Photronics: Steady Improvement Ahead
Salomon Smith Barney
Friday, December 10, 1999
--SUMMARY:--Photronics--Semiconductor Equipment
Photronics reported an inline 4Q99, with EPS of $0.20 vs. our est.
of $0.19
(consensus). The $0.01 upside was due to a lower tax rate.
The high-end is continuing to ramp, with sales of 0.25 micron and
below
masks up 25% sequentially. High-end sales accounted for 21% of revenues
vs.
18% in 3Q99.
Leaving our estimate of $0.97 in FY00 unchanged.
We expect steady improvement ahead as high-end design releases are
beginning to accelerate. Maintain 1H (Buy, High Risk) and target
of $29.
--EARNINGS PER SHARE--------------------------------------------------------
FYE 1 Qtr 2 Qtr
3 Qtr 4 Qtr
Year
Actual 10/99 EPS $0.03A
$0.09A $0.14A $0.20A
$0.45A
Previous 10/00 EPS $0.14E
$0.21E $0.30E $0.32E
$0.97E
Current 10/00 EPS $0.14E
$0.21E $0.30E $0.32E
$0.97E
Previous 10/01 EPS $N/A
$N/A $N/A
$N/A $N/A
Current 10/01 EPS $N/A
$N/A $N/A
$N/A $N/A
Previous 10/02 EPS $N/A
$N/A $N/A
$N/A $N/A
Current 10/02 EPS $N/A
$N/A $N/A
$N/A $N/A
Footnotes:
--FUNDAMENTALS--------------------------------------------------------------
Current Rank........:1H Prior:No Change Price (12/8/99).....:$25.18
P/E Ratio 10/00.....:26.0x
Target Price..:$29.00 Prior:No Change
P/E Ratio 10/01.....:N/Ax
Proj.5yr EPS Grth...:20.0%
Return on Eqty 99...:11.4%
Book Value/Shr(99)..:7.02
LT Debt-to-Capital(a)34.2%
Dividend............:$N/A
Revenue (00)........:244500.00thous Yield...............:N/A%
Shares Outstanding..:28.6mil
Convertible.........:Yes
Mkt. Capitalization.:720.1mil
Hedge Clause(s).....:#
Comments............:(a) Data as of the most recently reported quarter.
Comments............:
--OPINION:------------------------------------------------------------------
Photronics reported 4Q99 results which were inline with expectations,
with EPS of $0.20 versus our estimate of $0.19 (consensus). The $0.01
in
upside was due to a lower tax rate in the fourth quarter as the company
overestimated its tax rate in the first three quarters of the year.
We
believe Photronics is well positioned to see steady sequential sales
increases over the course of next year. We remain optimistic on
Photronics' outlook for next year due to the following reasons: 1)
high-end design releases are beginning to accelerate as the Tier
2 and
Tier 3 semiconductor companies move to 0.25 micron and below linewidths.
2) pricing in the low and mid-end has stabilized as overcapacity
is being
absorbed by the strong pickup in semiconductor sales, and 3) capacity
utilization rates continue to improve, and 4) the company is well
positioned for the ramp in the high-end with an installed base of
5 Alta
3500's. We continue to believe the photomask sector is on a path
towards
a steady secular recovery and reiterate our 1H, Buy rating and price
target of $29 (3x our calendar 2000 sales per share estimate of $9.6).
We
believe the stock will trade towards our price target as the market
begins discounting the recovery over the next 3-6 months.
Inline 4Q99
Photronics reported 4Q99 EPS of $0.20, inline with our estimate of
$0.19
(consensus). The $0.01 was due to a lower than expected tax rate
as the
company underestimated the R&D and tax credits it would receive.
Sales
increased 7% sequentially to $63 million, inline with our estimate
of
$63.5 million. Of the 7% sequential sales increase, 60-65%
was due to
better pricing while the remaining 35-40% was attributable to higher
unit
volume. The company experienced improved sales trends as the quarter
progressed, with sequentially higher sales in each month. Sales in
all
regions improved steadily, with Europe reaching another sales record.
Gross margins improved 220 basis points sequentially as the sales
mix
shifted towards higher margin 0.25 micron and below masks and overhead
absorption improved. Capacity utilization improved to 77-78% from
around
75% in 3Q99. Operating expenses of 19.7% were almost identical to
our
estimate of 19.8%.
SSB Actual
Sales $63.5M $63M
Gross Margins 33.0% 33.2%
Operating Exp. 19.8% 19.7%
Operating Mgn. 13.2% 13.5%
EPS $0.19 $0.20
Continued Growth in Europe, Captive Divestitures in Japan Opens Up
Opportunities
Photronics continues to expand its efforts overseas. International
revenues accounted for 23% of revenues (same as in 3Q99), with sales
in
Europe reaching another record. Photronics has been helped in Europe
by
the success of the semiconductor companies in this region and is
continuing to grow its market share. Photronics' strategic
decision to
enter the European market with high-end capability is allowing the
company to gain market share as a second source supplier. From a
market
share of 15-18% currently, we expect the company to reach a mid 20%
market share in FY00. Japan is another region which has potential
for
appreciable growth. Following the trend of captive mask shops in
the US
and Europe, the Japanese semiconductor companies are increasingly
divesting their captive mask operations. Toshiba recently announced
that
it will set up a joint venture mask operation with Dai Nippon and
not too
long ago Hitachi sold its mask operations to Dai Nippon. We believe
the
move by captives in Japan to an outsourcing model will create
opportunities for Photronics to enter the Japanese market. However,
given
the traditional difficulty with cracking the Japanese market, it
may take
time. Japan currently accounts for 2-3% of revenues (Photronics supplies
US companies with operations in Japan). With 7 mask shops, Taiwan
is
still suffering from overcapacity in the low-end and given this less
than
favorable environment, Photronics is abstaining from entering this
market. We believe the overcapacity issues in Taiwan are likely to
linger
for some time until consolidation occurs.
High-End Ramp Is Encouraging
The continued steady ramp in the high-end is encouraging. High-end
mask
sales increased 25% sequentially and accounted for 21% of sales versus
18% in 3Q99. We believe that 0.25 micron and below masks will account
for
1/3 of sales in FY00 versus 16% in FY99. PSM/OPC masks accounted
for 10%
of business. Photronics plans to handle all of its PSM volume out
of
Texas and does not plan to install PSM capability on its 5 high-end
tools
until demand increases significantly. High-end design releases at
Tier 1
and Tier 2 semiconductor companies are accelerating and Tier 3
semiconductor companies are overcoming difficulties in the move to
0.25
micron and below linewidths. Photronics is seeing good activity with
0.18
micron and expects the Tier 1 companies will begin to releasing more
0.18
micron designs in January. These trends bode well for Photronics
given
that higher end masks carry higher ASPs and gross margins. However,
the
move to 0.18 micron is being driven primarily by DRAM/microprocessor
companies which are less mask sensitive than the ASIC industry. We
estimate that DRAM/microprocessor companies can get 10,000 to 20,000
wafers per mask set versus 1,000 to 2,000 wafers per mask set for
ASICs.
We believe that the transition to 0.18 micron by the
non-DRAM/microprocessor industry will not occur until March-June
2000.
Given that Photronics' customer base is dominated by logic/ASIC
companies, we believe the company will not see appreciable revenues
from
0.18 micron masks until late 2000 (we look for a ramp to 10% of sales
in
4Q00).
Improvement in Gross Margins Reflect High-end Ramp and Better Capacity
Utilization
Gross margins continue to improve with the increased sales volumes
and
mix shift toward high-end masks. In 4Q99, gross margins increased
220
basis points sequentially to 33.2% and were 20 basis points above
our
estimate of 33.0%. The stable pricing the low/mid-end and improved
capacity utilization also favorable affected gross margins. Capacity
utilization improved as the quarter progressed and averaged 77-78%
for
the quarter versus around 75% in 3Q99. We are forecasting gross margins
to improve from the low 30% range to the high 30% range in 3Q99/4Q99.
We
believe there could be upsides to our forecast if high-end mask sales
ramp faster than expected.
Operating Expenses Well Controlled
Photronics has done a superb job of managing operating expenses.
Operating expenses only increased 3% sequentially versus the 7% rise
in
sales. SG&A expenses increased 2% to $8.2 million (vs. our $8.4M
est.)
from $8.0 million due to increased payroll costs and infrastructure
investments. R&D expenses increased 5% to $4.3 million (vs. our
$4.1M
est) primarily due to costs associated with the Mask Center of
Competency, a joint effort with IBM. Photronics is obligated to fund
approximately $300K during each quarter. While Photronics is unlikely
to
see NGL mask revenues for at least 2 years, we believe the investment
is
a prudent one as it allows the company an early jump on future photomask
technologies. As a percentage of sales, operating expenses of 19.7%
were
10 basis points below our estimate of 19.8%, with SG&A expenses
at 13.0%
(vs. our estimate of 13.3%) and R&D at 6.8% (vs. our estimate
of 6.5%).
Cash Position Improves
Due to the improved financial results, Photronics was able to improve
its
cash position from just $8 million in 3Q99 to $16 million. Capital
expenditures amounted to $12 million during the quarter ($72 million
for
the entire year), with depreciation at $11 million. The company expects
capital expenditures to total $65-70 million in FY00 before the merger
with Align-Rite. Photronics ended the quarter with book value of
$8.68
and long-term debt of $117 million ($103 due to the convertible note
outstanding). Accounts receivable increased 11% to $41 million
with DSOs
increasing slightly to 59 days from 57 days. Inventories remained
essentially flat at $14 million.
Look For A Steady Ramp in Sales During FY00, Maintain Estimates.
Following a seasonally slow quarter in 1Q00, we believe Photronics
is
well positioned to report steady sequential sales increases. The
move to
finer geometries will necessitate new design releases, which will
allow
high-end mask sales to continue increasing as a proportion of total
sales. In addition, the strength of the semiconductor recovery is
allowing for overcapacity in the low-end to be absorbed, which alleviates
the pricing pressures in this segment of the market. While the slower
than expected ramp in the high-end and the overcapacity at the low-end
had previously constrained the company to reporting sales/earnings
at the
low-end of Street estimates, we believe the positive trends in both
the
high-end and the low-end should allow Photronics to comfortably meet
estimates going forward. While visibility is still low due to the
virtual
absence of backlog in the mask business, the strong sales trends
upstream
provide us with some comfort.
We are maintaining our estimates in FY00 for sales to increase 18%
year-over-year to $264 million, gross margins to improve 550 basis
points
to 35.6%, and operating expenses to decline 150 basis points to 19.3%
-
which leads to EPS of $0.97 (consensus - $0.98). Photronics
typically
experiences a sequential decline in sales during the January quarter
since design releases are slow during the end of the year. In 1Q98,
the
company recorded a 8% sequential decline in sales and in 1Q99, the
company had a 9% sequential decline in sales. For 1Q00, we are modeling
an 8% decline in sales to $58 million, consistent with the sales
declines
in the previous two years. However, we believe that the company could
report a smaller sequential decline this time around, on the order
of
4-5% (which implies sales of around $60 million) due to fewer shutdowns
(given the strength of semiconductor sales). Assuming the company
reported sales of $60 million, we believe EPS could be as high as
$0.15
(consensus). Following 1Q00, we are looking for quarterly sequential
sales increases of 12% in 2Q00 and 5% in both 3Q00 and 4Q00. The
timing
of the ramp in the high-end will determine whether we see any upsides
to
our sales/earnings estimate in FY00. Photronics is expected
to close the
Align-Rite merger in late January 2000. We will adjust our model
for the
combined company at that time.