Q1 2022 Photronics Inc Earnings Call
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Good day and thank you for standing by welcome to the Photronics Q1 fiscal year 'twenty two earnings conference call. At this time all participants are in a listen only mode. After the speaker's presentation there'll be a question and answer session to ask a question during that session. Please press star one on your telephone.
As a reminder, this conference is being recorded Wednesday February 23 2022.
I would now like to turn the conference over to John Jordan Executive Vice President and CFO , Sir the floor is yours.
Thank you, Chris and good morning, everyone.
Welcome to our review of Photronics, physical 2022 first quarter results.
Joining me. This morning are Peter Kirlin, our Chief Executive Officer, and Chris <unk>, 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 webpage.
The presentation material contains non-GAAP financial measures a reconciliation of GAAP to non-GAAP financial measures May also be found at the end of the presentation.
Comments made on today's call May include forward looking statements. These forward looking statements are based on a number of risks uncertainties and other factors.
That are difficult to predict.
We refer you to the documents we file with the SEC for a discussion of the risks that may affect our future results.
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 John and good morning, everyone.
I am pleased to report strong sales and earnings for the first quarter.
Period that is typically seasonally soft.
As end market demand was strong and our global team worked hard to deliver another record quarter for <unk>.
Fourth in a row.
Demand activity remains elevated across the semiconductor and mobile display industry.
We are clearly benefiting from the investments in capacity and capability.
And it positioned us to outgrow the market.
We're seeing an acceleration of the trends that drove achieved record performance in 2021.
And our content at 2022 will be even better for photronics, our customers our employees and our shareholders.
Well, it's great to see the growth in revenue is even more rewarding to see our profitability step up over the last several quarters.
Our long term investors know that we repositioned the business nearly five years ago.
<unk> launched an initiative to build new IC and SPD effect.
Increase in China.
<unk> larger than any of the existing facility in the company.
There is all of this has been record revenues for the past four years running.
With a clear line of sight to a fifth in 2022.
On the other hand, our profitability was compressed.
As we build and ramp these two new facilities.
We experienced it typically invest to grow scenario for a manufacturing company.
Our short term financial pain is treated for long term gains so long as the team executes.
For SPD factory ramped the full phase one capacity in FY 'twenty.
Our IC factory did likewise in FY 'twenty one.
But the initial ramp is complete.
However, our long term model is now coming into view.
We set three new finance should we set a new three year financial.
Target model at our December 20, Investor Day.
We targeted gross margins in the mid to high <unk> and operating margin in the mid to high teens.
Which represent prior peaks for photronics.
Our recent results have blended December model obsolete.
As we have operated the upper end of the range in the second half of 2021.
We were well above it in Q1.
As a result, we are announcing new long term targets to reflect our current performance and the leverage in our new business model I.
I will say more about this in a few minutes.
Yes.
In addition to strong growth in revenues and profit.
Operating cash flow was up 125% over last year.
This further strengthened our balance sheet.
<unk> us to continue pursuing our investments in profitable growth.
And our leadership position and improve our return on invested capital.
A major objective of our investment strategy and we are making progress on improving this metric.
Our investment strategy is supported by three pillars revenue growth margin expansion and exploration of strategic partnerships.
Our success in growing revenue depends on having the right tools and the right location with the right technology.
At the right time.
Coupled with solid execution and strong customer relationships.
One is a result of this approach has been our expansion in the market in China.
Which is the most rapidly growing geographic market today for semiconductors and displays.
Chinese customers are growing fast and we're growing faster with a 36% CAGR over the past three years.
As a result product shipped to China represented 40% of our trailing 12 months revenue at the end of Q1.
In addition, we are leveraging our technology leadership and analytic displays and their penetration in the smartphones to grow our SPD business.
These displays are becoming more common across premium as well as mid range phones as performance advantages are well known and the cost of basic amyloid displays comes down.
For the most advanced displays and premium smartphones. The mask intensity is increasing to enable the added functionality displays such as embedded touch screen and fingerprint sensor, which is great for us.
Looking forward, we expect the SPD <unk> market to be flat in 2022 with growth in 2023, driven by industry investments in Korea and China.
We are investing in new add PD capacity with orders placed for tools that.
That should come online mid 2023.
To support these investments we have recently signed customer supply agreements there.
They are expected at 10% to MPD revenue and we are in conversations regarding additional agreements to add 10% more.
A recent development feeding into our growth is the resurgence of legacy semiconductor foundry demand.
We view this as the rebirth of the ASIC market.
He has placed increased demand in the mass sector as industry supply growth has been limited historically.
It is called lease times to expand his creative pricing leverage in this sector for the first time in decades.
We're sold out of mainstream capacity in Asia.
Better exploit this opportunity we are investing incremental capacity.
By installing point tools at several of our factories, including the expansion of one of our facilities in Taiwan to make additional clean room space for these tools.
We believe the growth in legacy foundry, coupled with the masking hence the of this segment.
Strong pricing leverage.
<unk> us to profitably grow in this sector.
The legacy foundry sector is driving revenue growth as well as margin expansion.
Pillar of our investment strategy.
Sustained pricing strength is evident globally as we implemented double digit price increases in Taiwan, and China in 2021 and.
And are actively raising prices in Europe and Korea.
CBOE driver of gross margin improvement in Q1 was pricing, which.
Which we believe the sustainable giving us confidence to invest in capacity expansion and raise our long term targets.
As we grow our business the inherent operating leverage in our model will further expand margins and drive improved financial performance.
Finally, we are continuing continually exploring strategic partnerships to grow our business inorganically.
This pillar focuses on opportunities that would extend our position as the market leader by either bringing capacity or capability to help us better serve our customers.
We have a history of successful M&A and joint venture formation and believe this can be an important piece of future growth.
Before turning the call over to John to review, our financial results and provide guidance I would like to take a moment to present, our updated target model.
As I mentioned earlier, we provided a three year target model in December of 2020.
Due to strong market dynamics and our successful execution, we achieved those targets within one year.
And are now operating well above them.
In order to help investors understand where we're heading we are providing updated targets collaborated in the supplemental slides on our company website.
We've increased the revenue ranges to reflect strong demand and continued investment in capacity.
Margins at both the gross and operating level are higher because we anticipate mainstream IC pricing benefits to be long lasting.
We've established a strong moat with analyst technology in SPD <unk>.
We continue to target, 50% incremental margins.
So far our new long term model, we see gross margins, reaching the mid <unk> and operating margin in the mid twenties.
This improvement in profitability should produce higher cash flows in EPS.
Including earnings approaching $2 per share and free cash flow of 200 million annually.
Elevating the financial profile of our business and ultimately, creating greater value for our shareholders.
Linked to emphasize that this level of financial performance has never been achieved by the company.
<unk> is right in our line of sight and it already represents transformational change to our business model.
This is the gold medal for all the hard work by the entire team over the past five years.
I want to take a moment to thank all of our employees for your state effort and the shared sacrifices it took to get here.
I am humbled by what you have accomplished and it is truly an honor to lead you.
In conclusion, we have made a great start to 2022, performing above expectations and raising our long term outlook and market demand is strong and we are investing to increase capacity to better serve our customers.
We have a great team that continues to exceed expectations.
Content to their best days are right in front of us.
At this time I will turn the call over to John .
Thank you Peter.
Good morning again, everyone.
First quarter revenue improved 5% quarter over quarter, and 25% over first quarter last year.
As demand continued to be robust for both semiconductor.
And mobile display photo masks.
We have had notable success in aligning our operations with market trends and once again saw the benefits of these investments as we achieved record revenue in what is typically a seasonally soft period.
IC revenue improved 3% sequentially and 24% year over year as strong demand continued in Asia for mainstream and high end logic.
The proliferation of chips used in multiple end use applications such as the rollout of five G propagation of consumer electronics and the electrification of an increasing number of the products. We use every day, including automotive is driving what might be characterized as an explosion.
The design of new devices.
In addition to growing volumes to supply demand dynamic is driving pricing power across the industry as Peter mentioned, enabling pricing actions globally for mainstream masks.
MPD revenue increased 8% over Q4 revenue and 27% over last year's first quarter revenue.
We have an enviable market position and advanced displays for mobile applications, specifically <unk> and LTE EPS.
Due to our industry, leading technology and first class operations.
Demand for G 10, five plus masks was also stronger this quarter, adding two high end growth.
Demand for products shipped into China was strong again, this quarter, improving 6% quarter over quarter and 69% year over year, China continues to be an important market for both IC and SPD photo mask and our business development initiatives and operations expansion.
Paying off.
We established photronics is a clear market leader.
Margins expanded again this quarter due to the operating leverage provided by higher volumes implementation of price increases in mainstream IC and.
And continued focus on cost controls.
Gross margin of 31, 5% and operating margin of 21% are both above the long term ranges we communicated in December 2020.
And that led to our decision to update the ranges in our target model.
Peter discussed the factors underlying the model and we're confident in our ability to maintain improved margins and deliver on the new targets.
Below the line income tax provision increased due to the increased earnings and the distribution of earnings among the various tax jurisdictions, where we operate.
Net income to Noncontrolling interests increased with the strong performance of our joint ventures in China and Taiwan.
And other income was due primarily to unrealized gain on foreign exchange.
Diluted earnings per share was 38, a 15% increase over the 33 in Q4 and nearly triple the 13th.
In Q1 last year.
Cash and equivalents increased to $314 million in debt increased to $97 million net cash of $217 million.
Resulting from operating cash flow of $59 million as Peter mentioned more than double the cash flow in the same period as last year.
$15 million from our JV partner is their contribution.
The impending capacity expansion in China.
We invested $19 million in Capex during Q1, which indicates free cash flow of $40 million for the quarter and our capex forecast for the year remains at $100 million.
Primarily for increases in mainstream IC capacity and deposits on tools to be delivered in 2023.
We spent $2 $5 million to repurchase.
<unk> shares in the quarter, which brings the total spend so the current $100 million authorization.
$268 million.
Since we began the repurchase program in 2018, we have repurchased 12 million shares and returned $130 million to shareholders through share buybacks.
Before I provide guidance I'll remind you that our visibility is always limited as our backlog is typically only one to three weeks and demand for some of our products is inherently uneven and difficult to predict.
Additionally, the Asps for high end mask sets are high.
And as this segment of the business grows a relatively low number of high end orders can have a significant impact.
On our quarterly revenue and earnings.
Given those caveats, we expect second quarter revenue to be in the range of $188 million to $196 million driven by a continuation of favorable end market demand trends across both IC and mobile FPGA.
Based on those revenue expectations and our current operating model we.
We estimate adjusted earnings per share for the second quarter to be in the range of 32 to 38 cents per diluted share.
First quarter fiscal 2022 off to a strong start continuing the performance of 2021 Red.
Revenues are growing margins are expanding cash flow is increasing and we see performance improving in the second quarter as well as longer term as we indicated in our updated target model.
I will now turn the call over to the operator for your questions.
Thank you.
To ask a question you will need to press star one on your telephone to withdraw your question. Please press the pound key.
Standby as we compile the Q&A roster.
And again to ask a question press star one on your telephone.
Our first question comes from Tom differently.
Davidson.
Your line is open.
Yes. Good morning. Thank you for the question in the new guidance.
I'll talk a model so Peter I guess the question I have is maybe talk a little bit more about the sustainability of the mainstream pricing.
Perhaps where it is in regards to what it would take to support the purchase of new equipment to.
And capacity in that space.
Yeah.
Yes so.
You can see Tom right historically.
Our mainstream.
Business was running for 10 years at about 250.
Annually.
We're in a mature market there'd be a few percent of price down and we gain a few percent of market share.
And as a result of that or whatever and he is really remarkably stable.
<unk>.
Leaving the quarter were $333 million run rate.
Sure.
We're sold out.
Throughout Asia, we're raising prices, we're nearly done.
We're in the we're in the top half of the ninth inning raising prices in.
In Korea.
And in Europe . So.
So basically globally with the exception of the U S. We have double digit price increases.
Now in place everywhere.
Typically.
Can you hear us we went with one to two weeks worth of backlog.
Mainstream right now.
The backlog is two to three months.
So we're operating.
At about a 25% deficit.
And our capacity to market demand.
We're going to try to add.
We won't be able to given our.
Given the tools, we can intelligently yet this year, we will get back hopefully get back most of that maybe.
And you can get 15%, 20% back by the end of the year our expectations for growth in demand as we will end the year.
In the same hole or a bigger one than we start that's what we see in the market. So.
So if we can get capacity up 15% to 20%, we still see the market.
Leading us to have about a 25% deficit at year end.
And as I said.
In prior calls we look back at the ASIC market.
And when that market was booming.
<unk> foot enhanced revenues to semiconductor revenues was running about 3%.
Yeah.
The closest where this business is most concentrated as China today.
Right and when you look at that market right now.
We see.
Today.
<unk> revenues are running about 2%.
Of.
China Silicon revenues, so it's double double.
Double.
Photo mask content of the global market right now.
So to me a specific industries for the last 10 years have run 1% China is running too.
Given our estimates what we see and we see.
The photo mass market in China, right now growing at about double so about 25%.
The growth rate in the silicon market.
So you kind of put all those things together.
And that's where our.
That forms the mosaic that we see and view the market through and.
And when we look at our competitors, we see them doing the same thing that we're trying to add point tools.
Don't think theyre going to be more any any more effective then we aren't raising capacity.
So theres, a 25% to 30% deficit today, theres likely going to be at 25% to 30% deficit at the end of the year.
Sure.
It's kind of what we see.
Even though overall.
Trying to cobble together point to investments to raise output.
Okay. That's very helpful thing.
Curious.
The strength Youre seeing on the mainstream side is it certain segments or is it across the board in things like power, we hear a lot about but is it a certain segment or a couple of segments that are really driving that strength.
Well it really.
Sure.
It's.
The way, we the lens through which we view it is more through the lens of technology nodes.
And what really is driving it is 90 $65 55 and 40.
And there is some shift moving to 28, what you call that a legacy.
Our mainstream or high end node is up to debate I guess, but right now it's really $40 65 is the sweet spot and 90.
In 2008 are strong so that's where the bulge in the business is concentrated.
Okay, Great and then just last question then on the capital spending side.
<unk>.
Adding these point tools materially.
Next you expect for the next one to two years.
No our capex.
It has been running about $100 million rate, we expect that it's going to run.
This year.
John did some.
So so.
We continue to look at.
$100 million spend and of course.
As the business grows and earnings grow operating cash flow growth, so that spend level that creates more free cash flow and you can see it this quarter rate $60 million of operating cash flow $40 million of free cash flow.
So.
This is all quite good.
Okay. Thank you for your time.
Thank you Tom.
Thank you.
And Atlanta to ask a question you will need to press star one on your telephone to withdraw your question. Please press the pound key.
Our next question comes from Aaron Martin of AIG Agency partners.
Line is open.
Hey, good morning, guys.
Congratulations on a great quarter, great execution in the stroke market.
I appreciate you updating the long term model.
I understand things are fluid, but I'm trying to understand you don't have to look at Q1, and the Q2 guidance.
The run rate there.
Especially.
Q1, being the seasonally weak quarter.
Heading into the second half year, we just annualized were already passed.
The low end of the of the target model.
From a top line and then you talked about exiting this year still to industry.
Deficit demand, hoping to add no.
These kind of tools, adding 15% capacity, which then puts you over the top end.
Your long term target model so with those.
That in mind.
I'm trying to reconcile that with.
It sounds like they are today almost already.
This being a two to three year target model.
Yes. So thank you for that question. So first of all the capacity add is on the mainstream business alone, which is right now to $330 million.
Run rate. So when you do the math you have to apply the math to that segment of the business, but having said, yes, having made that clarification I guess is the right way to describe it.
Part of the Capex. This year is also for SPD deposits and we're also investing in our high end business, but anyways.
If you look at 800 right on the top line.
For the last four years, we've been on a 10% CAGR. If you just project that forward to 2023, which is.
This target model is focused on it takes you to that $800 million.
Number and <unk>.
The improvements, we're making in our operations likewise.
It's very.
It's very easy.
To just rationally run the numbers forward to see that nothing on the chart is anything other than.
Projection of.
Last several quarters and several years of business performance to hit $800 million.
So the way we kind of look at this is $800 million.
More of the same.
But it's more of the last four years. So we don't have a tremendous amount of credibility $8 50 is aspirational and two years and 775 sort of kind of says well we get a downturn in 2023 that we don't expect that.
Could happen.
So that's how the model.
Yes.
It reflects itself into the market.
And Aaron just from from an accounting standpoint.
This model is not a thumb in the wind just assuming continuation of certain trends.
It's a bottom up.
By operating location.
Of what we expect the capex to generate an additional revenue and the pricing that we expect to maintain so it's.
It's a bottom up generated model, but that we expect to be able to accomplish and as you pointed out.
We could be almost there with our current performance, but theres a big stretch between 775 and $8 50, and if we just maintain that 10% CAGR that we've that we've done over the last four years.
800 should be.
Really well assured I think you guys would both be personally disappointed with just maintaining because its not I don't know you guys to be that way, but.
Those back to the bottoms up analysis.
Okay.
Yes.
Talk about the.
The backlog is it fair.
Fair to call it that the unusual lead times right now and then how you've been parlayed that into longer term commitments from some customers I want to make sure I got the numbers there on the 10% 10% of water than what you can add upon that.
What can we how can we take the current market conditions and ensure that into long term, maybe three four years down the line.
Is this going to end up being a different model, where you have more visibility.
Yes.
So.
Yes, So let me answer that because it really is a tale of two markets right. So our investors I think.
There is something that is widely Miss I think construed and that is our SPD capacity for the last several years running has been sold out.
So the investors our investors I think assuming the market.
Is strong the reality is.
Our largest competitor in SPD, which is S. K E. They were down sequentially, 16%.
We were up eight.
That's a 25% swing.
Our second largest competitor isn't a public company, so I won't name them, but what we hear from the market is there.
They're empty, which of course doesn't mean, they have nothing but it means <unk>.
Lots of Unutilized capacity so.
The contractual commitments we just.
Entered into or for the.
PD different tools, we're going to be installing.
In 2023.
Ramping in the second half of 2023.
So we.
We have 10% in the bag the other 10% the conversations are very mature so I'd be disappointed.
Very disappointed if we don't wrap them up by the end of March. So we are very close.
Sealing the other 10, so shortly will have capacity commitments in hand for.
20% more.
Of our PD business, despite the fact that.
The market right now.
Generally is not strong with his strong as amyloid.
We are a technology moat there.
And it's allowing us to fill our factories when our competitors cannot but more importantly customers are making multi year to three year.
<unk>.
Yes.
Out another if theres a year between here and there and it's a two to three year contractual commitment hung on the end of that.
Because of the strength of our technology.
That's the that's where.
Where the 20% is it's on the business that last quarter was running it at $240 million run rate.
That's where the commitments are.
As far as the IC business is concerned we have the mainstream and we have the high end.
At the high end business is behaving.
Typically I guess is the way I would describe it we have one to two weeks worth of backlog, we don't have.
Ah.
On a typical levels of.
Backlog in the mainstream again, which is running along at a $330 million clip.
Two to three months worth of backlog there.
And the way I answer Tom <unk> question, we believe that.
And it's hard to know but.
When the next downturn happens if the market kind of continues like it is.
Okay.
That's typical number so if the next downturn is typical.
Given where we're operating now and if that doesn't change.
We will still have more mainstream demand then we will have capacity and it wont just be that won't just be photronics.
That will be the photo mask industry in which case the <unk>.
Pricing stability will stick because there'll be no reason.
For anyone to lower price, because you can't gain more market share when youre sold out.
So that's that's that's our current.
In terms of the difference in markets.
And market share.
Ed.
LCD or other generation, what do you estimate your market share and amyloid relative to.
Other displays.
Yes.
<unk>.
We don't typically give.
Market share numbers, but you can see that 75% of our SPD business as high in <unk> and it's the high end is dominated by amyloid. So that's basically what we sell we have we obviously keep our tools full.
No.
And it's a constant.
Challenge.
Balance our lines because a typical Ms set has.
Yes, hi, and layers and.
<unk> layers in mature layers.
But.
We have our factory right now optimized to build as much amyloid.
Business as we.
As we can.
We really can't make anymore.
Okay. Thank you very much and congratulations again.
Incredible job.
Thank you thanks John .
Okay.
Thank you.
Again to ask a question. Please press star one on your telephone to withdraw your question press the pound key.
Our next question comes from Richard Greenberg of Donald Smith.
Hi.
Your line is open.
Yes, I think you answered my question on the previous questioners, but I remember your previous model did sort of built in.
And it sounded like you potentially done that with the lower end so.
I think that answers yet, but the second part of my question was what are you assuming in this model of you use all this free cash flow for I mean, it seems like youre not really assuming any additional buyback, even though that is a possible a possibility or acquisitions. So there is no.
Incremental either revenues or less shares outstanding or further growth.
Assumed with that free cash flow is that correct.
So Richard we maintain our.
The capital allocation strategy that we've had.
First priority is organic growth.
Second is.
Whatever M&A opportunities allegiances alliances.
Partnerships et cetera, and then the third.
Would be share repurchase so that's that's our ongoing capital allocation strategy, we still have $32 million of our 100 million authorization available.
And.
We maintain that strategy.
Right I understand that but im just saying that would all be incremental to the model that you show here right.
That's exactly right Richard and thank you for that.
Okay and I guess my second question is.
Peter at some point it seems to me with margins like this.
Semi manufacturers will.
Finally, as kind of much more expensive for them to go merchant and they will just bring more in house what is their capability to do that and how much of a concern do you have that.
The competition will ramp up from the manufacturers themselves produce masks.
Yes, well.
Most.
Most of the captives.
They're not.
Actually all the catheters Theyre focus is the high end and some of them look for example until.
Sure.
Samsung don't build mainstream phone.
Asks so I guess they could.
<unk> tried to do.
What.
We're trying to do which is find a way to eat.
Economically.
Expand capacity into the mainstream sector, but.
A lot of the tools, we have rich that build mainstream photo mask used to be owned by people like Intel and Samsung.
They got out of the business, so listen tools, so getting back in the business.
He is going to be.
Very expensive.
So I think current pricing as we've said doesn't support that.
I think if we go through the downturn the way I <unk>.
Described it with no loss of pricing leverage.
The next upturn will be raising price again.
So I think if we're able.
To go through a downturn with no price erosion and upturn with pricing another upturn with pricing power.
We may be reaching a point and we're adding new lines.
Have the appearance of generating acceptable financial returns in that.
You won't be unique to us.
It will be it will be germane to other merchants.
<unk> and what happens then I really can't tell you, but I think yes.
We're cycle away from them.
Really needing to worry about your question.
Okay, great. Thanks, a lot guys.
Thank you rich.
Yeah.
Thank you.
Yes.
Ladies and gentlemen, there are no further questions at this time I will now turn the call over to Peter Kirlin for closing comments.
Thank you for joining us this morning, I am proud of the entire Photronics organization.
They have worked hard to meet elevated customer demand, while keeping costs low and maintaining high quality.
We are optimistic about our future and believe that we are on track to deliver against our updated target model look forward to updating you as move forward have a great day.
By at all.
Okay.
Ladies and gentlemen that concludes the conference call for today, we thank you for your participation that you. Please disconnect your line.
Yes.
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