Logic parts of our business that are spending more. We're also exposed to parts of WFE that maybe some of our peers aren't in the wafer houses, in theoretical houses. And so when you add that all together, I think that given our relative exposure to logic foundry, which is higher than memory, it's positioning the company to I think do a little bit better than the broader industry this year. Maybe if you look at consensus estimates where they are today, mid high single digit down versus industry to your point at down 15% or 20%, mid-40s WFE levels. So I don't think it's changed much.
I mean there's certainly a lot of noise in the system on the trade front and so on. I think the impact to our business has been minimal. There's been some tariff exposure we've had for a while, but most of our sourcing of commodities or commodity parts in China usually go into broader subsystems and other places. And so the impact has been as country of origin changes and value gets added, the impact has been fairly minimal. So very little impact there.
Certainly, customers get cautious and try to figure things out. And so you've got some of those dynamics. I think procurement organizations try to leverage the noise that's out there. And so we have to be disciplined. I'm spending a lot of time talking to my sales team about what's actually subject to tariff, what de minimis tests are, all these kinds of things, which I never thought I'd be having these a lot of these conversations.
But in general, it's I think holding together I think pretty well as much as we had said. And I think in particular to the quarter, the quarter is shaping up as we thought and the second half dynamics as well. So I think Foundry and Logic business will be relatively balanced across the year. It seems like it's shaping up that way. Have a little bit of improvement into the second half in Memory, more related to technology migration than capacity investments and we tend to participate in that.
So that's good for us. Certainly not I would not call it a recovery. And I think the second half is stronger. And I think the way we characterize the quarter to quarter absent Orbotech, the quarter to quarter sequential path is the June be up and then we'd see sequential growth through the second half of the year and we still see it that way. Got it.
And if you look at within memory the DRAM versus NAND dynamics, what you thought at the start of the year versus what you're seeing right now? Has there been any noticeable change? No, not really. If you go back to the 2018, that's when we saw things change in a very dramatic way, particularly around the flash investments. And you saw a number of new fabs effectively push most of the investment for those facilities from the 2018 early twenty nineteen in most cases completely out of 2019.
So despite that I think for those customers because they're doing technology work we still have a level of business there that's been good for us. And it's been I think pretty consistent. Customers have been despite all the noise in the system, I think pretty disciplined about how they've managed capacity. Now they have to get or satisfy big growth today with more capacity than just shrinks. And so those are bigger bets and I think they're more sensitive and more disciplined to the timing of those bets both turning on or turning off in this case, but also when we get to turning them back on as well.
So it's played out I think as much as there's noise in the system, it's I think pretty consistent with the way we saw and we continue to see it.
And in terms of China demand both sort of from indigenous Chinese customers versus the multinationals, give us some relative sense of how big your business is in China and if there is a way to kind of break it down in terms of indigenous versus multinational and how they
are trending this year? Yes. So it is the multinational investment has been mostly around one project this year and the rest has been indigenous. I would say that our China exposure overall, including multinationals mid-20s, I've been pretty public that we our expectations for native China business is probably about 10% to 15% lower The last couple of years has been relatively strong.
It's been very good years. So in the ballpark of around 500,000,000 for the company on the systems side. And that has held together I think pretty well too. I mean I think we have seen some puts and takes there. But initially in the March we talked about a project, the second phase of a project in memory that we thought would shift out of the year.
It looks like we'll actually come into the year. But then I'd say maybe at the second tier I've seen some movement around some of the project timing. So overall, the forecast underneath the forecast has moved a little bit, but
we still feel pretty comfortable about the business levels we expect. Got it. Now looking at longer term trends, I think you have given a growth target longer term of a 7% to 9%. What are the underlying drivers? And how do you come up with that?
Because if I look at the broader semiconductor industry and if I ask management teams there, they will say, we think this industry is going to grow somewhat faster than GDP because there is content growth, there is data and so forth. How do you come up with your growth targets? Do you kind of tie into semiconductor industry growth or is there something else that goes into that forecasting? No, it's a good question.
I mean, I think there's a baseline expectation for growth of the industry that's given that capital intensity has flattened out, it's no longer declining. There's lots of efforts in the industry to keep it from going up. And so we think that baseline industry growth for semi equipment through cycle ought to grow generally in line with where semiconductor revenue ought to grow. And so that puts you at a baseline growth rate of four percent to 5%, let's say worldwide GDP plus. We have an element that we believe is related to share improvement opportunities.
It could come in the form of process control intensity improvement opportunities as well. But as we look at those opportunities that are out there from opportunities around EUV, opportunities around increasing intensity in memory and then overall share in existing products. If you look at the market position we have, we're in the low 50% of Process Control. We don't participate in all of it. Segments we participate in, we've got a pretty strong share, but there is money that is being spent in Process Control in certain areas that we believe that product offerings that we have today and we'll have moving forward will enable us to gain additional share.
So I think that customers like second sources, but at the same time I do believe that there is additional share opportunity for us. Our service business is growing and so it's growing faster than the core business. So historically it's been around nine to 11%. It looks moving forward to grow in the same range. So that incrementally will contribute about one to two points to the compound annual growth rate.
So you take that, you take the share opportunities and you couple that with baseline industry growth and that gets us in that range. If you add Orbotech into that, certainly in the 1% to 2% to the top line, I think their businesses have the same GDP base growth rate expectation. The share gain I think piece sort of fits in that 1% to 2%. And there is some service opportunity. The PCB business has an imaging product line that has a very strong, which is the majority of the revenue, very strong contract component to its service stream.
And then the other businesses don't have a lot of service. And in particular the Specialty Semiconductor part of Orbotech sells to a lot of the same customers. And so they have the same we do and we have the same customer list. So we have infrastructure and capability around the world that a larger supplier can help enable those smaller supplier to try to get more out of that business. So I think as you add Orbotech into it, it sort of contributes to those pieces, the one to two in the service, one to two in share and that's how we get to the seven to nine.
Got it. So and against that backdrop, believe given the operating leverage targets of the company, we ought to be able to deliver bottom line growth of about 1.5 times that top line growth rate. One thing about the Orbotech business, it has lower margins overall as you aggregate them and they're different across the three businesses. But I believe the operating leverage opportunity that exists as we grow revenue of driving 40% to 50% drop through of the revenue growth in terms of incremental operating margin growth is attainable in that business just like it's we've been managing our Semiconductor Process Control business. Got
it. Hypothetically, if next year WFE is flat, what would you be doing differently? Well, I think
the way we've managed the company through 'nineteen and is that we've seen this as generally a digestion more than a downturn overall for us. I mean we're talking about mid to high single digit declines, and so that's not significant. And we've got up in our including Orbotech, we're talking about 30 -plus operating margins or low-thirty percent operating margins. And so against that backdrop, we believe that we're investing in some unique opportunities moving forward. I think the opportunities that we talked about a little bit around EUV and some of the memory challenges are multiyear challenges and multiyear investment cycles and that we are investing into those.
So we've always made sure that we invest in the right products almost independent of what happens in the top line and continue our product development because it's so important to the differentiation model of KLA. Our margin profile is dictated by our ability to do things that our competitors can't, to introduce products at a cadence that our competitors can't, to tie the data and output out of the tools together so we can try to leverage the portfolio of the company. And so we will continue to do those things. So to answer your question, I'm not so sure we do anything differently. As we look at next year, we say, okay, so if it is to and I'm not so sure I have deeper insight into 2020, but if you're talking about a flattish environment, we'd see the service business grow.
And I think against that backdrop, I think you'd see our operating expense profiles probably level out a bit. But I don't think we do things that were meaningfully different than what we're doing right now.
What does the introduction of EUV mean for process control intensity? Does it increase your opportunity set in the industry? Does it kind
of flatten it? What is the impact for KLA? Well, so the short term and longer term and I think as it moves into higher volume production, there's a different opportunity. In the short run, certainly from a development perspective, any EUV development in and around the radical ecosystem is being done with KLA systems. We've enhanced some of the offerings that are in our existing 193 reticle inspection offering, which customers are using and also using our high end wafer inspection to do reticle qualification and this is how it's being done today across any customer that's doing EUV development.
As you start to transition to more and more layers then you start to need production solutions. There is a high NA and other dynamics that are probably playing out as you get to crossover in terms of EUV layers, 50% when I say crossover, mean more than 50% out in the 2021, 2022 timeframe. So against that backdrop, I think that the ecosystem around the reticle will be a challenge for the industry. There's issues with pellicles and what that does to production and also defectivity management. We're investing in a couple of products to support that volume environment.
And so it's our belief that you'll see an inflection around the reticle in terms of process control intensity. And certainly historically, anytime we've had significant changes in process technology, you see increases in process control just because the immaturity of the process and certainly at higher volume levels that poses a challenge for customers. So we think it's a great opportunity for us. Smaller defects is also enabled now that you have linear scaling. Linear scaling drives smaller defects, which is something that's always been part of the sort of core capability of the company.
So enabling that to happen and that driving value to solving those problems to our customers, we believe that's an opportunity for us. So
we're excited about And if you look to next year, what is the trade off between let's say if there is WFE growth next year, but it comes more from memory where process control intensity is lower than foundry logic, but there is more use of EUV where process control you're saying you have more opportunities. Should we be worried about that trade off right now? Does it
kind of balance itself out? Or how do you look at it? Yes. No, it's a good question. And I think there are fundamental dynamics about chip architecture design and how customers behave in memory and foundry that won't change.
Now at the same time, so foundry logic customers will spend more on process control, high mix foundries will spend more on process control. The chip complexity is higher. They have to deliver yielded product to tighter market windows and so on. In memory, you have less complication, you have more redundancy, you have repair, you have those dynamics. But at the same time, there are unique challenges that are out there and we're process control intensity in memory improving.
If you look at last year, 70% of the industry spend was memory and we actually had a performance that was in line with the industry. So we are seeing improvements there. It will never look like foundry logic, but at the same time there are significant challenges and if we can solve these problems, I think customers will spend with us. We have products under development to improve and I've talked about it more publicly recently as to improve metrology and in stack metrology using new technology that's available in the market that would replace a destructive process that customers use. And as you're increasing layer accounts and going to double stacking
It creates challenges in the overlay area of registering layers on top of each other. And so there's opportunity out there if we can solve these problems. So I'd like to think that we'd see continued improvement in process control intensity and in the memory space. And I think last year is pretty good evidence of it improving for KLA. I think historically we would have been a very different place and I think these investments we've made, these changes that have made driven more complexity have been
good for the Got it. When you made the decision to acquire Orbotech, so first give us a sense for why you made that acquisition? How has the integration process been so far? I think initially, it came as somewhat of a surprise to the investment community, right, because we are so used to seeing your business kind of focused in a certain direction with very high margins. And Orbotech has a slightly different structure.
Although it's very interesting when you actually reported Orbotech results, their business is very resilient, right? It's holding up among the best in the industry. So just help us understand why you made that acquisition? Sure. What has been the feedback so far?
No. It has held up. And I think when you look at the way
we looked at the business is it really is three distinct businesses in one. And so there's a specialty semiconductor business that they have that has is exposed to a lot of the what I'll call the more than more markets of WFE and it's WFE that is spending more today. And I think going forward has higher semiconductor content and probably less cyclicality given that it's serving automotive markets, it's serving industrial automation markets, IoT markets and so on. It's a business that is has designed for particular niches and has seen those niches start to inflect and they've been able to have very differentiated positions and I think a margin profile that reflects that. We certainly give them more credibility.
There's perhaps an opportunity for us to enable additional process control sort of insight into helping them deliver better products to market. And so we're excited about that opportunity both from a strategic perspective, what it exposes to, but also the ability to leverage their position better as part of a bigger company with KLA and synergy with channel and service. There is a printed circuit board business which is mostly focused on imaging which is direct writing of lines and spaces in high end printed circuit boards. Imaging is technology synergies related to optics and related to lasers. And so we think that there is some crossover opportunity for us to help enable not only their position, but you're also seeing this transition in the industry to more from high end PCB boards to changing substrates to advanced packaging.
And so this exposes us to more of that, their efforts in the company already and then efforts that Orbotech was doing to try to address this market. This is an area where customers are doing a lot. If you look at our customer base and what they do to enable cost or capability, they do front end process node shrinks, which we all know real well. But they are doing a lot of things with packaging, with PCB board technology to enable I think new innovation and cost and so on. And so this exposes us to those markets which we think there's strategic and sort of technical synergy as well.
They also have a flat panel business that after six years of growth is down this year and they're more exposed to the transitions and less to capacity similar to the KLA business that it's more technology transition centric than it is capacity. And it's a business that I think that we've got do some work structurally with the cost structure to get it in the right place and ensure that we can deliver leverage over time through the cycles. I don't think those cycles matter that much to KLA frankly. I mean in a business it's 200 to $250,000,000 level and it cycles up to $350,000,000 or 400,000,000 in upturns. Think in a $5,000,000,000 company that doesn't matter.
It's much more about through cycle growth can we enable them to solve bigger problems and get a structure in a place that we can deliver sort of through cycle average profitability that makes sense. And so that's how we see it. Obviously, there's service opportunities. There's the ability to take the cash flow and deploy it through our model, do things with it that perhaps they couldn't do on their own given the small company three cycles, different And cycles and things like the ability to finance some of the transaction with some I think pretty attractively priced debt. So when we looked at it financially, I think it was a pretty easy decision for us to make against the alternatives that made a lot of sense and I think exposed us to more of where we think innovation is also going.
It's going in our front end business, but we also see it going this direction too. We're excited about those opportunities. In terms of integration, there are things we're doing that are sort of longer term in terms of leveraging our internal supply, doing some things with cost structure around manufacturing and so on. There's common supply chain. We're doing this work that work.
And then from an integration perspective, in some ways, it's kind of two separate companies. So it's a little bit more complicated in terms of how we're executing that. But we're working through those through that planning now and would expect to achieve the $50,000,000 synergy target as we start to see the bulk of it, at least from a run rate perspective as we move into the first part of twenty twenty. All right. The gross margin, there has been a short term hit because of Orbotech's gross margins I think for June are 58%, 59% or so.
I think generally your gross margins have tended to start with the 6%. So how soon do we get back tomorrow? Do you need to do anything special? Or is this a course of mix that helps gross margins get back to trend? Well, I think we had some mix issues in our Process Control business that drove our margins a little lower than the trend we've seen.
At these revenue levels in our Process Control business, our model has been sort of 62%, 63%, which we've And been very public so I would expect to see us get back into the target model range as we move into the second half of the year. So Orbotech obviously comes in with a different margin profile and there's a couple of points of dilution kind of related to that. But I think that we're in that sort of 60% plus or minus kind of range as we think about the year. I provided some guidance to that effect in the last call. And I think in some ways in our Process Control business, it's what we're shipping is what we revenue and we have a lot of different products and some products carry different mix dynamics than others in terms of the profitability model.
But structurally it's I think pretty intact and we'll see it in the model range if you will as we move into the second half
of the year. Longer term what is the right way to think of KLA's gross margins? Well, lot of
it depends on these mix dynamics and what grows. But I think as we look at the core business and the growth rate expectations we talked about earlier, I feel comfortable that you'll see a couple of points of dilution related to the So if we were 62% to 63 before, it would be a couple of points off of that. And then our objective to drive the incrementals on the incremental growth of 40% to 50% on the operating margin line. Got it.
Or operating income.
And then on the OpEx side, I think you guided to about $375 ish million, I think, for June. I think people were looking for somewhat lower than that. Can you help us level set, is this the baseline level of spending? Do we you know have synergies on top of this? Or how do we look at
the progression of OpEx from here? Yeah. There was some confusion out there. I think there was some modeling that wasn't all that thoughtful about the Orbotech piece. I think sometimes small companies exclude stock based compensation and we it's customary for us to report it and so that wasn't necessarily reflected in the models.
We have seen some increase in our investment. I've talked about some of the things that we're investing in, in terms of new products to support the EUV transition, vertical NAND and so on. So I think where we're at right now, I said that we'd see this sort of $3.70 to $3.75 range moving forward. Given these comments we talked about earlier in terms of industry dynamics, I think we'll see spend starting to flatten out in our core business and we'll start to see the synergies fall off on the Orbotech side. So I feel pretty comfortable that we'll see this level off and we'll start to see some of the synergy value start to flow through as we move through.
Maybe not so much in the second half of year but certainly as we get into the first part of you have a Some of that's just the timing related to actions that you take. It takes some time before it comes out. Do you have a longer term operating margin model in mind for the combined company? Well, again back to what I said earlier about the impact on the public model from Orbotech, it was about two points dilution. So I would expect that against the backdrop of high 30s percent kind of operating margin on our core business, had an Orbotech, so it drops in the kind of mid-thirty percent.
Mid-thirty percent. So I think when you're talking about revenue levels in excess of $5,000,000,000 we're probably in that mid-thirtieth percentile type operating margin expectation. Got it. The one other interesting aspect of
the business is on the services side. How are your services business how is your services business different than your peers? Because we they have spares, they have refurbs, they have a lot of but I think your services business is actually very different than that. I think it
will be useful for people to hear what is that difference? It is different. There's no consumables, right? So that's a big part of process tools is that consumable parts. And some of it relates to how customers buy process control.
Part of the reasons is they buy process control, they try not to spend. It's one of those things that they have to spend, but they only want to spend up to a level and they hope they don't have to spend any more than that. And so the trade off they make is that
spend what they want to
spend and they buy the tools and they run them pretty hard. And so they're very complicated systems and they only buy what they need. They run the utilization at pretty high levels. And so they need a contract support structure to be able to keep those tools up. They also in contrast to a capacity tool where you have lots of them and you can offload capacity when tools go down or you just in general you have enough, you can build capability to provide your own service.
The level of complexity is not as high. For process control tools, you don't have that many, you have to match results. It's very hard for a customer to say, okay, I'm going to go invest in that capability. A, could I even do it because of the complexity, but secondly, there's just not the volume set to be able to get the economic return. So they tend to rely on us for that too.
The supply chain is something that we have control over. So it's very hard to buy parts for KLA systems on the outside from third parties. You have to buy them from us. And then we have to go in and make sure that performance matches. They have to have identical results across different wafers, across different tool sets.
And then we can customize our offerings in a way that allows customers to have very custom service offerings in terms of response times, part stocking levels, coverings components, fab wide versus tool and so on. As a result of all that, it's a bit of a long winded answer, but as a result of all that, we tend to see about 70% to 75% of the revenue stream as contract. They run these tools for a long period of time. We've seen useful lives increase as we've seen more growth in the trailing edge parts of WFE. And so that's been a nice tailwind to our service business as well.
So it's extremely believe it's accretive. Everyone sort of debates about how you do the accounting, but we've been very consistent and we've seen with consolidation the ability to drive incremental leverage on the service business. And that contract stream has been very predictable. It's had one down year in the last twenty years and that was 2009 and even in that year it was only down 10% when the systems business was down considerably more than that. So on pace for almost $1,000,000,000 now and growing at about 10% And no upgrades in that.
It's all the service dynamics that I mentioned. Got it. And how does OrgoTech change that? Because I
think they also have a very interesting services component to their
business. It varies on