KLA Corp (KLAC) — Q2 2015 Earnings Call Transcript

Thank you, Candice. Good afternoon, everyone, and welcome to our conference call. Joining me on our call today are Rick Wallace, our President and Chief Executive Officer; and Bren Higgins, our Chief Financial Officer. We’re here to discuss second quarter results for the period ended December 31, 2014. We released these results this afternoon at 1:15 PM Pacific Time. If you haven’t seen the release, you can find it on our website. A simulcast of this call will be accessible on demand following its completion on the Investor Relations section of our website. This quarter we prepared a brief slide presentation to supplement this earnings call, which includes the GAAP to non-GAAP reconciliation of the EPS guidance and other supplemental financial information. These slides can be found on KLA-Tencor’s Investor Relations website. There, you’ll also find a calendar of future investor events, presentations, and conferences, as well as links to KLA-Tencor’s SEC filings, including our annual report on Form 10-K for the year ended June 30, 2014, and our subsequently filed 10-Q reports. In those filings, you’ll find descriptions of risk factors that could impact our future results. As you know, our future results are subject to risks. Any forward-looking statements, including those we make on this call today, are subject to those risks, and KLA-Tencor cannot guarantee those forward-looking statements will come true. Our actual results may differ significantly from those projected in our forward-looking statements. More information regarding factors that could cause those differences is contained in the filings we make with the SEC from time to time. We assume no obligation and do not intend to update those forward-looking statements. However, any updates we do provide will be broadly disseminated and available over the web. With that, I’ll turn the call over to Rick.

Thanks, Ed. Good afternoon, everyone, and thank you for joining today’s call. KLA-Tencor posted solid results that met or exceeded our expectations for the second quarter of fiscal year 2015. Our financial performance in Q2 was highlighted by gross margin and non-GAAP EPS finishing above the range of guidance, reflecting KLA-Tencor’s strong competitive positioning in the most critical process control markets as well as a heightened focus on cost discipline across our worldwide operations. New orders were also strong in Q2, finishing above the midpoint of the range of guidance at $865 million and up 53% compared to Q1. The recent end market demands trend continued in the second quarter with new orders from leading edge foundry and logic for sub 20-nanometer production comprising the majority of system bookings in December, followed by 20-nanometer capacity conversions in DRAM. As we look ahead to calendar 2015, with leading edge device demand expected to be strong and customer profitability expected to remain at a high level, we are planning for another year of growth for the industry and for process control, with semiconductor WFE investment forecasted to grow in a range of 5% to 10% in the year. In this environment of sustaining strong investment in the leading edge, the demand outlook for process control and KLA-Tencor’s prospects also remain very favorable. In the near term, however, demand remains fluid, particularly in foundry and logic, where we have recently seen orders from select customers slated for sub 20-nanometer, originally expected in the March quarter, pushed to later in the calendar year. We believe these delayed orders reflect yield and process stability issues associated with bringing these advanced device architectures to market. Demand from memory customers remains robust, and in fact we achieved our highest quarterly bookings level for memory in Q2. Memory demand is expected to remain strong in calendar 2015, with 20-nanometer conversions in DRAM making up the majority of memory customer activity. NAND projects in calendar 2015 are expected to be largely focused on planar architectures with expanded investment in 3D planned for later in the year. As always, demand growth in our business is driven by the strong pace of investment in next generation semiconductor device technologies by the market leaders in logic, foundry, and memory. Process control plays a critical role in helping these customers solve the mission-critical production problems associated with managing yields in a leading edge manufacturing environment. As the market leader in process control, KLA-Tencor continues to benefit from these ever more complex and costly yield challenges. So from our perspective, 2015 promises to be an exciting year for KLA-Tencor. Looking beyond these near-term market factors, we’re well positioned in key markets with innovative products to execute our strategies for growth and market leadership and to deliver strong returns to our stockholders. Turning now to guidance for the third quarter of fiscal year 2015, new orders in March are expected to be in the range of $500 million to $700 million. Our current forecast shows orders in the first half of calendar 2015 on par with levels achieved in the second half of calendar 2014. Revenue guidance for Q3 is in the range of $685 million to $765 million and non-GAAP earnings per share in the range of $0.63 to $0.87 per share for the quarter. And with that, I’ll turn the call over to Bren for his commentary on the quarter before returning for Q&A.

Thanks, Rick and good afternoon. Revenue for Q2 was in the upper half of the range of guidance at $676 million and non-GAAP earnings per share finished above the guided range for the quarter at $0.68, driven by stronger than expected gross margins in the quarter and good execution of cost management. Fully diluted GAAP earnings per share in Q2 was $0.12. The GAAP earnings per share in Q2 included $0.53 of charges related to the leveraged recapitalization transaction, which we completed in Q2 and $0.03 of restructuring and acquisition related charges, net of the income tax effect on these adjustments. My comments on the quarter will be focused on the non-GAAP results, which exclude these adjustments. A detailed reconciliation of GAAP to non-GAAP earnings per share can be found in the press release and supplemental materials posted on our website prior to this earnings call. New orders in Q2 were $865 million, above the midpoint of guidance of $700 million to $900 million for the quarter. We continue to experience a high degree of variability in order timing and delivery day commitments from our customers. We believe this is the new normal for our industry, with our top five customers accounting for approximately 75% of demand today, and often with one or two customers accounting for a significant portion of order and shipment volume in a given quarter. With each customer having their unique timeline for executing their technology, investment, and capacity expansion plans and with shorter product delivery lead times becoming normal in our industry, forecasting accuracy of bookings within a 12-week window has clearly become even more of a challenge. With that, though December orders and shipments were strong, the near-term shift in customer demand requirements that Rick mentioned have resulted in certain shipments which were originally slated for the March and June quarters moving into the second half of calendar 2015. We see this as largely a timing issue and our optimism for calendar 2015 to be a growth year for KLA-Tencor is high.

Okay, thank you, Bren. At this point, we’d like to open the call to questions. We once again request that you limit yourself to one question and one follow-up given the limited time we have for today’s call. Please feel free to re-queue for your follow-up questions and we’ll do our best to give everyone a chance for further questions as time permits. Candice.

Bren, your commentary on the first calendar half of the year. Did I hear that right in that it suggests that the June orders are going to be up like 35% - 40% sequentially and I guess does that assume that the push outs on FinFET come in June or are they more additive to that during the back half of the year? Then I had a follow-up.

So Tim, that’s a great question. When we examined it, we noticed a similar pattern to the second half of 2014, with a weaker first quarter followed by some recovery in the June quarter. Therefore, when we assess the six-month period, it appears quite comparable to us. Additionally, as I mentioned in the prepared remarks, the 12-week window is becoming increasingly challenging for us to predict due to our customer concentration and order sizes. So, as we consider the six-month timeframe, it seems to be roughly the same size.

Can you briefly talk about, like the push outs that you saw, are they coming more from the leading edge sub-20 nanometer production as you mentioned? Is it coming from primarily in U.S. region or is it coming from overseas, some foundries? Can you just briefly describe which region did you see the push outs from?

Well, we came in obviously stronger versus the midpoint in Q2. So certainly that impacted our views on Q3 with some pull ins in the Q2. But in terms of Q3 versus what we thought, it’s really a mixed bag across foundry and logic. So it's leading edge, but also some of the trailing edge business that we’ve been forecasting for some time and has been a bit elusive, and I think that’s dependent ultimately on some competitive dynamics in terms of second source strategies and so on. So I would say it’s across the board in terms of what we saw in Q3, and as I said earlier, some of it we think comes back in Q4.

So our commentary on the first half was bookings related, not revenue. So I expect the revenue to be higher than bookings. I won't guide June obviously but I don't think we will see sequential growth into the June quarter. So I don't have the math in front of me on EBITDA, but as I've looked at it relative to the covenants I have with bank debt, I feel pretty comfortable with the level we have relative to what our expectations are for the business going forward. So I don't have any concerns based on what we see today. Obviously, with the backlog position we have and our expectations for shipments into this quarter, June should set us for a sequential increase and improving operating profitability.

Two of them. First one, Rick or Bren, it looks like you're running at a $600 million run rate for bookings in March and $800 million or so in June. What do the composition of those orders look like in March and June in terms of memory and foundry? And I had a follow-up.

Yes, so we're not guiding the June quarter but for March. March looks to be pretty foundry centric, so 70% foundry. And memory is 19%, logic 11%. And NAND as a percent of the total memory mix is up 31%.

I was hoping to go back to your comments on your customer concentration, because if we go back in time, you guys had great ability to manage through a six-month backlog give or take, and clearly there was customer concentration issues then as well. And so just curious, is it movement of market share from one player to another? Is it enhanced customer concentration? What's driving the change in your business model?

I believe the changes we're experiencing are largely due to our customers. As lead times in their markets have shortened, we've felt that pressure as well. This has required us to adjust our business to be more flexible and responsive. In many situations, when we request longer lead times, our customers are unable to accommodate us due to their own challenges. This results in less predictability, a trend we've noticed for some time, and it marks a shift from our previous experience. The factors influencing this change are tied to end markets and the significant orders we have, as the adjustments made by our customers can significantly affect our quarterly shipments.

I also think if you think about consolidation, one way I would think about it is, I look at consolidation of our customer's customer in terms of their influence on the spend. So especially in the foundry space, their actions actually are often not really clear until very late to our foundry customers and that’s part of the dynamics of the movement. That’s why we don’t get more visibility I think from our foundry customers.

I just want to get one more clarification on the foundry push out. ASML reported a pretty good booking, and I think that primarily came from Taiwan, and I think you commented that your booking had a pretty good Taiwan component. So my guess is that the push out you were seeing is not from Taiwan and other places?

Well, as I said earlier, I think it’s a mix group and it comes from a number of regions and in a number of nodes. So I think given lead time, I think certainly customers tend to get into the queue with litho sooner. I don’t know exactly what ASML said or how they positioned it. But as we look at it today, and into Rick’s point earlier there is some fluidity to these orders, certainly at 28-nanometer and so they’re moving around a little bit and so the timing is uncertain.

If we reflect on the situation, we had been pushing out certain initiatives in December and engaging in high-level discussions with customers who seemed to have strong commitments to proceed. They were in the process of allocating space and scheduling support for their developments, but unexpectedly, that progress was delayed, causing some of those initiatives to extend beyond March and into the second half of the year.

Okay, thank you, Bren. That concludes our call for today. Thank you all for joining and we look forward to seeing you later on in this quarter.