Ladies and gentlemen, thank you for standing by. Welcome to the Tower Semiconductor Second Quarter 2021 Results Conference call. All participants are currently in a listen-only mode. Following management's prepared statements, instructions will be given for the question-and-answer session. As a reminder, this conference is being recorded, August 2, 2021. Joining us today are Mr. Russell Ellwanger, Tower's CEO; and Mr. Oren Shirazi, CFO. I would now like to turn the conference over to Ms. Noit Levy, Senior Vice President of Investor Relations and Corporate Communications. Ms. Levy, please go ahead.

Thank you, and welcome to Tower Semiconductor's financial results conference call for the second quarter of 2021. Before we begin, I would like to remind you that some statements made during this call may be forward-looking and are subject to uncertainties and risk factors that could cause actual results to be different from those currently expected. These uncertainties and risk factors are fully disclosed in our Form 20-F, F-4, F-3 and 6-K filed with the Securities and Exchange Commission, as well as filings with the Israeli Securities Authority. They also available on our website. Tower assumes no obligation to update any such forward-looking statements. Please note that the second quarter of 2021 results have been prepared in accordance with US GAAP. The financial tables and data in today's earnings release and in the earnings call also include certain adjusted financial information that may be considered non-GAAP financial measures under Regulation G and related reporting requirement is established with the Securities and Exchange Commission. The financial tables include a full explanation of these measures and the reconciliation of these non-GAAP measures to the GAAP financial measures. Now, I'd like to turn the call to our CEO, Mr. Russell Ellwanger. Russell, please go ahead.

Thank you, Noit. A Pleasure. We're quite excited to share with you our second quarter results and business activities. Our revenue for the second quarter of the year was $362 million, a record for Tower, representing 17% year-over-year total and 26% organic growth. In the order of revenue dollars, the year-over-year organic growth was mainly driven by RFSOI at over 40% year-over-year organic increase, power IC at 35% year-over-year organic increase, image sensors 30% year-over-year organic increase, and power discrete at 23%. To note, all business segments demonstrated growth in the second quarter. We guide the third quarter of the year to increase to a midrange of $385 million, representing year-over-year 24% total growth and a 38% organic growth and breaking a $1.5 billion annualized revenue run rate. This should be driven by a further and large year-over-year increase in RFSOI and image sensors with all business segments expected to demonstrate growth. Our customer demand and served markets are strong. Hence, we expect continued top and bottom line growth in the fourth quarter as tools become qualified for production, enabling further increases in high-value flows. To support continued growth, based on our customer demand, we continue to execute the previously announced capacity expansion plans as well are adding 200-millimeter new capacity, which will be addressed with more details by Oren.

Hi, everyone. We released today our second quarter 2021 results, achieving record revenues of $362 million, reflecting a remarkable 17% year-over-year revenue increase and resulting in significant increases in gross profit, operating profit, and net profit. We are providing our revenue guidance of $385 million for the third quarter of 2021, representing an additional record revenue quarter.

The first question is from Mark Lipacis of Jefferies. Please go ahead.

Hi, Mark.

The next question is from Rajvindra Gill of Needham & Company. Please go ahead.

Yes. Thank you, and congratulations on the great momentum across all the major business lines. That's great to hear.

Thank you.

Absolutely. So, Oren, just a question on the gross margins as we progress throughout the year. You had mentioned in your prepared remarks that in Q4 that you would expect the model to exceed the 50% gross profit fall through in Q4 as some of those incremental costs related to capacity kit have been absorbed. Wondering how we think about that upside to the 50% gross profit fall through? Without giving any numbers, but just are we seeing a higher margin process flows in Q4 that would give you the confidence to say that we're going to be above the 50% GP profit fall through?

I'll give an answer there. We have seen very, very strong increases in demand and for a variety of the increases in demand in order to be able to cover it, we have worked with customers for increases in ASPs that provide higher margins in order to have a quicker return on the investment itself. So a good portion of what's going on in Q4 is a result of Q3 starts that are now under POs that have a higher selling price than previous quarters and it's driven off of customers that are working towards increasing demand versus previous run rates for the most part. And yes, as mentioned during the script itself, as we move more and more into some of the, for example, 5G-driven activities, as we move into higher gigabit per second data center, as we move towards more large digitized wafers, all of that are higher margin flows to begin with. So it's a combination of a richer mix and where we talked about the increase of another $100 million of 200-millimeter investment, that really is for the main part to increase capacity for a richer mix for a higher margin mixes. So Q4 is a combination of both. It's as higher-margin mixes are growing and in instances where we are and have increased capacity that those are coming in at this point or will be coming in offer purchase orders that had an increase in ASP.

Okay. Got it. That's super helpful in terms of the drivers for the margins. And with respect to the ST Micro partnership that you announced a few weeks ago, a very, very interesting announcement, wondering kind of the rationale for both parties, particularly ST Micro, who essentially began construction of this facility in 2018 in Italy and is kind of bearing the bulk of the construction, but is allowing you guys to leverage your expertise and LM 300-millimeter and 200-millimeter to really kind of maximize the foundry. I'm curious kind of what was ST Micro's thinking in terms of partnering with you and the value that you will bring to the table? And then maybe if you could just remind us in terms of how much expected capacity you're kind of targeting in 2024 and beyond, so we get kind of a sense of the potential scale of this partnership? Thank you.

So the fundamental drives was really stated by ST in the press release itself and that was to drive a faster ramp to high utilizations and a faster ramp of capacity, which obviously then reduces the fixed cost per substrate. So the deal is a very strong, we believe and they believe, win-win for both companies. The specifics of the financial model has not been released and I'm not sure that all the details will ever go out into the public, that's part of the confidentiality that ST and ourselves have. But the model itself is a very good model for both companies for many, many reasons and I believe there is the major driver again from their side was what was stated in the PR and that is a faster ramp to high utilizations, which is the key towards good margins in a manufacturing facility.

The next question is from Mark Lipacis from Jefferies. Please go ahead.

Russell, on Agrate, I think you mentioned second half of '22 prototype, I just want to make sure I had that right? When do you think you start shipping production revenues?

Our target would be to start shipping production revenues in the first half of '23.

And when you talked about, I think, several capacity expansion plans, I don't think I heard silicon germanium mentioned there, are you - what is the - is that included in the capacity additions? Can you talk about what you're doing with silicon germanium from a capacity expansion standpoint?

It is definitely included in it. The infrastructure activities that we're doing, we had mentioned, are very strong. We have growing demand consistently in data center and, yes, so the silicon germanium and silicon photonics are both parts of our expansion plan.

Got you. And you mentioned…

…that's where we said out the - now to invest in 200-millimeter differentiated platforms, so --

Got you.

…those 5G platforms are certainly one of our differentiated platforms.

Got you. That makes sense. Thanks for that clarification. And then on the CHIPS Act and your view to kind of target San Antonio there, do you have a sense of when you would expect to get visibility on this? And to what extent would you expect this to be direct funding or versus tax credits?

Expectation doesn't necessarily tie into what will happen. Our expectation is direct upfront funding and that's where we'd like to be. I think city, county governments do a lot and have offered a lot in areas of tax abatement and that I think is a very good thing for ongoing margins and reduction of ongoing running costs. But the big issue of any greenfield activity is the upfront investment and the amount of years that it takes to bring that upfront investment into a net profit positive business and upfront grounds are what really enables that. So, for us, the important thing is to whatever works out or whatever might be worked out with us is then to make sure that it really pencils well for the company and for our shareholders and that's what our target is, is to have a deal, we'd love to increase capacity in the United States. Again, I think the San Antonio facility is a very beautiful campus to target it within, but certainly it has to be something that pencils and so that would be part of the discussions that we would have at a point that whatever committee would be ultimately used to determine and grant awards would be granting these awards.

The next question is from Richard Shannon of Craig-Hallum. Please go ahead.

Good morning, Russell, or I guess good afternoon or evening to you and to Oren. I'm going to follow-up on the gross margin question here. You've talked about some new investment in differentiated flows and at the same time you talked about some of your power discretes may be leveling off here. I'm going to jump to that one in a second, but how do we think about the longer-term gross margin model of the company as you make all these investments, obviously expecting get a run rate utilization on those? And it'd be interesting to hear that answer in context to your past history in gross margins where you've, three, four years ago, got into the mid-20s level herein and at the low-20s today. I'm more than curious to the degree to which you think you're going to approach those prior high levels?

Yes. So, hi, Richard. I believe I related to that a little bit in the prepared remarks. So, for Q3, we will see probably gross margin increase and all the margins will increase. However, not to the full 50% incremental model. And from Q4, we expect it to be - to exceed the 50% incremental model, also as Russell explained, previously because of some very good selling price increase trend and improved mix for the next year. If you ask going forward, I think you should go from the baseline of the Q4 betterment on the margins and then from that point in time to assume incremental model slightly above the 50%. If you want to be conservative or not, slightly above, but better than the 50% if the trend in the market, which you know better than me, will continue or, as me, continue like now, because now it's a very good trend for us.

Okay. And, Oren, just to follow up on the same side, I don't have details on what kind of total dollar capacity you're expecting here. I'm not sure how far to take that incremental 50% gross margins and get to a - hope for level down the road here? Again, I'll ask if it's - if we can get to near prior levels here as you thought this new capacity is at. Is that possible or can we approach that? Just any comments relative to your history would be great.

What is your question? The maximum revenue capacity? What was it?

No, where we can go with gross margins over time giving all - given all these investments here? Again, relative to your history here we've got up to the 25%, even closer to 26% level figures ago and now we're at the 20% level and obviously we've got some investments that will increase depreciation here, but over time as you fill that up, can we get back up close or to that level that you see?

Yes. There - yes, of course, it depends what outlook in the future you're looking into. But for the next year, yes, definitely we can achieve the 25% or even higher, slightly higher.

Kind of a multipart question here on the power market here. First of all, you said, I think Russ you said, discrete you're expecting the level off here over the next few quarters. Help us to understand why there? And if you can make some broader comments also on your power IC space where I think you've been gaining some share? It'd be great to know what voltage levels you're seeing the benefit and to what degree that's happening in EV set would be a great to know? Thanks, Russell.

Yes. So our power discrete market has been a little bit different than others in that for power discretes we don't offer a foundry offering flow and for the power discretes we have customer flows that we bring into the company and we do, in many instances, co-developments on additional flows or incremental flows or capabilities. The - and power discrete business itself is not the highest margin business within the company, but it's a very stable business for us by virtue of the relationships we have with those customers. And the fact that it's very dependent upon each of these customers, we've reached levels of revenue that we think is very adequate in the companies and the company is not presently taking the capital expenditure to put into those flows as there is others such as was the follow-up question on previously, such as our silicon-germanium, such as some imaging capabilities, certainly SiPho capabilities that both have a higher margin impact for us. And, secondly, we own the flow, so we have much more freedom in the market as to who we work with. So that's the issue there. It's not that we don't have customers that would not wish or do not wish to grow with us in that area, it's at this point not our preferred area that we wish to grow our capacity in the company.

The next question is from Patrick of Stifel. Please go ahead.

Thank you very much, and congrats on the nice quarter. Russell, maybe first off, in terms of, I think you guys were very present in terms of the capacity expansion plans to meet the market demand environments. I know you have a lot of customers today and obviously some of the capacity expansion is dedicated to getting more share with the existing customers. But can you qualitatively, maybe, discuss how potential new customers can be brought on-board as you expand this capacity given the current demand environment?

Certainly. We are actually, in some instances, taking new customers on-board, but those customers are coming in under different types of arrangements, where potentially they'd be paying for certain capacity itself as it's all pure incremental capacity. And when a customer would give money towards capacity, the model is one of two. One model is that, whatever the prepayment is would be amortized over time against wafers typically a nominally with end time date, so that the capacity is more or less are committed or money is forfeited. The other is that the money is just given with no amortization, which is more or less a guarantee for the company that does return on that incremental capacity and has one impact and that is, it really does increase the specific margin dollars for that customer on top of whatever the selling prices on the wafer. So those are two models. For the most part, at this point, we're working to support our present customers that all have increasing demands and we think that that's very important that those people who really have made commitments to us, you know, relying on us that we're doing all that we can to enable their growth within the market. And I think one thing that is very, very indicative that we have a good truly taxonomy of customers is the percentages of organic growth that we're seeing that, I believe, really are much higher than the market growth itself. And hence it shows that the customers that we're working with are good growth customers that themselves are increasing market share and, hence, we're increasing market share in the respective end segments. Hopefully, that answers your question.

Yes, it does. Thank you very much. And maybe as a quick follow-up. I know 200-millimeter tools are different from 300-millimeter tools, but we're hearing more from the equipment industry that they're facing supply constraints. And, again, I know 200-millimeter, there are probably a little more - or there are probably more options out there to procure those type of tools. But have you seen any constraints on your end trying to get deliveries of some tools or is everything still kind of on track on your end?

For the most part, all of the POs that have already gone out for equipment is on time on deliveries. And what we're seeing now is just that the lead time on deliveries is extending for new POs and that's particularly the case for 300-millimeter, but for 200-millimeter as well, but we've not seen a gating of - on any of our suppliers refusing to take a purchase order.

The next question is from Lisa Thompson of Zacks Investment Research. Please go ahead.

Good morning.

Good morning, Lisa, or good afternoon from me, I guess, or morning.

Yes, I guess. Good morning, okay. So you spent about $56 million…

Lisa, I'm having a very hard time hearing you. Yes.

Hi. Can you hear me any better now?

Yes. Much better.

Yes. Much better.

Okay. I'll just yell. All right. So this quarter you said about $56 million CapEx and said it was going to be like $45 million to $49 million, so do you have any different thinking on Q3, Q4, and Q1 from what you had previously said?

We have a little bit different because of the - what we said in the press release that we have announced an additional $100 million. So, actually, it's a - this is why I said in my script that I expect now - you know, we announced in January - in February, $150 million and we announced to additional $100 million, so total is $250 million. As I said in my prepared remarks, we'll be paid in the coming five quarters. So, if you assume it linearly, it's additional $50 million to the baseline. Since we just announced the new $100 million recently, you may assume obviously that it will be below $50 million extra from Q3. So I would assume a lower than $50 million, for Q3 like something like $40 million and then $50 million a quarter and maybe sometimes $60 million to capture for the full $250 million and this is on top of the baseline that we had without those CapEx plan, which is like you mentioned $45 million. So if you want to know Q3, Q3 will be about $45 million base, plus additional $40 million from the $250 million and pretty similar for the upcoming quarters, so between $85 million to $95 million total.

The next question is from David Duley of Steelhead Securities. Please go ahead.

Yes. Thanks for taking my question. Just out of curiosity, as far as the Panasonic business goes, is that capacity fungible to other customers? Just kind of curious if it's unique to them or if, let's say, theoretically Panasonic didn't exist, could that capacity be transferred to other customers easily?

Yes. So I understand the question, I just want to clarify so I don't offend anybody. Nuvoton bought the Panasonic semiconductor, right? So, it's now - the Group is called Nuvoton Japan Technology, but - so, again, just don't want to offend anybody there. I think to a good extent the capacity is fungible to the extent that there is some specific flows that are used that are non-fungible that's the case as well. So there are some flows that really is pretty much dedicated to end markets that are served with certain products had previously been Panasonic Semiconductor now are Nuvoton Japan and are serving Nuvoton as a whole, but a good amount of that capacity is fungible.

Okay. And then as far as the - you mentioned the utilization rates and you just gave us layer counts that were processed at different wafer sizes.

Yes, sir.

But did you give a - I guess, there are still a utilization rate number available, right, because you gave us a total layer counts at 100-millimeter, and 200-millimeter, and 300-millimeter, we could calculate the utilization rates, so could you help us understand - you gave us the number of process, what's the total number available, so we can back into the utilization rate?

No, that's exactly why I'm using the process layers. The exact amount of photo layers is not necessarily a relevant number as there is other constraints and bottlenecks that are not necessarily photo related. And we're adding photo as time goes on. So that's not an area that we'll be presenting at all anymore. We've all just be presenting photo layers used and, on a comparative basis, it's a good operational metric.

And so then how do we tie that into utilization rates and efficiency of using your equipments, in fact basically one of the most important metrics of a foundry business is the utilization of your equipment. So is there another metric that we can look at? Because when you just give us the foundry - the number of layers processed, it's not necessarily utilization rate driven. So is there any other metrics you'll be giving us to understand about how efficient you're using your equipment?

You can certainly assume that presently we are fully utilized, that every layer that we can ship are shipping before…

Okay.

…tools are rising.

Okay. And then, Oren, what would we expect for operating expenses in the Q3 and Q4? I know, you've been adding people and capacity at various locations, what should we kind of expect on a dollar basis for operating expenses in Q3 and Q4?

Yes. Operating expenses should remain flat in the future quarters, because you're right that we are adding people, but they are in COGS, it's mainly technicians and the operators, engineers to support the fab production. So that in the course that's within the 50% incremental model. OpEx, R&D, M&A, SG&A, we are keeping them flat.

So, we should see some nice leverage in the back half of the calendar year?

Some what? Nice leverage?

Some strong earnings leverage from operating expenses being flat in the back half of the calendar year?

Yes, in percentages, yes.

Okay. Thank you. That's it for me.

Yes. So just to follow up on your question. In the prepared script, I had mentioned the Q3 guidance and then I said that we expect top and bottom line continued growth in the fourth quarter as more tools become qualified for production, enabling further increases in high value flows. So, I think, somewhat intrinsic to the statement and if we're depending on new tools to be qualified what we're running right now is running at full utilization.

The next question is from Richard Shannon of Craig-Hallum. Please go ahead.

Just a couple of quick follow-ups from me. Just to be clear, I'm pretty sure the answer is no, but I just want to confirm Russell the new $100 million CapEx addition here, that doesn't including equipment that would be installed within the ST Micro facility, is that correct?

You are correct. It does not include.

Okay. That's what I thought. A quick question on another topic, your silicon germanium. Are you seeing much of any benefit from 400-gig devices or I guess devices that go into 400-gig datacom modules yet or is that still a pretty small piece of business?

It's a growing piece. I wouldn't say - it's certainly not the biggest portion of the SiGe, but it is a growing piece and we've press released our revenue customer Infi for silicon photonics, that Infi does 400-gig right?

Yes. Yes. Okay. Are you seeing a 100-gig capacity or 100-gig, are those still growing at a decent rate, or is that starting to plateau?

So in the prepared remarks, I had mentioned that's what's really up and moving right now is the datacom, not the telecom. The telecom is where we do predominantly the 100-gig, right, so telecom is not - the 100-gig is not increasing hugely in volume at this point, the datacom is and those are typically 25-gig chips.

There are no further questions at this time. Mr. Ellwanger, would you like to make your concluding statement?

Certainly. Thank you very much. Thank you for your interest and for the good questions. For your reference, posted on our website on the Quarterly Release page on the Investor Relations section is our second quarter 2021 financial results slide deck. Please access it as per desire and interest. To summarize the call and where we're at, we really were excited, are excited with second quarter record revenue results and particularly the activities that have led to a third quarter guidance of substantial continued growth and breaking a $1.5 billion annualized run rate. We believe that the $385 million Q3 guidance, which represents a 38% year-over-year organic growth is really extremely strong evidence that we're serving the right customers in the right markets and that type of a growth, I think, is quite substantial. We are really executing well on our expansion plans and most everything is in place and on target and hence, as stated in the script, we are looking for and expect fourth quarter growth in both top and bottom lines and we're very excited with the partnership with ST at the Agrate factory. And over the next years, expect and believe that we'll see very important and significant movement in 300-millimeter growth and 300-millimeter capabilities as we qualify our tools and install more tools in that facility. Other activities happening in the company are still exciting and look forward to meeting with you again for the third quarter release and possibly other interactions in the interim. So, thank you very much for your interest and best wishes for health and happiness. Thank you.

Thank you. This concludes the Tower Semiconductor second quarter 2021 results conference call. Thank you for your participation. You may go ahead and disconnect.