KLA-Tencor: Soaring Despite the Chip Slump
By Cliff Edwards
It's unlikely that many people would call Kenneth L. Schroeder a captain of industry. In fact, many would be hard-pressed to guess the industry the KLA-Tencor chief executive represents. Like the wizard behind the curtain, though, Schroeder is the man many semiconductor companies are quietly seeking out as the industry undergoes wrenching technological changes in the way it makes computer chips.
Schroeder is the gremlin-killer -- the leader of a company that has quietly cemented its position as the premier maker of machines and software that can detect and correct the tiniest flaws even as chips are being manufactured. Thanks in no small part to an impressive 80% combined worldwide share in its market, KLA-Tencor (NasdaqNM:KLAC - news) was among the best-performing companies in the semiconductor sector during a time when the industry was suffering its worst downturn ever.
The San Jose [Calif.]-based company is one of only three tech concerns to make this year's BusinessWeek 50 list of top-performing companies, finishing at No. 6. "Demand for semiconductors has been weak, but KLA has remained strong because it's a leader in the most critical part of manufacturing: the yield-management and inspection process," says Bear Stearns analyst Robert Maire.
MONEY-SAVERS. That's not the most glamorous-sounding work. But in an industry beset by competitive pricing pressures and rising manufacturing costs, KLA-Tencor's focus on providing money-saving solutions has fit the bill. Chipmakers and microelectronics companies are working to squeeze more functions onto chips the size of fingernails while also completely revamping the manufacturing process.
Instead of using eight-inch silicon wafers to produce hundreds of chips at a time, companies like Intel and Advanced Micro Devices are spending billions of dollars to build plants that can handle 12-inch wafers that can churn out more than a thousand chips. Another change: Microscopic copper layering on chips is gaining favor over aluminum, since it can significantly lower the heat such complicated designs generate.
Such advances sound simple enough, but because of the technical hurdles and the added raw materials expenses in the manufacturing process, continuous monitoring at every step is required to prevent costly errors. KLA-Tencor has offered 22 new products over the past 18 months to do just that, and more are in the pipeline. "We're working on programs together [with customers] to solve their unique problems," Schroeder says.
AVOIDING WRITE-OFFS. Partnering with customers has paid off. By designing and manufacturing software and hardware packages only after receiving key customer input, KLA-Tencor saw fewer order cancellations than competitors such as Japan's Hitachi -- even during the height of the downturn. That's how it avoided taking huge one-time write-offs for excess and obsolete inventory.
As a result, revenues in its fiscal year ending June 30 are expected to exceed $1.57 billion. That's down 25% from the $2.1 billion of a year ago, but it's still healthy in the face of an overall semiconductor industry slump that saw chip sales tumble 32%, according to the Semiconductor Industry Assn.
KLA-Tencor also has consistently topped Wall Street earnings estimates, resulting in a total return of 62% on shares over the past year. With its stock hovering near $67, it hardly seems a bargain [ed. note: as of May 6, the stock price has slid to just under $53], but that's well off its peak 2000 share price of $97.75. And KLA's price-to-earnings ratio in the trailing 12 months is 32.16, compared with a 1999 high of 264.31. Its p-e is now on par with that of its peers.
BENEFICIAL FLOOD. Sure, KLA-Tencor could be pummeled if customers don't move as aggressively as they've indicated to adopt newer manufacturing technologies. And competitors such as Applied Materials are hoping to snatch new business away from KLA-Tencor with new all-in-one equipment and service packages. Still, going forward, analysts say KLA-Tencor and other players in the chip-equipment industry are poised for strong growth.
That's even if the semiconductor industry faces only a gradual recovery. Why? Equipment makers are benefiting by charging higher average selling prices for their newest technologies. And with only 5% of the installed equipment base at semiconductor fabrication plants worldwide consisting of leading-edge technology, there's a potential flood of pent-up business waiting to be released.
"We'll see a steady increase throughout the entire year for our customers, and that will be translate into more business for us," Schroeder says. In a notoriously cyclical industry still on shaky ground, that's more than anybody could ask for.
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