KLA Corporation (KLAC) Earnings Call Transcript & Summary

All right. Good morning, and good afternoon, everyone. This is Krish Sankar from Cowen. I'm the Semi Cap Equipment Analyst. We are fortunate enough to have KLAC, the next company presenting, and we are very lucky to have Oreste Donzella, EVP; and along with him, Kevin Kessel and Ed Lockwood from the IR team at KLA. With that, I'll quickly turn it over for -- to Kevin for a quick intro. Kevin?

Thanks, Krish. And so Krish, very pleased to be here and have the opportunity to speak with you and the investors that are listening. For those of you who don't know us, we're a worldwide leader in process control equipment for the semiconductor industry. We sell products into the foundry and logic manufacturers as well as the memory industry that provides critical inspection and measurement capabilities. Our products help drive the leading-edge semiconductor development as it continues to advance through EUV as well as other technologies. And as you mentioned, I'm very lucky to have Oreste Donzella with us here today. He's our EVP in charge of our newly formed EPC group, and he'll talk more about that. And he's also our executive in charge of industry forecast and collaborations. Oreste spent over 20 years at KLA in a variety of different roles of exceeding responsibility. And prior to KLA, Oreste worked for both TI and Micron in the fabs. His perspectives on the industry are also of benefit to SEMI North America organization where he serves on its Advisory Board. So before I turn it over to Oreste, I just wanted to mention our safe harbor language that can be found on our Investor Relations website and in our SEC filings and it pertains to today's discussion in the event that we'd be making forward-looking statements. Oreste, over to you.

Thank you, Kevin, for the introduction. Thank you, Krish, for hosting us today. Hello, everyone. I hope you and your family are safe. In the last few months, we have all been facing unparalleled challenges. And yet KLA continues to perform well and deliver on our commitments, demonstrating strong resiliency under these extraordinary circumstances. Our market leadership and a strong business performance showcased the company's ability to execute our long-term strategic objectives and then customers and partners advance their technology roadmaps and achieve their financial goals. We remain very focused on delivering differentiated innovative solutions to tackle the technical and cost challenges that our industry is facing. The strength of our growth product portfolio, combined with a strong customer engagement has been demonstrated by the market share gain that was mentioned in the most recent annual report. We closed the March quarter with a record backlog and we differentiate among peers in our ability to provide guidance for the June quarter as a further evidence of the resiliency of our business. We feel well positioned for the balance of the 2020, and we are confident relative to the long-term targets we articulated in our September 2019 Investor Day. As Kevin said, I'm particularly excited to be here today, in my first investor conference, as a head of the company's new format, Electronics, Packaging and Components group, leveraging the KLA operating system and the new growth that brings together the Orbotech, SPTS and ICOS organizations, targeting growth in new and faster-growing markets. I'm thrilled with these opportunities and looking forward to discussing in greater detail with you today. In conclusion, there is no doubt that we'll continue to face significant challenges in this new COVID world, but given the close collaboration with our customers, pipeline of new exciting products and our track record for strong and predictable execution, we feel KLA is in a good position to successfully execute our growth strategies and demonstrate resilience in these staggering times. So let's start with your question, Krish.

Thank you, Oreste. Thank you very much for that. And I got to say, since you wear multiple hats, I do have a question on a variety of topics. So let me start with one that has been on top of most people's mind and I understand there's no real good answer to this, but the whole China trade commerce department ruling and I understand a lot of unknowns. I think the main questions -- investors have been grappling at this. One is the Civil-Military Fusion -- I mean lineup. The other one is a Direct Product Rule targeting Huawei shipments via TSM. So from your vantage point, how do you see this impact KLA?

Well, we're going to start with the easy one. Krish, you are right, that I was feeling many unknowns and the potential outcomes of these 2 rulings. And we have previously stated that the KLA will comply with all of those. We are working in concert with our peers and industry trade organizations and we are waiting for additional guidance from U.S. government regarding the scope and the practical applications of these new rules. Once we have planned, we can better determine the impact on our business, if any.

Got it. All right. And then the other common theme you have seen emerge during this earnings season, both from you and many of your peers, has been that demand is still very strong. Most of it has been supply constrained. So how is that supply constraint looking? Has it eased up? And given what happened in the last few months, does it make you revisit your supplier base? Or do you think this is a onetime exogenous that it should not be changed anything in the long term?

Yes. If you look at since the last quarter, we have been able to mitigate the supply chain issues relative to COVID as demonstrated by our strong execution in March quarter, and we said also openly that we didn't miss any shipment in the March quarter, which is a big proof of our ability to manage through these very, very [ stormy weather ]. Longer than industry average lead time and, of course, hedging strategies provided us with extra flexibility to ensure business continuity. I believe the supply constraint is easing right now. I will remain vigilant and maintain a very close communication with our suppliers to identify potential pressure points and eventually creating any options whenever they are needed. I would say we see the management of our supply chain is a competitive advantage. And one thing that we are doing, especially with me in the new role, is leveraging the common process across all KLA divisions, including the former Orbotech subsidiary to make sure that we identify a potential problem as we react very, very quickly to them. So in conclusion on this topic, we remain confident on our ability to meet the shipment demand and successfully support our customers in the industry.

Got it. All right. And then on the topic of around the second half and foundry/logics trend, on the earnings call, you guys mentioned how second half -- we still looking balance on the foundry/logic side despite the fact that TSMC spent almost 40% of its CapEx in Q1. So I thought that the commentary was pretty interesting. So where are you on pockets of strength and weaknesses in the second half of this year?

First of all, let me say, we're not providing any specific number relative to industry outlook for the second half of the year because of the uncertainties around the COVID. However, to the best of our knowledge, we see continuous strength in the foundry/logic segment, which leads to our view of balanced CapEx throughout the year of a very strong 2019. As I said now that we see a company of the demand, and more -- multiple customers. You mentioned TSMC from [ Taiwan ], but we have other advanced customers that are going to make some of my commitment in the second half to advance to the next design and successfully implementing our ability of production. And these are an advanced node. When you look at the threading edge nodes, we see an increased adoption of specialty devices like RF or for 5G, for example, MEMS for medical application. The bottom line, the real story here is when we enter the so-called data year, a couple of years ago, we emphasized that we were transition, we are more diversified and end demand, with expansion of clients with AI, 5G across multiple in the space, all the industry is requiring a higher content of semiconductors. As a result of this transformation, we saw -- and we said equipment reuse decreasing and the demand of new products increasing. So it was a big -- a big argument, big topic, may be 3, 4 years ago about how much of the existing equipment was going to reduce for next load, we didn't see that starting from 7-nanometer because of the diversification, the broadening over in the market. So also, when you look at the particular situation where we are today, work-from-home, visual interaction, telemedicine are also requiring faster connectivity, networking, more automation, more advanced computing and storage. So I want to respond to your question also making a more long-term secular statement here. The end market diversification makes us -- drive equipment demand, especially for foundry and logic but not only for foundry and logic. And as you know, KLA is very well positioned to capitalize on this.

That's very helpful, Oreste. And then along the same path, kind of the thought process on the memory side, especially with DRAM, kind of interesting because your own numbers for DRAM seem to be improving, the Micron just positively being announced in the -- a conference, but there's also some concern that maybe DRAM pricing might slow down into the back half. But kind of how do you look at DRAM spending trends into the second half and into 2021 from where we are today?

Yes. Let me give you a pitch of the entire year. Memory market went through, I would say, 5, 6 quarters, sorry, of inventory correction, resulting in a very steep decline in the 2019 spending, as you know. In the last few months, supply demand appeared to rebalance and we saw mostly [ volatility ] for example. So there is an expectation of higher spending in the second half of this year, but the extent of this recovery will depend on the mobile market. So given the highest push into smartphone unit sale, we saw for sure, an acceleration of DRAM in the first half of the year because of data center demand and we believe that the inventory has already been digested in 2018 and maybe the second half of 2017 -- 2019, sorry, in the second half of 2019. So we expect that the memory will recover. But again, it depends on the number of the smartphone units that we will see by the end of year. What we know for sure is the complexity, in both advancing DRAM to the next node and also adding more layers to NAND, will need more advanced process control. And clearly, we were positioned to take advantage with the new products pipeline, specifically designed for memory customers.

Got it. All right. That makes sense. And then just sticking with memory, more information on the process control intensity. Well, there's a general view that KLA is more foundry/logic focused company. But people tend to forget that you have very good NAND exposure also. So can you talk a little bit about NAND exposure? And I'm more curious to know how do you think KLA's NAND exposure would evolve this cycle compared to the last 3D NAND cycle when you had your customers spending a lot to get into 3D NAND, and now it's going to be more layer count going to 128 and beyond?

Yes. It's true that we are more exposed to foundry/logic because of higher process control intensity. However, you are right. I would like to remind that where -- the NAND technology moved from 2D to 3D, we saw an increase in process control intensity for a couple of reasons. First of all, they were more number of film layers to be monitored in this sector and the second reason was the challenges around the profile measure and wafer sizes. So we saw a pretty interesting boost in the metrology business in the transition. And then we see this process control intensity to remain kind of stable even after the -- our customers starting to ramp and produce more and more of this 3D NAND technology and products. So we see -- we see the leading-end process control intensity will not go down because the challenge will sell layer when you are the moderators. And eventually, there will be some changes in the architecture of the NAND. They will drive more need for advanced inspection and metrology tools. Also during the Investor Day in September, we said that we are working on new products, new pipeline of interesting products to serve both the NAND and the DRAM market. In particular, we mentioned the X-ray metrology platform to accurately measure the profile aspect ratio structures. And of course, we decided to launch a couple of tools in the field just to learn about potential applications and valuing this platform. The first results have been very encouraging, and we expect this product to become mainstream production next year. So we see an opportunity in this time frame and also in the future to increase the process control intensity in NAND and even in DRAM. And I want also to remind you, the DRAM is going to increase the utilization of EUV as well, same as logic. And in this case, even if this implementation of EUV is limited to few layers, but because of the volume, this may lead to a meaningful business in -- especially in metrological EUV DRAM as well.

It's very interesting on the EUV angle. And then on the EPC, or the Electronics, Packaging and Components business you recently took over, congrats again on that, Oreste. So how do you think of the legacy Orbotech business? I believe it's part of the EPC. And within the Orbotech, I remember it used to have flat panel, PCB, semi specialty segment. So how should we think of that business evolving for the next 6 to 18 months or so?

Krish, thanks for the congratulations, first of all. As I said in the opening remarks, I'm excited by the opportunity to grow the KLA business beyond the cross-selling of the process control market with the creation of the new EPC group. This organization is a part of well shorter management transition process that we have been planning over the last several months to leverage the KLA operating system. I've been working at KLA for more than 2 decades. And I would say customer for 7 more years before then and I have a great appreciation of the system that we put in place to deliver consistent results by culture of accountability and disciplined process to track both financial results, but also the way how we develop innovative solutions. We are at the beginning of this journey with EPC. I'm confident that the team will be able to meet the very aggressive long-term goals that we outlined in our September investor conference. Now let me talk a little bit about the specifics of the organization. EPC operates 4 business units operating in 4 different, some overlapping markets. SPTS is a specialty semiconductor division, which operates from Wales, U.K. and is the leader in deposition process solution in specialty markets like MEMS, RF and power and also is a growing presence in advanced packaging. Out of the historical Orbotech markets, we also have 2 divisions, headquartered in Israel, to sell printed circuit board and the flat panel display markets. While the display market is showing weaknesses due to highest pusher to consumer market in this COVID world, PCB is showing resiliency, driven by a strong service business and also an expansion up-sell into the so-called IC subset market that is very, very critical for packaging. So finally, we include in EPC, the ICOS division. This was a company we bought more than 10 years ago. It's a leader in final component inspection assembly test. So we have already seen a strong pull from the top KLA semiconductor customers took after in these new areas, for example, packaging or substrates. And we see this as a part of the narrative around the acquisition of Orbotech. As we said in the Investor Day in New York, one of the reasons why we bought a good company like Orbotech was because we expect to make them better. We expect to make them great. And by applying the KLA operating system or operating model, we believe that we can inject what is good at KLA in terms of financial rigor, in terms of the way out we are disciplined to build new products, new technology and interact with the customers and thus open the door to the top semiconductor customers because we know them from the front end part of our business. So again, I remain very excited about the Orbotech acquisition, and I'm super proud and feel -- to be in charge of this organization.

That's very good, Oreste. And then I just want to ask one more question on the EPC or I should say, Orbotech, specifically SPTS. The bull argument is that it gives you a good exposure to the 5G side. But if I just want to play the devil's advocate and look at SPTS, it seems like a low volume product, mainly on the ICP plasma etch and PVD for packaging, PECVD, these are all typically -- traditionally these are processes that are not KLA's focus, which is more -- KLA is more on the process control inspection side. So I'm kind of curious, do you still think SPTS is a strategic fit and when would you expect this segment to blossom as 5G comes on?

I believe it is. And actually, it gave me the opportunity to go back to 20, 25 years ago when I was in charge of process integration in the fab. So now I go back in my past of process guy, totally process control person. It actually has given me the opportunity to double down in SPTS, that I'm very, very excited about it. Actually, when I work together with the team in U.K. and when I talk to the customers around the world, I get excited about the potential growth ideas. So SPTS is a low cost, very unique position, is the leader in plasma-based etch deposition solutions for these markets that are fast-growing markets. And we are really at the right time, in the right place because with also the COVID pandemic crisis, we are seeing in particular these markets [ locks on ], you mentioned RF is instrumental for the 5G connectivity. But also we have seen in the last couple of quarters, a huge increase in the MEMS business. And the MEMS are everywhere because MEMS are sensors, you can deploy in the industry, you can deploy in the medicine, you can deploy in many, many areas of our culture and society. So that's the reason why I believe strategic because it gives us the opportunity to play in this fast-growing markets and also give us the opportunity to enlarge, expand our reach into the semiconductor, not only limited in the process control, but also in the process solutions where we are leaders and opportunities in niche markets. So that's the reason why the strategy is twofold. Is strategically because it gives us the opportunity to double down in this fast-growing market, but also to learn and understand the processes, the tool market from a leadership position. And that's the reason why I expect SPTS to deliver excellent top and bottom line results in the calendar year, remain very confident in the long-term growth of this business.

A very interesting perspective. Got it. Talking about you wearing multiple hats, if I remember right, you used to be the former General Manager of the e-beam business. So can you talk a little bit about update on KLA's e-beam product and the competitive situation with Hermes which is part of the ASML now and also Applied Materials?

Yes. e-beam, oh gosh, 2004, 2007, so a long time ago. Yes, I'm happy to do so. So we have been very consistent with our message around e-beam inspection. We have been saying for years that we would have entered this market again only with a differentiated solution. And this is what we did last year. So we believe we have a superior hardware and software technology to tackle the small physical defect detection challenge in conjunction with our best-in-class Gen 4 and Gen 5 optical with inspection platforms. As you may know, e-beam is actually split in main subsegments. There is physical -- small physical detection. There is the voltage contrast electrical vehicle detection, some metrology. The space that we are targeting in our solution, at least initially, is in the small physical defect detection because we can leverage this pipe [ hard pulling ] between wafer inspection optical-based technology and the e-beam-based technology. So again, these 2 technology markets, very, very close to leverage each other's strength, share advanced machine learning-based algorithms, for example, and we are very encouraged by the strong customers pool for the new e-beam specialty technology after we successfully demonstrated value, a unique differentiation in several data sites last year. So we are excited about to be making e-beam. For me, in particular, is the reason to be proud because I've been there many, many years ago, and I was not happy to seeing the gap in annual report e-beam specialty KLA 0% share for many, many years. So last year, we gained a little bit of share and I expect to gain more share in the coming years.

That's right. And just one follow-up question on e-beam. I think ASML and AMED have publicly spoken about doing the multi-beam approach, something -- some of them beginning multicolumn. I'm kind of curious where you guys' take out on that standpoint for e-beam?

Yes. Making a multicolumn wafer inspection, e-beam inspection, is no sense. A multi-beam, of course, people are trying, and that had been the desire from our competitors for many, many years. There is no proof that a wafer inspection, multi-beam or multicolumn e-beam technology works yet. My thinking is very, very different. We would like to have the most differentiated and providing the highest value e-beam inspection technology to our customer. It doesn't matter which technology we use, we believe our technology is highly differentiated to serve the customer needs. And we will stick to our technology for now. On the other hand, I want also to mention that on the radical inspection side, however, we are developing a multicolumn beam radical inspection tool that will be in the market next year.

Got it. Got it. It makes sense. And then a couple of questions on the non-technology side. One is on OpEx. Clearly, what you have seen is that demand is still very strong. There are some people concerned about a recession. So if things do head south from here, how much flexibility is there on the OpEx based on market condition? And within that also, one other question is that you're seeing with COVID, there's been some headwinds in the form of higher freight and shipping costs. There have been probably some tailwinds in the form of lower travel expenses. So if you roll it all together, how flexible is the OpEx of the margin structure?

Yes. I'll start to say that we published our business model in the last September investment conference outlining margins by various revenue ranges, as you know. We're continuing to operate our company based on our capital allocation priorities. We have flexibility in managing our construction through variable compensation. You mentioned travel of course, but also the annual bonus payout is another variable compensation level we have. So I would say, yes, we have room. You asked about flexing the OpEx. We have room for flexing our OpEx in this market condition. But again, I want to make sure that the capital allocation priorities are clear and we start from allocating -- deploying our cash for R&D, in particular, it is growing in our business and the venture work that we're doing also in this time frame.

Got it. And then honestly, one quick question on lead times. With the whole COVID, have you seen lead time stretch for you maybe because of supply chain inefficiencies? And inherent, there is also an assumption that -- my view was that out of your long lead times for inspection had to do more with actually testing the tool rather than actually just procuring the materials to build it. So is that true? And given all of that, how do you see lead times today in a COVID or a post-COVID world?

Well, we have a very broad portfolio. So it depends on the products and some products have shorter lead times, some products have longer lead time. I don't want to say that the lead time is long because of testing only. I mean the lead time is a combination of procuring the parts and building the machine, integrating the parts and eventually testing the machine before we ship to customers. I don't really see any change, actually. As I said in the previous question, that we have been quite successful in managing the supply chain through these incredibly painful times. And I don't see -- frankly speaking, I don't see any change in the future in the way how we manage our supply chain and the way how the lead times will change.

Got it. Got it. And then my final question, given the interest of time, my last question for you is, it looks like you have about $1 billion left in the buyback. Are you continuing to buy back shares in this environment? Or are you slowing it down during this COVID period?

As I said earlier, redeploying our business and eventual allocation for M&A transaction to achieve our top line growth objectives are top priorities of our capital allocation strategy. The rest is to return to shareholders under either forms of dividends or share repurchase. As you know, we have a long history of increasing dividends year after year. And our goal is always to be -- to return over 70% of the free cash flow. In the March quarter, we returned much more than that. We returned more than 100% of the cash flow, including at that time $316 million repurchased. It was higher than historical average. As you said, we still have approximately $1 billion remaining under our share repurchase authorization but we have scaled back the pace this quarter to be more prudent given the global macro uncertainty.

Got it. I think, with that, we're right, hitting up the time. And, Oreste, thank you very, very much for your time and input, and hope you guys have a good rest of the day. And thank you, Oreste and Kevin.

Thank you, Krish.

Thanks for having us.