Photronics, Inc.

Good day, and thank you for standing by. Welcome to the Photronics fourth quarter fiscal year 2021 earnings conference call. At this time, all participants are in 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 1 on your telephone. As a reminder, this conference is being recorded Wednesday, December 8, 2021. I would now like to turn the conference over to John Jordan, Executive Vice President and CFO.

Thank you, Shannon. Good morning, everyone. Welcome to our review of Photonics fiscal year 2021 fourth quarter and full year financial results. Joining me this morning are Peter Curlin, our chief executive officer, and Chris Progler, our chief technology officer. The press release we issued earlier this morning, along with the presentation material, which accompanies our remarks, are available on the 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, 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. At this time, I will turn the call over to Peter.

Thank you, John, and good morning, everyone. We ended 2021 with accelerating momentum in a market environment of robust design activity from a diverse customer base. In addition, we strategically expanded capacity in 2021, most notably in display with the addition of three new lithography tools. These factors, among others, enable us to deliver another quarter and year of record revenues across the business, including both IC and FPD. This is our fourth consecutive year of record revenue, demonstrating our ability to drive our top line up the entirety of a semiconductor industry cycle. These increasing levels of performance have been made possible by the efforts of the entire team to provide outstanding customer service, coupled with solid investments in the right technology in the proper location to position us to win in the marketplace. In addition to growing the top line, we expanded margins during the quarter. This was driven by operating leverage, the ability to realize higher prices in mainstream products, and the present focus on cost reductions. It was just one year ago in December when we communicated our long-term target model, the growth margins in the high 20s and operating margins in the high teens. Today, we are already operating in the upper end of that model. While we recognize the need to improve, we are extremely pleased with the progress that we have made and even more excited about what is possible going forward. Cash flow was strong for the quarter and the year. enable us to maintain a strong balance sheet while investing in organic growth and returning cash to shareholders. Since initiating our first share repurchase program in 2018, we have brought back $128 million of shares, reducing our share count by approximately $12 million, a testament to our commitment to creating shareholder value. Making targeted investments that improve our return on capital is one of the key factors contributing to our success. Outside of strong end market demand and great execution by our entire team. Our investment philosophy is built upon aligning operations and technology with specific market trends and ensuring that every decision to invest is backed by customer commitment. This approach mitigates risk enables us to quickly ramp new tools to volume production, which helps to ensure we deliver required returns. Work remains to be done to further improve return on invested capital, but we are very encouraged by our progress. Over the last few years, our investment strategy has been focused on mounting a geographic expansion into China while exploiting the technology inflection from LCD AMOLED and advanced mobile displays. Beyond these longer-term secular trends, we are now capitalizing on another rapidly growing sector in the IC market, mainly in China and Southeast Asia, that is now being referred to throughout the industry as, you know, I would say in quotes, legacy foundry. We have been speaking about this for the last several quarters as a growing demand for masks versus relatively fixed supply of has placed pressure on capacity, providing us with very rare, very rare pricing leverage. These photomask technologies have been in production for many years, with a particular focus on the advanced end of the mainstream, a range that spans roughly from 40 to 90 nanometers. Demand for these nodes is tied across the entire photomask industry, for us as well as for our competitors. While at the same time, more and more IC capacity is being installed, which leads us to conclude the favorable pricing will be sustainable. Demand is particularly strong in China and Taiwan. And along with our JV partner, we are investing now in the expansion of our facility in Taiwan, while adding capacity across the region to meet this growing demand. We believe this is a unique opportunity that will play out over the next several years. and we are positioning ourselves to capture the lion's share of the growth that we see in this segment. We see several drivers of growth in the legacy foundry sector. First, on the demand side, Moore's Law has essentially come to a halt for most logic applications, with 28NMB being the last node where incremental economic benefit was achieved by moving to the next smaller node. There are very few applications that justify the cost to design, develop, and manufacture at the very leading edge of 10 nanometer and below. For most applications, older technologies do the job effectively, including automotive, industrial applications, and the ubiquitous internet of things. This has created a renewed drive to install more semiconductor capacity at the mature nodes. As the chip market leads, the photo mass market follows as more and more customers are now differentiating their products based on design rather than next-node technology. This is very exciting for a mass maker as we believe we are witnessing the effective rebirth of the ASIC market. Second, the development of the semiconductor ecosystem in China spurred by that government's 2025 strategic goals, has caused significant investment in chip capacity at these mainstream nodes. Since our decision five years ago to expand our operations into China, working closely with our JV partner, we have built a sizable business there with leading market share. Revenue shipped into China is presently at a trailing 12-month run rate of $250 million. This momentum positions us well to continue growing in this important country. Finally, the market growth within mainstream nodes is sustainable due to growing nationalism within the semiconductor industry. After navigating the external shocks of trade agreements and lockdowns, companies are rethinking their reliance on manufacturing other countries, which is driving our new investment in domestic chip manufacturing. We are seeing this in Asia and are now seeing it in the US and Europe. In fact, the supply-demand inversion that led to pricing strength in Asia is now being replicated in Europe, and we are beginning to take pricing action in this region as well. While our European business is much smaller than Asia, it is more biased towards the mainstream, and we anticipate pricing actions will raise sales and margins in this region as well. In summary, there are several catalysts across our business to drive sustainable growth of photo mass demand for both IC and FPD well into the future. We have made investment decisions in the past that enabled us to benefit from these trends, propelling us to the outstanding performance we achieved in the fourth quarter and throughout the full year of 2021. We have the widest range of technology, an unparalleled global footprint that enables us to respond quickly to dynamic market in any customer request. Record revenue, expanding margins, and strong cash flow position us to continue to make improvements that we believe will allow continued growth. I am very proud of the entire team and what we're able to achieve this year, and I'm optimistic that 2022 will be even better. At this time, I will turn the call over to John.

Thank you, Peter, and good morning again. Record fourth quarter revenue of $181 million was driven by the same enablers we've seen throughout 2021. Strong demand, growth in new designs for semiconductors and displays that are enabled by our leading technology, unparalleled geographic presence, and strategic investments to expand capacity. Fourth quarter revenue improved 6% sequentially and 21% compared with last year. Demand strength was broad-based, including both IC and FPD, and across both mainstream and high-end products. Both IC and FPD also posted record revenues for Q4 and the full year. In IC, the high-end business grew primarily from logic demand for major foundries. Memory demand remained fairly stable. In the mainstream, revenue increase was driven by the demand profile that Peter commented on and the pricing actions we've enacted since earlier last year. We believe these market trends are sustainable and expect to continue IC growth with more investments planned in 2022. FPD strength was driven by displays for mobile applications as well as a recovery in mainstream LCD demand. We've stated before that the LCD photo mass market was soft as customers focused on mass-producing existing products to ship into their strong display markets. Thus, we're not releasing new products. We saw this trend start to shift in the fourth quarter as panel makers began to introduce new product designs to maintain or expand market share. This recovery, together with continued strength in mobile displays and the full-year benefit of our tools installed during 2021, instills confidence that 2022 will be another record year for FPD revenue. Demand for products shipped into China was strong again, setting a record in Q4 and for the full year. On a consolidated basis, China now represents 37% of our total revenue. In FPD, photomass demand in China continues to increase as panel makers look to expand their presence in the global market. IC sales to China customers are driven primarily by the high end of the mainstream technology, and we've established a market-leading position in that merchant-dominant region. Margin expansion in the quarter enabled us to deliver the best gross and operating margins before we began repositioning the business in 2016. Gross margin of 28.7% and operating margin of 18.5% position us solidly within the upper end of the three-year target model we presented about a year ago at our investor day. Achievement of these margins results from technology leadership, consistent reliable delivery, constant focus on cost reduction, and insistence on disciplined expense controls. While we're encouraged by this performance, we recognize the need to execute consistently, and we expect to be able to continue generating growth and operating margins in the target ranges. Below the operating income line, other income increased due primarily to unrealized foreign exchange gains, primarily from remeasurement of monetary assets and liabilities at our international locations. The income tax provision increase was consistent with the increase in earnings, and the net income to non-controlling interest increased with the strong performance of our joint ventures in China and Taiwan. Earnings per diluted share was 33 cents for the quarter and 89 cents for the year, with 61 million and 62 million diluted shares outstanding, respectively. Cash and equivalents were $277 million at the end of the fiscal year. We have $112 million in debt and net cash of $165 million. Our balance sheet has remained strong throughout the year, and as we discussed earlier in the year, debt increased from two low-interest rate equipment leases and equipment purchases in China. Operating cash flow is $38 million in the fourth quarter, bringing full-year operating cash flow to $151 million, 5% better than last year. Capital expenditures of $17 million in the quarter brought the full-year CapEx total to $103 million, net of nearly $6 million in subsidies received and slightly below previous projections, as some payments were deferred into 2022. During fiscal 2022, we expect to spend about $100 million in capex for point tools to supplement and expand existing mainstream IC capacity and for initial deposits on tools for delivery in fiscal 2023. We believe our capital allocation strategy is having a tangible impact on shareholder value. We again spent $12.5 million in the fourth quarter, repurchasing 937,000 shares of our stock, which brought total repurchases for the year to 3.9 million shares for $48 million. Cumulatively, we've spent $66 million of the current $100 million authorization. As Peter mentioned, we've repurchased an aggregate of 11.8 million shares for $127.5 million in since we began the repurchase initiative. Total shares eliminated from the diluted share count, if we include repayment of the convertible issues, is over 22 million shares for an aggregate of $242 million. We believe there's significant value in PLAB equity, and we plan to continue buying under this authorization. Before I provide first quarter guidance, I'll remind you that our visibility is always limited as our backlog is typically only one to three weeks, and demand for some of our products is inherently uneven and difficult to predict. Additionally, the ASPs for high-end masks 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 first quarter revenue to be in the range of $178 to $186 million. The Photronics fiscal first quarter is normally a slower quarter due to seasonality. But as we've discussed throughout our commentary, end market demand factors are favorable across both IC and FPD, and we expect them to continue into 2022. Thus, we are expecting the strong demand to more than offset the seasonal weakness and contribute to a stronger first quarter and carry through the remainder of the year for another strong, strong single-digit annual revenue increase. Based on those revenue expectations and our current operating model, we estimate earnings per share in the first quarter to be in the range of $0.27 to $0.34 per diluted share. We delivered better results, results better than expectations in Q4, and the entire organization performed well in an environment that remains challenging. That performance is a testament to the soundness of our operating model, the strength of our customer and industry relationships, the resilience of our employees, and our disciplined cost management. We're encouraged that we've brought the operations to this level. And we believe that as we embark on our 2022 fiscal year, we are well positioned to continue our consistent execution and deliver another great year. Thanks very much for your interest in Photronics. I will now turn the call over to the operator for your questions.

Thank you. As a reminder, to ask a question, you will need to press star 1 in your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from the line of Patrick Ho with Stifel. Your line is open.

Hi there. Good morning. This is Brian on for Patrick. Congratulations on the execution results, and thanks for letting us ask a few questions. Maybe the first question, clearly the mainstream ICU photo mask revenue is very strong, queue-on-queue. Can you just maybe first break out how much of that sequential increase was attributable to volume versus pricing, which seems to be having a significant effect on revenue and gross margins?

I think we've commented on that in the past, Brian. We've got about two margin points out of price increases compared to prior to when we started increasing prices. So you can calculate that difference.

Yeah, and I would also point out that if you, I've been here 14 years, the mainstream business over that period has maybe vacillated between 265 at the top end and 240 million on the bottom. And, you know, last year, you know, we had $300 million in revenue in the mainstream segment, which is 20% up year over year. We exited the year, as you pointed out, at a $325 million run rate.

Yeah, for sure. And I guess, you know, thinking about just the fiscal 1Q January guidance, and thinking about the potential for further IC photomask increases in Europe, what kind of favorable benefit do you think could materialize in the fiscal first quarter? on the gross margins?

We expect them to stay essentially the same. Revenue increase and the margin difference will probably stay pretty similar. As we are increasing prices, as we mentioned in the other geographies, the revenue will increase and the difference in margin will stay right around the same.

Again, as far as the market is concerned, You know, you're too young to remember the ASIC business. But when I was, you know, young, the ASIC business, the photo mass content to the ASIC business when companies like LSA Logic were going great guns, it's about 3% of IC revenue. It was the best market for a mass maker. And Moore's Law and FPGAs basically destroyed the ASIC business over many years. But given the fact that the economic paradigm that was part of Moore's Law has derailed, what we see happening, and what people now call legacy foundry, is really ASIC market rebounding because it doesn't make economic sense to put more of those transistors on that very expensive dying Moore. So for us, this is great because if it has a foot-of-mask revenue dollar content per Silicon dollar content that's similar to what we saw before, there's a lot of Fedomask revenue leverage and legacy foundry.

So I think the key takeaway from this, Brian, is the change and it's essentially a change in the paradigm where the pricing environment is going to be sustained over at least you know, medium term. And I think our margins show that benefit and will continue to show that.

Got it, got it. And I think your fiscal 22 CapEx is somewhat flattish relative to what the fiscal 21 was. You did add three FPD tools. So last year, and so this year, given sort of the dynamics in fiscal 22, do you expect that to shift that more towards IC relative to FPD and any other color you can provide on sort of what tools and where you're placing them on the IC side?

Yeah, I think we mentioned that during the comments. The tools are designed to supplement the existing capacity in several locations in IC. And then some significant deposits for tools, again, IC tools, that we expect to have delivered and ramp up in fiscal 23. So there's not one location where we can say we're adding a major tool and major capacity. We're kind of putting in tools that are necessary to get the full benefit out of existing tools. So where we may be limited with inspection capacity for one of our lithography tools, we need more inspection capacity. So we would add that and optimize the production out of the lithography tool.

Got it, got it. Yeah, and maybe one last one. It doesn't seem apparent based on the results, but did you see any disruptions direct or indirect in the quarter, not only from supply chain, but really in particular the power outages that are occurring in China, and how does that sort of factor into your outlook as well?

Yes, so as far as the supply chain, the material supply chain is concerned, we, like everybody else, had issues with local suppliers. But unlike most others, we have a global footprint. So if we had a problem with a supplier in Asia, we reacted to that problem with an existing supplier in the US or Europe, for example, just to give an example. So the supply chain, even though there was disruptions, they didn't disrupt our business. Likewise, if you look at the rolling outages in China, we cannot afford to have our operations go down. So we have our own backup power generation as part of our standard you know, package, so to speak. So as a result of that, we have been able to manage wherever others have struggled. So the answer is absolutely not, no disruption, none.

Okay, great. Thank you.

Thank you. As a reminder, to ask a question at this time, please press R then 1 on your touchstone telephone. Our next question comes from Tom Diffley with DA Davidson. Your line is open.

Yeah, good morning, and congratulations on especially a great outlook during the seasonally week, January quarter. And, Peter, I am old enough to remember the ASIC market back in the 90s and early 2000s, and it was the heyday for your business, and hopefully we return there. So on the mainstream business, I'm curious, you know, in the past we've talked about how the pricing there is did not support the addition of new tools. Has that dynamic changed, and can you now buy new tools to economically support the mainstream business?

Yeah, so to be clear, the answer is we still cannot, with the current pricing, install new lines to support the mainstream demand. That's one of the reasons why... We're reasonably optimistic that the market pricing environment is going to stay strong. But what you can do, and our CapEx plan this year, as John described it, we're sprinkling either lithography or inspection tools around our global network. Most of them, admittedly, are in Asia, but not all of them, to try to take advantage of... the installed tool set to just add an incremental bump up where the price of, as I said, is either inspection or lithography given the other tools that are already in place allows the tool to hit our hurdle rate for return on invested capital. This is a dynamic situation. Pricing does not support full lines, but it does support In almost every factory, we have one or two tools to maximize the value of what we already got. So that's what we're doing. I've never seen a year like this. I've never seen a year where there's no high-end tools bought, because there's not going to be. It's really sprinkle the foo-foo dust everywhere you can to maximize sparkle.

All right. So, I mean, in a sense... It sounds like that's kind of good news in the sense that you don't see a big surge of new capacity being added on the mainstream side, which would hurt the dynamics over time. It sounds like it's going to remain in this limited capacity and hopefully good pricing environment for some time to come.

Yeah, and eventually, of course, if price goes up and up and up, which would be a great thing, there'll be a dynamic where new lines make economic sense. And that would be different for, you know, different, how we look at that versus a comparator looks at that, of course, will be similar but not the same. But I think we're still, unless they have a different set of tool suppliers than we do, we're still quite a ways, you know, from that point. But as I said, our mainstream business, you know, year over year, you know, grew, you know, 25%. And we're at a rate that's considerably above that. in the fourth quarter. So there is a lot of growth. And when you listen to companies like Applied, when they tell you that they're now selling more 8-inch capacity in a quarter than they did at the heyday of the 200-millimeter expansion, it's pretty clear that there's a lot of capacity that's going to be installed. And I think this has taken even very seasoned industry executives you know, by surprise. But it's the fact that the economic power of Moore's Law has been derailed. And what was going on for years, what ate out the basic market, as you know, is, hey, that function was consolidated on, you know, a dye that had three others because the silicon was almost free. Not true. It's not true. So where this goes, I think nobody really has a real clear picture of But what is clear, and I was talking to someone this morning, is this segment of our business is going to grow, and it's going to grow materially. And this is great for a mass maker because, as I said earlier, the mass content of ASICs was always by far the best of any product line, the best.

All right. No, that makes a lot of sense. So my second question on the mainstream business is, you know, where are you seeing the particular strength? Is it just broad-based across all categories? Or is it really the rise of some of these new segments like power and EVs that is really driving the growth? Because you talk to equipment guys, they're seeing power EV as the big driver for incremental equipment purchases. And I'm kind of curious what your trends are.

No, those are very strong sectors. you know, for us as well, right? Because as I said in my remarks, it's very clear, you know, where silicon goes, photomass follows. And the other good, great thing about EVs is, boy, the display content in those is something special. Something special. So not only does it help our IC business, which we're talking a lot about, but it's fabulous for our display business, which Had a new record last quarter, and as John Cooley said, we expect another record in Q1. That business is screaming now.

Okay. And maybe the final question then for Chris, what are you seeing on the technology side for flat panel? Is it really the move between mainstream or, I should say, LCD and OLED? Or are you starting to see some creep in of mini micro LED and If so, what is the impact from that on the photomath side?

Yeah, thanks, Tom. So I would say no disruptive change beyond the trends we've highlighted in the past, which is the gradual pivot of capacity from LCD-type displays to AMOLED. There was a bit of a pause on that in the last year or so because a lot of the panel makers wanted to take advantage of higher LCD displays display prices, so there was some capacity put into that. But by our view, it's kind of recovered, and the trend to replace a lot of the capacity or add new capacity for AMOLED now continues, and we think that'll continue unabated for the next three, five years. So those displays are more complicated. There's more lithography and mass content in them, as you know, so that's a positive trend. We also see some additional... more complex technologies going into TVs. QNED is a bunch of acronyms around them. Most of those drive stronger patterning solutions. A lot of them are based on particularly the Korean panel makers' desire to differentiate their products, so they are moving down a technology roadmap on the TV side as well. It's mostly LCD-based for the very large ones, Gen 8 and above. but they're adding functionality that's requiring more lithography as well. We're seeing a lot of the prototype designs for those, and some are actually hitting the market as well. And last, the micro-LED is getting a lot of attention. There's a lot of CES, consumer electronics, show displays with full micro-LED. Of course, this technology is a very interesting one for the display people, but it still seems quite some way... from being used for larger format displays. The mask content in micro LED remains a little bit unclear. One thing that's different about it compared to other displays is it can be, these larger displays can be assembled in kind of modular format. So if you want to make a 100 inch TV, the micro LED approach tends to allow you to do that by assembling sub modules that are smaller. So it might not drive substrate size for photo masks But what it does drive, and we're seeing this now, is the circuitry to drive the micro LEDs, which was kind of promised to be very, very simple and simple Christmas tree lights, if you will. We're seeing already that that promise isn't really accurate, that we're going to need to tune, or the users are going to need to tune current and voltage. The transistors will be more complicated with the compensation circuits. So we do think the micro-LED trend, once it's finally adopted mass production, which is still a ways off for larger displays, will be a positive trend for masks as well. Mini-LED now is used quite widely, as you know. It's taken the LED backlights from dozens to thousands, and that's driven some circuitry enhancements on LCD screens. Most of those are a little bit more lower-end sorts of masks. and patterning solutions. But it's driven some demand as well. So there's definitely a strong technology trajectory for display. And as we see it, most all of them are indicative of more complex lithography and higher value masks.

Hey, so that Chris gave you, Tom, I think a great answer and very comprehensive. I'd like to just chime in on the back of that. You know, if you look at, for example, we've made comments before. If you look at rigid AMOLED, so let's look at it. So a TFT LCD maybe has 68 mass levels. And then if you go to rigid AMOLED, it's 12 or 13. And now the most advanced AMOLED displays has maybe 25 or 26 mass levels. So not only is the specification going up, the mass count is going up, which is great for sort of mass suppliers, right? You know, one particular customer who will go nameless makes big TVs, right? And Chris made comments, I think they were right on the money, right, on the circuit complexity for micro LEDs, not mini, but micro. So large customer, right now, they're assembling, say, a 110-inch TV from, say, 50 PCB boards on the back, and it's Christmas tree-like, like Chris described, but not naming them. They have a specific project underway right now to replace those PCDs with LTPS TFTs. And just as is the case with the most complex AMOLED displays. To build this very complex transistor array, which Chris described accurately, requires 25 mass levels. So if that market happens to go that way, right, that would be great. We would absolutely love that because it would create high specification and high volume. Will it? Right now, that's clearly going to be too expensive, but if it happens, this will be, you know, very, you know, good for, you know, our display business. Yeah. So early on, but as Chris said, it's very clear. If you want the same functionality, the same visual experience out of that large display built with micro LEDs, it's going to be built with mask sets that have complexity that's similar to the most advanced AMOLED, you know, masks that we make. So I hope the market goes that way. It would be great for us.

Great. Well, I appreciate all the detail on that, and thank you all for your time this morning.

Thank you, Tom.

Ladies and gentlemen, there are no further questions at this time. I will now turn the call over to Peter Curlin for closing comments.

Thank you once again for taking time to join us. We appreciate your interest in our company. This is a great time to be associated with Photronics. as we continue to raise the bar on our performance by delivering value to our customers, partnering with them to solve all their photo mass requirements. At the same time, our financial performance is reaching new highs. We believe we're on the right path to create more value for our shareholders. We look forward to updating you as we move forward, and we wish all of you and your families a wonderful holiday season.

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