**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM10-Q**

 

ý  **QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended September 30, 2004**

 

**o**** TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For thetransition period from _______ to _______**

 

**Commission file number 0-20839**

 

**DUPONTPHOTOMASKS, INC.**

(Exactname 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 bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant was requiredto file such reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes ýNo o

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined in Rule12b-2 of the Exchange Act).Yes ý No o

 

As of November01, 2004, 18,551,879 shares of common stock, $.01 par value, were outstanding.

 

 

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**TABLE OF CONTENTS**

 
| **Part I**   |   |    |   |                                                                                                                                                       |
|--------------|--------|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |   |    |   |                                                                                                                                                       |
|         |   | Item 1. |   | Financial Statements                                                                                                                                       |
|         |   |    |   | Consolidated Income Statements (unaudited) for the Three Months Ended  September 30, 2003 and 2004                                                         |
|         |   |    |   | Consolidated Balance Sheets as of June 30, 2004 and September 30,  2004 (unaudited)                                                                        |
|         |   |    |   | Consolidated Statements of Cash Flows  (unaudited) for the Three Months Ended September 30, 2003 and 2004                                                  |
|         |   |    |   | Consolidated Statements of Stockholders’  Equity for the Twelve Months Ended June 30, 2004 and the Three Months Ended  September 30, 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 6. |   | Exhibits                                                                                                                                                   |
|         |   |    |   | Signatures                                                                                                                                                 |

 

2

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## **PART I**

 

**Item 1. Financial Statements**

** **

**DUPONT PHOTOMASKS, INC. AND SUBSIDIARIES**

 

## **CONSOLIDATED INCOMESTATEMENTS**

**(Dollars in thousands, except share data)**

**(unaudited)**

 
| ** **                                               | ** ** | **Three Months Ended  September 30,** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                               | ** ** | **2003**                              | ** ** | **2004** | ** ** |
|                                                     |       |                                  |       |   |   |
| Revenue, net                                             |       | $                                     | 82,374     |   | $ | 94,847 |   |
| Cost of goods sold                                       |       | 75,647                                |       | 73,777 |   |
| Selling, general and administrative expense              |       | 12,323                                |       | 12,758 |   |
| Research and development expense                         |       | 7,051                                 |       | 7,140 |   |
| Special charges, net                                     |       | 1,230                                 |       | 310 |   |
| Operating income (loss)                                  |       | (13,877                               | )          | 862 |   |
| Other expense, net                                       |       | (663                                  | )          | (684 | ) |
| Income (loss) before income taxes and  minority interest |       | (14,540                               | )          | 178 |   |
| Provision for income taxes                               |       | 650                                   |       | 900 |   |
| Loss before minority interest                            |       | (15,190                               | )          | (722 | ) |
| Minority interest in (income) loss of joint  ventures    |       | 86                                    |       | (296 | ) |
| Net loss                                                 |       | $                                     | (15,104    | ) | $ | (1,018 | ) |
|                                                     |       |                                  |       |   |   |
| Basic loss per share                                     |       | $                                     | (0.83      | ) | $ | (0.06 | ) |
|                                                     |       |                                  |       |   |   |
| Weighted average shares outstanding                      |       | 18,108,478                            |       | 18,457,554 |   |
|                                                     |       |                                  |       |   |   |
| Diluted loss per share                                   |       | $                                     | (0.83      | ) | $ | (0.06 | ) |
|                                                     |       |                                  |       |   |   |
| Weighted average shares outstanding                      |       | 18,108,478                            |       | 18,457,554 |   |

 

The accompanying notes are an integral partof these consolidated statements

 

3

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**DUPONT PHOTOMASKS, INC. AND SUBSIDIARIES**

 

## **CONSOLIDATED BALANCESHEETS**

**(Dollars in thousands, except share data)**

 
| ** **                                                                                                                    | ** ** | **June 30,  2004** | ** ** | **September 30,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-------------------------|------------|
| ** **                                                                                                                    | ** ** | ** **         | ** ** | **(unaudited)**         | ** ** |
| **ASSETS**                                                                                                                    |       |               |       |                    |       |
| Current assets:                                                                                                               |       |               |       |                    |       |
| Cash and cash equivalents                                                                                                     |       | $                  | 231,351    |                    | $          | 143,596 |   |
| Accounts receivable, trade, net                                                                                               |       | 75,094             |       | 61,576                  |       |
| Accounts receivable, related parties                                                                                          |       | 1,984              |       | 1,821                   |       |
| Other receivables                                                                                                             |       | 21,192             |       | —                  |       |
| Inventories                                                                                                                   |       | 12,023             |       | 10,764                  |       |
| Deferred income taxes                                                                                                         |       | 416                |       | 488                     |       |
| Prepaid expenses and other current assets                                                                                     |       | 14,216             |       | 13,807                  |       |
| Total current assets                                                                                                          |       | 356,276            |       | 232,052                 |       |
| Assets held for sale                                                                                                          |       | 8,926              |       | 8,692                   |       |
| Property and equipment, net                                                                                                   |       | 395,507            |       | 376,073                 |       |
| Accounts receivable, related parties                                                                                          |       | 916                |       | 896                     |       |
| Deferred income taxes                                                                                                         |       | 887                |       | 874                     |       |
| Other assets, net                                                                                                             |       | 32,860             |       | 31,328                  |       |
| Total assets                                                                                                                  |       | $                  | 795,372    |                    | $          | 649,915 |   |
|                                                                                                                          |       |               |       |                    |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                |       |               |       |                    |       |
| Current liabilities:                                                                                                          |       |               |       |                    |       |
| Accounts payable, trade                                                                                                       |       | $                  | 45,540     |                    | $          | 29,292 |   |
| Accounts payable, related parties                                                                                             |       | 5,098              |       | 3,630                   |       |
| Income taxes payable                                                                                                          |       | 3,396              |       | 2,394                   |       |
| Other accrued liabilities                                                                                                     |       | 70,093             |       | 44,160                  |       |
| Short-term borrowings                                                                                                         |       | 22,347             |       | 22,221                  |       |
| Convertible notes                                                                                                             |       | 100,000            |       | —                  |       |
| Total current liabilities                                                                                                     |       | 246,474            |       | 101,697                 |       |
| Long-term borrowings                                                                                                          |       | 59,302             |       | 57,842                  |       |
| Long-term convertible notes                                                                                                   |       | 125,000            |       | 125,000                 |       |
| Deferred income taxes                                                                                                         |       | 781                |       | 842                     |       |
| Other liabilities                                                                                                             |       | 9,764              |       | 9,963                   |       |
| Minority interest in net assets of joint  ventures                                                                            |       | 58,863             |       | 59,190                  |       |
| Total  liabilities                                                                                                            |       | 500,184            |       | 354,534                 |       |
|                                                                                                                          |       |               |       |                    |       |
| 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; 18,407,733 and 18,482,388 issued and outstanding,  respectively |       | 184                |       | 185                     |       |
| Additional paid-in capital                                                                                                    |       | 324,049            |       | 325,072                 |       |
| Accumulated deficit                                                                                                           |       | (31,405            | )          | (32,423                 | )          |
| Accumulated other comprehensive income                                                                                        |       | 2,360              |       | 2,547                   |       |
| Total stockholders’ equity                                                                                               |       | 295,188            |       | 295,381                 |       |
| Total liabilities and stockholders’ equity                                                                               |       | $                  | 795,372    |                    | $          | 649,915 |   |

 

The accompanying notes are an integral partof these consolidated statements.

 

4

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**DUPONT PHOTOMASKS, INC. AND SUBSIDIARIES**

 

## **CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Dollars in thousands)**

**(unaudited)**

 
| ** **                                                                       | ** ** | **Three Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                       | ** ** | **2003**                              | ** ** | **2004** | ** ** |
|                                                                             |       |                                  |       |   |   |
| Cash flows from operating activities:                                            |       |                                  |       |   |   |
| Net loss                                                                         |       | $                                     | (15,104    | ) | $ | (1,018 | ) |
| Adjustments to reconcile net loss to net  cash provided by operating activities: |       |                                  |       |   |   |
| Depreciation and amortization                                                    |       | 23,176                                |       | 24,172 |   |
| Minority interest in income (loss) of joint  ventures                            |       | (86                                   | )          | 296 |   |
| Special charges, net                                                             |       | 1,230                                 |       | 310 |   |
| Other                                                                            |       | 169                                   |       | (355 | ) |
| Changes in assets and liabilities:                                               |       |                                  |       |   |   |
| Accounts receivable, trade, net                                                  |       | (6,046                                | )          | 13,431 |   |
| Accounts receivable, related parties                                             |       | (631                                  | )          | 187 |   |
| Inventories                                                                      |       | 1,649                                 |       | 1,282 |   |
| Other assets, net                                                                |       | 4,341                                 |       | (114 | ) |
| Accounts payable, trade                                                          |       | (3,025                                | )          | (16,961 | ) |
| Accounts payable, related parties                                                |       | 1,996                                 |       | (731 | ) |
| Other liabilities                                                                |       | (3,566                                | )          | (8,728 | ) |
|                                                                             |       |                                  |       |   |   |
| Net cash provided by operating activities                                        |       | 4,103                                 |       | 11,771 |   |
|                                                                             |       |                                  |       |   |   |
| Cash flows from investing activities:                                            |       |                                  |       |   |   |
| Purchases of property and equipment                                              |       | (20,046                               | )          | (19,772 | ) |
| Proceeds from investment subsidies                                               |       | —                                |       | 20,843 |   |
|                                                                             |       |                                  |       |   |   |
| Net cash provided by (used in) investing  activities                             |       | (20,046                               | )          | 1,071 |   |
|                                                                             |       |                                  |       |   |   |
| Cash flows from financing activities:                                            |       |                                  |       |   |   |
| Proceeds from borrowings                                                         |       | 41                                    |       | 11 |   |
| Payments on borrowings                                                           |       | (968                                  | )          | (102,344 | ) |
| Proceeds from issuance of common stock  under employee plans                     |       | 1,154                                 |       | 1,024 |   |
| Decrease in minority interest in net assets  of joint ventures                   |       | —                                |       | (150 | ) |
|                                                                             |       |                                  |       |   |   |
| Net cash provided by (used in) financing  activities                             |       | 227                                   |       | (101,459 | ) |
|                                                                             |       |                                  |       |   |   |
| Effect of exchange rate changes on cash                                          |       | 303                                   |       | 862 |   |
|                                                                             |       |                                  |       |   |   |
| Net decrease in cash and cash equivalents                                        |       | (15,413                               | )          | (87,755 | ) |
| Cash and cash equivalents at beginning of  period                                |       | 250,355                               |       | 231,351 |   |
|                                                                             |       |                                  |       |   |   |
| Cash and cash equivalents at end of period                                       |       | $                                     | 234,942    |   | $ | 143,596 |   |
|                                                                             |       |                                  |       |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW  INFORMATION:                               |       |                                  |       |   |   |
| Cash paid for:                                                                   |       |                                  |       |   |   |
| Interest                                                                         |       | $                                     | 179        |   | $ | 1,003 |   |
|                                                                             |       |                                  |       |   |   |
| Taxes, net                                                                       |       | $                                     | 275        |   | $ | 1,830 |   |

 

The accompanying notes are an integral partof these consolidated statements.

 

5

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**DUPONT PHOTOMASKS, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY**

**(Dollars in thousands)**

 
| ** **                                                 | ** ** | ** **       | ** ** | **Additional  Paid-In** | ** ** | **Retained  Earnings  (Accumulated** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Total  Stockholders’** | ** ** |
|------------------------------------------------------------|------------|------------------|------------|-------------------------|------------|--------------------------------------|------------|---------------------------------------|------------|-------------------------------|------------|
| ** **                                                 | ** ** | **Common Stock** | ** ** | ** **              |
| ** **                                                 | ** ** | **Shares**       | ** ** | **Amount**              | ** ** | **Capital**                          | ** ** | **Deficit)**                          | ** ** | **Income**                    | ** ** | **Equity** | ** ** |
|                                                       |       |             |       |                    |       |                                 |       |                                  |       |                          |       |   |   |
| Balance as of June 30, 2003                                |       | 18,064,964       |       | $                       | 181        |                                 | $          | 317,220                               |       | $                             | 41,544     |   | $ | — |   | $ | 358,945 |   |
|                                                       |       |             |       |                    |       |                                 |       |                                  |       |                          |       |   |   |
| Issuance of common stock under employee  plans             |       | 162,072          |       | 1                       |       | 2,831                                |       | —                                |       | —                        |       | 2,832 |   |
| Issuance of common stock                                   |       | 180,697          |       | 2                       |       | 3,998                                |       | —                                |       | —                        |       | 4,000 |   |
| Foreign currency translation adjustments                   |       | —           |       | —                  |       | —                               |       | —                                |       | 2,360                         |       | 2,360 |   |
| Net loss                                                   |       | —           |       | —                  |       | —                               |       | (72,949                               | )          | —                        |       | (72,949 | ) |
|                                                       |       |             |       |                    |       |                                 |       |                                  |       |                          |       |   |   |
| Balance as of June 30, 2004                                |       | 18,407,733       |       | 184                     |       | 324,049                              |       | (31,405                               | )          | 2,360                         |       | 295,188 |   |
|                                                       |       |             |       |                    |       |                                 |       |                                  |       |                          |       |   |   |
| Issuance of common stock under employee  plans (unaudited) |       | 74,655           |       | 1                       |       | 1,023                                |       | —                                |       | —                        |       | 1,024 |   |
| Foreign currency translation adjustments  (unaudited)      |       | —           |       | —                  |       | —                               |       | —                                |       | 187                           |       | 187 |   |
| Net loss (unaudited)                                       |       |             |       |                    |       |                                 |       | (1,018                                | )          | —                        |       | (1,018 | ) |
|                                                       |       |             |       |                    |       |                                 |       |                                  |       |                          |       |   |   |
| Balance as of September 30, 2004  (unaudited)              |       | 18,482,388       |       | $                       | 185        |                                 | $          | 325,072                               |       | $                             | (32,423    | ) | $ | 2,547 |   | $ | 295,381 |   |

 

The accompanying notes are an integral part of these consolidatedstatements.

 

6

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**DUPONT PHOTOMASKS, INC. AND SUBSIDIARIES**

 

## **NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Dollars in thousands, except share data)**

**(unaudited)**

 

**1.****             Basisof Presentation**

 

The interimconsolidated financial statements presented in this report include the accountsof DuPont Photomasks, Inc., our controlled and wholly owned subsidiariesand a variable interest entity of which we are the primary beneficiary. Allsignificant inter-company transactions and accounts have been eliminated inconsolidation. These interim consolidated financial statements have beenprepared by us, without audit, pursuant to the rules and regulations of theSecurities and Exchange Commission, or SEC. All adjustments have been made tothe accompanying interim consolidated financial statements which are, in theopinion of management, necessary for a fair presentation of our operatingresults and include all adjustments of a normal recurring nature. Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with accounting principles generally accepted in theUnited States of America have been condensed or omitted pursuant to the rulesand regulations of the SEC.

 

It isrecommended that these interim consolidated financial statements be read inconjunction with the consolidated financial statements and the notes theretoincluded in our Annual Report on Form 10-K for the year endedJune 30, 2004. The preparation of financial statements in conformity withaccounting principles generally accepted in the United States of America requiresthe use of estimates and assumptions by management in determining the reportedamounts of assets and liabilities, disclosures of contingent liabilities as ofthe date of the financial statements and the reported amounts of revenue andexpenses during the period. Actual results could differ from those estimates.The results of operations for any interim period are not necessarily indicativeof the results of operations for the entire fiscal year.

 

**2.****             DerivativeInstruments and Hedging Activities**

 

Forwardforeign exchange contracts are utilized to mitigate the risks associated withcurrency fluctuations on certain foreign currency balance sheet exposures, andare, therefore, held primarily for purposes other than trading. These foreignexchange contracts do not qualify for hedge accounting under FinancialAccounting Standards Board (“FASB”) Statement No. 133 *Accountingfor Derivative Instruments and Hedging Activities*, as amended.Unrealized gains and losses resulting from the impact of currency exchange ratemovements on forward foreign exchange contracts designated to offset certainnon-U.S. dollar denominated assets and liabilities are recognized as otherincome or expense on the accompanying consolidated income statements in theperiod in which the exchange rates change. These gains and losses substantiallyoffset the foreign currency exchange gains and losses on the underlyingexposures being hedged. An unrealized loss of $177 for the three months endedSeptember 30, 2004 is recorded in other expense, net on the accompanyingconsolidated income statement in relation to our forward exchange contractsoutstanding as of September 30, 2004. These instruments may involve elements ofcredit and market risk in excess of the amounts recognized on the consolidatedfinancial statements. We monitor our positions and the credit quality ofcounterparties, consisting primarily of major financial institutions, and donot anticipate nonperformance by any counterparty, although nonperformancecould occur.

 

**3.****             ComprehensiveIncome**

 

Our comprehensive income is comprised of net loss and foreign currency translation adjustmentsfor the three months ended September 30, 2003 and 2004, respectively.

 

**4.****             Earnings(Loss) Per Share**

 

Basic earnings(loss) per share, or basic EPS, is computed by dividing net income (loss) bythe weighted number of common shares outstanding during each period. Dilutedearnings (loss) per share, or diluted EPS, is computed by dividing net income(loss) after adjustments for the dilutive effect of our convertible notes (ifdilutive), by the weighted average number of common shares and potentiallydilutive shares outstanding (if dilutive) during each period. Potentiallydilutive shares include stock options and assumed conversion of the

 

7

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convertible notes. The number of potentially dilutive sharesoutstanding relating to stock options is computed using the treasury stockmethod and the number of potentially dilutive shares outstanding relating tothe convertible notes is computed using the if-converted method.

 

Thereconciliation of the amounts used to calculate the basic EPS and diluted EPSis as follows:

 
| ** **                                         | ** ** | **Three Months Ended  September 30,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                         | ** ** | **2003**                              | ** ** | **2004** | ** ** |
|                                               |       |                                  |       |   |   |
| Net loss for the period—basic                 |       | $                                     | (15,104    | ) | $ | (1,018 | ) |
| Dilutive effect of convertible notes               |       | —                                |       | — |   |
|                                               |       |                                  |       |   |   |
| Net loss for the period—diluted               |       | $                                     | (15,104    | ) | $ | (1,018 | ) |
|                                               |       |                                  |       |   |   |
| Weighted average shares outstanding—basic     |       | 18,108,478                            |       | 18,457,554 |   |
| Plus: Potentially dilutive shares                  |       | —                                |       | — |   |
|                                               |       |                                  |       |   |   |
| Weighted average shares  outstanding—dilutive |       | 18,108,478                            |       | 18,457,554 |   |
|                                               |       |                                  |       |   |   |
| Basic loss per share                               |       | $                                     | (0.83      | ) | $ | (0.06 | ) |
|                                               |       |                                  |       |   |   |
| Diluted loss per share                             |       | $                                     | (0.83      | ) | $ | (0.06 | ) |

 

Stock optionsto acquire 4,598,313 shares for the three months ended September 30, 2003 and5,337,747 for the three months ended September 30, 2004 were not included inpotentially dilutive shares because the effect of including these stock optionswould have been anti-dilutive. Shares that would be issued upon the conversionof convertible notes that totaled 5,824,850 for the three months endedSeptember 30, 2003 and 4,883,762 for the three months ended September 30, 2004were not included in the computations of diluted EPS because the effect ofincluding them would have been anti-dilutive. These options and the convertiblenotes may become dilutive in the future.

 

**5.**             **Income Taxes**

 

The provision for income taxes differs from amounts computed byapplying the federal statutory rate of 35% to loss before income taxes andminority interest because of our inability to record deferred tax benefits fornet operating losses generated in certain tax jurisdictions and our reduced taxrates in certain Asian jurisdictions. In addition, our net tax provision duringthe three months ended September 30, 2004 included a benefit of $225 from thepositive resolution of a tax audit.

 

**6.****             Propertyand Equipment**

 

Property andequipment are stated at cost. Property and equipment are depreciated using thestraight-line method over the estimated useful lives of the assets ranging fromthree to seven years for equipment and 10 to 20 years for buildings. Leaseholdimprovements are amortized using the straight-line method over the shorter ofthe estimated useful lives of the assets or the estimated remaining terms ofthe leases. Accumulated depreciation and amortization was $493,378 as ofJune 30, 2004 and $513,102 as of September30, 2004. Amounts accrued for equipment purchases were $35,710 as ofJune 30, 2004 and $14,893 as of September 30, 2004 and are included in otheraccrued liabilities on the accompanying consolidated balance sheets.  Assets held for sale relate primarily to ourGresham, Oregon and Danbury, Connecticut facilities. We are actively marketingthese assets and will sell the assets after appropriate evaluation of allproposals.

 

8

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**7.****             Transactionswith and Consolidation of Variable Interest Entity**

 

The MaskhouseBuilding Administration GmbH & Co. KG (“BAC”) is a state-of-the-artphotomask research and manufacturing facility and is a joint venture equallyowned by AMD, Infineon and DuPont Photomasks, Inc. Based on the guidance inFASB Interpretation No. 46R (“FIN No. 46R”), we have concluded that we are theprimary beneficiary of the BAC and, therefore, we began consolidating thefinancial results of the BAC as of March 31, 2004. The consolidation of the BAChad no impact to our net loss for the three months ended September 30, 2004 aswe would have otherwise continued to record our equity interest in the BACunder the equity method had we not consolidated the BAC. However, theconsolidation of the BAC did increase our consolidated assets, as well asliabilities and stockholders’ equity, as of September 30, 2004 by $88,448. AMDand Infineon’s combined equity ownership in the net assets of the BAC as ofSeptember 30, 2004 was $13,103 and was recorded as minority interest in netassets of joint ventures on our consolidated balance sheet. The consolidationhas not altered the operational agreements, guarantees and other commitmentsbetween the BAC, its partners and lenders.

 

We leaseapproximately 50% of the facility from the BAC for advanced photomaskmanufacturing and the remainder is leased by the Advanced Mask TechnologyCenter GmbH & Co. KG (“AMTC”). Both operating leases are for 10-year termsand commenced July 2003. Future minimum lease payments to be received by theBAC during the remaining term of the non-cancelable lease with the AMTC areestimated to be approximately $61,000. The BAC’s lease income from its leasewith the AMTC and the associated operating expenses are recorded net in otherexpense, net on our accompanying consolidated income statement for the threemonths ended September 30, 2004.  Leaseincome of the BAC was approximately $2,200 and the associated operatingexpenses were approximately $1,600 during the three months ended September 30,2004.

 

As ofSeptember 30, 2004, the carrying value of the BAC property and equipment was$70,744 and is included in property and equipment, net, in our accompanyingconsolidated balance sheet. In addition, a portion of the BAC’s facility issubsidized by the German government. In July 2004, the BAC receivedapproximately $17,100 in investment subsidy payments from the Germangovernment.

 

The BACexecuted a term loan agreement for its research and manufacturing facility inDecember 2002. The BAC term loan had $71,027 (approximately 57,600 Euro)outstanding as of September 30, 2004. Of this amount, $15,332 (approximately12,400 Euro) is due within one year and is included in short-term borrowings onour accompanying consolidated balance sheet as of September 30, 2004. The BACterm loan matures in June 2012 and principal and interest payments are duequarterly. The interest rate on the BAC term loan is EURIBOR plus 1.5%. The BACterm loan is secured by the property, other financial assets of the BAC, theassignment of rights from BAC insurance contracts, the tenant rent paymentguarantees and German government guarantees. Prior to the initial occupancy ofthe building and initiation of the lease rental payments, we had guaranteedone-third of the BAC’s indebtedness. Effective July 2003, we were released fromthe guarantee except if the lenders become liable to return monies received inpayment of the indebtedness as a result of any bankruptcy, composition orsimilar proceedings affecting the BAC.

 

**8.****              EmployeePlans**

 

We apply theintrinsic-value-based method of accounting prescribed by Accounting PrinciplesBoard (“APB”) Opinion No. 25, *Accounting for StockIssued to Employees*, and related interpretations including FASBInterpretation No. 44, *Accounting for CertainTransactions 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 currentmarket price of the underlying stock exceeded the exercise price. We also havean Employee Stock Purchase Plan. FASB Statement No. 123, *Accountingfor Stock Based Compensation*, established accounting and disclosurerequirement alternatives which involve using a different accounting method forexpensing the calculated value of option awards. As allowed by FASB StatementNo. 123, we have elected to continue to apply the intrinsic-value-based methodof accounting described above, and have adopted only the disclosurerequirements of FASB Statement No. 123. We use the Black-Scholes model tocalculate pro forma expense for disclosure purposes. The Black Scholes optionvaluation model was developed for use in estimating the fair value of tradedoptions that have no vesting restrictions and are fully transferable. Optionvaluation models require the input of highly subjective assumptions includingthe expected stock price

 

9

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volatility. We use projectedvolatility rates which are based upon historical volatility rates. Because ouremployee stock options and Employee Stock Purchase Plan shares havecharacteristics significantly different from those of traded options, andbecause changes in the subjective input assumptions can materially affect thefair value estimate, in our management’s opinion, the existing models do notnecessarily provide a reliable single measure of the fair value of our employeestock options and Employee Stock Purchase Plan shares.

 

FASB StatementNo. 148, *Accounting for Stock-Based Compensation—Transitionand Disclosure, an amendment of FASB Statement No. 123*, amends thedisclosure requirements of FASB Statement No. 123. The following tableillustrates the effect on net loss if the fair-value-based method had beenapplied to our stock-based employee compensation plans in each period.

 
| ** **                                                                                                                              | ** ** | **Three Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                              | ** ** | **2003**                              | ** ** | **2004** | ** ** |
| Net loss:                                                                                                                               |       |                                  |       |   |   |
| As reported                                                                                                                             |       | $                                     | (15,104    | ) | $ | (1,018 | ) |
| Deduct total stock-based employee  compensation expense determined under the Black-Scholes valuation method for all  awards, net of tax |       | (3,580                                | )          | (2,850 | ) |
|                                                                                                                                    |       |                                  |       |   |   |
| Pro forma net loss                                                                                                                      |       | $                                     | (18,684    | ) | $ | (3,868 | ) |
|                                                                                                                                    |       |                                  |       |   |   |
| Basic loss per share:                                                                                                                   |       |                                  |       |   |   |
| As reported                                                                                                                             |       | $                                     | (0.83      | ) | $ | (0.06 | ) |
| Pro forma                                                                                                                               |       | $                                     | (1.03      | ) | $ | (0.21 | ) |
|                                                                                                                                    |       |                                  |       |   |   |
| Diluted loss per share:                                                                                                                 |       |                                  |       |   |   |
| As reported                                                                                                                             |       | $                                     | (0.83      | ) | $ | (0.06 | ) |
| Pro forma                                                                                                                               |       | $                                     | (1.03      | ) | $ | (0.21 | ) |

 

**9.****             SpecialCharges**

 

Wecontinuously evaluate the overall business climate in general and our industryin particular. During fiscal 2003 and 2004, we concluded that we had excesscapacity that was unwarranted. Given the change in the business climate eachperiod, we identified certain manufacturing operations to be consolidated andcertain equipment to be sold or abandoned.

 

During thethree months ended September 30, 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 inDanbury. During the three months ended September 30, 2003, we recorded specialcharges of $2,722 for employee severance and asset disposal costs and receivedproceeds of $1,200 from the sale of certain pellicle technology.  In addition, we reduced accrued liabilitiesfor lease termination and asset disposal related costs by $367 during the threemonths ended September 30, 2003 in relation to our fiscal 2003 Europeconsolidation initiatives. The liabilities associated with the fiscal 2003Europe consolidation initiatives have been substantially settled as ofSeptember 30, 2004.

 

During fiscal2004 and subsequent to the three months ended September 30, 2003, we adoptedadditional initiatives to reduce costs in North America and Europe thatresulted in recording special charges in relation to employee severance. Theliabilities associated with the North America initiative were substantiallysettled during the three months ended September 30, 2004. We recorded additionalemployee severance related special charges during the three months endedSeptember 30, 2004 in association with the fiscal 2004 Europe initiative.  We expect to substantially settle the relatedEurope liabilities of approximately $1,200 by March 31, 2005.

 

The charges,net of any sale proceeds, and any adjustments to the liability have beenrecorded as special charges, net on the accompanying consolidated incomestatements.

 

10

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A summary ofthe related accrued liabilities associated with the plans is shown below:

 
| ** **                                                 | ** ** | **Employee  Severance** | ** ** | **Asset  Disposals and  Related  Costs** | ** ** | **Total** | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|------------------------------------------|------------|-----------|------------|
|                                                       |       |                    |       |                                     |       |      |       |
| Remaining liability as of June 30, 2004                    |       | $                       | 2,452      |                                     | $          | 151       |       | $ | 2,603 |   |
| Charges during the three months ended  September 30, 2004  |       | 310                     |       | —                                   |       | 310       |       |
| Utilized during the three months ended  September 30, 2004 |       | (1,151                  | )          | (127                                     | )          | (1,278    | )          |
|                                                       |       |                    |       |                                     |       |      |       |
| Remaining liability as of September 30,  2004              |       | $                       | 1,611      |                                     | $          | 24        |       | $ | 1,635 |   |

 

**10.****          SegmentInformation**

 

We conductoperations worldwide and are managed on a geographic basis, with thosegeographic segments being North America, Europe and Asia. The North Americasegment consists of the U. S. and BAC, the Europe segment includes France andGermany and the Asia segment includes China, Japan, Korea, Taiwan andSingapore. We allocate resources to and evaluate the performance of oursegments based on operating income (loss). Corporate expenses are included inour measure of segment operating income (loss) in North America for managementreporting purposes. Expenses incurred by the BAC and paid by our Dresden manufacturingfacility are included in our measure of segment operating income (loss) inEurope for management reporting purposes. The asset totals disclosed bygeography are directly managed by these segments. Segment information is asfollows for the time period or date as noted:

 
| ** **                                | ** ** | **North  America** | ** ** | **Europe** | ** ** | **Asia** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|--------------------|------------|------------|------------|----------|------------|-----------|------------|
|                                      |       |               |       |       |       |     |       |      |       |
| **Three Months Ended September 30, 2003** |       |               |       |       |       |     |       |      |       |
| External revenue                          |       | $                  | 34,080     |       | $          | 19,691   |       | $         | 28,603     |   | $ | 82,374 |   |
| Transfers between geographic segments     |       | 1,343              |       | (7,297     | )          | 5,954    |       | —    |       |
| Revenue, net                              |       | $                  | 35,423     |       | $          | 12,394   |       | $         | 34,557     |   | $ | 82,374 |   |
|                                      |       |               |       |       |       |     |       |      |       |
| Operating income (loss)                   |       | $                  | (12,593    | )          | $          | (7,019   | )          | $         | 5,735      |   | $ | (13,877 | ) |
| **June 30, 2004**                         |       |               |       |       |       |     |       |      |       |
| Total assets                              |       | $                  | 373,901    |       | $          | 133,048  |       | $         | 288,423    |   | $ | 795,372 |   |
|                                      |       |               |       |       |       |     |       |      |       |
| **Three Months Ended September 30, 2004** |       |               |       |       |       |     |       |      |       |
| External revenue                          |       | $                  | 32,714     |       | $          | 29,414   |       | $         | 32,719     |   | $ | 94,847 |   |
| Transfers between geographic segments     |       | 7,965              |       | (14,846    | )          | 6,881    |       | —    |       |
| Revenue, net                              |       | $                  | 40,679     |       | $          | 14,568   |       | $         | 39,600     |   | $ | 94,847 |   |
|                                      |       |               |       |       |       |     |       |      |       |
| Operating income (loss)                   |       | $                  | (5,048     | )          | $          | (5,506   | )          | $         | 11,416     |   | $ | 862 |   |
| **September 30, 2004**                    |       |               |       |       |       |     |       |      |       |
| Total assets                              |       | $                  | 236,223    |       | $          | 122,969  |       | $         | 290,723    |   | $ | 649,915 |   |

 

Products aretransferred between geographic areas on a basis intended to approximate themarket value of such products.

 

11

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**11.****          Commitmentsand Contingencies**

 

#### *AMTC*

 

We, along withInfineon 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 arecommitted to funding a portion of the operating cash requirements of the AMTCunder research and development reimbursement and capacity utilizationobligations through June 30, 2007. We expect our portion of these operatingcash requirements, which is estimated to be $39,000 exclusive of rent due bythe AMTC to the BAC, to vary between approximately 22% to 26% through June 30,2007. Research and development costs for services rendered by the AMTC jointventure were $2,085 and $2,400 during the three months ended September 30, 2003and 2004, respectively.

 

The AMTC hasexecuted a 120,000 Euro revolving credit facility, which has a final maturitydate of December 19, 2007, to be used for equipment purchases. The revolvingcredit facility had 59,000 Euro ($73,351) outstanding as of September 30, 2004. Each of the partnersof the joint venture has executed one-third guarantees for up to 32,000 Euroand certain additional costs as defined in the revolving credit facilityagreement for as long as any obligation remains outstanding under the revolvingcredit facility. We will be required to honor our guarantee if the AMTC failsto make timely payments under the revolving credit facility; breaches certainfinancial covenants; becomes insolvent; or in any other way defaults under therevolving credit facility. We will also be required to honor our guarantee ifany of the owners of the AMTC breach certain terms of the joint ventureagreement, become insolvent or cease doing business, experience a materialadverse change affecting their obligations under the guarantee, fail to paytheir respective indebtedness in excess of 50,000 Euro or otherwise experiencean event constituting a default under the revolving credit facility.

 

#### *Infineon*

 

In fiscal2002, we entered into an agreement to acquire photomask production equipmentfrom Infineon’s internal photomask manufacturing operations in Munich, Germanyand became Infineon’s strategic photomask supplier. In consideration for theacquisition of certain photomask production assets and the agreement to supplyInfineon with photomasks over a 10 year term, we agreed to pay Infineon $53,500over a seven-year period ending in March 2009. As part of the fiscal 2002agreement, we also agreed to purchase from Infineon additional photomaskproduction equipment for approximately $28,100 payable over a five-year periodending in December 2006. As of June 30, 2004, we had made aggregate purchasesof approximately $26,600 pursuant to the fiscal 2002 agreement. Effective July1, 2004, the fiscal 2002 agreement was superseded by a new agreement. As aresult, our previous commitment to acquire certain photomask production assetsin the amount of $28,100 was reduced to $23,345 due to a change in the tools tobe acquired from Infineon. In addition, we are now committed to pay Infineon atotal of $1,750 in three equal installments over a three-year period endingDecember 31, 2007, for the use of certain photomask production assets owned byInfineon. We do not expect that the changes to the fiscal 2002 agreement termswill be material to our financial condition, results of operations or cashflows. Per the terms of the fiscal 2002 agreement, we could elect to satisfy aportion of certain amounts payable by issuing shares of our common stock. Thisprovision has been retained in the agreement that became effective July 1,2004. Our decision as to the form of each such payment (cash only or cash andshares of our common stock) will be made at least thirty days prior to the duedate for each payment.  Each payment isconsidered independently and the payment in shares of our common stock may not exceed40% of the total of any single payment. The maximum value of our common stockthat we could issue to Infineon if we choose to fully exercise our rights forfuture payments, approximated $18,700 as of September 30, 2004.

 

#### *BindKey*

 

We haveestablished a profit sharing plan with the BindKey employees. Through March2006, BindKey employees may earn amounts annually based on the annual after-taxearnings of BindKey. Upon the termination of the final year subject to theprofit sharing plan, the employees may earn an additional lump-sum amount basedon the after-tax earnings of BindKey in the final year. Any amounts earned inrelation to the profit sharing plan will be expensed in the period earned. Asof September 30, 2004, no amounts had been earned under this plan.

 

12

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#### *Other*

 

In fiscal 2002, we sold all of our photoblank manufacturing assets toSchott.  We also entered into a supplyagreement with Schott for a significant portion of our future purchases of photoblanks,as needed. In April 2004, the asset purchase agreement associated with the 2002sale was amended to allow us to be paid additional amounts contingent upon theoccurrence of certain future performance and specified purchase level basedevents.  We do not expect any contingentamounts that may be received under this amended agreement would be material toour consolidated financial condition, results of operations or cash flows.

 

In fiscal2004, we signed a multi-year pellicle supply agreement with MLI for asignificant portion of our future purchases of pellicles, as needed.

 

#### *General*

 

As of September 30, 2004, minimum lease paymentsfor non-cancelable operating lease obligations are estimated to be $3,057,$2,027, $1,899, $1,818, and $670 for annual periods ending September 30, 2005 through 2009,respectively, and $6,902 in the aggregate thereafter.

 

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

 

Our operationsand our ownership of real property are subject to various environmental lawsand regulations that govern, among other things, the discharge of pollutantsinto the air and water and the handling, use, storage, disposal and clean-up ofsolid and hazardous wastes. Compliance with such laws and regulations requiresthat we incur capital expenditures and operating costs in connection with ourongoing operations. In addition, such laws and regulations may imposeliabilities on owners and operators of businesses and real property withoutregard to fault and such liabilities may be joint and several with otherparties. More stringent environmental laws and regulations may be enacted inthe future, which may require us to expend additional amounts on environmentalcompliance or may require modifications in our operations. Although we areunable to predict the extent of our future liability with respect to anyenvironmental matters, we believe, based upon current information, thatenvironmental liabilities will not be material to our financial condition orresults of operations. E. I. du Pont de Nemours and Company has agreed togenerally indemnify us against substantially all liabilities relating to anyenvironmental contamination present on our manufacturing sites as ofJune 13, 1996, the date of our initial public offering, or present at anysuch site due to the generation, use, treatment, storage, release, emission,discharge or disposal of hazardous waste or hazardous materials before suchdate. The Environmental Protection Agency andConnecticut Department of Environmental Protection are reviewing agroundwater contamination issue at our Danbury, Connecticut site undervoluntary corrective action. Any such contamination is believed to be offsiteor historical, and, if that is the case, any environmental liabilities would becovered by the indemnification agreement with E. I. du Pont de Nemours andCompany.

 

**12.****         ****Subsequent Events**

 

On October 5,2004, we and Toppan Printing Co., Ltd. (“Toppan”) entered into an Agreement andPlan of Merger (“Merger Agreement”) pursuant to which we  would become a wholly owned subsidiary ofToppan. The Merger Agreement was unanimously approved by our Board of Directorsand the transactions contemplated thereby are subject to regulatory approvals,approval of our stockholders and other customary closing conditions. The MergerAgreement is expected to close in early calendar 2005. On November 1, 2004, wefiled a preliminary proxy statement regarding the Merger Agreement.

 

On October 8,2004, a lawsuit was filed in the District Court of Travis County, Texas againstus and our Board of Directors by purported stockholders of DuPont Photomasks,Inc. on behalf of a putative class of stockholders. The plaintiffs’petition alleges breaches of fiduciary duty including self-dealing on the partof our Board of Directors in connection with the announced Merger Agreement. Webelieve that the plaintiffs’ claims are without merit. We and our Board ofDirectors intend to vigorously defend this lawsuit. As with any litigation, weare unable at this early stage to predict the outcome of the lawsuit or theimpact of its pendency on our financial results or the consummation of theMerger Agreement with Toppan.

 

13

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

 

The followingdiscussion and analysis of the financial condition and results of operationsshould be read in conjunction with our consolidated financial statements andrelated notes included elsewhere in this document. All references to years areto our fiscal years, which end on June 30, unless otherwise noted. Results forinterim periods are not necessarily indicative of results for the full year.Due to rounding, some columns may not total and some calculations may notrecalculate within the financial tables. Statements in this report that relate to future results and events arebased on our current expectations. Actual results in future periods may differmaterially from those currently expected or desired because of a number ofrisks 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 yearended June 30, 2004.

 

# **Overview**

 

We are aleading global provider of microimaging solutions. We develop and producephotomasks, a key enabling technology used in the manufacture of semiconductorand other microelectronic devices. We also develop and market electronic designautomation (“EDA”) software. Our current EDA software products enable chipdesigners to ensure manufacturability earlier in the design cycle and aretargeted at the design for manufacture (“DFM”) market.

 

Virtually allof our revenue is derived from the semiconductor industry. Our customersinclude integrated device manufacturers (“IDMs”) (companies that design, buildand market semiconductor chips), semiconductor foundries (companies thatprovide sub-contract manufacturing of semiconductor chips) and fablesssemiconductor companies (companies that design and market semiconductor chipsand sub-contract manufacturing to foundries or IDMs).

 

The photomaskis a template used to transfer circuit images onto semiconductor wafers.Because in most instances a photomask does not degrade with use, photomaskindustry revenue more closely correlates with new chip design activity ratherthan the volume of semiconductor wafers processed or the resultant chiprevenue. However, photomask demand is affected by the cyclical nature of thesemiconductor industry. Based on data published by industry analysts, annualworldwide semiconductor revenue increased by two percent in calendar 2002 andby 14% in calendar 2003 and is forecasted to increase by at least 25% incalendar 2004. Industry forecasters believe that the photomask industryrealized no growth in calendar years 2002 and 2003, and forecast an increase ofapproximately 14% in calendar 2004.

 

Our quarterlyrevenue has demonstrated seasonal buying patterns on the part of our customers.Our historical performance suggests that our fiscal fourth quarter ending inJune usually reflects our customers’ highest period of demand for photomasks.Over the last seven years, quarterly revenue has increased sequentially sixpercent on average in the June quarter. We believe this is primarily due to agreater number of effective workdays in the June quarter as compared to the Marchquarter that includes the calendar and Asian New Year holidays. In contrast,our fiscal first quarter ending in September usually reflects our customers’lowest period of demand for photomasks. Over the last eight years (includingthe quarter just completed), on average, quarterly revenue has declined fourpercent sequentially in our fiscal first quarter ending in September. Webelieve increased summer vacation periods, particularly in North America andEurope and the more difficult sequential comparison to the typically seasonallyhigher June quarter, are the primary reasons for the sequential decline.

 

In the future,the size of the photomask market may be adversely affected by a variety offactors, including, but not limited to, overall semiconductor industryconditions, pricing pressures, a decrease in unit volumes caused by increasingchip design costs or the usage of multi-project wafers and multi-layerreticles.

 

During thefirst quarter of fiscal 2005, leading edge revenue, defined as products supporting130nm and below design rules, represented 33% of our total revenue, as comparedto 18% a year ago. Our leading edge revenue in absolute terms has more thandoubled over the last year. We believe this trend is important as it reflectsimproved conditions across the semiconductor industry and is an indication thatour customers’ ability to manage complex design issues and achieve acceptablewafer fab yields have improved. Additionally, we believe this trend reflectsthe recognition by our customers of our strong and improving technologyposition. Certain sales

 

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in Europe and Asia aredenominated in local currencies, and accordingly, the U.S. dollar equivalent ofthese sales is affected by changes in foreign currency exchange rates. Themajority of our sales in currencies other than the U.S. dollar are in the Euro.When comparing the first quarter of fiscal 2005 to the first quarter of fiscal2004, the increase in revenue resulting from the weakening of the U.S. dollarin relation to the Euro was largely offset by a corresponding increase in Eurodenominated expenses. The weakening of the U.S. dollar in relation to the Eurodid not have a material impact on our net loss for the three months endedSeptember 30, 2004.

 

Over thelonger term, we expect the photomask industry’s revenue growth will be drivenby leading edge products supporting design rules of 130-nanometer and below. Inorder to improve our competitive position in those products, we have co-investedin the AMTC, a unique joint venture research and development initiative withAMD and Infineon. The AMTC operates in a new, state-of-the-art facility inDresden, Germany and is focused on developing next generation photomaskproducts and processes supporting 65-nanometer and below design rules.

 

Since fiscal2003, we have been executing plans designed to increase revenue, reduce ourbreakeven level and advance our technology position. Revenue increased 15% thisquarter over the same quarter a year ago while our pre-tax breakeven dropped$5.0 million to approximately $95.0 million. Since December 2002, we haveceased manufacturing operations in three manufacturing facilities and reducedheadcount by over 200 employees, while at the same time staffing the newadvanced development and manufacturing facility in Dresden. We expect we willcontinue to evaluate the need to deploy our operating assets most efficiently,and improve the utilization of our manufacturing operations.

 

On October 5, 2004, we entered into adefinitive agreement to be acquired by Toppan Printing Co., Ltd (“Toppan”).Pursuant to the agreement, upon the closing, we will become a wholly ownedsubsidiary of Toppan and each outstanding share of our common stock will beexchanged for the right to receive $27.00 in cash without interest. The mergeris conditioned upon, among other things, approval by our stockholders,clearance under applicable antitrust laws and other customary closingconditions. We currently expect that the merger will be consummated in earlycalendar 2005.

 

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**Results of Operations**

 

**Financial Summary**

**(Dollars in millions)**

 
| ** **                                  | ** ** | **Three Months Ended  September 30,** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|---------------------------------------|------------|------------|------------|
| ** **                                  | ** ** | **2003**                              | ** ** | **2004**   | ** ** | **% Change** | ** ** |
|                                        |       |                                  |       |       |       |   |   |
| Revenue, net                                |       | $                                     | 82.4       |       | $          | 94.8 |   | 15.1 | % |
|                                        |       |                                  |       |       |       |   |   |
| Cost of goods sold                          |       | 75.6                                  |       | 73.8       |       | (2.5 | %) |
|                                        |       |                                  |       |       |       |   |   |
| Gross profit                                |       | 6.7                                   |       | 21.1       |       | 213.2 | % |
|                                        |       |                                  |       |       |       |   |   |
| Selling, general and administrative expense |       | 12.3                                  |       | 12.8       |       | 3.5 | % |
|                                        |       |                                  |       |       |       |   |   |
| Research and development expense            |       | 7.1                                   |       | 7.1        |       | 1.3 | % |
|                                        |       |                                  |       |       |       |   |   |
| Special charges, net                        |       | 1.2                                   |       | 0.3        | * *   | *NM* | * * |
|                                        |       |                                  |       |       |       |   |   |
| Operating income (loss)                     |       | $                                     | (13.9      | )          | $          | 0.9 | * * | *NM* | * * |
|                                        |       |                                  |       |       |       |   |   |
| Expenses as a percentage of Revenue         |       |                                  |       |       |       |   |   |
|                                        |       |                                  |       |       |       |   |   |
| Cost of goods sold                          |       | 91.8                                  | %          | 77.8       | %          |   |   |
|                                        |       |                                  |       |       |       |   |   |
| Gross profit                                |       | 8.2                                   | %          | 22.2       | %          |   |   |
|                                        |       |                                  |       |       |       |   |   |
| Selling, general and administrative expense |       | 15.0                                  | %          | 13.5       | %          |   |   |
|                                        |       |                                  |       |       |       |   |   |
| Research and development expense            |       | 8.6                                   | %          | 7.5        | %          |   |   |
|                                        |       |                                  |       |       |       |   |   |
| Operating margin                            |       | (16.8                                 | %)         | 0.9        | %          |   |   |

* *

----

*NM — notmeaningful*

* *

*(Dollars in Millions)*
| ** **                              | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|------------------------|------------|------------|------------|
| **For the Period Ended September  30:** | ** ** | **2003**               | ** ** | **2004**   | ** ** | **Delta** | ** ** |
|                                    |       |                   |       |       |       |   |   |
| Revenue, net                            |       | $                      | 82.4       |       | $          | 94.8 |   | 15.1 | % |
|                                         |            |                        |            |            |            |  |  |  |  |

 

Revenue, netis comprised primarily of photomask sales to semiconductor manufacturers.  Revenue, net increased 15.1% for the threemonths ended September 30, 2004compared with the same period in the prior year.  The increase was primarily attributable to animprovement in mix driven by leading edge revenue, defined as 130-nanometersand below design rules. Leading edge revenue grew for the fourth consecutivequarter and represented 33% of our total revenue. During the three months endedSeptember 30, 2004, we set another company record for revenue from phase shiftmasks. Compared to the same three-month period in 2003, leading edge revenue morethan doubled.

 

16

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*(Dollars inMillions)*
| ** **                              | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|------------------------|------------|------------|------------|
| **For the Period Ended September  30:** | ** ** | **2003**               | ** ** | **2004**   | ** ** | **Delta** | ** ** |
|                                    |       |                   |       |       |       |   |   |
| Cost of goods sold                      |       | $                      | 75.6       |       | $          | 73.8 |   | (2.5 | )% |
|                                    |       |                   |       |       |       |   |   |
| As a percent of revenue, net            |       | 91.8                   | %          | 77.8       | %          | — |   |
|                                         |            |                        |            |            |            |  |  |  |  |

 

Cost of goodssold consists of materials, labor, depreciation, and overhead. Cost of goodssold decreased 2.5% for the 2004 three-month period compared with the samethree-month period in the prior year. The decrease was due to lowerdepreciation expense resulting from the impairment of certain long-lived assetsin June 2004, lower costs associated with improved operating efficiencies,savings from the closure of our pellicle production facility in Danbury inSeptember 2003 and the absence of costs associated with the consolidation oftrailing-edge production in Europe that were incurred during the September 2003quarter. These decreases in cost of goods sold were partially offset by theramp-up of our advanced production facility in Dresden and equipment relatedcosts.

 

*(Dollars inMillions)*
| ** **                                  | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------------------|------------|------------|------------|
| **For the Period Ended September  30:**     | ** ** | **2003**               | ** ** | **2004**   | ** ** | **Delta** | ** ** |
|                                        |       |                   |       |       |       |   |   |
| Selling, general and administrative expense |       | $                      | 12.3       |       | $          | 12.8 |   | 3.5 | % |
|                                        |       |                   |       |       |       |   |   |
| As a percent of revenue, net                |       | 15.0                   | %          | 13.5       | %          |   |   |
|                                             |            |                        |            |            |            |  |  |  |  |

 

Selling,general and administrative expense includes salaries of sales andadministrative personnel, marketing expense, general and administrative expenseand product distribution expense. Selling, general and administrative expenseincreased 3.5% for the 2004 three-month period compared with the prior year.The increase in expense during the 2004 three-month period was primarilyattributable to professional fees related to our pending merger with Toppan. Weexpect to pay additional fees related to our pending merger in our second andthird fiscal 2005 quarters. Selling, general and administrative expense as apercentage of revenue decreased from 15.0% for the three months ended September 30, 2003 to 13.5% for the threemonths ended September 30, 2004.

 

*(Dollars inMillions)*
| ** **                              | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|------------------------|------------|------------|------------|
| **For the Period Ended September  30:** | ** ** | **2003**               | ** ** | **2004**   | ** ** | **Delta** | ** ** |
|                                    |       |                   |       |       |       |   |   |
| Research & development expense      |       | $                      | 7.1        |       | $          | 7.1 |   | 1.3 | % |
|                                    |       |                   |       |       |       |   |   |
| As a percent of revenue, net            |       | 8.6                    | %          | 7.5        | %          |   |   |
|                                         |            |                        |            |            |            |  |  |  |  |

 

Research anddevelopment expense consists primarily of employee costs, cost of consumedmaterials, depreciation, engineering related costs and costs related to ourAMTC joint venture. Research and development expense increased 1.3% for the2004 three-month period compared with the same three-month period in the prioryear. As a percentage of revenue, research and development expense decreasedfrom 8.6% for the three months ended September 30, 2003 to 7.5% for the threemonths ended September 30, 2004. Although research and development expense intotal remained consistent, during the three months ended September 30, 2004there was an increase in expense for the AMTC as its activities continued toramp and an increase in information systems costs. These increases weresubstantially offset by a credit associated with the expiration of the RTCagreement in June 2004 and an increase in research and development subsidiesrecorded by the AMTC.

 

*(Dollars inMillions)*
| ** **                              | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|------------------------|------------|------------|------------|
| **For the Period Ended September  30:** | ** ** | **2003**               | ** ** | **2004**   | ** ** | **Delta** | ** ** |
|                                    |       |                   |       |       |       |   |   |
| Special charges, net                    |       | $                      | 1.2        |       | $          | 0.3 |   | NM |   |
|                                         |            |                        |            |            |            |  |  |  |  |

 

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During thethree months ended September 30, 2003, as part of our efforts to reduce costs,we signed a multi-year pellicle supply agreement with MLI, while concurrentlydeciding to close our pellicle production facility in Danbury. During the threemonths ended September 30, 2003, we recorded special charges of $2.7 millionfor employee severance and asset disposal costs and received proceeds of $1.2million from the sale of certain pellicle technology. In addition, we reducedaccrued liabilities for lease termination and asset disposal related costs by$0.4 million during the three months ended September 30, 2003 in relation toour fiscal 2003 Europe consolidation initiatives.

 

During fiscal2004 and subsequent to the three months ended September 30, 2003, we adoptedadditional initiatives to reduce costs in North America and Europe thatresulted in recording special charges in relation to employee severance. Werecorded additional special charges during the three months ended September 30,2004 in association with the fiscal 2004 Europe initiative.

 

A summary ofthe related accrued liabilities associated with the plans is shown below(dollars in millions):

 
| ** **                                                 | ** ** | **Employee  Severance** | ** ** | **Asset  Disposals and  Related  Costs** | ** ** | **Total** | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|------------------------------------------|------------|-----------|------------|
|                                                       |       |                    |       |                                     |       |      |       |
| Remaining liability as of June 30, 2004                    |       | $                       | 2.5        |                                     | $          | 0.2       |       | $ | 2.6 |   |
| Charges during the three months ended  September 30, 2004  |       | 0.3                     |       | —                                   |       | 0.3       |       |
| Utilized during the three months ended  September 30, 2004 |       | (1.2                    | )          | (0.1                                     | )          | (1.3      | )          |
|                                                       |       |                    |       |                                     |       |      |       |
| Remaining liability as of September 30,  2004              |       | $                       | 1.6        |                                     | $          | 0.0       |       | $ | 1.6 |   |

 

*Otherexpense, net*. Other expense, net includes interest income, interest expense, our equityin earnings of our equity method investees, foreign currency exchange gains andlosses and the lease income and associated operating expenses of the BAC.Although other expense, net in total remained consistent, during the threemonths ended September 30, 2004 there was an increase in interest expenseassociated with the BAC’s term loan agreement and an increase in the netforeign currency exchange loss. These increases were offset by an excess oflease income over associated operating expenses of the BAC as a result of itslease with the AMTC. Lease income of the BAC was approximately $2.2 million andthe associated operating expenses were approximately $1.6 million during thethree months ended September 30, 2004. We began consolidating the financial results of the BAC effective March31, 2004.

 

*Provision for Income Taxes*.  Theprovision for income taxes differs from amounts computed by applying thefederal statutory rate of 35% to loss before income taxes and minority interestbecause of our inability to record deferred tax benefits for net operatinglosses generated in certain tax jurisdictions and our reduced tax rates incertain Asian jurisdictions. In addition, our net tax provision during thethree months ended September 30, 2004 included a benefit of $0.2 million fromthe positive resolution of a tax audit.

 

*MinorityInterest in (Income) Loss of Joint Ventures*.  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 during thethree months ended September 30, 2003 and additionally the BAC operationsduring the three months ended September 30, 2004. The minority interest impactof our joint ventures was a decrease of $0.1 million to our net loss for thethree months ended September 30,2003 and an increase of $0.3 million to our net loss for the three monthsended September 30, 2004. The changewas a result of a decrease in the net loss recorded for our Taiwan facility.

 

**Liquidity and Capital Resources**

 

Our workingcapital was $109.8 million as of June 30, 2004 and$130.4 million as of September 30, 2004. The increase in workingcapital was due principally to net cash provided by operating activities andcollection of

 

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investment subsidies from theGerman government by our Dresden manufacturing facility and the BAC in theamounts of $3.7 million and $17.1 million, respectively. Cash and cashequivalents were $231.4 million as of June 30, 2004 and$143.6 million as of September  30, 2004.

 

Cash providedby operating activities was $4.1 million and $11.8 million for thethree months ended September 30, 2003 and 2004, respectively. The increase incash provided by operating activities is primarily the result of betteroperating results and collections of outstanding trade accounts receivableoffset by payments made on accounts payable and other accrued liabilities.

 

Cash providedby (used in) investing activities was $(20.0) million and$1.1 million for the three months ended September 30, 2003 and 2004,respectively. The increase in cash flows provided by investing activities wasdue to the receipt of the German investment subsidies. We expect capitalexpenditures for fiscal 2005 to be between $70.0 and $80.0 million.Capital expenditures have been and will in the future be used primarily toadvance our technical capability at the 90 and 65-nanometer nodes.Additionally, in the future we may pursue acquisitions of businesses, productsand technologies, or enter into joint venture arrangements, that couldcomplement or expand our business. Any material acquisition or joint venturecould result in a decrease to our working capital depending on the amount,timing and nature of the consideration to be paid.

 

Cash provided by (used in) financing activities was $0.2 millionand $(101.5) million for the three months ended September 30, 2003 and2004, respectively. The change in cash flows used in financing activities wasdue to our repayment of the $100.0 million convertible subordinated notes whichwere issued in July 2000 and due in July 2004, and repayment of $2.3 million bythe BAC on its term loan. The $100.0 million convertible notes were repaidusing our existing cash balances. We expect the remainder of the BAC’s termloan will be repaid by the BAC using proceeds from the BAC’s investmentsubsidies and lease payments received from us and the AMTC for use of the BAC’sfacility. Prior to the consolidation of the BAC, we recorded our rent paymentsto the BAC in our cash flows from operating activities.

 

On May 5, 2003, we issued and sold $125.0 million aggregateprincipal amount of convertible subordinated notes in a private placement. Thenotes were sold at face value less an underwriting discount of2.625 percent and we received net proceeds of $121.2 million. Thenotes are due May 15, 2008, accrue interest at an annual rate of1.25 percent and are convertible at any time into shares of our commonstock at a conversion price of $25.595 per share. Interest on the notes ispayable semi-annually on May 15 and November 15 of each year. We havereserved 4,883,762 shares of our common stock for conversion of the convertiblesubordinated notes. If a change of control occurs, each holder of notes willhave the right to require us to redeem, in cash, any or all of such holder’snotes at a price equal to 100% of the principal amount to be redeemed. A changeof control is any transaction in which a person or group becomes the beneficialowner of 50% or more of our common stock or has the power to elect a majorityof our board of directors, any consolidation, merger or similar transaction inwhich our stockholders immediately prior to the transaction hold less than amajority of the outstanding voting stock of the surviving corporation and theconsideration in the merger or consolidation is not common stock listed on anational securities exchange or approved for quotation on the Nasdaq NationalMarket, or the holders of our capital stock approve any plan or proposal forour liquidation or dissolution. A change of control will not be deemed to haveoccurred if the last sale price of our common stock for any five trading daysduring the ten trading days immediately preceding the change of control is at leastequal to 105% of the conversion price of the notes. If a change of control wereto occur, we cannot assure you that we will have sufficient funds to pay theredemption price for all the notes tendered by the holders. In that case, ourfailure to redeem tendered notes would constitute an event of default under theindenture for the notes, and may constitute a default under the terms of otherindebtedness that we may enter into from time to time. Debt issue costs of$3.8 million related to these notes are included in non-current otherassets on the accompanying consolidated balance sheets and are being amortizedusing the straight-line method, which approximates the interest method, tointerest expense over the scheduled maturity period. In connection with theissuance of the notes, we entered into a Registration Rights Agreement andfiled a shelf registration statement covering resales of the notes and thecommon stock issuable upon conversion of the notes. If we fail to comply withcertain of our obligations under the Registration Rights Agreement, additionalinterest will accrue on the affected notes at an annual rate of0.5 percent. Also in connection with the issuance of the notes, we amendedour Rights Agreement dated January 30, 2001, to provide that the issuanceof the notes to the initial purchasers would not cause the initial purchasersto be Acquiring Persons (as defined in the Rights Agreement) under the RightsAgreement and therefore no Distribution Date (as

 

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defined in the Rights Agreement) under the Rights Agreement would occuras a result of the issuance of the notes to the initial purchasers.

 

Our ongoingcash requirements will be for capital expenditures, acquisitions, research anddevelopment, working capital and the repayment of convertible notes and otherindebtedness. Management believes that cash on hand and any cash provided byoperations will be sufficient to meet our cash requirements for at least thenext 12 months. However, based on our current operating plans, we may seekexternal financing from time to time to fund our capital expenditures, workingcapital requirements and other growth initiatives. Sources of externalfinancing could include issuances of equity, convertible debt and short-term orlong-term borrowings. There can be no assurance that alternative sources offinancing will be available if our capital requirements exceed cash flow fromoperations or that we will be able to obtain any additional financing requiredto fund our capital needs on reasonable terms, or at all.

 

Our consolidated cashand cash equivalents balances as of September 30, 2004, were $143.6 million, ofwhich $24.8 million was attributable to minority shareholders based on theirownership interests in our consolidated joint ventures. As of September 30,2004, we have pledged $7.5 million of our cash and cash equivalents balances ascollateral security for a portion of our short term borrowings.

 

The followingsummarizes our contractual cash obligations as of September 30, 2004 (inmillions):

 
| ** **                                            | ** ** | **Payments Due for the Periods ending September 30,** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                            | ** ** | **Total**                                             | ** ** | **Year  2005** | ** ** | **Two Years  2006-2007** | ** ** | **Two Years  2008-2009** | ** ** | **Beyond** | ** ** |
|                                                  |       |                                                  |       |   |   |   |   |   |   |   |   |
| Short-term and long-term borrowings                   |       | $                                                     | 80.1       |   | $ | 22.2 |   | $ | 20.4 |   | $ | 18.3 |   | $ | 19.1 |   |
| Convertible notes                                     |       | 125.0                                                 |       | — |   | — |   | 125.0 |   | — |   |
| Operating leases                                      |       | 16.4                                                  |       | 3.1 |   | 3.9 |   | 2.5 |   | 6.9 |   |
| Purchase obligations                                  |       | 29.2                                                  |       | 28.8 |   | 0.4 |   | — |   | — |   |
| Other long-term obligations (AMTC amounts  estimated) |       | 42.2                                                  |       | 13.7 |   | 25.2 |   | — |   | 3.3 |   |
|                                                  |       |                                                  |       |   |   |   |   |   |   |   |   |
| Total contractual cash obligations                    |       | $                                                     | 292.9      |   | $ | 67.8 |   | $ | 49.9 |   | $ | 145.8 |   | $ | 29.3 |   |
|                                                       |            |                                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

We arecommitted to funding a portion of the operating requirements of the AMTC underresearch and development reimbursement and capacity utilization obligations throughJune 30, 2007. We expect our portion of these cash requirements to vary betweenapproximately 22% to 26% of the AMTC’s operating costs through June 30, 2007.

 

As ofSeptember 30, 2004, we are contractually obligated to fulfill the remainingamount on a portion of our existing purchase orders. The purchase orders thatwe are contractually obligated to fulfill are primarily related to purchases ofequipment and equipment service contracts.

 

The followingsummarizes our commercial commitments as of September 30, 2004 (in millions):

 
| ** **                   | ** ** | **Amounts  of Commitment Expiration by Periods Ending September 30,** | ** ** |
|------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                   | ** ** | **Total**                                                             | ** ** | **Year  2005** | ** ** | **Two Years  2006-2007** | ** ** | **Two Years  2008-2009** | ** ** | **Beyond** | ** ** |
|                         |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Guarantees                   |       | $                                                                     | 24.5       |   | $ | 24.5 |   | $ | — |   | $ | — |   | $ | — |   |
| Other commercial commitments |       | 52.0                                                                  |       | 23.2 |   | 24.7 |   | 4.1 |   | — |   |
|                         |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Total commercial commitments |       | $                                                                     | 76.5       |   | $ | 47.7 |   | $ | 24.7 |   | $ | 4.1 |   | $ | — |   |
|                              |            |                                                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

We haveexecuted a one-third guarantee for up to 32.0 million Euro of the AMTC’s 120.0million Euro revolving credit facility. The revolving credit facility had 59.0million Euro ($73.4 million as of September 30, 2004) outstanding as ofSeptember 30, 2004.

 

In fiscal2002, we entered into an agreement to acquire photomask production equipmentfrom Infineon’s internal photomask manufacturing operations in Munich, Germanyand became Infineon’s strategic photomask

 

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supplier. In consideration forthe acquisition of certain photomask production assets and the agreement tosupply 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 thefiscal 2002 agreement, we also agreed to purchase from Infineon additionalphotomask production equipment for approximately $28.1 million payable over afive-year period ending in December 2006. As of June 30, 2004, we had madeaggregate purchases of approximately $26.6 million pursuant to the fiscal 2002agreement. Effective July 1, 2004, the fiscal 2002 agreement was superseded bya new agreement. As a result, our previous commitment to acquire certainphotomask production assets in the amount of $28.1 million was reduced to $23.3million due to a change in the tools to be acquired from Infineon. In addition,we are now committed to pay Infineon a total of $1.8 million in three equalinstallments over a three-year period ending December 31, 2007, for the use ofcertain photomask production assets owned by Infineon. We do not expect thatthe changes to the fiscal 2002 agreement terms will be material to ourfinancial condition, results of operations or cash flows. Per the terms of thefiscal 2002 agreement, we could elect to satisfy a portion of certain amountspayable by issuing shares of our common stock. This provision has been retainedin the agreement that became effective July 1, 2004. Our decision as to theform 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 paymentis considered independently and the payment in shares of our common stock maynot exceed 40% of the total of any single payment. The maximum value of ourcommon stock that we could issue to Infineon if we choose to fully exercise ourrights for future payments, approximated $18.7 million as of September 30,2004.

 

In addition tothe commitments in the tables above, the following commitments andcontingencies exist:

 

•      Wehave established a profit sharing plan with the BindKey employees. Through March2006, BindKey employees may earn amounts annually based on the annual after-taxearnings of BindKey. Upon the termination of the final year subject to theprofit sharing plan, the employees may earn an additional lump-sum amount basedon the after-tax earnings of BindKey in the final year. Any amounts earned inrelation to the profit sharing plan will be expensed in the period earned. Asof September 30, 2004, no amounts had been earned under this plan.

 

•       Infiscal 2002, we sold all of our photoblank manufacturing assets to Schott.  We also entered into a supply agreement withSchott for a significant portion of our future purchases of photoblanks, asneeded. In April 2004, the asset purchase agreement associated with the 2002sale was amended which will allow us to be paid additional amounts contingentupon the occurrence of certain future performance and specified purchase levelbased events.  We do not expect anycontingent amounts that may be received under this amended agreement would bematerial to our consolidated financial condition, results of operations or cashflows.

 

•      Infiscal 2004, we signed a multi-year pellicle supply agreement with MLI for asignificant portion of our future purchases of pellicles, as needed.

 

**Critical Accounting Policies**

 

Our critical accounting policies are as follows:

 

•      Revenuerecognition

 

Revenue is recognized, net of an allowance for estimated returns, whenboth title and risk of loss transfer to the customer, provided that nosignificant obligations remain. In connection with each transaction involvingour products, we must evaluate whether: persuasive evidence of an arrangementexists, delivery has occurred, pricing is fixed or determinable, andcollectibility is probable. We recognize revenue on transactions involvingmultiple elements based on the relative fair values of the elements.  Discounts and rebates are recorded as areduction of revenue during the period they are earned by our customers andperiodically must be estimated.

 

•      Estimates,specifically sales return allowances, the allowance for doubtful accountsreceivable, inventory valuation and depreciation expense

 

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The preparation of consolidated financial statements requires us tomake estimates and assumptions that affect the reported amount of assets anddisclosure of contingent assets and liabilities at the date of the consolidatedfinancial statements and the reported amounts of revenue and expenses duringthe reported period.

 

•              We must makeestimates of potential future product returns related to current period productrevenue. We analyze historical returns and changes in customer demand andacceptance of our products when evaluating the adequacy of the sales returnsand other allowances. Significant management judgments and estimates must bemade and used in connection with establishing the sales returns and otherallowances in any accounting period. Material differences may result in theamount and timing of our revenue for any period if management made differentjudgments or utilized different estimates.

 

•     Wemust make estimates of the collectibility of our accounts receivable. Weconsider trends of historical bad debts, customer concentrations, customercredit-worthiness and changes in our customer payment terms when evaluating theadequacy of the allowance for doubtful accounts. If circumstances change or ifour original estimates are otherwise incorrect, we may have to reduce ourestimates of the recoverability of amounts due us by a material amount.

 

•     Inventoriesare stated at the lower of cost or market. Estimates of market value are basedon assumptions of future demands and market conditions. If actual marketconditions are materially less favorable than those projected by management, orif our estimates of market value are later determined to have been materiallyincorrect, future inventory write-downs may be required.

 

•     Propertyand equipment are depreciated using the straight-line method over the estimateduseful lives of the assets ranging from three to seven years for equipment and10 to 20 years for buildings. Leasehold improvements are amortized using thestraight-line method over the shorter of the estimated useful lives of theassets or the estimated remaining terms of the leases.

 

•      Valuationof identifiable intangibles and other long-lived assets

 

We assess the possible impairment of identifiable intangibles subjectto amortization and other long-lived assets whenever events or changes incircumstances indicate that the carrying value may not be recoverable. Factorsconsidered important which could trigger an impairment review include thefollowing:

 

•     Significantunderperformance relative to expected historical or projected future operatingresults;

 

•     Significantchanges in the manner of our use of the acquired assets or the strategy for ouroverall business;

 

•     Significantnegative industry or economic trends; and

 

•     Ourmarket capitalization relative to net book value.

 

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

 

•      Accountingfor income taxes

 

We are required to consider our income taxesin each of the tax jurisdictions in which we operate in computing our effectiveincome tax rate. This process involves estimating our current tax exposuretogether with assessing temporary differences resulting from differingtreatment of items for tax and financial reporting purposes. These differencesresult in deferred tax assets and liabilities, which are

 

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included on our consolidated balance sheets.Further, the actual annual amount of taxable income in each tax jurisdictionmay differ from the estimates we use to compute the effective tax rate duringour first, second and third quarters. Additionally, we evaluate therecoverability of the deferred tax assets from future taxable income andestablish valuation allowances if recovery is not more likely than not. Ourincome tax provision on the consolidated income statements are impacted bychanges in the valuation allowance. This process is complex and involvessignificant management judgment in determining our provision for income taxes,deferred tax assets and liabilities and any valuation allowance recordedagainst our net deferred tax assets.

 

•      Consolidation

 

The consolidated financial statements include the accounts of DuPontPhotomasks, Inc and our controlled and wholly owned subsidiaries, and avariable interest entity of which we are the primary beneficiary. Allsignificant intercompany transactions and accounts are eliminated inconsolidation. The minority interest impact is reflected in minority interestin income of joint ventures and is the partners’ share of consolidated jointventure operations. We consolidate our Hsinchu, Taiwan and Shanghai, Chinaoperations as well as the financial results of the BAC.

 

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**ForwardLooking Statements**

 

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

 

•       Theproposed merger with Toppan may divert the attention and resources of management,may affect our relationships with customers and employees, and, if notconsummated, may adversely affect our business and stock price. With respect tothe lawsuit filed in connection with the proposed merger with Toppan by apurported stockholder on behalf of a putative class of stockholders, we areunable at this early stage to predict the outcome of the lawsuit or the impactof its pendency on our financial results or the consummation of the proposedmerger with Toppan.

 

•       Adownturn in the semiconductor industry could lead to a decrease in the demandfor our photomask products;

 

•       Thesemiconductor industry is highly cyclical and has been subject to significanteconomic downturns at various times;

 

•       Ourfinancial results may vary significantly from quarter to quarter or we may failto meet investors’ expectations, which could negatively impact the price of ourstock;

 

•       Lackof visibility and short turn around time of orders may impact our ability torespond to a changing business environment;

 

•       Wemay not obtain sufficient capital to fund our needs;

 

•       Ouroperating results could be adversely affected by under-utilized productioncapacity;

 

•       Asignificant portion of our revenue is derived from Asia and Europe, andtherefore, our business, financial condition and results of operations are to asignificant degree subject to economic, political and social events in theseregions;

 

•       Macroeconomicconditions may have effects on the semiconductor industry;

 

•       Wemay be unable to enhance our existing products and develop and manufacture newproducts and upgrades with improved capabilities to satisfy anticipated demandfor more technologically advanced photomasks;

 

•       Rapidtechnological change could render our products obsolete or our manufacturingprocesses ineffective;

 

•       Wemay not remain competitive and increased competition could seriously harm ourbusiness;

 

•       Wemay be unable to successfully develop or market our EDA software;

 

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

 

•       Oursuccess depends, in part, upon key managerial, engineering and technicalpersonnel as well as our ability to continue to attract and retain additionalpersonnel and integrate new personnel into key positions; and

 

•       Otherrisks indicated in our other filings with the SEC, including but not limited tothose factors which are fully discussed under the caption “Risk Factors” in ourAnnual Report on Form 10-K filed with the SEC on September 9, 2004.

 

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These risks and uncertainties are beyond our control and, in manycases, we cannot predict the risks and uncertainties that could cause ouractual results to differ materially from those indicated by the forward-lookingstatements.

 

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

 

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**Item3.   Quantitative and QualitativeDisclosures About Market Risk**

 

**Market Risk**

 

Market risksrelating to our operations result primarily from changes in interest rates andchanges in foreign currency exchange rates. As of September 30, 2004, wehad $125.0 million in 1.25% convertible subordinated notes and$80.0 million in interest bearing borrowings of which $22.2 millionwere short-term borrowings. Of this amount, $71.0 million is related to the BACterm loan which matures in June 2012. As a result of our interest bearingborrowings, changes in the interest rate market would change the estimated fairvalue of our long-term convertible notes and other interest bearing borrowings.We believe that a 10% change in interest rates would not have a material effecton our business, financial condition, results of operations or cash flows.

 

Foreigncurrency exposures are primarily due to non-North America operations which aresubject to certain risks inherent in conducting business abroad, includingprice and currency exchange controls, fluctuation in the relative value ofcurrencies and restrictive governmental actions. Changes in the relative valueof currencies occur from time to time and may, in certain instances, have amaterial effect on our results of operations. Any exchange rate fluctuationscan affect our margins since we may have imbalances between some foreign currencydenominated revenue and expenses. Our consolidated financial statements reflectremeasurement and translation of items denominated in non-U.S. currencies toU.S. dollars, our reporting currency. Exchange gains or losses are included incomprehensive income in the period in which they occur. We monitor our exchangerate exposure and attempt to reduce such exposure by hedging. We have enteredinto forward contracts in currencies of the countries in which we conductbusiness in order to reduce such exposure. The net unrealized loss related toour forward exchange contracts outstanding as of September  30, 2004 was$0.2 million. In relation to foreign currency translation adjustments, anunrealized gain of $2.5 million is recorded in accumulated other comprehensiveincome on the accompanying consolidated balance sheet and statement ofstockholders’ equity as of September  30, 2004. Forward exchange contractsmay involve elements of credit and market risk in excess of the amountsrecognized on the consolidated financial statements. We monitor our positionsand the credit quality of counterparties, consisting primarily of majorfinancial institutions, and do not anticipate nonperformance by anycounterparty, although nonperformance could occur. We have performed asensitivity analysis as of September 30, 2004 using a modeling technique that measures the change in the fair valuesarising from a hypothetical 10% adverse movement in the levels of foreigncurrency exchange rates relative to the U. S. dollar with all other variablesheld constant. The analysis covers all of our foreign currency contracts offsetby the underlying exposures. The foreign currency exchange rates used werebased on market rates in effect as of September  30, 2004. The sensitivityanalysis indicated that a hypothetical 10% adverse movement in foreign currencyexchange rates would not have a material effect on our business, financialcondition, results of operations or cash flows. There can be no assurance thatsuch forward contracts or any other hedging activity will be available oradequate to eliminate, or even mitigate, the impact of our exchange rateexposure. There can be no assurance that such risks will not have a materialadverse impact on our liquidity, financial condition and results of operationsin the future.

 

**Financial Risk Management**

 

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

 

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Themarketplace for our products dictates that we maintain inventories of rawmaterials. Therefore, inventory obsolescence is a risk for us due to frequentengineering changes, shifting customer demand, the emergence of new industrystandards and rapid technological advances including the introduction by ourcompetitors or us of products embodying new technology. While we regularlyreview our inventory valuation estimates to ensure approximation of fair marketvalue of the inventory on hand, there can be no guarantees that futureinventory writedowns will not be required.

 

As ofSeptember 30, 2004, we had outstanding foreign short-term borrowings,totaling $22.2 million. Of this amount, $15.3 million is related to theBAC term loan. As of September 30, 2004, we had no relationships withunconsolidated entities or financial partnerships, such as entities oftenreferred to as structured finance or special purpose entities, which would havebeen established for the purpose of facilitating off-balance sheet arrangementsor other contractually narrow or limited purposes. Accordingly, we are notexposed to any financing, liquidity, market or credit risk that could arise ifwe were engaged in such relationships.

 

In addition,we issued and sold $125.0 million aggregate principal amount ofconvertible subordinated notes in a private placement in May 2003. Thenotes are due May 15, 2008, accrue interest at an annual rate of1.25 percent and are convertible at any time into shares of our commonstock at a conversion price of $25.595 per share. Interest on the notes ispayable semi-annually on May 15 and November 15 of each yearbeginning November 15, 2003. If a change of control occurs, each holder ofnotes will have the right to require us to redeem, in cash, any or all of suchholder’s notes at a price equal to 100% of the principal amount to be redeemed.A change of control is any transaction in which a person or group becomes thebeneficial owner of 50% or more of our common stock or has the power to elect amajority of our board of directors, any consolidation, merger or similar transactionin which our stockholders immediately prior to the transaction hold less than amajority of the outstanding voting stock of the surviving corporation and theconsideration in the merger or consolidation is not common stock listed on anational securities exchange or approved for quotation on the Nasdaq NationalMarket, or the holders of our capital stock approve any plan or proposal forour liquidation or dissolution. If a change of control were to occur, we cannotassure you that we will have sufficient funds to pay the redemption price forall the notes tendered by the holders. In that case, our failure to redeemtendered notes would constitute an event of default under the indenture for thenotes, and may constitute a default under the terms of other indebtedness thatwe may enter into from time to time. In connection with the issuance of thenotes, we entered into a Registration Rights Agreement and filed a shelfregistration statement covering resales of the notes and the common stockissuable upon conversion of the notes. If we fail to comply with certain of ourobligations under the Registration Rights Agreement, additional interest willaccrue on the affected notes at an annual rate of 0.5%.

 

### **Item 4.  Controls and Procedures**

 

Our chiefexecutive officer and our chief financial officer, based on their evaluation ofthe effectiveness of our disclosure controls and procedures (as defined inRules 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 DuPontPhotomasks, Inc., have concluded that our disclosure controls and procedureswere effective. There were no changes in internal control over financialreporting (as defined in Rules 13a - 15(f) and 15d - 15(f) under the SecuritiesExchange Act of 1934) during our most recent fiscal quarter that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

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## **PART II**

 

# **Item 1. Legal Proceedings**

 

There were nolegal proceedings that became a reportable event during the quarterly periodended September 30, 2004.

 

**Item 6. Exhibits**

 
|   | (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) |
|   |   |   | 4.7      |   | Amendment No. 2 to Rights Agreement between DuPont Photomasks, Inc.  and EquiServe Trust Company, N.A., as Rights Agent, dated as of October 5,  2004. |
|   |   |   | 4.8      |   | October 30, 2001 Amendment to Non-Employee  Directors Stock Option Plan |
|   |   |   | 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. |
|   |   |   | 32       |   | 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. |

 

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| ** ** | ** ** | ** ** | **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.                           |

 

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**SIGNATURES**

 

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

 
|                   | DUPONT PHOTOMASKS, INC.  (Registrant) |
|------------------------|---------------------------------------|
|                   |                                  |   |
|                   | By:                                   | /s/ SATISH RISHI |   |
|                   |                                  | Satish Rishi |
| Date: November 5, 2004 |                                  | *Executive Vice President—Finance and Chief Financial  Officer (Principal Financial and Accounting Officer)* |

 

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