Photronics, Inc.

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Good day and thank you for standing by. Welcome to the Photronics fourth quarter and full year 2022 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 this session, you will need to press star 1-1 on your telephone. Please be advised that today's conference is being recorded Tuesday, December 13, 2022. I would now like to hand the conference over to your host, Rochelle Burr. Executive Vice President, Chief Administrative Officer, and General Counsel. Please go ahead. Thank you, Michelle. Good morning, everyone.

Welcome to our review of Photonics' fiscal 2022 full year and fourth quarter results. Joining me today is our chief financial officer.

He does financial, financial, financial, financial, financial, financial, financial, Thank you. I'm going to perform.

And reconciliation of these metrics to gap financial results is provided in our presentation material. At this time, I will turn the call over to Frank.

Thank you, Michelle, and good morning, everyone. Q4 was sort of finished to a great year. Remedy grew 24% in 2022 as we achieved our fifth consecutive year of record revenue. Both ICM and FED generate strong growth as design activity remains robust. We saw annual growth across nearly all products. It remains clear that our broad technology, portfolio, operation excellence, and the close customer relationship have made us the market leader. Q4 revenue was less than third quarter revenue. with demand slowing in high-end logic IC. But this trend will be indicated by current semiconductor industry downturn as design activity remains relatively strong. There was also some negative impact from depreciation of Asian currencies on FDD business. However, We believe that fractures cause the solvent demand to be transient, and we maintain our positive view on the long-term demand trend. Growth margin and operation margin was essentially flat compared with the third quarter, as we mitigate the impact on lower borrowing by closely managing our costs while continuing to benefit from strong pricing. We also realized a foreign exchange gain that John will discuss in more details later. The end result is we deliver EPS of $0.60 for fourth quarter. Looking now to industry outlook, while we believe the design trends in addition to customer capacity extensions are intact in the long term, The next picture is Claudia due to current market uncertainty. Factors such as high interest rates, rising inflation, and slowing GDP are already having a negative impact on some sectors of the electronic product supply chain and could potentially impact photo mass demand. Adding to the uncertainty is the U.S. government's new export restriction imposed on China on certain semiconductor technologies that may further impact the Chinese IC industry. So far, these actions have had minimal impact on Fortran's business or operations. However, the situation is dynamic and fluid. which we continue monitoring. At the same time, we will ensure our compliance with all regulations while taking necessary actions to mitigate the impact on our supply chain and business. Although the near-term view is uncertain, we are confident that as IC design and manufacturing continue to play a central and expanding role in the global economy. Photomass is a key element within the ecosystem will continue to thrive over the long term. Currently, IC manufacturing regionalization is spurring investment across the world. This new capacity will generate additional photomass demand. will capitalize on these opportunities from a position of leadership and strength. Our deep customer relationships are beyond trust, supported by our technology, service, quality, and global production capacity. These customer relationships, coupled with many long-term purchase agreements, have continued to support our competitive advantage in the business. I would like to thank the entire Patronage team for excellent performance in the fourth quarter and throughout the whole year. We navigate challenges and change and embrace opportunities as we deliver another record year. Our long-term strategy is intact. and I'm trying to achieve our financial targets. I'm proud of what we have accomplished together and believe we can do even better in the future. At this time, I will turn the call to John.

Thank you, Frank, and good morning, everyone. Revenue in the fourth quarter was lower sequentially as some of the softer demand trends were experienced in both IC and FPD, primarily for high-end products. Our product diversity and global customer base helped mitigate high-end softness with mainstream revenue higher for both IC and FPD. We have invested in tool sets for a broad array of technologies and nodes, enabling us to support our customers' technology roadmaps across both high-end and mainstream. As a result, fourth quarter revenue of $210 million was down only 4% sequentially despite the declines in high-end product revenue. Our commercial teams have done a great job of working with customers to identify opportunities, and our operations teams were effective in supporting this demand with on-time executions. delivering the highest quality products that enable our customers' success. IC revenue of $156 million in the fourth quarter was up 25% year-over-year and down 3% sequentially. Although high-end revenue was lower quarter-over-quarter due to some reduction in agent foundry logic demand, that business has been significantly better than last year due to some increases in capacity through the year. Mainstream revenue improved on continued strong demand, especially in Asia. MPD revenue of $54 million was down 8% year-over-quarter and 3% year-over-year. Demand for mobile display masks was lower, as panel makers focused on producing current products for new premium smartphones and not releasing new designs. G10.5 plus demand was also lowered during the fourth quarter. We were successful in picking up mainstream to maintain higher capacity utilization. Gross and operating margins were essentially flat in the third quarter as improved pricing and continued cost discipline offset the negative impact of lower volumes on operating leverage. Gross margin of 38.2% and operating margin of 28.8% are already within our target model range. Based on our outlook and the continued focus on cost reductions, we expect to continue to deliver margin improvement as our revenue moves into the targeted zones, with price increases holding stable in 2023, while the outlook for continuation of premiums may be less certain. Operating expenses decreased compared with the third quarter as we balanced the need to maintain margins while also investing in people and resources to support revenue growth, positioning us to continue to grow both revenue and profit. Non-operating income of $11 million was primarily due to FX gains, primarily resulting from remeasurement of U.S. dollar-denominated balances in foreign locations into the local functional currencies. Income tax provision of $16 million resulted in an effective tax rate of 22.5% for the fourth quarter and 25% for the full year. Saluted EPS for Q4 was $0.60, an 18% increase over Q3, and an 82% increase over the $0.33 of last year's fourth quarter. Saluted EPS for the whole year of 2022 was $1.94, an increase of 118% over 2021, demonstrating the achievement of the entire Fortronics team during a challenging and changing year. Cash flow generated from operating activities was $79 million in the fourth quarter, bringing the 2022 total operating cash flow to $275 million. We used this cash to invest in growth by funding capital expenditures of $66 million in the quarter. Full-year CapEx was $109 million, net of nearly $4 million in government subsidies. For 2023, we achieved CapEx to be approximately $130 million as we continued to invest in growth, primarily for high-end and mainstream IC capacities. We also continued to reduce debt during the quarter, bringing total year-end total long-term debt to $42 million, a reduction of $69 million since last year end. Cash balance at the end of the quarter was $320 million. If we include short-term investments of $39 million, net cash and short-term investments at the end of the quarter was $316 million. Our balance sheet is strong and flexible, and we're able to pursue both investments, both organic and inorganic, while also being prepared to weather potential future economic challenges and uncertainty. Before I provide guidance, I'll remind you that our visibility is always limited, as our backlog is typically only once every week. And demand for some of our products is inherently uneven and difficult to predict. Additionally, the ASPs for high-end masks 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 $203 to $213 million, as we expect positive demand trends with less than typical seasonality. Based on those revenue expectations and our current operating model, we estimate earnings per share for the first quarter to be in the range of 40 cents to 48 cents per diluted share. 2022 was a great year. We grew revenues 24%, posted our fifth consecutive year of record revenue, expanded margins, which places us into the bottom end of the range in our target model, and strengthened our balance sheet, generating cash, reducing debt, and investing in growth. Looking forward, we believe positive long-term market trends and our leadership position, together with financial flexibility, positions us to continue our profitable growth and achieve even greater success for our customers, our employees, and our shareholders. I will now turn it over to the operator.

Thank you. And again, if you have a question at this time, please press star 11 on your touch tone telephone. One moment while we compile our Q&A roster.

And our first question comes from the line of Hans Chung with DA Davidson.

Your line is open. Please go ahead.

Hi. Thank you for taking my question. First, so it seems that you have the pretty good gross margin for quarter and then just want to kind of deep dive back what's the driving factors that I know you mentioned the some cost management and then the pricing still variable. So just any detail on that and then how should we think about the gross margin into the 23?

Hello?

Hans, I think they're having technical issues. Just a moment, sir.

Okay.

Michelle? Hello? Can you hear me?

I can hear you now, sir. Go ahead.

Okay. Yeah.

So first, yeah. I'm not sure. Where did we leave off?

Yeah.

So the pricing environment has been very good. So our pricing is stronger than it has been historically. And we expect that pricing to maintain. We've seen even as demand is still strong but not quite what it has been, The pricing holds up. We have pricing agreements across the board. And in Asia, they've held, as I mentioned, as demand is not quite as strong. We have had premiums as people pay to, quote, queue hop to move up in the queue because the queue for mainstream deliveries has been much more extended than it had been historically before. Those premiums are less predictable, but through the fourth quarter, both pricing and premiums have held up. So the combination of change and mix with some of our operations picking up business and improving their margins and with sustained pricing strength, we think we will stay within the margin ranges that we've been experiencing.

And then next question, just I know you mentioned that the China recent impact on China, the research in that that's that's minima to our business. So but you also mentioned there is still some uncertainty. So just want to kind of get more understanding that what's the potential risk from from the new China Expo control? or is any indirect impact from that?

So, so far, Hans, we've been, there are a couple of factors. One is that our business in China is primarily mainstream. So, and most of the restrictions that are issued are to prevent, you know, the leading edge technology from leaking into Chinese military primarily. So those restrictions to some extent have affected us, but we've been able to essentially figure them out, understand them, and work with them. So the restrictions have affected us very little over the past few years since they started imposing them. I think if they stay in the leading-edge technologies, we're going to remain unaffected. But we spend a lot of effort to understand the restrictions as they're imposed and to make sure that we stay within the law. So, so far, not much effect. There has been some, but very minimum. And we expect that to continue. And as restrictions continue to get issued, we'll continue to assess how they affect our business, and work within the restrictions. Hopefully, we'll continue to experience the same minimum effect that we've had because they're directed primarily at leading-edge technologies where we're not engaged.

Chris, I might add one thing to that. There is a positive side to this. Since the leading edge has become kind of restricted in China, a lot of that capacity is and deployed to mid-range and mainstream. So that's creating a fairly healthy design pipeline at mid-range and mainstream nodes in China, and Russia's seeing that in the local facilities. And those are sweet spot nodes for us, particularly how we're tooled up there. So that kind of situation is unfortunate, but that's kind of a positive knockout effect for our local business.

Thank you. I'll jump to Q. Thank you.

And one moment for our next question. And our next question comes from the line of Gus Richard with Northland Capital Markets. Your line is open. Please go ahead.

Yes. Thanks for taking the question. About six months ago, Topan, POTOMAS was spun out and sold to private equity. And I'm just wondering, you know, given that transaction has been a little bit of time, you know, how has that affected the market or hasn't it?

Michelle, are we still – has that technical difficulty cleared up?

Yes, you're loud and clear, sir.

Do we have other questions?

Did you not hear Hans' question?

It is not.

Hans, could you repeat your question, sir?

Yes, can you hear me? Yes, thank you, Hans. This is Gus. Real quick, Topan's photo mask got spun out about six months ago. It's been in that state for a while now, and I'm just wondering, How is that impacting the photo mask market? You know, or is it, or things remain the same?

Thank you. Basically, we don't see major change in the business model. Since the spin-off, they haven't made major capital investments. even announced some projects in Texas, but nothing materialized. So at this moment, from customer side, from our side, we haven't seen a real difference.

Got it. Thanks for that. And then in terms of the $130 million in CapEx, can you provide a little bit of color? Is that for you know, de-bottlenecking? Are you going to get some, you know, high-throughput tools for, you know, mainstream? Is it going to be for high-end? What, you know, can you give a little color on where you're investing? Sure.

Actually, in the past 16 months, the equipment this time in 4.5 months is that also very long, same as in semiconductor business. So some tour we actually order one year and a half ago. So the tour will come in 2023. The main purpose of this tour is to serve the mainstream business expansion. And also we do have some tour which are going to be end of life. So we are doing certain tour replacement in addition to mainstream business expansion. However, the tour to be replaced are old tour. So the new tour has a better performance, higher throughput. So we expect not only just a replacement, we will see some new capacity added to our overall production capacity.

Got it. And then the last one for me, you talked a little bit about demand softening a bit. Can you put that in context of lead times? Lead times have stretched quite a bit from days to, I think, weeks or months. you know, how has lead time changed over the, you know, the course of the quarter?

The solvent demand actually started about two, three months ago, particularly in the high-end side. But it doesn't really impact our fail utilization. we still have enough work. But of course, the demand to customer has been reduced because the width level is lower. However, there are certain signs that the demand for the high-end is coming back. At this moment, It's a little bit too early to be very precise in terms of the degree of recovery, but from our input from sales and customers, we do see the high-end tech startups will come back.

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

Thank you, and I'm showing no further questions at this time, and I'd like to hand the conference back over to Frank Lee for any further remarks.

Thank you, Michelle. Thank you for joining the meeting. I'm very pleased with our performance in 2022 and proud of the way our team has responded to the challenging and changing environment. We are well positioned to continue our success in the future, And I'm looking forward to updating you as we continue to make progress. Thank you for your interest and have a good day. Thank you, everybody. Thank you.

This concludes today's conference. Thank you for participating. You may now disconnect. Everyone, have a great day.

Thank you. Thank you, Michelle.

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