Photronics, Inc.

Good day and thank you for standing by. Welcome to Photronix second quarter 2023 earnings conference call. At this time, I'll participate on 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 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1-1 again. As a reminder, this conference is being recorded Wednesday, May 24th, 2023. I would now like to turn the conference over to Rochelle Burr, Chief Administrative Officer. Please go ahead.

Thank you, Kevin. Good morning, everyone. Welcome to our review of Botronic's fiscal 2023 second quarter results. Joining me this morning are Frank Lee, our Chief Executive Officer, John Jordan, our Chief Financial Officer, Chris 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 materials. At this time, I will turn the call over to Frank.

Thank you, Richa, 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 photomaster supplier provide us broad exposure to global markets and make us less dependent on any one sector or region. In addition, we have a talent and dedicated global team. Their performance has enabled Fortranus 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 to 55 nanometer range is especially strong. On the other hand, we observed some softness in high end. However, 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 get market share in the next generations of smartphones, tablets, and PCs. 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 strike pricing and tight cost management across the organizations. As a result, we earned $0.65 per share on a GAAP basis and $0.45 per share on a non-GAAP basis after excluding $0.11 per share gained 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 activities often follow different demand cycles than capital equipment or wafer stocks. For example, our customers often release new designs when their demand is soft and utilization is low. And that could be a better time to introduce new products into their operations. The other condition that drives photo mass demand is capacity expansion, either through new fab or new tools in existing fabs. These factors tend to make photo mass demand more sustainable and even counter Since I was named CEO one year ago, I spent a lot of time with our employees across organizations and have enhanced and driven a great team which has the characteristics to win. In addition, we have strategically invested 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 romance. Our differentiated EUV product line continues to expand, achieving a number of important milestones including our first EUVD red mask shipments in Q2. We have a great market position as a lithium photo mask supplier with 11 strategically located manufacturing sites. Based on data recently published by Tech Insights, we shipped approximately 30% of all photo mask units The leading providers of semiconductors and the display panels trust us to supply their photo masks. This confirms our leading position and is an indication of our broad and diverse market exposure. Finally, we have a great balance sheet of farm 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 detail. Photon mask 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.

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 photo masks and 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 and 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. Our winning commercial teams are doing a great job of bringing those orders in, and 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 photo mask 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 white 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 reported in second quarter 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 re-measurement of U.S. dollar-denominated balance sheet items into the local functional currencies of our foreign operations. This compares to the 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 65 cents a share. After eliminating the effects of foreign exchange and the related income tax of minority interest, adjusted EPS was 54 cents for Q2, compared with adjusted EPS of 40 cents last quarter and 38 cents 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 to $234 million. We believe photo mass 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 48 to 54 cents per diluted share. New today, 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.

Thank you. Ladies and gentlemen, if you have a question or a comment at this time, please press star 1-1 on your telephone. If your question has been answered or you wish to remove yourself from the queue, please press star 1-1 again. We'll pause for a moment while we compile our Q&A roster.

Our first question comes from Tom Diffley with DA Davidson. Your line is open.

Hi, good morning. This is Linda on behalf of Tom Gipsley. 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 US. And I think, I believe you mentioned you had 51% shipments into China this quarter. So 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.

Yeah, thanks for that, Linda. Good morning. Richelle Burr, who's our chief administrative officer, will cover that question.

Hey, Richard. Yeah, so with respect to the geopolitical tensions, to date we have not had a material impact in 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, but again, we monitor the controls very carefully. We are working closely with our suppliers. We are 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.

Thanks, Michelle. That's helpful. And then 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? And maybe discuss how this is impacting your pricing dynamics as well as your margin profile. Hi, this is Chris.

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

Correct. Yeah, that's correct. Yeah. So, 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. But 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. But 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. And we're seeing pretty strong R&D cycles and pretty strong product development cycles still. So that hasn't changed. So, 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.

Oh, thank you for the color. And then my last question is on Cut-Ex. Maybe, John, I might have missed it, but what are you thinking in terms of Cut-Ex for this year? And maybe could you give us a split for this year for SPD and IC?

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

Also, some of our tours we call end-of-life. So we are planning to replace certain old tours with more efficient and updated tours. So some capex in IC spending on the end-of-life tour replacement.

Got it. Thank you for your time.

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

FPD is not controlled. So the animal control regulations, yeah, those impact IC, not FPD.

Thank you so much for your time.

Thank you, Linda. Again, ladies and gentlemen, if you have a question or a comment at this time, please press star 11 on your telephone.

Our next question comes from Gus Richard with Northland.

Your line is open.

Yes, thanks for taking my question. Good morning. I appreciate it. Real quick, could you talk a little bit about, you know, expedites? Are you still seeing those in the mature side, or has that activity slowed?

The expedites? Yeah, premiums. The premiums. 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, And in those long-term agreement, the premium charge has been defined and will continue to continue through the period of the agreement. And certain agreement is for two years. Some agreement is for three years. So we will maintain certain premium charge in this year and next year.

Got it. And then in terms of industry-wide capacity, you know, it seems like particularly mature, it remains tight. And 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?

In our industry, we do see some expansion, some new local mart house in China. And these new players, some are in a very early stage, some start to get a customer qualification and enter the market. We believe that the impact will start on the low end of the business and also for these new competitors to achieve certain economic scale, it will take several years. So our business in China, basically we are focused on the higher end of the mainstream So we will have some differentiation with the new competitors. Outside of China, IC photomask capacity expansion actually is not significant. And as we just mentioned, we spent some capacity. Part of those, of course, is for capacity expansion, but some portions of those are end-of-life replacement. And this kind of end-of-life situation happen to every merchant mashup now, only to us. So even with every mashup is doing capex, but some tour will be end-of-life. So overall, the capacity increase here limit.

Got it. Basically, just to summarize, overall, you see the capacity kind of remaining tight and the incremental cap access for replacement of all the tools that are no longer supported. All right. Got it. And then, you know, over the last 40 years, you know, I see photo mask margins rarely have gotten into the 30s, and 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?

I think in the past years, as you mentioned, photo mask is not a big player in the semi-industry. A lot of companies are focusing on wafer strap capacity expansion and pay little attention to photomask supply. So the supply demand, of course, was on the other side more supply than demand. Because most merchant photomars are not making enough money to make an investment. So gradually, the trend has shifted between the supply and demand. Especially in the past two years, a lot of new IC application and create a lot of new wave of expansion. So the combination of supply side of photo masks do not expand on the demand side, a lot of new wave effects and new product demand. So the supply and demand imbalance getting worse. And under such situations, we believe we have some leverage in terms of pricing and also profit margin.

Got it. Got it. And just last one for me. Are you seeing an extension in the mature markets of lead times or have they stabilized at this point? For you guys, your lead times.

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

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

Thank you. Thanks very much.

Again, ladies and gentlemen, if you have a question or a comment at this time, please press star 11 on your telephone. And I'm not showing any further questions at this time. I'd like to turn the call back over to Frank.

We are glad that you have chosen to join us this morning and appreciate your interesting performance. 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 customers and continue to contribute to our achievements. We believe we are on our way to achieving our long-term target and look forward to updating you again on our progress. And have a good day to everyone. Thank you.

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