Afternoon. My name is Mike, and I will be your conference operator today. At this time, I would like to welcome everyone to the KLA Tencor First Quarter Fiscal Year 20 15 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.
I will now turn the call over to Ed Lockwood with KLA 10 Core Investor Relations. You may begin your conference.
Thank you, Mike. 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 today to discuss Q1 results for the period ended September 30, 2014. 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.kla 10cor.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. 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, 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 would make on this call today, are subject to those risks and KLA Tencor cannot guarantee those forward looking statements will come true. These forward looking statements including references to the future financial performance and condition of the company, future macroeconomic and industry conditions, future growth and the anticipated drivers of such growth, the company's future capital structure our leverage recapitalization a special cash dividend incremental debt, plans to reduce debt, uses of cash, plans to purchase shares and levels of stockholder return, potential market and revenue opportunities and trends in the semiconductor industry and the anticipated challenges associated with them are based on the company's estimates, assumptions and expectations of future events and are subject to a number of risks and uncertainties. Our actual results may differ significantly from those projected in our forward looking statements.
More information regarding factors that can cause those 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 those 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. Thanks, Ed.
Good afternoon, everyone, and thank you for participating
in our earnings call. Today, I'll discuss our refinancing and recapitalization announcement and the business highlights of the Q1. Bren will then review the financial details of today's announcements, to recapitalize our balance sheet. These actions reflect management and the Board of Directors' confidence in our market leadership, business model and long term growth strategies, as well as our leadership and strong commitment to delivering a high level of returns to stockholders. Bren will have more details of the transaction.
But in summary, what we're announcing today is proposed leverage recapitalization of KLA Tencor, which would return approximately $4,000,000,000 to our stockholders. Subject to the closing of the financial aspects of this initiative, we intend to issue a $16.50 per share special dividend. We are also announcing that our Board of Directors has authorized an increase to the company's stock repurchase program by an additional 3,000,000 shares of common stock. This increase in value at approximately $250,000,000 based upon the closing cost of our common stock as of October 20, 2014. We believe our capital structure strategy underscores our confidence and the strength of our strategic objectives in our business model, but also the strength of our balance sheet.
As we have invested in our business and executed our growth strategies over time, we have experienced strong cash generation in excess of what we believe is necessary to fund our operations and invest in our future growth. We intend to continue to execute our business model and strategies, manage our company profitably and provide a high level of value to our stockholders. Turning now to highlights for the Q1 of fiscal 2015. September quarter revenue and earnings per share results finished as expected, but new orders in Q1 ended below the guided range at $567,000,000 as orders from one of our foundry market customers ended below the original forecast for the quarter. We believe this is due to 2 factors.
First, there are many challenges associated with adopting the new technologies required to fabricate leading edge transistor architectures. 2nd, tighter order lead times have become the norm in our industry today and this coupled with a concentrated customer base is resulting in increased quarterly order variability. We currently expect a rebound in foundry orders levels in the December quarter as customers move closer to the implementation of new capacity additions in leading edge foundries that are expected to begin in the first half of calendar twenty fifteen. Although the September quarter bookings profile reflects an unusually low level activity from one of our foundry market customers in terms of next generation thinFET build out, it's clear that the battlefield for sub-twenty nanometer competition has been formed with many players positioning to meet next generation production ramp schedules. Recall the near record level of foundry orders booked by KLA-ten core from a single customer in the June quarter with delivery dates for these orders slated for early 2015.
These orders combined with a strong foundry order forecast KLA Tencor in the current quarter indicate the more aggressive pace of investment in thinFET capacity has begun. FinFET processes are extremely complex and challenging to bring to market and our customers rely on KLA 10 Core to help address the ongoing yield issues associated with these new technologies. Logic orders came in largely as expected in the September quarter. Memory orders grew sequentially in the September quarter with roughly a fifty-fifty split between DRAM and NAND flash. DRAM customers are continuing their investments in 2x nanometer technology conversions.
In addition to new capacity activity, the flash demand continues to be focused on planar NAND. For KLA-ten Core, our market leadership and growth are driven through successful collaboration with our customers. Our mission is to help our customers navigate the ever changing landscape of increasing device complexity and yield challenges that accompany each major node transition. Turning now to our outlook for the Q2 of fiscal 2015. The December quarter booking profile represents a meaningful pickup in order activity, largely driven by the leading edge foundries as they move to prepare FinFET production capacity ahead of anticipated end customer demand in 2015.
We expect December order quarter bookings to be in the range of $700,000,000 to $900,000,000 up approximately 40% at the midpoint from September. Guidance for revenue in the December quarter is in the range of $620,000,000 to $700,000,000 and non GAAP earnings per share is projected to be in the range of $0.46 to $0.70 in the quarter. December quarter EPS guidance does not consider the impact on other income and expense and tax rate related to the proposed recapitalization transaction. However, upon completion of proposed transaction later in the quarter, we plan to update guidance to reflect the earnings impact of the proposed transaction. So to wrap it up, KLA Tencor is acknowledged as the market leader in process control with a proven track record of consistently delivering industry leading revenue growth, profitability and strong cash flow generation.
KLA Tencor's strong business model and the ongoing successful execution of our strategic plans enable us to continue to invest in our business at a high level to fuel our growth and support our customers' needs, while also delivering meaningful returns to stockholders as exemplified by today's announcements. Today, the factors driving our growth and market leadership remain favorable. We are confident in KLA Tencor's ability to drive innovation and help customers address the increasing cost and complexity of competing at the leading edge. I'll now turn it over to Bren for more details on today's announcement and his perspective on the quarter.
Thanks, Rick. Good afternoon, everyone, and thanks for joining us today. Today, we are very pleased to announce new dimensions to our capital allocation strategy. To support our ongoing commitment to return capital to stockholders, we plan to pursue a $4,000,000,000 leveraged recapitalization featuring a $16.50 per share special cash dividend with an aggregate value of approximately $2,750,000,000 The special cash dividend would be in addition to our regular $0.50 per share quarterly dividend. The intended special cash dividend will be funded in part with a portion of cash on the company's balance sheet and in part with $2,500,000,000 incremental debt that will be added to the balance sheet.
Our regular $0.50 per share quarterly cash dividend is expected to be declared and paid following our regularly scheduled Board of Directors meeting in November 2014. In addition to the $16.50 per share special dividend, our Board of Directors has also approved an additional authorization of 3,600,000 shares for our stock repurchase program, representing an additional $250,000,000 increase over the $1,000,000,000 originally authorized in July. We expect to complete the new share repurchases over the next 12 to 18 months. Including the special cash dividend with an aggregate value of approximately $2,750,000,000 the $250,000,000 increase to the stock repurchase program announced today and the $1,000,000,000 stock repurchase program previously announced in July 2014, the the total capital to be directed to stockholders would be approximately $4,000,000,000 in aggregate. The aggregate value of the special dividend of approximately $2,750,000,000 includes the portion of the special cash dividend that could be payable to holders of outstanding equity awards under the company's 2,004 Equity Incentive Plan.
This leveraged recapitalization will add a more permanent tiered debt with longer maturity dates in our current notes, thereby improving the efficiency of our balance sheet. As part of our recapitalization, we intend to issue incremental debt consisting of a prepayable term loan facility, which we intend to delever over the next 3 to 5 years and investment grade senior notes with staggered maturities. We also expect to enter into revolving credit facility. An unprecedented lending environment, coupled with what we expect to be a robust capital spending profile in our industry over the next few years, has enabled us to undertake this program and borrow above our long run debt target of 2 to 2.5 times EBITDA leverage to opportunistically optimize the company's capital structure and enhance total stockholder returns over our base plan. We intend to maintain an investment grade rating.
As Rick mentioned, our strategic position remains strong and we are delivering superior cash flows and financial results. We ended the Q1 of fiscal year 2015 with over $2,900,000,000 of cash and investments with roughly 2 thirds of our through cycle cash flow generated in the U. S. As we look ahead, the near term priorities for our domestic cash include about $500,000,000 of cash to fund operations on an ongoing basis. We will continue to execute the same strategies that have enabled us to sustain our market leadership and process control, deliver long term revenue growth in excess of the market and deliver superior profitability and cash flows.
As part of these market leadership and growth strategies, we are committed to continuing to invest at a high level in research and development and evaluating prospective strategic growth opportunities that are complementary to our model. This is a formula for success that has served us well over the years in extending our market leadership, fueling strong cash flows and establishing KLA Tencor among the leaders in returning value to stockholders. Our strategies for growth are driven by a goal to deliver better than industry average revenue across a multiyear cycle and earnings growth targeted at 1 point 5 to 2 times revenue growth over time. We believe today's news reflects our confidence in the prospects for continued successful execution of these strategies. As we execute on these long term growth strategies, we plan to deliver returns to stockholders via dividends, through stock repurchases and by reinvesting in the business in ways that deliver sustainable value.
We see today's announcement as the next logical step in our ongoing efforts to drive stockholder value. Turning now to more specifics on the financial results for the Q1 of fiscal year 2015. I will provide summary highlights in my commentary on the call today. Please refer to the supplemental materials we have posted to the Investor Relations page on our website for additional detail on the financial results for the quarter. Revenue for Q1 was $643,000,000 above the midpoint of guidance and fully diluted GAAP earnings per share were $0.43 Non GAAP earnings per share finished the quarter above midpoint of the guided range at $0.47 per share.
Non GAAP earnings would have been 0 point 5 $5.0 per share at our guided tax rate of 22%. In our press release and in our supplemental financial data accompanying our results, you will find a GAAP to non GAAP reconciliation the $0.04 difference in EPS. My comments on the quarter will be focused on the non GAAP results, which exclude the adjustments covered in today's press release. New orders in Q1 were $567,000,000 below the guided bookings range for the quarter of $600,000,000 to 800,000,000 dollars as orders from one of our foundry market customers originally scheduled to be placed in the September quarter were pushed out. As Rick noted, we believe the day in orders from the delay in orders from this customer for FinFET ramp is partially a timing issue with this customer providing shorter lead times from order placement to shipment than we have seen in the past.
Calendar 2015 is expected to be a year of growth for the semiconductor equipment industry with multiple customers simultaneously ramping new leading edge capacity in foundry, logic and memory in the year. That said, we continue to experience low order visibility with a limited number of customers placing sizable orders comprising the majority of our forecast. And as these plans change, driven by yield issues or lead time commitments, the impact on quarterly forecast accuracy is significant. Turning now to our customer segment commentary for the September quarter. Foundry was 25% of new orders in Q1 and very low compared with recent history.
In fact, orders from 1 of our foundry market leaders finished over $100,000,000 below the original forecast, ending at unexpected low levels in Q1. Foundry demand is expected to rebound to 62% of orders in the December quarter. As Rick noted, the competitive battleground in next generation foundry is taking shape and capacity plans for FinFET are lining up for the first half of calendar twenty fifteen. As the market leader in process control, KLA-ten Core is well positioned to benefit from what we expect to be a strong broad based foundry demand at the 16 14 nanometer nodes. Memory was 46% of new system orders in September, up sequentially both in terms of percentage of total orders and absolute dollars compared to June.
Logic was 28% of new orders in September, above the original forecast for the quarter. Customer investments in technology at 20 nanometer and below constituted roughly 66% of the orders we received in Q1. Turning now to the distribution of orders by product group. Wafer inspection was approximately 49%, reticle inspection was approximately 3%, metrology was 15%, service was approximately 30%, Storage, high brightness LED and other non semi was 3%. Total shipments in Q1 were $548,000,000 and below the bottom end of the guided range of $600,000,000 to $660,000,000 as delivery timing for certain orders related to leading edge foundry projects originally expected to ship in the September quarter shifted into Q2 and early 2015.
This is consistent with the conditions we experienced in the March June quarters, as shipment delivery dates for tools currently in backlog are featuring extended lead times, resulting in a lower quarterly shipment profile over the near term. We expect shipments in Q2 to grow approximately 40% sequentially at the midpoint of December guidance. We ended the quarter with approximately $1,200,000,000 of total backlog comprised of $993,000,000 of shipment backlog or orders that had not yet shipped to customers and expect to ship over the next 6 to 9 months. Our current shipment backlog is at historic high levels for the company, providing a baseline for strong shipment and revenue growth as we convert this backlog in the coming quarters. Dollars 173,000,000 of revenue backlog products that have been shipped in invoice, but have not yet been signed off by customers.
Turning to the income statement. The numbers show Kale and Encore executed well operationally in the September quarter with revenue, gross margin and EPS all finishing in the upper end of the range of guidance. As I previously mentioned, revenue in September was $643,000,000 just above the midpoint of the guided range for the quarter. Gross margin was 55.6 percent, 100 basis points above the midpoint of the guided range for the quarter in spite of the $91,000,000 sequential decline in revenue. Gross margin exceeded our expectations in the quarter due to lower than forecasted parts costs in our service business and a favorable product mix in Q1.
We expect gross margin to be in the range of 56% to 57% in December. Total operating expenses in the September quarter were $240,000,000 up sequentially about $9,000,000 compared with June, mainly due to higher employee related costs in the quarter. Consistent with expectations, prototype material costs for certain next generation products are expected to be higher in the first half of our fiscal year versus the second half. For the December quarter, we are modeling operating expenses to be between $236,000,000 $238,000,000 Other income and expense was approximately $10,000,000 in September. Prior to the recapitalization, our expectation is that OIE will be about $10,000,000 in the December quarter.
However, given the unknowns currently surrounding the structure and timing of the proposed recapitalization, at this time, we are unable to guide OIE for the December quarter. We plan to provide detailed guidance updates sometime later this quarter to reflect the impact of the transaction on OIE tax rate earnings per share. Our effective tax rate was 26% in the quarter, above our long term planning rate of about 22%. We believe the appropriate long term planning rate should be 22%, given our expectations for the mix of business over the next few years. The 22% planning rate also reinstatement of the U.
S. R and D tax credit that expired at the end of calendar year 2013. Given the low probability that this extension will occur in the December quarter, we are modeling a tax rate of 24% for the December quarter. Finally, net income for Q1 was 79,000,000 dollars or $0.47 per fully diluted share. I'll turn now to the balance sheet and our cash flow statement.
Cash and investments ended the quarter at 2,940,000,000 dollars a decrease of $210,000,000 compared with June. The sequential decline in our cash balance is largely due to stock repurchases and annual bonus payments in the quarter. Cash from operations was $35,000,000 in the quarter. The sequential decline in cash flow from operations in Q1 is consistent with seasonal trends and was driven in part by lower revenue levels as well as the timing of our annual bonus compensation payments in the quarter. In the September quarter, we paid $82,000,000 in dividends and repurchased $125,000,000 of our common stock.
Fully diluted shares ended the quarter at just under 100 $6,000,000 So with that, to reiterate our guidance for the December quarter is bookings are expected to be within a range of $700,000,000 to $900,000,000 shipment guidance for the December quarter in a range of $740,000,000 to $800,000,000 revenue between $620,000,000 $700,000,000 and EPS of $0.46 to 0 point 7 Once again, we plan to provide an update to December quarter guidance that will reflect the impact of the proposed recapitalization concurrent with the currently scheduled closing of the transaction later This concludes our remarks on the quarter. I will now turn the call back over to Ed to begin the Q and A.
Okay. Thank you, Brent. At this point, we'd like to open up the call to questions and 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. So Mike, we're ready for your first question.
This is Farhan asking a question on behalf of John. Rick, can you just talk about briefly like why you chose to do a special dividend instead of buybacks? And what were the puts and takes in making the decision?
Well, I'll give an overview and then I'll turn it over to Brand to get to the specifics. So look, the way we look at it, there are 3 uses of cash. And the primary use is to fund our organic growth. And we fully satisfy that and we continue to build upon that. The second is to look for accretive and enabling M and A.
And we've done those things and continue to evaluate those and we feel we can do them. And then the third one is returning cash to shareholders. And in that, we look for the most efficient way and effective way to do that considering a lot of factors including who our shareholders are and also the size of the return and what's most efficient. And so from that, I'll hand it to Brian.
So I think anytime you consider a large return of capital, I mean, certainly, we start from an assessment of our business around how much cash does the business have, what kind of reserves do we need, also the potential debt capacity of the company. And so as we looked at that and to Rick's point as we assessed our options, we clearly did not see at least for now anything on the M and A front that looked as compelling to shareholder value as what we're doing here today. But given the size of the transaction itself, the practice of trying to execute a share repurchase is difficult. There's a tender offer and their premiums and all those kinds of things. And I think it really comes back to Rick's point, who are our shareholders, what do they value?
And we think our shareholders value our dividend practice, our practice of returning cash, the ability to treat all shareholders the same, and the timeliness and efficiency of the execution. There is a piece of this obviously that is share repurchase that we will execute over time. We made the previous announcement back in July of $1,000,000,000 of which we've executed $125,000,000 and we added another $250,000,000 to that. So, we will be executing that over time as another component. There are, I think, different opinions on what's the best approach.
I think it goes back to how we think about our business, how much cash do we need. And ultimately, we made the call to do it this way where we feel like we're optimizing between the two vehicles.
Thank you. And just one question in terms of the first half of calendar first half of next year. What kind of pickup are you expecting in the first half of next year?
Well, as you know, we don't guide beyond the next quarter. But overall for calendar 2015, I think it is setting up nicely for heavily investment in FinFET across the board. And when we look at our foundry customers, really nobody is shipping products today on a large volume with FinFET devices. And I think by the end of calendar 2015, the expectation is there'll be multiple devices from multiple suppliers of FinFET technology. So that bodes well for investment.
So what we're anticipating as we said for the December quarter is a pickup in investment associated with that. But then throughout 2015, the way the plans look and the way our customers are talking to us about it, I think we'll see multiple players supporting that ramp.
Yes. I think the only thing I would add to that is given the timing of the second half of the year to be delivering product, it does make sense that you'd start to see capacity ramping in the first half of the year. Certainly, we are driving our supply chain and building towards that expectation. And I think it lines up with the end market dynamics that Rick mentioned.
Thank you. That's all I had.
Your next question is from Timothy Arcuri with Cowen and Company.
Two things. First of all, Rick, I'm sort of curious if you can talk about the FinFET timing issues and if it's possible to segment it out, whether it's process related or if some of it is like customer related, I. E. Sort of like your customer's customer, there's a lot of obvious uncertainty out there. And so I'm wondering whether you could sort of segment the 2?
And then I had a follow-up. Thanks.
Sure. From what we understand in talking to our customers, I think there is a desire by the end customers to get to the technology. But there's an inability right now in general to have a large scale deployment of technologies that are reliable enough to be deployed in high volume. So I think that that's really limiting. Like I said, we expect the first commercial devices to come out or consumer devices to come out by the end of the calendar year with FinTech technology, but that's really only from one supplier.
The other ones are working through a number of issues and there are associated challenges with defect density, but also structural reliability. And I think that for people that haven't done FinFET, it's turning out to be a very challenging process. So I think there's a lot of effort going on to deal with that. And as you know, there has been some success on 20 nanometers. So given that that's made it into the current product cycle, we're really talking about a next product cycle, which I think is the soonest we expect to see volume is mid calendar year of 2015.
So as I said, we expect investment to be ramping in dealing with some of those challenges. But the people that are in front on FinFET struggled quite a bit getting yields on them and we were involved in working through some of those challenges. So I don't think it's going to be easy. And I think that on the one hand we're enabling that, but on the other hand until it starts to work there's not going to be a lot of customer demand, not a lot of tape outs. But then I expect you'll see kind of an avalanche of demand once the process starts working.
Okay. Thanks for that. And then I guess just a follow-up to the prior question about the decision to pay a special dividend. Why would you decide to do that when you are about to put up a quarter that where the guidance is definitely disappointing relative to what the Street was thinking and you could have maybe bought stock back at a much, much lower price. I guess I'm just wondering the calculus around paying that special dividend versus maybe doing an ASR post these results something like that.
Thanks.
Sure. Well as you can imagine, this is Rick. I'll start with an overview and let Bren fill it in. First of all, this wasn't a decision that was something about a near term decision. It was a long term decision around capital structure of the company, something that we've been working at for quite a while to figure out what is the right way to position the company and structure it.
So it's independent of ups and downs of particular quarters and we certainly aren't market timers. So we look at that and we said what's the best way, what's the best capital structure. And in this case, there is a blend, but it's obviously greater in the special dividend and it's the most efficient way to be able to return cash to shareholders. That was really the thinking. It wasn't meant to be coincident with any particular quarter.
It just happened to coincide.
Yes. Tim, the only thing I think I'll add is, is clearly, the ability to finance this was driven by a very attractive debt market both in terms of rates terms and financial flexibility. Also our view on being able to overshoot or go further than our long term target of 2 to 2.5 times leverage was also driven by our views of capital intensity and healthy capital spending environment over the next couple of years to enable us to deleverage some of this debt we're taking on back to our target. So, as I've been saying, I think even going back to May and even into semicon that we felt like it made sense for our company given the dynamics, our secular dynamics, our business model, the barriers to entry, our market share that more assertive capital structure would drive additional value to our shareholders. And so this was a process.
We made the share repurchase announcement. At the time, we said that that was a first step. This is the next step. So, we talked a lot already about the pros and cons of the vehicle, but at the same time, I just wanted to give you a little bit of insight in terms of how we're thinking about
it. Okay, Brent. Thanks a lot.
The next question is from C. J. Muse with ISI Group. J.
Muse:] Yes, good afternoon. Thank you for taking my question. I guess, if I could, I'll try to ask both my questions at once as they're partially related. I guess, first off, when you consider this special dividend, I'm curious whether you focused at all on the M and A side or increased R and D. When I look at your relative position to WFE over the last 2 years, you've underperformed by about 8 points each year.
And we'd love to hear your thoughts on whether that was a consideration and how you're going to rectify this relative underperformance that has gone on at least for the last 2 years. And then second part of the question is flexibility. If I look at you guys pro form a post the transaction, roughly 20% debt to cap and roughly 2 thirds of your free cash flow will cover interest and dividend. And I'm wondering if that's enough flexibility for what may come for what is still a cyclical industry? Thank you.
Yes, C. J, I'll take part of it and then again, Bren can look at it. We can talk about the relative performance. I think as you're well aware, we have a we're biased towards increased adoption in logic and less so in memory, although memory is increasing. And what we've seen this year clearly is that the memory investment has been higher than maybe anticipated originally and has continued to go up.
We expect that trend to reverse a little bit in 2015 where we do see the foundry customers increasing their investment. And our expectation is memory will probably normally hold to what they're doing in 2014. So I think the mix becomes favorable for us. So we look at over the long term. The second part I look at is a big change in the company and in the industry, I think has to do with while the near term volatility has increased, the longer term volatility has actually decreased because of, I think the efficiencies associated with consolidation.
And the other thing that gives us a lot of confidence is in our ability to service the debt and do everything else that we want to do is a growing service business, which is much more aligned with what's going on in overall semiconductor manufacturing. And we just looked and we've had 7 consecutive growth of service business. And so we look at that as a business that can fuel and can help dramatically service this debt.
And Fran you want to in? Yes. So, C. J, I think you mentioned operational investment and I think that we have ramped up our investment to support our businesses. We have a product cadence that's 2x our competitors.
So we believe we are investing enough in our business to be able to maintain our market position. And I think that the underperformance we talk about is more driven by the most sensitive element I think in that is to Rick's point more about customer mix than anything else. From a flexibility perspective, we aren't using our offshore cash in this transaction. There's an unfunded revolver that's a component to it. We also plan to have about $500,000,000 in the U.
S. We're going to execute the share repurchase over time. And certainly, there are some elements that provide flexibility there. As you know, covering this industry for a long time, this is not a capital intensive industry. And so, we don't need a lot of cash to run the business.
We have the growing service business that's a bigger percentage of the revenue. So, we're much more comfortable given the cyclical dynamics as well. I think we're much more comfortable with the risk profile of this. And our intent is to delever a significant portion of this rather quickly over the next couple of years. So, all that coupled with the cost of the debt plus the outlook that we have, we think that it's a prudent structure.
And I think we expect our debt to be investment grade and I think that that also reflects the structure and our ability to execute our strategies without the risk or the financial financial distress that affect sometimes goes with that.
Operator, next question?
And the next question is from the line of Karish Sankar with Bank of America Merrill Lynch.
Yeah. Hi. Thanks for taking my question. The first one I had was just to follow-up on the special dividend recap question. Is it fair to assume at this point that you probably looked around and found out no suitable M and A candidates and decided this is a better way to return capital?
And does it impact your 6.9% convert due in a few years? And I had a follow-up.
Again from the strategic perspective, we have looked at opportunities continue to look at opportunities to enable further growth and look for things that are going to be accretive to either our current business or places to grow. And when we evaluate that, we feel very well positioned with the product portfolio that we've developed organically or through the M and A that we've done in the past. And we've said this on a number of occasions. While we look, we don't see anything that's so compelling that we wanted to move in the past or would have. And we always compare the returns that we would get from that from what returns we get from an action like this.
The second one is, we still can do M and A. I mean, if there is M and A that's compelling and accretive over time, we're not limited to do that. And so our view is this doesn't disable that option. It just would have to pass hurdles that would make it long term accretive to our company and that's always been the case. So we don't think that we're limited in any way from the deals that we anticipate might come our way as we look forward.
And then on the question on the 2018 debt, so that's straight corporate debt. And an option under consideration is do we details ultimately of the various aspects of it. It's an option under consideration and we'll update you at the appropriate time.
Got it. And then just as a follow-up, I mean, it looks like there's a lot of activity going on in the foundry side. Besides the FinFET related yield issues, have you seen any pickup or incremental sales for 28 nanometer? Or are you just focused mostly on 20 16, 2014 at this point?
We do have some forecast in the we did expect in the second half to see some incremental 28 nanometer activity. We didn't see that in the September quarter. We do expect some of that business in the December quarter. I think some of the lithography orders happened in the September quarter and I think just given general lead time dynamics that would imply that the September quarter and I think just given general lead time dynamics that would imply that other tools will follow. So, we do expect some of that business.
I thought we'd see some of it in September and it looks like I'm going to see maybe more of it in September or the December quarter now.
Yes. Clearly, there are players that haven't participated where that is a leading edge node for them that have come to us for support and help. And to Bren's point, we expect to see that because as you know that's the node that's probably generating a lot of the revenue and cash flow for the industry right now, not the very leading edge stuff.
Got it. Thanks, Rick. Thanks, Brian.
Thank you.
The next question is from Harlan Sur with JPMorgan.
Yes. Hi, good afternoon. This is Bill Peterson calling on behalf of Harlan. Congratulations on the recapitalization program. My question is actually more about the outlook, particularly in the 2015.
Wondering, with typically long lead time, lead times, orders in hand coupled with orders you expect in December, How do you see 2015 playing out in terms of first half versus second half? I understand not looking for forecast, but how do you see that playing out? And then I have a follow-up question.
So Bill, I think the first half given the earlier comments, we think the first half should be strong given the ramp we expected associated with 16 and 14 nanometers. Beyond that though, it's hard for me to guess. I think we're consistent with everybody else. We see it as a year of growth as we said in the prepared remarks. In the first half, we're certainly building to support a strong shipment profile through the first half.
Okay. And I guess the second part is, I guess should we expect with some customers that the shorter lead times would be, I guess become a new norm? Or is there something else at play? I'm just kind of curious on your thoughts on where the typical lead times would be going particularly in the key foundries?
Lead times have been coming in over the last few years. I think one of the byproducts of the mobility driven cycle that we've been in since 2010 is because it's consumer centric. Our customers are more sensitive to consumer dynamics. They have less lead time and so some of that lack of visibility passes through. It tends to be customer specific.
As we saw in the June quarter, we booked a significant of business in the foundry from a customer that gave us extended lead times. And I think based on another customer that we expect to see some activity from here coming up to support the ramp we talked about, the lead times are pulling in. So it tends to vary across customers. But over time, I think we've seen them shrink. I mean, we're still sitting, I think we ended the quarter around 5 months of backlog, but it isn't 6 to 7 months backlog.
And as we model it going forward, we model somewhere between 4 5 months generally. It does mean that we carry more inventory to be flexible, and that's certainly a dynamic that we has changed in terms of how we manage the company and the business. But we need to be able to respond and these are big orders from single customers and so we have to be sensitive and flexible to their plans.
Yes. And I think in general, Bill, as you know, as the industry has transitioned to more much more of consumer orientation for devices and that drives the business, it's our customers don't really have a lot of visibility. So they're asking us to be responsive to their need to respond quickly. And I think in exchange for that what we get is pretty close collaboration on their needs. We just don't get great insight into timing largely because in many cases they're not sure.
So we have a lot of provisional plans that change pretty quickly and we try to synchronize those, but it's a challenge because the end markets move and the players are all trying to be positioned to take share when it's available to them. So we have to support that. And to Bren's point, we've taken on some inventory to be able to do that.
Okay. Thanks for that color and good luck.
Thank you.
The next question is from Mahesh Sankanariya with RBC Capital Markets.
Thank you very much. Rick, you talked about next year one of your peers talk about next year up 5% to 10%. Let's say, if the CapEx next year is up 5%, Where do you think your revenue can track in that environment?
I'll give that to Bren.
So Mahesh, I think a lot of it depends on the customer mix. I think after 2 years where we had pretty heavy memory spending, I think underperformance relative
to the market. I think with the ramp of a
new technology, we think that we should be able to grow with the market into next year. That's certainly how we're modeling it. But I think that's the more sensitive item. I mean over the last couple of years, I think there's been just a fundamental delay I think around some of the new technologies, whether on the NAND side or even in the foundry. And certainly, that's put pressure on process control because the customer buying patterns are typically heavier when they're ramping technology.
So given the assumption of the ramp into next year, we do believe that next year positions us for growing at least at the market rate and perhaps faster if process control intensities move the way we think they're going to move on these new technologies.
I'm assuming that this is a special dividend and you're paying the basis, so it's going to be tax free to the investors. And also if you can give us some math around the investors? And also if you can give us some math around why do you need a $2,500,000,000 of debt to fund this? And because you have so much pretty good amount of cash in have a pretty good amount of cash in U. S?
Yes. So the dividend versus return of capital calculation, which gets in whenever you pay a large special, a portion of it is dividend. And based on tax retained earnings over time, a piece could be return of capital. And we don't have the specifics on that to share with you today. We'll share that with you when we ultimately get to where we pay the special.
So that's how that works. On the amount of debt, the way we thought about it was how far how much debt could we borrow. We want to maintain an investment grade profile, as we said. We also had a plan around share repurchase. And so once we pay the special and then go through the share repurchase commitment, we will have the U.
S. Cash number right around $500,000,000 And then most of the way I am thinking about over time, the way we will drive this is our free cash flow into the U. S. Will pay our ongoing dividend and then the remainder will be targeted towards deleveraging back to our long term target of 2x to 2.5x EBITDA. So that's how we're thinking about it.
I think the overall scope was driven by what's prudent for us and also clearly we thought it was important to maintain investment grade profile through this.
That's very helpful. Thank you very much.
Welcome.
The next question is from Jim Covello with Goldman Sachs.
Jim?
Jim Covello, your line is open.
Okay, operator, next question.
Your next question is from Edwin Mok with Needham and Company.
Great. Thanks for taking my question. So first question is we have seen quite a bit of activity by the 3 technology leader around the 10 nanometer logic process right now. And I'm a little surprised that your mass inspection order is so low this quarter. I would suspect that some of those guys will start to order mass inspection for 10 nanometer.
Can you give some color around that where is mass inspection and do you expect incremental order around 10 nanometer on mass inspection number 1? And then related to that is do you expect kind of ramp up in those 10 nanometer activity to benefit you in 2015?
Yes, Edmond, it's a good question. So mass particularly around the mask shop tends to be a lumpy business. We had a decent quarter in June and we have a forecast for a decent quarter in December. So there is some lumpiness to the order profile. As you might recall and we were fairly open with this, we did book for a leading logic manufacturer, we did book a multiple set of MassShop tools to support the 10 nanometer node with those tools shipping over the course of 2015.
So with a lot of it in the first half of twenty fifteen. So there is some activity there. I think we'll start to see more of that activity as we move forward. I don't know how much of it we'll see in December, but clearly that's an aspect obviously of this transition to 10. But very limited activity on 10.
I don't think we'll start seeing orders for 10 nanometer beyond what we've seen and some very early development stuff. I don't think you'll see any meaningful orders until we get closer to the end of next Yeah.
And to that point, the existing capability that we have can support the pilot and R and D work. And given the fact that there are very few sub-twenty nanometer designs working anywhere except for some at one customer then there's a lot of there's capacity in the system to handle things until we see really ramp up of 2016, 2014. That will start to consume some capacity. And then the 10 has really been, as Brent said, in the pathfinding usage for the reticle tool. So it will come.
It's just not going to and it's going to be lumpy, but it's not going to be imminent given the 10 nanometer so far out.
I see. Okay. That's helpful. And then just talk about your commentary on the first half of 2015, you said strong driven by 16, 14 nanometer investment from your customer. What about on the memory side?
Are we at least are you seeing any subsiding in investment in memory? Or do you think that will remain strong in the first half? Or is it more back half loaded on the memory side? What color can you provide to us? Thank you.
Yes. I'll give my perspective and Bren can weigh in. I haven't seen a lot of expectations of it building. I think that the strength in memory probably And most of the investment in Flash has been as we And most of the investment in Flash has been as we talked in the past more plainer than 3 d. There have been some in 3 d, but I think 3 d is yet to come and that will be dependent on a number of factors, although we're participating in that.
And then the DRAM side, we do see technology investment going and there are definitely some capacity adds being pursued. So I think memory, I don't see a big difference between Q1 and Q2 or I'm sorry, first half or second half of twenty fifteen for that. And as you know, we don't really forecast that far out. And so our visibility is pretty limited in terms of exactly where things are going to fall. So we're we struggle to predict much beyond what we're going to see in December.
Great. That's actually very helpful. Thank you.
The next question is from Atif Mallouk with Citigroup. Your line is open.
Hi. Thanks for taking my question and congratulations to the team on a special dividend. And the comments on the FinFET push outs are quite understandable given your peers ASML also talked about the uncertainty in the foundry market. So my question is on the lead times, Rick. And then sort of same lines as Tim was alluding to.
So if your customers' customers they have to make their devices let's say September next year, when is the latest they can order your equipment? So I'm just trying to gauge if there's further risk in these bookings pushing out into the March quarter given your lead times are typically longer than your peers? And then I have a follow-up.
Yes. I think given what we've seen, I think that there is a sensitivity clearly to the end market dynamics there. And I expected frankly, I expected the orders in September. So I have some orders forecasted in December. And certainly, that's the plan based on what we see today.
But it does as we've seen, it has been a little bit fluid. I think given the calendar timing that we talked about and roughly 3 month cycle times on devices, you really have to start putting that capacity in place in the March June quarters to be able to deliver those schedules. And so that's I think the calendar that or cadence that looking at in terms of expected deliveries. But could it be a situation where I get very short lead times, I get finally get orders from customers and they turn around and want shipments in a couple of weeks, that could happen. I wouldn't be surprised if it does at some level, but this is we're trying to give you as much guidance as we get based on the conversations we're having with the customer.
And certainly, we're positioned to be able to respond with the flexibility to be able to deliver in a meaningful way into the first half of the year.
Yes. And to the point of if you look at the last two quarters of we missed low in terms of the midpoint and the June quarter and we missed high and then missed low. So we're not very good at forecasting the next 90 days. And so we really think about it on a longer term basis. And the way I think about it, how is adoption relative to our model and expectation and how are we doing relative to share?
And timing is something we have less influence over. But certainly from an adoption standpoint, we're seeing it. I think 2014 and 2016 will be good adoption for we'll see strong adoption for process control, but we're just not seeing it yet because that investment is not there. I think our market share continues to be strong, but until they place the orders we don't know. So it is true we're going to be I think short term very volatile in terms of the ins and outs.
Got it. And then as
a follow-up, you guys talked about the 2 d NAND investments are more dominant right now than 3 d investments. If you can rank for us the reason for that. Is it that the economics of 3 d are not at par with 2 d? Or is it yield related? Or just are the memory makers just trying to keep a tight supply demand balance as 3 d could add more bits in the market?
Well, clearly, there's a continuum of process maturity for the different providers, right? You have people that are already yielding devices and able to ship and shipping in small volume. You have others still in development and you have others earlier in development. So I think it really ranges whereas 2 d capacity is much broader. So to the degree there is market demand for NAND, I think there's a big opportunity for everybody to participate in that.
So you're going to see planar NAND continue. I do believe that people have underestimated the challenges in 3 d both in the NAND and also in FinFET in terms of integration and yield. And some of that we can help with and some of that's just debugging the processes. So when there's a robust market environment, I think many of our customers will produce the products that they can produce. But the crossover point once the 3 d is working of 3 d Flash is going to be compelling as well.
But it's got to work and get to economics that make sense. And we anticipate the soonest that happens is in calendar 2015. But it's kind of a bit of both. If the economics don't work, the demand isn't there. But if it does work, there's a lot of interest in the customer's customer for it.
Got it. Thank you.
The next question is from Stephen Chen with UBS.
Thanks. Hi, Rick and Brent. Just a follow-up question on the recapitalization. Did the company consider a management buyout? And perhaps you can share some of the puts and takes and why not just the management buyout here?
No, we didn't consider it. I mean, it's just given our situation that wasn't something we consider. What we considered was what's a prudent level of debt that the company should be taking on to optimize our capital structure and then what's the best way and most efficient way to return cash to shareholders after we've gone through and evaluated uses 1 and 2 of cash, which is invest in our business, look at accretive M and A or enabling technology. But no, we didn't we weren't looking at a management buyout.
I think when you have a business like ours that has strong technology position, differential margins, the ability to invest and therefore generate strong operating margins and a strong cash flow profile. I think you take that and you couple it with the what we clearly see are changes in the secular dynamics that of our industry that lends itself to, I think, a more predictable earnings stream over time. And so a business like that certainly has the capacity to carry more debt. And to Rick's point, when you look at the first two considerations, which we work through, at least for now, as we saw, we saw this as the best opportunity to deliver incremental value to our shareholders as we execute what we believe is a very solid plan going forward. So that was the thought process.
And again, the level of debt determined by our goal of what makes sense for our business as exhibited by the investment grade profile that we have. And then, obviously, how do we move forward with it.
Okay. Thanks for that, Brent. And then just a follow-up on the ongoing business. So it looks like you're seeing the improved gross margins in both September December quarter. I missed the main driver that got you back into the gross margin range in September.
And does it appear that you, I guess, overcome those issues that occurred in the June quarter? Thanks.
Yes. The June quarter, I had a couple of issues on revenue mix where some of the tools that came in on the revenue side were had a weaker revenue mix profile. And I also had higher than expected costs in my service business. And so that drove one time weakness, if you will, into the June quarter. I think we saw a very normal gross margin structure play out as we went into this quarter, something more consistent with what we've seen historically and consistent with our model.
So, the mix turned out to be a little bit more favorable and I think the dynamics I saw in the service business corrected and is more consistent with our expectations for that. So and I think as we look into the December quarter, the same dynamics play out.
Okay. Thanks, Brian.
You're welcome.
The next question is from Reuben Roy with Piper Jaffray.
Hi, good evening everyone. This is Sean on for Reuben. Just wondering if you could kind of give us an update on how you're thinking about gross margin, gross margin profile for 2015 given the ramp that you're seeing for 2016 and 2014? And then just sort of opportunities for expansion headwinds there, just some kind of directional indication of how things could play out?
Yes. The gross margin profile on our latest products that we've introduced is actually is very solid and very consistent with our historical pattern. We believe we'll see incremental gross margins between 60% percent 70% going forward through 2015. And so I think we're very well positioned as we see this pickup in business into the first half of the year for very good gross margin performance and very consistent with our historical model.
Great. And if we could
you talked a little bit about ongoing sort of focus on investment in the business and just trying to think about sort of your OpEx levels into 20 15. Is this something that will kind of continue to grow? Or how do we think about the magnitude of that growth or whether it will remain roughly consistent with where we see it currently?
Well, the first half of this fiscal year, so the September quarter and the December quarter coming up, I expect it to be a higher OpEx level than we expected in the second half and that was driven by some programmatic timing on some next generation
programs.
So I think the second half of the year comes down from the first half. I'm modeling the year right now, the fiscal year at around $935,000,000 So given the performance in Q1 and what we guided for Q2, it does imply somewhere around that $230,000,000 range in the March and the Q2. And so our OpEx levels are really dependent on what's required to support our roadmaps. And I think we're not necessarily on where the revenue level is. So if the business is stronger, I don't think it changes our OpEx all that much.
It turns out to be marginally weaker. I don't think it changes it that much either. So it's really driven by the business requirements and maintaining the differentiation that we need to support the gross margin profile that enables that kind of investment.
Yeah. Just to add to that, one of the big initiatives we have been investing in is what we call the 5d solution for lithography for multi patterning. And while we're seeing a little bit of revenue from those efforts, I think that that's an investment that will show up in future years as we continue to build out the suite of products and solutions we have to support multi patterning going forward. So that's part of the step up in the increase. But to Bren's point, we're looking to don't see dramatic increases beyond our current levels, but we'll continue to invest in the business as we go forward.
Great. That's very helpful. Thank you. That's it.
The last question is from Weston Twigg with Pacific Crest Securities.
Hi. Thanks for squeezing me in. I just I have 3 really easy questions. One is shipments last quarter you expected you said you expected shipments to trend higher each quarter through the fiscal year. It sounds like you're saying the same thing today, but I wanted to verify that that is the case.
The second question is, I'm just if you could remind us how much cash you currently have offshore? And then the third is your planned share count for
the December quarter?
So as on shipments, so we guided next quarter at $7.70 at the midpoint. And yes, I think given the commentary around the second or the first half of the exact number, but about 1.2 $1,000,000,000 at this point of the total of the $2,900,000,000 And share count that we're modeling is about $165,000,000 in December.
Very helpful. Thank you.
You're welcome.
Operator, that concludes our call for today. Thank you all for joining and we look forward to seeing you later on in this
quarter. This concludes today's conference.