Photronics, Inc. — Q2 FY2015 Form 10-Q
Reporting period: Three and six months ended May 3, 2015. Amounts are in millions of U.S. dollars except per-share data. Photronics manufactures photomasks for semiconductor and flat-panel display (FPD) applications. Results include Photronics DNP Mask Corporation (PDMC), consolidated since its formation in April 2014; Photronics owns 50.01% and DNP owns 49.99%.
Financial results
| Metric | Q2 FY2015 | Q2 FY2014 | Six months FY2015 | Six months FY2014 |
|---|---|---|---|---|
| Net sales | $127.3 | $104.9 | $250.8 | $206.4 |
| Gross margin | 26.0% | 21.2% | 24.4% | 21.8% |
| Operating income | $14.9 | $2.8 | $26.4 | $8.5 |
| Net income | $12.2 | $16.0 | $19.3 | $18.0 |
| Net income attributable to Photronics shareholders | $10.1 | $15.5 | $13.9 | $17.5 |
| Diluted EPS | $0.14 | $0.22 | $0.21 | $0.27 |
Revenue mix and drivers: Q2 IC sales rose 35.6% to $103.8; FPD sales fell 17.1% to $23.5. Management attributed overall quarterly growth primarily to higher-end IC sales in Taiwan, partly offset by lower high-end FPD sales. Q2 high-end product revenue increased to $56.6 from $37.8. For the first six months, IC sales increased $52.5, principally associated with the DPTT acquisition; high-end revenue rose to $108.4 from $70.0.
Margins and earnings: Management attributed improved gross margin to higher sales, including high-end products, and lower variable costs, principally materials, in a high-fixed-cost business. SG&A and R&D were lower year over year; SG&A comparisons also benefited from $2.0 of prior-year Q2 acquisition costs. Q2 net income attributable to shareholders declined despite higher operating income, reflecting the prior-year $16.4 acquisition gain and a larger share of earnings attributable to noncontrolling interests. The six-month comparison likewise includes that prior-year gain. Effective tax rates were 9.3% for Q2 and 18.5% year to date; the year-over-year reduction primarily reflected a $1.5 deferred-tax-asset valuation allowance release in a foreign jurisdiction.
Cash flow, balance sheet and liquidity
- Six-month cash flows: Operating cash flow was $57.9, versus $39.9 a year earlier. Investing cash outflow was $68.2, primarily for capital expenditures; reported property, plant and equipment purchases were $67.9. Financing cash outflow was $3.6, mainly debt repayments. Cash declined $16.9 to $176.1.
- Liquidity: Working capital was $151.4, down from $197.4 at November 2, 2014, primarily due to planned capital equipment purchases. Cash included $93.3 held by foreign subsidiaries; repatriation could incur U.S. and local withholding taxes.
- Debt: Total borrowings were $137.4, including $57.5 of 3.25% convertible notes due in 2016, $57.5 due in 2019, and capital leases. The company exchanged $57.5 of 2016 notes for notes due in 2019 and intends to repay $50 of remaining 2016 notes using its credit facility. No credit-facility borrowings were outstanding; $50 was available under the $50 facility, expandable to $75. The company reported compliance with its financial covenants.
- Investment and commitments: Capital expenditure commitments were approximately $6. Management said available resources should cover planned expenditures and anticipated working-capital needs for the next 12 months, while cautioning that financing may not be available on favorable terms if needs exceed resources.
Material changes, outlook and risks
- Photronics announced that the MP Mask joint venture with Micron will not be renewed after May 5, 2016. Micron is to purchase Photronics’ interest based on its ownership share of net book value, approximately $93 as of March 5, 2015; management does not expect a significant gain or loss. A new supply agreement starting May 6, 2016 makes Photronics Micron’s majority outsource supplier for an initial one-year term, subject to mutually agreeable renewals. A related technology license began in March 2015.
- Management expects most revenue growth to continue coming from Asia, with additional North American growth anticipated from technology available under the Micron license. No numerical earnings or revenue guidance was provided.
- Risks include semiconductor and FPD industry cyclicality and seasonality, short order visibility, customer design activity and product mix, utilization and pricing, foreign exchange, and the timing and execution of capital investment. A 10% adverse currency move across primary exposures was estimated to produce a $3.6 pretax unrealized loss. Management noted that liquidity depends on sales, cash conversion and capital spending, and that future facility closures, asset redeployments, impairments, workforce reductions or added capacity remain possible.
- The company reported ordinary-course claims that it does not expect to have a material financial effect. Unrecognized tax benefits were $5.3; the company did not expect them to change significantly in the next 12 months. It may be asked to contribute additional capital to MP Mask or PDMC under their agreements.
Key facts for investors to verify
- How much of sales growth and improved utilization is attributable to acquired PDMC operations versus underlying demand, and whether the high-end IC trend continues.
- Whether FPD sales weakness persists and what customer demand, pricing and utilization imply for gross margins.
- The cash and funding impact of planned capital spending, the $50 million 2016 note repayment plan, and the availability of credit under covenant requirements.
- The final terms and value realized when Photronics exits MP Mask, and the economics and renewal prospects of the Micron supply and technology agreements.
- Whether foreign cash can be deployed efficiently, and the potential impact of currency movements, tax positions and any requested joint-venture contributions.