Washington, D.C. 20549
PHOTRONICS, INC.
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
PHOTRONICS, INC.
See accompanying notes to condensed consolidated financial statements.
PHOTRONICS, INC.
See accompanying notes to condensed consolidated financial statements.
PHOTRONICS, INC.
See accompanying notes to condensed consolidated financial statements.
PHOTRONICS, INC.
PHOTRONICS, INC.
As of January 1, 2018, the Act reduced the corporate income tax rate from a maximum 35% to account fora flat 21%, requiring us to revalue our deferred tax assets and qualitatively disclose; (1)liabilities utilizing the effects of the change in tax law for which accounting is complete; (2) provisional amounts (or adjustments to provisional amounts) for the effects of the tax law for where accounting is not complete, but that a reasonable estimate has been determined; and (3) a reasonable estimate cannot yet be made and therefore taxes are reflected in accordance with law priorrate applicable to the enactment of the Act.
We continue to analyze the provisions of the Act addressing theperiod when a temporary difference will reverse. Our net deferred tax asset revaluationis fully offset by a valuation allowance, and its calculations, the deemed earnings repatriation, including the determination of undistributed non-U.S. earnings, and evaluate potential actions we may consider in lightrevaluation of the deferred tax assets and liabilities resulted in a net-zero impact for the period.
The Act that could affect our fiscal year of 2018 U.S. taxable income. As such, our accountingimposed a transition tax for certain elements within the Act is preliminary, and subject to further clarificationa one-time deemed repatriation of the Actaccumulated earnings of foreign subsidiaries. The entire amount of transition tax was fully offset by Internal Revenue Service. The following istax credits (including carryforwards) that resulted in a discussion of the major provisions of the Act that affect our financial statements, and our preliminary assessment of theprovisional net-zero impact of such provisions on the statements.
period.
| · | The Act repeals the corporate alternative minimum tax (“AMT”) for tax years beginning after December 31, 2017, and provides that existing AMT credit carryforwards are fully refundable over a four year period, starting with the tax year beginning after December 31, 2017. We have approximately $3.9 million of AMT credit carryforwards that we previously determined were not more likely than not going to be realized and, as such, established a valuation allowance for these carryforwards. Accordingly, the Act has changed our determination regarding the realization of the benefit of the carryforwards; therefore, the related valuation allowance has been reversed and the $3.9 million tax benefit has been recorded in our tax provision, excluding any impact of potential future sequestration reductions. |
| · | As of January 1, 2018, the Act reduces the corporate income tax rate from a maximum 35% to a flat 21%. Our fiscal year 2018 blended statutory tax rate is approximately 23.4%, the weighted daily average rate between the pre-enactment U.S. federal statutory tax rate of 35% applicable to our 2018 fiscal year prior to the rate change effective January 1, 2018 and the post-enactment U.S. federal statutory tax rate of 21% applicable to the balance of our 2018 fiscal year. The 21% rate will be applicable to fiscal year 2019 and beyond. Under generally accepted accounting principles, we are required to revalue our deferred tax assets and liabilities utilizing the rate applicable to the period when a temporary difference will reverse. Our preliminary analysis of the two stepped revaluation indicates that our net deferred tax asset will be increased by $2.5 million, with an offsetting change in the related valuation allowance resulting in a provisional net zero impact for our period. |
| · | The Act imposes a transition tax for a one-time deemed repatriation of the accumulated earnings of foreign subsidiaries. The transition tax effective rates are 15.5% on accumulated earnings held in cash (as defined by the Act), and 8% on any remaining balance. Our preliminary analysis indicates an estimated deemed repatriation transition tax of $28.4 million. The preliminary analysis also indicates that the entire amount of transition tax will be fully offset by tax credits and/or available loss carryforwards, resulting in a provisional net zero impact on our period, due in part to an offsetting change in the related valuation allowance. We do not expect that future earnings of foreign subsidiaries will be subject to U.S. federal income tax. No change has been or is anticipated to be made with respect to the year-end fiscal year 2017 indefinite reinvestment assertion of foreign subsidiary earnings. |
| · | Our preliminary analysis of other provisions of the Act, including, but not limited to, 100 percent bonus depreciation and changes to the limitations on the deducibility of meals and entertainment expenses indicate that under our current tax profile there should be limited or no provisional impact for our period. |
| · | Based on the effective date of certain provisions, we will be subject to additional requirements of tax reform beginning in fiscal year 2019. Those provisions include a tax on global intangible low-taxed income (GILTI), a tax determined by base erosion tax benefits (BEAT) from certain payments between a U.S. corporation and foreign subsidiaries, a limitation of certain executive compensation, a deduction for foreign derived intangible income (FDII) and interest expense limitations. We have not completed our analysis of those provisions and the estimated impact. |
On January 18, 2018, the Taiwan Legislature Yuan approved amendments to the Income Tax Act, enacting an increase in the corporate tax rate from 17% to 20%. Under generally accepted accounting principles, we are, which required us to revalue our deferred tax assets and liabilities utilizing the rate applicable to the period when a temporary difference will reverse. Our analysis indicates that our Taiwan deferred tax asset will be increased and, accordingly,Accordingly, a net benefit of $0.2 million is reflected in our period tax provision.provision for the period.
The 19.0% effectiveAdoption of New Accounting Standard
In the first quarter of 2019, the Company adopted Accounting Standards Update No. 2016-16 – “Intra-Entity Transfers Other Than Inventory”, which requires an entity to recognize the income tax rate differs fromconsequences of an intra-entity transfer of an asset other than inventory when the U.S. statutory ratetransfer occurs. In connection therewith, we recorded a transition adjustment of 35%$1.1 million that reduced prepaid income taxes (included in the three month period ended January 29, 2017, primarily due to earnings being taxed at lower statutory rates in foreign jurisdictions, combined with the benefit of various investment credits in a foreign jurisdiction. Valuation allowances in jurisdictions with historic losses eliminate the tax benefit of these jurisdictions. Two five-year tax holidays in Taiwan, one that expired in 2017 and the other that expires in 2019, reduced foreign taxes by $0.1 million in the three month periods ended January 28, 2018 and January 29, 2017, respectively. These tax holidays had no effectOther current assets on the earnings per share of either period.condensed consolidated balance sheets) against beginning retained earnings.
There were unrecognized tax benefits related to uncertain tax positions of $3.7 million at January 28, 2018, and $3.4 million at October 29, 2017, all of which, if recognized, would favorably impact the Company’s effective tax rate. Accrued interest and penalties related to unrecognized tax benefits was $0.1 million at January 28, 2018 and October 29, 2017. Although the timing of the expirations of statutes of limitations may be uncertain, as they can be dependent upon the settlement of tax audits, we believe that it is reasonably possible that up to $1.4 million of our uncertain tax positions (including accrued interest and penalties, and net of tax benefits) may be resolved over the next twelve months. Resolution of these uncertain tax positions may result from either or both of the lapses of statutes of limitations and tax settlements.
NOTE 9 - EARNINGS PER SHARE
The calculationcalculations of basic and diluted earnings per share is presented below.
| | | Three Months Ended | | | Nine Months Ended | |
| | | | | | | | |
| | | Three Months Ended | | | July 28, 2019 | | | July 29, 2018 | | | July 28, 2019 | | | July 29 2018 | |
| | | January 28, 2018 | | | January 29, 2017 | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Net income attributable to Photronics, Inc. shareholders | | $ | 5,898 | | | $ | 1,946 | | | $ | 6,347 | | | $ | 13,005 | | | $ | 20,093 | | | $ | 29,568 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Effect of dilutive securities | | | - | | | | - | | |
| Effect of dilutive securities: | | | | | | | | | | | | | | | | | |
| Interest expense on convertible notes, net of tax | | | | - | | | | 496 | | | | 845 | | | | 1,488 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Earnings used for diluted earnings per share | | $ | 5,898 | | | $ | 1,946 | | | $ | 6,347 | | | $ | 13,501 | | | $ | 20,938 | | | $ | 31,056 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Weighted-average common shares computations: | | | | | | | | | | | | | | | | | | | | | | | | |
| Weighted-average common shares used for basic earnings per share | | | 68,755 | | | | 68,176 | | | | 66,313 | | | | 69,374 | | | | 66,386 | | | | 69,141 | |
| Effect of dilutive securities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Convertible notes | | | | - | | | | 5,542 | | | | 3,147 | | | | 5,542 | |
| Share-based payment awards | | | 617 | | | | 993 | | | | 257 | | | | 342 | | | | 386 | | | | 438 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Potentially dilutive common shares | | | 617 | | | | 993 | | | | 257 | | | | 5,884 | | | | 3,533 | | | | 5,980 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Weighted-average common shares used for diluted earnings per share | | | 69,372 | | | | 69,169 | | | | 66,570 | | | | 75,258 | | | | 69,919 | | | | 75,121 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| Basic earnings per share | | $ | 0.09 | | | $ | 0.03 | | | $ | 0.10 | | | $ | 0.19 | | | $ | 0.30 | | | $ | 0.43 | |
| Diluted earnings per share | | $ | 0.09 | | | $ | 0.03 | | | $ | 0.10 | | | $ | 0.18 | | | $ | 0.30 | | | $ | 0.41 | |
The table below shows the outstanding weighted-average share-based payment awards that were excluded from the calculation of diluted earnings per share because their exercise priceprices exceeded the average market value of the common shares for the period or, under application of the treasury stock method, they were otherwise determined to be anti-dilutive. The table also shows convertible notes that, if converted, would be antidilutive.
| | | Three Months Ended | |
| | | January 28, 2018 | | | January 29, 2017 | |
| | | | | | | |
| Convertible notes | | | 5,542 | | | | - | |
| Share-based payment awards | | | 1,583 | | | | 993 | |
| | | | | | | | | |
| Total potentially dilutive shares excluded | | | 7,125 | | | | 993 | |
| | Three Months Ended | | | Nine Months Ended | |
| | | July 28, 2019 | | | July 29, 2018 | | | July 28, 2019 | | | July 29, 2018 | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| Potentially dilutive shares excluded | | | 1,979 | | | | 1,873 | | | | 1,415 | | | | 1,826 | |
NOTE 10 - CHANGES IN ACCUMULATED OTHER COMPREHENSIVE INCOME BY COMPONENT
The following tables set forth the changes in our accumulated other comprehensive income by component (net of tax of $0) for the three monthand nine-month periods ended JanuaryJuly 28, 20182019 and JanuaryJuly 29, 2017.2018.
| | | Three Months Ended January 28, 2018 | |
| | | Foreign Currency Translation Adjustments | | | Amortization of Cash Flow Hedge | | | Other | | | Total | |
| | | | | | | | | | | | | |
| Balance at October 30, 2017 | | $ | 7,627 | | | $ | (48 | ) | | $ | (688 | ) | | $ | 6,891 | |
| Other comprehensive income (loss) before reclassifications | | | 30,087 | | | | - | | | | (32 | ) | | | 30,055 | |
| Amounts reclassified from other comprehensive income | | | - | | | | 32 | | | | - | | | | 32 | |
| | | | | | | | | | | | | | | | | |
| Net current period other comprehensive income (loss) | | | 30,087 | | | | 32 | | | | (32 | ) | | | 30,087 | |
| Less: other comprehensive (income)loss attributable to noncontrolling interests | | | (4,866 | ) | | | - | | | | 16 | | | | (4,850 | ) |
| | | | | | | | | | | | | | | | | |
| Balance at January 28, 2018 | | $ | 32,848 | | | $ | (16 | ) | | $ | (704 | ) | | $ | 32,128 | |
| | Three Months Ended July 28, 2019 | |
| | | | |
| | | Foreign Currency Translation Adjustments | | | Other | | | Total | |
| | | | | | | | | | |
| Balance at April 29, 2019 | | $ | (6,212 | ) | | $ | (616 | ) | | $ | (6,828 | ) |
| Other comprehensive (loss) income | | | (8,882 | ) | | | 28 | | | | (8,854 | ) |
| Less: other comprehensive (loss) income attributable to noncontrolling interests | | | (1,269 | ) | | | 14 | | | | (1,255 | ) |
| | | | | | | | | | | | | |
| Balance at July 28, 2019 | | $ | (13,825 | ) | | $ | (602 | ) | | $ | (14,427 | ) |
| | | Three Months Ended January 29, 2017 | |
| | | Foreign Currency Translation Adjustments | | | Amortization of Cash Flow Hedge | | | Other | | | Total | |
| | | | | | | | | | | | | |
| Balance at October 31, 2016 | | $ | (6,567 | ) | | $ | (177 | ) | | $ | (927 | ) | | $ | (7,671 | ) |
| Other comprehensive income (loss) before reclassifications | | | (614 | ) | | | - | | | | (20 | ) | | | (634 | ) |
| Amounts reclassified from other comprehensive income | | | - | | | | 32 | | | | - | | | | 32 | |
| | | | | | | | | | | | | | | | | |
| Net current period other comprehensive income (loss) | | | (614 | ) | | | 32 | | | | (20 | ) | | | (602 | ) |
| Less: other comprehensive (income)loss attributable to noncontrolling interests | | | (1,267 | ) | | | - | | | | 10 | | | | (1,257 | ) |
| | | | | | | | | | | | | | | | | |
| Balance at January 29, 2017 | | $ | (8,448 | ) | | $ | (145 | ) | | $ | (937 | ) | | $ | (9,530 | ) |
| | Three Months Ended July 29, 2018 | |
| | | Foreign Currency Translation Adjustments | | | Other | | | Total | |
| | | | | | | | | | |
| Balance at April 30, 2018 | | $ | 24,433 | | | $ | (677 | ) | | $ | 23,756 | |
| Other comprehensive (loss) income | | | (24,572 | ) | | | 65 | | | | (24,507 | ) |
| Less: other comprehensive (loss) income attributable to noncontrolling interests | | | (4,806 | ) | | | 33 | | | | (4,773 | ) |
| | | | | | | | | | | | | |
| Balance at July 29, 2018 | | $ | 4,667 | | | $ | (645 | ) | | $ | 4,022 | |
| | Nine Months Ended July 28, 2019 | |
| | | | |
| | | Foreign Currency Translation Adjustments | | | Other | | | Total | |
| | | | | | | | | | |
| Balance at November 1, 2018 | | $ | (4,328 | ) | | $ | (638 | ) | | $ | (4,966 | ) |
| Other comprehensive (loss) income | | | (9,364 | ) | | | 72 | | | | (9,292 | ) |
| Less: other comprehensive income attributable to noncontrolling interests | | | 133 | | | | 36 | | | | 169 | |
| | | | | | | | | | | | | |
| Balance at July 28, 2019 | | $ | (13,825 | ) | | $ | (602 | ) | | $ | (14,427 | ) |
| | Nine Months Ended July 29, 2018 | |
| | | | |
| | | Foreign Currency Translation Adjustments | | | Amortization of Cash Flow Hedge | | | Other | | | Total | |
| | | | | | | | | | | | | |
| Balance at October 30, 2017 | | $ | 7,627 | | | $ | (48 | ) | | $ | (688 | ) | | $ | 6,891 | |
| Other comprehensive (loss) income before Reclassifications | | | (5,583 | ) | | | - | | | | 86 | | | | (5,497 | ) |
| Amounts reclassified from accumulated other comprehensive income | | | - | | | | 48 | | | | - | | | | 48 | |
| | | | | | | | | | | | | | | | | |
| Net current period other comprehensive (loss) income | | | (5,583 | ) | | | 48 | | | | 86 | | | | (5,449 | ) |
| Less: other comprehensive (loss) income attributable to noncontrolling interests | | | (2,623 | ) | | | - | | | | 43 | | | | (2,580 | ) |
| | | | | | | | | | | | | | | | | |
| Balance at July 29, 2018 | | $ | 4,667 | | | $ | - | | | $ | (645 | ) | | $ | 4,022 | |
NOTE 11 - FAIR VALUE MEASUREMENTS
The accounting framework for determining fair value includes a hierarchy for ranking the quality and reliability of the information used to measure fair value, which enables the reader of the financial statements to assess the inputs used to develop those measurements. The fair value hierarchy consists of three tiers as follows: Level 1, defined as quoted market prices (unadjusted) in active markets for identical securities; Level 2, defined as inputs other than Level 1 that are observable, either directly or indirectly; and Level 3, defined as unobservable inputs that are not corroborated by market data.
We did not have any assets or liabilities measured at fair value, on a recurring or a nonrecurring basis, at January 28, 2018 or October 29, 2017. The assets acquired in connection with our acquisition discussed in Note 4 were recorded at fair value.
Fair Value of Other Financial Instruments
The fair values of our cash and cash equivalents (Level 1 measurements), accounts receivable, accounts payable, and certain other current assets and current liabilities (Level 2 measurements) approximate their carrying valuevalues due to their short-term maturities. The fair valuevalues of our variable rate debt instruments is a Level 2 measurement and approximates their carrying values due to the variable nature of the underlying interest rates. The fair values of our convertible senior notes is a Level 2 measurement, as it was determined using inputs that were either observable market data, or could be derived from, or corroborated with, observable market data. These inputs included our stock price and interest rates offered on debt issued by entities with credit ratings similar to ours. We did 0t have any assets or liabilities measured at fair value, on a recurring or a nonrecurring basis, at July 28, 2019 or October 31, 2018.
Fair Value of Financial Instruments Not Measured at Fair Value
The fair value of our convertible senior notes was a Level 2 measurement, as it was determined using inputs that were either observable market data or could be derived from, or corroborated with, observable market data. These inputs included our stock price and interest rates offered on debt issued by entities with credit ratings similar to ours. The table below presents the fair and carrying values of our convertible senior notes at January 28,October 31, 2018.
| | October 31, 2018 | |
| | | | |
| | | Fair Value | | | Carrying Value | |
| | | | | | | |
| 3.25% convertible senior notes matured April 2019 | | $ | 62,094 | | | $ | 57,453 | |
NOTE 12 – SHARE REPURCHASE PROGRAM
In October 2018, the Company’s board of directors authorized the repurchase of up to $25 million of its common stock, to have been executed in open-market transactions or in accordance with a repurchase plan under rule 10b5-1 of the Securities Act of 1933 (as amended). The share repurchase program commenced on October 22, 2018, and October 29, 2017.was terminated on February 1, 2019.
| | | January 28, 2018 | | | October 29, 2017 | |
| | | Fair Value | | | Carrying Value | | | Fair Value | | | Carrying Value | |
| | | | | | | | | | | | | |
| 3.25% convertible senior notes due 2019 | | $ | 64,486 | | | $ | 57,366 | | | $ | 67,396 | | | $ | 57,337 | |
| | Nine Months Ended July 28, 2019 | | | From Inception Date of October 22, 2018 | |
| | | | | | | |
| Number of shares repurchased | | | 1,137 | | | | 1,467 | |
| | | | | | | | | |
| Cost of shares repurchased | | $ | 10,694 | | | $ | 13,807 | |
| | | | | | | | | |
| Average price paid per share | | $ | 9.40 | | | $ | 9.41 | |
In August 2019, the Company’s board of directors authorized the repurchase of up to $100 million of its common stock, to be executed in accordance with a repurchase plan under rule 10b5-1 of the Securities Act of 1933 (as amended). The authorization does not obligate the Company to repurchase any dollar amount or number of shares of common stock, and the repurchase program may be suspended or discontinued at any time.
NOTE 1213 - COMMITMENTS AND CONTINGENCIES
As of JanuaryJuly 28, 2018,2019, the Company had commitments outstanding for capital equipment expenditures of approximately $190 million.$100 million, nearly all of which related to building and equipping our China facilities.
The Company is
We are subject to various claims that arise in the ordinary course of business. We believe that such claims, individually or in the aggregate, will not have a material effect on the condensed consolidated financial statements.
NOTE 1314 - RECENT ACCOUNTING PRONOUNCEMENTS
Accounting Standards Updates to be Implemented
In December 2017,June 2016, the SecuritiesFinancial Accounting Standards Board (“FASB”) issued ASU 2016-13 “Measurement of Credit Losses”, the main objective of which is to provide more useful information about expected credit losses on financial instruments and Exchange Commission released Staff Accounting Bulletin No. 118 (“SAB 118”)other commitments of an entity to address situations whereextend credit. In support of this objective, the accounting under ASC Topic 740 – “Income Taxes” is incomplete for certain income tax effectsASU replaces the incurred loss model, found in current GAAP, with an expected credit loss model; the new model requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This ASU requires a cumulative-effect adjustment as of the Tax Cuts and Jobs Act,beginning of the first reporting period in which was signed into law on December 22, 2017, and changed existing U.S. tax law. We adopted thisthe guidance is adopted. ASU 2016-13 is effective for Photronics, Inc. in ourits first quarter of fiscal year 2018. Please see Note 82021, with early adoption permitted. We are currently evaluating the effect that this ASU will have on our consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02 “Leases (Topic 842)”, which requires lessees to recognize right-of-use assets and corresponding liabilities for all leases with an initial term in excess of twelve months. ASU 2016-02 was to be adopted using a discussionmodified retrospective approach, that requires leases to be measured and recognized under the new guidance at the beginning of the earliest period presented. In July 2018, the FASB issued ASU 2018-11 “Leases (Topic 842) – Targeted Improvements” (“ASU 2018-11”), which provided entities with an additional (and optional) transition method to adopt the new leases standard. Under this optional transition method, an entity initially applies the new leases standard at its adoption date and recognizes the effects of adoptingadoption through cumulative-effect adjustments to its beginning balance sheet. We will utilize this optional method when we transition to the new leases guidance and, as a result, expect to recognize significant amounts of right-of-use assets and lease liabilities in our fiscal year 2020 beginning balance sheet. ASU 2016-02 included a number of practical expedients, which we are currently in the process of evaluating, that entities can elect to use as they transition to the new guidance. To date, an implementation team has been established to evaluate our lease portfolio, system process and policy change requirements. The Company has made progress in drafting new lease accounting policies, and is gathering the necessary data elements for the lease population.
Accounting Standards Updates Implemented
In November 2016, the FASB issued ASU 2016-18 “Restricted Cash”, which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 iswas effective for Photronics, Inc. in its first quarter of fiscal year 2019 and should bewas applied on a retrospective transition basis. EarlyOur adoption is permitted, including adoption in an interim period. We are currently evaluating the effect thatof this ASU will have onUpdate did not materially impact our consolidated financial statements.cash flows statement.
In October 2016, the FASB issued ASU 2016-16 “Intra-Entity Transfers of Assets Other Than Inventory”, which eliminates the exception of recognizing, at the time of transfer, current and deferred income taxes for intra-entity asset transfers other than inventory. ASU 2016-16 iswas effective for us in our first quarter of fiscal year 2019 and should be applied on a modified retrospective transition basis. Early adoption is permitted asPlease see Note 8 for a discussion of the beginningeffects of an annual reporting period for which interim or annual financial statements have not been issued or made available for issuance. We are currently evaluating the effectadopting this ASU will have on our consolidated financial statements.
guidance.
In June 2016, the FASB issued ASU 2016-13 “Measurement of Credit Losses”, the main objective of which is to provide more useful information about expected credit losses on financial instruments and other commitments of an entity to extend credit. In support of this objective, the ASU replaces the incurred loss impairment methodology, found in current GAAP, with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This ASU requires a cumulative-effect adjustment as of the beginning of the first reporting period in which the guidance is adopted. ASU 2016-13 is effective for Photronics, Inc. in its first quarter of fiscal year 2021, with early adoption permitted beginning in the first quarter of fiscal year 2019. We are currently evaluating the effect that this ASU will have on our consolidated financial statements.
In March 2016, the FASB issued ASU 2016 – 09 “Improvements to Employee Share-Based Payment Accounting”, which simplifies the accounting for share-based payment transactions including their income tax consequences, classification as either equity or liability awards, classification on the statement of cash flows, and other areas. The method of adoption varies with the different aspects of the Update. Adoption of this guidance in the first quarter of our fiscal year 2018 did not have a material impact on our financial statements.
In February 2016, the FASB issued ASU 2016-02 “Leases (Topic 842)”, which requires lessees to recognize right-of-use assets and corresponding liabilities for all leases with an initial term in excess of twelve months. ASU 2016-02 is to be adopted using a modified retrospective approach, which includes a number of practical expedients, that requires leases to be measured and recognized under the new guidance at the beginning of the earliest period presented. The ASU is effective for Photronics, Inc. in the first quarter of fiscal year 2020, with early application permitted. We are currently evaluating the effect that this ASU will have on our consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09 “Revenue from Contracts with Customers”, which will supersedesuperseded nearly all then existing revenue recognition guidance under accounting principles generally accepted in the United States. The core principle of this ASU is that revenue should be recognized for the amount of consideration expected to be received for promised goods or services transferred to customers. This ASU also requires additional disclosure about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments, and assets recognized for costs incurred to obtain or fulfill a contract. In August 2015, the FASB issued ASU 2015-14 which defersdeferred the effective date of ASU 2014-09 by one year and allowsallowed entities to early adopt, but no earlier than the original effective date. ASU 2014-09 will now be effective for Photronics, Inc. in the first quarter of our fiscal year 2019. This update allowsallowed for either full retrospective or modified retrospective adoption. In April 2016, the FASB issued ASU 2016-10 “Identifying Performance Obligations and Licensing” which amendsamended guidance previously issued on these matters in ASU 2014-09. The effective date and transition requirements of ASU 2016-10 arewere the same as those for ASU 2014-09.
We anticipateadopted the new revenue and related guidance on November 1, 2018, using the modified retrospective approach, under which we increased our accounts receivable by $0.6 million, recognized contract assets of $4.6 million, reduced our inventories balance by $3.7 million, and recorded an accrual for income taxes of $0.3 million. The recognition of, and adjustments to, these items were reflected in increases to our retained earnings and noncontrolling interest balances of $1.1 million and $0.1 million, respectively. The most significant impact of the new guidance on our financial statements is its requirement for us to recognize revenue as we manufacture products for which, in the event that the customer cancels the contract, we are entitled to reasonable compensation for work we have completed prior to cancellation. Prior to our adoption of Topic 606, we recognized revenue when we shipped to customers or, under some arrangements, when the customers received the goods. The impact of the adoption of this ASUguidance on our July 28, 2019, financial statements is presented in Note 6.
The guidance allows for a number of accounting policy elections and practical expedients. In addition to our above-mentioned election to use the modified retrospective application method for adopting the guidance, those we have employed that are most significant to us are summarized below.
Shipping and handling activities performed after control of a good is transferred to a customer
We have elected to treat shipping and handling activities that occur after control of a good is transferred to a customer as activities to fulfill our promise to transfer goods to the customer. Thus, such activities will result in the accelerated recognition of certain revenue streams as, upon adoption of this Update, some amounts in our work-in process inventory willnot be considered to represent promisedbe separate performance obligations under contracts with our customers.
Non-recognition of financing component when we transfer goods transferredto a customer and the period between when we transfer and when we are paid will be less than one year
We have elected the practical expedient that allows for the non-recognition, as a component of a customer contract, of a financing component when the period between when we transfer a good and when we are paid will be less than one year.
Exclusion of sales and similar taxes collected from customers in the transaction price
Consistent with our practice before adoption of the new guidance, we will not recognize sales and similar taxes we collect from customers as revenue.
Use of an “input method” to measure our progress towards the transfer of control of performance obligations to customers
As, in our judgment, an input method based on our efforts to satisfy our performance obligations will best serve to depict the transfer of control of our performance obligations to our customers, requiring uswe have adopted an accounting policy to recognize consideration for thoseemploy such a method. Our decision was based primarily on the facts that our photomasks are not physically transferred goods in amountsto customers until they are complete, and that we expectcan employ our input-based cost accumulation systems and methods to be entitledmeasure our progress towards the transfer of control of our performance obligations to receive in exchange for them. However, we cannot currently quantify with reasonable certainty the effect this anticipated acceleration of revenue will have on our consolidated financial statements. We expect to adopt this guidance using the modified retrospective approach.customers.
Non-disclosure of the transaction prices of unsatisfied or partially satisfied performance obligations
17
For contracts that have an original expected duration of one year or less, we have elected the practical expedient that allows us not to disclose the aggregate transaction prices of unsatisfied or partially satisfied performance obligations that exist at the end of a reporting period.
| 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 20172018 year), that may cause actual results to materially differ from these expectations.
We sell substantially all of our photomasks to semiconductor and FPD designers and manufacturers. Photomask technology is also being applied to the fabrication of other higher performancehigher-performance electronic products such as photonics, micro-electronicmicroelectronic 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 microeletronicmicroelectronic 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.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 24twenty-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 performancehigh-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.
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, to be executed in accordance with a repurchase plan under rule 10b5-1 of the Securities Act of 1933 (as amended). The authorization does not obligate the Company to repurchase any dollar amount or number of shares of common stock, and the repurchase program may be suspended or discontinued at any time.
Effective the third quarter of fiscal 2019, the Company entered into a Master Lease Agreement (“MLA”) which enables us to request advance payments or other funds for equipment or enter into an equipment lease in the U.S. In connection with this MLA, we were approved for financing of $35 million for the purchase of equipment; as of July 28, 2019, we had no outstanding borrowings against this MLA. In the fourth quarter of fiscal 2019, the financing entity, upon our request, made an advance payment of $3.4 million to an equipment vendor on our behalf. Interest on this borrowing is payable monthly at thirty-day LIBOR plus 1%, and will continue to accrue until the borrowing is repaid or, as allowed under the MLA, we enter into a lease for the equipment. All borrowings under the MLA are secured by the equipment purchased or financed.
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 second quarter of fiscal 2019, PDMC, the Company’s majority-owned IC subsidiary in Taiwan, declared a dividend of which 49.99%, or approximately $18.8 million, will be paid to noncontrolling interests in the fourth quarter of fiscal 2019.
In the first quarter of fiscal 2019, PDMC paid a dividend, of which 49.99%, or approximately $26.1 million, was paid to noncontrolling interests.
In the first quarter of fiscal 2019, PDMCX was approved for credit of $50 million, subject to certain limitations related to PDMCX registered capital at the time of the initial approval, pursuant to which PDMCX has and will enter into separate loan agreements (“the Project Loans”) for intermittent borrowings. The Project Loans, which are denominated in Chinese renminbi (RMB), are being used to finance certain capital expenditures in China. PDMCX granted liens on its land, building, and certain equipment as collateral for the Project Loans. As of July 28, 2019, PDMCX had borrowed 243.4 million RMB ($35.4 million) against this approval, which includes $9.6 million borrowed during the three-month period ended July 28, 2019. 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 $25.0 million, pursuant to which PDMCX may enter into separate loan agreements. Under this credit agreement (the “Working Capital Loan”), PDMCX can borrow up to 140.0 million RMB, or approximately $20.4 million, to pay value-added taxes (“VAT”) and up to 60.0 million RMB ($8.7 million) to fund operations; combined total borrowings are limited to $25.0 million. During the quarter ended July 28, 2019, PDMCX borrowed 11.4 million RMB ($3.9 million) to fund operations, with repayments due one year from their borrowing dates. Through July 28, 2019, PDMCX borrowed 68.0 million RMB ($9.9 million) to pay VAT, and repaid $0.1 million as of that date. Payments on these borrowings are due semiannually, at an increasing rate, through January 2022. See Note 5 of the condensed consolidated financial statements for additional information on these loans.
In the fourth quarter of fiscal 2018, we entered into a five year amended and restated credit agreement (“the credit agreement”), which has a $50 million borrowing limit, with an expansion capacity to $100 million. The credit agreement is secured by substantially all of our assets located in the United States and common stock we own in certain foreign subsidiaries. The credit agreement includes minimum interest coverage ratio, total leverage ratio, and minimum unrestricted cash balance covenants (all of which we were in compliance with at July 28, 2019), and limits the amount of dividends, distributions, and redemptions we can pay on our stock to an aggregate amount of $100 million. We had no outstanding borrowings against the credit agreement at July 28, 2019, and $50 million was available for borrowing. The interest rate on the credit agreement (2.5% at July 28, 2019) is based on our total leverage ratio at LIBOR plus a spread, as defined in the credit agreement.
In the fourth quarter of fiscal 2018, the Company’s board of directors authorized the repurchase of up to $25 million of its common stock, to have been executed in open-market transactions or in accordance with a repurchase plan under rule 10b5-1 of the Securities Act of 1933 (as amended). The share repurchase program commenced, under rule 10b5-1, on October 22, 2018, and expired on February 1, 2019. In total, we repurchased 1.5 million shares at a cost of $13.8 million (an average of $9.41 per share) under this program.
In the third quarter of fiscal 2018, the Company’s board of directors authorized the repurchase of up to $20 million of its common stock, which was effectuated in open-market transactions or in accordance with a repurchase plan under rule 10b5-1 of the Securities Act of 1933 (as amended). The share repurchase program commenced on July 10, 2018, and ended in October 2018. In total, under this program, we repurchased 2.2 million shares at a cost of $20 million (an average of $8.97 per share).
In the first quarter of fiscal 2018, we announced the successful closing of the China joint venture agreement with Dai Nippon Printing Co., Ltd. (“DNP”), which we had agreed to enter into and announced in the third quarter of fiscal 2017. Under the agreement, our wholly-ownedwholly owned Singapore subsidiary owns 50.01% of the joint venture, which is named Xiamen American Japan Photronics DNP Mask Corporation XiamenCo., Ltd. (PDMCX), and a subsidiary of DNP owns the remaining 49.99%. The financial results of the joint venture are included in the Photronics, Inc. consolidated financial statements. See Note 54 of the condensed consolidated financial statements for additional information on the joint venture.
In the fourth quarter of fiscal 2017, we announced that Photronics UK, Ltd.,
oura wholly owned subsidiary
of ours, signed an investment agreement with
the 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
willagreed to 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.
TheAs of April 28, 2019, we had met the minimum investment requirement and satisfied the terms of the agreement. Hefei State Hi-tech Industry Development Zone
will provideis providing certain investment incentives and support for this facility, which
will have initialhas the capability to produce up to G10.5+ large area masks and AMOLED products. Construction
beganof this facility was completed in late
20172018, and production
is anticipated to commencecommenced in
2019.
In the fourthsecond quarter of fiscal 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. As discussed above, in the first quarter of fiscal 2018, we entered into a joint venture agreement with DNP, under which they obtained a 49.99% ownership interest in this facility. The total investment, per the agreement, is $160 million to be funded over the next several years with cash and local borrowings. Construction began in 2017 and production is anticipated to start in 2019.
Material Changes in Results of Operations
Three and Nine Months ended JanuaryJuly 28, 2018, October 29, 2017 and January 29, 20172019
The following table representspresents selected operating information expressed as a percentage of net sales.revenue.
| | | Three Months Ended | | | Three Months Ended | | | Nine Months Ended | |
| | | January 28, 2018 | | | October 29, 2017 | | | January 29, 2017 | | | July 28, 2019 | | | April 28, 2019 | | | July 29, 2018 | | | July 28, 2019 | | | July 29, 2018 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Revenue | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % |
| Cost of goods sold | | | (77.6 | ) | | | (78.1 | ) | | | (79.1 | ) | | | 77.9 | | | | 80.2 | | | | 73.9 | | | | 79.0 | | | | 75.4 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | | 22.4 | | | | 21.9 | | | | 20.9 | | | | 22.1 | | | | 19.8 | | | | 26.1 | | | | 21.0 | | | | 24.6 | |
| Selling, general and administrative expenses | | | (9.5 | ) | | | (8.4 | ) | | | (9.9 | ) | | | 9.5 | | | | 10.1 | | | | 9.2 | | | | 10.2 | | | | 9.7 | |
| Research and development expenses | | | (3.3 | ) | | | (3.2 | ) | | | (3.1 | ) | | | 2.9 | | | | 2.7 | | | | 1.9 | | | | 3.0 | | | | 2.7 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Operating income | | | 9.6 | | | | 10.3 | | | | 7.9 | | | | 9.7 | | | | 7.0 | | | | 15.0 | | | | 7.8 | | | | 12.2 | |
| Other income (expense), net | | | (3.4 | ) | | | 0.4 | | | | (1.9 | ) | |
| Other (expense) income, net | | | | (0.2 | ) | | | 3.0 | | | | 1.0 | | | | 1.2 | | | | 0.2 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Income before income taxes | | | 6.2 | | | | 10.7 | | | | 6.0 | | | | 9.5 | | | | 10.0 | | | | 16.0 | | | | 9.0 | | | | 12.4 | |
| Income tax benefit (provision) | | | 1.5 | | | | (2.0 | ) | | | (1.9 | ) | |
| Income tax provision | | | | 2.4 | | | | 2.5 | | | | 1.5 | | | | 2.0 | | | | 1.0 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | | 7.7 | | | | 8.7 | | | | 4.1 | | | | 7.1 | | | | 7.5 | | | | 14.5 | | | | 7.0 | | | | 11.4 | |
| Net income attributable to noncontrolling interests | | | (2.9 | ) | | | (4.2 | ) | | | (2.3 | ) | | | 2.5 | | | | 1.1 | | | | 5.0 | | | | 1.9 | | | | 3.8 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income attributable to Photronics, Inc. shareholders | | | 4.8 | % | | | 4.5 | % | | | 1.8 | % | | | 4.6 | % | | | 6.4 | % | | | 9.5 | % | | | 5.1 | % | | | 7.6 | % |
Note: All of the following tabular comparisons, unless otherwise indicated, are for the three months ended JanuaryJuly 28, 2019 (Q3 FY19), April 28, 2019 (Q2 FY19) and July 29, 2018 (Q1(Q3 FY18), Octoberand for the nine months ended July 28, 2019 (YTD FY19) and July 29, 2017 (Q4 FY17) and January 29, 2017 (Q1 FY17)2018 (YTD FY18), in millions of dollars.
Revenue
| | | Q1 FY18 FROM Q4 FY17 | | | Q1 FY18 FROM Q1 FY17 | |
| | | Revenue in Q1 FY18 | | | Percent Change | | | Increase (Decrease) | | | Revenue in Q1 FY18 | | | Percent Change | | | Increase (Decrease) | |
| IC | | | | | | | | | | | | | | | | | | |
| High-end | | $ | 33.4 | | | | 9.6 | % | | $ | 2.9 | | | $ | 33.4 | | | | 50.6 | % | | $ | 11.2 | |
| Mainstream | | | 62.3 | | | | (5.0 | %) | | | (3.3 | ) | | | 62.3 | | | | (3.0 | %) | | | (1.9 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 95.7 | | | | (0.4 | %) | | $ | (0.4 | ) | | $ | 95.7 | | | | 10.7 | % | | $ | 9.3 | |
| FPD | | | | | | | | | | | | | | | | | | | | | | | | |
| High-end | | $ | 18.7 | | | | 9.6 | % | | $ | 1.7 | | | $ | 18.7 | | | | 8.9 | % | | $ | 1.5 | |
| Mainstream | | | 9.0 | | | | 15.4 | % | | | 1.2 | | | | 9.0 | | | | 45.3 | % | | | 2.8 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | $ | 27.7 | | | | 11.4 | % | | $ | 2.9 | | | $ | 27.7 | | | | 18.5 | % | | $ | 4.3 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Revenue | | $ | 123.4 | | | | 2.0 | % | | $ | 2.5 | | | $ | 123.4 | | | | 12.4 | % | | $ | 13.6 | |
Revenue increased 2.0% in Q1 FY18, compared with Q4 FY17, mainlyThe following tables present revenue changes by product type and geographic areas. Columns may not total due to increased FPD and high-end IC revenues, partially offset by decreased mainstream IC sales. The high-end IC increase was driven by sales of high-end logic to Asian foundries. For FPD, demand for LCD masks improved as our customers released new designs in an effort to improve factory utilization. Sales of mainstream IC products were down due to seasonal softness.rounding.
| | | Q3 FY19 from Q2 FY19 | | | Q3 FY19 from Q3 FY18 | | | YTD FY19 from YTD FY18 | |
| | | Revenue in Q3 FY19 | | | Increase (Decrease) | | | Percent Change | | | Increase (Decrease) | | | Percent Change | | | Revenue in YTD FY19 | | | Increase (Decrease) | | | Percent Change | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| IC | | | | | | | | | | | | | | | | | | | | | | | | |
| High-end | | $ | 38.5 | | | $ | 0.0 | | | | 0.1 | % | | $ | (7.6 | ) | | | (16.5 | )% | | $ | 111.5 | | | $ | (9.5 | ) | | | (7.8 | )% |
| Mainstream | | | 61.7 | | | | 1.6 | | | | 2.6 | % | | | 0.6 | | | | 0.9 | % | | | 182.2 | | | | (2.1 | ) | | | (1.1 | )% |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total IC | | $ | 100.2 | | | $ | 1.6 | | | | 1.6 | % | | $ | (7.1 | ) | | | (6.6 | )% | | $ | 293.7 | | | $ | (11.5 | ) | | | (3.8 | )% |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| FPD | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| High-end | | $ | 25.9 | | | $ | 3.0 | | | | 13.0 | % | | $ | 8.9 | | | | 52.0 | % | | $ | 70.4 | | | $ | 16.3 | | | | 30.1 | % |
| Mainstream | | | 12.0 | | | | 2.0 | | | | 19.4 | % | | | (0.1 | ) | | | (0.7 | )% | | | 30.4 | | | | (1.0 | ) | | | (3.0 | )% |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total FPD | | $ | 37.9 | | | $ | 4.9 | | | | 15.0 | % | | $ | 8.8 | | | | 30.1 | % | | $ | 100.8 | | | $ | 15.3 | | | | 17.9 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total Revenue | | $ | 138.1 | | | $ | 6.5 | | | | 5.0 | % | | $ | 1.7 | | | | 1.3 | % | | $ | 394.4 | | | $ | 3.8 | | | | 1.0 | % |
Revenue increased 12.4% in Q1 FY18, compared with Q1 FY17, mainly due to increased FPD and high-end IC revenues, partially offset by decreased mainstream IC sales. The high-end IC increase was driven by high-end logic and memory sales to Asian foundries, as demand in the prior year had been soft for these products. For FPD, demand of LCD masks improved as our customers released new designs in an effort to improve factory utilization. Mainstream IC demand was softer compared to last year.
In Q1 FY18, we changed the threshold for the definition of high-end IC, from 45 nanometer or smaller to 28 nanometer or smaller, to reflect the overall advancement of technology in the semiconductor industry. All comparisons to prior period results in this MD&A reflect this modification. Our definition of high-end FPD products remains as G8 and above and active matrix organic light-emitting diode (AMOLED) display screens. High-end photomasks typically have higher ASPs than mainstream products.
| | Q3 FY19 from Q2 FY19 | | | Q3 FY19 from Q3 FY18 | | | YTD FY19 from YTD FY18 | |
| | | Revenue in Q3 FY19 | | | Increase (Decrease) | | | Percent Change | | | Increase (Decrease) | | | Percent Change | | | Revenue in YTD FY19 | | | Increase (Decrease) | | | Percent Change | |
| Taiwan | | $ | 61.3 | | | $ | 4.8 | | | | 8.5 | % | | $ | (0.8 | ) | | | (1.3 | )% | | $ | 175.5 | | | $ | 0.7 | | | | 0.4 | % |
| Korea | | | 37.1 | | | | (0.9 | ) | | | (2.4 | )% | | | (0.1 | ) | | | (0.3 | )% | | | 110.4 | | | | 4.1 | | | | 3.8 | % |
| United States | | | 25.4 | | | | (1.4 | ) | | | (5.2 | )% | | | (2.4 | ) | | | (8.5 | )% | | | 74.6 | | | | (7.4 | ) | | | (9.0 | )% |
| Europe | | | 7.9 | | | | (0.5 | ) | | | (5.9 | )% | | | (0.6 | ) | | | (7.0 | )% | | | 24.7 | | | | (1.0 | ) | | | (4.0 | )% |
| China | | | 6.0 | | | | 4.5 | | | | 306.4 | % | | | 5.7 | | | | 2,225.3 | % | | | 7.7 | | | | 7.2 | | | | 1,363.0 | % |
| Other | | | 0.5 | | | | 0.0 | | | | 6.2 | % | | | (0.1 | ) | | | (17.4 | )% | | | 1.5 | | | | 0.2 | | | | 14.5 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | $ | 138.1 | | | $ | 6.5 | | | | 5.0 | % | | $ | 1.7 | | | | 1.3 | % | | $ | 394.4 | | | $ | 3.8 | | | | 1.0 | % |
The revenue momentum at the end of 2017 has continued into 2018. We anticipate that most of our high-end markets should continue to grow in Q2 FY18, the exception being high-end logic where, given the increase in business that we have experienced during the last two quarters, there may be a pause.
Our quarterly revenues can be affected by the seasonal purchasing tendencies of our customers. As a result, demand for our products is typically negatively impacted during the first, and sometimes the second, quarters of our fiscal year, by the North American, European, and Asian holiday periods, as some of our customers reduce their development and, consequently, their buying activities during those periods. High-end photomask applications include mask sets for 28 nanometer and smaller products for IC, and G8 and above and active matrix organic light-emitting diode (AMOLED) display technologies for FPD products. High-end photomasks typically have higher selling prices (ASPs) than mainstream products.
The following tables present changesRevenue increased 5.0% in revenue from Q4 FY17 and Q1 FY17 to Q1 FY18 by geographic area:
| | | Q1 FY18 FROM Q4 FY17 | | | Q1 FY18 FROM Q1 FY17 | |
| | | Revenue in Q1 FY18 | | | Percent Change | | | Increase (Decrease) | | | Revenue in Q1 FY18 | | | Percent Change | | | Increase (Decrease) | |
| | | | | | | | | | | | | | | | | | | |
| Taiwan | | $ | 56.5 | | | | 2.7 | % | | $ | 1.5 | | | $ | 56.5 | | | | 21.6 | % | | $ | 10.0 | |
| Korea | | | 33.0 | | | | 14.0 | % | | | 4.0 | | | | 33.0 | | | | 8.9 | % | | | 2.7 | |
| United States | | | 25.0 | | | | (5.5 | )% | | | (1.5 | ) | | | 25.0 | | | | 5.9 | % | | | 1.4 | |
| Europe | | | 8.5 | | | | (12.8 | )% | | | (1.2 | ) | | | 8.5 | | | | (2.8 | )% | | | (0.2 | ) |
| Other | | | 0.4 | | | | (48.7 | )% | | | (0.4 | ) | | | 0.4 | | | | (44.8 | )% | | | (0.3 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | $ | 123.4 | | | | 2.0 | % | | $ | 2.4 | | | $ | 123.4 | | | | 12.4 | % | | $ | 13.6 | |
Gross Profit
| | | Three Months Ended | |
| | | | Q1 FY18 | | | | Q4 FY17 | | | Percent Change | | | | Q1 FY17 | | | Percent Change | |
| | | | | | | | | | | | | | | | | | | |
| Gross profit | | $ | 27.7 | | | $ | 26.4 | | | | 4.6 | % | | $ | 23.0 | | | | 20.3 | % |
| Gross margin | | | 22.4 | % | | | 21.9 | % | | | | | | | 20.9 | % | | | | |
Gross profit and gross margin both increased in Q1 FY18 from Q4 FY17Q3 FY19, compared with Q2 FY19, as a result of overall FPD and IC growth. FPD revenue increased 15% due to increased demand for AMOLED products, as our customers in Korea and China continued to release new designs, and we benefited from an increase in capacity as we ramp production in China, including for G10.5+ photomasks. IC revenue and reduced labor and overhead costs, with the greatest reductions experiencedincreased 1.6% due to increased demand from Asian foundries for mainstream nodes.
Revenue increased 1.3% in equipment maintenance and outsourced manufacturing costs. These reductions were somewhat offset by increased material costs. Gross profit and gross margin increased in Q1 FY18,Q3 FY19, compared with Q1 FY17,Q3 FY18, as increased FPD revenues offset a decline in IC. FPD revenues increased 30.1% primarily due to significantly increased demand for AMOLED products. We also ramped production of G10.5+ photomasks at our new facility in China. IC revenue decreased 6.6% from the prior year quarter, due in part to the geopolitical conditions in Asia tempering growth in that region.
Revenue increased 1.0% in YTD FY19, compared with YTD FY18, as increased demand for AMOLED products offset a moderate decline in IC demand and a more substantial decrease in demand for other high-end FPD products (excluding G10.5+ masks). Demand for IC was notably strong from both foundries and customers with captive mask shops in YTD FY18.
Looking forward, we expect demand for both AMOLED and large format FPD masks (i.e. G10.5+) to increase, as more panel fabrication facilities begin production and new design releases occur at both new and existing facilities. High-end IC is expected to be stable to improving, but growth may be temporarily forestalled in Asia due to the effects of the current state of U.S. – China trade relations, as well as rising tensions between Japan and Korea, which may present supply-chain challenges for some of our customers. Despite these issues, we believe that the IC and FPD markets in Asia represent long-term growth opportunities.
Gross Margin
| | Three Months Ended | | | Nine Months Ended | |
| | | Q3 FY19 | | | Q2 FY19 | | | Percent Change | | | Q3 FY18 | | | Percent Change | | | YTD FY19 | | | YTD FY18 | | | Percent Change | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Gross profit | | $ | 30.6 | | | $ | 26.0 | | | | 17.5 | % | | $ | 35.6 | | | | (14.1 | )% | | $ | 82.7 | | | $ | 96.1 | | | | (13.9 | )% |
| Gross margin | | | 22.1 | % | | | 19.8 | % | | | | | | | 26.1 | % | | | | | | | 21.0 | % | | | 24.6 | % | | | | |
Gross margin increased 2.3% from Q2 FY19, primarily as a result of the $6.5 million increase in revenue discussed above. Reduced compensation and related expenses of $0.3 million, and an increase of $0.6 million of overhead costs transferred to research and development expense, also favorably impacted gross margin. Somewhat offsetting these favorable impacts, depreciation expense increased $2.2 million in overallQ3 FY19, as we recognized a full quarter of depreciation for assets placed in service at our China FPD plant and commenced depreciation on a significant number of assets at our China IC plant. In addition, equipment costs, primarily related to tool relocations to our China facilities, increased $0.6 million from the prior quarter. On a consolidated basis, material costs, as a percentage of revenue, which was predominantly driven bysequentially increased sales of high-end IC photomasks. We operate1.7%, primarily due to changes in a high fixed cost environment and, to the extent that our revenues and utilization increase or decrease, our gross margin and gross profit will generally be positively or negatively impacted.product mix.
Gross margin decreased 4.0% in Q3 FY19 from Q3 FY18, despite a 1.3% increase in revenue from the prior year quarter. The decrease was, in significant part, due to increased losses at our two China facilities of $6.3 million, both of which recently commenced manufacturing operations. The increased losses at the China facilities were, to a great degree, caused by increased depreciation expense of $2.8 million, as depreciation commenced on equipment when it achieved customer qualification, which precedes revenue generation. Compensation and related expenses at the China facilities increased by $0.9 million from the prior year quarter, reflecting the increased staffing required for qualification and production.
On a year-to-date basis, gross margin decreased 3.6%, with increased losses totaling $9.8 million at our two China-based facilities constituting the most significant causes; our FPD facility in China commenced production late in Q2 FY19, and our IC facility commenced production in Q3 FY19.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by $1.6decreased $0.1 million, or 15.4%1.1%, to $11.8$13.1 million in Q1 FY18,Q3 FY19, from $10.2$13.3 million in Q4 FY17,Q2 FY19, primarily due to bad debt reserve adjustments that occurreddecreased general and administrative expenses of $0.3 million, partially offset by increased selling expenses in the prior quarter and increased professional fees in the current quarter.China. Selling, general and administrative expenses increased in Q1 FY18 by $0.9Q3 FY19 $0.6 million, or 8.1%5.0%, to $11.8$13.1 million from $10.9$12.5 million in Q1 FY17, primarily asQ3 FY18. Selling general and administrative expenses incurred in China increased $0.7 million from the prior year quarter, reflecting the completion of construction and commencement of operations at our two China facilities. On a result ofyear-to-date basis, selling, general and administrative expenses increased professional fees, freight, and travel expenses, which increased as a result of activities$2.3 million, or 6.1%, to $40.2 million from $37.9 million. Expenses related to our expansion into China.China accounted for $2.0 million of this increase; increased compensation and related expenses at other sites comprised an additional $0.2 million of the total increase.
Research and Development Expenses
Research and development expenses primarily consist of development efforts related to high-end process technologies for 28nm and belowsmaller IC nodes. In Asia, in addition to the focus on high-end IC process technology nodes, G8 and above FPDs and AMOLED applications. applications are also under development.
Research and development expenses increased by $0.3$0.5 million, or 6.9%14.2%, to $4.1from Q2 FY19, reflecting an increase in IC related qualification activities somewhat offset by decreased qualification activities in FPD (except China). Research and development expenses increased $1.4 million in Q1 FY18Q3 FY19, or 52.5% from $3.8 million in Q4 FY17,Q3 FY18; increased IC related qualification activities accounted for the preponderance of the change, with most of the remainder being attributable to qualification activities at our China FPD facility. On a year-to-date basis, research and by $0.6development expenses increased $1.3 million, or 17.8%12.1%, from Q1 FY17, withas qualification related expenses increased for both of the increases primarily resulting from increased customer qualification costs for high-end IC reticles in the U.S.and FPD products.
Other Income (Expense), net
| | | Three Months Ended | | | Three Months Ended | | | Nine Months Ended | |
| | | | Q1 FY18 | | | | Q4 FY17 | | | | Q1 FY17 | | | Q3 FY19 | | | Q2 FY19 | | | Q3 FY18 | | | YTD FY19 | | | YTD FY18 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest income and other income (expense), net | | $ | (3.5 | ) | | $ | 1.1 | | | $ | (1.5 | ) | | $ | - | | | $ | 4.3 | | | $ | 2.0 | | | $ | 6.0 | | | $ | 2.3 | |
| Interest expense | | | (0.6 | ) | | | (0.6 | ) | | | (0.6 | ) | | | (0.4 | ) | | | (0.4 | ) | | | (0.6 | ) | | | (1.3 | ) | | | (1.7 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Other income (expense), net | | $ | (4.1 | ) | | $ | 0.5 | | | $ | (2.1 | ) | | $ | (0.4 | ) | | $ | 3.9 | | | $ | 1.4 | | | $ | 4.7 | | | $ | 0.6 | |
OtherInterest income and other income (expense), net decreased from Q2 FY19 by $4.3 million, primarily due to a $4.0 million negative change in Q1foreign currency exchange results. Interest income and other income (expense), net decreased from Q3 FY18 by $4.6 million and $2.0 million, from Q4 FY17 and Q1 FY17, respectively. The decreases were primarily the resultbecause of significanta $1.2 million negative change in foreign currency exchange results and decreased interest income of $0.4 million, which was due to our lower average cash balance in the current year period. On a year-to-date basis, Interest income and other income (expense), net, increased $3.7 million, primarily because of the impact of $6.2 million from foreign currency exchange gains in YTD FY19, in contrast to losses incurred in Q1YTD FY18. The effect of the foreign exchange gains was somewhat offset by government incentives of $0.8 million received, a $0.6 million gain on the sale of certain assets recognized in YTD FY18, whileand reduced interest income of $1.1 million, due to the lower average cash balance in Q4 FY17, we recognized a net gain,the current year period.
Interest expense was $0.4 million in Q3 FY19, unchanged from Q2 FY19. Interest expense decreased $0.2 million in Q3 FY19 from Q3 FY18, and $0.4 million in Q1 FY17, we recognized a more moderate lossYTD FY19 from YTD FY18, primarily due to the repayment of our cross-currency transactions.$57.5 million convertible senior notes in April 2019; interest incurred on our loans in China partially offset these reductions.
Income Tax Benefit (Provision)Provision
| | | Three Months Ended | | | Three Months Ended | | | Nine Months Ended | |
| | | | Q1 FY18 | | | | Q4 FY17 | | | | Q1 FY17 | | | Q3 FY19 | | | Q2 FY19 | | | Q3 FY18 | | | YTD FY19 | | | YTD FY18 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Income tax benefit (provision) | | $ | 1.8 | | | $ | (2.5 | ) | | $ | (2.1 | ) | |
| Income tax provision | | | $ | 3.2 | | | $ | 3.3 | | | $ | 2.1 | | | $ | 7.9 | | | $ | 3.8 | |
| Effective income tax rate | | | (23.1 | )% | | | 19.0 | % | | | 31.3 | % | | | 24.7 | % | | | 25.0 | % | | | 9.4 | % | | | 22.3 | % | | | 7.8 | % |
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 decreasedecreased in Q1 FY18,Q3 FY19, compared with Q1 FY17Q2 FY19, primarily due to changes in the jurisdictional mix of earnings. The effective income tax rate increased in Q3 FY19, compared with Q3 FY18, due to changes in the jurisdictional mix of earnings and Q4 FY17, is primarily attributable to the recognition of $3.9 million of previously unrecognized deferrednonrecurring tax benefits related to alternative minimuma settlement with a taxing authority and a statute of limitations expiration in Q3 FY18.
The effective income tax credits as a resultrate increased in YTD FY19, compared with YTD FY18, primarily due to our recognition in YTD FY18 of nonrecurring tax benefits related to tax reform in the U.S. Tax Cuts and Jobs Act ("Act"), which was signed into law on December 22, 2017 (See Note 8 to the condensed consolidated financial statements for further information),Taiwan of $4.2 million, and an increasea one-time audit settlement benefit of deferred tax assets of $0.2 million, which was the result of an$1.9 million. The year-over-year increase in the Taiwaneffective tax rate. These benefits were partially offsetrate was somewhat tempered by a higher percentageone-time audit settlement benefit of income before income taxes being generated$0.9 million in jurisdictions where we recorded income tax provisions which, due to valuation allowances, were not offset by income tax benefits recordedYTD FY19, as well as changes in jurisdictions in which we incurred losses before income taxes.the jurisdictional mix of earnings.
Net Income Attributable to Noncontrolling Interests
Net income attributable to noncontrolling interests was $3.6$3.5 million in Q1 FY18,Q3 FY19, which represented a decrease of $1.5 million and an increase of $1.0$2.1 million and a decrease $3.3 million from Q4 FY17Q2 FY19 and Q1 FY17,Q3 FY18, respectively. Year-to-date, noncontrolling interests’ share decreased $7.5 million from YTD FY18. The changes from bothfor all comparative periods were due to changes in net income at our IC manufacturing facilityfacilities in Taiwan and China, in which wenoncontrolling interests hold a 50.01%49.99% ownership interest.interests.
Liquidity and Capital Resources
Our working capital at the end of Q1 FY18Q3 FY19 was $404.3$261.2 million, compared with $367.3$311.7 million at the end of Q4 FY17, and ourfiscal 2018. The $50.5 million net decrease is primarily attributable to:
- Decreased cash and cash equivalents increasedof $74.5 million (net of $57.5 million used to repay our convertible senior notes, which had no impact on working capital);
- Increased inventories of $10.8 million, the predominance of which was to supply our China FPD facility and,
- Receivables for investment subsidies in Q1 FY18China of $11.9 million at the end of Q3 FY19.
We had cash and cash equivalents of $197.2 million at the end of Q3 FY19, compared with $329.3 million at the end of fiscal 2018. The net decrease is primarily attributable to:
- $57.5 million used to repay our convertible notes;
- $160.1 million used to purchase capital assets (the preponderance of which related to equipping our China-based facilities);
- $10.7 million used to repurchase our common stock;
- $53.2 million received from borrowings in China;
- $17.7 million received from investment incentives in China and,
- $23.5 million provided by $40.5operating activities.
The net cash provided by operating activities of $23.5 million in YTD FY19 decreased $63.5 million, from $308.6$87.0 million at October 29, 2017. Favorableprovided in YTD FY18. The net decrease was due primarily to:
- Lower net income of $17.0 million in YTD FY19;
- A greater increase in the change in inventories balances of $6.7 million in YTD FY19 (primarily attributable to the stocking of our FPD facility in China) and,
- A comparative increase in value added tax prepayments related to our China facilities of $24.3 million in YTD FY19. These prepayments are recoverable through future sales transactions of the facilities.
The favorable effects of foreign currency exchange rates contributed $9.7$1.2 million to our increase inreported cash in Q1 FY18. Net cash provided by operating activities was $30.9 million in Q1 FY18, compared with $31.5 million in Q1 FY17, as increased net income and noncash expenses were exceeded by net cash consumed by operating assets and liabilities by $0.7 million. balance at July 28, 2019.
Net cash used in investing activities was $11.1$142.5 million in Q1 FY18, a decreaseYTD FY19, an increase of $4.3$78.4 million from the $15.4$64.1 million used in Q1 FY17.YTD FY18. The decreasenet increase was primarily attributable to increased capital expenditures of $95.8 million, the predominance of which related to the building and equipping of our China facilities. Partially offsetting the increased capital expenditures was $17.7 million received in China from investment incentives.
Net cash flows from financing activities decreased from funds provided of $5.4$2.6 million in YTD FY18 to $14.3 million of funds used in YTD FY19. Significant components of the net decrease were:
- $57.5 million used to repay (upon their maturity) our convertible senior notes;
- $26.1 million used to pay dividends to DNP (related to their 49.99% interest in our IC facility in Taiwan);
- $10.7 million used to acquire our common stock under a businessshare repurchase program;
- $53.2 million received from borrowings in Q1 FY17, which was somewhat offsetChina and,
- $29.4 million contributed by a $1.4 million increase in purchases of property, plant and equipment in Q1 FY18. Cash flows from financing activities increased from funds used of $0.2 million in Q1 FY17 to $11.2 million provided in Q1 FY18, primarily due to the receipt of $12.0 million from a noncontrolling interestDNP for their investment in our recently established IC businessjoint venture in China.
As of JanuaryJuly 28, 20182019, and October 29, 2017,31, 2018, our total cash and cash equivalents included $213.3$153.9 million and $190.0$244.5 million, respectively, held by our foreign subsidiaries.
Our credit facility, which expires in December 2018, has a $50 million limit with an expansion capacity to $75 million, and is secured by substantially all The majority of earnings of our assets locatedforeign 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 United Stateshigh-end IC and the common stock of certain foreign subsidiaries. The credit facility is subject to a minimum interest coverage ratio, total leverage ratio and minimum unrestricted cash balance financial covenants, all of which we were in compliance with at January 28, 2018. We had no outstanding borrowings against the credit facility at January 28, 2018, and $50 million was available for borrowing. The interest rate on the credit facility (2.82% at January 28, 2018) is based on our total leverage ratio at LIBOR plus a spread, as defined in the credit facility.FPD areas.
As of JanuaryJuly 28, 2018,2019, we had capital commitments outstanding of approximately $190 million.$100 million, much of which related to building and equipping our China facilities (discussed below). We intend to finance our capital expenditures with our working capital, cash generated from operations and, if necessary, additional borrowings. We have entered into a joint venture that is constructingconstructed an IC facility in China with an estimated total joint investment of $160 million. Our remaining funding commitment for the joint venture is approximately $68$7 million which we will fulfill over the next several years. We have alsoquarters. In Q2 FY19, we commenced construction of anproduction at our newly constructed FPD facility in China in which, as of July 28, 2019, we will investhad invested $160 million over that same period.million. 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 capital requirements exceed our existing cash, cash generated by operations, and cash available under our credit facility.agreement.
Our liquidity, as we operate in a high fixed cost environment, is highly dependent on our revenue, cash conversion cycle, and the timing of our capital expenditures (which can vary significantly from period to period). Depending on conditions in the semiconductor and FPD markets, our cash flows from operations and current holdings of cash may not be adequate to meet our current and long-term needs for capital expenditures, operations, and debt repayments. Historically, in certain years, we have used external financing to fund these needs. Due to conditions in the credit markets and covenant restrictions on our existing debt, some financing instruments we have used in the past may not be available to us when required. Consequently, we cannot assure that additional sources of financing would be available to us on commercially favorable terms, should our long-term cash requirements exceed our existing cash and cash available under our credit facility.agreements.
Off-Balance Sheet Arrangements
In January 2018, Photronics, through its wholly-ownedwholly owned Singapore subsidiary, and DNP, through its wholly owned subsidiary “DNP Asia Pacific PTE, Ltd.” entered into a joint venture under which DNP obtained a 49.99% interest in our IC business in Xiamen, China. The joint venture, known as “Photronics DNP Mask Corporation Xiamen” ( “PDMCX”(“PDMCX”), was established to develop and manufacture photomasks for leading edgeleading-edge and advanced generationadvanced-generation semiconductors. Under the Joint Venture Operating Agreement of Photronics DNP Mask Corporation XiamenPDMCX (“the Agreement”), DNP is afforded, under certain circumstances, the right to put“put” its interest in PDMCX to Photronics. These circumstances include disputes regarding the strategic direction of PDMCX that may arise after the initial two yeartwo-year term of the Agreement that cannot be resolved between the two parties. 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'sPDMCX’s net assets, incur a loss.
In April 2014, we acquired a 50.01% controlling interest of PDMC, our IC manufacturing facility located in Taiwan. Under the PDMC joint venture 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 a 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 during both PDMC’s first four years and during any individual year within those first four years. As of JanuaryJuly 28, 2018, we2019, Photronics and DNP each had not been requested to make any additional capital contributions to PDMC.net investments in PDMCX of approximately $42.5 million.
We lease certain office facilities and equipment under operating leases that may require us to pay taxes, insurance and maintenance expenses related to the properties. Certain of these leases contain renewal or purchase options exercisable at the end of the lease terms.
Business Outlook
A majority of our revenue growth is expected to continue to come from the AsianAsia region, predominantly in China. In response to this expectation, we have entered into a joint venture that will completecompleted the construction of an IC research and development and manufacturing facility in Xiamen, China, in late 2018.2018; Production is anticipated to begincommenced at this facility in 2019.Q3 FY19. In addition, in August 2017, we entered into an investment agreement to construct an FPD manufacturing facility in Hefei, China. Construction of this facility was completed in late 2018, and production commenced in Q1 FY18, and production is anticipated to begin inthe second quarter of 2019.
We continue to assessmake continual assessments of our global manufacturing strategy and monitor our revenue and related cash flows from operations. ThisThese ongoing assessmentassessments 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 were discussed in Part1, Item 1A in our Annual Report on Form 10-K for the year ended October 29, 2017,31, 2018, 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–Statements – Notes to Condensed Consolidated Financial Statements – Note 1314 – Recent Accounting Pronouncements” for recent accounting pronouncements that may affect the Company’s financial reporting.
| Item 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Foreign Currency Exchange Rate Risk
We conduct businesstransact in several major internationala number of different 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 haveengage in transactions and balances inhave exposures to the Japanese yen.
We attempt to minimize our risk of foreign currency transaction losses by producing products in the same country in which the products are sold (thereby generating revenues and incurring expenses in the same currency), and by managing our working capital. However, in some instances, we sell and collect for 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.
entity. In addition, to the extent practicable, we attempt to reduce our exposure to foreign currency exchange fluctuations by converting cash and cash equivalents into the functional currency of the subsidiary which holds the cash. We may also enter into derivative contracts to mitigate our exposure to foreign currency fluctuations when we have a significant purchase obligation or significant receivable denominated in a currency that differs from the transacting subsidiaries’ functional currencies. We do not enter into derivatives for speculative purposes. There can be no assurance that this approachour attempts to minimize our foreign currency exchange rate risks will protect us from the need to recognize significant foreign currency transaction gains and losses, especially in the event of a significant adverse movement in the value of any foreign currency in which we conduct business against any of our functional currencies, including the U.S. dollar.
As of JanuaryJuly 28, 2018,2019, a 10% adverse movement in the value of currencies different than the functional currencies of ourthe Company or its subsidiaries would have resulted in a net unrealized pre-tax loss of $16.0$34.0 million, which represents an increase of $3.0$20.8 million from our exposure at October 29, 2017.31, 2018. The increase in foreign currency rate change risk is primarily the result of increased USexposures of the Chinese renminbi, South Korean won, and JPY denominated exposuresNew Taiwan dollar against the U.S. dollar. We do not believe that a 10% change in Taiwanthe exchange rates of non-US dollar currencies, other than the aforementioned currencies and South Korea.
the Japanese yen, would have had a material effect on our July 28, 2019, condensed consolidated financial statements.
Interest Rate Risk
At January 28, 2018, we did not have anyA 10% adverse movement in the interest rates on our variable rate borrowings. A 10% change in interest ratesborrowings would not have had a material effect on our July 28, 2019, condensed consolidated financial position, results of operations, or cash flows in the three month period ended January 28, 2018.statements.
| Item 4. | CONTROLS AND PROCEDURES |
We have established and currently maintain disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), designed to provide reasonable assurance that information required to be disclosed in its reports filed under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to management, including our chief executive officer and chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefitcost—benefit relationship of possible controls and procedures.
Our management, under the supervision and with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of the end of the period covered by this report.
There have been no material changes to risks relating to our business as disclosed in Part 1, Item 1A of our Form 10-K for the year ended October 29, 201731, 2018.
