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KLA Corporation (NASDAQ:KLAC) Beats Q3 Sales Targets, Provides Optimistic Sales Guidance


Full Report / June 28, 2022
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Maker of equipment for semiconductor manufacturing, KLA Corporation (NASDAQ:KLAC) reported Q3 FY2022 results that beat analyst expectations, with revenue up 26.8% year on year to $2.28 billion. On top of that, guidance for next quarter's revenue was surprisingly good, being $2.42 billion at the midpoint, 3.27% above what analysts were expecting. KLA Corporation made a GAAP profit of $730.6 million, improving on its profit of $567.1 million, in the same quarter last year.

KLA Corporation (KLAC) Q3 FY2022 Highlights:

  • Revenue: $2.28 billion vs analyst estimates of $2.2 billion (3.84% beat)
  • EPS (non-GAAP): $5.13 vs analyst estimates of $4.82 (6.36% beat)
  • Revenue guidance for Q4 2022 is $2.42 billion at the midpoint, above analyst estimates of $2.34 billion
  • Free cash flow of $718.5 million, roughly flat from previous quarter
  • Inventory Days Outstanding: 202, up from 183 previous quarter
  • Gross Margin (GAAP): 61%, in line with same quarter last year

Formed by the 1997 merger of the two leading semiconductor yield management companies, KLA Corporation (NASDAQ:KLAC) is the leading supplier of equipment used to measure and inspect semiconductor chips.

KLA sells the tools used by semiconductor foundries and memory chip producers to inspect semiconductors and measure their precise dimensions throughout the manufacturing process, from the wafers to patterning to final production. Today, accuracy and defect detection in the semiconductor manufacturing process is becoming even more crucial as chip sizes continue to shrink, making it increasingly difficult to find defects. As the cost to create chips has gone up, even a small irregularity early on in the manufacturing process can render a chip useless, costing companies time and money.

KLA is the dominant provider of process control systems, maintaining around 50% market share for more than a decade, or 4x its closest competitor. It works closely with its customers to develop specific tools for specific semiconductor manufacturing processes. In recent years it has looked to expand its addressable market and the 2019 acquisition of Orbotech extended its business into printed circuit boards and flat panel displays.

KLAC’s primary peers and competitors are Applied Materials (NASDAQ:AMAT), ASML (NASDAQ:ASML) Lam Research (NASDA:LCRX), and Tokyo Electron (TSE:8035).

Semiconductor Manufacturing

The semiconductor capital (manufacturing) equipment group has become highly concentrated over the past decade. Suppliers have consolidated, and the increasing cost of innovation have made it unaffordable to almost everybody, except the largest companies, to produce leading edge chips. The result of the increased industry concentration has been higher operating margins and free cash generation through the cycle. Despite this structural improvement, the businesses can still be quite volatile, as demand fluctuations for the semiconductor equipment are magnified by the already cyclical nature of underlying semiconductor demand. Read More Chip manufacturing is done in "batches" on a single round silicon disk, known as a "wafer". Multiple chips can be fabricated on a single wafer, which itself can cost over $10,000 today for the more advanced nodes. The actual chip fabrication process requires hundreds to thousands of steps that are executed at an atomic scale. From start to finish, including fabrication, testing and packaging, it can take 3 months to make a chip. The process to create a silicon wafer starts with sand, which is melted to extract silicon, then purified and formed into a cylinder, which is then sliced down into discs about 1mm thick that are then polished into wafers. Next, the wafers go to a semiconductor foundry and go through a process where successive layers of insulating, conducting, and semiconducting materials are stacked on top of one another to form many small complex interconnected 3D structures (wires, insulators, etc), with each layer consisting of 15-20 processes such as deposition, lithography, etching, stripping, testing, and cleaning.

Sales Growth

KLA Corporation's revenue growth over the last three years has been strong, averaging 25.7% annually. And as you can see below, last year has been especially strong, with quarterly revenue growing from $1.8 billion to $2.28 billion. Semiconductors are a cyclical industry and long-term investors should be prepared for periods of high growth, followed by periods of revenue contractions (which can sometimes offer opportune times to buy).

KLA Corporation Total Revenue

This was a decent quarter for KLA Corporation as revenues grew 26.8%, topping analyst estimates by 3.84%.

KLA Corporation believes the growth is set to continue, and is guiding for revenue to grow 25.9% YoY next quarter, and Wall St analysts are estimating growth 17.7% over the next twelve months.

Product Demand & Outstanding Inventory

Days Inventory Outstanding (DIO) are an important metric for chipmakers, as it reflects the capital intensity of the business and the cyclical nature of semiconductor supply and demand. In a tight supply environment, inventories tend to be stable, allowing chipmakers to exert pricing power. Steadily increasing DIO can be a warning sign that demand is weak, and if inventories continue to rise the company may have to downsize production.

KLA Corporation Inventory Days Outstanding

This quarter, KLA Corporation’s inventory days came in at 202, which is exactly around the five year average, showing that despite the recent increase there is no indication of an unusual inventory buildup at the moment.

Pricing Power

KLA Corporation's gross profit margin, how much the company gets to keep after paying the costs of manufacturing its products, came in at 61% in Q3, up 0.4 percentage points year on year.

KLA Corporation Gross Margin (GAAP)

Over the past year, KLA Corporation has seen its already strong gross margins continue to rise, averaging 60.8%, indicative of a potent competitive offering, pricing power, and efficient inventory management.

Profitability

KLA Corporation reported an operating margin of 42.6% in Q3, up 2 percentage points year on year. Operating margins are one of the best measures of profitability, telling us how much the company gets to keep after paying the costs of manufacturing the product, selling and marketing it and most importantly, keeping products relevant through research and development spending.

KLA Corporation Adjusted Operating Margin

Operating margins have been trending up over the last year, averaging 39.7%. KLA Corporation's margins remain one of the highest in the semiconductor industry, driven by its highly efficient operating model's economies of scale.

Earnings, Cash & Competitive Moat

Analysts covering the company are expecting earnings per share to grow 19.6% over the next twelve months, although estimates are likely to change post earnings.

Earnings are important, but we believe cash is king as you cannot pay bills with accounting profits. KLA Corporation's free cash flow came in at $718.5 million in Q3, up 22.8% year on year.

KLA Corporation Free Cash Flow

KLA Corporation has generated $2.66 billion in free cash flow over the last twelve months, translating to 30.8% of revenues. This is a great result; KLA Corporation's free cash flow conversion was very high compared to most semiconductor companies, in the last year. This high cash conversion, if maintained, puts it in a great position to invest in new products, while also remaining resilient during industry down cycles.

KLA Corporation’s average return on invested capital (ROIC) over the last 5 years of 52.3% implies it has a strong competitive position and is able to invest in profitable growth over the long term.

Key Takeaways from KLA Corporation's Q3 Results

Sporting a market capitalization of $47.4 billion, more than $2.57 billion in cash and with positive free cash flow over the last twelve months, we're confident that KLA Corporation has the resources it needs to pursue a high growth business strategy.

We were impressed by how strongly KLA Corporation outperformed analysts’ earnings expectations this quarter. And we were also excited to see that it outperformed Wall St’s revenue expectations. On the other hand, it was less good to see the inventory levels increase. Zooming out, we think this was still a decent, albeit mixed, quarter, showing the company is staying on target. The company currently trades at $340 per share.

Is Now The Time?

When considering KLA Corporation, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. There are a number of reasons why we think KLA Corporation is a great business. While we would expect growth rates to moderate from here, its revenue growth has been solid, over the last three years. On top of that, its powerful free cash generation enables it to sustainably invest in growth initiatives while maintaining an ample cash cushion, and its impressive operating margins are indicative of an highly efficient business model.

KLA Corporation's price to earnings ratio based on the next twelve months is 14.1x. Looking at the semiconductors landscape today, KLA Corporation's qualities really stand out, and we really like it at this price.

The Wall St analysts covering the company had a one year price target of $440 per share right before these results, implying that they saw upside in buying KLA Corporation even in the short term.

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