Photronics Inc (PLAB) 2010 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Photronics third-quarter earnings call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference call is being recorded Wednesday, August 18, 2010. I would now like to turn the conference over to Richelle Burr, Vice President and General Counsel. Please go ahead, Ms. Burr.

Thank you and good morning, everyone. My name is Richelle Burr, Vice President and General Counsel of Photronics. We would like to thank you for joining our third-quarter 2010 conference call.

Before we begin, I would like to remind all participants about the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995 and that, except for historical events, the information we will 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 that may affect the Company's operations, market, pricing, competition, procurement, manufacturing efficiencies and other risks detailed from time to time in the Company's SEC reports. This call will remain archived on our website until we report our fourth-quarter 2010 results.

Joining us on the call today is Constantine Deno Macricostas, Chairman and Chief Executive Officer; Sean T. Smith, Senior Vice President and Chief Financial Officer; Dr. S.H. Jeong, Chief Operating Officer and President, Asia; Dr. Christopher Progler, Vice President and Chief Technology Officer; and Dr. Peter Kirlin, Senior Vice President, US and Europe.

Deno will provide a brief review of market conditions and our strategic direction. Sean will then provide a comprehensive review of Photronics' third-quarter performance. During Deno's and Sean's remarks, they will be referring to slides posted on our website under the Investor Relations link. Deno?

Thank you, Richelle and good morning, everyone. Please turn to slide 3 in our slide presentation. [Besides] performing well in the third quarter of fiscal 2011 [because] we exceeded our guidance range for both sales and EPS, our third-quarter sales of $112.3 million improved 7% from the sequential second quarter as a result of increased demand for high-end IC and FPD photomasks. Both the IC and FPD high-end businesses reported sequential growth.

We also performed well from a bottom-line perspective, reporting $0.13 per diluted share. The operating model continues to demonstrate substantial leverage to as evidenced by the 58% gross operating margin on incremental sales from the sequential second quarter.

We also improved the balance sheet during the quarter. Our net cash position at quarter's end was $17 million,(Sic-see press release) marking the first time we have been in a net cash position since Q2 2006.

I would like to talk a moment about the success we have had in our investments on the high end of both the IC and FPD markets. Please turn to slide 4. During the past four years, more than 90% of our capital spend has been dedicated to high-end IC customers who have been investing in 32 nanometer and below capacity in Boise, 45 nanometer capacity in Korea and 65 nanometer capacity in Taiwan. As a result, our 65 nanometer and below business has increased by more than 137% in the first nine months of fiscal 2010 over the same period last year. Furthermore, our 45 nanometer business has increased to more than $25 million year to date compared with less than $14 million for all of last year.

As I mentioned on the last-quarter call, our focus on investing in leading-edge capabilities has come at the expense of our advanced flat-panel display capabilities. During the third quarter, we saw FPD leading-edge technology capability in Korea. We expect to reap the benefits of this investment later this year and continue to expect advanced FPD growth into the future. Please turn to slide 5.

Our leading-edge capabilities, coupled with excellent customer service and manufacturing cost efficiency will position Photronics for significant high-end marketshare growth in the US and Asia with permanent global -- with preeminent global memory and logic customers.

Customer sentiment, especially at the advanced nodes, continues to be positive through 2011 with the following opportunities -- in Taiwan, DRAM capacity ramp and node migration opportunities; in Singapore, expanding flash DRAM opportunities; in the US, renewed customer commitment to high-end logic capacity; in Korea, growing high-end logic foundry opportunities; and new access to #1 NOR Flash provider. Please turn to slide 6.

While we are positioned for growth, we plan to deploy additional high-end capabilities to ensure that we maintain our momentum at and below 45 nanometers and fully capitalize with the opportunity this provides for us.

Our projected EBITDA for 2010 is approximately $120 million. We expect CapEx to be in the range of $70 million to $75 million for the year as a result of the improved environment for high-end IC and FPD photomasks. For 2011, the investment we plan to make will result in CapEx in the range of $60 million to $100 million. We believe the [OIBDA] for next year should continue to grow to a level higher than the $120 million we expect for 2010.

Keep in mind this investment will be targeting growth at and below the 45 nanometer node, so we do have a good level of downside protection in our investment. In other words, even if there were to be a downturn in the market, this [certain] equipment we will be purchasing will be needed when demand returns and customers eventually require this 45 and below nanometer technology.

Let me close with a few key remarks. First, our high-end (inaudible) has been very successful and reflected in our strong third-quarter financial results. Our investment during the past few years has certainly paid off. Second, we will continue to execute our high-end strategy, making the necessary investment for future growth and success for continue to serve our mainstream customers. And third, we expect to report strong top and bottom-line growth in the fourth quarter for a continued (inaudible) balancing.

Before I turn the call to Sean, I would like to thank the entire Photronics global organization for their hard work and dedication. The teamwork and commitment has enabled Photronics to turn aggressively into success. We are well-positioned to capitalize on many exciting opportunities. Now I will turn the call over to Sean.

Thanks, Deno and good morning, everyone. I will provide a brief analysis of our financial results for the third quarter of fiscal 2010. I will also review our balance sheet and cash flows during the period and discuss our outlook going forward. During my remarks, I will also be referring to slides posted on our website under the Investor Relations link.

Slide number 7 refers to a reconciliation of GAAP to non-GAAP information or EPS. Slide number 8 details our sequential revenue for Q3 and Q2 2010, including high-end splits. Slide number 9 details the capitalization of the balance sheet and debt. Slides 10 and 11 depict our estimate of global IT marketshare with and without captives, and slides 12 and 13 reviews Photronics' high-end IC revenue quarter over quarter and year over year.

Before we begin, I would like to highlight an item that did affect our results for the third quarter. Included in our press release issued last night were the reconciliation of GAAP to non-GAAP results to reflect the non-cash income of $400,000 related to warrants issued in 2009 in connection with our financing agreements. As we have done historically, for purposes of our discussions and operations for the third quarter, I will be primarily referring to our operating results, excluding the impact of this item.

Excluding the effects of this item, non-GAAP net income was $7.3 million, or $0.13 per share for the third quarter, which compares favorably to our guided range of $0.07 to $0.11 per share. Net sales for the third quarter amounted to $112.3 million, which exceeded our guided range. Revenues for IC and FPD photomasks were $86 million and $26.3 million respectively. Sequentially, total sales increased by 6.8%, or $7.2 million, due primarily to increased high-end IC and FPD sales.

The higher demand is a result of increased year-over-year marketshare gains and improving market conditions based upon our internal estimates as evidenced on slides 10 and 11.

Advanced IT sales were 20.2% of total IC sales for the quarter, which represents a 13.4% sequential increase over Q2. Advanced FPD sales were 62% of total FPD sales. Included in these percentages are mask sets for semiconductor designs at and 65 nanometers and FPD sets used to fabricate flat-panel products using G7 and higher technology.

As a percent of total sales for the third quarter, sales were approximately 63% in Asia, 27% in North America and 10% in Europe. The gross margin for third quarter was 23.4%. Sequentially, the gross margin increased by 240 basis points. As Deno stated, the incremental margin on the increased sales was approximately 58%. This compares favorably to our expectation of 50% to 60% leverage that we discussed in the second-quarter conference call.

Selling, general and administrative expenses were essentially flat for the third quarter at $11.1 million as compared to $10.9 million sequentially. In R&D, expenses, which consist principally of continued development for our global advanced process technologies, were $3.4 million in the third quarter as compared to $3.6 million sequentially.

During the quarter, we generated operating income of $11.8 million, or 10.5% of sales. EBITDA for the quarter was $34 million, which equates to $136 million on an annualized basis. Our internal goals, as we stated in Q2, are to generate annualized EBITDA in excess of $150 million and to achieve an operating margin of at least 15%. Sequentially, we also experienced a 58% drop-through on the operating margin on the incremental sales. Other expense net for the third quarter was $1.2 million and includes approximately a $400,000 gain on the warrants previously mentioned.

During the quarter, we recorded a tax provision of $2.9 million, which is slightly higher than the high end of our guided range of $2.5 million as a result of exceeding our forecasted net income for the quarter. Excluding the previously mentioned items, the warrant items discussed earlier, non-GAAP net income was $7.3 million for the quarter or $0.13 per diluted share. GAAP net income was $7.7 million with EPS also at $0.13 per diluted share. At the end of the third quarter, we had approximately 1300 employees, which equates to revenue per employee of $345,000 on an annualized basis.

Now taking a look at our balance sheet. Cash and cash equivalents at August 1 amounted to $104 million with working capital of $77 million, a sequential decrease of $16 million. Please note, however, that the decreased working capital is primarily related to the $17 million paydown during Q3 of our revolving credit facility, which was classified as long term. Accounts payable and accrued liabilities at August 1 amounted to $123 million as compared to $94 million at the end of the second quarter. The increase primarily related to accrued CapEx with extended payment terms. At August 1, 2010, we had $45 million of accrued CapEx.

Taking a look at our debt position, total debt at August 1 was $88 million, which is down approximately $20 million sequentially. The principal components of outstanding debt include $57.5 million of senior unsecured convertible notes, approximately $27.5 million in aggregate capital lease obligations, and approximately $3 million related to an obligation with a customer who cofunded a tool purchase.

At the end of the quarter, we did not have any amounts outstanding on our revolving credit facility and therefore have $65 million of availability. Additionally, during Q3, we went from a net debt position of $17 million to a positive cash position of $16 million, which equates to a $33 million positive swing. As Deno stated, this is the first time since Q2 2006 that Photronics was in a net cash position.

Cash, taking a look at our cash flows. Cash provided by operations for the third quarter of 2010 was approximately $40 million and $74 million year to date. Depreciation and amortization for the quarter amounted to approximately $22 million. Cash flow used in investing activities during Q3 amounted to $6 million and $25 million year to date and includes $38 million for cash payments on CapEx. Free cash flow year to date amounted to $36 million and is expected to remain positive for 2010. Net cash used in financing activities during Q3 amounted to $20 million and $35 million year to date and includes approximately $34 million of net debt repayments year to date.

As Deno mentioned, as a result of the improved environment for high-end IC and FPD photomasks, specifically in Boise, Taiwan and Korea, we are increasing our CapEx fiscal 2010 on a cash basis to approximately $75 million. With projected EBITDA to be at least $120 million, it certainly will generate sufficient free cash flow for 2010. As I mentioned, during 2010, we principally invested in high-end capacity in Boise, Korea and Taiwan.

As Deno discussed, our initial CapEx needs on a cash basis for fiscal 2011 are in the range of $60 million to $100 million as we are presently evaluating the addition of high-end capacity for our leading-edge IC network. The significant high-end marketshare gains that have driven our increased year-to-date revenue in 2010 validate our high-end investment strategy.

Now taking a look ahead, our visibility, as always, continues to be limited as our backlog is typically one to two weeks. We are encouraged by the number of strategic opportunities at the leading edge with our expanded opportunities in both high-end IC and FPD customers. So as we begin Q4, we are optimistic that we will experience sequential growth. We will, however, be modestly impacted by the winddown of the summer vacation period.

That said, we are projecting revenue for the fourth quarter to be in the range of $112 million to $116 million. For the fourth quarter, we are projecting income taxes to be in the range of $1.5 million to $3 million. And as a result, based upon our current operating model, we estimate that earnings per share for the fourth quarter of fiscal 2010, which is exclusive of the impact of any warrants, to be in the range of $0.12 to $0.16 per diluted share.

In summary, I will emphasize that although our visibility is limited, customer sentiment remains increasingly positive, especially at the high end. That concludes my remarks. Now I would like to turn the call over to the operator for Q&A

(Operator Instructions). Krish Sankar, Bank of America.

Yes, hi. Thanks for taking my question. I had couple of them. Number one, Sean or Deno, when you look at the upside to your July revenues versus your guidance, was it predominantly driven by FPD?

I think it was a combination of both IC and FPD. Certainly there was, on the high end ,a higher increase weighted towards FPD, but we saw, as Deno stated in his prepared remarks, both high-end FPD and IC sequential growth.

All right, okay. And then when you look at your guidance for July, can you kind of give a sense of what the split would be between IC and FPD and who are the key drivers for the IC end of the business from a segmented standpoint of like foundry, memory and logic?

Okay, maybe we will take that in two parts. We don't typically guide to the IC/FPD split, but FPD has been averaging anywhere from 20% to 25% of our top line and we would expect that to continue going forward. And perhaps, Chris, you can talk about the concentration of customers at the high-end price (inaudible).

Sure. I think it is fairly broad-based. We are seeing good demand in memory, logic and foundry. I think for the highest end, the biggest pull is the memory right now, node conversions and new capacity ramping. But we are seeing node migrations at the foundries as well and some stronger commitments from some of our customers to go to new nodes in foundries. So I think it is fairly broad-based across those three areas.

All right. And Sean, in your slides, you kind of like spoke about the IC marketshare growth overall on the merchant side of the business. Do you have a similar thing for FPD marketshare, both on like overall and also actually on the leading edge?

Yes. Well, we have an estimate on the FPD side. We believe that certainly from the merchant share, our share has grown in Q3 to greater than 20%. We saw some pick-up and with the installation of an advanced leading-edge tool that Deno referred to in his remarks, we would expect that to continue. So we expect to continue to gain marketshare at the leading edge for FPD products.

All right. And then just a final question. If I look at your CapEx run rate for the (inaudible) 17%, 18% of sales for this period. Is that a fair approximation to model going forward that your CapEx is possibly still going to be in the high teens?

Perhaps, Deno, do you want to talk about our target you referred to last quarter, 15% if the opportunities will (inaudible)?

Rule of thumb basically is we [have] about 15% of revenue because our depreciation runs 20% of our revenue usually, so if we are going to have a free cash flow. With this tremendous opportunity right now, (inaudible) is a much [earlier] (inaudible) flash memory, new facilities and we are qualifying to do business there. And also we see opportunities in Taiwan in the memory area.

In a period (inaudible), more specific, do see opportunities basically in NOR Flash and a whole bunch of other opportunities (inaudible) US in the logic area. So in those periods, yes, for us. We take certain (inaudible) investment in the CapEx in the new technology, 45 and lower, we are going to miss the opportunity. This time, we are not going to (inaudible) account (inaudible). So the business can be ours if we have the capability.

I think in the short term, it would be a little bit in the high teens, but that is just additional capacity, as Deno said, for existing business and we expect to be there.

Thank you, guys.

(Operator Instructions). Chip Bonnett, FM Global.

Good morning. Nice execution here. A couple questions if I could. First, you increasingly are doing a nice job with breakout on the slides. If I could just get you to elaborate a little bit there. You have got some marketshare data and can you define it anymore what you think your share is at say the high-end IC mask area because that seems to be where you guys think you are taking share? So I am wondering if you hold an even higher percentage in that area.

Unfortunately, Chip it is very difficult for us to do because we don't have all the data from our competitors since they don't report it separately, but, Chris, perhaps you can add some color to it, but I think we would tend to believe that we are gaining high-end IC share. We look at our customer portfolio today as opposed to two years ago or a year ago, we have customers in the mix that weren't there before and they were going elsewhere.

An overall picture, Chip, is we are a newcomer basically on the high end and we have lost a fiscal formation. We do only have a very small percentage of the high end. That's why we look to grow at the high end through our opportunities. Maybe Chris can give you more information on the high end, but for us, it is a wide-open area for the high end.

Yes, we do think we are outgrowing the market there on the high end for sure, definitely gaining share, particularly on the memory side, but also on logic. We hit a milestone of 20% of our revenue from high end now that is a very significant part of our business. But in terms of giving specific marketshare numbers, we are working on it, we are looking at it. A lot of the high end is running in captives, so on the merchant side, I think our marketshare is significant. But to give out a particular number, we are just not ready to do that yet. But suffice it to say, we are pretty sure we are outgrowing the market as we have a lot of upside there as well.

Okay, just so I have an understanding, you show the merchant -- your merchant marketshare 2010 at 19%. Would the high end be higher or lower than that?

As Chris stated, it would be very difficult to determine that. And it depends if you are including -- if you are just talking -- we stated, I believe, that we have a significant percentage of the merchant share.

The whole message though is we will take a look at it for next time, see if we can collect enough data to be more specific on the high-end side of the marketshare.

Okay, that's fine. I am just trying to get a sense that, if that is really where you are making hay and if you are really coming from a lower share, that you guys could really move the needle here.

It would be fair to say, Chip, it wasn't that long ago, perhaps a year, that we were in mid single digits at the high end as a percentage of our total IC revenue.

We are a newcomer to the high end, Chip, so (inaudible) continue growing. We have the technology to fill that capacity and (inaudible). So the business is there. So that's why we need the capacity.

Okay. Good. Thanks. Secondly, I just wanted to see if I can get some better color on what you guys think your earnings power can be as a company as you are kind of coming into your own here. And it seems like your model is steadier, your share is solid and growing. And Sean, you have thrown out that 15% operating margin. Can you kind of give us an idea of what revenue level that is based on?

Sure. Under our current -- where we exited Q3 and this is mix-dependent, we would probably get to a 15% operating margin. It would be anywhere from $128 million to $133 million. That said, it will be throwing off a significant amount of cash. We are very focused and continue to be very focused on incremental leverage in the model, maintaining our cost structure, but yet having the opportunity to grow. We are cognizant of it and work towards that 50% to 60% leverage at the operating margin line as we move forward on incremental revenue. And so what we expect, if we reach -- as we said in the previous last call, once we reach a plateau, we are looking for the next plateau and this is Q4. So while the 15% is a little bit longer away, we certainly are a lot closer to our $150 million of annualized EBITDA (inaudible) level we did in Q3.

Okay. And so you said you are committed to that 50% to 60% leverage as you work to that number? Is that right?

That is our goal, 50% operating margin leverage. Mix can play a role in that, but the last few quarters -- I believe last quarter was 57% on the gross margin line. This quarter, it was 58%.

Okay. And I guess how steady do you think that is and just to kind of put some context around it? Going back years ago, we used to talk about a model with a certain gross margin and operating margin on a set revenue level and as various investments were made, etc., that revenue level continued to tick up in order to obtain that margin. And I just want to make sure we are not necessarily going down that path again.

I don't quite follow, Chip. But I can say that our model, as it stands today, our cost structure is vastly different than it was a few years ago, including our high-end mix. Our opportunity today, and perhaps Deno, Chris or Peter can further elaborate. Our opportunity today to grow and get leverage in the model is still there, but the high-end business that will come in as a result will continue to drive improved performance, cash flow and profits for the Company.

I think when we sit together as a management team and then we walk out the door and focus on execution, generally our strategy is one of growth with cost containment. That doesn't mean the model is steady-state, but what it means is that we can see significant uplift in the revenue line without significantly impacting the cost structure. So that is our focus as a leadership team.

Okay. Let me just try to help you out a little bit more, Sean. I guess what I am thinking back is the days where we used to talk about 40% gross margin, 20% operating margin and I can't remember exactly, but say that was achievable on a revenue base of $110 million or something and it seemed as we went on, there were investments that you made and pushed the model so that that was still your margin target, but you needed to do $120 million, or $130 million. That continually got pushed up a little bit and I think it was because of various investments you made and there may have been some other dynamics, but does that give you some context of where I am coming from?

Certainly, the market dynamics six years ago are much different today, as well as the business has changed dramatically. So that is why we are trying to get color with respect to what our targets are in the near term or a little bit longer term and that would be steady-state. As the dynamics of the industry have changed, the investment level has changed and we have just come out of a period of not too long ago. In 2008, 2009 as you're well aware, we had significant trouble. So we are focused on the long term and incremental growth, as we said, establishing a new plateau. But to compare that six years ago I don't think would be fair in this environment.

Okay, that's fine. Thanks very much and nice quarter.

Thank you.

(Operator Instructions). Ladies and gentlemen, there are no further questions at this time.

This concludes our conference call. I would like to thank you for your participation and see you next time again. Thank you.

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