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KLA-Tencor (NASDAQ:KLAC)

F4Q07 Earnings Call

July 26, 2007 5:00 pm ET

Executives

Jeff Hall - CFO

Rick Wallace - CEO

John Kispert – President & COO

Analysts

Harlan Sur - Morgan Stanley

Brett Hodess - Merrill Lynch

Tim Arcuri - Citigroup

Jim Covello - Goldman Sachs

Satya Kumar - Credit Suisse

Stephen Chin - UBS

Edward White - Lehman Brothers

Gary Hsueh - CIBC World Markets

Robert Maire - Needham & Company

Mahesh Sanganeria - RBC Capital Markets

Steven Pelayo - HSBC

Raj Seth - Cowen and Company

Peter Kim - Deutsche Bank

Jen Wong – JP Morgan

Presentation

Operator

I would like to welcome everyone to the KLA-Tencor fourth quarter fiscal 2007 earning conference call. (Operator Instructions) Now I would like to introduce Jeff Hall, Chief Financial Officer. Thank you, Mr. Hall. You may begin your conference.

Jeff Hall

Good afternoon and welcome to KLA-Tencor fourth quarter 2007 earnings conference call. I am Jeff Hall, the Chief Financial Officer. Joining me on our call today are Rick Wallace, our CEO; and John Kispert, our President and COO.

We are here today to discuss the fourth quarter results for the period ending June 30, 2007. We released these results this afternoon at 1:15 pm Pacific time. If you haven't seen the release you can you find it on our website at www.KLATencor.com, or call 408-875-3600 to request a copy. Rick will lead off today's call with a discussion of industry developments and KLA-Tencor’s recent progress and strategy. Afterwards, I will review the financial results for the quarter and then I'll open the call for questions until 3:00 Pacific time.

On the investor's section of our website you will find a simulcast of this call, which will be accessible on-demand for 90 days. On the website 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 future results.

As you know, our future results are subject to risks and any forward-looking statements we make are subject to those risks. KLA-Tencor cannot guarantee that those forward-looking statements will come true. Although we take no obligations to update those forward-looking statements, you can be assured that any update we do make will be broadly disseminated and available over the web.

With that, I will turn it over to Rick.

Rick Wallace

Thank you, Jeff and thank you all for joining our fourth quarter fiscal year 2007 quarterly conference call. Today, I will review highlights of our performance in FY'07 and for the June quarter as well as provide guidance for the September quarter. Fiscal 07 was a good year for KLA-Tencor, the result of strong demand in our end markets and solid execution by the entire KLA-Tencor team. Revenue grew 32% to $2.7 billion in fiscal '07. Net income including share-based compensation but excluding one-time and deal-related charges was $633 million or $3.13 per diluted share in fiscal 2007.

Cash flow was also strong in fiscal 2007. We generated approximately $611 million and operating cash flow in the year. Over the 12 months ending in June, we repurchased over $800 million in common stock and paid out cash dividends of approximately $95 million.

As most of you know, at KLA-Tencor we solve mission-critical production problems for our customers by delivering a portfolio of differentiated inspection metrology solutions. Our four strategic objectives are customer focus, revenue growth, operating excellence and talent development. I would like to provide some insight into each objective.

First of course is the focus on the customer. We work closely with our customers to help them solve mission critical production problems. Our objective is to have market leadership in each market that we serve. Today we have leading positions in 18 of our 20 markets and over the past two years we have seen share growth across our major markets. KLA-Tencor tools help our customers increase their ROI and keep pace with the increasingly more complex demands of advanced technology nodes.

Our second strategic objective is growth. Our goal is to outgrow the industry, and in FY07 we were able to meet that goal. With the challenges that our customers face at 45 nanometers and our product portfolio, we are well-positioned to continue to outgrow the industry.

Our third objective is to continuously improve our business model. Today we are driving many different initiatives worldwide to improve profitability through optimizing our global footprint and improving organizational efficiency. Of course, none of this is possible without the world-class talent within KLA-Tencor. We work very hard to attract, develop and retain an outstanding work force. We have been successful in building our team and I am especially proud of the performance of the entire KLA-Tencor team this year.

In summary, we are very pleased with our growth in revenue and profitability in fiscal 2007, an indication that our strategy to focus on inspection metrology is working and we are excited about the opportunities that lie ahead. We will help our customers continue to tackle difficult yield issues as they adopt new technologies.

Turning our attention to the highlights of the June quarter results. Bookings for the June quarter were $708 million, about 3% higher than the March quarter in the upper end of guidance. Recent booking strength has been driven by increasing adoption of 45 nanometer technology and continued progression to the transition the 300 millimeters. 45-nanometer represented 28% of our incoming orders in June. Customers that are focused on next-generation technologies are beginning to invest in pilot lines and R&D efforts.

Regardless of geometry, customers are investing in order to improve yields and lower their costs under pressure to get to market quicker. This is a challenging problem for our customers, one that will be more difficult as customers transition to compete with newer technologies. Of course, KLA-Tencor plays a critical role in that process.

Turning now to the specifics underlying our strong bookings results in the June quarter. In June, we saw continued strength in wafer inspection as well as gains in our core metrology and medical businesses. Memory was approximately 50% of orders in Q4, NAND was 40% of memory and up marginally compared with the prior quarter. Foundry grew sequentially and was 35% of orders in the fourth quarter as foundries continued to build out their 65 nanometer capacity. Logic was 15% of orders. We are watching logic demands closely and see growth opportunities in 45 nanometer later in the year.

Revenue in the June quarter was $736 million, an increase of 3% compared with the prior quarter and up 27% compared with the fourth quarter of last year. Net income including stock-based compensation, but excluding certain one time charges and deal-related amortization in the fourth quarter was $177 million or $0.90 per share.

Before I turn the call over to Jeff, I would like to discuss innovation, which is something that we do continuously at KLA-Tencor in order to differentiate and grow our market leadership. One of our core competencies at KLA-Tencor is new product development and introduction. This year as we continue to develop our 45 nanometer product suite, we are introducing a record number of new products, a tribute to the hard work of the KLA-Tencor team.

This high tempo of productivity has helped fuel our growth. In fact, 85% of new systems ordered in the fourth quarter were from new products we've announced in the last 12 months, so we continue to be very prolific in introducing new technologies to the market. I'd like to highlight some of the new products we introduced this quarter.

Two of these strengthen our position in core markets for KLA-Tencor, and the third, our new EBeam Review tool, not only complements our existing portfolio but also positions us well in a new market opportunity for KLA-Tencor.

We featured two new products in the Brightfield inspection family at SemiCON last week; the 2810 which is focused on memory customers and the 2815 which is targeted for logic customers. The 2800 product series is our DQV broadband wafer inspection system. We hold the leadership position in the wafer inspection market and these two new products should help extend our position even further, offering more flexibility, sensitivity and speed for our customers as they advance in new technologies. We have begun shipments of both the 2810 and 2815 products to customers investing in 45 nanometer development.

We feature the new Puma 9150 at SemiCON last week, the latest generation in our Darkfield product line, building on our position in the market place with higher throughput and higher sensitivity. Puma combines the high throughput characteristics of Darkfield inspection with the high sensitivity imaging necessary to capture defects on a small design.

A third new product announced at SemiCON last week, the EDR 5200 is one I am particularly excited about. The EDR 5200 is an EBeam Review solution that also enhances resolution, improving the productivity of our inspectors. Our customers are telling us as they go to 45 nanometers they're not satisfied with the resolution and other capabilities that existing review solutions are offering. We believe the EDR 5200 provides a great solution and positions us for growth in this new market.

A critical element to our continued success is our emphasis on delivering an outstanding customer experience and delivering superior customer service and best in breed technology, KLA-Tencor creates a significant competitive advantage that translates to strong market leadership, revenue growth and profitability.

Now, let me turn to our guidance for the September quarter. Our September outlook is a little complex this year, as we have a number of factors impacting our results, largely related to recent acquisitions. Jeff will give you more of the details. Given that, our bookings outlook for September is down 15%, with a range of plus or minus 10%. This is on par with the typical seasonality we experience in September.

Revenue in the September quarter is expected to be between $670 million and $690 million. EPS is expected to be in a range of $0.72 to $0.76 per share. Now to give you more details on the results, let me turn the call back over to Jeff.

Jeff Hall

Thank you, Rick. Let me start by going through the quarter in more detail. Net bookings for the June ending quarter were $708 million which is roughly 3% higher than the March ending quarter and 11% lower than our quarterly results from one year ago. Every quarter, we review our backlog in detail and debook in accordance with our bookings policy that restrict 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 debooked $23.3 million of orders.

We ended the quarter with approximately $1 billion of backlog for unshipped orders. Remember, we do not include any service bookings in the backlog number. In addition we have $468 million of deferred revenue related to products that have shipped, but not yet been signed off by customers. 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 June quarter was as follows: the U.S. was 22%, lower than its historical average of 25%. Taiwan was 23%, higher than its historical average of 20%. Korea, China, Singapore combined were 22%, higher than their historical average of 20%. Europe was 7%, lower than its historical average of 10% and Japan was 26%, higher than its historical average of 25%.

The product distribution of orders was wafer inspection was 45%. Reticle inspection was 14%. Metrology was 25%. Data storage was 1%. Service was 15%.

Before we start with the income statement, let me summarize the special charges in the quarter. We had $37.9 million of pretax, non-cash charges related to acquisitions. The breakdown of these charges is $13.8 million is included in the cost of goods sold, $22.3 million is research and development, and $1.7 million is including in SG&A. In the September quarter, we expect $12.3 million of pretax non-cash charges related to acquisitions. We also incurred $10.8 million in pretax charges related to a reduction in force completed in April. $2.4 million is included in cost of goods sold, $2.3 million is included in R&D, and $6.1 million is included in SG&A.

Now, turning to the income statement, revenue for the quarter was $736 million, up about 3% quarter to quarter, and up 27% from the same quarter last year. Revenue for the full fiscal year ended June 30, 2007 was $2.7 billion, up 32% from fiscal year 2006. The recent acquisitions are making things a little lumpy for the June and September quarters. We have a lot of activities going on to get them integrated and to realize the synergies as quickly as possible.

This impacts revenues in two ways. First, in the June quarter, we were able to integrate some of the products into our sales channel faster than expected, and as a result recognized revenue and cost savings faster than previously expected, resulting in about $20 million of revenue being recognized in June instead of September.

Second, in the September quarter, we have several acquired products that we will recognize nearly zero revenue from as a result of converting them to our revenue recognition policy, which is more conservative.

GAAP gross margin was 57.1%. As discussed earlier, this includes $13.8 million of charges for acquisition and deal-related amortization and $2.4 million of charges for the April reduction in force. Excluding these items, gross margin was 59.3%, off about 50 basis points from Q3, as savings realized from our cost reduction initiatives was greater than transition costs related to our move to Singapore and the dissolution from recent acquisitions.

Operating expenses including both SG&A and R&D were $246 million. As discussed earlier, this number includes $24 million of charges for acquisitions and deal-related amortization and $8.4 million of charges for the reduction in force completed in April. Excluding these items, operating expenses were $213 million, up $7 million from the prior quarter as a result of the recent acquisitions.

As a result of our continuing efforts to reduce costs, we expect operating expenses in the September quarter to be down about 1% from June despite an increase of $8 million in operating expenses related to the acquisitions. Operating income for the quarter was 30.4%, up 20 basis points from the prior quarter. For the fiscal year, operating margin was 28.4% as our cost reduction efforts drove 63% incremental operating margins.

For the quarter, other income was $21.4 million and included a $4 million gain of our interest in Blue29. Going forward we will no longer have minority interest on our balance sheet or income statement.

The effective tax rate for the quarter was 26.7%. This rate was lower than the ongoing tax rate of 28%, as a result of the one time charge in the quarter. Net income for the quarter was $147.3 million or $0.75 per diluted share. Excluding the charges discussed earlier, net income was $177 million or $0.90 per fully diluted share. This number includes share-based compensation expenses of about $0.09 per diluted share and the approximate breakout is cost of goods sold $0.03; R&D, $0.04; SG&A, $0.06; and a tax benefit of $0.04.

In the September 2007 quarter we expected expense for share-based compensation to be approximately $0.10 per share. Net income for fiscal 2007 was $528 million or $2.61 per fully diluted share. Excluding the one-time charges, net income was $632 million, up 74% from fiscal 2006 and earnings per fully diluted share for the year were $3.13.

Turning to the balance sheet, cash and investments ended the quarter at $1.7 billion, an increase of $125 million quarter to quarter and a decrease of $615 million year on year. Inventory increased by $5 million to $535 million, as a result of the recent acquisitions. Excluding these acquisitions, inventory was down $45 million in the quarter.

Accounts receivables finished the quarter at $582 million, up $82 million from the prior quarter. $20 million of this increase was related to the acquisition. Capital additions related to fixed assets were approximately $29 million for the quarter as we completed the construction of our new facility in Asia. Depreciation was $15.4 million, and on a net basis including retirements, fixed assets increased by $815 million over the quarter.

Cash from operations was $153 million for the quarter and $611 million for the year. We paid a dividend of $23 million in the quarter. In the quarter, we also completed the accelerated share repurchase plan buying 14 million shares at an average price of $53.52. We also restarted our systematic buyback plan and bought back an additional 820,000 shares. Fully diluted shares outstanding ended the quarter at 197 million.

Headcount ended the June quarter at about 6,000 flat from March and up 100 from one year ago.

Finally, as Rick commented earlier, September is a bit of a complex quarter for us and we have a lot of both accounting and operational integration going on. Given that, our guidance for the quarter is: bookings down 15%, plus or minus 10%; revenue between $670 million and $690 million; operating expenses down about 1%; and EPS of $0.72 to $0.76.

This concludes our remarks on the quarter. We will now open the call to questions. Before I turn the call over to Celeste to give the full instructions, let me request that you refrain from asking multi-part question to give others some time.

Celeste, can you begin the polling please?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Harlan Sur - Morgan Stanley.

Harlan Sur - Morgan Stanley

Nice job on the quarter. As it relates to your non-memory customers transitioning to the advanced technology nodes, although some of them may be holding flat or even cutting back on their CapEx here in 2007, is the spend at these customers actually going up due to the increase in inspection in metrology intensity at the sub 56 nanometer nodes?

Rick Wallace

Hi, Harlan. Yes, great question. No, no question that we are seeing increase out of the non-memory guys and you alluded to the reasons. Just the challenges associated even with 65 and below are causing them to pursue both advanced inspection tools as well as the metrology tools to support their performance needs as they go there. So we are seeing increased demand there and working very closely with those customers for that.

Harlan Sur - Morgan Stanley

I think you've said before, you expected about a 30% increase in the dollar opportunity. As you are starting to engage with these customers, is that what you are finding the numbers to actually be?

Rick Wallace

Yes, it definitely appears that way. As you know we really haven't seen 45 nanometers completely built out, but the indications we're getting in the development phase is certainly a lot of concern around the challenges associated and as a result people making incremental investment in both inspection and metrology to satisfy those needs.

Operator

Your next question comes from the line of Brett Hodess - Merrill Lynch.

Brett Hodess - Merrill Lynch

Rick, I am wondering, with the large number of new products that you're rolling out, and I know you never like to give us specifics on this, but could you talk to us a little bit about the profile? Are ASPs changing with the large number of rollouts in a meaningful way? Now that you have collapsed the number of product platforms you have, will this new product rollout be able to take advantage of that in terms of perhaps with more margin leverage than you've seen in the past?

Rick Wallace

Hi, Brett, yes, good questions, both of those. I'll tell you what, I'll take the first part, then I will let John deal with the platform question. From an ASP standpoint, there's no question that as we bring out new tools our customers are pushing for more performance and that results in higher ASPs as we bring out the latest products and we are definitely seeing ASP growth as a result of the new technologies, for example the 2810 and 2815, that we talked about bringing out are of course higher ASPs as they're delivering more performance.

The platform side the story is pretty good as well, and I will let John talk to that.

John Kispert

Brett, as you know we have been focusing on this for the last couple of years. Seems to me three or four years and it is getting much better now. The synergies that were seeing are not only in R&D and development, as we go from say 25 different platforms to a much smaller number. In R&D obviously, sharing there. But certainly in manufacturing and in the cost service and the maintenance because the learning curve for our install folks, our service folks, worldwide is much less steep. It allows us to do things quicker and be much more flexible across our entire portfolio of KLA-Tencor products.

I think our challenge recently has been with some of the acquisitions. How quickly can we extrapolate this commonality, the quest for more and more commonality across that acquisitions and that is something we are really focused on right now. If there has been a speed bump, it's been there. We see great opportunities with the newer platforms to incorporate those into what we have today. Does that make sense?

Brett Hodess - Merrill Lynch

Makes sense, thanks.

Operator

Your next question comes from the line of Tim Arcuri - Citigroup.

Tim Arcuri - Citigroup

John, can you give us some sense of what shipments were in June and what you think you will ship in September? And also what of that portion do you will be from [inaudible]? Thanks.

Jeff Hall

Shipments in the June quarter were 693, shipments in the September quarter are going to be 690 and we're not going to break out the acquisitions, but it is deminimus.

Operator

Your next question comes from the line of Jim Covello - Goldman Sachs.

Jim Covello - Goldman Sachs

You are going to book maybe 590, round numbers, you're shipping 690, 680. What would have to happen in order for your revenues to equal the bookings level you're going to see in September? What kind of environment would you have to see over the next couple of quarters in order for that bookings number in September to ever wind up as a quarterly revenue number at some point in the future? Thank you.

Rick Wallace

I want to make sure I understand the question, if you don't mind. It's over what time period, what kind of run rate would it take to get to that shipment level?

Jim Covello - Goldman Sachs

Yes, well it is kind of open-ended. Do you have to see orders at that level for one quarter, two quarters, three quarters, four quarters?

Rick Wallace

I understand. We run the company around a model for a long time which is to have an unshipped backlog of five to six months. Most of you folks that listen in understand that and the deferred revenue profile is anywhere from two to three months, and I think that model fits well into the way the industry is run today as far as lead times and cycle times are concerned and I think bodes well for us financially and gives us a level of insurance given the cycles in this business, which is really around your question Jim.

I think in your hypothetical example, which is orders come down to a certain level and stay there, we would probably react sooner than maybe the math would suggest just because we have been doing this for awhile and we know backlog is not such a bad thing, particularly around the newer products. We also have the wherewithal obviously, to not have to react very quickly and we could run it at the high 600s for a while, given the high profile.

So it's tough to actually call, Jim. But I think we're ready for either scenario, we can react up or down, depending on what we see over the six to nine months.

Jim Covello - Goldman Sachs

Do you think two or three quarters would be enough to cause you to?

Rick Wallace

I think, yes, by the second quarter we are going to be thinking that we want to start protecting not only our R&D stream, our customers, our shareholders and everything. We will probably start tracking things down.

Operator

Your next question comes from the line of Satya Kumar - Credit Suisse.

Satya Kumar - Credit Suisse

You talked about $23 million in cancellations, can you give some color on that? Was it any particular type of customer or geography? The $708 million, is that a gross number or net of these cancellations?

Jeff Hall

$708 million is net, so gross is $23 million higher than that. The debookings, what we do is we go through and cull our backlog really line by line every quarter and make sure it is all going to ship out in the next 12 months. We will move it out of there if we think they're not going to ship in the next 12 months. What usually happens, they always come back, they end up shipping or come back and order something else. In this case it was a mix of things, but mostly foundry.

Satya Kumar - Credit Suisse

What was the quarter ending share count? How much do you have in repurchase authorization, what's left at this point?

Jeff Hall

We ended the quarter at 197 million fully diluted shares and we have a little over 12 million shares still authorized for repurchase that we're in the market buying back against every day.

Satya Kumar - Credit Suisse

The foundry reorders are up and I look at your logic orders year-to-date, they're running at a substantially lower run rate versus last year. Sort of going back to an earlier question on the call, whether the 45 nanometer's really helping you here or not. Can you give us some color as to how this logic outsourcing to IBM is impacting the overall pipeline for that combined segment? Secondly, do you think the foundry order level is sustainable or is this just a pooling of these orders into the second quarter here?

Rick Wallace

The question around foundries, the strength we saw in foundries, no question being pushed by the advanced design rules and the increasing amount of products they have in terms of NICs inside the foundries that has created an opportunity for them to get leverage using our tools.

We did say we expect logic to pick up in the second half, so logic has been a little bit light and we do see that coming back. So while we think foundry will continue to be strong, relatively strong, we see logic actually improving in the second half.

Operator

Your next question comes from the line of Stephen Chin - UBS.

Stephen Chin - UBS

Just to follow up on that, Rick. I just want to make sure I understood. So do you think this absolute level of orders of foundry customers is sustainable going forward here in the near term? It looks like they did hit the three year high here for KLA. Secondly, are most of these incremental foundry orders for 65 nanometer equipment?

Rick Wallace

Stephen, most of what we saw was 65. As we said, we think September is wider just due to the seasonal slow down and we will see some falloff in general in September quarter. But we do think the foundry as a percent remains relatively strong as we said, as we go beyond that. We are obviously not forecasting in the second half of the year or next year, but all the indicators are positive for the foundry business. The logic we said we think will pick up towards the second half.

Operator

Your next question comes from the line of Edward White - Lehman Brothers.

Edward White - Lehman Brothers

I was wondering if you give us an update on the timing that you think you might have for the completion of the integration of the acquisition of ADE and Therma-Wave? When we get to a point where all the charges are done and you begin to get some of the benefits from those acquisitions?

Jeff Hall

It is really four acquisitions that we have done here recently; we are in the process of integrating them. Certainly we are pretty well engaged at the moment. Things are going along. They are about 3 or 4 points dilutive to margins today. We think that over the next few quarters we will get them to in line with the rest of our business.

Edward White - Lehman Brothers

Are there any charges related to these? Was there some talk of a charge in the September quarter related to acquisitions?

Jeff Hall

The way the accounting works for these is you end up capitalizing a bunch of the intangibles and then amortizing them over the life of the intangibles. So the amortization is going to run for a while, it is going to be about $12.3 million in the September quarter.

Operator

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

Gary Hsueh - CIBC World Markets

Looking at your revenue guidance, it looks like revenues is rolling over a little more steeply than I would have expected. How is it that revenue is actually dipping below shipment levels in a September quarter? If you can help me understand that.

Jeff Hall

It as couple of things. Really it is all related to the integration of these recent acquisitions and it really comes down to two things. First, we were able to in June really accelerate the integration of some of the new products into our sales channel and the result of that is we were able to recognize about $20 million of revenue in June that moved in from September.

The second factor is, the other thing we do on the acquisitions, is we've got to convert them to our revenue recognition policy. Our policy is pretty conservative, we only take revenue when a customer's actually signed off. As we convert these products we typically have a quarter, and a lot of that is happening in September, where we recognize zero revenue on the accounting conversion.

So that's what we're seeing. We are seeing $20 million move from September into June because of accelerated integration and another bit of products that's got zero revenue in September because of the conversion of accounting principles.

Gary Hsueh - CIBC World Markets

So you talked about $468 million of deferred rev exiting June. It sounds like deferred revenue account is going to build significantly in September and looks like you have got a nice tailwind for revenues kicking back in December? Is that the right way to think about the mechanics here?

Jeff Hall

Yes. I think that's right.

Operator

Your next question comes from the line of Robert Maire - Needham.

Robert Maire - Needham

You guided orders down 15% plus or minus 10%. After having covered the company for a while, that is obviously it's within the range of your normal September seasonality. If I took out the seasonality, would you suggest that business was flat or is there any particular tone in business that you are seeing going forward or is it sort of within the noise figure at this point?

John Kispert

I understand your question. Our feeling is you take the first half of the calendar year and relative to what we see today in the second half of the year. Given the timing between September and the ending quarter and December ending quarter that it is roughly flat for what we see today, first half to second half. If you put in the historical seasonality that means December would be up to offset that.

I would say on the margin of error, probably what we see today is probably $100 million, $150 million for the second part of the year. That's just the typical movement of orders or opportunities in and out of the second half of the year. But I hope that makes sense. I think it is relatively flat is the way we are looking at it. Maybe 3% to 5%, up or down first half to second half.

Robert Maire - Needham

That makes sense. Since you mentioned it, in terms of orders moving in, moving out, no particular direction or noticeable trend in that?

John Kispert

No, I am just forecasting what it is going to be like in October or November. A typical fourth calendar quarter, where there's lots of jockeying around and queuing up, particularly around our newer products. That's the piece that is hard for us to judge as we bring them out in the second half of the year. How does that play and how quickly does that queue builds.

Operator

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

Mahesh Sanganeria - RBC Capital Markets

A question on metrology. Looks like it has been very lumpy, even if you take into account acquisitions compared to the last five or six quarters has been up 20%, down 30% in that 30%, 40% kind of range. Is there anything that is different that we need to know?

John Kispert

I don't think there is a big change. I am looking at the numbers to see if I see what you see. I don't think -- we have been successful picking up share particularly as Rick mentioned around the earlier 45 nanometer with all the changes that are needed at 45 nanometers. So that has worked well for us, although that is a not a large part of the business right now.

The lumpiness tends to be driven by metrology I think a lot like the process businesses that you folks also cover. The buys are made generally along with the process buys. You buy process tools you buy metrology tools. Through the years I've always felt that in one quarter when it is a much higher percent, it is driven by more buys of lithography and etch and deposition systems and that's typically what the driver is.

Operator

Your next question comes from the line of Steven Pelayo - HSBC.

Steven Pelayo - HSBC

You made some comments at SemiCON West about December sales funnel looking strong, it looks like you just suggested that revenues could likely grow back in the December quarter based on your shipments. I am curious on your December outlook there. Do you think those orders can return back to the June model? What do you think that suggests then for your December shipment level?

John Kispert

I think it can return to the June levels. I certainly see the opportunities out there. I think it's too far away to actually be able to predict or forecast. I think a lot of the demands we are discussing right now with our customers is driven around their demand and what they perceive for electronics in general; consumer in particular for the second half of this calendar year and that's why the timing of that is difficult, Steve.

Steven Pelayo - HSBC

What about on a December shipment basis? You probably have a little better visibility on that.

John Kispert

Sure. It is queued up very nicely today, for shipments to be relatively at least flat. That's the beauty of the backlog, to Jim Covello's earlier question, is that we're excited to keep shipping right on through the rest of this calendar year. We are cranking away.

Steven Pelayo - HSBC

And just one to clarify for Jeff here. Your guidance, what is the ongoing EPS assumption there, the tax rate assumption?

Jeff Hall

Right now we are at still 28%. We are continuing to move through our tax planning for the year. But 28% is our core tax rate.

Steven Pelayo - HSBC

The only charge is that $13 million in September?

Jeff Hall

Yes, only charge we are expecting at this point is $12.3 million for intangible.

Operator

Your next question comes from the line of Raj Seth - Cowen.

Raj Seth - Cowen

A question on the 45 nanometer bookings at 28% of the total. How broad at this point, John, is the participation, is that Intel and a handful of others or is it broader than that?

John Kispert

It is not very broad, Raj, at this point. But it is certainly more than one and we said recently, 10. Inside that 10 are some small orders and some that are further ahead. I think the other inference from this is that we expect it to be broadening over through the second half of the year and into 2008. That's typically how it works and of course the leaders. Those first three to five, I would expect when see that in the forecast that to keep picking up in the upcoming quarters.

Raj Seth - Cowen

When do expect foundries in there? Or are they already a part of that 45 nanometer?

John Kispert

I think it is safe to assume they are a part of that.

Raj Seth - Cowen

You talked about operating margin targets at $900 million and $1 billion a quarter levels with ongoing restructuring move to Singapore, et cetera. I am curious just to separate out higher absorption on higher revenues than we have seen. At these kind of revenue levels, $700 million, if you were complete in your transition and you got the 3 or 4 points you expect to get that's currently a drag from the acquisitions, what would operating margins be?

John Kispert

Raj, as we get through the acquisitions. As we've said, we have three or four points of drag right now from the acquisitions. We've also talked about our transition to Singapore, that our factory there is only about 5% full at the moment, we think a year or so out, it is going to be more like 50%. That's going to add a couple more points. We have got a bunch of other things we are working on. So it will certainly be a lot higher.

The other thing I would say is this is a culture of continuous improvement. We are going to keep going after things and keep going after ways to improve margins time after time.

Operator

Your next question comes from Peter Kim - Deutsche Bank.

Peter Kim - Deutsche Bank

You talked about the foundries being stronger and maybe maintaining strength into the second half of the year and expecting logic to come back. How do you characterize the memory business?

John Kispert

The memory business looks to us to be down, first half to second half. Memory, I am going to include NAND in memory, DRAM and NAND. I think NAND is going to be up half on half for the year and that the DRAM portion of that is going to be down. As far as the dollar value where they offset themselves, I don't think so. I think it is probably slightly down, but as Rick alluded to earlier, as we look out over the next two quarters, we see that the logic investments and we would believe the foundry investments will offset that decline or come close to offsetting that decline and that's how that all adds up for us.

Peter Kim - Deutsche Bank

With regard to the memory capacity in your backlog do you still feel confident about those tools being shippable in the second half of this year?

John Kispert

Peter, they are beating me over the head to ship them. Nobody's blinking.

Operator

You have a follow-up question from Tim Arcuri - Citigroup.

Tim Arcuri - Citigroup

Hi, John, I just wanted to clarify something you said. You were implying that I think you were saying that bookings at this point you thought it was roughly flattish first half of the year versus second half of the year. If I just take the mid-point of your guidance for September that means bookings have to grow like 30% sequentially in September. But then it sounds like there is not really enough out there to drive that, if memory is going to be down, per your other comments. So I am just trying to rectify those two.

John Kispert

Yes. I think your math is relatively correct. 30% is probably a little bit higher of what I'm thinking right now quarter on quarter September to December. I think just listening to what you are saying, I think memory is probably a little bit stronger than what you are assuming. I also think that foundry will bounce back more likely in the October, November, December timeframe. Tim, this is not me with a crystal ball, this is me talking to customers. That's all I am repeating back.

Tim Arcuri - Citigroup

When you run your macro analysis and look at capital intensity levels and you look at intensity levels in memory and you look at some of the secular shifts going on in foundries, you would have been ordering at a level that has essentially been on average $725 million or $750 million for about seven quarters in a row. So, when you start to add that much capacity to the system, does that argue that we are getting close in your estimation to a pretty sizeable correction? I think that everyone is thinking '08 is going to be a good year. But when you're adding that much capacity, does that actually make you worry?

John Kispert

As far as the business philosophy at KLA-Tencor, I'd say we have been worried for about three, four quarters. That doesn't mean we don't take orders, and try to execute and support our consumers every which way we can. The answer, Tim, is there is not a day that I don't worry about a correction. A couple of questions about what is our philosophy on this. Our philosophy is to be very conservative in how we approach the business and call it as we see them and try to take care of all of our customers, meet their needs as soon as they need them but also have the flexibility to be able to pull back as quickly as possible and I think we are well positioned right now.

Operator

You have a follow-up question from Steven Pelayo - HSBC.

Steven Pelayo - HSBC

Rick, just one quick follow-up question. I am curious about your expectations for the 45 nanometer adoption rate. Have those changed at all? Have you thought about what you were thinking about at the beginning of the year and 90 days ago and today? I'm curious if customers are saying that this is harder or easier and that may affect your thoughts on the ramp rate of that?

Rick Wallace

I think that the 45-nanometer, there's no question there's been some industry changes, say if you go back to the beginning of the year in terms of who is doing 45. But I think that the challenges associated with that are continuing as we anticipated and we are obviously a little bit smarter now, having seen more customers deal with it.

So I think that the benefits are still there for our customers, they are all talking about 45. But I was in meetings last week and customers said they are dealing with the ramp and they are terrified of the challenges associated with the inspection of metrology, but they feel compelled to go there from a competitive standpoint.

So I think the challenges are still there. There's been some shift as you indicated toward some people that were going to do it themselves, maybe going through foundries or other ways to get there. But pretty much modeling and as we said at SemiCON West last week, we are a little ahead of our anticipated percent of our bookings for 45s. So the demand certainly seems to be there. On top of all that we're bringing out new products, so to some degree we create additional demand when we do that because when people see the new products they get excited and that helps drive some business for us too.

Steven Pelayo - HSBC

Do you think that the concentration of 45 nanometer bookings actually stays at this level going forward? Or was this a one-quarter pop and then it is going to stay at a lower level before it grows again?

Rick Wallace

No, I think it probably stays in this range and particularly if you think there is an overall slow down. The other thing, John just took a question about the second half. I think what differentiates KLA-Tencor, even if the capacity buy is slowed down, is we continue to get technology buys and that typically in slower parts of the cycle really helps us from an overall business standpoint. So memory may slow down from their capacity and some of the questions that Tim is raising. But technologically they are still pushing very hard and NAND flash is pushing the hardest. So we will see our newer products going to them. So from that standpoint, I think the story's a little different for KLA-Tencor than for the process guys.

Steven Pelayo - HSBC

I mean, it really sounds like from a bottom line basis the dollars at 45 nanometer related equipment are likely flat to up every quarter as far as we can see at this point.

Rick Wallace

That's right.

Operator

Your final question comes from the line of Jen Wong - JP Morgan.

Jen Wong - JP Morgan

Good afternoon. I just wondered if you could talk a little about 2008. Where do you see CapEx going and where do you see process control going? Do you think memory will come back in the first half of 2008, or how do you see that playing out?

Rick Wallace

That's a great question. I wish we could offer you a lot of insight around that. Like John, the only insight I really get on 2008 is when we talk about customers and hear what they have to say. They'll usually relay stories which aren't really our data, but they'll say they are enthusiastic because of the Olympics or because of Vista or because of additional application coming out in the consumer space, like we've seen recently. So we don't have any particular insight. I think there are people that probably spend more energy trying to figure out. 2008. What we're trying to do is really understand what are our customers needs and we know in the yield and the metrology challenges we're bringing out the products to be able to respond to their needs.

But by and large, our customers are enthusiastic and we are tracking the number of fabs anticipated for 2008, it looks pretty healthy. So from that standpoint for us 45 nanometer, and the challenges associated with that and the general health of the overall industry, we feel pretty good about the future.

Jen Wong - JP Morgan

So you would say it is up more so than flat?

Rick Wallace

I didn't say that. I thought that there are a lot of positive drivers, but there's just way too much in terms of unknown of there 2008. You have to get somebody that has a lot more time to do an analysis of the future.

John Kispert

You know what we do, the macro economic analysis we will do that far out is to listen to a lot of the same folks you listen to and look at their data. Right now, I think you know this, when we look at 2008, we just read the same things you are probably reading. It looks relatively flat, maybe slightly up and of course there is a bell curve around that. Now do we plan for that? No. We find it interesting. We watch it closely. We know it is going to change. As the year goes on, you keep asking the question, I think probably in the middle of 2008, probably a year from now we will have a good idea.

Rick Wallace

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

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