KLA Corporation (KLAC) Earnings Call Transcript & Summary

Hello, everyone. My name is Mehdi Hosseini, senior analyst at Susquehanna International covering technology and hardware. Today, as part of our Tech Conference, we have a fireside chat with the team from KLA. I have Oreste here to help us with several topics that we have prepared and we also have the IR team. And the format here is that we will go through these topics and questions that we have prepared. And if there is any question from the audience, please feel free to shot me an e-mail at [email protected]. So with that, I want to thank the entire KLA team for giving us an opportunity. And Oreste, thanks so much for cover some time to go over some of these very exciting topics. Perhaps I want to just dive in and put things in perspective. It has been about 3 years since KLA acquired Orbotech, and 2 years since Orbotech and SPT (sic) [ SPTS ] as were consolidated into the organization. And we now refer to it as EPC. Can you give us an update as to how the integration of these assets are going on?

Mehdi, thanks for having me. I'm really happy to be here with you guys today, and happy to tell you a little bit more about EPC and where we are with the integration and the progress as planned. So as you said, we completed the acquisition of Orbotech and SPTS exactly 3 years ago, it was February 2019. Time goes very, very fast these days. And we are very, very happy with the progress that we have made since then. So if you look at the revenue and profitability targets that we outlined at the time of the acquisition and we presented at Investor Day in New York City in September 2019, we are ahead of these targets. And also another thing that I'm very, very impressed with all the organizations that we acquired and eventually integrated under KLA operating model inside EPC is the way how the employees embrace the KLA value and all the processes we have. I believe the integration has been successful for a few reasons. First of all, we have been very, very clear with what we were trying to accomplish with the acquisition of Orbotech and SPTS. SPTS, I would remind investors who is an independent subsidiary in [ Saudi Orbotech ]. It came with the Orbotech acquisition. So we wanted to expand our span. We wanted to enter new markets. We wanted to enter new markets in the electronic ecosystem, in particular printers board and display. And we wanted also to strengthen our portfolio in packaging and specialty semiconductor with the additional process tools like the SPTS vacuum-based PVD, CVD edge tools in addition what we have developed for many, many years at KLA that means inspection and metrology. So we were very, very clear. The second thing is we wanted to buy organizations that will lead in their sectors, and organizations that can benefit from KLA competencies or even a market presence. For example, since then we have done some work together to improve the technologies or the former Orbotech divisions, the Orbotech product lines. We introduced, for example, optics designed by KLA in the next generation of PCB automated optical inspection tool. We also use some of the KLA simulation and modeling capability to help with direct imaging, photolithography development. We initiated collaborations with top semiconductor customers in packaging, including some offerings from Orbotech and SPTS. And these organizations, of course, previously had no interaction with these customers. So all these things that we have done in the last 2, 3 years, made this integration more successful. And of course, we are still along the course of the integration, we are not done yet. Finally, I would like to mention probably the secret sauce of the integration is the KLA operating model that I explained during the Investor Day in 2019.

Okay. Now 1 thing that I asked you a couple of years ago, I'm going to ask you again, is KLA's core competency in front end, in process diagnostic inspection and metrology. And what I want to get an update on -- like if you were to focus on like a packaging yield management, how are you going to take the leadership that you have in the front end in process diagnostic and apply it to advanced packaging and basically standardizing the back-end processes? Is that even possible?

Yes, that's a great question. Actually, opening one of the main focus of EPC organization is, of course, advanced packaging. And before answering your question, let me say a little bit about our -- first of all, how the advanced packaging is progressing and our role in advanced packaging. And then I'll respond, if you don't mind, with a direct answer to your question about standardization packaging. So first of all, let's talk about overall packaging. So as you know, the ability of scaling transistors like the model it's slowing down, and it's becoming very, very expensive. So it doesn't mean that [ auto ] is dead. In fact, it's not. In fact, our advanced customers are progressing towards 3-nanometer or even beyond 3-nanometer, introducing a lot of very, very innovative technologies like photolithography going to the next level of transistor architecture, we get all around. So we still see scaling in the front end wafer part. However, it's so enough anymore. And that's the reason why advanced packaging is being used as augmentation of a front end technology road map to make sure that the entire semiconductor industry can advance. And advanced packaging has become a key enabler. And we see a lot of top semiconductor companies now heavily investing in this area. So let me give you 2 examples. First of all, heterogeneous integration. So -- and this is at the front and the center of advance packaging technology roadmap right now. So with the heterogeneous integration, we allowed the aggregation of multiple chips on a single package. So in this case, everything gets integrated in a single package with the help of very advanced subsidy. And this is leading a lot of significant process control and process integration challenges. In particular, when you try to integrate multiple guys, multiple chips on a single package and you want to do like the next generation, heterogeneous integration will be bumpless. So will be direct copper to copper bonding, what we call hybrid bonding architecture. You will see even more challenges in terms of [ multi facilitation ], the placement overlay, workage measurement and overlay high-level cleanliness. So this is, of course, a significant impact to our business, positive impact to our business because now the challenges that we have seen from front end [indiscernible] to process a long time. Now they are converting into similar challenges in packaging as well with all these heterogeneous integration, in particular, the hybrid bonding architecture. The other thing that is happening in packaging, that is something I'd like to talk today because I believe has not been really understood is the role of IC substance. So IC substance is -- just to give you an idea what the substance stands for. So whenever you place multiple chips in a package, you need to land the package on a substrate before connecting to the PCB. So these substrates are acting as an intermediate layer between the chip's package and the PCB. And these subsets are evolving a lot. In particular, they are important for FPGA, CPU, GPU or all the computing chips. And these subsets are done in PCB fabricators right now. I want to say this is like the high-end PCB technology. And we have seen an unprecedented tightening of substrate supply right now. And sometimes, as we talk about chip shortage in the world, sometimes the chip shortage is there relative to substrates shortage, and you don't have substrates where you like your packaging with chips. So substrates are becoming extremely important because they are becoming much, much tighter in terms of geometry. And also the complexity overall in public substrate is becoming really real challenging for the PCB fabrication. So with Orbotech, we have an opportunity because Orbotech, off course, is in the PCB space. And now it's fully integrating the PCB group to play in this segment, developing very interesting products to have the fabrication of the substrates. So -- and this is the second portion of the packaging, the challenge I want to discuss. The third one has nothing to do with the computing chip, but used to do with another important trend that is 5G. And the adoption of 5G network communication protocol in smartphones is significant innovation as well in packaging and boards. And in particular, I think maybe you do a lot of research, I know you are very well aware there is a big inflection of what we call SIP, system in a package. And whenever you transition, for example, the 5G communication to millimeter wave, there is a new integrated RF front-end model that is designing, including many components, power amplifiers, switches, transceivers, antennas in a single package. And in addition to reduce the form factor that is by itself a big challenge, you also have a lot of complexity in the design of these packaging and the board supporting SIP where we see our ICOS business and PCB business getting more and more critical. So you see like an incredible inflection packaging and subs that then PCB, driven by all these trends happening right now in electronics. Now going back to your question that is a very good question. So as you know, I joined KLA a long time ago, 2 or 3 years ago. But before KLA, I was working in semiconductor fabs, a worked specifically in Texas Instruments and Micron. So I start to work in semiconductor almost 30 years ago. And at the beginning of my career, when you call about process diagnostic control, there is nothing -- there was nothing. I remember, we were in the clear room looking at wafers with optical microscope, trying to find a defect. When we find the defect, everybody was up or happy depending on which process are you get the defects from. But it was not real, the semiconductor industry, 30 years ago, 25 years plus ago, was not really set up to monitor the line and do a proper process diagnostics. So KLA 25 years ago, invented in semiconductor wafer fabs, the concept of inline monitoring and yield management system. And it was -- in reality, it was a more rigorous way to split the fabrication process in multiple models. At the end of each model, we have an inspection point or a metrology point. This concept of process diagnostic control or a line module with the management system became standard in semiconductor front end. Now standard, there's an existing packaging. Under this, an existing substrate in PCB. Can we do something? Yes, we can. So when you look at what happened, for example, in wafer fabs, this transition from optical manual inspection to fully automated feedback -- feedforward control loop based on process control was gradually done. It didn't change in a day, it was done in the last 25 years. So we are starting now partnering with top 5 customer packaging companies in implementing the same concept in terms of data control and data analytics. So as you know, we have our software platform that everybody is using in wafer fabs. It's called Klarity and 5DA. These are software solutions like KLA has been developing for many, many years to make sure that all the data we aggregate in the semiconductor fabs. And that are used for process control optimization, feedback and feedforward control loop. And generally, on top of the software infrastructure, we build AI and machine learning analytics. So we are starting having this conversation right now with the packaging customers. First of all, to standardize the output of the tools and then after the output of the tools, is standardize like 6th gen or something similar to what we do -- similar that we have had in wafer fabs. We can create a software suite, and then we can build algorithms on top to have much better control of the line in packaging. And eventually, we will build a similar thing lever for substrate in PCB. This is a fantastic question maybe, and this is something that, frankly speaking, I'm spending a lot of my time and my body because I'm really passionate about it.

Sure. So essentially, is opportunities presented -- these opportunities presented relates to nongood dye and nongood dye has historically been the challenge. Now -- and I don't want to deviate from the topics. But I think 1 way to better understand opportunities for KLA and as a follow-up to that, standardization thought process. Who would be your customer, especially with hybrid bonding, advanced substrate, silicon package, and we're dealing with the nongood dye improving the yield. Does that create opportunity as you would sell systems and solutions to multiple customers? Or you basically are offering data -- analytics to connect the data, but ultimately, there is 1 single customer?

No, it's not a single customer. If you look at what I said before, the inflections in packaging and substrates are driven by all these trends happening in the digital society. This is, first of all, we sell products to our customers. And this is not only one. There are many customers in packaging, many customers in subs and PCB. From the data analytics point, we will sell to the same customers. Because eventually, the advanced packaging line or the subset publicators, they needed to control the outline, they didn't control their quality and they need to make this automated. So who will sell these software solutions to the same customer, we sell our hardware product list. On top of that, there is an opportunity. This is a very good point, actually. There is an opportunity to broaden our collaboration with entire ecosystem. For example, fabless. Fabless, they design their own ships and generally the wafers are built in foundries and package either in foundries or in OSATs. So there is an opportunity for us and there has been for a long time because we work with the fabless not only with direct customers who understand how we can have entire ecosystem to talk to them about these new software solutions to make sure that they may have some value or they may see some value from the data that we are generating the fab. Of course, this is a part of their agreement with their suppliers, KLA is absolutely agnostic to their agreement. So -- but there is a possibility by developing some software analytics and some analytics that can create more value out of the data coming from the tools in the packaging line that the fabless will have a different type of agreement with their suppliers, either foundries or OSATs, and eventually they can leverage this data.

So when it comes to how KLA could leverage relationship collaboration with customers, these additional services or solution becomes critical. And to that end, well, it was AMD that finally brought the concept of SIPO chiplets to headlines. We have known about SIP for maybe more than 2 decades, but 1 fabless company commercialized it. Now looking into next year, the other leading logic IDM based in the Bay Area wants to do that. So this is where like KLA could catalyze the chiplet opportunity for these other logic manufacturer. And actually, you can become a part of their success stories as they catch up to AMD. Am I thinking about this the right way?

Absolutely. In fact -- as a matter of fact, again, we have 2 roles in all this innovation and inflection. One role is 2 providers. And the other one is, I would say, solution providers through our data analytics platform. And again, the data analytic platform, of course, if you can leverage the data out of a fab, a packaging line or an assembly line or a substrate publication line, so you are better in determining what the problems are in the line. How you control it, how you monitor, how would you solve. So eventually, AMD or rather fabless or other OEMs will take advantage of it. And frankly speaking, as I said, we have a collaboration. We don't sell tool to our fabless. We don't sell tools to mobile OEM, we don't sell tools to automotive OEM. Maybe we can talk about automotive later on. But we leverage the corporation to make sure that they can get the best out of the tool, the best value out of the tool that we ship to their suppliers.

Just a quick follow-up here, and I'll move on to the next topic. If an IDM has a hybrid strategy utilizing their own fabs as well as foundries and also trying to scale chiplet, will managing the nongood dye will give you additional opportunity? Like if they're fabbing GPUs at TSM, but they want to do it back in in-house. Is there an opportunity for KLA or is this...

Absolutely, if they want to do back-end, they start operating their own back-end fabs, they will become customers of ours. And they was a customer of ours where KLA is a kind of sort of priority because we have already implemented the same system and the same, let's say, standardization at their current suppliers. Yes, absolutely, it's an opportunity.

Okay. One other end market that doesn't get as much attention with traditional semi-cap, but everything else is in a headline is electrification in other industry, automotive electronics, which requires new material, new substrate, new way of putting more silicon into the package. So can you help us understand how those opportunities are presenting to KLA and any detail will be great because I think this is 1 area that yes, there is a shortage. But I think this is -- we're in an inflection point in supply chain changing to accommodate electrification in other industries. So how does they can capitalize that?

Yes. I'll respond to your question again in a broader way. Talking a little bit about automotive electronics first and then the role of KLA that is quite unique in the automotive industry. Now let me talk about automotive electronics first of all. So as you know, automotive industry is [ mainly in ] Russia. So right now, we see implementation of electrification, autonomous connectivity. All these trends will require a new approach how to develop and qualify a manual or semiconductor boards. So when you look at electrification, for example. So it's no secret that the automators -- the automakers are making significant investment. They want to accelerate electrification. We hear almost every week that the automotive OEM, they want to have like full line of electrical vehicles by 2030. They want to get pretty much this transition prolification as fast as possible. But this is not easy because the electrification, although I still believe the electrical car is much easier to produce than the combustion engine car. But there are very, very big challenges from power efficiency point of view. And of course, when you talk about power efficient in the car, the first thing that you think is how can we have a different material than silicon to provide better power efficiency in the car. And of course, you think about silicon carbide. The silicon carbide is more power efficient, you can operate at a higher temperature, you can operate at higher frequency. So it seems to be a perfect matter compound semiconductor material to handle this challenge. However, these materials are very hard to manage. And I'm talking about silicon carbide, but I can combine with gallium nitride for some onboard charging and also gallium nitride is very, very well used for 5G infrastructure as well. So these materials are new. So we have been working with silicon for 50 years. These materials are exotic and new or hard to manage and they are still a very low yield right now. However, they are going to progress. And when I look at the automotive power, right now and for electrification, I expect there is going to be a mix between silicon power and silicon carbide power inverter for the next 5, 10 years. And then eventually, it will shift to silicon carbide for the vast majority of power devices. So when you look at all these compound semiconductors, this is a great example where the new group, the EPC that we formed after the acquisition of Orbotech SPTS is very, very helpful to the industry because SPTS has been the market leader for PVD technology serving power semiconductor for a long time. And we see an adoption increase for our deposition in edge solutions for both silicon carbide and gallium nitride. And now going back to your question, apart from silicon carbide, gallium nitride, our solution either for process control or process tools for this kind of compounded semiconductor. Let's talk much more in a broad sense about quality and reliability control in automotive. As you know, and I want also to make a link to the nongood dye question on packaging you asked me before. So when you look at automotive, it's always been the most demanding industry in terms of reliability and quality of semiconductor, of course, because live -- very liability, expensive cost and so on. And for that kind of reason, the level of scrutiny that you have on automotive industry, you don't have in any other industry of electronics. So the chips are tested multiple times. Sometimes you try to replicate the harsh environmental conditions with environment testing and so on. But despite all these testing that are done -- that is done in automotive semiconductor, you still have marginal parts, marginal chips, they can still escape and enter in the car, enter in the automotive supply chain. And what happen? What happen is the chip can fail and the airbag can fail, and you have million of vehicles that are recalled, causing a huge cost and also frankly speaking, a legal liability. So that's the reason why KLA started getting really interested in automotive semiconductor even before the acquisition of Orbotech SPTS. Now we don't go against SPTS, we grew our presence in the automotive semiconductor. But even before then, we thought that we have a role to play because we are -- the quality the reliability like we drive the standard and reliability overall in the wafer fabs. And we thought in automotive was much easier for us to make a big impact, a big presence. So what we have done 3, 4 years ago, we started talking to everybody in automotive, including the carmakers, the Tier 1, the supply chain of automotive is extremely complex, I think maybe you know there are automotive OEM, the carmakers and then the Tier 1, preparing the boards. And then the Tier 2, the semiconductor supply. And there are the fabless, there are OSATs. It's so complicated. Also, that's another reason why the automotive was the first industry to pay really the fleet to the chip shortage at the beginning of last year. So -- but what happened was we decided to partner with everybody. And we came up with an idea that we call I-PAT. I-PAT means inline parts average testing. It's really a clever way based on machine learning methodology to screen the potential reliability phase in fact. Instead of waiting the chip will be the concern getting into a car or getting into automotive supply chain. We came with some ideas how to create a new solution in between electrical test and inspection that creates pretty much -- it's a software charge solution that use some KLA hardware tools with some machine learning methodology as a software to make sure that you test exactly the chips, exactly the steps, exactly the parts of the dye that is more exposed to potential hardware failure later. Now how do we know? Because we create this suite of software algorithm solution that can collect all the data for many, many different sources from inspection tools, metrology tools, process tools, from reliability test, from failure, from electrical tests and so on. You can talk together, we create a huge database, we know prime machine learning methodology, and the outcome is whatever is the best solution for screening chips in the form of -- by dimension, by reducing the potential reliability figures that may happen later on. So that's what we have done. We produces I-PAT. I-PAT now is a standard in the automotive electronic council guideline specs for automotive semiconductor devices. So in other words, it's been built-in in the spec. And you use our machine learning methodology, proprietary methodology plus KLA tools for inspection. And that's the reason why we are part of the automotive ecosystem, and we are a big influencer in the way we expect, or the industry expect automotive semiconductor for reliability and quality control. On top of that, of course, we released other products after the I-PAT a couple of years ago.

So although electrification in the auto industry may present unit opportunity for broader semi-cap, like units of chips like logic chips going into the car industry is good for everyone. But when it comes to KLA, perhaps the TAM opportunities are bigger given the way you described it, it's more than just etchant acquisitions for trading chips that go into a...

Correct. It's many things, is getting all these tailwinds from electrification of vehicle, silicon power and silicon carbide power in our SPTS business that is processed tools. It's like process control tools that are becoming more and more important and relevant because most semiconductor content in a fab, also more advanced technology in the fab. We have 5-nanometer controller now in car. And then the third thing is our ability to create standard in terms of software/hardware solutions that the semiconductor industry got to follow in order to make sure that they comply with the specs and eventually they minimize the order of reliability failures at the end of the line.

And then finally, you want to give us a preview of what these incremental TAM opportunities could be like? Is it like a $0.5 billion, more than $1 billion? Anyway you can quantify the incremental TAM opportunities?

Well, it's definitely very, very I would say, double digit. We don't give like big numbers in this context and so on, of course. But I'll tell you 1 thing very, very clear. In 2019, in the Investor Day in September in New York City, I presented -- at that time was kind of awkward because nobody was thinking about automotive. At that time, automotive semiconductor industry was not really an important stepping stone of semiconductor. But we presented a plan on all these ideas that, by the way, get this idea materialized in the last 2, 3 years. And then we put up a plan to say we will reach 4x the -- pretty much the revenue by 2023. Well, I got to tell you, we are ahead of that plan. So if you look at how much revenue we had from automotive semiconductor in '19 and you see like how much revenue we will have in 2023, we have more than 4x increase. So that is quite significant. Of course, with the insertion of the Orbotech and SPTS sites as well. So we are talking about impressive growth.

And what was the revenue in 2019?

Don't let me say numbers publically. We don't publish these numbers. I don't want to -- but the growth has been -- is going to be 4x depending what you have before the acquisition of Orbotech and SPTS, after acquisition of Orbotech and SPTS together with all these machine learning methodology and new products that we developed and released in semiconductor process control, we said we increased our revenue 4x in 4 years, that is amazing.

Okay. I'll just check my inbox. There is no follow-up question, and we're reaching the time limit. So I want to thank the entire KLA team. And Oreste, safe travel. And thanks so much for providing an insight, I think these are very exciting opportunities beyond the traditional front-end prices diagnostic.

You are right, Mehdi. We have a lot more to say in the industry together with the automotive and packaging subs in PCB and whatever we have done in the last few years to diversifying and make our pipeline of tools and the presence in the market stronger. Thank you. Thank you for having me.

Thank you, and I wish everyone a great and healthy weekend.

Thank you.