Fitch Ratings has affirmed the following ratings for KLA-Tencor Corp. (KLA-Tencor) (Nasdaq: KLAC):
--Issuer Default Rating (IDR) at 'BBB';
--Senior Unsecured Debt at 'BBB'.
Fitch's actions affect approximately $750 million of total debt. The Rating Outlook is Stable.
The ratings on KLA-Tencor continue to be supported by:
--The company's technology leadership resulting in strong market share positions in the process control market for semiconductors and a growing mix of less volatile services revenues.
--Fitch's expectation that the company will maintain conservative financial policies; and
--Secular long-term growth trends, including increased technological complexity and shortened life cycles for semiconductor products (Moore's Law) and increased outsourcing to foundry partners.
Fitch's ratings concerns focus on:
--KLA-Tencor's need for substantial ongoing investments in R&D and sales and marketing, each of which Fitch believes will continue to represent 15%-20% of revenues (although capital spending for semiconductor equipment makers is comparatively low) to maintain technology and market leadership;
--Substantial customer concentration with expectations for ongoing customer consolidation; and
--The highly cyclical demand patterns associated with the semiconductor equipment market.
The rating and outlook incorporate expectations for flat to down 10% capital spending by semiconductor companies in calendar year 2012, following robust spending in 2011. After taking share in certain end markets (most notably, metrology) over the past year, Fitch expects revenue growth in the low single digits in the current calendar year. The company exited the recent quarter with record revenues and a book-to-bill ratio (new orders to revenues) of 1.48x, despite experiencing a nearly 20% sequential revenue decline for the quarter.
Foundries and logic providers continue investing in tools and services to address leading edge capabilities in mobility platforms. Meanwhile, Moore's Law continues unabated with more than 50% of new orders focused on systems around 28 nanometer (nm) and smaller. Fitch continues to believe KLA-Tencor is the only provider of a broad set of yield maximization tools at leading edge circuitry nodes.
Importantly, the company should be able to hold gross margins between 55% - 60% and unwind some investment in working capital to drive free cash flow. Fitch expects annual free cash flow for fiscal 2012 will approach $500 million. Incorporated into the rating and outlook is KLA-Tencor using excess free cash flow for a combination of dividends and stock buybacks under the existing share repurchase authorization.
Credit protection measures will remain strong for the rating with a Fitch estimated total leverage (total debt/operating EBITDA) and interest coverage (operating EBITDA to gross interest expense) below 1x and above 15x, respectively. Through the semiconductor equipment cycle, Fitch anticipates these metrics will range from 0.5x - 3x and 5x - 20x. The ratings incorporate Fitch's expectation that the company will use free cash flow to fund a combination of share repurchases and acquisitions.
Positive ratings actions could most likely result from:
--Stronger mid-cycle annual free cash flow of approximately $500 million, likely driven by profitability growth.
--Significantly higher cash balances from lower than expected share repurchases and acquisitions, in conjunction with a revolving bank credit facility.
Negative rating actions could occur if KLA-Tencor's:
--Free cash flow is impaired by slower than expected profitability expansion, likely from a return to higher levels of fixed costs, or a significant structural degradation in working capital.
--Revenue growth is meaningfully lower than anticipated, most likely from a return to more conservative capital investment strategies by key foundry and memory customers.
As of Dec. 31, 2011 Fitch believes KLA-Tencor's liquidity was solid although limited to the company's approximately $2.2 billion of cash, cash equivalents, and marketable securities (the majority of which was located in the U.S.). The company currently has no bank credit facility. Total debt consists solely of $750 million of 6.9% of senior notes due 2018.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Criteria:
--'Corporate Rating Methodology' (Aug. 12, 2011);
--'Rating Global Technology Companies Sector Credit Factors' (Sept. 20, 2010).
Applicable Criteria and Related Research:
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229
Rating Global Technology Companies - Specific Rating Factors
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=543285
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Contacts:
Fitch Ratings
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Jason Pompeii, +1-312-368-3210
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Director
Fitch, Inc.
70 W Madison Street
Chicago, IL 60602
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Secondary
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John Witt, CFA, +1-212-908-0673
Senior Director
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Committee
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Senior Director
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brian.bertsch@fitchratings.com