KLA Corporation

Ladies and gentlemen, thank you for standing by, and welcome to the KLA Corporation Fourth Quarter Calendar Year 2019 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press the star 1 on your telephone keypad. If you require any further assistance, please press the star 0. Please be advised that today's call is being recorded. I would now like to hand the conference over to Mr. Kevin Kessel, Vice President of Investment Relations for KLA Corporation. Please go ahead, sir.

Thank you, Charlie, and welcome to KLA's earnings conference call to discuss the results of the December 2019 quarter and the outlook for the March 2020 quarter. Joining me today is Rick Wallace, our Chief Executive Officer, and Brent Higgins, our Chief Financial Officer. During today's conference call, we will discuss quarterly results for the period ended December 31, 2019, that we released today after the market closed, and is currently posted on the investor relations section of our website at ir.kla.com. Today's discussion of our financial results and outlook is presented on a non-GAAP financial basis, unless otherwise specified. A detailed reconciliation of GAAP to non-GAAP results is in today's earnings press release and the earnings slides presentation posted on the KLA website. Investor Relations website. Our IR website also contains a calendar of future investor events and presentations, including those from our September 2019 Investor Day and corporate governance information, including our quiet period policy, as well as links to KLA's 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 factors disclosure in our SEC filings. Any forward-looking statements, including those that 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. I'd like to now turn the call over to our President and Chief Executive Officer, Rick Wallace.

Rick? Thank you, Kevin, and thank you all for joining us today. I'm going to begin with a high-level strategic overview aimed at what drives KLA's long-term business success and differentiation strategy. before I cover the near-term December quarter business highlights. Please turn to slide four. KLA continues to benefit from multiple secular growth drivers we discussed in depth at our September 2019 Investor Day. Our performance this quarter in our strategies for diversified growth, technology leadership, and operational excellence are playing out according to our plans. By numerous measures, the December 2019 quarter was strong for KLA. Revenue and both gap and non-gap EPS finished at the upper end of the range of guidance, a result of strong demand and exceptional execution. This performance was particularly satisfying, given it was set against a backdrop of still lackluster memory demand. As the global leader in process control and supplier of critical process enabling solutions for the data era, KLA remains at the forefront. of the most important industry trends and technology inflections in the electronics industry. Our deep collaborative customer relationships, broad IP portfolio, and differentiated solutions that address our customers' most complex challenges are the essential ingredients in the recipe that sustains our market leadership. Our business also continues to benefit from increasing complexity and advanced semiconductor device design and manufacturing processes as well as megatrends driving demand across multiple product generations and in numerous key industries. Please turn to slide five. Underpinning our success and consistent outperformance is the KLA operating model. Many of you are becoming more familiar with this model, given that we spent a fair amount of time in our investor day discussing it. And while it's not new to KLA, we understand talking about it may be, which is why we decided to codify it the way that we did. Expect to continue to hear us refer to it as it does the best job of simplifying how we run the company. It also helps reinforce the critical core competencies that we believe can enhance the long-term performance and profitability of acquired businesses such as Orbitek. Most importantly, the KLA operating model is critical to align the company on a consistent strategy and execution heighten accountability, and facilitate continuous improvement while ensuring we always operate with strong financial discipline and rigor. Please turn to slide six. Strategically, we have four objectives that serve as our guide and drive our sustainable high-performance culture. I find it's always worth reinforcing objectives when speaking with investors and analysts as they provide a helpful window into our strategy going forward. These four objectives are market leadership, product differentiation, operational excellence, and attracting and developing talent. We run all our businesses and integrate newly acquired companies with a focus on these four key objectives. Today's results point to our alignment and achievement of all four of these. Please turn to slide seven for the December quarter business highlights. Before I cover the business highlights for the quarter, I'd like to provide some high-level perspective on the current industry environment. I'll begin by addressing the coronavirus situation. First and foremost, our primary concern is with the health and well-being of all affected by the situation. We are taking the recommended precautions and have implemented appropriate measures within our global business operations, including widening the range of guidance for the March 2020 quarter to reflect the uncertainty we see in the marketplace. Bren will provide further color on this. We are closely monitoring this situation and will update investors as material new developments arise. Nonwithstanding this hopefully short-term issue, the long-term growth opportunity for the semiconductor market remains very compelling, driven by the proliferation of electronics across more diversified end markets, the introduction of new advanced technologies supporting the development and rollout of 5G, growing semiconductor investment in China, and continued device and performance innovation to develop superior performance and return on investment. KLA's strong results are primarily driven by our industry-leading positions across various markets and the demand momentum that has continued for both technology development and capacity growth in advanced logic nodes. The demand to support advanced logic nodes is expected to remain healthy through 2020 and in 2021, driven by accelerating investment in EUV, competitive dynamics, and new capacity additions. 2020 is setting up to be our fifth consecutive year of year-over-year growth for KLA, with top-line growth currently expected to be in the high single to low double-digit range. tracking ahead of our long-term revenue growth of 7% to 9% that underpins our 2023 target model. In terms of our outlook for the WFE wafer demand environment in 2020, given the recent news of increased CapEx investment from leading Foundry and Logic customers and the improving business conditions in memory, we are aligned with the consensus expectations for 2020 to be a growth year for WFE, coming off a stronger than anticipated finish to 2019. Now let me cover some of the product highlights from the quarter. KLA's market leadership is the product of successful execution of our portfolio strategy, focused on differentiation to address our customers' most critical challenges. We are confident in our product positioning and the validation from strong customer acceptance across our portfolio. We continue to see accelerated growth of our flagship Gen5 optical inspection platform, deployed for both technology development and production monitoring at the advanced nodes. Our customers are now using the Gen5 platform to identify and solve yield-limiting issues at the 7-nanometer node and beyond. We're also encouraged by the growing adoption of patterned wafer print check applications to qualify reticles for EUV. Gen5 offers the best solution to make sure EUV masks are defect-free and optimized to achieve process window requirements. Boosted in part by this expanded use case, Gen5 shipments nearly tripled in 2019. and adoption is expected to grow in 2020. Also, at our recent investor day, we announced our first new E-beam inspection platform in multiple years, and we continue to receive very positive feedback from initial customer evaluations, and we're starting to receive purchase orders. KLA's E-beam inspection platform works seamlessly with our Gen 5 optical inspection platform through built-in connectivity, offering customers the best inspection performance combination at the lowest overall cost of ownership. This combination is a unique differentiator in the marketplace today, and we can identify and detect critical yield-limiting defects at the most advanced nodes. After proving the value of the technology in initial customer evaluations, we delivered the industry's first production-ready version of the X-ray metrology platform to customers in the December quarter. Introduced initially at our September Investor Day, the Axion platform is a small angle x-ray scattering technology for inline metrology applications to monitor the high aspect ratio features in advanced 3D and DRAM device architectures. This platform provides a lower cost of ownership and improved cycle times when compared with existing destructive metrology techniques. We're now focused on establishing new use cases with all leading memory customers. Last but certainly not least, KLA's service business continues to deliver excellent revenue growth performance while simultaneously generating strong free cash flow. Semi-process control service revenue reached $1.1 billion in 2019, with 70% of this revenue generated from subscription-like service contracts. This performance continues to give us high levels of confidence that KLA services can deliver long-term revenue growth rates in the range of 9% to 11%. Several factors drive growth in our services business, including increased complexity of our systems, expansion of the installed base, and expanded demand at the trailing edge nodes. With high fabulization in Foundry and Logic and signs of improvement in memory, our customers are also looking for opportunities to enhance productivity and extend the life of their installed base. As a result, we see robust service contract penetration, and our service business is providing a steady recurring revenue stream for all our businesses. Please turn to slide eight. In summary, the KLA operating model drives our investment thesis. This is accomplished by driving sustained technology leadership with a strong competitive mode, supported by a track record of strong free cash flow generation and capital returns. As we begin the new year with the expectation that the industry will see a resumption of growth in 2020, we are energized by the prospects that lie ahead. KLA continues to execute exceptionally well and deliver healthy relative revenue and earnings growth. Our focus on driving innovation and providing a steady stream of differentiated products and solutions position KLA to achieve the long-term growth targets we established at our 2019 Investor Day. Despite industry headwinds, 2019 was a historic year for KLA, showcasing the enduring value created by the successful execution of our strategic objectives. As we look ahead, we are confident that we're investing in our future and are well positioned for growth and market leadership, building on the momentum we have established in our process control markets and capitalizing on the market expansion opportunities from the Orbitek acquisition. Our Orbitek integration and product synergy programs are firmly on track and progressing well. I'd like to now turn the call over to Bren for his commentary on the December quarter financial results in our March quarter outlook. Bren?

Thank you, Rick. Please turn to slide 10 for December quarter 2019 financial highlights. This was a strong quarter for KLA, with revenue and EPS each coming in at the high end of our guidance ranges. Total revenue for the December quarter was $1.509 billion, which was at the upper end of the range of guidance of $1.435 to $1.515 billion. Gross margin for the quarter was 60.8%, and the upper end of the guided range for the quarter of 60 to 61%, driven by incremental revenue growth and product mix. Operating margins was set 34.8%. GAAP EPS was $2.40, and non-GAAP EPS was $2.66, both of which were also at the upper end of the range of guidance of $2.13 to $2.43, $2.39 to $2.69, respectively. Cash from operations and free cash flow were both strong and above our internal targets, coming in at $388 million and $353 million, respectively. Our financial results this quarter were exceptionally strong all around, and we remain laser-focused on our overall execution, as well as our integration and synergy plans for Orbitek. During the quarter, we remained consistent and effective in our capital return framework by returning 119% of quarterly free cash flow to investors. Our capital return was accomplished by repurchasing $285 million of common stock and also distributing $135 million in quarterly dividends. We currently have $1.3 billion remaining under our share repurchase authorization and plan to continue to execute our repurchases consistently going forward. A key pillar of our investment thesis is KLA's longstanding commitment to returning cash to shareholders. For calendar 19, KLA returned approximately $1.5 billion, or 127% of our free cash flow to shareholders through our dividend and share repurchase programs. Our capital return included more than $1 billion in stock buybacks. Please turn to slide 11 for revenue breakdown by reportable segments and end markets. Revenue for the semi-process control segment, which includes the associated service business, was healthy at $1.248 billion in the quarter, up 7% sequentially on the back of continued strength in Foundry and Logic. As Rick mentioned, our initial view of the WFE demand environment for 2020 is for solid growth off of a better than expected finish to 2019, driven by continued strong investment from multiple Foundry and Logic customers, investment in EUV, and expanded memory investment in the year. In addition, continued high levels of demand from native China is expected to contribute to overall industry growth in 2020. As I mentioned, Foundry was very strong in Q4 at approximately 52% of semi-process control revenue, up from 44% last quarter. Memory was 40% in December, down from 43% last quarter. Logic was 8% versus 13% last quarter, and in line with our expectations. I'll turn now to the specialty semiconductor process segment. As a reminder, SPTS was formerly part of Orbitek and is a leader in PVD and etch process solutions in fast-growing specialty semiconductor applications like MEMS, sensors, power and RF devices, as well as in advanced packaging markets. Revenue for SPTS was $75 million, up 9% sequentially. While SBTS revenue for 2019 was impacted by global trade issues, we expect 2020 to be a year of strong growth, driven by expanding RF demand to support 5G investment and a potential recovery in the automotive electronics market in the second half of the calendar year. On a very encouraging note, SBTS ended the December 19 quarter with record backlog in quarterly bookings. Revenue for the PCB, display, and component inspection segment was $186 million, up 4% sequentially and in line with expectations. This segment includes the former PCB and display businesses of Orbitek and KLA's component inspection business. After a cyclical low, we expect 2020 to be a modest year of growth for PCB, driven by the transition to 5G smartphones. Please turn to slide 12 for a breakdown of revenue by major products and region. The distribution of revenue by major product category in the December quarter was as follows. Wafer inspection was 40%. Patterning, which includes reticle inspection, was 19%. Wafer inspection and patterning are part of our semiconductor process control segment. Specialty semiconductor process was 4%. PCB display and component inspection revenue was 9%. Service was 24% of revenue in the quarter. Other was 4%. In terms of regional split, Taiwan was 30%, China was 25%, Japan was 13%, Korea was 12%, the U.S. was 11%, Europe was 6%, and the rest of Asia was 3%. Please turn to slide 13 for other income statement highlights. Total operating expenses were $391 million in the quarter, including $220 million of R&D expense. Operating expenses were slightly higher than expected in the quarter due to non-headcount related engineering development expenses and modest variable compensation adjustments. Operating margin was 60 basis points higher than modeled at 34.8%. Other income and expense in the December quarter was 38 million. The effective tax rate was 13.5% in line with our long-term tax planning rate of 14%. Going forward, based on our expectations for the geographic distribution of profit, You should now use 13% as the long-term tax planning rate. Net income was $422 million, and we had just under $159 million diluted weighted average shares outstanding. Please turn to slide 14 for a look at our balance sheet highlights and debt maturities profile. We ended the quarter with $1.7 billion in cash, total debt of $3.4 billion, and a flexible and attractive debt maturity profile supported by investment grade ratings from all three agencies. In October, we retired our 250 million, 3.375% senior notes due November 2019. We intend to refinance our $500 million senior notes due November 2021 during the March quarter. Please turn to slide 15 for a review of free cash flow. KLA has a history of consistent free cash flow generation and high free cash flow conversion. Over the past five years, we have averaged 99% free cash flow conversion, and in calendar 2019, it was nearly 90%. Our innovation and differentiation in the marketplace are what drives our industry-leading growth and operating margins, and ultimately our free cash flow conversion. Please turn to slide 16 for a review of our capital return to investors. KLA continues to execute on its commitment to return capital to shareholders in the form of both dividends and share repurchases. The dividend payout has increased at a CAGR at 15% since inception 13 years ago. Share repurchases have also increased over the years, with the average price paid for repurchased shares being slightly under $70 and with approximately $3.8 billion deployed for repurchases since 2010. The only exception to the company's systematic repurchasing activity was during the periods when it was blacked out due to acquisition proceedings. Please turn to slide 17 for March quarter 2020 guidance. The fluid situation accompanying the coronavirus response is adding complexity to our forecasting process. As seen with others, we are operating with key assumptions regarding the resumption of business activities in China, both in Hubei Province in addition to the rest of the country. To date, we do not expect a protracted disruption of our business for calendar year 2020. Policy changes regarding the response could affect our ability to ship and support shipments into China as well as to access key components from our China-based supply chain necessary to meet system shipment commitments to our worldwide customer base. In short, this is a situation with limited visibility that could impact our near-term results, and we will be prudent in providing you with the best information we have as we proceed through the quarter. As Rick mentioned, the range of guidance has been widened to reflect this quarter's uncertainty and our current estimate of potential disruption. We expect total revenue to be in the range of 1.325 billion to 1.525 billion in the March quarter. This revenue guidance would have approximately been 3% to 5% higher at the midpoint without the adjustments for the coronavirus impact. Foundry is forecasted to be about 60% of semi-process control system revenue in the March quarter, depicting the strength we continue to see amongst our Foundry customer base. We expect memory to be approximately 28% of system revenue, reflecting continued headwinds we see in the memory market. Logic is expected to be about 12% of semi-process control system revenue next quarter. Based on product mix expectations for the March quarter, we forecast gross margin to be in the range of 59.5% to 61.5%. Operating expenses will be in the range of $380 to $385 million, down sequentially from December as prototype material expenses normalize to run rate. Given expected revenue levels for 2020, new product development investments of multiple product technologies to support the industry's transition to high volume production of EUV lithography, and initiatives to reduce our long-term structural cost position, we expect quarterly operating expenses to remain in this range for the remainder of the calendar year. For 2020 operating margin, we are running the company to perform in line with the $5.5 to $6 billion revenue interval of our business model presented at investor day back in September. We expect other interest and expense to be approximately $39 million in the quarter and the effective tax rate to be 13%. For earnings, we expect GAAP diluted EPS of $1.79 to $2.57 per share and non-GAAP diluted EPS of $2.04 to $2.82 per share. Our EPS guidance is based on a fully diluted share count of approximately 158 million shares. In conclusion, the December quarter results demonstrated strong performance and relative strength for KLA across many areas of our business. With our diversified end markets, continued technology leadership across a broadening product portfolio, and operational discipline, KLA is delivering on our mission, strategy, and objectives. As we begin the new year, calendar 2020 is shaping up for another year of growth in line with or slightly better than our long-term revenue growth rate target of 7% to 9% earnings per share growth of 1.5 times the revenue growth rate, and demonstrating progress towards our 2023 revenue and non-GAAP EPS targets of $7 to $7.5 billion and $14.50 to $15.50 per share. With that, I'll now turn the call back over to Kevin to begin with the Q&A.

Thank you, Brent. As we begin the Q&A, we request you limit yourself to one question and one follow-up question to ensure we get through as many questions as possible. With that, Charlie, we are ready for the first question.

Please, gentlemen, if you would like to ask a question, please press the star 1 on your telephone keypad and wait for your name to be announced. Your first question comes from the line of CJ Muse from Evercore. Your line is now open.

Good afternoon. Thank you for taking the question. I guess first question, you talked about 2020 year-over-year growth of high single to low double-digit. And based on the other segments, it looks like that implies your semi-business growing, you know, roughly 9%, 11%. So curious, you know, is that the right math? And then as part of that, what are the puts and takes in terms of process control intensity in 2020, presumably a year with more memory, which, you know, is an obvious negative. However, you have your new X-ray tool and growing share at NAND. as well as Gen 5 and exposure to EUV. So can you kind of walk us through the puts and takes around your exposures to WFE, both good and bad, in 2020?

Yeah, sure, CJ. It's Brandon. I'll go first here just in terms of just context on the numbers. I mean, certainly, you know, 2019 finished much stronger than what we expected, which was good to see. And as we look at 2020, if you go back to last earnings versus where we are today, you Given what we've seen in the Foundry logic space, we'd expect to see more growth in the space this year than what we thought before. And I don't think that our views on the memory environment have changed all that much, that we'll see flash memory recover. We would expect to see that through the year. And we're not relying much on DRAM in our overall forecast in terms of incremental WFE investment. So When you take all those puts and takes and then say, okay, where's the growth coming from? So certainly our logic foundry process control intensity is good. Some of the growth coming from memory is lower process control intensity. But to your point, we do have new product introductions that we believe will help drive some of that. So our assumptions is that we think from a process control intensity perspective, it stays relatively flat year over year. And with new product introduction, we would expect to see some modest share improvement as well. So that's pretty much how we see things at this point.

Very helpful. And as my follow-up, how should we think about seasonal trends for your PCB business? You know, I imagine that that's much more of a second-half Apple-weighted kind of ramp. So, you know, is there any sort of, you know, kind of range, first-half, second-half kind of mix there?

I would expect PCB to be stronger in the second half. It tends to be more mobile centric. So to your point, we would expect to see stronger revenue profile in the second half for PCB. Would expect this year to be, as Rick had indicated, a year of modest growth in the space. And keep in mind in that part of the business, we also have a big chunk of it is also service where it's over 90% of its contract base. So there's a high service utilization on those tools and stickiness to the investment as well.

Thank you very much.

Thanks, CJ.

Your next question comes from the line of Harlan Seward with J.P. Morgan. Your line is now open.

Good afternoon, guys. Great job on the quarterly execution and strong start to 2020. Great services showing on process control in calendar year 19. According to my calculations, your services business was up about 11% and at the upper end of your long-term target of 9% to 11%. On your full year view of 10% revenue growth for the business here in calendar 20, based on your installed base growth in 2019, how do you see your process control services business growing in calendar 20?

So I think when you look at the comparison to the year, I mean, certainly we've got some incremental growth from the inclusion of the Orbitek business in 19 that drove the growth rate to the upper end of the range. So on the process control side, given the weakness in memory, particularly in the first half of the year, it did push us down towards slightly below the 9% to 11% range in terms of year-over-year growth for the process control part of the business. As we look at 20, though, as we've seen utilizations tighten pretty significantly, both in memory but also in the logic space over the course of the year, we would expect the service business to perform in line with its long-term growth rate expectation, which is the 9% to 11%. So we feel pretty good about what's going on there. Certainly the contract penetration is high, as Rick had indicated. I think with rising utilization with new products, given demand from customers as they ramp new facilities, we tend to see strong service performance there, and I would expect to see that play out in 2020. So I'd expect more growth next year or in 2020 versus 2019.

Yeah, I appreciate the insights there. And, you know, a big part of the growth that the team has been driving is really due to new product cycles, right? Gen 5, Terran for EUV as an example, To that end, can you guys just give us an update on some of your next-generation programs, like X-Ray for stack profiling, eBeam both for wafer and reticle, maybe some rough guidelines on product launch timing and contribution to revenues?

Yeah, I'll take part of that, and then Brent can talk about contribution. As we talked about it at the analyst day and also in our last earnings call, we – have seen progress in some of the new products. We introduced the Axion, and I mentioned that in the prepared remarks. We're seeing POs now for some of the e-beam inspection tools that before were under evaluation. So we're pretty much on target in terms of the growth potential that we envisioned when we laid out the 2023 plan, and that starts to become more material in the second half of this calendar year. We're very excited about what we've seen with the CDE product because the x-ray product, we're seeing more use cases. We're getting customers to give us really positive feedback, and we see a continued acceleration. Then I'd also say that the e-beam inspection combined with the optical tool has been performing as we expected, and we're seeing momentum grow there. So we're on target. We continue to be on the strategic objectives that we laid out for those products. to get us to where we believe we need to be to support our 2023 plan. And in terms of impact for this year, it's more second half loaded. And so Brent can talk to a little bit of sizing it.

Yes, to Rick's point, I mean, it's an important part of our strategy here to seed the market with these products and to start to develop use case and to drive value with these offerings with customers. And so initial results are pretty promising. And it's really one of the factors as we look at those products, whether it's incremental Gen 5 print check applications, which is how customers will qualify reticles in the fab. in EUV or whether it's E-beam to RixPoint or X-ray metrology, we're really excited about the contributions from those products as we move forward here. So, you know, the contribution in 20 will be, you know, less than what I would consider sort of a steady state expectation for those business because we're starting to see the market with those products, but we will see revenue, and I would think that it's one of those factors that I believe keeps process control intensity despite the memory growth that we would expect to see in 20.

The one other area you didn't ask about, Harlan, but just for more perspective, the Gen 5 adoption has accelerated throughout 2019, and now in 2020 we're seeing additional growth, and we're seeing it really being a major product for multiple customers on both advanced but some nodes that we would have thought Maybe it was late for insertion, but we're finding some applications. And where it's really gaining some traction is with EUV qualification. And I mentioned that in the prepared remarks, but I think it's really important as EUV fans out. We think it's a great opportunity for Gen 5 to exceed even some of the potential that we had originally envisioned. because it's really the best way to verify the quality of the EUV masks, and especially as customers are ramping the number of devices running on EUV, we're seeing a lot of support and interest from our customers for that. So we feel really good about where Gen 5 is right now.

Great. Great job on the execution. Thank you. Thank you. Thanks, Arlan.

Your next question comes from the line of David Wong from Instanet. Your line is now open.

Thanks so much. Can you give us some ideas to what percent of your semi-equipment sales are to domestic Chinese chip makers?

I would say probably between 25% and 30% generally. So to think about the systems piece in 2019, it was about $665 million on our what was about 3.5 $2 billion of semiconductor shipments or semiconductor revenue.

Okay, great. And the other question I had is when we tried to calculate year-over-year for the March quarter, it's, of course, confused by the closing of Orbitech a year ago. So can you give us some idea of what the midpoint of your guidance implies in terms of organic year-over-year growth for traditional KLA excluding Orbitech?

Yeah, so we would expect, and again, with some range to this, but the midpoint on the semiconductor side would be approximately 1.2, about 1215 to, let's say, 1230, 35 in that ballpark.

Okay, great. Thanks.

Your next question comes from the line at Timothy Arcuri with UBS. Your line is now open.

Thanks a lot. So Bren, I'm just looking at the second half of 2019. I'm just looking at your process control system shipments. And you did 831 in September and you just did 875. And last September you did 830 and then you did 850 last calendar Q4. So that's up like small single digits year over year. But if I add together Intel and, you know, TSMC CapEx, it's up like more than 30%. So it seems like the number ought to be a little higher. I'm just wondering if maybe there's some timing effect there or, you know, how you sort of reconcile those numbers. Thanks.

So, Tim, I think when I look at the data on the semiconductor process control part of the business, it looks like revenue was up about 24%, half over half. in the second half versus the first half of 19.

Yeah, Brent, I guess I was talking second half of 19 versus second half of 18.

Second half of 19 versus second half of 18.

Yeah, it's basically barely up.

Yeah, it looks like it's up a few hundred million. Yeah.

And I guess the question is, you know, you guys are pretty well exposed to Foundry and Logic, so why would it be up so little when those guys' CapEx is up massively? I mean, it's up 30-plus percent.

Well, Tim, you've got to remember that even the activities that we saw at the end of the calendar year, that's revenue that didn't come in at the end of the calendar year. And the other part of that was the change in memory during that same time period. Got it, Rick.

Okay, so it's a timing issue. Okay, thanks.

Yeah, Tim, I think it's timing. I mean, look, it's not a way I've really thought about it. So, you know, we can follow up on it. I need to think about those dynamics. I mean, you get different customers, different customer mix. You have the China dynamic. So there are a number of moving parts here that influence the numbers. I mean, if you look at our year-over-year performance, you know, in a down year for the industry, a down what looks like about 10%, We're gonna be up modestly, maybe, I think it looks like we were up about 1% or so. So the second half, strength driven by strong investment, really from the foundry leader. I would say logic, if you look back at the details, logic was not all that strong for us, really over the course of most of 19. I think that the relative performance was pretty good in 19 versus 18.

Yeah, and one last point, Tim, is there was a change in bear wafer, and we talked about that, that 19 was softer than 18. And so some of the business you would have seen in 18 would have been the wafer. So it was both a mix and timing issue. Got it.

Yeah, bear wafer was down about 10% year to year. So that was another factor as well.

Okay. Okay, awesome. Got it. And then, Rick, I think you said in the prepared remarks that obviously you've widened the range, but I think you also said something about potential policy changes. Were you referring to export control that could come about, or were you referring specifically to just the virus and something that might happen around that? Thanks.

No, just nothing about anything other than we're complying with all the, and as you know, rather fluid changes in policy of support of for overall China, but also Wuhan in particular, and following that and monitoring that very closely as everyone is right now. Got it. Okay. Thanks so much. Thank you.

Your next question comes from the line up, Chris Sancor with Cohen & Company. Your line is now open.

Yeah, hi. Thanks for taking my question. Two ones. First one for either Rick or Brent. If I look at your March quarter guidance, it looks like sequentially foundries up while memory is down. I'm kind of curious, why is memory down so much if NAND is going to come back? And secondly, in an environment where people think foundry logic APEX is front half loaded, should we assume that's how your revenues have to trend, or is it tough to say at this point? I had a follow-up.

Well, Krish, on the memory recovery, it's more of a second half driven dynamic. I mean, the activity out there is pretty limited right now to one customer, so not a lot of investment. And so I wouldn't expect to see memory until we move into the second half of the year.

Got it, got it. And then just as a follow up, if the memory recovery is going to be back half loaded and foundry logic is front half loaded, how does it impact your gross margin profile?

There are no changes in gross margin. Our gross margin across all our customer segments is generally the same. Now, it varies across different product types, but customer segments don't influence our gross margin unless the product mix dramatically changes. But product to product is the same margin generally across all segments.

Thanks, Ren. Thanks, Rick.

Your next question comes from one of John Pitzer with Credit Suisse. Your line is now open.

Yeah, good afternoon, guys. Thanks for letting me ask the question. Brandon, in your prepared comments, you said that the midpoint of the March quarter REV guidance would have been 3% to 5% higher if not for the cushion you guys are baking in for the uncertainty around the coronavirus. I'm just kind of curious, is that true of the EPS as well, or are you not curtailing spending to sort of that lower number? And so EPS... would actually be up more if we had a higher revenue midpoint.

Yeah, the assumption is really about revenue. It's not about spending. Our spending plans are based on product development requirements and infrastructure requirements across the company over a broader view of the future. So in any given quarter in a situation like this, we would continue to spend according to our plan. I also said in the expectations that I don't think it affects our overall plan for 2020. So, I would think that that business just shifts into the first part of or later on in the next quarter or two as we progress through the year. Obviously, this is a fluid situation and things can change, but based on how we see it today, that's how we're thinking about it. So, So the 3% to 5% is basically just comes off the top, the same expectations for spending. And of course, there's a gross margin impact to that, which is reflected in the guidance. So we widen the range because there's some fluidity around not just what happens in Hubei province, but even broader China and how that restarts, not just with customers, but suppliers. So we tried to bake in the broader range to accommodate that potential risk. But that's how we're thinking about it right now.

That's helpful. And as my follow-on, Rick, it's always helpful when you give kind of your perspective at the industry. I'm going to put you on the spot a little bit. Your peer last week was a little bit more explicit on a WFE forecast for calendar year 20. Wondering if you endorse that forecast, and if you don't want to get too specific with numbers. I'm just kind of curious how you think about the profile of WFE. You know, there's a lot of concern about that maybe it's front-half weighted versus second-half weighted? How do you kind of see the half-on-half both for WFE and your business this year?

Yeah, thanks a lot, John. I think that, you know, what I can say is the end of calendar year, there was more momentum maybe than we would have anticipated from a lot of the activity with our logic and foundry. In fact, as you know, it was very strong and very encouraging, the number of design starts. And so Foundry really shapes up to be quite strong, and it's more than just one customer and advanced nodes. So we feel really good about Foundry logic, and we're getting the right signals from our customers about the strength there. Memory did strengthen in terms of our view, and as Bren just indicated, it's earlier for us to size what second half. And as you know, we don't give annual guidance. But I would say there is certainly momentum for the memory investment. And even if you look at the way 19 ended, and you've talked about this in the past, if this is a downturn, it's a pretty good downturn because 19 ended pretty strong and the momentum feels pretty good. So if you take out any exogenous factors like some of the things we're dealing with in terms of the coronavirus, things look pretty good for 2020 and we're pretty excited. It's really hard for us to size it. And for us, we definitely feel momentum and we're building our capacity to be able to support the increased demands. And we have some product areas where we're out of supply for what customers want. So we're having to add capability to support that. So I don't want to give a number, but we definitely feel more positive about 20 than we did probably four or five months ago, especially in light of how strong 19 ended.

Yeah, John, and the only other things I'll add to that is, to Rick's point, I mean, look, strength and timing of memory recovery is probably the biggest wild card. And so certainly people have different views on that. And depending on which markets that you tend to do better in, you may have a different view of that. So I think that's one of the wild cards. The second one is how much growth do we see in China? How robust is the growth? We do expect China to grow year over year in terms of WFE investment. I think the question right now, or maybe one of the wild cards, if you will, is how much of that is memory in terms of the next phase of investment on the memory side. So certainly there are a number of projects on the FoundryLogic side that are investing in overall, but it's more FoundryLogic heavy. So I think the memory sort of question in China is probably another factor that influences that forecast. But I do think that where we line up is probably in this you know, high single, low double-digit kind of range, plus or minus, and we'll see how it plays through as we move through the year. Given the flexibility we believe we have in the factory, if it turns out that it's stronger than that, we should be able to support that demand. So we are well-positioned for that if that materializes that way.

Perfect. Very helpful.

Thanks, guys. Your next question comes from the line of Vivek Arya from Bank of America Securities. Your line is now open.

Thanks for taking my questions. I get that you're taking a conservative view to Q1. When I look at your peers and others in the semiconductor industry, they have chosen not to adopt that conservatism or assume that even if there is a pause in China, that there is sufficient time to recover from it. So let's assume Q1 plays out for you the way you are guiding right now. Do you think there is an above-seasonal catch-up in the following quarter, or it's too early to make that determination? Like is there a demand destruction here, or do you think that there is a chance for a catch-up here?

Yeah, Rebecca, so when I look at it, I think that business just shifts. Part of it is process control. Part of it is it's really across our broader business. There's an impact to the specialty semiconductor business in Wuhan in Hubei Province there, an impact to the flat panel business, and to process control. So what we're assuming is that area, given it's the epicenter of the coronavirus so far, that it takes a little bit longer for that to recover. And so we're adjusting our outlook to accommodate that. Perhaps we're a little bit later than the others, and so we're adopting a slightly more conservative view. But my view is that the 2020 outlook is no different. And so I would expect that business to, as we start to be able to engage there and be able to support those customers, that we'll shift that capability in the June quarter and in that time frame.

Yeah, and if you want perspective, you just look back at other disruptions in supply in our industry's history just recently. And what comes to mind to me are floods. that we had in Southeast Asia. We had the tsunami and the effect of that. And we've had fires and fabs. And in every case, it bounced back. So I think if it's a temporary disruption, it comes back. And that's what we're, as we're viewing it right now.

Correct. Very helpful. And for my follow-up, do you see higher process control intensity in memory in this cycle than it has been in the past, and within that, is there a difference between NAND or DRAM process control intensity?

There is higher. I think what's interesting is this is a case of having the capability as opposed to the desire. Our customers, especially in NAND, had a huge desire for more process control capability. We just didn't necessarily have the solution, so that was why the intensity was lower. There was plenty of desire. Well, we have now our products that we've been working on for years targeting and supporting some of the challenges in the advanced NAND technology nodes, and we're seeing adoption as a result of those new products, so that's driving that process control intensity. DRAM's benefiting from the fact they're still shrinking, and so you're seeing some use for some of the advanced wafer inspection capabilities to be able to deal with the increased defectivity requirements. So both of those are are cases where we're seeing higher intensity and it's brought on mainly by solutions, not so much by need.

Thank you. Your next question comes from Blonde at the Shia Harry with Goldman Sachs. Your line is now open.

Hi, guys. Thanks for taking the question and congrats on a strong year. Just a quick follow up on the coronavirus impact. Have you already identified disruptions to the supply chain, or have you received changes in terms of demand signals from customers, or is this you guys being proactive and prudent and conservative?

Yeah, we're not seeing any change in the customer needs. And, in fact, if anything, we're having more conversations with customers to ensure that we can continue to support them. We are modeling supply chain questions, and I think that that is something that we continue to model, and that's what accounts for the range that we provided and the size of the range. So it's much more about sorting it out, and there's new information every day. I'd say in the last couple days it's actually been slightly more positive in terms of the ability to navigate, and so we're still working through a lot of those details. Okay.

But we do have suppliers that haven't been able to get back in in other parts of China, whether it's in Shanghai or in Suzhou, that deliver capability that gets integrated into systems. And it's supply chain that could be dual sourced, but not in a short run. It would take a couple of months to qualify a second supplier. So right now, when those suppliers are able to come back online, their people can actually get back into the factory, we would expect to have very little, if any, disruption based on the current plan. Now, if it extends out and people can't get back in and these facilities stay closed, then it would have a broader impact. And again, another reason for the wider range.

And maybe the last point, you all know this, is the extension of the Chinese New Year means that there's still we're still sorting through what that means because people have been off. And so as they go back, we're trying to determine exactly how that plays out.

Got it. That's very helpful. And then a quick follow-up on SPTS. Bren, you talked about exiting the year with record backlog. It looks like you guys are expecting a pretty strong year this year. In addition to RF, I think you talked about a recovery in auto in the second half. But if you can kind of speak to the relative contributions from those two dynamics in the year, that would be helpful. Thank you.

Yeah, I mean, certainly 5G and increasing RF requirements are going to be a big driver for SVTS, both in the infrastructure for 5G, but also in the mobility cycle as that starts to play through. Automotive, there's increasing semiconductor content in automotive, and automotive had a difficult year in 19. So even some of the stronger customers for SVTS bought very little in 19. So we're comfortable and optimistic about seeing that part of the business recover, And I would expect SVTS, if you add the two together, both in terms of what 5G is driving an automotive, you end up with a 10% to 15% kind of growth year for that business. So we're excited about those opportunities. Packaging might provide another tailwind, and I think they're very well positioned in those markets.

Thanks so much. Your next question comes from the line of Joe Quattrocchi with Volkswagen. You're signing this now, but

Yeah, thanks for taking the question. In the past, you've talked about the memory adoption on Gen 5 being stronger than expected. So I was hoping maybe you could talk about just your confidence going into, you know, what it looks to be a memory cycle and the potential incremental growth drivers there versus prior cycles. And then, you know, are those net new opportunities or are they competitive displacements?

Joe, hi, this is Rick. I'll take the first part and let Bren finish with the hard stuff. So my view is we are seeing the adoption. We talked about it earlier over process control adoption. So you just back up and say the process control intensity in 20 being nominally flat to 19. That's really a function of memory adoption being higher than it's been historically. And that's a function of the new products that we have as well as increased adoption and wafer inspection. We have seen new use cases in terms of what we're seeing in for example, for Gen 5 as we expand that capability out. One thing we don't know is when or if EUV is really going to be implemented in any big way in memory, but that creates some upside. But the other thing is the metrology opportunities that we see based on the new products that we've introduced drive that intensity up. So there is some displacement in terms of, you know, our new tools displace our prior generation, but the net of it all is process control intensity improving as we see it in the memory specifically in the NAND.

Yeah, I think to Rick's point, I mean, one of the big things that we saw change in NAND intensity as we went to 3D was a driver of our unpatterned inspection business to keep tools cleaner because of defectivity challenges as they start to process the stacks. You have increasing flatness requirements, and so as the stacks are rising, flatness becomes more and more important. Wafer stress is more important. And so we're We have capabilities for that. And then certainly the metrology requirements, as you've gotten into 3D structures, have intensified in a meaningful way for us. Then you add in new products, and we feel pretty good about that, both with new products for metrology, but also in terms of some of the e-beam capability that we're bringing to market. To Rick's point, DRAM, with the introduction of EUV into DRAM, even at a single layer or two, that should drive scaling again and ultimately will enable smaller defects, which tends to drive our inspection business. And with the broader portfolio, we feel like we're very well positioned there. So we think there's opportunities for, we have to execute, but we think there's opportunities for us to continue to drive some improvement in process control intensity and memory. It'll never look like foundry logic, but at the same time, I think there's incremental opportunity there if we can execute.

Thanks. That's helpful. And then just as a quick follow-up, your expectations for domestic China revenue for 2020, I apologize if I missed it, is that still flat year over year?

No. It's one of the drivers that's changed since last earnings is I would expect to see some growth there. It's more logic, foundry heavy. I think the amount of memory investment in China next year is probably one of these wild cards that will influence the WFE level overall for next year. But I would expect to see it grow, and I think it's double-digit growth year to year. Thank you. Thank you.

Your next question comes from the line at Sidney Ho from Deutsche Bank. Your line is now open.

Thanks for taking my question. Just following up to previous questions on the implied memory revenue guide for the March quarter, I understand memory capex recovery is more a second half But it does imply a sharp decline quarter over quarter after three straight quarters of revenue being at a high level. So what was driving that dynamic in the previous three quarters that will be absent until the second half of this year?

Well, you have multiple customers investing. And right now when you look at the March quarter, you know, there just isn't a lot of activity on the memory front. You still see customers investing in technology progression. but very little new capacity, particularly in the flash space right now in the March quarter for us. Now, we shipped into that business more in the December quarter, so it could be a timing issue between when we see it versus where a capacity-centric player might see it. But, you know, memory in the March quarter is kind of weak, and I would expect to see it strengthen as we move through the year.

Okay, that's helpful. Maybe a follow-up is, sorry if this has been asked earlier, but Last quarter, you had expected revenue to come down like 5% half over half in the first half of calendar 20. And given calendar Q4 was much stronger, does that change the slope of that? And assuming that the coronavirus impact kind of offset itself in the first half of the year, and how should we think about first half or second half for this year?

I think it's a relatively flat outlook half to half in the first half of 20, given the assumptions that... that we have on the coronavirus and we start to see this work itself and clear itself as we move into the June quarter. So relatively flat for the overall business.

Okay, great. Thanks.

We have no further question at this time. I will now turn the call back to the presenters.

Thank you. And thank you everyone for your time and interest in KLA today. Charlie, can you please conclude the call?

Thank you, sir. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.