Photronics, Inc. — Q3 FY2019 Form 10-Q
Reporting period: Third quarter and nine months ended July 28, 2019. Amounts are in U.S. dollars; financial figures below are in millions unless noted. Photronics manufactures photomasks for semiconductor and flat-panel display (FPD) production.
Financial performance
| Metric | Q3 FY2019 | Q3 FY2018 | Nine months FY2019 | Nine months FY2018 |
|---|---|---|---|---|
| Revenue | $138.1 | $136.4 | $394.4 | $390.6 |
| Gross profit / margin | $30.6 / 22.1% | $35.6 / 26.1% | $82.7 / 21.0% | $96.1 / 24.6% |
| Operating income | $13.4 | $20.4 | $30.6 | $47.6 |
| Net income attributable to Photronics shareholders | $6.3 | $13.0 | $20.1 | $29.6 |
| Diluted EPS | $0.10 | $0.18 | $0.30 | $0.41 |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $23.5 | $87.0 |
| Capital expenditures | Not provided for the quarter | Not provided for the quarter | $160.1 | $64.4 |
Q3 revenue rose 1.3% year over year and 5.0% sequentially. FPD revenue increased 30.1% year over year, led by AMOLED demand and ramping Chinese production; IC revenue declined 6.6%. For the nine months, FPD revenue increased 17.9%, while IC revenue fell 3.8%.
Despite modest revenue growth, Q3 gross margin fell to 22.1% from 26.1% and operating income declined 34% year over year. Management attributed much of the margin pressure to startup losses and depreciation at the two new China facilities. For the first nine months, net income attributable to Photronics shareholders declined about 32% year over year.
Balance sheet, debt and liquidity
- At July 28, 2019, cash and cash equivalents were $197.2 million, compared with $329.3 million at October 31, 2018; working capital was $261.2 million, down from $311.7 million.
- Total debt was $49.1 million, primarily borrowings by the consolidated China joint venture. The $57.5 million convertible notes were repaid at maturity in April 2019.
- The company had no borrowings under its $50 million revolving credit agreement and reported the full amount available. It was in compliance with the agreement’s financial covenants.
- Nine-month investing cash outflow was $142.5 million, including $160.1 million of property and equipment purchases, partly offset by $17.7 million of China government incentives. Cash declined $132.0 million including restricted cash and exchange effects.
- Outstanding capital expenditure commitments were approximately $100 million, nearly all related to China facilities. Management said cash, operating cash generation and available borrowing capacity should cover requirements for the next 12 months, while noting financing availability could be uncertain if needs exceed those sources.
Material changes, outlook and risks
- China FPD production began in Q2 FY2019 and the Xiamen IC joint venture began production in Q3. The facilities contributed to higher depreciation and operating costs before reaching scale; combined China facility losses increased by $6.3 million year over year in Q3 and totaled $9.8 million year to date.
- Management expected demand for AMOLED and large-format FPD masks to increase as panel facilities begin production and new designs are released. High-end IC demand was expected to be stable to improving, though growth could be delayed by U.S.–China trade conditions and Japan–Korea tensions. The filing gives no numerical earnings or revenue guidance.
- Management identified Asia, particularly China, as the expected source of much of future revenue growth. The business remains cyclical and depends on customer design activity, order timing, pricing, product mix and utilization; backlog is typically only weeks long.
- Foreign-exchange exposure increased: a hypothetical 10% adverse currency movement was estimated to cause a $34.0 million unrealized pretax loss, primarily reflecting renminbi, won and New Taiwan dollar exposures. Q3 currency results also reduced other income versus the prior quarter.
- The company consolidates the PDMCX joint venture as its primary beneficiary despite DNP’s 49.99% ownership. Photronics’ maximum exposure to loss was $42.5 million; specified circumstances allow either partner to put or purchase the other’s interest at net book value.
- In August 2019, the board authorized up to $100 million of common-stock repurchases; the authorization is discretionary. The prior $25 million program ended in February 2019.
- Adoption of the new revenue standard changed recognition to generally recognize revenue over time as photomasks are manufactured. Prior-year results were not restated, so comparisons are not fully on the same accounting basis. The filing quantifies the standard’s effect on current-period results.
- The Taiwan tax holiday expires at the end of calendar 2019. Management reported no material change in the risk factors from the prior annual report.
Important facts for investors to verify
- Whether China facilities can increase utilization and revenue enough to absorb startup losses, depreciation and the remaining investment needs.
- Cash conversion and funding capacity given nine-month operating cash flow of $23.5 million, capital spending of $160.1 million and approximately $100 million of outstanding capital commitments.
- How trade and regional tensions, customer design cycles, product mix and currency movements affect demand, margins and reported results.
- Terms and potential financial effects of PDMCX funding, debt, incentives and partner put rights, along with the status of the $100 million repurchase authorization.
- The revenue-standard accounting effects when comparing current results with prior periods, and the effect of the Taiwan tax holiday’s expiration.