**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

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**FORM 10-Q**

 

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

 

**Forthe quarterly period ended December 31, 2003**

**Commissionfile number 0-20839**

 

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**DUPONT PHOTOMASKS, INC.**

(Exact name of registrant as specified in ourcharter)

 

| **Delaware**                                                    |   | **74-2238819**                       |
|-----------------------------------------------------------------|--------|--------------------------------------|
| (State or Other Jurisdiction of  Incorporation or Organization) |   | (I.R.S. Employer Identification No.) |

 

**131 Old Settlers BoulevardRound Rock, Texas 78664**

(Address ofPrincipal Executive Offices)

Registrant’stelephone number, including area code: **(512) 310-6500**

 

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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 wasrequired to file such reports), and (2) has been subject to such filingrequirements for the 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  February 9, 2004, 18,195,708 shares ofcommon stock, $.01 par value, were outstanding.

 

 

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**TABLEOF CONTENTS**

 
| **Part I**  |    |                                                                                                                                                         |   |
|-------------|---------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|        |    |                                                                                                                                                         |   |
|        | Item 1. | Financial Statements                                                                                                                                         |   |
|        |    | Consolidated Income Statements (unaudited) for the Three Months Ended  December 31, 2002 and 2003 and for the Six Months Ended December 31, 2002 and  2003   |   |
|        |    | Consolidated Balance Sheets as of June 30, 2003 and December 31, 2003  (unaudited)                                                                           |   |
|        |    | Consolidated Statements of Cash Flows  (unaudited) for the Six Months Ended December 31, 2002 and 2003                                                       |   |
|        |    | Consolidated Statements of  Stockholders’ Equity for the Twelve Months  Ended June 30, 2003 and the Six Months Ended December 31, 2003 (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 4. | Submission of Matters to a Vote of Security  Holders                                                                                                         |   |
|        |    |                                                                                                                                                         |   |
|        | Item 6. | Exhibits and Reports on Form 8-K                                                                                                                             |   |
|        |    | Signatures                                                                                                                                                   |   |

 

2

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## **PART I**

 

**Item 1. FinancialStatements**

 

**DUPONTPHOTOMASKS, INC. AND SUBSIDIARIES**

 

## **CONSOLIDATED INCOMESTATEMENTS**

**(Dollarsin thousands, except share data)**

**(unaudited)**

** **
|                                                  |   | **Three Months Ended  December 31,** |    | **Six Months Ended  December 31,** |   |
|-------------------------------------------------------|--------|--------------------------------------|---------|------------------------------------|--------|
|                                                  |   | **2002**                             |    | **2003**                           |   | **2002** |   | **2003** |   |
| Revenue, net                                          |   | $                                    | 80,969  |                               | $      | 85,964 |   | $ | 165,209 |   | $ | 168,341 |   |
| Cost of goods sold                                    |   | 71,000                               |    | 77,153                             |   | 141,734 |   | 152,802 |   |
| Selling, general and administrative expense           |   | 10,415                               |    | 13,375                             |   | 20,335 |   | 25,699 |   |
| Research and development expense                      |   | 7,592                                |    | 7,566                              |   | 15,166 |   | 14,617 |   |
| Special charges, net                                  |   | 12,507                               |    | 361                                |   | 12,507 |   | 1,591 |   |
| Operating loss                                        |   | (20,545                              | )       | (12,491                            | )      | (24,533 | ) | (26,368 | ) |
| Other income (expense), net                           |   | 236                                  |    | (457                               | )      | 110 |   | (1,120 | ) |
| Loss before income taxes and minority interest        |   | (20,309                              | )       | (12,948                            | )      | (24,423 | ) | (27,488 | ) |
| Provision for income taxes                            |   | 1,769                                |    | 800                                |   | 1,358 |   | 1,450 |   |
| Loss before minority interest                         |   | (22,078                              | )       | (13,748                            | )      | (25,781 | ) | (28,938 | ) |
| Minority interest in (income) loss of joint  ventures |   | (939                                 | )       | 521                                |   | (2,731 | ) | 607 |   |
| Net loss                                              |   | $                                    | (23,017 | )                                  | $      | (13,227 | ) | $ | (28,512 | ) | $ | (28,331 | ) |
|                                                  |   |                                 |    |                               |   |   |   |   |   |
| Basic loss per share                                  |   | $                                    | (1.28   | )                                  | $      | (0.73 | ) | $ | (1.59 | ) | $ | (1.56 | ) |
|                                                  |   |                                 |    |                               |   |   |   |   |   |
| Weighted average shares outstanding                   |   | 17,993,994                           |    | 18,130,468                         |   | 17,982,365 |   | 18,119,473 |   |
|                                                  |   |                                 |    |                               |   |   |   |   |   |
| Diluted loss per share                                |   | $                                    | (1.28   | )                                  | $      | (0.73 | ) | $ | (1.59 | ) | $ | (1.56 | ) |
|                                                  |   |                                 |    |                               |   |   |   |   |   |
| Weighted average shares outstanding                   |   | 17,993,994                           |    | 18,130,468                         |   | 17,982,365 |   | 18,119,473 |   |

 

The accompanying notes are an integral partof these consolidated statements.

 

3

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**DUPONTPHOTOMASKS, INC. AND SUBSIDIARIES**

 

## **CONSOLIDATEDBALANCE SHEETS**

**(Dollarsin thousands, except share data)**

** **
|                                                                                                                         |   | **June 30,  2003** |       | **December 31,  2003** |       |
|------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|------------------------|------------|
|                                                                                                                         |   |               |       | **(unaudited)**        |       |
| **ASSETS**                                                                                                                   |   |               | ** ** |                   | ** ** |
| Current assets:                                                                                                              |   |               |       |                   |       |
| Cash and cash equivalents                                                                                                    |   | $                  | 250,355    |                   | $          | 226,783 |   |
| Accounts receivable, trade, net                                                                                              |   | 54,312             |       | 60,728                 |       |
| Accounts receivable, related parties                                                                                         |   | 996                |       | 1,704                  |       |
| Inventories, net                                                                                                             |   | 13,434             |       | 11,767                 |       |
| Deferred income taxes                                                                                                        |   | 4,454              |       | 290                    |       |
| Prepaid expenses and other current assets                                                                                    |   | 12,705             |       | 13,788                 |       |
| Total current assets                                                                                                         |   | 336,256            |       | 315,060                |       |
| Assets held for sale                                                                                                         |   | 5,087              |       | 9,033                  |       |
| Property and equipment, net                                                                                                  |   | 379,582            |       | 361,875                |       |
| Accounts receivable, related parties                                                                                         |   | 1,048              |       | 941                    |       |
| Deferred income taxes                                                                                                        |   | 1,603              |       | 1,405                  |       |
| Other assets, net                                                                                                            |   | 46,006             |       | 37,648                 |       |
| Total assets                                                                                                                 |   |               | $          | 769,582                |       | $ | 725,962 |   |
|                                                                                                                         |   |               |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                |   |               |       |                   |       |
| Current liabilities:                                                                                                         |   |               |       |                   |       |
| Accounts payable, trade                                                                                                      |   | $                  | 45,935     |                   | $          | 37,279 |   |
| Accounts payable, related parties                                                                                            |   | 4,553              |       | 5,524                  |       |
| Income taxes payable                                                                                                         |   | 884                |       | 2,224                  |       |
| Other accrued liabilities                                                                                                    |   | 59,559             |       | 59,713                 |       |
| Short-term borrowings                                                                                                        |   | 11,903             |       | 7,630                  |       |
| Convertible notes                                                                                                            |   | —             |       | 100,000                |       |
| Total current liabilities                                                                                                    |   | 122,834            |       | 212,370                |       |
| Long-term borrowings                                                                                                         |   | 1,973              |       | 44                     |       |
| Long-term convertible notes                                                                                                  |   | 225,000            |       | 125,000                |       |
| Deferred income taxes                                                                                                        |   | 4,872              |       | 712                    |       |
| Other liabilities                                                                                                            |   | 10,522             |       | 8,727                  |       |
| Minority interest in net assets of joint ventures                                                                            |   | 45,436             |       | 44,829                 |       |
| Total liabilities                                                                                                            |   |               | 410,637    |                   | 391,682    |   |
|                                                                                                                         |   |               |       |                   |       |
| Commitments and contingencies                                                                                                |   |               |       |                   |       |
| Stockholders’ equity:                                                                                                   |   |               |       |                   |       |
| Preferred stock, $.01 par value; 5,000,000 shares  authorized; none issued and outstanding                                   |   | —             |       | —                 |       |
| Common stock, $.01 par value; 100,000,000 shares  authorized; 18,064,964 and 18,130,619 issued and outstanding, respectively |   | 181                |       | 181                    |       |
| Additional paid-in capital                                                                                                   |   | 317,220            |       | 318,378                |       |
| Retained earnings                                                                                                            |   | 41,544             |       | 13,213                 |       |
| Accumulated other comprehensive income                                                                                       |   | —             |       | 2,508                  |       |
| Total stockholders’ equity                                                                                              |   |               | 358,945    |                   | 334,280    |   |
| Total liabilities and  stockholders’ equity                                                                             |   |               | $          | 769,582                |       | $ | 725,962 |   |

 

The accompanying notes are an integral partof these consolidated statements.

 

4

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**DUPONTPHOTOMASKS, INC. AND SUBSIDIARIES**

 

## **CONSOLIDATED STATEMENTSOF CASH FLOWS**

**(Dollarsin thousands)**

**(unaudited)**

** **
|                                                                             |   | **Six Months Ended  December 31,** |    |
|----------------------------------------------------------------------------------|--------|------------------------------------|---------|
|                                                                             |   | **2002**                           |    | **2003** |   |
| Cash flows from operating activities:                                            |   |                               |    |   |   |
| Net loss                                                                         |   | $                                  | (28,512 | ) | $ | (28,331 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities: |   |                               |    |   |   |
| Depreciation and amortization                                                    |   | 49,443                             |    | 46,600 |   |
| Minority interest in income (loss) of joint  ventures                            |   | 2,731                              |    | (607 | ) |
| Deferred income taxes                                                            |   | 2,048                              |    | 202 |   |
| Special charges, net                                                             |   | 12,507                             |    | 1,591 |   |
| Other                                                                            |   | (308                               | )       | 355 |   |
| Changes in assets and liabilities:                                               |   |                               |    |   |   |
| Accounts receivable, trade, net                                                  |   | 2,217                              |    | (10,905 | ) |
| Accounts receivable, related parties                                             |   | 1,978                              |    | (570 | ) |
| Inventories, net                                                                 |   | (1,143                             | )       | 1,544 |   |
| Other assets, net                                                                |   | 24,090                             |    | 4,413 |   |
| Accounts payable, trade                                                          |   | (3,958                             | )       | (4,255 | ) |
| Accounts payable, related parties                                                |   | 862                                |    | 972 |   |
| Other liabilities                                                                |   | (8,228                             | )       | (9,081 | ) |
|                                                                             |   |                               |    |   |   |
| Net cash provided by operating activities                                        |   | 53,727                             |    | 1,928 |   |
|                                                                             |   |                               |    |   |   |
| Cash flows from investing activities:                                            |   |                               |    |   |   |
| Purchases of property and equipment                                              |   | (30,107                            | )       | (24,680 | ) |
| Proceeds from sale of warrants and investments                                   |   | 105                                |    | — |   |
| Purchases of investments                                                         |   | (1,983                             | )       | — |   |
| Proceeds from sale of assets                                                     |   | —                             |    | 2,000 |   |
|                                                                             |   |                               |    |   |   |
| Net cash used in investing activities                                            |   | (31,985                            | )       | (22,680 | ) |
|                                                                             |   |                               |    |   |   |
| Cash flows from financing activities:                                            |   |                               |    |   |   |
| Proceeds from borrowings                                                         |   | 2,006                              |    | 401 |   |
| Payments on borrowings                                                           |   | (2,779                             | )       | (4,918 | ) |
| Proceeds from issuance of common stock under  employee plans                     |   | 1,499                              |    | 1,158 |   |
|                                                                             |   |                               |    |   |   |
| Net cash provided by (used in) financing  activities                             |   | 726                                |    | (3,359 | ) |
|                                                                             |   |                               |    |   |   |
| Effect of exchange rate changes on cash                                          |   | 587                                |    | 539 |   |
|                                                                             |   |                               |    |   |   |
| Net increase (decrease) in cash and cash  equivalents                            |   | 23,055                             |    | (23,572 | ) |
| Cash and cash equivalents at beginning of period                                 |   | 138,918                            |    | 250,355 |   |
|                                                                             |   |                               |    |   |   |
| Cash and cash equivalents at end of period                                       |   | $                                  | 161,973 |   | $ | 226,783 |   |
|                                                                             |   |                               |    |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                |   |                               |    |   |   |
| Cash paid (received) for:                                                        |   |                               |    |   |   |
| Interest                                                                         |   | $                                  | 279     |   | $ | 1,147 |   |
|                                                                             |   |                               |    |   |   |
| Taxes, net                                                                       |   | $                                  | (20,849 | ) | $ | 404 |   |

 

The accompanying notes are an integral partof these consolidated statements.

 

5

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**DUPONTPHOTOMASKS, INC. AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**(Dollarsin thousands)**

** **
|                                          |   | **Common Stock** |   | **Additional  Paid-In  Capital** |   | **Retained  Earnings** |   | **Accumulated Other  Comprehensive  Income** |   | **Total  Stockholders’Equity** |    |
|-----------------------------------------------|--------|------------------|--------|----------------------------------|--------|------------------------|--------|----------------------------------------------|--------|-------------------------------------|---------|
| **Shares**                                    |   | **Amount**       |
| Balance as of June 30, 2002                   |   | 17,927,294       |   | $                                | 179    |                   | $      | 314,430                                      |   | $                                   | 155,054 |   | $ | — |   | $ | 469,663 |   |
|                                          |   |             |   |                             |   |                   |   |                                         |   |                                |    |   |   |
| Issuance of common stock under employee plans |   | 137,670          |   | 2                                |   | 2,790                  |   | —                                       |   | —                              |    | 2,792 |   |
| Net loss                                      |   | —           |   | —                           |   | —                 |   | (113,510                                     | )      | —                              |    | (113,510 | ) |
|                                          |   |             |   |                             |   |                   |   |                                         |   |                                |    |   |   |
| Balance as of June 30, 2003                   |   | 18,064,964       |   | 181                              |   | 317,220                |   | 41,544                                       |   | —                              |    | 358,945 |   |
|                                          |   |             |   |                             |   |                   |   |                                         |   |                                |    |   |   |
| Issuance of common stock under employee plans |   | 65,655           |   | —                           |   | 1,158                  |   | —                                       |   | —                              |    | 1,158 |   |
| Foreign currency translation adjustments      |   | —           |   | —                           |   | —                 |   | —                                       |   | 2,508                               |    | 2,508 |   |
| Net loss                                      |   | —           |   | —                           |   | —                 |   | (28,331                                      | )      | —                              |    | (28,331 | ) |
|                                          |   |             |   |                             |   |                   |   |                                         |   |                                |    |   |   |
| Balance as of December 31, 2003 (unaudited)   |   | 18,130,619       |   | $                                | 181    |                   | $      | 318,378                                      |   | $                                   | 13,213  |   | $ | 2,508 |   | $ | 334,280 |   |

 

The accompanying notes are an integral part of these consolidatedstatements.

 

6

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**DUPONTPHOTOMASKS, INC. AND SUBSIDIARIES**

## **NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Dollarsin thousands, except share data)**

**(unaudited)**

 

**1.             Basis of Presentation**

 

The interimconsolidated financial statements presented in this report include the accountsof DuPont Photomasks, Inc. and our controlled and wholly-owned subsidiaries.All significant 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 is recommended that these interim consolidatedfinancial statements be read in conjunction with the consolidated financialstatements and the notes thereto included in our Annual Report onForm 10-K for the year ended June 30, 2003. The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires the use of estimates andassumptions by management in determining the reported amounts of assets and liabilities,disclosures of contingent liabilities as of the date of the financialstatements and the reported amounts of revenue and expenses during the period.Actual results could differ from those estimates. The results of operations forany interim period are not necessarily indicative of the results of operationsfor the entire fiscal year. Certain reclassifications have been made in theprior period consolidated financial statements to conform with the currentperiod presentation.

 

**2.             Property and Equipment**

 

Property andequipment are stated at cost. Property and equipment under capital leases arestated at the present value of future minimum lease payments. Property andequipment 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. Property and equipment held under capital leasesand leasehold improvements are amortized using the straight-line method overthe shorter of the estimated useful lives of the assets or the estimatedremaining terms of the leases. Accumulated depreciation and amortization was$443,410 as of June 30, 2003 and $465,976 as of December 31, 2003.Assets held for sale relate to the Gresham, Danbury, and Rousset facilities andcertain other equipment. We are actively marketing these assets and will sellthe assets after appropriate evaluation of all proposals.

 

**3.             New Accounting Pronouncements**

 

In January2003, the FASB issued FASB Interpretation No. 46, or FIN No. 46, *Consolidationof Variable Interest Entities* (“VIE”).  FIN No. 46 requiresthat if an entity is the primary beneficiary of a VIE, the assets, liabilities,and results of operations of the VIE should be consolidated on the entity’sfinancial statements.  In December 2003,the FASB revised FIN No. 46 which, among other revisions, resulted in thedeferral of the effective date of applying the provisions of FIN No. 46 to thefirst interim or annual period ending after March 15, 2004 for qualifyingVIE’s. We are currently assessing the impact that FIN No. 46, as revised, mayhave on our consolidated financial condition or results of operations.

 

In January2003, the SEC issued a final rule requiring enhanced disclosure of materialoff-balance sheet transactions, arrangements, and other relationships withunconsolidated entities. The rule also requires a tabular disclosure of futurepayments due under contractual commitments. The disclosure requirements willbecome effective for our fiscal 2004 Annual Report on Form 10-K.  We do not expect this pronouncement to havea material impact on our consolidated financial condition or results ofoperations.

 

7

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**4.             Derivative Instruments and HedgingActivities**

 

Forwardforeign exchange contracts are utilized to mitigate the risks associated withcurrency fluctuations on certain foreign currency  balance sheet exposures, and are, therefore, held primarily forpurposes other than trading. These foreign exchange contracts do not qualifyfor hedge accounting under SFAS No. 133 *Accounting for Derivative Instrumentsand Hedging Activities*, as amended. Unrealized gains and lossesresulting from the impact of currency exchange rate movements on forwardforeign exchange contracts designated to offset certain non-U.S. dollardenominated assets and liabilities are recognized as other income or expense onthe accompanying consolidated income statements in the period in which theexchange rates change. These gains and losses offset the foreign currencyexchange gains and losses on the underlying exposures being hedged. Anunrealized loss of $28 for the three and six months ended December 31, 2003 isrecorded in other expense, net on the accompanying consolidated incomestatement in relation to our forward exchange contracts outstanding as ofDecember 31, 2003.  These instrumentsmay 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.

 

**5.             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 common shareequivalents outstanding (if dilutive) during each period. Common shareequivalents include stock options and assumed conversion of the convertiblenotes. The number of common share equivalents outstanding relating to stockoptions is computed using the treasury stock method and the number of commonshare equivalents outstanding relating to the convertible notes is computedusing the if-converted method.

 

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

 
|                                              |   | **Three Months Ended  December 31,** |    | **Six Months Ended  December 31,** |   |
|---------------------------------------------------|--------|--------------------------------------|---------|------------------------------------|--------|
|                                              |   | **2002**                             |    | **2003**                           |   | **2002** |   | **2003** |   |
| Net loss for the period—basic                |   | $                                    | (23,017 | )                                  | $      | (13,227 | ) | $ | (28,512 | ) | $ | (28,331 | ) |
| Dilutive effect of convertible notes              |   | —                               |    | —                             |   | — |   | — |   |
|                                              |   |                                 |    |                               |   |   |   |   |   |
| Net loss for the period—diluted              |   | $                                    | (23,017 | )                                  | $      | (13,227 | ) | $ | (28,512 | ) | $ | (28,331 | ) |
|                                              |   |                                 |    |                               |   |   |   |   |   |
| Weighted average shares outstanding—basic    |   | 17,993,994                           |    | 18,130,468                         |   | 17,982,365 |   | 18,119,473 |   |
| Plus: Common share equivalents                    |   | —                               |    | —                             |   | — |   | — |   |
|                                              |   |                                 |    |                               |   |   |   |   |   |
| Weighted average shares outstanding—dilutive |   | 17,993,994                           |    | 18,130,468                         |   | 17,982,365 |   | 18,119,473 |   |
|                                              |   |                                 |    |                               |   |   |   |   |   |
| Basic loss per share                              |   | $                                    | (1.28   | )                                  | $      | (0.73 | ) | $ | (1.59 | ) | $ | (1.56 | ) |
|                                              |   |                                 |    |                               |   |   |   |   |   |
| Diluted loss per share                            |   | $                                    | (1.28   | )                                  | $      | (0.73 | ) | $ | (1.59 | ) | $ | (1.56 | ) |

 

Stock optionsto acquire 4,392,116 and 4,860,628 shares for the three and six months endedDecember 31, 2002 and 2003, respectively, were not included in common shareequivalents because the effect of including these stock options would have beenanti-dilutive.  For the three and sixmonths ended December 31, 2002, 941,088 shares were not included in thecomputations of diluted EPS because the effect of including the shares to be issuedupon the conversion of convertible notes would have been anti-dilutive. For thethree and six months ended December 31, 2003, 5,824,850 shares were notincluded in the computations of diluted EPS because the effect of including theshares to be issued upon the conversion of convertible notes would have beenanti-dilutive. These options and the convertible notes may become dilutive inthe future.

 

**6.****                                         ComprehensiveIncome**

 

We had no itemsof comprehensive income other than net loss for the three and six months endedDecember 31, 2002.  Our comprehensiveincome for the three and six months ended December 31, 2003 is comprised of netloss and foreign currency translation adjustments.

 

8

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**7.****                                         EmployeePlans**

 

We apply theintrinsic-value-based method of accounting prescribed by Accounting PrinciplesBoard, or APB, Opinion No. 25, *Accounting for Stock Issued to Employees*,and related interpretations including FASB Interpretation No. 44, *Accountingfor Certain Transactions involving Stock Compensation, an interpretation of APBOpinion No. 25*, to account for our stock performance plans. Underthis method, compensation expense is recorded on the date of grant only if thecurrent market price of the underlying stock exceeded the exercise price. Wealso have an Employee Stock Purchase Plan. SFAS No. 123, *Accounting for Stock Based Compensation*,established accounting and disclosure requirement alternatives which involveusing a different accounting method for expensing the calculated value ofoption awards. As allowed by SFAS No. 123, we have elected to continue to applythe intrinsic-value-based method of accounting described above, and haveadopted only the disclosure requirements of SFAS No. 123. We use the Black-Scholesmodel to calculate pro forma expense for disclosure purposes. The Black-Scholesoption valuation model was developed for use in estimating the fair value oftraded options that have no vesting restrictions and are fully transferable.Option valuation models require the input of highly subjective assumptionsincluding the expected stock price volatility. We use projected volatilityrates which are based upon historical volatility rates. Because our employeestock options and Employee Stock Purchase Plan shares have characteristicssignificantly different from those of traded options, and because changes inthe subjective input assumptions can materially affect the fair value estimate,in management’s opinion, the existing models do not necessarily provide areliable single measure of the fair value of our employee stock options andEmployee Stock Purchase Plan shares.

 

SFAS No. 148, *Accountingfor Stock-Based Compensation—Transition and Disclosure, an amendment of FASBStatement No. 123*, amends the disclosure requirements of SFAS No.123. The following table illustrates the effect on net loss if thefair-value-based method had been applied to our stock-based employeecompensation plans in each period.

 
|                                                                                                                                    |   | **Three Months Ended  December 31,** |    | **Six Months Ended  December 31,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------|---------|------------------------------------|--------|
|                                                                                                                                    |   | **2002**                             |    | **2003**                           |   | **2002** |   | **2003** |   |
| Net loss:                                                                                                                               |   |                                 |    |                               |   |   |   |   |   |
| As reported                                                                                                                             |   | $                                    | (23,017 | )                                  | $      | (13,227 | ) | $ | (28,512 | ) | $ | (28,331 | ) |
| Deduct total stock-based employee compensation  expense determined under the Black-Scholes valuation method for all awards,  net of tax |   | (4,043                               | )       | (3,507                             | )      | (8,086 | ) | (7,087 | ) |
|                                                                                                                                    |   |                                 |    |                               |   |   |   |   |   |
| Pro forma net loss                                                                                                                      |   | $                                    | (27,060 | )                                  | $      | (16,734 | ) | $ | (36,598 | ) | $ | (35,418 | ) |
|                                                                                                                                    |   |                                 |    |                               |   |   |   |   |   |
| Basic loss per share:                                                                                                                   |   |                                 |    |                               |   |   |   |   |   |
| As reported                                                                                                                             |   | $                                    | (1.28   | )                                  | $      | (0.73 | ) | $ | (1.59 | ) | $ | (1.56 | ) |
| Pro forma                                                                                                                               |   | $                                    | (1.50   | )                                  | $      | (0.92 | ) | $ | (2.04 | ) | $ | (1.95 | ) |
|                                                                                                                                    |   |                                 |    |                               |   |   |   |   |   |
| Diluted loss per share:                                                                                                                 |   |                                 |    |                               |   |   |   |   |   |
| As reported                                                                                                                             |   | $                                    | (1.28   | )                                  | $      | (0.73 | ) | $ | (1.59 | ) | $ | (1.56 | ) |
| Pro forma                                                                                                                               |   | $                                    | (1.50   | )                                  | $      | (0.92 | ) | $ | (2.04 | ) | $ | (1.95 | ) |

 

9

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**8.             Segment Information**

 

The Companyconducts operations worldwide and is managed on a geographic basis, with thosegeographic segments being North America, Europe and Asia. The North Americasegment consists only of the U.S., the Europe segment includes France andGermany and the Asia segment includes China, Japan, Korea, Taiwan andSingapore.

 
|                                      |   | **North  America** |    | **Europe** |   | **Asia** |   | **Eliminations** |    | **Total** |   |
|-------------------------------------------|--------|--------------------|---------|------------|--------|----------|--------|------------------|---------|-----------|--------|
| **Three Months Ended December 31,  2002** |   |               |    |       |   |     |   |             |    |      |   |
| Revenue, net                              |   | $                  | 38,609  |       | $      | 15,877   |   | $                | 26,483  |      | $      | — |   | $ | 80,969 |   |
| Transfers between geographic segments     |   | 1,690              |    | 227        |   | 5,479    |   | (7,396           | )       | —    |   |
|                                      |   | $                  | 40,299  |       | $      | 16,104   |   | $                | 31,962  |      | $      | (7,396 | ) | $ | 80,969 |   |
|                                      |   |               |    |       |   |     |   |             |    |      |   |
| Net income (loss)                         |   | $                  | (16,493 | )          | $      | (12,286  | )      | $                | 5,762   |      | $      | — |   | $ | (23,017 | ) |
|                                      |   |               |    |       |   |     |   |             |    |      |   |
| **Six Months Ended December 31,  2002**   |   |               |    |       |   |     |   |             |    |      |   |
| Revenue, net                              |   | $                  | 77,948  |       | $      | 29,873   |   | $                | 57,388  |      | $      | — |   | $ | 165,209 |   |
| Transfers between geographic segments     |   | 3,331              |    | 270        |   | 10,302   |   | (13,903          | )       | —    |   |
|                                      |   | $                  | 81,279  |       | $      | 30,143   |   | $                | 67,690  |      | $      | (13,903 | ) | $ | 165,209 |   |
|                                      |   |               |    |       |   |     |   |             |    |      |   |
| Net income (loss)                         |   | $                  | (28,441 | )          | $      | (15,044  | )      | $                | 14,973  |      | $      | — |   | $ | (28,512 | ) |
|                                      |   |               |    |       |   |     |   |             |    |      |   |
| **June 30, 2003**                         |   |               |    |       |   |     |   |             |    |      |   |
| Identifiable assets                       |   | $                  | 308,821 |       | $      | 113,787  |   | $                | 346,974 |      | $      | — |   | $ | 769,582 |   |
|                                      |   |               |    |       |   |     |   |             |    |      |   |
| **Three Months Ended December 31,  2003** |   |               |    |       |   |     |   |             |    |      |   |
| Revenue, net                              |   | $                  | 37,428  |       | $      | 22,244   |   | $                | 26,292  |      | $      | — |   | $ | 85,964 |   |
| Transfers between geographic segments     |   | 6,597              |    | —     |   | 6,758    |   | (13,355          | )       | —    |   |
|                                      |   | $                  | 44,025  |       | $      | 22,244   |   | $                | 33,050  |      | $      | (13,355 | ) | $ | 85,964 |   |
|                                      |   |               |    |       |   |     |   |             |    |      |   |
| Net income (loss)                         |   | $                  | 1,952   |       | $      | (18,705  | )      | $                | 3,526   |      | $      | — |   | $ |  (13,227 | ) |
|                                      |   |               |    |       |   |     |   |             |    |      |   |
| **Six Months Ended December 31,  2003**   |   |               |    |       |   |     |   |             |    |      |   |
| Revenue, net                              |   | $                  | 71,510  |       | $      | 41,936   |   | $                | 54,895  |      | $      | — |   | $ | 168,341 |   |
| Transfers between geographic segments     |   | 12,702             |    | 53         |   | 12,202   |   | (24,957          | )       | —    |   |
|                                      |   | $                  | 84,212  |       | $      | 41,989   |   | $                | 67,097  |      | $      | (24,957 | ) | $ | 168,341 |   |
|                                      |   |               |    |       |   |     |   |             |    |      |   |
| Net income (loss)                         |   | $                  | (10,729 | )          | $      | (26,529  | )      | $                | 8,927   |      | $      | — |   | $ | (28,331 | ) |
|                                      |   |               |    |       |   |     |   |             |    |      |   |
| **December 31, 2003**                     |   |               |    |       |   |     |   |             |    |      |   |
| Identifiable assets                       |   | $                  | 240,248 |       | $      | 130,798  |   | $                | 354,916 |      | $      | — |   | $ | 725,962 |   |

 

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

 

**9.**             **Income Taxes**

 

The provisionfor income taxes differs from amounts computed by applying the federalstatutory rate of 35% to loss before income taxes and minority interest becauseof: our inability to record deferred tax benefits for net operating lossesgenerated in certain tax jurisdictions; our reduced tax rates in certain Asianjurisdictions; and for other adjustments described below.

 

During thethree months ended December 31, 2002, we recorded a valuation allowance of$1,812 against our net deferred tax asset in Europe (primarily related to netoperating loss carryforwards) for the restructuring in Germany.  During the three months ended December 31,2003, our net tax provision included a $950 benefit from the positiveresolution of tax audits in multiple jurisdictions and a provision of $1,250for withholding taxes related to a planned dividend distribution from withinour group of foreign subsidiaries.  Whenconsummated, this dividend distribution will utilize the majority of our U.S.net operating loss carryforward.

 

10

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**10.          Special Charges, net**

 

During fiscal 2003,we implemented programs to reduce costs associated with our North America,Europe and Asia segments. The integration and consolidation initiatives inNorth America and Asia were completed as of March 31, 2003, and the relatedliabilities were settled as of September 30, 2003. We plan to complete theconsolidation initiatives in Europe and settle the related liabilities duringfiscal 2004.  During the three monthsended September 30, 2003, we reduced accrued liabilities for lease terminationand asset disposal related costs by $367 as a result of our renegotiation ofour lease termination agreement for our Hamburg facility.  During the three months ended December 31,2003, we recorded special charges of $757 which were not previously estimableand related to employee severance for our former employees at our Roussetfacility.  In addition, we recorded a$553 benefit as a result of terminating a capital lease liability on December31, 2003 for our Hamburg facility.  Thecharges, benefit and adjustments to the liability have been recorded as SpecialCharges, net on the accompanying consolidated income statements.

 

During the threemonths ended September 30, 2003, we closed our pellicle production facility inDanbury as part of our efforts to reduce costs. In relation to this decision,we recorded special charges of $2,722 for employee severance and asset disposalcosts and received proceeds of $1,200 from the sale of certain pellicletechnology during the three months ended September 30, 2003.  We recorded additional special charges of$234 for employee severance and reduced the employee severance liability by $77during the three months ended December 31, 2003.  The charges and adjustments to the liability, net of sale proceeds,have been recorded as Special Charges, net on the accompanying consolidatedincome statements.  We expect tocomplete the closure initiatives in Danbury and extinguish the relatedliabilities during the three months ending March 31, 2004.

 

A summary of therelated accrued liabilities is shown below:

 
|                                                                           |   | **Employee  Severance** |   | **Asset  Disposals and  Related  Costs** |   | **Lease  Termination  and Other  Costs** |   | **Total** |   |
|--------------------------------------------------------------------------------|--------|-------------------------|--------|------------------------------------------|--------|------------------------------------------|--------|-----------|--------|
| Remaining liability as of June 30, 2003                                        |   | $                       | 11,404 |                                     | $      | 1,307                                    |   | $         | 1,949  |   | $ | 14,660 |   |
| Charges during the three months ended September  30, 2003                      |   | 2,057                   |   | 740                                      |   | —                                   |   | 2,797     |   |
| Adjustments to the liability during the three  months ended September 30, 2003 |   | —                  |   | (129                                     | )      | (238                                     | )      | (367      | )      |
| Utilized during the three months ended  September 30, 2003                |   | (4,526                  | )      | (715                                     | )      | —                                   |   | (5,241    | )      |
|                                                                           |   |                    |   |                                     |   |                                     |   |      |   |
| Remaining liability as of September 30, 2003                                   |   | 8,935                   |   | 1,203                                    |   | 1,711                                    |   | 11,849    |   |
|                                                                           |   |                    |   |                                     |   |                                     |   |      |   |
| Charges during the three months ended December 31,  2003                       |   | 991                     |   | —                                   |   | —                                   |   | 991       |   |
| Adjustments to the liability during the three  months ended December 31, 2003  |   | (77                     | )      | —                                   |   | —                                   |   | (77       | )      |
| Utilized during the three months ended  December 31, 2003                 |   | (3,531                  | )      | (93                                      | )      | —                                   |   | (3,624    | )      |
|                                                                           |   |                    |   |                                     |   |                                     |   |      |   |
| Remaining liability as of December 31, 2003                                    |   | $                       | 6,318  |                                     | $      | 1,110                                    |   | $         | 1,711  |   | $ | 9,139 |   |

 

**11.          Commitments and Contingencies**

 

 

#### *RTC*

 

We guarantee aportion of certain equipment leases of the DPI Reticle Technology Center, LLC,or RTC. Our portion of this guarantee was $2,955 as of December 31, 2003.

 

#### *AMTC and BAC*

 

We, along withInfineon and AMD, have established joint ventures in Dresden, Germany toconduct leading edge photomask research and pilot manufacturing. The venturesconsist of the Advanced Mask Technology Center GmbH & Co. KG, or AMTC, andthe Maskhouse Building Administration GmbH & Co., or BAC. The AMTC conductsphotomask research and pilot manufacturing. The BAC is the owner of astate-of-the-art photomask research and manufacturing facility.

 

11

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We leaseapproximately 50% of the facility from the BAC for advanced photomaskmanufacturing and the remainder is leased by the AMTC. Both operating leasesare for 10-year terms and commenced July 2003. The BAC executed a term loan agreement for its research andmanufacturing facility in December 2002. The term loan had 63,143 Euro ($78,820 as of December 31, 2003) outstandingas of December 31, 2003.  Prior to theinitial occupancy of the building and initiation of the lease rental payments,we had guaranteed one-third of the BAC’s indebtedness.  Effective July 2003, we were released 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.

 

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 to vary between approximately 22% to 26% through June 30,2007.  Included in these amounts is ourguarantee of a portion of the operating lease obligations of the AMTC to theBAC.  The estimated guarantee related tothe 10-year term of the AMTC lease agreement aggregated $18,800 as of December31, 2003.

 

The AMTC hasexecuted a 120,000 Euro revolving credit facility to be used for equipmentpurchases.  The revolving creditfacility had 59,000 Euro ($73,649 as of December 31, 2003) outstanding as ofDecember 31, 2003. Each of the partners of the joint venture executed one-thirdguarantees for up to 32,000 Euro and certain additional costs as defined in therevolving credit facility agreement for as long as any obligation remainsoutstanding under the revolving credit facility. We will be required to honorour guarantee if the AMTC fails to make timely payments under the revolvingcredit facility; breaches certain financial covenants; becomes insolvent; or inany other way defaults under the revolving credit facility. We will also berequired to honor our guarantee if any of the owners of the AMTC breach certainterms of the joint venture agreement, become insolvent or cease doing business,experience a material adverse change affecting their obligations under theguarantee, fail to pay their respective indebtedness in excess of 50,000 Euroor otherwise experience an event constituting a default under the revolvingcredit facility.

 

#### *Infineon*

 

In May 2002,we entered into an agreement to acquire photomask production equipment fromInfineon’s internal photomask manufacturing operations in Munich, Germany and becomeInfineon’s strategic photomask supplier. In consideration for the acquisitionof certain photomask production assets and the agreement to supply Infineonwith photomasks over a 10 year term, we agreed to pay Infineon $53,500 over aseven-year period ending in March 2009. We also agreed to purchase fromInfineon, additional photomask production equipment for approximately $28,100payable over a five-year period ending in December 2006. We have made purchasesof approximately $20,900 in association with this agreement as of December 31,2003; $6,728 of which is reflected as a liability on the accompanyingconsolidated balance sheet as of December 31, 2003. We may elect to satisfy aportion of future amounts payable by issuing shares of our common stock.  The amount of which we may satisfy with ourcommon stock approximated $24,500 as of December 31, 2003.

 

#### *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 in relationto the profit sharing plan will be expensed in the period earned.

 

#### *Schott*

 

In March 2002, we sold all of our photoblank manufacturing assets toSchott Lithotec AG, or Schott. We also entered into a supply agreement withSchott for a significant portion of our future purchases of photoblanks.

 

#### *MLI*

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

 

#### *General*

 

As of December31, 2003, minimum lease payments for noncancelable operating lease obligationsare estimated to be $13,300, $11,500, $10,900, $10,800 and $10,500 for annualperiods ending December 31, 2004 through 2008, respectively, and $43,200 in theaggregate thereafter.

 

12

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

 

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 operations and ourownership of real property are subject to various environmental laws andregulations that govern, among other things, the discharge of pollutants intothe 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 to 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 position orresults of operations. E.I. du Pont de Nemours and Company, has agreed toindemnify us for any environmental contamination present on our manufacturingsites at June 13, 1996, the date of our initial public offering, or presentat any such site due to the generation, use, treatment, storage, release,emission, discharge or disposal of hazardous waste or hazardous materialsbefore such date. The Environmental Protection Agency is reviewing agroundwater contamination issue at our Danbury site under voluntary correctiveaction. Any such contamination is believed to be offsite or historical, and, ifthat is the case, any environmental liabilities would be covered by theindemnification agreement with E.I. du Pont de Nemours and Company.

 

**Item 2****.  Management’s Discussion andAnalysis 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 for interim periods are notnecessarily indicative of results for the full year.  Statements in this report that relate to future results andevents are based on our current expectations. Actual results in future periods may differ materially from thosecurrently expected or desired because of a number of risks anduncertainties.   For a discussion offactors affecting our business, see “Item 1-Business” in our Annual Report onForm 10-K for the fiscal year ended June 30, 2003.

 

# **Overview**

 

We are a leading global provider ofmicroimaging solutions.  We develop andproduce photomasks, a key enabling technology used in the manufacture ofsemiconductor and other microelectronic devices. We also develop and marketelectronic design automation, or EDA, software.   Our current EDA software product enables chip designers toensure manufacturability earlier in the design cycle and is targeted at themarket segment referred to in the industry as “Design for Manufacturing”, orDFM.

 

Virtually all of our revenue is derived fromthe semiconductor industry.  Ourcustomers include integrated device manufacturers (companies that design, buildand market semiconductor chips), or IDMs, semiconductor foundries (companiesthat provide sub-contract manufacturing of semiconductor chips) and fablesssemiconductor companies (companies that design and market semiconductor chipsand sub-contract manufacturing to foundries or IDMs).

 

The semiconductor industry is cyclical innature. Based on data published by industry analysts, annual worldwidesemiconductor revenue increased by 33% in calendar 2000, decreased by 31% incalendar 2001, and increased by 2% in calendar 2002. Preliminary estimatessuggest that revenue increased by 12% in calendar 2003.  Most recently, based on reports fromindustry analysts, and our own discussions with customers, we believe theprospects of revenue growth in calendar 2004 for the semiconductor industryhave improved. Most industry observers predict semiconductor revenue incalendar 2004 will increase at least 20%.

 

Although photomask revenue is not directlylinked to semiconductor revenue, we believe that once we get beyond thehistorically slow calendar first quarter, the improving semiconductor marketshould translate into an increase of new semiconductor design releases and thecontinued increase of more leading edge and complex designs, which shouldincrease our revenue.

 

13

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Over the longer term, we expect the photomaskindustry’s revenue growth will be driven by leading edge products supportingdesign rules of 130-nanometers and below.  In order to improve our competitive position in those products, wehave co-invested in the AMTC, a joint venture research and developmentinitiative with AMD and Infineon.  TheAMTC operates in a new, state-of-the-art facility in Dresden, Germany and is focusedon developing next generation photomask products and processes supporting90-nanometer and below design rules. The AMTC operates in the same cleanroom alongside our new advancedmanufacturing operations.  Theco-location of a research and development center and commercial operations isdesigned to streamline the transfer of new photomask technologies intoproduction volumes.  We believe that ourinvestments in the AMTC and our operations in Dresden will acceleratedevelopment and commercialization of leading edge photomask technologies andthereby provide us with future opportunities to gain market share.

 

We have developedand will continue to execute on plans that include various revenue growthinitiatives and plans that take actions necessary to more closely match ourcapacity with our revenue projections. Our plans are designed to increase revenue and reduce our break-evenlevel, thereby returning us to profitability. Since December 2002, we have ceased manufacturing operations in threemanufacturing facilities and reduced headcount by over 200 employees, while atthe same time staffing our new manufacturing facility in Dresden.  We also expect that in the future ourinvestments in Dresden will increase our share of leading edge masks and thatour investments in DFM and microimaging capabilities will expand our targetmarkets.

 

Our primary photomask competitors includeCompugraphics, Dai Nippon Printing, Photronics and Toppan Printing.  In addition, several IDMs, including IBM,Intel, Micron and Samsung, and some semiconductor foundries such as SMIC andTSMC, maintain their own captive photomask manufacturing operations.  The capacity and technical capabilities ofthese captives, relative to their owners’ demand for photomasks, affect thesize of the photomask market in which we compete.

 

14

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**Results of Operations**

** **
|                                        |   | **Financial Summary**                |   |
|---------------------------------------------|--------|--------------------------------------|--------|
|                                        |   | **Three Months Ended  December 31,** |   | **Six Months Ended  December 31,** |   |
|                                        |   | **2002**                             |   | **2003** |   | **2002** |   | **2003** |   |
| Revenue, net                                |   | $                                    | 81.0   |   | $ | 86.0 |   | $ | 165.2 |   | $ | 168.3 |   |
|                                        |   |                                 |   |   |   |   |   |   |   |
| Cost of Goods Sold                          |   | 71.0                                 |   | 77.2 |   | 141.7 |   | 152.8 |   |
|                                        |   |                                 |   |   |   |   |   |   |   |
| Gross Profit                                |   | $                                    | 10.0   |   | $ | 8.8 |   | $ | 23.5 |   | $ | 15.5 |   |
| Gross Margin                                |   | 12.3                                 | %      | 10.3 | % | 14.2 | % | 9.2 | % |
|                                        |   |                                 |   |   |   |   |   |   |   |
| Selling, General and Administrative Expense |   | $                                    | 10.4   |   | $ | 13.4 |   | $ | 20.3 |   | $ | 25.7 |   |
|                                        |   |                                 |   |   |   |   |   |   |   |
| Research and Development Expense            |   | 7.6                                  |   | 7.6 |   | 15.2 |   | 14.6 |   |
|                                        |   |                                 |   |   |   |   |   |   |   |
| Special Charges, net                        |   | 12.5                                 |   | 0.4 |   | 12.5 |   | 1.6 |   |
|                                        |   |                                 |   |   |   |   |   |   |   |
| Operating Loss                              |   | $                                    | (20.5  | ) | $ | (12.5 | ) | $ | (24.5 | ) | $ | (26.4 | ) |
| Operating Margin                            |   | (25.4                                | )%     | (14.5 | )% | (14.8 | )% | (15.7 | )% |

 

*Revenue, net.*  Revenue, net is comprised primarily ofphotomask sales to semiconductor manufacturers.   Revenue, net increased 6.2% from $81.0 million during thethree months ended December 31, 2002 to $86.0 million during the threemonths ended December 31, 2003.  Theincrease was primarily attributable to an improvement in mix driven by leadingedge revenue, defined as 130nm and below design rules.

 

Leading edgerevenue increased approximately 90% over the same three month period last yearand represented 25% of our total revenue. Currently, we are qualified at more than a dozen customers at the 130nmnode globally.  During the quarter wealso saw increased qualification activity at leading edge design rules,including the 90nm node.  While we donot expect to see a significant increase in demand at the 90nm node during2004, early qualification is essential to garnering market share in the ramp-upphase at the 90nm node.  We continue toactively pursue qualifications at 130nm and 90nm customers around the world andlook for new opportunities to grow market share through our capability, qualityand service.

 

During thethree months ended December 31, 2003, we set a company record for revenue fromphase shift masks, the most complex and difficult mask technology required inthe industry. During the three months ended December 31, 2003, revenue fromphase shift mask layers alone represented more than 10% of our total revenue.  In working with our strategic customers, webelieve that multiple lithography strategies will emerge at 65nm design rulesand require different phase shift masks. Through our work performed to date, which we believe will be acceleratedby the ramp-up of the AMTC, we expect our position to support these advancedmask types will be strong.

 

Revenue, netincreased 1.9% from $165.2 million during the six months ended December 31,2002  to $168.3 million during the sixmonths ended December 31, 2003. The overall increase was primarily attributableto an improvement in mix driven by revenue from leading edge technology.  Revenue from 130nm and below design rulesrepresented 22% of revenue for the six months ended December 31, 2003 ascompared with 12% of revenue for the same time period during the prior year.

 

15

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*Cost of Goods Sold.*  Cost of goods sold consists of materials,labor, depreciation, and overhead. Cost of goods sold increased 8.7% from$71.0 million to $77.2 million for the three months endedDecember 31, 2002 and 2003, respectively.   Gross margin decreased from 12.3% for the three months endedDecember 31, 2002 to 10.3% for the three months ended December 31,2003. Cost of goods sold increased over the same period last year due to theramp-up of our advanced production facility in Dresden, costs that had beenpreviously included in our RTC joint venture prior to the modification of theagreement with the RTC partners and expenses related to the consolidation oftrailing edge production in Europe. These increases in cost of goods sold were partially offset by benefitsfrom decreased depreciation expense resulting from the impairment of certainlong-lived assets during 2003 as well as cost savings from the closure of ourpellicle production facility in Danbury in September 2003.

 

Cost of goodssold increased 7.8% from $141.7 million during the six months ended December31, 2002 to $152.8 million during the six months ended December 31, 2003.  The increase was primarily attributable tothe ramp-up of our advanced production facility in Dresden, cost previouslyincluded in our RTC joint venture and expenses related to the consolidation oftrailing edge production in Europe. These increases in cost of goods sold were partially offset by benefitsfrom decreased depreciation expense resulting from the impairment of certainlong-lived assets during 2003.

 

During theshort term, we expect to continue to incur costs associated with the ramp-up ofour Dresden facility, partially offset by cost savings from the Europeanconsolidation and other employee related costs.  During the three months ending March 31, 2004, we expect grossmargin to be between 3% and 11%.

 

*Selling, General and Administrative Expense.*  Selling, general and administrative expenseincludes salaries of sales and administrative personnel, marketing expense,general and administrative expense and product distribution expense. Selling,general and administrative expense increased 28.4% from $10.4 million forthe three months ended December 31, 2002 to $13.4 million for thethree months ended December 31, 2003. Selling, general and administrativeexpense as a percentage of revenue increased from 12.9% for the three monthsended December 31, 2002 to 15.6% for the three months endedDecember 31, 2003.   Selling,general and administrative expense increased 26.4% from $20.3 million to $25.7million for the six months ended December 31, 2002 and 2003, respectively. Theincreases during the three and six month periods were primarily attributable topersonnel related expenses, BindKey software development costs and the ramp-upof our Dresden facility.  During thethree months ending March 31, 2004, we expect selling, general andadministrative expense as a percentage of revenue to be between 14% and 15%.

 

*Research and Development Expense.*  Research and development expense consistsprimarily of employee costs, cost of consumed materials, depreciation,engineering related costs and our share of costs of the RTC and AMTC jointventures. Research and development expense remained flat at $7.6 millioncomparing the three months ended December 31, 2002 with the three monthsended December 31, 2003. As a percentage of revenue it decreased from 9.4% forthe three months ended December 31, 2002 to 8.8% for the three months endedDecember 31, 2003. Research and development cost remained flat as increases inthe ramp-up expense of the AMTC, material cost and BindKey software developmentexpense were equally offset by decreases resulting from reduced cost of the RTCdue to a modification of the agreement with the RTC partners during December2002 as well as transitioning labor cost from development to processintegration as AMTC becomes the focus of our research and development activity.  Our ability to successfully develop andcommercialize our technical and manufacturing capabilities will be a key factorin realizing significant revenue and market share at the 90nm and smallernodes.

 

Research anddevelopment expense decreased 3.6% from $15.2 million to $14.6 million for thesix months ended December 31, 2002 and 2003, respectively.  The decrease in research and developmentexpense resulted primarily from a $0.7 million subsidy received in Europeduring September 2003.

 

We believe thecosts of the AMTC will continue to increase with its ramp-up.  During the three months ending March 31,2004, we expect research and development expense as a percentage of revenue tobe between 10% and 11%.

 

*Special Charges, net.*  During2003, we implemented programs to reduce costs associated with our Europeoperations which resulted in special charges related to employee severance,asset disposal, lease termination and related costs. During the three monthsended September 30, 2003, we reduced accrued liabilities for lease terminationand asset disposal related costs by $0.4 million as a result of ourrenegotiation of our lease termination agreement for our Hamburg facility.  During the three months ended December 31,2003, we recorded special charges of $0.8 million which were not previouslyestimable and related to employee severance for our former employees at ourRousset facility.  We also recorded a$0.6 million benefit as a result of terminating a capital lease liability onDecember 31, 2003 for our Hamburg facility. We plan to complete the consolidation initiatives in Europe and settlethe related liabilities during 2004.

 

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We closed ourpellicle production facility in Danbury during the three months ended September30, 2003. As a result, we recorded special charges of $2.7 million for employeeseverance and asset disposal costs and received proceeds of $1.2 million fromthe sale of certain pellicle technology during the three months ended September30, 2003.  We recorded additionalspecial charges of $0.2 million for employee severance and reduced the employeeseverance liability by $0.1 million during the three months ended December 31,2003.  We expect to complete the closureinitiatives in Danbury and extinguish the related liabilities during the threemonths ending March 31, 2004.

 

*Other Income (Expense), net.*  Otherincome (expense), net includes interest income, interest expense, and foreigncurrency exchange gains and losses. Other income (expense), net was income of$0.2 million for the three months ended December 31, 2002 and expense of$0.5 million for the three months ended December 31, 2003. The change was dueto interest expense on our $125.0 million convertible subordinated notes issuedand sold in May 2003 and a net foreign currency exchange loss in the currentthree month period as compared to a net foreign currency exchange gain duringthe same three month period during the prior year.

 

Other income(expense), net for the six months ended December 31, 2002 was income of $0.1million and expense of $1.1 million for the six months ended December 31,2003.  The change was primarilyattributable to interest expense on our $125.0 million convertible subordinatednotes issued and sold during May 2003 and, to a lesser extent, a higher netforeign currency exchange loss.

 

*Provision For Income Taxes. *Our income taxesare based on the statutory rates in effect in the countries in which weoperate. Certain of our operations in Asia are subject to various tax holidays.We recorded a provision for income taxes of $1.8 million and $0.8 millionduring the three months ended December 31, 2002 and 2003, respectively.  The provision for and benefit from incometaxes differs from the amounts computed by applying the federal statutory rateof 35% to loss before income taxes and minority interest because of: ourinability to record deferred tax benefits for net operating losses generated incertain jurisdictions; reduced tax rates in certain Asian jurisdictions; andfor other adjustments described below.

 

During thethree months ended December 31, 2002, we recorded a valuation allowance of $1.8million against our net deferred tax asset in Europe (primarily related to netoperating loss carryforwards) for the restructuring in Germany.  During the three months ended December 31,2003, our net tax provision included a $1.0 million benefit from the positiveresolution of tax audits in multiple jurisdictions and a provision of $1.3million for withholding taxes related to a planned dividend distribution fromwithin our group of foreign subsidiaries. When consummated, this dividend distribution will utilize the majorityof our U.S. net operating loss carryforward.

 

*Minority Interest in (Income) Loss of JointVentures.* Minority interest reflects our partners’ share of the earnings or lossesof our consolidated joint venture operations, which currently include ourShanghai, China and Hsinchu, Taiwan operations. The minority interest impact ofour joint ventures was an increase of $0.9 million to our net loss for thethree months ended December 31, 2002 and a decrease of $0.5 millionto our net loss for the three months ended December 31, 2003. The change duringthe same three month period was a result of lower revenue and higher productioncost driven largely by depreciation expense from added equipment in our Taiwanfacility*.*

 

For the six monthsended December 31, 2002, the minority interest impact of our joint ventures wasan increase of $2.7 million to our net loss and a decrease of $0.6 million toour net loss for the six months ended December 31, 2003.  Similarly, the change resulted from lowerrevenue and higher production cost.

 

**Liquidity and CapitalResources**

 

Our workingcapital was $213.4 million as of June 30, 2003 and $102.7 millionas of December 31, 2003. The decrease in working capital was primarily dueto the reclassification of our $100.0 million of convertible subordinated notesfrom a non-current liability to a current liability combined with cash used forcapital expenditures.  The $100.0million notes mature in July 2004.

 

Cash used ininvesting activities was $32.0 million and $22.7 million for the sixmonths ended December 31, 2002 and 2003, respectively. Cash used forcapital expenditures was $30.1 million and $24.7 million for the sixmonths ended December 31, 2002 and 2003, respectively. We expect capitalexpenditures for 2004 to be approximately $60.0 million to $65.0 million.Capital expenditures have been and will be used primarily to advance ourtechnical capability.  Additionally, inthe future we may pursue acquisitions of businesses, products and technologies,or enter into joint venture arrangements, that could complement or expand ourbusiness. Any material acquisition or joint venture could result in a decreaseto our working capital depending on the amount, timing and nature of theconsideration to be paid.

 

Cash provided byfinancing activities was $0.7 million for the six months endedDecember 31, 2002 and cash used in financing activities was $3.4 million forthe six months ended December 31, 2003. The cash used in financing activities during the six months ended

 

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December 31, 2003 was primarily the result ofpayments on borrowings in China.

 

Our ongoing cashrequirements will be for working capital, capital expenditures, acquisitions,research and development and the repayment of convertible notes and otherindebtedness. We expect to repay our $100.0 million convertible notes due inJuly 2004 from our existing cash balances. Management believes that cash onhand and any cash provided by operations will be sufficient to meet our cashrequirements for at least the next 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 noassurance that external sources of financing will be available if our capitalrequirements exceed cash flows from operations or that we will be able toobtain any additional financing required to fund our capital needs onreasonable terms, or at all.

 

Our consolidated cashand cash equivalents balances as of December 31, 2003, was $226.8 million, ofwhich $11.5 million was attributable to minority shareholders in ourconsolidated joint ventures.  As ofMarch 31, 2004, we expect our consolidated cash and cash equivalentsbalances will be approximately $200.0 million.

 

The followingsummarizes our contractual cash obligations as of December 31, 2003 (inmillions):

 
|                                                  |   | **Payments Due for the Periods ending Dectember 31,** |   |
|-------------------------------------------------------|--------|-------------------------------------------------------|--------|
|                                                  |   | **Total**                                             |   | **Year  2004** |   | **Two Years  2005-2006** |   | **Two Years  2007-2008** |   | **Beyond** |   |
| Short-term and long-term borrowings                   |   | $                                                     | 7.2    |   | $ | 7.2 |   | $ | — |   | $ | — |   | $ | — |   |
| Convertible notes                                     |   | 225.0                                                 |   | 100.0 |   | — |   | 125.0 |   | — |   |
| Capital lease obligations                             |   | 0.4                                                   |   | 0.4 |   | — |   | — |   | — |   |
| Operating leases (BAC amounts estimated)              |   | 100.1                                                 |   | 13.3 |   | 22.3 |   | 21.3 |   | 43.2 |   |
| Other long-term obligations (AMTC amounts  estimated) |   | 57.9                                                  |   | 13.7 |   | 32.5 |   | 8.6 |   | 3.1 |   |
|                                                  |   |                                                  |   |   |   |   |   |   |   |   |   |
| Total contractual cash obligations                    |   | $                                                     | 390.6  |   | $ | 134.6 |   | $ | 54.8 |   | $ | 154.9 |   | $ | 46.3 |   |

 

We leaseapproximately 50% of the Dresden facility from the BAC for advanced photomaskmanufacturing.  This operating lease isfor a 10-year term and commenced July 2003. In addition, we are committed to funding a portion of the operating cashrequirements of the AMTC under research and development reimbursement andcapacity utilization obligations through June 30, 2007. We expect our portionof these operating cash requirements to vary between approximately 22% to 26%through June 30, 2007.

 

The followingsummarizes our commercial commitments as of December 31, 2003 (in millions):

 
|                                |   | **Amounts of Commitment Expiration by Periods Ending  December 31,** |   |
|-------------------------------------|--------|----------------------------------------------------------------------|--------|
|                                |   | **Total**                                                            |   | **Year  2004** |   | **Two Years  2005-2006** |   | **Two Years  2007-2008** |   | **Beyond** |   |
| Guarantees (AMTC amounts estimated) |   | $                                                                    | 39.4   |   | $ | 27.5 |   | $ | — |   | $ | 3.0 |   | $ | 8.9 |   |
| Other commercial commitments        |   | 60.7                                                                 |   | 21.1 |   | 26.1 |   | 10.0 |   | 3.5 |   |
|                                |   |                                                                 |   |   |   |   |   |   |   |   |   |
| Total commercial commitments        |   | $                                                                    | 100.1  |   | $ | 48.6 |   | $ | 26.1 |   | $ | 13.0 |   | $ | 12.4 |   |
|                                     |        |                                                                      |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Guaranteesinclude our proportionate share of the AMTC lease payments to the BAC in excessof our commitment to fund the operating cash requirements of the AMTC throughJune 30, 2007. We estimate this guarantee to be $10.7 million as of December31, 2003. We have also executed a one-third guarantee for up to 32.0 millionEuro of the AMTC’s 120.0 million Euro revolving credit facility. The revolvingcredit facility had 59.0 million Euro ($73.6 million as of December 31, 2003)outstanding as of December 31, 2003. Guarantees also include our portion of certain equipment leases of theRTC.  Our portion of this guarantee wasapproximately $3.0 million as of December 31, 2003.

 

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InMay 2002, we entered into an agreement to acquire photomask productionequipment from Infineon’s internal photomask manufacturing operations inMunich, Germany and become Infineon’s strategic photomask supplier. Inconsideration for the acquisition of certain photomask production assets andthe agreement to supply Infineon with photomasks over a 10-year term, we agreedto pay Infineon $53.5 million over a seven-year period ending inMarch 2009.  We also agreed topurchase from Infineon additional photomask production equipment forapproximately $28.1 million payable over a five-year period ending inDecember 2006. We have made purchases of approximately $20.9 million inassociation with this agreement as of December 31, 2003; $6.7 million of whichis reflected as a liability on the accompanying consolidated balance sheet asof December 31, 2003.  We may elect tosatisfy a portion of future amounts payable by issuing shares of our common stock. The amount of which we may satisfy with our common stock approximated$24.5 million as of December 31, 2003.

 

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

 

•                  Wehave established a profit sharing plan with the BindKey employees. ThroughMarch 2006, BindKey employees may earn amounts annually based on the annualafter-tax earnings of BindKey. Upon the termination of the final year subjectto the profit sharing plan, the employees may earn an additional lump-sumamount based on the after-tax earnings of BindKey in the final year. Anyamounts earned in relation to the profit sharing plan will be expensed in theperiod earned.

 

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

 

•                  InJuly 2003, we signed a multi-year pellicle supply agreement with MLI for asignificant portion of our future purchases of pellicles.

 

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

 

**Critical AccountingPolicies**

 

Our critical accounting policies are as follows:

 

•                  Revenuerecognition

 

Product revenue is recognized when both titleand risk of loss transfers to the customer, provided that no significantobligations remain. Discounts and rebates are recorded as a reduction ofrevenue during the period they are earned by the customer. Provision is madefor an estimate of product returns based on historical experience and isrecorded as a reduction in revenue. Customarily, our shipping terms are FOB orFCA shipping point; however, our final terms depend upon the negotiations withour customers.

 

•                  Estimates,specifically sales return allowances, the allowance for doubtful accountsreceivable, allowance for excess and obsolete inventory and depreciationexpense

 

The preparation of consolidated financialstatements requires us to make estimates and assumptions that affect thereported amount of assets and disclosure of contingent assets and liabilitiesat the date of the consolidated financial statements and the reported amountsof revenue and expenses during the reported period.

 

•                  We must make estimates of potential futureproduct returns related to current period product revenue. We analyzehistorical returns, current economic trends, 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.

 

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

 

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•                  We maintain inventory reserves for estimatedobsolescence or unmarketable inventory equal to the difference between the costof inventory and estimated market value based on assumptions of future demandsand market conditions. If actual market conditions are materially lessfavorable than those projected by management, or if our estimates of marketvalue are later determined to have been materially incorrect, additionalinventory writedowns may be required.

 

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

 

•    Valuation ofidentifiable intangibles and other long-lived assets

 

We assess the impairment of identifiableintangibles subject to amortization and other long-lived assets whenever eventsor changes in circumstances indicate that the carrying value may not berecoverable. Factors considered important which could trigger an impairmentreview include the following:

 

•                  Significant underperformance relative toexpected historical or projected future operating results;

 

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

 

•                  Significant negative industry or economictrends; and

 

•                  Our market capitalization relative to netbook 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.

 

•    Accounting forincome taxes

 

We are required toconsider our income taxes in each of the tax jurisdictions in which we operatein computing our effective income tax rate. This process involves estimatingour current tax exposure together with assessing temporary differencesresulting from differing treatment of items for tax and financial reportingpurposes. These differences result in deferred tax assets and liabilities,which are included on our consolidated balance sheets. Further, the actualannual amount of taxable income in each tax jurisdiction may differ from theestimates we use to compute the effective tax rate during our first, second andthird quarters. Additionally, we evaluate the recoverability of the deferredtax assets from future taxable income and establish valuation allowances ifrecovery is not more likely than not. Our income tax provision on the consolidatedincome statements are impacted by changes in the valuation allowance. Thisprocess is complex and involves significant management judgment in determiningour provision for income taxes, deferred tax assets and liabilities and anyvaluation allowance recorded against our net deferred tax assets.

 

•    Consolidation

 

The consolidated financial statementspresented herein include the accounts of DuPont Photomasks, Inc. and ourcontrolled and wholly-owned subsidiaries. All significant inter-company transactionsand accounts are eliminated in consolidation. Entities that are not controlledbut on which we can exercise significant influence are recorded under theequity method of accounting.

 

**Other Matters**

 

In January2003, the FASB issued FASB Interpretation No. 46, or FIN No. 46, *Consolidationof Variable Interest Entities* (“VIE”).  FIN No. 46 requires that if an entity is the primary beneficiaryof a VIE, the assets, liabilities, and results of operations of the VIE shouldbe consolidated on the entity’s financial statements. In December 2003, theFASB revised FIN No. 46 which, among other revisions, resulted in the deferralof the effective date of applying the provisions of FIN No. 46 to the firstinterim or annual period ending after March 15, 2004 for qualifying VIE’s. Weare currently assessing the impact that FIN No. 46, as revised, may have on ourconsolidated financial condition or results of operations.

 

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In January2003, the SEC issued a final rule requiring enhanced disclosure of materialoff-balance sheet transactions, arrangements, and other relationships withunconsolidated entities. The rule also requires a tabular disclosure of futurepayments due under contractual commitments. The disclosure requirements willbecome effective for our fiscal 2004 Annual Report on Form 10-K.  We do not expect this pronouncement to havea material impact on our consolidated financial condition or results ofoperations.

 

**Forward LookingStatements**

 

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.  Such forward-lookingstatements are generally accompanied by words such as  “intend”, “may”, “plan”, “expect”,  “believe”,  “should”, “would”,  “could”, “anticipate”or other words that convey uncertainty of future events or outcomes. Althoughwe believe that the expectations reflected in such forward-lookingstatements are reasonable, such forward-looking statements are subject torisks and uncertainties that could cause actual results to differ materiallyfrom those indicated by the forward looking statements. Such risks anduncertainties include, without limitation, the following:

 

•                  Arenewed downturn in the semiconductor industry could lead to a decrease in thedemand for our photomask products;

 

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

 

•                  Our financial results may vary significantlyfrom quarter to quarter or we may fail to meet investors’ expectations, whichcould negatively impact the price of our stock;

 

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

 

•                  We may not obtain sufficient capital to fundour needs;

 

•                  Our operating results could be adverselyaffected by under-utilized production capacity;

 

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

 

•                  Macroeconomic conditions may have effects onthe semiconductor industry;

 

•                  We may be unable to enhance our existingproducts and develop and manufacture new products and upgrades with improvedcapabilities to satisfy anticipated demand for more technologically advancedphotomasks;

 

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

 

•                  We may not remain competitive and increasedcompetition could seriously harm our business;

 

•                  We may be unable to successfully develop ormarket our EDA software;

 

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

 

•                  Our success depends, in part, upon keymanagerial, engineering and technical personnel as well as our ability tocontinue to attract and retain additional personnel and integrate new personnelinto key positions; and

 

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

 

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

 

Theforward-looking statements are made as of the release date hereof, and wedisclaim any intention or obligation to update or revise any forward-lookingstatements or to update the reasons why the actual results could differmaterially from those projected in the

 

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forward-looking statements,whether as a result of new information, future events or otherwise.

 

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**Item 3.  Quantitative and Qualitative Disclosures 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 December 31, 2003, we hadoutstanding $100.0 million in non-interest bearing convertiblesubordinated notes due in July 2004, $125.0 million in 1.25% convertiblesubordinated notes due in May 2008 and approximately $7.5 million in interestbearing borrowings. As a result, changes in the interest rate market wouldchange the estimated fair value of our convertible notes and other interestbearing borrowings. We believe that a 10% change in interest rates would nothave a material effect on our business, financial condition, results ofoperations 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 consolidated financial condition and results ofoperations. Any exchange rate fluctuations can affect our margins since we mayhave imbalances between some foreign currency denominated revenue and expenses.Our consolidated financial statements reflect remeasurement and translation ofitems denominated in non-U.S. currencies to U.S. dollars, our reportingcurrency. Exchange gains or losses are included in comprehensive income in theperiod in which they occur. We monitor our exchange rate exposure and attemptto reduce such exposure by hedging. We have entered into forward contracts incurrencies of the countries in which we conduct business in order to reducesuch exposure.  The net unrealized lossrelated to our forward exchange contracts outstanding as of December 31, 2003was not significant.  An unrealized gainof $2.5 million as of December 31, 2003, is recorded in accumulated othercomprehensive income on the accompanying interim unaudited consolidated balancesheet and statement of stockholders’ equity in relation to foreign currencytranslation adjustments.  These instrumentsmay involve elements of credit and market risk in excess of the amountsrecognized on the interim unaudited consolidated financial statements. Webelieve that a 10% change in exchange rates would not have a material effect onour business, financial condition, results of operations or cash flows. Wemonitor our positions and the credit quality of counterparties, consistingprimarily of major financial institutions, and do not anticipate nonperformanceby any counterparty, although nonperformance could occur. There can be noassurance that such forward contracts or any other hedging activity will beavailable or adequate to eliminate, or even mitigate, the impact of ourexchange rate exposure. There can be no assurance that such risks will not havea material adverse impact on our liquidity, financial condition and results ofoperations in the future.

 

**Financial RiskManagement**

 

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 offoreign laws. Some of our sales outside of North America are denominated inlocal currencies, and accordingly, we are subject to the risks associated withfluctuations in currency rates. In general, increases in the value of the dollaragainst foreign currencies decrease the U.S. dollar value of foreign salesrequiring us either to increase our price in the local currency, which couldrender our product prices noncompetitive, or to suffer reduced revenue andgross margins as measured in U.S. dollars. Our foreign currency  hedging program is not designed to hedge themargin risks associated with foreign exchange rate changes. Our hedging iscomprised of foreign currency forward exchange contracts utilized to mitigatethe risks associated with foreign currency fluctuations on certain balancesheet exposures. However, the hedging program will not eliminate all of ourforeign exchange risks.

 

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 maintainvaluation allowances for excess and obsolete inventory and we continue tomonitor the adequacy of such valuation allowances, there can be no assurancethat such valuation allowances will be sufficient.

 

As of December31, 2003, we had outstanding foreign currency denominated short-term borrowingstotaling approximately $7.2 million.  Asof December 31, 2003, we did not have any relationships with anyunconsolidated entities or financial partnerships, such as entities often referredto as structured finance or special purpose entities, which would have beenestablished for the purpose of facilitating off-balance sheet arrangements orother contractually narrow or limited purposes. Accordingly, we are not exposedto any financing, liquidity, market or credit risk that could arise if we wereengaged in such relationships.

 

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As ofDecember 31, 2003 we had $100.0 million of convertible subordinatednotes outstanding due in July 2004.  Thenotes have no stated interest, are convertible at any time into shares of ourcommon stock at a conversion price of $106.26 per share, are unconditionallyguaranteed by E.I. du Pont de Nemours and Company and are not callable by us.In the event of a fundamental change in our company, each holder of notes 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.  If a fundamental change were to occur, wecannot assure you that we will have sufficient funds to pay the redemptionprice for all the notes tendered by the holders, although E.I. du Pont deNemours and Company would be required to pay the redemption price under itsguarantee. In that case, our failure to redeem tendered notes would constitutean event of default under the indenture for the notes, and may constitute adefault under the terms of other indebtedness that we may enter into from timeto time.

 

In addition,we had $125.0 million of convertible subordinated notes outstanding as ofDecember 31, 2003 that are due in May 2008. The notes accrue interest at anannual rate of 1.25% 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 beredeemed.  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. 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 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 or in other factors during our most recent fiscal quarter that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

## **PART II**

 

# **Item 1. LegalProceedings**

 

We are notcurrently involved in any material legal proceedings.

### ** **

# **Item 4. Submission of Matters to a Vote ofSecurity Holders**

### ** **

The Company’s Annual Meeting of Stockholders was held November 4, 2003(the “Annual Meeting”). At the Annual Meeting, (i) the Company elected Class Idirectors to the Board of Directors to serve until our 2006 annual meeting oruntil their successors are elected and qualified, subject to their death,resignation or removal, and (ii) the selection of PricewaterhouseCoopers LLP asthe Company’s independent public accountants for the year ending June 30, 2004was ratified. Votes cast at the Annual Meeting are as follows:

** **

(i) Election of Class IDirectors

 
|                 |   | **FOR**    |   | **WITHHELD** |   |
|----------------------|--------|------------|--------|--------------|--------|
|                 |   |       |   |         |   |
| E. James Prendergast |   | 14,178,938 |   | 2,396,220    |   |
| William T. Siegle    |   | 14,676,150 |   | 1,899,008    |   |

 

(ii) Ratification of the appointment of PricewaterhouseCoopers LLP

 
| **FOR**    |   | **AGAINST** |   | **ABSTAIN** |   | **NON-VOTE** |   |
|------------|--------|-------------|--------|-------------|--------|--------------|--------|
| 14,631,107 |   | 1,858,271   |   | 85,780      |   | 0            |   |

 

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**Item 6. Exhibitsand Reports on Form 8-K**

 
| (A)    |   | Exhibits |
|--------|--------|----------|
|   |   |     |   |
|   |   | 3.1.1    | Certificate of Incorporation of the Company, as amended and restated  on April 3, 1996. (A) |
|   |   | 3.1.2    | Amendment to the Certificate of Incorporation of the Company. (B) |
|   |   | 3.2      | Bylaws, as amended on October 26, 1999. (B) |
|   |   | 3.2.1    | Amendments to the Bylaws Of DuPont Photomasks, Inc. as approved by  the Board Of Directors on June 23, 2003. (E) |
|   |   | 4.1      | Specimen Certificate for Common Stock. (A) |
|   |   | 4.2      | Form of Indenture, between DuPont Photomasks, Inc. and Chase Bank of  Texas, N.A., as trustee, including the form of Convertible Subordinated Notes  due July 24, 2004 attached as Exhibit A thereto. (F) |
|   |   | 4.3      | Indenture, between DuPont Photomasks, Inc. and JPMorgan Chase Bank,  as trustee, including Form of 1.25% Convertible Subordinated Notes due 2008  (144A Global Note and Reg S. Global Note). (C) |
|   |   | 4.4      | Rights Agreement, dated as of January 30, 2001, between DuPont  Photomasks, Inc. and EquiServe Trust Company, N.A., as Rights Agent, together  with the following exhibits thereto: Exhibit A-Form of Certificate of  Designation of Series A Junior Participating Preferred Stock of DuPont  Photomasks, Inc.; Exhibit B-Form of Right Certificate; Exhibit C-Summary of  Rights to Purchase Shares of Preferred Stock of DuPont Photomasks, Inc. (D) |
|   |   | 4.5      | Amendment No. 1 to Rights Agreement, between DuPont Photomasks, Inc.  and EquiServe Trust Company, N.A., as Rights Agent, dated as of April 29,  2003. (C) |
|   |   | 4.6      | Registration Rights Agreement among DuPont Photomasks, Inc., Credit  Suisse First Boston LLC and Lehman Brothers Inc. dated as of May 5, 2003. (C) |
|   |   | 31.1     | Certification of Chief Executive Officer pursuant to Rule 13a-14 of  the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|   |   | 31.2     | Certification of Chief Financial Officer pursuant to Rule 13a-14 of  the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002. |
|   |   | 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. |

 
| **Letter** |   | **Definition**                                                                |
|------------|--------|-------------------------------------------------------------------------------|
| (A)        |   | Registration Statement on Form S-1, Registration No. 333-33869.               |
| (B)        |   | Form 8-A12 G/A on June 23, 2000.                                              |
| (C)        |   | Quarterly Report on Form 10-Q for the quarterly period ended March  31, 2003. |
| (D)        |   | Form 8-A12B on January 30, 2001.                                              |
| (E)        |   | Annual Report on Form 10-K for the fiscal year ended June 30, 2003.           |
| (F)        |   | Amendment No. 2 to Form S-3 filed on July 19, 2000.                           |

 
| (B) |   | Reports on Form 8-K |
|-----|--------|--------------------------|

 

Our report on Form 8-K, dated October 22,2003, reporting our announcement on October 22, 2003 of our financial resultsfor the fiscal quarter ended September 30, 2003.

 

Our report on Form 8-K/A, dated October 22,2003, reporting our corrected announcement on October 22, 2003 of our financialresults for the fiscal quarter ended September 30, 2003.

 

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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: February 12, 2004 |                                | *Executive Vice  President—Finance and Chief Financial Officer (Principal Financial and  Accounting Officer)* |

 

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