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 Brent Higgins, our Chief Financial Officer. We're here to discuss Q3 results for the period ended March 31, 2015. 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 at www.kla10cor.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 10 Core'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 ks 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 ks and our subsequently filed quarterly reports on Form 10 Q and current reports on Form 8 ks. 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 in line with our expectations. Revenue in the quarter grew 9% sequentially, finishing above the midpoint of our guidance at 738,000,000 dollars 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 $692,000,000 These results are a good start for KLA Tencor 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 10 Core is addressing our customers' most critical yield challenges and the various technology transitions underway in the marketplace today, including multi patterning, new device architectures such as SpinFET and 3 d 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 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 with a consolidated customer base demand for leading edge logic and foundry limited to 1 or 2 large customers in the initial phases of a new node, the continued high cost of next generation node transitions, we have come to accept a high degree of volatility in quarterly demand, shorter leading times and the result in 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 year for 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 ramps 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 3 d NAND investment in the second half of calendar twenty fifteen. 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 R and 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 customers' growth strategies, creating opportunity for KLA Tencor and fueling 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 strategic objectives of customer focused 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 is 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 and business processes in response to the changing customer requirements in our industry. Our efforts are directly directed in improving efficiency and removing complexity throughout our organization, streamlining our customer focus strategies and better integrating our R and 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.
Examples of areas we have identified for future realignment of investment priorities, including scaling 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'll 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're announcing today, we are currently finalizing the details and specifics of these actions and we'll 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 by the market leaders in logic, boundary 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're 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 execute our strategies for growth and market leadership and to deliver strong returns to our stockholders. Turning now to guidance for the Q4 of fiscal 2015. New orders in June are expected to be in the range of $550,000,000 to $750,000,000 Revenue guidance for Q4 is in the range of $710,000,000 to $790,000,000 and non GAAP earnings per share in the range of $0.78 to 1.02 dollars per share for the quarter.
Before I conclude, I'd 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'll turn the call over to Bren for his commentary on the quarter before returning for Q and A. Bren?
Thanks, Rick, and good afternoon. Revenue for Q3 was above the midpoint of guidance at $738,000,000 and non GAAP earnings per share finished at the upper end of the guided range for the quarter at 0.84 dollars 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 of 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 10 Core 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 KALI Tencor and for the industry remains the same today. New orders in Q3 were $692,000,000 at the upper end of the range of guidance of $500,000,000 to $700,000,000 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 $715,000,000 Given current shipment backlog, we expect shipment levels in the second half calendar 2015 to be roughly equal to the levels in the first half. In total, we ended the quarter with just over $1,300,000,000 of total backlog comprised of $1,100,000,000 of shipment backlog or orders that have not shipped to customers and expect to ship over the next 6 to 9 months. Total backlog also includes $239,000,000 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 $738,000,000 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 $218,000,000 down from $231,000,000 in Q2 and below the guided range of $227,000,000 to $229,000,000 a result of favorable variance in some discretionary budgets in the quarter and from our continuing focus on cost controls. The global employee workforce reduction plan announced today and previous organizational alignment actions 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 initiatives and appropriately align our organization and business processes to fit an evolving industry and customer landscape. We are currently modeling operating expenses for the June quarter to be flat compared with March. At this time, we are unable 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 of 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 $29,000,000 in March and we expect OIE to be a net expense in the June quarter of approximately 28,000,000 dollars The tax rate was 21.1 percent in Q3 and in line with the long term planning rate of 22%. Net income was 137,000,000 dollars or $0.84 per fully diluted share on a non GAAP basis. Turning to the balance sheet. Cash and investments ended Q3 at 2,300,000,000 dollars We repurchased 2,600,000 shares of stock and paid a dividend of $82,000,000 in the period and cash from operations was strong at $242,000,000 in the quarter. Lastly, we ended Q3 with approximately 163,000,000 fully diluted shares outstanding.
I expect Q4 to end at approximately 160,000,000 In conclusion, to reiterate, our guidance for the June quarter is new orders are expected to be in the range of $550,000,000 to $750,000,000 Revenues expected in the range of $710,000,000 to $790,000,000 with non GAAP earnings per share in the range of $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 and 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 first question.
Your first question comes from the line of Krish Sankar with Bank of America Merrill Lynch. Your line is open.
Yeah. Hi. Thanks for taking my question. The first question I had was quickly, Ben, you kind of mentioned that the second half shipment should be similar to the calendar 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 $800,000,000 So the guidance range is $760,000,000 to $840,000,000 for shipments.
Got it. That's very helpful. And then a question for Rick as a follow-up. I'm kind of curious to know the thought process behind the 10% workforce reduction because looks like the industry spending is robust and you guys also said that you need to count debt like 6 months ago. So why the reason for the cuts?
None of your competitors seem to be doing it? Is this more 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 5 years and thinking about how we should be structured and to provide answers to customers' challenges. So two things. 1, as we know the industry has gotten a lot simpler in terms of customer consolidation and we have had the luxury of being able to afford a relatively expensive go to market strategy which we are streamlining in this. The second one is our product divisions. We had a number of product divisions.
And for a while that made a lot of sense for most of the company's history. But we think now that in as what we're seeing now from our customers is really request for solutions across products. And our ability to do that means we streamline those product divisions and so 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. Got it. Thanks Rick.
Your next question comes from the line of Timothy Arcuri with Cowen and Company. Your line is open.
Thanks a lot. 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's 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 like 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 will 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's some opportunity for growth there.
And we also as we model it out, we do think we are in a secular part of, I guess, 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 than if you go back 3 or 4 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 back 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, I mean, 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 TAM. So every WFE dollar 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 transitions that Rick mentioned, we feel pretty good about our relative performance at that point.
Okay, great. And then just a quick follow-up to that. Brent, you had guided I have in my notes last call you said that you thought orders in the first calendar half of this year would be about flat with the calendar second half of last year, which was implying that orders in June would be like $825,000,000 something like that. Now even if I adjust for March being a bit better, being above the range, it seems like roughly $100,000,000 pushed out of the first half of this year from an order perspective. Can you talk about what that
was? Well, not
to get into specific customer situations, but I was expecting more, at least from an order perspective, more 10 nanometer activity to start to show itself in the June quarter. And that looks like that that's delaying now through the second half of the year. I'd say 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.
Yes. Good afternoon. This is Bill Peterson for Harlan. Thanks for letting me ask a question. I guess 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's your view on, I guess, capital intensity uplift for process control as we compare to, say, 2014, 2016 or 2020 the combined node? And also related to that, 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, it's 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 a 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 it's pretty clear that in cases like the 20 to 16 nanometer transition, you do see the opportunity for customers to have a fair amount of reuse depending on the back end of the process and how much change there is.
And so far that's part of it. The other part is 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, if that makes any sense. So 10, we think is entirely a different case, more like the transition from 28 to 20 than it is from 20 to 16. And so we expect more intensity as a result of that.
And we're looking for some of that data and the specifics here in a second.
Yes. So the way we laid it out, I think we feel pretty comfortable with the data at least on the foundrylogic side that at what we considered 1x and below which included 29 was in excess of 18% on the LogicFoundry. So to Rick's point, I think the biggest issue is very similar tool sets from 2020 to 2016, 2014 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 at 20 nanometer beyond a couple of customers, customers are able to migrate capacity down to 16.
And so I think that's the dynamic that we're seeing. But we're comfortable with the 18% as Rick said, it's very early on 10%. So I think we'll save that for another day. And depending on how you to the earlier question, depending on how you blend it gets us to the total. But with memory blended at 40% to 45%, which is probably where it is this year, you're probably sub-fourteen percent 14.5% or so in that range between 14% and 15%.
So but we'll see how it plays out through the year.
Okay, great. Thanks for that color. I guess as my follow-up and switching gears to memory, we are getting closer to 3 d NAND adoption as we witnessed from a lot of the press releases out there. We'd expect of course more etch and depth intensity with reuse of lithography. But can you give us an updated view on what your customers are saying is required for a process control perspective and how it compares to 15, 16 nanometer planer?
I guess presumably are like don't thickness OCD stress become more intensive, but what about some other areas inspection overlay and things like Thanks for the insight.
Sure. I'd say it is more intensive in metrology than it is in inspection when you look at the transition to 3 d. There are a couple of areas for opportunity in inspection. There's definitely opportunity when it comes to measuring, inspecting films and especially blank films. And there's a big desire to keep those processes clean given the stacks.
So you do have opportunities there. Because of the design rules are relaxed, you have less intensity associated with advanced wafer inspection except 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's so much in terms of number of layers requirements around overlay and film measurements. So we do see a big opportunity in terms of what's going on in the metrology.
And so in aggregate, you do get an increase in the intensity, but it still is significantly less than what we see in the logicfoundry. But the rate of increase is similar to what we see in the rate of increase from logicfoundry, but the intensity is probably modeled as about half of that of what you see in logicfoundry. So we're much more subject to the shift from memory to logic or logic to memory than we are necessarily node to node where we do see increased adoption associated with the advanced 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 hectic EUV mask inspection, how quickly could you ramp that program And does that potentially impact your workforce layoff plan?
Well, I guess the we are having a 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 inspections. So the soonest 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 the 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 the 6XX product line that we have there can service that and service those needs and is going to be utilized to do that. So the answer remains the same.
It's probably 4 to 5 years. If we were to get funding. We don't anticipate that happening anytime 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 leaner structure as we go forward. And so from that standpoint, it really has no bearing on actions that we're taking now.
Okay. That's helpful. And then just secondly, Intel announced a large CapEx reduction this year from its forecast, largely based on equipment reuse as they 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 just wondering if maybe that's a little different this time around. Are you seeing much reuse from that 22 nanometer node at Intel?
Well, I think to not to get into 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, you had about $2,000,000,000 of CapEx come out of the market. And so about $1,000,000,000 of that was WFE. And at the intensity levels we described earlier represents probably somewhere around somewhere between $100,000,000 $150,000,000 of KLA 10 core opportunity given our share and the intensity as I mentioned. So clearly those push outs had an effect on our business as we look at the year.
There's probably some opportunities for some upside out there if things happen around 10 nanometer or strengthening in some of the memory markets. So at least in terms of how we see it today, it's hard to ignore that impact in terms of 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 ways, I think you've got the ability to extend certain tools, metrology requirements are different. So there is some there.
Customers always try to do that. I think at this node, I think it's particularly a little bit more there's more reuse. But in general, that's always they always attempt to use more and it really depends on how much of the process is changing through the front and back end.
Very helpful. Thank you.
Your next question comes from the line of Jim Carvello with Goldman Sachs. Your line is open.
Hi. This is Chelsea German on behalf of Jim. Thanks for taking the question. It sounds like you're now expecting WFE to be flat or up slightly and that this is going to be really 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?
Well, I think, yes, I mean, that's the way we're seeing it right now. And as I said, I think upside is related to foundrylogic 10 nanometer and V NAND. I think that on the downside to there, I think is all probably related to how much end market demand you actually see start to come into play around 2016, 2014 and what does that do to drive more capacity adds? I would say that 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?
Yeah, I think we're in line with the rest of our peers around the views of the year. And I think with the public announcements from 2 significant customers in our strongest space, our strongest segment. That has 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 mass 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 outside funding? Or is that 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 to 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, if we build that tool and there's not a market for it, there's no other application for it. It can only be used for one thing, which is to inspect EUV masks.
And if you build an advanced wafer inspection tool, it really only matters that people are making wafers and doesn't really matter the technology they're 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 it 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.
Okay, great. That's really helpful. And maybe, Brent, for you. In terms of some of the industry commentary just provided particularly some of the pulls and pushes you're getting both on the FinFET 16, 14 and the 10 nanometers. Do you see any, I guess, pulls from your vantage point of or pushes and pulls from 14 to 16 maybe being pushed out with 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 I guess in lieu of the capacity adds for 2016 and 14?
I mean, I guess it's possible. What we've seen so far is I think a continuation of what we've experienced over the last couple of quarters and that's been a very measured pace of additional capacity adds for 2014, 2016. 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 orders and shipments. And so as we look at beyond, I mean, who knows what's going to happen.
I think certainly there's some high profile potential announcements
out into in the second half
of the year. And does that drive We are certainly living in an environment today where we don't get a lot of lead time. We are certainly living in an environment today where we don't get a lot of lead time visibility from our customers because our customers aren't getting it from theirs. So think we have the capacity to be flexible to respond to an uptick if it were to happen. I mean, right now, based on the commentary earlier, the way we're modeling it is a modest sort of up year for the industry and our performance in line with that.
Great. Thank you.
Operator, we'll wait for the next question.
Your next question comes from the line of Farhan Ahmed with Credit Suisse. Your line is open.
Thanks for taking my question. My first question is regarding the OpEx that you announced. How should we think 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 our normalized targets are going to be as part of this. I mean, part of this action is really being driven by our strategic need in terms of how we're going to structure the company. Obviously, it's a more efficient structure and there will be savings, but some of those 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 allows us to very easily move capital across different projects to capitalize on opportunities in a more effective and expeditious way, if you will. So I think that that's certainly something that we're looking at.
In terms of a model, the way I'm thinking about is if you take the current business levels, which roughly equate to about an annualized level of $3,000,000,000 With fully loaded variable comp, we will be 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 margins off of that base. So that's how we're modeling it, but I think we're very early and we'll have more to say as we progress over the coming weeks towards Semiconductor 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 1 or 2 areas where you think like which are very good growth opportunities for inspection where you may be increasing the OpEx?
Well, I'll take. There's 2 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'd emphasize and move. Really around the 2 solutions we have, one is around patterning solutions, which we look at the opportunity to bring together and we've already introduced 5 d, which is our solution to really trying to help our customers manage the challenges of complex patterning. And so there's elements of that that include some of the design information as well as the overlay measurements of film thickness and stack and integrating that into a 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 a 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. And those are 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 had.
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 percentage of equipment spending, WFE has been coming down from 8% to 9% to 7%. So can you talk about your opportunities in the non semi markets for storage packing?
Is there anything you can do either organically or inorganically to track outgrow 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. What we think is more important is associated with the intensity of process control and foundry and memory and a big part of that transition as you 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 grow faster in the industry. We do see increased intensity as we go node to node. Some of that is opportunity that we'll capture with our existing products and some of it is opportunity that we're going to need new capability to capture and we're committed to both. 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 then Brent 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 delevering the some of the debt that we brought on. And we structured a component of that debt with a term loan bank component that we have prepayability to. So using 100% of the cash flow, obviously, 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 percent of the total, unless the ongoing dividend goes towards share repurchase and delevering. So we're committed to executing the share repurchase and delevering. 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 at least beyond dilution more towards more towards delevering to my long term leverage target of 2 to 2.5 times EBITDA.
Great. Thanks.
Your next question comes from the line of Mahesh Chandanaria with RBC Capital Markets. Your line is open.
Thank you. Thank you very much. Just want to follow-up on a comment you guys made earlier that 2016 2014 node is not ramping as fast as you had thought. And yes, 2020 was supposed it was supposed to be slow. And I remember 28 when you ramped first it was a huge year for you.
I mean you outperformed by 20% in that year. And we haven't seen that at 2016 2014. So do you have some thoughts on what's happening in the marketplace with this particular node? If we consider this as a one node 2016 2014 and compare it to 2018, why it's so much difference in these two nodes?
Well, I think I mean the end market demand at 20 nanometer wasn't particularly strong beyond a couple of customers. And so have the ability to migrate some of that capacity. We've seen that in a few areas to 2014, 2016 given the similarities with part of the process. So I think having to lump them together is how we think about them. And I think the it is probably a combination of factors, end market demand, competitive dynamics and so on that were different and stronger perhaps 28 nanometer than what we've seen so far at 20 and below.
Now that can change and change quickly, but at least so far that's the pattern we've seen and it's a pattern we've seen over the last few quarters. So it's not necessarily something different in the last couple of quarters. We think that that a lot of that capacity begins to ship and then we'll start to see how the rest 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 they're just qualitatively, there's a fair amount of memory activity here in the June quarter as I look at the data and then also some foundry shipments, very strong quarter from Taiwan as you'll see in some of the data for the in terms of bookings and I think that will turn quickly. So foundry pretty strong as well through June. Okay. I think for the year, as I said earlier, I think if you look at total order mix and remodeling that memory is probably in the low 40th 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 Brent. Just another follow-up question on the gross margin. Does any of this foundry 28 nanometer fill spend that you talked about have a negative mix impact on Kaley's gross margin now and maybe that reverses itself the second half of the year? Or is this 28 nanometer fill in spend just not that meaningful?
Our margins across all of our segments are generally very consistent in segments and customers. So there isn't really an impact if you have one customer heavy versus another in
a given quarter. Most of
it's driven most of the variations frankly in our gross margin is driven more around product mix than anything else, right? High end wafer inspection versus low or reticle 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.
Okay. 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 this year or has that benefit kind of played itself out already? Thanks.
Well, we've certainly seen, at least from some of the market leaders, we've seen some investment this quarter and last quarter. We had a 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 booked in previous quarters also that we expect to ship as we move into the second half of the year. So I think a lot of it is going to be driven by end market demand and competitive dynamics among our customers and we want to see how that plays out.
Okay. Thanks, Brent.
Your next question comes from the line of Srini with Cambrexon. Your line is open.
Hi. Thank you. Thanks for taking my question. My first question would be, are you planning to invest more into e beam inspection and into packaging related 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 are 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're proud of there. We have not been in the inspection market, but we are certainly evaluating ways to enter.
But we also believe that customers very much want high productivity solutions and the capability, which is part of what our Fusion offering is aimed at is providing the capability of linking both the 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 it, 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 macro inspection that you might invest in?
Well, we have and we've had some success there. Again, these are on a relative basis pretty small, but we do have a product line that is a variant of some of our laser scanning product offerings that are used in the front end. And this one is services the automotive and that's a product line called Altair, where we have had some success in automotive and we're seeing adoption across a 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 Monk with Needham and Co. Your line is open.
Hi. Thanks for taking my question. First is a follow-up question on gross margin. So it was down sequentially in the quarter. I know you guys guided for that already, but I was wondering what contributed to that?
And I think previously you guys said that you expect the year to fall within the same range of 57% to 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 that's how you got to think about it at these business levels. So $57,000,000 to $58,300,000,000 ish is where I think we're going to end up. We had a very rich margin in the December quarter and very much in alignment with guidance for the March quarter. We think that you got some slight mix improvements as I look at June with very modest revenue increase.
So but I think that's how you got to think about it. And then over time, I think you ought to think that ought to continue, as I said in the prepared remarks, to move at 60% to 70% incremental.
One of
the things we're seeing as the service business grows, it does put some pressure on margin, but that's contemplated in that incremental margin range. But we've got that dynamic that goes on as well. So certainly at certain revenue levels, the impact of service margin can be higher than others. But that's how you got to think about
it. Okay, great. That's helpful. And then on I guess a longer term question on mass inspection, right? With the mass the photomass industry kind of consolidated already, right?
And there's kind of capacity out there, right? Do you see that kind of normalizing in the lower level and kind of stabilize here? And especially with UV out there somewhere, is it possible that these kind of company prefer not to invest in mass instruction or mass capacity in general?
Well, I think that the challenges 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 masks, 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 to the tool. So unlike going to a new platform, we think that the investment required will be significant, but not as significant if you had to do a 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 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 product line, but that's already something that we've developed.
There might be some tailwinds there, but product line. But that's already something that we've developed. There might be extensions to that. But we think there's good opportunity. I don't think the mask business goes away at all.
I think it probably has seen some of the tougher periods that'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 Reuben Roi with Piper Jaffray. Your line is open.
Hi, good evening. This is Sean Lachman on for Reuben. I was wanting to kind of 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 kind of 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 just kind of time lines around that?
Well, we have for quite a while been very public that we're not going to continue to go forward on EUV reticle inspection without significant customer support because there's a limited set of customers. So while we will continue to do feasibility in 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 dialogue with customers. But I think there's only one of 2 answers that really makes 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 it's early to know that.
And the ways 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. Hopefully there will be. That's in everyone's best interest.
And then the last one is that the industry comes back and says that they are committed to an 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'll continue to do IP work. We'll continue to do some work on source, but we're going to we have been reducing that and that's part of this transition.
Great. The extra color is helpful.
I was wondering also if
you could talk about any customer activity you're seeing in China right now a lot of chatter around kind of build out there in terms of the industry. And just wondering if you could kind of 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 2 to 3 years?
Well, in terms of current activity, we did see some business out of China from one of our major customers there. It's business that we've been tracking for some time and I think has 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 the last couple quarters. We're not modeling any fundamental shift in over the long run of spend in China or growth beyond what we have normally seen and something consistent with the market at least at this point. Don't know enough about what will happen, what node, what we continue to see we continue to see we had a very good quarter there and 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 been at a pretty healthy level. I think it was about 1 $100,000,000 to $1,100,000,000 a couple of years ago and now sitting around $1,300,000,000 to $1,400,000,000 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? Just trying to gauge the health of the backlog in orders.
Yes. So the backlog the majority of the backlog will ship over the next 6 months and just about all of it is planned to ship over the next 6 to 9 months or so. So it is a little bit higher now. We booked some business and there's been some delays on certain fab projects. And so that has made the backlog a little bit bigger than what we saw, let's say, a year ago.
If you go back a ways ago, you go back a few years, you'd see our backlog shipment backlog was usually 6 to 7 months. Right now, it's about 5 months. And so but it's probably bigger than it was in the last year where it was 4 to 5. 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 of it reflects the composition of our orders.
The tools are in backlog for anywhere from 3 to 5 months and then they ship out in revenue within about 6 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 cut by 2 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 efficiency maybe just better yields and whatnot. Does that well, I assume this is kind of unique for the 1st generation of FinFET, but does that change a few whether this WFE market will eventually reach what everyone's been thinking like call it $37,000,000,000 at some point?
On the I'm probably not the best guy to ask about when the industry peaks at 37 or we see a run up to there. I mean the way we model is that capital intensity is probably not declining much anymore. Probably flat. It's probably not increasing. And so the underlying semiconductor revenue growth rate of 4% to 5%, which means CapEx wafer fab equipment ought to grow generally in line with that over time.
And so as we run our business, we see similar growth rates on the systems 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 a 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 Sanjay with RBC Capital Markets. Your line is open.
Thank you very much. And so I had a question on the restructuring. I know it's early and you're still working through it. Can you give us a sense of where is the majority of the cut will be in sales or G and A or R and D or is it more even?
Yes. We're 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're going to make that public as soon as we finalize those. But we're 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. So if EUV is used just for cut mask, you think it's much easier to do the cut mask without a
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 volume is a different question, but for development, I think we're certainly in a position to be able to help customers do that. And yes, the technical challenges associated with the cut masks 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 all for joining and we look forward to seeing you later on in the quarter.