Good afternoon. My name is Magen and I will be your conference operator today. At this time, I would like to welcome everyone to the KLA-Tencor's Second Quarter Fiscal Year 2018 Conference Call. [Operator Instructions] Thank you. Ed Lockwood with KLA-Tencor Investor Relations, you may begin your conference.

Thank you, Magen. Good afternoon, everyone, and welcome to our conference call. Joining me on our call today are Rick Wallace, our President and Chief Executive Officer and Bren Higgins, our Chief Financial Officer. We're here today to discuss quarterly results for the period ended December 30, 2017. We released these results this afternoon at 1:15 Pacific Time. If you haven't seen the release, you can find it on our website. A simulcast of this call will be accessible on demand following its completion on the Investor Relations section of our website. Today's discussion of our financial results will be presented on a non-GAAP financial basis, unless otherwise specified. A detailed reconciliation of GAAP to non-GAAP results can be found in today's earnings press release and in the Investor presentation on KLA-Tencor's investor relations website. There, you'll also find a calendar of future investor events, presentations and conferences as well as links to KLA-Tencor's SEC filings, including our annual report on Form 10-K for the year-ended June 30, 2017. In those filings, you'll find descriptions of risk factors that could impact our future results. As you know, our future results are subject to risks. Any forward-looking statements, including those we make on the call today, are subject to those risks, and KLA-Tencor cannot guarantee those forward-looking statements will come true. Our actual results may differ significantly from those projected in our forward-looking statements. With that, I'll turn the call over to Rick.

Thank you, Ed. Good afternoon everyone and thank you for joining us today. Leading off with the December quarter highlights, KLA-Tencor reported another record quarter, delivering new quarterly highs in shipments, revenues, gross margin, non-GAAP earnings per share in the period. Full year results for calendar 2017 also set records in each of these metrics as well as in free cash flow generation. These outstanding results demonstrate the dedication that runs throughout our organization to serving our customers and delivering results to our stockholders as well as the long-term value generated and successful execution of the company's strategic objectives. I'd like to take this opportunity to highlight some of the dynamics underlying our record performance and the momentum we are experiencing in the marketplace today. I will begin with the orders for our optical inspection products, including both patterned and un-patterned wafer inspection, which grew 18% in calendar 2017, following 11% growth in 2016. Total optical inspection revenue grew to record levels for the second consecutive year in 2017. The same expansion we are experiencing in these core markets for KLA-Tencor are partially driven by strong customer acceptance of three of our major pattern inspection systems. Gen 5, our flagship broadband plasma inspection platform, is being deployed by customers across all segments and is solving their most critical defect in yield challenges. The ramp of Gen 5 is performing to our expectations and we are seeing an increasing number of layers implemented for production, for advanced logic and memory devices. In addition, the Gen 4 broadband plasma inspection platform and the Puma laser scanning platforms continue to provide the most cost effective wafer inspection performance to meet current yield and quality production requirements. Additionally, our un-patterned or bare wafer inspection and metrology products are also experiencing record demand today. Wafer…

Thanks, Rick and good afternoon, everyone. As Rick highlighted in his opening remarks, KLA-Tencor delivered another outstanding period of financial performance and operational execution in the December quarter and in calendar 2017. Shipments, revenues, non-GAAP gross margin and non-GAAP diluted earnings per share each came in at the upper end or above the range of guidance and achieved new records in both the December quarter and for the calendar year. Revenue in the quarter was 976 million. Non-GAAP diluted earnings per share was $1.97 and would have been $1.83 at the guided tax rate of 18% for the quarter. GAAP loss per diluted share was $0.86 in December, largely resulting from a charge taken in the quarter for the transition tax on historical cumulative earnings outside of the US and tax asset and liabilities revaluation related to the new tax law. In our press release, you will find a reconciliation of GAAP to non-GAAP diluted earnings per share. With the exception of when I explicitly refer to GAAP results, my commentary will be focused on the non-GAAP results, which exclude the adjustments covered in the press release. Now, turning to highlights of the December quarter, demand environment in terms of shipments. Total shipments were 1.041 billion in December, up 7% sequentially and finishing above the guided range for the quarter as customer pull for tool deliveries across the product portfolio drove upside to the quarter. Looking forward, we are modeling March quarter shipments to be in the range of 945 million to 1.025 billion. Our expectation is for shipment levels for the first half of calendar '18 to be roughly flat compared to the second half of 2017 and with low to mid single digit have to have growth planned in the second half of the calendar year. For the…

Thank you. Bren. And is always, we ask that you limit yourself to one question per firm and a brief follow-up so that we can accommodate as many questions as possible. Okay. Magen, we're ready for the first question.

[Operator Instructions] Our first question comes from Farhan Ahmad with Credit Suisse.

Thanks for taking my question. My first question is on the overall strategy for capital deployment. Can you just talk about how are you thinking about [indiscernible]. And if I think about your prior commentary, you've always said that if it's a tax reform, you would think about giving back more to the shareholders. So if you can just comment on that, that would be really helpful.

Sure, Farhan. It's Bren. Thanks for the question. It's certainly an exciting time for the company and I think given our historical track record around how we think about deploying cash in the business, either investing in the business or how we look at M&A opportunities or certainly returns to shareholders, it's an opportunity that adds additional flexibility to what we can do going forward. As I said in the prepared remarks, we don't have any update today, although, we do expect to have more to say on the topic in the coming weeks. I would say philosophically, our position is no different. We have a great business, a strong business model. It's not capital intensive and so the free cash flow margin is pretty strong. And so, we have the ability to return, I think, a fair amount of cash to shareholders, if that is where our process takes us. We're not compelled at this point to do any significant de-levering. We've been doing that over the course of the year. We have the leverage in the right place for the company. And so going forward, I think we have to look at the alternatives and make those calls. Our feelings haven't changed. We're going to grow the dividend certainly over time, consistent with the growth rate in cash flow. And, or the earnings of the company and we're going to target a payout ratio that's somewhere in the through cycle 40% to 50%. So I think that part of the strategy is well understood. And as far as the cash reserves on the balance sheet, we'll have more to say about that coming in the next few weeks.

And then, in regards to my second question, can you just talk about the e-beam versus optical. There is a concern in the market that ASML is ramping their holistic lithography. That can be a threat to your business. Can you just, at a high level, talk about how do you see that as a competitor to the optical inspection technology?

Sure. We've seen, as you know Farhan, the Gen 5 has really been the tool we've been deploying for leading edge really across the board with our customers in terms of advanced memory, both in NAND, but also in DRAM, but also in advanced logic and we've seen good adoption of that. As we said in the prepared remarks, we continue to see development being - leveraging the capabilities of Gen 5 and that product has a lot of legs. As you know, that was recently introduced and there's quite a roadmap for that. So, customers definitely want the coverage capable, only really delivered by Gen 5 and they want to have continue to be able to leverage optical, just the price performance relative to e-beam. There is a place for e-beam, there's been a place for e-beam for many years and we suspect that will continue. But on a relative basis, we had a record year in optical wafer inspection in 2017 and we expect that to continue in 2018.

Your next question comes from the line of Harlan Sur with JPMorgan.

We're hearing that in addition to using Gen 5 for print check and also for early defect learning for EUV based technologies that some of your customers may be actually looking to use Gen 5 for high volume production, even this year before EUR, just given some of the yield challenges associated with some of these next generation manufacturing technologies. Is it something that you guys are actually seeing and is this just with your foundry and logic customers or is this also across some of your memory customers?

Harlan, great question. As is typical, when we introduce a new tool, depending on the particular user and their ability to understand the value and to leverage in, some of the early users tend to deploy first in production. We are seeing it in production on some layers. There are typically the more critical layers where it provides a pronounced benefit from capabilities they had before. We have had recent customer experience where they're now able to detect inline defects that they before could only see end of line, as they were missed by prior optical tools and also not detectable by e-beam. So those tools are being deployed in line. It really is in both logic and memory structures, perhaps a little more surprising with some of the memory applications that we've seen. So we're encouraged by those signs and we fully expect that to continue.

Harlan, it's Bren. The only thing I'll add is, is that Gen 5, the reception to Gen 5 from a value perspective has been really strong with the customer base over the last 12 to 18 months or so. And as we look at 2018, part of the company's year-to-year performance is driven by a bigger contribution from that product line. So, you mentioned print checks. Certainly, there's a lot of value that's demonstrated there. Defect discovery is still the place where it competes and where we saw the growth there where it has made significant inroads against the e-beam opportunities for the reasons Rick talked about earlier. But then also in some of these really high end opportunities in early production and difficult layers, so really across all segments, we're pretty confident with what we're seeing there and excited to get a higher level adoption of this product as we move forward over the course of the year.

And then on EUV mask inspection, as EUV starts to ramp here, what's the traction been like with the Teron platform in conjunction with 5 for print check, first question. And then more importantly, for kind of next generation high volume EUV mask inspection, can you guys just give us an update on your multi-beam mask inspection platform. What's been the early feedback from your lead alpha customers here?

Sure. The Teron isn't really used for print check, it's used for the mask development. So - and that's, we're seeing great demand for that across a number of players, simply because of the increased activity in terms of EUV mask production. So that's really the workhorse right now for the industry in terms of, for the, [indiscernible]. We have had a lot of interest in multi-beam. I do think customers, as they contemplate high volume, they are going to work through, I think, a couple of scenarios. The most likely is, there will be some level of e-bean inspection and there'll be print check inspection and the print check, we're well suited to support that with the Gen 5 platform and there's a lot of interest as I said in the multi-beam and we've got a heavy customer engagements on that front. But as we said, when we first started discussing that tool, that's still a ways out, I think that we will intercept the market when it's needed in terms of volume. Right now, it's really people preparing for volume down the road.

Your next question comes from the line of C.J. Muse with Evercore ISI.

I guess first question, when I think about your WFE guide and I compare it to Lam's, you're coming in a little bit lighter and it sounds like DRAM was one of the principal drivers of the uplift at least for them. So I guess a question off of that which is, are you contemplating upside from DRAM within your model here in calendar '18, particularly as you think about some of the more logic related structures that are being adopted, as we move to 18-nanometer, would love to hear your thoughts on that front.

Yes. C.J., I don't think we're that far off where Lam is, we're talking about, at the beginning of the year in a few percentage points. So there's a margin for error on this that probably puts this all in about the same place. I think fundamentally, the way they talk about segments from what I understand was, around memory, with DRAM strength, NAND flash strength in the year. We think we see a little bit more logic strength at least around our business. And, foundry looks like it'll be down some. So add it all up, you end up in this mid 5%, 7% type single digit growth rates. We're encouraged by what we're seeing in DRAM in terms of adoption from a process control intensity perspective. You have more logic in the devices, you also have the dynamics that are happening in China that are good for process control adoption intensity as well. So I think one of the good - really strong stories about the company right now, given the improvements we've seen in intensity is to have a year that is this strong around memory and have the company in a position to perform at least in line with the market and at least as the way we wanted, perhaps a little bit better. So we're really encouraged by what we're seeing across all segments and I think there's opportunities for us to solve unique problems, given the technology transitions that are in front of us.

And I guess as my follow up, as you think about second half rise in shipment and I guess I'm making the assumption, correct me if I'm wrong that logic foundry will be greater percentage there, which I would think would deliver upside to gross margin. So should we be contemplating an uplift to gross margins through the year for you guys.

So I think the way you're modeling it in terms of the segment mix half to half is right. I mean, it's still pretty strong memory through the course of the year, but foundry logic does pick up in to the second half. I think, one of the wildcards in the year is the order profile into the December quarter and in that time frame is pretty strong around foundry. So depending on when those orders actually materialize, that there's a pull in, does that create opportunity at the end of the year to ship those tools or not. Right now, we haven't slotted the way that we do with these four orders in Q4. So around gross margins, our gross margin profile across the different segments is not any different. The way that the company delivers value - we share value with customers, the ROI is understood, the pricing is very consistent and so sometimes mix of products changes a little bit, but I'm modeling gross margin consistent with the prepared remarks, the bias to the higher end of the range of 63% to 64% that I mentioned. And over the course of the year, movement within the quarters will be driven largely by some smaller product mix issues here and there, but I expect most quarters to be operating in and around the range I mentioned in the prepared remarks.

Your next question comes from the line of Edwin Mok with Needham & Company.

Just a fall question on China. I think some of your peers is talking kind of increased spending from the domestic memory chip makers now and I think historically an investor base be that that will be very possible for KLA. I'm just curious where do we stand on that? Do you have any update in terms of the cadence of that spending? Are we seeing a strong pickup this year or it's really more like '19.

Yes. So it's been a good segment of business for us. China, as a region, as Rick mentioned in his comments, we saw a tripling of native China bookings in calendar '17 versus calendar '16. Those orders tend to come with longer lead times, given the nature of not just new fabs, but also new fabs and new locations. So there's always infrastructure and other requirements that are part of the equation to get something up and running. As we look at calendar '18, I don't see any change in momentum. I think the mix shifts a little bit, where it was more 50-50 memory foundry in calendar '17. Again, this is from an order perspective, calendar '18 seems a little bit more foundry heavy. But the contribution roughly in the same in the same range. So we're very encouraged by what we're seeing there and as these projects come up to speed and they start to make progress, I think that's going to influence the timing of the next round or next phases of investment that happen over the coming years. But what's in front of us looks pretty good.

Just to be really clear, so you're basically not kind of low single digit growth does not factor in comp growth in China and it sounds like you expect a kind of similar level, but a mix shift there. Is that correct?

You know what, we'll ship more in '17 than we shipped in '16. My commentary was focused on the order mix. So yeah, there's more contribution from China in terms of shipment and revenue, native China in the calendar '18 numbers than there was in calendar '17.

And then my follow-up question is on the pattern wafer inspection market, it's really strong right now, but historically the business tend to be more, they go bigger cycle. Is there anything structurally changed for that market that give you confident that demand is sustainable?

A couple of things have. I think, it is true first of all that those businesses happen to be very strong when there is a reinvestment cycle, but there's a couple of - and to new technology and that can be driven by a couple of things, but one of the - volume of course drives and the other one is when there are new specs relative to, particularly based on design rules. The other thing we're seeing is the flatness market growing, an acquisition we did years ago is doing very well inside the bare wafer market to measure wafer flatness and that's being driven a lot by additional requirements, driven in part by 3D NAND. And so we're seeing new specs, driving new tool purchases in addition to the traditional drivers of volume and sensitivity.

Your next question comes from the line of Romit Shah with Nomura Instinet.

I just had one question for you, Rick. It just seems like as demand for AI and server/ high performance computing hardware inflects the size of the silicon that powers that functionality is also growing at a fairly tremendous rate. Nvidia's got a V100 GPU that they say has north of 20 billion transistors. And so the byproduct of that is that you've got these very high performance CPEs and GPEs, but the yields are not great. And it would seem like the implication here is that demand for top tier process control equipment should be stronger benefit from this trend and I was hoping you could talk about that.

Sure. Yes, absolutely. One of the main drivers is the push for AI and also the high performance computing just in general as a category and we are seeing and it plays really on a couple of places for us. One, it drives additional designs, which drives mask, which drives our mask business. So we are seeing benefit. And then in the fab, the additional complexity of those very advanced chips drives everything about complexity, including defectivity requirements because a larger die and also the metrology requirements associated with it. So it is a positive inflection for us overall and it is going to be a multiple foundries as well, not just in one. So there are other players in that. So we expect that to be something that continues to drive the need for process control as we go forward.

Is it fair to say that this trend, as it accelerates is good for your blended ASPs and then consequently your gross margins over time.

Well, certainly the percentage of tooling as Bren mentioned, we're not really customer dependent on gross margin as we are mix, but as the process gets more complex, the mix of customer use case tends to go toward the more advanced tools. So sure, we would see a benefit in terms of our overall profitability and business level based on advanced devices of any kind, pushing demand forward. So yes, absolutely it's a driver for us.

[Operator Instructions] Your next question comes from the line of Patrick Ho with Stifel Nicolaus.

Rick, in terms of memory capital intensity, you've talked about in the past how 3-D NAND and a lot of the manufacturing challenges there has helped increase process control intensity. I know, we're at the early ramp of the new 64-layer devices that we're seeing in the marketplace, but as we go to 96 and 128, are the increases in layer going to continue to help in capital intensity or have we kind of just reached maybe a leveling at this time? I think you said you've gain one or two percentage process control intensity points with the 3-D transition. How do you look at it as we go to more layers?

Great question and the answer is there is more opportunity. And there's two ways for us to address that. One is continued and even more deployment of existing tools, which I don't think would drive intensity significantly higher, if that's all we do, but we do have new tools in the pipeline to address 3D NAND and when those come online and they're going to be in support of these advanced technologies, then we can actually drive increased adoption based on new use cases. There are more problems in 3D NAND metrology and defectivity than we can solve right now. And if we can bring the new tools out and get those in and those are something that we're targeting for in the next 12 to 24, having starting to make an impact on the market. So yeah, that will drive intensity up.

Great. And a question for Bren in terms of managing supply chain, obviously yourself and the rest of the equipment industry, you're seeing record demand today and you've been able to turn around tools at a pretty rapid rate, even as demand trends continue to rise. You're also managing your inventories and AR really well. What have you done over the last couple of quarters, especially as you've seen this rise in demand and your ability to continue to I guess deliver to the customers, given their kind of strict and tight timelines for tool deliveries.

Yeah. Well, it hasn't been easy. A lot of heavy lifting by the operational teams to execute in this environment. I mean, one of the things that we've done I think pretty effectively across all of our products is to do a lot more hedging of long lead time materials, whether we're buying supplier long lead time materials or we're buying our - the assembled parts and that shortens the lead time and gives us a little bit more flexibility to be able to deliver. So that certainly is one of the things we're doing. I mean obviously, we're making stronger commitments further out in some cases to be able to make sure we've got the supplier ramping their capacity to be able to support us. So a lot of tactical things there to be able to deliver that. We're spending some time sometimes, sending our own guys out to work with our suppliers to improve their processes to deliver better yields of parts and so on to be able to meet our needs. So a lot of small things there. Like everybody else, we're putting a lot of pressure on the chain. Some of our suppliers are unique and supply only to us in this space. So that helps in some cases, but it's a challenge, but so far we're doing okay with it and I'm really pleased with the leverage and the operational execution in the factories across the world for us.

Your final question comes from Atif Malik with Citigroup.

Rick, I have a question on your foundry opportunity. TSMC on its earnings call talked about a flattish CapEx, with capital intensity longer term coming down from low to - 20% to 30% for them. Within that declining capital intensity, can you just talk about how do you see PDC opportunity for you? I assume EUV opportunity is obviously growing within that CapEx, but just talk about the PDC opportunity for you guys? And then I have a follow-up.

Sure. I think that the foundry capital intensity ranges depending on where we are in the cycle and the customer, but it's somewhere in the order of 15% to 17%. We see upside to that, if we can provide more capability as we discussed earlier in 3D NAND. There are problems that are unsolved in terms of foundry and especially as we get to EUV. So we think that'll head toward the high end of that range. And customers of course are going to try to optimize their investment and try to minimize their investment in capital and in process control. So we're constantly showing that we have created value for them and then we share that value in terms of the way we deploy in the market. So I think as we're modeling it forward, it continues to be in that 15% to 17% range.

Great. And then Bren, are you expecting your logic plus foundry opportunity this year to be flattish over last year, like prior comments or has there been a change to that.

As I look at it and I look at the breadth of customers investing across foundry and as more of a shipment statement, I think the foundry shipments are probably down a little bit. So I think our expectations would be around foundry, as I said earlier, we're - foundry down a little bit, logic up, DRAM strong and NAND obviously strong as well. So that's how you get to the guidance we provided for WC.

There are no further questions at this time. I'll turn the call back to presenters for closing remarks.

Okay. Thank you, Magen. Thank you all for joining us today and enjoy the rest of your day.