Photronics Inc (PLAB) 2005 Q2 法說會逐字稿

Good morning. My name is Katie and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Photronics second-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. (OPERATOR INSTRUCTIONS). Mr. McCarthy, you may begin your conference.

Thank you, Katie and good morning, everyone. My name is Mike McCarthy, Vice President of Investor Relations and Corporate Communications for Photronics. I'd like to thank everyone for participating in this morning's conference call during which we will discuss the record results of our fiscal 2005 second quarter, which were reported last night.

Before we begin I would like to remind all participants about the Safe Harbor statement provision under the Private Securities Litigation Reform Act of 1995 and 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 2005 third-quarter results the week of August 15th. Our call this morning will begin with Sean Smith, our CFO, providing a detailed review of our financial results. After which he will share some brief comments and then moderate the Q&A session. Joining Sean in the Q&A will be Deno Macricostas, Chairman; S.H. Jeong, our President of Asia; Chris Progler, our Chief Technical Officer, and John Chin, our Vice President of Asia, as well as 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 Q2 of fiscal '05. I will also review our balance sheet and cash flows during the period to provide an outlook for the next quarter. Before we begin, I would like to congratulate the entire Photronics organization for their continued teamwork, dedication, and focus in servicing our global customers, which has enabled the Company to achieve a quarterly record for revenues and net income.

Congratulations are also to be extended to Mike Luttati and Deno Macricostas. Mike joins our Company as CEO officially on June 7th. His experience in leadership will make him an outstanding addition to the Photronics team. The management team, arm, and the Board want to extend both our personal and professional thanks to Deno. Deno's commitment to our customers and investors in addition to the well-being of our employees has and will continue to serve as a model for each of us who had the privilege of working with him. Thanks, Dino.

For purposes of our discussion of operations, I'll be referring to our operating results excluding the impact of the following items. During Q2, we repurchased $10 million of our previously outstanding $110 million 4.75 convertible notes. The redemption resulted in an early extinguishment loss during the second quarter of approximately 200,000 or $0.01 per diluted share.

Additionally, during the first six months of 2005, we repurchased an aggregate $51 million of the 4.75 convertible notes, which has resulted in a $1.4 million, or $0.03 per share charge. Net sales in our second quarter amounted to a quarterly record of 112.9 million, an increase of 15.7 million or 16% as compared with the second quarter last year. The increase, as a result, is improved demand for both IC and flat-panel display, or FPD masks.

Sequentially, net sales improved by 11.6% as a result of the continued revenue growth with FPD photomasks and increased demand for IT photomasks across all geographic areas. To the extent we have exceeded our guidance, it was the result of a stronger than anticipated demand in FPD sets. This emerging market continues to show great promise for Photronics.

Total sales outside North America, including export, accounted for approximately 71% of Q2 revenues compared with 65% in the second quarter of the prior year and 71% sequentially. As a percent of total sales for Q2, sales were approximately 51% in Asia, 31% in North America, and 18% in Europe. Shipments of advanced photomasks increased to 20% during the second quarter, which amounts to a sequential increase of 24% in absolute dollars.

Included in this percentage would be mask sets for semiconductor design at and below 130 nanometer and for FPD sets used to fabricate flat-panel products using G6 and G7 technology. Gross margins for the second quarter was 34%, which represents a sequential improvement of 240 basis points. SG&A expenses for the second quarter were 13.5 million as compared to 13.3 million last year. Sequentially, SG&A increased 800,000 as a result of the startup costs associated with our China and Taiwan ventures and costs associated with Sarbanes-Oxley compliance. SG&A as a percent of sales was 12% during Q2 as compared to 13.7% in 2004 and 12.6% sequentially.

Research and development expenses, which consist principally of the continued development for advanced process technologies, were 8.1 million in the second quarter. R&D represented 7.2% of sales in Q2 compared with 7.7% last year. During the second quarter, we generated operating income of $16.8 million or 14.9%, which is a $4.6 million improvement over last year's second quarter.

Sequentially, net sales and operating income increased by 11.77 million and 5.3 million respectively. Our operating model continues to provide significant leverage. Or global team continues to do an outstanding job in matching our cost structure to the changing demand and opportunities in the global marketplace. We are intensely focused on improving this metric. Over the next few quarters, however, we will likely experience some moderate fluctuations here as we continue the expansion of our greenfield facilities in China and Taiwan.

Net other expense for the second quarter was 2.1 million as compared to 2.7 million in 2004. Net other expense for the second quarter includes approximately 200K related to the $10 million bond redemption. During the second quarter, we recorded a tax provision of 2.6 million or 17.8% effective tax rate.

Net income of $10.6 million for the second quarter represents an all-time quarterly high for Photronics. Net income, exclusive of the onetime charge, was 10.8 million for the second quarter of '05 as compared to 6 million in the second quarter last year. Sequentially, net income increased 87% for $5 million. Net income per diluted share was $0.28 for the second quarter of '05 as compared to $0.17 per share in the second quarter of '04.

EPS for the second quarter, exclusive of the bond charge, was $0.29 per share. Sequentially, net income improved by $0.13 per share. As we exited the second quarter, we had approximately 1460 employees equating to sales of 309,000 per employee on an annualized basis. Our improvements in yield and in automation have enabled this metric to be the highest in the history of the Company.

Now taking a look at our six-month year-to-date operating results before the impact of the bond charges. Sales for the first six months of 2005 were 214 million, up approximately 26.4 million, or 14%, from the first six months of last year. The increase is a result of increased sales of FPD photomasks and increased design releases associated with the improved semiconductor market.

Our gross margin was 32.9% for the first half of 2005 and SG&A expenses decreased 2.2% to 26.2 million, or 12.3% of net sales. SG&A last year totaled 26.8 million, or 14.3% of net sales. Research and development costs were 15.9 million for the first six months of 2005 as compared to 14.9 million last year. R&D was 7.4% of sales for fiscal '05 versus 8% 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 lithography solutions required by our customers.

Operating income for the first six months was $28.3 million, or 13.2% of sales, as compared to 19.9 million, or 10.6% in 2004. Net other expense, exclusive of the aggregate $1.4 million charge, decreased to $3.7 million in 2005 as compared to 5.4 million in 2004 as a result of reduced interest expenses associated with the decreased year-over-year debt.

For the first six months of 2005, we recorded a tax provision of $4.5 million, which amounts to an effective tax rate of approximately 19%. For the first six months of 2005, exclusive of the onetime charges, our net income amounted to 16.5 million, or $0.44 per diluted share compared with 8.1 million, or $0.24 per diluted share last year.

Now turning to the balance sheet. Cash and short-term investments were 116 million at the end of the second quarter, a decline of approximately 67 million from year end. However, during the first six months of 2005, we bought back 51.4 million of our 4.75 convertible notes and increased our stake in PKL to 90%, which was an investment of approximately $40 million. Sequentially, cash in investments improved by $11 million.

Working capital, at the end of the second quarter, remain strong at over $200 million. Goodwill increased from year end by approximately $20.5 million as a result of the increased investment in PKL. During the second quarter, our long-term debt decreased by $13.8 million, which includes the redemption of 10 million of the Company's 4.75 convertible debentures. Total debt at May 1, 2005 was 263 million and the principal components of outstanding debt include $100 million 4.75 convert, which is due in December '06. 150 million 2.25 convert due in April of '08, and approximately $13 million in other term loans.

Minority interest of 62 million represents a share of net assets, which we do not own, in our majority held subsidiaries in Korea and in Taiwan. Shareholders equity aggregated 377 million, which amounts to a book value per share of $11.47. Taken with their cash flows, cash provided by operations for the second quarter was approximately $31 million. Year-to-date, cash provided by operations was 58.3 million, an improvement of 17.1 million as compared to the first six months of 2004.

Cash flow used in investing activities during the first six months amounted to approximately $56 million, of which 32 million represented capital expenditures and 40 million of additional investment in PKL. Free cash flows from operations, which are net of capital expenditures, was 26.5 million for the first six months of '05 as compared to 10.3 million for the comparable period last year. Cash used by financing activities for the first six months amounted to $54 million, which primarily relates to the repayment of a total of $56 million of debt during the year.

Taking a look ahead, our short-term visibility continues to be limited as our order backlog is typically one to two weeks. We believe, however, that in 2005, we will continue to see increased design activity across all technology notes. We're also encouraged by a number of strategic opportunities that should enable us to increase our revenue through organic growth and market share gains from our competitors, including our expanded presence in FTP mask, an increased ability to support 65 nanometer development with our second tool set being installed in Asia during the third quarter.

Based upon our current operating model, the outlook for the third quarter revenue is in the range of 113 million to $118 million. As was the case in the latter part of '04 and throughout 2005, we will selectively expand our operating infrastructure to capitalize on strategic alliances offered and opportunities with key customers.

As a result, our operating expenses are projected to increase modestly during Q3 and throughout the rest of the year. This will have some manageable impacts on our meeting our near-term operating margin goal. But when evaluated over the longer-term horizon, we believe these investments, in the manner in which they are being made, will provide greater stability and diversity in our revenue base and enable the Company to generate improved returns on its invested capital. As an example, we're very encouraged with our growth in FPD masks, an area in which we began to invest in over the last two years.

Capital expenditures in fiscal '05 are forecasted to be approximately 105 to 125 million as we invest in capability and customer relationships to enable us to achieve additional growth and share gains. One of our team's key priorities is to maintain our financial flexibility and continue matching capital outlays to meet both increasing demand and new opportunities.

While we're not providing guidance for the full year, we continue to expect to fund our 2005 capital expenditures from operating cash flow, including in 2005's plant CapEx, our tool set, and process technology for 65 nanometer and below development, additional FPD capacity, and facilities and tools associated with our greenfield sites in China and Taiwan. I would emphasize to you this morning that we maintain a significant degree of flexibility in how we invest into our organization. So if trends accelerate or decelerate, we can move quickly to optimize our competitive position, while also aggressively managing our quarterly breakeven levels.

At the same time, we feel it is important to remind the members of the investment community that we see opportunity for growth in the year ahead and are confident that we can increase our marketshare. Our investment to successfully expand our FPD capabilities is a very visible example of this strategy. During 2005, our tax rate will continue to be impacted by the flow of income in jurisdictions for which we may have tax holidays or credits. And upon our limited ability to recognize tax benefits in areas which we are taxable.

Accordingly, we're estimating an effective tax rate for 2005 to be in the range of 17 to 22%. For the third quarter, this will equate to a range of 2.5 million to 3.2 million in whole dollars. Accordingly, based upon our current operating model, we estimate that earnings per share for the third quarter of fiscal 2005 to be in a range of $0.28 to $0.33 per share.

That completes my review of the financial results and provides you with an up to date view on how we expect the third quarter to build off the excellent momentum we generated in the second quarter.

In other exciting developments during the quarter, we broke ground in Taiwan for our new FPD mask fab in Taichung and begin implementing our global R&D strategy that we briefly outlined during our analyst meeting in San Francisco this past March. The groundbreaking in Taichung was a very well-received event that drew key customers and officials from all over Taiwan. The shell should be completed by the end of 2005 with operations beginning in 2006.

Our global R&D center strategy was developed with a goal of being able to bring our global technology expertise to address the regional needs of our customers from semiconductors to FPDs and into advanced mask integration initiatives. We believe that our global approach provides Photronics with a competitive advantage as opposed to the limitations of a more centralized strategy.

The first centers were established in Austin and Korea. Austin, which had served as the Company's primary R&D location, was also the facility, the first facility, to install Photronics initial 65 nanometer line. In Korea, an official ceremony was held during the quarter to introduce our Asian customers to the R&D center that they will be working with to meet their advanced technology requirements. Attendance was excellent, and the most senior levels of customer management were on hand to learn more about Photronics commitment to their success.

During the event, Chris Progler and S.H. Jeong outlined our roadmap and the capabilities being installed into the site to address 65 and 45 nanometer development. In addition to IC mask technology, our Korean R&D center will work with FPD customers to ensure that Photronics provides cost-effective, innovative solutions they need to smoothly transition to Gen 7 and beyond.

Our last comment before we move to the Q&A portion of the call, one last comment. During the quarter, the competitive landscape changed. Toppan received approval and completed their acquisition of DuPont Photomasks. As we have said in the past, this represents a tremendous opportunity for Photronics. If we execute as we expect, we should be able to grow our marketshare with a variety of global and regional customers that depend upon service, in addition to technology, to be successful. Though not the largest today, Photronics is the most agile and customer service oriented global photomask supplier. Our ability to move quickly and maintain flexibility gives us great confidence as we survey a landscape full of promise and opportunity.

In summary, again, I will emphasize that though our visibility is short, customer sentiment remains positive. The global demand for the full range of photomask technology services and products should continue to grow as should Photronics ability to service a larger share of the worldwide market. That wraps up our prepared remarks.

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

+++ q-and-a.

(OPERATOR INSTRUCTIONS). Balaraman Suresh with ThinkEquity.

Great quarter and outlook. Regarding the flat-panel segment, what are the annual -- what is the market size currently running at? And it appears to me that the quarterly run rate is averaging about what it should be given the annual market size. I may be wrong on that. Can you please clarify that? And also can you comment on any marketshare gains you have bought in terms of new customer in this quarter and in July quarter?

Okay, Suresh. This is Sean. Both myself, S.H. and Deno will address that. I will first address the increased demand in FPD mask. We did see quarter-over-quarter increases in both IC and FPD photomasks and we have estimated the marketshare that we disclosed in our March analyst meeting to be approximately -- market size to be approximately $450 million. At this point in time, we are not giving any guidance with respect to our share of it. But we do expect -- we have seen it grow sequentially and we do expect it to continue to grow in the future. S.H., any follow-up?

And also in terms of the gross margins, given the fact that you guys had record levels, one would have expected a more leverage in terms of gross profitability. How would you expect that to change over the next few quarters?

Our entire workforce and Company is focused on improving our operating margins. We did see good growth in our operating margins quarter-over-quarter. We do expect sequentially our operating margins to grow. When we get to full capacity at some of our locations, as we get all of our tools rental (ph), see our gross margins increase as well.

Suresh, I'd like to add a little bit to it. This is Deno. The FPD market, we believe, is about 550 now. We've done some more evaluation. The competition survey whole landscape with the increased about 550 (ph). The FPD masks require less capital. Now, it is equipment intensive. The material cost is higher. Definitely, the cost is much less, does not require as much capital. So by the time -- one balances the other. So we feel good about it from that point of view. That we're not require as much capital.

In terms of the marketshare in flat panels, do you anticipate any significant changes in near-term in Taiwan?

Well, maybe S.H. will answer your question -- will answer right now. Hold on a minute. S.H.

Our marketshare overall worldwide is 10% at this moment. We invested more on a (indiscernible) side. So I expected more marketshare next to 2 to 3 quarter.

Did you guys disclose a percent of flat panel as a percent of business? And I think last quarter you said it was around 10%.

Last quarter, we said it was greater than 10%. The competitive landscape changed during the quarter and from a competitive positioning standpoint, for the time being, we're not going to be providing further granularity with respect to the breakdown of IC, photomask, and flat-panel display because we feel it could compromise our competitive position as we see opportunities on the horizon to expand our marketshare.

However, I can reiterate, as I mentioned in the text, that we did see growth in both IC photomasks across all geographic areas and in FPD masks.

Jay Deahna with JP Morgan.

Congratulations on the nice quarter and Deno, congratulations on a terrific career and your impending retirement.

Thank you, Jay. I appreciate it.

Sean, in terms of the Company's gross margin peak potential, once you get your incremental CapEx in place and grow your revenues further, should we be thinking in terms of a 38 to 40% growth margin peak potential or what? And then I have got a follow-up question.

I think when we get fully ramped, we can get certainly into the high to mid 38 to 40%. I do believe we will achieve wonderful capacity on operating margin at 20% or greater before we hit 40% gross margins.

And then in terms of the incremental design activity in semiconductor, would you say that that is growing from last quarter at a linear rate or is about the same, accelerating or decelerating? And following up on that, is your confidence level in your turants (ph) business in semiconductor mask demand going into this quarter better or worse than it was going into last quarter, which was certainly pretty good?

I think we're going to have a couple of speakers address that. I think John Chin will provide comment on the IC.

I think we have seen the design activity pretty much the same and slightly increased. Most of the results showing from here is the design (indiscernible) activity. We gain ground on the marketshare and also some new customer penetration. Overall, if you look at industry design activity, pretty much flat and a little bit high.

The second question, Jay, we do believe that the second quarter we see some activity in the design landscape in the existing quarter.

So in other words, you are feeling a little more comfortable going into this quarter than you were last?

Absolutely.

And then the last one is are you guys starting to see a meaningful pickup in 90 nanometer mask design or is it primarily being driven by 130?

Hi, Jay. This is Chris. We have seen more qualification activity in all regions of the world. So there is a lot of prototyping qualifications. We have seen some additional design activity; but can't say it is dramatic. Whether it will pickup in subsequent quarters, right now, it's a little hard to say. I think a lot of the chip makers are still feeling out that particular node and then deciding what kind of migration path they want there. So I'd say qualification activity is up. Design activity modestly up. And it's a little hard to forecast if that will dramatically increase over the next few quarters or not.

You're talking about 90, I presume?

90, yes.

So in terms of your revenues then, most of the incremental demand in semi is coming from 130. Is that correct?

Yes. I think it's pretty broad-based but 130 has also more mainstream technologies.

I also do believe, Jay, because (indiscernible) qualification (indiscernible) some revenue, nice revenue, this quarter. We're anticipating.

So it's picking up, in other words?

Some areas, not all customers, some customers.

Robert Maire with Needham.

Congratulations on a nice quarter and nice management change here. In terms of your sales and orders by application, can you give us a little bit more detail as to where some of the strength was on the semiconductor side? What product type and what mix you are seeing out there?

This is John Chin. We have seen the increase of the activities grid across the board. In terms of application settlement, whether you categorize a consumer, computer, or on the other side, analog or digital, we do not differentiate that sector very clearly. The business activities standpoint is all across the board front (ph) technology now.

So no particular sector of strength?

We service a broad array of customers and we see strength throughout our mix of customers.

So no particular change in terms of mix in the quarter or expected mix going forward?

No.

You mentioned that the capital requirements for FPDs are lower going forward. Should we expect any change in terms of what your overall CapEx to revenue should be going forward given a higher mix of FPD? Or will perhaps somewhat higher costs in leading-edge semiconductor offset the reduced capital requirements in the FPD part of the business?

Robert, the guidance that we are providing for our capital expenditures is for fiscal '05, which includes some additional FPD capacity as well as our second 65 nanometer line going into Korea. But we don't anticipate any structural changes in our CapEx. We haven't provided guidance with respect to '06 as of yet. But we would not expect that to be, as our revenues to increase, that to be a significantly larger percentage of overall spent.

Right now, we're probably seeing good revenues off of some previous CapEx for what is current generation. When would you suggest the next sort of lump or hump or node of capital spending for the next generation technologies? Realizing that capital spending isn't perfectly linear. Would that be something you would expect to see ramping up again a little bit more aggressively in '06?

I'll try to answer the first part and then turn that over to Chris as well. We don't anticipate at this point in time any significant, or the next CapEx ramp, to be of significance. We have invested in the 265 nanometer line. We have strategically went from four high-end locations to now at 65 to 2. So we are investing -- As we see the opportunities in the marketplace, we will invest to match the demand.

The next significant potential CapEx activity would be for 45 nanometer node. We have looked at what tools would need to be upgraded, etc. for that node. But there is really a timing issue there. So there is nothing particularly on the horizon for 65 that we see additional.

One last question. You mentioned opportunities given DuPont's acquisition. Any specific customer activity that you can point to or specific wins, maybe without naming customer names, that you have had or are looking at in the near-term?

This is Deno. We can't really say which customers. But what happened is when you are consolidating you try to rollout production from a 322 (ph) facilities, creates problems for the other company. So capitalize on the mistakes or missteps or execution problems of the competition. So anything's a play (ph), any customer that cannot be able to service well, then be happy to take care of them. So in a sense, really, the less (indiscernible) is open to us in the whole United States. Plus here we gain our marketshare. In Europe, because they shut down a couple of locations. So we've had to take of the customers. I have, with competition of course, ready to take care of them.

So probably talking about a potential of gaining a few points of share primarily in the U.S. market right?

That's our goal, yes.

Congratulations again.

Bill Ong with American Technology Research.

In your new retail site in Taiwan scheduled for production mid 2006, what is your plant capacity? In other words, how much revenue can we expect out of this new flat-panel plant? And maybe as a reference point, what's your revenue support levels on your Korean flat-panel facility?

Bill, this is Sean. Our Taiwan flat-panel facility will be up sometime in 2006. And to date, we haven't quoted or disclosed the capacity. That is going to be dependent upon how we feel we can access the market.

Maybe you can give me a reference on Korea then.

Our capacity in Korea?

Yes.

At this point in time for competitive purposes, we're not going to go into it. We do have -- we do have enough confidence to be able to handle the additional share that we expect to get in capacity. We are virtually today the only stand-alone public merchant photomask supplier. So we are a stand-alone entity and to some extent, some of the disclosure topics that we go through could put us at a competitive disadvantage.

Okay. That's fair. But it sounds like you're not going to be constrained in the near-term.

Definitely not.

Timothy Arcuri with Citigroup.

This is Dan Berenbaum for Tim. Congratulations on a great quarter. Back to the flat panel -- I needed to follow-up on a couple of the previous questions. Number one, did you give a break out of revenue percentages of the trailing technologies greater than 0.13 and greater than 0.18? Then you had mentioned you saw increases in revenue across all geographic regions. Did you also see increases across all different segments of the technology spectrum or was lagging -- dropping off a little bit more?

Dan, I'll try to answer those questions. We did see IC demand across all geographic regions go up sequentially as well as flat-panel display mask. We did not disclose and we're not going to disclose the increase or the absolute percentage (indiscernible). But we are confident that we increased our share, that our high-end mix of 0.13 for IC photomasks went up, and our high-end mix for G6 and G7 applications is up sequentially.

Ultimately, we were focused on improving our operating results regardless of mix. But we did see a nice healthy improvement in our mix sequentially quarter-over-quarter.

So everything there went up. That's very helpful. Then just one other question. Any guidance on what you guys are going to do in terms of repaying debt or potentially buying more of the JV partners in the next quarter or the next couple of quarters?

That obviously is going to be market-driven. We have bought back $54 million or so or $51 million of our convert in the first six months and we increased our investment in PKL. So what we do in the future is going to be dependent upon what we see on the horizon. But as you can tell by our past actions, we have been pretty opportunistic when we see events come our way.

Peter Wright with CIBC World Markets.

Another good quarter, guys. A couple of questions for you. It's a record quarter for you guys, revenue was. I was wondering if you could comment if it was also a record quarter on the IC side of your business?

Yes, it was.

And when looking at the share gains, you're obviously gaining share in both segments of your business, flat-panel display and semi. When looking at your guidance, which is flat to up 5%, is there a big difference in, I guess, the visibility that you have in this business? Everybody knows that it's a very limited visibility on the semi side. Is there possibly better visibility on the FPD or does it have a similar dynamic on that side of the business? And what is the expected near-term growth rates of the two respective businesses?

Our visibility has not really changed since the Company was founded by Deno many years ago. It is short -- it's a quick turn, short backlog, and we have to execute on a day in, day out basis. So to the extent that we exceed our revenue guidance, are we going to achieve our revenue guidance, to some extent it is in how we execute and service our global customers.

Are you expecting both the semi side and FPD business to grow in the next quarter? July quarter?

This is Deno. We do expect really to -- we have an organic growth, number one, by the high single digits. We do believe we are going to gain marketshare. That will bring us to the low double digits. And with a large area of FPD mask, that will bring us to the mid high teens growth. We definitely are going to grow simultaneously in the IC and the FPD, or the large area masks, simultaneously and gain marketshare. So that is how our game is and we have successfully doing it for the past couple three quarters. And it is picking up momentum too.

Has consolidation within the marketplace allowed you guys to be able to pick up that share without sacrificing price? Is there any noticeable pricing pressure?

That is the whole, I guess, plan is to gain marketshare without sacrificing prices. Yes.

So there was no noticeable pricing pressure?

No, there was not.

My final question is if you look at your CapEx budget, 105 to 125 million, I was hoping you'd be able to break that out of what percentage is going to flat-panel display versus IC?

We don't break it but what we do is I can only say the flat-panel display mask do not require as much capital. Material cost is higher than the IC masks. But do not require -- we invest in all three areas basically. We did invest already in U.S. a 65 nanometer line. At the present time, we invest in Korea in the 65 nanometer line. And at the same time, we invest in the large FPD masks in Taiwan.

Congratulations on a good quarter.

Brett Hodess with Merrill Lynch.

Congratulations also. A couple of questions. First, I've noticed that over the last year or so we have completely stopped hearing about price pressure at the leading edge, which was really common a year or two ago. Customers complaining about that. That seems to have gone away. Is that the case? And is that because they're starting to recognize the value you are providing or is the industry tight? Can you talk about that a little bit?

Brett, this is Dino. I cannot say that the high-ended price is completely stable because there is a learning curve. If your learning curve gets better, our yields get better or am I making some kind of a price adjustment. But again I would not say killing each other. But this is price adjustment as the learning curve gets better. It's an eventual course of the business. It happens every note (ph).

I think you're also seeing more recognition of the value in the masks. I think that has been mentioned for a number of years. I think we are starting to see more of that. The cost to go to the next generation exposure tool sets are extremely expensive. The foundries are looking for ways to get better utilization for the older exposure tools. So I think you are seeing more fundamental value in the photomask that people are willing to pay for.

Second question. Sean, did you say that the CapEx for the first six months was about 32 million, I think?

Yes, yes.

So the largest portion is coming in the second half of the year of the 105 to 125?

Yes. Brett, we added and anticipated and made commitments in the beginning of the year or plans to put an additional 55 nanometer line in, buildout China and Taiwan. The timing of when tools come in and when they are accepted requires when they go on the balance sheet. You will see a pickup in the third quarter as a result of the 65 nanometer line going into Korea. And we still do expect this year to be in that 105 to 125 range and still have the ability, if we see fit, to self-fund that through our operating cash flow.

So when we look at your comments earlier about margins, that operating margins could grow more quickly toward the 20% goal and gross margins might grow a little more slowly. As you bring on that extra capacity, you have the utilization to fill up in the depreciation costs to offset, even though the incremental sales out of that will carry little operating expense with it?

That's correct. You are investing in the next technology note to get those tools fully ramped. You are incurring those costs before you get the significant commensurate revenue flow. But we really refocus the entire corporation on that operating margin target and what we need to get there. So we believe we will get to the 20% earlier than we will get to the 40%.

So that makes sense relative to how the capacity comes on sort of in bigger lumps, right?

Right.

So as you start to see the flat panel and the 65 start to ramp, you will get a catch-up on the gross margin side, if you will, as you fill up those facilities and that could actually end up pushing your operating margin above your 20% goal at that point?

Absolutely.

Derek Wenger (ph) with Jefferies and Company.

Two questions. Have you repurchased any convertible bonds since the end of the quarter and what was your gross interest expense for the quarter?

Derek, we have not purchased any other bonds since we had our announcement. And our gross interest expense for the quarter was approximately $3 million.

What kind of prevented you from buying more at lower prices?

That is a discussion that -- we review each and every opportunity that is presented to us. It's depending upon a number of different conditions. And at this point in time, we have elected not to do so.

Gus Richard with First Albany Capital.

Just real quick. On the uptick in gross margin, is that mix or utilization driven?

It's really a combination of both. I mean we have nine manufacturing facilities. We have a number of fixed costs that we try to load level each facility to ensure that we're improving our utilization across all locations. So it's a combination of mix and utilization.

Are the more advanced masks that carry higher gross margin or is it still the mature that carry the higher gross margin on the semi side?

I don't think we've seen much of a change. In theory, you would expect a better margin at the more advanced mask sets. But to the extent those tools aren't fully utilized, it's a theoretical margin, not an actual margin.

And then on the quals you've seen at 90 nanometer, I would suspect that is primarily memory and not logic?

No, that's not true. I think we are seeing it in logic and memory both and in all regions of the world.

Is it weighed towards one or the other?

I think we have more qual activity on the logic side right now.

And then finally, on the flat-panel side, as a rough cut, did that grow faster than corporate revenue sequentially?

Gus, we saw growth in both IC and flat-panel display.

Did flat panel grow a little bit more quickly than IC or were they the same?

Percentage-wise was, Gus, again, a small number. Percentage-wise looks bigger. In absolute dollars, no. But percentage-wise, yes.

Got it. Perfect. Thanks a lot.

Mark Fitzgerald with Banc of America Securities.

I'm curious to get to the 20% operating margins. Do you talk about a revenue level for that?

Well, Mark, I think we use the cost structure for this quarter we just exited, it would probably be, depending on mix, in the range of 119 to 121.

Can you give us a tax rate for 2006 at this point?

We haven't provided any specific guidance. Our Treasurer is sitting right behind me and he's been tasked with reducing our overall tax rate. So hopefully we will see the 20% go down next year.

Lower than 20%?

We haven't provided any specific guidance. We set very aggressive targets internally here and we try to achieve those targets.

Our goal is to reduce cost not only from the operations. We try to reduce cost from -- maximize our headcount, to operations, to (indiscernible). At the same time, it is to reduce taxes too. We're not unpatriotic. But if we can do -- reduce taxes, why not?

Does this press (ph) of new facilities coming up offshore and tax holidays there?

Combination of many things. We look at every opportunity.

Just lastly, when you talk about share gains at this point, is that against other merchant suppliers or do you feel that you're getting some share against the captives as well?

Captives really -- this is Deno again. They only outsource when they have, what they call a bubble, when they cannot handle the inside business, they go outside. Except if they have enough capacity. Or a specific note that may not want (indiscernible) technology. But I cannot see a gain in marketshare. It's kind of difficult to say.

So, basically when you claim marketshare gains, you're saying it's against the merchants?

Mostly, I would say 95% is merchant, yes.

Chip Bonnet (ph) with FM Global.

Congratulations on the good quarter. A couple of questions here. I guess I wanted to push on the gross margin a little bit harder here. If you look back to even last year, you were doing about a point to two points better of revenue level of about 8 million less. So I want to understand a little bit more what is going on with your model. You used to talk about that 40/20 model on revenue around this level and obviously we're not doing that. I guess it has to do with flat-panel mix. If you could talk about that and then I have a follow-up.

Sure, Chip. I believe a couple of quarters ago on the, I think, the December conference call, we discussed -- we see some strategic opportunities in the marketplace to gain share and to diversify our revenue-base. Not just with flat-panel display but also I see IC share. We elected to invest in those opportunities. I think we discussed saying that we will take some short-term hits to our overall goals. But we're still keeping those goals. It's just going to take us a little bit longer to get there. I think based upon the results you see for this quarter, bottom-line net income quarter-over-quarter almost doubled. We are seeing a drop-through. As we bring these additional costs on and we get some near-term, not as much of a margin increases, gross margin increases, we had expected. We are maintaining our operating margin target by keeping our SG&A and R&D spend in line. And last year, or last quarter, we did disclose within our range what our EPS would be. We were focused on generating positive profits, sequentially growing our gross and operating margins. But more importantly, improving our -- just as importantly, is improving our balance sheet.

So is the idea with the flat-panel business, is that -- while that would have gross margins below kind of your corporate averages you're managing to the operating margin line there and you think that could have similar margins to the rest of your photomask business?

We believe that our -- on our flat-panel photomask that the target margins are similar to the IC, our IC gross margins. While there is less, Deno mentioned, there is less equipment. Material component is a bit higher. We do not operate currently these two products as separate business units. It's really how we leverage our overall cost structure, our facilities, and our back room functions to generate that lift in operating income.

Then just last one also on flat panel. How lumpy or linear do you expect that business to be? So just for example, if you get 5 million in revenue from that business, could that just disappear next quarter and then two quarters from now, all of a sudden you do 10 million? Are you at a certain level and you expect at least to maintain that and have some growth off of that?

This is S.H. Flat-panel display units is, I believe, is growth rate is much much higher than IC side at this moment. So it is lumpy this quarter. It will be more, I think, more than 20% growth rate yearly basis. So I am very confident this market will grow quickly.

And you guys would fully participate in that?

In the growth. Yes.

Thanks a lot. Congratulations again.

(OPERATOR INSTRUCTIONS). Marissa Hernandez with UBS.

This is Marissa from (indiscernible) Stephen Chin. Congratulations on the quarter. I was wondering if you can help me understand the revenue growth that you reported in the April quarter, at least qualitatively. How much would you attribute to marketshare gains and how much do overall increases demand?

Marissa, we really haven't broken it down. But I would say there was a percentage -- a percentage growth in marketshare gain and in just increased organic growth within our customers. But as far as specifics, we don't really have those specifics at the tips of our fingers.

And then I wanted to follow-up on the operating margin. If you can help me understand a little bit more how this is working. I believe at your analyst meeting you had even 20% operating margin target, at a revenue level of about $116 million. Now you're talking about 119 to 121. So I don't understand what has changed since the analyst meeting. Is this a function of the ramp up of your facilities or is it a mixed issue?

Marissa, it's a combination of the ramp of our facilities in Taiwan, in China. We're moving ahead a little bit more quickly than we had anticipated. In addition, some other costs that we incurred for some revenue initiatives that we expect to obtain in the next few quarters.

And regarding the ramp up of your facilities. That impacts your gross margin and your SG&A as well?

As you build the facility, until you start the manufacturing process, you're not incurring much of a gross margin cost. Yet, as you incur those costs, for startup costs if you will, those are lumped in with SG&A.

And finally, can you help me understand a little bit better the timing or the timeframe for the ramp up of this facility. If you go back to your operating model of the analyst meeting, when would you be in a position, which you can say that we are back to that model because of ramp up is done?

Let me just reclarify or restate something Marissa. At the analyst meeting, our long-term goal is to achieve a 20% operating margin. That is not a near-term goal. It's our long-term goal. As we see opportunities in the marketplace, we have stated, we will continue to state, that we will invest strategically for those opportunities. As a result, we will take a quarter or two of short-term hit on the -- while we will still have operating margin growth, it won't be to the level that we had had we remained stagnant. However, the up side and the opportunity to diversify our revenue base provides a much greater stability to our Company and should, over the long-term, improve our returns on invested capital.

So the 20% operating margin target at 119 to 121. Is that within this time period in which you are ramping or is that a long-term model?

It's a fluid number. What we are focused on is achieving the guidance that we laid out. Improving our top line, improving our operating margin sequentially, improving our bottom-line, and strengthening our balance sheet as we gain marketshare. Those are our targets for the next quarter.

Timothy Arcuri with Citigroup.

Two quick questions. Inventory turns, I noticed that inventory turns have been flat. Inventory went up commencatory with revenue. But turns seem to be a little bit lower than they were last year. How should we model that moving forward? Does that in effective the higher material costs in FPD that you mentioned? And then also a follow-up on the taxes. How much NOLs do you have on the (indiscernible)?

We have two -- I'll get to the latter first. We have -- our NOLs are too high. They are about $80 million, I believe. With respect to the inventory turns yes (ph) versus last year, you do see an increased lag, if you will, because of the material component related to flat-panel display.

Is that -- is the level where we are at now how we should think about it moving forward? Or do you have a plan to get turns back up?

Well, what I would say is we don't see a significant increase in our inventory levels sequentially. To the extent we ramp our Taiwan facility, how quickly that comes up into the future, you may see inventory creep up. But just to remind the listeners, inventory that we hold is raw stock. It's not finished goods. So we just need the place on hand to turn the product in a just-in-time environment.

At this time, there are no further questions. Mr. McCarthy, are there any closing remarks?

Deno?

In close, I like to thank you, every one of you people for your interest, your support, and confidence in Photronics. Definitely think Photronics is poised very very well. We have a very good dream (ph) team, I think, the best I have ever seen at Photronics. I'm excited about (indiscernible). And the senior management excited about Michael Luttati joining the Company and the Company is poised very very well for the future because the technology gap is closing under the leadership of Dr. Progler. So we made tremendous improvement closing the gap with the competition, the Japanese basically. Definitely all the post production problems are in process. We will look to reduce costs from operations to everything from headcount from 80 and at the same time, our focus to gain marketshare and to grow three ways, organic growth, gain marketshare and large area masks. Definitely combines very well. I'm excited about Mike joining the Company and I'm looking forward to watch you guys from the sidelines. Thank you for your support.

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