Photronics Inc (PLAB) 2022 Q3 法說會逐字稿

Good day, and thank you for standing by. Welcome to the Photronics' Q3 Fiscal Year '22 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. And I would now like to hand the conference over to your speaker today, Ms. Richelle Burr, Executive Vice President, Chief Administrative Officer and General Counsel. Ms. Burr, please go ahead.

Thank you, Chris. Good morning, everyone. Welcome to our review of Photronics' Fiscal 2022 Third Quarter Results. Joining me this morning are Frank Lee, our Chief Executive Officer; John Jordan, our Chief Financial Officer; Chris Burr, our Chief Technology Officer; and Eric Rivera, our Corporate Controller and Chief Accounting 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 participant on today's call may include forward-looking statements that include such words as anticipate, believe, estimate, expect, forecast or 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 statements.

At this time, I will turn the call over to Frank.

Thank you, Richelle, and good morning, everyone. Q3 was an outstanding quarter. We achieved great new records in both revenue and profit. Demand for photomasks remains strong for IC and FPD, both high-end and mainstream applications. With our global presence, in-store production capacity and deep portfolio of customer partnership, we increased revenue 8% sequentially. Once again, it is our fifth consecutive quarter of record revenue.

Gross margin and operation margin also reached 25-year record highs of 38% and 29%, respectively, as we benefit from higher price operation at capacity in most locations and superior cost control. The net result was earnings of $0.51 per share. Cash generation was also strong, and we ended the quarter with $324 million in net cash, position us to continue investing in profitable growth opportunities. I'm very proud of the entire Photronics organization and what we had been able to accomplish by working together and serving our customers to deliver great results.

There has been pronounced mask capacity shortage since the beginning of second half 2021. Consequently, our customer has been dealing with long masks delivery time. Since Photronics full commitment is to our customers' success and growth, we have evaluated that situation, and we have been making the next wave of capital investment to closely align with our customers for their technology and production capacity road map. This strategy has been extending across geographies for both IC and FPD. These actions will help us continue to be a strong partnership with customers and establish several long-term agreements.

Recently, there have been some slowdown in customer new tape-out activities, more in high-end than mainstream. However, our experience has shown that customers will impress megatrends in the market that drive development of new IC and FPD designs, such as the lower of 5G better communication; the expansion of electronics and automotive application; and of course, the continued expanding need for consumer electronics. As a result, we believe the negative impact of any slowdown on Photronics will be minor as reflect in our Q4 guidance.

In the U.S., We joined our semiconductor peers in uploading the passage of chips and size act. Photronics, a critical member of the U.S. semiconductor ecosystem for 53 years, is the largest global photomask manufacturer and the only domestic supplier of high-end commercial mask, including U.S. trust products through 14-nanometer.

In cooperation with chips, we stand ready to invest and support the expansion of our customers' domestic manufacturing and technology needs. We performed very well in the third quarter, and we believe we are on track to have the best year in the history of the company. I'm proud of our team, and I want to thank all of our employees for their extraordinary work to achieve the quarter's results and look forward to accomplishing even more in the future. Thank you.

At this moment, I turn the call to John.

Thank you, Frank. Good morning, everyone. Design activity remained strong in the third quarter, driving growth across both IC and FPD businesses. Our operations teams did a tremendous job of meeting demand in an environment that remains challenging. As Frank mentioned, we achieved our sixth consecutive quarter of record revenue and grew the top line at $220 million, up 8% sequentially and 29% compared to the prior year quarter.

This quarter's performance is another data point that we believe validates our growth strategy. We have strategically invested in capacity and capabilities that are aligned with the high-growth sectors of our markets, such as AMOLED displays for mobile applications in our FPD business as well as both mainstream and high-end IC nodes. We are pleased with the results and believe we are well positioned to continue to outperform the market.

IC revenue of $161 million was 11% higher sequentially and up 37% year-over-year on strong demand growth and improved pricing across both high-end and mainstream. For high end, U.S. and Asia demand increased, particularly for 22-nanometer and smaller nodes, as demand remained strong, and we saw a pickup for EUV applications.

Mainstream demand also continued strong, driven by applications across the industry. The ubiquitousness and continued proliferation of the use of semiconductors in everything we use is widely discussed in the industry, and our customers continue to innovate and bring new products to market, resulting in new design starts in driving the increase in mask demand. Our investments in capacity across the organization expand our operations to supply more masks that enable product development initiatives.

There are also selective opportunities for pricing action across our IC business to help capture the value that we deliver to our customers.

FPD Revenue of $59 million increased 11% year-over-year, driven by strong high-end demand during the quarter, as both AMOLED for mobile displays and G10.5+ for ultra-large screen TV were up strong double-digit percentages compared with both last quarter and last year. Although demand was robust in both high-end and mainstream FPD, the dedication of production capacity to the higher-margin products resulted in decreased mainstream FPD revenue.

Revenue from products shipped to China continued its strong growth trend. Our investments and work to build our business there have paid off, and we expect to remain the market leader.

Gross and operating margins continued to improve during the third quarter and benefited from improved pricing, operating leverage from higher volumes and continued cost discipline. Gross margin of 38.1% and operating margin of 29%, both 25-year records, improved sequentially 380 basis points and 480 basis points, respectively, and are both entering into the bottom end of the ranges in our long-term target model. Based on our outlook and the continued focus on cost reductions, we expect to continue to deliver sequential margin improvements as our revenue moves into the targeted ranges.

Operating expenses were well controlled during the quarter, and we were below -- were well below the implied target in our long-term model of 10% of revenue. We expect this metric to trend toward our long-term target model as we invest in resources to support growth and continue to qualify more products.

Income tax provision increased on increased earnings, and net income to noncontrolling interest increased with the strong performance of our Taiwan and China JVs. The totality of the operating results, together with an unrealized gain on foreign exchange, resulted in diluted earnings per share of $0.51.

We generated $93 million in cash flow from operations during the quarter due to strong earnings, good management of working capital and VAT refunds we received in China, which we used to further reduce long-term debt. Since the beginning of the fiscal year, we have reduced long-term debt by $54 million. We ended the quarter with $324 million in net cash, maintaining our ability to invest in growth opportunities and providing the wherewithal to weather potential economic troughs.

CapEx for the quarter was $12 million, bringing year-to-date CapEx to $45 million, net of government subsidies. We still project a spend of $100 million this fiscal year, although some of the remaining spend could lapse into next fiscal year. While it is too early to provide precise CapEx guidance for fiscal 2023, early indicators point to continued expansion of demand and an abundance of investment opportunities, especially in IC, that will likely cause CapEx next year to increase.

Before I provide guidance, I'll remind you that our visibility is always limited, as our backlog is typically 1 to 3 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 fourth quarter revenue to be in the range of $205 million to $215 million, driven by a continuation of favorable end-market demand trends across both IC and FPD.

At the midpoint, this represents an increase of 16% over last year's Q4 revenue and for the full fiscal year 2022, an increase of 24% over full year fiscal 2021 revenue, in line with our expectations, somewhat tempered by economic uncertainty, the effects of foreign currency and typical Q4 seasonality.

Based on those revenue expectations and our current operating model, we estimate adjusted earnings per share for the fourth quarter to be in the range of $0.44 to $0.52 per diluted share, at the midpoint, a 45% increase over last year's Q4 EPS and for the full year, more than double the full year fiscal '21 earnings per share of $0.89.

Our outstanding performance through the first 9 months of fiscal 2022 is on pace to deliver another record year in revenue with expanding margins, strong cash flow and a solid balance sheet to support our growth strategy. We are making palpable, steady progress toward achieving our long-term target model that we believe will ultimately lead to greater value creation for our shareholders.

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

(Operator Instructions) Our first question will come from Hans Chung of D.A. Davidson.

This is Linda on behalf of Hans Chung. First of all, congratulations on a great quarter. So I guess my first question, in terms of the moving pieces in the demand environment as well as supply constraints, I was wondering, from your perspective, if you saw any supply chain issues in the quarter? And how much the constraints are limiting you in terms of potential revenue or output? And if any of the constraints are embedded in your outlook? And then I have a follow-up.

The supply chain impact on our output actually is very minimal. We do see some small shortage in FPD brand supply, but we are able to deliver, develop second and third source. So to answer your question, this is not a factor on our Q4 output.

That's helpful. And I guess as my follow-up, in terms of the demand side of things, you noted strong demand in the quarter. But with concerns of potential slowdown in the coming year in different end markets, are you seeing any order pushouts or any actual cancellations? And then as you think about 2023, obviously, a lot of changes in the end markets, I'm curious how you're thinking about net effect into 2023? And whether we could see any growth or declines? And here, I'm wondering what you think.

At this moment, the mainstream product, we don't see any slowdown in customer type activities. However, we do see a little bit push out in the high-end mask tape-out and not necessarily in all customers, but we do see some slowdown in the customer tape-out.

For 2023, actually, as John mentioned, our business model, our backlog normally is 3 to 4 weeks. So at this moment, we...

So Linda, we had -- at the beginning of the fourth quarter, we saw a little bit of push out from some of our major customers. But from our discussions with them, that demand is going to be coming back. When we put our long-term model together, the 2024 model, as we've discussed, we anticipate that there's going to be a pullback sometime during the cycle. We're 3 years into a pretty good cycle now. And we all know that -- and notwithstanding some people's contention that it's different now, it never has been different. So we expect a pullback sometime during our forecast period. And our growth anticipation through 2024 has been muted to factor a slowdown in the industry. Whether that slowdown is occurring now or not, we don't know. We expect our demand to pick back up during the quarter. And we haven't put our budget for 2023 together yet. So actually, we're about to do that next week. We'll have a better feel for what we expect for 2023.

As you know, from the past, we do well to forecast 1 quarter at a time, and we never give guidance for the full year or for the following year. So the best we can do at this point is our guidance for Q4 with the knowledge that we have now.

And this is Chris. I can make one additional comment. There's still a lot of capacity constraints in the global photomask industry, which will not be easily solved over the next year or 2 years. So even if demand pulls back a little bit, utilization should remain quite high in commercial photomask.

The other dynamic that often happens is as fab utilization goes down in the wafer fabs, you tend to see design activity pick up because they're working harder to try to refill that capacity. So it can be a little bit countercyclical if the downturn is not severe where design activity improves while fab utilization goes down. So these may give us buffers as well to not see the same kind of impact that some of the chip makers will see.

I appreciate the color. And then as my last question, a bit above the pricing dynamics. Could you talk a little bit more about pricing changes in the quarter? And of course, we saw a good strong quarter-over-quarter growth in mainstream and advanced automask revenues. Can you maybe break down how much of the growth was coming from the pricing versus volume, which seems to be having a significant effect on revenue and gross margins?

Yes, thank you for that, Linda. It's difficult to fix and quantify, but the effect is significant. We've seen an improvement in the pricing environment for our high-end business in Asia. So we've been able to take advantage of that. And as you know, we've had a very supportive pricing environment in Asia since our second quarter of last year.

We had -- we used to approach customers to try to put long-term purchase agreements in place, and that helped us support our revenue predictions for our investments in China. Over time, since then, it's now more symbiotic, and the customers are coming to us for long-term agreements as much as we're going to them because they want to ensure their capacity going forward to get the masks that they need.

So as a result, the number of long-term purchase agreements we have in place continues to increase. Many of those rolled over in March and April, March 15 and April 1. And we got the benefit of those price increases in third quarter. I think if we just look at the differences in gross margin over the time period since the pricing environment started to improve, we can come up with a rough estimation on our own of what that pricing effect has been. We can't really put a fixed number on it.

And our next question will come from the line of Patrick Ho of Stifel.

Congrats on a nice quarter. Maybe first off, as a follow-up to the comments you made about the high-end market and seeing some pushouts, are you able to discern if they're in marketplaces that are currently weak today? So what I'm getting at is, are they in markets like PCs, low-end smartphones, consumer electronics, where we've seen tangible reductions in overall orders across the semiconductor chain? Or are you seeing them in other markets that haven't been as for weak?

I think from customer to customer, the situation may be different. But one thing we see, one of the main factors is the inventory build-up in end user, especially the IC design house. So before the cleanout of the inventory, some customers are reluctant to make a new product. So according to our input and interface with customers, the high-end tape-out activity should start to recover perhaps by the end of September or in October. So we believe there's a pushout due to inventory -- high inventory and -- but the design activity should continue.

And as Chris mentioned, because the wafer fab utilization is a little bit down, and that allows customers to have the room to tape-out pilot activity. So we hope and we believe this is a short-term effect.

Great. That's helpful. And maybe my follow-up question for you, John, in terms of CapEx. Obviously, customer demand is quite high, both particularly in the mainstream IC business. Is there any nuances or differences in the type of CapEx you need to acquire for either the high end versus, say, mainstream? And does that affect the overall CapEx dollars? Or are they kind of fungible, the type of equipments you buy?

They're hardly fundable, Patrick. Thanks for that question. During my comments, I mentioned that our CapEx for next year will increase. And as I also mentioned, we're having our planning meeting next week when we're going to determine just what that increase is going to be. As you've observed over the past several years, we've been doing very well with our investments. The criteria that we use to make sure that our investments are going to produce improvements in ROIC have been effective in making sure that we do exactly that. And we've seen the result of that scrutiny over CapEx, and we've seen the improvement in ROIC.

We've already -- as we mentioned in prior calls, the CapEx for this year was primarily for mainstream and also deposits on high-end tools for IC for next year. And there are going to be a lot of tools delivered next year. We've expanded a couple of facilities, and we've got high-end lithography tools, inspection tools, et cetera, to really expand our high-end capabilities, especially in Asia. We did that in the U.S. last year, and we're going to do it in Asia next year.

To the extent that they're available, we're also buying point tools for mainstream as we've discussed previously. So as specific as I can be, we're buying almost full lines, if you put everything together, to expand our capabilities in high end IC. They aren't full lines. But if we took the tools that we're putting in each of the lines and put them together, we'd wind up with real expansion in our high-end capacity.

Patrick, this is Frank. Actually, in Taiwan, we are building a fab expansion, and the facility will be ready by the end of this year. And we -- after the clean room is ready, we do have several writer and inspection tour move in next year, including the high-end and also the middle-end tools. So we do have some CapEx in 2023 to meet our customer demands.

And the only other thing I'd add, Patrick, is we can run mainstream products on high-end tools. I mean the capabilities are there. It just doesn't make sense economically for cost reasons. So we really look very, very hard at price on mid-range tools and productivity. We also look at that at high-end tools, but capability tends to be the overriding decision factor and how we look at CapEx. So the high-end tools and cost of ownership, ROI, those sorts of things get a lot more scrutiny for midrange mainstream tools. So the capacity is a little bit fungible, but if we need to, we can run lower-end products on higher-end equipment, but it isn't really the right way to operate the fab.

(Operator Instructions) Our next question will come from the line of Gus Richard of Northland Capital Markets.

Just real quick on the slowdown in tape-outs. Is there any regional impact on that? Is it China or Asia in general or just across the board?

Actually, China, we don't see any slowdown, a little bit slowdown in other regions. China activity remain very strong. So thus, while our China operation still run at overcapacity. So the slowdown is in our region. And as I mentioned, we do see some coming back recovery happen.

Okay. And then as I recall over the last few decades, is Q4 -- your Q4 are seasonally down quarter? Or is it typically up?

So Gus, if we didn't have incremental revenue coming on from CapEx additions during the year, Q4 typically would be lower seasonally than Q3. But for the last several years, starting with the big investments in China, Q4 has benefited from the incremental revenue from CapEx during the year. So it's been stronger.

In this case, we don't have as much incremental revenue coming on. And we also have the dampening effect from foreign exchange in a couple of the locations where they record revenues in the local currency, and then they have to translate them into dollars. So we know the dollar is strong, so that's giving rise to some muted translation in muted-translated revenues.

Got it. And then the last one for me. When I look at your FPD revenue, it was flat sequentially. It's had nice growth over the last few years. I'm just wondering, are you at a point where you're fully utilized and there's not much upside in that part of your business until more capacity comes on? And if so, when would you expect that incremental supply to come on?

In FPD, we are focusing more on the higher profit product, and our booking is over the capacity. But at this moment, we finished our first major capacity, especially in (inaudible) last year. So at this moment, we focus on making profit, and we kind of cherry-picking our orders for the time being, before we make a next decision for our next wafer of investment.

Thank you. And I see no further questions in the queue. I would now like to turn the conference back over to Frank Lee for closing remarks.

Thank you. Thank you for joining the meeting this morning. We performed well in the third quarter, and we are on the way to delivering another record year. End market is strong, end-market demand remains strong across the business. And our entire team is working hard to serve our customer. I'm proud of our achievement this year, and we look forward to continued success in the future. Thank you.

Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Have a pleasant day.