Photronics, Inc. (PLAB) Q4 2020 Earnings Call Transcript

Photronics, Inc. (NASDAQ: PLAB) Q4 2020 earnings call dated Dec. 09, 2020

Corporate Participants:

R. Troy Dewar — Vice President, Investor Relations

Peter S. Kirlin — Chief Executive Officer

John P. Jordan — Executive Vice President, Chief Financial Officer

Analysts:

Patrick Ho — Stifel — Analyst

Frank — D. A. Davidson — Analyst

Gus Richard — Northland — Analyst

Presentation:

Operator

Ladies, and gentlemen, thank you for standing by, and welcome to the Photronics Q4 Fiscal Year 2020 Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded, Wednesday, December 9, 2020 [Operator Instructions].

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

R. Troy Dewar — Vice President, Investor Relations

Thank you, Jimmy. Good morning, everyone. Welcome to our review of Photronics 2020 fourth 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 section of our webpage.

Comments made by any participants on today’s call may include forward-looking statements. They 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.

Lastly, before turning the call over to Peter, I invite you all to join us next Monday, December 14, at 10:00 a.m. Eastern, for our 2020 Investor Analyst Day. The event, which will be webcast, will include an update on our long-term strategy and outlook. More details are available on our website or you may contact me with any questions.

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

Peter S. Kirlin — Chief Executive Officer

Thank you, Troy, and good morning, everyone. Despite operating in a very challenging environment, full year revenue in 2020 was $610 million, the highest ever, and the third consecutive year of record revenue. FPD achieved record revenue for the second year in a row, surpassing last year’s record level total by an eye popping 32%. IC revenue in 2020 was the second highest ever, just shy of the record established in 2015. We also achieved record revenue product shipped to customers in China on a consolidated basis, also for both IC and FPD.

It was a great year for Photronics. We accumulated many significant milestones.

For the fourth quarter, revenue was lower as typical seasonality was worsened by geopolitical factors; primarily in FPD, where mobile display demand was constrained by U.S. trade sanctions against Huawei.

In IC, we saw strengthening trends among some logic foundry customers in the U.S., and Asia. However, memory demand was weaker. But the combination of these factors, our revenue was down 5% sequentially.

With the quarterly decrease in revenue and the high amount of operating leverage in our business, we saw a contraction in profit margin.

Operating expenses stayed under control as we maintained cost discipline amidst the challenging circumstances. Thus, we were able to deliver $0.10 in diluted earnings per share.

We ended the year with $279 million in cash, an increase of $72 million from last year. This was accomplished even as we spent $71 million on capex, investing in future growth; and $34 million on share repurchases, returning cash to our shareholders. I believe these achievements demonstrate that our investment strategy is working, and we are on the path to improving long-term shareholder return.

Looking back on 2020, the challenges we faced were unlike any in my 35-year career. Primarily among them were significant supply chain and customer design team disruption, as governments around the world placed restrictions on travel, working conditions, and commercial activity, to limit spread of the coronavirus. In addition, trade restrictions implemented by the U.S. Federal Government against certain companies in China, created their own set of market dislocations.

Fortunately, with the development and approval of effective vaccine, and the expected impact of the U.S. election results, it appears these challenges will diminish as we move through 2021.

Regardless of the 2020 challenges, I am proud the way our team responded. They worked tremendously hard to take care of our customers and win every opportunity in the market. Due to their efforts, we achieved record revenue and I’m confident that we have gained market share.

Our 2020 revenue came within just a few percentage points of the target we set three years ago. While we formerly rescinded the $630 million goal in May, during the height of the COVID driven market uncertainty, we continue to chase this target to maximize our growth. There are no more victories, and we recognize there is room for improvement, but I’m really proud of our performance. Further, I like our position in the market and the long-term outlook for our business.

Next week, we will host an Investor Day. Let me preview some of the key points we will discuss during that event. Photronics represents a compelling investment thesis. We are the largest merchant photomask manufacturer with 11 global facilities, something none of our competitors can match. We have invested in technology to align our operations with secular market trends, such as the industry’s geographic expansion into China; the growth of high-end display technology, such as AMOLED for mobile applications; and enabling of our customers technology roadmap to continue introducing new semiconductor nodes and pursue the continuation of Moore’s law.

We have investment model that enables us to invest in growth, which expands our cash flow and strengthens our balance sheet, positioning us to consolidate our market while returning cash to shareholders. We believe this will lead to greater shareholder returns.

We have performed well since our last Investor Day in 2018, delivering on many of the commitments we made then, such as constructing, equipping, staffing, qualifying, and ramping two new manufacturing facilities in China. In addition, we have made further progress against our key initiatives to diversify our business by growing our China revenue, increasing our share of business with customers that have captive shops, and increasing our sales of high-end products.

We’ve been able to do this despite the challenges in 2020, by staying true to our core competency, being a low-cost producer, employing operational excellence in everything we do, prioritizing customer intimacy to become our customers trusted photomask partner, and maintaining technology leadership to ensure we can meet all of our customer’s needs.

These attributes have served us well for over 50 years, while we remain committed to them heading into the future.

Looking forward, we are increasingly optimistic regarding our long-term outlook and have positioned the business for sustained growth. By delivering the right technology to the right customer at the right time, we intend to expand our leadership position.

With plans to increase profit margins and enhance cash generation, we expect to deliver even greater shareholder value.

We have much more to say next week and I hope you can join us.

Before turning the call over to John to provide additional commentary on our performance and outlook, we’d like to thank all the Photronics employees for their commitment and hard work, and wish all a wonderful holiday season. John?

John P. Jordan — Executive Vice President, Chief Financial Officer

Thank you, Peter. Good morning, everyone. As Peter mentioned, 2020 was a record revenue year. The year began on a run rate in Q1, well in excess of the $630 million target we set almost three years ago. And after the COVID-related disruption in Q2, we recovered to a run rate still in excess of the target.

Q4 was again impacted by geopolitical influences when the trade sanctions against Huawei suppressed the FPD business, while that supply chain reset. Nonetheless, with $610 million, fiscal year 2020 revenue exceeded the fiscal year 2019 record by 11%, and set the third consecutive annual revenue record.

During fourth quarter, our business typically sees a slight seasonal decrease in demand, as the design cycle winds down from recent introductions of new consumer electronics products. Our fourth quarter decline was exacerbated by pockets of softness in some sectors, and a negative impact from U.S. trade sanctions against Huawei.

Revenue for the quarter was up 5% compared with last quarter and 4% compared with the same quarter last year.

IC revenue was particularly strong in China as we shipped a record level of products to customers there. Foundry logic demand drove the increase as the region continued to be a healthy location for new design activity.

In other geographies, Korea and Taiwan also saw a good foundry logic demand and U.S. logic revenue benefited from an emergence of trusted supplier opportunities for defense applications. The area of weakness for high end IC was memory, where recovery is not expected until sometime during 2021.

FPD mask demand was negatively impacted by two factors. First, as we discussed during our third quarter call, U.S. trade restrictions against Huawei is having a dramatic impact on the China global supply chain. As Huawei was effectively prohibited from supplying leading edge semiconductors, their ability to release new mobile phones is very limited. That reduced their demand for new display panels, which reduced demand for masks from their channel producers.

That supply chain is in process of resetting to meet the demand especially in China, and we’ve seen the market move away from Huawei to other China mobile phone manufacturers. Huawei recently sold their low end to mid-priced phone division to separate and insulate that business from the U.S. trade restrictions.

Since Huawei was one of the largest suppliers of smart phones by units, the ripple effect of these moves is being felt throughout the supply chain, exerting a meaningful effect on the mobile supply chain and therefore our business. As a result, our revenue for AMOLED masks sets was down 21% sequentially.

The second display trend was the improving profitability of panel producers. Strong unit demand and higher pricing for TV and IT products created incentives for them to continue production runs of existing products to maximize short-term profit. That resulted in delay of new design releases, the driver of mask demand. Thus, demand for our LCD masks for G10.5+, as well as a smaller form factors, was down for the quarter, negatively impacting both the high end and mainstream revenue.

Profit margins on the gross and operating line were lower due to the impact of operating leverage on the results. Our continued focus on margin expansion should yield improved results next year, as we complete the ramp of our IC phase one investment in China and implement our next phase of FPD investment. We will elaborate more on our long-term margin targets during our Investor event next Monday.

Below the operating line, other expense of $2.9 million included interest expense and the primarily unrealized effect of the remeasurement of U.S. dollars denominated balance sheet items of our foreign subsidiaries.

Tax provision and noncontrolling interest were in line with expectations, resulting in earnings of $0.10 per diluted share for the quarter.

Our cash balance at the end of 2020 was $279 million, an increase of $72 million during the year, and $18 million during the quarter. Significant cash events during the quarter was $63 million generated from operating activities, $34 million of capital expenditures, $18 million return to shareholders via share repurchases. We repurchased 1.7 million shares of Photronics stock during the quarter, and $13 million in net proceeds from debt.

We also paid $16 million in dividends to our Taiwan JV partner. Those dividends are generally contributed back to our China JV in future periods.

Total capex in 2020 was $71 million, less than our $80 million target. Next year, we forecast capex of about $100 million, as we complete the phase investment in Xiamen, and execute the next phase of our FPD investment in Asia.

Our strong balance sheet has enabled us to invest in China, and return $79 million through share repurchases since 2018. Looking forward, we have plotted a course that would generate sufficient cash from operations to continue to invest in organic growth and return cash to shareholders.

In parallel, we will be actively open to M&A opportunities in the photomasks space to extend our market and technology leadership. We will share more on Monday.

Before I provide first quarter guidance, I’ll remind you that our visibility is always limited as our backlog is typically only 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 relatively low number of high-end orders, it can have a significant impact on our quarterly revenue and earnings.

Geopolitical risks related to government actions to address health concerns or trade policy may have an impact on our operations, the operations of our customers and suppliers or end market demand, resulting in an adverse impact on our industry and therefore our results. I will also point out that our first quarter will have two more days than the fourth quarter.

Given those caveats, we expect first quarter revenue to be in the range of $145 million to $155 million. Underlying market demand in many sectors is healthy and improving, driven by trends in remote work and education, although geopolitical headwinds remain due to trade restrictions and government actions to limit travel and business activity.

The midpoint of our guidance implies revenue essentially flat with Q4. Based on our revenue expectation and our current operating model, we estimate earnings for the first quarter to be in the range of $0.07 to $0.14 per diluted share.

2020 was a challenging year and it appears many of these challenges carried into 2021. However, our workforce has responded well all around the globe and we are in a solid position financially to be able to continue to invest in capabilities and technology to drive growth while taking meaningful steps to improve profit margins and optimize returns.

Our initial outlook for fiscal year 2021 suggests that revenue growth will be high single-digit percent and that operating profit growth will be similar through the 23% growth we achieved in 2020. Again, please join us on Monday to learn more.

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

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from Patrick Ho with Stifel. Your line is now open.

Patrick Ho — Stifel — Analyst

Thank you very much. Maybe first off, Peter, in terms of the mainstream IC marketplace, can you just help reconcile a little bit of the commentary I’ve been getting in terms of high utilization rates for many market segments within the trailing edge geometries and I guess just kind of the mixed outlook you’re talking about on that side of things?

Peter S. Kirlin — Chief Executive Officer

Yes, so if you look at our mainstream business this year, Patrick, when you look at it at the 100,000 foot level, right, been pretty stable quarter-to-quarter, right; revenues of high 60’s, $67 million, $68 million, maybe that $70 million.

If you peel back that remarkably stable trend, right, maybe what has happened during years of rotation of the business from the U.S. and Europe into primarily Taiwan and China. So, our mainstream businesses, the demand profile is shifting, with — as I said, with the West seeing the market diminish with growth in the Far East.

We think that rotation has more or less run its course and we see upward demand in the foundry logic business in Asia, and we expect that to continue in strength and actually as we move through next year and into the following year. So, there has been a shift. We think the shift is more or less complete and we are actually really bullish on the market opportunity in China, in Taiwan and you will hear a bit more about that next week. But it’s clear target for us for growth.

Patrick Ho — Stifel — Analyst

Fair enough. Thanks for that color. And maybe as my follow-up question on the memory side of things, I concur that the current environment for most of the memory market continues to be soft. But at the same time, you do hear of the industry transitions both in terms of DRAM as well as NAND towards next generation devices. I guess, can you reconcile little bit of typically the shift to next generation knows and layer counts that’s usually a positive driver for Photronics in terms of design wins? Can you reconcile, I guess, a little of what’s going on there versus some of the softness that you are seeing in the near-term?

Peter S. Kirlin — Chief Executive Officer

It’s interesting, because again, if you look at our IC business year-to-year, we have had a lot of — our business has been assaultive, right, this year, where we had two — we would describe as pretty healthy quarters, right, Q1 and Q3. And those quarters have been at about $640 million run rate, which is great. But we’ve had Q2 and Q4. Q2 was basically driven down into the high 500s on a run rate basis by COVID, and Q4 was driven to just slightly below 600 by geo — basically trade war impacts.

So, our business has been schizophrenic from what I would describe as strong and normal to profoundly influenced by external factors. Through that, our memory likewise has been assaultive through the year, up and down. And the only real material trends you can see if you look year-over-year, our memory business is down, which I think reflects the overall state of the memory industry.

We do, from the perspective of our customers, we are expecting our memory business to step up significantly next year, particularly as we get into the early spring. So, we see this as more or less at where we are as near-term belly, but I guess we are optimistic given what we see in the market for a rebound in the Memory business and our particular customers have pretty aggressive plans for no transition next year, which is really as you point out what drives our revenue in that industry.

So, yes — so that’s the quick summary.

Patrick Ho — Stifel — Analyst

Great. Look forward to your day on Monday. Thank you.

Peter S. Kirlin — Chief Executive Officer

Okay.

Operator

Thank you. And I’m showing no further questions in the queue at this time. I’d like to turn the call back to Peter Kirlin for closing comments.

Peter S. Kirlin — Chief Executive Officer

Okay. Thank you for joining us this morning and we look forward to reconnecting next Monday during our Investor Day.

Operator

Before we sign off, speakers, I did see two other participants join the Q&A queue. Would you like to continue to take their questions?

Peter S. Kirlin — Chief Executive Officer

Of course, yes.

Operator

Understood. Our next question comes from Tom Diffely with D. A. Davidson. Your line is now open.

Frank — D. A. Davidson — Analyst

Hi. Good morning, guys. This is actually Frank [Phonetic] for Tom this morning. Thanks for taking my questions. I guess I wanted to ask how much conservatism are you including in your first quarter outlook? I understand that right now I guess with the geopolitical headwinds are difficult to ascertain, but any color on as for quantifiable conservatism number?

Peter S. Kirlin — Chief Executive Officer

Yes. So, if you look at our business, normally, Q1, seasonally is down maybe 5% off of Q4. So, the midpoint of our guidance reflects a flat quarter. So our business is — our markets are improving, so we take the guides to basically improvements in our market to offset seasonality. That’s what we have done.

If you look at our IC business, right, first, demand trends in Asia have been pretty solid. You look at FPD, right, last quarter we estimate that the industry, our industry, photomask industry, maybe ran at about 70% utilization in FPD. In turn, this is internally what we estimate. That’s the worst quarter I can remember. My memory maybe goes back three to five years. I’m getting old, but it was a really stellar quarter for FPD.

Likewise, the month of November through Thanksgiving remained stellar. Right around Thanksgiving, the FPD market started to rebound and it continues to improve. Now, could it — what will it do, right? We don’t know. So, we are trying to kind of gauge between our normal market and what is — and what was a terrible market. And our utilization was probably 15% above the industry average last quarter, but it’s the first quarter in several years where we haven’t been sold out.

So, that’s kind of our markets. That’s what we see and that’s our guidance.

Frank — D. A. Davidson — Analyst

Thank you so much for all the color there, Peter.

Peter S. Kirlin — Chief Executive Officer

Yes. Yes, I would also add, unlike prior years, right, before the new revenue recognition rules, right, every plate we have in the line has a percent completion associated with it, right. So, our business is a complete reflection of what the market is. We are not a capital equipment company that runs with backlogs that can pull some tools into this quarter that would shift next quarter with a week, two too in backlog, right?

Our business is an exact representation of what the market gives us. There is no ability for us to manage our whip or our backlog to strengthen one quarter at the expense of another. Management has no operational discretion whatsoever. Comes in, we make it, and you guys see exactly what the tone of the business is, real time.

Operator

Thank you. Our next question comes from Gus Richard with Northland. Your line is now open.

Gus Richard — Northland — Analyst

Yes. Thanks for taking the question. Real quick on SMIC, which has just gotten banned. Are you seeing customers migrate their business to other foundries, and is that helping the mainstream?

Peter S. Kirlin — Chief Executive Officer

Well, I think to the extent that happens over time, right, SMIC — so first of all, SMIC is a customer of ours. They’re not a big customer because they have their own captive, but they’re customer. Anything that harms the customer, for us, is a negative. We don’t like to see any customer harmed in any way by external factors that are not driven by the market.

So, I think that will be the first comment. We wish SMIC, like all our customers, well. And it’s our culture regardless of where a customer sits in the world, to run through walls to help them be successful. That’s really what we want.

Having said that, it is true that if we shift market demand from a customer that builds a significant fraction of their own photomasks, customers who buy them on the merchant market, that’s going to create demand for Photronics, but it’s not a happy way in our mind of seeing our market expand.

Gus Richard — Northland — Analyst

Got it. And then you know there’s been a number of companies that have planned to or have listed on the star market, where evaluations for semiconductor-related companies are significantly higher than the US. Is that something you guys might consider or any thoughts there?

Peter S. Kirlin — Chief Executive Officer

Well, we constantly, relentlessly, look for ways to increase shareholder value. And this is one of many possibilities that we either have or intend to consider. A move like that has some potential upsides and it could have potential downs, depending on what happens on the geopolitical front.

So, we are aware of it. We are looking at it. But we’re a company generally that’s been around for 50 years, and we’re normally slow to move to new trends, because it’s typically a good way to get a lot of arrows in your back.

So, we’re very aggressive with the market. So, we, unlike others, have really rushed headlong into China, because we see that’s where the growth is in our industry. So, from an execution perspective, we’re very aggressive. From the standpoint of what I would describe as other trends, we generally like to see others move forward, look at the outcome of that and evaluate both pluses and the minuses based on some kind of history and then make an informed decision. So, that’s where we are.

Gus Richard — Northland — Analyst

Okay. Thank you for that.

Peter S. Kirlin — Chief Executive Officer

Yes, it looks interesting, but it’s really early in the game, yes.

Gus Richard — Northland — Analyst

Okay. That’s it from me. Thanks so much.

Operator

Thank you. And I’m not showing any further questions in the queue at this time.

Peter S. Kirlin — Chief Executive Officer

Okay. So thank you for joining us this morning and we look forward to reconnecting next Monday.

Operator

[Operator Closing Remarks]