Photronics Inc (PLAB) 2003 Q2 法說會逐字稿

Good morning every one. My name is Salvis (ph) and I will be your conference facilitator. At this time I would like to welcome everyone for the second quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. Please limit yourself to one question and one follow up question during the session. If you would like to withdraw your question, press the pound key. Thank you. Mr. McCarthy, you may begin your conference.

Thank you very much. And good morning. My name is Mike McCarthy, Vice President of Investor Relations and Corporate Communication for Photronics. I'd like to thank everyone for participating in this morning's conference call, during which we'll discuss the results of our fiscal second quarter, which were reported last night. Before we begin I'd like to remind all participants about the Safe Harbor Statement Provision under the Private Securities Litigation Reform Act of 1995 and thus except for historical events the information we'll cover during this call may be considered forward looking and may be subject to certain risks and uncertainties that could cause actual events to differ materially from those projected, including uncertainties in the market, pricing, competition, procurement and manufacturing efficiencies, and other risks detailed from time to time in the company's SEC reports. This call will remain archived on our Web site until we report our fiscal 2003 third quarter results after the market closes during the week of August 18. Our call this morning will begin with Sean Smith, our CFO, providing a detailed review of our income statement and balance sheet after which Dan Del Rosario, our CEO will share some brief comments and then moderate the Q&A session. Joining Dan and Sean in the Q&A will be Paul Fego, President and COO and other members of the senior management team. Sean.

Thanks Mike, and good morning everyone. I will provide a brief analysis of our financial results for the second quarter of fiscal 2003. I'll also review our balance sheet and cash flows during the period as well as review our outlook going forward. During the quarter, we incurred an after-tax charge of $39.9m or $1.24 per share resulting from the streamlining of our North American operating infrastructure with the closure of our Phoenix manufacturing facility and additional workforce reduction.

I will elaborate further in a few minutes on these and other cost reduction activities. But for purposes of our discussion of operation, I will be primarily referring to our operating results excluding the impact of these items. Net sales in our second quarter managed to $85.5m, compared with $103.1m in second quarter last year. And, while we are pleased to report that the company has returned to profitability on an operating income basis, we all know that there is still more that needs to be done before our shareholders should be satisfied. Total sales outside North America accounted for approximately 61% of second quarter revenues, compared with 50% in second quarter of last year and 61% sequentially. As a percent of total sales for the second quarter, sales were approximately 41% in Asia and in North America and 18% in Europe.

Second quarter sales increased in all geographic areas and were up $4.1m or 5% as compared to the first quarter. Sequentially, shipment to photomasks(ph) for devices utilizing 0.18-micron design and below were flat in total dollars. As a percentage, total 0.18-micron and below revenues accounted for approximately 27% in second quarter compared to 28% in the first quarter. The second quarter gross margin was 26.6%, as compared to last year's second quarter level of 30.8%. Sequentially, second quarter gross margins improved 490 basis points as a result of the increased volumes during the second quarter coupled with the favorable impact of cost reduction associated with our consolidation plan.

Depreciation and amortization for the second quarter was approximately $21m as compared to $19.9m for the second quarter of 2002, and $22.6m sequentially. SG&A expenses for the second quarter were $14.6m, essentially flat year-over-year. Sequentially, SG&A increased approximately $200,000. SG&A as a percent of sales were 17.1% during the second quarter of 2003 as compared to 14.2% in 2002 and 17.7% sequentially. Research and Development expenses of $7.5m in second quarter were flat with last year. It consists principally of continued development for 90 to 65 nanometer process technology. Sequentially, R&D expenses decreased by approximately $100,000. R&D represented 8.8% of sales in the second quarter of 2003, compared with 7.2% last year and 9.4% of sales sequentially. As I sated in my opening remarks, during the second quarter we returned to operating profitability with income from operations of $600,000, a $5m turnaround from the $4.4m operating loss incurred during the quarter.

Net other expense was $3.3m for the second quarter of 2003, as compared to $4.1m in 2002. Sequentially, net other expenses increased $300,000. During the second quarter, we recorded a tax benefit which includes the impact of the charge associated with the reduction in our North American operating infrastructure of $1.9m, which amounted to approximately 4.1% overall tax rate. Excluding the impact of the consolidation charge, we incurred tax expense of approximately $300,000. Net loss was $4.2m for the second quarter of 2003 as compared to net income of $2.5m in the second quarter of last year and the net loss of $8.5m sequentially.

The loss per share for the second quarter was $0.13 as compared to $0.08 diluted earnings per share in the second quarter of 2002. Our loss per share for the quarter was slightly ahead of the high-end guidance as a result of increased volume and additional manufacturing savings associated with our cost containment programs. As we exited the second quarter, we had approximately 1,500 employees equating to sales of 228,000 per employee on an annualized basis. Now, taking a look at our six-month due-to-date operating results before the impact of our consolidation charge, net sales for the first six months of 2003 were $166.9m, down approximately 16% from the first six months of last year.

The decline is primarily attributable to the depressed semiconductor, which has had a significant impact on our business since the beginning of the third quarter of 2002. As a result of the declined volume, our gross margins for the six months of 2003 decreased to 24.2%, as compared to 30% in 2002. The decline is primarily attributable to the decreased utilization of our increased fixed equipment base. SG&A expenses increased slightly, or 1.7% to $29m or 17.4% of net sales. SG&A last year totaled $28.5m or 14.3% of net sales. Research & Development cost was $15.2m, or 3.9% higher than the $14.6m last year. R&D was 9.1% of sales for fiscal 2003, versus 7.3% of sales in the prior year. Our investments in this area are viewed as strategically important to the company's future growth and ability to provide the innovative lithography solutions required by our customers. For the first six months of 2003, we incurred an operating loss of $3.8m as compared to operating income of $16.6m last year.

Net other expense amounted to $6.3m in 2003, compared with $7.2m in 2002, down due primarily to the result of increased year-over-year investment(ph) income. For the first six months of 2003, we recorded a tax benefit including the impact of the consolidation charges of approximately 4.8% for all geographic areas in which we are taxpayers. When we include the impact of pre-tax income for jurisdictions from which we have tax holidays, our tax benefit amounted to 4.3% or $2.4m. For this first six months of 2003, our net loss amounted to $12.7m or $0.40 per diluted share compared with income of $4.3m or $0.14 per diluted share last year. During the second quarter, we issued a $150m, 2.25% Convertible Subordinate Notes, which was due in April 2008.

In conjunction with the convertible issuance, we amended our $100m revolving credit facility, which relaxed certain financial covenants and increased our availability for borrowing. On May 7, we announced our plan to redeem our outstanding $62.1m, 6% notes on June 1, of this year. The redemption will result in the company incurring an early extinguishments loss of approximately $900,000 or $0.03 per share related to a redemption premium in a write-off of one amortized issuance cost. Once the notes are redeemed, our additional availability under the revolving credit facility will be approximately $89m. As a result of these transactions, we have successfully reduced our interest costs and have significantly improved our liquidity. The balance of the net proceeds from the $150m convertible issuance or approximately $83m will be used as a strategic tool for general corporate purposes. Now, taking a look at the balance sheet, from a liquidity position, our balance sheet at the end of the second quarter was quite strong, with working capital in excess of $289m.

Cash and short-term investments were $259m as compared to $129m at the end of the last year, with the increase resulting from the net proceeds of the convert issuance. The company's current ratio at the end of the second quarter improved to 4.3 to 1 as compared to the 2.3 to 1 at the end of 2002. Sequentially, the company's cash in investments, exclusive of the net proceeds from the convert, increased $7m during the second quarter to a $114m, due impart to our return to operating profitability in the quarter and our continued focus on asset management in such a way as to maximize our liquidity. Total debts for the first six months of 2003 increased $134m to $442m, as a result of the $150m convert issuance, net of debt repayment. The principal components of debt now include a $200m convert, 4.75 % due in December of 2006. The $150m, 2.25% convert due in April 2008, $62.1m of the 6% converts which are being redeemed on June 1 of this year, a $11m, which is outstanding on our revolver balance, which is due in July 2005, and approximately $19m of foreign long-term loans. With the recent convert issuance, in plan redemption on June 1, we have effectively deferred any substantial debt repayments until December 2006.

The minority interest in PSMC and PKL amounted to $48.9m at the end of the quarter and total equity aggregated $292m which amount to a book value per share of $9.10. Cash provided by operations for the second quarter was approximately $25m or $18m year-to-date. Year-to-date cash flow use in investing activities amounts to $18.6m of which $17.6m represented capital expenditures. Free cash flow from operations net of capital expenditures for the second quarter was $17m and $400,000 year-to-date. Year-to-date cash provided by financing activities amounted to $128m, which primarily relates to the convert issuance offset partially by the pay down of outstanding debt. Our business model continues to generate a significant amount of EBITDA despite the challenging environment. EBITDA for the quarter amounted to approximately $20.9m in which $38.9m year-to-date.

Taking look at some of our cost reduction measures. During the second quarter, we reduced our North American operating infrastructure with closure of our Phoenix manufacturing facility and reduction of other manufacturing asset. There were also additional workforce reductions of approximately 10% and the consolidation of our corporate headquarters to Brookfield, Connecticut. Of the total asset tax charge of $39.9m or approximately 81%, $32.5m was non-cash as it related to the facilities and manufacturing equipment taken out of service. The cash component of the charge consisted of severance and exit cost related to the Phoenix and Jupiter facilities. The total charge is expected to be recovered in approximately 2 years. Quarterly pre-tax savings once the initiative is complete will be in a range of $4m to $5m. We also continue to focus on numerous other cost containment measures as we work with our key vendors to reduce our material, equipment, data communication and other fixed cost to ensure that we maintain our operating profitability and return to generating bottom line process.

Taking a Look ahead, our short-term visibility continues to be limited. However, we are encouraged by our reduced operating cost in our current booking levels. Our guidance for revenue for the third quarter is projected to be in the range of $85m to $90m. Capital expenditures for tools and equipment in fiscal 2003 continue to track in the $40m range, which is down significantly from fiscal 2002 level of $126m. Our tools sets are largely increased and we are clearly in the maintenance mode. Capital expenditures for facilities will be in the range of $12m to $17m. Accordingly, based upon our current operating model we estimate that the earnings per share for the third quarter, which is exclusive of the early extinguishments loss of $0.03 per share on the 6% bond retention to be in the range of a loss of $0.08 to earnings of $0.05 per share. That wraps up overview of our financial performance and a short-term outlook. Now I would like to turn the call over to Dan for a brief comment before we open up the call for questions. Dan

Thanks Sean and good morning everyone. Photronics is focused through the balance of this fiscal year and into 2004 will be on its positioning. As Sean pointed out also fairly in his remarks, Photronics is first and foremost committed to achieving its near-term and long-term profitability goals. The measures we've taken to control cost whether they are working with vendors or realigning our regional and global manufacturing and support infrastructures are continuously evaluated for their effectiveness in helping the company to meet its goals. Photronics continues to make major strides in improving its position to address the complex requirements that customers working on 90-nanometer implementation and 65-nanometer development demand of this strategic technology development partners.

Today, the Photronics technology genes is incorporating the best each regional division has to offer, so that the company is positioned to capture the opportunities that these nodes will offer to innovative and cost effective lithography solution suppliers. This enables us to work with two leading maverly (ph) manufacturers including Samsung in Asia and other leading IC manufacturers such as ST in Europe, as they accelerate their move to the next technology node on the road map in an effort to leverage the performance of their latest design. Then, there is our position in the global markets we serve. We believe, we have matched our technological capability and capacity to the revenue opportunities available to us in the markets we serve in Asia, Europe, and North America. As business conditions improve, we believe our operating and financial strengths provide us with the flexibility required to increase the market share and further leverage the assets we have put into service for the benefits of our customers. Our global key continues to focus on executing so that we remain profitable in the most challenging environments. Thank you for your attention. Following some brief instructions from the conference call operator, we will be happy to address your questions.

Thank you. At this time, I would like to remind everyone in order to ask a question, press star one on your telephone keypad. Again, please limit yourself to one question and one follow up question during the session. We will pause for just a moment to compile the Q&A roster. Your first question comes from Michael O'Brien of SoundView Technology.

Hi, good morning. May be Dan, you can just give your view on the activity level just, I mean, is there any signs of strength out there that that starting to ramp or is just lot of activity that's waiting to ramp?

Good morning O’Brien. In our discussions with the major EDA companies, we are led to believe that 130-nanometer design activity is a bit robust and very strong. We reported that, a couple of quarters ago that - but one particular EDA Company of their 1,400 users about 26% were designing of the 1.3 nodes. Their most recent numbers released in the April timeframe shows that 53% of the users are designing of the 130-nanometer node. However, we have not seen the tape-outs. We believe some of the yield obstructions have been mitigated. However, there is still the issue of the end-market demand and secondly, while there has been quite a number of contentions made around the fact that the cost of the mask sets are mitigating this tape-outs, we believe it's more related to the cost of designs and the cost of designs are estimated at $5m to $10m for 130 nanometer node and $36m to $35m for the 90 nanometer node. Therefore the end-markets have to be there before anyone will release any design.

So, in general though you haven't seen specific, any real regions of your product types that maybe -- are seeing that initial acceleration?

We saw an improvement in activity around the world in the second quarter, but we believe that was more related to an inventory build. We are going into this quarter somewhat strong, but our visibility is still somewhat cloudy going into the second half. So, our concentration will be on execution and trying to gain market share in the second half to ensure our profitability.

Okay. And then just one question for Sean. Operating expenses are comfortable at these levels or are they be worked down? They are pretty flat sequentially or we are going to work this down a little bit?

Yes Mike. We will be - we have not benefited in the second quarter from the full impact of the consolidation that we announced at the end of March. So, we should see the operating expenses continue to wane down as we decreased our bottom line profitability to the $87m, $88m revenue range.

Great. In that $87m, $88m breakeven rate, what kind of mark gross margins is that?

At $85.5m, we were at 26.6%. So, you should see a couple of hundred basis points improvement over that.

Okay. Thanks.

Your next question comes from Derrick Winger (ph) of Jefferies & Company, Inc

Yes, three just actual ones. Gross interest expense for the quarter, capital expenditure guidance for the year and then if you could just review the bank line status in terms of total size and availability and maturity?

The bank line, we have $100m revolving credit facility, that's June/July of 2005. We have approximately $11m borrowed on it and once we redeem the 6% converts, we will have full availability on that or another $89m.

So, it's gross interest expense and capital expenditure guidance for the year?

Capital expenditure guidance for the year, as I said in my opening comments, was approximately $40m for maintenance items and $12m to $17m for bricks and mortar.

And gross interest expense?

Our net other expenses is approximately $3.3m and we did have some interest income in there, of approximately $700,000 to $800,000.

$700,000 to $800,000?

Yes.

So, gross would have been around $3.9m or $4m?

No. We have other factors that go into that line item which we break out fully in our 10-Q with respect to our foreign exchange gains and losses.

Ok. Thank you.

Your next question comes from Ali Irani of CIBC World Markets.

Good morning gentleman. Clearly, your gross margin improvement is impressive and I am hoping Sean, you could give us some idea of how much of it is driven by the volume gains in the quarter and how much of it is driven by the cost improvements. I was also hoping you could give us the headcount for the quarter and the mix in units in ASP and driving the sequential growth?

Good Morning Ali. To answer your first question, clearly the additional volume helped us absorb some of our fixed costs. We did generate some savings in the consolidation plan, although it is best to generate more savings into the third quarter before we received the full impact of that. Your second question, if you could repeat it for one second for me?

The units versus the ASP’s in driving the business model, this quarter, the 5% sequential gains?

It is a pretty broad range. I mean, we had increases in units across all geographic areas and in volumes.

So, they are the combination of both units and blended ASPs.

Yes.

And the headcount in the quarter?

The headcount as we exited the quarter was about 1,500 employees Ali.

Would it be fair for me to assume, just looking at your historical models that volume contributed about a third of the gain sequentially and cost about the other two-thirds of the gain sequentially in the gross margins?

I would say it is just the inverse Ali.

So, volume two-thirds and the costs one-third and then maybe a reverse mix of that going forward?

Yes.

Great. Thank you Sean.

Okay.

Your next question comes from Jay Deanna (ph) of JP Morgan.

Hi. Good morning. Sean, did you say that 0.18-micron and below revenues were flat sequentially as a percentage of sales or in dollars?

Jay good morning. They were flat in absolute dollars and as a result of our increased revenues they were down approximately a percentage point.

So, all the growth in revenues came from above 0.18-microns. Is that right?

We had additional volume in all geographic areas.

Right. Okay, then the other question that I had is do you believe that there is excess lithography capacity in the industry for 0.13-microns and 300 millimeter of that could quickly take new photomasks once the industry sort of turns on a little bit?

Jay, speaking for ourselves, we put in four nanotechnology lines last year in anticipation of the roll out of 0.13. Obviously, we expected 0.13 to roll out in 2001, we saw some releases at the end of 2002; it's been slow because of the end-markets in 2003. But we expect fully in 2004 that utilization will increase the 0.13. So, we do have the capacity right now in anticipation of the 0.13, but it's really the significant ramp. We believe that capacity will be challenged.

Right. I wasn't referring to your mask rating capacity; I was referring to the base of steppers out there in customer land.

We believe that there is enough capacity out there. If we look at the foundries that how much capacity that they have put in place and then also what certain IDM’s that have 0.13 capacity in place.

Okay. So you are basically saying that you think that there is excess lithography units in the industry that could absorb incremental photomask going for production once the same turn is on.

Hi Jay, it's Steve Carlson. Yeah, what were we seen is as these designs are being built up in the queue, the companies have done two things, they have invested in some 193 nanometer systems, but as this ramp take place, it also gives them an opportunity to try and push their 248 systems, which rely heavily on reticule(ph) technology that creates essentially additional area of lithography including capacity that we can take advantage of when these designs break free.

And when do you think that's going to happen?

As soon as the end market demands it. We can't predict that right now. We don't have that crystal ball.

Right, thanks very much.

Your next question comes from Steven Pelayo (ph) of Morgan Stanley.

Great. I remember from the Analyst Day, you guys talked about your short-term goals about profits next quarter including your gross margin and generating cash and the last one is increasing the high-end mix. So, you have got 3 of the 4 there, it looks like you are tracking the deal. Decrease in the high-end mix, it seems to [inaudible] most of the growth came from 0.18-micron and above. I guess, can you talk about what your expectations are for that mix going forward?

Good morning Steve. Obviously, what our investment in the 0.13 and the early 90 nanometer mode (ph), its really a timing issue. We expect that the 0.13 would significantly improve or 0.13 releases will significantly impact our revenue, our mix at 0.18 and below. You have to also remember, Steve, with the cost of these mask sets it wouldn't take that much to get there. Again this is all about utilization of assets and yields and we can look at our financial models that have been challenged by some people but, we, from a micro point of view, we can look at one of our facilities where the utilizations are extremely high. They are running better than 40% at the 0.18 and below, they are running somewhere in the region of 17% at 0.13 and their gross margins are well in excess of 40%. On the other side of the coin, we also have through the restructuring of retiring 0.25 and above capacity, we have one mature side that has increased utilization significantly and interestingly enough their gross margins are running at about 45%.

So Dan, I guess looking once again, the incremental growth coming from 0.18 micron and above and Sean's comment suggesting that it was both units and pricing. Could you talk a little bit about pricing because if the growth came from 0.18 micron and above and you saw units and pricing increase. Should I then infer that you guys are getting price increases at the mature end for 0.25-micron and above?

Hi Steve, this is Paul. Yes we have said before that we did some spot price increases and it has absorbed and been taken in some areas. Again, we were selective, of course, to do that and we tried to do the best it can, but it comes down to that we have done some. It has to stay through this quarter and in the results it has given up some help in the cost side. So the answer your question absolutely --

I would like to sneak two quick ones, I think you have answered all these question on head count and I missed that. And the second one was just related to, I think at the Analyst Day, you guys talked about some joint development projects, there was some Japanese IDM’s and working with another Japanese IDM through Taiwan or something like that. Could you give us an update on the Japan penetration? That's it for me.

Steve, we had about 1,500 employees as we exited the quarter.

Steve, we continue to exercise our strategy that a lot of the Japanese IDM’s will eventually go through the fablites (ph) philosophy because there are lack of investment over the last few years and will be utilizing the foundries in Southeast Asia. First and foremost in Taiwan and eventually shifting to China as well, some going into the Korean front and I can tell you that it have been qualified at 2 of the top 5 in Japan and we will continue to work with the other 3.

I would like to sneak one more into Sean. I know I was asking something about margins and I haven't, so I would better. You talked about your 40% gross margin as a long-term goal, 40% plus actually 20% plus operating margin long-term goal. Could you give us an update on what kind of revenue levels do you think you need to get at that kind of model (ph) ?

I can give you a broad range Steven. We are focused on our short-term goal to get back to profitability that is our primary focus as we sit here and talk today and we feel we are well on our way there. Longer-term, we do want to get to our gross margin to exceed 40% in operating margin, to exceed 20%. Based upon our current cost structure, I can just give you a frame of point of reference. If we get to a $100m in revenue, our gross margin would be in the range of about 35% and some of you remember from our Analyst Day, by effectively reducing our breakeven point to $87m, $88m every million dollars of incremental revenue over that, a substantial portion of approximately 70% to 75% will drop through operating income line. There is a tremendous leverage in this model.

And do you have the capacity currently to, if you are fully utilized on 90% or something across all your tools what kind of revenues could you generate from that?

We feel pretty confident seeing that we could do up to $110m in revenue in our current operating model.

Okay great. Thanks guys.

Again I would like to remind everyone, in order to ask a question press star one on your telephone keypad. Again, please limit your questions to one question and one follow-up question. Your next question comes from Brett Hodess (ph) of Merrill Lynch.

Good morning. Two questions, first, within the mix at 0.18 and below, while the overall was stable, was the mix between 0.18 and 0.13 the same as last quarter or was there a shift within that?

It was roughly the same Brett.

Okay. And then, second, when you look at the competitive environment at this stage, obviously pricing as Paul laid out was get a little bit better, but do you see opportunities right now for further penetration of customers or is it basically the same customers you've seen that are driving the growth that you have been seeing?

We still see significant opportunities for penetration, our technology investments in both capability and capacity as we talked about has improved significantly, given us some traction and therefore, as I stated earlier in my prepared comments, we are addressing the memory requirements of two of the leading manufacturers, as well as many of the major IC manufacturers around the world and Japan represents a significant improvement for us.

So, some of the growth you saw in the quarter, would you say is that inline with the industry or some of that is from penetrating those new memory agents (ph) of Japanese customers and some of the others?

We believe they are little bit from both, as we've said Brett, we saw improving requirements around the world. We think it's related to inventory build, but we believe we've also picked up some market share gains.

Thank you.

Thanks.

Your next question comes from Gus Richard of First Albany Corporation.

Good morning. Just real quickly at the analyst meeting you eluded to penetrating TSMC, and I was wondering if you guys could give an update on that?

Gus you are talking about PSMC or you mean TSMC right?

Correct. Yes, TSMC.

Okay. As far as TSMC is concerned, as you know they have a large internal capacity and right now being at there operating is considerably lower; they have not been going to the outside for any work. However, our strategy has been to penetrate the areas outside of Taiwan and so in Singapore at SSMC, which is a joint venture between Philips and TSMC who are the major supplier of radicals there and with TSMC also moving into China, they've indicated that they will not be installing a mask operation in China. So, we've had preliminary discussions with them and we have an excellent opportunity to take advantage of that. However, we still maintain our talks with them, in Taiwan, we are qualified at a number of technology nodes with them and we believe at some point in time, with the investments that they have made, they are facing the same thing everybody else is in the industry around return on assets, return on investment and they may have to consider their investment strategy in that area.

Got it. Thank you.

At this time there are no further questions. Are there any closing remarks?

I would like to thank everyone for attending our conference call this morning and have a good day.

Thank you. This concludes today's conference. You may all disconnect.