KLA-Tencor Corporation’s (KLAC) second quarter earnings exceeded the Zacks Consensus Estimate by 6 cents, driving the shares up 3.74% in after-market trading.
Revenue
KLA reported revenue of $642.5 million, which was down 19.3% sequentially, 16.2% year over year, within the guided range of $600-650 million and slightly ahead of the consensus estimate of $631.3 million. The technical complexity of manufacturing semiconductors and increasingly challenging yield issues remain revenue drivers for the leading manufacturer of process control equipment.
Additionally, delays in EUV adoption are likely to increase yield issues and the demand for better yields, which will be a positive for KLA.
Products generated 78% of total revenue, a decline of 23.0% sequentially and 20.3% year over year. Services revenue comprised the remaining 22%, down 3.0% sequentially and up 2.4% year over year. Services are likely to grow in importance, as the company strives to maintain its large installed base.
As usual, KLA did not provide product-wise and geography-wise details on the call, so they would not be available until the company files its Form 10Q.
Orders
KLA’s orders were up 95.5% sequentially and 31.0% year over year to $950 million in the last quarter. Logic customers generated the strongest growth in the last quarter, followed by foundry and then memory. March quarter orders are expected to be softer however, as the spurt in logic and foundry spending may be expected to moderate.
KLA’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. In the last quarter, KLA benefited from the continued ramp up of 28nm processes, as well as capacity builds at 32nm. As a result, the segment continued to make up the largest chunk of orders (57%) in the last quarter.
The memory segment (16% of total orders) was up 48.9% and 4.8%, respectively from the previous and year-ago quarters, mainly on account of increased technology-driven spending. The NAND side remains the major driver of growth in memory and KLA stated that NAND spending overtook DRAM for the first time in the last quarter.
Logic brought in the remaining 27% of orders, up 139.9% sequentially and 342.2% from the year-ago quarter, driven mostly by a diversified chip manufacturer looking to increase its leading edge logic capacity.
There is considerable lumpiness in KLA’s semiconductor business, since individual units are of high value. However the last quarter’s performance indicates that the market is recovering.
The wafer inspection product line saw orders jumping 235.1% on a sequential basis and 109.7% year over year. Reticle Inspection grew 41.2% sequentially, while declining 34.5% from a year ago. Metrology was up 207.2% sequentially and 44.1% from last year. Solar, storage, HB LED and other products were down 34.8% sequentially and 21.4% from last year.
All except Europe and smaller Asian countries grew orders in the last quarter. Korea and Taiwan saw the biggest increases, followed by Japan and the U.S. Overall, the order contribution by geography was as follows–The U.S. 19%, Europe 2%, Taiwan 39%, Korea 28%, Japan 9% and Other Asia/Pacific 3%. The relatively higher concentration in Asia is due to the presence of a larger number of foundries and memory manufacturers in the region.
The six-month backlog at quarter-end was $1.4 billion, up 27.3% sequentially and flat year over year.
KLA’s gross margin expanded just 31 bps sequentially to 58.3%, as the lower revenue were almost totally offset by lower inventory-related charges. It also shrunk 177 bps from the year-ago quarter. Incremental gross margins dropped to just below the targeted 60-70%.
Operating expenses of $206.5 million were up 4.4% from the previous quarter’s $197.8 million. The operating margin was 26.2%, down 700 bps sequentially and 997 bps year over year. While except cost of sales increased sequentially as a percentage of sales, although the increase in ER&D was the most significant. ER&D was also the most significant contributor to the decline from the year-ago quarter (57%), followed by SG&A and then cost of sales.
Excluding the impact of acquisition-related expenses and restructuring costs on a tax-adjusted basis, as well as some discrete tax items, the pro forma net income came in at $121.9 million, or 19.0% of sales, compared to $198.1 million, or 24.9% in the previous quarter and $187.2 million, or 24.4% of sales in the year-ago quarter.
Including the special items, the GAAP net income was $110.8 million ($0.66 per share) compared to income of $191.9 million ($1.13 per share) in the September 2011 quarter and $185.5 million ($1.09 per share) in the December quarter of last year.
Balance Sheet
Inventories were up 4.4%, with inventory turns going down slightly from 2.2 X to 1.7X. Days sales outstanding (DSOs) went up from 53 to around 77. KLA ended with cash and short term investments of $2.18 billion, up $76.5 million during the quarter. The company generated $187.2 million of cash from operations, spending $14.9 million on capital expenses, $63.6 million on share repurchases and $58.1 million on dividends during the quarter.
Guidance
For the second quarter of fiscal 2012, KLA expects orders to be down 13.2% to up 2.6%, revenue of between $770 million and $830 million, opex to be flat sequentially, other income/expense to be a net expense of $10 million, tax rate 26% and a share count of 169 million, resulting in a non-GAAP EPS of between $1.00-1.18.
In Summary
KLA reported a good quarter, although the guidance was not very exciting. Management’s optimism is based on the fact that foundry orders appear to be coming back, mainly on account of yield issues at 28nm and the fact that process control equipment is expected to remain an important investment area.
Additionally, KLA has been recording some wins at NAND manufacturers that have done better than other memory makers this year and are likely to remain stronger. Therefore, although KLA’s position in the segment is below desirable levels, the increasing penetration is a positive.
We are not surprised by the softer order guidance for next quarter, since we cannot ignore the excess capacity that remains at foundries. We think that significant growth in KLA’s business is not likely until semiconductor demand gains momentum, driving foundries to capacity expansion. This could happen in the back half of calendar 2012 if economic pressures alleviate.
While the non-semi business could have provided something of a buffer in these trying times, there are issues in the solar market as well, which makes this difficult. Additionally, the segment still generates less than 10% of its orders, so the impact is relatively small.
There have been limited changes in estimates over the last month or so and expectations for fiscal 2013 remain higher than those for fiscal 2012, indicating improving trends.
KLA shares currently carry a Zacks Rank of #2, implying a short-term Buy recommendation. We are also positive about other equipment providers, such as Novellus Systems (NVLS), although we are slightly less positive about Applied Materials (AMAT) given its exposure to solar.
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