PHOTRONICS INC - Quarter Report: 2010 May (Form 10-Q)

 

 

x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended May 2, 2010 OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

Connecticut	06-0854886
(State or other jurisdiction	(IRS Employer
of incorporation or organization)	Identification Number)

 

 

 

 

 

 

 

 

Class	Outstanding at June 1, 2010
Common Stock, $0.01 par value	53,620,694 Shares

 

 

 

 

 

PART I.		FINANCIAL INFORMATION	Page
Item 1.		Condensed Consolidated Financial Statements	4
		Condensed Consolidated Balance Sheets at May 2, 2010 and November 1, 2009	4
		Condensed Consolidated Statements of Operations for the Three and Six Months Ended     May 2, 2010 and May 3, 2009	5
		Condensed Consolidated Statements of Cash Flows for the Six Months Ended     May 2, 2010 and May 3, 2009	6
		Notes to Condensed Consolidated Financial Statements	7
Item 2.		Management's Discussion and Analysis of Financial Condition and Results of Operations	22
Item 3.		Quantitative and Qualitative Disclosures about Market Risk	28
Item 4.		Controls and Procedures	29
PART II.		OTHER INFORMATION
Item 1A.		Risk Factors	30
Item 6.		Exhibits	30

 

 

 

 

	May 2,				November 1,
	2010				2009
ASSETS
Current assets:
Cash and cash equivalents	$	91,410			$	88,539
Accounts receivable, net of allowance of $3,434 in 2010
and $2,669 in 2009		81,247				66,920
Inventories		15,861				14,826
Deferred income taxes		3,509				3,264
Other current assets		6,403				6,448
Total current assets		198,430				179,997
Property, plant and equipment, net		360,108				347,889
Investment in joint venture		60,901				60,945
Intangible assets, net		50,794				55,054
Other assets		19,175				19,771
	$	689,408			$	663,656
LIABILITIES AND EQUITY
Current liabilities:
Current portion of long-term borrowings	$	11,364			$	10,301
Accounts payable		68,317				59,187
Accrued liabilities		25,700				20,967
Total current liabilities		105,381				90,455
Long-term borrowings		96,897				112,137
Deferred income taxes		1,342				1,487
Other liabilities		9,619				9,881
Total liabilities		213,239				213,960
Commitments and contingencies
Equity:
Preferred stock, $0.01 par value,
2,000 shares authorized, none issued and outstanding		-				-
Common stock, $0.01 par value,
150,000 shares authorized, 53,497 shares issued and outstanding
at May 2, 2010 and 53,011 at November 1, 2009		535				530
Additional paid-in capital		434,976				432,160
Accumulated deficit		(18,460	)			(26,546	)
Accumulated other comprehensive income (loss)		6,218				(6,389	)
Total Photronics, Inc. shareholders' equity		423,269				399,755
Noncontrolling interests		52,900				49,941
Total equity		476,169				449,696
	$	689,408			$	663,656

 

 

 

	Three Months Ended								Six Months Ended
	May 2,				May 3,				May 2,				May 3,
	2010				2009				2010				2009
Net sales	$	105,070			$	83,232			$	203,267			$	171,275
Costs and expenses:
Cost of sales		(82,980	)			(71,792	)			(163,000	)			(149,275	)
Selling, general and administrative		(10,870	)			(10,630	)			(21,018	)			(21,032	)
Research and development		(3,601	)			(4,177	)			(7,556	)			(7,801	)
Consolidation, restructuring and
related (charges) credits		5,029				(406	)			4,836				(2,086	)
Impairment of long-lived assets		-				(1,458	)			-				(1,458	)
Operating income (loss)		12,648				(5,231	)			16,529				(10,377	)
Other income (expense):
Interest expense		(3,059	)			(4,430	)			(5,981	)			(9,076	)
Investment and other income (expense), net		876				(571	)			1,345				451
Income (loss) before income taxes		10,465				(10,232	)			11,893				(19,002	)
Income tax (provision) benefit		(1,860	)			76				(2,880	)			(1,122	)
Net income (loss)		8,605				(10,156	)			9,013				(20,124	)
Net (income) loss attributable to
noncontrolling interests		(732	)			84				(927	)			(181	)
Net income (loss) attributable to
Photronics, Inc.	$	7,873			$	(10,072	)		$	8,086			$	(20,305	)
Earnings (loss) per share:
Basic	$	0.15			$	(0.24	)		$	0.15			$	(0.49	)
Diluted	$	0.14			$	(0.24	)		$	0.15			$	(0.49	)
Weighted-average number of common shares
outstanding:
Basic		53,405				41,775				53,253				41,749
Diluted		65,780				41,775				54,291				41,749

 

 

 

	Six Months Ended
	May 2,				May 3,
	2010				2009
Cash flows from operating activities:
Net income (loss)	$	9,013			$	(20,124	)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization		45,863				42,027
Consolidation, restructuring and related charges (credits)		(5,059	)			2,086
Impairment of long-lived assets		-				1,458
Changes in assets and liabilities:
Accounts receivable		(12,918	)			5,952
Inventories		(592	)			756
Other current assets		1,199				2,284
Accounts payable, accrued liabilities, and other		(3,743	)			(8,090	)
Net cash provided by operating activities		33,763				26,349
Cash flows from investing activities:
Purchases of property, plant and equipment		(31,003	)			(20,375	)
Proceeds from sale of facility		12,880				-
Increase in restricted cash		(1,250	)			-
Proceeds from sales of investments and other		255				941
Distribution from joint venture		-				5,000
Net cash used in investing activities		(19,118	)			(14,434	)
Cash flows from financing activities:
Repayments of long-term borrowings		(40,302	)			(10,889	)
Proceeds from long-term borrowings		26,622				-
Payments of deferred financing fees		(1,056	)			(2,249	)
Other		71				-
Net cash used in financing activities		(14,665	)			(13,138	)
Effect of exchange rate changes on cash		2,891				(1,052	)
Net increase (decrease) in cash and cash equivalents		2,871				(2,275	)
Cash and cash equivalents at beginning of period		88,539				83,763
Cash and cash equivalents at end of period	$	91,410			$	81,488
Supplemental disclosure of cash flow information:
Change in accrual for purchases of property, plant
and equipment	$	19,521			$	(14,542	)

 

 

 

 

 

 

 

 

 

 

 

		Three Months Ended May 2, 2010
		Photronics, Inc. Shareholders
														Accumulated
							Add'l							Other				Total				Non-
		Common Stock					Paid-in			Accumulated				Comprehensive				Photronics,				controlling				Total
		Shares		Amount			Capital			Deficit				Income				Inc.				Interests				Equity
Balance at January 31, 2010		53,281		$	533		$	433,632		$	(26,333	)		$	(444	)		$	407,388			$	51,051			$	458,439
Comprehensive income:
Net income		-			-			-			7,873				-				7,873				732				8,605
Unrealized holding gain		-			-			-			-				76				76				56				132
Amortization of cash flow hedges		-			-			-			-				33				33				-				33
Foreign currency translation
adjustments		-			-			-			-				6,553				6,553				1,061				7,614
Total comprehensive income		-			-			-			-				-				14,535				1,849				16,384
Sale of common stock through
employee stock option and
purchase plans		53			1			74			-				-				75				-				75
Share-based compensation expense		1			-			454			-				-				454				-				454
Common stock warrants exercised		162			1			816			-				-				817				-				817
Balance at May 2, 2010		53,497		$	535		$	434,976		$	(18,460	)		$	6,218			$	423,269			$	52,900			$	476,169
	Three Months Ended May 3, 2009
	Photronics, Inc. Shareholders
														Accumulated
							Add'l							Other				Total				Non-
		Common Stock					Paid-in			Accumulated				Comprehensive				Photronics,				controlling				Total
		Shares		Amount			Capital			Deficit				Loss				Inc.				Interests				Equity
Balance at February 1, 2009		41,757		$	418		$	385,188		$	5,131			$	(33,052	)		$	357,685			$	48,608			$	406,293
Comprehensive income:
Net loss		-			-			-			(10,072	)			-				(10,072	)			(84	)			(10,156	)
Unrealized holding gains		-			-			-			-				15				15				-				15
Amortization of cash flow hedges		-			-			-			-				32				32				-				32
Foreign currency translation
adjustments		-			-			-			-				10,998				10,998				712				11,710
Total comprehensive income		-			-			-			-				-				973				628				1,601
Sale of common stock through
employee stock option and
purchase plans		-			-			15			-				-				15				-				15
Share-based compensation expense		20			-			623			-				-				623				-				623
Noncontrolling interests’ subsidiary dividend		-			-			-			-				-				-				(437	)			(437	)
Balance at May 3, 2009		41,777		$	418		$	385,826		$	(4,941	)		$	(22,007	)		$	359,296			$	48,799			$	408,095

 

		Six Months Ended May 2, 2010
		Photronics, Inc. Shareholders
														Accumulated
							Add'l							Other				Total				Non-
		Common Stock					Paid-in			Accumulated				Comprehensive				Photronics,				controlling				Total
		Shares		Amount			Capital			Deficit				Income				Inc.				Interests				Equity
Balance at November 1, 2009		53,011		$	530		$	432,160		$	(26,546	)		$	(6,389	)		$	399,755			$	49,941			$	449,696
Comprehensive income:
Net income		-			-			-			8,086				-				8,086				927				9,013
Unrealized holding gain		-			-			-			-				76				76				56				132
Amortization of cash flow hedges		-			-			-			-				65				65				-				65
Foreign currency translation
adjustments		-			-			-			-				12,466				12,466				1,976				14,442
Total comprehensive income																			20,693				2,959				23,652
Sale of common stock through
employee stock option and
purchase plans		93			1			104			-				-				105				-				105
Share-based compensation expense		43			-			1,031			-				-				1,031				-				1,031
Common stock warrants exercised		350			4			1,681			-				-				1,685				-				1,685
Balance at May 2, 2010		53,497		$	535		$	434,976		$	(18,460	)		$	6,218			$	423,269			$	52,900			$	476,169
		Six Months Ended May 3, 2009
		Photronics, Inc. Shareholders
														Accumulated
							Add'l							Other				Total				Non-
		Common Stock					Paid-in			Accumulated				Comprehensive				Photronics,				controlling				Total
		Shares		Amount			Capital			Deficit				Loss				Inc.				Interests				Equity
Balance at November 2, 2008		41,712		$	417		$	384,502		$	15,364			$	(17,501	)		$	382,782			$	49,616			$	432,398
Comprehensive income:
Net income(loss)		-			-			-			(20,305	)			-				(20,305	)			181				(20,124	)
Unrealized holding gains		-			-			-			-				90				90				39				129
Amortization of cash flow hedges		-			-			-			-				513				513				-				513
Foreign currency translation
adjustments		-			-			-			-				(5,109	)			(5,109	)			(600	)			(5,709	)
Total comprehensive loss		-			-			-			-				-				(24,811	)			(380	)			(25,191	)
Sale of common stock through
employee stock option and
purchase plans		-			-			38			-				-				38				-				38
Share-based compensation expense		65			1			1,286			-				-				1,287				-				1,287
Noncontrolling interests’ subsidiary dividend		-			-			-			-				-				-				(437	)			(437	)
Balance at May 3, 2009		41,777		$	418		$	385,826		$	(4,941	)		$	(22,007	)		$	359,296			$	48,799			$	408,095

 

 

 

     On May 5, 2006, Photronics and Micron Technology, Inc. ("Micron") entered into the MP Mask joint venture, which develops and produces photomasks for leading-edge and advanced next generation semiconductors. As part of the formation of the joint venture, Micron contributed its existing photomask technology center located at its Boise, Idaho, headquarters to MP Mask and Photronics invested $135 million in exchange for a 49.99% interest in MP Mask (to which $64.2 million of the original investment was allocated), a license for photomask technology of Micron, and certain supply agreements.

 

     This joint venture is a variable interest entity (as that term is defined in the Accounting Standards Codification) primarily because all costs of the joint venture will be passed on to the Company and Micron through purchase agreements they have entered into with the joint venture. The Company determined that, in regards to this variable interest entity ("VIE"), it and Micron are de facto agents (as that term is defined in the Accounting Standards Codification) and that Micron is the primary beneficiary of the VIE as it is the de facto agent within the aggregated group of de facto agents (i.e. the Company and Micron) that is the most closely associated with the VIE. The primary reasons the Company concluded that Micron is the most closely associated of the de facto agents to the VIE are that Micron is both the ultimate purchaser of substantially all of the products produced by the VIE and that it is the holder of decision making authority in the ordinary course of business.

 

     The Company has utilized MP Mask for both high-end IC photomask production and research and development purposes. MP Mask charges its variable interest holders based on their actual usage of its facility. MP Mask separately charges for any research and development activities it engages in at the requests of its owners. The Company recorded cost of sales of $1.5 million and $2.7 million and research and development expenses of $0.2 million and $0.5 million during the three and six month periods ended May 2, 2010. Cost of sales of $0.9 million and $1.2 million and research and development expenses of $0.3 million and $0.8 million were recorded during the three and six month periods ended May 3, 2009.

 

     MP Mask is governed by a Board of Managers, appointed by Micron and the Company. Since MP Mask's inception, Micron, as a result of its majority ownership, has appointed the majority of its managers. The number of managers appointed by each party is subject to change as ownership interests change. Under the operating agreement relating to the MP Mask joint venture, in order to maintain its 49.99% interest, the Company may be required to make additional capital contributions to the joint venture up to the maximum amount defined in the operating agreement. However, should the Board of Managers determine that further additional funding is required, the joint venture shall pursue its own financing. If the joint venture is unable to obtain its own financing, it may request additional capital contributions from the Company. Should the Company choose not to make a requested contribution to the joint venture, its ownership interest may be reduced. The Company received no distributions from MP Mask during the three and six month periods ended May 2, 2010, and received a $5 million distribution during the three and six month periods ended May 3, 2009. The Company made no contributions to MP Mask during the three and six month periods ended May 2, 2010 and May 3, 2009.

 

     The Company's investment in the VIE, which represents its maximum exposure to loss, was $60.9 million at May 2, 2010 and November 1, 2009. These amounts are reported in the Company's condensed consolidated balance sheets as "Investment in joint venture".

 

 

 

 

		Three Months Ended							Six Months Ended
		May 2,			May 3,				May 2,			May 3,
		2010			2009				2010			2009
Net income (loss) attributable to Photronics, Inc.		$	7,873		$	(10,072	)		$	8,086		$	(20,305	)
Effect of dilutive securities:
Interest expense on convertible notes,
net of related tax effects			1,016			-				-			-
Earnings (loss) for diluted earnings (loss) per share		$	8,889		$	(10,072	)		$	8,086		$	(20,305	)
Weighted-average common shares computations:
Weighted-average common shares used for
basic earnings (loss) per share			53,405			41,775				53,253			41,749
Effect of dilutive securities:
Convertible notes			11,311			-				-			-
Employee stock options and restricted shares			989			-				990			-
Common stock warrants			75			-				48			-
Potentially dilutive common shares			12,375			-				1,038			-
Weighted-average common shares used for
diluted earnings (loss) per share			65,780			41,775				54,291			41,749
Basic earnings (loss) per share		$	0.15		$	(0.24	)		$	0.15		$	(0.49	)
Diluted earnings (loss) per share		$	0.14		$	(0.24	)		$	0.15		$	(0.49	)

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

 

		Three Months Ended				Six Months Ended
		May 2,		May 3,		May 2,		May 3,
		2010		2009		2010		2009
Convertible notes		-		-		11,311		-
Employee stock options and restricted shares		2,844		2,193		2,652		2,200
Common stock warrants		747		-		854		-
Total potentially dilutive shares excluded		3,591		2,193		14,817		2,200

     In periods in which the Company incurred a net loss, the assumed exercise of certain outstanding employee stock options and the vesting of restricted shares had an antidilutive effect. Had the Company recognized sufficient net income, there would have been 0.1 million and 0.3 million of incremental weighted-average shares of these employee stock options and restricted shares outstanding during the three and six month periods ended May 3, 2009, respectively.

 

 

 

     In March 2007, the Company’s shareholders approved a new share-based compensation plan ("Plan"), under which options, restricted stock, restricted stock units, stock appreciation rights, performance stock, performance units, and other awards based on, or related to, shares of the Company's common stock may be granted from shares authorized but unissued, shares previously issued and reacquired by the Company, or both. The maximum number of shares of common stock approved by the Company’s shareholders to be issued under the Plan was increased from three million shares to six million shares during the three month period ended May 2, 2010. Awards may be granted to officers, employees, directors, consultants, advisors, and independent contractors of the Company or its subsidiaries. The Plan, aspects of which are more fully described below, prohibits further awards from being issued under prior plans. The Company incurred compensation cost under the Plan for the three and six month periods ended May 2, 2010 of $0.3 million and $0.8 million, respectively, and $0.6 million and $1.3 million for the three and six month periods ended May 3, 2009, respectively. The Company received cash from option exercises of $0.1 million for the three and six month periods ended May 2, 2010, respectively, and did not receive any cash from option exercises during the three and six month periods ended May 3, 2009. No share-based compensation cost was capitalized as part of inventory and no related income tax benefits were recorded during the periods presented.

 

 

     Option awards generally vest in one to four years, and have a ten-year contractual term. All incentive and non-qualified stock option grants have an exercise price equal to the market value of the underlying common stock on the date of grant. The option and share awards provide for accelerated vesting if there is a change in control as defined in the Plan.

 

     The grant date fair value of options is based upon the closing price on the date of grant using the Black-Scholes option pricing model. Expected volatility is based on the historical volatility of the Company's stock. The Company uses historical option exercise behavior and employee termination data to estimate expected term, which represents the period of time that the options granted are expected to remain outstanding. The risk-free rate of return for the estimated term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Inputs used to calculate the grant date fair value of options issued during the three month and six month periods ended May 2, 2010 and May 3, 2009, are presented in the following table.

 

		Three Months Ended					Six Months Ended
		May 2,		May 3,			May 2,		May 3,
		2010		2009			2010		2009
Expected volatility		N/A		82.1	%		89.3%		69.8	%
Risk free rate of return		N/A		1.9	%		2.2 – 2.4%		2.5	%
Dividend yield		N/A		0.0	%		0.0%		0.0	%
Expected term		N/A		4.7	years		4.5 years		4.7	years

 

							Weighted
				Weighted			Average
				Average			Remaining		Aggregate
				Exercise			Contractual		Intrinsic
Options		Shares		Price			Life		Value
Outstanding at May 2, 2010		4,013,990		$	9.95		6.6 years		$	6,804
Exercisable at May 2, 2010		2,014,230		$	16.69		4.4 years		$	1,133

 

     There were no share options granted during the three month period ended May 2, 2010. There were 5,000 share options granted with a weighted-average grant date fair value of $0.84 during the three month period ended May 3, 2009. There were 846,400 share options granted during the six month period ended May 2, 2010, with a weighted-average grant date fair value of $2.97 per share and 1,348,250 share options granted during the six month period ended May 3, 2009, with a weighted-average grant date fair value of $0.44 per share. As of May 2, 2010, the total unrecognized compensation cost related to non-vested option awards was approximately $2.4 million. That cost is expected to be recognized over a weighted-average amortization period of 3.2 years.

 

 

     The Company periodically grants restricted stock awards. The restrictions on these awards lapse over a service period that has ranged from less-than-one to eight years. No restricted stock awards were issued during the three or six month periods ended May 2, 2010 or during the three month period ended May 3, 2009, and 75,000 shares with a weighted-average grant date fair value of $0.76 per share were granted during the six months ended May 3, 2009. As of May 2, 2010, the total compensation cost related to nonvested restricted stock awards not yet recognized was approximately $1.5 million. That cost is expected to be recognized over a weighted-average amortization period of 3.3 years. A summary of the status of the Company's non-vested restricted shares as of May 2, 2010 is presented below.

 

				Weighted
				Average
				Remaining		Aggregate
				Contractual		Intrinsic
Restricted Stock		Shares		Life		Value
Outstanding at May 2, 2010		114,335		3.1 years		$	623

 

 

     During the three months ended August 2, 2009, the Company ceased the manufacture of photomasks at its Shanghai, China, facility. In connection with this restructuring, the Company has recorded total net charges of $5.4 million through May 2, 2010, including $4.2 million of net asset write-downs. The fair value of the assets written down was determined by management using a market approach. Approximately 75 employees were affected by this restructuring.

 

     The Company recorded an initial restructuring charge of $10.1 million during the three month period ended August 2, 2009, which included $7.7 million to write down the carrying value of the Company's Shanghai manufacturing facility to its estimated fair value at that time. During the three months ended May 2, 2010, the Company sold its facility in Shanghai, China, for net proceeds of $12.9 million which resulted in a gain of $5.2 million. This gain was recorded as a credit to the restructuring reserve during the three months ended May 2, 2010.

 

     The Company expects this restructuring to be completed during the third quarter of fiscal 2010, and does not expect the remaining restructuring costs to be significant. The following table sets forth the Company's restructuring reserve related to its Shanghai, China, facility as of May 2, 2010, and reflects the activity affecting the reserve for the three and six month periods then ended. The remaining balance at May 2, 2010 primarily relates to expenses incurred relating to the sale of the facility.

 

		Three Months Ended													Six Months Ended
		May 2, 2010													May 2, 2010
		February 1,			Charges							May 2,			November 2,			Charges								May 2,
		2010			(credit)				Utilized			2010			2009			(credit)				Utilized				2010
Net gain on sales of assets		$	-		$	(5,020	)		$	5,238		$	218		$	-		$	(5,020	)		$	5,238			$	218
Employee terminations
and other			-			(9	)			9			-			134			184				(318	)			-
		$	-		$	(5,029	)		$	5,247		$	218		$	134		$	(4,836	)		$	4,920			$	218

 

 

     During the three months ended February 1, 2009, the Company ceased the manufacture of photomasks at its Manchester, U.K., facility and, in connection therewith, incurred total restructuring charges of $3.3 million through its completion in the fourth quarter of fiscal 2009, primarily for employee termination costs and asset write-downs. Approximately 85 employees were affected by this restructuring. The following table sets forth the Company's 2009 restructuring reserve related to its Manchester, U.K., facility as of May 3, 2009, and reflects the activity affecting the reserve for the three and six month periods then ended.

 

		Three Months Ended													Six Months Ended
		May 3, 2009													May 3, 2009
		February 1,										May 3,			November 2,										May 3,
		2009			Charges			Utilized				2009			2008			Charges			Utilized				2009
Employee terminations		$	-		$	328		$	(328	)		$	-		$	-		$	1,390		$	(1,390	)		$	-
Asset write-downs
and other			154			78			(232	)			-			-			696			(696	)			-
		$	154		$	406		$	(560	)		$	-		$	-		$	2,086		$	(2,086	)		$	-

 

     The effective income tax rates differ from the amount computed by applying the U.S. statutory rate of 35% to the income (loss) before income taxes primarily because income tax provisions incurred in jurisdictions where the Company generated income before income taxes were, due to valuation allowances, not significantly offset by income tax benefits in jurisdictions where the Company incurred losses before income taxes. Further, various investment tax credits have been utilized in Korea and Taiwan which reduced the Company's effective income tax rate.

 

     The Company accounts for uncertain tax positions by recording a liability for unrecognized tax benefits resulting from uncertain tax positions taken, or expected to be taken, in its tax returns. The Company recognizes any interest and penalties related to uncertain tax positions in the income tax provision in its condensed consolidated statement of operations.

 

     As of May 2, 2010 and November 1, 2009, the gross unrecognized tax benefits for income taxes associated with uncertain tax positions totaled approximately $2.0 million (including interest and penalties of $0.4 million). If recognized, the benefits would favorably impact the Company's effective tax rate in future periods. As of May 2, 2010, the Company believes it is not reasonably possible that the total amounts of unrecognized benefits will significantly increase or decrease in the next twelve months.

 

     Currently, the statutes of limitations remain open subsequent to and including 2006 in the U.S., 2007 in the U.K., 2008 in Germany and 2005 in Korea.

 

 

     The Company utilizes derivative instruments to reduce its exposure to the effects of the variability of interest rates and foreign currencies on its financial performance when it believes such action is warranted. Historically, the Company has been a party to derivative instruments to hedge either the variability of cash flows of a prospective transaction or the fair value of a recorded asset or liability. In certain instances, the Company has designated these transactions as hedging instruments. However, whether or not a derivative was designated as being a hedging instrument, the Company's purpose for engaging in the derivative has always been for risk management (and not speculative) purposes. The Company has historically not been a party to a significant number of derivative instruments and does not expect its derivative activity to significantly increase in the foreseeable future.

 

 

 

 

 

 

Derivatives
Not Designated
as Hedging				Fair Value at
Instruments Under				May 2,			November 1,
ASC 815		Balance Sheet Location		2010			2009
Warrants on common stock		Other liabilities		$	2,272		$	3,205

 

Derivatives
Not Designated		Location of Gain (Loss)		Amount of Gain (Loss) Recognized in Income on Derivatives
as Hedging		Recognized in		Three Months Ended						Six Months Ended
Instruments Under		Income on		May 2,			May 3,			May 2,			May 3,
ASC 815		Derivatives		2010			2009			2010			2009
Warrants on common stock		Investment and other income (expense), net		$	(860)		$	-		$	(751)		$	-
Foreign exchange contracts		Investment and other income (expense), net		$	-		$	(425)		$	-		$	93

 

 

 

		May 2,			November 1,
		2010			2009
5.5% convertible senior notes due
on October 1, 2014		$	57,500		$	57,500
Borrowings under revolving credit facility, which
bears interest at a variable rate, as defined (4.31% at
May 2, 2010 and 8.0% at November 1, 2009)			17,000			2,568
8.0% capital lease obligation payable through
January 2013			19,449			22,552
5.6% capital lease obligation payable through
October 2012			10,987			12,614
4.75% financing loan with customer			3,325			-
Term loan which bore interest at a variable rate
as defined (8.0% at November 1, 2009)			-			27,204
			108,261			122,438
Less current portion			11,364			10,301
		$	96,897		$	112,137

 

 

 

 

     In addition to the former credit facility discussed above, the Company also entered into a term loan agreement with an aggregate commitment of $27.2 million in the U.S. dated on June 8, 2009. This loan was repaid in February 2010 with funds from the credit facility.

 

     On September 11, 2009, the Company sold, through a public offering, $57.5 million aggregate principal amount of 5.5% convertible senior notes which mature on October 1, 2014. Note holders may convert each $1,000 principal amount of notes to 196.7052 shares of stock (equivalent to an initial conversion price of approximately $5.08 per share of common stock) on September 30, 2014. The conversion rate may be increased in the event of a make-whole fundamental change (as defined in the prospectus supplement filed by the Company on September 11, 2009) and the Company may not redeem the notes prior to their maturity date. The net proceeds of the convertible senior notes offering were approximately $54.9 million.

 

     In January 2010 the Company borrowed $3.7 million from a customer to purchase manufacturing equipment. This loan bears interest at 4.75% and will be repaid with product supplied to the customer. Product valued at $0.2 million was shipped to the customer and applied against the loan during the three month period ended May 2, 2010. The Company estimates that the loan will be fully repaid by December 2014.

 

     In the first quarter of 2008 a capital lease agreement commenced for the U.S. nanoFab facility which bore interest at 8%. This lease was cancelled in the third fiscal quarter of 2009, at which time the Company and Micron (the lessor) entered into a new lease agreement for the facility. Under the provisions of the new lease agreement, quarterly lease payments were reduced from $3.8 million to $2.0 million, the term of the lease was extended from December 31, 2012 to December 31, 2014, and ownership of the property will not transfer to the Company at the end of the lease term. As a result of the new lease agreement, the Company reduced its lease obligation and the carrying value of its assets under capital leases by approximately $28 million. The lease will continue to be accounted for as a capital lease until the end of its original lease term. For the additional two years of the new lease term, the lease will be accounted for as an operating lease. As of May 2, 2010, total capital lease amounts payable were $21.8 million, of which $19.5 million represented principal and $2.3 million represented interest.

 

     In October 2007, the Company entered into a capital lease agreement in the amount of $19.9 million associated with certain equipment. Under the capital lease agreement, the Company is required to maintain the equipment in good working condition, and is required to comply with certain non-financial covenants. Payments under the lease are $0.4 million per month over a 5-year term at a 5.6% interest rate.

 

 

     On September 10, 2009, the Company entered into two warrant agreements with Intel Capital Corporation to purchase a total of 750,000 shares of the Company's common stock. Under one warrant agreement 500,000 shares of the Company's common stock can be purchased at an exercise price of $4.15 per share and under the second warrant agreement 250,000 shares of the Company's common stock can be purchased at an exercise price of $5.08 per share. The warrant agreements expire on September 10, 2014. Also, on September 10, 2009, the Company and Intel Corporation entered into an agreement to share technical and operations information regarding the development of the Company's products, the capabilities of the Company's photomask manufacturing lines and the alignment of photomask toolsets. Intel Capital Corporation also invested in the Company's September 2009 convertible debt offering. The warrants were recorded at their fair value on their date of grant, which was determined using the Black-Scholes option pricing model. As of May 2, 2010, none of the warrants had been exercised.

 

     In conjunction with an amendment to its credit facility on May 15, 2009, the Company also entered into a warrant agreement with its lenders. See Note 9 for further discussion of these warrants.

 

 

 

     Fair value, as defined in accounting guidance, is the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. An "orderly transaction" is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities (i.e. it is not a forced transaction). The transaction to sell an asset or transfer a liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability. Therefore, the objective of a fair value measurement is to determine the price that would be received to sell the asset or paid to transfer the liability (an exit price) at the measurement date.

 

     A fair value measurement further assumes that the hypothetical transaction occurs in the principal (or if no principal market exists, the most advantageous) market for the asset or liability. Further, a fair value measurement assumes a transaction involving the highest and best use of an asset and the consideration of assumptions that would be made by market participants when pricing an asset or liability, such as transfer restrictions or non-performance risk.

 

     The Company follows a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. This fair value hierarchy gives the highest priority to unadjusted, quoted market prices in active markets for identical assets or liabilities (including when the liabilities are traded as assets) while giving the lowest priority to unobservable inputs, which are inputs that reflect the Company's assumptions about the factors that market participants would use in valuing assets or liabilities, based upon the best information available under existing circumstances. In cases when the inputs used to measure fair value fall in different levels of the fair value hierarchy, the level within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety. When, due to changes in the inputs to valuation techniques used to measure its fair value, an asset or liability is transferred between levels of the fair value hierarchy, the Company recognizes all transfer to or from any level to be as of the beginning of the reporting period. Assessing the significance of a particular input to the fair value measurement in its entirety requires judgment, including the consideration of factors specific to the asset or liability. The hierarchy consists of the following three levels:

 

 

     Level 2 - Inputs other than quoted prices included within Level 1 are observable for the asset or liability, either directly or indirectly. At May 2, 2010, the Company's Level 2 asset is a foreign bond fund and its Level 2 liability consists of its common stock warrants which are reported in other liabilities.

 

 

 

 

 

	May 2, 2010
	Quoted
	Prices
	in Active			Significant
	Markets			Other				Significant
	for Identical			Observable				Unobservable
	Instruments			Inputs				Inputs
	(Level 1)			(Level 2)				(Level 3)			Total
Foreign bond fund	$	-		$	330			$	-		$	330
Total assets	$	-		$	330			$	-		$	330
Common stock warrants	$	-		$	(2,272	)		$	-		$	(2,272	)
Total liabilities	$	-		$	(2,272	)		$	-		$	(2,272	)

	November 1, 2009
	Quoted
	Prices
	in Active			Significant
	Markets			Other				Significant
	for Identical			Observable				Unobservable
	Instruments			Inputs				Inputs
	(Level 1)			(Level 2)				(Level 3)			Total
Foreign bond fund	$	-		$	-			$	148		$	148
Total assets	$	-		$	-			$	148		$	148
Common stock warrants	$	-		$	(3,205	)		$	-		$	(3,205	)
Total liabilities	$	-		$	(3,205	)		$	-		$	(3,205	)

 

 

 

 

 

 

 

 

 

		Three Months Ended						Six Months Ended
		May 2,			May 3,			May 2,			May 3,
		2010			2009			2010			2009
Net sales
Asia		$	61,821		$	50,942		$	122,628		$	107,183
Europe			10,665			9,336			20,182			18,085
North America			32,584			22,954			60,457			46,007
		$	105,070		$	83,232		$	203,267		$	171,275

		As of
		May 2,			November 1,
		2010			2009
Long-lived assets
Asia		$	205,892		$	199,179
Europe			14,215			9,579
North America			140,001			139,131
		$	360,108		$	347,889

 

 

 

 

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

 

 

     In January 2010, the Financial Accounting Standards Board ("FASB") issued updated guidance to improve disclosures related to fair value measurements. The amended guidance includes new requirements to separately disclose transfers in and out of Level 1 and Level 2, and to present separately information about purchases, sales, issuances, and settlements in the reconciliation of Level 3 fair value measurements. The guidance also clarifies existing disclosures by changing the level of disaggregation of fair value measurements to the class of asset or liability, which is often a subset of a line item within the statement of financial position. In addition, the guidance requires reporting entities to provide disclosures about inputs and valuation techniques for both recurring and nonrecurring fair value measurements. The guidance is effective for interim and annual periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3, which are effective for interim and annual periods beginning after December 15, 2010. The Company adopted the guidance related to the disclosure of transfers in and out of Level 1 and 2 during the three month period ended May 2, 2010.

 

     In September 2009, the FASB issued revised guidance for multiple-deliverable revenue arrangements. This guidance changes the criteria for separating consideration in multiple-deliverable arrangements by establishing a selling price hierarchy for determining the selling price of a deliverable. Under the revised guidance, the selling price for each deliverable in a multiple-deliverable arrangement will, in order of preference and when available, be based on vendor specific objective evidence, third party evidence, or estimated selling price. The revised guidance prescribes that an estimated selling price be determined in a manner that is consistent with that used to determine the price to sell the deliverable on a stand alone basis, eliminates the residual method of allocation, and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The revised guidance also significantly expands the disclosures related to multiple-deliverable arrangements, and is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. The Company does not expect that the adoption of the revised guidance will have a material impact on its consolidated financial statements.

 

     In June 2009, the FASB issued amended standards for determining whether to consolidate a variable interest entity. The amended standards require an enterprise to perform an analysis to determine whether its variable interest or interests give it a controlling financial interest in a variable interest entity. This analysis is performed in order to identify the primary beneficiary of the variable interest entity as being the enterprise that has certain characteristics described in the amended standards. The amended standards, in addition to other requirements, require an enterprise to assess whether it has an implicit financial responsibility to ensure that a variable interest entity operates as designed when determining whether it has the power to direct the activities of the variable interest entity that most significantly impact the entity's financial performance and, mandates ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. These amended standards are effective for financial statements issued for fiscal years beginning after November 15, 2009, and interim financial statements within those fiscal years. The Company is currently evaluating the impact, if any, this guidance will have on its consolidated financial statements.

 

 

Item 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

     Management's discussion and analysis ("MD&A") of the Company's financial conditions, results of operations, and outlook should be read in conjunction with its condensed consolidated financial statements and related notes. Various segments of this MD&A contain forward-looking statements, all of which are presented based on current expectations and may be adversely affected by uncertainties and risk factors (presented throughout this filing and in the Company's Annual Report on Form 10-K for the fiscal 2009 year), that may cause actual results to materially differ from these expectations.

 

     The Company sells substantially all of its photomasks to semiconductor designers and manufacturers, and manufacturers of FPDs. Photomask technology is also being applied in the fabrication of other higher performance electronic products such as photonics, micro-electronic mechanical systems and certain nanotechnology applications. Thus, the Company's selling cycle is tightly interwoven with the development and release of new semiconductor designs and flat panel applications, particularly as it relates to the semiconductor industry's migration to more advanced design methodologies and fabrication processes. The Company believes that the demand for photomasks primarily depends on design activity rather than sales volumes from products produced using photomask technologies. Consequently, an increase in semiconductor or FPD sales does not necessarily result in a corresponding increase in photomask sales. In addition, the reduced use of customized ICs, reductions in design complexity, other changes in the technology or methods of manufacturing or designing semiconductors, or a slowdown in the introduction of new semiconductor or FPD designs could reduce demand for photomasks even if demand for semiconductors and FPDs increases. Advances in semiconductor and photomask design and semiconductor production methods could also reduce the demand for photomasks. Historically, the semiconductor industry has been volatile, with sharp periodic downturns and slowdowns. These downturns have been characterized by, among other things, diminished product demand, excess production capacity, and accelerated erosion of selling prices. The semiconductor industry experienced a downturn in 2008 that continued into 2009, which had a negative impact on the Company's 2009 operating results. The Company's 2009 operating results were also negatively impacted by the global recession, which could also impact the Company's 2010 operating results.

 

     The global semiconductor industry is driven by end markets which have been closely tied to consumer driven applications of high performance semiconductor devices including, but not limited to, communications and mobile computing solutions. The Company is typically required to fulfill its customer orders within a short period of time, sometimes within 24 hours. This results in the Company having a minimal level of backlog orders, typically one to two weeks. The Company cannot predict the timing of the industry's transition to volume production of next generation technology nodes or the timing of up and down cycles with precise accuracy, but believes that such transitions and cycles will continue into the future, beneficially and adversely affecting its business, financial condition and operating results in the near term. The Company's ability to remain successful in these environments is based upon achieving its goals of being a service and technology leader, an efficient solutions supplier, and a company able to continually reinvest in its global infrastructure.

 

     The effects of the weakened global economy and the tightened credit market require the Company to continue to make significant improvements in its competitiveness. In connection therewith, the Company continues to delay capital expenditures and evaluate further cost reduction initiatives.

 

     The Company's ability to comply with the financial and other covenants in its debt agreements may be affected by worsening economic or business conditions, or other events. Existing covenant restrictions limit the Company's ability to obtain additional debt financing and, should the Company be unable to meet one or more of these covenants, the Company's lenders may require the Company to repay its outstanding balances prior to the expiration date of the agreements. The Company cannot assure that additional sources of financing would be available to the Company to pay off its long-term borrowings to avoid default. Should the Company default on any of its long-term borrowings, a cross default would occur on certain other of its other long-term borrowings, unless amended or waived. As of May 2, 2010, the Company was in compliance with its debt covenants.

 

 

 

 

		Three Months Ended						Six Months Ended
		May 2,			May 3,			May 2,			May 3,
		2010			2009			2010			2009
Net sales		100.0	%		100.0	%		100.0	%		100.0	%
Cost of sales		(79.0	)		(86.3	)		(80.2	)		(87.2	)
Gross margin		21.0			13.7			19.8			12.8
Selling, general and administrative expenses		(10.3	)		(12.8	)		(10.3	)		(12.3	)
Research and development expenses		(3.4	)		(5.0	)		(3.7	)		(4.6	)
Consolidation, restructuring and related (charges) credits		4.7			(0.5	)		2.3			(1.2	)
Impairment of long-lived assets		-			(1.7	)		-			(0.8	)
Operating income (loss)		12.0			(6.3	)		8.1			(6.1	)
Other expense, net		(2.0	)		(6.0	)		(2.3	)		(5.0	)
Net income (loss) before income taxes		10.0			(12.3	)		5.8			(11.1	)
Income tax benefit (provision)		(1.8	)		0.1			(1.4	)		(0.7	)
Net income (loss)		8.2			(12.2	)		4.4			(11.8	)
Net (income) loss attributable to noncontrolling interests		(0.7	)		0.1			(0.4	)		(0.1	)
Net income (loss) attributable to Photronics, Inc.		7.5	%		(12.1	)%		4.0	%		(11.9	)%