Kulicke & Soffa Industries, Inc. — Form 10-Q Summary
Reporting period: The supplied filing is for the quarter ended June 30, 2018, covering the three and nine months ended June 30, 2018. Comparable 2017 periods ended July 1, 2017 and were restated. The request metadata identifies “2017 Q3,” but the filing itself is a fiscal 2018 third-quarter report.
Business Context
K&S designs, manufactures and services semiconductor assembly equipment, advanced packaging and electronic assembly solutions, tools, spare parts and related services. Reportable segments are Capital Equipment and Aftermarket Products and Services (APS). Results depend heavily on semiconductor manufacturers’ capital spending, industry cycles, customer demand and seasonality. Approximately 94.2% of third-quarter revenue and 91.6% of nine-month revenue came from customers outside the United States, primarily in Asia/Pacific.
Financial Performance and Position
| Metric | Three months ended June 30, 2018 | Three months ended July 1, 2017 | Nine months ended June 30, 2018 | Nine months ended July 1, 2017 |
|---|---|---|---|---|
| Revenue | $268.8 million | $243.9 million | $704.3 million | $593.1 million |
| Gross profit | $127.0 million | $114.0 million | $323.6 million | $274.7 million |
| Gross margin | 47.2% | 46.7% | 45.9% | 46.3% |
| Operating income | $64.5 million | $15.7 million | $142.1 million | $71.2 million |
| Net income | $60.3 million | $34.8 million | $27.0 million | $84.9 million |
| Diluted EPS | $0.86 | $0.48 | $0.38 | $1.18 |
Third-quarter revenue increased 10.2% year over year, driven primarily by higher Capital Equipment volume. Nine-month revenue increased 18.7%. Third-quarter operating margin was approximately 24.0%, compared with 6.4% in the restated prior-year period; nine-month operating margin was approximately 20.2%, compared with 12.0%.
- Capital Equipment: Third-quarter revenue increased 13.5% to $229.5 million; nine-month revenue increased 21.0% to $578.2 million. Third-quarter operating income was $57.8 million versus $31.0 million.
- APS: Third-quarter revenue declined 5.5% to $39.4 million, while nine-month revenue increased 9.5% to $126.1 million. Third-quarter results were affected by lower EA/APMR aftermarket volume and tool price reductions.
- Cash flow: Nine-month operating cash flow was $93.8 million, versus $68.2 million in the prior-year period. Investing cash flow was negative $57.5 million, principally reflecting net purchases of short-term investments and $16.2 million of capital expenditures. Financing cash flow was negative $65.8 million, primarily due to $65.3 million of share repurchases.
- Liquidity: Cash, cash equivalents, restricted cash and short-term investments totaled $621.2 million at June 30, 2018, up $12.3 million from September 30, 2017. Cash and cash equivalents were $362.7 million and short-term investments were $258.0 million.
- Debt and obligations: The headquarters financing obligation was approximately $16.2 million. A $5.0 million credit facility supported bank guarantees, with $2.9 million outstanding. Contractual commitments included $149.4 million of inventory purchase obligations and $19.0 million of operating lease obligations.
Material Changes and Unusual Items
- Tax expense materially reduced year-to-date earnings: Nine-month income tax expense was $122.5 million, including a provisional $105.7 million discrete provision related to the Tax Cuts and Jobs Act. This included approximately $103.2 million for the one-time transition tax and $2.6 million for deferred-tax remeasurement. The nine-month effective tax rate was 81.9%, compared with a 13.3% benefit in the prior-year period.
- Restatement and internal control issues: The Company restated prior periods after identifying unsupported or falsified manual journal entries involving warranty accruals, cost of sales and accounts payable, as well as an unauthorized $5.8 million disbursement by a senior finance employee. The payment was recovered. Restated nine-month 2017 net income increased by $9.4 million to $84.9 million.
- Material weaknesses: Management concluded that disclosure controls were ineffective as of June 30, 2018 because of material weaknesses in controls over manual journal entries and cash disbursements. Remediation efforts included tighter approval procedures, finance personnel training, changes in finance management and revised bank mandates. The weaknesses were not considered remediated as of the filing date.
- Capital allocation: The Company repurchased 2.8 million shares for $67.3 million during the nine months and initiated a quarterly dividend of $0.12 per share. On July 10, 2018, the Board authorized an additional $100 million of repurchases.
- Acquisition: The Company acquired Liteq, an advanced-packaging lithography provider, on July 2, 2017 for approximately $28.6 million of cash, with potential earn-out payments. The acquisition added approximately $1.1 million of third-quarter SG&A and contributed to higher R&D expense.
Outlook, Risks and Contingencies
Management expects fiscal 2018 capital expenditures of $18 million to $20 million, with approximately $16.2 million incurred through the third quarter. Management believes existing cash, investments and operating cash flow will satisfy liquidity needs for at least the next twelve months.
The filing provides no specific revenue or earnings guidance. Management describes limited visibility into demand, continuing semiconductor industry cyclicality and typical seasonality, including potential reductions in the December quarter after customers add capacity ahead of the September quarter. Key risks include semiconductor capital-spending volatility, customer and geographic concentration, pricing pressure, foreign exchange exposure, reliance on suppliers and subcontractors, inventory demand uncertainty, tax-law changes and unresolved control weaknesses. A 10% foreign-exchange fluctuation could affect financial position, results or cash flows by approximately $2 million to $3 million.
Customer concentration is significant: Haoseng Industrial Company Limited represented 12.8% of nine-month revenue and 27.6% of accounts receivable at June 30, 2018. The filing also reports $14.4 million of warranty reserves and $7.4 million of retirement and other severance obligations.
Investor Verification Priorities
- Verify the final accounting for the Tax Cuts and Jobs Act, including the provisional $105.7 million tax provision and transition-tax payable.
- Assess remediation and independent testing of the two material weaknesses, particularly controls over manual journal entries and cash disbursements.
- Reconcile the restated 2017 results and understand the effect of warranty-accounting corrections and the unauthorized disbursement.
- Monitor semiconductor capital-spending trends, China and Asia/Pacific exposure, customer concentration and Capital Equipment demand.
- Evaluate cash deployment among repurchases, the new dividend, capital expenditures and potential acquisitions.
- Confirm the impact of pricing pressure, inventory commitments, warranty reserves and foreign-exchange movements on future margins and cash flow.