Photronics Inc (PLAB) 2006 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Photronics third-quarter earnings conference 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 Wednesday, August 16, 2006. I would now like to turn the conference over to Michael McCarthy, Vice President of Investor Relations. Please go ahead, sir.

Thanks, Pam. 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 call this morning.

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, information we will cover during this call may be considered forward-looking and may be subject to certain risks and uncertainties that could cause actual events to differ materially from those projected -- including uncertainties in the market; pricing; competition; procurement and manufacturing efficiencies and other risks detailed from time to time in the Company's SEC reports.

This call will remain archived on our website until we report our fiscal 2006 fourth-quarter results after the market closes on Tuesday, December 5th. Sean Smith, our CFO, will begin with a comprehensive overview of third-quarter results and update you on our guidance. He'll be followed by Mike Luttati, our CEO, who will share some brief comments after which he will then moderate the Q&A session. Joining Sean and Mike in the Q&A this morning will be Dr. S.H. Jeong, our Chief Operating Officer, and Dr. Chris Progler, our Chief Technology Officer. Sean?

Thanks, Mike, and good morning, everyone. I'll provide a brief analysis of our financial results for the third quarter of fiscal 2006; I will also review our balance sheet and cash flows during the period and discuss our outlook going forward.

To supplement this discussion we have posted on our website three slides for your reference. The first slide is a semiconductor IC and FPD revenue split for fiscal years 2004, 2005 and the nine months year-to-date for 2006. The second slide is the semiconductor IC and FPD flat panel displays revenue splits by quarter for fiscal 2006. And the last slide is our third-quarter results as compared to our revised guidance that we gave out on August 1st.

During the quarter we incurred an after-tax charge of $1.8 million or $0.04 per share resulting from the previously announced restructuring of our North American manufacturing network. The total charge incurred year-to-date is $13.2 million and is on track with the previously announced range of 15 to $18 million.

Additionally, as we discussed on our conference call on May 18th, during the quarter we invested $135 million, $120 million of which was paid during the quarter for a 49.99% stake in a joint venture known as the MP Mask Technology Center. In connection with the JV, Micron and Photronics entered into a technology license agreement and certain supply agreements. Micron contributed its existing photomask facility into the JV and Photronics will pay the remaining $15 million in fiscal 2007 and 2008.

In a few minutes I will elaborate further on these initiatives; for purposes of our discussions on operations for the third quarter I will be referring to our operating results excluding the impact of the charges related to the North American restructuring.

As many of you have read in our press release, this is the first quarter in which we have broken out our IC and FPD photomask sales. For purposes of our high-end and mainstream revenue disclosures we will continue, however, to combine FPD and IC together. Additionally, we will not be providing any further granularity at this time on our combined operating model as we feel this could place us at a competitive disadvantage.

In reviewing our sales for the third quarter I will compare them to three periods -- first the year-over-year discussion; second, sequentially; and third, as compared to our initial guidance discussed in May 2006. Net sales in the third quarter amounted to $108.2 million, a decrease of $6.7 million or 5.9% as compared with the third quarter last year. The year-over-year decrease is primarily related to reduced volume and ASPs for both mainstream, IC and FPD photomasks.

Sales of flat-panel photomasks for the third quarter were $21 million which were essentially flat with the prior year. The reduced volume was anticipated as customers migrated to newer (technical difficulty) compared to our initial guidance and as we discussed in our pre-release announcement, the lower than forecasted revenue growth for the quarter was related to the reduced tape-out activity for FPD photomasks, both high-end and mainstream.

Sales of advanced photomasks were 32% of total sales during the third quarter as compared to 35% in the second quarter, which represents a decrease in absolute dollars of $7.2 million primarily all of which related to G6 and above FPD sets. 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 and higher technology.

As a percent of total sales for the third quarter sales were approximately 55% in Asia, 27% in North America and 18% in Europe. Gross margin for the third quarter was 30.4% as compared to 34.4% in 2005. Sequentially gross margin decreased 400 basis points primarily as a result of the reduced demand for FPD photomasks coupled with the increased manufacturing capacity associated with the ramping of our Taichung FPD facility.

Selling, general and administrative expenses for the third quarter were $15.5 million as compared to $13.8 million last year with the increase primarily related to our Asian expansion, specifically startup costs for our two new facilities in Taiwan and China. Sequentially SG&A decreased $200,000. SG&A as a percent of sales was 14.4% during the third quarter of 2006 as compared to 12% in 2005 and 13.2% sequentially.

Research and development expenses, which consist principally of continued development for advanced process technologies, were $6.7 million in the third quarter as compared to $7.9 million in 2005. Sequentially R&D decreased $1.3 million due in part to our redeployment of R&D resources through our Micron joint venture and the closure of our Austin facility. R&D represented 6.2% of sales in the third quarter of '06 compared to 6.9% last year.

During the third quarter we generated operating income of $10.6 million or 9.8% of sales as compared to operating income of $17.9 million or 15.6% for the third quarter of 2005. Sequentially our operating margin decreased $7.5 million on reduced sales volume of $11.3 million. Despite the sequential decline in sales our operating expenses by and large came in line and our focus on maintaining an appropriately scaled operating infrastructure has not wavered.

As we have stated on previous calls, the next two quarters will likely experience some moderate fluctuations on the operating margin as we continue to monetize our two new facilities in Taichung and Shanghai as well as complete the redeployment of our Austin assets. In view of the many opportunities we see ahead the fluctuations resulting from our investing in Photronics' future growth are expected to be short-term and are complementary to our achieving our goals of profitable technology leadership, tighter global integration and marketshare leadership.

Net other income expense for the third quarter was an expense of $1.3 million as compared to income of $2 million in the third quarter of '05, a decrease year-over-year as related to reduced foreign exchange gains and investment income; and two, the impact of onetime favorable settlement of a grant benefit in 2005. During the third quarter we recorded a tax provision of $1.7 million.

Net income, exclusive of the restructuring charge, was $6.3 million or 5.9% of sales for the third quarter of '06 as compared to net income of $14.8 million or 12.9% of net sales in the third quarter last year. Net income per diluted share on a GAAP basis was $0.11 per share. Net income per diluted share, exclusive of the restructuring charge, was $0.15 for the third quarter of 2006. As we exited the third quarter we had approximately 1,490 employees equating to sales of $290,000 per employee on an annualized basis.

Taking a look ahead at our nine months year-to-date operating results before the impact of the onetime charges; net sales for the first nine months of 2006 were $340 million, up approximately $11 million from the first nine months of last year. The increase is the result of increased sales of both high-end FPD and IC photomasks. Sales of FPD masks year-to-date for fiscal 2006 have increased to $75 million from $53 million for the first nine months of 2005.

Year-to-date gross margin was 32.7% as compared to 33.4% last year's. The decline is directly attributable to our year-over-year increase in manufacturing infrastructure principally in Asia. SG&A increased $6.4 million to $46.4 million or 13.7% of net sales. SG&A last year totaled $40 million or 12.2% of net sales; the increase in SG&A is primarily related to our Asian expansion.

R&D costs were $23 million for the first nine months of 2006 as compared to $23.8 million last year. R&D was 6.8% of sales versus 7.2% of sales in the prior year. Our operating income for the first nine months of 2006 was $41.5 million or 12.2% of sales as compared to $46.2 million or 14% in 2005. Net other income amounted to $4.3 million in 2006 compared to net expense of $3.1 million in 2005 and the change resulting from the following -- increased investment income in 2006; year-over-year foreign currency exchange gains; and gains on the sale of certain investments.

For the first nine months of 2006 we recorded a tax provision of $9.3 million which amounted to an effective tax rate of 20.4% exclusive of the restructuring charge. For the first nine months of 2006, exclusive of the restructuring charge, our net income amounted to $32.7 million or $0.71 per diluted share.

Now taking a look at our balance sheet. Photronics' balance sheet has been a strategic competitive asset with improved liquidity that has enabled us to invest in market opportunities such as our joint venture with Micron. From a balance sheet perspective we recorded the $135 million investment subject to final valuation appraisal of acquired assets and rights as follows.

Approximately $65 million has been treated as an equity investment in the JV on our balance sheet. As we do not have effective control of the JV we will not consolidate its assets and results of operations. We will, however, record our share of the JV's net income or loss on a quarterly basis through the nonoperating income expense line. The remaining consideration, or approximately $70 million, will be amortized over its expected useful life. We have also recorded a $[15] million liability for the remaining payments which are due in equal installments of $7.5 million in May 2007 and May 2008.

Cash and short-term investments at the end of the third quarter amounted to $164 million and working capital amounted to $98 million. At the end of the quarter current liabilities included $87 million of debt which relates to the 4.75% convert which is due in December. Accounts Receivable have increased approximately $10 million since year end due in part to increased foreign sales during 2006 and the timing of settlements related to our recently initiated Micron supply agreement.

Total debt at July 30, 2006 was $252 million; the principal components of outstanding debt include the 4.75% convert due in December of 2006; the $150 million 2.25 convert which is due in April of 2008; and approximately $15 million of foreign and other term loans. During our prior calls we have discussed our options with respect to the 4.75 bonds due in December. We continue to monitor the market and will be opportunistic as conditions dictate. We do believe, however, that we have access to both the capital and credit markets if needed.

Minority interest at the end of the third quarter amounted to $44.8 million, the majority of which relates to the minority interest and the equity of our 58% owned majority owned subsidiary PSMC. Shareholders' equity aggregated $603 million which amounts to a book value per share of $14.46.

Reviewing our cash flows, cash provided by operations for the third quarter of 2006 was approximately $30 million. Year-to-date cash provided by operations was $80 million. Cash flow used in investing activities during the first nine months of 2006 amounted to approximately $199 million of which $83 million represented cash payments for capital expenditures and $120 million of which related to the Micron investment.

Year-to-date free cash flows, which is cash from operations less CapEx, was slightly negative; however, we remain confident that we should be relatively neutral with respect to free cash flow for the year. Total CapEx year-to-date on an accrual basis was approximately $95 million and is primarily related to our greenfield facilities in Asia.

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 '06 and into '07 that we will continue to see increased design activity especially in the advanced nodes. Based upon our current operating model the projected outlook for revenue for the fourth quarter of 2006 is in the range of 108 to $114 million.

While we are not providing any specific guidance beyond the fourth quarter, I would like to remind the participants on this morning's call that our first quarter of 2007, which ends in January, includes Thanksgiving and the year-end holiday periods.

Capital expenditures for 2006 are forecast to be approximately $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 multiyear investment programs that will be made over the next two to three years. The two major initiatives include the North American and Asian NanoFabs which Photronics will invest up to $150 million each. Our focus is on high return capital programs that align us with advanced technology customers.

During the next quarter we do expect to incur charges of 2 to $4 million related to the finalization of our Austin plant closure and tool redeployment. 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 in which we are taxable. Accordingly, we are estimating an effective tax rate for 2006 to be approximately 20% which is exclusive of the restructuring charge. For the fourth quarter this will equate to a range of $1.6 million to $2.2 million in whole dollars.

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 fourth quarter of fiscal 2006 to be in the range of $0.12 to $0.18 per share. In summary, I again want to 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 concludes my remarks. Now I'd like to turn the call over to Mike. Mike?

Thanks, Sean, and good morning, everyone. The results we released last night were slightly better than the high-end of the revised guidance range we issued on August 1st. However, this quarter's performance was not up to our expectations. The shortfall was a result of a market-driven slowdown in our flat panel display mask business which has become a more substantial component of our overall business.

Discussions with flat-panel customers and other suppliers to the flat-panel market leave us to conclude that this disruption will be relatively short in duration and, in fact, we are already beginning to see some positive signs of improvement. More important is that the fundamental long-term growth drivers for flat panel displays remains intact.

Our technology leadership position and our investment strategy provides Photronics with a strong competitive position. And our data confirms that Photronics has gained share in spite of the market's perturbations. As market conditions resume their favorable long-term growth trends we will further leverage our gains.

When assessing the performance of our semiconductor business we did generate results that were generally in line with expectations across all three regions. This included a projected decline in U.S. revenue as a result of the Austin closure. During the quarter every department and function inside the Company continued to execute with focus and intensity on our three strategic objectives of profitable technology leadership, global integration and marketshare leadership. We also implemented some structural changes to provide additional depth to the management team in the areas of operations, R&D and finance. Additionally, we promoted several exceptionally talented executives.

While all strong contributors, I think that it is important to single out the value in promoting Dr. S.H. Jeong to Chief Operating Officer. S.H. has been a fixture in the Asian photomask industry for nearly his entire career and he has been a catalyst in the Company's growing presence across Asia and a champion of our flat panel business. His vision and ability to execute has earned him the respect of customers, suppliers and competitors. Now the Company's entire global network and customer base can benefit from his leadership.

Before moving into the Q&A I would like to briefly touch on two recent milestones that demonstrate the progress in our transforming Photronics. First, a grand opening was held in Shanghai for our newest facility which will begin production qualifications in fiscal Q1. The Chinese semiconductor market promises to be a good one for the mask industry based on the diversity of products and rapidly evolving customer process requirements. Second, we held a groundbreaking in Idaho last week for our North American NanoFab. The NanoFab strategy, together with the development mission of MP Mask, are the twin drivers of Photronics' profitable technology leadership initiative.

Leading semiconductor manufacturers around the world are expressing interest in our capabilities as they see Photronics developing the resources capable of delivering a technology and service solution that is clearly differentiated for designs at and below 65 nm. While volatility is an inherent characteristic of technology industries, Photronics has consistently identified and acted on opportunities where industry discontinuities have occurred. We see another opportunity in front of us now. By acting assertively we believe we can accelerate our growth and advance our strategic competitive position. Our consistent year-over-year performance highlights our success thus far.

While we have a set of longer-term goals that are clearly more ambitious, the confidence in our strategy continues to grow as our global infrastructure increases in depth and breadth through disciplined investments which are best exemplified through our customer alignment and NanoFab strategies. Thank you for your attention this morning. Following some brief instructions from the conference call operator we will be happy to address your questions.

(OPERATOR INSTRUCTIONS). Suresh Balaraman, ThinkEquity Partners. Timothy Arcuri, Citigroup.

This is actually [Brian Lee] calling in for Tim. I just had a few quick things. First, if I look at your Q4 guidance it looks like gross margins are effectively being guided down 100 to 150 basis points on a sequential basis assuming the mid point of revenues and flattish OpEx. Is that the right way to think of it and can you talk about what's driving this margin compression? And then I had a quick follow-up.

Brian, this is Sean. We haven't provided specific guidance with respect to our gross margin. It's our goal that our gross margin would improve sequentially to the extent we hit the high-end of the range. Bear in mind that we are bringing additional tools on line which will add some cost to our infrastructure. But as we do that we're looking to drive costs out and increase our efficiency. So we are optimistic that we will see some improvement in our margin going forward.

Okay. And then second, can we expect the product mix in fourth quarter to be similar to what we saw in the third quarter, roughly 80-20 semi and flat-panel?

This is Mike. We're not going to provide any further granularity on guidance. As I mentioned in our last call and I commented in my prepared remarks, we are seeing a pickup in flat-panel, that's good. We had anticipated that to occur into third quarter and then following into fourth quarter. So to the extent that the business environment continues to pickup and the growth rate of flat-panel continues at the rate that we projected for the future we expect that will become an increasing percentage of our business.

Okay. And then maybe if I can just squeeze in one last one and then I'll go away. At what point do you guys start feeling a little less comfortable with your cash position? If my model is correct it looks like you'll end the year with about $100 million, there abouts, on the balance sheet and then you've obviously got the $150 million convert coming due in April. Any color there would be great. Thanks, guys.

Speaking to the latter part of your question, the $150 million convert is due in April of '08; that's two fiscal years away from us. There is $87 million that is due in December. We certainly have cash on hand should we want to pay that off. As I mentioned in my text, we are also monitoring the markets and we're looking at a number of options. And if we deem that we need to do it, we certainly can access the commercial markets or if the price is right the capital markets, but we're certainly not in any type of panic mode. We feel we can self fund our CapEx as we move forward, at least in the short-term, and we'll continue to evaluate our opportunities.

Jay Deahna, JPMorgan.

Good morning. Mike, just a small follow-up on Brian's question there. It sounds like what you're saying triangulates into some level of higher flat-panel mask revenues in the October quarter as the market begins to recover and then hopefully further in the January quarter and less seasonality impacts it. Just wanted to get your thoughts on that logic.

And then secondly and more importantly, just wondering if you could talk a little bit more in detail about what you're seeing in terms of design tape-outs on the silicon side, in particular at 90 nm and the likelihood that we can kind of skate through this period of time without any substantial issues on the silicon side like we saw in flat panel last quarter? Thank you.

Thanks, Jay. Yes, on the flat-panel side, as I mentioned, we are in fact seeing some recovery -- customers that had dropped utilizations in the June/July timeframe are back up and we're seeing pickup in the Taiwan market with the opening of our new facility. So we're optimistic but cautious just because of the transition we've gone through over the last few months. So we generally believe that the high-end masks will recover faster, that's the indication we're getting, particularly for the larger screen TVs and the larger node -- displays.

I don't know if -- S.H. is here with us -- if he has any additional color, but generally we believe that we should see -- going into our first and then certainly into -- our first fiscal and certainly into calendar first quarter of 2007 that we should be back at pretty good sustainable levels. And as I mentioned in the last call, Samsung will be bringing on their G8 line sometime in the first quarter of 2007 so we should see some revenue as a result of that as well.

In terms of 90 nm, we're continuing to see acceleration on 90 nm design ins. This is an area of opportunity for us obviously. We have started to make some progress at 90 and the MP Mask and Boise NanoFab and Asian NanoFab strategies will further position us there, as well as the relocation of the toolsets that we have in Austin which are currently being redeployed into our Manchester site and our Hsin-Chu site. So as we have that capability more local to the areas where the 90 nm tape-out activity is occurring we hope to be able to gain additional share there.

Mike, as 90 nm picks up are you seeing 130 and above holding steady so it's not necessarily a one step forward, one step backwards exercise?

Generally the mainstream, as Sean mentioned in his comments, has declined over the past 12 months as a result of just normalized price erosion and shifts. But generally it's held up to our expectations, certainly hasn't declined any faster than we would have expected. So I think if we can maintain that base, which we've said all along has been the platform of our strategy to maintain our base and mainstream and then to grow in both high-end flat-panel and high-end IC, that gives us a significant growth engine.

And you're confident that that can materialize over the next several quarters?

I think the confidence on flat-panel is very high. I believe in 90 nm we should be able to make progress significantly as we put the tools in, and MP Mask in Boise, we feel the timing of that is perfect for us to enter at 65.

Thank you.

Daniel Berenbaum, Susquehanna Financial Group.

Just a little bit of clarification maybe on the guidance and the trajectory of your IC mask business and a little clarification on how you intend to account for revenue from the JV. I understand it will be an unconsolidated JV, but if I look at the midpoint of your 4Q guidance it sort of implies that your IC businesses will be sort of flat compared to a year ago. So number one, is that the right way to think about it? And then what's going to grow? Is the revenue going to grow from the MP Mask JV or how should I think about How the minority interest line grows?

Dan, this is Sean; I'll try to answer your questions. With respect to the minority interest line, there is no minority interest on our balance sheet related to MP Mask. We get a royalty stream or commission stream, if you will, on the orders that we flow through the facility there, so we don't gross up the actual sales on the income statement. The opportunity we have, quite frankly, is to in the short-term -- and we talked about this in May and we're working on it as we speak -- is to get some of our current customers' business flowing through that JV which we will then record the revenue at.

And then with respect to guidance -- specific and on IC revenue versus last year, we do expect our high-end IC, which is 130 and below, to continue to increase. It's increased sequentially each quarter this year and we expect that to continue into Q4.

Okay, great. Thanks.

Matt Petkun, Davidson & Co.

Thanks for taking my call. Sean, are we starting to see some of the benefits from the R&D line of the joint venture with Micron or when does that really start to take hold?

I don't think -- this quarter proved that it has started to take hold and we should see continued improvement as we move forward. That doesn't mean, however, that we will not invest in advanced process technologies going forward. I think what we have now is a model with a much more efficient spend and a quicker realization to market. And Mike, you may want to add (multiple speakers)

I just would say that we have -- I think we talked about this in the past that we had more of a distributed R&D model in the past and therefore did not wring all the efficiency out of that and leverage that on a global basis and we're doing a much better job now centered around Micron. But also, as you know, we have an R&D effort in Korea as well, so we're trying to leverage that more globally and get more efficiency out of it.

I guess I'm just trying to figure out how you guys are able to cut R&D so significantly from April to the July quarter.

Our Austin facility, which was our R&D center if you will, was closed effectively half the quarter; it was open for half the quarter. So there was a lot of cost associated with that, a lot of underutilized capacity, people and associated costs.

And do you expect that to ramp up as you move that into Asia?

Ramp up from (multiple speakers)

(multiple speakers) R&D costs to come back up as you move that 65 nm line into Asia?

I don't expect the R&D costs to go up significantly as we move forward. We'll provide further guidance after we close the year. But we should probably spend not the same run rate that we've spent in the past, but we'll still invest significant dollars.

I'd say, Matt, just to add a little bit to that that probably the only perturbations in R&D will come as a result of qualification work that we're going to try and get customers qualified for MP Mask in addition to getting customers that we have moved from Austin to other sites. And as you know, that could be a couple quarter process. And so we'll see some variation there, but that's money well spent and that can be turned very quickly.

Okay, and then real quick. The royalties that you'd be taking on the MP Mask, would that be above the line or would you have a separate royalty item below the line? I'm just kind of wondering -- did that contribute to higher gross margin, how do you look at that?

That's a good question, Matt. It's above the operating income line and to the extent that number starts becoming material we will break it out going forward. But as we had just started with this initiative this quarter, and we don't have truly the full quarter results embedded in our P&L it wasn't significant enough to break out. But we will do that certainly on an annualized basis and we'll benchmark our goals and objectives to what we talked about in May at the end of the year and give everyone an update.

Okay, and then last real quick. Sean, I wasn't able to find the slides you referred to on your website. Can you help me find those real quick?

Matt, if you click on the conference call access you should be able to pull down the slides from there.

Okay. Thanks, Mike.

Patrick Ho, Stifel Nicolaus.

Thanks a lot. A question maybe perhaps for Sean. I guess I'm not asking you for a direct gross margin guidance, but just to help me understand what the components are. And I know there are a few moving pieces within it, but how much of a fixed cost would you say are in the gross margins line and how much of it is a variable cost. So as you ramp up these facilities I can make a better judgment on my model of how much leverage you're driving out of the gross margin line.

Okay, Patrick, I will try to provide some additional color. On the IC side what we've typically said in the past that if you look at a target margin, if you will, our target margin is a gross margin of 40% or so. And the material component of that is about 15 or 20%, so that's the variable component of the cost. When you look at flat-panel display products the material component can range anywhere from 40 to 50 with the same target margin. So said another way, the flat-panel business has a little bit more variable cost nature to it while the IC is a higher fixed cost.

That's very helpful. In terms of the interest income line, there was some variability of this quarter. Do you see some of those types of fluctuations also going on for the next few quarters as well?

The next few quarters we will have, as we talked about, a debt instrument that matures in December of '06, 4.75 notes, and we haven't announced what our plans are with respect to that as of yet. So I really can't comment going out into the first quarter of fiscal '07 at this point in time. But certainly when we close the year I'll be able to do so.

Okay, and I guess a final question for Mike. In terms of just an update, you mentioned briefly about the qualifications for the MP Mask. How do you think those are going? Can you just give a little color on the process on that front?

Yes, I'll comment and then maybe I'll ask Chris to pick up because he's here as well -- he's much closer to the activity there. But generally we are very pleased with the progress we're making. We have two sorts of qualifications going on. One is qualifying Micron product inside of the Photronics network and the other one is setting up customers that we will qualify in MP Mask and then -- actually three. And the third is some Austin customers that we're trying to move to other sites.

Generally we had a list of targeted customers specifically for the -- well, considered the leading-edge. And those are in process and aligned well. These are, as I said earlier, several quarters' worth of activity, particularly for the high-end. Chris, maybe you can add a little more color to it.

Sure. Thanks, Mike. The JV which we call MP Mask today is shipping 65 nm and below already to the U.S. and Asia actually to existing customers. We are at the early phases of a 65 nm logic qualification side MP Mask. The risk for us was understanding how the memory mask technology developed in the Micron captive report to advanced logic applications. So what we've observed so far is about 75% of the process technology is plug and play, it's very compatible with the logic applications, resonating very well with the customers.

We actually have a lot of interest for advanced qualifications and the capability is very highly regarded by the customer base. So we are at the early phase of a logic qualification, it's going very well and we're just filling in some of the pieces on the logic side. But so far a very positive experience.

Great, thank you.

(OPERATOR INSTRUCTIONS). Brett Hodess, Merrill Lynch.

Good morning. I've got a couple of questions. First of all, based on your comments about the holidays and what not in the January quarter, Sean, should we be expecting a normal seasonal dip, even off of the October quarter? Or do you think that some of the issues that have gone on recently could make the January quarter have some nonseasonal trends?

At this point in time, Brett, it's difficult to say. We're a ways away from that. But we have -- in the past have seen some seasonal dip of -- I think we remain at this point in time fairly optimistic that we'll have a positive trend upward without providing any specific guidance.

Okay. And then secondly, on your CapEx you mentioned that you have the $250 million up (indiscernible) for their two- to three-year projects for the two NanoFabs. So if we took those numbers and spread them over two to three years, is the best guess at this point that CapEx would stay in that sort of 120 to $125 million range per year that you've sort of been the upper end of the range for the last few years?

I think, Brett, what we may see is we may see a spike in one year and then less in the following year. We are fully committed to both our NanoFab initiatives and we feel very opportunistic that we can turn those into advanced process technology with increased penetration with high-end customers. So we may, without providing you specific guidance for '07, at this point in time we may see a blip in one period or one quarter. But I think over time generally what you're speaking about is correct.

And then final question is if you look at the advanced semiconductor side of the business -- you've talked quite a bit about it already, but can you give us a feel for the ramp rate that you're expecting to see when you move towards 65 versus 90 versus what it was on 30? In other words, are the ramp rates pretty similar to what you're seeing from the design activity or are they accelerating, are they slowing down as the complexity increases? Can you give us an idea of how we should think about that as we roll forward?

Chris, do you want to comment?

I can make a few comments. I think the industry transition to 130 was a fairly painful and protracted a lot of yield problems in foundries early on. A lot of these supply chain had a wake-up call, some of the complexities of this type of technology. I think the transition to 90 actually is going quite well and early indications on the initial tape-out activity at 65 are also quite strong.

Beyond 65 the 45 and 32 nm nodes I think we're going to see some additional challenges there for those technologies. But 90 and 65 I think look pretty solid both from the mask side and the wafer side and the remaining parts of the infrastructure.

And more specifically, Brett -- this is Mike -- why we're excited is that we believe that with the NanoFab and with the MP Mask technology in place at 65 nm that we'll be able to aggressively move into that space when volume ramps and be able to take business that we were not in a position to as a fast follower.

Great, thank you.

Stephen Chin, UBS.

Thanks for taking my question. This is [Jack] (indiscernible) on behalf of Stephen Chin. If we look at your North American sales for the July quarter it seems sequentially down. Can you please clarify the reason for that given that you had said that in your earlier comments I believe that FPD masks were weak -- if you could clarify it that would be great. Thanks.

The primary driver for the sequential decline in the North American market resulted from the closure of our Austin facility that we announced at the end of March. We had anticipated a declined quarter-over-quarter as a result as we redeploy certain of these assets. Our Austin facility, in addition to being an R&D center which focused on high-end development, did do some mainstream products through the facility.

So we expected that. We expect going forward many opportunities to capitalize on in the North American sphere with our alliance with Micron and plus there are improved efficiencies in our manufacturing network.

I have one follow-up question. Could you give us an idea of the tax rate for 2007, please?

At this point in time, we're not providing specific guidance on '07, but I would think that it shouldn't vary too much from where we are in '06.

Okay, great. Thank you.

Gus Richard, First Albany Capital.

Just looking at your numbers on the website in terms of the semiconductor industry, at best I could argue that your semiconductor mask business has been flat fiscal '04, '05 and '06. And actually, it looks like just back of the envelope it's going to be down about 5% this year over fiscal '05. Can you talk about what is going on in that business, in terms of lack of growth? Is it competitive, is it pricing pressure, is it reduced volumes? I would expect that this is to be growing at about 8% compounded, and it is not.

Yes, Gus, this is Mike. Let me articulate what we see and why we are doing what we are doing as it leads into the strategy. The IC business, as you know, for Photronics we have always been sort of a strong player in the mainstream and not -- basically a fast follower on the leading-edge. We found over the last couple of years of investments that we had to invest roughly equivalent capital dollars to be able to compete at those [nodes]. And then being late to market, obviously, it was always tough getting a learning cycle and repenetrate it, which is why we revised the strategy, made the investments that we have made here over the last year with MP Mask and the NanoFabs strategy to position ourselves to be able to take share at the high end, which is a higher growth segment.

So as I mentioned earlier, we have seen a decline -- not an unexpected decline, but a general decline in the mainstream business which is normal. Obviously mainstream will become 130 and above at some point. But that is really the story on the IC side of the business. I believe that we'll see roughly flat performance year-over-year, but we're not getting the growth out of the high-end that we need to get which is why we have made this aggressive investment in MP Mask and in NanoFabs.

Got it. All right, so from your perspective it's not necessarily marketshare loss, but the fact that you are more rooted than the mainstream historically and that business it is trailing off more rapidly than it has in the past?

Right, I would say that's an accurate statement. We are very strongly rooted in the mainstream and have not participated as significantly in the high-end, as you indicate. And so I think that this gives us a huge growth potential. The last data I saw both from our analysis as well as rolling it up is the 130 and above nodes were growing at about a 4 to 5% rate and below that at a much higher 40% rate. So we've got a -- and the ASPs are obviously higher, there's more complexity and getting in on that earlier will certainly drive growth for us.

Okay, thanks.

(OPERATOR INSTRUCTIONS). Jay Deahna, JPMorgan.

In light of the fact that the lower-than-expected revenues in the July quarter kind of lowers the bar here, would you expect the seasonal affect in the January quarter to be normal or less than normal especially in light of the fact that your flat-panel business could potentially be up sequentially given the Samsung G8 factory? And I've got a follow-up on that.

Let me take that -- this is Mike. As Sean indicated, obviously we're not giving guidance for Q1, but we have a lot of positive factors coming online in our first quarter. The Austin closure is pretty much completed. We're still transitioning, working through some equipment moves that should be in place and qualifications will begin in Q1 at those sites. Flat-panel, which we believe was a perturbation based on what we're seeing and the outlook looks good, so we should see pick up there.

We hope to be able to get some closure on some of the additional qualifications as a result of the Austin shut down and bring some business in from customers that transitioned there. So we have a lot of positive things offsetting the seasonality dips that we normally see and we hope that that will give us a more positive trend.

Another follow-up on that is as you get some of those tools up and running in other regions, let's say hypothetically your revenues are flat to down a little bit -- would you still have a down gross margin in that? Or since you have some tools that were not being utilized that are kind of coming up, how would you see the gross margin effect in the flat to modestly down January revenue scenario?

Jay, this is Sean. There in all likelihood would be some margin compression as we redeploy or put additional capital on line on a flat to down scenario. While we do that, bear in mind we're still extracting costs out through some other initiatives and costs are actually falling by the wayside.

Mike was talking briefly before about our mainstream IC business and what I'd like to highlight there is although we've seen a decline in that when we talked about it in the text with respect to ASP and volume decline; when we take a look at our mainstream manufacturing locations, by and large third quarter this year versus Third-quarter last year the margins are actually flat to up because the infrastructure has been reduced. So we've been able to offset that decline in volume and ASPs with improved margins.

Okay, and then one last question. Giving your arrangement with Micron at this point, assuming you're successful on some level with your ability to do more leading-edge mask work, what would you say at this point in time is the long-term revenue growth profile for this company?

Well, we've said that if you take the normal market growth, factor in marketshare gains in the high-end, on IC alone we should be in the low double digits. And if you add flat-panel on top of that, given what our position is on the high-end we could be in the mid teens.

Okay, then last question. How does that square with what Gus was saying about your mask business essentially being kind of flattish for the last couple years? Is that growth that you're talking about in the mask portion exclusively dependent upon gaining share at the leading-edge? Or is there some level of expectation that the trailing edge will start to fall off slower? Because I think you actually said that's been falling off faster.

The question is whether that's an anomaly as we shift. Chris mentioned that the industry moved very quickly from 130 down to 90 and so there's still a lot of tape-out obviously at the 130 and above nodes and we expect that to continue. We did see some specific customer activity in any particular quarter where they may drop off that has an effect on our mainstream business where we have high share positions.

But the answer is, yes, we have a solid mainstream business. We expect to hold that share, perhaps gain some as we consolidate and as customers consolidate their business around the globe. We're bringing China online which is a mainstream facility and we expect that will provide some growth in our mainstream business for the Chinese market. But the real growth driver is going to be our high-end performance, both in flat-panel and in IC.

Okay, thank you.

Krishna Shankar, Banc of America Securities.

Just a quick question. In light of all these changes are you still maintaining your target model of 20% operating margin at $130 million run rate?

Krishna, this is Sean. Our 20% target remains intact, but as a result of the increased capacity we've brought on line with the two new facilities, as we exited this quarter to achieve a 20% operating margin line -- and this is dependent upon mix. There are a number of factors that go into the (indiscernible). Our top line would need to be in the range of 135 to 140.

Okay. And this is assuming like an 80-20 mix for flat-panel or --?

We do not provide any specific guidance with respect to what the mix would need to be. But when I meant mix I was talking more on high-end versus mainstream for both product categories.

All right, thank you.

There are no further questions at this time. I'll turn the ball back to you. Please continue your presentation or closing remarks.

We'd like to thank you all for joining us this morning. We have, as we indicated, a very good positive outlook on the future of the Company and the direction we're going and our strategic execution continues. And we look forward to updating you on our next call. Thank you.

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