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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2004

Commission file number 0-20839

 

DUPONT PHOTOMASKS, INC.

(Exact name of registrant as specified in our charter)

 

Delaware

 

74-2238819

(State or Other Jurisdiction of Incorporation or Organization)

 

(I.R.S. Employer Identification No.)

 

131 Old Settlers Boulevard
Round Rock, Texas 78664

(Address of Principal Executive Offices)

 

Registrant’s telephone number, including area code: (512) 310-6500

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes
ý No o

 

As of May 10, 2004, 18,378,069 shares of common stock, $.01 par value, were outstanding.

 

 



 

TABLE OF CONTENTS

 

Part I

 

 

 

 

 

Item 1.

Financial Statements

 

 

Consolidated Income Statements (unaudited) for the Three Months Ended March 31, 2003 and
2004 and for the Nine months ended March 31, 2003 and 2004

 

 

Consolidated Balance Sheets as of June 30, 2003 and March 31, 2004 (unaudited)

 

 

Consolidated Statements of Cash Flows (unaudited) for the Nine Months Ended March 31, 2003
and 2004

 

 

Consolidated Statements of Stockholders’ Equity for the Twelve Months Ended June 30, 2003 and
the Nine Months Ended March 31, 2004 (unaudited)

 

 

Notes to Consolidated Financial Statements (unaudited)

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

 

 

 

Item 4.

Controls and Procedures

 

 

 

 

Part II

 

 

Item 1.

Legal Proceedings

 

 

 

 

Item 2.

Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities

 

 

 

 

Item 6.

Exhibits and Reports on Form 8-K

 

 

Signatures

 

 

2



 

PART I

 

Item 1. Financial Statements

 

DUPONT PHOTOMASKS, INC. AND SUBSIDIARIES

 

CONSOLIDATED INCOME STATEMENTS

(Dollars in thousands, except share data)

(unaudited)

 

 

 

Three Months Ended
March 31,

 

Nine Months Ended
March 31,

 

 

 

2003

 

2004

 

2003

 

2004

 

 

 

 

 

 

 

 

 

 

 

Revenue, net

 

$

76,141

 

$

88,019

 

$

241,350

 

$

256,360

 

Cost of goods sold

 

74,491

 

75,791

 

216,225

 

228,593

 

Selling, general and administrative expense

 

11,163

 

11,953

 

31,498

 

37,652

 

Research and development expense

 

6,569

 

8,792

 

21,735

 

23,409

 

Special charges, net

 

9,247

 

506

 

21,754

 

2,097

 

Operating loss

 

(25,329

)

(9,023

)

(49,862

)

(35,391

)

Other income (expense), net

 

(1,079

)

64

 

(969

)

(1,056

)

Loss before income taxes and minority interest

 

(26,408

)

(8,959

)

(50,831

)

(36,447

)

Provision for (benefit from) income taxes

 

(3

)

1,300

 

1,355

 

2,750

 

Loss before minority interest

 

(26,405

)

(10,259

)

(52,186

)

(39,197

)

Minority interest in (income) loss of joint ventures

 

551

 

(305

)

(2,180

)

302

 

Net loss

 

$

(25,854

)

$

(10,564

)

$

(54,366

)

$

(38,895

)

 

 

 

 

 

 

 

 

 

 

Basic loss per share

 

$

(1.43

)

$

(0.58

)

$

(3.02

)

$

(2.14

)

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

18,037,432

 

18,176,334

 

18,000,257

 

18,138,289

 

 

 

 

 

 

 

 

 

 

 

Diluted loss per share

 

$

(1.43

)

$

(0.58

)

$

(3.02

)

$

(2.14

)

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

18,037,432

 

18,176,334

 

18,000,257

 

18,138,289

 

 

The accompanying notes are an integral part of these consolidated statements

 

3



 

DUPONT PHOTOMASKS, INC. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

 

 

 

June 30,
2003

 

March 31,
2004

 

 

 

 

 

(unaudited)

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

250,355

 

$

228,820

 

Accounts receivable, trade, net

 

54,312

 

63,616

 

Accounts receivable, related parties

 

996

 

2,265

 

Other receivables

 

 

17,461

 

Inventories

 

13,434

 

11,505

 

Deferred income taxes

 

4,454

 

351

 

Prepaid expenses and other current assets

 

12,705

 

14,272

 

Total current assets

 

336,256

 

338,290

 

Assets held for sale

 

5,087

 

8,926

 

Property and equipment, net

 

379,582

 

425,496

 

Accounts receivable, related parties

 

1,048

 

933

 

Deferred income taxes

 

1,603

 

991

 

Other assets, net

 

46,006

 

33,054

 

Total assets

 

$

769,582

 

$

807,690

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable, trade

 

$

45,935

 

$

36,866

 

Accounts payable, related parties

 

4,553

 

4,700

 

Income taxes payable

 

884

 

3,128

 

Other accrued liabilities

 

59,559

 

58,325

 

Short-term borrowings

 

11,903

 

22,705

 

Convertible notes

 

 

100,000

 

Total current liabilities

 

122,834

 

225,724

 

Long-term borrowings

 

1,973

 

59,811

 

Long-term convertible notes

 

225,000

 

125,000

 

Deferred income taxes

 

4,872

 

781

 

Other liabilities

 

10,522

 

9,773

 

Minority interest in net assets of joint ventures

 

45,436

 

57,801

 

Total liabilities

 

410,637

 

478,890

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued and outstanding

 

 

 

Common stock, $.01 par value; 100,000,000 shares authorized; 18,064,964 and 18,377,161 issued and outstanding, respectively

 

181

 

184

 

Additional paid-in capital

 

317,220

 

323,529

 

Retained earnings

 

41,544

 

2,649

 

Accumulated other comprehensive income

 

 

2,438

 

Total stockholders’ equity

 

 

358,945

 

328,800

 

Total liabilities and stockholders’ equity

 

 

$

769,582

 

$

807,690

 

 

The accompanying notes are an integral part of these consolidated statements.

 

4



 

DUPONT PHOTOMASKS, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(unaudited)

 

 

 

Nine Months Ended
March 31,

 

 

 

2003

 

2004

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(54,366

)

$

(38,895

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

74,450

 

69,229

 

Minority interest in income (loss) of joint ventures

 

2,180

 

(302

)

Deferred income taxes

 

1,065

 

624

 

Special charges, net

 

21,754

 

2,097

 

Other

 

180

 

340

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable, trade, net

 

(696

)

(13,649

)

Accounts receivable, related parties

 

3,376

 

(371

)

Inventories

 

(1,338

)

1,431

 

Other assets, net

 

23,103

 

4,583

 

Accounts payable, trade

 

(5,181

)

(5,175

)

Accounts payable, related parties

 

(4,634

)

2,375

 

Other liabilities

 

(13,135

)

(16,116

)

 

 

 

 

 

 

Net cash provided by operating activities

 

46,758

 

6,171

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of property and equipment

 

(50,045

)

(33,528

)

Cash assumed in consolidation of BAC

 

 

5,821

 

Proceeds from sale of assets

 

 

2,000

 

Proceeds from sale of warrants and investments

 

105

 

 

Purchases of investments

 

(1,983

)

 

 

 

 

 

 

 

Net cash used in investing activities

 

(51,923

)

(25,707

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from borrowings

 

2,368

 

723

 

Payments on borrowings

 

(3,369

)

(5,453

)

Proceeds from issuance of common stock under employee plans

 

2,727

 

2,312

 

 

 

 

 

 

 

Net cash provided by (used in) financing activities

 

1,726

 

(2,418

)

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

595

 

419

 

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(2,844

)

(21,535

)

Cash and cash equivalents at beginning of period

 

138,918

 

250,355

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

136,074

 

$

228,820

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

 

 

 

 

 

Cash paid (received) for:

 

 

 

 

 

Interest

 

$

362

 

$

1,202

 

 

 

 

 

 

 

Taxes, net

 

$

(21,825

)

$

403

 

 

The accompanying notes are an integral part of these consolidated statements.

 

5



 

DUPONT PHOTOMASKS, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Dollars in thousands)

 

 

 

 

 

 

 

Additional
Paid-In
Capital

 

Retained
Earnings

 

Accumulated Other
Comprehensive
Income

 

Total
Stockholders’ Equity

 

 

 

Common Stock

 

 

 

 

 

 

 

Shares

 

Amount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of June 30, 2002

 

17,927,294

 

$

179

 

$

314,430

 

$

155,054

 

$

 

$

469,663

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock under employee plans

 

137,670

 

2

 

2,790

 

 

 

2,792

 

Net loss

 

 

 

 

(113,510

)

 

(113,510

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of June 30, 2003

 

18,064,964

 

181

 

317,220

 

41,544

 

 

358,945

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock under employee plans

 

131,500

 

1

 

2,311

 

 

 

2,312

 

Issuance of common stock (Note 12)

 

180,697

 

2

 

3,998

 

 

 

4,000

 

Foreign currency translation adjustments

 

 

 

 

 

2,438

 

2,438

 

Net loss

 

 

 

 

(38,895

)

 

(38,895

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance as of March 31, 2004 (unaudited)

 

18,377,161

 

$

184

 

$

323,529

 

$

2,649

 

$

2,438

 

$

328,800

 

 

The accompanying notes are an integral part of these consolidated statements.

 

6



 

DUPONT PHOTOMASKS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except share data)

(unaudited)

 

1.                                      Basis of Presentation

 

The interim consolidated financial statements presented in this report include the accounts of DuPont Photomasks, Inc., our controlled and wholly-owned subsidiaries, and variable interest entities of which we are the primary beneficiary. All significant inter-company transactions and accounts have been eliminated in consolidation. These interim consolidated financial statements have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission, or SEC. All adjustments have been made to the accompanying interim consolidated financial statements which are, in the opinion of management, necessary for a fair presentation of our operating results and include all adjustments of a normal recurring nature. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the SEC.

 

It is recommended that these interim consolidated financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended June 30, 2003. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the use of estimates and assumptions by management in determining the reported amounts of assets and liabilities, disclosures of contingent liabilities as of the date of the financial statements and the reported amounts of revenue and expenses during the period. Actual results could differ from those estimates. The results of operations for any interim period are not necessarily indicative of the results of operations for the entire fiscal year. Certain reclassifications have been made in the prior period consolidated financial statements to conform with the current period presentation.  As of March 31, 2004, we began consolidating the financial results of the Maskhouse Building Administration GmbH & Co. KG (“BAC”), a joint venture equally owned by AMD, Infineon and DuPont Photomasks, Inc., in accordance with the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 46R (“FIN No. 46R”), Consolidation of Variable Interest Entities (“VIE”).  See Notes 2 and 8.

 

2.                                      New Accounting Pronouncements

 

In December 2003, the FASB issued FIN No. 46R, a revision to FIN No. 46.  FIN No. 46R clarifies some of the provisions of FIN No. 46 and exempts certain entities from its requirements.  FIN No. 46R requires that if a company is the primary beneficiary of a VIE, the assets, liabilities and results of the VIE’s operations should be consolidated in the company’s financial statements.  Based on the guidance in FIN No. 46R, we concluded that we are the primary beneficiary of the BAC. Accordingly, we began consolidating the financial results of the BAC as of March 31, 2004.  The consolidation of the BAC had no impact on our consolidated income statements during the three and nine months ended March 31, 2004. However, the consolidation of the BAC did increase our consolidated assets and liabilities as of March 31, 2004 by approximately $89,000. AMD and Infineon’s equity ownership in the net assets of the BAC as of March 31, 2004 was approximately $13,000 and is recorded as minority interest in net assets of joint ventures on our consolidated balance sheet. Subsequent to March 31, 2004, we expect the consolidation of the BAC will have no impact on our consolidated net income or loss as we would have otherwise continued to record our equity interest in the BAC under the equity method.  The receipt of the investment subsidies from the German government by the BAC and the payments on the BAC term loan by the BAC will have material impacts on our consolidated cash flows from investing and financing activities, respectively.  Prior to our consolidation of the BAC, we have recorded our rent payments to the BAC in our cash flows from operating activities.  The consolidation has not altered the operational agreements, guarantees and other commitments between the BAC, its partners and lenders.

 

In January 2003, the Securities and Exchange Commission (“SEC”) issued a final rule requiring enhanced disclosure of material off-balance sheet transactions, arrangements, and other relationships with unconsolidated entities. The rule also requires a tabular disclosure of future payments due under contractual commitments. The disclosure requirements will become effective for our fiscal 2004 Annual Report on Form 10-K. We do not expect this rule will have a material impact on our consolidated financial condition or results of operations.

 

7



 

In December 2003, the SEC issued Staff Accounting Bulletin (“SAB”) No. 104, Revenue Recognition, which supersedes SAB No. 101, Revenue Recognition in Financial Statements. The adoption of SAB No. 104 did not have a material impact on our consolidated results of operations or financial position. Accounting guidance contained in SAB No. 101 related to multiple-element revenue arrangements was superseded as a result of the issuance of Emerging Issues Task Force (“EITF”) EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. SAB No. 104 restates the affected portion of SAB No. 101 to reflect the issuance of EITF 00-21 while the revenue recognition principles of SAB No. 101 remain largely unchanged. SAB No. 104 was effective upon issuance.

 

3.                                      Derivative Instruments and Hedging Activities

 

Forward foreign exchange contracts are utilized to mitigate the risks associated with currency fluctuations on certain foreign currency balance sheet exposures, and are, therefore, held primarily for purposes other than trading. These foreign exchange contracts do not qualify for hedge accounting under SFAS No. 133 Accounting for Derivative Instruments and Hedging Activities, as amended. Unrealized gains and losses resulting from the impact of currency exchange rate movements on forward foreign exchange contracts designated to offset certain non-U.S. dollar denominated assets and liabilities are recognized as other income or expense on the accompanying consolidated income statements in the period in which the exchange rates change. These gains and losses offset the foreign currency exchange gains and losses on the underlying exposures being hedged. An unrealized gain of $154 for the three and nine months ended March 31, 2004 is recorded in other income (expense), net on the accompanying consolidated income statement in relation to our forward exchange contracts outstanding as of March 31, 2004. These instruments may involve elements of credit and market risk in excess of the amounts recognized on the consolidated financial statements. We monitor our positions and the credit quality of counterparties, consisting primarily of major financial institutions, and do not anticipate nonperformance by any counterparty, although nonperformance could occur.

 

4.                                      Comprehensive Income

 

We had no items of comprehensive income other than net loss for the three and nine months ended March 31, 2003. Our comprehensive income for the three and nine months ended March 31, 2004 is comprised of net loss and foreign currency translation adjustments.

 

5.                                      Earnings (Loss) Per Share

 

Basic earnings (loss) per share, or basic EPS, is computed by dividing net income (loss) by the weighted number of common shares outstanding during each period. Diluted earnings (loss) per share, or diluted EPS, is computed by dividing net income (loss) after adjustments for the dilutive effect of our convertible notes (if dilutive), by the weighted average number of common shares and potentially dilutive shares outstanding (if dilutive) during each period. Potentially dilutive shares include stock options and assumed conversion of the convertible notes. The number of potentially dilutive shares outstanding relating to stock options is computed using the treasury stock method and the number of potentially dilutive shares outstanding relating to the convertible notes is computed using the if-converted method.

 

8



 

The reconciliation of the amounts used to calculate the basic EPS and diluted EPS is as follows:

 

 

 

Three Months Ended
March 31,

 

Nine Months Ended
March 31,

 

 

 

2003

 

2004

 

2003

 

2004

 

 

 

 

 

 

 

 

 

 

 

Net loss for the period—basic

 

$

(25,854

)

$

(10,564

)

$

(54,366

)

$

(38,895

)

Dilutive effect of convertible notes

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss for the period—diluted

 

$

(25,854

)

$

(10,564

)

$

(54,366

)

$

(38,895

)

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding—basic

 

18,037,432

 

18,176,334

 

18,000,257

 

18,138,289

 

Plus: Potentially dilutive shares

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding—dilutive

 

18,037,432

 

18,176,334

 

18,000,257

 

18,138,289

 

 

 

 

 

 

 

 

 

 

 

Basic loss per share

 

$

(1.43

)

$

(0.58

)

$

(3.02

)

$

(2.14

)

 

 

 

 

 

 

 

 

 

 

Diluted loss per share

 

$

(1.43

)

$

(0.58

)

$

(3.02

)

$

(2.14

)

 

Stock options to acquire 4,341,430 and 4,837,688 shares for the three and nine months ended March 31, 2003 and 2004, respectively, were not included in potentially dilutive shares because the effect of including these stock options would have been anti-dilutive. For the three and nine months ended March 31, 2003, 941,088 shares were not included in the computations of diluted EPS because the effect of including the shares to be issued upon the conversion of convertible notes would have been anti-dilutive. For the three and nine months ended March 31, 2004, 5,824,850 shares were not included in the computations of diluted EPS because the effect of including the shares to be issued upon the conversion of convertible notes would have been anti-dilutive. These options and the convertible notes may become dilutive in the future.

 

6.                                      Income Taxes

 

The provision for income taxes differs from amounts computed by applying the federal statutory rate of 35% to loss before income taxes and minority interest because of our inability to record deferred tax benefits for net operating losses generated in certain tax jurisdictions, our reduced tax rates in certain Asian jurisdictions, and other adjustments described below.

 

During the nine months ended March 31, 2003, we recorded valuation allowances against our net deferred tax assets in the U.S. and in Europe (primarily related to net operating loss carryforwards). The restructuring in Germany (Note 10) also resulted in a charge for a valuation allowance of $1,812 during the nine months ended March 31, 2003.  Additionally, during the nine months ended March 31, 2003, we received income tax refunds of approximately $23,300 by carrying U.S. net operating losses back to prior years.

 

During the three months and nine months ended March 31, 2004, our net tax provision included a provision of $400 and $1,650, respectively, for withholding taxes related to a previously announced dividend distribution from one subsidiary within our group of foreign subsidiaries. When consummated, this dividend distribution will utilize the majority of our U.S. net operating loss carryforward.  For the nine months ended March 31, 2004, our net tax provision also included a $950 benefit from the positive resolution of tax audits in multiple jurisdictions.

 

7.                                      Property and Equipment

 

Property and equipment are stated at cost. Property and equipment under capital leases are stated at the present value of future minimum lease payments. Property and equipment are depreciated using the straight-line method over the estimated useful lives of the assets ranging from three to seven years for equipment and 10 to 20 years for buildings. Property and equipment held under capital leases and leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful lives of the assets or the estimated remaining terms of the leases. Accumulated depreciation and amortization was $443,410 as of June 30, 2003 and $481,346 as of March 31, 2004. Assets held for sale relate to our Gresham, Danbury, and Rousset facilities and certain other equipment. We are actively marketing these assets and will sell the assets after appropriate evaluation of all proposals.

 

9



 

8.                                      Transactions with Consolidated Variable Interest Entity

 

We, along with Infineon and AMD, have established the BAC which is a joint venture that owns a state-of-the-art photomask research and manufacturing facility in Dresden, Germany.  We lease approximately 50 percent of the facility from the BAC for advanced photomask manufacturing and the remainder is leased by the Advanced Mask Technology Center GmbH & Co. KG (“AMTC”).  Both operating leases are for 10-year terms and commenced July 2003.  Future minimum lease payments to be received by the BAC during the remaining term of the non-cancelable lease with the AMTC are estimated to be approximately $63,000.

 

The BAC executed a term loan agreement for its research and manufacturing facility in December 2002.  The BAC term loan had $74,946 outstanding as of March 31, 2004.  Of this amount, $15,199 is due within one year and is included in short-term borrowings on our accompanying consolidated balance sheet as of March 31, 2004.  The BAC term loan matures in June 2012.  Principal payments and interest are due quarterly. The BAC term loan is secured by the property, other financial assets of the BAC, the assignment of rights from BAC insurance contracts, the tenant rent payment guarantees and German government guarantees. Prior to the initial occupancy of the building and initiation of the lease rental payments, we had guaranteed one-third of the BAC’s indebtedness.  Effective July 2003, we were released from the guarantee except if the lenders become liable to return monies received in payment of the indebtedness as a result of any bankruptcy, composition or similar proceedings affecting the BAC.  As of March 31, 2004, the carrying value of the BAC property and equipment was $71,012 and is included in property and equipment, net, in our accompanying consolidated balance sheet.  In addition, investment in the BAC facility is subsidized by the German government.  As of March 31, 2004, amounts receivable by the BAC in relation to these investment subsidies were $17,461 and are included in other receivables on the accompanying consolidated balance sheet.

 

9.                                         Employee Plans

 

We apply the intrinsic-value-based method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations including FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25, to account for our stock performance plans. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. We also have an Employee Stock Purchase Plan. SFAS No. 123, Accounting for Stock Based Compensation, established accounting and disclosure requirement alternatives which involve using a different accounting method for expensing the calculated value of option awards. As allowed by SFAS No. 123, we have elected to continue to apply the intrinsic-value-based method of accounting described above, and have adopted only the disclosure requirements of SFAS No. 123. We use the Black-Scholes model to calculate pro forma expense for disclosure purposes. The Black Scholes option valuation model requires the input of highly subjective assumptions including the expected stock price volatility. We use projected volatility rates which are based upon historical volatility rates. Because our employee stock options and Employee Stock Purchase Plan shares have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our employee stock options and Employee Stock Purchase Plan shares.

 

10



 

SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of FASB Statement No. 123, amends the disclosure requirements of SFAS No. 123. The following table illustrates the effect on net loss if the fair-value-based method had been applied to our stock-based employee compensation plans in each period.

 

 

 

Three Months Ended
March 31,

 

Nine Months Ended
March 31,

 

 

 

2003

 

2004

 

2003

 

2004

 

Net loss:

 

 

 

 

 

 

 

 

 

As reported

 

$

(25,854

)

$

(10,564

)

$

(54,366

)

$

(38,895

)

Deduct total stock-based employee compensation expense determined under the Black-Scholes valuation method for all awards, net of tax

 

(4,176

)

(3,950

)

(12,130

)

(11,037

)

 

 

 

 

 

 

 

 

 

 

Pro forma net loss

 

$

 (30,030

)

$

 (14,514

)

$

 (66,496

)

$

 (49,932

)

 

 

 

 

 

 

 

 

 

 

Basic loss per share:

 

 

 

 

 

 

 

 

 

As reported

 

$

 (1.43

)

$

 (0.58

)

$

 (3.02

)

$

 (2.14

)

Pro forma

 

$

 (1.66

)

$

 (0.80

)

$

 (3.69

)

$

 (2.75

)

 

 

 

 

 

 

 

 

 

 

Diluted loss per share:

 

 

 

 

 

 

 

 

 

As reported

 

$

 (1.43

)

$

 (0.58

)

$

 (3.02

)

$

 (2.14

)

Pro forma

 

$

 (1.66

)

$

 (0.80

)

$

 (3.69

)

$

 (2.75

)

 

10.                               Special Charges, net

 

During fiscal 2003, we implemented programs to reduce costs associated with our North America, Europe and Asia segments. The integration and consolidation initiatives in North America and Asia were completed during fiscal 2003, and the related liabilities were settled as of September 30, 2003. We expect to complete the consolidation initiatives in Europe and extinguish the majority of the related liabilities during the three months ending June 30, 2004.  During the three months ended March 31, 2004, we recorded special charges of $707 primarily related to asset dispositions and we recorded a $224 benefit related to the revision of previously recorded estimates for the closure of the Rousset facility.  During the nine months ended March 31, 2004 we also reduced accrued liabilities for lease termination and asset disposal related costs by $367 as a result of our renegotiation of our lease termination agreement for our Hamburg facility; recorded special charges of $757 which were not previously estimable and related to employee severance for our former employees at our Rousset facility; and recorded a $553 benefit as a result of terminating a capital lease liability on December 31, 2003 for our Hamburg facility. The charges, benefit and adjustments to the liability have been recorded as Special Charges, net on the accompanying consolidated income statements.

 

In July 2003, as part of our efforts to reduce costs, we signed a multi-year pellicle supply agreement with Micro Lithography, Inc. (“MLI”), while concurrently deciding to close our pellicle production facility in Danbury. The closure of the facility was completed as of September 30, 2003. We expect to complete the closure initiatives in Danbury and extinguish the related liabilities during the three months ending June 30, 2004. During the nine months ended March 31, 2004, we recorded special charges of $3,054 for employee severance and asset disposal costs; reduced the employee severance liability by $77; and received proceeds of $1,275 from the sale of certain pellicle technology and equipment.  The charges and adjustments to the liability, net of sale proceeds, have been recorded as Special Charges, net on the accompanying consolidated income statements.

 

11



 

A summary of the related accrued liabilities is shown below:

 

 

 

Employee
Severance

 

Asset
Disposals and
Related
Costs

 

Lease
Termination
and Other
Costs

 

Total

 

 

 

 

 

 

 

 

 

 

 

Remaining liability as of June 30, 2003

 

$

11,404

 

$

1,307

 

$

1,949

 

$

14,660

 

Charges during the nine months ended March 31, 2004

 

3,107

 

1,486

 

 

4,593

 

Adjustments to the liability during the nine months ended March 31, 2004

 

(77

)

(353

)

(238

)

(668

)

Utilized during the nine months ended March 31, 2004

 

(10,523

)

(1,556

)

(1,711

)

(13,790

)

 

 

 

 

 

 

 

 

 

 

Remaining liability as of March 31, 2004

 

$

3,911

 

$

884

 

$

 

$

4,795

 

 

12



 

11.                               Segment Information

 

We conduct operations worldwide and are managed on a geographic basis, with those geographic segments being North America, Europe and Asia. The North America segment consists only of the U.S., the Europe segment includes France and Germany and the Asia segment includes China, Japan, Korea, Taiwan and Singapore.

 

 

 

North
America

 

Europe

 

Asia

 

Eliminations

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2003

 

 

 

 

 

 

 

 

 

 

 

Revenue, net

 

$

38,304

 

$

13,913

 

$

23,924

 

$

 

$

76,141

 

Transfers between geographic segments

 

2,312

 

 

3,979

 

(6,291

)

 

 

 

$

40,616

 

$

13,913

 

$

27,903

 

$

(6,291

)

$

76,141

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(8,286

)

$

(17,498

)

$

(70

)

$

 

$

(25,854

)

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended March 31, 2003

 

 

 

 

 

 

 

 

 

 

 

Revenue, net

 

$

116,252

 

$

43,786

 

$

81,312

 

$

 

$

241,350

 

Transfers between geographic segments

 

5,643

 

270

 

14,281

 

(20,194

)

 

 

 

$

121,895

 

$

44,056

 

$

95,593

 

$

(20,194

)

$

241,350

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(36,727

)

$

(32,542

)

$

14,903

 

$

 

$

(54,366

)

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2003

 

 

 

 

 

 

 

 

 

 

 

Identifiable assets

 

$

308,821

 

$

113,787

 

$

346,974

 

$

 

$

769,582

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended March 31, 2004

 

 

 

 

 

 

 

 

 

 

 

Revenue, net

 

$

34,275

 

$

25,210

 

$

28,534

 

$

 

$

88,019

 

Transfers between geographic segments

 

10,049

 

 

6,472

 

(16,521

)

 

 

 

$

44,324

 

$

25,210

 

$

35,006

 

$

(16,521

)

$

88,019

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(7,089

)

$

(11,413

)

$

7,938

 

$

 

$

(10,564

)

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended March 31, 2004

 

 

 

 

 

 

 

 

 

 

 

Revenue, net

 

$

105,785

 

$

67,146

 

$

83,429

 

$

 

$

256,360

 

Transfers between geographic segments

 

12,702

 

53

 

12,202

 

(24,957

)

 

 

 

$

118,487

 

$

67,199

 

$

95,631

 

$

(24,957

)

$

256,360

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(17,817

)

$

(37,942

)

$

16,864

 

$

 

$

(38,895

)

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2004

 

 

 

 

 

 

 

 

 

 

 

Identifiable assets

 

$

216,656

 

$

229,025

 

$

362,009

 

$

 

$

807,690

 

 

Products are transferred between geographic areas on a basis intended to approximate the market value of such products.

 

13



 

12.                               Commitments and Contingencies

 

RTC

 

We guarantee a portion of certain equipment leases of the DPI Reticle Technology Center, LLC (“RTC”). Our portion of this guarantee was $2,644 as of March 31, 2004.

 

AMTC

 

We, along with Infineon and AMD, have established the AMTC, a joint venture in Dresden, Germany which conducts leading edge photomask research and pilot manufacturing.  The AMTC leases approximately 50% of the BAC’s facility.  We are committed to funding a portion of the operating cash requirements of the AMTC under research and development reimbursement and capacity utilization obligations through June 30, 2007. We expect our portion of these operating cash requirements to vary between approximately 22% to 26% through June 30, 2007.

 

The AMTC has executed a 120,000 Euro revolving credit facility to be used for equipment purchases. The revolving credit facility had 59,000 Euro ($71,724 as of March 31, 2004) outstanding as of March 31, 2004. Each of the partners of the joint venture has executed one-third guarantees for up to 32,000 Euro and certain additional costs as defined in the revolving credit facility agreement for as long as any obligation remains outstanding under the revolving credit facility. We will be required to honor our guarantee if the AMTC fails to make timely payments under the revolving credit facility; breaches certain financial covenants; becomes insolvent; or in any other way defaults under the revolving credit facility. We will also be required to honor our guarantee if any of the owners of the AMTC breach certain terms of the joint venture agreement, become insolvent or cease doing business, experience a material adverse change affecting their obligations under the guarantee, fail to pay their respective indebtedness in excess of 50,000 Euro or otherwise experience an event constituting a default under the revolving credit facility.

 

Infineon

 

In May 2002, we entered into an agreement to acquire photomask production equipment from Infineon’s internal photomask manufacturing operations in Munich, Germany and become Infineon’s strategic photomask supplier. In consideration for the acquisition of certain photomask production assets and the agreement to supply Infineon with photomasks over a 10 year term, we agreed to pay Infineon $53,500 over a seven-year period ending in March 2009. As part of the same agreement, we also agreed to purchase from Infineon additional photomask production equipment for approximately $28,100 payable over a five-year period ending in December 2006. We have made aggregate purchases of approximately $26,200 pursuant to this agreement as of March 31, 2004. Included in that amount is a $10,000 payment we made to Infineon in March 2004; $4,000 of which was satisfied through the issuance of 180,697 shares of our common stock and the remaining $6,000 was settled using cash.  Per the terms of the agreement, we may elect to satisfy a portion of certain additional future amounts payable by issuing shares of our common stock.  Our decision as to the form of each such payment (cash only, or cash and shares of our common stock) will be made at least thirty days prior to the due date for each payment.  Each payment is considered independently and the payment in shares of our common stock may not exceed forty percent of the total of any single payment.  The maximum value of our common stock that we could issue to Infineon, if we choose to fully exercise our rights for future payments, approximated $20,500 as of March 31, 2004.

 

BindKey

 

We have established a profit sharing plan with the BindKey employees. Through March 2006, BindKey employees may earn amounts annually based on the annual after-tax earnings of BindKey. Upon the termination of the final year subject to the profit sharing plan, the employees may earn an additional lump-sum amount based on the after-tax earnings of BindKey in the final year. Any amounts earned in relation to the profit sharing plan will be expensed in the period earned.

 

Schott

 

In March 2002, we sold all of our photoblank manufacturing assets to Schott Lithotec AG (“Schott”). We also entered into a supply agreement with Schott for a significant portion of our future purchases of photoblanks.

 

14



 

MLI

 

In July 2003, we signed a multi-year pellicle supply agreement with MLI for a significant portion of our future purchases of pellicles.

 

General

 

As of March 31, 2004, minimum lease payments for non-cancelable operating lease obligations are estimated to be $3,741, $2,432, $1,970, $1,934, and $1,182 for annual periods ending March 31, 2005 through 2009, respectively, and $2,894 in the aggregate thereafter.

 

We have various purchase commitments incidental to the normal course of business, including non-refundable deposits to purchase equipment. In the aggregate, such commitments are not at prices in excess of current market.

 

We are subject to litigation in the normal course of business. We believe the effect, if any, of an unfavorable settlement of such litigation would not have a material adverse impact on our financial position, results of operations or cash flows.

 

Our operations and our ownership of real property are subject to various environmental laws and regulations that govern, among other things, the discharge of pollutants into the air and water and the handling, use, storage, disposal and clean-up of solid and hazardous wastes. Compliance with such laws and regulations requires that we incur capital expenditures and operating costs in connection with our ongoing operations. In addition, such laws and regulations may impose liabilities on owners and operators of businesses and real property without regard to fault and such liabilities may be joint and several with other parties. More stringent environmental laws and regulations may be enacted in the future, which may require us to expend additional amounts on environmental compliance or may require modifications to our operations. Although we are unable to predict the extent of our future liability with respect to any environmental matters, we believe, based upon current information, that environmental liabilities will not be material to our financial position, results of operations or cash flows. E.I. du Pont de Nemours and Company has agreed to indemnify us for any environmental contamination present on our manufacturing sites at June 13, 1996, the date of our initial public offering, or present at any such site due to the generation, use, treatment, storage, release, emission, discharge or disposal of hazardous waste or hazardous materials before such date. The Environmental Protection Agency is reviewing a groundwater contamination issue at our Danbury site under voluntary corrective action. Any such contamination is believed to be offsite or historical, and, if that is the case, any environmental liabilities would be covered by the indemnification agreement with E.I. du Pont de Nemours and Company.

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of the financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this document. All references to years are to our fiscal years, which end on June 30, unless otherwise noted. Results for interim periods are not necessarily indicative of results for the full year. Due to rounding, some columns may not total and some percentage calculations may not recalculate within the financial tables.  Statements in this report that relate to future results and events are based on our current expectations. Actual results in future periods may differ materially from those currently expected or desired because of a number of risks and uncertainties. For a discussion of factors affecting our business, see “Item 1-Business” in our Annual Report on Form 10-K for the fiscal year ended June 30, 2003.

 

Overview

 

We are a leading global provider of microimaging solutions. We develop and produce photomasks, a key enabling technology used in the manufacture of semiconductor and other microelectronic devices. We also develop and market electronic design automation (“EDA”) software. Our current EDA software product enables chip designers to ensure manufacturability earlier in the design cycle and is targeted at the market segment referred to in the industry as “Design for Manufacturing” (“DFM”).

 

Virtually all of our revenue is derived from the semiconductor industry. Our customers include integrated device manufacturers (companies that design, build and market semiconductor chips) (“IDMs”), semiconductor foundries (companies that provide sub-contract manufacturing of semiconductor chips) and fabless semiconductor companies (companies that design and market semiconductor chips and sub-contract manufacturing to foundries or IDMs).

 

15



 

The semiconductor industry is cyclical in nature. Based on data published by industry analysts, annual worldwide semiconductor revenue increased by 30% in calendar 2000, decreased by 31% in calendar 2001, increased by 2% in calendar 2002 and increased by 14% in calendar 2003.  Most industry observers predict semiconductor revenue in calendar 2004 will increase at least 20%.

 

Our revenue derived from leading edge designs during our third quarter of fiscal 2004 grew for the third consecutive quarter and represented approximately 30% of our total revenue.  Leading edge designs are those with design rules at and below 130-nanometers.  We believe that this trend is important as it reflects the improving conditions across the semiconductor industry and it is an indication that our customers have improved their abilities to better manage complex design issues and have improved wafer fab yields at the leading edge.  Additionally, we believe this trend reflects the recognition by our customers of our strong and improving technology position as evidenced by the fact that the 2004 third fiscal quarter marked another record for our revenue from phase shift masks, the most complex and difficult mask technology required in the industry. With phase shift production processes now in place at four of our sites globally, and with steadily improving yields, we believe we have recently gained market share at major customers.  In addition, we continue to benefit from increasing revenue from one of our strategic partners, Infineon Technologies.  We are ahead of our original revenue projections from Infineon, as they phase out their internal photomask operations in Munich, Germany.

 

Over the longer term, we expect the photomask industry’s revenue growth will be driven by leading edge products supporting design rules of 130-nanometers and below. In order to improve our competitive position in those products, we have co-invested in the AMTC, a joint venture research and development initiative with AMD and Infineon. The AMTC operates in a new, state-of-the-art facility in Dresden, Germany and is focused on developing next generation photomask products and processes supporting 90-nanometer and below design rules. The AMTC operates in the same cleanroom alongside our new advanced manufacturing operations. The co-location of a research and development center and commercial operations is designed to streamline the transfer of new photomask technologies into production volumes. We believe that our investments in the AMTC and our operations in Dresden will accelerate development and commercialization of leading edge photomask technologies and thereby provide us with future opportunities to gain market share.

 

We continue to execute on plans that include various revenue growth initiatives and plans that take actions necessary to more closely match our capacity with our revenue projections.  Our plans are designed to increase revenue and reduce our break-even level, thereby returning us to profitability.  In our fiscal quarter ended March 31, 2004, we increased revenue sequentially and improved product mix and operational efficiencies.  Since December 2002, we have ceased manufacturing operations in three manufacturing facilities and reduced headcount by over 200 employees, while at the same time staffing our new manufacturing facility in Dresden. We also expect that in the future our investments in Dresden will increase our share of leading edge masks and that our investments in DFM and microimaging capabilities will expand our target markets.  Our primary photomask competitors include Compugraphics, Dai Nippon Printing, Photronics, TMC and Toppan Printing. In addition, several IDMs, including IBM, Intel, Micron and Samsung, and some semiconductor foundries such as SMIC and TSMC, maintain their own captive photomask manufacturing operations. The capacity, technical capabilities and resultant volumes processed through these captives affect the size of the photomask market in which we compete.

 

In the future, the size of the photomask market may also be affected by a variety of other factors such as pricing pressures and unit volumes, including an increasing number of layers per device as design rules decrease, the reluctance to initiate production of new semiconductor designs should our customers’ factories be running at high utilization rates, and increased usage of multi-project wafers and multi-layer reticles.

 

16



 

Results of Operations

 

Financial Summary

(Dollars in millions)

 

 

 

Three Months Ended
March 31,

 

Nine Months Ended
March 31,

 

 

 

2003

 

2004

 

2003

 

2004

 

 

 

 

 

 

 

 

 

 

 

Revenue, net

 

$

76.1

 

$

88.0

 

$

241.4

 

$

256.4

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

74.5

 

75.8

 

216.2

 

228.6

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

$

1.7

 

$

12.2

 

$

25.1

 

$

27.8

 

Gross margin

 

2.2

%

13.9

%

10.4

%

10.8

%

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative expense

 

$

11.2

 

$

12.0

 

$

31.5

 

$

37.7

 

 

 

 

 

 

 

 

 

 

 

Research and development expense

 

6.6

 

8.8

 

21.7

 

23.4

 

 

 

 

 

 

 

 

 

 

 

Special charges, net

 

9.2

 

0.5

 

21.8

 

2.1

 

 

 

 

 

 

 

 

 

 

 

Operating loss

 

$

(25.3

)

$

(9.0

)

$

(49.9

)

$

(35.4

)

Operating margin

 

(33.3

)%

(10.3

)%

(20.7

)%

(13.8

)%

 

(Dollars in Millions)

 

 

Three Months Ended

 

 

 

Nine Months Ended

 

 

 

For the Period Ended March 31:

 

2003

 

2004

 

Delta

 

2003

 

2004

 

Delta

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue, net

 

$

76.1

 

$

88.0

 

15.6

%

$

241.4

 

$

256.4

 

6.2

%

 

Revenue, net is comprised primarily of photomask sales to semiconductor manufacturers.  Revenue, net increased 15.6% for the three months ended March 31, 2004 compared with the same period in the prior year.  The increase was primarily attributable to an improvement in mix driven by leading edge revenue, defined as 130-nanometers and below design rules.

 

Leading edge revenue grew for the third consecutive quarter and represented approximately 30% of our total revenue.  During the 2004 three-month period, we set another record for our revenue from phase shift masks.  Compared to the same three-month period in 2003, leading edge revenue increased approximately 60%.  In the leading edge market, we experienced strong demand from customers participating in the dynamic random access memory, and flash memory and logic markets, including digital signal processors.

 

Revenue, net increased 6.2% during the 2004 nine-month period compared with the prior year. The overall increase was primarily attributable to an improvement in mix driven by revenue from leading edge technology. Revenue from 130-nanometers and below design rules represented approximately 24% of revenue for the 2004 nine-month period as compared with approximately 16% of revenue for the same time period during the prior year.

 

17



 

(Dollars in Millions)

 

 

Three Months Ended

 

 

 

Nine Months Ended

 

 

 

For the Period Ended March 31:

 

2003

 

2004

 

Delta

 

2003

 

2004

 

Delta

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

$

74.5

 

$

75.8

 

1.7

%

$

216.2

 

$

228.6

 

5.7

%

 

 

Cost of goods sold consists of materials, labor, depreciation, and overhead. Cost of goods sold increased 1.7% for the 2004 three-month period compared with the prior year.  The increase was due to the ramp-up of our advanced production facility in Dresden and personnel-related costs in North America. These increases in cost of goods sold were mostly offset by decreased depreciation expense resulting from the impairment of certain long-lived assets in June 2003, operational cost savings and cost savings from the closure of our pellicle production facility in Danbury in September 2003.

 

Cost of goods sold increased 5.7% for the 2004 nine-month period compared with the prior year. The increase was primarily attributable to the ramp-up of our advanced production facility in Dresden, costs previously included in our RTC joint venture, expenses related to the consolidation of trailing edge production in Europe and personnel-related costs in North America. These increases in cost of goods sold were partially offset by decreased depreciation expense resulting from the impairment of certain long-lived assets in June 2003.

 

Gross margin increased from 2.2% for the three months ended March 31, 2003 to 13.9% for the three months ended March 31, 2004.

 

During the short term, we expect that cost savings from the consolidation of Europe manufacturing, closure of our Danbury pellicle facility, improved operational efficiencies and reductions of other employee related costs will offset expenses associated with the ramp-up of our Dresden facility. During the three months ending June 30, 2004, we expect gross margin to be between 14% and 18%.

 

(Dollars in Millions)

 

 

Three Months Ended

 

 

 

Nine Months Ended

 

 

 

For the Period Ended March 31:

 

2003

 

2004

 

Delta

 

2003

 

2004

 

Delta

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative expense

 

$

11.2

 

$

12.0

 

7.1

%

$

31.5

 

$

37.7

 

19.5

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As a percent of revenue, net

 

14.7

%

13.6

%

 

 

13.1

%

14.7

%

 

 

 

Selling, general and administrative expense includes salaries of sales and administrative personnel, marketing expense, general and administrative expense and product distribution expense. Selling, general and administrative expense increased 7.1% for the 2004 three-month period compared with the prior year. Selling, general and administrative expense as a percentage of revenue decreased from 14.7% for the three months ended March 31, 2003 to 13.6% for the three months ended March 31, 2004.  The increase in expense during the 2004 three-month period was primarily attributable to personnel-related expense, professional fees related to the Sarbanes-Oxley Act of 2002 and BindKey costs.

 

Selling, general and administrative expense increased 19.5% for the 2004 nine-month period compared with the prior year.  Selling, general and administrative expense as a percentage of revenue increased from 13.1% for the nine months ended March 31, 2003 to 14.7% for the nine months ended March 31, 2004. The increase during the 2004 nine-month period was primarily attributable to personnel-related expense, BindKey costs, the ramp up of our Dresden facility and professional fees related to the Sarbanes-Oxley Act of 2002.

 

During the three months ending June 30, 2004, we expect selling, general and administrative expense as a percentage of revenue to be between 13% and 14%.

 

18



 

(Dollars in Millions)

 

 

Three Months Ended

 

 

 

Nine Months Ended

 

 

 

For the Period Ended March 31:

 

2003

 

2004

 

Delta

 

2003

 

2004

 

Delta

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research & development expense

 

$

6.6

 

$

8.8

 

33.8

%

$

21.7

 

$

23.4

 

7.7

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As a percent of revenue, net

 

8.6

%

10.0

%

 

 

9.0

%

9.1

%

 

 

 

 

Research and development expense consists primarily of employee costs, cost of consumed materials, depreciation, engineering related costs and our share of costs of the RTC and AMTC joint ventures. Research and development expense increased 33.8% for the 2004 three-month period compared with the prior year.  As a percentage of revenue it increased from 8.6% for the three months ended March 31, 2003 to 10.0% for the three months ended March 31, 2004.  The increase was primarily due to the ramp-up expense of the AMTC and BindKey software development expense.

 

Research and development expense increased 7.7% for the 2004 nine-month period compared with the prior year. The increase was primarily due to the ramp-up expense of the AMTC and BindKey software development expense.  The increase was partially offset by reduced costs of the RTC due to a modification of the agreement with the RTC partners during December 2002.

 

We believe the costs of the AMTC will continue to increase with its ramp-up. During the three months ending June 30, 2004, we expect research and development expense as a percentage of revenue to be between 9% and 10%.

 

 

(Dollars in Millions)

 

 

Three Months Ended

 

 

 

Nine Months Ended

 

 

 

For the Period Ended March 31:

 

2003

 

2004

 

Delta

 

2003

 

2004

 

Delta

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Special charges, net

 

$

9.2

 

$

0.5

 

(94.5

)%

$

21.8

 

$

2.1

 

(90.4

)%

 

During 2003, we implemented programs to reduce costs associated with our European trailing edge operations which resulted in special charges related to employee severance, asset disposal, lease termination and related costs. During the three months ended March 31, 2004, we recorded special charges of $0.7 million primarily related to asset dispositions and we recorded a $0.2 million benefit related to the revision of previously recorded estimates for the closure of the Rousset facility.  During the nine months ended March 31, 2004, we also reduced accrued liabilities for lease termination and asset disposal related costs by $0.4 million as a result of our renegotiation of our lease termination agreement for our Hamburg facility; recorded special charges of $0.8 million which were not previously estimable and related to employee severance for our former employees at our Rousset facility; and recorded a $0.6 million benefit as a result of terminating a capital lease liability on December 31, 2003 for our Hamburg facility.

 

In July 2003, as part of our efforts to reduce costs, we signed a multi-year pellicle supply agreement with MLI, while concurrently deciding to close our pellicle production facility in Danbury. During the nine months ended March 31, 2004, we recorded special charges of $3.1 million for employee severance and asset disposal costs; reduced the employee severance liability by $0.1 million; and received proceeds of $1.3 million from the sale of certain pellicle technology and equipment.

 

(Dollars in Millions)

 

 

Three Months Ended

 

 

 

Nine Months Ended

 

 

 

For the Period Ended March 31:

 

2003

 

2004

 

Delta

 

2003

 

2004

 

Delta

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other income (expense), net

 

$

(1.1

)

$

0.1

 

(105.9

)%

$

(1.0

)

$

(1.1

)

9.0

%

 

Other income (expense), net includes interest income, interest expense, our equity in earnings of our equity method investees, and foreign currency exchange gains and losses.  For the 2004 three-month period, expense decreased primarily due to a lower net foreign currency exchange loss compared with the prior year.

 

For the 2004 nine-month period, expense increased due to interest expense on our $125.0 million convertible subordinated notes issued and sold during May 2003 partially offset by a smaller net foreign currency exchange loss and an increase in interest income.

 

19



 

(Dollars in Millions)

 

 

Three Months Ended

 

 

 

Nine Months Ended

 

 

 

For the Period Ended March 31:

 

2003

 

2004

 

Delta

 

2003

 

2004

 

Delta

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for (benefit from) income taxes

 

$

(0.0

)

$

1.3

 

NM

 

$

1.4

 

$

2.8

 

103.0

%

 


NM — not meaningful

 

The provision for income taxes differs from amounts computed by applying the federal statutory rate of 35% to loss before income taxes and minority interest because of our inability to record deferred tax benefits for net operating losses generated in certain tax jurisdictions, our reduced tax rates in certain Asian jurisdictions, and for other adjustments described below.

 

During the three months and nine months ended March 31, 2004, our net tax provision included a provision of $0.4 million and $1.7 million, respectively, for withholding taxes related to a previously announced planned dividend distribution from one subsidiary within our group of foreign subsidiaries. When consummated, this dividend distribution will utilize the majority of our U.S. net operating loss carryforward.  For the nine months ended March 31, 2004, our net tax provision also included a $1.0 million benefit from the positive resolution of tax audits in multiple jurisdictions.

 

During the nine months ended March 31, 2003, we recorded valuation allowances against our net deferred tax assets in the U.S. and in Europe (primarily related to net operating loss carryforwards). The restructuring in Germany also resulted in a charge for a valuation allowance of $1.8 million during the nine months ended March 31, 2003.  Additionally, during the nine months ended March 31, 2003, we received income tax refunds of approximately $23.3 million by carrying U.S. net operating losses back to prior years.

 

(Dollars in Millions)

 

 

Three Months Ended

 

 

 

Nine Months Ended

 

 

 

For the Period Ended March 31:

 

2003

 

2004

 

Delta

 

2003

 

2004

 

Delta

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Minority interest in (income) loss of joint ventures

 

$

0.6

 

$

(0.3

)

(155.4

)%

$

(2.2

)

$

0.3

 

(113.9

)%

 

Minority interest reflects our partners’ share of the earnings or losses of our consolidated joint venture operations, which included our Shanghai, China and Hsinchu, Taiwan operations as of March 31, 2004. The minority interest impact of our joint ventures was a decrease of $0.6 million to our net loss for the three months ended March 31, 2003 and an increase of $0.3 million to our net loss for the three months ended March 31, 2004. The change was a result of higher revenue produced in our Taiwan facility.

 

The minority interest impact of our joint ventures was an increase of $2.2 million to our net loss for the nine months ended March 31, 2003 and a decrease of $0.3 million to our net loss for the nine months ended March 31, 2004. The change resulted from lower revenue and higher production costs driven largely by depreciation expense from added equipment in our Taiwan facility.

 

Liquidity and Capital Resources

 

Our working capital was $213.4 million as of June 30, 2003 and $112.6 million as of March 31, 2004. The decrease in working capital was primarily due to the reclassification of our $100.0 million of convertible subordinated notes from a non-current liability to a current liability combined with cash used for capital expenditures. The $100.0 million notes mature in July 2004.

 

20



 

Cash used in investing activities was $51.9 million and $25.7 million for the nine months ended March 31, 2003 and 2004, respectively. Cash used for capital expenditures was $50.0 million and $33.5 million for the nine months ended March 31, 2003 and 2004, respectively. We expect capital expenditures for 2004 to be approximately $45.0 million. Capital expenditures have been and will be used primarily to advance our technical capability at the 65 and 90-nanometer nodes. Additionally, in the future we may pursue acquisitions of businesses, products and technologies, or enter into joint venture arrangements, that could complement or expand our business. Any material acquisition or joint venture could result in a decrease to our working capital depending on the amount, timing and nature of the consideration to be paid. We expect the BAC will receive a $17.5 million payment related to investment subsidies granted by the German government during calendar 2004. Due to the consolidation of the BAC, these amounts will be included in our cash flows from investing activities.

 

Cash provided by financing activities was $1.7 million for the nine months ended March 31, 2003 and cash used in financing activities was $2.4 million for the nine months ended March 31, 2004. The cash used in financing activities during the nine months ended March 31, 2004 was primarily the result of payments on borrowings in China. We expect the BAC’s term loan will be repaid by the BAC using proceeds from the BAC’s investment subsidies and lease payments received from the lessees of the BAC’s facility. Due to the consolidation of the BAC, the payments on the BAC’s term loan will be included in our cash flows from financing activities.

 

Our ongoing cash requirements will be for working capital, capital expenditures, acquisitions, research and development and the repayment of convertible notes and other indebtedness. We expect to repay our $100.0 million convertible notes due in July 2004 from our existing cash balances. Management believes that cash on hand and any cash provided by operations will be sufficient to meet our cash requirements for at least the next 12 months. However, based on our current operating plans, we may seek external financing from time to time to fund our capital expenditures, working capital requirements and other growth initiatives. Sources of external financing could include issuances of equity, convertible debt and short-term or long-term borrowings. There can be no assurance that external sources of financing will be available if our capital requirements exceed cash flows from operations or that we will be able to obtain any additional financing required to fund our capital needs on reasonable terms, or at all.

 

Our consolidated cash and cash equivalents balances as of March 31, 2004, were $228.8 million, of which $12.9 million was attributable to minority shareholders based on their ownership interests in our consolidated joint ventures. As of March 31, 2004, we have pledged $7.5 million of our cash and cash equivalents balances as collateral security for a portion of our short term borrowings. We expect our consolidated cash and cash equivalents balances will be between $225.0 to $230.0 million as of June 30, 2004.

 

The following summarizes our contractual cash obligations as of March 31, 2004 (in millions):

 

 

 

Payments Due for the Periods ending March 31,

 

 

 

Total

 

Year
2005

 

Two Years
2006-2007

 

Two Years
2008-2009

 

Beyond

 

 

 

 

 

 

 

 

 

 

 

 

 

Short-term and long-term borrowings

 

$

82.3

 

$

22.5

 

$

18.2

 

$

18.2

 

$

23.4

 

Convertible notes

 

225.0

 

100.0

 

 

125.0

 

 

Capital lease obligations

 

0.2

 

0.2

 

 

 

 

Operating leases

 

14.1

 

3.7

 

4.4

 

3.1

 

2.9

 

Other long-term obligations (AMTC amounts estimated)

 

46.9

 

11.7

 

28.4

 

3.6

 

3.2

 

 

 

 

 

 

 

 

 

 

 

 

 

Total contractual cash obligations

 

$

368.5

 

$

138.1

 

$

51.0

 

$

149.9

 

$

29.5

 

 

 

We are committed to funding a portion of the operating cash requirements of the AMTC under research and development reimbursement and capacity utilization obligations through June 30, 2007. We expect our portion of these operating cash requirements to vary between approximately 22% to 26% through June 30, 2007.

 

21



 

The following summarizes our commercial commitments as of March 31, 2004 (in millions):

 

 

 

Amounts of Commitment Expiration by Periods Ending March 31,

 

 

 

Total

 

Year
2005

 

Two Years
2006-2007

 

Two Years
2008-2009

 

Beyond

 

 

 

 

 

 

 

 

 

 

 

 

 

Guarantees

 

$

26.5

 

$

26.5

 

$

 

$

 

$

 

Other commercial commitments

 

55.4

 

27.6

 

24.3

 

3.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total commercial commitments

 

$

81.9

 

$

54.1

 

$

24.3

 

$

3.5

 

$

 

 

We have also executed a one-third guarantee for up to 32.0 million Euro of the AMTC’s 120.0 million Euro revolving credit facility. The revolving credit facility had 59.0 million Euro ($71.7 million as of March 31, 2004) outstanding as of March 31, 2004. Guarantees also include our portion of certain equipment leases of the RTC. Our portion of this guarantee was approximately $2.6 million as of March 31, 2004.

 

In May 2002, we entered into an agreement to acquire photomask production equipment from Infineon’s internal photomask manufacturing operations in Munich, Germany and become Infineon’s strategic photomask supplier. In consideration for the acquisition of certain photomask production assets and the agreement to supply Infineon with photomasks over a 10 year term, we agreed to pay Infineon $53.5 million over a seven-year period ending in March 2009. As part of the same agreement, we also agreed to purchase from Infineon additional photomask production equipment for approximately $28.1 million payable over a five-year period ending in December 2006. We have made aggregate purchases of approximately $26.2 million pursuant to this agreement as of March 31, 2004. Included in that amount is a $10.0 million payment we made to Infineon in March 2004; $4.0 million of which was satisfied through the issuance of 180,697 shares of our common stock and the remaining $6.0 million was settled using cash.  Per the terms of the agreement, we may elect to satisfy a portion of certain additional future amounts payable by issuing shares of our common stock.  Our decision as to the form of each such payment (cash only, or cash and shares of our common stock) will be made at least thirty days prior to the due date for each payment.  Each payment is considered independently and the payment in shares of our common stock may not exceed forty percent of the total of any single payment.  The maximum value of our common stock that we could issue to Infineon, if we choose to fully exercise our rights for future payments, approximated $20.5 million as of March 31, 2004.

 

In addition to the commitments in the tables above, the following commitments and contingencies exist:

 

                  We have established a profit sharing plan with the BindKey employees. Through March 2006, BindKey employees may earn amounts annually based on the annual after-tax earnings of BindKey. Upon the termination of the final year subject to the profit sharing plan, the employees may earn an additional lump-sum amount based on the after-tax earnings of BindKey in the final year. Any amounts earned in relation to the profit sharing plan will be expensed in the period earned.

 

                  In March 2002, we sold all of our photoblank manufacturing assets to Schott. We also entered into a supply agreement with Schott for a significant portion of our future purchases of photoblanks.

 

                  In July 2003, we signed a multi-year pellicle supply agreement with MLI for a significant portion of our future purchases of pellicles.

 

                  We also have various purchase commitments incidental to the normal course of business, including non-refundable deposits to purchase equipment. In the aggregate, such commitments are not at prices in excess of current market.

 

22



 

Critical Accounting Policies

 

Our critical accounting policies are as follows:

 

                  Revenue recognition

 

Product revenue is recognized when both title and risk of loss have transferred to the customer, provided that no significant obligations remain. Discounts and rebates are recorded as a reduction of revenue during the period they are earned by the customer. Provision is made for an estimate of product returns based on historical experience and is recorded as a reduction in revenue. Customarily, our shipping terms are FOB or FCA shipping point; however, our final terms depend upon the negotiations with our customers.

 

                  Estimates, specifically sales return allowances, the allowance for doubtful accounts receivable, allowance for excess and obsolete inventory and depreciation expense

 

The preparation of consolidated financial statements requires us to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reported period.

 

                  We must make estimates of potential future product returns related to current period product revenue. We analyze historical returns, current economic trends, and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns and other allowances. Significant management judgments and estimates must be made and used in connection with establishing the sales returns and other allowances in any accounting period. Material differences may result in the amount and timing of our revenue for any period if management made different judgments or utilized different estimates.

 

                  Similarly, we must make estimates of the collectibility of our accounts receivable. We consider trends of historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. If circumstances change or if our original estimates are otherwise incorrect, we may have to reduce our estimates of the recoverability of amounts due us by a material amount.

 

                  We maintain inventory reserves for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and estimated market value based on assumptions of future demands and market conditions. If actual market conditions are materially less favorable than those projected by management, or if our estimates of market value are later determined to have been materially incorrect, additional inventory write-downs may be required.

 

                  Property and equipment are depreciated using the straight-line method over the estimated useful lives of the assets ranging from three to seven years for equipment and 10 to 20 years for buildings. Property and equipment held under capital leases and leasehold improvements are amortized using the straight-line method over the shorter of the estimated useful lives of the assets or the estimated remaining terms of the leases.

 

                  Valuation of identifiable intangibles and other long-lived assets

 

We assess the impairment of identifiable intangibles subject to amortization and other long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered important which could trigger an impairment review include the following:

 

                  Significant underperformance relative to expected historical or projected future operating results;

 

                  Significant changes in the manner of our use of the acquired assets or the strategy for our overall business;

 

                  Significant negative industry or economic trends; and

 

                  Our market capitalization relative to net book value.

 

23



 

When it is determined that the carrying value of intangibles subject to amortization and other long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, the measurement of any impairment is determined and the carrying value is reduced as appropriate.

 

                  Accounting for income taxes

 

We are required to consider our income taxes in each of the tax jurisdictions in which we operate in computing our effective income tax rate. This process involves estimating our current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and financial reporting purposes. These differences result in deferred tax assets and liabilities, which are included on our consolidated balance sheets. Further, the actual annual amount of taxable income in each tax jurisdiction may differ from the estimates we use to compute the effective tax rate during our first, second and third quarters. Additionally, we evaluate the recoverability of the deferred tax assets from future taxable income and establish valuation allowances if recovery is not more likely than not. Our income tax provision on the consolidated income statements are impacted by changes in the valuation allowance. This process is complex and involves significant management judgment in determining our provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets.

 

                  Consolidation

 

The consolidated financial statements presented herein include the accounts of DuPont Photomasks, Inc., our controlled and wholly-owned subsidiaries, and variable interest entities of which we are the primary beneficiary. All significant inter-company transactions and accounts are eliminated in consolidation. Entities that are not controlled but on which we can exercise significant influence are recorded under the equity method of accounting. As of March 31, 2004, we began consolidating the financial results of the BAC in accordance with the provisions of FIN No. 46R.

 

Other Matters

 

In December 2003, the FASB issued FIN No. 46R, a revision to FIN No. 46.  FIN No. 46R clarifies some of the provisions of FIN No. 46 and exempts certain entities from its requirements.  FIN No. 46R requires that if a company is the primary beneficiary of a VIE, the assets, liabilities and results of the VIE’s operations should be consolidated in the company’s financial statements.  Based on the guidance in FIN No. 46R, we concluded that we are the primary beneficiary of the BAC. Accordingly, we began consolidating the financial results of the BAC as of March 31, 2004.  The consolidation has not altered the operational agreements, guarantees and other commitments between the BAC, its partners and lenders.

 

In January 2003, the SEC issued a final rule requiring enhanced disclosure of material off-balance sheet transactions, arrangements, and other relationships with unconsolidated entities. The rule also requires a tabular disclosure of future payments due under contractual commitments. The disclosure requirements will become effective for our fiscal 2004 Annual Report on Form 10-K. We do not expect this rule will have a material impact on our consolidated financial condition or results of operations.

 

In December 2003, the SEC issued SAB No. 104, Revenue Recognition, which supersedes SAB No. 101, Revenue Recognition in Financial Statements. The adoption of SAB No. 104 did not have a material impact on our consolidated results of operations or financial position. Accounting guidance contained in SAB No. 101 related to multiple-element revenue arrangements was superseded as a result of the issuance of EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. SAB No. 104 restates the affected portion of SAB No. 101 to reflect the issuance of EITF 00-21 while the revenue recognition principles of SAB No. 101 remain largely unchanged. SAB No. 104 was effective upon issuance.

 

24



 

Forward Looking Statements

 

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, that involve a number of risks and uncertainties. Although we believe that the expectations reflected in such forward-looking statements are reasonable, such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those indicated by the forward looking statements. Such risks and uncertainties include, without limitation, the following:

 

                  A renewed downturn in the semiconductor industry could lead to a decrease in the demand for our photomask products;

 

                  The semiconductor industry is highly cyclical and has been subject to significant economic downturns at various times;

 

                  Our financial results may vary significantly from quarter to quarter or we may fail to meet investors’ expectations, which could negatively impact the price of our stock;

 

                  Lack of visibility and short turn around time of orders may impact our ability to respond to a changing business environment;

 

                  We may not obtain sufficient capital to fund our needs;

 

                  Our operating results could be adversely affected by under-utilized production capacity;

 

                  A significant portion of our revenue is derived from Asia and Europe, and therefore, our business, financial condition and results of operations are to a significant degree subject to economic, political and social events in these regions;

 

                  Macroeconomic conditions may have effects on the semiconductor industry;

 

                  We may be unable to enhance our existing products and develop and manufacture new products and upgrades with improved capabilities to satisfy anticipated demand for more technologically advanced photomasks;

 

                  Rapid technological change could render our products obsolete or our manufacturing processes ineffective;

 

                  We may not remain competitive and increased competition could seriously harm our business;

 

                  We may be unable to successfully develop or market our EDA software;

 

                  E.I. du Pont de Nemours and Company has influence on all stockholder votes;

 

                  Our success depends, in part, upon key managerial, engineering and technical personnel as well as our ability to continue to attract and retain additional personnel and integrate new personnel into key positions; and

 

                  Other risks indicated in our other filings with the SEC, including but not limited to those factors which are fully discussed under the caption “Risk Factors” in our Annual Report on Form 10-K filed with the SEC on September 10, 2003.

 

These risks and uncertainties are beyond our control and, in many cases, we cannot predict the risks and uncertainties that could cause our actual results to differ materially from those indicated by the forward-looking statements.

 

The forward-looking statements are made as of the release date hereof, and we disclaim any intention or obligation to update or revise any forward-looking statements or to update the reasons why the actual results could differ materially from those projected in the forward-looking statements, whether as a result of new information, future events or otherwise.

 

25



 

Item 3.   Quantitative and Qualitative Disclosures About Market Risk

 

Market Risk

 

Market risks relating to our operations result primarily from changes in interest rates and changes in foreign currency exchange rates. As of March 31, 2004, we had outstanding $100.0 million in non-interest bearing convertible subordinated notes due in July 2004 and $125.0 million in 1.25% convertible subordinated notes due in May 2008.  We have $82.4 million in other interest bearing borrowings. Of this amount, $75.0 million is related to the BAC term loan which matures in June 2012.  As a result, changes in the interest rate market would change the estimated fair value of our convertible notes and other interest bearing borrowings. We believe that a 10% change in interest rates would not have a material effect on our business, financial condition, results of operations or cash flows.

 

Foreign currency exposures are primarily due to non-North America operations which are subject to certain risks inherent in conducting business abroad, including price and currency exchange controls, fluctuation in the relative value of currencies and restrictive governmental actions. Changes in the relative value of currencies occur from time to time and may, in certain instances, have a material effect on our consolidated financial condition and results of operations. Any exchange rate fluctuations can affect our margins since we may have imbalances between some foreign currency denominated revenue and expenses. Our consolidated financial statements reflect remeasurement and translation of items denominated in non-U.S. currencies to U.S. dollars, our reporting currency. Exchange gains or losses are included in comprehensive income in the period in which they occur. We monitor our exchange rate exposure and attempt to reduce such exposure by hedging. We have entered into forward contracts in currencies of the countries in which we conduct business in order to reduce such exposure. The net unrealized gain related to our forward exchange contracts outstanding as of March 31, 2004 was not significant. In relation to foreign currency translation adjustments, an unrealized gain of $2.4 million is recorded in accumulated other comprehensive income on the accompanying interim unaudited consolidated balance sheet and statement of stockholders’ equity as of March 31, 2004.  Forward exchange contracts may involve elements of credit and market risk in excess of the amounts recognized on the interim unaudited consolidated financial statements. We believe that a 10% change in exchange rates would not have a material effect on our business, financial condition, results of operations or cash flows.  We monitor our positions and the credit quality of counterparties, consisting primarily of major financial institutions, and do not anticipate nonperformance by any counterparty, although nonperformance could occur. There can be no assurance that such forward contracts or any other hedging activity will be available or adequate to eliminate, or even mitigate, the impact of our exchange rate exposure. There can be no assurance that such risks will not have a material adverse impact on our liquidity, financial condition and results of operations in the future.

 

Financial Risk Management

 

Our international revenue is subject to inherent risks, including fluctuations in local economies; difficulties in staffing and managing foreign operations; greater difficulty in accounts receivable collection; costs and risks of localizing products for foreign countries; unexpected changes in regulatory requirements, tariffs and other trade barriers; difficulties in the repatriation of earnings; and burdens of complying with a wide variety of foreign laws. Some of our sales outside of North America are denominated in local currencies, and accordingly, we are subject to the risks associated with fluctuations in currency rates. In general, increases in the value of the dollar against foreign currencies decrease the U.S. dollar value of foreign sales requiring us either to increase our price in the local currency, which could render our product prices noncompetitive, or to suffer reduced revenue and gross margins as measured in U.S. dollars. Our foreign currency hedging program is not designed to hedge the margin risks associated with foreign exchange rate changes. Our hedging is comprised of foreign currency forward exchange contracts utilized to mitigate the risks associated with foreign currency fluctuations on certain balance sheet exposures. However, the hedging program will not eliminate all of our foreign exchange risks.

 

The marketplace for our products dictates that we maintain inventories of raw materials. Therefore, inventory obsolescence is a risk for us due to frequent engineering changes, shifting customer demand, the emergence of new industry standards and rapid technological advances including the introduction by our competitors or us of products embodying new technology. While we maintain valuation allowances for excess and obsolete inventory and we continue to monitor the adequacy of such valuation allowances, there can be no assurance that such valuation allowances will be sufficient.

 

As of March 31, 2004, we had outstanding foreign currency denominated short-term borrowings totaling $22.6 million Of this amount, $15.2 million is related to the BAC term loan.  As of March 31, 2004, we did not have any relationships with any unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Accordingly, we are not exposed to any financing, liquidity, market or credit risk that could arise if we were engaged in such relationships.

 

26



 

As of March 31, 2004 we had $100.0 million of convertible subordinated notes outstanding due in July 2004. The notes have no stated interest, are convertible at any time into shares of our common stock at a conversion price of $106.26 per share, are unconditionally guaranteed by E.I. du Pont de Nemours and Company and are not callable by us. In the event of a fundamental change in our company, each holder of notes will have the right to require us to redeem, in cash, any or all of such holder’s notes at a price equal to 100% of the principal amount to be redeemed. If a fundamental change were to occur, we cannot assure you that we will have sufficient funds to pay the redemption price for all the notes tendered by the holders, although E.I. du Pont de Nemours and Company would be required to pay the redemption price under its guarantee. In that case, our failure to redeem tendered notes would constitute an event of default under the indenture for the notes, and may constitute a default under the terms of other indebtedness that we may enter into from time to time.

 

In addition, we had $125.0 million of convertible subordinated notes outstanding as of March 31, 2004 that are due in May 2008. The notes accrue interest at an annual rate of 1.25% and are convertible at any time into shares of our common stock at a conversion price of $25.595 per share. Interest on the notes is payable semi-annually on May 15 and November 15 of each year. If a change of control occurs, each holder of notes will have the right to require us to redeem, in cash, any or all of such holder’s notes at a price equal to 100% of the principal amount to be redeemed. If a change of control were to occur, we cannot assure you that we will have sufficient funds to pay the redemption price for all the notes tendered by the holders. In that case, our failure to redeem tendered notes would constitute an event of default under the indenture for the notes, and may constitute a default under the terms of other indebtedness that we may enter into from time to time. In connection with the issuance of the notes, we entered into a Registration Rights Agreement and filed a shelf registration statement covering resales of the notes and the common stock issuable upon conversion of the notes. If we fail to comply with certain of our obligations under the Registration Rights Agreement, additional interest will accrue on the affected notes at an annual rate of 0.5%.

 

Item 4.  Controls and Procedures

 

Our chief executive officer and our chief financial officer, based on their evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d -15(e) under the Securities and Exchange Act of 1934) as of the end of the period covered by this report on Form 10-Q of DuPont Photomasks, Inc., have concluded that our disclosure controls and procedures were effective. There were no changes in internal control over financial reporting or in other factors during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II

 

Item 1. Legal Proceedings

 

We are not currently involved in any material legal proceedings.

 

Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities

 

In May 2002, we entered into an agreement to acquire photomask production equipment from Infineon’s internal photomask manufacturing operations in Munich, Germany and become Infineon’s strategic photomask supplier. In consideration for the acquisition of certain photomask production assets and the agreement to supply Infineon with photomasks over a 10 year term, we agreed to pay Infineon $53.5 million over a seven-year period ending in March 2009. As part of the same agreement, we also agreed to purchase from Infineon, additional photomask production equipment for approximately $28.1million payable over a five-year period ending in December 2006. We have made aggregate purchases of approximately $26.2 million pursuant to this agreement as of March 31, 2004. Included in that amount is a $10.0 million payment we made to Infineon in March 2004; $4.0 million of which was satisfied through the issuance of 180,697 shares of our common stock and the remaining $6.0 million was settled using cash.

 

The issuance of 180,697 shares of our common stock to Infineon on March 31, 2004 did not involve a public offering and we relied on the exemption from registration of the issuance of these shares to Infineon provided by Section 4(2) of the Securities Act of 1933.  Pursuant to the terms of our agreement with Infineon, we will file a Form S-3 shelf registration statement registering the resale of these shares by Infineon.

 

We made no repurchases of our equity securities during the three months ended March 31, 2004.

 

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Item 6. Exhibits and Reports on Form 8-K

 

(A)

 

Exhibits

 

 

 

 

 

3.1.1

Certificate of Incorporation of the Company, as amended and restated on April 3, 1996. (A)

 

 

3.1.2

Amendment to the Certificate of Incorporation of the Company. (B)

 

 

3.2

Bylaws, as amended on October 26, 1999. (B)

 

 

3.2.1

Amendments to the Bylaws Of DuPont Photomasks, Inc. as approved by the Board Of Directors on June 23, 2003. (E)

 

 

4.1

Specimen Certificate for Common Stock. (A)

 

 

4.2

Form of Indenture, between DuPont Photomasks, Inc. and Chase Bank of Texas, N.A., as trustee, including the form of Convertible Subordinated Notes due July 24, 2004 attached as Exhibit A thereto. (F)

 

 

4.3

Indenture, between DuPont Photomasks, Inc. and JPMorgan Chase Bank, as trustee, including Form of 1.25% Convertible Subordinated Notes due 2008 (144A Global Note and Reg S. Global Note). (C)

 

 

4.4

Rights Agreement, dated as of January 30, 2001, between DuPont Photomasks, Inc. and EquiServe Trust Company, N.A., as Rights Agent, together with the following exhibits thereto: Exhibit A-Form of Certificate of Designation of Series A Junior Participating Preferred Stock of DuPont Photomasks, Inc.; Exhibit B-Form of Right Certificate; Exhibit C-Summary of Rights to Purchase Shares of Preferred Stock of DuPont Photomasks, Inc. (D)

 

 

4.5

Amendment No. 1 to Rights Agreement, between DuPont Photomasks, Inc. and EquiServe Trust Company, N.A., as Rights Agent, dated as of April 29, 2003. (C)

 

 

4.6

Registration Rights Agreement among DuPont Photomasks, Inc., Credit Suisse First Boston LLC and Lehman Brothers Inc. dated as of May 5, 2003. (C)

 

 

31.1

Certification of Chief Executive Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

31.2

Certification of Chief Financial Officer pursuant to Rule 13a-14 of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

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Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

99.1

DuPont Photomasks, Inc. Code of Business Conduct and Ethics

 

 

 

Letter

 

Definition

 

 

(A)

 

Registration Statement on Form S-1, Registration No. 333-33869.

 

 

(B)

 

Form 8-A12 G/A on June 23, 2000.

 

 

(C)

 

Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2003.

 

 

(D)

 

Form 8-A12B on January 30, 2001.

 

 

(E)

 

Annual Report on Form 10-K for the fiscal year ended June 30, 2003.

 

 

(F)

 

Amendment No. 2 to Form S-3 filed on July 19, 2000.

 

(B)

 

Reports on Form 8-K

 

 

 

 

 

Our report on Form 8-K, dated January 21, 2004, reporting our announcement on January 21, 2004 of our financial results for the fiscal quarter ended December 31, 2003.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

DUPONT PHOTOMASKS, INC. (Registrant)

 

 

 

 

By:

/s/ SATISH RISHI

 

 

 

Satish Rishi

Date: May 12, 2004

 

Executive Vice President—Finance and Chief Financial Officer
(Principal Financial and Accounting Officer)

 

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