Photronics, Inc. (PLAB) Q4 2014 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to Photronics’ Fourth Quarter Earnings Call. During the presentation all participants will be in listen-only mode. Afterwards we will conduct a question-and-answer session. [Operator Instructions]. As a reminder this conference is being recorded Tuesday, December 9, 2014. I would now like to turn the conference over to Pete Broadbent, Vice President, Investor Relations and Marketing. Please go ahead, Mr. Broadbent.

Thank you, and good morning, everyone. We’d like to thank you for joining our fourth quarter 2014 conference call. Before we begin, I would like to remind all participants about the Safe Harbor Provision under the Private Securities Litigation Reform Act of 1995, and thus any statement we make during this call, except for historical events, may be considered forward-looking and may be subject to certain risks and uncertainties that could cause actual events to differ materially from those projected, including uncertainties that may affect the company's operations, market, pricing, competition, procurement, manufacturing efficiencies, and other risks detailed from time to time in the company's SEC reports. These statements will contain words such as believe, anticipate, expect or similar expressions. This call will be archived on our website until we report our first quarter 2015 results. Joining us on the call today are Constantine Deno Macricostas, Chairman and Chief Executive Officer; Dr. Peter Kirlin, President; Sean T. Smith, Senior Vice President and Chief Financial Officer; Dr. Christopher Progler, Vice President, Chief Technology Officer and Strategic Planning. During our remarks this morning, we will be referring to slides posted on our website under the Investor Relations link. Before we begin I would like to point to two upcoming calendar items. Photronics' management will be presenting at both the Needham Growth Conference in New York City on January 13th, and the Stifel Technology, Internet, and Media Conference in San Francisco in early February. And now, I would like to turn the call over to Deno Macricostas. Deno?

Thank you Pete and good morning everyone. Please turn to slide 3 in our presentation. I would like to begin by speaking about market position and the progress we have made this year. We successfully completed the joint venture in Taiwan. The JV has made us stronger in a strategic Asia market for our customers. Restructure our loan agreement continued to pay down debt, a strategy [ph] of our initial position. Importantly for future growth we deployed additional capital equipment both in IC and FPD to sell to high-end customers globally. The result is that we are now the leading IC photomask manufacturer in the world. And most importantly we have taken the steps to leverage our position during the next technology cycle at the leading edge. As the industry now focuses on the soft 20 nanometer products per ton is out [ph] in front of our competition. We believe we have more capability and capacity for 40 nanometer logic and 60 nanometer memory in all of our competitors combined. It’s the first time we have felt such a technological lead in our 45 years history. And by all accounts sheer size and scale of the soft 20 nanometer business is a great time to be in this position. We have achieved the success in that spot because of an experience of proven leadership team. And focus on serving our customers in a culture of driving cost of operation. And also we have been successfully executing on a long range plan that was drafted a number of years ago, to focus on leading edge technology. A slide showing in this business of a number of years we have invested capital to become a technology leader initiating important strategic partnerships. Now all of these efforts are coming together, what are really in a marketplace. We are confident that this strategy and our execution is the best way to grow the company and maximize shareholder value. 2014 was an important year for Photronics. It was critical that we put in place the pieces to drive our future success. As we proceed through 2015, in this technology generation we expect to capitalize on our leadership position. I am very excited for our employees, our customers, and our shareholders upon the opportunities that are here for the company. And now I’d like to turn the call over to Peter.

Thank you Deno and good morning everyone. Please turn to slide 4 in our slide presentation. In a moment Sean will provide a detailed breakdown of our financials. But first a few highlights and some comments on our business. In Q4 we achieved a sales of $124.3 million short of our guidance of 125 million to 130 million. Offsetting some nice gains in our mainstream business, was a reduction in 28 nanometer demand in the key foundry customer. This particular family customer spent our Q4 bringing silicon to successfully verify their first weight of 28 nanometer designs. With impact of our quarter, this represents a positive step forward for both of us and an early potential for increased 28 nanometer for the mass demand in the coming quarters. Also in the quarter we’d expected to lift from the initial node migration by one of our memory customers which didn’t materialize. In this case having shift just one leading edge mass set we have met our revenue expectations for the quarter. Turning to the positives and continued strength across our core customer base helped us to achieve mainstream revenues of 65.9 million, up 3% sequentially. FPD revenues were also up 3% sequentially at 24.9 million. All the remaining operational integrations objectives at PDMC were completed in Q4. Year-over-year high-end revenues were up $24 million at 104 million. Looking forward we have successfully qualified at both the 1X logic and memory nodes. And we believe that we experienced no loss of market share as we work closely with our customers as they attempt to ramp these advanced nodes to commercially viable deals. In Q4 we were profitable and generated cash. We delivered gross and operating margins of 21.4% and 7.5% respectively. We generated non-GAAP earnings at $0.07 a share, non-GAAP EBITDA was 33 million, and we improved our net cash position by $22 million sequentially. Overall the trends in the semiconductor and flat panel display certainly is quite positive for Photronics. We are well positioned in the mainstream IC market with the right capacity for our customers. High degree of operational efficiency and continued focus to improve our competitive position, at the high-end we are well positioned to capture significant share of the 28 nanometer business as it continues to scale in the merchant market. We are poised significant ahead of our competition with right to point of IC and FPD equipment, capture meaningful share to next technology node. A few short years ago we were strong mainstream photomask company. Today we believe we are the photomask technology leader with more installed leading edge capacity in the rest of the merchant market combined. Looking forward we expect 2015 to be strong, 20 nanometer foundry logic is currently building through the next generation memory and FPD arriving mid-year, 12:1X logic late in the second half. As Deno mentioned we have achieved key milestones in our strategic plan. Our customers are making progress in node transitions and we are focused on delivering growth and value for our shareholders. And now I will turn the call over to Sean.

Thanks Peter and good morning everyone. I will provide a brief analysis of our financial results for the fourth quarter of 2014. We view our operating results, balance sheet, cash flows, and forecast. Please turn to slide 6, 7, and 8 which shows our sequential, quarterly, and year-over-year IC and FPD revenue performance. Fourth quarter revenues was approximately 123 million down 600k sequentially due to the reasons Peter mentioned. Revenues for IC photomask were $99.4 million down $1.2 million sequentially. Revenues for high end IC photomask which are 45 nanometers and below were $33.5 million or 34% of total IC sales. Sequentially high-end IC revenue decreased $3.1 million. The decrease was primarily related to reduced high-end pay downs in Taiwan and to a lesser extent the U.S. The decrease was partially offset by increased sequential IC mainstream revenue of 1.9 million. For 2014 high-end IC revenue increased 30% to $104 million while mainstream sales increased $8 million to $249 million. As a reminder our mainstream business is a significant cash generator for us. Revenues for FPD photomask were $24.9 million up $600,000 sequentially. High-end FPD revenue for the quarter at $15.2 million was essentially flat on a sequential basis. Breaking out Q4 sales geographically, 71% of total sales were from Asia, 22% from North America, and 7% from Europe. Now let's continue through the income statement. Gross margins for the fourth quarter was 21.4% down 150 basis sequentially. The decrease was related to increased manufacturing cost principally equipment, the bulk of which is not expected to be recurring. Selling, general and administrative expenses for the fourth quarter were $11.5 million. SG&A decreased approximately $800,000 sequentially as a result of cost savings and cost avoidance programs. R&D expenses which consists principally of continued development for our global advanced process technologies and qualifications at advanced nodes were $5.8 million up $600k sequentially. During the quarter we generated operating income of $9.3 million or 7.5%. EBITDA as defined in our credit agreement for the fourth quarter was $33 million down $1 million sequentially. This represents a $117 million for the year, also our free cash flow for the year was $25 million. Other expense net for the fourth quarter was down $600k sequentially principally driven by foreign exchange, favorable foreign exchange. During the fourth quarter we reported tax provision of approximately $2 million and minority interest expense was $2.4 million and principally consists of DNP share of PDMC’s profits for the fourth quarter. Minority interest expense decreased 700,000 during the quarter. GAAP and non-GAAP net income was $4.3 million or $0.07 per share. At the end of the fourth quarter we had 1500 full-time employees which equates to annualized revenue per employee of $331,000. Now turning to the balance sheet, for fiscal 2014 we have strengthened our consolidated balance sheet including our net cash position from $22 million at the beginning of 2014 to $51 million at year-end. Cash and cash equivalents at the end of the quarter amounted to $193 million. As I mentioned, our net cash which is cash plus debt was $51 million at the end of the quarter, up $22 million sequentially, principally as a result of our previous outstanding 5.5% $22 million convertible notes converted to equity in October. Our working capital at the end of the quarter was $197 million as compared to $205 million at the end of Q3. Accounts receivable at the end of the quarter decreased $8.4 million sequentially to $94.5 million primarily as a result of improved collections. AP and accrued current liabilities at quarter end amounted to $129 million down $10 million sequentially primarily as a result of reduced accrued CAPEX. At the end of the quarter $31 million of CAPEX was accrued for, down $5 million from the third quarter. Please turn to slide 10 as we review our capitalization. Total debt at the end of the year was $142 million, the principal components of outstanding debt include a 115.75 [ph] senior unsecured note due April 2016 and approximately $27 million in capital lease obligations. Our leverage ratio improved for 1.76 times at the end of 2013 to 1.21 times at the end of fiscal 2014. During the quarter and through today we have not borrowed on our 5 year $50 million credit agreement. Taking a look at our cash flows, cash provided by operations for the fourth quarter of 2014 was approximately $35 million. G&A was approximately $21.7 million and cash provided by operations for fiscal 2014 was $96 million with G&A amounting to $80 million. Cash flow used in investing activities amounted to approximately $33 million in fourth quarter which is primarily all CAPEX. As previously stated 2014 cash CAPEX amounted to $91 million. Net cash used by financing activities during Q4 2014 amounted $2 million and the for the year was $30 million both primarily for repayments of debt. Please turn to slide 11 as we take a look ahead. Taking a look at CAPEX we expect our 2015 cash CAPEX needs to be in the range of $100 million to $110 million. We do however have the flexibility to accelerate or decelerate our spend depending upon market conditions. We expect to generate -- continue to generate free cash flow in 2015 and our 2015 investments will be principally geared towards high end leading edge products for IC and FPD applications. Our visibility as always continues to be limited as our backlog is typically only one to two weeks. For Q1 2015 we do expect to experience some reduced orders related to typical yearend holiday seasonality. That said we are projecting revenue for the first quarter of 2015 to be in the range of $121 million to $126 million. During 2015 our tax rate will be affected by the flow of income from jurisdictions for which we may have credits and upon our limited ability to recognize cash benefits in years which we are taxable. For the first quarter of 2015 this will equate to a range of 2 million to 2.5 million in whole dollar terms and for fiscal 2015 we estimate total taxes will range from $11 million $13 million. We will continue to be impacted by the minority interest expense related to PDMC. By the first quarter of 2015 we are estimating minority interest expense to be in the range of approximately $2.5 million to $3.5 million. As a result based upon our current operating model we estimate EPS for the first quarter of 2015 to be in the range of $0.02 to $0.07 per diluted share. In summary I’ll leave you with a few key thoughts. First, we expect top and bottom-line improvement in 2015. Second, we expect our – continue to grow in 2015 and third, we are confident about our business model and our ability to grow market share to leading edge. We see continued opportunities in our customers businesses and node migrations plans and we have a strong financial position and excellent technology to capitalize on those plans. And finally we expect to continue to build on the momentum that we have established over the past few years as a leader in advanced photomask technology. Now I would like to turn the call over to the operator for Q&A

Thank you. [Operator Instructions]. And our first question comes from the line of Edwin Mok of Needham & Company, your line is now open.

Hey, guys. Thanks for taking my questions. Sorry for the background noise here but first question I guess is just maybe a high level. Now that you have completed the joint venture, the Taiwan joint venture for the last -- for two quarters already, how do you think the business is trending there, you now have been running this -- is the business running at 20 million also a quarter run rate that you guys thought about when you bought the business or when you did the joint venture and any color you can provide there, how much of that business comes from mainstream versus high-end?

Yeah I will make some comments about the general tone of the business and then I will turn it over to Sean. The market in Taiwan is more or less what we expected it to be. When we did the deal we did it primarily to accelerate our move in Taiwan into the high-end of the business. If you recall we had the choice of either investing there ourselves, building a facility and equipping it or doing the JV. So, the JV was a quick way to the end state we desired in Taiwan. And indeed that's I think where we are. In my remarks you heard me say that the 28 nanometer business in particular during the quarter wasn’t as high as we had expected it would be. On the other hand the reason for that is the 28 nanometer takeouts we had the prior quarter were being run through silicon trials and qualification during this quarter and the results of that were largely positive. So, the business this quarter in Taiwan looked strong and we are already seeing more 28 nanometer takeouts quarter-to-date in Taiwan than we did all of last quarter. So I think in general Taiwan for the IC industry, particularly the foundry businesses where we see the growth and we have the capacity and capability there to exploit it. So, more or less it is and it has been and we expect it will be what it was when we originally did the deal. So Sean, do you want to add some comment.

Just as a reminder we did say to your point that the JV was to have incremental revenue of at least 20 million but approximately 75% of that being high-end. If you step back from the beginning of the JV year-to-date and I would say definitely we hit those targets. One other comment though from the synergy standpoint we are also still on target with our plan. That said, as you can see minority interest expense is down for the quarter which is primarily a result of the decreased top line that Peter just alluded to in his remarks.

Okay, great and thanks for giving some color about the 28 nanometer cost delay in revenue as well. So can you give some color about the memory, translate -- no translation rate, the customer didn’t happen as you thought, do you think that is something that will come back in the January quarter or is it more like an [indiscernible] before we start to see those?

So, as far as the memory transition is concerned, it feels to us as you heard in my remarks that we really see strength as we move into the middle of our year which is two months accelerated relative to the calendar year. So, it has slowed down but it is certainly not going away. So, it feels like mid-year for us.

Okay, great. Thanks for the color and one last question, Sean if I look at the model and your guide for revenue cash vanish but the midpoint of EPS is guiding down sequentially, can you walk me through the math there?

Excuse me, midpoint of the guidance is down. We expect some increased cost into the quarter but if we hit the high-end we will get about $0.07, it might beat that. So, that's our target to get to the high-end of the range.

So the increased cost is in the OPEX side because of year end or any comp pressure on margin side?

No, we will have some additional tools coming online to capture some high end business. But it’s not going to be a significant cost increase. We’ll manage it.

Okay, great. That’s all I have. Thank you.

Thanks Edwin.

Thank you and our next question comes from the line of Harlan Sur of J.P. Morgan, your line is now open.

Hi, good morning. Thank you for taking my question. Given the advanced node migrations ahead of you, both project and memory and sort of given your pipeline what’s the likelihood that advanced IC photomasks represents 50% or more of your total IC revs either in fiscal year 2015 or exiting fiscal year 2015?

That’s a great question and in a scenario where -- when we are exiting the end of the fiscal year, the scenario where the 28 nanometer foundry logic market is very healthy in non TSMC base in Taiwan and both 1x logic and high-end memory are in commercial volumes, we could easily see a doubling of our high-end IC revenues. And as shocking as it might sound that does not require a lot of orders in the quarter, maybe it requires more incrementally 28 nanometer orders but less than 10 high-end memory logic orders a quarter with solid 20 nanometer business gets us to that point. Its -- these are big ticket tape outs.

To Peters point Harlan as well if we go back to Q3 which will be a breakout quarter at the high end 36% of our revs related to high end business and since that time we continued to install and bring online additional high end capacity. So the numbers Peter is talking about would be achievable.

And I would also say if you, just going back to my prepared remarks, all the qualification work that we need to do to realize or monetize our investment has already been done. And historically technology node transitions have been primarily driven by lithography. When you get down to where we’re presently operating there is a lot of whether it be treating memory or whether it be fin set, there is a lot of materials challenges that our customers are struggling to solve that is sort of delaying the car from pulling out of the garage. But the lithography aspects are largely enhanced.

Great, thanks for that great color. And then on the fiscal year 2015 CAPEX outlook, if you can just help us understand what percentage of the CAPEX is targeted for IC versus FPD and what kind of revenue per quarter does this CAPEX size the company for?

Okay Harlan, in our Q3 conference call we did indicate that we were pulling in an FPD tool that will be delivered during this fiscal year and installed. Typically we need to operate about 75% to 25% split. I think this year maybe a little bit maybe could be 60% to 40% depending upon the cash expenditures. But certainly the entire CAPEX is related to primarily all high-end applications in the U.S., Taiwan, and in Korea. And as Peters point talked about we expect to monetize those as soon as possible and hit some of the revenues numbers that Peter is talking about where the percentage of high-end business that you referred to earlier.

Great and then just my last question, you know, last call I think you talked about being qualified with 40 nanometers for one of your Asian customers, when do production tape out try to hit your photomask pipeline?

We expect to see that business materialize in the middle of our fiscal year, and it’s not just in Asia it’s also now in United States where we were qualified.

Great, congratulations on that. Thank you.

Thanks Harlan.

Thank you.

[Operator Instructions]. And our next question comes from the line of Patrick Ho of Stifel Nicolaus, your line is now open.

Thank you very much. Accounting for the seasonality that you typically experienced in the January quarter, would it be fair given some of your comments about the push outs of the leading edge IC mask, would it be fair to characterize that that could be potentially up quarter-over-quarter while you see your mainstream business go down with normal seasonality?

Yes, that’s a fair comment. Patrick basically what we expect in the current quarter is an uplift in 28 nanometer foundry logic of balancing the classic seasonal slowdown in mainstream. If memory were 40 nanometer, we’re really participating in the quarter we would expect to see upside that’s not baked into our guidance right now.

Great, that’s helpful. Just -- you answered the question a second ago regarding 40 nanometer logic, I think we can all attest that there is lot of yield challenges going on with that transition that the industry is seeing, and well I guess giving guidance or a specific commentary, what gives you confidence that you can do those tape outs say midyear or fiscal year for 40 nanometers and you won’t potentially see push outs given that the customers maybe struggling themselves to get their yields up and start their own volume productions.

That’s a great question Patrick. It looks more like a Rubik’s cube than the old fashioned checkers it used to be but there is one, there is at least one customer that we all know of the teams to have this technology in hand. So I think we can bank on them.

Great and a final question maybe for Sean in terms of some of the FX impacts that we’re seeing particularly in the past quarter or so with the Yen weakening and the dollar strengthening, have you seen any competitive dynamic changes particularly for the mainstream business given those with foreign currency impacts.

The mainstream business continues to be competitive but we haven’t really seen a sea change there. I did mention that that the FX hasn’t had a significant impact on that. We did see as I mentioned in my prepared remarks, an increase in the main stream business of about $8 million quarter over quarter -- year-over-year which is primarily related to increased market share. We also do benefit on the FX side because we do buy some of our tools and another equipment in Yen so, we do see some reduced cost going forward.

Great, thank you very much.

Thanks Patrick.

[Operator Instructions]. And our next question comes from the line of Tom Diffely of D.A. Davidson. Your line is now open. Mr. Diffely please press your mute button. And I am showing no further questions at this time.

Why don’t you just, I think we are having a few logistic issues because one of our speakers is not on the call as well. So why don’t we just wait a minute or two just to see if someone will come back in.

Hello. Operator, are you there.

Mr. Diffely, your line is now open.

Yes, good morning. Can you hear me now.

Yes Tom.

Oh, great. Maybe just tailing on the last question about the mainstream, what is your big picture view of mainstream kind of out your bases and maybe both on in terms of units as well the competitive environment?

Tom the mainstream business is in a slow decline but it’s kind of -- it’s unusual in the sense that it is a very mature business. It’s -- we have a quarter micron and greater on 8 inches really pretty stable, whether it be analog or power semiconductors that are made on those nodes. There is no economic benefit to shrink further. Where the mainstream business does drop away is at the 90 nanometer, 65 nanometer, and to a lesser degree 130 nanometer nodes. So that’s where we see the slow sort of erosion of the mainstream. And if you look at our industrial footprint, the manufacturing footprint in the U.S. and Europe we are very well positioned with the right toolsets to continue to service the part of the market that is largely stable. And where the rest of the mainstream market is dropping away is largely in the foundry space and there is enough overall pan there that we see ourselves positioned, so we can continue to either stay stable or in fact even incrementally grow market share.

I think Peter too he said on the prior call so just double up on that, we certainly have benefit on the foundry side of getting some excess tools put in our facility. And we are servicing those customers as we go forward.

And another way of saying what Sean just said is we have 45 years of being a service leader and the industries low cost producer and all the work we do every quarter, it preserves the integrity of our business model despite the fact that we are adding high-end capacity that we are waiting to monetize. All of that is what continues to make us highly competitive in the mainstream market.

Okay, while at some point over the next few years would you expect to see more of an internet of things type push where you get a lot of higher volumes at these lower cost chips. Mostly aren’t impacted today but I am wondering longer term if you think there might be impact for your mainstream business?

Not without doubt. A few weeks ago we had the senior leadership team globally together and that was a major discussion point for us, and how it match into our mainstream business and the industrial footprint that we continue to tune. As Sean pointed out with the rate incremental capacity buzz and of course the other node that a industry can just find a way to wrestle more of it away from TSMC that is going to usually benefit from the either net of things at least as far as our leadership teams view is concerned. And I wish we can get someone on the phone but unfortunately speaking for all of them is the 28 nanometer node.

Okay thanks and then Sean when you look at the current toolset, how do you view incremental gross margin on additional revenue at this point?

I think we still target Tom the 50% drop through on incremental margin. Our margin decline this quarter wasn’t related to the operational issues but rather we saw an increase in equipment related cost, maintenance types cost principally in Asia, the bulk of which will be recurring. So going forward we expect to achieve -- our target is still 50% drop through. We do expect -- we got it up on the high-end to 126 but that profile will still hold true to form. And it will drop down to the operating margin line as well. And we would also like to just add one other point related to our operating expenses, Peter talked about cost controls and cost continue programs. You know if you look year-over-year and our OPEX its essentially flat, at 69 million SG&A and R&D together. And that’s in a period of increasing cost so there is quite a bit of cost avoidance and cost savings programs in place that we are actually achieving results. That’s why we have confidence in the integrity and the integrity of the business model.

Great, thank you very much.

You are welcome.

Thank you and I am showing no further questions at this time. I would like to turn the call back over to you Mr. Macricostas for any closing remarks.

Thank you for participating in this morning's call. I would like to thank the Photronics team for their dedication and hard work this past year. I would like to wish everyone Happy Holidays and a Prosperous New Year. Thank you.

Ladies and gentlemen this does conclude your conference for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day everyone.