KLA Corp (KLAC) — Q4 2019 Earnings Call Transcript

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 June 30, 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 will 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.

Thank you, Ed. Good afternoon everyone and thank you for joining us for today's call. Q4 was another solid quarter for KLA with results finishing above the midpoint of guidance demonstrating the company is benefiting from our strategies for growth in market leadership while delivering strong relative performance in a challenging year for the industry. I'd like to provide some insights into today's equipment demand environment. Even with the signs of stabilization and NAND pricing, DRAM continues to be weak and the business environment in memory is soft. This has resulted in broad-based low levels of investment as customers have idled existing capacity and delayed new capacity plans as they focus on rebalancing supply and demand. The weakness in memory is being offset by rising demand from foundry and logic, which are traditionally strong markets for KLA. The business environment in foundry and logic is expected to continue to be strong through the second half of 2019 and into 2020, driven by next-generation technology development, capacity additions at the leading-edge, increasing competitive dynamics, and investment in EUV infrastructure. Altogether our outlook for WFE investment in 2019 remains consistent with the initial view we held in January, with demand expected to decline by approximately 20% in the year and with a significant shift in product mix to foundry and logic. Now I'd like to update you on some recent product highlights from our semiconductor process control business. KLA's market leadership is enabled by successful execution of a portfolio strategy focused on differentiation to address our customers' most critical challenges. We're very pleased with our product positioning and the strong customer acceptance we're experiencing across our portfolio. For example, we are currently seeing accelerated adoption of our flagship Gen 5 optical inspection platform, which is now in its second iteration since first being produced in 2016. We expect Gen 5 shipments to double in 2019 compared to the previous year. Customers are leveraging the combination of sensitivity and throughput in this platform to enable unique detection of yield limiting defects at significantly lower cost of ownership compared to the alternatives. The strong customer adoption of Gen 5 and the continued success of the Gen 4 platform, now in its fifth iteration, are further confirmation of the success of our multi-generation platform strategy for innovation and market leadership in optical inspection. Further, the latest generation of our laser scattering optical inspection platform, known as Voyager, is also enjoying strong adoption in the marketplace. Leading memory and foundry customers are deploying Voyager for in-line monitoring applications in high-volume manufacturing. In mask inspection, the strong momentum which we have experienced over the past several quarters continues and is positioned to extend through 2020. We are seeing upside from leading foundries for our latest generation mask inspection platform and expect demand to broaden as customers move ahead with our EUV deployment strategies. In metrology as WFE is transitioning more toward logic and foundry, we're seeing strong adoption of the new film and CD platforms released last year as our customers ramp complex technology architectures like finFET, new materials and new metal interconnects. And with the recent acquisition of Orbotech, we are further diversifying our business, broadening our product portfolio and growth opportunities and serving a larger market. Integration and synergy activities are now well underway and we're very excited about the growth opportunities in combination with Orbotech. We look forward to further discussions on this in our upcoming Investor Day in September. In summary, despite uncertainty in the current industry demand environment, momentum is building for KLA driven by strength in our semiconductor process control business and contributions from the recent acquisition of Orbotech. As a result, we are on a path for strong relative performance in 2019 while we continue to drive innovation and introduce differentiated products and solutions to serve the market when growth re-accelerates. With that, I'll turn the call over to Bren for his commentary on the Q2 financial results. Bren?

Thanks Rick, and good afternoon everyone. Total revenue in Q2 was 1.258 billion, exceeding the midpoint of our guidance range. GAAP earnings per share was $1.35, while non-GAAP earnings per share was $1.78, both at the upper end of our guidance range. Total shipments reached $1.354 billion, approximately $79 million above the midpoint, surpassing the high end of our guidance for the quarter. Semiconductor process control shipments totaled around $1.080 billion. We are satisfied with our results from the June quarter despite considerable noise and uncertainty in the global electronics market. We continue to execute our business across all markets and move ahead with integrating and realizing synergies from the Orbotech acquisition. Starting this quarter, we will adopt a new segment reporting structure following the completion of the Orbotech acquisition, which will be reflected in our Form 10-K when filed. Under this structure, we will report the KLA process control business within the semiconductor process control segment and separate the former Orbotech businesses into two segments: specialty semiconductor process and PCB display and component inspection. The latter now incorporates the former ICOS component inspection business of KLA. We believe this new structure accurately represents our business organization and the unique characteristics of each segment in terms of channels, markets, and technology. Results from applicable services will also be included in each segment. Additionally, this June quarter will be the last time we report shipments in our earnings calls, and we will cease providing shipment guidance moving forward. As detailed during the earnings call last May, under ASC 606 revenue recognition rules, the overall timing of revenue has shifted forward, making the difference between shipments and revenue immaterial and not justifying the resource investment for dual reporting. Therefore, investors can consider shipments to closely approximate reported revenue in any given quarter. Now, regarding the June quarter results, total revenue was $1.258 billion. We project total revenue growth of about 7% at the midpoint, with expectations of $1.31 billion to $1.39 billion in the September quarter. For the second half, we anticipate revenue levels to surpass the first half, with ongoing sequential growth expected in the December quarter across all business segments. Let's delve into segment revenue trends for the June quarter. For the semiconductor process control segment, which represents all legacy KLA operations except for our component inspection business, revenue stood at $1.003 billion. Component inspection revenue was slightly above [indiscernible]. As Rick mentioned in his opening comments, our outlook on the WFE demand environment for 2019 remains largely unchanged from January, with KLA benefiting from stronger foundry and logic demand. I should note that while our overall demand view for 2019 is stable, the near-term outlook for foundry and logic investment has improved, countered by declines in memory. In fact, our overall expectations for the second half have modestly improved during the June quarter. We now anticipate semiconductor process control revenue in the second half to increase in the low double digits compared to the first half of the calendar year, primarily driven by a more than 35% rise in revenue from foundry and logic customers. Memory investment continues to be weak and focused solely on technology migration. Memory accounted for approximately 51% of semiconductor process control systems shipments in June, and we anticipate it will represent around 42% of system revenue in the September quarter. Foundry constituted 35% of shipments and is projected to account for about 44% of system revenue in Q3. Shipments from logic customers were 14%, with revenue projections for logic expected to remain flat in September. Now, turning to the semiconductor process segment formerly known as the SPTS division at Orbotech, SPTS is recognized for its PVD and etch solutions in the rapidly growing specialty semiconductor applications such as MEMS, sensors, power, and RF devices, as well as advanced packaging markets. Revenue for SPTS was $67 million. Results for this business in the June quarter were significantly affected by the U.S. Department of Commerce ban preventing shipments of RF and MEMS semiconductors to Huawei, causing customers with Huawei market shares to postpone planned capacity investments. As the leader in etch and deposition tools in these markets, SPTS experienced some delays in expected business due to the ban. Although the long-term implications are uncertain, SPTS is still projected to achieve year-over-year pro forma revenue growth in calendar year 2019. Revenue for the PCB display and component inspection segment amounted to $185 million. This segment encompasses the former PCB and display businesses of Orbotech along with KLA's ICOS component inspection business. Results for this segment aligned with our expectations for the quarter and continue to meet our plans for the year. Now, I'll outline the revenue distribution by major product category in Q2. Wafer inspection comprised 32%. Patterning, which includes reticle inspection, represented 23%. Both wafer inspection and patterning fall under the semiconductor process control segment. PCB display and component inspection revenue accounted for 10%, and specialty semiconductor processes made up 4%. Other, which encompasses solar, instruments, and KLA pro mature product enhancements, was 4%. Service contributed 27% of revenue in the June quarter. In terms of regional revenue distribution, China accounted for 32%, Taiwan for 25%, the U.S. for 15%, Japan for 10%, Korea for 8%, Europe for 6%, and the rest of Asia for 4%. Now moving to more specifics regarding the results and P&L. Gross margin was 58.9% in June, at the top end of our guided range of 58% to 59%, as a higher level of semiconductor process control revenue counteracted the impact of the Huawei situation on our specialty semiconductor business. We expect gross margin in the September quarter to range between 60% and 61%, driven by a more favorable product mix in our semiconductor process control business and improved service margins. Looking ahead, we see numerous opportunities to enhance the gross margin profile of the Orbotech business by leveraging our global supply chain, service infrastructure, and footprint. We will discuss these initiatives in greater detail in the coming quarters as the timing and financial implications become clearer. Total operating expenses were $370 million in June, below the guided target of $375 million, thanks to lower-than-expected business expenses and some synergy benefits from Orbotech. Our operating margin was 29.5%. We anticipate quarterly operating expenses will remain in the range of $370 million to $375 million for the rest of 2019, consistent with our planned product development investments and the beginning of synergy realization. Other income and expenses in the June quarter were $38 million, and we expect this to be around $36 million this quarter. The effective tax rate was 13.7%, and moving forward, investors should plan for our tax rate to be modeled at the 40% level due to the new U.S. corporate tax structure and our expectations for profit distribution geographically. Net income was $289 million, and we had 162 diluted weighted average shares outstanding. Now, some highlights from our balance sheet and cash flow statement. Cash and investments totaled $1.7 billion, while total debt was $3.4 billion. Cash from operations was $325 million, and free cash flow amounted to $270 million. We are investing in infrastructure to support future growth, which includes building a new facility at our Milpitas Headquarters and another in Ann Arbor, Michigan. We forecast annual capital expenditures will exceed [indiscernible] in the coming years due to these and other necessary investments to sustain our growth expectations. In the June quarter, we distributed $121 million in regular quarterly dividends and dividend equivalents upon the vesting of restricted stock units, and repurchased $345 million of common stock at an average price just below $112 per share as part of our share repurchase program. Approximately $900 million of repurchase authorization remains available. For September, we expect a fully diluted share count of between 159 million and 160 million shares. In conclusion, the June quarter results exhibited strong operational performance through our diversified markets, continued technology leadership across our broad product portfolio, and operational discipline. KLA is well-positioned for strong relative performance in 2019, and we are encouraged by the momentum we see in our business. To summarize, for the third quarter, we anticipate revenue of between $1.31 billion and $1.39 billion, with GAAP diluted EPS ranging from $1.75 to $2.05 per share, and non-GAAP diluted EPS between $2.04 and $2.34 per share. Before we proceed to questions, I would like to remind investors that our 2019 Investor Day is scheduled for Tuesday, September 17 in Midtown, New York, and we look forward to seeing you there. I'll now turn the call back over to Ed to begin the Q&A.

Thank you, Bren. As we begin the Q&A, we request that you limit yourself to one question and one follow-up. Please feel free to requeue if you have any additional questions, which we will accommodate as time permits. Jerome, we're ready for the first question.

Yes, good afternoon guys. I appreciate letting me ask questions, congratulations on the solid results. Rick, it's good to see foundry and logic performing strongly in the calendar second half's expectation that continues into 2020. I'd be kind of curious, as you look at the memory market and differentiate between NAND, DRAM and maybe process control and bare wafer, how do you think that market plays out in the back half of year, which quarter do you think it bottoms in and how do you think about the recovery potential in 2020?

I'll give you some thoughts and then let Bren weigh in. Right now we don’t see, as we said, we don’t see a lot of momentum in DRAM. I think what we've got now is some strengthening I think we think in the foundry and logic as we said, but not a lot other than technology migration and not a lot of capacity. So if you think about when the recovery might come for NAND probably first half of 2020 and DRAM what our customers are saying now is more mid 2020 timeframe before we would see any meaningful change.

Yes, John, I would say that I'd characterize the market as what we're most is seeing the technology migration investment only and one thing about KLA is since we do help our customers navigate their roadmap transitions we are seeing some level of business from some of these customers. There is also some activity in China. We saw some last quarter shift influenced our shipments and we expect to see some more in the second half of the year. But to Rick's point, I think as we look at the overall market I wouldn’t expect to see any meaningful capacity until we get into 2020. And given that customers have been disciplined and pushing out capacity they have been idling capacity. How quickly that comes back is a little early to tell from this point. You mentioned bare wafer, on the bare wafer side we see our business at bare wafer being roughly flat into the second half of 2019. Now 2019 overall for that business is lower than it was in 2018. We had a huge inflection in 2018. We've seen it come off a bit in 2019, it probably comes off a little bit in 2020. I think we're operating that at a more sustainable or higher level for that business moving forward given the dynamics around memory, around specifications both for inspection, but also from metrology. So, and the numbers that we provided in the commentary I think that's been part of our view in terms of expectations moving forward. So I wouldn’t say that much has changed there and that's certainly we've been pretty open about.

Well that all, I got it. And maybe as my follow-up, Rick I'd love to get your comments on just inspection and process control intensity in foundry and logic as you move to 7 and then 5 and I guess it's kind of a complex equation. How does EUV going to fit you guys in the business going forward?

Sure, John. I think a couple of things, one we mentioned the strength in Gen 5 and a lot of that is driven, of course logic is going to drive that harder than we're seeing that transition from Gen 4 to Gen 5 in terms of the bulk of our system. So the design will shrink. We're going to drive smaller deep activity requirements driving toward the Gen 5. The other thing that's happening is overlay is a big driver for us in terms of the additional pressure put on our customers as they drive advanced design roles. Eventually we're seeing that in a couple of ways. One, we're seeing it in our shop with the number of starts, pre-EUV but also the anticipated large number of EUV, but also the print down checks, because I think what's really going to happen for a while is people are going to want to verify the designs, so another use for Gen 5. So overall, we think there is going to be an increase in process control intensity as we introduce EUV I think that that's more in the development phase. Longer term I think it levels out a bit as we get into high volume production later. But right now definitely the mix is favorable to us in terms of what we're seeing. We also mentioned increased competition in foundry and that's also been a driver I think to the mixed shift overall.

Thanks and congratulations.

Thanks John.

Good afternoon, guys. Nice job on the quarterly execution and strong outlook. In terms of the strong results and outlook, specifically within your mask or reticle inspection business, EUV system shipments, looks like they are going to grow about 70% this year. If I look into next year, the installed EUV base is still growing about 50% to 60%. So given your guide is very high market share at the of mash ups how do you see your mash up inspection business directionally and do you guys already have visibility into the directionality of this segment next year just given the long lead times and continued growth of the installed base?

Yes Harlan, it's Bren and I'll go first here, but if you look at the reticle inspection business couple of things are driving it. First, significant tape-out in the foundry at 7 nanometer and so that's driving significant purchasing of the product. You have to remember that reticle inspection in a mash up behaved somewhat to process, when you are inspecting every reticle before you ship it to the fab. So it has some unique dynamics in terms of how customers buy relative to the design starts and they move together. That's one dynamic and that's driving the business. The other obviously is the EUV development activity that's also driving the Teron system. So you have both effects, but frankly the biggest driver today is more around the design start at 7 and it is driving that business to have nice solid growth in the year obviously where WFE is down. So we're seeing growth in that and as Rick said in his prepared remarks, we would expect that to continue into 2020. Timing of the EUV deployment and how we see that plays out next year, it will potential influence some of the upgrades to the existing install base out there, but there is some sustainability in the business and we're seeing a nice recovery in it. And then we'll see that next generation products as they come out as we move into the second half of next year to support EUV directly. So there's a lot of exciting things happening in that space and we're seeing the numbers flow through in terms of P&L impact.

I think just to build on one aspect of it, I think the fact that we have extended the Teron platform to be able to handle these EUV layers, yes we benefit whether or not depending on the number of EUV layers, we still benefit because we've got an optical platform that can handle either the mask for EUV or for traditional lithography. So I think that's a part of why we're benefiting more depending on the starts and just the intensity of the advanced nodes, not necessarily just on the EUV because it's still not clear how many layers and at what nodes they are going to be adopted, but we're seeing strength in reticle regardless of which way that goes.

All right, thanks for the insights there. And then you guys were thinking 90 days ago that there was an upward bias for the Orbotech business moving into the second half of the year, but just given all of the China trade overhang, given that Orbotech has a number of large customers, do you guys still see the second half of this will be better for the Orbotech team and if so, maybe a bit of color on what segments are improving in the second half? I mean I would assume that specialty semi is doing well just given the strong focus on RF and power, but what about FPV and PCB?

Yes, so growth expectations for specialty semi have come down a bit for this year directly related to the Huawei effect. The indirect effect, but you do have customers in the RF space that have market share with Huawei phones and so they've more cautious and in some of their plans for capacity and that's impacted that business. So that business is still going to grow year-over-year, but probably not to the degree that that we expected 90 days ago before the ban came out. I would say PCB and flat panel are in line with our expectations, PCB flattish, flat panels down this year, but most of the growth for the business is going to come from specialty semi. So there's still some growth there year-to-year, but a little bit less given the Huawei effect.

Yes. But just to put it in perspective Harlan, we're still within a few percentage of what we had originally modeled in terms of profitability and contribution to KLA for the business. So it still looks good. As Bren said, some kind of shifting dynamics, so not really that different from what we thought earlier in the year.

Yes, great job on the execution. Thank you.

Thank you.

Thanks.

Thanks a lot. I guess the first question Rick is that, there have been some other companies in your broader sector that the past couple of weeks have talked about, some pull-ins from China that are sort of helping the back half of the year. And I know you talked last quarter about a big project that was out of the second half and now is sort of back in the second half, but what are you seeing generally in China? I guess, is it your view that the trade stuff only increases the pace of these projects as you kind of look into the back half of the year and into next year?

We have definitely seen some puts and takes in China to the point, but we're seeing what others are seeing, where so maybe increased urgency in terms of the second half to get those projects fully up and as you know, there's just a lot of noise in the system. In terms of what effects might come in. The only substantial thing we've seen is a very small part of our business as Bren mentioned, but overall, pretty much where we thought in terms of the second half having some strength in it.

Yes, I think the DRAM project, I mean it's interesting at that start beginning of the year, we thought it was completely out and wow it looks like we'll see it ship in the second half of the year. We're seeing to Rick's point some puts and takes related to some of the wafer plants in China. So overall I would say our expectations for China business this year versus where we thought are probably on the margin, slightly higher than where we were before, but not a lot of change there overall.

Okay Bren, thanks. And then I guess is the second question, I'm wondering if you can quantify in the spec SMEs segment how much the sort of indirect Huawei there, is it something like $10 million to $20 million a quarter, is that what it's costing you sort of into the back half of the year? I'm just sort of trying to baseline what the business would look like if this ban had not, or is not in effect?

Yes, so Tim, I think in the immediate quarter and you'll see some adjustments to plan meet the quarter, the impact was between $20 million and 25 million and certainly some of the strength in other parts of our business helped us achieve our results for the quarter. That number probably goes up to the $35 million-ish plus or minus as we move into the second half of the year in terms of our expectations. In total, so probably somewhere around $35 million to $40 million impact on calendar 2019. In the long run, it's interesting as those, as other providers that are non-U.S. providers start to ramp their capacity that creates an opportunity for the specialty semiconductor business there. So in the long run, and they are in an inferior position, so in the long run there potentially is a big opportunity out there in terms of how the designing around the supply chain works. But in terms of the current year, the impact is probably somewhere between $35 million and $40 million in total.

Okay, guys, awesome. Thank you so much.

Yes, hi, thanks for taking my question. First one for Rick or Bren, I know you guys have not given out your guidance, but if I look at some of the commentary you made in terms of strength of foundry lasting into first half of '20 and NAND in first half and maybe DRAM in the second half of '20 recovering, is it fair to assume that your legacy KLA, the business is going to be up in calendar '20 versus calendar '19 and if so, what is the risk to that guesstimate? And then I had a follow-up.

Yes, so let me take the first part and then give it to Bren. So we're not going to call it legacy. It's a process control business now that we have other businesses and the trajectory is good. We're going to get into more discussion of the outlook at our Analyst Day next month, but definitely, we feel like things are coming our way in terms of the right kind of market momentum, the advanced design rule work that's going on. In addition, some of the competitive dynamics, we talked about Gen 5 strengthening and some new projects, new products hitting the market. So we feel very good about overall position and Bren can talk in broader terms.

Yes, I think we feel pretty good about logic, foundry and sustainability of spend levels into 2020. So I think if you look across those end markets and you look at the activity there. We would expect to see continued investment. We talked about competitive dynamics, the strength of the 7 nanometer node out there is also limiting how much reuse customers can do, and so that's certainly having an effect as well. You'll see automotive and industrial hopefully start to come back next year and so as you think about the broader demand across all of logic, foundry, I think there are a number of drivers that give us some confidence moving into next year about those segments.

Got it, okay. And then as a follow-up, you guys introduced a new e-beam wafer defect review product recently and I'm kind of curious, how do we think about the coexistence of Gen 5 and e-beam down the road for your product portfolio and is this e-beam kind of just targeted towards specialized applications, so just kind of curious on how to think about the lay of the land for your products? Thank you.

Well, I think what we said all along is we think there is a complementary role for optical and e-beam and this continues that. I think that what we have in our latest technology is a very capable e-beam tool that when our customers utilize with our advanced optical they really get the best of both in terms of capabilities for the market. But I don't think there will ever be a day where there is not a complementary e-beam solution with optical. Optical keeps getting better, e-beam has to get better too, but I think the general mix between e-beam and optical will remain about the same in terms of the way customers spend their dollars. But we're very excited about what we've seen in the market and we think the synergy of having our optical tool, coupled with our e-beam is really great for our customers trying to solve some of their very challenging problems.

Great, thank you. Good afternoon and thanks for taking the question. I guess, I wanted to follow up on that last question regarding your expectations for sustainability of foundry. Strength to continue through 2020. I guess within that could you speak to, I guess both your positioning within Gen 5 EUV, e-beam, perhaps new products that you haven't announced yet, but you just highlighted? And then also from an end-market perspective in terms of rising competition as you look at Samsung coming in, we'd love to hear, I guess in more detail your thoughts on that front?

Yes. So, this is Rick. I'll talk more sentiment than actual numbers in terms of 2020 because we really don't know, but you can always assume higher customer behavior and what the mood is in the market. And right now we're actually in a situation where we see a lot of energy around our customers pushing for new capability, pushing for getting their advanced designs out, you see a lot of tape-outs, the mask business has been good, so definitely feel strong. The other thing and not to be missed, what Bren mentioned is, we don't see a lot of reuse happening because of some of the challenges of the new technologies. So that was something that we were trying to really map out and see what it was going to look like and the combination of new capability on our side, new challenges on our customer side, make us feel like it looks very strong in terms of the momentum. How long into '20, we don't really have great visibility into that. It's just now we have a case where you've got multiple players really concerned about bringing out new technology and ramping new devices, and at the same time we're hitting with some products that are new to the market and very exciting for us.

Yes, I think we feel bullish about what we are seeing across the front. So I think the number of tools are actually being shipped this time around is certainly more aggressive to those earlier nodes. There's a lot of engagement. The number of customers involved is different for this progression than in '19, and so that's good news. I feel good that the generation of products we bring to market need to be sort of meeting that earlier and earlier demand.

Very helpful, thank you. As my follow-up, could you, I guess, speak a little bit to your expectations for growth in the service bucket, both for process control as well as for overall Orbotech?

Yes, CJ, so in process control for those process control customers we believe we have a long-term trajectory somewhere in that 9% to 10% CAGR opportunity over time. We're adding tools to the installed base at a much faster rate than they're coming off, so that creates opportunities for us. 75% of that revenue stream is contract-based because of customers' desire to keep those tools up, and how they buy process control also just a general complexity of what we sell. So that's good for that business. We've seen it slow a little bit in the near term related to just some of the idling of capacity that's well understood in the market. But over the long run we've seen it grow at that rate and we expect it to continue to grow like at that rate over time. The PCB business for Orbotech has a strong service profile, say 95% of the tools are under contract, so of the PCB revenue we reported about 40% of it is service stream. So because of the imaging technology and the need for that tool as enabling for circuit boards, that's a positive trend for that business. I think on the flat panel side, there is very little service activity in terms of some consumable parts that are attractive, but there is some opportunity there for us certainly. And on specialty semiconductors, as we think about how we try to leverage our position in working with customers to offer better solutions over time there might be an opportunity for us to help customers that way on the specialty side. Smaller companies always have a harder time with service just the broader footprint. So maybe what we end up doing is enabling a better cost position for both flat panel and for specialty semi, but a lot of opportunity for us moving forward I think in terms of driving that straightforward for the company.

Thank you for taking my question and congratulations on the nice results and outlook. I'm really just wondering, you mentioned the strength on the Gen 5 tool, you guys introduce the fifth iteration of Gen 4 last month, just wondering what demand you're seeing for the older Gen 4 systems as Gen 5 ramps?

Well, it's, think of it like a lithography mix and match. So what you get is, you end up with customers deploying the most cost-effective solution they can that has the capability that they need and that really cascades starting with e-beam, then getting to 39xx, than 29xx, and then the new Voyager platform. So it's really - the easier layers are harder than they used to be on the advanced node. So customers will deploy where they can the Gen 4 and then they'll put Gen 5 up against the problems when that's the only way to really solve them. Did that answer your question?

That's helpful. Thank you. And then just a follow-up on the China question, you referenced some puts and takes, but generally, perhaps a strengthening in that market versus 90 days ago. Do you have any sense as to the demand strength, I mean you're seeing more of a timing shift where projects are getting pulled in or do you think that this is just an acceleration in the roadmap for some of those indigenous Chinese fabs? Thanks.

I don't think it's as much about, - I think what happens is, there is uncertainty may be about their own plans and their ability to procure tools. So that may be pushed it out and then when they realized they could do it, pulled it back in. I don't want to speak for them, but I think it's more that the projects getting solidified. And I think 90 days ago maybe that was more on par is to see if they can even get the tool sets. So that's kind of where we are. It's not so much about end demand. I don't think as them staying on some of their plans. And by the way, there are a lot more programs there that we already derated. If you go back a couple of years ago and had listened to what customers have said, we're getting closer and closer to what we anticipated for 2019 and a going run rate for 2020.

Thank you. If you look at the capacity build for the upcoming 5 nanometers, how do you think the rate at which the capacity is being built is compared to previous, now let's say, to 7 nanometer or 10 nanometers? Wafer that the pilot line for 5 nanometers could be a little bit bigger than in the past, but just want to hear from your perspective of what is driving that kind of changes?

Yes, I think that, and I'll go first here. I mean, we are seeing a little bit stronger adoption level and to the point earlier, you're seeing less migration of other tools from previous nodes, and so that's driving a certain amount of activity. I would expect it will probably be somewhere between 80 and 90 k wafer starts and for 5 nanometers get into that sort of through the first part of 2020 or maybe that's towards the end of 2020. So I would say that because of some of those other dynamics related to 7 we're seeing perhaps more activity for us on the 5 nanometer node. Yes, so growth expectations for specialty semi have come down a bit for this year directly related to the Huawei effect. The indirect effect, but you do have customers in the RF space that have market share with Huawei phones and so they've more cautious and in some of their plans for capacity and that's impacted that business. So that business is still going to grow year-over-year, but probably not to the degree that that we expected 90 days ago before the ban came out. I would say PCB and flat panel are in line with our expectations, PCB flattish, flat panels down this year, but most of the growth for the business is going to come from specialty semi. So there's still some growth there year-to-year, but a little bit less given the Huawei effect.

Yes, hey guys, thanks for taking my follow-up question. On the strong adoption of the Gen 5 wafer inspection platforms, this I think was originally targeted for sub-7 nanometer nodes. We keep hearing that customers are adopting Gen 5 for yield improvement even at some of the older nodes, and we also hear that Gen 5 has been adopted earlier by the memory guys. And then you also have EUV print check as another use case. So, how much of these types of buyers are driving the strength in shipments this year versus the real leading-edge development activities?

We haven't thought about it in those terms. I'd probably half and half, though, I mean if I thought about it. It's broad use in development. I think what happens in especially since we make improvements to it and drive the productivity of the tool up, then it starts to be competitive in terms of cost of ownership with some applications for Gen 4. But a lot of this, as you might imagine, the discovery aspect of a new product is, you're not really sure what it's going to find and what value it's going to create. So now what we're seeing is significant value as you say, even in some maybe more traditional places and frankly what we originally expected was, in some places people might have tried to deploy e-beam inspection, they get away from that by leveraging the much higher throughput of the optical platform. So we kind of see it broadening and feel very good. It took a little while, but we feel very good about the progress there.

Customers are experiencing increasing demand and activity at various nodes, which is leading to more yield challenges. The tool has become faster, and the debugging issues that were present at earlier nodes are now being addressed using the Gen 5 capability. As Rick mentioned, there is significant headroom that allows customers to utilize that tool for comprehensive wafer coverage yield analysis, which was not possible prior to the introduction of the Gen 5 product line. Given the rising demand and the activity across new designs at those nodes, more debugging is taking place as well.

So, just one last dynamic, I think you may know that what a lot of customers do is, it takes them a while to prove out the capability of the tool before they release it even internally for broad years. And so what we've seen in the last couple of quarters as we've kind of broken through at some critical places where they have broader ability now to deploy outside of the first people who were just evaluating it. So that really opens up a number of use cases and hence the significant progress in Gen 5.