Tower Semiconductor Reveals Optimistic Forecast Despite Underwhelming First Quarter

2017 was a record-breaking year for Israel-based wireless chip and camera sensors manufacturer Tower Semiconductor Ltd., with a quick growth in revenue and a jump in the company’s net profits.

After years of piling up losses and debt that required substantial dilution of the company’s shares, Tower has, in recent years, began reporting impressive profitability and stock value jumped. In 2017, Tower reported revenues of $1.39 billion, compared with $1.25 billion in 2016. Tower’s 2017 net profit was up to $203 million, compared with $154 million the year before.

Tower CEO Russell Ellwanger . Photo: Eran Sokol

But looking at Tower’s reports for the second half of 2017 and the company’s lukewarm forecast for the first quarter of 2018, which predicts lower revenues compared with the same period last year, shows that the company is no longer growing in the same accelerated pace.

Tower’s strategic collaboration with Panasonic, a five-year deal signed in 2014, makes up a large part of Tower’s growth potential, but it also represents a risk. The upcoming quarterly reports will determine if Tower has passed its peak or if CEO Russell Ellwanger is right to be optimistic. Following the publication of the company’s annual report, Mr. Ellwanger forecasted Tower could reach 10% organic growth in 2018 in an earnings call.

The company operates two manufacturing facilities in Israel, a facility in California and an 8-inch wafer fabrication facility in San Antonio, Texas, which it acquired in 2016 from Maxim Integrated Products, Inc. Tower also operates three factories in Japan as part of its joint venture with Panasonic, in which Tower holds a 51% stake.

A comparison of the company’s annual reports for 2016 and 2017 paints a positive picture with an 11% growth in revenue year-over-year. Tower receives relatively fixed income from Panasonic—$400 million annually—and from its deal with Maxim. Aside from the income coming from Panasonic and Maxim, Tower’s revenues for 2017 represent year-over-year growth of 25%. The net cash flow for 2017 was $191 million.

Tower’s operating profit for 2017 was 15.8%, compared with 14.1% the year before. Mr. Ellwanger said he presumed the company’s operating profit will continue to rise in 2018.

Tacoma chairman Joseph Lee and Tower CEO Russell Ellwanger signing a partnership agreement

Tower’s activity is seasonal—revenue and profit in the first quarter of the year are typically lower and tend to be at a maximum in the fourth quarter. The growth pace from quarter to quarter in 2017 matches this tendency, but it does not reflect the significant growth that characterized 2016. In fact, the changes in operating profit from quarter to quarter in 2017 suggests stagnation, even a decline in the last two quarters compared with a record-breaking second quarter of 2017.

Tower’s sales forecast for the first quarter of 2018—which at $325 million is $5 million lower than the sales in the same period last year—shows growth is stopping.

This trend could be partially attributed to irregular capital investments of $210 million which the company made in 2016. In both 2015 and 2017, Tower’s capital investment amounted to $165 million annually. These investments are tied to specific orders Tower delivered in the last half of 2016 and first half of 2017. These orders contributed to Tower’s revenue and profitability in that period, which Tower is now having difficulties matching.

Tower needs to work at an 85% capacity in its production facilities to maintain efficiency. In the fourth quarter of 2017, Tower’s fabrication facilities in Israel were operating at a capacity of 93% and 85%. The capacity of the California facility was 76%, and the Texas facility was producing at a 55% capacity. The average capacity of the Panasonic facilities was 60%. Tower’s growth potential lays with increasing the manufacturing capacity in its Panasonic facilities, the San Antonio facilities, and one of its Israel-based facilities.

Tower’s joint venture with Panasonic makes up the lion’s share of Tower’s growth potential in coming years. In April 2019, Panasonic would be eligible to try and alter the terms of the deal. The joint venture includes the ownership of the machines, workforce, and manufacturing rights in the three Japanese facilities, but not the facilities themselves, nor the land, which remain in the sole ownership of Panasonic. The joint venture pays Panasonic $13.4 million in annual rent for the use of its facilities. Panasonic is committed to sending these facilities $400 million worth of orders a year.

An extension of the deal will give Panasonic the opportunity to renegotiate its terms, which could negatively affect Tower.

As part of Tower’s 2016 deal with Maxim, the U.S.-based analog and mixed-signal integrated circuits manufacturer committed to providing the facilities with order over a period of 15 years. The Maxim orders should cover the facility’s expenses by 2021, but the orders from the company are expected to drop gradually.

In August 2017, Tower received $18 million for consulting, training, and management services provided to Hong Kong-registered holding company Tacoma Technology Ltd. as the latter establishment a new facility in China. As part of the Tacoma deal, Tower would be able to use up to 50% of the manufacturing capacity of the new facility, estimated at up to 40,000 silicon wafers a month. Tower is expected to begin using the China facility during 2019.

The majority of Tower’s sales are to customers in the U.S. (52%) and Japan (32%). While most of Tower’s main target markets are showing growth, the first quarter of 2018 saw a global slowdown in chip manufacturing, which likely contributed to Tower’s lower-than-expected forecast.

During Tower’s earnings call, Mr. Ellwanger said the company’s sales target for 2018 is valued at $2.3-2.5 billion, which he said Tower could reach organically by expanding manufacturing capacity in all its facilities.

Due to plans for additional purchases and investments, Tower has avoided giving out dividends despite experiencing a positive cash flow. The company expects organic growth of 10% in 2018 compared with 2017. This is an optimistic forecast taking into consideration the fact that the first quarter of 2018 is showing zero growth.

Uri Tal Tenne is an economist at an Israel-based tech company.