PHOTRONICS INC 10-Q

Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview Management's discussion and analysis (“MD&A”) of the Company's financial condition and results of operations should be read in conjunction with its condensed consolidated financial statements and related notes. Various sections of this MD&A contain forward-looking statements, all of which are presented based on current expectations, which may be adversely affected by uncertainties and risk factors (presented throughout this filing and in the Company's Form 10-K for fiscal year 2023), that may cause actual results to materially differ from these expectations. See “Forward-Looking Statements”. 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, microelectronic 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 displays 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, typically two to three weeks of backlog for FPD photomasks and one to two weeks for IC photomasks. However, the demand for some IC photomasks has expanded beyond the industry’s capacity to supply them within the traditional time period; thus, for some products, the 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. 24 Table of Contents Results of Operations Three Months Ended January 28, 2024 The following table presents selected operating information expressed as a percentage of revenue. The columns may not foot due to rounding. Three Months Ended January 28, October 31, January 29, 2024 2023 2023 Revenue 100.0 % 100.0 % 100.0 % Cost of goods sold 63.4 62.7 64.0 Gross profit 36.6 37.3 36.0 Operating expenses: Selling, general, and administrative 8.5 7.4 8.0 Research and development 1.6 1.5 1.6 Operating income 26.6 28.5 26.5 Other operating income (expense), net (1.7 ) 8.2 (6.8 ) Income before income tax provision 24.8 36.7 19.7 Income tax provision 6.8 8.9 6.0 Net income 18.1 27.8 13.7 Net income attributable to noncontrolling interests 6.0 8.2 7.1 Net income attributable to Photronics, Inc. shareholders 12.1 % 19.6 % 6.6 % Note: All tabular comparisons included in the following discussion, unless otherwise indicated, are for the three months ended January 28, 2024 (Q1 FY24), October 31, 2023 (Q4 FY23), and January 29, 2023 (Q1 FY23). The columns may not foot due to rounding. Revenue Our quarterly revenues can be affected by the seasonal purchasing practices of our customers. As a result, demand for our products is typically reduced during the first quarter of our fiscal year by the North American, European, and Asian holiday periods, as some of our customers reduce their development and, consequently, their buying activities during those periods. 25 Table of Contents The following tables present changes in disaggregated revenue in Q1 FY24 from revenue in prior reporting periods. Quarterly Changes in Revenue by Product Type Q1 FY24 compared with Q4 FY23 Q1 FY24 compared with Q1 FY23 Revenue in Increase Percent Increase Percent Q1 FY24 (Decrease) Change (Decrease) Change IC High-end * $ 60.9 $ 3.2 5.5 % $ 12.9 26.8 % Mainstream 96.7 (10.1 ) (9.4 )% (11.9 ) (10.9 )% Total IC $ 157.6 $ (6.9 ) (4.2 )% $ 1.0 0.6 % FPD High-end * $ 50.6 $ (2.7 ) (5.0 )% $ 4.9 10.8 % Mainstream 8.1 (1.6 ) (16.2 )% (0.7 ) (7.7 )% Total FPD $ 58.7 $ (4.3 ) (6.7 )% $ 4.2 7.8 % Total Revenue $ 216.3 $ (11.2 ) (4.9 )% $ 5.2 2.5 % * High-end photomasks typically have higher average selling prices (ASPs) than mainstream products. Quarterly Changes in Revenue by Geographic Origin** Q1 FY24 compared with Q4 FY23 Q1 FY24 compared with Q1 FY23 Revenue in Increase Percent Increase Percent Q1 FY24 (Decrease) Change (Decrease) Change Taiwan $ 75.0 $ (4.3 ) (5.5 )% $ (0.6 ) (0.8 )% China 58.1 (1.1 ) (1.8 )% (0.8 ) (1.3 )% Korea 40.3 (1.9 ) (4.4 )% 2.5 6.6 % United States 32.7 (4.1 ) (11.1 )% 2.8 9.5 % Europe 9.7 0.4 4.4 % 1.3 14.9 % Other 0.5 (0.2 ) (34.4 )% - 7.0 % $ 216.3 $ (11.2 ) (4.9 )% $ 5.2 2.5 % ** This table disaggregates revenue by the location in which it was earned. Revenue in Q1 FY24 was $216.3 million, representing a decrease of 4.9% compared with Q4 FY23 and an increase of 2.5% from Q1 FY23. IC photomask revenue decreased by 4.2% compared with Q4 FY23. The decrease from Q4 FY 23 was primarily the result of reduced mainstream demand in Asia. IC photomask revenue slightly increased compared to Q1 FY23 with an increase in high end demand offsetting the decrease in mainstream. FPD revenue decreased 6.7% compared with Q4 FY23. The decrease from Q4 FY23 was due to premium smartphone seasonality. FPD revenue increased 7.8% from Q1 FY23 due to increased high end demand for AMOLED. We believe that strong demand for AMOLED photomasks will continue, as expected technology advances drives increasing overall demand for higher-value masks. 26 Table of Contents Gross Margin Percent Percent Q1 FY24 Q4 FY23 Change Q1 FY23 Change Gross profit $ 79.3 $ 84.9 -6.6 % $ 76.1 4.2 % Gross margin 36.6 % 37.3 % 36.0 % Gross margin decreased 70 basis points in Q1 FY24, from Q4 FY23. Material costs decreased 5.1% from the prior quarter, and, as a percentage of revenue, by 3 basis points. Labor cost decreased 2.7% from the prior quarter, but, as a percentage of revenue, increased by 27 basis points. Equipment and other overhead costs decreased 3.3% but increased 47 basis points as a percentage of revenue. Gross margin increased 60 basis points, in Q1 FY24, from Q1 FY23, primarily as a result of the increase in revenue from the prior year quarter and favorable product mix. Material costs increased 2.3% from the prior year quarter, but decreased as a percentage of revenue by 3 basis points. Labor and benefits costs increased 4.1% from the prior year quarter, and increased, as a percent of revenue, by 19 basis points as labor increased in both the U.S. and at several Asia-based facilities, reflecting labor market conditions. Equipment and other overhead costs remained flat but decreased 67 basis points as a percentage of revenue. Selling, General, and Administrative Expenses Selling, general, and administrative expenses were $18.3 million in Q1 FY24, compared with $16.7 million in Q4 FY23. The increase of $1.6 million was primarily the result of increased compensation and related expenses of $1.6 million. Selling, general, and administrative expenses increased $1.5 million in Q1 FY24, from $16.8 million in Q1 FY23, primarily as a result of increased compensation and related expenses of $1.4 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, were $3.4 million in Q1 FY24, $3.4 million in Q4 FY23, and $3.3 million in Q1 FY23. Non-operating Income (Expense) Q1 FY24 Q4 FY23 Q1 FY23 Foreign currency transactions impact, net $ (8.9 ) $ 13.2 $ (16.9 ) Interest expense, net (0.1 ) (0.1 ) (0.1 ) Interest income and other income (expense), net 5.3 5.6 2.6 Non-operating income (expense), net $ (3.7 ) $ 18.7 $ (14.4 ) Non-operating income (expense) decreased $22.4 million to $(3.7) million in Q1 FY24, compared with $18.7 million in Q4 FY23, primarily due to foreign currency transactions impact, net, driven by unfavorable movements of New Taiwan Dollar and the South Korean won against the U.S. dollar. Non-operating income (expense) increased $10.7 million from Q1 FY23 compared with $(14.4) million, primarily due to foreign currency transaction impact, net, driven by favorable movements of the South Korean won and RMB against the U.S. dollar. Interest income and other income (expense), net, of $5.3 million in Q1 FY24 remained flat compared with $5.6 million in Q4 FY23. Interest income and other income (expense), net, increased $2.7 million compared to Q1 FY23 driven by an increase in cash and cash equivalents, and higher interest rates. 27 Table of Contents Income Tax Provision Q1 FY24 Q4 FY23 Q1 FY23 Income tax provision $ 14.7 $ 20.3 $ 12.6 Effective income tax rate 27.3 % 24.3 % 30.3 % The effective income tax rate is sensitive to the jurisdictional mix of earnings, due in part to the non-recognition of tax benefits on losses in jurisdictions with valuation allowances where the tax benefits of the losses are not available. The effective income tax rate increase in Q1 FY24, compared with Q4 FY23, is primarily due to changes in the jurisdictional mix of earnings and an increase in foreign taxes in Q1 FY24. The effective income tax rate decrease in Q1 FY24, compared with Q1 FY23, is primarily due to changes in the jurisdictional mix of earnings. Net Income Attributable to Noncontrolling Interests Net income attributable to noncontrolling interests was $12.9 million in Q1 FY24, compared with $18.5 million in Q4 FY23, and $15.0 million in Q1 FY23. The decrease from Q4 FY23 and Q1 FY23, to Q1 FY24 resulted from decreased net income at our Taiwan-based IC joint venture. Liquidity and Capital Resources Cash and cash equivalents were $508.5 million and $499.3 million as of January 28, 2024, and October 31, 2023, respectively. As of the most recent balance sheet date, total cash and cash equivalents included $494.0 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 $485.0 million and $474.7 million as of January 28, 2024, and October 31, 2023, respectively. Our primary sources of liquidity are our cash on hand, cash we generate from operations, and borrowing capacity we have available from financial institutions. In China, we currently have approximately $25.0 million of borrowing capacity to support local operations. See Note 7 to the condensed consolidated financial statements for additional information on our outstanding debt and 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 arrangement, we plan to continue to invest in our business, with our investments targeted to align with our customers’ technology road maps. We may also elect to use our cash to reduce our debt through early repayments. In addition, we stand ready to invest in mergers, acquisitions, or strategic partnerships, should a suitable opportunity arise. We estimate capital expenditures for full year FY24 will be approximately $140 million; these investments will be targeted towards high-end and mainstream IC capacity and efficiency and enable us to support our customers’ near-term demands. As of January 28, 2024, we had outstanding capital commitments of approximately $142.2 million and recognized liabilities related to capital equipment purchases of approximately $13.9 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 $99.1 million of our total $156.1 million committed and recognized obligations for capital expenditures over the next twelve months. 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. The most recent 10b5-1 plan expired on September 15, 2022, and has not been renewed. As of January 28, 2024, our current share repurchase program had approximately $31.7 million remaining under its authorization. Depending on market conditions, we may utilize some or the entire remaining approved amount to reacquire additional shares. 28 Table of Contents As discussed in Note 6 to the condensed consolidated financial statements, DNP, the noncontrolling interest in our China-based joint venture has, under certain circumstances, the right to put its interest in the joint venture to Photronics, or to purchase our interest in the joint venture. Under all such circumstances, the sale of DNP’s interest would be at its ownership percentage of the joint venture’s net book value, with closing to take place within three business days of obtaining required approvals and clearance. As of the date of issuance of this report, DNP had not indicated its intention to exercise this right. As of January 28, 2024, Photronics and DNP each had net investments in this joint venture of approximately $ 127.4 million . Cash Flows Q1 FY24 Q1 FY23 Net cash provided by operating activities $ 41.5 $ 27.7 Net cash used in investing activities $ (42.2 ) $ (30.2 ) Net cash used in financing activities $ (2.9 ) $ (9.7 ) 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 impacts of cash from changes in operating assets and liabilities. Net cash provided by operating activities increased $13.8 million in Q1 FY24, compared with Q1 FY23. Free Cash Flow which is non-GAAP financial measure as discussed in the “Non-GAAP Financial Measures” section below, increased by $1.6 million, compared with Q1 FY23, primarily due to the increase in net cash provided by operating activities, partially offset by the increase in purchases of property, plant, and equipment. Investing Activities: Net cash flows used in investing activities primarily consisted of purchases of property, plant, and equipment of $43.3 million, which increased $12.2 million in Q1 FY24, compared with Q1 FY23. Financing Activities: Net cash used in financing activities decreased by $6.8 million in Q1 FY24, compared with Q1 FY23, primarily due to decreased debt repayments of $8.0 million. The increase in our cash balance from Q1 FY23 was favorably impacted by the effects of exchange rate changes in the amount of $13.0 million in Q1 FY24, which was less than the $27.5 million favorable impact of exchange rate changes had on our cash balance in Q1 FY23. Non-GAAP Financial Measures Non-GAAP Non-operating (loss) income, Non-GAAP Income tax provision, Non-GAAP Noncontrolling interests, Non-GAAP Net Income attributable to Photronics, Inc. shareholders and non-GAAP earnings per share, Free Cash Flow, and Net Cash are "non-GAAP financial measures" as such term is defined by the Securities and Exchange Commission and may differ from similarly named non-GAAP financial measures used by other companies. The financial tables below reconcile Photronics, Inc. financial results under GAAP to non-GAAP financial information. We believe these non-GAAP financial measures that exclude certain items are useful for analysts and investors to evaluate our future on-going performance because they enable a more meaningful comparison of our projected performance with our historical results. These non-GAAP metrics are not intended to represent funds available for our discretionary use and are not intended to represent, or be used as a substitute for, net income attributable to Photronics, Inc. shareholders, diluted earnings per share, cash and cash equivalents, or cash flows from operations, as measured under GAAP. The items excluded from these non-GAAP metrics but included in the calculation of their closest GAAP equivalent, are significant components of the condensed consolidated statements of income, condensed consolidated balance sheets and statement of cash flows and must be considered in performing a comprehensive assessment of overall financial performance. 29 Table of Contents The following table reconciles GAAP to Non-GAAP Income at the balance sheet dates. The columns may not foot due to rounding. Three Months ended January 28, October 31, January 29, 2024 2023 2023 Reconciliation of GAAP to Non-GAAP Non-operating (loss) Income: GAAP Non-operating (loss) income, net $ (3,747 ) $ 18,660 $ (14,425 ) FX (gain) loss 8,909 (13,234 ) 16,944 Non-GAAP Non-operating (loss) income, net $ 5,162 $ 5,426 $ 2,519 Reconciliation of GAAP to Non-GAAP Income tax provision: GAAP Income tax provision $ 14,660 $ 20,288 $ 12,582 Estimated tax effects of FX (gain) loss (2,244 ) 3,437 (4,506 ) Non-GAAP Income tax provision $ 16,904 $ 16,851 $ 17,088 Reconciliation of GAAP to Non-GAAP Noncontrolling interests: GAAP Noncontrolling interests $ 12,902 $ 18,545 $ 14,964 Estimated noncontrolling interest effects of above (2,939 ) 2,431 (2,060 ) Non-GAAP Noncontrolling interests $ 15,841 $ 16,114 $ 17,024 Reconciliation of GAAP to Non-GAAP Net Income: GAAP Net Income $ 26,180 $ 44,611 $ 13,986 FX (gain) loss 8,909 (13,234 ) 16,944 Estimated tax effects of above (2,244 ) 3,437 (4,506 ) Estimated noncontrolling interest effects of above (2,939 ) 2,431 (2,060 ) Non-GAAP Net Income $ 29,906 $ 37,245 $ 24,364 Weighted-average number of common shares outstanding – Diluted 62,283 62,067 61,470 Reconciliation of GAAP to Non-GAAP EPS: GAAP diluted earnings per share $ 0.42 $ 0.72 $ 0.23 Effects of the above adjustments $ 0.06 $ (0.12 ) $ 0.17 Non-GAAP diluted earnings per share $ 0.48 $ 0.60 $ 0.40 30 Table of Contents The following tables reconcile Net cash provided by operating activities to Free Cash Flow for Q1 FY24 and Q1 FY23. The columns may not foot due to rounding. Prior year amounts in the non-GAAP disclosure below have been recast to eliminate government incentives to conform to current year presentation. Q1 FY24 Q1 FY23 Free Cash Flow Net cash provided by operating activities $ 41.5 $ 27.7 Purchases of property, plant, and equipment (43.3 ) (31.1 ) Free cash flow $ (1.8 ) $ (3.4 ) 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 proceeds from maturities of available-for-sale debt securities, decreased debt repayments and increase in Net cash provided by operating activities, as discussed above. The columns may not foot due to rounding. Prior year amounts in the non-GAAP disclosure below have been recast to eliminate government incentives to conform to current year presentation. As of January 28, October 31, January 29, 2024 2023 2023 Net Cash Cash and cash equivalents $ 508.5 $ 499.3 $ 334.8 Current portion of Long-term debt (20.8 ) (6.6 ) (6.6 ) Long-term debt (2.7 ) (18.0 ) (27.3 ) Net cash $ 485.0 $ 474.7 $ 300.9 Business Outlook Our current business outlook and guidance was provided in the Photronics Q1 FY24 earnings release, earnings presentation, and financial results conference call, but is not incorporated herein. 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 the Photronics Q1 FY24 earnings release, and the related financial results conference call and earnings presentation involve a number of risks and uncertainties, some of which were discussed in Part I, Item 1A of our 2023 Form 10-K. A number of other unforeseeable factors could cause actual results to differ materially from our expectations. Critical Accounting Estimates Please refer to Part II, Item 7 of our 2023 Form 10-K for discussion of our critical accounting estimates. There have been no changes to our critical accounting estimates since the filing of our Form 10-K for the year ended October 31, 2023.