Photronics - Q2 2023

Transcript

Operator (participant)

Good day. Thank you for standing by. Welcome to Photronics second quarter 2023 earnings conference call. At this time, all participants are in a listen only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you'll need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. As a reminder, this conference is being recorded Wednesday, May 24th, 2023. I would now like to turn the conference over to Richelle Burr, Chief Administrative Officer. Please go ahead.

Richelle Burr (Chief Administrative Officer)

Thank you, Kevin. Good morning, everyone. Welcome to our review of Photronics fiscal 2023 second quarter results. Joining me this morning are Frank Lee, our Chief Executive Officer, John Jordan, our Chief Financial Officer, Christopher Progler, our Chief Technology Officer, and Eric Rivera, our Corporate Controller and Chief Accounting Officer. The press release we issued earlier this morning, together with the presentation material that accompanies our remarks, are available on the investor relations section of our webpage. Comments made by any participants on today's call may include forward-looking statements that include such words as anticipate, believe, estimate, expect, forecast, and in our view. These forward-looking statements are based upon a number of risks, uncertainties, and other factors that are difficult to predict. Actual results may differ materially from those expressed or implied, and we assume no obligation to update any forward-looking information.

During the course of our discussion, we will refer to certain non-GAAP financial metrics. These numbers are useful for analysts, investors, and management to evaluate ongoing performance. A reconciliation of these metrics to GAAP financial results is provided in our presentation material. At this time, I will turn the call over to Frank.

Frank Lee (CEO)

Thank you, Richelle, and good morning, everyone. Second quarter results were strong as we achieved record revenue and profit. Demand for our products grew in both IC and FPD with sequential revenue growth in all regions. Our position as the largest merchant photomask supplier provide us broad exposure to global markets and make us less dependent on any one sector or region. In addition, we have a talented and dedicated global team. Their performance has enabled Photronics to deliver record results in Q2. IC demand was strong again this quarter, especially for mainstream. This sector has been growing for the last several quarters. Demand for the advanced portion of mainstream in the 40-55 nanometer range is especially strong. On the other hand, we observed some softness in high-end.

We expect this to recover in the next one to two quarters and to resume a growth trend. Within FPD, demand for AMOLED grew significantly. Our customers are releasing new designs for mobile displays as they try to gain market share in the next generations of smartphones, tablets, and PC. Demand for LCD has stabilized with good sequential growth. We expect this favorable trend to continue. Growth and operation margin benefit again this quarter from strong pricing and tight cost management across the organizations. We earn $0.65 per share on a GAAP basis and $0.54 per share on a non-GAAP basis after excluding $0.11 per share gain from foreign exchange. This was an excellent quarter as we continue to build to another record year. Photomask demand is driven mainly by new designs.

Design activity often follow different demand cycle than capital equipment or wafer start. For example, our customer often release new designs when their demand is slow and utilization is low, and that could be a better time to introduce new products into their operations. The other condition that drive photomask demand is capacity expansion, either through new fab or new tools in existing fabs. This factor tend to make photomask demand more sustainable and even countercyclical. Since I was named CEO one year ago, I spent a lot of time with our employees across the organization and have enhanced and driven a great team which has the characteristic to win. In addition, we have strategically invest in technology and develop advanced process know-how for our leading-edge mask solutions.

By working closely with our customers, we are able to fully support their technology and product roadmaps. Our differentiate EUV product line continue to expand, achieving a number of important milestones, including our first EUV DRAM mask shipments in Q2. We have a great market position as a leading photomask supplier with 11 strategically located manufacturing sites. Based on data recently published by TechInsights, we shipped approximately 30% of all photomask units globally. The leading providers of semiconductors and the display panels trust us to supply their photomask. This confirms our leading position and is an indication of our broad and diverse market exposure. Finally, we have a great balance sheet of fund growth. Through cash flow generation and financial discipline, we have built a strong and flexible balance sheet that provides liquidity to invest in growth while also providing support should we see a decline in demand.

We are on track to deliver another record year in 2023. Later on, John will provide our Q3 guidance in more details. Photomask market demand is strong and our team is performing well. I am very optimistic about our future. With that, I will turn the call over to John.

John Jordan (EVP and CFO)

Thank you, Frank. Good morning, everyone. Second quarter revenue of $229 million was another record, a 9% sequential increase and 12% increase over last year's second quarter. That represented the ninth consecutive quarter of year-over-year revenue growth. Demand remained robust across both IC and FPD, reflecting strong design activity from our customers, releasing new products and expanding production capacity. Shipments within and into China represented 51% of second quarter revenue. We are the global market leader in merchant photomasks. Our customers partner with us to achieve their product roadmap objectives. IC revenue of $167.1 million was up 7% sequentially and 15% compared with last year. Demand was strong across all regions. Mainstream growth more than offset some high-end softness. Pricing remains favorable as demand growth continues to outpace some increases in supply.

We are seeing the strongest demand within the higher end of the mainstream technologies, which aligns well with the investments we have made to increase IC capacity. We believe new designs and increases in chip capacity driven by regionalization of the semiconductor supply chain will continue to drive long-term positive trends in the photomask sector. FPD revenue is also a record in the quarter, improving 14% quarter-over-quarter and 6% year-over-year. AMOLED panels used in advanced mobile displays continue to fuel healthy demand for high-end masks, which represented 83% of the FPD revenue in the quarter. Mainstream revenue also grew sequentially with increased right capacity and stable LCD demand.

Gross and operating margins increased quarter-over-quarter by more than 260 and 270 basis points respectively, to 38.6% and 29.2%, which were 430 and 500 basis points more than the margins recorded in the second quarter of last year. The sustained strong margins benefited from volume leverage, pricing power, favorable mix, and disciplined cost management. Operating expenses increased by 6%, but at 9.3% of revenue were lower as a percentage of revenue. Second quarter operating income of $67 million is the most the company has ever recorded in a quarter. The non-operating gain in the quarter of $13.6 million resulted primarily from the unrealized gain from remeasurement of U.S. dollar-denominated balance sheet items into the local functional currencies of our foreign operations.

This compares with a loss of $14.4 million in the first quarter, resulting in a $28 million sequential tailwind due to changing FX rates. Similar to last quarter, we provided non-GAAP results that exclude the foreign exchange effect for better comparison of operating results. GAAP EPS was $0.65 a share. After eliminating the effects of foreign exchange and the related income tax or minority interest. Adjusted EPS was $0.54 for Q2, compared with adjusted EPS of $0.40 last quarter and $0.38 in the same quarter last year. The strong net income performance and tight working capital management produced an outstanding $82 million in cash from operating activities. We invested $27 million in capital expenditures in the quarter, bringing year-to-date CapEx to $58 million.

Our 2023 CapEx forecast remains approximately $130 million, primarily for increased IC capacity. Our cash balance was $367 million at the end of the quarter, and we held an additional $45 million in short-term investments. We have $28 million of debt remaining, consisting almost entirely of low-cost equipment leases. Our cash and short-term investments, combined with funds available under the credit agreement, provide ample liquidity for our growth investments and resilience against uncertainties we could face in the future. Before I provide guidance, I'll remind you that our visibility is always limited, as our backlog is typically only 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, a relatively low number of high-end orders can have a significant impact on our quarterly revenue and earnings. Given those caveats, we expect third quarter revenue to be in the range of $224 million-$234 million. We believe photomask demand will continue to do well in the current semiconductor environment, and we will continue to strive to increase our market-leading position. Based on those revenue expectations in our current operating model, we estimate non-GAAP earnings per share for the third quarter to be in the range of $0.48-$0.54 per diluted share. Year to date, we have grown revenue 12% and expanded operating margins by 570 basis points. Demand remains strong and our team is performing well.

Our confidence that we can achieve our long-term targets and continue creating shareholder value is supported by our level of execution, strong balance sheet, and positive outlook on continued strong design activity. I will now turn the call over to the operator for your questions.

Operator (participant)

Thank you. Ladies and gentlemen, if you have a question or a comment at this time, please press star one one on your telephone. If your question has been answered and you wish to remove yourself from the queue, please press star one one again. We'll pause for a moment while we compile our Q&A roster. Our first question comes from Tom Diffely with D.A. Davidson. Your line is open.

Linda Bolton Weiser (Managing Director)

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

John Jordan (EVP and CFO)

Yeah, thanks for that, Linda. Good morning. Richelle Burr, who's our Chief Administrative Officer, will cover that question.

Richelle Burr (Chief Administrative Officer)

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

Linda Bolton Weiser (Managing Director)

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

Christopher Progler (CTO)

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

Linda Bolton Weiser (Managing Director)

Correct. Yeah, that's correct.

Christopher Progler (CTO)

You know, we have exposure to part of the memory market, and those customers haven't been as strong as they were in previous quarters. Particularly our most advanced DRAM customer is still doing fairly strong roadmap and development cycles, preparing for recovery of the markets. It looked like some of the memory pricing has started to stabilize. Maybe it's hit a bottom, maybe not. The two or three primary customers we have on memory, seem to be a bit more optimistic about what might unfold in the second half of 2023 calendar year. We're seeing pretty strong R&D cycles and pretty strong product development cycles still. That hasn't changed.

It was not strong in the quarter, but it looks like at least customers we serve, are getting a bit more optimistic about the latter half of 2023.

Linda Bolton Weiser (Managing Director)

Oh, thank you for the color. My last question is on CapEx. Maybe, John, I might have missed it, but what are you thinking, in terms of CapEx, for this year? Could you give us a split, for this year, for FPD and IC?

John Jordan (EVP and CFO)

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

Frank Lee (CEO)

These are also some of our tools we call end of life. We are planning to replace certain old tools with the more efficient and updated tools. Some CapEx in IC are spending on the end of life tool replacement.

Linda Bolton Weiser (Managing Director)

Got it. Thank you for your time.

John Jordan (EVP and CFO)

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

Richelle Burr (Chief Administrative Officer)

Yeah. FPD is not controlled.

John Jordan (EVP and CFO)

Right.

Richelle Burr (Chief Administrative Officer)

FPD is not controlled.

Linda Bolton Weiser (Managing Director)

That makes a difference.

Richelle Burr (Chief Administrative Officer)

The export control regulations. Yeah. Those impact IC, not FPD.

Linda Bolton Weiser (Managing Director)

Got it. Thank you so much for your time.

John Jordan (EVP and CFO)

Thank you, Linda.

Operator (participant)

Again, ladies and gentlemen, if you have a question or a comment at this time, please press star one one on your telephone. Our next question comes from Gus Richard with Northland. Your line is open.

Gus Richard (Managing Director)

Yes, thanks.

John Jordan (EVP and CFO)

Good morning, Gus.

Gus Richard (Managing Director)

Thanks for my question. Morning. Appreciate it. real quick, could you talk a little bit about, you know, expedites? Are you still seeing those on the mature side, or has that activity slowed?

Frank Lee (CEO)

The expedite? Yeah. Premium.

John Jordan (EVP and CFO)

The premium.

Frank Lee (CEO)

Oh, okay. Gus, thank you. The premium side has been slowed down in Taiwan. However, we still have some long-term agreement which we signed last year or early this year. In those long-term agreement, the premium charge has been defined, and we're continue to continue through the period of the agreement. Certain agreement is for two years, some agreement is for three years. We will maintain certain premium charge in this year and next years.

Gus Richard (Managing Director)

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

John Jordan (EVP and CFO)

The photomask industry.

Frank Lee (CEO)

Yeah. In our industry, we do see some expansion and some new local mask shop in China. These new players, some are in a very early stage. Some are start to get a customer qualification and enter the market. However, we believe the impact will start on the low end of the business. Also for these new competitors to achieve certain economic scale, it will take several years. Our business in China, basically we are focused on the higher end of the mainstream. We will have some differentiation with the new competitors. Outside of China, photomask, IC photomask capacity expansion actually is not significant. As we just mentioned, we spent some CapEx.

Part of those, of course, is for capacity expansion, but some portion of those are for end of life replacement. This kind of end of life situation happened to every merchant mask shop, not only to us. Even with every mask shop doing CapEx, but some tool will be end of life. So overall, the capacity increase still limited.

Gus Richard (Managing Director)

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

Frank Lee (CEO)

Correct.

Gus Richard (Managing Director)

Got it. You know, I've, you know, over the last 40 years, you know, I see photomask margins rarely have gotten into the 30s. I'm just kind of curious, you know, what gives you the confidence that that's a sustainable level, just given the history of the industry?

Frank Lee (CEO)

I think, in the past years, as you mentioned, photomask is not a big player in the semi industry. A lot of companies are focusing on wafer fab capacity expansion and pay little attention to photomask supply. The supply demand, of course, was on the other side, more supply than demand. However, because most merchant photomasks are not making enough money to make investment. Gradually, the trend has shift between the supply and demand. Especially in the past two years, a lot of new IC application and create a lot of new wafer fab expansion. The combination of supply side of photomask do not expand. On the demand side, a lot of new wafer fab and new product demand.

The supply and demand imbalance, getting worse. Under such situations, we believe we have some leverage in terms of pricing and also, profit margin.

Gus Richard (Managing Director)

Got it. Got it. Just last one from me. Are you seeing an extension in the mature markets of lead times, or have they stabilized at this point?

Frank Lee (CEO)

The equipment? Extension.

Gus Richard (Managing Director)

It said lead times for.

Frank Lee (CEO)

Yeah, the delivery time.

Gus Richard (Managing Director)

For you guys, your lead times.

Frank Lee (CEO)

Oh, yeah. Our lead time was very long last year. Before the shortage, the lead time, like, seven, 10 days, the longest. Last year, some lead time was as long as 90 days. At this moment, the lead time have been improved, but still, it is much, much longer than the normal lead time before. We are still seeing some premium charge and... This lead time is different from a node to node. Certain nodes, the lead time remain very long and certain nodes, lead time has improved.

Gus Richard (Managing Director)

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

Frank Lee (CEO)

Thank you.

Gus Richard (Managing Director)

Thank you, Gus. Thanks very much.

Operator (participant)

Again, ladies and gentlemen, if you have a question or a comment at this time, please press star one one on your telephone. I'm not showing any further questions at this time. I'd like to turn the call back over to Frank.

Frank Lee (CEO)

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

Operator (participant)

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