Results of Operations for the Years Ended October 28, 2012, October 30, 2011 and October 31, 2010

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.

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. The Company, in order to lower its operating costs and increase its manufacturing efficiencies, ceased the manufacture of photomasks at its Singapore facility in December 2011.

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 2012 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 designs to continue to move to wafer fabrication throughout fiscal 2013, 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 2012, 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 $250 million for the three fiscal years ended October 28, 2012, resulting in significant increases in 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 2013.

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.

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 are based on a ten year repayment period). The amendment also included a twenty-five basis point reduction in the interest rate charged on any borrowings under the credit facility. The credit facility bears interest (2.5% at October 28, 2012), 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. Subsequent to fiscal year 2012, PSMC completed its most recent share repurchase program in November 2012 with the repurchase of an additional 9.2 million shares for $4.2 million, which increased the Company's ownership in PSMC to 75.11%.

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.

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.

Results of Operations

The following table presents selected operating information expressed as a percentage of net sales:

                                                                 Year Ended
                                               October 28,       October 30,       October 31,
                                                  2012              2011              2010

Net sales                                             100.0 %           100.0 %           100.0 %
Cost of sales                                         (75.1 )           (73.4 )           (78.4 )
Gross margin                                           24.9              26.6              21.6
Selling, general and administrative
expenses                                              (10.4 )            (8.9 )           (10.0 )
Research and development expenses                      (4.3 )            (3.0 )            (3.5 )
Consolidation, restructuring and related
(charges) credits                                      (0.3 )               -               1.2
Operating income                                        9.9              14.7               9.3
Interest expense                                       (1.7 )            (1.4 )            (2.3 )
Interest and other income (expense), net                0.8               0.6               0.6
Debt extinguishment loss                                  -              (6.9 )               -
Income before income tax provision                      9.0               7.0               7.6
Income tax provision                                   (2.4 )            (3.1 )            (1.7 )
Net income                                              6.6               3.9               5.9
Net income attributable to noncontrolling
interests                                              (0.4 )            (0.8 )            (0.3 )
Net income attributable to Photronics, Inc.
shareholders                                            6.2 %             3.1 %             5.6 %

Note: All the following tabular comparisons, unless otherwise indicated, are for the fiscal years ended October 28, 2012 (2012), October 30, 2011 (2011) and October 31, 2010 (2010), in millions of dollars.

Net Sales

                                                          Percent Change
                                                      2011 to        2010 to
                   2012        2011        2010         2012          2011

IC                $ 350.1     $ 391.2     $ 329.8        (10.5 )%        18.6 %
FPD                 100.3       120.8        95.8        (17.0 )         26.2
Total net sales   $ 450.4     $ 512.0     $ 425.6        (12.0 )%        20.3 %

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 average selling prices (ASPs). 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 2012 as compared to 2011 decreased by $32.8 million or 10.7% in Asia, decreased by $22.8 million or 14.5% in North America, and decreased by $6.0 million or 12.8% in Europe. As a percent of total sales in 2012, sales were 61% in Asia, 30% in North America and 9% in Europe.

Net sales for 2011 increased 20.3% to $512.0 million as compared to $425.6 million for 2010. The increase was primarily related to increased high-end IC and FPD sales, mainly resulting from increased unit demand and ASPs for both high-end ICs and FPDs. FPD sales increased primarily as a result of increased unit demand for high-end products. Sales of high-end IC photomasks increased to $95 million in 2011 as compared to $37 million in 2010, and sales of high-end FPD photomasks increased to $67 million in 2011 as compared to $37 million in 2010. By geographic area, net sales in 2011 as compared to 2010 increased by $47.4 million or 18.3% in Asia, increased by $34.3 million or 27.7% in North America, and increased by $4.8 million or 11.4% in Europe. As a percent of total sales in 2011, sales were 60% in Asia, 31% in North America and 9% in Europe.

Gross Margin

                                                        Percent Change
                                                    2011 to        2010 to
                  2012        2011        2010        2012          2011

Gross margin     $ 111.9     $ 136.2     $ 91.8        (17.8 )%        48.4 %
Gross margin %      24.9 %      26.6 %     21.6 %          -              -

Gross margin percentage decreased to 24.9% in 2012 from 26.6% in 2011, primarily due to a decrease in sales in 2012 as compared to 2011. 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 increased to 26.6% in 2011 from 21.6% in 2010. This increase was primarily due to increased sales volume, including high-end photomasks which typically have higher ASPs.

Selling, General and Administrative Expenses

                                                      Percent Change
                                                  2011 to        2010 to
                  2012       2011       2010        2012          2011

S,G&A expenses   $ 46.7     $ 45.2     $ 42.4          3.2 %          6.7 %
% of net sales     10.4 %      8.9 %     10.0 %          -              -

Selling, general and administrative expenses increased by $1.5 million to $46.7 million in 2012, as compared to 2011, and increased by $2.8 million to $45.2 million in 2011 as compared to 2010. These increases were primarily related to increased employee compensation and selling-related expenses.

Research and Development

                                                      Percent Change
                                                   2011 to       2010 to
                  2012       2011       2010        2012          2011

R&D expense      $ 19.4     $ 15.5     $ 14.9          24.9 %         3.9 %
% of net sales      4.3 %      3.0 %      3.5 %           -             -

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 $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 and FPD photomasks. Research and development expenses did not change significantly in 2011 as compared to 2010.

Consolidation, Restructuring and Related Charges (Credits)

                                        2012           2011          2010

Employee terminations and other       $     1.1     $        -     $     0.2
Asset write-downs                           0.3              -             -
Net gain on sales of assets                   -              -          (5.2 )
Total consolidation, restructuring
and related charges (credits)         $     1.4     $        -     $    (5.0 )

Singapore Facility

In the first quarter of fiscal 2012 the Company ceased the manufacture of photomasks at its Singapore facility and, in connection therewith, recorded charges of $1.4 million during fiscal 2012. This restructuring, which was comprised primarily of employee termination costs, was substantially completed in fiscal 2012.

Shanghai, China, Facility

Net restructuring credits of $5.0 million in 2010 primarily relate to the sale of the Company's Shanghai, China, manufacturing facility. In 2009 the carrying value of this facility was written down to its estimated fair value at that time, and in 2010 the facility was sold for net proceeds of $12.9 million, which exceeded its carrying value and resulted in a gain of $5.4 million that was recorded as a credit to the restructuring reserve.

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.

Other Income (Expense)

                                            2012       2011        2010

Interest expense                           $ (7.5 )   $  (7.2 )   $ (9.5 )
Interest and other income (expense), net      3.7         2.9        2.6
Debt extinguishment loss                        -       (35.3 )        -
Total other expense, net                   $ (3.8 )   $ (39.6 )   $ (6.9 )

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.

Interest expense decreased in 2011, as compared to 2010, primarily as a result of higher interest rate debt being replaced with the 3.25% convertible senior notes issued by the Company in March 2011. In addition, in 2010, the Company wrote off $1.0 million of deferred financing fees, that was charged to interest expense, in connection with refinancing its credit facility. Interest and other income (expense), net, increased in 2011 as compared to 2010 primarily due to increased investment earnings on the Company's higher cash balances in 2011, lower non-cash losses related to changes in the fair value of certain of the Company's common stock warrants and increased earnings on its equity method investment, all of which were largely offset by less favorable foreign currency transaction results.

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

                             2012       2011       2010

Income tax provision        $ 10.8     $ 15.7     $  7.5

Effective income tax rate     26.6 %     43.7 %     23.0 %

The effective tax rate differs from the U.S. statutory rate of 35% in fiscal year 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 effective income tax rate differs from the U.S. statutory rate of 35% in 2010 primarily due to tax rates being lower than the U.S. rate in other countries where the Company's income is taxed. The Company, in 2010, also benefitted from the utilization of various investment tax credits in Korea and Taiwan.

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 evaluations, the valuation allowance was increased (decreased) by $2.5 million, $(8.2) million and $10.9 million in 2012, 2011 and 2010, respectively. The Company also regularly assesses the potential outcomes of ongoing and future 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 2012, 2011 or 2010 fiscal years.

Net Income Attributable to Noncontrolling Interests

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). Net income attributable to noncontrolling interests increased to $4.0 million in 2011 as compared to $1.2 million in 2010, primarily as a result of increased net income in 2012 at PSMC.

In 2012 and 2011 the board of directors of PSMC authorized PSMC to repurchase shares of its outstanding common stock for retirement. These repurchase programs resulted in 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, and to 72.09% at October 28, 2012. See Note 15 of the consolidated financial statements for more information. The Company's ownership percentage in its subsidiary in Korea was 99.7% throughout fiscal 2010 to fiscal 2012.

Liquidity and Capital Resources

                                               October 28,        October 30,        October 31,
                                                   2012               2011               2010
                                              (in millions)      (in millions)      (in millions)

Cash and cash equivalents                     $        218.0     $        189.9     $         98.9

Net cash provided by operating activities     $        132.5     $        136.6     $         95.9

Net cash used in investing activities         $       (111.9 )   $       (100.7 )   $        (58.2 )
. . .