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TMCNet:  PHOTRONICS INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

[January 03, 2014]

PHOTRONICS INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) Results of Operations for the Years Ended November 3, 2013, October 28, 2012 and October 30, 2011 Overview The Company sells substantially all of its 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. Thus, the Company's selling cycle is tightly interwoven with the development and release of new semiconductor designs and flat panel applications, particularly as it relates to the semiconductor industry's migration to more advanced design methodologies and fabrication processes. The Company believes that the demand for photomasks primarily depends on design activity rather than sales volumes from products manufactured using photomask technologies. Consequently, an increase in semiconductor or FPD 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 FPD designs could reduce demand for photomasks even if demand for semiconductors and FPDs increases.


Advances in semiconductor, FPD and photomask design and semiconductor and FPD production methods could also reduce the demand for photomasks. Historically, the semiconductor industry has been volatile, with sharp periodic downturns and slowdowns. These downturns have been characterized by, among other things, diminished product demand, excess production capacity and accelerated erosion of selling prices.

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

The Company is focused on improving its competitiveness by advancing its technology and reducing costs and, in connection therewith, has invested in manufacturing equipment to serve the high-end market. As the Company continues to face challenges in the current and near term that require it to continue to make significant improvements in its competitiveness, it continues to evaluate further cost reduction initiatives.

As of December 2013 state-of-the-art production for semiconductor masks is considered to be 45 nanometer and lower for ICs and Generation 8 and above and AMOLED display based process technologies for FPDs. However, 65 nanometer and above geometries for semiconductors and Generation 7 and below, excluding AMOLED, process technologies for FPDs constitute the majority of designs currently being fabricated in volume. At these geometries, the Company can produce full lines of photomasks and there is no significant technology employed by the Company's competitors that is not available to the Company. The Company expects 45 nanometer and below designs to continue to move to wafer fabrication throughout fiscal 2014, and believes it is well positioned to service an increasing volume of this business as a result of its investments in manufacturing processes and technology in the global regions where its 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, the Company will be required to continually anticipate, respond to, and utilize changing technologies. In particular, the Company believes that, as semiconductor geometries continue to become smaller, it 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 semiconductor and 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. 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 2013, one alternative method, direct-write lithography, has not been proven to be a commercially viable alternative to photomasks, as it is considered too slow for high volume semiconductor wafer production, and the Company has not experienced a significant loss of revenue as a result of this or other alternative semiconductor design methodologies. However, should direct-write or any other alternative method of transferring IC designs to semiconductor wafers without the use of photomasks achieve market acceptance, and the Company does not anticipate, respond to, or utilize these or other changing technologies due to resource, technological or other constraints, its business and results of operations could be materially adversely affected.

Both 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"). The Company's capital expenditure payments aggregated approximately $243 million for the three fiscal years ended November 3, 2013, which has significantly contributed to the Company's operating expenses. The Company intends to continue to make the required investments to support the technological demands of its customers and position itself for future growth, and expects capital expenditure payments to be between $70 million and $90 million in fiscal 2014.

The manufacture of photomasks for use in fabricating ICs and other related products built using comparable photomask-based process technologies has been, and continues to be, capital intensive. The Company's integrated global manufacturing network, which consists of eight manufacturing sites, and its employees represent a significant portion of its fixed operating cost base.

Should sales volumes decrease as a result of a decrease in design releases from the Company's customers, the Company may have excess or underutilized production capacity that could significantly impact operating margins, or result in write-offs from asset impairments.

18 -------------------------------------------------------------------------------- In the first quarter of fiscal 2014 the Company entered an agreement to merge PSMC with DNP Photomask Technology Taiwan Co., Ltd., a wholly owned subsidiary of Dai Nippon Printing Co., Ltd. (DNP), to form a joint venture which will operate under the name of Photronics DNP Mask Corporation (PDMC). The pending merger, which is a noncash transaction, will result in the Company owning 50.01% and DNP owning 49.99% of PDMC, whose financial results will be included in the Company's consolidated financial statements. PDMC is expected to generate sufficient cash flows to fund its operating and capital requirements. The merger is subject to regulatory approvals and customary closing conditions, and is expected to be finalized during the first half of fiscal 2014.

In the first quarter of fiscal 2014 the Company amended its credit facility to a five year $50 million credit facility (the "new credit facility") with an expansion capacity to $75 million, and simultaneously repaid its $21.3 million term loan. The new credit facility, which replaced the credit facility in effect at November 3, 2013, bears interest based on the Company's total leverage ratio, at LIBOR plus a spread, as defined in the new credit facility.

In the fourth quarter of fiscal 2013 a $26.4 million principal amount, five year capital lease to fund the purchase of a high-end lithography tool commenced.

Payments under the lease, which bears interest at 2.77% are $0.5 million per month through July 2018. Under the terms of the lease agreement, the Company must maintain the equipment in good working order, and is subject to a cross default with a cross acceleration provision related to certain nonfinancial covenants incorporated in its credit facility. As of November 3, 2013, the total amount payable through the end of the lease term was $26.8 million, of which $25.1 million represented principal and $1.7 million represented interest.

In the third quarter of fiscal 2013 the Company completed a tender offer for shares of PSMC. A total of 50.3 million shares were tendered at the offering price of 16.30 NTD (equivalent to a total of $27.4 million), which increased the Company's ownership interest in PSMC from 75.11% to 98.13%. In the fourth quarter of fiscal 2013 the Company further increased its ownership interest in PSMC to 98.63% with the purchase of an additional 1.1 million shares of PSMC for $0.7 million.

In the first quarter of fiscal 2013 PSMC completed a stock repurchase plan that had been authorized by its board of directors in fiscal 2012. The completion of this repurchase plan resulted in the Company acquiring an additional 9.2 million shares at a cost $4.2 million, and increasing its ownership percentage in PSMC from 72.09% at October 28, 2012 to 75.11% as of January 27, 2013.

In the second quarter of fiscal 2012 the Company paid $35 million to Micron in connection with its purchase of the U.S. nanoFab facility, which it had been leasing from Micron under an operating lease that was to end in December 2014.

The purchase of the facility resulted in the Company's outstanding operating lease commitments being reduced by a total of $15 million for fiscal years 2013 and 2014.

In the second quarter of fiscal 2012 the Company, in connection with its purchase of the U.S. nanoFab facility, amended its credit facility ("the credit facility") to include the addition of a $25 million term loan maturing in March 2017 with minimum quarterly principal payments of $0.6 million (quarterly payments commenced in June 2012 and were based on a ten year repayment period).

The Company repaid the $21.3 million balance of this term loan that was outstanding at November 3, 2013, in the first quarter of fiscal 2014. The credit facility bore interest (2.69% at November 3, 2013), based on the Company's total leverage ratio, at LIBOR plus a spread, as defined in the credit facility.

In the first quarter of fiscal 2012 the Company ceased the manufacture of photomasks at its Singapore facility. This action, which was substantially completed in fiscal 2012, resulted in the Company recording restructuring charges of $1.4 million in fiscal 2012.

In 2012 the board of directors of PSMC authorized PSMC to repurchase additional shares of its outstanding common stock for retirement. These repurchase programs resulted in 35.9 million shares being purchased for $15.6 million in the fiscal year ended October 28, 2012. PSMC's repurchase of these shares increased the Company's ownership percentage in PSMC from 62.25% at October 30, 2011 to 72.09% as of October 28, 2012.

In 2011 the board of directors of PSMC authorized PSMC to repurchase shares of its outstanding common stock for retirement. These repurchase programs resulted in 21.6 million shares being purchased for $9.9 million. PSMC's repurchase of these shares increased the Company's ownership percentage in PSMC from 57.53% at October 31, 2010 to 62.25% as of October 30, 2011.

19 -------------------------------------------------------------------------------- In the second quarter of fiscal 2011 the Company issued, through a private offering pursuant to Rule 144A under the Securities Act of 1933, as amended, $115 million aggregate principal amount of 3.25% convertible senior notes. The notes mature on April 1, 2016, and note holders may convert each $1,000 principal amount of notes to 96.3879 shares of common stock (equivalent to an initial conversion price of $10.37 per share of common stock) at any time prior to the close of business on the second scheduled trading day immediately preceding April 1, 2016. The conversion rate is subject to adjustment upon the occurrence of certain events, which are described in the indenture dated March 28, 2011. The Company is not required to redeem the notes prior to their maturity date. Interest on the notes accrues in arrears, and is paid semiannually through the notes' maturity date. Interest payments on the notes commenced on October 1, 2011. The net proceeds of the notes were approximately $110.7 million, which were used, in part, to repurchase $35.4 million of the Company's 5.5% convertible senior notes, which were to mature in October 2014, and to pay, in full, its then outstanding obligations under capital leases of $19.8 million.

In the second and third quarters of fiscal 2011 the Company, in two separate transactions, acquired $35.4 million of its 5.5% convertible senior notes in exchange for 5.2 million shares of its common stock, with a fair value of $45.7 million, and cash of $22.9 million (the note holders received 147.529 shares and cash of $647 for each $1,000 note). The Company, in connection with these transactions, recorded extinguishment losses of $35.1 million, which included the write-off of deferred financing fees of $2.0 million. The losses are included in other income (expense) in the Company's consolidated statements of income. As discussed above, in the first quarter of fiscal 2014 the Company entered into an amended five year $50 million credit facility. The Company intends to repay its remaining 5.5% convertible senior notes with borrowings against the amended credit facility and, therefore, has classified as long-term the entire $22.1 million of those notes that was outstanding as of November 3, 2013.

Results of Operations The following table presents selected operating information expressed as a percentage of net sales: Year Ended November 3, October 28, October 30, 2013 2012 2011 Net sales 100.0 % 100.0 % 100.0 % Cost of sales (76.4 ) (75.1 ) (73.4 ) Gross margin 23.6 24.9 26.6 Selling, general and administrative (11.4 ) (10.4 ) (8.9 ) expenses Research and development expenses (4.9 ) (4.3 ) (3.0 ) Consolidation, restructuring and related - (0.3 ) - charges Operating income 7.3 9.9 14.7 Interest expense (1.9 ) (1.7 ) (1.4 ) Interest and other income (expense), net 0.9 0.8 0.6 Debt extinguishment loss - - (6.9 ) Income before income tax provision 6.3 9.0 7.0 Income tax provision (1.7 ) (2.4 ) (3.1 ) Net income 4.6 6.6 3.9 Net income attributable to noncontrolling (0.3 ) (0.4 ) (0.8 ) interests Net income attributable to Photronics, Inc. 4.3 % 6.2 % 3.1 % shareholders Note: All the following tabular comparisons, unless otherwise indicated, are for the fiscal years ended November 3, 2013 (2013), October 28, 2012 (2012) and October 30, 2011 (2011), in millions of dollars.

20 -------------------------------------------------------------------------------- Net Sales Percent Change 2012 to 2011 to 2013 2012 2011 2013 2012 IC $ 320.6 $ 350.1 $ 391.2 (8.4 )% (10.5 )% FPD 101.6 100.3 120.8 1.3 (17.0 ) Total net sales $ 422.2 $ 450.4 $ 512.0 (6.3 )% (12.0 )% Net sales for 2013 decreased 6.3% to $422.2 million as compared to $450.4 million for 2012, primarily related to reduced high-end IC sales of $30 million as compared to the prior year. The reduced high-end IC revenue was primarily attributable to an Asian foundry customer for which the Company was not qualified as a result of a node migration, and to a lesser extent, reduced average selling prices (ASPs). Total IC sales decreased by $29.5 million or 8.4% in 2013 as compared to 2012, primarily due to reduced high-end IC sales discussed previously, and mainstream IC sales were essentially flat. Total FPD sales increased by $1.3 million or 1.3% in 2013 as compared to 2012, primarily due to increased high-end FPD sales, which was partially offset by a $4 million decrease in mainstream FPD sales. Total revenues attributable to high-end products decreased by $24 million to $149 million in 2013, as high-end revenues for IC decreased by $30 million to $80 million, which were partially offset by a $6 million increase in high-end FPD revenues to $69 million. High-end photomask applications, which typically have higher ASPs, include photomask sets for IC products using 45 nanometer and below technologies, and for FPD products using Generation 8 and above and AMOLED technologies. By geographic area, net sales in 2013 as compared to 2012 decreased by $26.9 million or 16.7% in Korea, decreased by $8.1 million or 6.0% in the United States, increased by $8.1 million or 7.4% in Taiwan, increased by $0.5 million or 1.2% in Europe and decreased by $1.8 million at other international locations. As a percent of total sales in 2013, sales were 32% in Korea, 30% in the United States, 28% in Taiwan, 9% in Europe, and 1% at other international locations.

Net sales for 2012 decreased 12.0% to $450.4 million as compared to $512.0 million for 2011, primarily due to reduced photomask demand as a result of a general slowdown in the semiconductor industry, although high-end IC unit demand and revenues increased. Revenues attributable to high-end products increased by $12 million to $173 million, as high-end revenues for IC increased by $15 million to $110 million, which were partially offset by a $3 million reduction in high-end FPD revenues to $63 million. Mainstream IC and FPD revenues decreased in 2012 as compared to 2011 as a result of decreases in both unit demand and ASPs. By geographic area, net sales in 2012 as compared to 2011 decreased by $22.8 million or 14.5% in the United States, by $12.8 million or 10.5% in Taiwan, by $10.2 million or 5.9% in Korea, by 9.8 million in Singapore or 69.8% (the Company ceased the manufacture of photomasks at its Singapore facility in the first quarter of fiscal 2012) and by $6.0 million or 12.8% in Europe. As a percent of total sales in 2012 sales were 36% in Korea, 30% in the United States, 24% in Taiwan, 9% in Europe and 1% at other international locations.

Gross Margin Percent Change 2012 to 2011 to 2013 2012 2011 2013 2012 Gross margin $ 99.6 $ 111.9 $ 136.2 (11.0 )% (17.8 )% Gross margin % 23.6 % 24.9 % 26.6 % - - 21 -------------------------------------------------------------------------------- Gross margin percentage decreased to 23.6% in 2013 from 24.9% in 2012, primarily due to a decrease in sales in 2013 as compared to 2012. The Company operates in a high fixed cost environment and, to the extent that the Company's revenues and utilization increase or decrease, gross margin will generally be positively or negatively impacted. Gross margin percentage decreased to 24.9% in 2012 from 26.6% in 2011. This decrease was also primarily due to a decrease in sales in 2012 as compared to 2011.

Selling, General and Administrative Expenses Percent Change 2012 to 2011 to 2013 2012 2011 2013 2012 S,G&A expenses $ 48.2 $ 46.7 $ 45.2 3.2 % 3.2 % % of net sales 11.4 % 10.4 % 8.9 % - - Selling, general and administrative expenses increased by $1.5 million to $48.2 million in 2013, as compared to 2012, primarily as a result of transaction expenses of $0.8 million related to a pending joint venture, and to a lesser extent, increased selling-related expenses. Selling, general and administrative expenses increased by $1.5 million to $46.7 million in 2012 as compared to 2011 primarily as a result of increased employee compensation and selling-related expenses.

Research and Development Percent Change 2012 to 2011 to 2013 2012 2011 2013 2012 R&D expense $ 20.8 $ 19.4 $ 15.5 7.2 % 24.9 % % of net sales 4.9 % 4.3 % 3.0 % - - Research and development expenses consist primarily of global development efforts related to high-end process technologies for advanced sub-wavelength reticle solutions for IC technologies. Research and development expenses increased by $1.4 million to $20.8 million in 2013 as compared to 2012, and increased by $3.9 million to $19.4 million in 2012 as compared to 2011, primarily due to increased activities at advanced nanometer technology nodes for IC photomask applications.

Consolidation, Restructuring and Related Charges Consolidation, restructuring and related charges of $1.4 million in 2012 primarily relate to the Company ceasing the manufacture of photomasks at its Singapore facility, and were primarily comprised of employee terminations and other costs of $1.1 million and asset write-downs of $0.3 million.

The Company continues to assess its global manufacturing strategy. This ongoing assessment could result in future facility closures, asset redeployments, workforce reductions, and the addition of increased manufacturing facilities, all of which would be predicated on market conditions and customer requirements.

22 -------------------------------------------------------------------------------- Other Income (Expense) 2013 2012 2011 Interest expense $ (7.8 ) $ (7.5 ) $ (7.2 )Interest and other income (expense), net 3.9 3.7 2.9 Debt extinguishment loss - - (35.3 ) Total other income (expense), net $ (3.9 ) $ (3.8 ) $ (39.6 ) Interest expense increased slightly in 2013 as compared to 2012, primarily as a result of an additional capital lease commencing in 2013 related to the purchase of high-end equipment. Interest and other income (expense), net increased in 2013 as compared to 2012, primarily as a result of increased foreign currency exchange gains.

Interest expense increased slightly in 2012 as compared to 2011, primarily as a result of the term loan entered into in the second quarter of 2012. Interest and other income (expense), net increased in 2012 as compared to 2011, primarily as a result of increased interest income on the Company's higher cash balances in 2012.

In the second and third quarters of fiscal 2011, the Company acquired $35.4 million aggregate principal amount of its 5.5% convertible senior notes by delivering $22.9 million in cash and 5.2 million shares of its common stock, with a fair value of $45.7 million. In connection with these 2011 acquisitions the Company recorded total debt extinguishment losses of $35.1 million, which included the write-off of $2.0 million of deferred financing fees. A portion of the net proceeds of the Company's March 28, 2011, 3.25% convertible senior notes offering was used to repurchase these notes.

Income Tax Provision 2013 2012 2011 Income tax provision $ 7.2 $ 10.8 $ 15.7 Effective income tax rate 27.0 % 26.6 % 43.7 % The effective tax rate differs from the U.S. statutory rate of 35% in fiscal years 2013 and 2012 primarily due to a higher level of earnings being taxed at lower statutory rates in foreign jurisdictions, combined with the benefit of various investment credits in the foreign jurisdictions.

The effective tax rate differs from the U.S. statutory rate of 35% in fiscal year 2011 primarily due to the impact of the non-deductible debt extinguishment losses and the impact of a foreign subsidiary tax settlement, offset by a higher level of earnings taxed at lower statutory rates in foreign jurisdictions.

Further, in Korea and in Taiwan, various investment tax credits have been earned, which also reduced the Company's effective income tax rate in 2011.

The Company considers all available evidence when evaluating the potential future realization of its deferred tax assets and, when based on the weight of all available evidence, it determines that it is more likely than not that some portion or all of its deferred tax assets will not be realized, reduces its deferred tax assets by a valuation allowance. As a result of these considerations, the valuation allowance was increased (decreased) by $1.1 million, $2.5 million and $(8.2) million in 2013, 2012 and 2011, respectively.

The Company also regularly assesses the potential outcomes of ongoing and future tax examinations and, accordingly, has recorded accruals for such contingencies.

PKLT, the Company's FPD manufacturing facility in Taiwan, has been accorded a tax holiday which commenced in 2012 and expires in 2017. In addition, the Company was accorded a tax holiday in China which expired in 2011. The availability of these tax holidays did not have a significant impact on the Company's decision to increase its Asian presence, which was in response to fundamental changes that took place in the semiconductor industry that the Company serves. These tax holidays had no dollar or per share effect on the 2013, 2012 or 2011 fiscal years.

23 -------------------------------------------------------------------------------- Net Income Attributable to Noncontrolling Interests Net income attributable to noncontrolling interests decreased to $1.6 million in 2013 as compared to $2.0 million in 2012, primarily as a result of the effect of shares of PSMC purchased under the tender offer and share repurchase programs discussed in Note 15 to the consolidated financial statements. Net income attributable to noncontrolling interests decreased to $2.0 million in 2012 as compared to $4.0 million in 2011, primarily as a result of decreased net income at PSMC, the Company's non-wholly owned subsidiary in Taiwan, and to a lesser extent, due to PSMC's share repurchase program (discussed below).

In June 2013 the Company completed the tender offer for the outstanding shares of PSMC that commenced in April 2013. A total of 50.3 million shares were tendered at the offering price of 16.30 NTD, equivalent to a total of $27.4 million. This increased the Company's ownership interest in PSMC to 98.13%. In September 2013 the Company purchased an additional 1.1 million shares for $0.7 million which further increased its ownership interest in PSMC to 98.63% as of November 3, 2013.

PSMC, through a series of repurchase programs which commenced in 2011 and ended in 2013, repurchased shares of its outstanding common stock. These repurchase programs resulted in 9.2 million shares being purchased for $4.2 million in 2013, 35.9 million shares being purchased for $15.6 million in 2012 and 21.6 million shares being purchased for $9.9 million in 2011. PSMC's repurchase of these shares increased the Company's ownership percentage in PSMC from 57.53% at October 31, 2010, to 62.25% as of October 30, 2011, to 72.09% as of October 28, 2012, and to 75.11% as of January 27, 2013.

Liquidity and Capital Resources November 3, October 28, October 30, 2013 2012 2011 (in millions) (in millions) (in millions) Cash and cash equivalents $ 215.6 $ 218.0 $ 189.9 Net cash provided by operating activities $ 99.4 $ 132.5 $ 136.6 Net cash used in investing activities $ (66.2 ) $ (111.9 ) $ (100.7 ) Net cash provided by (used in) financing $ (39.8 ) $ 4.6 $ 54.5 activities As of November 3, 2013, the Company had cash and cash equivalents of $215.6 million compared to $218.0 million as of October 28, 2012. The Company's working capital decreased $20.4 million to $213.9 million at November 3, 2013, as compared to $234.3 million at October 28, 2012. The decrease in working capital was primarily the result of the purchase of PSMC shares and increased payables for capital expenditures. The Company may use its cash available on hand for operations, capital expenditures, debt repayments, strategic opportunities, stock repurchases or other corporate uses, any of which may be material.

As of October 28, 2012, the Company had cash and cash equivalents of $218.0 million compared to $189.9 million as of October 30, 2011. The Company's working capital increased $25.0 million to $234.3 million at October 28, 2012, as compared to $209.3 million at October 30, 2011. The increase in working capital was primarily the result of cash generated from operations.

As of November 3, 2013 and October 28, 2012, the Company's total cash and cash equivalents include $165.7 million and $158.2 million, respectively, held by its foreign subsidiaries. The majority of earnings of the Company's foreign subsidiaries are considered to be indefinitely reinvested. The Company's foreign subsidiaries continue to grow through the reinvestment of earnings in additional manufacturing capacity and capability, particularly in the high-end IC and FPD areas. Repatriation of these funds to the U.S. may subject these funds to U.S.

federal income taxes and local country withholding tax in certain jurisdictions.

24 -------------------------------------------------------------------------------- Net cash provided by operating activities decreased to $99.4 million in fiscal 2013, as compared to $132.5 million in fiscal 2012, primarily due to reduced year-over-year net income and depreciation and amortization, and less cash generated from accounts receivable in 2013 than in 2012. Net cash provided by operating activities was $132.5 million in fiscal 2012, as compared to $136.6 million in fiscal 2011. The decrease was the result of less favorable, when adjusted for a significant non-cash debt extinguishment loss charge, year-over-year operating results, which was partially offset by more cash generated through reduced accounts receivable and inventory balances. Net cash provided by operating activities was $136.6 million in fiscal 2011 as compared to $95.9 million in fiscal 2010. The increase was the effect of improved year-over-year operating results (excluding the effect of the non-cash debt portion of the extinguishment loss) as a result of increased sales.

Net cash used in investing activities in fiscal 2013 decreased to $66.2 million, as compared to $111.9 million in 2012, primarily due to less capital expenditure payments in 2013, and also due to no additional investments being made in the MP Mask joint venture in 2013, whereas $13.4 million was invested in 2012. Net cash used in investing activities increased to $111.9 million in fiscal 2012, as compared to $100.7 million in fiscal 2011, due to increased purchases of property, plant and equipment, which were partially offset by a decrease in the amount of the Company's year-over-year investment in the MP Mask joint venture.

The investments in the joint venture were primarily the result of capital calls made by the joint venture. Net cash used in investing activities in fiscal 2011 increased to $100.7 million, as compared to $58.2 million in 2010, primarily due to increases in the Company's investment in MP Mask as a result of capital calls and net proceeds from the sale of the Company's former manufacturing facility in Shanghai, China, which reduced total net proceeds used in investing activities in fiscal 2010, and increased capital expenditures in 2011. Capital expenditure payments for the 2013, 2012, and 2011 fiscal years were $63.8 million, $97.0 million and $82.1 million, respectively. The Company expects capital expenditure payments for fiscal 2014 to range between $70 million and $90 million, primarily related to investment in high-end IC manufacturing capability.

Net cash used in financing activities was $39.8 million in fiscal 2013 as compared to $4.6 million provided by financing activities in fiscal 2012, and was primarily comprised of payments to acquire additional shares of PSMC and repayments of long-term borrowings. Net cash provided by financing activities was $4.6 million in fiscal 2012, as compared to $54.5 million provided by financing activities in fiscal 2011 and, in 2012, was primarily comprised of the proceeds of a $25 million term loan, that was entered into by the Company in connection with its purchase of the US nanoFab facility, which was partially offset by payments for the repurchase of common stock of PSMC from noncontrolling interests and repayments on long-term borrowings. Net cash provided by financing activities was $54.5 million in fiscal 2011 as compared to $32.4 million used in financing activities in fiscal 2010, and was primarily comprised of the net proceeds received from the March 2011 issuance of 3.25% convertible senior notes, partially offset by the repayment of certain other higher interest rate long-term borrowings.

In November 2013 the Company entered into an agreement to merge PSMC with DNP Photomask Technology Taiwan Co., Ltd., a wholly owned subsidiary of Dai Nippon Printing Co., Ltd. (DNP), to form a joint venture which will operate under the name of Photronics DNP Mask Corporation (PDMC). The pending merger, which is a noncash transaction, will result in the Company owning 50.01% and DNP owning 49.99% of PDMC, whose financial results will be included in the Company's consolidated financial statements. PDMC is expected to generate sufficient cash flows to fund its operating and capital requirements. The merger is subject to regulatory approvals and customary closing conditions, and is expected to be finalized during the first half of fiscal 2014.

In December 2013 the Company amended its credit facility to a five year $50 million credit facility (the "new credit facility") with an expansion capacity of $75 million. The new credit facility, which replaces the credit facility in effect at November 3, 2013, bears interest based on the Company's total leverage ratio, at LIBOR plus a spread, as defined in the credit facility.

Simultaneously, the Company repaid its $21.3 million term loan.

In March 2011 the Company issued $115 million aggregate principal amount of 3.25% convertible senior notes. The Company realized net proceeds of $110.7 million from the issuance of the notes, which mature on April 1, 2016, and commenced paying interest semiannually on October 1, 2011. During the three month period ended May 1, 2011, the Company used $19.7 million of the net proceeds of the 3.25% convertible senior notes and issued common stock to repurchase approximately $30.4 million principal amount of its 5.5% convertible senior notes, and used an additional $19.8 million of the net proceeds to repay its outstanding obligations under capital leases. In June 2011 the Company acquired an additional $5.0 million principal amount of its outstanding 5.5% convertible senior notes for $3.2 million and common stock. The Company may use a portion of the remaining net proceeds of its 3.25% convertible senior notes to repurchase additional amounts of its outstanding 5.5% senior convertible notes and for capital expenditure and working capital purposes.

25 -------------------------------------------------------------------------------- In March 2011 the Company and its lenders amended its revolving credit facility. Under the terms of the amended credit facility, the total amount available to the Company to borrow was reduced from $65 million to $30 million.

The credit facility bore interest (2.69% at November 3, 2013), based on the Company's total leverage ratio, at LIBOR plus a spread, as defined in the agreement. The credit facility was secured by substantially all of the Company's assets located in the United States, as well as common stock the Company owns in certain of its foreign subsidiaries, and was subject to financial covenants, including the following, as defined in the agreement: minimum fixed charge ratio, total leverage ratio and minimum unrestricted cash balance. As of November 3, 2013, the Company was in compliance with the covenants of its credit facility, had no outstanding borrowings under the credit facility and $30 million was available for borrowing. As discussed above this credit facility was replaced with a new credit facility in December 2013.

In June 2013 the Company completed a tender offer for shares of PSMC. A total of 50.3 million shares were tendered at the offering price of 16.30 NTD, equivalent to a total of $27.4 million.

PSMC, through a series of repurchase programs which commenced in 2011 and ended in 2013, repurchased shares of its outstanding common stock. These repurchase programs resulted in 9.2 million shares being purchased for $4.2 million in 2013, 35.9 million shares being purchased for $15.6 million in 2012 and 21.6 million shares being purchased for $9.9 million in 2011.

In August 2013 a $26.4 million principal amount, five year capital lease to fund the purchase of a high-end lithography tool commenced. Payments under the lease, which bears interest at 2.77% are $0.5 million per month through July 2018. Under the terms of the lease agreement, the Company must maintain the equipment in good working order, and is subject to a cross default with a cross acceleration provision related to certain nonfinancial covenants incorporated in its credit facility. As of November 3, 2013, the total amount payable through the end of the lease term was $26.8 million, of which $25.1 million represented principal and $1.7 million represented interest.

In April 2011 the Company entered into a five year, $21.2 million capital lease of manufacturing equipment. Payments under the lease, which bears interest at 3.09%, are $0.4 million per month through March 2016. As of November 3, 2013, the total lease amount payable through the end of the lease term was $11.1 million, of which $10.7 million represented principal and $0.4 million represented interest.

In February 2012 the Company paid $35 million to Micron in connection with the purchase of the U.S. nanoFab facility. In connection therewith, the Company amended its credit facility to include the addition of a $25 million term loan maturing in March 2017, with minimum quarterly principal payments of $0.6 million. In the first quarter of fiscal 2014 the Company repaid the $21.3 million balance of this term loan that was outstanding at November 3, 2013. As a result of the purchase of the U.S. nanoFab facility, the Company's lease agreement with Micron for the U.S. nanoFab facility was cancelled, which reduced the Company's related outstanding operating lease commitments by a combined total of $15 million for fiscal years 2013 and 2014.

The Company's liquidity is highly dependent on its sales volume, cash conversion cycle, and the timing of its capital expenditures (which can vary significantly from period to period), as it operates in a high fixed cost environment.

Depending on conditions in the semiconductor and FPD markets, the Company's cash flows from operations and current holdings of cash may not be adequate to meet its current and long-term needs for capital expenditures, operations and debt repayments. Historically, in certain years, the Company has used external financing to fund these needs. Due to conditions in the credit markets, some financing instruments used by the Company in the past may not be currently available to it. The Company continues to evaluate further cost reduction initiatives. However, the Company cannot assure that additional sources of financing would be available to it on commercially favorable terms, should its cash requirements exceed cash available from operations, existing cash, and cash available under its credit facility.

At November 3, 2013, the Company had outstanding purchase commitments of $48 million, which included $42 million related to capital expenditures, primarily for investment in high-end IC photomask manufacturing capability. The Company intends to finance its capital expenditures with its working capital, cash generated from operations, and, if necessary, with additional borrowings.

26 -------------------------------------------------------------------------------- Cash Requirements The Company's cash requirements in fiscal 2014 will be primarily to fund its operations, including capital spending, and to service its debt. The Company believes that its cash on hand, cash generated from operations and amounts available under its credit facility will be sufficient to meet its cash requirements for the next twelve months. The Company regularly reviews the availability and terms on which it might issue additional equity or debt securities in the public or private markets. However, the Company cannot assure that additional sources of financing would be available to the Company on commercially favorable terms, should the Company's cash requirements exceed its cash available from operations, existing cash, and cash available under its credit facility.

Contractual Obligations The following table presents the Company's contractual obligations as of November 3, 2013: Payment due by period Less More Than 1 - 3 3 - 5 Than Contractual Obligations Total 1 Year Years Years 5 Years Long-term borrowings $ 158,304 $ 2,500 $ 142,054 $ 13,750 $ - Operating leases 8,180 2,152 3,592 1,715 721 Capital leases 35,717 9,318 16,779 9,620 - Unconditional purchase 47,544 44,421 3,123 - - obligations Interest 14,309 6,439 7,483 387 - Other noncurrent 8,634 - 180 - 8,454 liabilities Total $ 272,688 $ 64,830 $ 173,211 $ 25,472 $ 9,175 In December 2013 the Company amended its credit facility, which increased its limit to $50 million and extended its term to December 2018. The Company intends to repay the remaining outstanding 5.5% convertible senior notes issued in September 2009 with borrowings against this new credit facility and, therefore, has classified as long-term the entire $22.1 million of those notes that were outstanding as of November 3, 2013.

As of November 3, 2013, the Company had recorded accruals for uncertain tax positions of $1.7 million which was 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 Under the MP Mask joint venture operating agreement, in order to maintain its 49.99% ownership interest, the Company may be required to make additional capital contributions to the joint venture up to the maximum amount defined in the operating agreement. Cumulatively, through November 3, 2013, the Company has contributed $32.5 million to the joint venture, and has received distributions from the joint venture totaling $10.0 million. The Company did not make any contributions and received no distributions from MP Mask during fiscal 2013.

Under the PDMC joint venture operating agreement the shareholders of PDMC may be requested to make additional contributions to the pending joint venture. In the event that PDMC requests additional capital from its shareholders, the Company may be required to make additional capital contributions to the joint venture in order to maintain its 50.01% ownership. The joint venture operating agreement limits the amount of contributions that may be requested during both the first four years of the joint venture and during any individual year within those first four years.

27 -------------------------------------------------------------------------------- The Company leases certain office facilities and equipment under operating leases that may require it to pay taxes, insurance and maintenance expenses related to the properties. Certain of these leases contain renewal or purchase options exercisable at the end of the lease terms. See Note 9 to the consolidated financial statements for additional information on these operating leases.

Business Outlook A majority of the Company's revenue growth is expected to continue to come from the Asian region as customers increase their use of manufacturing foundries located outside of North America and Europe. Additional revenue growth is also anticipated in North America, as the Company expects to continue to benefit from advanced technology it may utilize under its technology license with Micron.

The Company continues to assess its global manufacturing strategy and monitor its market capitalization, sales volume and related cash flows from operations.

This ongoing assessment could result in future facility closures, asset redeployments, additional impairments of intangible or long-lived assets, workforce reductions, or the addition of increased manufacturing facilities, all of which would be based on market conditions and customer requirements.

The Company's future results of operations and the other forward-looking statements contained in this filing involve a number of risks and uncertainties.

While various risks and uncertainties have been discussed, a number of other unforeseen factors could cause actual results to differ materially from the Company's expectations.

Critical Accounting Estimates The Company's consolidated financial statements are based on the selection and application of accounting policies, which require management to make significant estimates and assumptions. The Company believes that the following are some of the more critical judgment areas in the application of the Company's accounting policies that affect its financial condition and results of operations.

Estimates and Assumptions The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect amounts reported in them. Management bases its estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances.

The Company's estimates are based on the facts and circumstances available at the time they are made. Changes in accounting estimates used are likely to occur from period to period, which may have a material impact on the presentation of the Company's financial condition and results of operations. Actual results reported by the Company may differ from such estimates. The Company reviews these estimates periodically and reflects the effect of revisions in the period in which they are determined.

Fair Value of Financial Instruments The fair values of the Company's 3.25% and 5.5% convertible senior notes are estimated by management based upon reference to quoted market prices and other available market information. The fair values of the Company's cash and cash equivalents, accounts receivable, accounts payable, certain other current assets and current liabilities, and variable rate borrowings approximate their carrying value due to their short-term maturities.

Property, Plant and Equipment Property, plant and equipment, except as explained below under "Impairment of Long-Lived Assets," are stated at cost less accumulated depreciation and amortization. Repairs and maintenance, as well as renewals and replacements of a routine nature, are charged to operations as incurred, while those that improve or extend the lives of existing assets are capitalized. Upon sale or other disposition, the cost of the asset and accumulated depreciation are removed from the accounts, and any resulting gain or loss is reflected in earnings.

Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the related assets. Buildings and improvements are depreciated over 15 to 40 years, machinery and equipment over 3 to 10 years and furniture, fixtures and office equipment over 3 to 5 years. Leasehold improvements are amortized over the life of the lease or the estimated useful life of the improvement, whichever is less. Judgment and assumptions are used in establishing estimated useful lives and depreciation periods. The Company also uses judgment and assumptions as it periodically reviews property, plant and equipment for any potential impairment in carrying values whenever events such as a significant industry downturn, plant closures, technological obsolescence or other changes in circumstances indicate that their carrying amounts may not be recoverable.

28 -------------------------------------------------------------------------------- Intangible Assets Intangible assets consist primarily of a technology license agreement, a supply agreement and acquisition-related intangibles. These assets, except as explained below, are stated at fair value as of the date acquired less accumulated amortization. Amortization is calculated based on the estimated useful lives of the assets, which range from 3 to 15 years, using the straight-line method or another method that more fairly represents the utilization of the assets.

The Company periodically evaluates the remaining useful lives of its intangible assets to determine whether events or circumstances warrant a revision to the remaining periods of amortization. In the event that the estimate of an intangible asset's remaining useful life has changed, the remaining carrying amount of the intangible asset is amortized prospectively over that revised remaining useful life. If it is determined that an intangible asset has an indefinite useful life, that intangible asset would be subject to impairment testing annually or whenever events or circumstances indicate that the carrying value may not, based on future undiscounted cash flows or market factors, be recoverable, and an impairment loss would be recorded in the period so determined. The measurement of the impairment loss would be based on the fair value of the intangible asset.

Impairment of Long-Lived Assets Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on the Company's judgment and estimates of undiscounted future cash flows resulting from the use of the assets and their eventual disposition. Measurement of an impairment loss for long-lived assets that management expects to hold and use is based on the fair value of the assets. The carrying values of assets determined to be impaired are reduced to their estimated fair values. Fair values of the impaired assets would generally be determined using a market or income approach.

Business Combinations When acquiring other businesses or participating in mergers or joint ventures in which the Company is deemed to be the acquirer, the Company generally recognizes identifiable assets acquired, liabilities assumed and any noncontrolling interests at their acquisition date fair values, and separately from any goodwill that may be required to be recognized. If applicable, goodwill, when recognizable, would be measured as the excess amount of any consideration transferred, which is generally measured at fair value, over the acquisition date fair values of the identifiable assets acquired and liabilities assumed.

Accounting for such transactions requires the Company's management to make significant assumptions and estimates. These include, among others, any estimates or assumptions that may be made for the amounts of future cash flows that will result from any identified intangible assets, the useful lives of such intangible assets, the amount of any contingent liabilities to record at the time of the acquisition, the extent of any restructuring charges expected to be incurred and the fair values of any tangible assets acquired. Although the Company believes any estimates and assumptions it makes to be reasonable and appropriate at the time they are made, unanticipated events and circumstances may arise that affect their accuracy, causing actual results to differ from those estimated by the Company.

Investments in Joint Ventures The financial results of investments in joint ventures of which the Company has a controlling financial interest are included in the Company's consolidated financial statements. In the case of any investment in a joint venture that gave rise to goodwill, such goodwill would be tested for impairment annually or when an event occurred or circumstances changed that would more likely than not have reduced the fair value of the joint venture below its carry value.

Goodwill would be tested for impairment using a two-step process. The Company might, at its option, assess qualitative factors to determine whether it was necessary to perform the two-step impairment test. If it was determined that the two-step test was necessary, the Company would use the test to identify potential goodwill impairment and to measure the amount of a goodwill impairment loss to be recognized (if any).

29 -------------------------------------------------------------------------------- Investments in joint ventures over which the Company has the ability to exercise significant influence and that, in general, are at least 20 percent owned are accounted for under the equity method. An impairment loss would be recognized whenever a decrease in the value of such an investment below its carrying amount is determined to be other than temporary. In judging "other than temporary," the Company would consider the length of time and the extent to which the fair value of the investment has been less than the carrying amount of the investment, the near-term and longer-term operating and financial prospects of the investee, and the Company's longer-term intent of retaining its investment in the investee.

Variable Interest Entities The Company accounts for the investments it makes in certain legal entities in which equity investors do not have 1) sufficient equity at risk for the legal entity to finance its activities without additional subordinated financial support or, 2) as a group, the holders of the equity investment at risk do not have either the power, through voting or similar rights, to direct the activities of the legal entity that most significantly impact the entity's economic performance or, 3) the obligation to absorb the expected losses of the legal entity or the right to receive expected residual returns of the legal entity. These certain legal entities are referred to as "variable interest entities", or "VIEs".

The Company would consolidate the results of any such entity in which it determined that it has a controlling financial interest. The Company would have a "controlling financial interest" in such an entity if the Company had both the power to direct the activities that most significantly affect the VIE's economic performance and the obligation to absorb the losses of, or right to receive benefits from, the VIE that could be potentially significant to the VIE. On a quarterly basis, the Company reassesses whether it has a controlling financial interest in any investments it has in these certain legal entities.

Income Taxes The income tax provision is computed on the basis of the various tax jurisdictions' income or loss before income taxes. Deferred income taxes reflect the tax effects of differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, as well as the tax effects of net operating losses and tax credit carryforwards. The Company uses judgment and assumptions to determine if valuation allowances for deferred income tax assets are required, if their realization is not more likely than not, by considering future market growth, forecasted operations, future taxable income, and the amounts of earnings in the tax jurisdictions in which it operates.

The Company considers income taxes in each of the tax jurisdictions in which it operates in order to determine its effective income tax rate. Current income tax exposure is identified and temporary differences resulting from differing treatments of items for tax and financial reporting purposes are assessed. These differences result in deferred tax assets and liabilities, which are included in the Company's consolidated balance sheets. Additionally, the Company evaluates the potential realization of deferred income tax assets from future taxable income and establishes valuation allowances if their realization is deemed not more likely than not. Accordingly, income taxes charged against earnings may have been impacted by changes in the valuation allowances. Significant management estimates and judgment are required in determining any valuation allowances recorded against net deferred tax assets.

The Company accounts for uncertain tax positions by recording a liability for unrecognized tax benefits resulting from uncertain tax positions taken, or expected to be taken, in its tax returns. The Company includes any applicable interest and penalties related to uncertain tax positions in its income tax provision.

Revenue Recognition The Company recognizes revenue when there is persuasive evidence that an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collectability is reasonably assured. Delivery is determined by the shipping terms of the individual sales transactions. For sales with FOB destination shipping terms, delivery occurs when the Company's product reaches its destination and is received by the customer. For sales with FOB shipping point terms, delivery occurs when the Company's product is received by the common carrier. The Company uses judgment when estimating the effect on revenue of discounts and product warranty obligations, both of which are accrued when the related revenue is recognized.

Warranties and Other Post Shipment Obligations - For a 30-day period, the Company warrants that items sold will conform to customer specifications.

However, the Company's liability is limited to the repair or replacement of the photomasks at its sole option. The Company inspects photomasks for conformity to customer specifications prior to shipment. Accordingly, customer returns of items under warranty have historically been insignificant. However, the Company records a liability for the insignificant amount of estimated warranty returns based on historical experience. The Company's specific return policies include accepting returns of products with defects, or products that have not been produced to precise customer specifications. At the time of revenue recognition, a liability is established for these items.

30 -------------------------------------------------------------------------------- Share-based Compensation The Company recognizes share-based compensation expense over the service period that the awards are expected to vest. Share-based compensation expense includes the estimated effects of forfeitures, which are adjusted over the requisite service period to the extent actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures are recognized in the period of change and will also impact the amount of expense to be recognized in future periods. Determining the appropriate option pricing model, calculating the grant date fair value of share-based awards and estimating forfeiture rates requires considerable judgment, including the estimations of stock price volatility and the expected term of options granted.

The Company uses the Black-Scholes option pricing model to value employee stock options. The Company estimates stock price volatility based on daily averages of its historical volatility over a term approximately equal to the estimated time period the grant will remain outstanding. The expected term of options and forfeiture rate assumptions are derived from historical data.

Effect of Recent Accounting Pronouncements There have been no recent accounting pronouncements whose adoption is expected to affect the Company's financial statements or related disclosures.

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