PHOTRONICS, INC.
ANNUAL REPORT ON FORM 10-K
OCTOBER 31, 2023
Glossary of Terms and Acronyms
Definitions of certain terms and acronyms that may appear in this report are provided below.
| AMOLED | Active-matrix organic light-emitting diode. A technology used in mobile devices. |
| Application-specific IC | An integrated circuit customized for a particular use, rather than intended for general-purpose use |
| ASC | Accounting Standards Codification |
| ASP | Average Selling Price |
| ASU | Accounting Standards Update |
| COVID-19 | Covid virus 2019, an infectious disease that was declared a pandemic by the World Health Organization in March 2020 |
| DNP | Dai Nippon Printing Co., Ltd. |
| EUV | A wafer lithography technology using the industry standard extreme ultraviolet (EUV) wavelength. EUV photomasks function by selectively reflecting or blocking light, in contrast to conventional photomasks which function by selectively transmitting or blocking light |
| Exchange Act | The Securities Exchange Act of 1934 (as amended) |
| FASB | Financial Accounting Standards Board |
| Form 10-K | Annual Report on Form 10-K |
| Form 10-Q | Quarterly Report on Form 10-Q |
| FPDs | Flat-panel displays, or “displays” |
| Generation | In reference to flat panel displays, refers to the size range of the underlying substrate to which a photomask is applied. Higher generation (or “G”) numbers represent larger substrates |
| High-end (photomasks) | For IC, photomasks that are 28nm or smaller; for FPD, AMOLED, G10.5+, and LTPS photomasks |
| ICs | Integrated circuits, or semiconductors |
| LIBOR | London Inter-Bank Offered Rate |
| LTPS | Low-Temperature Poly Silicon, a polycrystalline silicon synthesized at relatively low temperatures; polycrystalline silicon in thin-film transistors (TFTs) are used in liquid-crystal display (LCD) flat panels and to drive organic light-emitting diode (OLED) displays |
| MLA | Master Lease Agreement |
| Optical proximity correction | A photolithography enhancement technique applied to compensate for the limitations of light to maintain the edge placement integrity of an original design, imaged onto a silicon wafer, for further processing to an etched pattern. |
| PDMCX | Xiamen American Japan Photronics Mask Co., Ltd., a joint venture of Photronics and DNP |
| Phase-shift photomasks | Photomasks that take advantage of the interference generated by phase differences to improve image resolution in photolithography |
| Pure-play foundry | A company that does not produce a significant volume of IC products of its own design, but rather operates IC fabrication plants dedicated to producing ICs for other companies |
| RMB | Chinese renminbi |
| ROU (assets) | Right-of-use asset |
| SEC | Securities and Exchange Commission |
| Securities Act | The Securities Act of 1933 (as amended) |
| U.S. GAAP | Accounting principles generally accepted in the United States of America |
| Wafer | A wafer, or silicon wafer, is a thin slice of semiconductor material that, in the fabrication of microelectronics, serves as the substrate for microelectronic devices built in and upon the wafer |
All references to “2023”, “2022”, and “2021” are to our fiscal years ended on October 31 of those years, unless otherwise stated.
Forward-Looking Statements
This Form 10-K contains forward-looking statements, as defined by the SEC. The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements made by us, or on our behalf. Forward-looking statements are statements other than statements of historical fact, including, without limitation, those statements that include such words as “anticipates”, “believes”, “estimates”, “expects”, “intends”, “may”, “plans”, “predicts”, and similar expressions, and, without limitation, may address our future plans, objectives, goals, strategies, events, or performance, as well as underlying assumptions and other statements that are other than statements of historical facts. On occasion, in other documents filed with the SEC, press releases, conferences, or by other means, we may discuss, publish, disseminate, or otherwise make available, forward-looking statements, including statements contained within Part II, Item 7 – “Management’s Discussion & Analysis of Financial Condition and Results of Operations” of this Form 10-K.
Forward-looking statements involve risks and uncertainties, which could cause actual results or outcomes to differ materially from those expressed. Our expectations, beliefs and projections are expressed in good faith and are believed by us to have a reasonable basis, including, without limitation, management’s examination of historical operating trends, information contained in our records, and information we’ve obtained from other parties. However, we can offer no assurance that our expectations, beliefs, or projections will be realized, accomplished or achieved.
Forward-looking statements within this Form 10-K speak only as of the date of its filing, and we undertake no obligation to update any such statements to reflect changes in events or circumstances that may subsequently occur. Users of this Form 10-K are cautioned that various factors may cause actual results to differ materially from those contained in any forward-looking statements found within this Form 10-K and that they should not place undue reliance on any forward-looking statement. In addition, all forward-looking statements, whether written or oral and whether made by us or on our behalf, are expressly qualified by the risk factors provided in Part I, Item 1A “Risk Factors” of this Form 10-K.
PART I
General
Photronics, Inc. (and its subsidiaries, collectively referred to herein as “Photronics”, the “Company”, “we”, “our”, or “us”) is the world's leading manufacturer of photomasks, which are high precision photographic quartz or glass plates containing microscopic images of electronic circuits. Photomasks are a key element in the manufacture of ICs and FPDs and are used as masters to transfer circuit patterns onto semiconductor wafers and FPD substrates during the fabrication of ICs, a variety of FPDs and, to a lesser extent, other types of electrical and optical components. We have eleven manufacturing facilities, which are located in Taiwan (3), China (2), Korea, the United States (3), and Europe (2).
Our principal executive offices are located at 15 Secor Road, Brookfield, Connecticut, 06804, telephone (203) 775-9000. Our website address is http://www.photronics.com. We make available, free of charge through our website, our Forms 10-K, Definitive Proxy Statements on Schedule 14A, Forms 10-Q, Current Reports on Form 8-K, and any amendments to these reports as soon as reasonably practicable after such materials are electronically filed with or furnished to the SEC. The information found on, or incorporated into, our website is not part of this or any other report we file with or furnish to the SEC. The SEC also maintains a website at http://www.sec.gov that contains reports, proxy statements and other information regarding SEC registrants, including Photronics.
Sales
We manufacture photomasks, which are used as masters to transfer circuit patterns onto semiconductor wafers and FPD substrates. The photomasks we manufacture incorporate circuit designs provided to us on a confidential basis by our customers. Photomasks are typically sold in sets comprised of layers, with each layer having a distinct pattern that is etched onto a different photomask. The resulting series of photomasks is then used to image the circuit patterns onto each successive layer of a semiconductor wafer or FPD substrate. The typical manufacturing process for a photomask involves the receipt and conversion of circuit design data to manufacturing pattern data. A lithography system then exposes the circuit pattern onto a photomask blank. The exposed areas are developed and etched to imprint the pattern on the photomask. The photomask is then inspected for defects and conformity to the customer's design data. After the repair of any defects, the photomask is cleaned, any required pellicles (protective translucent cellulose membranes) are applied and, after final inspection, the photomask is shipped to the customer.
“High-end” photomasks support 28 nanometer and smaller design nodes for ICs and Generation 10.5+, AMOLED, and LTPS display-based process technologies for FPDs. However, 32 nanometer and above geometries for semiconductors and Generation 8 and below (excluding AMOLED and LTPS) process technologies for displays, which we refer to as “mainstream” photomasks, constitute the majority of designs currently being fabricated in volume. At these geometries and at various high-end nodes, we can produce full lines of photomasks. Moreover, there is no significant technology employed by our competitors that is not available to us. We expect advanced-generation designs to continue to be developed, and we believe we are well positioned to service an increasing volume of this business as a result of our ongoing investments in manufacturing processes and technology in the regions where our customers are located.
Generally, Photronics and each of its customers engage in a qualification and correlation process before we become an approved supplier. Thereafter, based on the customer’s specifications, we typically negotiate pricing parameters for the customer's order. Some prices may remain in effect for an extended period of time. In many instances, we enter into sales arrangements with an understanding that, as long as our performance is competitive, we will receive a specified percentage of that customer's photomask orders.
The first several layers of photomasks are sometimes required to be delivered to customers within twenty-four hours from the time we receive customer design data. Because of the short period between order and shipment dates (typically from one day to three weeks) for a significant amount of our revenue, the dollar amount of our current backlog is not a reliable indicator of future revenue. However, the demand for some IC photomasks can extend over the traditional time period; thus, for some products, our backlog can expand to as long as two to three months.
The ability to manufacture high-quality photomasks within short time periods is dependent upon robust processes, efficient manufacturing methods, high production yield, available manufacturing capacity, and high equipment reliability. We work to meet these requirements by making significant investments in research and development, manufacturing capacity, preventive and on-going equipment maintenance programs, manufacturing and data processing systems, and by utilizing statistical process control methods to optimize our manufacturing processes and reduce cycle times.
Quality control is an integral part of the photomask manufacturing process. Photomasks are manufactured in temperature, humidity, and particulate-controlled clean rooms because of the high level of precision, quality and manufacturing yield required. Each photomask is inspected several times during the manufacturing process to ensure compliance with customer specifications. We continue to make substantial investments in equipment to produce, inspect and repair photomasks to ensure that customer specifications are met.
We conduct our sales and marketing activities primarily through a staff of full-time sales personnel and customer service representatives who work closely with the Company's management and technical personnel. We support non-U.S. customers through both our domestic and foreign facilities and consider our presence in non-U.S. markets to be an important factor in attracting new customers, as it provides global solutions to our customers, minimizes delivery time, and allows us to serve customers that utilize manufacturing foundries outside of the United States, principally in Asia. See Notes 9 and 17 to our consolidated financial statements in Part II, Item 8 of this report for the amount of revenue and long-lived assets attributable to each of our geographic areas of operations.
Research and Development
We primarily conduct research and development activities for IC photomasks at our Boise, Idaho, facility and, to a lesser degree, Photronics DNP Mask Corporation (“PDMC”), our joint-venture subsidiary in Taiwan. Research and development for FPD photomasks is primarily conducted at Photronics Korea, Ltd., our subsidiary in South Korea. Additionally, we conduct site-specific research and development programs to support local, strategic customer roadmaps. All of these research and development programs and activities are undertaken to advance our competitiveness in technology and manufacturing efficiency. We also conduct application-oriented research and development, including data and service technology to support the integration of photomasks into customer processes. Currently, research and development for IC photomasks are primarily focused on photomasks enabling wafer geometries of 14 nanometer node and smaller, including EUV and, for FPDs, on Generations 8 and 10 substrate size photomasks for new TV technologies, emerging opportunities for micro- and mini-LED displays, and photomask technology for the complex FPD photomasks required in the manufacture of advanced mobile displays, such as AMOLED. We believe these core competencies will continue to be a critical part of semiconductor and FPD manufacturing, as wafer and FPD substrate optical lithography continues to enable new high-end ICs and displays. We incurred research and development expenses of $13.7 million, $18.3 million, and $18.5 million in 2023, 2022 and 2021, respectively. It is our belief that we own, control, or license the proprietary information (including trade secrets and patents) that we need to continue to meet our customers’ requirements. We also believe that our intellectual property and trade secret know-how will continue to be important to maintaining technical leadership in the field of photomasks.
Markets
The customers for photomasks are primarily semiconductor and FPD manufacturers and to a lesser degree fabless design and equipment companies serving those industries. The size of the photomask market is driven by the number of designs released to support IC and FPD product introductions and manufacturing expansions. The photomasks required for those designs are manufactured by independent merchant manufacturers like Photronics and by semiconductor and FPD manufacturers that produce photomasks for their own use (captive manufacturers). In rare instances, captive manufacturers also sell to other semiconductor or FPD manufacturers.
The value of masks produced by merchant suppliers has transitioned from a period when there was a trend toward the divesture or closing of captive photomask operations by semiconductor manufacturers, and an increase in the share of the market served by independent merchant manufacturers. This trend was driven by the increased complexity and cost of capital equipment used in manufacturing photomasks and the lack of economy of scale for many semiconductor and FPD manufacturers to effectively utilize the equipment.
That period was followed by a period during which, in order to reach certain roadmap milestones, some captive mask facilities invested at faster rates than independent manufacturers, and the revenue share of market transitioned to masks being majority captive-supplied. More recently, there has been a tendency of more production being directed to the independent merchant manufacturers, and market share has begun moving toward the independents. Nevertheless, most captive manufacturers maintain business and technology relationships with independent photomask manufacturers for ongoing support.
We support customers across the full spectrum of IC production and FPD technologies by manufacturing photomasks using electron beam or optical (laser-based) lithography systems. For IC photomasks, the predominant writing technology used for advanced photomasks with fine-scale resolution requirements is electron beam writing systems, while FPD mask fabrication utilizes optical writing systems. These systems are capable of producing the most advanced semiconductor and display photomasks for use in an array of products. End markets served with IC photomasks include devices used for microprocessors, memory, telecommunications, the Internet of Things, crypto mining, and other applications. We own a number of both high-end and mature electron beam and laser-based lithography systems.
We sell our products primarily to leading semiconductor and FPD designers and manufacturers. These include integrated device manufacturers, fabless semiconductor companies, and “pure-play” foundries. During 2023, we sold our products to approximately 696 customers. Revenue from United Microelectronics Corp. Co., Ltd. accounted for approximately 14%, 15% and 17% of our total revenues in 2023, 2022 and 2021, respectively, and revenue from Samsung Electronics Co., Ltd. accounted for approximately 10%, 11% and 12% of our total revenues in those respective years. In addition, revenue from Semiconductor Manufacturing International Corporation accounted for approximately 13%, 5% and 3% of our total revenues in 2023, 2022 and 2021, respectively. Our five largest customers, in the aggregate, accounted for approximately 51%, 45% and 43% of our revenue in 2023, 2022 and 2021, respectively. A significant decrease in the amount of revenue from any of these customers could have a material adverse effect on our financial performance and business prospects.
Competition
The photomask industry is highly competitive, and most of our customers utilize multiple photomask suppliers. Our ability to compete depends primarily upon the consistency of our product quality, timeliness of delivery, competitive pricing, technical capability, and service, which we believe are the principal factors considered by customers in selecting their photomask suppliers. An inability to meet these requirements could adversely affect our financial condition, results of operations, and cash flows. We also believe that geographic proximity to customers is an important factor in certain markets where cycle time from order to delivery is critical. While some of our competitors may have greater financial, sales, marketing, or other resources than Photronics, we believe that we are able to compete effectively because of our dedication to customer service, ongoing investments in state-of-the-art photomask equipment and facilities, and experienced technical employees.
We estimate that, for the types of photomasks we manufacture (IC and FPD), the size of the total market (captive and merchant) is approximately $7.5 billion. Our competitors include Compugraphics International, Ltd., Dai Nippon Printing Co., Ltd (outside of Taiwan and China), Hoya Corporation, LG Innotek Co., Ltd., Shenzhen Newway Photomask Making Co., Ltd., Shenzhen Qingyi Photomask, Ltd., SK-Electronics Co., Ltd., Taiwan Mask Corporation, and Toppan Electronics Products Co., Ltd. We also compete with semiconductor and FPD manufacturers' captive photomask manufacturing operations that supply photomasks for internal use and, in some instances, also for external customers and foundries. We expect to face continued competition which, in the past, has led to pressure to reduce prices. We believe the pressure to reduce prices, together with the significant investment required in capital equipment to manufacture high-end photomasks will continue in the future.
International Operations
Revenues from our non-U.S. operations were approximately 86%, 85% and 84% of our total revenues in 2023, 2022 and 2021, respectively. We believe that our ability to serve non-U.S. markets is enhanced by our having, among other things, a local presence in the markets we serve. This requires significant investments in financial, managerial, operational, and other resources.
Operations outside of the United States are subject to inherent risks, including fluctuations in currency exchange rates, political and economic conditions in various countries, legal compliance and regulatory requirements, tariffs and other trade barriers, difficulties in staffing and managing international operations, longer accounts receivable collection cycles, potential restrictions on transfers of funds, and potentially adverse tax consequences. These factors may have a material adverse effect on our ability to generate revenue outside of the United States and may require us to deploy resources where they could otherwise be used to their greatest advantage and, consequently, may adversely affect our financial condition and results of operations. Notes 9 and 17 of our consolidated financial statements, in Part II, Item 8 of this report, respectively, present our revenue and long-lived assets by geographic area.
Resources
Raw materials used by Photronics generally include: high precision quartz plates (including large area plates), which are used as photomask blanks and are primarily obtained from Japanese and Korean suppliers; pellicles and electronic grade chemicals, which are used in the manufacturing process; and compacts, which are durable plastic containers in which photomasks are shipped. These materials are generally sourced from several suppliers. We believe that our utilization of a select group of strategic suppliers enables us to access the most technologically advanced materials available. On an ongoing basis, we continue to consider additional supply sources.
We typically enter into annual pricing agreements with our suppliers, some of which include volume-based incentives that have resulted in substantial cost savings; these agreements do not require us to purchase minimum dollar amounts or quantities of their subject materials.
We rely on a limited number of equipment suppliers to develop and provide the equipment used in the photomask manufacturing process. Although, historically, we have been able to obtain equipment on a timely basis, an inability to obtain or repair equipment when required could have a material adverse effect on our business and results of operations.
Intellectual Property Rights
We have developed and hold ownership interests in intellectual property (“IP”) rights, in the forms of patents issued in the U.S., and other trademark and trademark registrations in the U.S. and other countries. Patents in which we hold ownership interests generally relate to the manufacture of photomasks or the use of photomasks to manufacture other products. While we believe that our IP rights are, and will continue to be, important to our technical leadership in the field of photomasks, our operations are not dependent on any one individual IP right. In addition to patenting, when practicable, we further protect our IP rights, and our other proprietary processes and trade secrets, by utilizing non-disclosure agreements with employees, customers, and vendors.
Seasonality
Our business is typically impacted during the first quarter of our fiscal year by the North American, European, and Asian holiday periods, as some customers reduce their development and buying activities during those periods.
Government Contracts
We are party to a limited number of fixed-price contracts with the U.S. government. Revenues earned from these contracts do not comprise a significant portion of our total revenue.
Government Regulation
We are subject to government regulations within the U.S. and in other countries in which we produce or market our products. The effects of compliance with these regulations are currently not material to our results of operations, capital expenditures, or competitive position. However, compliance with changes to existing or new regulations may have a material adverse effect on our future results of operations, capital expenditures, or competitive position. We discuss the potential impact of our not adhering to a number of these regulations in Item 1A. “Risk Factors”, of this Form 10-K. The following is a list of major subjects of the regulations that pertain to our business:
| • | Regulations, such as those under the Foreign Corrupt practices Act that prohibit providing remuneration to government officials for the purpose of obtaining or securing business in the jurisdictions in which they serve; |
| • | Regulations that require the minimization and proper disposal of the by-products of our manufacturing processes; |
| • | Regulations that require us to provide a safe working environment for our employees; |
| • | Regulations that restrict our ability to transfer assets between operations not within the same legal jurisdiction; |
| • | Regulations that require us to provide information through the submission of government surveys; |
| • | Regulations that require us to maintain an effective system of internal accounting controls; |
| • | Regulations that prohibit us from engaging in business in specified countries, or with specified customers; |
| • | Regulations that require us to protect the personal information of our customers and employees; |
| • | Regulations that require us to accurately determine our liabilities to taxing authorities, and to settle such liabilities within their statutorily prescribed time periods; |
| • | Regulations that require us to withhold and timely remit taxes on our employees’ compensation to government authorities; |
| • | Regulations that require us to contribute to government-sponsored social insurance plans; |
| • | Regulations that require us to contribute to employee severance plans; |
| • | Regulations that prohibit us from disseminating material nonpublic information prior to the public announcement of such information; |
| • | Regulations pertaining to financial reporting, insider transactions, executive compensation, and other areas overseen by the SEC and governing bodies in other countries in which our operations are located. |
Human Capital
As of October 31, 2023, we had approximately 1,885 full-time and part-time employees worldwide. Our business results depend in part on our ability to successfully manage our human capital resources, including attracting, identifying, and retaining key talent. Factors that may affect our ability to attract and retain qualified employees include employee morale, our reputation, competition from other employers, and availability of qualified individuals. As of October 31, 2023, none of our employees at any of our worldwide facilities was represented by a union. We consider our employee relations to be good. We believe our commitment to our diverse human capital resources is an important component of our mission to deliver superior photomasks and customer care. We provide all employees with the opportunity to share their opinions in open dialogues with our human resources department and senior management. We provide all employees a wide range of career development opportunities, both formal and informal. Our formal offerings include tuition reimbursement, leadership development experiences and vocational training. The safety of our employees is a paramount value for us.
We provide mandatory safety trainings in our production facilities, which are designed to focus on empowering our employees with the knowledge and tools they need to make safe choices and to minimize risks. Supervisors complete safety management courses as well. The health and wellness of our employees are critical to our success.
We provide our employees with access to a variety of innovative, flexible and convenient health and wellness programs. Such programs are designed to support employees' physical and mental health by providing tools and resources to help them improve or maintain their health status and encourage engagement in healthy behaviors. Additionally, we provide robust compensation and benefits. In addition to salaries, these programs, which vary by country/region, can include annual bonuses, stock-based compensation awards, a 401(k) plan with employee matching opportunities, healthcare and insurance benefits, health savings and flexible spending accounts, paid time off, family leave, family care resources, employee assistance programs, and tuition assistance.
Set forth below are discussions of the risk factors we believe can make an investment in our business speculative or risky.
Concentration Related Risk Factors
Our dependency on the microelectronics industry, which as a whole is volatile, could create volatility in our demand and have a negative material impact on our business.
We sell substantially all of our photomasks to semiconductor or FPD designers, manufacturers and foundries, as well as to other high-performance electronics manufacturers. We believe that the demand for photomasks depends primarily on design activity rather than sales volume from products using photomask technologies. Consequently, an increase in semiconductor or FPD sales does not necessarily result in a corresponding increase in photomask sales. In addition, the reduced use of application-specific ICs, reductions in design complexities, other changes in the technology or methods of manufacturing or designing semiconductors or FPDs, or a slowdown in the introduction of new semiconductor or FPD designs could reduce demand for photomasks ‒ even if the demand for semiconductors and FPDs increases. Historically, the microelectronics industry has been volatile, with sharp periodic downturns and slowdowns. These negative trends 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 depend on a limited number of suppliers for equipment and raw materials and, if those suppliers fail to timely deliver their products to us, we may be unable to fulfill orders from our customers, which could adversely affect our business and results of operations.
We rely on a limited number of photomask equipment manufacturers to develop, supply, and repair the equipment we use. These equipment manufacturers usually require lead times of twelve months or longer between the order date and the delivery of certain photomask imaging and inspection equipment. The failure of our suppliers to develop, deliver or service such equipment on a timely basis due to internal issues, supply chain constraints or government imposed restrictions could have a material adverse effect on our business and results of operations. In addition, the manufacturing equipment necessary to produce advanced photomasks could become prohibitively expensive, which could similarly affect us.
We use high-precision quartz photomask blanks, pellicles, and electronic grade chemicals in our manufacturing processes. There are a limited number of suppliers of these raw materials, and we do not have long-term contracts with these suppliers. Any delays or quality problems in connection with significant raw materials, particularly photomask blanks, could cause delays in the shipments of photomasks, which could have a material adverse effect on our business and results of operations. The fluctuation of foreign currency exchange rates, with respect to prices of equipment and raw materials used in manufacturing, could also have a material adverse effect on our business and results of operations.
We have been dependent on sales to a limited number of large customers; the loss of any of these customers or a significant reduction in orders from these customers could have a material adverse effect on our revenues and results of operations.
Historically, we have sold a significant proportion of photomasks to a limited number of IC and FPD manufacturers. During 2023, 2022 and 2021, our two largest customers accounted for an aggregate of 27%, 25% and 29%, respectively, of our revenue. Our five largest customers accounted for an aggregate of 51%, 45% and 43% of our revenue in 2023, 2022 and 2021, respectively. The loss of a significant customer, a significant reduction or delay in orders from any significant customer (including reductions or delays due to customer departures from recent buying patterns), or an unfavorable change in competitive conditions in the semiconductor or FPD industries could have a material adverse effect on our financial performance and business prospects. The consolidation of semiconductor manufacturers, or an economic downturn in the semiconductor industry, may increase the likelihood of losing a significant customer and could also have an adverse effect on our financial performance and business prospects.
Financing Related Risk Factors
Our cash flows from operations and current holdings of cash may not be adequate for our current and long-term needs.
Our liquidity, as we operate in a high fixed-cost environment, is highly dependent on our revenue volume and the timing of our capital expenditures, which can vary significantly from period to period. Depending on conditions in the semiconductor and FPD markets, our cash flows from operations and current holdings of cash may not be adequate to meet our current and long-term needs for capital expenditures, operations, and debt repayments. Historically, in certain years, we have used external financing to fund these needs. Due to conditions in the credit market, some financing instruments used by us in the past may not be available. Therefore, we cannot provide assurance that additional sources of financing would be available to us on commercially favorable terms, if at all, should our cash requirements exceed our existing cash, and operating cash flows.
Our operations will continue to require substantial capital expenditures, for which we may be unable to provide or obtain funding.
The manufacture of leading-edge photomasks requires us to make substantial investments in additional manufacturing capability. We expect that we will be required to continue to make substantial capital expenditures to meet customer requirements and to position us for future growth. Our capital expenditure payments for fiscal 2024 are expected to be approximately $140 million, of which approximately $18.7 million was included in Accounts payable and Accrued liabilities on our October 31, 2023, consolidated balance sheet. We cannot provide assurance that we will be able to obtain the additional capital required to fund our operations or capital expenditures on reasonable terms, if at all, or that any such inability will not have a material adverse effect on our business and results of operations.
Industry and Competitive Related Risk Factors
Our business depends on managerial and technical personnel, who are in great demand, and our inability to attract and retain qualified employees could adversely affect our business and results of operations.
Our success depends, in part, upon key managerial and technical personnel, as well as our ability to continue to attract and retain additional qualified personnel. The loss of certain key personnel (for example, our chief executive officer, chief financial officer, and chief technology officer) could have a material adverse effect on our business and results of operations. We cannot offer assurance that we can retain our key managerial and technical employees, or that we can attract similar additional employees in the future.
The photomask industry is dependent on the semiconductor and display industries, which are subject to rapid technological change and fluctuations in capacity needs. Consequently, we might fail to adequately time our capabilities to market needs, which could have a material adverse effect on our business and results of operations.
The photomask industry has been, and we expect it to continue to be, characterized by technological change and evolving industry requirements, which recent supply chain regionalization efforts have accelerated. In order to remain competitive, we will be required to continually anticipate, respond to, and scale technologies of increasing complexity in both traditional and emerging markets that we serve. In particular, we believe that, as semiconductor geometries continue to become smaller and FPDs become larger or otherwise more advanced, we will be required to manufacture photomasks of increasingly more challenging complexity. Moreover, the demand for photomasks in non-leading-edge nodes may increase beyond our ability to meet our customers’ requirements within adequate response times. Additionally, the demand for photomasks has been, and could in the future be, adversely affected by changes in semiconductor and high-performance electronics fabrication methods that affect the type or quantity of photomasks utilized, such as changes in semiconductor demand that favor field-programmable gate arrays and other semiconductor designs that replace application-specific ICs, or the use of certain chip-stacking methodologies that lessen the emphasis on conventional lithography technology. Furthermore, evidence of the viability and the corresponding market acceptance of alternative methods of transferring IC designs onto semiconductor wafers could reduce or eliminate the need for photomasks in the production of semiconductors. As of the end of 2023, one alternative method, direct-write lithography, has not been proven to be a commercially viable alternative to photomasks, as it is considered to be too slow for high-volume semiconductor wafer production. However, should direct-write or any other alternative method of transferring IC or FPD designs without the use of photomasks achieve market acceptance, and if we are unable to anticipate, respond to, or utilize these or other technological changes, due to resource, technological, or other constraints, our business and results of operations could be materially adversely affected.
The risk of loss of our intellectual property, trade secrets, or other sensitive business or customer confidential information or disruption of operations due to cyberattacks or data breaches could negatively impact our financial results.
Cyberattacks or data breaches could compromise confidential, business-critical information, cause disruptions in our operations, expose us to potential litigation, or harm our reputation. We have important assets, including intellectual property, trade secrets, and other sensitive, business-critical and/or confidential information which may be vulnerable to such incidents. While we have a comprehensive cybersecurity program that is continually reviewed, maintained, and upgraded, we cannot assure that we are invulnerable to cyberattacks and data breaches which, if significant, could negatively impact our business and financial results.
We may be unable to enforce or defend our ownership and use of proprietary technology, and the utilization of unprotected company developed technology by our competitors could adversely affect our business, results of operations, and financial position.
We believe that the success of our business depends more on proprietary technology, information and processes, and know-how than on our patents or trademarks. Much of our proprietary information and technology related to manufacturing processes is not patented and may not be patentable. We cannot offer assurance that:
| | • | we will be able to adequately protect our technology; |
| • | competitors will not independently develop similar technology; |
| • | international intellectual property laws will adequately protect our intellectual property rights. |
We may become the subject of infringement claims or legal proceedings by third parties with respect to current or future products or processes. Any such claims, with or without merit, or litigation to enforce or protect our intellectual property rights that require us to defend against claimed infringements of the rights of others, could result in substantial costs, diversion of resources, and product shipment delays or could force us to enter into royalty or license agreements, rather than dispute the merits of these claims. Any of the foregoing could have a material adverse effect on our business, results of operations, and financial position.
We operate in a highly competitive environment, and, should we be unable to meet our customers’ requirements for product quality, timeliness of delivery or technical capabilities, our revenue could be adversely affected.
The photomask industry is highly competitive, and most of our customers utilize more than one photomask supplier. Our competitors include Compugraphics International, Ltd., Dai Nippon Printing Co., Ltd (outside of Taiwan and China), Hoya Corporation, LG Innotek Co., Ltd., Shenzhen Newway Photomask Making Co., Ltd., Shenzhen Qingyi Photomask, Ltd., SK-Electronics Co. Ltd., Taiwan Mask Corporation, and Toppan Electronics Products Co., Ltd. We also compete with semiconductor and FPD manufacturers' captive photomask manufacturing operations, some of which market their photomask manufacturing services to outside customers. We expect to face continued competition from these and other suppliers in the future. Some of our competitors have substantially greater financial, sales, marketing, or other resources than we do. Also, when producing smaller geometry photomasks, some of our competitors may be able to more rapidly develop and produce such masks and achieve higher manufacturing yields than we can. We believe that consistency of product quality, timeliness of delivery, competitive pricing, technical capability and service are the principal factors considered by customers when selecting their photomask suppliers. Our inability to meet these competitive requirements could have a material adverse effect on our business and results of operations. In the past, competition has led to pressure to reduce prices and the need to invest in advanced manufacturing technology, which we believe contributed to the decrease in the number of independent photomask suppliers, several years ago. These pressures may worsen in the future, causing further consolidation.
Investment Related Risk Factors
Joint ventures may not operate according to their business plans if our partners fail to fulfill their obligations, which may adversely affect our results of operations and compel us to dedicate additional resources to these joint ventures.
The nature of a joint venture requires us to share control in certain areas with unaffiliated third parties and it is always possible that the alignment that brought us and our joint venture partner together may change over time, whether due to change in business strategy, change in control, change in market conditions or applicable laws, or other events. Differing views among joint venture participants may result in delayed decisions or failures to agree on major issues. If our joint venture partner does not fulfill its obligations or that alignment changes, the affected joint venture may not be able to operate in accordance with its business plan or the parties may seek to exit the joint venture under the terms of the joint venture agreement or otherwise. Under such a scenario, among other possible consequences, our results of operations may be adversely affected, we may be compelled to increase the level of our resources devoted to the joint venture or our company-wide business plan may need to be adjusted. If such differences caused a joint venture to deviate from its business plan, or put, change of control or other exit or termination provisions triggered, our results of operations could be materially adversely affected.
Our operations in China expose us to substantial risks.
In 2019, we commenced operations at our two manufacturing facilities in China. These investments are subject to substantial risks which may include, but are not limited to: the inability to protect our intellectual property rights under Chinese law, which may not offer as high a level of protection as U.S. law; unexpectedly long negotiation periods with Chinese suppliers and customers; quality issues related to materials sourced from local vendors; limited access to electricity; unexpectedly high labor costs due to a tight labor supply; and difficulty in repatriating funds and selling or transferring assets. Our investments in China also exposed us to a significant additional foreign currency exchange risk, which we had not been subject to in prior years. In addition, as tensions have, from time to time, escalated between the U.S. and China, we believe there is an enhanced risk that our substantial investments in China may be subject to unforeseen restrictions, which may include expropriation of the investments by the Chinese government or restrictions imposed on our operations by the U.S. or other countries. These and other risks may result in our not realizing a return on, or losing some, or all, of our investments in China, which would have a material adverse effect on our financial condition and financial performance.
We may incur unforeseen charges related to possible future facility closures, restructurings, or forfeitures.
We cannot provide assurance that there will not be facility closures, restructurings, or forfeitures in the near or long term, nor can we assure that we will not incur significant charges should there be any future facility closures, restructurings, or forfeitures.
We may not be able to consummate future acquisitions or joint ventures or integrate acquisitions into our business, which could result in unanticipated expenses and losses.
As part of our business growth strategy, we have acquired businesses and entered into joint ventures in the past, and we may pursue acquisitions and joint venture opportunities in the future. Our future efforts to grow the Company may include expanding into new or related markets or industries. Our ability to implement this component of our growth strategy may be limited by both our ability to identify appropriate acquisition or joint venture candidates and our financial resources, including our available cash and borrowing capacity. The expense incurred in consummating acquisitions or entering into joint ventures, the time it takes to integrate an acquisition, or our failure to integrate businesses successfully, could result in unanticipated expenses and losses. Furthermore, we may not be able to realize any of the anticipated benefits from acquisitions or joint ventures.
The process of integrating acquired operations into our existing operations may result in unforeseen operating difficulties, and may require significant financial resources that would otherwise be available for the ongoing development or expansion of existing operations. Some of the risks associated with the integration of acquisitions include: potential disruption of our ongoing business; distraction of management; unforeseen claims and liabilities, including unexpected environmental exposures; unforeseen adjustments, taxes, charges and write-offs; problems enforcing the indemnification obligations of sellers of businesses or joint venture partners for claims and liabilities; unexpected losses of customers of, or suppliers to, the acquired business; difficulty in conforming the acquired business’ standards, processes, procedures and controls with our operations; variability in financial performance arising from the implementation of acquisition accounting; inability to coordinate new product and process development; loss of senior managers and other critical personnel; problems with new labor unions; and challenges arising from the increased scope, geographic diversity, and complexity of our operations.
Operations Related Risk Factors
Our quarterly operating results fluctuate significantly and may continue to do so in the future.
We have experienced fluctuations in our quarterly operating results, and we anticipate that such fluctuations will continue and could intensify in the future. Fluctuations in operating results may result in volatility in the prices of our common stock and financial instruments that could be linked to its value. Operating results may fluctuate as a result of many factors, including the size and timing of orders and shipments, the loss of significant customers, changes in product mix, the flow of customer design releases, technological change, fluctuations in manufacturing yields, the actions of our competitors, and general economic conditions. We operate in a high fixed-cost environment and, should our revenues and asset utilization decrease, our operating margins could be negatively impacted.
Our customers generally order photomasks on an as-needed basis; thus, our revenue in any quarter is dependent primarily on orders received during that quarter. Since we operate with little backlog, and the rate of new orders may vary significantly from quarter to quarter, our capital expenditures and consequential expense levels are, to some extent, based primarily on sales forecasts and technological advancements in photomask manufacturing equipment. Consequently, if anticipated revenues in any quarter do not occur when expected, our capital investments could result in underutilized capacity and disproportionately high expense levels, causing operating results to be adversely affected. Due to the foregoing factors, we believe that quarter to quarter comparisons of our operating results cannot be relied upon as indicators of future performance. In addition, in future quarters, our operating results could be below guidance we may provide or the expectations of public market analysts and investors, which could have a material adverse effect on the market price of our common stock.
Our substantial non-U.S. operations are subject to additional risks.
Revenues from our non-U.S. operations were approximately 86%, 85% and 84% of our total revenues in 2023, 2022 and 2021, respectively. We believe that maintaining significant international operations requires us to have, among other things, a local presence in the geographic markets that we supply. This requires significant investments in financial, managerial, operational, and other resources. Since 1996, we have significantly expanded our operations in international markets by acquiring existing businesses in Europe and Asia, and building manufacturing facilities in Taiwan and China. In order to enable us to optimize our investments and other resources, we closely monitor the semiconductor and FPD manufacturing markets for indications of geographic movement and, in conjunction with these efforts, continue to assess the locations of our manufacturing facilities. These assessments could result in the opening of additional facilities or closing of our current facilities.
Operations outside of the United States are subject to inherent risks, including: fluctuations in currency exchange rates; unstable political and economic conditions in various countries; changes in economic alliances; unexpected changes in regulatory requirements including import and export regulations; compliance with a variety of burdensome foreign laws and regulations; compliance with anti-bribery and anti-corruption laws (such as the Foreign Corrupt Practices Act); tariffs and other trade barriers; difficulties in staffing and managing international operations; and longer accounts receivable collection cycles. In addition: foreign countries may enact other restrictions on foreign trade or investment, including: currency exchange controls; trade sanctions which result in our losing access to customers and suppliers; legislation which renders agreements to be difficult to enforce; impositions on the movement of funds or other assets; or we may be subject to adverse tax consequences. These factors may have a material adverse effect on our costs or our ability to generate revenues outside of the United States and, consequently, on our business and results of operations.
We could be subject to damages based on claims brought against us by our customers, or lose customers as a result of the failure of our products to meet certain quality specifications.
Our products provide important performance attributes for our customers’ products. If a product fails to perform in a manner consistent with quality specifications, or has a shorter useful life than warrantied, a customer could seek replacement of the product or damages for costs incurred as a result of the product failing to perform, particularly if such products are sold under agreements that contain limited performance and life cycle warranties. Our customers often require us to guarantee that our products conform to certain product specifications that they provide. Any failure to comply with such specifications could result in claims or legal action. A successful claim, or series of claims, against us could have a material adverse effect on our financial condition and results of operations and could result in a loss of one or more customers.
We face risks associated with the use of sophisticated equipment and complex manufacturing processes and technologies. Our inability to effectively utilize such equipment and technologies and perform such processes could have a material adverse effect on our business and results of operations.
Our complex manufacturing processes require the use of expensive and technologically sophisticated equipment and materials, and are continually modified in an effort to improve manufacturing yields and product quality. Minute impurities, defects, or other difficulties in the manufacturing process can lower manufacturing yields and render products unmarketable. Moreover, the manufacture of leading-edge photomasks is more complex and time consuming than manufacturing less advanced photomasks, and their fabrication may result in delays in the manufacture of all levels of photomasks. We have, on occasion, experienced manufacturing difficulties and capacity limitations that have delayed our ability to deliver products within the time frames contracted for by our customers. We cannot provide assurance that we will not experience these or other manufacturing difficulties, or be subject to increased costs, which could result in a loss of customers or otherwise have a material adverse effect on our business and results of operations.
We have a high level of fixed costs.
Because of the capital-intensive nature of the photomask manufacturing business, we have a high level of fixed costs and a high degree of operating leverage. Accordingly, should our sales volumes decline as a result of a decrease in design releases from our customers or for any other reason, we may have excess or underutilized production capacity which could significantly impact our operating margins or result in write-offs from asset impairments.
Regulatory Related Risk Factors
Additional taxes could adversely affect our financial results.
Our tax filings are subject to audits by tax authorities in the various jurisdictions in which we do business. These audits may result in assessments of additional taxes that are subsequently resolved with the taxing authorities or through the courts. Currently, we believe there are no outstanding assessments whose resolution would result in a material adverse financial result. However, we cannot offer assurances that unasserted or potential future assessments would not have a material adverse effect on our financial condition or results of operations.
Our products and technology could be subject to U.S. export control laws and the export control laws of the foreign jurisdictions where we operate.
We are subject to various laws relating to the export of products we manufacture, and the technology related thereto, and our failure to comply with these laws could subject us to substantial fines, penalties, and even injunctions, the imposition of which could have a material adverse effect on the success of our business.
Certain of our products are or could be subject to the Export Administration Regulations (“EAR”) if they are manufactured in the U.S., or based on U.S. technology, or contain more than a de minimis amount of controlled U.S. content. The EAR could prohibit the export of certain products out of the US or could prohibit our foreign sites from manufacturing or delivering photomasks to certain restricted entities. Additionally, the Company has a large, global business with sales outside the U.S. representing a majority of the Company’s total net sales, and the Company believes that it generally benefits from growth in international trade. However, trade policies and disputes and other international conflicts can result in tariffs, sanctions and other measures that restrict international trade, and can materially adversely affect the Company’s business, particularly if these measures occur in regions where the Company derives a significant portion of its revenues.
Based on the complex relationships between the United States and certain foreign countries including, but not limited to China, there is inherent risk that political, diplomatic and national security influences might lead to trade disputes, impacts and/or disruptions to our operations or our ability to sell our photomasks. The United States and other countries have imposed and may continue to impose trade restrictions and have also levied tariffs and taxes on certain goods and imposed export restrictions. Increases in tariffs, additional taxes or other trade restrictions and retaliatory measures may increasingly impact customer demand and customer investment in manufacturing equipment, increase our manufacturing costs, decrease margins, reduce the competitiveness of our products, or inhibit our ability to sell, export products or purchase necessary equipment and supplies, which could have a material adverse effect on our business, results of operations, or financial condition.
We may be unprepared for changes to environmental laws and regulations and may incur liabilities arising from environmental matters.
We are subject to numerous environmental laws and regulations that impose various environmental controls on, among other things, the discharge of pollutants into the air and water and the handling, use, storage, disposal, and cleanup of solid and hazardous wastes. Changes in these laws and regulations may have a material adverse effect on our financial position and results of operations, and inadequate compliance with their requirements could give rise to significant liabilities.
If we violate environmental, health or safety laws or regulations, in addition to being required to correct such violations, we can be held liable in administrative, civil, or criminal proceedings, and substantial fines and other sanctions could be imposed that could disrupt or limit our operations. Liabilities associated with the investigation and cleanup of hazardous substances, as well as personal injury, property damages or natural resource damages arising from the release of, or exposure to, such hazardous substances, may be imposed in many situations without regard to violations of laws or regulations or other fault, and may also be imposed jointly and severally (so that a responsible party may be held liable for more than its share of the losses involved, or even the entire loss). Such liabilities may also be imposed on many different entities with a relationship to the hazardous substances at issue, including, for example, entities that formerly owned or operated the property affected by the hazardous substances and entities that arranged for the disposal of the hazardous substances at the affected property, as well as entities that currently own or operate such property. The nature of our business, including historical operations at our current and former facilities, exposes us to risks of liability under these laws and regulations due to the production, storage, use, transportation and sale of materials that can cause contamination or personal injury if released into the environment. Additional information may arise in the future concerning the nature or extent of our liability with respect to identified sites and additional sites that may be identified, for which we are alleged to be liable.
General Risk Factors
We could be negatively impacted by Environmental, Social and Governance (ESG), climate change and other sustainability-related matters.
In recent years, there has been an increased focus from stakeholders on environmental, social, and governance matters, including greenhouse gas emissions and climate-related risks, sustainability, renewable energy, water stewardship, waste management, diversity, equality and inclusion, responsible sourcing and supply chain, human rights, and social responsibility. Evolving stakeholder expectations and our efforts to manage these issues, report on them, and accomplish our goals present numerous operational, regulatory, reputational, financial, legal, and other risks, any of which could have a material adverse impact, including on our reputation and stock price, reputational harm, including damage to our relationships with customers, suppliers, investors, governments, or other stakeholders, adverse impacts on our ability to manufacture and sell products and maintain our market share, the success of our collaborations with third parties, increased risk of litigation, investigations, or regulatory enforcement action, unfavorable environmental, social, and governance ratings or investor sentiment, diversion of resources and increased costs to control, assess, and report on environmental, social, and governance metrics.
Ineffective internal controls could impact our business and operating results.
Our internal controls over financial reporting may not prevent or detect misstatements because of their inherent limitations in detecting human errors, the circumvention or overriding of controls, or fraud; even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. If we: fail to maintain the adequacy of our internal controls, including any failure to implement required new or improved controls; otherwise fail to prevent financial reporting misstatements; or experience difficulties in implementing internal controls, our business and operating results could be adversely impacted, and we could fail to meet our financial reporting obligations.
Our business could be adversely impacted by global or regional catastrophic events.
Our business could be materially adversely affected by terrorist acts, widespread outbreaks of infectious diseases (such as COVID-19), government responses emplaced to limit the impact of infectious diseases (such as shelter-in-place directives), or the outbreak or escalation of wars including, but not limited to, the invasion of Ukraine by the Russian Federation. Such events in the geographic regions in which we do business, including escalations of political tensions and military conflicts in the U.S., Europe, the Republic of South Korea, the People’s Republic of China, or the Republic of China (Taiwan), and any governmental sanctions enacted in reaction thereto, could result in a global energy crisis, economic inflation, supply-chain disruptions, or the confiscation or destruction of our facilities; all and any of these outcomes could have material, adverse impacts on our results of operations, financial condition, and cash flows.
Our production facilities could be damaged or disrupted by natural or manmade disasters or labor strikes, either of which could adversely affect our financial position, results of operations, and cash flows.
A major catastrophe, such as an earthquake, flood, fire, or other disaster, labor strike, or work stoppage at any of our manufacturing facilities, or a manufacturing facility of our suppliers or customers, could result in a prolonged interruption of our business. A disruption resulting from any one of these events could cause significant delays in shipments of our products and the loss of revenue and customers, which could have a material adverse effect on our financial position, results of operations, and cash flows. Our facilities in Taiwan are located in a seismically-active area.
Our sales can be impacted by the health and stability of the general economy, which could adversely affect our results of operations and cash flows.
Unfavorable general economic conditions in the U.S. or other countries in which we or our customers conduct business may have the effect of reducing the demand for photomasks. Economic downturns may lead to a decrease in demand for end products whose manufacturing processes involve the use of photomasks, which may result in a reduction in new product design and development by semiconductor or FPD manufacturers and adversely affect our results of operations and cash flows.
Technology failures or cyber security breaches could have a material adverse effect on our operations.
We rely on information technology systems to process, transmit, store, and protect electronic information. For example, a significant portion of the communications between our personnel, customers, and suppliers depends on information technology. Our information technology systems may be vulnerable to a variety of interruptions due to events beyond our control, including, but not limited to, natural disasters, terrorist attacks, telecommunications failures, computer viruses, hackers, and other security issues. Although we have technology and information security processes and disaster recovery plans in place to mitigate our risks to these vulnerabilities, these measures may not be adequate to ensure that our operations will not be disrupted, should such an event occur.
The General Data Protection Regulation (“GDPR”), which went into effect in the European Union (EU) on May 25, 2018, applies to the collection, use, retention, security, processing, and transfer of personally identifiable information of residents of E.U. countries. The GDPR created a range of new compliance obligations and imposes significant fines and sanctions for violations. It is possible that the GDPR may be interpreted or applied in a manner that is adverse to, or unforeseen by us, including requirements that are inconsistent with our practices, or that we may otherwise fail to construe its requirements in ways that are satisfactory to the E.U. authorities. Upon leaving the E.U. on January 31, 2021, the U.K. enacted a new domestic data privacy law called the “U.K. – General Data Protection Regulation” (“UK-GDPR”). Although somewhat less restrictive than the GDPR, the UK-GDPR is similar to the GDPR with respect to both an entity’s obligation to protect personal information and the imposition of significant fines for violations.
Any failure, or perceived failure, by us to comply with the GDPR or the UK-GDPR, or with any applicable regulatory requirements or orders, including, but not limited to privacy, data protection, information security, or consumer protection related privacy laws and regulations, in one or more jurisdictions within the E.U., the U.K. or elsewhere, could: result in proceedings or actions against us by governmental entities or individuals; subject us to significant fines, penalties, and/or judgments; require us to change our business practices; limit access to our products and services in certain countries, or otherwise adversely affect our business, as we would be at risk to lose both customers and revenue, and incur substantial costs.
We may, in the future, incur net losses.
Although the Company has been profitable since fiscal 2010, it has, in the past, incurred net losses. We cannot provide assurance that the Company will not incur net losses in the future.
Market Related Risk Factors
Changes in foreign currency exchange rates could have a material adverse effect on our results of operations, financial condition, or cash flows.
Our consolidated financial statements are prepared in accordance with U.S. GAAP and are reported in U.S. dollars. Our operations have transactions and balances denominated in currencies other than the U.S. dollar; primarily the South Korean won, New Taiwan dollar, Japanese yen, Chinese renminbi, euro, Singapore dollar, and the British pound sterling. In 2023, we recorded a net gain from changes in foreign currency exchange rates of $2.5 million in our consolidated statement of income, while our net assets increased by $5.6 million as a result of the translation of foreign currency financial statements to U.S. dollars. Significant foreign currency fluctuations may adversely affect our results of operations, financial condition, or cash flows.
Our hedging activity could negatively impact our results of operations and cash flows.
We may enter into derivatives to manage our exposures to interest rate and currency movements. If we do not accurately forecast our results of operations, execute contracts that do not effectively mitigate our economic exposures to interest rates and currency rates, elect to not apply hedge accounting (when doing so would have mitigated our losses), or fail to comply with the complex accounting requirements for hedging transactions, our results of operations and cash flows could be volatile, as well as negatively impacted.
The market price of our common stock is subject to volatility and could fluctuate widely in response to various factors, many of which are beyond our control.
Factors that may influence the price of our common stock include, but are not limited to, the following:
| | • | loss of any of our key customers or suppliers; |
| • | additions or departures of key personnel; |
| • | third party sales of common stock; |
| • | short interest in our common stock; |
| • | our ability to execute our business plan, including but not limited to, our expansion into China; |
| • | announcements and consummations of business acquisitions; |
| • | operating results that fall below or exceed expectations; |
| • | announcements of forecasted earnings or material transactions; |
| • | issuances or repurchases of our common stock; |
| • | intellectual property disputes; |
| • | reputational damage suffered with or without merit; |
| • | news about or disclosures made by our competitors or customers; |
| • | business combinations, divestitures, or bankruptcies by customers, suppliers, or competitors; |
| • | economic and other external factors including (but not limited to) inflation, recessions, natural disasters, military actions, political instability, or social unrest; and |
| • | period to period fluctuations in our financial results. |
In addition, securities markets have from time-to-time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our common stock. Such fluctuations may be the result of imbalances between buy and sell offers, the actions of quantitative or algorithmic stock traders and short-sellers, or low trading volume which can magnify the effects of a small number of transactions on the price of a stock.
We operate in a global, competitive environment which gives rise to operating and market risk exposure.
We sell our products in a competitive, global environment, and compete worldwide for sales on the basis of product quality, price, technology, and customer service. Sales of our products are also subject to federal, state, local, and foreign taxes, laws and regulations, trade agreements, import and export controls, duties, and tariffs. The imposition of additional regulations or controls including export controls, duties, tariffs, or changes to bilateral and regional trade agreements, could negatively impact our results of operations.
| ITEM 1B. | UNRESOLVED STAFF COMMENTS |
None.
The following table presents certain information about the Company's photomask manufacturing facilities:
| Location |
| Type of Interest
|
Allen, Texas |
| Owned |
Boise, Idaho |
| Owned |
Brookfield, Connecticut |
| Owned |
Bridgend, Wales |
| Leased |
Cheonan, Korea |
| Owned |
Hefei, China |
| Owned(1) |
Dresden, Germany |
| Leased |
Hsinchu, Taiwan |
| Owned(1) |
Hsinchu, Taiwan |
| Leased |
Taichung, Taiwan |
| Owned(1) |
Xiamen, China |
| Owned(1) |
(1) We own our manufacturing facilities in Hefei, Taichung, Xiamen, and one of our manufacturing facilities in Hsinchu. However, we lease the related land at these sites. We believe our facilities, with planned expansions, are adequate to support our current and near-term requirements.
Please refer to Note 15 to our consolidated financial statements in Part II, Item 8 of this report for information on legal proceedings involving the Company.
| ITEM 4. | MINE SAFETY DISCLOSURES |
Not applicable.
PART II
| ITEM 5. | MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
Our common stock is traded on the NASDAQ Global Select Market ("NASDAQ") under the symbol PLAB. On December 14, 2023, the closing sale price of our common stock, per the NASDAQ Global Select Market, was $29.09. Based on available information, we have 229 registered shareholders.
To date, we have not paid any cash dividends on Photronics shares, and, for the foreseeable future, we anticipate that earnings will continue to be retained for use in our business.
In September 2020, 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. The most recent 10b5-1 plan expired on September 15, 2022, and has not been renewed. Share repurchases under this authorization commenced on September 16, 2020. The repurchase authorization by the Board of Directors has no expiration date, does not obligate us to acquire any common stock, and is subject to market conditions. In 2023, we did not repurchase any further shares as part of this program. In 2022, we repurchased 0.2 million shares at a cost of $2.5 million (an average of $13.43 per share) and, since the program’s inception, we have repurchased 5.8 million shares at a cost of $68.3 million (an average of $11.70 per share). There is $31.7 million remaining under the Board of Director authorization. All shares repurchased under the program have been retired.
Securities authorized for issuance under equity compensation plans
The information regarding our equity compensation required to be disclosed by Item 201(d) of Regulation S-K is incorporated by reference from the Photronics, Inc. 2024 Definitive Proxy Statement in Item 12 of Part III of this report. The 2024 Definitive Proxy Statement will be filed within 120 days after our fiscal year ended October 31, 2023.
Stock Price Performance
The information regarding our stock price performance required to be disclosed by Item 201(e) of Regulation S-K is incorporated by reference from the Photronics, Inc. 2024 Definitive Proxy Statement in Item 12 of Part III of this report. The 2024 Definitive Proxy Statement will be filed within 120 days after our fiscal year ended October 31, 2023.
| ITEM 7. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Overview
We sell substantially all of our photomasks to semiconductor designers and manufacturers, and manufacturers of FPDs. Photomask technology is also being applied to the fabrication of other higher-performance electronic products such as virtual reality/augmented reality advanced IC packages, photonics, micro-electronic mechanical systems, and certain nanotechnology applications. Our selling cycle is tightly interwoven with the development and release of new semiconductor and display designs and applications, particularly as they relate to the semiconductor industry's migration to more advanced product innovation, design methodologies, and fabrication processes. The demand for photomasks primarily depends on design activity rather than sales volumes from products manufactured using semiconductor manufacturing technologies. Consequently, an increase in semiconductor or display sales does not necessarily result in a corresponding increase in photomask sales. However, the reduced use of application-specific ICs, reductions in design complexities, other changes in the technology or methods of manufacturing or designing semiconductors, or a slowdown in the introduction of new semiconductor or display designs could reduce demand for photomasks ‒ even if the demand for semiconductors and FPDs increases. Advances in semiconductor, display, and photomask design and production methods that shift the burden of achieving device performance away from lithography could also reduce the demand for photomasks. Historically, the microelectronics industry has been volatile, experiencing periodic downturns and slowdowns in design activity. These negative trends have been characterized by, among other things, diminished product demand, excess production capacity, and accelerated erosion of selling prices with a concomitant effect on revenue and profitability.
We are typically required to fulfill customer orders within a short period of time, sometimes within twenty-four hours. This results in a minimal level of backlog orders, typically one to two weeks of backlog for IC photomasks and two to three weeks of backlog for FPD photomasks. However, the demand for some IC photomasks can extend longer than the traditional time period; thus, for some products, our backlog can expand to as long as two to three months.
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.
We are focused on improving our competitiveness by advancing our technology and reducing costs and, in connection therewith, have invested and plan to continue to invest in manufacturing equipment to serve both the high-end photomask and trailing-edge markets. As we face challenges that require us to make significant improvements in our competitiveness, we continue to evaluate further cost reduction initiatives.
State-of-the-art production for semiconductor masks is considered to be 28 nanometer and smaller for ICs and Generation 10.5+ and AMOLED and LTPS display-based process technologies for FPDs. However, 32 nanometer and above geometries for semiconductors and Generation 8 and below (excluding AMOLED and LTPS) process technologies for displays constitute the majority of designs currently being fabricated in volume. At these geometries and various high-end nodes, we can produce full lines of photomasks, and there is no significant technology employed by our competitors that is not available to us. We expect advanced-generation designs to continue to move to production throughout fiscal 2024, and we believe we are well positioned to service an increasing volume of this business as a result of our investments in manufacturing processes and technology in the regions where our customers are located.
The photomask industry has been, and is expected to continue to be characterized by technological change and evolving industry standards. In order to remain competitive, we will be required to continually anticipate, respond to, and utilize changing technologies. In particular, we believe that, as semiconductor geometries continue to become smaller, and display designs become larger or otherwise more advanced, we will be required to manufacture even more complex optically-enhanced reticles, including optical proximity correction, phase-shift and EUV photomasks. Additionally, demand for photomasks has been, and could in the future be, adversely affected by changes in high-performance electronics fabrication methods that affect the type or quantity of photomasks used, such as changes in semiconductor demand that favor field-programmable gate arrays and other semiconductor designs that replace application-specific ICs, or the use of certain chip-stacking methodologies that lessen the emphasis on conventional lithography technology. Furthermore, increased market acceptance of alternative methods of transferring circuit designs onto semiconductor wafers could reduce or eliminate the need for photomasks in the production of semiconductors. As of the end of 2023, one alternative method, direct-write lithography, has not been proven to be a commercially viable alternative to photomasks, as it is considered to be too slow for high-volume semiconductor wafer production, and we have not experienced a significant loss of revenue as a result of this or other alternative semiconductor design methodologies. However, should direct-write lithography or any other alternative method of transferring IC designs to semiconductor wafers without the use of photomasks achieve market acceptance, and we do not anticipate, respond to, or utilize these or other changing technologies due to resource, technological, or other constraints, our business and results of operations could be materially adversely affected.
Our revenues have benefitted, and our costs, including depreciation, have been affected by the increased demand for high-end-technology photomasks that require more advanced manufacturing capabilities, but generally command higher ASPs. Our capital expenditure payments were $131.3 million, $112.3 million and $109.1 million in 2023, 2022 and 2021, respectively. Nonetheless, we intend to continue to make the required investments to support the technological requirements of our customers that we believe will continue to enable our growth. In support of this effort, we expect capital expenditure payments to be approximately $140 million in fiscal year 2024.
The manufacture of photomasks for use in fabricating ICs, FPDs, and other related products built using comparable photomask-based process technologies has been, and continues to be, capital intensive. Our employees and our integrated global manufacturing network represent a significant portion of our fixed operating cost base. Should our revenue decrease as a result of a decrease in design releases from our customers, we may have excess or underutilized production capacity, which could significantly impact our operating margins, or result in write-offs from asset impairments.
Results of Operations
The following tables present selected operating information expressed as a percentage of revenue. The columns may not foot due to rounding.
| | Three Months Ended | |
| | | October 31, 2023 | | | July 30, 2023 | | | October 31, 2022 | |
Revenue | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % |
Cost of goods sold | | | 62.7 | | | | 61.3 | | | | 61.8 | |
| | | | | | | | | | | | | |
Gross profit | | | 37.3 | | | | 38.7 | | | | 38.2 | |
Selling, general and administrative expenses | | | 7.4 | | | | 8.0 | | | | 7.5 | |
Research and development expenses | | | 1.5 | | | | 1.6 | | | | 1.9 | |
| | | | | | | | | | | | | |
Operating income | | | 28.5 | % | | | 29.1 | % | | | 28.8 | % |
Non-operating income (expense), net | | | 8.2 | | | | -0.4 | | | | 5.1 | |
| | | | | | | | | | | | | |
Income before income tax provision | | | 36.7 | | | | 28.7 | | | | 33.9 | |
Income tax provision | | | 8.9 | | | | 7.2 | | | | 7.6 | |
| | | | | | | | | | | | | |
Net income | | | 27.8 | | | | 21.5 | | | | 26.3 | |
Net income attributable to noncontrolling interests | | | 8.2 | | | | 9.5 | | | | 8.7 | |
| | | | | | | | | | | | | |
Net income attributable to Photronics, Inc. shareholders | | | 19.6 | % | | | 12.0 | % | | | 17.6 | % |
| | | Year Ended | |
| | | October 31, 2023 | | | October 31, 2022 | | | October 31, 2021 | |
Revenue | | | 100.0 | % | | | 100.0 | % | | | 100.0 | % |
Cost of goods sold | | | 62.3 | | | | 64.3 | | | | 74.8 | |
| | | | | | | | | | | | | |
Gross profit | | | 37.7 | | | | 35.7 | | | | 25.2 | |
Selling, general and administrative expenses | | | 7.8 | | | | 7.8 | | | | 8.7 | |
Research and development expenses | | | 1.5 | | | | 2.2 | | | | 2.8 | |
Other operating income, net | | | 0.0 | | | | 0.0 | | | | 0.5 | |
| | | | | | | | | | | | | |
Operating income | | | 28.4 | % | | | 25.7 | % | | | 14.2 | % |
Non-operating income (expense), net | | | 1.9 | | | | 3.3 | | | | 1.1 | |
| | | | | | | | | | | | | |
Income before income tax provision | | | 30.3 | | | | 29.0 | | | | 15.4 | |
Income tax provision | | | 7.9 | | | | 7.3 | | | | 3.5 | |
| | | | | | | | | | | | | |
Net income | | | 22.4 | | | | 21.7 | | | | 11.9 | |
Net income attributable to noncontrolling interests | | | 8.3 | | | | 7.3 | | | | 3.5 | |
| | | | | | | | | | | | | |
Net income attributable to Photronics, Inc. shareholders | | | 14.1 | % | | | 14.4 | % | | | 8.4 | % |
Note: All the following tabular comparisons, unless otherwise indicated, are for the three months ended October 31, 2023 (Q4 FY23), July 30, 2023 (Q3 FY23) and October 31, 2022 (Q4 FY22), and for the fiscal years ended October 31, 2023 (YTD FY23) and October 31, 2022 (YTD FY22). Please refer to Part II, Item 7 of our 2022 Form 10-K for comparative discussion of our fiscal years ended October 31, 2022, and October 31, 2021. The tables in this item may not foot due to rounding.
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 quarter 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.
The following tables present changes in revenue disaggregated by product type and geographic origin, in Q4 FY23 and YTD FY23 from revenue in prior reporting periods.
Quarterly Changes in Revenue by Product Type
| | | Q4 FY23 compared with Q3 FY23 | | | Q4 FY23 compared with Q4 FY22 | |
| | | Revenue in | | | Increase | | | Percent | | | Increase | | | Percent | |
| | | Q4 FY23 | | | (Decrease) | | | Change | | | (Decrease) | | | Change | |
| IC | | | | | | | | | | | | | | | |
| High-end * | | $ | 57.7 | | | $ | 12.4 | | | | 27.4 | % | | $ | 13.4 | | | | 30.2 | % |
| Mainstream | | | 106.8 | | | | (11.0 | ) | | | (9.3 | )% | | | (5.1 | ) | | | (4.5 | )% |
| | | | | | | | | | | | | | | | | | | | | |
| Total IC | | $ | 164.5 | | | $ | 1.4 | | | | 0.8 | % | | $ | 8.3 | | | | 5.3 | % |
| | | | | | | | | | | | | | | | | | | | | |
| FPD | | | | | | | | | | | | | | | | | | | | |
| High-end * | | $ | 53.3 | | | $ | 3.3 | | | | 6.6 | % | | $ | 9.9 | | | | 22.8 | % |
| Mainstream | | | 9.7 | | | | (1.4 | ) | | | (12.5 | )% | | | (0.9 | ) | | | (8.9 | )% |
| | | | | | | | | | | | | | | | | | | | | |
| Total FPD | | $ | 63.0 | | | $ | 1.9 | | | | 3.1 | % | | $ | 9.0 | | | | 16.5 | % |
| | | | | | | | | | | | | | | | | | | | | |
Total Revenue | | $ | 227.5 | | | $ | 3.3 | | | | 1.5 | % | | $ | 17.2 | | | | 8.2 | % |
| * | High-end photomasks typically have higher ASPs than mainstream products. |
Quarterly Changes in Revenue by Geographic Origin**
| | | Q4 FY23 compared with Q3 FY23 | | | Q4 FY23 compared with Q4 FY22 | |
| | | Revenue in | | | Increase | | | Percent | | | Increase | | | Percent | |
| | | Q4 FY23 | | | (Decrease) | | | Change | | | (Decrease) | | | Change | |
Taiwan | | $ | 79.3 | | | $ | (2.3 | ) | | | (2.8 | )% | | $ | 3.0 | | | | 3.9 | % |
China | | | 59.2 | | | | (2.9 | ) | | | (4.6 | )% | | | 6.8 | | | | 12.9 | % |
Korea | | | 42.2 | | | | 1.4 | | | | 3.3 | % | | | 4.2 | | | | 11.2 | % |
United States | | | 36.8 | | | | 7.1 | | | | 23.9 | % | | | 2.8 | | | | 8.2 | % |
Europe | | | 9.3 | | | | (0.2 | ) | | | (2.2 | )% | | | 0.3 | | | | 3.0 | % |
Other | | | 0.7 | | | | 0.2 | | | | 34.4 | % | | | 0.1 | | | | 24.7 | % |
Total revenue | | $ | 227.5 | | | $ | 3.3 | | | | 1.5 | % | | $ | 17.2 | | | | 8.2 | % |
| ** | This table disaggregates revenue by the location in which it was earned. |
Revenue in Q4 FY23 of $227.5 million represented an increase of 1.5% compared with Q3 FY23, and an increase of 8.2% from Q4 FY22.
Overall IC revenue increased 0.8 % from Q3 FY23, and increased 5.3% from Q4 FY22 due to stronger high-end foundry and logic demand in Asia. IC mainstream decreased in Q4 FY23 by 9.3% from Q3 FY23, and 4.5% from Q4 FY22 primarily the result of reduced mainstream demand in Asia.
FPD revenue increased 3.1% and 16.5% in Q4 FY23, compared, respectively, with Q3 FY23 and Q4 FY22. The increases were caused by continued strong AMOLED demand in mobile display during Q4 FY23. Revenue from mainstream products decreased 12.5% from Q3 FY23 as more production capacity was dedicated to meet strong high-end demand.
Year-over-Year Changes in Revenue by Product Type
| | | YTD FY23 compared with YTD FY22 | |
| | | Revenue in | | | Increase | | | Percent | |
| | | YTD FY23 | | | (Decrease) | | | Change | |
| IC | | | | | | | | | |
| High-end * | | $ | 195.0 | | | $ | (0.4 | ) | | | (0.2 | )% |
| Mainstream | | | 456.3 | | | | 58.6 | | | | 14.7 | % |
| | | | | | | | | | | | | |
| Total IC | | | 651.3 | | | $ | 58.3 | | | | 9.8 | % |
| | | | | | | | | | | | | |
| FPD | | | | | | | | | | | | |
| High-end * | | | 200.8 | | | $ | 13.9 | | | | 7.4 | % |
| Mainstream | | | 40.0 | | | | (4.6 | ) | | | (10.3 | )% |
| | | | | | | | | | | | | |
| Total FPD | | | 240.8 | | | $ | 9.3 | | | | 4.0 | % |
| | | | | | | | | | | | | |
Total Revenue | | | 892.1 | | | $ | 67.5 | | | | 8.2 | % |
| * | High-end photomasks typically have higher ASPs than mainstream photomasks. |
Year-over-Year Changes in Revenue by Geographic Origin**
| | | YTD FY23 compared with YTD FY22 | |
| | | Revenue in | | | Increase | | | Percent | |
| | | YTD FY23 | | | (Decrease) | | | Change | |
Taiwan | | $ | 316.9 | | | $ | 25.5 | | | | 8.8 | % |
China | | | 245.4 | | | | 32.8 | | | | 15.4 | % |
Korea | | | 162.2 | | | | 6.1 | | | | 3.9 | % |
United States | | | 128.9 | | | | 2.7 | | | | 2.1 | % |
Europe | | | 36.6 | | | | 0.2 | | | | 0.5 | % |
Other | | | 2.1 | | | | 0.3 | | | | 13.5 | % |
| | | $ | 892.1 | | | $ | 67.5 | | | | 8.2 | % |
| ** | This table disaggregates revenue by the location in which it was earned. |
Revenue in YTD FY23 of $892.1 million surpassed our prior record revenue set in YTD FY22 by $67.5 million, or 8.2%. IC revenue increased by 9.8%, due to strong demand for mainstream products earlier in the year. FPD revenue increased by 4.0%, driven by a 7.4% increase in revenue from high-end products due to increased AMOLED demand in mobile displays, which offset decreased mainstream resulting from shifting capacity to meet strong high-end demand. We believe that strong demand for AMOLED photomasks will continue, as expected technology advances drives increasing overall demand for higher-value masks.
Gross Margin
| | | | | | | | | Percent | | | | | | Percent | |
| | | Q4 FY23 | | | Q3 FY23 | | | Change | | | Q4 FY22 | | | Change | |
Gross profit | | $ | 84.9 | | | $ | 86.8 | | | | (2.2 | )% | | $ | 80.3 | | | | 5.7 | % |
Gross margin | | | 37.3 | % | | | 38.7 | % | | | | | | | 38.2 | % | | | | |
Gross margin was 37.3% for Q4 FY23, representing a slight decrease from the Q3 FY23 gross margin of 38.7%, as increase in revenue of 1.5% was offset by increased material costs of 4.2%, or 69 basis points as a percentage of revenue. Labor costs increased 4.5%, or 30 basis points as a percentage of revenue, due to increased costs in some locations. Equipment and other overhead costs increased 3.0%, or 41 basis points as a percentage of revenue, with increased equipment maintenance costs, partially offset by lower outsourced manufacturing costs, most significantly contributing to the net cost increase.
Gross margin decreased by 0.9 percentage points in Q4 FY23, from Q4 FY22, primarily as a result of the increase in material costs as a percentage of revenue from the prior year quarter. Equipment and other overhead costs increased 9.7%, or 37 basis points, as a percentage of revenue. Increased depreciation expense, utilities expenses, and outsourced manufacturing costs, which were partially offset by decreased equipment maintenance costs, were the primary contributors to the overall increase.
| | | | | | | | | Percent | |
| | | YTD FY23 | | | YTD FY22 | | | Change | |
Gross profit | | $ | 336.2 | | | $ | 294.2 | | | | 14.3 | % |
Gross margin | | | 37.7 | % | | | 35.7 | % | | | | |
Gross margin increased by 2.0 percentage points in YTD FY23, from YTD FY22, primarily as a result of the increase in revenue from the prior year period, offset somewhat by the following net cost increases: Material costs increased 2.8% from the prior year period, but decreased 129 basis points as a percentage of revenue. Labor costs increased 10.3% from the prior year, and increased 30 basis points as a percentage of revenue, primarily due to increased labor costs in Asia. Equipment and other overhead costs increased by 4.5% but decreased 95 basis points as a percentage of revenue, with increased utilities, equipment service contract costs, and less transfer of research and development cost from cost of goods sold to research and development expense, as well as increases in computer software costs, offset by decreased importation costs most significantly contributing to the overall cost increase.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $16.7 million in Q4 FY23, compared with $18.0 million in Q3 FY23, and $15.7 million in Q4 FY22. The decrease from Q3 FY23 was primarily the result of decreased compensation and related expenses of $1.5 million offset partially by increased insurance expenses and outside services of $0.1 million and $0.1 million, respectively. The increase from the prior year quarter was primarily the result of increased compensation and related expenses of $1.0 million and increased insurance expenses of $0.2 million. Selling, general and administrative expenses increased $5.5 million to $69.5 million in YTD FY23, from $64.0 million in YTD FY22, primarily due to an increase in compensation and related expenses, professional fees, travel and entertainment and insurance expenses in the respective amounts of $4.1 million, $1.2 million, $0.4 million and $0.3 million.
Research and Development Expenses
Research and development expenses, which primarily consist of development and qualification efforts related to process technologies for high-end IC and FPD applications, decreased $0.1 million to $3.4 million in Q4 FY23, from Q3 FY23; the decrease was primarily caused by a decline in development activities in Asia. Research and development expenses in Q4 FY23 decreased by $0.7 million from Q4 FY22 as a result of decreased development activities in the U.S. and Asia. On a year-to-date basis, research and development expenses decreased $4.7 million, to $13.7 million, primarily due to decreased development activities in the U.S.
Non-Operating Income (Expense)
| | | Q4 FY23 | | | Q3 FY23 | | | Q4 FY22 | |
Foreign currency transactions impact, net | | $ | 13.2 | | | $ | (4.5 | ) | | $ | 10.4 | |
Interest expense, net | | | (0.1 | ) | | | (0.1 | ) | | | (0.4 | ) |
Interest income and other income, net | | | 5.6 | | | | 3.7 | | | | 0.8 | |
| | | | | | | | | | | | | |
Non-operating income (expense), net | | $ | 18.7 | | | $ | (0.9 | ) | | $ | 10.8 | |
Non-operating income (expense) increased in Q4 FY23 from Q3 FY23 by $19.6 million, primarily due to foreign currency impacts, driven by favorable movements of the South Korean won, the New Taiwan dollar, RMB dollar against the U.S. dollar offsetting unfavorable movements of the Singapore dollar against the U.S. dollar. Non-operating income (expense) increased from Q4 FY22, by $7.9 million, primarily due to higher interest and investment income earned on our cash balances, in addition to foreign currency transactions impact.
| | | YTD FY23 | | | YTD FY22 | |
Foreign currency transactions impact, net | | $ | 2.5 | | | $ | 27.3 | |
Interest expense, net | | | (0.4 | ) | | | (1.9 | ) |
Interest income and other income, net | | | 14.8 | | | | 1.7 | |
| | | | | | | | | |
Non-operating income (expense), net | | $ | 16.9 | | | $ | 27.2 | |
Non-operating income (expense) decreased $10.3 million in full year FY23, compared with full year FY22, due to foreign currency transactions, driven by unfavorable movements of the South Korean won, the New Taiwan dollar, and the Singapore dollar offsetting favorable movements of the RMB against the U.S. dollar, partially offset by increased interest income in the current year resulting from higher average cash, cash equivalents and short-term investments balances in FY23, compared with FY22 and lower interest expense, net of subsidies, due to receiving a lower amount of interest subsidies on our China-based debt in FY23, the effect of which was partially mitigated by lower average interest-bearing debt balance in FY23 than in the prior year. The columns presented above may not foot due to rounding.
Income Tax Provision
On December 15, 2022, the European Union (EU) Member States formally adopted the EU’s Pillar Two Directive, which generally provides for a minimum effective tax rate of 15%, as established by the Organization for Economic Co-operation and Development (OECD) Pillar Two Framework. The EU effective dates are January 1, 2024, and January 1, 2025, for different aspects of the directive. A significant number of other countries are expected to also implement similar legislation with varying effective dates in the future. The Company is continuing to evaluate the potential impact on future periods of the Pillar Two Framework, pending legislative adoption by additional individual countries.
| | | Q4 FY23 | | | Q3 FY23 | | | Q4 FY22 | |
Income tax provision | | $ | 20.3 | | | $ | 16.1 | | | $ | 16.1 | |
Effective income tax rate | | | 24.3 | % | | | 25.0 | % | | | 22.5 | % |
The effective income tax rates are sensitive to the jurisdictional mix of our earnings, due, in part, to the non-recognition of tax benefits on losses in jurisdictions with valuation allowances where the tax benefits of losses are not available.
The effective income tax rate decreased slightly in Q4 FY23, compared with Q3 FY23, primarily due to changes in the period-to-period mix of jurisdictional earnings. The effective income tax rate increase in Q4 FY23, as compared with Q4 FY22, is primarily due to changes in the jurisdictional mix of earnings as well as an increase in foreign tax as compared to the prior year.
| | | FY23 | | | FY22 | |
Income tax provision | | $ | 70.3 | | | $ | 59.8 | |
Effective income tax rate | | | 26.0 | % | | | 25.0 | % |
The increase in the effective income tax rate on a full-year basis in FY23, compared with FY22, is primarily due to an increase of unremitted earnings tax in a non-US jurisdiction, as well as changes in the jurisdictional mix of earnings. We consider all available evidence when evaluating the potential future realization of deferred tax assets, and when, based on the weight of all available evidence, we determine that it is more likely than not that some portion or all of our deferred tax assets will not be realized, we reduce our deferred tax assets by a valuation allowance. We also regularly assess the potential outcomes of ongoing and future tax examinations and, accordingly, have recorded accruals for such contingencies. Included in the balance of unrecognized tax benefits as of October 31, 2023 and October 31, 2022, are $8.9 million and $5.6 million respectively, recorded in Other liabilities in the consolidated balance sheets that, if recognized, would impact the effective tax rates.
Net Income Attributable to Noncontrolling Interests
Net income attributable to noncontrolling interests was $18.5 million in Q4 FY23, compared with $21.3 million in Q3 FY23; the decrease was the result of a net decrease in the net incomes of our joint venture operations. Net income attributable to noncontrolling interests increased by $0.3 million in Q4 FY23 from Q4 FY22, and by $13.7 million in YTD FY23 from YTD FY22, as a result of increased net income at both our Taiwan-based and China-based IC facilities.
Liquidity and Capital Resources
Cash and cash equivalents was $499.3 million and $319.7 million as of October 31, 2023, and October 31, 2022, respectively. As of the most recent balance sheet date, total cash and cash equivalents included $473.2 million held by foreign subsidiaries. Net Cash, a non-GAAP financial measure as defined and discussed in the Non-GAAP Financial Measures section below, was $474.7 million and $277.3 million as of October 31, 2023, and October 31, 2022, respectively. Our primary sources of liquidity are our cash on hand and cash we generate from operations.
We continually evaluate alternatives for efficiently funding our capital expenditures and ongoing operations. These reviews may result in our engagement in a variety of investing and financing transactions, in the transfer of cash among subsidiaries, and/or the repatriation of cash to the U.S. The transfer of funds among subsidiaries could be subject to foreign withholding taxes; in certain jurisdictions, repatriation of these funds to the U.S. may subject them to U.S. state income taxes and/or local country withholding taxes. We believe that our liquidity, including available financing, is sufficient to meet our requirements through the next twelve months and thereafter for the foreseeable future. Through the utilization of our existing liquidity, cash we generate from operations and short-term investments, we plan to continue to invest in our business, with our investments targeted to align with our customers’ technology road maps. In addition, we stand ready to invest in mergers, acquisitions, or strategic partnerships, should a suitable opportunity arise.
We estimate capital expenditures for our fiscal year 2024 will be approximately $140 million; these investments will be targeted towards high-end and mainstream “point” tools that will increase our operating capacity and efficiency, and enable us to support our customers’ near-term demands. As of October 31, 2023, we had outstanding capital commitments of approximately $106.8 million and recognized liabilities related to capital equipment purchases of approximately $18.7 million. Although payment timing could vary, primarily as a result of the timing of tool delivery, installation and testing, we currently estimate that we will fund $88.6 million of our total $125.5 million committed and recognized obligations for capital expenditures over the next twelve months. Please refer to Notes 10 and 15 to our consolidated financial statements for additional information on our lease liabilities and unrecognized commitments, respectively.
In September 2020, 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. This authorization does not obligate the Company to repurchase any dollar amount or number of shares of common stock. As of October 31, 2023, there was approximately $31.7 million remaining under that authorization. Depending on market conditions, we may utilize some or the entire remaining approved amount to reacquire additional shares.
As discussed in Note 6 of our consolidated financial statements, DNP, the noncontrolling interest in our China-based joint venture has, under certain circumstances, the right to put its interest in the joint venture to Photronics, or to purchase our interest in the joint venture. Under all such circumstances, the sale of DNP’s interest would be at its 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. As of the date of issuance of this report, DNP had not indicated its intention to exercise this right. As of October 31, 2023, Photronics and DNP each had net investments in this joint venture of approximately $117.1 million.
| | Year Ended | |
| | October 31, 2023 | | | October 31, 2022 | | | October 31, 2021 | |
Net cash provided by operating activities | | $ | 302.2 | | | $ | 275.2 | | | $ | 150.8 | |
Net cash used in investing activities | | $ | (101.5 | ) | | $ | (147.8 | ) | | $ | (103.5 | ) |
Net cash used in financing activities | | $ | (18.5 | ) | | $ | (38.7 | ) | | $ | (53.9 | ) |
Operating Activities: Net cash provided by operating activities reflects net income adjusted for certain non-cash items, including depreciation and amortization, share-based compensation, and the effects of changes in operating assets and liabilities. Net cash provided by operating activities increased by $27.0 million in FY23, compared with FY22, primarily due to increased net income and net cash-favorable changes in working capital, predominantly in Asia.
Free Cash Flow, which is a non-GAAP financial measure as discussed in the “Non-GAAP Financial Measures” section below, increased by $8.0 million in FY23, compared with FY22, and $121.2 million in FY22, compared with FY21, primarily due to increases in net cash provided by operating activities.
Investing Activities: In FY23, net cash flows used in investing activities primarily consisted of purchases of $131.3 million of property, plant and equipment. Net cash flows used in investing activities decreased by $46.2 million in FY23, compared with FY22, primarily as a result of $47.5 million in proceeds from the maturity of available-for-sale debt securities.
Financing Activities: In FY23, net cash flows used in financing activities primarily consisted of debt repayments of $18.5 million. Net cash used in financing activities decreased by $20.2 million in FY23, compared with FY22, primarily due to decreased repayments of debt of $47.0 million, offset by decreased contributions from noncontrolling interests of $25.0 million that occurred in FY22 but did not repeat in FY23.
Our cash, cash equivalents, and restricted cash balances were negatively impacted by changes in foreign currency exchange rates in FY23 by $2.7 million.
Non-GAAP Financial Measures
Non-GAAP Non-operating (loss) income, Non-GAAP Income tax provision, Non-GAAP Noncontrolling interests, Non-GAAP Net Income attributable to Photronics, Inc. shareholders and non-GAAP earnings per share, Free Cash Flow, and Net Cash are "non-GAAP financial measures" as such term is defined by the Securities and Exchange Commission and may differ from similarly named non-GAAP financial measures used by other companies. The financial tables below reconcile Photronics, Inc. financial results under GAAP to non-GAAP financial information. We believe these non-GAAP financial measures that exclude certain items are useful for analysts and investors to evaluate our future on-going performance because they enable a more meaningful comparison of our projected performance with our historical results. These non-GAAP metrics are not intended to represent funds available for our discretionary use and are not intended to represent, or be used as a substitute for, net income attributable to Photronics, Inc. shareholders, diluted earnings per share, cash and cash equivalents, or cash flows from operations, as measured under GAAP. The items excluded from these non-GAAP metrics but included in the calculation of their closest GAAP equivalent, are significant components of the consolidated statements of income, consolidated balance sheets and statement of cash flows and must be considered in performing a comprehensive assessment of overall financial performance.
The following table reconciles GAAP to Non-GAAP Income at the balance sheet dates. The columns may not foot due to rounding.
| | | Three Months ended | | | Year ended | |
| | | Oct 31, | | | July 30, | | | Oct 31, | | | Oct 31, | | | Oct 31, | | | Oct 31, | |
| | | 2023 | | | 2023 | | | 2022 | | | 2023 | | | 2022 | | | 2021 | |
| Reconciliation of GAAP to Non-GAAP Non-operating (loss) Income: | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
GAAP Non-operating (loss) income, net | | $ | 18,660 | | | $ | (911 | ) | | $ | 10,797 | | | $ | 16,896 | | | $ | 27,167 | | | $ | 7,452 | |
| FX (gain) loss | | | (13,234 | ) | | | 4,543 | | | | (10,369 | ) | | | (2,466 | ) | | | (27,344 | ) | | | (7,972 | ) |
Non-GAAP Non-operating (loss) income, net | | $ | 5,426 | | | $ | 3,632 | | | $ | 428 | | | $ | 14,430 | | | $ | (177 | ) | | $ | (520 | ) |
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| Reconciliation of GAAP to Non-GAAP Income tax provision: | | | | | | | | | | | | | | | | | | | | | | | | |
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GAAP Income tax provision | | $ | 20,288 | | | $ | 16,098 | | | $ | 16,074 | | | $ | 70,312 | | | $ | 59,791 | | | $ | 23,190 | |
| Estimated tax effects of FX (gain) loss | | | 3,437 | | | | (1,193 | ) | | | 2,522 | | | | 317 | | | | 5,933 | | | | 1,829 | |
Non-GAAP Income tax provision | | $ | 16,851 | | | $ | 17,291 | | | $ | 13,552 | | | $ | 69,995 | | | $ | 53,858 | | | $ | 21,361 | |
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| Reconciliation of GAAP to Non-GAAP Noncontrolling interests: | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
GAAP Noncontrolling interests | | $ | 18,545 | | | $ | 21,296 | | | $ | 18,204 | | | $ | 74,149 | | | $ | 60,456 | | | $ | 23,367 | |
| Estimated noncontrolling interest effects of above | | | 2,431 | | | | 1,328 | | | | 1,990 | | | | 2,676 | | | | 4,275 | | | | (481 | ) |
Non-GAAP Noncontrolling interests | | $ | 16,114 | | | $ | 19,968 | | | $ | 16,214 | | | $ | 71,473 | | | $ | 56,181 | | | $ | 23,848 | |
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| Reconciliation of GAAP to Non-GAAP Net Income: | | | | | | | | | | | | | | | | | | | | | | | | |
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GAAP Net Income | | $ | 44,611 | | | $ | 26,959 | | | $ | 37,060 | | | $ | 125,485 | | | $ | 118,786 | | | $ | 55,449 | |
| FX (gain) loss | | | (13,234 | ) | | | 4,543 | | | | (10,369 | ) | | | (2,466 | ) | | | (27,344 | ) | | | (7,972 | ) |
| Estimated tax effects of above | | | 3,437 | | | | (1,193 | ) | | | 2,522 | | | | 317 | | | | 5,933 | | | | 1,829 | |
| Estimated noncontrolling interest effects of above | | | 2,431 | | | | 1,328 | | | | 1,990 | | | | 2,676 | | | | 4,275 | | | | (481 | ) |
Non-GAAP Net Income | | $ | 37,245 | | | $ | 31,637 | | | $ | 31,203 | | | $ | 126,012 | | | $ | 101,650 | | | $ | 48,825 | |
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| Weighted-average number of common shares outstanding - Diluted | | | 62,067 | | | | 61,974 | | | | 61,374 | | | | 61,755 | | | | 61,189 | | | | 61,999 | |
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| Reconciliation of GAAP to Non-GAAP EPS: | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
GAAP diluted earnings per share | | $ | 0.72 | | | $ | 0.44 | | | $ | 0.60 | | | $ | 2.03 | | | $ | 1.94 | | | $ | 0.89 | |
| Effects of the above adjustments | | | (0.12 | ) | | | 0.07 | | | | (0.10 | ) | | | 0.01 | | | | (0.28 | ) | | | (0.10 | ) |
| Non-GAAP diluted earnings per share | | $ | 0.60 | | | $ | 0.51 | | | $ | 0.51 | | | $ | 2.04 | | | $ | 1.66 | | | $ | 0.79 | |
The following table reconciles Net cash provided by operating activities to Free Cash Flow for FY23, FY22, and FY21. The columns may not foot due to rounding. Prior year amounts in the non-GAAP disclosure below have been recast to eliminate government incentives to conform to current year presentation.
| | | FY23 | | | FY22 | | | FY21 | |
| Free Cash Flow | | | | | | | | | |
Net cash provided by operating activities | | $ | 302.2 | | | $ | 275.2 | | | $ | 150.8 | |
Purchases of property, plant and equipment | | | (131.3 | ) | | | (112.3 | ) | | | (109.1 | ) |
Free cash flow | | $ | 170.9 | | | $ | 162.9 | | | $ | 41.7 | |
The following table reconciles Cash and cash equivalents to Net Cash at the balance sheet dates. The increase in Net Cash was primarily driven by an increase in Net cash provided by operating activities, as discussed above. The columns may not foot due to rounding.
| | | As of | |
| | | October 31, 2023 | | | October 31, 2022 | |
| Net Cash | | | | | | |
Cash, cash equivalents | | $ | 499.3 | | | $ | 319.7 | |
Current portion of Long-term debt | | | (6.6 | ) | | | (10.0 | ) |
Long-term debt | | | (18.0 | ) | | | (32.3 | ) |
Net cash | | $ | 474.7 | | | $ | 277.4 | |
Business Outlook
Our current business outlook and guidance was provided in our Full Year and Fourth Quarter Fiscal 2023 Results earnings call, and related slide deck. These can be accessed in the investor section of our website - www.photronics.com.
Our future results of operations and the other forward-looking statements contained in this filing and in our “Full Year and Fourth Quarter Fiscal 2023 Results” earnings call and presentation involve a number of risks and uncertainties, some of which are discussed in Part I, Item 1A of this report. A number of other unforeseeable factors could cause actual results to differ materially from our expectations.
Critical Accounting Estimates
Our consolidated financial statements are based on the selection and application of accounting policies, which require management to make significant estimates and assumptions. We believe the following to be the more critical areas that require judgment when applying our accounting policies:
| | • | Revenue Recognition: The application of GAAP related to the measurement and recognition of revenue requires us to make judgments and estimates, including the determination of whether we should recognize revenues as we perform or upon the completion of our performance, as these determinations impact the timing and amount of our reported revenues and net income. Other significant judgments include the estimation of the point in the manufacturing process at which we are entitled to recognize revenue, as well as the measurement of our progress towards satisfying our performance obligations, which determine the amount of revenue we are entitled to recognize. |
| • | Property, Plant and Equipment: Significant judgment and assumptions are employed when we establish the estimated useful lives of asset classes, and determine when depreciation should commence for individual assets, as these determinations can significantly impact our gross margin and research and development expenses. Significant judgment would also be employed when events or changes in circumstances indicate that the carrying amount of a group of assets may not be recoverable, as the recoverability assessment requires us to forecast future cash flows related to these assets; this evaluation can significantly impact our gross margin and operating expense. |
| • | Leases: Significant judgment is applied in the determination of whether an arrangement is, or contains, a lease and, in certain instances, whether the lease should be classified as an operating lease or a finance lease, which can impact the timing and classification of lease costs. |
| • | Contingencies: We are subject to the possibility of losses from various contingencies. Significant judgment is necessary to estimate the probability and amount of a loss, if any, from such contingencies. An accrual is made when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. Changes in estimates related to, and resolutions of, contingencies may have a material impact on our financial performance. |
| • | Income Taxes: Our annual tax rate is determined based on our income and the jurisdictions where it is earned, statutory tax rates, and the tax impacts of items treated differently for tax purposes than for financial reporting purposes. Also inherent in determining our annual tax rate are judgments and assumptions regarding the recoverability of certain deferred tax assets, and our ability to uphold certain tax positions. We are subject to complex tax laws, in the U.S. and numerous foreign jurisdictions, and the manner in which they apply can be open to interpretation. Realization of deferred tax assets is dependent upon generating sufficient taxable income in the appropriate jurisdiction in future periods, which involves business plans, planning opportunities, and expectations about future outcomes. Our assessment relies on estimates and assumptions and may involve a series of complex judgments about future events. |
There are a number of estimates and assumptions inherent in calculating the various components of our tax provision. Future events such as changes in tax legislation, geographic mix of earnings, findings in tax audits, and earnings repatriation plans could have an impact on those estimates and our effective tax rate.
Please refer to Notes 1, 10, 13, and 15 to our consolidated financial statements for additional information related to these critical accounting estimates.
Effect of Recent Accounting Pronouncements
See Note 22 to our consolidated financial statements of this report for recent accounting pronouncements that may affect our financial reporting.
| ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Foreign Currency Exchange Rate Risk
We conduct business in several major 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 RMB, and the Singapore dollar. The functional currencies of our European subsidiaries are the British pound and the euro. In addition, we engage in transactions and have exposures to the Japanese yen.
We attempt to minimize our risk of foreign currency transaction losses by producing products in the same country in which the products are sold (thereby generating revenues and incurring expenses in the same currency), and by managing our working capital. However, in some instances, we sell products in a currency other than the functional currency of the country where it was produced, or purchase products in a currency that differs from the functional currency of the purchasing entity. 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 functional currency of the transacting subsidiary. We do not enter into derivatives for speculative purposes. There can be no assurance that this approach will protect us from the need to recognize significant foreign currency transaction gains and losses, especially in the event of a significant adverse movement in the value of any foreign currency in which we conduct business against any of our functional currencies, including the U.S. dollar.
Our primary net foreign currency exposures as of October 31, 2023, included the South Korean won, the Japanese yen, the New Taiwan dollar, the Chinese renminbi, the Singapore dollar, the British pound sterling, and the euro. As of October 31, 2023, a 10% adverse movement in the value of these currencies against the functional currencies of our subsidiaries would have resulted in a net unrealized pre-tax loss of $52.0 million, which represents an increase of $17.3 million from the same movement as of October 31, 2022. The increase in foreign currency rate change risk is primarily the result of increased net exposures of the New Taiwan dollar and South Korean won against the U.S. dollar. We do not believe that a 10% change in the exchange rates of other non-U.S. dollar currencies would have had a material effect on our October 31, 2023, consolidated financial statements.
Interest Rate Risk
A 10% adverse movement in the interest rates on our variable rate borrowings would not have had a material effect on our October 31, 2023, consolidated financial statements.
