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TowerJazz (TSEM) EPS Estimates Raised But Capacity Plans Still Not Settled

By Lisa Thompson


TowerJazz (NASDAQ:TSEM) reported another record quarter in terms of revenue and profitability. While revenues were exactly on target, net income was helped by a reduction in taxes and profits at the Japanese TPSCo subsidiary. According to a previous agreement, once revenues hit a certain level at TPSCo, the business was to start paying royalties to Panasonic and TowerJazz. Since Japan is the country in which TowerJazz pays taxes, by paying a royalty to the owner companies, profits and therefore taxes are reduced for TowerJazz. So while gross margins now come in lower at TPSCo, net profits are up as TowerJazz pays less in taxes. This new structure has caused us to raise 2018 estimates significantly as TPSCo profits are reduced.  This reduces minority income subtracted from profits by $25 million, and a 2018 reduction of taxes of $23 million. As a result we are raising 2018 fully diluted GAAP EPS to $2.21 and diluted non-GAAP EPS to $2.36 from $1.89 and $2.07

Business continues solid and the company gave midpoint guidance for Q4 at $358 million in revenues. This is up $3 million from previous sequentially flat expectations. Gross margins should continue to be lower as the royalties at TPSCo continue, with an even higher offset being in taxes. The focus of investors continues to be on what the company will do to increase capacity. Current operations have a revenue run rate capacity of $1.6B, which is a $400 million quarter. TowerJazz continues to scour the earth for fire sales of foundries, foundry equipment, and partnerships to add capacity at cheap prices. It continues in talks for all three solutions. Certainly a purchase or partnership structured like TPSCo or Maxim would let TSEM add capacity at very low incremental costs, but it is prepared to also expand its current facilities to meet demand. Since it has so far been unable to find used equipment at bargain prices, it has not started on the internal expansion solution as hope springs eternal for better economics. Management indicated that if they were not successful in negotiating a deal with a third party, it would let investors know when it reports earnings for the year how it plans to expand its current facilities. Its current possibilities include adding buildings and equipment in San Antonio and/or in its 300mm fab in Uozu, Japan. In San Antonio capacity can be increased by 50-60% and that process could start at any time. Capacity in Uozu could be tripled but it would be expensive to buy tools.

Q3 Revenues on Target; Tax Strategy Creates Earnings Beat

TowerJazz reported Q3 2017 revenues of $355 million versus last year’s $326 million, up 9% and $345 million in Q2 2017. This was the exact guidance. The company gave midpoint guidance of $358 million for revenue for Q4 2017, pointing to year over year revenue growth of 5%. This is $3 million higher than previous guidance for flat sequential revenues. This quarter TSEM’s revenues reflected organic growth, ex-TPSCo, and Maxim, of 20%, down from 26% growth in the June quarter. 

Gross margins had a setback in the quarter due to new royalties kicking in at TPSCo. Gross margin for the quarter was 25.1% versus 24.9% last year, and 26.4% in Q2 2017. Sequentially the additional $9.5 million in sales generated $1.9 million fewer gross margin dollars due to new royalty payments at TPSCo. TPSCo is now paying its owners, Panasonic and TowerJazz, royalties because it has hit a prespecified revenue level. Since TPSCo pays taxes in Japan, lowering profits there also lowers taxes paid. So by paying the parents a royalty, TowerJazz manages to make even more after tax money that if the profits were left in TPSCo. As a result despite gross margin and operating profits being hit, on a net income basis TowerJazz comes out ahead. We expect this strategy to continue in future quarters. 
While revenues grew 9%, operating income grew 13%, to 16% of sales. This was down from 43% growth in Q2 due to the new royalties. There was a tax reversal of $3 million in the quarter. For the first three months the company paid $4.7 million in taxes. In Q4 we expect the company to pay $500,000 in taxes continuing at the nine-month rate.

Fully diluted GAAP EPS was $0.54 versus $0.52 a year ago. Adjusted Non-GAAP EPS was $0.60 versus $0.51, up 7%. Adjusted EBITDA was $109 million versus $97 million a year ago. At yesterday’s closing price, this is an enterprise value to EBITDA run rate of 7.8 times. 


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