Tower Semiconductor Ltd Q4 FY2023 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to the Tower Semiconductor Fourth Quarter and Full Year 2023 Financial Results Conference Call. All participants are currently in a listen-only mode. Following management's prepared statements, instructions will be given for the question-and-answer session. As a reminder, this conference is being recorded February 14th, 2024. Joining us today are Mr. Russell Ellwanger, Tower's CEO, and Mr. Oren Shirazi, CFO. I would now like to turn the conference over to Ms. Noit Levy, Senior Vice President of Investor Relations and Corporate Communications. Ms. Levy, please go ahead.

Thank you, and welcome to Tower Financial results conference call for the fourth quarter and full year of 2023. Before we begin, I would like to remind you that some statements made during this call may be forward-looking and are subject to uncertainties and risk factors that could cause actual results to be different from those currently expected. These uncertainties and risk factors are fully disclosed in our forms 20-F and 6-K filed with the Securities and Exchange Commission, as well as filings with the Israeli Securities Authority. They are also available on our website. Tower assumes no obligation to update such forward-looking statements. Please note that the fourth quarter and full year of 2023 financial results have been prepared in accordance with U.S. GAAP. The financial tables and data in today’s earnings release and in these earnings calls also include certain adjusted financial information that may be considered non-GAAP financial measures under Regulation G and related reporting requirements as established by the Securities and Exchange Commission. The financial tables include the full explanation of these measures and the reconciliation of these non-GAAP measures to the GAAP financial measures. Please note we have a supporting slide deck that complements today's conference call. This presentation is accessible on our company's website and is also integrated into today's webcast for your convenience. Now I'd like to turn the call to our CEO, Mr. Russell Ellwanger. Russell, please go ahead.

Thank you, Noit. Welcome everybody. Thank you for joining our call today. During today's call, we'll discuss our financial results for the fourth quarter and the full year of 2023, and share our strategic direction and expected growth outlook for 2024. To begin, as is known, on January 1st of this year, there was an earthquake in Japan and a surrounding area to our facilities at Hokkaido. We are grateful that no employee suffered any physical harm through this event. Due to state-of-the-art building practices, we did not suffer facility structural damage. We did suffer tools damage and scrap of some percentage of work in progress at both factories as well as cessation of operations. Our dedicated and most capable employees have recovered both factories to full operation with start levels currently aligned to the levels set in the annual plan. 2023 was marked by an industry-wide slowdown resulting in an annual revenue of $1.42 billion. As we transition into 2024, there are clearer indicators of market recovery. We are realizing renewed demand across several of our key market segments. We'll give more color on this as we continue the call. Revenue for the fourth quarter was $352 million. At this revenue level, Fab utilizations were: Fab 1 6-inch was about 60%, Fab 2 8-inch was about 75%, Fab 3 remained at about 40%, Fab 5 8-inch was about 40%, Fab 7 12-inch was about 70%, and Fab 9 8-inch was also about 70%. As a validation of our value-add products and next-generation customer-aligned roadmaps, we not only maintained our blended average selling price per layer but saw an increase of about 4% in 2023 over 2022. This was not due to price increases, but rather due to value-add products resulting in a richer mix, which is a reason for maintaining good margins in a period of industry pullback. Anticipating shifting market dynamics and customer demand, we are actively optimizing our operations through a consolidation of our 6-inch activities into our 8-inch operations in Migdal, Mick Israel. As part of this optimization process, we will phase out certain lower-margin products in our 6-inch offerings, aligning with our long-term strategic goals and financial model while porting certain activities to the Fab 2 8-inch. For example, a high-value technology serving a next-generation advanced computer tomography, CT scan machine, will be moved into our 200 mm factory, ensuring continuity and even greater efficiency for this technology, which will require several hundred 200 mm wafers per CT machine. A breakdown of our 2023 revenue per end market is as follows: Census and displays represented 20%, RF mobile business 22%, RF infrastructure business 10%, power IC business 24%, discrete 15%, Mixed-signal CMOS 7%, and about 2% miscellaneous for this period. Revenue breakdown by end market is as follows: Infrastructure revenue, which is predominantly RF optical with some amount of advanced discrete, was 11%. Wireless was approximately 22%, automotive 17%, which we serve with power ICs, discrete with imagers, and RF radar. Consumer, which we consider compute, power management for general accessories and home appliances and home use security cameras, was approximately 13%. Industrial was about 7%, image sensors for high-end photography and medical applications about 7%. Aerospace and defense accounted for about 4%, and there was about 2% of mixed-signal CMOS where we do not have exact end market knowledge. Additionally, about 14% of power device revenue for which we do not have granularity on the exact end market application served multiple segments mentioned above such as automotive, industrial, wireless, and consumer. Finally, an additional 3% was divided among the end markets that we've spoken of but cannot further granulate. Specifically, on RF mobile, we are experiencing a rebound in the mobile market, running presently at high utilization for both 200 mm and 300 mm RF SOI capacity with additional capacity coming online throughout 2024 and 2025. Our capacity planning is and will continue to pay off, having met our initial targets at the Agrate, Italy facility, having qualified and shipped our first products with a planned ramp throughout this year, supported by an executed double-digit number of production tape-outs to meet the increasing demands shown in our customers' forecasts. Wisely partnering with ST and leveraging the ST build-out, we reduced the impact on margins of new manufacturing activity. However, as is the case with any new capacity ramp from scratch, there is an initial headwind on margins. This should be fully absorbed and become accretive margins within the first half of 2025, the planned completion of the present capacity ramp in the Agrate facility. Looking forward, we are prototyping new 200 mm and 300 mm technologies, with best-in-industry efficiency measured by output power and breakdown voltage, while winning new customers and design slots and beginning conversations with customers about 6G requirements. Prior to the adoption of new wireless standards such as 6G, we see additional AI and mobile AR, VR applications having the potential to drive a stronger handset refresh market over the next several years to further benefit our RF business. RF infrastructure, we are strongly positioned supplying AI infrastructure growth in part by our previously announced silicon photonics partnership with InLight, the global number one optical module provider and Marvell, a tier one optical connectivity provider, as well as with a total of over 50 additional customers currently using our silicon photonics foundry platform. In addition to our current silicon photonics production supplying 400G and 800G AI, data center, and Datacom infrastructure, we are investing with our lead customers in new technologies enabling more efficient 1.6T systems through innovation in both materials and architectures, including options for co-pack optics. We continue to expand the silicon photonics application space by working with leaders in automotive and commercial LiDAR to enable silicon photonics-based future frequency modulated continuous wave that can create solid-state cost-effective LiDAR solutions with better resolution capability than other technologies. Leveraging our incumbent position, we continue to work with our previously announced silicon photonics customers, including MACOM, Broadcom, and Semtech among many others, to develop next-generation optical components for pluggable transceivers, active cables, and linear programmable optics to not only support faster data transmission rates for single wavelength but also to reduce latency and power consumption for data centers supporting generative AI and machine learning applications. We recently announced our partnership with Renaissance, a global conglomerate and market leader in supporting the rapidly growing satellite broadband market. Today, our silicon germanium products can be used in beam former terrestrial and antenna terminals where each user terminal requires more than 250 silicon germanium transceivers. Longer term, the industry is exploring ways to incorporate satellite reception into systems which could create an even larger market opportunity, including a shift in cadence and next-generation mobile platform refresh adoption. With multiple fab qualifications for silicon germanium, we are well-positioned to support the capacity needed for these expanding markets. Looking at our power business, while 200 mm power is undergoing some level of inventory correction driven in part by automotive, we continue to see very strong demand for 300 mm power management BCD platforms, where advanced power performance and increased digital processing create the ideal match for the smaller sizes needed for power, audio, and battery management ICs with a broad feature catalog to pick and choose modular platforms. We have recently delivered successful first silicon from our most advanced and feature-rich 65 nanometer BCD platform to a Tier 1 customer and are working together to bring initial products to market on this most advanced platform. Regarding progress in Albuquerque, we have completed initial full flow material while making meaningful progress in qualifying the technology to enable further ramp for both existing customers, as well as new high-volume power and mixed-signal customers, and we will begin customer prototyping in the second half of 2024 towards full qualification and production in 2025 and beyond. Moving to sensors and displays, our machine vision market is expected to get back to high demand levels in 2024. This rebound is mainly driven by the Chinese machine vision camera market where our customers and their customers are gaining significant share in factory automation and embedded robotic camera systems. For this market, we are completing the development of a small pixel global shutter roadmap, scalable to various resolutions from mainstream five megapixel to 12-megapixel sensors to very high-resolution sensors of up to 325 megapixels enabled by our advanced proprietary stitching technology, printing sensors larger than the lithography frame size. In the medical market, we've developed a new 12-inch 65 nanometer length flow as a comparative answer to non-CMOS, non-silicon IGZO, Indium Gallium Zinc Oxide, thin film transistor technology. This enabled customers to retain the high performance of CMOS imagers, namely low dose x-ray sensitivity and high frame rate at a cost level now competitive with IGZO. As mentioned, as a key technology being moved from 6-inch to 8-inch, we are producing new photon counting sensors for next-generation CT scanner, a new market for us with a Silicon SAM of about $300 million. In this market, we partner with an absolute leader to provide a unique technology, which allows scanning at lower doses with much higher resolution due to energy separation. Additionally, we are expanding our high-end photography portfolio, capitalizing on our leadership position and learnings in the cinematography and broadcasting market, where in one instance, the end customer is an iconic industry leader. Revenue guidance for the first quarter of 2024 is $325 million plus or minus 5% in line with industry seasonality and in spite of the impact of the earthquake in Japan. Looking throughout 2024, we target notable quarter-over-quarter sequential growth. We exited 2023 with multiple powerful doors having been opened, catalyzed through the unrealized merger deal. Tower is in the best position in its history based on financial strength, technical offerings, operational performance tied with growing operational capacity, and backed by strategic customer partnerships, the strength of which cannot be overstated. We enter 2024 with a strong focus on strategic value-add growth, addressing both immediate and longer-term objectives. What is the strategic value-add growth based upon? Market expansion with growing capacity and innovation, both based upon strategic partnerships. For market expansion, we continue intensifying our efforts in several markets where we see substantial demand and opportunities. RF infrastructure with a very strong focus on Silicon Photonics and a complete power offering, our two areas poised for robust growth that we are well positioned to serve. Innovation, to meet the evolving needs of customers and outpace the competition, remains at the core of our value proposition. In this call, we've discussed several areas of best in industry figures of merit. Strategic partnership, we believe in the superpower of collaboration. We are expanding our partnerships with existing customers, leaders in their respective markets, as well as new customers with ideas and excitement, positioning them to become leaders as well. With that, I'm pleased to turn the call to our CFO, Mr. Oren Shirazi.

Hello everyone. We released today our total and annual financial results. For Q4 ‘23 we reported revenues of $352 million, gross profit of $84 million, and net profit of $54 million. For the full year, we reported revenues of $1.42 billion, gross profit of $354 million, and net profit of $518 million, which included a $290 million net profit impact of the merger contract termination fee received from Intel. I will start my review by analyzing the P&L highlights followed by our balance sheet and CapEx plans. Revenue for Q4 was $352 million as compared to $358 million in the prior quarter, and gross profit for Q4 was $84 million as compared to $87 million in the prior quarter. Operating profit for Q4 was $45 million and net profit was $54 million or $0.49 basic and $0.48 diluted earnings per share. Operating and net profit for the third quarter included the net impact of the merger contract termination fee we received from Intel in the amount of $314 million net of associated costs included in operating profit, and an amount of $290 million net of tax included in net profit, based on a 7.5% preferred income tax rate as applicable to us in Israel. Including the termination fee, operating profit for the third quarter was $362 million and net profit was $342 million or $3.10 basic and $3.07 diluted earnings per share. For the full year, revenue was $1.42 billion as compared to $1.68 billion in 2022, and gross profit was $354 million as compared to $466 million in ‘22. Operating profit for the full year was $547 million and included $314 million net from the Intel merger contract termination fee compared to operating profit of $312 million in ’22. Net profit for the full year was $518 million or $4.70 basic and $4.66 diluted earnings per share and included a $290 million net due to the payment by Intel of a merger contract termination fee compared to net profit of $265 million or $2.42 basic and $2.39 diluted earnings per share in 2022. Moving to the balance sheet and future CapEx and cash plans, our balance sheet as of the end of December 2023 totaled $2.9 billion, primarily comprised of $1.2 billion of fixed assets, mostly machinery and equipment, and $1.7 billion of current assets. Current assets ratio reflecting the multiple by which current assets are larger than short-term liabilities is very strong, at a multiple of 6.2x as compared to 3.9x as of the end of ’22. Shareholders’ equity increased by 29% as compared to its amount at the end of ‘22 and reached a total of $2.4 billion. Our strong financial position enables us to plan the following investment in strategic opportunities that are aligned with our vision: approximately $500 million of total aggregate cash was allocated to make investments in equipment and other CapEx items required for the 12-inch factory in Agrate, Italy. Following the previously announced STMicroelectronics partnership agreement signed in 2021, we invested $100 million in ‘22, an additional $200 million in ‘23, and the remaining $200 million will be paid during ‘24 and ‘25. In addition, as previously announced, we will invest up to $300 million to buy equipment and other CapEx items that we will own in Intel Fab in New Mexico, enabling Tower to ramp up this Fab's capacity and capabilities for our customers. Our maintenance CapEx baseline level is expected to remain as previously announced at about $200 million per annum. Lastly, we expect to invest additional cash to acquire more capability CapEx tools and other assets to expand our future technology offering, including increasing our 5G and CIFO capacity and technological offerings to enhance our flexibility to support our customers from different sites and change our product mix to result in a richer mix from a margins perspective. All of this aligns with our business strategy and financial model. The financial model outlines our revenue target of $2.66 billion per annum that could be achieved by loading our existing factories at 85% utilization, resulting in $500 million annual net profit based on the specified assumptions outlined previously. Now, I'd like to turn the call back to our CEO, Mr. Russell Ellwanger.

Yes, maybe we would open up to questions and from there we can go ahead and I will give a closing.

The first question is from Cody Acree of Benchmark. Please proceed.

This is actually David Williams on for Cody this morning. Well thanks for all the great color, as usual, but wanted to dig in a bit on the impact on the revenue side and maybe even on the margins from the transition or the shutting down of that 6-inch and moving to 8-inch. Seems like there should be some nice margin tailwinds there, but also just kind of what that revenue impact could look like over the next couple of quarters as you port that over.

Yes. It'll not impact the margins at all. This Fab 1, because anyway, that's the oldest Fab we had built 40 years ago in 1984. It was very nice, highly utilized. But in recent years, it's about at the breakeven point, so it did not really contribute to the margin. So, there will not be any deficiency to the margin. It'll be pretty much break even. The revenues we didn't disclose publicly, but it's immaterial really to the total amount, and it's already baked into our financial model that's represented previously.

It seems like that might have been margin dilutive and you might get a tailwind from that in addition to the economics of moving that from that 6-inch to the 8-inch. Is that fair to say?

It is, but over the next few quarters, we have been well aligned with customers and are getting prepared for this. If anything, revenues will be higher due to some pull-ins of end life activities. So, over the next two to three quarters, it's going to be beneficial, not negative, but on a small level.

And then maybe just on the rebound that you're talking about, what can you point to that's giving you that confidence? Is it really the near-term order rates that are forecasting customers, or are you getting better longer-term visibility of the customer demand?

We're aiming for significant quarter-over-quarter growth throughout the year. Our forecasts indicate strong double-digit growth in most of our core businesses, particularly driven by the second half of the year. The RF SOI is currently performing well, alongside robust mixed signal and power segments in mobile platforms. In Italy, our Agrate facility is on track to ship its first wafers in the fourth quarter of 2023, which is crucial for our capacity needs. As this capacity comes online, it's already allocated for this year and projected to remain utilized through to 2025, when we expect it to reach full capacity by the second quarter. We’ve seen a substantial increase in orders for Silicon Germanium and Silicon Photonics, with forecasts indicating significant year-over-year growth, especially in Silicon Photonics. Our 300 mm power and mixed signal products are also experiencing strong growth, serving emerging mobile applications. In our core CIS activities, industrial sensors are expected to double from current levels in Q3 and Q4. These forecasts come from our customers, who have a good track record for predicting their needs. Overall, we are anticipating strong growth this year, mainly in the second half, buoyed by new technologies gaining market share and a general market recovery, both of which should positively impact revenue and margins. However, we are currently seeing weakness in our 200 mm power management segment, particularly from our factory in Tanami, Japan, with automotive and battery management demand softening. While this area is not projected to rebound soon according to our customer forecasts, the rest of our operations look promising, especially in the latter half of the year, with some already showing positive trends in the first half.

No, very, very great color. Thanks. Thanks for that, Russell. And then maybe just one last one for Oren. Just kind of given the trough that we're seeing in revenue next quarter, how should we think about the gross margin and just given the mix and that revenue base there and I appreciate the help here and thank you.

Yeah, I believe you should assume that the baseline of Q4 actual, which resulted in, I believe, 24% gross profit, is the baseline. For Q1, now since the revenue guidance is indicating about 25 million to 27 million lower revenue, you should apply the 50% incremental model whether we go up or down.

Great. Thanks again.

The next question is from Richard Shannon of Craig Hallum. Please go ahead.

I'm actually going to follow up on the gross margin question. I appreciate the thoughts here, Oren, as to how to think about the first quarter here. I think I heard from one of you two about some sort of impact here from the SC micro fab ramping up here. I'm wondering, what that effect might be because it doesn't seem like you're necessarily seeing it here in the first quarter. How do we think about that? And then as the lower margin products in Fab One roll off, does that give us any thought process for a higher feeling of gross margins in your model? I think I heard you say no, Oren, but I just want to make sure.

I believe my earlier response, which suggests a 50% impact on revenue changes, takes everything into consideration. For instance, if the gross profit was $84 million and there was a hypothetical $25 million drop in revenue, then 50% of that gross profit should be attributed to it. So, instead of $84 million, it would adjust to $72 million. Additionally, Russell's point about starting from scratch with the new factory is valid. Until it hits the breakeven point, which Russell mentioned could slightly affect the margins, we haven't provided a specific amount for that impact. It could result in lower margins, but this will be balanced out by other initiatives and a more favorable product mix, which I believe is already reflected in the previously mentioned figures.

Okay. Fair enough. Thanks for that clarification, Oren. Russell, kind of going on your press release and your comments here on the call about notable growth after this first quarter here, and you're clear on saying more in the second half here. Trying to put numbers together and think about the total year, I think that the fair question to ask here is do you think you are going to grow your total revenues in ‘24 compared to ‘23? It seems like it’d be right in that range, but just want to get a sense of how do we interpret 'notable'?

I would expect that we grow our revenue in ‘24 over ‘23. Yes.

Excellent. That's great to hear. Let's hear maybe a couple of questions in...

I'll actually be very disappointed if we don't.

Excellent. Well that's great to hear. Quick question on the data center area here. It sounds like you're seeing some pickup here, but want to get a sense of some of the growth drivers. Here you talked about higher-end datacom and 800G. I'm wondering if you could quantify how much your business is 800G and then you have talked about today and in the past about linear pluggable optic (LPO). Do you think that's going to be a sizable part of the market down the road?

I believe there are significant advantages that should be pursued, but I'm uncertain about how large the market will be. There are benefits to be had, especially for our offerings, although I'm not a market analyst. That's a question better suited for your expertise. Technically, I see strong benefits. Regarding data centers, I have not observed a noticeable increase in purchase orders, only a rise in forecasts, which can differ. However, I am optimistic about the forecast and expect increases in purchase orders and shipments in the latter quarters of the year. During a meeting with a major integrator, I was pleasantly surprised to learn that a substantial portion of their current volume is going toward 800G, exceeding the estimates provided by analysts. This seems largely driven by AI. In terms of how much is currently being directed to 800G, I would defer to market analysts for precise figures, but I believe most of our shipments will focus on that, particularly in silicon photonics, which targets 800G and aims for 1.6.

Okay, that’s helpful. Two quick questions. I will jump out of line. You've talked positively about silicon photonics, and I think it's a very small piece of your revenues within the company, much less in data centers. How can we think about this over the next couple of years? Big picture about how much this becomes part of your data center business? I don't know if you'd want to get a percentage of that business and how fast that can grow or just any context of this area that you seem very excited about.

I see by all of our own plans and by customer alignments that SiPho will be a predominant portion of the data center market and elsewhere as well. But data center definitely. Realize that we have both passive and active SiPho. The activity that we have going on integrated laser is pretty exceptional, and we are the only pure-play foundry that has that. Those are very, very high dollar, high-value systems, as well as what we're doing now with SiPho that, for example, we're shipping to InLight. I wouldn't say that it's an insignificant amount of our revenue presently. If I look at what we have in our forecast for ‘24, the SiPho revenue is not insignificant.

Well, thanks for that clarification. Russell, my last question, I'll jump in the line here. Obviously, you have a very strong balance sheet here, and I think you're probably going to be free cash flow positive to some degree this year. How do we think about your plan for the cash here as it continues to grow?

First, I don't expect us to have positive cash flow because we didn't have it in Q4 or Q3, primarily due to the significant capital expenditures for Agrate and Intel. These expenses are exceeding our operational cash flow, specifically related to the Intel Fab in Albuquerque. The $300 million along with the additional $200 million in annual capital expenditures is more than our operational cash flow. While we won't be positive, it's beneficial that we have cash on hand to support these expenses. As I mentioned in my prepared remarks, we still have outstanding payments for $300 million for our tools at Fab 11, and we also need $200 million for a new facility and another $200 million for maintenance. We plan to invest in increasing capacity at our various sites to maintain flexibility.

The next question is from Lisa Thompson of ZACKS Investment Research. Please go ahead.

I just have a quick question a little bit about the finances, Oren. So, given your plans for this year, what would be the CapEx expenditure by quarter? Given that and your nice $1.2 billion in cash, what should we expect for interest income?

Okay. Interest income, you can see in the balance sheet the cash amounts we have. You can assume that we on the other hand have $200 million loans. The loans are carrying 2%. Our investments are currently enjoying rates of between 6% to 7% interest on deposits and yields on multiple securities. So, we did really well. Currently, the interest rates are a little bit lower in the world, so instead of getting excellent 6.5% to 7% that we got last year, maybe you should assume 5% or 5.5%. Of course, not on the entire cash amounts because some of that is for working capital required all the time. But for the majority of our cash, we invested in deposits and up to about $150 million in multiple securities. I would assume 5.5% of that for CapEx. I initially said we have a $200 million maintenance CapEx, the sustainable level. So, it's $50 million a quarter, right? On top of that, you should assume, I mean, I said $200 million remaining for Agrate that's in the coming one and a half years. So, if you want, you can divide it by six to reach the quarterly CapEx for the Agrate fab. For the Fab 11 tools, I assume the $300 million will be paid in the coming two, two and a half years. So, everyone can make their assumptions overall. For sure, the CapEx should be more than $100 million per quarter, between $100 million to $150 million.

Okay. Great. Thanks. And so just take that off the cash balance. No, because you're going to generate a little bit in operating income, right?

Yes, but as I answered before too, I believe our cash flow operations are typically lower than $100 million to $150 million a quarter. Right?

Right, right. So definitely negative cash flow, obviously. All right, great. Thank you. That helps a lot. That's all my only question.

This concludes the question and answer session. Mr. Ellwanger, would you like to make your concluding statement?

Thank you. Thank you for joining the call. It really is a very exciting time for the company. As stated in the press release itself, it is probably the best position Tower has ever been in, in its history, in all aspects of our financial strength, our technology offering, and our operational capability. And that is all underpinned by our customer partnerships. It’s an amazing place to be. We look forward to tracking our progress over the year and reporting on it. In the upcoming short period on February 29th, Dr. Racanelli, our President, will host one-on-one meetings at the Susquehanna Technology Conference in New York. On March 19th, we'll be hosting an investor conference at the Tel Aviv Stock Exchange at the Tase building itself. Overall, I appreciate your continued support and confidence. Our team is eager and ready to seize opportunities ahead, and to drive value for our customers and stakeholders. Thank you, and I look forward to follow-up conversations.

Thank you. This concludes Tower Semiconductor's conference call. Thank you for your participation. You may go ahead and disconnect.