科磊 (KLAC) 2010 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the KLA-Tencor Corporation first quarter fiscal year 2010 earnings 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.

(Operator Instructions) Thank you.

I'd like to turn the conference over to Mr.

Ed Lockwood, Senior Director of Investor Relations.

Sir you may begin your conference.

Thank you.

Good afternoon everyone and welcome to KLA-Tencor's first quarter fiscal year 2010 earnings conference call.

Joining me on our call today are Rick Wallace, President and Chief Executive Officer and Mark Dentinger, Chief Financial Officer.

We're here today to discuss first quarter results for the period ended September 30, 2009.

We released these results this afternoon at 1:15 Pacific time and if you haven't seen the release you can find it on our website at www.kla-tencor.com.

Or call 408-875-3600 to request a copy.

Rick will lead off today's call with updates on the current market environment and the Company's performance in the September quarter and provide guidance for the December quarter.

Afterwards Mark Dentinger will review the preliminary financial results for the quarter and then we'll open the call for questions.

A simulcast of this call will be accessible On Demand following its completion on the investor section of the website.

On the website you'll also find a calendar of future investor events, presentations and investor conferences as well as links to KLA-Tencor's SEC filings including our annual report on Form 10-K for the year-ended June 30, 2009.

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 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 those differences is contained in the filings we make with the SEC from time to time including our fiscal year 2009 Form 10-K and our current reports on Form 8-K.

We assume no obligation and do not intend to update these forward-looking statements.

However, you can be assured that 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.

Welcome to our first quarter Fiscal Year 2010 earnings call.

Let me start with the highlights.

Q1 was a strong quarter for KLA-Tencor.

Bookings revenue and EPS all topping our previously revised guidance.

Revenue was $343 million an increase of 22% compared with June and we returned to profitability in the quarter.

Non-GAAP net income per share including stock based compensation but excluding some one-time items was $0.15 in Q1.

Net income for the quarter includes a one-time non-operating gain of about $0.06 per share related to an international tax matter.

We generated $73 million in operating cash flow in the period and our cash position grew to a healthy $1.4 billion at quarter end.

So, clearly a very good result for KLA-Tencor.

Though there is still uncertainty about the pace of global economic recovery, our industry environment continues to strengthen off the lows seen at the beginning of the year, while the market for capital equipment is clearly stronger than it's been in some time, the demand is still primarily focused on advanced technology development.

We're also now seeing a broader range of customers moving ahead with capital investment plans in addition to the market leaders so at this point it feels like the worst is behind us.

We have a lot of optimism as we look ahead at the next stage of the industry growth because we believe we're in an early part of a capital investment cycle characterized by increased technical complexity and more challenging yield issues for our customers.

This in turn should drive higher adoption of process control technology and position KLA-Tencor for growth in excess of the industry.

To benefit from that growth we continue to invest heavily and maintain a high pace of innovation.

In the September quarter we launched several new products to address next generation technology development in our core markets.

I'm excited to say we're seeing strong customer interest and we begin to take orders for these new products.

I'll have more specifics to discuss on the technology front in my comments to follow.

But even with our optimism and our improving outlook, we remain financially conservative and continue to focus on optimizing our cost structure while responding to the improving business conditions.

With the actions we've taken in recent quarters we've successfully managed our cost structure to a quarterly breakeven revenue of around $325 million and our business is positioned to generate incremental gross margins in the targeted 60 to 70% range with incremental operating margin leverage in the range of 50 to 60%.

We're well positioned to deliver even higher operating leverage than we did at comparable revenue levels in the past.

Turning now to some specifics on the current demand picture, gross bookings in Q1 were up sharply to $493 million, an increase of 50% compared with June, driven by increased investment in memory and foundries.

Demand was primarily for technology buys focused on conversions and advanced technology development with some capacity investment at the advanced nodes.

We also benefited from a major new product introduction in our reticle inspection business which is enjoying strong initial market acceptance.

Foundry was 76% of new orders and we saw greater breadth in demand among our foundry customers in the September quarter.

Historically foundry customers have been high adopters of process control due to the nature of the foundry business model.

Memory grew sequentially in the September quarter to 13% of orders on increasing technology buys.

We see overall memory orders levels on the upswing.

Logic was down sequentially in Q1 to 11% of bookings.

We do expect to see an increase in logic investment in the December quarter.

As you know, technology changes that enable Moore's Law are a constant in our industry and regardless of where we are in the industry cycle, chip manufacturers are continuously innovating to lower the cost of production and improve performance of their products.

Process control is a key enabler of innovation for our customers.

As the market leader in process control, investment in innovation is a top priority for KLA-Tencor, maintaining a focus on technology brings us closer to our customers, extends our competitive advantage and strengthens our leadership position here are some highlights of a few of our recent new products.

First, we introduced and took orders in the September quarter for the new Teron 600 reticle inspection tool.

The industries first sub-32-nanometer production capable photo mask inspection system.

We've received initial orders for this new platform from customers in IC manufacturing and merchant mass shop markets contributing to our very strong sequential order growth in Q1.

We also booked orders in the quarter for our new 2830 Brightfield inspection system.

The 2830 features a revolutionary high brightness light source that enables more repetitive, more capture of difficult defects for accelerated ramp of leading edge devices.

KLA-Tencor's new brightfield platform is critical for advanced technology development and its generated strong customer interest.

Finally, during the quarter we entered beta agreement with leading memory customer for our next generation darkfield inspection system, the Puma 9500.

The 9500 is designed to dramatically increase throughput and sensitivity from our prior generation darkfield technology.

We expect to see increased demand for the 9500 as capacity investments resume over the next several quarters.

In summary the challenges our customers face today and advancing on Moore's Law are significant.

KLA-Tencor continues to drive innovation and maintain a rapid pace of new product development, to help our customers address these challenges and remain on their technology road maps.

In terms of guidance for Q2 FY '10, we expect demand to once again be focused primarily on technology buys with memory increasing as a percentage of the total.

We expect orders in December to be flat plus or minus 10% compared with September.

Revenues are expected to be between 420 million and $450 million, with non-GAAP earnings per share in the range of $0.24 to $0.30 per share.

I will now turn the call over to Mark for his comments.

Mark?

Thanks, Rick.

As most of you know we present our income statement in two formats, one under US GAAP and the other in a non-GAAP format which excludes amortization and writedowns of intangible assets associated with acquisitions.

Expenses associated with our stock options related litigation and certain cost expenses which we do not expect to be recurring such as restructuring charges.

Our balance sheet and cash flow statements are presented in GAAP format only.

Most of my prepared remarks and operations will reference non-GAAP Income Statement but where I reference GAAP numbers I'll make the distinction.

Before reconciliation of our GAAP to non-GAAP Income Statement is attached to our press release and available at our website.

Revenue for Q1 was $343 million, over the high end of the guided range we provided in July of 295 million to $335 million.

Non-GAAP earnings per share were $0.15 also above the favorable end of our guidance range of a $0.10 loss to breakeven.

Our Q1 GAAP EPS was $0.12.

Earnings guidance range assumed non-operating expenses of $10 million in a tax rate of 30%.

In the quarter we recorded an OIE gain of $8 million and we posted a tax rate of only 17%.

The effect of both the OIE gain and the low tax rate added $0.09 to GAAP and non-GAAP earnings.

The summary of the differences between this quarters GAAP and non-GAAP numbers are as follows: Acquisition related charges of $8 million before taxes or $0.03 per share after-taxes.

Restructuring and severance credit of $4 million before taxes or $0.02 per share benefit after-taxes and stock option litigation expenses of $5 million pre-tax or $0.02 per share after-taxes.

At Semicon West in July, Rick indicated the improved order activity we experienced late in our June quarter would drive an unseasonably strong fiscal Q1 and that proved to be true.

Looking forward while business conditions have improved in the first half of the calendar year, this ability into a broad based capacity driven expansion remains limited.

New orders for Q1 were $493 million, an increase of 50% over Q4 and significantly above the high end of our guided range of flat plus 20% from last quarters new bookings of $327 million.

This quarter, $16 million in orders pushed out of our 12 month delivery window resulting in net new orders of $477 million.

We ended the quarter with $649 million in total systems backlog, after adjusting for foreign exchange impact.

The backlog at September 30, included $223 million of revenue backlog, for products that have been shipped and invoiced but not yet recognized as revenue and $426 million in system orders that have not yet shipped.

Most of the backlog typically ships over the following six months.

The approximate regional distribution of new systems orders and the quarter to quarter change in distribution was as follows: The US was 13% of new system orders in Q1, down from 29% in the June quarter.

Europe was 3% of new systems orders, down from 4% in Q4 of '09, Japan was 9%, up from 4% last quarter, Korea was 6% down from 13% last quarter, Taiwan was 51% up from 46% last quarter, and the rest of Asia was 18%, up from 4% in Q4.

The approximate Q1 distribution of new systems and services orders by product as well as the quarter to quarter change in distribution was as follows: Wafer inspection was 32% down from 34% last quarter, critical inspection was 22% up from 10% last quarter, Metrology was 17% down from 18% in the prior quarter, and solar storage high brightness LED and other non-semi was 7% even with last quarter.

Services was 22% of new orders in Q1 down from 31% last quarter.

Foundry customers comprised 76% of semiconductor systems orders in Q1 versus 53% in Q4.

Logic and memory orders were 11% and 13% in Q1 versus 37% and 10% respectively in Q4.

Technology purchases generated most of the activity this quarter with 45-nanometer and below development pilot activity comprising 95% of the semiconductor systems orders versus 97% of orders received in the June quarter.

We expect the Q1 strength in order activity to continue in the December quarter and as a result we are assuming new orders in Q2 will be flat with Q1 plus or minus 10%.

Shipments in Q1 which included both system shipments and services revenue were $383 million, up 11% from $344 million last quarter.

Systems revenue for Q1 was up 30% to $229 million versus $176 million in Q4.

Services revenue was $114 million in Q1 up from $105 million in Q4.

Our expectations for total revenue in Q2 is a range between 420 million and $450 million and we expect services to contribute a little less than 30% of the total.

Non-GAAP gross margin was 51% in the September quarter, up 5 percentage points from the June quarter.

The improved margin percentage in Q1 was partly because we took about $10 million less in excess and obsolete charges than in Q4 and partly because of capacity improvements.

In Q2, we expect that our gross margin percentage will improve slightly because of the incremental margin on higher expected revenue.

Operating expenses were $153 million, an increase of $5 million from the June quarter.

R&D was $78 million, about flat with Q4 and selling, general, and administrative expenses or SG&A were $75 million, a $5 million increase from last quarter.

The primary reason for the increase in operating expenses was higher, a higher accrual rate for variable pay based on our updated full year projections for operating profit.

These higher accruals resulted in $8 million additional operating expenses this quarter.

Without the additional accruals operating expenses would have been about $145 million or about $3 million down versus Q4.

Other income and expense or OIE was a net $8 million credit in Q1 or approximately $19 million higher than our Q4 net expense of $11 million.

The higher Q1 net credit is largely due to a non-recurring $16 million gain from reversing a consumption tax contingency which is no longer required.

Without this credit, OIE would have been a net expense of about $8 million.

In Q2 we expect OIE to be a net expense of approximately 9 million to $10 million.

In Q1, our non-GAAP income tax expense was $6 million or 17% of pre-tax income versus a $15 million credit in Q4 when we had a pre-tax loss of $30 million.

The 17% rate this quarter was lower than our 30% model rate largely because of a non-taxable investment gain on our deferred compensation plan.

Consistent with the last few quarters, lower negative pre-tax profits coupled with other unique factors each quarter make predicting short-term tax rates difficult and we are modeling a 30% rate for our December quarter.

Beginning this quarter we anticipate that our GAAP tax rate will be adversely affected by an additional non-cash component that we estimate will add 5 million to $10 million additional tax expense in Q2.

This additional GAAP tax expense results from how accounting rules are applied to excess shortfalls associated with employee stock activity.

This issue is more fully described in our Form 10-K for the year-ended June 30, 2009, and will also be described in the 10-Q we file for this quarter.

Because this expense is non-cash, non-predictable and materializes only when a Company is in a net shortfall position we will remove the effect of this charge when comparing our non-GAAP statements in the future but we will highlight the charge each quarter in our GAAP to non-GAAP reconciliation.

Non-GAAP net income was $26 million or $0.15 per share in Q1.

These numbers include a pre-tax stock based compensation expenses of $20 million.

Our model tax rate of 30% and excluding the OIE credit, our non-GAAP earnings per share would have been $0.06 this quarter.

At the revenue range I previously mentioned we would expect our Q2 non-GAAP earnings to be somewhere between $0.24 and $0.30 per share, assuming a tax rate of 30%.

The weighted average shares used to compute EPS in Q1 were 173 million versus 170 million in Q4.

The primary reason for the increase in shares was because we were profitable in Q1 and therefore we included the effect of potentially dilutive securities.

For the December quarter, we also expect to be profitable so our average share count should be approximately 174 million assuming we do not repurchase shares.

Turning to the balance sheet, cash and investments ended the quarter at $1.4 billion, an increase of $57 million quarter to quarter.

Cash generated from operations of $73 million in Q1 equal to what we generated in Q4.

In Q2 our cash flow from operations should improve because we are anticipating a significant US federal income tax refund based on a decision to carry back our 2009 income tax loss to prior years.

Net accounts receivable ended the quarter at $244 million up from $210 million at June 30, because of higher shipments.

DSOs were 65 days at September 30, versus 68 days at the end of June.

Net inventory decreased by $23 million from last quarter and ended the quarter at $347 million as we began consuming inventories that built up earlier this year.

Net capital expenditures were $4 million in Q1 versus $2 million in Q4.

Total headcount ended the quarter at 4850, a net decrease of 89 from June 30.

We expect our headcount will remain relatively flat during Q2.

Over the last year we've talked about our plan to reduce our quarterly non-GAAP operating expenses to 140 million to $145 million range by our December '09 quarter.

We've now completed most of the steps we contemplated and the only differences between our stated goal and current spending levels are the results of adding back some of the temporary compensation and benefit reductions we enacted last fiscal year.

While we don't have a timetable for completely restoring these cuts, our belief is that complete restoration at today's headcount levels would raise our quarterly non-GAAP operating expenses to about $165 million.

In summary our guidance for Q2 is new orders are expected to be flat plus or minus 10% versus Q1.

Total revenue between 420 million and $450 million, non-GAAP earnings per share will be $0.24 to $0.30, assuming a tax rate of 30% of the pre-tax income.

This concludes our prepared remarks on the quarter and we'll now turn the call back over to Ed to begin Q&A.

Okay, thank you, Mark.

We'll now take your questions and we once again request each participant to please limit yourself to one question and a brief follow-up to allow us to get to as many callers as possible in the time allotted today.

And with that, operator, we are ready for our first question.

(Operator Instructions) Your first question comes from C.J.

Muse of Barclays Capital.

Yes, good afternoon.

Thank you for taking my question.

I guess first part, in your prepared remarks you talked about calling it early stage of recovery and I guess I was hoping you could talk about your visibility into the first half of 2010, I guess particularly around sustainability of spending from the foundries?

Sure, C.J.

it's Rick.

What we're seeing now I think is a couple things.

One, a number of foundries that are investing has broadened so clearly we saw that as a benefit and the other thing we're seeing is the advanced technology that is really being pushed by the foundries now, there are a lot of starts that have happened and there's a lot of demand for the events out of the foundries they just have to make investments to catch up to that, whether it can remain at exactly this level or go down, I think it's hard to say but on balance, when we look out to December and think forward, we think that there continues to be opportunity in the foundry space for a couple reasons.

One is there's increasing demand on the low end and we don't have a large percent of the revenues generated on the advanced design rules.

The second one is I think we're finally seeing effect of the guys that went off line a few years ago, some of the major guys that were investing that had shifted their production over to the foundries and now we're seeing foundries finally starting to invest to essentially absorb some of that CapEx so we see the situation pretty good because of the challenges they face and I think probably favoring inspection Metrology in particular for their needs.

Great, and then I guess as my quick follow-up, you talked also about the Puma 9500 darkfield inspection and seeing some success there.

I was hoping I guess in light of that success you could talk about capital intensity for process control from memory users and what kind of trends you're seeing there.

Sure.

It's still I think early to say because most of what we seen in the memory side has been relative to development and so I think it's really more customer specific what kind of intensity they have than sector in particular so there's a range across them, but I think that the current way we see the market developing much the same way the foundries had to turn on and invest more heavily to get their yields up we're seeing some of the early signs in memory that will be similar to that but I'd say it's too early to say that that thesis has been proven out so I'd say we are where we were with foundry say a year ago relative to memory.

Perfect.

Thank you.

Okay.

Your next question comes from Timothy Arcuri with Citi.

Hi.

A couple things.

First of all Mark, can you give us some shipment guidance?

Yes.

We aren't guiding shipments, Tim.

I know this has come up before but we haven't guided it for over a year and we aren't prepared to guide it today.

Okay, just as a comment, it is helpful to kind of help us plan the business.

Second question, as you kind of look at the debt now that you have relative to last cycle, it takes roughly between $0.30 and $0.50 in earnings power away this cycle relative to what it was last cycle because you have a flip in the other income line, so as you think about earnings power this cycle versus last cycle, is there something that you feel like you have to do to sort of make up that difference?

How do you view that debt level as it relates to compressing possible earnings power this time versus last cycle?

Yes, well it's not the only way that we view it, Tim, but the simple way to view it is that although the debt obviously decreases the earnings power through the Income Statement, if you view the debt as actually a vehicle for repurchasing your share it increases your earnings per share power through the share count, so at some level, you are making a tradeoff if you just look at that in simplistic way but the real issue is that KLA-Tencor basically has a predictive enough earnings model and is strong enough to basically have apportion of its capital structure allocated to a less expensive form of capital which is the debt and if we could come through what our fiscal 2009 was and still generate almost $200 million in operating income, the logical question would be why wouldn't you have some leverage and that's certainly what we went out and did, so the real answer to the question is that the debt is a cheaper form of financing than the equity.

I guess my question is whether you're going to buyback stock, that's all.

Oh, yes.

It will certainly come under consideration now that it appears we've cleared through the worst of the down cycle and we'll be certainly talking about that in the coming days.

We have an active authorization available to go back and it's probably high time we go back and examine that question.

Okay, thanks Mark.

Our next question comes from Jim Covello of Goldman Sachs.

Hi, this is Kate for Jim Covello.

I had a quick question object activity that you guys are seeing in the memory side.

I know you had talked about orders still being driven by technology transitions for the most part.

I was curious what your conversations with customers are like now about potential capacity additions, particularly given some of the shortages we're seeing both on the DRAM and NAND side today?

Sure I think that the way I'd characterize the memory players is that they're all still a little bit thankful to be in a position where they're generating cash but not confident enough yet, to be adding significant capacity, so you seen spot prices come up, they're cash positive but being pretty conservative in terms of their investments and most of it has been focused on technology as opposed to capacity and maybe converting some of the existing capacity to new technology nodes.

So I think that just like everyone they're waiting to see how real these trends are and there's some particular drivers for memory that are going to be important to watch, two that come to mind immediately are the new Operating System just released from Microsoft, is that a part of the PC reinvestment cycle and the other one is associated with NAND, is there another stimulus and driver for NAND capacity so I think both of those things is early to call and I haven't seen a lot of discussion about new capacity investment across the memory front, as we said it's probably more conversion.

In order for this to turn into a full blown recovery though we will need to see memory investing at a more healthy rate and the way we're modeling that is that doesn't happen until later in 2010.

That's really helpful and then maybe just more of a housekeeping question.

I just wanted to understand the one-time gain a little bit better.

Was there a one-time gain both in the tax item and then also in other income or is there just one item for the quarter?

It's one item and an unusual phenomenon that happens to taxes but it's not one-time.

So there was one item in other income which was that we resolved a consumption tax contingency which was in an international location that added about $16 million of favorability through the other income line.

That is one-time in the sense that it doesn't recur every quarter and the tax line our rate was unusually low this quarter but part of the reason that it's low right now is that the aggregate earnings aren't very big so a small phenomenon that maybe unique to the quarter can swing it quite a bit and the phenomenon that did swing it is that the investments that are in our deferred compensation plan increased during the quarter and they are non-deductible so as a result we got a tax break as a result.

That will happen once in a while because the investments do swing up and down so although it was lower than our modeled rate I wouldn't describe it as one-time.

Okay, so the item you guys referenced in the press release was referring to that $16 million in the other income line?

That's right.

Okay, great.

Thank you.

That's it for me.

Your next question comes from Satya Kumar from Credit Suisse.

If I look at your memory exposure versus your peers there's a clear discrepancy with you being a lot lower than say someone like a LAN or SML, and your exposure a lot like the foundry, foundries are adding both capacity and shrinking memory is a bit more of the shrink I thought you were more exposed to shrinks and capacity.

What sort of explains that maybe you can help by giving us your outlook for orders by type and December quarter that better helps us to understand that?

Sure, Satya.

We see memory going up, I think we ended as we said about 13% and we're modeling in the 20, 25% range for memory for the December so we do see it increasing and I think that's equally split for us the way we view it right now between NAND and Flash or NAND Flash and DRAM, so we're seeing some exposure.

I think I mentioned earlier on the question I got regarding this that it does look as though the customers are in the early stages of some of the advanced technology and we expect that they are going to hit speed bumps relative to yield ramp and that's when we would expect to see intensity increase for the memory guys.

Okay, a couple of quick follow-ups, on gross margin how should we think about incremental gross margins going forward and on lead times, you're guiding revenue substantially below your bookings run rate of September.

Are your lead times stretching out for any of the products that you make?

I know it's different for different products but I was wondering if you could add some color around that.

I'll give an initial thought and let Mark follow-up.

Incremental gross margin we're modeling 60, 70% as we go forward.

We feel good about that and we've got a lot of programs going inside to support that and I think in terms of lead times, part of this is we have seen a relatively aggressive snapback in terms of orders of what we saw last quarter and as a result we do have some push outs and you're right, it is somewhat product dependent and of course we work closely with our customers to manage their delivery requirements for that, but there is some stress in terms of getting -- making shipments given the recent activity we've seen.

Thank you.

Your next question comes from Krish Sankar with Banc of America-Merrill Lynch.

Thanks for taking my question.

Rick, I had two questions.

One is if I look at your bookings guidance clearly nice jump in bookings and at a flat guidance you're probably about a third to 40 person below the last peak in other words, I'm trying to understand, for the bookings to move higher from here do we need memory to come back or can foundry and logic alone take it from here?

Yes, we need memory to come back.

We also don't have much activity in some of the other plays we have.

For example, we sell to the wafer manufacturers and they have been very modest in terms of their overall investment level, so we definitely need to see that sector.

The sector that did turn on last quarter is the reticle sector which had been very dormant for a while and so we got one of the legs back with the engine but it's true Memory is still not on and the wafer manufacturers are not on so we need to see those guys kick in.

Got it and just a follow-up, in terms of your migration to Singapore and margin upside from that, clearly I guess you're seeing a pretty good jump in revenues in December.

At what revenue level do you think we'll start seeing gross margin kicker coming in because of the manufacturing transition?

I'll take a pass and then Mark wants to add to it.

Singapore doesn't manufacture all our products.

It's somewhat product dependent and some of the order activity we've seen that we don't break out by product line, we have a mix of those products and I would say it hasn't emphasized the products that are in Singapore so we would need to see a broader based recovery for the Singapore aspect of the operation but I would also say that we've made operational improvements in all our manufacturing sites as we've gone through this downturn so that's why we can support the incremental operating margin of 50 to 60% as we go forward which gives us higher leverage than we've had in previous cycles at the same revenue level.

Yes, I would just add to that that Singapore -- getting Singapore up to full capacity is contemplated in both our incremental gross margin and our incremental operating margin leverage equation.

It is not there yet but it is anticipated and contemplated in those numbers.

Got it.

Thank you.

Next question comes from Gary Hsueh with Oppenheimer.

Hi, thanks for taking my question.

If I look at your guidance for orders being kind of flattish but still the reticle inspection having a pretty massive come back here to the $100 million level, is your guidance basically for reticle inspection to kind of subside back down without more meaningful contribution from the memory guys?

Is it really more of a reticle inspection driven sort of guidance here in terms of your order number for the December quarter?

And then I have a follow-up.

Gary you're paying attention.

Yes, exactly that.

So I think you might know our process, when bringing on a new product we can only take orders on that when we reach a certain point in our product development cycle and we have the customer agreements to support it so there's a process we go through.

Reticle having a new product introduction we did see an initial as you said very strong level of business for the reticle side and while we expect reticle to continue to do well, the $100 million that you referred to annualized, we won't see that level for reticle until we're in a full blown recovery and we don't believe we're at a full blown recovery so exactly right how you characterized it.

Okay, and congratulations on the success of rolling that 193-nanometer light source reticle inspection tool out.

Given the fact that it's a relatively new tool should we expect this reticle inspection tool to layer or add-on to the P&L at above the 60 to 70% incremental gross margin kind of follow through like most of your reticle inspection tools or will the first batch of reticle inspection tools given the fact they're relatively new in the product development cycle do they come with a little bit lower drop through?

Thanks.

Yes, Gary, as you know we don't break out the product, specific products but I can tell you that we have certainly contemplated all the new products that we've introduced as we talk about our incremental operating margin and incremental gross margin and clearly reticle is a product we've been counting on and talking about being in development for some time so it will support our 50 to 60% incremental operating margin story and gross margin story as well.

Thank you.

Your next question comes from Raj Seth of Cowen & Co.

Mark, both you and Rick have referenced higher margins on revenues versus last cycle, I wonder if maybe you could detail that a little bit at 500, 600, 700, what was the model, what do you think the model moves to?

The easiest thing to do, Raj, is to pencil out from where we were in the last model which we basically had an operating margin of 19% when we got quarterly revenue run rates of about $500 million.

We think we'll do a little bit better than that in this cycle and if you can pencil out from here where we are to date and use an incremental gross margin of 60 to 70%, a point along that line and you can use an incremental operating margin of 50 to 60% and you pencil that out I think you'll see that we probably do have some more earnings power in this model.

I always issue the caveat that of course it will depend on exact composition of the revenue mix as we reescalate but we've modeled this under a variety of different scenarios and most of the scenarios suggest that you get more earnings power out of this than you've got out of the last time we had the model published.

And at 500 should I assume something on the order of 165 OpEx per your earlier comment about some of the comp related costs coming back?

I don't know about that.

It might be easier to say if you had a fully loaded OpEx meeting with all of the compensation costs coming back in and then you leverage that at 50 to 60% comp, that may be a little bit more accurate way to do it because we are feathering in those cost reduction, the temporary cost reduction actions as we go back up, but the reality is we think 165 would be today's outcome with all of the cuts fully restored at today's headcount levels.

So you can sort of draw a linear line from there.

I would say headcount wouldn't remain exactly flat but we were hoping it wouldn't go up radically from there.

And if I might a quick follow-up on the reticle business.

Rick what actually are the drivers there?

Clearly you got a new product out, there's initial investment for people that need to build early capacity to support I suppose 32.

Is that starts driven or what ultimately drives other than that new product introduction, the cycle in reticle that you're hoping to see as you move forward at some point?

Maybe not so much start.

Well it depends.

New designs is really what drives it, Raj, new take outs, new designs, and a pretty long gap in terms of investment by some of these guys, and also an early look at advanced technologies.

Historically when we've introduced new reticle platforms we've done pretty well with them because there's pent-up demand for the new capability.

Have you seen any pick up other than that pop from the new product?

Well, yes.

I mean the rest of the business we saw increase as well so if you do the math on it you can see reticle was up and partly why we exceeded I think above the range is we did see increasing strength in reticle but also we saw just foundry related investment associated with the ramp that's going on there.

Okay, great.

Thanks.

The next question comes from Stephen Chin of UBS.

Great, thanks, hi Rick and Mark.

Nice execution at these foundry customers.

Any way you can estimate how much market share you think you've taken at the foundry customers and you believe it's most are in reticle inspection and brightfield products or other products and I have a follow-up question.

Yes, so the way we look at share, we measure it all the time but I think it's awfully noisy so I like to aggregate it over a few quarters and I was just looking at some estimates we have for 2009 and it looks remarkably similar to what we've seen in the past, Stephen, in terms of overall share story, pretty much across the product line and I'll say what is different in this phase of the cycle is certain products are more emphasized at different phases and this being more technology oriented tends to favor more the products that are more about early phase characterization and development and reticle had its own dynamics based on the new product introduction but clearly brightfield was strong for us as well.

There just wasn't as much activity in some of the other historically strong product lines for us so it was favored by those but not so much because of the share as it was just where they were in the cycle.

Does that make sense?

That's helpful, thanks, Rick, and the second question I had is could you share your latest thinking on 2010 industry capital spending, year-over-year and how you see the linearity of the CapEx spend across the first half of the year versus the second half of the year for the industry perhaps playing out?

Sure, and I think we're also good at doing it last year that we should be confident in next year as well.

It's really hard as you know to forecast this stuff, Stephen, so we're looking at right now our estimates for the year for 2010, when we look at the analyst estimates, the broad range of industry watchers and you guys, we're modeling in a 35 to 45% increase in CapEx for 2010, but that is obviously contingent on many factors, not the least of which is that memory returns to some kind of increased investment level because we can't get there without memory, but as we said the foundry and logic just wouldn't be enough to sustain that but more important to us than specifically what the overall levels are is just how we're positioned across each one of the sectors so we probably spend more time working on that than we do worrying about absolute numbers because we've been able to respond in either direction but historically we're pretty confident we can in this cycle as well.

If it does pick up and go faster then we'll be able to support it.

Thanks, Rick.

You bet.

The next question comes from Patrick Ho of Stifel Nicolaus.

Hi, this is Mary in for Patrick Ho.

Thank you for taking my question.

First one is in terms of the business model, now that you're profitable how much of the temporary costs that you have already taken are coming back?

Yes, well, Mary, this is Mark, as I described we actually began feathering in some of those costs this quarter.

We added $8 million of expenses this quarter again relative to what we experienced in the prior quarter in contemplation that we will be adding back some variable compensation this year, but that's only a step towards what we would say would be the final destination.

This quarter we incurred about $153 million worth of operating expenses when we feathered them all back in we'll probably have a cost structure with today's headcount levels of about $165 million which is $12 million ahead so if you want to use very loose math we're about 40% of the way to feathering everything back in.

Okay.

Great, and a follow-up.

Given that demand has picked up, can you comment maybe on your suppliers and if you are seeing component shortages or any tightness in the supply chain and if so how are you addressing it?

Yes, we work closely with our suppliers and have throughout the cycle.

I think fortunate for us, we didn't go down as far as many others in our peer group so I think we're pretty well positioned to handle it but I say that and I know our procurement group has been working awfully hard to make that true but we feel very confident of our ability to meet the ramp that we're seeing.

That's helpful, thank you.

The next question is a follow-up from Timothy Arcuri with Citigroup.

Hi, just to clarify, you guided gross margin up just slightly, yet revenue is growing over $100 million.

I'm wondering are there some one-timers that you're not seeing margin leverage in December?

No.

We should get margin leverage but we're coming off of a margin that's about 51.5%, we would guide it up slightly and again if you use our stated model of incremental gross margin leverage of 60 to 70% and you pencil that out against our revenue guide, that would be a reasonable expectation for margins in the next quarter which would be I don't know, potentially 2 to 3 percentage points up.

Okay, thank you.

So maybe it's the word, Slightly.

That's still a decent improvement.

Okay, thank you.

The next question comes from Mahesh Sanganeria with RBC Capital Markets.

Thank you.

Another question on reticle inspection.

Considering this order was for a new product, was it an evaluation tool which you recognized revenue in the current quarter too?

No.

No.

Okay.

And so is the lead time still staying in the nine months kind of range for the reticle inspection tools?

Well so you can imagine that we've been working on reticle tools and to some degree they aren't all made to build based on the order so as we're bringing on new product we've been in the investment phase for our reticle which means building initial tools prior to necessarily having customers lined up so obviously, we have a number of tools we can ship but yes, if you ordered new one today then we haven't been talking then the lead time certainly takes a while to produce these tools.

Does that make sense?

Yes, that makes sense.

Okay, thank you.

Your next question comes from Atif Malik with Morgan Stanley.

Hi, thanks for taking my question.

In your non-semi business, LED, data storage, is there anything still in there that could materially upside on the top line for next year?

We hope so.

I mean, we seen some good penetration in some of these markets and we think that there's good growth but again as you know, they're coming off of relatively small numbers so on a relative basis compared with what can happen on the IC business, it's going to be hard to see it but we do see steady growth and growth that's faster than industry average just where these new spaces are, so yes, we do see exciting prospects.

We had pretty good progress quarter on quarter.

We were up pretty good in our non-semi and we anticipate another good bump in the December quarter off of non-semi.

Can you comment on your appetite for acquisition in those segments or any other segments or do you think you're in good shape for a while?

I think that's right.

I think we're in good shape for a while and I am pleased with the position we have with the acquisitions that we've done.

We're almost through all of the integration of those efforts and there's still a little bit more work to do but we're pretty pleased with our platform and we think that we've got enough growth engines to move forward and execute on our long term strategic plans with the products that we have in house today.

Thanks.

Your final question comes from [Jaggadesh Ayer] with RT Research.

Hi, thanks for taking my question, two questions, Rick.

One is big picture question.

How should we think about the process controlled market overall for 2010 given that there is strong technology reflections for memory as well as challenges at 40 and 45-nanometer and the second question is that on your order guidance for December, I just want to understand, that is the disconnect for the major foundry customers still have a decent amount of CapEx left in the fourth quarter and your guidance seems to be just flat plus or minus 10 so just maybe all you need to consider to understand the dynamics here?

Thanks.

Sure, yes, so the first question was 2010.

So if you model industry growth CapEx at 35 to 45 for calendar '10, our expectation is we would outperform that and our stated goal is to outgrow the industry by 5%.

Based on all of the analysis that we've done today we think that is still achievable and that's what we're shooting for, so while we don't know what the overall growth will be for the year, we do believe we're positioned to outgrow the industry.

Relative to December and the guides being flat it is true we're flat.

We're also flat off of a guide or performance that we're up 50% so part of that was a phenomenon associated with the new product and the reticle product as we broke out segments and reticle, we had over $100 million of business.

Now we don't believe that that is a $400 million business in this current market environment so part of the effect that we had was a new product effect, so while we do see reticle being strong we don't think it will remain at that level until we're in a full blown recovery so we see increases in the other parts of the business that will offset getting to a more normalized level for reticle but the net of all that is we end up with a picture that looks like flat plus or minus on a range.

Okay, thank you.

This concludes the Q&A portion of today's conference.

I will now turn the call back over to Mr.

Ed Lockwood for closing remarks.

Thank you, Operator and thank you all for joining us today.

We look forward to seeing you throughout the quarter and please join us again for our next call.

This concludes our conference call for today.

Thank you.

This concludes your conference.

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