PHOTRONICS INC - Annual Report: 2020 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended October 31, 2020

OR

For the transition period from ___ to ___

Commission file number 0-15451

PHOTRONICS, INC.

(Exact name of registrant as specified in its charter)

15 Secor Road, Brookfield, Connecticut 06804

(Address of principal executive offices)(Zip Code)

(203) 775-9000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer,” “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act ((§15 U.S.C 7262(b)) by the registered public accounting firm that prepared or issued its audit report. Yes ⌧  No ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐  No ☒

As of May 3, 2020, which was the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the shares of the registrant’s common stock held by non-affiliates was approximately $727,752,716 (based upon the closing price of $11.35 per share as reported by the NASDAQ Global Select Market on that date).

As of December 11, 2020, 63,916,262 shares of the registrant’s common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

PHOTRONICS, INC.

ANNUAL REPORT ON FORM 10-K

OCTOBER 31, 2020

Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements made by or on behalf of Photronics, Inc. (“Photronics”, the “Company”, “we”, “our”, or “us”). These statements are based on management's beliefs, as well as assumptions made by and information currently available to management. Forward-looking statements may be identified by words like “expect,” “anticipate,” “believe,” “plan,” “project,” “could,” “estimate,” “intend,” “may,” “will”, “in our view” and similar expressions, or the negative of such terms, or other comparable terminology. All forward-looking statements involve risks and uncertainties that are difficult to predict. In particular, any statement contained in this annual report on Form 10-K or in other documents filed with the Securities and Exchange Commission, in press releases, or in the Company's communications and discussions with investors and analysts in the normal course of business through meetings, phone calls, or conference calls regarding, among other things, the consummation and benefits of transactions, joint ventures, business combinations, divestitures and acquisitions, expectations with respect to future sales, financial performance, operating efficiencies, or product expansion, are subject to known and unknown risks, uncertainties, and contingencies, many of which are beyond the control of the Company. Various factors may cause actual results, performance, or achievements to differ materially from anticipated results, performance, or achievements expressed or implied by forward-looking statements. Factors that might affect forward-looking statements include, but are not limited to, overall economic and business conditions; economic and political conditions in international markets; pandemics affecting our labor force, customers or suppliers; the demand for the Company's products; competitive factors in the industries and geographic markets in which the Company competes; the timing of orders received from customers; the gain or loss of significant customers; competition from other manufacturers; changes in accounting standards; federal, state and international tax requirements (including tax rate changes, new tax laws and revised tax law interpretations); changes in the jurisdictional mix of our earnings; interest rate and other capital market conditions, including changes in the market price of the Company's securities; foreign currency exchange rate fluctuations; changes in technology; technology or intellectual property infringement, including cybersecurity breaches, and other innovation risks; unsuccessful or unproductive research and development or capital expenditures; the timing, impact, and other uncertainties related to transactions and acquisitions, divestitures, business combinations, and joint ventures as well as decisions the Company may make in the future regarding the Company’s business, capital and organizational structures, and other matters; the seasonal and cyclical nature of the semiconductor and flat panel display industries; management changes; changes in laws and government regulation impacting our operations or our products, including laws relating to export controls and import laws, rules and tariffs; the occurrence of regulatory proceedings, claims or litigation; damage or destruction to the Company's facilities, or the facilities of its customers or suppliers, by natural disasters, labor strikes, political unrest, or terrorist activity; acts of war, construction of new facilities and acquisition of new equipment; dilutive issuances of the Company’s stock; the ability of the Company to (i) place new equipment in service on a timely basis; (ii) obtain additional financing; (iii) achieve anticipated synergies and cost savings; (iv) fully utilize its tools; (v) achieve desired yields, pricing, product mix, and market acceptance of its products and (vi) obtain necessary import and export licenses. Any forward-looking statements should be considered in light of these factors. Accordingly, there is no assurance that the Company's expectations will be realized. The Company does not assume responsibility for the accuracy and completeness of the forward-looking statements and does not assume an obligation to provide revisions to any forward-looking statements, except as otherwise required by securities and other applicable laws.

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 semiconductors and flat-panel displays (“FPDs”), and are used as masters to transfer circuit patterns onto semiconductor wafers and FPD substrates during the fabrication of integrated circuits (“ICs” or “semiconductors”), 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), Korea, the United States (3), Europe (2), and two recently constructed facilities in China. Our FPD Facility in Hefei, China, and our IC facility in Xiamen, China, commenced production in the second and third quarters of our fiscal 2019, respectively.

Photronics is a Connecticut corporation, organized in 1969. Our principal executive offices are located at 15 Secor Road, Brookfield, Connecticut 06804, telephone (203) 775-9000. Our website address is http://www.photronics.com. We make available, free of charge through our website, our Annual Reports on Form 10-K, Definitive Proxy Statements on Schedule 14A, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to these reports as soon as reasonably practicable after such materials are electronically filed with or furnished to the Securities and Exchange Commission (“SEC”). The information found on, or incorporated into, our website is not part of this or any other report we file with or furnish to the SEC. The SEC also maintains a website at http://www.sec.gov that contains reports, proxy statements and other information regarding SEC registrants, including Photronics.

Products and Manufacturing Technology

We manufacture photomasks, which are used as masters to transfer circuit patterns onto semiconductor wafers and FPD substrates. Photomasks are manufactured incorporating circuit designs provided to us on a confidential basis by our customers. IC and FPD photomask sets are manufactured in layers, each having a distinct pattern which is etched onto a different photomask. The resulting series of photomasks is then used to image the circuit patterns onto each successive layer of a semiconductor wafer or 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 the photomask blank. The exposed areas are developed and etched to produce that pattern on the photomask. The photomask is then inspected for defects and conformity to the customer's design data. After any defects are repaired, the photomask is cleaned, any required pellicles (protective translucent cellulose membranes) are applied and, after final inspection, the photomask is shipped to the customer.

We support customers across the full spectrum of IC production and FPD technologies by manufacturing photomasks using electron beam or optical (laser-based) systems, the predominant technologies used for photomask manufacturing capable of producing the finer line resolution, tighter overlay, and the more complex circuits currently being designed. Electron beam and laser-generated photomasks can be used to produce the most advanced semiconductors and FPD photomasks for use in an array of products. However, in the case of IC production, the large majority of higher-cost critical-layer photomasks are fabricated using electron beam technologies, while photomasks produced using laser-based systems are used for all FPD photomasks and less critical IC photomasks.  End markets served with IC photomasks include devices used for microprocessors, memory, telecommunications, and related applications. We own a number of both high-end and mature electron beam and laser-based production systems.

The first several layers of photomasks are sometimes required to be delivered to customers within 24 hours from the time we receive customer design data. The ability to manufacture high-quality photomasks within short time periods is dependent upon robust processes, efficient manufacturing methods, high production yield, available manufacturing capacity, and high equipment reliability. We work to meet these requirements by making significant investments in research and development, capital equipment, manufacturing and data processing systems, and by utilizing statistical process control methods to optimize our manufacturing processes and reduce cycle times.

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.

State-of-the-art production for semiconductor masks is considered to be 28 nanometer and smaller for ICs and Generation 10.5+, active-matrix organic light-emitting diode (“AMOLED”) and low-temperature polysilicon (“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, 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 wafer fabrication throughout fiscal 2021, 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.

Sales and Marketing

The market for photomasks primarily consists of domestic and non-US semiconductor and FPD manufacturers and designers. Photomasks are manufactured by independent merchant manufacturers like Photronics, and by semiconductor and FPD manufacturers that produce photomasks for their own use (captive manufacturers). In rare instances, captive manufacturers also sell to other semiconductor or FPD manufacturers. Previously, there was a trend towards the divesture or closing of captive photomask operations by semiconductor manufacturers, and an increase in the share of the market served by independent manufacturers. This trend was driven by the increased complexity and cost of capital equipment used in manufacturing photomasks and the lack of economy of scale for many semiconductor and FPD manufacturers to effectively utilize the equipment. However, more recently, to reach certain roadmap milestones, some captive mask facilities have been investing at faster rates than independent manufacturers, particularly in the foundry logic and memory spaces. Nevertheless, most captive manufacturers maintain business and technology relationships with independent photomask manufacturers for ongoing support.

Generally, Photronics and each of its customers engage in a qualification and correlation process before we become an approved supplier. Thereafter, based on the customer’s expectations, 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 requirements.

We conduct our sales and marketing activities primarily through a staff of full-time sales personnel and customer service representatives who work closely with the Company's management and technical personnel. We support non-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 8 and 15 to our consolidated financial statements for the amount of revenue and long-lived assets attributable to each of our geographic areas of operations.

Customers

We sell our products primarily to leading semiconductor and FPD manufacturers. During fiscal year 2020, we sold our products to approximately 530 customers. Revenue from United Microelectronics Corp. Co., Ltd. accounted for approximately 16%, 15% and 15%  of our total revenues in fiscal years 2020, 2019 and 2018, and revenue from Samsung Electronics Co., Ltd. accounted for approximately 14%, 16% and 16% of our total revenues in fiscal years 2020, 2019 and 2018, respectively. Our five largest customers, in the aggregate, accounted for approximately 45%, 46% and 47% of our revenue in fiscal years 2020, 2019 and 2018, 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.

Seasonality

Our business is typically impacted during the first, and sometimes the second, 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.

Research and Development

We primarily conduct research and development activities for IC photomasks at our Boise, Idaho, facility, as well as at Photronics, Cheonan, Ltd. (formerly PK, Ltd.), our subsidiary in Korea and Photronics DNP Mask Corporation (“PDMC”), one of our joint venture subsidiaries in Taiwan. Research and development for FPD photomasks is primarily conducted at Photronics Cheonan, Ltd. Additionally, we conduct site-specific research and development programs to support strategic customers. These research and development programs and activities are undertaken to advance our competitiveness in technology and manufacturing efficiency. We also conduct application-oriented research and development including data and services technology activities to support the early adoption of new photomasks or supporting data and services technology into our customers' applications. Currently, research and development photomask activities for IC photomasks are primarily focused on photomasks with enabling wafer geometrics of 14 nanometer node and smaller and, for FPDs, on Generations 8 and 10.5+ substrate size photomasks process enhancements for new TV technologies, emerging opportunities for micro- and mini-LED, together with photomask technology for 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 substrate optical lithography scaling continues to enable capabilities of high-end devices and displays. We incurred research and development expenses of $17.1 million, $16.4 million, and $14.5 million in fiscal years 2020, 2019 and 2018, respectively. It is our belief that we own, control, or license the proprietary information (including trade secrets and patents) that is necessary for our business, as it is presently conducted. We also believe that our intellectual property and trade secret know-how will continue to be important to our maintaining technical leadership in the field of photomasks.

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, by utilizing non-disclosure agreements with employees, customers, and vendors.

Materials, Supplies and Equipment

Raw materials used by Photronics generally include: high precision quartz plates (including large area plates), which are used as photomask blanks and are primarily obtained from Japanese and Korean suppliers; pellicles and electronic grade chemicals, which are used in the manufacturing process; and compacts, which are durable plastic containers in which photomasks are shipped. These materials are generally sourced from several suppliers. We believe that our utilization of a select group of strategic suppliers enables us to access the most technologically advanced materials available. On an ongoing basis, we continue to consider additional supply sources.

We 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 supply the equipment used in the photomask manufacturing process. Although, historically, we have been able to obtain equipment on a timely basis, an inability to obtain equipment when required could adversely affect our business and results of operations.

Backlog

The first several layers of a set of photomasks for a circuit pattern are often required to be shipped within twenty-four hours of receiving a customer's designs. Because of the short period between order and shipment dates (typically from one day to two weeks) for a significant amount of our revenue, the dollar amount of our current backlog is not a reliable indicator of future revenue.

International Operations

Revenues from our non-U.S. operations were approximately 83%, 81% and 79% of our total revenues in fiscal 2020, 2019 and 2018, 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 exchange rates, political and economic conditions in various countries, legal compliance and regulatory requirements, tariffs and other trade barriers, difficulties in staffing and managing international operations, longer accounts receivable collection cycles, potential restrictions on transfers of funds, and potentially adverse tax consequences. These factors may have a material adverse effect on our ability to generate revenue outside of the United States and to deploy resources where they could otherwise be used to their greatest advantage and, consequently, may adversely affect our financial condition and results of operations. Notes 8 and 15 of our consolidated financial statements, respectively, present revenue and long-lived assets by geographic area.

Competition

The photomask industry is highly competitive, and most of our customers utilize multiple photomask suppliers. Our ability to compete depends primarily upon the consistency of our product quality, timeliness of delivery, 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, 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 $5.1 billion. Our competitors include Compugraphics International, Ltd., Dai Nippon Printing Co., Ltd (outside of Taiwan and China), Hoya Corporation, LG Innotek Co., Ltd., Shenzhen New Way Photomask Making Co., Ltd., Shenzhen Quingyi Photomask, Ltd., SK-Electronics Co., Ltd., Taiwan Mask Corporation, and Toppan Printing 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, has contributed to the decrease in the number of independent manufacturers, and we expect such pressure to continue in the future.

Employees

As of October 31, 2020 we had approximately 1,728 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, 2020, 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 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 professional development experiences, 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 mitigate risks. Supervisors complete safety management courses as well. In response to the COVID-19 pandemic, we implemented significant changes that we determined were in the best interest of our employees and which comply with government orders in all the states and countries where we operate. In an effort to keep our employees safe and to maintain operations during the COVID-19 pandemic, we have implemented a number of new health-related measures including, the requirement to wear company provided face-masks at all times while on company property, implemented temperature taking protocols, increased hygiene, cleaning and sanitizing procedures at all locations,  implemented social-distancing, implemented restrictions on visitors to our facilities, limiting in-person meetings and other gatherings. Further, 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.

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 customized ICs, a reduction in design complexity, other changes in the technology or methods of manufacturing or designing semiconductors or FPDs, or a slowdown in the introduction of new semiconductor or FPD designs could reduce demand for photomasks ‒ even if the demand for semiconductors and FPDs increases. Historically, the microelectronics 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 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 and supply 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 or deliver such equipment on a timely basis could have a material adverse effect on our business and results of operations. In addition, the manufacturing equipment necessary to produce advanced photomasks could become prohibitively expensive, which could similarly affect us.

We use high-precision quartz photomask blanks, pellicles, and electronic grade chemicals in our manufacturing processes. There are a limited number of suppliers of these raw materials, and we 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 fiscal years 2020, 2019 and 2018, our two largest customers accounted for 29%, 31% and 31%, respectively, of our revenue. Our five largest customers accounted for 45%, 46% and 47% of our revenue in fiscal years 2020, 2019 and 2018, 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.

Our cash flows from operations and current holdings of cash may not be adequate for our current and long-term needs.

Our liquidity, as we operate in a high fixed-cost environment, is highly dependent on our revenue volume and the timing of our capital expenditures, which can vary significantly from period to period. Depending on conditions in the semiconductor and FPD markets, our cash flows from operations and current holdings of cash may not be adequate to meet our current and long-term needs for capital expenditures, operations and debt repayments. Historically, in certain years, we have used external financing to fund these needs. Due to conditions in the credit markets and covenant restrictions on our existing debt, some financing instruments used by us in the past may not be available. Therefore, we cannot provide assurance that additional sources of financing would be available to us on commercially favorable terms, if at all, should our cash requirements exceed our existing cash, operating cash flows, and cash available under our credit agreements.

Our credit facility restricts our business activities, limits our ability to obtain additional financing or pay cash dividends, and may obligate us to repay debt before its maturity.

Financial covenants related to our credit facility, which expires in September 2023, include a total leverage ratio, a minimum interest coverage ratio, and minimum unrestricted cash balances. Our credit facility may also limit our flexibility in planning for, or reacting to, changes in our business and industry, which may place us at a competitive disadvantage compared with our competitors. We are also subject to covenants that limit our operating flexibility, such as a limit on the amount we can spend to repurchase shares of our common stock. Existing covenant restrictions, and noncompliance with covenants or cross default provisions could limit our ability to draw down on current facilities or our ability to obtain additional debt financing, and limit the amount of dividends, distributions, and redemptions we can pay on our common stock to an annual amount of $50 million. Should we be unable to meet one or more of these covenants, our lenders may require us to repay any outstanding balance prior to the expiration date of the agreement. Our ability to comply with the financial and other covenants in our credit agreement may be affected by deteriorating economic or business conditions, or other events. We cannot assure that, under such circumstances, additional sources of financing would be available to fund operating requirements or repay any long-term borrowings, to avoid default. Please also refer to Item 9A for discussion of material weakness.

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 high-end manufacturing capability. We expect that we will be required to continue to make substantial capital expenditures to meet the technological demands of our customers and to position us for future growth. Our capital expenditure payments for fiscal 2021 are expected to be approximately $100 million, of which approximately $15 million was included in Accounts payable on our October 31, 2020 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.

Servicing our debt requires a significant amount of cash, and we may not generate sufficient cash flows from our operations to pay our indebtedness.

Our ability to make scheduled payments of debt principal and interest, or to refinance our indebtedness, depends on our future performance, which is subject to economic, financial, competitive, and other factors beyond our control. Our business may not continue to generate sufficient cash flows from operations to fund operations, service our debt and make necessary capital expenditures. If we are unable to generate such cash flows, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt, or obtaining additional equity capital on terms that may be onerous or highly dilutive. Our ability to refinance our indebtedness would depend upon the conditions in the capital markets and our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations.

Our 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 (i.e. CEO, CTO, etc.) 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 subject to rapid technological change, and we might fail to remain competitive, which could have a material adverse effect on our business and results of operations.

The photomask industry has been, and is expected to continue to be, characterized by technological change and evolving industry standards. In order to remain competitive, we will be required to continually anticipate, respond to, and utilize changing technologies of increasing complexity in both traditional and emerging markets that we serve. In particular, we believe that, as semiconductor geometries continue to become smaller and FPDs become larger or otherwise more advanced, we will be required to manufacture increasingly challenging photomasks. Additionally, the demand for photomasks has been, and could in the future be, adversely affected by changes in semiconductor and high- performance electronics fabrication methods that affect the type or quantity of photomasks utilized, such as changes in semiconductor demand that favor field-programmable gate arrays and other semiconductor designs that replace application-specific ICs. Furthermore, evidence of the viability and the corresponding market acceptance of alternative methods of transferring IC designs onto semiconductor wafers could reduce or eliminate the need for photomasks in the production of semiconductors. As of the end of fiscal 2020, 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 breaches of cybersecurity could negatively impact our financial results.

Cyberattacks or security breaches could compromise confidential, business-critical information, cause disruptions in our operations, 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 continuously reviewed, maintained, and upgraded, a significant cyberattack could result in the loss of vital business or confidential information and/or could negatively impact operations, which could have a negative impact on our 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 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 New Way Photomask Making Co., Ltd., Shenzhen Quingyi Photomask, Ltd., SK-Electronics Co. Ltd., Taiwan Mask Corporation, and Toppan Printing 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, technical, 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. These pressures may continue in the future.

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. If our joint venture partner does not fulfill its obligations, the affected joint venture may not be able to operate in accordance with its business plan. Under such a scenario, our results of operations may be adversely affected and we may be compelled to increase the level of our resources devoted to the joint venture. Also, differing views among joint venture participants may result in delayed decisions, or failures to agree on major issues. If such differences caused a joint venture to deviate from its business plan, our results of operations could be adversely affected.

Our expansion into China entails substantial risks.

In 2019, we commenced operations at our two newly constructed 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; unexpectedly high labor costs due to a tight labor supply; and difficulty in repatriating funds and selling or transferring assets. Our investments in China also expose us to a significant additional foreign currency exchange risk, which we had not been subject to in recent years. In addition, as tensions have 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. These and other risks may result in our not realizing a return on, or losing some, or all, of our planned investments in China, which would have a material adverse effect on our financial condition and financial performance.

We may incur unforeseen charges related to possible future facility closures or restructurings.

We cannot provide assurance that there will not be facility closures or restructurings in the near or long term, nor can we assure that we will not incur significant charges should there be any future facility closures or restructurings.

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. 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 and distraction of management; unforeseen claims and liabilities, including unexpected environmental exposures; unforeseen adjustments, taxes, charges and write-offs; problems enforcing the indemnification obligations of sellers of businesses or joint venture partners for claims and liabilities; unexpected losses of customers of, or suppliers to, the acquired business; difficulty in conforming the acquired businesses’ standards, processes, procedures and controls with our operations; variability in financial performance arising from the implementation of purchase price accounting; inability to coordinate new product and process development; loss of senior managers and other critical personnel and problems with new labor unions; and challenges arising from the increased scope, geographic diversity, and complexity of our operations.

Changes in foreign currency exchange rates could have a material adverse effect on our results of operations, financial condition, or cash flows.

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) and are reported in U.S. dollars. Our operations have transactions and balances denominated in currencies other than the U.S. dollar; primarily the South Korean won, New Taiwan dollar, Japanese yen, Chinese renminbi, euro, Singapore dollar, and the British pound sterling. In fiscal year 2020, we recorded a net loss from changes in foreign currency exchange rates of $0.5 million in our statement of income, while our net assets increased by $36.4 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 exposure to interest rate and currency movements. If we do not accurately forecast our results of operations, execute contracts that do not effectively mitigate our economic exposure to interest rates and currency rates, elect to not apply hedge accounting (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:

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, 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.

Our quarterly operating results fluctuate significantly, and may continue to do so in the future.

We have experienced fluctuations in our quarterly operating results, and we anticipate that such fluctuations will continue and could intensify in the future. Fluctuations in operating results may result in volatility in the prices of our common stock and financial instruments linked to its value. Operating results may fluctuate as a result of many factors, including the size and timing of orders and shipments, the loss of significant customers, changes in product mix, the flow of customer design releases, technological change, fluctuations in manufacturing yields, 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, to some extent, expense levels are based primarily on sales forecasts and technological advancements in photomask manufacturing equipment. Consequently, if anticipated revenues in any quarter do not occur when expected, 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 83%, 81% and 79% of our total revenues in fiscal years 2020, 2019 and 2018, 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 may result in the opening or closing of facilities.

Operations outside of the United States are subject to inherent risks, including: fluctuations in exchange rates; unstable political and economic conditions in various countries; changes in economic alliances; unexpected changes in regulatory requirements; compliance with a variety of 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 payment cycles. In addition: foreign countries may enact other restrictions on foreign trade or investment, including currency exchange controls; trade sanctions could result in our losing access to customers and suppliers; legislation may cause agreements to be difficult to enforce; accounts receivable may be difficult to collect, 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 to 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.

As a consequence of the capital-intensive nature of the photomask manufacturing business, we have a high level of fixed costs and a high degree of operating leverage. Accordingly, should our sales volumes decline as a result of a decrease in design releases from our customers or for any other reason, we may have excess or underutilized production capacity which could significantly impact our operating margins or result in write-offs from asset impairments.

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 business could suffer as a result of the United Kingdom’s decision to end its membership in the European Union.

The decision of the United Kingdom to exit from the European Union (generally referred to as “BREXIT”) could cause disruptions to, and create uncertainty surrounding, our business, including affecting our relationships with existing and potential customers, suppliers, and employees. The effects of BREXIT will depend on any agreements the United Kingdom makes to retain access to European Union markets either during a transitional period or more permanently. The measures could potentially disrupt some of our target markets and jurisdictions in which we operate, and adversely change tax benefits or liabilities in these or other jurisdictions. In addition, BREXIT could lead to legal uncertainty and potentially divergent national laws and regulations, as the United Kingdom determines which European Union laws to replace or replicate. BREXIT also may create global economic uncertainty, which may cause our customers and potential customers to monitor their costs and reduce their budgets for either our products or other products that incorporate our products. Any of these effects of BREXIT, among others, could materially adversely affect our business, business opportunities, results of operations, financial condition, and cash flows. The United Kingdom left the European Union on January 31, 2020, and is currently in a stand-still transition period which is scheduled to end on December 31, 2020.

Our products and technology could be subject to and negatively impacted by the recent expansion of the foreign-produced direct product rule.

In May 2019, the U.S. Department of Commerce, Bureau of Industry and Security (“BIS”) amended export administration regulations by adding Huawei Technologies Co., Ltd. (“Huawei”) and certain affiliates to the “Entity List” for actions contrary to the national security and foreign policy interests of the United States, imposing significant new restrictions on export, re-export and transfer of U.S. regulated technologies and products to Huawei. On August 17, 2020, BIS issued a final rule adding additional Huawei non-U.S. affiliates to the Entity List, confirming the expiration of a temporary general license applicable to Huawei, and amended the foreign-produced direct product rule in a manner that represents a significant expansion of its application to Huawei.

Expansion of the foreign-produced direct product rule and additional companies being added to the entity list may adversely affect our business in various ways, including by: increasing the cost of regulatory compliance for the export of our products, equipment, services, and technology from the United States and abroad; increasing the time necessary to obtain required authorizations; increasing the risk of monetary fines and other penalties for non-compliance, and negatively impacting our customers who may no longer be able to supply their customers and thereby reducing demand for their or our products. Any of these effects could result in lost revenue, additional product costs, increased lead times and deployment delays that could harm our business and customer relationships.

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.

We are subject to the export control laws of the United States and the export control laws of the foreign jurisdictions where we operate. On April 28, 2020, the U.S. administration significantly expanded the reach of U.S. export controls over certain products and certain countries. The U.S. Department of Commerce has, among other things: expanded license requirements to China, Russia and Venezuela; broadened the list of products covered by these expanded license requirements; expanded the definition of “military end use” created a new “reason for control” created a new review policy for certain items to certain countries; added substantial electronic export information filing requirements; eliminated the license exception for civil end use for certain countries, including China, Russia and Venezuela; and proposed to remove those same countries from the list of those eligible for additional re-exports license exceptions. The final rules relating to most of these changes were effective June 29, 2020. Application of these laws may adversely affect our business in various ways, including by regulating the export of our products, equipment, services, and technology from the United States and abroad, increasing the time necessary to obtain required authorizations, and the possibility of monetary fines and other penalties for non-compliance.

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.

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 if we experience difficulties in implementing internal controls, our business and operating results could be harmed, and we could fail to meet our financial reporting obligations. In our assessment of internal control over financial reporting for the fiscal year ended October 31, 2020, we identified a material weakness.  Please refer to Item 9A of this annual report on Form 10-K for further information.

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

Our business could be adversely affected by terrorist acts, widespread outbreaks of infectious diseases (such as the COVID-19 pandemic), government responses such as shelter-in-place directives to limit the impact of infectious diseases, or the outbreak or escalation of wars, especially in the Asian markets in which we generate a significant portion of our sales and in Japan where we purchase raw materials and capital equipment. Such events in the geographic regions in which we do business, including escalations of political tensions and military conflicts within the Korean Peninsula, or between the People’s Republic of China and the U.S. or the Republic of China (Taiwan), could have material adverse impacts on our revenue, cost and availability of raw materials, results of operations, cash flows, and financial condition.

Our production facilities could be damaged or disrupted by natural disasters or labor strikes, either of which could adversely affect our financial position, results of operations, and cash flows.

A major catastrophe, such as an earthquake or other natural disaster, labor strike, or work stoppage at any of our manufacturing facilities, or a manufacturing facility of our suppliers or customers, could result in a prolonged interruption of our business. A disruption resulting from any one of these events could cause significant delays in shipments of our products and the loss of revenue and customers, which could have a material adverse effect on our financial position, results of operations, and cash flows. Our facilities in Taiwan are located in a seismically-active area.

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 EU 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 EU authorities.

 Any failure, or perceived failure, by us to comply with the 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 EU 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 we have been profitable since fiscal 2010, we have, in the past, incurred net losses. We cannot provide assurance that we will not incur net losses in the future.

None.

The following table presents certain information about the Company's photomask manufacturing facilities:

(1)  The Company owns its manufacturing facility in Hefei, Taichung, Xiamen, and one of its manufacturing facilities in Hsinchu. However, it leases the related land.

Please refer to Note 14 within Item 8 of this report for information on legal proceedings involving the Company.

Not applicable.

PART II

Our common stock is traded on the NASDAQ Global Select Market ("NASDAQ") under the symbol PLAB. On December 11, 2020, the closing sale price of our common stock, per the NASDAQ Global Select Market, was $11.25. Based on available information, we estimate that we have approximately 8,400 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. Further, our credit agreement limits the amount that can be paid as cash dividends on Photronics stock.

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 of 1933 (as amended) (“the Securities Act”). Share repurchases under the program commenced on September 16, 2020.

In August 2019, the Company’s board of directors authorized the repurchase of up to $100 million of its common stock, pursuant to a repurchase plan under Rule 10b5-1 of the Securities Act. This repurchase program was terminated on March 20, 2020.

In July 2018 and October 2018, the Company’s board of directors authorized the repurchase of up to $20 million and $25 million, respectively, of its common stock, to have been executed in open-market transactions or in accordance with a repurchase plan under Rule 10b5-1 of the Securities Act. The July 2018 repurchase program was completed in October 2018, and the October 2018 repurchase program was terminated on February 1, 2019.

All of the shares purchased under the above repurchase programs in fiscal 2020 were retired prior to the end of the fiscal year. All of the shares purchased under prior year repurchase programs were retired in fiscal year 2019. The tables below present additional information on the above repurchase programs.

* The share repurchase program was terminated on March 20, 2020.

** The share repurchase program was terminated on February 1, 2019.

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. 2021 Definitive Proxy Statement in Item 12 of Part III of this report. The 2021 Definitive Proxy Statement will be filed within 120 days after our fiscal year ended October 31, 2020.

The following selected financial data (in thousands, except per share amounts and employees) is derived from our audited consolidated financial statements. The data should be read in conjunction with the audited consolidated financial statements and notes thereto, and other financial information included elsewhere in this Annual Report on Form 10-K.

Overview

We sell substantially all of our photomasks to semiconductor designers and manufacturers, and manufacturers of FPDs. Photomask technology is also being applied to the fabrication of other higher-performance electronic products such as photonics, micro-electronic mechanical systems, and certain nanotechnology applications. Our selling cycle is tightly interwoven with the development and release of new semiconductor 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 photomask 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 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 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 microelectronic industry has been volatile, experiencing periodic downturns and slowdowns in design activity. These downturns have been characterized by, among other things, diminished product demand, excess production capacity, and accelerated erosion of selling prices with a concomitant effect on revenue and profitability.

We are typically required to fulfill customer orders within a short period of time, sometimes within twenty-four hours. This results in a minimal level of backlog orders, typically one to two weeks of backlog for IC photomasks and two to three weeks of backlog for FPD photomasks.

The global microelectronics industry is 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 the high-end markets. As we face challenges in the current and near term that require us to make significant improvements in our competitiveness, we continue to evaluate further cost reduction initiatives.

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, 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 2021, 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 and phase-shift 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 fiscal year 2020, 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.

Both our revenues and costs have been affected by the increased demand for high-end-technology photomasks that require more advanced manufacturing capabilities, but generally command higher average selling prices ("ASPs"). Our capital expenditure payments aggregated approximately $342 million for the three fiscal years ended October 31, 2020, which has significantly contributed to our cost of goods sold. We intend to continue to make the required investments to support the technological demands of our customers that we believe will position the Company for future growth. In support of this effort, we expect capital expenditure payments to be approximately $100 million in fiscal year 2021.

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.

Recent Developments

During the fourth quarter of fiscal 2020, we entered into a Master Lease Agreement with a financing entity for the lease of an inspection tool with a maximum value of $10 million.  The tool was delivered during the fourth quarter of fiscal year 2020, and the financing entity made a progress payment to the vendor of $6.5 million in the first quarter of fiscal year 2021. The progress payment will accrue interest at 1.56% payable monthly until the final payment for the tool is made, at which time the lease will begin.

In the fourth quarter of fiscal 2020, we were approved to borrow 200 million Chinese renminbi (RMB) (approximately $29.8 million, at the balance sheet date) from the China Construction Bank Corporation. We received initial proceeds of 41 million RMB (approximately $6.2 million) against this approval in November 2020. Loan proceeds have been, and will be, used for the purchase of two lithography tools at our facility in Hefei, China. Interest rate on the loan is variable and based on the RMB Loan Prime Rate of the National Interbank Funding Center less 0.45% (adjusted annually), and is to be repaid semiannually, over five years, commencing on March 5, 2022. The interest rate on the loan was 4.2% at the borrowing date. The first five semiannual loan repayments will each be for 7.5 percent of the approved 200 million RMB loan principal; the last five installments will each be for 12.5 percent of the approved loan principal, with the final installment due on September 30, 2026. Semiannual repayments of the initial $6.2 million borrowed will commence on March 5, 2022, with a repayment of $2.3 million; subsequent semiannual repayments will be in the amounts of $2.3 million and $1.6 million. The borrowings are secured by the Hefei facility, its related land use right, and certain manufacturing equipment, which had a combined carrying value of $87.8 million as of October 31, 2020.

In the fourth quarter of fiscal 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 of 1933 (as amended) (“the Securities Act”). We repurchased 1.7 million shares at a cost of $17.5 million (an average price of $10.11 per share) under this authorization. All shares repurchased were retired in fiscal 2020.

In the fourth quarter of fiscal 2020, PDMC, the Company’s majority-owned IC subsidiary in Taiwan, paid a dividend of which 49.99%, or approximately $16.2 million, was paid to noncontrolling interests.

In the first quarter of fiscal 2020, we acquired the remaining 0.2% of noncontrolling interests in PK, Ltd. for $0.6 million.

In the first quarter of fiscal 2020, we adopted ASU 2016-02 and all subsequent amendments, collectively codified in Accounting Standards Codification Topic 842 - “Leases” (“Topic 842”). This guidance requires modified retrospective adoption, either at the beginning of the earliest period presented or at the beginning of the period of adoption; we elected to apply the guidance at the beginning of the period of adoption, and recognized right-of-use leased assets of approximately $6.5 million, and corresponding lease liabilities, which were discounted at our incremental borrowing rates, on our November 1, 2019, consolidated balance sheet to reflect our adoption of the guidance. Our adoption of Topic 842 did not affect our cash flows or our ability to comply with covenants under our credit agreements.

In the fourth quarter of fiscal 2019, PDMC, the Company’s majority-owned IC subsidiary in Taiwan, paid a dividend of which 49.99%, or approximately $18.9 million, was paid to noncontrolling interests.

In the fourth quarter of fiscal 2019, upon our request, a financing entity made an advance payment of $3.5 million to an equipment vendor. We entered into a Master Lease Agreement (“MLA”) with this financing entity, which became effective in July 2019. The MLA enables us to request advance payments or other funds to finance equipment to be leased or purchased in the U.S. In connection with this MLA, we have been approved for financing of $35 million for the purchase of a high-end lithography tool. Interest on this borrowing is variable and payable monthly at thirty-day LIBOR plus 1% (1.15% at October 31, 2020), and will continue to accrue until the borrowing is repaid or, as allowed under the MLA, we enter into a lease for the equipment. During the first quarter of fiscal 2021, this financing entity made an additional payment of $28 million to the equipment vendor on our behalf.

In the fourth quarter of fiscal 2019, the Company’s board of directors authorized the repurchase of up to $100 million of its common stock, pursuant to a repurchase plan under Rule 10b5-1 of the Securities Act of 1933 (as amended). We repurchased 2.5 million shares at a cost of $27.9 million (an average price of $11.34 per share) under this authorization. The repurchase program was terminated on March 20, 2020.

In the second quarter of fiscal 2019, we repaid, upon maturity, the entire $57.5 million principal amount of the convertible senior notes we issued in April 2016.

In the first quarter of fiscal 2019, PDMC paid a dividend, of which 49.99%, or approximately $26.1 million, was paid to noncontrolling interests.

In the first quarter of fiscal 2019, PDMCX was approved for credit of 345.0 million RMB (approximately $51.4 million, at the balance sheet date), subject to certain limitations related to PDMCX registered capital at the time of the initial approval, pursuant to which PDMCX has and will enter into separate loan agreements (“the Project Loans”) for intermittent borrowings. The Project Loans, which are denominated in RMB, are being used to finance certain capital expenditures in China. PDMCX granted liens on its land, building, and certain equipment as collateral for the Project Loans. As of October 31, 2020, PDMCX had outstanding 336.0 million RMB ($50.1 million) against this approval. Payments on these borrowings are due semiannually through December 2025. See Note 7 of the consolidated financial statements for additional information on these loans.

In the first quarter of fiscal 2019, PDMCX received approval for unsecured credit of $25.0 million, pursuant to which PDMCX may enter into separate loan agreements. Under this credit agreement (the “Working Capital Loans”), PDMCX can borrow up to 140.0 million RMB to pay value-added taxes (“VAT”) and up to 60.0 million RMB to fund operations; combined total borrowings are limited to the equivalent of $25.0 million. As of October 31, 2020, PDMCX had outstanding 8.0 million RMB ($1.2 million) to fund operations, with repayments due one year from the borrowing dates of the separate loan agreements. As of October 31, 2020, PDMCX had outstanding 93.2 million RMB ($13.9 million) borrowed to pay VAT. Payments on these borrowings are due semiannually, in increasing amounts, through July 2023. See Note 7 of the consolidated financial statements for additional information on these loans.

In the fourth quarter of fiscal 2018, the Company’s board of directors authorized the repurchase of up to $25 million of its common stock, to have been executed in open-market transactions or in accordance with a repurchase plan under Rule 10b5-1 of the Securities Act of 1933 (as amended). The share repurchase program commenced, under Rule 10b5-1, on October 22, 2018, and was terminated on February 1, 2019. In total, we repurchased 1.5 million shares at a cost of $13.8 million (an average of $9.41 per share) under this authorization.

 In the third quarter of fiscal 2018, the Company’s board of directors authorized the repurchase of up to $20 million of its common stock, which was effectuated in open-market transactions or in accordance with a repurchase plan under Rule 10b5-1 of the Securities Act of 1933 (as amended). The share repurchase program commenced on July 10, 2018, and ended in October 2018. In total, under this authorization, we repurchased 2.2 million shares at a cost of $20.0 million (an average of $8.97 per share).

In the third quarter of fiscal 2018, PDMC paid a dividend, of which 49.99%, or approximately $8.2 million, was paid to noncontrolling interests.

In the first quarter of fiscal 2018, we announced the successful closing of the China joint venture agreement with Dai Nippon Printing Co., Ltd. (“DNP”), which we had agreed to enter into and announced in the third quarter of fiscal 2017. Under the agreement, our wholly-owned Singapore subsidiary owns 50.01% of the joint venture, which is named Xiamen American Japan Photronics Mask Co., Ltd. (PDMCX), and a subsidiary of DNP owns the remaining 49.99%. The financial results of the joint venture, which commenced production in the third quarter of 2019, are included in the Photronics, Inc. consolidated financial statements. See Note 5 of the consolidated financial statements for additional information on the joint venture.

Results of Operations

The following tables present selected operating information expressed as a percentage of revenue:

Note: All the following tabular comparisons, unless otherwise indicated, are for the three months ended October 31, 2020 (Q4 FY20), August 2, 2020 (Q3 FY20) and October 31, 2019 (Q4 FY19), and for the fiscal years ended October 31, 2020 (FY20) and October 31, 2019 (FY19). Please refer to the MD&A in our 2019 Annual Report on Form 10-K for comparative discussion of our fiscal years ended October 31, 2019 and October 31, 2018.

Revenue

Our quarterly revenues can be affected by the seasonal purchasing practices of our customers. As a result, demand for our products is typically reduced during the first, and sometimes the second, quarters of our fiscal year, by the North American, European, and Asian holiday periods, as some of our customers reduce their development and, consequently, their buying activities during those periods.

At the beginning of fiscal year 2020, we changed the threshold for the definition of high-end FPD, from G8 and above and active matrix organic light-emitting diode (AMOLED) display screens, to G10.5⁺, AMOLED, and low-temperature polysilicon  (LTPS) display screens, to reflect the overall advancement of technology in the FPD industry. Our definition of high-end IC products remains as 28 nanometer or smaller. High-end photomasks typically have higher selling prices (ASPs) than mainstream products.

The following tables present changes in revenue disaggregated by product type and geographic origin, in Q4 FY20 and FY20 from revenue in prior reporting periods. Columns may not total due to rounding.

Revenue decreased 5.5% in Q4 FY20, compared with Q3 FY20, as FPD demand fell 11.9% due, in significant part, to U.S. trade sanctions placed on Huawei Technologies Co., Ltd. which negatively impacted their ability to release new mobile devices, thereby decreasing demand for new display panels and, ultimately, new FPD photomasks; consequentially, our mobile display panel revenue declined 21% from Q3 FY20. In addition, high prices and unit demand for current products resulted in panel producers extending production runs of current designs and delaying design changes, which led to decreased demand of masks used for production of LCD displays on G10.5+, and smaller substrates. FPD revenue attributable to China decreased 12% from Q3 FY20, while representing 56% of our total FPD revenue in Q4 FY20. IC revenue decreased from the prior quarter by 2.5%, as improvement at some logic foundries in the U.S. and Asia somewhat mitigated weakened demand for memory photomasks. IC revenue attributable to China increased 14% from Q3 FY20, and accounted for a quarter of our IC revenue in the current quarter.

Revenue decreased 4.5% in Q4 FY20, compared with Q4 FY19; IC demand declined 5.9%, due to weakened demand for memory photomasks, while FPD demand fell less than 1%, despite the disruptions to the China supply chain discussed above.

Revenue increased 10.7% in FY20, compared with FY19, to a record high of $609.7 million, eclipsing our previous record set in FY19. FPD revenue increased 32.4%, on strong demand for high-end products, despite the disruptions to the China FPD supply chain encountered in Q4 FY20. IC revenue increased 3.0%, year-over-year; the increase was driven by higher demand for mainstream logic masks in Asia and the U.S. The outbreak of the COVID 19 pandemic in FY20 tempered revenue growth for both IC and FPD, as supply chains were, at least temporarily, disrupted and travel restrictions were imposed, resulting in delays to equipment installations and customer design team projects.

Gross Margin

Gross margin decreased by 2.5 percentage points in Q4 FY20, from Q3 FY20, primarily as a result of the above mentioned 5.5% decrease in revenue from the prior quarter. Gross margins decreased in Taiwan, Korea, and the U.S., primarily as a result of decreased revenue; gross margins at our China-based operations increased, overall, primarily due to lower glass blank costs. Total cost of goods sold decreased $2.7 million, or 2.3%, from the prior quarter, primarily due to a 6.1% decrease in material costs, which were essentially flat as a percentage of revenue. Labor costs decreased 1.9%, but were essentially flat as a percentage of revenue, while overhead costs increased $0.5 million, and 2.3 percentage points, as a percentage of revenue.

Gross margin decreased by 3.0 percentage points in Q4 FY20, from Q4 FY19, primarily as a result of the 4.5% decrease in revenue in the current year quarter. Gross margins at our China-based IC and FPD operations increased as they continue to ramp up to full production. Gross margins decreased in Taiwan, and the U.S., primarily as a result of decreased revenue. Total cost of goods sold decreased $0.7 million, or 0.6%, from the prior year quarter, with $1.9 million of the decrease resulting from lower materials costs, which fell 4.1%, but were essentially flat as a percentage of revenue. Labor costs increased 9.5%, up 1.5 percentage points of revenue, while overhead costs were essentially flat, and up 1.4 percentage points of revenue.

Gross margin increased by 0.2 percentage points in YTD FY20, from YTD FY19, primarily as a result of the 10.7% increase in revenue from the prior year period. Gross margins at our China-based IC and FPD operations increased as these facilities continue to ramp up to full production. Gross margins decreased in Taiwan primarily due to lower revenue, and in the U.S due to overhead costs increasing, while revenue was, essentially, unchanged. Total cost of goods sold increased $45.2 million, or 10.5%, from the prior year period, with $19.6 million of the increase resulting from greater materials costs, which were up 12.0% from YTD FY19, and increased 0.4%, as a percentage of revenue. Labor costs increased 4.9%, but were down 0.6 percentage points against revenue, while overhead costs increased 11.2%, with increased equipment costs (which reflected our expanded installed tool base) comprising the majority of this increase.

As we operate in a high fixed cost environment, increases or decreases in our revenues and capacity utilization will generally positively or negatively impact our gross margin.

Selling, General and Administrative Expenses

Selling, general and administrative expenses were $12.8 million in Q4 FY20, compared with $13.3 million in Q3 FY20, and $12.1 million in Q4 FY19. The decrease from Q3 FY20 was primarily the result of decreased compensation and related expenses of $0.8 million, and the increase from the prior year quarter was primarily the result of increased compensation and related expenses of $1.2 million, which were partially offset by decreased travel costs of $0.6 million. Selling, general and administrative expenses increased $1.3 million, or 2.4%, in YTD FY20, from YTD FY19, primarily as a result of increased compensation and related expenses and professional fees of $2.7 million and $0.8 million, respectively, partially offset by decreased travel expenses of $1.7 million.

Research and Development Expenses

Research and development expenses consist of development efforts related to high-end process technologies for high-end IC and FPD applications.

Research and development expenses were $4.1 million in Q4 FY20, compared with $4.5 million in both Q3 FY20 and Q4 FY19. The decrease from Q3 FY20 was primarily the result of decreased development activities in the U.S., which were partially offset by increased activities in China, and the decrease from the prior year quarter was the result of decreased activities in China and Taiwan. Research and development expenses increased $0.8 million, or 4.6%, in YTD FY20 from YTD FY19, primarily due to increased development activities in China, which were partially offset by reduced activities in the U.S. and Taiwan.

Other Income (Expense), net

The unfavorable change in Other income (expense), net of $0.8 million, from a loss of $2.1 million in Q3 FY20, to a loss of $2.9 million in Q4 FY20, was primarily due to increased foreign currency exchange losses of $0.7 million, and increased interest expense on our China-based debt. The majority of the interest on our China-based debt is eligible for reimbursements through subsidies, which we recognize upon receipt. Other income (expense), net increased $3.2 million from Q4 FY19, primarily due to less unfavorable foreign currency transaction results of $4.0 million, which were partially offset by increased interest expense of $0.6 million on our China-based debt; the increased interest expense reflected the higher average debt balance in the current year quarter.

The unfavorable year-to-date change in Other income (expense), net of $0.9 million was primarily due to increased interest expense of $1 million on our China-based debt, and decreased interest income of $0.6 million. The effects of these decreases were partially offset by decreased foreign currency exchange losses of $0.8 million.

Income Tax Provision

Certain provisions of the U.S. Tax Cuts and Jobs Act, which was signed into law on December 22, 2017, were effective for tax years beginning on or after January 1, 2018. As a fiscal year U.S. taxpayer, these provisions were applied to our fiscal year 2019, including the elimination of the domestic manufacturing deduction, creating new taxes on certain foreign sourced income, and introducing new limitations on certain business deductions.

The effective income tax rate is sensitive to the jurisdictional mix of our earnings, due, in part, to the non-recognition of tax provisions and benefits on losses in jurisdictions with valuation allowances.

The effective income tax rate increased in Q4 FY20, compared with Q3 FY20, due to the non-recognition of more tax benefits in Q4 FY20 on losses in the U.S. and in a non-U.S. jurisdiction; non-recognized tax benefits in both quarters were a result of valuation allowances applying to those provisions and benefits. The effective income tax rate increased in Q4 FY20, from Q4 FY19, due to the non-recognition of tax benefits in a non-U.S. jurisdiction during FY20; the non-recognized tax benefits in both quarters were a result of valuation allowances applying to those benefits. However, in Q4 FY19, tax benefits not recognized on U.S. quarterly income were somewhat reduced by the benefit of $0.9 million from a tax holiday in Taiwan.

The increase in the effective income tax rate on a full-year basis in FY20, compared with FY19, is primarily due to the net increase in non-recognition of tax benefits in the US and in a non-U.S. jurisdiction during FY20; the non-recognition is the result of valuation allowances applying to those benefits, the $1.5 million post-settlements increase in the provision for unrecognized tax benefits, and a $1.9 million decrease in the benefit related to the FY20 tax holiday in Taiwan, which expired at the end of December 2019.

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, 2020 and October 31, 2019, are $2.0 million and $1.9 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 $2.1 million in Q4 FY20, unchanged from Q3 FY20, and was the result of net income realized at our China-based IC facility in Q4 FY20, which realized a net loss in Q3 FY20, and decreased net income at our Taiwan-based IC facility. Net income attributable to noncontrolling interests decreased $1.2 million in Q4 FY20 from $3.3 million in Q4 FY19; decreased income at our Taiwan-based IC facility exceeded the favorable effect of our China-based IC facility income in the current year quarter, and a net loss in the prior year quarter.

On a year-to-date basis, net income attributable to noncontrolling interests decreased $4.2 million; the decrease was the result of decreased net income at our Taiwan-based IC facility, the effect of which was somewhat mitigated by a decreased net loss at our China-based IC facility. We hold 50.01% ownership interests in both the China-based and Taiwan-based IC facilities.

Liquidity and Capital Resources

We had cash and cash equivalents of $278.7 million at the end of Q4 FY20, compared with $206.5 million at the end of fiscal 2019. The net increase of $72.2 million was primarily attributable to:

- $143.0 million provided by operating activities;

- $17.6 million contributed to our China-based IC joint venture by noncontrolling interests;

- $5.3 million government incentives received in China;

- $4.2 million received from exercises of employee stock options;

- $20.3 million received from borrowings in China;

- $(70.8) million paid for property, plant, and equipment;

- $(34.4) million used to repurchase our common stock;

- $(16.2) million dividend paid to noncontrolling interest

- $(7.4) million used to repay debt;

- $11.0 million favorable effects of currency exchange rate changes on cash          

Our working capital at the end of Q4 FY20 was $357.2 million, compared with $275.6 million at the end of fiscal 2019. The increase is primarily attributable to the following increases (decreases) in working capital:

- Increased cash and cash equivalents of $72.2 million;

- Increased inventories of $9.1 million, mainly acquired to protect against potential COVID-19 related supply chain disruptions;

- Increased compensation and related expenses accrual of ($2.1) million;

- Increased contract liabilities of $(3.7) million;

- Increased current debt of $(2.8) million;

- Increased current portion of operating leases of $(2.3) million, reflecting our adoption of ASC 842 at November 1, 2019.

The net cash provided by operating activities of $143.0 million in YTD FY20 was a $74.6 million increase from $68.4 million provided in YTD FY19. The net increase in YTD FY20 was primarily due to:

- Increased non-cash add backs to net income, including depreciation, amortization, share-based compensation, and deferred income taxes of $14.4 million;

- A comparative decrease in accounts receivable of $19.3 million;

- A comparative decrease in the build-up of inventories of $16.2 million, which was primarily the  result of our initially supplying our China-based FPD facility in YTD FY19;

- A comparative increase in other current assets of $16.5 million, mostly related to increases in refundable income tax of $4.6 million, contract assets of $8.9 million and recoverable VAT of $2.2 million.

- A comparative increase in accounts payable, accrued liabilities and other of $8.5 million, mostly related to the  net of the following comparative changes: an increase in noncurrent recoverable VAT of $28.3 million related  to our China facilities, increase in contract liability of $5.3 million, decrease in accounts payable and accruals of $(24.5) million, and a decrease in income tax payable of $(3.2) million.

Net cash used in investing activities was $65.7 million in YTD FY20, a decrease of $85.7 million from $151.4 million used in YTD FY19. The net decrease in cash used was primarily attributable to decreased capital expenditures of $107.6 million; this was the result of a reduction in payments to equip our China-based facilities, which were in the start-up phase in the first half of fiscal year 2019. A reduction in investment incentives of $21.7 million in YTD FY20, from YTD FY19, also reduced net cash flows used in investing activities.

Net cash flows from financing activities changed from $42.1 million used in YTD FY19 to $16.0 million used in YTD FY20. Significant components of the $26.0 million net change were:

- Repayments of debt were $53.9 million less in YTD FY20 than in YTD FY19; the primary cause of the decrease was repayment (upon their maturity) of our convertible senior notes in YTD FY19;

- Dividends to DNP (related to their 49.99% interest in our IC facility in Taiwan) were $28.9 million less in YTD FY20;

- $(34.3) million less debt was incurred in YTD FY20 than in YTD FY19;

- $(11.8) million less contributed by DNP to maintain their proportionate ownership interest in our IC joint venture in China in YTD FY20 than in YTD FY19;

- $(12.7) million more paid in YTD FY20, than in YTD FY19, to acquire our common stock.

As of October 31, 2020 and October 31, 2019, our total cash and cash equivalents included $218.0 million and $147.2 million, respectively, held by our foreign subsidiaries. The majority of earnings of our foreign subsidiaries are considered to be indefinitely reinvested. Repatriation of these funds to the U.S. may subject them to U.S. state income taxes and local country withholding taxes in certain jurisdictions. Furthermore, our foreign subsidiaries continue to grow through the reinvestment of earnings in additional manufacturing capacity and capability, particularly in the high-end IC and FPD sectors.

Since we operate in a high fixed cost environment, our liquidity is highly dependent on our revenue, cash conversion cycle, and the timing of our capital expenditures (which can vary significantly from period to period). We believe that our cash on hand, cash generated from operations, and amounts available to borrow will be sufficient to meet our cash requirements for the next twelve months. However, depending on conditions in the semiconductor and display markets, our cash flows from operations and current holdings of cash may not be adequate to meet our current and long-term needs for capital expenditures, operations and debt repayments. Historically, in certain years, we have used external financing to fund these needs. Due to conditions in the credit markets and covenant restrictions on our existing debt, some financing instruments we have used in the past may not be available to us when required. Consequently, we cannot assure that additional sources of financing would be available to us on commercially favorable terms, should our long-term cash requirements exceed our existing cash and cash available under our credit agreements (which are discussed in Note 7 to the consolidated financial statements). Please also refer to Financing Related Risk Factors.

 As of October 31, 2020, we had outstanding capital commitments of approximately $112 million. We intend to finance our capital expenditures with our working capital, contributions from our joint venture partners, cash generated from operations and, if necessary, additional borrowings. As of the end of fiscal 2020, we had no unfulfilled commitments to fund our IC facility in China.

Our cash requirements in fiscal 2021 will primarily be for funding our operations, capital spending, and debt repayments. At our option, should we deem it to be an optimal use of our cash, we may repurchase some of our common stock. We regularly review the availability and terms at which we might issue additional equity or debt securities in the public or private markets. However, we cannot assure that additional sources of financing would be available to us on commercially favorable terms, should our cash requirements exceed our existing cash and cash available under our credit agreements.

Contractual Obligations

The following table presents our contractual obligations as of October 31, 2020:

As of October 31, 2020, the Company had recorded accruals for uncertain tax positions and related interest and penalties of $2.7 million; these accruals were not included in the above table due to the high degree of uncertainty regarding the timing of future payments related to such liabilities.

Off-Balance Sheet Arrangements

In January 2018, Photronics, through its wholly owned Singapore subsidiary, entered into the PDMCX joint venture with DNP, through its wholly owned subsidiary “DNP Asia Pacific PTE, Ltd.” under which DNP obtained a 49.99% interest in our IC business in Xiamen, China. The joint venture was established to develop and manufacture photomasks for leading edge and advanced generation semiconductors. Under the joint venture’s operating agreement, DNP is afforded, under certain circumstances, the right to put its interest in PDMCX to Photronics. These circumstances include disputes regarding the strategic direction of PDMCX that may arise after the initial two-year term of the Agreement that cannot be resolved between the two parties. As of the date of issuance of this report, DNP had not indicated its intention to exercise this right. In addition, both Photronics and DNP have the option to purchase, or put, their interest from, or to, the other party, should their ownership interest fall below twenty percent for a period of more than six consecutive months. Under all such circumstances, the sales of ownership interests would be at the exiting party’s ownership percentage of the joint venture’s net book value, with closing to take place within three business days of obtaining required approvals and clearance. Should DNP exercise an option to put their, or purchase our, interest in PDMCX we may, depending on the relationship of the fair and book value of PDMCX’s net assets, incur a loss. As of October 31, 2020, Photronics and DNP each had net investments in PDMCX of $54.8 million.

We lease certain office facilities and equipment under leases with terms of one year or less that may require us to pay taxes, insurance and maintenance expenses related to the properties. See Note 9 to the consolidated financial statements for additional information on these short-term leases. In concurrence with our November 1, 2019, adoption of Accounting Standards Codification Topic 842 – “Leases”, we recognized right-of-use leased assets of approximately $6.5 million and corresponding lease liabilities, which were discounted at our incremental borrowing rates. As a result, most of our lease agreements ceased to be off-balance sheet arrangements on that date.

Business Outlook

       While we, as always, caution that our outlook, due to our short back-log (which typically does not exceed two weeks) is limited, we expect revenue to increase, as a percentage of FY20 revenue, in the high single digits. We are also anticipating operating profit to grow at a rate similar to the 23% increase we experienced in FY20. The bases of our expectations include growth for both IC and FPD in FY2021. IC growth drivers include added capacity across our global operations including the completion of Phase 1 of our China IC facility ramp, growing demand for semiconductor masks in China, and increased demand in the IC memory space. For FPD, mobile displays are once again expected to be a sector of growth with additional demand coming from new large-screen TV technology, such as OLED, which will be supported by the implementation of the next phase of investment at our Asia-based FPD facilities. We are also encouraged by the impending distribution of recently developed coronavirus vaccines, as we think this supports a reasonable expectation that supply chain disruptions and travel restrictions will be eased, thereby reducing the impediments to growth they represented in FY20.

The impact, if any, on our business of changing geopolitical conditions, such as U.S.-China trade relations, tensions between the Republic of South Korea and Japan, and the effects of the United Kingdom exiting the European Union cannot be predicted. However, we believe the impending change in leadership in the U.S. may lead to an improvement in its trade relationship with China, including the possible removal of sanctions on some Chinese enterprises, as well as a reduction in the likelihood of the impositions of additional sanctions.

We believe that a majority of the growth in the IC and FPD markets will come from the Asia region, predominantly in China. We expect to meet these demands both through the utilization of our facilities in China and by importing photomasks into China from our other facilities. We make continual assessments of our global manufacturing strategy and monitor our revenue and related cash flows from operations. These ongoing assessments could result in future facility closures, asset redeployments, impairments of intangible or long-lived assets, workforce reductions, or the addition of manufacturing facilities, all of which would be based on market conditions and customer requirements.

Our future results of operations and the other forward-looking statements contained in this filing involve a number of risks and uncertainties, some of which are discussed in Part1, Item 1A 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:

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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. In accounting for the resolution of contingencies, significant judgment may be necessary to estimate amounts pertaining to periods prior to the resolution that are charged to operations in the period of resolution and amounts related to future periods.

Because 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, completion of tax audits or earnings repatriation plans could have an impact on those estimates and our effective tax rate.

Please refer to Notes 1, 8, 9, 12, and 14 to our consolidated financial statements for additional information related to these critical accounting estimates and our other significant accounting policies.

Recent Accounting Pronouncements

See “Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Note 23 Recent Accounting Pronouncements” for recent accounting pronouncements that may affect our financial reporting.

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 Chinese renminbi 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. In addition, to the extent practicable, we attempt to reduce our exposure to foreign currency exchange fluctuations by converting cash and cash equivalents into the functional currency of the subsidiary which holds the cash. We may also enter into derivative contracts to mitigate our exposure to foreign currency fluctuations when we have a significant purchase obligation or significant receivable denominated in a currency that differs from the functional currency of the transacting subsidiary. We do not enter into derivatives for speculative purposes. There can be no assurance that these practices 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, 2020, 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, 2020, 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 $31.9 million, which represents a decrease of $1.2 million from the same movement as of October 31, 2019. The decrease in foreign currency rate change risk is primarily the result of decreased net exposure of the Chinese renminbi 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, 2020 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, 2020, consolidated financial statements.

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and the Board of Directors of Photronics, Inc.

Opinions on the Financial Statements

We have audited the accompanying consolidated balance sheets of Photronics, Inc. and subsidiaries (the "Company") as of October 31, 2020 and October 31, 2019, the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the three years in the period ended October 31, 2020, the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of October 31, 2020 and October 31, 2019, and the results of its operations and its cash flows for each of the three years in the period ended October 31, 2020, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of October 31, 2020, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated January 14, 2021, expressed an adverse opinion on the Company's internal control over financial reporting because of a material weakness.

Basis for Opinions

The Company's management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinions.

Critical Audit Matter

 

The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Revenue — Contracts with Customers— Refer to Note 1 to the financial statements

Critical Audit Matter Description

The Company recognizes revenue over time for in-process production orders that have not shipped for contracts with customers for which it has an enforceable right to bill and collect consideration, inclusive of a reasonable profit, in the event the in-process orders are cancelled by the customers. This results in the Company recording a corresponding contract asset as of period end for these contracts. Significant judgment is exercised by the Company in determining the amount of revenue to recognize for these contracts and the corresponding contract asset, specifically in estimating the point within the production cycle at which the production orders stand in relation to the Company’s enforceable right within the contract. Pursuant to these contracts, revenue recognized over time and the associated contract asset as of October 31, 2020 was $6.3 million.

We identified the determination of revenue recognized over time for in-process productions orders as of October 31, 2020 a critical auditing matter because of the significant estimates and assumptions management makes in determining the amount of revenue to recognize for these contracts. This required a high degree of audit judgment and an increased extent of effort when performing audit procedures to evaluate the reasonableness of management’s determination of the progress point of in-process orders and the amount of revenue recognized over time and the corresponding contract asset as of October 31, 2020.

How the Critical Audit Matter Was Addressed in the Audit

Our audit procedures related to the Company’s determination of the progress point of in-process orders and resulting revenue recognized over time and corresponding contract asset as of October 31, 2020 included the following:

- We tested the operating effectiveness of controls over management’s determination of the point in the production process and correlation to stated contractual rights.

- We tested the mathematical accuracy of management’s calculations of revenue and the associated timing of revenue recognized in the consolidated financial statements.

- We selected a sample of in-process production orders as of October 31, 2020 and performed the following procedures for each selection:

- Obtained and read the contract.

- Physically observed existence of the in-process production order.

- Tested management’s identification of significant contract terms and resulting revenue recognition for the in-process production order.

- Tested management estimate of the production point for the in-process order and corresponding revenue recognition and contract asset based on the Company’s enforceable right within the contract.

/s/ Deloitte & Touche LLP

Hartford, Connecticut

January 14, 2021

We have served as the Company’s auditor since 1991.

PHOTRONICS, INC.

Consolidated Balance Sheets

(in thousands, except per share amounts)

PHOTRONICS, INC.

Consolidated Statements of Income

(in thousands, except per share amounts)