KLA-Tencor Corporation’s (KLAC) first quarter earnings came in line with the Zacks Consensus Estimate. Results were weak as expected due to the broad-based revenue decline that impacted margins in the last quarter. However, the lower tax rate helped.
Revenue
KLA reported revenue of $796.5 million, which was down 10.8% sequentially, up 16.7% year over year and within the guided range of $770-820 million. The technical complexity of manufacturing semiconductors and increasingly challenging yield issues remain secular 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 82% of total revenue, a decline of 12.6% sequentially and increase of 18.1% year over year. Services revenue comprised the remaining 18%, down 1.7% sequentially and up 11.0% year over year. Services are likely to grow in importance, as the company strives to maintain its large installed base.
The metrology product line was the clear winner in the last quarter, increasing 20.1% and 52.1% from the previous and year-ago quarters, respectively. Defect inspection (the largest segment) dropped 20.4% sequentially, while growing 7.4% from last year.
Other products were down 24.4% sequentially and up 21.2% year over year. Services were down 3.3% sequentially and up 13.1% from last year. Defect inspection, metrology, other products and services generated 56%, 23%, 3% and 18%, respectively of quarterly revenue.
The U.S. and Taiwan, together generating 53% of quarterly revenue were up strongly from both the previous and year-ago quarters. Japan and Europe & Israel (together 29%) were down sequentially, while increasing from last year. Korea and other Asian countries were very weak, declining both sequentially and from the year-ago quarter.
Orders
KLA’s orders were down 43.0% sequentially and 38.1% year over year to $486 million in the last quarter. The decline in orders was broad-based across foundries, memory and logic segments, although foundry appeared to be holding out better than the others. December quarter orders were guided up 25-45%, because KLA is seeing some traction from 28nm manufacturing, where yield issues are a challenge.
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.
As a result, the segment continued to generate the largest chunk of revenue (57%) in the last quarter, despite the 24.5% sequential and 19.8% year-over-year declines in revenue. The last quarter appears to be a trough in foundry spending, since guidance was significantly stronger.
The memory segment (21% of total orders) was down 60.1% and 65.8%, respectively from the previous and year-ago quarters. The NAND side remains the major driver of growth in memory and KLA has been seeing some gains at NAND manufacturers that should help the company. DRAM remains sluggish, consistent with industry-wide trends.
Logic brought in the remaining 22% of orders, down 53.6% sequentially and 24.3% from the year-ago quarter.
There is considerable lumpiness in KLA’s semiconductor business, since individual units are of high value. However the last quarter’s performance includes market softness as well, as evident from the significant declines from both the previous and year-ago quarters.
The wafer inspection product line saw orders declining 62.0% on a sequential basis and 64.6% year over year. Reticle Inspection declined 39.7% sequentially, while increasing 1.3% from a year ago. Metrology was down 55.7% sequentially and 49.0% from last year Solar, storage, HB LED and other products were down 14.5% sequentially and 7.1% from last year.
Orders declined across all geographies except Korea. The U.S. and Japan saw the biggest declines from June. Overall, the order contribution by geography was as follows—The U.S. 25%, Europe 7%, Japan 8%, Taiwan 22%, Korea 29% and Other Asia/Pacific 9%. 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 $1.1 billion, down 21.4% sequentially and 23.6% year over year.
Margins
As may be expected, the significantly lower volumes also pulled down KLA’s gross margin in the last quarter. As a result, the pro forma gross margin for the quarter shrunk down 268 basis points (bps) from the previous quarter’s 60.7% and 412 bps from 62.2% in the year-ago quarter to 58.0%. Incremental gross margins jumped, much higher than the targeted of 60-70%.
Operating expenses of $197.8 million were up 7.4% from the previous quarter’s $184.2 million. The operating margin was 33.2%, down 688 bps sequentially and 252 bps year over year. While all expenses increased sequentially as a percentage of sales, cost of sales alone pulled down the comparison with the year-ago quarter.
Excluding the impact of acquisition-related expenses, restructuring costs and restatement-related charges on a tax-adjusted basis, the pro forma net income came in at $198.1 million, or 24.9% of sales, compared to $254.4 million, or 28.5% in the previous quarter and $168.7 million, or 24.7% of sales in the year-ago quarter.
Including the special items, the GAAP net income was $191.9 million ($1.13 per share) compared to income of $245.0 million ($1.43 per share) in the June 2011 quarter and $154.2 million ($0.91 per share) in the September quarter of last year.
Balance Sheet
Inventories were up 6.4%, with inventory turns going down slightly from 2.4 X to 2.2X. Days sales outstanding (DSOs) went down further from 60 to around 53. KLA ended with cash and short term investments of $2.10 billion, up $61.6 million during the quarter. The company generated $219.0 million of cash from operations, spending $12.1 million on capital expenses, $66.4 million on share repurchases and $58.5 million on dividends during the quarter.
Guidance
For the second quarter of fiscal 2012, KLA expects orders to be up 25-45%, revenue of between $600 million and $650 million, gross margin of 57-58%, opex of $200-205 million, 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 $0.56-0.72.
In Summary
KLA’s results and guidance indicate that the fiscal second quarter will be the trough, with revenue increasing thereafter. Management’s optimism is based on the fact that foundry orders appear to be coming back, mainly on account of yield issues at 28nm.
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.
While management tone has turned positive, we cannot ignore the excess capacity that remains at foundries, which increases the risk that any improvement in the market could be short-lived. 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.
Estimates for the next few quarters and fiscal years 2012 and 2013 have moved down over the past seven days, reflecting the current market trends. However, expectations for fiscal 2013 remain higher than those for fiscal 2012.
KLA shares currently carry a Zacks Rank of #3, implying a short-term Hold recommendation. We have a similar rank on other equipment providers, such as Novellus Systems (NVLS) and Applied Materials (AMAT).
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