Ladies and gentlemen, thank you for standing by. Welcome to Photronics First Quarter Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, February 24, 2016. I would now like to turn the conference over to Troy Dewar.

Thank you, Chelsea. Good morning, everyone. Welcome to our review of Photronics' 2016 first quarter financial results. Joining this morning are Dr. Peter Kirlin, Chief Executive Officer; Sean T. Smith, Senior Vice President and Chief Financial Officer; and Dr. Christopher Progler, Vice President, Chief Technology Officer and Strategic Planning. The press release we issued this morning along with the presentation material which accompanies our remarks are available on the Investor Relations section of our web page. Comments made by any participants on today's call may include forward-looking statements that include such words as anticipate, believe, estimate, expect, forecast, may, will, should or the negative thereto and similar expressions within the meaning of U.S. federal securities laws. Forward-looking [ph] 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. More complete disclosure regarding these forward-looking statements can be found at the bottom of our press release. Photronics assumes no obligation to update any forward-looking information. Finally, 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. The reconciliation of these metrics to GAAP financial results is provided in our presentation materials. At this time, I'll turn the call over to Peter.

Thank you, Troy, and good morning, everyone. The financial results we reported earlier today reflect a combination of factors, some good and some less good, which on the whole contributed directly to first quarter sales, significantly higher income in the same period last year and strong cash flow providing additional financial strength and flexibility to fund our growth plan. On the positive side, demand for high-end FPD and memory photomask continued along the growth trajectory we saw last year. The display customers in Korea continued to release new products, featuring advanced LCD and OLED displays. And memory customers continued to transition to 20-nanometer DRAM. These 2 market sectors have been strong for us over the last several quarters, and the market and technology leadership position we built has enabled us to enjoy profitable growth from these 2 trends. The better news is that we anticipate both of these markets to remain strong for us with memory ramping 3D NAND just as the DRAM activity tapers later this year and more product innovation pushing demand for advanced FPD masks. On a not so positive side, mainstream IC saw a softer-than-normal seasonal slowdown in U.S. and Europe. The high-end logic was soft as we experienced reduced demand from some of our large Asian foundry customers. We believe that the high level of macroeconomic uncertainty caused our customers to grow more conservative, effectively dampening demand. Beyond that at the high end, it is more and more apparent that [indiscernible] are increasingly more complex and difficult to produce. When this happens, new design launches can be delayed, meaning the demand for photomask can be pushed out. Given the high average selling price of these advanced masks set, pushing out even a few orders has a significant negative impact on our results. Given the challenge…

Thanks, Peter, and good morning, everyone. First quarter sales increased 5% year-over-year and was our highest first quarter ever as an increase in high-end sales more than offset lower mainstream shipments. Again, sequentially, sales were down 8%, slightly more than typical seasonal trends with lower sales in high-end foundry logic, principally in Asia, and to a lesser extent, lower U.S. and European-based mainstream sales. Breaking Q1 sales out geographically, 66% of total sales were from Asia, 28% from North America and 6% from Europe. IC sales were down 2% compared with last year and 11% sequentially. We realized the benefit of product diversity as the impact of soft logic demand was partially mitigated by continued strength in memory. High-end IC sales were $41.2 million, a sequential decline of $8.7 million, principally in Asia. The transition to 20-nanometer DRAM is still ongoing, driving strong global demand for high-end memory masks. On the high-end logic side, our customers are in the process of ramping 28 and 14 nanometers. And as is typical with any new product introduction, demand has been lumpy over the last several quarters. In mainstream, greater-than-normal seasonal softness in the U.S. and Europe and lower foundry demand in Asia led to year-over-year and quarter-over-quarter decreases. While we anticipate demand for high-end memory to remain strong and for mainstream to rebound from the slow seasonal trends in the U.S. and Europe, high-end logic demand will likely not recover until the second half of 2016, and we anticipate potential headwinds in Asia due to the Chinese New Year. Sales of FPD photomask were flat compared with a very strong fourth quarter and up 37% over last year on continued strength in the high-end, which increased 7% sequentially. Demand for advanced LCD and OLED displays is extremely strong, and we've seen an…

[Operator Instructions] And our first question comes from the line of William Stein with SunTrust.

Guys, you've had some tremendous earnings growth in the last few quarters. If your April guidance winds up playing out to the midpoint, though, you wind up with the first negative year-over-year earnings growth quarter in a while. I'm wondering if you've contemplated when you think that reverts back to positive year-over-year growth? Do you think that's in the July quarter? Or is it further out perhaps not until fiscal '17? Any color on that would be helpful.

Well, I think we're hearing the same thing from our customers as many of the other suppliers in the space are and that is the second half of the year is showing quick [ph] to be strong. Having said that, we run with 2 weeks worth of backlog, so it's hard for us to, with any kind of certainty, predict what happens in the second half of the year. So generally speaking, our customers are optimistic. We believe we're clearly kind of in a bottom -- in a bottoming right now. The strength of that rebound and the timing of it is hard to predict.

That's fair and helpful, Peter. One other, if I can on NAND, you mentioned 3D NAND. I'm wondering if cross-point is an opportunity for the company? And if so, in what sort of time frame should we be contemplating a benefit?

Without a doubt, we are already qualified for the 3D cross-point memory supply chain to both end customers, both Micron and Intel. Without a doubt, that for us represents a significant piece of business. The question again is the timing of it. And I think our thoughts are that it's not material in '16. That's more of a fiscal year '17 demand uplift for Photronics. But without a doubt, it's like a brand-new memory market that we had not addressed previously. So the opportunity is significant.

If I can -- if I can just squeeze in one more.

Well, if I can just interject for a second to comment on if we're at the midpoint of the range. If we're at the midpoint of the range, our revenue will be up versus the first 6 months of last year because we're up. We did $123.5 million in Q1 and $127 million in Q2 last year. We just did $130 million.

Got it. And I acknowledge it's a helpful clarification. If I can just squeeze in one more. The weakness in high-end logic. Should we think about that as largely coming from the joint venture in Taiwan? Or is this more sort of a wholly owned business where you're seeing this weakness?

If you look at the high-end logic market, right, we have basically 3 nodes in that bucket that are commercial today. It's 40, 28 and 14. And the severity of the problem that's due to lack of demand ramps as you go down steps. So 40 is lackluster, 28 is poor and 14 is more than poor. So I'll let you decide who might -- what Asian foundry customers those nodes might most reflect on, but that's how the picture stacks up for us. And unfortunately, as you step down nodes, the ASP of each set goes up. So it doesn't take a lot of 14-nanometer demand disappearing to have a material impact on our revenue..

And our next question comes from the line of Stephen Chin with UBS.

This is Dan on behalf of Stephen. So first of all, on the guidance, can you give some color on maybe how we should think about gross margin going forward if the macro remains weak? Is this just mostly a function of revenue or volumes and customer mix? Or are there other things you can do to keep gross margin steady?

We have a number of levers that we can pull, Dan, to keep gross margin steady. Obviously, our objective is to hit the high end of the range. And with our cost-reduction programs, we can still have some good leverage. We still stick by to the extent of revenue growth. We expect at least a 50% drop-through. And when you look at -- just one other point, when you look at Q1's results, they're in lockstep with Q3 of last year before we had the big growth in Q4. So the top line was essentially the same. The operating margin was spot on. And the EPS was exactly the same. So as Peter mentioned in his prepared remarks, operationally, the company performed very well, and to the extent we don't see revenue growing or we see revenue dropping, we have some levers that we can pull to minimize the impact on gross margins.

Got it. That's helpful. And then next question on 3D NAND ramp in China. So you mentioned that you might have some 3D cross-point exposure from Intel in fiscal '17. I'm wondering for the 3D NAND ramp in China that Intel is doing, curious to hear whether you expect to have exposure here and, if so, when we should start to see revenue?

Yes. We certainly are looking forward to that pool of business as Intel equips and then ramps that factory. So again, we're already qualified. I think, we build more NAND reticles than any merchant suppliers for the merchants. But again that appears to us to be modest demand this year. Our fiscal year 2016 with more of a strong uptick in our fiscal 2017. And again, I mean, you can easily triangulate that with the capital equipment guys than with just the sort of normal time to install and ramp new equipment.

Got it, okay. And then just last question on OLED, which obviously has been performing really well. So just curious to hear your thoughts on what sort of growth rate we should expect from this business over the next few years and then how margins compare to corporate average?

This year is kind of an interesting year, right. This year is going to be a year where, particularly in Korea, a lot of new OLED and AMOLED capacity is being installed. Normally, what that generates is a significant [indiscernible] of capacity this year and early in calendar year '17 will generate a lot of demand for mask immediately following. So we are looking at trying to ensure that when that slug of new capacity comes online that we are properly positioned to take advantage of it. So I do believe that we should see a significant step-up in AMOLED and OLED demands in 2017 and then beyond. So -- and we're trying, just like we did the last time, at the time our expansion in capacity and capability so that when the customers are ready, we're ready. I guess, to quantify that, right, the last time we added a tool takes 1 increment of [indiscernible] capacity or AMOLED or FPD revenues jumped by $5 million approximately on a quarterly basis. So each lift of the tool is a $5 million to $6 million step-up in our quarterly run rate.

And to Peter's point to the extent we monetize that, our margins will go up without giving specific ranges.

And our next question comes from the line of Edwin Mok with Needham & Company.

So I actually want to go back and ask a question on the first quarter first. If I go back 3 months ago when I listened to you on the call, I think you guys were already anticipating some lumpiness in the high-end logic side of the business. Did that business just came in a lot worse than you expected resulting in kind of the eventual weaker 1Q? And I have 2 follow-ups.

Yes, it did. What we saw was the demand that was projected for the high end both in Taiwan and Korea as the quarter rolled itself out. The tape-outs just continued to push out, push out, push out. So it was like Chinese water torture as far as the business level is concerned. I think we're very confident that we lost no market share. The business simply didn't materialize. Even leading up to -- I mean, normally, what we see in both the U.S. and Europe before Christmas and then in Asia before Chinese New Year is there's a big push in the last few weeks to get the designs that have been lingering out the door. And unfortunately, this year, that push did not materialize. So that's more or less how the quarter evolved.

Okay. Okay. That's helpful. Can I ask you guys about China? One of your large customer in Taiwan [indiscernible] capacity in China. I was wondering how likely are you going to be able to get business from that? And how you going to service that business given you have no capacity in China?

We're servicing that business today primarily from Taiwan but also to a lesser extent from Korea and the nanoFab, depending on the technology node. And our revenues -- our quarterly revenues from China today are on a -- on an upward trend. They have been for the last 2-plus years, but they're now material for Photronics, and it's actually not just IC but FPD as well. So in the short term, we can clearly service the China demand from outside of China. In the long run, we think there's an opportunity for our business in both IC and FPD, an opportunity to become a domestic source of supply. Doing that the right way is clearly important. That represents a significant capital investment for us, right, because it's not low-end business where the growth is. It's high end. So that's a lot of new expensive tools. So we're actively discussing with both customers as well as the local -- the various local governments had entered that market in a way that maximizes our upside but at the same time mitigates risk. So -- and until we get to that point where we're comfortable, we'll continue to service demand from outside of China.

Okay. That's helpful. And then, I guess lastly, go back to OLED. You mentioned that some of the -- your customer is adding OLED capacity and even converting some of the LCD over [ph] to OLED. Just curious anyway you can kind of give us some sense in terms of, I don't know what's the proper way to do apples-to-apples but kind of your exposure for LCD versus OLED? How much opportunity do you see, for example, if a customer is ramping a standard LCD line versus OLED line. Do you see a step-up in opportunities, similar level of opportunity or less opportunity for you guys?

Well, I think the opportunity really is in different locations. The OLED and AMOLED opportunity clearly is in Korea. But if you look at our high-end business, as you know, it's 75% of our high-end business or our FPD business is high end. We don't split it out between LCD and AMOLED, but 75% of the business is high end. So we see a high-end opportunity for AMOLED and OLED in Korea, and we see a high-end opportunity in LCD in China. So the way we address those 2 opportunities likely will be different, but both are significant.

Okay. So basically -- so if I understand that answer correctly then from LCD to OLED, there's -- you can compare -- or there's no comparison in terms of, if there is a bigger dollar spend on mask in OLED versus -- I guess that's what I'm trying to ask, right, is that this is all spend on the mask set for LCD or OLED similar, or less, I guess, what I'm trying to ask.

This is Chris. I can just make a comment on the mask complexity piece of it. For sure, the OLED devices have more mask layers and each mask layer is more complex. So I think the ASPs of the OLED masks are higher. But the form factor, the size of the masks tend to still be much larger for LCD applications for TVs and things like that. So that drives higher ASP. So the complexity and the mask count goes up for OLED at mobile displays, but still LCDs, high-end is driven mostly by larger size masks and they -- higher ASPs, too. So don't know if that helps, but that's kind of the way to distinguish the mask value in each of those, I think.

Yes. I'll come back and answer your question more -- maybe with more clarity. If we found -- to find a way to appropriately address the high end in China and the growth in Korea of the large format LCD and the OLED/AMOLED, respectively, it represents about a doubling of our high-end business -- would represent that doubling.

And our next question comes from the line of Tom Diffely with D.A. Davidson.

First, did you guys suffer any damage or have any impact from the earthquake in Taiwan?

Fortunately, the answer is effectively not. I think we lost 7 reticles in total that were in the manufacturing line. So it's essentially 0.

Okay. What about the impact on your customers and potentially the business you got from them?

I think our customers -- depending on which customer may have lost a few days' worth of production on the IC side of the business, one of our competitors on the FPD side of the business actually had some significant problems. So the net effect overall to us is essentially a wash.

Okay. Okay. So when you look at the high-end IC where the -- most of the softness is right now, what should we expect to come back first: the 28-nanometer or the 14-nanometer business?

Very -- that's very hard to say precisely. But if we had to guess, we would expect the 28 will come back before the 14.

Okay. And are your tools qualified potentially down to the 10-nanometer node? Or do you need new tools or new supplemental pieces for that?

As far as the 10-nanometer goes, we're actively working with our customers in a joint development fashion. There's no real commercial demand there yet. By the time there is, we'll be qualified. I think we have all the capability we need to make those masks. When we reach high-volume production, we'll probably have to add capacity and at that time perhaps some capability, but it'll be more capacity.

Okay. And then Sean, what was the CapEx in 2015?

Total CapEx? Cash CapEx, I believe, was $104 million.

Okay. So in the $50 million to $75 million for this year, does that include any mainstream at this point? Or would you comment earlier that if you invest in mainstream that would be in addition to that $50 million to $75 million?

There's some components of various strategic additions or movements, whether they're newer tools or used tools in there. But a lot of the cash CapEx, Tom, in this year that we're talking about is actually -- most of it's already installed and was installed. They were just paying for it this year.

Okay. And then, I guess, after the big year of CapEx last year, do you expect any kind of a ramp or increase in depreciation expense in the next few quarters?

Not necessarily. As I think we've talked about this before, I think, we were at $20.9 million this quarter all-in. As we bring or have brought new tools on, including high-end tools, older tools fall off the depreciation rolls. So we haven't seen a significant increase.

Okay. And I guess, the gross margin decline sequentially, that was all over an absorption as opposed to the mix or an increase in depreciation?

That's correct. As we talked about in Q4, our incremental gross margin on the increased sales was about 74%. And on the decreased sales, it was eerily similar. It was at 79%. So it's pretty symmetrical.

Okay. And finally, when you look at the guidance for the out quarter, midpoint down 4%, 5%. It sounds like each of the segments when you describe them, whether flat or hopefully improving for the mainstream, where's the sequential weakness you believe that gets you the midpoint and down quarter-over-quarter?

Tom, if you look at what we saw in the U.S. as far as the mainstream in Europe, as far as the mainstream business is concerned, normally after Christmas, we see a rebound in about 3 weeks. It's now recovered to preholiday levels, which is good news. The bad news is, it took about 5 weeks to get there. So if Asia behaves the same way as the U.S. did vis-à-vis Chinese New Year, it'll be a longer recovery period for the mainstream business. So therefore, we would see a drop in the mainstream revenues throughout Asia, which now happened to be our largest -- Asia is our largest market. So we don't know how quickly things recover. But if Asia looks like U.S. and Europe, we've built the -- we've built that into the guidance.

[Operator Instructions] And our next question comes from the line of Patrick Ho with Stifel.

This is Brian on for Patrick. First, just isolate on the slowdown in your mainstream IC business. Were any markets in particular weaker than originally anticipated? I know you just discussed the linearity in the past quarter. Also embedded in your Q2 outlook, what market or markets more specifically are you seeing a rebound from in Europe and U.S.? Is it more automotive weighted, more industrial weighted? And I had a follow-up question.

There really wasn't a specific end market for customer concentration. In what we've seen, it really is broad-based. So it would be, I think, inappropriate to try to single out any one end market as being responsible for the overall slowdown.

Okay. Also on the way up, any sort of granularity you can provide the second part of that question?

No. Again, it's just -- it really is like -- there's no doubt, right, that the semiconductor industry is becoming much more closely aligned with the global GDP because the applications are everywhere. And the slowdown and the pickup of the business in the U.S. and Europe more or less happen everywhere. All the markets, all the customers. It's just a -- it was a broad-based phenomena. And what we're seeing is, as Asia comes out of Chinese New Years', again, it's -- there seemed to be any customer end market concentration.

Okay. That's helpful still. My second question is following a very strong growth year in your leading-edge IC photomask business in 2015 and, I guess, also your comments regarding second half weighted recovery from leading-edge logic, how confident are you still that the leading edge will grow again in 2016 also factoring any possible technology- or yield-driven delays that might be occurring?

Well, if you look at our business now, we have -- basically, all the major customers now are our customers. And really, the question you're asking is, how well do they do competitively vis-à-vis CSMC [ph]? Because the industry clearly does not want to be sole source the 28- or 14-nanometer. Our customers' customers don't want that to be the case. So there's a clear overall industry drive to develop viable second sources of both 28 and 14 to the extent that, that happens, our business is going to grow. To the extent that it doesn't, our business is going strong.

Okay. Maybe just to throw one quick one in there, just kind of curious, roughly speaking, when looking at your leading-edge IC mask business, how much of that is memory driven, so DRAM plus NAND combined? Are we talking about 1/3 of that slug perhaps? Or any help you can provide there would be great.

Yes. Generally, we don't break or further segment our high-end business now, logic. There's 3 components that are really memory, IBM logic and foundry logic. We started out and we walked across the market in that -- in those steps. And today, we have broad exposure. That's the good news so that when one market suffers and the business goes down -- if you look at Photronics, right, we're effectively back to Q3 levels, which for us is still reasonably high gross margins, high operating income -- double-digit operating income. We're not happy with last quarter. We're not happy that the business didn't perform the way we hoped it would on the top line. On the other hand, relative to our historical financial performance, we did quite well. So I can't break out the high end for you. We're, I think, pretty confident that as the year wears on, the high-end logic business will bounce back. The difficulty we have is predicting the cadence of it.

And our next question comes from the line of Tom Diffely with D.A. Davidson.

Just one quick question for Chris. What's the current view for OLED TVs? And if the market does move the OLED TVs, does your toolset handle both the large size and the complexity that this would require?

Thanks. I mean, the toolset does handle the large size and the complexity. As far as OLED TVs, the OLED backlighting is already in use. You see a lot of TVs you can go buy with OLED backlights. What that hasn't driven, though, is the complexity and the kind of switching or transistor layer you get for TVs, so-called AMOLED applied to large-format TVs. I think that's still quite a ways off before that happens. It's very difficult technology to yield for reasonable cost. But folks are definitely working on it. And the good news is the OLED backlighting is embedded now in high-end TVs. So it's coming, but I think it's still some ways off before they can be done economically. My toolset definitely supports that technology, though. And the other thing on laptop screens, that sort of stuff, there, you're going to see it next, I think, adopted much more widely.

Ladies and gentlemen, there are no further questions at this time.

Okay. Thank you once again for taking time to join the discussion this morning. 2016 is [indiscernible] with lots of challenges as well as opportunities. We like our position as we navigate through the next few quarters. We look forward to updating you along the way.

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