KLAC Has Another Good Quarter - Analyst Blog

KLA-Tencor Corporation's (KLAC) second quarter earnings beat the Zacks Consensus by 4 cents, or 3.8%. Revenue was also better than expected, beating by 6.1%. Investors did not react too strongly, considering the fact that after-market trading just pulled up prices by 0.94%.

Revenue

KLAC reported revenue of $766.3 million, which was up 12.3% sequentially, 74.0% year over year and exceeding the high end of the guided range of $700-740 million. While technology purchases continue, the company also significant demand related to capacity additions.

The technical complexity of manufacturing semiconductors and increasingly challenging yield issues remain longer-term revenue drivers for the leading manufacturer of process control equipment.

Products generated 82% of total revenue, an increase of 14.0% sequentially and 99.4% year over year. Services revenue comprised the remaining 18%, up 5.1% sequentially and 10.4% year over year. Services are likely to grow in importance, as the company strives to maintain its large installed base.

The revenue distribution by product line shows the areas that were particularly strong in the last quarter. Defect Inspection is KLAC's most important product line, with a 66% revenue share in the last quarter. The product line grew 22.6% sequentially and 94.5% from last year, driven mainly by strength at foundries.

Metrology brought in another 14% of total revenue, declining 13.1% sequentially, but growing 90.8% from the comparable year-ago quarter. Other products generated 2% of total revenue, down 14.1% and up 1,276.7% from the previous and year-ago quarters. The balance came from services.

Orders

Orders declined again in the last quarter. KLAC reported total orders of $725 million, representing a sequential decline of 7.6%. Order levels remained above year-ago levels, increasing 40.5% from the December quarter of 2009. This was at the high end of management expectations of a sequential decline of 0-20%.

KLAC's fortunes are tied to the foundry segment, first because the company is more exposed to this market and second, because its process control equipment is in higher demand at foundries that are always looking to improve efficiencies in order to drive down costs.

KLAC stated that foundries spent on both technology and capacity expansion in the last quarter and judging from the 51.1% sequential and 71.5% year-over-year increase in foundry orders, this spending is likely to continue.

While memory faced a temporary slowdown (orders declined 51.4% sequentially), KLAC expects increasing demand for NAND to drive up spending again in the March quarter. Orders stayed 65.3% over year-ago levels.

Logic orders softened in the last quarter from both sequential and year-over-year perspectives, but KLAC continued to show optimism stating that 22nm buildouts - most likely at Intel Corp (INTC) – would drive order strength through the year.

There is considerable lumpiness in KLAC's semiconductor business, since individual units are of high value. Consequently, the wafer inspection product line saw orders declining 43.5% sequentially, while reticle inspection saw orders expand 118.3%. Metrology was up 8.7%. Solar, storage, HB LED and other products were down 23.0% sequentially, but up 17.1% from last year.

Orders were fairly broad-based across geographies, although the U.S. and Korea declined substantially to 19% and 16%, respectively from 21% and 24%, respectively in September. Europe, Taiwan, Japan and other Asian countries brought in 10%, 45%, 5%, and 5%, respectively of total orders in the December quarter. The relatively higher concentration in Asia is due to the presence of a larger number of foundries and chip manufacturing companies in the region.

The six-month backlog at quarter-end was $1.4 billion, down 2.8% sequentially abut up 84.5% year over year.

Margins

The pro forma gross margin for the quarter was 60.1%, down 204 basis points (bps) from the previous quarter's 62.2% and up 543 bps from 54.7% in the year-ago quarter. Incremental gross margins were well below the long term target of 60-70%.

KLAC stated that the gross margin decline in the last quarter was mix-related. However, lower-cost manufacturing at Singapore and Israel are offsetting factors.

Operating expenses of $183.5 million were up 1.7% from the previous quarter's $180.4 million. The operating margin was 36.2%, up 45 bps sequentially and 1,875 bps year over year. However, both SG&A and R&D expenses declined as a percentage of sales, offsetting the lower gross margin.

Excluding the impact of restructuring credits, acquisition-related expenses and restatement-related charges on a tax-adjusted basis, as well as certain discrete tax items, the pro forma net income came in at $187.2 million, or 24.4% of sales, compared to $168.7 million, or 24.7% in the previous quarter and $49.4 million, or 11.2% of sales in the year-ago quarter.

Including the special items, the GAAP net income was $185.5 million ($1.09 per share) compared to income of $154.2 million ($0.91 per share) in the September 2010 quarter and $21.8 million ($0.13 per share) in the December quarter of last year.

Balance Sheet

Inventories were up 8.7%, with inventory turns edging up to around 2.4X. Days sales outstanding (DSOs) dropped from 67 to around 63. KLAC ended with cash and short term investments of $1.64 billion, up $117.4 million during the quarter.

The company generated $193.9 million of cash from operations, spending $11.5 million on capital expenses, $62.2 million on share repurchases and $57.0 million on dividend payouts during the quarter.

Guidance

For the third quarter of fiscal 2011, KLAC expects orders to be up 5-25% sequentially, revenue of between $780 million and $830 million, incremental gross margin to be slightly higher than the long-term target of 60-70%, opex to increase slightly, a tax rate of 30%, other income/expense of -$13 million and non-GAAP EPS of between $1.15-1.30 based on 169 million shares outstanding. KLAC stated that headcount would increase slightly in the next quarter.

In Summary

KLAC reported a strong quarter, although order trends are not too encouraging at this point. While this supports projections from Gartner and SEMI regarding a peaking of the equipment cycle, we note that there are undercurrents of growth this year from NAND an foundry buildouts.

Consistent with the overall sector, we believe KLAC's results in the next few quarters will not be too exciting, particularly since year-over-year comps will start getting more difficult come March. Given the lack of near-term catalysts and prospects of weakening revenues, we expect the shares to be range-bound.

Hence we have a short-term hold recommendation (Zacks Rank #3) on the shares. Our longer-term (6-12 months) rating on KLAC shares is also Neutral, since we don't see much benefit from investing in them at this point.

 
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