KLA Corporation

Good afternoon. My name is David, and I will be your conference operator today. At this time, I would like to welcome everyone to the KLA Corporation March Quarter 2022 Earnings Conference Call and Webcast. All participant lines have been placed in a listen-only mode to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question at that time, please press the star and 1 on your telephone keypad. If you wish to remove yourself from the question queue, please press the pound key. Please limit yourself to one question and one follow-up. Lastly, if you should need operator assistance, please press star and zero. I will now turn the call over to Kevin Kessel, Vice President of Investor Relations and Market Analytics. Please go ahead.

Thank you and welcome to KLA's Fiscal Q3 2022 Quarterly Earnings Call to discuss the results of the March quarter and the outlook for the June quarter. Joining me today is Rick Wallace, our Chief Executive Officer, and Brent Higgins, our Chief Financial Officer. During this call, we will discuss the results released today after the market closed. You can find the press release, shareholder letter, slide deck, and infographic all on our KLA-IR website. Today's discussion is presented on a non-GAAP financial basis unless otherwise specified, and whenever references are made to fully your business performance, they are on a calendar year basis. 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. I would also like to take this opportunity to remind investors and analysts to sign up for our June 16th Investor Day taking place in New York. If you didn't receive an email the invitation, please reach out to the KLA IR team, and we will get you one. Our comments today are subject to risks and uncertainties reflected in the risk factors disclosure in our SEC filings. Any forward-looking statements, including those we make on the call today, are also subject to those risks, and KLA cannot guarantee those forward-looking statements will come true. Our actual results may differ significantly from those projected in our forward-looking statements. I'd like to now turn the call over to our CEO, Rick Wallace. Rick?

Thanks, Kevin. Before getting into KLA's results in more detail, I want to acknowledge and thank the global KLA team. Their perseverance and drive to be better remains at the center of our consistent execution and outperformance. You have remained focused despite challenging macro and supply chain conditions. It was our high-performing teams that drove KLA's indispensability to customers, resulting in additional process control market share growth for the recently ended year. ALA's March quarter results demonstrate strong execution across multiple areas of our business in a persistently challenging supply chain environment, delivering revenue, gap, and non-gap earnings per share above the midpoint of the guidance ranges for the quarter. We once again displayed strong execution across multiple areas of our business. Our focus on consistently meeting commitments and delivering on our long-term strategic objectives and financial targets is the hallmark for which KLA is known and the standard by which we measure our success. Customer demand across major product groups continues to build as secular trends drive broad-based growth across a range of markets and applications served by the semiconductor industry. This robust demand has been putting pressure on the industry's ability to supply semiconductors. Simultaneously, our leading-edge customers are increasing their strategic CapEx investment to improve their competitive positioning while addressing growth in markets that demand new leading-edge semiconductor capabilities. Against this rising demand backdrop, KLA has remained focused on responding to evolving customer needs and navigating supply chain challenges. Very important that KLA continues to operate with purpose and precision so we can create value for our customers, partners, and shareholders by outperforming expectations. Our talented global teams both run and improve the KLA operating model and use it as a critical guide to rise to the challenges and opportunities of the evolving marketplace. The market leader in process control, one of the fastest growing segments of the overall WFE market, KLA remains in a position of strength when we look at the industry demand landscape. Semiconductor industry has evolved to be more significantly strategic and has an increasingly less cyclical end market mix, with many fundamental drivers advancing the critical nature of semiconductors throughout the global economy. Factors such as the continuing advancement of technology at the leading edge, increasing investment in legacy nodes, and innovation and growth of new enabling technologies such as advanced packaging are fueling long-term growth for the semiconductor industry and for equipment and capabilities that make it possible. Despite persistent supply challenges and macro headwinds, our outlook for the WFE industry this year remains intact, albeit with an expectation for a stronger second half than anticipated in January. We expect WFE demand to top $100 billion this calendar year, making it the third consecutive year of double-digit growth. KLA's expected growth in calendar 2022 will mark the seventh consecutive year of growth. This sustained strength in customer demand is happening in an environment of increasing momentum for process control, where KLA's market leadership is strengthened further, and our market share results remain 4x our nearest competitor. KLA's expanding lead is the result of our number one market position in some of the fastest growing segments of WFE that have a market size greater than $1 billion in terms of annual revenue. We attribute KLA's strengthening market leadership who are ongoing successful execution of the company's customer-focused strategies, including investing at a high level to drive differentiation with a unique portfolio of products and technologies that address the most critical process control challenges in the marketplace and help our customers drive their growth strategy. We're pleased to see the success of our strategies validated by our customers' purchasing decisions and reflected in the April 2022 Gartner Market Share Report, showing KLA's market leadership advancement. This emphasizes the power of the portfolio strategy we employ. The recently published Gartner Market Share Report shows process control was one of the fastest-growing segments of WFE in 2021, growing 43% in the year to $10.4 billion. KLA's share of process control grew approximately one percentage point to over 54% and has increased over three percentage points since 2018. and remains greater than four times our nearest competitor across all regions. Within process control, the optical inspection market grew to approximately $2.5 billion in annual sales, outpacing WFE by 40%, and our share of this market remained above 80%. Other highlights demonstrate the power of KLA's portfolio strategy in delivering strong growth in other critical process control markets, including metrology, macroinspection, and very strong growth in EV review. Turning now to the top five highlights for the March 2022 quarter. First, KLA's market leadership in some of the most critical and fastest-growing markets in WFE continues to fuel growth. We remain nimble and innovative in addressing global supply challenges to meet customer requirements and our financial targets. Boundary and logic, simultaneous investments across multiple nodes, and rising capital intensity remain a tailwind. In memory, demand is broad-based across multiple customers. Second, our optical metrology business stood out in the March quarter, driven by KLA's market leadership and increasing customer adoption of market applications and leading-edge technology development and capacity monitoring. Optical metrology market is strongly leveraged to EUV and critical next-generation architects, including gate-all-around and multi-stack 160-plus layer 3D NANDs. This was further illustrated in the new Gartner Market Share Report, which showed 50% growth in 2021. Third, KLA is intensifying our efforts in advanced packaging and automotive electronics, leveraging the combined portfolio of both the SPC and EPC groups. KLA is broadening our product portfolio and delivering a comprehensive suite of products and technologies that include wafer-level packaging and final assembly and test products for advanced packaging markets. and a portfolio of inspection systems and process tools designed to help customers achieve their zero defect goals. These collaborations continue to grow, with KLA recording our highest ever customer engagement in terms of wafer inspection revenue for automotive applications in the March quarter. Fourth, services revenue was $488 million, up 14% year over year. The company tallied a record 349 installs in the March quarter, well above the previous high of 293. This was a remarkable achievement given travel restrictions in Asia, lockdowns related to COVID-19, and complexity related to the current supply environment. Service revenue is consistently outperforming the 9% to 11% long-term growth target, driven by growing installed base, increasing customer adoption of long-term service agreements, higher utilization rates, and expansion of service opportunities in the legacy nodes. Finally, the March quarter was another exceptional period from a free cash flow perspective. We generated quarterly free cash flow of $719 million for 23% year-over-year growth. We've also remained focused on returning capital to shareholders via our dividend and stock repurchase programs. both of which are up materially year over year, including a $565 million in quarterly share repurchases and an additional $159 million in dividends in the March quarter. Before passing the call over to Brent to review the financial highlights and guidance, let me summarize briefly. KLA's March quarter demonstrates sustained outperformance, highlighting the critical nature of KLA's products and services in enabling the digital transformation of our lives. Our consistent, strong execution, against significant challenges in the marketplace, both in terms of meeting rising demand and addressing persistent supply issues, highlights the resiliency of the KLA operating model and our commitment to productive capital allocation. KLA is exceptionally positioned at the forefront of technology innovation with a comprehensive portfolio of products to meet demanding customer requirements, balancing sensitivity, and throughput. Semiconductor and electronics landscapes are constantly changing, and we continue to see more customer interest driven by technology change than ever before at the leading edge. Simultaneously, the need for increasing performance and reliability requirements for legacy nodes to support evolving markets like automotive and 5G are also important to help deliver new capabilities. We believe KLA will continue to benefit from numerous secular growth factors that drive long-term industry demand, At the same time, our strategy of driving diversified growth with strong long-term operating leverage should provide durable free cash flow generation and consistent capital returns to our shareholders. With that, I'll turn the call over to Brett. Thanks, Rick. Our results reinforce the success of our execution and strong market position. We continue to focus on meeting customer needs in a robust demand environment while expanding market leadership, growing revenue, increasing gross and operating profits, generating strong free cash flow, maintaining our long-term strategy of productive capital allocation. Quarterly revenue was $2.289 billion at the upper end of the guided range of $2.1 to $2.3 billion. Non-GAAP gross margin was above the midpoint of guidance at 62.9%, as the various components performed mostly as expected, with upside coming from the higher-than-expected semiconductor process control systems revenue, which enhanced the product mix for the quarter. Non-GAAP diluted EPS was $5.13, also towards the upper end of the guided range of $4.35 to $5.25. GAAP diluted EPS was $4.83. Non-GAAP operating expenses were $484 million, below our expectation of $495 million, mostly due to the pace of new hiring, which was slower than originally planned. Total operating expenses were comprised of $285 million in R&D, and $199 million in SG&A. Given the strong demand backdrop, rapid expansion of our business over the last couple of years, and our revenue expectations for the business going forward, we expect to continue to invest in our global infrastructure and systems to scale the KLA operating model to facilitate growth. This includes investing in new product development programs and volume-dependent resources to support our business expansion as we position the company to execute against our long-term structural growth thesis. Furthermore, we, as most companies, are seeing a strong labor market driving cost pressure across our global workforce and adjustments related to our annual merit process that went into effect during March. As a result, we expect operating expenses to grow to approximately $525 million in the June quarter, and we forecast quarterly operating expenses to trend higher over the balance of 2022 along with our sequential revenue growth expectations. We continue to size the company based on our target operating model, which delivers 40% to 50% incremental operating margin leverage on revenue growth over a normalized time horizon. Non-GAAP operating income as a percentage of revenue was once again strong at 41.7% in the March quarter. Other income and expense net was $46 million, compared with guidance of $41 million, with a variance from guidance reflecting the mark-to-market impact of a strategic supply investment. For the June quarter, we forecast other income and expense net at approximately $43 million. The quarterly effective tax rate was 14.6%, above our guided tax rate of 13.5%. Non-GAAP earnings per share at the guided tax rate would have been $5.20. Non-GAAP net income was $776 million. GAAP net income was $731 million. Cash flow from operations was $819 million, and free cash flow was $719 million, resulting in free cash flow conversion of 93% and free cash flow margin of 31.4%. Looking at revenue by reportable segments and end markets, revenue for the semiconductor process control segment, including its associated service business, was $1.98 billion, up 31% year-over-year and down 4% sequentially as expected. The approximate semiconductor process control system customer segment mix for Foundry Logic customers was approximately 63%. Memory was approximately 37%, with a further breakdown comprised of 26% from DRAM customers and 11% from NAND. Revenue for our EPC group continues to be driven by strength in automotive, 5G, and advanced packaging. Within EPC, the specialty semiconductor process segment, which includes its associated service business, generated revenue of $117 million, up 28% over the prior year, and up 4% sequentially. CCB display and component inspection revenue was $193 million, down 6% year-over-year, and up 2% on a sequential basis. For an additional breakdown of revenue by major products and region, please see the shareholder letter and slides. In terms of the balance sheet, KLA ended the quarter with $2.6 billion in total cash, debt of $3.7 billion, and a flexible and attractive bond maturity profile supported by strong investment grade ratings from all three agencies. We have growing confidence in our business over the long run and are committed to a consistent strategy of cash returns to shareholders that enables growing dividends and increased share repurchases. Over the long term, we target returning at least 70% of free cash flow generated. Our capital return strategy underscores our strong record of predictable and productive capital deployments. and remains an important differentiating element of the KLA investment thesis. Over the last 12 months, KLA has returned $2.3 billion to shareholders, including $1.7 billion in share repurchases and $620 million in dividends paid. KLA has an impressive history of consistent free cash flow generation, high free cash flow conversion, and a strong free cash flow margin across all phases of the business cycle and economic conditions. Turning to the outlook. Our overall semiconductor demand in WFE outlook for calendar 22 remains unchanged. We expect the WFE market to grow in the mid-teens to over $100 billion in 2022, off a higher base of approximately $87 billion in calendar 21 after assessing reported results for the December quarter. Although based on peer company March reporting, it appears that industry supply issues will increase the loading in the second half of the year. This reflects the continued broad-based strength of demand across all customer segments. While we add capacity at KLA and with our suppliers, supply chain shortages continue to constrain our ability to meet customer demand. In addition, the duration and potential expansion of COVID-19-related lockdowns in China are unknown and could adversely impact some suppliers with operations in the affected areas. Furthermore, these lockdowns could delay systems installations and customer acceptance processes due to resource mobility restrictions in the country. In short, the situation is fluid and will be monitored closely. Supplier visibility remains challenging and has not improved over the past three months. We still expect to see quarterly sequential revenue growth throughout calendar 2022 and overall revenue growth for the calendar year to exceed 20%. In addition, we believe that demand will continue to exceed supply through the remainder of the calendar year. ALA is in position to deliver another year of sustainable outperformance in our semiconductor process control business and strong relative growth overall. Looking ahead, we remain encouraged by the strength and sustainability of our current demand profile. Our bookings momentum and strong backlog positions us to outperform WFE. As in calendar 2021, we are strategically adding capacity across our global manufacturing footprint to support this outlook and our customers' growing process control requirements. Our June quarter guidance is as follows. Total revenue is expected to be in a range of $2.25 billion, plus or minus $125 billion. Boundary logic is forecasted to be approximately 56%, and memory is expected to be approximately 44% of semiconductor process control systems revenue. Within memory, DRAM is expected to be about 66% of the segment mix, and NAND is forecasted to be about 34%. We forecast non-GAAP gross margin to be in a range of 61.5% to 63.5% as we expect sequential growth in EPC revenue in the quarter and a slightly weaker product mix within semi-process control to dilute margins modestly versus the March quarter. Longer term, infrastructure investments, labor cost inflation, supply chain strain, and rising global logistics costs are surpassing the benefits of economies of scale normally seen in a rising revenue environment. Given expectations for revenue for the year, we continue to expect that calendar 2022 gross margins will be in a range of 63% plus or minus 50 basis points. Other model assumptions for the June quarter include non-GAAP operating expenses of approximately $525 million, other income and expense net of approximately $43 million, and an effective tax rate of approximately 13.5%. Finally, GAAP diluted EPS that is expected to be in a range of $4.60 to $5.70, and non-GAAP diluted EPS in a range of $4.93 to $6.03. The EPS guidance is based on a fully diluted share count of approximately 150 million shares. In closing, the secular trends driving semiconductor growth and investments in WFP are compelling, despite the current macroeconomic headwind. Broad-based customer demand and simultaneous investments across technology nodes are strong and resilient trends. We have confidence in the leading indicators for our business, including our backlog and bookings visibility, which motivates us to invest in expanding our business infrastructure and the required capabilities to support our outlook. Our customers' multi-year investment plans provide an element of stability in the demand outlook for the future. The ALA operating model positions us well to outperform our industry and guides our important strategic objectives. These objectives fuel our growth, reliable operational excellence, and differentiation across an increasingly diverse product and service offering. They are also the foundation of our sustained technology leadership, wide competitive mode, leading financial performance, longstanding track record of strong free cash flow generation, and consistent capital returns to shareholders.

And with that, I'll turn the call back over to Kevin to begin the Q&A session. Kevin? Thank you, Brent. David, please queue for questions.

At this time, if you would like to ask a question, please press the star and 1 on your telephone keypad. If you wish to remove yourself from the question queue, you may do so by pressing the pound key. We remind you to please unmute your line when introduced, and if possible, pick up your handset for optimal sound quality. In the interest of time, we also ask that you please limit yourself to one question and one follow-up. We'll now take our first question from Harlan Sir with J.P. Morgan. Please go ahead. Your line is open.

Good afternoon, guys. Thanks for taking my question and great job on the solid execution. You know, as you guys pointed out, the market share numbers are out for last year. You grew your process control market share at almost 55% or more. well over four times larger than your nearest competitor. I was looking at the data. So in the seven major categories in the process control, you had the number one market share position in five of the seven categories. And the categories where you guys actually grew more than 50% were pattern weight for inspection, overlay, metrology, macro inspection, and review and classification. Obviously, all of these are very critical solutions for next-generation manufacturing technologies. So on the strong growth outlook for this year, what areas or segments do you anticipate driving the outperformance and maybe even further share gains in your process control franchise for this year?

Yeah, Harlan, I'll go ahead and start and let Rick add if he needs to here.

But it was a very strong year, obviously, for the company, and we're really pleased with the share results. One of the things as we look at just our expectations this year is we expect to see continued momentum in a lot of the markets that you referenced. So there's certainly strength that's expected there. We're expecting greater than market growth out of our reticle inspection business, which was a little slower than market last year, and it tends to be a lumpier business. But as we move into this year, it should be a little bit stronger. So overall, we feel pretty good about the roadmap across our products. As we said in the prepared remarks, our biggest challenge is just getting the parts we need to meet the very strong customer demand that's out there. But we're encouraged by the momentum we have, and our internal plan is to continue to gain share. We think there's more opportunity for us, given what you said in terms of where we are. These go linearly, but at the same time, we've had a nice trajectory over the last few years and would expect to see it grow as we move forward. Yeah, just to add a couple things, Harlan. One is, of course, Gartner's data is revenue, and the bookings picture is even stronger. So we're in really good shape in terms of that. We've talked about the backlog and the demand that we have. So we'll continue to see share gain in terms of – or strength of share in the segments that you outline. Also, the new technologies that are coming offer more process control intensity opportunities. For example, high-K metal gate. You know, if you look at that, if you look at gate all around, the metrology, bigger die size, all those things are going to allow there to be more opportunity, and we have products in the queue as well as in the field that are going to take advantage of that. So we feel very – well-positioned. The biggest challenge, as we've talked about, is satisfying demand, and that's related to we think we've done a really good job with the supply chain, but there's more work to do there to continue to support our customers.

I appreciate the insights there. And then on your EPC franchise specialty, semiconductor manufacturing, packaging, PCB display franchises, it's been a great diversification for the KLA business and I know going back, and you guys will probably update us, but going back to the last analyst day, the team's outlook for EPC was to grow that business at a 9% to 10% CAGR. You grew that business, and this includes services. You grew that business about 15% last year. The two-year CAGR up through last year has been about 12%. So tracking ahead of your targets, what type of growth do you guys expect for EPC this calendar year? Just given, you know, the strong focus by your semi-customers on power, RF sensors, advanced packaging, and new PCB architectures, and maybe that's been slightly offset by smartphone and display weakness, but wanted to get your views on EPC growth for this year.

Yeah, Harlan. So in terms of the systems part of EPC, we're somewhere close to 20% is our expectation for the year. Obviously, we'll have to see how that plays out. That tends to be a little bit of a shorter lead time business and has some parts of its markets that are a little bit more sensitive to some of the consumer dynamics. But in general, we expect to see about a 20% growth there. Now, if you blend it with its service business, It'll be in the high teens. Service business tends to grow a little bit slower than that. But you're right. Over the last couple of years on the system side, we've been in that 20% range. And, you know, it hasn't got as much of a play as given the strength of our semi-process control business. But we're pleased with where we're going directionally there. And we'll have more to say about the longer-term view at our investor day in mid-June.

Great. Thank you very much. Thank you.

We'll take our next question from CJ Muse with Evercore. Please go ahead. Your line is open.

Yeah, good afternoon. Thank you for taking the question. I guess first question, can you speak to your backlog, what your blended kind of lead times look like today, and what kind of visibility that provides you into 2023? Sure.

Yeah, CJ, it's a great question. Right now, blended lead times, and they're blended across products and the revenue value of the composition of the backlog. But it's well over a year now in terms of where lead times are. Obviously, certain product lines are longer than that. We're slotting certain product lines now today out into 2024. So there's quite a bit of demand for for some of the products. And given the constraints we have around key components and the lead time for those components, it just pushes those lead times out. So overall, we've seen it trend up here. And as I said in the prepared remarks, as we go through the year, I continue to expect to see demand exceeding supply. So I would expect lead times to probably increase a little bit as we move over the course of the year.

Very helpful. As my follow-up, curious on the China lockdowns, any impact or future impact in your view, particularly around kind of PCB and display area? I would imagine that might be a downstream potential risk in terms of taking the deliveries.

Well, our guidance implies a risk-adjusted assessment of where we're at. Obviously, you know, there's always some unknowns about that, both from a supply point of view, which we feel pretty good about, but also more so from a just can we get access to customers, can we get tools installed, can we get acceptances done, and so on. We've contemplated that in the guidance we've given. We do have an expectation of seeing some opening begin in the – we'll call it sort of the middle of May – If things drift out further than that or there's a significant expansion of lockdown activity, it could have more of an impact. But I think we've risk-adjusted it as best as we can. There's certainly some unknowns, but we feel pretty good about the guidance we've provided.

Thank you.

We'll take our next question from Timothy Arcuri with UBS. Please go ahead. Your line is open. Thank you.

Thanks a lot. Brent, I wanted to try to probe a little bit on that question around backlog, because backlog really doesn't mean a whole lot when your lead times are sitting beyond that 12-month window for backlog. So I guess the question is more on purchase obligations. I think you report that in the queue, and it was greater than $8 billion, I think, exiting December. And so I guess the first question is sort of where does that stand now? I'm just trying to get a sense of sort of how long booked a bill is going to stay above one, and maybe if you could give us backlog.

Yeah, so Tim, you'll see the exact number in the 10-Q that we file, and it's the performance obligations, not purchase commitments. But anyway, the performance obligations, you're right, were over $8 billion last quarter and will be in excess of $10 billion this quarter. And to my earlier comment, I think we'll see book-to-bills above one through the year.

I guess I had a question also on... Process control systems. So March came in like almost $100 million better than what I had and what I think your sort of guidance was implying. June is about in line. I think before you were talking about the second half of the year, process control systems being up sort of low to mid-teens. And I guess the question within that is, is that still the right number, even though March came in a bit better? And part of that is a question really on timing because But the, you know, films guys, as you said, they're having problems shipping tools. And so that is tending to push some WFE from the first half into the back half. And I guess the question is, since you guys are sort of upsiding shipments and they're sort of downsiding shipments, does it become a problem for you where you have like timing mismatches and maybe, you know, because they can't get films tools, maybe they start to push out your tools? Thanks.

You know, Tim, usually that doesn't impact us all that much because we tend to see process control tools go in early. Also, given the demand environment, customers will deal with timing issues in terms of taking tools and storing them to align with expectations around the other tool sets. So I'm less concerned about that given the strength of demand. Customers are beating on us every day to ship sooner, so I'm not – I'm not concerned about delays and other types of tools impacting our products. And you're right. We did have Q1 was stronger, certainly the execution by the teams in the last month as we dealt with a lot of delays in parts, particularly around automation for our systems. The execution was really solid, and we're really pleased with the upside we saw in Q1. So as I think about the second half, the second half, I'm still in the same range, low to mid-teens in terms of semiconductor process control systems, the half-to-half versus the first half.

Cool, Brent. Thank you very much. Thank you.

We'll take our next question from Joe Quattrochi with Wells Fargo. Please go ahead. Your line is open.

Yeah, thanks for taking the question. I was curious, how should we think about, you know, you mentioned slower than planned or hiring in a difficult labor environment. I assume, you know, that's more maybe geared towards 2023, or how do we think about that in terms of, you know, your ability to have enough labor to meet demand for this year?

Yeah, so it's Rick. It wasn't really – It was much more about the impact to cost about when they're hired. We actually did quite well of hiring in Q1. It's just if they're not hired at the beginning of the quarter and we factored in the payroll for the whole quarter, we're on track for our hiring this year. And most of that had to do, frankly, more with some of the engineering work than it does the work that's associated with both operations and service, where you could potentially, if you didn't have the resources, see a shortfall for the year. But even then, it would just Right now we're trying to alleviate the teams who are doing a lot of overtime and trying to provide them some backfill. So none of our hiring challenges are affecting our ability to support the revenue for this year or next year. But we do want to get people in. We've had good success, but it's more, you know, we're talking months as opposed to quarters or years behind.

Got it. That's helpful. And then just as a quick follow-up, I was wondering if you could talk about the strength you saw in DRAM in the quarter, and I think even implied in the guide, you know, I think we're at record levels for process control systems. Just kind of curious what drove that, if it's, you know, architectural changes, EUV, anything like that would be helpful.

Yeah, Joe, it's mostly technology transitions this year and certainly the introduction of EUV and DRAMs. has been a driver for investment from our customers. It's pretty broad as I look at the DRAM investment.

It's a pretty broad base across our customer set. Thank you.

We'll take our next question from Patrick Ho with Stiefel. Please go ahead. Your line is open.

Thank you very much. Maybe first off for you, Rick, in terms of the advanced packaging market, you've done a great job in terms of getting the value proposition for front-end chip makers with your process control solutions. Now, some of these customers are the same ones on the advanced packaging side. Some of them obviously are OSATs and customers like that. As advanced packaging becomes a much more complex problem, how do you get the customer mindset changed to get that same value proposition for those type of processes, given the complexities that are occurring?

Yeah, good question. And one that obviously we're excited about the EPC acquisition for exactly this. So I would say really for EPC, even an earlier – question we had about how we're doing and how we think about it. I really think of it in three stages. The first stage for EPC for KLA was to employ the operating model on how we run the businesses, and that was really what we did initially. The second stage was customer engagement, and because, as you say, some of these customers are bigger customers, more complex problems, and they know KLA, they wanted to engage with us. So that's actually been going quite well, and we've been having a lot of discussions But, of course, then you get to the third part of that, which is technology leverage from the rest of KLA and the ETC. And we're kind of in phase two and phase three now where we've been having those meetings. There are a lot of clear opportunities for us, and we're developing those solutions and rolling those out. So I think that you'll see the leverage, the revenue synergy associated from the additional channel access and the needs, and then the benefit of our technology as we go forward. That's coming, and we're going to talk more about that at the analyst day in June as we roll that out. But right now, huge opportunities, and we feel like we're just in time with that acquisition to be in a position to support them.

Great. And as my follow-up, maybe for Brent, given WFE, the outlook looks like it's going to be a much more second-half weighty year, particularly in terms of revenues and when the equipment companies receive cash. You guys have been executing well, getting tools out on time, but we've heard from other companies where they're quote, shipping incomplete tools where they'll finish the install and get the revenue recognition later on. So to not expect a huge, quote, shipment ramp or a huge production ramp in the second half of the year. How are you balancing those dynamics? Are you shipping any incomplete tools at the customer site where you can then go back later on so it doesn't, you know, overly imbalance, you know, both shipments as well as your revenue recognition?

Patrick, that's a great question. And when you're talking about process tools, you have modular systems. And so, you know, they kind of come together as a customer site in a lot of cases between the automation and then the gas boxes and the process chambers. And so if you're missing parts sometimes, you know, you have that issue. With our systems, and we internally source the handlers for our systems, but our systems ship completely, and so they don't come for the most part. I mean, we might have an issue here or there on the FPD business where you'll have a similar dynamic. And in some cases, there's a reasonable carve-out based on the substance of the transaction where you defer some of the revenue. But it's a very, very small part of KLA. So on our semi-process control part of the business, we're shipping complete systems. And so you wouldn't see a big correction in a deferred revenue that all of a sudden comes together as you move forward. So what we're shipping is complete systems, and that's what's revenue-ing as we go forward.

Great, thank you.

We'll take our next question from Vedvati Chotri with Jefferies. Please go ahead. Your line is open.

Hi, good afternoon. Thanks for taking my question. I think my first question is I wanted to understand if you have a sense of what the industry wafer capacity is expected to grow in this year and for the next year. WRC is expected to be around the mid-teens growth for this year. How does that translate to an increased capacity if you can provide any color here? And I understand if you don't have an industry view, maybe you could talk to a subset of your customers. That would be helpful.

Yeah, so at least $100 billion in WFE. It's translating, and I don't have the exact numbers, but we're seeing new wafer starts per month being added across all production nodes. And you're seeing it in memory at a limited level, certainly this year, compared to prior years, less, because it's more of a technology transition-focused year. But certainly on the foundry logic side, you're seeing increases at 3 nanometer and at 5 nanometer and 7 and 10 nanometers, probably flattish, but then you get 28 and 40 and above and sort of those nodes. You've got the legacy investment that's happening there. So you're really seeing wafer start additions across just about all production nodes.

So is that in line with WSE code? That's what I was trying to get at. So is that like an 80% increase or if you could help me characterize what kind of capacity increase that is?

Yeah, I don't think I can help you with that right now. You know, by node, the capital intensity changes. And so it's not dollar for dollar in terms of how it applies to wafer starts at a given node.

Got it. Okay, okay. And for my follow-up, you know, four to five years ago, most of the customers used to talk about reusing about 70% to 80% of their tools. How has this changed now? Is majority of the WFE spend on capacity additions? How has that changed since, you know, if you could help me understand?

Yeah, that's an interesting change in the dynamics of the industry. And that was really more isolated to one period in time than if you look at the overall history of the industry. And that was largely because there were not very many new starts on advanced nodes that were primarily just a handful of customers, a handful of devices, and so that reuse was something that happened when Moore's Law wasn't scaling. We're seeing very little reuse now, and there's a couple reasons for that. One of the primary reasons is the number of starts, the broad-based number of devices that's being run on these nodes, and the ability of more and more customers To support that, that means that our customers are running flat out those technology nodes as they're introducing new ones. So we're actually seeing kind of the opposite effect, if you will. We're seeing some capacity, some of our sales are actually into ramps that historically we would have considered to be done. And they're actually buying tools, for example, for 7 nanometer. Right now there's still some of that going on in spite of the new investment being advanced. So reuse is significantly down in terms of the amount, and that's a trend that our customers believe is going to continue is that it's going to be a focus on supporting that. And if you look at the overall semiconductor shortage in the world, you can imagine that that's not something that they can really afford to do because they're running those old lines flat out, and we see that in our service business and the overall fabulization around the world.

Thanks. That's helpful.

And as a reminder, if you'd like to ask a question today, please press the star and one keys on your telephone keypad. We'll take our next question from Krish Sankar with Cohen. Please go ahead. Your line is open.

Hi, this is Robert Mertens on behalf of Krish. Thanks for taking my question. I guess looking into the services, you've been growing the business nicely and mentioned a strong install-based component in the quarter and just in general. But looking at the attach rate opportunity, I think you've mentioned maybe over 75% process control systems and maybe 90% in PCB. Is that a fair assessment, and is there further improvement room to growth in terms of that side of the service business?

Yeah, look, certainly as the tools increase in complexity and the demand on uptime increases, it does create opportunities for us to drive a contract model, a subscription-like model with those customers. And so... We do think there's some upside potential over time, and we'll talk a little bit about some of the longer-term drivers of our service business and its trajectory going forward at our investor day in June. But obviously, PCB is closer to 90%. It's hard to improve much on that, but I think that there's still some opportunity on the semi-PC side given that. the dynamics I mentioned. One of the other opportunities we have in our acquired businesses is to try to drive more and higher attach on those tools in terms of service. and certainly smaller players have a harder time having the infrastructure to be able to engage with customers to try to monetize that service business. And so there's opportunities for us in our specialty semiconductor business, our flat panel business, and some other smaller acquisitions we've done to drive more service opportunity. We'll have a lot more to say about it in June, but hopefully that helps for now.

Great. That's helpful. And then just as a follow-up, in terms of the WFE view you gave and sort of peers are indicating, would assume that supply issues are going to sort of ease in the second half. What sort of incremental challenges have you seen within the industry over the past couple of months? Are there any sort of specific shortages, key components, or is it sort of an ongoing rolling issue where things crop up or are dealt with and then other things pop up?

Yeah, I think that the whack-a-mole analogy is applicable here. It seems that as we work certain issues, other issues materialize. The dynamic in China with the COVID lockdowns does have some potential impact on some suppliers, although we think we've We've dealt with it and the guidance we've given in terms of just our assessment of the risk profile of that. But I would say they're all the same issues and we just continue to work on the teams that have done a really good job with it.

Great. Thank you. We'll take our next question from Atif Malik with Citi.

Please go ahead. Your line is open.

Thank you for taking my questions. First one for maybe Rick, if you can update us on your single-beam ESL 10 platform in terms of design wins and sales expectations this year. And the reason I ask that question is because we were at SPIE conference this year, and it appears that the multi-e-beam platforms are showing limited flexibility and gaps to HVM manufacturing at logic makers like Intel, and then I have a follow-up.

All right.

Yeah, I guess the landscape, let me just generalize, and I would say the e-beam inspection landscape has not really dramatically shifted. We've had some success, as we indicated, with the ESL-10. But, you know, if you back up and look more about the overall balance between optical and e-beam for inspection, it's continuing remarkably to be at about that 80-20 range. split from optical to e-beam. It's been true for over the years. So there are more e-beam applications, I think, that are showing up. The one for inspection, for example, that's showing up that we're participating in uniquely is for reticle inspection, and that's what we're doing with our new 8XX. to address some of the opportunities in EUV. But not really a lot has changed. I mean, we go back and forth with the latest introductions from EVM inspection, but by and large, we've had some success, but the market is, on a relative basis, overall, the EV market's about 20% to the 80% that is optical inspection. Brent, anything to add? No, I think they're complementary technologies, and scaling into production is the challenge, as you mentioned. And even as you increase the beams, it doesn't necessarily equate to a lot of throughput. It does equate to some, but there is still a challenge, and the throughput disparity is quite significant relative to optical solutions. So it's relegated to defect discovery and engineering analysis-type cases and isn't all that applicable to a production environment. And that's – I think it's been – very well validated, I think, with the strength that we've seen in optical pattern inspection over the last few years. Just one more example. I think this is important to understand. If you look at calendar 2021, our Gen 4 optical actually outsold our Gen 5 optical in terms of amount of revenue in that split of the 80% of the market, and then the rest was divided in the E-beam among the different E-beam players. So this idea that the latest technologies would require eBEAM inspection hasn't been proven. In fact, if anything, it shows the extendability of optical as we, even in 2021 and what we're seeing in 2022, in fact, we expect the Gen 4 to continue to have significant success in terms of serving the overall inspection needs. So the view is it'll be complementary. eBEAM will primarily be a tool that'll be used for engineering analysis, but not for inline inspection.

Great. Then my follow-up, Brent, is it possible to break out the leading edge sales, let's say 10 nanometer or below, within your Foundry logic sales?

Yeah, it's about 80% is leading edge. Thank you.

Yeah, that might include 14, 16, but that's only a few percent. So it's safe to say that pretty much 80% or so is 10 nanometer and below.

Right. We'll take our next question from Weston Twigg with Piper Sandler.

Please go ahead. Your line is open.

Hey, thanks. Thanks for taking my question. I just wanted to follow up on your comments about reticle outgrowing the market this year. Can you just let us help us understand why it undergrew a little bit last year? Was it customer mix or is it just lumpiness? And what makes you confident that you get faster than market growth this year?

Well, yeah, last year it was, you know, it was a very strong 2020 and then 2021 was, was, was, uh, below market growth. It was still an up year for the business, but below the market. And so we do have more strength this year. It tends to be lumpy. If you're thinking about mass shop systems, so our Tehran systems that we sell into the mass shop, those are very high dollar, revenue dollar tools. So the ASP is quite high. So they tend to skew the numbers a bit in that market, given that. But Certainly, we're seeing strength both in terms of EUV and, you know, new layers given the strength of foundry and logic, and that drives more reticle sets. And you've got, obviously, a lot of new designs, but you have re-spins of older designs, and so that's driving a lot of reticle demand. That's probably the biggest driver. You have also applications that are in the way for FAB for contamination monitoring. And we would also expect to see some revenue this year from the EVM system that Rick mentioned as we get to the end of the year. So I think it's those factors that are driving it. Yeah, Wes, I would add one thing to it also is, you know, we're talking about the reticle inspector, but if you look at the application itself of qualifying reticles, a lot of the success we had in 2021 was and continue to have now, is use of Gen 5 to qualify EUV reticles. So while it may not be the rapid systems we're selling, it's the application and support of those, largely because that is the most effective way to determine the quality of those reticles is to actually inspect them. And finally, we have the capability to do it on the way first with Gen 5. And so we saw a huge push from customers, multiple customers, everyone who's doing EUV to utilize Gen 5 to qualify those radicals.

Okay. That's helpful. And that actually leads to a follow-on question. Just as high NA EUV comes down the pipeline over the next two or three years, do you have a solution ready for that, maybe leveraging your optical inspection platform, or do you have to develop something novel?

We have continued evolution of the platforms to support it, and we continue to work on additional reticle capabilities to support it. So I think the answer is a little bit of both. I mean, the advantage of the on wafer with the Gen 5 is that those tools already exist. And so right now, they could inspect those, albeit at a slower throughput. But of course, we're working on continuing to improve that capability, both with increases in hardware, but also a lot of the work we've been doing with machine learning and AI and the algorithm front to support those applications. And then at the same time, we have the 8xx, which will continue to support as well as 6xx. And as I think you know, we also are working on next generation reticle inspection as well. So we got quite a bit of, I think our two biggest investment programs inside the company are both dealing with the challenges of reticle inspection over the next several years.

Perfect. Very helpful. Thank you.

Thank you, Wes. And it looks like that brings us to the end of the call. I wanted just to, again, remind everyone that we're hoping we can see you in person in New York, June the 16th. If you don't have an invitation, please do reach out to the KLAIR team, and we will get you one. And with that, I'll turn the call back over to David, Bernie, final statements.

This does conclude the KLA Corporation March quarter 2022 earnings call and webcast. Please disconnect your line at this time and have a wonderful day.