Photronics Inc (PLAB) 2015 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Photronics fourth-quarter earnings call.

(Operator Instructions)

As a reminder this conference is being recorded Thursday, December 3, 2015. I would now like to turn the conference over to Troy Dewar. You may begin.

Thank you, Kevin. Good morning, everyone. Welcome to our review of Photronics' 2015 fourth-quarter financial results. Joining me this morning are Dr. Peter Kirlin, Chief Executive Officer; Sean T. Smith, Senior Vice President and Chief Financial Officer; and Dr. Christopher Progler, Vice President, Chief Technology Officer and Strategic Planning. The press release we issued yesterday along with the presentation material which accompanies our remarks, are available on the investor relations section of our webpage. Comments made by any participants on today's call may include forward-looking statements within the meaning of the US federal securities laws. Forward-looking statements are based upon a number of risks, uncertainties, and other factors that are difficult to predict. Actual results may differ materially from those expressed or implied. A complete disclosure regarding these forward-looking statements can be found at the bottom of our press release. Photronics assumes no obligation to update any forward-looking information.

Finally, during the course of our discussion we will refer to certain non-GAAP financial metrics. These numbers are useful for analysts, investors, and Management to evaluate our ongoing performance. A reconciliation of these metrics to GAAP financial results is provided in our presentation materials.

At this time I will turn the call over to Peter.

Thank you, Troy, and good morning, everyone. By just about any metric our fourth quarter was one of the best quarters in the history of the Company. We achieved record quarterly revenues with strong demand across all our high-end product groups, including memory and logic IC and FPD. Our gross margin was higher than we have achieved in nearly a decade, and our operating margin was the highest ever, with both measures exceeding the financial target established at our analyst day in March.

Our operating model, which is capital intensive with high operating leverage, is over-delivering, with incremental margins again ahead of our targets. Additionally we added to our growing cash position, providing us with significant financial strength and flexibility to invest in our future. While there's always room for improvement and we are by no means complacent, I'm extremely pleased with our results and the performance of everyone in the organization.

Several years ago we established a strategic focus to invest and grow our high-end business. Our investments in advanced tools for IC and FPD as well as PDMC, have not only grow our high-end revenues but have firmly established us as both the global technology and market leader for supply of photomasks.

For example, total sales in the fourth quarter increased 14% compared with last year, while total high-end, including IC and FPD, increased 49%. This is a clear indication that the investments we've made to grow our high-end business are paying off. Customers rely upon us to provide them with high-quality masks as they launch new designs, and are increasingly looking to us as a trusted resource when they plan their future products road maps.

I'm proud to say that we were recently named the best partner by UMC, and we were awarded the Best Mask Shop Supplier of the Year Award by TowerJazz, achievements that you do not receive without a lot of hard work and dedication by the entire organization. I think it's fair to say our strategy for our high-end business is working. As we begin a new fiscal year, I would like to spend a few minutes discussing the strategic priorities we are focusing on as an organization.

The focus for 2016 and beyond is growth. For us, this boils down to three simple objectives: win high-end business in IC and FPD, expand our market-leading position in mainstream IC, and expand our geographic footprint into areas where we see opportunity for long-term growth.

In order to discuss our first objective we must look back about 10 years ago when we were best described as a low cost technology following the photomask industry, and our high-end IC business was essentially zero. We then made a strategic decision to partner with Micron, forming a mask joint venture with them that provided us with advanced process technology. Over the last eight years our high-end business has grown such that today it represents nearly half of our IC revenues. While that is a tremendous accomplishment, we believe that there is still room for us to significantly expand our high-end presence.

The advanced semiconductor market is now consolidated, dominated by a handful of IDMs and foundries. To win we must deliver great customer service, utilizing our global manufacturing footprint and unmatched process technology to provide the best photomask to our customers. To this end we are currently working to leverage the power of the Micron process of record to expand our memory market share and the foundry memory space in Taiwan, while ensuring that we are well-positioned to supply the memory market in China as it develops. The format should hedge any potential reduction in Micron demand post the termination of our JV in May, and it will be a growth driver for us in 2017 and beyond.

In the logic space we shipped several hundred 14 nanometer masks in 2015 to the semiconductor industry's technology leaders, but we are still in the very early stages of the ramp of this node. It is no secret that these customers have their own captive mask making operations. However, these mask sets are by far the most complex ever fabricated, and they consume disproportionate amounts of high-end mask-making capacity. When this node ramps, we believe that our customers will need significant merchant capacity in order to meet their cycle time target, and we stand ready to support them.

Meanwhile, we are already well engaged in 10 nanometer EUV development work with these very same customers. Similarly the high-end FPD market is consolidated among a few key customers located primarily in Korea. Our facility there, with unmatched capability, has enabled us to grow our business. Demand for our mask is very high, and we are actively working to incrementally raise our high-end output with our current asset base.

Display quality is an increasingly important differentiator for the mobile market, and we see the long-term demand for advanced SPD photomasks growing. Beyond the high-end there is significant growth occurring in the SPD market in China, and although small, our Chinese FPD business, which has serviced primarily our facility in Taiwan, nearly doubled in 2015. To better develop this business, we recently opened a sales and application office in China for both IC and FPD customers.

Our second growth objective is based on new opportunities we see in our mainstream IC business. Historically this business has been tough due to a high level of competition and constant pricing pressure. These factors have not changed, but we believe there is potential for growth in this market segment driven by the overarching application called the Internet of Things.

While much has been said and written about this megatrend, and at times it seems that reality doesn't match the hype, it is definitely happening. Some industry research suggests that the semiconductor market targeting applications for the Internet of Things, could grow by over 30% on a compound annual basis for the next few years. While this is coming off a small base, expectations are high. We think that means a lot of new designs and consequently a lot of new photomasks.

These products don't offer the same ASP as our high-end counterparts, but they drive volumes through our facilities, absorbing fixed costs on relatively low cost assets, having us maintain attractive margin even with legacy products.

Moving to our third objective. In addition to growing via our current industrial footprint, we are exploring strategic geographic regions to which we can expand our business. Our planning process is still in the early stages regarding this initiative, but there is little doubt that China presents an opportunity for us in both semiconductor and flat panel display markets.

We believe there is a role we can play, and are currently formulating strategic plans to establish a local presence. This is not likely to significantly move the needle on revenues during the next four to six quarters, but we believe the long-term outlook for this country is very compelling.

2015 was a great year for Photronics, but there are many reasons to believe the best is yet ahead of us. If we perform against our growth objectives while continuing to drive cost out of the business, we have the potential to reach new highs in both market share and financial performance.

Before turning the call over to Sean, I would like to thank all the Photronics employees for their commitment and dedication to improving our Company in 2015. Sean will now provide more details on our Q4 performance and our outlook. Sean?

Thanks, Peter, and good morning, everyone. I'll provide a brief analysis of our financial results for the fourth quarter of 2015, review our operating results, balance sheet, cash flows, and forecast. I will also briefly review our results for FY15.

Please turn to slide 4, 5, and 6 which shows our sequential quarterly results and IC and FPD revenue performance. Total revenue for the fourth quarter was a record $141.7 million, up 8% sequentially and 14% versus last year, with the growth in high-end photomasks for both IC and FPD. Total high-end revenue improved 28% sequentially and 49% year over year as demand was very strong.

Revenues for IC photomasks were $111.5 million as compared to $104 million for Q3. As Peter alluded to, revenues for high-end IC photomasks, which a 45 nanometers and below, were a record $50 million, representing 45% of our total IC sales. Sequentially, high-end IC revenue was up $11 million as a result of increased high-end memory and logic during the quarter, as memory customers continued to ramp 20 nanometer DRAM products and logic customers launched new designs at 40 and 28 nanometers.

Mainstream IC sales during the quarter were $61.6 million, a sequential decrease of $3.4 million or 5% as a result of reduced foundry demand in Asia. Revenues for FPD photomasks were $30.2 million, up 9% or $2.5 million sequentially. The increase was related to increased G8 and above orders as market demand for advanced displays is extremely high.

The new writing tool we commissioned earlier this year has been running at capacity, and demand from our customers for advanced mobile displays, such as AMOLED, is high. High-end FPD revenue was $22.5 million, or 75% of total FPD revenues, an increase of $4.4 million sequentially. Breaking out Q4 sales geographically, 66% of total sales were from Asia, 28% from North America, and 6% from Europe.

Now let's continue through the income statement. Gross margin for the fourth quarter was 31.5%, up 320 basis points, which equates to an incremental drop through of 74% sequentially. This represents the highest gross margin since Q2 2006. The increase was related to high operating leverage on the increased sales, improved manufacturing efficiencies, and reduced variable costs, as certainly litho tools were fully optimized this quarter.

Operating expenses were essentially flat compared with the previous quarter, resulting in an operating profit margin of 19.2%, the highest in over 15 years. This represents an increase of 510 basis points from Q3, and amounts to an 87% incremental margin on a sequential basis. EBITDA for the quarter was $50 million, and was $161 million for the full year.

Other income net for the quarter was $300,000 as compared to expense of $600,000 last year, the improvement resulting from favorable foreign exchange. During the quarter we recorded a task provision of $5.4 million, which is higher than our guided range as a result of increased profits outside the US. GAAP net income was $18.6 million, or $0.25 per diluted share.

Now taking a brief look at our results for the year. Our revenues were a record $524 million. IC revenues were $421 million, with high-end at $167 million, or 40% of total IC revenue.

FPD revenues were $103 million, with high-end at 69%. The gross margin of 27.3% was the highest since 2006. Operating income was $72 million, or 13.8% of sales, the highest since 2011.

Year over year, the incremental growth and operating margins were 68% and 63% respectively. And net income for the year was a record high of $44.6 million, which equated to $0.63 per diluted share.

Now turning to the balance sheet. Please turn to slide 7. Cash and cash equivalents at the end of the quarter amounted to $206 million. Our net cash, or cash less debt, was $73 million at the end of the quarter, an increase of $16 million sequentially.

Our investment in our JV in Boise amounts to $93 million, which we expect to monetize once the JV concludes. Total debt at quarter end was $133 million, which includes a $57.5 million 3/4 senior unsecured convertible note which is due in April of 2016. And our leverage ratio is now less than 1 at 80.82, which is our lowest leverage ratio in many years.

Taking a look at our cash flows. Cash provided by operations for the fourth quarter was $41 million, and was $133 million for the year. Depreciation and amortization was $21 million in Q4 and $82 million for the year. Cash flow used in investing activities in Q4 amounted to approximately $24 million, and $104 million for 2015, which was primarily all CapEx.

Please turn to slide 8 as we take a look ahead. Taking a look at CapEx, we expect our 2016 cash CapEx needs to be approximately $50 million to $75 million, of which approximately $26 million was accrued for at year end. Our 2016 investments will be principally geared towards high-end, leading-edge products for IT and FPD applications.

We do expect to continue to generate free cash flow in 2016. Our visibility as always continues to be limited, as our backlog is typically one to two weeks. For Q1 2016, we do expect to experience some variability with high-end foundry logic orders, as customer ordering patterns tend to be lumpy with the introduction of new product designs.

As a result, we are projecting revenue for the first quarter of 2016 to be in the range of $133 million to $143 million. We also expect our depreciation and amortization to increase modestly during the quarter, as additional tools come online.

For the first quarter we were estimating taxes to be in the range of $4 million to $6 million. As a result, based upon our current operating model, we estimate earnings per share for the first quarter to be in the range of $0.14 to $0.23 per diluted share.

In summary, I'll leave you with a few key thoughts. As Peter said, we expect to have top and bottom-line improvement in 2016. We expect our EBITDA to grow as well. And we are confident about our business model and our ability to grow market share at the high end.

We see continued opportunities in our customers' businesses and noted migration plans, and we have a strong financial position and excellent technology to capitalize on those plans. And finally, we expect to continue to build on the momentum that we have established over the past few years as a leader in advance photomask technology.

Now I'd like to turn the call over to the operator for your questions.

(Operator Instructions)

William Stein, SunTrust

Congratulations on the very strong results. I'm hoping you might talk a bit about the longer term strategic options that the Company has with the cash flow delivering a greater cash balance and of course with the ending of the Micron joint venture and the cash that comes from that, I believe in May of next year.

I think you alluded to evaluating capacity additions in China as the potential main use of those funds. Did I understand that correctly, or are there other alternatives that the Company is contemplating for the strategic use of that cash?

Bill, if you look at what we might do in the future, I think you correctly heard that we see China as an area for organic growth. And of course the high-end business is another area for organic growth.

So both of those would require additional CapEx. Beyond that of course we have the ability -- we have the cash flow we're generating to reduce debt.

Moving beyond that we would and are thinking about accretive M&A to further expand our footprint, and then finally there's the traditional -- more traditional methods of returning value to shareholders. So we are actively discussing and looking at all of those uses of the cash the business is generating.

That's a very helpful clarification, thank you. If I can just squeeze one more in perhaps on the margin structure of the Company.

You clearly out-delivered relative to your targets in the quarter, and the guidance implies to me I think another quarter of being above your target level. I'm wondering when you might reevaluate your margin targets, whether it's something that we should expect at an upcoming event or how we should think about that?

50% drop through, which we generally target, is quite I think -- it's still quite relevant. One of the reasons why we over-delivered in the current quarter -- if you look at our FPD business, it's running at full capacity utilization, and so we're sold out.

And when you're running consistently sold out, you have another gear which you typically don't have. And our team in Korea did an outstanding job in ramping that tool. It's a highly seasoned group, and they are now managing the order intake to maximize our profitability.

Normally we wouldn't have that extra gear. We have it now. We're likely to have it or expect to have it in the coming quarter. How long we will have it depends a lot on how the market itself evolves.

I think I understand. Thank you and again, congratulations.

Patrick Ho, Stifel Nicolas.

Congratulations on the strong performance. First off on the larger commentary that you made in your prepared remarks, as you look forward and the variability that you talked about, are you seeing that on say the foundries or the second-tier foundry 40 and 28 nanometer node, or are you seeing some of that variability on the 14 nanometer side?

It's both, Patrick. Our high-end logic business went up both in Taiwan and Korea last quarter, and it's across both the 14 and the 28 nanometer nodes.

And there's still a lot of chop and unpredictability in that segment, and it doesn't have anything to do with our execution. It has everything to do with our customers' execution and the development of the market. So it's really tough for us to predict what's going to happen there as every quarter goes by.

Fair enough. Maybe moving to the memory side of things. Obviously the last couple of quarters you have been benefiting from the industry transition to 20 nanometer DRAM.

As you look forward into both the first quarter as well as the rest of 2016, how do you see the industry's ramp of 3D NAND being a growth driver for the Company as we look forward?

Basically what we see is as the 20 nanometer DRAM ramps down we see the 3D NAND ramping up in 2016. And obviously where the Intel announcement of ramping of non-volatile memory capacity or capability in China, so that should give that transition more legs than it normally otherwise would have. It will kind of be a bit prolonged.

Final question for me on the flat-panel display market. You saw some of the traditional strength in the Gen8 picking up. Can you give at least qualitatively how the AMOLED market did in the past quarter as well as your outlook for 2016 as a whole?

I think there's -- in the mobile space there is clearly a trend afoot with more large customers evaluating the adoption of AMOLED. And we see that in our business presently.

The extent that, that trend builds on momentum or gains momentum, it'll be very good for us. It's hard -- I don't think we can make any definitive comments about that, but it looks like the winds are blowing in the right direction.

Edwin Mok, Needham.

Congratulations again for the quarter and guidance. First question on the guidance. Just trying to understand how much of that is just seasonal factor? In January quarter is it typically a seasonal softer quarter for you guys versus this foundry that you mentioned on the call?

As Peter was mentioning and I mentioned my prepared remarks, Edwin, the foundry business is a bit choppy with logic, so it's hard to predict. And with the ASPs on those products can wreak havoc with the range, and there will be some seasonality in Q1, but to the extent we hit the high end of our guidance we would still expect to have a 50% drop to what the operating margin's line.

That's helpful. On the quarter, I noticed that mainstream IC decline I guess you mentioned soft to flat kind of [this cline that small], right? How do you kind of think about that business going to the January quarter and going to 2016? What contributed to the sequential decline in last quarter, and is that a short-term event or do you expect that to continue?

Edwin, if you look at our mainstream business for the last, more than the last 12 months the US and Europe mainstream has been rock solid and stable. The reduction in mainstream revenues in the fourth quarter was all in basically in the foundry market in Asia.

And I think the softness in that business is well documented everywhere you look in our industry. So we would expect that when the Asia business comes back, the foundry business comes back, the mainstream business in Asia will come back with it.

We've seen no loss of market share. We just see a loss of market in total.

And just so I can add on, Edwin. The mainstream business year over year was up to $254 million, which is about $63.5 million, $64 million per quarter.

And if you remember in Q2 of 2015, we did see a drop, I think it went down to about $62 million related to the Lunar New Year in Asia. So to Peter's point, it's been pretty stable throughout the year and we expect that to continue into 2016.

That's very helpful. On the memory side with the end of the Micron joint venture in May, how are you trying to think of Micron as a customer?

Do you expect them to do more insourcing right after that end of the joint venture, or should we expect that to really continue to be a pretty decent customer until at least the next content knowledge you know for the DRAM ramp, which probably won't happen until 2016 or 2018. How do you think about that?

Chris?

Sure, I can take this one. Thanks, Edwin. I think as far as the Micron business per se, we have the technologies transferred for the current nodes and the next couple nodes.

You probably know Micron is working with customers in tech transfer outside of their Company, companies in Asia and other places. We're working with them as well.

Peter mentioned the fab -- Intel fab in China, obviously we are looking at that. So we do expect a gradual decline in the Micron business as they start to do more insourcing. We continue to believe we'll be their largest supplier, perhaps exclusive outsource partner.

On the other hand, we also think we have very good position with some of the companies around the world that are adopting the Micron processes into their fab. So we are -- our intention of course is to make as a smooth as possible, continue to be a strong supplier to Micron, and then also take advantage of the technology with other customers around the world.

That's helpful. Lastly on the flat panel display, I think you mentioned Gen8 was a big driver for the quarter. Can you maybe provide some color on that, if we could go back to you, Chris, as well in terms of how that business is trending?

My understanding is it's an increased complexity, especially on the 4K TV for example, that's driving that demand, right? And it seems like that should be a trend that can continue with the AMOLED potential layer on top of that.

So even though your flat panel display is at peak, or pretty close to record revenue, that can continue to grow. Is that the right way to think about that business?

For the high-end FPD, a little more strength recently on the large-format displays. Some 4K smart TV, other things as well, more complex transistors.

AMOLED, it's used of course in certain applications quite widely, particularly for Samsung products. We're also starting to see it move outside of that space and that particular application too.

Regarding your question, I think right now the LCD TFT side is a little bit stronger, but we see the early signs of AMOLED kind of breaking out of its traditional use model, and hopefully we'll get wider adoption. And the complexity of the masks and the technology to build those masks is actually quite advanced.

The tool we have in Korea is well suited for it. So we're very well positioned to take advantage of that, I think.

Tom Diffely, D.A. Davidson.

First, Sean, in the past when there's been a slight miss, penny or two, you pre-announced the downside. With such a big upside this quarter, why didn't you pre-announce upside?

That's a good question, Tom. We were going through our year-end processes and our audit, so we wanted to ensure the numbers were rock solid before we announced anything.

Makes sense. Starting with the AMOLED or OLED part of the business, I know for several years you've been working closely with Samsung. You've developed some really great technology there.

You're one of the leaders in the marketplace. Does the relationship with Samsung preclude you from supplying anybody else?

It certainly does not, and I think the right way to answer that is that the leaders in the FPD market in Korea look to us to supply the most advanced photomasks, so it doesn't preclude us from working with others. And as Chris mentioned, both in AMOLED and now in the FPD space, there's more and more where I would -- where you could think of like the traditional approach to building high-end IC photomasks is finding its way into the FPD space.

And we're at the cutting edge of that. And the pricing on those masks right now, because they are novel for the market, is quite high.

Okay. Good. You talked earlier about how the dynamics on the memory space, you have DRAM, the 20 nanometer build outs that are slowing down a bit, and then NAND is picking up. When we go through that transition from DRAM to NAND from a mask point of view, what is the impact to your business?

I know the NAND masks themselves are less expensive, but there's probably more of them. I'm curious, the net/net if you look in the out year would you expect memory to be up or down?

That's a very tough question. It really depends on the speed at which one node ramps down versus the speed at which the other goes up.

And you're right about the flash -- 3D NAND flash mask sets, and that is the price is less but the units are greater. So it's a very tough call, but I think generally speaking we're expecting the memory market to be more or less stable.

So the tools are -- you have about the same utilization rates and the market is pretty similar?

Without any other greater color, this is something that will -- obviously we are very close to, we're working hard at. And as the year evolves, we will update you every quarter. But it's a really -- it's very tough to give you any more clarity than that.

With the huge growth in the high-end business over the last year, did you mention that you were fully utilized with some of your tools at this point with your capacity?

We're not at capacity in the IC business. We are at capacity in the FPD business. Having said that, we're watching the market.

We're aware of some capacity additions coming online. Demand is very strong, so we're very much on top of can and should we add capacity in our display business.

Right now we're trying to incrementally increase our capacity through tuning of the tool sets that we presently have. Whether that's going to be enough to capture all the demand that's out there is something that we evaluate constantly.

As the market moves from more of the large panel TVs to the smaller panel AMOLEDs over the next year or two, does that free up capacity or does that utilize more capacity for you? The transaction from large screens to small screens?

That's a highly mix dependant question. I really can't answer it. There's not a great difference.

What I can tell you is that it doesn't matter what the size of the mask is. Our P80 tool is significantly faster than the P10. So whether it's large-format masks or whether it's AMOLED masks, the P80 tool will write those layers with higher fidelity, higher CD performance, and higher speed.

When you look at the mainstream business, would you expect greater than normal levels of shutdowns over the holiday period this year versus normal years, just from the softness in the marketplace?

Well, we have seen that. We have seen it and we are expecting to see it in some of the foundry business in Asia.

Again, if you look at US and North America the holiday plans as we understand them now are pretty traditional. No great variance, really.

Over time as you see IoT becoming a bigger driver of your mainstream business, how much excess or how much capacity could you expand into or bring online on the mainstream side if it continues to ramp here?

Our mainstream is very much I think -- the challenges there are different than the high-end. Generally we look to add capacity in the mainstream from the used-tool market rather than the new-tool market given the ASPs that are out there.

And thus far anyways, we've been able to cost effectively add mainstream capacity anywhere we've found a bottleneck. And certainly that's what we will continue to do going forward.

Final question. When you look at the Chinese market, what is the competitive environment like there now? Are there domestic players popping up, or is it still a market that's mainly served from the other regions?

If you look at China, there is -- so SNIC has their own captive just as TSMC has their own captive. Outside of that there is one supplier of mainstream photomasks in China.

The real growth in the China market isn't at the mainstream, it's at 40 nanometers and below. So there is right now an absence of domestic merchant that has the capability to supply the high-end market. And those reticles are presently being supplied from outside of China.

(Operator Instructions)

Stephen Chin, UBS.

Congrats on the strong results. You mentioned before that you are looking at M&A given the high cash balance. Can you just talk about how you approach that, what you're looking for in a potential target, and when you think we'll start to see some M&A activity?

It's quite clear that there's a lot of consolidation happening in the semiconductor space presently, both at our customer level as well as in the supply chain. If you look at our JV in Taiwan, we formed a little more than a year ago now, about a year and half ago actually, with DNP, at the time we said we thought that it was the first step down the path of the consolidation of the photomask industry.

So we when look at M&A the first place we look is where we know the best. And we are in constant discussion with all the players in the space. So that's -- consolidating our core business is job one.

And then beyond that, we look at similar players where we believe that strategically some of the things we do well could play well in their business. But the key word there that you heard me use is accretive. So that's generally how we look at consolidation.

Looking to 2016, can you give us an initial view of how you expect spend to trend for merchant photomasks in IC? And then how you see that playing out in the logics market and the memory market?

I think as Sean and I both said, we're expecting to grow as a company in 2016. There's no doubt that if you look in the industry right now, our industry is not growing.

But we are growing because we are gaining market share. And our objective for next year is to grow the business regardless of whether the market improves or not.

I'm not showing any further questions at this time. I would like to turn the conference back over to our host.

Thank you, everyone, for participating in this morning's call. I am encouraged by our performance in 2015, and believe that 2016 will be another great year for Photronics. We look for to updating you throughout the year on our progress. Thank you.

Ladies and gentlemen, this concludes today's conference call for today. We thank you for your participation and ask that you please disconnect your line.