Photronics Inc (PLAB) 2007 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Photronics' first-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 Thursday, February 15, 2007. I would now like to turn the conference over to Michael McCarthy, Vice President, Investor Relations. Please go ahead, sir.

Thanks, Chris, and good morning, everyone. My name is Mike McCarthy, Vice President of Investor Relations and Corporate Communications for Photronics. (inaudible) Thank you for joining our fiscal 2007 first-quarter conference call this morning.

Before we begin, I would 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, 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 2007 second-quarter results after the market closes on Tuesday, May 15.

Mike Luttati, our CEO, will open the call with some brief comments about the Company's performance and strategic positioning. He will be followed by Sean Smith, our CFO, who will provide a comprehensive overview of our first-quarter results. After Sean provides an update on our first-quarter guidance, Mike will then moderate a Q&A session. Joining Mike and Sean during the Q&A session will be Dr. Chris Progler, our Chief Technical Officer. Mike?

Thanks, Mike, and good morning, everyone. Despite a relatively strong second half of January, especially in our IC photomask business, we were not able to keep up the deficit that we had experienced during the holiday season. As a result, we fell short of the low end of our guidance, with revenues of $106 million. Earnings per share of $0.13, which was within our guidance range, reflects our continued cost disciplines and operational effectiveness.

While Q1 performance was within the historical seasonal decline range, of 3 to 10% from Q4 levels, there were two major factors that contributed to the decline. First was that among our IC photomask customers there were an increased number and longer duration of fab shutdowns during the holiday period. Secondly, our flat-panel customers did not rebound as expected as they continued to work off inventory. We also saw a decline in the high-end G6 and above sets. The combined effect of these market-driven dynamics was the primary cause of the shortfall.

During the quarter, we continued to strengthen our long-term position by executing on our strategic initiatives and improving our competitive positioning in the high-growth segments of the advanced semiconductor and flat-panel mass markets. Some major achievements included additional 90-nanometer customer qualifications in Europe and in Asia, where redeployed assets are now coming online and will be available to allow us to capture capacity orders at the 130- and 90-nanometer nodes.

Our two new facilities in China for semiconductor masks, which will begin generating revenue in our fiscal Q2, and our FPD facility in Taiwan expand our market reach in high-growth markets. At the MP Mask Technology Center, we shipped our second 65-nanometer class production mask set to a Photronics customer, and our leverage in our global development and deployment processes. This will allow Photronics to accelerate our time-to-market and development efficiency for leading-edge products.

The construction of our North American NanoFab remains on track for completion by the end of calendar 2007, with a production ramp scheduled in 2008. We are now proving that the design principles and methods carried over from our and MP Mask Center to the NanoFab will deliver industry-leading yields on the most advanced photomask products. Having a product yield advantage enables both customer satisfaction and profitability for the high end.

While our visibility remains limited, and several recent announcements by some of our IC customers will likely alter the future industry landscape, we believe that as these industry dynamics unfold they will play to Photronics' core strengths as a technology capable and cost disciplined mask producer. This gives us even more optimism about our future.

For the second quarter, our semiconductor customers are forecasting a continued improvement in tape-out activities, building on the stronger bookings we experienced at the tail end of Q1. With fab utilization rates declining off such high levels, this should create an opportunity for new designs to be released, supporting their forecasts.

Although we remained cautious, the underlying fundamentals of the FPD business are improving. We will remain focused on further improving our operational efficiencies and preparing to scale our growth to meet the demands of our customers.

The one question mark that remains in Q2 is whether or not and to what extent the extended lunar new year will have on tape-out activity. To the best of our ability, we have carefully analyzed these inputs from our customers; and as a result, we are widening our range of guidance for the second quarter from 107 to $117 million.

I will now turn the call over to Sean for a review of the Q1 financials and an elaboration of our Q2 guidance. We will then be happy to answer your questions. Sean?

Thanks, Mike, and good morning, everyone. I will provide a brief analysis of our financial results for the first quarter of fiscal year 2007, and I will also review our balance sheet and cash flows during the period and discuss our outlook going forward.

To supplement this narrative we have posted on our website three slides for your reference. The first slide is a GAAP to Street EPS reconciliation. The second slide is semiconductor IC and FPD revenue splits by quarter, including high-end mix, which we are now defining at 90 nanometers and below, and FPD G6 and above. And the third slide is the MP Mask Photronics flowchart.

During the quarter, we sold one of our foreign manufacturing facilities for a gain of $2.3 million or $0.04 per share. In reviewing operating results for the first quarter, I will be primarily referring to our results excluding the impact of the gain on the disposition of our former facility.

Net sales in the first quarter amounted to $106 million, a decrease of $6 million as compared with the first quarter of last year. The year-over-year decrease is related to reduced tape-out activity principally for high-end applications for FPD photomasks. Sales of advanced photomasks increased to 23% of total sales during the first quarter as compared to 21% in the fourth quarter. Included in this percentage are mask sets for semiconductor designs at and below 90 nanometers and FPD sets used to fabricate flat panel products using G6 and higher technology.

As a percent of total sales for the first quarter, sales were approximately 55% in Asia, 26% in North America, and 19% in Europe. Sequentially, sales of both IC and FPD photomasks decreased as a result of typical seasonality associated with our first quarter. When including the revenue attributable to the MP Mask joint venture, which we do not consolidate, our revenue would have been approximately $121 million for the first quarter.

Gross margin for the first quarter was 28% as compared to 32.3% in 2006. Sequentially, gross margin decreased 330 basis points primarily as a result of the reduced volume.

SG&A expenses for the first quarter were $16.4 million, as compared with $15.2 million last year, with the increase related to our startup cost for our new facilities in Asia. R&D expenses, which consist principally of continued development for advanced process technologies, were $4.7 million in the first quarter. Sequentially, R&D increased by $400,000.

During the first quarter, we generated operating income, exclusive of the gain on the sale of our former manufacturing facility, of $8.5 million or 8% of sales as compared to operating income of $12.7 million or 11.4% for the first quarter of '06. Sequentially, our operating margin decreased from 13.9% to 8% as a result of the reduced volume. However, the integrity of our operating model continues to remain intact.

We will continue to match our cost structure to the changing nature of demand and new opportunities in the global market environment and remain committed to improving our operating margins. However, the next few quarters could experience some moderate fluctuations on the operating margin line as we work to effectively monetize our new facilities in China and Taiwan.

Net other expense income for the first quarter was expense of $300,000 as compared to income of $1.8 million for the first quarter of '06. The decrease year-over-year is related to decreased investment income associated with reduced investment balances and decreased foreign currency gains, both of which were mitigated to some extent by decreased interest expense with our reduced debt year-over-year.

During the first quarter, we recorded a tax provision of $1.3 million which was within our forecasted range of 1.2 to $2.2 million in whole dollar terms. Excluding the $2.3 million gain previously mentioned, our effective tax rate would have been about -- would approximate 16%. Net income, exclusive of the gain, was $5.6 million or 5.3% of sales for the first quarter. Net income per diluted share excluding the gain was $0.13 for the first quarter of 2007.

As we exited the first quarter, we had approximately 1,530 employees, equating to sales of $277,000 per employee on an annualized basis.

Now taking a look at our balance sheet, cash and short-term investments at the end of the first quarter amounted to $132 million. Working capital amounted to $143 million. During the quarter, we did pay off our previously outstanding $87 million 4.75 convert.

Accounts receivable decreased $7.8 million since the end of the year, primarily as a result of the reduced volume. Other accrued current liabilities decreased $14 million since the end of the fourth quarter as a result of the timing associated with the payment of various accrued liabilities. Total debt at January 28, 2007, was $173 million with the principal components including $150 million 2.25 convert due in April of '08, and approximately $23 million of foreign loans.

Shareholders equity aggregated $628 million, which amounts to a book value per share of $15.12.

Taking a look at our cash flows, cash flow provided by operations for the first quarter of '07 was approximately $24 million. Cash flow provided by investing activities during the first quarter amounted to approximately $33 million, of which $38 million represent the proceeds from the sale of short-term investments, and $5.6 million represents cash payments for capital expenditures. Total CapEx for the quarter on a GAAP basis was approximately $20 million.

Taking a look ahead, our short-term visibility as always continues to be limited as our backlog is typically one to two weeks. We do believe, however, that in 2007 we will continue to see increased design activity, especially at the advanced nodes. We're also encouraged by a number of strategic opportunities created by our relationship with Micron, our expanded presence in the FPD mask business, and increased penetration and capacity to support 90-nanometer customers.

As Mike stated, based upon our current operating model, the projected outlook for revenue for the second quarter is in the range of 107 to $117 million. Capital expenditures for fiscal 2007 on a cash basis are forecasted to be approximately 130 to $150 million as we selectively invest in capability and customer relationships.

Based upon our current projections, we should generate sufficient cash flow to cover our planned CapEx. However, as most of the CapEx relates to the completion of our U.S. NanoFab, the timing and delivery of the tools will dictate the need, if any, for additional financial flexibility. We continue to meet with a number of financial providers and are confident that our access to capital will not inhibit our growth plans.

We would like to emphasize to you this morning that we do maintain a significant degree of flexibility in how we invest capital into our organization; so that if trends accelerate or decelerate we can move quickly to optimize our competitive position while also aggressively managing our cost structure. At the same time, we see opportunity for growth and are confident in our ability to execute.

During 2007 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, for the second quarter of fiscal 2007, this will equate to a range of $1.6 million to $2.6 million in whole dollar terms. As a result, based upon our current operating model, we estimate that earnings per share for the second quarter of fiscal 2007 to be in the range of $0.11 to $0.20 per share.

That concludes my prepared remarks. Now I would like to turn the call back over to Mike. Mike?

Thanks, Sean. We will now open it up for any questions [anyone has].

(OPERATOR INSTRUCTIONS) Brett Hodess of Merrill Lynch.

I am wondering, Sean, if you could -- now that you are further into the MP Mask project or partnership, if you could talk a little bit about operating expenses. R&D was remaining fairly low. Is this the rate we can expect it to stay in, now that you have the benefit of the R&D out of MP Mask?

Then if you can talk a little bit about sort of the timing of revenues from that in terms of royalty versus actual product revenues at some point.

Sure, Brett. With respect to our relationship with Micron and our investment into MP Mask, and what we did with our Austin facility and how we repackaged our R&D initiative, we can certainly state in Q1 of 2007 that this transaction all-in was accretive to our results and enabled the U.S. to be profitable all-in, as compared to a loss of last year. I might add that that since we are not a taxpayer in the U.S., that certainly helped with our EPS.

With respect to the specific breakout between commission income and customer top-line revenue, there was both during the quarter. We can state that, as I mentioned earlier, the transaction related to Micron with the repackaged R&D was accretive for the quarter. We would expect going forward, depending upon the qualifications that we push into MP Mask, we may see some fluctuations in our R&D line. It could trend up $0.5 million here or there depending upon the opportunity and availability.

Okay, but it sounds like it is still going to stay $1 million or more below sort of the $8 million range we were at, say, a year ago.

Certainly, Brett. As we have talked about in the past calls, we have incurred -- or generated significant savings as a result of a more effective spend on our R&D initiative. Certainly we are going to create leverage with respect to our model now.

So going forward, we hope to -- we have mentioned before that we should save on an annual basis up to $5 million based upon our previous spend. But we would expect to hopefully get that number a bit higher as we move forward.

The quick second question was if you look at the U.S. NanoFab, can you talk about what the timing on that is? Give us an update on the timing of when you think that will start to have production.

This is Mike. As I mentioned in my opening remarks, we are on schedule. We have -- the current plan is to have the equipment start to arrive at site sometime between July and November. We hope to be able to get some of the equipment qualified by the end of the year. Our plan would be to have shipments commence in Q1 of '08.

We also just as an update, we plan to have our analyst meeting in September in Boise. We will be able to at that time provide some more color and show you the facility for both MP Mask and the NanoFab.

Suresh Balaraman of ThinkEquity.

I see that in the slide you have indicated that the high-end 90-nanometer is (technical difficulty) million dollars for fiscal Q1. Is that the (technical difficulty)?

I'm sorry, Suresh. Could you repeat that? You were coming -- fading in and out.

Sure, for Q1 '07, the 90 nanometers and below mask revenues came in at $9 million. Is that the right number based on your slide?

Yes, that's correct.

I am wondering what is -- how the pricing on that segment. Also can you give us some color on what the number would look like for 130 nanometers and below, which would give us probably a better sample size.

Yes, we actually decided to break the 90-nanometer node out because mostly everyone is viewing the 130 (technical difficulty) more to the mainstream node. I don't know, Sean, if you have the number with 130 in it. But certainly it would be a higher number.

We're very optimistic about 90 nanometer tape-out activity moving into Q2. In fact, just to give you some sort of color on what we see going into Q2, it appears that in Asia we are going to see relatively strong IC activity at the 130- and 90-nanometer node. Europe appears to be relatively flat.

The big question mark and the reason for the widening of our guidance in the second quarter is we're not sure what is going to happen with flat-panel yet. We are optimistic that probably -- certainly in the second half, we will start to see improved activity. There is some indication that we could see some design tape-out in Q2, but we are a little cautious there. And the U.S. market is still unclear as we enter the quarter.

But 90 nanometer and 130 tape-outs in both Europe and Asia should be pretty strong in the second quarter.

Pricing, to answer your question, hasn't changed dramatically from what we reported in the past. There's always spot opportunities. We move to compete there, and understand that, and have been doing that pretty consistently. So no major changes that we see, certainly at those advanced nodes.

But the 90 nanometer, if I remember right, was about $1 million or so per mask set. Is that still the range?

It varies depending upon the number of number of masks per set. But it could be as high as $1 million, it as low as $750,000, perhaps.

Timothy Arcuri of Citigroup.

Hi, this is [Srini] calling for Timothy Arcuri. My first question is whether your EPS guidance is ex-charges, or is it GAAP? Also I would like some color on the impact and timing of the ramping depreciation costs on margins going forward.

Sean?

With respect to our guidance for Q2, that would be on a GAAP basis. With respect to our depreciation, we would expect our depreciation to ramp up as we move into Q2 in the range of anywhere from $0.5 million to $1.5 million depending on when certain tools come online. That is embedded into our forecast.

Okay. My next question is what are you doing to improve your OPC capability and the inspectability of your masks?

Well, we have Chris there. Chris, perhaps I can have you answer that.

In terms of OPC, OPC usage is fairly standard in the industry now. So most of the efforts are working with customers to make the OPC create a little bit simpler and easier to manufacture masks. So it's more of a collaborative effort, looking at the operations customers are doing to masks, and letting them know things that would make the mask easier to build, more cost-effective for them. So that is where most of the effort is on OPC.

We are developing some internal capabilities to do OPC ourselves in-house as well, which we are exploring as an opportunity.

Your second question on inspectability remains a big challenge, I think, in the photomask industry in general. The (technical difficulty) manufacturer is an expensive one, and it is the number one unit loss mechanism. So we are also looking at ways where we can with the same inspection have a higher yield level, by improving inspectability of the masks, working directly with customers.

Did you have a specific question on these two areas? What were you specifically after here?

Actually, what I was specifically after was how are you doing on these relative to your competitors? Because I had noted that this could be areas of concern.

I think all the mask makers since generally receiving data and looking at customer data is in our process flow, all the mask makers are needing to and wanting to study and develop OPC capabilities. So I think it is pretty much an even field. I don't think there is any particular differentiation here in this area. It is a natural part of being a mask maker, to get into these areas, and work with customers on OPC avoidance and inspectability of the product. So I don't think there is a big differentiation in my opinion right now in this area.

Okay, thank you very much.

Ajay Saproo of JPMorgan.

A quick housekeeping question, first; and then I have another question. What was your stock comp for the quarter?

Our stock comp for the quarter was approximately $800,000.

Okay, and should we assume most of that goes into SG&A?

We don't at this point in time provide specific breakouts to the components of our stock comp. It is in a number of -- in our cost of goods and our SG&A and in our R&D, wherever the people are assigned.

Okay, and my next question is regarding your comments on, say, the level and mix of the tape-out activity going forward in your Q2 and what you are seeing. Do you see a pickup in, A, the level and, B, sort of the mix? Particularly any pickup in the 65-nanometer tape-out activity.

Yes, this is Mike. There's some 65-nanometer activity. Obviously there is also some development of 45-nanometer work. It is still a very, very insignificant percentage of the total that we see, certainly through '07.

Just to sort of put it in numbers, we believe it is probably on the order of 50 sets maybe during the course of calendar '07. Certainly, this pales compared to what we're going to see in 90 nanometer and above.

Just one other point because I wanted to make some clarification on the near-term drivers, both for our investments, as well as for what we believe the market tape-out activity will be, will be in 90 and 130. One of the reasons we made the move in Q2 of last year to redeploy assets was to be able to capture that business, 90 and 130, both in Asia and in Europe. We believe going into Q2 that we will start to see the benefit of that.

All indications are that the tape-out activity should be quite strong there. Just to put it in reference, in Q2 of last year our 90 nanometer -- and this would be Q2 of calendar or our fiscal '06 -- our 90 nanometer was under $3 million, which is one of the major reasons why we decided to drive that. So we effectively tripled our business at the 90 nanometer and below, and we are very optimistic that we will capture share going through the remainder of this year.

Quickly on gross margins, you mentioned that gross margins were down mostly because of volume. But if I go back and look back a couple of quarters, revenues came in around the same level, but gross margins were like 240 basis points higher. So is there a fundamental shift in your cost structure that we should be looking at? Or is there something that I am not reading right in this?

As compared to say a year or so ago, we have continued to invest into two new facilities in Asia, our PKLT facility in Taichung, flat-panel facility [hand into] China.

So we have increased the fixed cost nature of our business, and we need to effectively monetize those assets to improve our margins. So as we have invested into Asia, we have also looked to pull out cost in the U.S., specifically with the Austin closure and redeployment of assets. So we have -- as Mike stated in his prepared remarks, there has been a fundamental shift in the business. We have invested in Asia. Now we need to execute on those investments and monetize those investments to drive the margin up. (multiple speakers)

Just to add to that, Sean, I think you are right. The two major drivers -- China, which has progressed and has not turned on as quickly as we would have liked to have it turn on, but it will be generating revenue this quarter for us. There are a number of reasons for that. And then of course, our Taiwan facility. We were ready when the market was hot, and the market went soft on us. So we had some decline. Particularly the Taiwan market in FPD was hit very hard in the current quarter, in Q1.

So we have those two things coupled with the NanoFab, which will capture our 65- and 45-nanometer IC business going forward. We feel like we have got all three legs of the stool going here, and are positioned and ready. We have customers willing and anxious to participate with us. So as the market evolves, we are very confident in our ability to take a position and these growing segments.

Colin McArdle of Needham & Company.

I was wondering on the flat-panel side, that has been volatile and problematic at times. What percentage of revenue was that in the quarter?

Colin, it was approximately 19% of our top line.

What historical context can you put that in? Like what was it at its largest?

I believe at its peak it was about 23 or 24% of our top line. Since Q2 of last year, we have seen some -- you know, Q3, Q4 this year and Q1 this year -- a little bit of a softening, obviously, in the marketplace.

Our flat-panel business is primarily driven by the high end, the G6 and above sets. If you have a chance, take a look at the slides that we posted on our website, which will give you the breakout quarter-over-quarter on our flat-panel business and the percentage of the high-end piece of that.

Okay.

Just get to add a little more color, Colin, this is Mike. The reports from our customers, AU, Chi Mei, and others, certainly are indicating that there will be a move toward larger panel size going into the second half of this year. Monitors are showing signs of demand. They are optimistic that there will be a supply shortage, potentially, in the lower technology nodes, which should stabilize pricing and hopefully drive additional design activity.

So we are cautious because we had less -- I guess it was Q3 of our fiscal year, we had high expectations for growth; the market sort of contracted; we came into Q4; it improved some; and then we had a setback again in Q1. But the long-term viability of the business and the growth, we are still very confident in.

We have key qualifications ongoing in Taiwan with the key panel makers there. Our expectation is that we will ramp that facility through the end of the year.

Thanks, Mike. Sean, with all the moving parts including the facilities in China and Taiwan, etc., would you mind updating the target operating model and revenue level that you would expect to make that happen?

Based upon -- our target operating margin remains at 20%. We have invested quite a bit in the last 18 months to capitalize on the market opportunities. So we are a ways away from hitting that 20%, obviously, coming in at, I believe, it was 8% this quarter. To achieve it based upon a 20% margin, we would have to do revenue of 137 to $140 million per quarter.

Now that said, as we look to monetize our new investments and capitalize on our 90-nanometer business, it is somewhat -- there is some opportunities to reduce that target down as we look for other cost-saving initiatives, as we look to improve our operating efficiencies. So that number is not a static number. It will move, and we will work to get to that.

[Jagdish Bayeur] of UBS.

This is Jagdish on behalf of Stephen Chin. I have two questions. The first question is, how would you characterize the FPD mask pricing in the quarter? How do you see that price trending in the next quarter and possibly into the second half, please?

Sure, this is Mike. The high-end pricing has actually held up pretty well. The problem is the market for high-end tape-out dropped in the quarter, so we didn't get the benefit of that.

I think that the Taiwan market is probably the most under price pressure right now, because they tend to be -- the bulk of the volume there is GE 5 and under technology. So there is a supply-capacity-demand imbalance right now, and that is creating some price pressure.

It is nothing that we didn't expect. In fact we fully expected that this would happen. So we believe, as I said earlier, that this will turn around going into Q2, as the panel shortage sort of reverses and activity picks back up.

But there is no question there's price corrections occurring both -- basically throughout the supply chain in flat-panel. The high-end, as I said though, we believe will hold up.

So is it then fair to say that going into next quarter, that both the FPD mask and IC (technical difficulty) likely to increase quarter-over-quarter in terms of revenue?

That is our plan.

Sean, I have a quick question. Could you help us understand how the CapEx trend is going towards 2007 in terms of how would you characterize that, please?

Sure. Our planned CapEx for 2007 is primarily back-end loaded into the summertime and into Q4, as Mike alluded to in his comments. The timing of the CapEx, there's a lot of moving parts with that because of the delivery and the high cost of these advanced lithography tools and inspection tools. So it could slip a month or two either way. But it's mostly in the midsummer to early fall time period.

I should just clarify, Sean, because I think I may have said our fiscal Q1 for the startup of the Boise NanoFab. I just want to clarify that is calendar Q1 for revenue generation of '08.

Good point, Mike.

(OPERATOR INSTRUCTIONS) Timothy Arcuri of Citigroup.

Hi, this is Srini again calling for Timothy Arcuri. My next question is whether you see the revenues in the first quarter as a trough for this cycle; or do you think that there could be further weakness down the line?

This is Mike. We believe this is a trough quarter. We said that coming into the quarter. If you go back to our last conference call, I indicated that our guidance -- we have come off a $115 million Q4. We guided down in Q1 because, one, we knew historically it had some seasonal softness. But we also had some visibility, given the timing of our call, coming into the holiday season, that bookings were turning soft.

Obviously, we can't control the market. We feel very confident about our position, where we are aligned with the customers. The business is there, we believe will grow, and so I'm pretty confident that this will be the trough.

Now, as I said, we can't control the market conditions, but we certainly believe very strongly that we are there. The only issue that I mentioned in my prepared remarks is the lunar new year effect. But so far -- you know, one of the problems we had coming into Q4 was that normally before the holiday shutdowns we get a surge of bookings that tends to get us through that period, and in Q1, we didn't get that. So far so good this quarter.

Thank you very much.

Matt Petkun of D.A. Davidson & Co.

I really appreciate the slides you guys put together, especially the one on the MP Mask relationship. Could you help me understand your point for the time delayed technology transfer? At what point do you think you will be porting technology from MP Mask? Obviously the NanoFab needs to be constructed first; but to the other Photronics sites?

Yes, Chris, maybe you could cover that.

Okay, sure, this is Chris. In terms of technology transfer, we have already completed a Phase I exercise from MP Mask to our facility in Europe on some module transfers. We have shown measurable yield improvements at that facility due to that transfer. We are looking at other opportunities for sites besides the NanoFab.

Beginning in the middle of this year, as Mike said, when tools start to come into the NanoFab in Boise, we will focus most of the efforts on moving technology from MP into the NanoFab. We have a full team of people, both Micron and Photronics assignees, that are geared up and ready to do that transfer. That will be a full-node, full technology transfer into the NanoFab.

So short answer is we have already started benefiting from technology transfer activities selectively. But we have moved some things out, and we have seen measurable improvements to first-pass yield and other metrics at our sites.

Okay, thanks, Chris. I guess as a follow-up question, you guys mentioned having customer quals at MP Mask both last quarter and this quarter. Will you be able to then take those customers to your sites in Korea and Taiwan? Or is it really that you need the NanoFab to come on, or otherwise you will have to run those customers' demand through MP Mask?

We have multiple ways we can service customers with MP, our new facility and our other sites. One would be running full sets for these customers at MP Mask, keeping them in the JV for various reasons. The other would be running full product sets for them in our NanoFab.

The third model is mix and match, where we run perhaps the most critical layers, the most demanding layers in our new facility or in the JV; and we run the noncritical or semi-critical layers in our other sites for better margins and things like that.

So it really depends on the customer mapping, where they are located, and the complexity of their technology, how we will map them into our JV and our new facility.

Okay. Then if I recall correctly, one of the reasons for the lower R&D in Q4 was that your Austin toolset had been off-line. Was it still off-line here in Q1? Will you be bringing it online in Korea, or was it already back online this quarter?

This is Sean. The Austin toolsets have been scattered about our network, not just in one particular location. Some of which were online during Q1 and some of which are come online during Q2.

The decreased R&D or the level of $4.7 million -- believe it was $4.3 million in Q4 -- we expect going forward to incur significant savings as we stated earlier as a result of in essence the prepayment of our technology with -- through Micron, and capitalize that on our top line as we move forward.

[Cliff Sincar] of Banc of America.

Sean, I had a question on your operating margin target of 20% at 137 to $140 million revenue level. Is there an inherent assumption built in with regards to trading edge or leading edge mix (indiscernible)?

I did not give specific granularity as to FPD or IC, but it would primarily be driven by high-end product, high-end shipments both FPD and IC.

Can you talk quantify a trailing edge versus leading edge mix percentage that is required, or no?

I'm sorry, could you repeat that?

Can you quantify a percentage mix of trailing versus leading edge?

Not at this point, but it would be -- we would expect our high-end mix as we disclosed today at 23% to be higher than that to get to those levels, obviously. Because that is what is going to drive the efficiencies in our network.

Okay, thank you.

Gus Richard of First Albany Capital.

Mike, could you talk just a little bit about where -- I think you said you shipped your second 65-nanometer set; what kind of product is that going into or what end market?

I can't really disclose that, but I can tell you it is a U.S. customer.

Okay, I was thinking leading into logic, wireless, memory, you can't give any of that color?

You know what? Not at this time, Gus.

All right, let me try it another way. Can you talk a little bit about, within semiconductors, how your end-market exposure is? What percent is, say, analog memory, leading-edge logic, how that looks today and over the last year, and how you think that evolves going forward?

Okay, that is a good question. We actually have less impact on the DRAM side of the business or the memory side of the business today. I think that will change going forward. That is a positive because it is a market segment that has been driven by basically high-performance; and we haven't had the technology to basically compete there.

The same is true for high-end logic. We are -- I think we reported in our last call, Chris mentioned that we had validated a 65-nanometer logic customer in MP Mask, so we know that the technology from MP is portable.

Probably the most substantial, if you look at the nodes that we have serviced and where we have been strong, at 180, 130, and above, it is heavily based on analog. It is also based on sort of what I would consider mainstream logic. So we are really moving the needle here into the high-end logic and to the memory business, which is where the sort of leading technology is going.

Okay. Then just as a follow-on because this is ultimately where I was going, when you look at the needs -- since you're intimately familiar with a DRAM or memory maker at this point -- their needs at 65 in contrast with the needs of a logic vendor, how much overlap is there? How much reinvention do you need to do in order to service the logic vendor at 65?

Maybe let me start and then I will have Chris build on this. The assumption we went into this was that about 75% of the technology if you will at a macrolevel inside of MP would be portable. First validation of that with a logic customer indicates that to be the case. Chris, I don't know if you have any more color on --?

Yes, I guess just a couple of comments. What we are finding in terms of mask technology for logic and memory at 65 and below, they're starting to converge a lot more. Because of DSM initiatives, logic designs are actually getting more regular looking, more array like.

There's huge memory caches in high-performance logic now. So if you look just generally from a high level, the technology required to build a state-of-the-art logic mask and memory mask are starting to get much closer than they had been in previous nodes. In fact, it has a lot to do with the logic people trying to improve manufacturability, regularity of design, and that sort of thing.

Then other technology we can develop in the joint venture that is logic specific, we have a very efficient model for that. We do a gap analysis. We understand the needs and we do very directed kind of targeted R&D projects to fill in those gaps. So we know what they are. The team, the joint venture, has been very responsible to filling in those gaps. We think we have a good model there.

We also see an industry trend where the technology is starting to harmonize more than they had in the past.

Chris, would you say just as a rule of thumb that the logic guys have -- with the exception of perhaps Intel and AMD on the microprocessor side, pushing the technology down into 65 and 45 -- have slowed there? Moved to 65 relative to the memory?

I think that is true. The technology driver for feature size has been recently memory and flash. Everybody knows the NAND Flash companies are on a very aggressive shrink roadmap. So I would say that gap has widened some as well.

So to Mike's point, we have the benefits now of getting more a look ahead on fine-scale features on the memory side; then the logic guys are slowing down a little bit on their node migration. So if there are gaps to be filled, there is more time to fill them as well.

Robert Jacapraro with ICM.

Could you please discuss where you are in your qualification process with Micron on your existing facilities and anticipated time frame of when that process may be completed?

Yes, we started working with Micron in May of last year when we signed the agreement to look at a number of different types of qualifications. Chris mentioned earlier one option is to do mix and match; and we are looking at that in a number of our sites.

Also realize that originally the toolsets that we had in Austin were intended to be used to source the Micron product. Obviously, we relocated those, so we had some delay in that process. But we are currently -- our expectation is to have that completed during our second, perhaps into early part of our third fiscal quarter.

Terrific. Thank you very much.

[Chip Bonnet] of [FM Global].

A couple questions if I could. Mike, you talked about the quarter ending fairly strong, but though it wasn't enough to offset some of the holiday shutdowns, etc. Has that continued into February?

A little slow start into early part of February, but in polling our guys over the last -- in fact, Sean and I were in Asia, in Taiwan, end of January, early part of February. Got very good read from the marketplace there and talked to the rest of our Asia team, which is why I gave sort of color that Asia appears to be very strong coming into the second quarter. That is continuing with bookings now that we're seeing.

The real question mark for us, right now, is not anything that we can control, which is (technical difficulty) other than perhaps gaining some market share at some customers. But the flat-panel market and the U.S. market are sort of slow out of the box.

Okay. On the flat-panel market, you talked about some of the issues there. I guess there had been utilization rates and some inventory issues with the panel makers. But can you talk a little bit about the seasonality of that business? Should we be looking at a stronger period? How does that relate to a ramp into the holiday season later in the year?

Yes, if you look at our last 2006 quarterly performance, part of that was because of share gains, but also because of seasonality effects. Q2 was very strong. Coming out of Q4 and into Q1, we had expected Q2 would be strong.

You know, indications now are that it may be toward the latter end of Q2 and into Q3. We are hoping that there will be some pull in. But right now, that is why we are sort of cautious on the guidance, because that could have a big swing either way.

Okay. Then just my last one, talking about I guess kind of a secular growth rate here, going back probably I guess to when you guys did the secondary and you talked about how you thought the opportunities for Photronics were to grow solidly in the double-digit rate. We haven't really seen that over the last year and a half.

I was wondering if you could talk a little bit about are you sticking to some kind of double-digit growth expectation going forward, and when you think we can expect to see that?

We absolutely are not backing off from that. The timing of that, we believe, should occur as we move -- as the business picks up in 90 and 130, we are right now positioned, (technical difficulty) capacity in place at the right locations to be able to gain share there.

Flat-panel market, as I said, we have Taiwan up and running. We have Korea. As the high-end business starts to get back in shape, we should be able to grow that.

We see no change in the CAGRs for the FPD business, which we have moderated to be about 13 to 15% over the next five years. I think that will continue.

So our big growth drivers are the high-end IC business, which will turn on mostly when we get our NanoFab up in '08; and flat-panel; and then of course 130 and 90 where we are positioned now to take share.

The market, obviously, there has been some seasonality effect in Q1. We had the flat-panel, sort of, if you separate that out. From an IC point of view, our mainstream business continues to do well. Obviously that is growing at a much lower rate than the higher-end product, but we feel very well positioned there. Feel like we have held our share, if not gained some share there, and have expectations to do that going forward. So short form answer to your question is we are sticking to our growth objectives.

Okay, terrific. Thanks a lot.

Ajay Seppuro of JPMorgan.

On R&D expenses, this question was partially answered, but I just want to know how to look at it going forward. Should we expect it to sort of ramp up back up in 2Q, or is that more a 3Q event now?

This is Sean. We believe R&D, depending upon the level of qualification work we are doing, it should ramp up to some extent. We exited the quarter at $4.7 million -- or $4.7 for the quarter. It could go up, up to $0.5 million, but we wouldn't expect it to go up much higher.

If it does, it is a result of activity in the marketplace that we want to capitalize on. So for modeling purposes, I would consider anywhere from $300,000 to $500,000, plus or minus.

Okay, and this had to do with the redeployment of the tools that you moved from Austin, right? The depressed R&D in 4Q?

No, the R&D -- if we go back to 2Q or Q3 of last year, we had a designated facility with fixed costs, some equipment, and people that was our advanced R&D facility. We have repackaged that and redeployed those assets to other areas in the network. We have also -- intend to capitalize on our MP Mask joint venture where it is in essence our R&D center right now.

Okay, understood. Thanks for clarifying that.

Mr. McCarthy, I'm showing no further questions at this time. I will now turn the call back to you.

Thanks, Chris.

Okay, thank you, everyone, for your attention, participation, and questions in this morning's call. We look forward to seeing some of you at some upcoming conferences. And look forward to talking to you again at the end of our second quarter.

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.