KLA Corporation

Ladies and gentlemen, thank you for standing by and welcome to the KLA Corporation September 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during this session, you will need to press star one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance Please press 5-0. I would now like to hand the call over to Mr. Kevin Kessel, Vice President of Investor Relations for KLA Corporation. Thank you. Sir, please go ahead.

Thank you, Christian, and welcome to today's KLA Earnings Conference Call to discuss the results of the September 2019 quarter and outlook for the December 2019 quarter. I recently joined KLA, and today marks my first KLA Earnings Call. I'm glad to be here and look forward to meeting and talking with all of you over the quarters and years ahead. Joining me on the call are Rick Wallace, our President and Chief Executive Officer, and Bren Higgins, our Executive Vice President and Chief Financial Officer. During today's conference call, we will discuss quarterly results for the period ending September 30, 2019. We released these results this afternoon after the market closed, and they are also posted on the investor relations section of our website at ir.kla.com. Today's discussion of our financial results and outlook is presented on a non-GAAP financial basis unless otherwise specified. A detailed reconciliation of GAAP to non-GAAP results is in today's earnings press release and the earnings slide presentation posted on the KLA Investor Relations website. Our IRR website also contains a calendar of future investor events, presentations including those from our recent investor day, and corporate governance information, as well as links to KLA's SEC filings, including our annual report on Form 10-K for the year ended June 30, 2019. Our comments today are subject to risks and uncertainties reflected in the risk factors disclosure in our SEC filings. Any forward-looking statements, including those we make on the call today, are also 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'd like to now turn the call over to our Chief Executive Officer, Rick Wallace.

Rick? Thank you, Kevin, and welcome to KLA. Good afternoon, everyone, and thank you for joining us on today's call. I'll start with a brief strategic overview before I cover the business highlights from the quarter. Please turn to slide four. KLA continues to see strong momentum in our business from the secular trends we articulated at our recent September 17th Investor Day. Our performance this quarter clearly demonstrates how KLA is benefiting from our strategies for growth, technology leadership, and operational excellence. We delivered another solid quarter with revenue in both GAAP and non-GAAP EPS finishing above the range of guidance, a result of strong customer pull for KLA solutions and focused execution, despite a backdrop that still includes some industry headwinds in key segments. As a global leader in process control and supplier of process-enabling solutions for the data era, KLA remains at the forefront of the most important industry trends and technology inflections in the electronics industry. Our deep collaborative customer relationships, broad IT portfolio, and differentiated solutions that address our customers' most complex challenges is the recipe that sustains our market leadership. Our business also continues to benefit from more complexity within semiconductor devices, as well as multiple megatrends driving demand across multiple product generations and numerous key industries. Please turn to slide five. Five, underpinning our success and consistent outperformance is the KLA operating model, which codifies our corporate values and management principles. We have been running the company this way for a long time, but we discussed it much more extensively at our recent investor day to better illustrate its power and impact on the KLA business and explain how it represents critical core competencies that we believe can enhance the long-term performance and profitability of acquired businesses. The KLA operating model is essential to align the company on a consistent strategy and execution, heighten accountability, and facilitate continuous improvement while ensuring we always operate with strong financial discipline and rigor. Please turn to slide six. Strategically, we have four objectives that serve as our guide and drive our high-performance culture. I also spoke about this extensively at our recent investor day, but it's worth reinforcing for those who couldn't attend. These four objectives are market leadership, product differentiation, operational excellence, and attracting and developing talent. We run all our businesses, including acquired ones, with a focus on these key four objectives, and it shows in our overall results published today. Please turn to slide seven for the September quarter business highlights. Before I cover the business highlights for the quarter, I'd like to provide some high-level perspective on the current industry environment. The long-term growth opportunity for the semiconductor markets remains compelling, driven by the proliferation of electronics across more diversified end markets, the introduction of new advanced technologies supporting 5G and artificial intelligence, growing semiconductor investment in China, and continued device and process innovation to deliver superior performance and return on investment. KLA's strong results are primarily driven by demand momentum we see due to support both development and capacity growth in advanced logics. The demand to support advanced logic nodes is expected to remain healthy through the balance of 2019 and into 2020, driven by investment in EUV, competitive dynamics, and capacity additions. Given the recent news of increased CapEx investment in 2019 at leading-edge logic and better-than-expected demand from domestic memory customers in China, our outlook for WFE investment in 2019 has improved since our initial view for the year. We now expect WFE levels to decline by approximately 10% to 15% in 2019, with KLA's semi-process control business, inclusive of our guidance today, outperforming the broad semiconductor capital equipment market and growing modestly compared to 2018. Now let me cover some of the product highlights from the quarter. KLA's market leadership is evidence of the successful execution of our portfolio strategy focused on differentiation and to address our customers' most critical challenges. We're happy with our product positioning and the strong customer acceptance we are experiencing across our portfolio. We continue to see accelerated growth of our flagship Gen5 optical inspection platform, with customers now deploying Gen5 for both technology development and production monitoring at the advanced nodes. Driven by this expanded use case, we expect Gen5 shipments to double in 2019, an adoption to continue to grow in 2020 as customers are under intense pressure to ramp quickly, and KLA's advanced optical inspection platform is on the critical path to their success. The accelerating adoption of EUV and increased investment in leading-edge Foundry and Logic will continue to drive strong Gen 5 demand in the near term. Also, at last month's Investor Day, we announced the first new e-beam inspection platform in several years. I'm pleased to report that we're receiving very positive feedback from our early customers related to the initial tool performance. KLA's differentiated e-beam inspection platform works with Gen 5 optical inspection platform with seamless connectivity to offer customers the best inspection performance combination at the lowest overall cost of ownership to identify and detect yield killer defects at the most advanced nodes. Demand for mask inspection continues to be a highlight for KLA. In the September quarter, we saw a continuation of the momentum we have experienced over the past several quarters, and better-than-expected demand in the September quarter, helping to contribute to the revenue upside we experienced in the quarter. We're seeing strong demand from leading foundries for our Tehran mask inspection platform for optical and EUV applications, and expect this to continue as customers ramp their advanced technology roadmaps. And finally, KLA's service business continues to deliver excellent revenue growth performance while simultaneously generating record free cash flow. Semi-process control service revenue is on track to top $1 billion in 2019, with over 70% of the revenue generated from subscription-like service contracts. This gives us high confidence that this business can deliver long-term revenue growth rates in the range of 9% to 11%. Several factors drive growth in our service businesses, including increased complexity of our systems, expansion of the installed base, and extended demand at the trailing edge nodes. With high fab utilization in Foundry and Logic and stable or bottoming in memory, our customers are also looking for opportunities to enhance productivity and extend the life of their installed base. As a result, we see robust service contract penetration, and our service business is providing a steady recurring revenue stream to our business. Please turn to slide eight. In summary, the KLA operating model drives our investment thesis. This is accomplished by driving sustained technology leadership with a strong competitive moat supported by a track record of free cash flow generation and capital return. Despite near-term headwinds in the industry demand environment centered on the timing of memory capacity investment, KLA continues to execute exceptionally well and deliver healthy relative revenue and earnings growth. Our focus on driving innovation and providing a steady stream of differentiated products and solutions sets the stage for growth in 2020 and positions KLA to achieve the long-term growth targets we established in our September Investor Day. 2019 is turning out to be a banner year for KLA, showcasing the enduring value created by the successful execution of our strategic objectives. Looking to 2020 and beyond, we're very excited about our prospects for growth, and market leadership, building on the momentum we've established in our process control markets and capitalizing on the market expansion opportunities from the Orbitech acquisition. We remain impressed with the Orbitech team and excited by market opportunities and technology leadership. Our integration and product synergy programs are on track and progressing well. With that, I'll turn the call over to Bren for his commentary on the September quarter financial results and our December quarter outlook. Bren?

Thank you, Rick, and good afternoon, everyone. Please turn to slide 10 for a review of the September quarter financial highlights. This was a very strong quarter for KLA, with revenue and EPS each coming in above the high end of our guidance ranges. Our free cash flow results also marked a new record for the company. Total revenue for the September 2019 quarter was $1.413 billion, which was above the range of guidance of $1.31 billion to $1.39 billion. Gross margin for the quarter was 60.8%, and the upper end of the guided range for the quarter was 60 to 61%, driven by incremental revenue growth and a stronger-than-expected semi-process control product mix. GAAP EPS was $2.16, and non-GAAP EPS was $2.48, both of which were also above the range of guidance of $1.75 to $2.05, and $2.04 to $2.34, respectively. Our cash flow execution was exceptional this quarter, as both cash from operations and free cash flow came in at record levels of $496 million and $464 million. We are proud of our financial results this quarter, and we remain focused on executing across all markets as we move forward, with a focus on our integration and synergy plans for the Orbitek acquisitions. A key element of our investment thesis is KLA's commitment to returning cash to shareholders. On September 17th, we announced a 30% increase in our quarterly dividend level to $0.85 per share. This marks the 10th consecutive annual increase in our quarterly dividend level, reflecting our confidence in our business strategy, the strength of our free cash flow generation, and our ability to grow it over time, as well as our commitment to returning value to shareholders. In terms of returning capital to shareholders during the quarter, We were consistent and effective in our execution as we repurchased $228 million of common stock and also paid $122 million in regular quarterly dividends and dividend equivalents upon investing in restricted stock units. In addition, we reaffirmed our commitment to continuing to return capital to shareholders as we announced that the Board of Directors authorized an additional $1 billion share repurchase program, resulting in $1.6 billion available to repurchase under Board authorization at quarter end. Please turn to slide 11. for a review of the revenue breakdown by reportable segments and key end markets. Revenue for the semi-process control segment was healthy and a new record at $1.163 billion in the quarter, up 16% sequentially on the back of strength in foundry and logic. As Rick discussed in his opening remarks, our view of the WSB demand environment for 2019 has improved modestly, driven by investment in EUV and stronger foundry demand. In addition, increased demand from native China is also contributing to this improvement, where expectations are for this business in 2019 to be relatively flat now versus 2018. As I mentioned, foundry is very strong at approximately 44% of semi-process control revenue, up from 36% last quarter. Memory was 43% in September, down from 52% last quarter. Logic was 13% of total semi-process control revenue versus 12% last quarter. I'll turn now to the specialty semiconductor process segment. SBTS is a leader in PVD and edge solutions and fast-growing specialty semiconductor applications like MEMS, sensors, power and RF devices, as well as in advanced packaging markets. Revenue for SBTS was $69 million, up 3% sequentially. While we're encouraged by the market position of these products, SPTS revenue for 2019 has been impacted by ongoing global trade issues and a slowdown in the automotive semiconductor market. Despite these near-term headwinds, we expect SPTS to deliver revenue levels in 2019 that are roughly flat on a pro forma basis to calendar year 2018. Revenue for the PCB display and component inspection segment was $179 million, down 3% sequentially and in line with expectations. This segment includes the former PCB and display businesses of Orbitech and KLA's component inspection business. Please turn to slide 12 for a breakdown of revenue by major products and region. The distribution of revenue by major product category in the September quarter was as follows. Wafer inspection was 32%. Patterning, which includes reticle inspection, was 27%. Wafer inspection and patterning are part of our semiconductor process control segment. Specialty semiconductor process was 4%. PCB display and component inspection revenue was 9%. Other, which includes bench top analytical instruments and the KLA Pro mature product and enhancements business, was 3%. Service was 25% of revenue in the quarter. In terms of regional split, Taiwan was 27%. China was 24%. Japan was 15%. Korea was 14%. The U.S. was 13%, Europe was 4%, with the rest of Asia at 3%. Please turn now to slide 13 for other income statement highlights. Total operating expenses were $376 million in the quarter, and our operating margin was 34.2%. Other income and expense in the September quarter was $39 million. The effective tax rate was just under 11%, below our long-term tax planning rate at 14%, due to a decrease in tax reserves related to the resolution of a tax audit in the U.S. Non-GAAP earnings per share under the 14% planning rate would have been $2.39 per share. Going forward, you should continue to use 14% as a long-term planning rate. Net income was $398 million, and we had 160 million diluted weighted average shares outstanding. Please turn to slide 14. We ended the quarter with $1.8 billion in cash total debt of $3.4 billion, and a flexible and attractive debt maturity profile supported by investment-grade ratings from all three agencies. Please turn to slide 15 for review of free cash flow. KLA has a history of consistent free cash flow generation and high free cash flow conversion. Over the past five years, we have averaged just over 100% free cash flow conversion, and over the last 12 months, it's been 84%. Our innovation and differentiation in the marketplace are what drives our industry-leading gross margins and ultimately our free cash flow conversion. Please turn to slide 16. KLA continues to execute on its commitment to return capital to shareholders in the form of both dividends and share repurchases. The dividend payout has increased at a compound annual growth rate of 15% since inception. The share repurchase has also increased over the years, but the average price paid to repurchase shares being slightly over $66 since 2010. The only exception to the company's systematic repurchasing activity was during the period when it was blacked out due to merger discussions. Please turn to slide 17 for December quarter 2019 guidance. We expect total revenue to grow sequentially roughly 4% at the midpoint and be in a range of $1.435 billion to $1.515 billion in the December quarters. Foundry is forecasted to be about 55% of semi-process-controlled system revenue in the December quarter, depicting the strength we continue to see among our Foundry customer base. We expect memory to be approximately 36% of system revenue in the December quarter, reflecting continued headwinds we see in the memory market. Logic is expected to be about 9% For the second half of the year, we now expect Foundry and Logic revenue combined to be up over 50% in the second half of the calendar year versus the first half. Based on product mix expectations for the December quarter, we forecast gross margin to be in a range of 60% to 61%. In terms of operating expenses, we are modeling them to be approximately $385 million. The higher operating expense level in the December quarter is due principally to the timing of non-headcount related product engineering expenses for next generation programs. as well as new risk mitigation bubble costs associated with recent actions taken to drive long-term structural cost reduction actions related to leveraging KLA's global footprint to relocate certain manufacturing and engineering activities to lower-cost locations. We would expect to see an impact from these activities through 2020, with the return on these investments beginning in 2021. As we move forward to the March quarter, our expectation today is that operating expenses will return back into the range of $370 to $375 million as product development expenses normalize to run rate levels and acquisition synergies offset other costs. We expect other interest and expense to be approximately $38 million in the December quarter and the tax rate to be about 14%. For earnings, we expect GAAP diluted EPS of $2.13 to $2.43 per share and non-GAAP diluted EPS of $2.39 to $2.69 per share. Our EPS guidance is based on a fully diluted share count of approximately 159 million shares. In conclusion, the September quarter results demonstrate strong operating performance and relative strength for KLA across many critical segments and what remains an environment with some headwinds. With our diversified end markets, continued technology leadership across a broad product portfolio, and operational discipline, KLA is delivering strong relative performance, and we are encouraged by the momentum we see in our business. Before I turn the call over to Kevin to begin the Q&A, I'd like to make a few qualitative comments on our outlook for the wafer fab equipment market in 2020. While it is too early for us to provide specific guidance or have to have trajectories for the year, we continue to see a strong year for Foundry and Logic investment with investment levels consistent with what we've experienced in 2019 as customers continue to progress their technology roadmaps in a strong demand environment with improving competitive dynamics and diversified end demand. For memory, we expect a better year in 2020 as discipline supply management in 2019 has improved the overall condition of both segments. Given the strength of our market position, the purchasing behavior of process control and foundry logic, improving process control intensity and memory, and contributions from new products. Calendar 2020 is setting up for another year of relative outperformance for KLA. We'll have more to say on this when we report earnings for the December quarter. I'll now turn the call back over to Kevin to begin the Q&A.

Kevin? Thank you, Bryn. As we begin the Q&A, we request you limit yourself to one question and one follow-up question. With that, Christian, we are ready for the first question.

Thank you, sir. And as a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, please press the found key. Please stand by while we compile the Q&A poster. Your first question is from John Pitzer from Credit Suisse. Your line is open.

Yeah, good afternoon, guys. Congratulations on the very solid results. Rick, I want to go back to one of your comments you made in your prepared comments about the Gen 5 optical inspection platform. You mentioned that you expect shipments to double in 2009 and for that to still be a good growth driver in 2020. So I guess I'm trying to get a sense from you, where in sort of the potential of that product cycle over time do you think we are? Maybe using a baseball analogy here, might be the right way to look at it. And as you think about Logic Foundry being strong next year, to what extent is that just a call on Logic Foundry CapEx versus perhaps a Gen 5 product cycle that's still in the sweet spot and accelerating? Sure.

John, thanks for the question. Yeah, I think if I thought about Gen 5 right now and you want to use baseball, it's third inning. It's relatively early in the life. We're now on the second iteration of that product in terms of a new platform and there are several iterations to follow. Engineering is being dedicated to that, but we're now starting to see broad adoption and really the beginning of adoption in production where what we really had been dealing with for the most part in the last couple of years was during the development cycle. So we're still early on and we think it will become a primary tool. We always thought it would become the HVM tool once we got to EUV. in ramping in production, and it definitely feels like it's doing that. The upside to that is we've seen more memory adoption in the Gen 5 than we originally anticipated. So that's probably upside to what we'd originally envisioned.

Hey, John, it's Brent. The only other thing I'd add to that is, as we talked about at our investor day, there is an application for reticle qualification in the FABs for EUV reticles. So You know, as we start to progress that use case, it's how the tool is used for full wafer coverage to be able to qualify reticles as they're being used in the wafer fab. So an incremental opportunity there that is slowly evolving, but we think adds another dimension of growth for Gen 5 as it gets adopted.

That's helpful. And, Brent, maybe just for my follow-up, I want to go back to the operating model you shared at the analyst day earlier. around op margin sort of bridge between now and 2023. You're already kind of ahead of the revenue op margin targets you gave in that model, both in the September quarter and in the December guide. And it sounds like December op ex is unusually high for your comments. And in general, that op margin target you gave only assumed incremental op margins at the low end of your historical guidance. I'd hate to obsolete that. the model less than a quarter out. But can you talk a little bit about whether or not, you know, you think there's upside or conservatism to that model you gave at the analyst end?

Yeah, John, it's a good question. I mean, I think one of the challenges in putting together the model is it reflects a different mix of business that we have today, but also expected moving forward. So clearly in the September quarter and even in December, what's driving our business in terms of incremental growth is the process control part of the business. And that is behaving, you know, consistent with the historical model that we've had out there. So anytime the mix is shifting in that direction, you're going to see outperformance against the base model. So what we tried to reflect was based on our expectations for growth over time, what the mix of business would do and how that would impact the model. Obviously, there's synergy and other actions that are that are embedded in that. But anytime we have an inflection driven by the process control part of the business, we're going to see a period of outperformance. But in terms of your long-term view, I think it's the right way to think about it.

Perfect.

Thanks, guys. Congratulations again. Thank you, John.

Thank you. The next question is from CJ News from Evercore. Your line is open.

Thank you for taking the question. I guess first question on the FoundryLogix side of things. Can you speak to whether you're seeing increasing breadth of spending in that category and really focus on the leading edge? And as part of that, if you could speak to also reuse. That clearly was a headwind, you know, basically from 20 nanometer down, but it sounds like it's seven non-EUV progressing to five EUV, but that's a seismic shift here. but is driving a real uptick in process control intensity. What would be your thoughts on both of those things?

Yeah, CJ, I'll take the question, and then Bran will add some color to it as well. It's not very broad right now. I think that the Foundry logic is – it's not particularly broad. We expect it to broaden out next year in 20 as it expands. In terms of reuse, there – a couple of dynamics that are quite different from the prior cycles. One is the just very large number of starts, design starts. So there's a lot of demand being driven by the fact that there's so many different devices that are being introduced at these advanced nodes. So we don't suspect that there'll be that much. The other thing is we have new product cycle, which are really adding a lot of capability. So obviously customers are always trying to optimize their capital and we'll see them be as efficient as possible, but we don't expect a repeat in the way we've seen in some of the prior cycles. And that's based on our early returns and also some of the additional challenges the advanced nodes are pushing, even without broad EUV. And once you broaden out EUV, you get even more of that.

Yeah, I think the big difference between this node and, let's say, 20 nanometer, even down to 1416, as we're seeing, much broader end market adoption that's driving these design starts through the advanced foundry and the leader there. And so all of that is sort of preventing any reuse as that capacity is deployed to support all that activity. And a high-mix environment puts more pressure on yield and delivering to tight product windows. So it's a good story, and we expect this node to have some legs and certainly – the investment for N5 is starting to pick up and strong expectations for that.

Very helpful. If I could sneak in a quick second question. You talked about a return to 370, 375 optics in March, and I'm just curious, how should we think about potential synergies related to Orbitech as we move through 2020?

Yeah, CJ, you know, I outlined it at Investor Days, the number of activities that are happening, and we'll see those play through as we move through the year. One of the dynamics that I wanted to put a little bit of extra time into in the prepared remarks was some of the investments that we're making to drive longer-term structural cost reduction, namely relocating some operations from subscalar higher-cost regions into lower-cost parts of our global footprint. So as you're ramping up one team and ultimately ramp down another team, there's some incremental investment, but those have returns over time. So as I think about that range, I think we're in that range as we move in. You know, based on how we're sizing the business right now and thinking about top line, we'll be operating in that range as we move through the year with, you know, the usual program development expenses that could cause you to move one direction or the other. I would think it would probably be lower end or slightly below the range as we move towards the end of the year, the beginning of the year. It's probably at the higher end. Great.

Thank you. Thank you. The next question is from Krish Sankar from Cohen & Co. Your line is open.

Yeah, hi. Thanks for taking my question. I just had a quick one, Rick. You know, you kind of spoke about how GenPy is going to double in 2020. Is it primarily coming from boundary 5 nanometres? or is there a significant chunk coming from DRAM adoption too?

So, Chris, the comments were that we saw a doubling in 19 from 18, although to Rick's earlier point about Gen 5, I mean, we're really encouraged by starting to see that deployed into production use cases and away from just defect discovery and R&D applications. And then the print check, as that rolls in in terms of – year in Gen 5. But we haven't quantified, you know, how much more. I mean, we are shipping both generations to support activity, both for 7-animeter and for 5, but you'll see more adoption of Gen 5 in production at N5.

Yeah, and just to add to Brent's point, what happened in 19 also was penetration across almost every customer, major customer, in terms of the early evaluation and use, so that sets up the case for the longer run of but that was really a proliferation year for 19 where we got it out and established in all the leading firms.

Yeah, I mean, certainly, Chris, just one other thing. As I look at the order profile, it would imply, you know, we're going to have growth in the number of units as we move into next year. I don't know if it will double, but we'll certainly see growth in adoption next year.

Got it. Thanks, Rick. Thanks, Bill.

Thank you. The next question is from Harlan Sur from JP Morgan. Your line is open.

Good afternoon, guys. Great job on the quoted execution and strong free cash flow. On easy little adoption in your mass inspection business, you know, from analyst day, I think you could gather that your vertical inspection franchise is going to grow pretty strongly this year, up about 40%, 45%. But if I look at the shipment profile for ASML, let's say, over the next couple of years, it's still a runway for very strong growth around, you know, 25%, 30% shipment figure. With that in mind, how should we think about the trajectory of your mass inspection business looking into next year?

Yeah, I mean, I think, Harlan, you're right. We've had a very good year and a down WFE year in reticle inspection, and that's been adoption for the Tehran platform, both for optical and EUV, inspection support. Some of the drivers moving forward is, yes, the number of scanners, but also design starts tends to drive reticle inspection demand. So we would expect to see, you know, some incremental demand on the seven nanometer side as we see incremental capacity there. And then you'll start to see, you know, some activity as we move into next year. As we talked about at Analyst Day, we do have a new platform that's specific for EUV inspection that will start shipping in 2020 also. So you'll see a mix and match. But as we stand today, I think given what's out there for 7 nanometer and then for the layers that will be happening in EUV, we believe we've got the market pretty well served with the capabilities that we're offering.

Yeah, makes a lot of sense. And then on the specialty semiconductor segment, you can draw pretty good quarterly results despite even the trade headwinds. And so, again, if I look at the trends heading into next year, you've got a big step up in RF content, in 5G smartphones and infrastructure. You've got more power products in auto and industrial. And, of course, all this advanced packaging and things like system and package. All of this should provide performance. a pretty good backdrop for growth next year, but wanted to get your initial views in terms of how you're thinking about 2020 for SPTS.

Right. Well, obviously we're newer to that business, but as we spend more time with the team and spend more time with customers, it is well-positioned to grow. And as you pointed out, we had some headwinds that happened in 19, but still managed to get some traction. 20 looks like a good year for SPTS, and our current modeling of it based on what we see for the, as you say, for RF supporting 5G, it looks like hopefully a 10% to 20% range of growth for that business as we go into next year. So we feel good about it, and we're continuing to learn more about those customers.

Great. Thank you very much.

Thank you, Arlan. Thank you. The next question is from Timothy Archery from UBS. Your line is open. Thank you.

Thanks a lot. Rick, so if I look at your WFE share this year, you're going to gain about 50 bps of WFE share. But I think a lot of people are looking at 5B CapEx and they're sort of worried that this is a near-term peak, at least here in the back half of the year. And if you look at the capital intensity numbers, like we haven't seen these kind of quarterly numbers only really once in the past 20 years from kind of a quarterly capital intensity, you know, point of view for non-memory. So, you know, also people are looking at, you know, TSMC CapEx and it's kind of $5 billion in Q4, and that's kind of a, you know, $20 billion run rate. So how do you respond to concerns that this is sort of a near-term peak in, you know, final view logic shipments? Is that not what you see? Do you see the, you know, quarterly shipment rates continuing to grow in final view logic next year? Thanks.

Sure, Tim. Well, it is true that we have strength, as we mentioned, half-on-half considerable strength, but really not in a lot of customers. There are other customers that will broaden out. in next year, and so we feel pretty good about how we're positioned. We think that the actual mix between Foundry and Logic and memory for this year is about equivalent to what we see for next year, and that's driving some of the capacity or the intensity that we're seeing. So we feel pretty good about next year. Obviously, we had a good second half of this year, but we're counting on some broadening, and again, some of what we're seeing this year is ordering that will actually have deliveries in next year, so we'll see some of the benefits of that revenue next year. Brad, you want to add anything to that?

No, I think Rick covered it. I mean, look, if you think most of the investment we've seen this year has been from the leader. And so the broadening out across, you know, a pretty diversified in-demand environment into next year, we feel comfortable with given the comments we made and the prepared remarks that we see some sustainability and foundry and logic as we move into 2020.

Okay, thanks. And then I guess I had a question on Orbitek. If you look at systems revenue, it was pretty flat. It looked like display was still pretty weak. What's assumed for December brand for Orbitek shipments? And what's the outlook for the flat panel display and the PCB business? I guess the real question is, why is the flat panel business still interesting to you? Because it seems like it's kind of on its lows and and it would be arguably accretive if you sold it because it has much, much lower margins. So can you just kind of talk through all that? Thanks.

Well, so we didn't guide the individual segments. I mean, I will say that it looks like we'll have an uptick sequentially in FPD next quarter in terms of overall planning. That does tend to be lumpy, but based on the order profile we saw in the June quarter and lead times there, those deliveries happen in December. And that business is a build-to-order business, so well. So, I would expect it to uptick. I think as we think about, you know, next year, I don't think we'll see any real recovery in the flat panel business. And I think that, you know, after six years of growth, we saw 2020 or 2019 was a difficult year. I don't think it's going to grow much in 2020 either. So, we're focused on the business. I mean, I hear your points and we're, you know, some of the actions we're taking that I refer to in terms of, you of structural cost reduction actions are particular to that business. And so the first thing we're going to do is get that business in a place that we believe is an acceptable level of profitability at these trough levels and position that we can, as the business recovers, that we can scale it and drive operating leverage through that model. But we're taking these actions first. I hear your point, and we'll see how it plays out over time.

Thanks, Brenton. Thank you. The next question is from Vivek Arya from Bank of America, Merrill Lynch. Your line is open.

Thanks for taking my questions and congratulations on the strong growth. I have two questions as well. For the first one, I'm curious, what is the right way to think about process control intensity in EUV versus non-EUV systems? I imagine EUV was not as big of a factor this year. Do you think it's a bigger factor this year?

Yes. Process control intensity for EUV is higher than it is for non-EUV, in spite of the fact that there are fewer layers. I mean, obviously, the value of EUV is a reduction in layers, and so we would see that that has some mitigating effect on the increased intensity around EUV, but you really get process control intensity in a couple ways. One, you get it in the mass shot because you have to do more inspection to assure that you have a high-quality mask, and We're still, as an industry, trying to work out some of the challenges, pellicle, non-pellicle, and getting masks to be good in the lifetime of the mask. The other thing is in print check to verify and validate that Brent mentioned in an earlier question, we see that as an opportunity, and that's been driving process control intensity around Gen 5. So overall, it's a plus for some of our businesses. It is a minus for some, but the net-net of it all is process control intensity ticks up and in the EUV world as the industry goes forward. And on balance, it's a net positive for KLA.

And for my follow-up, how large was domestic China spent for you this year? And just conceptually, how are you thinking about it going into next year?

Yeah, that's a good question. Actually, as I said in the remarks, I mean, at the beginning of the year, we thought it would be down, you know, 10% to 15% from KLA. a very solid number in 2018, and it turned out with some projects that came back into the year, one major one in particular, we're going to end up about flat. And as I look at our preliminary scoping into 2020, and you do have some mix on what kind of projects are going to be invested in, but it looks relatively flat to me again, so I don't see it changing much as we move into 2020. So it's in the you know, $650 million range, plus or minus, in terms of revenue level for the company. And I would expect that to stay relatively consistent based on what I see today for 2020.

So that is not part of the outperformance assumption, perhaps?

No, I think, look, I don't think it's going to fall off. I mean, certainly it improved, you know, the performance with a factor in performance improvement in 2019. So as I think about next year, no, I'm not banking on a lot of extra business in China to deliver the year in terms of how we're planning. I expect a flattish environment in native China.

Thank you. Thank you. The next question is from Quinn Bolton from Needham & Company. Your line is open.

Hey, guys. Thanks for taking my question. I just wanted to follow up on the question from Vivek about EUV driving higher process intensity. I assume that that's true in the memory side of the business as well. So as we look at EUV insertion in 1Z and then 1 alpha processes, do you see a meaningfully higher process control intensity in those steps as we see EUV coming into high-volume manufacturing? And then I've got a quick follow-up.

Yeah, I mean, it's early for memory. As you know, they're still trying to figure out what role UV will play and how many layers. But that is definitely a driver for us in a positive sense, again, for the same reasons you have the mash-up and you have on the wafer and you have a reduction in layers counterbalancing it. I don't think it's a huge change in the intensity. It's a nudge up, but it's not a big change in the overall intensity, maybe on the order of If you're going to be at an average of, say, 10% process control intensity, you might get half a point to a point of increase in terms of overall process control intensity on that. So it depends, but it will depend how much it's deployed, and ultimately it will also depend on what the strategy is relative to what people are going to do with pellicles or not have pellicles. It will change a little bit how it plays out for us.

Okay, great. And then the follow-up question was just it sounds like you're getting a little bit more optimistic in the memory side of the business, and that might be somewhat driven by the indigenous Chinese guys. But just wondering if you could comment based on sort of orders for the surf scan business. Are you starting to see better activity in the NAND business, or is it fairly isolated to certain customers at this point? You wouldn't call it kind of the beginning of a broader-based recovery.

No, I wouldn't call it that. I mean, certainly, you know, that business inflected pretty strongly through calendar 18, and so it's been down this year. And, you know, I would expect to see a little bit of recovery in the way for part of that, which ultimately supports memory in 2020. But, you know, right now I think it's too early to see that impact. So I wouldn't say I see that as a leading indicator of new business, but – And certainly, you know, given the market position of that product and how memory drives wafers, if you do see a pickup in memory, we will see that business impacted. Thank you.

Thank you. The next question is from Joe from Wells Fargo. Your line is open.

Yeah, thanks for taking the question, and congrats on the results. As it relates to your service business, I was wondering if you could give us an update, on some of the capacity idling that you've seen, particularly around the memory side in your install base, and maybe how do we think about that relative to your gross margin guide for the December quarter?

Yeah, no, it's a good question. I mean, one of the things that we are seeing that drove an uptick in the revenue level for service quarter to quarter was a reduction in idling, so more of that capacity being utilized, and so that drove some incremental revenue to side of the business. So, you know, look, you do have a gross margin impact to growth and service on the overall model, which is contemplated in the guidance that we give generally. And the thing to keep in mind is that with our service business as it grows, the profitability stream, we believe, is an accretive stream to the overall total. So it's not affecting, I think, quarter to quarter. It has very little effect on the overall overall on the overall gross margin in terms of the guidance. So it's really, when I think about guidance quarter to quarter, it's mostly around some of the product dynamics and how that plays through our model.

Okay, that's helpful. And then on the specialty semi side, now I think you're calling for flat this year. Can you help us understand, was there any incremental impact indirectly from Huawei or is this more related to weakness that you're seeing in just general demand?

Yeah, I wouldn't say it's an incremental effect that we talked about last quarter. So we continue to see that, and we talked about, if I recall, $40-ish million impact for the year related to that one in particular. There are broader trade issues. Certainly there's the issue with Korea and Japan and how that's affecting Korean OSAPs. So, there are a number of trade issues beyond Huawei that's affecting that business. Now, in the long run, as those customers in that area or the end customer, the customer's customer starts to redesign around some of these issues, it creates opportunities for us. So, but in this year, it's affecting that business. Also, automotive has been on the margin a little bit, so that's affected that business as well. So, You know, it's still showing, I think, a decent result this year against the backdrop of the WFE environment we're in and would expect to see it recover next year in terms of growth, as Rick suggested earlier. But, you know, so it's a business that has a really good market position. I think the long-term drivers around 5G, advanced packaging power, and so on are good ones. And so we're encouraged by what we see, and we like the business model of that business.

Yeah, and more specifically, I think, on Huawei, if you thought about the reaction to the suppliers to Huawei – was there was uncertainty when the BAM first came and trying to figure out and I think everybody froze so the baseball analogy would be there was a rain delay in terms of trying to figure out what the next step was and now there is more activity going on in the supply chain so we think that business ultimately comes back but it was impacted probably more and longer in the year because just uncertainty around that. Now I think people are dealing with it and that will actually caused the business to resume its growth. Thank you.

Thank you. The next question is from Patrick Ho from Stifle. Your line is open.

Thank you very much. Rick, maybe first off, in the past you've talked about increasing metrology intensity on the manned flash side of things, particularly as layers increase. As the industry starts shifting to 128 layers, Do you see any potential new opportunities on the inspection side, you know, given the complexity of the layers and the increased number of layers for next-generation devices?

I think the main opportunity – that's a good question, Patrick. The main opportunity for inspection is really in what's happening on the bare wafer on surf scan and dealing with the flatness requirements as the wafers get higher, both the cleanliness and flatness. So it may be less obvious at first. I mean, we've talked in the past about being hopeful about finding defects in deep trenches, but it's probably more flatness-driven and desire to have clean wafers. So that's really been where we see it. Metrology has some opportunities we talked about at the analyst day with the work we have on CD Sachs in terms of great opportunity there. But specifically for inspection, it's more about surf scan.

Great. As my follow-up question in terms of the domestic China opportunity question, Obviously, we're seeing some of these capacity builds begin, and you're benefiting from new capacity build-outs. But given some of it is also trailing-edge logic type of capacity builds, is it simply because they're new capacity, or are there opportunities within, I guess, the foundry logic segment of that region that you see new opportunities, you know, both for your inspection and metrology products?

Yeah, I think that the – There are a number of players that are small, maybe subscale in terms of what you think of as the larger. So there's actually some inefficiency in that supply chain if you're starting smaller companies in terms of trying to support for a strategic reason. So that kind of creates additional demand for us, and we're benefiting from that. Also, I think that as they're trying to figure out some of these capabilities, then there's opportunity for us to help them, and that drives both good share but also good intensity there. And then lastly, I think the move for auto, as China is an important auto market, there are more specialties having conductors, and there's more opportunity for us there as a result.

Yeah, Patrick, I mean, look, I think this year is a heavier memory year in China. Not by much. I'd say probably of our mix of semiconductor business, it's, you know, 55, 45 to memory. I look at calendar 20, and it's pretty balanced. So to your point, there's a lot of activity around IoT. Rick talked about automotive. And so the yield learning challenges in Logic are more complicated. The tools that we are shipping are configurable in terms of helping customers meet their requirements, also providing some upgrade paths as they start to progress some of their technology. And they're serving, you know, I think real markets ultimately. And so I think, you know, that they're designing for specific opportunities, which is good just in terms of the long-term trajectory of that investment and their viability. So we feel pretty good about all of it. And I think it's a mix across both segments there.

Great. Thank you.

Thank you. Your final question is from Tashi Harvey. from Goldman Sachs here on this webinar.

Hi, guys. Thanks so much for taking the question and congrats on the very strong results. I just wanted to go back to the half over half kind of cadence for your business going into next year. You know, you guys accurately called your core process control business being up, I guess, every quarter on a sequential basis this year a couple of quarters ago. So I guess the question is based on you know, customer projects based on customer conversations. What are your thoughts into the first half of 2020 relative to the second half of 19? Do you think you can grow your business, or should we be expecting more of a flattish outlook on a half-over-half basis? Thank you.

Well, like I said, I think we're a little early to guide second half or half-to-half trajectories, and obviously I think that, you know, part of how we do in the fourth quarter will impact, you know, how the March quarter lines up. I mean, across the segments, again, as we said earlier, we feel that there's broadening and sustainability investment in Logic and Foundry. I mean, if you just take a step back and look at the second half, up 20-ish percent over the first half, it does, you know, obviously imply, you know, that WFE is higher in the second half versus first half, so the run rate of this WFE is probably, you know, 10 to 15 percent kind of growth into next year at these levels. So, You know, it does imply, you know, that you've got a second half. You'd have to have that kind of growth to sort of sustain at this level of business. But I think that's probably as far as I can go at this point.

Yeah, I guess what I would add to that is we feel pretty good about understanding our position relative to WFE. We're not in a great position to predict WFE.

Got it. Yes, it does. As a quick follow-up – On China, on native China WFE, I think, Brent, you talked about 2020, at least at this point, kind of looking kind of flattish relative to 2019. When you think about the mix of spend on process control, could that move higher, or what are your preliminary thoughts on that? Thank you.

Yeah, no, as I said earlier, I think it's balanced across the business that we expect, and we expect a flattish level of business in 2019. in 2020. So not expecting, at least for our business, not expecting growth, but not expecting decline in 2020 at this point. And we'll see how it plays out. But that's at least where we stand today.

Thanks so much.

Thank you. And that concludes the Q&A session. I was going to call over back to Mr. Kessel for closing remarks.

Yeah, thank you, Christian. And thank you, everyone, for your time today and interest in KLA. Christian, please conclude the call.

Ladies and gentlemen, that concludes today's conference call. Thank you for participating and you may now disconnect. Have a good day, everyone.