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.