KLA Corporation ($KLAC)

Good morning, everyone. Welcome to Day 2 of the Bank of America Tech Conference. I'm Vivek Arya from BofA semiconductor and semi-cap equipment research team and really delighted and honored to have the team from KLA join us this morning. We have Bren Higgins, Chief Financial Officer. As usual, we'll start with a few kind of opening comments from Bren. I'll get to my questions. But if you have any specific questions, please feel free to raise your hands, and I'll be sure to get you in. So with that, a very warm welcome to you, Bren. Very happy to have you here. If you could perhaps give a state of the union and help us understand how KLA can be the next $1 trillion market cap I could get the day started.

So nice to have aspirations. So thank you very much for having us. Excited to be here. Yes, maybe I'll just frame things up a little bit here as we the midpoint of 2026. The year is shaping up to be a very good 1 for the company and for the industry on top of a couple of good years, right? So we have a nice sustainable period of growth. 2026, we expect the overall industry investment to be up somewhere in the high teens, maybe 20-ish percent and I think that's been -- we've been incrementing that up as we've not only gotten better visibility. We've seen customer behavior and certainly some urgency around that, more exposure to sort of packaging that tends to be shorter lead time in terms of strength in the second half. And I think some firming up of schedules, particularly in the second half, that are tied to some of the construction projects that are out there. So I think when all said and done, we likely end up -- we said at earnings, we thought the wafer equipment mark would be about $140 billion plus kind of market. I think when all said and done, it might be a little bit stronger than that, all right? We think there's certainly some upside to that. One of the other things that's great right now is that as we look at 2027, the visibility is really remarkable to be midway through '26 and be talking about '27 and talking about '27 with meaningful growth expectations. But as we've heard from our customers with lots of expansion and new fabs coming online, that it's setting up to be an additional very strong year for the industry across all segments with broad-based participation at the leading edge in logic and foundry, but also strength in -- continued strength in DRAM. And I think we'll even see some expansion in the flash part of the market. So overall, a very constructive environment. We're pretty excited about it. And most of our focus inside the company is, how can we ramp up our supply chain and make sure the execution model is positioned to support what we think will be a number of years of strong growth here moving forward. Back on March 12, we had an Investor Day in New York, and we outlined a 2026 plan, our 2030 plan for KLA and stepped up our talked about how we had beaten our 2026 plan that we laid out in 2022, but a new 2030 plan for KLA that translated into a top line industry model of 11% growth for semiconductor revenue 12% on slightly rising capital intensity per wafer equipment and rising KLA share of the overall wafer equipment market, consistent with the growth in share of market that we've seen over the last years or so. So that translates into KLA moving from 7.5% of the market to 9% of the market, which translates into a 4.5% CAGR over the market baseline for our semiconductor process control business. We stepped up our growth in service. Our expectations for service moving from 13% to 15%. I'm sure we'll talk about [indiscernible] in a moment, real unique opportunity for the company and a unique business that drives predictable and sustainable accretive cash flow and profit for the company, which gets you to $26 billion, plus or minus $2.5 billion and $84 plus or minus $8 and earnings. Finally, market share results were announced by a third party in early April, and we saw a year -- another year of share gain, gained 80 points -- 80 basis points of share in overall process control, I think, which supports not only the differentiation that drives KLA's business model, the portfolio approach that we can offer a lot of capability to customer, depending on where they are in their maturity process, either highly technical solutions or more more economic solutions to meet their needs as they ramp process nodes. So another validation point, 7.5x our nearest competitor in the space. So we think we're positioned very well, very well across the products. Growth drivers are intact. We're excited about what high-performance compute brings to process control, a lot of unique opportunities, both in terms of the design environment that we're facing and how that benefits process control, die size and how that affects defect density, value of die. And then also what's happening in the memory with high performance with high bandwidth memory, but also improvements in overall intensity as it relates to conventional memory because of the introduction and scaling of EUV layers in DRAM. So we think that the overall market sets up what was a good sort of gain in performance relative to the overall market. And as we look forward, we feel like that we will see a continuation of that. So we're pretty excited about it. So why don't I stop there, and I'm happy to take your question.

So we talk about the near to medium term. But Bren, I really first want to start with the longer term, right? You outlined at your Analyst Day, the 26% to 30% growth and strategic framework. When investors look at the semicap space, they see something that is exceptionally high quality right? There's no lack of investment, 1 can go into lithography, right, etch deposition, right, or process control. What is the case for process control and metrology to outperform those other parts of the WFE share of wallet? .

Yes. No, it's an interesting question from shareholders because if you look back from 2019 or 2020, 2021 pick your starting point, I showed a slide at Investor Day that really 2 markets have gained in share of overall market over that time frame, it was lithography and of course, with the introduction of new lithography capability that's understandable and process control. So the last 5 or 6 years has been very good for the company and has translated into a 6.5 point delta on overall compound annual growth rate. So the question I get from investors, yes, it's been a nice run. What changes from here. If you look at the drivers, as I mentioned earlier, if you look at as high-performance compute drive semiconductor revenue and moves from 20% to 25% to 50% of semiconductor revenue, that the attributes that I talked about earlier are more compelling for process control than what we've experienced. If you just go back and look at, okay, so you had leading-edge road map that was finally available starting in 2020, 2019, 2020 time frame with the introduction of [indiscernible] that drove a design environment that drove higher intensity because you're managing a lot of different designs. Our customers have to manage a much more robust environment with different process flows. It design environment consumes the previous nodes. And so as a result of that, the reuse of capability from our previous node to the next node is limited. In the middle of that time frame, we saw the start the beginnings of what was happening with high-performance compute. And then you had -- as I said, you had the introduction of EUV and memory, which was changing process control intensity and then high bandwidth memory added an accelerant to that. There's a lot of logic, there's less redundancy, the dire bigger, the performance specs are more rigorous, you can't bin with high-performance compute and memory or in logic. You can't sell down market into a down product. So hitting performance specs matters a lot. And then I mentioned defect density, right? So you have a big die. And so you've hit the same number of particles that fall on to a wafer, the bigger the die are, the more of an impact on yield. And when things are worth more, you inspect more. You want to make sure that it functions. So these are all good drivers that are accelerating moving forward. Then you have packaging, which is augmenting that growth. Packaging was an afterthought for KLA because the technology in packaging was more cost competitive, less advanced. But as packaging, particularly in logic foundry, has moved more towards front-end like processing it has pulled forward the need for front-end tools. And so we did engineering in parts of the portfolio to serve that part of the market that we can now leverage across their products. But the packaging requirements are only becoming more stringent. One of the things we're seeing this year is that we're actually now seeing a higher mix of more advanced front-end capability being sold in the packaging market, particularly as customers move towards hybrid bonding technologies for die-to-wafer die-to-die type die stacking. So we think that's a part of the market that will augment the growth moving forward. So we have a lot of good drivers in traditional WFE, but then also augmented by what's happening in wafer or in advanced packaging. We were -- I never talked about it because we were 1% of the advanced packaging market or less just a few years ago. We -- last year were over 6%. This year, I think it will be somewhere in the mid-7s, maybe higher we see how big the market is. So it's materially changed. We're going to be $1 billion in packaging up from $635 million last year and $300-ish million the year before. So it's been quite a run. And I think that there's more opportunity that will avail itself there. So we feel very good about we gained 150 basis points plus over the last 5 years, and we think we're going to gain another 150 basis points of the overall market over the next 5. The structural growth opportunity as it relates to process control over the extended period time -- it doesn't mean in every year that you're going to have performance that's going to be stronger, some performance will be even less depending on the mix and how customers are investing. But at the end of the day, we think that there's an opportunity to grow our relevance and that's what we're driving the company towards. And that's implicit in that $26 billion target model for 2030.

Got it. One other pushback that investors, not pushback, I would say the framing that investors often have is that if you look over the last 6 years, either 2019 to '25 cycle, KLA did extremely well. The [indiscernible] did extremely well. It was a very logic-driven cycle. If we go back in time, '12 to '19 was a memory-driven cycle where some of your etch and deposition peers did well. And now there is a perception that over the next 3 to 4 years, memory, again, comes back and it will be a more memory-driven cycle. So what helps KLA outperform if the mix moves more to memory, right, versus logic on a relative basis.

Well, it's interesting if you go to 2012 to 2018, Logic WFE was negative, right? So the market was really being driven by what was happening in memory. There was also a period of time in there where you had the retooling moving from planar to 3D NAND, which was unique retooling of fabs to a fundamentally new technology in that part of the market. Our model is based on 60% logic. We think the market overall will be roughly 60%. And if you go back over the last few years, it's been near 70%. And so memory will have inflections. Memory's always been kind of the sort of cyclical dynamic in the industry, more commodity like, although a little less of that today than the way it used to be. But it's also driven some of the sort of the momentum and kind of work both ways in the overall industry. So I think a few points. First of all, logic intensity for the reasons I talked about will grow. And we think that the leading edge of logic has been very efficient over the last 5 years with effectively 1 player investing. Going forward, would expect broader-based participation of leading edge. And so that will drive more strategic investment, maybe a little more inefficiency at the leading edge. So we feel very good about that. We're going to continue to gain share. We feel pretty comfortable about trajectory of modest share gain over the next few years. Our internal target is to gain 50 basis points a year, it doesn't sound like much, but when we start aggregating it over time from a very strong position. We know if we can deliver the right solutions to our customers, particularly the ones that are the most compelling to their long-term road maps that we can win more share. So that's an assumption that's implicit in that. Packaging, I talked about that. I think that road map not only continues but continues to drive more advanced capability. high-bandwidth memory is as intense in certain product lines has high mix logic. It's a very different kind of device. And so that's going to drive that coupled with more EUV and DRAM will drive higher memory intensity. So I think going forward, memory intensity will be higher. So even though in last year, the percent of the industry that was memory last year was higher than it was the year before, but our performance against the overall market was slightly -- was better. So I think all the drivers we talked about related to high-performance compute plus packaging plus improving intensity in DRAM, I think, sets up the company pretty well that in an environment of 60% plus, we feel like we can maintain that outperformance and continue to grow our share of the overall market.

Got it. Memory, is it different design? Is it going to be less cyclical, more secular or 1 always hesitate to make that point. What are you hearing from your memory customers, right? Of course, they see pricing going up, supply being very constrained. That's a great environment for them. But as they are signing long-term agreements, do you think they now have to provide supply assurance so then they need to align with their supply chain, including with KLA.

So you're going to ask me that question. Look, you have multiple players investing in memory. And memory is more commodity-like than logic, although high bandwidth memory does change things in that way. Right now, our engagement with customers is all focused on how do we drive more capacity, how do we deliver sooner, how do we support these fab greenfield projects that are upcoming. So I understand the pricing opportunity. I feel it in my own business for our own image computing requirements as we're procuring our own memory. So right now, the focus is on supporting what is a very strong market. And I think that, that continues for a while, right? I think given the expectations around some of these greenfield activity that's coming. So we'll see. I mean I've been in the industry a long time. As I said earlier, memory has driven some of the cyclicality in the industry, and you've had multiple players investing. As I said earlier, the leading edge was driven mostly by 1 player on the logic side. And logic is more custom, if you will. And so where we have seen that, it's come from some of the sickle dynamics have come from memory. So we'll have to see. But right now, the environment looks very constructive over the next several quarters, and our efforts are all focused on how do we support our customers through this.

Got it. Given your long lead times, what indications are you getting from just memory customers broadly about more greenfield write more clean room availability in the second half of next year. Like when is your kind of memory-related inflection, does it happen like 6 months before clean rooms, -- is it when clean rooms come? Or is it a 28% inflection? Like what is the right way to think about clean room availability and your inflection in the memory market?

Well, I think as you open up these facilities. Process control tends to be a little bit more on the front end as they start to scale. There's also the customer has to bring in all the tools they need, right? So there's a cadencing process that typically happens as they come in. I mean, you typically see bare wafer tools because you have to monitor tools, you have metrology tools because you have to measure the films that get deposited by process tools. So I think that given it's greenfield and retooling, I don't think it's going to be that different in terms of a timing issue because you're going to be adding a whole new set of new capacity into the fab. So I don't think that there's a we see it way in advance or than others. I think it's all going to be more or less across the same time frame and be driven partly by just the ability to procure the entire tool sets to support the wafer start ramp.

Got it. You think that given the expectation of clean rooms coming out that it is still reasonable for people to assume that WFE growth in '27 could be faster than WFE growth in '26.

Well, obviously, we're '26 ends up. I have said that I think it's at least as fast. I still think that that's the case in 2027. But the 2026 is also a little bit stronger now than we thought when I made -- first said, made the statement. But I still, as I look forward, I think we are looking at a pretty robust environment into next year with growth rates that are similar or better than what we're seeing in 2026.

Got it. So if, let's say, next year is at or above, I mean, we could be looking at a 170, 180 WFE next year, conceptually, and 200 is not that far from there, and that is your 2030 WFE assumption. So should we be rethinking what 2030 WFE.

Well, 2.15.

Well, 2.15. So more to go.

Yes, more to go. Look, we'll have to see where I can't and I don't want to speak for what our peers are able to do and how that lines up with our customers' capacity planning. We do contemplate the scenarios and I've been spending a lot of time over the last few months out in our factories because I oversee our manufacturing and supply chain operations with suppliers over the last couple of weeks, positioning the company and contemplating the different scenarios that are being discussed in terms of growth. Never want to be the bottleneck. I don't want to be the bottleneck, part of the, I would say, slower sequential growth that we're seeing here in the first half is really being driven by some of the constraints we have in supply chain, the ability to procure certain components, particularly around optics, just takes a longer period of time. Process tools come together easier. And so that's been a challenge for us. But as we move into the second half of the year, more capacity comes online, I think the acceleration of half-to-half growth is pretty meaningful. So as we contemplate what we need to do next year and is working with customers, -- we're certainly considering some of these scenarios and our ability to support it. And I feel that based on what our customers are saying that we're in a position to be able to support their requirements. And I lean in, right? I mean we'll lean in with our suppliers. We'll make investments or our suppliers for capacity. We have the lead time element. We'll we've been I talked at Investor Day about how we manage our supply chain, how it's a much more strategic, less transactional I give suppliers multiple years of visibility. I don't cancel orders. We make investments in those suppliers that it's required to ensure that we get dedicated capacity. I don't share the critical capacity necessarily with our competitors. I sometimes share it across the company. So winding up the right mix of KLA products is always sometimes a bit of a challenge -- but it proves, I think once we get to the volume levels that meet the industry requirements that it actually proves to be a pretty resilient supply chain because I don't have to worry about my component going to or my needs being shared with another player. So I think that as we get positioned into next year, and as we think about what's required for 2030, I think we're in a a good position to support what the industry is contemplating in terms of growth here moving forward. There was an upside case to our plan, right? We said plus or minus $20 billion on wafer equipment and how that translates I think at the time, for Investor Day, I had some investors saying, well, 2015 seems like too much. I had other rests not enough. So maybe it was right. I would say that as we sit today, certainly, the momentum is higher, right? So I think that had I done it today, what I consider upticking it a bit, perhaps. But I think the point of that was to have some pretty clear assumptions and then the ability to execute and what those -- how those assumptions then translate both into a share market and the financial model underneath -- and our track record again in public commitments is very strong both if you look at the '29, what the plan we had for 2023, we have plan for 2026. So I think that against that backdrop, we can execute and deliver on the commitments we've made. I think our track record of performance is reflective of that.

Absolutely. One question on gross margins kind of on a more near-term basis, Bren, which is that KLA's gross margin is like 62% best-in-class, right? So nothing to complain about. But you had still outlined about a 100 basis point headwind from some of the input cost inflation. Why doesn't KLA have enough pricing power to kind of pass that through?

So we do have some pressure from memory, as I mentioned earlier, and there's some tariff headwind as well. Our pricing is really based off of -- it's a value pricing sale for our customers. And we have a limited set of customers and practical it is when you have a negotiated price with a customer and you go and say, "Okay, now I'm going to raise the price of already previously negotiated price. So the way we look at it at KLA is -- and why I spent time on this at Investor Day is it's very important for us to maintain a product introduction cadence of new capability. Because when you introduce new capability, you're moving target, your salespeople have some to sell but you also get an opportunity to look at against a baseline of cost of ownership for our customers, you get an opportunity to look at price, consider cost changes and so on. So it matters a lot for us to maintain this cadence. And -- that's where we get an opportunity to make the adjustments. We still have to hit our customer expectations for cost of ownership, but if we do our product development, right, it does create opportunities for us to manage our way through that. So I think in a value sell or a return-based transaction, if the cost goes up, it affects how the customer sees the return, right? Because if you think about just the elasticity of the market. And we have to have the long-term long-term relationships. We have these, I think, sort of partnership type engagements in terms of how we work with our customers. I think it translates into market share, which then translates into share of market. So there's a number of vectors that we consider as we work our way through it. But I think the thing for us that matters is to maintain that cadence, which allows us to do that resetting to take into consideration what could be structural cost dynamics that are affecting our business. And they need to be structural. Our customers would want symmetry. If I start doing an up charge related to memory, then memory goes down and then they want a reduction in price. I don't want to go down that path. It's how do we deliver against their cost of ownership expectations over time, by product across the road map. And if we can deliver to that, I feel pretty comfortable that we can maintain what is a meaningfully better sort of financial model relative to the rest of the industry. And I think it's reflective of the differentiation of our products and that strategy.

Got it. Over time, do you see further upside to margins? Because we have seen with several of the other WFE peers the margins used to be in the mid-40s right now. Now they have moved to over 50%. Obviously, they are still not 60% plus every 1 of your customers and their customers is expanding margins. So why is KLA more measured in talking about margin expansion?

Well, like I said, I think there's -- we're optimizing around a number of vectors. And so we have to be thoughtful about that. And when you sell a portfolio, the competitive position across the portfolio is not consistent really across all of them. So you have to be thoughtful about that as well. We segment report, right? So you can see our system and service for semiconductor process control margins. And they're in the mid-60s, right? And so our service business is dilutive to the gross margin. It's accretive to the operating margin, but dilutive to the gross margin of the company. So that gives you a sense of where systems gross margins are service about 25% of the overall revenue stream. So I think, like I said, we're optimizing on a number of vectors and our long-term plan contemplates steady improvement in gross margin. And so we're operating today at 62%, and we think that we can get it somewhere between 63% and 64% over the next several years. We're going to drive incremental operating margins and which is how we sort of size the company but also contemplate the contributions in our gross margins to drive towards the higher end of our target 40% to 50% sort of structural model. And so we'll be the higher end of that range, and so we think we can deliver that over time. And that will translate against the 26 model to 3 points of operating margin improvement. So the best model in the industry gets marginally better here moving forward as our overall relative performance at the top line improves. That's the model for the company.

Maybe 1 question on the competitive landscape, what I find fascinating is, I think your R&D expenses are more than the process control sales of your nearest competitor, right? So there is such a wide gap. But there's still a 40-plus percent of the market that remains very fragmented, right, beyond KLA. So do you see competition becoming more intense in any specific application, any specific end market?

Well, we're continuing to gain share, which I think is a validation of the differentiation in our offerings. And particularly in the last year, we have -- the markets that are growing fast as we have a strong share position, and so that's certainly influencing share. There's some electron beam products. We gained share there, reticle inspection and other opportunity. Where we saw some share improvement. I talked about this at Investor Day that we have big programs that what I worry more about, and I think I can speak for Rick, my boss also on this, is we worry a lot more about relevance and solving problems uniquely to our customers and less about competition because you can deliver capability. But if it doesn't solve a problem that has a strong financial return, then just won't buy it sample less. It isn't necessarily by a competitor, they just don't eat it. So our focus inside the company is sharing is ensuring that we are delivering capabilities, solving unique problems, solving problems at scale in production, the driver -- so we have the investments we're making, we're making big bets to ensure we support the road map. So , but we also are supporting a cadence in the industry of new development. It drives the design start environment from a process point of view, but also allows us to really extend the platforms we have and optimize the R&D that we're spending. And then there's higher levels of growth. So our percent of revenue on R&D, there is some scale benefit to that. But because we're supporting a cadence that is -- I'll call it kind of -- it's not exactly Moore's Law. It's certainly slower than that. It's almost perfect in that if you run a much faster cadence, you'd have to spend more. You'd have to introduce more advanced capability in the form of new platforms, which you spend a lot more on, you'd have to introduce those at a much faster cadence. So -- by having this progression and the process road map allows us to achieve, I think, higher levels of efficiency, and it ultimately translates, I think, to better overall financial performance. on R&D. We're investing in all the things we need to invest in, in terms of market opportunities. So I think we're pretty well positioned, and we're making the bets we need to bet to make.

Very final question, Bren, which is I think the services business at KLA is fascinating, right, because it is not as cyclical as that of your peers, which is more exposed to spares and things of that nature. So maybe just give us a quick view on how you see your services. I think you raised the growth rate to 13% to 15%. Should we just think of it as kind of this quarter of your business that is kind of countercyclical, right? Or it has no cyclical sensitivity for the...

Well, one down in '25 right? And that was in 2009 and even then, it was in the 10% range or so. It's pure service. So there's no systems that are in there. And look, what we sell is we sell this very advanced complex high mix, low redundancy products. And so our customers have high uptime expectations and so they buy the process control they need and then they run the tools at very high uptime. And so it tends to be higher than how they run process tools. And when leveraging the installed base to drive yield, is efficient in terms of managing the overall capacity. The lifetime of the tools is extending. One thing that's been great about the extending or stratification of demand at semiconductors has driven a lifetime of our tools up. When I first became CFO, I've said this before, lifetime is about 10 years of a tool in the field now it's over 20. The percent that we get as a percent of ASP in a contract first of all, 80% of the revenue is contract back to the predictability of it. But the percent we get is 1 point to 2 points higher than it was 10 years ago. There are opportunities for additional growth in memory because of the demands in the memory market, the requirements for high bandwidth memory to drive more of a contract stream packaging, is an area where more service was underpenetrated. So we've got a number of good drivers, I think, that not only enable the top line but allow us to drive that predictability. We sell parts, but what we really sell to our customers is high uptime and performance and performance across the fleet. And it's very hard for third parties or our customers to maintain and deliver those kinds of results. The supply because of the complexity of what we do, the parts are fairly custom, and so we're the source of that. So because it's lower -- it's high mix and it's relatively low volume by comparison, really hard for our customers to pursue other alternatives for service. And so they rely on us to ensure that the fleet performs and expected and delivers the kind of performance that meets their requirements. And I think it's unique in the industry and it continues to scale despite some of the headwinds we've had related to export controls and so on. So I never thought I'd say that service would be dilutive to our growth rate at 13% to 15% with its growth. But given our expectations here of 16.5% growth for SME PC business, service brings that element, but it brings an element of predictability that's always given us comfort around how we finance the business, the capital structure, how we think about how we allocate capital, dividends and buybacks that we have this very predictable stream of profitability, cash flow and revenue that we can rely on.

Right. Wonderful for that. Bren, thank you so much.

Thank you. Thanks for having us.