Photronics, Inc. (PLAB) Q2 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Photronics’ Second Quarter Fiscal Year 2019 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded on Wednesday May 22, 2019. I would now like to turn the conference over Troy Dewar, Vice President of Investor Relations. Sir, you may begin.

Thank you, Ashley . Good morning everyone. Welcome to our review of Photronics 2019 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, 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 participants 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 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. During the course of our discussion, we will refer to certain non-GAAP financial metrics. These numbers are useful for analysts, investors and management to evaluate ongoing performance. A reconciliation of these metrics to GAAP financial results is provided in our presentation materials. At this time, I will turn the call over to Peter.

Thank you, Troy, and good morning everyone. We performed well during our second quarter in the face of the semiconductor industry downturn due to our assign driven business model, a diverse product platform, and advanced suite of technology and a resilient customer relationships. In the current industry environment, our customers are introducing new designs as we the attempt to attract consumer attention and gaining market share increasingly crowded competitive landscape. These new designs required new photo masks which is great for Photronics. Our leadership position in the market enables us to provide these customers with high quality masks and they grow revenue despite the current industry slowdown. On top of this, we are investing to improve capability and increase capacity while ramping two new facilities in China. We have placed ourselves in a great position as our performance clearly demonstrates. Second quarter revenue grew 6.6% sequentially, with growth in both IC and FPD. In IC, high-end memory recovered as anticipated with good demand for NAND and some of the DRAM masks in Asia. FPD growth was once again led by mobile displays both AMOLED and LTPS LCD. Excluding our new Hefei facility that is currently ramping production, we continue to run at full capacity with panel producers across Asia preferentially turn to Photronics for their high-end FPD masking. Operating margin improved from the previous quarter, as we maintain tight control on cost while ramping senior facilities, margin were off last year's levels primarily as a result of start-up activity in China. All of this plus an FX gain and other income resulted in solid earnings of $0.13 per share. On our balance sheet, we ended the quarter with the $167 million in cash in terms our debt of $36 million as we repaid our convertible security. This is significant not only because we reduced our long-term debt, but we also lowered our diluted share count. With this enabling portion of our China investment complete, we had a great balance sheet and investing to increase shareholder value led by organic growth, strategic M&A and returning cash to shareholders. For the first half of 2019, we performed in-line with our initial expectations for the year. We have achieved year-over-year growth in each of the first two quarters. In fact, Photronics has grown year-over-year in the last seven quarters and I believe we can continue to do this for the remainder of 2019. Margin should improve as we make progress ramping our China factory and the imagery profits there by the end of the year. Our free cash flow should increase once our China facilities are ramped, providing additional options to increase shareholder value. Our performance during these challenging times due to resign driven business model, which also benefits from the transitions and our growing exposure to China, which continues to expand capacity and production of semiconductors and flat-panel displays. Our total revenue in China’s quarter was the highest ever, representing 20%, 26% of total our revenue. In addition FPD revenue at China set a new record representing 47% of total FPD sales. Our China IC customers are developing new products and moving along the path of enhanced notes in both logic and memory. This increases the diversity of our product mix and decreased customer concentration, as we ship mails to dozens of Chinese producers. We announced our Xiamen investment agreement in August of 2016, we mentioned that our largest IC customer has signed an agreement with us, that will enable us to operate between the breakeven profitability. Recently, we signed a second long-term purchase agreement with another large customer in China. The business resulting from these two agreements, combined with a dozens of smaller accounts to support the sustainability of the China IC operation. Each of these companies will enjoy earnings levels of commercial success. As a result, each one of different levels of long-term demand. However, just as repositioned the businesses has increased the breadth and stability of our revenue stream across Photronics. We expect the growing diversity of the customer base in China will ensure success overtime. The FPD story is similar, we have two customers that signed long-term purchase agreements to support our Hefei investment. They are not the only customers. While the overall number of FPD manufacturers in China is fewer than IC as is the nature of the industry, our sales team is still has solid foundation of business, reducing our dependence of anyone customer, thereby creating a healthier and more sustainable revenue streams. China has a growing number of AMOLED panel producers and we supply mask to all them. Likewise, we plan to sell G10.5+ masks to every panel manufacturer using a substrate side. Last month, we celebrated grand openings of our two new facilities in China. During these celebration, I was once again reminded of our customers enthusiasm to add a local supply of high-quality photomasks. Government officials also reiterated their support for our contribution to the local supply chain and industry development. We broke ground in Xiamen just over two years ago. In Hefei we went from a shovel in the dirt to reducing our first mass in less than 18 months. I'm extremely proud of what our team and employees working with our partners and suppliers has been able to accomplish in such a short period of time. While our accomplishments in China over the last few years have been remarkable, our work there is not complete. We must finish the setup and fine tuning all tools and qualify many customers in the new facilities. Beyond these near-term goals, I challenged our employees and customers to fill our current capacity, so we can then increase our investment and providing more masks to the growing China market. We expect the return of these investments was already significantly above our historical ROIC. In steps taking continue to develop the business in China further expands potential financial returns, which in turn, enable us to fund our long-term growth plans. Throughout the first half of 2019, we are performing well and in line with expectations. Equally important, our China facilities are transitioning from the build to the ramp stage as we need the last few adjustments to tools and move forward with customer qualification. We are ahead of last year's record revenue. And I'm optimistic that we will set a new record this year. This will keep us on-track to deliver on our 2020 target of $630 million in revenue, and $0.80 EPS. I’m pleased with what we have done and excited to see what we have been able to achieve. Before I turn the call over to John, I would like to point out to those of you who do not know it. That this is Photronics' 50th year in the mass business, our golden anniversary. We started in a storefront down the street from National Semiconductor startup facility in Danbury, Connecticut. Today we are the largest merchant mass manufacturer in the world. We have survived numerous economic downturns and navigated industry consolidation to establish our leadership position. Through it all, we have always focused on being a low cost producer while providing outstanding customers service. This approach has served us well in the U.S., Europe, Korea, and Taiwan. We now carry our banner in China and I'm confident that we will realize the same success there. I thank everyone, employees, customers, suppliers partners, their support in allowing us to reach this milestone. I look forward with much enthusiasm to see what we can accomplish together. At this time, I will turn the call over to John to provide commentary on our performance and outlook.

Thank you, Peter. Good morning everyone. Second quarter revenue of $131.6 million was a 6% sequential improvement and 1% better than the same quarter last year. FPD recorded double-digit growth rates when compared with both previous periods while IC was moderately better than last quarter and moderately lower than last year. High-end IC was the largest contributor to sequential growth, improving $3.8 million or 11% over the first quarter, thanks to the recovery in memory orders, which we anticipated. Both logic and memory were off the very strong levels of last year. There are still some sectors where demand remains taped and resolution to the trade issues between the U.S. and China seem to have been pushed out further into the future. But our customer relationships, long-term purchase agreements and China market share provide reason for optimism on the IC outlook. Overall, we are cautiously optimistic and look for demand to be stable to improving. FPD performed exceptionally well with displays for mobile applications once again leading the way. High-end FPD comprised mostly of AMOLED masks today, continues to be strong in both Korea and China and improved 7% for quarter-over-quarter and 26% year-over-year. Our technology for these products is excellent and as AMOLED is used in more Smartphone and in new applications, we are well-positioned to grow with this sector. In mainstream, mobile displays are also the driver for growth as LTPS LCD demand improved. Looking forward, we expect demand for mobile applications to remain robust and we anticipate shipping more G10.5+ masks as we are able to complete additional qualifications in our new facility in Hefei, China. Gross margin was 19.8%, reflecting the impact of China startup activity and unfavorable mix. China startup also impacted operating profit, but lower operating expenses in our other operations as some qualification activity from the first quarter was completed, resulted in an operating margin of 7%, somewhat better than the first quarter. Below the operating line, other income is primarily comprised of foreign exchange gain. With already entrances our partner share of the income in Taiwan partially offset by the share of the loss in Xiamen. The bottom line, net income attributable to Photronics Inc’s shareholders is $8.5 million or $0.13 per diluted share. Operating cash turned positive with lower prepaid VAT for tools delivered into China and without many of the timing issues related to our fiscal year end payments, and collections that affected Q1. Operating cash was $17 million for the quarter. CapEx in Q2 was $33.5 million, somewhat less than our Q1 commentary suggested due to rescheduling payments and not a change in project schedule. Year-to-date CapEx is $140 million and we still expect full-year CapEx to be approximately $210 million. We paid $61.2 million of debt in the quarter, primarily for the $57.5 million convertible securities that matured on April 1st and eliminated $5.5 million potentially dilutive shares. When combined with the previous repayment of convertible debt in April 2016, $10.4 million potentially dilutive shares have been eliminated over the last three years. As we have previously reported, we also repurchased 3.7 million shares beginning in July 2018. In total 14.1 billion shares, or 18%of dilutive or potentially dilutive shares has been eliminated since 2016. As a result of this latest debt repayments, strong operations, and additional actions we have taken over the last several years, our balance sheet is solid. Just over five years ago we had debt over $194 million including $137 million in convertible senior notes and net cash $22 million. Since that time we have eliminated all the converts, and we now have $36 million in long-term debt, comprised entirely of interest subsidized local borrowings in Xiamen, used to finance that project. Repayments of those loans is expected to be made with operating cash anticipated to be regenerated in Xiamen. Before I provide third quarter guidance, I will reiterate the reminder that our visibility is always limited, as our backlog is typically only one to two weeks, and demand for some of our products is inherently uneven and difficult to predict. Additionally, the ASPs or high-end mask sets are high. And as the segment of the business grows a relatively low number of high end orders can have a significant impact on our revenue and earnings for quarter. Given those caveats, we expect third quarter revenue to be in the range of $134 million to $144 million. This assumes that our IC markets will be stable to improving and FPD will remain near full capacity. We also anticipate a larger contribution from the ramp of China facilities especially FPD. I will also caution that any development from the ongoing trade discussions between the U.S. and China could potentially have an adverse impact on our industry and therefore our results. Based on this revenue expectation and our current operating model, we estimate earnings for the third quarter to be in the range of $0.06 to $0.15 per share, including approximately $0.03 to $0.06 per diluted share net negative impact from China startup operations. Through the first half of 2019, we have been performing in-line with our expectations, revenue is up and bottom line results reflect the headwinds inherent in starting up two new facilities. Our balance sheet is in great shape and we are well positioned to achieve sequential growth throughout the rest of the year as our on demand grows and we rent productions in China. We expect this will improve cash generation and enable us to further invest in organic growth, be opened to strategic M&A opportunities and potentially return more cash to shareholders. I will now turn the call over to the operator for your question.

Yes, actually before turning the call to the operator, John, I think you misstated the guidance. Our third quarter guidance is for revenue between $132 million and $142 million and diluted EPS between $0.05 and $0.14. So I just want to make clear that this is what was in the press release and this is the guidance for the company moving forward. We can now turn the call over to the operator for questions. Thank you.

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

Hi, guys, good morning. This is actually Franco in for Tom. First from us, could you qualify the headwinds that you have seen from China in terms of what the macro headwind I guess compared to your guide?

Yes. Franco I think on the slide we talked about the operating profit impact from China was about 4.1 million. I think the bottom line is up $0.04 a share. And as far as the business goes our overall revenue and FPD revenue, China set records in the quarter. So, I wouldn’t described the market and the headwind, but clearly the startup costs affect the bottom line.

Okay. Thank you. And then from that, I guess you just announced the new long-term purchase agreement in China for your IC fab, after you said service contract and what percentage of the capacity would you be running at?

Well I think the way I would answer that question is, new contract is with another large foundry customer in China. Their right now run rate is actually larger than the run rate with the original customer we signed the first contract with. So we won’t specifically divulge the exact capacity, with that extra contract, we are very confident we can ramp that facility to profitability. So we now have two large anchors instead of just one, just as we have in FPD.

Yes. Okay. And then do you still expect to be at full capacity in the FPD side at the end of the year.

Do we still expect full capacity in FPD at the end of year?

Yes. We still expect to drive to full loading as we exit the year. As we remark we shipped our first G10.5+ mask in the current or in the prior quarter in Q2 in the month of April. And this quarter’s mix would be a mix of qualifications and commercial business, shifting as we go through the quarter and the fourth quarter, if we continue to stick to our plan, certainly by the time we hit mid-quarter, we should be through all the qualification work and flat out commercial volume.

Okay. Very helpful. Thank you. And then final from us. you had previously mentioned that the qualification for the high-end IC was between nine to 12 months. One is this still the case and then to how does that compares to FPD? Thanks.

That is certainly true for high-end IC. As far as FPD is concerned, qualifications usually run about - they are typically concluded in a quarter. So, once we start, it's anywhere from 30 to 90 days to completion. So the FPD is much shorter and that is why we can ramp the factory to full volume much quicker.

Alright. Thank you.

Thank you. [Operator Instructions] And our next question comes from the line of Patrick Ho, with Stifel. Your line is now open.

Thank you very much. Peter, maybe first off in terms of the IC qualifications in China, you mentioned that you added on a second customer, is it fair to say that the bias right now in terms of qualifications with other potential customers, is more foundry logic base? Or is there a good mix between memory and foundry logic?

It's weighted Patrick to logic and Foundry logic. But there is a growing - our memory - as you heard in my prepared remarks, that our memory business in China is building I guess, and it's a mix of very large international companies with facilities in China, and domestic China manufacturers. So it's both, but still weighted to foundry logic.

Great. That is helpful. And maybe as my follow-up question on the display side of things. Form a CapEx perspective this year in 2019, China seems to be a little more weighted towards the G10.5+ versus AMOLED. So you obviously did very well, in getting, good revenues on the AMOLED side of things, as 2019 progresses and even to 2020. How do you see the growth forecast for the G10.5+ given that that is where I guess for local Chinese vendors are least focused this year?

Yes. So as we sit here today, there are two G10.5+ factories in volume manufacturing in China. A third one we will start - so the first reticle set for the third factory will be purchased within the Q3 and the fourth, we expect to see a reticle set purchased - I don't know by around the end of the calendar year and then the fifth will clearly be in the first half of next calendar year. So by the end - a year from now the overall capacity in China and demand for G10.5+ will have doubled. And by the end of next calendar year, it will have gone up by factors 2.5. So yes, the market there for G10.5+ is really hitting its sweet spot. This is one of the reasons why we drove so hard to get that perfect factory built and ready to run reticles to hit the sweet spot of the growth curve in the market. As far as AMOLED goes, you can see from our current financial results that we are doing quite well, you know almost half of our FPD business is in China and its heavily weighted to AMOLED.

Great. And final question from me. May be for John in terms of the headwinds from China. I understand the start up cost and the ramp there. Given that you had a really good quarter on the OpEx side of things, all the remaining I guess headwinds and I guess start up and ramp cost, is that all going to come out of the cost of goods and that is where we will see the leverage as 2019 progress and going into 2020?

We have OpEx in China as well Patrick. So, we see cost of goods and OpEx running at similar level for next quarter. Cost of goods obviously varying with the level of business.

I think you are right Patrick. Our OpEx expenses should be pretty stable in China, they do go up and down quarter-to-quarter. And most of swing is driven by R&D expenses, so they can move around. But as I mentioned, we have a death grip on the operating expense to the extent we can control them.

And as the revenue increases and we start actually shipping more the tools that are there will be depreciated as well. So, cost of goods will increase with the depreciation and amortization as well as the cost of the goods that are produced.

Great. Thank you very much.

Thank you. Ladies and gentleman there are no further questions at this time. I will now like to turn the call over to Peter Kirlin for closing comments.

Thank you for your time this morning. 2019 is shaping up to be a great year for Photronics. So I look forward to updating you as we move forward.

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