Photronics Inc (PLAB) 2020 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Photronics Second Quarter Fiscal Year 2020 Earnings Conference Call. (Operator Instructions)

Please be advised that today's conference is being recorded. Wednesday, May 27, 2020. (Operator Instructions)

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

Thank you, Sarah. Good morning, everyone. Welcome to our review of Photronics 2020 second quarter financial results. Joining me this morning are Peter Kirlin, our Chief Executive Officer; John Jordan, our Chief Financial Officer; and Chris Progler, our Chief Technology 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 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'll turn the call over to Peter.

Thank you, Troy, and good morning, everyone. Before beginning our discussion of second quarter results and third quarter outlook, I would like to take a few moments to recognize our global workforce for their outstanding response to recent challenges. Beginning in February with our operations in China and extending globally over the last 3 months our employees have display dedication, commitment and a real customer-centric attitude that has enabled us to continue operating to meet customer expectations. As events started to evolve, we quickly developed and implemented a game plan to focus on 4 key areas: employee health, raw material supply, customer support and tool maintenance.

All these are critical for sustaining our global operations. Across our sites, we immediately implement policies to protect our employees through health monitoring, the adoption of known best practices to limit spreading the virus, including the use of personal protective equipment, and a comprehensive global visitor policy and enabling small segments of our workforce store from home in accordance with local requirements.

We initiated regular internal meetings to monitor our global supply chain and address any issues. And continue to be in direct content with our raw material suppliers, logistics partners and OEM equipment service groups to minimize any impact on our operations.

Because of these actions, we've been able to meet all our customers' photomasks needs with the same quality and delivery performance to which they are accustomed.

Effectively business as usual. It's been a true team effort and I am very proud of our response.

Moving on to second quarter results. Revenue was higher year-over-year, driven by FPD as we benefited from stronger global demand as well as more capacity from our new Chinese factory. This enabled us to achieve year-over-year revenue growth for the 11th consecutive quarter. For the first half of this year, revenues are 18% ahead of last year's pace, which was a record year for Photronics.

This demonstrates the performance we can achieve with our expanded global footprint, and we look to realize even greater growth in the future as both our Chinese factories, IC and FPD, continue to ramp, and our product mix is better optimized.

Revenues dropped sequentially due to a push out of orders, first in China, and then to a lesser extent, across the globe, resulting from the extended Chinese New Year shutdown and subsequent worldwide mobility restrictions to combat the coronavirus. The impact was felt most strongly in demand for photomasks used in IC foundry and high-end display production. Fortunately, we are already beginning to see our sales in these markets improve. And while there is uncertainty ahead, we are cautiously optimistic regarding the overall market outlook for the balance of the fiscal year.

For most of our IC customers, products have been deemed essential and operations have not faced interruptions. However, today's device designs are complex, requiring large teams of engineers, and approval loops often have multiple layers. With many of our customers' engineers working from home, design verification is more difficult, which seems to have slowed the pace of design releases early on as staff adjusted to remote working conditions.

Based on an order uptick during April and May, it appears that design teams are adjusting to the remote work setting or in some cases, have returned to the office, plus we believe that companies are moving forward with the introduction of next-generation devices in anticipation of a recovering economic environment.

As far as FPD is concerned, all 3 of our factories were fully booked during the entire quarter. However, mix suffered in China due to a significant decline in G10.5+ bookings. We do not believe we lost market share, but instead customers simply ran existing products, pushing out the timing of new design releases. We're already seeing bookings rebound in May with an immediate line of sight to more, leading us to expect G10.5 business to be back to normal by the end of the third quarter.

Earnings were impacted by the decrease in revenue. We always keep a keen eye on costs to maintain our status as the low-cost producer, and this quarter was no exception.

Due to this focus, we delivered earnings of $0.10 per share. We improved the strength and flexibility of our balance sheet during the quarter, increasing our cash balance to $238 million. John will say more in a few moments, but we believe we are well positioned to navigate this period of market uncertainty as well as to execute against our strategic growth objectives.

To summarize what we saw in the second quarter, our team has responded well, working with our partners across the supply chain with no meaningful disruption to our operations, while maintaining the health and well-being of our employees.

Some of our customers pushed out orders, but those were limited primarily to China, and we have seen improved bookings in April and May.

There is too much uncertainty regarding future economic growth to state of the worst is behind us. However, I'm extremely pleased with how we have responded and encouraged by current trends.

During this period of uncertain dynamic market conditions, one thing that has not changed is our commitment to invest in growth. Investing is not new to us. With our facilities in China performing well, we're preparing for the next phase of our growth strategy. This will entail targeted investment in display. We recently placed an order for a second Prexision 800 mask writer from Mycronic. This tool is scheduled to be delivered early in calendar year 2021.

We are also scheduled to receive 2 Prexision 8 lite writers in 2021. The addition of these 3 machines to already formidable lineup will fortify our leadership position, providing us as the most advanced and broadest technology portfolio available. We have the flexibility to install these new tools in any of our 3 FPD facilities in Asia, and we will select the best location to serve our customers while optimizing our financial return.

Total investment, including any additional support tools will be in the range of $50 million to $70 million, depending on the location of each mask writer. To support this investment, we have entered into 3 multiyear purchase agreements that collectively represent a business commitment in excess of $40 million annually. There are multiple market factors driving the need for these advanced tools. Primary among them is strong and growing AMOLED demand.

Most manufacturers of premium smartphones have transitioned to AMOLED, and more and more mid-range models are adopting the technology. The rollout of 5G technology is expected to accelerate this transition.

Second, high end tablets and laptops are now beginning to migrate to the superior AMOLED displays. Finally, premium smartphones continually adopt more innovative display technologies with greater resolution and features, such as integrated fingerprint sensors. This creates design and manufacturing complexity, thereby increasing the number of mask per set. The most basic AMOLED mask set has 12 layers, while the most advanced can have up to 25 layers. Not only does the number of layers increase, but there are more critical layers further enhancing the value we provide. Our new tools will enable us to better serve this growing market, extending our market leadership and protecting our technology leadership.

In addition to growing AMOLED demand for mobile applications, Korean panel producers are in the process of shifting production from LCD to high-end OLED for large screen TVs. This move is intended to provide competitive differentiation based on technology. As these advanced display makers innovate to maintain their technology leadership, we will partner with them to enable them to deliver on their strategic objectives.

Our new tools, especially the P 8 lites are the perfect solution to allow us to satisfy this demand.

Before concluding, I would like to speak to the recent rulings by the U.S. Department of Commerce. Our first order of business is to understand how the rules apply to us and to ensure we are in compliance.

Fortunately, our FPD photomask are not touched by U.S. technology or suppliers, so they do not apply. Regarding IC photomask, based on our initial work, we believe that we should be able to comply without significant interruption.

As with all such ruling, it often takes some time to fully understand and adapt to their implications, while we do not currently anticipate significant changes to our business outlook.

The trajectory of our business activity during the second quarter and into the third quarter has been encouraging. Current booking activity is moving in a positive direction in both our IC and FPD businesses. I believe the underlying long-term trends that we have aligned our strategic growth objectives with have not changed. While the exact profile of the business in 2020 is uncertain, we remain confident on our long-term outlook and believe that we are in a strong position to deliver.

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

Thank you, Peter. Good morning, everyone. We performed well during the second quarter and managed our business through very challenging circumstances. Revenue of $142.8 million improved 9% compared with the same period last year, albeit down 11% sequentially as some customers, particularly in China, pushed out orders.

We believe that the order rate will recover. And indeed, we have already seen improving trends during our third quarter. IC revenue was lower compared with both the previous quarter and the same quarter last year. More than half of the sequential variance in IC revenue was due to lower demand from China foundries as their operations were impacted by the protracted Chinese New Year shutdown.

FPD revenue improved over last year as additional capacity in our new Hefei facility expanded output.

On a sequential comparison, the revenue declined due to softer demand in China as customers pushed out orders, particularly for G10.5+ and AMOLED.

We were able to keep our FPD plants running at full capacity, albeit, with a mix of product not as favorable to the top line.

Both gross margin and operating margin moved in line with revenue trends. During this period of economic uncertainty, we intensified our perennial focus on cost control. We accelerated global cost reduction programs, and we are challenging all spend to ensure we are properly prioritizing expenses.

SG&A expense in the second quarter was nearly $1 million lower than the previous quarter, essentially equal to the prior year quarter. Year-to-date SG&A expense declined as a percentage of revenue from 10.6% in fiscal 2019 to 9.1% in fiscal year 2020.

Overall OpEx increased nearly $1.2 million from the first half of fiscal 2019, due in large part to increased R&D expenses resulting from the many new product qualifications in several of our operations.

Total OpEx as a percentage of revenue decreased from 13.6% in the first half of fiscal year 2019 to 11.9% in fiscal year 2020.

China effect on operating income was reduced to just about $1 million in the quarter.

Margins in the second quarter were reasonably good in the circumstances, but we expect to do better and will continue to drive costs out of the business. Other expense of $1 million resulted primarily from the foreign exchange impact of remeasurement of U.S. dollar-denominated assets and liabilities on the books of our foreign subsidiaries together with interest expense, primarily in China.

Tax provision and noncontrolling interests were in line with expectations enabling us to deliver $0.10 per diluted share for the quarter. We are in a very strong financial position with sufficient cash, manageable debt and ample liquidity, including our unused $50 million revolving credit line that is available if needed.

Our cash balance increased $19 million during the quarter, a result of investing $16 million in CapEx and repurchasing $6 million of our common stock from the $31 million we generated from operations and $10 million of government subsidies and contributions from noncontrolling interests.

Earlier in the second quarter, we made the decision to terminate our share repurchase program out of an abundance of caution in consideration of the uncertainty in the current environment. Our desire to use this vehicle as a means of improving shareholder value has not diminished, and we anticipate resuming this activity at an appropriate time in the future.

Our forecast of total CapEx for fiscal year 2020 will remain at approximately $100 million including about $35 million for equipment that will be lease financed. As always, we have some flexibility on exact timing of CapEx to allow us to respond to changing market conditions.

Before I provide third quarter guidance, I remind you that our visibility is always limited as our backlog is typically only 1 to 3 weeks, and demand for some of our products in 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, geopolitical risk may have an impact on our operations, the operations of our customers or suppliers or end market demand as governments announce restrictions to add corona -- to address coronavirus or changes in trade policy, resulting in an adverse impact on our industry and, therefore, our results. Given those caveats, we expect third quarter revenue to be in the range of $145 million to $155 million. End market demand trends for IC and FPD appear to be positive as we get well into the third quarter, and we anticipate the longer-term trend to remain positive. However, it's difficult to ignore the macroeconomic uncertainty, and we have attempted to incorporate this when developing our third quarter outlook.

Further, as a result of this uncertainty, especially as it relates to demand during our fiscal fourth quarter, we are withdrawing our full year fiscal year 2020 targets that were previously announced.

While we may still meet these targets, the confidence level in doing so is reduced by the uncertain demand environment.

Based on our revenue expectation and current operating model, we estimate earnings for the third quarter to be in the range of $0.11 to $0.17 per diluted share. These are certainly challenging times. And as always, during periods of uncertainty, we increased our focus on Photronics' long-standing core competency of being the low-cost technology leader, delivering high-quality photomasks to our customers. Successful execution of these competencies, combined with our financial strength and flexibility should enable us to overcome these challenges and emerge strong and better able to serve our customers' evolving needs.

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

(Operator Instructions)

Our first question comes from the line of Tom Diffely with D.A. Davidson.

So I guess going back to the guidance you gave for the April quarter. At that time, you're expecting about a $10 million impact from COVID-19. Curious what drove a little bit of upside to that? Was it domestic China being a little softer or was it the impact to the rest of the world?

Yes. The original guidance did not contemplate the virus rolling through Europe and the United States. So if you look at our quarter, about 75% of the loss of revenue came from China, the other 25% came from the U.S. and Europe, and that was not contemplated in the guidance when we gave it. So that's more or less how the quarter -- the drop in revenues split out.

Okay. Is there any way to quantify the COVID impact you have embedded in your guidance for the July quarter?

Yes. Well, if you look at our year, right, Q1 was just shy of $160 million, so we were at a $640 million clip. If you look at the second quarter, we had a [V] so February was $48 million, March was $44 million and April was $51 million. So when you look at our guidance for the current quarter, and you look at the April number, it doesn't take a lot of imagination to determine where it came from.

Okay. And it sounds like you're not seeing any end market demand disruption outside of the delay you saw from the design activity early in the quarter or I guess, in the March time frame?

Yes. We saw the big dip, right? March, we saw the hangover from a Chinese New Year shutdown, which I think we all know extended several weeks beyond what was originally intended, plus the effect of U.S. and Europe starting to be felt, so that was a big dig. But where we sit right now, right? I would still say that our overall demand is down mid-single digits as a result of the overall economic hangover from COVID-19.

Okay, great. And then the...

Yes, sorry, Tom, relative to what it would have been absent it, yes.

Okay. And then reading your comments on the commerce department, it sounds like your withdrawal of the full year guidance is really a COVID impact, not any impact from the new commerce department rulings?

That's absolutely correct. I mean, no one knows what the fall will hold. I think the only thing that we can say definitively is the virus will not have left us by then. So what this profile looks like in the fall is anybody's guess. But what I will say is if you look around Asia, Korea, Taiwan, China, these are significant markets for us. Somewhere between 70% to 80% of our revenue is coming from the Asian markets. And when you compare their ability to manage the virus this spring versus the west, it was very favorable. So if the fall is a replay of the spring, everybody should do better because everybody should be better informed. And we're hopeful that the effects will be quite modest in Asia, don't really know about Europe and North America. So this is why we're withdrawing the full year targets. We do that with lots of disappointment because it's very clear. We were -- with 11 quarters of year-over-year revenue growth and Q1 being what it was, we were well -- we were, in fact, ahead of our plan to hit the [$630 million] and $0.80.

Having said that, the current quarter is a significant step-up, so we're cautiously optimistic.

Okay. I understand. And then finally for me, just maybe a technology question. Probably for Chris, I guess. If the industry moves to adoption of mini LED, how does that impact the photomasks?

Sure. Thanks, Tom. So mini LED, that's technology with the larger size LEDs, as you know. It's mostly applicable to 2 applications, kind of, very large TV, signage, that sort of thing. And then it's kind of dynamic backlighting in regular displays. So in both cases, they need driver circuitry. They're not as complicated to operate as organic LEDs, but still the driver circuitry is fairly complicated, and we see a pretty healthy mask profile for mini LED, particularly for the dynamic backlighting. There, you're going to need some additional circuitry to make those work. The micro LED, those are kind of direct drive LED similar to AMOLED, but using inorganic LEDs. Same kind of story on the surface LEDs, they're relatively easy to operate. But to get the right control on the displays, you'll have to operate current and voltage, just like OLEDs. So we see pretty strong profile for lithography and mask demand from micro LED as well.

Comparable kinds of mask counts, but for some of the integration schemes, perhaps even higher.

Our next question comes from the line of Gus Richard with Northland Securities.

Just quickly, can you talk about the normal linearity in a quarter and was Q1 unusual in that respect? And kind of what is typical linearity in Q2?

Yes. Q2, if you compare our business, right, as a cardiogram, right. The cardiogram has the most year-over-year correlation based on the build for the holiday season of products. So if you look at our business, where we see normally a definitive profile is -- Q1 is typically a down quarter, Q2 and Q3 step up for the holiday season and then Q4 steps down as a result of the holiday season. So Q1 is the lag of products not being in the pipeline. Q2, there's more; Q3, there's even more; and then Q4 incorporates the holidays. So that's the normal cardiogram for our business in a year. So based on that, Q2 should have been up, but obviously, it was not.

A typical quarter, there's some statistical variation month-to-month. But normally, with the exception of January, always being down relative to December. And February, there is no systematic month-to-month variation within a quarter.

Got it. And then just talking about the expansion of the entity list by the commerce department. You guys made some comments that you don't see that impacting you. And I was just wondering how you've walked through that analysis? Do you have low exposure to those companies? And/or do you think you can get around the regulations?

Yes, it's actually -- it's quite -- it's a -- so Huawei, right, is the major poster child. So -- and the affiliate -- companies affiliated with them, right? That's already well in the rearview mirror, right? Then when you when you step away from that, there's a complicated gauntlet you have to run regarding EAR codes and it's quite complicated. So each customer and the products they sell require a separate assessment. So we have several individuals or at least 1 individual that is really an expert in this area inside the company. So they've been through the new regulations. And relative to the prior ones, there's really only 2 customers of concern for us right now. We're working to try to determine what we can do for them. If we can do nothing, it's still should not have a significant impact on our revenues. And so you kind of take it to the highest level. Why is that so? Well, the why is that so is, we're building reticles all around the world. Our factories, our IC factories in Taiwan and in China, use technology that was largely developed in Asia. And if not, we have a giant Japanese partner that where we can use Japanese technology to get the job done. So yes -- so right now, we're, I think, in pretty good shape. But there's still a lot of dialogue, by the way, going on to clarify exactly what the wording in the rulings mean. So that's why in my prepared remarks, we were quite careful to say we're still, along with others in the industry, working to get complete clarification on specifically what the wording means.

Got it. And then just remind me, say, your top couple of IC customers. How big would they be? Are they 1%, 2% of revenue on an annual basis?

If you look at our top 5 IC customers in a quarter. Typically, they're more than 50% of our revenues. And that number varies, right? I don't know if we break that out. But we do, at the top of our business, have a high customer concentration. But I'll tell you that we have, in a typical year, more than 600 customers. So we have a broad -- very broad and diverse customer base. But the very top, there's a significant amount of customer concentration.

And just to be clear, is that -- I would imagine it's mostly dominated by FPD customers as opposed to IC?

There are more FPD customers in the top 10 than IC, that's correct.

Our next question comes from the line of Patrick Ho with Stifel.

Peter, maybe just as a follow-up from your prepared remarks, can you discuss your manufacturing situation? And I guess, with all the new rules of social distancing and all of that. How it impacts your core throughput capabilities? And maybe as a second part of that question is, how much do you believe of some of the lost revenues and the pent-up demand that's starting to come back now in the July quarter? How much of it do you believe is made up in July? Or does it carry over a couple of quarters where you make up that lost revenue from the April quarter?

Yes. So as far as our manufacturing operations are concerned, we -- I don't know if you want to use the word fortunate. But I would use that word from the standpoint of knowledge is power and that is in Asia, right? This is not the first coronavirus the Asian communities had to deal with, right? Since 2000, there's been 6 -- 3 significant coronavirus epidemics in Asia. There was the Middle East Respiratory system -- Syndrome, there was the swine flu and there was SARS, right? So there were 3. And the best practices in how to operate in a coronavirus-infected community were already known to our -- particularly our Taiwanese operation. So we took that playbook, and we rolled it out around the world, right? So rolling out that playbook, our manufacturing output is the same today as it was 3 months ago as it was 3 months before that. So we have not seen any degradation in our top line as a result of the virus. We had a lot of supply chain disruptions. We had to actively manage through, but we were able to do that. And again, we're -- we still think of ourselves as a small company, but we have a really dispersed global footprint. So when we are having problems with particular materials in one location, we would buy them in another and reexport them ourselves. So by being flexible and acting as a global team, we did not have any manufacturing disruption, 0, nada, nothing. So -- and we're already preparing for the fall, right? We would be foolish not to because we know something is going to happen, and we just don't know what. But what we do know is we're going to be ready. So -- yes, so our revenue output, same as always. Of course, I say always, I mean, as our -- as we add tools, changes. But aside from capacity additions, no impact. As far as the demand goes, we expect what was there to push out over the next few quarters, that assumes there's no major economic dislocation as a result of the pandemic. And I don't think, right now, anyone knows what the overall economic outlook looks like 3 months from now. I think that's really hard. I think that's really hard to have a firm grip on. But I will say, again, the countries that have done a good job managing the virus are likely to do a better job in the fall. And fortunately, that's where the majority of our global footprint resides.

Having said that, also, as everyone knows, right, the West represents a significant amount of demand for chips. And if we're having difficulty, there's bound to be some economic impact of that, that is hard to predict. So we're doing what we always do. We got our head down. We're focused on execution with things we can control. We're managing our costs. We're making sure that we're well set up for the fall. We're not deviating from our long-term strategy to the extent that we can get customers to hold hands with us. So we're hyper-focused on what we can control, and we're vigilant on what is happening outside of us.

But it's uncertain -- it's an uncertain time.

Ladies and gentlemen, that concludes the conference call -- Ladies and gentlemen, that concludes our question-and-answer session. I would now like to turn the call back over to Peter Kirlin for closing remarks.

Thank you once again for your interest in Photronics. We understand the current environment has created uncertainty for all of us has caused disruptions to our daily routines. Despite all of this, we are encouraged to see demand recover, and look forward to updating you as we progress throughout the rest of 2020.

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