Photronics Inc (PLAB) 2019 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Photronics Fourth Quarter Fiscal Year '19 Earnings Conference Call. (Operators Instructions) As a reminder, this conference is being recorded Wednesday, December 11, 2019.

I would now like to turn the conference over to Troy Dewar, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Joel. Good morning, everyone. Welcome to our review of Photronics 2019 fourth quarter financial results. Joining me this morning are Dr. Peter Kirlin, Chief Executive Officer; John Jordan, Senior Vice President, Chief Financial Officer; and Dr. Christopher Progler, Vice President, Chief Technology Officer and Strategic Planning.

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 web page.

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, Troy, and good morning, everyone. We ended 2019 with momentum, achieving record quarterly and annual revenue due to strong design activity across the majority of our customer base, increased capacity as we ramp production in 2 new manufacturing facilities and outstanding work by our entire organization to win new business and expand share.

In addition to record total revenue, we raised the bar with record quarterly revenue for IC and FPD photomasks, while annual FPD revenues also reached a new high. It was a superb quarter, capping off a great year, and I'm very pleased with our performance.

With growing revenue and high operating leverage, profit margins expanded. Combined with consistent efforts to control cost, we delivered 13.7% operating margins, better than last quarter and last year, despite a larger operating footprint and growing headcount. For the year, operating margins were 9.5%, a remarkable achievement given the challenges we faced, including headwinds from start-up expenses, the semiconductor and LCD industry downturn and growing geopolitical uncertainty. These outstanding operating results generated an EPS of $0.15 per share for the quarter, which is in line with our expectations and included significant foreign exchange loss below the operating line.

In addition to record revenue and solid earnings, we maintained a strong cash balance, ending the quarter with $154 million in net cash. Cash generated from operations more than offset our strategic uses of cash during the quarter, including share repurchases. With the bulk of our China investments now behind us and growing confidence in our long-term ability to generate cash, we have restarted our share repurchase activity. We see this as an effective use of cash to invest in what we believe to be an undervalued asset, while also reducing number of shares outstanding. We spent approximately $11 million for shares in the last 2 months of the fourth quarter since announcing our new $100 million share repurchase program at the end of August. We anticipate our purchases will continue for the foreseeable future, given the value we see in this activity.

The fourth quarter was a great end to a superb year. For the ninth consecutive quarter, we achieved year-over-year revenue growth. And for the second successive year, we attained record revenue. Our balance sheet remains strong following 2 years of major investment, and we are well on the way to meet the financial targets we established nearly 2 years ago. I am very proud of what we've been able to accomplish and remain confident in our long-term strategy.

As I meet with investors, the top 2 questions I receive relate to China. These come in 1 of 2 forms. The current outlook for our business in China, and how the U.S.-China trade discussions are impacting our business. I would like to address each of these, starting with the latter.

A trusted philosophy of management is to focus on things you can control. When it comes to the current geopolitical environment, there is much that we cannot control that could easily become a distraction. As we see it, our challenge is to focus on our customers, while effectively managing our operations in a dynamic, uncertain environment.

During our third quarter conference call, we stated an uncertainty created by actions taken by the U.S. administration had begun to have a negative impact on some of our Chinese customers' demand. However, the impact was concentrated and relatively small. In the fourth quarter, the impact flipped and become positive and more pervasive. As trade discussions have gone unresolved and certain high profile companies in China have been placed on restricted trade list, the resulting uncertainty has motivated Chinese companies to seek local solutions for their semiconductor needs as they try to become more independent and self-sufficient. Net-net, in our view, the Made in China 2025 initiative has been irreversibly accelerated. One outcome of this is a growing need for photomasks. With a manufacturing facility in China supported by our global manufacturing footprint, we were able to quickly respond to these needs to enable our Chinese customers' success. In fact, our IC capacity in Taiwan and Korea was sold out in Q4 as a result of satisfying a sudden uptick in China demand and PDMC set a new record -- new revenue record in Q4. We are now exactly where we want to be, ramping the Xiamen factory into an oversold Asia IC manufacturing network.

Looking forward, even if a trade deal is finalized, we believe this trend will continue as many Chinese technology companies are concerned about future restrictions and want to avoid any potential impact from trade wars.

Turning to the outlook for our business. It's very clear that China has become a material region for us. Just over 3 years ago, we announced the first of 2 greenfield investments to build state-of-the-art manufacturing sites. Today, both of these facilities are complete, and we are in the process of ramping into full production. The FPD facility at Hefei began production at the end of the second quarter and has ramped quickly due to strong end market demand and relatively short qualification times. The IC facility in Xiamen, which is part of the JV with DNP, began qualifications in the third quarter. As a result of 9- to 12-month qualification time, it's trailing the FPD ramp by approximately 4 quarters. During the fourth quarter, we generated $11 million in revenue from masks produced in China, nearly all FPD.

In parallel with expanding our manufacturing operations into China, we have also intensely focused on building a strong book of business there. Revenues to China were a record in the fourth quarter and represented 33% of our total revenue. Not only did we set a new record in the quarter, but our total was an outstanding 49% better than the previous high watermark that was established just 1 quarter ago. For the year, revenue of products shipped to China was 27% of our total revenue. To put that in perspective, when we announced our Xiamen investment in 2016, China represented about 5% of our total revenue. In just 3 years, we have increased our China revenue 5-fold. Over that time, we have entered into long-term purchase agreements with 4 customers in China, 2 IC and 2 FPD. As you would expect, they are well represented in our China revenue corresponding to just under 60% of the total. However, we also have numerous other customers that make up the other 40%. This means our business is diverse and not overly reliant on any 1 customer or product, which makes our revenue stream healthier and more sustainable. Even now, we are engaged with other customers on discussions for long-term agreements, which will further enhance the quality of our China business.

As has been the case for most of last year, FPD demand was very strong for us in all regions, particularly China. FPD revenue this quarter was $43.7 million, which corresponds to an annual run rate of $175 million. 61% of this was for customers in China. When we presented our long-term outlook in early 2018, we indicated our FPD revenues would double to about $200 million annually, which included Hefei production, plus growth in other facilities. Since then, capacity additions in the LCD market have outpaced growth in demand, resulting in a market downturn. As a result, the near-term outlook for G10.5+ production has softened, as has the associated photomask demand.

Conversely, AMOLED demand has strengthened more rapidly than we expected 2 years ago. In addition to a vibrant Korean business, we are now shipping to more than half a dozen Chinese AMOLED display manufacturers, whose customers are focused on penetrating the global market for premium smartphones, the most advanced of which incorporate foldable displays. Recently, BOE announced a significant increase in plans for production of flexible AMOLED panels in 2020. Dynamic markets create opportunities. And our AMOLED outlook is now much stronger than we projected in 2018. With the balance of these puts and takes, we see China being a very attractive region for FPD investment well into the future.

Earlier this year, we ordered 2 precision light 8 mask writers from Mycronic. These will be important assets as we optimize our existing operations, allowing us to expand capacity for mainstream masks, which are used for certain layers of mask set for high-end applications such as AMOLED and large screen OLED TVs that are manufactured on G8 or smaller panels.

Samsung, our largest FPD customer, recently reported plans to expand their QD-OLED capacity. These new tools, by optimizing the balance of throughput and resolution, effectively map our global factory into the sweet spot of this expanded range of applications.

With the excess of our business in China, we expect to operate Hefei at full capacity for the remainder of the quarter. When we designed our Hefei cleanroom, we include the option for future expansion within the building's footprint to allow us to grow without the need to add bricks and mortar. Display market in China is very strong and we have established ourselves as the domestic end market and technology leader. We are, therefore, considering accelerating our Phase II investment to extend this leadership position and realize additional financial benefits more quickly, enhancing our return on investment.

2019 was a great year for Photronics. We made significant strides towards meeting our long-term target. Revenue is running at record levels across the organization. Production is ramping at 2 new manufacturing facilities. As utilization levels rise, we anticipate growing earnings more quickly than revenue. We have a clear line of sight to additional organic growth. Our balance sheet is strong and can support investments for profitable growth. We are very optimistic.

At this time, I will turn the call over to John to provide commentary on our performance and outlook.

1

Thank you, Peter. Good morning, everyone. We saw strength across nearly all of our end markets in the fourth quarter, resulting in record quarterly revenue of $156.3 million, 13% better than the previous quarter and 8% better than the fourth quarter of last year.

Sectors that have been strong, remained strong and other sectors strengthened during the quarter. Our new manufacturing facilities in China contributed $11.2 million in revenue, further fueling growth. It was a great quarter and demonstrates the benefit of our broad and deep product lineup and global footprint.

IC revenue was a record in the fourth quarter, up 12% sequentially and 1% year-over-year. Demand growth was broad-based with increases in logic and memory and across technology nodes encompassing high-end and mainstream.

From a regional standpoint, China and Taiwan were notable areas of strength. While revenue of IC products shipped into China grew significantly, up 72% from the previous quarter, the predominance of these masks were produced outside of China. As we've reported previously, qualification for IC products takes 9 to 12 months, so production from our new Xiamen facility will be increasing over the next few quarters, providing another leg of growth as those qualifications are completed. Underlying IC market demand is expected to be stable to improving, influenced somewhat by normal seasonality.

FPD revenue was also a record, 15% higher than the previous record established last quarter. The drivers remained the same. Strong demand for mobile displays and increased production from our Hefei facility. We do not anticipate any weakening of these trends. So we expect the growth at Hefei to continue as production ramps.

Gross margin improved sequentially. The impact from operating leverage expanded margins to 24.4%. Operating margin also improved to 13.7%, the effect of increased revenue and lower operating expenses. The headwind from China operations was $4.1 million and our Hefei operation was close to breakeven in Q4.

Total year operating expense margin, excluding China expenses, was essentially flat year-on-year. Other expense was $6.1 million, almost entirely due to unrealized foreign exchange loss, primarily in China and Korea. Minority interest was essentially flat compared with the third quarter. Earnings from our Taiwan JV were partially offset by losses from the China JV. This resulted in net income attributable to Photronics Inc. shareholders of $9.7 million or $0.15 per diluted share.

Cash generated by operations was quite strong at $48 million for the quarter. We also received $5 million in government incentives from China. We spent $17 million for CapEx in the quarter and paid $19 million in dividends to our Taiwan JV partner. We also repurchased nearly 1 million shares of our common stock in the quarter for $11 million. For the fiscal year 2019, we repurchased 2.1 million shares for a total of $22 million. Since inception of our share repurchase program in July 2018, we have spent $45 million to repurchase 4.7 million shares. The share repurchases, combined with the redemption of our convertible debt over the last few years, have reduced our reported diluted shares by 15% from the peak in 2015, creating additional value for our shareholders.

CapEx for the full year 2019 was $177 million, slightly less than our estimate of $185 million. We expect that difference together with the approximately $25 million deferral we mentioned during our third quarter conference call to be spent in early 2020. For the fiscal year 2020, we expect total CapEx to be approximately $100 million, which includes the 2019 carryover.

Before I provide first quarter guidance, I will remind you that our visibility is always limited as our backlog is typically only 1 to 2 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. Lastly, I'll caution that any development from the ongoing trade discussions between the U.S. and China or from tensions between Korea and Japan could potentially have an adverse impact on our industry and therefore, our results.

Given those caveats, we expect first quarter revenue to be in the range of $146 million to $154 million. The first fiscal quarter is typically a seasonally slower quarter for Photronics, but we assume that our IC markets will be stable to improving, and the strength in mobile displays will continue to fuel the FPD business. We also anticipate increasing contribution from our new China facilities.

Based on this revenue expectation and our current operating model, we estimate earnings for the first quarter to be in the range of $0.13 to $0.18 per diluted share.

At the beginning of 2019, we spoke of a cautious optimism as market conditions appeared challenging and we needed to complete and equip our new China facilities, but we were encouraged by our financial strength and market position. At the end of the year, and looking into 2020, we believe we have performed well and are in a great position. We are financially strong, and our market position is better than ever. We are optimistic and look forward to even greater accomplishments next year.

I will now turn the call over to the operator for your questions.

[Operators Instructions) Our first question comes from the line of Patrick Ho with Stifel.

It's Brian Chin on for Patrick. Congratulations on the results. Maybe a first question here. Just, Peter, maybe to go back and just clarify something in addition. So the $100 million CapEx for fiscal '20, which includes the carryover. Does that include that potential acceleration? Peter, you referenced in terms of the Phase II capacity install in Hefei? And also, with that Phase II effectively double your output from that facility? And from a timing standpoint, how quickly can you install and ramp that capacity?

Okay. So the $100 million is -- the approximate $100 million is a $33 million carryover and in addition to that, what we would describe as maintenance CapEx at our current run rate, that number is current run rate, $625 million, 10% of $625 million is $62.5 million, add $33 million and you get approximately $100 million. So there is no CapEx for the next wave in Hefei in that number. The magnitude of the CapEx will dictate the amount of revenue uplift that we can achieve, right? So we've not definitively made up our mind exactly how much to invest and when, but our global factory is sold out. We have no more capacity. We are turning business away from multiple customers. We're the market leader in AMOLED display. So the demand there is tremendous. So there's no doubt, if we invest, we can fill the tools, I think, no doubt. So we're talking to customers, we're talking to the local government, and we're trying to arrive at a business plan for the next wave that has the acceptable financial returns that we're looking for. That's not done yet. That's a work in progress. Hopefully, we'll have a lot more to say about that on the next call, but we're getting close.

Timing of it is more difficult because the long pole in the tent typically can easily run now, anyways from -- anywhere from 15 to 18 months. So that's the only -- the only challenge we have is the speed at which our suppliers can respond. So everything else is lining up nicely.

Okay. Was that 15 to 18 months? Was that a lead time on the tool? Just to clarify.

Yes.

Okay, got it. So even if you made the decision in the next quarter, it wouldn't be producing revenue within the fiscal '20 horizon. It would be beyond that.

No, not unless we can pull a miracle, right? But highly unlikely. Yes.

Got it, got it. And just kind of related to that, the China start-up cost, it looks like it's being kind of a 200 basis point lesser headwind in the fiscal 4Q. What are you sort of thinking in terms of fiscal 1Q, January? And yes, I guess that would be my next question.

Brian, it will be less in the first quarter. As we said, Hefei almost reached breakeven in the fourth quarter. So we expect that to continue improving and the effect from Xiame will be less. With the -- go ahead, Peter.

No, just to clarify that, as John said, Hefei is profitable. We expect it to make money in the quarter, and we expect that it will continue to make quarter every quarter. So we're through the knot hole and out the other site and quickly, as I said, sold out qualifications behind us. So Hefei is making money. Xiamen, on the other hand, we can't accelerate qualification. The market pull might help us -- is helping us, I think, a little in that respect. But no revenue and lots of people and lots of plates create expense, but that expense as we reach the -- second half of the current year and moving into next fiscal year should rapidly turn to revenue and profit. So it's getting less. It's getting less because of the profit we're generating in FPD. And we'll turn the corner late in the year, early next, when both FPD and IC are making money.

Okay. Maybe my last question, just stand things out a little bit here. But it sounds like what was more of a headwind now has shifted to a little bit of a tailwind in fiscal 4Q in terms of China and maybe China mainstream, in particular, in terms of on the IC side of the business. I'm kind of curious, can you sort of maybe calibrate sort of how your non-China high end, mainstream business is doing right now, and that encompasses maybe the memory market as well? And also sort of -- how you sort of -- whether you think there's any sort of temporary unsustained business coming from China-based on sort of, like you said, the -- maybe buffering that might be happening in the China market right now?

No, I think you have read my comments wrong. We don't see the China -- the momentum in China diminishing. We don't see this as a temporary blip on the radar screen. There's been a strategic shift in the market that isn't -- that in our view, is not moving in the opposite direction. China is -- they have their foot flat on the floor. And the market is part of it, but also the government is behind it, and the government doesn't really have the same profitability requirements that a normal enterprise has. So China is moving to be self-sufficient. They see non-Chinese suppliers as strategic liabilities and they aren't turning back. So this is not a temporary blip. It is a material change in how the business goes. Not to diminish.

As far as the rest of the business is concerned, this particular quarter, our memory business was up relative to the prior quarter. It was down slightly prior to the quarter a year ago. Given our customer base in memory, which is basically foundry DRAM and 1 very large nonvolatile player who's not really sensitive to the industry downturn, our memory business is going along quite nicely through the last year, up, down a little, but not a material change either way. I do think that when we get somewhere around the middle of the calendar year and the overall memory market, if it improves as many people think, we should be in a position to build on our memory revenues. So the way we see the business, the guidance for the quarter is seasonal softness. And to the extent it's offset by growth in FPD, we get to the top of the range. And by the way, to get to the top of the range, FPD should be at/or above its $200 million run rate that we've projected so long ago.

So that's kind of how the quarters fit and we really can't build on the IC revenue beyond what we have because the Asian network is sold out right now. And China has not yet been qualified, so we can't shift revenue. So there's no more IC revenue to come out of China. Now if the non-China business, non-China Taiwanese business picks up in IC, we can raise our IC revenue bar. So whether the second half of the year is memory getting better or it's the Xiamen capacity ramping in, we see a nice revenue trajectory for our IC business in the second half. Could be great or it could be good, but it's going to likely be one or the other.

Our next question comes from the line of Tom Diffely with Davidson.

Can you hear me?

Yes.

This is Franco on for Tom. You talked about IC coming back in China. Can you speak a little more to it in terms of what is driving the return on spending and is it memory or logic? And maybe a little farfetched, but perhaps, who are the main players behind it?

Yes, the demand in China really is both memory, logic, high end, mainstream. It's very broad-based. It's the customers like Huali or SMIC and it's many other smaller customers with factories that are ramping and coming online. So it's really quite broad. I think, generally speaking, some real bright spots are if the movement of the display driver business, the 28-nanometers and then you heard a lot about how strong the AMOLED market is, how vibrant the display business is where there's a big shift underway right now at the 28-nanometer nodes to push the display driver business down there. 5G is an unbelievable, I think, driver in the China business right now, both in-country and then the movement of the China mobile products down there, what is it, the Gate and Road initiative, the China manufacturers are really following the money around the world as China expands its global footprint. So automotive applications, a real driver in our business, consumer products, it's really hard to point to any 1 specific market, but generally, IOT, mobile, 5G and display all are hitting on 8 cylinders in China right now and Taiwan, right, because -- and Korea is feeding into that, too, because it's the non-U. S. supply chain.

All right. And then as a follow-up to Brian's question on CapEx earlier. So when you remove the carryover from this year, you get roughly $70 million. Is this sort of the ballpark that you're thinking about moving forward as the maintenance level? Or what are your thoughts on that?

I think our view of maintenance CapEx is about 10% of revenue, right? So that for us is that we see as a good target going forward. There will be more some years, maybe a little less others. So I'll just remind you, a leading-edge lithography tool is $40 million. So you don't need to buy many of those to be at 10%.

Yes. Okay. And then, right now you have 4 customers with long-term agreements in China. How many of these customers do you have the capacity to serve over time?

Well, we're taking care of all of them. I think, to quantify it, what we said was it represents about $300 million of business over a 3-year period. So that's $100 million a year on average. Right now that's between 15% and 20% of our revenue, which is on 1 hand a really nice solid base load, but it's not something that overwhelms our global footprint on the other. And one of the reasons that Hefei is such a success story for us is we ramped it into an oversold manufacturing network, and we have been working to put our IC factory in Xiamen into the same scenario. You want to ramp into an oversold condition so that as the business comes, or as the capability comes, you can sell it. So we feel right now, you can say on one hand, it's lucky, but on the other hand, a great factory we've been working with for almost 3 years. We're in exactly the same spot in Xiamen that we were 2 quarters ago at Hefei. We can sell everything we can make.

Okay. And then lastly from us. Thank you for the color regarding the headwinds in China. You said that the effect has been concentrated and relatively small. And could you sort of quantify what you're baking into your guidance for the first quarter?

No, the headwinds in China were in Q3, we mentioned that the business was impacted. What happened over the summer, as some very prominent companies got put on, on restricted trade list. There was disruption in the product development road maps. But generally, the Chinese electronics manufacturers came to the conclusion that by buying from Chinese companies or Taiwanese companies and, perhaps, if they have the Korean companies, they can build their products. They don't quite work as well as they thought they might, but they work well enough. And when they came to that realization, we saw a real acceleration in our Asian IC business. We saw an acceleration that for me was really remarkable. So that happened in the fourth quarter. So Q3 was a slight headwind, Q4 was a significant tailwind.

Regarding Q1, there is this -- the whole world in the electronics business works on a product development cycle targeted at the Christmas holiday season. Some people don't celebrate it. But generally, there's a huge product cycle that goes on every year and have the shelves full for the holiday shopping season. So for our business, what that means is this quarter, which includes Christmas, is sort of a low. So we work on a cardiogram where Q1 is typically the lowest, Q2 and Q3 are the highest, and Q4 typically slides down between Q1 and Q3. That's how our business works every year in a flat market. If there's an industry upturn, it sits on top of that cardiogram, if there's an industry downturn, it sits on top of that cardiogram. So for us, Q1 is normally the seasonally slowest quarter. And the guidance at the bottom of the range reflects that. That's what we look like in a flat market with season -- with seasonality on top 5% down. But what John said and what I reiterated is, we could be flat, which is 5% up, depending on how strong the growth in FPD is in the quarter to offset the normal seasonality across the entirety of the business. So that's how the guidance comes about.

Ladies and gentlemen, there are no further questions at this time. I would now like to turn the call over to Peter Kirlin for closing remarks.

Thank you for joining us this morning. As we move into a new year, our business is performing, and we are well positioned to continue growing into 2020 and beyond. We're the leader in our merchant photomask industry with tremendous market position and leading technology. Our operations are aligned with several secular growth trends, such as the adoption of AMOLED for mobile displays. And we've a proven investment strategy that is driving profitable growth.

Finally, before closing, I would like to take this opportunity to, once again, thank all our employees for their outstanding contributions throughout this year and to wish everyone a safe and happy 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.