Photronics, Inc.
10-K on 12/23/2019   Download
SEC Document
SEC Filing


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

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

For the fiscal year ended October 31, 2019

OR

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

For the transition period from ___ to ___

Commission file number 0-15451

graphic
PHOTRONICS, INC.
(Exact name of registrant as specified in its charter)

Connecticut
 
06-0854886
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)

15 Secor Road, Brookfield, Connecticut 06804
(Address of principal executive offices)(Zip Code)
(203) 775-9000
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class
 Trading Symbol(s)
Name of each exchange on which registered
COMMON
 PLAB
NASDAQ Global Select Market
PREFERRED STOCK PURCHASE RIGHTS
N/A
N/A

Securities registered pursuant to Section 12(g) of the Act:
None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes  No 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes  No 

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer,” “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer
Accelerated Filer
Non-Accelerated Filer
Smaller Reporting Company
  
Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes   No

As of April 28, 2019, which was the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the shares of the registrant’s common stock held by non-affiliates was approximately $617,084,612 (based upon the closing price of $9.43 per share as reported by the NASDAQ Global Select Market on that date).

As of December 13, 2019, 65,416,365 shares of the registrant’s common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

     
Proxy Statement for the 2020
   
Annual Meeting of Shareholders
 
Incorporated into Part III
to be held on March 16, 2020
 
of this Form 10-K




Table of Contents
Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements made by or on behalf of Photronics, Inc. (“Photronics”, the “Company”, “we”, “our”, or “us”). These statements are based on management’s beliefs, as well as assumptions made by, and information currently available to, management. Forward-looking statements may be identified by words like “expect,” “anticipate,” “believe,” “plan,” “project,” “could,” “estimate,” “intend,” “may,” “will” , “in our view” and similar expressions, or the negative of such terms, or other comparable terminology. All forward-looking statements involve risks and uncertainties that are difficult to predict. In particular, any statement contained in this annual report on Form 10-K or in other documents filed with the Securities and Exchange Commission in press releases or in the Company’s communications and discussions with investors and analysts in the normal course of business through meetings, phone calls, or conference calls regarding, among other things, the consummation and benefits of transactions, joint ventures, business combinations, divestitures and acquisitions, expectations with respect to future sales, financial performance, operating efficiencies, or product expansion, are subject to known and unknown risks, uncertainties, and contingencies, many of which are beyond the control of the Company. Various factors may cause actual results, performance, or achievements to differ materially from anticipated results, performance, or achievements expressed or implied by forward-looking statements. Factors that might affect forward-looking statements include, but are not limited to, overall economic and business conditions; economic and political conditions in international markets; the demand for the Company’s products; competitive factors in the industries and geographic markets in which the Company competes; the timing of orders received from customers; the gain or loss of significant customers; competition from other manufacturers; changes in accounting standards; federal, state and international tax requirements (including tax rate changes, new tax laws and revised tax law interpretations); changes in the jurisdictional mix of our earnings and changes in tax laws and rates; interest rate and other capital market conditions, including changes in the market price of the Company’s securities; foreign currency exchange rate fluctuations; changes in technology; technology or intellectual property infringement, including cybersecurity breaches, and other innovation risks; unsuccessful or unproductive research and development or capital expenditures; the timing, impact, and other uncertainties related to transactions and acquisitions, divestitures, business combinations, and joint ventures as well as decisions the Company may make in the future regarding the Company’s business, capital and organizational structures and other matters; the seasonal and cyclical nature of the semiconductor and flat panel display industries; management changes; changes in laws and government regulation impacting our operations or our products, including laws relating to export controls and import laws, rules and tariffs; the occurrence of regulatory proceedings, claims or litigation; damage or destruction to the Company’s facilities, or the facilities of its customers or suppliers, by natural disasters, labor strikes, political unrest, or terrorist activity; the ability of the Company to (i) place new equipment in service on a timely basis; (ii) obtain additional financing; (iii) achieve anticipated synergies and cost savings; (iv) fully utilize its tools; (v) achieve desired yields, pricing, product mix, and market acceptance of its products and (vi) obtain necessary import and export licenses. Any forward-looking statements should be considered in light of these factors. Accordingly, there is no assurance that the Company’s expectations will be realized. The Company does not assume responsibility for the accuracy and completeness of the forward-looking statements and does not assume an obligation to provide revisions to any forward-looking statements, except as otherwise required by securities and other applicable laws.

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PART I

ITEM 1.
BUSINESS

General

Photronics, Inc. (and its subsidiaries, collectively referred to herein as "Photronics", the "Company", “we”, “our”, or “us”) is one of the world's leading manufacturers of photomasks, which are high precision photographic quartz or glass plates containing microscopic images of electronic circuits. Photomasks are a key element in the manufacture of semiconductors and flat-panel displays ("FPDs"), and are used as masters to transfer circuit patterns onto semiconductor wafers and FPD substrates during the fabrication of integrated circuits ("ICs" or “semiconductors”), and a variety of FPDs and, to a lesser extent, other types of electrical and optical components. We currently have eleven manufacturing facilities, which are located in Taiwan (3), Korea, the United States (3), Europe (2), and two recently constructed facilities in China. Our FPD Facility in Hefei, China, and our IC facility in Xiamen, China, commenced production in the second and third quarters of our fiscal 2019, respectively.

Photronics is a Connecticut corporation, organized in 1969. Our principal executive offices are located at 15 Secor Road, Brookfield, Connecticut 06804, telephone (203) 775-9000. Our website address is http://www.photronics.com. We make available, free of charge through our website, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to these reports as soon as reasonably practicable after such materials are electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”). The information found on, or incorporated into, our website is not part of this or any other report we file with, or furnish to, the SEC. The SEC also maintains a website at http://www.sec.gov that contains reports, proxy statements and other information regarding SEC registrants, including Photronics.

Products and Manufacturing Technology

We manufacture photomasks, which are used as masters to transfer circuit patterns onto semiconductor wafers and FPD substrates. Photomasks are manufactured in accordance with circuit designs provided to us on a confidential basis by our customers. IC and FPD photomask sets are manufactured in layers, each having a distinct pattern which is etched onto a different photomask. The resulting series of photomasks is then used to image the circuit patterns onto each successive layer of a semiconductor wafer or FPD substrate. The typical manufacturing process for a photomask involves the receipt and conversion of circuit design data to manufacturing pattern data. A lithography system then exposes the circuit pattern onto the photomask blank. The exposed areas are developed and etched to produce that pattern on the photomask. The photomask is then inspected for defects and conformity to the customer's design data. After any defects are repaired, the photomask is cleaned, any required pellicles (protective translucent cellulose membranes) are applied and, after final inspection, the photomask is shipped to the customer.

We currently support customers across the full spectrum of IC production and FPD technologies by manufacturing photomasks using electron beam or optical (laser-based) systems, which are the predominant technologies used for photomask manufacturing, and are capable of producing the finer line resolution, tighter overlay, and larger IC chip size for the more complex circuits currently being designed. Electron beam and laser-generated photomasks can be used to produce the most advanced semiconductors and FPD photomasks for use in an array of products. However, in the case of IC production, the large majority of higher-cost critical layer photomasks are fabricated using electron beam technologies, while photomasks produced using laser-based systems are used for all FPD photomasks and less critical IC photomasks.  End markets served with IC photomasks include devices used for microprocessors, memory, telecommunications, and related applications. We currently own a number of both high-end and mature electron beam and laser-based systems.

The first several layers of photomasks are sometimes required to be delivered by us within 24 hours from the time we receive the customers' design data. The ability to manufacture high-quality photomasks within short time periods is dependent upon robust processes, efficient manufacturing methods, high production yield, available manufacturing capacity, and high equipment reliability. We work to meet these requirements by making significant investments in research and development, capital equipment, manufacturing and data processing systems, and by utilizing statistical process control methods to optimize our manufacturing processes and reduce cycle times.

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Quality control is an integral part of the photomask manufacturing process. Photomasks are manufactured in temperature, humidity, and particulate-controlled clean rooms because of the high level of precision, quality and manufacturing yield required. Each photomask is inspected several times during the manufacturing process to ensure compliance with customer specifications. We continue to make substantial investments in equipment to produce, inspect and repair photomasks to ensure that customer specifications are met.

The majority of IC photomasks produced for the semiconductor industry employ geometries larger than 28 nanometers. At these geometries, we can produce full lines of photomasks, and there is no significant technology employed by our commercial competitors that is not also available to us. We are also capable of producing full lines of photomasks for high-end IC and FPD applications. In the case of ICs, this includes photomasks at and below the 28 nanometer technology node and, for FPDs, at and above the Generation 8 technology node and active-matrix organic light-emitting diode (AMOLED) display screens. We hold customer-qualified manufacturing capability and own, or have access to, technology that enables us to compete in the high-end markets that serve IC and FPD applications.

Sales and Marketing

The market for photomasks primarily consists of domestic and non-US semiconductor and FPD manufacturers and designers. Photomasks are manufactured by independent merchant manufacturers like Photronics, and by semiconductor and FPD manufacturers that produce photomasks for their own use (captive manufacturers). In some instances, captive manufacturers also sell to other semiconductor or FPD manufacturers. Previously, there was a trend towards the divesture or closing of captive photomask operations by semiconductor manufacturers, and an increase in the share of the market served by independent manufacturers. This trend was driven by the increased complexity and cost of capital equipment used in manufacturing photomasks and the lack of economy of scale for many semiconductor and FPD manufacturers to effectively utilize the equipment. However, more recently, some captive mask facilities have been investing at faster rates than independent manufacturers to reach certain roadmap milestones, particularly in the foundry logic and memory spaces. Nevertheless, most captive manufacturers maintain business and technology relationships with independent photomask manufacturers for ongoing support.

Generally, Photronics and each of its customers engage in a qualification and correlation process before we become an approved supplier. Thereafter, based on the customer’s expectations, we typically negotiate pricing parameters for the customer's order. Some prices may remain in effect for an extended period of time. In many instances, we enter into sales arrangements with an understanding that, as long as our performance is competitive, we will receive a specified percentage of that customer's photomask requirements.

We conduct our sales and marketing activities primarily through a staff of full-time sales personnel and customer service representatives who work closely with the Company's management and technical personnel. We support non-US customers through both our domestic and foreign facilities and consider our presence in non-US markets to be an important factor in attracting new customers, as it provides global solutions to our customers, minimizes delivery time, and allows us to serve customers that utilize manufacturing foundries outside of the United States, principally in Asia. See Notes 7 and 14 to our consolidated financial statements for the amount of revenue and long-lived assets attributable to each of our geographic areas of operations.

Customers

We sell our products primarily to leading semiconductor and FPD manufacturers. During fiscal year 2019, we sold our products to approximately 550 customers. Revenue from Samsung Electronics Co. Ltd. accounted for approximately 16% of our total revenues in fiscal years 2019, 2018 and 2017, and revenue from United Microelectronics Corp. Co. Ltd. accounted for approximately 15%, 15% and 16% of our total revenues in fiscal years 2019, 2018 and 2017, respectively. Our five largest customers, in the aggregate, accounted for approximately 46%, 47% and 43% of our revenue in fiscal years 2019, 2018 and 2017, respectively. A significant decrease in the amount of revenue from any of these customers could have a material adverse effect on our financial performance and business prospects.

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Seasonality

Our business is typically impacted during the first, and sometimes the second, quarter of our fiscal year by the North American, European, and Asian holiday periods, as some customers reduce their development and buying activities during those periods.

Research and Development

We primarily conduct research and development activities for IC photomasks at our U.S. nanoFab, which is located in Boise, Idaho, as well as at PK, Ltd. (“PKL”), our subsidiary in Korea and Photronics DNP Mask Corporation (“PDMC”), one of our joint venture subsidiaries in Taiwan. Research and development for FPD photomasks is primarily conducted at PKL. Additionally, we conduct site-specific research and development programs to support strategic customers. These research and development programs and activities are undertaken to advance our competitiveness in technology and manufacturing efficiency. We also conduct application-oriented research and development activities to support the early adoption of new photomask or supporting data and services technology into our customers' applications. Currently, research and development photomask activities for ICs are primarily focused on photomasks with wafer geometrics of 20 nanometer node and smaller and, for FPDs, on Generations 8 and 10.5+ substrate-size photomask process enhancements and photomask technology for complex FPD photomasks used in the manufacture of advanced mobile displays, such as AMOLED. We believe these core competencies will continue to be a critical part of semiconductor and FPD manufacturing, as optical lithography continues to scale capabilities on high-end devices. We incurred research and development expenses of $16.4 million, $14.5 million, and $15.9 million in fiscal years 2019, 2018, and 2017, respectively. It is our belief that we own, control, or license the proprietary information, including trade secrets and patents that is necessary for our business, as it is presently conducted. We also believe that our intellectual property and trade secret know-how will continue to be important to our maintaining technical leadership in the field of photomasks.

Intellectual Property Rights

We have developed and hold ownership interests in intellectual property (“IP”) rights, in the forms of patents issued in the U.S., and other trademark and trademark registrations in the U.S. and other countries. Patents in which we hold ownership interests generally relate to the manufacture of photomasks or the use of photomasks to manufacture other products. While we believe that our IP rights are, and will continue to be, important to our technical leadership in the field of photomasks, our operations are not dependent on any one individual IP right. In addition to patenting, when practicable, our IP rights, we further protect them, and our other proprietary processes, by utilizing non-disclosure agreements with employees, customers, and vendors.

Materials, Supplies and Equipment

Raw materials used by Photronics generally include: high precision quartz plates (including large area plates), which are used as photomask blanks and are primarily obtained from Japanese and Korean suppliers; pellicles and electronic grade chemicals, which are used in the manufacturing process; and compacts, which are durable plastic containers in which photomasks are shipped. These materials are generally sourced from several suppliers. We believe that our utilization of a select group of strategic suppliers enables us to access the most technologically advanced materials available. On an ongoing basis, we continue to consider additional supply sources.

We rely on a limited number of equipment suppliers to develop and supply the equipment used in the photomask manufacturing process. Although, historically, we have been able to obtain equipment on a timely basis, an inability to obtain equipment when required could adversely affect our business and results of operations.

Backlog

The first several layers of a set of photomasks for a circuit pattern are often required to be shipped within 24 hours of receiving a customer's designs. Because of the short period between order and shipment dates (typically from 1 day to 2 weeks) for a significant amount of our revenue, the dollar amount of our current backlog is not a reliable indicator of future revenue.

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International Operations

Revenues from our non-U.S. operations were approximately 81%, 79% and 77% of our total revenues in fiscal 2019, 2018 and 2017, respectively. We believe that our ability to serve non-US markets is enhanced by our having, among other things, a local presence in the markets that we serve. This requires significant investments in financial, managerial, operational, and other resources.

Operations outside of the United States are subject to inherent risks, including fluctuations in exchange rates, political and economic conditions in various countries, legal compliance and regulatory requirements, tariffs and other trade barriers, difficulties in staffing and managing international operations, longer accounts receivable collection cycles, potential restrictions on transfers of funds, and potentially adverse tax consequences. These factors may have a material adverse effect on our ability to generate revenue outside of the United States and to deploy resources where they could otherwise be used to their greatest advantage and, consequently, may adversely affect our financial condition and results of operations. Notes 7 and 14 of our consolidated financial statements, respectively, present revenue and long-lived assets by geographic area.

Competition

The photomask industry is highly competitive, and most of our customers utilize multiple photomask suppliers. Our ability to compete depends primarily upon the consistency of our product quality, timeliness of delivery, competitive pricing, technical capability, and service, which we believe are the principal factors considered by customers in selecting their photomask suppliers. An inability to meet these requirements could adversely affect our financial condition, results of operations, and cash flows. We also believe that geographic proximity to customers is an important factor in certain markets where cycle time from order to delivery is critical. While some of our competitors may have greater financial, technical, sales, marketing, or other resources than Photronics, we believe that we are able to compete effectively because of our dedication to customer service, investments in state-of-the-art photomask equipment and facilities, and experienced technical employees.

We estimate that, for the types of photomasks we manufacture (IC and FPD), the size of the total market (captive and merchant) is approximately $5.0 billion. Our competitors include Compugraphics International, Ltd., Dai Nippon Printing Co., Ltd (outside of Taiwan and China), Hoya Corporation, LG Innotek Co., Ltd., Shenzhen New Way Photomask Making Co., Ltd., SK-Electronics Co. Ltd., Supermask Co. Ltd., Taiwan Mask Corporation, and Toppan Printing Co., Ltd. We also compete with semiconductor and FPD manufacturers' captive photomask manufacturing operations that supply photomasks for internal use and, in some instances, also for external customers and foundries. We expect to face continued competition which, in the past, has led to pressure to reduce prices. We believe the pressure to reduce prices, together with the significant investment required in capital equipment to manufacture high-end photomasks, has contributed to the decrease in the number of independent manufacturers; we expect such pressure to continue in the future.

Employees

As of October 31, 2019, we had approximately 1,775 employees. We believe we offer competitive compensation and other benefits, and that our employee relations are good.

ITEM 1A.
RISK FACTORS

Technology failures or cyber security breaches could have a material adverse effect on our operations.

We rely on information technology systems to process, transmit, store, and protect electronic information. For example, a significant portion of the communications between our personnel, customers, and suppliers depends on information technology. Our information technology systems may be vulnerable to a variety of interruptions due to events beyond our control, including, but not limited to, natural disasters, terrorist attacks, telecommunications failures, computer viruses, hackers, and other security issues. Although we have technology and information security processes and disaster recovery plans in place to mitigate our risks to these vulnerabilities, these measures may not be adequate to ensure that our operations will not be disrupted, should such an event occur.


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The General Data Protection Regulation (GDPR), which went into effect in the European Union (EU) on May 25, 2018, applies to the collection, use, retention, security, processing, and transfer of personally identifiable information of residents of EU countries. The GDPR created a range of new compliance obligations, and imposes significant fines and sanctions for violations. It is possible that the GDPR may be interpreted or applied in a manner that is adverse to, or unforeseen by us, including requirements that are inconsistent with our practices, or that we may otherwise fail to construe its requirements in ways that are satisfactory to the EU authorities.

Any failure, or perceived failure, by us to comply with the GDPR, or with any applicable regulatory requirements or orders, including but not limited to privacy, data protection, information security, or consumer protection related privacy laws and regulations, in one or more jurisdictions within the EU or elsewhere, could: result in proceedings or actions against us by governmental entities or individuals; subject us to significant fines, penalties, and/or judgments; require us to change our business practices; limit access to our products and services in certain countries, or otherwise adversely affect our business, as we would be at risk to lose both customers and revenue, and incur substantial costs.

The risk of loss of the Company’s intellectual property, trade secrets or other sensitive business or customer confidential information or disruption of operations due to breaches of cybersecurity could negatively impact the Company’s financial results.

Cyberattacks or security breaches could compromise confidential, business-critical information, cause disruptions in the Company’s operations, or harm the Company's reputation. The Company has important assets, including intellectual property, trade secrets, and other sensitive, business-critical and/or confidential information which may be vulnerable to such incidents. While the Company has a comprehensive cybersecurity program that is continuously reviewed, maintained, and upgraded, a significant cyberattack could result in the loss of vital business or confidential information and/or could negatively impact operations, which could have a negative impact on the Company’s financial results.

Our dependency on the microelectronics industry, which as a whole is volatile, could create volatility in our demand and have a negative material impact on our business.

We sell substantially all of our photomasks to semiconductor or FPD designers, manufacturers and foundries, as well as to other high performance electronics manufacturers. We believe that the demand for photomasks depends primarily on design activity rather than sales volume from products using photomask technologies. Consequently, an increase in semiconductor or FPD sales does not necessarily result in a corresponding increase in photomask sales. In addition, the reduced use of customized ICs, a reduction in design complexity, other changes in the technology or methods of manufacturing or designing semiconductors or FPDs, or a slowdown in the introduction of new semiconductor or FPD designs could reduce demand for photomasks ‒ even if the demand for semiconductors and FPDs increases. Historically, the microelectronics industry has been volatile, with sharp periodic downturns and slowdowns. These downturns have been characterized by, among other things, diminished product demand, excess production capacity, and accelerated erosion of selling prices with a concomitant effect on revenue and profitability.

We may, in the future, incur net losses.

Although we have been profitable since fiscal 2010, we have, in the past, incurred net losses. We cannot provide assurance that we will not incur net losses in the future.

We have a high level of fixed costs.

As a consequence of the capital-intensive nature of the photomask manufacturing business, we have a high level of fixed costs and a high degree of operating leverage. Accordingly, should our sales volumes decline as a result of a decrease in design releases from our customers or for any other reason, we may have excess or underutilized production capacity which could significantly impact our operating margins or result in write-offs from asset impairments.

Our quarterly operating results fluctuate significantly, and may continue to do so in the future.

We have experienced fluctuations in our quarterly operating results, and we anticipate that such fluctuations will continue and could intensify in the future. Fluctuations in operating results may result in volatility in the prices of our common stock and financial instruments linked to its value. Operating results may fluctuate as a result of many factors, including the size and timing of orders and shipments, the loss of significant customers, changes in product mix, the flow of customer design releases, technological change, fluctuations in manufacturing yields, the actions of our competitors, and general economic conditions. We operate in a high fixed-cost environment and, should our revenues and asset utilization decrease, our operating margins could be negatively impacted.


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Our customers generally order photomasks on an as-needed basis; thus our revenue in any quarter is dependent primarily on orders received during that quarter. Since we operate with little backlog, and the rate of new orders may vary significantly from quarter to quarter, our capital expenditures and, to some extent, expense levels are based primarily on sales forecasts and technological advancements in photomask manufacturing equipment. Consequently, if anticipated revenues in any quarter do not occur when expected, capital expenditures could be higher than needed, resulting in underutilized capacity and disproportionately high expense levels, causing operating results to be adversely affected. Due to the foregoing factors, we believe that quarter-to-quarter comparisons of our operating results cannot be relied upon as indicators of future performance. In addition, in future quarters, our operating results could be below guidance we may provide or the expectations of public market analysts and investors, which could have a material adverse effect on the market price of our common stock.

The photomask industry is subject to rapid technological change, and we might fail to remain competitive, which could have a material adverse effect on our business and results of operations.

The photomask industry has been, and is expected to continue to be, characterized by technological change and evolving industry standards. In order to remain competitive, we will be required to continually anticipate, respond to, and utilize changing technologies of increasing complexity in both traditional and emerging markets that we serve. In particular, we believe that, as semiconductor geometries continue to become smaller and FPDs become larger or otherwise more advanced, we will be required to manufacture increasingly complex photomasks. Additionally, the demand for photomasks has been, and could in the future be, adversely affected by changes in semiconductor and high- performance electronics fabrication methods that affect the type or quantity of photomasks utilized, such as changes in semiconductor demand that favor field-programmable gate arrays and other semiconductor designs that replace application-specific ICs. Furthermore, evidence of the viability and the corresponding market acceptance of alternative methods of transferring IC designs onto semiconductor wafers could reduce or eliminate the need for photomasks in the production of semiconductors. As of the end of fiscal 2019, one alternative method, direct-write lithography, has not been proven to be a commercially-viable alternative to photomasks, as it is considered to be too slow for high-volume semiconductor wafer production. However, should direct-write or any other alternative method of transferring IC or FPD designs without the use of photomasks achieve market acceptance, and if we are unable to anticipate, respond to, or utilize these or other technological changes, due to resource, technological, or other constraints, our business and results of operations could be materially adversely affected.

Our operations will continue to require substantial capital expenditures, for which we may be unable to provide or obtain funding.

The manufacture of leading-edge photomasks requires us to make substantial investments in high-end manufacturing capability. We expect that we will be required to continue to make substantial capital expenditures to meet the technological demands of our customers and to position us for future growth. Our capital expenditure payments for fiscal 2020 are expected to be approximately $100 million, of which approximately $14 million was included in accounts payable on our October 31, 2019 consolidated balance sheet. We cannot provide assurance that we will be able to obtain the additional capital required to fund our operations or capital expenditures on reasonable terms, if at all, or that any such inability will not have a material adverse effect on our business and results of operations.

We have been dependent on sales to a limited number of large customers; the loss of any of these customers or a significant reduction in orders from these customers could have a material adverse effect on our revenues and results of operations.

Historically, we have sold a significant proportion of photomasks to a limited number of IC and FPD manufacturers. During fiscal years 2019, 2018 and 2017, our two largest customers accounted for 31%, 31% and 32%, respectively, of our revenue. Our five largest customers accounted for 46%, 47% and 43% of our revenue in fiscal years 2019, 2018 and 2017, respectively. The loss of a significant customer, a significant reduction or delay in orders from any significant customer (including reductions or delays due to customer departures from recent buying patterns), or an unfavorable change in competitive conditions in the semiconductor or FPD industries could have a material adverse effect on our financial performance and business prospects. The consolidation of semiconductor manufacturers, or an economic downturn in the semiconductor industry, may increase the likelihood of losing a significant customer and could also have an adverse effect on our financial performance and business prospects.


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We depend on a limited number of suppliers for equipment and raw materials and, if those suppliers fail to timely deliver their products to us, we may be unable to fulfill orders from our customers, which could adversely affect our business and results of operations.

We rely on a limited number of photomask equipment manufacturers to develop and supply the equipment we use. These equipment manufacturers currently require lead times of twelve months or longer between the order date and the delivery of certain photomask imaging and inspection equipment. The failure of our suppliers to develop or deliver such equipment on a timely basis could have a material adverse effect on our business and results of operations. In addition, the manufacturing equipment necessary to produce advanced photomasks could become prohibitively expensive, which could similarly affect us.

We use high-precision quartz photomask blanks, pellicles, and electronic grade chemicals in our manufacturing processes. There are a limited number of suppliers of these raw materials, and we do not have long-term contracts with these suppliers. Any delays or quality problems in connection with significant raw materials, particularly photomask blanks, could cause delays in the shipments of photomasks, which could have a material adverse effect on our business and results of operations. The fluctuation of foreign currency exchange rates, with respect to prices of equipment and raw materials used in manufacturing, could also have a material adverse effect on our business and results of operations.

We face risks associated with the use of sophisticated equipment and complex manufacturing processes and technologies. Our inability to effectively utilize such equipment and technologies and perform such processes could have a material adverse effect on our business and results of operations.

Our complex manufacturing processes require the use of expensive and technologically sophisticated equipment and materials, and are continually modified in an effort to improve manufacturing yields and product quality. Minute impurities, defects, or other difficulties in the manufacturing process can lower manufacturing yields and render products unmarketable. Moreover, the manufacture of leading-edge photomasks is more complex and time consuming than manufacturing less advanced photomasks, and their fabrication may result in delays in the manufacture of all levels of photomasks. We have, on occasion, experienced manufacturing difficulties and capacity limitations that have delayed our ability to deliver products within the time frames contracted for by our customers. We cannot provide assurance that we will not experience these or other manufacturing difficulties, or be subject to increased costs, which could result in a loss of customers or otherwise have a material adverse effect on our business and results of operations.

We could be subject to damages based on claims brought against us by our customers, or lose customers as a result of the failure of our products to meet certain quality specifications.

Our products provide important performance attributes to our customers’ products. If a product fails to perform in a manner consistent with quality specifications, or has a shorter useful life than warranted, a customer could seek replacement of the product or damages for costs incurred as a result of the product failing to perform, particularly if such products are sold under agreements that contain limited performance and life cycle warrantees. Our customers often require us to represent that our products conform to certain product specifications that they provide. Any failure to comply with such specifications could result in claims or legal action. A successful claim, or series of claims, against us could have a material adverse effect on our financial condition and results of operations, and could result in a loss of one or more customers.

Our credit facility restricts our business activities, limits our ability to obtain additional financing, pay cash dividends, and may obligate us to repay debt before its maturity.

Financial covenants related to our credit facility, which expires in September 2023, include a total leverage ratio, a minimum interest coverage ratio, and minimum unrestricted cash balances. Our credit facility may also limit our flexibility in planning for, or reacting to, changes in our business and industry, which may place us at a competitive disadvantage compared with our competitors. We are also subject to covenants that limit our operating flexibility, such as a limit on the amount of shares we can repurchase of our common stock. Existing covenant restrictions limit our ability to obtain additional debt financing, and limit the amount of dividends, distributions, and redemptions we can pay on our common stock in 2019 to an aggregate amount of $100 million and $50 million annually thereafter. Should we be unable to meet one or more of these covenants, our lenders may require us to repay any outstanding balance prior to the expiration date of the agreement. Our ability to comply with the financial and other covenants in our credit agreement may be affected by deteriorating economic or business conditions, or other events. We cannot assure that, under such circumstances, additional sources of financing would be available to fund operating requirements or repay any long-term borrowings, so as to avoid default.


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Joint ventures may not operate according to their business plans if our partners fail to fulfill their obligations, which may adversely affect our results of operations and compel us to dedicate additional resources to these joint ventures.

The nature of a joint venture requires us to share control in certain areas with unaffiliated third parties. If our joint venture partner does not fulfill its obligations, the affected joint venture may not be able to operate in accordance with its business plan. Under such a scenario, our results of operations may be adversely affected and we may be compelled to increase the level of our resources devoted to the joint venture. Also, differing views among joint venture participants may result in delayed decisions, or failures to agree on major issues. If such differences caused a joint venture to deviate from its business plan, our results of operations could be adversely affected.

We may not be able to consummate future acquisitions or joint ventures or integrate acquisitions into our business, which could result in unanticipated expenses and losses.

As part of our business growth strategy, we have acquired businesses and entered into joint ventures in the past, and we may pursue acquisitions and joint venture opportunities in the future. Future efforts to grow the Company may include expanding into new or related markets or industries. Our ability to implement this component of our growth strategy may be limited by both our ability to identify appropriate acquisition or joint venture candidates and our financial resources, including our available cash and borrowing capacity. The expense incurred in consummating acquisitions or entering into joint ventures, the time it takes to integrate an acquisition, or our failure to integrate businesses successfully, could result in unanticipated expenses and losses. Furthermore, we may not be able to realize any of the anticipated benefits from acquisitions or joint ventures.

The process of integrating acquired operations into our existing operations may result in unforeseen operating difficulties, and may require significant financial resources that would otherwise be available for the ongoing development or expansion of existing operations. Some of the risks associated with the integration of acquisitions include: potential disruption of our ongoing business and distraction of management; unforeseen claims and liabilities, including unexpected environmental exposures; unforeseen adjustments, taxes, charges and write-offs; problems enforcing the indemnification obligations of sellers of businesses or joint venture partners for claims and liabilities; unexpected losses of customers of, or suppliers to, the acquired business; difficulty in conforming the acquired businesses’ standards, processes, procedures and controls with our operations; variability in financial information arising from the implementation of purchase price accounting; inability to coordinate new product and process development; loss of senior managers and other critical personnel and problems with new labor unions; and challenges arising from the increased scope, geographic diversity and complexity of our operations.

Our expansion into China entails substantial risks.

We have recently commenced operations at our two newly-constructed manufacturing facilities in China. These investments are subject to substantial risks which may include, but are not limited to: the inability to protect our intellectual property rights under Chinese law, which may not offer as high a level of protection as U.S. law; unexpectedly long negotiation periods with Chinese suppliers and customers; quality issues related to materials sourced from local vendors; unexpectedly high labor costs due to a tight labor supply; and difficulty in repatriating funds and selling or transferring assets. Our investments in China also expose us to a significant additional foreign currency exchange risk, which we had not been subject to in recent years. These and other risks may result in our not realizing a return on, or losing some, or all, of our planned investments in China, which would have a material adverse effect on our financial condition and financial performance.


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Our cash flows from operations and current holdings of cash may not be adequate for our current and long-term needs.

Our liquidity, as we operate in a high fixed-cost environment, is highly dependent on our revenue volume and the timing of our capital expenditures, which can vary significantly from period to period. Depending on conditions in the semiconductor and FPD markets, our cash flows from operations and current holdings of cash may not be adequate to meet our current and long-term needs for capital expenditures, operations and debt repayments. Historically, in certain years, we have used external financing to fund these needs. Due to conditions in the credit markets and covenant restrictions on our existing debt, some financing instruments used by us in the past may not be available. Therefore, we cannot provide assurance that additional sources of financing would be available to us on commercially favorable terms, if at all, should our cash requirements exceed our existing cash, operating cash flows, and cash available under our credit agreements.

We may incur unforeseen charges related to possible future facility closures or restructurings.

We cannot provide assurance that there will not be facility closures or restructurings in the near or long term, nor can we assure that we will not incur significant charges should there be any future facility closures or restructurings.

We operate in a highly competitive environment, and, should we be unable to meet our customers’ requirements for product quality, timeliness of delivery or technical capabilities, our revenue could be adversely affected.

The photomask industry is highly competitive, and most of our customers utilize more than one photomask supplier. Our competitors include Compugraphics International, Ltd., Dai Nippon Printing Co., Ltd (outside of Taiwan and China), Hoya Corporation, LG Innotek Co., Ltd., Supermask Co., Ltd., SK-Electronics Co. Ltd., Shenzhen New Way Photomask Making Co., Ltd., Taiwan Mask Corporation, and Toppan Printing Co., Ltd. We also compete with semiconductor and FPD manufacturers' captive photomask manufacturing operations, some of which market their photomask manufacturing services to outside customers. We expect to face continued competition from these and other suppliers in the future. Some of our competitors have substantially greater financial, technical, sales, marketing, or other resources than we do. Also, when producing smaller geometry photomasks, some of our competitors may be able to more rapidly develop and produce such masks, and achieve higher manufacturing yields than we can. We believe that consistency of product quality, timeliness of delivery, competitive pricing, technical capability, and service are the principal factors considered by customers when selecting their photomask suppliers. Our inability to meet these competitive requirements could have a material adverse effect on our business and results of operations. In the past, competition has led to pressure to reduce prices and the need to invest in advanced manufacturing technology, which we believe contributed to the decrease in the number of independent photomask suppliers. These pressures may continue in the future.

We operate in a global, competitive environment which gives rise to operating and market risk exposure.

We sell our products in a competitive, global environment, and compete worldwide for sales on the basis of product quality, price, technology, and customer service. Sales of our products are also subject to federal, state, local, and foreign taxes, laws and regulations, trade agreements, import and export controls, and duties and tariffs. The imposition of additional regulations or controls including export controls and duties and tariffs or changes to bilateral and regional trade agreements, could negatively impact our results of operations.

Our substantial non-US operations are subject to additional risks.

Revenues from our non-U.S. operations were approximately 81%, 79% and 77% of our total revenues in fiscal years 2019, 2018 and 2017, respectively. We believe that maintaining significant international operations requires us to have, among other things, a local presence in the geographic markets that we supply. This requires significant investments in financial, managerial, operational, and other resources. Since 1996, we have significantly expanded our operations in international markets by acquiring existing businesses in Europe, acquiring majority equity interests in photomask manufacturing operations in Korea and Taiwan, building a manufacturing facility for FPD photomasks in Taiwan, and two manufacturing facilities in China. In order to enable us to optimize our investments and other resources, we closely monitor the semiconductor and FPD manufacturing markets for indications of geographic movement and, in conjunction with these efforts, continue to assess the locations of our manufacturing facilities. These assessments may result in the opening or closing of facilities.

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Operations outside of the United States are subject to inherent risks, including: fluctuations in exchange rates; unstable political and economic conditions in various countries; changes in economic alliances; unexpected changes in regulatory requirements; compliance with a variety of burdensome foreign laws and regulations; compliance with anti-bribery and anti-corruption laws (such as the Foreign Corrupt Practices Act); tariffs and other trade barriers; difficulties in staffing and managing international operations; and longer accounts receivable payment cycles. In addition: foreign countries may enact other restrictions on foreign trade or investment, including currency exchange controls; trade sanctions could result in our losing access to customers and suppliers; legislation may cause agreements to be difficult to enforce; accounts receivable may be difficult to collect, or we may be subject to adverse tax consequences. These factors may have a material adverse effect on our ability to generate revenues outside of the United States and, consequently, on our business and results of operations.

Our business could suffer as a result of the United Kingdom’s decision to end its membership in the European Union.

The decision of the United Kingdom to exit from the European Union (generally referred to as “BREXIT”) could cause disruptions to, and create uncertainty surrounding, our business, including affecting our relationships with existing and potential customers, suppliers, and employees. The effects of BREXIT will depend on any agreements the United Kingdom makes to retain access to European Union markets either during a transitional period or more permanently. The measures could potentially disrupt some of our target markets and jurisdictions in which we operate, and adversely change tax benefits or liabilities in these or other jurisdictions. In addition, BREXIT could lead to legal uncertainty and potentially divergent national laws and regulations, as the United Kingdom determines which European Union laws to replace or replicate. BREXIT also may create global economic uncertainty, which may cause our customers and potential customers to monitor their costs and reduce their budgets for either our products or other products that incorporate our products. Any of these effects of BREXIT, among others, could materially adversely affect our business, business opportunities, results of operations, financial condition, and cash flows. The United Kingdom’s deadline to leave the European Union has twice been extended, from its original date of March 31, 2019, to its current date of January 31, 2020. In light of the recent UK elections, BREXIT is now a virtual certainty.

Changes in foreign currency exchange rates could have a material adverse effect on our results of operations, financial condition, or cash flows.

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) and are reported in U.S. dollars. Our operations have transactions and balances denominated in currencies other than the U.S. dollar; primarily the South Korean won, New Taiwan dollar, Japanese yen, Chinese renminbi, euro, Singapore dollar, and the British pound sterling. In fiscal year 2019, we recorded a net loss from changes in foreign currency exchange rates of $1.3 million in our statement of income, while our net assets decreased by $2.9 million as a result of the translation of foreign currency financial statements to U.S. dollars. Significant foreign currency fluctuations may adversely affect our results of operations, financial condition, or cash flows.

Our business depends on managerial and technical personnel, who are in great demand, and our inability to attract and retain qualified employees could adversely affect our business and results of operations.

Our success depends, in part, upon key managerial and technical personnel, as well as our ability to continue to attract and retain additional qualified personnel. The loss of certain key personnel (i.e. CEO, CTO, etc.) could have a material adverse effect on our business and results of operations. We cannot offer assurance that we can retain our key managerial and technical employees, or that we can attract similar additional employees in the future.

We may be unable to enforce or defend our ownership and use of proprietary technology, and the utilization of unprotected company developed technology by our competitors could adversely affect our business, results of operations, and financial position.

We believe that the success of our business depends more on proprietary technology, information and processes, and know-how than on our patents or trademarks. Much of our proprietary information and technology related to manufacturing processes is not patented and may not be patentable. We cannot offer assurance that:

we will be able to adequately protect our technology;
competitors will not independently develop similar technology; or
international intellectual property laws will adequately protect our intellectual property rights.


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We may become the subject of infringement claims or legal proceedings by third parties with respect to current or future products or processes. Any such claims, with or without merit, or litigation to enforce or protect our intellectual property rights that require us to defend against claimed infringements of the rights of others, could result in substantial costs, diversion of resources, and product shipment delays or could force us to enter into royalty or license agreements, rather than dispute the merits of these claims. Any of the foregoing could have a material adverse effect on our business, results of operations, and financial position.

We may be unprepared for changes to environmental laws and regulations and may incur liabilities arising from environmental matters.

We are subject to numerous environmental laws and regulations that impose various environmental controls on, among other things, the discharge of pollutants into the air and water and the handling, use, storage, disposal, and clean-up of solid and hazardous wastes. Changes in these laws and regulations may have a material adverse effect on our financial position and results of operations, and inadequate compliance with their requirements could give rise to significant liabilities.

If we violate environmental, health or safety laws or regulations, in addition to being required to correct such violations, we can be held liable in administrative, civil, or criminal proceedings, and substantial fines and other sanctions could be imposed that could disrupt or limit our operations. Liabilities associated with the investigation and cleanup of hazardous substances, as well as personal injury, property damages or natural resource damages arising from the release of, or exposure to, such hazardous substances, may be imposed in many situations without regard to violations of laws or regulations or other fault, and may also be imposed jointly and severally (so that a responsible party may be held liable for more than its share of the losses involved, or even the entire loss). Such liabilities may also be imposed on many different entities with a relationship to the hazardous substances at issue, including, for example, entities that formerly owned or operated the property affected by the hazardous substances and entities that arranged for the disposal of the hazardous substances at the affected property, as well as entities that currently own or operate such property. The nature of our business, including historical operations at our current and former facilities, exposes us to risks of liability under these laws and regulations due to the production, storage, use, transportation and sale of materials that can cause contamination or personal injury if released into the environment. Additional information may arise in the future concerning the nature or extent of our liability with respect to identified sites and additional sites that may be identified, for which we are alleged to be liable.

Our production facilities could be damaged or disrupted by natural disasters or labor strikes, either of which could adversely affect our financial position, results of operations, and cash flows.

A major catastrophe, such as an earthquake or other natural disaster, labor strike, or work stoppage at any of our manufacturing facilities, or a manufacturing facility of our suppliers or customers, could result in a prolonged interruption of our business. A disruption resulting from any one of these events could cause significant delays in shipments of our products and the loss of revenue and customers, which could have a material adverse effect on our financial position, results of operations, and cash flows. Our facilities in Taiwan are located in a seismically-active area.

Our sales can be impacted by the health and stability of the general economy, which could adversely affect our results of operations and cash flows.

Unfavorable general economic conditions in the U.S. or other countries in which we or our customers conduct business may have the effect of reducing the demand for photomasks. Economic downturns may lead to a decrease in demand for end products whose manufacturing processes involve the use of photomasks, which may result in a reduction in new product design and development by semiconductor or FPD manufacturers, and adversely affect our results of operations and cash flows.

Additional taxes could adversely affect our financial results.

Our tax filings are subject to audits by tax authorities in the various jurisdictions in which we do business. These audits may result in assessments of additional taxes that are subsequently resolved with the taxing authorities or through the courts. Currently, we believe there are no outstanding assessments whose resolution would result in a material adverse financial result. However, we cannot offer assurances that unasserted or potential future assessments would not have a material adverse effect on our financial condition or results of operations.


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Our business could be adversely impacted by global or regional catastrophic events.

Our business could be adversely affected by terrorist acts, widespread outbreaks of infectious diseases, or the outbreak or escalation of wars, especially in the Asian markets in which we generate a significant portion of our sales and in Japan where we purchase raw materials and capital equipment. Such events in the geographic regions in which we do business, including escalations of political tensions and military operations within the Korean Peninsula, where a significant portion of our foreign operations are located, could have material adverse impacts on our revenue, cost and availability of raw materials, results of operations, cash flows, and financial condition.

Servicing our debt requires a significant amount of cash, and we may not generate sufficient cash flows from our operations to pay our indebtedness.

Our ability to make scheduled payments of debt principal and interest, or to refinance our indebtedness, depends on our future performance, which is subject to economic, financial, competitive, and other factors beyond our control. Our business may not continue to generate sufficient cash flows from operations to fund operations, service our debt and make necessary capital expenditures. If we are unable to generate such cash flows, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt, or obtaining additional equity capital on terms that may be onerous or highly dilutive. Our ability to refinance our indebtedness would depend upon the conditions in the capital markets and our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations.

Our hedging activity could negatively impact our results of operations and cash flows.

We may enter into derivatives to manage our exposure to interest rate and currency movements. If we do not accurately forecast our results of operations, execute contracts that do not effectively mitigate our economic exposure to interest rates and currency rates, elect to not apply hedge accounting, or fail to comply with the complex accounting requirements for hedging transactions, our results of operations and cash flows could be volatile, as well as negatively impacted.

The market price of our common stock is subject to volatility and could fluctuate widely in response to various factors, many of which are beyond our control.

Factors that may influence the price of our common stock include, but are not limited to, the following:

loss of any of our key customers or suppliers;
additions or departures of key personnel;
third party sales of common stock;
our ability to execute our business plan, including but not limited to, our expansion into China;
announcements and consummations of business acquisitions;
operating results that fall below expectations;
issuances or repurchases of our common stock;
intellectual property disputes;
industry developments;
news or disclosures by competitors or customers;
business combinations, divestitures, or bankruptcies by customers, suppliers, or competitors;
economic and other external factors; and
period-to-period fluctuations in our financial results.

In addition, securities markets have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our common stock. Such fluctuations may be the result of imbalances between buy and sell offers, or low trading volume which can magnify the effects of a small number of transactions on the price of a stock.


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Ineffective internal controls could impact our business and operating results.

Our internal controls over financial reporting may not prevent or detect misstatements because of their inherent limitations in detecting human errors, the circumvention or overriding of controls, or fraud; even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. If we: fail to maintain the adequacy of our internal controls, including any failure to implement required new or improved controls; otherwise fail to prevent financial reporting misstatements; or if we experience difficulties in implementing internal controls, our business and operating results could be harmed, and we could fail to meet our financial reporting obligations.

ITEM 1B.
UNRESOLVED STAFF COMMENTS

None.

ITEM 2.
PROPERTIES

The following table presents certain information about the Company's photomask manufacturing facilities:

Location
 
Type of
Interest
 
 
 
 
 
Allen, Texas
 
Owned
 
Boise, Idaho
 
Owned
 
Brookfield, Connecticut
 
Owned
 
Bridgend, Wales
 
Leased
 
Cheonan, Korea
 
Owned
 
Hefei, China
 
Owned
(1)
Dresden, Germany
 
Leased
 
Hsinchu, Taiwan
 
Owned
(1)
Hsinchu, Taiwan
 
Leased
 
Taichung, Taiwan
 
Owned
(1)
Xiamen, China
 
Owned
(1)

(1)  The Company owns its manufacturing facility in Hefei, Taichung, Xiamen, and one of its manufacturing facilities in Hsinchu. However, it leases the related land.

ITEM 3.
LEGAL PROCEEDINGS

We are subject to various claims that arise in the ordinary course of business. We believe such claims, individually or in the aggregate, will not have a material adverse effect on our business.

ITEM 4.
MINE SAFETY DISCLOSURES

Not applicable.

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PART II

ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

The common stock of the Company is traded on the NASDAQ Global Select Market ("NASDAQ") under the symbol PLAB. On December 13, 2019, the closing sale price of our Common Stock, per the NASDAQ Global Select Market, was $15.94. Based on available information, we estimate that we have approximately 9,400 shareholders.

To date, we have not paid any cash dividends on Photronics shares, and, for the foreseeable future, we anticipate that earnings will continue to be retained for use in our business. Further, our credit agreement limits the amount that can be paid as cash dividends on Photronics stock.

Issuer Purchases of Equity Securities

In August 2019, the Company’s board of directors authorized the repurchase of up to $100 million of its common stock, pursuant to a repurchase plan under Rule 10b5-1 of the Securities Act of 1933 (as amended). The repurchase program may be suspended or discontinued at any time.

In July 2018 and October 2018, the Company’s board of directors authorized the repurchase of up to $20 million and $25 million, respectively, of its common stock, to have been executed in open-market transactions or in accordance with a repurchase plan under Rule 10b5-1 of the Securities Act of 1933 (as amended). The July 2018 repurchase program was completed in October 2018, and the October 2018 repurchase program was terminated on February 1, 2019.

August 2019 Authorization
 
Total Number of
Shares Purchased
(in millions)
   
Average Price
Paid
Per share
   
Total Number of Shares
Purchased as Part of
Publicly Announced
Program (in millions)
   
Dollar Value of
Shares That May
Yet Be Purchased
(in millions)
 
 
                       
Fiscal year 2019 repurchases
                       
 
                       
September 23, 2019 – October 31, 2019
   
1.0
   
$
11.05
     
1.0
   
$
89.0
 
Total
   
1.0
             
1.0
         

2018 Authorizations
 
Total Number of
Shares Purchased
(in millions)
   
Average Price
Paid
Per share
   
Total Number of Shares
Purchased as Part of
Publicly Announced
Program (in millions)
   
Dollar Value of
Shares That May
Yet Be Purchased
(in millions)
 
 
                       
Fiscal year 2019 repurchases
                       
 
                       
November 1, 2018 – November 25, 2018
   
0.2
   
$
9.49
     
0.2
   
$
20.1
 
November 26, 2018 – December 23, 2018
   
0.7
   
$
9.38
     
0.7
   
$
13.4
 
December 24, 2018 – January 27, 2019
   
0.2
   
$
9.41
     
0.2
   
$
11.2
*
Total
   
1.1
   
$
9.40
     
1.1
         

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Fiscal year 2018 repurchases
 
Total Number of
Shares Purchased
(in millions)
   
Average Price
Paid
Per share
   
Total Number of Shares
Purchased as Part of
Publicly Announced
Program (in millions)
   
Dollar Value of
Shares That May
Yet Be Purchased
(in millions)
 
 
                       
July 10, 2018 – July 29, 2018
   
0.8
   
$
8.72
     
0.8
   
$
13.2
 
July 30, 2018 – August 26, 2018
   
0.9
   
$
9.05
     
0.9
   
$
5.0
 
September 23, 2018 – October 31, 2018
   
0.9
   
$
9.46
     
0.9
   
$
21.9
 
Total
   
2.6
   
$
9.04
     
2.6
         

* The share repurchase program was terminated on February 1, 2019, with no additional shares being purchased subsequent to January 27, 2019.

Securities authorized for issuance under equity compensation plans

The information regarding our equity compensation required to be disclosed by Item 201(d) of Regulation S-K is incorporated by reference from the Photronics, Inc. 2020 Definitive Proxy Statement in Item 12 of Part III of this report. The 2020 Definitive Proxy Statement will be filed within 120 days after our fiscal year ended October 31, 2019.

ITEM 6.
SELECTED FINANCIAL DATA

The following selected financial data (in thousands, except per share amounts and employees) is derived from our audited consolidated financial statements. The data should be read in conjunction with the audited consolidated financial statements and notes thereto, and other financial information included elsewhere in this Annual Report on Form 10-K.

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Year Ended
 
   
October 31,
2019
   
October 31,
2018
   
October 29,
2017
   
October 30,
2016
   
November 1,
2015
 
 
                             
OPERATING DATA:
                             
 
                             
Revenue
 
$
550,660
   
$
535,276
   
$
450,678
   
$
483,456
   
$
524,206
 
 
                                       
Gross profit
 
$
120,841
   
$
131,503
   
$
91,315
   
$
118,706
   
$
143,136
 
 
                                       
Gross margin
   
21.9
%
   
24.6
%
   
20.3
%
   
24.6
%
   
27.3
%
 
                                       
Operating income
 
$
52,121
   
$
65,627
   
$
31,868
   
$
52,475
   
$
72,233
 
 
                                       
Operating margin
   
9.5
%
   
12.3
%
   
7.1
%
   
10.9
%
   
13.8
%
 
                                       
Effective tax rate (a)
   
20.1
%
   
10.7
%
   
19.9
%
   
7.9
%
   
18.8
%
 
                                       
Net income (a), (b), (c), (d)
 
$
40,491
   
$
61,236
   
$
21,289
   
$
55,676
   
$
56,859
 
 
                                       
Net income attributable to  Photronics, Inc. shareholders (a), (b), (c), (d)
 
$
29,793
   
$
42,055
   
$
13,130
   
$
46,200
   
$
44,625
 
Earnings per share:
                                       
 
                                       
Basic (a), (b), (c), (d)
 
$
0.45
   
$
0.61
   
$
0.19
   
$
0.68
   
$
0.67
 
 
                                       
Diluted (a), (b), (c), (d)
 
$
0.44
   
$
0.59
   
$
0.19
   
$
0.64
   
$
0.63
 
 
                                       
Weighted-average diluted number of common shares outstanding:
   
69,155
     
74,821
     
69,288
     
76,354
     
78,383
 
 
                                       
Net cash provided by operating activities
 
$
68,386
   
$
130,567
   
$
96,833
   
$
122,137
   
$
133,195
 
 
                                       
Purchase of property, plant and equipment
 
$
178,375
   
$
92,585
   
$
91,965
   
$
50,147
   
$
104,033
 
 
                                       
Purchase of treasury stock
 
$
21,696
   
$
23,111
   
$
-
   
$
-
   
$
-
 
 
                                       
Employees
   
1,775
     
1,575
     
1,475
     
1,530
     
1,550
 

BALANCE SHEET DATA
     
 
 
As of
 
 
     
 
 
October 31,
2019
   
October 31,
2018
   
October 29,
2017
   
October 30,
2016
   
November 1,
2015
 
 
                             
Working capital
 
$
275,573
   
$
311,655
   
$
367,348
   
$
360,269
   
$
168,237
 
Property, plant and equipment, net
 
$
632,441
   
$
571,781
   
$
535,197
   
$
506,434
   
$
547,284
 
Total assets
 
$
1,118,665
   
$
1,110,009
   
$
1,020,794
   
$
987,988
   
$
1,042,811
 
Long-term debt
 
$
41,887
   
$
-
   
$
57,337
   
$
61,860
   
$
67,120
 
Total Photronics, Inc. shareholders’ equity
 
$
769,892
   
$
759,671
   
$
744,564
   
$
710,363
   
$
646,555
 
Noncontrolling interests
 
$
141,200
   
$
144,898
   
$
120,731
   
$
115,111
   
$
115,511
 

(a)
In 2016, includes tax benefits in Taiwan of $4.8 million primarily related to the recognition of prior period tax benefits and other tax positions no longer deemed necessary.
(b)
In 2018, includes $0.6 million gain on sale of assets.
(c)
In 2016, includes $8.8 million gain on sale of investment in a foreign entity and $0.2 million gain on the sale of the Company’s 49.99% interest in the MP Mask joint venture.
(d)
In 2015, includes $0.9 million of financing expenses related to the exchange of $57.5 million of 3.25% convertible senior notes.

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ITEM 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We sell substantially all of our photomasks to semiconductor designers and manufacturers, and manufacturers of FPDs. Photomask technology is also being applied to the fabrication of other higher performance electronic products such as photonics, micro-electronic mechanical systems, and certain nanotechnology applications. Our selling cycle is tightly interwoven with the development and release of new semiconductor and FPD designs and applications, particularly as they relate to the semiconductor industry's migration to more advanced product innovation, design methodologies, and fabrication processes. We believe that the demand for photomasks primarily depends on design activity rather than sales volumes from products manufactured using photomask technologies. Consequently, an increase in semiconductor or FPD sales does not necessarily result in a corresponding increase in photomask sales. However, the reduced use of customized ICs, reductions in design complexity, other changes in the technology or methods of manufacturing or designing semiconductors, or a slowdown in the introduction of new semiconductor or FPD designs could reduce demand for photomasks ‒ even if the demand for semiconductors and FPDs increases. Advances in semiconductor, FPD, and photomask design and semiconductor and FPD production methods that shift the burden of achieving device performance away from lithography could also reduce the demand for photomasks. Historically, the microelectronic industry has been volatile, experiencing periodic downturns and slowdowns in design activity. These downturns have been characterized by, among other things, diminished product demand, excess production capacity, and accelerated erosion of selling prices with a concomitant effect on revenue and profitability.

We are typically required to fulfill customer orders within a short period of time, sometimes within twenty-four hours. This results in a minimal level of backlog orders, typically one to two weeks of backlog for IC photomasks and two to three weeks of backlog for FPD photomasks.

The global semiconductor industry is driven by end markets which have been closely tied to consumer-driven applications of high-performance devices, including, but not limited to, mobile display devices, mobile communications, and computing solutions. While we cannot predict the timing of the industry's transition to volume production of next-generation technology nodes, or the timing of up and down cycles with precise accuracy, we believe that such transitions and cycles will continue into the future, beneficially and adversely affecting our business, financial condition, and operating results as they occur. We believe our ability to remain successful in these environments is dependent upon the achievement of our goals of being a service and technology leader and efficient solutions supplier, which we believe should enable us to continually reinvest in our global infrastructure.

We are focused on improving our competitiveness by advancing our technology and reducing costs and, in connection therewith, have invested and plan to continue to invest in manufacturing equipment to serve the high-end markets. As we face challenges in the current and near term that require us to make significant improvements in our competitiveness, we continue to evaluate further cost reduction initiatives.

State-of-the-art production for semiconductor masks is considered to be 28 nanometer and smaller for ICs and Generation 8 and above and AMOLED display-based process technologies for FPDs. However, 32 nanometer and above geometries for semiconductors and Generation 7 and below, excluding AMOLED, process technologies for FPDs constitute the majority of designs currently being fabricated in volume. At these geometries, we can produce full lines of photomasks, and there is no significant technology employed by our competitors that is not available to us. We expect 28 nanometer and below designs to continue to move to wafer fabrication throughout fiscal 2020, and we believe we are well positioned to service an increasing volume of this business as a result of our investments in manufacturing processes and technology in the regions where our customers are located.

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The photomask industry has been, and is expected to continue to be, characterized by technological change and evolving industry standards. In order to remain competitive, we will be required to continually anticipate, respond to, and utilize changing technologies. In particular, we believe that, as semiconductor geometries continue to become smaller, and FPD designs become larger or otherwise more advanced, we will be required to manufacture even more complex optically-enhanced reticles, including optical proximity correction and phase-shift photomasks. Additionally, demand for photomasks has been, and could in the future be, adversely affected by changes in semiconductor and high-performance electronics fabrication methods that affect the type or quantity of photomasks used, such as changes in semiconductor demand that favor field-programmable gate arrays and other semiconductor designs that replace application-specific ICs, or the use of certain chip-stacking methodologies that lessen the emphasis on conventional lithography technology. Furthermore, increased market acceptance of alternative methods of transferring circuit designs onto semiconductor wafers could reduce or eliminate the need for photomasks in the production of semiconductors. As of the end of fiscal year 2019, one alternative method, direct-write lithography, has not been proven to be a commercially viable alternative to photomasks, as it is considered to be too slow for high-volume semiconductor wafer production, and we have not experienced a significant loss of revenue as a result of this or other alternative semiconductor design methodologies. However, should direct-write lithography or any other alternative method of transferring IC designs to semiconductor wafers without the use of photomasks achieve market acceptance, and we do not anticipate, respond to, or utilize these or other changing technologies due to resource, technological, or other constraints, our business and results of operations could be materially adversely affected.

Both our revenues and costs have been affected by the increased demand for high-end-technology photomasks that require more advanced manufacturing capabilities, but generally command higher average selling prices ("ASPs"). Our capital expenditure payments aggregated approximately $363 million for the three fiscal years ended October 31, 2019, which has significantly contributed to our cost of goods sold. We intend to continue to make the required investments to support the technological demands of our customers that we believe will position the Company for future growth. In support of this effort, we expect capital expenditure payments to be approximately $100 million in fiscal year 2020.

The manufacture of photomasks for use in fabricating ICs, FPDs, and other related products built using comparable photomask-based process technologies has been, and continues to be, capital intensive. Our employees and our integrated global manufacturing network represent a significant portion of our fixed operating cost base. Should our revenue decrease as a result of a decrease in design releases from our customers, we may have excess or underutilized production capacity, which could significantly impact our operating margins, or result in write-offs from asset impairments.

Recent Developments

In the first quarter of fiscal 2020, we acquired the remaining 0.2% of noncontrolling interests in PK, Ltd. for $0.6 million.

In the first quarter of fiscal 2020, we adopted ASU 2016-02 and all subsequent amendments, collectively codified in Accounting Standards Codification Topic 842 - “Leases” (“Topic 842”). This guidance requires modified retrospective adoption, either at the beginning of the earliest period presented or at the beginning of the period of adoption; we elected to apply the guidance at the beginning of the period of adoption, and recognized right-of-use leased assets of approximately $6.7 million, and corresponding lease liabilities, which were discounted at our incremental borrowing rates, on our November 1, 2019, consolidated balance sheet to reflect our adoption of the guidance. We do not expect our adoption of Topic 842 to affect our cash flows or our ability to comply with covenants under our credit agreements.

In the fourth quarter of fiscal 2019, our board of directors declared a dividend of one preferred stock purchase right (a “Right”), payable on or about October 1, 2019, for each share of common stock, par value $0.01 per share, of the Company outstanding on September 30, 2019, to the stockholders of record on that date. In connection with the distribution of the Rights, we entered into a Section 382 Rights Agreement (the “Rights Agreement”), dated as of September 23, 2019, between the Company and Computershare Trust Company, N.A., a federally chartered trust company, as rights agent. The purpose of the Rights Agreement is to deter trading of our common stock that would result in a change in control (as defined in Internal Revenue Control Section 382), thereby preserving our future ability to use our historical federal net operating losses and other Tax Attributes (as defined in the Rights Agreement). Each Right entitles the registered holder to purchase from the Company one one-thousandth of a share of Series A Preferred Stock, par value $0.01 per share, at a price of $33.63, subject to adjustment. The Rights, which are described in the Company’s Current Report on Form 8-K filed on September 24, 2019, are in all respects subject to and governed by the provisions of the Rights Agreement. The Rights will expire at the earliest to occur of (i) the close of business on the day following the certification of the voting results of the Company’s 2020 annual meeting of stockholders, if at that meeting, or any other meeting of stockholders of the Company duly held prior to September 22, 2020, a proposal to approve this Rights Agreement is not passed by the affirmative vote of the majority of the voting interests; (ii) the date on which our board of directors determines, in its sole discretion, that the Rights Agreement is no longer necessary for the preservation of material valuable tax attributes, or the tax attributes have been fully utilized and may no longer be carried forward, and (iii) the close of business on September 22, 2022.
 
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In the fourth quarter of fiscal 2019, PDMC, the Company’s majority-owned IC subsidiary in Taiwan, paid a dividend of which 49.99%, or approximately $18.9 million, was paid to noncontrolling interests.

In the fourth quarter of fiscal 2019, upon our request, a financing entity made an advance payment of $3.5 million to an equipment vendor. We entered into a Master Lease Agreement (“MLA”) with this financing entity, which became effective in July 2019. The MLA enables us to request advance payments or other funds to finance equipment to be leased or purchased in the U.S. In connection with this MLA, we have been approved for financing of $35 million for the purchase of a high-end lithography tool. Interest on this borrowing is payable monthly at thirty-day LIBOR plus 1% (2.76% at October 31, 2019), and will continue to accrue until the borrowing is repaid or, as allowed under the MLA, we enter into a lease for the equipment. We intend to enter into a lease agreement for the related equipment in fiscal year 2020.

In the fourth quarter of fiscal 2019, the Company’s board of directors authorized the repurchase of up to $100 million of its common stock, pursuant to a repurchase plan under Rule 10b5-1 of the Securities Act of 1933 (as amended). As of October 31, 2019, we had repurchased 1.0 million shares at a cost of $11.0 million (an average price of $11.05 per share). The repurchase program may be suspended or discontinued at any time.

In the second quarter of fiscal 2019, we repaid, upon maturity, the entire $57.5 million principal amount of the convertible senior notes we issued in April 2016.

In the first quarter of fiscal 2019, PDMC paid a dividend, of which 49.99%, or approximately $26.1 million, was paid to noncontrolling interests.

In the first quarter of fiscal 2019, PDMCX was approved for credit of $50 million, subject to certain limitations related to PDMCX registered capital at the time of the initial approval, pursuant to which PDMCX has and will enter into separate loan agreements (“the Project Loans”) for intermittent borrowings. The Project Loans, which are denominated in Chinese renminbi (RMB), are being used to finance certain capital expenditures in China. PDMCX granted liens on its land, building, and certain equipment as collateral for the Project Loans. As of October 31, 2019, PDMCX had borrowed 243.4 million RMB ($34.5 million) against this approval. Payments on these borrowings are due semi-annually through December 2025; the initial payment is scheduled for June 2020. See Note 6 of the financial statements for additional information on these loans.

In the first quarter of fiscal 2019, PDMCX received approval for unsecured credit of $25.0 million, pursuant to which PDMCX may enter into separate loan agreements. Under this credit agreement (the “Working Capital Loans”), PDMCX can borrow up to 140.0 million RMB to pay value-added taxes (“VAT”) and up to 60.0 million RMB to fund operations; combined total borrowings are limited to $25.0 million. As of October 31, 2019, PDMCX had outstanding 36.8 million RMB ($5.2 million) to fund operations, with repayments due one year from the borrowing dates of the separate loan agreements. As of October 31, 2019, PDMCX had outstanding 67.3 million RMB ($9.5 million) borrowed to pay VAT. Payments on these borrowings are due semiannually, at an increasing rate, through January 2022. See Note 6 of the consolidated financial statements for additional information on these loans.

In the fourth quarter of fiscal 2018, we entered into a five-year amended and restated credit agreement (the “Credit Agreement”), with JPMorgan Chase Bank, N.A., as Administrative Agent and Collateral Agent, Bank of America, N.A., as Syndication Agent, each of JPMorgan Chase Bank, N.A. and Merrill, Lynch, Pierce, Fenner & Smith Incorporated as joint bookrunners and joint lead arrangers, and each of JPMorgan Chase Bank, N.A., Bank of America, N.A., Citizens Bank, N.A., and TD Bank, N.A. as lenders from time to time party thereto. The Credit Agreement has a $50 million borrowing limit, with an expansion capacity to $100 million, and is secured by substantially all of our assets located in the United States and common stock we own in certain foreign subsidiaries. The Credit Agreement includes minimum interest coverage ratio, total leverage ratio, and minimum unrestricted cash balance covenants (all of which we were in compliance with at October 31, 2019), and limits the amount of dividends, distributions, and redemptions we can pay on our common stock to an aggregate amount in 2019 of $100 million and $50 million annually thereafter. We had no outstanding borrowings against the Credit Agreement at October 31, 2019, and $50 million was available for borrowing. The interest rate on the Credit Agreement (2.78% at October 31, 2019) is based on our total leverage ratio at LIBOR plus a spread, as defined in the Credit Agreement.

In the fourth quarter of fiscal 2018, the Company’s board of directors authorized the repurchase of up to $25 million of its common stock, to have been executed in open-market transactions or in accordance with a repurchase plan under Rule 10b5-1 of the Securities Act of 1933 (as amended). The share repurchase program commenced, under Rule 10b5-1, on October 22, 2018, and was terminated on February 1, 2019. In total, we repurchased 1.5 million shares at a cost of $13.8 million (an average of $9.41 per share) under this authorization.

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In the third quarter of fiscal 2018, the Company’s board of directors authorized the repurchase of up to $20 million of its common stock, which was effectuated in open-market transactions or in accordance with a repurchase plan under Rule 10b5-1 of the Securities Act of 1933 (as amended). The share repurchase program commenced on July 10, 2018, and ended in October 2018. In total, under this authorization, we repurchased 2.2 million shares at a cost of $20.0 million (an average of $8.97 per share).

In the third quarter of fiscal 2018, PDMC paid a dividend, of which 49.99%, or approximately $8.2 million, was paid to noncontrolling interests.

In the first quarter of fiscal 2018, we announced the successful closing of the China joint venture agreement with Dai Nippon Printing Co., Ltd. (“DNP”), which we had agreed to enter into and announced in the third quarter of fiscal 2017. Under the agreement, our wholly-owned Singapore subsidiary owns 50.01% of the joint venture, which is named Xiamen American Japan Photronics Mask Co., Ltd. (PDMCX), and a subsidiary of DNP owns the remaining 49.99%. The financial results of the joint venture, which commenced production in the third quarter of 2019, are included in the Photronics, Inc. consolidated financial statements. See Note 4 of the consolidated financial statements for additional information on the joint venture.

Results of Operations

The following tables present selected operating information expressed as a percentage of revenue:

 
Three Months Ended
 
 
 
 
 
 
 
October 31,
2019
 
 
July 28,
2019
 
 
October 31,
2018
 
 
 
 
 
 
 
 
 
 
 
Revenue
 
 
100.0
%
 
 
100.0
%
 
 
100.0
%
Cost of goods sold
 
 
75.6
 
 
 
77.9
 
 
 
75.5
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit
 
 
24.4
 
 
 
22.1
 
 
 
24.5
 
Selling, general and administrative expenses
 
 
7.8
 
 
 
9.5
 
 
 
9.3
 
Research and development expenses
 
 
2.9
 
 
 
2.9
 
   
2.7
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating income
 
 
13.7
 
 
 
9.7
 
 
 
12.5
 
Other income (expense), net
 
 
(3.9
)
 
 
(0.2
)
 
 
1.5
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income before income tax provision
 
 
9.8
 
 
 
9.5
 
 
 
14.0
 
Income tax provision
 
 
1.5
 
 
 
2.4
 
 
 
2.4
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
 
8.3
 
 
 
7.1
 
 
 
11.6
 
Net income attributable to noncontrolling interests
 
 
2.1
 
 
 
2.5
 
 
 
3.0
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income attributable to Photronics, Inc. shareholders
 
 
6.2
%
 
 
4.6
%
 
 
8.6
%

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Year Ended
 
 
 
 
 
 
 
October 31,
2019
 
 
October 31,
2018
 
 
October 29,
2017
 
 
 
 
 
 
 
 
 
 
 
Revenue
 
 
100.0
%
 
 
100.0
%
 
 
100.0
%
Cost of goods sold
 
 
78.1
 
 
 
75.4
 
 
 
79.7
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit
 
 
21.9
 
 
 
24.6
 
 
 
20.3
 
Selling, general and administrative expenses
 
 
9.5
 
 
 
9.6
 
 
 
9.7
 
Research and development expenses
 
 
2.9
 
 
 
2.7
 
 
 
3.5
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating income
 
 
9.5
 
 
 
12.3
 
 
 
7.1
 
Other income (expense), net
 
 
(0.3
)
 
 
0.5
 
 
 
(1.2
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Income before income tax provision
 
 
9.2
 
 
 
12.8
 
 
 
5.9
 
Income tax provision
 
 
1.9
 
 
 
1.4
 
 
 
1.2
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
 
7.3
 
 
 
11.4
 
 
 
4.7
 
Net income attributable to noncontrolling interests
 
 
1.9
 
 
 
3.5
 
 
 
1.8
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income attributable to Photronics, Inc. shareholders
 
 
5.4
%
 
 
7.9
%
 
 
2.9
%

Note: All the following tabular comparisons, unless otherwise indicated, are for the three months ended October 31, 2019 (Q4 FY19), July 28, 2019 (Q3 FY19) and October 31, 2018 (Q4 FY18), and for the fiscal years ended October 31, 2019 (FY19) and October 31, 2018 (FY18). Please refer to the MD&A in our 2018 Annual Report on Form 10-K for comparative discussion of our fiscal years ended October 31, 2018 and October 29, 2017.

Revenue

Our quarterly revenues can be affected by the seasonal purchasing tendencies of our customers. As a result, demand for our products is typically negatively impacted during the first, and sometimes the second, quarters of our fiscal year, by the North American, European, and Asian holiday periods, as some of our customers reduce their development and, consequently, their buying activities during those periods. High-end photomask applications include mask sets for 28 nanometer and smaller products for IC, and G8 and above and active matrix organic light-emitting diode (AMOLED) display technologies for FPD products. High-end photomasks typically have higher selling prices (ASPs) than mainstream products.

The following tables present changes in disaggregated revenue in Q4 FY19 and FY 19 from revenue in prior reporting periods. Columns many not total due to rounding.

Quarterly Changes in Revenue by Product Type

 
 
Q4 FY19 from Q3 FY19
   
Q4 FY19 from Q4 FY18
 
 
 
Revenue in
Q4 FY19
   
Increase
(Decrease)
   
Percent
Change
   
Increase
(Decrease)
   
Percent
Change
 
 
                             
IC
                             
High-end
 
$
45.0
   
$
6.5
     
16.9
%
 
$
5.5
     
14.0
%
Mainstream
   
67.6
     
5.9
     
9.5
%
   
(3.9
)
   
(5.4
)%
 
                                       
Total IC
 
$
112.5
   
$
12.4
     
12.3
%
 
$
1.7
     
1.5
%
 
                                       
FPD
                                       
High-end
 
$
28.5
   
$
2.5
     
9.8
%
 
$
6.5
     
29.4
%
Mainstream
   
15.2
     
3.3
     
27.2
%
   
3.5
     
29.5
%
 
                                       
Total FPD
 
$
43.7
   
$
5.8
     
15.3
%
 
$
9.9
     
29.4
%
 
                                       
Total Revenue
 
$
156.3
   
$
18.1
     
13.1
%
 
$
11.6
     
8.0
%

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Table of Contents


Quarterly Changes in Revenue by Geographic Origin

 
Q4 FY19 from Q3 FY19
   
Q4 FY19 from Q4 FY18
 
 
           
 
 
Revenue in
Q4 FY19
   
Increase
(Decrease)
   
Percent
Change
   
Increase
(Decrease)
   
Percent
Change
 
 
                             
Taiwan
 
$
68.9
   
$
7.6
     
12.4
%
 
$
6.6
     
10.6
%
Korea
   
37.3
     
0.2
     
0.6
%
   
(3.4
)
   
(8.4
)%
United States
   
30.5
     
5.1
     
20.1
%
   
(0.2
)
   
(0.8
)%
Europe
   
7.9
     
(0.1
)
   
(1.0
)%
   
(1.9
)
   
(19.6
)%
China
   
11.3
     
5.4
     
89.8
%
   
10.7
     
1,692.9
%
Other
   
0.4
     
(0.1
)
   
(16.6
)%
   
(0.1
)
   
(22.6
)%
 
                                       
Total revenue
 
$
156.3
   
$
18.1
     
13.1
%
 
$
11.6
     
8.0
%

Revenue increased 13.1% in Q4 FY19, compared with Q3 FY19, as both mainstream and high-end revenue increased. The largest increases in percentages were in FPD mainstream and IC high-end masks, which increased 27.2% and 16.9%, respectively. Revenues from China-based customers represented 33% of our total revenues in Q4 FY19. While some of the China-based revenue reflected a 77.5% increase in revenue at our FPD plant in China, much of the increase was due to increased shipments into China from IC facilities in Taiwan and Korea, both of which operated at full capacity during Q4 FY19. Our IC facility in China was, and is expected to be for a significant part of fiscal 2020, in the qualification stage with many of its customers; however, revenues increased significantly from Q3 FY19.

Revenue increased 8.0% in Q4 FY19, compared with Q4 FY18, primarily as a result of increased mainstream and high-end FPD growth, both of which increased over twenty-nine percent from the prior year quarter. High-end IC revenue also contributed to the increase, growing at 14.0%. Our expansion into China, as a ship-to destination from our Taiwan and Korea facilities, and from local production was a significant driver of the increase.

Year-over-Year Changes in Revenue by Product Type.

 
FY19 from FY18
 
 
 
Revenue in
FY19
   
Increase
(Decrease)
   
Percent
Change
 
 
                 
IC
                 
High-end
 
$
156.4
   
$
(3.9
)
   
(2.5
)%
Mainstream
   
249.8
     
(5.9
)
   
(2.3
)%
 
                       
Total IC
 
$
406.2
   
$
(9.9
)
   
(2.4
)%
 
                       
FPD
                       
High-end
 
$
98.8
   
$
22.7
     
29.9
%
Mainstream
   
45.6
     
2.5
     
5.8
%
 
                       
Total FPD
 
$
144.5
   
$
25.3
     
21.2
%
 
                       
Total Revenue
 
$
550.7
   
$
15.4
     
2.9
%

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Table of Contents


Year-over-Year Changes in Revenue by Geographic Origin

 
FY19 from FY18
 
 
     
 
 
Revenue in
FY19
   
Increase
(Decrease)
   
Percent
Change
 
 
                 
Taiwan
 
$
244.4
   
$
7.3
     
3.1
%
Korea
   
147.7
     
0.7
     
0.5
%
United States
   
105.0
     
(7.6
)
   
(6.7
)%
Europe
   
32.6
     
(3.0
)
   
(8.3
)%
China
   
19.0
     
17.9
     
1,543.0
%
Other
   
1.9
     
0.1
     
4.5
%
 
                       
Total Revenue
 
$
550.7
   
$
15.4
     
2.9
%

Revenue increased 2.9% in FY19, compared with FY18, to a record high of $550.7 million. A 29.9% increase in high-end FPD sales was primarily responsible for the increase, with strong demand for mobile displays driving much of the increase. Our China FPD facility, which commenced production late in the second quarter, contributed 11.4% of our total FPD revenue. Overall IC revenues decreased from FY18 by 2.4%, as both mainstream and high-end IC revenues fell between 2 to 3%. The decrease was geographically broad-based, with our Taiwan IC facility being a notable exception, as its revenue grew 3.8%.

We anticipate a softening of the demand for G10.5+ FPD photomasks, which we expect to be offset to some extent by a strengthening of the demand for AMOLED photomasks. We expect our customers to continue to focus on improving mobile displays, including the development of foldable smartphones. Should demand increase sufficiently, we will be ready to increase our capacity to meet customer demands by expanding the production capacity of our FPD facility in China. We currently have two lithography tools on order that will enable us to expand our Asian capacity for mainstream photomasks, which are often used for certain layers of high-end applications. We anticipate that IC demand will be stable to improving. As ASPs for high-end masks are high, a relatively small shift in the timing of their demand can have an out-sized effect on the timing of our revenues.

The impact, if any, on our business of changing geopolitical conditions, such as U.S.-China trade relations, tensions between the Republic of South Korea and Japan, and the effects of the United Kingdom potentially exiting the European Union cannot be predicted.

Gross Margin

                     
Percent Change
 
 
                       
 
 
Q4 FY19
   
Q3 FY19
   
Q4 FY18
   
Q4 FY19
from Q3
FY19
   
Q4 FY19
from Q4
FY18
 
 
                             
Gross profit
 
$
38.2
   
$
30.6
   
$
35.4
     
24.8
%
   
7.7
%
Gross margin
   
24.4
%
   
22.1
%
   
24.5
%
               

Gross margin increased 2.3% from Q3 FY19 to 24.4%, primarily as a result of the $18.2 million increase in revenue discussed above. Contribution margin from our high operating leverage, 1.9% decrease in compensation and related expenses as a percent of revenue, offset increased overhead costs which were primarily driven by increased equipment costs of $2.4 million and outside processing costs of $0.5 million. Material costs, as a percent of revenue, decreased by 0.4% from the prior quarter.

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Gross margin decreased by 0.1% from Q4 FY18, primarily due to a 11.3% increase in overhead costs as a percent of revenue. Significant increases from the prior year quarter included depreciation expense of $3.6 million and service contract expense of $1.2 million, both of which resulted from our increased installed tool base in China. Increases in other non-equipment related overhead costs of $1.4 million were incurred at our two China-based manufacturing facilities, in which production commenced, but had not yet reached capacity, in fiscal 2019. On a consolidated basis, both material and compensation-related expenses, as a percentage of revenue, did not change significantly from the prior year quarter.

             
Percent Change
 
 
                 
 
 
FY19
   
FY18
   
FY19 from FY18
 
 
                 
Gross profit
 
$
120.8
   
$
131.5
     
(8.1
)%
Gross margin
   
21.9
%
   
24.6
%
       

On a year-to-date basis, gross margin decreased 2.7%; increased losses at our two China-based facilities constituting the most significant causes. Our FPD facility in China commenced production late in Q2 FY19, and our IC facility commenced production in Q3 FY19.

Selling, General and Administrative Expenses

Selling, general and administrative expenses decreased by $1.0 million, or 7.5%, to $12.1 million in Q4 FY19, from $13.1 million in Q3 FY19, and by $1.4 million, or 10.1%, from $13.5 million in Q4 FY18, primarily due to decreased compensation and related expenses of $1.0 and $1.3 million from the respective comparative periods. On a full-year basis, selling, general and administrative expenses increased $0.9 million, or 1.8%, in FY19 to $52.3 million, from $51.4 million in FY18, primarily due to a reduction in bad debt recoveries of $0.8 million in FY19, as compared with FY18.

Research and Development Expenses

Research and development expenses consist of development efforts related to high-end process technologies for 28nm and smaller IC nodes. In Asia, in addition to the focus on high-end IC process technology nodes, G8 and above FPDs and AMOLED applications are also under development.

Research and development expenses increased $0.5 million to $4.5 million in Q4 FY19, or 12.2%, from Q3 FY19, primarily as a result of increased development costs of $0.9 million at our China facilities. A decrease from the prior quarter in research and development expense of $0.8 million in the U.S. was somewhat offset by increased expenses of $0.4 million at our other Asia-based facilities. Research and development expenses increased $0.6 million, or 16.3%, in Q4 FY19 over Q4 FY18. The increase was due to $1.1 million of expense incurred at our China-based facilities, both of which commenced operations in FY19; decreased expense in the U.S. of $0.8 million was partially offset by increased spending of $0.3 million at our other Asia-based facilities.

On a full-year basis, research and development expenses increased $1.9 million in FY19, or 13.2%, to $16.4 million. The increase is largely attributable to spending of $1.6 million at our China-based facilities, which commenced operations in FY19. The remainder of the increase is primarily attributable to increased development spending at our IC facility in Taiwan.

Other Income (Expense), net
 
Q4 FY19
   
Q3 FY19
   
Q4 FY18
 
 
                 
Interest income and other income (expense), net
 
$
(5.9
)
 
$
-
   
$
2.9
 
Interest expense
   
(0.2
)
   
(0.4
)
   
(0.6
)
 
                       
Total other income (expense)
 
$
(6.1
)
 
$
(0.4
)
 
$
2.3
 

Interest income and other income (expense), net decreased by $5.9 million in Q4 FY19, compared with Q3 FY19, primarily as a result of increased foreign currency transaction losses of $6.2 million. Interest expense, which is related to our China-based debt, decreased $0.2 million in Q4 FY19 from Q3 FY19; interest on our China-based debt is partially subsidized by a local authority.

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Interest income and other income (expense), net decreased by $8.9 million in Q4 FY19, compared with Q4 FY18, primarily as a result of unrealized foreign currency remeasurement effect of $7.9 million. Also contributing to the decrease was a reduction in interest income of $0.5 million, which resulted from our lower average cash balances during the current year quarter, and the absence, in Q4 FY19, of $0.4 million of gains realized on the sales of assets in Q4 FY18. Interest expense decreased $0.4 million in Q4 FY19 from Q4 FY18. The decrease is attributable to the repayment of our $57.5 million of 3.25% convertible senior notes in April 2019, the impact of which was somewhat offset by interest incurred on our China-based loans.

 
FY19
   
FY18
 
 
           
Interest income and other income (expense), net
 
$
-
   
$
5.2
 
Interest expense
   
(1.4
)
   
(2.3
)
 
               
Total other income (expense)
 
$
(1.4
)
 
$
2.9
 

Interest income and other income (expense), net decreased by $5.2 million on a full-year basis in FY19, compared with FY18, primarily as a result of: unrealized foreign currency remeasurement effects of $1.6 million; decreased interest income of $1.5 million (due to our lower average cash balances); a reduction, in the current year, of $1.0 million of gains realized on the sales of assets; and a decrease in subsidy income in China of $0.7 million. Interest expense decreased $0.9 million in FY19 from FY18. The decrease is attributable to the repayment of our $57.5 million of 3.25% convertible senior notes in April 2019, the impact of which was somewhat offset by interest incurred on our China-based loans.

Income Tax Provision

Certain provisions of the U.S. Tax Cuts and Jobs Act, which was signed into law on December 22, 2017, were effective for tax years beginning on or after January 1, 2018. As a fiscal year U.S. taxpayer, these provisions were applied to our fiscal year 2019, including the elimination of the domestic manufacturing deduction, which created new taxes on certain foreign sourced income, and introduced new limitations on certain business deductions.

 
Q4 FY19
   
Q3 FY19
   
Q4 FY18
 
 
                 
Income tax provision
 
$
2.3
   
$
3.2
   
$
3.6
 
Effective income tax rate
   
15.1
%
   
24.7
%
   
17.5
%

The effective income tax rate is sensitive to the jurisdictional mix of our earnings, due, in part, to the non-recognition of tax provisions and benefits on losses in jurisdictions with valuation allowances.

The effective income tax rate decreased in Q4 FY19, compared with Q3 FY19, primarily due to the non-recognition of tax provisions in Q4 FY19 on U.S. quarterly income, compared with the non-recognition of tax benefits in Q3 FY19 on losses in the U.S.; the non-recognition of tax provisions and benefits in both quarters was a result of valuation allowances applying to those provisions and benefits. The effective income tax rate decreased in Q4 FY19 from Q4 FY18, for the same reasons; however, the effective income tax rate decrease was somewhat reduced by a decrease in the benefit of $0.9 million from a tax holiday in Taiwan.

 
FY19
   
FY18
 
 
           
Income tax provision
 
$
10.2
   
$
7.3
 
Effective income tax rate
   
20.1
%
   
10.7
%

The increase in the effective income tax rate on a full-year basis in FY19, compared with FY18, was primarily due to FY18 recognition of a tax benefit related to $3.7 million of alternative minimum tax credits that became fully refundable under U.S. tax reform, and an FY19 decrease of $1.1 million in the recognition of previously unrecognized tax benefits; the change in unrecognized tax benefits resulted from the differences in audit settlements and expirations of assessment period statutes of limitations between the two periods.

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We consider all available evidence when evaluating the potential future realization of deferred tax assets, and when, based on the weight of all available evidence, we determine that it is more likely than not that some portion or all of our deferred tax assets will not be realized, we reduce our deferred tax assets by a valuation allowance. We also regularly assess the potential outcomes of ongoing and future tax examinations and, accordingly, have recorded accruals for such contingencies. Included in the balance of unrecognized tax benefits as of both October 31, 2019 and October 31, 2018, are $1.9 million, recorded in Other liabilities in the consolidated balance sheets that, if recognized, would impact the effective tax rates.

Net Income Attributable to Noncontrolling Interests

 
Q4 FY19
   
Q3 FY19
   
Q4 FY18
   
FY19
   
FY18
 
 
                             
Net income attributable to noncontrolling interest
 
$
3.3
   
$
3.5
   
$
4.3
   
$
10.7
   
$
19.2
 

The changes, for all comparative periods, in net income attributable to noncontrolling interests were due to changes in net income at our IC manufacturing facilities in Taiwan and China, in which noncontrolling interests hold 49.99% ownership interests.

Liquidity and Capital Resources
 
October 31,
2019
   
October 31,
2018
 
 
 
(in $ millions)
   
(in $ millions)
 
 
           
Cash and cash equivalents
 
$
206.5
   
$
329.3
 
 
               
Net cash provided by operating activities
 
$
68.4
   
$
130.6
 
Net cash used in investing activities
 
$
(151.4
)
 
$
(90.9
)
Net cash used in financing activities
 
$
(42.1
)
 
$
(13.8
)

We had cash and cash equivalents of $206.5 million at the end of FY19, compared with $329.3 million at the end of fiscal 2018. The net decrease is primarily attributable to:

- $57.5 million used to repay our convertible senior notes;
- $178.4 million used to purchase capital assets (the preponderance of which related to equipping our China-based facilities);
- $21.7 million used to repurchase our common stock;
- $15.7 million dividends, net of contributions, paid to noncontrolling interests
- $54.6 million received from borrowings in China;
- $27.0 million received from government incentives in China and the U.S.,
- $68.4 million provided by operating activities.

As of October 31, 2019, our working capital was $275.6 million, compared with $311.7 million at the end of fiscal 2018. The $36.1 million net decrease is primarily attributable to:

- Decreased cash and cash equivalents of $65.2 million (net of $57.5 million used to repay our convertible senior notes, which had no impact on working capital);
- Increased inventories of $19.0 million, the predominance of which was to supply our China FPD facility and;
- Receivables for investment subsidies in China of $3.2 million at the end of FY19,
- Increased value added tax prepayments at our China-based facilities of $3.7 million.

The net cash provided by operating activities of $68.4 million in FY19 decreased $62.2 million, from $130.6 million provided in FY18. The net decrease was due primarily to:

- Lower net income of $20.7 million in YTD FY19;
- Increased trade accounts receivable of $13.7 million, primarily attributable to our $11.6 million increase in revenue in Q4 FY19, compared with Q4 FY18.
- A greater increase in the change in inventories balances of $11.4 million in FY19 (primarily attributable to the stocking of our FPD facility in China) and;
- An increase in value added tax prepayments related to our China facilities of $15.7 million in FY19. These prepayments are recoverable through future sales transactions of the facilities.

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Net cash used in investing activities was $151.4 million in FY19, an increase of $60.5 million from $90.9 million used in FY18. The net increase was primarily attributable to increased capital expenditures of $85.8 million, the predominance of which related to the building and equipping of our China facilities. The increased capital expenditures were partially offset by $27.0 million received in China and the U.S. from investment incentives in FY19.

Net cash flows from financing activities increased from funds used of $13.8 million in FY18 to $42.1 million of funds used in FY19. Significant components of the net decrease were:

- $57.5 million used to repay (upon their maturity) our convertible senior notes;
- $45.1 million used to pay dividends to DNP (related to their 49.99% interest in our IC facility in Taiwan);
- $21.7 million used to acquire our common stock under share repurchase programs;
- $54.6 million received from borrowings in China and,
- $29.4 million contributed by DNP for their investment in our IC joint venture in China.

Foreign currency exchange rates contributed $2.4 million to our reported cash balance at October 31, 2019.

As of October 31, 2019, and October 31, 2018, our total cash and cash equivalents included $147.2 million and $244.5 million, respectively, held by our foreign subsidiaries. The majority of earnings of our foreign subsidiaries are considered to be indefinitely reinvested. Repatriation of these funds to the U.S. may subject them to U.S. state income taxes and local country withholding taxes in certain jurisdictions. Furthermore, our foreign subsidiaries continue to grow through the reinvestment of earnings in additional manufacturing capacity and capability, particularly in the high-end IC and FPD areas.

Our liquidity, as we operate in a high fixed-cost environment, is highly dependent on our revenue, cash conversion cycle, and the timing of our capital expenditures (which can vary significantly from period to period). Depending on conditions in the semiconductor and FPD markets, our cash flows from operations and current holdings of cash may not be adequate to meet our current and long-term needs for capital expenditures, operations, and debt repayments. Historically, in certain years, we have used external financing to fund these needs. Due to conditions in the credit markets and covenant restrictions on our existing debt, some financing instruments we have used in the past may not be available to us when required. Consequently, we cannot assure that additional sources of financing would be available to us on commercially favorable terms, should our long-term cash requirements exceed our existing cash and cash available under our credit agreements.

As of October 31, 2019, we had outstanding capital commitments of approximately $112 million. We intend to finance our capital expenditures with our working capital, contributions from our joint venture partners, cash generated from operations and, if necessary, additional borrowings. Our remaining funding commitment for our IC facility in China, which commenced production in the third quarter of fiscal 2019, was approximately $7 million as of October 31, 2019; we will fulfill this commitment over the next several quarters.

Cash Requirements

Our cash requirements in fiscal 2020 will primarily be for funding our operations, capital spending, (including the completion of our two facilities in China, and the acquisition of additional high-end equipment at other sites), and debt repayments. At our option, should we deem it to be an optimal use of our cash, we may repurchase some of our common stock. We believe that our cash on hand, cash generated from operations and amounts available to borrow will be sufficient to meet our cash requirements for the next twelve months. We regularly review the availability and terms at which we might issue additional equity or debt securities in the public or private markets. However, we cannot assure that additional sources of financing would be available to us on commercially favorable terms, should our cash requirements exceed our existing cash and cash available under our credit agreements.

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Contractual Obligations

The following table presents our contractual obligations as of October 31, 2019:

 
Payment due by period
 
 
     
Contractual Obligations
 
Total
   
Less
Than
1 Year
   
1 - 3
Years
   
3 - 5
Years
   
More
Than
5 Years
 
                               
Debt (1)
 
$
52,760
   
$
10,873
   
$
20,735
   
$
10,029
   
$
11,123
 
 
                                       
Operating leases
   
6,701
     
2,010
     
3,148
     
1,166
     
377
 
 
                                       
Purchase obligations (1)
   
130,270
     
105,579
     
24,691
     
-
     
-
 
Interest
   
7,385
     
2,433
     
3,034
     
1,609
     
309
 
Other noncurrent liabilities
   
11,436
     
1,046
     
2,656
     
2,658
     
5,076
 
Total
 
$
208,552
   
$
121,941
   
$
54,264
   
$
15,462
   
$
16,885
 

(1) Included above, in the less-than-one-year amounts of Debt and Purchase Obligations, are $3.5 million and $30.8 million, respectively, which we intend to finance under a multi-year capital lease in fiscal 2020. As discussed in Note 6 of the consolidated financial statements, we have been approved for a lease to finance the purchase of a high-end lithography tool under an agreement entered into in fiscal 2019.

As of October 31, 2019, the Company had recorded accruals for uncertain tax positions and related interest and penalties of $1.9 million; these accruals were not included in the above table due to the high degree of uncertainty regarding the timing of future payments related to such liabilities.

Off-Balance Sheet Arrangements

In January 2018, the Company, through its wholly owned Singapore subsidiary, and DNP, through its wholly owned subsidiary “DNP Asia Pacific PTE, Ltd.” entered into a joint venture under which DNP obtained a 49.99% interest in our IC business in Xiamen, China. The joint venture, known as “Xiamen American Japan Photronics Mask Co., Ltd.” (“PDMCX”), was established to develop and manufacture photomasks for leading-edge and advanced-generation semiconductors. Under the Joint Venture Operating Agreement of PDMCX (“the Agreement”), DNP is afforded, under certain circumstances, the right to “put” its interest in PDMCX to the Company. These circumstances include disputes regarding the strategic direction of PDMCX that may arise after the initial two-year term of the Agreement that cannot be resolved between the two parties. In addition, both the Company and DNP have the option to purchase, or put, their interest from, or to, the other party, should their ownership interest fall below 20% for a period of more than six consecutive months. Under all such circumstances, the sales of ownership interests would be at the exiting party’s ownership percentage of the joint venture’s net book value, with closing to take place within three business days of obtaining required approvals and clearance. Should DNP exercise an option to put their, or purchase our, interest in PDMCX we may, depending on the relationship of the fair and book value of PDMCX’s net assets, incur a loss. As of October 31, 2019, the Company and DNP each had net investments in PDMCX of approximately $39.6 million.

We lease certain office facilities and equipment under operating leases that may require us to pay taxes, insurance and maintenance expenses related to the properties. Certain of these leases contain renewal or purchase options exercisable at the end of the lease terms. See Note 8 to the consolidated financial statements for additional information on these operating leases. In concurrence with our November 1, 2019, adoption of Accounting Standards Codification Topic 842 – “Leases”, we recognized right-of-use leased assets of approximately $6.7 million and corresponding lease liabilities, which were discounted at our incremental borrowing rates. As a result, most of our lease agreements ceased to be off-balance sheet arrangements on that date.

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Business Outlook

 The majority of our revenue growth is expected to continue to come from the Asia region, with significant portion in China – in the forms of both shipments into China and masks produced in China. We are anticipating short-term seasonal softness, with growth in FPD potentially alleviating some portion of the seasonality. We are in the process of expanding our tool base to allow us to meet increased demand across all technology nodes, and, if warranted by market demand, are prepared to expand our production. Production at our China-based IC facility should begin to significantly increase during fiscal 2020. However, the timing of the increase is dependent on customer qualifications. Overall, in terms of IC business, we see opportunities for growth, either through the ramp-up of the China facility, or through a recovery in the memory market, which we believe to not be an unlikely scenario, sometime during the calendar year 2020.

 We make continual assessments of our global manufacturing strategy and monitor our revenue and related cash flows from operations. These ongoing assessments could result in future facility closures, asset redeployments, impairments of intangible or long-lived assets, workforce reductions, or the addition of manufacturing facilities, all of which would be based on market conditions and customer requirements. Our future results of operations and the other forward-looking statements contained in this filing involve a number of risks and uncertainties. While various risks and uncertainties have been discussed, a number of other unforeseen factors could cause actual results to differ materially from our expectations.

Critical Accounting Estimates

Our consolidated financial statements are based on the selection and application of accounting policies, which require management to make significant estimates and assumptions. We believe the following to be the more critical areas that require judgment when applying our accounting policies:

the determination of whether revenues related to our revenue contracts should be recognized over time or at a point in time, as these determinations impact the timing of our reported revenues and net income;
the estimation of the point in the manufacturing process at which we are entitled to receive payment as we perform;
the determination of the useful lives of our property, plant, and equipment and the timing of when depreciation should begin on such assets, as these determinations can significantly impact our gross margin and research and development expenses;
the evaluation of the recoverability of our long-lived assets and definite-lived intangible assets, which requires us to forecast the future cash flows related to these assets; this evaluation can significantly impact our gross margin and operating expense;
the estimation of the collectability of our accounts receivable which impacts our gross margin and operating expenses;
the recognition and measurement of current and deferred income taxes, including the measurement of uncertain tax positions, which impacts our provision for income taxes and our tax-related asset and liability balances.

Please refer to Notes 1,7, and 11 to our consolidated financial statements for additional information related to these critical accounting estimates and our other significant accounting policies.

Recent Accounting Pronouncements

See “Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 22 Recent Accounting Pronouncements” for recent accounting pronouncements that may affect our financial reporting.

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ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Exchange Rate Risk

We conduct business in several major currencies throughout our worldwide operations, and our financial performance may be affected by fluctuations in the exchange rates of these currencies. Changes in exchange rates can positively or negatively affect our reported revenue, operating income, assets, liabilities, and equity. The functional currencies of our Asian subsidiaries are the South Korean won, the New Taiwan dollar, the Chinese renminbi and the Singapore dollar. The functional currencies of our European subsidiaries are the British pound and the euro. In addition, we engage in transactions and have exposures to the Japanese yen.

We attempt to minimize our risk of foreign currency transaction losses by producing products in the same country in which the products are sold (thereby generating revenues and incurring expenses in the same currency), and by managing our working capital. However, in some instances, we sell products in a currency other than the functional currency of the country where it was produced, or purchase products in a currency that differs from the functional currency of the purchasing entity. In addition, to the extent practicable, we attempt to reduce our exposure to foreign currency exchange fluctuations by converting cash and cash equivalents into the functional currency of the subsidiary which holds the cash. We may also enter into derivative contracts to mitigate our exposure to foreign currency fluctuations when we have a significant purchase obligation or significant receivable denominated in a currency that differs from the transacting subsidiaries’ functional currencies. We do not enter into derivatives for speculative purposes. There can be no assurance that these practices will protect us from the need to recognize significant foreign currency transaction gains and losses, especially in the event of a significant adverse movement in the value of any foreign currency in which we conduct business against any of our functional currencies, including the U.S. dollar.

Our primary net foreign currency exposures as of October 31, 2019, included the South Korean won, the Japanese yen, the New Taiwan dollar, the Chinese renminbi, the Singapore dollar, the British pound sterling, and the euro. As of October 31, 2019, a 10% adverse movement in the value of these currencies against the functional currencies of our subsidiaries would have resulted in a net unrealized pre-tax loss of $33.1 million, which represents an increase of $19.9 million from the same movement as of October 31, 2018. The increase in foreign currency rate change risk is primarily the result of increased exposures of the Chinese renminbi and the South Korean won against the U.S. dollar. We do not believe that a 10% change in the exchange rates of other non-U.S. dollar currencies would have had a material effect on our October 31, 2019 consolidated financial statements.

Interest Rate Risk

A 10% adverse movement in the interest rates on our variable rate borrowings would not have had a material effect on our October 31, 2019, consolidated financial statements.

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ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Page
   
Report of Independent Registered Public Accounting Firm
34
   
Consolidated Balance Sheets at October 31, 2019 and October 31, 2018
36
   
Consolidated Statements of Income for the years ended October 31, 2019, October 31, 2018 and October 29, 2017
37
   
Consolidated Statements of Comprehensive Income for the years ended October 31, 2019, October 31, 2018 and October 29, 2017
38
   
Consolidated Statements of Equity for the years ended October 31, 2019, October 31, 2018 and October 29, 2017
39
   
Consolidated Statements of Cash Flows for the years ended October 31, 2019, October 31, 2018 and October 29, 2017
40
   
Notes to Consolidated Financial Statements
41

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To Shareholders and the Board of Directors of Photronics, Inc.
Brookfield, Connecticut

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Photronics, Inc. and subsidiaries (the "Company") as of October 31, 2019 and 2018, the related consolidated statements of income, consolidated statements of comprehensive income, consolidated statements of equity, and consolidated statements of cash flows, for each of the three years in the period ended October 31, 2019, the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the “financial statements”). We also have audited the Company's internal control over financial reporting as of October 31, 2019, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of October 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended October 31, 2019, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of October 31, 2019, based on the criteria established in Internal Control — Integrated Framework (2013) issued by COSO.

Basis for Opinions

The Company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting in Item 9A. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
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Critical Audit Matter
 
The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the Company’s Audit Committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgment. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
 
Revenue Recognition on In-Process Production Orders — Refer to Note 7 to the consolidated financial statements

Critical Audit Matter Description
 
The Company recognizes revenue over time for in-process production orders that have not shipped for contracts with customers for which it has an enforceable right to bill and collect consideration, inclusive of a reasonable profit, in the event the in-process orders are cancelled by the customers. This results in the Company recording a corresponding contract asset as of period end for these contracts. Significant judgment is exercised by the Company in determining the amount of revenue to recognize for these contracts and the corresponding contract asset, specifically in estimating the point within the production cycle at which the production orders stand in relation to the Company’s enforceable right within the contract. Pursuant to these contracts, revenue recognized over time and the associated contract asset as of October 31, 2019 was $7.6 million.

We identified the determination of revenue recognized over time for in-process productions orders as of October 31, 2019 a critical auditing matter because of the significant estimates and assumptions management makes in determining the amount of revenue to recognize for these contracts. This required a high degree of audit judgment and an increased extent of effort when performing audit procedures to evaluate the reasonableness of management’s determination of the progress point of in-process orders and the amount of revenue recognized over time and the corresponding contract asset as of October 31, 2019.

How the Critical Audit Matter Was Addressed in the Audit
 
Our audit procedures related to the Company’s determination of the progress point of in-process orders and resulting revenue recognized over time and corresponding contract asset as of October 31, 2019 included the following:
 

- We tested the operating effectiveness of controls over management’s determination of the point in the production process and correlation to stated contractual rights.

- We tested the mathematical accuracy of management’s calculations of revenue and the associated timing of revenue recognized in the consolidated financial statements.
 
- We selected a sample of in-process production orders as of October 31, 2019 and performed the following procedures for each selection:
 
- Obtained and read the contract.
 
- Physically observed existence of the in-process production order.
 
- Tested management’s identification of significant contract terms and resulting revenue recognition for the in-process production order.
 
- Tested management estimate of the production point for the in-process order and corresponding revenue recognition and contract asset based on the Company’s enforceable right within the contract.


/s/ Deloitte & Touche LLP
Hartford, Connecticut
December 20, 2019

We have served as the Company’s auditor since 1991.


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PHOTRONICS, INC.
Consolidated Balance Sheets
(in thousands, except per share amounts)
 
October 31,
2019
   
October 31,
2018
 
ASSETS
           
             
Current assets:
           
Cash and cash equivalents
 
$
206,530
   
$
329,277
 
Accounts receivable, net of allowance of $1,334 in 2019 and $1,526 in 2018
   
134,454
     
120,515
 
Inventories
   
48,155
     
29,180
 
Other current assets
   
38,388
     
23,759
 
Total current assets
   
427,527
     
502,731
 
                 
Property, plant and equipment, net
   
632,441
     
571,781
 
Intangible assets, net
   
7,870
     
12,368
 
Deferred income taxes
   
20,779
     
18,109
 
Other assets
   
30,048
     
5,020
 
Total assets
 
$
1,118,665
   
$
1,110,009
 
                 
LIABILITIES AND EQUITY
               
                 
Current liabilities:
               
Short-term debt
 
$
8,731
   
$
-
 
Current portion of long-term debt
   
2,142
     
57,453
 
Accounts payable
   
91,379
     
89,149
 
Accrued liabilities
   
49,702
     
44,474
 
Total current liabilities
   
151,954
     
191,076
 
                 
Long-term debt
   
41,887
     
-
 
Other liabilities
   
13,732
     
14,364
 
Total liabilities
   
207,573
     
205,440
 
                 
Commitments and contingencies
   
     
 
                 
Equity:
               
Preferred stock, $0.01 par value, 2,000 shares authorized, none issued and outstanding
   
-
     
-
 
Common stock, $0.01 par value, 150,000 shares authorized, 65,595 shares issued and outstanding at October 31, 2019, and 69,700 shares issued and 67,142 outstanding at October 31, 2018
   
656
     
697
 
Additional paid-in capital
   
524,319
     
555,606
 
Retained earnings
   
253,922
     
231,445
 
Treasury stock, 0 shares at October 31, 2019 and 2,558 shares at October 31, 2018
   
-
     
(23,111
)