Photronics, Inc. — Q2 FY2018 Form 10-Q
Reporting period: Three and six months ended April 29, 2018. Photronics manufactures photomasks for semiconductor integrated circuits (IC) and flat panel displays (FPD). Unless noted, financial amounts below are in U.S. dollars in millions.
Business context and financial performance
- Q2 revenue: $130.8, up 20.8% from $108.3 a year earlier and 5.9% sequentially. High-end IC revenue rose 82.7% year over year to $41.5; total IC revenue rose 23.7% to $102.3. FPD revenue rose 11.2% to $28.5.
- Six-month revenue: $254.2, up 16.5% year over year. High-end IC revenue increased 66.8%; total IC revenue increased 17.1%, while FPD revenue increased 14.7%.
- Profitability: Q2 gross profit was $32.8 versus $20.2; gross margin improved to 25.1% from 18.6%. Operating income was $15.4 versus $5.5, and operating margin was 11.8% versus 5.1%. Net income attributable to Photronics shareholders was $10.7 versus $1.8; diluted EPS was $0.15 versus $0.03.
- Six-month results: Gross profit was $60.5 versus $43.2; operating income was $27.2 versus $14.2. Net income attributable to Photronics shareholders was $16.6 versus $3.7; diluted EPS was $0.23 versus $0.05.
- Cash flow: For the six months, operating cash flow was $37.9, down from $46.9 a year earlier. Capital expenditures were $44.1 versus $14.2; investing cash outflow was $43.7. Cash and cash equivalents increased $13.2 to $321.2, including a $6.3 favorable foreign-exchange effect.
- Liquidity and debt: Working capital was $333.8, down from $367.3 at fiscal year-end, primarily because $57.5 of convertible notes was reclassified as current. Total borrowings were $59.3, including $57.4 of 3.25% convertible notes due April 2019 and $1.9 of capital lease obligations. The company had no credit-facility borrowings and $50 available under its facility; it reported compliance with its covenants.
Material changes and notable items
- Revenue growth was led by high-end IC, with management citing healthy foundry demand for logic and memory across Asia. Mainstream IC revenue was slightly lower sequentially; softer AMOLED demand weighed on high-end FPD, partly offset by LTPS LCD demand.
- Higher unit sales improved gross profit and margins. SG&A rose year over year, including costs related to China expansion; six-month R&D expense also increased.
- Q2 “interest income and other income (expense), net” was income of $3.9, versus expense of $3.1 a year earlier. Management attributed the improvement mainly to favorable foreign-exchange movements and $0.6 of asset-sale gains. YTD this line remained an expense of $0.8, but improved from $4.6 of expense.
- The six-month effective tax rate was 6.5%, compared with 29.3% a year earlier. This included $4.2 of nonrecurring U.S. and Taiwan tax-reform benefits in Q1. Certain Tax Cuts and Jobs Act calculations remained preliminary; the filing reported provisional net-zero impacts for the deferred-tax revaluation and estimated repatriation tax after offsets.
- Q2 comprehensive income attributable to Photronics shareholders was $2.3, down from $15.5 a year earlier, despite higher earnings, reflecting a $11.1 foreign-currency translation loss in the quarter. Six-month foreign-currency translation adjustments were positive $19.0.
Outlook, commitments, and risks
- Management expected favorable demand to potentially continue into Q3, with growth across most high-end markets. Annual preventive maintenance on high-end lithography tools could constrain revenue growth; a high-end FPD mask writer in Korea was expected to ramp in the second half.
- Two China facilities—an IC facility in Xiamen and an FPD facility in Hefei—were under construction, with production anticipated in the first half of 2019. The company reported approximately $176 of capital-expenditure commitments, nearly all related to China. It expected to fund spending with cash, operating cash flow, and, if needed, borrowing, and said resources should meet requirements for the next 12 months.
- The Xiamen IC operation is a joint venture with DNP; Photronics holds 50.01% and consolidates it as the primary beneficiary of a variable-interest entity. The company estimated its remaining funding commitment at approximately $68 over several years and disclosed a maximum exposure to loss of $11.4 at period-end. The agreement includes specified put and purchase rights that could expose Photronics to a loss.
- Key risks include cyclical and seasonal semiconductor/FPD demand, customer design activity and order timing, pricing and capacity utilization, foreign-exchange changes, execution and financing of China projects, and availability of additional financing. A 10% adverse currency movement was estimated to cause a $7.1 million unrealized pretax loss. The filing also added GDPR compliance risk.
- The company reported disclosure controls effective at a reasonable assurance level and no material change in internal control over financial reporting during the quarter. No quantified full-year earnings or revenue guidance was provided.
Important facts for investors to verify
- How the company plans to address the $57.5 million convertible-note maturity in April 2019, and the implications of potential conversion and dilution.
- The total cost, funding schedule, remaining commitments, and production ramp assumptions for both China facilities, including whether expected 2019 start dates remain achievable.
- Whether operating cash flow and available credit can support substantial planned capital spending while maintaining covenant compliance and liquidity.
- How much reported earnings improvement reflects sustainable operating growth versus foreign-exchange gains, asset-sale gains, and the nonrecurring tax benefit.
- Whether favorable high-end IC demand continues and whether FPD softness, tool maintenance, or industry cyclicality affects revenue and margins.