Photronics Inc (PLAB) 2003 Q4 法說會逐字稿

Good morning. My name is Latangy (ph) and I will be your conference facilitator today. At this time, I would like to welcome everyone to Photronics' fourth-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS).

During the question-and-answer period, we request that you limit your questions to one with one follow-up question. Thank you. Mr. McCarthy, you may begin your conference.

Good morning, everyone. My name is Mike McCarthy, Vice President of Investor Relations and Corporate Communications for Photronics. I would like to thank everyone for participating in this morning's call, during which we will discuss the results of our fiscal fourth quarter, as well as our full-year results for fiscal 2003, which were reported last night.

Before we begin, I'd like to remind all participants about the safe Harbor statement provision under the Private Securities Litigation Reform Act of 1995. (indiscernible) 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 Web site until we report our fiscal 2004 first-quarter results after the market closes the week of February 16th.

I would also like to announce that we secured a date and location for our annual analyst meeting. Once again, we will host a breakfast in New York at the Hotel Intercontinental on Wednesday, March 24th at 8:30 AM. If you'd like to join us, please feel free to give me a call or send me an e-mail. Reminders will be sent out later in January.

Our call this morning will begin with Sean Smith, our CFO, providing a detailed review of our income statement and balance sheet, after which Dan Del Rosario, our CEO, will share some brief comments and then moderate a Q&A session. Joining Dan and Sean on the Q-and-A will be Paul Fego, President and COO, and other members of the senior management team. Sean?

Thanks, Mike, and good morning, everyone. I will provide a brief analysis of our financial results for the fourth quarter of '03. I will also review our balance sheet and cash flows during the period, as well as review our outlook, going forward.

However, before we would begin, I would like to congratulate the entire Photronics organization for their teamwork, dedication and commitment during a difficult year. Through their collective efforts, the Company has been able to report positive results over the last two quarters.

For the purposes of this discussion of operations for the quarter and the year, I will primarily be referring to our operating results, excluding the impact of the following three items -- first, during the second quarter of '03, 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; secondly, during the third quarter of '03, we redeemed our outstanding 62.1 million 6 percent Convertible Notes. The redemption resulted in an early extinguishment loss of approximately 900,000, or 3 cents per share; and finally, during the fourth quarter of '02, we incurred an after-tax charge of 10 million, or 31 cents per share, resulting from the closure of our Milpitas manufacturing facility and a net, after-tax gain of 1.7 million, or 5 cents per share, relating to the repurchase of a portion of our then-outstanding 6 percent notes.

Net sales in our fourth quarter amounted to 91.5 million compared with 90.1 million in the fourth quarter last year. Total sales outside North America, including exports, accounted for approximately 63 percent of fourth-quarter '03 revenues, compared with 59 percent in the fourth quarter of the prior year and 61 percent sequentially.

As a percent of total sales (inaudible) for the fourth quarter, sales were constantly 45 percent in Asia, 40 percent in North America and 15 percent in Europe. Sequentially, sales increased by one million.

Shipments for photomasks, or devices utilizing .18 micron design (indiscernible) and below, were approximately 30 percent of total fourth-quarter revenues.

The fourth-quarter gross margin was 32.1 percent as compared to last year's fourth-quarter margin of 25.2. Sequentially, fourth-quarter gross margins improved 70 basis points as a result of the increased revenues during the fourth quarter, coupled with the continued favorable impact of our cost-reduction initiatives.

Depreciation and amortization for the fourth quarter was 21 million as compared to 21.4 million for the fourth quarter of '02 and 20.6 million sequentially.

Selling, General & Administrative expenses for the fourth quarter were 13.5 million, as compared to 14.4 million last year. Sequentially, SG&A decreased approximately $100,000. SG&A as a percent of sales was 14.8 percent during the fourth quarter of '03, compared to 16 percent in 2002 and 15.1 percent sequentially.

Research and Development expenses, which consist principally of continued development for 90 and 65 nm process technologies, were 7.5 million in the fourth quarter, as compared to 7.9 million last year. Sequentially, R&D expenses increased by approximately 200,000. R&D represented 8.2 percent of sales in the fourth quarter of '03, compared with 8.7 percent last year and 8.1 percent of sales sequentially.

During the fourth quarter, we generated operating income of 8.4 million, an $8 million improvement over last year's fourth quarter on increased sales of 1.4 million. Sequentially, net sales increased by one million with operating income increasing by $900,000. Our operating model continues to provide significant leverage once we reach our breakeven of approximately $88 million.

As our revenues continue to grow, including our high-end mix, we believe that the long-term goal 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 streamlining our cost structure to the changes in the global market environment.

Net Other Expense for the fourth quarter was 2.4 million as compared to 4.6 million in 2002. Sequentially, Net Other Expense, excluding the bond redemption, increased by 300,000 as a result of slightly reduced investment income during the quarter.

During the fourth quarter, we recorded a tax provision of 1.7 million, which amounted to an effective tax rate of 36 percent for the quarter. The provision was higher than previously forecasted as a result of increased income (indiscernible) jurisdictions for which we are currently taxpayers.

Net income was $3.1 million for the quarter, as compared to a net loss of $2 million for the fourth quarter of last year. Sequentially, net income increased 900,000 from 2.2 million (indiscernible) loss associated with our bond buyback. Net income per share was 10 cents for the fourth quarter of '03 as compared to 6 cents net loss per share for the fourth quarter of '02. Sequentially, net income rose 3 cents per share.

As we exited the fourth quarter, we had approximately 1,480 employees, equating to sales of 247,000 per employee on an annualized basis.

Taking a look at our 2003 operating results before the impact of certain charges, net sales in fiscal 2003 were 349 million, down approximately 10 percent from fiscal 2002. The decline, which is the first in 12 years, is primarily attributable to the depressed semiconductor market, which has had a significant impact on our business since the beginning of the third quarter of 2002.

As a percentage of total sales, Asian sales in 2003 increased to 42 percent from 34 percent in 2002. North American sales were 41 percent in '03, as compared to 50 percent in '02. Sales in Europe were 17 percent in '03, as compared to 16 percent in '02.

As a result of the decreased revenue base, our gross margins for fiscal '03 decreased slightly to 28.1 percent, as compared to 28.5 percent for fiscal 2002.

Selling, General & Administrative expenses decreased 3.1 percent to 56.2 million, or 16.1 percent of sales, in fiscal '03. SG&A last year totaled 58 million, or 15 percent of sales.

Research and Development consists -- costs of 30 million were essentially flat, compared to 30.2 million invested last year. R&D was 8.6 percent of sales for fiscal '03, versus 7.8 percent of sales 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 (indiscernible) solutions required by our customers.

For fiscal 2003, we had operating income of 12.1 million, as compared to operating income of 22.3 million last year.

Net Other Expense decreased to 10.8 million in 2003, compared with 15.9 million in 2002, due primarily as a result of increased year-over-year investment income and reduced interest costs.

During 2003, we recorded a tax provision, including the impact of the consolidation charge, of approximately 2 percent. The tax charges that were associated with geographic regions in the world where we are taxpayers were mitigated by both the utilization of tax holidays and tax credits in such taxable jurisdictions, as well as the minimal tax benefits that were recorded in the United States.

For fiscal 2003, our net loss amounts to 7.4 million, or 23 cents per share, compared with income of 3.4 million, or 11 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 (ph), were utilized in June to redeem our outstanding 6 percent convertible bond.

From a liquidity position, our balance sheet year-over-year has improved significantly. Cash and short-term investments were $232 million as of November 2, 2003, as compared to 129 million at November 3, 2002. The Company's current ratio at the end of the fourth quarter improves to 4.2 to 1, as compared to 2.3 to 1 at the end of 2002.

At the end of the year, our balance sheet was quite strong with working capital of 259 million, our highest in over ten years. Sequentially, the Company's cash and short-term investments increased by $20 million during the fourth quarter due in part to our continued disciplined approach to Asset Management in such a way as to maximize our liquidity.

Accounts Payable and accruals decreased 20.5 million year-over-year, primarily as the result of timing of progress (inaudible) payments to vendors, predominantly for equipment, which were approved at the end of 2002.

Total debt for fiscal '03 increased 66.4 million to 373.8 million as a result of the $150 million convert issuance net of debt repayment. The principle components of outstanding debt at the end of fiscal '03 include a200 million 4.75 convert due September '06, 150 million 2.25 percent convert due April of '08 and approximately 23 million in foreign term loans. We had no outstanding borrowings at year-end on our $100 million global revolving credit facility, as we paid down the previously outstanding balance of $11 million during the fourth quarter.

Shareholders equity aggregated 308 million, which amounts to book value per share of $9.49.

Taking a look at our cash flows, cash provided by operations for the fourth quarter of '03 was approximately $41 million. For the year, cash flow from operations was 83.2 million. Cash flow used in the investing activities for 2003 amounted to 48 million, of which 47 million represented capital expenditures.

Free cash flows from operations, which are net of capital expenditures, was (sic) 36.2 million for the year, which puts us well above our long-term goal of $25 million. Cash provided by financing activities in '03 amounted to 64.1 million, which primarily relates to the 150 million convert issuance, offset partially by the 6 percent bond redemption and by the paydown of other outstanding debt.

Taking a look ahead, our short-term visibility continues to be limited. Our first-quarter guidance reflects the seasonality associated with the North American and European holiday periods. Additionally, our Asian customer base will be enjoying the Asian New Yorker during our first quarter. While our booking trends for the first five weeks of the quarter has been quite strong, our visibility to the post-holiday season is limited. As a result, we believe it is prudent to take a conservative view in forecasting revenues and earnings for the first quarter of 2004.

Based upon our current operating model, the outlook for first-quarter revenue of 2004 is in the range of 85 to $90 million. While we will not be providing detailed guidance for the second quarter this morning, initial inputs from our largest global customers indicate that we will likely track the historical patterns of strong, sequential revenue performance during the second quarter, as these customers release designs help up through the year-end holidays.

Capital expenditures for tools and equipment in fiscal 2004 are expected to be in the range of 75 to $85 million. Included in 2004's planned CapEx are carryover items from 2003, which are primarily maintenance type items, toolset and process technology for 65 nm and below development and a bricks and mortar associated with the new facility in South Korea.

As I mentioned earlier, we recorded a tax provision of approximately 2 percent for 2003, which was lower than statutory rates as a result of our limited ability to continue to carry back and recover taxes previously paid, primarily in the United States.

During 2004, our tax rate will be impacted by the flow of income from jurisdictions for which we may have tax holidays or credits and upon our limited ability to recognize tax benefits in areas in which we are taxable. Accordingly, we are estimating an effective tax rate for 2004 to be in the range of 15 to 25 percent. As a result, based upon our current operating models, we estimate result for this first quarter to be in the range of a loss of 11 cents to earnings of 4 cents per share.

That wraps up the overview of our financial performance and our short-term outlook. Now, I'd like to turn the call over to Dan, who will provide some brief comments before we go into the Q&A. Dan?

Thanks, Sean, and good morning, everyone. I would like to begin by letting each of you on the call and those that dial into the replay know that we believe our market is poised for growth in the months and years ahead. Sources within the EDA and design communities indicate that the design pipeline, particularly at the 130 nm node is growing.

The recent visibility the front-end equipment companies have provided for 300 mm tools, which is all 130 nm and below, underscores the growing confidence of the global semiconductor manufacturing community that better days are ahead. Especially because of strategic supplier like Photronics (sic), you are positioned to support these growth drivers in their business.

Sean's detailed commentary served to highlight what we believe was a very strong quarter below the revenue line. Incremental revenue improvements have a big impact on the operating and bottom lines of the Company and its ability to achieve its performance goals, including the ability to self-fund Photronics' growth. We will most certainly continue to manage these areas aggressively and build upon a very strategic competitive advantage, as we know such strengths also afford the Company some latitude in other areas.

While yields of 130 nm have improved considerably throughout the year, there is still substantial progress to be made before reaching levels the industry has historically considered robust. While our own revenues from this note has grown, we are clearly capable of supporting higher levels in part as a result of our own advanced solution, robust yields and strategically-located investment.

Our qualification activity has proceeded at an accelerated pace in fiscal 2003 throughout Asia, Europe, Japan and North America, since our nanotechnology lines and supporting process technology were rolled out in 2002. However, a smoother and more reliable flow of (indiscernible) has been gated in part by wafer yields and market demand that has focused on large wafer-locked-based products and high design costs. We do not view these issues as obstacles but more as opportunities for our company to provide greater value as a supplier to our customers.

While the end-market issues are beyond our ability to influence directly, customer feedback on their use of our mask sets that we have supplied has demonstrated meaningful yield enhancement. Addressing design costs will require members of the design and lithography communities to be somewhat more innovative.

Our position is strong and we have aligned ourselves with the right players, so we do not believe that we have missed any opportunity or come in behind a competitor, merchants or (inaudible). As an example, we continue to advance chromeless phase lithography masks of technology critical to the smooth transition into the 65 nm node through work we've published previously with Motorola.

More recently, we have engaged with a leading lithography equipment supplier to further develop all aspects of CPL, including critical imaging technology and software required to realize efficient CPL mask fabrication.

Uneven 130 nm tape-outs (ph) certainly had some impact but this will soon resolve itself as the semiconductor industry transitions into full recovery.

Our pricing has been consistent with a longer-term strategy of moving average selling prices higher. While we have not seen anything that resembles the pressure we experienced in the second half of 2002, Photronics' strong financial position enables (indiscernible) on long-term technology and servers-driven relationships that are consistent with the Company meeting its targets of average selling price improvements and enhanced margin performance.

Based on our ability to improve operating margins and generate free cash flow, we believe our approach is the correct one. One of the more immediate benefits of these results is our ability to self-fund CapEx in fiscal 2003 and 2004, which, in the current year, includes our initial investments in toolsets and process technology for 65 nm development.

Our guidance reflects the seasonal impacts of the holidays for the January quarter but it should not result in diminished expectations on your part in our ability to generate success in the fiscal year ahead. We are confident that our strong competitive position, technology-based and service-driven, will enable us to meet our revenue growth and earnings goals for the new fiscal year. So, until 130 nm tape-outs (ph) reveal themselves to be the catalysts of a sustainable and broad-based recovery for a large number of our global customers, Photronics' near-term success will be closely associated with our strong operations and service (inaudible). Manufacturing efficiency and strong financial asset management continue to serve as a strong point of contrast for Photronics, as the global semiconductor industry finally begins showing healthy signs of recovery.

We are encouraged by many of the data points entering into the dataflow from both a quantitative and qualitative perspective. As supporting data about gathering momentum following the year and holiday (indiscernible)-through begins to emerge, we are confident that are positioning of the Company -- financially, geographically, and technologically -- will enable Photronics to grow at a rate that exceeds industry averages in the years ahead.

As I travel around the world visiting customers, suppliers, Photronics sites and members of the investment community, my optimism grows as our strategy begins to reap rewards. The men and women of Photronics have always performed at levels that impress the management team. More importantly, these dedicated people impress our customers and thereby enable the Company to achieve its sustainable profitability goals, providing it with the resources required to transition to the next technology node ahead of our competitors.

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

(OPERATOR INSTRUCTIONS). Bill Lu of Morgan Stanley.

Hi, guys. I've got a couple of questions. First of all, it seems like you're fairly confident about the second quarter after a seasonally weak first quarter and yet, it seems like .13 tape-outs (ph) are still sort of uncertain right now, based on yields. Can you just tell me with that? What exactly (indiscernible) in the second quarter?

I think, Bill, we look at two things. One, we more than anything else is from a historical basis; our second quarter has always been the stronger quarter as we get over the holiday season. In fact, if you go back, you'll see that two of our highest-performing quarters were in the second quarter.

What gives us some confidence, going into the second quarter, is the fact that, this year, for the first time since 9/11, we're definitely seeing a Christmas pull-through, and it's occurring in the PC and also in the wireless. I think, even today, I saw that (indiscernible) purchases of home PCs for December will be up some 28 percent, so that gives us this underlying surge of confidence. Also because companies are returning to profitability, albeit at a lower-level, that confidence brings us into the next year.

Right now, we are building chips. The question is we won't know until February whether these chips are going into products or some of it is going into inventory. But we also know that there is pent-up demand as far as the PC side of the business. We been hearing from substantially large customers that they are going to make corporate IT investments in the coming year, as we will ourselves, and so we believe that the industry is poised for recovery in the second quarter. I believe we should see more 130 nm tape-outs (ph) as yields improve.

Just one follow-up question for Sean. In the fourth quarter, gross margin was up 700 basis points basically on essentially flat sales. Was that mix related, or was there something else.

Then, going forward in the first quarter, can you just help me with gross margins?

It was a combination of a number of things, including higher sales and improved manufacturing efficiencies, as well as some minor continued cost reductions.

Going forward, as our revenues grow, you'll see that gross margin going up as well.

Thank you.

Your next question comes from Gerry Fleming with Oppenheimer and Company.

Yes, could you, Dan, give us an idea of how much of your business wasn't the 130 nm node? Also, going to the other extreme, what's the pricing environment at 0.25 micron and above?

Let me address the percentage and then I will have Paul address the pricing environment. At 130 nm and below, it was up 10 percent. At 180 nm and below, which we traditionally report, it was at 30 percent. Paul, would like to address the pricing question?

On the pricing front, as far as 0.25 micron and above, we continue to see a much more disciplined, stable environment over the prior quarters earlier in the year. There is some spot-buying that will go on but this is historically the way it's been, so we feel very much confidence in where we are today versus where we were at the beginning of the year.

Okay. One follow-on and that is that Sean gave guidance of 85 to 90 million, which is sort centered around your breakeven level and yet your earnings guidance is skewed more towards the negative side.

Jerry, it refers to the leverage in the model. Once we reach a breakeven point of approximately $88 million, every million dollars a so thereafter, 70 percent will drop down. That's why our breakeven is so important; that's why we continue to focus on our active cost-containment programs, so that we can react as we see the market conditions change.

What is your ongoing interest expense?

Bear with me for one second -- probably in the range of about 3.3, $3.2 million.

Thank you.

Cherise Lalaria (ph) of (inaudible) Equity.

Good morning, guys. You guys used to quote fab-less (ph) survey about the kind of designs that are being gone and you said -- I think in one of probably the last conference call that about half of them (inaudible). Any updates on that?

Also, in terms of regional pricing trends, can you give us more color on -- I mean, I heard some comments -- I mean some sources saying that there are actually price increases. I was wondering if you guys are seeing any of that in the photomask business. Thanks.

Addressing the first part of your question, that was not from the fab-less. What we have quoted previously was from one of the major EDA suppliers and their survey of their 1,400 customers, or 1,400 users. The latest survey, which was that we had read about, which was last spring of 2003, revealed that, in six months, the design activity had gone from about 22 percent to about 56 percent. So, that's why we believe there is -- the design activity is going on; there's products in the pipeline. What's mitigating, however, the tape-outs (ph) is, one, again, the yields at 130 nm and more importantly, end-market demands. But as we see the global economy strengthen, we believe that -- and the market demands and the yields go up, there will be more designs that will be taped out and that will be beneficial to us.

What we've seen in the pick-up here in the first -- or the last half of '03 is tied to the Christmas (indiscernible) (inaudible). A lot of those designs were already done six months ago and they are long runners because they are tied, again, to PCs and wireless. That's where we are (inaudible).

On the pricing front, as we've mentioned in prior conference calls, that we have (indiscernible) raised prices at mature and high-end products and we continue to look at our opportunities to do that. As – (technical difficulty) -- continues to tighten up and utilization rates, it makes (inaudible) a little bit easier (sic). Some of our customers are also aware of it and they're trying to secure some longer deals with us to secure pricing. So, we're definitely in an environment that's more positive for us than it has been in the past for sure.

Just a follow-up -- in terms of the planned shutdowns this year, it appears that it is much lower than it was the last years. In looking at your guidance, does it reflect that? Are you being more on the conservative side?

For us, the big thing that we're trying to reiterate in this call today is that, in this quarter, we have anywhere from basically two to six work days that will not be in this quarter. You can do the math yourself and know we(indiscernible) per day.

So, the fabs themselves are going at a much-reduced schedule, not the two week type of shutdowns, but they got the one or two day plan in there. With Thanksgiving, Christmas, New Year's, the Asian New Year, we've really got a fully loaded quarter here (indiscernible) note. Things could change but we are playing a little on the safe side because we want to guide because we believe our credibility and our guidance is strong and we don't want -- the upside there for us (indiscernible).

Paul, to your point on the -- this year, in the first quarter, we were impacted by the full Asian holiday, whereas last year, it kind of spilled over into the second quarter to some extent.

Michael O'Brien of SoundView Technology.

Good morning. Dan, could you just give me an idea of what you're seeing coming out of the foundries in Taiwan? Are you getting any more activity? What's the general tone over there, given somewhat disappointing November sales, although that may be pricing-related? Could you just give me a little commentary on what you're seeing out of Taiwan?

I think what you are seeing from the two major foundries in Taiwan -- I think one of the foundries mentioned that they reported a better quarter in November but that foundry is primarily driven towards the consumer products side, so at the consumer products side, it's typically .18 and above. We've seen that their utilization rates at .18 and above have been extremely high.

With the other customer, that customer is driven by more North design activity because it's tied to, again, PCs and wireless and several very large graphic chips manufacturers and also a very large PLV manufacturer. So, with the (indiscernible) Christmas pull-through (ph), I think those products were built in the August, September, October timeframe, so you would naturally see a drop in November.

This foundry has also said, as I mentioned earlier, they are not quite sure how much of this product is going into actual products or going into inventory, but we will get a clear idea as we emerge into February. I think that's more important to see in February -- is this a sustainable growth?

Thanks. Just one other question -- could you talk about the competitive environment? Anything increasing from out of Japan?

As far as the competitive environment, we've always had competition from around the world. Let me have Paul address this and then I will come back to you, Mike.

Mike, from our side, clearly, on the Japanese side of the world, we've been asked about scenarios (indiscernible) and their (inaudible). We have a long relationship with Taupan (ph); they were part of our Board at one time but the fact of life is that Taupan (ph) was in the U.S. market at one time. They weren't successful; they ended up selling their operation to us. They want to compete again, we welcome the challenge, we welcome sending them back home again. (inaudible) Nippon (ph), we had met them on not only in the upfront (indiscernible) of Europe but we have also met them on their own homeland, which maybe Dan wants to emphasize a little bit here.

I think, Mike, one of the things we did in early 2002, we put an office in Japan. We knew it was going to be very difficult to compete within Japan because of the nationalistic fervor there. However, we also know, because of the last decade with a lack of investment in Japan, that the Japanese would have to outsource the foundries quite heavily as the economy recovers. In fact, if we go back to 2000, Toshiba, at that time, had outsourced 10 percent in 2001. They had projected there were going to outsource 30 percent to the foundry. That did not happen because of the downturn, but we have -- our goal in Japan has been to qualify at the major semiconductor companies, and we're well on our way; we started about two years ago when we qualified at Hitachi (indiscernible) -- it was a 300 mm wafer fab. That has been accelerated.

So, we are confident, as they outsource to the Asian areas -- Taiwan and China and Korea -- that we can compete effectively because we are regionally located there and that gives us an advantage over the Japanese, where they have a single site in Japan.

Thank you.

Christina Osmena of Needham and Company.

Good morning. You gave some guidance for capital spending for 2004 for an increase (inaudible) 75 to 85 million. I was just wondering if you could give us the quarterly patterns for your CapEx plans and also, how your depreciation expenses will look on a quarterly basis next year?

Christina, good morning. This is Sean. It's rather difficult for me to give the quarterly breakout as a result of -- you know, we exited the third quarter anticipating that we would do $60 million for the year. We came in at $47 million, so there was a $13 million push out, if you will. We do have a great deal of control over that CapEx. To the extent we need certain tools in earlier, we will accelerate our buys and to the extent we don't see things developing, we will push out.

That being said, our depreciation and amortization next year should be pretty consistent all-in with what it was this year, about 85 million; it should be in the range of 85 to $87 million.

(indiscernible). Great, so your minority interest -- it declined sequentially. I was just wondering if you might give us a little bit more color on maybe what region drove that decline?

Actually, our minority interest on the balance sheet actually increased.

I'm sorry, your minority interest expense, it went to 1.1 million versus 1.6, right, from last quarter?

That's not that much of a significant change.

Okay. Could you give us a sense of what you're leading edge mix is going to be in the fourth quarter, given that you were (indiscernible) earlier that consumers were probably going to be stronger and that the PC market was probably going to have (indiscernible)?

I'm sorry, Christina, did you say for the first quarter?

Yes, for the first quarter.

Christina, because of the seasonally adjusted guidance for the first quarter, we believe it's probably going to be flat with this quarter (indiscernible) fourth quarter.

Flat as a percentage of revenues, right?

As a percentage of revenues, yes. We expect them to start increasing in the second quarter.

Christina, one follow-up to the minority interest question -- it did go down and one of the reasons it did go down was the result of the increased taxes that we had recorded during the quarter.

Okay.

I'm misunderstood your question. I do apologize.

(indiscernible) Was down 34 percent sequentially. Great. Thank you.

Your next question comes from Byron Walker of UBS.

This is Helen Rattee for Byron Walker. We thought that your Convertible Note that you issued earlier this year would have been dilutive this quarter. Can you just run through at what levels of net income the converts actually would be dilutive?

Yes, it would be dilutive at about 3.6 to $3.7 million of net income.

Okay. Then just to clarify, you had mentioned that gross margins would be going up from current levels, but I'm assuming that's when you are revenue levels start to pick up again, so we would see gross margins go down in the first quarter?

The model is -- you know, our gross margins will increase to the extent we get past our breakeven point. Certainly, mix plays into that. Depending on where we come in for the quarter, you would probably see a slight deterioration in gross margins.

Okay. Just one last question -- in terms of -- I know you're not giving guidance for the second quarter but you referred to seasonality; typically, second quarter is stronger than the first quarter. Is there sort of a range historically, in terms of sequential growth, that you can sort of point to?

It's all dependent upon how we exit the first quarter but back in 2002, we had our record second quarter and in 2001, it was a previous record second quarter, so we are anticipating a significant pick-up as we exit the first quarter. At this point in time, we are not willing or able to quantify that but we have great expectations for that.

It's really hard to predict because we're not really, as I said, fully into the 130 nm tape-out phase. It all depends on how that ramps.

Thank you.

Your next question comes from James Pausch (ph) of Paul (ph) Partners.

I just wanted to ask you, can you try to quantify ASP trend per note?

Clearly, on the (indiscernible) right now, really (inaudible). We said before that over the last two quarters, that overall has had -- (technical difficulty).

Hello?

Mr. Pausch's line has disconnected. Your next question comes from Ted Berg of Lehman Brothers.

Hi, thank you. I was wondering -- you were talking about a recovery that's happening in the PC area, the consumer electronics areas, but historically, the ASIC business has been a big driver of merchant photomask demand and ASIC designs are heavily weighted towards communications, the communications markets, which I think are close to half of ASIC design starts. Then you've got data networking, which is another maybe 25 percent or so of -- I believe -- of ASIC design starts, so it's heavily commendated (ph) networking related. How much of that is a factor in terms of kind of, I guess, the lag? The chip sector is rebounding but photomasks seem to be lagging at this point. Is that a big factor, those two markets? When would you expect those markets to pick up more significantly?

I think it's not as significant a factor as it was in the past downturns because, in the past downturns, when you were at 180 nm and above, there was significant impetus for design activity with ASICs to -- you know, at that time, we tried to design ourselves -- the industry tried to design itself out of the downturn. However, the industry transitioning to the 150, 130 nm nodes, the devices are much more -- (technical difficulty).

So, the difference now is that you've got much more layers in there; the ASPs are much higher for the extra-critical levels and so that mitigates some of the loss that we've had on the ASIC side.

Paul, do you want to add anything?

Yes. I think the other thing you have to look at for us is that, clearly, there's been a huge consumer rush here towards the end of the year on the IC side of the world. Go back and look at our second and third quarter, we had a healthy growth in our (indiscernible) technology. We believe a lot of those designs released were for the push of the (indiscernible) you're seeing here in the fourth quarter. So, we believe or second quarter will (indiscernible) another cycle (indiscernible), which is going to support our growth in the next year.

Okay. I had a follow-up question to the earlier question on leading-edge revenue for the January quarter. You mentioned that it would be pretty much flat as a percent of revenue and there are different definitions of leading-edge. I know you guys use 1.8 micron and below but would this definition also mean that .13 microns specifically would be flat at 10 percent -- at revenue roughly versus the October quarter?

Basically, (indiscernible) is definitely included. There are things in the Q that could be cut here in our fiscal quarter. It really depends on the fabs and their cycles of when these people are going to start shutting down and when they're going to launch a product. So the answer is it could be flat, it could be up but we are playing it out in the conservative side a little bit but we definitely have some things in the loop that we feel comfortable about.

Thanks a lot.

Our next question comes from Ali Irani of CIBC Global Markets.

Good morning, gentlemen. A number of questions for you -- one, would we be correct in assuming that your utilization was essentially flat quarter-to-quarter -- no major asset retirement or tool downtimes?

Then secondly, I was hoping you could talk about the constructure of the model. It seems you're super-leveraged to revenues.

Sean, you talked a little bit about breakeven. I am hoping you could give us an idea of how that 85 to 90 million in guidance works at the low end of your EPS guidance at 11 cents. It just strikes me that it would suggest a much higher breakeven, or are there some timing issues here to consider? Thank you.

On the utilization rate, actually, our utilization rate was a little bit up quarter-over-quarter. We did take some of our assets and do some upgrades to take advantage of the opportunity, the windows that we had to do that. The mix also generated a little bit of a benefit for us for the quarter.

Okay, so in this case, you're talking about masks that are taking longer to right at the .18 and .13 micron nodes?

Some of those, absolutely, some of the (indiscernible) we are utilizing some of that (inaudible).

Okay, and then to the structure of the model, Sean?

Yes, Ali, good morning. Our breakeven point is at about $88 million. It hasn't changed too significantly over the last couple of quarters. You refer to them as timing issues; I would refer to them as flow of income. Depending upon where we have our flow of income in the opportunities and the corresponding tax rate, that's why you see the 11 cents per share at the 85 million (sic). The leverage in the model, however, even at the low end of our guidance -- we will not be burning a significant amount of cash at all; our cash should remain relatively stable. So, once we reach our breakeven point, that's the sweet spot where we see the leverage and we get the pick-up and the drop-down to the bottom line.

Let me put this question in a different way and perhaps this is for the restructuring program, but a 20 cent swing in earnings between the October and the January quarters is just pretty significant, I think. I'm wondering what can be done to lessen the volatility, or are these just some surprises we're going to have every couple of quarters because of geographic spread?

Perhaps (indiscernible) question to Dan, Dan, you have talked in the past about using your network of manufacturing sites to ship from one geography to another to smooth these effects. I'm wondering whether that isn't being effective or what can be done to further that.

Ali, we do -- as I mentioned earlier, we do have some fluidity in the model. However, the basic cost structure has not changed. We continue to work on it and will work on it during the first quarter, cost-containment and cost-avoiding initiatives and accelerate several initiatives as a result of the current operating environment and work on automating some other types of costs to pull them out.

So, we're consciously and diligently working on pulling down our breakeven below $88 million per. However, the flow and the geographic regions from where the income is coming from and our ability to recognize certain benefits do have an impact on it. Once we reach the breakeven level, as we've demonstrated, the significant drop to the bottom line is there.

One final question Dan's comments about the first five weeks of the quarter having been pretty strong -- the channel checks that we have done in the last couple of weeks suggest that your customers are planning to continue to buy photomasks through year-end, perhaps in anticipation of some of the shutdowns and the January effects. Do you see that first five weeks at least being sustainable into the next two? Is this really a January concern that we would have at the lower end of the guidance, relative to the higher end of the guidance?

I will answer this. As far as the Q and the customer-based releasing orders (ph), yes, they maintain this rate that we look for but historically, what they have done is they have done is they have done a free push (ph) right before their shutdown, then basically going (indiscernible) spot for several days before they get back (inaudible) like anything else. They are counting on an end-product demand -- if the customer pulls back on inventories (indiscernible) a lot of factors that play into somebody pushing that button (inaudible) the data loose. But we are, as Dan mentioned earlier, we are encouraged by the run-rates currently being run but we know there is a pre-build going on prior to the holidays.

So, Paul, I guess we would have to just check on the early January progress to determine where we fit in the range. Am I reading that correctly?

Absolutely.

Ali, getting back to your other question as far as our moving work from our sites around the world, where that gives us a significant leverage is in two areas where we -- if one site is very, very busy, we can move the work around so that we can be efficient in meeting the delivery schedules and the time to market of our customers. Of course, that's more effective when have a market that's robust and our utilization is high.

Going back to what Sean was talking about, to look at it from a different perspective is that what drives any high-CapEx business -- two factors. One is yields, and we've worked very, very hard on our yields at the high-end and of course, our yields (inaudible) the mature products are extremely high.

After that comes utilization. That's one reason why, this year, we've been very, very active in the last couple of years as far as consolidations are concerned.

I can tell you that the model works because we have one site that benefited from our closing of our Phoenix facility, and they are fully utilized and it's mature site. They are generating the gross margins in the 40 percent-plus range. We also have another site that is driven by high-end -- (technical difficulty) -- and they are fully utilized as well. They are running in the mid 45 range in the gross margins.

So, our leverage now is for the recovery and getting utilization up at all of our sites around the world. We think that's a significant advantage for us.

Also, in answer to the other question as far as our competition coming from Japan, as utilization grows up, we are strategically located to address all markets.

Thank you very much, Dan.

Our next question comes from Brett Hodess of Merrill Lynch.

Just two quick ones -- first, can you characterize for us -- when the recovery comes in April, how much do you think that will be unit-driven versus ASP-driven, you know, as the mix comes back through the high-end? I know you haven't put a specific quantity on it but I'm just trying to get a feel for how you think that will play out.

I think, Brett, both factors would play into it. If you're at the high-end, obviously, it's going to be unit-driven because you have significantly more levels in the higher-end sets. But it will also be ASP-driven as well because, as we said earlier, there are much more extra-critical and critical layers with these advanced sets.

Secondly, a quick one for Sean -- on the tax rate of 15 to 25 percent, given that the quarter we just ended was about 35 percent or so, jurisdictionally, or -- you know, the area in which you're paying taxes and going forward -- is that going to change a lot from the quarter we were just in? Can you give us any more color on how that's going to play out?

Brett, it shouldn't change too much from the quarter we were just in. When we give guidance for the tax rate, it's really the effective rate for all of our geographic regions for the year, not on a quarter-by-quarter basis. When we get to the fourth quarter and go through our normal closing process, we have to adjust our effective tax rate for each geographic region to true them up, so to speak. That has an overall impact on the global rate, which has been, during the year, quite volatile as a result of our limited ability to continue to recognize tax benefits here in the United States. So we feel pretty comfortable, though, that it will be between 15 to 25 percent for the year next year. There may be some anomalies on a quarter-to-quarter basis, based upon the flow of income, but it should be pretty well set for the year.

Our next question comes from Timothy Akiri (ph) of Deutsche Bank.

This is actually Dan Barrenbaum (ph) for Tim. Some questions -- we had talked about breakeven and the amount that's going to drop through and maybe to look at it a different way -- at what point the tape-outs increase to the level where you need to start adding operational structure? You know, at what point does that breakeven of 88 million start going up?

I think, Dan each quarter that we move forward, we will be discussing what our breakeven level is but we feel we certainly have the capacity within our network today to do upwards to $110 million. We're making the investments into the 65 nm and below process lines, which Steve Carlson can elaborate on, but as we do add costs into the system, we will be looking to pull other costs out.

Just to add a little bit on the high-end, as Sean mentioned earlier, a portion of the CapEx projected for '04 is to install the 65 nm line capability. As we talked about earlier, some of the major inflection points at 65 will drive a lot of the development cycles and pace going out of the middle of '04 into '05.

One of the critical technologies there, as we talked about, is called CPL, and this is one example of many activities we have in working across the lithography space to try and provide our customers with more cost advantage, better time to market and, as Dan mentioned (indiscernible) critical yield recovery as these designs get more and more complex. Our success there will help to drive additional tape-outs in these more complex areas and also impact the revenue potential.

Also, getting back to the question poised (sic) to Sean as far as what is our capacity levels, what can we get up to, Sean said 110 million but a lot depends also on the mix. If we get a higher mix of leading-edge .13 and below, we certainly are capable of much higher than 110. Because we are being very cautious about the sustainability of this recovery in the market, we are still in the maintenance mode as far as CapEx is concerned with the exception of the 65 nm line that we referred to, but that's for future development.

However, we, in our industry now, being that we're such a large supplier of the photomask industry, we can get tools relatively fast and we have proven, in the past, that we can wrap these tools very rapidly. So, we would like nothing more than to have demands grow and we would have to move from the maintenance mode to the investment mode again for capacity.

One final comment to that, there are variables out there, such as emergent lithography. To the extent that that comes online more quickly than we had anticipated, that will further stimulate activity at 90 and 65 nm. We are in a position to capitalize on that.

So, it's something like immersion lithography caused you guys to have to put maybe unplanned CapEx, unplanned development CapEx in?

No, I think the advantage there with immersion is immersion will allow us to extend the process and the modeling and simulation capabilities that we've been developing already. Essentially, what it will allow us to do is increase our leverage and the return on invested capital.

There would essentially been nothing new that you guys would have to develop for it?

We're in the process, right now, of focusing on that very, very heavily. As that technology works its way into the system, both the sub-wavelength reticle design, the NTL line, all play into our ability to react to that very rapidly.

Okay, Great. Thanks very much.

Derek Wagner (ph) of Jefferies and Company.

Yes, three questions -- what is the gross interest expense for the fiscal year that just concluded? Also, what was the pretax charge for the early retirement of the debt? I know the after-tax charge was 900,000. Lastly, capital expenditure outlook for next year, 10/04 or 11/04?

Derek, the gross interest expense for the year was approximately $15 million. With respect to the charge for the bond redemption, it was about 900,000. We did not really record -- we recorded a nominal tax benefit from that so the pre and after-tax charge is still 3 cents per share. The CapEx for next year is projected to be about $85 million.

Okay, great. Thank you.

Our next question comes from Mark FitzGerald of Banc of America Securities.

On your guidance of getting to 20 percent operating margins, I'm curious how you come up with that, given you haven't been there since the mid-'90s, and looking at the capital intensity and the pricing environment, going forward.

Mark, in April of 2001, the second quarter that we ended there, we reached an operating margin of 17.5 percent. (indiscernible) seen our operating margins decline. For us to reach our internal long-term goal of 20 percent under our current operating model, we would need to generate topline revenues -- depending on the mix -- of about $110 million.

When you look at some of the facilities that are fully loaded that you referred to today, can you describe 20 percent operating margins in any of those facilities?

For our non-manufacturing facilities, Mark, we have a number of them that have 20 percent operating margins. That would include at the high-end and at the mature and, which provides validation that our model works.

What we need to continue to do, as I have said over and over, is try to automate our systems, maintain our cost controls and increase our manufacturing efficiencies, as Dan mentioned, with utilization and yield.

At 110 million, what kind of pricing environment do you assume you're in to get to 20 percent operating margins?

Basically, that's (indiscernible) see some mature price (indiscernible), we believe, at some percentage of single digits. At the high end, we would see a slight drop at 130 (indiscernible) the mature cycle. We see pretty good pricing at 90 and 65 and very good pricing (indiscernible) vantage point (inaudible).

Thank you.

Our next question comes from Kevin Vassily of (indiscernible).

My questions have all been answered.

Our next question comes from Chip Bonnett of SNC (ph) Global.

Good morning. A couple questions, if I could? Last quarter, you talked about some share gain due to some missteps at a competitor. I'm wondering if you saw a follow-through of those share gains this quarter, or have things kind of leveled out on that front?

On the share gains, basically, that we had achieved, we have basically held that position. We are in a position right now -- we're not in a position today to talk about it but we believe we also have a pretty good opportunity (inaudible) two of our regions now basically is the work of our -- or the qualifications and stuff that we (indiscernible) it on. There will be another opportunity to take away marketshare from our competitors. We continue to believe that, globally, because we look at our customer base, our top 10 customers, 9 of them are in every region of the world where we are at. This is giving us a huge competitive edge on some opportunities that are out there for us.

Okay. Then, I just wanted to circle back on capacity in utilization issues. We've kind of touched around it a couple times but you had mentioned that ASPs are firming and what's allowing you to do that is capacity tightening a little bit. I was wondering if you could either quantitatively or qualitatively talk about the change in utilization on your equipment through the course of the past year?

What we've seen on the utilization front, because we had done consolidations, obviously, you (indiscernible) pick up some gains from that right out of the gate. But in fairness, the utilization number can be a very funny number because a guy can be quoting a very high utilization rate and he's got very bed yields, so you've got to be very careful there.

The thing we focused on and we talked about in prior times is that we continue to focus on our ability to improve our write times, process techniques to enhance the capacity, so in other words, we buy (indiscernible) and can produce ten plates a day. Our goal is to get that thing up 1.5 or 2 times with outputs, and so that that takes a lot of process work, a lot of upgrades (inaudible). Of course, (indiscernible) utilization rates are going up and some of that is related to the consolidation; some of that relates to our activities; some of that's related to the mix and how we get things. So, it plays out a lot but the bottom line is earnings going up; this is key. It's regional for us -- (inaudible) (indiscernible) grow for us. Again, we have to get prepared because when the cycle ramps again, which we believe we will see, we've got to be prepared to produce a lot more -- therefore, without doing a lot of capital investment but using our current assets to capitalize on the model and have that dropped to the bottom line.

One last one, if I could? In the third quarter, gross margins jumped up from the second quarter almost 500 basis points. Also, in that quarter, you had a significant sequential growth in high-end mask sets, so should we be thinking that the shift to the high-end mask set is really a key leverage factor for your and that whenever the shift occurs to more .13 and below is when we will start to see Photronics really outperform?

The .13 mix is certainly one of the levers to our model but to the extent we add some more mature work into our very efficient manufacturing sites, our margin will also increase, so it's not solely contingent upon high-end mix.

I think what we wanted to highlight is that we believe that, depending on the site and its role in the Company, we can slug it out with the best of them out in the industry. At the high-end site, we can slug it out and at the mature end, we can slug it out. I think this is a key; you can gain from ASP gains on the high end but you've got to be able to battle out in the mature sector too and be profitable. That's our goal (indiscernible) universal and the service to our customers for everything they need.

Right. I guess my only point here was that there is obviously some industry issues with yields at .13. To the extent that those start to get resolved and yields really improve, that should be a nice -- lead to nice enhancements in Photronics' model here.

There's many leverage points but clearly, the shift to the high end will give you some leverage on the gross margins.

Great, thank you.

Our next question comes from Henry Voskovanich (ph) of Wachovia Securities.

Good morning, everybody. Two questions, one for Dan and one for Sean. Dan, if you could just give us a little more color on your commentary about the EDA companies. The reason I'm asking about this is synopsis at their analyst day on Monday talked about sort of stability in the business but only guided for 3 to 5 percent growth in '04 versus '03. I'm just (inaudible) if you could provide a little more color as to what the pipelines (inaudible) talking about?

The second question is for Sean. You guys have done a good job generating cash flow in the current quarter. Your DSOs are at 56 days -- couple of year lows -- and your inventory turns are at the 17 plus a couple years' highs. Are these levels sustainable? Is there more upside to those, or is there any guidance there? Thanks.

I think, first of all, on the EDA space, obviously, we track that space closely because it's one of the drivers we see there in looking at the end market demands. But they are somewhat driven like we are. They are not driven by silicon; they're driven by design, and so they are driven by selling seats.

I think when we referred to the fact that designs went up, from, I believe it was from about 22 percent, (indiscernible) .13 in, I think, the fall of '02 and then jumping to about 56 or 55 percent it in the spring of '03 -- that tells you that their design cycle -- the design cycle goes on much earlier and so that's probably reflective in that you would have to generate significantly more demand for them in not only the 130 but 90 nm area to get more seats and drive their business.

But I think one of the things that they are also -- I saw in the report that they are focusing on is BFM (ph) (sic). BFM (ph) is a way to enhance or mitigate some of the costs associated with high designs and enable the industry to release more designs.

(indiscernible) trying to provide the service basically, I think that -- (technical difficulty) -- somewhat similar to what you guys were trying to do with (inaudible) CDW (ph), I think, with their -- the designs and manufacturing -- just trying to lower the cost, I guess, of maskmaking or providing better cost of ownership.

Right. You can call it cost of ownership; you can call it design for profitability. It's a matter of how to be much more efficient to be able to produce chips that are, again, better cost of ownership, and that would enable the entire industry.

I guess you're just talking about the pick up in demand activity at the higher end, or .09 or .13 microns, but at the same time, the number of new designs (indiscernible) mature products kind of levels off, so the overall number of designs is growing but not as fast as the number of designs on the high end?

I think you also -- you know, we certainly, from a technological point of view, we certainly continue to drive Moore's Law down to 65 or 45, whatever the case may be. What's happening now, people are looking at what they call the value transistor. In the past, (indiscernible) thing was to scale everything to the next node. What we see going on out there is that some products are more efficiently built at 150 or 180 and people are redesigning these chips to be more efficient, so that also generates new designs.

Henry, the improvements you are seeing on the inventory turns and the receivable turns are really a complement to our Sourcing Group and Finance Group.

On the Sourcing side, they've put together active inventory programs where we have now extended supply-chain partnerships with our key suppliers, so we take the cost of ownership down and we partner with our key suppliers, utilizing our leverage to keep our levels low.

Can we improve upon that? Yes. Once we (indiscernible) an objective here, we raised the bar even higher for the following year.

On Receivables, we have had some improvements in there. It will be difficult to get that down a little bit lower because of the mix of customers we have and the global nature with paying patterns, but we will actively continue to pursue that.

One other quick follow-up on the cash flow again -- did you say that you don't expect to burn much cash next quarter, or is there any better guidance (inaudible)?

Within the range of our guidance that we announced today, we will not be burning any significant amounts of cash flow. Our goal is to add cash to the balance sheet during the quarter.

Thank you.

At this time, we've reached the allotted time for questions. Mr. McCarthy, do you have any closing comments?

This is Dan Del Rosario. I would like to thank you for your attention today and for your participation in this morning's call. Finally, I would like to wish everybody a very joyous holiday season and also a safe holiday season.

We will be available for follow-up throughout the day. Please feel free to give me a call in the office -- 203-775-9000. Thanks.

This concludes today's Photronics fourth-quarter conference call. You may now disconnect.