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EX-32.2 - EXHIBIT 32.2 - PHOTRONICS INCex32_2.htm
EX-32.1 - EXHIBIT 32.1 - PHOTRONICS INCex32_1.htm
EX-31.2 - EXHIBIT 31.2 - PHOTRONICS INCex31_2.htm
EX-31.1 - EXHIBIT 31.1 - PHOTRONICS INCex31_1.htm
EX-23 - EXHIBIT 23 - PHOTRONICS INCex23.htm
EX-21 - EXHIBIT 21 - PHOTRONICS INCex21.htm
EX-10.42 - EXHIBIT 10.42 - PHOTRONICS INCex10_42.htm
EX-10.31 - EXHIBIT 10.31 - PHOTRONICS INCex10_31.htm
EX-10.1 - EXHIBIT 10.1 - PHOTRONICS INCex10_1.htm

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 29, 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)
(203) 775-9000
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common Stock, $.01 par value
 
NASDAQ Global Select Market

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 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter)  is not contained herein, and will not be contained, to the best of registrant’s knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒

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” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ☒
Accelerated Filer
Non-Accelerated Filer
Smaller Reporting Company
Emerging growth company
     

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 30, 2017, 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 $777,531,974 (based upon the closing price of $11.50 per share as reported by the NASDAQ Global Select Market on that date).

As of December 15, 2017, 69,052,587 shares of the registrant’s common stock were outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Proxy Statement for the 2018
 
Annual Meeting of Shareholders
Incorporated into Part III
to be held in March 22, 2018
of this Form 10-K
 


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” 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 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 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 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.
 
2

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 flat panel display 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. 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. We have announced plans to construct two manufacturing facilities in China, as we expand our global manufacturing footprint. See Note 19 to the consolidated financial statements for additional information.

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. These reports may also be obtained at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, DC 20549. Investors may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at http://www.sec.gov that contains reports, proxy statements and other information regarding SEC registrants, including Photronics.
 
The Board has adopted a code of ethics, which is posted on the Company’s website at http://www.photronics.com/plab/photronics/. The code of ethics may be found as follows: from the Company’s web address listed above, first click on “Investors” then click on “Corporate Governance”, then on “Photronics, Inc. Code of Ethics”. The Company’s code of ethics applies to the Company’s senior financial officers, including our Chief Executive Officer; Senior Vice President and Chief Financial Officer; Chief Financial Officer, Asia; Vice President and Treasurer; Vice President, Corporate Controller; and Vice President, Tax. We intend to disclose any amendment to, or waiver from, the code of ethics for our senior financial officers, including our principal executive officer, principal financial officer, principal accounting officer or controller or persons performing similar functions, to the extent disclosure is required by applicable rules of the SEC and NASDAQ Stock Market LLC by posting such information on our website, at the address and location specified above.

Products and Manufacturing Technology

We manufacture photomasks, which are used as masters to transfer circuit patterns onto semiconductor wafers and flat panel display 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 flat panel display 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 die size for the larger and more complex circuits currently being designed. Electron beam and laser generated photomasks can be used to produce the most advanced semiconductors and FPDs 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 less expensive and less precise.  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 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 inspect and repair photomasks to ensure that customer specifications are met.

The majority of IC photomasks produced for the semiconductor industry employ geometries of larger than 45 nanometers. At these geometries, we can produce full lines of photomasks and there is no significant technology employed by our 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 45 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, the remaining and largest captive mask facilities have started 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 one becomes an approved supplier. Thereafter, based on the customer’s expectations, we typically negotiate pricing parameters for a customer’s orders. Some prices may remain in effect for an extended period of time. In some 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. We 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 Note 13 to our consolidated financial statements for the amount of revenues and long-lived assets attributable to each of our geographic areas of operations.

Customers

We primarily sell our products to leading semiconductor and FPD manufacturers. During fiscal year 2017, we sold our products to approximately 600 customers. Revenue from United Microelectronics Corp. accounted for approximately 16%, 17% and 15% of our total revenues, and sales to Samsung Electronics Co. Ltd. accounted for approximately 16%, 19% and 18% of our total revenues in fiscal years 2017, 2016 and 2015, respectively. Our five largest customers, in the aggregate, accounted for approximately 43%, 50% and 52% of our revenue in fiscal years 2017, 2016 and 2015, 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 quarterly revenues can be affected by the seasonal purchasing patterns of our customers. We are typically impacted during our first quarter by the North American and European holiday periods, as some customers reduce their effective workdays and orders during this period. Additionally, we can be impacted during our first or second fiscal quarter by the Asian New Year holiday period, which also may reduce customer orders and deliveries.

Research and Development

We 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 subsidiaries in Taiwan. Research and development for FPD photomasks is 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 focused on 20 nanometer node and below, and, for FPDs, on Generation 8 resolution enhancement, substrates larger than Generation 8 and more complex masks for AMOLED-type displays. 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 $15.9 million, $21.7 million, and $21.9 million in fiscal years 2017, 2016, and 2015, respectively. It is our belief that we own, control, or license the proprietary information that is necessary for our business, as it is presently conducted. This includes trade secrets as well as patents. 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.
 
On May 5, 2016, we sold our investment in MP Mask to Micron for $93.1 million and recorded a gain on the sale of $0.1 million, which is included in our 2016 consolidated statements of income in interest income and other income (expense). On that same date, a supply agreement commenced between Photronics 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. Photronics has unlimited rights to use the technology it acquired under its prior technology license agreement.

Patents and Trademarks

We have ownership interests in approximately 49 issued U.S. patents. The subject matter of these patents, which are registered in various countries, generally relates to the manufacture of IC photomasks or the use of photomasks to manufacture other products. The expiration dates of these patents range from 2018 to 2034. We also have a number of trademarks and trademark registrations in the United States and in other countries.

While we believe that our intellectual property is, and will continue to be, important to our technical leadership in the field of photomasks, our operations are not dependent on any one individual patent. We protect our intellectual property rights and proprietary processes by utilizing patents and 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.
 
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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 considered to be a reliable indicator of future revenue.

International Operations

Revenues from our non-U.S. operations were approximately 77%, 76% and 75% of our total revenues in fiscal 2017, 2016 and 2015, 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. Note 13 of the notes to our consolidated financial statements presents 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, as well as 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 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 $4.1 billion. Our competitors include Compugraphics International, Ltd., Dai Nippon Printing Co., Ltd (outside of Taiwan), Hoya Corporation, SK-Electronics Co. Ltd., Taiwan Mask Corporation, Toppan Printing Co., Ltd., Supermask Co. Ltd., and Chengdu NeWay Photomask Making Co., Ltd. We also compete with semiconductor 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, and we expect such pressure to continue in the future.

Employees

As of October 29, 2017, we had 1,475 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. We have technology and information security processes and disaster recovery plans in place to mitigate our risks to these vulnerabilities. However, these measures may not be adequate to ensure that our operations will not be disrupted, should such an event occur.
 
6

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

We sell substantially all of our photomasks to semiconductor or flat panel display 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 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.

We may, in the future, incur net losses.

Although we have been profitable since fiscal 2010, we have, in the past, incurred net losses. The net losses experienced in prior years were due, in part, to macroeconomic factors, which resulted in our incurring significant charges for restructurings and impairments of long-lived assets. We cannot provide assurance that we will not incur net losses in the future.

We have a high level of fixed costs; thus we must achieve minimum sales volumes sufficient to cover our 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, competition 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.

Our customers generally order photomasks on an as-needed basis, and our revenue in any quarter is dependent 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 as well as the expectations of public market analysts and investors which, in turn, could have a material adverse effect on the market price of our common stock.
 
7

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 2017, 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 obtain funding.

The manufacture of 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 2018 are expected to be approximately $250 million, of which $3 million was included in accounts payable on our October 29, 2017, consolidated balance sheet. We cannot provide assurance that we will be able to obtain the additional capital required to fund our operations 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 2017, 2016 and 2015 our two largest customers accounted for 32%, 36% and 33%, respectively, of our revenue. Our five largest customers accounted for 43%, 50% and 52% of our revenue in fiscal years 2017, 2016 and 2015 respectively. The loss of a significant customer or 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.

We depend on a limited number of suppliers for equipment and raw materials, and, if those suppliers do not 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 up to twelve months or longer between the order and the delivery of certain photomask imaging and inspection equipment. The failure of such manufacturers 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 have no 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.
 
8

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 make 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, under such circumstances, we will not experience these or other manufacturing difficulties, or be subject to increased costs or production capacity constraints in the future, any of which could result in a loss of customers or could 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 debt agreements limit our ability to obtain additional financing and may obligate us to repay debt before its maturity.

Financial covenants related to our credit facility, which expires in December 2018, include a Total Leverage Ratio, a Minimum Interest Coverage Ratio, and Minimum Unrestricted Cash Balances. Existing covenant restrictions limit our ability to obtain additional debt financing and, 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 agreements. Our ability to comply with the financial and other covenants in our debt agreements may be affected by worsening economic or business conditions, or other events. We cannot assure that, under such circumstances, additional sources of financing would be available to pay off any long-term borrowings, so as to avoid default.  Should we default on certain of our long-term borrowings, a cross default would occur on other long-term borrowings, unless amended or waived.

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 may force 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 partners do not fulfill their obligations, the affected joint venture may not be able to operate according to its business plan. In that case, our results of operations may be adversely affected and we may be required to increase the level of our commitment to the joint venture. Also, differences in views among joint venture participants may result in delayed decisions or failures to agree on major issues. If these differences cause the joint ventures to deviate from their business plans, our results of operations could be adversely affected.
 
9

We may not be able to consummate future acquisitions 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. Our ability to implement this component of our growth strategy will be limited by 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 announced expansions into China entail substantial risks.

During the last two years we have announced plans to expand our manufacturing operations into China, see note 19 to the consolidated financial statements for more information on these expansion plans. These investments are subject to substantial risks which may include, but are not limited to: delays in or the inability to obtain necessary permits that are needed to enable us to construct our facilities or conduct our ongoing business; the inability to protect our intellectual property rights under Chinese law, which may not offer as high of 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 have 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.

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 and cash available under our credit facility.

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.
 
10

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., DNP (outside of Taiwan), Hoya Corporation, SK-Electronics Co., Ltd., Taiwan Mask Corporation and Toppan Printing Co., Ltd. We also compete with semiconductor 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 us. Also, when producing smaller geometry photomasks, some of our competitors may be able to more rapidly develop, produce, and achieve higher manufacturing yields than us. We believe that consistency of product quality and timeliness of delivery, as well as price, 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.

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

Revenues from our non-U.S. operations were approximately 77%, 76% and 75% of our total revenues in fiscal years 2017, 2016 and 2015, 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 and building a manufacturing facility for FPD photomasks in Taiwan. Additionally, since 2016, we have announced plans to expand our manufacturing operations into China, see Note 19 to the consolidated financial statements for more information on these expansion plans.  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.

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 foreign laws and regulations may be burdensome, compliance with anti-bribery and anti-corruption laws (such as the Foreign Corrupt Practices Act) as well as anti-money-laundering laws may be costly, tariffs and other trade barriers, difficulties in staffing and managing international operations, longer accounts receivable payment cycles, foreign countries may adopt other restrictions on foreign trade or investment, including currency exchange controls, trade sanctions could result in losing access to customers and suppliers in those countries, agreements may be difficult to enforce and receivables difficult to collect and potentially 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.

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 Korean won, New Taiwan dollar, Japanese yen, euro, Singapore dollar, and the pound sterling. As a result of commencing construction of two new facilities in China, we now also have transactions and balances denominated in the Chinese renminbi. In fiscal year 2017, we recorded a net loss from changes in foreign currency exchange rates of $5.2 million in our statement of income, while our net assets were increased by $19.7 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 could have a material adverse effect on our business and results of operations. There can be no assurance that we can retain our key managerial, and technical employees, or that we can attract similar additional employees in the future.
 
11

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.

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 and 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.
 
12

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.

Our financial results may be adversely impacted by proposed legislative tax reform.

Various U.S. corporate tax reform bills and other proposals have been, or are currently, under consideration by Congress and the Executive branch. These proposals include, among other items, corporate income tax rate changes in varying, uncertain or unspecified amounts; the modification or elimination of certain tax incentives and changes to the existing rules and regulations for taxing overseas earnings (including possible modifications to the current rules and regulations for repatriating such earnings); and measures to prevent base erosion and profit splitting (“BEPS”). It is not clear whether these proposals, if enacted, would materially affect the taxation of our domestic and foreign earnings.
 
In addition to the U.S. tax proposals, corporate tax reform proposals are under consideration in Taiwan and Korea including, among other items, corporate income tax rate changes, the modification or elimination of certain tax incentives, changes in unremitted earnings tax rates and modification of the related rules, and measures to prevent BEPS.  Enactment of such changes could materially affect the tax treatment of our foreign subsidiaries’ earnings and their statutory deferred tax assets and liabilities.

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

Our business could be adversely affected by terrorist acts, major natural disasters, widespread outbreaks of infectious diseases, or the outbreak or escalation of wars, especially in the Asian markets, where 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 both 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, our results of operations and cash flows could be volatile, as well as negatively impacted.

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

Factors that may influence the price of the common stock include, without limitation, the following:

·
loss of any of our key customers or suppliers;

·
additions or departures of key personnel;

·
sales of common stock;

·
our ability to execute our business plan, including but not limited to, our plans to expand into China;
 
·
announcements and consummations of business acquisitions;

·
operating results that fall below expectations;

·
additional issuances of common stock;
 
13

·
intellectual property disputes;

·
industry developments;

·
news or disclosures by competitors;

·
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, the 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 the Company’s common stock.  One should also be aware that price volatility might be worse if the trading volume of shares of the common stock is low.

Ineffective internal controls could impact the Company’s business and operating results.

The Company’s internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, 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 the Company fails to maintain the adequacy of its internal controls, including any failure to implement required new or improved controls, or if the Company experiences difficulties in their implementation, the Company’s business and operating results could be harmed, and the Company could fail to meet its 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
 
Dresden, Germany
 
Leased
 
Hsinchu, Taiwan
 
Owned
(1)
Hsinchu, Taiwan
 
Leased
 
Taichung, Taiwan
 
Owned
(1)

(1)  The Company owns its manufacturing facility in Taichung and one of its manufacturing facilities in Hsinchu. However, it leases the related land.
 
We have announced plans to expand into China and construct two manufacturing facilities. Production at both of these facilities is expected to commence in early 2019.
 
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.
 
14

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. The table below shows the range of high and low sale prices per share in each quarter for fiscal years 2017 and 2016, as reported by the NASDAQ Global Select Market.

   
High
   
Low
 
Fiscal Year Ended October 29, 2017:
           
             
Quarter Ended January 29, 2017
 
$
12.10
   
$
8.20
 
Quarter Ended April 30, 2017
   
11.80
     
10.30
 
Quarter Ended July 30, 2017
   
11.63
     
8.80
 
Quarter Ended October 29, 2017
   
10.10
     
7.55
 
                 
Fiscal Year Ended October 30, 2016:
               
                 
Quarter Ended January 31, 2016
 
$
13.05
   
$
9.57
 
Quarter Ended May 1, 2016
   
12.39
     
9.30
 
Quarter Ended July 31, 2016
   
10.69
     
8.56
 
Quarter Ended October 30, 2016
   
10.90
     
8.81
 

On December 15, 2017, the closing sale price of our Common Stock, per the NASDAQ Global Select Market, was $8.70. Based on available information, we estimate that we have approximately 11,285 shareholders.

To date, we have not paid any cash dividends on PLAB shares and, for the foreseeable future, we anticipate that earnings will continue to be retained for use in our business. Further, our credit facility precludes us from paying cash dividends.

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. 2018 definitive Proxy Statement in Item 12 of Part III of this report. The 2018 Proxy Statement will be filed within 120 days after our fiscal year ended October 29, 2017.
 
15

ITEM 6.
SELECTED FINANCIAL DATA

The following selected financial data (in thousands, except per share amounts) 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.
 
   
Year Ended
 
   
October 29,
2017
   
October 30,
2016
   
November 1,
2015
   
November 2,
2014
   
November 3,
2013
 
OPERATING DATA:
                             
                               
Revenue
 
$
450,678
   
$
483,456
   
$
524,206
   
$
455,527
   
$
422,180
 
Cost of goods sold
   
(359,363
)
   
(364,750
)
   
(381,070
)
   
(355,181
)
   
(322,540
)
Gross profit
   
91,315
     
118,706
     
143,136
     
100,346
     
99,640
 
                                         
Selling, general and administrative
   
(43,585
)
   
(44,577
)
   
(48,983
)
   
(49,638
)(d)
   
(48,213
)(f)
Research and development
   
(15,862
)
   
(21,654
)
   
(21,920
)
   
(21,913
)
   
(20,758
)
Operating income
   
31,868
     
52,475
     
72,233
     
28,795
     
30,669
 
                                         
Other income (expense):
                                       
Interest and other income (expense), net
   
(3,068
)
   
2,424
     
2,797
(c)
   
3,410
     
3,892
 
Interest expense
   
(2,235
)
   
(3,365
)
   
(4,990
)
   
(7,247
)
   
(7,756
)
Gains on sales of investments
   
-
     
8,940
(a)
   
-
     
-
     
-
 
Gain on acquisition
   
-
     
-
     
-
     
16,372
(e)
   
-
 
Income before income tax provision
   
26,565
     
60,474
 
   
70,040
     
41,330
     
26,805
 
Income tax provision
   
(5,276
)
   
(4,798
)(b)
   
(13,181
)
   
(9,295
)
   
(7,229
)
Net income
   
21,289
     
55,676
     
56,859
(c)
   
32,035
(d)(e)
   
19,576
(f)
Net income attributable to noncontrolling interests
   
(8,159
)
   
(9,476
)
   
(12,234
)
   
(6,039
)
   
(1,610
)
Net income attributable to Photronics, Inc. shareholders
 
$
13,130
   
$
46,200
(a)(b)
 
$
44,625
(c)
 
$
25,996
(d)(e)
 
$
17,966
(f)
                                         
Earnings per share:
                                       
                                         
Basic
 
$
0.19
   
$
0.68
(a)(b)
 
$
0.67
(c)
 
$
0.42
(d)(e)
 
$
0.30
(f)
Diluted
 
$
0.19
   
$
0.64
(a)(b)
 
$
0.63
(c)
 
$
0.41
(d)(e)
 
$
0.29
(f)
                                         
Weighted-average number of common shares outstanding:
                                       
                                         
Basic
   
68,436
     
67,539
     
66,331
     
61,779
     
60,644
 
Diluted
   
69,288
     
76,354
     
78,383
     
66,679
     
61,599
 
 
16

BALANCE SHEET DATA
   
As of
 
   
October 29,
2017
   
October 30,
2016
   
November 1,
2015
   
November 2,
2014
   
November 3,
2013
 
                               
Working capital
 
$
367,348
   
$
360,269
   
$
168,237
   
$
190,152
   
$
212,837
 
Property, plant and equipment, net
   
535,197
     
506,434
     
547,284
     
550,069
     
422,740
 
Total assets
   
1,020,794
     
987,988
     
1,042,811
     
1,025,564
     
883,040
 
Total borrowings
   
61,976
     
67,288
     
132,219
     
141,011
     
191,596
 
Total Photronics, Inc. shareholders’ equity
   
744,564
     
710,363
     
646,555
     
628,050
     
585,314
 
 
   
FY 2016
   
FY 2015
   
FY 2014
   
FY 2013
 
Working Capital (g):
                       
Previously reported
 
$
360,269
   
$
168,068
   
$
190,152
   
$
212,797
 
ASU 2015-03 adjustment
   
-
     
169
     
-
     
40
 
Retrospectively adjusted
 
$
360,269
   
$
168,237
   
$
190,152
   
$
212,837
 
Total Assets (g):
                               
Previously reported
 
$
988,267
   
$
1,043,376
   
$
1,026,739
   
$
885,505
 
ASU 2015-03 adjustment
   
(279
)
   
(565
)
   
(1,175
)
   
(2,465
)
Retrospectively adjusted
 
$
987,988
   
$
1,042,811
   
$
1,025,564
   
$
883,040
 
                                 
Total borrowings (g):
                               
Previously reported
 
$
67,567
   
$
132,615
   
$
142,186
   
$
194,021
 
ASU 2015-03 adjustment
   
(279
)
   
(396
)
   
(1,175
)
   
(2,425
)
Retrospectively adjusted
 
$
67,288
   
$
132,219
   
$
141,011
   
$
191,596
 

 
(a)
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
 
(b)
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.
 
(c)
Includes $0.9 million of financing expenses related to the exchange of $57.5 million of 3.25% convertible senior notes.
 
(d)
Includes $2.5 million, net of tax, of expenses related to the acquisition of DPTT.
 
(e)
Includes non-cash gain of $16.4 million, net of tax, on acquisition of DPTT.
 
(f)
Includes $0.8 million, net of tax, of expenses related to the acquisition of DPTT.
 
(g)
Balances reflect the impact of the adoption of a new accounting standard in fiscal year 2016 (ASU 2015-03) related to the balance sheet classification of debt issuance costs. See Note 6 to the consolidated financial statements for additional information.
 
17

ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Results of Operations for the Years Ended October 29, 2017, October 30, 2016 and November 1, 2015

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 designs and flat panel display 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.

We are typically required to fulfill customer orders within a short period of time, sometimes within 24 hours. This results in our having 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 semiconductor 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.

As of December 2017, state-of-the-art production for semiconductor masks is considered to be 45 nanometer and lower for ICs and Generation 8 and above and AMOLED display-based process technologies for FPDs. However, 65 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 45 nanometer and below designs to continue to move to wafer fabrication throughout fiscal 2018, 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.
 
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 2017, 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 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.
 
18

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 $246 million for the three fiscal years ended October 29, 2017, 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 us for future growth. In support of this effort, we expect capital expenditure payments to be approximately $250 million in fiscal year 2018.

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, which currently consists of nine manufacturing sites, 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.

In the fourth quarter of fiscal 2017, we announced that Photronics UK, Ltd., a wholly owned subsidiary of ours, signed an investment agreement with Hefei State Hi-tech Industry Development Zone to establish a manufacturing facility in Hefei, China. Under the terms of the agreement, through our subsidiary, we will invest a minimum of $160 million, a portion of which may be funded with local borrowings, to build and operate a research and development and manufacturing facility for high-end and mainstream FPD photomasks. Hefei State Hi-tech Industry Development Zone will provide certain investment incentives and support for this facility, which will have initial capability to produce up to G10.5+ large area masks and AMOLED products. Construction began in late 2017 and production is anticipated to commence in early 2019.
 
In August 2016, Photronics Singapore Pte, Ltd., a wholly owned subsidiary, signed an investment agreement with the Administrative Committee of Xiamen Torch Hi-Tech Industrial Development Zone (Xiamen Torch) to establish an IC manufacturing facility in Xiamen, China. Under the terms of the agreement, we will build and operate an IC facility to engage in research and development, manufacture and sale of photomasks, in return for which Xiamen Torch will provide certain investment incentives and support. This expansion is also substantially supported by customer commitments for its output. The total investment per the agreement is $160 million to be funded over the next five years in cash, transferred equipment and potential local borrowings. Construction began in 2017 and production is anticipated to start in early 2019.

In the third quarter of fiscal 2017, we agreed to create a joint venture with DNP to encompass the Xiamen project. Under the agreement, our wholly-owned Singapore subsidiary 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.

In the third quarter of fiscal 2017, our majority owned IC facility in Taiwan paid a dividend of $8.3 million to its noncontrolling interests.

In the third quarter of fiscal 2016, our majority owned IC facility in Taiwan paid a dividend of $11.9 million to its noncontrolling interests.

In the third quarter of fiscal 2016, we sold our investment in MP Mask to Micron for $93.1 million and recorded a gain of $0.1 million on the sale. On that same date a supply agreement commenced between Photronics 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. We have unlimited rights to use the technology under our prior technology license agreement.

In the second quarter of fiscal 2016, $57.5 million of our senior convertible notes matured. We repaid $50.1 million to noteholders, and issued approximately 0.7 million shares to noteholders that elected to convert their notes to common stock. The notes were exchanged at the rate of approximately 96 shares per $1,000 note principle, equivalent to a conversion rate of $10.37 per share.
 
19

In the first quarter of fiscal 2015 we privately exchanged $57.5 million in aggregate principal amount of our 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 we are 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.

Results of Operations

The following table presents selected operating information expressed as a percentage of revenue:

   
Year Ended
 
   
October 29,
2017
   
October 30,
2016
   
November 1,
2015
 
                   
Revenue
   
100.0
%
   
100.0
%
   
100.0
%
Cost of goods sold
   
(79.7
)
   
(75.4
)
   
(72.7
)
Gross profit
   
20.3
     
24.6
     
27.3
 
Selling, general and administrative expenses
   
(9.7
)
   
(9.2
)
   
(9.3
)
Research and development expenses
   
(3.5
)
   
(4.5
)
   
(4.2
)
Operating income
   
7.1
     
10.9
     
13.8
 
Interest income and other income (expense)
   
(0.7
)
   
0.5
     
0.5
 
Interest expense
   
(0.5
)
   
(0.7
)
   
(1.0
)
Gains on sales of investments
   
-
     
1.8
     
-
 
Income before income tax provision
   
5.9
     
12.5
     
13.3
 
Income tax provision
   
(1.2
)
   
(1.0
)
   
(2.5
)
Net income
   
4.7
     
11.5
     
10.8
 
Net income attributable to noncontrolling interests
   
(1.8
)
   
(1.9
)
   
(2.3
)
Net income attributable to Photronics, Inc. shareholders
   
2.9
%
   
9.6
%
   
8.5
%

Note:  All the following tabular comparisons, unless otherwise indicated, are for the fiscal years ended October 29, 2017 (2017), October 30, 2016 (2016) and November 1, 2015 (2015), in millions of dollars.
 
20

Revenue

                     
Percent Change
 
   
2017
   
2016
   
2015
   
2016 to
2017
   
2015 to
2016
 
                               
IC
 
$
350.3
   
$
364.6
   
$
420.8
     
(3.9
)%
   
(13.4
)%
FPD
   
100.4
     
118.9
     
103.4
     
(15.6
)%
   
15.0
 
Total revenue
 
$
450.7
   
$
483.5
   
$
524.2
     
(6.8
)%
   
(7.8
)%

Revenue decreased 6.8% in 2017 to $450.7 million from $483.5 million in 2016. IC photomask revenue decreased $14.3 million, or 3.9%, as a result of decreased volume of both high-end (4.8%) and mainstream (3.4%) products. Revenue from high-end IC products decreased $23.9 million, or 18.3%, from $130.4 million last year to $106.5 million, primarily as a result of decreased ASPs, while revenue from mainstream IC products increased $9.7 million, or 4.1%, from $234.1 million to $243.8 million which resulted from increased ASPs. FPD sales decreased in 2017 by $18.5 million, or 15.6% from 2016. Revenue from high-end FPD sales fell $18.7 million, or 21.6%, year-over-year, the causes of which were $11.8 million and $6.9 million from decreased ASPs and volume, respectively. FPD mainstream photomask revenue was $32.5 million, essentially flat year-over-year, with a modest increase in volume offsetting a slightly lower decrease in ASPs. 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. High-end photomasks typically have higher ASPs than mainstream products.

We believe our revenue will increase in 2018, as we expect revenues to increase for both high-end IC and FPD products. Our projected increase in high-end IC revenue is based on our expectation that our largest IC customer will increase its market share at the 28 nanometer node. In addition, we are anticipating growth at the 22 and 14 nanometer node levels. We are expecting increased demand for AMOLED products to lead to revenue growth in 2018, and plan to support this growth, in part, with a new high-end mask writing tool, which is due for delivery to us in the first half of 2018. Beyond 2018, we are anticipating our IC and FPD facilities under construction in China and expected to commence production in the spring of 2019 to fuel growth.

Net revenue decreased 7.8% in 2016, compared with 2015. IC photomask revenue was down primarily as a result of a decline in customer new product launches that require logic masks, as well as some reduction in foundry demand for memory masks. Revenue from high-end IC products decreased $36.5 million from last year to $130.4 million. FPD revenue increased from 2015 primarily due to increased demand for high-end large area masks. Revenue from high-end FPD Masks increased by $15.7 million to $86.6 million in 2016. High-end photomasks typically have higher ASPs than mainstream photomasks.

The following table presents changes in revenue from fiscal years 2016 to 2017 and 2015 to 2016 by geographic area:

   
2016 to 2017
   
2015 to 2016
 
   
Revenue in
2017
   
Increase
(Decrease)
   
Percent
Change
   
Revenue in
 2016
   
Increase
(Decrease)
   
Percent
Change
 
                                     
Taiwan
 
$
187.8
   
$
(5.4
)
   
(2.8
)%
 
$
193.2
   
$
(11.9
)
   
(5.8
)%
Korea
   
122.2
     
(18.8
)
   
(13.4
)%
   
141.0
     
(6.9
)
   
(4.7
)%
United States
   
102.0
     
(11.7
)
   
(10.2
)%
   
113.7
     
(19.1
)
   
(14.4
)%
Europe
   
36.1
     
2.7
     
8.1
%
   
33.4
     
(2.4
)
   
(6.7
)%
All other Asia
   
2.6
     
0.4
     
18.7
%
   
2.2
     
(0.4
)
   
15.3
%
   
$
450.7
   
$
(32.8
)
   
(6.8
)%
 
$
483.5
   
$
(40.7
)
   
(7.8
)%
 
21

Gross Profit

             
Percent Change
 
 
2017
 
2016
 
2015
 
2016 to
2017
 
2015 to
2016
 
                     
Gross profit
 
$
91.3
   
$
118.7
   
$
143.1
     
(23.1
)%
   
(17.1
)%
Gross margin
   
20.3
%
   
24.6
%
   
27.3
%
               

Gross profit and gross margin decreased in 2017, compared with 2016, primarily due to a decrease in overall revenue that resulted from lower ASPs and, to a lesser extent, a reduction in units sold. Gross profit and gross margin decreased in 2016, compared with 2015, primarily as a result of decreased revenue of high-end IC and, to a lesser extent, mainstream IC photomasks. 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

                     
Percent Change
 
   
2017
   
2016
   
2015
   
2016 to
2017
   
2015 to
2016
 
                               
Selling, general and administrative expenses
 
$
43.6
   
$
44.6
   
$
49.0
     
(2.2
)%
   
(9.0
)%
Percentage of net sales
   
9.7
%
   
9.2
%
   
9.3
%
               

Selling, general and administrative expenses decreased by $1.0 million in 2017, compared with 2016, primarily due to reduced bad debt expense and professional fees, which were partially offset by increased compensation costs and selling expenses. Selling, general and administrative expenses decreased $4.4 million in 2016, compared with 2015, primarily due to reduced compensation, freight, and other expenses.

Research and Development

                     
Percent Change
 
   
2017
   
2016
   
2015
   
2016 to
2017
   
2015 to
2016
 
                               
Research & Development expense
 
$
15.9
   
$
21.7
   
$
21.9
     
(26.7
)%
   
(1.2
)%
Percentage of net sales
   
3.5
%
   
4.5
%
   
4.2
%
               

Research and development expenses primarily consist of development efforts related to high-end process technologies for 10nm and below IC nodes, FPD G8 and above, and AMOLED applications. Research and development expenses decreased by $5.8 million in 2017 to $15.9 million, from $21.7 million in 2016 as a result of lower customer qualification costs for high-end reticles in both Asia and the U.S. Research and development expenses did not change significantly from 2015 to 2016.
 
22

Other Income (Expense), net

   
2017
   
2016
   
2015
 
Interest income and other income (expense)
 
$
(3.1
)
 
$
2.4
   
$
2.8
 
Interest expense
   
(2.2
)
   
(3.3
)
   
(5.0
)
Gains on sales of investments
   
-
     
8.9
     
-
 
Total other income (expense), net
 
$
(5.3
)
 
$
8.0
   
$
(2.2
)

Interest income and other income (expense) decreased by $5.5 million in 2017, compared with 2016, primarily as a result of increased foreign currency transaction losses in 2017. Interest expense decreased in 2017 compared with 2016 primarily as a result of the maturity of our 3.25% convertible senior notes in April 2016, and lower average outstanding debt balance on our other debt obligations.

Interest expense decreased in 2016 compared with 2015 primarily as a result of the maturity of our 3.25% convertible senior notes in April 2016. Interest income and other income (expense) decreased in 2016, compared with 2015, primarily as a result of unfavorable foreign currency results in 2016, compared to favorable results in 2015. The negative impact of the change in foreign currency results was somewhat mitigated by the favorable settlement of a liability related to our 2014 DPTT acquisition, as well as the favorable effect of not incurring financing fees (which were related to the exchange of senior convertible notes) in 2016 that we had incurred in 2015.
 
In January 2016, we sold a minority interest investment in a foreign entity and recognized a gain of $8.8 million. In May 2016, we sold our 49.99% interest in the MP Mask joint venture and recognized a gain of $0.1 million.

Income Tax Provision

   
2017
   
2016
   
2015
 
                   
Income tax provision
 
$
5.3
   
$
4.8
   
$
13.2
 
Effective income tax rate
   
19.9
%
   
7.9
%
   
18.8
%

The effective tax rate differs from the U.S. statutory rate of 35% in fiscal years 2017, 2016 and 2015 primarily due to earnings being taxed at lower statutory rates in foreign jurisdictions, the benefit of various investment credits claimed in a foreign jurisdiction, and valuation allowances in jurisdictions with historical and continuing losses.

The increase in effective income tax rate in 2017 compared with 2016 was primarily due to recognition of $1.0 million of previously unrecognized tax benefits, the result of audit settlements and expirations of assessment period statutes of limitations. Those effects were partially offset by 2016 benefit factors, including: the recognition of $2.5 million of previously unrecognized deferred tax assets, the result of improved performance of our FPD operations; the reversal of previously recognized tax expense of $2.4 million that was eliminated by a distribution of the earnings of a foreign subsidiary to its foreign parent; a higher percentage of income before income taxes, including an $8.8 million gain on the sale of an investment in the first quarter of fiscal year 2016, generated in jurisdictions where we previously incurred losses that, due to valuation allowances, did not result in recognition of expense.

The effective income tax rate decreased in 2016 compared with 2015 as a result of the following major factors: recognition in 2016 of $4.3 million, compared with $1.5 million in 2015, of previously unrecognized deferred tax assets, which primarily resulted from the improved performance of our FPD operations; the reversal of previously recognized tax expense of $2.4 million that was eliminated by a distribution of the 2015 earnings of a foreign subsidiary to its foreign parent; and a higher percentage of income before income taxes, including an $8.8 million gain on the sale of an investment in 2016, generated in jurisdictions where the Company previously incurred losses that, due to valuation allowances, did not result in recognition of tax expense.
 
23

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 October 29, 2017, October 30, 2016 and November 1, 2015, are $3.4 million, $4.6 million and $4.1 million recorded in other liabilities in the consolidated balance sheets that, if recognized, would impact the effective tax rate.
 
Net Income Attributable to Noncontrolling Interests

Net income attributable to noncontrolling interests decreased $1.3 million to $8.2 million in 2017 compared with $9.5 million in 2016 due to decreased net income at our IC manufacturing facility in Taiwan, and decreased $2.7 million to $9.5 million in 2016 compared with $12.2 million in 2015 as a result of decreased net income at that same facility.
 
Liquidity and Capital Resources

   
October 29,
2017
   
October 30,
2016
   
November 1,
2015
 
   
(in $ millions)
   
(in $ millions)
   
(in $ millions)
 
                   
Cash and cash equivalents
 
 
308.0
   
 
314.1
   
 
205.9
 
                         
Net cash provided by operating activities
 
 
96.8
   
 
122.1
   
 
133.2
 
Net cash (used in) provided by investing activities
 
 
(98.1
)
 
 
52.3
   
 
(104.3
)
Net cash used in financing activities
 
 
(10.9
)
 
 
(67.0
)
 
 
(7.1
)

As of October 29, 2017, we had cash and cash equivalents of $308.0 million compared with $314.1 million as of October 30, 2016. Our working capital increased $7.1 million to $367.3 million at October 29, 2017, compared with $360.3 million at October 30, 2016. We may use our available cash on hand for operations, capital expenditures, debt repayments, strategic opportunities, stock repurchases or other corporate uses, any of which may be material.

As of October 30, 2016, we had cash and cash equivalents of $314.1 million compared with $205.9 million as of November 1, 2015. Our working capital increased $192.2 million to $360.3 million at October 30, 2016, compared with $168.1 million (as retrospectively adjusted to reflect our adoption of ASU 2015-17 in the fourth quarter of fiscal year 2016) at November 1, 2015. The increase in cash and cash equivalents in 2016 was primarily attributable to the sale of our 49.99% interest in the MP Mask joint venture for $93.1 million and proceeds from the sale of an investment in a foreign entity of $8.8 million. The increase in working capital was the result of these same factors, as well as the conversion of $7.4 million of debt to common stock, reduced accounts payable and accrued expense balances as of the end of 2016 compared with the end of 2015, which were caused, in significant part, by lower accruals for capital expenditures and employee compensation.

As of October 29, 2017 and October 30, 2016, our total cash and cash equivalents included $190.0 million and $141.4 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 these funds to U.S. federal income taxes and local country withholding taxes in certain jurisdictions. 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.
 
Net cash provided by operating activities decreased by $25.3 million to $96.8 million in fiscal 2017, compared with $122.1 million in fiscal 2016, primarily due to the decrease of $34.4 million of net income. Net cash provided by operating activities decreased to $122.1 million in fiscal 2016, compared with $133.2 million in fiscal 2015, primarily due to reduced year-over-year operating income, partially offset by net cash favorable changes in accrual accounts. Net cash provided by operating activities increased to $133.2 million in fiscal 2015, compared with $96.4 million in fiscal 2014, primarily due to increased net income in 2015, excluding the 2014 noncash gain on the acquisition of DPTT.
 
24

Cash flows from investing activities decreased from funds provided of $52.3 million in 2016 to $98.1 million used in fiscal year 2017 due to $101.9 million aggregate proceeds received from the sale of our investments in MP Mask and an interest we held in a foreign entity in fiscal 2016, compared to increased capital expenditures of $41.8 million and the acquisition of a business of $5.4 million in fiscal 2017. Cash flows from investing activities increased to $52.3 million provided in fiscal year 2016 from $104.3 used in fiscal year 2015, primarily due to proceeds of $101.9 million received from the sale of our investments in the MP Mask joint venture and an interest we held in a foreign entity, as well as decreased expenditures for capital equipment. Net cash used in investing activities in fiscal 2015 was $104.3 million primarily due to capital expenditure payments. Capital expenditure payments for the 2017, 2016, and 2015 fiscal years were $92.0, $50.1 million, and $104.0 million, respectively. We expect capital expenditure payments in fiscal 2018 to be approximately $250 million.

Net cash used in financing activities was $10.9 million in fiscal 2017, which primarily comprised repayments of long-term borrowings and a dividend paid to the noncontrolling interest in a subsidiary, partially offset by proceeds received from employee share-based arrangements. Net cash used in financing activities was $67.0 million in fiscal 2016, primarily comprised of repayments of long-term borrowings (including $50.1 million to retire our 3.25% convertible senior notes which matured in April 2016) and $11.9 million dividend paid to the noncontrolling interest in a subsidiary, partially offset by proceeds received from employee share-based arrangements. Net cash used in financing activities was $7.1 million in fiscal 2015, primarily comprised of repayments of borrowings, offset, in part, by proceeds from share-based arrangements.
 
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. Although we continue to evaluate further cost reduction initiatives, 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 facility.

At October 29, 2017, we had outstanding purchase commitments of $168 million, which included $162 million related to capital expenditures. We intend to finance our capital expenditures with our working capital, cash generated from operations, and, if necessary, with additional borrowings. We have agreed to enter into a joint venture that is constructing an IC facility in China with an estimated total investment of $160 million.  Our funding commitment for the joint venture is approximately $80 million in the form of a combination of cash and transferred capital over the next several years. We have also entered into an agreement to construct an FPD facility in China in which we will invest $160 million over that same period.
 
Cash Requirements

Our cash requirements in fiscal 2018 will be primarily to: fund our operations; capital spending, including the construction of an IC research and development and manufacturing facility in Xiamen, China and an FPD manufacturing facility in Hefei, China; and service our debt. 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 facility.
 
25

Contractual Obligations

The following table presents our contractual obligations as of October 29, 2017:

   
Payment due by period
 
Contractual Obligations
 
Total
   
Less
Than
1 Year
   
1 - 3
Years
   
3 - 5
Years
   
More
Than
5 Years
 
 
                     
 
 
Long-term borrowings
 
$
57,500
   
$
-
   
$
57,500
   
$
-
   
$
-
 
                                         
Operating leases
   
4,012
     
1,138
     
1,123
     
751
     
1,000
 
                                         
Capital leases
   
4,639
     
4,639
     
-
     
-
     
-
 
                                         
Purchase obligations
   
168,219
     
160,534
     
7,685
     
-
     
-
 
                                         
Interest
   
2,987
     
2,053
     
934
     
-
     
-
 
                                         
Other noncurrent liabilities
   
10,897
     
-
     
2,164
     
1,733
     
7,000
 
                                         
Total
 
$
248,254
   
$
168,364
   
$
69,406
   
$
2,484
   
$
8,000
 

Long-term borrowings of $57.5 million in the table above represent our obligation under our 3.25% senior convertible notes which, at the option of the note holders, may be settled either in cash or by conversion into our common stock. See Note 6 to the consolidated financial statements for additional information. As of October 29, 2017, the Company had recorded accruals for uncertain tax positions of $3.4 million which 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

We own a 50.01% (controlling interest) of PDMC, our IC manufacturing facility located in Taiwan. Under the PDMC operating agreement, the shareholders of PDMC may be requested to make additional contributions to PDMC. In the event that PDMC requests additional capital from its shareholders, we may, in order to maintain our 50.01% ownership interest, be required to make such contributions to PDMC.  The PDMC operating agreement limits the amount of contributions that may be requested both during the first four years of PDMC and during any individual year within those first four years. As of October 29, 2017, we had not been requested to make any additional capital contribution to PDMC.
 
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 7 to the consolidated financial statements for additional information on these operating leases.

Business Outlook

A majority of our revenue growth is expected to continue to come from the Asian region, predominantly in China. In response to this expectation, we agreed to enter into a joint venture that will complete the construction of an IC research and development and manufacturing facility in Xiamen, China, in late 2018. Production is anticipated to begin at this facility in early 2019. In addition, in August 2017, we announced our plan to construct an FPD manufacturing facility in Hefei, China, in which production is also anticipated to begin in early 2019. Please refer to Note 19 of our consolidated financial statements for additional information on these undertakings.
 
26

We continue to assess our global manufacturing strategy and monitor our sales volume and related cash flows from operations. This ongoing assessment could result in future facility closures, asset redeployments, additional impairments of intangible or long-lived assets, workforce reductions, or the addition of increased 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 that the following are some of the more critical judgment areas in the application of our accounting policies that affect our financial condition and results of operations:

·
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 and definite-lived intangible assets, which requires us to forecast the future cash flows related to these assets, and impacts our gross margin and operating expenses;

·
the estimation of the collectability of our accounts receivables, 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 impact our provision for income taxes and our tax-related asset and liability balances.

Please refer to Note 1 to our consolidated financial statements for additional information on 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 21 Recent Accounting Pronouncements” for recent accounting pronouncements that may affect our financial reporting.

ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Exchange Rate Risk

We conduct business in several major international 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 have transactions and balances in 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. There can be no assurance that this approach will continue to be successful, especially in the event of a significant adverse movement in the value of any foreign currency against the U.S. dollar, the New Taiwan dollar, the South Korean won, the Chinese renminbi, the Singapore dollar, the British pound, or the euro. 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 manufacturing facility.
 
27

Our primary net foreign currency exposures as of October 29, 2017, included the South Korean won, the Japanese yen, the New Taiwan dollar, the Chinese renminbi, the Singapore dollar, the British pound, and the euro. As of October 29, 2017, 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 $13.0 million, which represents an increase of $3.9 million from October 30, 2016. The increase in foreign currency rate change risk is primarily the result of increased exposures of the Chinese renminbi against the U.S. dollar, and the Taiwan dollar against the U.S. dollar and, to a lesser extent, the Japanese yen. We do not believe that a 10% change in the exchange rates of other non-US dollar currencies would have had a material effect on our October 29, 2017 consolidated financial statements.

Interest Rate Risk

At October 29, 2017, we did not have any variable rate borrowings. Therefore, a 10% change in interest rates would not have had a material effect on our consolidated financial position, results of operations, or cash flows in the year ended October 29, 2017.

ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 
Page
   
29
 
30
   
31
   
32
   
33
   
34
   
35
 
28

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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

We have audited the accompanying consolidated balance sheets of Photronics, Inc. and subsidiaries (the “Company”) as of October 29, 2017 and October 30, 2016, and 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 fiscal years ended October 29, 2017, October 30, 2016, and November 1, 2015. We also have audited the Company’s internal control over financial reporting as of October 29, 2017, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. 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 conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. 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.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel 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 the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Photronics, Inc. and subsidiaries as of October 29, 2017 and October 30, 2016, and the results of their operations and their cash flows for each of the fiscal years ended October 29, 2017, October 30, 2016, and November 1, 2015, 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 29, 2017, based on the criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
 
/s/ Deloitte & Touche LLP
Hartford, Connecticut
December 20, 2017
 
29

PHOTRONICS, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except per share amounts)
 
   
October 29,
2017
   
October 30,
2016
 
ASSETS
           
             
Current assets:
           
Cash and cash equivalents
 
$
308,021
   
$
314,074
 
Accounts receivable, net of allowance of $2,319 in 2017 and $3,901 in 2016
   
105,320
     
92,636
 
Inventories
   
23,703
     
22,081
 
Other current assets
   
12,080
     
12,795
 
Total current assets
   
449,124
     
441,586
 
                 
Property, plant and equipment, net
   
535,197
     
506,434
 
Intangible assets, net
   
17,122
     
19,854
 
Deferred income taxes
   
15,481
     
16,322
 
Other assets
   
3,870
     
3,792
 
Total assets
 
$
1,020,794
   
$
987,988
 
                 
LIABILITIES AND EQUITY
               
                 
Current liabilities:
               
Current portion of long-term borrowings
 
$
4,639
   
$
5,428
 
Accounts payable
   
50,834
     
48,906
 
Payables – related parties
   
-
     
2,743
 
Accrued liabilities
   
26,303
     
24,240
 
Total current liabilities
   
81,776
     
81,317
 
                 
Long-term borrowings
   
57,337
     
61,860
 
Deferred income taxes
   
2,049
     
1,491
 
Other liabilities
   
14,337
     
17,846
 
Total liabilities
   
155,499
     
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, 68,666 shares issued and outstanding at October 29, 2017, 68,080 shares issued and outstanding at October 30, 2016
   
687
     
681
 
Additional paid-in capital
   
547,596
     
541,093
 
Retained earnings
   
189,390
     
176,260
 
Accumulated other comprehensive income (loss)
   
6,891
     
(7,671
)
Total Photronics, Inc. shareholders’ equity
   
744,564
     
710,363
 
Noncontrolling interests
   
120,731
     
115,111
 
Total equity
   
865,295
     
825,474
 
Total liabilities and equity
 
$
1,020,794
   
$
987,988
 
 
See accompanying notes to consolidated financial statements.
 
30

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

   
Year Ended
 
   
October 29,
2017
   
October 30,
2016
   
November 1,
2015
 
                   
Revenue
 
$
450,678
   
$
483,456
   
$
524,206
 
                         
Cost of goods sold
   
(359,363
)
   
(364,750
)
   
(381,070
)
                         
Gross profit
   
91,315
     
118,706
     
143,136
 
                         
Operating expenses:
                       
                         
Selling, general and administrative
   
(43,585
)
   
(44,577
)
   
(48,983
)
                         
Research and development
   
(15,862
)
   
(21,654
)
   
(21,920
)
                         
Total operating expenses
   
(59,447
)
   
(66,231
)
   
(70,903
)
                         
Operating income
   
31,868
     
52,475
     
72,233
 
                         
Other income (expense):
                       
                         
Interest income and other income (expense)
   
(3,068
)
   
2,424
     
2,797
 
                         
Interest expense
   
(2,235
)
   
(3,365
)
   
(4,990
)
                         
Gains on sales of investments
   
-
     
8,940
     
-
 
                         
Income before income tax provision
   
26,565
     
60,474
     
70,040
 
                         
Income tax provision
   
(5,276
)
   
(4,798
)
   
(13,181
)
                         
Net income
   
21,289
     
55,676
     
56,859
 
                         
Net income attributable to noncontrolling interests
   
(8,159
)
   
(9,476
)
   
(12,234
)
                         
Net income attributable to Photronics, Inc. shareholders
 
$
13,130
   
$
46,200
   
$
44,625
 
                         
Earnings per share:
                       
                         
Basic
 
$
0.19
   
$
0.68
   
$
0.67
 
                         
Diluted
 
$
0.19
   
$
0.64
   
$
0.63
 
                         
Weighted-average number of common shares outstanding:
                       
                         
Basic
   
68,436
     
67,539
     
66,331
 
                         
Diluted
   
69,288
     
76,354
     
78,383
 

See accompanying notes to consolidated financial statements.
 
31

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

   
Year Ended
 
   
October 29,
2017
   
October 30,
2016
   
November 1,
2015
 
                   
Net income
 
$
21,289
   
$
55,676
   
$
56,859
 
Other comprehensive income (loss), net of tax:                        
Foreign currency translation adjustments
   
19,799
     
6,334
     
(40,154
)
Amortization of cash flow hedge
   
129
     
129
     
128
 
Other
   
478
     
(589
)
   
(381
)
Net other comprehensive income (loss)
   
20,406
     
5,874
     
(40,407
)
Comprehensive income
   
41,695
     
61,550
     
16,452
 
Less: comprehensive income attributable to noncontrolling interests
   
14,003
     
12,448
     
4,174
 
Comprehensive income attributable to Photronics, Inc. shareholders
 
$
27,692
   
$
49,102
   
$
12,278
 

See accompanying notes to consolidated financial statements.
 
32

PHOTRONICS, INC. AND SUBSIDIARIES
Consolidated Statements of Equity
Years Ended October 29, 2017 October 30, 2016 and November 1, 2015
(in thousands)
 
   
Common Stock
   
Additional
Paid-In
   
Retained
   
Accumulated
Other
Comprehensive
   
Non-
Controlling
   
Total
 
   
Shares
   
Amount
   
Capital
   
Earnings
   
Income (Loss)
   
Interests
   
Equity
 
                                           
Balance at November 2, 2014
   
65,930
   
$
659
   
$
520,182
   
$
85,435
   
$
21,774
   
$
111,444
   
$
739,494
 
                                                         
Net income
   
-
     
-
     
-
     
44,625
     
-
     
12,234
     
56,859
 
Other comprehensive loss
   
-
     
-
     
-
     
-
     
(32,347
)
   
(8,060
)
   
(40,407
)
Sales of common stock through employee stock option and purchase plan
   
513
     
5
     
2,505
     
-
     
-
     
-
     
2,510
 
Restricted stock awards vesting and expense
   
159
     
2
     
1,064
     
-
     
-
     
-
     
1,066
 
Share-based compensation expense
   
-
     
-
     
2,623
     
-
     
-
     
-
     
2,623
 
Repurchase of common stock by subsidiary
   
-
     
-
     
28
     
-
     
-
     
(107
)
   
(79
)
                                                         
Balance at November 1, 2015
   
66,602
     
666
     
526,402
     
130,060
     
(10,573
)
   
115,511
     
762,066
 
                                                         
Net income
   
-
     
-
     
-
     
46,200
     
-
     
9,476
     
55,676
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
2,902
     
2,972
     
5,874
 
Sales of common stock through employee stock option and purchase plan
   
618
     
6
     
3,441
     
-
     
-
     
-
     
3,447
 
Restricted stock awards vesting and expense
   
143
     
2
     
1,190
     
-
     
-
     
-
     
1,192
 
Share-based compensation expense
   
-
     
-
     
2,637
     
-
     
-
     
-
     
2,637
 
Conversion of debt to common stock
   
717
     
7
     
7,431
     
-
     
-
     
-
     
7,438
 
Dividends to noncontrolling interests
   
-
     
-
     
-
     
-
     
-
     
(11,901
)
   
(11,901
)
Return of capital to noncontrolling interest
   
-
     
-
     
-
     
-
     
-
     
(955
)
   
(955
)
Repurchase of common stock by subsidiary
   
-
     
-
     
(8
)
   
-
     
-
     
8
     
-
 
                                                         
Balance at October 30, 2016
   
68,080
     
681
     
541,093
     
176,260
     
(7,671
)
   
115,111
     
825,474
 
                                                         
Net income
   
-
     
-
     
-
     
13,130
     
-
     
8,159
     
21,289
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
14,562
     
5,844
     
20,406
 
Sales of common stock through employee stock option and purchase plan
   
459
     
5
     
2,877
     
-
     
-
     
-
     
2,882
 
Restricted stock awards vesting and expense
   
127
     
1
     
1,508
     
-
     
-
     
-
     
1,509
 
Share-based compensation expense
   
-
     
-
     
2,118
     
-
     
-
     
-
     
2,118
 
Dividends to noncontrolling interests
   
-
     
-
     
-
     
-
     
-
     
(8,383
)
   
(8,383
)
                                                         
Balance at October 29, 2017
   
68,666
   
$
687
   
$
547,596
   
$
189,390
   
$
6,891
   
$
120,731
   
$
865,295
 

See accompanying notes to consolidated financial statements.
 
33

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

   
Year Ended
 
   
October 29,
2017
   
October 30,
2016
   
November 1,
2015
 
                   
Cash flows from operating activities:                        
Net income
 
$
21,289
   
$
55,676
   
$
56,859
 
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Depreciation and amortization of property, plant and equipment
   
81,699
     
77,613
     
75,684
 
Amortization of intangible assets
   
4,874
     
5,228
     
6,729
 
Gains on sales of investments
   
-
     
(8,940
)
   
-
 
Share-based compensation
   
3,627
     
3,827
     
3,689
 
Deferred income taxes
   
1,633
     
(3,816
)
   
3,401
 
Changes in assets, liabilities, and other:
                       
Accounts receivable
   
(9,625
)
   
18,807
     
(21,815
)
Inventories
   
(602
)
   
2,268
     
(2,893
)
Other current assets
   
1,127
     
7,936
     
(2,557
)
Accounts payable, accrued liabilities and other
   
(7,189
)
   
(36,462
)
   
14,098
 
                         
Net cash provided by operating activities
   
96,833
     
122,137
     
133,195
 
                         
Cash flows from investing activities:
                       
Purchases of property, plant and equipment
   
(91,965
)
   
(50,147
)
   
(104,033
)
Acquisition of business
   
(5,400
)
   
-
     
-
 
Proceeds from sales of investments
   
167
     
101,853
     
-
 
Purchases of intangible assets
   
(834
)
   
(13
)
   
(771
)
Other
   
(34
)
   
597
     
499
 
                         
Net cash (used in) provided by investing activities
   
(98,066
)
   
52,290
     
(104,305
)
                         
Cash flows from financing activities:
                       
Repayments of long-term borrowings
   
(5,428
)
   
(57,609
)
   
(9,571
)
Dividends paid to noncontrolling interests
   
(8,298
)
   
(11,890
)
   
-
 
Proceeds from share-based arrangements
   
2,830
     
3,463
     
2,651
 
Return of capital to noncontrolling interests
   
-
     
(966
)
   
-
 
Other
   
(32
)
   
(20
)
   
(179
)
                         
Net cash used in financing activities
   
(10,928
)
   
(67,022
)
   
(7,099
)
                         
Effects of exchange rate changes on cash and cash equivalents
   
6,108
     
802
     
(8,853
)
                         
Net (decrease) increase in cash and cash equivalents
   
(6,053
)
   
108,207
     
12,938
 
                         
Cash and cash equivalents at beginning of year
   
314,074
     
205,867
     
192,929
 
                         
Cash and cash equivalents at end of year
 
$
308,021
   
$
314,074
   
$
205,867
 
                         
Supplemental disclosure of non-cash information:                        
Accrual for property, plant and equipment purchased during year
 
$
2,767
   
$
7,866
   
$
25,858
 
Conversion of debt to common stock
   
-
     
7,439
     
-
 

See accompanying notes to consolidated financial statements.
 
34

PHOTRONICS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended October 29, 2017, October 30, 2016 and November 1, 2015
(in thousands, except share amounts)

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business

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 display 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. 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. We have announced plans to construct two manufacturing facilities in China. See Note 19 for additional information.
 
Consolidation

The accompanying consolidated financial statements include the accounts of Photronics, Inc. and majority-owned subsidiaries that it controls. All intercompany balances and transactions have been eliminated in consolidation.
 
Estimates and Assumptions

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect amounts reported in them. Estimates are based on historical experience and on various assumptions that are believed to be reasonable under the circumstances. Our estimates are based on the facts and circumstances available at the time they are made. Actual results we report may differ from such estimates. We review these estimates periodically and reflect any effects of revisions in the period in which they are determined.

Fiscal Year

Our fiscal year ends on the Sunday closest to October thirty-first, and, as a result, a 53-week year occurs every 5 to 6 years. Fiscal years 2017, 2016 and 2015 each included 52 weeks.

Cash and Cash Equivalents

Cash and cash equivalents include cash and highly liquid investments purchased with an original maturity of 3 months or less. The carrying values of cash equivalents approximate their fair values, due to the short-term maturities of these instruments.

Accounts Receivable and Allowance for Doubtful Accounts

We generally record our trade accounts receivable at their billed amounts. All outstanding past due customer invoices are reviewed during and at the end of every reporting period for collectability. When, in the judgment of management, a loss on the collection of a customer invoice is probable, the amount is charged to expense and credited to the allowance for doubtful accounts.  When the amount is determined to be uncollectible, the amount is charged to the allowance for doubtful accounts, and the related receivable is eliminated.
 
35

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:

   
October 29
2017
   
October 30,
2016
 
             
Finished goods
 
$
664
   
$
142
 
Work in process
   
2,957
     
2,987
 
Raw materials
   
20,082
     
18,952
 
   
$
23,703
   
$
22,081
 

Property, Plant and Equipment

Property, plant and equipment, except as explained below under “Impairment of Long-Lived Assets,” is stated at cost less accumulated depreciation and amortization. Repairs and maintenance, as well as renewals and replacements of a routine nature, are charged to operations as incurred, while those that improve, or extend the lives of, existing assets are capitalized. Upon sale or other disposition, the cost of the asset and its related accumulated depreciation are removed from the accounts, and any resulting gain or loss is reflected in earnings.

Depreciation and amortization, substantially all of which are included in cost of goods sold, are computed using the straight-line method over the estimated useful lives of the related assets. Buildings and improvements are depreciated over 15 to 40 years, machinery and equipment over 3 to 10 years, and furniture, fixtures and office equipment over 3 to 5 years. Leasehold improvements are amortized over the life of the lease or the estimated useful life of the improvement, whichever is less. We employ judgment and assumptions when we establish estimated useful lives and depreciation periods, as well as when we periodically review property, plant and equipment for any potential impairment in carrying values, whenever events such as a significant industry downturn, plant closures, technological obsolescence, or other change in circumstances indicate that their carrying amounts may not be recoverable.

Intangible Assets

Intangible assets consist primarily of a technology license agreement and acquisition-related intangibles. These assets, except as explained below, are stated at fair value as of the date acquired, less accumulated amortization. Amortization is calculated based on the estimated useful lives of the assets, which range from 3 to 15 years, using the straight-line method or another method that more fairly represents the utilization of the assets.

We periodically evaluate the remaining useful lives of our intangible assets to determine whether events or circumstances warrant a revision to the remaining periods of amortization. In the event that the estimate of an intangible asset’s remaining useful life has changed, the remaining carrying amount of the intangible asset is amortized prospectively over that revised remaining useful life. If it is determined that an intangible asset has an indefinite useful life, that intangible asset would be subject to impairment testing annually or whenever events or circumstances indicate that its carrying value may not, based on future undiscounted cash flows or market factors, be recoverable; and an impairment loss would be recorded in the period where the impairment determination is made. The amount of the impairment loss recorded would be based on the fair value of the intangible asset at the measurement date.
 
Impairment of Long-Lived Assets

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determinations of recoverability are based upon our judgment and estimates of undiscounted future cash flows resulting from the use of the assets and their eventual disposition. Measurement of an impairment loss for long-lived assets that we expect to hold and use is based on the fair value of the assets determined using a market or income approach compared to the carrying value of the asset. The carrying values of assets determined to be impaired are reduced to their estimated fair values.
 
36

Business Combinations

When acquiring other businesses, or participating in mergers or joint ventures in which we are deemed to be the acquirer, we generally recognize identifiable assets acquired, liabilities assumed and any noncontrolling interests at their acquisition date fair values, separately from any goodwill that may be required to be recognized. Goodwill, when recognizable, would be measured as the excess amount of any consideration transferred, which is generally measured at fair value, over the acquisition date fair values of the identifiable assets acquired and liabilities assumed.

Accounting for such transactions requires us to make significant assumptions and estimates and, although we believe any estimates and assumptions we make to be reasonable and appropriate at the time they are made, unanticipated events and circumstances may arise that affect their accuracy, which may cause actual results to differ from those we estimated. When required, we will adjust the values of the assets acquired and liabilities assumed against the acquisition gain or goodwill, as initially recorded, for a period of up to one year after the transaction.

Costs incurred to effect a merger or acquisition, such as legal, accounting, valuation and other third party costs, as well as internal general and administrative costs incurred are charged to expense in the periods incurred.  Costs incurred to issue any debt and equity securities are recognized in accordance with other applicable generally accepted accounting principles.

Investments in Joint Ventures

The financial results of investments in joint ventures of which we have a controlling financial interest are included in our consolidated financial statements.  Investments in joint ventures over which we have the ability to exercise significant influence and that, in general, are at least 20 percent owned are accounted for under the equity method. An impairment loss would be recognized whenever a decrease in the fair value of such an investment below its carrying amount is determined to be other than temporary. In judging “other than temporary,” we would consider the length of time and the extent to which the fair value of the investment has been less than the carrying amount of the investment, the near-term and longer-term operating and financial prospects of the investee, and our longer-term intent of retaining our investment in the investee.

Variable Interest Entities

We account for the investments we make in certain legal entities in which equity investors do not have 1) sufficient equity at risk for the legal entity to finance its activities without additional subordinated financial support or, 2) as a group, the holders of the equity investment at risk do not have either the power, through voting or similar rights, to direct the activities of the legal entity that most significantly impact the entity’s economic performance or, 3) the obligation to absorb the expected losses of the legal entity or the right to receive expected residual returns of the legal entity as “variable interest entities”, or “VIEs”.

We would consolidate the results of any such entity in which we determined that we have a controlling financial interest. We would have a “controlling financial interest” in such an entity when we have both the power to direct the activities that most significantly affect the VIE’s economic performance and the obligation to absorb the losses of, or right to receive the benefits from, the VIE that could be potentially significant to the VIE. On a quarterly basis, we would reassess whether we have a controlling financial interest in any investments we have in these certain legal entities.

We account for investments we make in VIEs in which we have determined that we do not have a controlling financial interest but have a significant influence over, and hold at least a 20 percent ownership interest in, using the equity method. Any such investment not meeting the parameters to be accounted for under the equity method would be accounted for using the cost method, unless the investment had a readily determinable fair value, at which value it would then be reported.
 
Income Taxes

The income tax provision is computed on the basis of the various tax jurisdictions’ income or loss before income taxes. Deferred income taxes reflect the tax effects of differences between the carrying amounts of assets and liabilities for financial reporting purposes and their amounts used for income tax purposes, as well as the tax effects of net operating losses and tax credit carryforwards. We use judgment and make assumptions to determine if valuation allowances for deferred income tax assets are required, if their realization is not more likely than not, by considering future market growth, operating forecasts, future taxable income, and the mix of earnings among the tax jurisdictions in which we operate. Accordingly, income taxes charged against earnings may have been impacted by changes in the valuation allowances.
 
37

We consider income taxes in each of the tax jurisdictions in which we operate in order to determine our effective income tax rate. Our current income tax expense is thus identified, and temporary differences resulting from differing treatments of items for tax and financial reporting purposes are assessed. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheets.
 
We account for uncertain tax positions by recording a liability for unrecognized tax benefits resulting from uncertain tax positions taken, or expected to be taken, in our tax returns. We include any applicable interest and penalties related to uncertain tax positions in our income tax provision.

Earnings Per Share

Basic earnings per share (“EPS”) is based on the weighted-average number of common shares outstanding for the period, excluding any dilutive common share equivalents. Diluted EPS reflects the potential dilution that could occur if certain share-based payment awards or financial instruments were exercised, earned or converted.