Good morning, everyone. Welcome to this session. I'm Vivek Arya from BofA Semiconductor team. Really delighted to have Bren Higgins, Executive Vice President and CFO of KLA, join us. KLA is the most profitable company in semi cap equipment, and Bren will give us all the secrets as to how to make a company the most profitable in their sector. But I'm very delighted to have you.
Yeah. Thank you for having me. Good to be here.
What I thought we could start with, Bren, is maybe at the high level, in 2022, you had an analyst day where you laid out the target of 9%-11% top line growth, right? Getting to $14 billion in sales and $38 in earnings. I was just hoping that you could maybe take a step back and tell us where KLA is in that journey and what needs to happen from an industry perspective, what needs to happen from a KLA perspective to kind of make progress towards that goal.
Sure. And it was an interesting time back then, where we spent a lot of time talking about supply chain challenges and shortages, the ability to ship to demand, which was hard for all of us in the industry. I think we navigated it pretty well, and then, of course, went through 2023 with a correction from our major customers, but, you know, cushioned by some of the dynamics in China. But the plan we laid out to your point, was 9%-11% expectation for top-line growth, and we get there with a view of semiconductor revenue growth of, you know, roughly, we'll call it 6%-7%. This plan or view of 2030 at about approximately $1 trillion in semi revenue.
That we would see a continuation of rising capital intensity. You know, so for the past decade or so, we've seen capital intensity rising in the industry, and that would drive the WFE part of the market, which is the front end of investment for our customers and equipment, that would grow a little bit faster than semiconductor revenue. So let's call it, you know, 7%-8%. But if you look at the mix and some of the drivers, particularly given what we've seen in the last couple of nodes in terms of design activity and the robustness of the designs that are moving through these nodes, that would create an opportunity to see a re-acceleration of investment in logic and foundry.
Which went through a period of time where it was really kind of negative, right? From about 2013 till about 2018, with very limited design activity outside of some high-volume parts and limited scaling benefits from a Moore's Law attribute point of view. 2019, that all started to change with the introduction of EUV at 7 nm node, and then we've seen that escalate as we've moved forward. So given that you'd see roughly a you know, 60%+ kind of mix of logic foundry WFE, and that's an important the mix is important for KLA because of the relative process control intensity of the logic foundry business. We have lots of designs. We have customers that are designing for specific nodes.
In contrast to memory, where you have more commodity-like parts and redundancy and repair and in the process. And so as a result of that, the process control intensity can be, you know, mid to high teens, kind of leading-edge process control intensity for leading-edge logic, foundry, and memory, a little bit different between NAND and DRAM, but we'll call it somewhere closer to 10%, + or - . So that mix would ultimately drive the process control part of the market to grow a little faster than WFE.
And then if you look at KLA's position in process control, which is approximately 5-6 times more than our nearest competitor, that in the markets that we're in, and we're in a number of segments within process control, that the relative growth of those markets, particularly like optical pattern inspection, and then also some share opportunities with some new development programs, that we thought that we would see that an opportunity for KLA to grow a little faster than that. So you take that, that's our systems business gets up somewhere closer to 10% as a result of that. And then you take our service business, where we updated our long-term service model to be 12%-14% through cycle growth. That was up from 9%-11%, and we're seeing a number of factors that are driving this.
The biggest being, obviously, the growth in systems, which you have tools that go out of warranty and come onto contract, and our attach rate is very high in excess of 90%, and about 75% of the revenue is subscription-like contracts. So we get a contract stream with an average of about three years, so pretty predictable service revenue stream over time. You also have the extending life of our systems in the field that are servicing a number of markets where you're seeing rising semiconductor content, so automotive, industrial, communication, infrastructure, IoT, and so on. So all that is positive for overall service growth. And if you look at where we are today, we generally think we're probably towards the higher end of that range than the lower end of that range.
Then we have our EPC, which is the more-than-more platform for KLA, which is electronics, packaging, and components, has specialty, nice growth over the last few years, better, and now seeing demand in advanced packaging. So that business has done pretty well. It's been offset by some weakness in more consumer-centric markets-
Right.
like our component inspection market and our PCB market, and then the flat panel part of the business, which we made a decision last quarter to exit that business. So when you take that, I think we had an expectation of somewhere around 10% growth from a systems point of view in that part of the business, and we think that is likely somewhere less than 10%, just given the growth that we have to grow from where we are today over the next couple of years. Fast-forward to where we are today, looks like, you know, given, you know, WFE levels somewhere in the low to mid-90s today, our view of the 2026 plan got into the 120s.
And so I think if you look at where we are today and expectations over the next two years and drivers, I'm sure we'll talk about, that implies that, you know, a kind of a mid-double-digit, mid-teen kind of growth rates over the next couple of years to enable the plan. You drop through the plan, gross margins of 63%+ , pretty confident in our ability to continue to drive scale. We made a lot of investments to that are in some ways headwinds today to be able to position us for improvement in margin as we approach a $14 billion level from the low tens, where we are today, in terms of expectations for 2024.
With our incremental operating margin target, in terms of how we size the business overall, that will deliver 40%-50% incremental operating margin. So that'll translate into operating margin somewhere 42%+ and earnings per share, the $38+ or - . Underneath that plan, we'll continue to be assertive in capital structure and in capital allocation for the company. We plan to We like the businesses we're in. We think we can continue to return about 85% of the free cash flow we'll generate. So you'll have that, you know, shared between the dividend, which is growing over the last 14 years consecutively and growing at about 15% CAGR, and then the remainder in deployment to buybacks.
And so, we also did a large debt-financed ASR to sort of reinforce our view of the strength of the model and the relative valuation at the time versus what the implied value of the plan. So I think in general, we feel pretty good about this trajectory. We'll talk about some of the drivers, I'm sure.
Nice.
But, that's in a short summary, that's the plan.
That's great. Very comprehensive. You know, we'll talk about the product side of the business, but the services business of KLA, I find fascinating because it is not really cyclical per se, because with a lot of your peers, what I find is what is classified in services, right, is a lot of, you know, cyclical usage-based spares, right, as refurbishment of old equipment, right? Of course, there is a, you know, maintenance part of it, right?
Mm-hmm.
That is more subscription-based. So talk to us about maybe help us unpack what is in your services business and what is helping it to grow 12%-14% this year, even though overall tool spending is really not growing that much this year.
Yeah, and not really correlated to WFE, more correlated to semiconductor revenue, because ultimately, our customers running their install base is what supporting their businesses is what drives service. You're right, it is different, and our, our service revenue stream is all associated with service. There's no equipment in that number, there are no upgrades or things like that, and there's, there's limited consumables. And so if you think about the business, it is a, a high mix, high complexity, relatively low volume business, if you look at, you know, what we sell, and then even within each product family, you have versions and variants of certain types of tools. Our customers buy process control and tend to, you know, want to spend only what they feel like they need to, because ultimately, you're really trying to drive productivity and cost performance out of the fab.
We can contribute to that, but they usually start with, "Hey, we want to spend a certain budget.
Right.
And then we will have high uptime expectations, 90%+ , generally across our systems. They'll run the tools pretty hard. They like and need matching performance across those systems.
Right.
So we're able to go in and provide an entitlement stream that the customer wants in terms of support levels across different tool types or broadly across fabs. And we can customize these offerings, and these offerings can vary around response times and can also include assets like, you know, inventory and inventory in the fab, inventory and region, and all these things we can try to monetize, and then get clarity in terms of what we have to deliver to you over an extended period of time, and then do a lot of cost work underneath that to make sure that we deliver to those commitments. Given the nature of the complexity of the systems, there's a lot of custom parts.
Given the breadth of the company and our engineering teams, most of what we do is custom, and so the ability to procure those parts can only come through KLA. And our engineers are trained such that they can generally serve as one tool type. So there's a high level of capability that's required in our field service engineers to be able to support it. Even in downturn environments, our customers will always, they run their install base, and they tend to run process control at a higher level. They'll take offline some of their process tools, excuse me, as utilization rates come down. But in a capital-constrained environment, higher yields and only starting as many wafers as you really need is something that our customers, in a finite sort of capital environment, are very careful with.
So our utilization rates are always a little bit higher. Contracts, even though they'll idle some capacity, the contract model stays intact. And so as a result of that, even last year, where a number of the service businesses were down because, you know, some of, you know, the lower utilization rates across most segments, we still saw, you know, mid-high single-digit growth last year. And so you've got those dynamics that drive service, and our service business has grown every year, except for in 2009, it was down about 12%. So you have this, I think, a fairly predictable stream over time of growth expectation that you can plan around, and I think you can optimize for from a an efficiency and profitability point of view. So as utilization rates improve, that's been a driver.
I talked about the extending life and all the metrics we look at for service, whether it's contract revenue, whether it's how much of a tool sales price we capture over time in terms of revenue. We've seen all these metrics improve over the last five years, but the useful life of the tools or the service life, we are still servicing tools that we shipped in the nineties that are making parts for you know, for a lot of the industrial markets and appliance markets and things like that. I think there are unique attributes to our service stream that creates this opportunity. And if you look at where we are today in this increasing growth, we shipped a bunch of systems, and so we can take the growth rate higher. That... And, and those-...
Tools will come off of warranty and go into contract, and we'll drive $250 million-$300 million of incremental revenue this year, irrespective generally of WFE, unless WFE levels come way down because our customers take utilization rates down or something like that. But in terms of, you know, where forecasts are. And then, we're also seeing utilization rates improve, which is also a driver to that. So, we feel pretty comfortable about that target range, and I think we're probably trending more towards the top end of that range than the bottom.
You know, everyone does accounting a little bit differently in terms of how you look at the cost structure, but you know, we believe it carries a stream that's you know, in line or better than our corporate averages. So, it does have an effect on gross margin. Gross margins are lower, but in terms of operating margins, it's more aligned with the company average. So, it certainly is part of the business that has gotten us comfortable with some level of predictability, gotten us comfortable with how we think about how cash flow behaves over time and through cycles, which has then led and fed not only our capital structure decisions at a certain level, but then also how we think about returns to shareholders.
Got it. Maybe one kind of near to medium-term question, as we look at, the demand for wafer fab equipment, this year, how is second half looking versus, the first half, right? What are the moving pieces in terms of whether it's, by end market or whether it's by geography, China demand, second half versus first half?
Sure. So part of our messaging at earnings, there were a couple of messages. The first is in some ways, you know, over the last 12 weeks, from sort of, you know, March until or from the January reporting out and expectations for 2024 and where we ended up in reporting in late April, that there wasn't a lot of change in terms of how we were seeing the overall market in WFE levels. And our messaging around the March quarter was likely the bottom for us, and that we expected sequential growth moving forward. So we were down in the $2.3 range, and then we guided in the $2.5 range from a revenue point of view for June.
An expectation of sequential growth through the year, which implies, you know, a second half somewhere in, you know, kind of mid-high single digits of expectation. That translates, you know, more into the semi, you know, kind of a flattish WFE environment. Obviously, if WFE is a little bit stronger, I think we're in a position to continue to grow with the market, perhaps a little bit faster, frankly, given some of the incremental demand we've seen. Certainly, the leading-edge investment is a big driver for KLA. You know, one of our objectives for this year is preparing for growth at the leading edge, because leading edge has a very different process control intensity profile than legacy investment, like we've seen over the last couple of years, last year or so.
So, we need to be able to support our customers. The competitive dynamics are pretty strong, and the investment plans in the second half and feeding into 2025 look pretty encouraging. We made some comments, I think some constructive comments around expectations for the 2-nanometer node as we move into next year and beyond, both in terms of our customer expectations, the design environment and expectation of design, certainly at the front end of the node, and potentially the size of the node moving forward. The HPC and AI drivers are pretty strong for N2. The architecture is very power-friendly, and so I think that that's driving a lot of that interest.
Memory, I would say that the market, now all this growth is off of fairly low levels because ex-China, our customers adjusted pretty significantly in 2023, versus 2022. So, but I would expect to see growth in leading-edge investment. Legacy investment, after a couple of strong years, and certainly a strong year last year, would likely be down, you know, particularly as the automotive market has corrected some. And that the China market, you know, the mix of it changing, but generally would be mostly flat into this year. Memory, I think we're seeing signs of improvement in financial performance of our memory customers and cash flow and pricing environment and inventory.
All the indicators you look for that sort of demonstrate supply-demand parity and an expectation that I think we'll see, you know, growth as we move into next year. I think most of what's happening in memory today is more about utilization rate improvements, some technology investment, and... But I think, you know, that as you start to see some correction, obviously in DRAM, you know, we've seen some of the AI investment and some of that capacity conversion, and that's having an effect on this utilization and I think plans for the future. So I think those markets generally lining up the way we would expect to see in a recovering environment with some optimism as we move into next year.
Got it. Does HBM require higher process control intensity than DRAM? I would assume so, right? Because yields are still low, and it's consuming a lot of wafers. So, is it still? I assume it's not as close to what logic process control intensity would be, but does that become a driver for-
Yeah
... higher process control intensity?
No, no, it's a great question, and it's not, I think getting to where logic is a very different level. But if you just back up and look at the die size, the die are bigger. You've got the introduction of EUV, which has been a real positive for process control intensity. You've got higher reliability requirements in-
Right
... in those devices as you're stacking, and you have to connect these devices, and so you want to make sure that they're all working and functioning as designed. You've got a silicon trade in terms of the supply, right? So it's consuming some capacity.
Right.
So in general, and then, of course, you've got to take the device and then you know, you've got to connect them together, but then you also have to integrate it into the GPU package, which, you know, our logic customer is doing. So I think all those are drivers that are positive for us, and I think as you start to see continuation of that growth, not only will it, not only is it driving profitability, which is good for our customers, it's consuming capacity, which is driving up utilization rates. And because of the capacity trade and the go-forward technology roadmaps, it does create perhaps an increment moving forward for process control intensity that we're encouraged by.
Got it. It's you know, you, you mentioned that, so historically, the mix of foundry logic to memory has kind of been this 55, you know, 45 or so in WFE. I think you're suggesting something in the 60s. We heard from Applied earlier today, they also suggested something in the 60s, right? So it's more like 65-35. Shouldn't that, you know, be favorable to KLA because doesn't it kind of mix up process control intensity? My only kind of part B of that question, how much of that is going to be taken up more by litho? So except that part of the wallet, right, does like, what drives process control intensity higher from there?
You know, it's, it's an interesting question, and, and I said, you know, 60%, because I—but I do think if you look at just where the trends have been, that, you know, that there's potential kind of upside to, to that number. I think that was just in terms of how it supports the-
Right
... the 2026 plan and the revenue associated with it. We've seen a nice move in process control intensity and KLA's share of WFE over the last few years that have been driven by the incremental scaling benefits that we've seen with more and more EUV layers. The design environment that's consuming capacity, it's driving our customers to do more sampling and production because they're managing a more robust design environment and making sure that they can deliver to their customer requirements, and that tends to be a positive. We're getting ready for some significant changes to transistor architecture and power distribution that are coming, and so we think those are drivers as well. I think if you back up and look at the overall markets over the last five years, I mean, litho intensity has increased, and process control intensity has increased.
I think in most of the other markets, and maybe there's some smaller parts of markets that haven't, but in general, they've been, the players have changed a little bit in terms of share, but overall, the markets as a percent of the total haven't changed all that much. So, we think that there, because of these challenges that our customers are facing, the ROI is pretty easy if you can improve yield sustainably in this sort of rich design environment or speed the time through a ramp cycle and get to volume production sooner. So as long as we can continue to demonstrate our relevancy, I think we're in a pretty good position to be able to not only, you know, help with R&D, speed ramp, but also increase our exposure in production.
We've been supply constrained around some of the most important products that the company sells, our Broadband Plasma, high-end optical inspection systems. We have more capacity coming online. I think it affected our sort of share and revenue performance in 2023 because we were limiting capacity. As that capacity comes online, I have, you know, an increment that improves 2024 and expectation around that business and even more into the future. So I think that's reflective of the benefits that this product can provide and the constraints that we've been under to be able to ship to market requirements, even despite the what has been a correction period for the industry. So we feel pretty good about our relevancy, if we can continue to execute on our roadmaps and introduce our products.
And I think the value case, if we can do that, is pretty easy to demonstrate to our customers, which is why it's important for us to really understand and collaborate closely with our customers to deliver and innovate and invest, to be able to deliver products and new capability at a faster cadence, and then to understand that value and have a shared relationship in terms of how we share the value of that, in terms of how we price those products. So we feel pretty good about the roadmap and the opportunity moving forward to continue to see improvement in KLA's share of the market.
I wanted to touch on advanced packaging. I think about $400 million this year, you know, half in specialty markets. Maybe tell us where exactly does KLA play in advanced you know packaging? And how correlated is it to just the growth in the accelerator market?
Yeah, no, it's an interesting thing, and we come at the market with multiple products in the portfolio. And we are even seeing some strengthening as our customers are investing more with some of the improvement in the AI market that, you know, that we talked about a $400 million growing from $300 million last year, and I think it's probably, you know, $450-$500 at this point, right? As we just look at expectations for the second half and some of the incremental demand that-
Mm
... that we're hearing from our customers. As you said, we have a split. We participate in process where we do plasma dicing, we do barrier seed layers, we do RDL and TSV reveal steps. So a number of process steps through specialty, through our specialty semiconductor business, which has, I think over time, uniquely designed for some of these market opportunities and has a fairly differentiated position, and I think that's reflected in the gross margins. We do segment reporting, so you can see kind of the gross margins of our process business relative to some of the others that are out there.
We also monitor chemical properties and, you know, when you're doing depositing metal layers to do like TSV formation and so on, and so we have a business that participates there. So that's roughly about half of it. And then there's actually, I left out, there's a piece that's tied to IC substrates, right? As you think about, you know, CoWoS and Wafer on substrate and how the substrate integrates into the board, where there's increasing opportunities, I think, over time, as lines and spaces, as feature sizes shrink, to drive more demand in that part of the market, too. And that's part of the reason why we bought Orbotech was this exposure and this evolution of the substrate into the package. So you have that piece in it, too. So that's roughly half.
And then the remainder is in our core inspection and metrology businesses. There are metrology steps, as you think about, you know, bonding steps, and you have to do overlay, and there's feature size measurement and shape, and so on. And then inspection, both in terms of inspecting the connecting interposer layers, as you're connecting the various, you know, sort of tiles or chips into the overall device. So we come at it in a number of different ways, and we think that over time, as you start to see more complexity and shrinking densities in these layers, that it will drive the need for higher-level inspection. And the challenge in inspection is that if you increase sensitivity, you have an effect on the speed, right?
So very sensitive tools are very slow, and, you know, less sensitive tools are fast. So right now they're using lower-end tools that run pretty fast, and you can get pretty high sampling levels. But over time, if you need-- the sensitivity requirements are increasing, you're going to need more capability, and that will have a throughput hit, right, in terms of what you can actually, you know, how many wafers an hour you can process. So in that environment, so if customers are going to maintain similar sampling strategies, then there's a ASP element, but there's also a unit element as well. So, you know, I think those are the, you know, sort of the bigger drivers as it relates to the packaging part. Obviously, the-- what is driving the need for more packaging is much more relevant to KLA.
And if you look at today, just with all the focus on high-performance compute devices with larger die, with a similar defect density, you have more yield challenges, same number of particles fall on larger die, your yields are lower, higher value die, and more pushing of leading-edge design rules earlier in node ramps, are all good drivers for ultimately for our business. And I think an increment versus historic, where you had, you know, more mobility driving most of the leading-edge progression and process debugging, which, you know, smaller die and a lot of volume around singular sort of device design versus, you know, a more robust design environment.
So all these things are good, and then, of course, it translates into this packaging opportunity, which likely grows faster than overall WFE, and with increasing technology requirements within that over time. So I think we're encouraged by a lot of it. It's excited about it.
Are there parts of advanced packaging where you don't play yet? Because we look at a number of other smaller companies, you know, who are seeing, you know, 30%-40% kind of growth rates. So are there parts of the market where you don't play yet, where KLA can play, but in, you know, meeting your business model, of course?
Yeah, no, there is some segmentation within it. I mean, we're seeing within our business, you know, those kinds of growth rates. But if you look at, you know, in certain parts of HBM, how it integrates, you know, through TSV formation into the package, you know, that's more of a, you know, a CoWoS step, and I think, there's participation there.
But if you look at how the DRAM devices are stacked within an HBM device, that you do have some traditional packaging steps, like bump packaging, which drives bump inspection, which is not as much of an advanced packaging step, more of a traditional packaging structure that is a requirement where we do have some competition and is a, you know, kind of a lower-end requirement in the market. And so we're—we don't really serve that part of the market, I think, given some of the dynamics relative to price and cost of ownership and the needs that our customers have, right? At the end of the day, our customers want as much capability as they need to drive the highest level of productivity.
You see that in a lot of markets where, you know, if you come in with more capabilities, more than you need, then there isn't necessarily as much value in paying for that. So there are opportunities there. I think that, you know, we think over time, as you move to different hybrid bonding techniques, that you start to uplevel the technology requirements there, so it creates some opportunities in the future. But for now, you know, we're less exposed in that sort of HBM formation of HBM stacks than the other parts of the packaging market.
Got it. I know it seems a little early for 2025, but given the lead times for your tools, maybe you could, you know, help quantify what the lead times are. What is kind of the early preview of what 2025 might look like?
Yeah, well, we're in a very good position to be able to supply. I talked about some of the challenges in some of the product types that we have. It's interesting, and I said this at the call, about 40% of the backlog of the company is tied to supply-constrained products, where you either have the biggest part being the Gen 4 optical inspection that I talked about earlier, but we even have products that we're selling into some of the N-1 and N-2 market opportunities. We are going from very low volume levels to much higher, and so spinning that supply chain to be able to supply has been somewhat of a challenge. So I think we're in a pretty good place.
I mean, it's one of the things that, that, you know, we did in the last cycle was in preparation for this plan that we're pretty convicted about, was making sure we had the investments in our supply chain to deliver the capacity. I've continued to take inventory, even though I haven't necessarily had the demand for it, to keep my suppliers committed to, to the supply that they're providing for us in anticipation of, of the future. So, I think we're in a pretty good place from a company capacity, from a supply chain capacity, point of view, as we think about next year. Our lead times are generally, you know, they vary across products, but generally somewhere around the nine months + or - range. That being said-
You pretty much know what next year-
Well, that being said, we're willing to also, you know, do what we need to, to make sure we don't lose business because we can't deliver. So, I think given some of the leading-edge commentary we talked about earlier, I would expect that, you know, foundry logic investment next year will be pretty good. And I think the memory dynamics portend, I think, a pretty good environment for DRAM. And Flash, you know, is not really growing this year. We'll have to see. I think it's going to be more consumer market-centric as we see that next year. But I think in anticipation, based on what we're hearing from customers and the improvement we're seeing in their businesses, I think we anticipate a pretty strong demand environment into 2025.
On that positive note?