Photronics Inc (PLAB) 2003 Q3 法說會逐字稿

Good morning. My name is Jodie and I will be your conference facilitator today. At this time I would like to welcome everyone to the Photronics third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question and answer period. If you would like to ask a question during that time, simply press * then the number 1 on your telephone key pad. If you would like to withdraw your question, press the # key. Thank you. Mr. Fego, you may begin your conference.

Thank you, Jodie and good morning everyone. My name’s Paul Fego, President and Chief Operating Officer for Photronics. I would like to thank everyone for participation in this morning’s conference call, during which we will discuss the results of our fiscal third quarter, which we reported last night. Before we begin, unfortunately, Mike McCarthy, our Vice President of Investor Relations will not be with us today, as he is a bit under the weather.

I’d like to remind all participants about the Safe Harbor Statement Provision, which is under the Private Securities Litigation Reform Act of 1995. Thus, except for historical events, the information we will cover during this call may be considered forward-looking and may be subject to certain risks and uncertainties that could cause actual events to differ materially from those projected, including uncertainties in the market, pricing, competition, procurement and manufacturing efficiencies, and other risks, detailed from time to time in the company’s SEC reports. This call will remain archived on our website until we report our fiscal 2003, fourth quarter results after the market closes, on the week of December 8th.

Our call this morning will begin with Sean Smith, our Chief Financial Officer, providing a detailed review of our income statement and balance sheet, after which Dan Del Rosario, our Chief Executive Officer, will share some brief comments and then moderate the Q and A session. Joining Dan and Sean in the Q and A will be myself and other key members of the management team. Sean?

Thanks, Paul. And good morning, everyone. I’ll provide a brief analysis of our financial results for the third quarter of fiscal 2003. I will also review our balance sheet and cash flows during the period, as well as review our outlook going forward.

However, before we begin, I would like to congratulate the entire Photronics organizations for their hard work and commitment during this quarter. Through their collective efforts, the company was able to report results that met or exceeded our objectives for this quarter.

During the second quarter we incurred an after tax charge of 39.9 million, or $1.24 per share, resulting from the streamlining of our North American operating infrastructure with the closure of our Phoenix facility and additional workforce reduction. During the third quarter we redeemed all of our outstanding 62.1 million, 6 percent convertible note. The redemption resulted in an early extinguishment loss of approximately 900,000, or 3 cents per share.

I will elaborate further in a few minutes on these and other cost reduction activities. But for the purposes of our discussion of operations, I will primarily be referring to our operating results, excluding the impact of these items.

Net sales in our third quarter amounted to 90.5 million, compared with 98.1 million in third quarter last year. And while we are pleased to report that the company has returned to profitability, we all know that there’s still work that needs to be done before our management team, valued employees and shareholders should be satisfied.

Total sales outside North America accounted for approximately 61 percent of third quarter 2003 revenues, compared with 56 percent in third quarter last year and 61 percent sequentially. As a percent of total sales, sales were approximately 23 percent in Asia, 41 percent in North America and 16 percent in Europe. Sequentially, third quarter sales increased by 4.9 million, or 5.7 percent. The sequential growth was primarily centered in Asia and in North America.

Shipments of photomasks for devices utilizing .18 micron design rules and below, accounted for 30 percent of our third quarter revenues, up from 27 percent in the second quarter. This represented a 17.6 percent sequential increase in .18 micron and below revenues.

The third quarter growth margin was 31.4 percent, as compared to last year’s third quarter level of 28.6 percent. Sequentially, third quarter growth margins improved 480 basis points, as a result of the increased high-end volume during the third quarter, coupled with the favorable impact of our cost reduction initiative. Depreciation and amortization for the third quarter was 20.6 million, as compared to 21.8 million for the third quarter of ’02 and 21 million sequentially.

Selling, general and administrative expenses for the third quarter was 13.6 million, as compared to 15.1 million last year. Sequentially, SG and A decreased approximately $1 million. SG and A as a percent of sales was 15.1 percent during the third quarter of ’03, as compared to 15.4 percent in 2002 and 17.1 percent sequentially.

R and D expenses, which consist principally of continued development for 90 manometer and 65 manometer process technologies, were 7.3 million in the third quarter, as compared to 7.7 million last year. Sequentially, R and D expenses decreased by approximately 210,000. R and D represented 8.1 percent of sales in the third quarter, compared with 7.8 percent last year and 8.8 percent of sales sequentially.

During the third quarter we generated operating income of 7.5 million, a 41 percent improvement over last year’s third quarter. Sequential net sales increased by 4.9 million, however, operating income increased by 6.9 million. This represents an 11.5 time improvement in sequential operating income.

As I’ve mentioned in numerous conversations with the investment community, our model provides significant leverage once revenues reach break-even. As our high-end revenues continue to grow, we believe that that long-term goals of achieving operating margins of 20 percent or greater are achievable, as long as we continue to aggressively manage our cost structure. Our global team has done an outstanding job and has risen to the challenge of swiftly matching our cost structure to the changes in the global market environment.

Net other expense of $3 million, includes an early extinguishment loss of 900,000 or 3 cents per share, related to the bond redemption. Excluding the impact of this one time loss, net other expense for the third quarter was 2.1 million, as compared to 4.1 million in 2002. Sequentially, net other expense, excluding the bond redemption, decreased 1.2 million as a result of favorable investment returns and reduced borrowing costs.

During the third quarter we recorded tax expense of 1.6 million, which includes the valuation of allowance of approximately $650,000, which is deferred tax benefits for which recoverability is uncertain. Exclusive of the valuation allowance, the effective tax rate approximated 33 percent for the quarter.

We are pleased to report that we returned to profitability during the quarter. Net income was 1.3 million for the third quarter of 2003, as compared to 1.2 million in the third quarter last year. Net income, exclusive to bond buy-back, was 2.2 million for the third quarter, representing $6.3 million sequential bottom-line improvement in profitability. Net income per share, excluding the bond buy-back was 7 cents for the third quarter, as compared with 4 cents per share in the third quarter of 2002.

Our income per share for the quarter was ahead of our high-end guidance as a result of the increased high-end volume in addition to savings associated with our ongoing cost containment programs and reduced operating structure. As we exited the third quarter, we had approximately 1,480 employees, equating to sales of 245,000 per employee, on an annualized basis.

Now taking a look at our nine-month year-to-date operating results before the impact of the consolidation charge and bond redemption, net sales for the first nine months of 2003 were 257 million, which were down approximately 13 percent from the first nine-months of last year. The decline is primarily attributable to the depressed market, which has had a significant impact on our business since the beginning of the third quarter in 2002. As a result of the declined volume, our gross margin the first nine months decreased to 26.7 percent, as compared to 29.6 percent for 2002.

SG and A expenses decreased slightly, or 2.3 percent, to 42.6 million, or 16.6 percent of sales. SG and A last year totaled 43.6 million, or 14.7 percent of net sales. Research and development costs of 22.5 million was slightly higher than the 22.3 million last year. R and D was 8.7 percent of sales for the first nine months of 2003, versus 7.5 percent of sales in the prior year. Our investments in this area are [technical difficulty] of the company’s future growth and ability to provide the innovative photography solutions required by our customers.

For the first nine months of ’03, we had operating income of 3.7 million, as compared to operating income of 21.9 million last year. Net other expense, exclusive of the bond redemption, amounted to 8.4 million in 2003, compared with 11.3 million in 2002, due primarily as a result of increased, year-over-year invested income and reduced interest costs.

For the first nine months of 2003 we recorded a tax benefit, including the impact of the consolidation charge, of approximately 3.5 percent for all geographic areas in which we are tax [inaudible]. When we improve the impact of pretax incomes in jurisdictions for which we have tax [holidays] [ph], our tax benefits amounted to 1.5 percent or $800,000. For the first nine months of 2003 our net loss amounted to 10.5 million, or 33 cents per diluted share, compared with income of 5.5 million or 17 cents per diluted share last year.

Now turning to the balance sheet. In April of 2003 we issued 150 million 2.25 percent convertible subordinated notes, which are due in April of 2008. A portion of the proceeds, or approximately 63 million, were utilized in June to redeem our outstanding 6 percent bond. From a liquidity position, our balance at the end of the third quarter was quite strong, with working capital in excess of $246 million. Cash and short-term investments were 211 million, as compared to 129 million at November 3rd, 2002. With the increase resulting from the net proceeds of the convert issuance. The company’s current ratio at the end of the third quarter improved to 4.2 to 1, as compared to 2.3 to 1 at the end of 2002.

Sequentially, the company’s cash and investments, exclusive of the bond redemption, increased $4.8 million during the third quarter, due in part to our returned profitability and our continued focus on asset management in such a way as to maximize our liquidity.

Total debt for the first nine months of 2003 increased to 78.7 million, or increased 78.7 million, to 386 million, primarily as a result of the $150 million convert issuance net of debt retainment. At the end of the quarter total debt includes a $200 million convert that’s due in December of ’06, $150 million [indecipherable] quarter convert that’s due in April of 2008, $11 million outstanding on a revolver balance, which is due in July of ’05, and approximately 25 million in foreign terminal. Shareholder’s equity aggregated 297 million, which amounts to a book value per share of approximately $9.25.

Now taking a look at our cash flows. Cash flow provided by operations for the third quarter of 2003 was approximately $24 million, or $42 million year-to-date. Year-to-date cash flow used in investing activities amounted to 36 million, of which 35 million represented capital expenditures. Free cash flows from operations net of CapEx for the third quarter was 6.6 million and approximately 7.1 million year to date. Year-to-date cash provided by financing activities amounted to 73 million, which we primarily relate to the $150 million convert issuance, offset partially by the 6 percent bond redemption and pay-down of other outstanding debt.

Taking a look ahead, our short-term visibility continues to be limited. However, we are encouraged by our reduced operating costs and our current booking level. Our guidance for revenue for the fourth quarter is projected to be in the range of $90-$95 million. Capital expenditures in fiscal ’03 continues to track in the range of 55-60 million, down significantly from fiscal 2002 levels of 126 million.

Free cash flow for fiscal 2003 is projected to be in the range of $10-$15 million. Accordingly, based upon our current operating model, we estimate that the earnings per share for the fourth quarter to be in the range of 5 cents to 13 cents per share.

That wraps up an overview of our financial performance and our short-term outlook. Now I’d like to turn the call over to Dan for brief comments before we open up the call for questions. Dan?

Thanks, Sean. And good morning everyone. As Sean detailed in his comments to you, Photronics achieved its stated goals and return to profitability. During our February conference call, we discussed the factors behind the company's first operating loss in more than 60 quarters. At that time I also put the entire Photronics team on record that we would return to profitability this quarter.

Since that time, achieving this goal has been a singular focus of Paul Fego, Sean Smith and the entire Photronics team. I knew that if we issued the challenge, the entire team would rise to meet it. Speed, flexibility and cost control have always been characteristics that enable Photronics to stand out against our competitors and larger semiconductor industry piers.

Once again, they have served the company and its shareholders well. However, one quarter does not a turn around make. The bar is being lifted into a position of sustained profitability. Many of the actions we have taken so far, set us well along this path. We remain firmly committed to realizing the full potential of our long-term operating model and believe that our continued focus on the efficient management of our operations is the key ingredient to our success. Strong operational execution and market share gains must also be carefully balanced with the requirements our customers have as they look to the future.

At the Advanced Radical Symposium held in San Jose, this past June, I had the opportunity to use my keynote address, to lay out a cornerstone of a technology and marketing based strategy designed to be proactive in addressing the challenges of simplifying and increasing the efficiency of taping out sub-130 nanometer design. Integrating the lithography plane, a phrase that was coined in my presentation, is a means to enable semiconductor designers and manufacturers to make greater and more cost-effective use of advanced process technologies coming on line throughout the rest of this decade.

By implementing a series of strategies and cultivating new relationships that promote the integration of the lithography plane, Photronics is leveraging the strong assets that is our leadership position as a key technology enabler, in order to promote the development of processes and line of communication that allow semiconductor designers, wafer fabs and foundries to maximize the returns on their multi-billion dollar investments.

This initiative is still young, but the groundswell of support we have seen at this early juncture leads us to believe that our integrating the lithography plane vision is shared. I look forward to reporting back to you on future developments and successes here.

Thank you for your attention. Following some brief instructions from the conference operator, we will be happy to address your questions.

At this time I would like to remind everyone, in order to ask a question, please press * and the number 1 on your telephone keypad. We’ll pause for just a moment to compile the Q and A roster. Your first question comes from [Seresh Balaramin] [ph], from Think Equity Partners.

Good morning guys. How about the pricing in [indecipherable] in terms of the different regions and also the technology nodes? And also, an additional question, can you break out the revenues for .13 micron and below?

We’re going to take that question in three parts. First of all, Paul will address the pricing. Steve Carlson, our Vice President of Technology will address the technology as far as the nodes. And then Sean will take the .13 and below.

Hi, Seresh. As far as pricing goes, for the region of the world, we have seen stability basically, in all three major regions that we service, the US, European and Asian markets. We have not seen any desperate moves or attempts by anyone. Everyone is trying to do their best to get back to profitability and right now we’ve been encouraged by the pricing environment. Steve, you want to make a comment.

Sure. Good morning Seresh. The technology node, as you know, right now we’re in the early stages of 130 nanometer ramp. And 90 nanometer is falling right behind it. We’re also engaged already at the 65 nanometer node, with multiple customers. As you’re well aware, the complexity as we head the 90 nanometer, 65 nanometer, provides us additional opportunities to help the customers optimize the design to silicon flow as it increasingly relies on map based solution to deliver the process margin required.

Hey, Steve, are there any pricing changes on a quarterly basis on any particular technology node that’s something we should be aware of?

This is Paul. We’re not seeing any pricing changing on any of the nodes right now. As far as the .13, Sean?

Yes, Seresh, as a result of the qualifications that we’ve been successfully achieving over the last couple of quarters, our .13 revenue and below increased 60 percent sequentially from the second quarter.

And any thoughts on what is was as a percent of revenues?

It was approximately 10 percent.

Your next question comes from Ali Irani, from CIBC World Markets.

Good afternoon and congratulations. This is Peter Wright, actually, for Ali. First of all, would you guys be able to discuss the activity levels on a month-over-month basis that you saw throughout the quarter, specifically where you guys are experiencing share gains as this type of revenue is more robust than it appears the merchant mass market in general?

Secondly, if you could comment on your gross margins. And if you exclude depreciation, if you could qualitatively explain where your incremental margins are by node? For instance, are the margins on 90 nanometer assets 20, 40, 80, higher than that, which you receive on 250 nanometers?

Okay, Peter, first of all, as far as the revenue is concerned, most of that revenue gain has been through market share gains globally. And we’ve been able to make those market share gains because of our penetration through technology at 130 nanometers and below. In some cases we’ve penetrated new customers. In other cases it’s customers that we had, however, we have migrated from high performance logic to being also able to do their memory products, both from DRAM to Flash to SRAM.

Okay, now Peter, this is Sean Smith. With respect to breaking down gross margins by tech node, we don’t typically disclose that. However, what I will tell you, in our network we have a couple of mature facilities with margins in excess of 30 percent and one approaching above 40 percent as well as some of our high [indecipherable] performing very well. So, we’re satisfied with our mix and we continue to work with all of our customers.

Great. One follow-up on that. I guess the month-over-month trend, did you see a heavy July month?

We simply don’t comment on a month-to-month trend, however, we stated all during the quarter that we were tracking according to our guidance and we’ll leave it at that for now.

Great. And finally, if you could comment on the utilization rate – your guy’s utilization rate?

We’re basically, at some facilities we’re in the high 60s, low 70 percent range right now. Like we said, we’re very encouraged that it’s also being seen across the enterprise in all divisions. So we’re not seeing any spiking by any particular customer or product lines that would give us a false impression.

Peter, one additional comment is that on 130 nanometers we are quite confident on what the gross margins are projected to be. However, 90 nanometers is still in the development mode and there haven’t been enough sets for cycles of learning, let alone to determine what the margins are going to be at that node. In fact, if we look at most of the 90 nanometer developments, if we look at minimum features, they’re not really at the 90 nanometer design as yet. And so it’s still too early to designate differences between 130 nanometers and 90 nanometers.

Your next question comes from Mike O’Brien, from Soundview.

Michael O’Brien: Yes, hi, good morning. Just a quick question. Sean, you mentioned bookings trend is encouraging. Could you give us a little more detail? Are you seeing requests that are stretching out or just further booking for any particular region, just some further color on the bookings trend you mentioned.

Mike, this is Dan. While we have had about a 5.9 percent growth sequentially over the last two quarters, that has been primarily, as I mentioned earlier, from market share growth. If we look at the markets and the present time for the latter part of this year, we still believe that they will be flat. We do not see a significant upturn in the industry.

However, we are encouraged, because we believe inventory levels are extremely low. Secondly, the other point that encourages us, is that if we look at PCs out there, they’re approaching 48 and 50 months. And as you saw last month, Intel has made the decision to move back to 36-month replacements. So that, coupled with the consumer confidence today, we believe that in this year, for the first time in three years, we might see a Christmas pull through and, therefore, our encouragement as far as our final quarter of the year.

Michael O’Brien: Okay. And are you seeing anything from the Taiwan mask makers outside of Taiwan or so you see any of them trying to migrate out of Taiwan?

The Taiwan mask makers as far as TMC and then THTC, which is [Topan] [ph], they have from time-to-time, over many, many years tried to penetrate the US market as well as the European market. One of the advantages that we have is that we’re a global company and able to out-perform them on surface basis. We just have a very, very strong natural efficiency and we’ve been able to do that.

Yes, they’re just like any other competitor we have to deal with. And just like Dan said, we continue to form everyday to satisfy our customers. We have pretty loyal customers who are willing to work with us. And our team has done well so far against any of the competition.

Michael O’Brien: When you do see them in the market, when they’re trying to go after North American companies, are they pricing very aggressively?

We’re not seeing the behavior pattern of them trying to buy in on price. They’re selling the same as everybody else, service, and what they can sell it for. But as anything else, this is a relationship business and people want to deal with people they know and they trust and depend on for now and in the future. And I think for our company, that’s one of our strongholds, is our business relationships and how we work things.

Basically, what you also see is that in the case of Taiwan mask company, their technology is limited to mature products. And so from the point of Photronics, we service the entire spectrum of the market, from mature products to the most advanced products. And therefore, with advanced products becoming more critical in the path of many of the major IDMs, a lot of them are not looking for second sources. And as you see, utilization increase, they’re going to want to have commitment for capacity from their key suppliers.

Your next question comes from Ted [Burg] [ph], from Lehman.

Hi, thanks. On the capital spending and kind of cash flow trends for next year, where do you see CapEx for fiscal ’04. I know, Dan, at the ARS conference you mentioned there’s going to be much higher level of capital spending for mask plant that you needed for the 65 nanometer node. Will that begin to start in ’04 or will that really begin to ramp more aggressively in ’05 in terms of your capital commitments for capacity?

Ted, how are you doing? This is Sean Smith. I’ll answer the first part and then we’ll turn that back over to Dan. With respect to 2004’s planned CapEx and forecast cash flows, we’re in the process of pulling that all together. That being said, we do not anticipate at this present time, unless a capacity need dictates, to have a significant increase in CapEx for 2004.

Ted, as I mentioned to you before, we need to be on the leading edge. And although 65 nanometers is considerably out, remember, as Steve said, we’re just starting to see the early production ramp of 130 nanometers, we’re starting to see the development of 90 nanometers. But the complexity is at 65 nanometers. Now it will be done with 193 and higher [indecipherable] makes it imperative that we start to develop technologies now, because it is the next inflection point. And therefore, this year we will be making investments on at least one 65 nanometer line.

Okay, thanks. And if I could ask one other question related to the overall mask market. I think, did you note just a little bit ago that you thought the overall mask market was trending roughly flat here in 2003, or do you anticipate it being down some this year, for revenue for the industry?

It’s actually sequentially up, but just modestly.

In the full year, versus last year?

It’s also up from last year, but Sean, why don’t you take it.

Yes, Ted, we project, based upon our guidance, our revenues to be down anywhere from 9-11 percent year-over-year. But since we hit what we feel is the bottom in the first quarter, we’ve seen sequential modest improvement and we expect that going forward.

Your next question comes from Steven [Palleo] [ph], from Morgan Stanley.

Yes, a couple of questions. First for you, Sean. Incremental margin performance is just phenomenal here. You have better gross profit dollars than the sequential increase in revenues. I’m curious about the incremental gross margins going forward. I don't know how you want to quantify it for me. Maybe if we just talked about on flat revenues, would we expect further margin improvement from here?

Steven, on flat revenue basis, we may have a slight deterioration in margin, because there is a small amount of additional depreciation coming on line. But we’re going to consciously manage our cost as we move forward. We would expect, with modest revenue growth, to see the 31.4 percent margins to go up. As I mentioned in the call, we’re pleased that we’ve returned to profitability. In fact, our gross margins for this quarter were the highest in the last nine quarters. We want to get them up to our stated goal of 40 percent or more. We have a long way to go to get there.

So, the leverage in the model is there. We just need to execute on a day-in, day-out basis.

And just to make sure, in the current pricing environment that you suggested as being stable, that’s all that’s required to hit the 20 percent margin target?

I’m sorry, could you repeat that?

The current pricing environment, which you characterized as being stable, is that all the pricing environment that you need to hit your operating margin target, I think of 20 percent you were talking about?

Yes. We need to continue to gain additional market share and have some modest pick up.

Okay great. And then the last question for you, Sean, was just the ongoing tax rate now that you’re flipped to the positive here?

For the first half of 2003, Steven, we recorded a tax benefit saved of approximately 5 percent. And during the quarter we reduced our projected tax rate for 2003 to approximately 1.5 percent. That being said, our projected tax rates for the fourth quarter will be in the range of 1-10 percent and will be contingent upon the flow of income from taxable and non-taxable jurisdiction. And unfortunately, for most of you on the phone, the composition of our effective tax rate does not coincide with a linear calculation. So, we’re gonna probably be 1-10 percent depending on the flow of income. There are some puts and takes to that number.

Okay. And then the last question was just – I mean, you guys are doing great on the margin side. So to talk a little bit more about the top line. You talked about bookings being fairly encouraging going forward. The demand going forward and the potential upside in revenues, of 90, 95 million next quarter, is that mix, market share or organic market growth, or all three?

I think the overriding point would be still continued market share gains and opportunities at the high end. Again, because of our global positioning as well as our move into the advanced technologies at 130 nanometers, where our yields are quite good now and we’re starting to move to the 90 nanometer, Steve.

Great, Dan. If it is going to be any more mix related, you got any thoughts on what your mix from .13 micron and .18 micron could be next quarter?

We haven’t looked at that yet. It’s really difficult, Steve, in the environment still being uncertain, without looking at the terms. As you know, one set of .13 or one set of 90 nanometer being delayed can make a significant change in that number, because of the prices of these sets.

One of the things I’d like to add, Steve, on the gross margin side, for any CapEx business, there are two leverage points; first of all, yield and then secondly, capacity utilization. And so, in a very difficult market environment it’s most important for us to control costs stringently. Of course we need to control cost, regardless of the market conditions. But in a market condition as we have now, that’s the biggest contributor to our gross margin performance. However, as we see the turnaround and as we gain market share or combination there of, what happens then is it’s because of capacity utilization.

And I can tell you the model still works, because we have sites today, one operating at very high end, where their .18 mix is higher than 40 percent and their gross margins are running in excess of 40 percent. We also have a very mature site, which is fully utilized, because of our taking some capacity out in last quarter . And that site is also running at 40 percent plus gross margin.

So, the model still is in tact and it’s all about utilization. We’ve managed our cost very well. We’ve managed our yields very well. And so now we need the market to turn, so we can get that utilization.

Your next question comes from Gerry Fleming, from Fahnestock.

Yes, first for Sean, and then one for Dan. Sean, you mentioned something about a 650,000 tax charge in the quarter, relative to past lost credits?

Yes, Gerry, what we did during the quarter was we re-looked at some of our foreign tax benefits that we had set up and determined that it was more likely than not that we wouldn’t realize those tax benefits. So we took a charge for that.

So, as we go forward you won’t have that sort of an impact again?

We shouldn’t have that impact. But we need to continue to look at what we have recorded and value our balance sheet to ensure that we do have the potential for recoverability. Here in North America we had stopped recording tax benefits since we fully utilized our ability to carry back any claims.

Okay and for Dan, what’s the relationship these days between design activity and the status of design activity and that translating into tape-outs?

We believe that, as we reported before, from one of the major EDA companies, from their surveys, that design activity at 130 nanometers continues to grow and is quite robust. The real issue here is two things for the release of these designs. And it’s a new paradigm. Because of the cost of developing a design at 130 nanometers of $5 million plus, you really need the end market. And so, we need a global recovery to drive that end market. And then we believe there would be substantial tape-out in the Q.

Your next question comes from Derrick [Wanger] [ph], from Jeffries and Company.

Yes, several financial questions. What was the gross interest expense for the third quarter?

Gross interest expense, we did not break that out, but if you give me a second, I can - our interest expense for the quarter was approximately $3.5 million.

Okay. And what was the pretax figure for the loss on the early retirement of the debt?

The pretax figure and the after tax were essentially one in the same.

Okay. And then capital expenditure guidance for the full year and for next?

For the full year, it’s between $55 and $60 million.

And next year, have you given any?

We have not.

Okay, so the quarter CapEx was what?

I believe it was $24 million for the quarter.

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

I wanted to follow-up on the comment you made about the release of the 130 nanometer designs. And I’m curious why you wouldn’t think that would happen sooner, given the need for your customers refreshing their product cycles at this point?

I did not say that the need would not be sooner. I’m saying that we need end market demands before we see the 130 nanometer designs flowing. And thus far we have seen the release of the 130 nanometers as being quite – although they’re increasing, they’re still sporadic.

But I mean, your customers are looking at some of the same data that’s making you enthusiastic and typically design activity leads any sort of real end market data here. So, I’m just curious in terms of your conservatism about the next couple of quarters here.

No, I think if you look at in previous downturns, we were able to get out of the downturns one or two ways; either we had an end market or secondly, we could design our way out of the downturns. If you look at the 350 nanometer, 250 nanometers, you know, design costs at that time were probably in the range of $300,000 or less. This time it’s a little paradigm, with 130 nanometers development design costs are upwards of $5 million. So, end markets now drive the tape-outs.

Is another way to look at this, are design costs starting to limit the number of new designs. So as we go to 130 and then 90 and 65 we’re looking at the number of new designs shrinking going forward?

I don’t think it’s really limiting the designs. We still believe that there will be significant design activity, once the end market drives them. Because if you look at the products that need to be driven, these are 130 nanometers and below, it would be the microprocessors. It would be your DRAM, SRAM memory, flash memory type products, your PLDs and high performance logic products.

But when you look at just the kind of raw unit design demand for new products, I’d assume things like ASIC and application specific have higher volumes, smaller lot runs and that these higher design costs are going to limit those guys in terms of being able to justify coming up with multiple designs.

Well, I think if you look at - the paradigm has changed as far as ASICs. ASICs in the past has always driven the mask business as well as the EDA business, because you had a significant amount of ASIC designs. If you go back to the mid-90s, you were at about 10,000. But when you reach the crossover point of 180 nanometers with data rates and PLBs, the cost for transistor was the same as an ASIC, so you saw some of the ASIC designs diminishing and then other designs increasing.

And so some of it is, what’s important for you guys, what you’re saying is that total number of designs at 130 will be actually greater than 180 and the total number of designs at 90 will be greater than 130, and at 65 greater than 90?

No. We’re not saying that. What we’re saying is that the number of designs may [technical difficulty] 180 nanometers. However, if you look at the number of levels in 130 nanometer design – if you look at 180 nanometers, you’re talking about 24, 25 levels. When you get to 130 nanometers, if it’s a complex memory product, you’re looking at upwards of 42 levels. And then you’re looking at very aggressive RET. So the ASPs are going up and the number of levels are going up, so you do not need to have as many designs to drive that.

While we don’t have as many designs as 130 nanometers on the other end of the sword, is very, very technology driven. When you were at 250 nanometers, most of the technology was embedded in the tools. Now in 130 nanometers and below, there’s only a small number of companies can make the investment and develop the technology to compete at that level. And so for Phototronics, we feel it’s an advantage for us.

And as I said earlier, we believe it’s optical forever, because 193 with immersion, whether it’s wet or with high NA, looks like it’s going to take us down to 45 nanometers. So, the technology, we leverage at 130 nanometers. But our nano technology lines will take us down to 90 nanometers. Our development at 65 nanometers will take us down to 45 nanometers.

Your next question comes from Bill [Oing] [ph], from [Melkin] [ph] Technology.

Hi. Given that the DRAM tends to use more events for the mask, such as phase shift and DRAM activities are increasing, are you blending ASPs because mask as going up? And what’s the trend going forward?

If you look at the ASPs, there’s not a significant rise in ASPs. What you have is a significant increase in individual, extra critical layers, because of the complexities with either OPC or the reticle enhancement techniques or phase shift. And because you have more mass at more levels, as we mentioned earlier, even if you go to a memory set with 40 levels or 42 levels, probably 1/3 of those levels are critical levels. The other levels are non-critical.

So, our advantage is we have very , very good technology for the extra critical and critical levels, where we have tremendous manufacturing efficiency that gives us an advantage on the other 2/3 that are really more mature technology.

Your next question comes from Peter St. [Dentiss] [ph], from Advent Capital.

Most of my questions are related to CapEx. The CapEx has really been ramping up and I’m just wondering why? I mean, is that volume driven? And then you said CapEx would be flat for next year, the first quarter. Is the pattern likely to be the same in ’04 as it is in ’03?

I believe I said that CapEx is actually down for 2003. We did $126 million –

I know it’s down in 2003. I’m talking about the first half of the year you only spent like 18, now you spent like 24.

Year-to-date CapEx is $34 million. We spent $17 million during the third quarter. We’re projected to spend $55-$60 million for the fourth quarter, or for the full year. And with respect to 2004, we’re finalizing that plan and we don’t expect a significant increase from this year’s level, unless it’s capacity dictated.

Your next question comes from Ben [Pang] [ph], from JP Morgan.

Hi. A couple of questions. On your operating model, when you get to the 20 percent margin, what is your R and D target there?

Our R and D target is we’re going to continue to spend a similar amount in absolute dollars for R and D as it is critical in the lifeline for us in the future on 90 and 65 nanometer development. But as a percentage of sales, it should decrease, but in absolute dollars, it should stay at the same level or modestly increase.

So, even though the 65 nanometer is getting more complex, you think you can have the same amount of R and D with the same dollars?

This is Steve Carlson. I think what Sean said is, as our top line grows, we’ll have the ability to adjust – to match the demand in the development flow. We are getting a lot more interest much earlier in the cycle. We’re already engaged, as we said, with our 65 nanometer node technologies with multiple customers.

I think one of the interesting things as we go forward, is this complexity drives quite a bit of opportunity and we’re becoming increasingly tight with a higher percentage of the leading edge customers. It gives us a lot more visibility into the appropriate timing. And that allows us to tune our development cycles to match the demand.

And even with this increased complexity, while we’re doing that, the opportunities to integrate across the plane give us a lot more efficiencies. In those cases we get to a point where we must rely increasingly on modeling and simulation. And on a learning cycle basis, that tends to be a more efficient method to gain increased learning, than having to rely on completely physical experimentation. So, the learning rates will increase per unit of time, but we’ll have a lot more visibility as well.

So basically, you have some new tools that you can use for this round of development, versus the 130 nanometer?

Yes we can. And that’s heavy usage of modeling and simulation based tools to help give us increased learning rates.

Okay and on the .13 micron technology, I want to get a better understanding here. Do you guys think things have stabilized in terms of – I think the comment you made is that you kind of can understand what margin you guys are going to be getting for that business, right?

Yes we have. Under 30 nanometers was supposed to be rolled out in 2001, hence we made our investments in our nano technology lines, five of them around the world, in 2001 and 2002. It affected us adversely from the standpoint where we had to depreciate these tools.

However, on the positive side, because of the delay of the production ramp of 130 nanometers, we had 18 months to develop a very, very advanced positive and negative process based on chemically amplified resist. And we have run enough sets that we have enough data points to determine what our gross margins are going to be. Because, as I said, our yields are robust at 130 nanometers.

So, the yields are basically stable and that implies the pricing is also stable there?

Right. Pricing is stable, but as I said, in a capital intensive business, there’s two leverage points; yields and utilization. So the yields are now stabilized. We’re positioned with these tools around the world. So, all we need now is the ramp of the 130 nanometer tape-outs and we’ll get the utilization and our gross margin should be there.

Okay, so on the device side, it looks like the .13 micron yields are much better right now, right, in the chip factories? Are you seeing any, now increased demand? I mean is that driving any increased demand or it’s still in that market place?

We’re seeing from a confidence factor that there is slight increase, very modest increase. For us to see significant demand, we have to see the end markets develop.

Okay and the final question is, on the competition in gaining market share, are you talking about versus merchant mask shops or is this gaining some of the captive mask making business?

It’s gaining primarily globally from our major competitors on the merchant side.

Your next question comes from Gus Richards, from First Albany Corporation.

Yes, good morning. Can you talk a little bit about pricing at the mature end?

Hi, this is Paul. As far as what could be considered at this point mature, point for [indecipherable] and above, we have not. Pricing there has been very, very stable over the last few quarters for us and this is across the world. In Asia, the US and Europe we have not seen any problems.

I think one of the differences on the mature pricing this year, as in previous years, in previous years, because of utilization, everyone started to go aggressively after the mature business. However, our strategy this year was to take capacity out rather than play the pricing game. And I think everybody has taken note of that.

Got it. And then the migration to 193, I noticed some of your customers busting a gut trying to get there. Are you seeing issues with your customers migrating to that wavelength? And then as a follow on, can you talk a little bit about sort of what that would mean to your businesses in increased phase shifting and do you get more dollars per map set if they have to lag at 248 for a while?

Hey, Gus. This is Steve. On the transition to the 193 wavelength, yes, it had a slower take off than had been originally anticipated. There’s a lot of reasons for that. Some of them had to do with the infrastructure, resistive element and so forth.

In the meantime, I think there’s an increased focus on reticle enhancement technology, whether it’s 248 based or 193. And because it’s pretty clear that 65 nanometer and 45 nanometer will be optically based with the graphics technologies, all of the reticle enhancement technologies have been improved across the board. So, the opportunity when the customers move from 248 to 193 or remain at 248 for a longer period of time, for us, essentially remains the same.

We’ve accelerated our capability in all of the different reticle enhancement technologies. So, delay of actual tool shipments at 193 doesn’t impact us specifically, but in any case, I think overall we’re getting more and more opportunity for reticle enhancement.

Does 248 get extended to the critical layers at 90 nanometers?

In all of the different leading edge customers they have different strategies and it depends a lot upon their individual requirements and needs. We do have some that are extending 248 into the 90 nanometer regime at least at the beginning. But as Dan pointed out, not all 90 nanometer designs are at the most aggressive design rules. So, we see various strategies and we’re in a position to take advantage of those with the RET.

So essentially, as long as you progress to the smaller geometries, it’s all good news, it doesn’t matter what wavelength.

Essentially, at the top level, that’s true.

Okay. And then just real quickly, on the P and L, I noticed Sean mentioned a couple of times that interest income has been growing or a little bit better. That's a little bit of an anomaly. Can you talk about that trend going forward and sort of what’s giving you the bump in interest income?

We had, Gus, several investment returns during the quarter with some of the markets coming back. We do expect that net other line, as we mentioned in the prior conference call, our interest expense should go down as a result of the redemption of the 6 percent convert. So, some of it is due to market conditions. We do have quite a bit of cash that we could invest at this point in time.

Okay, so your interest income should decline sequentially? If I just aggregate the other income line and just look at the income off of your cash, should that decline sequentially?

To the extent we’re growing cash, we would expect that to decline.

Gus, I wanted to add, on the technology side, we are developing the technologies at both the aggressive RETs as well as phase shift and hard shifters. However, what’s really important here, again, because of yield and cost consideration, this is a new paradigm and we really have to look at how do we enable the wafer fabs for them to be profitable.

And so, it all comes down to, everyone along the [indecipherable] refining, from design to wafer, anyone that influences how we put an image on the wafer, needs to start working together to make these technologies more efficient. Because we’re going to be using 193 down to 45 nanometers. So we’re not going to get relief from moving to another wavelength, such as 157.

Your next question comes from Brett Hodess, from Merrill Lynch.

Good morning. Just one question after all the good answers you’ve already given. You’ve given the mix shift that you’ve been seeing. And I know you can’t give us exact percentage, as you mentioned earlier in the call. But given the mix shift that you’ve been seeing to the high end at this point, and the design activity you’ve been seeing, can you talk at this stage, how much of the product you’re selling has the reticle enhancement technique that Steve was just mentioning? Give us some kind of a feel of how far we have to go in terms of mix that will benefit from having RET on it.

Hey Brett, this is Steve. Yes, it’s a little bit difficult to predict and typically we don’t break those numbers out separately. The reason that it’s difficult to predict is that it’s very dependent on the individual and customer design. But to the extent that they are looking to utilize these technologies, we have active programs in virtually every reticle enhancement technology that’s being looked at.

And just the quick and obvious follow-on to that, when you look at the different reticle enhancement technology you have, are there some that give you better margin leverage, because they’re more proprietary or they’re more difficult to do or have higher yield, versus others? So are there certain OPC versus phase shifts or certain types of phase shifts, or what not that we can look for to give us a better or worse margin going forward?

I think if you look at 65 nanometer node, as Dan mentioned, is the next significant inflection point and it will be 193. And what that means for us is first of all we have to be able to increase the interaction across the [indecipherable] plane. But at the same time is does allow the opportunity for potentially much more differentiation in the various solutions. Because we’re involved this early and because we’re leading the integration effort across the designs, the silicon space, that potentially gives us an opportunity for some more differentiation going forward.

Your next question comes from John Lopez, from Minot Capital.

Hey guys. Great quarter. Just three quick ones, if I can. The first one is, you mentioned the bookings, that you feel encouraged looking forward. Can you just give us an idea of what revenue levels those bookings support in your range?

John, we stated we are encouraged by our current booking levels. We have a week to two week backlog. And our revenue guidance range is $90-$95 million.

Okay. Looking forward, you guys have mentioned the last couple of quarters, you feel like the growth has been largely from share gain. Do you feel like as we enter Q3, Q4 that will continue to be the trend? Do you feel like the market is stabilizing and the market will grow?

As we said, we still continue to receive modest growth, but we expect most of our gains through the end of this year, to be from market share gains. However, we said earlier that we feel that inventory levels are low, that we might see Christmas pull through this year, so we’re encouraged by those potentials.

Okay, great. And the last one was just, you commented the pricing environment is stable. Can you give us a feel for when the last period of comparable pricing stability was?

This is Paul. I think, again, we talk about the stability of the pricing, I have stated before, we have actually at some points in mature technologies, which I stated earlier was [indecipherable] we had increased some pricing on certain select customers. So we feel very good where things are right now.

Right. But I guess I just wanted to get a feel for was it three quarters ago, eight quarters ago, last quarter, when did the pricing environment last look like the one that you see currently?

Probably we’d have to look back almost three or four quarters ago. Absolutely, almost a year ago.

Your next question comes from Matt [Hedkin] [ph], from DA Davidson and Company.

Good morning. Dan, can you help me understand talking about hopes for market share gains and then as well as that, the nature of your business and the importance of capacity utilization. At what point, when you gain share from your merchant competitors do they start to look at their lower utilization rates and start to price more aggressively? And really how, at least at the current nodes, how sustainable would your market share gains be long-term, or at least through this next node before new investments occur for 65 nanometers?

Well, I think our market share gains have come for two reasons; one, issues or problems some of our competitors have had over the last few quarters. And in other areas, with existing customers that we have where they have qualified, as I said, in the memory arena. And so, as we start to gain, with new qualifications that we’ve had, gain the confidence of those companies, we expect to get additional business from them.

As we identified before, this is on a global basis. But one area that previously we were not getting any business out of, it was very, very difficult to penetrate that market, was the Japanese market. And we recently, our strategy has always been to qualify with the Japanese customers. Because we knew eventually they would have to outsource with the foundries, be it in Taiwan or Singapore or Korea and eventually China. And that is all playing out. And we’re starting to see some tape-outs from the Japanese companies as well. Plus as we said, we see strength in other geographic regions where we’re participating in very high performance logic devices as well as in memory devices.

But at a certain point if your competitors, be they in Japan or elsewhere, have underutilized capacity, would they be reducing their prices to gain that share back?

At the cost of the investment at 130 nanometers and below, I don’t think it would be wise for anyone to play the pricing games. In this very difficult environment the rules have changed. We all need to be profitable in any environment. And so that would be somewhat of a losing strategy. Paul, you have anything to add?

No, I agree with Dan, actually, the question prior asked when we saw pricing and stability and we said it was over a year ago. We believe that that tactic was attempted multiple times. The end objective of getting the business back did not come. So therefore, people are realizing that that means is no longer a means. It’s go to be through daily execution by our teams and servicing what the customer needs today. Because he’s in a competitive environment. He’s got to win his design wins and his end products.

Your next question comes from Cristina Osmena, from Needham.

Before we take the question from Cristina, because of time constraints, we’ll have time for one more question after Cristina.

Congratulations first of all, on executing so nicely in the quarter. A couple of questions here. Could you please give us an estimate of your global market share as it is today, including captive?

Cristina, we’ll have to get back to you on that one. We don't have that data in front of us right now.

When you take a look at your sequential growth in your .13 revenues, it looks like it drove the majority of your revenue growth and you said that it’s mostly market share gains. So, I assume that you’ve been gaining some good share of .13. Could you tell us if the number of customers is increased or is that increased activity with your existing .13 customers.

I think, Cristina, our market share gains have been at .18 and below. While .13 shows some growth, we also had growth at .18. We also have a broader base of .13 customers, because of our technology. But we’ve also had – this thing is a shifting trend. Because it takes so much time to develop a 130 nanometer device, we can find in one quarter one customer would be down and another customer would be up. And so that’s why it’s behooved us to qualify at most of the 130 nanometer fabs, be there IBMs or foundries around the world.

Is it then that .13 activity is qual activity?

No, it’s not qual activity, it’s actual products.

Cristina, this is Paul. On that .13 qual, as you know, we had said, based on profit. What we’re seeing now is that we stayed in the [indecipherable] quarters. We were in qualifications at all of our major accounts that we’ve been servicing and some new accounts. We’re now starting to see the production releases of those quals and that’s why we see an increase as our customers are getting healthy.

Okay, wonderful. Can you tell us how the prospects were increased outsourcing from the mask shops that are currently doing .13 captively is going? And if maybe you could give us also a sense of how much of the .13 is actually done captively today.

Well, I think there’s a limited amount of captive mask operations in the world. Probably in the US, the two familiar ones are Intel and IBM. When you look at Intel, while they have a huge operation, they have a very narrow product focus. So, I don’t think you see as much tape-outs as you would on memory product, where you see a lot of the tape-outs on the logic side.

So, our main focus as far as captive operations is concerned, would be in Taiwan with TSMC. And as we’ve mentioned before, it’s very, very difficult with Taiwan, because of their operation. But we have some other opportunities, because we have qualified and are the major supplier to SSMC in Singapore, which is a joint venture between TSMC and Phillips. So, that gives us a window into there. TSMC will be moving to China. They will not be installing a mask operation in China. So, with our activities in China, we have an excellent opportunity there. And at the point that TSMC needs to outsource, we are qualified at TSMC, so we can take advantage of that.

Okay. But could you give us a sense then of how much of that activity is actually – you’re gonna go merchant as a perspective business prospect?

I don't have an estimate of that at this time.

Your last question comes from Byron Walker, from UBS.

Good morning. Sean, can you remind us what your target financial model is?

Yes, Byron. Our internal long-term goal is to get our gross margins up to and exceeding 40 percent and operating margins up to and exceeding 20 percent. We obviously are a ways from those targets, but we’re making progress on them.

Are we primarily waiting then for top line growth? Do you feel pretty comfortable with where you are with your infrastructure now?

Yes, we’re waiting for additional market share gain, top line growth. We’ll continue to evaluate our infrastructure as we move forward. And the day-in, day-out methodology that we go through. Paul would you like to comment?

Yes, Byron, it’s Paul. We continue to look at our yield improvement programs, our automation program, robustness of our equipment sets and how we utilize them in the regions of the world. So, it’s a combination of many, many [indecipherable].

At this time I’d like to thank everyone for your attention and participation in this morning’s call and especially in helping us celebrate our return to profit ability. Thank you very much.

This concludes today’s conference call. You may now disconnect.