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KLA-Tencor Corporation (KLAC - Analyst Report) reported fourth-quarter 2013 earnings of 82 cents per share, beating the Zacks Consensus Estimate of 79 cents.

Revenues

KLA reported revenues of $720.0 million, down 1.2% sequentially and 19.3% from the year-ago quarter. Reported revenues were toward the higher end of the company guided range of $670 million - $730 million.

KLA-Tencor remains an equipment supplier in a weak demand environment. Customers are making the most of existing inventory, and maintaining low utilization rates. Additionally, since each system is high-valued, there is a natural customer concentration, which results in great fluctuations in revenue/orders in times of weak demand. All these factors were evident in KLA’s fourth-quarter results.

Products generated 79% of total revenue, a 23.5% year-over-year decline. Services revenues comprised the remaining 20%, an increase of 7.1% year over year.

Orders

New orders in the fourth quarter were $713 million, down 3.4% sequentially. The last quarter was not a good one for KLA in terms of orders, although the memory side of the business was quite strong.

Overall, the order contribution by segment was as follows: foundry customers 33%, logic customers 23% and memory customers accounted for 44% of new orders in the last quarter.

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. Historically, KLA has had low exposure to the memory segment, but management’s focus on the area and declines in other segments have made it a more significant contributor. KLA’s strength in the logic segment is tied to its relationship with Intel Corp. (INTC - Analyst Report), which is ramping its 14nm production.

The wafer inspection product line saw new system orders increase of 5.9% on a sequential basis. Reticle Inspection was up 50.0% sequentially, Metrology was down 30.0% sequentially, Non-semi businesses were down 33.3% sequentially, while Service was up 5% sequentially.

U.S., Japan and Other Asia/Pacific drove the increase in orders. Overall, the order contribution by geography was as follows: The U.S. 38%, Europe 6%, Japan 12%, Korea 10%, Taiwan 10% and Other Asia/Pacific 24%. The relatively higher concentration in Asia was due to the presence of a larger number of foundries and memory manufacturers in the region.

Margins

KLA’s gross margin was down 10 basis points (bps) sequentially and 210 bps year over year to 57.4%. The decrease was on account of lower revenues.

Operating expenses of $225.9 million were up 6.3% from the year-ago quarter. Operating margin was 26.1%, down 960 bps year over year. Higher research and development (R&D) and selling, general and administrative (SG&A) expenses as a percentage of sales were responsible for the contraction from last year.

The quarter’s GAAP net income was $134.8 million or earnings per share of 80 cents compared with net income of $247.9 million or $1.46 in the comparable quarter last year. Excluding the impact of acquisition-related and restructuring charges on a tax-adjusted basis, pro forma net income came in at $138.6 million or 82 cents per share compared to $253.4 million or $1.49 per share in the year-ago quarter.

Balance Sheet

KLA ended with cash and short-term investments balance of $2.92 billion, up $39.4 million during the quarter. Accounts receivables were $524.6 million versus $454.2 million in the prior quarter.

The company generated $175.6 million in cash from operations, spending $18.9 million on capital expenses, $68.3 million on share repurchases and $66.2 million on dividends during the quarter.

Guidance

For the first quarter of fiscal 2014, KLA expects orders of $600-$750 million and shipments of $620-$680 million. Quarterly revenues are expected to be between $620 million and $680 million, gross margin between 56%-57.5%, and opex in a range of $218-$222 million. The tax rate is expected to be 23%, yielding non-GAAP EPS in the range of 53 - 73 cents, below the Zacks Consensus Estimate of 87 cents.

In Summary

KLA’s fourth quarter results and first quarter guidance indicate that the key foundry segment remains under pressure.

However, underlying drivers (process node transition and strong demand for smartphones and mobile computing devices) should increase capex spending in the second half of the year.

The technical complexity of manufacturing semiconductors and increasingly challenging yield issues are long-term revenue drivers for this leading manufacturer of process control equipment.

Currently, KLA shares have a Zacks Rank #2 (Buy). Investors can also consider some other stocks with a positive Zacks Rank and expected surprise prediction or ESP Read: Zacks Earnings ESP: A Better Method):

  • InvenSense Inc. (INVN - Snapshot Report), Earnings ESP of +8.33% and a Zacks Rank #2 (Buy)
  • Gartner Inc. (IT - Snapshot Report), Earnings ESP of +1.96% and a Zacks Rank #2 (Buy)
  • Scientific Games Corp. (SGMS - Analyst Report), with an ESP of +100.0% and a Zacks Rank #3 (Hold)

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