KLA-Tencor Corporation (KLAC) reported first-quarter 2014 earnings of $0.47 a share, topping the Zacks Consensus Estimate of 46 cents, or 2.2%. Management offered very limited commentary on the quarterly results saying that the trends remain largely the same. The discussion instead focused on the leveraged recapitalization, which sent shares soaring.
The leveraged recapitalization is intended to raise capital to return value to shareholders and entails a special cash dividend of $16.50 per share, (23% of share price on Oct 22) or an aggregate value of $2.75 billion to be paid by year-end. This is in addition to the regular cash dividend. It will also repurchase up to 3.6 million additional shares for $250 million in aggregate.
A quick look at the numbers:
Revenues
KLA reported revenues of $642.9 million, down 12.5% sequentially, 2.3% from the year-ago quarter, within the guided range of $590-650 million and 3.4% over the Zacks Consensus Estimate.
Products generated 74% of total revenue, down 16.4% sequentially and 5.0% year over year. Services revenue comprised the remaining 26%, up 1.5% sequentially and 6.2% year over year.
Defect inspection and services were clearly the points of strength in the last quarter, growing a respective 85.6% and 86.6% sequentially and a respective 8.7% and 6.2% year over year. Metrology and other products were down a respective 59.2% and 87.4% from the Jun 2014 quarter. They also declined 28.7% and 65.9% year over year. The defect inspection, metrology and other products generated 58%, 15% and 1% of quarterly revenue, respectively. Services brought in the rest.
The U.S., Taiwan, Europe & Israel were notably weaker, down 2.8%, 45.6% and 20.4%, respectively from Jun 2014. Europe & Israel and Korea declined 54.6% and 10.3% from last year while all other regions grew. The strongest growth came from Japan (up 25.9% sequentially, 37.8% year over year). Revenue share by region was as follows- the U.S. 30%, Taiwan 20%, Japan 17%, Korea 11%, Other Asia/Pacific 13% and Europe & Israel 9%.
Orders
New orders in the second quarter were $567 million, down 36.9% sequentially, 28.2% year over year and short of the guided $600-800 million. Management attributed the decline to a foundry customer, which pushed out orders during the quarter.
Shipments declined both sequentially and from year-ago levels. The extended lead times are resulting in lower shipments in the near term, but KLA management expect a 40% increase in the current quarter. Backlog was consistent with both the previous and year-ago quarters. Backlog excluding the value shipped but not recognized as revenue grew 10.3% sequentially and 8.2% from year-ago levels.
Overall, the order contribution by segment was as follows: memory customers 46%, logic 28% and foundry 25%.
Foundry orders were impacted by the push-out of an order worth $100 million at a single customer. In the June quarter, management mentioned a large 20nm order, shipments related to which will not start until later this year and will continue through 2015, which is why it will not have an impact on near term revenue. Management has said that foundry contribution will jump to 62% in the Dec quarter.
20nm and below processes accounted for 66% of orders in the last quarter.
The decline in orders was broad-based across product lines but reticle inspection and metrology suffered the most in the year on year comparison. The wafer inspection, reticle inspection and metrology product lines generated 49%, 3% and 15% of quarterly revenue. Other products brought another 3%. Services accounted for 30%.
Margins
KLA’s gross margin shrank 35 basis points (bps) sequentially and 266 bps year over year to 55.6%. The better-than-expected gross margin was due to a favorable mix of products and lower-than-expected parts costs related to the services business.
Operating expenses of $240.0 million were up 4.0% sequentially, 5.3% from a year ago and higher than guided. The operating margin shrank 624 bps sequentially and 536 bps from last year due to the significant decline in revenue and higher employee-related costs.
The pro forma net income was $78.7 million, or 12.2% of sales compared to $133.2 million, or 18.1% in the Jun 2014 quarter and $114.9 million, or 17.5% in the Sep quarter of last year. Including one-time restructuring and acquisition-related charges on a tax-adjusted basis, the GAAP net income was $72.2 million ($0.43 a share) compared to $128.7 million ($0.77 a share) in the previous quarter and $111.2 million ($0.66 a share) in the year-ago quarter.
Balance Sheet
KLA ended with a cash and short term investments balance of $2.94 billion, down $210.1 million from the previous quarter. The company generated $34.9 million of cash from operations, spending $13.4 million on capital expenses, $124.8 million on share repurchases and $82.4 million on dividends during the quarter.
Guidance
For the first quarter of fiscal 2015, KLA expects orders of $620-700 million. Quarterly revenues are expected to be between $590 million and $650 million, gross margin of 56-57% and opex in a range of $236-238 million. The tax rate is expected to be 24%, yielding non-GAAP EPS in the range of $0.46 – $0.70, an extremely wide range and well below the Zacks Consensus Estimate of $0.91. The weak guidance is mainly because of extended lead times on its recent orders, which is having an effect on order shipments, revenue and therefore, margins.
In Summary
KLA-Tencor reported a weak quarter and provided disappointing guidance. Note that since each system is high-valued, customer concentration is obviated, which results in great fluctuations in revenue/orders in times of uncertain demand. However, the business is expected to recover in the Dec quarter, as some longer-lead time orders are converted. KLA is still highly dependent on foundries, where orders and revenues are expected to rebound driven by the transition to 20nm and below.
However, underlying demand remains strong given the high demand for more efficient manufacturing processes and the preference for mobile. The technical complexity of manufacturing semiconductors and increasingly challenging yield issues remain revenue drivers for this leading manufacturer of process control equipment.
Considering the weak outlook and commentary, estimates are likely to come down, which would further pressure this Zacks Rank #4 (Sell) company. Although, share prices are likely to remain buoyant because of the special dividend and share repurchase program.
But you may also consider these better-ranked stocks — Intel (INTC), Micron (MU), or even Ecommerce China Dangdang (DANG), all of which have a Zacks Rank #2 (Buy).
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