Photronics, Inc. — Q1 FY2017 Form 10-Q
Business context and period: Photronics manufactures photomasks used in semiconductor and flat-panel display (FPD) production. The filing covers the three months ended January 29, 2017, compared with the three months ended January 31, 2016. Management notes that first-quarter results can be affected by North American, European, and Asian holiday periods.
Financial performance
| Metric | Q1 FY2017 | Q1 FY2016 |
|---|---|---|
| Net sales | $109.8 million | $130.0 million |
| Gross margin | $23.0 million; 20.9% | $35.4 million; 27.3% |
| Operating income | $8.6 million | $17.5 million |
| Net income | $4.5 million | $23.5 million |
| Net income attributable to Photronics shareholders | $1.9 million; diluted EPS $0.03 | $21.0 million; diluted EPS $0.28 |
| Cash provided by operating activities | $31.5 million | $43.4 million |
| Capital expenditure payments | $9.6 million | $21.5 million |
Sales declined 15.5%. IC sales fell 13.4% to $86.4 million and FPD sales fell 22.4% to $23.4 million. High-end product revenue decreased to $42.7 million from $65.1 million. Gross margin contracted as demand for high-end IC and FPD photomasks weakened; management also highlighted the sensitivity of margins to factory utilization in its high-fixed-cost business.
Cash and cash equivalents were $329.7 million at January 29, 2017, versus $314.1 million at October 30, 2016. Working capital was $375.2 million. Total borrowings were approximately $66.0 million, comprising convertible notes and capital lease obligations. The company had no credit-facility borrowings and $50 million available under its facility. The filing reports compliance with its financial covenants. Balance-sheet amounts are compared with October 30, 2016, not the prior-year quarter.
Operating cash flow was lower year over year, primarily due to reduced net income. Investing activities used $15.4 million, including capital expenditures and a business acquisition; financing activities used $0.2 million. The company held $167.2 million of cash at foreign subsidiaries; repatriation could incur U.S. federal and local withholding taxes.
Material changes and unusual items
- SG&A decreased to $10.9 million from $12.2 million, and research and development expense decreased to $3.5 million from $5.7 million. Management attributed the R&D decline primarily to reduced advanced-node activity in the U.S. and Asia.
- Other income and expense shifted from net income of $9.7 million in the prior-year quarter to net expense of $2.1 million. The prior-year period included an $8.8 million gain on sale of an investment; the current quarter also had unfavorable foreign-currency transaction results.
- The company acquired manufacturing assets and intellectual property for approximately $5.7 million to expand large-area IC mask capability. It also received customer equipment valued at approximately $2.1 million in a noncash transaction.
- Capital equipment commitments were approximately $64 million at quarter-end. The company announced a planned $160 million investment, in cash and transferred capital over several years, for an IC R&D and manufacturing facility in Xiamen, China.
Outlook, risks, and contingencies
Management expects most revenue growth to come from Asia, particularly China. Construction of the Xiamen facility was expected to begin in 2017, with production anticipated in late 2018. Management believes available cash, operating cash generation, and the credit facility will be sufficient for planned expenditures and working capital needs for at least the next 12 months, while cautioning that financing may not be available on favorable terms if needs exceed available resources. The company continues to assess its manufacturing footprint; future actions could include facility closures, asset redeployments, impairments, workforce reductions, or additional facilities.
Key risks include cyclical and seasonal semiconductor and FPD markets, design activity and customer order timing, utilization and pricing, foreign-exchange movements, and the ability to finance and execute capital plans. A 10% adverse movement in specified foreign currencies was estimated to produce an $11.4 million net unrealized pretax loss. The company had $4.7 million of unrecognized tax benefits and said up to $1.4 million could be resolved within 12 months. It reported no material changes to previously disclosed risk factors and no material effect expected from ordinary-course claims. The Micron supply agreement was due to expire in May 2017 unless renewed by mutual agreement.
Important facts for investors to verify
- Whether IC and FPD demand, especially high-end mask demand and utilization, recover enough to improve sales and gross margin.
- Progress, total funding needs, and expected returns for the Xiamen facility and the $64 million of committed capital equipment expenditures.
- Renewal and terms of the Micron supply agreement, then due to expire in May 2017.
- Foreign-currency exposure, the location and potential tax cost of overseas cash, and continued compliance with credit-facility covenants.