Thank you. Ed Lockwood with KLA Tencor Investor Relations, you may begin your conference.
Thank you, Christine. 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 Q1 results for the period ended September 30, 2016. We released these results this afternoon at 1:15 p.
M. Pacific Time. If you haven't seen the release, you can find it on our website 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. Today's discussion of our financial results will be presented on a non GAAP financial basis unless otherwise specified.
A detailed reconciliation between GAAP and non GAAP results can be found in today's earnings press release. These slides will be found on KLA Investor Relations website. There you'll also find a calendar of future investor events, presentations and conferences as well as links to KLA 10 Core's SEC filings, including our Annual Report on Form 10 ks for the year ended June 30, 2016. 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 these forward looking statements will come true. Our actual results may differ significantly from those projected in our forward looking statements. With that, I'll turn the call over to Rick.
Good afternoon, everyone. 2 weeks ago, we held a conference call reintroducing the KLA Tencor story to our stockholders, featuring a message that highlighted how our strategies for growth based on market leadership, customer focus and operational execution provided the foundation for the outstanding results we achieved in fiscal year 2016 and set the stage for an exciting future for the company as we move forward. Today, I'm very pleased to announce that we got off to a very solid start in FY 2017 as KLA 10 Core finished above the midpoint of guidance for shipments and revenue for the Q1 and exceeded the range for non GAAP diluted earnings per share. September quarter orders came in slightly better than our internal forecast, highlighted by strong foundry demand. These results were fueled by strong customer acceptance of new products and a business model that consistently delivers superior operating leverage, providing the resources to rank KLA 10 Core among the top tier of all technology companies in terms of returning cash to shareholders.
Our recently announced 4% increase in the quarterly dividend level from $0.52 to $0.54 per share is further evidence of our confidence in the strength of our business and our ongoing commitment to enhance stockholder value. Our performance in Q1 also affirmed KLA Tencor's ongoing focus on providing value to our customers in terms of meeting market requirements and delivering superior competitive offerings. As in the past, a key contributor to the strong demand we're experiencing today is the success of new products across our product portfolio. Our market leadership is sustained by ongoing successful execution of a product strategy that's focused on intersecting market needs with a portfolio of complementary solutions to address the broad range of yield challenges our customers are facing at the leading edge. And the pace of new product introduction continued at a rapid clip.
Over the past 12 months, we have launched 2 new products in broadband plasma wafer inspection as well as new products in laser scanning wafer inspection, e beam review, unpatterned wafer inspection and mask inspection. In our flagship broadband plasma optical inspection portfolio, the new Gen5 platform is currently addressing early yield learning challenges and engineering analysis applications critical to both EUV and advanced optical lithography design rule development. We have also recently introduced upgraded capability for our Gen 4 the expanded Gen 4
platform is currently experiencing
The expanded Gen 4 platform is currently experiencing very strong customer acceptance in the marketplace and is exceeding our own expectations both in terms of market reception and operational execution. We're also very encouraged by the strength we're seeing today in mask inspection. Our leading edge mask inspection portfolio is not only being incorporated into our customers' optical mask inspection techniques, but is also the preferred technology to support early adoption of EUV as customers work to qualify masks for this very important technology inflection. So to summarize, our Q1 results demonstrate our strategies are working and the company is operating from a position of strength. As we look ahead to the December quarter and beyond, the stage is set to build on this success and deliver what we expect to be an exciting year for the company in 2017.
Given our leading market position, our focus on customer collaborations and with our continued operating discipline, we believe KLA Tencor is well positioned to successfully execute our strategies and achieve growth in calendar 2017 consistent with our long term revenue growth objective of 5% to 7%. This is against the backdrop of WFE growth forecast to be in the lowtomidsingle digits for the year. Now turning to the guidance for the December quarter. Q2 shipments are expected to be in the range of $800,000,000 to $880,000,000 Revenue for the quarter expected to grow approximately 11% sequentially at the midpoint of our guidance to a range of $805,000,000 to $865,000,000 with non GAAP diluted earnings in the range of $1.28 per share to 1.48 dollars per share. I will now turn the call over to Bren Higgins for his comments.
Bren?
Thanks, Rick, and good afternoon, everyone. The September quarter represented another solid period of financial performance and operational execution for KLA Tencor. Revenue was near the top end of the range and earnings per share finished the quarter above the range, driven by strength in gross margins that continue to reflect strong differentiation of our products in the marketplace. Revenue for Q1 was $751,000,000 and fully diluted non GAAP earnings per share was $1.16 dollars GAAP diluted earnings per share was $1.13 in the quarter. In our press release, you will find a GAAP to non GAAP reconciliation of the $0.03 difference.
With the exception of when I explicitly refer to GAAP results, my commentary will be focused on the non GAAP results, which exclude the adjustments covered in the press release. In regards to highlights of the Q1 demand environment, we are no longer reporting quarterly booking results or quantifying order guidance in terms of dollar amounts, but we will continue to share our perspective on the current quarterly demand picture to give investors insight into our industry trends. End market mix estimates for the December quarter are based on current forecasts. Foundry was 69% of new semiconductor system orders in September. Foundry bookings featured strong demand across our product portfolio to support leading edge development projects.
Although foundry is expected to decline to 30% of total system orders in Q2 due to project timing, we are currently expecting foundry orders to grow in the first half of calendar twenty seventeen compared with the second half of this calendar year. Memory was 15% of new system orders in Q1 with demand evenly split between DRAM and NAND. Memory orders are expected to jump to 60% of the total in December, largely due to concentration of orders to support a single new memory project build out in Korea. Logic was 16% of new system orders in the September quarter and is expected to be approximately 10% of the Q2 order mix. In terms of distribution of orders by product group for the Q1 of the fiscal year 2017, wafer inspection was approximately 37% of new system orders, Patterning was approximately 33% of orders.
The patterning order profile includes mask inspection system bookings. Service was 28% and non semi was approximately 2%. Total shipments in Q1 were $786,000,000 and in the upper half of the guided range of $735,000,000 to $815,000,000 Looking forward, we are modeling December quarter shipments to grow sequentially 7% at the midpoint and be in the range of $800,000,000 to $880,000,000 Turning now to the income statement. Revenue was 751,000,000 dollars finishing at the top end of the range of guidance for the quarter. We expect revenue to grow approximately 11% sequentially at the midpoint to a range of 805 dollars to $865,000,000 in the December quarter.
And our current forecast shows revenue levels in the first half of calendar twenty seventeen growing in the mid to high single digits compared with the second half of calendar twenty sixteen, consistent with our long term annual growth target of 5% to 7% and driven by our strong backlog and expected order profile for the next few quarters. Gross margin was 63.1% in Q1 and nearly flat compared with the record gross margin result we posted in the June quarter in spite of the sequential quarterly decline in revenue. The strong gross margin performance in Q1 reflects the benefit of a more favorable product mix than was originally modeled for the quarter, lower parts expenses in our service business and lower inventory reserve expenses associated with new product transitions. We expect gross margin to be in the range of 62% to 63% in the December quarter, down slightly versus the September quarter, principally due to a less favorable product mix in the revenue plan, offset by an increase in revenue. Total operating expenses were $220,000,000 down $6,000,000 compared with the June quarter and operating margin was 33.8 percent in the quarter.
We expect quarterly operating expense levels to remain at the $220,000,000 level, plus or minus a few million, for the next several quarters and to continue to deliver strong operating leverage and what we expect to be a growth year for the company in 2017. Our effective tax rate was 20% in the quarter, just below our long term planning rate of 21%. The lower tax rate in the quarter largely reflects the benefit of early adoption of a new accounting standard for stock based compensation. You should continue to use 21% for modeling purposes. Finally, net income for the September quarter was $182,000,000 and we ended the quarter with 157,000,000 fully diluted shares outstanding.
I'll turn now to the highlights from the balance sheet and our cash flow statement. Cash and investments ended the quarter at $2,500,000,000 roughly flat with the June quarter. Cash from operations was $170,000,000 in the quarter and free cash flow was $160,000,000 In September, we paid an aggregate of 89,000,000 dollars in regular quarterly dividends and dividend equivalents for fully vested restricted stock units and made a supplemental payment of $40,000,000 towards our outstanding term loan. To date, the total amount of payments of principal on our term loan has amounted to approximately $214,000,000 since it was added in the December quarter of 2014. In conclusion, KLA Tencor's results in September signal a strong start for the company in FY 2017 and coupled with expectations for the December quarter, position the company for strong relative growth versus the wafer fab equipment market in calendar 'sixteen.
This performance demonstrates the company's market leadership, the strong customer acceptance of a portfolio of solutions addressing the most critical yield requirements at the leading edge and our operational core competencies. Given our strong backlog and with the expected growth trajectory in new orders, including a book to bill forecast of greater than 1 in the December quarter and a first half of twenty seventeen order profile that is stronger than the second half of twenty sixteen, KLA-ten Core is in a position for a year of solid growth in 2017. With that, to reiterate our guidance for the December quarter is shipments in the range of $800,000,000 to $880,000,000 revenue between $805,000,000 and $865,000,000 and non GAAP diluted EPS of 1.28 dollars to $1.48 per share with GAAP EPS of $1.26 to $1.46 per share. This concludes our remarks on the quarter. I'll now turn the call back to Ed to begin the Q and A.
Okay. Thank you, Bren. At this point, we'd like to open up the call to Q and A. We do once again request that you limit yourself to one question and one follow-up given the limited time we have for today's call. Please feel free to re queue for your follow-up questions and we'll do our best to give everyone a chance for follow ups in today's call as time permits.
Christine, we're ready for our first question.
Your first question comes from the line of Timothy Arcuri from Cowen and Company. Your line is open.
Thank you so much. I had 2 nice job guys. I guess the first question is really Rick on 7 nanometer. The last really economical node in foundry we had was 28 nanometer. But recently a host of companies most recently TSMC are now talking about 7 nanometer being very big, maybe even as big as 28 was.
So I'm curious on getting your perspective on wafer demand at that node and how much of this maybe has been bought already in the orders you got for 10 in the 3rd calendar quarter? And how much of that is still on the comp? Thanks.
Thanks, Tim. Yes. I was in Asia last week revisiting and getting reacquainted with our customer base, and there is a lot of excitement, I think, about the potential for 7 nanometer to your point. Most of the investment that we've seen so far in terms of production investment has been for 10 nanometer. We have seen investment for the development in 7 and even some looking forward to 5.
So I'd say most of what happened was to date that we've seen is 10 and we do expect to see continued strength as we go forward in 4 nanometer, 7 nanometer. Brent, anything to add to that?
No, I think, Tim, we've had foundry has been very strong and even though it drops off this quarter, we think it's still we see a bounce back into the first half of calendar twenty seventeen. There's always the dynamics about how the capacity ultimately gets filled by the people following the leaders. And so customers will try to optimize their capacity as much as they can. So to the extent they try to use some of that equipment, they may try. But I think given the challenges in the node and what we're hearing about the size of it, we feel pretty confident about the foundry trajectory into the calendar year.
Thanks a lot. And then
I guess the second thing, I wanted to talk a little bit about memory because it looks like there's some uptick in the adoption of inspection and memory here in this next round of orders. You had cited some big orders coming out of Korea during the Q4. Can you talk about what's going on in memory? Is there an uptick in inspection intensity in memory? And particularly, why is it happening?
And can it sustain going forward? Thanks.
Yes. It's not just inspection. I think process control in general, we are seeing some strength. And I think it kind of goes across the portfolio. I would attribute the increase in inspection to memory, which we have seen some, is more a function of Gen 5, where we've had some placements there that maybe in the past might have been served by alternate technologies like e beam.
So we've seen some strength, albeit modest at this point. But metrology is also growing and a lot of that has to do with some of the challenges in terms of things like registration and so the overlay business and some of the films businesses. So we're feeling pretty good about it. It's not at the intensity levels, of course of foundry, but it is significantly up from where it had been in prior nodes and we see strength going forward there.
Thank you, guys. Appreciate it.
Your next question comes from the line of Farhan Akhmad from Credit Suisse. Your line is open.
Thanks for taking my question. Rick, I had a question on Gen 5, just in terms of how where you're seeing that option of Gen 5 versus Gen4 and how we should think about the ramp of Gen5 next year? And also, when at the Analyst Day at Semicon, you had first talked about Gen 5, you had talked about potential to gain some of the layers from e beam applications. And is that something that you're already starting to see?
Faran, thanks for the question. Yes. We feel pretty good about Gen 5. I think that what we were hoping for is to get it out mainly as a discovery tool. So way back in semicon in 2015, we talked about the discovery market.
And our goal over time was to get to 50% of that market served by optical. I think by at the run rate we have now at the end of calendar 2016, we're addressing about a third of that market. So I'd say we have about a third of that market. And our target remains that by the end of 2017 to be 50% of that market. Part of it, the market grew a little bit because e beam was just is not capable of satisfying some of it.
So there was a gap in terms of functionality in terms of whole wafer. But the displacement, I think, is going on. We're seeing Gen 5 adopted more broadly. Gen 5 really doesn't go into production though and replace Gen 4 until future nodes when the critical defect size gets smaller and you can really think about that more in terms of the adoption of EUV lithography. So for now, it's doing what we hoped it would do.
Customers like what they see. It's a new product. So of course, there's improvements that we need to keep making. But we think we're on track for the plan that we laid out a little over a year 3 months ago.
Yes, Fahren, the only thing I'd add to that is, I mean, we're pretty much in line to Rick's point with what we thought we'd be. We'd have 4 or 5 units revenued in this calendar year and then that number would probably double or so. So let's say 8 to 10 units into calendar 2017. So to Rick's point, given our objectives at the end of 2017, we think that's how the adoption plays out. Most of what we're seeing in terms of 10 nanometer production is really being driven by the Gen 4 product line.
The reception has just been really strong for that and its capability. So we're really encouraged by that, the extendibility we think it has as we move into 7. And the 2 will be mixed and matched and impaired to meet discovery high end production and then ultimately high volume production type use cases.
Got it. And then my second question is on the foundries. There has been a big growth in foundry investments in China this year. I wanted to understand like from your perspective, how much of the foundry demand this year is coming out of China foundries? And as you think about the 28 nanometer ramp at those foundries, how do you think that will play to your advantage as you typically have like a very strong process control intensity at 28 nanometers, some of the first wave of foundry investment that we saw?
So on the foundry business overall, I mean, we had a record year in China in FY 2016, so the year that ended in June in bookings. So those tools will be revenue in through the course of this year. So I would say of our total foundry business in the year, maybe 30%, 35% or so of the total is probably foundry.
Yes. And in terms I was there last week meeting with customers, and I think this 28 nanometer demand, this is there's a lot of investment going on, as you know. There's a lot of new employees. I think they're counting on us to help educate and train and support them as they ramp these new fabs and they've got very aggressive ramps. So I think we look forward to good business and being able to support our customers as they go through there.
And I think that we see the intensity being similar. In fact, in some ways, because in many cases, you're starting greenfield for some of these facilities, the intensity ends up being front end loaded for some of them. So it's even higher as we go forward. So we're looking forward to great things in our China operation.
Yes. And to clarify, I meant 30% to 35% of the foundry business was China.
Got it. Thank you. That's all I have.
Your next question comes from the line of Harlan Sur from JPMorgan. Your line is open.
Good afternoon and congratulations on the solid results and great margin profiles. Given a view of WFE growth next year and obviously your business growing in line or better than that, we should see the team roughly around $3,300,000,000 in revenues in calendar 2017, combination of industry growth momentum in Gen 4, Gen 5 and your other new products. And if you continue to drive the better performance on the margin front, it feels like operating margins in the kind of 36 percent to 38% range would seem achievable. I'm not asking you guys to endorse the $3,300,000,000 revenue number, but if you were to be at those levels, does 36% to 38% operating margin sound reasonable?
Harlan, it's Brent. So I mean, just following the math to the point that if we think that we're going to grow sort of in line with the market in the next year and the market forecast that we laid out. You end up with that revenue level, I think that's fair. I think we're seeing some tailwinds in gross margin right now that we've seen for several quarters. But I think as we start to transition into some of the newer products, some of the benefits we've seen around warranty and support costs and efficient cycle times and things like that.
I think some of that goes away. Now, I do think and as I've said in the call a couple of weeks ago, I do believe that versus the model we published that we're operating probably a solid 100 basis points above what we had put out there. So and I think that's sustainable. So I think some of what we're seeing today, it'd be hard for me to, I think, to replicate that type of gross margin profile into next year. So there might be a little bit of degradation there.
So, given at that revenue level, the range that you mentioned probably feels a little bit hot, But, I would say you're probably in that 35 ish percent range plus or minus, 100 basis points or so. Now there's a lot of factors in that mix and so on, but that's how I would characterize
it. Great. Thanks for the insights there. And we've tended to focus on the Gen 5 and the 2,930, 2,00935 upgrade cycles in some of our most recent reports. But obviously, you guys are driving new product cycles across bare wafer inspection, review, darkfield inspection and of course your new reticle inspection platform.
I'm sure you guys track this, but can you give us a view of the mix of your new platforms as a percent of your current bookings and maybe some comparison of that to some of your prior cycles?
The comparison will be tough. I mean, I don't really have that data. I mean, we are booking a lot of these new platforms and things that have come out in this last year, right? So and even in the more trailing edge businesses like in China, they are buying the latest gen of tools, right, with the ability to try to use that capability as they ramp through this early development of new technology there. So I would say a pretty solid amount of the business is new products, but I don't have the actual percentage.
Great. Thank you.
Your next question comes from the line of Stephen Chen from UBS. Your line is open.
Hey, guys. Thanks for taking my question. Related to the foundry opportunity in China, there was an announcement of a ramp of 8 inches 12 inches capacity earlier this week. I just want to get a sense of if you can sort of size this. Looking back last few years, I see that the 10% customers sort of mix between 4 big customers.
And can you maybe give us a sense of China foundry customers getting into that category?
I guess I'm not sure exactly the question, sorry, Stephen, but what's the
I'm just trying to like, I guess simply how big do you think the China foundry opportunity could be?
Oh, I
see. Well, Brent talked about the percent of our business that we had. If we look back just to give you an idea of FY 2016 that finished, China was the 2nd biggest market for us. And that was partly because there was some underspending going on. But China is pretty significant for KT.
And I think as we go forward, you have the combination of this investment, even though it's in maybe N-two technology, we also have a very significant amount of penetration market share and also this is higher adoption because it's foundry. So they are buying some of our newer tools and we see a lot of interest in ramping these facilities quickly. They're spending a lot of money. They're trying to grab market share, in some cases serve the domestic demand. So we feel pretty good about our position there.
And in fact, if there's an area where we're going to invest more heavily going forward, it's overall to support the China investment cycle. This one's real.
But the only thing I would add is, while I think that there's certainly some new development activity that's happening there as they're ramping these fabs from a greenfield state that ultimately, it's serving a global market. And so I think you'll see some movement around in terms of who gets market share. But there'll be an inflection in the short term, probably some of it doesn't necessarily will stay pretty consistent, but there's certainly a commitment there. And, will stay pretty consistent, but there's certainly a commitment there. And there's a focus to Rick's point, not only on the ramping of new technology, but also our market position there is very strong.
Thank you.
Your next question comes from the line of Edwin Mok from Needham and Company. Your line is open.
Great. Thanks for taking my question. So I guess first question on the patenting part of your business. I think on the last call, you guys talked about increased focus there on patenting. Just kind of want to see if you can provide more commentary around that.
Is that more focused on metrology? And also kind of in terms of the financial impact, should we expect more R and D spending on that side, which ultimately will increase your OpEx?
I'll take the first part and then let Bren talk about the second part. We're definitely seeing demands associated with multi patterning, right, and also EUV. And I'd say the EUV work is in the reticle space where we do have tools that are dedicated now to EUV in terms of our 6XX, some of our newest 6XX capability people are buying for EUV. So that's early days of course for that. In terms of overall challenges customers whether it be registration overlay, film thickness or optical CD, all those things are potential areas for growth.
We're doing well. We think there's more upside to them, and we feel good about our competitive position. Now whether or not we see significant increases in the next 12 months, but I think over time, there's a potential to keep that business growing. And from an investment standpoint, Brendan, you can talk a little bit about how we've thought about that. Yes.
I mean, we've got a pretty active portfolio management process here in the company. And I think given the strategic reorganization that we did a year ago, we have the ability to move capital around much more freely than we did in the past. So we will continue to execute our process. We've been investing in those businesses. We'll continue to do so.
I gave some guidance in the prepared remarks around what I expect the OpEx levels to be overall. And there is a bit of an increase there and we're trying to drive the focus of that to be mostly R and D with an overall target of 60% of the R and D expenses or the overall OpEx as R and D.
Okay, great. That's helpful. And then I guess just circle back to China and maybe just kind of this increased level of investment we see on the trailing edge, right? I think you talked a lot about selling a new product and even these customers are buying new products. But to the extent that you buy kind of older generation products because that's what they need for the 28 or higher node.
Do you should we expect some pricing pressure on that end just because they are more legacy tools?
I don't think that's really what we're seeing. I mean, right now, we do have some ability to flex the different tool capability people need. But a lot of these facilities don't think they're going to stay at 28. So there's a desire to have newer capability. And of course, it doesn't hurt them to have it when they're doing their 28 work, but they're hoping that they're going to go obviously lower than that.
So I think we're in pretty good shape regardless of where they buy in the portfolio. It's not quite the same. I'll give you a very different example. If you think of some of the investment going on in Internet of Things where people may be in automotive or they're in sensor technology, then we're talking about older toolsets and maybe even some of our KT Pro stuff, which is reconfigured or refurbished tools. That's not what we're seeing in our markets in China for the most part.
Maybe there'll be an element of that later, but that's not what it looks like right now.
Great. Thank you.
Your next question comes from the line of Jagdish Iyer from Summit Redstone. Your line is open.
Yes. Thanks for taking my question. Rick, two questions. First, post the termination of the deal with Lam, how much of your effort is focused on putting on the EUV mask inspection? And can you give us some clarity in terms of the line of sight of revenues from this product line as ASML prepares to ship a dozen tools next year?
And then I have a follow-up.
So the way we're serving the EUV market is with the 6XX series that's been out for several years and we have some additional capability to do that. So that's already part of the portfolio and had nothing to do with any discussions we had with other companies. That's out there and now we're seeing their demand some demand for that. I can't really say at what point that's going to ramp because for a long time it was a part time application for some customers, but we are seeing some dedicated purchase of those tools for that capability. And it really will depend on how many starts they have in terms of different types of devices, how many masks they have.
But whatever they have with the adequate lead time, we're prepared to serve it. We don't it's not really about additional development beyond the capability that we have and some software upgrades and algo upgrades in that platform. We're not talking about a new platform, which we talked about several years ago. That's not what we're doing. We're not doing an actinic inspector.
We're developing additional capability on our existing products to serve it.
Okay. Fair enough. And maybe
the only other thing on that is that we would add is that they will do flop down inspection to qualify reticles, certainly for requal capabilities and incoming quality checks where they'll basically print the wafer and do Gen 5 inspections on the wafer to qualify reticles as another checkpoint in terms of making sure reticles are good.
Okay, fair enough. Then on a big picture question, I just wanted to understand, given that there are so many smaller players in the process control segment, What are your thoughts on consolidation post termination of the deal with Lam?
It's not really an area we're products that we have, the range that we have and our ability to satisfy the markets with our organic efforts in terms of process control. So not really something we're looking at. Thank you.
Your next question comes from the line of Patrick Ho from Stifel Nicolaus. Your line is open.
Thank you very much. Rick, first, in terms of some of your comments about memory and inspection, given the transitions that are going on, particularly in the 3 d NAND front, the capital intensity metrology is obviously increasing. It makes sense for your overlay thin films and even OCD metrology business. What's been some of the key drivers that have gotten at least some Gen 5 evaluations in that marketplace where traditionally they haven't used as much inspection?
I think that just the fact that there as customers are looking at the newer technology nodes, first of all, there are more customers trying to get in production. 2nd of all, as those that are in production are looking to new capability, just the ability to have a better sense of debugging the process in terms of from the discovery phase, not really from in production. So it's really that. And in terms of their ability to see things they've never seen before because if they had, an E beam solution, they could find small defects, but they couldn't get a wafer signature. And now they can do both.
They can find small defects and get away for level signature.
Great. And Brent, on the supply chain side of things, you guys have performed really well over the last probably over the last year in terms of seeing the increase in bookings and shipments and turning this around very quickly. Can you just give a little bit of color on what some of the tactics and I guess efforts you've made that have had the quick turnarounds you've had on the in terms of the shipments from bookings?
Yes. The MPI process at Caela, which is new product introduction where engineering is handing off to manufacturing on a lot of the new platform transitions that we've had has been really exceptional. So tools are being handed over to operations where you have good design stability. Our marketing and sales teams are managing the transitions well with customers. So we're not getting stuck necessarily with a lot of extra inventory as we move customers from one platform to the next.
Because of the design stability, you don't have retrofit programs and other things where you're out there trying to fix tools as you're shipping them out. So it's been a huge factor, I think, not only in the conversion, but also been a factor in the margin profile, a, because of the inventory issues, but also the fact that the service costs around the warranty costs to support the tools and get them installed quickly, has been fairly efficient. And so that's been a factor as well. So very impressed with the teams being able to do this and do this in a period of time where there was a lot of work around integration planning, distraction and so on. So, really impressive work.
I think the one other thing is, as we've taken more risk in terms of inventory risk, so one of the things we've done is provided more flexibility in the master schedule to be able to react to market demands. Especially most of our customers now have very short visibility into their cycle. So we're trying to be prepared so that we don't get caught out not having capacity when it's needed.
Great. Thank you.
Your next question comes from the line of Ahad kif Malik from Citigroup. Your line is open.
Hi, thanks for taking my question. Good job on the quarter. Rick, can you talk about the yield that you guys are seeing on 3 d NAND over the last year or so? There's been a leader on 3 d NAND and there are a bunch of followers. And just curious where you think the yields are broadly speaking on 3 d NAND?
And is the yield curve on 3 d NAND different from other devices in logic and DRAM side?
Yes. Obviously, given the relative small number of players, I'm going to be careful about this. I would say the leaders feel good about the leader feels good about where they are and I won't comment to that. There are other players getting in the market and I would say that we are seeing success, but it is if you think about a yield curve, I think there's a long flat part of that curve down around 0. And I think it took a while for people to debug the process.
And frankly, one of the things, one of the areas for opportunity for us going forward is there's not really a good defect discovery mode for 3 d NAND because there's really no tool capable of helping debug. And even although we've made some attempts, when you do find the defects, they're very hard to verify because you have to essentially de process or fib them to go find it. So I'd say it's been slow in terms of getting started. Now it's getting better. I think that there's some people are getting their process.
But as they look at expanding to the next technical challenges, we anticipate yield is going to be a big part of the challenge. And I think there's a lot of interest in partnering with us to come up with solutions to address that because obviously there's a demand there, but they're certainly getting very challenged by making the processes actually work.
Okay. And then on the foundry side, we heard from Lam Research yesterday that their expectations for next year foundry investments are kind of flat to down and then you talked about maybe a little bit of a digestion in the 10 nanometer and you're expecting mid to high single digit growth in the first half of twenty seventeen. Is your optimism based on the success of your new products? Or are you assuming the investments at foundries will kind of sustain at the level we're exiting this year?
I think so Atif, this is Brent. I don't think our general view on the year is much different. I think there could be some growth in foundry as we build it bottoms up. But we think that we'll see continued momentum around and my comments were orders. So you'll start to see those tools ship in the second half of the year that we'll see stronger foundry shipments and revenue in the second half related to 7 nanometer activity.
So but I don't know what how they make up their forecast. But at the end of the day, as I said, I feel like we're not that far apart generally in terms of how we look at it and how we look at the year overall.
So Ben, just to be clear, you expect orders in first half of calendar 'seventeen to be higher than the second half of 'sixteen?
Yes, I do, both overall and within foundry.
Got it. Thanks.
Your next question comes from the line of Craig Ellis from B. Riley. Your line is open.
Thanks for taking the question. I'll start with one that's pretty high level. It's very nice to hear the confident tone on what can happen in the first half of calendar twenty seventeen. So the question is relative to a year ago or a little bit more when you were last providing quarterly updates, has the visibility on the business improved? And if it has, to what extent is that improvement due to industry dynamics versus company specific potentially product cycle dynamics that are at play for KLA?
I don't think it's really changed all that much. I mean, to Rick's point earlier, I think we've tried to be flexible as we can. We've taken some risks. I think we're managing through transitions. And any time we have product transitions and bring a new product with new capability to the market, there is a level of customer demand that goes with that.
So I guess in one way on any time you have a transition, you do see some increase in visibility. But we are still reacting to our customers are facing short lead times with their customers and trying to expect us to follow suit with that. And we're doing all we can to try to be as flexible as we can to meet their needs.
I think maybe the one other thing though that is a little different is the strength out of China is pretty different. And there are greenfields that are happening. There's big investment plans. So if you think about that part of our business, there's a much more committed and maybe that could change, but they're more committed than it was hard to see in the past.
That makes sense. The follow-up is a question on products and next year's outlook. So in a year where the business has potential to grow 5% to 7% in line with the target model, if a product like Gen 5 can double next year, as I think I heard previously, what would some of the other products be that would be fueling some of that company specific growth in a year with a rising top line?
Well, our 5% to 7% is our through cycle multiyear target, right? And that was when we put that together and said, hey, look, from calendar 2015 and as we're sizing and running the business, we're going to position it so we can deliver that level of revenue growth and try to have operating leverage that's 2x the growth rate. I mean, certainly Gen 5 is a bigger piece, but there will be some mix and matching that will happen within broadband plasma. So I think it's really the strength is I don't see a fundamental shift in overall mix as we move into next year. To Rick's point earlier, there could be more investment in reticle inspection as customers begin to prepare for more development activities around overall, I overall, I think the mix looks relatively consistent across the different product segments.
Thanks, guys.
We have time for one more question. Your last question comes from the line of Sidney Ho from Deutsche Bank. Your line is open.
Thanks for taking my question. My first question is, if you look at your annualized revenue for your December quarter, you get to somewhere around 3,300,000,000 dollars Sorry if the question has been asked before. But if you look at the operating model that you guys put out, you guys should be somewhere around 59% in gross margin. Curious if you think this is a kind of permanent step up in gross margin forecast or are there some other factors that's driving the upside in the near term?
Yes. Sydney, we got that question earlier. But just to go over it again really quickly is, yes, there is we've clearly been outperforming the model. I think some of that is due to some of the maturity of the platforms that are out there. We're transitioning to some new platforms.
And so I think we'll lose some of those tailwinds we've had. But to the point I made earlier, I think we're operating probably 100 basis points or more over that model. And so as you play that through, I think you'll see the same kind of performance in the operating margin line.
Okay, great. Sorry for asking the same question. My follow-up question is, when I go back to Gen 5 products, it sounds like you guys don't expect Gen 5 to be cannibalizing Gen 4 until EUV is in production. So that would be put you in 2018 to 2020 timeframe. But if you go back to when Gen 4 was in R and D mode per se, is that roughly the same kind of timeframe, the same number of tools that you use for R and D before they go into production?
Yes. Here's the big difference is there's no real scaling going on right now. I mean, until you hit BUV, essentially with the multi patterning, you're not really doing anything relative to defect size. So Gen 4, from a lot of customers' perspective, serves that market. So it's really people want more sensitivity, but it's more about discovery.
Frankly, if they had to deal with those same defects on the earlier nodes, on the current nodes, they wouldn't be able to be in large scale production. So it really is hinged on when you see advanced technologies going into production, a la EUV.
Okay, great. Thank you.
Thank you. Mr. Ed Lockwood, I turn the call back over to you.
Okay. Thank you, Christine, and thank you everyone for joining us on the call today. Reminder, an audio replay of today's call will be available on our website later on this afternoon. We appreciate your interest in KLA. Thank you.
Thank you, ladies and gentlemen. This concludes today's conference call. You may now disconnect.