Good day, ladies and gentlemen and welcome to the Photronics Q2 fiscal year 2018 earnings conference call. [Operator Instructions]. As a reminder, this conference is being recorded Tuesday, May 22, 2018. I would now like to turn the conference over to Troy Dewar, Director of Investor Relations. You may begin, sir.

Thank you, Kevin. Good morning, everyone. Welcome to our review of Photronics' 2018 second-quarter financial results. Joining me this morning are Dr. Peter Kirlin, Chief Executive Officer; John Jordan, Senior Vice President and Chief Financial Officer; and Dr. Christopher Progler, Vice President and Chief Technology Officer and Strategic Planning. 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 participant on today's call may include forward-looking statements that include such words as anticipate, believe, estimate, expect, forecast. These forward-looking statements are based upon a number of risk, 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. 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 our ongoing performance. Reconciliation of these metrics to GAAP financial results is provided in our presentation materials. At this time, I will turn the call over to Peter.

Thank you, Troy and good morning, everyone. We delivered strong performance in the second quarter, achieving 6% sequential revenue growth and 21% growth compared with the second quarter of 2017. Revenue for Q2 of $130.8 million is the highest we have achieved since the record-setting fourth quarter of 2015. This marks the fourth consecutive quarter of sequential revenue growth and the third consecutive quarter of double-digit year-over-year growth. One year ago, our business troughed as several challenges reduced demand from some of our largest customers. Since then, we have worked hard to regain our momentum, primarily by repositioning our business, including a targeted effort to accelerate our China bookings and an initiative to increase our revenues from customers with captive mask operations. I'm happy to report that these two initiatives are paying off as evidenced by our current business levels. Based upon our Q2 results, we are currently operating at an annual run rate of $523 million, essentially even with our record-setting 2015 revenue of $524 million. This is a remarkable turnaround from last year and I am extremely proud of the fine work done across our organization to achieve it. Margins improved as well; operating income increased 30% sequentially and is nearly three times greater than last year. From a profitability perspective, this was the highest quarter in nearly two years, demonstrating yet again the high operating leverage in our business model, which has been preserved by maintaining tight cost controls. Our net cash balance at the end of the quarter was $262 million, a strong position from which to make the bulk of our China investments over the next few quarters. Through the first half of the year, 2018 performance is ahead of our expectations and we are optimistic that this will continue during the second half of…

Thank you, Peter and good morning, everyone. Our performance continued to improve during the second quarter; both IC and FPD revenue increased compared with the previous quarter and the same quarter last year. On a consolidated basis, revenue grew 6% sequentially and 21% compared with the second quarter of 2017. High-end IC was exceptionally strong. That revenue was up 24% quarter-over-quarter and surged 83% year-over-year. We achieved impressive growth in both logic and memory from the healthy foundry demand across Asia. Q2 was our fourth consecutive quarter of very significant year-over-year growth albeit coming off the suppressed levels of 2017. But even at the current superb run rate, we believe there is still potential to move higher and expect to see demand trends continue into the third quarter. Mainstream IC revenue was in line with both the prior quarter and prior-year quarter. One exciting aspect of our Q2 IC performance is the fact that revenue for products shipped into China doubled compared with the previous year and now represents 11% of total IC revenue. This is very encouraging to us as we invest to establish our manufacturing presence in that country. FPD revenue moved higher. On a sequential basis, high-end FPD was down slightly due to softness in AMOLED demand, but we did see good demand from masks used in LTPS LCD displays providing a 14% sequential increase in mainstream FPD revenue. On a year-over-year basis, both high-end and mainstream revenue improved as we saw better demand across our products and markets. We just completed the installation of our newest mask writer in Korea and expect to ramp production on that tool over the next few months. With this added capacity and capability, we are well-positioned to benefit from an expected increase in AMOLED panel production in the latter half…

[Operator Instructions]. Our first question comes from Edwin Mok, Needham.

Hey, guys, congrats on a great quarter. So my first question is on your China revenue that you mentioned or talked about. Is it possible for you to segment how much of that is tied to domestic versus multinational customers there right now? And then I think, based on your commentary, it sounds like IC was around $11 million and the rest is FPD. Is that correct? And what kind of products -- are these high-end or mainstream products? Any kind of color you can provide around the sales you guys have going into China right now.

Okay, as far as our China revenues go, as John said, 11% of our IC revenues are from China. As far as our FPD business goes, more than a third of our revenues are China sourced. So I will start with FPD first. Today, as we sit here, there is not a customer in China that makes displays in volume where we do not do business. So we have them all. Likewise, if you look at the seven AMOLED factories in China, we have all -- basically we have all of those customers and in most cases, we are POR. So we are in a commanding position in display in China. As far as our IC business goes, it is a wide net, so we have significant business with some notable large multinational customers in China, particularly in the memory area. We have significant business with nearly every high-end customer in China. Likewise, we have business with customers like Huawei and Grace that have a wide portfolio of technologies and products. So we are an $80 million run rate in China; that's a lot of IC business. Sorry -- we are an $80 million run rate corporate wide in China, but anyways there's a lot of IC business in that bucket.

Okay, actually that's very helpful. And then on the FPD side, I guess the largest equipment manufacturer out there is talking about equipment demand will be down in 2019. Do you see that potentially causing kind of a slower demand for photomasks in -- by that timeframe?

If you look at China display right now, there is approximately as much capacity being installed as there is capacity operating. So you can't fill display fabs without photomasks. So there is a huge bubble of business coming our way in the next two years as all of that capacity ramps to production. So obviously, I think if you listened to the Applied call, maybe they called the peak on equipment demand, but what few people understand completely enough is that once the equipment is installed, you have to fill it with something and you can't fill it with anything without photomasks. So in our case, the ramp has just started.

Okay, great. That's helpful color. Last question I have on your guidance, I remember you guys were planning on installing a tool and I thought that that would drive some growth on your photomask business in the fiscal third quarter. Is that factored into your guidance in terms of your revenue? And if I look at the numbers, revenue is not up a lot sequentially from what you just reported, but on the earnings perspective, a lot -- this past quarter, you have this one-time FX gain; and in the coming quarter, you've got EPS guide -- this guideline of what we just saw, right? So are you expecting a higher gross margin or lower OpEx? Can you walk through how the model works [indiscernible] quarter?

Yes, I think you've got the timing of the one-time tax benefit incorrect. It was actually in the first, not the second quarter. But I will let John again walk through the one-time benefits, the puts and takes running through the income statement in Q1 and Q2. So John?

Yes, hi, Edwin. Thanks for the question. We had a pretty serious FX loss in the first quarter; the tax benefit essentially offset it. In second quarter, we've eliminated a lot of the exposure we had in FX and because the dollar increase, we wound up with a $2.2 million gain. Our third quarter doesn't factor in any FX activity obviously, so essentially the same EPS without the addition of a $2.2 million FX gain.

And as far as the tool that we've installed, the installation is basically complete as we are having the call. It will take time to qualify that tool, but we are expecting a very rapid ramp. So it will contribute to the quarter, but not throughout the entire quarter. And beyond that, as John also said, normally Q3 on a calendar year basis, particularly the month of August as we head towards August, the business slows. So often we will take tools down in July and August to do the annual PMs. We kind of anticipate the slowdown so that we are ready for when the business picks back up in September. So if we want those tools to run well, we still need to take them down and PM them. So this quarter on the high end, IC will have some capacity limitations towards the end of the quarter and the very beginning of next quarter, but we don't anticipate any slowdown in the business. The business is strong and getting stronger.

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

Our next question comes from Tom Diffely, D.A. Davidson.

Yes, good morning. Thanks for taking my call. So I guess just to follow up on that last point, I thought typically you guys had the maintenance in the January quarter for the annual PMs.

We also, in January, plan to do PMs. We kind of time it for late summer and the Christmas holiday. So we are, as I said earlier, running close to up against the stops on our high-end capacity right now given how successful we have been at penetrating some new business. So any capacity coming off there has a direct impact on revenue.

Okay. And then I guess coming off the Applied call last week, it's my impression that there is a little bit of a digestion period with the OLED tools that have already shipped and as you mentioned will kind of mask demand for you over the next year or two. But it sounded like the 10.5G stuff is still very hot and heavy and I believe that's your main focus as far as the flat-panel facility in China itself.

That's correct, right. We are going as quickly as we possibly can go to get the FPD factory ramped because they are -- right now today there is no G10.5 mask-making capacity in China and BOE has already earlier this year brought their factory online. CSOT will be ordering their first development masks within the next quarter, we believe. And then there is additional capacity coming online next year. As far as our customers are concerned, we can't get that factory built and equipped fast enough so we are working very hard at it. As far as the softness in AMOLED goes, right now there is a push and pull in the mobile phone market between G6 LTPS, LCD and AMOLED. It's a performance cost tug-of-war and although our AMOLED revenues were down, our G6 LTPS revenues were up an equal amount, so the two for us were offsetting in the quarter.

Okay. And then a question on your diversification from a couple key customers. Are you starting to see that now in your list of 10% customers or maybe the contribution from your top 10 customers? Is it becoming evident, your diversification strategy?

It is. Where it's coming from is certainly China. It's also coming from large multinational customers in China. It's coming from FoundryLogic, both 28 and 14 nanometers in Taiwan and Korea.

Okay, and then maybe just a technology question for Chris. Are there any roadblocks as far as you producing masks for the 7 nanometer production that you are seeing over the next couple years or on the NAND side, when you move to high layer counts, say 96 layers, is there anything that is prohibiting you from joining those nodes?

Yes, thanks, Tom. For the 7 nanometer logic, for the optical masks, assuming that those nodes use optical lithography 193, we are in good shape there. We can run those on existing writing tools. We have demo processes already sampling masks actually through 7 nanometer, so we are good there. To the extent EUV might creep in at 7 nanometer, we do have engagements on that. We expect most of those will initially be built by captives. We do have a viable 7 nanometer EUV product we can bring out without incremental investments. So I think we are covered both for the optical and even limited EUV production through 7. And as you say, that gets us through the next couple years. And the second part of the question--?

Just as we go to more layers on the NAND side, is there any--?

NAND. Generally, the lithography does not scale that much as you make higher stacks of NAND. So NAND for sure out quite a ways, we have the capability to deliver those. If you look at 96 layer, for example, it is probably two 48-layer decks stacked on top of each other and the lithography, at least the lateral dimension of the lithography, does not really scale that much with layer count. Of course, the etch depth does, but the lateral part does not scale that much. So we are well-covered there from a technology perspective.

Yes, and just to add a little color, we are actually qualified there in shipping masks. So as far as 96-layer NAND flash goes, that horse is already out of the barn, right; we are already in commercial production.

Yes, that's right. It was -- of the three main development programs, which we will talk more about tomorrow, the logic, DRAM and NAND, there are challenges in NAND, but for sure it's the one where the processes come together the quickest as far as the mask patterning.

Great. And then the final question just on the model, was there any impact from China in the model, either for the quarter or the out quarter in terms of maybe headcount or SG&A?

It was actually somewhat less than we expected. But, yes, there was some impact.

Okay, thank you very much.

[Operator Instructions]. Our next question comes from Patrick Ho, Stifel.

Thank you very much. First off, maybe Peter, in terms of the DRAM industry, right now, a big transition to 1X and eventually to 1Y, the complexity of manufacturing are increasing quite a bit. Yields are still low for the 1X nanometer node. I guess a two-part question. One, you've talked about utilization being high for the leading edge for yourself. How do you see, as yields improve, your utilization and also will you have enough capacity? And I guess the second question maybe for Chris, in terms of the technology, how are some of the new manufacturing challenges you are seeing, especially on the patterning side of 1X and 1Y, how is that affecting I guess mask development for you guys and your ability to get higher margins?

Okay. Well, as I said earlier, we have -- it's funny. Actually I pulled the team into my office just within the last two weeks because, twice a day, I get a look at all the WIP in the nanofab, which you know is our most advanced site. I just pulled up the WIP and I looked at the map of what the business looked like and it was really striking. It was 25% NAND flash, 25% advanced DRAM, 25% advanced logic and 25% EUV et al. So the nanofab had this beautiful portfolio of business in it; it's almost remarkable. It would be an ideal map and it just kind of popped up. So I got everybody in the office and gathered them and said, hey, look at this. We've been working at this for the last two years and it's finally here. So we have a good balance of business and as always, at the leading edge, as the business ramps, it's a balance to balance our leading-edge capacity. And as always, if we need to, we will make the investments required to bring revenues up. But having said that, at the same time, and you will hear a bit about this if you -- tomorrow, we work to move the N minus 1 technology out of the nanofab either to Taiwan and Korea to again enable an overall global factory balance. And we are in good shape there and Chris and his team have done a solid job there. So business is really strong. Our leading-edge qualifications have proceeded better than we had hoped and we have a strong book of business. So I think we are in good shape from a capacity point of view. We want to be pressed. That is how we make money. That is when we make money. As far as technology goes on memory, your two-part question, I will turn it over to Chris.

Okay, thanks, Patrick. So for the 1X, 1Y, as you know, we had joint venture development agreements with Micron for 10 years and actually we had -- while that was in play, we were already doing development on 1Y level photomasks and we already -- I will use the word -- certified to ship masks to that caliber. So we have that technology in hand. Because of that joint venture, as far as other merchant competitors, we believe we are well ahead on DRAM mask technology and it's actually one of our core strengths. So we are quite comfortable with the mask technology through 1Y. We also are engaged in some process of record codevelopment with some of the new entrants into 1X, 1Y sorts of DRAM. So in those cases, we are actually co-developing technology for those nodes. So I think we are in good shape; it's a strength of ours absolutely and the lifetime we have on the technology from the Micron joint venture, we continue to apply it and evolve it for these new nodes and for different customers.

Great, thank you very much.

Ladies and gentlemen, there are no further questions at this time. I'd like to turn the call over to Peter Kirlin for closing comments.

Thank you once again for joining us this morning. I and the rest of the team look forward to seeing you tomorrow. We are performing well, our markets are strengthening and believe that we have a great long-term story. This is an exciting time to be part of Photronics. We look forward to sharing more with you tomorrow.

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