Photronics Inc (PLAB) 2017 Q1 法說會逐字稿

Good day ladies and gentlemen, thank you for standing by. Welcome to the Photronics first quarter earnings call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session, and instructions will follow at that time. (Operator Instructions). As a reminder, this conference call is being recorded Wednesday, February 15, 2017. I would now like to turn the call over to Troy Dewar, Director of Investor Relations. Please go ahead.

Thanks Charlotte. Good morning everyone, welcome to our review of Photronics 2017 first 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 this morning, along with the presentation material which accompanies our remarks, are available on the Investor Relations section of our webpage.

Comments made by any participants on today's call may include forward-looking statements that include such words as anticipate, believe, estimate, expect, forecast. These forward-looking statements are based upon a number of risks and uncertainties and other factors that are difficult to predict. Actual results may differ materially from those expressed or implied, and we assume no obligation to update any forward-looking information. Finally, during the course of our discussion we will refer to certain non-GAAP financial measures. These numbers are useful for analysts, investors, and management, to evaluate our ongoing performance. A reconciliation of these measures to GAAP financial results is provided in our presentation materials.

At this time, I'll turn the call over to Peter.

Thank you Troy, and good morning everyone. First quarter sales improved from the previous quarter, as an increase in IC sales was partially offset by a lower FPD demand. In high end IC, both logic and memory contributed to improved sales, with US and Taiwan being the strongest regions. Mainstream IC was strong in all regions despite seasonal headwind. FPD high end sales improved, particular in Korea, while mainstream demand softened, as customers are focused on volume production of existing displays, reducing demand for new masks. Operating profit also improved over the last quarter helped by growing sales, operating leverage, and a reduction in R&D expense. As an organization, we are deeply committed to controlling costs, not only when sales are declining, but also when sales are increasing, this enhances competitiveness, while maximizing profitability and cash flow for our shareholders.

Along with improved profitability, operating cash flow was positive, further increasing our net cash position, which is important given the number of strategic investments we are making. Furthermore, the quality of our balance sheet provide us with flexibility to explore strategic growth opportunities, in a market that is consolidating at both the supplier and customer levels. Finally, despite reduced R&D spending, we kicked off a multi-year EUV strategic partnership with a key customer in Q1, which includes joint technology development, as well as commercial reticle supply. We believe that we are the merchant market leader in EUV, and we have taken this step to better prepare for potential EUV commercialization at the 7-nanometer and/or 5-nanometer nodes.

Looking forward in the second quarter we see a mixed demand environment. On the positive side, we expect the underlying markets for mainstream IC to continue to exhibit healthy demand trends. For high end IC, we expect memory demand to improve, whereas high end logic, particularly 28-nanometer, will likely be down as a result of additional capacity coming online for a leading foundry, with no merchant photomask demand. For FPD, we anticipate relatively flat demand before orders for new AMOLED displays begin to ramp at quarter end. Should our top line improve, we should see margin expansion through the leverage in our operating model.

Beyond the next quarter, we expect to see high end growth in the second half of the year, on the memory side demand should come from the release of the next generation of 3D NAND, and a transition to foundry memory to 2X DRAM. As a leading merchant mass producer with the technology needed by key IEDMs, as well as the majority of the memory foundries, we are well-positioned to benefit from these ramps.

In logic, our largest IC customer is working hard to expand their 14- and 28-nanometer production, including a new manufacturing facility in China. We have the required technology and are poised to meet their photomask needs. As they successfully increase production for the leading edge nodes, it should drive additional demand for our masks. Finally, we are expecting meaningful FPD growth in the second half of the year, as the technology inflection from LCD to AMOLED, and other advance displays accelerate. We will soon receive the first of our new FPD litho tools to increase capacity, and expect installation to begin in the third quarter. This should allow us to grow as industry demands for these advanced displays beings to accelerate.

Longer term, there are several factors that we see as attractive growth drivers for 2018 and beyond. Two in particular technology, the technology inflection currently underway for FPD, as AMOLED screens become more prevalent in smartphones, and the broad based semiconductor industry investments presently underway in China. We've spoken at length over the last several quarters regarding anticipated growth in AMOLED displays later this year as the percentage of smartphones with this type of display grows. In fact over the next few years, penetration of AMOLED displays in smartphones should double. While this is exciting, we believe it's only part of the story.

Migration in the high end and eventually midrange phones will play over the next several years. In addition to smartphones, other consumer products are expected to adopt the technology, such as tablets, PCs, and TVs. There is also potential for this technology to find its way into emerging applications, such as virtual reality and automotive. We appear to be entering a super cycle for AMOLED and other advanced displays, with our technology leadership and customer relationships we are positioned to grow with this industry over the long term.

Shifting our focus to China, by now I'm sure you're all aware of the tremendous amount of investment currently underway to expand semiconductor manufacturing in that country. As an example, according to SEMI, more than 40% of front end semiconductor fabs scheduled to begin operation between 2017 and 2020 are in China. Even if we assume a small portion of the planned facilities will be delayed or canceled, this is still a significant amount of growth targeted in one country. Last year we announced a $160 million investment over five years to build a state-of-the-art facility in Xiamen, China to build IC photomasks. They will break ground on this facility later this month, and expect to begin production by the end of 2018.

Additionally, we have a balance sheet that is able to fund our organic growth plans, as well as explore strategic M&A that is targeted to consolidating our current markets, or expanding into adjacent markets, that provides synergies and touch points with our proven operating model: technology leadership, outstanding customer service, and remaining a low cost producer.

I really like the current direction of the Company, and the near term market demand is showing signs of improvement. We have additional capacity coming online in the next few quarters to take full advantage of the technology inflection in FPD. Beyond that, we are investing in China, and have a solid balance sheet to fund these growth initiatives and explore strategic M&A.

Before turning the call over to Sean to provide more detail on our first quarter results and second quarter guidance, I would like to thank all of our employees to their hard work and commitment to improving our company in Q1. Sean.

Thanks Peter, and good morning everyone. First quarter sales improved 2% sequentially, as an increase in IC sales was partially offset by lower FPD demand. IC sales were up 5%, with growth being achieved in both high-end and mainstream. High-end growth was primarily in the US and Taiwan, with logic and memory both contributing to the increase. Mainstream sales increased quarter-over-quarter which is noteworthy, given the seasonal headwinds we typically face during the first quarter.

FPD sales fell 7% quarter-over-quarter, as an increase in high end sales was not enough to offset the lower demand for mainstream masks, as our customers focused on producing current product displays, limiting their releases of new mask for production. We think this is a short term phenomenon, and anticipate demand as Peter stated, starting to improve later this year, with an increase in orders beginning to ramp by the end of, by the second half of the year, in anticipation of new AMOLED displays for smartphones.

Last year we announced an additional investment in FPD capacity, which we plan to install in the second half of the year. Our new tools allow us to begin production sometime in the third quarter. This is a slight delay from our original plan, as we have pushed out the schedule to better align with the current supply and demand dynamics of the market. We are still confident on growing demand in the second half of the year, and believe these new tools sets should set us up to benefit from this trend.

On a year over year comparison, both IC and FPD were down significantly, as a result of high end business which was exceptionally strong during the first quarter of 2016. However, our gross margin improved sequentially due to higher sales and lower manufacturing costs and mix. Operating expenses were also lower by approximately $900,000, primarily as a result of lower R&D expenses offset by increased SG&A expenses. As a result our operating margin improved to 7.9%. Net income was $1.9 million, or $0.03 per share, and it does include $2.1 million of other expense, primarily related to foreign exchange loss, as a result of US dollar and Japanese yen weakened, as compared to our foreign sites currencies during the quarter.

Minority interest expense increased by $1.3 million during the quarter, as our JV in Taiwan was more profitable for the quarter on a sequential basis. I just want to remind you also recall that our fourth quarter earnings of $0.08 per share, included nonrecurring tax benefit of approximately $0.03 per share.

EBITDA was $29 million during the quarter, and on a trailing 12-month basis is $129 million.

Operating cash generation was $32 million during the quarter, and we spent approximately $10 million on CapEx. As a result, our cash balance stands now at $330 million, with net cash at $264 million. Based on our latest projections, we anticipate spending $80 million to $100 million in CapEx this year, including the balance of our FPD investment, and $20 million to $30 million towards our China IC investment. This is a little lower than our previous projections, as we now believe some of our cash flow will occur in 2018 instead of 2017. We continue to explore areas to increase the amount of deployed capital used in China, which will have the effect of reducing our cash flow outflows for the investment in future years.

Before providing second quarter guidance, I'd just like to remind everyone that our visibility is always limited, as our backlog is typically one to two weeks. Also, demand for some of our products is inherently lumpy and difficult to predict. Finally, our high end business has grown, ASPs for these masks are higher, and relatively a fewer number of high end orders can have a significant impact on our sales for the quarter.

Given these caveats, we expect second quarter sales to be in the range of $105 million to $115 million. This range assumes improved mainstream IC sales, mixed in with high end IC and flat FPD sales, with orders for new AMOLED displays ramping at the end of the quarter. Based on this revenue expectation and our current operating model, we estimate earnings for the second quarter to be in the range of $0.01 to $0.07 per share.

2017 is starting off on a good note, and we are cautiously optimistic that we will continue to achieve sequential growth throughout the balance of the year. We believe we have tremendous opportunity to build on our market and technology leadership, as well as we continue to explore ways to use our balance sheet to produce sustainable profitable growth. Thank you for your interest, and we'll now turn the call over to the operator for questions.

Thank you. (Operator Instructions). Our first question comes from the line of Edwin Mok from Needham. Your line is now open.

Great. Thanks for taking my question. So first question I have on the guidance, you mentioned kind of a mix for the high end IC side. Just curious, what's driving the weakness in the logic side, and based on your commentary, I assume that the weakness in logic is awaiting the improvement in the high end memory, is that correct?

Yes. We do in the coming quarter expect the high end memory to be up, it was up in the prior quarter sequentially. So the memory market is looking quite good to us. As far as logic goes, the quarter started out, our Q1 started out pretty strong in Taiwan. Moving into the calendar year here, it's January. There's a very large foundry that brought incremental 28-nanometer capacity online in January. At the same time, they reduced silicon wafer pricing. And what that has done is has created a dislocation through the 28-nanometer business in the foundry market.

Of course, there's been a competitive response now by our customers. But until the market settles, we've seen a drop in tapeouts, so we right now it's unsure, we're unsure exactly how quickly the market reallocates the demand again, given that dislocation. And that was highly unexpected. It's never happened in my career before, where this particular company that I'm speaking about, at the N-2 node has brought more capacity online, but I think the good news in all of that, is it clearly demonstrates that the 28-nanometer node has more legs than anyone might imagine. So that is what happened. And the situation that is dynamic.

Okay. Great. That is helpful color there. On the investment side, I guess two questions. Right. First it sounds like you guys pushed out the FPD tool installation by roughly about a quarter, and then on the call you mentioned that just because the demand market demand is a little weaker, so you farrowed that back, is that the only reason that you have any issue getting the equipment in place, and are you still expecting that to start contributing revenue in the fiscal third quarter? That's the first one, and second thing, are you pushing out the China investment as well, because you now guide for a lower number?

As far as FPD goes, since we ordered that equipment more than a year ago, there's been a lot of dynamic change, not in AMOLED but in the LCD market. Almost every quarter for the last three quarters running there has been significant news that changed the demand profile for new devices, first in 42-inch displays, then in 21-inch and smaller displays. And last quarter with FoxConn basically announcing that they were not going to supply their panels to any of their TV makers, it created yet another shift in demand.

So when we look at our FPD business right now, we are not running at full capacity. And the additions as you might remember are not technology, they are capacity. So as we always do, we try to stage additional CapEx with demand, so that we can maximize the return on investment. So we're right now not operating at full capacity, so we have pushed out delivery, so it's timed with demand. As far as China goes, we have not changed our investment plans there at all. We are running to the plan we set when we made the announcement late last summer.

Okay. Great. Last question I have, I think, Peter, you mentioned that you expect a super cycle, which are your words for the AMOLED space, based on your commentary, it sounds like in the second half you expect kind of stronger demand from that side of the market, and how that will benefit you guys. Just curious are you seeing that mostly from very concentrated one or two customers, or are you starting to even start to have potential customers in China or starting to, talking to them, and you expect to generate revenue from those customers too? Or is this just most concentrated from the top one or two customers in the display side? That is all I have.

Yes. There is, it depends on whose numbers you want to look at. And I used the word AMOLED and other advanced displays. I would put AMOLED and OLED, and maybe even Samsung's Quantum dot displays into the general bucket of non-LCD technology, new display technology. If you look at that market forecasters have growth rates in excess of 30% for the next several years in front of us. And right now there is business developing outside of Korea in that general category of advanced displays. We have a sales guy right now meeting with a customer, trying to generate first orders in China for advanced display products. So we see this phenomenon as being prevalent of literally in all markets where displays are built and fabricated.

Okay. Great. That is all I have. Thank you. Appreciate it.

Thanks Edwin.

Thank you. Our next question comes from the line of Stephen Chin from UBS. Your line is open.

Hi this is Neal on for Stephen. Thanks for taking my question. So following up on the AMOLED display outlook for the second quarter, you mentioned orders starting to ramp in the second quarter, and strength in the second half of the year. Without really trying to forecast a number, can you describe the magnitude that we should see in the increase, is it more of an incremental, or more of a step-up function?

You want me to take that one? Yes. Sure.

So the question was the AMOLED, whether it's going to be a step function increase or gradually ramping over the next couple of quarters, and there's one significant product driver for AMOLED over the next few quarters, which you're aware of, one of the variants of the Apple phone. So that's going to, obviously, push a pretty large spike in demand. But just to amplify Peter's point, we see a lot of companies now looking at AMOLED for a variety of different sorts of products. So it's kind of a prototyping product demo phase going on now. So I don't think we can be specific to say, is it going to step up significantly one quarter versus others. But I think the forecast would suggest a pretty strong and fairly rapid ramp on the AMOLED side. But I wouldn't be comfortable to break it down by quarter.

Just add to Chris's point, we don't for competitive reasons don't break out our FPD sales, but I would agree with what Chris said and what Peter said, that we do expect it to ramp up.

Okay. Thanks. I appreciate that. And then as a follow-up looking forward into to 2017, semi cap companies have been pretty positive on logic and NAND, including a relative increase in DRAM, for 2017 can you talk about how that maybe factors into your outlook for IC photomasks?

Yes we certainly on the memory side of our business, we are now seeing what I would describe as the increased activity before a node really starts to ramp. So what you see is respins of certain levels in pilot line reticle sets to improve yield, or as a result of the design change. So in 3D NAND we're seeing that kind of activity at the present time. And we're also starting to see in the last quarter we're starting to see the very first tapeouts of the 2X nanometer foundry, DRAM foundry business. So we're very bullish on what we'll see in memory over the coming several quarters.

As far as logic goes, I think we're positioned well where we need to be with all our customers. For us, it really, the demand we'll see is really a function of how well our customers do competing with 800-pound gorilla, because it's clear that the 28-nanometer node, there is tremendous demand for it. There is more and more demand for 14, but really for us it is a competitive struggle our customers have with one company, and our business is directly hitched to how successful they happen to be.

Thank you.

Thank you. Our next question comes from the line of William Stein from SunTrust. Your line is now open.

Great. Thanks for taking my question. Guys, I just want to make sure I understand. I think the previous guidance of CapEx was $100 million for the year, now it's $80 million to $100 million. And I think you cited pushouts in production for FPD. Does that relate to ramps in AMOLED that you now expect the timing to be pushed out, or is it some other factor? I'm sorry. I just didn't understand?

I don't think it does, Will, the AMOLED, the FPD tools are coming in in the fiscal year, I think some of the timing related to some of the investments as we pay for gets pushed out, but it's not related to FPD at all.

And the other question, I answered it unrelated to our plans in China either, but if you look at our revenue, revenue level we're running at right now, our core business does not require any additional capital investment. So again, we are very focused on making sure that we only, that we spend what we need to spend to put ourselves in the competitive positions we need to be to maximize our market share. But we don't spend because we have a planned spend. So the adjustments you're seeing in our CapEx plan related to the overall tone of our business, not related to our strategic initiatives in any way, shape, form, or fashion.

So one other follow-up. The ramp at the big handset customer that you already cited, it sounds like there's no meaningful concern that won't ramp. That's still on track to deliver some revenue in the current quarter, and then I assume it will grow after that, and then maybe just one question connected to that. I would assume that the expectation is that ramps not only in fiscal to 2017, but then in fiscal 2018 as more SKUs are added, and so overall volumes are required added to produce rise, is that correct?

That is correct. We can't make any, and wouldn't make any commentary about the plans of that customer. But if you read the popular press, one scenario is that there will be actually be two generations released in September. It will be the 7S generation, which is, and there will be the 8, but there will only be one 8. That's what a lot of people think. But normally when there's an 8, there's a companion. And when is that companion going to release? I don't know, but I don't think it will be the following September.

So we very much expect to see demand step up for September, but there's probably another product release somewhere between this September and next, that would create additional demand. For that customer alone, and Chris and I have made other comments about other handset makers trying to push this technology into their high-end products, which is in addition and above what I just discussed.

Great. That is helpful. Thank you.

Thank you. Our next question comes from the line of Tom Diffely from D.A. Davidson. Your line is now open.

Yes. Good morning. So maybe just a quick follow-up to that. It seems like the main driver of the AMOLED, that time frame hasn't changed. So I'm just curious what do you think drove the timing for your business to be pushed out a little bit, if the end market seems to be pretty stable?

Yes. We don't see our business being pushed out in the advanced display arena. Where the business is low right now relative to what we expected a year ago is in LCD. That's where the softness sits. And it's a result of a large, it's the result of the actions of one or two large customers making decisions about whether they want to stay in the market or not, and the capacity that will generate a lot of new products in the LCD space, yet to come online in China. So the advanced display market is healthy and good, basically isn't any different than we expected. But where the market has softened is in the in the standard display arena, and given that, we don't need the capacity as soon as we thought we would. So we step it to be coincident with the market.

Okay. So it sounds like the new tool that you're getting, you have existing capacity to serve the high end space for AMOLED, and the additional tools are just for additional capacity not additional capabilities?

That is correct. Our investments were to balance our lines. And I think we mentioned there was two steps. We have already said that in our capacity addition. And we will work them into the business. As the demand that we see in front of us ramps, because our objective is to fill those tools as quickly as we can, once they're delivered.

Okay.

That's what we plan to do.

Okay. That makes sense. And then I was just a little unclear on the high end logic side. It sounded like you said UMC was adding extra capacity that hit the pricing, and that somehow lowered their demand. I didn't quite catch the logic there?

No. I wasn't referring to UMC adding capacity. I was referring to the 800-pound gorilla adding capacity.

Oh, okay. Okay.

I don't know whether that's new or repurposed. But that capacity addition, when that capacity was added, along with it came a price reduction in the silicon pricing. And that caused a market share shift.

Okay. So this customer that you're aligned with lost a little share perhaps. Then cost you a little bit of business.

Yes. That's correct, but I think it affected more than just one of our customers.

Okay. And then Sean I don't have a model in front of me right now, but it sounds like the revenues went up, margins went up, and net income went down. Was that strictly just because most of the increased revenue was driven out of your joint venture where you share the process, or was there something else?

Yes. Tom, actually our operating margins, gross and operating margins went up, and we did, I think in my prepared remarks we did say that we had a foreign currency issue. No issue, but unfavorable. And last quarter, if you remember we had a favorable tax adjustment. So from an operating perspective, everything improved.

Okay. All right. And then when you look out to China, it sounds like you're expecting the new facility to come online in the second half of 2018. What is your view for growth in China over the next year, that I assume you'll serve out of your other locations?

We are presently serving the China market out of primarily three locations, Taiwan, our nanoFab, and our facility in Korea. It's right now is a market that is in a growth mode, and we're working hard to develop the business there, with what we feel is an unfair competitive advantage, because we're going to be locating there. So we'll do our best to maximize our market share with our existing manufacturing footprint until our new facility ramps.

Okay. Thank you.

Thanks Tom.

(Operator Instructions). Thank you. Our next question comes from the line of Patrick Ho from Stifel Nicolaus. Your line is now open.

Thank you very much. Just first a clarification on some of the comments you made regarding the new capacity additions on the display side of things. Am I right to take away from it that the new capacity that you are putting in place in the third quarter of your fiscal year is related to LCD, or is it kind of just swing capacity that could also be used for AMOLED, if that demand could be higher than you're currently forecasting?

Yes, the capacity that is going, that we're installing can be used for either high-end LCD or AMOLED. It's either/or. The capability isn't limited to one product type.

Okay. That helps. And maybe a second follow-up question to that for either yourself, Peter or Chris. AMOLED is a little bit of a different process from your traditional LCD. Are there any different lead times? Do you get better visibility with AMOLED, or is the process still close enough to the LCD, where it's the same kind of lead times that you previously have gotten?

Thanks, Patrick. This is Chris. It is a different process. It's certainly more complicated from a photomask and lithography perspective. The lead times in terms of order volume, that sort of thing, there are fewer products. So to some extent, it tends to be easier to forecast. But I don't think it's fundamentally different, AMOLED versus LCD, in terms of lead time. The process time is longer for both the panel maker and the masks, and there are fewer products. But aside from that, I don't see a fundamental difference between those two

Great. And a final question from me and maybe for Sean, you guys did a really good job on the OpEx once again. R&D came in a lot lower than expected. Is that a sustainable rate, or was that kind of an anomaly quarter, and you'll see it kind of trend back to somewhat normalized levels as the year progresses?

I'll let Chris talk about that

Sure, I can comment on that, Patrick. Partly the step down was due to we completed a fairly large long duration 14-nanometer qualification project, so that kind of stepped it down, taking a breather to some extent on that particular work for that particular customer. We have three or four other things that are in the pipeline. Peter mentioned we're doing a little more R&D on the EUV side, 7/10 nanometer logic, and the next node of memory. As we enter into qualifications on those, they tend to be R&D mask intensive, and I think you will see the R&D spend level go up to a more historical norm, so I don't think, we would not classify it as a trend, more of a cyclical, or a cycle, R&D cycle sort of step down.

Great. Thank you very much.

Thanks, Patrick.

Thank you. Our next question comes from the line of Tom Diffely from D.A. Davidson. Your line is now open.

Yes. Just a quick follow-up on that one. Chris, when you look at EUV, because it's mirror based instead of lens based, going forward, is that a completely new set of tools for you guys as well?

It's not completely new, Tom, but there are a few tools that are EUV specific. For the most part, we've developed work arounds for those tools, particularly for early production and development on EUV. So we don't see it driving significant CapEx in the early stages. If EUV goes into full mask production, there could be some incremental CapEx associated with it. But generally we worked hard interactive with our customers to develop work arounds for a lot of the EUV specific tools. It seems to be a very effective approach. So the incremental CapEx is modest right now to cover the EUV products we want to supply.

Okay. It sounds like you've been on different consortiums on EUV for several years. And is this partnership new then it's very customer specific?

It is new, and it is very customer specific. So generally, among all of the customers we interact with on EUV, the tone is shifting a little bit from development to production readiness, and this particular partnership is kind of geared toward that sort of trajectory, moving a little bit out of pilot, and starting to anticipate potential production usage. So it's a multi-year agreement, and it is connected to specific devices as opposed to engineering grade, R&D masks.

Okay. Great. That is very helpful.

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

Okay. Thank you, once again, for joining us this morning. We are encouraged by the start of 2017, and are optimistic that we have the opportunity to invest and grow our business throughout the year. As we complete our FPD investment, and begin our China IC investment. This is a very exciting time for Photronics, I look forward to updating you as we move forward.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Thank you.