科磊 (KLAC) 2015 Q1 法說會逐字稿

Good afternoon.

My name is Mike and I will be your conference operator today.

At this time, I would like to welcome everyone to the KLA-Tencor first-quarter FY15 earnings conference call.

(Operator Instructions)

I will now turn the call over to Ed Lockwood with KLA-Tencor Investor Relations.

You may begin your conference.

Thank you, Mike.

Good afternoon, everyone, and welcome to our conference call.

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

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

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, 2014 and our subsequently filed 10-Q reports.

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

As you know, our future results are subject to risks.

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

These forward-looking statements, including references to the future financial performance and condition of the Company, future macroeconomic and industry conditions, future growth and the anticipated drivers of such growth, the Company's future capital structure, our leverage recapitalization, a special cash dividend, incremental debt, plans to reduce debt, uses of cash, plans to purchase shares and levels of stockholder return, potential market and revenue opportunities, and trends in the semi-conductor industry and the anticipated challenges associated with them, are based on the Company's estimates, assumptions and expectations of future events and are subject to a number of risks and uncertainties.

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

More information regarding factors that can cause those differences is contained in the filings we make with the SEC from time to time, including our FY14 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'll turn the call over to Rick.

Thanks, Ed.

Good afternoon, everyone, and thank you for participating in our earnings call.

Today, I'll discuss our refinancing and recapitalization announcement, and the business highlights of the first quarter.

Bren will then review the financial details of today's announcements, followed by Q&A.

Today, as part of our ongoing activities focused on returning value to shareholders, KLA-Tencor is announcing our intention to recapitalize our balance sheet.

These actions reflect management and the Board of Directors' confidence in our market leadership, business model, and long-term growth strategies, as well as our leadership and strong commitment to delivering a high level of returns to stockholders.

Bren will have more details of the transaction, but in summary, what we're announcing today is a proposed leverage recapitalization of KLA-Tencor, which would return approximately $4 billion to our stockholders.

Subject to the closing of the financial aspects of this initiative, we intend to issue a $16.50 per share special dividend.

We are also announcing that our Board of Directors has authorized an increase to the Company's stock repurchase program by an additional 3 million (sic -- see press release "3.6 million") shares of common stock.

This increase in value at approximately $250 million based upon the closing cost of our common stock, as of October 20, 2014.

We believe our capital structure strategy underscores our confidence in the strength of our strategic objectives and our business model, but also the strength of our balance sheet.

As we have invested in our business and executed our growth strategies, over time, we have experienced strong cash generation in excess of what we believe is necessary to fund our operations and invest in our future growth.

We intend to continue to execute our business model and strategies, manage our Company profitably, and provide a high level of value to our stockholders.

Turning now to highlights for the first quarter of FY15, September quarter revenue and earnings per share results finished as expected, but new orders in Q1 ended below the guided range, at $567 million, as orders from one of our foundry market customers ended below the original forecast for the quarter.

We believe this is due to two factors.

First, there are many challenges associated with adopting the new technologies required to fabricate leading-edge transistor architectures.

Second, tighter order lead times have become the norm in our industry today.

And this, coupled with a concentrated customer base, is resulting in increased quarterly order variability.

We currently expect a rebound in foundry order levels in the December quarter as customers move closer to the implementation of new capacity additions in leading-edge foundries that are expected to begin in the first half of calendar 2015.

Although the September quarter bookings profile reflects an unusually low-level activity from one of our foundry market customers in terms of next-generation FinFET buildout, it's clear that the battlefield for sub-20 nanometer competition has been formed, with many players positioning to meet next-generation production ramp schedules.

Recall the near-record level of foundry orders booked by KLA-Tencor from a single customer in the June quarter, with delivery dates for these orders slated for early 2015.

These orders, combined with a strong foundry order forecast for KLA-Tencor in the current quarter, indicate the more aggressive pace of investment in FinFET capacity has begun.

FinFET processes are extremely complex and challenging to bring to market, and our customers rely on KLA-Tencor to help address the ongoing yield issues associated with these new technologies.

Logic orders came in largely as expected in the September quarter.

Memory orders grew sequentially in the September quarter, with roughly a 50/50 split between DRAM and NAND flash.

DRAM customers are continuing their investments in 2X nanometer technology conversions.

In addition to new capacity activity, the flash demand continues to be focused on planar NAND.

For KLA-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.

Turning now to our outlook for the second quarter of FY15, the December quarter booking profile represents a meaningful pickup in order activity, largely driven by the leading-edge foundries as they move to prepare FinFET production capacity ahead of anticipated end-customer demand in 2015.

We expect December order quarter bookings to be in the range of $700 million to $900 million, up approximately 40% at the midpoint from September.

Guidance for revenue in the December quarter is in the range of $620 million to $700 million, and non-GAAP earnings per share is projected to be in the range of $0.46 to $0.70 in the quarter.

December quarter EPS guidance does not consider the impact on other income and expense, and tax rate, related to the proposed recapitalization transaction.

However, upon completion of the proposed transaction later in the quarter, we plan to update guidance to reflect the earnings impact of the proposed transaction.

So, to wrap it up, KLA-Tencor is acknowledged as the market leader in process control, with a proven track record of consistently delivering industry-leading revenue growth, profitability, and strong cash-flow generation.

KLA-Tencor's strong business model and the ongoing successful execution of our strategic plans enable us to continue to invest in our business at a high level to fuel our growth and support our customers' needs, while also delivering meaningful returns to stockholders, as exemplified by today's announcements.

Today, the factors driving our growth in market leadership remain favorable.

We are confident in KLA-Tencor's ability to drive innovation and help customers address the increasing cost and complexity of competing at the leading edge.

I'll now turn it over to Bren for more details on today's announcement and his perspective on the quarter.

Thanks, Rick.

Good afternoon, everyone, and thanks for joining us today.

Today, we are very pleased to announce new dimensions to our capital allocation strategy.

To support our ongoing commitment to return capital to stockholders, we plan to pursue a $4 billion leveraged recapitalization, featuring a $16.50 per share special cash dividend with an aggregate value of approximately $2.75 billion.

The special cash dividend would be in addition to our regular $0.50 per share quarterly dividend.

The intended special cash dividend will be funded in part with a portion of cash on the Company's balance sheet and in part with $2.5 billion incremental debt that will be added to the balance sheet.

Our regular $0.50 per share quarterly cash dividend is expected to be declared and paid following our regularly scheduled Board of Directors meeting in November 2014.

In addition to the $16.50 per share special dividend, our Board of Directors has also approved an additional authorization of 3.6 million shares for our stock repurchase program, representing an additional $250 million increase over the $1 billion originally authorized in July.

We expect to complete the new share repurchases over the next 12 to 18 months.

Including the special cash dividend with an aggregate value of approximately $2.75 billion, the $250-million increase to the stock repurchase program announced today, and the $1 billion stock repurchase program previously announced in July 2014, the total capital to be directed to stockholders would be approximately $4 billion in aggregate.

The aggregate value of the special dividend of approximately $2.75 billion includes a portion of the special cash dividend that could be payable to holders of outstanding equity awards under the Company's 2004 equity incentive plan.

This leveraged recapitalization will add a more permanent tier of debt with longer maturity dates than our current notes, thereby improving the efficiency of our balance sheet.

As part of our recapitalization, we intend to issue incremental debt consisting of a pre-payable term loan facility, which we intend to delever over the next three to five years, and investment-grade senior notes with staggered maturities.

We also expect to enter into a revolving credit facility.

An unprecedented lending environment, coupled with what we expect to be a robust capital spending profile in our industry over the next few years, has enabled us to undertake this program and borrow above our long-run debt target of 2 to 2.5 times EBITDA leverage to opportunistically optimize the Company's capital structure and enhance total stockholder returns over our base plan.

We intend to maintain an investment-grade rating.

As Rick mentioned, our strategic position remains strong and we are delivering superior cash flows and financial results.

We ended the first quarter of FY15 with over $2.9 billion of cash and investments, with roughly two-thirds of our through-cycle cash flow generated in the US.

As we look ahead, the near-term priorities for our domestic cash include about $500 million of cash to fund operations on an ongoing basis.

We will continue to execute the same strategies that have enabled us to sustain our market leadership in process control, deliver long-term revenue growth in excess of the market, and deliver superior profitability and cash flows.

As part of these market leadership and growth strategies, we are committed to continuing to invest at high levels in research and development and evaluating perspective strategic growth opportunities that are complementary to our model.

This is a formula for success that has served us well over the years in extending our market leadership, fueling strong cash flows, and establishing KLA-Tencor among the leaders in returning value to stockholders.

Our strategies for growth are driven by a goal to deliver better-than-industry-average revenue across a multi-year cycle and earnings growth targeted at 1.5 to 2 times revenue growth, over time.

We believe today's news reflects our confidence in the prospects for continued successful execution of these strategies.

As we execute on these long-term growth strategies, we plan to deliver returns to stockholders via dividends, through stock repurchases, and by reinvesting in the business in ways that deliver sustainable value.

We see today's announcement as the next logical step in our ongoing efforts to drive stockholder value.

Turning now to more specifics on the financial results for the first quarter of FY15, I will provide summary highlights in my commentary on the call today.

Please refer to the supplemental materials we have posted to the Investor Relations page on our website for additional detail on the financial results for the quarter.

Revenue for Q1 was $643 million, above the midpoint of guidance and fully diluted GAAP earnings per share were $0.43.

Non-GAAP earnings per share finished the quarter above midpoint of the guided range, at $0.47 per share.

Non-GAAP earnings would have been $0.50 per share, at our guided tax rate of 22%.

In our press release and in our supplemental financial data accompanying our results, you will find a GAAP to non-GAAP reconciliation of the $0.04 difference in EPS.

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

New orders in Q1 were $567 million, below the guided bookings range for the quarter of $600 million to $800 million, as orders from one of our foundry-market customers originally scheduled to be placed in the September quarter were pushed out.

As Rick noted, we believe the day in orders from this -- the delay in orders from this customer for FinFET ramp is partially a timing issue, with this customer providing shorter lead times from order placement to shipment than we have seen in the past.

Calendar 2015 is expected to be a year of growth for the semi-conductor equipment industry, with multiple customers simultaneously ramping new leading-edge capacity in foundry, logic, and memory in the year.

That said, we continue to experience low order visibility with a limited number of customers placing sizable orders comprising the majority of our forecast.

As these plans change, driven by yield issues or lead-time commitments, the impact on quarterly forecast accuracy is significant.

Turning now to our customer segment commentary for the September quarter, foundry was 25% of new orders in Q1 and very low compared with recent history.

In fact, orders from one of our foundry-market leaders finished over $100 million below the original forecast, ending at unexpected low levels in Q1.

Foundry demand is expected to rebound at 62% of orders in the December quarter.

As Rick noted, the competitive battleground in next-generation foundry is taking shape, and capacity plans for FinFET are lining up for the first half of calendar 2015.

As the market leader in process control, KLA-Tencor is well positioned to benefit from what we expect to be a strong, broad-based foundry demand of the 16- and 14-nanometer nodes.

Memory was 46% of new-system orders in September, up sequentially both in terms of percentage of total orders and absolute dollars, compared with June.

Logic was 28% of new orders in September, above the original forecast for the quarter.

Customer investments and technology of 20-nanometer and below constituted roughly 66% of the orders we received in Q1.

Turning now to the distribution of orders by product group, wafer inspection was approximately 49%; reticle inspection was approximately 3%; metrology was 15%; service was approximately 30%; storage, high brightness LED, and other non-semi was 3%.

Total shipments in Q1 were $548 million, and below the bottom end of the guided range of $600 million to $660 million, as delivery timing for certain orders related to leading-edge foundry projects originally expected to ship in the September quarter shifted into Q2 and early 2015.

This is consistent with the conditions we experienced in the March and June quarters, as shipment delivery dates for tools currently in backlog are featuring extended lead times, resulting in a lower quarterly shipment profile over the near term.

We expect shipments in Q2 to grow approximately 40% sequentially, at the midpoint of December guidance.

We ended the quarter with approximately $1.2 billion of total backlog, comprised of $993 million of shipment backlog for orders that had not yet shipped to customers and expect to ship over the next six to nine months.

Our current shipment backlog is at historic high levels for the Company, providing a baseline for strong shipment and revenue growth as we convert this backlog in the coming quarters -- $173 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, the numbers show KLA-Tencor executed well operationally in the September quarter, with revenue, gross margin, and EPS all finishing in the upper end of the range of guidance.

As I previously mentioned, revenue in September was $643 million, just above the midpoint of the guided range for the quarter.

Gross margin was 55.6%, 100 basis points above the midpoint of the guided range for the quarter, in spite of the $91-million sequential decline in revenue.

Gross margin exceeded our expectations in the quarter, due to lower-than-forecasted parts cost in our service business and a favorable product mix in Q1.

We expect gross margin to be in the range of 56% to 57% in December.

Total operating expenses in the September quarter were $240 million, up sequentially about $9 million compared with June, mainly due to higher employee-related costs in the quarter.

Consistent with our expectations, prototype material costs for certain next-generation products are expected to be higher in the first half of our fiscal year versus the second half.

For the December quarter, we are modeling operating expenses to be between $236 million and $238 million.

Other income and expense was approximately $10 million in September.

Prior to the recapitalization, our expectations at OIE will be about $10 million in the December quarter.

However, given the unknowns currently surrounding the structure and timing of the proposed recapitalization, at this time we are unable to guide OIE for the December quarter.

We plan to provide detailed guidance updates some time later this quarter to reflect the impact of the transaction on OIE, tax rate, and earnings per share.

Our effective tax rate was 26% in the quarter, above our long-term planning rate of about 22%.

We believe the appropriate long-term planning rate should be 22%, given our expectations for the mix of business over the next few years.

The 22% planning rate also assumes reinstatement of the US R&D tax credit that expired at the end of calendar year 2013.

Given the low probability that this extension will occur in the December quarter, we are modeling a tax rate of 24% for the December quarter.

Finally, net income for Q1 was $79 million, or $0.47 per fully diluted share.

I'll turn now to the balance sheet and our cash flow statement.

Cash and investments ended the quarter at $2.94 billion, a decrease of $210 million compared with June.

The sequential decline in our cash balance is largely due to stock repurchases and annual bonus payments in the quarter.

Cash from operations was $35 million in the quarter.

The sequential decline in cash flow from operations in Q1 is consistent with seasonal trends and was driven, in part, by lower revenue levels as well as the timing of our annual bonus compensation payments in the quarter.

In the September quarter, we paid $82 million in dividends and repurchased $125 million of our common stock.

Fully diluted shares ended the quarter just under 166 million.

With that, to reiterate, our guidance for the December quarter is: bookings are expected to be within a range of $700 million to $900 million; shipment guidance for the December quarter in a range of $740 million to $800 million; revenue between $620 million and $700 million; and EPS of $0.46 to $0.70 per share, exclusive of the impact of the recapitalization.

Once again, we plan to provide an update to December quarter guidance that will reflect the impact of the proposed recapitalization concurrent with the currently scheduled closing of the transaction later this quarter.

This concludes our remarks on the quarter.

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

Okay.

Thank you, Bren.

At this point, we'd like to open the call to questions.

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

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

Mike, we are ready for your first question.

(Operator Instructions)

John Pitzer, with Credit Suisse.

This is [Farhan] asking a question on behalf of John.

Rick, can you just talk about briefly why you chose to do a special dividend instead of buybacks?

What were the puts and takes in making the decision?

I'll give an overview, and then I'll turn it over to Bren to get the specifics.

Look, the way we look at it, there are three uses of cash.

The primary use is to fund our organic growth.

And we fully satisfy that and we continue to build upon that.

The second is to look for accretive and enabling M&A.

We've done those things and continue to evaluate those, and we feel we can do them.

And then, the third one is returning cash to shareholders.

And in that, we look for the most efficient way and effective way to do that, considering a lot of factors, including who our shareholders are and, also, the size of the return and what's most efficient.

From that, I'll hand it to Bren.

I think any time you consider a large return of capital, certainly, we start from an assessment of our business around how much cash can the -- does the business have, what kind of reserves do we need.

Also, the potential debt capacity of the Company.

As we looked at that, and to Rick's point, as we assessed our options, we clearly did not see, at least for now, anything on the M&A front that looked as compelling to shareholder value as what we're doing here today.

But, given the size of the transaction itself, the practice of trying to execute a share repurchase is difficult.

There's a tender offer and there're premiums and all those kinds of things.

I think it really comes back to Rick's point.

Who are our shareholders?

What do they value?

We think our shareholders value our dividend practice, our practice of returning cash, the ability to treat all shareholders the same.

And the timeliness and efficiency of the execution.

There is a piece of this, obviously, that is share repurchase that we will execute over time.

We made the previous announcement, back in July, of $1 billion, of which we executed $125 million, and we added another $250 [million] to that.

So, we will be executing that over time as another component.

There are, I think, different opinions on what's the best approach.

I think it goes back to how we think about our business, how much cash do we need, and ultimately, we made the call to do it this way where we feel like we're optimizing between the two vehicles.

Thank you.

And, just one question in terms of the first half of -- calendar first half of next year.

What kind of pickup are you expecting in the first half of next year?

As you know, we don't guide beyond the next quarter.

But, overall, for calendar 2015, I think it is setting up nicely for heavy investment in FinFET across the board.

When we look at our foundry customers, really, nobody is shipping products today on a large volume with FinFET devices.

I think, by the end of calendar 2015, the expectation is there'll be multiple devices from multiple suppliers of FinFET technology.

So, that bodes well for investment.

What we're anticipating, as we said, for the December quarter, is a pickup in investment associated with that, but then throughout 2015, the way the plans look and the way our customers are talking to us about it, I think we'll see multiple players supporting that ramp.

Yes.

I think the only thing I would add to that is, given the timing of the second half of the year, to be delivering product, it does make sense that you'd start to see capacity ramping in the first half of the year.

Certainly, we are driving our supply chain and building towards that expectation.

I think it lines up with the end market and dynamics that Rick mentioned.

Thank you.

That's all I had.

Timothy Arcuri, with Cowen and Company.

Two things.

First of all, Rick, I'm sort of curious if you can talk about the FinFET timing issues and if it's possible to segment it out, whether it's process related or some of it is customer related, i.e., sort of like your customer's customer.

There's a lot of obvious uncertainty out there.

I'm wondering whether you could segment the two.

And then I had a follow-up.

Thanks.

Sure.

From what we understand, in talking to our customers, I think there is a desire by the end customers to get to the technology.

But there's an inability right now, in general, to have a large-scale deployment of technologies that are reliable enough to be deployed in high volume.

So, I think that, that's really limiting.

Like I said, we expect the first commercial devices to come out -- or consumer devices to come out by the end of the calendar year with FinFET technology, but that's really only from one supplier.

The other ones are working through a number of issues.

And there are associated challenges with defect density, but also structural reliability.

I think that, for people that haven't done FinFET, it's turning out to be a very challenging process.

So, I think there's a lot of effort going on to deal with that.

As you know, there has been some success on 20-nanometer.

Given that, that's made it into the current-product cycle, we're really talking about a next-product cycle, which I think is that the soonest we'd expect to see volume is mid-calendar year of 2015.

As I said, we expect investment to be ramping in dealing with some of those challenges.

But the people that are in front on FinFET struggled quite a bit getting yields on them.

We were involved in working through some of those challenges.

So, I don't think it's going to be easy.

And I think that, on the one hand, we're enabling that.

But, on the other hand, until it starts to work, there's not going to be a lot of customer demands, not a lot of tape outs.

But then, I expect you'll see an avalanche of demand, once the process starts working.

Okay.

Thanks for that.

And then, just a follow-up to the prior question about the decision to pay a special dividend.

Why would you decide to do that when you are about to put up a quarter that -- where the guidance is definitely disappointing, relative to what the Street was thinking, and you could've maybe bought stock back at a much, much lower price?

I'm just wondering the calculus around paying that special dividend versus maybe doing an ASR post these results, something like that.

Thanks.

Sure.

As you can imagine -- this is Rick.

I'll start with an overview and let Bren can fill it in.

First of all, this wasn't a decision that was something about a near-term decision.

It was a long-term decision around the capital structure of the Company, something that we've been working at for quite a while, to figure out what is the right way to position the Company and structure it.

So it's independent of ups and downs of particular quarters, and we certainly aren't market timers.

So, we look at that and said, what's the best way, what's the best capital structure?

In this case, there is a blend, but it's obviously greater in the special dividend and it's the most efficient way to be able to return cash to shareholders.

That was really the thinking.

It wasn't meant to be coincident with any particular quarter.

It just happened to coincide.

Tim, the only thing I'll add is, clearly, the ability to finance this was driven by a very attractive debt market, both in terms of rates, terms, and financial flexibility.

Also, our view on being able to overshoot or go further than our long-term target of 2 to 2.5 times leverage was also driven by our views of capital intensity and a healthy capital spending environment over the next couple of years to enable us to deleverage some of this -- some of this debt we're taking on back to our target.

So, as I've been saying, I think, for -- even going back to May and even into SEMICON, that we felt like it made sense for our Company, given the dynamics -- our secular dynamics, our business model, the barriers to entry, our market share, that a more assertive capital structure would drive additional value to our shareholders.

So, this was a process.

We made the share repurchase announcement.

At the time, we said that, that was a first step.

This is the next step.

We talked a lot already about the pros and cons of the vehicle, but at the same time, I just wanted to give you a little bit of insight in terms of how we're thinking about it.

Okay, Bren.

Thanks a lot.

CJ Muse, with ISI Group.

If I could, I'll try to ask both my questions at once, as they're partially related.

First off, when you consider this special dividend, I'm curious whether you focused at all on the M&A side, or increased R&D?

When I look at your relative position to WFE over the last two years, you've underperformed by about 8 points each year.

We'd love to hear your thoughts on whether that was a consideration and how you're going to rectify this relative underperformance that has gone on at least for the last two years.

And then, second part of the question is flexibility.

If I look at you guys pro forma posted transaction, roughly 20% debt to cap, and roughly two-thirds of your free cash flow will cover interest and dividend.

I'm wondering if that's enough flexibility for what may come, for what is still a cyclical industry?

Thank you.

CJ, I'll take part of that and then, again, Bren can look at it.

We can talk about the relative performance.

I think, as you're well aware, we have a -- we're biased towards increased adoption in logic and foundry, and less so in memory -- although memory is increasing, and what we've seen this year, clearly, is that the memory investment has been higher than anticipated originally and has continued to go up.

We expect that trend to reverse a little bit in 2015, where we do see the foundry customers increasing their investment.

And our expectation is, memory will probably nominally hold to what they're doing in 2014, so I think the mix becomes favorable for us.

We look at over the long term.

The second part I look at is, a big change in the Company and in the industry I think has to do with, while the near-term volatility has increased, the longer-term volatility has actually decreased because of, I think, the efficiencies associated with consolidation.

The other thing that gives us a lot of confidence is -- in our ability to service the debt and do everything else that we want to do, is a growing service business which is much more aligned with what's going on in overall semi-conductor manufacturing.

We just looked and we've had seven consecutive growths of service business.

And so we look at that as a business that can fuel and can help dramatically service this debt.

Bren, you want to fill in?

CJ, I think -- you mentioned operational investment and I think that's -- we have ramped up our investment to support our business as we have a product cadence that's 2 times our competitors.

So, we believe we are investing enough in our business to be able to maintain our market position.

And I think that the underperformance you talk about is more driven by -- the most sensitive element, I think in that is, to Rick's point, more about customer mix than anything else.

From a flexibility perspective, we aren't using our offshore cash in this transaction.

There's a unfunded revolver that's a component to it.

We also plan to have about $500 million in the US.

We're going to execute the share repurchase over time and, certainly, there are some elements that provide flexibility there.

As you know, covering this industry for a long time, this is not a capital intensive industry, so we don't need a lot of cash to run the business.

We had the growing service business that's a bigger percentage of the revenue.

We're much more comfortable -- and, given the cyclical dynamics as well, I think we're much more comfortable with the risk profile of this.

Our intent is to delever a significant portion of this rather quickly over the next couple of years.

So, all that, coupled with the cost of the debt, plus the outlook that we have, we think that it's a prudent structure.

And I think we expect our debt to be investment grade, and I think that, that also reflects the structure and our ability to execute our strategies without the risk or the financial -- just financial distress effect sometimes goes with that.

Operator?

Next question?

Krish Sankar, with Bank of America Merrill Lynch.

Thanks for taking my question.

The first one I had was just a follow-up on the special dividend recap question.

Is it fair to assume, at this point, that you probably looked around and found out no suitable M&A candidates and decided this is a better way to return capital?

Does it impact your 6.9% convert due in a few years?

I had a follow-up.

Again, from the strategic perspective, we have looked at opportunities, continue to look at opportunities to enable further growth and look for things that are going to be accretive to either our current business or places to grow.

When we evaluate that, we feel very well positioned with the product portfolio that we have developed organically or through the M&A that we've done in the past, and we've said this on a number of occasions.

When we look, we don't see anything that's so compelling that we wanted to move, in the past, or we would have.

We always compare the returns that we would get from that, from what returns we'd get from an action like this.

Second one is, we still can do M&A.

If there's M&A that's compelling and accretive, over time, we're not limited to do that.

Our view is, this doesn't disable that option, it just would have to pass hurdles that would make it long-term accretive to our Company, and that's always been the case.

So, we don't think that we're limited in any way from the deals that we anticipate might come our way as we look forward.

And then, on the question on the 2018 debt, that's straight corporate debt.

An option under consideration is, do we -- we may consider refinancing that.

The financing is not complete, yet.

We don't want to get into the details, ultimately, of the various aspects of it.

It's an option under consideration and we'll update you at the appropriate time.

Got it.

As then, just as a follow-up, looks like there's a lot of activity going on, on the foundry side.

Besides the FinFet-related yield issues, have you guys seen any pick up on incremental size, say, for 28-nanometer?

Or, are you just focused mostly on 20, 16, 14 at this point?

We do have some forecast and we did expect, in the second half, to see some incremental 28-nanometer activity.

We didn't see that in the September quarter.

We do expect some of that business in the December quarter.

I think some of the lithography orders happen in the September quarter and I think, just given general lead-time dynamics, that would imply that other tools will follow.

So, we do expect some of that business.

I thought we'd see some of it in September, and it looks like I'm going to see maybe more of it in the December quarter, now.

Clearly, there are players that haven't participated where that is a leading-edge node for them that have come to us for support and help.

To Bren's point, we expect to see that because, as you know, that's the node that's probably generating a lot of the revenue and cash flow for the industry right now -- not the very leading-edge stuff.

Got it.

Thanks, Rick.

Thanks, Bren.

Harlan Sur, with JPMorgan.

This is Bill Peterson calling on behalf of Harlan.

Congratulations on the recapitalization program.

My question's actually more about the outlook, particularly in 2015.

Wondering with typically long lead times, orders in hand, coupled with orders you expect in December, how do you see 2015 playing out in terms of first half versus second half.

I understand -- I'm not looking for forecast, but how do you see that playing out?

And then, I have a follow-up question.

Bill, I think the first half, given the earlier comments, we think the first half should be strong, given the ramp we expected associated with 16-, 14-nanometers.

Beyond that, though, it's hard for me to guess.

I think we're consistent with everybody else.

We see it as a year growth, as we said in the prepared remarks.

In the first half, we're certainly building to support a strong shipment profile through the first half.

Okay.

The second part is, should we expect with some customers that the shorter lead times would be -- I guess become a new norm?

Or is there something else at play?

I'm curious on your thoughts on where the typical lead times would be going, particularly in the key foundries.

Lead times have been coming in over the last few years.

I think one of the byproducts of the mobility-driven cycle that we've been in since 2010 is because it's consumer centric.

Our customers are more sensitive to consumer dynamics.

They have less lead time and so some of that lack of visibility passes through.

It tends to be customer specific, as we saw in the June quarter.

We booked a significant amount of business in the foundry from a customer that gave us extended lead times.

I think, based on another customer that we expect to see some activity from here coming up to support the ramp we talked about, the lead times are pulling in.

It tends to vary across customers.

Over time, I think we've seen them shrink.

We're still sitting -- I think we ended the quarter around five months of backlog.

It isn't six to seven months of backlog, and as we model it going forward, we model somewhere between four and five months, generally.

It does mean that we carry more inventory to be flexible.

And that's certainly a dynamic that has changed in terms of how we manage the Company and the business.

But we need to be able to respond, and these are big orders from single customers, and so we have to be sensitive and flexible to their plans.

I think in general, Bill, as you know, as the industry has transitioned to much more of consumer orientation for devices, and that drives the business.

It's our customers don't really have a lot of visibility, so they're asking us to be responsive to their need to respond quickly.

And I think, in exchange for that, what we get is pretty close collaboration on their needs.

We just don't get great insight into timing, largely because in many cases they're not sure.

So, we have a lot of provisional plans that change pretty quickly, and we try to synchronize those but it's a challenge because the end markets move and the players are all trying to be positioned to take share when it's available to them.

So, we have to support that and, to Bren's point, we've taken on some inventory to be able to do that.

Okay.

Thanks for that color, and good luck.

Mahesh Sanganeria, with RBC Capital Markets.

Rick, you talk about next year -- one of your peers talk about next year up 5% to 10%.

Let's say, if the CapEx next year is up 5%, where do you think your revenue can track in that environment?

I'll give that to Bren.

Mahesh, I think a lot of it depends on the customer mix.

After two years where we had pretty heavy memory spending -- and, I think, underperformance relative to the market -- with the ramp of a new technology, we think that we should be able to grow with the market into next year.

That's certainly how we're modeling it.

But I think that's the more sensitive item.

Over the last couple of years, I think there's been just a fundamental delay around some of the new technology, whether on the NAND side or even in the foundry.

And, certainly, that's put pressure on process control because the customer buying patterns are typically heavier when they're ramping technology.

So, given the assumption of the ramp into next year, we do believe that next year positions us for its growing at least at the market rate, and perhaps faster, if process control intensities move the way we think they're going to move on these new technologies.

And, the second question, on the debt.

I'm assuming that this is a special dividend and you're paying the basis, so it's going to be tax free to the investors.

Also, if you can give us some math around why do you need $2.5 billion of debt to fund this, because you have pretty good amount of cash in US?

The dividend versus return of capital calculation, which gets in whenever you pay a large special, a portion of it is dividend.

Based on the tax retain earnings over time, a piece could be return of capital.

And we don't have the specifics on that to share with you today.

We'll share that with you when we ultimately get to where we pay the special.

So, that's how that works.

On the amount of debt, the way we thought about it was how far -- how much debt could we borrow?

We wanted to maintain an investment-grade profile, as we said.

We also had a plan around share repurchase.

So, once we pay the special and then go through the share repurchase commitment, we will have the US cash number right around $500 million.

And then most of -- the way I am thinking about it, over time, the way we will drive this, is our free cash flow into the US will pay our ongoing dividend and then the remainder will be targeted towards deleveraging back to our long-term target of 2 to 2.5 times EBITDA.

So, that's how we're thinking about it.

And I think the overall scope was driven by what's prudent for us and also, clearly, we thought it was important to maintain investment-grade profile through this.

That's very helpful.

Thank you very much.

Jim Covello, with Goldman Sachs.

Jim?

Okay, operator, next question.

Edwin Mok, with Needham and Company.

First question is, we have seen quite a bit of activity by the three technology leader around the 10-nanometer logic process right now.

And I'm a little surprised that your mask inspection order is so low this quarter.

I would suspect that some of those guys would start to order mask inspection tool for 10-nanometer.

Can you give some color around that?

Where is mask inspection, and do you expect incremental order around 10-nanometer on mask inspection, number one?

And then, relate to that is, do you expect ramp up in those 10-nanometer activity to benefit you in 2015?

Edwin, it's a good question.

Mask inspection, particularly around the mask shop, tends to be a lumpy business.

We had a decent quarter in June and we have a forecast for a decent quarter in December.

So there is some lumpiness to the order profile.

As you might recall, and we were fairly open with this, we did book -- for a leading logic manufacturer, we did book a multiple set of mask shop tools to support the 10-nanometer node, with those tools shipping over the course of 2015, with a lot of it in the first half of 2015.

So, there is some activity there.

I think we'll start to see more of that activity as we move forward.

I don't know how much of it we'll see in December, but clearly that's an aspect, obviously, of this transition to 10.

But, very limited activity on 10.

I don't think we'll start seeing orders for 10-nanometer beyond what we've seen, and some very early development stuff.

I don't think you'll see any meaningful orders until we get closer to the end of next year.

To that point, the existing capability that we have can support the pilot and R&D work.

And, given the fact that there are very few sub-20-nanometer designs working anywhere, except for some at one customer, then there's a lot of -- there's capacity in the system to handle things until we see, really ramp up of 16 and 14.

That'll start to consume some capacity, and then the 10 has really been, as Bren said, in the pathfinding usage for the reticle tool.

So, it'll come, it's just not going to -- and it's going to be lumpy, but it's not going to be imminent, given that 10-nanometer is so far out.

I see.

Okay.

That's helpful.

And then, just talk about your commentary on the first half of 2015, you said strong driven by 16-, 14-nanometer investment from your customer.

What about on the memory side?

Are we at least -- are you seeing any subsiding in the investment in memory?

Or do think that will remain strong in the first half?

Or is it more back half loaded on the memory side?

What color can you provide to us?

Thank you.

I'll give my perspective and then Bren can weigh in.

I haven't seen a lot of expectations of it building.

I think that the strength in memory probably continues through 2015, at some level, probably not growing from here, though.

Most of the investment in flash has been, as we talked in the past, more planar than 3D.

There have been some in 3D, but I think 3D is yet to come and that'll be dependent on a number of factors, although we're participating in that.

And then, the DRAM side, we do see technology investment going and there are definitely some capacity adds being pursued.

So, I think memory, I don't see a big difference between Q1 and Q2 or -- I'm sorry, first half or second half of 2015 for that.

As you know, we don't really forecast that far out.

Our visibility is pretty limited, in terms of exactly where things are going to fall.

We struggle to predict much beyond what we are going to see in December.

Great.

That's actually very helpful.

Thank you.

Atif Malik, with Citigroup.

Congratulations to the team on the special dividend.

The comments on the FinFET push outs are quite understandable, given your peers, ASML, also talked about the uncertainty in the foundry market.

My question is on the lead times, Rick, and then sort of same lines as Tim was alluding to.

If your customer's customers -- they have to make their devices, let's say, September next year, when is the latest they can order your (inaudible)?

I'm just trying to gauge if there's further risk in these bookings pushing out into the March quarter, given your lead times that could be longer than your peers.

And then I have a follow-up.

Given what we've seen, I think that there's a sensitivity, clearly, to the end-market dynamics there.

I expected -- frankly, I expected the orders in September.

I have some orders forecast in December and certainly that's the plan based on what we see today, but it does -- as we've seen, it has been a little bit fluid.

Even the calendar timing that we talked about, and roughly three-month cycle times on devices, you really have to start, I think, putting that capacity in place in the March and June quarters to be able to deliver those schedules.

That's, I think, the calendar -- or cadence that we're looking at in terms of expected deliveries.

But could it be a situation where I get very short lead times -- I finally get orders from customers and they turn around and want shipments in a couple of weeks?

That could happen.

I wouldn't be surprised if it does at some level.

This is -- we're trying to give you as much guidance as we get, based on the conversations we're having with the customer.

And, certainly, we're positioned to be able to respond with the flexibility to be able to deliver in a meaningful way into the first half of the year.

To the point of, if you look at the last two quarters of, we missed low in terms of the midpoint in the June quarter, and we miss high and then miss low.

We're not very good at forecasting the next 90 days.

We really think about it on a longer-term basis.

And the way I think about it, how is adoption relative to our model and expectation, and how are we doing relative to share.

Timing is something we have less influence over.

But, certainly, from an adoption standpoint, we're seeing it.

I think 2014 and 2016 will be good adoption -- we'll see strong adoption for process control.

We're just not seeing it yet, because the investment's not there.

I think our market share continues to be strong, but until they place the orders, we don't know.

So, it is true -- we're going to be, I think short term, very volatile in terms of the ins and outs.

Got it.

And, as a follow-up, you guys talked about that the 2D NAND investments are more dominant right now than 3D investments.

If you could rank for us the reason for that.

Is it that the economics of 3D are not at par with 2D?

Or is it yield related, or just maybe because it's trying to keep a tight supply demand balance as 3D could add more in the market?

Clearly, there's a continuum of process maturity for the different providers, right?

You have people that are already yielding devices and able to ship, and shipping in small volume.

You have others still in development.

You have others earlier in development.

It really ranges, whereas 2D capacity is much broader.

To the degree there is market demand for NAND, I think there's a big opportunity for everybody to participate in that, so you're going to see planar NAND continue.

I do believe that people have underestimated the challenges in 3D, both in the NAND and also in FinFET, in terms of integration and yield.

Some of that we can help with and some of that's just debugging the processes.

So, when there's a robust market environment, I think many of our customers will produce the products that they can produce.

But the crossover point, once the 3D is working, of 3D flash, is going to be compelling, as well, but it's got to work and get to economics that make sense.

We anticipate the soonest that happens is in calendar 2015.

But it's kind of a bit of both.

If the economics don't work, the demand isn't there.

But if it does work, there's a lot of interest in the customer's customer for it.

Got it.

Thank you.

Stephen Chin, with UBS.

A follow-up question on the recapitalization.

Did the Company consider a management buyout?

And perhaps you can share some of the puts and takes on why not just a management buyout, here?

No.

We didn't consider it.

It is just, given our situation, that wasn't something we'd consider.

What we considered was, what's a prudent level of debt that the Company should be taking on to optimize our capital structure.

And then, what's the best way and most efficient way to return cash to shareholders after we've gone through and evaluated uses one and two of cash, which is, invest in our business, look at accretive M&A or enabling technology.

But, no.

We were looking at a management buyout.

I think when you have a business like ours that has a strong technology position, differential margins, the ability to invest and therefore generate strong operating margins and a strong cash flow profile, I think you take that and you couple it with what we clearly see are changes in the secular dynamics of our industry that lends itself to a more predictable earnings stream over time.

A business like that certainly has the capacity to carry more debt.

And, to Rick's point, when we look at the first two considerations which we worked through, at least for now, as we saw it, we saw this as the best opportunity to deliver incremental value to our shareholders as we execute what we believe is a very solid plan going forward.

So, that was the thought process -- again, at a level of debt determined by our goal of what makes sense for business as exhibited by the investment-grade profile that we have, and then, obviously, how do we move forward with it.

Okay.

Thanks for that, Bren.

Just a follow-up on the ongoing business.

It looks like you're seeing the improved gross margins in both September, December quarter.

I missed the main driver that got you back into that gross margin range in September.

Does it appear that you've overcome those issues that occurred in the June quarter?

Thanks.

Yes.

The June quarter, I had a couple of issues on revenue mix, where some of the tools that came in on the revenue side were -- had a weaker revenue mix profile.

I also had higher than expected costs in my service business.

So, that drove a one-time weakness, if you will, into the June quarter.

I think we saw a very normal gross margin structure play out as we went into this quarter, something more consistent with what we've seen historically and consistent with our model.

So, the mix turned out to be a little bit more favorable.

I think the dynamics I saw in the service business corrected and is more consistent with our expectations for that.

I think as we look into the December quarter, the same dynamics play out.

Okay.

Thanks, Bren.

Ruben Roy with Piper Jaffray.

This is Sean on for Ruben.

Just wondering if you could give us an update on how you're thinking about gross margin, gross margin profile for 2015, given the ramp that you're seeing for 16 and 14?

And then, opportunities for expansion headwinds, there?

Just some kind of directional indication of how things could play out?

The gross margin profile on our latest products that we've introduced is actually -- is very solid and very consistent with our historical pattern.

We believe we'll see incremental gross margins between 60% and 70% going forward through 2015.

So I think we're think we're very well positioned as we see this pickup in business into the first half of the year for very good gross margin performance, and very consistent with our historical model.

Great.

If we could -- you talked a little bit about ongoing focus on investment in the business and just trying to think about your OpEx levels into 2015?

Is this something that will continue to grow?

How do we think about the magnitude of that growth or whether it will remain roughly consistent with where we see it currently?

The first half of this fiscal year -- the September quarter and the December quarter coming up -- I expect it to be a higher OpEx level than we expected in the second half.

That was driven by some programmatic timing on some next-generation programs.

The second half of the year comes down from the first half.

I'm modeling the year, right now -- the fiscal year, at around $935 million.

So, given the performance in Q1 and what we guided for Q2 does imply somewhere around that $230-million range in the March and June quarters.

Our OpEx levels are really dependent on what's required to support our roadmaps.

I think we're -- not necessarily on where the revenue level is.

So, if the business is stronger, I don't think it changes our OpEx all that much.

If it turns out to be marginally weaker, I don't think it changes it that much, either.

So, it's really driven by the business requirements and maintaining the differentiation that we need to support the gross margin profile that enables that kind of investment.

Just to add to that, one of the big initiatives we have been investing in is what we call the 5D solution for lithography for multi-patterning.

And, while we're seeing a little bit of revenue from those efforts, I think that, that's an investment that'll show up in future years as we continue to build out the suite of products and solutions we have to support multi-patterning going forward.

That's part of the step up in the increase.

To Bren's point, we're looking to -- don't see dramatic increases beyond our current levels, but we'll continue to invest in the business as we go forward.

Great.

That's very helpful.

Thank you.

That's it.

Weston Twigg, with Pacific Crest Securities.

I have three really easy questions.

One is, shipments, last quarter you expected -- you said you expected shipments to trend higher each quarter through the fiscal year.

It sounds like you're saying the same thing today, but I wanted to verify that, that is the case.

The second question is, if you could remind us how much cash you currently have offshore.

And then, the third is, your planned share count for the December quarter.

On shipments, we guided next quarter at $770 million at the midpoint.

And, yes, I think, given the commentary around the second -- or the first half of calendar 2015, we'll see how it lands, but we do expect a step up in activity in the first half of the year.

On offshore cash, our offshore cash position is about -- I don't have the exact number, but about $1.2 billion at this point -- of the total, of the $2.9 billion.

And, share count that we're modeling is about 165 million in December.

Very helpful.

Thank you.

Operator, that concludes our call for today.

Thank you all for joining, and we look forward to seeing you later on in this quarter.

This concludes today's conference call.

You may now disconnect.