KLA Corporation (KLAC) Earnings Call Transcript & Summary

Okay. I think we're live now. So we're with KLA -- sorry, just KLA today. We have Oreste Donzella, who's the head of the newly-formed EPC division, Electronics, Packaging and Components. So welcome, Oreste.

Thank you, West, for hosting us today. Hello, everyone. I hope you and your families are safe. I'm particularly excited to be here today at KLA's first investor conference following our strong June earnings report, which included a record quarter for the EPC group, which, as you know, I'm leading with the help of an awesome team. There are a lot of exciting happening in EPC that I'm looking forward to discussing in the Q&A. KLA's performance in the June quarter, our position in the marketplace and the progress towards the 2023 target model. Altogether, alike all the KLA operating model, our long-term strategic objectives provide a dependable framework to guide execution and help us consistently deliver on our commitments. As you know, June results came in at the midpoint to upper end of guidance, driven by strong foundry and logic demand. We added up sequentially in September and see growth for the company in the second half of 2020, driven by broadening foundry and memory spending resuming in Q4. And of course, service, which is 26% of our business, is on track for a solid growth year in 2020. Finally, EPC delivered record results in June. EPC comprises of the Orbotech SPTS and ICOS businesses, and we are very excited about the strong results we are showing today in specialty semiconductor, packaging and printed circuit board market. EPC is leveraged to growth markets like 5G infrastructure, smartphones, high-performing computing that will create a tremendous opportunities for KLA in the next few years. KLA is delivering on our commitments in the middle of a pandemic, which is remarkable. And has given the company an opportunity to demonstrate our resiliency and the dispensability to our customers. Even with all the disruptions of COVID, our team's execution, market leadership and solid free cash flow about the KLA successfully navigated through these challenging times. We are looking forward to even more exciting time side. So with that, let's dive into your questions, Wes.

All right.Thanks, Oreste. And by the way, if people do have questions, feel free to submit them on the website. There should be a window that you can click on, and I'll take a look at those questions as well. So first, can you tell us about the new EPC division? Why was it created as a separate division? And what do you hope to accomplish?

Yes. Thanks for the question. So EPC started to comprise, as I said, in my introduction, the Orbotech SPTS cycles of businesses. Let me go back to the time we announced the acquisition of Orbotech, and then we finalized the deal. It was February 2019. In February 2019, we completed the deal, and we decided to learn as much as we could from these markets. And eventually, during the September Investor Day, we decided to create an organization that is going to instill the KLA operating model into the new organizations. So we see benefits in instilling whatever we have developed for decades in KLA in terms of process, how we developing technologies, how we interface with the customer, how we efficiently run the operations. And putting all this work for the new organizations, we see a possibility to grow even further these kind of organizations and business and meeting the operating targets we outlined in our Investor Day in September. So the creation of this organization is just because we want to make sure that we leverage our operating model and we grow these organizations.

Okay. And that makes sense. Can you walk us through some of the moving parts, like specialty semis, the ICOS piece, PCB, display. And maybe discuss how you think about the growth opportunities in each of those? In other words, what are the longer-term growth rates that you're anticipating?

Yes. So first of all, let me start to reemphasize the very strong results in Q2, calendar year 2020. So 3 out of the 4 divisions inside EPC published a record revenue, in particular, specialty semiconductor process technology called SPTS and the ICOS division that is delivering differentiated technology for component inspection and finally, printed circuit board. So let me go through these divisions, just to give the investors a little bit more of an understanding of what these divisions do. Let's start from a specialty semiconductor technology. So we expect, first of all, a double-digit growth this year from this particular business. And we expect this double-digit growth to continue in the next 2, 3 years to meet our financial goals for 2023. So specialty semiconductor process technology, SPTS, is a division operating in U.K., and we deliver -- we develop and deliver differentiated solutions for edge and the position in niche markets such as RF devices, power semiconductor, MEMS. And also, we have a pretty good presence in advanced packaging as well. So these are markets that are growing quite fast. In particular, I want to talk about the RF semiconductor devices that are at the core of the 5G infrastructure right now. So this reason why we remain very, very confident that SPTS will continue to grow in the near and long-term future because as opposed to very, very fast-growing market. So going to PCB. PCB, print circuit board, also is an exciting market. First of all, let me say that Orbotech is a very, very broad and comprehensive portfolio of products in the PCB and IC software space. So we deliver inspection tools, repair machines. We have design solutions, software solutions, imaging, like photolithography type of products, drilling. So you can see it's really, really broad in the way how we serve this market. And also, PCB is having a very, very strong momentum driven mostly by 5G, both infrastructure and smartphones. And 5G is a long wave. It's not something that it starts today, finished tomorrow. So we have a year side of us of a very, very strong investment in this area. And the complexity of the board and the subs rate is becoming a growth engine for the PCB vision. And then ICOS. ICOS is a company we bought in 2008. We never fully integrated the KLA semiconductor process control organization. So we kept a little bit separated because of the market that ICOS is serving is different, the diesel assembly and test for semiconductor packages. And we are seeing strong momentum there also. First of all, because the packaging business is flourishing right now and the technology is becoming more complex. But also because we see a lot of new packages coming in, in particular in the area of 5G and high-performing computing. And then finally, the only division is not growing in a -- my new organization is display. Display is still digesting some inventory of equipment that have been purchased in the last couple of years. So -- and also, display is very much exposed to consumer market that is, of course, not doing very, very well during this pandemic. So for that kind of reason, display is really more of a long-term play in terms of revenue for KLA because we don't see the market to resume for the next maybe 3, 4 quarters. However, we are taking this opportunity to reduce the cost and streamline the organization in such a way we'll be leaner when the market receives.

Okay. That's helpful. You mentioned a double-digit growth in specialty. Do you have projected growth rates in PCB or ICOS divisions?

We expect both PCB and ICOS to be high-single digit in the near future. And it depends, again, especially for PCB that is so much exposed to 5G, maybe even more than that, depending how the 5G infrastructure will evolve in the next few quarters. This play, as I said, we are not expecting to grow until the end of 2021, and then we'll see how pretty much the market resumes.

Okay. I see. In these markets, these are outside of KLA's core expertise in some cases. How do you differentiate yourself in these markets?

That's a great question. I'll say, one of the negatives behind the Orbotech acquisition was to acquire a leader and even in their space. SPTS is a clear leader in [ action ] and position solutions for the markets I mentioned before that we consider specialty semiconductors. Our PCB is a clear leader in the PCB and IC software market, and ICOS is the leader of component inspection and display as well. We have leading position, although the market is depressed, but we have leading position in our product technologies. So we compete by market leadership. We compete by technology differentiation, we compete by customer interaction. And these are things that in KLA, we know very well, and this seems Orbotech knew already and now putting together the companies is giving us the possibility to add even extra value because we are opening, for example, for Orbotech, some markets or some customers that they were not engaged for.

Okay. That's helpful. Do you anticipate more M&A in this segment? And if so, what would the focus area likely be?

Yes. So definitely, we are putting our foot in the door right now. So we are a much wider participation in the electronics value chain. So KLA, of course, has been in the semiconductor wafer front-end, the process control business for many, many years. But now with one acquisition and also the creation of the EPC organization, we have the ability to expand in many different markets. And we have the opportunity also to capitalize our effort in the next few quarters to seek more acquisition targets in these markets. So of course, right now, my primary job is to make sure we are successful with the Orbotech SPTS cycles and EPC organization. And we would like pretty much to leverage the success of this integration to make sure we can access to different type of acquisition targets in the future.

Okay. You mentioned a goal. I was wondering if maybe you could share us some of your goals as the new head of the division? Are there any targets or goals?

Well, the financial goals have been outlined in the Investor Day in September. They didn't change. So the goal is to grow the top line revenue of the EPC, double-digit pace by 2023. So the goal didn't change. Actually, we are even more confident in the last few months since I took the new responsibility to the goal that we outlined in September. We are encouraged to see continued market leadership in the segments we serve and also the very good exposure to as growing market like the 5G I mentioned before. So the goals didn't change. And these are the financial goals. Of course, my personal goal as the head of this organization is also to make sure that I have a very, very strong team supporting the long-term growth strategy of the group and the company, and eventually making sure that everything we do well at KLA is going to be received and implemented in my new organization.

Okay. You mentioned display is soft. You didn't really talk about automotive. Are you seeing any signs of life for recovery in automotive yet?

I believe automotive, it bottom last quarter. I'm not the only one to say that. So we have seen several automotive semiconductor companies calling the bottom of the automotive semiconductor market last quarter. So automotive is an important segment, especially for SPTS. And this makes me even more positive about the future because, for example, SPTS posted the record revenue last quarter without automotive semiconductor business. So it's pretty amazing when this business is historically 20%, 25% of the revenue of the division that is got to 0, so there is a pretty good upside ahead of us that is great news. So I believe automotive will recover. Automotive semiconductor, of course, is less depressed of the automotive industry overall because some strategic investments, for example, in compound semiconductor electrification of the vehicle are continuing even during these big crisis of automotive industry. So again, we see a slow recover in the next couple of quarters, and maybe towards the second half of 2021 will semiconductor promotive will recover to the normal historical pace.

Got it. Okay. And the PCB recovery that you mentioned, how much of that is related to the 5G ramp? And is there some risk that maybe the PCB recovery slows down in the back half of the year if it [indiscernible] ?

As I said before, it's really early exposed to 5G, but this is not going to be a slowdown because I mean, if you look at 5G today, we are at the beginning. There are, I don't know, maybe 600,000 base stations being built in China only. And there are going to be many more built in China, built in rest of the world. So -- and PCB is very much exposed to 5G infrastructure that will continue for the next several years. And it's also very, very much exposed to the mobile market, the smartphone markets. And as you know, the smartphone market may go down in terms of units this year, maybe 10%, 15%. But eventually -- first of all, the semiconductor content is going up, especially with the introduction of 5G phones. The complexity of the board is going up. And in the future, also, the units are going up. So it seems to be pretty much a great trajectory for PCB to show growth in the market.

Okay. Maybe we could spend a minute on 5G, more broadly speaking. So it seems to be a big enabler for a lot of new compute technologies in the space. How's the ramp of 5G factoring into your conversations, your long-term conversations with your semiconductor customers?

Not only semiconductor, semiconductor and packaging and the PCB, as I said. Yes, 5G is pervasive, is the biggest driver we are seeing right now in the electronics space. And again, it's only at the beginning. So let me talk a little bit about the infrastructure first. When I look at, for example, the requirement of semiconductor in the 5G base stations today versus all chip base stations, these are really big -- there are really big differences there. For example, the baseband units and the radio units, they have more RF content, much more RF content than 4G. There is more adoption of advanced technologies, either FPGA or CPU or processors in the base stations are becoming more and more advanced, and there are 10-nanometer chips right now in the base stations for 5G infrastructure. So 5G infrastructure is a very good growth engine for semiconductor and board markets. And also, the phones are gaining more and more semiconductor content, transceiver, communication shapes, modem baseband, processor are becoming more powerful and not only 5G, but they got to also embrace all the higher evolution as well. So the products are becoming more expensive and more complex. There is more memory going to the phone, of course, both the DRAM and NAND. So you see, really, when I see one big trend -- and there are many trends. The good news about semiconductor industries these days is we are exposed to a very, very much diversified end demand. It's not the same as 5 years ago where the semiconductor industry was only exposed by mobile phones. Now we have a many, many trends, the 5G infrastructure, the mobile, we have the higher-performing computer, the cloud transition to be the center, eventually the transition to the edge. So all these trends are very, very positive for semiconductor. I will say, right now, 5G is number one.

Okay. Is there a way to quantify the opportunity -- the incremental opportunity that it creates for KLA over the next few years?

It's very hard to say, actually, because it's so broad that it touches many, many, many different type of segments and so on. I would say if I look at the WFE in general, I'm getting more and more positive about the WFE future growth. In the past, we said it's between 4% and 5%. I believe in the next 4 years, it's going to pass 5% growth that is way more than a normal historical GDP growth year-over-year. And some of these most -- a big part of this is relative to 5G.

Okay. That makes sense. That's helpful. I'll spend a few minutes on semiconductor technology, that's a lot of what drives KLA. Technology is increasingly complex. We've seen some pretty aggressive note transitions over the last couple of years. But it's hard, and we even had 1 big company announced a delay of 7-nanometer. So I'm just wondering, your level of conviction and technology road map is progressing at a fairly rapid clip in the next few years? Or do you see that slowing down? And how communicative are your customers related to the road maps with you?

First of all, let me say, I've been in this industry for almost 28 years. I've never been more excited than today. I remember when I started, I starting the transition to 6-inch wafers. And I was working Texas Instruments on the memory side. And that time, we're talking about 1-micrometer and now we go down in the 10-nanometer space of single-digit nanometer in logic and so on that is fascinating and exciting. So I'm still very, very excited about this industry. And for sure, the lateral scaling slowed down in the past few years. However, the ability to pack more transistors in a piece of silicon was not affected because the industry find other way to scale. And they sign technology optimization was one way. The second way was introduction of new materials like cobalt in the back end interconnect or we went to different architectures, like, for example, the vertical transistor, the FINFET replacing plan of transistor in logic or 3D NAND replacing horizontal. So you see, the semiconductor industry is a great ability to reinvent itself. And for that kind of reason, I'm very optimistic for the future as well. Now, there are another couple of things happening right now that are very, very important. One is the introduction of EUV for litho. So for many, many years, [indiscernible] couldn't catch up with the pace of semiconductor industry. So we were using 193-nanometer wavelength in the scanner for many, many years with many, many [indiscernible] like multiple pattern, inversion and so on. But now it's a time that, especially the advanced logic will transition into UV space. That means, the photolithography people need to pattern a pitch. So needs pretty much to get the real value of the wavelength of the illumination scanner in the geometry that you are printing imaging on a wafer. That means first of all, more complexity because, of course, the goemoetry are getting smaller, that means more need to use advanced inspection for KLA. And the second one is more ability to scale to the next node of [ max ] technology. The second big trend I see is in the packaging. I remember when packaging was like wrapping a box around the chip, it doesn't work that way anymore. I mean the packaging is becoming more and more complex. And also, you see the big semiconductor companies like the Intel, TSMC and the other people, Samsung in the company, Micron, putting a lot of effort in making sure that the packaging technology continue to innovate even faster than front-end [indiscernible]. And we see all these integration schemes, 2.5D, vertical 3D, heterogeneous integration chiplet. These kind of packaging technologies are becoming incredibly complex, but it give you a lot of opportunity to scale the semiconductor index in the future and give, of course, the KLA, a great opportunity to contribute that [indiscernible].

Okay. That's helpful. A couple of follow-up questions. If packaging becomes more of an enabler than scaling, or there's more of a shift industry-wide in DRAM and logic to the 3D structures and less dimensional scaling, does that have a favorable or negative impact to KLA's opportunity?

As I said, the front-end semiconductor is going to scale no matter what. And now we have EUV to prompt on the scaling. And in the future, we'll have new transistor architecture. Every time you have something new in the device fabrication process, it's good for KLA in the front-end. I would say packaging is becoming an incremental opportunity for KLA. Because we were not in packaging before because packaging was really not a leading technology, not very complex. Now we see complexity there. We see the customers pulling us in. And I'll tell you one thing that I'm very, very proud of the last several months taking the leader of this organization is really to have a very open conversation with our packaging customers, top customers pulling us in and say, "Hey, we need a KLA in packaging because the complexities are becoming so huge that we need somebody with a front-end process control experience to drive us." And I see many, many, many customers really are asking for up there in packaging. So I would say, our classify packaging is an incremental opportunity for KLA. Now also back to your question about, "Do you see collaboration with your customer?" I've never seen so much openness to talk about technology roadmap, either in packaging or semiconductor data front-end as today. And even with their customer, even with the OEM, the people building phones or cars or boards and so on, we see more and more momentum generating from this collaboration because the complexity of what we do is so hard that you cannot do a lot.

That makes sense. Okay. Moving to memory. There's been an opportunity for KLA to expand the shared memory, particularly in 3D NAND. You talked about it a little bit on the earnings call. Can you explain what that incremental opportunity is? And how the revenue ramp might look?

Yes. This is good. So good question because, of course, as you know, KLA is more exposed to foundries than memories historically. Because generally, the foundry customers spend in inspection and metrology, a higher percentage of WFE we call process control intensity. However, we have seen changes in the memory market, and I want to make an example, the conversion from planner to 3D NAND -- to vertical NAND. At the beginning, it was kind of a concern for us. Because generally, when a technology in front-end like NAND went from planar to 3D, the geometry tend to relax a little bit. So maybe less need for advanced inspection, too. However, we came out with exactly the opposite outcome. So the process control intensity in 3D NAND was higher than a 2D NAND, it continues to be higher. And the reason is because when you need to develop a vertical NAND memory, you create new problems, and new problems need new metrology and new inspection tools on KLA and others. For example, stacking multiple layers on top of each other create a stress on the wafer. And when you create a stress on the wafer, we develop and deploy a wafer geometry metrology tool that is perfectly suitable for the 3D NAND market. There are many, many layers and you need to be monitored that have created more opportunity for our -- bear with inspection tool, so and so forth. So we see this to continue. And we are developing new solutions to address new challenges that can come up in the next years in the memory space, in particular, in NAND. On DRAM also, we have the upside from the implementation of [indiscernible]. And even if it's limited for a few layers only, the volume of DRAM and the wafer output in memory is so big that will create a significant opportunity for us that we are very much just supposedly in lithography in the process control area. So just to mention -- the last one I want to mention is we just launched our new EBM inspection tool, eSL10 at the SEMICON West. This was first, newly e-beam inspection product in 8 years on KLA. So pretty much is bringing us back in the e-bream inspection arena. And this is very important, not only for logic and foundries to advance their technology node but also for memory because in the memory, you have the need to find a very, very small defense, in particular in pathfinding and developing new technologies in very dense areas. And that's the reason why also our new e-beam inspection technology is very well matching the need for the memory market, particular in [indiscernible].

Okay. That's helpful. We're almost out of time. I would like to ask just one more question that's a little bit open-ended. But you have a really strong ramp in foundry, memory, good product lineup, high demand for process control. So it sounds like things are going well. So what are the top 2 or 3 things that you're most concerned about over the next couple of years?

Well, the pandemic is one. And eventually, fortunately for us, it's providing an acceleration of our business instead of a slowdown of our business. And eventually, the pandemic is teaching everybody about the resiliency of semiconductor electronics in general. I mean without semiconductor, there won't be any idea how to fight pretty much a pandemic. Live, a pseudo-normal life, connect with Zoom or virtual study and online classes and so on. So I would say we don't know when it's going to finish, but of course, this is on top of my concern. And again, everyone concerned, not only from a business point of view but of course, for health reasons as well. On the business side, frankly speaking, we keep marching along and make a lot of progress in our technology development in the integration of new acquired companies, and I feel very optimistic and excited about the future.

All right. Fair enough. Well, with that, we are out of time. So Oreste, thank you so much. It was great talking with you. And we really appreciate your participation.

Thanks for having me. Thank you.

Bye. Thank you.