Photronics Inc (PLAB) 2006 Q2 法說會逐字稿

Welcome to the Photronics second-quarter earnings call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded today, May 17, 2006. I would now like to turn the conference over to Mr. Mike McCarthy at Photronics.

Good morning, everyone. My name is Mike McCarthy, Vice President of Investor Relations and Corporate Communications for Photronics. I'd like to thank you for joining our fiscal 2006 second-quarter earnings conference call.

Before we begin I'd like to remind all participants about the Safe Harbor statement provision under the Private Securities Litigation Reform Act of '95. 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 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 third-quarter results after the market closes on Tuesday, August 15th. Sean Smith, the Company's Chief Financial Officer, will begin with a comprehensive overview of Photronics' second-quarter results and update you on the Company's guidance. He will be followed by Mike Luttati, our CEO, who will share some very brief comments after which he will then moderate the Q&A session. Joining Sean and Mike in the Q&A will be Dr. Chris Progler, our CTO, and Dr. S.H. Jeong, our President of Asia. Sean?

Thanks, Mike, and good morning, everyone. I'll provide a brief analysis of our financial results for the second quarter of fiscal 2006. I will also review our balance sheet, cash flows during the period and review our outlook going forward. Before we begin I would like to congratulate entire Photronics organization for their continued teamwork, dedication and focus in servicing our global customers which has enabled the Company to achieve yet another record quarter.

During the quarter we incurred an after-tax charge of $11.4 million or $0.22 per share resulting from the previously announced restructuring of our North American manufacturing network. In a few minutes I will elaborate further on this initiative and the impact of the recently announced transaction with Micron. For purposes of our discussions on operations for the second quarter, I will be primarily referring to our operating results excluding the impact of charges related to the North American restructuring.

Net sales in our second quarter amounted to a record $119.5 million, Which is an increase of $6.69 million or 5.8% as compared with the second quarter of last year. The year-over-year increase is primarily related to the improved tape out activity for high-end applications in both IC and FPD photomasks. Sequentially sales rose by 6.7% as a result of improved demand for all product offerings in each region. Sales of advanced photomasks were 35% of total sales during the second quarter as compared to 36% in the first quarter which represents an increase in absolute dollars of approximately 3.8%. Included in this percentage would be mask sets for semiconductor designs at and below 130 nm and for FPD sets used to fabricate flat-panel products using G6, G7 and higher technology.

As a percent of total sales for the second quarter, sales were approximately 55% in Asia, 29% in North America and 15% in Europe. Gross margin for the second quarter was 35% as compared to 34% in 2005. Sequentially gross margin improved 270 basis points primarily as a result of our improved demand for both IC and FPD photomasks at both high-end and mainstream nodes and our continued focus on operational efficiency and cost control.

Selling, general and administrative expenses for the second quarter were $15.7 million as compared to $13.5 million last year with the increase related to our Asian expansion, specifically the startup costs for two new facilities in Taiwan and China and, to a lesser extent, increased costs related to the implementation of FAS 123R. Sequentially SG&A increased $500,000 all of which related to the Asian startup operations. SG&A as a percent of sales was 13.2% during the second quarter of '06 compared to 12% in '05 and 13.6% sequentially.

R&D expenses, which consist principally of continued development for advanced process node technologies, were $8 million for the second quarter. R&D represented 6.7% of sales in the second quarter of '06 compared with 7.2% last year.

During the second quarter we generated operating income of $18.1 million or 15.1% of sales as compared to operating income of $16.8 million or 14.9% for the second quarter of 2005. Sequentially our operating margin improved by $5.3 million on increased sales of $7.5 million. This represented a 71% fall through on our incremental sales due in part to increased utilization and improved mix coupled with our cost containment programs. Our operative model is in excellent condition and continues to produce the results management expects.

As we have stated on previous calls, the next two quarters will likely experience some moderate fluctuations on the operating margin line as we continue with our expansion and look to monetize our greenfield facilities in Taiwan during Q3 of '06 and in China in the latter part of '06. In view of the many opportunities we see ahead, the fluctuations resulting from our investing of Photronics' future growth will be short-term and are not expected to be reflected as a negative change in the overall fundamental operating model of our Company.

Net other income and expense for the second quarter was income of $3.8 million as compared to expense of $2.1 million in the second quarter of 2005. The improvement year-over-year is related to increased investment income and increased foreign currency gains and also includes realized gains associated with the sale of certain investments which were approximately $2.2 million or $0.04 per diluted share.

During the second quarter we recorded a tax provision of $3.8 million which amounts to an effective tax rate of 36%. Exclusive of the restructuring charge and investment gains the Company's effective tax rate was approximately 19%. Net income exclusive of the restructuring charge and investment gains was $14.5 million or 12% of sales for the second quarter of 2006 as compared to 10.69 or 9% of sales in the second quarter last year. Sequentially net income improved by $4.8 million. On a GAAP basis net income per diluted share was $0.12. Net income per diluted share for the second quarter exclusive of other restructuring charge and investment gains was $0.31 which does include the favorable impact of rounding.

As we exited the second quarter we had approximately 1450 employees equating to sales of 330,000 per employee on an annualized basis. Taking a look ahead at our six months year-to-date operating results before for the impact of the restructuring charge, net sales for the first six months of 2006 were $231 million, up approximately $17.3 million or 8.1% 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.

Year-to-date gross margins improved by 80 basis points to 33.7% as compared to last year and SG&A expenses increased $4.7 million to $30.9 million or 13.7 -- 13% of net sales. SG&A totaled $26.2 million or 12% of net sales last year. The increase in SG&A is primarily related to our Asian expansion. Research and development costs were $16.2 million for the first six months of '06 as compared to $15.9 million last year. R&D was 7% of sales for fiscal '06 versus 7.4% of sales in the prior year.

Our operating income for the first six months of 2006 was $30.8 million or 13.3% of net sales as compared to $28.3 million or 13.2% in 2005. Net other income expense for the first six months amounted to $5.6 million compared with $5.1 million in 2005 as a result of the increased investment income associated with higher cash balances, year-over-year favorable foreign currency exchange gains, and the aforementioned gains on sales of certain investments.

For the first six months of 2006 we recorded a tax provision of $7.6 million which amounts to an effective tax rate of 22% which is exclusive of the restructuring charge and investment gains. For the first six months of '06, exclusive of the restructuring charges and investment gains, our net income was $24.2 million or $0.52 per diluted share.

Now turning to the balance sheet. Photronics' balance sheet has experienced a positive transformation over the past couple of years. The strength of the balance sheet and improved liquidity has enabled us to strategically invest in market opportunities such as our recently announced joint venture with Micron. Cash and short-term investments at the end of second quarter amounted to $280 million and working capital amounted to $222 million. At the end of the quarter current liabilities included $87 million of debt which relates to a 4.75 convert which is due in December '06.

Subsequent to the end of the quarter, as I mentioned, we invested $120 million into the joint venture with Micron which brought our working capital on a pro forma basis down to $102 million. At the end of the second quarter our net cash, which is cash less debt, amounted to approximately $31 million. Receivables increased $6.9 million from year to date as a result of higher sales during the first half of '06 and our inventory increased approximately $6.3 million since the end of the year as a result of the strategic decision to increase blank inventory for FPD masks as our business begins to ramp in our new facility in Taichung.

Total debt at April 30, 2006 was $249 million. The principal components outstanding include $86.6 million of 4.75 convert due in December of '06; $150 million 2.25 convert due in April '08; and approximately $12 million in foreign and other term loans. During our prior calls we had discussed it was our intent to call the remaining 4.75 bonds on or after December 15, 2005 when their premium was reduced. Since that time yields on our investments have increased and to date we have not issued a call notice. We will continue to monitor the market and be opportunistic as conditions dictate.

Minority interest at the end of the second quarter amounted to $44.7 million, the majority of which relates to the minority interest in the equity of our 58% majority owned subsidiary, PSMC. Shareholders' equity aggregated $598 million which amounts to a book value per share of $14.43.

Taking a look at our cash flows, cash provided by operations for the second quarter of 2006 was approximately $38.8 million. Year-to-date cash flow provided by operations was $50.2 million. Cash flow used in investing activities during the first half of 2006 amounted to approximately $49.9 million of which $56.6 million represented cash payments for capital expenditures. Year-to-date free cash flows were slightly negative; however, we remain confident that we will generate free cash flow for the year. Total CapEx year-to-date on an accrual basis was approximately $65.6 million and it primarily relates to our two new facilities in Asia.

Before we discuss our forecast for the third quarter with CapEx for the remainder of 2006 and our initial view of capital projections over the next several years, we wanted to provide additional highlights related to our recently announced transaction with Micron. As Mike Luttati stated on a conference call a week ago, this is truly a transforming event which we believe will significantly benefit the Company, its customers, its shareholders and employees for the foreseeable future.

Some of the key provisions of the transaction include the following -- on May 5, 2006 Photronics invested $135 million of which $120 million was paid on closing for a 49.99% stake in the joint venture known as MP Mask Technology Center. In connection with the joint venture Micron and Photronics entered into a technology license agreement and certain supply agreements. Micron contributed its existing photomask facility into the venture. Photronics will pay the remaining $15 million in fiscal 2007 and 2008.

Additionally, in conjunction with the joint venture, Micron and Photronics intend to build an independent state of the art nanofab in Boise, Idaho that will be operated by Photronics for volume production of advanced photomask. We expect the investment and new facility to range from 125 to $150 million which will include the building and new capital in addition to redeployed assets. In conjunction with the joint venture Micron is, on behalf of Photronics, financing and constructing the new facility. Total expected cost for this facility will be in the range of 45 to $55 million which will be repaid to Photronics over the next five years. The new facility is expected to be operational during our first fiscal quarter of 2008.

From a balance sheet perspective Photronics anticipates recording $135 million investment subject to final valuation and appraisal of acquired assets and rights as follows. Approximately $65 million will be treated as an equity investment in the joint venture on our balance sheet. As we do not have effective control of the joint venture we will not consolidate its assets and results of operations. We will, however, record our share of the joint venture's net income or loss on a quarterly basis through the nonoperating income and expense line. The remaining consideration, or approximately $70 million, will be amortized over its expected useful life. We will also record a $15 million liability for the remaining payments which are due in equal installments of $7.5 million due in May 2007 and May in 2008.

With respect to the income statement we anticipate the following accretive impact related to this transaction. Under the supply agreement Photronics will receive a commission for all orders for which the joint venture is subcontracted. We estimate this commission could be up to $5 million annually based on projected demand. We also intend to amortize the $70 million which is the value associated with the technology agreement subject to a final valuation, the amortization of which will be a component of our operating expenses. Furthermore, we project research and development expenses to decrease 3 to $5 million annually as we benefit from improved efficient in our global R&D effort.

We also expect revenue upside as a result of the supply agreement under which we will receive a minimum 67% of Micron's outsourcing needs. This opportunity exists immediately at one of our facilities once quantified and our new facility once completed. We expect to monetize this opportunity with one of our existing facilities in fiscal 2007 if not sooner. Once one of our existing facilities is qualified we estimate that we could earn incremental high-end revenue of 1 to $3 million on a quarterly basis. Once our new facility is fully ramped and qualified we believe the facility will be capable of generating a minimum range of 40 to $60 million in high-end revenue coming from servicing Micron's outsourcing needs as well as servicing the needs of other advanced technology customers in the United States and Europe.

Now taking a look ahead, the third quarter is a transitional quarter for Photronics as we have three key initiatives which will have a direct impact on the results for the quarter. These include the following -- we expect to finalize the closure of our Austin facility and redeploy its high-end toolsets. As we do so we will experience a brief period in which we will not generate any revenue from this equipment. Secondly, we will also have our new FPD facility in Taichung fully operational during the quarter. And finally, we do expect to benefit, albeit modestly, from the transaction with Micron during this quarter.

Taking a look ahead, our short-term visibility, as always, continues to be limited as our backlog is typically one to two weeks. We believe, however, for the remainder of 2006 and into the foreseeable future we will continue to see increased design activity, especially at the advanced nodes. We're also encouraged by a number of strategic opportunities such as Micron and our expanded presence in FPD masks and increased ability to support 65 nm customers.

Based upon our current operating model, the projected outlook for revenue for the third quarter of 2006 is in the range of 119 to $124 million. Capital expenditures for 2006 are forecast to be approximately 100 to $120 million as we selectively invest in capability and customer relationships that enable us to continue to achieve profitable technology leadership and consolidate market share gains. Our initial pass at future capital expenditures includes multi-year investment programs that would be made over the next two to three years. The two major initiatives include the U.S. and Korean nanofabs, each of which could cost up to $150 million. Our focus is on high return capital programs that align us with advanced technology customers.

During the next two quarters we do expect to incur further consolidation charges of approximately 4 to $7 million related to the finalization of our Austin plant closure and tool redeployment. During 2006 our tax rate, which 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 years which we are taxable. Accordingly we are estimating our effective tax rate for '06 to be in the range of 20 to 25%. For the third quarter this will equate to a range of $3.3 million to $4 million in whole dollar terms. As a result, based upon our current operating model we estimate earnings per share, exclusive of the anticipated charges related to the Austin closure, for the third quarter of 2006 to be in the range of $0.24 to $0.32 per diluted share.

In summary, I again will emphasize that our visibility assured customer sentiment remains positive. They global demand for the full range of photomask technology services and products should continue to grow. (indiscernible) Photronics' ability to service a larger share of the worldwide market. That concludes my remarks; now I would like to turn the call over to Mike.

Thanks, Sean. Good morning, everyone. We are all very pleased with the Company's performance in Q2. Tactically we continue to execute at servicing our customer base and at the same time kept our strict discipline on cost controls. This translated into solid top- and bottom-line results. Strategically we took several transforming actions including the opening of our new flat-panel facility in Taiwan, announcing the closure of our Austin facility and entering into a joint venture partnership with Micron Technology to form MP Mask. These actions are certain to propel the Company toward achieving our goal of profitable technology leadership.

We enter Q3 with enthusiasm, a renewed level of energy and the highest degree of confidence. Although this quarter does represent somewhat of a transitional period given the actions we've taken thus far, we know there will be significant upside as we look out over the next few quarters and into fiscal 2007.

Let's consider the following upside opportunities and revenue drivers. First, we are well along in ramping our new flat-panel mask facility in Taiwan. Second, in Shanghai our new facility there will be coming online at the end of Q3 and into early Q4. This establishes Photronics in a market that is anticipated to be among the more robust design centers for the future. Third, in North America we have restructured our manufacturing operations and are in the process of redeploying assets. The process of transitioning customers previously served by the Austin facility is well under way. Fourth, MP Mask is under way operationally and we will begin qualifying other high-end customers there over the next several months. And finally, we will begin qualifying Micron outsourced product at a Photronics site.

Bringing each of these projects to a successful conclusion will substantially improve our manufacturing efficiencies and technical competency and improve our overall level of customer satisfaction. Our global team is focused on ensuring that disruptions which could impact our revenue growth in the very near term are minimized and that we remain diligent on our execution.

In closing, I would just like to reinforce the significance of MP Mask and our relationship with Micron Technology. For Photronics the timing is perfect for us to take offensive. And with the commitment of a major technology driver like Micron we have instantaneously shifted the competitive landscape into our favor. From a capital efficiency standpoint MP Mask reduces the amount we needed to invest in R&D, independently to achieve comparable levels of success that Micron has already achieved. We expect that the positive impact to our customers, employees and shareholders will be immediate and long-lasting.

Thank you for your attention. We will now be happy to take your questions.

(OPERATOR INSTRUCTIONS). Robert Maire, Needham.

In terms of -- maybe I missed it during your prepared comments, but quarter growth on the flat-panel versus your core products, can you give us that breakdown?

Robert, this is Sean. We do not disclose the breakdown between our FPD IC photomask growth rates for competitive purposes as we are the only publicly traded stand-alone entity. Suffice it to say, we saw growth in both areas and we do believe we're continuing to take share on the FPD side.

And in terms of growth in the U.S. versus Asia or Europe, can you give us some sense as to what you're seeing in the U.S. ex Micron? Our things slowing down in the U.S. and picking up faster in Asia or what are you seeing?

We can speak to the U.S. I did comment earlier about the splits, but we did see sequential growth in the U.S. and this was despite the announced closure of our Austin facility at the end of March. And I don't know if Mike or Chris wants to add any color to that.

Additionally, Robert, we continue to see strong demand for the mainstream product both in the U.S. and in Europe and strong demand in Asia across the productline, and obviously as we ramp the new facility in Taichung. We did not recognize revenue in the second quarter for that facility, but we will start to see that taking impact in Q3 and certainly into Q4.

And on the Micron JV, still trying to understand that a little bit. Is there an assumed level of profitability that you have there? Is it in line with your current overall business? Like we lower the expectation that you can get it higher? I guess I'm looking for what that is going to contribute to the bottom-line as compared to your core or your flat panel businesses. It sounds to me or feels to me as if the business with Micron may be more additive to revenues than to earnings.

I'm sorry, Robert -- the last word I didn't hear what you said -- more additive to revenues?

Revenues than to earnings. I guess I'm wondering as to what level of profitability we can expect out of the Micron business -- or the Micron JV I should say.

Certainly the transaction Micron over the long-term is going to be tremendously beneficial to Photronics, to its topline and bottom-line vis-à-vis with the new nanofab that's going up that opens us up to the high-end customer and increases our presence in the U.S. to service other customers that we may not have the majority share right now, so that's an opportunity. The joint venture itself is a technology driver which we can parlay with our other customers -- and Chris, I'm sure, will talk about that in a second. And certainly the basic components which I went through earlier in the text, we do believe all in that the joint venture, the supply agreement and the technology agreement will be accretive to our topline and bottom-line for Photronics.

I guess the point I'm trying to ask is I'm assuming it's at a lower profitability level than your current overall business?

I wouldn’t necessarily say so. It's a different type of venture, especially in the short-term before we have our nanofab ramp where we will see potentially some compression on the margin itself as a percent operating margin, but certainly in absolute dollars it will go up. But it's really a longer-term venture that enables us to be a technology driver. Chris, maybe you can highlight a little bit more on that?

Sure. The idea here with the technology we're working on in the JV, it's kind that already operating, functioning, producing very high-end masks for the primary customer which is Micron. Those masks have very high-value on the open market today if they were sold because they're very leading-edge. To the extent we extract that technology out and put it into our independent facility, that is a premier mask product which if we deploy it with our customer base will commend the same kind of premium treatment in the marketplace.

So from the point of view I think what you're getting out is there are opportunities to improve margins and take advantage of the high-end business, I think the answer is, yes, and that will do with extracting technology out from an entity that's already operating at that level and getting yields running quickly which, due to the way this is structured, should be achievable and then we'll be able to take advantage of that premium product placement in the industry.

This is Mike. One other -- just to add to this, short-term, as we mentioned in the prepared remarks, there's a commission structure that is set up that we estimate will be about $5 million annually. In addition to that we hope to qualify Micron outsource business at one of our initial sites and we expect that to provide both revenue and bottom-line that's consistent with our other customer base.

Long-term, as Chris mentioned, we'll have MP Mask and the benefits that we see of this overall is, A, we lower our R&D investment cost for high-end development; B, we lower the risk of us doing this on our own and not being able to succeed; and thirdly, we accelerate the timing and learning curve that we would normally have to do on our own. So we would expect the product moving from MP Mask into the new Boise nanofab to be yielding at a high-level sort of out of the chute. And that certainly will contribute to better gross margin performance.

And one final point of clarification on the MP JV, what prohibitions or restrictions are there on the distribution of the technology or the reuse of the technology that is jointly developed with Micron? My assumption is that Micron isn't going to want you turning around and selling it to its memory competitors. Is there a restriction in memory or is it a time delay or what if any restrictions are there on the resale of that technology?

There are certain timing restrictions that are primarily related to competitive products at the same -- or advanced node. However, we have agreed that on certain time period that have passed and as Micron has transitioned that Photronics would have flexibility to utilize this technology and service our other customers producing similar devices. And as we've assessed this given the competitive landscape we don't see this as a negative detractor to our ability to get customers of equivalent products to be able to source -- provide them the technology.

Okay, thank you.

Bill Ong, American Technology Research.

Congratulations, nice quarter. If we sort of step back and look at your guidance, you gave conservative guidance back for the January quarter and you delivered strong upsides and then once again you gave conservative guidance in the April quarter as well as flat growth and then again you delivered strong upsides. So I understand the turns business and your visibility is limited, but it seems that it's very back end loaded. So are your customers really just waiting towards the end of the quarter to order these photomasks? It's almost like a software business type of model. So are you going into business in a more liner fashion or is it a scramble towards the end of the quarter?

No, it's very dependent on design tape outs. Obviously as our mix shifts to the higher end the complexity of those designs often sometimes will cause customers to delay taping out considering design modifications and the like. But it's day in and day out, as we said before; we have a blended customer base that provides us product pretty consistently through the quarter. And as you said, our visibility is short; we try to give our best view based on what we know is in the pipeline and what our customers are describing as being taped out over the next couple of months.

We also, as both Sean and I mentioned in our prepared remarks, have a quarter here where we're doing -- we've got a lot of transitional events occurring with the two moves out of Austin, ramping facilities and the like. So we think that, again, the guidance that we've provided is our best view of what we believe we see today and we'll continue to execute against it.

Okay. And just as a follow-up -- for the April quarter how's your revenue spread out? Was it like a third each or maybe a little bit of a rough guess of how that played out in April, March and February?

Bill, this is Sean. Certainly it's not back end loaded. I wouldn't say it's linear because it's a day by day, week by week proposition. We had some good weeks in the quarter and some slower weeks, but it's something we monitor everyday, the first thing we do when we come in is to look at the previous day's orders. So we saw pretty solid movement throughout the bulk of the quarter.

Okay, thanks.

Timothy Arcuri, Citigroup.

Several things. Number one, if you look at your semi business versus your flat panel business, I know that you don't break out flat-panel, but it appears that if you did, at least in my model, it looks like relative to 2004 pretty much all of the growth in revenue has come from flat-panel. Is that wrong or is that right?

With respect to 2004?

Yes. So if I take that $100 million run rate that you averaged back in 2004 and I take where you are now versus then, almost all the increment upwards of 80% of that extra $20 million has come from flat-panel.

The majority of our growth comes from two areas. One is certainly the flat-panel business; two is high-end penetration with IC customers. Back in 2004 -- I don't have the information right at the tips of my fingers -- we did have some flat-panel business embedded in our numbers as well. But we have seen growth in both FPD and semi IC business as well as some increased customer alliances that we did not have certainly in 2004.

Okay. I guess where I was going with that is it seems that the semi business is up modestly relative to 2004, yet chip units are up 20 to 25% relative to 2004. So you guys are doing great on the top line, but I would think that it could be even better given what's happened to chip units over the last two years.

Tim, this is Mike. Look, the fact is we've been very forthcoming I think in saying that our mainstream business has been the bread and butter and has been a solid piece of business for the Company. It continues to be and we continue, we believe, to not only hold but gain share there. Our vulnerability has always been on the high end and we have aggressively moved here with this initiative with Micron to close that gap immediately -- to have a technology partner not only from a mask making point of view but a semiconductor company with leading-edge capability.

Just do the translation and the math and you can see that this deal for us shifts just about 6 to 8 points of overall market share in our favor and probably 20 to 25% market share in the sub 90 nm mask range. So this is a significant transforming event. No question that we have not done as well competitively in the high end and this will make the difference for us.

Great. Thanks, Mike. I guess to that point, Sean, it seems like cash, given this deal, is going to be down to about $100 million as of July. Is that the right number?

We had cash of 280 and we spent $120 million, so that's where we'll be. We expect to generate cash during the quarter from operations. I believe our cash balance quarter-over-quarter in the second quarter was up sequentially $18 million. So we'll still have a pretty healthy balance at the end of July.

Okay. And then I guess the last thing for me -- as you look at the Micron deal, how does it change if at all the longer-term model in terms of gross margin? So maybe if you pick a revenue number out there -- maybe pick 130 or 140, whatever you want to pick -- how does this change what the operating model will look like going forward?

We tried to give as much guidance and color to the transaction as we could on the impact on an annualized basis, but we firmly believe that this transaction over the long-term will significantly improve our margins in both percent and absolute dollars as well as our high-end topline revenue.

So do you think 40% is still achievable even with this deal?

We have not backed off our overall long-term goals.

Okay, thanks.

Suresh Balaraman, ThinkEquity.

Based on my rule of thumb estimate, which could be wrong, you guys must be pretty tight on capacity of your 130 nm and below mask capacity. And I'm wondering if this segment can continue to grow as it has been without you guys raising prices?

Suresh, I'm sorry, you came through a little muffled. Could you repeat that question please?

Yes. The 130 nm and below segment has been having a reasonable growth the last few quarters or so. And based on my estimate you should be pretty much -- grow to full capacity. And adding so much 130 nm capacity takes time and I'm wondering if this segment can continue to grow for the next few quarters without the prices being raised?

We definitely agree that we see increases in tape out activity at 130 and below. We believe we have adequate capacity. One of the decisions we made on the Austin redeployment was to help provide the toolset and capacity in the regions where we saw the best opportunity to take advantage of that. That's underway, as we said, through the -- into the third quarter. So we think that that is going to continue based on what we see in our crystal ball looking out over the next few quarters.

And what is your current revenue capacity assuming current ASPs?

Suresh, we haven't broken that out in a while for competitive purposes, but certainly we had the ability, Mike, as we exited the quarter to do significantly north of the 119.5.

That's true.

Okay. And also, can you update us on any ASP trends in the 130 nm and below segments, just the industry conditions, not necessarily as specific to Photronics?

As we've said in the past, there's always pressure on pricing as the nodes mature and we come up learning curve, that we'll continue to see. But we haven't seen any what I'll describe as a rational pricing move.

Okay, great. Thanks, guys.

Timm Schulze-Melander, Morgan Stanley.

Good morning, guys, and congratulations on a nice quarter. Two quick questions if I may. The first, just on the incremental gross margin, it looked very strong at about 75%. I'm assuming that's obviously pretty significantly north of marginal gross margins that you're earning on some of your products. Could you just explain what underlies that and then I have a follow up?

Timm, this is Sean. Part of the reason is certainly the increased utilization of our installed tool base which falls at the high end in the mature side -- the leverage within the model yielded that improved gross margin on a sequential basis. Just general basis conditions. And as we look to extract further costs, albeit a lot of pennies here and there out of our operating system, that also drives the margin.

Okay. So I guess implicit in the question is as you model further revenue growth going out, as the Street does that, is it reasonable to essentially assume incremental gross margins with a seven (ph) handle on them or should we expect that number to start trending down?

I did mention in the prepared text that we are bringing -- our Taichung facility is beginning to ramp this quarter. With that come some additional costs and we will look to monetize that as soon as possible. We may see some short-term pressure albeit maybe a quarter or so, but certainly longer-term or even six months out we expect to see increases at the topline gross.

Okay. And then the second question I had, if I understand it correctly the nanofab you're building is really targeted at 65 nm. So can you just help us understand for the joint venture, how is pricing determined for 130 masks, 90 nm masks, etc., given that there's not a spot market, there's no easy reference market? How do you determine pricing? Thank you.

On the roadmap topic 65, 45, 32 are the nodes we're targeting for the nanofab. In terms of pricing, could you clarify a little bit your question -- at least I'm not sure I understand it. Did you mean -- if you can just clarify it a bit.

Yes. I guess what I'm saying is this used to be a captive mask shop, right? So it wasn't essentially run for profit. It wasn't run on a necessarily commercial basis. Now you're partnered with Micron, yet it's clearly a commercial venture and one of the elements that's going to determine the kind of contribution that that makes to you is going to be obviously cost and pricing. So what I'm trying to figure out is how is the pricing element of that equation determined. Are the prices for the masks already set in contract or I just want to figure out how you determine pricing for the MP tech output.

Timm, this is Sean. I know there are benchmarks out there with one or two of our competitors from Japan that potentially serve Micron currently since they do limited outsourcing. So there will be a benchmark to determine what the pricing will be and it will be a negotiated amount as with everything else.

Well, and just to add to that, Timm. I think we've proven that as a service leader we have been not a price leader, but we have been able to run lean and to be cost efficient and provide market pricing, if you will, at good returns for the business. And I think Micron recognized that in partnering with us that they wanted someone that could drive an efficient operation and provide them with market competitive pricing and that's what we intend to do.

Great, thanks very much.

Matt Petkun, D.A. Davidson & Co.

Good morning. A couple question. First, Sean, with the offset that you're going to get from the R&D in the joint venture, would you expect on an absolute basis R&D to be down in 2007 or will that just be offsetting other incremental R&D expenses in the rest of the business?

I would, as we sit here today, expect our R&D spend to be down as we leverage our investment with Micron in a JV. And Chris, maybe you want to elaborate further on that.

Sure. The structure of the JV allows Photronics to put [assignees] which we plan to take advantage of. There are a lot of efficiencies, no question about it. This again is an entity that's already running full stream ahead on technology R&D. To some extent we're grabbing on to the tail here and holding on and we plan to do that by putting signees in, having a very, very efficient technology transfer model and doing a limited customization of that technology for our own customer base.

So when you think of it that way the total R&D picture should be much more efficient for us to maintain also a leading-edge posture we just have never had opportunity to be in before. So I think it both advances us, and it also does it in a very cost-effective low-risk way.

Okay. And then at what point should we start modeling the initial commission payment to the $1.2 million a quarter?

We should benefit to some extent this quarter from that. Didn't give specific guidance. I think what I said in my text was on an annualized basis. But we're ramping that up this quarter, so it could be anywhere from $0.5 million to $1 million depending on how -- subject to our ability to perform and execute.

Okay. And then with the rest of your business this next quarter, it sounds like the bulk of the reduced margin is going to be coming from the new facility in Taichung coming online or is it more Austin's inability to produce this quarter?

You're right on the former. Certainly when the facility comes up or has come up, starts shipping product you're going to incur the depreciation and the overhead cost on day one and the revenue level won't be commensurate out of the box, although we soon expect it to be. With respect to Austin, it's effectively or it will be effectively closed for operation soon and it's on a -- a small-scale as we speak. So that's been factored into our results or our projection for the quarter.

But as we do so, as we see some compression in certain areas we're still sitting here and Mike is driving the entire management team to extract additional costs out of our system. We have a number programs in place and a number of initiatives that hopefully will yield some positive improvements during this quarter.

Okay. And then my last area of focus is trying to understand your revenue opportunity and the supply agreement. I think one thing maybe I don't understand is why you wouldn't have had any one of your outside facilities qualified with Micron before you parted with $115 million. You guys have been working on this with them since last November, December -- at least you stated that to the Street and I know you've been working on it even before then. So why aren't you qualified and when can we start to see the supply agreement contribute to the top line?

I think as you might imagine these discussions are complex and no one wants to get ahead of themselves in anticipation of something closing. Obviously we had several objectives from both sides coming into this in terms of what we needed to accomplish. And so to start [qualling] in the middle of a complex negotiation like this just didn't seem to make a whole lot of sense for either party. It's a lengthy process, but we also have -- we've done some benchmark work through this process with them. We believe that we have a good understanding and we'll be able to accelerate that now that we're in the position to do so.

Okay, Mike, and I missed your comment. You said -- at some point in your prepared remarks you said a minimum of how much high end revenue could come through this?

What we said was that there's a minimum of 67% of their outsource business.

I said in the prepared remarks, Matt, that once our nanofab is up and running we have the potential at a minimum for a range of 40 to $60 million of revenue -- hopefully it's north of that. That would include Micron's outsourcing needs, 57%, subject to our ability to perform and execute which we're extremely confident; and two, additional high end U.S. and European customers -- essentially taking share from our competitors.

And maybe to just add a little more color, because I think it's -- to your point on the question of why didn't we qualify. The Austin decision obviously was in the mix on this and at the time we were contemplating what we would do in the event that we moved to this Boise nanofab and where we would move the high-end business. That was also a factor in not doing it sooner.

Okay, fair enough. Good quarter.

Patrick Ho, Stifel Nicolaus.

Thanks a lot and congratulations on the quarter. I think this question may be more for Mike from a broader strategic operations question. We're in an upturn environment, I think the business trends near term appear very healthy. I understand I think the long-term strategic actions that you're taking with the joint venture as well as cutting your cost. Do you believe you're taking on all these initiatives all at once and that could pose a potential challenge near term in terms of execution and potentially stunt the growth that you're trying to do? Can you just give me the reasoning I guess for the timing of all these actions that are coming all within a pretty short amount of time?

That's a good question and it's certainly a discussion we've had amongst the management team and with our Board. If you look at the key -- three areas that we're focused on, the mainstream business we've done very well, we're continuing to execute and we intend to maintain our service leadership capability in that segment. So we don't see a whole lot of risk there. The issue there is keeping the facilities utilized, continuing to service our customers and ensuring that we keep those facilities running efficiently.

In the high-end, the Micron solution to our high-end issues, actually we believe took a significant amount of risk that we might have had going in from an execution point of view and eliminated it because, as Chris mentioned, we have a facility here that is already operational, already producing advanced photomasks, yielding advanced photomasks and a customer that's relying on those masks for their roadmap alignment.

So the issue there is can we successfully, as Chris mentioned, insert ourselves into that and extract the knowledge and technology as we move to our new facility? And I can assure you that the partnership between us and Micron in terms of accountability for that execution is very tight and they have a vested interest in our success. We have resources to bear there that we didn't have in the Company prior.

And then in the third component is in flat-panel mask and I think we're well on our way given the success we've had in Korea. We did a copy exact facility and Taichung. We have I would say, and I could ask S.H. who's here, probably 90% of the targeted customers that we had for that facility either qualified or in qualification. And so we see that as very low risk from an execution point of view.

So when you look at all three of them, they each have different dynamics, but we feel very good about the fact that we're on the path we're on and where we're looking obviously as we expand and grow to add additional bandwidth to the organization. We'll continue to do that, but we don't see the significant -- any significant risk in our ability to execute.

Great, thank you very much.

Phillip Lee, JPMorgan.

Can you talk about your advanced technologies and how you expect that to grow for next quarter? And then whether the flat-panel is greater than the IC component of that?

Well, let's see -- this is Mike, and maybe I'll have Chris or Sean add to this. As we mentioned, the short-term transition here as we move Austin tools, we should see minimal impact in the third quarter for high-end growth. But because we redeploy those tools we have customers and demand that we believe we'll be able to see that pick back up. So we don't see a blip down, there may even be some upside given that we do still have capacity in the network.

As we enter this agreement with Micron, as I mentioned, we'll see some revenue via commission stream as a result of that joint venture this quarter. And I'm sorry, the third question was on flat panel?

He wants to know how much the shared was to high-end. I wouldn't say -- they're marginally different.

Between high-end flat-panel and high-end IC?

Right.

That's true. Was that your question, Phillip?

Yes. My question was within the advanced technology dollars which portion is bigger flat-panel or the IC?

We're not in a position to disclose that at this point in time. As we mentioned earlier, flat-panel is growing. And from a competitive standpoint we aren't at liberty to break that out. But we certainly, as we sit here today and we talk about historical information, our IC high-end business, as Mike mentioned, has undergone a significant transformation. So to quote where we were and where we're going, we expect to see growth in both high-end IC and high-end FPD masks.

Okay. And then one other good question. What do you expect your OpEx to be next quarter?

We didn't provide specific guidance with respect to our OpEx. It's embedded into the range that we gave.

That's fine, thank you.

(OPERATOR INSTRUCTIONS). Brett Hodess, Merrill Lynch.

Sean, it looks to me like your cash flow from operations is at a run rate that will exceed your CapEx pretty handily this year. And if you take the midpoint of the capital spending ranges for the two nanotechnology centers over the next couple of years, it looks like you'll still be at a cash flow from operations level that will be higher than what your CapEx needs are over the next couple years including the, like I said, sort of the mid point of the CapEx guidance for those two nanotech facilities. Is that roughly right?

Brett, that would be our goal certainly to continue to self-fund our expansion through operating cash flows. While we don't have specific guidance for '07, there may be points in time where we get a little tight, but we still will look to keep funding our initiatives through that. And I wouldn't necessarily disagree, but it's contingent upon how we execute, how we perform which we're confident of, and the timing which is contingent upon our ability to get the tools in with the vendors. So there are some puts and takes but generally I would not disagree with your comment.

And then the second question I had was if you look at the ramp up on the flat-panel side in Taiwan, I think you said at your analyst meeting earlier this year that with that incremental capacity and with the market share gains that that allows and whatnot, that that business could grow close to 50% this year. It looks like that's still on track. Is that accurate still?

Yes, that would be accurate, Brett.

Okay, great. Thank you.

Timothy Arcuri, Citigroup.

Two things, first for Sean. Sean, what's your feeling on the tax rate next year?

I would probably at this point in time, Tim, stick with our guidance for '06 at 2o to 25%. It is really contingent upon where we generate -- I know I sound redundant -- generate income from. We have some past holidays in areas which we're ramping up now and to the extent those are profitable that would drive the tax rate down certainly to the extent we're profitable in the U.S., where we're in an NOL position that will drive down the tax rate. So our goal is not to be higher than 20 to 25%.

Okay, great. And then I guess kind of a philosophical question for Mike. Mike, what does Micron get out of the deal -- out of this deal, I guess? Obviously they get money, but what else do they get relative to others that they could have partnered with? Thanks.

As I mentioned earlier, they were looking for a partner that would work within a co developing technology going forward. I think they saw our proximity, our ability to service our customer base as a big advantage. Obviously they're not interested in being in the mask business, they're looking for someone that could be a preeminent service provider to them and be able to, again, drive cost efficiency. We have a U.S. presence, I think that's a big advantage strategically.

And as I said, they would like to invest their capital into making ICs and we would like to invest our capital into providing high-end photomasks to them and our other customers. So I think in the end when we aligned all -- the stars aligned very well in terms of mutual objectives between both what we were trying to accomplish, which was get a strong high-end position and enable a new customer, and for them to have a reliable source of supply.

Okay. And then I guess last thing, Sean, you said that Advance was up about 3.8% sequentially. Can you give us an idea of what flat-panel -- was flat-panel up more than that 3.8 or less than that 3.8? Thanks.

Tim, unfortunately I cannot comment on that as we speak for competitive purposes.

So you're giving absolutely no commentary on flat-panel at all?

The breakdown between semi IC and FPD high-end, correct.

Okay, thanks.

There are no further questions as this time, Mr. McCarthy.

I'd like to thank you all. As we've said, stay tuned. We're continuing to execute on our path of three strategic initiatives. We're very pleased, again, with the performance of the quarter, but we know we have more work to do and we'll continue to do that. And we'll look forward to talking to you in August. Thanks.

Ladies and gentlemen, that does conclude the conference call for today. We would like to thank you for your participation and we ask that you please disconnect your lines.