U.S. Markets open in 8 hrs 19 mins

Photronics Inc (PLAB) Q3 2019 Earnings Call Transcript

Motley Fool Transcribers, The Motley Fool
Logo of jester cap with thought bubble.

Image source: The Motley Fool.

Photronics Inc (NASDAQ: PLAB)
Q3 2019 Earnings Call
Aug 20, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Photronics Third Quarter Fiscal Year 2019 Earnings Conference 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.

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

R. Troy Dewar -- Vice President, Investor Relations

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 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 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, 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.

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

Peter S. Kirlin -- Chief Executive Officer

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 phase of an industry downturn that is now being reinforced by a geopolitical environment that has become increasingly uncertain.

Revenue grew 5% compared with the 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 verticals 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 because 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 investments 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're 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 what 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 vertical market and revenues for G10.5+ masks increased as our Hefei facility became qualified for more applications. The demand for the large format mask should increase going forward as more panel flats begin production and new designs are released at both new and existing plants.

China IC softness appears to be primarily at 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 US 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 increase 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're more optimistic than ever that China IC and FPD market 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 US, 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 requirement. As the market evolves, we continually evaluate our operations to ensure we are aligned to support our customers technology road-maps 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're looking to expand upon this approach to developing new business once we complete the initial phase of investment in China. We have performed well to the first nine 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're 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 on line 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 two plus years. We'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 bright in China.

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

John P. Jordan -- Senior Vice President and Chief Financial Officer

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 broad product diversity have enabled us to continue to grow revenue despite a semiconductor industry downturn and a challenging geopolitical environment. We're 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 and 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 software 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 $6 million headwind to operating income although the tax benefit of those costs and the JV partners 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 to 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 one to two 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 US 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 masks markets will be stable to improving and FPD will see continued strength in the AMOLED for 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 two 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.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from Tom Diffely with D.A. Davidson. Your line is now open.

Thomas Diffely -- D.A. Davidson & Co. -- Analyst

Yes. Good morning and 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?

Peter S. Kirlin -- Chief Executive Officer

Yeah. It is now more what I would describe as broad-based. I have basically spent the first half of August in China and if you look back two or three 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 customers, Tom. So it's generally affecting their local market and particularly with the 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, harder 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.

Thomas Diffely -- D.A. Davidson & Co. -- Analyst

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

Peter S. Kirlin -- Chief Executive Officer

Seeing no impact in the FPD business at all. In fact, if I look at FPD, 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 it, but aside from that, not a lot of additional headwind.

Thomas Diffely -- D.A. Davidson & Co. -- Analyst

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 of China that those costs will go up over the next couple of quarters?

John P. Jordan -- Senior Vice President and Chief Financial Officer

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

Thomas Diffely -- D.A. Davidson & Co. -- Analyst

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

John P. Jordan -- Senior Vice President and Chief Financial Officer

You want to repeat that Tom? Thanks.

Thomas Diffely -- D.A. Davidson & Co. -- Analyst

Just 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?

John P. Jordan -- Senior Vice President and Chief Financial Officer

No, it's amortized over a long period, so the impact of that tool alone wouldn't be material.

Thomas Diffely -- D.A. Davidson & Co. -- Analyst

Okay. And then finally just a question for Chris. When you look at the High-End, it's roughly two-thirds of flat panel, one-third of the IC business that you have. Is that ratio fixed based on your tool-set or can the High-End portion go up with demand if need be?

Christopher J. Progler -- Chief Technology Officer and Strategic Planning

I don't think it's fixed based on the tool-set, Tom. I think it can -- the High-End portion can go up, I think particularly on the IC side, perhaps more than the FPD side and maybe some -- a little more constrain 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 is really fixed. We do tend to sometimes 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 not too much. I think we have a lot more room to grow the High-End with the existing tool-set.

Thomas Diffely -- D.A. Davidson & Co. -- Analyst

Great. Thank you. Thanks for your time.

Operator

[Operator Instructions] Our next question comes from Patrick Ho with Stifel. Your line is now open.

Brian Chin -- Stifel Nicolaus -- Analyst

Hi, good morning. This is Brian Chin on for Patrick Ho. Thanks for letting us ask a few questions and 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 baseline, can you give us a sense exiting this fiscal year, so in fiscal 4Q , you how much roughly revenue you expect the China facility to contribute on the flat panel side?

Peter S. Kirlin -- Chief Executive Officer

Yeah. 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 are still qualifying customers for specific products in our FPD fab. What we had 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 qual will be done. We are making good progress. We 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 would 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, this quarter we just muscled out the first radical sets at the end of the quarter. So it was not a material contributor to revenue, don't expect to be this quarter either. But when you did hear is, we push 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. It's not trivial. But what we can do and what we have done for years is mix and match, so we can build certain radicals of a set in China and others elsewhere, most likely Taiwan, is where the bulk of that activity is under way 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 push-out. And then, hopefully, with that two quarter shove, look 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 are right now using a mix-and-match strategy to not lose momentum.

Brian Chin -- Stifel Nicolaus -- Analyst

Okay. All right. Thanks, Peter. I appreciate the color. If you can, just taking [Phonetic] against that $630 million topline 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?

Peter S. Kirlin -- Chief Executive Officer

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 the China drag on EPS.

I'll turn it over to John. John, do you want to add something or maybe give a more direct or expansive answer?

John P. Jordan -- Senior Vice President and Chief Financial Officer

Yeah. 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 cost, we'll start generating more profit, so that $0.04 should decrease going forward.

Brian Chin -- Stifel Nicolaus -- Analyst

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

John P. Jordan -- Senior Vice President and Chief Financial Officer

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

Brian Chin -- Stifel Nicolaus -- Analyst

Okay. Got it. Maybe one more thing. In terms of the IC side, just curious if there is 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, do you have any sort of commentary about how the memory IC masks business is trending. There has obviously been some reduction in output recently and just kind of curious what we are seeing in that part of the business? Thank you.

Peter S. Kirlin -- Chief Executive Officer

Yeah. Our IC revenues in China went back to Q1 levels. So we lost the growth in Q2, in Q3. Again, it's a very fluid dynamic market. We are 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 topline. 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 phase of the downturn. It's been up and down a little bit quarter-to-quarter. We are not expecting that memory is going to materially improve until calendar year 2020. And exactly when in calendar year 2020, I think right now it is hard to predict.

Brian Chin -- Stifel Nicolaus -- Analyst

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

Peter S. Kirlin -- Chief Executive Officer

Yeah, 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 again, 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 to remind you, when we put our targets in place 15 months ago, we explicitly said they contemplated a downturn, which we are in. But we didn't contemplate the extra noise going on with trade wars and weaponizing photo-resist in the rest. So nobody knows, at least nobody I talk to knows what that means next week, let alone next year.

Brian Chin -- Stifel Nicolaus -- Analyst

Okay. Very fair. Thank you, Peter.

Operator

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

Peter S. Kirlin -- Chief Executive Officer

Thank you for taking your 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 is 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.

Operator

[Operator Closing Remarks]

Duration: 33 minutes

Call participants:

R. Troy Dewar -- Vice President, Investor Relations

Peter S. Kirlin -- Chief Executive Officer

John P. Jordan -- Senior Vice President and Chief Financial Officer

Christopher J. Progler -- Chief Technology Officer and Strategic Planning

Thomas Diffely -- D.A. Davidson & Co. -- Analyst

Brian Chin -- Stifel Nicolaus -- Analyst

More PLAB analysis

All earnings call transcripts

AlphaStreet Logo

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

Motley Fool Transcribers has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com