Photronics Inc (PLAB) 2017 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 call is being recorded, Wednesday, November 29, 2017.

I would now like to turn the conference over to Troy Dewar, Director of Investor Relations.

Thank you, Crystal. Good morning, everyone. Welcome to our review of Photronics' 2017 fourth quarter financial results.

Joining me this morning are Dr. Peter Kirlin, Chief Executive Officer; John Jordan, Senior Vice President and Chief Financial Officer; and Dr. Christopher Progler, Vice President, Chief Technology Officer and Strategic Planning.

The press release we issued earlier this morning, along with the presentation material which accompanies our remarks, are available on the Investor Relations section of our web page.

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, 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.

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.

Before turning the call over to Peter, I'm pleased to announce that Photronics will host an investor day on May 23, 2018 in New York City. More details will be coming soon, and I hope to see you all there.

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

Thank you, Troy, and good morning, everyone. We performed well in the fourth quarter, with revenue exceeding our expectations, growing 8% sequentially and 13% year-over-year. The main driver of this improvement was high-end revenue growth in both IC and FPD.

High-end logic was strong, and we benefited from solid Asian foundry demand, especially at the 28-nanometer node, which is being used by more customers across an increasingly wide array of applications. High-end memory achieved incremental revenue growth for the fourth consecutive quarter, as our customers continued to release new products. Overall, a very good quarter for high-end IC, and it's extremely encouraging to see a significant uptick in both memory and logic within the same quarter.

High-end FPD mask revenue also increased during the quarter, primarily due to AMOLED sales in China. Overall FPD revenue declined as many of our LCD customers continue to focus on producing current products to maximize profit, resulting in lower mask demand, temporarily shrinking the total available photomask market.

Given the market dynamics we encountered during the quarter, I'm pleased with the revenue growth we achieved. I'm even more pleased that we expanded operating margin to just over 10%, delivering incremental margins in excess of our targets.

We've historically done a tremendous job of controlling costs and employing our high operating leverage to grow profit more quickly than revenue. And this quarter, we delivered once again. We also generated cash from operations, which is important as we enter a period of high capital investment. CapEx in the fourth quarter was $53 million, our third highest quarterly CapEx ever.

If we hit our CapEx projections in 2018, it will be the highest annual CapEx ever. These investments will be funded primarily through the cash on our balance sheet. It's very reassuring to know that strong financial discipline over the last several years has given us the strength to make very substantial investment in our future growth, without the need for significant leverage.

We exited 2017 with momentum. And while we will likely experience some seasonal effects in the first quarter of 2018, we expect to have the wind at our backs throughout 2018 in both high-end IC and FPD markets. High-end IC should improve in 2018, as our largest IC customer is expected to increase market share at the 28-nanometer node, and we see a clear line to growth in our 22-nanometer and 14-nanometer offerings.

In FPD, it is widely acknowledged that large amounts of new AMOLED panel capacity will be entering the market in 2018, which we expect to flip the current supply-demand balance to excess supply. The last 20-plus years as a mask supplier to the FPD market has taught us that excess supply drives demand for new masks as new products are released to absorb the capacity.

As a well-established supplier to the leading panel producers, we are well-positioned to benefit from this inversion. Going beyond that, we have a long-standing reputation for being the technology leader in FPD, which is reflected in our high-end revenue split.

To this end, we've recently placed an order for a Mycronic -- for a P-800 mask writer, which will be delivered to Korea in the first half of 2018. We will be the first company, merchant or captive, to install this tool, which will enable us to make the most advanced photomasks in the display industry.

This, in turn, should increase our market share with customers who are eager to manufacture the most advanced AMOLED display panels. And it is no secret that the competition among the panel makers in this market is starting to heat up. Yet again, this investment demonstrates that Photronics is fully committed to being a technology leader in the FPD photomask market.

As we turn the calendar on a new fiscal year, beyond executing on the core business, our strategic priority is to build out, equip and start to ramp our new China factories. These facilities and this market is what we expect to fuel our growth in 2019 and beyond.

We are very excited about the growth potential of the China market for several reasons. First, the China government, as part of their Made in 2025 (sic) [Made in China 2025] target, has prioritized developing semiconductor production in the country. In response, leading semi manufacturers from around the world are investing in China.

In fact, nearly all of the incremental global foundry capacity planned over the next several years is in China. These investments span technologies, including high-end and mainstream, logic and memory. These products will be used in various end markets such as mobile, industrial, automotive and the ubiquitous Internet of Things.

Based upon this growing manufacturing base and the inherent demand for photomasks it will create, we are building a new IC facility in Xiamen. The equipment we are installing in this facility is a mix of new plus redeployed tools, enabling us to produce high-quality and low-cost masks, delivering superior value to our customers. Our goal here is straightforward, and that is to become the leading merchant IC photomask manufacturer in China.

Similarly, the Chinese display market is growing rapidly for both AMOLED and LCD, and the collective investments being made by the country's leading display manufacturers are unmatched by any of the established players in the existing global market. The new FPD facility we are building in Hefei will be the first to manufacture G10.5+ photomasks in China. And we will be able to efficiently and effectively supply world-class masks to the growing number of domestic G10.5+ display factories.

Coupled with our advanced capabilities in Korea and Taiwan, we aim to be the leading global FPD mask producer. Many of our Chinese customers have ambitions to be not only the lowest cost producer for large-format LCD TV displays, but also leaders in AMOLED displays for mobile phones and other advanced applications.

For example, last month BOE announced the start of the nation's first G6 flexible AMOLED production line. They also plan to ramp a second G6 line in 2019. It is apparent that the Chinese market is growing, and we are positioning Photronics to benefit from this trend.

Construction activity is underway at both of our China sites, and both are on track to begin production in early 2019. In Xiamen, we have met all the regulatory conditions necessary to close our JV with Dai Nippon, and we expect this to be finalized shortly.

This will allow us to work together in Mainland China, expanding our 3-year relationship, while leveraging our combined strength to most effectively compete for the business. In Hefei, we have just started the construction of our FPD factory and have placed orders for all long lead time tools. We have significant contractual commitments from large customers, and they are very anxious for us to begin production.

Looking back, it's fair to say that 2017 was a challenging year. However, I believe that we executed well by taking all that the market presented to us, while preserving the integrity of our business model to relentless focus on cost reduction.

Beyond that, we kept our eyes on our long-term strategic objectives in China and have solidified the customer and local relationships required to facilitate our ramp. Sitting here today, more than 10% of our revenues originate in Mainland China. In wrapping up 2017, I would like to thank all the Photronics employees for their commitment and hard work and wish all a wonderful holiday season.

Looking forward to 2018, we cannot anticipate everything that will happen. However, we are cautiously optimistic that demand for our products will improve. We see the potential for profitable growth by capitalizing on specific opportunities that we have identified in high-end logic, memory and display markets. By doing so, we should see a positive impact on our margins and cash flow.

Notwithstanding these improvements, 2018 will be a year of significant investment for Photronics as we execute our China expansion plan. And as we've indicated, these plans will consume some of our cash balance and present margin headwinds during the second half of the year, as our new facilities start to incur startup costs.

As a management team, we are unified in our commitment to improving ROIC by investing in high-return projects that add lasting sustainable value for all stakeholders and believe these investments will achieve their desired outcomes.

I will now turn the call over to John for more details on our Q4 performance and Q1 outlook.

Thank you, Peter, and good morning, everyone. I have been at Photronics as CFO for nearly 3 months. I've been visiting and getting familiar with the operations, and I'm pleased with the competence, engagement and enthusiasm of the organization, from those in sales and administration to those in development and production, and the leadership who have brought the business to this level of success.

It's an exciting company in a challenging industry with a strategy for organic growth and opportunistic acquisitions, and I look forward to working with the team to deliver shareholder value. I've met many of our constituents over the past 3 months, and I look forward to meeting you all in the coming months.

Fourth quarter operations improved considerably over the previous quarter. Fourth quarter revenue increased 8% sequentially and 13% compared with last year's Q4, resulting in large part from growth in high-end sales. Integrated circuit, IC, revenue was $96.1 million, 13% over third quarter 2017 and 17% over fourth quarter 2016 revenue.

High-end IC revenue of $35.3 million improved 49% over the $23.7 million in Q3 and 44% over Q4 2016 revenue of $24.6 million. As Peter reported, the primary driver of the improvement was high-end logic, principally due to growing demand for 28-nanometer from our Asian foundry customers, whose production of 28-nanometer chips continues to grow and create photomask demand.

High-end memory has continued to be positive for us throughout 2017. We've seen 4 consecutive quarters of growth. We're well-positioned in the market, but we anticipate seasonal headwinds in IC during Q1 before returning to sequential growth later in the year. We don't foresee any deterioration in underlying demand drivers, and we expect to at least maintain market share.

High-end FPD revenue of $17.1 million also improved over both comparable periods based on AMOLED demand from China, albeit less dramatically and not enough to overcome softness in the mainstream nodes. Q4 high-end FPD increased 2% over Q3 2017 revenue of $16.8 million and 8% over Q4 2016 revenue of $15.9 million.

Our customers are seeing strong display demand, which typically is an indicator that new product introductions were soft, resulting in lower mask demand. We still expect to see high-end ramp but likely later in the year. With our increased capacity and capability, we will be posed -- poised to benefit from this demand increase when it materializes.

The increased revenue generated improved gross margin in the quarter. As reflected in the supplemental slides, Q4 gross margin was 21.9%, 240 basis points over the Q3 margin of 19.5%, and 280 basis points over the Q4 2016 gross margin of 19.1%.

Operating expenses of $14 million improved sequentially over the prior year quarter, due primarily to reclassification of $1 million of M&A -- amortization expense from R&D to cost of goods sold, slightly lower SG&A expenses in the quarter and the net effect of recording certain one-time accounting adjustments to adjust unneeded reserves and other expenses.

We expect the run rate of SG&A to increase nominally for existing operations during the year, in line with inflation. And there will be some additional ramping during the year, as staffing is recruited for the China operations. R&D should remain essentially flat.

Operating income of $12.4 million and operating margin of 10.3% improved over the comparable margin of 4.7% in Q3 2017 and 4.9% in Q4 2016, as a result of the superior gross margin and effective cost control, which demonstrates the benefit to margin from incremental revenue. The minority interest deduction of $5.1 million in Q4 reflected the substantial increase in revenue and healthy profitability at PDMC, our joint venture in Taiwan.

Other income of $0.5 million is comprised primarily of FX gain. Interest income and expense are essentially a wash.

The tax provision in the quarter of $2.5 million represented an effective tax rate of 19%, and the total tax year -- total year tax provision of $5.3 million was similar at 20%. Changes in valuation allowances, foreign tax rate differentials, tax credits and tax holidays reduced the effective rate from the expected U.S. statutory rate.

Net income of $5.4 million in the quarter represented $0.08 per diluted share. Weighted average diluted shares outstanding were 69,218,000.

We generated operating cash of $23 million in the quarter, somewhat less than Q3 2017, due to the increase in accounts receivable as revenue increased. Still, strong operating cash generation.

Our CapEx of $53 million during the quarter reflects spend for a portion of the China projects combined with other growth initiatives. Operating cash generated for the year was $97 million, leaving a cash balance of $308 million at year-end after rounded numbers, $92 million of CapEx, $5 million for an acquisition, $5 million of debt repayment and $8 million payments to our joint venture partner and noncontrolling interests.

Foreign exchange and share-based arrangements also contributed approximately $9 million to cash flow during the year. Net cash at year-end was $246 million.

Planned CapEx for fiscal 2018 is approximately $250 million, which includes the tools and buildings for the China initiatives as well as maintenance CapEx and other growth initiatives.

Our cash balance, strong balance sheet and strong operating cash generation provide adequate resources to fund the planned investments. The 2018 expenditures will be mostly back-end loaded, with about half of the total planned for Q4 2018, as we begin receiving the tools and equipment for both China facilities.

We had previously discussed the importance of the China initiatives in this and other forums as a necessary component of our overall strategy of growth, growth of revenue and profit and improving value for our shareholders. Expansion into China is essential for Photronics to remain competitive at the leading edge of geographic expansion by our customer base and it's a significant aspect of our organic growth initiative, integral to maintaining service levels with our existing customer base and expanding our outreach.

Continuing to spend on CapEx to improve and equip the other Photronics locations will also help to increase revenues and profits at those facilities.

The second component of our growth strategy is strategic, opportunistic acquisitions, preferably of related or adjacent technologies. We remain vigilant for opportunities and are continually exploring possibilities. The timing for acquisitions is impractical to try to predict and control, but we endeavor to maintain adequate dry powder in the form of cash and credit availability to be prepared to act when the right opportunity surfaces.

In addition to our overall growth strategy and preparedness to repay the outstanding $57.5 million convertible debt, if necessary when it matures, we are not unaware of the cyclical nature of this industry, and we have observed the fate of those who take undue risks. In that context, we will also endeavor to retain adequate cash balances and creditworthiness to ensure the viability of Photronics in a downturn.

The forecast CapEx of $250 million, together with the convertible debt repayment, will consume more than $300 million of cash over the next 6 quarters. It will be incumbent on us to meet our operating projections over this period, since cash generated from operations will be the source of funds to meet the business' operating needs.

Other uses of our funds, including share repurchase or dividends, will be reconsidered sometime in the medium to longer term, when we are confident that the growth initiatives are adequately funded and our ability to maintain viability in the events of -- in event of cyclical adversity is preserved.

Before providing first quarter guidance, I will provide a reminder that our visibility is always limited, as our backlog is typically only 1 to 2 weeks. And demand for some of our products is inherently uneven and difficult to predict. Additionally, the ASPs for high-end mask sets are high, and as this segment of the business grows a relatively low number of high-end orders can have a significant impact on our revenue for a quarter.

Given those caveats, we expect first quarter revenue to be between $110 million and $118 million. Based on this revenue expectation and our current operating model, we estimate earnings for the fiscal 2018 first quarter to be in the range of $0.02 to $0.09 per diluted share.

As we enter the 2018 fiscal year, we are excited about the business prospects this year as well as the investments we're making in China to position us for the next wave of growth in 2019 and beyond. We have a leading position in the global merchant photomask industry and plan to further expand our position as we invest. Due to our financial discipline and low-cost manufacturing approach, we are confident this growth will be profitable and will provide increase in value to shareholders.

I will now turn the call over to the operator for your questions.

(Operator Instructions) Our first question comes from Tom Diffely from D.A. Davidson.

First a question on the income statement. I guess, I missed it. What was -- what drove the big increase in the noncontrolling interest this quarter? Typically, it comes from the joint venture in Taiwan but just curious if there's more to it.

Yes, that's exactly it, Tom. Joint venture did really well. Revenue increased in the order of $10 million over prior quarter, and drove great profitabilities. So that minority interest share was over $5 million.

Okay. In your guidance for the first fiscal quarter, do you have similar levels coming out of Taiwan, then?

Actually, PDMC probably won't be quite as strong in first quarter as it was in fourth quarter.

Okay. And then a question on the new tools, the P-800. Just curious, what extra capabilities does that give you versus what you have today? And you mentioned that you'll be the first in the marketplace to have one. So just wondering what the other leading-edge manufacturers are using today?

Yes. Presently, the most advanced tool in the market is P-80. And right now, the P-80s are manufacturing photomasks that are creating displays with resolutions of maximum maybe 800 PPI. The P-800, along with some internal development programs we have going on, should easily allow AMOLED displays with resolutions at 1200 PPI and more. So as our growing customer base is very enthusiastic about gaining market share from each other, we intend to equip them with a photomask that makes that battle possible.

Okay. Great. And then I guess similarly with the P10, as of today, there's no other merchant players out there with that capability?

Not in China. There's only really -- there's really only 1 merchant with that capability, and they sit in Japan. And today, there's really only 2 customers globally for those displays. But by the time that we're in production, the customer base will have expanded by 1 or 2 more players. And just to give you a point of reference, right now, a single mask set for a G10.5+ exceeds $10 million, 1 mask set. So there's a lot of revenue potential in that market segment.

Okay. Doesn't do much for smoothing out your business, though.

No. That thought -- obviously, that concept is not lost on us. But there's nothing that we manufacture today that has double-digit million price tags hung on it.

Okay. Is there any way to quantify what the impacts on the COGS will be from these new tools going in, and what the timing of that is?

What I would say is we're -- we've decided to have an investor day to give a much clearer picture to anyone who is interested in what the investment and the opportunity looks like in China. So what I would suggest is that you put that on your calendar, and you'll hear more about that than probably you -- even you want to hear if you come visit with us in May.

Okay, yes, sounds good. One final question. You talked about a significant contractual demand for these new projects. Will you have the ability to serve those out of your other facilities until these facilities are up and running, the new Chinese facilities are up and running?

A majority of the contractual commitments, overwhelming majority is -- are for G10.5+. What I can tell you is the contractual commitments we have guarantee profitable operations for multiple years after we start production.

Our next question comes from Edwin Mok from Needham & Company.

So first question on the quarter and kind of outlook. You mentioned high-end IC was stronger than expected, that drove the upside. Just curious how much of that was driven by 28-nanometer versus more leading edge like 20 or below? And how much was baked into 1Q guidance? And I think beyond that, if you can you give some color on that?

About 60% of it was driven by 28. So a little more than half was driven by 28-nanometer logic. The remainder was driven by memory and smaller geometry of logic business. As far as Q1 goes, we always have seasonal softness in our IC business in our first quarter. That's kind of, you know, classic, so that's baked into the guidance. Also, what we've seen, you've heard us discuss it time and time again, our 28-nanometer business has never, quarter-to-quarter, been smooth. It's always had the profile of a sawblade. So we're hopeful that doesn't happen in the current quarter. But if you look back over the last, at least 12, that's the way it's been. So that's how we feel we have to guide.

Okay, great. That's actually helpful color. Second question I have on the China -- your 2 investments in China. If I remember correctly, I think previously when you guys first announced your IC JV, I think you were targeting this production second half '18, and now you said early '19. I just want to make sure I understand if that was pushout or is it just due to the, call it, arrangement or the JV that delayed that. That's the first part of the question. And then second thing, on the $250 million CapEx. It's a little bigger than what I was modeling. I was just wondering if that was an increase from where you were before. And if so, what drove the increase?

Yes, the answer -- to answer the first question, building a facility, a manufacturing facility in China, there is a very long list of regulatory hurdles that need to be jumped. So as we have worked through that, it's taken a bit longer for us to clear some of those hurdles. Having said that, you can see that we learn from our experience. So our FPD operation is likely going to come online nearly coincidentally with our IC. We've nearly halved the time it's taken us to jump all of the regulatory requirements the second time around. So yes, it's a little bit longer than we had hoped, but we still believe well-timed to the market. And we've taken lessons learned and applied them to the FPD project, and it's sailing along quite nicely. So and then...

And then on the total CapEx number?

Your question regarding CapEx, wasn't -- what wasn't in the prior guidance was the P-800. That now is in there.

I see. Okay, that's -- that would explain that. Thanks.

Our 2017 guidance, our actual CapEx was a little bit soft. So obviously some of the things we thought would happen in 2017 were pushed out a bit. And that -- that's contemplated in that as well.

Okay. Great. Last question I have, on the margin side, I think, Peter, you mentioned that as you ramp the facility that might have some kind of near-term margin headwind that could start to come in the second half of '18. Any way you can kind of quantify that, how much impact it has -- you expect to have on your margins?

We may be able to quantify it better getting toward the investor day in May. But at this point, it's difficult to forecast it.

Okay. Great. That's all I have. Before I go, just quickly, if, Sean, you're listening, a quick shout out to you. I hope all is well. I was glad to work with you all these years.

(Operator Instructions) Our next question comes from Patrick Ho from Stifel, Nicolaus.

Maybe just to follow up on the new mask writing tool on the display side that you had mentioned. Is that focused primarily on China only or are there existing leading-edge or high-end display customers that are also going to benefit from the increasing capacity that you'll have later on in 2018?

Yes. That tool is really focused on ensuring that if any customer globally, wherever they reside, wants the best mask with the highest resolution, they come to us to buy it So it's not specific to any 1 geography.

Okay, great. That's helpful. Maybe moving to the IC side. There's a lot more activity, there's a lot more chatter about next-generation 7-nanometer, particularly with 1 of your customers as they try and sign on next, I guess, customers for that node. How do you see the activity as it is right now for potential 7 nanometers masks for you in 2018 as a whole? Is that a node that you guys are focused on? Or are you seeing I guess a lot of qualification activity today that will lead to potential revenues in 2018?

Patrick, yes, this is Chris. I can try to answer that one. So on the IC side, as Peter mentioned, the bulk of the business uplift was 28-nanometer. We have quite a few late-stage quals at 22, 14. Some new ones there that are going to complete in '17, early '18. So we expect those 2 nodes will be more material in '18. As far as 7, we are engaged in qualifications there, both for optical and EUV as well. Although I think to suggest that we would have material revenue at 7-nanometer in '18 is a little premature. Most of it is matching to captives and doing some initial work to get those processes set. I think '18 will be a little early though. On the EUV side, we've signed a joint development agreement with IBM recently to look at EUV for 7- and 5-nanometer applications. As you know, they have a pretty strong high-performance computing roadmap. They don't have a captive, so we're collaborating with them to develop processes. And there should be some revenue connected to that program as well. So there is work, it's a focus for us, but I don't think we can say it will be a strong revenue driver in '18. But 28, 14 and 22 should continue to pick up.

And I am showing no further questions from our phone lines. I would now like to turn the conference back over to Peter Kirlin for any closing remarks.

Thank you for joining us this morning. We are entering an important year, focused on growing our revenue to improve earnings and cash generation and investing our long-term strategic growth initiatives. It's important that we perform well against these objectives. I'm optimistic about the direction of the company and what we expect to accomplish over the next several years. I look forward to updating you as we move forward. Happy holidays to all.

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