Photronics Inc (PLAB) 2007 Q2 法說會逐字稿

Welcome to the Photronics' second-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, May 16, 2007. It is now my pleasure to introduce Michael McCarthy, of Investor Relations. Please go ahead, sir.

Good morning, everyone. My name is Mike McCarthy, Vice President of Investor Relations and Corporate Communications for Photronics. I would like to thank everyone for joining our fiscal 2007 second-quarter earnings conference call.

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 third-quarter results after the market closes on Tuesday, August 14.

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 Photronics' second-quarter results. After Sean provides an update on third-quarter guidance, Mike will moderate the Q&A session. Joining Mike and Sean during the Q&A will be Dr. Chris Progler, our Chief Technical Officer. Mike?

Thanks, Mike, and good morning, everyone. Our performance for the quarter was within the range we expected, albeit on the low end, with revenues of $109.6 million and earnings per share of $0.14. This performance reflects the outlook expressed in our last call, where I indicated that there may be continued softness in our mainstream IC and flat-panel businesses, both of which played out in Q2.

Looking across each of the product areas, in mainstream IC we experienced an improvement in tape-out activity. However, this was muted by product mix and some isolated regional pricing pressure, especially in Taiwan. Despite this, we have managed our mainstream sites with a high degree of operating efficiency, and they continue to contribute positively to revenue, operating income, and cash flow.

In high-end IC we increased revenues sequentially of 90-nanometer [low] by just under 15%, primarily due to gains made in Asia. Total high-end IC revenues were $10.4 million compared to $9.1 million in Q1. This progress confirms the continued execution of our strategic focus on the advanced technologies.

Flat-panel was up about 5%, with strength building at the end of the quarter. We shipped our first Gen 8 production set, marking a key milestone. Overall, we believe the FPD market is turning the corner, certainly for the high-end.

With respect to the progress of our two new facilities in China and Taiwan, our Taichung FPD facility had sequential growth from Q1, as the qualifications that we completed in previous quarters began to yield production orders in Q2. As the FPD market rebounds, we are very confident about our ability to grow our Taiwan share.

The startup of our China facility has been slower than planned. Customer quals and process tuning efforts are underway; however, the site did not contribute to revenues in Q2 as planned. We have customer engagement. However it will take the next few months to bring the site into a steady-state production mode. We expect both sites will contribute incrementally positive results and are well positioned to contribute to Photronics' growth in these fast-growing markets.

At MP Mask Technology Center, we shipped additional 65-nanometer class production sets to Photronics customers and continued to leverage our global development and deployment processes. Construction of our North American NanoFab remains on track for completion by the end of calendar 2007, with a production ramp scheduled in 2008.

While near-term industry visibility remains limited, we have growing optimism about Photronics' momentum, establishing ourselves as a technology leader, and building on our core strength as a cost disciplined mask producer.

I will now turn the call over to Sean for a review of the Q2 financials and an elaboration of our Q3 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 second quarter of fiscal year '07. I will also review our balance sheet, the cash flows during the period, and discuss our outlook going forward. To supplement this discussion, we have posted on our website two slides for your reference. The first is a GAAP to a Street EPS reconciliation; the second is sequential semiconductor IC and FPD revenue splits by quarter including high-end mix.

During the quarter, we recorded a net benefit of $7.9 million or $0.16 per share related to the resolution and settlement of US and foreign tax matters associated with uncertain tax positions in prior years. As a reminder, during the first quarter we sold one of our former manufacturing facilities for a gain of $2.3 million or $0.04 per share. In reviewing our operating results for Q2 and year-to-date 2007, I will be primarily referring to our results excluding the impact of these items.

Net sales in the second quarter amounted to $109.6 million, a decrease of $9.9 million as compared with the second quarter of last year. The year-over-year decrease is primarily related to decreased sales for FPD photomasks and, to a lesser extent, reduced IC photomask volume. Revenues for FPD and IC photomask declined $7.1 million and $2.7 million to $21.3 million and $88.3 million, respectively, during Q2 '07 as compared to Q2 '06.

Sales of advanced FPD and IC photomasks were approximately 14% and 10%, respectively, of total sales for the quarter. Included in this percentage are mask sets for semiconductor design 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 second quarter, sales were approximately 58% in Asia, 24% in North America, and 18% in Europe. Sequentially sales of both IC and FPD photomasks increased modestly at 3.4% during the quarter.

We did not experience the typical increased photomask activity associated with the second quarter. However, we did see modest signs of improvement during the month of April.

Gross margin for the second quarter was 23.9% as compared to 35% in Q2 '06. The decrease is associated with the reduced year-over-year sales coupled with an expanded manufacturing base, primarily associated with our two new facilities in Taiwan and China.

Sequentially, gross margin decreased 410 basis points as a result of the increased depreciation associated with our expanded manufacturing base, principally in Asia, and to some extent reduced ASPs.

Selling, general, and administrative expense for the second quarter were $14.4 million as compared to $15.7 million last year, with the decrease primarily related to the inclusion of PKLT and China startup costs in SG&A last year, as they were yet to open. On a sequential basis, SG&A decreased $2 million as a result of the commencement of our manufacturing in our China facility and, to a lesser extent, reduced compensation and corporate overhead expenses associated with ongoing cost reduction programs.

R&D expenses, which consist principally of continued development for advanced process technologies, were $4.3 million in the second quarter. Sequentially R&D decreased by approximately $400,000.

During the second quarter, we generated operating income of $7.4 million or 6.8% of sales, as compared to operating income of $8.5 million or 8% for the first quarter of '07, which is exclusive of the sale of the former manufacturing facility in Q1 2007.

We will continue to match our cost structure to the changing nature of demand and new opportunities in the global market environment. We remain committed to improving our operating margins. Though our revenues may have come in toward the lower end of the guidance, the operating margin leverage in our model enabled the Company to benefit from even modest revenue increases going forward. However, the next few quarters could experience some modest fluctuations in the operating margin line as we continue to monetize our new facilities in China and Taiwan and build the NanoFab in the US.

Net other income expense for the second quarter was income of $400,000 as compared to income of $3.8 million in the second quarter of 2006. The decrease year-over-year is related to decreased investment income associated with reduced investment balances, decreased foreign currency gains year-over-year, both of which were mitigated to some extent by decreased interest expense associated with our reduced debt year-over-year.

During the second quarter, we reported a tax provision of $1 million, which is exclusive of the previously-mentioned net tax benefit, which equates to an effective tax rate of 14%.

Net income, exclusive of the $7.9 million benefit previously discussed, was $6.1 million or 5.6% of sales for the second quarter. Net income per diluted share, excluding the benefit, was $0.14 for the second quarter of 2007.

As we exited the second quarter we had approximately 1,510 employees, equating to sales of $290,000 per employee on an annualized basis.

Taking a look ahead, taking a look at our six-months year-to-date operating results, before the impact of onetime events, our net sales for the first six months of 2007 were $216 million, a decrease of approximately $16 million or 6.8% for the six months of last year. The decrease is a result of reduced sales of FPD photomasks year-over-year of $12.3 million and reduced IC sales of $3.5 million, both of which were associated with reduced design releases coupled with reduced ASPs for FPD masks.

Year-to-date gross margin decreased to 25.9% from 33.7% as a result of the increased manufacturing base and reduced ASPs, principally FPD.

Selling, general, and administrative expenses were flat year-over-year. R&D expenses were $9 million for the first six months of 2007 as compared to $[15.2] million last year. R&D was 4.2% of sales for fiscal '07 versus 9% in the comparable period in the prior year.

Net other income and expense amounted to income of $145,000 in 2007 as compared to income of $5.6 million in 2006, as a result of the following. Decreased investment income associated with lower investment balances and reduced year-over-year foreign currency gains.

For the first half of 2007, we recorded, exclusive of the gain of the facility and net benefit previously discussed, a tax provision of $2.3 million, which amounts to an effective tax rate of 14.2%.

For the first six months of 2007, exclusive of the items previously mentioned, our net income amounted to $11.7 million or $0.27 per diluted share.

Now turning to the balance sheet. Cash and short-term investments at April 29, 2007, amounted to $153.7 million. Working capital amounted to $143.2 million. We have classified $125 million of our $150 million 2.25% convert, which is due in April of 2008, as current; as we have received firm commitments from financial providers for a five-year $125 million revolving credit facility. The revolving credit facility is being led by JPMorgan, and we expect to close this facility within the next few weeks.

Other accrued current liabilities decreased approximately $7 million since the end of the first quarter, primarily as a result of the timing assisted with the payment of various accrued liabilities. Total debt at April 29, 2007, was approximately $174 million. The components include the previously-mentioned $150 million 2.25% convert, which is due in April of '08, and approximately $24 million of foreign loans.

Shareholders equity aggregated $643 million, which amounts to a book value per share of $15.38.

Taking a look at our cash flows, cash provided by operations for the second quarter was approximately $53 million and amounted to $71.5 million year-to-date. Cash flow provided by investing activities during the first half of 2007 amounted to approximately $16 million, of which $49 million represents proceeds from the sale of short-term investments and $37 million represents cash payments for capital expenditures. Year-to-date free cash flow, which is cash flow from operations net of CapEx, was approximately $34 million.

Now, taking a look ahead. As a reminder, our visibility as always continues to be limited, which is typically one to two weeks. Turning to our outlook for the third quarter, many industry factors reflect continued softness. While we expect to see a moderate improvement in the environment for design activity, especially for advanced IC and high-end flat panels, we feel that it is prudent to remain cautious. Based upon our best analysis, our revenue guidance for the third quarter is in the rage of 110 to $120 million.

Capital expenditures for 2007 on a cash basis are forecasted to be approximately 135 to $165 million, as we selectively invest in capability and customer relationships. This is up slightly from our previous guidance of 130 to $150 million. Most of our CapEx relates to the completion of the US NanoFab and for additional high-end capacity in Korea. The timing and delivery of the tools will dictate the need, if any, for additional financial flexibility.

We continue to review all of our financial options and are confident that our access to capital, coupled with our anticipated cash flows, will not inhibit our growth plans. We also would like to emphasize to you this morning that we 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 long-term competitive position while also aggressively managing our cost structure. At the same time, we do see opportunity for growth and are confident in our ability to execute.

During 2007, our tax rate will continue to 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 where we are taxable. Accordingly, for the third quarter of fiscal 2007 this will equate to a range of $1.7 million to $2.9 million in whole dollar terms.

As a result, based upon our current operating model, we estimate that earnings per share for the third quarter of fiscal 2007 to be in a range of $0.10 to $0.18 per share. Now this concludes my prepared remarks, and now I would like to turn the call back over to Mike. Mike?

Thanks, Sean. We will open now questions (inaudible).

(OPERATOR INSTRUCTIONS) Suresh Balaraman from ThinkEquity Partners.

Can you give us some color on how much of the increase in cost of goods sold was due to pricing pressure that you mentioned in Taiwan? And how much was -- how much of an effect did the higher depreciation have?

As a follow-up, where should we model our long-term gross margins? We have taken a significant hit since the mid-30s that you guys did a few years back. Are those numbers even achievable in the next three to four quarters?

This is Sean. I will try to answer those questions and perhaps turn it back over to Mike for additional color. With respect to gross margin for the quarter, the primary driver was increased manufacturing capacity. Our depreciation was up sequentially $3 million. We had anticipated that it would be up from our previous call anywhere from $0.5 million to $1.5 million.

A couple of things happened. We did accelerate the deployment of certain tools in certain areas where we saw opportunities to capitalize in the near-term on future revenue growth. But the primary driver in our cost structure for the decline in margin related to the onset of manufacturing in our China facility. Mike alluded to that it did not contribute to the top line; it contributed very small to the top line, but the cost load was quite heavy. And the ongoing process improvement at our PKLT facility. We were impacted to some extent by some ASP pressure in certain geographic locations, but that was not the primary driver.

Going forward, we do expect that, once we have the ability to continue to monetize or sequentially monetize China and PKLT, and reap the benefits related to the assets that were put in place this quarter, we should see growth in our gross margin line.

Is the pricing pressure in the mainstream ICs or is it at the leading edge?

Primarily in the mainstream, and it was very spotty, Suresh. This is Mike. Primarily in the quarter we saw some significant pressure in Taiwan as a result of supply and demand at sort of 180 and above. I think that has been muted now, and we should hopefully be stabilized going forward. But there was some supply-demand issues there.

So it is part of what we see. As I mentioned on previous calls, either during periods of ramps or where there may be some customer bidding that occurs, we will start to see some. FPD in Taiwan has also been under a lot of pricing pressure. We expect that will similarly improve as high-end business picks up. We started to see a nice pickup toward April, and then the forecast going into the second half of the year is we should see very strong FPD demand.

Great, thank you.

Matt Petkun with D.A. Davidson.

I was wondering if you guys could hazard a guess about the overall market share in the IC part of your business at 90 nanometer and below. Both as it relates between kind of what you would consider the captive and the merchant market; and then just how you play within the merchant market, in terms of your perceived market share.

Obviously, that is going to ramp pretty significantly and change a lot over the course of the next couple of years, given your partnership with Micron. But I wanted you to kind of lay out what you see that looking like today.

Are you talking, Matt, about just high-end 90 nanometer and below, or total market share?

Just 90 nanometers and below.

As we said, I believe on the last call, our estimate for our share at 90 nanometer and below is probably below 10%. The captives, if you model them to say that they represent roughly equivalent to what they have in total, it is about one-third. Maybe in the high-end, that would inch them up a little bit more. Just because the data I have from both TSMC, Chartered, UMC in terms of their 90-nanometer and below mix is about 25% of their total business on average; maybe it varies a little bit by captive foundry.

So we have a lot of upside here. We have made some incremental progress. Frankly, we are not -- I have mentioned this before -- as happy as we would like to be in terms of the progress, given that we have redeployed tools. But it turns out at 90 nanometer and below, the quals are very complex. There are requirements, process requirements, like haze that are part of the qualification process. So it takes the customer some number of iterations before they can validate.

We feel very confident about our capability. So I don't anticipate that is going to be an issue. It is just it has taken longer than we had hoped.

Okay. Then, Sean, could you help us understand the R&D? I know you explained why it was lower than we had modeled at least for this quarter. But as we looked towards the remainder of this year, as we start to see those 90-nanometer mask sets to ramp, how should we be looking at R&D? It seems like a tough number for us to model.

Matt, that is a good question. I would expect R&D to be at its run rate of about between 4.5 to $5.5 million as we move forward, depending upon the level of the qualifications and process methodologies we are deploying throughout the global network. But I would say between 4.5 and $5 million moving forward.

Okay, if you had several customers come in and want a qual in advance of going into your NanoFab, working with Micron and you to do that, could that cause R&D to jump up above the $6 million run rate? Or is it not that variable?

I think if we accelerated -- and we see opportunities to accelerate -- and, quote unquote, outsource some R&D initiatives, we would see the number go up. But it is not planned at this point in time. I don't know if, Chris, if you want to -- have any further color on that.

I don't really, Sean. I think Matt is correct. If you see an increase in that, it is going to be qual and opportunity driven, as opposed to launching large new R&D initiatives. So as it does go up, to capture opportunities, we think we have the bases very well covered now on our core process technology. So it would be qualification-oriented increases.

Okay. Then Sean, just on the credit facility. So that is a revolving credit facility you guys have set up that should last for five years. How should we be looking at interest expense and kind of the overall interest and other income line item over the next couple of quarters?

We would expect once the facility is in place -- obviously to the extent we draw upon this facility in the short-term our interest costs to go up nominally in Q3 and then more so in Q4 when we plan to spend some of the cash. I would expect anywhere from $0.5 million to $1 million or so, depending upon what we do with the investments, invested cash balances as well.

Okay, so you are saying $0.5 million to $1 million in incremental interest expense?

(multiple speakers) If you are asking me with respect to the other income and expense line item on a go-forward basis, all-in, what with that number be?

Sure, on a quarterly basis.

Yes, I would say probably right -- as we look out into the third and fourth quarter, anywhere from $1 million to $2 million based upon what we know today of net expense.

Okay, thank you.

Patrick Ho, Stifel Nicolaus.

Thanks a lot. In terms of your gross margin results as well as the outlook going forward, what can we look for in the other additional cost that might come that, I guess, could surprise us one way or the other? I mean, I am sure your are still adding on capacity going forward with several of these ramps. I'm not going to lie; this was a bit of a surprise on the downside. What can we expect going forward?

I think, Patrick, for Q3 we don't anticipate any significant increased manufacturing cost with respect to our depreciation or people, labor coming online. We do expect to improve our manufacturing processes at some of our new locations and continue to penetrate in the high-end.

But I think in the short term, I think our cost structure is basically in place on our manufacturing. So to the extent that we receive incremental top-line dollars, that would drive the margins up and the operating margins up.

As we get into fiscal 2008 and our NanoFab comes on board, those will be additional costs we will need to monetize.

I think just to add a little more color, Patrick. This is Mike. We have got -- we have talked about this on several of the calls -- we have got a lot of moving parts here. We have got new facilities coming online, strategy change, driving execution of 90 nanometer and below, the NanoFab coming online. In the background, we're not -- let me say, we are not ignoring the fact that we need to drive cost out in the other pieces to make room for the growth opportunities.

In fact, during the quarter we to take some actions to reduce some costs; and we will continue to look at that, consolidation of other sites and the like, as time goes on.

But we believe very strongly in our strategy. I have been on the road the last six weeks meeting with customers, talking to them about what we're doing and the change that Photronics is undergoing, getting them positioned to work with us as we move into the NanoFab. The response has been extremely positive. They want an alternative.

The good news is, we're being told by our customers that with the joint venture, Micron, the technology development we have underway, that we are as good if not better than any of our merchant competitors. Just that on the surface really gives us a high degree of optimism that if we can execute here, securing some of these design wins, the next several quarters should start to prove very positive for us.

Okay. Mike, and this might be better for you, I know I have talked to you about this in the past. I think we can see the long-term goals with all these strategic initiatives. But obviously you are trying to do them all simultaneously. Over the last few quarters we have seen things start up a little slower in some areas like the China FPD facility ramp, and even in Taiwan.

Is there any question on, or do you have any doubts about trying to do this all simultaneously, which is obviously impacting some of your near-term results?

No, I think we have the organizational bandwidth; it is not an issue, you know, as one thing you normally worry about. China, we had a couple of problems starting up. One was getting the equipment in and getting it through sort of a government approval process. That delayed some of the timing.

Getting customers qualified and tuning the process has been a little more difficult than we had anticipated. But we have customer engagement there, as I mentioned in my prepared remarks. I expect to see progress made over the next coming months there. So no real issues there.

In Taiwan in the FPD side, that was sort of unfortunately affected more by the market than by our performance. We saw some improvement in the last quarter, with pickup in business in that site. Our people in Taiwan and Korea that are supporting the FPD business and our roadmap there are very confident that we are in good shape there.

Micron, the great thing about the Micron joint venture and the NanoFab is that we have a committed customer right at the start-up. We have very good local management at our site. So I'm very, very confident that we will be able to execute. There are, as I said, no bandwidth issues.

But the fact is, we have been hit by some market conditions and some of our own start-up issues. And that has put a drag on some of the performance here in the short term. But we are obviously not happy about the performance but we are very optimistic about the future.

Okay. A final question on the flat panel display business. You did note that you saw a pickup in the month of April. Is this kind of across the board, or just on the high-end side of things?

Mostly on the high-end, although we did see some improvements in Taiwan on the more mature side. We received our first Gen 8 production set. That will put us as process of record in Korea, a significant milestone for us. It's something we have been talking about.

With the ramp up in large-screen TVs, we think that will play out well for us over the next few quarters. Then as LG and others move to Gen 8 we should be able to capitalize on that as well.

Thank you.

Colin McArdle with Needham.

Good morning, guys. Thanks for taking my questions. I was wondering, Mike, you described it as a lot of moving parts; and I totally agree. I wondered if you guys could share what the target operating model would look like, given all the things that are going on.

This is Sean. We haven't changed our target operating model trying to achieve a 20% operating margin. We do have a lot of moving parts, as we put capital in and reduce some of the other costs, and we look to monetize some of our new facilities. So it is going to take a bit of time to get to our 20% target.

But as we do so, and Mike alluded to we do have a lot of moving parts, we're managing our cash appropriately. Our cash was up $21 million sequentially. Our SG&A is under control. So we do see a lot of opportunity for leverage within our operating model today and for Q3, to the extent we can drive the top line.

Okay, and is there a revenue level that 20% operating margins are realistic?

Well, it is a moving target. The reason I'm hesitating is because as we put capital in that changes; and it all depends upon utilization of our asset base.

But as we exited the quarter, I believe if we had about 148 to $145 million of top line, depending upon mix and so forth, we would have been at about the 20% operating margin.

We did have substantial costs come in, related to our manufacturing facilities this quarter. Principally in Asia, with additional deployed capital that we did monetize to some extent. But as Mike said, we were probably overly optimistic in that regard. But we do have good local management in our new locations. We still remain very confident about the future with respect to be able to get to that. And we are continuing to manage the balance sheet to the extent we can.

Thanks, Sean. That's helpful. Then lastly, gross margins above 30%, should we think about seeing that this fiscal year?

Gross margins above 30%?

Yes.

I would certainly hope so.

Okay. So that is something that you anticipate in the next few quarters?

We are at 23.9% on $109 million or $109.6 million in revenues; so we certainly -- to the extent we get some lift in our top line, and we do expect to get it, we're not adding a lot of cost in, except for the variable component of which it is just the material. So we do set our targets to get back to where they should be.

Okay. Thanks, guys.

Mark FitzGerald with Banc of America Securities.

Thanks. Just curious if you can help me resolve -- I mean, your comments about the cautious environment still into the current quarter, July quarter. And then the fact that you accelerated deployment here in the April quarter. So is there something that is forcing you to do this in terms of development? Or do you see an opportunity coming down the road? Why the accelerated deployment?

Mark, this is Mike. There are some positive signs out there, especially for us. One, building momentum in qualifications, as I said, in 90 nanometer and below. I expect that we will see continue to see improved progress there. Particularly in Asia, where we have made some good traction and we have got quals underway with key customers that could drive pretty good volume.

We're starting to see toward the end of our second quarter a ramp up in analog design activity, particularly for the wireless and power mobile kind of applications. That is encouraging and I believe that will continue. Certainly, our US and Europe customers have been fairly bullish about turning design activity back on there. So that is all positive.

The memory business, as you know, has bit rates going up and ASPs are going down. There is a whole bunch of caution there. Fortunately -- or unfortunately, I guess, we're not as dependent on the DRAM piece of that. That will become a bigger issue obviously as we get more business through Micron and [Ironflash]. But at this point, it is not a significant component.

So you know, a lot of what we are tempering our view on is other market conditions that are beyond our control.

Mike, to some extent too, when we accelerate the deployment of certain assets or put in place, it does take a bit of time, as you say, to ramp up. So we see the opportunity down the road, whether it be Q4 or Q1 of next year, to be prepared for the additional share we intend to take.

But obviously going into the last quarter just reported, something changed from where you -- you know, you made a decision at some point in the quarter to accelerate, because your depreciation obviously was much higher here. So what caused that? Is it like coming out that you're a bit disappointed that the market is not quite there for you? Is that the message?

No, I would say that the big hit was China. We put a lot of cost into the model and did not get the top line to support it. To some extent, the redeployment of tools for 90 nanometer, as I mentioned.

The quals taking longer than we hoped. Customers are -- you know, the bar has been raised in terms of the qualification process for a number of other issues other than just what we traditionally do in a qual, because of some of these process issues that I mentioned at haze and the like. So it is just a timing issue more than it is a customer acceptance or market issue.

Is China an issue of just getting new customers in China at this point and loading that facility? Is that the timing issue?

Yes, we have -- the top players that we're targeting are the 180 players. So [Haijin], GSMC, [HSNEC], ASMC are customers that we are working with. We expect to be able to get business building over the next few quarters.

Okay, thank you.

Brett Hodess with Merrill Lynch.

Good morning. I guess, Sean, you commented a little bit ago that I think the depreciation wasn't going to change much in 3Q. But with half the cap spending still coming in the second half of the year, how much should we look for depreciation to increase for -- by the end of the year?

Most of our -- we talked about, Brett, in the past that our CapEx is back-end loaded for fiscal 2007. So the timing related to the latter part of Q3, some time into Q4, is contingent upon when we get those tools in.

But based upon our projections, I would expect cap depreciation to be relatively flat to up slightly for Q3 and maybe up quarter over (technical difficulty) by the end of the year $500,000 in total. So it is really more of an '08 issue.

So how much will it be up going into '08, Sean, given the spending?

It is all contingent upon the acceptance of the tools as they come in, Brett. If you take four of the -- two lithography tools and two inspection tools, that is the bulk of the spend there. So it could increase our depreciation as we move forward into '08; on a sequential basis, about $1 million or so each quarter.

Okay, then the big drop in SG&A this quarter and the controls you put in place, how does that look as you go forward and revenue growth re-establishes?

I'm looking at Mike as I answer this question, but we're going to maintain tight controls on our SG&A spend and try to keep it at the level that we exited this quarter at. We don't intend to add a significant amount of infrastructure going forward, except in one location, which is the US NanoFab, which we are in the process of hiring employees and getting people in place. Those costs would then flow into manufacturing sometime in '08 when we turn that facility on.

Okay. Then finally, when you're commenting on the price pressure in Taiwan in the quarter on flat-panel, and you said that was market conditions, have you started to see more competition in the flat-panel market in Taiwan at this point? Or is it still coming mainly out of Japan? Or are you starting to see some native competition there?

Has not really changed much, Brett. The same level of players. The issue is there has been a lot of capacity put in place over the last several years; and the demand has not aligned with that.

So particularly for the G5 and below technologies, there's plenty of capacity. So the customers have options, and they are driving the pricing down. It is not something we didn't anticipate; it is just it is putting a lot of pressure on a lot of the margins as a result of that.

As the business picks up, which will -- the growth looks still very robust for flat-panel. As the capacity starts -- I don't think a lot of paper are going to add capacity, let's put it that way.

But what we're really positioning to do is to continue to have a disproportionate amount of our business in the high-end; and the margins and the pricing in the high-end have held pretty well.

Great, thank you.

Jay Deahna with JPMorgan.

Thank you; good morning. Mike, if I look at the revenues for Photronics, for the last 12 quarters they have oscillated in the roughly 100 to $115 million range, so it is kind of ranging sideways. Now, you talked about a lot of your plans to reinvigorate growth. Assuming that you're successful with those plans, what should we be thinking in terms of the achievable, long-term sustainable, compound annual growth rate for Photronics?

Thanks. You're right, in fact, I've been looking, been tracking these charts for the last eight quarters. And it has basically moderated around that level that you indicated.

When you make a change like this, as you know, it doesn't happen overnight. We're doing all the right things. I believe the traction is building, but it is taking time.

Our view is that if we can make substantive penetration in 90 nanometer and below markets, as a result of the work we have already done at 90 and the joint venture between Micron and our new NanoFab, that we should be able to increase share in the high-end, and take our sort of growth rate in the IC business into the, let's say, 9 to 11% range, 10 to 11% range.

If you factor FPD on top of that, we are somewhere in the low to midteens; and I think that is a growth rate that is pretty exciting, given the rest of the market that is out there.

But that is going to require all the execution we talked about, which I am not concerned about, because we don't have technical hurdles. We have timing issues with getting customer quals done and getting them committed for giving us the business. All the indications, as I said, with customers -- I have been on the road the last six weeks. We have got visits planned through the balance of our third quarter. I'm getting very positive engagement, and that is very encouraging.

Okay, then a couple other questions. First of all, in terms of the 90-nanometer design activity at this point, is that -- how would you describe that? Is that kind of percolating up from a cyclical perspective, neutral, or percolating down?

Then the other question is, with DNP coming into Taiwan with their facility, is there enough business there that that can happen and not have a negative competitive consequence for you? Or how are you thinking about their foray into that market and how you're going to deal with that?

90-nanometer designs are improved, are continuing to ramp up. That is one of the reasons why we feel good about where we are positioned now with capacity. DNP, the nano facility in Taiwan, we know well about. It would probably be best if you ask them the question. But our view is that that is very targeted toward a specific customer.

Certainly having additional capacity is not a good thing competitively. But I don't think based on the discussions we have had with customers that that is going to create any more of a threat to us than we already have competing them on the high-end. Chris, I don't know do have any other color you might want to add to this.

Sure, I think the customers, particularly the foundries, definitely tell us they want to move as quickly as possible to 65. Some of that I think is to just make sure the supplier base is prepared and making the right investments.

But I would agree with Mike, the data suggest there's still a lot of activity in 90 nanometer over the next couple of years. So we are in a good position there.

In terms of the new facility from DNP in Taiwan, we see the mask opportunity -- mask market in Taiwan being one of the strongest internationally. Even one company like Texas Instruments moving to Taiwan to do a lot of R&D work with the foundries, [then], to drive demand in that region for high-end masks. The Taiwan memory companies are investing very heavily in capacity; those masks are complicated.

So even with DNP coming in, we believe that as we put our stronger technology position online there, there is big opportunities for us in that region and we can compete effectively.

Just one last comment, Jay. We already compete with them in Taiwan. So this is capacity that I think, in their view, that they had to either design to add in Japan or in Taiwan. So I don't necessarily view it as any additional threat.

The other thing is as you move from 90 to 65 to 45, the write times become so much longer that the capacity gets consumed pretty quickly. So one of the things we are looking at is how -- what the supply-demand situation will be as customers move to 65, given the available capacity in the high-end and what the tool suppliers are capable of ramping to.

We actually think there could be potentially a supply shortage several years down on these high-end masks. That will play certainly to everyone's benefit from a pricing point of view.

Right, okay. Thanks.

Timothy Arcuri of Citigroup.

Hi, this is [Srini] calling in for Timothy Arcuri. My question is, what is your breakeven point in terms of--?

Our breakeven for the second quarter that we just exited was approximately, before minority interest and taxes, approximately about $98 million or so.

Okay, and going forward how does it look?

Going forward, as we move out sequentially we had cost related to the NanoFab; it will go up modestly.

Okay, the other question that I had is in terms of the 20% operating margin target. When would be a good time to think that you would get there?

I mentioned a bit earlier that we are -- and Mike did too -- we are in a little bit of a state of flux as we are putting in additional capital for (inaudible) opportunities that will come in the latter part of '08, when we get our NanoFab up and ramped and get increased capacity into Korea. So at this point in time, we're not providing guidance into '08; but we are optimistic that we can still achieve those targets.

Okay. This next question is for Chris Progler. Regarding the haze, are you referring to something like the ammonium sulfate on the mask? If so, are you trying to work with clean companies to get rid of that?

Yes, that is correct. The haze problem or challenge Mark alluded to has to do with these contaminants that are left on the reticle; and after prolonged exposure in the wafer fab, defects form and appear on the mask; and it renders it unusable; and it has to be either cleaned or scrapped.

This is a challenge the mask industry has been facing the last couple of years, so it is not necessarily new. The reason Mike mentioned it in relation to qualifications is has just added another complexity in qualifications in terms of lifetime and longevity. So even if you your masks are clean, still a customer wants to run them for certain duration before they will certify. So it has just added a longer time period on qualifications and it added complexity.

In terms of who Photronics and others in the mask industry cooperate with, definitely the cleaning companies, mask -- the companies that make mask cleaning equipment are very key in this area. There are other partners as well in materials and boxes that hold masks, pellicles. All of these elements have a factor in the things that drive haze formation.

So it's actually fairly broad based. But that's right, the cleaning companies are the most important in terms of process technology for haze.

But we feel like we have a good solution now at our sites for 90; and we are working obviously with a joint venture partner to continue to enhance that as we move into the even more advanced nodes.

Who would the joint venture partner be? (inaudible) Are you talking about Micron here or a cleaning company?

That would be Micron.

The memory companies, because they run so-called high runners -- that means they expose many, many wafers on a single mask for DRAM and other memory applications -- they tend to be the first to see problems with mask longevity in general. So memory companies are going to be the first that are sensitized to a problem like this.

So the interactions with Micron and our other customers that make memory have given us pretty early insight into some of the things that are causing haze formation. So we certainly are not surprised here, but it is a challenging problem. All the mask suppliers and the captives continue to work today on trying to improve the situation.

But we feel we have a very competitive solution there. Our masks are world-class lifetimes; and the customers are shipping into, so we think we are okay. But it is a challenging problem on the qualification side.

Are you working with -- are you -- currently are you like doing the [mozon] mask inspection tools?

The mask inspection tools are certainly the tools that are used to validate the formation of defects as a result of haze. We work with the major inspection tool companies in our production lines and in our R&D joint venture. Is that your question, or was there something different?

I think are you planning to increase your number of mask inspection tools anytime soon?

We have our normal capability capacity purchases we plan through 2007. The NanoFab of course will need inspection tools; and we are in the process of evaluating options there. We plan on adding, as Mike mentioned in his opening remarks, some inspection capacity particularly in Korea for high-end.

Okay, thank you very much.

(OPERATOR INSTRUCTIONS) [Chip Bonnet] from FM Global.

Good morning. I was just wondering if you could talk a little bit more about monetizing the assets you put in place. Specifically China, since that seems to be where the disappointment occurred. So if you can talk about when you think that facility reaches a level of contribution that you're kind of expecting?

We expect, Chip -- this is Sean. It is not -- it is China and other assets we put in place principally in Asia; the new PKLT facility. We were perhaps overly optimistic on our ramp plans, but we expect them to be contributors this quarter, as well as benefit from the additional tools that we put in place there.

We have very strong management teams both at our new facilities in Taiwan and China. We did experience some start-up problems, which is part of the issue. But our long-term opportunities we still feel very strongly about.

I think, just to give you a better time frame, as Sean mentioned, Chip, the next six months I think we should sort things through; and we should get a big lift going into '08.

Okay. So it gets sorted through the end of the year; and '08 you expect things to be running at a kind of a normal utilization rate, I guess, if you will?

Exactly.

Okay. The China facility, what is kind of a quarterly run rate there with not full capacity, but something that you view as acceptable?

I think, Chip, for competitive purposes because it is a new market for us, we would rather not discuss that.

Okay. Then, my other question on that, too, and I don't know if you can discuss this. But in terms of margins on that facility, if that is running at a normal run rate, is that basically giving you core margins or not?

Well, it is in its infancy, so we would not be at our core margins just yet. But I believe that to the extent any of our facilities generate incremental revenue based upon our cost structure as we exited Q2, it will generate operating margin and gross margin dollars as we move forward.

I mentioned earlier we don't anticipate adding a lot of additional costs in Q3 from our Q2 run rate. So we are less, at this point, concerned with target margins per location. We are more concerned with getting these facilities up and running to an appropriate level. As Mike mentioned, the six-month horizon. So we expect sequentially them both to be accretive to our results.

The other thing is the assets that are in China are a blended set of assets. Some of them are used, some of them are new. So we should -- incremental revenue should help a lot.

Okay. Then last question on a different topic, it looks like your minority interest was much lower this quarter. Can you talk about that a little bit?

Certainly, Chip. That relates primarily to our majority held entity in Taiwan. Mike did allude to some pressures there; and that is the reason it is down.

Okay, and that gets back to the pricing pressure issues?

Just the competitive environment there, yes. That is correct.

Okay, do you expect to -- I am just kind of modeling out going forward -- do you expect a resumption to more normal levels going out a couple quarters? Or might we stay at a lower level here?

I think as we change the mix more to the high-end, which we have underway as I mentioned -- we have got tools that there; now we are 90-nanometer capable; we have got qualifications going on -- that will change.

To the extent that the technology mix stays in the -- the issue you have is once you go down, you never come back up. So the pricing levels sort of get stabilized; and then we just drive cost out on that. But really the mix change is going to be a positive piece for this.

I would say, Chip, that we anticipate that our minority interest expense to return to more appropriate levels going forward.

Okay, great. Thanks very much.

Timothy Arcuri from Citigroup.

This is again Srini for Timothy Arcuri. My other question is in your JV with Micron, are you primarily working on DRAM, or both DRAM and NAND wafers? No, masks.

This is Chris. We have DRAM, NAND, flash, and logic R&D programs going on inside the joint venture.

Okay.

Roughly equal, more DRAM-NAND heavy. But about a quarter of the R&D work there, a little bit more, is logic oriented.

Thanks very much.

You're welcome.

Speakers, this does conclude the Q&A portion of the day. I will turn the call back to you.

Thanks everyone for joining us. We remain very optimistic about the strategic path we are on. We look forward to talking to you on the next call.

Thank you, ladies and gentlemen, this does conclude the conference call for today. We thank you all for your participation and ask that you please disconnect your lines. Have a great day, everyone.