KLA-Tencor Corporation’s(KLAC) first quarter earnings beat the Zacks Consensus by 13 cents, or 15.1%. Revenue was also better than expected, beating by 5.0%. Investors did not react too strongly, considering the fact that after-market trading just pulled up prices by 0.76%. We expected the company to report a strong quarter and provide softer guidance and results were within these expectations.
Revenue
KLA reported revenue of $682.3 million, which was up 22.0% sequentially, 99.1% year over year and at the high end of the guided range of $620-660 million. With technology purchases rather than capacity expansions continuing to drive investments in capital equipment, management is optimistic about sustained growth. KLA also stated that 13 new projects were on, so there seems to be optimism regarding capacity purchases further down the line. 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 81% of total revenue, an increase of 28.0% sequentially and 140.2% year over year. Services revenue comprised the remaining 19%, up 2.0% sequentially and 16.1% year over year. Services are likely to grow in importance, as the company strives to maintain its large installed base.
Orders
Orders started declining in the last quarter, as expected. The company reported total orders of $785 million, representing sequential decline of 17.9%. Order levels remained above year-ago levels, increasing 59.2% from the September quarter of 2009. This was at the low end of management guidance of $750-900 million.
Interestingly, the memory segment (38% of total orders) was the only segment that saw sequential increase in orders. We note that KLA has relatively lower exposure to memory, although this is the area that is likely to see some sustained growth. Memory orders were up 365.4% from the year-ago quarter.
The foundry segment (44% of total orders) on the other hand, started softening in the last quarter, declining 11.9% sequentially and 7.8% from a year ago. This is not really surprising, since foundries have been accumulating some inventory.
Logic customers, primarily Intel Corp. (INTC) strengthened in the last quarter, the main reason being Intel’s expenditure at 22nm.
Semiconductor orders were down from 87% in the June quarter to 83% in the September quarter. Orders by product line were—wafer inspection 49%, reticle inspection 11%, metrology 17% and solar, storage, high brightness LED and other non-semiconductor 6%. Services were 17% of total orders.
Orders were fairly broad-based across geographies, although the U.S. and Europe declined substantially to 21% and 4%, respectively from 25% and 12%, respectively in June. Taiwan, Korea, Japan and other Asian countries brought in 34%, 24%, 7% and 10%, respectively of total orders in the September 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 $1.44 billion, up 7.5% sequentially and 121.9% year over year.
The pro forma gross margin for the quarter was 62.2%, up 188 basis points (bps) from the previous quarter’s 60.3% and 1,068 bps from 51.5% in the year-ago quarter. Incremental gross margins were above management’s targeted 60-70%. The gross margin benefited from higher volumes and the resultant improvement in fixed cost absorption over the larger sales base. A richer mix of higher-margin products and the lower-cost manufacturing at Singapore ensures margins at these levels, if revenue holds up.
Operating expenses of $180.4 million were higher than the previous quarter’s $165.7 million. The operating margin was 35.7%, up 506 bps sequentially and 2,878 bps year over year. KLA stated that the increase in operating expenses was partially attributable to the distribution of Apple Inc.’s (AAPL) iPad devices to employees in the last quarter. However, both SG&A and R&D expenses declined as a percentage of sales, which along with the improved gross margins resulted in stellar operating margins.
Excluding the impact of acquisition-related expenses, the associated tax impact, as well as certain discrete tax items, the pro forma net income came in at $168.7 million, or 24.7% of sales, compared to $120.0 million, or 21.4% in the previous quarter and $26.2 million, or 7.6% of sales in the year-ago quarter.
Including the special items, the GAAP net income was $154.2 million ($0.91 per share) compared to income of $113.1 million ($0.66 per share) in the June 2010 quarter and $20.4 million ($0.12 per share) in the September quarter of last year.
Balance Sheet
Inventories were up 15.6%, although inventory turns were flattish at around 2.2x. Days sales outstanding (DSOs) dropped from 72 to around 67. KLA ended with cash and short term investments of $1.52 billion, down $15.0 million during the quarter. The company generated $95.5 million of cash from operations, spending $11.2 million on capital expenses, $62.2 million on share repurchases and $41.8 million on dividend payouts during the quarter.
Guidance
For the second quarter of fiscal 2011, management expects orders to be flat to down 20%, revenue of between $700 million and $740 million, a tax rate of 30% and non-GAAP EPS of between $1.00-1.10 based on 169 million shares. KLA stated that headcount would increase slightly in the next quarter.
In Summary
KLA reported a strong quarter, although guidance indicates that the company is already seeing softness and order trends indicate that the softness is in the semi fab equipment market. Overall, this supports our view that the equipment business has peaked. Consistent with the overall sector, we believe KLA’s results in the next few quarters will not be too exciting. Given the lack of near-term catalysts and prospects of weakening revenues, we expect the shares to be range-bound. Hence the company has a short-term (1–3 months) “Hold” recommendation (Zacks #3 Rank). Our longer-term (6–12 months) rating on KLA shares is also “Neutral”, since we don’t see much benefit from investing in them at this point.
KLA-TENCOR CORP (KLAC): Free Stock Analysis Report
Zacks Investment Research
