KLA-Tencor Corporation (KLA) — Form 10-Q Summary
Reporting period: Fiscal first quarter ended September 30, 2018. The filing was signed October 31, 2018. KLA-Tencor supplies process-control, inspection, metrology, and yield-management equipment and related services, primarily to semiconductor manufacturers.
Financial results and liquidity
| Metric | Three months ended Sep. 30, 2018 | Comparable 2017 period |
|---|---|---|
| Revenue | $1.093 billion | $969.6 million |
| Gross profit / margin | $711.9 million / 65.1% | $616.1 million / 63.5% |
| Income before taxes | $427.6 million | $336.2 million |
| Income tax provision / effective rate | $31.6 million / 7.4% | $55.2 million / 16.4% |
| Net income | $395.9 million | $280.9 million |
| Diluted EPS | $2.54 | $1.78 |
| Cash from operations | $381.4 million | $373.6 million |
- Revenue rose 13% year over year as reported. Product revenue was $829.2 million; service revenue was $264.0 million. Reported gross margin was 65.1%.
- Operating cash flow was $381.4 million; capital expenditures were $22.3 million, implying approximately $359.1 million of operating cash flow less capex. Investing activities provided $314.9 million, principally reflecting securities maturities and sales. Financing activities used $449.7 million, including $300.0 million of repurchases and $122.8 million of dividends and dividend equivalents.
- At September 30, cash and equivalents were $1.650 billion and marketable securities were $1.131 billion, totaling $2.780 billion. Working capital was $3.21 billion.
- Long-term debt was $2.238 billion carrying value, representing $2.25 billion principal. KLA had no revolver borrowings and reported compliance with debt covenants. The $750 million revolving facility matures in November 2022.
- The quarterly dividend declared was $0.75 per share, versus $0.59 in the year-ago quarter.
Changes versus comparable periods
- Reported revenue increased 13% year over year and 2% from the June 2018 quarter. Management attributed year-over-year product growth mainly to inspection demand and customer investment in China and Taiwan; service growth reflected both more installed systems and newly recognized warranty-service revenue.
- China accounted for 31% of revenue and Taiwan 23%, compared with 17% and 14%, respectively, a year earlier. Korea’s share declined from 28% to 14%.
- Management cited higher volume and favorable product/service mix as contributors to gross-margin improvement, partly offset by higher service and manufacturing costs.
- R&D expense increased 5% year over year to $153.5 million. SG&A increased 7% to $114.4 million, including higher merger-related and travel costs. Interest expense fell to $26.4 million from $30.6 million.
Accounting comparability and unusual items
- KLA adopted ASC 606 revenue accounting on July 1, 2018 using the modified retrospective method; 2017 results were not restated. As a result, reported year-over-year revenue and profit are not directly comparable. For the current quarter, the company’s table shows revenue of $930.6 million and net income of $288.5 million under the prior revenue standard, versus $1.093 billion and $395.9 million as reported under ASC 606. The filing attributes the difference primarily to warranty accounting and the timing of transfer of product control.
- ASC 606 adoption reduced opening retained earnings by a net $21.0 million. The filing also reports a separate $10.7 million reclassification of stranded tax effects from accumulated other comprehensive income to opening retained earnings.
- The 7.4% effective tax rate reflects the Tax Cuts and Jobs Act and other tax items. KLA recorded a provisional $19.8 million tax benefit related to the transition-tax liability and stated its accounting for the Act was not complete; estimates could change.
Outlook, transaction, and risks
- The filing provides no specific forward quarterly revenue or EPS guidance. Management said process-control equipment revenue increased modestly from the June quarter and described long-term demand drivers including advanced technology, EUV qualification, AI, IoT, and automotive applications. It cautioned that semiconductor capital spending is cyclical and timing of orders, deliveries, acceptance, or cancellations is unpredictable.
- The proposed Orbotech acquisition remained subject to regulatory approvals and customary closing conditions. The announced consideration was $38.86 in cash plus 0.25 KLA-Tencor share per Orbotech share; the deal was valued at approximately $3.2 billion in enterprise value at announcement. KLA said it intended to fund the cash portion from the combined company’s balance sheet. It also described a repurchase authorization of up to $2 billion if the merger closes, with approximately $1 billion of new long-term debt contemplated to fund repurchases.
- Customer concentration is significant: two customers represented approximately 15% and 10% of quarterly revenue. Orders may be delayed or canceled, often with limited or no penalty, and KLA held elevated inventory to meet anticipated demand.
- After quarter-end, the U.S. Department of Commerce added China’s JHICC to its Entity List, effective October 30, 2018. KLA said it would be unable to fulfill JHICC orders or provide service unless the restriction changed.
- Other risks include semiconductor-industry cyclicality, technology and competitive shifts, dependence on key suppliers, foreign-exchange and investment-market exposure, tax uncertainty, acquisition integration and financing, and litigation or indemnification claims. KLA said its legal accruals were adequate but noted outcomes remain uncertain.
- Significant stated commitments include approximately $476.6 million of purchase commitments, $304.6 million of estimated transition-tax payments, and $161.1 million of future cash long-term incentive obligations.
Investor facts to verify
- Assess operating performance on a comparable basis after adjusting for ASC 606; the reported year-over-year growth materially reflects the accounting change.
- Track Orbotech regulatory approval, closing terms, integration costs, and the proposed acquisition-related debt and repurchases.
- Monitor customer spending and concentration, particularly China and Taiwan exposure, order pushouts, and inventory levels.
- Check subsequent tax disclosures for changes to provisional Tax Act estimates and the transition-tax liability.
- Review the effect of the JHICC export restriction and any further trade or export-control developments.