Item 2.
|
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
Overview
Management’s discussion and analysis (“MD&A”) of the Company’s financial condition, results of operations and outlook should be read in conjunction with its condensed consolidated financial statements and related notes. Various segments of this MD&A contain forward-looking statements, all of which are presented based on current expectations, which may be adversely affected by uncertainties and risk factors (presented throughout this filing and in the Company’s Annual Report on Form 10-K for the fiscal 2019 year), that may cause actual results to materially differ from these expectations.
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, microelectronic mechanical systems and certain nanotechnology applications. Our selling cycle is tightly interwoven with the development and release of new semiconductor and FPD designs and applications, particularly as they relate to the semiconductor industry’s migration to more advanced product innovation, design methodologies, and fabrication processes. We believe that the demand for photomasks primarily depends on design activity rather than sales volumes from products manufactured using photomask technologies. Consequently, an increase in semiconductor or FPD sales does not necessarily result in a corresponding increase in photomask sales. However, the reduced use of customized ICs, reductions in design complexity, other changes in the technology or methods of manufacturing or designing semiconductors, or a slowdown in the introduction of new semiconductor or FPD designs could reduce demand for photomasks ‒ even if the demand for semiconductors and FPDs increases. Advances in semiconductor, FPD, and photomask design and semiconductor and FPD production methods that shift the burden of achieving device performance away from lithography could also reduce the demand for photomasks. Historically, the microelectronic industry has been volatile, experiencing periodic downturns and slowdowns in design activity. These downturns have been characterized by, among other things, diminished product demand, excess production capacity, and accelerated erosion of selling prices, with a concomitant effect on revenue and profitability.
We are typically required to fulfill customer orders within a short period of time after receipt of an order, sometimes within twenty-four hours. This results in a minimal level of backlog orders, typically one to two weeks of backlog for IC photomasks and two to three weeks of backlog for FPD photomasks.
The global semiconductor and FPD industries are driven by end markets which have been closely tied to consumer-driven applications of high-performance devices, including, but not limited to, mobile display devices, mobile communications, and computing solutions. While we cannot predict the timing of the industry’s transition to volume production of next-generation technology nodes, or the timing of up and down-cycles with precise accuracy, we believe that such transitions and cycles will continue into the future, beneficially and adversely affecting our business, financial condition, and operating results as they occur. We believe our ability to remain successful in these environments is dependent upon the achievement of our goals of being a service and technology leader and efficient solutions supplier, which we believe should enable us to continually reinvest in our global infrastructure.
Recent Developments
In the first quarter of fiscal 2020, we acquired the remaining 0.2% of noncontrolling interests in Photronics Cheonan, Ltd. (formerly PK, Ltd.), our South Korean subsidiary, for $0.6 million.
In the first quarter of fiscal 2020, we adopted ASU 2016-02 and all subsequent amendments, collectively codified in Accounting Standards Codification Topic 842 - “Leases” (“Topic 842”). This guidance requires modified retrospective adoption, either at the beginning of the earliest period presented or at the beginning of the period of adoption; we elected to apply the guidance at the beginning of the period of adoption, and recognized right-of-use leased assets of $6.5 million and corresponding lease liabilities which were discounted at our incremental borrowing rates, on our November 1, 2019 condensed consolidated balance sheet to reflect our adoption of the guidance. Our adoption of Topic 842 did not affect our cash flows or our ability to comply with covenants under our credit agreements.
In the fourth quarter of fiscal 2019, our board of directors declared a dividend of one preferred stock purchase right (a “Right”), payable on or about October 1, 2019, for each share of common stock, par value $0.01 per share, of the Company outstanding on September 30, 2019, to the stockholders of record on that date. In connection with the distribution of the Rights, we entered into a Section 382 Rights Agreement (the “Rights Agreement”), dated as of September 23, 2019, between the Company and Computershare Trust Company, N.A., a federally chartered trust company, as rights agent. The purpose of the Rights Agreement is to deter trading of our common stock that would result in a change in control (as defined in Internal Revenue Code Section 382), thereby preserving our future ability to use our historical federal net operating losses and other Tax Attributes (as defined in the Rights Agreement). Each Right entitles the registered holder to purchase from the Company one one-thousandth of a share of Series A Preferred Stock, par value $0.01 per share, at a price of $33.63, subject to adjustment. The Rights, which are described in the Company’s Current Report on Form 8-K filed on September 24, 2019, are in all respects subject to and governed by the provisions of the Rights Agreement. The Rights will expire at the earliest to occur of (i) the close of business on the day following the date on which our board of directors determines, in its sole discretion, that the Rights Agreement is no longer necessary for the preservation of material valuable tax attributes, or the tax attributes have been fully utilized and may no longer be carried forward or (ii) the close of business on September 22, 2022.
In the fourth quarter of fiscal 2019, PDMC, the Company’s majority-owned IC subsidiary in Taiwan, paid a dividend of which 49.99%, or approximately $18.9 million, was paid to noncontrolling interests.
In the fourth quarter of fiscal 2019, upon our request, a financing entity made an advance payment of $3.5 million to an equipment vendor. We entered into a Master Lease Agreement (“MLA”) with this financing entity, which became effective in July 2019. The MLA enables us to request advance payments or other funds to finance equipment to be leased or purchased in the U.S. In connection with this MLA, we have been approved for financing of $35 million for the purchase of a high-end lithography tool. Interest on this borrowing is payable monthly at thirty-day LIBOR plus 1% (1.18% at August 2, 2020), and will continue to accrue until the borrowing is repaid or, as allowed under the MLA, we enter into a lease for the equipment. We intend to enter into a lease agreement for the related equipment in fiscal year 2020.
In the fourth quarter of fiscal 2019, the Company’s board of directors authorized the repurchase of up to $100 million of its common stock, pursuant to a repurchase plan under Rule 10b5-1 of the Securities Act. We repurchased 2.5 million shares, at a cost of $27.9 million (an average price of $11.34 per share), under this authorization. All shares repurchased during fiscal 2019 (0.9 million) were retired in fiscal 2019; the repurchase program was terminated on March 20, 2020.
In the second quarter of fiscal 2019, we repaid, upon maturity, the entire $57.5 million principal amount of the convertible senior notes we issued in April 2016.
In the first quarter of fiscal 2019, PDMC paid a dividend, of which 49.99%, or approximately $26.1 million, was paid to noncontrolling interests.
In the first quarter of fiscal 2019, PDMCX was approved for credit of the equivalent of $50 million, subject to certain limitations related to PDMCX registered capital at the time of the initial approval, pursuant to which PDMCX has and will enter into separate loan agreements (“the Project Loans”) for intermittent borrowings. The Project Loans, which are denominated in Chinese renminbi (RMB), are being used to finance certain capital expenditures in China. PDMCX granted liens on its interest in land, building, and certain equipment as collateral for the Project Loans. As of August 2, 2020, PDMCX had outstanding borrowings of 234.4 million RMB ($33.5 million) against this approval. Payments on these borrowings are due semiannually through December 2025. See Note 5 of the condensed consolidated financial statements for additional information on these loans.
In the first quarter of fiscal 2019, PDMCX received approval for unsecured credit of the equivalent of $25.0 million, pursuant to which PDMCX may enter into separate loan agreements. Under this credit agreement, PDMCX can borrow up to 140.0 million RMB to pay value-added taxes (“VAT”) and up to 60.0 million RMB to fund operations; combined total borrowings are limited to the equivalent of $25.0 million. As of August 2, 2020, PDMCX had outstanding 18.0 million RMB ($2.6 million) to fund operations, with repayments due one year from the borrowing dates of the separate loan agreements. As of August 2, 2020, PDMCX had outstanding 93.2 million RMB ($13.3 million) borrowed to pay VAT. Payments on these borrowings are due semiannually, in increasing amounts, through July 2023. See Note 5 of the condensed consolidated financial statements for additional information on these loans.
In the fourth quarter of fiscal 2018, the Company’s board of directors authorized the repurchase of up to $25 million of its common stock, to have been executed in open-market transactions or in accordance with a repurchase plan under Rule 10b5-1 of the Securities Act. The share repurchase program commenced, under Rule 10b5-1, on October 22, 2018, and was terminated on February 1, 2019. We repurchased 1.5 million shares at a cost of $13.8 million (an average of $9.41 per share) under this authorization.
Results of Operations
Three and Nine-Months ended August 2, 2020
The following table presents selected operating information expressed as a percentage of revenue.
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
August 2,
2020
|
|
|
May 3,
2020
|
|
|
July 28,
2019
|
|
|
August 2,
2020
|
|
|
July 28,
2019
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
Cost of goods sold
|
|
|
76.1
|
|
|
|
78.7
|
|
|
|
77.9
|
|
|
|
77.7
|
|
|
|
79.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
23.9
|
|
|
|
21.3
|
|
|
|
22.1
|
|
|
|
22.3
|
|
|
|
21.0
|
|
Selling, general and administrative expenses
|
|
|
8.4
|
|
|
|
9.3
|
|
|
|
9.5
|
|
|
|
8.9
|
|
|
|
10.2
|
|
Research and development expenses
|
|
|
2.9
|
|
|
|
3.1
|
|
|
|
2.9
|
|
|
|
2.8
|
|
|
|
3.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
|
|
12.6
|
|
|
|
8.9
|
|
|
|
9.7
|
|
|
|
10.6
|
|
|
|
7.8
|
|
Other (expense) income, net
|
|
|
(1.3
|
)
|
|
|
(0.7
|
)
|
|
|
(0.2
|
)
|
|
|
0.2
|
|
|
|
1.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes
|
|
|
11.3
|
|
|
|
8.2
|
|
|
|
9.5
|
|
|
|
10.8
|
|
|
|
9.0
|
|
Income tax provision
|
|
|
3.2
|
|
|
|
2.6
|
|
|
|
2.4
|
|
|
|
3.9
|
|
|
|
2.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
8.1
|
|
|
|
5.6
|
|
|
|
7.1
|
|
|
|
6.9
|
|
|
|
7.0
|
|
Net income attributable to noncontrolling interests
|
|
|
1.3
|
|
|
|
1.2
|
|
|
|
2.5 1.1
|
|
|
|
1.0
|
|
|
|
1.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income attributable to Photronics, Inc. shareholders
|
|
|
6.8
|
%
|
|
|
4.4
|
%
|
|
|
4.6
|
%
|
|
|
5.9
|
%
|
|
|
5.1
|
%
|
Note: All tabular comparisons included in the following discussion, unless otherwise indicated, are for the three months ended August 2, 2020 (Q3 FY20), May 3, 2020 (Q2 FY20) and July 28, 2019 (Q3 FY19), and for the nine months ended August 2, 2020 (YTD FY20) and July 28, 2019 (YTD FY19), in millions of dollars.
Revenue
Our quarterly revenues can be affected by the seasonal purchasing practices of our customers. As a result, demand for our products is typically reduced during the first, and sometimes the second, quarters of our fiscal year, by the North American, European, and Asian holiday periods, as some of our customers reduce their development and, consequently, their buying activities during those periods.
At the beginning of fiscal year 2020, we changed the threshold for the definition of high-end FPD, from G8 and above and active matrix organic light-emitting diode (AMOLED) display screens, to G10.5 and above, AMOLED, and low-temperature polysilicon (LTPS) display screens, to reflect the overall advancement of technology in the FPD industry. Our definition of high-end IC products remains as 28 nanometer or smaller. The following analyses of quarterly changes in revenue by product type for the periods ended July 28, 2019, have been modified to reflect this change. High-end photomasks typically have higher selling prices (ASPs) than mainstream products.
The following tables present changes in disaggregated revenue in Q3 FY20 and YTD FY20 from revenue in prior reporting periods. Columns may not total due to rounding.
Quarterly Changes in Revenue by Product Type
|
|
Q3 FY20 from Q2 FY20
|
|
|
Q3 FY20 from Q3 FY19
|
|
|
YTD FY20 from YTD FY19
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue in
Q3 FY20
|
|
|
Increase
(Decrease)
|
|
|
Percent
Change
|
|
|
Increase
(Decrease)
|
|
|
Percent
Change
|
|
|
Revenue in
YTD FY20
|
|
|
Increase
(Decrease)
|
|
|
Percent
Change
|
|
IC
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
High-end
|
|
$
|
38.7
|
|
|
$
|
0.4
|
|
|
|
1.0
|
%
|
|
$
|
0.2
|
|
|
|
0.5
|
%
|
|
$
|
118.0
|
|
|
$
|
6.5
|
|
|
|
5.8
|
%
|
Mainstream
|
|
|
70.0
|
|
|
|
11.4
|
|
|
|
19.5
|
%
|
|
|
8.3
|
|
|
|
13.4
|
%
|
|
|
194.5
|
|
|
|
12.3
|
|
|
|
6.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total IC
|
|
$
|
108.7
|
|
|
$
|
11.8
|
|
|
|
12.2
|
%
|
|
$
|
8.5
|
|
|
|
8.5
|
%
|
|
$
|
312.5
|
|
|
$
|
18.8
|
|
|
|
6.4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
FPD
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
High-end
|
|
$
|
36.7
|
|
|
$
|
4.9
|
|
|
|
15.3
|
%
|
|
$
|
13.6
|
|
|
|
58.8
|
%
|
|
$
|
108.2
|
|
|
$
|
47.8
|
|
|
|
79.0
|
%
|
Mainstream
|
|
|
12.6
|
|
|
|
(1.6
|
)
|
|
|
(11.1
|
)%
|
|
|
(2.3
|
)
|
|
|
(15.4
|
)%
|
|
|
39.7
|
|
|
|
(0.6
|
)
|
|
|
(1.5
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total FPD
|
|
$
|
49.2
|
|
|
$
|
3.3
|
|
|
|
7.2
|
%
|
|
$
|
11.3
|
|
|
|
29.8
|
%
|
|
$
|
147.9
|
|
|
$
|
47.2
|
|
|
|
46.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Revenue
|
|
$
|
157.9
|
|
|
$
|
15.1
|
|
|
|
10.6
|
%
|
|
$
|
19.8
|
|
|
|
14.3
|
%
|
|
$
|
460.4
|
|
|
$
|
66.0
|
|
|
|
16.7
|
%
|
Quarterly Changes in Revenue by Geographic Origin
|
|
Q3 FY20 from Q2 FY20
|
|
|
Q3 FY20 from Q3 FY19
|
|
|
YTD FY20 from YTD FY19
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue in
Q3 FY20
|
|
|
Increase
(Decrease)
|
|
|
Percent
Change
|
|
|
Increase
(Decrease)
|
|
|
Percent
Change
|
|
|
Revenue in
YTD FY20
|
|
|
Increase
(Decrease)
|
|
|
Percent
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taiwan
|
|
$
|
60.8
|
|
|
$
|
5.3
|
|
|
|
9.6
|
%
|
|
$
|
(0.4
|
)
|
|
|
(0.7
|
)%
|
|
$
|
182.5
|
|
|
$
|
7.0
|
|
|
|
4.0
|
%
|
Korea
|
|
|
39.5
|
|
|
|
3.2
|
|
|
|
8.9
|
%
|
|
|
2.4
|
|
|
|
6.4
|
%
|
|
|
116.5
|
|
|
|
6.1
|
|
|
|
5.5
|
%
|
United States
|
|
|
28.4
|
|
|
|
3.5
|
|
|
|
14.1
|
%
|
|
|
3.0
|
|
|
|
11.8
|
%
|
|
|
78.3
|
|
|
|
3.7
|
|
|
|
5.0
|
%
|
China
|
|
|
21.0
|
|
|
|
3.5
|
|
|
|
20.0
|
%
|
|
|
15.0
|
|
|
|
252.0
|
%
|
|
|
58.4
|
|
|
|
50.7
|
|
|
|
658.8
|
%
|
Europe
|
|
|
7.7
|
|
|
|
(0.6
|
)
|
|
|
(7.7
|
)%
|
|
|
(0.2
|
)
|
|
|
(3.1
|
)%
|
|
|
23.6
|
|
|
|
(1.2
|
)
|
|
|
(4.7
|
)%
|
Other
|
|
|
0.5
|
|
|
|
0.2
|
|
|
|
66.7
|
%
|
|
|
0.1
|
|
|
|
19.4
|
%
|
|
|
1.2
|
|
|
|
(0.3
|
)
|
|
|
(18.6
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
157.9
|
|
|
$
|
15.1
|
|
|
|
10.6
|
%
|
|
$
|
19.8
|
|
|
|
14.3
|
%
|
|
$
|
460.4
|
|
|
$
|
66.0
|
|
|
|
16.7
|
%
|
Revenue increased $15.1 million, or 10.6%, in Q3 FY20, compared with Q2 FY20, continuing a trend that began in the latter part of Q2 FY20, as COVD-19 related mobility restrictions on many supply chains were lifted. The greatest impacts of these restrictions were experienced in the mainstream IC and high-end FPD product lines. In Q3 FY20, strong foundry logic demand drove revenue for mainstream IC products up $11.4 million, or 19.5%. High-end FPD revenue also largely recovered from the prior quarter, increasing $4.9 million, or 15.3%, as demand nearly doubled for G10.5+ displays and demand for AMOLED and LTPS products improved, as panel makers released new designs for the next generation of smartphones. On a geographic basis, revenue generated at our Asia and U.S. based-facilities increased in the current quarter, with revenue from our China-based facilities increasing $3.5 million, or 20.0%, as our China-based FPD facility continued to ramp to full production. While our China-based IC facility also experienced growth from the prior quarter, travel restrictions had delayed the installation and certification of a tool, which resulted in concomitant delays in our fully utilizing the facility. Installation work on this tool has now commenced, and we anticipate that it will be in production by the end of the second quarter of fiscal 2021.
Revenue increased 14.3% in Q3 FY20, compared with Q3 FY19, due to increased demand for high-end FPD products, which rose 13.6 million, or 58.8%, and mainstream IC products which were up $8.3 million, or 13.4%. The increases reflected both stronger global demand and our increased ability to meet it through the commencement of production at our China-based facilities. Revenue generated at our China-based facilities increased $15.0 million, or 252%, from the prior year quarter. Revenue generated in the U.S. and Korea also grew by 11.8% and 6.4%, respectively, while revenue in Taiwan and Europe decreased moderately.
On a year-to-date basis, revenues increased $66.0 million, or 16.7%, from YTD FY19, primarily due to strong growth in demand for high-end FPD products which increased by $47.8 million, or 79.0%, and, to lesser extents, mainstream and high-end IC products which increased 6.8% and 5.8%, respectively. Revenue increased from the prior year period by over 30% in each of the G10.5+, AMOLED, and LTPS FPD product categories. Revenue from mainstream IC products was up $12.3 million, or 6.8% and, high-end IC revenue increased $6.5 million, or 5.8%, due to favorable foundry demand in Asia. On a geographic basis, approximately 77% of the increase was attributable to revenues from our two China-based sites.
Gross Margin
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|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
Q3 FY20
|
|
|
Q2 FY20
|
|
|
Percent
Change
|
|
|
Q3 FY19
|
|
|
Percent
Change
|
|
|
YTD FY20
|
|
|
YTD FY19
|
|
|
Percent
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
$
|
37.7
|
|
|
$
|
30.4
|
|
|
|
24.0
|
%
|
|
$
|
30.6
|
|
|
|
23.4
|
%
|
|
$
|
102.8
|
|
|
$
|
82.7
|
|
|
|
24.3
|
%
|
Gross margin
|
|
|
23.9
|
%
|
|
|
21.3
|
%
|
|
|
|
|
|
|
22.1
|
%
|
|
|
|
|
|
|
22.3
|
%
|
|
|
21.0
|
%
|
|
|
|
|
Gross margin increased by 2.6 percentage points in Q3 FY20, from Q2 FY20, primarily as a result of the above mentioned 10.6% increase in revenue from the prior quarter. Gross margins at our China-based IC and FPD operations increased as these facilities continue to ramp up to full production. Gross margin also increased at our Taiwan-based IC facility, primarily resulting from an 11.8% increase in revenues at that location. Total cost of goods sold increased $7.8 million, or 7.0%, from the prior quarter, with $4.3 million of the increase resulting from greater materials costs, which rose 10.1%, but remained flat as a percentage of revenue. Labor costs increased 11.2%, but were essentially flat as a percentage of revenue, while overhead costs increased 3.1%, but fell 6.8% as a percentage of revenue.
Gross margin increased by 1.8 percentage points in Q3 FY20, from Q3 FY19, primarily as a result of the 14.3% growth in revenue in the current year quarter. Gross margins at our China-based IC and FPD operations increased as they continue to ramp up to full production. Gross margin also increased in the U.S., with the increase resulting from an 11.8% increase in revenues and costs in most categories falling as a percentage of revenue. Total cost of goods sold increased $12.6 million, or 11.7%, from the prior year quarter, with $4.8 million of the increase resulting from greater materials costs, which rose 11.4%, but fell 2.6%, as a percentage of revenue. Labor costs increased 7.1%, but decreased 6.3%, as a percentage of revenue, while overhead costs increased 13.7%, as a result of greater contracted manufacturing, depreciation, and service contract costs.
Gross margin increased by 1.3 percentage points in YTD FY20, from YTD FY19, primarily as a result of the 16.7% increase in revenue from the prior year period. Gross margins at our China-based IC and FPD operations increased as these facilities continue to ramp up to full production. Gross margin also increased at our Taiwan-based FPD facility, with the increase primarily resulting from a 13.4% increase in revenues, and a decrease in the cost of materials, as a percentage of revenue, of 13.8% due to favorable product mix. Total cost of goods sold increased $45.9 million, or 14.7%, from the prior year period, with $21.5 million of the increase resulting from greater materials costs, which were up 18.4% from YTD FY19, and increased 1.4%, as a percentage of revenue. Labor costs increased 3.4%, but were down 11.4%, as a percentage of revenue, while overhead costs increased 15.8%, with increased equipment costs (which reflected our expanded installed tool base) comprising the majority of this increase.
As we operate in a high fixed cost environment, increases or decreases in our revenues and capacity utilization will generally positively or negatively impact our gross margin.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $13.3 million in Q3 FY20, essentially unchanged from Q2 FY20, and up $0.2 million from Q3 FY19. The increase from the prior year quarter was the result of increased compensation and related expenses of $0.9 million, which were partially offset by decreased travel and freight costs of $0.5 and $0.2 million, respectively. Selling, general and administrative expenses increased $0.6 million, or 1.5%, in YTD FY20, from YTD FY19, primarily as a result of increased compensation and related expenses of $1.5 million, partially offset by decreased travel expenses of $1.1 million.
Research and Development Expenses
Research and development expenses consist of development efforts generally related to process technology development for high-end IC nodes and FPD applications.
Research and development expenses were $4.5 million in Q3 FY20, essentially unchanged from Q2 FY20, and up $0.4 million from Q3 FY19, primarily as a result of increased development activities in China, where increases of $0.2 million occurred at both our IC and FPD facilities. Research and development expenses increased $1.2 million, or 10.0%, in YTD FY20, from YTD FY19, primarily due to increased development activities at the two China-based facilities, where spending increased by $1.3 million and $0.7 million, respectively, at the IC and FPD facilities; these increases were partially offset by reduced spending in the U.S. of $1.0 million.
Other Income (Expense)
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
Q3 FY20
|
|
|
Q2 FY20
|
|
|
Q3 FY19
|
|
|
YTD FY20
|
|
|
YTD FY19
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency (losses) gains, net
|
|
$
|
(1.6
|
)
|
|
$
|
(1.4
|
)
|
|
$
|
(0.1
|
)
|
|
$
|
1.7
|
|
|
$
|
5.0
|
|
Interest expense, net
|
|
|
(0.6
|
)
|
|
|
0.8
|
|
|
|
(0.4
|
)
|
|
|
(1.6
|
)
|
|
|
(1.3
|
)
|
Interest income and other income (expense), net
|
|
|
-
|
|
|
|
(0.3
|
)
|
|
|
0.1
|
|
|
|
0.5
|
|
|
|
1.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense), net
|
|
$
|
(2.1
|
)
|
|
$
|
(1.0
|
)
|
|
$
|
(0.4
|
)
|
|
$
|
0.6
|
|
|
$
|
4.7
|
|
Other income (expense), net decreased $1.1 million, from a loss of $1.0 million in Q2 FY20, to a loss of $2.1 million in Q3 FY20, due to interest expense incurred in the current quarter and interest subsidies received in Q2 FY20. Interest expense and interest subsidies both primarily relate to our China-based debt, the majority of which is eligible for reimbursements through subsidies. Other income (expense), net decreased $1.7 million from Q3 FY19, primarily due to an unfavorable change in foreign currency transaction results of $1.5 million. Other income (expense), net decreased $4.1 million year-to-date primarily due to a decrease in foreign currency exchange gains of $3.3 million, decreased interest income of $0.4 million, and increased interest expense of $0.4 million (net of subsidies received) in YTD FY20, compared with the prior year period.
Income Tax Provision
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
Q3 FY20
|
|
|
Q2 FY20
|
|
|
Q3 FY19
|
|
|
YTD FY20
|
|
|
YTD FY19
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax provision
|
|
$
|
4.9
|
|
|
$
|
3.8
|
|
|
$
|
3.2
|
|
|
$
|
17.8
|
|
|
$
|
7.9
|
|
Effective income tax rate
|
|
|
27.7
|
%
|
|
|
32.2
|
%
|
|
|
24.7
|
%
|
|
|
35.9
|
%
|
|
|
22.3
|
%
|
The effective income tax rate is sensitive to the jurisdictional mix of earnings, due, in part, to the non-recognition of tax benefits on losses in jurisdictions with valuation allowances.
The effective income tax rate decreased in Q3 FY20, compared with Q2 FY20, primarily due to changes in the jurisdictional mix of earnings. The effective income tax rate increased in Q3 FY20, compared with Q3 FY19, due to changes in the jurisdictional mix of earnings and the expiration of a tax holiday in Taiwan in December 2019.
The effective income tax rate increased in YTD FY20, compared with YTD FY19, primarily due to the YTD FY20 establishment of a valuation allowance for a loss carryforward in a non-U.S. jurisdiction, which was partially offset by a non-repetitive, one-time audit settlement benefit in YTD FY19, as well as changes in the jurisdictional mix of earnings, the expiration of a tax holiday in Taiwan, and use of investment tax credits to reduce tax expense in 2019.
Net Income Attributable to Noncontrolling Interests
Net income attributable to noncontrolling interests was $2.1 million in Q3 FY20, which represented an increase of $0.4 million from Q2 FY20, and was the result of increased net income at our Taiwan-based IC facility, and a decreased net loss at our China-based IC facility. Net income attributable to noncontrolling interests decreased $1.4 million in Q3 FY20 from $3.5 million in Q3 FY19, as decreased income at our Taiwan-based IC facility exceeded a decreased loss at our China-based IC facility. On a year-to-date basis, net income attributable to noncontrolling interests decreased $3.0 million; the decrease was the result of decreased net income at our Taiwan-based IC facility and an increased net loss at our China-based IC facility. We hold 50.01% ownership interests in both the China-based and Taiwan-based IC facilities.
Liquidity and Capital Resources
We had cash and cash equivalents of $260.6 million at the end of Q3 FY20, compared with $206.5 million at the end of fiscal 2019. The net increase of $54.1 million was primarily attributable to:
|
-
|
$78.3 million provided by operating activities;
|
|
-
|
$17.6 million contributed to our China-based IC facility by noncontrolling interests;
|
|
-
|
$5.3 million government incentives received in China;
|
|
-
|
$3.9 million received from exercises of employee stock options;
|
|
-
|
$5.7 million received from borrowings in China;
|
|
-
|
$36.7 million paid for property, plant, and equipment;
|
|
-
|
$16.9 million used to repurchase our common stock;
|
|
-
|
$5.9 million used to repay debt;
|
|
-
|
$3.3 million favorable effects of currency exchange rates on cash
|
Our working capital at the end of Q3 FY20 was $335.3 million, compared with $275.6 million at the end of fiscal 2019. The increase is primarily attributable to the following increases (decreases) in working capital:
|
-
|
Increased cash and cash equivalents of $54.1 million;
|
|
-
|
increased accounts receivables of $12.4 million;
|
|
-
|
Increased inventories of $6.6 million, acquired to protect against potential COVID-19 related supply chain disruptions;
|
|
-
|
Increased recoverable value added taxes of $10.4 million, related to our China-based facilities;
|
|
-
|
Increased liabilities for capital expenditures of $(24.4) million;
|
|
-
|
Increased current debt of $(3.8) million;
|
|
-
|
Increased value added taxes payable of $(7.8) million;
|
|
-
|
Decreased compensation accruals of $2.1 million;
|
|
-
|
Decreased other accruals and payables (net) of $10.7 million.
|
The net cash provided by operating activities of $78.3 million in YTD FY20 was a $54.8 million increase from $23.5 million provided in YTD FY19. The net increase was primarily due to:
|
-
|
Increased net income of $4.3 million in YTD FY20;
|
|
-
|
Increased non-cash add backs to net income, including depreciation, amortization, share-based compensation, and deferred income taxes of $13.8 million in YTD FY20;
|
-
|
A comparative decrease in value added tax prepayments related to our China facilities of $17.7 million in YTD FY20. These prepayments are recoverable through future revenue transactions of the facilities;
|
-
|
A comparative decrease in the build-up of inventories in YTD FY20 of $8.9 million, which was primarily the result of our initially supplying our China-based FPD facility in YTD FY19;
|
-
|
A comparative increase in value added taxes payable at our two China-based facilities of $7.5 million, which is reflective of their increased revenues in YTD FY20.
|
Net cash used in investing activities was $31.6 million in YTD FY20, a decrease of $110.9 million from the $142.5 million used in YTD FY19. The net decrease in cash used was primarily attributable to decreased capital expenditures of $123.5 million; this was the result of a reduction in payments to equip our China-based facilities, which were in the start-up phase in the first half of fiscal year 2019. A reduction in investment incentives of $12.4 million in YTD FY20, from YTD FY19, partially offset the decrease in net cash used in investing activities realized from the reduction in capital spending.
Net cash flows from financing activities changed from $14.3 million used in YTD FY19 to $4.1 million provided in YTD FY20. Significant components of the $18.4 million net change were:
|
-
|
$55.4 million less debt was repaid in YTD FY20, than in YTD FY19; the primary cause of the decrease was repayment (upon their maturity) of our convertible senior notes in YTD FY19;
|
|
-
|
$26.1 million used to pay dividends to DNP (related to their 49.99% interest in our IC facility in Taiwan) in YTD FY19;
|
|
-
|
$(44.0) million less received from borrowings in China in YTD FY20 than in YTD FY19;
|
|
-
|
$(11.8) million less contributed by DNP to maintain their proportionate ownership interest in our IC joint venture in China in YTD FY20 than in YTD FY19;
|
|
-
|
$(6.2) million more paid in YTD FY20, than in YTD FY19, to acquire our common stock.
|
As of August 2, 2020 and October 31, 2019, our total cash and cash equivalents included $223.8 million and $147.2 million, respectively, held by our foreign subsidiaries. The majority of earnings of our foreign subsidiaries are considered to be indefinitely reinvested. Repatriation of these funds to the U.S. may subject them to U.S. state income taxes and local country withholding taxes in certain jurisdictions. Furthermore, our foreign subsidiaries continue to grow through the reinvestment of earnings in additional manufacturing capacity and capability, particularly in the high-end IC and FPD areas.
Our liquidity is highly dependent on our revenue, cash conversion cycle, and the timing of our capital expenditures (which can vary significantly from period to period). 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. However, depending on conditions in the semiconductor and FPD markets, our cash flows from operations and current holdings of cash may not be adequate to meet our current and long-term needs for capital expenditures, operations and debt repayments. Historically, in certain years, we have used external financing to fund these needs. Due to conditions in the credit markets and covenant restrictions on our existing debt, some financing instruments we have used in the past may not be available to us when required. Consequently, we cannot assure that additional sources of financing would be available to us on commercially favorable terms, should our long-term cash requirements exceed our existing cash and cash available under our credit agreements (which are discussed in Note 5 to the condensed consolidated financial statements).
As of August 2, 2020, we had outstanding capital commitments of approximately $103 million. We intend to finance our capital expenditures with our working capital, contributions from our joint venture partners, borrowings under the MLA we entered into in fiscal 2019 (as discussed in Note 5 to the condensed consolidated financial statements), cash generated from operations and, if necessary, additional borrowings.
Off-Balance Sheet Arrangements
In January 2018, Photronics, through its wholly owned Singapore subsidiary, entered into the PDMCX joint venture with DNP, through its wholly owned subsidiary “DNP Asia Pacific PTE, Ltd.” under which DNP obtained a 49.99% interest in our IC business in Xiamen, China. The joint venture was established to develop and manufacture photomasks for leading edge and advanced generation semiconductors. Under the joint venture’s operating agreement, DNP is afforded, under certain circumstances, the right to put its interest in PDMCX to Photronics. These circumstances include disputes regarding the strategic direction of PDMCX that may arise after the initial two-year term of the Agreement that cannot be resolved between the two parties. As of the date of issuance of this report, DNP had not indicated its intention to exercise this right. In addition, both Photronics and DNP have the option to purchase, or put, their interest from, or to, the other party, should their ownership interest fall below 20% for a period of more than six consecutive months. Under all such circumstances, the sales of ownership interests would be at the exiting party’s ownership percentage of the joint venture’s net book value, with closing to take place within three business days of obtaining required approvals and clearance. Should DNP exercise an option to put their, or purchase our, interest in PDMCX we may, depending on the relationship of the fair and book value of PDMCX’s net assets, incur a loss. As of August 2, 2020, Photronics and DNP each had net investments in PDMCX of $52.4 million.
Business Outlook
We observe that there are significant opportunities in the FPD market, as Korea continues to transition production capacity away from LCD to OLED or AMOLED, China increases G10.5+ development and further penetrates the mobile AMOLED market, and Taiwan invests in micro-LED development. We believe our capacity additions planned for fiscal 2021 will enable us to continue to benefit from all of these factors. In addition, the last phase of our initial investment at our China-based IC facility is scheduled to be in production by the end of the second quarter of 2021, which should enable us to grow our business in this product category. It is, however, to be emphasized that our backlog is typically one to three weeks, which serves to limit our visibility. Furthermore, the demand for photomasks is inherently uneven, both due to the timing of development activities and the composition of the product mix, which may significantly affect our revenues. In addition, the high ASPs of certain high-end products can create volatility in our revenue and profitability.
The near-term effects on our business of geopolitical developments, such as trade policy or measures taken to prevent the spread of coronavirus, cannot be predicted and may have an impact on our operations. We continue to believe that a majority of the growth in the IC and FPD markets will continue to come from the Asia region, predominantly in China. We expect to meet these demands both through the utilization of our new facilities in China, and by importing photomasks into China from our other facilities. We make continual assessments of our global manufacturing strategy and monitor our revenue and related cash flows from operations. These ongoing assessments could result in future facility closures, asset redeployments, impairments of intangible or long-lived assets, workforce reductions, or the addition of manufacturing facilities, all of which would be based on market conditions and customer requirements.
Our future results of operations and the other forward-looking statements contained in this filing involve a number of risks and uncertainties, some of which are discussed in Part1, Item 1A in our Annual Report on Form 10-K for the year ended October 31, 2019, and in Part 2, Item 1A in our Quarterly Report on Form 10-Q for the quarter ended May 3, 2020; a number of other unforeseen factors could cause actual results to differ materially from our expectations.
Effect of Recent Accounting Pronouncements
See “Item 1. Condensed Consolidated Financial Statements– Notes to Condensed Consolidated Financial Statements – Note 15 – Recent Accounting Pronouncements” for recent accounting pronouncements that may affect the Company’s financial reporting.