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Edited Transcript of PLAB earnings conference call or presentation 20-Aug-19 12:30pm GMT

Q3 2019 Photronics Inc Earnings Call

Brookfield Aug 20, 2019 (Thomson StreetEvents) -- Edited Transcript of Photronics Inc earnings conference call or presentation Tuesday, August 20, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher J. Progler

Photronics, Inc. - VP of Strategic Planning & CTO

* John P. Jordan

Photronics, Inc. - Senior VP & CFO

* Peter S. Kirlin

Photronics, Inc. - CEO & Director

* R. Troy Dewar

Photronics, Inc. - Director of IR

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Conference Call Participants

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* Brian Edward Chin

Stifel, Nicolaus & Company, Incorporated, Research Division - Associate

* Thomas Robert Diffely

D.A. Davidson & Co., Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Photronics Third Quarter Fiscal Year 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this call is being recorded.

I would now like to introduce your host for today's conference, Mr. Troy Dewar. You may begin.

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R. Troy Dewar, Photronics, Inc. - Director of IR [2]

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Thank you, Skyler. Good morning, everyone. Welcome to our review of Photronics 2019 Third Quarter Financial Results. Joining me this morning are Dr. Peter Kirlin, Chief Executive Officer; John Jordan, Senior Vice President, 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 participant 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. Reconciliation of these metrics to GAAP financial results is provided in our presentation materials.

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

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [3]

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Thank you, Troy, and good morning, everyone. The press release we issued earlier today illustrates, once again, the ability of our entire organization to execute in the face of an industry downturn that is now being reinforced by a geopolitical environment that has become increasingly uncertain.

Revenue grew 5% compared with previous quarter and 1% compared with the same quarter last year, making this the eighth consecutive quarter of year-over-year revenue growth. FPD achieved record revenue as demand for AMOLED reticles remained strong. We benefited from additional production capacity from our new facility in Hefei, China. IC revenue improved sequentially on greater demand for mainstream nodes from Asian foundries, while high-end IC was flat with growth in Taiwan offset by softness in China.

Margins improved compared with the previous quarter as we controlled costs despite higher start-up expenses. This enabled us to deliver earnings of $0.10 per share.

In addition, our cash balance grew to $197 million aided by strong operating cash flow, government incentives we received for our China investment and additional borrowings in China. CapEx of $20 million was consistent with plan as we near completion of our initial China investment.

As we head into the end of our fiscal year, we are in a superb financial position. Year-to-date revenues are ahead of last year's record levels, and our outlook for the fourth quarter puts us on pace to improve on last year's total. Our cash balance continues to be strong despite paying off our convertible debt and funding our expansion into China. Our outlook remains positive as we strive to hit our fiscal 2020 targets of $630 million in revenue and $0.80 of EPS.

Overall, business conditions are more challenging today than when we first established those goals 15 months ago. But we still believe they are attainable, and we remain optimistic about our long-term outlook.

Revenues to China this quarter grew, representing 25% of total revenue and reaching record levels as growth for FPD masks more than offset IC softness. FPD was up 31% sequentially and 61% compared with last year with China now making up 53% of our FPD revenue.

We continue to be the vendor of choice in the AMOLED reticle market, and revenues for G10.5+ masks increased as our Hefei facility became qualified for more applications. The demand for large format masks should increase going forward as more panel fabs begin production and new designs are released at both new and existing plants.

China IC softness appears to be primarily related to geopolitical issues that are slowing demand for some of our customers. It is undeniable that the level of uncertainty in China has increased as the trade war between the U.S. and China has escalated. In addition, rising tensions between Korea and Japan is challenging the supply chain for some of our customers. While these issues do not directly impact our products or operations, we are exposed indirectly as more and more of our customers are beginning to feel the impact. Even though our demand is design-driven and not necessarily tied to units of semiconductors or displays, uncertainty can cause some customers to become more cautious and slow the rate of new product releases, thus impacting our business. We did see some of this in our China IC business in Q3, and we have tuned our CapEx plan yet again to better align expenses with revenue. Consequently, we expect to conclude the initial phase of our CapEx in Xiamen in the first half of 2020.

Long term, we believe the impact of the trade dispute to be a significant positive for our business because it significantly increased the resolve of our Chinese customers to fully localize their supply chain. And we have tremendous support from local customers with production ramping at both facilities, which should provide a tailwind as trade discussions progress, and we successfully qualify for new applications. We are more optimistic than ever that China IC and FPD markets will be tremendous growth opportunities for us.

Looking at the photomask market globally, mask demand is trending positive. This is in part the result of companies using new photomask technology as well as design to differentiate their products. This differentiation creates more specialized and innovative solutions. These trends are great for Photronics. We have formed a global network that is unmatched by any other mask producer. 11 locations across U.S., Europe and Asia strategically located close to customers.

In addition, we have capability through advanced tools and processes to meet all of our customers' technical requirements. As the market evolves, we continually evaluate our operations to ensure we are aligned to support our customers' technology roadmaps with the optical mix of manufacturing assets. Recently, we have been successful in securing long-term customer commitments to reduce the risk and improve the potential financial return of capital investments. We are looking to expand upon this approach developing new business once we complete the initial phase of investment in China.

We have performed well through the first 9 months of 2019, and Q4 looks like it will follow the same trend. Our financial health is very good and our addressable market is growing as more fabs come online and the amount of design activity increases. I'm pleased with how we are performing and excited about our potential to grow and extend our leadership position.

I am very grateful to all our employees worldwide for their skill and professionalism as well as their willingness to do what it takes to win in a very challenging environment. The results speak louder than any words possibly could. Bringing the China facilities online would have not been possible without the extraordinary efforts of everyone involved in the planning and execution of the construction and production ramp over the past 2-plus years. I'd like to thank all of our employees for their hard work. We are off to an excellent start. The ramp is accelerating and I believe that our future is extremely great in China.

At this time, I will turn the call over to John to provide commentary on our performance and outlook.

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John P. Jordan, Photronics, Inc. - Senior VP & CFO [4]

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Thank you, Peter. Good morning, everyone. Revenue in the third quarter was $138.1 million, 5% better than the previous quarter and 1% better than the third quarter of last year. Our design-driven business model and product -- broad product diversity have enabled us to continue to grow revenues despite a semiconductor industry downturn and a challenging geopolitical environment. We are also beginning to see the impact of our new China facilities as they ramp production. Together they contributed approximately $6 million in revenue.

IC revenue in the third quarter improved 2% sequentially to $100.2 million on demand from Asian foundries for mainstream nodes. High end was flat sequentially as macro uncertainty continued to weigh on demand. Compared with Q3 last year, high-end IC was lower on softer logic and memory demand. Looking forward, the underlying demand drivers for IC look positive but geopolitical factors may delay a recovery beyond the next quarter.

FPD business continued strong this quarter setting a record with revenue of $37.9 million, 15% better than Q2 and 30% better than Q3 last year.

Mobile AMOLED displays were the primary driver of the increase as our customers in Korea and China continued to release new innovative designs. We also benefited from an increase in capacity as we ramp production in China, including G10.5+ photomasks.

We expect sequential FPD growth in the fourth quarter. AMOLED demand should remain healthy and shipments from the new China plant should continue to increase.

Gross margin improved sequentially to 22% as revenue growth and a more favorable product mix offset the impact from China start-up activity.

Operating margin improved to 10%. We had a modest increase in operating expenses due to qualification activity in R&D expense.

In total, China operations were a $6 million headwind to operating income. Although the tax benefit of those costs and the JV partner's share reduced the overall impact on EPS to $0.04 per share, we expect that effect to decrease going forward.

Other income expense was a modest expense this quarter consisting of miscellaneous interest expense. Prior quarter had a one-off FX gain that did not repeat in Q3. Minority interest increased compared with last quarter due to increased revenue and earnings at our Taiwan JV partially offset by losses from our China JV. This resulted in net income attributable to Photronics Inc. shareholders of $6.3 million or $0.10 per diluted share.

Our cash balance increased $30 million during the quarter to $197 million. We generated $26 million in cash from operations, received $12 million in government incentives from China and borrowed an additional $14 million in China for equipment purchases.

CapEx in the quarter was $20 million, bringing the year-to-date total CapEx to $160 million. Total CapEx for the year is expected to be $185 million as we near completion of the initial phase of our China investment. The remainder of the China IC investment will be completed in the first half of 2020.

Before I provide fourth quarter guidance, I will reiterate the 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 and earnings for quarter.

Lastly, I'll caution that any development from the ongoing trade discussions between the U.S. and China or growing tension between Korea and Japan could potentially have an adverse impact on our industry and therefore our results. Given those caveats, we expect fourth quarter revenue to be in the range of $143 million to $151 million. We assume that our IC mask markets will be stable to improving and FPD will see continued strength in the AMOLED from mobile displays. We also anticipate a larger contribution from our new China facilities. Based on this revenue expectation and our current operating model, we estimate earnings for the fourth quarter to be in the range of $0.11 to $0.17 per diluted share.

We are pleased with our performance in the third quarter as we have grown revenue meeting our expectations in an environment that has become progressively more challenging. We are positioned to finish the year ahead of last year's pace with 2 new production facilities in the important China market. Our balance sheet has remained healthy even as we have made significant investments for future growth, and we are poised to deliver on our commitments as we enter 2020.

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

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Questions and Answers

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Operator [1]

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

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [2]

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Great outlook in this tough environment right now. So Peter, I guess when we look at the slowdown or the geopolitical risk in China, does that impact more on the high-end side or the mainstream side? Is there any way to discern where the biggest impact will be?

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [3]

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Yes. I -- it is now more what I would describe as broad-based. I basically spent the first half of August in China. And if you look back 2 or 3 months ago, the trade war was obviously going on but it really wasn't present in the active dialogue. Now it's on the tip of every -- almost every customer's tongue. So it's generally affecting their local market, and particularly with threats that were in place when I was in China regarding the additional 10%. It was hanging out there regarding the largest export market. Some of that is, at the present time, damped down but who knows what tomorrow's Twitter feed will bring, so it's very hard to -- for anyone to quantify. As I said in my remarks, it's a short-term drag. Long term, it's a clear accelerant for the China market. And it's an accelerant that is shared not just by the customers but by the government as a whole. So long term, undeniably, it's positive. Short term, negative. Hard to -- like I said, hard to really gauge in the next few months what the real impact looks like because it's a dynamic situation.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [4]

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Okay. I guess just one more following up on that. Have you seen it impact your 4 key new customers for the 2 Chinese facilities as well?

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [5]

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Seeing no impact in the FPD business at all. In fact, if I look at FPD, I -- we can say with pretty good confidence that, that market through the end of the calendar year, not just the end of our fiscal year, is going to be very strong. So no impact in FPD. One of our -- in fact, our largest Chinese IC customer has Huawei as a very large customer. So there is an impact there and anyone would expect that. But aside from that, not a lot of additional headwind.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [6]

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Okay. That's very helpful. And then John, a question about the cost structure. With the delay in spending on the last tranche of CapEx, does that mean that the cost structure that we're seeing next quarter doesn't fully represent the true cost in China that those costs will go up over the next couple of quarters?

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John P. Jordan, Photronics, Inc. - Senior VP & CFO [7]

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Well, the delay is a tool that's going to be delivered during 2020. So the depreciation associated with that would come in, in 2020, Tom. So yes, to the extent that, that's into the future, it's not reflected in next quarter. But that would also bring revenue with it.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [8]

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Okay. Is that a meaningful slug? Or is it tool amortized over multiple years that isn't too great on a quarterly basis?

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John P. Jordan, Photronics, Inc. - Senior VP & CFO [9]

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Want to repeat that, Tom? Thanks.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [10]

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I was wondering if it's going to be a material impact to the cost structure when it hits the books. Or if it's going to be amortized over a longer period of time, where it's not too impactful on a quarterly basis?

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John P. Jordan, Photronics, Inc. - Senior VP & CFO [11]

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No. It's amortized over a long period. So the impact of that tool alone wouldn't be material.

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Thomas Robert Diffely, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [12]

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Okay. And then finally just a question for Chris. When you look at the high end, it's roughly 2/3 of flat panel, 1/3 of the IC business that you have. Is that ratio fixed based on your toolset? Or can the high-end portion go up with demand, if need be?

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Christopher J. Progler, Photronics, Inc. - VP of Strategic Planning & CTO [13]

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I don't think it's fixed based on the toolset, Tom. I think it can -- the high-end portion can go up. I think, particularly, on the IC side or perhaps more than the FPD side and maybe some -- a little more constrained on FPD. But on the IC side, definitely, we have capacity at the high end to deliver a larger fraction of our IC revenue with our existing tools. And we have made some investments this year, and John alluded to one next year, which will allow us to grow share and grow our percent of revenue on the high end as well. So it isn't really fixed. We do tend to -- some fabs run more mainstream or let's call them lower-end masks on higher-end equipment, if necessary, based on the dynamics of the market. There's a little of that going on but not too much. I think we have a lot more room to grow the high end with the existing toolset.

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Operator [14]

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

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Brian Edward Chin, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [15]

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This is Brian Chin, on for Patrick Ho. Congratulations on the results. Maybe the first question for you, looking at that $630 million fiscal '20 sales target, I'm kind of curious, how much flat panel sales out of the China facility is, sort of, assumed in that revenue level? And for a baseline, can you give us a sense exiting this fiscal year? So in fiscal 4Q, how much roughly revenue you expect the China facility to contribute on the flat panel side?

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [16]

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Yes. So Brian, we -- 15 months ago, right, when I think we set the target out there, we looked and said, we expected about $150 million of incremental revenue coming from the combined China factories. We did not quantify the split between FPD and IC. Coming out of the current year, we do not expect the China factory to have maximized its revenue on the FPD front yet. Because in the fourth quarter, right, we're still qualifying customers for specific products in our FPD fab. What we have said that exiting the fourth quarter, we expect the qualifications to essentially be complete with FPD. So moving into next fiscal year, the FPD fab should be largely running production or the number of qualifications happening should be consistent with what we see in our other FPD factories in Taiwan and Korea. Nothing has changed about that. By the end of this year, this fiscal year, we think quals will be done. We're making good progress. We've got a lot of customers now qualified in China. So Q1 is kind of the first quarter where Hefei is running full capacity. Having said that, as the year moves on, we expect more G10.5 demand in the form of new factories to come online and that will change the revenue mix in Hefei and give it additional revenue momentum. So that's kind of the trajectory on FPD.

As far as IC goes, we -- this quarter, we just muscled out the first reticle sets at the end of the quarter. So it was not a material contributor to revenue, don't expect it to be this quarter either. But what you did hear is, we pushed CapEx out into next year and the original guidance was $210 million, we ratcheted that back to $185 million. So it, kind of, quantifies the amount of CapEx push out it was, so not trivial. But what we can do and what we have done for years is mix and match. So we can build certain reticles of the set in China and others elsewhere, most likely Taiwan is where the bulk of that activity is underway right now. A small amount in Japan because, of course, DNP is our partner. So we can use the mix-and-match strategy, so we don't miss any revenue opportunity. So really it's just simply an expense pushout.

And then hopefully, with that 2 quarter shove, we'll be beyond the nonsense, that at least I would describe as nonsense called the trade war, and we'll be able to pick up without a lot of disruption with IC. So IC by middle of next year should be through the qualification phase and ramping revenue strongly. And that is because we're, right now, using a mix-and-match strategy to not lose momentum.

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Brian Edward Chin, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [17]

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Okay. All right. Peter, appreciate the color. If you can -- just pegging against that $630 million top line target for next fiscal year, can you remind us, again, sort of, what the CapEx assumption is against that revenue level? And also what you envision through the full year what the gross margin and/or EPS drag would be relative to the start-up cost throughout the fiscal full year?

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [18]

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Yes. Well, I think what we have historically said was we expect maintenance CapEx to be about $50 million, right? But now you've heard we pushed some CapEx that was expected this year into next. So you can, kind of, work the simple math on that yourself. John also commented, we see this quarter as being the inflection point for China drag on EPS. I'll turn it over to John. John, you want to add something or maybe give a more direct or expansive answer?

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John P. Jordan, Photronics, Inc. - Senior VP & CFO [19]

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Yes. So as I mentioned the effect this quarter was $0.04 a share and as our revenues increase in China and offset some of these cost of goods to fixed costs, we'll start generating more profit, so that $0.04 should decrease going forward.

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Brian Edward Chin, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [20]

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Okay. So maybe, like less than the $0.10 impact perhaps through the full fiscal next year?

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John P. Jordan, Photronics, Inc. - Senior VP & CFO [21]

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One would hope. We expect to be profitable in China overall after this quarter.

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Brian Edward Chin, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [22]

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Got it. Maybe one more thing. In terms of the IC side, just curious, if there's a way to quantify what that drag was on the top -- from a revenue perspective in fiscal 3Q and/or expected in fiscal 4Q? And also, Peter, if you have any sort of commentary about how the memory IC mask business is trending? There's obviously been some reduction in output recently, and just kind of curious what you're seeing in that part of the business.

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [23]

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Yes. Our IC revenues in China went back to Q1 level. So we lost the growth in Q2 -- in Q3. Again, it's a very fluid dynamic market. We're not expecting, as John said in his guidance, the market to deteriorate more than it has on the IC front. So that's the best I can do to -- again, you can do that simple math and you'll know what kind of a drag that was on the top line. It basically represents -- anyway, so that's pretty straightforward. As far as memory goes, the downturn in memory, as I think everyone is aware, has been very severe. Our memory business has held up pretty well in the face of the downturn. It's been up and down a little bit quarter-to-quarter. We're not expecting that memory is going to materially improve until calendar year 2020. And exactly when in calendar year 2020 I think right now is hard to predict.

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Brian Edward Chin, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [24]

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Got it. So not necessarily improved till next calendar year but not necessarily be a drag -- incremental drag in the business either?

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [25]

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Yes. Not necessarily, not changed materially, right, because our customer base is, in memory, pretty diverse, right? We have the best -- we think, at least, we have the best photomask technology for memory globally. We do as I think others expect NAND to recover in advance of DRAM, but it's tough to know exactly when that happens. It's a 2020 event. Time will tell exactly when because we all are operating in an environment where we have the normal industry cycle. And just remind you, when we put our targets in place 15 months ago, we explicitly said, they contemplated the downturn, which we're in. But we didn't contemplate the extra noise going on with trade wars and weaponizing photoresist and the rest. So nobody knows, at least nobody I talked to knows what that means next week, let alone, next year.

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Operator [26]

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And at this time, I'm showing no further questions. I'd like to turn the call over to Peter Kirlin for closing remarks.

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [27]

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Thank you for taking the time to join us this morning. We are pleased with our performance this quarter and believe we have done a great job of maximizing our business in light of the current environment. At the same time, we know there's much more we can do to truly exploit the opportunities ahead. Our future looks good, and we are well positioned to continue to grow in 2020 and beyond.

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Operator [28]

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Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.