Ladies and gentlemen, thank you for standing by and welcome to the Photronics Second Quarter Fiscal Year 2020 Earnings Conference Call. At this time all participant lines are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [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 webpage.

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 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 will turn the call over to Peter. .

employee health, raw material supply, customer support, and tool maintenance. All these are critical for sustaining our global operations.

Across our sites we immediately implemented policies to protect our employees through health monitoring, the adoption of known best practices [to not] [ph] spreading the virus, including the use of personal protective equipment and a comprehensive global visitor policy, and enabling small segments of our workforce to work from home in accordance with local requirements.

We initiated regular internal meetings to monitor our global supply chain and addressing the issues, and continue to be in direct contact with our raw materials 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’ photomask 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 the 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. 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 corona virus.

The impact was felt most strongly in demand for photomask use in IC foundry and high end display production. Fortunately, we were 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 interruption. However, today's device designs are complex requiring large teams of engineers and approval loops often have multiple layers.

But many of our customer’s 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. Of course 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 three of our factories were fully booked during the entire quarter. However, our mix suffered in China due to significant decline in G10.5+ bookings. We do not believe we lost market share, but instead customers simply ran existing products, pushing up of the timing of new design releases.

We're already seeing bookings rebound in May with 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 cost 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 means of 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.

We've seen improved bookings in April and May. There's too much uncertainty regarding future economic growth to state 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 investing 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 investments 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 were also scheduled to receive two Prexision 8 writers in 2021.

The addition of these three machines to an already formidable lineup will fortify our leadership position, [indiscernible] the most advanced and broadest technology portfolio available.

We have the flexibility to install these new tools in any of our three FPD facilities in Asia, and we will select the best location to serve our customers while optimizing our financial return. Tool 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 three 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. [Indiscernible] 5G technology is expected to accelerate this transition. Second, high-end -- are now beginning to migrate to a [indiscernible] AMOLED displays.

Finally premium smartphones continued to adopt more innovative display technologies with greater resolution features such as integrated fingerprint sensors. Discrete design and manufacturing complexity thereby increasing number of mask per set. A most basic AMOLED mask 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, they will partner with them to enable them to deliver on their strategic objectives. Our new tools, especially the P8 Lite 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. But 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. We believe the underlying long-term trends that we have aligned our strategic growth objectives with have not changed.

But 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'll 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 a million dollars 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 a million dollars in the quarter. Margins in the second quarter were reasonably good in the circumstances but we expect to do better and we'll continue to drive costs out of the business.

Other expense of a million dollars 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 non-controlling interest 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 non-controlling interests.

Earlier in the second quarter, we made the decision to terminate our share repurchase program out of an abundance of caution and 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 forecasts of total CAPEX for fiscal year 2020 will remain at approximately a $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 one to three weeks and demand for some of our products is inherently uneven and difficult to predict.

Additionally, the ASPs for high 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 corona virus 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 appeared 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 macro economic 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 increase our focus on Photronics longstanding 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..

Thank you. [Operator Instructions]. Our first question comes from the line of Tom Diffely with D.A. Davidson. Your line is now open..

Yes, good morning. Thanks for the question.

So I guess going back to the guidance you gave for the April quarter, at that time you were 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 impacts to the rest of the world?.

Yeah, 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, and is there any way to quantify the COVID impact you have embedded in your guidance for the July quarter?.

Yeah, well, if you look at our year, right, Q1 was just shy of a 160 million, so we were at a 640 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 timeframe?.

We saw a big dip, right, in March we saw the hangover from the Chinese New Year shut down, 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.

Where we sit right now, right, I would still say that our overall demand it's down mid-single-digits as a result of the overall economic hangover from COVID-19..

Okay, great. And….

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

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 the spotlight. 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 [78%] [ph] of our revenue is coming from the Asian market. And when you compare their ability to manage the virus this spring versus the West, it was still 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 [6.30 and $00.80] [ph]. 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 technology question probably for Chris I guess, if the industry moves to adoption of mini LED, how does that impact the photomasks?.

Hi, sure, thanks Thomas. Mini LED that's technology with a larger size OED, as you know, and it's mostly applicable to applications, kind of very large TV signage, that sort of thing. And then it's kind of dynamic backlighting and regular displays. So in both cases, they need driver circuitry.

They're not as complicated to operate as organic LED but still, the driver circuitry is fairly complicated and we see a pretty healthy mask profile from 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 LED, they are 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..

Okay, great. I appreciate that. Thanks for your time today..

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

Yes, thanks for taking the questions.

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

Yeah Q2 if you compare our business, right, has a cardiogram, the cardiogram has the most year-over-year correlation based on the deal 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 just 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 holiday.

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 that 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..

Thank you. And then just talking about the expansion of the entities 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 walked through that analysis or do you have low exposure to those companies and where do you think you can get around the regulations?.

Yes, actually it's quite -- it's so far away or it is the major poster child so -- and the affiliate -- the companies affiliated with them. Right, that's already well in the rearview mirror. Then, when you step away from that there's a complicated gauntlet you have to run regarding AIR code 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 one individual that is really an expert in this side of the company. So they've been through the new regulations and relative to the prior ones there's really only two 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 still should not have a significant impact on our revenues. And you kind of take it to the highest level, why is that so? Well, the why is that so is we're building the radicals 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 where we can use Japanese technology to get the job done. 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 means. So that's why in my prepared remarks, we were quite careful to say we're still, along with others in industry, working to get complete clarification on specifically what the wording means..

Got it.

And then just remind me on say, your top couple of IC customers, how big would they be, are they 1% or 2% of revenue on an annual basis?.

Oh, if you look at our top five 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 at 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?.

They're full FPD customers in the top 10 than IC, that's correct..

Okay, alright. That's it for me, thanks so much. .

Thank you. Our next question comes from the line of Patrick Ho with Stifel. Your line is now open..

Thank you very much and glad to hear everyone is well.

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 capabilities? And maybe as a second part of that question is how much do you believe that some of the lost revenues and the pent up demand that started 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 corona virus the Asian community has had to deal with, right.

Since 2000 there's been six -- three significant corona virus epidemics in Asia. There was the Middle East Respiratory Syndrome, there was the Swine Flu, and there was SARS, right. So there were three. And the best practices in health to operate in a corona virus infected community were already known to or particularly our Taiwanese operation.

So we took that playbook and we rolled it out around the world, right? So rolling out that playbook or manufacturing output is the same today as it was three months ago, as it was three 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 particularly materials in one location, we would buy them and all -- we would buy them in another and re-export them ourselves. So by being flexible and acting as a global team, we did not have any manufacturing disruption, zero, nada, nothing. So -- and we were already, preparing for the fall.

We would be foolish not to because we know something is going to happen, we just don't know what. But what we do know is we're going to be ready. So yeah, so our revenue output same as always. Of course as they always, I mean as our -- as we add tools it changes. But, aside from capacity additions no impact.

As far as demand goes we expect what was there to push out over the next few quarters, that seems there is 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 three 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 that 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 are 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 know we've 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. .

Now, fair enough. Thank you very much. .

Thank you. 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. If you understand the current environment is creating uncertainty for all of us that has caused disruptions to our daily routines, despite all of this we are encouraged to see demand recover and look forward to updating its 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..