Tower Semiconductor Ltd

NASDAQ:TSEM

Earnings Call Transcript 2018-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to the TowerJazz Second Quarter 2018 Results Conference Call. All participants are currently present in a listen-only mode. Following management's prepared statements, instructions will be given for the question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded, July 26, 2018.

Joining us today are Mr. Russell Ellwanger, TowerJazz's CEO; and Mr. Oren Shirazi, CFO.

I would now like to turn the conference call over to Ms. Noit Levi, Vice President of Investor Relations and Corporate Communications. Ms. Levi, please go ahead.

[Noit Levi, VP, IR and Corporate Communications]

Thank you, and welcome to TowerJazz financial results conference call for the second quarter of 2018. Before we begin, I would like to remind you that some statements made during this call may be forward-looking, and are subject to uncertainties and risk factors that could cause actual results to be different from those currently expected.

These uncertainties and risk factors are fully disclosed in our Forms 20-F, F-4, F-3, and 6-K filed with the Securities and Exchange Commission, as well as filings with the Israeli Securities Authority. They are also available on our website. TowerJazz assumes no obligation to update any such forward-looking statements.

Now, I'd like to turn the call to our CEO, Mr. Russell Ellwanger. Russell, please go ahead.

[Russell Ellwanger, CEO]

Thank you, Noit. Welcome to our second quarter 2018 results conference call, thank you for your interest. Our second quarter results were in line with the expectations, with revenues of $335 million, a 7% increase over the prior quarter. EBITDA for the quarter was $96 million, representing a 55% contribution from incremental growth for our model. Net profit for the quarter was $38 million. We generated free cash flow of $37 million.

Our first half represented a 4% decrease as compared with the same period of 2017, following regular industry seasonality with also the industry noted specific mobile market weakness, with some customer inventory corrections due to over ordering at the end of a very strong 2017.

Where it was possible to transfer for the benefit of higher margin, silicon germanium capacity in Fab 3, we transferred several non-silicon germanium aura flows [ph] to San Antonio for qualification, but not everything could transfer leaving some gap.

Lastly, having expected the recovery, which did not occur from recent reports it is apparent that one of our major power management customer’s end customer has lost substantial market share. This revenue will be restored through our 300 millimeter activity, which we will talk about.

Entering the third quarter, we have the proper wafer start plan and product mix to transition us to a fourth quarter targeted record revenue. For the silicon germanium infrastructure technology, given its strong and higher than originally expected customer demand. And hence the high number of customers in flow variant that needed to be qualified, the shipment profile from recently added capacity is pushed up slightly.

Customers were notified of increased silicon germanium capacity and starts have now been maximized expecting full revenue realization in the fourth quarter. As our customers, mid to long-term demand for silicon germanium exceeds our newly acquired capacity we are investing in additional CapEx for our Newport Beach facility, targeted to begin qualification in the first quarter of 2019. Additionally demand remained strong for discrete power and all of our 300 millimeter offering.

Our major focuses for this year are, firstly, various organic activity focused on increasing our served market, targeting additional mid to long-term organic growth. These include among other analog, artificial intelligent, virtual reality, silicon photonic, sensors and automotive sensor fusions. And for the short-term the two major focuses have been, Newport Beach mix shift to high end silicon germanium infrastructure market and ensuring high yielding flow capabilities for the Q3, Q4 400 -- 300 millimeter ramp.

In line with this, we continue to see growth second half versus first half of this year, forecasting the third quarter mid-range guidance flat of $355 million and transitioning to a targeted record fourth quarter revenue of about $360 million to $380 million, representing above 25% organic Q4 growth over Q1.

The growth drivers remain as stated, the 300 millimeter production ramp and the increased capacity and customer demand for silicon germanium. First in reference to 300 millimeter, over the past years TowerJazz and our TPSCo 300 millimeter factory has developed and refined process flows and PDK offerings in three strategic segments. Namely, radio frequency, power management, and CMOS image sensor.

The specific end markets we are serving in these segments are RF low noise amplifier and switch for mobile application, low voltage power management ICs less than 30 volt, with an industry lowest RDS (on) on figure of merit and associated 65 nanometer logic circuitry benefit and image sensors for multiple end market applications to include machine vision, DSLR, medical X-ray and surveillance.

We continue to engage with multiple industry leading customers in an effort to meet or exceed their stringent state-of-the-art figures of merit. The fruits of our labors can be observed in the high number of new products introduced into our 300 millimeter factory being well distributed over the three general market segments. I’ll provide additional information for each of our business unit activities later in the call.

Secondly with silicon germanium, we continue to focus on qualifying and increasing our silicon germanium manufacturing capacity in both our Newport Beach and San Antonio manufacturing facilities. We just recently reached the full wafer start capacity in Newport Beach, which is a 75% ramp in Silicon germanium against the 217 Newport Beach run rate.

And while the ramp and start is only a small impact to wafer output in the third quarter, we will see full revenue impact in the fourth quarter of this year. We are progressing well with the San Antonio silicon germanium qualification adding an additional 25% capacity against our 2017 run rate with production starting in Q1, 2019 and ramping through the third quarter of 2019.

Strong customer demand in silicon germanium not only continue, but is increasing, resulting in additional tool buys for Newport Beach, which will enable our further increase of over 15% silicon germanium output, which should be running and in qualification at the end of the first quarter of 2019. We plan significant revenue production ramp in the fourth quarter, positioning ourselves with accelerate our organic growth, carrying forward into 2019.

In terms of utilization rates in the quarter, Migdal Haemek Fab 1, our six-inch factory was at 95% utilization, Fab 2 our eight-inch factory was at about 85%. Both have increased compared with 90% and 80% respectively in the previous quarter. The Newport Beach California Fab 3 our eight-inch factory we are at about 85% utilization versus 80% in the prior quarter.

The 3 TPSCo factories had an average of about 50% utilization, similar to that of past quarter with third quarter start ramp in 300 millimeter planned to triple the present run rate. Our San Antonio factory Fab 9 was about 60% utilization compared with 55% last quarter, with an expected 20% increase in the third quarter for third party wafer starts.

Additionally, with regards to our operations, we have recently notified our customer base of a price increase as a result of continued silicon price increases to us. Our industry is experiencing shortages of silicon wafers along with significant price increases. With the strong business continuity plan in place, our global sourcing organization has ensured sufficient silicon supply thus mitigating any and all shortage impact to our customers. As part of this BCP, we have qualified multiple suppliers and or entered long-term supply agreements for each of the more than 50 silicon substrate types that are required for our customer products.

We have been successful at minimizing substrate cost increases through these multi-sourcing activities. To-date we have absorbed this increase through other general ledger accounts with the hope that the substrate market would normalize. But with the continuation of this trend, we have notified our customers of silicon wafer price attars to new orders, which should positively impact 2019 revenue and margins.

I would now like to spend some time discussing performance specific to our various business units. Starting with the RF high performance analog business unit. We have strong and continued growing demand for silicon germanium. This is driven by the 100 gigabit per second data center and cloud computing segments for which we manufactured fiber optic components.

As stated, we have begun wafer starts to full capacity of this silicon germanium ramp and expect to see the full revenue impact of the increased SiGe capacity in the fourth quarter and are adding even additional capacity in Newport Beach targeted to be in qualification by the end of first quarter 2019. We also expect to be in revenue SiGe shipments from our San Antonio factory in the first quarter of 2019.

As part of the plan to move to a higher silicon germanium rich mix in Newport Beach, we executed a successful qualification and have begun a substantial ramp for RF SOI and other wafers in San Antonio that were displaced from Fab 3. To further increase our silicon germanium served markets, which is our most highly differentiated RF technology. We have added more content to the site for applications. And we are happy to report that we are beginning production of our first silicon photonics project and have launched multiple others, including a project that will ultimately integrate indium falsified lasers and modulators into the silicon photonics platform, process in our Newport Beach eight-inch facility.

For silicon photonics, our lead customer recently gave us their technology partner of the year award. We announced the initial ramp of 300-millimeter RF SOI in our Uozu facility in Japan. This is a significant milestone for our RF business units and for TowerJazz. As we take advantage of added capabilities and capacity at 300-millimeter. 300-millimeter provides our RF SOI customers, not only a very high performance switch, but also the ability to integrate state of the art, low noise amplifiers and large amounts of digital content on the same die.

While relevant for products today, this added capability can address a segment of the front end module market that we expect will grow significantly in the next years with the advent of 5G and MIMO technology that multiplies the numbers of antennas, low noise amplifiers and complexity required in a handset.

We also announced signing of substantial contract with SOI Tech to supply 300-millimeter RF SOI wafers, ensuring customer supply for years to come. This contract adds to our already strong 200-millimeter business with SOI Tech. For continued leadership in mobile platforms over the next years, we continue our RF SOI roadmap, but also are working on advanced technologies that can leap frog present RF SOI performance.

This includes RF MEMS we have customer programs and are delivering today volume production on initial generation products, as well as working on next generation projects that will address a much larger portion of the total RF switch market, as well as a new proprietary technology that relies on different material to provide breakthrough switch performance for which we are now engaging lead customers.

Moving on to the CMOS image sensor business unit. We had announced the new 25 megapixel sensor using our state-of-the-art and record smallest 2.5 micron global shutter pixels with Gpixel, a leading industrial sensor provider in China.

The product is achieving very high traction in the market with samples having been delivered to major and to customers. Another leading provider in this market, who has worked with us for many years will soon release a new global shutter sensor based on the same platform. Both of the above mentioned sensors are the first for families of sensors with different pixel count resolutions for each of those customers next generation industrial sensor offering ranging from 1 megapixel to above 100-megapixel.

We expect this global shutter with this outstanding performance based on our 65-nanometer 300- millimeter wafers to drive high volumes in 2019 and the years following. We see this as a key revenue driver from our industrial sensor customers. In parallel, e2v is ramping to production with its very successful Emerald sensor family on our 110-nanometer global shutter platform using state-of-the-art 2.8 micron pixel with best in class shutter efficiency and noise level performance. We recently released our 200-millimeter backside illumination for selected customers.

We are working with them on new products based on this technology, as well as on upgrading existing products from our front side illumination version to a BSI version, increase in the quantum efficiency of the pixels by using BSI, especially for the near IR regime within the industrial and surveillance markets, enabling our customers improve performance of their existing products. As a bridge to the next generation family of sensors in our advanced 300-millimeter platform.

The medical X-ray market, we are continually gaining momentum and are working with several market leaders on large panel dental and medical CMOS detectors based on our one dye per wafer sensor technology using our well established and high margin stitching with best in class high dynamic range pixels providing customers with extreme value creation and high yield both in 200-millimeter and 300-millimeter wafer technology.

We presently have a strong business with market leadership in this segment and expect substantial growth in 2019 on 200-millimeter with 300 millimeter initial qualifications that will drive an incremental growth over the next multiple years.

For mid to long-term accretive market growth, we are progressing well with a leading DSLR camera supplier and have as well begun a second project with this customer, using state-of-the-art stacked wafer technology on 300-millimeter wafers. For this DSLR supplier, the first front side elimination project is progressing according to plan, expecting to ramp the volume production in 2020, while the second stacked wafer based project with industry leading alignment accuracy and associated performance benefits is expected to ramp to volume production a year after.

In the narrow network field, we made substantial progress and expect that we will start to ramp multiple mobile platforms towards the end of 2019. In addition, we are progressing on two very exciting programs in the augmented and virtual reality markets, one for 3D time of flight-based sensors and one for silicon-based screens for a virtual reality, head-mount displays.

We are addressing the power management IC market with four major activities. First, best in the world up to 16 volt 300-millimeter, 65 nanometer BCD platform. Secondly incorporating 1.2 volt to enable high-gig count logic to this previously mentioned best-in-world flow, adding advanced reprogrammation NVM to our 0.18 micron BCD platform. And fourthly, adding high-voltage offering of up to 140 volt breakdown to the 0.18 micron BCD platform.

I'll spend a little bit more time on the first two activities. Our 65 nanometer platform provides a unique combination of advantages over the competition. With an ultralow RDS on, less than 1 milliohm square meter to the 5 volt LED mass versus the otherwise industry best of 1.1 milliohm square millimeter for IDM and 1.2 milliohm to 1.3 milliohm square millimeter for foundries.

For projects which operate at the megahertz switching frequencies, the 65 nanometer BCD powered transistor benefits from a very low Aura on QTD down to 2.6 milliohm nanocoulomb and low mass counts for the 65 nanometer BCD platform. This positions us as the technology leader in this multi-billion dollar market of up to 16 volt operational power management. And we continue to receive very high interest from multiple customers, including leading power management companies targeting a very wide range of products across various market segments. This includes, mobile Pemics load switches, battery management ICs for PCs and servers and DC-to-DC converters.

So far in the short time since we released the PDK, more than 20 customers has downloaded the design kit that are in various stages of evaluation and design. Multiple customers boarded our June wafer shuttle with products and test chips. The platform initial ramp to productions plan for the fourth quarter of 2018. And we expect this platform would one of our main power management growth drivers in 2019 and beyond.

Secondly, we are increasing our market coverage by expanding this platform to support 1.2 volt transistors targeting to release this quarter. These advantages will provide our customers with performance superiority, as well as with new opportunities for integrated high-gig count logic with power managed devices all on the same dye. The integration of logic and power management will enable new types of devices and will significantly reduce the overall system level costs as well as minimize the PCB footprint. This for the reason that two different ICs will be integrated into one.

To discuss the TOPS business unit, the focus of our TOPS business unit is working with our customers to co-develop and or transfer unique process growth, for which we provide capacity under a long-term supply agreement. Throughout the first half of 2018, we successfully ramped our TOPS capacity in multiple of our manufacturing facilities. The greatest revenue portion of it is based upon IDM partnerships, specifically driven through co-development of discrete power device next generation platforms, built upon customers transfer technology.

Significant dimension, these activities are now loading our first facility our six-inch facility even presently to record breaking high utilization rates. The second focus in this business unit, our partnerships for co-development for unique market application or very unique process features or implementation of unique technologies for highly differentiated end products and product applications. Example for the latter are biosensors differentiated magnetic sensors, digital MEM speakers and specialized high-end accelerators. Among this grouping, we have recently started engagement with a lead Tier 1 customer at our 300-millimeter facility.

In summary, we have solid expectations for the latter half of 2018, especially with regard to organic growth in the fourth quarter, as a result of continued investment in our capabilities. We remain profitable and a strong cash generating business, serving various high growth markets and technology.

The second quarter showed our expectations are on track to achieve our financial model targets with incremental growth operating and EBITDA margins of between 50% to 60% on incremental revenue growth.

With that, I would like to turn the call over to our CFO, Oren Shirazi, Oren please.

[Oren Shirazi, CFO]

Thank you, Russell and welcome everyone. Thank you for joining us today. I’ll start by providing the P&L highlights for the second quarter of 2018 and then discuss the cash flow and balance sheet.

Revenues for the second quarter of 2018 were $335 million, a $22 million or 7% revenue growth over the previous quarter, which resulted in $12 million in higher gross, operating and net profit, reflecting approximately 55% incremental profit margins over the $22 million revenue increase. Gross and operating profit for the second quarter of 2018 increased to $79 million and $44 million respectively, representing an increase of 19% and 39% over the prior quarter respectively.

Net profit was $38 million or $0.38 per share basic, $0.11 higher as compared to $26 million or $0.27 of basic earnings per share in the previous quarter. The net profit represents an increase of 45%, which reflected a 52% incremental margin increase. EBITDA for the second quarter was $96 million and free cash flow was $37 million. EBITDA for the second quarter of 2018 reflect $12 million better EBITDA than the prior quarter or 13% EBITDA growth.

I would like to note that the non-controlling interest was a $1.7 million positive amounts for the quarter, which represents our GAAP net loss at TPSCo. This was due to the royalty structure we presented in the second half of 2017, under which the royalties from TPSCo to Panasonic and to TowerJazz are calculated as a percentage of TPSCo profitability under Japanese GAAP report.

The Japanese GAAP net profit does not differed much from the U.S. GAAP as far as TPSCo’s P&L excluding fixed asset depreciation. This item fixed asset depreciation is higher under U.S. GAAP when compared to JP GAAP, mainly due to valuation of the assets for the purchase price allocation done at the time of the TPSCo acquisition, which is used only for U.S. GAAP.

This is higher than the JP GAAP asset base, since the JP GAAP assets are measured according to the historical costs. This lower depreciation amount under JP GAAP results in higher profitability at TPSCo under JP GAAP for the second quarter. And royalties payments to Panasonic and TowerJazz as compared to the U.S. GAAP under, which the non-controlling interest line is calculated from the lower profit.

As a reminder this royalty structure results in a higher cost of revenue yielding a lower gross margin creating a lower tax expense and lower non-controlling interest, which ultimately generates greater net profit, greater cash and greater free cash flow.

I would like to discuss now our applicable and effective all-in tax rates. Our U.S. affiliates and TowerJazz Texas, which own our Newport Beach Fab and the San Antonio Fab respectively are subject to a 21% tax rate following the recent U.S. Tax Reform effective January 1, 2018, as compared to 35% prior to the U.S. Tax Reform.

Our profit in Japan are subject to an approximate 32% tax rate. Our profits in Israel from Fab 1 and Fab 2 operations while subject to 7.5% statutory tax rate are not expected result in any cash tax payments in Israel in the foreseeable future since we have more than $1 billion of NOLs, net loss carry forward to utilize indefinitely. Considering all this since we have seen tax exemptions discount and credits our all in worldwide weighted average effective tax rate was 7% for the second quarter of 2018. 6% for the first half of 2018 and 5% for the first half of last year.

The 2017 all in effective tax rate were lower than 2018. Mainly since, we commence to include the 7.5% Israeli statutory non-cash tax provisions for the Israeli operations from our 2017 fourth quarter. Following the realization of the tax deferred assets in that fourth quarter.

I will now provide the cash flow highlights for the second quarter and the balance sheet analysis as of the end of June 2018. Cash including short-term marketable securities net of gross debt as of June 30, 2018, total the record of $276 million as compared to net cash of $247 million as of March 31, 2018. The gross debt outstanding amount as of June 30, 2018, was $351 million. Comprised mainly of $140 million in bank loans and $180 million in debentures.

The main cash flow activities in the second quarter of 2018 were comprised of the following. Cash from operations of $77 million and investment in CapEx tools fixed assets net of $40 million, resulting in $37 million free cash flow. Also, we had $15 million investment in marketable securities and $4 million net of debt received.

In addition to debt, as we previously stated during the second quarter of 2018, we received an upgrade of our company general as well as our bond specific rating recommendation from Standard & Poor’s Ma’alot a wholly owned subsidiary of S&P global ratings, both ratings were upgraded to iLAA minus with a stable horizon from the previous iLA plus with a stable horizon. The upgrades are based on our strong balance sheet and financial profile as well as our ongoing solid operating performance strong EBITDA and generation of significantly cash flows.

Second update in relation to the debt in June 2018, we restructured our Japanese subsidiary loans originally due 2018, 2019 and 2020, which carried variable interest rates of TIBOR plus 1.65% and TIBOR plus 2% by early repaying them and borrowing instead $100 million new loan from three leading Japanese banks at better terms and longer duration. The new loan final maturity date is June 2025 and it includes a three grace period followed by 9 equal installments from June 2021 to June 2025 and carries a fixed interest rate of 1.95% per annum.

And lastly, in July, 2018, we early repaid $40 million loan, which was borrowed in 2016 from JA Mitsui U.S. in relation to the acquisition of the San Antonio Fab and its ramp up. The loan carried annual interest of ICE LIBOR plus 2%. Hence, its early payment will save the company between $1.5 million to $2 million per annum in interest and fees.

Net current assets presented on the balance sheet increased to $648 million on June 30, 2018, resulting in a current ratio of 3.1x. Shareholders' equity is at the record of $1.1 billion as of June 30, 2018 as compared to $1.03 billion at the end of the year 2017. Share count as of June 30, 2018 was 9 million in outstanding shares. Fully diluted share count as of June 30, 2018, included an additional 9 million maximum possible shares to be issued comprised as follows 2 million ease of related options and RSU, 6 million underlying convertible bonds and 1 million underlying capital notes. As a result the fully diluted share count has remained 108 million, the same as in previous quarters.

I would like to discuss now the currencies and hedging activities. In relation to the euro currency we have almost zero business in euros hence no exposure to the euro. In relation to the Japanese yen since all Panasonic revenues are denominated in yen and the vast majority of TPSCo's costs are in yen, we have a natural hedge over most of our Japanese business and operations, excluding the portion in which the yen denominated variable cost related to the third party foundry business exceed the yen net gains from the Panasonic business.

In order to mitigate a large portion of this net yen exposure, we have executed zero cost cylinder hedging transaction. This zero cost cylinder transaction hedge all currency fluctuation to be contained in a very narrow range as compared to the spot exchange rate. Hence, while the yen rate against the dollar may fluctuate, our margins were almost not impacted.

In addition, in relation to the Japanese yen impact on the balance sheet, we have a natural hedge on cash and loan balances since the loans and the cash are both yen denominated. This help to protect us from potential impact of yen fluctuations.

Lastly, in relation to the fluctuations of the Israeli shekel currency, we have no revenues in this currency. And while less than 10% of our costs are denominated in the Israeli currency, we also hedge a large portion of this currency risk using zero cost cylinder transaction, which headed in a narrow range.

This ends my summary. And now I wish to turn the call back to Noit Levi. Noit, please go ahead.

[Noit Levi, VP, IR and Corporate Communications]

Thank you, Oren. Before we open up the call to the Q&A session, I would like now to add a general and legal statements to our results in regards to statements made and to be made during this call. Please note that the second quarter of 2018 financial results have been prepared in accordance with U.S. GAAP. The financial tables in today's earnings release also include certain adjusted financial information that may be considered non-GAAP financial measures under Regulation G and related reporting requirements as established with the Securities and Exchange Commission.

The financial tables include the full explanation of these measures and the reconciliation of these non-GAAP measures through the GAAP financial measures. For the Q&A session, we are pleased to have with us [indiscernible]. And now, we will open the call for Q&A. Operator?

[Operator]

Thank you. Ladies and gentlemen at this time we will begin the question-and-answer session. [Operator Instructions] The first question is from Cody Acree of Drexel Hamilton. Please go ahead.

[Russell Ellwanger, CEO]

Hey, Cody.

[Cody Acree, Drexel Hamilton]

Hey, Russell. Thank you guys for taking my questions. Russell, if we can maybe start with the wireless outlook and the weakness it’s extending into the September quarter we’re seeing better indications from your customers regarding sequential growth into the second half, how do you pair that with what you’re seeing?

[Russell Ellwanger, CEO]

We’ve seen a major customer recently reduce its forecast for the third quarter is that due to a single end customer of theirs that had a very, very high demand, that’s maybe reduced the demand is due to possibly a loss of market share either way would not be -- I don’t know the exact answer I wouldn’t speculate on. But we certainly within the past weeks have seen a reduction in demand to a appoint that it was not forecasted even a month ago.

We have three other customers that are more reasonable size customers for us that have also showed weakness extending into the third quarter. So where others might be seeing strength, certainly we have not seen that across the base that we have in the area of the RF SOI more than that I can’t really state.

The people that we’re dealing with as far as our customers are very good customers with we believe excellent products and customer relationships. Some of what we're seeing right now is possible delay or reduction we believe will be made up it forecasted 300 millimeter RF SOI in the fourth quarter and that being directed at new skews and new wins for at least one big customer. But -- and the rest of another large customer they're a very strong player within front end module. I would believe that whatever downs we have with them, which we are seeing, will be restored as well.

So, I don't see this as being something that's long-term or long lasting, I can't overly speak to the mobile market what other people are seeing, Q3 is not over. So, what people had forecasted weeks ago or a month ago or two months ago on previous releases. How that really has impacted with the present reality, because the present reality is what we've seen within the past 10 to 12 days.

[Cody Acree, Drexel Hamilton]

Russell, thank you for that. And you mentioned that you don't have visibility as to whether the change from the customers are their market share related or inventory. But do you have a sense of given that this is a recent change? Do you believe that this is really more a matter of your customers rationalizing inventory into the second half? Or do you think it's something more than that?

[Russell Ellwanger, CEO]

At least in one case, the change is abrupt enough that it has to be a rationalization of inventory. In the other cases, I think it's just a forecast that's down for whatever end markets that they're serving, their customers are not overly pumped at the moment. I think recent reports and it's really not my part in the call to speak to end users that are up or down, but there are multiple end cell phone providers that are not seeing big growth in their business at the moment. So and some that are candidly flat to down, some that are very down.

So -- but in the one case that came in most recently, I would believe that that's an inventory correction based upon a reduction of demand. But if you have certain customers that require a very high upside capability and a demand goes down, then you have an over correction because you had oversupply to make sure you can cover an upside.

[Cody Acree, Drexel Hamilton]

And then lastly on RF, last quarter you mentioned that it was both on wireless. I guess you mentioned that it was both RF and a bit of turns impact on your power management business. I guess, what you're seeing as far as order change rates into Q3. How do you parse that between RF SOI and power management?

[Russell Ellwanger, CEO]

We haven't seen any changes in power management. What I did mention in the -- during the call was that one of our larger power management customers, that's a substantial amount of revenue from the Power BU had reduced against their forecasts in the second quarter, and that we had all expected a reversal on that. But it has become apparent by looking at end market reports that their major customer has dropped it substantially in market share. So I don't see that recovering.

But other than that, I don't see that we have any changes within power management that's really going into the mobile market. I think, there's some of our customers that had expected much higher ramps coming into this year for the SKUs that they won. And the ramps are hitting the levels that they had thought. And -- but that's not a change from a -- when we had announced Q1 to the present. Some of that has not yet recovered or hit the ramp levels that they thought, that they would be. But I'm not sure that there's an additional, any additional weakness or surprise.

[Cody Acree, Drexel Hamilton]

Thank you. And then just lastly, Oren, just with the ramp of silicon germanium and Russell talking of additional capacity going into next year. Does that capacity fall within your prior CapEx budgets have kind of the low $40 million range for the quarter?

[Russell Ellwanger, CEO]

Yes. So I believe that the new investment that Russell informed about it to add more additional 15% SiGe capacity in Newport Beach maybe will cause the $40 million to be for a quarter or two more closer to the $45 million. But in the past, we always say that it's been $40 million to $45 million. So probably it will be the upper end of that for a quarter or two in the beginning of 2019, but it's too premature to know.

[Cody Acree, Drexel Hamilton]

Great, thank you guys very much. Appreciate the info.

[Russell Ellwanger, CEO]

Thank you, Cody.

[Operator]

The next question is from Rajvindra Gill of Needham & Co. Please go ahead.

[Rajvindra Gill, Needham & Company]

Yes, thanks very much for taking my question. So just a follow up on the RF business. Now that it had a few quarters of weakness, how are you internally thinking about forecasting that business going forward and kind of calibrating those numbers and communicating that to the Street as it is about 22% of revenue or so. And it's cut off -- caught some folks up by surprise over the last two, three quarters where there has been such a significant drop off in that business. How you look at that business internally going forward and kind of what are the thoughts in terms of turn to calibrate the downside going forward?

[Russell Ellwanger, CEO]

As far as what we're targeting in Q4, everything is already within that number. So when we said that we're targeting a record revenue somewhere of between $360 million and $380 million. What we see right now on the market is absorbed in that. As we enter into Q1, Q2, Q3, it really as we always do we work very closely with our customers to understand their present forecasts to make sure that we have capacity for their forecasts.

And certainly as there had been some surprises this year, will be from my standpoint and then from the standpoint of the sales and the BUs a bit more stringent about trying to understand why they were deltas against their own forecast this year and what is the safe number and how do we mitigate any changes next year.

Now as far as what we're doing within the specific the RF SOI space we have continuous developments driving really outstanding performance, but we believe there is probably the best Ron-Coff offerings in the world. And if we look at the 300 millimeter offering that's a very, very excellent Ron-Coff that's combined with a 65 nanometer digital that allows for an outstanding O&A.

So the big thing for us is always to focus on increasing our share of market and in other areas then increasing our served market whenever possible. In the area of RF SOI in and of itself it's a question of really increasing the share by making sure that we have the best platform available that addresses the upcoming requirements in the market as we had mentioned with the 5G and MIMO believe that our 300 millimeter platforms have a very, very special capability there. As far as with the 200 millimeter for switching capabilities we have really outstanding performances, and I think the best in the world.

So continual working with customers on tapping out and winning the new SKUs that's the best way that one has protection over any market movement. As if you're growing your market share and especially if you're increasing your served market. As we mentioned we are very engaged in advanced technologies to replace RF SOI that bring the performance into really a very, very new level one is the MEMS switch and another is a total different material.

For the total different material we are engaged with leaders in the market on a co-development. And I think that's always been as well as with the MEMS switch. But that's I believed in what's been somewhat of our success formula for the way that we've been able to grow is that we look at breakthrough development not in an isolated fashion, but in a fashion of partnering with the customer and with the lead customer in that segment during the development itself. And as long as we continue to do that, and the technologies are successful you would then have a very sure roadmap of a two to four year growth as those technologies get adopted and really do a breakthrough performance.

[Rajvindra Gill, Needham & Company]

And I just want to just get some more clarity on the RF business again. So was there two things that happened in the smartphone, you had a power management customer that was selling into smartphones that had a significant reduced forecast that’s not going to reverse course. Then you had your RF customers also who are reducing forecasts. I was just wondering if you can clarify that, because it seems the power management customer seem to be new. The weakness across your RF suppliers seem to be ongoing, I was wondering if you can clarify that?

[Russell Ellwanger, CEO]

Sorry, if I said something that was confusing. In the case of the power customer, a large power customer that we had expected recovery from that had forecasted much higher had stated in when we gave our Q1 guidance that we saw some weakness within power management. And stated that some power management was also serving mobile, this customer does not serve mobile, it’s another end application where we had or the end customer doesn’t serve mobile maybe our customer does, but the end customer is not a mobile application. And in that case it was the biggest portion of one of our customers and the business has just gone away the end customer really has lost its market. So I don’t expect that that will recover.

In the area of where our power management serve the mobile market it’s more on the discrete space and there is some power management discrete and as well as another specific application within a power IC and that serves a customer that is a very, very big customer that just is a bit off of its growth right now, but I believe that that will recover.

[Rajvindra Gill, Needham & Company]

Okay. And then with regards to the -- trying to match the demand and supply for the SiGe infrastructure capacity. So you mentioned that the demand was much stronger than expected and so as a result your shipment profile from recently added capacity has been pushed out slightly. When you are looking at Q4 target of $360 million to $380 million, how much visibility do you have now in terms of China as best as you can obviously match the level of capacity to support the demand. Do you think this year you’ve got the right process flows in place you move them, you transition to the right fabs in order to support that ramp in Q4, because it seems like there is a lot of drivers to a big Q4 ramp, but the capacity has to be there in order to support that?

[Russell Ellwanger, CEO]

The qualified capacity. Yes, I believe that the nice -- pretty sure we have this in the press release itself, but we do have presently the start plan in place for qualified materials to hit the $360 million to $380 million. In the case of the silicon germanium, the demand remains very strong and that’s really the reason to on top of what we’re qualifying in San Antonio to add additional capacity in Newport Beach, beyond what we are adding right now or what we’ve now fully started to.

So the capability for the starts themselves it’s fully there where I to have more capacity at the moment for our Newport Beach we would fill more capacity. So the ramp is there, the customer demand is there and we’re looking for it to continue to load and ship these wafers.

The silicon germanium is that you are dealing with a very, very long flow, it’s somewhere between 40 and 44 layers and that type of a layer count from the time that you started, it’s not turn business within the same quarter. So the starts having been in place at the beginning of Q3 those shipments really happen then in Q4.

[Rajvindra Gill, Needham & Company]

And last question for me Oren, if you’re talking about a ramp of $360 million to $380 million in Q4 so that’s an incremental $35 million of revenue from Q4 to Q3, are we still kind of assuming that we’re going to have a 50% to 55% gross profit fall through. And as a result we should start to see gross margins in the high 26.7, 26.8 in that range is that what we’re expecting?

[Oren Shirazi, CFO]

Yes, yes like Russell mentioned the major part of the growth should be SiGe, which is high margin and the 300 millimeter Fab. So we should expect those incremental margins like we achieved in Q2.

[Rajvindra Gill, Needham & Company]

Thank you, appreciate it.

[Operator]

The next question is from Quang Le of Credit Suisse. Please go ahead.

[Quang Le, Credit Suisse]

Hi, thank you for taking my question. So we know that your guidance for 2018, would you be able to provide more comments for 2019? And how is your discussion with Panasonic going on I believe the deal expires in March 2019? And also if you could add any comments on your China deals with the comment on idea that would be greatly appreciated.

[Russell Ellwanger, CEO]

So we haven’t given any targets for 2019 other than I will very happily state that we’re excited to complete the Q3 as was asked just previously do we have the right ramp plan in place, do we have the capacity in the right factories qualified and in place the answer is we do. So should finish the Q4 with this $360 million to $380 million very accelerated organic growth and this should propel us very nicely into the next year on the growth trajectory that we believe our capability has shown in the past and will continue to show.

So we believe that 2019 on the organic side will be a very, very strong growth year. As far as the negotiations with Panasonic you’re correct the present contract expires at the end of the first quarter of 2019. We are in discussion negotiation with Panasonic. There’s no question of an extension of the contract and an extension of what we’re doing it becomes at this point really a discussion of multiple factors, some of the deals with internal costings and how things are charged.

So it’s not at a point yet to discuss openly we’re not at an endpoint, but I believe that we’ll be in a very good position and it will be a win-win for Panasonic and for TowerJazz as it has been a win-win from the past 4.5 years. So hopefully that answers your first question. Your second question was again about Tacoma?

[Quang Le, Credit Suisse]

Yes, China deal, yes.

[Russell Ellwanger, CEO]

So, yes, very happy to state that the governmental entity the Nanjing Development Zone had recently become the general partner and the majority shareholder of the Tacoma venture within the past month we received a commitment letter from Nanjing Development Zone for the completion of the project and that they’re really backing it. I'll be in China for our own internal technical seminar in August and look forward to following meetings there, but we sit at this point very optimistic on what’s happening with the movement to the government to take the majority ownership of the entity and the commitment letter that we received.

We additionally have a customer that is committed to load 50% of the factory and that’s why it’s very exciting and very important to move it along. Single customer with that type of the commitment it’s a long-term commitment that becomes a very, very big buyable opportunity for whoever is involved and investing in it.

[Quang Le, Credit Suisse]

And if I could, like the your power customer that lost the market share, could you specify what is the percentage of your revenue?

[Russell Ellwanger, CEO]

I didn’t say that our customer lost the market share, I said our power management customer’s customer loss making…

[Quang Le, Credit Suisse]

Yes. Yes, so could you just specify more or less what is the percentage of that customer related to power in terms of revenues?

[Russell Ellwanger, CEO]

It’s on the order of 1.5% of our total revenue.

[Quang Le, Credit Suisse]

Did you say 1.5%?

[Russell Ellwanger, CEO]

Yes sir.

[Quang Le, Credit Suisse]

Of total revenue?

[Russell Ellwanger, CEO]

Yes.

[Quang Le, Credit Suisse]

I see yes. And also in terms of tax rates that you’ve been mentioning given that you still have these to add tax deferred asset in Israel what should we be modeling for 2018 and full year 2019?

[Oren Shirazi, CFO]

Yes, so…

[Russell Ellwanger, CEO]

Just let me clarify that customer is about 1.5% of our total revenue, that end customer of theirs is not 100% of the revenue we get from them.

[Quang Le, Credit Suisse]

Okay. Got it. Yes.

[Oren Shirazi, CFO]

Yes. So from -- I spoke about it in my words. So basically we have the statutory tax in Israel of 7.5%, this is for the P&L basis. But cash wise, like I said, it's not -- we will not pay taxes in the coming foreseeable future because this is reducing the tax asset that we have utilizing. The tax deferred asset that we recorded in Q4 2017. So at least, I mean, if we continue or we will improve our net profit still we will not pay taxes at least for the coming five, six years, in Israel.

So we will have in the P&L a charge of 7.5%, which is an amortization of this deferred tax asset. But on the cash basis net cash or free cash flow or cash from operations there will be zero payment.

[Quang Le, Credit Suisse]

And in terms of effective tax rate for the whole year -- full year then?

[Oren Shirazi, CFO]

For the consolidated, so considering that in U.S. we have 21% and in Japan 32%, but still majority of the profits are generated in Israel. So I believe to assume the current 7% that will we saw in Q2 is reasonable. I mean, considering that we have some credits and the other waivers. So, just you can model the current 7%, I think it's reasonable.

[Quang Le, Credit Suisse]

Got it, thank you.

[Operator]

The next question is from Richard Shannon of Craig-Hallum. Please go ahead.

[Russell Ellwanger, CEO]

Hey, Richard.

[Richard Shannon, Craig-Hallum]

Hey, Russell. How are you, thanks for taking my questions.

[Russell Ellwanger, CEO]

Very good. Thank you.

[Richard Shannon, Craig-Hallum]

Good. My first question is I think early in your prepared remarks you talked about wafer prices that you pass along to your customers will have an impact to sales and gross margins, any way you can characterize or quantify that for us?

[Russell Ellwanger, CEO]

With regards to what?

[Richard Shannon, Craig-Hallum]

How much of an impact the wafer price increases that you're passing along to your customers. I think you said that will have an impact on your 2019 sales and margins and wondering if you can quantify that in any way?

[Russell Ellwanger, CEO]

We're targeting to get somewhere about 50 basis points, if we were to look at this. We think that that's probably somewhat reasonable. It's -- we have different requirements for different customers as you do on pricing to start with. But across the board, we think it's a fair thing to share in the increase that we're seeing. We -- but I think, our target of 50 basis points is probably reasonable. Does that answer your question, Richard?

[Richard Shannon, Craig-Hallum]

Yes, it does. Going over to silicon germanium, I mean, you're talking about additional capacity increases beyond what currently have in place here. When do you -- I mean it sounds like you have great demand from a number of different products here. When do you start to reach kind of maximum utilization on that capacity that you've referred to? Is that happened in the first half of the year or is that second half of next year?

[Russell Ellwanger, CEO]

About which capacity you mean?

[Richard Shannon, Craig-Hallum]

The silicon germanium companywide.

[Russell Ellwanger, CEO]

So right now, it is running at full utilization. I believe that, it will continue to run at full utilization throughout 2019 as additional capacity comes online, it's immediately sold and used. So we are running right now at full utilization of the silicon germanium installed capacity.

[Richard Shannon, Craig-Hallum]

Okay. And did I hear you correctly that the silicon germanium is ramping up in the San Antonio fab starting in the first quarter?

[Russell Ellwanger, CEO]

Yes, in the first quarter we’ll begin revenue starts and will we ship revenue in the first quarter. Not sure yet we’ll either ship in the first or the second. But we will begin by plan we’ll be beginning revenue starts in the first quarter.

[Richard Shannon, Craig-Hallum]

Got it, okay. So probably not much of an impact in revenues in the first quarter, then is that fair?

[Russell Ellwanger, CEO]

It'll be minimal and ramping through the second and third.

[Richard Shannon, Craig-Hallum]

Okay, perfect. Maybe a question on our RF SOI. Obviously you're expanding your capacity into 300-millimeter, but kind of moving some away from 200-millimeter that you've talked about earlier this year. How should we think about your capacity growth corporate wide overall wafer size and RF SOI in 2019 over 2018. Is that going to be growing much if at all?

[Russell Ellwanger, CEO]

The 200-millimeter?

[Richard Shannon, Craig-Hallum]

The total RF SOI capacity corporate wide.

[Russell Ellwanger, CEO]

It's a little bit hard to answer that. Because the RF SOI doesn't necessarily require any separate tools for the any of the other CMOS flows that we're doing. So in the RF SOI capacity is the more or less the full capacity of our factories. But are we investing specifically to increase RF SOI capacity at this point we're not. We will most likely invest some amount or with customers invest some amount to increase capability on advanced flow such the MEMS flow or of this new material that we're speaking of.

[Richard Shannon, Craig-Hallum]

Okay. So is it if fair to think about your RF SOI growth like counter 2019 over 2018, is that something that you may not necessarily expect to grow then?

[Russell Ellwanger, CEO]

I don't think that that's the case because of the 300-millimeter. So the incremental revenue of 300-millimeter I believe will be incremental on top of the RF SOI that we're doing presently.

[Richard Shannon, Craig-Hallum]

Got it, okay. Just want to make sure what kind of growth you expect from that. I think that's pretty helpful. My last question I'll jump out of the line is on the topic of silicon photonics. I think you talked about a lead customer here, ramping up -- well actually let me ask that question this lead customer, when do you expect that one to ramp up?

[Russell Ellwanger, CEO]

We stated that it entered production presently.

[Richard Shannon, Craig-Hallum]

Okay. And can you give us a sense of what kind of customer breadth you have here? And can you characterize any of the customer base here known silicon photonics suppliers in the market today or any other way, please?

[Russell Ellwanger, CEO]

I don't know if I could do that without very much specifying who they are. There is not so many known players at the moment, but certainly, somebody that would go into production presently is someone that's playing in the market presently.

[Richard Shannon, Craig-Hallum]

Okay, fair enough. I'll probably follow-up on that one offline. That's all the questions for me. Thank you.

[Russell Ellwanger, CEO]

Thank you, Richard.

[Operator]

The next question is from Lisa Thompson of Zacks Investment Research. Please go ahead.

[Russell Ellwanger, CEO]

Hey, Lisa.

[Lisa Thompson, Zacks Investment Research]

Hi, good morning. So just two quick ones. When you talk about the fourth quarter revenue range to get to the high-end, are you expecting any change in mobile orders, or is that just based on the current level it’s at now?

[Russell Ellwanger, CEO]

That's based on the current level. I mean, there is puts and takes in all our business that was a reason to say a target of $360 million to $380 million. But, I mean, we didn't put a guidance out, what we're saying is we do expect the fourth quarter to be at least $360 million and we wouldn't expect it to be over $380 million. And at as we release Q3, we'll obviously give a target that will have the guidance with a plus minus around it. But this was just from what we see now the reasonable midpoint that we think that we would target in Q4.

[Lisa Thompson, Zacks Investment Research]

Okay, good. And then just on 2019, Oren, do you think that the incremental gross margin contribution from new revenues will go higher than 55% is in product mix or is it going to stay there?

[Oren Shirazi, CFO]

No I believe it's always aggressive 50% or 60% incremental margin is very nice model to continue. I don't think it will be better, but will not be lower.

[Lisa Thompson, Zacks Investment Research]

Okay, great. Thanks, that's my only question. Thank you.

[Russell Ellwanger, CEO]

Thank you.

[Operator]

There are no further questions at this time. Mr. Ellwanger, would you like to make your concluding statement?

[Russell Ellwanger, CEO]

Sure, thank you. So I thank all of you for your attention and support. We really are excited to complete our third quarter and built upon the activities, deliver our fourth quarter record revenue, entering then into 2019 well poised to continue on a significant growth path.

In August and September, we'll be participating in the following conferences, I will be at the Oppenheimer 21st Annual Technology Conference in Boston on August 7th, would love to meet with whoever would be available in formal one-on-ones or whatever. I’ll also -- I am sorry, Dr. Racanelli will be presenting at the Jefferies 2018 Semiconductor Conference on Tuesday August 28th in Chicago and he will be happy to meet, explain and talk in much more detail about anything happening in RF than I would be capable to do.

Oren Shirazi and myself will be presenting in Israeli Capital Market Conference on September 3rd in Tel Aviv, and I will be presenting and attending at the Credit Suisse 19th Annual Asian Conference at the Grand Hyatt in Taipei on September 5th. So if anyone is available to be at any or all of those conferences, we look forward to the opportunity to interact and see you there.

With that, I thank you again for your attention, for your participation and look forward to sharing very nice results with you and trajectories of activity over the next years. Thank you again.

[Operator]

Thank you. This concludes the TowerJazz second quarter 2018 results conference call. Thank you for your participation. You may go ahead and disconnect.