KLA-Tencor Corporation’s (NASDAQ:KLAC) fourth-quarter earnings beat the Zacks Consensus by 13 cents. Revenue came in more or less as expected, beating by 1.2%.
 
Revenue
 
Revenue of $559.4 million was up 17.0% sequentially, 98.7% year over year and on the higher end of the guided range of a 10-19% sequential increase. Management stated that KLAC gained from customer adoption of its efficient systems that help semiconductor manufacturers lower costs and increase efficiencies. Additionally, the company also saw some application in new markets and continued strength in the services business. The technical complexity of manufacturing semiconductors and increasingly challenging yield issues remain longer-term revenue drivers.
 
Products generated 77% of total revenue, an increase of 23.0% sequentially and 144.2% year over year. Services revenue comprised the remaining 23%, up 0.5% sequentially and 22.7% year over year. Services are likely to grow in importance, as the company strives to maintain its large installed base.
 
Orders
 
Orders were up strongly in the last quarter. The company reported $956 million in net bookings, representing a sequential increase of 47.3% and a year-over-year increase of 192.4%. This was much better than management’s expectations of a 5-25% sequential increase, as demand remained strong, with no order push-outs and only minimal cancellations.
 
While the foundry segment (41% of total orders) remained strong in the last quarter, the memory segment softened to 21% and logic customers leaped from 13% to 38% of total orders. All three groups were up triple-digits from the year-ago quarter, although the 513.9% year-over-year increase in memory was the most significant.
 
Orders by product line were—wafer inspection 48%, reticle inspection 19%, metrology 14% and solar, storage, high brightness LED and other non-semiconductor 6%. Services were 13% of total orders.
 
Orders were fairly broad-based across geographies, an indication that the company’s business is seeing broad-based strength, irrespective of concerns in Europe and Asia. The relatively higher concentration in Asia is due to the presence of a larger number of foundries and chip manufacturing companies in the region. Around 25% of total orders originated in the U.S., 19% in Korea, 18% in Taiwan, 12% each in Europe and Japan and the remainder from other Asian countries.
 
The six-month backlog at quarter-end was $1.34 billion, up 42.7% sequentially and 158.7% year over year.
 
Margins
 
The pro forma gross margin for the quarter was 60.3%, up 260 basis points (bps) from the previous quarter’s 57.7% and 1,415 bps from 46.1% in the year-ago quarter. The gross margin benefited from higher volumes and the resultant improvement in fixed cost absorption over the larger sales base. A richer mix of higher-margin products and the move to lower-cost manufacturing in Singapore also helped margins.
 
Operating expenses of $165.7 million were lower than the previous quarter’s $167.1 million. The operating margin was 30.7%, up 792 bps sequentially and 3,711 bps year over year. The sequential improvement was equally attributable to the higher gross margin and lower SG&A and R&D expenses as a percentage of sales.
 
Excluding the impact of restructuring charges, acquisition-related expenses, restatement-related charges and the associated tax impact, the pro forma net income was $120.0 million, or 21.4% of sales, compared with $71.3 million, or 14.9% in the previous quarter and a loss of $14.6 million, or 5.2% of sales in the year-ago quarter.
 
Including special items, the GAAP net income was $113.1 million ($0.66 per share) compared with income of $57.0 million ($0.33 per share) in the March 2010 quarter and loss of $25.6 million ($0.15 per share) in the June quarter of last year.
 
Balance Sheet
 
Inventories were up 7.3%, although inventory turns were flattish at around 2.2X. Days sales outstanding (DSOs) jumped up from 62 to 72. KLAC ended with cash and short-term investments of $1.53 billion, up $520 million during the quarter. The company generated $83.3 million of cash from operations, spending $5.8 million on capital expenses, $81.6 million on share repurchases and $25.4 million on dividend payouts during the quarter.
 
Guidance
 
For the first quarter of fiscal 2011, management expects orders in the $750-900 million range, revenue of between $620 million and $660 million, a tax rate of 30% and non-GAAP EPS between 80 cents and 88 cents.
 
In Summary
 
KLA reported a strong quarter, although guidance indicates that the company is beginning to see some softness, particularly at memory customers. The fact that there were no order push-outs or cancellations in the quarter is encouraging, but we note that memory orders declined double-digits sequentially and management guided down orders for the upcoming quarter.
 
Overall, this supports our view that the equipment business has recovered, with the slowdown in memory attributable to the broader slowdown in the consumer market. It is a bit difficult to determine the extent of softness in consumer spending, so we have become more cautious on KLAC shares. We believe the 6-12 month story will not change much. Consequently, we have a neutral rating on KLAC shares. The Zacks Rank on KLAC is also #3, implying a short-term Hold recommendation.

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