Ed Lockwood - IR Rick Wallace - President and CEO Bren Higgins - EVP and CFO

Krish Sankar - BofA Merrill Lynch Timothy Arcuri - Cowen and Company Bill Peterson - JPMorgan Weston Twigg - Pacific Crest Securities Chelsea Jurman - Goldman Sachs Patrick Ho - Stifel Nicolaus Farhan Ahmad - Credit Suisse Atif Malik - Citigroup Mahesh Sanganeria - RBC Capital Markets Steven Chin - UBS Edwin Mok - Needham & Company Shawn Lockman - Piper Jaffray Sidney Ho - Deutsche Bank

Good afternoon. My name is Stephanie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter Fiscal Year 2015 Earnings Conference Call. [Operator Instructions] Thank you. Mr. Ed Lockwood, with KLA-Tencor, Investor Relations, you may begin your conference.

Thank you, Stephanie. Good afternoon, everyone, and welcome to our conference call. Joining me on our call today are Rick Wallace, our President and Chief Executive Officer; and Bren Higgins, our Chief Financial Officer. We're here to discuss third quarter results for the period ended March 31, 2015. We released these results this afternoon at 1:15 PM Pacific Time. If you haven't seen the release, you can find it on our website at www.kla-tencor.com or call 408-875-3000 to request a copy. A simulcast of this call will be accessible on demand following its completion on the Investor Relations section of our website. This quarter we prepared a brief slide presentation to supplement this earnings call, which includes the GAAP to non-GAAP reconciliation of the EPS guidance and other supplemental financial information. These slides can be found on KLA-Tencor's Investor Relations website. There, you’ll also find a calendar of future investor events, presentations and conferences, as well as links to KLA-Tencor’s SEC filings, including our annual report on Form 10-K for the period ended June 30, 2014, and our subsequently filed 10-Q reports. In those filings, you’ll find descriptions of risk factors that could impact our future results. As you know, our future results are subject to risks. Any forward-looking statements, including those we make on this call today are subject to those risks, and KLA-Tencor cannot guarantee those forward-looking statements will come true. Our actual results may differ significantly from those projected in our forward-looking statements. More information regarding factors that could cause these differences is contained in the filings we make with the SEC from time-to-time, including our fiscal year 2014 Form 10-K and our subsequently filed quarterly reports on Form 10-Q and current reports on Form 8-K. We assume no obligation and do not intend to update these forward-looking statements. However, any updates we do provide will be broadly disseminated and available over the Web. With that, I’ll turn the call over to Rick.

Thank you, Ed. Good afternoon, everyone, and thank you for joining today’s call. KLA-Tencor delivered another quarter of solid financial performance in Q3 driven by our market leadership, our innovative portfolio of process control solutions and strong operational execution. Financial results for Q3 were inline with our expectations, revenue in the quarter grew 9% sequentially finishing above the midpoint of our guidance at $738 million. And non-GAAP earnings per share came in at the upper end of the range at $0.84 per share driven by lower operating expenses in the period. New orders also finished in the upper end of the range of guidance in Q3 at $692 million. These results are a good start for KLA-Tencor in calendar 2015 reflecting continued solid execution against our strategic objectives and the benefits of our ongoing focus on innovation and market leadership. In fact, our latest industry market share data shows KLA-Tencor delivered another year of strong market leadership in the most critical areas of process control in calendar 2014 demonstrating success in our customer focus initiatives and the value of our portfolio of process control solutions. As the market leader in process control, KLA-Tencor is addressing our customers most critical yield challenges and the various technology transitions underway in the marketplace today including multi-patterning, new device architecture such as FinFET and 3D NAND. Turning now to our perspective on the current market environment and thoughts on the industry landscape for the remainder of calendar 2015, first I think it's important to remind to everyone that setting aside the seemingly never ending stream of conflicting signals and uncertainty as to the magnitude and timing of near term investment in the leading edge, equipment demand is generally healthy and our customers continue to drive their long-term strategies for growth led by major technology inflections at the leading edge. But over the consolidated customer base, demand for leading edge logic and foundry limited to one or two large customers in the initial phases of a new node, the continued high class of next generation node transitions, we have come to accept a higher degree of volatility and quarterly demand, shorter leading times and the result of low visibility in the demand environment as just being part of our industry today. But even with these factors and with caveats related to the timing of investments in the year, we still expect 2015 to be a solid - a solid demand for the equipment industry. With investment levels forecasted to be on par with what we saw in 2014 and with the potential for modest industry growth depending on the timing of some of the larger capacity RAMs that are expected in the second half of the year. In terms of our view of the end markets, we see memory investment initially focused on 20-nanometer conversions in DRAM followed by increasing 3D NAND investment in the second half of calendar 2015. The primary focus of investment for foundry in 2015 continues to be FinFET development and capacity ramp for a number of customers in addition to fill in capacity demand for 28-nanometer. We also expect our R&D and pilot investment for the 10-nanometer design node to begin picking up in the second half of the calendar year. In this environment, process control plays a critical role enabling the successful execution of our customer's growth strategies creating opportunity for KLA-Tencor and fuelling our long-term growth. As the market leader in process control, we would expect revenue growth at least in line with the industry in the year. In KLA-Tencor, we have an ongoing process for evaluating the company's progress in our long-term strategic objectives of customer focus growth, operational excellence and talent development. Our goal in successfully executing these strategies is to deliver consistent growth, strong cash flows and profitability and sustain market leadership over the long-term with superior returns to our stockholders. We believe our ability to proactively get ahead of shifting customer and market dynamics as one of KLA-Tencor’s competitive strength and a key differentiator for the company. Consistent with this ongoing process, today we announced a plan to reduce our global employee workforce by up to 10%. This action and previous organizational alignment actions are aimed at streamlining our organization NAND business processes in response to the changing customer requirements in our industry. Our efforts are directly - are directed and improving efficiency and removing complexity throughout our organization, streamlining our customer focus strategies and better integrating our R&D and product introduction processes. The goal of these efforts is to deliver an increased capacity for investment in innovation and market leadership and direct our resources toward our best opportunities while enabling improved earnings power over time. Example of various we have identified for future realignment of investment priorities includes scaling back our investment in EUV, as well as consolidating our customer facing organizations and our go-to-market strategies to better match the consolidated customer base. We will continue to make the strategic investments necessary to fuel our long-term growth strategies and we’ll also continue to proactively evaluate and adjust our plans as appropriate. Regarding the headcount reductions we are announcing today, we are currently finalizing the details and specifics of these actions and we will have more information and details in the weeks to come. In closing, long-term growth for KLA-Tencor is driven by the strong pace of investment in next generation semiconductor device technologies by the market leaders in logic, foundry, and memory. Process control plays a critical role in helping these customers solve the mission critical production problems associated with managing yields in the leading edge manufacturing environment. As the market leader in process control, KLA-Tencor continues to benefit from these ever more complex and costly yield challenges. As we look ahead, we are energized by the opportunities that lie ahead and optimistic that 2015 promises to be an exciting year for KLA-Tencor. We are well positioned in key markets with innovative products to execute our strategies for growth in market leadership and to deliver strong returns to our stockholders. Turning now to guidance for the fourth quarter of fiscal 2015. New orders in June are expected to be in the range of $550 million to $750 million. Revenue guidance for Q4 is in the range of $710 million to $790 million and non-GAAP earnings per share in the range of $0.78 to a $1.02 per share for the quarter. Before I conclude, I would like to thank the entire KLA-Tencor team for their continued hard work and dedication. As always, our driving focus remains on innovation and execution enabling us to meet complex customer requirements and deliver consistent solid financial results. As we move forward we will continue to support high levels of investment and innovation to drive our market leadership, generate improved operating leverage in our business and deliver strong returns to our stockholders. With that, I will turn the call over to Bren for his commentary on the quarter before returning for Q&A. Bren?

Thanks Rick and good afternoon. Revenue for Q3 was above the mid-point of guidance at $738 million and non-GAAP earnings per share finished at the upper end of the guided range for the quarter at $0.84 driven by higher revenue and lower than modeled operating expenses in the period. Fully diluted GAAP earnings per share in Q3 was $0.81. The GAAP earnings per share in Q3 included $0.03 of acquisition, restructuring, severance and other related charges net of the income tax effect on these adjustments. My comments on the quarter will be focused on the non-GAAP results, which exclude these adjustments. A detailed reconciliation of GAAP to non-GAAP earnings per share can be found in the press release and supplemental materials posted on our website prior to this earnings call. Looking at the overall business environment, the landscape is similar to what we described back in January with shipments and revenue levels for KLA-Tencor expected to be generally balanced half over half in 2015 and what is now planned to be a year of modest growth for WFE. There are assumptions in the forecast that could impact the timing of results but the overall view that calendar 2015 will be a solid but not spectacular year for KLA-Tencor and for the industry remains the same today. New orders in Q3 were $692 million at the upper end of the range of guidance of $500 million to $700 million for the quarter. Foundry was 76% of new orders in Q3 and logic was 7%, memory bookings finished at 17% of new system orders in the period. Turning now to the distribution of orders by product group, wafer inspection was approximately 39%, reticle inspection was 11%, metrology was approximately 22%, service was 26%, storage, high brightness LED and other non-semi was approximately 2%. Total shipments in Q3 were $715 million. Given current shipment backlog we expect shipment levels in the second half of calendar 2015 to be roughly equal to the levels in the first half. In total, we ended the quarter with just over $1.3 billion of total backlog comprised of $1.1 billion of shipment backlog or orders that have not shipped to customers and expect to ship over the next six to nine months. Total backlog also includes $239 million of revenue backlog or products that have been shipped and invoiced but have not yet been accepted by customers. Turning to the income statement, revenue for the quarter was $738 million up 9% compared with Q2. Gross margin was 57% and in line with the guided range. We expect gross margin to be in the range of 57% to 58% in June driven by a more favorable mix of high end wafer inspection tools in the quarter. Looking ahead, our gross margin performance should continue to reflect our differentiated business model which is fueled by 60% to 70% incremental gross margins. Operating expenses were $218 million, down from $231 million in Q2 and below the guided range of $227 million to $229 million, a result of favorable variance and some discretionary budget in quarter and from our continuing focus on cost controls. The global employee workforce reduction plan announced today and previous organizational alignment action are intended to optimize our global business operations to maintain our leading market position, free up resources to direct investment on our most important customer and product development initiative and appropriately aligned our organization and business processes to fit in involving industry and customer landscape. We are currently modeling operating expenses for June quarter to be flat compared with March. At this time, we're enable to make a good faith determination of the cost estimates associated with the global employee workforce reduction plan and our June quarter GAAP EPS guidance does not consider the impact to these costs. We plan to update GAAP guidance once we have determined the earnings impact of the proposed plan. Other income and expense was a net expense of $29 million in March, and we expect OAE to be a net expense in the June quarter of approximately $28 million. The tax rate was 21.1% in Q3 and inline with the long term planning rate of 22%. Net income was $137 million or $0.84 per fully diluted share on a non-GAAP basis. Turning to the balance sheet, cash and investments ended Q3 at $2.3 billion, we repurchase 2.6 million shares of stock and paid a dividend of $82 million in period, and cash from operations was strong at $242 million in a quarter. Lastly we ended Q3 with approximately $163 million fully diluted shares outstanding. I expect Q4 to end at approximately $160 million. In conclusion to reiterate our guidance for the June quarter is new orders are expected to be in range of $550 million to $750 million. Revenues expected in the range of $710 million to $790 million with non-GAAP earnings per share in the range $0.78 to $1.02 per share. This concludes our prepared remarks for today. I will now turn the call back over to Ed to begin the Q&A

Okay. Thank you, Bren. At this point we'd like to open the call to questions. We once again request that you limit yourself to one question and one follow-up given the limited time we have for today’s call. Feel free to re-queue for your follow-up questions and we’ll do our best to give everyone a chance for further questions as time permits. Stephanie, we're ready for your question.

Your first question comes from the line of Krish Sankar with Bank of America Merrill Lynch. You line is open.

Hi, thanks for taking my question. The first question I had was quickly, Bren, you mentioned that the second-half shipment should be similar to the kind of first half. What is your shipment guidance for June quarter? And I also had a follow-up after that.

Sure, Krish, the guidance for the June quarter, at the midpoint is up 12% to $800 million, so the guidance range is $760 million to $814 per shipment.

Got it, that is very helpful. And then a question for Rick as a follow-up. I am curious to know the thought process behind the 10% workforce reduction, because it looks like the industry spending is robust and you guys also said that you need to go in debt like six months ago. So why the reason for the cuts now that you are confident and seem to be doing it? Is this more a reaction to any kind of competitive situation, market share loss, or is it more looking at KLA specifically over the next 12 to 24 months?

Well it's actually looking at the industry over the next five years and thinking about how we should be structured and to provide answers to customer's challenges. So two things, one, as we know that industry has gotten a lot simpler in terms of customer consolidation and we have the luxury of being able to forward a relatively expensive go-to-market strategy which we are streamlining in this. The second one is our product divisions, we'd had number of product divisions and for while that made a lot of sense for most of company's history, but we think now that in – as what we're seeing now from our customers is really request for a solutions across products and our ability to do that means we streamline those product divisions, let's say, you end up with a fair amount of excess capacity in terms of management to support that. And so we end up being streamlined in terms of our go-to-market but also our product development. So it's really reflection of what's going on in the industry and the result is we end up being in a position where we're going to have the reduction of some of the talent that’s been in the company.

Thanks Rick.

Your next question comes from the line of Timothy Arcuri with Cowen and Company. Your line is open.

Thanks a lot. A couple of things. Rick, I guess - this is just a big picture question, but I'm just looking at your WFE share. And in 2014 you lost about 50 bps of WFE share. And if the back half, revenue wise, is pretty similar to the front half of this year, you're going to lose another 50 bps roughly. And it seems like there is - that your lack of exposure to memory is becoming a real problem as a lot of the secular spending vectors are in memory. So I guess I wanted your opinion on is this finally the straw that sort of breaks the camel's back that forces you to get into the process business to gain some exposure to memory? And then I had a follow-up. Thanks, Rick.

Sure, Tim. So, let me start with no, this is not something that force us into process. I think what it does is - we have opportunities to create more value in memory and to increase the capital intensity, but we don't necessarily - we haven't delivered those solutions yet to the market. And some of those memory processes are inherently less process control intensive and we know that. So there is some opportunity for growth there. And we also as we model it out, we do think we are in a secular part of the, I guess, that the industry where memory is going to be higher, but not forever. And so when we model this we'd say, yes 2015 continues to be probably more memory heavy then if you go back three or four years, but we think that trend will swing particularly when we start seeing investment in next generation technologies as in the 10-nanometer node for logic and for process which have been delayed. Then we'll expect to see foundry come into balance and we'll see opportunities to grow relative to the market. We think we hold to the market overall this year but we have chances for growth as we go forward. Bren, you want to add any color to that.

No, I think, Tim, within the segment itself, our market share position is very strong. And so we're comfortable with our positioning but obviously as you know memory isn't our strongest hand so every WFE dollars is not created equal in terms of the impact on our business. So while we're - I think we're encouraged by what we're seeing on the share front memory and some of the opportunities to increase adoption, the adoption is not going to ever get to where foundry and logic is. So we think that once foundry and logic begins to invest in earnest and some of the technology transition that Rick mentioned, we feel pretty good about our relative performance at that point.

Okay, great. And then, a just quick follow-up to that, Bren you had guided, I have my notes, last call you said, that you saw orders in the first calendar half of this year would be about flat with the calendar second half of the last year, which is implying that orders in June would be like 825 something like that now even if I adjust for March being a bit better, being above the range, it seems like roughly $100 million pushed out of the first half of this year from the order perspective, can you talk about what that was?

So, once again the specific customer situations but I was expecting more for at least from an order perspective, more 10-nanometer activity to start to show itself from the June quarter and that looks like that's delaying now to the second half of the years. I'd see principally that's the biggest piece of the change.

Okay. Thanks guys.

Your next question comes from the line of Harlan Sur with JPMorgan. Your line is open.

Good afternoon this is Bill Peterson for Harlan. Thanks for letting me ask a question. Piggybacking on the move towards 10-nanometer, as you talked about, it's really limited to a few players at the moment, but as we look ahead, what is your view on capital intensity uplift for process control as we compare to, say, 14, 16, or 20, the combined node. And related, how should we think about the reuse of equipment when transitioning between these advanced nodes? Thanks for your insight on that.

Sure. The 10-nanometer process intensity we have some models for it but until it really happens, its going to be hard to validate those models because we're still early in terms of people's development for it. But we did have model that we laid out and we can talk to the specifics of that in a minute. In terms of the transition and the reuse issue, I think that its pretty clear in cases like the 20 to 16-nanometer transition you do see the opportunity for customers to have fair amount of reuse depending on the back end of the process and how much change there. So far that's part of it, but the other do they maintain the 20-nanometer line going and so reuse gets, I think you see more pronounced if the volume on the 20-nanometer decreases when they go to 16, does that make any sense. So 10 we think is entirely a different case more like the transition from 28 to 20 then it from 20 to 16 and so we expect more intensity as a result of that we're looking for some of that data and the specifics here inside. Yes, so the way we laid it out, I don't think we feel, we feel very comfortable with the data at least on the foundry logic side that what we consider one exit in below which included 20-nanometer was in excess of 18% on logic foundry. So to Rick's point, I think the biggest issue is very similar toolsets from 20 to 16, 14 with the same lithography, the biggest question was going to be the size of the node and the number of designs and therefore the ability to migrate capacity. So to the point earlier with very little activity, 20-nanometer beyond couple of customers, customer were able to migrate capacity down to 16 and so, so I think that's the dynamic that we're seeing. But we're comfortable with the 18% as Rick said early on 10 and so I think we'll save that for another day and depending on how you to that earlier question, depending on how you one day gets to this total, but with memory blended at 40% to 45% which is probably where it is this year. You're probably sub 14% -14.5% or so on that range between 14% and 15%, but we will see how it plays out through the year.

Thanks for that color. My follow-up, and switching gears to memory, we are getting closer to 3D NAN adoption as we witnessed from a lot of the press releases out there. We would expect, of course, more [caption depth] [ph] intensity with reuse of a lithography. But can you give us an updated view on what your customers are standing to require from a process control perspective and how it compares to 15-, 16-nanometer Planar? I guess presumably areas like [indiscernible] OCD stress become more intensive but what about some other areas, inspection overlay and things like that? Thanks for the insight.

Sure. I would say it is more intensive in metrology than it is inspection when you look at the transition of 3D. There are couple of areas for opportunity and inspection, there's definitely opportunity when it comes to majoring, inspecting films and especially buying films and there's a big desire to keep those process as clean given the stat. So you do have opportunities there because angles are relaxed, you have less intensity associated with advanced wafer inspection expect for in the development phase, so you do see it there but not as much in production. Metrology is kind of where the action is though, because there is so much in terms of number of players requirements, round overlay and film measurement, so we do see big opportunity in terms of what's going on in the metrology. And so, in aggregate you do get an increase and the intensity, but it still is significantly what we see in the logic foundry. But the rate of increases similar to what we see in the rate increase in logic foundry, but the intensity is probably modeled, it was about half of that what you see in large foundry. So, we’re matching subject to the shift for memory to logic or logic memory than we are necessary node to node, where we do see increased adoption associated with the advance node.

Okay. Very helpful. Thank you. Good luck.

Thank you.

Your next question comes from the line of Weston Twigg with Pacific Crest Securities. Your line is open.

Hi, thanks for taking my question. First just wanted to ask if you had a new investment program from your customers to move forward with actinic UV mass inspection, how quickly could you ramp that program up and does that potentially impact your workforce layoff plan?

I guess, we are having the lot of conversations with customers about that and nothing has really changed in terms of the customer sentiment around the need and timing of actinic inspection. So as soon as I think we see any capacity being available, should it get funded is 2019 and at this point we don't see a lot of appetite for that given the relative low adoption in terms of EUV and the production. So what we do see here, we have some recent examples of some plans as you know to do, cut mask, but 6XX product line that we have there can service that and service those needs and it is going to be utilize to do that. So the answer remains the same, its probably four to five years if we were to get funding we don't anticipate that happening any time soon and the talent that one would need to do that is not necessarily the talent that is - we’re viewing as part of a transition to this linear structure as we go forward. And so from that standpoint it really has no bearing on actions that we are taking now.

Okay, that's helpful. And just secondly, Intel announced a large CapEx reduction this year from its forecast, largely based on equipment reuse as we migrate from 22- to 14-nanometer. That's a full node transition, so traditionally you wouldn't have had a lot of impact from equipment reuse and I'm wondering if that's a little different this time around? Are you seeing much reuse from that 22-nanometer node at Intel?

Not given the specific customers in terms of how that's moving, but I think if you look at the reduction in CapEx there and the reduction in CapEx from TSMC, we had about $2 billion of CapEx come out of the market. So about $1 billion of that was WFE and at the intensity levels we described earlier represents probably somewhere around - somewhere between $100 million and $150 million of KLA-Tencor opportunity given our share in the intensities I mentioned. So, clearly those push-outs had an effect on our business as we look at the year. There is probably some opportunities for some upside out there, I think has happened around 10-nanometer or strengthening in some of the memory markets but recent terms however we see it today its hard to ignore that impact in terms of the - the impact on CapEx and the customer behavior we're seeing as a result of that. On the reuse from 22 to 16, I think it's the same thing. I think in some way I think - the ability to extent certain tools, metrology requirements are different, so there is some there - customers always try to do that. I think at this note, I think its particularly a little bit more, there is more reuse but in general its always - they always attempt to use more and it really depends on how much of that process is changing through the front end, back end.

Very helpful. Thank you.

Your next question comes from the line of Jim Covello with Goldman Sachs. Your line is open.

Hi, this is Chelsea Jurman on behalf of Jim. Thanks for taking the question. It sounds like you are now expecting WFE to be flat or up slightly and that this is going to be determined by the second half. Relative to where you provided your initial guidance for 2015, where are you seeing the most upside, and where is there the biggest risk to the downside?

That's the way we are seeing it right now and as I said I think upside is related to foundry logic 10-nanometer and Volume-NAND. I think that on downside there, I think is all publicly related to how much end market demand we actually see start to come into play around 16 to 14 and what does that do to drive more capacity I would say - absent the broader sort of macro issues that are out there that's how we would see it.

Got it. And then in terms of growing in line with the market in 2015 or in line with the industry, would you say that your forecast for industry growth has come down since the beginning of the year? And how is your growth impacted by the changing CapEx cuts at not only Intel but other big customers?

Yes I think we are inline with the rest of our peers around the views of the year and I think with the public announcements from two significant customers and our strongest space, or strongest segment that is certainly led us to moderate that view for the year.

Great. Thank you.

Your next question comes from the line of Patrick Ho with Stifel Nicolaus. Your line is open.

Thank you very much. Maybe as a follow-up to Wes' question for you, Rick, in terms of the mask inspection for EUV, how do you look at it from a KLA perspective in terms of the risk/reward, the investments? Will you only do it if you're going to get some of outside funding or is there something you can do if the customer demand is there to take on that project?

No, this is one where we need to work closely with the customers to make sure that A, the demand is there and the commitment is there because right now the uncertainty around the timing of high volume EUV makes this a very different kind of question in terms of the investment profile. Remember we build that tool and there is not a market for it, there is no other application for it. It can only be used for one thing which is to inspect EUV masks. And if you build advanced wafer inspection tool, it really only matters the people are making wafers and doesn’t really matter the technology they are making it with. So, for that reason we're coupled to our customers on this and talking closely with them about their needs and we'll develop in conjunction with them as we go forward. But to-date we have not seen compelling interest on their part to want to make that commitment.

Great; that's really helpful. And maybe, Bren, for you, in terms of some of the industry commentary you provided, particularly some of the pulls and pushes you're getting both on the FinFET 16-, 14-, and the 10-nanometers, do to see any pulls from your vantage point of -- or pushes and pulls from 14 to 16 being pushed out, but some customers trying to pull in 10 and accelerate that process? Is that something you could potentially see in the second half of the year in terms of additional 10-nanometer development in lieu of the capacity adds for 16 and 14.

I mean, I guess it's possible. What we've seen so far I think a continuation of what we've experience over the last couple of quarters and that's been a very measured pace of additional capacity adds for 14, 16. And so it's been a much more measured pace than we've seen in prior nodes and as a result on the margin we've had weaker sort of general results or order, orders and shipments. And so, as we look at beyond - who knows what's going to happen? I think there is some high profile potential announcements in the second half of the year and does that drive competitive dynamics that drive incremental capacity as possible. We are certainly living in environment today where we don't get a lead time visibility from our customers because our customers aren't getting it from there. So, I think we have the capacity to be flexible, the response to an uptick if it would happen. I mean, right now based on a commentary earlier and the way we're modeling is modest sort of up year for the industry and our performance in line with that.

Great. Thank you. Operator, read next question?

Your next question comes from the line of Farhan Ahmad with Credit Suisse. Your line is open.

Thanks for take my question. My first question is regarding the OpEx that you announced. How should we think about the OpEx level, given that you're cutting your OpEx and should we think should be roughly about 10% cut from the OpEx level that you are currently at? And also how does the OpEx cut change your onshore versus offshore cash generation?

Good question. So, I think we'll have more to say about what are normalized targets are going to be as part of this, I mean part of action is really been driven by our strategic need in terms of how we're going to structure company, obviously it’s a more efficient structure and they'll be savings, but some of the savings will be redirected into some other things that we want to invest more in. I mean one very strong aspect of this reorganization is it's allow us to very easily capital across different projects to capitalized on opportunities in a more effective and expeditious way if you well. So I think that's certainly something that we’re looking at. In terms of a model, the way I'm think about is we take the current business levels which roughly equate to about an annualize level of $3 billion with fully loaded variable comp we will generating operating margins of about 30% and with the ability to be able to scale the business on revenue growth at 50 to 60 incremental operating margin off of that base. That's how we're modeling, but I think we're very early and we'll have more to say as we progress over the coming weeks towards SEMICON West.

Thank you. And then in terms of the programs where you think some investment could be needed, can you just highlight like maybe like one or two areas where you think like which are very good growth opportunities for inspection where you maybe increasing the OpEx?

Well, I'll take this. There is two areas really, one is around – these are areas we'd emphasize more and recognize that to Bren's point we're modifying how much we're spending but where we would emphasize and move, really around the two solutions we have one is around patterning solutions, which we look at the opportunities to bring together and we've already introduce 5D which is our solution to really trying to help our customer managed the challenges of complex patterning. And so there's an elements of that that includes some of the design information as well as the overlay measurements of film thickness and stack and integrated that into complete solution that allows our customers to address the challenges they have. So investing in that is one, the other one is in our defect portfolio and part of the reason for these changes is integrating again some of the data that we see in design along with the information we find during inspection with some of the information we have in review and what we call fusion program and in that we take that information and it helps our defect discovery for our customers and allows them to accelerate their ramps and identifying and hunting down some of the challenges they face. So both of those are system solutions that our divisional structure didn’t necessarily inhibit but it certainly will be facilitated in this new structure in those areas we are certainly going to focus on big demand from our customers for that and we’re pretty excited about our ability to provide solutions there.

Thank you. That's all I have.

Your next question comes from the line of Atif Malik with Citigroup. Your line is open.

Hi. Thanks for taking my question. Rick, similar to Tim's question, if I look at your PDC market share, it has been pretty stable and actually going up, but the PDC share as a percent of equipment spending WFE has been coming down from 8% to 9% to 7%. Can you talk about your opportunities in the non-semi-markets, the storage packing? Is there anything you can do, either organically or inorganically to know there?

Sure. We certainly have, we participate in what’s going on in some of the back end and packaging and so on. And we have opportunities for growth there but let me just caveat it by saying the size of that opportunity relative to the rest of the company doesn’t provide a meaningful uplift to our overall. But we think it’s more important is associated with the intensity of process control and foundry and memory and a big part of that transition as we know is the increased memory spend. We think that that comes back into balance, in the future we’re not exactly sure when and we think that once again provides our opportunity to go faster in the industry. We do see increased intensity as we go node to node, some of that is opportunity that will capture with our existing products and some of it is opportunity that we’re going to need new capability to capture and work minute above. So we’re not really looking outside of our core for to grow faster than the industry. We think we’ve got what we need inside, we just need to execute.

Great. And, Bren, at SEMICON Analyst Day last year you talked about returning 100% of accessible free cash flow to shareholders and then post this restructuring move, is that still the plan?

Yes I mean I think the extra element in that is how we think about de-levering the - some of the debt that we brought on and we structured a component that debt with a term loan bank component that we have prepay ability to. So using 100% of the cash flow obviously we’ve got the ongoing dividend and that’s a different exercise in terms of how we think about the growth rate in that ongoing dividend relative to the growth rate in free cash flow of the company. And then the difference between the U.S. cash which is about 60% to 70% of the total less the ongoing dividend goes towards share repurchase and de-levering. So we’re committed to executing the share repurchase component of the recap announcement we made last fall and then beyond there I think my focus probably shifts more towards this beyond dilution more towards de-levering to my long-term leverage target at 2 to 2.5 times EBITDA.

Thanks.

Your next question comes from the line of Mahesh Sanganeria with RBC Capital Markets. Your line is open.

Thank you very much. Just want to follow up on comment you guys made earlier that 20, 16, 14 node is not ramping as fast as you would have thought. And 20, it was supposed to be slow and I remember 28, when you ramped first, it was a huge year for you. You outperformed by 20% in that year, and we haven't seen that at 20, 16 and 14. So do you have some thoughts on what is happening in the marketplace with this particular node? If you consider this as a one-node, 20, 16, 14, and compare it to 28, why so much difference in these two nodes?

Well I think you mean the end market demand at 20-nanometer wasn’t particularly strong beyond in couple of quarters and so customers have the ability to migrate some of that capacity, we’ve seen that in the few areas to 14 16 given the similarities with part of the process. So I think having lumped them together is how we think about them and I think it’s probably a combination of factors and market demand, competitive dynamics and so on that we’re different and stronger perhaps 28-nanometer than what we’ve seen so far at 20 and below. That can change and change quickly but at least so far that’s the pattern we’ve seen and it’s the pattern we’ve seen over the last three quarters. So it’s not necessarily something different in terms of couple of quarters. We think that that lot of that capacity begins to ship and then we will start to see how the rest play of it plays out here as we move through June and into the second half of the year.

And one more question on your commentary on first half similar to second half, can you talk a little bit about what do you see in terms of the distribution of spending in shipment terms between logic and memory in the first half over second half?

I don't know if I have that level of granularity, I know that that there just qualitatively fair amount of memory activity here in the June quarter that look at the data and then also some foundry shipments very strong quarter from Taiwan, you will see in some of the data in terms of bookings and I think that will turn quickly. So foundry pretty strong as well through June. I think for the year as I said earlier, I think if you look at total order mix and modeling that memory is probably in the low 40 percentile of the total. And I think our shipment profile would reflect that.

Okay. Thank you very much.

Your next question comes from the line of Stephen Chen with UBS. Your line is open.

Thanks. Hi, Rick and Bren. Just another follow-up question on the gross margin. Does any of this foundry 28-nanometer fill-in spend that you talked about have a negative mix impact on KLA's gross margin now and maybe that reverses itself the second half of the year or is this 28-nanometer fill-in expense just not that meaningful?

Our margins across all of our segments are generally very consistent and segments and customers. So there isn’t really an impact if have one customer having versus another in the given quarter. Most of it’s driven - most of the variations frankly are in gross margins driven more around product mix than anything else right high end wafer inspection versus low or radical for example mash up versus fab, those dynamics tend to influence our gross margin much more so than anything related to customer mix or segment.

And just a brief follow-up question on the capital intensity. The foundry customers have talked about moving quickly from this 2X technology node to the 1X technology node. Should this be any benefit to KLA at this year or has that played itself out already? Thanks.

While we’ve certainly seen at least from some of the market leaders we’ve seen some investments this quarter and in last quarter very, very strong quarter in the December quarter and those tools are now beginning to ship. There is some other backlog that we expect that we book in previous quarter also we expect to ship as we move into second half of the year. So I think a lot of it’s going to be driven by end market demand that is dynamics among our customers and we want to see how that plays out.

Okay. Thanks Bren.

Your next question comes from the line of [indiscernible]. Your line is open.

Hi, thanks for taking the question. My first question would be are you planning to invest more into e-Beam inspection and into packaging related to tools?

I’m sorry E-beam and packaging that was the question?

Yes E-beam inspection and packaging.

Okay. So separate, yes. What we have - we certainly we have interest in trying to provide a complete defect inspection solution and so there are certainly there are niches of that which are best served by E-beam and we participate in certainly E-beam review we have a product, we are proud of there, we have not been in the inspection market but we are certainly evaluating ways down there. But we also believe that customers very much want high productivity solutions and the capability which are part of what our Fusion offering is aimed out as providing the capability of linking both optical inspection with the ability to quickly review those defects. So we’re participating, we don’t have I don’t see a huge increase in our E-beam inspection investment overall, we are investing pretty heavily in E-beam in general and we might move between some of the segments there. As far as packaging, we do have some ongoing opportunity, we frankly don’t see that big of a market for process control and packaging, we do participate in that but I would not anticipate increasing our investment toward packaging. I think the front end is much more interesting for us in terms of the opportunities that are out there.

Okay, thanks. And is there any particular product that could be more useful regarding automotive electronics, like micro-inspection that you might be invest in?

Well we have and we have had some success there again these are on a relative basis pretty small but we do have a product line that is a variance of some of our laser scanning product offerings that are used in the front end and this one is services the automotive and that is a product line called Altair where we have shared some success in automotive than we are seeing adoption across the number of customers. But again relatively small ASP and pretty hard to see in our overall numbers but we certainly participate there.

Thank you.

Your next question comes from the line of Edwin Mok with Needham & Co. Your line is open.

Hi, thanks for taking my question. First is a follow-up question on gross margin. It was down a few points early in the quarter. I know you guys guided for that already, but I was wondering what contribute to that? And I think previously you guys said you expect a year to fall within the range of 57%, 58% range? Is that how we should think about maybe a longer-term gross margin or nominal gross margin for your business?

Yes I think as I have to think about at these business levels, so 57% to 58% three-ish billion range is where I think we are going to end up. We had a very rich margin in the December quarter and very much an alignment with guidance for the March quarter. We think that we got some slight mix improvements as I look at June with very modest revenue increase. That's why we had to think about it and then over time I think you are to think dollar continue as I said in the prepared remarks to move it 60% to 70% incremental. One of the things we’re seeing as a service business grows it does put some pressure on margin but that’s contemplated in that incremental margin range. But we’ve have got that dynamic that goes on as well. So certainly in certain revenue levels, the impact of service margin can be higher than others. But that's how I have to think about it.

Okay, great, that's helpful. I guess a longer-term question on mask inspection, right? With the mask, the photomask industry is not consolidated already, and there is capacity out there, right? Do you see that market normalizing in the lower level and stabilize here? Especially with UV out there somewhere, is it possible that these company prefer not to invest in mask inspection or mask capacity in general?

Well I think that the challenge is the of multi-patterning actually put some interesting stresses on the mask because as we go below the 16 or 14-nanometer what we are seeing is increasingly complex mask which are driving a lot of requirements for our 6XX product line. The good news is, we don’t think that's a tremendously expensive investment required, it's off mostly algorithms and some modifications for the tool. So unlike going to new platform, we think that the investment required will be significant but not a significant if you had to do new platform. But as long as multi-patterning progresses, we do see stress on the mask and we think that's opportunity for the mask business and albeit at perhaps at a slightly lower revenue level but profitability should be good because we can continue to invest but at a lower rate than if we are doing a new platform. So we feel pretty good about that. We do have some tailwinds there because we can provide some capability for the EUV with that product line but that's already something that we've developed, there might be extensions to that. But we think there is good opportunity, I don’t think the mask business goes away at all, I think it probably has seen some of the tougher periods it’s going to go through and we think it probably stabilizes from here as we go forward.

Great, that's helpful. Thank you.

Your next question comes from the line of Ruben Roy with Piper Jaffray. Your line is open.

Hi, good evening, this is Shawn Lockman on for Rubin. I was wanting to jump back to some comments you made in your prepared comments about scaling back investment in EUV as part of the workforce reduction. I was just wondering if you could talk a little bit more about your thinking there, and when you may reach a point again where that investment has to return, if that comes closer to 7 nanometer or prior to that and timelines around that.

Well we have for quite a while been very public that we are not going to continue to go forward on EUV reticle inspection without significant customer support because there is a limited set of customers. So while we will continue to do feasibility and some of the work there, we’re backing off some of the other work until we have that commitment from customers which isn't out there right now. So it's really not a question we can answer because it's an ongoing dialog with customers but I think there is only one of two answers that really make sense one is that, collectively the industry feels like we’re able to go ahead without actinic inspection for EUV and high production which I think is early to know that. And the way you go ahead is you leverage the 6XX platform and some other solutions to validate the reticles, that's one alternative. Another alternative is that there isn’t any high volume EUV production and we’re certainly as an industry a long way from knowing the answer to that and hopefully there will be in everyone's best interest. And then the last one is that the industry comes back and says that they are committed to actinic tool and we’ll work with them to develop it. But right now we’re backing off independent investment until we get that signal, we will continue to do IP work, we will continue do some work on source but we’re going to - we have been reducing that and that's part of this transition.

Great, that extra color is helpful. I was wondering also if you could talk about any customer activity you are seeing in China right now? A lot of chatter around buildout there in terms of the industry. Just wondering if you could shed some light on any sort of activity you're seeing there and then also what you might expect for that market in the next two to three years?

Well in terms of current activity we did see some business out of China from one of our major customers there, its business that we have been tracking for some time and I think it’s been related to second source opportunities by some fabulous players. And so it’s encouraging to see that investment actually play out over the last quarter and in last couple of quarters. We’re not modeling any fundamental shift in over the longer run spend in China or growth beyond what we have normally seen and something consistent with the market at least at this point. I don’t know enough about what will happen, won't know what technology all those kinds of questions to put a – in a timeframe that makes any sense to put to try to quantify it in anyway. But we continue to see we had a very good quarter there, we continue to see business there for non-TSMC foundry.

Great. Thank you.

Your next question comes from the line of Sidney Ho with Deutsche Bank. Your line is open.

Thanks for taking my question. Your backlog actually has a pretty healthy level. I think it was about 1 to $1.1 billion a couple of years ago and now sitting around $1.3 billion to $1.4 billion. Can you talk a little bit about the composition of the backlog by end market and how confident are you that these products will be shipped, let's say, this year? And follow-on to that, are you seeing any cancellation that is more than normal? And can some of these tools in your backlog actually be used for next year rather than this year? Trying to gauge the health of the backlog in orders.

Yes. So the backlog, the majority of the backlog will ship over the next six months and just about all of it is planned to ship over the next six to nine months or so. So it is a little bit higher now. We've booked some business and there has been some delays on certain fab projects and so that has made the backlog go little bit bigger than what we saw let’s say a year ago. If we go back way ago, if you go back a few years you would see our backlog, shipment backlog is usually six to seven months. Right now it’s about five months, and so it is probably bigger than it was in the last year where it was four to five. So we expect that as I said in the prepared remarks, we expect that to ship, I don’t have the details on the composition, but the composition ever reflects the composition of our orders. The tools are in backlog for anywhere from three to five months and then they ship out in revenue within about six months or so from the time we take the order overall. So I think that it matches the order percentages that we give every quarter.

Okay. As a follow-up, I know this -- the CapEx got by two of your major customers have been asked a few times and I think the reuse of tools are pretty well understood at this current generation. But they also both talk about better capital efficiencies, just better use and whatnot. I think this is unique for the first generation of FinFET, but does that change if you were to -- this WFE will eventually reach what everyone has been thinking, like $37 billion at some point?

I'm probably not the best guy to ask about when the industry is at 37 or we see run up to there I mean the way we model is the capital intensity is probably not declining much anymore, its probably flat, its probably not increasing. And so the underlying semiconductor revenue growth rate of 4% to 5% which means CapEx and wafer fab equipment on a growth generally inline with that over time. And so as we run our business, we see similar growth rates on the system side, our service business is growing faster than that and that's how we think about modeling the company. Where the peak is, is always hard to say, usually peaks are followed by troughs but in terms of through cycle view that's how we think about it.

Appreciate it. Thank you.

Operator, we have time for one more question.

Your next question comes from the line of Mahesh Sanganeria with RBC Capital Markets. Your line is open.

Thank you very much. So I had a question on the restructuring. I know it's early and you are still working through it. Can you give a sense of where is the majority of the cut will be, in sales or G&A or R&D or is it more even?

Yes. We are not really in a position to quantify that now. As Bren said, and we said in our prepared remarks over the next several weeks as we work through those details, we are going to make that public as soon as we finalize those. But we are not ready at this time to disclose that.

Okay. Then one quick question on the actinic inspection. I think you made some reference to cut mask. If you reuse just for cut mask, do you think it's much easier to do the cut mask without actinic inspection as opposed to the other steps?

I think that there are options, if it's cut mask and development that leverage the existing infrastructure. If it's only a couple of layers which is the way we’re understanding it now. And I think using the 6XX to support that work for development. High volumes are different question but for development I think we are certainly in a position to be able to help customers do that. And yes, the technical challenge is associated with the cut mask are going to be easier.

Okay. That’s very helpful. Thank you so much.

Thank you.

Okay operator, that concludes our call for today. Thank you for all joining and we look forward to seeing you later on in the quarter.

This concludes today’s conference call. You may now disconnect.