Ladies and gentlemen, thank you for standing by and welcome to the Photronics Second Quarter Fiscal Year 2020 Earnings Conference Call. [Operator Instructions].

I would now like to hand the conference over to Troy Dewar, Vice President of Investor Relations. Please go ahead.

R. Troy Dewar - Vice President, Investor Relations

Thank you, Sarah. Good morning, everyone. Welcome to our review of Photronics' 2020 second quarter financial results. Joining me this morning are Peter Kirlin, our Chief Executive Officer; John Jordan, our Chief Financial Officer; and Chris Progler, our Chief Technology Officer. 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 participants on today's call, may include forward-looking statements that include such words as anticipate, believe, estimate, expect, forecast, in our view. 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.

At this time, I will turn the call over to Peter.

Peter S. Kirlin - Chief Executive Officer

Thank you, Troy, and good morning everyone. Before beginning our discussion of second quarter results and third quarter outlook, I would like to take a few moments to recognize our global workforce for their outstanding response to recent challenges. Beginning in February with our operations in China and extending globally over the last three months, our employees have displayed dedication, commitment, and real customer-centric attitude that has enabled us to continue operating to meet customer expectation.

As events started to evolve, we quickly developed implement a gate [Phonetic] plan to focus on four key areas; employee health, raw material supply, customer support and tool maintenance. All these are critical for sustaining our global operations. Across our sites, we immediately implemented policies to protect our employees through health monitoring, the adoption of known best practices to [Indecipherable] the virus, including the use of personal protective equipment and a comprehensive global visitor policy and enabling small segments of our workforce to work from home, in accordance with local requirement. We initiated regular internal meetings to monitor a global supply chain and address any issues, and continue to be in direct contact with our raw material suppliers, logistics partners and OEM equipment service groups to minimize any impact on our operations. Because of these actions, we've been able to meet all our customers' [Indecipherable] needs with the same quality and delivery performance, to which they are accustomed. Effectively business as usual, it has been a true team effort and I'm very proud of our response.

Moving on the second quarter results, revenue was higher year-over-year driven by FPD, as we benefited from stronger global demand, as well as more capacity from our new Chinese factory this enabled us to achieve year-over-year revenue growth for the 11th consecutive quarter; to the first half of this year, revenues are 18% ahead of last year's pace, which was a record year for Photronics. This demonstrates the performance we can achieve with our expanded global footprint. To realize even greater growth in the future as both our Chinese factories IC and FPD, continue to ramp and our product mix is better optimized.

Revenues dropped sequentially, due to a push-out of orders, first, in China and then to a lesser extent across the globe, resulting from the extended Chinese New Year shutdown and subsequent worldwide mobility restrictions to combat the coronavirus. The impact was felt most strongly in demand for photomasks used in IC foundry, and high-end display production. Fortunately, we are already beginning to see our sales in these markets improve, and while there is uncertainty ahead, we are cautiously optimistic regarding the overall market outlook for the balance of the fiscal year.

For most of our IC customers, production has deemed central and operations have not faced interruptions. However, today's device designs are complex, requiring large teams of engineers and approvals often have multiple layers. With many of our customers' engineers working from home, design verification is more difficult, which seems to have slowed the pace of design releases early on, as staff adjusts its remote working conditions. Based on an order uptick during April and May, it appears that design teams are adjusting to the remote work setting or in some cases have returned to the office. Plus, we believe the companies are moving forward with the introduction of next generation devices, in anticipation of a recovering economic environment.

As far as FPD is concerned, all three of our factories were fully booked during the entire quarter. However, mix suffered in China due to a significant decline in G10.5 plus bookings. We do not believe we lost market share, but instead customers simply ran existing products, pushing out the timing of new design releases. We're already seeing bookings rebound in May, with immediate line of sight to more, leading us to expect G10.5 business to be back to normal by the end of the third quarter.

Earnings were impacted by the decrease in revenue. We always keep a keen eye on cost to maintain our status, as the low-cost producer, and this quarter was no exception. Due to this focus, we delivered earnings of $0.10 per share. We improved the strength and flexibility of our balance sheet during the quarter, increasing our cash balance to $238 million. John will say more in a few moments, but we believe we are well positioned to navigate this period of market uncertainty, as well as to execute against our strategic growth objectives.

To summarize what we saw in the second quarter, our team has responded well, working with our partners across the supply chain, with no meaningful disruption to our operations, while maintaining the health and well-being of our employees. Some of our customers pushed out orders, but those were related primarily to China and we are seeing improved bookings in April in May. There is too much uncertainty regarding future economic growth, this takes the worst is behind us. However, I'm extremely pleased with how we have responded and encouraged by current trends.

During this period of uncertain dynamic working conditions, one thing that has not changed, is our commitment to invest in growth. Investing is not new to us, with our facilities in China performing well, we're preparing for the next phase of our growth strategy. This will entail targeted investments in display. We recently placed an order for a second Prexision-800 mask writer from Mycronic. This tool is scheduled to be delivered earlier in calendar year 2021. We are also scheduled to receive two Prexision-8 writers in 2021. The addition of these three machines to an already strong lineup will fortify our leadership position, providing us with the most advanced and broader technology portfolio available. We have the flexibility to install these new tools in any of our three FPD facilities in Asia, and we will select the best location to serve our customers, while optimizing our financial return.

Total investment including any additional support tools will be in the range of $50 million to $70 million, depending on the location of each mask writer. To support this investment, we have entered into three multiyear purchase agreement that collectively represented business commitments in excess of $40 million annually. There are multiple market factors driving the need for these advanced tools, primary among them is strong and growing AMOLED demand. Most manufacturers of premium smartphones have transitioned to AMOLED, and more and more mid-range models are adopting the technology. The rollout of 5G technology is expected to accelerate this transition.

Second, high-end [Technical Issues] are now beginning to migrate to the superior AMOLED displays. Finally, premium smartphones continually adopt more innovative display technologies, with greater resolution features, such as integrated fingerprint sensors. This creates design and manufacturing complexity, thereby increasing number of masks per CIV [Phonetic]. And with basic AMOLED mask that has 12 layers, while the most advanced can have up to 25 layers. Not only does the number of layers increase, but there are more critical layers further enhancing the value we provide. Our new tools will enable us to better serve this growing market, extending our market leadership and protecting our technology leadership.

In addition to growing AMOLED demand for mobile applications Korean panel producers are in the process of shifting production from LCD to high end OLED for large screen TVs. This move is intended to provide competitive differentiation based on technology. As these advanced display makers innovate to maintain their technology leadership, we will partner with them to enable them to deliver on their strategic objectives. Our new tools, especially the P8 Lite, are the perfect solution to allow us to satisfy this demand.

Before concluding, I would like to speak to the recent rulings by the U.S. Department of Commerce. Our first order of business is to understand how the rules apply to us and to ensure we are in compliance. Fortunately, our FPD photomasks are not touched by U.S. technology or suppliers, so they do not apply. Regarding IC photomask based on our initial work, we believe that we should be able to comply without significant interruption. As with all such ruling, it often takes some time to fully understanding the depth to their implications, while we do not currently anticipate significant changes to our business outlook.

The trajectory of our business activity during the second quarter and into the third quarter has been encouraging, current booking activity is moving in a positive direction in both our IC and FPD businesses. Believe the underlying long-term trends that we have aligned our strategic growth objectives with, have not changed. While the exact profile of the business in 2020 is uncertain, we remain confident on our long-term outlook, and believe that we are in a strong position to deliver.

At this time, I will turn the call over to John, to provide additional commentary on our performance and outlook.

John P. Jordan - Executive Vice President, Chief Financial Officer

Thank you, Peter. Good morning, everyone. We performed well during the second quarter and managed our business through very challenging circumstances. Revenue of $142.8 million improved 9% compared with the same period last year, albeit down 11% sequentially in some customers, particularly in China, pushed out orders. We believe that the order rate will recover, and indeed we have already seen improving trends during our third quarter. IC revenue was lower compared with both the previous quarter and the same quarter last year, more than half of the sequential variance in IC revenue was due to lower demand from China foundries, as their operations were impacted by the protracted Chinese New Year shutdown.

FPD revenue improved over last year, as additional capacity in our new Hefei facility extended output. On a sequential comparison, the revenue declined due to softer demand in China, as customers pushed out orders, particularly for G10.5 plus and AMOLED. We were able to keep our FPD plants running at full capacity, albeit, with a mix of product not as favorable to the top line. Both gross margin and operating margin moved in line with revenue trends. During this period of economic uncertainty we intensified our perennial focus on cost control. We accelerated global cost reduction programs and we are challenging all spend, to ensure we are properly prioritizing expenses.

SG&A expense in the second quarter was nearly $1 million lower than the previous quarter, essentially equal to the prior year quarter. Year-to-date, SG&A expense declined as a percentage of revenue from 10.6% in fiscal 2019 to 9.1% in fiscal year 2020. Overall opex increased nearly $1.2 million from the first half of fiscal 2019, due in large part to increased R&D expenses, resulting from the many new product qualifications in several of our operations. Total opex as a percentage of revenue decreased from 13.6% in the first half of fiscal year 2019, to 11.9% in fiscal year 2020. China effect on operating income was reduced to just about $1 million in the quarter.

Margins in the second quarter were reasonably good in the circumstances, but we expect to do better and will continue to drive costs out of the business. Other expense of $1 million resulted primarily from the foreign exchange impact of remeasurement of U.S. dollar denominated assets and liabilities, on the books of our foreign subsidiaries, together with interest expense, primarily in China. Tax provision and non-controlling interest were in line with expectations, enabling us to deliver $0.10 per diluted share for the quarter. We are in a very strong financial position with sufficient cash, manageable debt and ample liquidity, including our unused $50 million revolving credit line that is available if needed.

Our cash balance increased $19 million during the quarter, a result of investing $16 million in capex and repurchasing $6 million of our common stock from the $31 million we generated from operations and $10 million of government subsidies and contributions from non-controlling interests. Earlier in the second quarter, we made the decision to terminate our share repurchase program out of an abundance of caution, in consideration of the uncertainty in the current environment. Our desire to use this vehicle as a means of improving shareholder value has not diminished, and we anticipate resuming this activity at an appropriate time in the future. Our forecast of total capex for fiscal year 2020 will remain at approximately $100 million, including about $35 million for equipment that will be lease financed. As always, we have some flexibility on exact timing of capex, to allow us to respond to changing market conditions.

Before I provide third quarter guidance, I'll remind you that our visibility is always limited, as our backlog is typically only one to three weeks and demand for some of our products is inherently uneven and difficult to predict. Additionally, the ASPs for high-end mask sets are high, and as this segment of the business grows a relatively low number of high-end orders, can have a significant impact on our quarterly revenue and earnings.

Lastly, geopolitical risk may have an impact on our operations, the operations of our customers or suppliers or end market demand, as governments announce restrictions to address coronavirus or changes in trade policy, resulting in an adverse impact on our industry and therefore our results. Given those caveats, we expect third quarter revenue to be in the range of $145 million to $155 million. End market demand trends for IC and FPD appear to be positive, as we get well into the third quarter and we anticipate the longer-term trend to remain positive. However, it's difficult to know the macroeconomic uncertainty and we have attempted to incorporate this, when developing our third quarter outlook. Further, as a result of this uncertainty, especially as it relates to demand during our fiscal fourth quarter, we are withdrawing our full year, fiscal year 2020 targets that were previously announced. While we may still meet these targets, the confidence level in doing so is reduced by the uncertain demand environment.

Based on our revenue expectation and current operating model, we estimate earnings for the third quarter to be in the range of $0.11 to $0.17 per diluted share. These are certainly challenging times and as always during periods of uncertainty, we increase our focus on Photronics longstanding core competency of being the low cost technology leader, delivering high quality photomasks to our customers. Successful execution of these competencies combined with our financial strength and flexibility should enable us to overcome these challenges and emerge strong and better able to serve our customers' evolving needs.

I will now turn the call over to the operator for your questions.

Question & Answers

Operator

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

Thomas Diffely - DA Davidson - Analyst

Yes, good morning and thanks for the question. So I guess, going back to the guidance you gave for the April quarter, at that time you were expecting about a $10 million impact from COVID-19. Curious what drove a little bit of upside to that? Was it domestic China being a little softer, or was it the impacts to the rest of the world?

John P. Jordan - Executive Vice President, Chief Financial Officer

Yeah. The original guidance did not contemplate the virus rolling through Europe and the United States. So if you look at it over a quarter, about 75% of the loss of revenue came from China, the other 25% came from the U.S. and Europe, and that was not contemplated in the guidance when we gave it. So that's more or less how the quarter - the drop in revenue split out.

Thomas Diffely - DA Davidson - Analyst

Okay. Is there any way to quantify the COVID impact you have embedded in your guidance for the July quarter?

John P. Jordan - Executive Vice President, Chief Financial Officer

Yeah. Well, if you look at our year, Q1 was just shy of $160 million. So we were at a $640 million clip. If you look at the second quarter, we had a V. So February was $48 million. March was $44 million, and April was $51 million. So when you look at our guidance for the current quarter and you look at the April number, it doesn't take a lot of imagination to determine where it came from.

Thomas Diffely - DA Davidson - Analyst

Okay. And it sounds like you're not seeing any end market demand disruption, outside of the delay you saw from the design activity early in the quarter or I guess in the March timeframe?

John P. Jordan - Executive Vice President, Chief Financial Officer

Yeah. We saw a big dip, right. March, we saw the hangover from the Chinese New Year shutdown, which I think we all know, extended several weeks beyond what was originally intended, plus the effect in the U.S. and Europe starting to be felt. So that was a big dip, But where we sit right now, I would still say that overall demand is down mid-single digits, as a result of the overall economic hangover from COVID-19.

Thomas Diffely - DA Davidson - Analyst

Okay, great. And the…

John P. Jordan - Executive Vice President, Chief Financial Officer

Sorry. Tom, relative to what would have been absent it.

Thomas Diffely - DA Davidson - Analyst

Okay, and then reading your comments on the Commerce Department, it sounds like year withdrawal of the full-year guidance is really a COVID impact, not any impact from the new Commerce Department rulings?

John P. Jordan - Executive Vice President, Chief Financial Officer

That's absolutely correct. I mean no one knows what the fall will hold. I think the only thing that we can say definitively, is the virus will not have left us by then. So what this profile looks like in the fall is anybody's guess, but what I will say is, if you look around Asia, Korea, Taiwan, China, these are significant markets for us, somewhere between 7% to 8% of our revenue is coming from the Asian markets and when you compare their ability to manage the virus this spring versus the West, it was very favorable. So if the fall is a replay of the spring, everybody should do better, because everybody should be better informed, and we're hopeful that the effects will be quite modest in Asia, don't really know about Europe and North America.

So this is why we're withdrawing the full year targets. We do that with lots of disappointment, because it's very clear we were - with 11 quarters in year-over-year revenue growth and Q1 being what it was, we were well - we were in fact ahead of our plan to hit the $630 million and $0.80 [Phonetic]. Having said that, the current quarter is a significant step up. So we're we're cautiously optimistic.

Thomas Diffely - DA Davidson - Analyst

Okay, I understand. And then finally for me, just maybe technology question, probably for Chris I guess; if the industry - moves to adoption mini LED, how does that impact the photomasks?

Christopher J. Progler - Executive Vice President, Chief Technology Officer, Strategic Planning

Sure. Thanks Tom. So mini LED, that's a technology with the larger size LEDs, as you know, and it's mostly applicable - the two applications, kind of very large TV, signage that sort of thing, and then it's kind of dynamic backlight in regular displays. So in both cases, they need driver circuitry. They are not as complicated to operate as organic LEDs, but still the driver circuitry is fairly complicated and we see a pretty healthy mask profile for mini LED, particularly for the dynamic backlighting there you're going to need some additional circuitry to make those work. The micro LED, those are kind of direct drive LED similar to AMOLED, but using inorganic LEDs, same kind of story on the surface LED, they are relatively easy to operate. But to put the right control on the displays, you will have to operate current and voltage, just like OLEDs. So we see pretty strong profile for lithography and mask demand from micro LED as well. A comparable kinds of mask counts, but for some of the integration schemes, perhaps even higher.

Thomas Diffely - DA Davidson - Analyst

Okay, great. I appreciate that. Thanks for your time today.

Peter S. Kirlin - Chief Executive Officer

Thank you, Tom.

Operator

Thank you. Our next question comes from the line of Gus Richard with Northland Securities. Your line is now open.

Gus Richard - Northland Securities - Analyst

Yes, thanks for taking the questions. Just quickly, can you talk about the normal linearity in a quarter? And was Q1 unusual in that respect and kind of what is typical linearity in Q2?

Thomas Diffely - DA Davidson - Analyst

Yeah Q2 if you compare our business, as a cardiogram, the cardiogram has the most year-over-year correlation based on the bill for the holiday season of products. So you look at our business, where we see normally a definitive profile, is Q1 is typically a down quarter. Q2 and Q3 step up for the holiday season and then Q4 steps down as a result of the holiday season. So Q1 is the lag of products not being in the pipeline. Q2, there is more. Q3, there is even more and then Q4 incorporates the holiday. So that's the normal cardiogram for our business in the year. So based on that Q2 should have been up, but obviously it was not. A typical quarter, there is some statistical variation month to month. But normally, with the exception of January always being down relative to December and February, there is no systematic month-to-month variation, you know, within a quarter.

Gus Richard - Northland Securities - Analyst

Got it. Thank you. And then just talking about the expansion of the entities list by the Commerce Department. You guys made some comments that you don't see that impacting you, and I was just wondering how you walk through that analysis, or do you have low exposure to those companies and/or do you think you can get around the regulations?

Peter S. Kirlin - Chief Executive Officer

Yeah, it's actually, it's quite - it's a - so Huawei, right, is the major poster child so, and the companies affiliated with them. That's already well in the rearview mirror, right? Then when you step away from that, there is a complicated gauntlet you have to run regarding EAR codes in and it's quite complicated. So each customer and the products they sell, require a separate assessment. So we have several individuals or at least one individual that is really an expert in this area inside the company. So they've been through the new regulations, and relative to the prior ones, there's really only two customers of concern for us right now. We're working to try to determine what we can do for them. If we can do nothing, it still should not have a significant impact on our revenues and you kind of take it to the highest level? Why is that so? Why is that so is, we we're building reticles all around the world. Our factories are IC factories in Taiwan and in China. You use technology that was largely developed in Asia, and if not, we have a giant Japanese partner where we can use Japanese technology to get the job done.

So right now we're I think in pretty good shape. But there is still a lot of dialog, by the way going on to clarify exactly what the wording in the rulings mean. So that's why in my prepared remarks, we were quite careful to say we're still along with others in the industry, working to get complete clarification on specifically what the wording means.

Gus Richard - Northland Securities - Analyst

Got it. And then just remind me, on say your top couple of IC customers, how big would they be? Are they 1%, 2% of revenue on an annual basis?

Peter S. Kirlin - Chief Executive Officer

So if you look at our top five IC customers in a quarter. Typically they are more than 50% of our revenues and that number varies, right. I don't know if we break that out, but it is we do at the top of our business, have a high customer concentration. But I'll tell you that we have, in a typical year, more than 600 customers. So we have a very broad and diverse customer base, but at the very top, there is a significant amount of customer concentration.

Gus Richard - Northland Securities - Analyst

And just to be clear is that - I would imagine it's mostly dominated by FPD customers as opposed to IC?

Peter S. Kirlin - Chief Executive Officer

There are more FPD customers in the top 10 than IC. That's correct.

Gus Richard - Northland Securities - Analyst

Okay, all right. That's it from me. Thanks so much.

Operator

Thank you. Our next question comes from the line of Patrick Ho with Stifel. Your line is now open.

Patrick Ho - Stifel - Analyst

Thank you very much and glad to hear everyone is well. Peter, maybe just as a follow-up from your prepared remarks, can you discuss your manufacturing situation and I guess with all the new rules, the social distancing and all of that, how it impacts your core throughput capabilities? And maybe as a second part of that question is, how much do you believe of some of the lost revenues and the pent-up demand that started to come back now in the July quarter, how much of it do you believe is made up in July, or does it carry-over a couple of quarters, where you make up that lost revenue from the April quarter?

Peter S. Kirlin - Chief Executive Officer

Yes. So as far as our manufacturing operations are concerned we - I don't know if you want to use the word fortunate, but I would use that word, from the standpoint of knowledge is power, and that is in Asia, right, this is not the first coronavirus the Asian communities had to deal with, right. Since 2000, there has been six - three significant coronavirus epidemics in Asia; there was the Middle East Respiratory Syndrome, there was the Swine Flu, and there was SARs right. So there were three. And the best practices [Indecipherable] to operate in a coronavirus infected community were already known to - particularly our Taiwanese operation. So we took that playbook and we rolled it out around the world, right. So rolling out that playbook, our manufacturing output is the same today as it was three months ago, as it was three months before that.

So we have not seen any degradation in our top line, as a result of the virus. We had a lot of supply chain disruptions we had to actively manage through, but we were able to do that. And again we still think of ourselves as a small company, but we have a really dispersed global footprint. So when we are having problems with particular materials in one location, we would buy them in another and re-export them ourselves. So by being flexible and acting as a global team, we did not have any manufacturing disruptions, zero, nada, nothing. And we are already preparing for the fall. We would be foolish not to, because we know something is going to happen, we just don't know what. But what we do know is, we're going to be ready.

So, yeah, so for revenue output, same as always. Of course, when I say always, I mean as our - as we add tools, it changes, but aside from capacity additions, no impact. As far as demand goes, we expect what was there to push out over the next few quarters. That assumes, there is no major economic dislocation, as a result of the pandemic, and I don't think right now, anyone knows what the overall economic outlook looks like, three months from now. I think that's really hard. I think that's really hard to have a firm grip on. But I will say again that countries that have done a good job managing the virus, are likely to do a better job in the fall and fortunately, that's where the majority of our global footprint resides.

Having said that, also as everyone knows, the West represents a significant amount of demand for chips and if we're having difficulty, there is bound to be some economic impact, that is hard to predict. So we're doing what we always do, you know got our head down. We're focused on execution with things we can control. We're managing our costs. We're making sure that we're well set up for the fall. We're not deviating from our long-term strategy to the extent that we can get customers to hold hands with us. So we are hyper-focused on what we can control, and we're vigilant on what is happening outside of us. But it's an uncertain time.

Patrick Ho - Stifel - Analyst

Fair enough. Thank you very much.

Operator

Thank you. Ladies and gentlemen, that concludes the conference call - ladies and gentlemen, that concludes our question-and-answer session. I would now like to turn the call back over to Peter Kirlin for closing remarks.

Peter S. Kirlin - Chief Executive Officer

Thank you once again for your interest in Photronics. We understand the current environment is creating uncertainty for all of us, has caused disruptions to our daily routines. Despite all of this, we are encouraged to see demand recover, and look forward to updating our progress throughout the rest of 2020.

Operator

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Q2 2020

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