科磊 (KLAC) 2014 Q3 法說會逐字稿

Good afternoon.

My name is Jamie.

I will be your conference operator today.

At this time I would like to welcome everyone to the third quarter FY14 earnings call.

(Operator Instructions)

Ed Lockwood, with KLA-Tencor Investor Relations, you may begin your conference.

Thank you Jamie.

Good afternoon everyone and welcome to our conference call.

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

We're here to discuss third quarter results for the period ended March 31st, 2014.

We released these results this afternoon at 1:15 PM pacific time.

If you haven't seen the release you can find it on our website at www.kla-tencor.com, or call 408-875-3000 to request a copy.

A simulcast of this call will be accessible on demand following its completion on the Investor Relations section of our website.

This quarter we prepared a brief slide presentation to supplement this earnings call, and those slides can also be found on KLA-Tencor's Investor Relations website.

There you will also find a calendar of future investor events, presentations and conferences as well as links to KLA-Tencor's SEC filings including our annual report on Form 10-K for the year ended June 30, 2013, and our subsequently filed 10-Q reports.

In those filings you will find descriptions of risk factors that could impact our future results.

As you know our future results are subject to risks.

Any forward-looking statements including those we make on this call today are subject to those risks, and KLA-Tencor cannot guarantee those forward-looking statements will come true.

Our actual results may differ significantly from those projected in our forward-looking results.

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 2013 Form 10-K and our subsequently filed quarterly reports on Form 10-Q and current reports on Form 8-K.

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

However, any updates we do provide will be broadly disseminated and available over the web.

With that I will turn the call over to Rick.

Thanks, Ed.

I will begin with an overview of the key developments during the quarter, followed by our perspective on the current demand picture and the industry CapEx outlook for 2014, and then guidance for the June quarter.

I will then turn the call over to Bren for his financial commentary.

KLA-Tencor delivered another solid quarter in Q3 FY14 benefiting from our market leadership and solid operational execution.

Revenue in Q3 was in the upper half of guidance at $832 million.

Gross margin was 59% at the upper end of the guided range, and earnings per share also finished above the range of guidance at $1.23 per share.

KLA-Tencor's strategic objectives are focused on achieving superior long-term growth and market leadership while delivering sustained operational excellence with the ultimate goal of delivering industry leading products to our customers and superior returns to our shareholders.

Our financial results for Q3 demonstrate continued strong execution against these strategic objectives.

Now for some perspective on the current demand environment.

New orders for March were $702 million finishing at the low end of the guided range for the quarter as bookings from foundry and logic customers fell below their original forecast for the quarter.

KLA-Tencor bookings result in Q3 is consistent with the widely reported slowdown in leading edge logic demand seen in the industry today as customers have delayed plans for additional production capacity for 20 nanometers on a strong initial ramp.

In the significant yield challenges the market leaders have encountered in early development of the 16-, 14-, and 10- nanometer nodes have created uncertainty over timing of these transitions and calendar year 2014.

For KLA-Tencor 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.

Now in logic and foundry, with the introduction of the new 3-D gate architectures, the yield issues our customers are grappling with today are proving to be the most challenging that the industry has ever faced, and even the smallest variation and process margin can cause significant yield losses for these devices.

Some of the issues of these process margin people are dealing with are CD dimensional changes, Fin height control, process challenges, such as difficulty in optimizing implant recipes, and then there are unique defect issues associated with new CMP steps, new etch steps that are all part of the FinFET process.

And that's just a small sampling of the complex technical challenge that is associated with bringing new 3-D device architectures to market.

So the market leader in process control, we're work closely with customers to resolve these issues but there is a steep learning curve, and there's questions over the timing and resolutions of these yield issues, and that has resulted in uncertainty and delaying plans for the ramping of FinFET technology.

And an uncertainty associated with the resumption of these programs.

Now, in memory the market leaders continue to demonstrate a commitment to pushing CapEx investment in both DRAM and NAND.

However, they're also facing similar challenges to logic when they deal with their leading edge complexity in phase one of the new China NAND fab, but there's uncertainty over the timing of follow-on production for 3-D NAND.

And there's an expected volume of planar NAND capacity for the industry that's clouding near-term forecast.

Finally, in DRAM, customers are continuing steady pace of investment in technology transitions in 2014 with the market leader currently ramping 20-nanometer conversion.

And various other conversion projects are underway as major players continue to invest in this market.

However, we think these projects are sufficient to meet the bit supply requirements for 2014.

So turning now to our industry outlook for the remainder of 2014, it's clear from our discussions with customers that despite near-term slowdown in demand their intentions are to continue to execute their strategies for growth at the leading edge and invest at high level to achieve and advance their competitive road maps.

But it is also clear that issues related to leading edge device yields and high concentration of demand across a consolidated customer base and uncertainty over the timing of follow-on capacities have introduced a degree of variability into our quarterly demand forecast and have made visibility into our customer production plans extremely challenging today.

While we acknowledge it is still early in the year, but given all the challenges forecast and the challenges associated with booking out through the rest of the year, we are adopting a slightly more conservative view of CapEx for 2014, and we're now modeling industry growth at about 5% for the year, with the up-side hinging on order momentum resuming across a broader base of customers in sub-20 nanometer foundry and in 3-D NAND.

The rapid advance in chip complexity brings enormous challenges to leading edge chip designers and it fuels the growth for KLA-Tencor.

And although the cost complexity and time to market pressures of technology changes have always been a driver for process control market adoption, the transition to 3-D structures and the introduction of the new multi-patterning technique is a significant change in terms of device cost and complexity and is proving to be extremely challenging for all of our customers.

So in this environment the long-term outlook for process control continues to be very favorable.

And as advance process control solutions are going to be essential for our customers' success now and well into the future.

So this obviously plays to our strength as the market leader in process control.

So in conclusion we're pleased with the results of the quarter, but we're adopting a more cautious approach in the near-term outlook.

We remain focused on continuing our market leadership and optimizing value for our shareholders in 2014 and beyond.

Now turning to guidance for the June quarter, bookings are expected to be in the range of $625 million to $825 million.

Revenue for the quarter is expected to be between $700 million and $760 million, with non-GAAP earnings in the range of $0.75 to 0.95 per share.

With that I will turn the call over to Bren.

Thanks Rick and good afternoon everyone.

My remarks today will focus on highlights of the financial results for Q3 and my perspective on current trends in the marketplace and our business model.

As Ed previously noted, beginning this quarter we will post a slide presentation with additional financial data and key operating metrics to supplement my commentary.

Will you find this information posted along with our press release in the Investor Relations section of the KLA-Tencor website.

On to the results for the third quarter FY14.

Revenue for Q3 was $832 million, $12 million above the midpoint of the range of guidance, and fully diluted GAAP earnings per share were $1.21.

Non-GAAP earnings per share finished the quarter above the guided range at $1.23 per share, applying effective tax rate of 19% resulting from a number of factors including a higher mix of offshore income and the release of certain tax reserves.

Non-GAAP earnings would have been $1.17 or $0.07 above the midpoint of guidance at our modeled non-GAAP tax rate of 23%.

In our press release and in our supplemental financial data accompanying our results you will find a GAAP to non-GAAP reconciliation of the $0.02 difference in EPS.

My comments on the quarter will be focused on the non-GAAP results, which exclude the adjustments covered in the press release.

New orders in Q3 were $702 million finishing at the low end of the guided bookings range for the quarter.

As Rick mentioned, we are currently experiencing a slowdown in leading edge demand.

We are encouraged by the adoption by customers of our high-end inspection of metrology products in navigating these significant process transitions.

As in fact, today we are positioned to achieve record bookings for both our wafer inspection and thin film critical dimension product for the full year and FY14.

Therefore we believe the weakening demand in both the foundry and logic segments is a near-term episode with our current expectation for stronger order momentum to resume in the second half of the calendar year.

Turning now to our customer segment commentary for the March quarter, foundry demand was 56% of new orders for Q3, consistent with our expectation as a percentage of the overall mix of orders, but lower in terms of absolute dollars compared with December and our original forecast.

Foundry orders were weaker than expected in Q3, as one large customer scaled back demand for 20-nanometer investment and another customer delayed leading edge capacity plans.

We believe the near-term foundry push-outs are largely a timing issue with 20-nanometers, as well as at sub-20 nanometer node transition where our customers are grappling with significant yield issues from process immaturity in the early stages of 3-D device development.

We expect to see foundry order growth in the second half of calendar 2014 with strong customer acceptance of our latest generation products driving demand.

Memory was 23% of new system orders in March, and down sequentially in absolute dollars from the prior quarter as expected.

We believe activity to support phase 1 of the new China-based NAND project is now largely complete.

All systems shipped by KLA-Tencor are installed currently being used in production.

Memory customer investment remains focused on 3-D technology development and new capacity in NAND and technology upgrades in DRAM.

We see memory orders increasing in the second half of 2014 with the timing of tool deliveries for phase 2 of the China NAND project the swing factor in the period.

Logic was 21% of new orders, in line with the original forecast.

Investment by our customers at 20 nanometer and below constituted roughly 63% of the orders we received in the March quarter.

Turning now to the distribution of orders by product group, wafer inspection was approximately 46%.

Reticle inspection was approximately 13%.

Metrology was approximately 15% of new orders.

And service was approximately 23%.

Storage, high brightness LED and other non-semi was approximately 3%.

Total shipments in the quarter were $731 million and below the midpoint of guided range of $720 million to $780 million for the quarter, as delivery timing for some orders shifted into the June quarter.

Push-outs of customer delivery requirements from the first half into the second half of 2014, related to sub-20 nanometer projects and leading-edge foundry and delays in NAND capacity additions, have contributed to a lower than expected shipment profile over the next six months.

June quarter shipments are expected to be in the range of $700 million to $760 million.

In total we ended the quarter with just over $1.1 billion of total backlog, comprised of $787 million of shipment backlog, orders that have not yet shipped to customers and expect to ship over next six months, and $308 million of revenue backlog for products that have been shipped and invoiced, but have not yet been signed off by customers.

Turning to the income statement, revenue for the quarter was $832 million, up 18% sequentially and in line with guidance.

Revenue growth in March reflects strong customer acceptance of new products.

Gross margin was 59%, down 80 basis points compared with the December quarter, but at the upper end of guidance largely due to lower installation, warranty and retrofit costs than had originally modeled in January.

Product mix was in line with expectation.

Incremental gross margins were 55%, slightly better than what was modeled for the quarter.

We expect gross margin to be in the range of 57% to 58% in the June quarter due to lower revenue volume and flat factory output.

Total operating expenses were $226 million, down slightly from December quarter and in line with the guidance range of $225 million to $230 million.

We are continuing to size the company's quarterly operating expenses in the $225 million to $230 million range, and expect it to remain in this range for the next few quarters.

Timing of product development investments will lead to some fluctuation within this range quarter-to-quarter.

Tax rate was19% in the quarter, below the 23% planning rate.

At the 23% guided tax rate for the quarter, non-GAAP earnings per share would have been $1.17.

Going forward you should continue to use the long-term planning rate of 23% for modeling purposes.

Finally, net income was $206 million, or $1.23 per fully diluted share.

I will turn now to the balance sheet and cash flow statement.

Cash and investments into the quarter at just over $3 billion, an increase of $76 million versus the December quarter.

Cash from operations was $238 million in the quarter, up $123 million sequentially and free cash flow was $220 million.

In the quarter we paid a dividend of $75 million and repurchased $60 million of stock at an average price of $64.41.

As of March 31st we had approximately 3 million shares available for repurchase under our current authorization.

Fully diluted shares ended the quarter just over 168 million and are expected to remain roughly flat for the June quarter.

Finally, although the equipment industry is currently experiencing a near-term reduced level of demand with uncertainty over the timing of orders, the long-term drivers for growth remain strong, as we expect the yield challenges associated with multi-patterning and FinFET to drive investments and process control by foundry and logic customers, and with our memory customers demonstrating the strong appetite for investment in 3-D NAND CapEx and 20 nanometer DRAM.

We remain focused on executing our long-term strategy, enabling customers' success in increasingly more complex industry and technical environment.

With that, to reiterate our guidance for quarter is, bookings are expected to be within a range of $625 million to $825 million, revenue between $700 million and $760 million, EPS of $0.75 to $0.95 per share.

This concludes our remarks on the quarter.

I will now turn the call back over to Ed to begin the Q and A.

Thank you, Bren.

At this point we would like to open the call up to questions.

We do once again request that you limit yourself to one question and one follow-up, given the limited time we have for today's call.

Feel free to re-queue for your follow-up questions and we'll do our best to give everyone a chance for further questions if today's call time permits.

Jamie, we're ready for your first question.

(Operator Instructions)

And your first question comes from the line of C.J. Muse with ISI Group.

Your line is open.

Great.

Good afternoon.

Thank you for taking my question.

I guess first question, you guys are kind of in the cat bird seat in terms of the issues that your key customers are facing.

I'm intrigued by your commentary about expectations for recovery in the second half.

So curious, given the work that you do on yield excursions how you're helping your customers solve these problems, what's giving you that confidence that we will indeed see the recovery either Q3 or Q4?

C J, good to hear you again.

This is Rick.

Let me kind of give a backdrop.

I think that the 3-D work people are doing, whether it be FinFET or 3-D NAND has been more challenging than our customers expected.

And I think that, that slowed down momentum as we came into the first part of this year.

That said, there's a lot of hard work going on.

We're working closely with customers across all major process technologies and they're certainly expressing a strong desire to get these problems behind them and resume their investment.

But until they do that, we don't see it happening.

So there is some progress at the very leading edge.

People are making some progress.

But I think it is going to take longer than was originally anticipated.

And as you know, we can't really forecast on a yearly basis but we do see some pausing now and expectations we will see resumed investment toward the end of the year.

Maybe Bren can comment on some of the numbers around that.

C.J., as we look out right now, certainly over the course of the last part of the March quarter we did see a fair amount of churn with our customers in terms of capacity planning, really driven by some of the challenges associated with these technology transitions both in NAND and the foundry and logic side.

So, as we have worked through these plans and started to think about factory loading in terms of delivery dates and so on, I think we feel like will be able to make some progress on this and we'll see some recovery in the order momentum certainly around foundry and logic in the second half of the year.

I think one of the upside factors in that relative to our more conservative outlook is that we would see broader base participation in sub-20-nanometer work in the second half of the year.

And I think if we see broader participation beyond the leaders, then that could be something that could be a swing factor as we look at the second half of the year.

But right now as we look at it, second half looks like it is probably up somewhere between 10% and 15% from an order perspective versus the first half of the year but we will to have see what it looks like when we get there.

As I said, there's been a fair amount of noise over the last month or so.

So it certainly has us operating a little bit more cautiously as we look at it.

That's helpful.

If I could ask a quick follow-up, now that we are a bit into the vertical NAND movement, I'm curious if there's sort of any update on your thoughts around process control intensity?

Whether we are, in fact, seeing that kind of 180 bips kind of an increase and where you are seeing that within your business?

We do see a lot of interest but I think it is still very early in the 3-D NAND, and there are some serious concerns about getting yielding processes that are economical from the manufacturer.

So I think this is the case where there's been a bet on technology.

It's not yet proven in terms of the leaders or the people that are behind them, that it is technically viable on an economic basis so that you can get both the yield and the performance you need to make it make sense.

So we actually see some degree of pause around that, and that's why I think that when Bren gets to the forecast for the year, part of the swing factor is what happens late in the year based on what has happened early in the year.

So there is some struggle.

We do see some intensity but there are definitely some concerns about just getting the overall process to perform as expected from a yield perspective.

Does that make sense, C.J?

It does.

Okay, thanks.

Your next question comes from Harlan Sur with JP Morgan.

Your line is open.

Hi.

This is [Saca Javeev] on behalf of Harlan Sur.

Last call you mentioned some weakness of slight delay in 28-nanometer (inaudible) capacity at foundry customers.

We have heard 28-nanometer (inaudible) starting to pick up meaningfully for shipment in second half of this year.

Are you guys anticipating that some of the foundry order activity near term is 28-nanometer driven, or is it all 20-nanometer and 16-nanometer (inaudible)?

Yes, this is Bren.

We did see some pickup in activity around 28.

It was minimal.

One thing about a maturing node is we tend to see less process control intensity as the node matures.

We did see some activity.

We're kind of waiting for that for the last quarter or so.

It wasn't as much as we expected, but we did see some there.

But I think as we look forward, I see, at least over the course of this year, probably somewhere between 60% and 70% of what I expect to see in the foundry to be 16/14 centric.

Very little 28, although there's probably going to be some, but most of it focused on 16/14 through the rest of the calendar year.

Okay, got it.

And a quick follow-up.

Any updates on the large inspection for 10-nanometer development that pushed out to first half of calendar 2014?

Shall we still expect revenue thru (inaudible) 2015 time frame?

There was no change really in that plan.

We actually ended up booking two of those systems in the March quarter and booked a third system about a week ago.

So those are in backlog now but they won't ship until the early part of 2015.

So it does put a little bit of pressure on revenue through the second half of the year because that's backlog that's going to sit for a little while.

But given the customer we think it's very solid backlog, and very consistent with our agreement with them in terms of lead time.

So we expect those tools to ship in the early part of 2015.

Thank you.

Your next question comes from John Pitzer with Credit Suisse.

Your line is open.

Hi, this is Farhan asking a question on behalf of John.

I just want to understand what are your expectations in terms of the mix for bookings in the June quarter which as you expect bookings to come from with regards to foundry versus logic versus memory?

Right.

Let me take a look at that for you.

So looks like foundry is about 71% of June's orders.

Logic is 13%, and memory at 15%.

And of the memory mix, 37% of that is NAND flash.

So back to after three fairly significant quarters from June through December of memory business, we're seeing something more similar to the 70/30ish mix going forward through here into 2014.

In terms of the memory, it seems to be a pretty significant drop in your order intake, and I just wonder how much is inspection specific and how much is industry specific?

I think around, certainly NAND flash weakness was something I think that was probably more industry specific.

From a DRAM perspective we expected memory to be down in the quarter, and it was relatively consistent with our expectations I think around some of the conversion activity.

Our level of participation, given the lower process control intensity, on memory, was lower.

And so with that level of activity out there, it was, there was a piece of that, that we obviously didn't participate in.

So it was about in line with what we were thinking through the March quarter.

Thank you.

That's all I had.

Your next question comes from Timothy Arcuri with Cowen and Company.

Your line is open.

Thanks a lot.

Bren, last quarter I asked you the same question.

Given that the shipment guidance for June is 100 million lower than what we thought it would be maybe three or so months ago, can you maybe hold our hand on what the September quarter shipment number is going to be relative to the June number?

Yes, so the shipment number primarily is lower because the bookings number, the midpoint of bookings was about 800.

We came in at 700.

So there were some orders there that we were expecting to ship that didn't materialize.

Back then we thought that shipments would be in excess of 800.

It's where we are now at the 730 midpoint.

As I said in the prepared comments I think as we continue here I think September is flattish, so without guiding it, as I look at it now, given the expectations around bookings in the June quarter and how those will flow through in terms of impacting shipments in September, I see sort of a flattish profile over the next six months if you will, with it picking back up in the December quarter.

Okay.

Thanks.

And then there was another one of your peers not in competition with you, but another company in your space that reported last night that has results that are significantly different than yours.

And it seems like they're being really uniquely helped by some of the multi-pass steps in DRAM.

And I'm wondering if there's any sort of prospective benefit that you might get from the explosion in multi-pass steps in DRAM as you go down to 20-nanometer.

Thanks.

Well, we definitely see an increased intensity in memory as you scale.

And we laid that out at Semicon West, and we're continuing to see that trend play out.

So we do see increased intensity both in memory, either NAND or DRAM as you scale.

So we have seen that.

That continues to hold.

And to the extent of the investment continuing we'll continue to see that penetration off of our growth.

But as we said before overall the intensity in memory is lower for process control than it is in foundry or logic.

Okay, thanks.

Your next question comes from Romit Shah with Nomura.

Your line is open.

Thanks and I apologize I'm just jumping on here a little bit late.

I wanted to ask you about the Samsung Global foundries partnership.

It seems like in the past the foundry space has become very competitive leading to multiple pilot-line projects but more recently we're seeing evidence of collaboration.

I wanted to understand from your perspective, how that might impact the total investment for FinFET looking out over the next one to two years?

Thank you.

This is Rick.

I think that consolidation has kind of two functions, from my perspective.

One is, it is a counter balance to the increasing cost of development that everybody is dealing with, which is why, of course, people are driving that direction.

The other thing that it certainly has done is created a much more rational market in terms of driving demand.

So [you have our] customers are more careful, and you don't have multiple lines competing for the same business.

So the other side of it would be if you had multiple players of FinFET all competing for the same end customer user business, then what you result in is you do a lot of development and build up the tabs but you can't fill them.

So this rationalization actually makes the business more predictable long term and is a natural consequence of increasing complexity and cost.

So from a planning perspective we generally favor it.

What it does mean is that you won't see as many spikes in demand but as we know from the past those are often met by crashes once the capacity gets on line and there's not a market for it.

So overall, I think it's the reality, I think that it is not a surprise.

The increasing intensity of the process control makes that a lot of opportunities for us.

I just think what it does is reduce the volatility but in the end it is probably the same aggregated investment gets rationalized over time.

Do you expect to see more collaboration as well?

Well, I think you're down almost -- you're not quite to a prime number of players but you're getting close.

There aren't that many people left who are doing advanced development on 1x design.

I think that as you go forward that you're pretty much down to a handful.

And in both memory and in logic.

I don't think there's a lot more room for consolidation across that.

There are industry consortiums where people do pretty competitive work that have been going on for awhile that provides some very front-end but still when it comes to process integration I think you're down to a handful at this point.

Okay.

Thanks a lot.

Appreciate it.

You bet.

Your next question comes from Weston Twigg with Pacific Crest Securities.

Your line is open.

Hi.

I was just wondering if maybe we could look ahead into 2015 if somehow yields get back on track for FinFET and 3-D NAND and we do end up with maybe a 5% up CapEx year like you are predicting.

What do you think demand could grow in to 2015?

What kind of percentage increase due think could happen?

Wes, it's Bren.

I don't know if we want to, if we can size it.

I think when you think about these transitions and how compelling they are I think, from an end-market perspective, I think that some of the noise around how big 2014 is, there's some of these rather significant projects actually start to shift into next year.

So, I think the way we're looking at it is, given the strength of these transitions, I think the commitment from our customers towards them, from the leading customers to the secondary customers, I think everyone is very focused, I think, on investing to stay competitive in the business.

So, I think we think we've got a year or a couple of good years of CapEx growth in front of us, but sizing it, I have a hard enough time with June, let alone thinking about 2015.

But in terms of how we're sizing the Company and how we're running the Company is that we do expect the kind of business levels we're seeing now and holding as we sort of move through, as we move into 2015.

So operating in the $700 million, $800 million range doesn't mean you won't have some quarter-to-quarter volatility in there but generally operating at that level.

I haven't seen anything to make me think otherwise at this point.

Okay, good.

And just real quickly, can you also give us an idea on 3-D NAND activity in terms of the number of companies you see working on that fan out?

Has it broadened out to all four being actively, more than actively engaged, not just really doing development work but maybe looking to add some pilot lines?

I would say at this point, no.

I would think momentum since our last call has cooled on 3-D NAND.

You still, obviously, have a leader in it, but I think the other players are in development.

But I would say right now it's kind of a slowdown in terms of active plans to drive the production, and we're not forecasting it in this calendar year.

Okay.

Very helpful.

Thank you.

Your next question comes from Srini Sundar with Summit Research.

Your line is open.

Thanks for taking the question.

I just have only one question.

Do you expect any 10-nanometer orders this year?

Yes, some of our forecast that's baked into the second half of the year has some early development work around 10 nanometer, beyond what we have booked on the mass inspection side.

Again, I think it's part of the second half thesis, but obviously I still think dependent on how progression through the current node focus and as we get to 10 nanometer we'll see if that schedule holds.

But right now we do have some activity forecasted for that.

Thank you.

Your next question comes from Mehdi Hosseini with Susquehanna Financial Group.

Your line is open.

Yes, thanks for taking my question.

Rick, the first one is for you.

Looking at your shipment over the past several years, overall shipment has averaged around $3 billion, and it seems to me we're in this perpetual pause mode where we have a strong, one or two strong quarterly booking, and then things phase out and some may refer to it as a pause.

And to that extent, my question to you is what gives you confidence that all of these inflection points in technology, like a 3-D NAND and FinFET is going to materialize and would lead to growth in shipment?

What if it's all spread over multi-year period and it would be more of a gradual?

(Multiple Speakers) You understand my question?

Let me just back it up and restate it.

What gives us confidence that we're going to outgrow WFE as a percent?

Is that really the question?

Yes, and also with the caveat that we have averaged 3 billion of shipment over the past three years.

We have had one or two quarters of strong momentum and then things slow down.

We have this perpetual pause mode that we have every year.

What gives you confidence that the next year will be any different?

Well, I'll actually turn it back to Bren because he has the specific numbers.

But, for example, for calendar 2014 when we modeled this year, it depends on where you think WFE lands in terms of overall but we do expect to outperform the market for the year, and Bren maybe can walk through the numbers.

Well Mehdi, I think it is clear, and if you look at our FY11 through FY14 that we're almost finished with here, that we've been operating between $2.8 billion and $3.2 billion of revenue.

And so clearly, from a historical perspective, that is unique.

I think it's one of issues as to why we think the industry driven by the end-markets has changed fundamentally, that we don't have the cyclicality that we used to have.

You can have quarter-to-quarter volatility with even some depth because of customer consolidation if one customer turns on or off but at the end of the day it still is relatively less cyclical.

Frankly maybe a little more predictable over the long run.

So, I think it has changed and I think as we look at, I think there are inflection points in the industry that can drive some growth but I think over, the area [out] of the curve is much larger, too, because you don't have the volatility so you're generating more aggregate revenue through a cycle, the more aggregate earnings and cash flow.

So yes it is different, and I think it makes the quarter-to-quarter changes less relevant in terms of an indicator of something more broadly cyclical, but I think that over time I think that we can run the business more efficiently, we can generate more aggregate cash flow with less volatility.

But the inflections I think will be, will provide some opportunities for some relative revenue growth as well.

Let's say in a scenario where your shipments were to average 3 billion for a few more years, would there be any adjustment to the operating model to be able to adjust to it, given where your margins are?

Well, I think we're operating with our operating model that we've had historically here.

The challenge obviously in that scenario would be how do you improve your productivity and find cost offsets to maintain your spend level in a consistent way.

Over time, I think we've done a pretty good job with that.

Certainly we have inflexions around program spending as you're bringing a new product to market.

In general it's what we've been doing historically but I think we have to look for those opportunities and keep our focus operationally, just to continue to deliver the kinds of operating margins that we have had over the years.

To your point Mehdi, let's assume there was an ongoing, that the market stayed flat, the WFE stayed flat, the percent of process control stayed flat or went up slightly and we held market share.

Then what you would be left with is growth in services which are actually continue to grow over time but we don't anticipate it will be flat.

We think there are opportunities for process control to continue to increase as a percent but we don't see it doubling.

It is not going to go from 15% to 30%.

But based on what we've seen over time we do see some opportunities for that to drive growth, then you also get growth in services, and as Bren says, our operational efficiency keeps improving over time as we drive the revenue with pretty effective utilization of our resources.

Thanks much for the detailed comments.

Okay.

Your next question comes from Mahesh Saganeria with RBC Capital Markets.

Your line is open.

Thank you very much.

You had a pretty good year of memory orders last year.

If my calculation is correct your orders were up 100%, and you are back down to probably 2,000 level run rate.

So I'm assuming when you talk about the second half pickup you're expecting most of that coming from foundry and none from memory.

Memory probably more flattish or down in the second half.

No Mahesh, It's Bren.

We are expecting obviously, some recovery from foundry and logic but we are expecting memory to improve in the second half as well.

I think right now it seems later in the second half.

As I said earlier I think that's one of the swing factors in terms of actual CapEx or WFE growth in calendar 2014.

You think about the next phase of capacity adds at the China NAND flash fab.

Right now we're planning for those orders late in the year.

If those were to pull in and those tools were to ship into revenue in December certainly that would have an impact on the WFE number.

So right now I plan for some of those shipments out in early 2015 but I think as we've seen, even over the last couple of months that our customers can be fairly fluid in terms of their plan.

So we'll see how that plays out.

But I expect a higher percentage of memory in the second half than we have in the first half.

Okay.

And the second question on 2016, is it your opinion that 20 nanometer is completely billed out and the inflection you are waiting for is more 16/14 from three customers you have?

I suppose there are probably three customers on the foundry side.

Is that the right way to think about?

I hesitate to talk specifically about 20 given that it's a relatively very small number of people on 20.

But I think that it is true most of the investment we're anticipating for the rest of the year is coming at sub-20 nanometer investment on the memory, or on the logic and foundry side.

So that is true that, that is the bulk of the investment we're anticipating the rest of the year.

Okay.

That's very helpful.

Thank you so much.

Your next question comes from Patrick Ho with Stifel Nicolaus.

Your line is open.

Thank you very much.

Rick, I know this is very hypothetical but looking out to the 16 and 14-nanometer ramp of next year, at 28 you benefited from a lot of the yield issues that the customer initially had where you saw additional process control capacity buys.

Given the significant challenges you mentioned with FinFET, could you see a repeat of that type of scenario with 16 and 14 go into high-volume manufacturing?

The challenge, yes.

Let me start with yes, but let me explain how the dynamic works, because we've seen this movie before.

When people start with a new node, usually there's a fair amount of investment in the front end, including end process control.

But if they're struggling to get yield, then it is a pause, because there's no point in pouring a lot more investment in, if the process isn't performing.

And if the process isn't performing as people expect, the costs aren't there, there aren't enough designs behind the customers, so there's this natural pause, but then they restart.

And when they restart, when they start getting more confidence you start bringing in more customers, then you get another set of yield problems.

So I would characterize it in three phases of yield challenges.

You have the developmental challenges where we participate.

In fact, a certain of our tool sets go in more for that phase and we've seen that penetration.

Then in the ramp which is, can be depending on the complexity in node can be sometime later, because they have to work out a bunch of issues, not all, or in many cases, many of them may not be related to what our tools can help with.

But in ramp, then there's a huge opportunity.

Ramp is arguably the biggest opportunity for process control, is during the ramp phase.

Then in high volume it's more about securing the games that people have made.

That's when the mix, like the 28 in the second half of last year, moves toward some of the lower cost tools.

So right now, I would say we're not completely done with development, depending on which customers you're talking about, and we're a ways away from ramp.

When that ramp hits, I expect there will be plenty of opportunity.

Does that make sense?

That's actually really helpful in terms of the color, in terms of scenario.

My follow-up question is just more, I guess, clarification.

Bren I think you mentioned a potential memory recovery or pickup in the second half of the year.

Is that totally biased toward 3-D NAND builds or are there other planar NAND capacity builds that could come in, in that second half recovery?

Right now I would say it's biased toward V-NAND but to Rick's point earlier, I think depending on progress around improving yield reliability and cost around that node, that you could see some of the bit growth get met by expanding planar capacity to support that.

But right now I'm thinking about it in terms of V-NAND.

But it certainly could change, I think there's been a fair amount of information publicly recently that there's some challenges there, including what Rick just talked about.

Great.

Thank you very much.

(Operator Instructions) Your next question comes from Edwin Mok with Needham & Company.

Your line is open.

Thanks for taking my question.

Follow-up to Patrick's question, should the industry continue to face issues with V-NAND and some of your customer decide to spend a little more on planar NAND rather than V-NAND, how does the process of control intensity affect you?

(Inaudible) technology?

It's too soon to really say.

It depends on if they're scaling, how much they're scaling of planar.

If they're not scaling, then it doesn't really, you go back to the intensity.

But if they're scaling the planar, there's a lot of opportunity there.

The challenges has been, with scaling planar some of the technologies associated with that.

There's less process control, or margin in there.

So you need more process control.

But the truth is we're very early in the 3-D NAND to know exactly what process control intensity is going to be.

Until somebody has gone through a real ramp of it, and arguably you would say more than one player, because the characteristics are usually different for different players ramping.

So I would say it's early, but our models say they're not that different if they're at a similar kind of performance expectation and device.

They're different technologies but the intensity is probably pretty comparable.

Great.

And then you guys talked a little bit about solution (inaudible) in the back half and as a result there's pause, right?

Have you seen more competitive pressure as a result of that?

Has your competitors take advantage of the fact that business is slower and they try to get into a customer and say, hey, qualify my queue instead because now the customer has more time to do that?

No, I haven't seen any change in the competitive environment over this.

I think there's always a push by customers to get the most value that they can for their investment, but if anything, the thing that's driving some of the pause is related to solving some very hard problems.

And if anything, we're seeing more push on us providing more support and capability toward de-bugging some of these processes.

So while I haven't seen a change negatively, I would argue that we're, in some cases, being relied on more heavily to de-bug.

Great.

That was very helpful color.

Thank you.

There are no further questions at this time.

Mr. Lockwood, I will turn the call back over to you.

Thank you, Jamie.

And I would like to thank everyone on behalf of the management team for joining us here today.

An audio replay of today's call will be available on this website later this afternoon.

Again, we appreciate your interest in KLA-Tencor.

This concludes today's conference call.