Troy Dewar - Director, IR Peter Kirlin - CEO John Jordan - SVP & CFO Christopher Progler - VP, CTO & Strategic Planning.

Tom Diffely - D.A. Davidson Edwin Mok - Needham & Company Patrick Ho - Stifel Nicolas.

Ladies and gentlemen, thank you for standing by. Welcome to the Photronics Fourth Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time.

[Operator Instructions] As a reminder, this conference call is being recorded, Wednesday, November 29, 2017. I would now like to turn the conference over to Troy Dewar, Director of Investor Relations..

Thank you, Crystal. Good morning, everyone. Welcome to our review of Photronics 2017 fourth quarter financial results. Joining me this morning are Peter Kirlin, Chief Executive Officer; John Jordan, Senior Vice President and Chief Financial Officer; and Christopher Progler, Vice President, Chief Technology Officer and Strategic Planning.

The press releases we issued earlier this morning, along with the presentation materials which accompanies our remarks, are available on the Investor Relations section of our webpage. Comments made by any participant on today’s call may include forward-looking statements that include such words as anticipate, believe, estimate, expect, forecast.

These forward-looking statements are based upon a number of risks, uncertainties and other factors that are difficult to predict. Actual results may differ materially from those expressed or implied and we assume no obligation to update any forward-looking information.

During the course of our discussion, we will refer to certain non-GAAP financial metrics. These numbers are useful for analysts, investors and management to evaluate our ongoing performance. A reconciliation of these metrics to GAAP financial results is provided in our presentation materials.

Before turning the call to Peter, I’m pleased to announce that Photronics will hold an Investor Day on May 23, 2018 in New York City. More details will be coming soon and hope to see you all there. At this time, I’ll turn the call over to Peter..

Thank you, Troy, and good morning everyone. We performed well in the fourth quarter with revenue exceed our expectations, growing 8% sequentially and 13% year-over-year. The main driver of this improvement was high-end revenue growth in both IC and FPD.

High-end logic was strong and we benefited from solid Asian foundry demand especially at the 28-nanometer node, which is being used by more customers across an increasingly wide array of applications. High-end memory achieved incremental revenue growth for the fourth consecutive quarter as our customers continue to release new products.

Overall a very good quarter for high-end IC and it's extremely encouraging to see a significant uptick in both memory and logic within the same quarter. High-end FPD [mask] [ph] revenue also increased during the quarter primarily due to AMOLED sales in China.

Overall FPD revenue declined as many of our LCD customers continue to focus on producing current products and maximize profit, resulting in lower mass demand, temporarily shrinking the total available photomasks market.

Given the market dynamics we encountered during the quarter, I’m pleased with the revenue growth we achieved and even more pleased as we expanded operating margin to just over 10%, delivering incremental margins in excess of our targets.

We’ve historically done a tremendous job of controlling cost and employing our high operating leverage to grow profit more quickly than revenue and this quarter we delivered once again. We also generated cash from operations which is important as we ended the period of high capital investment.

CapEx in the fourth quarter was 53 million, our third highest quarterly CapEx ever. If we hit our CapEx projections in 2018, it will be the highest annual CapEx ever. These investments we funded primarily through the cash on our balance sheet.

It’s very reassuring to know that strong financial discipline over the last several years has given us the strength to make very substantial investment in our future growth without the need for significant leverage.

We exited 2017 with momentum and while we would likely experience some seasonal effects in the first quarter of 2018, we expect to have the wind at our backs throughout 2018 in both high-end IC and FPD markets. High-end IC should improve in 2018 as our largest IC customer is expected to increase market share at the 28-nanometer node.

And we see a clear line to growth in our 22-nanometer and 14-nanometer offerings. In FPD, it is acknowledged that large amounts of new AMOLED panel capacity will be entering the market in 2018, which we expect to flip the current supply demand balance to excess supply.

The last 20 plus years as a main supplier to the FPD market has thought us an excess supply guides demand for new masks as new products are released to absorb the capacity. As a well-established supplier to leading panel producers, we were all positioned to benefit from this inversion.

Going beyond that, we have a long standing reputation for being the technology leader in FPD, which is reflected in our high-end revenue split. To this end, we’ve recently placed an order for –[Indiscernible] for a P-800 mask writer, which will be delivered to Korea in the first half of 2018.

We will be the first company, merchant or [captive] [ph] to install this tool, which will enable us to make the most advanced photomasks in the display industry. This in turn should increase our market share with customers who are eager to manufacture the most advanced AMOLED display panels.

And it is no secret that the competition among the panel makers in this market is starting to heat up. Yet again, this investment demonstrates that Photronics is fully committed to being a technology leader in the FPD photomask market.

As we turn the calendar to the new fiscal year beyond executing on the core business, our strategic priority is to build out, equip and start to ramp our new China factory. This facility and this market is what we expect to fuel our growth in 2019 and beyond. We are very excited about the growth potential to China market for several reasons.

First, the China Government as part of their Made In 2025 target has prioritized developing semiconductor production in the country. In response, leading semi manufacturers from around the world are investing in China. In fact, nearly all of the incremental global foundry capacity planned over the next several years is in China.

These investments span technologies including high-end and mainstream, logic and memory, these products will be used in various end markets such as mobile, industrial, automotive and ubiquitous Internet of Things.

Based upon this growing manufacturing base and the inherent demand for photomasks it will create, we are building a new IC facility in Xiamen. The equipment we are installing in this facility as a mix of new plus redeployed tools, enabling us to produce high quality and low cost masks, delivering superior value to our customers.

Our goal here is straightforward and that is become a leading merchant IC photomask manufacturer in China.

Similarly, the Chinese display market is growing rapidly for both AMOLED and LCD, and the collective investments being made by the country's leading the display manufactures are unmatched by any of the established players in the existing global market.

The new FPD facility we’re building in Hefei will be the first to manufacture G10.5+ photomask in China. And we will be able to efficiently and effectively supply world-class masks to the growing number of domestic G10.5+ display factories. Coupled with our advanced capabilities in Korea and Taiwan, we aim to be the leading global FPD mask producer.

Many of our Chinese customers have ambitions to be not only a lowest cost producer for large format LCD TV displays, but also leaders in AMOLED displays for mobile phones and other advanced applications. For example, last month BOE announced the start of the nation's first G6 flexible AMOLED production line.

They also plan to ramp a second G6 line in 2019. It's apparent that the Chinese market is growing and we are positioning Photronics to benefit from this trend. Construction activity is underway at both of our China sites and both are on track to begin production in early 2019.

In Xiamen, we have met all the regulatory conditions necessary to close our JV with Dai Nippon. And we expect this to be finalized shortly. This will allow us to work together in mainly in China, expanding our three-year relationship while leveraging our combined strength to most effectively compete for the business.

In Hefei, we have just started the construction of our FPD factory and have placed orders for all long lead-time tools. We have significant contractual commitments from large customers and they are very anxious for us begin production.

Looking back, it’s fair to say that 2017 was a challenging year and we believe that we executed well by taking all that the market presented to us, while preserving integrity of our business model through relentless focus on cost reduction.

Beyond that, we kept our eyes on our long-term strategic objectives in China and have solidified the customer and local relationships required to facilitate our ramp. Sitting here today, more than 10% of our revenues originate in Mainland China.

In wrapping up 2017 I would like to thank all the Photronics employees for their commitment and hard work and wish all a wonderful holiday season. Looking forward to 2018, we cannot anticipate everything that will happen. However, we are cautiously optimistic that demand for our products will improve.

We see the potential for profitable growth by capitalizing on specific opportunities that we’ve identified in high-end logic memory and display markets. By doing so, we should see a positive impact on our margins and cash flow.

Notwithstanding these improvements, the team will be a year of significant investments for Photronics as we execute our China expansion plan. And as we indicated, these plans will consume some of our cash balance and present margin headwinds during the second half of the year as our new facility starts to incur start up cost.

As the management team we are unifying our commitment to improving ROIC by investing in high return projects that advanced in sustainable value for our stakeholders and believe these investments will achieve the desired outcome. I will now turn the call over to John for more details on our Q4 performance and Q1 outlook..

Thank you, Peter, and good morning everyone. I have been in Photronics as a CFO for nearly three months. I’ve been visiting and getting familiar with the operations and I’m pleased with the confidence, engagement and enthusiasm of the organization.

For those in sales and administration to those in development and production, and the leadership who have brought the business to this level of success. It's an exciting company and a challenging industry with a strategy for organic growth and opportunistic acquisitions, and I look forward to working with the team to deliver shareholder value.

I met many of our constituents over the past three months and look forward to meeting you all in the coming months. Fourth quarter operations improved considerably over the previous quarter. Fourth quarter revenue increased 8% sequentially and 13% compared with last year's Q4 resulting in large part from growth in high-end sales.

Integrated circuit, IC revenue was $26.1 million, 13% over the third quarter of 2017 and 17% over fourth quarter 2016 revenue. High-end IC revenue of $35.3 million improved 40 million percent over the 23.7 million in Q3 and 44% over Q4 2016 revenue of $24.6 million.

As Peter reported, the primary driver of the improvement was high-end logic principally due to growing demand for 28-nanometer from our Asian foundry customers, this production of 28-nanometer chips continues to grow and create photomasks demand.

High-end memory has continued to be positive for throughout 2017, we’ve seen four consecutive quarters of growth. We’re well positioned in the market but we anticipate seasonal headwinds in IC during Q1 before returning to sequential growth later in the year.

We don’t foresee any deterioration in underlying demand drivers and we expect to at least maintain market share. High-end FPD revenues $17.1 million also improved over both comparable periods based on AMOLED demand from China albeit less dramatically and not enough to overcome softness in the mainstream nodes.

Q4 high-end FPD increased 2% over Q3 2017 revenue of $16.8 million and 8% over Q4 2016 revenue of $15.9 million. Our customers are seeing strong display demand, which typically is an indicator of that new product introductions were soft, resulting in lower mass demand. We still expect to see high-end ramp up likely later in the year.

With our increased capacity and capability, we will be poised to benefit from this demand increase when it materializes. The increase revenue generated improved gross margin in the quarter.

As reflected in the supplement slides, Q4 gross margin was 21.9%, 240 basis points over the Q3 margin of 19.5% and 280 basis points over the Q4, 2016 gross margin of 19.1%.

Operating expenses of $14 million improved sequentially over the prior year quarter due primarily to reclassification of a $1 million of amortization expense from R&D to cost of goods sold, slightly lower SG&A expenses in the quarter, and the net effective regarding certain one-time accounting adjustment to adjust unneeded reserves and other expenses.

We expect the run rate of SG&A to increase nominally for existing operations during the year in line with inflation and there will be some additional ramping during the year as staffing is recruited for the China -- China operations. R&D should remain essentially flat.

Operating income of $12.4 million and operating margin of 10.3%, improved over the comparable margin of 4.7% in Q3, 2017 and 4.9% in Q4 2016, as a result of the superior gross margin and effective cost control which demonstrates the benefit to margin from incremental revenue.

The minority interest deduction of $5.1 million in Q4 reflected the substantial increase in revenue and healthy profitability at PDMC, our joint venture in Taiwan. Other income of $0.5 million is comprised primarily of FX gain. Interest income and expense were essentially a wash.

The tax provision in the quarter of $2.5 million represented an effective tax rate of 19% and the total year tax provision of $5.3 million was similar at 20%. Changes in valuation allowances foreign tax rate differentials, tax currents and tax holidays reduced the effective rate from the expected U.S. statutory rate.

Net income of $5.4 million in the quarter represented $0.08 per diluted share. Weighted average diluted shares outstanding were $69,218 million. We generated operating cash of $23 million in the quarter somewhat less than Q3, 2017 due to the increase in accounts receivable as revenue increase, still strong operating cash generation.

Our CapEx of $53 million during the quarter reflects spend for a portion of the China projects combined with other growth initiatives.

Operating cash generated for the year was $97 million leaving cash balance of $308 million at year-end after rounded numbers $92 million of CapEx, $5 million from an acquisition, $5 million of debt repayment and $8 million payments to our joint venture partner and non-controlling interest.

Foreign exchange and share base arrangements also contributed approximately $9 million to cash flow during the year. Net cash at year end was $246 million. Planned CapEx for fiscal 2018 is approximately $250 million which includes the tools and buildings for the China initiatives as well as maintenance CapEx and other growth initiatives.

Our cash balance, strong balance sheet and strong operating cash generation, provide adequate resources to fund the planned investments. The 2018 expenditures will be mostly backend loaded with about half of the total planned for Q4 2018, as we began receiving the tools and equipment for both China facilities.

We have previously discussed the importance of the China initiatives in this and other forums as a necessary component of our overall strategy of growth, growth of revenue and profit and improving value for our shareholders.

Expansion into China is essentially for Photronics to remain competitive at the leading edge of geographic expansion by our customer base and is a significant aspect of our organic growth initiative, integral to maintaining service levels with our existing customer base and expanding our outreach.

Continuing to spend on CapEx to improve unequipped the other Photronics locations will also help to increase revenues and profits at those facilities. The second component of our growth strategy is strategic opportunistic acquisitions preferably related or adjacent technologies.

We remain vigilant for opportunities and are continually exploring possibilities. The timing for acquisitions is impractical to try to predict and control, but we endeavor to maintain adequate joint powder in the form of cash and credit availability to be prepared to act on the right opportunities surfaces.

In addition to our overall growth strategy and preparedness to repay the outstanding $57.5 million convertible debt, if necessary when it matures, we are not unaware of cyclical nature of this industry and we have observed the fate of those who take undue risks.

In that context, we will also endeavor to retain adequate cash balances and credit worthiness to ensure the viability of Photronics in a downturn. The forecast CapEx of $250 million together with the convertible debt repayment will consume more than 300 million of cash over the next six quarters.

It will be in counted on us to meet our operating projects over this period since cash generated from operations will be the source of funds to meet the business operating needs.

Other uses of our funds including share repurchases or dividends will be reconsidered sometime in the medium to longer term, when we are confident that the growth initiatives are adequately funded in our ability to maintain viability in the event of cyclical adversity is preserved.

Before providing first quarter guidance, I will provide a reminder that our visibility is always limited as our backlog is typically only one to two weeks and demand for several of our products in inherently uneven and difficult to predict.

Additionally in the ASPs for high-end masks sets are high, and as this segment of the business grows relatively low number of high-end orders is going to have a significant impact on our revenue for the quarter. Given those caveats, we expect first quarter revenue to be between $110 million and $118 million.

Based on this revenue expectation and our current operating model, we estimate earnings for the fiscal 2018 first quarter to be in the range of $0.02 to $0.09 per diluted share.

As we enter the 2018 fiscal year, we are excited about the business prospects this year as well as the investments we’re making in China to position us for the next wave of growth in 2019 and beyond. We have a leading position in the global merchant photomask industry and plan to further expand our position as we invest.

Due to our financial discipline and low cost manufacturing approach, we are confident that this growth will be profitable and will provide increase in value to shareholders. I will now turn the call over to the operator for your questions..

Thank you. [Operator Instructions] Our first question comes from Tom Diffely from D.A. Davidson. Your line is open..

First, question on the income statement.

I guess I missed it, what was -- what drove the big increase in the non-controlling interest this quarter? Typically, it comes from the joint venture in Taiwan, but just curious if there's more to it?.

Yes, that’s exactly it, Tom. Joint venture did really well. Revenue increased in the order of $10 million over prior quarter and drove great profitabilities. So that minority interest share was over $5 million..

Okay.

And your guidance for the first fiscal quarter, do you have similar levels coming out of Taiwan then?.

Actually PDMC probably won’t be quite as strong in the first quarter as it was in fourth quarter..

Okay. And then the question on the new tools, the P-800, just curious what extra capabilities does that give you versus what you have today? And you mentioned that you’ll be the first in the marketplace to have one.

So, just wondering, what the other leading edge manufacturers are using today?.

Yes. Presently, the most advanced tool in the market is P80. And right now, the PVs are manufacturing photomasks that are creating displays with resolutions of maximum maybe 800 PPI. The P-800 along with internal development programs we have going on should easily allow AMOLED displays with resolutions to 1,200 PPI and more.

So, as our growing customer base is very enthusiastic about gaining market share from each other, we intend to equip them with the photomask that makes that battle possible..

Okay, great.

And then I guess similar with the P10, as of today there is no other merchant players out there with that capability?.

Not in China, there is only really -- the really only one merchant with that capability and they sit in Japan. And today, there is really only two customers globally for those displays, but by the time they were in production the customer base will have expanded by one or two more players.

And just to give you a point of reference, right now, a single mass set for G10.5+ exceeds $10 million, one mask set. So, there is a lot of revenue potential in that market segment..

Okay, doesn’t do much for smoothing out your business though..

No, that thought - obviously that concept is not lost on us, but there is nothing that we manufacture today that has double digit million price tags hung on it..

Okay.

Is there any way to quantify what’s the impact on the COGS will be from these new tools going in? And what the timing of that is?.

What I would say is we’ve decided to have an investor day to give a much clearer picture to anyone who is interested, what the investment and the opportunity looks like in China. So, what I’d suggest is that you put that on your calendar and you’ll hear more about that then probably even you want to hear if you come visit with us in May..

Okay, that sounds good. And one final question, you talked about the significant contractual demand for these new projects.

Although, you have ability to serve those out of your other facilities until these facilities up and running, the new Chinese facilities are up and running?.

A majority of the contractual commitments overwhelming majority are for G10.5+; what I can tell you is the contractual commitments we have guarantee profitable operations for multiple years after we start production..

Thank you. Our next question comes from Edwin Mok from Needham & Company. Your line is open..

So, first question on the quarter and I will look -- you mentioned high-end IC was stronger than expected that drove upside.

Curious how much of that was driven by 28-nanometer versus [kind of more linear] [ph] 20 or below? And how much was baked in 1Q guidance? And I think beyond that, can you give some color on that?.

About 60% of it was driven by 28, so a little more than half was driven by 28-nanometer logic. The remainder was driven by memory and you know smaller geometry on logic business. As far as you know Q1 goes, we always have seasonal softness in our IC business in our first quarter that kind of [Indiscernible]. So that’s baked into the guidance.

Also what we’ve seen, you’ve heard us discuss it time and time again, our 28-nanometer business has never quarter-to-quarter been smooth. It has always had the profile of the saw blade. So, we’re hopeful that doesn’t happen in the current quarter, but if you look back over the last at least 12 that’s the way it's been.

So that’s how we feel we have to guide..

Okay, great. That’s actually helpful color. And the second question I have on the China, two investments China. If I remember correctly I think previously when you guys first announced your IC JV, I think you were targeting this production in the second half ’18, and now you said early ’19.

I just want to make sure I understand if that was a pushed out or is it just due to the, call it, arrangement or the JV that delayed that? That’s the first part of the question. And then the second thing, the $250 million of CapEx.

It’s a little bigger than what I was modeling, I was just wondering if that was an increase from where you were before, and if so, what drove the increase?.

Yes, the answer to the first question, building a facility - a manufacturing facility in China, there is a very long list of regulatory hurdles that need to be jumped. So, as we have worked through that it’s taken a bit longer for us to clear some of those hurdles.

Having said that, you can see that what we learned from our experience, so our FPD operation is likely going to come on-line nearly coincidentally with our IC, we nearly half the time taken us to jump all of the -- all of the regulatory requirements, the second time around.

So, yes, it's a little bit longer than we had hoped, but we still believe well timed to the market. And we’ve taken lessons learned and applied them to the FPD project, and it’s sailing along quite nicely..

And then on the total CapEx number?.

Your question regarding CapEx, wasn't -- what wasn't in the prior guidance was the P-800, that announced..

I see. I see, okay. That's explained that..

Yes. In our 2017 guidance, our actual CapEx is a little bit soft. So, obviously some of the things we thought for 2017 were pushed out of in that. That's contemplated in that as well..

Okay, great. Last question I have on the margin side, I think Peter you mentioned that, as you ramp the facility obviously that might have some near-term margin headwind that could start to come in the second half of 2018.

Anyway you can quantify that, how much impact to us you expect to have on your margins?.

We may be able to quantify better getting towards the Investor Day in May, but at this point it’s difficult to forecast..

Okay, great. That’s all I have. Before I go just quickly, if Sean, you're listening, a quick shout out to you. I hope all is well. I was glad to work with you all these years. Thank you..

Thank you. [Operator Instructions] Our next question comes from Patrick Ho from Stifel Nicolas. Your line is open..

Thank you very much.

Maybe just a follow-up on the new mask riding tool on the display side that you have mentioned, is that focused primarily on China only? Or are there existing leading edge or high-end display customers that are also going to benefit from the increase in capacity that you have later on in 2018?.

That tool is really focused on ensuring that, if any customer globally wherever they reside, wants the best mask with the highest level of revolution, they come to us to buy it. So, it's not specific to anyone geography..

Great, that’s helpful. Maybe moving to the IC side, there is a lot more activity, there is a lot more chatter about next generation 7 nanometer particularly with one of your customers as they try and sign on next -- I guess customers for that node.

How do you see the activity as it is right now for potential 7 nanometers max for you in 2018 as a whole? Is that a note that you guys are focused on? Or are you seeing I guess a lot of qualification activity today that will lead to potential revenues in 2018?.

Hi, Patrick. Yes, this is Chris. I can try to answer that one. So on the IC side, as Peter mentioned, the bulk of the business uplift was 28-nanometer. We have quite a few late stage calls at 22, 14, some new ones there that are going to complete in ’17 or early ’18. So, we expect those two nodes will be more material in ’18.

As far as 7, we are engaged in qualifications there, both for optical and EUV as well. Although, I think to suggest that we would have material revenue at 7-nanometer and 18 is a little premature. Most of it is matching for captives and doing some initial work to get those processes set. I think 18 will be a little early though.

On the EUV side, we signed a joint development agreement with IBM recently to look at EUV for 7 and 5 nanometer applications. As you know, they have a pretty strong high performance computing roadmap. They don’t have the captives, so we’re collaborating with them to develop processes, and there should be some revenue connected to that program as well.

So, there is work is focus for us, but I don’t think we can say it will be a strong revenue driver in ’18, but 28, 14 and 22 should continue to pick up..

Thank you. And I’m showing no further questions from our phone line, so I will now like turn the conference back over to Peter Kirlin for any closing remarks..

Thank you for joining us this morning. We are having an important year, focused on growing our revenue, improved earnings and cash generation, and investing our long-term strategic growth initiatives.

Important that we perform well against these objectives, I’m optimistic about the direction of the Company and what we expect to accomplish over the next several years. I look forward to updating you as we move forward. Happy holidays to all..

Ladies and gentlemen that concludes the conference call for today. We thank you for your participation and ask that you please disconnect your line..