KLA Corp (KLAC) — Q4 2023 Earnings Call Transcript

Thank you for joining us for our earnings call to discuss the results of the June 2023 quarter and our September quarter outlook. Joining me is our CEO, Rick Wallace, and our CFO, Bren Higgins. During this call, we will discuss our results released today after the market close, along with supplemental materials that are all available on our IR website. Today's discussion is presented on a non-GAAP financial basis unless otherwise specified. Whenever we make full year references, they relate to calendar years. A detailed reconciliation of GAAP to non-GAAP results is in the earnings materials posted on our website. Our IR website also contains future investor events as well as presentations, corporate governance information and links to our SEC filings, including our 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 factor disclosure in our SEC filings. Any forward-looking statements, including those we make on the call today, are subject to those risks, and KLA cannot guarantee those forward-looking statements will come true. Our actual results may differ significantly from those projected in our forward-looking statements. Rick will begin the call with some comments and quarterly highlights. Bren will conclude with our financial highlights, including our guidance and outlook. I will now turn the call over to our CEO, Rick Wallace. Rick?

Thank you, Kevin. Let's start with a summary of KLA's performance in the quarter, along with a few highlights. Further color and detail on my comments and the semiconductor demand environment can be found in our shareholder letter released earlier today. KLA's June quarter results exceeded expectations and demonstrated consistent execution despite a challenging marketplace. Specifically, revenue of $2.355 billion finished at the upper end of the guidance range, declining 5% on a year-over-year basis and 3% sequentially. GAAP earnings per share was $4.97 and non-GAAP EPS was $5.40, with each finishing at the upper end of their respective guidance ranges. As near-term demand headwinds persist, there are some bright spots. In particular, automotive and other markets served by legacy nodes remain strong, demonstrating the diversification of demand and growing adoption of semiconductor technology across multiple industries. Additionally, process control plays a critical role in enabling our customers to execute on node and technology transitions that are the focus of R&D efforts, and that is more resilient to near-term pressures. We work closely with our customers, and they continue to prioritize R&D investments. This is important for KLA as our products are heavily relied upon during the R&D process as well as the early ramp phase when faster time to yield is critical. KLA remains focused on supporting our customers' requirements while maintaining critical R&D investments to enable our technology roadmap. Our June quarterly results are the latest example of successfully meeting or exceeding our commitments and creating value for our customers, partners, and shareholders. Specific factors driving KLA's performance this quarter include KLA's market leadership in process control, which includes some of the most critical and fastest-growing segments of WFE. Growth and market leadership in critical wafer and reticle infrastructure is fueling relative growth for KLA. For example, revenues from our unpatterned wafer inspection and metrology products used in silicon wafer and photomask manufacturing are expected to significantly outperform the overall WFE market and deliver strong growth in a down year for the industry. The KLA Services business grew to $539 million in the June quarter, up 5% year-over-year. Our consistent execution despite challenges in the marketplace continues to prove the resiliency of the KLA operating model and the dedication of our global teams. KLA remains well positioned with a comprehensive portfolio of products to meet customer requirements. I'll now hand it to Bren to go through our financial highlights. Bren?

Thanks, Rick. KLA delivered results at the upper end of the range of guidance and commitments, demonstrating consistent execution despite a challenging marketplace. Our continued focus on meeting customer needs while expanding market leadership, sustaining industry-leading gross and operating margins, generating strong free cash flow, and maintaining our long-term strategy of assertive capital allocation is what makes us successful. Quarterly revenue was $2.355 billion towards the upper end of the guided range of $2.125 billion to $2.375 billion. Non-GAAP diluted EPS was $5.40, also towards the upper end of the guidance range of $4.23 to $5.43. GAAP diluted EPS was $4.97, above the midpoint of guidance. Non-GAAP gross margin was 61.2%, 45 basis points above the midpoint of the guidance range due to product mix as upside in the quarter was driven by higher-margin products, normalizing freight expenses, and improving factory utilization as overall capacity adjusts to current demand expectations. Non-GAAP operating expenses were $543 million, slightly higher than guidance due to adjustments to variable compensation. Total operating expenses comprised $314 million in R&D and $229 million in SG&A. Non-GAAP operating margin was 38.1%. Other income and expense net was $49 million, and the quarterly effective tax rate was 12.4%. With the guided tax rate of 13.5%, non-GAAP EPS would have been $0.07 lower or $5.33. Quarterly non-GAAP net income was $743 million, GAAP net income was $685 million. Cash flow from operations was $959 million and free cash flow was $880 million. As a result, free cash flow conversion was strong at 119%, and free cash flow margin was 37%. The company had approximately 137.7 million diluted weighted average shares outstanding at the end of the quarter. Breakdown of revenue by reportable segments and end markets and major products and regions can be found within the shareholder letter and slides. Switching to the balance sheet. KLA ended the quarter with $3.24 billion in total cash, cash equivalents, and marketable securities; debt of $5.89 billion; and a flexible and attractive bond maturity profile supported by strong investment-grade ratings from all three agencies. Turning to our outlook. Our WFE outlook for 2023 remains largely unchanged at down approximately 20% from $95 billion in 2022. While the timing of a meaningful resumption in WFE investment growth remains unclear, we continue to see overall demand stabilizing around current business levels for our semiconductor process control systems business and we expect this demand profile to continue through the remainder of the year. Our 2023 WFE estimate reflects a tops-down assessment of industry demand as follows: in memory, we expect WFE investments to decline by approximately 40%; foundry/logic to decline by about 10% overall, with legacy investment outperforming the segment overall due principally to automotive and continued demand for legacy design nodes. KLA's primary value proposition is focused on enabling innovation through technology transitions, which our customers continue to prioritize across all business environments. While capacity plans are often adjusted due to changing demand expectations, technology roadmap investments are more resilient. This adds additional confidence to our business expectations as customers align shipment slots with roadmap requirements. In this environment, we will continue to focus on meeting customer requirements, maintaining our high-level investment in R&D to advance our product roadmaps and KLA's market leadership, and delivering strong relative revenue growth and financial performance. Moving to guidance now. Our September quarter guidance is as follows: total revenue is expected to be $2.35 billion, plus or minus $125 million. Foundry/logic is forecasted to be approximately 70% and memory is expected to be around 30% of Semi PC systems revenue. Within memory, DRAM is expected to be about 90% of the segment mix and NAND at 10%. We forecast non-GAAP gross margin to be roughly flat at 61%, plus or minus 1 percentage point as product mix expectations and cost components are consistent with the prior quarter. Given our current view of a stabilizing demand environment for the remainder of 2023, we expect full-year calendar gross margin to trend near 61%. Non-GAAP operating expenses are expected to be approximately $535 million as cost measures executed earlier in the calendar year align our current cost structure with top-line expectations. We would expect quarterly operating expenses to remain around this level for the remainder of the calendar year. Other model assumptions for the September quarter include other income and expense net of approximately $48 million and an effective tax rate of approximately 13.5%. Finally, GAAP-diluted EPS is expected to be $5.02 plus or minus $0.60 and non-GAAP diluted EPS of $5.35 plus or minus $0.60. EPS guidance is based on a fully-diluted share count of approximately 137 million shares. In conclusion, we continue to see process controls' importance to technology transitions and advancements key to R&D growth and prioritization despite persistent weakness in our customers' businesses. We are also exposed to wafer and reticle infrastructure investments that are contributing to our revenue performance. As a result, KLA remains positioned for strong relative performance versus the industry in 2023. Looking ahead, we continue to see the business environment stabilizing and remain confident that the secular trends driving long-term semiconductor industry demand and investments in WFE remain strong and compelling. Broadening semiconductor demand and simultaneous investments supporting growing semiconductor content across multiple technology nodes remain catalysts for sustainable long-term industry growth. Multiple applications for leading-edge roadmaps are driving competitive dynamics and design challenges requiring more customer engagement and faster time to results. Technology investment and node transitions reflect the value that semiconductors and our industry have at lowering costs for our customers and enabling a broader application universe for semiconductor-based technology across multiple end markets. While a global economy and semiconductor industry are facing challenges, KLA is well positioned to deliver strong relative financial performance, driven by better than market performance of our Semi PC and SPTS businesses and continued growth in Services. We remain focused on innovation as we execute our portfolio strategy to support our customers' technology roadmaps and multiyear investment plans. Per the KLA operating model guiding our execution, we will implement our strategic objectives and drive outperformance. These objectives are also the foundation for our technology leadership and competitive differentiation. Our focus on customer success, delivering innovative and differentiated solutions and operational excellence continues to enable us to deliver industry-leading financial and free cash flow performance while delivering consistent capital returns to shareholders. That concludes my remarks. I'll now turn the call back over to Kevin to begin the Q&A.

Thank you, Bren. Chelsea, can you please provide instructions and queue for questions?

I was wondering if you could maybe talk about the strength that you're seeing in your blank wafer business. How do you see that looking into next year? And is there a risk of maybe some digestion after a pretty strong investment cycle there?

Thank you for your question, Joe. This year has been strong for us, and we hold a solid market position in that area. We are witnessing investments from major global players as well as infrastructure investments in China to boost domestic supply. The investment cycle there tends to differ; I wouldn't describe it as countercyclical. The lead time for acquiring equipment to manufacture silicon wafers is significant, which is why customers continue to invest in anticipation of future demand. Additionally, they are addressing new capacity needs linked to hybrid bonding and other wafer-to-wafer packaging techniques that are generating incremental demand. Looking ahead, we expect growth to continue this year. However, as we enter next year, I anticipate some moderation in that investment. While I don't expect a significant decline, I don't foresee it increasing further next year.

Got it. That's helpful. And then as a follow-up, you guys saw some pretty significant upside to your memory kind of expectations or at least relative to what you were thinking three months ago, particularly around DRAM. Just wondering if you could maybe comment on what drove that in the quarter?

Sure. We had some movement across a number of our customers, and the number overall is, frankly, pretty low. But that was part of it. The other part is we also had some shipments that we weren't expecting to make in the quarter related to one of our Chinese DRAM customers. And a clarification of some of the export rules enabled us to ship some additional equipment there, so that was a factor in the upside on the DRAM side.

I guess first question, can you update us on where optical inspection lead times are? And given the importance of that tool set for R&D lines, is that something that you expect will sustain at elevated levels? Or do you think that should normalize over time?

C.J., it's Rick. The answer is the demand continues to be very strong and for a couple of reasons that we've talked about many times. And we have struggled in increasing the output, so we're still booked out through, as far as we can see, into next year. So business remains strong. The product has had a lot of success dealing with some of the challenges we're seeing. So we expect that to remain elevated, and we're working hard to actually increase capacity in order to meet that demand, but that's going to take some time.

Yes. Lead times will come down a little bit. I don't know if they'll come down all that much, given the drivers of that product line. But as new capacity comes online as we move through '24 and beyond, we'll see them come down a little bit, but I think you'll still see them remain elevated for some time.

One of the positives we discussed previously, C.J., is that we're still operating Gen 4 alongside Gen 5. Gen 4 is experiencing strong adoption in areas we didn't initially predict, such as automotive. Therefore, we are still benefiting from favorable conditions for that.

Very helpful. And I guess as my follow-up, encouraging to see your Semi Services business grow sequentially. Can you kind of comment on how you see that playing out in the second half? And what kind of potentially negative impact are you seeing from lower utilization from your memory customers?

We are very pleased with the performance in Services. It is not unusual for us to see increased Services utilization during a downturn, as customers look to maximize their yield capabilities. We have observed higher utilization rates than what some customers initially forecasted, particularly in leading-edge logic and foundry. This has been a positive development. Memory utilization appears to be slower, which aligns with our expectations. Overall, based on the shipment levels, we are optimistic about the long-term outlook for our Services business.

Rick, obviously, you have like very strong revenues from China. There's been some chatter that the U.S. might expand export controls, even maybe mature nodes. I know right now, you're capped at 14-nanometer and below for foundry/logic. Is there any commentary you can give on that? And how to think about it, like, let's say, for example, 14 goes to 28, the restriction, or 28 goes to 40. Is there a way to quantify the impact to your sales? And then I have a follow-up.

Yes, I won't speculate what the government will do or not do on that. We have ongoing conversations with them, obviously, and really, we've been supportive of their efforts to try to figure out how to cut off the very leading edge. Beyond that, that's not conversations we've been having with them. But in terms of quantifying, obviously, given that most of the business we have in China is legacy, that would obviously impact our ability to support them in legacy.

Thanks, Rick. As a follow-up, based on the numbers, it seems you're set to outperform WFE once again this year, continuing the trend from the past couple of years. While some of your peers faced supply chain constraints, you did not. This year, there are significant technology purchases happening. I'm curious, as we move into next year and the following years, with WFE expected to rebound, could there be a risk that some fabs that have already purchased process control equipment might lead to you underperforming in WFE?

I would say that we faced supply constraints, but for a different reason. We continue to struggle with the demand we have for optical. As I mentioned before, we are still seeing demand for it. While we managed our supply chain, there were still gaps. It wasn't that we encountered unexpected issues; we simply couldn't ramp up as quickly as some of our customers wanted. The intensity of process control has increased. One thing we clearly forecasted and are now witnessing is that as EUV is adopted across more nodes and advanced architectures, the need for process control has grown, and that's what we are experiencing. When we discussed this during Analyst Day and what we are observing now, there is an increased need for process control across all technologies. We are optimistic about how this looks moving forward and we remain committed to the forecast we set during our Analyst Day for 2026.

Congrats on the good results. A few of your peers have talked about fab readiness impacting their shipment this year, especially for EUV tools. Is that something that you already kind of factored in your WFE outlook you gave a quarter ago, when you also said foundry/logic would be down 10%, which you reiterate today? Or are there some other offsets that you would point out that kind of offset that?

Yes, it's a good question. We had already considered this in our plans. What you're seeing are adjustments to some of the ramp plans. While we are still shipping some tools to these facilities, it is fewer than before. We had made the necessary adjustments. Generally, shorter lead time tools are affected first, and then the delays gradually impact everyone, although this takes time. We are confident about the forecast we shared regarding our expectations for the next couple of quarters.

Okay. Great. That's helpful. As a follow-up, speaking of China, I know the revenue is now back to the 30% level. You talked about some of the shipments that came in a little earlier. But I want to ask a little bit from a different angle. It's clear that there is a big push for self-sufficiency in China, but certain tool sets are harder to replace than others. Can you give us maybe a little bit of color on the competitive dynamics there, that some of your process control clients could be satisfied by domestic companies?

Yes, our market share remains strong. We began focusing on legacy market opportunities several years ago and even revitalized some older product lines, which continue to compete effectively at all price points. While there is increased competition at the trailing edge, we are confident in our position to succeed. Many customers worldwide trust our capabilities, and we believe we can compete against any rivals. Our history of competing based on our capabilities means that competition in China is not new to us.

And you have to remember, our competitive offerings in China or in any other region are really based on the portfolio of products that we can offer. So we can offer lots of solutions to our customers. To Rick's point, some of our older generation tools, which we've restarted, but even deconfigured versions of more recent tools. And then we allow our customers to manage across their requirements, either for economic or more advanced tools, more capabilities. So our go-to-market in terms of the portfolio benefits us in that region as much as it does anywhere else.

I guess understanding, again, that memory investment in general is reduced, and it sounds like the China memory shipment might have hit there in the June quarter, but if I were to assume that some of your DRAM activity in coming quarters will be more geared toward DDR5 and applications for high-performance, high-density DRAM for data center and AI applications, are you noticing or anticipating a higher level of process control intensity for that kind of spend?

Well look, for more advanced DRAM, particularly with the introduction of EUV, it's driven higher intensity levels, and there's the infrastructure to support the introduction of that, particularly around reticle quality and reticle fidelity. That's been a driver of process control intensity for us over the last couple of years. And so I would expect that, that we'll continue to see it. I'm not expecting to see an uptick in business from memory customers. There will be some additional business from the Chinese DRAM customer in the second half of the year. But we're not really seeing any changes in overall utilization rates in memory, as Rick said earlier, and so I think until our customers start to see a pricing improvement, improve their profitability and cash flow, I don't think we're going to see meaningful investments. Now we will participate in process node development, as we always have. And that's going to be the biggest driver of the contributions from that market.

Okay. Got it. That's helpful. And then maybe just a broader follow-up question. Obviously, there's some underutilization of capacity at the leading foundries, more advanced FinFET nodes. And this might just be a cyclical phenomenon, but in your conversations with them, do you detect any changes in how they might elect to deploy capital in support of multiple advanced nodes differently?

Well, I mean they've slowed down. I mean for sure, we've seen and heard the reports on forecast for their investment in WFE going down. So I think that's been the main one. What the leading indicators that we are looking at that are encouraging, as I mentioned earlier in this call, we've had utilization rates creep back up from what was forecasted just a few months ago. The other thing is we're still seeing a heavy number of design starts. And so of course, it takes a while for those to filter through. But we still anticipate a very large number of designs at the advanced node, and so that will portend for a strong business down the road. You can't pick the timing, but I think that the slowdown in terms of their investment is related to the overall business environment, but not the fundamental dynamics. I think that looks pretty good as we get the next few quarters behind us.

Bren, can you give the purchase obligation number? I think it was about $12 billion last quarter. I assume it came down a smidge and the book-to-bill is still less than 1. And then also, can you tell us how much is sitting outside of 12 months, that number?

So the specific details will come through when we file our K here in another week or so. But it was down about a little over $500 million quarter-to-quarter. So book-to-bill was a little less than 1. We still see some activity in terms of new orders. So the backlog levels are obviously very elevated. So it's come down. It seems like it's been coming down right around that $500 million or so per quarter for the last few quarters, but still close to $11.5 billion overall. And the beyond 12 months is between 40% and 50% of it, which we deliver beyond the 12-month window.

Cool. Bren, for the guidance in December, it appears that process control system shipments are relatively stable. It seems that EPC might see a slight increase since you previously mentioned it would decline by about 20% for the year. Is that correct? Also, during the last call, you indicated that the process control shipments in December would depend on a few projects. So what are the key factors influencing process control shipments in December?

I don't want to provide specifics for December guidance. However, aligned with the remarks I prepared, we expect a stabilizing trend moving forward. There may be fluctuations of around $20 million to $30 million across various segments due to our average selling prices. We focus on meeting overall business targets rather than specific numbers in each segment. Services continues to grow and will likely see incremental growth each quarter as our installed base expands. EPC may experience some volatility, but I remain optimistic that it will improve as we approach year-end, although I am not forecasting it at this moment. EPC serves as a good indicator for consumer markets due to its short lead time and capacity focus. We expect to see a recovery there sooner than in the Semi PC segment. The Semi PC sector should generally remain consistent with the results from June as we move into September, reflecting a relatively flat guidance from quarter to quarter. There are some projects at year-end that could affect delivery numbers in December, leading to potential increases, but overall we see the business stabilizing over the next few quarters.

Maybe as a follow-up to Tim's question, your prior view was for process control to be down roughly mid-teens, right, relative to WFE, which was down 20%. Now off of the better June quarter results and if I flatline stabilize that process control for the remainder of the calendar year after the June quarter, it looks like your process control franchise is actually going to be down only 10% to 12% for the full year. So even better outperformance versus WFE. You mentioned mask inspection, bare wafer, strong dynamics. Like what other product segments are driving the better implied outlook for process control?

Yes. Yes, your math is consistent. So yes, that's how it will play out, assuming the December quarter comes through the way we expect today. We talked about bare wafer obviously being a strong driver, optical inspection. Reticle inspection is also a business that isn't declining as much as the overall market. So we've seen strength in those areas. So it's mostly there. Look, given the percent of investment that's happening in logic and foundry, obviously, the process control intensity there is higher than it is in memory. So that tends to provide a nice tailwind in terms of the dynamics within WFE playing towards KLA. And so obviously, the products we talked about are big drivers. But overall, it's good in terms of the percent spend on our products as a percent of the total.

I appreciate that. Is that advanced packaging demand is kicking off quite strongly, right, driven by all these accelerated compute workloads like AI, right? You have HBM, CoWoS packaging, multichip stack-die configuration. TSMC, Intel, all the memory guys, the old stacks, right, you guys supplying to all of them. Are you seeing the demand pick up for your solutions for accelerated compute applications? And is the advanced packaging segment growing this year for the team? Or is that sort of AI accelerated compute demand being somewhat offset by some of the more consumer-focused end markets?

Harlan, yes, that's a good observation. We have noticed an increase—not many bright spots with our customers, but this is one that has occurred fairly recently. We’ve seen a rise, though it's a relatively small percentage overall. It has increased significantly, but it's still off a small base. We have indeed observed this, and we see it directly linked to some accelerated orders from work we've done with EPC and by combining some of our offerings, like Semi Process Control and EPC. We have definitely seen an uptick in that area.

Yes, you had the overall packaging market down, what, 15% to 20% or so. But if we look at our packaging business within the company, it's pretty flattish year-to-year. Rick talked about some of the recent upside we're seeing related to some of the AI drivers that are occurring right now. So it's a good and evolving story moving forward as more complexity moves into the package across process but also process control.

I have a question on leading-edge logic investments. At SEMICON West a couple of weeks ago, when you spoke to suppliers, there were expectations that the leading-edge spending could be up less than mature nodes into next year. And I assume process control intensity is higher on leading versus mature nodes. So my question to you is, are there any major product cycles or e-beam or X-ray or major contribution from areas like auto, which could help perhaps offset your exposure to leading-edge investments next year?

Sure. It's important to remember that KLA is still facing supply limitations on some of our key process control products, especially those relevant to leading-edge technology, such as optical and certain reticle products. We are unable to meet demand at this time. This situation acts as a natural constraint on our ability to sustain that business over the coming quarters, even considering the current booking environment. Additionally, we are observing a significant demand for leading-edge technology in the R&D phase, particularly as new transistor architectures emerge. Overall, we feel confident in our position, especially compared to those primarily focused on capacity.

Thank you very much, Chelsea, and I wanted to thank everyone again for their interest and their time. We know it's a very busy earnings season. It's also a very busy day. This was a later call in order to try to accommodate as much as we could. So we look forward to speaking to all of you in the weeks ahead. And with that, I'll turn it back to Chelsea for any final remarks.