It’s Priscilla, and I will be your conference operator today. At this time, I would like to welcome everyone to the KLA Corporation March Quarter 2021 Earnings Conference Call and Webcast. All participant lines have been placed in a listen-only mode to prevent any background noise.

After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the call over to Kevin Kessel, Vice President of Investor Relations. Please go ahead..

Thank you, Priscilla, and welcome to KLA's fiscal Q3 2021 quarterly earnings call to discuss the results of our March quarter and the outlook for the June quarter. With me today is Rick Wallace, our Chief Executive Officer; and Bren Higgins, our Chief Financial Officer.

During today's call, we will discuss quarterly results for the period ended March 31, 2021, that we released this afternoon after the market close in the form of a press release, shareholder letter and slide deck. All are available on the KLA IR section of our website.

Today's discussion 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 materials posted on our website. During today's call whenever we make references to a year, we were referring to the calendar year.

Our IR website also contains future investor events as well as presentations, corporate governance information and links to our SEC filings, including the most recent annual report and quarterly reports on Forms 10-K and 10-Q. Our comments today are subject to risks and uncertainties reflected in the risk factors disclosed in our SEC filings.

Any forward-looking statements, including those that 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.

I'd like to now turn the call over to our President and Chief Executive Officer, Rick Wallace.

Rick?.

Thanks, Kevin. And thank you for joining KLA’s earning calls today. KLA’s March quarter results demonstrate continued momentum in our business. We delivered strong 27% year-over-year revenue growth. Non-GAAP gross and operating profit rose 30% and 48% year-over-year, respectively and free cash flow grew 47% to a record level.

We accomplished these by executing our strategic vision amidst the dynamic business environment. Year-to-date, we've seen a sharp increase in business levels across each of our major markets.

This is primarily due to secular demand trends, driving semiconductor industry growth across a broad range of markets and applications such as 5G and cloud computing. Our customers are increasing their strategic CapEx investment to address these growth markets while continuing investment in leading-edge R&D efforts.

Against this backdrop of strong demand, we continue to navigate evolving customer requirements and dynamic supply chain challenges. Still KLA has not missed a beat and continues operating at an exceptionally high level, delivering on our commitments, staying focused on creating value for our partners, customers, and shareholders.

We would be remiss if we did not mention that achieving these results would be impossible without the extraordinary contributions of our talented global teams who always rise to the challenges of meeting our customer's needs in an increasingly complex global business environment. Three key things enabled KLA’s record results in momentum.

One, successful innovation and market leadership, two, the resourcefulness and talent of our global workforce, and three, the strength and resiliency of the KLA operating model. Before we discuss this further, let me begin by touching on how we see the industry demand environment now.

Strong secular demand trends continue to shape multiple markets and are fueled by the increasing digitization of end markets and industries. In addition, there's a heightened focus on the strategic nature of our customers' investments around both leading-edge development, optimizing facility utilization and regionalization.

As a result, our WFE forecast has improved even further from January, reflecting the strength of demand we're experiencing over the past couple of months, with momentum continuing into calendar 2022. In this environment, KLA is experiencing a sharp increase in customer demand for systems and support for 2021 deliveries.

And our expectations for KLA revenue growth have increased from our initial assessment in January. This momentum in customer investment is happening against a backdrop where process control intensity maintains its momentum and KLA continues to drive market leadership at levels approximately 4x the nearest competitor.

Propelled by the upside we are experiencing in the underlying WFE markets, KLA market leadership, increasing long-term process control intensity, our broader reach into electronics ecosystem and the contributions of our large and growing service business. KLA is on track to achieve our 2023 financial targets well ahead of our original expectations.

KLA’s market leadership results from the ongoing successful execution of the company's customer-focused strategy, which is based on investing a high level of R&D to drive differentiation with a unique portfolio of products, technologies, and strategies that address the most critical process control market challenges.

We're pleased to continue to see the success of our efforts being validated by our customers’ purchasing decisions. Here are some recent success stories to illustrate the point.

The most recently published Gartner data shows that in 2020, the total optical inspection market grew at a rate double that of the growth rate of the overall WFE market to approximately $1.9 billion with KLA maintaining our strong market leadership and 83% share of this critical market for process control.

Many already know that KLA is participating in the automotive electronics through our semiconductor packaging and PCP product lines. We're excited by near-term plans to launch new versions of our process control products, tailored to the automotive industry.

This quarter expect to hear more about how KLA has positioned our wafer inspection portfolio to help customers drive higher reliability, quality and yield in automotive applications in both 200-millimeter and 300-millimeter production, which will help address some of the reported automotive semiconductor shortages going forward.

Calendar year 2021 is position to be the sixth consecutive year of revenue growth for KLA, demonstrating strong through-cycle growth, the success of our diversification strategies and our market leadership in process control and a large and growing contribution from our services business.

Let's briefly cover the top five highlights from the March quarter results. First, we saw continued strength and breadth in foundry/logic demand in the quarter, as expected memory demand also grew as memory customer's plan for growth and equipment investment in 2021 to meet improving end demand.

We expect higher business levels across a broader set of customers in the March quarter, but the demand momentum continuing throughout 2021 across major end markets. The strength in demand we're seeing reflects KLA’s essential role in supporting our customers drive to innovate and continuing to invest in future technology notes.

Second, Gartner's recent market share report for 2020 sized KLA’s share of process control over 53% for the year. KLA’s market share in process control has maintained a steady growth trajectory over the past 10 years.

Highlights of the 2020 report show, KLA continuing to strengthen our core franchise and optical inspection and strong momentum and gains EBM inspection and optical metrology. Increasing investment in leading-edge foundry/logic, the accelerated adoption of EUV continues to be major factors, driving equipment spending.

KLA’s market leadership once again demonstrates the success of our portfolio approach to solving complex customer requirements at the leading-edge.

Third, our services revenue was $428 million in the March quarter or 24% of total sales, with over 75% of services revenue in our Semiconductor Process Control segment resulting from recurring contract agreements.

Services is on track for another strong double-digit growth year, driven by our growing installed base, higher utilization rate and increasing expansion of service opportunities in the trailing edge and the EPC group.

Our semi process control service business revenue continues to grow faster than the rate of the installed base, growing approximately 2.8 times faster over the last five years.

Fourth, this was another growth quarter for our electronics packaging and components or EPC group, highlighted by record quarterly bookings for the semiconductor – the specialty semiconductor business. Growth was driven by automotive, 5G wireless connectivity and advanced packaging applications across various end markets.

With EPC, KLA is now providing a more comprehensive and broader product portfolio across fast growing new markets in the electronics value chain, such as RF, automotive semiconductors, and advanced packaging.

As it relates to EPC's opportunities in advanced packaging markets, KLA strengthened our engagement with the top five semiconductor market leaders in packaging. And we're expanding our reach with those sets.

KLA is ramping our investment in advanced packaging market to drive adoption of new technologies in this exciting growth market, in addition to new inspection products for high level production and assembly.

Finally, in keeping with our commitment to deliver strong and predictable capital returns to our shareholders, in the March quarter, we repurchased $273 million of our common stock and paid a $139 million in dividends, for a total capital return of $412 million or 71% of free cash flow of $585 million, which was also a record.

Last July KLA’s Board of Directors authorized the 11 consecutive annual dividend increase to a yearly run rate of $3.60 per share. Since its inception in 2006, KLA’s dividend payout has grown at a CAGR of approximately 15%.

We believe KLA’s track record of delivering strong capital returns is a key component of the KLA investment thesis and offers predictable and compelling value creation for our shareholders. Before Bren gets into greater details of our financial highlights, let me recap.

KLA’s March, 2021 results demonstrate the critical nature of KLA’s products and services and enabling the digital transformation with our lives, the resiliency of the KLA operating model and our commitment to productive capital allocation.

KLA is exceptionally well positioned at the forefront of technology innovation with a comprehensive portfolio of products to meet demanding and customer requirements, balancing sensitivity and throughput. Semiconductor and electronics landscape is constantly changing.

We're seeing broadening customer interest driven by more technology innovation than ever before at the leading edge. We believe there are multiple secular factors driving industry demand and KLA will continue to benefit from and position us to exceed our 2023 financial targets reach them earlier than anticipated.

At the same time, our strategy of driving diversified growth, strong long-term operating leverage should provide robust cash flow generation and consistent capital returns to our shareholders. And with that, I'll pass the call over to Bren..

Thank you, Rick. Results this quarter highlighted the soundness and strength of our ongoing strategies. We continue to demonstrate our ability to meet customer needs and expand our market leadership, while growing operating profits, generating record free cash flow and maintaining our long-term strategy of productive capital allocation.

Total revenue in the March quarter was $1.8 billion at the top of the guided range. Non-GAAP gross margin was 62.9%, above the midpoint of the guided range is stronger revenue in favorable product mix drove upside in the quarter. Non-GAAP EPS was $3.85 at the upper end of the guided range, GAAP EPS was $3.66.

Non-GAAP total operating expenses were $407 million, including $239 million of R&D expense and $168 million of SG&A. At KLA technical application support for our customers is included in SG&A and was $42 million in the quarter. The combination of R&D expense and technical applications represents about 70% of total operating expenses.

Non-GAAP operating income as a percentage of revenue was very strong at 40.4%.

Given higher revenue expectations for the remaining three quarters of 2021, product development requirements, particularly in programs supporting next-generation reticle inspection capabilities, regionalization of additional customer engagement resources, and increased investment in our infrastructure globally, particularly in expanding our manufacturing footprint and completing our new HQ2 in Ann Arbor, Michigan.

We expect operating expenses to be approximately $412 million to the June quarter. We were budgeting quarterly operating expenses to increase sequentially $3 million to $5 million a quarter or the near-term horizon. Given top line expectations for 2021 and fueled by double-digit growth over the past two years.

We expect that the business will continue to outperform our target operating model, both in terms of overall profitability and operating margin leverage. Non-GAAP net income was $598 million, GAAP net income was $567 million. Cash flow from operations was $646 million and free cash flow was $585 million.

This resulted in a free cash flow conversion of nearly 100% and a very healthy free cash flow margin of over 32%. Our segment revenue was strong in the quarter, driven by growth in our Semiconductor Process Control business. The EPC group delivered results mostly in line with our model heading into the quarter.

Revenue for the Semiconductor Process Control segment, including its associated service business was $1.51 billion, the sequential quarterly increase of 9% and up 28% compared with March of last year. The approximate semiconductor customer mix was as follows. Foundry/logic was strong as expected at 69%, and memory was 31%.

In memory, the business was split roughly 55% NAND and 45% DRAM. Revenue for the specialty semiconductor process segment in March was $92 million, up 1% sequentially and up 8% over the prior year. Demand in this segment was driven by growth in RF, power and advanced packaging.

PCB, Display and Component Inspection revenue was $205 million, up 14% sequentially, and up 28% year-over-year with mobility markets driving strength in advanced PCB and finished component inspection. Revenue by major product category and region are both broken out in the shareholder letter in slides.

From a balance sheet perspective, KLA ended the quarter with $2.4 billion in total cash, total debt of $3.4 billion and a flexible and attractive bond maturity profile supported by strong investment grade ratings from all three agents. In terms of cash flow and capital returns, Rick already covered the highlights.

We believe our track record of delivering strong capital returns is a key component of the KLA investment thesis and offers predictable and compelling value creation for our shareholders. While circumstances can change, our current expectation is that our capital returns profile for calendar 2021 will exceed 85% of the expected free cash flow.

As it relates to guidance, our overall semiconductor demand at WFE outlook is expanded further from our view in January, where we characterize the WFE market to grow in the low teens plus or minus a few points.

We are revising up our view for the WFE market to grow on a percentage basis in the low-to-mid 20s with a bias to the upside at calendar 2021 from approximately $61 billion in 2020, reflecting the strengthening of demand we have experienced over the past couple of months across all segments.

Also in earnings in January, we provided a high level outlook of business levels being roughly flat quarter-to-quarter for calendar year 2021.

As we look ahead, based on the strength of our current backlog, sales funnel visibility over the next couple of quarters, along with expected product lead times, we are encouraged by the sustainability of our current demand profile for the year.

As a result, we would expect the company revenue to continue to improve sequentially quarter-to-quarter throughout the remainder of the calendar year, with the second half growing versus the first half, as more KLA manufacturing capacity comes online to support this robust customer demand environment.

This growth is fueled principally by our Semiconductor Process Control business. This business is positioned well in terms of expected performance in 2021, relative to the overall WFE market. Our June quarter guidance is as follows. Total revenues expected to be in a range of $1.855 billion plus or minus $100 million.

Foundry logic is forecasted to be about 68% and memory is expected to be approximately 32% of semi process control systems revenue to semiconductor customers. Within memory, DRAM is expected to be about 60% of the segment mix. We forecast non-GAAP gross margin to be in a range of 61% to 63%, as product mix expectations normalize in the June quarter.

Based on increased revenue volume and product mix expectations for 2021, we are now modeling gross margin to be between 62% and 62.5% for the calendar year.

While in any given quarter, the mix of our business will affect our gross margin results, the structural trends, both in terms of product cost and product positioning remain compelling in our sustainable tailwinds going forward.

Other model assumptions include non-GAAP operating expenses of approximately $412 million, interest and other expense of approximately $40 million and an effective tax rate of approximately 13.5%. Finally, GAAP diluted EPS is expected to be in a range of $3.20 to $4.8. And non-GAAP diluted EPS in a range of $3.47 to $4.35.

The EPS guidance is based on a fully diluted share count of approximately 154.5 million shares. In closing the industry dynamics driving semiconductors and investments in WFE remain compelling with solid demand across end markets in a multiple technology nodes.

We’re encouraged by the strength of the leading indicators of our business and our customers multi-year plans for continued investment. KLA is executing well and we have continued confidence that we're on track to both exceed our 2023 financial targets and achieve them sooner than anticipated on the strength of higher industry demand.

The KLA operating model positions us well to outperform and guides our strategic objectives. These objectives fuel our growth, operational excellence and differentiation across an increasingly diverse product and service offering.

They also underpin our sustain technology leadership, deep competitive moat, strong track record of free cash flow generation and capital returns to shareholders. With that, I’ll now turn the call back over to Kevin to begin the Q&A.

Kevin?.

Thanks, Bren. Priscilla, we're ready to queue for questions..

[Operator Instructions] We’ll now take our first question from Krish Sankar with Cowen & Company. Your line is open..

Yes, hi. Thanks for taking my question and congratulate on a really strong results. Rick or Bren, the first question I had was you're guiding to WFE obviously update since three months ago, similarly the mid-20 range.

I'm kind of curious, if I look at some of your peers, they're talking about 30% range, but either way from your vantage point, how do you think KLA has any process controlled revenues are going to do relative to your mid-20’s WFE growth on a calendar of 2021 basis, and then I have a follow-up..

Yes, Krish. Thanks for the comments. Hey, I'll start here, but you have to remember that everybody uses a different baseline. So that's why I put the baseline in there. So I said that against the baseline of 2020 of $61 billion, we saw a – we see growth from there in the low-to-mid 20s percentile as – with bias to the upside.

So I think that as we see it, you do the math on that, that puts you in that sort of $75 billion plus range of WFE, and certainly the momentum that we saw over the course of the quarter has increased pretty substantially, really across all segments.

So we feel pretty good, not only about the growth of the overall industry, but the positioning of the semi process control segment against that industry growth expectation.

So I think that it sets up well for us, we have to execute over the remainder of the year, but I think it sets up well for us in terms of relative performance against the industry..

Got it. Super helpful, Bren. And then as a follow-up, and thanks for the color on the market share data from last year. I'm just looking more – looking ahead, can you talk a little bit for the market share dynamics, obviously a large U.S.

company has spoken about gaining traction in process control, introduced a new optical inspection tool with the EB combo along with AI.

So I'm kind of curious, are you seeing that impact, especially in foundry and logic? Or how do you kind of counteract that especially given that you are obviously the leader in this space today?.

Yes. Thanks for the question. I think that there is no question that the demand for process control continues to be strong as Bren said, and we view process control in 2021 is outgrowing the overall market based on those drivers.

From a competitive standpoint, we also expect to be able to continue the plan we laid out in 2020 – 2019, which is to increase our overall position of process control as we have in the last couple of years and we think that continues based on the strength of our product portfolio and the engagement we have with our existing customers.

There is no question that there is always going to be competition out there, but if you look at the history of the gardener data, as we highlighted over time, KLA has consistently been successful in leveraging our strategies to build on our market position and gain share.

And we don't see anything about the current competitive environment that will change that. We do have some major products to deliver in terms of in areas like reticle inspection, but – and that's happening this year.

But we're very pleased with the performance of our optical inspection and we’re also very encouraged by the recent success of our e-beam offerings that we really got back in those segments in the last year or so, so we feel good about our competitive position.

And as you might imagine, it kind of shows up in our gross margin in terms of the strength of our business and our competitive position that we're able to continue to have the kind of margin profile that we have, despite the fact that we've added EPC, which overall at a corporate level you know was dilutive to the margins that KLA had prior to that.

So I think that should be evidence of our strength..

Got it. Really helpful. Thank you..

And we will move next to John Pitzer with Credit Suisse. Your line is open..

Yes, good afternoon guys. Thanks for letting me ask the question.

Bren, just first on the gross margin in the March quarter, what drove the upside and I guess importantly, as you look at June and full calendar year guide, what are the assumptions that you're making for kind of mix? And to what extent are you above target because of cyclical, because of mix, or should we just start thinking about 62 plus is being kind of a new target?.

Yes, John, thanks for the question. So when you look back at the March quarter, most of the growth sequentially in the quarter came from the semi process control business. And as Rick just mentioned and that's a richer business for us overall.

So that combined with the upside in the quarter in terms of incremental revenue is what drove the margins up to where they were. It's a little bit lower as we look at the June quarter. It’s still in line with the kind of guidance that we've been providing at 62% plus or minus.

So we're mostly in line with that as we look at quarter-to-quarter, we do have some sequential growth in EPC, and so that's diluted from that standpoint. But in general, I think that the margin drivers structurally are all pretty solid.

We're seeing nice leverage overall in the business from the activities – the strength of the business and the activities in our factory. So we're seeing good efficiencies there.

And then over the course of the year, I think just given the directionally where it's moving, as I mentioned last quarter, I thought it was 61.5% to 62% for the year, certainly the stronger outlook in terms of top line, but also just the drivers underneath in terms of what we're expecting from certain products.

I think we're in line with that sort of 62% to 62.5% that I talked about on prepared remarks. And given the strength in the business overall probably more biased to the upper end of that range. So I think that there is sustainable traction in these areas, particularly around certain products.

We talked about the inflection and growth and optical inspection. So anytime you see products like that inflecting, that's going to drive to a richer mix overall for the overall business..

That's helpful. And then Rick as my follow-up going back to kind of the market share question, which I think is one of the key investor concerns out there.

I think the concern that some investors have is that as we hit this inflection from optical to more exotic like – sources like e-beam an x-ray, there is sort of a view that the incumbency advantage kind of goes away. And perhaps we're all kind of estimating that inflection to happen more quickly than it will.

But can you help me better understand the 4x market share advantage that you have in the optical world? How does that position you as we start moving to these new technologies?.

Yes, thanks, John. I think the – I'm not certain of this, but I think the fastest growing product in metrology and inspection, pretty certain was our GEN5 over the last couple of years.

And the strength of that is driven by its ability to satisfy the needs that we have for inspection measurement with EUV, specifically around print down and also the advanced nodes. There is nothing that we're seeing that indicates the percent of inspection and metrology budget is dramatically increasing toward e-beam.

In fact, if anything, it's always been the challenge to drive the optical at a higher rate because the price performance is so much higher.

I'd also say that the people that are closest to having a multi beam – e-beam solution are KLA, we're the ones that have it, that we're developing and introducing in the radical space which is I think – where it's needed the most. So we don't really see any inflection, we don't see a change, the market share dynamic.

And if anything, the challenge that Bren and the operations team have is satisfying the increased demand around the optical portfolio that we have specifically GEN5, but also GEN4, which has it slowed down.

So I don't buy the thesis that this is the transition, it hasn't been for years, and the reason is because optical keeps getting better and it's really difficult to make at e-beam tool that's fast enough to satisfy most of the inspection requirements.

In terms of pointing e-beam – pointing optical with e-beam, that's not a new idea, that's been around quite a while, and at KLA, we introduced that concept when we introduced our e-beam inspection tool and talked about it at our Analyst Day, that just allows those tools to be functional and to continue to provide value.

So I don't think that transition is happening..

John, I’d just add – I'm sorry, just one other thing – I think just in terms of overall growth rates, right, so we talked about the accelerated growth relative to the market in 2020 and I would expect this business to grow faster than market again in 2021.

So I think the good thing about the complementary nature of our e-beam solutions with our optical is driving higher relevancy in use case application across the optical inspection, which is the large market, right, that's the market, that's $2 billion plus in terms of opportunities.

So to give you some perspective on the strategy overall, but there is an inflection here, that's validating, I think the relevancy of optical inspection in a lot of different ways..

And Rick, does the incumbency advantage you enjoy at optical transferable as the world starts to move to e-beam?.

Yes. John, I – again, I don't think the world is going to move large scale to e-beam.

I mean, we're well-positioned if it does, but I just don't think that the – I think there is going to be a mix and match and the percent of layers that could be inspected by e-beam is never going to be as high as what could be expected by optical, especially since GEN5 is still on the early iterations.

We have more capability to add to GEN5, it's – we've been adding – have for awhile added AI capability to that.

So I think in general, yes, we have a good e-beam solution, but our modeling doesn't show that that's going to be the increased percentage of the use case, because optical can satisfy, especially GEN5 and satisfy the needs that are going to be through the 2020s, even past when we get the high end – EUV, and remember, that's only a percentage of the layers that are going to be subject to that.

So I don't think we're going to see this transition to e-beam. I think incumbency for KLA has really been based on our ability to keep delivering new capability to the market. Not so much because we've been there, but our newest products, which is why we invest so heavily in R&D and the application support for our customers.

So I don't think it's going to transition, we'd be fine if it did, but I think it's a better price performance for our customers to have as many layers be done optically as possible, because the throughput capabilities just so much better in optical than it is in any form of e-beam..

Great color. Thank you..

We will take our next question from CJ Muse with Evercore. Your line is open..

Yes. Good afternoon. Thank you for taking the question.

I guess first question, Rick, I wanted to go back to your earlier comment around process control outgrowing WFE, and to me logically, when we're adding meaningful capacity, I would think process tools would outperform and process control would underperform, not any hit to you, but just where you fit in terms of the order of spending.

And here you've outlined mid-20s kind of growth for the industry, whereas we've heard 37% growth from ASML, we've got 30 plus percent growth from Lam.

How in that world does process control outperform? Is it Intel coming back? Is it at mask inspection spend from China, what are the moving parts that can allow that to happen?.

Yes, I'll give some color and then Bren can fill in some of the details.

But if you – if we assume the market is, let's say, just pick a number 22% WFE growth this year, what we're loaded right now and what we're modeling that we need to do, just based on the orders and the conversations we're having with customers daily is – will significantly outgrow that.

I don't know if it'll be 38%, but it'll probably start with a 3, in terms of what it is. Now, we don't know what WFE is going to actually be this year, but if that's what process control, that's just based on the conversations we're having right now.

Ahmad Khan, who runs that businesses and calls almost three times a week talking about slots and support for customers across his portfolio, I get pulled into them occasionally, but that's the conversation, it’s how can we support that. And when we model it, we look at that business and we think it's going to be a very strong grower this year.

Could the WFE numbers change? Yes, of course. What's it driven on to your other question CJ, it's – of course it's driven by the increased investment people have in the advanced design rules, it's not a secret that TSM has talked about dramatically increasing their CapEx this year.

And we know what Intel has said publicly, but it's not just that we're seeing increased commitment and conversation from the memory manufacturers who want that capability too.

So I think the difference between the process control intensity and foundry logic is still there, but it is narrowing a bit as people push harder on the advanced nodes for – specifically for the advanced DRAM work that's going, but also some NAND work too. Bren, maybe you can fill in..

Yes CJ, I always struggle a little bit with these questions just because everybody uses different baselines. I don't know what the baselines were for the different companies and sometimes they don't even share them, so you don't really know when you're thinking about percentages.

So I try to show our work here and let you know how we're thinking about it. If you look at 2020, that KLA’s performance was pretty much in line with the market, if you went from $50 million to $53 billion in 2019 to 2020 at $61 billion, that's about 16% overall. And if you look at semi-PC equipment, it was in that ballpark.

So as we look at this year, as I said earlier, if you're looking at $75 billion plus I think that's where the industry is against the $61 million baseline, then you're like in the mid-20s to our prepared remarks and against that backdrop, I would expect process control to do very well.

And so we'll see how it goes, I'm not going to guide the second half, certainly we would expect the second half to be stronger in that business overall. And I think the drivers are pretty compelling and pretty broad based. So we'll see how it goes as we move forward here, but that's – I think that's how I see it at this point..

Yes. Very helpful. As my follow-up, you alluded to supply constraints or adding on additional capacity.

We'd love to hear – you guys typically run your business to roughly seven months backlog, has that extended? And I guess, how should we be thinking about the timing of bringing on capacity implications to the model, either gross margins of OpEx, if at all? And if your lead times are extending beyond that kind of seven month timeframe, do you have visibility now into the first half of 2022? Thank you..

Well, we prefer to operate right around six months where we can, now our products do vary, some have very long lead times, where you're looking at some of our high end systems, the timing to procure and optical components, and then polish and grind optics can take some time. So for some of those products, the lead times are significantly longer.

I'd say today, if you aggregate it across the company, we're a little bit longer than we'd like to be. So we'd like to target somewhere in that five to six, and we're probably somewhere in that seven to eight range as we look at it today. And capacity is coming online, really across the board. We're adding people into all of our factories worldwide.

We've been doing that since we started to see the business inflect in November in a meaningful way. We're adding capacity in terms of space at all of our major factories around the world. And we're working very closely with our suppliers, suppliers have been great in supporting our ramp so far.

They're adding and investing and we're investing in them in a lot of cases. So I would expect that given the guidance, the growth we're expecting in the second half will happen as a result of incremental capacity and we can continue to work that.

So I think given the expectations around six months of – in terms of our lead time, we can continue to add to what we have to support whatever environment we’re facing. At the end of the day, KLA doesn't lose business because we can't deliver. So we also will move things around as needed to be able to support our customers.

And we do a lot from a tactical point of view to try to shorten cycle times, adding shifts, all the little things you can do to pull in and cut days out of out of a lead time.

So all those activities are ongoing, and I think that as we execute against that into the second half, I think it creates opportunities for us to deliver to the expectations we have right now, but also to support upside if it presents itself..

Thanks, Bren..

And I don't see any reason why it seems to be sustaining even as we move beyond right in terms of – I don't see anything falling off anytime soon..

Thanks, CJ..

We will take our next question from Harlan Sur with JP Morgan. Your line is open. Okay, good afternoon..

Hi, good afternoon and great job on the quarterly execution and strong results. In foundry I know most of the discussion has been focused on leading edge, but there is significant wafer tightness on lag in the c-mass technologies 16, 28, 40 nanometer and higher.

I know your sweet spot is advanced technologies, but there is some part of the demand strength in process control coming from these bagging-edge processes as capacity gets built out.

So what percentage of your business and process control is exposed to mature technology nodes?.

So the full China, all the business in China I’d classify as mature. And most of that is pretty boundary weighted this year. There is some wafer investment that's happening, there is some memory investment, but I'd still say it's probably greater than 60%, 65% boundary, I don't have it in front of me.

And so you've got that, plus you've got other activity. I would say probably somewhere in the semi process control equipment, if I just look at the equipment part of the business, it's probably somewhere around 25% of our revenue, I would call 28 nanometer and above, 25% to 30%..

Perfect..

Just to add to it. It's not just tight there as you know, it's tight everywhere. And so you do remember years ago, if you think back to when there was one product and that would transition to the next product and people would reuse capabilities, that's really not an option now.

And so what you get is that heavily utilization that benefits that sales, but also we see that in service. So that's what's part of what's driving the higher levels of our growth in service..

Great, good insights there. And then as a follow-on, I mean, on the EPC business with – again with the chip tightness on mature technologies, especially automotive and industrial focused and tightness in advanced packaging and substrates.

I would assume that this would be driving strong demand for EPCs portfolio of products, because they are focused on specialty processes, advanced packaging and PCB.

And I think last call, I think your view was that x-display that EPC would go 15% this year, but just given the strong demand for analog RF, power transistors, advanced substrates, PCB capacity.

Do you guys have a new view of EPC growth for this year?.

We do. I think you hit it, and again, if you take out the display piece, which has its own dynamics as you know, I'd say that we were being powered by – and we talked about this in past Harlan, but by 5G largely if you think about it, most of 2020 and early. Now the thing that we have counted on early in terms of the deal thesis was automotive.

And as you know and everybody knows, they hit the brakes hard last year when the view of the overall economy was tough. Largely, I'd say that in some other factors that would have contributed to this chip shortage. And so now they're back on and you're right, that's definitely driving EPC as PTS is being driven by that dynamic as well.

So now it's really firing on all cylinders. And so we're seeing really strong growth across EPC in terms of supporting both the continued momentum in 5G, but also now automotive.

And I mentioned in my comments that we're going to talk more about some of the new offerings we're having to support our automotive customers, which we hope will not just help in terms of solving some of their problems, but alleviate some of these shortages as we help them with yields, which is really the near-term, the best leverage they have in terms of providing more output is higher yield..

Yes, Harlan. One of the things I'm encouraged by with everything that Rick said is including display now, I would say that the expectations about – for EPC are in the mid-teens. So with that reflects some of the growth drivers in growth that we're seeing in the businesses that Rick mentioned.

We'll see how it plays out half to half, I think it will be reasonably balanced. We are doing a ERP integration on one of those businesses. And so that could drive some revenue across quarters a little bit as you prepare for that.

But pretty consistent level of business, and as I said overall for the entire group growth expectations that are kind of meet 15 for the year.

So we feel pretty good about where we're at with those businesses and particularly on that growth, I think with all the synergy work we've been doing across the company in those – in that group really pleased with the operating leverage as well..

Great insights. Thank you..

And we’ll take our next question from Joe Moore with Morgan Stanley. Your line is open..

Great. Thank you. You mentioned China and that the activity is mostly foundry.

Can you give us an update on how big you see the China sovereign business, how much growth you see coming this year? And how fragmented is it, how many different customers are you seeing that are kind of spread out across that WFE?.

It would probably grow mostly in line with the overall market I would think and very fragmented lots of customers..

Okay, great..

And also included in that Joe – Joe, also included in that is also some of the wafer activity that's happening, where you're in mask, where there some investment in infrastructure to support the broader ecosystem..

Yes, that makes sense. Okay. And then as it comes – pertains to regulation, whether it's the CHIPS Act or the export controls reform, that's kind of going through.

I guess, do you feel like the equipment industry in KLA specifically has kind of a voice in the government in terms of the direction of these things and – or is it kind of more dictated by the semiconductor customers? Just how big is the lobbying kind of government affairs efforts from the equipment companies these days?.

Joe, I think what's really happened is there has been an openness in general to understand the dynamics. I think that a fear that many of us had was that there might've been unilateral action if you go back a year or so. And it doesn't feel like there's going to be that now it's going to be multilateral. It's going to be thoughtful.

And we're all in favor of free trade and nobody wants IP or other factors to be compromised. So I do feel like there's a constructive dialogue around that, and it's not just the semiconductor guys. It's also the equipment companies and we feel really good about where that conversation is..

Great. Thank you very much..

Thank you..

And we'll move now to Joe Quatrochi with Wells Fargo. Your line is open..

Yes. Thanks for taking the question. On EUV, I’m just curious you talked a lot about process control intensity, clearly benefiting from EUV. But I guess at 3-nanometer, we're starting to see a big step up in the number of EUV layers.

Is that something we should think about as maybe an incremental driver is for you guys?.

Yes, Joe, for sure. I mean, we're having, as you know, the development work, there's a lot of process control work that goes on early on when we're doing R&D and development for our customers. And there's definitely an increased sensitivity to the number of layers that they have to qualify.

And that drives multiple markets, but obviously ensuring the quality of the radicals and when they're printed that the high quality is there. Now it's across more layers. So that drives adoption of Gen 5, also just more sensitivity to smaller defects. So in general, that shifts the dynamic.

If you thought about a blend between Gen 4 and Gen 5, Gen 4 is still very active. As a product line, this will shift it more in those advanced nodes to a higher percentage of those tools being Gen 5 tools and the next-generation or iterations on Gen 5 as we move forward. I think we mentioned I the past, Gen 5 is very early in its product life cycle.

And there are a number of additional capabilities that will be added to it to support advanced. So those are just two areas. There'll be others in terms of the metrology challenges, but in general, the process control challenges as we move forward especially on advanced design rules will increase.

And we're seeing that play out right now in development. So Joe, one other factor to keep in mind that now you have these technical drivers in these no transitions that forced customers to have to think about incremental capability and those requirements.

And so the ability to reuse a lot of the capacity they might've purchased in a prior node is harder because you've got stronger end market adoption that's clearly happening. Today, particularly at the 5-nanometre node, but then also the technical drivers of that, even if they could use the tool, it doesn't meet the technical requirements.

So that's another factor that drives intensity, that's pretty important to our overall business..

That's helpful.

And then maybe one for Bren, on the capacity increasing for your manufacturing footprint, I mean, how do we think about your planning in terms of, supporting overall WFE? Because I think in the prepared remarks, you talked about sustained growth looking even into next year?.

Yes. Look, I don't think we're capacity constrained within the windows that we talk about. Just in general that we think that we – there is no upper limit, right. We'll continue to work and we continue to invest.

Certainly, there's some time to some of the lead time on our parts, but whether it's facilities, we like to think about people, parts and space at KLA, typically our long-term goal is around parts around some of the components we talked about.

So we're going to continue to add capacity and send a strong signals into a supply chain to drive the investments that are required and will based on customer readiness and customer expectations. We'll do what we need to continue to support those activities as we go forward, even beyond 2021. So I'm not worried about our ability though.

I'm worried with that we're challenged and it's not easy, and there's a lot of work going on here. But at the same time, we know how to do this and we'll continue to make the investments that are required to get the capacity to support the environment we're in..

Thanks Joe..

Perfect, thank you..

And we’ll move next to Patrick Ho with Stifel. Your line is open..

Thank you very much and congrats. Rick, not to make you sound old, but you've been in this industry for awhile given that you've seen previous cycles and how they've acted in terms of these kinds of first volumes, where you've had to accelerate capacity.

Bren, just mentioned that he's not particularly worried about meeting customer demand, but as we get into the secular change in terms of the industry where we may have sustained an elevated spending, how do you look at, I guess meeting the challenges of supply as well as meeting customer demand, particularly for both, for new tools for their needs, how do you manage potentially an extended period of spending at very elevated levels?.

Yes, Patrick. Thanks for not making me feel old. I think every cycle as I'm sure you've heard is different. One of the things that we learned early on though, is to look at follow the money and figure out how profitable your customers are and what is sustainable.

And I go back to periods where I remember companies that were spending 2x their CapEx was twice the size of their revenue. And you just knew that couldn't last, right. So when we look at the supply chain, now one of the leading indicators we always look at is profitability of our customers and it's universally good.

I mean, there are some examples where customers are investing in, and we see this in China where they don't have a revenue base to support the investment. But those are viewed as strategic investments, but the percent of that that's in the industry right now is really low.

And so it's the growth of the semiconductor industry broadly with all the different drivers, the number of players that have maintained their profitability through these cycles and the fact that that gives us confidence in the sustainability. I don't think we're going to see growth rate that's 25%, 30%. We're talking about what it might be this year.

That's not going to be the long-term growth rate. I think there's a step up to get to support these new drivers. And I would imagine it presumes it's growth at a more reasonable, upper single-digit kind of level for the equipment industry as we kind of modeled. But the step up is consistent with the multiple drivers.

As Bren mentioned, we have a lot of leverage in terms of being able to utilize our facilities, but even that, given that we're investing right now to make sure we've got additional people, parts and space as Bren said, so that we could support the ramps that we're seeing. I do think this is a step up. I think we've seen it in the past.

And I think that the business is sustainable. I don't think 30% growth will happen for several years in a row. But if it did, we'd be there to support it. So we feel really good about where we are. And more importantly, the investments we're making in our capability are enabling our customers to achieve their objectives.

And that's really the key to our continued success is to make sure we're staying relevant with our customers.

Does that answer your question, Patrick?.

No, that's very helpful. And to make you feel younger, Rick, I'll ask you the follow-up as well. As we look forward and we know process control does get, I guess, a good look at a lot of next-generation process technologies and manufacturing. You mentioned about EUV increasing layers and the adoption of Gen 5.

As you look forward to foundry/logic, you have EUV increasing layers, but you also have in a few nodes, the transition to gate all around to nanowires, nanoribbons.

Qualitatively from a process control standpoint, I know it's very early, which do you see out of the EUV increasing layers and the transition to the new transition of structures, which do you see as a larger incremental opportunity for KLA?.

Yes, I think it's a great question. Just as you know, we do have a group inside of KLA that models out the advanced technology designs. We have some really talented people that we think about that years in advance, to think about what are the solutions that will be necessary.

Gate all around is an interesting one, because there it's actually an adaptation to Gen 4, that's going to be most relevant to solving some of those problems based on the contrast of those devices. So we think that'll be incremental.

As I mentioned in the earlier question, you think about more EUV layers that just drives the overall expectation of higher sensitivity across the portfolio, the increase for more inspection overall, and at a higher level of sensitivity.

I tip it toward the advanced nodes driving more intensity than the new structures, but the new structures can't be discounted because if you can't make them successful, then you're not going to be able to ramp those nodes. So, but I'd say probably 60/40, maybe even 65/35, that it'll be the advanced design rules that drive it more.

And it's not just going to be in foundry/logic because we're also seeing, even though it seems like they're almost out of gas, DRAM keeps pushing as well to drive the next capability improvement so that they can have competitive advantage. And I don't think that will base anytime soon..

Great, that's very helpful. Thank you..

We'll move next to Timothy Arcuri from UBS. Your line is open..

Hi, thanks a lot. I guess, I had the first question was on the whole e-beam versus optical thing. Applied to launch the enlightened tool in March and idea that you combine optical and e-beam and you do synchronizing to sort of determine what defects matter. You guys talked about that a lot back in the back half of 2019 with the eSL10.

So I guess, conceptually, it's not new, but they had a pretty strong e-beam review presence. So I guess in theory, that could provide kind of a better input for the AI algorithm.

But can you sort of talk about just this general idea and maybe sort of whether it can change the impact the e-beam could have on the market and your position?.

Yes, Tim. Thank you for remembering what we said in 2019. I could go back even further when we introduced some spec back years and years ago, and the idea it was a pointer for optical back then. And that was in the 90s. So this idea of e-beam directing optical is an old idea.

The idea that – the problem that it has in general, and this is an interesting question is, do you have systemic defects? Do you really – can you actually point that, AI has helped solve some of those problems, but there's still this basic question about coverage.

And can you cover enough of the wafers to see enough of the AI? If you look at a modern wafer in a leading fab, they don't have many defects. I mean, there are very few, so you need to cover a lot of area. And that's what optical is really good at.

The e-beam ends up being the most valuable in debugging of a new process at the very front end, which is why it's mostly been in R&D. And that's what we're continuing to see.

AI has been added to the products we've been doing that for a number of years, whatever your definition is, increasing the intelligence, the algorithm that's been KLA sweet-spot for years, and we continue to do that.

So I don't think that the announcement of two and a half year old technology earlier this year was really anything revolutionary, other than –it's not new. And I don't think that the relevancy of what we're doing changes as a result.

I do think that increasing the capability, the ML and the AI across all the products in this industry will continue to make them more relevant as we go forward for KLA and others as well.

So I think that's an area we're all taking advantage of, and that'll help increase the capability and the learning that the industry has in general, we'll be able to move forward. But I don't think this was not a dislocation. It was not anything new for customers.

It might've been new for other communities, but the disclosures and the conversations are not new to customers..

Thanks, Rick. And then, I guess just last thing for me, so service, obviously, it's a lower portion of your total, rather than your peers. I know that you're never going to be like the films guys given the nature of their technologies, some of their tools eat themselves.

So, obviously it's sort of like apples and oranges there, but some of them also were sort of guaranteeing performance and metrics like that. And they're sort of selling that. And I'm wondering what sort of new things you're bringing to bear in service to maybe help your service business start to grow a little faster? Thanks..

Yes, Tim. I mean, I think one of the things in service for us is that we have the ability to really customize our offerings for customers, both in terms of response times, in terms of stocking levels, in terms of uptime commitments and things like that.

And then given that, and given the nature of the contract that we structure, and it's pretty important for – when customers buy process control, they buy what they need. And then they have contracts to ensure that the tools are running full out all the time.

And they are willing to invest in a contract structure and ensure that we can keep them up and make sure that they match and all those sorts of things. So it's a little bit different business, customers because they don't have as many, they have tens instead of hundreds as they would in a process tool.

They don't necessarily have the ability to build the capability internally to be able to do self service. And so that's a unique aspect of our service business. There's also the complexity of what we offer relative to the process tools, which is far different. So for all those reasons, it does drive a different service experience with customers.

And as I said, we customize to meet their operating expense requirements and what they're looking to get out of their fab. And it does drive this 75% plus contract revenue stream. I think there's always what happens with the new tools in terms of our ability to sell and support service on new tools.

I think where we've seen a lot more engagement with customers is the – in the trailing edge where you're seeing higher reliability and quality requirements.

Particularly, let's say, for example, in areas like automotive, where customers weren't as focused on the process control outcomes as much as they are today, with the growth that we're seeing and the increase in reliability that's required.

And given the margin structure in that industry, for example, it's pretty important that you don't under kill, right, because of the cost of recall and so on, but then there's also overkill too. So there's a lot more process control engagement.

That's happening through our service business with those customers to support the install base at a greater level. So you don't see tools falling off, you see them staying in service. And that's what, it's probably the unique growth driver that we're seeing today as products are living longer. And some of these other markets are inflecting..

Okay. Thanks..

And we have time for one more question. We'll take our final question today from Vivek Arya with Bank of America. Your line is open..

Thanks for taking my question. You will be at your 2023 target model this year, basically two years ahead, but that seems to have been driven a lot more by market growth, rather than I think in your target model, you had penciled in one to two points of share gains.

And I know Rick, you highlighted a third-party survey that had your share kind of slipping a little bit last year. I'm just curious, when do you think we should start expecting share gains for you over the next few years.

And will that be driven by the launch of new products or will that be driven by share in a like-to-like category, will that be driven by spending being more foundry/logic based.

Just how do we think about what you had talked about share gains at the analyst day versus what you have seen so far and how we should think about this share shift over the next one to two years?.

Yes, Vivek, I'll take the first part and let Bren talk about model. We actually are ahead of our share projections that we laid out in the analyst day. In 2019, we gained 3.3 – 3% share and that got a 0.7 down. This is what the survey says, but we had modeled 2.5% over the four years and we've gained 2.3% over two years.

And we believe that this year will be another strong year. So I mean, these things move – annually it’s kind of hard because there are puts and takes, but competitively we're actually ahead of plan and largely that's driven by the success mainly of Gen 5 and what we're seeing in the optical inspection portfolio, that's been the bigger gains.

We have new products coming out that will add to that. But our expectation of share growth is actually higher than it was at the time when we did the analyst meeting based on the success that we've had today. And then Bren can talk more about the model..

From a top line point of view, you're right. It's been – what's driven, it mostly has been, yes. We had some incremental share improvement relative to the plan we were on, but just stronger industry growth.

We talked a lot in part of our theme was if you will, back for our Investor Day was to talk a lot about opportunities related to EUV and increasing memory opportunities to drive incremental adoption of process control and KLA solutions.

We talked about radical inspection requirements for EUV that would affect the radical inspection tools, but also the wafer inspection tools. We also talked about new markets like e-beam that we were reentering and then finally opportunities in memory metrology.

So those, in some ways we're going to create incremental revenues, almost irrespective of the WFE level. If we look at where we are today, most of it's been industry growth in the, I'll call the normal products and the regular products and share opportunities driven our performance relative to the overall plant.

The contributions from those products are still to come. We talked a lot about 2021 being opportunities to engage with customers to seed the markets and that we would start to see more steady state contributions in 2023 from those products. So we're still in that same phase regarding those.

And in some cases, COVID has made it a little bit harder to engage with customers out in the field to support new products and to drive new markets. But I think that's still to come. So we've got a higher industry environment that's driven us to where we are today, but those contributions are still coming over the next couple of years.

And so we're excited about that. And then on the leverage part, anytime you have revenue, that's growing what we saw in calendar 2020, where we were up 15% as a company and the growth expectations we now have for 2021, given the industry commentary earlier. Anytime you drive revenue like that, you're going to drive more leverage through the model.

So yes, we're outperforming our public model by about four points in operating margin today. Do I think that that's sustainable at four points? Probably not, but do I think there's a couple points for sure sustainability there, I do, just given the strength of the products and the expected mix going forward.

So yes, we're I think in a pretty good place relative to the overall model, we have to execute of course over the next year or so. And we'll have more to say about the future in the coming months and quarters..

If I can squeeze in a quick one, automotive, from your perspective, when do you think the automotive industry is able to address all these supply shortages that it's seeing from the semiconductor industry?.

I think we're not the right people to answer that question. We're going to do everything we can to help them, but it's hard to understand exactly how they got so out of line with the demand. But I know that, there've been contributing factors and you've heard of some of them.

Projects that weren't started fires that happened and the reluctance to invest earlier than them and retrospect was needed plus a strong demand. So we're going to do everything we can to help them, but they're the best people to ask for that..

Thanks Vivek..

Sorry, I’m just going to conclude the Q&A and turn the call back to you, Kevin..

Yes. Sorry about that. Again, we appreciate everybody's time. We know it's been a bit very busy week for earnings, very busy day for earnings. Won't be busy this summer here with a lot of investor events, we look forward to seeing you again then. Take care..

This concludes the KLA Corporation March Quarter….