Kulicke & Soffa Industries, Inc. — Form 10-Q Summary
Reporting period: The filing covers the quarter and six months ended March 31, 2018, compared with April 1, 2017. The request metadata identifies “2017 Q2,” but the filing is for fiscal 2018 second quarter. Results are unaudited and prior-year amounts were restated.
Business context
The company designs, manufactures, sells, services and upgrades semiconductor assembly equipment, tools and related products. Reportable segments are Capital Equipment and Aftermarket Products and Services (APS). Operations are highly dependent on semiconductor industry capital spending, customer demand, product mix, seasonality and cyclical conditions.
Financial performance
| Metric | Three months ended Mar. 31, 2018 | Three months ended Apr. 1, 2017 | Six months ended Mar. 31, 2018 | Six months ended Apr. 1, 2017 |
|---|---|---|---|---|
| Revenue | $221.8 million | $199.6 million | $435.5 million | $349.3 million |
| Gross profit | $99.4 million | $92.3 million | $196.6 million | $160.7 million |
| Gross margin | 44.8% | 46.2% | 45.2% | 46.0% |
| Operating income | $38.4 million | $36.5 million | $77.6 million | $55.6 million |
| Net income/(loss) | $36.3 million | $32.7 million | $(33.2) million | $50.1 million |
| Diluted EPS | $0.51 | $0.45 | $(0.47) | $0.69 |
Second-quarter revenue increased 11.1%, while operating income increased 5.3%. Six-month revenue increased 24.7% and operating income increased 39.7%. The six-month net loss was driven primarily by a $105.7 million discrete tax provision related to the Tax Cuts and Jobs Act, including approximately $103.2 million of provisional transition tax and $2.6 million of deferred-tax remeasurement.
Second-quarter operating margin was approximately 17.3%, compared with 18.3% in the prior-year quarter. Six-month operating margin was approximately 17.8%, compared with 15.9%. R&D increased 14.5% in the quarter and 26.6% year to date, reflecting higher staffing and investment in advanced packaging and lithography.
Segment and revenue trends
- Capital Equipment: Revenue increased 9.7% in the quarter and 26.5% year to date, primarily from higher volume in consumer, enterprise, automotive and industrial applications. Price pressure in LED and IC markets partially offset volume gains. Segment gross margin declined to 42.2% from 43.5% in the quarter and was broadly stable year to date at 42.8% versus 42.9%.
- APS: Revenue increased 17.0% in the quarter and 17.9% year to date, supported by capillaries, spares and wedge-bonder consumables. Segment gross margin declined to 55.4% from 57.8% in the quarter and to 54.6% from 57.8% year to date.
- Approximately 96.0% of quarterly revenue and 90.0% of six-month revenue came from shipments outside the United States, primarily Asia/Pacific. China represented approximately 45.5% of quarterly revenue and 42.9% of six-month revenue.
Cash flow, liquidity and debt
- Cash, cash equivalents, restricted cash and short-term investments totaled $628.7 million at March 31, 2018, up $19.7 million from September 30, 2017 and equal to 52.2% of total assets.
- Cash and cash equivalents were $340.2 million; short-term investments were $288.0 million. Approximately $510.4 million of cash, cash equivalents and short-term investments was held by foreign subsidiaries.
- Six-month operating cash flow was $57.1 million, compared with $43.0 million in the restated prior-year period. The increase was substantially supported by a $79.9 million increase in income taxes payable related to the transition tax.
- Investing cash flow was $(83.5) million, primarily reflecting $325.0 million of short-term investment purchases, $253.0 million of maturities and $11.7 million of capital expenditures.
- Financing cash flow was $(24.2) million, primarily from $24.0 million of share repurchases.
- The principal financing obligation was $17.0 million for the Singapore headquarters. A $25 million revolving credit facility expired March 20, 2018 and was not renewed. A separate Citibank facility supporting bank guarantees had $3.5 million outstanding.
- Contractual commitments included $180.4 million of inventory purchase obligations and $18.6 million of operating lease obligations. Long-term tax payable related to the transition tax was $77.4 million, including $6.2 million due within one year.
Material changes, unusual items and risks
- Restatement and control failures: The company concluded that previously issued fiscal 2017 and December 30, 2017 financial statements could no longer be relied upon. The investigation identified unsupported warranty journal entries, falsified accounting records, management override of controls and a $5.8 million unauthorized payment to an unapproved vendor. The payment was recovered in full on April 10, 2018.
- The company identified two material weaknesses: ineffective controls over manual journal entries and ineffective controls over cash-disbursement approvals. Disclosure controls were therefore not effective as of March 31, 2018. Remediation plans were still being assessed and had not been completed.
- Historical warranty accounting was corrected, including a cumulative understatement of operating income of approximately $17.6 million over fiscal 2015 through fiscal 2017. The prior-year comparable periods in this filing were restated.
- The Tax Cuts and Jobs Act produced a provisional $105.7 million discrete tax provision. The company stated that the final accounting could differ as additional guidance and analysis became available.
- The company acquired Liteq in July 2017 for approximately $28.6 million in cash, subject to potential earn-out payments, expanding its advanced-packaging lithography capabilities.
- Semiconductor demand is volatile and cyclical, and management stated that visibility into future demand is limited. Customer and geographic concentration, pricing pressure, foreign exchange exposure, supply-chain reliance, inventory commitments and evolving tax rules are key risks.
Guidance and outlook
Management expected fiscal 2018 capital expenditures of $20.0 million to $24.0 million, with $11.7 million incurred through the second quarter. Spending was expected to support R&D, Asian manufacturing enhancements, information technology infrastructure and facility improvements. Management believed existing cash, investments and operating cash flow would meet liquidity and capital requirements for at least the next twelve months, while noting that industry downturns and macroeconomic conditions could materially affect liquidity and results.
Investor verification items
- Verify the scope and status of remediation for the two material weaknesses and whether subsequent filings report effective controls.
- Reconcile the restated fiscal 2017 and December 30, 2017 financial statements, especially warranty accruals, cost of sales, accounts payable and retained earnings.
- Assess the final tax impact of the Tax Cuts and Jobs Act, including the transition tax, GILTI, BEAT and deferred-tax remeasurement.
- Evaluate whether Capital Equipment volume growth can offset pricing pressure and margin compression, particularly in LED and IC markets.
- Monitor China and Asia/Pacific exposure, customer receivables concentration, inventory purchase commitments and foreign-exchange sensitivity.
- Confirm cash availability, tax-payment timing, the status of the expired revolving facility and the pace of remaining share repurchases.