MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Amkoris one of the world's leading providers of outsourced semiconductor packaging and test services. Our financial goals are sales growth and improved profitability, and we are focusing on the following strategies to achieve these goals: leveraging our investment in services for advanced technologies, improving utilization of existing assets and selectively growing our scale and scope through strategic investments. We are an industry leader in developing and commercializing cost-effective advanced packaging and test technologies. These advanced technology solutions provide increased value to our customers while typically generating gross margins above the corporate average. This is particularly true in the mobile device market, where growth has outpaced the industry rate. The key to success in the advanced packaging and test area is to generate reasonably quick returns on investments made for customers seeking leading edge technologies. Another key to our success is to improve the utilization of our existing assets. The transition by leading edge customers to newer packaging and test equipment and platforms typically creates capacity to provide incremental packaging and test services without significant additional investment. As part of our strategy, we are focused on developing a second wave of customers in order to more effectively utilize these assets. For example, we have a concerted effort to increase our sales to Chinese and Taiwanese fabless chip companies, since they dominate the mid-tier and entry-level segments of the mobile device market where most of the growth is occurring. Recently, we began efforts to seek out and engage new customers in the analog area for our mainstream wirebond technologies. Another area of expanded emphasis is the automotive market where semiconductor content continues to grow. These efforts to enlarge our customer base will continue in 2014 as we target these and other customers to grow our revenue and improve the utilization of our existing assets. From time to time, we also see attractive opportunities to grow our customer base and expand markets. For example, in 2009 we invested in J-Devices Corporation, a joint venture to provide semiconductor packaging and test services in Japan. In 2013, we increased our investment in J-Devicesto 60%. In July 2013, we acquired Toshiba's power discrete semiconductor packaging and test business in Malaysia. The financial results of this entity have been included in our Consolidated Financial Statements from the date of acquisition. In addition to adding a new revenue stream from our existing customer, Toshiba, we are attracting other power discrete customers. We believe that selective growth through joint ventures, acquisitions and other strategic investments can help diversify our revenue streams, improve our profits and continue our technological leadership. We expect to continue to evaluate similar opportunities. Our IDM customers include: Intel Corporation; Micron Technology, Inc.; STMicroelectronics N.V.; Texas Instruments Incorporated and Toshiba Corporation. Our fabless customers include: Altera Corporation; Broadcom Corporation; LSI Corporation and Qualcomm Incorporated. Our contract foundry customers include: GlobalFoundries Inc.and Taiwan Semiconductor Manufacturing Company Limited. Our business is impacted by market conditions in the semiconductor industry, which is cyclical and impacted by broad economic factors, such as world-wide gross domestic product and consumer spending. Historical trends indicate there has been a strong correlation between world-wide gross domestic product levels, consumer spending and semiconductor industry cycles. The semiconductor industry has experienced significant and sometimes prolonged cyclical downturns in the past. We cannot predict the timing, strength or duration of any economic slowdown or subsequent economic recovery. Our net sales, gross profit, operating income, cash flows, liquidity and capital resources have historically fluctuated significantly from quarter to quarter as a result of many factors, including the seasonality of our business, the cyclical nature of the semiconductor industry and other factors discussed in Part II, Item 1A of this Quarterly Report on Form 10-Q. We operate in a capital intensive industry and have a significant level of debt. Servicing our current and future customers requires that we incur significant operating expenses and continue to make significant capital expenditures, which are generally made in advance of the related revenues and without any firm customer commitments. We fund our operations, including capital expenditures and debt service requirements, with cash flows from operations, existing cash and cash equivalents, borrowings under available credit facilities and proceeds from any additional financing. Maintaining an - 22-
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appropriate level of liquidity is important to our business and depends on, among other things, the performance of our business, our capital expenditure levels and our ability to repay debt out of our operating cash flows or proceeds from debt or equity financings.
Financial Highlights for the Three Months Ended
Our net sales increased
$8.5 millionor 1.2% to $696.0 millionfor the three months ended March 31, 2014, from $687.5 millionfor the three months ended March 31, 2013. The increase was driven by incremental business from our newly acquired power discrete business in Malaysia, strong demand for NAND memory used in mobile communications and products supporting the automotive and industrial end market. These increases in net sales were partially offset by lower net sales for other mobile communications products.
Gross margin for the three months ended
Our capital expenditures totaled
Net cash provided by operating activities was
Results of Operations
The following table sets forth certain operating data as a percentage of net sales for the periods indicated:
For the Three Months Ended March 31, 2014 2013 Net sales 100.0 % 100.0 % Materials 36.8 % 42.5 % Labor 14.7 % 14.8 % Other manufacturing costs 30.0 % 26.0 % Gross margin 18.5 % 16.7 % Operating income 6.5 %
6.0 % Income before taxes and equity in earnings of unconsolidated affiliate
2.9 % 2.6 % Net income attributable to Amkor 3.0 % 1.9 % Net Sales For the Three Months Ended March 31, 2014 2013 Change (In thousands, except percentages)
The increase in net sales for the three months ended
March 31, 2014, compared to the three months ended March 31, 2013, was primarily driven by incremental business from our newly acquired power discrete business in Malaysiaand strong demand for NAND memory used in mobile communications and products supporting the automotive and industrial end market. These increases in net sales were partially offset by lower net sales for other mobile communications products. - 23-
Table of Contents Gross Margin For the Three Months Ended March 31, 2014 2013 Change (In thousands, except percentages) Gross profit
$ 128,820 $ 114,953 $ 13,867Gross margin 18.5 % 16.7 % 1.8 % Our cost of sales consists principally of materials, labor, depreciation and manufacturing overhead. Since a substantial portion of the costs at our factories is fixed, relatively modest increases or decreases in capacity utilization rates can have a significant effect on our gross margin. Gross margin for the three months ended March 31, 2014, increased compared to the three months ended March 31, 2013. The increase in gross margin was attributable to improved capacity utilization and lower costs for gold, which is used in many of our wirebond products. These increases to gross margin were partially offset by higher depreciation expense and increases in manufacturing overhead costs.
Selling, General and Administrative Expenses
For the Three Months Ended March 31, 2014 2013 Change (In thousands, except percentages) Selling, general and administrative
$ 62,424 $ 59,559$
2,865 4.8 %
Selling, general and administrative expenses for the three months ended
March 31, 2014, increased compared to the three months ended March 31, 2013. The increase for the three months ended March 31, 2014, was attributable to incremental costs from our newly acquired power discrete business in Malaysiaand higher employee compensation costs. Research and Development For the Three Months Ended March 31, 2014 2013 Change (In thousands, except percentages) Research and development $ 21,045 $ 14,306 $ 6,73947.1 % Research and development activities are focused on developing new packaging and test services and improving the efficiency and capabilities of our existing production processes. Areas of focus include 2.5D and 3D packaging, including embedded die, silicon interposers and through silicon via technologies, fine pitch copper pillar packaging and wafer-level processing in support of advanced wafer nodes. The increase in research and development expenses for the three months ended March 31, 2014, compared to the three months ended March 31, 2013, was driven by expanded development activities related to 20 nanometer chipsets with strategic customers, higher employee compensation costs and increased depreciation expense from research and development investments. Other Income and Expense For the Three Months Ended March 31, 2014 2013 Change (In thousands, except percentages) Interest expense, including related party $ 24,964 $ 25,570 $ (606 )(2.4 )% Other expense (income), net 36 (2,222 ) 2,258 > 100% Total other expense, net $ 25,000 $ 23,348 $ 1,6527.1 % - 24-
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Interest expense for the three months ended
March 31, 2014, decreased as a result of the June 2013exchange of $193.7 millionof our 6.0% Convertible Senior Subordinated Notes for shares of our common stock. Other expense (income), net for the three months ended March 31, 2013, included foreign currency gains at our subsidiaries, which were driven by the depreciation of the Japanese yen relative to the U.S. dollar and the associated impact on our U.S. dollar denominated net monetary assets. Income Tax Expense For the Three Months Ended March 31, 2014 2013 Change (In thousands, except percentages) Income tax expense $ 4,929 $ 4,029 $ 90022.3 % Generally, our effective tax rate is below the U.S. federal tax rate of 35% because we have experienced taxable losses in the U.S. and our income is taxed in foreign jurisdictions where we benefit from tax holidays or tax rates lower than the U.S. statutory rate. Our income tax expense for the three months ended March 31, 2014and 2013, was attributable to income tax on profits earned in certain foreign jurisdictions and foreign withholding taxes. During 2014, our subsidiaries in Korea, Malaysia, the Philippinesand Taiwanoperated under tax holidays which will continue to expire in whole or in part at various dates through 2022. We expect our effective tax rate to increase as the tax holidays expire as income earned in these jurisdictions will then be subject to higher statutory income tax rates.
Equity in Earnings of
For the Three Months Ended March 31, 2014 2013 Change (In thousands, except percentages) Equity in earnings of J-Devices
$ 5,761 $ 55 $ 5,706
Our equity in earnings of
J-Devicesfor the three months ended March 31, 2014, increased compared to the three months ended March 31, 2013, as a result of J-Devices'higher net income and an increase in our ownership interest in J-Devicesfrom 30% to 60% in April 2013. The increase in J-Device's net income was driven by cost reduction efforts and the company's acquisition of three packaging and test facilities in June 2013.
Liquidity and Capital Resources
We assess our liquidity based on our current expectations regarding sales, operating expenses, capital spending and debt service requirements. Based on this assessment, we believe that our cash flow from operating activities, together with existing cash and cash equivalents and availability under our revolving credit facilities, will be sufficient to fund our working capital, capital expenditure and debt service requirements for at least the next twelve months. Thereafter, our liquidity will continue to be affected by, among other things, volatility in the global economy and credit markets, the performance of our business, our capital expenditure levels, other uses of our cash including the final amount of payments due in our pending patent license litigation, any purchases of stock under our stock repurchase program, any acquisitions or investments in joint ventures and our ability to either repay debt out of operating cash flow or refinance it at or prior to maturity with the proceeds of debt or equity offerings. There can be no assurance that we will generate the necessary net income or operating cash flows, or be able to borrow sufficient funds, to meet the funding needs of our business beyond the next twelve months due to a variety of factors, including the cyclical nature of the semiconductor industry and other factors discussed in Part II, Item 1A of this Quarterly Report on Form 10-Q. Our primary source of cash and the source of funds for our operations are cash flows from operations, current cash and cash equivalents, borrowings under available debt facilities and proceeds from any additional debt or equity financings. As of
March 31, 2014, we had cash and cash equivalents of $628.6 million. Included in our cash balance as of March 31, 2014, is $283.4 millionheld offshore by our foreign subsidiaries. If we were to distribute this offshore cash to the U.S. as repatriated - 25-
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earnings of our foreign subsidiaries, we would incur foreign withholding taxes; however, we would not incur a significant amount of U.S. federal income taxes, due to the availability of tax loss carryovers and foreign tax credits. We had availability of
$149.6 millionunder our $150.0 millionfirst lien senior secured revolving credit facility. Our foreign subsidiaries had $70.0 millionavailable to be drawn under secured revolving credit facilities for general corporate purposes, general working capital purposes and capital expenditures and $220.0 millionavailable to be borrowed under secured term loan credit facilities for general working capital purposes, capital expenditures and repayment of inter-company debt. As of March 31, 2014we had $1,652.6 millionof debt. Our scheduled principal repayments on debt include $61.4 milliondue in 2014, $5.0 milliondue in 2015, $70.0 milliondue in 2016, $170.0 milliondue in 2017, $345.0 milliondue in 2018 and $995.0 milliondue thereafter. In April 2014, holders of our 6.0% Convertible Senior Subordinated Notes due April 2014converted the outstanding principal amount of $56.4 millioninto 18.6 million shares of our common stock, and we repaid $60.0 millionof a foreign secured term loan credit facility maturing in July 2017. We were in compliance with all of our debt covenants at March 31, 2014, and we expect to remain in compliance with these covenants for at least the next twelve months. In order to reduce leverage and future cash interest payments, we may from time to time repurchase our outstanding notes for cash or exchange shares of our common stock for our outstanding notes. Any such transaction may be made in the open market, through privately negotiated transactions or otherwise and is subject to the terms of our indentures and other debt agreements, market conditions and other factors. Certain debt agreements have restrictions on dividend payments and the repurchase of stock and subordinated securities. These restrictions are determined by calculations based upon cumulative net income. We have never paid a dividend to our stockholders, and we do not have any present plans for doing so. Amkor Technology, Inc.also guarantees certain debt of our subsidiaries. We sponsor an accrued severance plan for our subsidiary in Korea, which under existing tax laws in Korea, limits our ability to currently deduct related severance expenses accrued under that plan. The purpose of these limitations is to encourage companies to migrate to a defined contribution or defined benefit plan. If we retain our existing severance plan, the deduction for severance expenses will be limited to severance payments made to retired employees, which results in a larger current income tax liability in Korea. If we decide to adopt a new plan, we would be required to fund a significant portion of the existing liability, which would provide a current tax deduction upon funding. Our Korean severance liability was $147.0 millionas of March 31, 2014. We refer you to Note 16 to our Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for a discussion of the pending litigation relating to Amkor'slicense agreement with Tessera. We expect to use cash on hand, proceeds from borrowings under our existing lines of credit or other sources to make any payments that become due in connection with our pending patent license litigation. We operate in a capital intensive industry. Servicing our current and future customers may require that we incur significant operating expenses and make significant investments in equipment and facilities, which are generally made in advance of the related revenues and without any firm customer commitments. Our Board of Directors previously authorized the repurchase of up to $300.0 millionof our common stock, exclusive of any fees, commissions or other expenses. We have not purchased any stock under the plan since 2012. At March 31, 2014, approximately $91.6 millionwas available to repurchase common stock pursuant to the stock repurchase program. The purchase of stock may be made in the open market or through privately negotiated transactions. The timing, manner, price and amount of any repurchases will be determined by us at our discretion and will depend upon a variety of factors including economic and market conditions, the cash needs and investment opportunities for the business, price, applicable legal requirements and other factors. Our stock repurchase program may be suspended or discontinued at any time. - 26-
Table of Contents Investments We make significant capital expenditures in order to service the demand of our customers. During the three months ended
March 31, 2014, our capital expenditures totaled $96.0 million. Our spending was primarily focused on investments in packaging and test equipment supporting mobile communications products. We have recently increased our forecast of 2014 capital expenditures to approximately $575 millionto support the demand of our customers and capture certain growth opportunities related to mobile communications. Ultimately, the amount of our 2014 capital expenditures will depend on several factors including, among others, the timing and implementation of any capital projects under review, the performance of our business, economic and market conditions, the cash needs and investment opportunities for the business, the need for additional capacity to service anticipated customer demand and the availability of cash flows from operations or financing. During 2013, we purchased land in anticipation of building a new factory and research and development center in Korea. The agreement to purchase the land for the facility is subject to our compliance with various construction, investment, hiring, regulatory and other requirements. We anticipate beginning construction of our new factory and research and development center in the second half of 2014. Construction work is planned to continue through 2015 and into early 2016. There can be no assurance that the new facility will proceed at all, or that the actual scope, costs, timeline or benefits of the project will be consistent with our current expectations. In addition, we are subject to risks associated with our capital expenditures, including those discussed in Part II, Item 1A of this Quarterly Report on Form 10-Q under the caption "Capital Expenditures - We Make Substantial Investments in Equipment and Facilities To Support the Demand Of Our Customers, Which May Adversely Affect Our Business If the Demand Of Our Customers Does Not Develop As We Expect or Is Adversely Affected."
The following table summarizes our contractual obligations at
March 31, 2014, and the effect such obligations are expected to have on our liquidity and cash flow in future periods: Payments Due for Year Ending December 31, 2014 - Total Remaining 2015 2016 2017 2018 Thereafter (In thousands) Total debt $ 1,646,350 $ 61,350 $ 5,000 $ 70,000 $ 170,000 $ 345,000 $ 995,000Scheduled interest payment obligations (1) 659,221 96,466 97,615 96,196 90,688 75,449 202,807 Purchase obligations (2) 138,003 117,947 4,032 2,471 2,471 4,908 6,174 Operating lease obligations 69,171 16,195 15,934 6,485 6,300 5,911 18,346 Severance obligations (3) 146,966 8,560 10,447 9,656 8,914 8,219 101,170 Total contractual obligations $ 2,659,711 $ 300,518 $ 133,028 $ 184,808 $ 278,373 $ 439,487 $ 1,323,497
(1) Scheduled interest payment obligations were calculated using stated coupon
rates for fixed rate debt and interest rates applicable at
for variable rate debt.
(2) Represents purchase obligations for capital expenditures and long-term
supply contracts outstanding at
(3) Represents estimated benefit payments for our Korean subsidiary severance
In addition to the obligations identified in the table above, other non-current liabilities recorded in our Consolidated Balance Sheets at
March 31, 2014, include: • $32.3 millionof net foreign pension plan obligations and $3.6 millionfor employee-related liabilities, for which the timing and actual amount of our future cash flow is uncertain.
to the uncertainty regarding the amount and the timing of any future cash
outflows associated with our unrecognized tax benefits, we are unable to
reasonably estimate the amount and period of ultimate settlement, if any, with the various taxing authorities. - 27-
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Off-Balance Sheet Arrangements
Contingencies, Indemnifications and Guarantees
We refer you to Note 16 to our Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for a discussion of our contingencies related to litigation and other legal matters. If an unfavorable ruling were to occur in these matters, there exists the possibility of a material adverse impact on our business, liquidity, results of operations, financial position and cash flows in the period in which the ruling occurs. The potential impact from legal proceedings on our business, liquidity, results of operations, financial position and cash flows could change in the future.
Critical Accounting Policies
Our critical accounting policies are disclosed in our Annual Report on Form 10-K for the year ended
December 31, 2013. During the three months ended March 31, 2014, there have been no significant changes in our critical accounting policies as reported in our 2013 Annual Report on Form 10-K.
New Accounting Pronouncements
For information regarding recent accounting pronouncements, we refer you to Note 2 to our Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q. Cash Flows
Net cash provided by (used in) operating, investing and financing activities for the three months ended
For the Three Months Ended March 31, 2014 2013 (In thousands) Operating activities
$ 131,946 $ 98,674Investing activities (95,539 ) (79,335 ) Financing activities (18,447 ) 32,910 Operating activities: Our cash flow provided by operating activities for the three months ended March 31, 2014, increased by $33.3 millioncompared to the three months ended March 31, 2013. The increase is primarily attributed to improved profitability. Investing activities: Our cash flows used in investing activities for the three months ended March 31, 2014, increased by $16.2 millioncompared to the three months ended March 31, 2013. The net cash used in investing activities for the three months ended March 31, 2013, was impacted by proceeds from the January 2013sale of office space and land located in Chandler, Arizona. Financing activities: The net cash used in financing activities for the three months ended March 31, 2014, was driven by the final payment for our newly acquired power discrete business in Malaysia. The net cash provided by financing activities for the three months ended March 31, 2013, primarily resulted from borrowings at our subsidiary in Korea. We provide the following supplemental data to assist our investors and analysts in understanding our liquidity and capital resources. We define free cash flow as net cash provided by operating activities less purchases of property, plant and equipment. Free cash flow is not defined by U.S. GAAP. We believe free cash flow to be relevant and useful information to our investors because it provides them with additional information in assessing our liquidity, capital resources and financial operating results. Our management uses free cash flow in evaluating our liquidity, our ability to service debt and our ability - 28-
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to fund capital additions. However, free cash flow has certain limitations, including that it does not represent the residual cash flow available for discretionary expenditures since other, non-discretionary expenditures, such as mandatory debt service, are not deducted from the measure. The amount of mandatory versus discretionary expenditures can vary significantly between periods. This measure should be considered in addition to, and not as a substitute for, or superior to, other measures of liquidity or financial performance prepared in accordance with U.S. GAAP, such as net cash provided by operating activities. Furthermore, our definition of free cash flow may not be comparable to similarly titled measures reported by other companies. We experienced positive free cash flow of
$35.9 millionfor the three months ended March 31, 2014, primarily due to improved profitability along with our reduced capital expenditures in the comparable periods. For the Three Months Ended March 31, 20142013 (In thousands)
Net cash provided by operating activities
$ 35,947 $ (13,869 )