PHOTRONICS INC 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview We sell substantially all of our photomasks to semiconductor designers and manufacturers, and manufacturers of FPDs. Photomask technology is also being applied to the fabrication of other higher-performance electronic products such as 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 application-specific ICs, reductions in design complexities, other changes in the technology or methods of manufacturing or designing semiconductors, or a slowdown in the introduction of new semiconductor or display designs could reduce demand for photomasks ‒ even if the demand for semiconductors and FPDs increases. Advances in semiconductor, display, and photomask design and production methods that shift the burden of achieving device performance away from lithography could also reduce the demand for photomasks. Historically, the microelectronics industry has been volatile, experiencing periodic downturns and slowdowns in design activity. These negative trends have been characterized by, among other things, diminished product demand, excess production capacity, and accelerated erosion of selling prices with a concomitant effect on revenue and profitability. We are typically required to fulfill customer orders within a short period of time, sometimes within twenty-four hours. This results in a minimal level of backlog orders, typically one to two weeks of backlog for IC photomasks and two to three weeks of backlog for FPD photomasks. However, the demand for some IC photomasks has recently expanded beyond the industry’s capacity to supply them within the traditional time period; thus, for some products, our backlog can expand to as long as two to three months. The global semiconductor and FPD industries are driven by end markets which have been closely tied to consumer-driven applications of high-performance devices, including, but not limited to, mobile display devices, mobile communications, and computing solutions. While we cannot predict the timing of the industry’s transition to volume production of next-generation technology nodes, or the timing of up and down-cycles with precise accuracy, we believe that such transitions and cycles will continue into the future, beneficially and adversely affecting our business, financial condition, and operating results as they occur. We believe our ability to remain successful in these environments is dependent upon the achievement of our goals of being a service and technology leader and efficient solutions supplier, which we believe should enable us to continually reinvest in our global infrastructure. We are focused on improving our competitiveness by advancing our technology and reducing costs and, in connection therewith, have invested and plan to continue to invest in manufacturing equipment to serve both the high-end photomask and trailing-edge markets. As we face challenges that require us to make significant improvements in our competitiveness, we continue to evaluate further cost reduction initiatives. State-of-the-art production for semiconductor masks is considered to be 28 nanometer and smaller for ICs and Generation 10.5+ and AMOLED and LTPS display-based process technologies for FPDs. However, 32 nanometer and above geometries for semiconductors and Generation 8 and below (excluding AMOLED and LTPS) process technologies for displays constitute the majority of designs currently being fabricated in volume. At these geometries, 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 2023, 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. 22 Table of Contents 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 2022, 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 ASPs. Our capital expenditure payments were $112.3 million, $109.1 million and $70.8 million in 2022, 2021 and 2020, respectively, and the depreciation on these investments has significantly contributed to our cost of goods sold. Nonetheless, we intend to continue to make the required investments to support the technological demands of our customers that we believe will position us for future growth. In support of this effort, we expect capital expenditure payments to be approximately $130 million in fiscal year 2023. 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 In the second quarter of 2021, under an MLA which we entered into effective October 2020, we entered into a five-year $7.2 million finance lease for a high-end inspection tool. Monthly payments on the lease, which commenced in February 2021, are $0.1 million per month. Upon the payment of the fiftieth monthly payment and prior to payment of the fifty-first monthly payment, we may exercise an early buyout option to purchase the tool for $2.4 million. If we do not exercise the early buyout option, then at the end of the five-year lease term, the lease shall continue to renew on a month-to-month basis at the same rental terms; at our option, after the original term or any renewal periods, we may return the tool, elect to extend the lease, or purchase the tool at its fair market value. Since we are reasonably certain that we will exercise the early buyout option, our lease liability reflects such exercise and we have classified the lease as a finance lease. The interest rate implicit in the lease is 1.08%. In the first quarter of 2021, under an MLA which we entered into effective July 2019, we entered into a five-year $35.5 million finance lease for a high-end lithography tool. Monthly payments on the lease, which commenced in January 2021, increased from $0.04 million after the first three months to $0.6 million for the following nine months, followed by forty-eight monthly payments of $0.5 million. As of the due date of the forty-eighth monthly payment, we may exercise an early buyout option to purchase the tool for $14.1 million. If we do not exercise the early buyout option, then at the end of the five-year lease term, at our option, we may return the tool, elect to extend the lease term for a period and a lease payment to be agreed with lessor at the time, or purchase the tool for its then-fair market value as determined by the lessor. Since we are reasonably certain that we will exercise the early buyout option, our lease liability reflects such exercise and we have classified the lease as a finance lease. The interest rate implicit in the lease is 1.58%. The lease agreement incorporates the covenants included in our Corporate Credit Agreement, which are detailed in Note 6 to our consolidated financial statements in Part II, Item 8 of this report, and includes a cross-default provision for any agreement or instrument with an outstanding, committed balance greater than $5.0 million in which we are the indebted party. In the fourth quarter of 2020, we entered into a MLA 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 2020, and the financing entity made a progress payment to the vendor of $6.5 million in the first quarter of 2021. The progress payment accrued interest at 1.56% payable monthly until the final payment for the tool was made in the second quarter of 2021, at which point the $7.2 million lease described above began. 23 Table of Contents In the fourth quarter of 2020, our Hefei, China, facility was approved to borrow 200 million RMB from the China Construction Bank Corporation. This credit facility was subject to annual reviews and extension; the most recent extension allowing us to borrow additional funds was expired in August 2022. The loan proceeds were used to fund purchases of two lithography tools at the Hefei facility. As of October 31, 2021, we had borrowed 135.7 million RMB ($21.2 million) against this approval (all of which was then outstanding), and 64.3 million RMB ($10.1 million) remained available to borrow; we repaid the entire outstanding balance in 2022, and did not apply to extend the agreement. The interest rate on the loan was variable and based on the RMB Loan Prime Rate of the National Interbank Funding Center. The borrowings were secured by the Hefei facility, its related land use right, and certain manufacturing equipment. The Hefei Equipment Loan was subject to covenants and provisions, certain of which relate to the assets pledged as security for the loan, including covenants for the ratio of total liabilities to total assets and the ratio of current assets to current liabilities, all of which we were in compliance with at the time of our repayment. In the fourth quarter of 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. Through October 31, 2022, we had repurchased 5.8 million shares at a cost of $68.3 million (an average price of $11.70 per share) under this authorization. All shares repurchased under the program have been retired. On August 16, 2022, the Inflation Reduction Act (“IRA”) was enacted in the U.S. Among other provisions, the IRA included a one percent excise tax on corporate share repurchases. The one percent excise tax on share repurchases applies to shares repurchased after December 31, 2022, and excludes repurchases under $1 million. We do not anticipate that the IRA will have a material effect on our financial performance. In the first quarter of 2020, we acquired the remaining 0.2% of noncontrolling interests in Photronics Cheonan, Ltd. for $0.6 million. In the first quarter of 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. 24 Table of Contents Results of Operations The following tables present selected operating information expressed as a percentage of revenue. The columns may not foot due to rounding. Three Months Ended October 31, 2022 July 31, 2022 October 31, 2021 Revenue 100.0 % 100.0 % 100.0 % Cost of goods sold 61.8 61.9 71.3 Gross profit 38.2 38.1 28.7 Selling, general and administrative expenses 7.5 7.3 7.9 Research and development expenses 1.9 1.9 2.3 Operating income 28.8 29.0 18.5 Non-operating income (expense), net 5.1 1.7 2.1 Income before income tax provision 33.9 30.6 20.6 Income tax provision 7.6 8.3 4.8 Net income 26.3 22.4 15.8 Net income attributable to noncontrolling interests 8.7 8.2 4.9 Net income attributable to Photronics, Inc. shareholders 17.6 % 14.2 % 10.9 % Year Ended October 31, 2022 October 31, 2021 October 31, 2020 Revenue 100.0 % 100.0 % 100.0 % Cost of goods sold 64.3 74.8 77.9 Gross profit 35.7 25.2 22.1 Selling, general and administrative expenses 7.8 8.7 8.8 Research and development expenses 2.2 2.8 2.8 Other operating income, net 0.0 0.5 - Operating income 25.7 14.2 10.5 Non-operating income (expense), net 3.3 1.1 (0.4 ) Income before income tax provision 29.0 15.4 10.1 Income tax provision 7.3 3.5 3.5 Net income 21.7 11.9 6.6 Net income attributable to noncontrolling interests 7.3 3.5 1.1 Net income attributable to Photronics, Inc. shareholders 14.4 % 8.4 % 5.5 % Note: All the following tabular comparisons, unless otherwise indicated, are for the three months ended October 31, 2022 (Q4 FY22), July 31, 2022 (Q3 FY22) and October 31, 2021 (Q4 FY21), and for the fiscal years ended October 31, 2022 (FY22) and October 31, 2021 (FY21). Please refer to Part II, Item 7 of our 2021 Form 10-K for comparative discussion of our fiscal years ended October 31, 2021, and October 31, 2020. The tables in this item may not foot due to rounding. 25 Table of Contents Revenue Our quarterly revenues can be affected by the seasonal purchasing practices of our customers. As a result, demand for our products is typically reduced during the first quarter of our fiscal year by the North American, European, and Asian holiday periods, as some of our customers reduce their development and, consequently, their buying activities during those periods. The following tables present changes in revenue disaggregated by product type and geographic origin, in Q4 FY22 and FY22 from revenue in prior reporting periods. Quarterly Changes in Revenue by Product Type Q4 FY22 compared to Q3 FY22 Q4 FY22 compared to Q4 FY21 Revenue in Q4 FY22 Increase (Decrease) Percent Change Increase (Decrease) Percent Change IC High-end* $ 44.3 $ (8.3 ) (15.8 )% $ 1.8 4.1 % Mainstream 111.9 3.3 3.0 % 29.0 35.0 % Total IC $ 156.2 $ (5.0 ) (3.1 )% $ 30.8 24.5 % FPD High-end* $ 43.4 $ (7.3 ) (14.4 )% $ 2.4 5.9 % Mainstream 10.6 2.6 33.0 % (4.2 ) (28.3 )% Total FPD $ 54.1 $ (4.6 ) (7.9 )% $ (1.8 ) (3.2 )% Total Revenue $ 210.3 $ (9.7 ) (4.4 )% $ 29.0 16.0 % * High-end photomasks typically have higher ASPs than mainstream products. Quarterly Changes in Revenue by Geographic Origin** Q4 FY22 compared to Q3 FY22 Q4 FY22 compared to Q4 FY21 Revenue in Q4 FY22 Increase (Decrease) Percent Change Increase (Decrease) Percent Change Taiwan $ 76.3 $ (1.1 ) (1.4 )% $ 7.1 10.3 % China 52.4 (8.1 ) (13.4 )% 14.1 36.7 % Korea 38.0 0.1 0.2 % 0.2 0.4 % United States 34.0 (0.7 ) (1.9 )% 7.4 28.0 % Europe 9.0 0.1 1.3 % 0.1 0.9 % Other 0.5 0.0 2.3 % 0.1 21.9 % Total revenue $ 210.3 $ (9.7 ) (4.4 )% $ 29.0 16.0 % ** This table disaggregates revenue by the location in which it was earned. Revenue in Q4 FY22 of $210.3 million represented a decrease of 4.4% compared with Q3 FY22, and an increase of 16.0% from Q4 FY21. Overall IC revenue decreased 3.1% from Q3 FY22 due to lower high-end foundry and logic demand in Asia, but increased 24.5% from the prior year quarter. IC mainstream growth continued in Q4 FY22, increasing 3.0% from Q3 FY22, and 35.0% from Q4 FY21, due to continued growth in demand and favorable pricing on photomasks used to produce semiconductors required to make or support consumer products, the “internet-of-things”, 5G wireless technology, and cryptocurrency mining. 26 Table of Contents FPD revenue decreased 7.9% and 3.2% in Q4 FY22, compared, respectively, with Q3 FY22 and Q4 FY21. The decreases were caused by weakened demand from Q322 for high-end large-area masks used for mobile displays and G10.5+ masks used for ultra-large screen televisions. Revenue from mainstream products increased 33.0% from Q3 FY22, as capacity became available from the decreased demand for high-end products. Year-over-Year Changes in Revenue by Product Type FY22 compared to FY21 Revenue in FY22 Increase (Decrease) Percent Change IC High-end* $ 195.3 $ 32.4 19.9 % Mainstream 397.7 100.5 33.8 % Total IC $ 593.0 $ 132.9 28.9 % FPD High-end* $ 187.0 $ 31.3 20.1 % Mainstream 44.5 (3.4 ) (7.1 )% Total FPD $ 231.5 $ 27.9 13.7 % Total Revenue $ 824.5 $ 160.8 24.2 % * High-end photomasks typically have higher ASPs than mainstream photomasks. Year-over-Year Changes in Revenue by Geographic Origin** FY22 compared to FY21 Revenue in FY22 Increase (Decrease) Percent Change Taiwan $ 291.3 $ 42.7 17.2 % China 212.6 96.9 83.7 % Korea 156.1 (0.3 ) (0.2 )% United States 126.2 21.2 20.2 % Europe 36.4 0.2 0.4 % Other 1.9 0.1 4.9 % Total Revenue $ 824.5 $ 160.8 24.2 % ** This table disaggregates revenue by the location in which it was earned. Revenue in YTD FY22 of $824.5 million surpassed our prior record revenue set in YTD FY21 by $160.8 million, or 24.2%. IC revenue increased by 28.9%, due to strong demand for both high-end and mainstream photomasks and improved pricing for mainstream products and products at the most advanced node levels. FPD revenue increased by 13.7%, driven by a 20.1% increase in revenue from high-end products, which was driven by increased demand and better pricing for AMOLED products used in mobile displays and increased demand for G10.5+ large area masks used for ultra-large televisions. 27 Table of Contents Gross Margin Percent Change Q4 FY22 Q3 FY22 Q4 FY21 Q4 FY22 from Q3 FY22 Q4 FY22 from Q4 FY21 Gross profit $ 80.3 $ 83.9 $ 51.9 (4.3 )% 54.5 % Gross margin 38.2 % 38.1 % 28.7 % Gross margin was 38.2% for Q4 FY22, representing a slight increase from the Q3 FY22 gross margin of 38.1%, as decreased revenue of 4.4% was offset by decreased material costs which fell 7.7%, or 80 basis points as a percentage of revenue. Labor costs increased 5.2%, or 100 basis points as a percentage of revenue, due to increased costs in some locations. Equipment and other overhead costs decreased 5.3%, or 30 basis points as a percentage of revenue, with lower outsourced manufacturing costs, partially offset by increased equipment maintenance costs, most significantly contributing to the net cost decrease. Gross margin increased by 9.5 percentage points in Q4 FY22, from Q4 FY21, primarily as a result of the increase in revenue from the prior year quarter, together with 1.6% decrease in material costs from the prior year quarter. Labor costs increased 21.8% from the prior year quarter, or 50 basis points as a percentage of revenue, primarily due to increased costs in some locations. Equipment and other overhead costs decreased 4.9%, or 580 basis points, as a percentage of revenue. Decreased depreciation expense and outsourced manufacturing costs, which were partially offset by increased equipment maintenance costs, were the primary contributors to the overall decrease. FY22 FY21 Percent Change FY22 from FY21 Gross profit $ 294.2 $ 167.0 76.1 % Gross margin 35.7 % 25.2 % Gross margin increased by 10.5 percentage points in FY22, from FY21, primarily as a result of the increase in revenue from the prior year period, offset somewhat by the following net cost increases: Material costs increased 7.9% from the prior year period, but decreased 380 basis points as a percentage of revenue. Labor costs increased 15.6% from the prior year, or 100 basis points as a percentage of revenue. Equipment and other overhead costs increased by 2.7%, but decreased 580 basis points as a percentage of revenue, with increased outsourced manufacturing costs, which were partially offset by decreased depreciation expense, most significantly contributing to the overall cost increase. Selling, General and Administrative Expenses Selling, general and administrative expenses were $15.7 million in Q4 FY22, compared with $16.0 million in Q3 FY22, and $14.3 million in Q4 FY21 . The decrease from Q3 FY22 was primarily the result of decreased compensation and related expenses of $0.5 million, and the increase from the prior year quarter was primarily the result of increased professional fees of $0.7 million and increased travel expenses of $0.3 million. Selling, general and administrative expenses increased $6.5 million to $64.0 million in FY22, from $57.5 million in FY21, primarily due to an increase in compensation and related expenses, professional fees, and travel expenses in the respective amounts of $4.6 million, $0.7 million, and $0.6 million. Research and Development Expenses Research and development expenses, which primarily consist of development and qualification efforts related to process technologies for high-end IC and FPD applications, decreased $0.1 million to $4.0 million in Q4 FY22, from Q3 FY22; the decrease was primarily caused by a decline in development activities in the U.S., which were partially offset by increased activities in Asia. Research and development expenses in Q4 FY22 decreased by $0.1 million in Q4 FY22 from Q4 FY21 as a result of decreased development activities in Asia moderately exceeding increased development activities in the U.S. On a year-to-date basis, research and development expenses decreased $0.1 million, to $18.3 million, primarily due to decreased development activities in Asia exceeding increased activities in the U.S. 28 Table of Contents Other Operating Income, Net In the third quarter of 2021, we recorded a $3.5 million gain on the trade-in of a lithography tool with a tool vendor as partial compensation for a more advanced tool. Non-Operating Income (Expense) Q4 FY22 Q3 FY22 Q4 FY21 Foreign currency transactions impact, net $ 10.4 $ 3.9 $ 4.3 Interest expense, net (0.4 ) (0.6 ) (1.0 ) Interest income and other income, net 0.8 0.4 0.5 Total other income (expense) $ 10.8 $ 3.6 $ 3.8 Non-operating income (expense) increased in Q4 FY22 from Q3 FY22 by $7.2 million, and from Q4 FY21 by $7.0 million, primarily due to foreign currency impacts, driven by favorable movements of the South Korean won, the New Taiwan dollar, and the Singapore dollar against the U.S. dollar offsetting unfavorable movements of the RMB against the U.S. dollar. In addition, higher average cash, cash equivalents, and short-term investments balances in Q4 FY22 resulted in increased interest income compared to both prior comparative periods, and lower average interest-bearing debt balances resulted in lower interest expense, net of subsidies received in Q4 FY22, than was incurred in the prior comparative periods. FY22 FY21 Foreign currency transactions impact, net $ 27.3 $ 8.0 Interest expense, net (1.9 ) (1.7 ) Interest income and other income, net 1.7 1.2 Total other income (expense) $ 27.2 $ 7.5 Non-operating income (expense) increased $19.7 million in full year FY22, compared with full year FY21, primarily due to foreign currency transactions, driven by favorable movements of the South Korean won, the New Taiwan dollar, and the Singapore dollar offsetting unfavorable movements of the RMB against the U.S. dollar. In addition, higher average cash, cash equivalents, and short-term investments balances in FY22, compared with FY21, resulted in increased interest income in the current year. Interest expense, net of subsidies increased in FY22, compared with FY21, due to receiving a lower amount of interest subsidies on our China-based debt in FY22, the effect of which was partially mitigated by lower average interest-bearing debt balance in FY22 than in the prior year. Income Tax Provision Q4 FY22 Q3 FY22 Q4 FY21 Income tax provision $ 16.1 $ 18.1 $ 8.7 Effective income tax rate 22.5 % 26.9 % 23.3 % The effective income tax rates are sensitive to the jurisdictional mix of our earnings, due, in part, to the non-recognition of tax benefits on losses in jurisdictions with valuation allowances where the tax benefits of losses are not available. The effective income tax rate decreased in Q4 FY22, compared with Q3 FY22, primarily due to changes in the period-to-period mix of jurisdictional earnings. The effective income tax rate decrease in Q4 FY22, compared with Q4 FY21, is primarily due to the benefits of investment credits in certain non-U.S. jurisdictions in Q4 FY22, as well as changes in the jurisdictional mix of earnings. 29 Table of Contents FY22 FY21 Income tax provision $ 59.8 $ 23.2 Effective income tax rate 25.0 % 22.7 % The increase in the effective income tax rate on a full-year basis in FY22, compared with FY21, is primarily due to an increase of unremitted earnings tax and a decrease in credits in non-U.S. jurisdictions and the release of a valuation allowance for a loss carryforward in a non-U.S. jurisdiction in FY21. 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, 2022 and October 31, 2021, are $5.6 million and $3.8 million respectively, recorded in Other liabilities in the consolidated balance sheets that, if recognized, would impact the effective tax rates. Net Income Attributable to Noncontrolling Interests Net income attributable to noncontrolling interests was $18.2 million in Q4 FY22, compared with $18.0 million in Q3 FY22; the increase was the result of a net increase in the net incomes of our joint venture operations. Net income attributable to noncontrolling interests increased by $9.4 million in Q4 FY22 from Q4 FY21, and by $37.1 million in FY22 from FY21, as a result of increased net income at both our Taiwan-based and China-based IC facilities. Liquidity and Capital Resources Cash and cash equivalents was $319.7 million and $276.7 million as of October 31, 2022, and October 31, 2021, respectively. As of the most recent balance sheet date, total cash and cash equivalents included $299.7 million held by foreign subsidiaries. Net Cash, a non-GAAP financial measure as defined and discussed in the Non-GAAP Financial Measures section below, was $316.2 million and $165.0 million as of October 31, 2022, and October 31, 2021, respectively. Our primary sources of liquidity are our cash on hand, cash we generate from operations, short-term investments, and borrowing capacity we have available from financial institutions. Our corporate credit agreement has a $50 million borrowing limit, with an expansion capacity to $100 million. Although we have not accessed funds under our corporate credit facilities since 2011, it continues to afford us financial flexibility. In addition, in China, we have approximately $21.5 million of borrowing capacity to support local operations. See Note 6 to our condensed consolidated financial statements in Part II, Item 8 for additional information on our currently available financing. We continually evaluate alternatives for efficiently funding our capital expenditures and ongoing operations. These reviews may result in our engagement in a variety of investing and financing transactions, in the transfer of cash among subsidiaries, and/or the repatriation of cash to the U.S. The transfer of funds among subsidiaries could be subject to foreign withholding taxes; in certain jurisdictions, repatriation of these funds to the U.S. may subject them to U.S. state income taxes and/or local country withholding taxes. We believe that our liquidity, including available financing, is sufficient to meet our requirements through the next twelve months and thereafter for the foreseeable future. Through the utilization of our existing liquidity, cash we generate from operations, short-term investments, and (potentially) our borrowing capacity under our financing arrangements, we plan to continue to invest in our business, with our investments targeted to align with our customers’ technology road maps. In addition, we stand ready to invest in mergers, acquisitions, or strategic partnerships, should a suitable opportunity arise. We estimate capital expenditures for our fiscal year 2023 will be approximately $130 million; these investments will be targeted towards high-end and mainstream point tools that will increase our operating capacity and efficiency, and enable us to support our customers’ near-term demands. As of October 31, 2022, we had outstanding capital commitments of approximately $147.8 million and recognized liabilities related to capital equipment purchases of approximately $5.3 million. Although payment timing could vary, primarily as a result of the timing of tool delivery, installation and testing, we currently estimate that we will fund $90.0 million of our total $153.1 million committed and recognized obligations for capital expenditures over the next twelve months. Please refer to Notes 8 and 13 to our consolidated financial statements in Part II, Item 8 for additional information on our lease liabilities and unrecognized commitments, respectively. 30 Table of Contents In September 2020, the Company’s board of directors authorized the repurchase of up to $100 million of its common stock, pursuant to a repurchase plan under Rule 10b5-1 of the Securities Act. This authorization does not obligate the Company to repurchase any dollar amount or number of shares of common stock. As of October 31, 2022, there was approximately $31.7 million remaining under that authorization. Depending on market conditions, we may utilize some or the entire remaining approved amount to reacquire additional shares. On August 16, 2022, the Inflation Reduction Act (“IRA”) was enacted in the U.S. Among other provisions, the IRA included a one percent excise tax on corporate share repurchases. The one percent excise tax on share repurchases applies to shares repurchased after December 31, 2022, and excludes repurchases under $1 million. We do not anticipate that the IRA will have a material effect on our liquidity. As discussed in Note 4 of our consolidated financial statements in Part II, Item 8, DNP, the noncontrolling interest in our China-based joint venture has, under certain circumstances, the right to put its interest in the joint venture to Photronics, or to purchase our interest in the joint venture. Under all such circumstances, the sale of DNP’s interest would be at its ownership percentage of the joint venture’s net book value, with closing to take place within three business days of obtaining required approvals and clearance. As of the date of issuance of this report, DNP had not indicated its intention to exercise this right. As of October 31, 2022, Photronics and DNP each had net investments in this joint venture of approximately $93.3 million. Cash Flows Year Ended October 31, 2022 October 31, 2021 October 31, 2020 Net cash provided by operating activities $ 275.2 $ 150.8 $ 143.0 Net cash used in investing activities $ (147.8 ) $ (103.5 ) $ (65.7 ) Net cash used in financing activities $ (38.7 ) $ (53.9 ) $ (16.0 ) Operating Activities : Net cash provided by operating activities reflects net income adjusted for certain non-cash items, including depreciation and amortization, share-based compensation, and the effects of changes in operating assets and liabilities. Net cash provided by operating activities increased by $124.4 million in FY22, compared with FY21, primarily due to increased net income and net cash-favorable changes in working capital, predominantly in Asia. Free Cash Flow, which is a non-GAAP financial measure as discussed in the “Non-GAAP Financial Measures” section below, increased by $119.0 million in FY22, compared with FY21, primarily due to increased net cash provided by operating activities, and decreased by $30.0 million in FY21, compared with FY20, primarily due to an increase in spending on property, plant and equipment. Investing Activities : In FY22, net cash flows used in investing activities primarily consisted of purchases of $112.3 million of property, plant and equipment. Net cash flows used in investing activities increased by $44.3 million in FY22, compared with FY21, primarily as a result of our investment of $38.9 million in short-term debt securities in FY22. Financing Activities : In FY22, net cash flows used in financing activities primarily consisted of debt repayments of $65.4 million, which were partially offset by contributions from noncontrolling interests of $25.0 million. Net cash used in financing activities decreased by $15.2 million in FY22, compared with FY21, primarily due to decreased share repurchases of $45.7 million and an excess of the change in contributions from, as compared with distributions to, noncontrolling interests of $34.6 million, which were partially offset by increased debt repayments of $45.1 million (which included early repayments of $15.8 million), and decreased proceeds from long-term debt of $20.9 million. Our cash, cash equivalents, and restricted cash balances were negatively impacted by changes in foreign currency exchange rates in FY22 by $46.0 million. 31 Table of Contents Non-GAAP Financial Measures We consider Free Cash Flow and Net Cash, which are “non-GAAP financial measures” (as such term is defined by the SEC), to be useful metrics in measuring our cash-generating performance. (Note that we may define these terms differently than other companies that use similarly-named non-GAAP financial measures.) These non-GAAP metrics are not intended to represent funds available for our discretionary use or to be used as a substitute for Cash and cash equivalents or Net cash provided by operating activities , as measured under GAAP. The following tables reconcile Net cash provided by operating activities to Free Cash Flow for FY22, FY21 and FY20. The columns may not foot due to rounding. FY22 FY21 FY20 Free Cash Flow Net cash provided by operating activities $ 275.2 $ 150.8 $ 143.0 Purchases of property, plant and equipment (112.3 ) (109.1 ) (70.8 ) Government incentives 3.6 5.8 5.3 Free cash flow $ 166.5 $ 47.4 $ 77.5 The following table reconciles Cash and cash equivalents to Net Cash at the balance sheet dates. The increase in Net Cash was primarily driven by an increase in Net cash provided by operating activities, as discussed above. The columns may not foot due to rounding. As of October 31, 2022 October 31, 2021 Net Cash Cash, cash equivalents $ 319.7 $ 276.7 Short-term investments 38.9 - Current portion of Long-term debt (10.0 ) (22.2 ) Long-term debt (32.3 ) (89.4 ) Net cash $ 316.2 $ 165.0 Business Outlook Our current business outlook and guidance was provided in our Full Year and Fourth Quarter Fiscal 2022 Results earnings call, and related slide deck. These can be accessed in the investor section of our website - www.photronics.com. Our future results of operations and the other forward-looking statements contained in this filing and in our Full Year and Fourth Quarter Fiscal 2022 Results earnings call and presentation involve a number of risks and uncertainties, some of which are discussed in Part I, Item 1A of this report. A number of other unforeseeable factors could cause actual results to differ materially from our expectations. Critical Accounting Estimates Our consolidated financial statements are based on the selection and application of accounting policies, which require management to make significant estimates and assumptions. We believe the following to be the more critical areas that require judgment when applying our accounting policies: • Revenue Recognition : The a pplication of GAAP related to the measurement and recognition of revenue requires us to make judgments and estimates, including t he determination of whether we should recognize revenues as we perform or upon the completion of our performance, as these determinations impact the timing and amount of our reported revenues and net income. Other significant judgments include the estimation of the point in the manufacturing process at which we are entitled to recognize revenue, as well as the measurement of our progress towards satisfying our performance obligations, which determine the amount of revenue we are entitled to recognize. 32 Table of Contents • Property, Plant and Equipment : Significant judgment and assumptions are employed when we establish the estimated useful lives of asset classes, and determine when depreciation should commence for individual assets, as these determinations can significantly impact our gross margin and research and development expenses. Significant judgement would also be employed when events or changes in circumstances indicate that the carrying amount of a group of assets may not be recoverable, as the recoverability assessment requires us to forecast future cash flows related to these assets; this evaluation can significantly impact our gross margin and operating expense. • Leases : Significant judgement is applied in the determination of whether an arrangement is, or contains, a lease and, in certain instances, whether the lease should be classified as an operating lease or a finance lease, which can impact the timing and classification of lease costs. • Contingencies : We are subject to the possibility of losses from various contingencies. Significant judgment is necessary to estimate the probability and amount of a loss, if any, from such contingencies. An accrual is made when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. Changes in estimates related to, and resolutions of, contingencies may have a material impact on our financial performance. • Income Taxes : Our annual tax rate is determined based on our income and the jurisdictions where it is earned, statutory tax rates, and the tax impacts of items treated differently for tax purposes than for financial reporting purposes. Also inherent in determining our annual tax rate are judgments and assumptions regarding the recoverability of certain deferred tax assets, and our ability to uphold certain tax positions. We are subject to complex tax laws, in the U.S. and numerous foreign jurisdictions, and the manner in which they apply can be open to interpretation. Realization of deferred tax assets is dependent upon generating sufficient taxable income in the appropriate jurisdiction in future periods, which involves business plans, planning opportunities, and expectations about future outcomes. Our assessment relies on estimates and assumptions, and may involve a series of complex judgments about future events. There are a number of estimates and assumptions inherent in calculating the various components of our tax provision. Future events such as changes in tax legislation, geographic mix of earnings, findings in tax audits, and earnings repatriation plans could have an impact on those estimates and our effective tax rate. Please refer to Notes 1, 11, and 13 to our consolidated financial statements in Part II, Item 8 for additional information related to these critical accounting estimates. Effect of Recent Accounting Pronouncements See Note 20 to our consolidated financial statements in Part II, Item 8 of this report for recent accounting pronouncements that may affect our financial reporting.