Photronics, Inc. — Q2 FY2016 Form 10-Q
Business context and reporting period. The company manufactures photomasks used in semiconductor and flat-panel display (FPD) production. This filing covers the quarter and six months ended May 1, 2016; comparisons are to the periods ended May 3, 2015. Amounts below are in millions of dollars unless noted.
Key financial metrics
| Metric | Q2 FY2016 | Q2 FY2015 | Six months FY2016 | Six months FY2015 |
|---|---|---|---|---|
| Net sales | $122.9 | $127.3 | $252.9 | $250.8 |
| Gross margin | 25.5% | 26.0% | 26.4% | 24.4% |
| Operating income | $14.8 | $14.9 | $32.4 | $26.4 |
| Net income attributable to Photronics shareholders | $11.9 | $10.1 | $32.9 | $13.9 |
| Diluted EPS | $0.16 | $0.14 | $0.44 | $0.21 |
- Revenue mix: Q2 IC sales declined 12.5% to $90.9 million, while FPD sales increased 36.4% to $32.0 million. For the six months, IC sales fell 7.1% to $190.6 million and FPD sales rose 36.7% to $62.3 million.
- Cash flow, six months: Operating cash flow was $65.1 million, versus $57.9 million. Investing activities used $26.0 million, including $34.9 million of property and equipment purchases and $8.8 million of investment-sale proceeds. Financing activities used $51.9 million, principally for debt repayment.
- Liquidity and debt at May 1: Cash was $194.0 million; working capital was $233.1 million. Total borrowings were $70.2 million, including $57.5 million of 3.25% convertible notes due 2019 and $12.7 million of capital lease obligations. The $50 million credit facility was undrawn and fully available; the company reported compliance with its covenants.
- Capital expenditure commitments were approximately $59 million. Cash held by foreign subsidiaries was $111.3 million.
Material changes and unusual items
- Q2 sales decreased 3.4%, primarily from lower high-end IC demand and Asian seasonality; increased advanced-display demand supported FPD growth. High-end product revenue rose to $58.1 million in Q2 and $123.2 million for the six-month period.
- Q2 gross margin declined to 25.5%, which management attributed primarily to lower IC demand. Six-month margin improved to 26.4%, reflecting higher high-end revenue. Lower compensation and selling expenses reduced SG&A.
- Six-month results included an $8.8 million gain from the sale of a minority investment in a foreign entity. Q2 included a $2.4 million tax benefit from reversal of a previously recorded foreign undistributed-earnings tax liability; a separate $0.7 million withholding tax was incurred on a subsidiary share redemption.
- In April, $57.5 million of notes matured: $50.1 million was repaid in cash and approximately 0.7 million shares were issued to converting noteholders.
- After quarter-end, on May 5, Photronics sold its MP Mask joint-venture investment to Micron for $93.1 million. A one-year supply agreement also began, making Photronics Micron’s majority outsourced supplier of photomasks and related services, subject to mutually agreeable renewal. Photronics retains perpetual rights to use the licensed technology.
Outlook, risks and contingencies
- No numerical earnings or revenue guidance was provided. Management expects most revenue growth to continue coming from Asia, with additional North American growth anticipated from advanced technology available under the Micron technology license.
- Management said available cash, operating cash generation and the credit facility should fund operations and planned needs for at least the next 12 months, but noted financing might not be available on favorable terms if requirements exceed available resources. Results and liquidity are sensitive to sales, utilization, working-capital timing and capital spending in a high-fixed-cost business.
- Demand depends on photomask design activity and technology transitions, not simply semiconductor or display unit sales. Seasonality, industry cycles, pricing, competition, currency movements and customer demand may affect results. A 10% adverse move in key foreign currencies was estimated to produce an $8.3 million unrealized pretax loss.
- The company had no material changes to the risk factors in its prior annual report. It reported ordinary-course claims that it did not expect to materially affect the financial statements. Its MP Mask investment was previously its stated maximum exposure to loss; that investment was sold after quarter-end. The filing also describes possible future capital contributions to PDMC under its operating agreement.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How recurring operating performance compares with reported six-month earnings, which include the $8.8 million investment-sale gain and significant tax items.
- Whether Micron’s one-year supply agreement is renewed and what the sale of MP Mask means for future supply costs, capacity and customer concentration.
- Execution of the $59 million capital expenditure commitments and the company’s ability to maintain cash generation, liquidity and credit-facility covenant compliance.
- Whether FPD growth can offset weaker IC demand and sustain margins amid industry cyclicality, seasonality and foreign-exchange exposure.