科磊 (KLAC) 2017 Q1 法說會逐字稿

Good afternoon, my name is Christine, and I will be your conference operator today. At this time, I would like to welcome everyone to the first quarter FY17 earnings call.

(Operator Instructions)

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

Thank you, Christine. 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 to discuss first quarter results for the period ended September 30, 2016.

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, 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.

Today's discussion of our financial results will be presented in non-GAAP financial basis, unless otherwise specified. A detailed reconciliation between GAAP and non-GAAP results can be found in today's earnings press release. These slides will be found on KLA-Tencor's Investor Relations website. There you'll also find a calendar of future investor events, presentations and conferences, as well as links to KLA-Tencor's SEC filings including our annual report on Form 10-K for the year ended June 30, 2016.

In those filings, you'll find descriptions of risk factors that could impact our future results. As you know, our future results are subject to risks. Any forward-looking statements including those we make on this call today are subject to those risks, and KLA-Tencor cannot guarantee these forward-looking statements will come true. Our actual results may differ significantly from those projected in our forward-looking statements. With that, I'll turn the call over to Rick.

Good afternoon, everyone. Two weeks ago, we held a conference call reintroducing the KLA-Tencor story to our stockholders, featuring a message that highlighted how our strategies for growth based on market leadership, customer focus, and operational execution provided the foundation for the outstanding results we achieved in FY16, and set the stage for an exciting future for the Company as we move forward. Today I'm very pleased to announce that we got off to a very solid start in FY17, as KLA-Tencor finished above the midpoint of guidance for shipments and revenue for the first quarter, and exceeded the range for non-GAAP diluted earnings per share.

September quarter orders came in slightly better than our internal forecast, highlighted by strong foundry demand. These results were fueled by strong customer acceptance of new products, and a business model that consistently delivers superior operating leverage, providing the resources to rank KLA-Tencor among the top tier of all technology companies, in terms of returning cash to shareholders. Our recently announced 4% increase in the quarterly dividend level from $0.52 to $0.54 per share is further evidence of our confidence in the strength of our business, and our ongoing commitment to enhance stockholder value.

Our performance in Q1 also affirmed KLA-Tencor's ongoing focus on providing value to our customers, in terms of meeting market requirements and delivering superior competitive offerings. As in the past, a key contributor to the strong demand we're experiencing today is the success of new products across our product portfolio. Our market leadership is sustained by ongoing successful execution of a product strategy that's focused on intersecting markets needs, with a portfolio of complementary solutions to address the broad range of yield challenges customers are facing at the leading edge.

And the pace of new product introduction continued at a rapid clip. Over the past 12 months, we have launched two new products in broadband plasma wafer inspection, as well as new products in laser scanning wafer inspection, e-beam review, unpatterned wafer inspection, and mask inspections.

In our flagship broadband plasma optical inspection portfolio, the new Gen 5 platform is currently addressing early yield learning challenges, and engineering analysis applications critical to both EUV and advanced optical lithography design rule development. We have also recently introduced upgraded capability for our Gen 4 product line, to meet high volume inline monitoring needs of customers who are ramping 10 nanometer capacity. The expanded Gen 4 platform is currently experiencing very strong customer acceptance in the marketplace, and is exceeding our own expectations, both in terms of market reception and operational execution.

We're also very encouraged by the strength we're seeing today in mask inspection. Our leading edge mask inspection portfolio is not only being incorporated into our customers' optical mask inspection techniques, but it is also the preferred technology to support early adoption of EUV, as customers work to qualify masks for this very important technology inflection.

So to summarize our Q1 results, demonstrate our strategies are working, and the Company is operating from the position of strength. As we look ahead to the December quarter and beyond, the stage is set to build on this success, and deliver what we expect to be an exciting year for the Company in 2017. Given our leading market position, our focus on customer collaborations, and with our continued operating discipline, we believe KLA-Tencor is well-positioned to successfully execute our strategies, and achieve growth in calendar 2017, consistent with our long-term revenue growth objective of 5% to 7%. This is against a backdrop of WFE growth forecast to be in the low to mid single-digits for the year.

Now turning to the guidance for the December quarter. Q2 shipments are expected to be in the range of $800 million to $880 million. Revenue for the quarter, expected to grow approximately 11% sequentially at the midpoint of our guidance to a range of $805 million to $[865] million, with non-GAAP diluted earnings in the range of $1.28 per share to $1.48 per share. I'll now turn the call over to Bren Higgins for his comments. Bren?

Thanks, Rick, and good afternoon, everyone. The September quarter represented another solid period of financial performance and operational execution for KLA-Tencor. Revenue was near the top end of the range, and earnings per share finished the quarter above the range, driven by strength in gross margins that continue to reflect strong differentiation of our products in the marketplace.

Revenue for Q1 was $751 million, and fully diluted non-GAAP earnings per share was $1.16. GAAP diluted earnings per share was $1.13 in the quarter. In our press release, you will find a GAAP to non-GAAP reconciliation of the $0.03 difference. With the exception of when I explicitly refer to GAAP results, my commentary will be focused on the non-GAAP results, which exclude the adjustments covered in the press release.

In regards to highlights of the Q1 demand environment, we are no longer reporting quarterly booking results or quantifying order guidance in terms of dollar amounts, but we will continue to share our perspective on the current quarterly demand picture to give investors insight into industry trends. End market [mix] estimates for the December quarter are based on current forecasts.

Foundry was 69% of new semiconductor system orders in September. Foundry bookings featured strong demand across our product portfolio to support leading edge development projects. Although foundry is expected to decline to 30% of total system orders in Q2 due to project timing, we are currently expecting foundry orders to grow in the first half of calendar 2017, compared with the second half of this calendar year.

Memory was15% of new system orders in Q1, with demand evenly split between DRAM and NAND. Memory orders are expected to jump to [60]% of the total in December, largely due to concentration of orders to support a single new memory project build out in Korea. Logic was 16% of new system orders in the September quarter, and is expected to be approximately 10% of the Q2 order mix.

In terms of distribution of orders by product group for the first quarter of the FY17, wafer inspection was approximately 37% of new system orders, patterning was approximately 33% of orders. The patterning order profile includes mask inspection system bookings. Service was 28%, and non-semi was approximately 2%. Total shipments in Q1 were $786 million, and in the upper half of the guided range of $735 million to $[815] million. Looking forward, we are modeling December quarter shipments to grow sequentially 7% at the mid-point, and be in the range of $800 million to $880 million.

Turning now to the income statement. Revenue was $751 million, finishing at the top end of the range of guidance for the quarter. We expect revenue to grow approximately 11% sequentially at the mid point to a range of $805 million to $[865] million in the December quarter. And our current forecast shows revenue levels in the first half of calendar 2017 growing in the mid to high single-digits, compared with the second half of calendar 2016, consistent with our long-term annual growth target of 5% to 7%, and driven by our strong backlog and expected order profile for the next few quarters.

Gross margin was 63.1% in Q1, and nearly flat compared with the record gross margin result we posted in the June quarter. In spite of the sequential quarterly decline in revenue, the strong gross margin performance in Q1 reflects the benefit of a more favorable product mix than was originally modeled for the quarter, lower parts expenses in our service business, and lower inventory reserve expenses associated with new product transitions. We expect gross margin to be in the range of 62% to 63% in the December quarter, down slightly versus the September quarter, principally due to a less favorable product mix in the revenue plan, offset by increase in revenue.

Total operating expenses were $220 million, down $6 million compared with the June quarter, and operating margin was 33.8% in the quarter. We expect quarterly operating expense levels to remain at the $220 million level, plus or minus a few million for the next several quarters, and to continue to deliver strong operating leverage, in what we expect to be a growth year for the Company in 2017.

Our effective tax rate was 20% in the quarter, just below our long-term planning rate of 21%. The lower tax rate in the quarter largely reflects the benefit of early adoption of a new accounting standard for stock-based compensation. You should continue to use 21% for modeling purposes. Finally, net income for the September quarter was $182 million, and we ended the quarter with 157 million fully diluted shares outstanding.

I'll turn now to the highlights from the balance sheet, and our cash flow statement. Cash and investments ended the quarter at $2.5 billion, roughly flat with the June quarter. Cash from operations was $170 million in the quarter, and free cash flow was $160 million. In September, we paid in aggregate $89 million in regular quarterly dividends, and dividend equivalents for fully [vested] restricted stock units, and made a supplemental payment of $40 million towards our outstanding term loan. To date, the total amount of payments, the principle on our term loan has amounted to approximately $214 million since it was added in the December quarter of 2014.

In conclusion, KLA-Tencor's results in September signal a strong start for the Company in FY17, and coupled with expectations for the December quarter, position the Company for strong relative growth versus the wafer fab equipment market in calendar 2016. This performance demonstrates the Company's market leadership, the strong customer acceptance of a portfolio of solutions addressing the most critical yield requirements at the leading edge, and our operational core competencies.

Given our strong backlog, and with the expected growth trajectory in new orders, including a book-to-bill forecast of greater than 1 in the December quarter, and our first half of 2017 order profile that is stronger than the second half of 2016, KLA-Tencor is in a position for a year of solid growth in 2017. With that, to reiterate our guidance for the December quarter is, shipments in the range of $800 million to $880 million, revenue between $805 million and $[865] million, and non-GAAP diluted EPS of $1.28 to $1.48 per share, with GAAP EPS of $1.26 to $1.46 per share. This concludes our remarks on the quarter. I'll now turn the call back to Ed to begin the Q&A.

Okay. Thank you, Bren. At this point, we would like to open up the call to Q&A. And 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. Please feel free to re-queue for your follow-up questions, and we'll do our best to give everyone a chance for follow-ups in today's call as time permits. Christine, we're ready for our first question.

(Operator Instructions)

Timothy Arcuri, Cowen and Company.

Thank you so much. I had two. Nice, nice job, guys. I guess, the first question is really, Rick, on 7 nanometer, the last really economical node in foundry we had was 28 nanometer. But recently a host of companies, most recently TSMC are now talking about 7 nanometer being very big, maybe even as big as 28 was. So I'm curious on getting your perspective on wafer demand at that node, and how much of this maybe has been bought already, in the orders you got for 10 in the third calendar quarter? And how much of that is still on the comp? Thanks.

Thanks, Tim. Yes, I was in Asia last week revisiting and getting reacquainted with our customer base, and there is a lot of excitement, I think about the potential for 7 nanometer to your point. Most of the investment that we've seen so far in terms of production investment has been for 10 nanometer. We have seen investment for the development in 7, and even some looking forward to 5. So I would say most of what happened was to date that we've seen is 10, and we do expect to see continued strength as we go forward in, for 7 nanometer. Bren, anything to add to that?

Yes, I think, Tim, we've had, and foundry has been very strong. And even though it drops off this quarter, we think it's -- we see a bounce back into the -- into the first half of calendar 2017. There is always a dynamics about how the capacity ultimately gets filled by the people following the leaders, and so customers will try to optimize their capacity as much as they can. So to the extent they try to use some of that equipment, they may try. But I think given the challenges in the node, and what we're hearing about the size of it, we feel pretty confident about the foundry trajectory into the calendar year.

Thanks a lot. And then I guess, the second thing, I want to talk a little bit about memory because it looks like there is some up tick in the adoption of inspection in memory here. In this next round of orders you had cited some big orders coming out of Korea during the fourth quarter. Can you talk about what going on in memory? Is there an uptick in inspection intensity in memory, and particularly why is it happening, and can it sustain going forward? Thanks.

Yes, it's not just inspection. I think process control in general, we are seeing some strength, and I think it kind of goes across the portfolio. I would attribute the increase in inspection to memory, which we have seen some, is more a function of Gen 5, where we've had some placements there, that maybe in the past might have been served by alternate technologies like e-beam. So we've seen some strength, albeit modest at this point.

But metrology is also growing. And a lot of that has to do with some of the challenges, in terms of things like registration, and so the overlay business and some of the films businesses. So we're feeling pretty good about it. It's not at the intensity levels, of course, of foundry, but it is significantly up from where had been in prior nodes, and we see strength, to going forward there.

Thank you, guys. Appreciate it.

Farhan Ahmad, Credit Suisse.

Thanks for taking the question. Rick, I had a question on Gen5. Just in terms of how, where you're seeing that option of Gen 5 versus Gen 4, and how we should think about the ramp of Gen 5 next year? And also, I, well, at the Analyst Day at SEMICON, you first talked about Gen 5. You talked about potential to gain some of the layers from e-beam applications. And is that something that you're already starting to see?

Farhan, thanks for the question, yes. We feel pretty good about Gen 5. I think that what we were hoping for, is to get it out, mainly as a discovery tool. So way back in SEMICON in 2015, we talked about the discovery market, and our goal over time was to get to 50% of that market served by optical.

I think by, at the run rate that we have now, at the end of calendar 2016, we're addressing about a third of that market. So I would say we have about a third of that market. And our target remains, that by the end of 2017 to be 50% of that market. Part of it, the market grew a little bit because e-beam was just, is not capable of satisfying some of it. So there was a gap in terms of functionality, in terms of whole wafer. But the displacement I think is going on, we're seeing Gen 5 adopted more broadly.

Gen 5 really doesn't go into production though and replace Gen 4 until future nodes, when the critical defect size gets smaller, and you can really think about that more in terms of the adoption of EUV lithography. So for now, it's doing what we hoped it would do. Customers like what they see. It's a new product, so, of course, there's improvements that we need to keep making, but we think we're on track for the plan that we laid out a little over a year and three months ago.

Yes, Farhan, the only thing I'd add to that is, I mean, we're pretty much in line, to Rick's point, with what we thought we would be, we'd have four or five units revenued in this calendar year, and then that number would probably double or so, so let's say 8 to 10 units into calendar 2017. So to Rick's point, given our objective as being to 2017, we think that's how the adoption plays out. Most of what we're seeing in terms of 10 nanometer production is really being driven by the Gen 4 product line, and the reception has just been strong for that, and it's capability. So we're really encouraged by that, the extendability we think it has, has moved into 7. And the two will be mix and matched and paired to meet discovery high end production, and then ultimately high volume production type use cases.

Got it. And then, my second question is on the foundry, there's been a big growth in foundry [investments] in China this year. I wanted to understand, like from your perspective, how much of the foundry demand this year is coming out of China, China foundry? And as you think of about the 28 nanometer ramp at those foundries, how do you think that will play out to your advantage, as you typically have a very strong process control intensity at 28 nanometers from what we, first wave of foundry investment that we saw?

So on the foundry business overall, I mean, we had a record year in China in FY16, so the year that ended in June in bookings. So those tools will be [revenue-ing] through the course of this year. So I would say of our total foundry business in the year, maybe 30%, 35% or so of the total is probably foundry.

Yes, and I was there last week, meeting with customers, and I think this 28 nanometer demand, this is -- there is a lot of investment going on as you know, there is a lot of new employees. I think they are counting on us to help educate and train and support them as they ramp these new fabs, and they've got very aggressive ramps. So I think we look forward to good business, and being able to support our customers as they go through there, and I think that we see the intensity being similar. In fact, in some ways, because in many cases you're starting a greenfield for some of these facilities, the intensity ends up being front-end loaded for some of them, so it's even higher as we go forward. So we're looking forward to great things in our China operation.

Yes, and to clarify, I meant 30% to 35% of the foundry business was China.

Got it. Thank you. That's all I have.

Next question comes from Harlan Sur from JPMorgan.

Good afternoon, and congratulations on the solid results and great margin profiles. Given a view of WFE growth next year, and obviously your business growing in line or better than that, we should see the [teen], roughly around $3.3 billion in revenues in calendar 2017, a combination of industry growth, momentum in Gen 4, Gen 5, and your other new products. And if you continue to drive the better performance in the margin front, it feels like operating margins in the kind of 36% to 38% range would seem achievable. I'm not asking you guys to endorse the $3.3 billion revenue number, but if you were to be at those levels, does 36% to 38% operating margin sound reasonable?

It, Harlan, it's Bren. So I mean, just following the math, to the point that if we think we're going to grow in line with the market into next year, and the market forecast that we laid out, you end up with that revenue level. I think that's fair. I think we're seeing some tailwinds in gross margin right now, that we've seen for several quarters. But I think as we start to transition into some of the newer products, some of the benefits we've seen around warranty and support costs, and efficient cycle times, and things like that, I think some of that goes away.

Now I do think, and as I've said in the call a couple of weeks ago, I do believe that versus the model we published, that we're operating probably a solid 100 basis points above what we had put out there so, and I think that's sustainable. So I think some of what we're seeing today, it would be hard for me I think to replicate that type of gross margin profile into next year. So there might be a little bit of degradation there. So given at that revenue level, the range you mentioned probably feels a little bit hot, but I would say you're probably in that 35%-ish range, plus or minus 100 basis points or so.

Great.

Now there's a lot of factors in that mix and so on, but that's how I would characterize it.

Great. Thanks for the insights there. And we've tended to focus on the Gen 5 and 29, 30, and 29,35 upgrade cycles in some of our most recent reports, but obviously you guys are driving new product cycles across bare wafer inspection, review, [dark field] inspection, and, of course, your new reticle inspection platform. I'm sure you guys track this, but can you give us a view of the mix of your new platforms, as a percent of your current bookings? And maybe some comparison of that to some of your prior cycles?

The comparison will be tough. I mean, I don't really have that data. We are booking a lot of these new platforms, things that have come out in this last year, right so? And even in the more trailing edge businesses like in China, they are buying the latest gen of tools, right, with the ability to try to use that capability as they ramp through this early development of new technology there. So I would say, the majority -- a pretty solid amount of the business is new products, but I don't have the actual percentage.

Great. Thank you.

Steven Chin, UBS.

Hey, guys, thanks for taking my question. Related to the foundry opportunity in China, there is an announcement of a ramp of 8 inch and 12 inch capacity earlier this week. I just want to get a sense of, and sort of size this. Looking back the last few years, I see that [some] customers sort of mix between four big customers. Can you maybe give us a sense of China foundry customers getting into that category?

I guess, I'm not sure exactly the question, sorry, Steven. But the -- ?

I'm just trying to -- like I guess, simply how big do you think the China foundry opportunity could be?

Oh, I see. Well, you know, Bren talked about the percent of our business that we have. If we look back, just to give you an idea of FY16 to finish, China was the second biggest market for us, and that was partly because there was some underspending going on. But China is pretty significant for KT. And I think as we go forward, you have the combination of this investment, even though it's in maybe [M minus 2] technology, we also have a very significant amount of penetration, and market share, and also that this is higher adoption, because it's foundry.

So they are buying some of our newer tools, and we see a lot of interest in ramping these facilities quickly. They're spending a lot of money. They're trying to grab market share, in some cases, serve the domestic demand. So we feel pretty good about our position there. In fact, if there's an area where we're going to invest more heavily going forward, it's overall to support to the China, China investment cycle. This one is real.

Only thing I would add, while I think that there is certainly some new development activity that's happening there, as they ramping these fabs from a greenfield state, that ultimately it's serving a global market. And so, I think you'll see some movement around in terms of who gets market share, but there will be an inflection in the short term. Probably some of it doesn't necessarily contribute to supply, but over time it eventually will. So I think the overall foundry dynamics in the long run, will stay pretty consistent. But there's certainly a commitment there, and there's a focus to Rick's point, not only on the ramping of new technology, but also our market position there is very strong.

Thank you.

Edwin Mok, Needham & Company.

Great. Thanks for taking my question. So I guess, first question on the patterning part of your business, I think on the last call, you guys talked about increased focus there on patterning. Just kind of want to see if you can provide more commentary around that, is there more focus on metrology? And also, guys, in terms of the financial impact, should we expect more R&D spending on that side, which ultimately would increase your OpEx?

I'll take the first part, and then let Bren talk about the second part. We're definitely seeing demands associated with multi-patterning, right, and also EUV. I would say the EUV work is in the reticle space, where we do have tools that are dedicated now to EUV, in terms of our 6xx, some of our newest 6xx capability, people are buying for EUV. So that's early days, of course, for that.

In terms of overall challenges, customers, whether it be registration overlay, film thickness or optical CD, all of those things are potential areas for growth. We're doing well. We think there is more upside to them, and we feel good about our competitive position. Now whether or not, we see significant increases in the next 12 months, but I think over time, there is a potential to keep that business growing. And from an investor's standpoint, Bren, you can talk a little bit about how we thought about that?

Yes, I mean, we've got a pretty active portfolio management process here in the company. And I think, given the strategic reorganization we did a year ago, we have the ability to move capital around much more freely than we did in the past. So we will continue to execute our process. We have been investing in those businesses. We'll continue to do so. I gave some guidance in the prepared remarks around what I expect OpEx levels to be overall, and there is a bit of an increase there, and we're trying to drive the focus of that to be mostly R&D, with an overall target of 60% of the R&D expenses, or the overall OpEx as R&D.

Okay. Great. That's helpful. And then, I guess just circle back to China, on maybe just increased level of investment we see on the trading (inaudible). I think you talked about a lot of selling your new product, and customers buying your new products. But to the extent you buy older generation products, because that's what they need for the 28 or higher node, should we expect some pricing pressure on that, and just because they're more legacy tools?

I don't think that's really what we're seeing. I mean, right now, we do have some ability to flex the different tool capability people need. But a lot of these facilities don't think they're going to stay at 28. So there's a desire to have newer capability. And, of course, it doesn't hurt them to have it, when they're doing their 28 work, but they're hoping they're going to go obviously lower than that. So I think we're in pretty good shape regardless of where they buy in the portfolio.

It's not quite the same, and I'll give you a very different example. If you think about some of the investment going on in the Internet of Things where people might be in automotive or they're in sensor technology, then we're talking about older tool sets, and maybe even some our [KT Pro] stuff, which is reconfigured or refurbished tools. That's not what we're seeing in our markets in China for the most part. Maybe there will be an element of that later, but that's not what it looks like right now.

Great. Thank you.

Jagadish Iyer, Summit Redstone.

Yes, thanks for taking my question, Rick. Two questions, first, what is the termination of deal with Lam, how much of your effort is focused on putting on the EUV mask inspection? And can you give us some clarity, in terms of the line of sight from this product line, as ASML prepares to ship a dozen tools next year? And then, I have a follow-up.

So the way we're serving the EUV market is with the 6xx series that's has been out several years, and we have some additional capability to do that. So that's already part of the portfolio, and had nothing to do with any discussions we had with other companies. That's out there, and now we're seeing their demand, some demand for that.

I can't really say at what point that's going to ramp, because for a long time, it was a part-time application for some customers. But we are seeing some dedicated purchase of those tools for that capability, and it really will depend on how many starts they have, in terms of different types of devices, how many masks they have. But whatever they have, with a adequate lead time, we're prepared to serve it.

We don't -- it's not really about additional development beyond the capability that we have, and some software upgrades, and algo upgrades in that platform. We're not talking about a new platform, which we talked about several years ago. That's not what we're doing. We're not doing an actinic inspector, we're developing additional capability on our existing products to serve it.

Okay. Fair enough. And then --

The only other thing on that is that we would add is, that they will do flop-down inspection to qualify reticles, certainly for re-qual capabilities, and incoming quality checks where they'll basically print the wafer, and do Gen 5 inspections on the wafer to qualify reticles, as another check point in terms of making sure reticles are good.

Okay, fair enough. Then on a big picture question, I just wanted to understand, given that there are so many smaller players in the process control segment, what are your thoughts on consolidation post the termination of the deal with Lam?

It's not really an area we're focused on. I mean, it is possible that others might do that, but we feel pretty good about the products that we have, the range that we have, and our ability to satisfy the markets with our organic efforts in terms of process control. So not really something we're looking at.

Thank you.

Patrick Ho, Stifel Nicolaus.

Thank you very much. Rick, first, in terms of some of your comments about memory and inspection, given the transitions that are going on particularly in the 3D NAND front, the capital intensity for metrology is obviously increasing, and it makes sense for your overlay thin films, and even OCD metrology business. What's been some of the key drivers that have gotten at least some Gen 5 evaluations in that marketplace, where traditionally they haven't used as much inspection?

I think that just the fact that there, as customers are looking at the newer technology nodes. First of all, there are more customers trying to get in production. Second of all, as those already in production, are looking to new capability. Just the ability to have a better sense of debugging the process, in terms of, from the discovery phase, not really from in production.

So it's really that. And in terms of their ability to see things they have never seen before, because if they had a e-beam solution, they could find small defects, but they couldn't get a wafer signature. And now they can do both. Now they can find small defects, and get a wafer level signature.

Great. And, Bren, on the supply chain side of things, you guys have performed really well over the last, probably over the last year in terms of seeing the increases in bookings and shipments, and turning this around very quickly. Can you just give a little bit of color, what some of the tactics, and I guess efforts you've made that have had the quick turnarounds you've had on the -- in terms of the shipments from bookings?

Yes, the [NPI] process at KLA, which is new product introduction, where engineering is handing off to manufacturing, on a lot of the new platform transitions that we've had, has been really exceptional. So tools are being handed over to operations, where you have good design stability. Our marketing and sales teams are managing the transitions well with customers, so we're not getting stuck necessarily with a lot of extra inventory, as we move customers from one platform to the next. Because of design stability, you don't have retrofit programs, and other things, where you're out there, trying to fix tools as you're shipping them out.

So it has been a huge factor, I think not only in the conversion but also been factor in the margin profile, A, because of the inventory issues. But also the fact that the service costs around the warranty costs to support the tools, and get them installed quickly has been fairly efficient, and so that's been a factor as well. So very impressed with the teams to being able to do this, and do this in a period of time, where there was a lot of work around integration planning, distraction, and so on. So really impressive work.

I think, the one other thing is, we have taken more risk in terms of inventory risk. So one of the things we've done is provided more flexibility in the master schedule, to be able to react to market demands, especially most of our customers now have very short visibility into their cycle. So we're trying to be prepared, so that we don't get caught out, not having capacity when it's needed.

Great. Thank you.

Atif Malik from Citigroup.

Hi, thanks for taking my question, and good job on the quarter. Rick, can you talk about the yield that you guys are seeing on 3D NAND over the last year or so, they've been a leader in 3D NAND, and there is a bunch of [followers]. I'm just curious, where you think the yields are, broadly speaking on 3D NAND? Is the yield curve on 3D NAND different from other devices, and logic in the DRAM side?

Yes, obviously, given the relatively small numbers of players, I'm going to be careful about this. I would say the leaders feel good about -- the leader feels good about where they are, and I won't comment to that. There are other players getting in the market. And I would say that, we are seeing success, but it is -- if you think about a yield curve, I think there's a long flat part of that curve down around zero. And I think it took a while for people to debug the process.

And frankly, one of the things, one of the areas for opportunity for us going forward, is there's not really a good defect discovery mode for 3D NAND, because there is really no tool capable of helping debug. And even, although -- we have made some attempts, when you do find defects, they are very hard to verify, because you have to essentially de-process or [fib] them to go find it. So I would say it's been slow, in terms of getting started. Now it's getting better. I think that there's -- some people are getting their process, but as they look at expanding to the next technical challenges, we anticipate yield is going to be a big part of the challenge. And I think there's a lot of interest in partnering with us, to come up with solutions to address that. Because obviously, there is a demand there, but that there's certainly getting very challenged by making the processes actually work.

Okay. And then, on the foundry side, we heard from LAM Research yesterday that their expectations for next year, foundry investments are kind of flat to down. And then they talked about maybe a little bit of [digestion] in 10 nanometer, and you're expecting mid to (inaudible) growth in the first half of 2017. Is your optimism based on the success of your new products, or are you assuming investment at foundries will kind of sustain at the level we're [exiting] this year?

I think -- so Atif, this is Bren. I don't think our general view on the year is much different. I think there could be some growth at foundry, as we build it bottoms-up. But we think that we'll see continued momentum around, and my comments were orders. So you'll start to see those tools ship in the second half of the year, that we'll also see, a stronger foundry, shipments and revenue in the second half, related to 7 nanometer activity. So but, I don't know what, how they make up their forecast. But at the end of the day, as I said, I feel like we're not that far apart, generally in terms of how we look at it, how we look at the year overall.

So Bren, just to be clear, you expect orders in first half of calendar 2017 to be higher than the second half of 2016?

Yes, I do. Both for overall, and within foundry.

Got it. Thanks.

Craig Ellis, B. Riley.

Thanks for taking the question. I will start with one that's pretty high level. It's very nice to hear the confident tone on, what can happen in the first half of calendar 2017. So the question is, relative to a year ago, or a little bit more when you were last providing quarterly updates, has the visibility on the business improved? And if it has, to what extent is that improvement due to industry dynamics versus company specific, potentially product cycle dynamics that are at play for KLA?

I don't think it's really changed all that much. I mean, to Rick's point earlier, I think we tried to be as flexible as we can. We've taken some risks. I think we're managing through transitions. And any time we have product transitions, and bring a new product with new capability to the market, there is a level of customer demand that goes with that. So I guess, in one way, on any time you have a transition, you do see some increase in visibility. But we are still reacting to, our customers are facing short lead times with their customers, and trying to expect us to follow suit with that. And we're doing all we can to try to be as flexible as we can to meet their needs.

Maybe the one other thing, though, that is a little different, is the strength that out of China is pretty different, and there are greenfields that are happening. There's big investment happening. So if you think about that part of our business, there's a much more committed, and maybe that could change, but they're more committed, than it was hard to see in the past.

That makes sense. The follow-up is a question on products and next year's outlook. So in a year, where the business has potential to grow 5% to 7% in line with the target model, if a product like Gen 5 can double next year, as I think heard previously, what would some of the other products be, that would be fueling some of that company-specific growth, in a year with a rising top line?

Well, our 5% to 7% of our through cycle multi-year target, right, and that was when we put that together, and said, hey, look from calendar 2015. And as we're sizing and run the business, we're going to position it, so we can deliver that level of revenue growth, and try to have operating leverage that's 2 times the growth rate. I mean, certainly, Gen 5 is a bigger piece, but there will be mix and matching that will happen within broadband plasma. So I think it's really, the strength -- I don't see a fundamental shift in overall mix, as we move into next year. To Rick's point earlier, there could be more investment in reticle inspection, as customers being to prepare for more development activities around EUV, so that could be inflecting product a little bit into the year, year to year. But overall, I think, that the mix looks relatively consistent across the different product segments.

Thanks, guys.

We have time for one more question. Your last question comes from the line of Sidney Ho from Deutsche Bank. Your line is open.

Thanks for taking my question. My first question is, if you look at your annualized revenue for your December quarter, you get to somewhere around [$3.3 billion]. Sorry if the question has been asked before. But if you look at the operating model that you guys put out, you guys should be somewhere around 59% in gross margin. Curious if you think this is a permanent step up in gross margin forecast, or there's some other factors that's driving the upside in the near-term?

Yes, Sidney, we got that question earlier, but just to go over it again, really quickly is, yes, there is -- we've clearly been outperforming the model. I think some of that is due to some of the maturity of the platforms that are out there. We're transitioning to some new platforms. And so, I think we'll lose some of those tailwinds we've had. But to the point I've made earlier, I think we're operating probably 100 basis points or more over that model. And so, as you play that through, I think you'll see the same kind of performance in the operating margin line.

Okay, great. Sorry for asking a same question. My follow-up question is, when I go back to Gen 5 products, it sounds like you guys don't expect Gen 5 to be cannibalizing Gen 4 until EUV is in production. So that would be, put you in 2018 to 2020 time frame. But if you go back to when Gen 4 was in R&D mode per se, is that roughly the same kind of time frame, the same number of tools that you used for R&D before they go to -- they go into production?

Yes, here's the big difference, is, there is no real scaling going on right now. I mean, and until you hit the EUV, essentially with multi patterning, you're not really doing anything relative to defect size. So Gen 4, from lot of customers' perspective, serves that market. So it's really, people want more sensitivity, but it's more about discovery. Frankly, if they had to deal with those same defects on the earlier nodes, on the current nodes, that they wouldn't be able to be in large-scale production. So it really is hinged on, when you see advanced technologies going into production, a la EUV.

Okay, great. Thank you.

Thank you. Mr. Ed Lockwood, I turn the call over to you.

Okay, thank you, Christine, and thank you, everyone for joining us on the call today. A reminder, that an audio replay of today's call will be available on our website later on this afternoon. We appreciate your interest in KLA. Thank you.

Thank you, ladies and gentlemen. This concludes today's conference call. You may now disconnect.