Fitch Revises Outlook on KLA-Tencor to Negative; Affirms IDR at 'BBB'

CHICAGO--([ BUSINESS WIRE ])--Fitch Ratings has revised the Rating Outlook on KLA-Tencor Corp. (KLA-Tencor) (Nasdaq: KLAC) to Negative from Stable and affirmed the following ratings:

--Issuer Default Rating (IDR) at 'BBB';

--Senior Unsecured Debt at 'BBB'.

The revised Outlook reflects Fitch's expectations that KLA-Tencor's revenues will be meaningfully lower than previously anticipated and potentially result in negative free cash flow for the fiscal year 2009 ending June 30, 2009. Consistent with Fitch's expectations for semiconductor equipment industry revenues declining by at least 20% in calendar year 2009, Fitch had anticipated weaker revenues for KLA-Tencor over the near-term. Nonetheless, KLA-Tencor recently lowered its new orders and revenue guidance for its second fiscal quarter ended Dec. 31, 2008. The company now expects new orders were $235 to $245 million, 25% lower than the original expectations of $325 million. KLA-Tencor expects revenues were approximately $390 to $400 million (6% lower than the approximately $420 million initially projected) and that the company will post an operating loss even after adjusting for an anticipated write-down of goodwill and intangible assets.

Given the current lack of industry visibility, customers continue to push out spending on new process technology transition and the associated services revenues to preserve cash and rebalance supply with demand. In addition, Kla-Tencor expects to increase accounts receivables reserves due to certain customers experiencing financial distress. As a result of the meaningfully weaker operating environment, Fitch believes that annual free cash flow, which historically has been positive (even during the 2001-2002 downturn) could be negative over the near-term, depending upon the company's ability to stem meaningful gross margin contraction and reduce inventory levels

Further negative rating actions could occur if:

--Current new order patterns continue, outpacing the company's ability to reduce inventory levels and increasing the likelihood for meaningful negative free cash flow; or

--Profitability significantly deteriorates, driven by the company's inability to reduce its cost structure or maintain pricing discipline.

The ratings could be stabilized if the company generates positive free cash flow over the near-term, driven by inventory reductions or stronger than anticipated profitability, most likely from aggressive cost cuts.

The ratings on KLA-Tencor continue to be supported by:

--The company's strong market share positions in the process control market for semiconductors, resulting in a significant installed base and increasing recurring revenue;

--Fitch's expectation that the company will maintain conservative financial policies, underpinned by a net cash position over the intermediate-term; and

--Semiconductor market trends, including increased complexity and shortened life cycles for semiconductor products, particularly consumer electronics, will continue unabated, resulting in lower operating volatility for KLA-Tencor.

Fitch's ratings concerns focus on:

--KLA-Tencor's need for substantial ongoing investments in research and development (R&D) and sales and marketing, each of which Fitch believes will continue to represent 15%-20% of revenues, although capital spending for the company is expected to remain below 3% of revenues over the next few years. Fitch recognizes these investments have enabled KLA-Tencor to maintain technology and market leadership in most of the end markets in which it competes, particularly given the company's comparatively strong financial flexibility. While KLA-Tencor's spending on R&D exceeds that of its peer group, Fitch believes it has resulted in the company's successful execution on its goal of achieving a two-process technology lead over its nearest competitor, enabling the company to partner with customers in leading edge development, and stem average selling price pressures; and

--The significant working capital intensity associated with providing process control and yield management solutions, resulting in historical cash conversion cycle days of approximately 200 days.

As of Sept. 30, 2008, Fitch believes KLA-Tencor's liquidity was solid although limited to the company's approximately $1.3 billion of cash, cash equivalents, and marketable securities (the majority of which was located in the U.S.), as the company currently has no bank credit facility. Total debt consists solely of $750 million of 6.9% of senior notes due 2018.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, [ www.fitchratings.com ]. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.

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Fitch Revises Outlook on KLA-Tencor to Negative; Affirms IDR at 'BBB'