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

FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 30, 2017
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


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)
 
Registrant’s telephone number, including area code
 
(203) 775-9000

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 periods 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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).
Yes ☒  No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “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 ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class
 
Outstanding at May 26, 2017
Common Stock, $0.01 par value
 
68,872,073 Shares
 


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,” “should,” “would,” “estimate,” “intend,” “may,” “will” 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 quarterly report on Form 10-Q 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 cyber-security 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; the occurrence of arbitration, 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 or (vi) obtain necessary 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.
 

PHOTRONICS, INC.
AND SUBSIDIARIES

INDEX
 
PART I.
FINANCIAL INFORMATION
 
Page
 
     
Item 1.
 
4
       
   
4
       
   
5
       
   
6
       
 
7
       
   
8
       
Item 2.
 
20
       
Item 3.
 
25
       
Item 4.
 
26
 
     
PART II.
OTHER INFORMATION
   
       
Item 1A.
 
27
       
Item 6.
 
27
 
PART I.
FINANCIAL INFORMATION

Item 1.
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

PHOTRONICS, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands, except per share amounts)
(unaudited)

   
April 30,
2017
   
October 30,
2016
 
             
ASSETS
           
             
Current assets:
           
Cash and cash equivalents
 
$
345,724
   
$
314,074
 
Accounts receivable, net of allowance of $3,796 in 2017 and $3,901 in 2016
   
91,150
     
92,636
 
Inventories
   
24,537
     
22,081
 
Other current assets
   
11,044
     
12,795
 
                 
Total current assets
   
472,455
     
441,586
 
                 
Property, plant and equipment, net
   
503,900
     
506,434
 
Intangible assets, net
   
19,152
     
19,854
 
Deferred income taxes
   
16,199
     
16,322
 
Other assets
   
3,865
     
3,792
 
                 
Total assets
 
$
1,015,571
   
$
987,988
 
                 
LIABILITIES AND EQUITY
               
                 
Current liabilities:
               
Current portion of long-term borrowings
 
$
5,503
   
$
5,428
 
Accounts payable
   
58,205
     
51,649
 
Accrued liabilities
   
28,260
     
24,240
 
                 
Total current liabilities
   
91,968
     
81,317
 
                 
Long-term borrowings
   
59,147
     
61,860
 
Other liabilities
   
19,702
     
19,337
 
                 
Total liabilities
   
170,817
     
162,514
 
                 
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, 68,496 shares issued and outstanding at April 30, 2017 and 68,080 shares issued and outstanding at October 30, 2016
685

681
Additional paid-in capital
   
545,019
     
541,093
 
Retained earnings
   
180,004
     
176,260
 
Accumulated other comprehensive income (loss)
   
4,171
     
(7,671
)
 
               
Total Photronics, Inc. shareholders’ equity
   
729,879
     
710,363
 
Noncontrolling interests
   
114,875
     
115,111
 
                 
Total equity
   
844,754
     
825,474
 
                 
Total liabilities and equity
 
$
1,015,571
   
$
987,988
 

See accompanying notes to condensed consolidated financial statements.
 
4

PHOTRONICS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Income
(in thousands, except per share amounts)
(unaudited)

   
Three Months Ended
   
Six Months Ended
 
   
April 30,
2017
   
May 1,
2016
   
April 30,
2017
   
May 1,
2016
 
                         
Net sales
 
$
108,297
   
$
122,923
   
$
218,128
   
$
252,879
 
                                 
Costs and expenses:
                               
                                 
Cost of sales
   
(88,140
)
   
(91,636
)
   
(174,973
)
   
(186,156
)
 
                               
Selling, general and administrative
   
(10,894
)
   
(11,024
)
   
(21,764
)
   
(23,222
)
                                 
Research and development
   
(3,726
)
   
(5,447
)
   
(7,212
)
   
(11,148
)
                                 
Operating income
   
5,537
     
14,816
     
14,179
     
32,353
 
                                 
Other income (expense):
                               
Interest and other income (expense), net
   
(3,073
)
   
(2,025
)
   
(4,596
)
   
27
 
Interest expense
   
(549
)
   
(964
)
   
(1,108
)
   
(2,138
)
Gain on sale of investment
   
-
     
-
     
-
     
8,785
 
                                 
Income before income tax benefit (provision)
   
1,915
     
11,827
     
8,475
     
39,027
 
 
                               
Income tax benefit (provision)
   
(431
)
   
2,326
     
(2,481
)
   
(1,374
)
                                 
Net income
   
1,484
     
14,153
     
5,994
     
37,653
 
                                 
Net (income) loss attributable to noncontrolling interests
   
313
     
(2,299
)
   
(2,250
)
   
(4,797
)
                                 
Net income attributable to Photronics, Inc. shareholders
 
$
1,797
   
$
11,854
   
$
3,744
   
$
32,856
 
                                 
Earnings per share:
                               
                                 
Basic
 
$
0.03
   
$
0.18
   
$
0.05
   
$
0.49
 
                                 
Diluted
 
$
0.03
   
$
0.16
   
$
0.05
   
$
0.44
 
                                 
Weighted-average number of common shares outstanding:
                               
                                 
Basic
   
68,426
     
67,372
     
68,301
     
67,090
 
                                 
Diluted
   
69,385
     
77,516
     
69,277
     
78,326
 

See accompanying notes to condensed consolidated financial statements.
 
5

PHOTRONICS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income
(in thousands)
(unaudited)

   
Three Months Ended
   
Six Months Ended
 
   
April 30,
2017
   
May 1,
2016
   
April 30,
2017
   
May 1,
2016
 
 
                       
Net income
 
$
1,484
   
$
14,153
   
$
5,994
   
$
37,653
 
                                 
Other comprehensive income, net of tax of $0:
                               
                                 
Foreign currency translation adjustments
   
18,308
     
23,811
     
17,675
     
2,735
 
                                 
Amortization of cash flow hedge
   
32
     
32
     
64
     
64
 
                                 
Net other comprehensive income
   
18,340
     
23,843
     
17,739
     
2,799
 
                                 
Comprehensive income
   
19,824
     
37,996
     
23,733
     
40,452
 
                                 
Less: comprehensive income attributable to noncontrolling interests
   
4,326
     
6,983
     
8,147
     
5,870
 
                                 
Comprehensive income attributable to Photronics, Inc. shareholders
 
$
15,498
   
$
31,013
   
$
15,586
   
$
34,582
 
 
See accompanying notes to condensed consolidated financial statements.
 
6

PHOTRONICS, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)

   
Six Months Ended
 
   
April 30,
2017
   
May 1,
2016
 
             
Cash flows from operating activities:
           
Net income
 
$
5,994
   
$
37,653
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
   
42,378
     
40,832
 
Gain on sale of investment
   
-
     
(8,785
)
Changes in assets and liabilities:
               
Accounts receivable
   
4,204
     
6,499
 
Inventories
   
(1,506
)
   
(256
)
Other current assets
   
2,103
     
3,095
 
Accounts payable, accrued liabilities, and other
   
(6,266
)
   
(13,899
)
                 
Net cash provided by operating activities
   
46,907
     
65,139
 
                 
Cash flows from investing activities:
               
Purchases of property, plant and equipment
   
(14,152
)
   
(34,928
)
Acquisition of business
   
(5,400
)
   
-
 
Proceeds from sale of investment
   
167
     
8,785
 
Other
   
(462
)
   
193
 
                 
Net cash used in investing activities
   
(19,847
)
   
(25,950
)
                 
Cash flows from financing activities:
               
Repayments of long-term borrowings
   
(2,695
)
   
(54,951
)
Proceeds from share-based arrangements
   
2,311
     
3,046
 
Other
   
(23
)
   
(19
)
                 
Net cash used in financing activities
   
(407
)
   
(51,924
)
                 
Effect of exchange rate changes on cash and cash equivalents
   
4,997
     
846
 
                 
Net increase (decrease) in cash and cash equivalents
   
31,650
     
(11,889
)
Cash and cash equivalents at beginning of period
   
314,074
     
205,867
 
                 
Cash and cash equivalents at end of period
 
$
345,724
   
$
193,978
 
                 
Supplemental disclosure of non-cash information:
               
Accrual for property, plant and equipment purchased during the period
 
$
11,409
   
$
3,297
 
Subsidiary dividend payable
 
$
8,383
   
$
11,901
 
 
See accompanying notes to condensed consolidated financial statements.
 
7

PHOTRONICS, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
Three Months and Six Months Ended April 30, 2017 and May 1, 2016
(unaudited)
(in thousands, except share amounts and per share data)
 
NOTE 1 - BASIS OF FINANCIAL STATEMENT PRESENTATION
 
Photronics, Inc. and its subsidiaries (“Photronics”, “the Company”, “we”, “our”, or “us”) is one of the world’s leading manufacturers of photomasks, which are high precision photographic quartz 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 flat panel substrates during the fabrication of integrated circuits (“ICs”) and a variety of FPDs and, to a lesser extent, other types of electrical and optical components. The Company currently operates principally from nine manufacturing facilities, two of which are located in Europe, three in Taiwan, one in Korea, and three in the United States. In May 2017 the Company announced that it had entered into an agreement to form a joint venture that would be based in Xiamen, China. Please refer to Note 15 for additional information.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for annual financial statements. All intercompany accounts and transactions have been eliminated in consolidation. In the opinion of management, adjustments, all of which are of a normal recurring nature, considered necessary for a fair presentation have been included. The Company is typically impacted during its first fiscal quarter by the North American and European holiday periods, as some customers reduce their effective workdays and orders during these periods. Additionally, the Company can be impacted during its first or second quarter by the Asian New Year holiday period, which may also reduce customer orders. Operating results for the interim period are not necessarily indicative of the results that may be expected for the fiscal year ending October 29, 2017. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended October 30, 2016.

NOTE 2 - CHANGES IN EQUITY

The following tables set forth the Company’s consolidated changes in equity for the three and six month periods ended April 30, 2017 and May 1, 2016:

   
Three Months Ended April 30, 2017
 
       
Photronics, Inc. Shareholders
     
 
Common Stock
   
 
Additional
Paid-in
    Retained    
Accumulated
Other
Comprehensive
   
 
Non-
controlling
    Total   
   
Shares
   
Amount
   
Capital
   
Earnings
   
Income (Loss)
   
Interests
   
Equity
 
                                           
Balance at January 30, 2017
   
68,333
   
$
683
   
$
543,116
   
$
178,207
   
$
(9,530
)
 
$
118,932
   
$
831,408
 
                                                         
Net income (loss)
   
-
     
-
     
-
     
1,797
     
-
     
(313
)
   
1,484
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
13,701
     
4,639
     
18,340
 
Sale of common stock through employee stock option and purchase plans
   
148
     
2
     
982
     
-
     
-
     
-
     
984
 
Restricted stock awards vesting and expense
   
15
     
-
     
431
     
-
     
-
     
-
     
431
 
Share-based compensation expense
   
-
     
-
     
490
     
-
     
-
     
-
     
490
 
Subsidiary dividend payable
   
-
     
-
     
-
     
-
     
-
     
(8,383
)
   
(8,383
)
                                                         
Balance at April 30, 2017
   
68,496
   
$
685
   
$
545,019
   
$
180,004
   
$
4,171
   
$
114,875
   
$
844,754
 
 
8

 
Three Months Ended May 1, 2016
 
      
Photronics, Inc. Shareholders
     
 
 
Common Stock
   
 
Additional
Paid-in
   
 
 
Retained
   
Accumulated
Other
Comprehensive
   
 
Non-
controlling
   
 
 
Total
 
   
Shares
   
Amount
   
Capital
   
Earnings
   
Loss
   
Interests
   
Equity
 
 
                                         
Balance at February 1, 2016
   
67,081
   
$
671
   
$
529,337
   
$
151,062
   
$
(28,005
)
 
$
114,398
   
$
767,463
 
                                                         
Net income
   
-
     
-
     
-
     
11,854
     
-
     
2,299
     
14,153
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
19,159
     
4,684
     
23,843
 
Sale of common stock through employee stock option and purchase plans
   
130
     
1
     
799
     
-
     
-
     
-
     
800
 
Restricted stock awards vesting and expense
   
15
     
-
     
313
     
-
     
-
     
-
     
313
 
Share-based compensation expense
   
-
     
-
     
663
     
-
     
-
     
-
     
663
 
Conversion of debt to common stock
   
717
     
7
     
7,431
     
-
     
-
     
-
     
7,438
 
Repurchase of common stock of subsidiary
   
-
     
-
     
(8
)
   
-
     
-
     
8
     
-
 
Subsidiary dividend payable
   
-
     
-
     
-
     
-
     
-
     
(11,901
)
   
(11,901
)
                                                         
Balance at May 1, 2016
   
67,943
   
$
679
   
$
538,535
   
$
162,916
   
$
(8,846
)
 
$
109,488
   
$
802,772
 
 
   
Six Months Ended April 30, 2017
 
      
Photronics, Inc. Shareholders
                 
 
 
Common Stock
   
 
Additional
Paid-in
   
 
 
Retained
   
Accumulated
Other
Comprehensive
   
 
Non-
controlling
   
 
 
Total
 
   
Shares
   
Amount
   
Capital
   
Earnings
   
Income (Loss)
   
Interests
   
Equity
 
                                           
 
                                         
Balance at October 31, 2016
   
68,080
   
$
681
   
$
541,093
   
$
176,260
   
$
(7,671
)
 
$
115,111
   
$
825,474
 
                                                         
Net income
   
-
     
-
     
-
     
3,744
     
-
     
2,250
     
5,994
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
11,842
     
5,897
     
17,739
 
Sale of common stock through employee stock option and purchase plans
   
323
     
3
     
2,068
     
-
     
-
     
-
     
2,071
 
Restricted stock awards vesting and expense
   
93
     
1
     
728
     
-
     
-
     
-
     
729
 
Share-based compensation expense
   
-
     
-
     
1,130
     
-
     
-
     
-
     
1,130
 
Subsidiary dividend payable
   
-
     
-
     
-
     
-
     
-
     
(8,383
)
   
(8,383
)
                                                         
Balance at April 30, 2017
   
68,496
   
$
685
   
$
545,019
   
$
180,004
   
$
4,171
   
$
114,875
   
$
844,754
 
 
9

   
Six Months Ended May 1, 2016
 
 
Photronics, Inc. Shareholders
     
Common Stock
   
 
Additional
Paid-in
   
 
 
Retained
   
Accumulated
Other
Comprehensive
   
 
Non-
controlling
   
 
 
Total
 
 
Shares
   
Amount
   
Capital
   
Earnings
   
Loss
   
Interests
   
Equity
 
                                           
 
                                         
Balance at November 2, 2015
   
66,602
   
$
666
   
$
526,401
   
$
130,060
   
$
(10,572
)
 
$
115,511
   
$
762,066
 
                                                         
Net income
   
-
     
-
     
-
     
32,856
     
-
     
4,797
     
37,653
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
1,726
     
1,073
     
2,799
 
Sale of common stock through employee   stock option and purchase plans
   
514
     
5
     
2,839
     
-
     
-
     
-
     
2,844
 
Restricted stock awards vesting and expense
   
110
     
1
     
563
     
-
     
-
     
-
     
564
 
Share-based compensation expense
   
-
     
-
     
1,309
     
-
     
-
     
-
     
1,309
 
Conversion of debt to common stock
   
717
     
7
     
7,431
     
-
     
-
     
-
     
7,438
 
Repurchase of common stock of subsidiary
   
-
     
-
     
(8
)
   
-
     
-
     
8
     
-
 
Subsidiary dividend payable
   
-
     
-
     
-
     
-
     
-
     
(11,901
)
   
(11,901
)
                                                         
Balance at May 1, 2016
   
67,943
   
$
679
   
$
538,535
   
$
162,916
   
$
(8,846
)
 
$
109,488
   
$
802,772
 

NOTE 3 - INVENTORIES

Inventories are stated at the lower of cost, determined under the first-in, first-out (“FIFO”) method, or market. Presented below are the components of inventory at the balance sheet dates:

   
April 30,
2017
   
October 30,
2016
 
             
Finished goods
 
$
74
   
$
142
 
Work in process
   
3,692
     
2,987
 
Raw materials
   
20,771
     
18,952
 
                 
   
$
24,537
   
$
22,081
 

NOTE 4 - PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consist of the following:

   
April 30,
2017
   
October 30,
2016
 
             
Land
 
$
9,732
   
$
8,036
 
Buildings and improvements
   
123,194
     
121,873
 
Machinery and equipment
   
1,514,409
     
1,475,755
 
Leasehold improvements
   
20,106
     
19,224
 
Furniture, fixtures and office equipment
   
13,045
     
12,700
 
Construction in progress
   
35,443
     
23,961
 
                 
     
1,715,929
     
1,661,549
 
Less accumulated depreciation and amortization
   
1,212,029
     
1,155,115
 
                 
   
$
503,900
   
$
506,434
 
 
10

Equipment under capital leases are included in above property, plant and equipment as follows:

   
April 30,
2017
   
October 30,
2016
 
             
Machinery and equipment
 
$
34,917
   
$
34,917
 
Less accumulated amortization
   
12,098
     
10,352
 
                 
   
$
22,819
   
$
24,565
 

Depreciation and amortization expense for property, plant and equipment was $20.1 million and $39.8 million for the three and six month periods ended April 30, 2017, respectively, and $18.9 million and $38.0 million for the three and six month periods ended May 1, 2016, respectively.

During the three month period ended January 29, 2017, the Company acquired a business comprised of manufacturing assets and certain intellectual property, that enables the Company to expand its manufacturing capability, primarily in large area masks for IC, for approximately $5.7 million, including a $0.3 million holdback payable one year from the acquisition date. The transaction was accounted for in accordance with ASC 805, “Business Combinations”, with substantially all of the purchase price being allocated to long-lived assets that will be depreciated over five years.

During the three month period ended January 29, 2017, the Company entered into a noncash transaction with a customer which resulted in the acquisition of equipment with a fair value of approximately $2.8 million and $5.0 million in the three and six month periods ended April 30, 2017, respectively.

NOTE 5 - JOINT VENTURE, TECHNOLOGY LICENSE AND OTHER AGREEMENTS WITH MICRON TECHNOLOGY, INC.
 
In May 2006 Photronics and Micron Technology, Inc. (“Micron”) entered into the MP Mask joint venture (“MP Mask”), which developed and produced photomasks for leading-edge and advanced next generation semiconductors. At the time of the formation of the joint venture, the Company also entered into an agreement to license photomask technology developed by Micron, as well as, certain supply agreements. In May 2016 the Company sold its investment in MP Mask to Micron for $93.1 million and recorded a gain on the sale of $0.1 million. On that same date a supply agreement commenced between the Company and Micron, which provided that we would be the majority outsourced supplier of Micron’s photomasks and related services. The supply agreement had a one year term and expired in May 2017. In addition, the Company forevermore has the right to use technology under the prior technology license agreement.

This joint venture was a variable interest entity (“VIE”) (as that term is defined in ASC 810) because all costs of the joint venture were passed on to the Company and Micron through purchase agreements they had entered into with the joint venture, and it was dependent upon the Company and Micron for any additional cash requirements. On a quarterly basis the Company reassessed whether its interest in MP Mask gave it a controlling financial interest in this VIE. The purpose of this quarterly reassessment was to identify the primary beneficiary (which is defined in ASC 810 as the entity that consolidates a VIE) of the VIE. As a result of the reassessments in fiscal year 2016, the Company determined that Micron remained the primary beneficiary of the VIE, by virtue of its tie-breaking voting rights within MP Mask’s Board of Managers, thereby having given it the power to direct the activities of MP Mask that most significantly impacted its economic performance, including its decision making authority in the ordinary course of business and its purchasing the majority of products produced by the VIE.

The Company utilized MP Mask for both high-end IC photomask production and research and development purposes. MP Mask charged its variable interest holders based on their actual usage of its facility. MP Mask separately charged for any research and development activities it engaged in at the requests of its owners. The Company recorded cost of sales of $2.7 million and $4.9 million and research and development expenses of $0.2 million and $0.5 million during the three and six month periods ended May 1, 2016.

The Company recorded a loss of $0.1 million related to its investment in the six month period ended May 1, 2016. Income or loss from the VIE is included in “Interest and other income (expense), net” in the condensed consolidated statements of income.
 
11

NOTE 6 - LONG-TERM BORROWINGS

Long-term borrowings consist of the following:

   
April 30,
2017
   
October 30,
2016
 
             
3.25% convertible senior notes due in April 2019
 
$
57,279
   
$
57,221
 
                 
2.77% capital lease obligation payable through July 2018
   
7,371
     
10,067
 
     
64,650
     
67,288
 
Less current portion
   
5,503
     
5,428
 
                 
   
$
59,147
   
$
61,860
 

The Company’s credit facility, which expires in December 2018, has a $50 million limit with an expansion capacity to $75 million, and is secured by substantially all of the Company’s assets located in the United States and common stock the Company owns in certain of its foreign subsidiaries. The credit facility stipulates that we may not pay cash dividends on Photronics, Inc. stock, and is subject to a minimum interest coverage ratio, total leverage ratio and minimum unrestricted cash balance financial covenants, all of which the Company was in compliance with at April 30, 2017. The Company had no outstanding borrowings against the credit facility at April 30, 2017, and $50 million was available for borrowing. The interest rate on the credit facility (2.24% at April 30, 2017) is based on the Company’s total leverage ratio at LIBOR plus a spread, as defined in the credit facility. In May 2017 the credit facility was amended to add certain covenants for our new joint venture in China and other potential investments. See Note 15 for additional discussion of our new joint venture in China.

The Company adopted Accounting Standard Update (“ASU” or “Update”) 2015-03 “Simplifying the Presentation of Debt Issuance Costs” in the first quarter of its 2017 fiscal year. This ASU requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct reduction from that debt liability, consistent with the presentation of a debt discount. We adopted this ASU on a retrospective basis, as a result of which our October 30, 2016, condensed consolidated balance sheet and its related long-term borrowings note have been adjusted, as necessary, to reflect this Update’s adoption. The effect on our October 30, 2016, condensed consolidated balance sheet is presented below.

Line Item
 
Previously
Reported
   
Change Due
to Adoption
   
Retrospectively
Adjusted
 
                   
Other Assets
 
$
4,071
   
$
(279
)
 
$
3,792
 
                         
Long-term Borrowings
 
$
62,139
   
$
(279
)
 
$
61,860
 

In January 2015 the Company privately exchanged $57.5 million in aggregate principal amount of its 3.25% convertible senior notes with a maturity date of April 1, 2016, for new 3.25% convertible senior notes with an aggregate principal amount of $57.5 million with a maturity date of April 1, 2019. The conversion rate of the new notes is the same as that of the exchanged notes, which were issued in March 2011 with a conversion rate of approximately 96 shares of common stock per $1,000 note principal, equivalent to a conversion price of $10.37 per share of common stock, and is subject to adjustment upon the occurrence of certain events, which are described in the indenture dated January 22, 2015. Note holders may convert each $1,000 principal amount of notes at any time prior to the close of business on the second scheduled trading day immediately preceding April 1, 2019, and the Company is not required to redeem the notes prior to their maturity date. Interest on the notes accrues in arrears, and is paid semiannually through the notes’ maturity date.

In August 2013 a $26.4 million principal amount, five year capital lease commenced to fund the purchase of a high-end lithography tool. Payments under the capital lease, which bears interest at 2.77%, are $0.5 million per month through July 2018. Under the terms of the lease agreement, the Company must maintain the equipment in good working order, and is subject to a cross default with cross acceleration provision related to certain nonfinancial covenants incorporated in its credit facility. As of April 30, 2017, the total amount payable through the end of the lease term was $7.5 million, of which $7.4 million represented principal and $0.1 million represented interest.
 
12

NOTE 7 - SHARE-BASED COMPENSATION

In March 2016, shareholders approved a new equity incentive compensation plan (the “Plan”), under which incentive stock options, non-qualified stock options, stock grants, stock-based awards, restricted stock, restricted stock units, stock appreciation rights, performance units, performance stock, and other stock or cash awards may be granted. Shares to be issued under the Plan may be authorized and unissued shares, issued shares that have been reacquired by the Company (in the open-market or in private transactions), shares that are being held in the treasury, or a combination thereof. The maximum number of shares of common stock approved that may be issued under the Plan is four million shares. Awards may be granted to officers, employees, directors, consultants, advisors, and independent contractors of the Company or its subsidiaries. In the event of a change in control (as defined in the Plan), the vesting of awards may be accelerated. Total share-based compensation costs for the three and six month periods ended April 30, 2017, were $0.9 million and $1.9 million, respectively, and $1.0 million and $1.9 million for the three and six month periods ended May 1, 2016, respectively. The Company received cash from option exercises of $1.0 million and $2.1 million for the three and six month periods ended April 30, 2017, respectively, and $0.9 million and $2.8 million for the three and six month periods ended May 1, 2016, respectively. No share-based compensation cost was capitalized as part of an asset and no related income tax benefits were recorded during the periods presented.

Stock Options

Option awards generally vest in one to four years, and have a ten-year contractual term. All incentive and non-qualified stock option grants have an exercise price no less than the market value of the underlying common stock on the date of grant. The grant date fair values of options are based on closing prices of the Company’s common stock on the dates of grant using the Black-Scholes option pricing model. Expected volatility is based on the historical volatility of the Company’s stock. The Company uses historical option exercise behavior and employee termination data to estimate expected term, which represents the period of time that the options granted are expected to remain outstanding. The risk-free rate of return for the estimated term of the option is based on the U.S. Treasury yield curve in effect at the date of grant.

The weighted-average inputs and risk-free rate of return ranges used to calculate the grant date fair value of options issued during the three and six month periods ended April 30, 2017 and May 1, 2016, are presented in the following table.

   
Three Months Ended
   
Six Months Ended
 
   
April 30,
2017
   
May 1,
2016
   
April 30,
2017
   
May 1,
2016
 
 
                       
Volatility
   
31.6
%
   
39.8
%
   
32.2
%
   
49.5
%
 
                               
Risk free rate of return
   
2.0
%
   
1.4
%
   
1.9-2.0
%
   
1.4-1.7
%
 
                               
Dividend yield
   
0.0
%
   
0.0
%
   
0.0
%
   
0.0
%
 
                               
Expected term
 
5.0 years
   
5.1 years
   
5.0 years
   
5.1 years
 

Information on outstanding and exercisable option awards as of April 30, 2017, is presented below.

Options
 
Shares
   
Weighted
Average
Exercise
Price
   
Weighted
Average
Remaining
Contractual
Life
   
Aggregate
Intrinsic
Value
 
 
                       
Outstanding at April 30, 2017
   
3,458,835
   
$
7.96
     
6.3 years
   
$
12,572
 
 
                               
Exercisable at April 30, 2017
   
2,176,719
   
$
6.49
     
5.0 years
   
$
10,997
 
 
There were 10,000 share options granted during the three month period ended April 30, 2017, with a grant date fair value of $3.35 per share and 23,000 share options granted during the three month period ended May 1, 2016, with a weighted-average grant date fair value of $3.74 per share. There were 348,750 share options granted during the six month period ended April 30, 2017, with a weighted-average grant date fair value of $3.59 per share and 602,250 share options granted during the six month period ended May 1, 2016, with a weighted-average grant date fair value of $4.63 per share. As of April 30, 2017, the total unrecognized compensation cost related to unvested option awards was approximately $4.2 million. That cost is expected to be recognized over a weighted-average amortization period of 2.5 years.
 
13

Restricted Stock

The fair value of restricted stock awards is based on the Company’s closing stock price on the date of grant. The restrictions on these awards typically lapse over a service period of less-than-one to four years. There were 25,000 restricted stock awards granted during the three month period ended April 30, 2017, with a grant date fair value of $10.75, and 285,000 restricted stock awards granted during the six month period ended April 30, 2017, with a weighted-average grant date fair value of $11.30 per share. No restricted stock awards were granted during the three month period ended May 1, 2016 and 115,225 restricted stock awards were granted during the six month period ended May 1, 2016, with a weighted-average grant date fair value of $12.13 per share. As of April 30, 2017, the total compensation cost not yet recognized related to unvested restricted stock awards was approximately $3.3 million. That cost is expected to be recognized over a weighted-average amortization period of 3.0 years. As of April 30, 2017, there were 344,094 shares of restricted stock outstanding.

NOTE 8 - INCOME TAXES

The effective tax rate differs from the U.S. statutory rate of 35% in the three and six month periods ended April 30, 2017 and May 1, 2016, primarily due to earnings being taxed at lower statutory rates in foreign jurisdictions, combined with the benefit of various investment credits in a foreign jurisdiction. Valuation allowances in jurisdictions with historic losses eliminate the tax benefit of these jurisdictions.

As of May 1, 2016, the Company determined that deferred tax assets of $2.5 million, whose realization was previously not considered to be more likely than not, are realizable and, therefore, reduced their related valuation allowance. During the three month period ended May 1, 2016, the Company realized a $2.4 million benefit, which resulted from the reversal of a previously recorded undistributed earnings tax liability in a foreign jurisdiction. As a result of a shareholder action to approve a dividend in this jurisdiction, the Company determined that it is no longer liable for this tax. In addition, during April 2016, $0.7 million of withholding tax was incurred upon the completion of a foreign subsidiary’s share redemption.

Unrecognized tax benefits related to uncertain tax positions were $4.2 million at April 30, 2017 and $4.6 million at October 30, 2016, all of which, if recognized, would favorably impact the Company’s effective tax rate. Accrued interest and penalties related to unrecognized tax benefits was $0.1 million at April 30, 2017 and October 30, 2016. In the six month period ended April 30, 2017, the net reduction of unrecognized tax benefit reflects the resolution of tax issues with the foreign tax authorities including the recognition of $0.5 million in previously unrecognized tax benefits. Although the timing of the expirations of statutes of limitations may be uncertain, as they can be dependent upon the settlement of tax audits, the Company believes that it is reasonably possible that up to $0.8 million of its uncertain tax positions (including accrued interest and penalties, and net of tax benefits) may be resolved over the next twelve months. The resolution of these uncertain tax positions may result from either or both the lapses of statutes of limitations and tax settlements.

PKLT Co. Ltd., the Company’s FPD manufacturing facility in Taiwan, has been accorded a tax holiday, which started in 2012 and expires in 2017. This tax holiday had no dollar or per share effect in the three or six month periods ended April 30, 2017 and May 1, 2016. Photronics DNP Mask Corporation (“PDMC”), the Company’s IC manufacturing facility in Taiwan, was accorded a tax holiday that commenced in 2015 and expires in 2019. The Company realized $0.1 million in tax benefits from this tax holiday in each of the three month periods ended April 30, 2017 and May 1, 2016, and $0.2 million in the six month periods ended April 30, 2017 and May 1, 2016. This tax holiday had no per share effect in the three and six month periods ended April 30, 2017 and May 1, 2016.
 
14

NOTE 9 - EARNINGS PER SHARE

The calculation of basic and diluted earnings per share is presented below.

   
Three Months Ended
   
Six Months Ended
 
   
April 30,
2017
   
May 1,
2016
   
April 30
2017
   
May 1,
2016
 
                         
Net income attributable to Photronics, Inc. shareholders
 
$
1,797
   
$
11,854
   
$
3,744
   
$
32,856
 
                                 
Effect of dilutive securities:
                               
Interest expense on convertible notes, net of tax
   
-
     
875
     
-
     
1,946
 
                                 
Earnings for diluted earnings per share
 
$
1,797
   
$
12,729
   
$
3,744
   
$
34,802
 
                                 
Weighted-average common shares computations:
                               
Weighted-average common shares used for basic earnings per share
   
68,426
     
67,372
     
68,301
     
67,090
 
Effect of dilutive securities:
                               
Share-based payment awards
   
959
     
948
     
976
     
1,096
 
Convertible notes
   
-
     
9,196
     
-
     
10,140
 
                                 
Potentially dilutive common shares
   
959
     
10,144
     
976
     
11,236
 
                                 
Weighted-average common shares used for diluted earnings per share
   
69,385
     
77,516
     
69,277
     
78,326
 
                                 
Basic earnings per share
 
$
0.03
   
$
0.18
   
$
0.05
   
$
0.49
 
Diluted earnings per share
 
$
0.03
   
$
0.16
   
$
0.05
   
$
0.44
 

The table below shows the outstanding weighted-average share-based payment awards that were excluded from the calculation of diluted earnings per share because their exercise price exceeded the average market value of the common shares for the period or, under application of the treasury stock method, they were otherwise determined to be anti-dilutive. The table also shows convertible notes that, if converted, would have been anti-dilutive.

   
Three Months Ended
   
Six Months Ended
 
   
April 30,
2017
   
May 1,
2016
   
April 30,
2017
   
May 1,
2016
 
                         
Convertible notes
   
5,542
     
-
     
5,542
     
-
 
Share-based payment awards
   
1,082
     
2,160
     
1,038
     
1,414
 
                                 
Total potentially dilutive shares excluded
   
6,624
     
2,160
     
6,580
     
1,414
 
 
15

NOTE 10 - CHANGES IN ACCUMULATED OTHER COMPREHENSIVE INCOME BY COMPONENT

The following tables set forth the changes in the Company’s accumulated other comprehensive income by component (net of tax of $0) for the three and six month periods ended April 30, 2017 and May 1, 2016.

   
Three Months Ended April 30, 2017
 
   
Foreign Currency
Translation
Adjustments
   
Amortization
of Cash
Flow Hedge
   
Other
   
Total
 
                         
Balance at January 30, 2017
 
$
(8,448
)
 
$
(145
)
 
$
(937
)
 
$
(9,530
)
Other comprehensive income (loss) before reclassifications
   
18,382
     
-
     
(74
)
   
18,308
 
Amounts reclassified from accumulated other comprehensive income
   
-
     
32
     
-
     
32
 
                                 
Net current period other comprehensive income (loss)
   
18,382
     
32
     
(74
)
   
18,340
 
Less: other comprehensive (income) loss attributable to noncontrolling interests
   
(4,676
)
   
-
     
37
     
(4,639
)
                                 
Balance at April 30, 2017
 
$
5,258
   
$
(113
)
 
$
(974
)
 
$
4,171
 

   
Three Months Ended May 1, 2016
 
   
Foreign Currency
Translation
Adjustments
   
Amortization
of Cash
Flow Hedge
   
Other
   
Total
 
                         
Balance at February 1, 2016
 
$
(27,118
)
 
$
(274
)
 
$
(613
)
 
$
(28,005
)
Other comprehensive income (loss) before reclassifications
   
23,861
     
-
     
(50
)
   
23,811
 
Amounts reclassified from accumulated other comprehensive income
   
-
     
32
     
-
     
32
 
                                 
Net current period other comprehensive income (loss)
   
23,861
     
32
     
(50
)
   
23,843
 
Less: other comprehensive (income) loss attributable to noncontrolling interests
   
(4,709
)
   
-
     
25
     
(4,684
)
                                 
Balance at May 1, 2016
 
$
(7,966
)
 
$
(242
)
 
$
(638
)
 
$
(8,846
)

   
Six Months Ended April 30, 2017
 
   
Foreign Currency
Translation
Adjustments
   
Amortization
of Cash
Flow Hedge
   
Other
   
Total
 
                         
Balance at October 31, 2016
 
$
(6,567
)
 
$
(177
)
 
$
(927
)
 
$
(7,671
)
Other comprehensive income (loss) before reclassifications
   
17,768
     
-
     
(93
)
   
17,675
 
Amounts reclassified from accumulated other comprehensive income
   
-
     
64
     
-
     
64
 
                                 
Net current period other comprehensive income (loss)
   
17,768
     
64
     
(93
)
   
17,739
 
Less: other comprehensive (income)loss attributable to noncontrolling interests
   
(5,943
)
   
-
     
46
     
(5,897
)
                                 
Balance at April 30, 2017
 
$
5,258
   
$
(113
)
 
$
(974
)
 
$
4,171
 
 
16

   
Six Months Ended May 1, 2016
 
   
Foreign Currency
Translation
Adjustments
   
Amortization
of Cash
Flow Hedge
   
Other
   
Total
 
                         
Balance at November 2, 2015
 
$
(9,634
)
 
$
(306
)
 
$
(633
)
 
$
(10,573
)
Other comprehensive income (loss) before reclassifications
   
2,746
     
-
     
(11
)
   
2,735
 
Amounts reclassified from accumulated other comprehensive income
   
-
     
64
     
-
     
64
 
                                 
Net current period other comprehensive income (loss)
   
2,746
     
64
     
(11
)
   
2,799
 
Less: other comprehensive (income) loss attributable to noncontrolling interests
   
(1,078
)
   
-
     
6
     
(1,072
)
                                 
Balance at May 1, 2016
 
$
(7,966
)
 
$
(242
)
 
$
(638
)
 
$
(8,846
)
 
The amortization of the cash flow hedge is included in cost of sales in the condensed consolidated statements of income for all periods presented.
 
NOTE 11 - FAIR VALUE MEASUREMENTS

The accounting framework for determining fair value includes a hierarchy for ranking the quality and reliability of the information used to measure fair value, which enables the reader of the financial statements to assess the inputs used to develop those measurements. The fair value hierarchy consists of three tiers as follows: Level 1, defined as quoted market prices (unadjusted) in active markets for identical securities; Level 2, defined as inputs other than Level 1 that are observable, either directly or indirectly; and Level 3, defined as unobservable inputs that are not corroborated by market data.

The Company did not have any assets or liabilities measured at fair value, on a recurring or a nonrecurring basis, at April 30, 2017 or October 30, 2016. In connection with the acquisition discussed in Note 4, the Company recorded and measured the assets acquired at fair value.

Fair Value of Other Financial Instruments

The fair values of the Company’s cash and cash equivalents (Level 1 measurements), accounts receivable, accounts payable, and certain other current assets and current liabilities (Level 2 measurements) approximate their carrying value due to their short-term maturities. The fair value of the Company’s convertible senior notes is a Level 2 measurement, as they were determined using inputs that were either observable market data, or could be derived from or corroborated with observable market data. These inputs included the Company’s stock price and interest rates offered on debt issued by entities with credit ratings similar to that of the Company’s.

The table below presents the fair and carrying values of the Company’s convertible senior notes at April 30, 2017 and October 30, 2016.

   
April 30, 2017
   
October 30, 2016
 
   
Fair Value
   
Carrying Value
   
Fair Value
   
Carrying Value
 
                         
3.25% convertible senior notes due 2019
 
$
72,663
   
$
57,279
   
$
68,230
   
$
57,221
 

NOTE 12 - COMMITMENTS AND CONTINGENCIES

As of April 30, 2017, the Company had commitments outstanding for capital equipment expenditures of approximately $62 million.

The Company is subject to various claims that arise in the ordinary course of business. The Company believes such claims, individually or in the aggregate, will not have a material effect on its condensed consolidated financial statements.
 
17

NOTE 13 - SUBSIDIARY DIVIDEND

In April 2017 PDMC, the Company’s majority owned IC subsidiary in Taiwan, declared a dividend of which 49.99%, or approximately $8.4 million, is expected to be paid to the third party that owns a noncontrolling interest in PDMC.

NOTE 14 - GAIN ON SALE OF INVESTMENT

The Company had a minority interest in a foreign entity. In the first quarter of fiscal year 2016, the Company sold this investment and recognized a gain of $8.8 million.

NOTE 15 - FORMATION OF PDMCX JOINT VENTURE

In May 2017 the Company announced that it had entered into an agreement with Dai Nippon Printing Co., Ltd. (DNP) to form a joint venture to serve semiconductor manufacturers in China. Under the agreement, PDMC will own 50.01% of the joint venture, which will be named Photronics DNP Mask Corporation Xiamen (PDMCX), and a subsidiary of DNP will own the remaining 49.99%. The financial results of the joint venture will be included in Photronics’ consolidated financial statements.

Our previously announced IC investment in China of $160 million will be based in Xiamen, China. Construction of the facility is currently underway, and production is anticipated to commence by the end of 2018. Photronics and DNP will contribute cash, in proportion to their ownership percentages, over five years to fund the equity portion of the investment. The joint venture, itself, may also fund a portion of the investment with local borrowings. The formation of the joint venture, which is subject to regulatory approvals and customary closing conditions, is expected to be completed by the end of the Company’s fiscal year 2017.

NOTE 16 - RECENT ACCOUNTING PRONOUNCEMENTS

In January 2017 the Financial Accounting Standards Board (“FASB”) issued ASU 2017-04 “Simplifying the Test for Goodwill Impairment”, which eliminates Step 2 of the goodwill impairment test and requires entities to perform their annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and to recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. In addition, this ASU eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, in the event the reporting unit fails the qualitative test, to perform Step 2 of the goodwill impairment test. ASU 2017-04 is effective for the Company in its first quarter of its fiscal year 2021, and should be applied on a prospective basis. The impact of this ASU will depend upon the nature of future acquisitions that the Company may make.

In January 2017 the FASB issued ASU 2017-01 “Clarifying the Definition of a Business”, with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. ASU 2017-01 is effective for the Company in its first quarter of fiscal year 2019, and should be applied on a prospective basis. The impact of this ASU will depend upon the nature of future acquisitions or dispositions that the Company may make.

In November 2016 the FASB issued ASU 2016-18 “Restricted Cash”, which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for the Company in its first quarter of fiscal year 2019 and should be applied on a retrospective transition basis. Early adoption is permitted, including adoption in an interim period. The Company is currently evaluating the effect this ASU will have on its consolidated financial statements.

In October 2016 the FASB issued ASU 2016-16 “Intra-Entity Transfers of Assets Other Than Inventory”, which eliminates the exception of recognizing, at the time of transfer, current and deferred income taxes for intra-entity asset transfers other than inventory. ASU 2016-16 is effective for the Company in its first quarter of fiscal year 2019 and should be applied on a modified retrospective transition basis. Early adoption is permitted as of the beginning of an annual reporting period for which interim or annual financial statements have not been issued or made available for issuance. The Company is currently evaluating the effect this ASU will have on its consolidated financial statements.

In August 2016 the FASB issued ASU 2016-15 “Classification of Certain Cash Receipts and Cash Payments”, which addresses eight specific cash flow issues with the objective of reducing diversity in practice. ASU 2016-15 is effective for the Company in its first quarter of fiscal year 2019 and should be applied using a retrospective transition approach. The Company is currently evaluating the effect this ASU will have on its consolidated financial statements.

In June 2016 the FASB issued ASU 2016-13 “Measurement of Credit Losses”, the main objective of which is to provide more useful information about expected credit losses on financial instruments and other commitments of an entity to extend credit. In support of this objective, the ASU replaces the incurred loss impairment methodology found in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This ASU requires a cumulative-effect adjustment as of the beginning of the first reporting period in which the guidance is adopted. ASU 2016-13 is effective for the Company in its first quarter of fiscal year 2021, with early adoption permitted beginning in the first quarter of fiscal year 2019. The Company is currently evaluating the effect this ASU will have on its consolidated financial statements.
 
18

In March 2016 the FASB issued ASU 2016-09 “Improvements to Employee Share-Based Payment Accounting”, which simplifies the accounting for share-based payment transactions including their income tax consequences, classification as either equity or liability awards, classification on the statement of cash flows, and other areas. The method of adoption varies with the different aspects of the Update. ASU 2016-09 is effective for the Company in its first quarter of fiscal year 2018, with early application permitted. The Company is currently evaluating the effect this ASU will have on its consolidated financial statements.
 
In February 2016 the FASB issued ASU 2016-02 “Leases (Topic 842)”, which requires lessees to recognize right-of-use assets and corresponding liabilities for all leases with an initial term in excess of twelve months. ASU 2016-02 is to be adopted using a modified retrospective approach, which includes a number of practical expedients, that requires leases to be measured and recognized under the new guidance at the beginning of the earliest period presented. The ASU is effective for the Company in its first quarter of fiscal year 2020, with early application permitted, and the Company is currently evaluating the effect this ASU will have on its consolidated financial statements.

In January 2016 the FASB issued ASU 2016-01 “Recognition and Measurement of Financial Assets and Financial Liabilities”, which provides targeted improvements to the recognition, measurement, presentation and disclosure of financial assets and financial liabilities. Specific accounting areas addressed include, equity investments, financial liabilities reported under the fair value option and valuation allowance assessment resulting from unrealized losses on available-for-sale securities. The ASU also changes certain presentation and disclosure requirements for financial instruments. ASU 2016-01 is to be applied by means of a cumulative effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. This ASU is effective for the Company in its first quarter of fiscal year 2019. Early adoption, with certain exceptions, is not permitted. The Company is currently evaluating the effect this ASU will have on its consolidated financial statements.

In April 2015 the FASB issued ASU 2015-03 “Simplifying the Presentation of Debt Issuance Costs”, which requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from that debt liability, consistent with the presentation of a debt discount. The Company adopted this ASU, and applied it on a retrospective basis, in the first quarter of its 2017 fiscal year. See Note 6 for the effects of its adoption on the Company’s October 30, 2016, condensed consolidated balance sheet.

In May 2014 the FASB issued ASU 2014-09 “Revenue from Contracts with Customers”, which will supersede nearly all existing revenue recognition guidance under accounting principles generally accepted in the United States. The core principle of this ASU is that revenue should be recognized for the amount of consideration expected to be received for promised goods or services transferred to customers. This ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments, and assets recognized for costs incurred to obtain or fulfill a contract. In August 2015 the FASB issued ASU 2015-14 which defers the effective date of ASU 2014-09 by one year and allows entities to early adopt, but no earlier than the original effective date. ASU 2014-09 will now be effective for the Company in its first quarter of fiscal 2019. ASU 2014-09 allows for either full retrospective or modified retrospective adoption. The Company is evaluating the transition method that will be elected and the potential effects of the adoption of ASU 2014-09 on its consolidated financial statements.
 
19

Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Management’s discussion and analysis (“MD&A”) of the Company’s financial condition, results of operations and outlook should be read in conjunction with its condensed consolidated financial statements and related notes. Various segments of this MD&A contain forward-looking statements, all of which are presented based on current expectations and may be adversely affected by uncertainties and risk factors (presented throughout this filing and in the Company’s Annual Report on Form 10-K for the fiscal 2016 year), that may cause actual results to materially differ from these expectations.

The Company sells substantially all of its 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. Thus, the Company’s selling cycle is tightly interwoven with the development and release of new semiconductor designs and flat panel applications, particularly as it relates to the semiconductor industry’s migration to more advanced design methodologies and fabrication processes. The Company believes 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 demand for semiconductors and FPDs increases. Advances in semiconductor, FPD and photomask design and semiconductor and FPD production methods could also reduce the demand for photomasks. Historically, the semiconductor 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.

The global semiconductor industry, including mobile displays, is driven by end markets which have been closely tied to consumer driven applications of high performance semiconductor devices including, but not limited to, mobile communications and computing solutions. The Company is typically required to fulfill its customer orders within a short period of time, sometimes within 24 hours. This results in the Company having a minimal level of backlog orders, typically one to two weeks for IC photomasks and two to three weeks for FPD photomasks. The Company 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, but believes that such transitions and cycles will continue into the future, beneficially and adversely affecting its business, financial condition and operating results as they occur. The Company believes its ability to remain successful in these environments is dependent upon achieving its goals of being a service and technology leader and efficient solutions supplier, which it believes should enable it to continually reinvest in its global infrastructure.

In May 2017 the Company announced that it had entered into an agreement to form a joint venture that would be based in Xiamen, China. Please refer to Note 15 of the condensed consolidated financial statements for additional information.
 
20

Material Changes in Results of Operations
Three and Six Months ended April 30, 2017 and May 1, 2016

The following table represents selected operating information expressed as a percentage of net sales.

   
Three Months Ended
   
Six Months Ended
 
   
April 30,
2017
   
May 1,
2016
   
April 30,
2017
   
May 1,
2016
 
 
                       
Net sales
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%
Cost of sales
   
(81.4
)
   
(74.5
)
   
(80.2
)
   
(73.6
)
                                 
Gross margin
   
18.6
     
25.5
     
19.8
     
26.4
 
Selling, general and administrative expenses
   
(10.1
)
   
(9.0
)
   
(10.0
)
   
(9.2
)
Research and development expenses
   
(3.4
)
   
(4.4
)
   
(3.3
)
   
(4.4
)
                                 
Operating income
   
5.1
     
12.1
     
6.5
     
12.8
 
Other income (expense), net
   
(3.3
)
   
(2.5
)
   
(2.6
)
   
(0.8
)
Gain on sale of investment
   
-
     
-
     
-
     
3.4
 
                                 
Income before income tax benefit (provision)
   
1.8
     
9.6
     
3.9
     
15.4
 
Income tax benefit (provision)
   
(0.4
)
   
1.9
     
(1.2
)
   
(0.5
)
                                 
Net income
   
1.4
     
11.5
     
2.7
     
14.9
 
Net (income) loss attributable to noncontrolling interests
   
0.3
     
(1.9
)
   
(1.0
)
   
(1.9
)
                                 
Net income attributable to Photronics, Inc. shareholders
   
1.7
%
   
9.6
%
   
1.7
%
   
13.0
%

Note: All of the following tabular comparisons, unless otherwise indicated, are for the three months ended April 30, 2017 (Q2-17) and May 1, 2016 (Q2-16) and for the six months ended April 30, 2017 (YTD-17) and May 1, 2016 (YTD-16), in millions of dollars.

Net Sales

   
Three Months Ended
   
Six Months Ended
 
   
Q2-17
   
Q2-16
   
Percent
Change
   
YTD-17
   
YTD-16
   
Percent
Change
 
                                         
IC
 
$
82.6
   
$
90.9
     
(9.1
)%
 
$
169.0
   
$
190.6
     
(11.3
)%
FPD
   
25.7
     
32.0
     
(19.9
)%
   
49.1
     
62.3
     
(21.1
)%
                                                 
Total net sales
 
$
108.3
   
$
122.9
     
(11.9
)%
 
$
218.1
   
$
252.9
     
(13.7
)%

Net sales for Q2-17 decreased 11.9% to $108.3 million as compared with $122.9 million for Q2-16. The decrease was primarily the result of lower demand for high-end products for both IC and FPD photomasks. Revenues attributable to high-end products decreased by $19.4 million to $38.7 million in Q2-17, as compared with $58.1 million in Q2-16. Net sales for YTD-17 decreased to $218.1 million as compared with $252.9 million for YTD-16. This decrease was also the result of weakened demand for both high-end IC and FPD photomasks which, combined, decreased by $41.8 million to $81.4 million in YTD-17 as compared with $123.2 million in YTD-16. High-end photomask applications include mask sets for 45 nanometer and below for IC products, and G8 and above and active matrix organic light-emitting diode (AMOLED) display screen technologies for FPD products.

We saw improving demand across the business during the quarter, and believe these positive trends will continue as we move into the second half of the year. Looking ahead, for IC photomasks, we believe growth in high-end memory products will be driven by increased foundry demand. We expect a shift in our 28 nanometer logic business, as our largest IC customer has obtained approval from the Taiwanese government to commence 28 nanometer node production in China. This customer will be the first volume producer of the High-K metal gate version of 28 nanometer IC in China. As a result, we should see improved high-end logic photomask sales. However, it is difficult to predict with certainty when we will benefit from these developments.
 
21

FPD sales increased during Q2-17 and both of our FPD facilities were near full capacity at the end of the quarter. We anticipate that we will continue to operate at or near full capacity over the next several quarters, even as we install and qualify two new writing tools at our FPD facilities. We believe the continuing transition to AMOLED displays for smartphones will be a major driver of this activity.

The Company’s quarterly revenues can be affected by the seasonal purchasing of its customers. Demand for the Company’s products is typically negatively impacted during the first six months of its fiscal year by the North American, European and Asian holiday periods, as some customers reduce their effective workdays and orders during this period.

The following table presents changes in net sales from Q2-16 to Q2-17 and YTD-16 to YTD-17 by geographic area:

         
Q2-16 to Q2-17
         
YTD-16 to YTD-17
 
   
Net Sales in
Q2-17
   
Percent
Change
   
Increase
(Decrease)
   
Net Sales in
YTD-17
   
Percent
Change
   
Increase
(Decrease)
 
                                     
Taiwan
 
$
42.3
     
(9.5
)%
 
$
(4.4
)
 
$
88.7
     
(7.1
)%
 
$
(6.7
)
Korea
   
30.9
     
(13.1
)%
   
(4.6
)
   
61.2
     
(14.5
)%
   
(10.4
)
United States
   
25.9
     
(17.8
)%
   
(5.6
)
   
49.6
     
(27.5
)%
   
(18.9
)
Europe
   
8.7
     
1.5
%
   
0.1
     
17.4
     
5.5
%
   
0.9
 
Other
   
0.5
     
(13.2
)%
   
(0.1
)
   
1.2
     
29.3
%
   
0.3
 
   
$
108.3
     
(11.9
)%
 
$
(14.6
)
 
$
218.1
     
(13.7
)%
 
$
(34.8
)

Gross Margin

   
Three Months Ended
   
Six Months Ended
 
   
Q2-17
   
Q2-16
   
Percent
Change
   
YTD-17
   
YTD-16
   
Percent
Change
 
                                         
Gross margin
 
$
20.2
   
$
31.3
     
(35.6
)%
 
$
43.2
%
 
$
66.7
     
(35.3
)%
Percentage of net sales
   
18.6
%
   
25.5
%
           
19.8
%
   
26.4
%
       

Gross margin percentage decreased to 18.6% in Q2-17 from 25.5% in Q2-16, and to 19.8% in YTD-17 from 26.4% YTD-16. Both of the decreases resulted from the declines in overall sales and sales of high-end products, as a percent of total sales, in the current year periods from their comparative prior year periods. The Company operates in a high fixed cost environment and, to the extent that the Company’s revenues and utilization increase or decrease, gross margin will generally be positively or negatively impacted.

Selling, General and Administrative Expenses

   
Three Months Ended
   
Six Months Ended
 
   
Q2-17
   
Q2-16
   
Percent
Change
   
YTD-17
   
YTD-16
   
Percent
Change
 
                                         
Selling, general and administrative expenses
 
$
10.9
   
$
11.0
     
(1.2
)%
 
$
21.8
   
$
23.2
     
(6.3
)%
Percentage of net sales
   
10.1
%
   
9.0
%
           
10.0
%
   
9.2
%
       

Selling, general and administrative expenses did not change significantly in Q2-17 as compared to Q2-16. Year to date, selling, general and administrative expenses decreased 6.3% compared to the prior period, primarily due to lower compensation expenses and professional and other service charges.
 
22

Research and Development

   
Three Months Ended
   
Six Months Ended
 
   
Q2-17
   
Q2-16
   
Percent
Change
   
YTD-17
   
YTD-16
   
Percent
Change
 
 
                                       
Research and development
 
$
3.7
   
$
5.4
     
(31.6
)%
 
$
7.2
   
$
11.1
     
(35.3
)%
Percentage of net sales
   
3.4
%
   
4.4
%
           
3.3
%
   
4.4
%
       

Research and development expenses consist primarily of global development efforts related to high-end process technologies for advanced sub-wavelength reticle solutions for IC technologies. Research and development expenses decreased by $1.7 million to $3.7 million in Q2-17, as compared with $5.4 million in Q2-16. YTD-17 research and development expenses decreased by $3.9 million to $7.2 million, as compared with $11.1 million in YTD-16. These decreases were primarily the result of fewer activities at advanced nanometer technology nodes for IC photomasks, in both the U.S. and Asia.

Other Income (Expense), net

   
Three Months Ended
   
Six Months Ended
 
   
Q2-17
   
Q2-16
   
YTD-17
   
YTD-16
 
                             
Interest and other income (expense), net
 
$
(3.1
)
 
$
(2.0
)
 
$
(4.6
)
 
$
-
 
Interest expense
   
(0.5
)
   
(1.0
)
   
(1.1
)
   
(2.1
)
Gain on sale of investment
   
-
     
-
     
-
     
8.8
 
Other income (expense), net
 
$
(3.6
)
 
$
(3.0
)
 
$
(5.7
)
 
$
6.7
 

Interest and other income (expense), net decreased in Q2-17, as compared with Q2-16, by $1.1 million and decreased $4.6 million in YTD-17, as compared with YTD-16, as a result of increased unfavorable foreign currency transaction results.

Interest expense decreased by $0.5 million in Q2-17, as compared with Q2-16, and by $1.0 million in YTD-17, as compared with YTD-16, primarily as a result of the impact of the 3.25% convertible debt that matured on April 1, 2016.

In January 2016 the Company sold a minority interest investment in a foreign entity and recognized a gain of $8.8 million.

Income Tax Benefit (Provision)

   
Three Months Ended
   
Six Months Ended
 
   
Q2-17
   
Q2-16
   
YTD-17
   
YTD-16
 
                             
Income tax benefit (provision)
 
$
(0.4
)