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Photronics Inc. (NASDAQ:PLAB)

F3Q09 (Qtr End 08/02/09) Earnings Call

August 19, 2009 8:30 am ET

Executives

Scott Gish - VP of Marketing and Corporate Communications

Constantine Macricostas - Chairman and CEO

Sean Smith - CFO

Peter Kirlin - SVP, United States and Europe

Christopher Progler - VP and CTO

Analysts

Matt Petkun - D.A. Davidson & Co.

Krish Sankar - Bank of America-Merrill Lynch

Patrick Ho - Stifel Nicolaus

Chip Bonnett - FM Global

Brett Hodess - Merrill Lynch

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Photronics third quarter earnings call. (Operator Instructions). As a reminder, this conference is being recorded Wednesday, August 19, 2009.

I would now like to turn the conference over to Scott Gish, Vice President of Marketing and Corporate Communications of Photronics. Please go ahead, sir.

Scott Gish

Thank you and good morning everyone. My name is Scott Gish, Vice President of Marketing and Corporate Communications of Photronics. We would like to thank you for joining our third quarter 2009 conference call. Before we begin, I would like to remind all participants about the Safe Harbor provision under the Private Securities Litigation Reform Act of 1995. 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 that may affect the company's operations, market, pricing, competition, procurement, manufacturing efficiencies and other risks detailed from time-to-time in the company's SEC reports. This call will remain archived on our web site until we report our fourth quarter 2009 results.

Joining us on the call today is Constantine "Deno" Macricostas, Chairman and Chief Executive Officer; Sean Smith, Chief Financial Officer; Dr. Peter Kirlin, Senior Vice President, United States and Europe; and Dr. Christopher Progler, Vice President and Chief Technology Officer. Deno will first provide a brief review of market conditions and our strategic direction. Sean will then provide a comprehensive review of Photronics' third quarter performance. Deno?

Constantine Macricostas

Thank you, Scott, and good morning everyone. Before turning the call over to Sean, I would like to take a few minutes to review our accomplishments from Q3 as we discuss our served markets and strategic direction. During our second quarter conference call, we stated that order activity had bottomed in March and gradually improved thereafter.

Now, in the third quarter, we saw the pace of orders accelerate as our customers' business came back to life. The flat panel display industry grew by 42% quarter-over-quarter. As a result, our photomask sales in this area increased by 22% sequentially. The IC mask business grew as well as fab utilization levels improved and new product designs were released.

Our key initiatives entering the quarter were, number one, continuing to lower our cost structure and improve our balance sheet. Number two, further penetrate the high-end flat panel display and IC markets, while continuing to ramp NanoFab. I am pleased to announce that significant progress has been achieved in both areas.

First, in July, we announced the closure of our Shanghai facility. The IC photomask market in China is competitive. It remains relatively small, and is mostly comprised of mature applications. These factors left little opportunity to establish a profitable operation.

Closing the facility will enable us to realize savings of $45 million annually with low revenue impact. Secondly, our strategy to penetrate and win tapeouts of advanced IC photomasks gained considerable traction during the quarter. Sales of photomask, at and below 65 nanometers increased 23% sequentially. Success in this area was driven in large part by gains within memory-based markets, including Taiwan. High-end IC sales expanded in all regions, and volume commitment was secured from two major customers.

At NanoFab, our newest and most advanced facility, sales again improved sequentially as we continued to ramp production. Qualification in a first production order was achieved with an additional Taiwanese DRAM manufacturer. Three previously qualified customers progressed to volume manufacturing, and five of our top 20 customers are now sourcing photomasks from NanoFab.

High-end flat panel display photomask sales were also strong, increasing 41% during the quarter. By geography, our technology position with top manufacturing in this market uniquely aligned Photronics to grow as the market expands. There's currently cautious but improving optimism within our customer base. Cheap ASP and factory utilization levels are on the rise, indicating an improving demand environment.

Capital spending, especially for technology and related equipment is increasing. In addition, photomask technology has been established as a key component, enabling smaller transistors. Device scaling in both NAND flash and DRAM has been accelerating, driving additional demand for leading-edge photomasks.

In the remaining of calendar 2009, we will stay intensely focused on cost control and advancing improvements. Simultaneously, we will aggressively pursue new technology node qualification and market share gains with the objective to outgrow the markets during the recovery. Thank you. Sean?

Sean Smith

Thanks, Deno, and good morning everyone. I'll provide a brief analysis of our financial results for the third quarter of fiscal 2009, and I will also review our balance sheet and cash flows during the period and review our outlook going forward.

During the quarter, as Deno alluded to, we announced the closure of our manufacturing facility in Shanghai. In connection therewith, including residual costs associated with our previously announced Manchester site closure, we recorded an aggregate charge of $10.7 million in the third quarter. The total Shanghai site closure is projected to be in the range of $11 million to $13 million, with approximately 85% of it being non-cash.

On May 15, 2009, we also issued 2.1 million warrants in connection with our amended credit agreement. For the quarter, we recorded a mark-to-market, non-cash charge of $6.8 million related to the appreciation in value in our stock price since the issuance. For purposes of our discussions on operations for the third quarter, I will be primarily referring to our operating results, excluding the impact of these items.

Net sales in the third quarter amounted to $95.4 million. Revenues for IC and FPD photomasks were $71.7 million, and $23.7 million respectively. Sequentially, total sales increased by 14.6%, or $12.2 million, with IC and FPD sales increasing by 12.4% and 22% respectively.

The increase in sales was by and large attributable to increased high-end demand for IC and FPD photomasks. However, both IC and FPD photomasks for mainstream products improved sequentially as well. The quarterly revenue of $95.4 million was also enhanced by the early arrival of a few high-end photomask sets during the last few weeks of the quarter. These sets were previously expected to be taped out during the fourth quarter.

Sales of advanced IC and FPD photomasks were 8% and 15% respectively of total sales for the quarter. Included in these percentages are mask sets for semiconductor designs at and below 65 nanometers, and FPD sets used to fabricate flat panel products using G7 and higher technology. Although not considered high-end, we also experienced increased demand for 90 nanometer sets during the quarter.

As a percent of total sales for the third quarter, sales were approximately 63% in Asia, 26% in North America and 11% in Europe. The gross margin for the third quarter was 18.9% as compared to 13.1% for the third quarter of last year. Sequentially, gross margins improved by 520 basis points, due in part to the increased unit volume, high-end demand and continuous efforts on cost-reduction programs.

Selling, general and administrative expenses for the third quarter were $10 million as compared to $13.7 million in the third quarter of 2008. Sequentially, SG&A decreased by $600,000. R&D expenses, which consists principally of continued development for advanced process technologies were $3.9 million for the third quarter.

Excluding the consolidation charges related to our Manchester and Shanghai site closures, we generated operating income of $4.2 million on $95.4 million of sales during the third quarter as compared to an operating loss of $3.2 million on $105.7 million in sales for the third quarter of 2008.

We are beginning to reap the benefits of our restructured operating model as evidenced by the ability to improve operating income Q3 '09 versus Q3 '08 by $7.4 million despite reduced revenue of $10.3 million. Sequentially, our operating margin improved by $7.6 million on increased sales of $12.2 million. This represented a 62% fall-through of our incremental sales, due in part to increased utilization, improved market share, coupled with our cost reduction programs.

Our restructured operating model has significant leverage on incremental sales growth. Other expense net for the third quarter was $14.2 million and includes a $6.8 million non-cash mark-to-market expense associated with the warrants. Excluding the impact of the charge, net other expense was $7.4 million as compared to $5 million for Q2 '09. The sequential increase is attributable to increased interest costs associated with our amended debt agreement and unfavorable foreign exchange.

During the third quarter, we recorded a tax provision of $1.8 million. Excluding the charges related to the facility closure and warrants, the net loss was $5.3 million for the third quarter of '09 with EPS loss of $0.13 per share. At the end of the quarter, we had approximately 1,280 employees, down from 1,450 at the end of our fiscal year 2008.

Now, taking a look at our nine months year-to-date operating results. Net sales for the first nine months of '09 were $267 million, a decrease of approximately $53 million from the first nine months of last year. The decrease is a result of reduced IC sales of $38 million and reduced FPD sales of $14 million. Year-to-date gross margin decreased to 15% from 17.2% as a result of the reduced revenues, and SG&A expenses decreased by $12.6 million to $31 million.

Research and development costs were $11.7 million for the first nine months of 2009 as compared to $13.1 million last year. Other expense, including warrants, was $16 million in 2009 compared with $6.3 million in 2008 as a result of increased interest expense associated with the increased interest rates, decreased investment income and increased foreign currency losses. For the first nine months, we recorded a tax provision of $2.9 million.

Now turning to the balance sheet. Cash and short-term investments at the end of the third quarter amounted to $85.7 million with working capital of $77 million. This represents a $37 million sequential improvement. Our accounts receivable increased by $7.8 million during the quarter as a result of the increased revenues in Q3 '09, and accounts payable and accrued liabilities at August 2, 2009 amounted to $72 million, which was essentially flat with the end of the second quarter.

Total debt at August 2, 2009 was $187 million. The principal components of outstanding debt include $123 million outstanding revolving credit balance, approximately $27 million in term loans, and approximately $37 million in capital lease and other obligations, including the US NanoFab.

As a reminder, on May 15, we amended our credit agreement. The key terms and conditions of the amended agreement include the following: The total availability under the revolver was increased from $120 million to $130 million at the end of our fiscal year 2009, and from $100 million to $110 million at the end of our first quarter 2010 through maturity.

The overall availability was reduced by $5 million to $130 million on May 15, and as I mentioned, the company issued warrants that could be exercised up to 5% of the company's stock. The maturity of the agreement was extended to January 31, 2011, and of course, certain financial covenants were modified.

On June 8, we completed or we entered into a new $27 million credit facility with our primary lenders, and repaid a foreign term loan of an equal amount and aligned the maturity of the new loan with our existing credit agreements. Additionally, $9.1 million of this new credit facility is due January 31, 2010.

While we have some financial flexibility as a result of our amended agreements, we are also faced with higher interest costs. Our focus over the near term is to reduce our interest costs and debt levels through operating cash flow, monetization of certain assets and reviewing opportunities as they present themselves. Minority interest at the end of the third quarter amounted to $49.7 million, which primarily relates to the minority interest in the equity of our 57% majority-owned subsidiary, PSMC.

Taking a look at our cash flows. Cash provided by operations for the third quarter was approximately $15 million, and it amounted to approximately $42 million year-to-date. Cash flow used in investing activities year-to-date amounted to $23.9 million, which includes $29.9 million for cash payments for capital expenditures.

Free cash flow year-to-date amounted to $11.5 million, and is expected to improve for the remainder of the year. We continue to feel confident that our significant capital expenditure spending is behind us, and we expect to generate cash from operations for the year certainly in an amount sufficient to cover our planned capital expenditures.

Taking a look ahead, our short-term visibility as always continues to be limited, typically one to two weeks. Turning to our outlook for the fourth quarter, we remain cautiously optimistic as the business conditions experience modest improvement from our Q2 '09 trough. Based upon our best analysis, our revenue guidance for the fourth quarter is in the range of $92 million to $97 million. The revenue guidance for the fourth quarter has been impacted by the previously mentioned high-end orders, which were pulled in during the last few weeks of the third quarter.

Capital expenditures for 2009 on a cash basis are expected to be less than $50 million, and when we take a look at our initial pass at CapEx in fiscal 2010, they should be in the range of $40 million to $50 million. However, we 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 competitive position.

In the remainder of 2009, 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 which we are taxable. Accordingly, for the fourth quarter of fiscal '09, this will equate to a range of $1 million to $1.8 million in whole dollar terms.

As a result, based upon our current operating model, we are estimating our loss per share, excluding the impact of the charges related to the consolidation charges and exclusive of the potential mark-to-market impact of the recently issued warrants, the EPS loss for the fourth quarter is expected to be in the range of $0.15 to $0.09 per share.

In summary, I would like to reiterate that we have made significant progress over the last few quarters in reducing our operating costs, stabilizing our financial situation, while expanding and growing our high-end business. While we are pleased with our progress, we are not done improving our business model. Over the near term, we plan to capitalize on our strategic position in an improving business environment while reducing our debt in order to ultimately return to bottom line profitability.

That concludes my remarks. Now, I would like to turn the call back over to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions). We'll take our first question from Matt Petkun with D.A. Davidson & Co.

Matt Petkun - D.A. Davidson & Co.

Solid quarter in Q3. Nice improvements both on the operations and in the balance sheet. One quick question Sean or Deno. You talked about this notion of pull-ins and that might impact the opportunity for revenue growth in the October quarter. Your business isn't one where I historically have thought much about orders being pulled in or pushed out given the short lead time nature. Can you talk more directionally what you are seeing both in the FPD market and the IC market, and what you would be expecting? Obviously, January is usually a seasonally down quarter, but what are we seeing in terms of maybe longer-term growth opportunities here?

Sean Smith

Matt, I think you are correct with the short lead times, but what we had anticipated when we guided for Q3, based upon our qualification processes at the NanoFab and some new customer engagements that Deno alluded to in his opening remarks, we had planned for some of those orders to come-in in Q4. The process for regular transfers of high-end orders were pulled in, so we were able to capitalize on that. However, we generally believe that we will continue to see modest improvement as we move forward.

Matt Petkun - D.A. Davidson & Co.

Okay. The next question I had again was kind of on the NanoFab. You are now only counting 65 nanometers or below versus a year ago. Those numbers included 90 nanometers. So, clearly, you are seeing improvement, but it sounds like you have had a lot of incremental customer traction. When can we see the numbers for the NanoFab start to improve on a year-over-year basis? I mean, the October quarter last year was over $10 million. Should we start to see double digit types of numbers from the leading edge?

Sean Smith

To answer your question, we have seen year-over-year improvement in the NanoFab, no question about it. We have also seen sequential improvement each of the last five quarters there. I am not sure the quote of the $10 million from Q4; that I believe was all high-end last year. It wasn't just the NanoFab. We probably won't be in a position to discuss the specific components of the P&L or the top line at the NanoFab, but that technology that's there, the process, the qualification process that's happened over the last year has enabled and benefited our other sites as we were able to transfer work around the network.

Now, as Deno alluded to, in the NanoFab, we have five of our top 20 customers doing business there now as opposed to Q1 where we only had one. So, that's where we are seeing the incremental lift.

Matt Petkun - D.A. Davidson & Co.

My last question is how should we be thinking about the relative margins. You guys now really dominate, it seems, the mainstream business and that's been historically a great cash cow for you. There is obviously a lot of opportunity to capture margin in the NanoFab, but how should we be thinking about relative margins between your high-end and low-end business both in mainstream and in FPD?

Sean Smith

Matt, we are at a point now in our operating model when we talk about sequential improvement in revenue and the drop-through, and that's primarily on the gross margin line, but we were quoted at the operating margin line. So that is going to happen across all facilities as we work to continue to drive costs down. So we are at the point now where we still have some capacity within the network, but to the extent we receive incremental revenue over what we did this quarter, we should see approximately the same level of drop-through that we saw this quarter.

Matt Petkun - D.A. Davidson & Co.

Sean, did you share depreciation and amortization on the quarter?

Sean Smith

Depreciation and amortization in the quarter was; $19 million for depreciation and then about $2.4 million of amortization.

Operator

We'll take our next question from Krish Sankar with Bank of America-Merrill Lynch.

Krish Sankar - Bank of America-Merrill Lynch

Sean, how do we think of the interest expense in Q4?

Sean Smith

The interest expense is certainly one of the areas we need to take a hard look at. We have an effective yield if you look at Q3 of about 11.4% all-in, including cash and non-cash. So, it would probably be about the same amount, 11.5% all-in of our outstanding debt. So, that is why we are incented to try to use some of our cash on the balance sheet, and our operating cash flow and the sale of certain assets taken out of service to pay down our debt to improve the bottom line.

Krish Sankar - Bank of America-Merrill Lynch

In terms of the high-end IC, do you think you have any terms of segmentation by customer or region for the IC photomask in the July quarter?

Sean Smith

No, we didn't, but I think it would be fair to say that we saw strength in all geographic areas where our customers are located. The manufacturing may have been done in the US or in Asia, but certainly we've benefited from all geographic areas.

Krish Sankar - Bank of America-Merrill Lynch

Along the same lines of the FPD, the high-end grew quite a lot, almost over 40%. Was this strength coming from Taiwan or was it Korea or both the regions?

Sean Smith

Primarily Korea.

Krish Sankar - Bank of America-Merrill Lynch

Primarily Korea. Then, did you guys see any new customer qualify in the NanoFab for July?

Scott Gish

We said that we qualified three additional customers in the NanoFab, and we also moved three customers who were already qualified to volume production.

Operator

(Operator Instructions). We'll take our next question from Patrick Ho with Stifel Nicolaus.

Patrick Ho - Stifel Nicolaus

Thanks a lot, guys. I understand it is prudent to be cautiously optimistic at this time, but what is your take or what is your color in terms of the sustainability of business trends on a going-forward basis? Do you feel much better that the worst is over and at the very least, we are at an inflection point of a recovery?

Constantine Macricostas

This is Deno. Patrick, I do believe the worst is over. The company is stable. I think the semiconductor sector is improving, top line is improving and particularly our [de-levers] over 60% of that's definitely bottom line. So, we feel very good about it. The only negative is the debt tied to improve the balance sheet and the interest expenses. But, definitely, we'll try to continue to reduce operational expenses.

Patrick Ho - Stifel Nicolaus

Right. I think you guys have done a really good job at least on the cost cutting front over the last few quarters and taken some major moves along the way. Maybe this is more for you, Sean. Would it be fair to say that a lot of the major moves are out of the way and from here on out, they are kind of tweaking moves? Or are you guys still evaluating like the overall structural basis of the company, and there could still be additional sizable moves ahead?

Sean Smith

I'll speak to that and if Deno wants to add some color to it. I think in the short-term, there is probably not a planned significant move. We believe the manufacturing network is well aligned and positioned to the extent something does change quickly; we obviously would make a move. So we always analyze things. You used the word tweaking; we'll constantly try to drive costs out of our system. We are in a stable position, but we do not forget where we came from a few months ago. So we are not going to relax. We are going to continue to try to squeeze every nickel out of the system we can. We are very excited about the high-end penetration traction we are getting and the customer engagements that we are having. So, assuming the economy modestly picks up or even stays where it is, we feel we have an opportunity to grow in the future.

Patrick Ho - Stifel Nicolaus

Great. A final question from me, along with these cost cutting moves and aligning your manufacturing cost structure to the next recovery scenario, how have your suppliers or how do you feel the supply base is for you guys on a potential recovery scenario? Do you feel confident that they will be ready to ramp up whenever things really start picking up steam?

Peter Kirlin

I think our supply chain is duly exercised and they are an active participant in our cost reduction. As Sean mentioned, we will be relentless day in and day out continuing to drive down our operating costs. However, they are largely intact. So, they are well-positioned to ramp with us.

Scott Gish

It would be fair to say we haven't seen suppliers unable to meet demand. That has not been an issue.

Peter Kirlin

Definitely not.

Operator

We'll take our next question from Chip Bonnett with FM Global.

Chip Bonnett - FM Global

Nice quarter, guys. Two questions for you. First, can you just give us an update on the total numbers for the NanoFab between the total numbers of customers qualified, and then total numbers of volume customers?

Sean Smith

Sure. Chip, Sean here. At the end of Q3, we had 15 qualified, seven are volume, and we mentioned that five are in our top 20. If we go back to Q1 of '09, just as a comparative reference point, we had 11 qualified, two in volume and one in our top 20.

Chip Bonnett - FM Global

Next, can you talk a little bit about the general sentiment among your customers? Your results here and just the general tone seemed much better. So what is kind of the sentiment out there?

Scott Gish

This is Scott. I will take that question. First of all, in flat panel display, it is a period of expansion as they try to respond to increasing unit demand. If you look at unit demand for large area panels, it's increased, I believe, every month sequentially for over a year. So, unit demand is very good there, so I think the customer sentiment is expand. Customer sentiment in the IC world is; we are encouraged by the capital equipment expenditures for technology. We believe that's going to lead to eventually getting some capacity add-ons. We see utilization rising. So, all of those are positive trends from the customer base.

Sean Smith

Not only the IC customer base; the lion's share of our customers all have visibility through the third quarter, and it's starting to materialize for Q4.

Christopher Progler

Sure. This is Chris Progler. I think on the IC memory side, what we are seeing is kind of renewed commitments to roadmaps and shrinks, which we haven't seen say over the last couple of quarters. So, if you're following that, you will be able to pick that up. Definitely there is some scaling competition going on among the big players. So, generally, that's good for photomasks because photomasks are used to enable a lot of those scaling pass. On the logic side, we see pretty vigorous activity coming for 65, much broader adoption, and 45 is still fairly muted, but definitely there are more companies jumping into the water at the 45 node too. So, overall, your question on sense and confidence, it looks decidedly more optimistic from a roadmap perspective right now.

Chip Bonnett - FM Global

Okay, that is all pretty solid. Last question is just on margins. Sean, you talked about the drop-through, and I think you might have said the drop-through on gross margin is about the same as on the operating line. You can correct me on that, but any chance that that number can actually go a little bit higher than what you did, and then how would mix impact that?

Sean Smith

Sure, Chip. To the extent we have projected sequential revenue growth; we would see an improvement in gross margins, absolutely, because we've already covered our fixed costs. So, our variable margin would drive the higher gross margins.

Chip Bonnett - FM Global

Was drop-through still around 60% there? Was that the number you gave?

Sean Smith

This quarter we did 62% I believe as I quoted, but depending upon the mix, it could be anywhere from 50% to 60%. We have seen some quarters where it is 70% and some quarters where it is 48%, but around 60% is a good benchmark.

Chip Bonnett - FM Global

So, that's kind of consistent for both on the gross margin line and the operating margin line?

Sean Smith

Yes. To the extent our top line is going up, we don't anticipate adding a great deal of additional costs on the SG&A side. However, on the R&D side to the extent we are involved in extended qualifications or additional qualifications with new business opportunities; we may see a modest pickup there but nothing substantial at this point in time.

Operator

(Operator Instructions). We'll take our next question from Brett Hodess with Merrill Lynch.

Brett Hodess - Merrill Lynch

Good morning, guys. I had two questions. On the commentary on the demand front from the high-end, we've seen -- you just commented that the logic area of 65 nanometers is pretty strong, and you are beginning to see a little bit at 45. We've seen a really big pickup in spending at 45 at TSMC, and now filter into the other foundries with a lot of customer announcements moving into 45. A lot of that spending is going into existing fabs where they are just upgrading those fabs.

So they expect that production to be online really quickly by year-end. They are also talking about going from, basically, 1% or 2% of their production at 40 to 45 nanometer now to over 10% exiting the year, and that's on a higher volume. So I am wondering, while the visibility is always short, the pull-ins that you saw this quarter, might those not be pull-ins, but just customers accelerating a lot of their designs that have been sort of lagging during the downturn? So, is it possible later this quarter and into the year end that you could see that pipeline from the logic side become much more steady? It just seems like, given the spending pattern; that implies that.

Christopher Progler

This is Chris. Certainly that is conceivable. The equipments going in now to establish 45 nanometer processes, particularly in the foundries, they'll want to get the utilization up quickly. So what we commented on is kind of isolated pull-ins could translate into kind of a sustained higher end ramp as customers adopt those nodes. However for us, I think it is just a little too soon to tell if that full pull-through will happen, but we see the same things that you commented on.

Capital equipment's going in, there seems to be a stronger commitment from the customer base to evolve to next nodes, and one interpretation of a design pull-in is trying to get a more aggressive product to market sooner. So, I think the vectors are there indicating what you suggested, but we do have to just still be a little bit cautious I think.

Brett Hodess - Merrill Lynch

The second question I had was really for Sean. You mentioned on the interest expense front, trying to be opportunistic to get down the debt levels and the interest expense. When you are talking about being opportunistic, I know there is lot of different opportunities, but are you focusing mainly on taking out new debt as the credit markets continue to loosen up or would you actually consider an equity offering as well, you think, to improve that issue?

Sean Smith

Brett, we need to be opportunistic, and look at every and all opportunities. We came from a relative weak point with our relationship and where we were in December and January and February. We've improved financially and stabilized the company. We have an amended debt agreement. To the extent we continue to improve our operations, we should have additional, I wouldn't say leverage, but a better bargaining position with our commercial bankers.

That said; we have to be prudent and look into other opportunities as they present themselves. So we will look at everything, including trying to dispose of a couple of the locations that we closed, and monetize those and pay down our bank debt. So, everything's on the table, but it is all going to be driven by costs and what's in the best interest of our shareholders as well.

Brett Hodess - Merrill Lynch

I guess a quick follow-on to that then is, as you shutdown Manchester and Shanghai, and as you mentioned on the call, you still have some fixed cost absorption and utilization rate issues, could you give us some kind of idea where your utilization rates are now or maybe if you'd rather deal with it in a different way, how much headroom you have to improve revenues in the remaining facilities?

Sean Smith

I'll take a shot at it, and then I'll let the others comment too. We certainly have enough installed capacity to do well north of what we did this quarter, and the product mix is going to dictate that. I don't believe, even in our initial capital plans for next year, which primarily is uncommitted, we intend to install significant capital. So we should be able to grow the company with what we have installed today.

Constantine Macricostas

We do have a lot of capacity in the high-end and the low-end, definitely. We have a lot of capacity, even north of first quarter, couple of years or year and a half ago.

Peter Kirlin

That was how I was going to answer the question. We can achieve peak revenue levels historically with the installed base as it sits now without any doubt.

Brett Hodess - Merrill Lynch

Can you exceed those levels given the higher ASP mix of the leading edge?

Constantine Macricostas

Yes, we can exceed them.

Operator

(Operator Instructions). We'll take a follow-up question from Matt Petkun with D.A. Davidson & Co.

Matt Petkun - D.A. Davidson & Co.

Just following on a little bit to some of Brett's more overlying industry commentary, and also what Chris said in terms of the memory customers starting to ramp up. Were there any 10% or greater customers in the quarter? I know historically you have a big customer in Korea.

Sean Smith

Matt, we historically have had a greater than 10% customer in Korea, and even in the low twenties in the last couple of years as we've disclosed in our 10-K. What I can say year-to-date, we have some customers approaching, but not quite approaching 10%, which is good, and some of those customers we hadn't had a business relationship with as recently as two or three years ago. So I think when we publish all our data at the end of the year, we are going to see a nice addition of a couple of customers, new customers into, say, our top 20 and then maybe one or two just a little bit around 10% or a little bit over 10%.

Matt Petkun - D.A. Davidson & Co.

How should we be thinking about Micron? I know primarily their volumes go through MP Mask, but I guess my understanding is that any overflow could go through the NanoFab. Is that correct?

Christopher Progler

Yes, Matt. I can take that one. MP Mask, that's our JV with Micron, does the R&D work primarily. That's its primary mission, the R&D work from Micron, and I'll say Micron group companies. These are companies that Micron has JV partnerships with to make memory and flash. So, the entire R&D for those group companies goes through MP Mask, and some of the production, but its primary purpose is really R&D, and usually the highest end-node production, initial sets for that to do proof of process.

However, the NanoFab very quickly moves those processes over, and its charter is to be the primary production engine for those masks. So it is a very kind of harmonious interaction between the two sites. Technology, R&D and most advanced nodes in MP, and then volume production in the NanoFab is how we've aligned it.

Matt Petkun - D.A. Davidson & Co.

Chris, it was my understanding that during the downturn, just given lower volumes at MP Mask, the intent is just to keep that shop busy first. Is that correct?

Christopher Progler

To some extent we have to keep some work flowing into MP Mask for sure. So, if there is very, very limited volume, in order to keep the R&D programs moving forward, we do have to ensure there is some amount of volume in MP. So that is true, but we've have taken the capacity down in the JV fairly significantly and we don't plan to ramp capacity there. So, with the improving demand profile, I am seeing much more activity in the NanoFab flowing from the MP Mask side.

Matt Petkun - D.A. Davidson & Co.

You did comment a little bit about just the technology partners that Micron has now. I assume you have an opportunity to serve some of the guys in Taiwan who will be accessing the Micron technology. Where will you be serving them from? I assume in Asia.

Christopher Progler

Initially, the intention is to service them from the US, but we will use mixed sets for some of those customers. So, to the extent our sites in Asia qualify for some fraction of the layers, perhaps non-criticals and other things, we'll ship those from Asia. So, we have a fairly flexible manufacturing strategy there depending on the needs of the customer and the type of technology in the set.

Operator

We'll take a follow-up question from Chip Bonnett with FM Global.

Chip Bonnett - FM Global

Thanks. Just to follow on to one of Brett's questions about having the capacity to achieve prior revenue levels. If I look back, it seems like a few times you were hitting on a quarterly basis about $115 million to $120 million in revenue, and EPS on those numbers was $0.25 to $0.30. So, if you have enough capacity to meet or possibly exceed that revenue level, where do you see EPS falling out? Would that also potentially be exceeding that prior level base or not necessarily, given your higher interest expense?

Sean Smith

Chip; there are a lot of moving pieces with that. The infrastructure is completely different than when we were at those levels. It's much reduced. So I think at this point in time, we probably won't comment on what the EPS potential could be at $115 million or $120 million, whatever those numbers are because, to the extent our business as we believe continues to improve, we will reduce our debt costs.

Constantine Macricostas

Definitely, we are a leaner company. Definitely our cost reductions and our breakeven point's lower than it used to be before.

Chip Bonnett - FM Global

That's definitely true. Obviously, the interest expense is different than you had several years back, and to the extent you pay that down, the earnings per share definitely go up. I was just trying to get a gauge of where EPS was on the same revenue level.

Sean Smith

I think maybe said another way; Dino's point is well taken. If I remember correctly, when we are at $115 million or $118 million, our breakeven from an operating income standpoint was probably about $102 million, $103 million, and where we stand today on an operating margin basis, it's probably $86 million, $87 million as we look out. So, we fixed above the operating margin line with the infrastructure and still have the ability to grow the high-end and engage with high-end customers. Now, what we need to do is reduce our debt and use that cash we are generating from operations to help get those costs down, which will drive EPS.

Chip Bonnett - FM Global

Sean, on the breakeven, the number you just threw out includes the Shanghai closing?

Sean Smith

It's on an ongoing basis. It doesn't include the Shanghai closing. That number is just from ongoing operations.

Chip Bonnett - FM Global

Is it going to kind of stay around that level or do you anticipate that going any lower?

Sean Smith

We will work to try to get that lower, barring any other significant move. I think we referred to it earlier on the call as tweaking, but we are going to continue to try to extract fixed costs out of our system.

Chip Bonnett - FM Global

However, it will be relatively minor compared to what you've done over the past year?

Sean Smith

Yes. As we sit here today, should market conditions change, as we've talked about continuously, we'll continue to evaluate our manufacturing network and align the business model to where our customers are.

Operator

(Operator Instructions). We have no further questions in the queue. I would like to turn the call back over to our presenters for any additional or closing remarks.

Constantine Macricostas

In closing remarks, I want to say we have the momentum and the leverage to continue growing and improving the bottom line. Also, I am very happy really that I have an excellent team here to implement and execute. So, with this team, definitely we are going to capitalize every opportunity going forward. In closing, I would like to thank you for your attention and participation in this morning's call. Thank you.

Operator

Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation and ask that you please disconnect your line.

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Source: Photronics Inc. F3Q09 (Qtr End 08/02/09) Earnings Call Transcript
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