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Edited Transcript of KLAC earnings conference call or presentation 6-May-19 9:00pm GMT

Q3 2019 KLA-Tencor Corp Earnings Call

MILPITAS Jun 12, 2019 (Thomson StreetEvents) -- Edited Transcript of KLA-Tencor Corp earnings conference call or presentation Monday, May 6, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bren D. Higgins

KLA-Tencor Corporation - Executive VP & CFO

* Richard P. Wallace

KLA-Tencor Corporation - President, CEO & Executive Director

* Ed Lockwood

KLA-Tencor Corporation - Senior Director of IR

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Conference Call Participants

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* Atif Malik

Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment & Specialty Semiconductor Analyst

* Christopher James Muse

Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst

* Harlan Sur

JP Morgan Chase & Co, Research Division - Senior Analyst

* John William Pitzer

Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head

* Quinn Bolton

Needham & Company, LLC, Research Division - Senior Analyst

* Shek Ming Ho

Deutsche Bank AG, Research Division - Director & Senior Analyst

* Sreekrishnan Sankarnarayanan

Cowen and Company, LLC, Research Division - MD & Senior Research Analyst

* Timothy Michael Arcuri

UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment

* Toshiya Hari

Goldman Sachs Group Inc., Research Division - MD

* Vivek Arya

BofA Merrill Lynch, Research Division - Director

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Presentation

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Operator [1]

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Good afternoon. My name is Jerome, and I will be your conference operator today. At this time, I would like to welcome everyone to the KLA Corporation First Quarter 2019 Earnings Conference Call. (Operator Instructions)

Now it's my pleasure to have the call over to your host, Mr. Ed Lockwood with KLA Corporation Investor Relations. The floor is yours.

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Ed Lockwood, KLA-Tencor Corporation - Senior Director of IR [2]

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Thank you, Jerome. 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 March 31, 2019. 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.

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 posted on the KLA Investor Relations website. There, you'll also find a calendar of future investor events, presentations and conferences as well as links to KLA's SEC filings, including our annual report on Form 10-K for the year ended June 30, 2018. In those filings, you'll also 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 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.

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Richard P. Wallace, KLA-Tencor Corporation - President, CEO & Executive Director [3]

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Thanks, Ed. KLA delivered strong results for the March quarter, finishing at the upper end of the range of guidance for revenue and above the range for non-GAAP EPS. We achieved these results despite the near-term softening in the wafer fab equipment market, showing the resiliency of KLA's business model and the compelling value of our strategies focused on market and technology leadership, revenue diversification and operational excellence.

We also closed the Orbotech acquisition in Q1, and work has begun to execute integration efforts and realize revenue and cost synergies. The value creation opportunity and the combination with Orbotech are compelling. We are further diversifying our revenue streams and expanding our reach in the global electronics value chain, enhancing our ability to serve new and existing customers in fast-growing end markets, such as 5G infrastructure, smart mobile and automotive, to name a few.

Now I'd like to point out key reasons why the combination with Orbotech is an important component of our long-term growth strategy. Orbotech shares core values with KLA as well as a proven track record of enabling customer success, long -- having long distinguished themselves through market leadership, innovation, technology and talent. Orbotech is a market leader in each of the segments it serves, and there's no customer overlap in the PCB and flat panel markets, and there's no product overlap in the specialty semiconductor and advanced packaging business. Now we are serving a larger and more diversified market with a broader portfolio of products and solutions.

Orbotech's business is diversified, serving different segments, each with their own cycle dynamics. Orbotech's revenue in calendar 2018 grew 16% to $1.04 billion with a 3-year CAGR of 12%. Of note, the specialty semiconductor business grew 23% in 2018 and is poised for high growth again in 2019 against the backdrop of broad-based weakness in electronics manufacturing.

Turning now to today's semiconductor market environment. Based on consensus industry reporting, WFE grew in the mid-teens in 2018, which is significantly higher than was previously projected. Process control intensity remained flat in 2018 in a year of strong memory investment. We are seeing higher adoption of inspection and metrology solutions for memory customers to support the 3D NAND road map and scaling to tighten design rules and DRAM.

EUV was also a key factor in 2018 equipment spending, including process control infrastructure in reticle and optical wafer inspection. Given the expectation that EUV investment will continue in 2019, and together with a large percentage of foundry and logic spending in the WFE mix, we expect process control intensity to increase in the calendar year.

The Gartner report for 2018 shows KLA held strong market share in process control, thanks to our differentiated product portfolio, technology leadership and strong customer collaboration.

Consistent with our peers, we expect WFE will be down approximately 15% to 20% in 2019. Largely due to weaker DRAM demand, NAND investment is also expected to be down in the year. While foundry and logic investments will increase driven by the 7-nanometer ramp, EUV development and the steady trailing edge demand to support 5G infrastructure, IoT and automotive applications.

2019 will be a dynamic and exciting year for KLA. Despite the current market turbulence, we are well positioned to leverage the breadth of our product portfolio and our business execution competencies to show good relative performance in the year and emerge even stronger when the market rebounds.

With that, I'll turn the call over to Bren for his review of the financial results. Bren?

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Bren D. Higgins, KLA-Tencor Corporation - Executive VP & CFO [4]

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Thank you, Rick, and good afternoon, everyone. Q1 was a busy quarter for KLA. We launched our new corporate brand in January, closed the Orbotech acquisition in late February, executed a $1.2 billion debt financing in March and delivered results that met or exceeded the updated guidance for the June quarter we issued on March 5 after the close of the acquisition.

Total revenue in the quarter was $1.097 billion at the upper end of the revised guidance range of between $1.025 billion and $1.115 billion. GAAP earnings per share was $1.23, and non-GAAP earnings per share was $1.80, finishing above the range of guidance. Non-GAAP earnings per share would have been $1.78 at the 14% long-term tax planning rate.

We are pleased with the results we achieved in Q1 and are off to a solid start for calendar '19 consistent with our expectations. We are now moving forward in our plans for integration of Orbotech and focusing on strong execution and operations excellence across our business.

Due to the close of the Orbotech acquisition, there are meaningful differences between the GAAP results and the non-GAAP results. I encourage you to review the reconciliation between the 2 contained in our press release. The remainder of my commentary today are based on the non-GAAP results.

As this is the first quarter we are reporting combined results for KLA and Orbotech, we will provide income statement, cash flow and balance sheet for KLA inclusive of Orbotech in addition to customary disclosures and demand commentary. To bridge the results to the original guidance we provided back in January for our semi process control business, we will share details on the financial results for this business and Orbotech separately.

We are disclosing this additional information as a means for investors to better understand the dynamics of the KLA and Orbotech businesses in the stub period. Looking ahead, as we move forward in integrating the businesses, we plan to transition our disclosures and financial reporting to reflect the results and operations for KLA on a consolidated basis.

Now for the March quarter results. As I mentioned, total revenues in the first quarter were $1.097 billion. Product sales accounted for 72% of total revenues. We expect total revenue to grow about 14% at the midpoint and be in a range of $1.21 billion to $1.29 billion in the June quarter with sequential quarterly revenue growth expected to continue through the calendar year. For both the semi process control business and the Orbotech business, we expect the second half revenue levels to be higher than the first half. In terms of regional split of revenue for the combined company, Taiwan was 25% of revenue, China was 19%, Korea was 18%, Japan was 13%, the U.S. was 14%, Europe was 7% and the rest of Asia was 4%.

Now I'll turn to some detail and commentary regarding demand trends in the March quarter for the semi process control business. Semi process control revenue, which includes the traditional KLA systems and service businesses, was $936 million in the quarter. The expected overall demand environment for 2019 in the semi process control market is consistent with our original view from January, with KLA looking to benefit from strong foundry and logic demand growth reasonably balanced across the year and with the expectation for the current soft demand environment in memory to persist throughout the year.

Weak memory industry demand continued to influence our customers' caution towards their equipment investment plans. While we have some visibility into plans in this segment, they remain fluid given the current industry outlook, and customer commitments could change quickly and without warning. We remain optimistic about long-term memory equipment demand due to rising capital intensity to deliver bit growth supply and disciplined financial management by our customers. However, due to the consolidated nature of our industry, any shift in customer delivery requirements could impact our near-term results.

Semi process control shipments were $957 million in Q1, above the range of guidance of $860 million to $940 million. As expected, with the adoption of the new accounting standard for revenue recognition, the difference between shipment results and revenue for KLA is immaterial and largely a function of short-term timing dynamics. As a result, we will continue to guide and report shipments through the June quarter but will move to revenue-only disclosure for business units, geographic distribution and customer mix beginning with the reporting of the September quarter. In short, under ASC 606, the difference between shipments and revenue is not sufficiently material to warrant the cost and effort required to maintain dual reporting.

We expect total shipments of 1.235 billion to 1.315 billion in Q2 with semi process control shipments of approximately $1 billion. Memory was 38% of semi process control system shipments in March, and we expect memory to be approximately 47% of this mix in the June quarter. Foundry was 54% of shipments and is forecasted to be about 41% of the total in June. Shipments to logic customers were 8%, and the current outlook is for logic to be approximately 12% into Q2.

The approximate distribution of shipments by product group for the semi process control business was: wafer inspection was 42%; patterning was 30%, including shipments for reticle inspection; service was 24%; and nonsemi and component inspection was approximately 4%.

Now for some additional details of results from the Orbotech businesses in the quarter. I'll remind you that these results are for the 39 days stub period following the February 20 close of the acquisition. Revenue was $161 million, above the guided range of $145 million to $155 million for the stub period. The semiconductor device business delivered strong revenues for the first quarter, and momentum is expected to continue throughout calendar 2019 driven by strength in PBD and edge applications for RF, power and advanced packaging.

This business is the market and technology leader in targeted specialty semiconductor segments and is delivering faster revenue growth rates in the overall semiconductor equipment market. And demand drivers include automotive, 5G investment and MEMS/sensor applications for IoT as well as growth in China.

The printed circuit board business grew 10% in 2018 and is positioned to deliver solid relative performance in '19 compared with the broad electronics market. Orbotech is the market and technology leader in critical application in the PCB manufacturing process, such as laser direct imaging, optical inspection for defect control and repair.

The PCB division will introduce several new products in 2019 that meet the requirements of new technologies, such as mSAP and flex PCB, and capture the future growth resulting from increasing PCB complexity. Additionally, the service component is an important aspect to the overall value proposition for this business and is approximately 40% of its total revenue. Similar to the semi process control service model, PCB service has a high percentage of recurring contract revenue and is focused on value-added services, such as application support and software upgrades and not just basic break-and-fix services.

The flat panel display business reflects the current weak overall industry demand conditions in LCD and OLED manufacturing. This market is experiencing a digestion period and is leading display customers to realign their product strategies and production capacities to shift to new technologies. Advanced panel designs, such as high-end jumbo OLED TVs and flexible foldable displays, are becoming more expensive and complex to manufacture, featuring smaller pixel sizes, increased pixel density and multiple mass layers.

As the market leader in test, repair and defect inspection solutions for FPD, our business benefits from new capacity growth as well as from the increasing technical complexity in the next-gen display market. Though the market environment is challenging in 2019, we believe we are well positioned when the market recovers.

Turning now to financial results for the combined company. Gross margin was 60% in March, slightly better than the implied gross margin associated with the updated guidance as product mix in the semi process control business was mostly consistent with what we modeled in January. In June, we expect gross margin to be in the range of 58% to 59%. Gross margin in the semi process control business is expected to be slightly lower quarter-to-quarter as modest volume benefit of higher revenue is offset by the expected product mix.

For KLA consolidated gross margin, in addition to expectations for our semi process control business, the change quarter-to-quarter is also the result of approximately $90 million of additional Orbotech revenue, representing a full quarter of revenue for this business.

Based on our current outlook for business unit performance and overall revenue levels for the remainder of calendar '19, we expect stronger quarterly gross margins in the second half, and you should model gross margins for the combined company in the range of 59.5% to 60.5%. As in past M&A, we see a number of opportunities to improve Orbotech gross margins over time as we leverage our global manufacturing scale shared in common supply chain, service infrastructure and internal supply capabilities.

Total operating expenses were $311 million in March, and operating margin was 31.6%. For the June quarter, we expect operating expenses to be approximately $375 million at the midpoint as we will incur a full quarter of Orbotech operating expenses and a modest increase in R&D expense in our semi process control business. Given our top line expectations and planned product development investment profile, we expect quarterly operating expenses to be in the range of $370 million to $375 million for the remainder of calendar '19.

I would note that OpEx includes stock-based compensation expenses from Orbotech, which is previously excluded from their non-GAAP public reporting as an independent company. Operating expense synergy planning related to the acquisition is underway, and we will provide periodic updates on our progress in this area over the coming quarters.

Other income and expense in the March quarter was $22 million, including the impact of the debt service to fund a portion of the transaction for the stub period. Going forward, you should model quarterly OIE at approximately $35 million principally due to the incremental debt and the capital structure to fund the acquisition and other corporate activities, including our ongoing share repurchase authorization.

The effective tax rate was 13% in the quarter. Given the new corporate tax structure in the U.S. and our expectations for the geographic distribution of profit, including the contribution from Orbotech, investors should continue to model our tax planning rate at 14% going forward.

Net income is $283 million, and we had 157 million fully diluted weighted average shares outstanding. During the quarter, we issued approximately 12 million shares as a component of the transaction consideration for the acquisition. We are expecting weighted average share count for Q2 to be approximately 162 million shares.

Now for some highlights of the balance sheet and cash flow statement. Cash and investments were $1.9 billion, and total debt was $3.4 billion. As stated earlier, on March 13, we issued $1.2 billion of 10- and 30-year senior notes with a blended coupon of 4.4%. Our gross leverage ratio at the end of the March quarter was 1.7x within our target range of 1.5 to 2x gross leverage.

Cash from operations was $164 million, and free cash flow was $138 million. We paid an aggregate of $114 million in regular quarterly dividends and dividend equivalents upon the vesting of restricted stock units and repurchased $200 million of common stock pursuant to our share repurchase program. We have approximately $1.2 billion available under our current share repurchase authorization. We expect to execute this repurchase program systematically over the next 12 to 18 months subject to market conditions.

In conclusion, the March quarter results demonstrated strong operating performance and relative strength for KLA in a weaker overall WFE environment. We completed the acquisition of Orbotech, and integration and synergy activities are underway. With our diversified end markets, market leadership across a broad product portfolio and operations discipline, KLA is positioned for strong relative performance in 2019 in what is expected to be a challenging year in the electronics manufacturing markets.

With that, to summarize, guidance for the June quarter is: revenue between $1.21 billion and $1.29 billion, GAAP diluted EPS of $1.09 to $1.39 per share and non-GAAP diluted EPS of $1.55 to $1.85 per share. Total shipments are expected between $1.235 billion and $1.315 billion with semi process control shipments of approximately $1 billion in the June quarter.

Before turning the call over for your questions, we're pleased to inform investors that we have scheduled our 2019 Investor Day for Tuesday, September 17, in Midtown New York. We will have more details to follow in the coming weeks, and we look forward to seeing you all in September.

With that, I'll now turn the call back over to Ed to begin the Q&A.

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Ed Lockwood, KLA-Tencor Corporation - Senior Director of IR [5]

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Okay. Thank you, Bren. At this point, we'll open up the call for your questions. (Operator Instructions) All right. Jerome, we're ready for the first question.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Timothy Arcuri from UBS.

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Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [2]

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I had a couple. So Bren, just on the gross margin guidance, 58% to 59% non-GAAP, it's a little lower than if you just sort of do the math for the 2 companies. It seems like it'd be in the 60% to 61% range.

So first of all, can you sort of talk, is there like a onetime happening in June and then things sort of snap up into the 60s maybe for the back half of the year?

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Bren D. Higgins, KLA-Tencor Corporation - Executive VP & CFO [3]

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Yes. Thanks for the question. So yes, I mean this quarter, there is some unique, just mix dynamics that are driving the margin a little bit lower than you would think. And as I said in the prepared comments that we would expect gross margins in the second half to be higher. At the end of the day, on our core business, it's going to move around on product mix across the different products. Orbotech is bringing revenue in at about $255 million in the quarter. We expect it to grow in the second half, as we said in the comments. And their gross margin is trending in the high 40th percentile. So when you blend it out, that's where you end up. But I would expect the second half margins to be higher, which is why I gave the full calendar year commentary as well that modeling is somewhere between 59.5% and 60.5% for the year.

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Timothy Michael Arcuri, UBS Investment Bank, Research Division - MD and Head of Semiconductors & Semiconductor Equipment [4]

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Okay. Awesome, Bren. And then maybe -- and I know probably you'll go through some of this at the Analyst Day, but can you give us maybe some mileposts as the business grows into next year and the year after, sort of what the financial model looks like and maybe just pick like $6 billion as like an annual run rate once you get to $1.5 billion a quarter. What does the model look like? What's roughly -- roughly, what's gross margin and what does op margin look like?

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Bren D. Higgins, KLA-Tencor Corporation - Executive VP & CFO [5]

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Yes. So Tim, I want to get away from -- or I don't want to get into necessarily guiding out further, and so this is just me just thinking about where the numbers might line up. Obviously, the comments I made around product mix are issues that would affect our performance. But yes, I think gross margins probably settle in at those kind of revenue levels in the between 60% and 61%. And certainly, operating expenses are going to move according to product development requirements. And then, of course, there are some synergy opportunities that we're going to be executing. So the time frame that we were to get to those kinds of numbers that you referred to would be a factor in all of that. So the way we presented it in the longer-term model was a couple of points of dilution related to the Orbotech transaction to our longer-term model that we published, which -- so I think that when you're thinking in the mid-30 kind of percent operating margin range on those revenue levels. So hopefully, that helps.

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Operator [6]

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Your next question comes from the line of Vivek Arya from Bank of America.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [7]

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I just wanted to go back to the overall demand environment. I think when the year started, the industry view was that WFE would be down 10% to 15%. It's down 15% to 20%, not just from you guys but obviously from all of your peers. What's the scope -- what's the slope of recovery here? When do you think we start to get visibility as to when we will see a recovery in overall spending?

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Richard P. Wallace, KLA-Tencor Corporation - President, CEO & Executive Director [8]

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Yes. This is -- I'll take part of it, and then -- this is Rick, and Bren can add in. It is true that the rate of decline -- the magnitude is higher, but that's largely because December finished stronger than 2018 than we had originally modeled. And so if you look at what the overall numbers we're talking about for 2019, we're still in a similar kind of range of $45 billion to $46 billion with WLP. So that was really the way we're looking at that. And we'd also said in the past that this is really starting to strengthen even into the June quarter. But the second half, as Bren indicated in his comments, are going to be stronger for KLA but also for the industry.

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Bren D. Higgins, KLA-Tencor Corporation - Executive VP & CFO [9]

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Yes. The only thing I'll add is, to Rick's point, I mean the year-over-year ratios are moving around given the strength of the finish to '18 now that everybody's reported. And so it looks like '18 is a little bit stronger. So our view is very consistent with what we thought in January that we saw mid-40s WFE levels for the year, with the March quarter being in the bottom and sequential growth for the company resuming in June and continuing in the second half, so second half stronger than first half.

Foundry logic reasonably balanced across the year was our perspective. So what's interesting is we're 3 months later, and it's played out as we thought. So I don't think that there's anything really different than what we thought a couple of months ago. And certainly, we're watching the end market dynamics and what those ultimately will mean to -- just given the consolidated nature of our business to our customers' investment plans but so far playing out as we expected a few months ago.

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Vivek Arya, BofA Merrill Lynch, Research Division - Director [10]

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And for my follow-up, China. So the demand from China, do you think that is kind of trending down in line with the overall WFE? Or are you seeing any more disruption because of trade tensions? Or is this just an absorption iterative because of what they installed last year? So what I'm getting with that is that as we hopefully get some easing of tensions, do you think demand from China will improve at some point?

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Bren D. Higgins, KLA-Tencor Corporation - Executive VP & CFO [11]

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Yes. We've had puts and takes around China. We disclosed our shipment profile in January that we thought it'd be down between 10% and 15% in calendar '19 versus calendar '18, and our view is pretty consistent with that. We've seen some strengthening from certain customers, some weakening from others. So our general view is pretty consistent overall. So it looks like we'll see more foundry logic investment this year. And certainly, you have the OEMs that are investing both in terms of -- or the need for wafer capacity material, so wafer capacity and reticle capacity. So I would say for '19, our views are pretty consistent and same with what we thought a few months ago.

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Richard P. Wallace, KLA-Tencor Corporation - President, CEO & Executive Director [12]

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And I would say that on the trade tensions, I'd say that was a factor early in the calendar year, at the end of last year, of uncertainty. And now I think the way that China is behaving is more just based on the way the overall industry is behaving relative to demand. And so we're seeing those plans are gated on that not as much on concerns around trade.

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Operator [13]

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

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Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [14]

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On Orbotech, there's been some headwinds on the display CapEx trends this year, as you guys mentioned. But the move to OLED by some of their customers should boost capital intensity for their products. In PCB, disappointing handset unit trends but again offset by the move to things like mSAP technology and more automotive goodness there, SDD continued strong, so a number of puts and takes. But based on the June quarter guidance and sort of backing into the full quarter March revenues for Orbotech and your comments about second half, it does appear that Orbotech will drive higher revenues versus calendar year '18. Is that a fair assumption?

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Bren D. Higgins, KLA-Tencor Corporation - Executive VP & CFO [15]

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So Harlan, when we look at the business today, and again, we only had it for the 40 days of the first quarter, so we do expect sequential growth through the year. I would say Orbotech will be in the ballpark of what they did in calendar '18 based on what we see today, perhaps slightly less. I think given a relative -- or given the environment overall for electronics in terms of just softening and digestion that's happening out there, it looks like that the business has been pretty resilient for the reasons that you described. And certainly, what we're seeing on the semiconductor side is that's an area of WFE where there is growth and investment. And so we'd expect to see that business grow more -- in a more meaningful way in '19 versus '18.

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Richard P. Wallace, KLA-Tencor Corporation - President, CEO & Executive Director [16]

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And longer term, Harlan, we're -- we believe we're on track with the Orbotech plan that was laid out in 2017 when you talked about the longer-term trends all seem to be very positive. And we're excited about what we've seen. We think the company is well positioned with the Orbotech assets as part of KLA, and we'll continue to build on the momentum. As you say, FPD has had some headwinds, but there's been some good wins in the other parts of the business.

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Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [17]

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Yes, absolutely. Good insights there. And then looking at the Gartner share data for 2018 in your flagship optical inspection franchise, I think you guys gained around 500 basis points of market share. And I think now you guys are almost like 14x larger than your nearest competitor. And this was versus a 7x delta last year, so a huge drop of your competitors. Is the bar just getting raised really that much higher with like your Gen 5 tools and your updated Gen 4 platform? And then how is the momentum shaping up this year for your Gen 5 platform?

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Richard P. Wallace, KLA-Tencor Corporation - President, CEO & Executive Director [18]

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So I'll take part and then let Bren get into the specifics. I think you're right. I think that what we're seeing is the continued investment by our customers in the flagship products, both Gen 4 and Gen 5. And so one of the things, I think a couple of generations we realized, is we're going to keep investing in prior generations. So for example, the Gen 4 has had a build-out too in addition to what we're seeing in Gen 5. And I think for our customers, it's the most effective way to manage their yield challenges and ramp their facilities. So we feel really good about where we are. We continue to invest strongly. And as Bren will tell you, we're seeing the progress that we are hoping for in Gen 5.

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Bren D. Higgins, KLA-Tencor Corporation - Executive VP & CFO [19]

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Yes. This year is a good year for Gen 5, Harlan. We expect to see multiple unit adoption from all major customers, so we're encouraged by that. We'll probably end the year with somewhere around 30 units in the field if I were to fast forward. Obviously, we need to execute over the next several months, but that's our expectation. So it's nice growth and adoption of that product line, and we've introduced a -- the next iteration on Gen 4 product as customers try to extend that capability, too. So you're seeing a mix-and-match adoption profile from our customers there.

We also have the -- a new product in the laser scanning space called Voyager, and that's -- the adoption has been really positive on that, too. So you're seeing a mix and match across the Puma platform plus Voyager. So for the total portfolio of optical pattern inspection, it's very well positioned in the market, and we would expect as you see foundry move on to 5-nanometer down the road, including what they're doing today to support 7-nanometer activities, the logic investments that are happening, we feel pretty good about the positioning of that product line.

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Harlan Sur, JP Morgan Chase & Co, Research Division - Senior Analyst [20]

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Yes. Nice job on the execution.

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Operator [21]

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Your next question comes from the line of John Pitzer from Credit Suisse.

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John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [22]

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Rick, as always, appreciate sort of the industry backdrop color you gave in your preamble. I'd be kind of curious, especially with the inclusion of Orbotech, you gave us a lot of color around what happens to the total addressable market in calendar year '19. Just curious as to how you see your SAM evolving in calendar year '19 with all the puts and takes.

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Richard P. Wallace, KLA-Tencor Corporation - President, CEO & Executive Director [23]

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Sure. I think that as we laid out early, Orbotech, we think, gives us access to another $2.5 billion in overall addressable market based on their position. We think that as we go forward, combine that with what we have in the rest of our business, we're at about $8 billion this year, and that should continue to grow. Basically, as we think about the products that are in the pipeline and things that we're working on, we think the TAM over the next few years grows maybe another 10% beyond that $8 billion as we go forward based on new product entries and market growth. So we don't need a tremendous amount of market growth based on some of the new work that's going on in pipeline, both for KLA, what was our process control business and now as we talk about our process business, which is in semiconductor, and also FPD and PCB.

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John William Pitzer, Crédit Suisse AG, Research Division - MD, Global Technology Strategist and Global Technology Sector Head [24]

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That's helpful. And then as my follow-up, Bren, just going back to the gross margin, you said in the June quarter guide, there's sort of a onetime mix issue. Is that just more Orbotech revenue? Or is there something going on in the mix with the core KLA business? And as we think about the full year gross margin, is it pretty much a linear progression in September, December to get to that number? Or how are we thinking about exit trajectory of gross margin? And what's driving the improvement? Is this overall mix of business? Or is it you actually getting your hands on the Orbotech asset and driving some cost synergies?

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Bren D. Higgins, KLA-Tencor Corporation - Executive VP & CFO [25]

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Yes, John, thanks for the question. So consistent with the commentary around revenue growth, I would expect gross margin to improve quarter-on-quarter as we progress through the year. So on the core KLA business, we saw a little bit more revenue in the June quarter, we'll see versus March. And the mix of the business, particularly around reticle inspection where we've had some higher mix mash-up business, and that's being offset by some fab business, which we're very happy with the penetration and performance there, but the margin profile is different. So we do see pretty wide swings around those products depending on what segment you're shipping into. So I do think that it's all kind of coming together into a lower profile in the June quarter, and we would expect to see it improve through the second half.

I would say the same thing about the Orbotech business given the ramp of growth there. And certainly, over time, as we execute on synergies and we're doing a lot of planning today, but we would expect to see that sort of start to flow through the model certainly around supply chain, internal supply and other things. It'll take a little bit of time for that to happen.

So I think the trajectory moves that way. June is a little bit weaker with the tools that we ship or the tools that we ship, and how that profile plays out is how it influences the mix. But over time, structurally, we feel pretty good about where the margin profile is overall in the KLA business, and there's opportunities on the Orbotech side over time.

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Operator [26]

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

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Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [27]

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I guess another question on gross margins. Just wanted to clarify, the 59.5% to 60.5% commentary, was that for all of calendar '19? Or is that the expected range for the back half of 2019? And as part of that, could you walk through, I guess, the margin contributions across the 3 subsegments within Orbotech? And if you can't be terribly precise, perhaps rank order, highest to lowest, that would be very helpful.

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Bren D. Higgins, KLA-Tencor Corporation - Executive VP & CFO [28]

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Sure, C.J. So the guidance for the calendar year, it obviously includes March and June and then what we expect in the second half. So when you're thinking about the calendar year profile, that's where the margin profile would be. To achieve that, you need to see the margins improve in the second half and I would say in the upper end of the range that I provided for the full calendar year. So hopefully, that helps from a modeling perspective.

On the Orbotech business, I think on the specialty semi side, the easiest way to think about the 3 businesses is the specialty semi side tends to be in the mid-50s, plus or minus. You're probably in the high 40s on PCB, and you're probably in the mid to high 30s generally on FPD. The FPD piece has a lot to do with the business levels given the leverage that's in that model, given the higher level cyclicality for that business. That's the smallest part of Orbotech if you think about the 3 businesses. So certainly, over time, given the expectations of growth around the specialty side, we would expect to see the mix improve in terms of the gross margin profile.

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Christopher James Muse, Evercore ISI Institutional Equities, Research Division - Senior MD, Head of Global Semiconductor Research & Senior Equity Research Analyst [29]

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That's very helpful. And as my follow-up, I guess at a higher level, can you talk through how you're partnering with Amichai and the rest of the Orbotech team to drive top line synergies that I think you guys so clearly see in both the specialty semi and PCB side, what kind of groups perhaps you created and what the time line is to start to see those revenue synergies hit the model?

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Richard P. Wallace, KLA-Tencor Corporation - President, CEO & Executive Director [30]

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Sure. This is Rick. There are 2 things going at once. One is, as you know, Orbotech was a successful company stand-alone for a number of years and has been successful in growing their business. So on the one hand, we've been very mindful of that as we begin integration to let them to continue to work together as a not quite separate but continue to drive their business independently. However, the last couple of months, we have seen customers actually ask us for -- to work together, and we've seen some opportunities to do that. So that's really a slow rollout. We're going to detail this in quite a bit when we come in September for our Analyst Day, and we're going to talk more about it. But it is very encouraging, especially in the specialty semiconductor where we do have customer overlap -- no product overlap but customer overlap, looking for more capability. And I also think there are some customers that the specialty semiconductor division was working on and the addition of KLA to the portfolio for them makes it more likely they'll gain mind share and also market share there. So we think there's great opportunity. The other businesses, it's maybe a little bit more of some cost synergies as we work through some of the operational opportunities we have there. And then there's supply chain, which kind of covers those 2 businesses also where we'll continue to drive that. But again, that's something we're going to lay out in more detail as we do our Analyst Day in September.

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Bren D. Higgins, KLA-Tencor Corporation - Executive VP & CFO [31]

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The only thing I'll add on that one is that if you think about the PCB business and advanced printed circuit board technologies, you are starting to see more blending between advanced packaging and PCB on the road map for our customers as they try to drive cost and capability improvements. And so certainly, we have some exposure to that space. Orbotech does as well. So we're investigating what -- how that strategy might play out and certainly how technology might be applicable as we start to think about the growth that exist there. So early days on a lot of this work but certainly something we'll outline in more detail when we get to the meeting in September.

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Operator [32]

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Your next question comes from the line of Krish Sankar from Cowen and Company.

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Sreekrishnan Sankarnarayanan, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [33]

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I have two of them. First one for Bren. Bren, I don't know if I missed it. If you strip out the Orbotech revenues in March and June, is the core legacy KLA business growing? So is it like low to mid-single digits? Just want to get color on that, and I have a follow-up.

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Bren D. Higgins, KLA-Tencor Corporation - Executive VP & CFO [34]

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Yes. So in the prepared remarks, so against the guidance we gave in January, we guided for a midpoint on revenue of $920 million. We came in at $936 million. And then for the June quarter, we talked about shipments of approximately $1 billion. And I also said had some comments around with 606, the transition to 606 that there isn't much difference between shipments and revenue. So hopefully, that gives you the color. And again, it's consistent with what we thought in terms of March being a bottom and expecting to see growth in the June quarter and sequentially for the remainder of the calendar year.

So if you think about the broader performance of the business, given the mix of WFE, yes, most of the decline is driven by DRAM and, to a lesser extent, the declines in NAND. But you also have significant growth in foundry and logic. We're also seeing investments that are happening in reticle and in wafer. So when you add all that together, our expectation is you'll see process control intensity improve in the year but also that our relative performance relative to the industry should be better. So I think it's playing out the way we thought, and we're pleased with our market position and how we're seeing the segments play out.

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Sreekrishnan Sankarnarayanan, Cowen and Company, LLC, Research Division - MD & Senior Research Analyst [35]

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Got it. Got it. It's very helpful, Bren. And then a question for Rick. It looks like you guys are gaining some traction in the EUV inspection side. EUV, in theory, is going to replay some of the multi-patterning steps. If I look at it on the inspection side, is it fair to assume that EUV inspection will replace some of the regular inspection, so net-net, it's a neutral impact for you guys? Or do you think there's actually growth at EUV inspection?

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Richard P. Wallace, KLA-Tencor Corporation - President, CEO & Executive Director [36]

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Process control intensity goes up with EUV. That's clear. And it does so because of the additional requirements associated with -- the reticle inspection is going to -- just the stakes are higher with those reticles. And I also think you're going to see more focus on print qual. So you're going to have more optical inspection as well, not to mention some of the changes we're going to have with overlay when they get to multi-pattern. So I think there's good reason to believe that we'll see intensity go up over time. Now when you think about how much of the market is really EUV at this time, it's a pretty small number. So that percent is going to take some time to accumulate, but it's definitely increased intensity.

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Operator [37]

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Your next question comes from the line of Quinn Bolton from Needham & Company.

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Quinn Bolton, Needham & Company, LLC, Research Division - Senior Analyst [38]

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I wanted to first ask on the memory side of the business. It sounds like DRAM is weak and as well 3D NAND. But in your June comments, I think you said January increases to 47% of shipments from 38% of shipments. Just wondering if you could give us a little bit of color what's going on there. And then my follow-up question is on the bare wafer inspection segment. It looks like Gartner's reporting that segment increased something like 87% in 2018. How do you see that part of the business in 2019?

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Bren D. Higgins, KLA-Tencor Corporation - Executive VP & CFO [39]

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Yes. So on the shipment profile, the shipments to memory customers are higher in the June quarter. There's a couple of big projects that we expect to ship to, both on the DRAM and the flash side. So I think in terms of the second half of the year, we'll see how that plays out. And we'd expect increasing momentum as we move through the year. But we do have higher shipment levels to both segments of memory in the quarter related principally to 2 or 3 projects.

On the bare wafer side, we've seen a lot of growth in that business. I mean '18 was a great year, and '19 was flat to '18. And it's not just the bare wafer customers as much as it's also unpatterned inspection of metrology overall, which has been driven by the high levels of memory investment. So you have capacity requirements, but you also have changing specifications for metrology and cleanliness requirements for 3D NAND that's driving a lot of investment in that product.

So we would expect similar results in calendar '19 versus calendar '18 in that business against the backdrop of the declines in the WFE market. Now as we move to '20, I would expect some of that capacity on the wafer side to or that demand on the wafer side to pull back a bit in calendar '20, still at a much higher sustaining level given the requirements I talked about but would expect for this year and to be very consistent with what we saw last year.

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Operator [40]

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Your next question comes from the line of Toshiya Hari from Goldman Sachs.

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Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [41]

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You guys provided long-term growth expectations for Orbotech when you guys announced the deal. I think it was 15% for semiconductor devices, 13% for display and 8% for PCB. Have those numbers changed at all given the developments over the past 12 months?

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Bren D. Higgins, KLA-Tencor Corporation - Executive VP & CFO [42]

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Yes. So we put those numbers out very consistent with the 2020 model that Orbotech had presented publicly back in 2017. So look, the assumptions move around. Certainly, the display assumptions move around. I would say I'm probably more optimistic on the semiconductor side and a little less so on the display side. But overall, the expectations for that business, which their 2020 model, I believe, was $1.25 billion, I feel pretty good about at least today based on the path that we see to get there. Obviously, the size of these markets and how the electronics market and end markets play out will influence that. But we haven't seen anything at a top level that we think dissuades us from that view that they should be able to achieve the 2020 plan that we laid out when we announced the transaction.

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Toshiya Hari, Goldman Sachs Group Inc., Research Division - MD [43]

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Okay. Great. And Bren, as a quick follow-up on synergies, is $50 million over the next 6 quarter still the right way to think about synergies from Orbotech? And I guess related to that, what sort of OpEx synergies are embedded in your June and back half guidance of $370 million to $375 million?

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Bren D. Higgins, KLA-Tencor Corporation - Executive VP & CFO [44]

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Yes. Very little is embedded. We targeted a time frame of 12 to 24 months. We're doing that work now. I think just given the timing of how those actions could play out and how you see it flow out of the model, it'd probably be -- we'd start to see some benefit towards the very tail end of the year. So limited synergies are forecasted in the guidance I gave both for OpEx and for top line.

So -- but our goal is $50 million by the -- a $50 million a year run rate by the end of -- 12 to 24 months from the transaction, and we feel pretty comfortable with the ability to get there. We'll see how it plays out. I would say it's probably more $20 million to $25 million in OpEx and maybe $25 million to $30 million in the COGS line.

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Operator [45]

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(Operator Instructions) Your next question comes from the line of Patrick Ho from Deutsche Bank.

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Shek Ming Ho, Deutsche Bank AG, Research Division - Director & Senior Analyst [46]

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Rick, maybe first off, in your comments regarding China, you said the industry spending to be down. However, with the memory market in China going through some significant yield issues, could you see KLA outperforming, I guess, that outlook based on increasing process control intensity or -- to help them along their development curve?

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Richard P. Wallace, KLA-Tencor Corporation - President, CEO & Executive Director [47]

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Yes. Both things are true. We do see overall market coming down. As we said, memory down, China may be a little less so, and we're continuing to be strong as we help them in terms of some of their aspirations about driving these new processes. So yes, we do see intensity higher there, and we should outgrow in China.

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Shek Ming Ho, Deutsche Bank AG, Research Division - Director & Senior Analyst [48]

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Great. Maybe as my follow-up question, on the EUV inspection side of things, you talked about the limited availability to date primarily on the foundry logic side of things. How do you see the memory market, particularly DRAM, in terms of its adoption and how it could influence your EUV inspection bias?

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Richard P. Wallace, KLA-Tencor Corporation - President, CEO & Executive Director [49]

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There is some adoption there. I would say it's -- from our perspective, we're going to be engaged if that happens. I think like everyone, they're going to look at the cost/benefit of doing that versus the alternatives, probably most pronounced in VF formation. So I think that we're going to see the opportunities there as they come, but I would say it's much more limited in memory than relative to logic or foundry.

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Operator [50]

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Your next question comes from the line of Atif Malik from Citi.

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Atif Malik, Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment & Specialty Semiconductor Analyst [51]

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Rick, as 3D sensing starts to move to 7-nanometer, 6, 5, 5.5, it just seems like there are just smaller and smaller increments in terms of the shrinkage. But can you just talk about within their like $10 billion to $11 billion kind of CapEx outlook, are you expecting your sales to grow as the leading foundries move into smaller steps?

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Richard P. Wallace, KLA-Tencor Corporation - President, CEO & Executive Director [52]

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We do. Before -- I want to correct something I just said. It's the storage node on DRAM. That's what I meant, not the VF formation.

In terms of increasing intensity for the foundries, absolutely. I think the challenge for the foundries is yield at these advanced nodes. And as you know, as you push these, the stress on EUV increases in terms of the economic viability. So we're going to see process control intensity throughout really the supply chain, whether it's -- and you have to make the reticles, and that's a challenging prospect now and maybe the most challenging. So between reticle formation and the print down on the wafer to make sure you have clean images, I think that's a challenge to make sure that the defectivity is low. So we're seeing demand in the design side to form these -- the [early] tape-outs. And then we'll see it in production. So as the nodes scale, I think they're going to be largely driven on the economics of those nodes as it drives our customers.

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Atif Malik, Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment & Specialty Semiconductor Analyst [53]

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Okay. And then when we were at SPIE conference earlier this year, there was a discussion on stochastic defects. But the message here was that the chip makers need help from every type of inspection equipment, whether it's e-beam or optical, just because these issues is far greater than anyone expected. Is your view on e-beam that it still will be available as a combination to optical as part of your strategy? Is that still your strategy or you've had a changed strategy?

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Richard P. Wallace, KLA-Tencor Corporation - President, CEO & Executive Director [54]

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No real change. I mean we've talked about leveraging e-beam and e-beam platform to do some of the inspections on the reticle itself, and that's a reticle without a pellicle just to validate the design. But when you do -- when you print down and you're trying to model and manage the stochastic implications, you really need optical for that because you need to have enough throughput to be able to cover enough area. So it's certainly going to be a blended approach by our customers, and we're committed to having all the capabilities that they need.

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Operator [55]

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At this time, there are no further questions on queue. Mr. Ed Lockwood, you may continue for any closing remarks.

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Ed Lockwood, KLA-Tencor Corporation - Senior Director of IR [56]

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Thank you, Jerome, and thank you all for joining us today. Jerome, you may conclude the call.

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Operator [57]

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That concludes today's call. Thank you all for joining KLA Corporation First Quarter 2019 Earnings Conference Call. You may now disconnect.