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KLA-Tencor Corp. (NASDAQ:KLAC)

F1Q08 (Qtr End 9/30/07) Earnings Call

October 25, 2007 5:00 pm ET

Executives

Jeff Hall - CFO

Rick Wallace - CEO

John Kispert - President and COO

Analysts

Harlan Sur - Morgan Stanley

Brett Hodess - Merrill Lynch

Jim Covello - Goldman Sachs

Vis Vellore - Credit Suisse

Timothy Arcuri - Citi

CJ Muse - Lehman Brothers

Mark Fitzgerald - Banc of America

Bin Pang - Caris Company

Garry Hsueh - CIBC World Markets

Steven Pelayo - HSBC

Mahesh Sanganeria - RBC Capital Markets

Suresh Balaraman - ThinkEquity

David Egan - Lehman Brothers

Operator

Good afternoon. My name is Marvin, and I will be your conference operator today. At this time, I would like to welcome everyone to the KLA-Tencor Corporations First Quarter Fiscal 2008 Earning Conference Call.

All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question-and-answer session. (Operator Instructions). Thank you.

I would now like to turn the conference over to Mr. Jeff Hall, Chief Financial Officer. Please go ahead, sir.

Jeff Hall

Thank you, Marvin. Good afternoon and welcome to KLA-Tencor's first quarter fiscal year 2008 Earnings Call. I am Jeff Hall, the Chief Financial Officer. Joining me today are Rick Wallace, our CEO; and John Kispert, our President and COO.

We are here today to discuss our first quarter results for the period ended September 30, 2007. We released these results this afternoon at 1:15 pm Pacific time. If you haven't seen the release you can find it on our website at www.kla-tencor.com, or call 408-875-3600 to request a copy.

Rick will lead off today's call with highlights from the September quarter update on the current market environment and key product activity, and provide guidance for the December quarter. Afterwards, I will review the preliminary financial results for the quarter and then I'll open the call up for questions.

In the investor section of our website you’ll find the simulcast of this call, which will be accessible on demand for 90 days. On the website you’ll also find a calendar for investor events and presentation 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.

And as you know, our future results are subject to risks and any forward-looking statements we make, including those we’ll make on the call today are subject to those risks. KLA-Tencor cannot guarantee that those forward-looking comments will come true.

Our actual results may differ significantly from those projected in our forward-looking statements. And although we take no obligation 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.

And with that, I will turn it over to Rick.

Rick Wallace

Thank you, Jeff, and thank you all for joining us for our Q1 earnings call this afternoon. Today I’ll be discussing highlights from the September quarter updates on the current market environment and update on our four strategic objectives and guidance for the December quarter.

I am pleased to report that we once again produce solid operating results. Revenue was $693 million at the upper-end of our range of guidance for the quarter. Net income excluding some one time charges was also at the upper-end of guidance and $146 million or $0.76 per diluted share. And we generated approximately $205 million in cash flow from operations in the quarter.

Jeff Hall will provide additional details on the company’s financial highlights later in the call. Orders for the September quarter were $482 million down 32% from the June quarter. Again, September has historically been a difficult period for bookings of KLA-Tencor since it is our first fiscal quarter.

This first quarter seasonality was compounded by a general end market weakness, which resulted in timing delays for some orders and certain logic and DRAM customers during the last few weeks of the quarter. Some of these or those who currently shifted into next year. In addition during last week of September we found that we are not able to reach final terms with a few customers, and as a result these orders did not close in September and will be shifting to December.

During the final weeks of the quarter, we also experienced a weakened demand in our other end markets including Logic, Foundry, Reticle, Fair Way for end service. This softening in demand will likely result in some orders that we are expected to book during September and December moving into calendar 2008.

I would like to take a few moments to clarify the current bookings environment by commenting on our customer base by customer segment. Memory was once again our largest segment during the first quarter, the current climate. The Memory customers are similar to what we've experienced over the past six months, i.e. the memory bip rate growth continues to be strong, despite persistent unit price declines in both DRAM and NAND Flash, and an unfavorable balance of supply and demand in DRAM. As memory and unit demand is expected to gain strength, due to seasonality in the proliferation of new applications, our memory customers are continuing to invest in advanced technologies and new materials to enable smaller design rules and higher density applications and to reduce cost which in turn leads to increased adoption of process control to drive down the affectivity.

Looking ahead, we expect overall memory CapEx to be choppy. But have seen an increased interest in process control as memory manufacturers struggle with the yield and metrology challenges of advanced notes. Foundry orders in September were down following a strong June quarter as we expected. Historically, the level of adoption of process control for Foundry customers has always been driven by the nature of the foundry business, faster learning cycles during development and the increased mix of products inside the foundries and reduced time to market. These conditions make achieving targeted yields in a shorter period of time critical to the success of the foundry segment.

While some major foundries have reported reduced CapEx forecast, their increased need for process control due to the nature of the Foundry business will continue to be a driver for our business.

Logic orders in the September quarter came in lower than expected, as upside from one MPU customer was offset by the push out of the meaningful order from another U.S.-based customer, who has recently scaled back its CapEx plans. We are forecasting higher order levels from the Logic segment in 2008, which will be driven by additional investment in leading-edge technology by one of our MPU logic customers.

To summarize, I'd like to note here that although in the short-term we are experiencing the somewhat choppy order market with some uncertainty as to the timing of some large projects, our long-term pipeline remains strong.

Next, I'd like to discuss some recent highlights for KLA-Tencor on our four strategic objectives: our customer focus, growth, operational excellence and talent development. Customer focus is the first of our four strategic objectives at KLA-Tencor. We work hard to understand our customers' requirements and to provide solutions in all the markets that we serve. Our measure of success is our market share, and our goal is to have market leadership in all the markets that we serve.

Today, we have market leading positions in 18 of 20 of the markets that we serve, and our key to success is to collaborate closely with our customers, innovate to bring creative differentiated solutions and then execute and bringing the new products to market and support them through their product life.

In the September quarter, we were successful in maintaining our market share in the markets where we have already established the leadership position. In addition to that, we will able to gain share in one significant market, where we currently do not enjoy market leadership e-beam review.

Our new electron-beam review and classification tool, the eDR-5200, was recently declared the tool of record for the 45-nanometer node at a European logic facility. The eDR-5200 is an e-beam review solution that also enhances resolution, thus improving the productivity of our inspectors.

Our customers needed to dramatically reduce their SEM Non-Visual rates and improve performance of defect detection on 65-nanometer and 45-nanometer technology nodes. ATE's eDR-5200 solution provide a connectivity with inspectors to improve brightfield recipes or also delivering very high resolution in stage accuracy, allowing maximum capture of defects on the review system.

Another eDR-5200 was installed at a key U.S. development center to enable advanced process development after 32-nanometer node. Competing eDR solution cannot resolve the smallest defects at the 32-nanometer node. We believe the eDR-500 provides a great solution and positions us for growth in this new market.

Now, I'll spend a few minutes going to our core markets of inspection of metrology. We have a broad portfolio of inspection products servicing the bare wafer Reticle manufacturers as well as the semiconductor market, included in this are the Surfscan, brightfield, darkfield, E-Beam inspection and our Reticle Inspection products.

Our market share performance remained at historical levels in all the key markets and product lines that we have, as in the past there was always a lot of hard work required to win the business especially in environment when capital is tight and our customers have to make sure that the premiums that we get on our products are worth the additional investment.

As in the past our teams did a good job of demonstrating our value and we are pleased with our market share performance across our inspection products. Let me give a couple of specific examples.

Our 2810 full-spectrum brightfield tool introduced in July 2007 and designed specifically for memory applications on large capacity expansion order with a Taiwanese memory manufacturer in the September quarter, demonstrating superior sensitivity, capture of key defect signatures and throughput and head-to-head competition.

The 2810 features twice the computing speed of our earlier generation brightfield inspection tool, as well as new optical merge that enables increase defect detection. The latest addition to our Puma darkfield inspection platform, the Puma 9150, was chosen by logic customer to help it achieve improved device quality and zero effect product liability for specialized applications.

After a rigorous six-month evaluation against the competing products, KT received orders for a delivery of multiple Puma 9150 units. The Puma 9150 demonstrated superior throughput stability and reliability of the production proven systems against the competition.

In Metrology, KLA-Tencor continues to be the market share leader, by offering a comprehensive suite of metrology analysis to process window optimization products, to give our customers the ability to maintain tight control of their process windows.

In the September quarter, we were successful in winning new business and displacing several competitors' tools, by demonstrating superior performance in optical CD films overlaying metrology for advanced applications in memory, foundry and logic customers.

Overall, our market share in the September quarter met our expectations, with regard to the maintaining our leadership positions in our core markets, in addition to picking up some nice gains in the e-beam review market.

In addition to that, we are well positioned going forward, based upon our product pipeline fueled by our R&D investments across our portfolio. These are just a few examples of recent successes. KLA-Tencor achieved during the September quarter and solving their customers' mission critical production challenges and expanding our market leadership.

Across the industry the technical challenges our customers are facing are significant and we're working closely with them to solve those problems.

Our second strategic objective at KLA-Tencor is growth. Our goal is to continue to outgrow the industry. Our growth prospects continue to look good based upon the market segments that we serve and increasing the need for inspection measurement as device makers address the increase challenges of next design-rules. The increased complexity our customers are facing, as they transition to the 45 nanometer node, whether introducing new manufacturing techniques such as Immersion lithography, double patterning, pitch splitting, or integrating new materials to improve device performance such high-k/metal-gate is creating new yield and defectively challenges driving the need for more accurate inspection and measurement technology. This is helping to drive accelerated adoption of process controls, and in turn new revenue opportunities for KLA-Tencor.

We estimate the increased adoption of process control by chip manufactures of 45 nanometers translates to an incremental revenue opportunity for KLA-Tencor of 30% or more as compared with the 65 nanometer node. We see evidence of that growth potential in our projections for the calendar year '07 performance for KLA-Tencor relative to overall CapEx market.

Based upon our current estimates KLA-Tencor will outgrow the market in calendar '07 as we’ll grow revenue in the range of 15% to 20% compared with an industry CapEx growth rate of around 5%. It looks very hard to predict calendar '08. We believe we are well-positioned to continue to outgrow the industry as a result of the increased challenges of 45 nanometers and based upon new markets that we have entered during calendar '07.

During calendar '07 we have entered six new markets, both organically and through M&A activity which increases our potential available market by more than $700 million as sized by industry analysts.

That being said, we are very selective about the growth prospects that we pursue. We will only enter a market that presents growth prospects that will enable profitable growth. While we are willing to be patient we have to make sure that we can differentiate and add value and grow in each market that we enter.

In addition to the six new markets that we entered during calendar '07, we have more growth initiatives in place at KLA-Tencor and we will be providing updates as they materialize. Our strategy will be to continue our organic efforts as well as leveraging our ability to successfully use acquisitions as a way to enter new markets.

Our third strategic objective at KLA-Tencor is operational excellence. Over a year ago we laid out a four year plan to drive continued improvement in our business model by driving operational excellence throughout the company. We have made steady progress on our plans and have seen the results of our efforts. During his prepared remarks, Jeff will go thorough the details of our progress.

Our fourth objective at KLA-Tencor is talent development. None of the success that KLA-Tencor enjoys would be possible without our world class workforce. While historically we have developed world class talent and achieved outstanding financial results through the cycles of the industry, we are increasing our efforts in talent development as we know that our people are the key to our success.

In summary, KLA-Tencor continues to be a company with an unparalleled portfolio of inspection measurement technologies. During relationships with every major IC manufacturers and great people who are driven by an unwavering passion for innovation and commitment to ensure our success. These unique attributes are what have sparked our market leadership over the past 31 years and what fuels our strong financial performance, providing the resources for continued innovation and a strong foundation for growth. We believe these attributes help to position KLA-Tencor to continue to outgrow the industry in 2008 and beyond.

I would like to wrap up my comments now by giving you our guidance for the December quarter. Orders are expected to be up 20% plus or minus 10% from the September quarter. Revenues are expected to be between $625 million and $640 million and EPS in the range of $0.68 to $0.73 including stock based compensation and excluding one time charges.

Thank you for your attention this afternoon. I will now turn the call back over to Jeff Hall.

Jeff Hall

Thanks, Rick. As Rick said, KLA-Tencor had a solid operational execution in the September quarter, as shipments, revenue and EPS all came in at or above guidance. Operating margin was also above expectations as some of the operational improvements we have been making began to show off, despite the drag of recent acquisitions and cost of transitions to Singapore. Cash from operations was $205 million.

We also ramp production of our second product in Singapore and made significant progress towards integrating our recent acquisitions. Our goal with these transitions is to get them seamlessly integrated with the rest of KLA-Tencor and began recognizing the synergy as quickly as possible.

This means converting systems and processes, engineering products on the common platform, taking pre-acquisitions, bookings and commitments to the P&L, consolidating distributors, sales and service efforts into our channels, and of course eliminating a lot of duplicate activities. It takes a considerable amount of effort and expense to execute these integration efforts while continuing to serve our customers well.

In the September quarter, these activities were approximately 1.6 points, diluted to gross margin and 2.4 point or approximately $15 million dilutive to operating margins. We expect this dilution to be reduced in the December quarter and eliminated by the end of the March quarter. Overall, our integration efforts are continuing to meet our expectations and we are on-track to achieve our margin improvement target.

Now let me spend a minute going through the quarter in more detail. September is always a challenging bookings quarter for us, as it is our first fiscal quarter. In the last few weeks of this quarter timing of some orders for logic and DRAM customers became less clear and some orders moved into the next calendar year. In the final few days of the quarter, we were unable to agree on final terms for the few customers, and as a result didn't close on these orders by September 30. We did close on these orders in early October.

While we expected some weakness in memory in the second half, it turned out to be more widespread than we anticipated as end markets were foundry, logic, reticle and bare wafer were all impacted. As a result of this, we now don't expect to close on the commercial terms of several orders until early 2008.

Net bookings for the quarter were $482 million, which is roughly 32% lower than the June ending quarter. This net bookings number includes $32 million of de-bookings. Every quarter, we close our bookings backlog line-by-line and de-book any order we do not expect to shift in the next 12 months.

The product distribution of orders for wafer inspection was approximately 40, reticle inspection was approximately 13%, metrology was 23% and service was 24%.

We ended the quarter with approximately $1.3 billion of backlogs, $835 million of shipment backlog or orders that have not yet shipped and $485 million of revenue backlog or products that have been shipped but have not yet been signed off by customers.

Remember, we do not include any service bookings or revenue in this backlog. We remain confident that we have strong backlog shippable over the next six to nine months, and our ability to maintain this significant level of both shipments and revenue backlog continues to help KLA-Tencor sustain profitability throughout any business cycle.

Now turning to the income statement; revenue for the quarter was $693 million, down about 6% compared with the previous quarter. At the midpoint of our guidance for the December quarter, we expect revenue growth for calendar year to be approximately 17% compared to about 10% for total process control and about 6% for wafer fab equipment.

We attribute this out-performance to new products and increasing adoption of process control as the industry moves to 45-nanometer design rules and below.

Gross margin for the quarter was 55.9%. This includes $10.7 million of charges for deal-related amortization and reductions in force. Excluding these items, gross margin including stock options was 57.4%, down about 1.8 point from Q4.

Our recent acquisitions for 1.6 point dilutive to margin, as we took several pre-acquisition commitments to the P&L and continue to consolidate and integrate the manufacturing operations.

Operating expenses, including both SG&A and R&D were $210 million. This number includes $6 million of charges for deal-related amortization, reduction in force and legal fees related to the stock-options investigations.

Excluding these items, operating expenses were $204 million, down $8 million quarter-to-quarter, as we continue to focus on driving down the breakeven point of the company. Breaking down operating expenses, R&D expenses were flat quarter-to-quarter, as we continue to ramp development programs and customer collaborations at 45 nanometers and below. And SG&A expenses were down approximately $8 million quarter-to-quarter despite the addition of cost in the first four quarter of '08.

As a result of our continuing efforts to stream line the business and reduce the breakeven points, we expect the operating expenses in the December quarter to be down another $8 million as a result of lower SG&A spending to approximately $196 million slightly below the levels of operating expense we had before the addition of over $25 million of quarterly expenses from the recent acquisitions.

Operating margins for the quarter excluding one-time charges were 28%, down 2.4 points from the prior quarter. This decline was a result of the integration of the recent acquisitions. We expect the margin pressure of these acquisitions to be reduced in December and expect them to be at company average margins in the March quarter.

For the quarter, other income was $17.5 million. In the December quarter, we expect other income to be approximately $14 million. The tax rate was 57.4% in the quarter. This rate was higher than our estimate of 28% as a result of an upfront tax payment related to the Singapore transition.

In addition to the cost savings expected as part of our ongoing globalization strategy, we also expect significant tax savings. In order to maximize these savings, we moved the related intellectual property to a non-US legal entity, resulting in a one-time tax expense of $47 million.

In the December quarter, we expect the tax rate of approximately 28%. Net income for the quarter was $88.2 million or $0.46 per fully diluted share. Excluding the charges discussed earlier, net income was $146 million or $0.76 per fully diluted share.

This number includes the share-based compensation expenses of $28 million or $0.10 per diluted share. In the December quarter, we expect expenses for share-based compensation to be approximately the same.

Turning to the balance sheet; cash and investments end of the quarter were 1.3 billion, a decrease of $428 million quarter-to-quarter. In the quarter, we spent $683 million to repurchase approximately 12 million shares and paid a dividend of $28 million. After these share repurchases approximately 11 million shares remain authorized for repurchase under our existing program. Inventory decreased by $35 million to $500 million. Accounts receivables finished the quarter at $619 million up $37 million from the prior quarter as a result of higher shipment levels and increased sales to Japan. Cash from operations was $205 million in the quarter and capital expenditures were approximately $11.6 million while depreciation was $14.6 million. So, on a net basis including retirement fixed assets decreased by $3 million quarter-over-quarter. Fully diluted shares ended the quarter at $193 million and headcount was about 6000.

Finally, as Rick commented earlier, we were in a choppy CapEx environment and so we continue to run our company in a way that will allow us to maintain high levels of investment in next generation technology and in collaborations with our customers, while maintaining our high levels of profitability and cash flow. With that our guidance for the quarter is bookings up 20% plus or minus 10 points. Revenue between $625 million and $640 million. Operating expenses down an additional $8 million to approximately $196 million and EPS including share based compensation but excluding one time charges and amortization of $0.68 to $0.73.

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

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Harlan Sur with Morgan Stanley.

Harlan Sur - Morgan Stanley

Thank you. Good afternoon. Yield issues are clearly a pressure point for the industry here as you know clearly guys struggling on 50 nanometer NAND, we’ve got the foundry sort of struggling with 65 nanometers. I know that there are some people today concerned about TSMC's comments about CapEx being down next year. Take all of these into account, I would assume though that even in a down CapEx environment, for foundries, and even for memory, that the spend for KLA solutions will be up. Is that a fair assumption?

Jeff Hall

Yeah, Harlan, I think it’s a good point. Obviously we are seeing various concerns from different customers about their yield challenges and that's actually heighten recently. John and I were both in Asia last week meeting with customers and an increased level of interest particularly in driving the latest technologies forward, so as we look forward we see process control continuing to out perform the overall industry. However, its hard to say when we get into a calendar '08 what it will overall look like, but we think we are going to out perform as a result of the challenges associated with the advance nodes and both the logic and DRAM and also the foundries basis.

Harlan Sur - Morgan Stanley

Okay, great and then given the sort of large revision down in bookings in September from your expectations entering the quarter, I am just wondering what your confidence level is here in the December quarter about delivering on the up 20% in orders?

John Kispert

Hey, Harlan, this is John Kispert. One of the things that happened in the September quarter is we saw a good chunk of the originally forecasted orders kind of move into the first week of October. So we are fortunate in the guidance that we just gave you for the December quarter, we are up to real fast start in that we already have a bunch of that already booked. So the linearity of the quarter will be far different as far as the order outlook and then say the September quarter was?

Harlan Sur - Morgan Stanley

Got it. And then one last question for Jeff, what do you expect shipments to be like here in the December quarter?

Jeff Hall

Right now we are running at about 575 to 600.

Harlan Sur - Morgan Stanley

Okay. Great, thank you very much.

Operator

Our next question comes from the line of Brett Hodess with Merrill Lynch.

Brett Hodess - Merrill Lynch

Hi, good afternoon. A couple of items, I am wondering if you can talk about, if the environment stage is sort of flattish like this, let's say the orders bounced back up after the big drop off, but generally sort of staying in this range. Can you give us some more inside now that you are moving the second product line into Asia about what kind of margin we should see over the next couple of quarters if you are in sort of a flattish revenue and shipping environment? And what kind of expansion we can see?

John Kispert

Hi Brett, it's John Kispert. I think the way to think about it for us right now given our backlog position, what we see on front of us is if you average over the last couple of quarters, we kind of have been running about $700 million with lots of ups and downs. Its always a chunky business, but roughly $700 million run-rate for the company. Right now it looks to us kind of run-rate for the next couple of quarters closer to 625 or so. There will be some quarters, where we ship a little bit less and some quarters we ship a little bit more, but we'll manage through that. That's kind of our bottoms up analysis of that.

Now, the delayer in Singapore, which is as we've told you in the past is kind of that 5% of its capacity right now, and is relatively large overhang of excess capacity for us. They are ramping very nicely I would think coming out of this quarter to the December earning quarter, we are closer to maybe 25%, 30% of their capacity, but still only about 5% to 10% of our shipments. But we will begin to absorb more and more of that overhead. And that will add at that 600, 625 run rate for us about a point of gross margin which should be helpful.

Brett Hodess - Merrill Lynch

Okay. So, just to be clear that that's a point of gross margin in the coming quarter over the next few quarters, does that 625 the standard run rate?

Rick Wallace

Yeah, over the next few quarter, take a couple of quarters to get Singapore ramped up and also a fast start but the plan was over the next three to four quarters just start to see it ramp.

Brett Hodess - Merrill Lynch

Got it. Very good thank you.

Operator

Our next question comes from the line of Jim Covello with Goldman Sachs.

Jim Covello - Goldman Sachs

Good afternoon guys. Thanks so much. My question, just I'll keep with the one question is, when I think back to semicon watch and what the application was for orders at that time for the second half for the year versus -- total second half versus what we are looking at today?

What do you think it is in nutshell changed the most and then why do you think that you have a handle on some of the environments going forward, given the delta between than and now? How do you get comfortable your view on the environment over the next couple of quarters is good given all the CapEx forecast declines that we're getting from the customers right now?

John Kispert

Yeah, Jim, it's John Kispert, COO. You are talking back to July, I guess.

Jim Covello - Goldman Sachs

Yeah. At some time, I think you guys add as much more optimistic outlook scenario for the total second half for the year at that time.

John Kispert

Yeah. As Rick said in his prepared statements that I'd say the big change has been really over the last 30 days. And it came kind of in two flavors at least my perception of it. In the last 30 days, we've seen the larger capacity adds that have been planned over the next six to nine months become smaller. I mean in another ways, you are going to still add some capacity to the smaller chunks or smaller bites in our case smaller orders. That happen about 30 days ago and as you would image because it's built out 50% of our businesses, it's now a little bit more and most of it's in memory.

And I think the other piece that happened, kind of, in the last couple of weeks is definitely a movement out of some of the capacity like ads, where folks would plan on purchasing stuff maybe in the December ending quarter and strongly then ramping in March timeframe and now taking more like the late spring summertime. And so you see this kind of moment out or to the right as we say.

When you combine those two together for us and I think you guys will do all the math here, it was kind of moment of maybe a half a quarter of orders and our run rate back then, it's kind of moved out into 2008. And, as Jeff said, our position is as usual, we're going to be very cautious from here on in. And we're running the business that way. The Brett's earlier question was sizing the company, low 600s right now for next couple of quarters. And we'll wait and see. And as you know, we work closely with our customer so we'll be on top of it.

Jim Covello - Goldman Sachs

Thank you.

John Kispert

Jim, have a good weekend.

Jim Covello - Goldman Sachs

Thank you.

Operator

Our next question comes from the line of Satya Kumar with Credit Suisse.

Jeff Hall

Satya, are you there?

Vis Vellore - Credit Suisse

Yeah. Hi. This is [Vis Vellore] on behalf of Satya Kumar.

Jeff Hall

Okay. How are you?

Vis Vellore - Credit Suisse

Yeah, doing good. One quick question, so now that like a major foundry talked about slowing spending in 2008. So what is your outlook for CapEx for 2008 and just want to get your thoughts on why foundry should be slow, it would be lowered in CapEx when utilization rates are so high?

Jeff Hall

Yeah, it's a confusing time. When we look at the forecast from folks like yourself and lots of other folks listening in where we see there is a wide range of 2008 CapEx being anywhere from flat to down 15%. We tend to look at it on the lower half when we do any kind of bottoms-up conversations with our customers.

So we take again to the earlier questions, we are taking a cautious stance there. The drivers underneath that are certainly fall off in DRAM spending. I think NAND will continue to be stronger. I think when we look at the foundry business, the timing of any sort of capacity as in foundry I think of very much in question right now. We see a lot of technical upgrading that we can do in the foundry businesses. But it's a smaller piece of the entire pie.

So it's either going to be flat, maybe slightly down. And as Rick said earlier, we think we can do well on that space. It's just that we don't see a lot of spending today through 2008, a big uptake in other words. And that leaves Logic which to us right now looks to be down on 2008 as far as CapEx is concerned. We think we cannot perform there and given the 45-nanometer challenges and the things that we can do there. So probably we at KLA-Tencor will be flat to up in Logic, but the industry trend looks like it's always probably down.

Vis Vellore - Credit Suisse

Okay. Thank you.

Operator

Our next question comes from the line of Timothy Arcuri with Citi.

Timothy Arcuri - Citi

Hi guys. Couple of things: First of all, John if you look at the bookings in the second half of the year versus the first half of the year. As you compare that to some of the other OEMs, it's in the [growth of] the suppliers and most of the other OEMs are down about 15% half-over-half and you are down like 2x of that. I mean there is obviously differences in timing of your tools versus their tools, but what do you think the reason is? Is it specific customers where you have big exposure that are cutting back or is it maybe that people kind of over bought inspection equipment early on, what do you think the dealt is there?

Jeff Hall

Yeah, Tim, that's news to me, but I'll tell you that we have like nine months lead times generally across our product line, I think the folk you are comparing us to probably much shorter lead times. In fact I know they do, but I deal with this continuously with our customer base. So, our lead time in our orders tend to be further out in time as far as been able to install and turn into capacity.

Timothy Arcuri - Citi

Sure, okay. Well, I understand. So then John I guess last question, it looks like shipments were about 710 in September is that about right?

John Kispert

Yeah, about 700.

Timothy Arcuri - Citi

700, okay, thanks guys.

Operator

Our next question comes from the line of CJ Muse with Lehman Brothers.

CJ Muse - Lehman Brothers

Yeah, good afternoon, thank you for taking my call, quick question here. If you look at the dealt of your bookings guide at the midpoint or I guess the lower end and then the actually down 32%, so just roughly I guess $100 million being pushed to December which would suggest pulling that out at roughly $500 million bookings run-rate, which compares to kind of mid 600 revenue guide. How should we think about this mismatch and the implications to your revenues in the quarters ahead?

Jeff Hall

Yeah, CJ, there was a prior question on that and I tried to answer that question. We have a bunch of backlog that will tapers in and I also think in as we said in the guidance our orders are going to be up in December.

CJ Muse - Lehman Brothers

I guess, that was going to lead my second question, just its seems like two months ago, you guys were talking a lot more bullishly about foundry and logic spending and now pulling back there, what gives you the confidence that your backlog is secured today?

Rick Wallace

Our backlog is generally technology buys for the work that they are doing in pilot lines strategic. We actively beat the books CJ where we don't think were there were capacity buys that we think are in danger is not actually happening. We are focused with our backlog and keeping it in the strategic aims of our customers and we will meet the tools, so they can push their business in line.

Jeff Hall

I think if you look at our track record rarely do you see we have to de-book a large part of our backlog in any kind of the environment.

CJ Muse - Lehman Brothers

Sounds good. I appreciate it.

Operator

Our next question comes from the line of Mark Fitzgerald with Banc of America.

Mark Fitzgerald - Banc of America

Rick, in the delay in some of these bookings and stuff that’s going to push down to the first calendar quarter here when you have these conversations with your customers are they waiting to see how market conditions unfold is that what this issue that saying in this company, these orders are?

Rick Wallace

Well I think there was a couple of issues: One is a lot of them based their investment plans based on overall market conditions and as those are soft and I think people will slowdown some of those overall. And I think we saw early signs of some of the recent announcement that have been made. We saw that at the end of September the things that have just been made in the last few days.

And so I think they are getting down, they have reset their base line about what do they think they need to invest. As counter balancing that is concerned that they don't want to get behind in particularly our new technologies and so that's where we see a lot of, why we have more confidence as John was saying in our backlog and then some of these orders coming in. So John also said they tend to overall get a little bit smaller and they get a little bit further out.

Mark Fitzgerald - Banc of America

And just a follow on here is, I mean dealing on price approach and lot of peoples cash cost is that an issue in terms of any these orders get pushed out that in terms of your conversation?

Rick Wallace

Certainly, that’s part of the factor into. But as, you know, for many of these customers if they want to stay in the market they have to keep investing and so that’s a counter balance for that. Now you can make a pretty good case, but over the next 12 months, there might not be as many players 12 months from now as there are right now. And, we’ll wait that’s why John was saying, we think from overall market for '08 we’re probably more cautions than last.

Mark Fitzgerald - Banc of America

And just one final question if I might: On the logic side of the business, when you look post 2000 you really haven’t seen this part of the business coming back in a big way? And I am curious if these technology notes ships on the logic side of the business are just slowing down from your guys manage point?

John Kispert

Yeah. I think the ramping of them has Mark, that this big spending to your point, but as you know we’re constantly collaborating with them on next generation technologies and so from that manage point we don’t feel like it slowed down at all.

Mark Fitzgerald - Banc of America

Well, you look at that is kind of over a long-term still a growth business were you in the logic part of it?

John Kispert

Yes, sure, not like it has been in the past but certainly, great opportunities particularly with our next generation technology. I mean that’s where we can get a lot of learning early on as they move forward with their next-gen. We have our entire suite of tools that has to be coupled with them.

Rick Wallace

I think some of what happen is well Mark, is some of that logic overtime is turning to foundry standard and some of these guys have stopped making some of their own devices.

Mark Fitzgerald - Banc of America

But foundry spending, that looking great item for 2000 year.

Rick Wallace

Post 2000.

Mark Fitzgerald - Banc of America

I mean as you look at the -- your recovery post 2000 are all memory driven at this point though.

Rick Wallace

From an overall industry there is no question that NAND, for example, you can even get more specific and lot of it has been about NAND, NAND investment and DRAM has been a little more cyclical and now we’re seeing some correction in NAND. Those, I think that’s true, I think for us that we still see our penetration in the logic and in the foundries being pretty strong relative to overall CapEx, now whether the overall CapEx is at the similar levels to what it has been historically, I think that maybe more of the point. The big CapEx spend is to be memory now.

Mark Fitzgerald - Banc of America

Thank you.

Operator

Our next question comes from the line of Bin Pang with Caris Company.

Bin Pang - Caris Company

Thanks for taking my question. I just want to get a clarification on a couple of your comments regarding 2008 spending. You mentioned for logic you expect the industry to be down but KLAs or spending on PDC will be flat to up. Correct?

John Kispert

I think flat that will be the right way to term it.

Bin Pang - Caris Company

Okay. When you talk about logic are you including foundry in that?

John Kispert

No.

Bin Pang - Caris Company

Okay. So that’s IDM spending.

John Kispert

Yes.

Bin Pang - Caris Company

And your comments regarding the foundry itself, could you, just repeat that again, you still expect PDC to be up for foundry in 2008.

Jeff Hall

No. I think and by the way 2008 we’re rarely right in predicting this. And we are just talking to a lot of folks and trying to anticipate how we should size the company to anticipate these questions. Right now foundry does look like it’s up marginally year-to-year, and that’s based on the plans we’re getting from our foundry customers. But as you know it’s a -- and we typically are well adopted in the foundry model. So, we would expect to do well there. But foundry as a percentage of the total pie for CapEx is as today is a smaller percentage but we would expect it to be higher in 2008.

Bin Pang - Caris Company

Okay, and the last question for me regarding memory spending. You commented that your orders for the 1Q were down because it primarily was memory driven, is that correct?

Jeff Hall

Yes.

Bin Pang - Caris Company

And when those companies come back in the 2Q, is that on the technology or is it capacity?

Jeff Hall

A little bit of both. Primarily what you see moving on is capacity. We talk about memory often it is the same thing than as you know. They will be pushing the envelope and adding capacity at the next technology node. So to answer your question, I would say it's a probably 50:50.

Bin Pang - Caris Company

Okay. Thank you very much.

Jeff Hall

Yeah.

Operator

Our next question comes from the line of Garry Hsueh with CIBC World Markets.

Garry Hsueh - CIBC World Markets

Thanks for taking my question. If I take the low end of the range for September and I take the midpoint of your order guidance for December. It looks like you are basically missing $75 million out of orders post in the second half. So my question is, basically, is there a reasonable expectation for orders in the first half of '08 now to somehow get to a $650 million to $700 million per quarter run-rate or has that $75 million just permanently flew the coup?

John Kispert

No, right now it definitely sitting in Q1, Gary.

Garry Hsueh - CIBC World Markets

Okay. So John, I mean there is a possibility here we could start to book somewhere between $650 million to $700 million per quarter here in March?

John Kispert

I think our bottoms-up would put us somewhere down there right now.

Garry Hsueh - CIBC World Markets

Okay, so we didn't permanently lose that business?

John Kispert

No, there is no share loss here. In fact, we did really well with share.

Garry Hsueh - CIBC World Markets

Okay, so we've got a pretty nice running start here in March on the order basis and we have got pretty strong backlog.

John Kispert

As looks today, it's moving, it's very fluid environment we are operating in.

Garry Hsueh - CIBC World Markets

Okay, I appreciate the honesty. And can you just give me a quick comment here on pricing? I know there is a lot of concern about DRAM and how that might be transferring over to tool pricing?

John Kispert

Oh, I don't price DRAMs. Our price is hanging in their really well. The next-generation tools have done really well with cost of ownership, sensitivity improvements, for ever battling pricing and trying to come up with the lowest cost of ownership with our customers. But the technology needs are such I think it's a fair battle. So our pricing is no change say the rest of this year has been.

Garry Hsueh - CIBC World Markets

Okay, John, can sneak one more question for Jeff, here?

John Kispert

Absolutely.

Garry Hsueh - CIBC World Markets

Jeff, what's going on here with unearned revenue, I see that for the first time, there is a slog of unearned revenue now moving to the long-term liability line, is there anything going on there?

Jeff Hall

Yeah, there is actually nothing going on, what happened is we implemented what's called FIN 48 a new accounting rule in the quarter, first quarter of the new year for us and as we did that, it changed how we bucketed some of our tax line and we bucketed, that resulted in us having some, taking some short-term tax liabilities and moving them to long-term tax liabilities. Previously, the unearned revenue had all been rolled up in the short-term, but when we created the long-term liabilities section of our balance sheet, we then move the unearned revenue from short-term to long-term.

Garry Hsueh - CIBC World Markets

Okay, perfect. Thanks.

Operator

Our next question comes from the line of Steven Pelayo with HSBC.

Steven Pelayo - HSBC

John, this is like the second or third quarter, I think our bookings are little bit of a surprise, KLA has started with them pretty good forecasting especially in the technology focus, nine months lead times and bookings guidance with the plus or minus 10% band. Is there any kind of secular change going on as a consist with reliability or forecast ability kind of deteriorated, what should I be thinking especially given your comment, I guess you just suggested that [by the time] you are looking at first quarter bookings to potential be up again from the 600 level maybe 650 to 700ish.

John Kispert

For the first half, I think it just a math it is bottoms-up but definitely looks that way to us and the first part, I'm scratching my head Steve, I don't know that we've particularly beat the order guidance a number of quarters in a row and as you know we follow the company for a long time and the September quarter is typically a more difficult quarter and hopefully I have characterized pretty well for you was backend loaded with generally memory orders that either slid out of the September quarter into the December quarter and we closed those. But I think since then what you've seen across the industry is folks really looking at their plans and kind of moving around at the beginning of 2008 when they are going to start adding something and that's what we are in the midst of right now and we are giving you our best view of what we have right now.

Steven Pelayo - HSBC

You are doing good on the cost side, John. You just talked about OpEx being down again in December, if you do state the revenue run-rate of 625 range, can OpEx had even lower?

John Kispert

The plan is for R&D to keep chugging along here, particularly with our -- what we call n plus two kind of two generations out, we are going to keep plenty of opportunities. Rick highlighted a bunch of in his prepared remarks. I think SG&A, there was room for us to continuously consolidate something. So at around $600 million, $625 million run-rate, we think an operating profit line, we can be at high 20s as a percent 28%, 29%, 27% and that's how we think we can run in at that level.

Steven Pelayo - HSBC

And Jeff at that level are you sustaining the kind of 30% of revenue in cash flow from operations? That looks pretty good.

Jeff Hall

Yes, absolutely. I think what you'll see is that if things level out, cash flow actually goes up. We had a strong cash flow this quarter, buffer some big tax payments. Next quarter, we're going to have another really big cash flow quarter, next quarter. So we're now starting to work down the working capital.

Steven Pelayo - HSBC

Hey, guys thanks.

Operator

Our next question comes from the line of Mahesh Sanganeria with RBC Capital Markets.

Mahesh Sanganeria - RBC Capital Markets

Thank you. Quick question on the wafer market, I know you guys did really well this year. Can you talk about little bit what's the size of the wafer market and how does that look in 2008?

Rick Wallace

Hi, Mahesh, it's Rick. As you know, we don't break out the market segments, you're right we've done well in wafer. I think that overall demand for 300-nanometer had been building. But we certainly see that there just like everything else I think probably a softening environment overall for wafer manufacturers as well in terms of additional spend on CapEx.

But that being said, we are well positioned within them, and we have some new products in the pipeline to be able to do better than the overall CapEx, based on our ability to bring out new technologies and new tools which will drive some ASP growth.

Mahesh Sanganeria - RBC Capital Markets

Okay. And then a quick question for Jeff, does that amortization of intangibles does that go mostly in COGS or they're distributed along all three lines?

Jeff Hall

The way it works in an acquisition is typically the first couple of quarters, it's heavier in COGS and that's start to go down as we realize the revenue on some of the tools and then the tail is in SG&A.

Mahesh Sanganeria - RBC Capital Markets

Okay, so should we put that most of $12 million or whatever you said?

Jeff Hall

Yes, the bulk of that is in SG&A going forward.

Mahesh Sanganeria - RBC Capital Markets

Okay. All right. Thank you very much.

Operator

Our next question comes from the line of Suresh Balaraman with ThinkEquity.

Suresh Balaraman - ThinkEquity

Thanks. Regarding Japan, whether any specific product groups say a reticle inspection or CD SEM that drove the orders or it is just normal lumpiness. The 20 percentage point above historical is unusual, isn't it?

Jeff Hall

It is above normal and unfortunately it was based on the fact that we have more softness in the other regions. So the percentage goes up, you might imagine. Its panel doing there pretty well, most of our softness was in other regions and so as a percent it goes up. Does that make sense?

Suresh Balaraman - ThinkEquity

Okay. And also can you breakout the thing that you usually do DRM foundries, NAND flash as the percentage of DRAM, do they missed up data?

Jeff Hall

(inaudible).

Suresh Balaraman – ThinkEquity

You guys used to give breakdown of DRAM, NAND flash foundries and Logic?

Jeff Hall

For the September quarter?

Suresh Balaraman – ThinkEquity

Yeah.

Jeff Hall

Yeah. So for the September quarter, memory was about 55% of the total, about half of that was NAND, logic was 25 and foundry was 20.

Suresh Balaraman – ThinkEquity

Okay. Thanks.

Operator

Our next question comes from the line of David Egan with Lehman Brothers.

David Egan - Lehman Brothers

Hi, guys. See you already got it.

Rick Wallace

I think we are out of time anyway. I would like to thank you all for participating in our conference call today. And we look forward to speaking with you again next quarter. Thank you.

Operator

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

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