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KLA-Tencor Corporation (KLAC - Analyst Report) reported third-quarter 2014 earnings of $1.23 a share, beating the Zacks Consensus Estimate by 13 cents, or 11.8%.

Revenues

KLA reported revenues of $831.6 million, up 17.9% sequentially, 14.1% from the year-ago quarter, within the guided range of $790-$850 million and 1.0% higher than our estimate.

Products generated 81% of total revenue, up 23.1% sequentially and 15.6% year over year. Defect inspection, metrology and other product lines grew 26.2%, 22.8% and -35.8%, respectively, on a sequential basis. They grew 16.4%, 17.9% and -24.3% from a year ago.

Services revenue comprised the remaining 19%, up 0.4% sequentially and 8.2% year over year.

Korea and Europe & Israel were the weakest, declining 47.3% and 35.0%, respectively on a sequential basis, while North America, Taiwan, Japan and Other Asia grew strong double-digits. Revenue from North America and Europe & Israel remained below year-ago levels, while other regions grew. Overall, North America, Taiwan, Japan, Europe & Israel, Korea and Other Asia/Pacific generated 21%, 29%, 12%, 5%, 10% and 22% of quarterly revenue, respectively.

Orders

New orders in the second quarter were $702 million, down 3.6% sequentially and 4.9% year over year. Management said that the weakness versus expectations was on account of temporary weakness at leading edge fabs.

Shipments also declined sequentially, but remained above year-ago levels. Backlog increased 2.3% sequentially and 12.5% from last year. Backlog excluding the value shipped but not recognized as revenue declined 10.0% sequentially but was consistent with year-ago levels.

Overall, the order contribution by segment was as follows: foundry customers 56%, memory 23%, and logic 21%. Foundry demand was weaker than expected because one large customer delayed 20nm deployment, while another delayed capacity addition. New capacity by NAND makers and technology purchases by DRAM makers will drive memory demand.

Logic demand was in line with expectations and management stated that deployments for 20nm and below were already 63% of orders in the last quarter. KLA’s most important logic customer is Intel Corp (INTC - Analyst Report).

Metrology products had a particularly bad quarter, with revenue declining 34.3% and 28.7% from the previous and year-ago quarters, respectively. Wafer inspection grew 3.2% and -14.2% from the previous and year-ago quarters, respectively. Reticle inspection products however saw extreme strength growing 14.0% sequentially and 106.1% from the year-ago quarter. Products were 77% of total orders with services accounting for the balance.

Europe, Korea and Other Asia/Pacific declined. Overall, the order contribution by geography was as follows: North America 36%, Europe 10%, Japan 11%, Korea 5%, Taiwan 25% and Other Asia/Pacific 13%. The relatively higher concentration in Asia is due to the presence of a larger number of foundries and memory manufacturers in the region.

Margins

KLA’s gross margin was down 80 basis points (bps) sequentially and up 109 bps year over year to 59.0%. KLA saw lower-than-expected installation, warranty and retrofit costs in the quarter.

Operating expenses of $225.7 million were down 1.1% sequentially and up 6.0% from a year ago. The operating margin expanded 441 bps sequentially and 315 bps from last year. All expenses as a percentage of sales were either flat or down sequentially and down from last year.

The pro forma net income was $206.2 million, or 24.8% of sales compared to $143.1 million, or 20.3% in the Dec 2013 quarter and $171.3 million, or 23.5% in the Mar quarter of last year. Including one-time acquisition-related charges on a tax-adjusted basis, the GAAP net income was $203.6 million ($1.21 a share) compared to $139.2 million ($0.83 a share) in the previous quarter and $166.5 million ($0.98 a share) in the year-ago quarter. 

Balance Sheet

KLA ended with a cash and short term investments balance of $3.03 billion, consistent with the previous quarter. The company generated $237.7 million of cash from operations, spending $18.2 million on capital expenses, $18.0 million on acquisitions, $59.9 million on share repurchases and $74.8 million on dividends during the quarter.

Guidance

For the fourth quarter of fiscal 2014, KLA expects orders of $625-825 million and shipments of $700-760 million. Quarterly revenues are expected to be between $700 million and $760 million, gross margin of 57-58% and opex in a range of $225-230 million. The tax rate is expected to be 23%, yielding non-GAAP EPS in the range of $0.75 - $0.95, well below the Zacks Consensus Estimate of $1.12.

In Summary

KLA managed to beat expectations, but the guidance was very weak, given order pushouts into the second half of 2014. We should bear in mind that these are not orders lost but orders delayed due to yield issues and other production concerns as most customers transition to smaller geometries. We therefore do not think that a lot of pessimism is warranted.

We note that 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.

At the same time, since each system is high-valued, customer concentration is obviated, which results in great fluctuations in revenue/orders in times of uncertain demand.

KLA shares currently have a Zacks Rank #3 (Hold), so it’s better to go for peers like Lam Research (LRCX - Snapshot Report) and Applied Materials (AMAT - Analyst Report), both of which have a Zacks Rank #2 (Buy).

Read the Full Research Report on KLAC
Read the Full Research Report on INTC
Read the Full Research Report on LRCX
Read the Full Research Report on AMAT


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