KLA-Tencor F2Q07 (Qtr End 12/31/06) Earnings Call Transcript

Feb. 5.07 | About: KLA-Tencor Corporation (KLAC)
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KLA-Tencor (NASDAQ:KLAC)

F2Q07 Earnings Call

February 5, 2007 8:00 am ET

Executives

Jeff Hall - Chief Financial Officer

Rick Wallace - CEO

John Kispert – President, COO

Analysts

Jay Deahna – JP Morgan

Jenny Yun – JP Morgan

Harlan Sur - Morgan Stanley

Mark Fitzgerald - Banc of America Securities

Jim Covello - Goldman Sachs

Tim Arcuri - Citigroup

Analyst for Edward White - Lehman Brothers

Brett Hodess - Merrill Lynch

Satya Kumar - Credit Suisse Securities

Gary Hsueh - CIBC World Markets

Suresh Balaraman - ThinkEquity Partners

Mahesh Sanginario - RBC Capital Markets

Steve O'Rourke - Deutsche Bank

Mehdi Hosseini - FBR

Stephen Chin - UBS

Robert Maire - Needham & Co.

Mark Bachman - Pacific Crest Securities

Presentation

Operator

I would like to welcome everyone to the KLA-Tencor second quarter 2007 earnings conference call. (Operator Instructions) I will now turn the call over to Mr. Jeff Hall, Chief Financial Officer. Sir, you may begin your conference.

Jeff Hall

Good morning and welcome to KLA-Tencor’s second quarter of fiscal year 2007 earnings conference call. I am Jeff Hall, Chief Financial Officer. Joining me on our call today are Rick Wallace, our CEO; and John Kispert, our President and COO. We're here today to discuss our second quarter results for the period ended December 31, 2006. We released these results this morning at 4:30 a.m. Pacific time. If you haven't seen the release or the recent SEC filing, you can find them on our web site at www.KLA-Tencor.com or call 408-875-3600 to request a copy.

On the investor section of our web site you will find a simulcast of this call, which will be accessible on demand for 90 days. On the web site, you will also find a calendar for investor events and presentations at investor conferences. You will also find links to KLA-Tencor's security filings. In those filings, you will find descriptions of risk factors that can impact our results. As you know, our future results are subject to risks and any forward-looking statements we make are subject to those risks and are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

KLA-Tencor cannot guarantee that any of those forward-looking comments will come through, and although we take no obligation to update those forward-looking statements, you can be assured any updates we do make will be broadly disseminated and available over the web.

We have a lot to cover today. I will start with a brief overview of the restatement and the June and September results that were released last week. I will then turn it over to Rick who will discuss industry developments and KLA-Tencor's recent progress and strategies. I will then review the financials for the December quarter and then we will open the call for questions.

As most of you know, on January 29 we filed our 10-K for the year ended June 30, 2006 and our 10-Q for the quarter ended September 30, 2006. These filings brought us back into compliance with all SEC reporting requirements and NASDAQ listing requirements. The delay in these filings was the result of the stock options investigation and resulting restatement. The investigation found that there was retroactive pricing of stock options; less than 15% of the retroactively-priced stock options were granted to senior executives. Retroactive pricing occurred primarily from 1997 to 2002 and no current members of management were involved in the retroactive pricing.

As a result of these findings, we have restated our financial statements back to 1995. Total share-based compensation charges were $376 million. $348 million of this charge was for fiscal 2005; $22 million of this charge was for fiscal 2006; and $6 million of this charge were for periods after fiscal 2006. The majority of this amount hit the quarter ended September 30, 2006. Other than the stock options issued, the investigation found no evidence of any financial reporting or other accounting issues.

Moving on to the June and September quarters, since this is all historical data and we have published the 10-K and 10-Q for these quarters, I'm only going to cover the highlights. If you have any questions on the details, I will be happy to take them in the Q&A.

Revenue for the June 2006 quarter was $579 million, up 11% from the March quarter and up 18% from the June quarter in the prior year. Net income for the June quarter was $132 million or $0.65 per diluted share. This EPS includes $0.13 of share-based compensation. The approximate breakout was COGS, $0.05; R&D, $0.06; SG&A, $0.08; and a tax benefit of $0.06.

Net income for the June quarter also included the following pre-tax charges: $27 million, or $0.08 per share, to cost of goods sold related to exiting the [CDM] business and $21 million or $0.07 per share to SG&A for expenses related to the stock option investigation. In the June quarter, cash from operations was $130 million, capital purchases were $15 million, and depreciation was $17 million.

Moving to the first quarter of fiscal 2007 ended September 30, 2006 revenue for the quarter was $629 million, up about 9% quarter to quarter and up 30% year over year. Net income for the September quarter was $136 million or $0.67 per diluted share. This EPS included share-based compensation of $0.13 and the approximate breakout is: COGS, $0.04; R&D, $0.06; SG&A, $0.09, and a tax benefit of $0.06. Net income also included pre-tax expenses related to the stock option investigation of $2.5 million or $0.01 per share. In the September quarter, cash from operations was $107 million, capital purchases were $12 million, and depreciation was $15 million.

With that, I'll turn it over to Rick.

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Rick Wallace

Thank you, Jeff and thank you for joining our earnings call for the second quarter FY07. Today I'll be discussing the highlights for the December quarter, updates on key product activity, and guidance for the March quarter.

In the December quarter, the company continued to execute on delivering new products and producing solid financial results. I'll begin with a quick rundown of the numbers and then I'll provide my perspective.

Orders for the December quarter were $725 million, up 12%; revenue was $649 million, at the lower end of our guidance. This was a timing issue resulting from a special upgrade we did to meet customer needs. Shipments were at the high end of expectations at $700 million; and excluding special charges, net income was $147 million or $0.72 per diluted share, including stock-based compensation. This strong financial performance is the result of meeting our customers' needs with the right products and services to help them be successful.

Memory was about 50% of orders, and again, the strongest segment in the December quarter with significant DRAM spending. NAND remains soft at only 30% of our memory bookings. Logic at around 30% of orders was also strong in December with investment and capacity in the U.S. the primary driver. Boundary was at the lowest segment at 15% of bookings. Boundary continued to spend under their historical rates as they cautiously add manufacturing capacity to existing fabs. We expect an increase in foundry orders as we go through 2007 in order to build out 65 nanometer capacity.

Looking ahead to 2007, we see a healthy semiconductor industry, but with some softness in specific markets. Current projections are for semi revenues to be up 5% to 7% and for CapEx to be flat to up 5% in 2007.

Let me now give you a couple of updates on our product activity. We continue to demonstrate our product leadership at the leading edge. Our Puma Darkfield inspection system continues its success as one of KT's fastest adopted products. In the December quarter, the 9130 won a head-to-head at a major Taiwanese memory fab because of our breakthrough Streak technology provided both high sensitivity for etch line monitor and high throughput for tool monitor applications.

Our 2800 Brightfield tool demonstrated superior DRAM performance for next generation design rules. A major Korean memory manufacturer chose the 2800 after it demonstrated five times better capture rate and 40% faster throughput than the competition on a critical layer.

During the December quarter, we also announced two new products: the VisEdge CV300 and the Archer 100 that will help our customers address the increasing lithography challenges including immersion and double patterning. With the recently announced acquisition of Thermawave, we are looking forward to extending our market leadership in metrology and supporting our long-term growth strategy. Thermawave’s portfolio of technologies in thin film and optical CD are complementary to KT’s existing solution.

In addition, Thermawave’s strong position in the growing implant dose monitoring market represents a new opportunity for us. We expect the deal to close in the March quarter, at which point we'll focus on integrating Thermawave and continuing to support their customers.

I am also pleased to announce that we have recently completed acquisitions of two private companies, OnWafer and SensArray, whose main products are on wafer metrology tools which solve the difficult challenge of controlling critical dimensions in both lithography and etch. This high precision measurement capability is critical for process development, tool matching, equipment maintenance, and production monitoring and is complementary with KLA-Tencor’s broad range of advanced metrology solutions.

Across the industry, the problems and challenges of qualifying 45 nanometer are significant. We are actively working with customers on multiple aspects of 45 nanometer adoption as evidenced by nearly one-quarter of our bookings being for 45 nanometer and below in the December quarter. As always, we have a number of new products under development and plan several new product introductions over the next several months that are critical to 45 nanometer.

Wrapping up, let me give you our guidance for March: orders down 5%, plus or minus 10%; revenues up between $700 million and $715 million; and shipments about $700 million; EPS of $0.76 to $0.79, including stock-based compensation. We will continue to see margin leverage over the mid to long term as we progress on our strategy. The company is strongly positioned to continue to outgrow the industry in 2007.

Our growth in yield management and process control is driven by the ROI that our tools provide for our customers. Our industry-leading products continue to enable our customers to meet their technical challenges and increase their profitability.

Now I will turn the call back to Jeff.

Jeff Hall

Thank you, Rick. We closed our acquisition of ADE on October 12, so the results for the second quarter include ADE from October 12th through December 31. As I told you on the call last quarter, we expected ADE to contribute bookings of $30 million, revenue of $20 million, be slightly dilutive to gross margin, and add $10 million to fixed costs. ADE performance was in line with our expectations. As I told you last quarter, since we are running ADE as a division of KLA-Tencor, we do not intend to break out or discuss the numbers on this call or going forward.

Net bookings for the December quarter were $725 million. Each quarter we review our backlog in detail and de-book in accordance with our bookings policy that restricts actual bookings to a set criteria. The set criteria mandates that technical specifications are signed off, valid terms and conditions are finalized, and delivery is scheduled within 12 months. This quarter, we de-booked $21.8 million of orders. Backlog for unshipped orders was $23 million in the quarter at $1 billion, or approximately five-and-a-half months at current shipping levels. We do not include any service bookings in this backlog number.

In addition, deferred revenue was up $54 million to $558 million, or about three months at current revenue levels. This is invoiced systems revenue deferred under SAB 104. It includes no service revenue and is made up of tools delivered but awaiting written acceptance from the customer.

We remain confident that we have a strong backlog shippable over the next six to nine months. Our ability to maintain this significant level of both shipment and revenue backlog continues to help KLA-Tencor sustain profitability throughout any business cycle.

The regional distribution of orders for the December quarter was as follows: the U.S. was 22%, lower than its historical average of 25%; Taiwan was 25%, higher than its historical average of 20%; Korea, China, Singapore combined were 23%, higher than their historical average of 20%; Europe was 9%, lower than its historical average of 10%; and Japan was 21%, lower than its historical average of 25%.

The product distribution of orders was: wafer inspection was 46%, reticle inspection was 13%, metrology was 25%, data storage was 2% and service was 14%.

Before we start with the income statement, let me summarize the special charges in the quarter. They fall into three separate buckets:

First, as we continue to execute on our four-year plan to restructure the business and increase operating margins, we incurred $67 million in one-time charges in the quarter. As we consolidate our facilities requirements, we put some buildings up for sale and as a result, wrote them down to the expected market value, resulting in a non-cash charge of $57 million. We also incurred $10 million in charges related to a reduction in force.

Second, we had $19 million of non-cash charges related to acquisitions, primarily ADE. $10 million is included in COGS, $3 million is included in R&D, $6 million is included in SG&A. In the March quarter, we expect $15 million of charges related to acquisitions. These estimates exclude potential charges for OnWafer, SensArray, and Thermawave, as we have not yet completed the purchase price allocation for these transactions and Thermawave has not yet received the required regulatory approvals.

Third, we had $15 million of expenses related to the stock option investigation. $11 million of compensation costs for the reimbursement of non-executive employees for penalty taxes under IRS section 409-A; and for lost benefits under the company's employee stock purchase plans; and $4 million for legal, accounting, and other costs. We expect to occur approximately $25 million of compensation expenses in the March quarter to resolve the remaining issues related to IRS section 409-A for non-executive employees.

Now, turning to the income statement. Revenue for the December quarter was $649 million, up about 3% quarter to quarter and up 33% from the same quarter last year. Revenue in the quarter was at the low end of our guidance as in order to help one of our customers solve an extremely difficult problem, we delivered a special upgrade to a toolset that we had expected to revenue in the quarter. Since the product solutions as upgraded has not been released, we were not able to take revenue on the tools in the quarter, even though the customer has signed the acceptance for the tools. As a result, approximately $15 million of revenue moved from the December quarter into the March quarter.

Gross margin for the December quarter was 54.4%. This includes $1 million in costs related to the reduction in force; $10 million of charges for acquisitions and deal-related amortization; and $3 million for the reimbursement of penalty taxes for non-executive employees. Excluding these items, gross margin was 56.5%. This is down about 60 basis points from Q1. Half of this decline was from the integration of ADE, which as we told you on the last call would be slightly dilutive to gross margins in the quarter. The balance of this decline was related to the movement of revenue from December to March I discussed earlier, and duplicate costs incurred as a result of the move of one of our products to Singapore. Gross margins excluding share-based compensation was 57.7%.

Operating expenses, including both SG&A and R&D, were $275 million. This number includes: $57 million of non-cash charges related to the writedown of buildings; $9 million of costs related to the reduction in force; $9 million of charges for acquisitions and deal-related amortization; $4 million of expenses for investigation costs; and $8 million for reimbursement of penalty taxes for non-executive employees.

Excluding these items, operating expenses for the December quarter were approximately $187 million. This includes a $20 million benefit related to the cancellation of a former executive equity award. Excluding this benefit, operating expenses were $208 million, up approximately $5 million from the prior quarter, as efficiencies realized in the quarter partially offset the increase from the addition of ADE. Excluding stock-based compensation, operating expenses were $179 million.

For the December quarter, other income was $22.7 million. The effective tax rate was 11.5%. This rate was lower than our ongoing tax rate of 28% as a result of the one-time charges in the quarter and the retroactive renewal of the R&D tax credit. For the remaining quarters of fiscal year 2007, we continue to anticipate that our tax rate will be approximately 28%.

Net income for the December quarter was $90 million. Excluding the one-time charges discussed above, net income was $147 million or $0.72 per fully diluted share. This number includes share-based compensation expenses of $0.05 per diluted share and the approximate breakout is as follows: COGS, $0.04; R&D, $0.05; a benefit in SG&A of $0.02 as a result of the cancellation of a former executive’s equity award; and a tax benefit of $0.02.

In the March 2007 quarter, we expect share-based compensation to be about $0.11 per diluted share and the approximate breakout is: COGS, $0.04; R&D, $0.05; SG&A, $0.07 and a tax benefit of $0.05.

Now, turning to the balance sheet. Cash and investments at December 31 were $2.1 billion, a decrease of $283 million quarter to quarter. We spent $390 million on the ADE acquisition, in line with our strategy of growing the business through targeted acquisitions.

During the December quarter, our stock repurchase program remained suspended. However, we expect it to resume this Thursday. We paid a dividend of $24 million, inventory increased by $74 million to $565 million, primarily as a result of the ADE integration and increasing shipments to Japan; accounts receivable finished the quarter at $449 million, up $33 million from September, again as a result of the ADE integration and the increase in shipments.

Capital additions were approximately $19 million for the quarter as we continued the construction of our new facility in Asia. Depreciation was $15 million so on a net basis, including retirements and the writedowns of buildings I discussed earlier, fixed assets decreased by $39 million in the quarter.

Headcount ended the December quarter at 6,250 up approximately 400 from September as a result of the ADE acquisition.

Finally, to recap the guidance Rick gave for March, bookings down 5% plus or minus 10%; shipments of about $700 million; revenue between $700 million and $715 million; operating expenses up 1% to 2% which includes approximately $4 million for the addition of OnWafer and SensArray; tax rate of 28%; and EPS, including share-based compensation but excluding one-time charges and deal-related amortization, of $0.76 to $0.79. Deal-related amortization, excluding charges for OnWafer, SensArray and Thermawave is expected to be $14.5 million. In March, we also expect to incur $25 million of compensation expenses to resolve the remaining issues related to IRS Section 409-A for non-executive employees and this guidance does not include Thermawave.

This concludes our remarks on the quarter. We will now open the call for questions. Before I turn the call over to Luan to give the polling instructions, let me request that you refrain from asking multi-part questions to give others some time. As always, we're all on a tight schedule. Luan, can you begin the polling, please?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Timothy Arcuri - Citigroup.

Timothy Arcuri - Citigroup

Hi, guys. A couple things. First of all, looking at the push outs that the other folks saw recently, it sounds like you didn't see those sort of push outs. I guess as you look out to the June quarter, I know it's difficult, but typically June is up seasonally for you; is there any reason to believe that wouldn't be the case this time?

John Kispert

On the push outs, what we saw -- I'd say over the last 45 days or so -- is some movement, but I'd call it net zero movement. As you guys all know, there's some JVs that are moving production around joint ventures, from one region to the other. Certainly some folks who are deciding who is going to fund what and when. But I'd say we saw as much stuff pull in as far as shipments are concerned and as much as we saw get pushed out. I'd also characterize this for everybody to make sure they understand this, probably less than 5% of our output that got moved in and out of the quarter.

I think the second quarter part of your question is, yes, if you look over the time, the June quarter is typically up for us. When I say over time, I mean 25 to 30 years; June is the end of our fiscal year for KLA-Tencor, it's our fourth quarter. For whatever reason, that usually drives an uptick in our business.

Timothy Arcuri - Citigroup

John, just to clarify, you would see that happening this year as well?

John Kispert

I think when we do a bottoms up, it looks that way to us today. Yes.

Timothy Arcuri - Citigroup

Okay, John. Thanks a lot.

Operator

Your next question comes from Jay Deahna - JP Morgan.

Jay Deahna - JP Morgan

Good morning. John, a question for you. As you look at the demand pattern throughout the year do you see actually a pickup in foundry in IDM in the latter half of the year? Generally speaking, do you think that demand in the second half of the year in terms of orders can be equal to or higher than the first half, given the fact that memory is pretty strong in the first half?

John Kispert

It's a tough one, Jay. Through the years we try to stay out of the second half of the year as far as predicting in January or February. What I can tell you when we do bottoms up, which is what people are telling us in the categories you're giving me which are foundry, logic and memory, memory certainly looks more front-end loaded. I would characterize the foundry plans today as being starting the beginning of the April/May timeframe and picking up through the second half of the year. I'd also characterize the logic pattern as being that also, which would in both those cases would be back-half loaded versus memory, which looks more front-end loaded today in a bottom up view of what customers are telling us.

Jay Deahna - JP Morgan

Just to follow-up on that, John, how much of the 65-nanometer ultimate build-out has already been done? I mean Intel's done, but I don't think a lot of other people are. So as we move into the back half and into the next year, is 65-nanometer logic a cyclical driver?

Secondly, do you see the development and early stage ramp of 45-nanometer happening simultaneous to that so that at some point there might be a sustainable new cycle out there after this flat stuff for a while, or do you see it differently than that?

John Kispert

Certainly a 65-nanometer build out, if you will, is the key for the 2007 for KLA-Tencor. We tend to look more at yields, as you guys know. The learning on yields for the majority of the industry are still very low. So there's lots of work to be done there if yields aren’t up. When I say low, well below 50% for most folks. So nobody's going to be adding capacity until you figure out how to get the yields up.

To the first part of your question, we see lots of opportunity not only in logic and foundry there, but with certainly some memory folks throughout the year. And then, 45-nanometer is a great driver for KLA-Tencor. I don't know if we've given you the number yet, but it was about 20%, 25% of our business this last quarter, 45-nanometer.

That R&D investment in those pilot investments will kind of pick up as the year goes on, no doubt, as people try to keep up with the leaders. Certainly that will be a big driver for us as the year goes on.

Jay Deahna - JP Morgan

Thank you.

Operator

Your next question comes from Harlan Sur - Morgan Stanley.

Harlan Sur - Morgan Stanley

Good morning. Just curious as to figure out what you're hearing from your NAND customers; and seeing in the way of orders and shipments, given the weak fundamentals in this part of the market? Any commentary on first half versus second half spend for this segment of your customer base?

Rick Wallace

John and I were just in Asia last week meeting with customers and spent some time with both NAND, flash, and DRAM customers. Clearly stronger momentum in the DRAM space, as we all know, and it doesn't appear that demand is going to pick up in the near term for that. There are some potential drivers that could kick in for the second half, things like the iPhone, which I think are going to use a lot more NAND.

In general what we're getting a sense of is that DRAM will carry the memory spend and the investment for the remainder of the calendar year. That's kind of how we're modeling it, is we think the DRAM continues to be strong, and as John said, the rest of the industry, foundry and logic picking up in the second half.

Harlan Sur - Morgan Stanley

Any expectations for NAND coming back in the second half of the year?

John Kispert

The way we've looked at it, Harlan, again, bottoms up is it's one-third of the memory spend throughout the year. I think it'll be very lumpy; memory in general is kind of lumpy for us; bigger orders some quarters and then it's quieter for a quarter. But hard to tell exactly as the year unfolds if it's back half or front half or when it is, but as we look at it bottoms up, it's about one-third, maybe a little bit less of the spend through the year.

Harlan Sur - Morgan Stanley

Great.

John Kispert

One-third of memory.

Harlan Sur - Morgan Stanley

One-third of memory. Yes, got it. So with 45-nanometer and below accounting for one-quarter of the bookings, I just wanted to know what your customers are saying about the yield challenges at this particular node? I know it is early days but any feedback would be great.

Rick Wallace

Very interesting meetings last week as we were going through that with a number of customers and huge concerns about defectivity in terms of managing yield at 45, and so we're getting a lot of pressure. The good news is, I suppose there's huge opportunity for us as we just sat through a litany of challenges people faced. The challenge, of course, is it means we've got to keep bringing out our latest generation products to be able to satisfy those needs, so it puts a lot of pressure on our engineering groups to bring out our latest generation, which is the kind of pressure we want, but it certainly seems to be defectivity is the key to success. We had a number of customers telling us that last week; the ability to find and fix these defects at 45 is going to be just tremendously challenging.

Harlan Sur - Morgan Stanley

Thank you.

Operator

Your next question comes from Jenny Yun - JP Morgan.

Jenny Yun - JP Morgan

Good morning. With $2.1 billion of cash and cash equivalent on your balance sheet, what kind of uses are you considering for that and how much do you need to run your business?

Jeff Hall

As we look over the past three months, we've used about $500 million of cash for acquisitions. We're restarting our normal buyback on Thursday, we still have about 3.8 million shares authorized on that plan. We have a plan for excess cash beyond this. We're not ready to disclose it today, but we expect to make an announcement of our plans in the relatively near future.

Of course going forward, as we continue to execute on our operating excellence and improvements, we're going to continue to increase our operating cash flow going forward.

Jenny Yun - JP Morgan

So you need, you said, $500 million of cash for operations?

Jeff Hall

No, I did not say that. I said we have done about $500 million of acquisitions over the last few months. I didn't say how much cash we actually need for running day-to-day operations. It's not a number we typically talk about.

Jenny Yun - JP Morgan

And then for your share buybacks, is that on a matrix or is it just from time to time when you find the opportunities available?

Rick Wallace

We don't disclose it, Jenny.

Jenny Yun - JP Morgan

Thank you.

Operator

Your next question comes from Mark Fitzgerald - Banc of America Securities.

Mark Fitzgerald - Banc of America Securities

With the shutdown of the facilities in the fourth quarter, can you give us an update on how far along you are in terms of this manufacturing transition, moving stuff overseas?

Jeff Hall

Let me just clarify, Mark. We didn't shut down any facilities in the quarter. What we did is we put some facilities on what's called available for sale, which means you write them down to the market value, but we're still using those facilities. We have plans to get out of those facilities as we transition. At this point, we've got some products up and running and we're going to continue that transition in line with our three-year plan.

Mark Fitzgerald - Banc of America Securities

Thank you.

Operator

Your next question comes from Jim Covello - Goldman Sachs.

Jim Covello - Goldman Sachs

Good morning, thanks so much. Question about the fungibility of NAND and DRAM capacity. Do you see NAND capacity getting moved back to DRAM to fix the excess in NAND? If you do, do you think that could have any impact on the planned DRAM orders as we go throughout the year?

What kind of revenue opportunity do you guys see in DRAM versus NAND under that kind of scenario, and are there any big differences between the yield issues that the customers are facing in either one of those segments? Thanks.

Rick Wallace

Hi, Jim. Thank you for the question. Fungibility. There's certainly, as you know, some key players out there that service both NAND and the DRAM market and flash and they do have fungibility, but I think those plans are already in place that they've already optimized for what they believe the needs are going forward and so we don't really see… I think John laid out earlier in the call how we see the memory market over the calendar '07.

In terms of yield challenges, there's no question that NAND presses the technology, but DRAM has its own set of challenges and so as I said, when we were meeting with memory customers last week, a lot of concern about the ability to ramp their yields. I would say that equally challenging, both tend to push the technology limits as they try to battle competitively to bring out new technology. So we see both opportunities for us in terms of bringing out yield capabilities.

It's really the other drivers more than the underlying technologies, such as emersion lithography, pushing things, high Ks, there's a number of technologies that are driving the need for better yield management than simply whether it is a DRAM or a flash.

Jim Covello - Goldman Sachs

So you don't perceive any incremental risk to your orders then from more NAND capacity getting moved over to DRAM and that in turn obviating the need for new DRAM orders?

Rick Wallace

No, I think we've modeled that in as we go forward. As I said, there's only a few people that can do that because they serve both markets, and that's what we're looking at as we go forward. John, do you want to add anything to that?

John Kispert

The only thing, Jim, as you know, your question is somewhat customer-specific. There might be timing issues if a particular customer decides to start moving more capacity off of NAND and on to DRAM as far as an order in a quarter or a capacity expansion or even R&D, but…

Jim Covello - Goldman Sachs

John, I understand that there are only a few customers that can do it, but those customers collectively represent over half of the NAND market.

John Kispert

But we're pretty close with those, Jim; that was the point.

Jim Covello - Goldman Sachs

Sure, sure. Okay, thank you.

Operator

Your next question comes from Edward White - Lehman Brothers.

Analyst for Edward White - Lehman Brothers

Hi guys, this is Dave for Ed. Could you talk a little bit more about 45 nanometers, where you were on terms of your orders for 45 nanometers about six months ago and where you expect to be six months in the future and then 12 months?

John Kispert

Six months ago was probably about 10% of our order book. In fact, we probably said it on the conference call. Today, as I just said, it's 20%, 25%. I think it probably stays in that range for most of this year. It's a different set of folks that start investing there over time, so it's a different set of folks every quarter. But in that 20%, 25% range we tend to, at a next technology node, I think most people know we tend to get a bunch of our next generation tools ordered early on in the R&D cycle. 45 nanometer, I think, is a bigger opportunity for process control or inspection of measurements, so I think 25%, maybe up to 30% in the back half of the year, depending on the total.

Rick Wallace

Just to give you an example, when 65 got to this level, to John’s point, it took about a year at the same level, so we're modeling 45 in a similar fashion, if that makes sense.

Analyst for Edward White - Lehman Brothers

Yes, that makes sense. A question about market share. Just looking at the [WWSens] data, it looks like, depending on how you look at it, you guys gained some share. Can you talk about how you think about that? Do you think that perhaps you are gaining any share and if so, why do you think that is the case?

Rick Wallace

We track pretty closely our market position. Our focus is on how do we make sure that we're bringing out the capability that our customers need? I would say that overall, our share pretty much stays kind of where it is. It's been pretty strong in the markets that we've been successful in historically. We've had a lot of people make a run at these markets over time and I think the reason we maintain our position is as a company, we're solely focused on inspection and metrology and we continue to bring out the capabilities; we invest heavily in R&D to do that and we support our customers. I don't see this being a particularly new story.

John Kispert

At this point in the cycle, Dave, where we are exposed on market, especially around price, are folks that will be investing in 90 nanometer; the trailing edge, if you will. Obviously, that's where our competition is going to come after us, that's going to be the area. The learning is done there, the technologies have been in place for a while, it's more price sensitive. Clearly, at this point in the cycle, that's where we're most focused when it comes to competition and market share.

Analyst for Edward White - Lehman Brothers

Very good. Thanks, guys.

Operator

Your next question comes from Brett Hodess - Merrill Lynch.

Brett Hodess - Merrill Lynch

Good morning. I was wondering if you could talk a little bit, with four acquisitions in the recent times, what you think these four acquisitions will look like in a couple quarters once they're consolidated? Ballpark percent of revenue and what kind of impact they might have on the margins, if any? Also if you can comment, if the environment out there is still fairly rich in opportunities for you to continue these acquisitions that are close to your product lines and technologies.

John Kispert

Brett, I will take the first part and Rick will take the second part, kind of how we've divvied up responsibilities. I think ADE, we've talked a bunch about here, Jeff, had them in the prepared remarks, so far so good. It's been very good. Good markets, good technology, good management team. The integration, although any integration is difficult, has gone relatively well and we're happy with the financial return on it. You know the size of it has been a $20 million to $30 million a quarter business and it's actually will be accretive here over the next quarter or two. We're happy with that. We think more and more opportunities with this technology, with our distribution and the challenge we have.

The other two acquisitions, SensArray and OnWafer are two companies we've known for a long time. We've known the management teams for a long time. One company is 20 years old and really adds to our mission, which is critical process control data. As Rick mentioned, it's not just in etch and litho, but also in deposition where we can get unique data essentially around temperature or thermal data and eventually we believe pressure and voltage kind of data that will complement the stuff that we do today. This is a much smaller business, 1% to 2% of KLA-Tencor's top line today. We do think the markets double in the next year or two as you move into 45-nanometer.

It also is complementary to our channel as far as the folks that we sell to and deal with every day. So that business, we believe, will take a little bit longer as far as accretion is concerned, but an opportunity for us to add more and more data, ease of use to our customers as far as controlling their process and production tools.

The fourth one, which is Thermawave, a much different business, as you know, Brett. I think bottom line for Thermawave, a company we've known for a long, long time and competed against for a long time is great technologies as we know, very good synergies with KLA-Tencor, not only in distribution and service and applications, but we know the markets pretty well. They have good products, and as we all know, they have good customers, because they're our customers. There's good synergy there. That will take a little bit longer for accretion, if you will, but we have to get the deal done, first.

Rick Wallace

Brett, the second part of your question, the opportunities that are out there, there are a number of opportunities as we focus on inspection and measurement in our core markets we serve today and in adjacent markets. We're monitoring those closely as we always have. I think the key to these is to maintain the right discipline, to make sure the valuations that one uses and pays for companies make sense in a relatively short order that we're not counting hugely on synergies, but that we see both the opportunities to fill out our product portfolio and as well to essentially create growth opportunities for us.

In some cases like the ADE, one of the real attractive aspects of that deal was that they had a product line which they really couldn't access a different part of the market with so it was a way for us to bring it in and we believe we'll be able to grow from there. It is a key part of our strategy going forward.

These happened to be available at the time we were looking at it, but we're going to continue to work the pipeline. I think we can continue to grow through acquisition if we're careful and thoughtful about it.

John Kispert

The key, obviously, Brett, is our execution on each one of these and we're very focused on that.

Brett Hodess - Merrill Lynch

Thank you.

Operator

Your next question comes from Satya Kumar - Credit Suisse.

Satya Kumar - Credit Suisse Securities

Thanks for taking my call. I wanted to get back to this question of fungibility and DRAM capacity. When I look at the industry out there, there are probably two or three companies that can actually make this transition, but if you look at the installed capacity, what they have is a lot of NAND capacity still sitting on 200 millimeter, which they converted from DRAM to NAND two or three years ago when NAND margins were higher.

My question is, how much longer do you think this 200 millimeter platform can actually continue to produce cutting edge memory, particularly given all of the new things we are seeing with the DRAM industry so far?

Rick Wallace

I think you bring up a very good point, Satya. I think the 200 millimeter NAND capability struggles as they get to the next node. In discussions with those very customers you're talking about over the last week or so, they're counting on the ability to get to 300 millimeter. I think that you're right that the 200 will play out, but part of the growth story in memory has been this transition to 300 millimeter. That will continue as that just has higher productivity than 200.

Satya Kumar - Credit Suisse Securities

Did you give an outlook for orders in March by device, by memory, foundry, and logic?

Rick Wallace

We didn't. We see it pretty similar to what we saw; memory still at the 55% range, with the split we talked about with NAND being maybe one-third of that. Logic, a little bit less, a little bit lighter at 25%, and foundry, a little bit up, closer to 20% range.

Satya Kumar - Credit Suisse Securities

If I try to reconcile that with what you seem to be saying for June, I think you mentioned that at this point based on June orders look up, but at the same time I think you mentioned that shipments are first half loaded for memory, which means at some point in September and December you start to see shipments from memory decline pretty substantially.

If that's the case, shouldn't you see orders for memory decline in the June quarter given that orders should lead shipments by a quarter? In other words, if you're seeing June more flat to up, how do you see memory orders trending into the June quarter? Shouldn't you be seeing June down at this point?

Rick Wallace

Yes. I think you see foundry get bigger in June, at least that's what we see in the funnel today.

Satya Kumar - Credit Suisse Securities

Is that foundry going to completely offset any declines in memory in June, is that the way you see it?

Rick Wallace

Today, that's how we see it.

Satya Kumar - Credit Suisse Securities

Thank you.

Operator

Your next question comes from Gary Hsueh - CIBC World Markets.

Gary Hsueh - CIBC World Markets

Hi guys. Just looking at your guidance here, if I look at 700 and 715, $0.76 and $0.79, and I look at my model, a consensus of 679 and $0.73 it looks like most of your upside to consensus in my model is coming from the top line here. Can you describe what it will take to start driving more massive earnings leverage at the bottom line with all of this restructuring going on? Is there a little bit of a longer tail, or do we need to restructure a little bit more here to see more meaningful leverage on R&D and SG&A and that kind of stuff?

John Kispert

On the bottom line, we've talked about getting out of some of our unprofitable product lines over the last couple of quarters and that takes a while. The key there for us is to not hurt our customers. So that you'll see unwinding over the next quarter or two.

I guess your question is the fixed costs of R&D and SG&A, does that come down over time? The biggest issue we have there is, as we've been able to move more and more of that to lower cost regions or to tamper it, we've added these three acquisitions now and then potentially a fourth. How do you consolidate those over the next three to four quarters and leverage the R&D and SG&A? We're confident we can do it.

The way I look at it, if we can execute over the next three to four quarters, it's relatively flat if not down a little bit relative to the top line. But the real leverage, as you pointed out, is in our gross margin. The key there for us over the next couple quarters is our cycle times. We have a lot of backlog we have to ship. The teams are focused on this. We're fortunate we can still take our cycle times down at this point in the ramp after a couple of quarters. I still think we can take our cycle times down by another 30% across the company, and that will continue to add leverage in the gross margin.

Gary Hsueh - CIBC World Markets

So, John, just to review, a lot of numbers flying around in the quarter, but that $10 million risk in terms of severance charges, is that mostly for your ADE division or acquisition?

John Kispert

Some of it was ADE and some of it was some management levels here in San Jose.

Gary Hsueh - CIBC World Markets

When you look at your guidance for the March quarter, you obviously guided to some in-process R&D charges. Any more restructuring or severance charges we should be modeling here in the March quarter?

John Kispert

Don't anticipate any related expenses in the March quarter.

Gary Hsueh - CIBC World Markets

So we're kind of fine here with SG&A running around the $105 million range. That's not going to come down appreciably or stepping down anytime soon?

Rick Wallace

It's about flat.

Gary Hsueh - CIBC World Markets

Just what John said. Perfect. Thanks, guys.

Operator

Your next question comes from Suresh Balaraman - ThinkEquity.

Suresh Balaraman - ThinkEquity Partners

With the acquisition of Thermawave, do you guys have some thoughts on how large the optical CD SIMM can get for you? This has been talked about as a very large market as you have talked about CD SIMM. I'm wondering, are there any hurdles that can be controlled by the acquisition as opposed to just a market adoption?

Rick Wallace

Yes, I think that the optical CD position that we have, we're in a good position and we definitely have seen good growth in that. Clearly there are some opportunities for some synergy with the Thermawave, but our optical CD strategy does not count on the Thermawave technology to execute.

I think our challenges are more fundamental, which is, we've got to meet our customer needs as they push their new design rules requiring us to bring out new algorithms and new capability to model these smaller devices. So it's more of a function of that. There may be some technology IP that we pick up, but we're actually not counting on that to execute on our optical market.

John Kispert

The opportunities, Suresh, are around the newer architectures and newer materials at 45 nanometer. That's where the opportunities are, and less around the two companies.

Suresh Balaraman - ThinkEquity Partners

Can you put some numbers on it, how big can it with be? $100 million, $500 million, $1 billion? People have talked about a $1 billion opportunity, but I'm just wondering, what can it potentially get to?

Rick Wallace

I think that the overall CD market is a pretty good-sized market and relatively slow growing, except for the optical CD part. I think there are more opportunities to grow that. It really is fundamentally a question of how many layers can you take from the CD measurements and put them on optical CD. To some degree the technology solutions we come up with can drive how large that market can become. We've got opportunities to grow it, but we've got to execute in order to do it.

Operator

Your next question comes from Mahesh Sanginario - RBC Capital Markets.

Mahesh Sanginario - RBC Capital Markets

A quick question on the bottom line. If I continue to model, say $700 million in revenues going forward for the next three or four quarters, where can I expect the EPS upside could come from? Will it be from restructuring, share buyback? How should it trend for next four quarters?

Rick Wallace

You're going to see us continue to execute on our operating goals, so as we see revenue at about 700 to 715, operating expenses flat, up a little bit as a result of the OnWafer SensArray acquisition. We'll see gross margin tick up a little bit as we go forward into the next quarter as we get through some of the issues we had in this quarter.

Right now in guidance, we are modeling share count at flat. So if it goes down from there, we'll see some benefit as well.

Mahesh Sanginario - RBC Capital Markets

You don't see for the next four quarters a substantial uptick in the EPS numbers at current revenue levels?

Rick Wallace

Mahesh, I don't intend to give guidance for the next four quarters.

Operator

Your next question comes from Steve O'Rourke - Deutsche Bank.

Steve O’Rourke - Deutsche Bank Securities

Good morning. Two questions. First in a flat CapEx environment, how much can KLA grow in 2007? Second, can you give us an update on the joint venture with DNS on electrolyte deposition?

Jeff Hall

I'll take those in reverse order. Let me start with the DNS one. When we announced last year that we were going to focus on inspection of antrology, part of what that meant was that we were not going to focus on process. We had a joint venture which we then started the process of unwinding, so we are now through that process and that joint venture has now been retired. It was successful in the sense that we brought out some interesting technology, but it was really for future nodes, so that is behind us.

In terms of our ability to grow in a flat market, as I've said, we've modeled it from zero to 5% growth for overall revenues and CapEx in 2007 and we see the ability for the KLA-Tencor to grow faster than that. We think probably 5% points faster than that as we go throughout 2007.

Steve O’Rourke - Deutsche Bank Securities

Thank you.

Operator

Your next question comes from Mehdi Hosseini with FBR.

Mehdi Hosseini - Friedman Billings Ramsey

Going back to the margin profile, if you could clarify, if I exclude the option expenses, I come up with a 60% gross and around 30% operating margin. My question in that regard is, is that the peak margins you're seeing, or is there still leverage left? If you could help us quantify this leverage.

With regard to revenue guidance, how much of the March quarter revenue comes from Thermawave?

John Kispert

I'll let Jeff take the last part of the question. When it comes to modeling gross margin and operating margin, what we do here is focus every quarter on just improving it. We try not to set a goal or a target internal to the company because goals and targets, once you make those goals and targets, people tend to stop. We just keep trying to up the bar.

So it is a really difficult question for us to answer pointing into the future. I think if you look at our history, you're probably not far off, but there's no way internally we are going to say that's where we're going to stop.

Mehdi Hosseini - Friedman Billings Ramsey

But are we talking about a low single-digit upside expansion from here?

John Kispert

Like I said, we're going to keep trying to push it higher. I'm not going to tell you what, because I have to idea. We think we can keep doing better and we are going to keep trying to do better.

Mehdi Hosseini - Friedman Billings Ramsey

How about on the OpEx side, should we assume on a dollar base, is this operating expansion going to remain flat, or is it going to increase? Can you help us understand to what extent?

Jeff Hall

Mehdi, operating expense, I said, was basically flat, up 1% to 2% as a result of the addition of On Wafer and SensArray. But I think the right assumption here is it's flat, it's not going up.

Thermawave, the other part of the your question, Thermawave is not included in guidance.

Mehdi Hosseini - Friedman Billings Ramsey

Thank you.

Operator

Our next question comes from Stephen Chin - UBS.

Stephen Chin - UBS

Good morning. Thank you. In terms of the operating expenses, is the company still hiring for the core KLA business? Secondly, if you were to exclude some of these acquisitions like Thermawave and the two other small pending acquisitions, would you expect the core KLA headcount levels to be up sequentially at the end of the March quarter?

Jeff Hall

We're always looking for good people. If we can find a good person, we'll bring them in. But I would think core KLA-Tencor is flat to down in headcount, especially locally here.

Stephen Chin - UBS

Thanks. In terms of orders by geography for the March quarter, which regions do you think might deviate from the historical average in the March quarter?

John Kispert

The U.S. looks to us to be a little bit down for the March quarter, that's just timing. It ran about 20% the last couple of quarters and I think it will probably be down closer to 10% of the total in the March quarter. The offset to that is Japan will pop back up to around 30%. I think we see Taiwan, Korea, China, and the rest of Asia, their typical percentage is flat to where they were last quarter.

I think there's some opportunities in Europe again, just timing for the March quarter that would pop Europe up to closer to 15% in the March quarter.

Operator

Your next question comes from Robert Maire – Needham & Co.

Robert Maire - Needham & Co.

We're going through a number of technology transitions or likely transitions this year, such as copper starting to come into memory and double printing on litho. How does that impact your mix of products of overlay versus wafer inspection versus other products that you put out there? Any significant changes in mix that we can expect?

Rick Wallace

Hi, Robert. Thanks for the question. There are some challenges out there, as you mentioned, copper coming into memory, double patterning, emersion lithography, IK. There are a lot of technology changes that are pushing our customers and they're pushing the demands in both the metrology space where the need to measure and control these materials is very important as well as the defectivity, where the integration of new materials and the challenges associated with that.

So I would say, just to give you a couple of specifics, double patterning, as it comes into being, pushes the overlay requirement specifically creating really a driver for our new technology, the Archer 100, to be able to go in and serve that market and we see that continuing to grow as a result. Also, emersion creates challenges with the edge of the wafer, which is something that our VisEdge product addresses.

In addition to just the overall defectivity challenges presented by those and by copper, we see both demands for metrology and inspection going up. Again, part of our overall thesis is that inspection of metrology will outgrow the market as new technologies continue to come on. So we're very bullish and we think challenges are broad-based in terms of the portfolio that we have and how those will address the challenges.

Robert Maire - Needham & Co.

A quick follow-up, I may have missed it, but any update on your data storage side of your business or any strategic changes there? What's the direction of that part of the business?

John Kispert

It's going well. As you probably know and I think most people know, it's not a part of our world where there's an incredible amount of investment right now, but it's a pretty steady business for us.

What we've done with ADE and with some of the other acquisitions is leverage that part of the business into other markets like high brightness LEDs, like not only the substraight and media, but also optical electronics, compound semis. So that business, we call it our growth and emerging business, is seeing an uptick the last couple of quarters, but I think generally the demand in that space is relatively flat.

We're planning on it being relatively flat the next quarter or two. We're trying to make our own way there as far as penetrating new applications, just like we do in the semi industry.

It's possible to see some pick up, but it's a small percentage of our business.

Robert Maire - Needham & Co.

Okay, just curious. Thank you very much.

Jeff Hall

Luan, we've got time for one more question.

Operator

Okay, sir. Your final question comes from Mark Bachman - Pacific Crest.

Mark Bachman - Pacific Crest Securities

Hi, thanks, guys. John or Rick, when looking at SensArray here and On Wafer, these products appear to be quite different from what you already have on the market. Just wondering, are these acquired technologies? Do you look to integrate these into your current product lines, or will these be new product categories for you? In other words, what was the thought process behind making these acquisitions?

John Kispert

I thought I said earlier that the thought process is pretty simple in that it adds more critical process control data to our suite. Organizationally, the divisions are going to report into our service organization.

Why is that? Because that's where we're closest to touching the preventive maintenance on process tools, the fixes that you do to process tools, because that's generally where you use these, as you probably know, these are wafers both wired and wireless wafers that you use to monitor process tools.

As you know, there's a handful of our products that do exactly the same thing. So it's a complementary set of data points that our customers can use.

I’d also say when it comes to SensArray and On Wafer, we're uniquely positioned in the industry in that these wafers are also bought by our sister companies, if you will, in the process space. So the process and litho guys also buy these to do their own development and their own testing. So KLA-Tencor, with our position in the industry, can kind of act as the arbiter of that and we can sell to everybody as well as sell to the semi guys and make sure that the data is getting used throughout the line and patched up and down the line with our software. Does that help?

Mark Bachman - Pacific Crest Securities

It does. Thanks so much. One follow-up for either you or Rick as well. I believe that AMAT’s UVision has made some in-roads against KT in the logic here in the U.S. I'm just wondering, can you talk about the merits behind the decision process here and how the competitive front might have changed with the newest version of UVision now on the market?

John Kispert

I don't know who you're referring to. On the competitor front, as Rick said earlier, we don't see much of a change here, we've always had competition in our Darkfield product space as well as our Brightfield. Our market share on the leading edge is as strong, if not better, as it has been in the last 10 to 15 years. As I said earlier, where we're challenged at this point in the cycle is when folks are investing more at the trailing edge, which in this case would be 90 nanometer, you'll see more of our competitors' tools pop in there, because it really gets down to more of a price decision. KLA-Tencor's lead in technologies aren't as high at 90-nanometer as they are at 65-nanometer, obviously.

But I don't see a change in our market share. You're picking a particular customer, which I don't know which one it is, but no big change in total market share, particularly at leading edge.

Mark Bachman - Pacific Crest Securities

Thanks so much.

Jeff Hall

Thank you all for participating on the conference call today. We look forward to speaking with you again next quarter.

Operator

This concludes today's conference call. You may now disconnect.

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