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Photronics Inc (PLAB 0.28%)
Q1 2019 Earnings Conference Call
Feb. 21, 2019, 8:30 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
See all our earnings call transcripts.
Prepared Remarks:
Operator
Good day, ladies and gentlemen, and welcome to the Photronics Q1 Fiscal Year 2019 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions for the participants will follow at that time. (Operator Instructions)
As a reminder, this conference call is being recorded on February 21, 2019.
I would now like to introduce your host for today's conference, Mr. Troy Dewar, Head of Investor Relations. Sir, you may begin.
R. Troy Dewar -- Vice President, Investor Relations
Thank you, Jeremy. Good morning everyone. Welcome to our review of Photronics 2019 first 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 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. Revenue for the first quarter of 2019 was mostly in line with expectations. We achieved year-over-year growth despite fewer days this quarter as an increase in high-end was somewhat offset by weaker mainstream. On a sequential basis, revenue was down 14% due to seasonal weakness, the shorter quarter, and macro industry headwinds. Whenever IC high-end grew, our mainstream was down compared with last year. On a sequential basis, both high-end and mainstream declined due to seasonality and uncertainty related to industry, economic and geopolitical concerns through a order activity.
We saw weaker high-end memory demand although we believe this is not related to order timing and neither market-driven. High-end logic remained soft. Looking into the second quarter, we expect to see a pickup in memory (inaudible) in logic is less clear. Regarding the latter, we don't expect to see material deterioration, the recovery may be beyond the second quarter. While we experienced lower demand across many parts of our business, high-end FPD was a notable exception.
Our FPD business is in a very strong competitive position, the industry's leading technology and our target relineup anchored by P-800, which offers superior resolution tools. Once again, AMOLED revenues were up sequentially to the extent that they now represent approximately half of our total FPD revenue and more than doubled compared to last year. The mainstream FPD revenue was down as we devoted more mainstream capacity to building the non-critical layers of the AMOLED mask sets and experienced competitive pressures associated with an oversupply market. FPD production capacity was sold out throughout the first quarter. Looking forward into the second quarter, we expect our FPD business to grow, driven primarily by mobile display with additional capacity coming online as we bring up production in China in the latter half of the second quarter.
Shifting to profitability, we saw a decrease compared with the fourth quarter resulting from lower revenue and higher costs in China. Below the line, we incurred some pluses and minuses, with that resulting earnings of $0.08 per share. Overall, I believe we performed well in what was a very challenging environment in line with our expectations. Operating cash flow for the quarter was negative, also in line with our expectations due in large part to temporary factors such as the timing of receivables and the payment of value-added taxes on tools delivered into China. We expect to see operating cash flow improve moving forward. Our China investments are peaking and with CapEx of $107 million, our cash balance dropped to $232 million at the end of the quarter. Even with this, we are in a great spot financially, which enabled us to repurchase 1.1 million shares during the quarter, and we expect to begin rapidly rebuilding our cash balance as our new facilities in China ramp.
As you know, we have placed a high strategic priority on developing the China business. We have already seen tremendous success. The customers are a combination of China headquarter companies and multinational companies that invested in the country in order to avail themselves of a growing semiconductor and flat panel display demand. Revenue to China in the first quarter improved 55% year-over-year with a solid 50-50 balance between IC and FPD.
To put our performance in a broader context, our revenue to China over the last 12 months was approximately $109 million. In 2017, it was $43 million. In other words, our business in China is over 2.5 times larger and it was just a little over one year ago. When we announced the first China investment in August of 2016, we said that one of the reasons we were confident in our ability to generate necessary returns on this investment was the fact that we already had developed a customer base in China. At that time, China represented approximately 5% of our revenue. In this quarter, China was 22% of our revenue. This gives us an extraordinarily strong foundation even before we manufacture the first IC or G10.5+ photomask in China. In addition to our already mature and growing China revenue stream, our investment risk management includes customer contractual commitments, investment incentives and the extension of our IC joint venture with DNP to help us more effectively compete in China.
These factors give us confidence that the investment return in China will be significantly better than historical return on invested capital. The Made in China 2025 goals for IC production are ambitious. and semiconductor manufacturers, they are making progress against industry objectives for domestic produced chips. The stated target has to achieve 40% self-sufficiency by the end of the year 2020. According to recent projections provided by IC Insights, they will only be at 20% by 2023. This implies that there is much more investment needed to hit the targets. If those investments occur, then they will need many more photomask to ramp production at those facilities.
While there is municipal short-term softness in the China economy, the long-term trend in the semiconductor industry looks robust, technology trends are also positive, in Chinese logic, companies are moving into production at 28-nanometer with early stage development commencing of 14. For Chinese memory manufacturers, we are starting to see both 1X DRAM and a 32-level 3D NAND flash in production. With development beginning at the 1Y DRAM and 96-level nodes -- 96-level flash nodes respectively. For FPD, G10.5+ in AMOLED are becoming important technologies for the country. Adoption of AMOLED displays for mobile application continues as more smartphone manufacturers are using this pure component. On the supply side, we continue to partner with more panel producers that are developing this technology. As competition increases, we will likely see reduction in panel prices, which should accelerate adoption rates increasing the total available market, as more smartphone makers shift from LCD.
In addition, other applications should also become more widely adopted such as laptop displays, providing additional growth drivers. We are the clear technology leader in this space, have supplied photomask at each and every one of the AMOLED panel producers. Without a doubt, we should continue to grow as this market accelerates.
Introduction of G10.5+ is already having a noticeable impact on the ultra large-screen TV panel market. And today, there is just one fab in China operating with the technology. We anticipate five more will move to production in the next two years to three years. This will be a disruptive shift in the industry. So aligned with this inflection point, we have equipped our Hefei plant to produce G10.5+ mask. We believe that local production coupled with our long history of supplying high-end reticles to industry's leading panel producers, will provide us with a competitive advantage sufficient to attain market leadership.
Our investments in China to expand our geographic footprint with the addition of two new manufacturing facilities are going well. Both buildings are complete, and tools are currently being installed and ready for production. Our FPD factory is proceeding to our original plan. We have largely completed the recruitment of hiring of key personnel and we expect to ship our first revenue generating photomask by the end of this quarter. As a reminder, our primary focus is G10.5+ photomask for ultra large-screen TVs, but we will also have the ability to make AMOLED mask sets. In contrast to FPD, which is sold out, despite market headwinds, our IC business is being negatively impacted by the semiconductor industry downturn.
Furthermore, the majority of the Chinese business is logic, which as you heard earlier, is the most affected. As a result, we have delayed the ramp of our IC factory by one quarter, which is reflected in the actual CapEx spend of $107 million, which is approximately $70 million less than the guidance given in the last earnings call.
As a reminder, qualification cycles for our high-end IC are nine months to 12 months. And the reason for the delay is to ensure that we are beyond the current downturn, and ramping volume production into a strong market. This three-month delay does not indicate a deepening of our enthusiasm for the China IC mass market, but instead reflects our operating methodology of always doing our best to align investment training with business growth.
As we expected, 2019 is starting out with a number of challenges across our industry. However, we are performing well, and see a pathway to growing sequentially throughout the remainder of this year wherever our two new facilities in China are nearly ready for production, and we anticipate a strong FPD revenue ramp in the second half of 2019.
At this time, I will turn the call over to John to provide commentary on our performance and outlook. John?
John P. Jordan -- Senior Vice President & Chief Financial Officer
Thank you, Peter. Good morning, everyone. Revenue of $124.7 million in the first (ph) quarter, was a 1% improvement over the same quarter last year as high-end growth more than offset weakness in mainstream products. Sequentially, revenue declined 14%, reflecting our anticipated combination of seasonal softness after a record quarter, and in the face of macroeconomic headwinds there were also six fewer days in the first quarter than in the fourth quarter due to reduction of October 31 as the fiscal year end. High-end IC improved 4% year-over-year primarily due to increased market share in a weaker market. IC revenue overall decreased 14%, from the previous quarter with similar declines in both high-end and mainstream. The drop in mainstream was mostly in Asia, particularly, Taiwan and China where macro uncertainty impacted some customers' cadence of new product designs. Within high-end, we experienced declines in logic as new designs for advanced applications such as smartphones were down, and memory due to order timing from a large customer.
FPD high-end was up 14% compared with last year's first quarter, once again void by AMOLED. We have currently established ourselves among the leaders with this technology, and we have benefited from expansion in industry demand. AMOLED growth was somewhat offset by a decline in demand for G8.5 masks used for large-screen TVs and lower demand for LTPS LCD screens in mobile applications. Both are trends that we have long anticipated and why we have positioned our FPD portfolio to align with growing AMOLED and G10.5+ secular demand.
Gross margin was 20.9%, impacted by both the revenue level and China start-up costs. Operating expense was higher due to increased compensation expense, China start-up activity, and R&D expense for qualification work on several high-end products. As a result, operating margin was 6.5%. Below the operating line, we recorded an FX gain in other income, effective tax rate of 15% and minority interest that reflected lower pre-tax income from our majority owned JVs, resulting in net income attributable to Photronics shareholders of $5.3 million, or $0.08 per diluted share.
Operating activities resulted in a loss of -- in the use of cash this quarter primarily due to payment of VAT on tools delivered into China, which we expect to recover in the future, and timing of receivables payments. We do approximately $29 million on our loan agreements in China to fund the VAT payments. Under our agreements in China, we anticipate receiving reimbursement for interest expenses related to these local borrowings. Over time, we plan to repay these loans from operating cash flow generated in Xiamen. The remainder of our debt is a $57.5 million convertible issue with a conversion price of $10.37 that matures on April 1, if all holders of that instrument convert approximately 5.5 million shares would be issued. If the bonds are not on the money, so to speak, or the holders elect cash payment, we are well positioned to pay the balance with cash on hand.
Payments of $107 million in capital expenditures, primarily for China, reduced our cash balance to $232 million. During the first (ph) quarter, we repurchased 1.1 million shares of our common stock for $10.7 million. Since announcing our first share repurchase program last July, we have repurchased a total of 3.7 million shares, returning over $33.8 million to shareholders. With the impending maturity of the convertible issue, the share repurchase program was recently concluded.
Our CapEx target for 2019, is unchanged at $210 million. We anticipate spending the majority of the remaining balance during the second quarter as we complete tool installation and prepare for production in our two China facilities. Before I provide second quarter guidance, I will reiterate, a reminder that our visibility is always limited as our backlog is typically only one week 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, it can have a significant impact on our revenue and earnings for a quarter.
Given those caveats, we expect second quarter revenue to be in the range of $125 million to $135 million. Coming out a seasonally soft first quarter, we expect market dynamics to be stable to improving with potential macro headwinds and the seasonal impact of Chinese New Year. Based on this revenue expectation and our current operating model, we estimate earnings for the second quarter to be in the range of $0.03 per diluted share to $0.10 per diluted share, including approximately $0.05 per diluted share effect for China start-up expenses.
During the first quarter, we have performed in line with expectations in 2019. Looking forward, we remain optimistic that we can grow market share this year as customers release new designs. In addition, the ramping of production in China should provide additional support to achieve meaningful growth this year.
I will now turn the call over to the operator for your questions.
Questions and Answers:
Operator
Thank you. (Operator Instructions) Our first question comes from Tom Diffely with D.A. Davidson. Your line is now open.
Tom Diffely -- D.A. Davidson & Co. -- Analyst
Yes, good morning. First of all, I was wondering if there some way to quantify the impact you're seeing from the macro headwinds right now? I know it's tough this time of the year because of seasonality, but any way to figure out or to calculate on what the actual impact is?
Peter S. Kirlin -- Chief Executive Officer
Yeah, I think Thomas, as you said, are quite tough to quantify. We aren't seeing any impact first of all in the FPD business. We are gaining market share in a shrinking market. So there is no effect in FPD. I see typically, a downturn impacts our business to a level of between 5% and 10%, that's a typical number for our IC business in a downturn. So I think that's the best we can do. Yeah.
Tom Diffely -- D.A. Davidson & Co. -- Analyst
Okay. And you talked about the impact of the China start-up being $0.03 per quarter to $0.06 per quarter. Is that just the flat panel facility at this point or is that both facilities?
John P. Jordan -- Senior Vice President & Chief Financial Officer
That's both, Tom; both facilities, that's a combination.
Tom Diffely -- D.A. Davidson & Co. -- Analyst
And what was it in the reported quarter?
John P. Jordan -- Senior Vice President & Chief Financial Officer
I think we said $0.04 before the effects of our FX recording and $0.02 net.
Tom Diffely -- D.A. Davidson & Co. -- Analyst
Okay. So it sounds like you expect that to disappear or to be profitable in China by the end of the year. Does that just require a ramp on the flat panel side to get to that break-even?
John P. Jordan -- Senior Vice President & Chief Financial Officer
Essentially, that's what's in our plan. Both plants should be online by the end of the year and our budget shows that we should be profitable overall.
Tom Diffely -- D.A. Davidson & Co. -- Analyst
Okay. Great. And then, recently Applied Materials talked about how there has been a little bit of a slowdown in the equipment ordering of Gen10.5, but I assume your customers are already in place running product and so the impact of you should not be too dramatic?
Peter S. Kirlin -- Chief Executive Officer
Yeah so, we've been -- we started construction of our FPD facility last December and we're going to start (ph) this evenly possible and sometimes I think even faster than that, to bring that factory online by the end of March. And the reason for that is, if you look at the landscape later, BOE a year ago brought their first G10.5 factory online in Hefei. This April -- March-April timeframe, CSOT's first factory in Guangzhou will start its volume ramp. So that timing as you can see, is not for two, it is with where we've been driving on our factory to be online. And then BOE's second G10.5 factory (inaudible) first reticle set early summer. So we've worked very hard to positioning our factory in Hefei to take advantage of the second and third factories coming online; one, from the point of view of being there for the volume ramp; the other from the point of view being PoR. So the delays in our softening in the G10.5 equipment spend has basically been from -- with maybe with one exception, companies we would call or describe as second-tier players. The companies that we have contractual commitments with are the strong players, the winners, and it's -- to the best of our knowledge, they have impact of one bid on their timetables. So no, it doesn't affect our business plan because our business plan is based on the winners; was, is and remains based on the winners.
Tom Diffely -- D.A. Davidson & Co. -- Analyst
Okay. Great. Thanks. And then finally, when you look at AMOLED and the potential that's really ramping up over the next few years in China, yeah, it seems to be a big incremental opportunity for you. Do you have the capabilities or will you have capabilities to serve that out of the same Chinese facility you are doing 10.5 then or is that going to be served or would that be served out of Korea?
Peter S. Kirlin -- Chief Executive Officer
Yeah, it will be a -- it will be a mix and match. Right now, there is no one in the business that can make the quality reticles that we do out of our Korean site and we've been building FPD reticles there for 20 years, more than 20 years. And -- as you know historically, Samsung has been our partner, they remain the technology driver despite all the great progress by a number of Chinese manufacturers. So best technology generally is created by your toughest customer. So as long as our toughest customer is in Korea, our best reticles are going to be made there.
Tom Diffely -- D.A. Davidson & Co. -- Analyst
Okay. Thank you very much.
Operator
Thank you. And our next question comes from Patrick Ho with Stifel. Your line is now open.
Patrick Ho -- Stifel Nicolaus -- Analyst
Thank you very much. Peter, maybe as a follow-up to your prepared remarks regarding China and some of the macro headwinds you're seeing there, you noted that you're seeing it in their foundry logic segment. Are you seeing any on the memory side of things given that their ramp-up of memory, particularly in the NAND side, has been slow to transpire given some of the yield issues that they're working through?
Peter S. Kirlin -- Chief Executive Officer
Yeah, so as far as China goes, in our prepared remarks, I -- maybe I will turn it over to Chris to make one or two quick comments. First, one thing that surprised us in the quarter was, we more or less expected our memory business to move along as it was, but we had some orders pushed out. As I sit here, those orders have materialized. So right now, we're swimming in memory reticles. And our memory business today is really dominated by large multinational, large multinational manufacturers or foundry memory manufacturers in Taiwan is what dominates our memory business. We happen to be -- PoR is what we believe to be the most advanced, domestic NAND flash manufacturer in China, and of course, we have some memory business with some of the other players in China. But certainly the speed at which they move will be a governor on the rate of which our high-end memory business can grow in China. Chris, do you want to -- is there anything else you want to add to that, Chris?
Christopher J. Progler -- Chief Technology Officer & Strategic Planning
No, I mean just to say regarding macro headwinds and that sort of thing, I don't think that's been a big factor on the Chinese memory ramp. It's more related to just the challenges of getting those factories into mass production. So I think they continue to work on it. They're making progress. If anything, the current pricing climate in memory is forcing them to shrink a little bit faster to stay competitive and add more layers on the 3D NAND side. So we're seeing a little more aggressive pursuit of the technology among these Chinese memory foundries. But generally, I think it's just proven to be more challenging than many anticipated to get those fabs really in mass production. So we are seeing, I would say, kind of slow, steady engagement with that community and we do expect eventually the yield situation to rectify itself and to see the production ramp, but it's kind of independent of any macro problems or headwinds.
Patrick Ho -- Stifel Nicolaus -- Analyst
Great, that's helpful. Maybe for either Peter or John, in terms of the CapEx spend, given the expectations of a strong display ramp and that's an area where I believe you've got a lot of opportunity, how flexible are you in terms of your CapEx spend where if I -- China IC remained sluggish because their challenge is internally, how flexible are your CapEx in terms of, could you shift some of that only to display given the promising outlook you have in that segment?
Peter S. Kirlin -- Chief Executive Officer
Yeah. Patrick, as you know, because you've been around the Company a long time, one of the things that has most historical, I think they compete as a small company in an industry of large players, is we are very flexible and we do our very best to move to focus our investments where the opportunities lie. I think it would be overly pessimistic right now to think that we would pull back on our IC investment in China.
We see some -- on the logic side, some partners -- potential partners moving pretty aggressively and we want to be there to support them, to ensure that with the exception of SMIC, the China IC market remains merchant. That's also one of the reasons why we partnered with DNP. We walk into all the Chinese customers, particularly the foundry logic, and we tell them look, together Photronics and DNP is a $1 billion mask company. You're trying to compete with TSMC, so once you let us handle the photomask challenge, you can focus on the silicon because you've got big enough job in front of you, with that already.
So as I said, right now, FPD is sold out. We're going to bring capacity online into the sold-out business IBO (ph). Our IC business is not sold out, so we are trying to adjust our timing to be beyond the downturn, so that when the capacity comes online, it's coming online into a very strong market. So that is the only message we're trying to send and nothing more.
Now going back to FPD, your comment about the opportunity. Yeah, it's big and I expect although not sure that by the end of the year, the capacity we've installed in Hefei will be sold out. So that means, if we want to maximize our revenue growth, additional capacity will be needed. The good news is, Hefei will -- is now sitting at the point where the rest of our business sits and that is, we don't have to add a whole line, we don't have to add a coder, an etcher, a metrology tool. All we need to do is, add (inaudible) inspection. So the capital efficiency of incremental CapEx goes up, as far as revenue generation is concerned.
So yeah, we're actively right now evaluating what we need to do to maximize our growth, but also our financial returns at the same time. So we are in a very strong position. In AMOLED, we want to build on it, exploit it. We do have incremental capacity coming online, should address G10.5 and also our AMOLED market position. So we're feeling pretty good about what we've done, the timing of what we've done -- what we've done and maximizing our growth quarter-by-quarter by quarter-by-quarter as we go.
Patrick Ho -- Stifel Nicolaus -- Analyst
Great, that's helpful. And maybe as a final question from me, in terms of -- for John, in terms of OpEx management, given the ramp of the two China facilities as the year progresses, how do you look at your OpEx trends? How much that could go up as 2019 progresses? Thank you.
John P. Jordan -- Senior Vice President & Chief Financial Officer
For the first quarter Patrick, we're probably not going to be increasing a lot. We've got a pretty good head start on the resources that we need to put into both China plants. So it will be increasing somewhat, but I think we're at a pretty good run rate where we are.
Patrick Ho -- Stifel Nicolaus -- Analyst
Great. Thank you.
Operator
Thank you. And I am showing no further questions in the queue at this time. I'd like to turn the call back over to Peter Kirlin for any closing remarks.
Peter S. Kirlin -- Chief Executive Officer
So in closing, I thank each of you for your time and interest in Photronics. We're in a great position to continue growing this year as we bring production on our new China facilities. I look forward to updating you on our progress.
Operator
Ladies and gentlemen, this concludes the conference call for today. We thank you for your participation and ask that you please disconnect your line.
Duration: 35 minutes
Call participants:
R. Troy Dewar -- Vice President, Investor Relations
Peter S. Kirlin -- Chief Executive Officer
John P. Jordan -- Senior Vice President & Chief Financial Officer
Tom Diffely -- D.A. Davidson & Co. -- Analyst
Patrick Ho -- Stifel Nicolaus -- Analyst
Christopher J. Progler -- Chief Technology Officer & Strategic Planning
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