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KLAC > SEC Filings for KLAC > Form 10-Q on 26-Oct-2012All Recent SEC Filings

Show all filings for KLA TENCOR CORP

Form 10-Q for KLA TENCOR CORP


26-Oct-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact may be forward-looking statements. You can identify these and other forward-looking statements by the use of words such as "may," "will," "could," "would," "should," "expects," "plans," "anticipates," "relies," "believes," "estimates," "predicts," "intends," "potential," "continue," "thinks," "seeks," or the negative of such terms, or other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements. Such forward-looking statements include, among others, forecasts of the future results of our operations; orders for our products and capital equipment generally; sales of semiconductors; the allocation of capital spending by our customers (and, in particular, the percentage of spending that our customers allocate to process control); growth of revenue in the semiconductor industry, the semiconductor capital equipment industry and our business; technological trends in the semiconductor industry; future developments or trends in the global capital and financial markets; our future product offerings and product features; the success and market acceptance of new products; timing of shipment of backlog; the future of our product shipments and our product and service revenues; our future gross margins; our future research and development expenses and selling, general and administrative expenses; our ability to successfully maintain cost discipline; international sales and operations; our ability to maintain or improve our existing competitive position; success of our product offerings; creation and funding of programs for research and development; attraction and retention of employees; results of our investment in leading edge technologies; the effects of hedging transactions; the effect of the sale of trade receivables and promissory notes from customers; our future income tax rate; future payments of dividends to our stockholders; the completion of any acquisitions of third parties, or the technology or assets thereof; benefits received from any acquisitions and development of acquired technologies; sufficiency of our existing cash balance, investments and cash generated from operations to meet our operating and working capital requirements; and the adoption of new accounting pronouncements. Our actual results may differ significantly from those projected in the forward-looking statements in this report. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in Part II, Item 1A, "Risk Factors" in this report as well as in Item 1, "Business" and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended June 30, 2012, filed with the Securities and Exchange Commission on August 6, 2012. You should carefully review these risks and also review the risks described in other documents we file from time to time with the Securities and Exchange Commission. You are cautioned not to place undue reliance on these forward-looking statements, and we expressly assume no obligation and do not intend to update the forward-looking statements in this report after the date hereof.
EXECUTIVE SUMMARY
KLA-Tencor Corporation is a leading supplier of process control and yield management solutions for the semiconductor and related nanoelectronics industries. Our broad portfolio of products and services primarily supports integrated circuit ("IC" or "chip") manufacturers throughout the entire semiconductor fabrication process, from research and development to final volume production. We provide leading-edge equipment, software and support that enable IC manufacturers to identify, resolve and manage significant advanced technology manufacturing process challenges and obtain higher finished product yields at lower overall cost. In addition to serving the semiconductor industry, we also provide a range of technology solutions to a number of other high technology industries, including the light emitting diode ("LED") and data storage industries, as well as general materials research.
Our products and services are used by the vast majority of bare wafer, IC, lithography reticle ("reticle" or "mask") and disk manufacturers in the world. Our products, services and expertise are used by our customers to measure and control nanometric-level manufacturing processes, and to detect, analyze and resolve critical product defects that arise in that environment. Our revenues are driven largely by our customers' spending on capital equipment and related maintenance services necessary to support key transitions in their underlying product technologies, or to increase their production volumes in response to market demand. Our semiconductor customers generally operate in one or more of the three major semiconductor markets - memory, foundry and logic. All three of these markets are characterized by rapid technological changes and sudden shifts in end-user demand, which influence the level and pattern of our customers' spending on our products and services. Although capital spending in all three semiconductor markets has historically been very cyclical, the demand for more advanced and lower cost chips used in a growing number of consumer electronics, communications, data processing, and industrial and automotive products has resulted in favorable long-term revenue growth rates for our process control and yield management solutions.


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As a supplier to the global semiconductor and semiconductor-related industries, we are subject to the cyclical capital spending that characterizes these industries. The timing, length, intensity and volatility of capacity-oriented capital spending cycles of our customers are unpredictable. In addition, our customer base continues to become more highly concentrated over time, thereby increasing the potential impact of a sudden change in capital spending by a major customer on our revenues and profitability.
The growing use of increasingly sophisticated semiconductor devices has caused many of our customers to invest in additional semiconductor manufacturing capabilities and capacity. These investments have included process control and yield management equipment and services, which have had a significant favorable impact on our revenues over the long term.
During the three months ended September 30, 2012, our customers reduced their purchases of process control and yield management equipment, primarily in response to the cyclical industry factors affecting our foundry and logic customers and the challenging demand environment for our memory customers. In the current environment, as our customer base become increasingly more concentrated, large orders from a relatively limited number of customers account for a substantial portion of our sales, which potentially exposes us to more new order volatility. The low level of demand for process control and yield management equipment in the September quarter, and the resulting negative impact on our new orders in the quarter, will result in lower levels of total revenues until market conditions improve and demand for our products recovers. We believe that, over the long term, our customers will continue to invest in advanced technologies and new materials to enable smaller design rules and new process technologies to deliver higher performance semiconductor capability at lower costs. We expect that these dynamics will drive long-term increased adoption of process control equipment and services that reduce semiconductor defectivity and improve manufacturing yields, leaving the longer-term drivers underlying growth in our industry intact.
During the three months ended September 30, 2012, we decided to exit the solar inspection business due to deteriorating solar industry fundamentals and declining near-term business opportunities in that market. We have recognized expenses of $3.1 million during the three months ended September 30, 2012 as a consequence of our decision.
The following table sets forth some of the key quarterly unaudited financial information that we use to manage our business:

                                                                  Three months ended
(In thousands, except net income   September 30,      June 30,      March 31,       December 31,       September 30,
per share)                             2012             2012           2012             2011               2011
Total revenues                   $       720,709     $ 892,465     $  840,521     $      642,482     $       796,476
Total costs and operating
expenses                         $       534,152     $ 574,166     $  556,247     $      483,019     $       542,187
Gross margin                     $       403,484     $ 530,802     $  485,372     $      369,627     $       456,127
Income from operations           $       186,557     $ 318,299     $  284,274     $      159,463     $       254,289
Net income                       $       135,367     $ 247,877     $  205,346     $      110,797     $       191,995
Net income per share:
Basic (1)                        $          0.81     $    1.48     $     1.23     $         0.67     $          1.15
Diluted (1)                      $          0.80     $    1.46     $     1.21     $         0.66     $          1.13


__________________


(1) Basic and diluted earnings per share are computed independently for each of the quarters presented based on the weighted-average basic and fully diluted shares outstanding for each quarter. Therefore, the sum of quarterly basic and diluted per share information may not equal annual (or other multiple-quarter calculations of) basic and diluted earnings per share.


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CRITICAL ACCOUNTING ESTIMATES AND POLICIES
The preparation of our Condensed Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions in applying our accounting policies that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Note 1 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended June 30, 2012 describes the significant accounting policies and methods used in preparation of the Consolidated Financial Statements. We base these estimates and assumptions on historical experience, and evaluate them on an on-going basis to ensure that they remain reasonable under current conditions. Actual results could differ from those estimates. We discuss the development and selection of the critical accounting estimates with the Audit Committee of our Board of Directors on a quarterly basis, and the Audit Committee has reviewed our related disclosure in this Quarterly Report on Form 10-Q. The accounting policies that reflect our more significant estimates, judgments and assumptions and which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:
Revenue Recognition

Inventories

Warranty

Allowance for Doubtful Accounts

Equity and Long-Term Incentive Compensation Plans

Contingencies and Litigation

Goodwill and Intangible Assets

Income Taxes

There were no significant changes in our critical accounting estimates and policies during the three months ended September 30, 2012. Please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our fiscal year ended June 30, 2012 for a more complete discussion of our critical accounting policies and estimates. Valuation of Goodwill and Intangible Assets We performed a qualitative assessment of the goodwill by reporting unit as of November 30, 2011 during the three months ended December 31, 2011 and concluded that there was no impairment. We assess goodwill for impairment annually as well as whenever events or changes in circumstances indicate that the carrying amount of goodwill in any reporting unit may not be recoverable. Long-lived assets are tested for recoverability whenever events or changes in circumstances indicate that the assets' carrying amount may not be recoverable.
Our next annual evaluation of the goodwill by reporting unit will be performed during the three months ending December 31, 2012. If we were to encounter challenging economic conditions, such as a decline in our operating results, an unfavorable industry or macroeconomic environment, a substantial decline in our stock price, or any other adverse change in market conditions, we may be required to perform the two-step quantitative goodwill impairment analysis. In addition, if such conditions have the effect of changing one of the critical assumptions or estimates we use to calculate the value of our goodwill or intangible assets, we may be required to record goodwill and/or intangible asset impairment charges in future periods, whether in connection with our next annual impairment assessment in the second quarter of fiscal year 2013 or prior to that, if any triggering event occurs outside of the quarter during which the annual goodwill impairment assessment is performed. It is not possible at this time to determine if any such future impairment charge would result or, if it does, whether such charge would be material to our results of operations.


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Revenue Recognition
We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable, and collectibility is reasonably assured. We enter into arrangements that may consist of multiple deliverables of our products and services where certain elements of the sales arrangement are not delivered and accepted in one reporting period. Judgment is required to properly identify the accounting units of the multiple deliverable transactions and to determine the manner in which revenue should be allocated among the accounting units. Additionally, judgment is required to interpret various commercial terms and to determine when all criteria of revenue recognition have been met in order for revenue recognition to occur in the appropriate accounting period. While changes in the allocation of the estimated sales price between the accounting units will not affect the amount of total revenue recognized for a particular arrangement, any material changes in these allocations could impact the timing of revenue recognition, which could have a material effect on our financial position and results of operations.
Recent Accounting Pronouncements
In September 2011, the Financial Accounting Standards Board ("FASB") issued an accounting standard update intended to simplify testing goodwill for impairment. The amendments allow an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity will no longer be required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that the fair value of the reporting unit is less than its carrying amount. The amendment becomes effective for annual and interim goodwill impairment tests performed for our fiscal year ending June 30, 2013, and early adoption is permitted. We elected to early adopt this accounting guidance at the beginning of the three months ended December 31, 2011 (see Note 5, "Goodwill and Purchased Intangible Assets," to the Condensed Consolidated Financial Statements for a detailed description).
In June 2011, the FASB issued an accounting standard update requiring an increase in the prominence of items reported in other comprehensive income. The amendment eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity and requires that the total of comprehensive income, the components of net income, and the components of other comprehensive income be presented in a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendment also required presentation of adjustments for items that are reclassified from other comprehensive income in the statement where the components of net income and the components of other comprehensive income are presented, which was indefinitely deferred by the FASB in December 2011. The amendment (other than the portion regarding the presentation of reclassification adjustments which, as noted above, has been deferred indefinitely) became effective for our interim period ended September 30, 2012. The amendment did not have an impact on our financial position, results of operations or cash flows as it is disclosure-only in nature.


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RESULTS OF OPERATIONS
Revenues and Gross Margin
                                     Three months ended
(Dollar amounts in     September 30,      June 30,      September 30,          Q1 FY13 vs.              Q1 FY13 vs.
thousands)                  2012            2012             2011                Q4 FY12                  Q1 FY12
Revenues:
Product               $      574,078     $ 745,662     $      650,256     $ (171,584 )    (23 )%   $ (76,178 )    (12 )%
Service                      146,631       146,803            146,220           (172 )      -  %         411        -  %
Total revenues        $      720,709     $ 892,465     $      796,476     $ (171,756 )    (19 )%   $ (75,767 )    (10 )%
Costs of revenues     $      317,225     $ 361,663     $      340,349     $  (44,438 )    (12 )%   $ (23,124 )     (7 )%
Gross margin
percentage                        56 %          59 %               57 %

Product revenues
Our business is cyclical with respect to the capital equipment procurement practices of semiconductor manufacturers, with revenues impacted by the investment patterns of such manufacturers.
Product revenues decreased during the three months ended September 30, 2012 compared to the three months ended June 30, 2012 as a result of the challenging demand environment for the semiconductor capital equipment industry, as customers revised their expansion plans in response to end-customer product demand levels and their need to absorb recent significant capital equipment purchases, as well as macro-economic uncertainty.
Product revenues decreased during the three months ended September 30, 2012 compared to the three months ended September 30, 2011, primarily due to lower levels of revenue backlog of $286 million at the start of the three months ended September 30, 2012 compared to $382 million at the start of the three months ended September 30, 2011.
Service revenues
Service revenues are generated from maintenance contracts, as well as billable time and material service calls made to our customers after the expiration of the warranty period. The amount of service revenues is typically a function of the number of post-warranty systems installed at our customers' sites and the utilization of those systems. Service revenues during the three months ended September 30, 2012 remained flat compared to the three months ended June 30, 2012 and September 30, 2011.
Revenues by region
Revenues by region for the periods indicated were as follows:

                                                                Three months ended
(Dollar amounts in thousands)        September 30, 2012            June 30, 2012            September 30, 2011
United States                   $     149,988           21 %   $  131,112       15 %   $     198,243           25 %
Taiwan                                276,299           38 %      270,507       30 %         223,289           28 %
Japan                                  88,715           12 %       77,969        9 %         134,815           17 %
Europe & Israel                        59,160            8 %       72,520        8 %          92,996           12 %
Korea                                  70,247           10 %      271,511       30 %          79,598           10 %
Rest of Asia                           76,300           11 %       68,846        8 %          67,535            8 %

Total $ 720,709 100 % $ 892,465 100 % $ 796,476 100 %

A significant portion of our revenues continues to be generated in Asia, where a substantial portion of the world's semiconductor manufacturing capacity is located, and we expect that trend to continue.


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Gross margin
Our gross margin fluctuates with revenue levels and product mix and is affected by variations in costs related to manufacturing and servicing our products, including our ability to scale our operations efficiently and effectively in response to prevailing business conditions. Over the past several years, we have embarked on various advanced product development, customer satisfaction improvement and globalization initiatives to improve our competitiveness and gross margins.
The following tables summarize the major factors that contributed to the changes in gross margin percentage for the periods indicated:

                                Gross Margin                                          Gross Margin
                                 Percentage                                            Percentage
Three months ended June 30,                       Three months ended September 30,
2012                              59.5  %         2011                                  57.3  %
Revenue volume of products                        Revenue volume of products and
and service                       (1.2 )%         service                                0.1  %
Mix of products and services
sold                              (0.1 )%         Mix of products and services sold     (1.0 )%
Manufacturing labor, overhead                     Manufacturing labor, overhead and
and efficiencies                  (1.3 )%         efficiencies                             -  %
Other service and                                 Other service and manufacturing
manufacturing costs               (0.9 )%         costs                                 (0.4 )%
Three months ended September                      Three months ended September 30,
30, 2012                          56.0  %         2012                                  56.0  %

Changes in gross margin percentage driven by revenue volume reflect our ability to leverage existing infrastructure in operating our business. It also includes the effect of fluctuations in average customer pricing and foreign exchange rates. Changes in gross margin percentage from mix of products and services sold reflect the impact of changes in the composition within product and service offerings, as well as differences in transaction-specific revenue realization. Changes in gross margin percentage from manufacturing labor, overhead and efficiencies reflect our ability to manage costs and drive productivity as we scale our manufacturing activity to respond to customer requirements; this includes the impact of capacity utilization, use of overtime and variability of cost structure. Changes in gross margin percentage from other service and manufacturing costs include the impact of customer support costs, including the efficiencies with which we deliver services to our customers, and the effectiveness with which we manage our production plans and inventory risk. Our gross margin declined to 56.0% during the three months ended September 30, 2012 from 59.5% during the three months ended June 30, 2012 primarily due to lower revenue volume and lower factory utilization as a result of lower shipments.
Our gross margin declined to 56.0% during the three months ended September 30, 2012 from 57.3% during the three months ended September 30, 2011 primarily due to a less favorable mix of products sold. Engineering, Research and Development ("R&D")

                                       Three months ended
(Dollar amounts in       September 30,      June 30,      September 30,          Q1 FY13 vs.            Q1 FY13 vs.
thousands)                    2012            2012             2011                Q4 FY12                Q1 FY12
R&D expenses            $      119,742     $ 118,710     $      107,762     $    1,032        1 %   $ 11,980       11 %
R&D expenses as a
percentage of total
revenues                            17 %          13 %               14 %

R&D expenses during the three months ended September 30, 2012 increased compared to the three months ended June 30, 2012, primarily due to an increase in employee-related expenses of $1.6 million as a result of additional engineering headcount and an increase in engineering material costs of $1.9 million related to our next-generation products, offset by a benefit to R&D expense from external funding.
R&D expenses during the three months ended September 30, 2012 increased compared to the three months ended September 30, 2011, primarily due to an increase in engineering material costs of $7.5 million related to our next-generation products, an increase in employee-related expenses of $1.9 million as a result of annual compensation adjustments and additional engineering headcount and an increase in depreciation of fixed assets of $1.3 million.


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R&D expenses include the benefit of $4.0 million, $0.1 million and $3.6 million of external funding received during the three months ended September 30, 2012, June 30, 2012 and September 30, 2011, respectively, for certain strategic development programs from government grants.
Our future operating results will depend significantly on our ability to produce products and provide services that have a competitive advantage in our marketplace. To do this, we believe that we must continue to make substantial investments in our research and development. We remain committed to product development in new and emerging technologies as we address the yield challenges our customers face at future technology nodes. Selling, General and Administrative ("SG&A")

                                        Three months ended
(Dollar amounts in         September 30,     June 30,      September 30,         Q1 FY13 vs.            Q1 FY13 vs.
thousands)                     2012            2012            2011                Q4 FY12                Q1 FY12
SG&A expenses             $      97,185     $  93,793     $      94,076     $    3,392        4 %   $    3,109       3 %
SG&A expenses as a
percentage of total
revenues                             13 %          11 %              12 %

SG&A expenses during the three months ended September 30, 2012 increased . . .

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