Photronics, Inc. — FY2016 Form 10-K
Reporting period: Fiscal year ended October 30, 2016. The filing also reports fourth-quarter results; FY2016 and Q4 are distinguished below. Photronics manufactures photomasks used in semiconductor integrated circuits and flat-panel displays.
Financial performance
| Metric | FY2016 | FY2015 |
|---|---|---|
| Net sales | $483.5 million | $524.2 million |
| Gross profit / gross margin | $118.7 million / 24.6% | $143.1 million / 27.3% |
| Operating income / margin | $52.5 million / 10.9% | $72.2 million / 13.8% |
| Net income | $55.7 million | $56.9 million |
| Net income attributable to Photronics shareholders | $46.2 million | $44.6 million |
| Diluted EPS | $0.64 | $0.63 |
| Cash from operating activities | $122.1 million | $133.2 million |
| Capital expenditures | $50.1 million | $104.0 million |
Q4 FY2016: Sales were $107.4 million, gross profit $20.5 million, net income $6.6 million, net income attributable to Photronics shareholders $5.3 million, and diluted EPS $0.08. Q4 FY2015 sales were $141.7 million, gross profit $44.6 million, attributable net income $18.6 million, and diluted EPS $0.25.
Liquidity, debt and financial position
At October 30, 2016, cash and cash equivalents were $314.1 million, working capital was $360.3 million, total assets were $988.3 million, and Photronics shareholders’ equity was $710.4 million. Cash increased from $205.9 million a year earlier, substantially reflecting investment-sale proceeds. Cash from operations declined year over year.
Borrowings totaled $67.6 million, including $57.5 million of 3.25% convertible notes due April 2019 and $10.1 million of capital leases. The company had no borrowings under its $50 million revolving credit facility, with the full amount available; it was in compliance with its financial covenants. The credit facility restricts cash dividends. About $141.4 million of cash was held by foreign subsidiaries, and most foreign earnings were considered indefinitely reinvested.
Changes and notable items
- FY2016 sales fell 7.8%; IC photomask sales declined 13.4% to $364.6 million, while flat-panel display sales rose 15.0% to $118.9 million. Management attributed the IC decline to weaker demand for high-end and mainstream products; stronger high-end FPD demand supported display growth.
- Gross margin declined 2.7 percentage points, primarily due to lower high-end and mainstream IC sales in a high-fixed-cost business. SG&A fell 9.0%, while R&D was broadly flat at $21.7 million.
- FY2016 included $8.9 million of gains on investment sales, principally an $8.8 million gain on a minority investment sale. The company also sold its MP Mask interest to Micron for $93.1 million, with a $0.1 million gain, and began a one-year supply agreement under which Photronics would be Micron’s majority outsourced supplier, subject to mutually agreeable renewals. Photronics retained perpetual rights to use technology under its prior license.
- Photronics reported a 7.9% effective tax rate versus 18.8% in FY2015. The lower FY2016 rate reflected foreign tax-rate differences and tax benefits, including recognition of previously unrecognized deferred tax assets and reversal of certain tax expense. Reported earnings therefore include material tax effects.
- In August 2016, the company announced a planned $160 million investment over five years in an IC research, development and manufacturing facility in Xiamen, China. Construction was expected to begin in 2017 and production in late 2018. FY2017 capital expenditure payments were forecast at approximately $100 million; the company said cash, operating cash flow and available credit should meet its needs for the next 12 months.
Outlook, risks and contingencies
Management expected growth to be concentrated in Asia, particularly China, and anticipated continued movement of advanced IC designs into wafer fabrication. The company continues to assess its global manufacturing footprint and cost reductions; future closures, asset redeployments, impairments, workforce reductions or added capacity remain possible. The filing gives no numerical revenue or earnings guidance.
Key risks include cyclical and design-driven semiconductor and display demand, pricing pressure, underutilized capacity, technology and yield requirements, and dependence on a small number of customers. Two customers represented 36% of FY2016 sales, and the five largest represented 50%; no significant long-term purchase commitments protect those sales. Other material risks include international and currency exposure, reliance on limited suppliers, substantial capital needs and debt covenants, and execution, regulatory, IP-protection and currency risks related to the China project. A 10% adverse move in specified foreign currencies was estimated to produce a $9.1 million unrealized pretax loss. Ordinary-course claims were not expected by management to have a material effect. The independent auditor gave an unqualified opinion and reported effective internal control over financial reporting.
Investor verification priorities
- Assess the source and sustainability of FY2016 shareholder earnings, including the $8.9 million investment-sale gains and tax benefits, against the weaker sales, gross profit and operating income.
- Track IC demand, high-end mask mix, utilization and margin recovery, while comparing FPD growth with the decline in consolidated sales.
- Verify Micron supply-agreement renewals, volumes and economics after the sale of MP Mask.
- Monitor the China project’s total funding, incentives, construction schedule, customer support, local financing and foreign-exchange exposure against the $160 million plan and FY2017 capex forecast.
- Review customer concentration, cash availability and repatriation constraints, debt and covenant headroom, and the $60 million of purchase commitments, including $51 million for capital expenditures.