for 2025. We spent $188 million in 2025 on CapEx. In 2026, we're going to spend $330 million on CapEx is what we've guided to. That's because of the continued investment in the U.S. The expansion in Korea kicks off in a big way. And this should be our peak year on end-of-life tool replacement costs. So just kind of a quick review of the numbers for Q4. I won't spend much time on this. Revenue was increased a little bit sequentially. Gross margin remained at a mid-30s percent level, which is important because there's been a lot of questions about the history of our company and producing gross margins in the low 20s, and now we're in the mid-30s, and is it sustainable? And I think over the last four years or so, we've definitely demonstrated that we've been a consistent mid-30s gross margin profile company, and that absolutely helps drive profitability and cash flow. We did see an acceleration in our business in the quarter, particularly in the China market and Asia markets leading up to Chinese New Year, which we see as continuing throughout Q1. And I want to touch, actually, I'm going to touch real quickly on the balance sheet, and then we can open it up for any additional questions. But we have $588 million of cash in the balance sheet, of which 422 million resides at our two joint ventures, which is important to understand. And obviously, we're talking about the accelerated investment in the United States and Korea that's expanding our CapEx program. So our usage of cash really is focused on CapEx at the moment. We did buy back $97 million worth of stock in fiscal 2025, but since we are focusing more on CapEx at this point in time, I would venture a guess to say that that's going to be the priority over any additional share repurchases in the future. So with that, I will open up the floor to any additional questions. Okay.

Speaker 4

In flat panel display, may I inquire how much is captive?

Speaker 3

The captive percentage on flat panel display is lower than it is on IC. And IC, I said, the captive portion was 63%. I actually don't have that number off the top of my head. I'd have to dig into it. What I would say is over the last five years, we have held very steady at about 27% market share and then obviously very focused on the high end. We feel really good about our position. and really good about our technological capabilities there. And so we see our positioning continuing and being a market leader in that market. But I don't think that – I don't know for sure. I'm going to have to dig into that number, but I don't think that the captive portion is anywhere near as high as it is on IC.

Speaker 4

Second, two more questions. When you move toward higher-end nodes, How should we be thinking in terms of gross margin? Will it be creative right away? Will it take some time to go to the steady state?

Speaker 3

So as you think about gross margin, in any given project, there's really not a trend that you can identify to say, yes, high-end has a better gross margin profile than mainstream on a project-for-project basis. And the reason for that is because mainstream projects typically run over a fully depreciated set of tools versus high-end projects typically run over tools that still are going through the depreciation timeline. With that said, in aggregate during a quarter, if we have a high, very significant fixed cost infrastructure that we have, and so that will drive a margin uplift. But on an individual basis, there's no real trend. It's project by project.

Speaker 4

Third question, in terms of cash usage, a large amount of cash is in China. So for share repurchase, I assume that the company has to rely on the cash in the U.S. If they want to take out cash from China, I know that you can use dividend as the purpose or the reason. But do you have to pay extra?

Speaker 3

So if we're going to use, so of the 422 million of cash that's associated with our joint venture, that cash can be used very freely within the two joint ventures. If we were to expand to a different geographic region, that's going to be, like hypothetically, this is a hypothetical, I'm not saying that we're not committed to this whatsoever, but I'm just talking hypothetically. If we were going to expand to another geographic region that's part of the joint venture, then we can use that cash. So 100% usage of that cash in those kind of scenarios. If we were to use that cash for Fortronics, not part of the joint venture, in that situation, the likelihood would be you dividend it out. We have a 50.01% ownership, so it's basically a 50-50 split. And then if it's going to be repatriated to the United States, we'd probably get taxed on that as well, right? So probably a 20% tax rate. So in that scenario, you would only have access to about 40% of that cash balance that you would allocate for that usage. So that is a little...

Speaker 5

Your overall perception of just the health of the demand environment for the high end versus the more traditional end markets?

Speaker 3

So over the last couple of years, the mainstream has been a little bit more sluggish, I think we've seen that, you know, across much of the, like, analog, you know, space, industrial markets, automotive markets and whatnot. You know, obviously, you know, it's great to hear that the analog chip guys are seeing a better demand environment. You know, for us on the mainstream, you know, it remains to be seen whether or not that actually translates into a better demand environment. Obviously, we are tied to design starts, less to actual volume. So they can see improvements in volume, but it doesn't necessarily translate. So we'll see how that plays out. Certainly in the October quarter, and then we're seeing it in the January quarter, based off of the guidance, we're definitely seeing an improvement in the high end, as I had mentioned, particularly in the Asia market heading into Chinese New Year. And then actually in the United States, we also had seen a strengthening of demand at the high end, which was anticipated. I think that the high-end demand in Asia, obviously given we had beaten fiscal Q4, was a little bit unanticipated. Yes, go ahead. Another question I want you to bring. I'll repeat your question. Question on demand.

Speaker 6

Yeah, so you mentioned you see growth in Korea and China market, and I wonder if that's on the IC side more or the FPI guidance for Q1.

Speaker 3

We have seen a strengthening of demand, particularly associated with Taiwan and China. And then longer term, you know, what we're seeing is opportunities, obviously, both in China and Taiwan, but opportunities accelerating in Korea.

Speaker 6

And those are like mainstream or high-end?

Speaker 3

We are going after more higher-end opportunities. That's why you're doing it. Correct. That's why we're expanding our facility in Korea. And that's why we actually took a strategy a number of quarters ago to focus our China business more on the high end because there are Chinese local players in the market at the mainstream that are trying to utilize a little bit of pricing in order to capture share. And so that's why we are shifting our business more towards higher end in China.

Speaker 1

Hi, thank you. I wanted to ask you about the high end of your mask business. I believe about five or six months ago, you've got your multi-beam capability running. Can you help us, dream to dream, think a little bit about what sort of share you might be able to take and what, like, if we move to five nanometer, three nanometer, two nanometer? How fast can that develop? Because I think you're the only U.S. manufacturer with this capability now. A lot of this is on shoring. And then can you help us think about what the ASP would be, you know, on these very high-end masters where you are now? Thanks.

Speaker 3

Questions that are a little bit more challenging to answer. You know, I can't really get into the ASPs. I apologize. Those are things that are, you know, not only that are a little, can be tough to predict, right? But we are, we do have this multi-beam that was installed in last spring. it's been producing masks already for customers, and it's been a very productive usage. So we're very pleased with that. And yes, I do believe we're the only ones with a multi-beam rider in the United States, although there are multi-beam riders in other geographic regions at competitors.

Operator

And with that, we are out of time. So that is the end of the Q&A and presentation. Thank you, everyone, for coming. Enjoy the rest of your conference.

Speaker 3

Appreciate the questions. Thank you so much.