KLA Corporation (KLAC) Earnings Call Transcript & Summary

Let's talk about new customers. Are you seeing a broadening in foundry logic customers as a new fab or a new project in the U.S.? There's the MPU maker is talking about significant increase in their CapEx next year. It's not really a new customer, but they're definitely ratcheting up their plans and spending. But just in terms of the kind of greenfield opportunities, you guys do benefit from that a lot more initially versus brownfield? Just can you talk about how you see the broadening of foundry logic customers kind of expanding your TAM?

Well, like I said earlier, I mean, one thing about the last several years, there was a lot of investment. If you go back a few years ago, a lot of investment in logic that was happening in the legacy nodes. But at the leading edge, it was incredibly efficient, effectively one player investing. So as you look moving forward, you have multiple players. And so we're excited about the opportunity, obviously, they feel that there's -- it's appropriate to invest given the opportunities they're facing, but that inefficiency that comes from multiple players investing will be good for KLA. And I think we've gotten really good traction for the reasons I talked about in terms of the kinds of devices that they're making, but also in our collaboration model, working with customers to deploy our capabilities in ways that accelerate those learning cycles to show KLA value. And I'm optimistic that because that's the way it translates into high-volume production capacity adds. So if we can demonstrate that value and earlier on in the investments cycle, then it does translate into more investment in capacity. And so we're excited about those opportunities. We're investing to ensure that we have the resources to support these fabs in different locations and also ensuring that we have not just people to service and to do applications but also inventory to be able to support. So there's a lot of activity there that more customers are better, excited about that.

Let's talk about advanced packaging. I think one thing that has kind of bifurcated your stock performance as well your fundamentals from lithography in the last few years has been your participation in the advanced packaging market. You're talking about 70% year-over-year growth, which is 2x the rate of the market growth in the advanced packaging market. And the idea is that you guys have these front-end tools that are very much capable of looking at larger geometries and all that, and you've been able to enter that market. And take share. Can you help us understand where are we in that kind of adoption cycle of your kind of front-end tools being increasingly adopted on advanced packaging side how much more room there is to expand share and...

Yes. No, it's a great opportunity. If you just go back a few years ago, our share of the advanced packaging market was a couple of percent, right? Just a few years ago, '23 time frame. And today, I think this year in 2026, is likely to be somewhere between 7% and 8%. So it's been a great opportunity. And as you moved to more front-end-like processing in advanced packaging, historic packaging was fan-out packaging. It wasn't particularly complex from a process control or inspection point of view. And so sampling rates were particularly high. The need for advanced capability was much lower. And so it was a very competitive market, multiple players investing certainly in logic front. But as we move to high-performance compute packages. That has changed. You've seen more front-end like processing, and that processing has driven more front-end tools. Our CEO tells a story that he got pulled into a meeting just a few years ago. about the need for our front-end tools and advanced packaging. And of course, the reaction from us was, hey, these are higher-end tools. You might not like the price, and the response from the customer was that now, we're moving to front-end processing in packaging and so we're going to need front-end capability. We had to do some engineering, and we did some engineering in our macro products, which had the highest market share in the segmented part of macro inspection. There was a front-end part and then there was the packaging part, there's 2.5D and 3D, we had the front-end share. So in some ways, kind of logical that when they move to more front-end requirements that the front-end share leader would get pulled into that. So it's been very good for our business. More success or more momentum on logic side. OSATs are an opportunity, memory, less complex, but we think the share opportunities there will grow over time as new technology is introduced. So it's been a great opportunity, very high sampling rates because you assemble this package, you have to integrate the HBM with the GPU or the custom ASICs. There's a lot of surrounding peripheral die you have to integrate, you have to make sure it works and hit specs. So the sampling in rates are very, very high. And so that's been really good for that business. There's new technology related to hybrid bonding, which is our exposure and moves the sensitivity requirements down in terms of sub sort of 1 micron sensitivity. And so we think that you're going to be even, in some cases, down to even more advanced sensitivity requirements. And so it's driving more of the front-end portfolio. And so we've been able to leverage the R&D we did in the macro product in the other parts of the front-end portfolio. So we're getting some leverage on the R&D investment, mostly for handling and handling the different substrates because they're different in packaging than the standard 300-millimeter hard wafer that you could use in the front end. And so we're starting to see now this year for the first time, we're actually seeing with the introduction of this new technology that we're starting to see some of the higher-end tools adopted. It's a pretty small percentage today of the overall, say, it's probably somewhere on the order of maybe 20% or so. So I think over time of the total number that we talked about, that 70% growth number was $1.1 billion. As we move into next year with what's happening with Agentic and CPU growth rates and some of the inference chips is going to create even more opportunities. So we're pretty excited about the die stacking opportunities that will happen there in advanced logic in their packages.

Let's talk about gross margin. It has been a topical topic with investors. We were a bit surprised by some of your systems gross margins being 70%. Those are top class. Any room for improvement in the gross margins to, let's say, to reach your target level or even beyond that, what knobs you have in kind of value-based pricing? Operational efficiencies, obviously, memory pricing coming down will be a huge tailwind whenever they start to normalize.

Yes. No, memory has had an impact. And with this, we were pretty smart early on securing supply very early in the process, but then the momentum in the industry has driven more demand. So we've had to buy more memory at current prices, which we don't love. So the impact on our gross margins, which we thought was closer to 75 basis points, is probably slightly ahead of 100 basis points today. So it's certainly more of a headwind. Our target model for gross margin is -- if you look at our business, it's generally to drive 60% to 65% incremental gross margins target model we presented was between 63% and 64%. We're operating in low 62 range today. We do have the headwind that you mentioned. There are puts and takes. I mean, value pricing is nothing new for KLA. I mean our approach to our customers is a deep understanding. We think it's a core competency of the company of the value that our products deliver in terms of faster learning rates, yield improvement. And as we introduce new capability, we improve our customers' cost of ownership and we get to share in that value that we create for them. So that's typically where we adjust our pricing is when you have -- you introduce new capability, improve cost of ownership, that's an opportunity to deal with your costs if you do your engineering right, and also to meet their targets. So customer benefits, but we also benefit. So we're able to usually adjust and we have been, but things like memory have escalated in a pretty rapid rate. So it will take time for that value pricing opportunity to play out. There are puts and takes in mix. Packaging, we just talked about it, but packaging generally carries a lower gross margin rate, gross margin dollar opportunity, which is, I think, really what we're here for, not every market carries the same margin profile. Growth in our EPC businesses, our PCB businesses, our semiconductor process business. Those margins are lower, but that business is now growing, supporting the high-performance compute environment. those carry lower margins, too. So I think there's some puts and takes. We factored that in as we thought about the long-term gross margin model that we should be able to drive 63% to 64% over time. And that's our plan here moving forward. We will drive leverage out of our manufacturing operations on the scale of volume. There's a ton of investments that are happening really worldwide, even facilities also inside the company. And every site, you have a project plan. And when you're dealing with structural growth the way we think, the way we laid it out at Investor Day, it's as soon as you get to a base where you think you're done, you're moving on to the next decision. For example, I'm going to Singapore later this year to do a grand opening and a groundbreaking on the same trip. I'm going to try to be efficient with the trip. So it will be clip and scoop and try to get it all done at once. So these are things that we're going to invest in to support the growth moving forward. And -- but I think that there's leverage in the model, ultimately, it's going to translate into that 60%, 65%, how we run the company and 40% to 50% incremental operating margins.

Great. Let me pause here and see if there are any questions in the audience. If you have a question, please raise your hand. Let's get moving. Bren, KLA uses a lot of AI and software in your tools and I believe that that's one of your key moats. Do you view that AI models becoming more capable to be a net positive for KLA?

It's interesting, we started investing in AI back in 2015 or so. We've had it in basically in all of our products. First product was 2018, 2019 electron beam inspection product. It's deployed across the portfolio today, physics-based AI. One of the ways we -- I think we bring a unique -- first of all, no one generates more data in a fab than KLA. And so the ability to process that data, move from a from raw image to a processed image that factors in both hardware dynamics, context, applications and then the algos that ultimately allow us to understand what's going on in terms of signal to noise and get ultimately speed, time to results, is a core competency of the company. And we're able to then take some of that capability. For example, I mentioned the electron beam tools where you can use AI to train your inspectors, to point your inspectors more effectively as an example. So we're using it in a number of ways. We're using it in recipe development and applications. We use it in our systems. We're doing things inside the company to drive productivity, both from an R&D point of view, but also in our business operations. We're pretty excited about it. The architecture benefit is clear. We see it in our own image computing where we're able to drive more capability at lower cost. And so we're big believers in this transition to high-performance compute. What it means? We think it's a pretty good microcosm of what AI data center is facing in terms of the compute transition. And so we're seeing it in our own systems, and we think it translates. So we're pretty excited about the benefits we see in our own systems. And we're able to use the capability in a lot of different ways.

When you talk about services business with all these increased shipments this year, next year reflecting WFE. Should we be thinking differently about the services growth rate beyond the kind of the mid-teens range with these higher tool shipments?

No, our service business is pure service, right? So there's no systems in there. And we have an updated target growth model of 13% to 15%. Moving forward 80% is contract-based, subscription-like in a lot of ways. And the service business, we believe, carries an operating margin profile in terms of profitability that's accretive to the overall. So it's a very resilient business for the company. It provides a nice anchor through any sort of cyclical dynamic where it's only had 1 down year, I think, 25 years, right? So it's a very unique service business. As we ship more tools, it creates more opportunities, I mean, what -- our business is it's a very relatively low-volume, very high mix, high-complexity service business. It's very hard for our customers given the fleets they have, they don't have redundancy. They tend to run them at very high uptimes to do their own service. So they rely on us to do service and to have a predictable level of support that shows up in that contract that we can customize to their needs. So we can deliver uptime, we can deliver matching performance and so on. So it carries a resiliency and it will grow as new systems are shipped. And if we end up at a higher growth rate overall in terms of our system expectations, certainly, when we laid out that target of 13% to 15% back in March, we had a view of the industry over the next 5 years. I would say that, that view looks conservative today. So I think it does create an opportunity for us to drive more growth out of service. It will move slowly, but it tends to be pretty resilient over time. And would expect it to be pretty predictable as well.

All right. And one question on the e-beam product and attach rates. You've talked about expecting 80% to 20% optical to e-beam split, when do you see that reaching that level?

Yes. I mean, historically, it's been about 80-20, and there's been periods of time where it's been higher. I think today, it's probably a little bit higher, in the higher end of the maybe 85% plus. A lot of it has to do with the relative growth rates of both parts of the market. Customers will use an E-beam inherently is a slow technology. So its applicability in production is not as high as an optical solution. So customers really trying to -- what's the most advanced capability to meet the problem at the most effective cost? And so typically, what you see is optical technologies in production. But there are certain electron beam opportunities where, again, you'll use it around certain defect types where you can only find it with e-beam and so our customers will deploy it in production because they're inspecting for a very specific type of defect. There are a number of those are buried defects in a gate-all-around structure that we have participated in. Or we use it to point the inspectors. So I would expect that ratio to hold more or less consistent. You're using multi-beam technologies, which are -- you sacrifice a little bit of resolution relative to a single beam, but there's some electrical defects and buried defect use cases that make sense. So the tools will continue to be complementary. I would expect that where the fastest-growing market, certainly in process control, maybe in the overall industry will be in optical inspection, optical high-end optical pattern inspection. And so you'll see that continue. But e-beam will have its place and will continue to grow I think, along with that. So I don't think the ratio changes all that much moving forward. And I think it's just because of the nature of the physics. It's the optical solution meets the requirements in high-volume production. So you'll see that in the vast majority of the use cases.

Great. We're almost out of time. And Bren, thank you -- sorry, you have a question? Can you have the mic here?

Bren, I had a question on market share. Applied has been pretty vocal in describing process control as one of the best growth opportunities. Their business for them is going to grow 50% this year. How do you think of -- and their approach is this integrated bundling strategy? How do you think about that threat versus your position as best-in-class in process control?

So we've gained share over the last several years -- I mean we gained share in the last year over the last several years. We've continued to gain share within process control. We're the only provider that comes to -- in this industry with the portfolio that we have that allows our customers to mix and match depending on where they are in the development or in a yield cycle, mix and match the actual kind of capability they need to meet their needs. So we feel pretty good about our competitive position. Our business model and market attracts competition. I think that they like the profitability. But we feel pretty good about our strategies. We feel pretty good about the portfolio. If I had a nickel for every time one of our competitors talked about gaining share in the industry, I'd have a lot of nickels. So I feel pretty good about our position. And I think we'll continue to gain share here moving forward. One thing that is clear is that if we can deliver more capability, there's room for us to have more share. And we've seen, as we've worked with customers in the most critical areas, but even in less critical areas that we can work in a much more collaborative way to gain share. So we feel -- packaging, we talked about earlier, e-beam is another opportunity. And then some of the core markets, we continue to maintain the momentum we've seen.

Thank you, Bren, for coming to the Citi Conference.

Thanks for having us.