Tower Semiconductor Ltd. (TSEM) Q2 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the TowerJazz Second Quarter 2017 Results Conference Call. All participants are currently present in listen-only mode. Following management's prepared statements, instructions will be given for the question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded, August 3, 2017. Joining us today are Mr. Russell Ellwanger, TowerJazz's CEO; and Mr. Oren Shirazi, CFO. I would now like to turn the call over to Ms. Noit Levi, Vice President of Investor Relations and Corporate Communications. Ms. Levi, would you like to begin.

Thank you and welcome to TowerJazz financial results conference call for the second quarter of 2017. 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 Forms 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 are also available on our website. TowerJazz assumes no obligation to update any such forward-looking statements. Now, I'd like to turn the call to our CEO, Mr. Russell Ellwanger. Russell, please go ahead.

Thank you, Noit. Welcome to all of you. Thank you for joining us today for our Q2 conference call. We reported record revenues for the second quarter of 2017 at $345 million, representing a 13% year-over-year growth. In terms of our profitability, we reported a record EBITDA for the quarter of $108 million, up 24% over last year. GAAP net profit for the second quarter was $50 million for an increase of 30% year-over-year. This profitability growth well in excess of our revenue growth was driven by ongoing improvements across all margins for which Oren Shirazi will give details in a few minutes. It demonstrates the strong operating leverage inherent to our business model. In the second quarter of 2017, we generated record free cash flow of $43 million. This further strengthened our balance sheet providing us with financial flexibility to be able to support exciting new opportunities. Looking ahead to the third quarter of 2017, we see continued growth and our expectation for revenues of $355 million plus or minus 5%. We remain focused and attentive to the needs of our broad customer base, working to provide full circle value creation, built upon our market leading specialty technology offerings. Looking in our business breakdown, the total end markets served by all wafer shipped meeting our corporate revenues in the first half of 2017 were for the RF-end market including mobile and infrastructure, about 30%, for power management, including power ICs and power discrete about 30%. For sensor end market including medical, machine vision, digital SLR cameras, cinematography and security among others, about 16%. About 24% of our corporate revenues served various other segments, many of which fall under IOT, such as computing and analog sensors, included here also is aerospace and defense and protection devices. Our first half year-over-year 2017 over 2016 growth was about 16%. Excluding the Panasonic and Maxim long-term contracts which are committed and stable or in other words considering only our business units driven growth, we recorded an industry-leading over 26% organic growth in the first half of 2017 year-over-year. I would like now to provide a summary of main activities for business group, which generates this 26% growth figure. During the second quarter, we continue to see strong demand for our RF high precision analog platforms serving both the mobile and infrastructure markets. Within the mobile market, demand was strong for both our RF SOI and silicon germanium technologies in line with the expectations set at the last quarterly call and higher than the demand that had been anticipated at the beginning of the year. To accommodate the growth, we continue to bring more RF SOI products for San Antonio facility where we now have multiple RF customers in production. Longer-term, we see significant interest and initial design activity for next-generation 5G handsets in both our state of the art 300 millimeter RF SOI processes and our high-performance silicon germanium technology capable at millimeter wave frequencies. These are being adapted for the most demanding versions of 5G. Within the infrastructure market, we continue to experience strong demand for our high-performance silicon germanium platform using optical fiber high-speed connections. As stated last quarter, this demand continues to be above original customer forecast and is primarily driven by new data center, fiber optics connectivity. Our high-performance silicon germanium platform is used for many of the devices used in 10, 25, 100 and now even 400 gigabit per second fiber optic connection that carry data within data centers, between data centers and throughout data networks around the globe. We conservatively have estimated our share in this market to be at about 60% and are seeing traction for new designs in the latest silicon germanium technology developed for this market, our H5 process family which we announced in Q1 of this year. Towards further growth in this market, we announced last quarter the launch of silicon photonics process which complements our silicon germanium offering and increases our content in fiber optic data connection. Since our announcement, we are seeing strong customer interest as silicon photonics promises to reduce the footprint and cost of otherwise bulky connection between optical fiber and electrical components by integrating on a single silicon die, wave guides, photo diodes and margin breakers. Our power management business unit continues to see strong demand. During the second quarter, we released a new and competitive platform aimed at lower 5 volt power management ICs. This segment represents a major portion of the 2016, $6 billion consumer market according to MarketsandMarkets reports with applications including laptops, cellular and IOT products. The new platform provides value added features such as better isolation, hence noise immunity which drives better efficiency at higher frequencies. A lead first tier customer reported fully functional prototype operating at very high frequencies switching speeds. Also, to support the growing requirements of integration of CMOS mixed signal functions with power management ICs, we have released a denser digital library, 95 kilogate per square millimeter with a large portfolio of memories. This is the best in the world 5 volt digital library density. We see increased demand for our leading very low Rdson Gen 4 LDMOS devices from multiple markets segments in need of improved efficiency ICs. The prototypes for many customers were taped out during the second quarter for multiple end usages. Specifically, with regard to automotive power offering from MarketsandMarkets, the overall automotive key markets was valued at $6.260 billion for packaged devices and is expect to growth to over $10 billion in 2022, a compounded annual growth of 10%. For the foundry market, the growth is predicted to be substantially higher at, at least a 15% compounded annual growth. The automotive power semiconductor market faces multiple challenges. First, reduction of electrical systems weight for greater efficiency yielding lower emissions; second, increased efficiency for batter life; third, high levels of reliability and fourth, this must be able to support wide ranges of voltages from 1.8 volts, 5 volts, 12 volts for infotainment to 48 volts for motor drivers to greater than 200 volts for battery management. TowerJazz is very well positioned to address new and additional requirements of this high growth segments. We already support today some of the leading automotive IC suppliers and plan to significantly expand our coverage in this market with our new and competitive technologies that address the above mentioned challenges. Our advanced 200 volt SOI platform best fits the automotive need for wide range of voltages, isolation reliability and continues to attract new designs, from in-design stage and more new evaluation stage. In parallel, our R&D team continues to work with our leading partners and additional advance features for the next generation of products. To further expand, our leading efficiency parameters for higher voltages, you are developing a new drain isolation platform that will include a leading edge low-Rdson LDMOS with voltages up to 90 volts, a very good match for the 48-volts automotive battery architecture. The general PDK will be released by Q4 2017 with leading customers having already decided to use this platform for new products targeting tape-outs in 2018. Our power management platforms are available at two production sites, both of which were qualified to support automotive customers. Our third site, the San Antonio factory is being qualified now and customer products have started to transfer to this factory with prototypes targeted for Q4 2017. It should be noted that San Antonio is already a large automotive manufacturer for non-foundry flows. With regards to the CMOS image sensor business unit, we also continue to see very strong demand especially in the industrial in the medical sensors market segments. According to analyst reports, the industrial sensor market is growing at about a 10% compounded annual growth. Above this number, by itself is large, our business in this market segment is growing even faster mainly due to the success of our customers who in sockets are replacing CCD sensors. The industrial sensor market is still predominantly dominated by CCD technology, but converting it to CMOS presently like other CIS market segments have already done. This conversion allows our customers that are top flexibility and performances, such as high frame rate and flexible region of interest in the image. As they ship from the CCD to CMOS based solutions. We continue to invest in global shutter pixel technologies for this market and already released a family of state of the art pixel including the smallest in the world 2.8 micron pixel that is now being prototyped by two customers, one of them is [indiscernible] with two products, a 16-megapixel and a 12-megapixel having already demonstrated outstanding results. In parallel, we are developing this technology on our 65 nanometer 12-inch wafer platform with even smaller pixels, using this advance flow capacities to producer smaller pixels while maintaining the same outstanding figure of merit such as low noise, low dark current, high shutter efficiency and high quantum efficiency. In the dental and medical X-ray markets, we are also growing faster than the market that grows also at about a 10% CAGR by winning more and more designs. Some of the large panel products produced from single die wafer fabrication are already in volume production and some are slated to ramp to high volume in the second half next year. This includes the dental intra and extra oral markets, medical, especially surge volt and mammography and non-destructive stress reliability testing market sub segments. For us, both the industrial and the X-ray markets are very fast-growing ones with the products being dual-sourced in Fab 2 in Israel and in Fab 6 in Japan. In Fab 7, our 12-inch line, we are developing several high-end digital SOR sensors and these are planned then for volume production starting from end of 2018 will continue to move volume designs into 2021. Although this market segment growth according to Analyst is mild, about a 2% CAGR, our growth in this is high double digit and due to fact that we are wining substantial market share. Our customers are designing with us versus buying an off the shelf sensor form system companies. In addition, looking at our CIS offering, recent technology trends of automotive is rapidly moving to ADAS automotive driver assistance system and autonomous driving system for which more sensors and higher speed networks will be required. We are receiving more and more requests related to automotive sensors in our CIS business unit, we're investing in two vastly differing platforms technologies that are targeted mainly to the automotive and 3D augmented reality markets. These are near infrared sensors for all kinds of time of flight application and SPAPD single photon avalanche photo diodes for automotive LIDARs. There is a consensus in the car industry that every autonomous car will have at least one LIDAR system. So, with around 90 million new cars sold every year, it should become a very large market once the market does move to autonomous cars for which we target to have strong presence. The TOPS business unit operations expanded to include all of TowerJazz fabs, with production in all sites in Japan in the U.S., in Israel, while both the customer in TowerJazz capacity upside capabilities and loading balance flexibility within a model of levels of guaranteed capacity usage. TOPS customer applications range from multiple types of discrete power devices to protection devices, multiple advanced memories, RF SOI and specialty sensors. One of our major focuses in the TOPS business units is to co-develop next-generation platforms incorporating both customers and application feature requirements, knowledge combined with our integration and device knowledge to create differentiated platforms for which they exclusively design families of their products. We are working with several of the large customers with new platforms with incremental production ramps expected over the next one to two years. In addition, we are expanding into new areas and technologies. The sensor market is an engine for growth particularly in IoT applications and we are ramping to production in magnetic sensors with strong – with a strong customer partner and are engaging and expanding this program with additional tier 1 customers. We also see an increasing demand for product served in the automotive markets and have several new engagements in automotive applications which fit well into our fab capabilities. Our operational model is to run at around 85% utilization, which provides us with the best balance between line flow and wafer shipments. The following were the utilization rates for the quarter. Fab 1 Migdal Haemek, Israel our 6-inch factory was at 90% utilization. This is a strong testimony to the long-term viability of the analog business and operating model as this fab was built in 1983 and as stated is running at even above our utilization model. Fab 2 Migdal Haemek, Israel our 8-inch factory was at 85% utilization after increasing the photo capacity by an additional 6% in the last quarter. Fab 3 Newport Beach, California, another 8-inch factory was at 86% utilization. The three TPSCo factory had an average of about 50%. Fab 9, our San Antonio factory was a bit above 60% utilization. To summarize, we continued our strong year-over-year revenue growth due to our business efficiencies and the leverage built into our operating model we continue to translate this growth and even stronger growth in profit and cash flow. As we continue our lead in the analog semiconductor space, we are taking significant stride to increase our activities and capabilities within the analog sensor space and look to further our market potential and competitive advantages by investing and focusing on other high growth and high margin markets. We look to provide our customers with the right platforms, support their need, capitalize on the trends that are prevalent now as well as emerging trends which are driving the world and will continue for the years to come. With that, I would like to turn the call over to our CFO, Mr. Oren Shirazi. Oren, please?

Thank you, Russell and welcome everyone. I will start my review by providing our P&L results highlights and then discussing our cash generation debt, share count and the balance sheet. We again reported a very successful quarter with year-over-year revenue growth of $40 million to a record of $345 million resulting in record gross profit of $91 million, record operating profit of $57 million and record shareholder's equity and divisional records in the balance sheet. Overall, year-over-year this increase of $40 million in revenue resulted in $17 million incremental operating profit, $21 million in incremental EBITDA, representing 53% incremental EBITDA margin and $12 million incremental net profit representing 29% incremental net profit margin which is ahead of our target growth model. Gross and operating profit for the quarter were at a record $91 million and $57 million, representing 25% and 43% increase effectively, as compared to $73 million and $40 million gross and operating profit in the second quarter of 2016, respectively. Net profit for the second quarter of 2017 was $50 million or $0.52 per share, basic representing an increase as compared to $38 million or $0.45 basic earnings per share in the second quarter of 2016. I know that the second quarter of 2016 included $10 million, a net gain from the acquisition of San Antonio facility and $7 million financing cost relating to early repayment of the Israeli banks' loans. If we look at earning per share for the second quarter increased to $0.49 per share as compared to diluted earnings per share of $0.40 in the second quarter of 2016. EBITDA for the quarter was at a record $108 million or 31% EBITDA margin as compared to $87 million in the second quarter of last year, up 24% year-over-year. Overall, quarter-over-quarter, our $15 million revenue increase resulted in EBITDA and net profit growth of $7 million and $5 million respectively, representing 49% incremental EBITDA margin and 30% incremental net profit margin, again ahead of our target model. The result for the first six months of 2017, revenues for the first half of 2017 were a record of $675 million reflecting 16% growth as compared with $580 million for the first half of 2016. Growth and operating profit for the first half of 2017 were a record $176 million and $110 million, respectively representing 31% and 55% increase as compared to $134 million and $71 million in the first half of 2016. Net profit for the first half of 2017 was $96 million or $1 in basic earnings per share. Net profit for the first half of 2016 was $104 million or $1.22 basic earnings per share and included $51 million gain from the acquisition of the San Antonio fab and $7 million financing cost related to the Israeli bank loan early repayment. Therefore the first half of 2017 was at a record $209 million or 31% EBITDA margin representing 27% increase as compared to $165 million in the first half of 2016. Overall, year-over-year, excluding the gain from the San Antonio acquisition and the cost associated with the bank early repayment, our $92 million higher revenue in the first half of 2017 as compared to first half of 2016 resulted in $39 million incremental operating profit, $45 million incremental EBITDA, representing 48% incremental EBITDA margin and $36 million incremental net profit, representing 39% incremental net profit margin which are ahead of our target growth model. I will now review the balance sheet analysis as of the end of June 2017. Cash, during Q2 2017, we achieved the record free cash flow of $43 million, with $84 million positive cash from operations and $41 million investments in fixed assets net. The other main cash activity during the second quarter of 2017 were comprised of the following $40 million received from exercise of warrants and options, which were mainly Warrant 9 issued four years ago, which was fully expired, and $6 million in debt repayment. As of the end of June 2017, our total growth debt was $341 million comprise of an outstanding principal amount of $161 million in bank loans, including $121 million from the Japanese bank to TPSCo, and debentures in the amount of $180 million. Our net cash, which is our total cash and deposits as presented in our balance sheet, less our total debt resulted in our record net cash position of $143 million as of the end of June as compared to $37 million as of December 31, 2016, only six months earlier, mainly due to the positive $84 million in free cash flow that we generated. Our net current assets or current assets less current liabilities increased to $553 million as of June 30, 2017 from $451 million as of December 31, 2016. Current ratio as of June 30, 2017 increased to a record 3.18% as compared to 2.82% as of December 2016. Shareholders' equity as of June 30, 2017 was at a record $814 million, 90% higher as compared to $683 million as of December 31, 2016. Share count as of June 30, 2017 included 98 million outstanding shares. The fully diluted number is 107 million unchanged the same as the last six consecutive quarters. Our fully diluted share count as of June 30, 2017 included 9 million maximum potential shares to be issued compared as follows, 2 million warrants is of related options and RSUs, 6 million shares underlying convertible bonds, and 1 million shares underlying capital note. To summarize, we are very pleased with the results for the second quarter of 2017 which demonstrates our excellent performance and very strong balance sheet, achieving revenue growth, margin increase and multiple recorded results including record in revenue, EBITDA, gross profit, operating profit and free cash flow, as well as a record cash balance, record shareholders' equity and the additional strong balance sheet ratio that I described before. That ends my summary, and I would like now to turn the call to Noit Levi. Noit, go ahead.

Thank you, Oren. Before we open up the call to the Q&A session, I would like now to add general and legal statements to our results in regards to statements made and to be made during this call. Please note that the second quarter of 2017 financial results have been prepared in accordance with U.S. GAAP and the financial tables in today's earnings release includes financial information that may be considered adjusted financial measures and non-GAAP financial measures under Regulation G and related reporting requirements as established with the Securities and Exchange Commission, as they apply to our company. Namely, this release also presented financial data, which is reconciled as indicated in the table or in the call on an adjusted basis, after deducting; one, amortization in acquired intangible assets; two, compensation expenses in respect of equity grants to directors, officers and employees; three, gain from acquisition net; four, non-cash financing expenses related to bank loans early repayment; and five, other non-recurring items such as acquisition related costs and Nishiwaki Fab restructuring costs and impairment. Adjusted financial measures and non-GAAP financial measures should be evaluated in conjunction with, and are not a substitute for GAAP financial measures. The tables and the earnings release also contained the comparable GAAP financial measures to the adjusted financial measures, as well as the reconciliation between the adjusted financial measures and the most comparable GAAP financial measures. EBITDA is reconciled in the tables from GAAP operating profit. EBITDA is not a required GAAP financial measure and may not be comparable to a similarly entitled measures employed by other companies. EBITDA, the adjusted financial and the non-GAAP financial information presented herein should not be considered in isolation or as a substitute for operating income net, income or loss, cash flows provided by operating, investing, and financing activities per share data or other income or cash flow statements that are prepared in accordance with GAAP and is not necessarily calculated or presented on a basis consistent with the same or similar data presented in previous communications. And now we will open up the call for Q&A. Operator?

Thank you. [Operator Instruction] The first question is from Cody Acree of Drexel Hamilton. Please go ahead.

Thanks for taking my questions and congratulation on the continued progress. Russell, if we could just maybe start with your thoughts on capacity expansion maybe kind of the timing and the type of transactions that you are looking at. Are you thinking about something more like a single fab maximum type acquisition or maybe another JV? Or are you possibly considering maybe something larger given the size of the Company today and the growth rate that you're seeing?

Thank you, Cody, firstly for the good wishes. Good question. As stated earlier in the call, we did see a 26% growth or above 26% organic growth in the first half and the second quarter. It's a, I think an amazing industry leading number and something that's between 20% and 30% organic growth, something we've been able to maintain for a while now. So, the question about capacity increases is a very, very real one. For the short-term, our focus is obviously to continue to take the benefit of the already covered fixed costs that we have within facilities and fulfill to higher utilization levels, which is the reason that on a percentage base, the margin growth is above the revenue growth because the fixed costs has been covered and our growth capacity model has been one that we've been able to through either in the partnership Panasonic, or TPSCo, or through the outright acquisition of a San Antonio fab, it's a loading agreement from Maxim, we've been able to take very, very high capacity facilities that were not fully utilized at a very reasonable if not low cost in a win-win model and have runway to build up a third-party business when from day one you have something accretive to the EPS and the EBITDA. And hence, at this point, as the utilization goes up, the percentage of growth on the margin number is higher than the percentage of growth in the revenue numbers. Uptake, so that being said, we are certainly focused on pursuing similar models. So one thing that we would be going after is still look at is the type of a deal that as you look at the end of 2018 sometime in the beginning or middle of 2019. We would need to have additional qualified capacity where we should need to have additional qualified capacity on top of these still open capacity that we have. If we are going to maintain at the same or similar levels of growth as we've been having. And we would like to pursue and actually are pursuing deals where we would have the ability to take over through a partnership an existing factory. We have as well talked in the past about partnering with someone on a little bit different model, but on a greenfield site potentially in China to where you would have a partner and maybe some municipality or central government funds that would be covering the greenfield costs, and we would be investing in kind, not necessarily at all with money, but in kind with capability as far as the knowledge to bring up the factory, the right equipment to buy for the factory then bringing up the factory and licensing certain technologies and hence, then have a good amount of free capacity from the moment that the factor would be turning on the market. So, that all contains within that first model which is similar to the last few acquisitions that we have done. Also however, due to the Company and the growth of the company meeting, not just the growth as far as revenue but the growth of the Company as far as our capacities. We are at this point, a cash producing company that has a nice free cash flow and a very nice net positive cash balance. So, we'd also be looking at possibly the acquisition of an undervalued asset that is a large undervalued asset that we would think either through our type of management or combined efficiencies would be able to have a much better valuation as part of our family of factories incorporated within our businesses. And the third area of growth is a little bit different area, it's not necessarily the capacity growth that you are speaking of, but where I had in the summary statement talked about that we're focused on other areas of high-margin business. We are actively pursuing and engaged in discussions to take on activities that would have both a technical capability and production capability that would be increasing our served market within the analog sector. So, those are the three areas that we look at. There is nothing at the point right now that we would need to give more details about what we're specifically pursuing, but in addition to not needing to give details, we would not risk to give details, because as with the previous deal with Maxim for San Antonio or with Panasonic for Panasonic Semiconductor, we got engaged early. We got exclusivity early and we drove very, very interesting model that probably other people hadn't thought of or looked at. So, with the activities that we're pursing right now to get into too much detail would basically open up others to want to be involved which then diminishes our ability to maybe converge on it as well as it would most likely create competition that could raise the acquisition price. So, it makes really for us no sense to give too much detail, other than those are really the three areas of growth that we're looking at, two of them that would add capacity. The third that doesn't necessarily add huge capacity, but adds a capacity with new markets that we'll be serving for which we presently don't have the technology, nor the traction with customers for the technology, and that's the big thing about going into new areas, something very different than we do presently. We can get into the area, we can try to attract customers in that area, but then you have somewhat of a three to five year latency before you start building it, pursing an acquisition of someone who already has the initial traction with multiple customers and hence then you just build the capability in that customer base. Hopefully, I mean that's a very long answer. I apologize for the length, but I wanted it to be complete.

No, I appreciate the information that left technical that new market, new areas at your Analyst Day you had openly talked about an interest in MEMS. Is that – is that related to that discussion?

MEMS and other types of – I said within the script that we're very interested in sensors, that opens up many, many different areas, I mean not just MEMS itself, but different materials.

And then just lastly, last quarter you raised your RF growth target based on the strength of silicon germanium. In you script, you talked about strength of silicon germanium. Can you parse out how much of that growth is being driven by Wi-Fi versus optical? I know we're getting a lot of mixed data points in the optical markets. Some are seeing strength, a lot aren't, so I'm just curious to see what you are seeing?

We're seeing it in both, in high-end performance for switches as well as certainly within the optical space. Now, I think most people and I'm not sure of anyone that is cleaning weakness within the data center arena within optical. And as stated in the previous call, and I'll reiterate that, that's where we're seeing the biggest uptick is within data centers. And I don't know of anyone that's saying that that are is weak, but whether there would be someone that's saying it's weak or not, we're not seeing any weakness there whatsoever. We're seeing very big demand and at or above our capacity presently.

Very good. Thank you and congratulations.

Thank you.

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

Thank you and congrats as well on good results. A question on the gross margins, so steady progress there for the second quarter revenue increased incrementally about $15 million and the incremental gross profit increase was $6 million on a non-GAAP basis, so about a 41% incremental. Wanted to get your thoughts on the gross margin progression as we get to third quarter and fourth quarter, how we should be thinking about the incremental margins going to the back half of the year and along the same lines, at what point do you think we'll start to see more higher margin flows occur in the 12-inch fab where the incremental margins are substantially higher in the 65% range, if I'm correct on that?

Yeah. So it's really like you say, the more the mix of the growth will be, the more it will be from Uozu factory from the 12-inch, the higher gross margin incremental, it will be. So, in this, therefore the second half of 2017, I would expect the incremental margin to be continue to extend with what we show here, which is 45%, 48%, 50% incremental and towards the end of the year and mainly in the beginning of 2018, first half of 2018 as much as we see the Uozu ramping up with its 60% plus incremental gross margin, then the weighted average depended – should go to like 55%, 57% incremental gross margin.

And another question on the gross margin, you know a competitor of yours saw increases in their cost of goods sold related to increased wafer pricing due to shortages and tight supply of 200 millimeter wafers. I was wondering, if you can maybe talk a little bit about that in terms of your supplier base, you seem not to be seeing that, are you more diversified on your supplier base? And then if you could elaborate a little bit on that and how you look at that dynamic affecting the margins going forward?

So, we had, just a few weeks ago, there was the Semicon Show in San Francisco at the Moscone Center and it's a very big day for our operation or week for our operations team to meet with many, many suppliers. Among the different suppliers that they had met with, and I was there for one short time, I met with some – on the silicon side, one of our major suppliers as well. So, overall, I think we're in pretty good shape with silicon suppliers as far as relationship based, I don't think we see any shortage at all. We've had a couple that have asked for some increases, but and they are really not prohibited increases. If we were to look, I believe for the blended 2017 cost of silicon, it's probably less than our blended 2016 cost of silicon. So, we have a good relationship and good activities for efficiency. Some of it deals with some multiple qualifications of different suppliers. We do have in specific one supplier who has asked for a very strong increase that we are in discussion with still. I'm personally in discussion with. But I believe in the big picture, that we would not see an impact in our gross margin as whatever if there was going to be some Q4 impact in COGS due to silicon, or a Q1, Q2 2018 impacted the COGS doing silicon, we'd very aggressively go after other GL accounts in order to take that cost out. So, and I think the big think about anything dealing with costing is truly being very proactive and smart and looking at an overall summary of what is the cost and having programs with suppliers, so where you are not really holding them over a barrel as far as cost reduction, but long-term programs are both benefit from by driving efficiencies. And I think we're fairly good with our major suppliers to do that.

Okay great. And last question on the Panasonic agreement, I know it's up for renegotiation, or up for renewal in Q1 of 2019 and you are actively in discussion now. I was wondering if you could kind of walk us through how you are thinking about that agreement in the future, without maybe going into specific numbers or anything like that, but how the agreement could potentially change versus the prior agreement?

Okay. So, basically there is no doubt that Panasonic will continue demand products from those factories. Those factories were built by Panasonic more than 100 years, that Panasonic is leader of electronics, maybe the founder of electronics in Japan. The foundry idea is not broadly used in Japan, so it's pretty common that the Japanese IDNs manufacture by themself. And the fact, the Panasonic will continue to demand quantities of wafers in significant amounts from those factories is unquestionable and it's a negotiation that we have like any other customer. Possibly then at better environment because any customer is used to outsource to maybe a few vendors and the Panasonic is used to manufacture in Japan, the products at least that are manufacturing in TPSCo fabs. So, I don't think there is any problem to assume that quantities will remain the same more or less, and it's just a matter of negotiation like any other customer.

Thank you.

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

Hi, guys. Thanks for taking my questions. I'll echo the great execution, keep up the good work. It guess my first question that organic growth, the number you mentioned 26%, I think is both of second quarter and first half number which is obviously a great number relative to the semiconductor growth markets. I guess two questions there. As you look through the rest of the year or as far as you'd like to, Russell, can you give us a sense of how you think the organic growth rate can trend going forward and are there any meaningful differences within the major functional buckets as you've split out over the last few quarters relative that – whatever that overall organic growth rate expectation is?

To begin with, I agree, I think 26% is quite an amazing number and I am very pleased that we've been able to do that. It shows having chosen the right markets and having capabilities and relationships with customers that allow us to grow with them in the right markets. The areas that have grown the strongest in the first half of the year and the second quarter of the year have been pretty much across the board, everything that we do which we had stated at the beginning of the year that all of our businesses we would see a 25% or greater growth in with the exception of the RF space, which we have said at the beginning of the year coming into it, that we had thought it would be somewhere in the mid-single digit and then we increased that to be some to ex-that or so at the last quarter and said that we've maintained it. So, on the RF side for some good reasons, we didn't want to do something that would have required us to do in order to have very, very strong double digit growth. But on the area of CMOS image sensors and the area of power management both discrete and PMIX, and some other areas of IoT. Our sensor business having really come from not very much is growing very good. So, across the board with everything other than the RF, we are seeing very strong double digit organic growth. Probably year-over-year we would expect to maintain in the 20s for Q3 and Q4.

Okay. Great, excellent to hear that. My second question Russell, is on your power management businesses that doing quite well here. I'd love to get a sense of what's current market applications that are driving that business today? And then a lot of your discussion both today, and I think you mentioned this increasingly in the past couple of conference calls is increasing exposure to the automotive market. I know that's a market, it takes a while to turn on, but why don't you gives us a sense of where you think the automotive exposure is today, and whether that will be a much larger part of your power management business in a couple of years or whatever timeframe you'd like to discuss?

Yes, certainly. The end market applications for the power, I think we've talked about quite a bit. It's really the overall motor drivers, AC-DC converters, everything across the board there within power management, what we have within there is really a very, very good industry best Rdson and that drives efficiency, which allows our customers to basically design a smaller part and hence off of those smaller parts to be able to get the higher margin off of an 8-inch wafer. So that's the big drive there as efficiency allows both us and our customers to share on margins and our customers tend to be more successful in their end markets. The area that we see strong demand and big growth in right now is that a battery management, and that's why I talked about higher voltages and that's an area that is within automotive and I think that we are gaining very, very strong presence within the battery management arena. I believe I had mentioned at the last conference call that we had a very big upside order within battery management because the device that we had made had some very succinct benefits from lithium-ion batteries, allowing a greater stacking of battery cells. So, we see across all conventional power management applications and I mean they are very conventional that we see – that's where our big growth is, but it's because of having a very, very efficient platform. And then the battery management which is a big driver within the whole electric vehicle that is where we see a lot of capability and customer attraction with present. Now your second part of the question was what Richard you asked something, what was it specifically you are asking about automotive?

Just to see how much of your power management business could be automotive in a year or two? I know those are long tail businesses you have to think longer-picture, longer term, but how big could automotive been in a couple of years for you?

We have already some very, very lead customers within automotive, within power managements. How much of the power management business itself would be automotive? I don't know. I really haven't put that thought into it. I don't necessarily want to give a number that is in base in fact or thought. I would say on the lower end that we could probably be driving at least a 20% share of automotive end applications. Some of it really does depend a bit on the growth of electric vehicles. The electric vehicle itself is driving a lot of what we have gained good market share with our customers and with a very lead customer for the battery management. So the electric is what's really putting huge requirement on power management for these stacked battery cells. So, providing that's the customers that we have in that field to maintain their market share, and that that electric vehicle will grow as per forecasted. I think a 20% would be at the low end of the percentage of our power management that would be in automotive and bigger numbers to go to. If you wish, we'll take this as an action for our next interaction be at the conference call whenever and I'll give you some ranges of what we think the automotive segment would be. But again, I think the 20% is not an overly aggressive number at all, but I wouldn't want to give numbers without having put a lot of direct call into the question.

I think people would appreciate that. I think automotive is becoming a more interesting topic, so we look forward to hear more about that in the future. Russell, my last question is on 3D-sensing augmented reality. I am curious when you expect that to become more of a notable part of your business and what applications are driving? Is it mobile that we are hearing about from certain large OEMs maybe introducing at this year versus automotive another applications. I am curious where you are seeing that coming from initially?

We have quite a bit of activity there with some outstanding customers and we're not yet allowed to press release with. I would see the augmented reality probably starting to ramp at the latter part of the 2018 time frame and continuing well beyond. We – again, the customer that – one lead customer that we're working with there, we're not allowed to specify, but if they take off, it will be pretty amazing and I think we're really leading or we're working with somewhat of a leader within this space.

Okay, looks like an increasingly interesting topic of discussion once we'll bring up in future conference calls. I think that's a good start. I think that's all the questions from me guys. Thanks a lot. Appreciate it and keep up the good work.

Thank you.

The next question is from Lee Meyer of Lord Abbett. Please go ahead.

Hi. Thank you very much for taking my call and congratulations on great set of numbers. My question is on the Japan fabs and utilization there. You had mentioned that in the second quarter utilization was around 50%. It seems as though it's been in that range for a while. When should we expect the utilization there to lift off and how should we expect to see that lift off over the next couple of quarters?

You will see most likely a substantial increase in the fourth quarter as well as the first and second of next year. The point that is slightly misleading when I talk about utilization rates in Japan is that we're continually ramping more, but the utilization goes against a total photolithography. So, the photolithography capability is very, very high in those factories. The actual capabilities wasn't necessarily as high as the photolithography. So, within having a very, very big amount of capability, the photo layers themselves were much higher than the other bottleneck tools within the factory. That becomes one of the difficulties of talking of utilization. If I was going to be talking utilization against bottleneck tools rather than talking utilization against photo lithography, you'd be seeing substantially higher numbers in the Panasonic factories, I'm sorry in the ex-Panasonic factories and the TPSCo. So, you know you'd be dealing somewhere about 72% to 76% for two of the three instead of dealing at the 50% average that we had talked about. So, you are dealing, the reason that the numbers don't look as impressive is really as we're dealing with the very, very high photo capacity, not necessarily are you seeing in those utilization numbers the increases that we're seeing in the revenue number out of those factories. But even against the utilization on photolithography in the Q4 I believe you will see a big uptick in that utilization number as well as then Q1 and Q2 of next year.

Okay, great. And my last question just relates to sort of the minority interest expense that you booked in the second quarter and I'm just curious as to how that is calculated, you know looking at the utilization of the Japan fabs and Panasonic's stake in that JV, I would have thought that the payout would have been a little bit higher just based on what might have missed our for what those fabs could be earning. I'm just – could you give us any color at all on what goes into that number?

Yes, sure it's Oren. So, of course it is 49% of the net profit from the TPSCo and that net profit is a result of the low double digit margin committed contract we have from Panasonic which we said is brining low double digit margin – EBITDA margin from – plus the very nice incremental margins that we'll bring from the sales, probably which we in the past said between 40% to 50% incremental. Now, consider before you calculate the net profit, the depreciation. So, when we acquired TPSCo and is in the financial statement, there was a valuation to which one of the TPSCo assets in the fab and it came out to be a total of about $250 million of value of the fixed assets, which were many the equipment tools. And this is being depreciated into the P&L and although actually, we as TowerJazz didn't pay $250 million, you know that we paid to buy the fabs only $8 million, still on their accounting balance sheet, this appeals like a $250 million CapEx gross. And once we started the activity, it start to be depreciated in to the P&L. So, those depreciation costs which are not cash because we – and they were never cashing the past even, because we never paid for them. Still accounting, in the TPSCo P&L, we record depreciation cost of the relative part of the $250 million and this is actually answering your questions why the profitability of TPSCo itself is lower than what is by the model or by the economic model. Economically, the profitability is very nice, double digit percentage of the $90 million to $105 million revenue a quarter of Panasonic plus 40% to 50% on the [indiscernible], yes of course the R&D, M&A, G&A and all that and also less this accounting deprecation. So, basically for example in Q2, the net profit of TPSCo before tax, before minority was about $5 million, then you have a tax provision of about 30%. So, it's about $1.5 million resulting in $3.5 million of net profit after tax and before minority. And now minority gets $1.7 million and we are left with $1.8 million, and that's mathematics.

That's great and just curios, how many years are you depreciating that $250 million over?

So most of the machinery and equipment is 15 years, so it is about $16 million a year right, I mean $250 million divided by 15. But some of them is – for example hardware, software IP, tools, cut tools, they are only for four to five years. So, maybe weighted average is 12 years, so it's like $20 million a year total, so $5 million a quarter.

Perfect. Thank you very much.

Welcome.

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

I just wanted to just follow-up on the automotive market. It seems like that's a huge theme going forward. Has that – has the location of those customers or potential customers changed at all, what you are considering about adding capacity and also the second question is, is there any more interest in product made in the U.S. from customer demand?

So, Lisa the automotive question that I answered was specific to power management. I mean automotive we have activities from actually all of our business units, not just the power management. The amount – the biggest amount of automotive that we have right now is actually within the RF business unit and that's for radar and it's for collision avoidance. We have…

Are those customers in the same geographies as traditional customers?

They are certainly in the geographies of automotive makers. But in the case of the bulk of what we're doing with radar, it's in Asia.

Okay, so that doesn't change your thinking any, that is because you are interested in Asia before?

Yes. I guess, I'm not necessarily understanding the question I suppose, but the – that portion of automotive that we're doing is into again it's driven by a big customer capability and necessity and that is within Asia. Within power management, we have quite a bit of power management that we serve, that we serve through the San Antonio factory and those are customers that are located predominantly within Europe and within the United States. As far as, I'm not talking about the end automaker, I'm talking about the integrator that's buying the parts.

Right.

In the case of the – they made sensors, we have again a variety of activities going on within image sensors. One of our customers and the longest term customer is a U.S. customer in the Midwest of the U.S. and other activities going on also within Asia.

Okay. Great. So, it's spread out. Thank you.

Yes.

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