KLA-Tencor Corporation (NASDAQ:KLAC)
Q2 2017 Earnings Conference Call
January 26, 2017 17:00 AM ET
Ed Lockwood - IR
Rick Wallace - President & CEO
Bren Higgins - EVP & CFO
Timothy Arcuri - Cowen & Co
Farhan Ahmad - Credit Suisse
Harlan Sur - JP Morgan
Edwin Mok - Needham & Co
Steven Chin - UBS
Patrick Ho - Stifel
Atif Malik - Citi
Mehdi Hosseini - Susquehanna
Good afternoon. My name is Mariana, and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter Fiscal Year 2017 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.
I would now like to turn the call over to Mr. Ed Lockwood. You may begin your conference.
Thank you, Mariana. 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 to discuss second quarter results for the period ended December 31, 2016. We released these results this afternoon at 1:15 PM Pacific Time. If you haven't seen the release, you can find it on our website at www.klatencor.com. A final cast of this call will be accessible on-demand following its completion on the Investor Relations section of our website.
Today's discussion of our financial results will be presented in 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 at KLA-Tencor's IR website. There you will also find a calendar of future investor events, presentations and conferences, as well as links to KLA-Tencor's SEC filings, including our Annual Report on Form 10-K for the year ended June 30, 2016. In those filings you'll find descriptions of risk factors that could impact our future results.
As you know, our future results are subject to risks; any forward-looking statements, including those we make on this call today are subject to those risks, and KLA-Tencor cannot guarantee those forward-looking statements will come true. Our actual results may differ significantly from those projected in our forward-looking statements.
With that, I'll turn the call over to Rick.
Good afternoon, everyone. Today, I am pleased to announce the KLA-Tencor's business continues to perform at a very high level. And we delivered another outstanding result in the December quarter, exceeding our guidance for shipments revenue and non-GAAP diluted earnings per share for the period. In addition, new orders topped $1 billion for the first time in Q2, reflecting KLA-Tencor's market leadership and the critical process control plays and enabling our customers' success at the leading edge, and in legacy notes.
For the full year in calendar 2016 KLA-Tencor grew revenue 14% compared to mid-to high-single digit growth for the wafer fabrication industry. Our example rate performance both in the December quarter and for the full year in 2016, as a result of KLA-Tencor's market leadership and coupled with our record backlog of over $1.6 billion sets the stage for another year of strong top line and earnings growth for the Company in calendar 2017.
As our record order and backlog numbers demonstrate, KLA-Tencor is experiencing unprecedented levels of demand in our end markets, particularly in foundry and memory. Memory was notable strong in the December quarter driven by both DRAM and 3D NAND investments in Korea where we are experiencing higher adoption of bear wafer inspection along within thin turn and critical dimension measurement solutions, as a result of more firms paying deposited in vertical memory.
KLA-Tencor's growth and market leadership is fueled by the successful execution of a product strategy that is focused on differentiation and intersecting market needs with the portfolio of complimentary solutions. This ongoing investment innovation and technology leadership help to drive these strong results in 2016, and as a critical component for our long-term growth strategies.
For example KLA-Tencor's two latest broadband plasma optical inspection platforms Gen 4 and Gen 5, together address the most challenging defect detection issues for development and capacity monitoring application of current and next generation devices in the marketplace today. We are now on our fourth major product upgrade for the Gen 4 optical inspection platform with multiple tools placed in every advanced production fab in the marketplace
And one of the key highlights of the year in 2016 was the successful launch of Gen 5, our new flagship broadband plasma inspection platform. Gen 5 is being deployed by customers to address early yield learning and engineering analysis applications for advanced optical lithography design rules and for EUV development. Calendar 2016 was a record year for the broadband plasma product family, and we see momentum continuing through 2017. In addition to the supplying wafer inspections capability for EUV layers, KLA-Tencor is also playing a critical role in radical inspection for EUV.
Our customers are relying on assets interested partner to enable success of the important technology transition to EUV, a move that will allow for lateral scaling and more economical device roadmaps at the leading edge. The new challenges and inherent to EUVs specific process control applications such as mask inspection, radical requalification and scanner control just to name the few present new market opportunities that we believe KLA-Tencor is uniquely positioned to address. Given our market and leadership in technology, EUV promises to be a positive catalyst for growth that the advanced process control market and for KLA-Tencor.
So to summarize KLA-Tencor's December quarter and calendar 2016 results demonstrates are strategies are working and the Company is operating from the position of strength as we've entered into another year of expected strong growth and earnings generation, given the business model that consistently delivers superior operating leverage, ranking KLA-Tencor's among the top tier of leading semiconductor companies, and with our strong leadership position in each of the most critical process control markets.
The stage is set to build on the momentum of calendar 2016 and deliver what we plan to be another exciting year in 2017. We believe KLA-Tencor's is well positioned to successfully execute our strategies and meet or exceed our long-term revenue growth objective of 5% to 7% in 2017 and what is expected to be another year of solid growth for the wafer fab equipment market.
Now turning to the guidance for the March quarter, Q3 shipments are expected to be in the range of $850 million to $930 million. Revenue for the quarter expected to be in the range of $860 million to $920 million, with non-GAAP diluted earnings in the range of $1.42 per share to $1.62 per share.
I will now turn the call over to Bren Higgins for his comments. Bren?
Thanks, Rick. Good afternoon everyone. As Rick highlighted in his opening remarks, the December quarter represented another outstanding period of financial performance and operational execution for KLA-Tencor. Shipments, revenue and non-GAAP diluted earnings per share each finished above the range of guidance in the quarter. This result was driven by strong demand across our product portfolio with particular strength in our flagship wafer and mass inspection product lines as well as solid execution and cost management in our manufacturing and service operations.
Revenue was 877 million in the December quarter, non-GAAP diluted earnings per share was a $1.52, and would have been a $1.57 per share at the 21% guided tax rate, GAAP earnings per share was also $1.52. In our press release, you will find a reconciliation of GAAP to non-GAAP diluted earnings per share. With the exception of when I explicitly refer to GAAP results, my commentary will be focused on the non-GAAP results which exclude the adjustments covered in the press release.
Now turning to the highlights of the December quarter demand environment, although we're no longer guiding quarterly orders we'll continue to share our perspective on the quarterly -- current quarterly end market demand picture to give investors insight into industry trends and KLA-Tencor's performance. We eventually plan to provide end market mix detail for shipments results and guidance and expect to have that information available once we complete an upgrade of our internal analysis systems sometime in the Company few quarters.
At that time our end market customer mix, business segment and regional breakdowns will be provided on the shipment basis. In the interim, we'll continue to provide additional detail on order mix by end market. New orders in the December quarter were approximately $1.1 billion. Memory was 61% in the orders and in line with our forecast for the quarter. Demand was roughly evenly split between DRAM and NAND. We're currently modeling memory orders to be 34% of the total in the March quarter.
Foundry was 37% in new system orders in December also as expected, and Foundry is forecasted to grow to 63% of orders in March. We're currently modeling solid growth in Foundry orders in the first half of calendar '17 fueled by 10-nanometer production and 7-nanometer development from multiple foundry customers, and by continued investment in legacy technology nodes. Logic was 2% in new system orders and is currently forecasted to be at a comparable level in the March quarter.
In terms of the approximate distribution of orders by product group for the fourth quarter, wafer inspection was 45% to new system orders, patterning was 35%. Patterning includes orders from our radical inspection business. Service was 18%, and non-semi was approximately 2%. New orders in the first half of calendar year 2017 are expected to be roughly flat compared with the second half of calendar '16.
Total shipments were 887 million in the quarter and just above the guided range for the quarter of 800 million to 880 million. Looking forward we're modeling March quarter shipments to be approximately flat at the mid-point compared with December and be in the range 850 million to 930 million. Our current build plans are supporting quarterly shipment levels at around 900 million for the next few quarters.
Turning now to income statement, as I mentioned in my highlights, revenue was 877 million in December, finishing above the range of guidance. We expect revenue to be in the range of $860 million to $920 million in the March quarter. Non-GAAP gross margin was 63.8% and a new quarterly record for the Company.
The better than model gross margin performance in December is largely a function of strong product mix on the incremental revenue delivered in the quarter and operating leverage in our manufacturing and service operations. We expect gross margin to be in the range of 62% to 63% in the March quarter, down slightly versus the December quarter due principally to the mix of products we plan to revenue in the quarter.
Going forward we expect to deliver gross margin results of couple of hundred basis points above our published business model target due to a number of factors including product positioning, new product introduction execution and cost management. We are currently forecasting gross margin in calendar '17 to be approximately 62% plus or minus 50 basis points.
Total non-GAAP operating expenses were $221 million, flat compared with September and non-GAAP operating margin was 38.6%. We are modeling operating expense levels of between $220 million and $225 million in the March quarter and in the range of $900 million and $920 million for the full year in calendar '17. Given our gross margin expectations, we continue to deliver operating margins at the upper end or above our published model for foreseeable future.
Our non-GAAP effective tax rate was 23.5% in the quarter, above our previously guided long-term planning rate of 21% reflecting the higher mix of revenue from products manufacturing in the U.S. and other discrete items impacting the tax rate. We are planning to this product mix trend to continue through calendar '17, which will put some pressure on the tax rate. We assume a 22% tax rate going forward for modeling purposes. Finally, net income for the December quarter was 238 million and in the end of the quarter was 157 million fully dilutes shares outstanding.
I'll turn now the highlights on the balance sheet and cash flow statement. Cash and investment end of the quarter 2.6 billion, an increase of approximately 100 million compared with the September quarter. Cash from operations was 222 million in the quarter. And free cash flow with 214 million. In December, we paid in aggregate of 85 million in regular quarterly dividends and dividend equivalents for fully vested restricted stock units, and made a supplemental payment of 40 million towards our outstanding term loans.
To date, the total amount of payments of principally on our term loan has amounted to approximately $254 million since it was added in the December quarter 2014. In conclusion, KLA-Tencor result in December reflect our market leadership the critical nature of process control and our customers gross strategies at the leading edge and in legacy designed rules and our industry leading business model. This coupled with almost 1.1 billion in new orders in the December quarter positioned the Company for strong relative growth versus the wafer fab equipment market in calendar year '17.
Current forecast for the wafer fab equipment market to grow mid-single digit in 2017. Against this industry backdrop, we are modeling the Company's revenue to grow slightly better than the broader market. This performance demonstrates the Company's market leadership, the strong customer acceptance of portfolio solutions addressing the most critical yield requirement to leading edge and our operational core confidences.
Given our record backlog and expectations for new orders, KLA-Tencor is well positioned for another year of solid growth in 2017. With that to reiterate our guidance for the March quarter is shipments in the range of 850 million to 930 million, revenue between $860 million and $920 million, and non-GAAP diluted EPS of $1.42 to $1.62 per share with GAAP EPS of $1.40 to $1.60 per share.
This concludes our remarks on the quarter. I will now turn the call back to Ed to begin the Q&A.
Okay, thank you Bren. At this point, we'd like to open the call up for questions, and we once again request that you limit yourself to one question and one follow-up given the limited time we have for today's call. Feel free to re-queue for your follow-up questions and we'll do our best to give everyone a chance to participate in today's call as time.
All right, Mariana, we are ready for the first question.
[Operator Instructions] Your first question comes from a line of Timothy Arcuri of Cowen & Co. Your line is open.
Rick, I wanted to get a sense of obviously memory orders were really, really strong at quarter. You guys have talked about that being the case. Is that more cyclical? Or is there something secular going on? And I guess I'm particularly asking about 3D NAND because seems like you guys maybe preparing a new solution that's going to help to improve yields there. So, I'm sort of wondering maybe what your outlook generally is for how your exposures are going to grow in memory? Thanks.
Thanks, Tim. Yes, we have some success recently with 3D NAND. I think both in terms of existing products, which we're finding more application as our customers. First, the technology is being more broadly deployed by our customer base. And the second is some of the yield challenges they are facing. We think leader in the calendar year will actually have more offerings to support 3D NAND. So, we think, if we execute properly by the end of '17, we should have a larger adoption of inspection to 3D NAND. So, we think that there is upside to our current levels of concentration now.
And I guess, Bren, question for you. Everybody else likes to put up their financial models and link their revenue to wafer fab equipment. I know it's a little harder for you because it depends on the mix. But if WFE is going to be 37 billion, yesterday, we haven't talked about that. Can you talk a little bit -- can you try to math for us WFE or your revenue relative to WFE? It seems like if you don’t take any share at all, it seems like you could do 3.7 billion pretty easily at 37 billion environment. So, I'm just wondering if you can math revenue your model to WFE? Thanks.
Yes, Tim it's a good question. I mean as we look at calendar 2017, we think WFE is probably up somewhere in the mid-single digits. When we do our math, we end-up somewhere around 36 billion. And so against that backdrop, as I said in the prepared remarks, we think that we should do better than the broader market, so somewhere in the high single digit growth rate versus calendar 2016. So we feel pretty good about that. I also said in the prepared remarks that over the next few quarters, we expect it will be shipping consistently in an around 900 million.
I think as we get further out into the second half of the year through December, I think I've got pretty visibility to my bill plans through September. And as we get to the December, we will see how the second half order book ultimately feels out, but I think we are going to position for a good year and I think depending on how the second half plays out particularly around December. The numbers that you are mentioning aren’t inconceivable to see, if that were to play out that way. But I think as the down, as I said we based on a mid single digit type growth rate, we think will do -- we should do better than the broader industry for the second consecutive year.
Your next question comes from Farhan Ahmad of Credit Suisse. Your line is open.
My first question is on EUV. Rick, you've mentioned that you're seeing a good activity for Gen 5 being deployed both for OPC and EUV development. Can you talk about what progress you're seeing there? And how far along do you think you're in the qualification process? And is that something that can materialize in 2018 in meaningful way?
EUV, we've had some momentum based on the fact that there's more activity going on in development and in multiple places, multiple sides for our customers, and also the fact that Gen 5 is now out and being deployed especially in the area of qualifying the images that are been printed by EUV lithography. I also mentioned that in mask, we have some success with the 6XX platform that we've serving the EUV mask qualification market, and we think that as the activity continues to pick up on EUV that that part of our business should grow over the next couple of years.
With the expectations of high volume manufacturing of EUV by 2019 or 2020, we'll continue to see ramping of those capabilities, and we'll move from characterization to be more part of the production flow as we get out into those out years. And we should see adoption of things like Gen 5 especially in the back end of the line supporting the ramps, middle end and back end of the line supporting ramps as EUV comes into production.
And then one question on the 3D NAND that you've mentioned for back half of the year, could you give us some sense of how big is the growth opportunity for you in 3D NAND, maybe just in terms of like what portion of the market do you address currently? And what sort of opportunity the new products can bring?
Well, Farhan, I think you know we've talked about essentially memory being at about half the adoption rate of foundry in terms of process control adoption; however, it tends to grow faster in many respects for two reasons. One, it looks like there's more capability certainly that we can bring to solve some existing problems that people are not using process control to solve right now, and that I think we can grow that adoption.
So, we think that the adoption and or the process control intensity grows in 3D NAND depending on how much ongoing investment there is that sets that market size. But we think it can contribute to our overall outperformance of the industry. 3D NAND recently process control intensity has kind of mapped to what 2D plainer was, as some of the complexity of the process is being understood by our customers. So for us there's not really big difference in process control intensity for plainer versus 3D NAND, as 3D NAND is actually picking up for us as we go forward.
Your next question comes from Harlan Sur of JP Morgan. Your line is open.
On the profitability profile, assuming you guys slightly outgrow the WSE market this year that would imply roughly kind of 3.5 billion in revenues. You guys drove 38% operating margins in December, 38% operating margins imply within your guidance in March. You've given us your sort of views on gross margins for the year and your level of OpEx, which would sort of in play operating margins in that sort of 36% to 37%. Last earnings call, you know of talked me down to a level of 35 percent-ish. But should we expect kind of 36% 37% operating margins on the parameters that you just gave us today? Is that kind of the way where do you think about it?
Harlan, it's Bren. Yes, in the prepared remarks I wanted -- as we head into in a year to give a little bit more perspective on how we are sizing the business. We've been doing obviously a lot of work on our strategic planning, so we've have got a deeper view and understanding of the mix of business going forward around certain products. And of course the backlog at the level that give us pretty good visibility to move to the year. So I wanted to go ahead and provide some of that information. I think the numbers that you are coming up with seem to make sense based on the numbers I provided.
I think in terms of how we are sizing the business I don’t see how that changes very much going forward, significant swings would cause go up and down but in terms of where we are today versus what we expect I don’t think that will change all that much. Gross margin is always a little bit with the business like ours and the mix of products we have depending on the mix of products can have some influence on gross margin both directions. But the ways you are thinking about it I think make sense and given the funnel and where we are loaded today I feel pretty comfortable with the guidance I provided.
You guys had a record year fiscal year '16 from China. It seems like there is more China domestic foundry spending coming online this year. And my question is, is China still a tailwind for KLA this calendar year? And even though these are more legacy type nodes like 20-nanometers, are these guys still tending to buy up to stock and purchasing your latest Gen 4 tools which we obviously know have richer ASPs?
They are investing for not only the nodes they are starting on, but they are also trying to invest to be able to migrate those nodes as they go forward and they expect to continue to migrate their designed ropes down. So the interest the other buying, they are not buying Gen 5, but they are buying we are seeing Gen 4 purchases. And also I think for the metrology challenge is that they feel like they are going to face, we're having pretty good penetration there. So, we feel good about China as it goes forward, it feels pretty sustainable based on the conversations we are having with customers and the successfully had to-date there.
The second half of '16 was a little bit slow on China so that wasn’t digesting but as we look at calendar '17 from an order perspective I think China indigenous China our native China business will be up pretty significantly from what we experienced in '16. To reach point across a number nodes and very foundry logic centric, don’t expect to see much memory investment in '17 I think that’s more of 18 of them. But we think China is one of these factors why we think that at least for as we look at foundry business into '17 that we have got enough profile from not just the diversity of other customers investing to leading edge but what's happening here.
Your next question comes from Edwin Mok of Needham & Co. Your line is open.
So, first question I have is on your mass inspection product. You talk about how the customer around EUV was seeing handful to 66 products. I am curious is there a way for us to think about that, like let's not about how many chose their shipping this year. Is there anything you think about how much capacity customer will need that to take these EUV tools?
Well, historically, there has been a ratio of about EUV. We use to model about 10 scanners for a radical tool. But sometimes I could be frontend loaded when there is, we are doing development work. Part of what's interesting about the scanner is that, lot of scanners during the field the day weren’t really driving much capacity any. Because I don’t think they were really pushing designs very much on the EUV capabilities. We're seeing more advance designs now on EUV, and so I do think that if we go back to that ratio that's not a bad model. Even though, we are not at wavelength with this radical tool, it does seem to be a tracking relatively consistent with that.
Okay, actually that's helpful color there. And then another question I have is, one of your peers yesterday talk a lot for the bigger follow-up in the WFE in the second half of this year. And the associate would just be more frontend loaded spending in NAND. I am just curious, are you guys are seeing the same trend in the industry? Do you expect some top trend for your shipment for this year?
Yes, I think the second half looks maybe marginally weaker from a shipment perspective in the first half, we're talking about a very low single digit percentage today, and so that could change pretty quickly. So, I don’t see it as a pronounce shift and then when I look through the revenue, I think revenue is sort of half-to-half in terms of how we are modeling today with the WFE assumptions I talked about earlier somewhat flattish.
So, I don’t think it's a significant downtick and I have a lot of it also depends on what happens in the second half of the year around some of these other the timing of some of these other investments and I think 7-nanometer development could be wild card for us so it could strengthen into the second half and we just don’t have a lot of visibility into some of that incremental business yet.
Our next question comes from Steven Chin of UBS. Your line is open.
I actually have a question on image sensor customers. We see some higher present sales than in the past. Just wondering, if you're see anything with customers that can give us some sort of outlook on sales image sensor customers?
Image sensors that what's you are asking?
We have had good participation from -- in general, I think about the IoT, automotive markets, image sensors kind of in that category of IoT stuff, that's actually have been pretty good for us often what we see there is. If you think Gen 4, it's more or like in the inspection product line and might be Gen 3 products, supporting that. And but it's relatively episodic, so you get somebody that's investing for a particular capacity demand. So, we can't count on it every year, but it's actually have been pretty good business, when it comes along. And I think we work closely with those customers to support them when they're bringing out new technologies. So that's been a steady part of our business over the last couple of years.
Thank you. And I have one follow-up. Not this only being seen as higher customer demand for 200-mm equipment. Can you talk maybe the mix that 200-mm equipment makes up for your sales? And maybe comment on this type of services revenue that you give 200-mm customer?
Yes, I think that one of the surprises, I'd say for the last several years, is the fact that 200-mm two things have happened. One, those fabs are being extended longer, and so what we are seeing as part of the supporting those customers is our service business grows. And we would have expected in a general transition to be down almost zero in terms of percent 200-mm. And I'd say probably its 5% to 10% of our business and systems now can be approaching 200.
There're also some older fabs on 300, so you kind of look at it more as the lagging technology. But yes, there's some business on the 200-mm that continues to get developed. They're not very big purchasers of capital, but they're often KLA-Tencor tools there, and it's a part of our business. There is upgrading capability and supporting them as they go forward.
[Operator Instructions] Your next question comes from Patrick Ho of Stifel. Your line is open.
Rick, a big picture question the last time you -- when we went through the industry ramp of 28-nanometers, you saw a large buying spree particularly from the leading edge, but one that also continued for several years. As we begin this transition to 10-nanometers and 7-nanometers, what is your perception of that node and could it be as large as the 28-nanometers which would give you guys, not only a near-term boost, but one that that's a little more sustainable?
It's certainly feels that way. I mean when we talk to customers, there're now multiple customers that are playing at 7-nanometers, and really no significant buys for seven right now, I mean there're 10-nanometer buys that are going to be applied to seven later. So, I think we're early days on seven, but it does feel like there'll be a wave of multiple players trying to pursue that node.
So, it's very hard for us to size it in general, but our customers seem very enthusiastic, because it's a node that gives both performance and also economic value to our customers, and there're multiple designs been started on seven. So, we feel pretty good about the extendibility of that node and the support for our business as we go forward.
And maybe, Bren, for you in terms of OpEx going forward, I think in your prepared remarks you talked about some of the new opportunities and some investments particularly as EUV gets more traction with customers out in the field. How do we look at overall R&D spending as it relates to EUV versus what you presented in your long term model?
Well, we're absolutely investing more I mean if you look at the numbers that I provided in the prepared remarks, we do think given the revenue level we have we think the opportunities that are out there, there is an opportunity for us to invest in some of these capabilities, not just in EUV, but Rick talked about 3D NAND earlier and so there's some opportunities there. In terms of EUV, there's some work going on, but as we've said and I'm sure Rick could more to this.
But as we said over the last couple of years or so, that any substantial investments to support EUV at least around the radical side of things, that we would be looking for customer participation disputed the business model dynamics there. But in terms of being able to drive higher level of sensitivity through our product portfolio, to be able to address what should be good opportunities for when you're scaling in again in the new EUV environment, we're continuing to invest as we always have to deliver that capability.
And your next question comes from Atif Malik from Citi. Your line is open.
Rick, if I look at the size of the GPU, the graphic processor, they're about two to five X bigger than eight to ten like an application processor. Are you guys seeing a demand for your tools increase as there is intrinsically lower use on bigger die sizes to the penetration of high performance computing and the gaming?
Great question I think in the early days have some of those designs playing out 10-nanometers. Certainly, the adoption level of process control at 10-nanometers and support of those new GPU is higher as that has been in prior nodes. The question will be what happens when those ramp in terms of does the intensity come back to more historic numbers, and I think that will depend a lot on the customers' actual experience in terms of how they perform and what kind of yield they get.
But your point, in terms of course there is more value and more challenge associated with getting the larger die to yield. So, we wouldn’t be surprised if there was -- there was support. Certainly, there are more applications being applied to try to make sure that those designs work, if that is more work going on with the customers. So, we think there is a good opportunity, but it's still relatively early to know how the story plays out in terms of total adoption. In our planning, just say you understand, in our business that Bren has led out, we are not assuming the adoption goes up, we are assuming that would be upside to our plan.
And then as a follow up you mentioned that you can help to improve the device yields in the 3D NAND. Can you tell us it’s a basic term of what are the issues on 3D NAND leave for customer?
Well, I think the most basic way to think about it is. If you think about the way these structures are built then you are going vertical versus always horizontally shrinking, now you are not shrinking as much, but you are going deeper. There is a lot of ways that those materials will break down under the stress of manufacturing, so you'll get defects that would parkway down or all the way down the stack. And for customers, it's very hard to see those. It's very hard to understand how to improve the process.
So, part of it what happens is they have to go through destructive, that is electrical test or other means of de-processing the wafers to identify the problem. If we can visualize that for them in the fab which is different kind of inspection challenge it allows them to have fast or correct action to get the yields ramped up. So, it's not so much a size of the defect problem it's depth of defect problem and that’s where we have had modified some of our technology to support that because as long as we have been in the industry it's about finding smaller defects not necessarily these very high aspect ratio defects.
Your final question comes from Mehdi Hosseini from Susquehanna. Your line is open.
Good afternoon guys this is Bill Grinstead in for Mehdi. Just quick question on reuse, equipment reuse as one of your customers, customers migrates probably 16-nanometer to 10-nanometer. What kind of impact you guys think that could have? Thanks.
Well, from 16 to 10, virtually no reuse. I mean that was more dynamic we saw from 20 to 16. So, you had new tools sets, you have more complicated patterning challenges. And since that you have a change in lithography and you have a change in the back in the line too. So those are all new tools. Customers always try to optimize their capital and so to the extent they can always reuse tools or any time they can it would try. So we think going forward from 10 to 7 there could potentially be some with we try to model that into how we think about it and so that's model in the and how we'd outline the financial performance for the next few quarters.
But I think if that, I think we feel pretty comfortable that what we experienced at 20 to 16 to 14 will, was a bit unique, and we won't see that going forward. Even from 10 to 7, you've got smaller or you get taller FinFETs, you've got in your new materials in the backend. You've got complicated multi-pattern in techniques, very significant process window challenges. So, we think there is a lot of additive opportunities there and as we introduce new products customers will quickly try to take up that capability and try to improve their costs to. So, I think that the new product cadence helps to insulate from some of that as well, and I think the challenge is going to or they are going to be pretty tough.
There are no further questions at this time. I will turn the call back over to the presenters.
Thank you, Mariana. And on behalf of everyone here, I'd like to thank you all for joining us on the call today. An audio reply of today's call will be available on our website shortly following the call, and we look forward to speaking to you all soon. Thank you.
This concludes today's conference call. You may now disconnect.
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