Photronics Inc (PLAB) 2002 Q3 法說會逐字稿

Good morning. My name is Dixie, and I will be your conference facilitator today. At this time I would like to welcome everyone to the Photronics third quarter conference call hosted by Dan Del Rosario, Chief Executive Officer. After the speakers' remarks there will be a question and answer period. If you would like to ask a question during this time, please press star and the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Please limit all questions to one with one follow-up question. I would now like to turn the call over to Mr. Mike McCarthy. Please go ahead, sir.

Thank you very much. Good morning, everyone. My name's Mike McCarthy, Vice President of Investor Relations and Corporate Communications with Photronics. I'd like to thank everyone for participating in this morning's conference call during which we'll discuss the results of our fiscal third quarter.

Before we begin I'd like to remind all participants about the safe harbor statement provision under the private securities litigation and reform act of 1995. Except for historical events, the information we'll cover during this call may be considered forward-looking and may be subject to certain risks and and uncertainties, including uncertainties in the market, pricing, competition, procurement, manufacturing efficiencies and other risks detailed from time to time in the company's S.E.C. reports. I'd like to inform everyone that this call will remain archived on our website until we report our fiscal fourth quarter results after the market closes the week of December 9th.

Sean Smith, our CFO, will begin the call with a detailed review of our income statement and balance sheet. Paul Fego, President and Chief Operating Officer, will then follow with a brief review of the company's operating performance. And Dan Del Rosario, CEO will conclude with brief remarks regarding our outlook after which he'll moderate the call's question and answer session. Joining us will be Steve Carlson, Sr. VP of Technology, John Hickey and John Smith, our CFO, and Dino Macricostas, our Chairman.

Good morning, everyone. I'll provide a brief analysis of the result of our first quarter and review changes in our financial position and cash floes during the period as well as review our outlook going forward.

In the fourth quarter of 2001 we acquired the controlling interest in PKL. We began consolidating PKL with Photronics at that time. Net sales in our third quarter amounted to 98.1 million, up 15.4% from the 85 million in the third quarter last year. Total sales outside the U.S. accounted for approximately 56% of third quarter twos revenues compared with 40% in the third quarter of the prior year and 50% sequentially. Our strategic investments in Europe and Asia continued to enable us to gain share in these growing international markets. Sequentially third quarter sales decreased 5 million, or 4.8%. The sequential decrease primarily resulted from a weakened pricing environment from mature technology and combined with an overall decrease in demand for technology, principally in North America. The third quarter gross margin of 28.6% decreased approximately 20 basis points from last year's third quarter level of 28.8%. Sequentially our third quarter gross margins decreased 220 basis points primarily as a result of lower utilization of our fixed equipment cost base.

Depreciation and amortization increased to 21.8 million for the third quarter of 2002 as compared to 18.5 million with the third quarter of 2001 and 20.4 million sequentially. The selling, general and administrative expenses of 15.1 million for the third quarter increased 16.1% year-over-year primarily as a result of an increased infrastructure to support our global enterprise. S.A.G. as a% of sales increased during the third quarter of 2002 as compared to 15.3% in 2001. Sequentially SG&A increased by 110 basis points. Research and development expenses of 7.7 million in the third quarter were approximately 23% higher than last year and 3% sequentially higher reflecting continued work on advanced sub wave solutions. R&D represented 7.8% of sales in the third quarter of 2002 compared with 7.4% last year and 7.2% of sales in the second quarter of this year.

Operating income decreased to 5.4% of sales compared with 6.1% earned in the prior year. Sequentially operating margins decreased by 400 basis points. Net other expenses increased from last year and the prior quarter primarily because of higher interest costs incurred with our increased convertible bonds and borrowings associated with the PKL acquisition. The increased interest costs were somewhat mitigated by investment income as a result of our strong cash position. During the third quarter we recorded a tax benefit of $900,000 to reflect a significant decline in pre-tax operating income, primarily in North America. Net income for the third quarter of 2002 was 1.2 million as compared to 1.8 million in the third quarter of last year. Sequentially net income as a percentage of sales for the third quarter decreased 120 basis points. Diluted earnings per share was 4 cents for the third quarter as compared with 6 cents per share in 2001. Sequentially diluted income per share decreased 2 cents. We had an average of approximately 1750 employees in the third quarter' equating to sales of 225,000 per employee on an annualized basis.

Taking a look at the fiscal 20002002 year to date results, as we disclosed in the second quarter of 2001 we recorded a 26.1 million, or 75 per diluted share consolidation and restructuring charge. For the purposes of our discussion on the comparison of operations for the fiscal year to date results of 2002 I will be excluding the consolidation charge. Now looking at the nine-month year to date operating results, year to date 2002 sales amounted to 297 million, an increase of 4.5% from the 284 million in sales for the comparable 2001 period. Gross margins in 2002 amounted to 29.6% as compared to 33.8% for the first nine months of 2001. Selling, general and administrative expenses increased 10.2% to 43.6 million or 14.7% of net sales. SG&A last year totalled 39.6 million or 13.9% of net sales. Research and development costs of 22.3 million were 22% higher than the 8.2 million last year. R&D was 7.5% of sales in the first nine months of 2002 versus 6.4% in the prior year. Our investments in this area are viewed as strategically important to the company's future growth and ability to provide the innovative lithography solutions required by our customers. Operating income decreased to 7.4% of sales for the fiscal year to date 2002 as compared to 13.5% of sales last year. Net other expense amounted to 11.3 million in 2002 compared with 6.7 million in 2001 as a result of year-over-year additional borrowings. Net income amounted to 5.5 million or 17 cents per diluted share compared with 20.1 million or 67 cents per diluted share last year.

Now taking a look at the balance sheet, we continue to be extremely liquid at the end of the quarter with working capital in excess of $200 million, which amounts to a 323% improvement in working capital since the beginning of the year. Cash and short-term investments were 149 million as compared to 35 million at October 31st, 2001. The company's current ratio at the end of the third quarter was 3.9 to 1 as compared to 1.5 to 1 at the ends of 2001. Primarily as a result of the increased cash associated with our convertible note issuance in December and our ability to refinance certain current debt of our subsidiaries with our new 100 million, three-year global credit agreement we entered into in July. The new credit facility, which includes all of the Key Banks from our priorities, allows us to borrow in local currencies, providing a natural hedge while also allowing us greater flexibility in the financial management of our growing international operation. Intangible assets increased by approximately $29 million during the year as a result of our increased investment in PKL. Total debt has increased 137 million during the first nine months of 2002 to 359 million. The increase is primarily attributable to the $200 million convertible issuance net of the repayment of our former line of credit. The minority interest in PSMC and PKL amounted to 44 million at the end of the quarter. Shareholders equity aggregated 355 million.

Cash flow from operations for the first nine months of 2002 was approximately $70 million. Cash flow used in investing activities amounted to 105 million, of which 88 million represented capital expenditures during the first nine months of 2002 and 15 million increased short-term investments. Free cash flows net of our capital expenditures was a negative 18.8 million for the first nine months of 2002. Cash provided by financing activities amounted to 129 million, which primarily represents the net proceeds from the convertible note issuance offset by the repayment of our former revolving credit agreement. We are projecting capital expenditures for the remainder of 2002 to be approximately 20 to 25 million as we complete our investments in equipment to support our customers with the capability at the 130 nanometer and 90 nanometer technology nodes. Free cash flow for fiscal 2002 is projected to be in the raj of a negative 15 to 25 million dollars.

Taking a look at the fourth quarter, our visibility continues to be limited. Based upon current market conditions and customer inputs, we're taking a conservative view in forecasting revenue and earnings for the fourth quarter. Based upon our current operating model, fourth quarter revenue of 2002 is expected to be in the range of 93 to 98 million dollars. As we announced yesterday, we will close our Milpitas manufacturing site and reduce our work force by 7 to 9%. The total after tax charge of approximately 9 to 10 million dollars, or 28 to 31 cents per share in the fourth quarter will enable us to streamline our fixed cost structure. This action, coupled with our ongoing cost containment programs, will reduce our fixed costs in the fourth quarter. Every line item continues to be under scrutiny as we align our cost structure with current market conditions to insure that we remain the world's most cost effective photo mask supplier. As a result, based on our current operating model, we estimate that earnings per share, excluding impact of our announced fourth quarter charge, will range from a loss of five cents to five cents per diluted share.

That wraps up the overview of our financial performance and our short-term outlook. Now I would like to turn the call over to Paul for an update on the business.

Thanks, Sean.

As all of you know, today's business climate is tough and this has been one of the toughest quarters our company has had to face in my past eight years at Photronics. We are facing a shift in global business and, of course, economic uncertainty. This quarter challenged our team to dig down deep and tighten their folks on two prominent characteristics, the first being financial discipline, and second, running the most efficient operations in the industry. As Sean detailed report on our financial performance has highlighted, the team's character was severely tested as we accelerated cost reduction activities and tightened manufacturing practices. In response to the rapid changes in our business conditions in late June and early July. While we were able to realize some benefits in the July quarter, we fully expect to reduce costs by approximately $1 million in the October quarter. Our challenge to the Photronics family was that in spite of a difficult business environment, that our team would achieve its 59th consecutive quarter of generating income from operations. And while this was achieved, I am encouraged by the team's belief that we can still do even better. The decision to reduce the company's work force was extremely difficult for the team. Committed and well-trained people are tough to come by, and many of them have contributed to Photronics's success in the past. While our customers share our difficulty in having to lay off valued employees, they have supported our decisiveness to stay focused on cost reduction and commitment to technology during a time when they themselves are struggling with a very tough recovery.

As for the closure of the Milpitas site, we had previously announced back in April of 2001 our plans to close this existing facility because of its age and associated operating costs. The continued fab manufacturing closures in California, the increasing number of customers adapting their business models to a fabless or fab light strategy and the overall economic uncertainty made it clear to us that we had a great opportunity to increase our return on invested capital elsewhere in the Photronics enterprise. Currently 95% of our customers served by the Milpitas site are cross-qualified at other Photronics locations. This in turn will make the closure of the Milpitas site much easier for the team to implement. This plan calls for the elimination of the photo mask manufacturing only at this location. The Milpitas site was the most expensive operation in our worldwide network. Photronics will maintain a front end marketing sales presence at this location to insure continuity to our customers. The continued presence is predicated by our commitment to provide a full range of services for this very important region of North America.

Looking beyond the discussions of the network consolidation, Photronics recorded a number of positive accomplishments during the quarter. Our facility in Korea was officially qualified at 130 nanometer technology node for Samsung. Our Taiwan site was qualified for 130 nanometer node and began shipping 90 nanometer test vehicles for UMC. Our Manchester team has started providing 90 nanometer node and 157 familiar character recognition to ASL for testing under an advanced system. And lastly, our Austin NTL line has currently qualified many of the region's technology leaders at 130 nanometer and below. We believe by taking decisive action today that we can provide a substantial benefit to our customers and shareholders. Our focus in the fourth quarter is clear. We need to execute on all cost reduction programs on time, speed up our key engineering excellence programs and yield improvement, global information technology effectiveness and automation with cybermask. We need to insure zero impact to our Milpitas customers during the transition. We are need to accelerate 130 nanometer and below qualifications, and finally, to further improve our technology profile through stepped up sales and marketing activities worldwide. It is essential that the management team, predictable, dependable and consistently do the right thing for our customers, shareholders and employees worldwide. I believe these actions we have taken today reinforce our commitment to being the worldwide leader of this industry.

Now I'd like to turn this call over to Dan for some closing remarks.

Thank you, Sean. Thank you, Paul.

Flexibility, manufacturing efficiency and unparalleled service continue to be Photronics's key attributes and differences. Our focus on technology is unabaited by evidence of our deployment of four nanometer technology lines globally and the 130 nanometer and 90 nanometer qualifications referred to by Paul. August 2nd was a major milestone for Photronics as we held groundbreaking ceremonies for our Shanghai, China plant. This serves as the exclamation mark to our strategic global positioning, and we are extremely confident that we are best prepared to capitalize on the inevitable semiconductor industry recovery.

Rather than reiterating the challenges on these issues facing the industry that we discussed on our May 15th and July 18th conference calls, I would like to open the calm to questions at this time.

At this time I would like to remind everyone in order to ask a question please press star then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q & A roster. Your first question comes from Steven Pilleo, Morgan Stanley.

The first question for Sean, your guidance on top line and bottom line. What type of gross margins are you assuming if you were kinds of in the middle of your range of your guidance on the top line, and also get to the middle range on your bottom line guidance?

Our gross margins, Steve, are going to be contingent upon how effective we are with the transition out of NCO. Certainly we would expect our gross margins on the top line to improve, if we hit the top end of the range. And at the bottom end they should decrease maybe slightly to 150 to 200 basis points. But we do feel confident that we will be able to move the work out of our Milpitas site and maintain a reasonable gross margin for the quarter.

Well, the middle of that range is actually still down sequentially, but it sounds like you're suggesting that through the cost controls your gross margin can still be flat on down revenues.

Yes. We are actively pursuing our cost controls, Steve. In addition to the NCO closing, as we mentioned on July 18th, we're working on all of our fixed costs, working with our vendors to cut down and reduce our costs going forward. We have a very proactive program that's company wide, and we have active teams targeting specific areas to pull costs out of the system.

Okay. And then relative to your operating expenses, how much of an impact will you actually see due to your operating expenses from the reductions?

As Paul mentioned, we should pull out at least a million dollars in this quarter. And we will expect to recover on a cash basis into 2003 a payback from the charge on a cash basis within the first three to four months.

All right. One last question. I guess Dan or Paul here, could you comment, I guess, regionally here? It sounds like a lot of your cost control efforts are really focusing on North America. Could you maybe just walk through the regions and talk about the demand environment, both leading edge, trailing edge and the pricing environment and see if -- I would assume, then, if it's non-U.S. is remaining the past and those areas remain firm in both those respects?

Yes, Steve. First of all, as weigh alluded to in the narrative by Sean that we saw sequential growth in sales internationally going from 50% in the previous quarter to 56% this quarter, and we remain confident in both our European and especially in the migration of Wafer manufacturing to Asia. Unfortunately, all indications suggest that activity -- design activity remains robust at the high end, but tape outs are being delayed. And there are two dynamics in play at this time. First it appears that there was an inventory billed in the first half of the calendar year, and now suppliers are closely monitoring inventories as end markets have been slow to develop. Secondly, the end market demand for new devices is not developing as expected. And also, in addition to that, to ex-acerbate the situation, the 139-nanometer process rollout, as you know, there have been significant questions about the yields. And that has really affected us, as well, as we expected a faster shift to 130 nanometers. Perhaps at this time Steve would like to elaborate on the yields at 130 nanometers.

Yeah, just real quickly Steve. The 130-nanometer node transition, as you know an unprecedented amount of technology and innovation content. That delayed some of the yield ramps. And today it's not uncommon for many of our leading edge customers to still be working in the low 20s to high teens in yields. This complexity has resulted in a slower yield ramp. However, our unique NCL line strategy has put us in the perfect position when this introduction accelerates. And on top of that, these platforms on the NTL lines are extendable. So, where you're also using the same infrastructure that has been developed globally to address the 90-nanometer node.

And I'm sorry. Did you comment on the pricing in individual regions? Is it only limited to certain areas and only on the trailing edge?

Steve, as far as pricing is concerned, you know, pricing pressure has always been an obvious reaction in previous downturns due to the number of suppliers and the drive to maximize utilization at the mature end. In this cycle we did not expect the severe and selective pricing pressures at the mature end in this current down cycle primarily due to the fact that we have seen significant consolidation in the industry. We really expected more rational behavior and were frankly surprised by the lack of discipline of one of our major competitors. We made a conscious decision early in the cycle not to engage in a price war at the mature end, and it has cost us market share at selective customer.

However, in addition we are reacting primarily by stressing to our customers our value added services of timely delivery and zero returns, and we have taken substantial and rapid actions as alluded to by Sean and by Paul to further reduce our costs and manage our capacity. We as a team firmly believe that these actions will mitigate the loss of market share in the short-term and that we will eventually regain the lost business. Paul, would you like to add anything to that?

Yeah. Steve, I think, you know, as Dan mentioned, we have basically decided not to get into the mud in some areas. We're going to stay away. We made that conscious effort. We, of course, come back with some counters that we believe are more effective for us as a company and the business, and we have won some of the business back based on our service performance am some things we've done with them. And we believe this is the right way to go to insure that our shareholders and everybody gets the best value for the company. And we'll continue this position as long as we have to.

All right, guys. Fair enough. Thanks.

Your next question comes from Byron Walker, UBS Warburg.

Good morning. Based on what you folks were just speaking about, I have a generic industry question for you. Despite your ability to be efficient asset managers, both you and your competitor historically net consumers of cash. And should the current competitive pricing pressures persist, the only response can be cost and expense reductions throughout the U.S. photomask industry. So, my question is in the current price environment, how do you plan to continue to fund R&D and cap ex at sufficient levels to insure that the industry has sufficient photomask capability and capacity for future requirements? The other way of looking at this is my concern is whether the semiconductor industry is headed for a wall because of photomask's inability to self-fund R&D and capacity.

Byron, as I mentioned earlier, we were early in deploying four nano technology lines around the world. And those lines are completely ramped at the present time. And they are extendable to 90 nanometers. So, we have made the initial investment in this imagine flexion point at 130 nanometers. And so, we believe although the investment was made early and it certainly is affecting us at the depreciation line, that we are positioned for the ramp in the 130-nanometer and eventually the shrink down to 90 nanometers. So, from that standpoint we've already made the investments. We have the capacity in place. And this I'd like Sean to add some color as to our plans for 2003.

Good morning, Byron. 2003, we're still in the preliminary process of planning it out, but we certainly expect our capital expenditures to be in the maintenance mode next year, and we firmly expect to be a generator of free cash flow. We haven't set our internal guidelines, but suffice it to say it's going to certainly be significantly better than it was this year. And if we continue along our current path of watching and controlling our costs, and with the cash that we have on hand, we certainly should see our cash balances to increase as we move forward.

One thing I'd like to add, Byron, is that as far as capital equipment, the cycle time required on capital equipment, there is an adequate backlog of equipment that we could, you know, acquire very rapidly and die ploy rapidly if capacity demands increase. And so, we believe we're in a good position. We've already gone through the ramp cycle so we can ramp these processes very quickly. We have fanned out the processes. The processes have a common platform across all four nano technology lines. And as a result, as I said, we can ramp for capacity very quickly. Would you like to add anything, Steve?

Sure. Byron, as you know, there are multiple components on the R&D side. And based upon our abilities in the past technology transitions to get more out of the platform base that we have deployed, that capability is extending forward. On the process side we have a unique structure tur. We have the four NCL lineback bone, but we also have put the industry's most intense focus on the integration component. And there are several key areas there that we've talked about in the past at 130 and 90, a major part of the R&D space is integrating across the lithography plane. And in order to do that effectively you have to have a common manufacturing control system to build upon, have to have world class automation, and you have to have the ability to understand the domain of the customers. And that is the key in lithography knowledge and understanding the product application that theoretical extensions will be used for. And we've put a lot of effort into this area and we are clearly in the best position in that area. So, the combination of the extendable platforms as well as the infrastructure programs that we've focused on in the last several years will allow us to continue on the pace necessary to intersect the 130 ramp and also the 90 nanometer development cycle.

I see where you're going and applaud that. I guess the issue is how can we be assured that your customers are going to pay for that in the currents environment? It seems that they're exceptionally price sensitive. And it's imperative that photomasks continue to investment fairly aggressively to keep the cycle moving ahead in accordance with Moore's Law. Are you getting the feeling from your customers that you can get this value added from them?

Certainly, Byron, you know, there is price sensitivity, and we hear a lot about the million dollar mask sets and the $2 million mask sets. However, pricing has been generally stable at 180 nanometers and below. And so, while the environment is very difficult we believe that we will get the return once, you know, the turn around in the industry comes.

Good. Thanks.

Your next question comes from Mark Fitzgerald, Banc of America Securities.

Thank you. I'm curious how you guys are measuring the design activity at your customers if they're not taping out and how you can know there's high level of design activity going on.

I think, first of all, Mark, there have been numerous articles published in the last couple months. We also keep close ties with our major customers. And that's where all indication suggests that the design activity remains robust. The issue as I mentioned earlier is that tape outs are being delayed, and it's primarily a function of demand at the ends markets.

So, is there any sense, though, these price increases that have gone on here at .13 and future are, the number of bets being put on the table are declining here, that there's a pricey last at the tee issue? Is there any sense from your measures here of that going on?

All indications, I'd say, tend to two items. One is end market demand, and the other is the issues around the complexity of 130 nanometers that Steve has reiterated a couple times, and the yields at that node. Our indicators are that there are numerous customers that would like to move or shrink down to 130 nanometers, but they have been unable to because of the yields at the wafer lines.

All right. And just on the China factory at this point, what kind of designs run through that? Is that all domestic designs, or are you doing masks for overseas companies there?

The China market is just in the emerging phase. At the present time SMIC has already ramped their eight-inch fab. The remainder of the companies, such as GSMC, Bayling and ASMC are just bringing out their eight-inch fab. We just broke ground and don't anticipate completing the factory until middle of 2003, the July-August time frame, and then ram putting the fab prior to the end of the year. And then we will redeploy some assets, and we will ramp the fab at the .22, .25 technology fab at initially consumer demands and then moving to Telecom, corporate IT demands.

And just one final question. Do you see any of your customers and the designers designing for manufacture ability at this point? Are there any plans being put in place to try and keep the costs down by changing the strategy in designing chips?

Yeah. Mark, hi, it's Paul. Absolutely. The question you asked earlier actually ties exactly to this. We're working very close with the manufacturers, the designers on layout rules, because in the past guys would just basically overspectate things that they didn't really need to do, driving the cost up. We have an absolute focus on keeping costs in line and pricing in line to keep the pipeline loaded. So, we are very tight with a lot of our customers, doing classes in, we call it design for manufacture ability, showing them ways to achieve their technology needs but at the same time in a cost effective method. The perfect mask doesn't always have to have the perfect specs. They're finding that out now. And that's how we know about the queue, and we know things are going on. We're doing a lot of internal test radicals for them for bench marking with Steve Carlson's team and our customers. I think having close contact with all these customers, we're helping them on the spec side, cost side, and keeping our pipeline loaded around the world.

With that comment, do you then not subscribe to the $2 million, 90-nanometer mask set?

The bleeding edge is always going to be there. But, you know, we have to work on making it more efficient for sure. Not many of our customers could afford $2 million mask sets.

Again, Byron, I think when we look at the so-called $1 million mask set at the 130-nanometer node and then looking at the $2 million mask set as you're talking about for the 90-nanometer node, I think these are worst cases when people first come out and say I'm going to add X amount of layer of face shift and so on and so forth. But as they start to drill down on their process platform, we have seen at the 130-nanometer node that those mask sets really ended up in the 650 to 750 thousand dollar node. So, we would expect, as Paul said, that $2 million, not many customers would be able to do that. We're going to optimize our platforms. And we believe it will be substantially lower than that.

Okay. Thank you.

We'll go on to the next question from Jeff Laberty, McMahon Securities.

I understand you're still working on your cap ex budget for next year going into maintenance node, but can you give us a sense of generally where you think it may be and the depreciation number will come out? And finally, looking at working capital management, do you think there's any room there for improvement on getting the questions up or the returns up?

Certainly. With respect to our Cap Ex for next year, we will be in a maintenance mode. We have not finalized our plans as of yet, but if you take a look at the cash flow that we're generating on a quarterly basis from operations for this year and what our run rate is and our cap -- level of cap ex being in the 115 to 120 million dollar range this year and being at a deficit of say a negative cash flow of 25, 28 million dollars, we certainly expect to turn that completely around next year and have a positive cash flow, free cash flow. You know, where we end up is going to be contingent on how quickly we ramp up certain facilities as Dan alluded to in China or redeploy certain assets. But we certainly have the cash to do that. And when we announce our fourth quarter we will be giving those targets for 2003.

With respect to asset management, working capital management, we have seen a slight deteriation in our receivables as a result of the slowdown in the economy with some of our customers. We do work with our customers diligently. The days have gone up a couple of days during the quarter. We do not see any significant issues or collectability issues there. Other areas that we're working on to improve our working capital and also to reduce our ongoing costs is taking a look at creative ways to reduce our don't burden, our interest costs and to also explore opportunities into reducing our long-term debt.

Okay. Thank you.

Your next question comes from Brett Hadus, Merrill Lynch.

a Couple of quick questions. On the tax provision that you had back in the quarter, that was because of the lower net income in the North America, you said?

Well, Brett, good morning. I'll give you a little color on that. The tax provision, you know, for the first half of 2002 we utilized an effective tax rate of about 25% based based upon our projects 2002 global pre-tax income flow. As a result of the changing market conditions during the quarter, we did record the tax benefit. We expect this trend to continue and expect to record a tax benefit of approximately 30% during the fourth quarter for all jurisdictions in which we are taxpayers. When we include the impact of pre-tax income from jurisdictions for which we have tax holidays, we anticipate the overall tax benefit to increase. That being said, our projected tax benefit for the fourth quarter, including the impact of the restructuring charge, will be in the range of 35 to 45%.

Okay. Great. And then on a more fundamental side, back to the advanced photomask versus the price pressure on the mature photo mask, in the quarter just ended, there really were two impacts. The slowdown of takeouts on the advance side actually caused a bit of a decline in the advanced mask revenues, and then you have the competitive pricing thing here in the U.S. Which of the two, were they about equal in magnitude, or were there -- you know, was one greater than the other? Because they both really had impact on the sequential design.

I think basically if you look at -- this is Paul. I think when you basically look at the situation, on the high ends tapeout, we're flat as a percent of our total revenue. We see some of that softening. The mature pricing battle continues, some very irrational behavior which, you know, we're addressing. Are they equal? I don't think so. But in general I'd say it's okay to use that assumption right now.

Okay. Great, thank you.

Your next question comes from Jerry Flemming, Fahnestock.

Most of my questions were answered, but I had one about the international mix up 6 percentage points this quarter. Where does that look like it goes over the next couple of quarters with the Milpitas closing and with apparently better pricing in that part of the world? Is it going to move north of 60%?

Jerry, good morning. This is Sean. We had previously projected that as we exited 2002 from the beginning of the year that our international mix would be 50%. We achieved that in the second quarter. Now it's up to 56%. We do expect it to trend up slightly, although we do have a stable North American business. And our Asian business and European business remains strong. Paul, would you like to add any color to that?

Yeah. Plus, as we mentioned earlier, a lot of the IC guys have really started accelerating their fab light and fab strategies here. And recently we've had some people, like STTI and Motorola, who have come out and publicly said they're moving some of the work to the factory to accelerate and hold down their capital costs. So, we're in a great position to pick up on an offload if it comes.

Could you shed a little more light on your earlier comment about yields at a 130 nanometers being in the 20% area plus or minus a little bit? Are the yield problems primarily the integration of materials, or are there also abnormally highly lithography related problems.

Good morning. This is Steve. I'm going to address this for you. Yeah, the integration issues that are occurring right now are across actually a fairly broad spectrum. As everyone is aware, copper in low K is a material player. There are some significantly thog are fee activities, as well. As you know, the 130 node is an inflection point there, as well, with the choice between extensions of 240 nanometer platforms, high end numerical aperture or the first migration to 193. The good news for us is all of those solutions require a mask enhancement type of approach. In terms of the overall yield ramp, I think it's a combination of all this complexity hitting it at the same time. There is actually an additional benefit in there for us in that it is also forced an analysis back up into the manufacturing chain, into the design loop that can take advantage of advances in design for manufacture ability and so forth while these issues are being worked out. Does that answer your question?

Yes. Thanks a lot.

Your next question comes from Christina Ossamina, Needham & Company.

a Question on the tax rates again. Is that tax benefit included in your guidance of a loss of five cents to a gain of five cents?

Yes, it is, Christina.

Okay. And what kind of tax rate do you think we can expect next year?

Well, we haven't formalized our 2003 plan. One of the volume tilts that we have, Christina, is we're located in many geographic areas, and the shift of income where we have favorable tax attributes to areas of our taxpayers is at times difficult to project. We would not expect to be in a tax benefit position, I can say, for 2003. We should have an effective tax rate. And once we close this year, complete our process for 2003, I would expect the tax rate to be back to where we thought it would be as we came into this year, about 25%.

Okay. Also, another question here. Dan, you said earlier that you were surprises at the degree of price competition in the market given all the consolidation that's taken place. So, what I wanted to know is what in your opinion would it take to reach that point where, you know, the mask business enters a period where we will actually have, you know, disciplined pricing during downturns so that you could -- or during periods of weak demands so you could assume that you could generate free cash flow units throughout, you know, all periods of time?

Well, fortunately, as I said earlier, the advance side of the business continues to be very stable. And our .18 and below revenues remain flat with the previous quarter. And as the turn around comes, we expect to increase that mix significantly. And that certainly will mitigate some of the issues that we face. I believe that that there will be continued pricing pressures in the future at the mature ends, but we certainly, by taking the tough actions that we did yesterday, are controlling our costs as well as our capacity at the mature ends.

Dan, could you share with us what your utilization rates are by outside advance and mature technology?

We don't break it out by advance in mature technologies.

Well, in any way that you're willing to break it out.

Christina, hi. It's Paul. We're right now running in the high 50% range. Clearly what the with the removal of the NCL facility our utilization rates will go up because we will basically spread that work throughout the enterprise and help saturate the rest of the assets in the enterprise for us. Also, I think it's important to understand that in your question on the margins and the mature that we are very capable of reaches reaching high 30s, low 40s percent ranges on our cost structure, but we continue to work on improving because we believe the evolution of this stuff will continue and we have to be competitive in the way we address and serve the customers.

Thank you.

Our next question comes from Chip Bonnet at FM Global.

Good morning. Just some follow-up on pricing in July. You said it was primarily at .25 micron and above. And I'm just wondering if through the course of the month since we last talked that it's crept into lower geometries and are there any indications that the specific customer is getting more aggressive on pricing at leading edge?

As I said, or reiterated a couple times before, at .18 and below we are pleased that the pricing has been stable. At the .25 and below, as we said, the pricing has been selective. And we are gaining some of that share back.

Okay. Thank you.

Your next question comes from Tim Acurry, Deutsche Bank.

I actually had two things. First of all, I missed part of the call, but I was wondering if you'd kind of look into your crystal ball. Do you think that an increase in tapeout activities is going to come initially from your IDM customers or from your fabless and foundry guys?

All indications are if we look at the utilization levels at the two major foundries in the first half that initially we would see significant releases at the foundry level. Again, it depends on the end markets. If we see it coming primarily from the consumer side, certainly there would be a major shift towards the foundries. If it's at the corporate side, then we may see selective markets pick up at the IDM side.

But based upon what you've seen in the last couple weeks, is it kind of too early to say?

It is definitely too early to say.

Okay. And I guess, secondly, maybe I missed this, but can you make any comments on the unit side of your business; the side of your business driven by wafer starts?

This is Paul. We're basically driven by designs, not the wafer start end of it. You know, it depends on the customer and the cycles that we're in themselves in the business units. We've actually seen activity on designs pick up quite rapidly on a down it is turn basically because they're trying to generate some new products on business themselves. Sometimes on closure they do a retooling. We're not really tied to the start levels. We're really tied to design levels. We're pretty closely tied to them. We can see what their cues are, what they're going to bust out. Some guys are discussing killing product lines, the news has been getting out on IBM that they're shifting their whole business. That could generate a whole new segment design for us. We don't really pay attention on the wafer side because that's not what drives our side of the business.

But haven't we discussed that maybe 50% is at times driven by units? I guess what I'm trying to get at is what's half to the unit-driven part of your business?

I know that I can say that we've never really discussed units as a driver of our business. It's always been design- there's clearly opportunities with a ramp up on a production that we'll take multiple mask sets. But that may be the only time that we have to use demand on the wafer side.

Okay. Thanks, guys.

At this time I'd like to remind everyone in orders to ask a question, please press star and then the number 1 on your telephone key pads. Your next question comes from Mike Hughes, Delaware Investments.

a Couple of questions. Dan, I think you said a few months all that one of the positions you were looking to fill was a VP of Worldwide Sales. Has that position been filled? Seconds question, I think you changed your sales organization from a regional structure about eight or nine months ago to a global organization. Would you attribute any of the shortfall in the July quarter to that change? Thirds question, I think in the past you said maintenance Cap Ex is 40 to 50 million dollars. Roughly where does that number fall out now with the closing of the California facility?

First of all, as far as the worldwide sales -- VP of Sales, we have identified a person for that position, and we expect to fill that position imminently. As far as switching from a regional to a global or centralized sales organization, we actually have been more efficient. And the short fall in the market is not attributable to sales, but rather, as we said earlier, to end market demands and the general economic -- demands and the general economic conditions facing the semiconductor industry.

Okay. And the maintenance Cap Ex number?

Maintenance cap ex number, you're well within the band width of where you would expect it to be. We are in the process of reviewing our 2003 plan, and, you know, with the build out in China, that we would not consider maintenance Cap Ex. So, we will be providing further guidance as we go forward when we formalize those plans.

Okay. And one last question. Can you give us some additional details on the cost savings for the October quarter? Did you say they'd be a million dollars? Can you break that out between, like, non-cash, meaning depreciation-related, and then cash savings? And will the savings in the ensuing quarters be more than a million dollars?

At this point in time we're not going to break out the cash/non-cash component of our projected savings in the fourth quarter. However, going into the first part of the year, as I said, the cash componentry lated to the cost savings is going to be paid back in less than a half a year, four months. So, we do expect to pick up a lot of cash savings throughout next year. And the entire payback from the charge will be about a year, including the non-cash component.

Okay. Great. Thanks a lot.

Your next question comes from Steven Pilleo, Morgan Stanley.

I think seasonally you guys tend to see a seasonal slowdown in your first quarter. When you look at your crystal ball, would you expect that still this year or are we running at lower levels that maybe it won't be as bad? Just your thoughts on the seasonality as you go into the first fiscal quarter.

Hi, Steve. It's Paul. I think, as you know, we're looking at a 5% type of scenario, you know, window either way. We traditionally have seen our first quarter with the amount of holidays that we have in that cycle definitely has an impact for us, and it always has. We're not expecting a whole lot of change to that behavior pattern going forward.

And then to follow up on the question that was asked, I think he was trying to get at units versus pricing and how that's impacting revenue. It's not necessarily chip unit on impacting your demand for mass. So, when you look at that and your guidance to roughly flattish to slightly down here for next quarter, are you assuming that most of that is related to unit softening, or are you expecting continued pricing pressures to drive that top line maybe lower?

I think that we're definitely seeing some unit impact there for sure on designs. But know, again, that can be very quickly offset by the different mix changes that we could see. We could see a downside on the mature end on units, but potentially an up side in on our revenue line because of basically more advanced tapeouts coming. As I mentioned earlier on my narrative, with the tapeouts we expect with the qualifications that we just completed this quarter, the tapeouts have slowed down, and that could affect some of the unit output. But depending on the mix that we receive, we could get a big bang from that. And we're very excited about the qualifications that we've talked about by ASML, UMC, Samsung. These guys are huge players in the market and we're very excited about them using us on the advanced products. So, I think this mix thing could have a bigger impact going forward in the couple quarters to come.

Paul, then, what do you think your 1.8 microns and below will be next quarter? They were down this quarter. Can that actually grow with the mix richening?

We would hope that our revenues do grow. They certainly will not be down next quarter. And if we stay at the high ends of our range, we do expect to see a pickup there.

Steve, as we said earlier, our visibility remains limited. Certainly there is, we believe, a backlog of designs. And if those designs were to be released, we are in good position to capitalize on them on our nanotechnology lines. But at this time it's very, very difficult for ourselves as well as anyone else to predict what the end markets are going to do.

Fair enough. Thanks, Dan.

Your next question comes from Byron Walger, UBS Warburg.

It appears you lost some market share during the quarter, but you alluded to winning some of it back. Do you expect to regain all the lost third quarter share by the end of the fourth quarter?

As we said, and Paul can add some color, as well, we have taken some very difficult actions. We continue to sell our value added services, that being turn around time, delivery and no returns. And we're gradually getting back some share. But whether or not we gain that back in the next quarter, I think, you know, these actions take the more longer term, three to six-month time frame.

Yeah. Byron, this is Paul. Clearly we're geared to support the growth when it comes with this latest activity we've taken, to become actually more cost effective than our competitors globally. And we believe that we have already recovered back basically some of our lost market share of last quarter and we have taken some. So, yes, absolutely we believe that we're in a very strong position, securing not only this quarter coming, but in the quarters in the future. And I think like I said earlier, with some of the qualification that is have officially been announced today and stuff, with he' positioned ourselves with some very key partners who are growing themselves. And we'll be there when they start to grow.

When you say that photomask units were slowing, can we infer that for the entire industry?

Yes. That was as an industry as a whole, you know, as Paul said, we're driven by designs. And the tapeouts of designs has been delayed.

Yeah. What do you think it's going to take to get the industry to reaccelerate their design activity through tapeout?

It will take the end market demand firming up. And it depends on when the corporate IT jumps in, or if we come up with a killer application. And I think that's primarily the main drivers at this present time.

You guys have an internal leading indicator, you know, prior to actually seeing tapeouts increase?

As we've said often in the past, our visibility, because of the quick turnaround time, is typically two weeks.

Okay. But no GDP-related or IT-related or PC-related kind of things? Those are more concurrent indicators for you?

Yes, absolutely.

Okay. Thanks.

Your next question comes from Gus Richards, First Albany.

Good morning. a Couple quick questions. When do you expect yields on.13 for your customers to start to improve?

This is Steve Carlson. That's a difficult question to answer because of the sheer number of variables that are involved in that question. Clearly there's a lot of focus at the very leading edge customers on the copper and low K integration, and then there's the high K materials aspect, as well. One of the things that we're in a great position for is in addition to all of this there is a lith owe graphy component on the design side, and that activity has really accelerated. I think the prediction of when is really kind of tough to hit, but what we do see is an enormous amount of focus on optimizing the lithography part of the equation, and that's where we have the biggest impact. And the air crass that we're addressing there are providing the different tools to extends the high system, the 140-nanometer face shift and other radical extensions and the most effective methodology for specific intergrating those solutions into their design space.

So, you know, from our side I think the lithogrophy part of the equation will start to solidify coming out of this calendar year. And that's also somewhat coincident to some of the 193-nanometer introductions to give some additional options. On the material space it's really hard to predict.

Have you seen your customers make any progress over, say, the last quarter ter or so and loosen up yields from even lower levels?

Yeah. I think the progress is there. It's just the slope of the lip is still somewhat depressed, say relative to a similar point of .18.

And then at this point in time are you seeing customers come in and do cost reductions on existing products, or are those being held off due to yield issues at the smaller geometries?

Well, it's he actually a little bit of a mixed bag. One of the by-products of this environment are that, you know, you are seeing some design activity, especially on the consumer side of trying to rationalize whether or not there are improvements on the design space that can get the similar type of benefit that in the past has been relied upon primarily from the progression down the node to node curve.

And one final question. Can you talk a bit about market share at the leading edge and sort of what you see amongst your competitors, I know, globally?

Well, as we said, our revenue mix at .18 and below remained flat from the previous quarter. And we said we were affected by the design activity not being taped out. But I think Paul could adds significant color to that.

Yeah. I think that clearly we have qualified, as I mentioned, some key customers. And UNC and Samsung are ready. Customers that we have qualified are ready at 130 and below. And it's a situation that we're not allowed to disclose. But we're very excited by our position in Europe, Asia and the U.S. right now. We think they will pick up their activities here in the quarter to come. We're expecting our .18 and basically below to start growing. And we think we have strategically picked the right partners, people that are growing.

And the question really comes down to, you know, when you look at product in the high end mix with our competitor, you know, we're reporting 24% of our -- basically our mix as .18 and below and my competitor is stating they're at 46%. The credibility of the data has to be really looked at. The situation being if I was to have a 46% .18 and below mix and I'm the lowest cost provider in the industry and I'm shipping one nm plate per day, in the Photronics cost structure, we would be somewhere in the mid 40% margins. If you look at my competitor and where he's at, he's in basically the low 20s. And to be frank and honest with everybody on the call, I could not walk into my Board of Directors and Chairman with that kind of performance.

So, the question of credibility of that data has to be asked. We think our data is very good. We feel that we are in very good shape going forward. We have to execute. And as I mentioned earlier, we've got some very key focus in the fourth quarter on our qualification cycles and technology that we have to achieve. But we have some very good relationships with some very good customers right now.

Okay. Thanks a lot.

Your next question comes from Chip Bonnet, FM Global.

I just wanted to jump back quickly to utilization rates. Earlier in the year I think they were running around 70%, I I know you said you don't really break it out quantitatively. But just qualitatively can you talk about where you've seen the fallout between, you know, high end and mature mask sets to bring it down into the high 50 area?

This is Paul again. We really don't break it out, but we can say that, you know, the high end tool lifetimes are obviously a little longer and the saturation on those are a little bit hard. The mature ends tools have softened a little bit, and that's where we're seeing a little bit larger the delta by the regions. We have new tools coming on-line that have impacted some of the use the rates. We were at 70%, but we brought on some NTL capacity which when you add that to the family drops the number for a while. But we expect those things to start climbing again into the 70% range over time.

And chip, one of the reasons that we made the announcement yesterday to close our Milpitas manufacturing site was because of the drop in utilization rates.

Okay. That's good. That's helpful. Thanks.

At this time there are no further questions.

I'd like to close with a few comments or a summary, summarize. This certainly has been a very difficult and challenging quarter for Photronics. And really the timing of the semiconductor turnaround remains cloudy. However, as you can see we have taken some very difficult and decisive actions and we continue to manage our costs very diligently. As I mentioned previously, we believe and are confident that we are best prepared and strategically positioned globally to capitalize on the inevitable turnaround. And so, with that I'd like to close and thank you for your participation.

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