KLA (KLAC): A Record Quarter, a Beat — and the 1% Number Nobody Noticed

KLA Corporation (KLAC) Q4 FY2026 — KLA Corporation (KLAC), the dominant supplier of semiconductor process-control (inspection and metrology) equipment with roughly 58% market share, reported fiscal Q4 2026 (quarter ended June 30, 2026) after the close on July 28. Revenue was a record $3.658B, +15.2% YoY and above the midpoint of guidance; non-GAAP EPS of $1.05 beat the ~$1.02 consensus; non-GAAP gross margin of 62.4% landed at the upper end of guidance. GAAP net income was $1.363B and GAAP diluted EPS $1.04 — the low per-share figure reflects the 10-for-1 stock split effected June 11, 2026 (1.315B diluted shares). FY26: revenue $13.579B (+11.7%), GAAP net income $4.831B (+18.9%), non-GAAP EPS $3.76. Guidance for Q1 FY27 was $4.0B +/- $200M (about +25% YoY, above the ~$3.92B consensus) with non-GAAP EPS of $1.16, and management raised its calendar-2026 wafer-equipment market view to the low $150B range from $140B+. Yet the stock fell ~9% after the print, on top of a 6.2% decline that session — about 42% below its June 30 closing high of $301.71. Two under-covered facts explain the reaction. First, wafer inspection — KLA's highest-margin, highest-share franchise — grew just 1% YoY and fell from ~56% to 49% of revenue; growth came from lower-margin patterning (+61%), PCB and component inspection systems (+96%) and services (+17%), which is why non-GAAP gross margin actually declined from 63.2% to 62.4% on 15% more revenue, and why September gross margin is guided flat at 62.5% on ~10% more revenue. Second, cash conversion deteriorated: FY26 free cash flow was $3.767B versus $3.747B — flat — while net income rose 19%, so FCF/net income fell to 78% from 92% in FY25 and 110% in FY24; Q4 FCF fell 23% YoY to $817M as receivables consumed $586M in the quarter and ended the year +28% against 15% revenue growth. KLA still returned $3.348B (89% of FCF) via buybacks and its 17th straight dividend increase. China was 26% of revenue. Our owner-earnings DCF on a ~$4.7B base, weighted 70% to the AI-secular path at a 9% discount rate, lands fair value near $110 versus ~$174 — about 37% below the price. Our call: HOLD, 2/5 — an A+ franchise whose 2030 plan is already in the price. Wall Street is at Buy (28 buy / 14 hold / 2 sell) with a ~$229 average target implying +32%, so we DIFFER and are materially more cautious. KLA Corporation (KLAC) just did something unusual: it printed the best quarter in its history, beat on earnings, guided above consensus, raised its forecast for the entire wafer-equipment market — and the stock fell anyway, leaving it about 42% below its June high. KLA is the near-monopoly of semiconductor process control, the inspection and metrology step that catches defects while chips are being built; it holds roughly 58% of that market and earns like it, with 62%+ gross margins, 42%+ operating margins and a return on equity near 76%. Fiscal Q4 2026 (ended June 30): revenue a record $3.658B (+15.2% YoY), non-GAAP EPS $1.05 versus ~$1.02 expected, non-GAAP gross margin 62.4% at the top of guidance, GAAP net income $1.363B. Full year: revenue $13.579B, GAAP net income $4.831B (+18.9%), non-GAAP EPS $3.76. September guidance is $4.0B +/- $200M, roughly +25% YoY and above the Street, with the calendar-2026 wafer-equipment market raised to the low $150B range from $140B+, backlog around $12.5B, and advanced-packaging process-control revenue guided to about $1.1B in 2026, up more than 70%. So why did it sell off? Two things the coverage largely skipped. First, the mix: wafer inspection — the crown-jewel franchise where KLA's share and pricing power are greatest — grew only 1% year over year and slipped from about 56% to 49% of revenue. The 15% growth came from structurally lower-margin lines: patterning +61%, PCB and component inspection systems +96%, services +17%. That is precisely why non-GAAP gross margin went down, from 63.2% to 62.4%, on 15% more revenue — and why September margin is guided flat at 62.5% despite roughly 10% more revenue, with management also flagging that memory input costs (KLA buys memory chips for its own tools) likely bite through 2027 and that repricing existing orders is limited. Second, the cash: FY26 free cash flow was $3.767B against $3.747B a year earlier — essentially flat — while net income rose 19%. Free cash flow as a share of net income fell to 78%, from 92% in FY25 and 110% in FY24, the weakest in at least eight years. In the June quarter alone FCF fell 23% to $817M as receivables absorbed $586M and finished the year up 28% versus 15% revenue growth. KLA still returned $3.348B, about 89% of free cash flow, and has targeted more than 90% going forward. China remains 26% of revenue, second only to Taiwan at 31%, in a business governed by export controls. Our owner-earnings DCF uses a ~$4.7B base (net income plus D&A, less capex, with a haircut for the working capital this business now consumes; reported FCF was $3.767B) and runs a cyclical path compounding at 8% and an AI-secular path at 16%. At a 9% discount rate those are worth about $75 and $123 per share; weighted 70% to the bull case, fair value is roughly $110 against a price near $174 — our value sits about 37% below the market. Even management's own 2030 target of $8.40 in split-adjusted non-GAAP EPS, at a generous 25x and discounted back four years at 9%, is only about $149. Our call: HOLD, 2/5 — this is a downgrade of the price, not the company; we'd get interested below roughly $120 and want real margin of safety under about $105. Wall Street disagrees: 28 buy, 14 hold, 2 sell, average target near $229, about 32% above the price, so we DIFFER and are more cautious. Watch free cash flow and gross margin every quarter. Not financial advice. THE CALL: HOLD (2/5, A WORLD-CLASS FRANCHISE WITH 2030 ALREADY IN THE PRICE — A DOWNGRADE OF THE PRICE, NOT THE COMPANY) — base-case value ~$110.00 vs ~$174.00 today. What to watch: hard evidence that calendar 2027 is another up year rather than a digestion year — backlog pushing durably past $12.5B and wafer inspection re-accelerating from its 1% growth — combined with gross margin actually breaking upward toward the 63.5%+ the 2030 target model requires, instead of drifting down while revenue climbs, would restore the compounding case and move us up; the risks that would deepen our caution are the mirror image — any pause in wafer-equipment spending, a new export-control round hitting the 26% China exposure, memory input costs persisting past 2027, or receivables and inventory continuing to grow roughly twice as fast as revenue and holding free-cash-flow conversion below 80% Also on YouTube: @ChargedAlpha DISCLAIMER: For informational and educational purposes only. Not financial advice. Do your own research before any investment decision.