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KLA-Tencor Corporation (KLAC - Free Report) reported fourth-quarter 2014 earnings of $0.80 a share, missing the Zacks Consensus Estimate by 10 cents, or over 11%.




KLA reported revenues of $734.3 million, down 11.7% sequentially, up 2.0% from the year-ago quarter, within the guided range of $700-$760 million and 2.0% lower than our estimate.

Products generated 78% of total revenue, down 14.9% sequentially and flat year over year. Services revenue comprised the remaining 22%, up 1.5% sequentially and 9.5% year over year.


New orders in the second quarter were $898 million, up 27.9% sequentially, 25.9% year over year and better than the guided 625-825 million. The strength in the last quarter was related to foundry demand in the sub-20nm category. DRAM is also picking up.

Shipments declined both sequentially and from year-ago levels. Backlog increased 9.1% from both periods. Backlog excluding the value shipped but not recognized as revenue grew 17.6% sequentially and 12.3% from year-ago levels.

Overall, the order contribution by segment was as follows: foundry customers 68%, memory 23%, and logic 9%. Foundry orders were helped by a large 20nm deployment that was pushed out from the March quarter. However, shipments related to this order will not start until later this year and will continue through 2015, which is why it will not have an impact on near term revenue.

The DRAM strength was related to 2X technology transitions with NAND demand remaining moderate. 3D NAND deployments were negigible. The decline in logic demand was largely as expected. Since Intel (INTC - Free Report) is a major customer in this segment, its product ramps have an impact on KLA’s business.

All product lines grew strong double-digits from the year-ago quarter. On a sequential basis, wafer inspection, reticle inspection and metrology grew 52.9%, -1.6% and 19.4%, respectively. This is the strongest growth rate for the wafer inspection business since the second quarter of fiscal year 2012.


KLA’s gross margin shrank 310 basis points (bps) sequentially and 188 bps year over year to 55.1%. Management attributed the weaker-than-expected margin to an unfavorable mix of products and higher-than-expected costs related to the services business.

Operating expenses of $230.9 million were up 2.3% sequentially and 3.6% from a year ago. The operating margin shrank 740 bps sequentially and 237 bps from last year as all except SG&A expenses increased substantially as a percentage of sales. SG&A was up significantly from the previous quarter but was flattish with the year-ago quarter.

The pro forma net income was $133.2 million, or 18.1% of sales compared to $206.2 million, or 24.8% in the Mar 2014 quarter and $138.6 million, or 19.2% in the June quarter of last year. Including one-time restructuring and acquisition-related charges on a tax-adjusted basis, the GAAP net income was $128.7 million ($0.77 a share) compared to $203.6 million ($1.21 a share) in the previous quarter and $134.8 million ($0.80 a share) in the year-ago quarter. 

Balance Sheet

KLA ended with a cash and short term investments balance of $3.15 billion, down $125.8 million from the previous quarter. The company generated $248.6 million of cash from operations, spending $13.1 million on capital expenses, $60.2 million on share repurchases and $74.5 million on dividends during the quarter.


For the first quarter of fiscal 2015, KLA expects orders of $600-800 million (70% in foundry and logic) and shipments of $800 million. Quarterly revenues are expected to be between $590 million and $650 million, gross margin of 54-55% and opex in a range of $230-235 million. The tax rate is expected to be 22%, yielding non-GAAP EPS in the range of $0.34 - $0.54, well below the Zacks Consensus Estimate of $0.90. The weak guidance is mainly because of extended lead times on its recent orders, which is have an effect on order shipments, revenue and therefore, margins.

In Summary

KLA-Tencor reported a weak quarter and provided disappointing guidance. However, orders were up strongly, benefiting from new business that was pushed out from the March quarter. Management says that this business has longer lead times (they usually provide 6-month backlog). KLA is still highly dependent on foundries, where order momentum is expected to continue. But management said that there was some uncertainty about the timing of foundry spending, which could delay shipments and revenue and thereby tell on its margins as well.

Considering the weak outlook and commentary, estimates are likely to come down, which would then push down the Zacks Rank #2 on KLA shares. This would however better reflect sentiments across the industry, where peers like Lam Research (LRCX - Free Report) has a Zacks Rank #3 (Hold) and Applied Materials (AMAT - Free Report) has a Zacks Rank #4 (Sell).

We also 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.

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.

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