KLA Casualty of Weak Mobile Demand

Zacks

KLA-Tencor Corporation’s (KLAC) fourth quarter earnings exceeded the Zacks Consensus Estimate by 18 cents, but investors remained unexcited, as orders remained sluggish.

Revenue

KLA reported revenue of $892.5 million, which was up 6.2% sequentially but consistent with the year-ago quarter. Revenue did, however, exceed the mid-point of guidance and was also ahead of the consensus estimate of $874.4 million.

The technical complexity of manufacturing semiconductors and increasingly challenging yield issues remain revenue drivers for the leading manufacturer of process control equipment. Additionally, despite Intel’s (INTC) efforts to speed up EUV technology development, adoption is likely to remain slow.

Therefore, the increase in yield issues and demand for better yields will remain positive influences on KLA in the near-to-medium term.

Products generated 84% of total revenue, an increase of 6.3% sequentially and 0.3% year over year. Services revenue comprised the remaining 16%, up 5.4% sequentially and down 1.3% 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 category-wise and region-wise revenue breakup on the call and the performance by category and geography will only be available when the company files its Form 10Q. 

Orders

KLA’s orders were flat sequentially and down 3.0% year over year to $827 million in the last quarter. We note that the quarter benefited from the pull-in of one big order from the March quarter, without which there would have been a substantial order decline on a sequential basis.

While order trends indicate conservatism at customers, management assured that significant yield issues remained at 28nm and below. Therefore, it appears that the current pause is driven by end-market concerns as consumers tighten their purse strings.

Foundry was the only segment to have grown from both the previous and year-ago quarters. Since KLA generates a major chunk of its revenue (65% in the last quarter) from the segment, this strength was sufficient to offset the weakness in memory and logic.

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. However, KLA cited weaker expectations by “industry observers” that now expect a 10-15% capex growth in 2012. The weaker outlook is the result of increased caution at foundry and memory makers.  

The memory segment (15% of total orders) was down 6.9% and 50.3%, respectively from the previous and year-ago quarters. Overall demand drivers weakened with weaker expectations for the mobile segment, which impacted production in the quarter.

Logic brought in the remaining 20% of orders, down 31.5% sequentially and 26.3% from the year-ago quarter. We note that logic demand in the March quarter was attributable to 28nm builds, as well as R&D for production at even lower geometries. With Intel Corp (INTC) as a major customer, the decline was not totally unexpected, since Intel’s investment is tapering off. 

There is considerable lumpiness in KLA’s semiconductor business, since individual units are of high value and there are a few large customers accounting for the bulk of revenue/orders.

The wafer inspection product line saw orders drop 11.8% on a sequential basis, while growing 10.8% year over year. Reticle Inspection was up 48.9% sequentially and down 48.7% from a year ago. Metrology was up 15.0% sequentially and 18.5% from last year. Solar, storage, HB LED and other products were down 25.5% sequentially and 51.5% from last year.

Taiwan and the U.S. saw order increases, while other geographies declined. Overall, the order contribution by geography was as follows—The U.S. 26%, Europe 3%, Taiwan 55%, Korea 8%, Japan 6% and Other Asia/Pacific 2%. 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 $1.23 billion, down 7.9% sequentially and 11.9% from the year-ago quarter.

Margins

KLA’s gross margin jumped 169 bps sequentially, to 60.0%, due to higher volume and favorable product mix. It also shrunk 74 bps from the year-ago quarter. The incremental gross margin was well over the targeted 60-70%.

Operating expenses of $210.1 million were up 5.7% from the previous quarter’s $198.7 million. The operating margin was 36.4%, up 179 bps sequentially and down 364 bps year over year. ER&D as a percentage of sales was up slightly on a sequential basis and more significantly from the year-ago quarter. SG&A was flattish compared with both quarters.

Excluding the impact of acquisition-related expenses on a tax-adjusted basis, the pro forma net income came in at $254.8 million, or 28.6% of sales, compared to $215.8 million, or 25.7% in the previous quarter and $254.4 million, or 8.5% of sales in the year-ago quarter.

Including the special item, the GAAP net income was $247.9 million ($1.46 per share) compared to income of $205.3 million ($1.21 per share) in the March 2012 quarter and $245.0 million ($1.43 per share) in the June quarter of last year.

Balance Sheet

Inventories were flat sequentially, with inventory turns also flat at 2.2X. Days sales outstanding (DSOs) went from 69 to around 72. KLA ended with cash and short term investments of $2.53 billion, up $164.7 million during the quarter. The company generated $273.3 million of cash from operations, spending $16.3 million on capital expenses, $66.9 million on share repurchases and $58.5 million on dividends during the quarter.

Guidance

For the first quarter of fiscal 2013, KLA expects orders to be down 24.4% to 6.3%, revenue of between $700 million and $760 million, gross margin of 56.5-57.5%, opex to be slightly up sequentially, other income/expense to be a net expense of $11 million, a tax rate of 24% and a share count of 170 million, resulting in a non-GAAP EPS of between $0.75-$0.95, well below the Zacks Consensus Estimate of $1.15.

In Summary

KLA’s fourth quarter results and first quarter guidance indicates slowing end markets and caution at customers. While the company’s technology increases the efficiency of semiconductor manufacturing, leading to relatively stronger demand than other equipment makers, there will be the inevitable slowdown in capital equipment purchases.

The market environment has turned adverse for KLA because of the sudden weakness in demand for mobile devices that usually drives demand for higher volumes at foundries and memory manufacturers.

The non-semi business also weakned in the last quarter and it appears that the issues in the solar market have started impacting the company. Of course, the segment still generates a very small percentage of its orders, so the impact is relatively small.

There have been no changes in estimates over the last few months and expectations for fiscal 2013 remain higher than those for fiscal 2012, indicating improving trends.

KLA shares currently carry a Zacks Rank of #3, implying a short-term Hold recommendation. The environment is clearly telling on other equipment makers as well, as seen from the Zacks Ranks of #3 and #4 (Sell), respectively on equipment makers Lam Research (LRCX) and Applied Materials (AMAT).

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