KLA-Tencor Tumbles Over Guidance

Updated from April 21

Shares of KLAC-Tencor ( KLAC)sagged Thursday after the company said orders could fall as much as 15%. The worst-case scenario guidance aroused some fears that thechip equipment industry could be nearing the top ofthe current upcycle.

The stock was recently down $3.06, or 6.3%, to$45.26.

Investors shrugged off upbeat news related to thequarter ending in March: Late Wednesday, thechip-equipment maker said it surpassed analystestimates on the top and bottom lines for its fiscalthird quarter.

Instead, they focused on the more unsettlingdetails of the company's current outlook. KLA saidafter the close that orders for new equipment couldrise as much as 10% or fall by as much as 15% in theJune quarter.

Chip equipment analysts have been nervouslyscanning for signs of slowing growth that would showthe current upcycle is about to peak and promptfurther slides in stock prices -- although investors,having bid down many names in the sector year to date,seem to have already started pricing in that scenario.

First Albany downgraded KLAC shares Thursday,citing weak bookings momentum for both the Junequarter and the just-reported March quarter (which sawbookings rise 18%, below the bank's expectations of20% to 30% growth).

The bank said KLA delivered a "solid quarter" interms of revenue and EPS, and it actually raised itsearnings estimate for the June quarter, predicting EPSof 46 cents instead of 40 cents, and for fiscal year2005, increasing EPS to $2.09 from $1.92. But theupside in earnings was outweighed by the prospect ofdecelerating growth, First Albany said.

But other investment banks were more forgiving. "The fuss isultimately about the timing of bookings, notfundamentals," said a research note from CIBC analyst Ali Irani, who argued KLAC could still see upsidegiven customer demand for its tools, which helpsemiconductor makers transition to new manufacturingprocesses.

"While we expect KLAC's shares to be weak on theback of its order guidance, we believe that thecompany is clearly on track to exceed its prior peakrevenues, margins (gross and operating), and EPS earlyin this cycle, with possible upside to our estimatesas the cycle gains additional breadth and strength," Irani wrote. (He has an overweight rating on the stock. An affiliate of CIBC has done investmentbanking for KLA.)

Management admitted on a conference call that the vast difference in outcomes makes the guidance unprecedented.

Orders could rise 10% if two events come to pass: a couple of pending orders close in June (the last month in the quarter) rather than July, and KLA sees its normal historical growth trends. Chief Executive Officer Ken Schroeder said both are "reasonably likely."

But if neither of those events occurs and a business segment known as reticle inspection slows down, KLA could see orders plunge 15%.

Earlier on the same call, Schroeder had made bullish comments on the outlook for the semiconductor-equipment market, noting global GDP growth is expected to hit 4.3% in 2004. "It is clear that the semi industry is at the beginning of another growth cycle," he said -- though in fact, industry revenues have been on the upturn since bottoming in the third quarter of 2001.

When an analyst noted that that flies in the face of a potentially sharp drop-off in orders, Schroeder responded that his upbeat outlook "doesn't mean that every quarter will be up sequentially."

In its fiscal third quarter, KLA reported sales of $390 million, up 28% from last year's levels and above analyst expectations for $380 million.

Net income totaled $66 million, up from $27 million a year ago. On a per-share basis, earnings of 33 cents were 4 cents above Wall Street predictions.

"As a result of rising revenues and our improved cost structure, we achieved gross profit margins in excess of 55% for the first time since the last quarter of fiscal 2001," Schroeder said in a prepared statement. Gross margins rose two percentage points from the prior quarter to 56%, as KLA reduced costs and saw greater demand.

In January, KLA guided for orders to grow 15% or more in the first quarter, with revenue between $370 million and $380 million and EPS of 27 cents to 29 cents.

For the quarter ending in June, analysts currently predict earnings of 42 cents per share on sales of $459.8 million.

KLA-Tencor sells equipment used to improve yields in the semiconductor manufacturing process; its products have seen rising demand as chipmakers have shifted to more intricate technologies.

In regular Wednesday trading, shares climbed 61 cents, or 1.3%, to $48.32.

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