Good day, ladies and gentlemen, and welcome to the Photronics third quarter Fiscal Year 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. The operator will conduct a question-and-answer session, and instructions will follow at that time. If anyone should require operator assistance during the call, please press star then zero on your touch-tone telephone. As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Mr. Troy Dewar. You may begin.
Thank you, Skyler. Good morning, everyone. Welcome to our review of Photronics 2019 third 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, Chief Technology Officer, and 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 risks, uncertainties, and other factors that are difficult to predict. Actual results may differ materially from those expressed or implied, and we assume the 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. 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 press release we issued earlier today illustrates once again the ability of our entire organization to execute in the face of an industry downturn that is now being reinforced by a geopolitical environment that has become increasingly uncertain. Revenue grew 5% compared with the previous quarter and 1% compared with the same quarter last year, making this the eighth consecutive quarter of year-over-year revenue growth. FPD achieved record revenue as demand for our AMOLED reticles remained strong. We benefited from additional production capacity from our new facility in Hefei, China. IC revenue improved sequentially on greater demand for mainstream nodes from Asian foundries, while high-end IC was flat, with growth in Taiwan offset by softness in China. Margins improved compared with the previous quarter as we controlled costs despite higher startup expenses.
This enabled us to deliver earnings of 10 cents per share. In addition, our cash balance grew to $197 million, aided by strong operating cash flow, government incentives we received for our China investments, and additional borrowings in China. CapEx of $20 million was consistent with plan as we near completion of our initial China investment. As we head into the end of our fiscal year, we are in a superb financial position. Year-to-date revenues are ahead of last year's record levels, and our outlook for the 4th quarter puts us on pace to improve on last year's total. Our cash balance continues to be strong despite paying off our convertible debt and funding our expansion into China. Our outlook remains positive as we strive to hit our fiscal 2020 targets of $630 million in revenue and 80 cents of EPS.
Overall, business conditions are more challenging today than when we first established those goals 15 months ago, but we still believe they are attainable, and we remain optimistic about our long-term outlook. Revenues to China this quarter grew, representing 25% of total revenue, and reaching record levels as growth for FPD masks more than offset IC softness. FPD was up 31% sequentially and 61% compared with last year, with China now making up 53% of our FPD revenue. We continue to be the vendor of choice in the AMOLED reticle market, and revenues for G10.5+ masks increased as our Hefei facility became qualified for more applications. The demand for large-format masks should increase going forward as more panel fabs begin production and new designs are released at both new and existing plants.
China IC softness appears to be primarily related to geopolitical issues that are slowing demand for some of our customers. It is undeniable that the level of uncertainty in China has increased as the trade war between the U.S. and China has escalated. In addition, rising tensions between Korea and Japan are challenging the supply chain for some of our customers. While these issues do not directly impact our products or operations, we are exposed indirectly as more and more of our customers are beginning to feel the impact. Even though our demand is design-driven and not necessarily tied to units of semiconductors or displays, uncertainty can cause some customers to become more cautious and slow the rate of new product releases, thus impacting our business.
We did see some of this in our China IC business in Q3, and we have tuned our CapEx plan yet again to better align expenses with revenue. Consequently, we expect to conclude the initial phase of our CapEx in Xiamen in the first half of 2020. Long-term, we believe the impact of the trade dispute to be a significant positive for our business because it significantly increased the resolve of our Chinese customers to fully localize their supply chain, and we have tremendous support from local customers with production ramping at both facilities, which should provide a tailwind as trade discussions progress and we successfully qualify for new applications. We are more optimistic than ever that China IC and FPD markets will be tremendous growth opportunities for us. Looking at the photomask market globally, mask demand is trending positive.
This is in part the result of companies using new photomask technology as well as design to differentiate their products. This differentiation creates more specialized and innovative solutions. These trends are great for Photronics. We have formed a global network that is unmatched by any other mask producer: 11 locations across the U.S., Europe, and Asia, strategically located close to customers. In addition, we have capability through advanced tools and processes to meet all of our customers' technical requirements. As the market evolves, we continually evaluate our operations to ensure we align and support our customers' technology roadmaps with the optical mix of manufacturing assets. Recently, we have been successful in securing long-term customer commitments to reduce the risk and improve the potential financial return of capital investments. We are looking to expand upon this approach to developing new business once we complete the initial phase of investment in China.
We have performed well through the first nine months of 2019, and Q4 looks like it will follow the same trend. Our financial health is very good, and our addressable market is growing as more fabs come online and the amount of design activity increases. I'm pleased with how we are performing and excited about our potential to grow and extend our leadership position. I am very grateful to all our employees worldwide for their skill and professionalism, as well as their willingness to do what it takes to win in a very challenging environment. The results speak louder than any words possibly could. Bringing the China facilities online would have not been possible without the extraordinary efforts of everyone involved in the planning and execution of the construction and production ramp over the past two-plus years. I would like to thank all of our employees for their hard work.
We are off to an excellent start. The ramp is accelerating, and I believe that our future is extremely bright in China. At this time, I will turn the call over to John to provide commentary on our performance and outlook.
Thank you, Peter. Good morning, everyone. Revenue in the 3rd quarter was $138.1 million, 5% better than the previous quarter and 1% better than the 3rd quarter of last year. Our design-driven business model and broad product diversity have enabled us to continue to grow revenue despite a semiconductor industry downturn and a challenging geopolitical environment. We are also beginning to see the impact of our new China facilities as they ramp production. Together, they contributed approximately $6 million in revenue. IC revenue in the 3rd quarter improved 2% sequentially to $100.2 million on demand from Asian foundries for mainstream nodes. High-end was flat sequentially as macro uncertainty continued to weigh on demand. Compared with Q3 last year, high-end IC was lower on softer logic and memory demand. Looking forward, the underlying demand drivers for IC look positive, but geopolitical factors may delay a recovery beyond the next quarter.
FPD business continued strong this quarter, setting a record with revenue of $37.9 million, 15% better than Q2 and 30% better than Q3 last year. Mobile AMOLED displays were the primary driver of the increase as our customers in Korea and China continued to release new innovative designs. We also benefited from an increase in capacity as we ramped production in China, including G10.5+ photomasks. We expect sequential FPD growth in the 4th quarter. AMOLED demand should remain healthy, and shipments from the new China plant should continue to increase. Gross margin improved sequentially to 22% as revenue growth and a more favorable product mix offset the impact from China startup activity. Operating margin improved to 10%. We had a modest increase in operating expenses due to qualification activity in R&D expense.
In total, China operations were a $6 million headwind to operating income, although the tax benefit of those costs and the JV partners' share reduced the overall impact on EPS to 4 cents per share. We expect that effect to decrease going forward. Other income expense was a modest expense this quarter, consisting of miscellaneous interest expense. Prior quarter had a one-off FX gain that did not repeat in Q3. Minority interest increased compared with last quarter due to increased revenue and earnings at our Taiwan JV, partially offset by losses from our China JV. This resulted in net income attributable to Photronics, Inc. shareholders of $6.3 million or 10 cents per diluted share. Our cash balance increased $30 million during the quarter to $197 million.
We generated $26 million in cash from operations, received $12 million in government incentives from China, and borrowed an additional $14 million in China for equipment purchases. CapEx in the quarter was $20 million, bringing the year-to-date total CapEx to $160 million. Total CapEx for the year is expected to be $185 million as we near completion of the initial phase of our China investment. The remainder of the China IC investment will be completed in the first half of 2020. Before I provide 4th quarter guidance, I will reiterate the reminder that our visibility is always limited as our backlog is typically only one to two 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 revenue and earnings for a quarter. Lastly, I'll caution that any development from the ongoing trade discussions between the U.S. and China or growing tension between Korea and Japan could potentially have an adverse impact on our industry and therefore our results. Given those caveats, we expect 4th quarter revenue to be in the range of $143-$151 million. We assume that our IC markets will be stable to improving, and FPD will see continued strength in AMOLED for mobile displays. We also anticipate a larger contribution from our new China facilities.
Based on this revenue expectation and our current operating model, we estimate earnings for the 4th quarter to be in the range of $0.11 to $0.17 per diluted share. We are pleased with our performance in the 3rd quarter as we have grown revenue, meeting our expectations in an environment that has become progressively more challenging. We are positioned to finish the year ahead of last year's pace with two new production facilities in the important China market. Our balance sheet has remained healthy even as we have made significant investments for future growth, and we are poised to deliver on our commitments as we enter 2020. I'll now turn the call over to the operator for your questions.
Ladies and gentlemen, if you have a question at this time, please press the star, then the number one key, or you can type show and telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from Tom Diffely with D.A . Davidson. Your line is now open.
Yes. Good morning and great outlook in this tough environment right now, so Peter, I guess when we look at the slowdown or the geopolitical risk in China, does that impact more on the high-end side or the mainstream side? Is there any way to discern where the biggest impact will be?
Yeah. It is now more what I would describe as broad-based. I basically spent the first half of August in China, and if you look back two or three months ago, the trade war was obviously going on, but it really wasn't present in the active dialogue. Now it's on the tip of almost every customer's tongue, so it's generally affecting their local market, and particularly with the threats that were in place when I was in China regarding the additional 10%, it was hanging out there regarding the largest export market. Some of that is, at the present time, damped down, but who knows what tomorrow's Twitter feed will bring, so it's very hard for anyone to quantify. As I said in my remarks, it's a short-term drag.
Long-term, it's a clear accelerant for the China market, and it's an accelerant that is shared not just by the customers but by the government as a whole. So long-term, undeniably, it's positive. Short-term, negative. Like I said, hard to really gauge in the next few months what the real impact looks like because it's a dynamic situation.
Okay. I guess just one more, following up on that. Have you seen it impact your four key new customers for the two Chinese facilities as well?
See, no impact in the FPD business at all. In fact, if I look at FPD, we can say with pretty good confidence that that market through the end of the calendar year, not just the end of our fiscal year, is going to be very strong. So no impact in FPD. One of our, in fact, our largest Chinese IC customer has Huawei as a very large customer. So there is an impact there, and anyone would expect it. But aside from that, not a lot of additional headwind.
Okay. That's very helpful. And then, John, a question about the cost structure. With the delay in spending on the last tranche of CapEx, does that mean that the cost structure that we're seeing next quarter doesn't fully represent the true cost of China, that those costs will go up over the next couple of quarters?
The delay is a tool that's going to be delivered during 2020. The depreciation associated with that would come in in 2020, Tom. Yeah, to the extent that that's into the future, it's not reflected in next quarter. That would also bring revenue with it, so.
Okay. Is that a meaningful slug, or is it a tool amortized over multiple years that isn't too great on a quarterly basis?
Want to repeat that, Tom? Thanks.
I was wondering if it's going to be a material impact to the cost structure when it hits the books or if it's going to be amortized over a longer period of time where it's not too impactful on a quarterly basis?
No, it's amortized over a long period. So the impact of that tool alone wouldn't be material.
Okay. And then finally, just a question for Chris. When you look at the high-end, it's roughly two-thirds of flat panel, one-third of the IC business that you have. Is that ratio fixed based on your tool set, or can the high-end portion go up with demand if need be?
I don't think it's fixed based on the tool set, Tom. I think the high-end portion can go up. I'd say particularly on the IC side, perhaps more than the FPD side. There may be a little more constraint on FPD, but on the IC side, definitely, we have capacity at the high end to deliver a larger fraction of our IC revenue with our existing tools, and we have made some investments this year, and John alluded to one next year, which will allow us to grow share and grow our percent of revenue on the high end as well, so it isn't really fixed. We do tend to sometimes run more mainstream or what's called the lower-end masks on higher-end equipment if necessary based on the dynamics of the market. There's a little of that going on, but not too much.
I think we have a lot more to grow the high end with the existing tool set.
Great. Thank you. Thanks for your time.
Again, if you have a question, please press star and then one. Our next question comes from Patrick Ho with Stifel. Your line's now open.
Hi, good morning. This is Brian Chin from Patrick Ho. Thanks for letting us ask a few questions and congratulations on the results. Maybe the first question for you. Looking at that $630 million fiscal 2020 sales target, I'm kind of curious how much flat panel sales out of the China facility is sort of assumed in that revenue level. And for a baseline, can you give us a sense exiting this fiscal year, so in fiscal 4Q, how much roughly revenue you expect the China facility to contribute on the flat panel side?
Yeah. So, Brian, 15 months ago, right, when I think we set the target out there, we looked and said we expected about $150 million of incremental revenue coming from the combined China factories. We did not quantify the split between FPD and IC. Coming out of the current year, we do not expect the China factory to have maximized its revenue on the FPD front yet because in the fourth quarter, right, we're still qualifying customers for specific products in our FPD fab. What we have said that exiting the fourth quarter, we expect the qualifications to essentially be complete with FPD. So moving into next fiscal year, the FPD fab should be largely running production or the number of qualifications happening should be consistent with what we see in our other FPD factories in Taiwan and Korea. Nothing's changed about that.
By the end of this year, this fiscal year, we think quality done. We're making good progress. We got a lot of customers now qualified in China. So Q1 is kind of the first quarter where Hefei is running full capacity. Having said that, as the year moves on, we expect more G10.5 demand in the form of new factories to come online. That will change the revenue mix in Hefei and give it additional revenue momentum. So that's kind of the trajectory on FPD. As far as IC goes, this quarter, we just shipped out the first reticle sets at the end of the quarter. So it was not a material contributor to revenue. Don't expect it to be this quarter either. What you did here is we pushed CapEx out into next year. Original guidance was $210 million. We ratcheted that back to $185 million.
So you kind of quantify the amount of CapEx push-out it was. It's not trivial. But what we can do and what we have done for years is mix and match. So we can build certain reticles of a set in China and others elsewhere. Most likely, Taiwan is where the bulk of that activity is underway right now. A small amount in Japan because, of course, DNP is our partner. So we can use the mix and match strategy so we don't miss any revenue opportunity. So really, it's just simply an expense push-out. And then hopefully, with that two-quarter shove, we'll be beyond the nonsense that at least I would describe as nonsense called the trade war and will be able to pick up without a lot of disruption with IC. So IC by middle of next year should be through the qualification phase and ramping revenue strongly.
That is because we're right now using a mix and match strategy to not lose momentum.
Okay. All right. Thanks, Peter. I appreciate the color. Maybe again, just pegging against that $630 million top-line target for next fiscal year, can you remind us again sort of what the CapEx assumption is against that revenue level and also what you envision through the full year with the gross margin and/or EPS drag would be relative to the startup cost throughout the fiscal full year?
Yeah. Well, I think what we have historically said was we expect maintenance CapEx to be about $50 million. Right. But now you've heard we pushed some CapEx that was expected this year into next. So you can kind of work the simple math on that yourself. John also commented we see this quarter as being the inflection point for China drag on EPS. I'll turn it over to John. John, do you want to add something or maybe give a more direct or expansive answer?
Yeah. So as I mentioned, the effect this quarter was $0.04 a share. And as our revenues increase in China and offset some of these cost of goods, the fixed costs will start generating more profit. So that $0.04 should decrease going forward.
Okay. So maybe less than a $0.10 impact perhaps through the full fiscal next year?
One would hope. We expect to be profitable in China overall after this quarter.
Got it. Maybe one more thing. In terms of the IC side, just curious if there's a way to quantify what that drag was on the top from a revenue perspective in fiscal 3 Q and/or expected in fiscal 4 Q. And also, Peter, if you have any sort of commentary about how the memory IC photomask business is trending. There's obviously been some reduction in output recently. And just kind of curious what you're seeing in that part of the business. Thank you.
Yeah. Our IC revenues in China went back to Q1 levels. So we lost the growth in Q2, in Q3. Again, it's a very fluid, dynamic market. We're not expecting, as John said in his guidance, the market to deteriorate more than it has on the IC front. So that's the best I can do to again, you can do that simple math and you'll know what kind of a drag that was on the top line that basically represents anyways. So that's pretty straightforward. As far as memory goes, the downturn in memory, as I think everyone is aware, has been very severe. Our memory business has held up pretty well in the face of the downturn. It's been up and down a little bit quarter to quarter. We're not expecting that memory is going to materially improve until calendar year 2020.
Exactly when in calendar year 2020, I think right now is hard to predict.
Got it. So not necessarily improve till next calendar year, but not necessarily be a drag, incremental drag on the business either?
Yeah. Not necessarily. Not change materially, right, because our customer base is in memory pretty diverse. Right. We have the best, we think at least we have the best photomask technology for memory globally. We do, as I think others, expect NAND to recover in advance of DRAM. But again, it's tough to know exactly when that happens. It's a 2020 event. Time will tell exactly when because we all are operating in an environment where we have the normal industry cycle. And just remind you, when we put our targets in place 15 months ago, we explicitly said they contemplated a downturn, which we're in. But we didn't contemplate the extra noise going on with trade wars and weaponizing photoresist and the rest. So nobody knows, at least nobody I talked to, knows what that means next week, let alone next year.
Okay. Very clear. Thank you, Peter.
And at this time, I'm showing no further questions. I'd like to turn the call over to Peter Kirlin for closing remarks.
Thank you for taking the time to join us this morning. We are pleased with our performance this quarter and believe we have done a great job of maximizing our business in light of the current environment. At the same time, we know there is much more we can do to truly exploit the opportunities ahead. Our future looks good, and we are well positioned to continue to grow in 2020 and beyond.
Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.