Photronics Inc

NASDAQ:PLAB

Earnings Call Analysis

Photronics Faces Soft Demand but Maintains Strong Financials

Photronics' Q3 revenue was $211 million, down 3% sequentially due to soft demand in Asia and macro uncertainties. High-end IC revenue grew 23% year-to-date, but FPD revenue declined. Gross margin fell slightly to 35.6%, while operating margin compressed to 24.7%. The company generated $75.1 million in operating cash flow and expects full-year CapEx of $130 million, down $10 million from previous estimates. Looking ahead, Q4 revenue guidance is $213 to $221 million with non-GAAP EPS between $0.48 and $0.54. Photronics expanded its share repurchase program to $100 million due to strong financial positioning and confidence in long-term market trends.

A Soft Quarter Amid Broader Market Challenges

In the third quarter of fiscal 2024, Photronics reported revenues of $211 million, which is a decline of 3% from the previous quarter. This downturn primarily stems from weaker demand in Asia's foundry market. Although the company experienced a surge in orders at the beginning of the quarter, this momentum was not sustained throughout, leading to slower photomask demand and ultimately lower sales in both Integrated Circuit (IC) and Flat Panel Display (FPD) segments.

IC and FPD Segments Show Contrasting Trends

Within the IC segment, revenue decreased by 3% quarter-over-quarter, impacted significantly by diminishing high-end logic mask orders, despite an uptick in memory sales. Interestingly, the high-end segment saw a year-over-year increase of 23%, fueled by strong U.S. sales and a shift by customers towards smaller design nodes including 22 and 28 nanometers. Meanwhile, the FPD revenue also declined sequentially; however, it witnessed growth in high-end AMOLED demand—a positive indicator aligning with a recovering smartphone market.

Managing Margins and Operational Cash Flow

Gross margins squeezed to 35.6%, down slightly due to reduced revenues, but reflected the strong pricing power from past price hikes. Operating margins fell to 24.7%, a drop of 110 basis points compared to the previous quarter. Nonetheless, the company managed to keep costs under control, achieving a non-GAAP EPS of $0.51, equal to the previous year, demonstrating resilient management amidst softening demand. Cash flow remained robust, with $75.1 million generated from operations.

Strategic Share Repurchase and Capital Expenditure Plans

Recognizing the ongoing challenges but optimistic about the long-term potential, Photronics announced an increase of its share repurchase program to $100 million. This decision reflects the company's confidence in its financial health, bolstered by $606.4 million in cash and equivalents. Additionally, Photronics projected full-year capital expenditures to reach $130 million, slightly reduced from earlier estimates, indicating a cautious but proactive investment approach.

Guidance for Future Growth: Opportunities Ahead

Looking ahead, the company expects fourth-quarter revenue to fall between $213 million and $221 million. This forecast comes with a cautious note due to lingering macroeconomic uncertainties. The non-GAAP EPS guidance for the quarter is estimated to be between $0.48 and $0.54, with operating margins between 25% and 27%. Despite the current market softness, management is optimistic, citing long-term trends in AI and mobile computing as key drivers for future growth in photomask demand.

Long-Term Trends Favorable for Photronics

The underlying demand for photomasks is anticipated to strengthen, driven by longstanding trends such as increased integration in automotive, energy, and consumer applications, as well as a boost in wafer manufacturing capacity. Photronics maintains a competitive edge through its strong customer relationships, technological leadership, and long-term agreements, positioning it well to weather short-term volatility while capturing future growth opportunities.

Earnings Call Transcript 2024-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to Photronics Third Quarter Fiscal Year 2024 Earnings Call. [Operator Instructions] Please be advised that today's conference is being recorded on Thursday, August 29, 2024. I would like now to turn the conference over to Eric Rivera, Chief Financial Officer. Please go ahead.

[Eric Rivera, executive]

Thank you, Michelle. Good morning, everyone. Welcome to our review of Photronics' fiscal 2024 third quarter results. Joining me this morning are Frank Lee, our Chief Executive Officer; and Chris Progler, our Chief Technology Officer. The press release we issued earlier this morning together with the presentation material that 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 and in our view. These forward-looking statements are based upon a number of risks, uncertainties and other factors that are difficult to predict.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We're under no duty to update any of the forward-looking statements after the date of the presentation to conform these statements to actual results.

During the course of our discussion, we will refer to certain non-GAAP financial metrics. These numbers are useful for analysts, investors and management to evaluate ongoing performance. A reconciliation of these metrics to GAAP financial results is provided in our presentation materials.

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

[KangJyh Lee, executive]

Thank you, Eric, and good morning, everyone. Third quarter sales came in lighter than we expected due to soft demand from Asia foundry as the strong order rate at the beginning of the quarter lost momentum.

Lingering macro uncertainty and customer concern on elevated inventory caused some to limit or defer releasing new designs. As a result, photomask demand slowed, resulting in lower sales for both IC and FPD.

High-end logic mask orders decreased while our memory business improved in the quarter. High-end FPD improved due to demand for AMOLED mask used for mobile displays as companies prepare for model release in a recovering smartphone market.

Compared with the second quarter, gross margin decreased due to the impact of lower revenue. Operational expenses were slightly lower than the second quarter.

EPS was $0.55. After adjusting for an FX gain, non-GAAP EPS was $0.51, higher than last quarter and the same as last year. We continue to generate strong operational cash, giving us added flexibility to invest in growth while also maintaining a strong balance sheet. As a result, we are announcing an increase of our existing share repurchase program to $100 million.

Eric will share details in a few minutes, but we believe this is the right time to restart our share repurchase activity and enhance our capital allocation framework. Based on our optimism in the long-range photomask market, we are also evaluating several growth options, including strategic expansion, partnerships and other possibility in U.S., Europe and Asia. We are maintaining flexibility to act quickly in support of our global customer and partners while remaining disciplined to ensure our investment meet financial objectives.

I'm very proud -- I'm very pleased with the way our team has performed during the quarter. They have taken care of the customers while managing costs and maximizing cash to maintain financial strength. We have a great team at Photronics, and they are navigating the challenges well.

Turning to the market, I would like to comment on the trend we are seeing. Photomask demand is driven mostly by design activity. Several long-term trends such as AI, mobile computing and increased IC content in automotive, energy and consumer applications drive new designs in both leading-edge and legacy technology nodes, all requiring new photomask.

As the global leader in IC mask units, we see a high level of new product qualification across the node spectrum, each with projected revenue opportunities. This all play well to our marginal strength and is a positive long-term trend for our business.

In addition to new designs, photomask demand is driven by an increase in wafer manufacturing capacity. New fabs are being built globally to meet the growth in applications such as data centers that are needed to support AI and to support an increase in supply chain regionalization. This is a positive long-term trend for photomask demand.

Due to our broad geographical footprint, capacity and suite of technologies, we are able to provide all of our customers' photomask needs. We supply nearly all leading logic fab with strong market share especially in Taiwan, China and Korea. In U.S. and Europe, we are seeing the initial signs of growing demand for regionalization.

Turning to display. Innovation is mostly due to new features in mobile displays and to a lesser degree, new TV technology that improve performance. On the mobile display, this trend was largely supported by new premium smartphones, higher screen resolution and the need to add additional functions such as fingerprint sensor and cameras, while reducing power require new advanced mask sets.

AMOLED continued to be introduced into larger-sized screens such as tablets and laptop. And the development is underway to produce AMOLED on G8.6 glass.

These trends all require high-quality photomasks. As the technology leader in FPD mask, we are well positioned to benefit from these trends and grow. While near-term demand is being challenged by dynamic market conditions, we remain optimistic regarding the long-term market outlook.

Our competitive advantage, including strong customer relations, long-term purchase agreement, leading technology and broad global capacity, position us to continue to outgrow the photomask industry. Our ability to control costs and manage cash should allow us to continue to invest in profitable growth and deliver shareholder value.

At this moment, I will turn the call to Eric to review our third quarter results and provide fourth quarter guidance.

[Eric Rivera, executive]

Thank you, Frank. Third quarter revenue of $211 million was down 3% sequentially, with market softness across both IC and FPD. IC revenue decreased 3% quarter-over-quarter. High-end was lower as improved memory sales were not enough to offset lower demand from logic foundries in Asia.

Compared with the third quarter of 2023, high-end improved on strong U.S. sales. High-end growth continues to be a factor for us as we see customers migrating to smaller design nodes, including 22 and 28 nanometers, to take advantage of the cost and performance benefits.

At the leading edge, our specialty EUV business continues to grow. Year-to-date, high-end IC revenue is up 23%, demonstrating our success in growing this segment of our business.

Mainstream once again achieved sequential growth as demand improved, particularly in the U.S. This further validates our belief that Q1 of this year was the bottom of the mainstream downturn, and we anticipate additional growth going forward.

FPD revenue was lower sequentially as well. On a positive note, high-end resumed growth with improved demand for mobile AMOLED displays. Overall, display industry dynamics remain somewhat soft largely due to the same factors that are impacting semiconductor demand. As uncertainty abates, we anticipate achieving above-market growth due to our leading technology, scale, market share and strong customer relationships.

Overall, our gross margin was 35.6%, down slightly as we would expect, given the softer revenue and our level of operating leverage. Blended ASP held up well as price increases implemented in previous years hold firm.

Our long-term purchase agreements continue to provide protection against downside risk during times of market softness, helping us maintain market share and pricing. Delivery premiums, which were meaningful last year, were no longer material to our results as lead times have normalized.

Operating expenses were slightly lower quarter-over-quarter with operating margins compressing around 110 basis points to 24.7%. Despite softer revenues through the first 9 months of 2024, we have maintained strong margins with the year-to-date operating margins of nearly 26%.

Below the operating line and excluding the impact of FX gain, we achieved non-GAAP net income of $32 million or $0.51 per share, ahead of last quarter and the same as last year. We generated $75.1 million in operating cash flow, and CapEx was $24.4 million in the quarter. Year-to-date CapEx is $87.7 million. We expect full year CapEx to be $130 million, $10 million lower than we previously estimated as some of the CapEx payments will not occur until next year.

Our CapEx will support anticipated demand growth primarily in multi-node IC capacity and capability and to continue replacing aging tools, all while ensuring we are increasing our return on invested capital.

Looking ahead to 2025, we see opportunities to continue investing in growth, primarily in IT, to ensure we are well positioned to capitalize on the positive long-term mega trends that are driving photomask demand. We will provide specific 2025 CapEx guidance during our Q4 earnings call in December.

We further strengthened our balance sheet during the quarter, increasing the amount of cash, cash equivalents and short-term investments to $606.4 million. Total debt, primarily for equipment leases in the U.S., was reduced to $20.1 million.

With our strong balance sheet and demonstrated ability to generate cash, we are increasing the size of our share repurchase program to $100 million and plan to restart activity under the program soon. We believe this is a good use of cash and will add value to our shareholders.

Before providing guidance, I'll remind you that demand for products is inherently uneven and difficult to predict, with limited visibility and typical backlog of 1 to 3 weeks. In addition, ASPs for advanced mask sets are high, meaning a relatively low number of high-end orders can have a significant impact on our quarterly revenue and earnings.

With those qualifications, we expect fourth quarter revenue to be in the range of $213 million to $221 million. While we are seeing good order rates at the beginning of the fourth quarter, lingering macro uncertainty is keeping us cautious.

Based on those revenue expectations and our current operating model, we estimate non-GAAP earnings per share for the fourth quarter to be in the range of $0.48 to $0.54 per diluted share. This equates to an operating margin between 25% and 27% as we continue to keep costs under control and maximize profitability.

We delivered sequentially higher adjusted EPS in the third quarter even as demand remains soft. This was achieved by keeping a tight control on cost. We also continue to generate strong cash flow, keeping our balance sheet strong and enabling us to invest in growth. As demand on our markets improve, we are in a great position to grow revenue and expand margins.

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

[Operator]

[Operator Instructions] And our first question will come from Tom Diffely with D.A. Davidson.

[Thomas Diffely, analyst]

Eric, I was curious, when we go through the results and how earnings kind of held in there despite the weaker revenue, it looks like a combination of tax and the noncontrolling interest were the big drivers there. Maybe you can talk about each one. On tax, why did it fall as much as it did? And then on noncontrolling, did the China percentage fall quite a bit? And if that's the case, is the profitability in China not where you want it to be quite yet?

[Eric Rivera, executive]

Sure, Tom. Thanks for the question. So from a tax perspective, what affected tax was the jurisdictional mix of earnings. Similar to the noncontrolling interest, so our noncontrolling -- our joint ventures didn't perform as well as they -- we would have liked them to perform. So as a result, there was less income attributed to them.

However, that was offset by some of our wholly owned subsidiaries. So as our wholly owned subsidiaries -- as the mix between -- earnings between our wholly owned subsidiaries and our joint ventures goes more towards our wholly owned subsidiaries, shareholders of Photronics, Inc. benefit from an additional EPS gain.

[Thomas Diffely, analyst]

So maybe to summarize, when you do projects in North America or outside of Asia, the tax rates are better and the profitability is better?

[Eric Rivera, executive]

So even within Asia, there are certain jurisdictions that just have different tax rates. So as that jurisdictional mix changes, as you have more income and lower tax jurisdiction, you benefit from a tax perspective.

[Thomas Diffely, analyst]

Okay. Great. And a couple more here. So I noticed that SG&A was up quite a bit quarter-over-quarter despite the revenue dip, maybe a little color there?

[Eric Rivera, executive]

Sure. So our SG&A was primarily increased due to professional services fees that were incurred during the quarter.

[Thomas Diffely, analyst]

Okay. I guess that leads me to my next question. Any update on the General Counsel dismissal?

[Eric Rivera, executive]

No update on that.

[Thomas Diffely, analyst]

And does that have any impact outside of...

[Eric Rivera, executive]

No, no. There was certainly no -- there was really no impact to our financial results, no significant impact, I should say. No update further than that, though, at this time.

[Thomas Diffely, analyst]

Okay. And then just one broad question. When you look at the margin structure on the mature -- the mainstream business and how, over the last few years, it's ramped nicely. It kind of peaked maybe a year ago. Is the mainstream business still healthy from a price point of view? Or has the softness in the overall transaction run rate put it back into its old kind of sequentially declining on an annual basis?

[KangJyh Lee, executive]

Tom, this is Frank. Our mainstream business actually is very stable because as we reported several times in the call, in the mainstream manufacturing side, there are many end-of-life tools. So with that, we have to replace the equipment to add capacity. But in general, the capacity for mainstream segment is not increasing. So that enabled us to keep a stable price.

[Thomas Diffely, analyst]

Okay. Great. And then I don't know if Chris is on the call, but I do have a kind of a technology question.

[Christopher Progler, executive]

Yes. Yes. I'm here, Tom.

[Thomas Diffely, analyst]

So I guess 2 things. First, are you seeing any -- or what do you think the longer-term impact is, if any, of Apple canceling its micro display project? And then how do you see OLED ramping into flat panels of a larger size over time?

[Christopher Progler, executive]

Yes. So the micro display, we don't really see much impact of micro display. We didn't have it marked up as a big growth driver for photomask. So to the extent companies like Apple decide not to commit to micro display does not really change our outlook on the FPD market.

As far as the OLED, definitely, we see the Gen 8.6 form factor starting to go into production next year, we believe. One of the large panel makers already has that fab, and we're talking to them about shipping initial masks into that. And we do think we'll be in a good POR position for that -- those high form factor masks.

And the ASPs for those because they're tough masks to make, AMOLED at Gen 8.6, much harder, much more complex than LCD, we'll see really good ASPs on those products.

[Thomas Diffely, analyst]

Okay. And I assume that you have a bit of a technology advantage over some of your newer peers in that space as well?

[Christopher Progler, executive]

Yes. For sure. In FPD, we think we have pretty strong technology lead. The other thing we see on AMOLED is a lot of take-up of so-called advanced masks, things that -- not to use jargon but phase-shifting masks and the types of technology that really helped IC evolve through Moore's Law. We're seeing the adoption rate on those for flat panel increase quarter-over-quarter.

So really good take-up on our higher-end masks to get more performance on panels. So we think, yes, our tech leadership here is going to be a big advantage.

[Operator]

Okay. I show no further questions in the queue at this time. I would now like to turn the call back over to Frank Lee for closing comments.

[KangJyh Lee, executive]

Thank you. Thank you for joining us this morning. While demand has been soft through the first 9 months of 2024, we have done a great -- a good job of maintaining margins and generating strong cash. I'm proud of the way we have performed.

Looking longer term, there are several mega trends that should support market growth. As the leading photomask producers, we are well positioned to grow as demand improves, creating value for our customers, employees and shareholders. I look forward to updating you on our progress. Thank you.

[Operator]

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