Photronics Inc (PLAB) 2005 Q4 法說會逐字稿

Good morning and welcome to the Photronics Q4 conference call. My name is Monica and I will be facilitating the audio portion of today's interactive broadcast. 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).

This show also features streaming audio which allows you to listen to the show through your PC speakers. For those of you on the Web, please notice the toolbar on the right of your screen; the features on this toolbar allow you to interact with the other show participants and choose show viewing options. (OPERATOR INSTRUCTIONS). At this time I would like to turn the show over to Mr. Michael McCarthy. You may begin your conference.

My name is Mike McCarthy, Vice President of Investor Relations and Corporate Communications with Photronics and I'd like to thank everyone for joining us on this call during which we'll discuss fiscal 2005 fourth-quarter and full-year results.

Before we begin I'd like to remind all participants about the Safe Harbor provision under the Private Securities Litigation Reform Act of '95 and thus, except for historical events the information we'll cover during this call may be considered forward-looking and may be subject to certain risks and 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 2006 first-quarter results after the market closes on February 14th. Our call this morning will begin with Sean Smith, our Chief Financial Officer, providing a detailed review of our financial results after which Mike Luttati, our CEO, will share some brief comments and then moderate the Q&A session. Sean?

Thanks, Mike, and good morning, everyone. I'll provide a brief analysis of our financial results for the fourth quarter and fiscal year 2005. I will also review our balance sheet and cash flows during the period and review our outlook going forward. Fiscal 2005 proved to be an outstanding year for Photronics, so before we begin each of us on the management team would like to congratulate the entire Photronics global organization for their commitment and dedication which enabled the Company to have a record year.

During 2005 we increased our ownership in PKL from 75% to 96.5% for approximately $58 million which has been accretive to our results. Subsequent to year-end we acquired an addition 3.2% of PKL bringing our ownership level up to 99.7%. Net sales in our fourth quarter amounted to 111.8 million, an increase of 7.6 million or 7.3% as compared with the fourth quarter of last year. The increase is a result of improved demand for flat panel displays or FPD photomask. As we discussed in our prerelease announcement, this increase was offset by decreased demand, primarily in North America, for mainstream IC photomasks which are defined as IC photomask above 130 nm.

As a percent of total sales for the fourth quarter, sales were approximately 57% in Asia, 28% in North America and 15% in Europe. Sequentially sales in Asia grew 5.9% and sales in North America and Europe decreased 13 and 11% respectively. Sales of advanced photomask increased to 28% of total sales during the fourth 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 nm and for FPD sets used to fabricate flat panel products using G-6 and G-7 technology.

While we did have a sequential decline in mainstream IC photomask during the quarter, we would highlight that we experienced sequential growth for mask sets at and below 130 nm. The gross margin for the fourth quarter was 31.4% as compared to 34.9% in 2004. Sequentially gross margin decreased from 34.4% to 31.4% primarily as a result of the reduced sales volume of $3.1 million.

Selling, general and administrative expenses for the fourth quarter were 14.3 million as compared to 13.1 million last year. Sequentially SG&A increased 500,000 primarily from severance charges associated with our previously announced North American reduction. SG&A as a percent of sales was 12.8% during the fourth quarter of 2005 as compared to 12.6% in 2004 and 12% sequentially.

R&D expenses, which consist principally of continued development for advanced process technologies, were 8.4 million in the fourth quarter which represents a sequential increase of approximately 400,000 due to increased costs associated with the development of advanced process technology. R&D represented 7.5% of sales in the fourth quarter of '05 compared to 7.6% last year.

During the fourth quarter we generated operating income of $12.5 million or 11.2% of sales as compared to operating income of 15.3 million or 14.7% for the fourth quarter of '04. The decline was primarily related to our increased infrastructure, predominantly in Asia, to capture an expanding high-end market for both IC and FPD masks. The integrity of our operating model continues to remain intact. However, we were impacted by the sequential decline in sales as our sales and operating margins decreased by 3.1 million and 5.4 million respectively due primarily to the decreased mainstream IC business.

We will continue to match our cost structure to the changing nature of demand and new opportunities in the global market environment. We remain committed to improving our operating margins and achieving our long-term goals. As we have stated on each call this year, the next few quarters we will likely experience some moderate fluctuations on our operating margins as we continue with the completion of the expansion of our greenfield facilities in China and Taiwan. These fluctuations will be short-term and are not expected to reflect a negative change in the overall fundamental operating model of Photronics.

Net other expense for the fourth quarter was 200,000 as compared to 2.3 million in the fourth quarter of 2004. The year-over-year improvement related to decreased interest expense associated with reduced debt and increased income associated with increased cash and improved returns. During the fourth quarter we recorded a tax provision of $2 million which amounted to a 15.4% effective tax rate. Net income for the quarter was 8.7 million and includes the impact of severance charges of approximately 400,000 net of tax.

Net income exclusive of severance charges was 9.1 million or 8.1% of sales for the fourth quarter of '05 as compared to 7.9 million or 7.6% of net sales in the fourth quarter last year. Net income per diluted share was $0.19 for the fourth quarter of 2005 as compared with $0.21 per share in the fourth quarter of 2004. Diluted EPS for the fourth quarter does include the full quarter impact of the secondary stock offering issuance of 8,050,000 shares. As we exited the fourth quarter we had approximately 1,500 employees equating to sales of 298,000 per employee on an annualized basis.

Now taking a look at our full fiscal year 2005 operating results, net sales for 2005 were a record $441 million, up approximately 45 million or 11% as compared to 2004. The increase was primarily driven by increased sales of FPD photomask and increased high-end IC photomask. Year-over-year gross margins decreased by 130 basis points due primarily to the increased cost associated with our expanded advanced manufacturing base.

Selling, general and administrative expenses were essentially flat at $54 million. As a percent of sales SG&A decreased to 12.3% in 2005 from 13.5% in 2004. Research and development costs were 32.2 million for fiscal 2005 as compared to 30.5 million last year. R&D was 7.3% of sales for fiscal 2005 versus 7.7% 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 2005 was 58.7 million or 13.3% of sales, a new record for Photronics as compared to 51.3 million or 13% in 2004. Net other expense decreased to 3.3 million in 2005 compared with 10.3 million in 2004 as a result of reduced interest expense and increased investment income. In 2005 we recorded a tax provision of $10.1 million which amounts to an effective tax rate of 18.2%. Net income for 2005 represents an all-time high for Photronics. Our net income amounted to $38.7 million or $0.95 per diluted share compared with 24.5 million or $0.68 per diluted share last year. As a percent of sales net income was 8.8% in 2005 as compared to 6.2% in 2004.

Now turning to the balance sheet, the balance sheet during the past year has shown excellent improvement. During 2005 we continued to focus on improving our balance sheet and increasing our liquidity. Cash and short-term investments of 287 million at October 30, 2005 compare favorably to cash and investments of 227 million at October 31, 2004. The cash balance at year-end includes the net proceeds from the recent secondary offering.

At the end of fiscal 2005 our net cash, which is cash less debt, improved to approximately $43 million as compared to a net debt position of 92 million at the end of '04. Goodwill increased approximately 20.4 million this year as a result of our additional investment in PKL during the year and working capital at year-end remains strong at 301 million compared to 240 million at the end of last year.

Other current assets at the end of 2005 decreased by approximately 12 million from October 31, 2004 primarily as a result of classifying deferred tax assets as long-term in 2005 which were included in currency (ph) in 2004 as a result of changes in circumstances with respect to the timing of our ability to recover such assets.

During 2005 our long-term debt decreased by $75 million which includes the redemption of an aggregate 64.4 million of the Company's 4.75 convertible debentures. Total debt at year-end was $243.8 million. The principal components of outstanding debt include 87.1 million of the 4.75 converts which are due in December of '06, $150 million 2.25 convert which is to in April of '08, and approximately $6.7 million of foreign and other term loans.

During our past two calls we announced it was our intent to call the remaining 4.75 bonds on or after December 15th when the premium is reduced. Since that time yields on our investments have increased and to date we have not issued such a call notice. We will continue to monitor the market and be opportunistic as conditions dictate. Minority interest at the end of fiscal 2005 amounted to 45.8 million the majority of which related to the minority interest in the equity of our 58% majority owned subsidiary, PSMC. Shareholders equity aggregated $562 million which amounts to a book value per share of approximately $13.62 (ph).

Taking a look at our cash flows. Cash provided by operations for the fourth quarter was approximately $38 million. For fiscal 2005 cash provided by operations was approximately $143 million, an improvement of $33 million as compared to 2004. Cash flow used in investing activities during 2005 amounted to 186 million of which 122 represented cash payments for capital expenditures and 58 million of additional investment in PKL. Total fiscal 2005 capital expenditures recorded on the balance sheet during '05 was approximately 102 million which is down approximately $21 million from our forecast principally as a result of timing.

Free cash flows from operations, which are net of capital expenditures, was $21 million for 2005. And cash provided by financing activities amounted to $99 million which primarily relates to the secondary offering proceeds offset by the cash repayment of approximately $72 million in long-term debt.

Now taking a look ahead, our short-term visibility continues to be limited as our backlog is one to two weeks. We believe, however, that during 2006 we will continue to see increased design activity especially at and below 130 nm. We are also encouraged by a number of strategic opportunities that should enable us to increase our revenue through organic growth and market share gains from competitors including our expanded presence in FPD masks and increased ability to support 65 nm developments.

We do typically encounter normal seasonal shutdowns associated with the holiday periods during our first quarter. We also expect to see the Asian foundries matching their production schedules to the U.S. in European holiday periods. As a result we believe it is prudent to take a conservative view in forecasting revenues and earnings for the first quarter of 2006. Based upon our current operating model the outlook for revenue for the first quarter of 2006 is in the range of $104 to $109 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 to historic patterns of strong sequential revenue performance during the second quarter as these customers release designs held up through the year-end holidays.

During the latter part of '05 we began to draw on the scope of our strategic investments into our operating infrastructure to capitalize on strategic alliances and opportunities with key customers. As a result our operating expenses are projected to increase modestly during the first quarter. Capital expenditures in 2006 are forecast to be approximately 90 to 120 million as we invest in capability and customer relationships that enable us to achieve additional growth and market share gains.

One of our team's key priorities is to maintain our financial flexibility and continue to match capital outlays to meet anticipated demand and opportunities. While we are not providing cash flow guidance for the full year at this time, we due expect to fund our 2006 capital expenditures from operating cash flow. Included in 2006 planned CapEx are -- commitments that we made during 2005; advanced high-end IC capacity; and completion of our greenfield sites in China and Taiwan.

Our company's willingness to maintain CapEx near these levels is a reflection of our confidence in being able to fully leverage our global leadership and changes in the competitive environment as well as responding to the market conditions that present themselves.

During 2006 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 which we are taxable. Accordingly, we are estimating an effective tax rate for 2006 to be in the range of 16 to 20%. For the first quarter this will equate to a range of 1.6 million to 2.1 million in whole dollar terms. As a result, based upon our current operating model, we estimate our earnings per share results for the first quarter of fiscal 2006 to be in the range of $0.08 to $0.15 per share.

In summary, I will again 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 my prepared remarks. Now I'd like to turn the call over to Mike. Mike?

Thanks, Sean, and good morning to those of you on the call. The revenues that we reported after the market closed last evening were largely in line with the high-end of our revised guidance. EPS slightly exceeded guidance in large part as a result of the unyielding focus by the Photronics team with respect to managing costs. And I would like to thank the team for their ongoing commitment to do so.

Clearly I had believed that our October quarter would have been better. We had a strong forecast coming into the quarter and, now that we have had some time to analyze the data and discuss it with customers, it appears that the sudden decline we experienced in the mainstream portion of our IC mask business was in fact an unusual event.

Nonetheless, as CEO I am responsible for delivering the results for Photronics and I intend to do so going forward. That being said, today I celebrate my six-month anniversary on the job and I am confident that we have set the Company on a strategic path that is executable and will meet our growth and return expectations.

Based on the Q4 slowdown in the mainstream sector we have continued to monitor the various data points even more closely so that we can properly position the Company and manage its infrastructure accordingly. Order activity so far has resumed to what we would consider to be normal seasonal levels for this time of the year across the technology spectrum.

It is clear to us that the migration from the very mature process technologies to the increasingly mainstream 130 nm node is going to continue. This requires Photronics to continue its strategic repositioning in order to satisfy our mainstream customers' needs for service and, at the same time, advance our technology roadmap.

The announcement we issued this morning regarding talks to jointly develop leading-edge mask technology with Micron is one of several initiatives that we have underway to accelerate our technology roadmap and drive our goal of being a profitable technology leader. This relationship will allow us to leverage the expertise of both companies, to develop advanced reticle manufacturing processes which includes the joint development of mask process technology, but even more importantly to address the critical manufacturability issues to ensure high yields in the early development cycle. You will be hearing more from us about this and other objectives as we proceed through 2006.

In summary, 2005 overall was a very good year for Photronics and we are encouraged by the results we have achieved in areas where we have made strategic investments in technology, financial resources and people. In the advanced IC mask applications our market penetration has been deliberate and consistent with strong growth throughout the year. I am carefully evaluating and acting upon the factors that will accelerate and replicate our successes in a way that secures our longer-term ability to generate returns on the human, intellectual and financial capital that we must invest.

In the mainstream IC mask applications the increasing number of customers seeking to take out products early in the quarter is encouraging. In most instances Photronics is the process of record supplier for those customers and we will continue to outperform the competition in serving their needs. The investments in flat panel display mask capability and capacity continue to generate outstanding results and strong growth.

I really can no longer say that this is a new market for us as we now have strung together eight consecutive quarters of sequential growth. Flat panel display masks is our fastest growing business and one where we hold both a technology and a service advantage. Each of these being key competitive strengths that are a part of our further plan to increase market share in 2006.

Our strategic alignment with the largest of panel producers in Korea is excellent. While in Taiwan the opening of our new site in Taichung will enable us to gain market share in this much more diverse region. Together I am confident that 2006 will see our FPD mask operations produce another strong year.

So as I look ahead at the opportunities I see for Photronics in 2006 and beyond I am energized by our positioning and the plans we have established to succeed. Now it's time to execute. Thank you for your attention. Following some brief instructions from the conference call operator we'll be happy to address your questions.

(OPERATOR INSTRUCTIONS). Suresh Balaraman.

Mike, can you give us a sense of the industry utilization rates for the mask capacity and how pricing trends are changing in the different geographic regions? And also would you expect your flat panel and advanced IC segment to decline in line with the overall business in the January quarter? Thanks.

From a macro view, as we indicated, we're encouraged as we came out of the fourth quarter with relatively strong bookings for this period which is typically seasonal we saw. In the U.S. especially we had a pretty strong November, but we know we're going into the holiday season so we do expect the seasonal softening to occur. Across the spectrum we're seeing 130 nm starting to become more of a mainstream node and acceleration into 90 nm in terms of takeouts; 65 is still early in the process.

In terms of global pricing -- generally pricing has remained reasonably stable. Obviously customer-to-customer or event-to-event we may see some pricing momentum, but generally not. It's been pretty good.

My question was on the specific utilization levels. I think the mask industry utilization levels have been 70 to 75% for a while in the earlier part of the year and it seems to have improved a bit. And I'm wondering, have you guys achieved 85% plus yet in terms of the mask industry levels. I'm not talking (indiscernible) industry levels?

Suresh, this is Sean. Maybe I'll try to answer that. With our sequential decline in revenue I don't think we can stand here today and say that our utilization levels were at the percentage you just mentioned. But be have seen a healthy November and a pickup, but we do expect a seasonal softness to occur.

And just to -- I think you asked one other question which was on our first-quarter mix, and we still believe that we will see an increasing amount of high-end mix going into our first quarter and into 2006.

Are the high-end mask driven more by the IT segment or the flat-panel segment?

Both.

Okay, great. Thanks, guys.

Timothy Arcuri.

Actually I have several things. The first thing, as I look at gross margin, the gross margin you're implying and I look back say three years ago back to early 2003, it looks like we've added about $20 million to the P&L but the gross margin is the same. Can you help explain why that might be? I know that you're obviously investing in these new facilities, but has there been some market share loss, is there something else going on underneath the surface?

I'll try to answer that question. Our footprint has drastically changed from three years ago. We've invested significantly into Asia for additional market share. We expended a lot of capital expenditures. We've expanded our facility in Korea. We've put some advanced toolsets in to capture additional share. That has had an impact on our gross margins, but we expect to recover that based upon the volume we expect to get going forward.

That's predicated I suppose on the capacity filling up. As you try to diagnose what's happened the last quarter or two, how much of the falloff and lagging edge do you think was related to capacity tightness? In other words, front-end manufacturing, chip manufacturing capacity tightness and how much of it do you think is related to market share?

Let me take that, Tim; this is Mike. Market share is sort of difficult now to predict based on the fact that we're the only company that reports, but what I would say is in the mainstream IC segment -- we know that during 2005 we won many new accounts and increased our share in the accounts that we had -- shared accounts with our competitors. Through the first nine months we increased revenues. So despite the fourth-quarter drop-off, which our datapoints indicate as a market-driven event, we didn't see any significant share erosion.

In the high-end we increased our percent of high-end mix for the last eight quarters, went from 15% in the first quarter to 28% in the fourth quarter. It's difficult to say whether we tracked with the increase in market or not, but we're confident with the progress we've been making there and we know of no significant macro level account losses. So on the IC side obviously we feel pretty good about where things stand. We're not serving the full market of course because we do limited activity in Japan, so you have to discount that out of our numbers.

So I guess as you kind of diagnose the issue you think it's more related to the fact that there's not a lot of front-end manufacturing capacity and that's limiting some of the lagging-edge take-outs rather than a market share issue?

That's what we believe we saw in the fourth quarter and the bookings, as I mentioned, that we saw in North America early in the first quarter -- November for instance historically has been a strong quarter, but it was the strongest we've had in three years in mainstream. So that was a good indicator, but we're not getting too excited because we want to make sure that we look at the quarter as it moves into the holiday season knowing that we'll save potentially a drop-off there. But generally the answer to your question is, yes; we believe it was a capacity-related issue.

Okay, thanks.

Matt Petkun.

Sean, just real quick -- I might have missed it, what your depreciation and amortization was in Q4?

Depreciation and amortization in Q4 was combined -- just bear with me for one second. Q4 about $23 million -- 22.5 million or so.

Okay. Unfortunately I'm traveling today so I don't have my full model in front of me. But it seems to me that that's roughly flat with what you had in depreciation and amortization the same quarter a year ago. Is that correct?

But we have a couple of interesting dynamics there, Matt; you're not that far off. We have seen our depreciation go up year-over-year, but embedded in that depreciation and amortization number is the amortization of intangibles and deferred financing fees that have gone down. So we did see a year-over-year increase in depreciation and we do expect that to continue to ramp as we move forward.

Okay. But generally speaking then, are you seeing higher labor costs as you bring on these new facilities and that's really what's bringing down -- not bringing down but keeping the gross margin flat -- and this is kind of going back to Tim's original question?

We're seeing it -- it's not higher labor costs, we're seeing an increased infrastructure for labor. Our model has, as we've talked about before, significant leverage. We were impacted in the quarter as a reduction of the sequential decline in North American sales, we have the infrastructure there. We did see growth in Asia where we have invested. So our objective obviously is to manage our assets and utilize them to effectively work around the network. But we do have a high fixed cost nature of the business that to the extent revenues do go down or do go up it does have an impact on the gross margin line.

Okay. And then looking to the next quarter, I don't think you gave your specific expectations for minority interest. I know that you've obviously paid off a lot for PKL, so what would you expect that to trend like given the revenue rates you suggested for next quarter or this quarter?

I would say a range for a minority interest because I know it's difficult for you guys to determine what that will be going forward -- anywhere from 600,000 to 1.2 million potentially in Q1.

And do you see that coming down over the course of the year, or is that pretty much -- it could go up if revenues increase?

It could fluctuate depending upon the results of our majority held subsidiaries.

Okay. And then just one more question for Mike or I don't know if Chris is on the call -- but this potential joint venture or potential relationship with Micron, it seems kind of unusual that you would announce that you're in talks. I would hope you were almost always in talks with what could be potential new customers or new relationships. So what changed, what's special about what's going on with Micron? I know you guys have worked with them in years past, not necessarily from a revenue perspective.

This is Mike. We can't unfortunately say too much more than what is included in the press release, but what I could say is that this approach of a joint development is consistent with what we're seeing as partnerships between semiconductor companies as they work to co-develop next generation technologies. It's top of my priority in driving the Company to be a profitable technology leader along with some other initiatives that we have underway. It's critical that we close the gap on the technology roadmap and be at the advanced technologies and this relationship is intended to allow us to be able to do that co-partnering with a customer.

So there is a relationship that's been defined? I guess that's my question more than -- I think I would laud any efforts to expand your technology partnerships going forward; I'm just trying to understand what this one is.

Matt, as the announcement suggested, we're in talks. We've been looking at a technology development model now for quite some time and trying to understand what additional value working more closely with captives could bring to us in general. The merchant mask industry has a certain technology development approach; captives have a certain approach linked to their driver customer, which is usually very aggressive in technology.

If you just look generically at combining those two things you get a lot of complementary strengths. So what we're trying to do here is look for opportunities to take advantage of what we do well which is development in a distributed merchant environment and combine it with some of the more leading-edge technology that's driven by unique captive needs. So as far as specifics or details, we really can't go into much more than that, but just to say that we're looking to improve our capability on leading-edge technology and this is one potential vehicle to do that.

Okay, that helps. Thank you.

Gus Richard.

Just quickly, Sean, could you give a little bit of a profile as to where the impact of the new facilities on the gross margin line is? Is it going to be the biggest impact in the first quarter and then lightening up in the second or -- how do you see that profile looking as you plan those facilities?

Gus, I don't think there'll be much of an impact in Q1. Those facilities in Taiwan I believe will be up and running sometime in early -- the second quarter of this year, February time frame we're pushing for so the depreciation would start to kick in there. We are effectively trying to monetize those investments as quickly as possible. The key to our success in the first -- let's talk about the first half of '06 will be how quickly can we qualify customers in both Taichung and in Shanghai and then ramp those facilities up.

What we've seen embedded in the cost that we've had in the fourth quarter into the first quarter is we do obviously have to hire people ahead of the curve to get the facilities going, the back office functions and so forth. But with respect to the margin itself, you'll see that impact in the second quarter.

Okay. And so that will be the -- and then depending on how quickly you can ramp a new facility in Taiwan and in China as to how that will get absorbed from after Q2, but the likely biggest impacts will be in Q2?

Yes.

Okay, thank you very much.

Philip Lee (ph).

Two questions. One is what do you expect your options expense to be in 1Q and is that included in your EPS guidance? And secondly, do you guys have a target for advanced technologies in terms of a percentage of your total revenues by the end of fiscal '06?

Our option expense, which is embedded under FAS 123(r), is embedded into our guidance and it's going to be approximately $300,000 -- $250,000 to $300,000 in Q1. With respect to our high-end mix, we do have internal targets -- perhaps I'll let Mike talk to it earlier. They are fairly aggressive, but regardless of the mix we do expect to see increasing penetration in the high-end and perhaps, Mike, if you want to add some color to that.

As I mentioned, this is a critical area for us and we're making investments in that area. I'll go out on a limb here and say that we're trying to hit at least 40% of our mix in 2006 to be in the high-end.

Do you expect about half of that to be flat-panel with your ramp up of Taiwan?

It will be some component of it, but we expect to make an increase, a substantial increase in the high-end IC business as well.

Thank you.

Brett Hodess.

Good morning. Two questions. First of all, on the operating expense increase sequentially, Sean, the $500,000 severance falls out and you expect that after that falls out you'll still see a sequential absolute dollar increase?

We'll see some modest increase, Brett, as we continue to add infrastructure into Taiwan and into China as we get closer to officially opening those facilities.

And then secondly, on the FPD side, a portion of the FPD, the portion that's in the high-end is just for the older pre Gen 5 stuff. So could you give us an idea of what the FPD mix was now that it's the end of the fiscal year for the year that just ended?

What I can say is we do not for competitive purposes want to specifically break out in absolute percentages or dollars our mix of high-end, but we can say it has grown sequentially, it continues to increase becoming a larger portion of our overall business. And year-over-year I can say -- and Mike can probably add additional color to this -- it did increase substantially.

I would just say that our flat-panel business year-over-year more than doubled.

And then the next question on flat-panel, can you just comment on what the margin on the flat-panel side looks like versus the IC side at this point? And is that -- the earlier questions regarding margins, most of it's obviously the larger footprint that you mentioned, but does that have any impact, that mix?

It does have an impact. We've stated previously that the flat-panel display margin as we ramp has a higher material component to it so there's a little bit more of a margin compression until we get fully utilized. I can say in Q4 we did see an improvement in the margin for flat-panel in our product mix equivalent to our target margin. However, we did also see, unfortunately with the reduction in the mainstream business and the infrastructure cost that's embedded into our system, it did cause the overall margins to come down sequentially.

And what we continue to do, Brett, is evaluate our operating infrastructure, evaluate our locations, we did take a small charge in Q4 with respect to what we see coming down the road. We will continue to evaluate our cost structure in the U.S. and Europe and in Asia to optimize our efficiency and maintain a relatively lean cost structure. Perhaps, Mike, if you want to (multiple speakers).

The only other thing I would say is that we will have a better sense of the FPD business model once we start Taichung up which will be a stand-alone facility. Today we operate out of PKL with a blended model, so we'll have a much better sense of what the overall cost structure will look like as we ramp that facility and hopefully we'll be able to give you more information on that in the latter part of next year.

And then just my last question, as you go to ramp up China and Taiwan, the comment was that it depends on how quickly you ramp up customers there. As those two factories come online will you have qualified customers for each factory lined up at that point?

Yes, in fact in Taiwan on flat-panel we already do have customers qualified. We're shipping to them from our PKL site in Korea and we expect that those customers will resume pretty much immediately. Remember, these are copy exact processes, so the same process technology that we run at PKL will be run in Taichung for flat-panel and the same processes that we run at our 180 node and above in IC will be a copy exact into China. So the risk in terms of any process issues is very low.

And Brett, I might add that the qualification process is going to start to in Taiwan within weeks.

Great, thank you.

Tim (indiscernible).

This is (indiscernible) for Tim. A question just concerning the increase in inventory in the quarter. Can you provide us more detail on why inventory increased by about $3.7 million?

The primary driver in that increase in inventory is related to our flat-panel display business. As I mentioned a few minutes ago, that has a much larger material component. These substrates are very large, 1 meter by 1 meter, they are quite expensive. But one can view that as an indication of our confidence in our expanded presence in that market.

Okay. And then second question, just in the IC photomask industry, has there been any indication of a change in the competitive landscape?

Not dramatically that we've seen. Do you have anything specific that you have in mind?

No, I was also just alluding to the growth in the -- you guys might not have lost market share in the merchant (ph) photomask industry. But do you think that this year captive has grown much quicker than merchant photomasks have?

Chris, do you have any view of that?

It's tough to get specifics on the market share of captives, but the indication is it has not really grown that dramatically. And unit volumes probably has declined, but the captives tend to focus on the more leading-edge masks, smaller volumes with very, very advanced technologies except for perhaps some of the captives that are owned by the foundries. But we haven't seen a dramatic shift, at least our indication, dramatic shift to captives.

So you think the captives which are owned by the foundries, that those have increased units this year?

I think no, yes.

Okay, great. Thanks.

Timothy Arcuri.

I just had a quick follow-up relative to when margins might get better. I can certainly understand that the footprint is bigger, but as I look back to 2003 and 2004, a lot of the reason why you had such big margin leverage in 2004 was because your CapEx was running well below your depreciation in 2003.

Now in 2005 your CapEx is running higher than depreciation and in 2006 CapEx will be even higher than depreciation. So can you help us understand whether it might be '07 until we really see the margin leverage given what you're having to spend right now in terms of CapEx?

We expect 2006 our margin year-over-year to improve over '05 certainly. We did invest significantly in some advanced tool lines in 65 nm the last couple of years. We've built out some additional manufacturing facilities in Asia. We've added some costs into our system. And our breakeven point quite frankly has gone up from back in '03 of about $90 million to about $96 million as we exit the fourth quarter.

So we have increased our infrastructure to capitalize on what we see in the marketplace as tremendous opportunities for us to take additional share and to grow. Our internal goal is to improve sequentially '06 versus '05.

So Sean, you're saying even if I gave you the same revenue in 2006, 441 million, that you'd be able to do better than 33% gross margin?

If you gave us the same revenue to maintain the same margins we would have to do something else. We would have to pull additional cost out of our system.

So you wouldn't be able to post higher margins on comparable revenue given the infrastructure today?

That's correct, but what I will say is Photronics has never been a stagnant player. We continually look at our operating infrastructure. We've invested in Asia where we believe the business is growing. If we determine throughout the year that our revenues are going to be flat, our footprint will be much different.

Okay, banks.

Marecia Hernandez (ph).

I have a couple of questions here. On the option expense I believe you said there's $300,000 after-tax included in your (indiscernible) estimate for Q1, is that correct?

I'm sorry, you're fading in and out. But I believe you asked our option expense in Q1, about $300,000 which is embedded in our guidance, that's correct.

Okay. Can you give us an idea of the breakdown of option expense in the different income statement items, i.e., in cost of goods sold and operating expenses -- approximate percentages?

The percentages at that level are quite insignificant. I don't have that granularity right at the tips of my fingers.

Okay. And then regarding general and administrative expenses, you indicated that you had $400,000 worth of severance (ph) projects (ph) this quarter on an after-tax basis, is that correct?

That's correct.

So at this point you do not have any plan for any restructuring charges and could we just assume that the SG&A will come back to the (indiscernible) level, so even below that given that your revenue may be lower as well?

We continuously take a look at our cost containment, cost avoidance programs specifically as it relates to SG&A. As we reduce costs in certain geographic areas such as the U.S. or in Europe we have expanded our infrastructure in Asia. So without commenting directly on what we believe the SG&A line will be in Q1, it should be somewhat similar to how we exited the fourth quarter give or take a couple hundred thousand dollars.

Okay. And regarding your LCD for the month, I believe you indicated that the advanced LCD photomask also contributed to the high-end photomask growth that you see in the fourth quarter. Of that 24% would you say that high-end LCD photomask are in line with that average (ph)?

We can say that we saw in our high-end business both for high-end IC photomask and high-end FPD photomask grew sequentially in absolute dollars quarter-over-quarter. We haven't broken down between the two for competitive purposes.

Okay. And just qualitatively, if you look at your whole LCD photomask business, including the older technologies, on a sequential basis did LCD photomask grow in Q4?

Yes, it did.

All right, thank you.

Chip Vonett (ph).

A few questions if I could. First, on the revenue guidance, I'm trying to reconcile that a little bit. At the midpoint implies about 5% sequential decline. If I look back at the last couple years you had a 3% decline and a 1% decline. And if you go back to the preannouncement call you had there was a lot of talk about some catch-up effect from customers that potentially withheld designs ramping to volume because they didn't have capacity, so there was some notion that maybe this would come back in this quarter and that would imply not normal seasonality?

And then also if you take the flat-panel business, which we've had prior discussions about, it was suggested that that would not have normal seasonality for two reasons. One, they wouldn't have the same holiday schedule as the U.S., and then secondly, because it's in a share growth mode it would grow through any kind of normal seasonal decline. Can you talk to that and reconcile that for me because again that would imply something less than normal seasonal revenue in next quarter?

Chip, with respect to the guidance your percentages are spot on. Last year it was about a 3% decline, the year before about 1%. I believe the year before that was a 9.8% decline. What we see and what we do know is the business typically starts very strong the first part of Q1, that's been the historic pattern since I've been here, the last six years. And then what we don't see is what is the impacts from the holiday period, post Christmas, post New Years in U.S. and Europe? And what is the impact of the Asian new year in the beginning -- end of January, beginning of February on our order pattern?

That's why we guided 104 to 109. There are a lot of components to that. We haven't broken down the granularity between the flat-panel side versus the IC side. So we feel pretty comfortable with the guidance and we'll see when we come back after the holiday period how the orders flow in and how the fabs that did close ramp back up. Because to the extent there are fab closures, people taking time off, they're not going to release designs for production and then when they come back after the holiday period it takes a few days -- three or four days, sometimes a week before they ramp back up. I don't know, Mike, if you had any further comments.

No, I think that's the relatively good assessment of what we see coming into the quarter. As I said earlier, we did have some residual orders coming from the fourth quarter into the first quarter. It was strong, particularly in the mainstream IC sector. But we're cautious about the fact that we're not sure what will happen in the holiday season here based on historical patterns. So I think our guidance is consistent with what we see at this point in time.

Just to follow-up on that. Given what happened in Q3 is there still more potential for a bit of a catch-up effect that was talked about previously whether it's this quarter or going out into Q2? Is that still out there?

I think it's a little too early to speculate.

Okay. And then just on the micron relationship, I'm not sure that I completely understand it, but just to try to put some kind of opportunity prospect on it, if this were to materialize into revenue at some point, how far out are we talking here?

I don't think we can say much more than what I said earlier, Chip. I know there's probably a lot of questions around what this is and what it means. We'll be able to hopefully give you a little bit more information on that as this starts to come to closure over the next several months. But as we said, this is a -- as the announcement discusses -- we're committed to getting alignment on the technology roadmap and being a technology leader. And this is a key component of that along with some other initiatives we are working against.

To the extent that the high-end -- it becomes an increasing mix of the overall total available market we intend to be a predominant player there and this is a key part of that. So I think if you think of it in that context, certainly we are internally looking at it in that context as we look to be the market share leader in the high-end.

Yes, it certainly seems like a nice future opportunity. Then I guess the last thing I just wanted to follow-up on was the questions Tim was asking and it was more kind of your cost structure and revenue levels and I guess what I'd ask then is that given these investments that you've made you must clearly be expecting a good acceleration in revenues to support the additional expenses that you have here so you could get back to margin levels and that goes back to your point that you'd have to take cost out at this point to get back to those margins at the same revenue level. So would that be fairly accurate?

Yes, we do, Chip, have fairly aggressive plans internally. Our management team is driving our employee base to monetize those as quickly as possible. If we did not deem them to be very -- the market to be there we wouldn't have made those investments. Maybe one another color point on the margin discussion, the operating margin year-over-year, if you focus on the growth and operating margin. Below that there's been substantial improvement, I would like to highlight or reiterate, in the reduction of our interest cost. And increasing our investment in PKL which is reduction in our minority interest. So there's a lot of leverage below the line now coming into '06 that we're very excited about.

And just one last item that I'd like to just add that sort of surrounds our strategy of more tightly integrating our global operations. I have been adding capability to the organization, I intend to continue to do that. One recent area that we'll be announcing shortly is the hiring of a Vice President of Global Sales to drive our global relationships with our key customers and we're going to continue to look at bringing the talent into the organization that we need to be able to grow our business globally.

Okay, thank you.

At this time there are no further questions. Are there any closing remarks?

Yes, I'd like to thank everyone for listening in. The management team is energized and enthusiastic about the prospects of the Company and we're committed to continue to deliver the results that we have set out for the Company. I'd just like to close by wishing everyone a safe and joyous holiday and a prosperous new year. Thank you.

Thank you. This concludes today's Photronics Q4 conference call. You may now disconnect.