Good day, ladies and gentlemen and welcome to the Photronics’ Fourth Quarter Fiscal Year 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded, Wednesday, December 12, 2018. I would now like to introduce your host for today’s conference, Mr. Troy Dewar, Director of Investor Relations. Troy, you may begin.

Thank you, Chanel. Good morning, everyone. Welcome to our review of Photronics’ 2018 fourth quarter financial results. Joining me this morning are Dr. Peter Kirlin, Chief Executive Officer; John Jordan, Senior Vice President and Chief Financial Officer; and Dr. Christopher Progler, Vice President and Chief Technology Officer, Strategic Planning. The press release we issued earlier this morning, along with the presentation material 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 risk, 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. At this time, I will turn the call over to Peter.

Thank you, Troy and good morning everyone. Earlier today, we posted another strong quarter with record revenue of a $144.7 million. This is the sixth consecutive quarter of sequential growth and the fifth consecutive quarter of double-digit year-over-year growth. The fact that we hit a record on the top line in the face of a semiconductor industry downturn is strong testimony to the effectiveness of our work to reposition the business to take advantage of growth in China, where we are finding our product offering to increase our penetration of captive customers. As with previous periods, we realized the benefits from both of these initiatives during the fourth quarter. Revenue shift to China increased to 146% year-over-year and revenue to captives improved 17% over last year. It was a superb quarter, which reinforces the fact that our strategy is working. In addition to record quarterly revenue, we also achieved record revenue of $535.3 million for the fiscal year. Entering 2018, we had the wind at our backs as the trajectory of the market along with qualifications wins we had secured indicated that we would have a solid year of growth. Looking back, our top line came in better than expected and we set a new record for Photronics. As an organization, I believe we did tremendous job of taking advantage of the opportunities afforded us by the market as well as creating some new ones to enable us to reach even higher. We have aligned our operation and business with secular market trends and I believe we are seeing the benefits of this approach. Despite the revenue growth, margins decreased sequentially. Some of this was driven by expenses associated with relocating existing tools as well as expected startup costs in China. Beyond that, we saw an impact from making mainstream…

Thank you, Peter. Good morning, everyone. The record revenue of $144.7 million in the fourth quarter reflects the successful repositioning of our business by developing business with China customers and increasing our market share with captives. Demand for photomask remained robust across most of our markets and we posted revenue growth in both IC and FPD. Before reviewing the results for the quarter, I want to discuss a change that impacts the comparison of fourth quarter results with previous periods. Beginning in 2018, we moved the fiscal year end to October 31. Going forward, the first three quarters will continue to end on the last Sunday in the quarter. Fourth quarter will end on October 31 every year. For this quarter’s comparisons, the importance of this change is that Q4 2018 is 3 days longer than the two previous comparable quarters. Revenue overall increased 6% sequentially and 20% over the same quarter in fiscal 2017 to $144.7 million. IC revenue improved 15% year-over-year and 3% sequentially driven by strength in overall logic demand in Asia and by strong demand for high-end memory generally. High-end logic demand was somewhat softer as demand for products using these advanced chips was tepid, but that softness was more than offset by stronger mainstream activity. Revenue growth for products shipped into China was once again a big factor in our performance increasing threefold over last year and representing 17% of total IC revenue. Revenue to captive customers was up year-over-year after a very strong year last year and down only slightly quarter-over-quarter related primarily to the softness in high-end logic. Looking ahead, we believe high-end logic demand will recover, but timing of that recovery is obviously uncertain. FPD revenues were a record $33.7 million in the quarter, up 36% over last year and 16% over…

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

Yes. Good morning. I wanted to dig into the impact that you’re seeing from the new costs. When you look at the gross margin impact of the reported quarter, is there some way to kind of give us the relative impact of the mix versus the start-up costs?

Tom, we don’t really get into the details of each of our operations other than at the bottom line we’ve given the result that we expect on the bottom line, but effect on margins, little more detail than we usually discuss.

Okay. So was the $0.05 [sic] projected impact in the current quarter similar to what it was last quarter?

I’m sorry, repeat that?

The $0.05 impact that you’re seeing for the current, the January quarter was at a similar level for the October quarter?

No, the October quarter was in the range of $0.01 to $0.02.

Okay. And then just on a broader basis when it comes to margins, when you look at China just ramping up overall becoming a bigger percentage of the business and growing very strong year-over-year. Has that had an impact on margins?

To the extent that we need to hire people in the production area, those costs don’t have revenue associated with them, so there isn’t an impact from those lead costs.

No, I think, I’m not sure – you answered – you interpreted his question, correctly.

Yes. No, looking forward –

So our variable margin model all year long has remained intact, no variation. What I said in my prepared remarks was we saw high-end demand drop, so – but we still saw strong demand in mainstream. So we built 45 nanometer and 55 nanometer business on tools that normally build 14 and 28. When we do that, we have depreciation running through the margin on those products that normally would not be there. So the way – our mainstream business and our high-end business has same margin as long as we’re building the business on the proper tools, when that’s not the case and we move mainstream business up, we see margin compression and that’s what we saw in the quarter, but it’s better than the alternative, which is to allow the competition to enjoy that business and the contribution margin is still positive, but it’s significantly less. So that’s what happened as far as the mix in the quarter was concerned.

Okay. But then maybe looking more broadly, when you look at the Chinese market for both IC and flat panel, do you see enough high-end business there to get back to kind of normal relationships between high-end and mainstream for your business and normal margin structure?

Yes, sure. And most of the lion’s share of the capacity on IC that’s headed into China initially is at the very top of the mainstream nodes, so it’s the right tools for the job at hand. And, of course, the FPD tools are targeted – first, the G10.5+, which has revenue associated with it like nothing we’ve ever seen. So it’s all new business. So we think the tools we have that we’re actively installing hit the sweet spot of both the IC and the FPD markets.

Okay, great. And it looks like the, obviously, the high-end flat panel facility in China is very much on track here, installing the equipment right now. What is the typical lead time or qualification time that you have with new customers for a new fab like that? Is it a situation where just within a quarter or two, you can have actual production revenue systems going out the door, does it take longer to qualify?

Yes, with FPD normally the qualification cycle concludes in a quarter unlike IC, which could easily take close to a year. So FPD is a much – all the guidance we have given around the China ramps, they all contemplate the fact that the FPD business is new for us as far as the substrate size is concerned. The customers are not new. We’re doing business with all of them and the qualification cycles are significantly shortened, right. I would also point out again that in the FPD arena, we have said that we have significant contractual commitments for the capacity there that will enable us to ramp the profitability quickly. So for us on the FPD side of business, it’s very much – the business is there, what’s gaining our ability to realize it is our ability to execute on the build plan for the factory, the equipping of the factory with the tools and then the ramp of our line and then finally, the qualification of our customers, right. So – but it’s in our hands, right. It’s – we’re not looking for business once the line is ramped, we’re looking to ramp the line, those are very different scenario.

Yes, no, it’s a good position to be in and then finally, what is the projected interest expense or the terms of the new credit line that you have in China it sounds like you’re going to take advantage of some tax benefits there?

Yes, the interest expense will be reimbursed by the incentives that we have there, Tom so the timing will be different, but that at the end of the period we’ll have zero for interest expense.

Okay, great. Alright well, thanks for your time today.

Thank you, Tom.

Thank you, and our next question comes from the line of Patrick Ho of Stifel. Your line is now open.

Thank you very much. Maybe as a follow-up to one of Tom’s questions about the startup costs Peter, you gave good color in terms of the qualification times between display and IC is it fair for me to look at that also as when you have to keep up the duplicate cost as you begin to qualify and get tools offline in China? Or do you believe that you can take away some of those duplicate costs faster than expected as you start ramping up the Chinese fabs?

I’m not sure Patrick, we any of us were looking at whole puzzle what you meant by the duplicate cost, can you explain that a little more?

Yes. So just to ensure that you’re qualifying and having the necessary capacity, I’m assuming you’re going to be holding costs at your current, where you’re actually qualify and where you’re doing production today into the Chinese fabs are up and running at optimum levels, you’re going to keep some level duplicate cost at your current capacity at your current facilities until the China fabs ramp up that’s kind of what I’m getting at?

Alright. So again, with FPD there really is no duplication, there is no duplication, of course, right now, our FPD capacity is fully sold out, right, this quarter it was fully sold out and what we said is next quarter, we expect it to be fully sold out at the end of the second quarter, we starting hope to see in the beginning of revenue coming out of China as long as nothing significantly changes between here and there, meaning Q2, will continue to be sold out so the new China capacity will be incremental to a business that has no more now they are early going in China, the major focus then what our two partner customers are asking us is to get the G10.5 qualified as fast as humanly possible as we’re doing that to the extent we have tool capacity will push that capacity to support the AMOLED demand in China and/or the LTPS demand won’t generate the same mobile revenue, but it’ll still generate incremental margin so as far as FPD goes, there are no incremental or duplicative cost in the system as far as IC business is concerned, the duplicative cost if they are there would be to like not fully loading, the global capacity footprint, right? That so I guess you could call those costs duplicative if you want to use a broad definition so that’s the only real inefficiency that I can point to in our system so we said, we have contractual commitments to drive Hefei sorry, John, and breakeven but not beyond it so we will have to ramp in new revenue in order to fully load the global factory now in the current quarter we had expenses related to tool moves, right of existing tools and we said before many times now that we’re billing some of that China business obviously in the IC arena, in other places so as China ramps were moving some of the existing capacity to build it there, so we’re not expecting it all to be greenfield once you start dismantling a line in a factory it doesn’t make sense may be to move all the tools to one location so you blend those tools across your network to get the most leverage out of them so the tool move expenses we saw on the quarter were primarily related to blending those tools out across the existing network, the ones not going to China so that was a onetime event that will not duplicate itself so they could also I guess be viewed as duplicative costs but they’re now through the P&L and go on so that’s the best I can do to answer your question.

That is helpful, Peter. Thank you. As my follow-up question, the weakness on the high-end logic side, I guess it’s not totally surprising given a lot of the uncertainty in the market to-date could you just give maybe a little more qualitative was it at a certain node whether 14 or 28 or was it broadly across a couple of nodes on the high-end logic front?

No, it was both 14 and 28 and as I said 45 and 55 really strong, but it was not confined to a single customer it was generally it was broad weakness that surfaced in the quarter and you don’t have to use too much imagination to understand where it was coming from in the downstream market so but anyways, there was enough business there that we were able to more or less continue to load or tools, it just wasn’t optimal.

Great. Maybe as my final question in terms of the relocation of some of the tools to I guess meet the appropriate demand it does that give an indication on your end over the next couple of quarters that the mainstream will continue to be healthy and the high-end logic I guess will continue to be a little bit softer than expected? Or I guess, it sound like it only took about a quarter for you to adjust the tool sets based on demand how quickly it high-end logic does turn around sooner than expected, will you be able to I guess reallocate those tools?

Yes, we can change. Yes, we are in a position to change the gear on the bike if in consistent with demand, right, and I will say that I’ve been here 10 years and we operated last quarter at the highest level of capacity utilization that I’ve seen in my 10 years at Photronics, because, again, the revenue potential of the more mainstream business is not as great as the high-end yet, we still had a record quarter so we were working hard generally, not at all our factories, but FPD was sold out we had several IC factory sold out there is still some capacity in the system, but we were running pretty fast and as I said earlier, fortunately, we haven’t slowed the capacity coming online in the second half of the year in both IC and FPD we would need to do that likely regardless even if we weren’t ramping factories in China in the second half of the year, depending on what happens obviously, with the overall market that’s the wildcard, nobody really knows, but there are still segments obviously of our business that John highlighted on the memory market for us right now is very strong and that obviously is a testimony to our specific customers and where they are in their node ramps and our FPD business particularly AMOLED segment of it is up, is strong and of course, we have the best technology so that puts our capacity preferentially in demand based on our market checks we don’t think any of our competitors in the FPD space are sold out right now, we are the only one because we have the right tools positioned against the right market segment.

Right thank you very much.

Yes.

Thank you. And I’m showing no further questions at this time. I would now like to turn the call over to Mr. Peter Kirlin for closing remarks.

Okay, thank you, once again for joining this morning. 2018 was a great year for Photronics, we performed well and our market strengthened. I believe that 2019 can be even better as our Chinese facility to come online and we take it to next step in our strategic growth plan. Happy holidays to all.

Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program. You may all disconnect. Everyone have a great day.