Photronics, Inc. — Q3 FY2016 Form 10-Q
Reporting period: Three and nine months ended July 31, 2016; comparisons are with periods ended August 2, 2015. Amounts below are in U.S. dollars; financial statement amounts are converted to millions unless otherwise stated.
Business context
Photronics manufactures photomasks used in semiconductor integrated circuits (ICs) and flat panel displays (FPDs). Its demand depends substantially on customer design activity, technology transitions and manufacturing utilization, and the business is seasonal and cyclical.
Financial performance
| Metric | Q3 FY2016 | Q3 FY2015 | Nine months FY2016 | Nine months FY2015 |
|---|---|---|---|---|
| Net sales | $123.2 | $131.7 | $376.1 | $382.5 |
| Gross margin | $31.5; 25.5% | $37.2; 28.3% | $98.2; 26.1% | $98.5; 25.8% |
| Operating income | $14.8 | $18.6 | $47.2 | $45.0 |
| Net income | $11.5 | $15.4 | $49.1 | $34.7 |
| Net income attributable to Photronics shareholders | $8.1 | $12.1 | $40.9 | $26.0 |
| Diluted earnings per share | $0.12 | $0.17 | $0.56 | $0.37 |
Revenue mix: Q3 IC sales fell 11.9% to $91.7 million, while FPD sales rose 13.9% to $31.5 million. Nine-month IC sales declined 8.7% to $282.3 million; FPD sales increased 28.1% to $93.8 million. Q3 sales were down 6.4% overall, primarily due to weaker demand for high-end and mainstream IC photomasks, partly offset by FPD demand. High-end product revenue declined in Q3 to $53.3 million from $57.0 million, but rose for the nine-month period to $176.5 million from $165.4 million.
Q3 gross margin contracted, which management attributed primarily to lower IC demand. Nine-month gross margin improved slightly, which management attributed to manufacturing efficiencies and cost reductions. SG&A and R&D expenses declined year over year in Q3; management cited reduced costs for SG&A and lower advanced-technology development activity in Asia for R&D.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $91.4 million, compared with $91.8 million a year earlier. Investing activities provided $57.6 million, including $101.9 million of investment-sale proceeds, partly offset by $44.8 million of property and equipment purchases. Financing activities used $65.0 million, including $56.3 million of debt repayments and an $11.9 million subsidiary dividend to noncontrolling interests.
- Cash and equivalents were $291.7 million at July 31, 2016, up from $205.9 million at November 1, 2015. Working capital was $344.4 million, versus $171.4 million. Cash held by foreign subsidiaries was $115.9 million; repatriation could result in additional U.S. federal and local withholding taxes.
- Total borrowings were $68.9 million, compared with $132.6 million at November 1, 2015. The balance included $57.5 million of 3.25% convertible notes due in April 2019 and capital lease obligations. In April, $57.5 million of notes matured: Photronics repaid $50.1 million and issued approximately 0.7 million shares for notes converted to common stock.
- No borrowings were outstanding under the $50 million credit facility, which had $50 million available and expires in December 2018. The company reported compliance with its financial covenants. The facility restricts cash dividends.
- Capital expenditure commitments were approximately $51 million. Management said available cash, operating cash flow and credit-facility capacity should fund planned expenditures and anticipated working-capital needs for at least the next 12 months, while noting financing availability and cash needs depend on market conditions and spending.
Material changes and unusual items
- Nine-month earnings included $8.9 million of gains on investment sales: approximately $8.8 million from a minority investment sale in January and a $0.2 million gain from the May sale of Photronics’ 49.99% interest in the MP Mask joint venture to Micron for $93.1 million. The sale proceeds contributed to higher cash and lower debt.
- Photronics’ Q3 net income attributable to shareholders fell despite positive reported earnings; nine-month shareholder earnings rose materially, with investment gains and tax items contributing. The nine-month effective tax rate was 11.1%, versus 18.3% in the prior-year period. Items included recognition of previously unrecognized deferred tax assets and a $2.4 million reversal of a previously recorded foreign undistributed-earnings tax liability, partly offset by $0.7 million of withholding tax.
- The Micron supply agreement that began with the MP Mask sale makes Photronics Micron’s majority outsourced photomask supplier. Its initial term is one year, subject to mutually agreeable renewal; Photronics retains perpetual rights to use the technology under the prior license.
- In August 2016, after quarter-end, Photronics announced a planned Xiamen, China IC manufacturing and R&D facility. The company expects to invest $160 million over five years; construction is planned to begin in 2017 and production is estimated to start in late 2018. Funding may include cash, transferred equipment and possibly local financing. An existing customer supports the project.
Outlook, commentary and risks
Management expects most revenue growth to continue coming from Asia and anticipates additional North American growth associated with advanced technology available under the Micron license. The filing gives no numerical revenue or earnings guidance. Management noted that photomask demand is driven more by design activity than by end-product sales, and that short order lead times leave limited backlog—typically one to two weeks for IC masks and two to three weeks for FPD masks.
Key risks include semiconductor and display industry cyclicality, customer demand and utilization, pricing and product mix, technology changes, foreign-exchange movements and the ability to obtain financing. The China project adds risks involving permits, intellectual-property protection, local suppliers and labor, fund repatriation and currency exposure; failure to achieve a return could materially affect results. A 10% adverse movement in specified foreign currencies was estimated to produce a $7.5 million net unrealized pretax loss. The company said ordinary-course claims were not expected to materially affect its financial statements. It also noted possible future facility closures, asset redeployments, impairments, workforce reductions or facility additions as it reassesses its global manufacturing strategy.
Important facts for investors to verify
- Whether IC demand and Q3 gross-margin pressure recover, and whether FPD growth can offset IC weakness.
- How much of nine-month earnings reflects recurring operations versus investment gains and tax benefits.
- The funding plan, incentives, customer support, total commitments and execution milestones for the $160 million Xiamen project.
- Whether the Micron supply agreement is renewed after its initial one-year term and what economic terms apply.
- Capital spending, debt repayment needs, credit-facility covenant headroom and the availability of cash held overseas.