KLA-Tencor Corporation (KLAC) reported second-quarter 2015 earnings of $0.68 a share, topping the Zacks Consensus Estimate of 51 cents by 33.3%. However, management tone was conservative, impacted by yield and other issues at customers, which continue to impact orders in its vital foundry and logic markets.
A quick look at the numbers-
Revenues
KLA reported revenues of $676.4 million, up 5.2% sequentially, but down 4.1% from the year-ago quarter, above the guided range of $590-650 million and 2.2% over the Zacks Consensus Estimate.
Products generated 74% of total revenue, up 5.7% sequentially and down 7.4% year over year. Services revenue comprised the remaining 26%, up 3.7% sequentially and 7.2% year over year.
As usual, management didn’t discuss the revenue breakup by category and geography on the call, so the data won’t be available until the company files its quarterly report.
Orders
New orders in the second quarter were $865 million, up 52.6% sequentially, 18.8% year over year and higher than the guided $620-700 million. Sub-20nm investments at foundry and logic customers and 20nm conversions in DRAM were the main drivers of orders in the quarter.
Management was optimistic about market growth trends for the year, saying that stronger demand for leading edge devices and improved profitability at customers would lead to a 5-10% increase in wafer fab equipment investment in 2015.
But KLA did see some order pushouts as well. Some sub-20nm orders expected in the current quarter are now expected for later in the year. Management said that yield and process stability issues were leading to delays.
Shipments grew sequentially but remained below year-ago levels. The extended lead times are resulting in lower shipment comparisons in the near term, but as indicated by KLA management during the third quarter, they were up nearly 40% sequentially in the fourth quarter. So some of the long-lead time business is beginning to kick in.
Backlog grew 8.3% and 5.9% from the previous and year-ago quarters, respectively. Backlog excluding the value shipped but not recognized as revenue grew 1.1% sequentially and 26.6% from year-ago levels.
Overall, the order contribution by segment was as follows: foundry customers 49%, memory 44% and logic 7%.
Management has said that foundry contribution will jump to 62% in the December quarter, so results were somewhat lower than expected due to the yield issues discussed above.
All product lines grew both sequentially and year over year. The wafer inspection, reticle inspection and metrology product lines generated 47%, 11% and 20% of quarterly revenue, with reticle inspection growing the strongest sequentially (459.4%), followed by metrology (103.4%) and wafer inspection (46.3%). Other products brought another 2%. Services accounted for the remaining 20%.
Margins
KLA’s gross margin expanded 295 basis points (bps) sequentially and shrank 130 bps year over year to 58.5%. The better-than-expected gross margin was due to a favorable mix of products and services, factory efficiencies related to higher volumes and a favorable currency impact at offshore factories.
Operating expenses of $231.4 million were up 3.6% sequentially, 1.4% from a year ago and lower than guided. The operating margin expanded 606 bps sequentially and increased 316 bps from last year helped by cost management.
The pro forma net income was $112.8 million, or 16.7% of sales compared to $78.7 million, or 12.2% in the Sep 2014 quarter and $143.1 million, or 20.3% in the December quarter of last year. Including one-time restructuring, acquisition-related and other charges as well as the loss of extinguishment of debt on a tax-adjusted basis, the GAAP net income was $20.3 million ($0.12 a share) compared to $72.2 million ($0.43 a share) in the previous quarter and $139.2 million ($0.83 a share) in the year-ago quarter.
Balance Sheet
KLA ended with a cash and short term investments balance of $2.37 billion, down $575.7 million from the previous quarter. During the quarter, the company generated $11.1 million of cash from operations, spending $12.8 million on capital expenses, $141.5 million on share repurchases, $2.80 billion on dividends and $877.4 million to retire its debt. The last two items were related to the leveraged recapitalization during the quarter.
Guidance
For the third quarter of fiscal 2015, KLA expects orders of $500-700 million. Quarterly revenues are expected to be between $685 million and $765 million, gross margin of 56.5-57.5% and opex in a range of $227-229 million.
The tax rate is expected to be 22%, yielding non-GAAP EPS in the range of $0.63 – $0.87, an extremely wide range and well below the Zacks Consensus Estimate of $1.03. The weak guidance is mainly because of increased uncertainties related to the timing of orders and extended lead times, which is having an effect on order shipments, revenue and therefore, margins.
In Summary
KLA-Tencor reported a strong quarter dampened by a rather conservative 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. 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)-rated company.
But you may instead consider these better-ranked stocks: Intel (INTC), Altera (ALTR) or Avnet (DANG), all of which have a Zacks Rank #2 (Buy).
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