KLA-Tencor Corporation — Q2 FY2014 Form 10-Q
Reporting period: Quarter and six months ended December 31, 2013. KLA-Tencor supplies process-control and yield-management equipment, software and services to semiconductor and related industries. Financial statements are unaudited.
Key financial results
| Metric | Q2 FY2014 | Q2 FY2013 | Six months FY2014 | Six months FY2013 |
|---|---|---|---|---|
| Revenue | $705.1 million | $673.0 million | $1,363.5 million | $1,393.7 million |
| Gross margin | 59.5% | 54.8% | 58.7% | 55.4% |
| Operating income | $188.0 million | $153.2 million | $337.9 million | $339.8 million |
| Net income | $139.2 million | $106.6 million | $250.4 million | $242.0 million |
| Diluted EPS | $0.83 | $0.63 | $1.49 | $1.43 |
| Operating cash flow | Not separately reported for the quarter | $292.5 million | $322.8 million |
- Q2 product revenue was $544.2 million and service revenue was $160.9 million. Compared with the prior-year quarter, product revenue rose 4% and service revenue rose 7%.
- Q2 operating margin was approximately 26.7%, versus 22.8% a year earlier; net margin was approximately 19.7%, versus 15.8%.
- For the six-month period, revenue declined 2% year over year, while net income increased 3%. Product revenue fell 5%, partly offset by 7% growth in service revenue.
- Six-month investing cash use was $262.8 million, including net purchases of securities; financing cash use was $221.3 million, including $149.6 million of dividends and $120.8 million of share repurchases. Capital expenditures were $36.2 million. Operating cash flow less capital expenditures was approximately $256.3 million.
- At December 31, cash and cash equivalents were $793.4 million and marketable securities were $2,157.3 million, totaling $2,950.7 million. Working capital was approximately $3.6 billion.
- Long-term debt was $747.6 million on the balance sheet; the notes have $750 million principal, bear 6.90% interest and mature in 2018. The company reported compliance with debt covenants.
Material changes and management commentary
- Q2 revenue increased 5% year over year, driven chiefly by higher shipments and opening backlog; management attributed higher backlog to customer adoption of leading-edge device architectures and process technologies. Gross margin improved on higher volume, manufacturing efficiencies and lower excess-inventory reserve requirements.
- Six-month revenue was lower primarily because of a lower opening shipment backlog, a greater share of newer products not yet eligible for revenue recognition upon shipment, and prior-year recognition of previously deferred customer revenue.
- R&D expense increased 11% year over year for both the quarter and six-month period, reflecting development activity, higher engineering headcount and variable compensation. Management said continued investment in R&D is important to product competitiveness.
- The six-month effective tax rate fell to 20.9% from 24.7%; management cited a greater share of earnings in lower-tax jurisdictions, reinstatement of the federal research credit and non-taxable gains in the executive deferred savings plan. The estimated FY2014 annual effective tax rate was approximately 21.4%.
- Management described near-term expectations for a robust level of new orders across memory, foundry and logic. No specific numerical revenue or earnings guidance is provided in the filing. It expects operating cash generation and existing liquidity to meet requirements for at least 12 months.
Risks, contingencies and unusual items
- The business is cyclical and depends on semiconductor customers’ capital spending. Customer concentration is material: four customers each represented more than 10% of Q2 revenue, and three each exceeded 10% for the six-month period.
- A significant customer notified the company of its intent to exercise audit rights concerning customer-specific commercial commitments. The outcome is unknown; the company had recorded no accrual for this contingency.
- The company recorded a $1.4 million other-than-temporary impairment of a private-company equity investment in Q2, reducing interest income and other, net.
- Legal claims, tax examinations, customer collectibility, product warranties, foreign exchange, supply constraints and changes in semiconductor demand could affect results. Management believes recorded legal provisions are adequate but says ultimate outcomes are uncertain. Up to $7.2 million of unrecognized tax benefits may be recognized within the next 12 months.
- Approximately $1.2 billion of cash, cash equivalents and marketable securities was held by foreign subsidiaries and branches. The company intends to permanently reinvest $1.0 billion; repatriation of that portion could incur estimated taxes of 30%–50%.
- Disclosure controls were assessed as effective at a reasonable assurance level, with no material changes in internal control over financial reporting during the quarter.
Investor verification priorities
- Confirm whether new orders, backlog and customer spending support management’s near-term commentary, given the industry’s cyclicality.
- Track customer concentration, receivables and deferred system profit, including the impact of customer liquidity and revenue-acceptance requirements.
- Follow the customer audit, pending legal matters and tax examinations for any change in exposure or accruals.
- Assess cash generation against dividends, repurchases, purchase commitments and the 2018 debt maturity; consider the location and potential tax cost of foreign-held funds.
- Monitor gross-margin durability, product mix, inventory reserves and rising R&D and employee-compensation costs.