Photronics - Q2 2024
May 22, 2024
Transcript
Operator (participant)
Good day, and thank you for standing by. Welcome to Photronics' second quarter 2024 earnings conference call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automatic message advising your hand is raised. As a reminder, this conference is being recorded Wednesday, May 22, 2024. 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, Livia. Good morning, everyone. Welcome to our review of Photronics' fiscal 2024 second quarter results. Joining me this morning are Frank Lee, our Chief Executive Officer, Chris Progler, our Chief Technology Officer, and Eric Rivera, our Interim Chief Financial Officer 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 participant 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. Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements.
We are under no duty to update any of the forward-looking statements after the date of the presentation to conform these statements to actual results. During the course of our discussion, we will refer to certain non-GAAP financial metrics. These numbers are useful for analysts, investors, and management to evaluate ongoing performance. A reconciliation of these metrics to GAAP financial results is provided in our presentation materials. At this time, I will turn the call over to Frank.
Frank Lee (CEO)
Thank you, Richelle, and good morning, everyone. Second quarter sales increased slightly from the first quarter as positive seasonality trends were mostly offset by temporary market softness following the Chinese New Year holiday and the impact from earthquake in Taiwan. On April 3, a major earthquake hit Taiwan, where we have three manufacturing facilities. I'm happy to report that our people are safe, and there was no significant damage to our sites or equipment. The strength of the earthquake and following aftershocks impact our production through tool downtime, as we must investigate to ensure there's no damage to our facilities and manufacturing equipment. In addition, we must repair or recheck masks that were in process at the time of the events. Our IC and FPD teams in Taiwan are experienced in dealing with these events, and nearly all tools were fully recovered within a few days.
However, the loss of production time and in-process inventory results in a reduction in sales of approximately $3 million. Order rates at the beginning of Q2 were strong, continuing the positive trend we saw at the end of Q1 and consistent with the high order rates we typically see ahead of the Lunar New Year holiday. Following the holiday, we usually see increase in bookings as customers return to work. This year, the rate in order rates was lower than our expectation. In addition, the timing of earthquake following the holiday further reduced booking, causing April revenue to be soft. Since then, order rates have increased, and we are entering the third quarter with higher confidence. These factors contribute to sales of $217 million in the second quarter. IC sales improved quarter-over-quarter, while FPD decreased.
Compared with the first quarter, gross margin was similar, and operating margin was slightly lower as we had higher R&D expense, driven by an increase in qualification activity. As a result, reported EPS was $0.58. On an adjusted base, EPS was $0.46. Cash flow was good during the quarter, and we further strengthened our balance sheet to position us to invest in the multiple growth opportunity we have, especially in IC. I would like to recognize the dedication of the global Photronics team this quarter to achieve these results, especially those in Taiwan that respond to the added challenge.... Turning to the markets, reversing the trend seen over the previous three quarters, our IC mainstream sales increased, mainly driven by market share gain. High-end was down, primarily due to lower U.S. demand.
Consistent with most of the end users, we see the overall semiconductor environment gradually improving into our fiscal Q3 and Q4 across most IC segments and regions. High-end FPD was softer as AMOLED design demand has not yet ramped ahead of new premium smartphones that will soon begin production ahead of fall launches. Longer term, we remain optimistic regarding positive demand trend for both IC and FPD. IC customers in Asia continue to migrate to smaller design nodes, including 22 nm and 28 nm. We are well positioned to capture this business. We also expect mega trends such as AI to drive chip design activity to handle AI workloads and edge processors. We expect a wide range of IC types to be developed in support of this AI ecosystem, from GPU, CPU, and ASIC, to High Bandwidth Memory and power electronics.
We also continue to expect trends in supply chain regionalization to drive market demand, photomask demand in support of new fab. For display, despite near-term softness in demand, we remain optimistic long term. Mobile device continue to be introduced with new displays that contain advanced features, enabled by higher value photomasks. In addition, panel makers continue development efforts to extend AMOLED technology into bigger displays, such as tablets and laptops. We will soon see AMOLED produce on G8.6 panels. Our FPD mask solution are relied upon for new design, for new display on these cycles and the most demanding mass production of advanced displays. Overall, we maintain an optimistic long-term outlook for mask demand and see many positive factors that support multi-node growth trends across Asia, U.S., and Europe.
We believe our strong customer relations, including long-term purchase agreement, coupled with leading technology and high output capacity, should allow us to outgrow the photomask industry. As we do, our proven ability and commitment to keep costs low should enable us to expand margins and generate strong cash flow, allowing us to continue investing in growth. At this time, I will turn the call over to Eric to review our second quarter results and provide third quarter guidance.
Eric Rivera (Interim CFO and Chief Accounting Officer)
Thank you, Frank, and good morning, everyone. Second quarter revenue of $217 million was slightly higher than the first quarter. There were headwinds that limited growth in a period that is typically up on seasonality, including the Taiwan earthquakes and soft demand following the Chinese New Year. IC revenue growth was mixed. Quarter-over-quarter improved as robust mainstream demand more than offset high-end weakness, primarily in the U.S. On a year-over-year comparison, IC was down as strong high-end volumes shipped to foundries in Asia were more than offset by lower mainstream demand. Order rates at the beginning of Q3 give us confidence for the upcoming quarter, and we remain confident on the long-term outlook for IC photomask demand. FPD revenue was lower sequentially and year-over-year, with softness in both high-end and mainstream. Seasonally soft high-end trends were heightened due to the earthquake and FX headwinds.
Looking into the third quarter, demand for mobile display masks is expected to pick up on seasonality trends ahead of anticipated fall launches of new premium smartphones. Gross margin was 36.5%, essentially the same as the first quarter and down from last year, primarily due to lower premium charges. The resulting operating margin was 25.8%, down from last quarter and last year. Operating expenses were higher this quarter due to increased R&D, as we had a high level of qualification activity. This bodes well for future demand as most qualifications result in incremental revenues. On that note, on the IC side, we processed qualification masks from EUV and sub-14 nm through mid-range and mainstream nodes in logic and memory. We also plan to enter qualifications of our new multi-beam mask writer in Q3, representing Photronics' commitment to the highest end of IC mask making.
On FPD, we saw increasing utilization of our advanced phase shift mask, indicating the higher value lithography processes under development by our customers, as Frank highlighted. Net income in the quarter was $36.3 million, or $0.58 per diluted share on a GAAP basis. After adjusting for non-operating FX gain, non-GAAP net income was $28.7 million or $0.46 per diluted share. We generated $76.5 million in operating cash flow, and CapEx was $20 million in the quarter. We still expect total CapEx of $140 million in 2024, primarily in both high-end and mainstream IC, to address anticipated demand growth while ensuring we're increasing our return on invested capital.
We ended the quarter with a cash balance of $539.2 million, short-term investments of $20.7 million, and debt of $21.8 million, allowing sufficient liquidity to fund investments in organic growth. Before I provide guidance, I'll remind you that our visibility is always limited, as our backlog is typically only one to three weeks, and demand for some of our products is inherently uneven and difficult to predict. Additionally, the ASPs for high-end mask sets are 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 revenues and earnings. Given those caveats, we expect the third quarter revenue to be in the range of $221 million-$229 million.
We expect positive photomask demand momentum that was interrupted by the Chinese New Year to resume and continue through the third quarter. Based on those revenue expectations and our current operating model, we estimate non-GAAP earnings per share for the third quarter to be in the range of $0.53-$0.59 per diluted share. This assumes an operating margin of between 28% and 30% as we continue to keep costs under control and maximize profitability. We faced some unique challenges in the second quarter. Despite this, we achieved sales slightly above Q1 levels, and we're able to maintain good margins. Positive order rates as we exited the second quarter are encouraging for our third quarter of full year outlook. We continue to perform well and build on our solid financial foundation to profitably grow and create shareholder value in 2024 and beyond.
I'll now turn the call over to the operator for your questions.
Operator (participant)
Thank you. Ladies and gentlemen, to ask a question, you will need to press star one one on your telephone and wait for your name to be announced. To withdraw your question, simply press star one one again. Please stand by while we compile the Q&A roster. So now the first question coming from the line of Tom Diffley with D.A. Davidson. Your line is open.
Linda Umali (Associate VP and Senior Research Associate)
Hi, this is Linda Umali on behalf of Tom Diffley. Thank you for letting us ask questions this morning. So to start, very sorry to hear about the impact of the earthquake, and we're glad to hear everyone there was safe. So it's a good thing to hear. So my first question will be on that. If I heard you correctly, the impact on the quarter from the earthquake was $3 million, or it was just that, was that just on production and inventory? And maybe if you could clarify and quantify how much the earthquake impact was and how much of it is embedded in your guidance for the July quarter? Thank you.
Eric Rivera (Interim CFO and Chief Accounting Officer)
Hello, Linda. Thank you for asking the question. This is Eric. So we had a $3 million impact, like we mentioned, related to the earthquake. Most of that was production loss time. In terms of materials or anything else, it was not significant. The majority of it was production loss time.
Linda Umali (Associate VP and Senior Research Associate)
Okay, and so not impact— Oh, go ahead.
Eric Rivera (Interim CFO and Chief Accounting Officer)
I'm sorry, go ahead. Yes, so with respect to, is that embedded in our forecast, that was a one-time event for us as the earthquake just impacted this quarter.
Linda Umali (Associate VP and Senior Research Associate)
Okay, I see. Thank you. And still on the earthquake impact, I have—I might have missed it, but are you—is there an impact on the CapEx plans for this year, or are you still thinking, the $140 million that you had mentioned last quarter? Because I'm thinking, given the repairs that might have to take place as you are still investigating, would that have any change on that? And what could be the split, in FPD and IC?
Eric Rivera (Interim CFO and Chief Accounting Officer)
We don't expect that to change our $140 million expected CapEx for the year.
Linda Umali (Associate VP and Senior Research Associate)
Okay. Could you remind me again, what the split would be, FPD and IC?
Eric Rivera (Interim CFO and Chief Accounting Officer)
It's mostly IC. There is some FPD there, but it's mostly IC.
Linda Umali (Associate VP and Senior Research Associate)
Got it. Thank you for the clarification. And going to overall revenue, it remains around 5% below your prior year levels. And you mentioned that the turn-in order rates was lower than expectations following the Lunar New Year. Could you walk us through what is happening here? Why do you continue to see such low levels of growth? And are you seeing impacts primarily from end market weakness, share losses, given ramping Chinese competitors or delayed new programs?
Frank Lee (CEO)
... Linda, thank you. In the past, a lot of customers, like the design house customers, they tape out before the New Year holiday, so people can take off for the holiday. And we see very heavy bookings both in high-end and mainstream before the holidays. And normally, after the holiday, the order will recovers step by step. But this year, it seems to be slower than the past, and so we still have very strong first two months in the quarter, but mainly because of the order before the New Year. And in the month of April, the new order come in, the rate of new order come in is kind of slow, especially in the high-end. So it do impact the April output.
The market seems to be very volatile. It's not quarter by quarter, it's month to month, especially in the high end, because the high-end order, every single set, is a much higher price, so the impact is bigger than the mainstream business. However, at the end of April and right going into Q3, we do see orders start to recover. Based on the seasonality, Q3 typically is a good month, is a good quarter for tape out. We are expecting the high-end order especially will reach to the good level in this quarter.
Linda Umali (Associate VP and Senior Research Associate)
Great. Thank you for that color. So seems like high end is expected to be doing well in the upcoming quarters. So if you think about mainstream, you mentioned a softer demand environment this quarter. Is that what you're expecting in the next quarter as well? And with the softness there, is it in certain segments or across the board? Maybe give us more color on how the demand environment looks like there, maybe current lead times, and maybe touch on pricing as well.
Frank Lee (CEO)
In the mainstream segments, because a lot of new fab, especially in China, they are ramping up in the mainstream business. So, compared to the previous quarters, mainstream demand actually very consistent and increasing quarter by quarter. And, in the past several quarters, we do increase our capacity to support our mainstream business. In previous two years, because of capacity limitation, our lead time for mainstream product are kind of relative long, and so we did not take as many mainstream order as we can. By starting this year, we do have some mainstream new capacity, and we start to take more order, and that reflect in our growth in the mainstream IC business.
Linda Umali (Associate VP and Senior Research Associate)
Great, got it. And then maybe, Eric, to looking at gross margins, quite flat, from first quarter and down from last year. And, I believe you mentioned it was due to, some premium charges, lower premium charges. Could you touch on that? And then, what are you thinking for next quarter?
Eric Rivera (Interim CFO and Chief Accounting Officer)
Sure. So yeah, as you mentioned, our premium charges are much lower this year than they were last year, and that explains the decrease in revenue and margin, and our margin. With respect to our margin levels, for the rest of the year, I don't expect them to be much different than what they are at the current level.
Linda Umali (Associate VP and Senior Research Associate)
Okay. So even if the demand environment changes, are you still expecting the same levels?
Eric Rivera (Interim CFO and Chief Accounting Officer)
I'm sorry, say again, I'm sorry.
Linda Umali (Associate VP and Senior Research Associate)
Even expecting an upturn on the horizon, are you thinking the same for next year and second half this year as well?
Frank Lee (CEO)
The premium may not come back. However, because the better product mix, more high-end, especially in the 22- and 28-nm product, our branded ASP do increase quarter by quarter. So if we compare with last year, even the premium disappear, our overall growth margin actually increase quarter by quarter. So, it's nice to have premium charge, but we know it's not a long-term event. So-
Linda Umali (Associate VP and Senior Research Associate)
Mm-hmm.
Frank Lee (CEO)
We put a lot of effort to improve our product is such that, the branded ASP can be higher.
Linda Umali (Associate VP and Senior Research Associate)
Awesome. Well, thank you so much for your time today.
Frank Lee (CEO)
Thank you, Linda.
Operator (participant)
Thank you. Our next question coming from the line of Eric Redwood, Portre Island Advisory. Your line is open.
Speaker 5
Thank you very much. Good to hear about the orders recovering at the end of April and looking good and going into May, you know, the minimal impact despite the earthquake. I guess the first question is on the earthquake. I'm not too familiar with how photomasks might fare in, you know, a disruptive earthquake like that. Do you expect that there was some damage to photomasks that were being used in the market at the time, and that should lead to, you know, some photomasks needing to be scrapped or serviced, and that could lead to a potential bump in, you know, future quarter revenues?
Frank Lee (CEO)
Yes. During the earthquake, most of our equipment has a self-protection system. So, if the earthquake is over a certain scale, the tool will shut down automatically to protect the tool. And at the same time, if there are any photomask in the process inside the tool, that photomask will be considered incomplete. So it cannot continue the process, it has to be rejected. And certain photomask, for example, if it's in a cleaning process, then we may have to check if there is any defect or contamination on the mask, and some can be repaired, some cannot be repaired, we have to reject. So none of the damage or impact mask will go to customer. However, there will be a reject or repair in the production line.
Operator (participant)
Thank you. Ladies and gentlemen, there are no further questions at this time. I will now turn the call back over to Mr. Frank Lee for closing comments.
Frank Lee (CEO)
Okay. Thank you for joining us this morning. We had a slower than expected start to 2024, and the earthquake in early April impact our results. Yet, we remain optimistic that we can achieve another year of solid results. The team is performing well. The long-term outlook for our market is supported by positive mega trends such as AI, and we are in a good position to benefit due to our global presence and advanced technology. I look forward to updating you on our progress. Thank you.
Operator (participant)
Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation, and I ask that you please disconnect your line at this time.