Photronics, Inc.

Good day and thank you for standing by. Welcome to the Photronics Q2 fiscal year 26 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 11 on your telephone. You will hear an automated message advising that your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Ted Moreau, Vice President of Investor Relations. Please go ahead.

Thank you, Operator. Good morning, everyone. Welcome to our review of Hotronix Fiscal Second Quarter 2026 Financial Results. Joining me this morning are George Makakasis, Chairman and Chief Executive Officer, Eric Rivera, President and Chief Financial Officer, and Frank Lee, Senior Executive for ASIA. The press release issued earlier this morning, along with the presentation materials accompanying our remarks, is available on the investor relations section of our website and on the form 8-K filed with the SEC. This call includes forward-looking statements that involve risks and uncertainties, which could cause Poltronix results to differ materially from management's current expectations. We encourage you to review the forward-looking statements disclosure included in our earnings release and in our most recent SEC filings. In the coming weeks, we will be participating in investor conferences hosted by Bank of America in San Francisco, three-part advisors in New York, DA Davidson in Nashville, and Singular Research in Las Vegas. With that, I will now turn the call over to George.

Thank you, Ted, and good morning, everyone. In Q2, global photomass dynamics reflected a mix of supportive long-term drivers alongside temporary headwinds. Industry demand for leading-edge memory and logic chips for AI applications remains exceptionally strong. Manufacturing these chips requires a significant number of high-end photo masks, which creates a compelling multi-year growth opportunity for Photonics. We are taking several strategic actions to strengthen our position in this growing market, which I will discuss later in more detail. Importantly, as a reminder, photo mask demand is more closely aligned with semiconductor design releases than to wafer starts. In the near term, several factors have delayed design releases, including elevated fab utilization rates, memory supply constraints, and geopolitical uncertainty. Eric will further elaborate on these factors. Given these unexpected near-term headwinds for certain ship design releases, the seasonal recovery following Chinese New Year has not occurred to the extent anticipated. As a result, our IC business decreased 5% year-over-year to 148 million, resulting in total fiscal Q2 revenue of $210 million, which was essentially flat year over year. Despite the near-term industry headwinds, we continue to execute against our investment priorities and strengthen our position in the robust high-end market segment. Our ongoing investments in our U.S. and Korea operations are designed to strengthen Photonics' long-term competitive position as we expand site capabilities into more advanced technology nodes. Both expansion projects remain on track, and over the next several years, we expect these investments to help us capture photo mass demand and support a more geographically diverse revenue base. Strategically, these investments align us with the industry's ongoing manufacturing regionalization trends. They also position us to benefit from increased outsourcing opportunities from captive photomask producers, which will further shift our product mix towards more advanced geometries that carry higher ASPs. At our Courier facility, we are preparing our cleanroom for the arrival of key equipment to extend our capabilities down to 8 nanometer and below, and we expect installations to begin later in the fiscal year. At our Allen facility, we are beginning production of qualification masks and continue to target initial revenue late in the fiscal year with a more meaningful contribution to revenue growth in 2027 and beyond. Over time, we expect the site will become an important mask supplier for U.S. onshore mainstream semiconductor manufacturing. For leading edge AI chips, our high-end U.S. facility in Boise is qualified to produce masks at the 7 nanometer node, and our teams are working closely with customers on even more advanced nodes. Otronic's facility in Taiwan and the U.S. are also well positioned to capture the increasing opportunities in advanced chip packaging applications. Turning to FPD, revenue of $62 million increased 13% year over year, reflecting our capability to produce more complex, larger mask sizes and our strong differentiation in AMOLED. Our market-leading high-end capabilities in the dynamic China market remain strong and should support display revenue growth in the coming years. In Korea, where we maintain strong market share, positive seasonality returned during fiscal Q2 after a slower start to the calendar year. The launch schedules of high-end consumer electronics, particularly in smartphones and smartwatches for Western markets, remain on track. Encouragingly, These high-end consumer electronics have not been impacted by tight memory conditions. Our recently installed FPD mask layer is entering production. This tool is expected to maximize our opportunity in G8.6 AMOLED, which carries higher ASP mask layers and is anticipated to be more widely adopted later in the calendar year. We expect continued strength in the Korea FPD market ahead of this higher resolution upgrade cycle. Returning to IC, while we are observing some signs of order recovery, near-term visibility regarding the timing of certain design releases remains limited. For the medium and long-term, secular demand trends remain positive, as highlighted at the beginning of my prepared remarks. We are excited about the benefits our expansion projects are expected to provide, with initial U.S. revenue anticipated late in fiscal 2026 and initial revenue from our Korea expansion by the end of fiscal 2027. Both expansion projects are expected to open additional leading edge opportunities. I will now turn the call over to Eric to review our second quarter results and provide third quarter guidance.

Thank you, George. Good morning, everyone. Second quarter revenue came in at 210 million roughly flat year over year and down sequentially following the strong performance in fiscal Q1 leading up to the Chinese New Year holiday. IC revenue of 148 million represented 70% of total revenue. High-end represented 38% of IC, while mainstream IC revenue was 91 million. Design releases and associated revenue, particularly from our foundry customers, were shaped by several factors during the period. First, the semiconductor industry is currently experiencing higher than normal fab utilization rates. As a result, FABs have been unable to accommodate additional design releases from some of their customers because of this limited capacity. Additionally, many chip OEMs have prioritized revenue and profitability from existing products, which has led them to continue wafer production on current designs while delaying new releases. Second, the recent surge in memory prices and related supply constraints have contributed to delays in the launch of several new consumer electronic products as OEMs have worked to secure memory supply and manage rising product costs. The final factor contributing to delays for design releases is geopolitical developments, including the US-Iran conflict, which has increased microeconomic uncertainty. Looking ahead, we expect our capital investments in the US and Korea to begin generating revenue at the end of 2026 and 2027, respectively. As the new capacity goes into full production, we expect our revenue mix in fiscal 2027 and 2028 to shift in two ways, by node towards high NIC and geographically towards the U.S. and Korea. These investments are consistent with our long-term strategy to further diversify our revenue mix by geography and technology node. Turning to FPD, fiscal Q2 revenue of $62 million increased 13% year-over-year and represented one of the strongest quarters in the history of our display business. Demand remained strong in the China market as activity shifted towards the high-end category. In Korea, we saw a reacceleration of business activity as customers prepare for regularly scheduled consumer electronic launches this fall. We foresee accelerated display market growth over the next several years following the increasing trend of GA.6 AMOLED applications. Display market growth is concentrated in China and Korea, which are competitive strongholds for Fortronics. Gross margin of 31% reflects the combination of operational leverage inherent in our financial model, driven by our significant FISC cost infrastructure, as well as product mix. Operating margin was 20%. Diluted gap EPS attributable to Fortronic shareholders was 54 cents per share. Excluding foreign exchange impacts, non-gap diluted EPS was 42 cents per share. The strong performance of our display operations contributed to our earnings during the quarter. Operating cash flow of 47 million equates to a healthy 22% of revenue. Cap backs was 46 million reflecting investments in Korean expansions to support 8nm production, the installation of new equipment in Allen, Texas, end-of-life tool upgrades, and facility optimization initiatives. As we have previously discussed, we have entered a period of elevated capital investments to drive future organic growth. Our initiatives in the U.S. and Korea, as endorsed by our customers, will further strengthen our ability to capitalize on growth trends including surging AI applications, increased captive outsourcing, high-end node migrations, geographic diversification, and regionalizations. We maintain our fiscal 2026 CapEx guidance of $330 million with elevated CapEx focused on strategic investments in the U.S. and Korea along with peak end-of-life tool upgrades. Given the favorable long-term secular growth outlook of the photo mass market, we continue to evaluate additional investment opportunities to further support our strategic priorities and long-term growth objectives. We will provide additional details as appropriate if and when we decide to move forward with these potential projects. Total cash and short-term investments remain flat at $638 million, including $477 million held within our joint ventures in which we hold a 50.01% ownership interest. Our capital allocation strategy remains focused on three priorities, reinvestment in the business to support organic growth, pursuing strategic opportunities, and returning capital to shareholders. We will continue to evaluate the most effective use of our cash and remain disciplined and opportunistic in our capital allocation decisions, prioritizing investments that offer the highest expected returns. With respect to internal reinvestment, we will continue to emphasize projects that support future revenue growth and enhance long-term shareholder value. Before providing guidance, I'd like to remind you that demand for our product is inherently variable. Visibility remains limited with a typical backlog of only one to three weeks. Additionally, high-end mass sets carry significantly higher ASPs, meaning even a small number of orders can materially impact revenue and earnings. Demand is also influenced by IC and display design activity and to a lesser extent by wafer and panel capacity dynamics. Given current market conditions and the influence of elevated AI demand on FAB utilization and therefore design starts, we expect fiscal Q3 revenue to be in the range of 207 to 215 million. Based on those revenue expectations in our operating model, We estimate fiscal Q3 operating margin between 18 and 20% and non-GAAP-diluted EPS between 39 and 45 cents per share. I will now turn the call over to the operator for your questions.

Certainly. As a reminder, to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. Please stand by while we compile our Q&A roster. And our first question will come from the line of Maxwell Michaelis of Lake Street Capital Markets. Your line is open, Maxwell.

Hey, guys. Thanks for taking my questions. First one from me. In terms of visibility, when did things really start to get cloudy in the quarter? Just given the guidance for Q2, came in a little bit below that. So really, when did visibility become cloudy in the quarter?

Hello, Max. This is Eric. Thanks for the question. So it really started becoming cloudy when the conflict in, you know, with Iran and the U.S. started during the quarter. Then after that, we started seeing fab utilization was also affecting us.

Go ahead, Frank. Please.

Meg, I'd like to comment more on this. Typically, we have a very strong booking before Chinese New Year, and after Chinese New Year, there will be a temporary slowdown. But this year, the slowdown after Chinese is much longer than we anticipate. Of course, The headwinds, as George and Eric highlight, may be the factors causing this longer slowdown in the tap out after Chinese New Year. So we do see the slowdown right after Chinese New Year, which is in the end of February. end of February okay and then I guess my second question and follow up to that would be when you're talking to your customers I mean have they given you any sort of rough timeline of when they expect to bring in these new designs or they still have no idea either our customers actually are still optimistic about a mid-term outlook however in the near terms the visibility is remain kind of limit. So we see a lot of delay in the tap out in Q2. However, at the beginning of Q3, we did see some recovery of those delay. A lot of tap outs have happened since the beginning of May. However, going forward, we remain very cautious. But at this moment, customers are still optimistic about the midterm outlook.

Okay. I'll take your question offline. Thank you.

And our next question will be coming from the line of Ghoshy Sri of Singular Research. Your line is open, Ghoshy.

Good morning, gentlemen. Can you guys hear me?

Yes, we can.

Okay, thank you. I just wanted to get these customers that are deferring designs. Are they, were they already in the pipeline or is this more about new designs that are starting to slow down and do those recovery times differ?

Yes, actually they are Whenever customer make a new design, they type out the data to the Foundry FAB, then the Foundry FAB give the order to the mass house they select. This time, the new design slowdown actually happened at the end of the Foundry customer, namely the design house. actually has a slower new design release. So it's not in the pipeline. It's at the very beginning of the new design release.

Eric, on the margin compression side, Are there any specific levers you guys can pull if the demand kind of stays soft for another couple of quarters? Are there any variable cost reductions available, or is it fundamentally a cost business that needs utilization to recover?

Yeah, very little. Very little levers we can pull. I mean, it's really the product mix that will be available that the market gives us is what we'll have. Most of our cost is fixed, or a big portion of it anyway is.

is very fixed so we don't have uh much leverage to pull there gotcha and and on the allen side um so if we if we if the island qualifies uh so if allen begins delivering qualifications masks and q3 uh as planned and i the demands kind of stays up till early 2027 Does bringing the new Allen capacity online to a weak demand environment kind of add depreciation costs, making margins even more compressed? Or is the Allen cost structure kind of light enough at the qualification stage that it doesn't meaningfully impact P&L until commercial production begins?

Yeah, so the Allen expansion already started. We started qualifications already in Q3. So everything is moving, you know, according to our timeline. We expect revenue generation to occur later in the year, and we do not expect that the current economic environment will depress the returns that we're expecting on our island expansion in the current year or in the next at the moment. Okay.

Sorry, I'd like to add some comments to your question. Our airline expansion is not only capacity expansion. We are upgrading our technology. So the qualification basically is for the technology which airline cannot do at this moment. Once we qualify the customer, I think we will increase our market share in the technology node, which Allen cannot produce right now. Also, another purpose of Allen expansion is we are planning to transfer some lower end of the high end order. sorry, the high end of the mainstream from our Boise side to Allen. So we can spare more capacity in our Boise side to take higher ASP orders. So this is a win for Boise side and also a win for the Allen side.

And in terms of the memory supply constraints and OEM cost pressure headwinds, I'm curious as to see whether you're seeing this evenly across your geography. For example, are your U.S. customers, Korean customers, behaving differently to your Chinese and Taiwan-founded customers in terms of deferring designs, or is the cost kind of fairly based across all regions?

Yes, the memory shortage and especially also the price surging has huge negative impact on the consumer product, especially the low-end consumer product. So those are mainly in Asia. So I think this impact happened in Taiwan and also in China.

Got you. Thank you for the call. I'll jump back in the queue. Thank you.

And our next question will come from the line of Christian Schwab of Craig Halem. Your line is open, Christian.

Yeah, great. Thanks. I understand the delays that you're seeing as design starts, and thanks for all that clarity. But as we increase our capacity capabilities on lower geometry nodes, chips on a medium-term basis. Can you give us an idea of either a yearly revenue target or a market share goal? And then my second question along those lines is, on the advanced node side, is seven or eight nanometers

the best that we're going to be able to make or do we have aspirations to to get down below that thanks Christian this is Eric here so starting with your last question first in terms of our aspirations to go eight nanometers seven nanometer you know or you know we're going to continue going down note I mean if we have to do that because that's the that's our industry we have to we have to continue investing and we see a lot of opportunity there. So definitely we plan to go below those ranges. Now with respect to the revenue that we expect to get out of our island facility with our recent investments, I'm not going to get into detail of revenue by site from that perspective, but that should give us an opportunity to expand our market share. in the U.S., and we expect the U.S. to be, at least in 27, to be heading us from a revenue expansion perspective. Our percentage of increase should be larger in the U.S. than anywhere else.

We're working with customers to that end. Frank, maybe you'd like to elaborate.

Yes, George, yes. I think our investments not necessary for the capacity only, because we are seeing a lot of ongoing unsure semiconductor manufacturing in the States. And for Trowness, We have a very unique strong position in the country because we have the Boise side where we have the very advanced photo mask technology. And also we have where we can make mainstream photo masks. So the capacity expansion and the technology upgrade by our CAPEX is to serve our company's goal. We like to be the main photo mask supplier in the United States.

Great. Thank you for that clarity. No other questions. Thank you. Thank you, Christian.

And I would now like to turn the conference back to Ted for closing remarks.

Thank you, Tanya, and thanks, everyone, for joining us on the call today. We really appreciate your interest in Fortronics. Look forward to connecting with everybody throughout the quarter. Have a great day.

And this concludes today's program. Thank you for participating. You may now disconnect.

Thank you.