Photronics, Inc. — Q3 Fiscal 2017 Form 10-Q
Reporting period: Three and nine months ended July 30, 2017; comparative periods ended July 31, 2016. Amounts below are in millions of U.S. dollars, except per-share data.
Business context
Photronics manufactures photomasks used in integrated circuit (IC) and flat panel display (FPD) production. It operates in a high-fixed-cost, cyclical industry, with short order backlogs and significant customer concentration. The company said large customers can represent substantial portions of high-end IC and FPD sales.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $111.6 | $123.2 | $329.7 | $376.1 |
| Gross profit / margin | $21.7 / 19.5% | $31.5 / 25.5% | $64.9 / 19.7% | $98.2 / 26.1% |
| Operating income | $5.3 | $14.8 | $19.4 | $47.2 |
| Net income | $4.8 | $11.5 | $10.8 | $49.1 |
| Net income attributable to Photronics shareholders | $4.0 | $8.1 | $7.7 | $40.9 |
| Diluted EPS | $0.06 | $0.12 | $0.11 | $0.56 |
Revenue mix and margins: Q3 IC sales were $85.1 million, down 7.1%; FPD sales were $26.5 million, down 16.2%. For the first nine months, IC sales fell 10.0% and FPD sales fell 19.5%. Management attributed lower gross margins primarily to weaker high-end product sales and increased depreciation. Q3 SG&A was $11.6 million, up 4.3%; R&D was $4.8 million, down 12.0%. Nine-month R&D declined 27.6%, primarily reflecting reduced development activity for advanced reticles.
Cash flow and liquidity: Nine-month operating cash flow was $73.8 million, versus $91.4 million a year earlier. Investing used $44.5 million, including $38.8 million of PP&E purchases and $5.4 million for a business acquisition. Financing used $9.9 million, including $4.1 million of debt repayments and $8.3 million paid to a subsidiary’s noncontrolling shareholder. Cash increased to $340.6 million from $314.1 million at October 30, 2016. Working capital was $389.3 million.
Debt and capital resources: Borrowings totaled $63.3 million, including $57.3 million carrying value of 3.25% convertible notes due April 2019 and $6.0 million of capital lease obligations. The company had no credit-facility borrowings and $50 million available under its facility; it reported compliance with financial covenants. Cash held at foreign subsidiaries was $179.2 million. Capital equipment commitments were approximately $60 million.
Material changes versus prior periods
- Sales fell 9.4% in Q3 and 12.3% year to date. The Q3 decline was driven mainly by lower high-end IC and FPD sales; nine-month high-end IC and FPD sales declined by $34.7 million and $20.0 million, respectively.
- Gross margin contracted by 6.0 percentage points in Q3 and 6.4 points year to date, reflecting weaker high-end mix, lower utilization and increased depreciation in a high-fixed-cost business.
- Nine-month net income attributable to Photronics shareholders declined to $7.7 million from $40.9 million. The prior-year period included an $8.8 million investment-sale gain and other favorable tax items; these make the comparison less representative of recurring performance.
- Cash increased despite lower operating cash flow, with foreign-exchange effects contributing $7.0 million to the nine-month cash movement.
Outlook, risks and other notable items
- Management expected markets to improve for the balance of 2017 and into 2018, except high-end logic, whose recovery was not expected until 2018. High-end memory sales had risen sequentially for three quarters; management expected current levels to continue. It anticipated FPD volume growth as capacity is installed, while noting product mix could take another quarter or two to improve. No numerical earnings or revenue guidance was provided.
- Photronics and DNP planned a 50.01%-owned IC photomask joint venture in Xiamen, China, involving a stated $160 million investment; production was anticipated in early 2019, subject to approvals and closing conditions. Separately, an August 2017 agreement set out a minimum $160 million investment in an FPD facility in Hefei, with construction planned for late 2017 and production anticipated in early 2019. Both projects may use local borrowing and are expected to receive local incentives.
- Management said available resources should cover planned spending and working capital for the next 12 months, but cautioned that additional financing might not be available on favorable terms if cash needs exceed resources. Liquidity depends on sales, cash conversion and capital-spending timing.
- Key operating risks include industry cyclicality, customer concentration and order volatility, competition from customers’ captive mask operations, foreign-exchange movements, technology shifts, and the ability to utilize capacity and achieve yields and pricing. A 10% adverse currency move was estimated to produce a $10.9 million net unrealized pretax loss.
- The company reported ordinary-course claims not expected to have a material effect and no material change to previously disclosed risk factors. It was in compliance with credit covenants; the credit facility restricts cash dividends on Photronics, Inc. stock. Management reported effective disclosure controls and no material change in internal control during the quarter.
Important facts for investors to verify
- Whether high-end logic and FPD demand recover as management expected, and whether the improving high-end memory trend continues.
- Customer concentration, utilization and product mix, given their direct effects on revenue volatility and gross margins.
- Funding, regulatory approvals, construction progress and expected timing for both China projects, alongside the $60 million of existing equipment commitments.
- Availability of cash held overseas for domestic needs, potential repatriation taxes, and the company’s ability to finance planned investment without weakening liquidity.
- Convertible-note terms and dilution exposure: $57.3 million carrying value, due 2019, with a stated conversion price of $10.37 per share; the filing also identifies potentially dilutive shares excluded from EPS calculations.