KLA Corporation (NASDAQ:KLAC) Q2 2023 Earnings Call Transcript

KLA Corporation (NASDAQ:KLAC) Q2 2023 Earnings Call Transcript January 26, 2023

Operator: Good afternoon. My name is Chelsea, and I will be your conference operator today. At this time, I would like to welcome everyone to the KLA Corporation December Quarter 2022 Earnings Conference Call and Webcast. All participant lines have been placed in a listen-only mode to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you. And I will now turn the call over to Kevin Kessel, Vice President of Investor Relations and Market Analytics. Sir, please go, ahead.

Kevin Kessel: Thank you, Chelsea, and welcome to our earnings call to discuss the results of the December quarter and our March quarter outlook. Joining me is Rick Wallace, our Chief Executive Officer; and Bren Higgins, our Chief Financial Officer. During this call, we will discuss our results released today after the market close. All materials can be found on our IR website. Today’s discussion is presented on a non-GAAP financial basis, unless otherwise specified. Whenever references are made to full year business performance, they are calendar year references. A detailed reconciliation of GAAP to non-GAAP results is in the earnings material posted on our website. Our IR website also contains future investor events, as well as presentations, corporate governance information and links to our SEC filings, including our most recent Annual Report and quarterly reports on Forms 10-K and 10-Q.

Our comments today are subject to risks and uncertainties reflected in the risk factor disclosure in our SEC filings. Any forward-looking statements, including those we make on the call today, are subject to those risks, and KLA cannot guarantee those forward-looking statements will come true. Our actual results may differ significantly from those projected in our forward-looking statements. Our CEO, Rick Wallace, will begin the call with some quarterly comments and highlights before discussing the semiconductor industry demand environment. Bren Higgins, our CFO, will conclude with the financial highlights, as well as our guidance and outlook. I will now turn the call over to our CEO, Rick Wallace. Rick?

Rick Wallace: Thanks, Kevin, and thank you all for joining us today. I will summarize KLA’s performance in the quarter and summarize calendar 2022. I’ll also provide a brief perspective on the overall semiconductor demand environment, as well as outline KLA’s priorities for 2023. Before we get into details, I want to first acknowledge our global KLA teams, who’ve continued to deliver for customers despite persistent challenges. KLA’s results are proof of their commitment. KLA’s December quarter have revenue of $2.98 billion, which is above the guidance range, with 27% growth on a year-over-year basis and 10% sequentially. Quarterly non-GAAP net income was $1.05 billion. GAAP EPS was $6.89 and non-GAAP EPS was $7.38, with each finishing above the midpoint of the guidance ranges.

Calendar 2022 was another year of record growth, profitability and free cash flow. Specifically, revenue increased 28% in 2022 to $10.5 billion, marking the seventh consecutive year of growth, driven by 36% growth in semiconductor process control systems. KLA also demonstrated strong operating leverage on our revenue growth in 2022, with non-GAAP operating profit up 31% in the year. Non-GAAP incremental operating margin on the revenue growth was 46% for the year. Calendar 2022, free cash flow was up a healthy 18% to a record $3 billion, with free cash flow growth exceeding our 15% long-term target growth rate. Now I’ll summarize some specific highlights from the quarter and the year. First, KLA continued to deliver strong relative outperformance versus peers.

KLA substantially outperformed overall WFE market growth in 2022. Looking ahead, our leadership in critical markets, such as wafer and reticle inspection are expected to demonstrate resiliency in a year of contraction in overall WFE demand, setting the stage for another year of relative strength for KLA. Second, our Patterning Systems revenue grew 17% sequentially, which is up 69% on a year-over-year basis. Third, KLA delivered record revenue in the 10th consecutive quarter of sequential growth in our specialty semiconductor process segment, demonstrating resiliency and expanding market opportunity. Fourth, the KLA Services business grew 14% year-over-year in the December quarter and was up 15% on a full year basis. Finally, the December quarter was another exceptional period from a capital returns perspective as we completed the $3 billion accelerated share repurchase component of the $6 billion share repurchase authorization announced last June.

KLA December quarter and calendar 2022 results and strong relative performance once again highlight the critical nature of KLA’s products and services. Our consistent strong execution against various challenges in the marketplace, both in terms of macroeconomic uncertainties and addressing persistent supply chain challenges highlight the resiliency of the KLA operating model, the dedication of our global teams and our commitment to assertive capital allocation and delivering long-term value to our stakeholders. Looking at 2023, we know that this will be a year of industry capacity adjustments as customers fine-tune their CapEx plan to address decreased demand in some segments. However, we recognize that the semiconductor industry continues to be positioned for long-term growth, benefiting from the continued advancement of leading-edge technologies, increasing investment in legacy nodes and innovation and growth of new enabling technologies such as advanced packaging.

To address this period of adjustment and maintain our commitment to growth, we’re emphasizing three main priorities for our teams in navigating 2023. First, we will continue to make sure that we support our customers by delivering on our commitments and continuing our levels of investment in R&D. Second, we’ll stabilize our spending levels. To strategically navigate the current environment, our focus will be on stabilizing spending, while maintaining R&D investments to drive market leadership. Our expectation is for R&D investment to increase in calendar 2023. Third, we’ll emphasize development of our workforce. After a strong hiring pace, we’re currently at approximately 15,000 employees worldwide. Optimizing training and developing our workforce will help ensure continued strength for the long-term.

Now Bren will review our December quarter highlights and our outlook. Bren?

Bren Higgins: Thanks. As Rick has detailed, we delivered strong December quarter and calendar 2022 results that demonstrated consistent execution by the global KLA team. While supply chain challenges remain and impact on certain products, we continue to demonstrate resourcefulness and the ability to adapt to meet customer requirements. Quarterly revenue was $2.98 billion, $184 million above the midpoint of guidance and just above the guided range of $2.65 billion to $2.95 billion. Revenue outperformance in the December quarter was driven primarily by KLA’s broadband plasma optical pattern wafer inspection and mask inspection systems, resulting from favorable mitigation of identified supply chain risks, as we move through the quarter.

Non-GAAP diluted EPS was $7.38, above the midpoint of the guided range of $6.30 to $7.70. GAAP diluted EPS was also above the midpoint of guidance at $6.89. Non-GAAP gross margin was 61% and just below the guidance range of 61.5% to 63.5%, due to the impact of increasing non-cash inventory reserves taken in the quarter as we adjusted our factory output expectations and supply chain commitments to the current outlook, which has weakened at an accelerated pace over the past several months. These reserves were primarily taken against high-volume products and are consistent with shifting customer delivery dates and resulting backlog adjustments in the quarter. Given the diversification of end demand across technology nodes, the extendability of our product platforms and the expectations for growth in our service business, it is likely that we will realize a benefit from releasing these reserves over time when industry growth resumes.

We estimate that these adjustments had a roughly 200-basis-point impact on GAAP and non-GAAP gross margin compared to what would have been assessed in a normalized industry environment. This impact was offset somewhat by higher business volume and by a strong product mix realized in the quarter. Non-GAAP operating expenses were $555 million, slightly above our estimated $550 million for the quarter. Total non-GAAP operating expenses comprised $332 million in R&D and $223 million in SG&A. Non-GAAP operating margin was strong at 42.4%. Quarterly non-GAAP net income was $1.05 billion. GAAP net income was $979 million. Cash flow from operations was $688 million, and free cash flow was $595 million. Breakdown of revenue by reportable segments and end markets and major products and regions can be found within the shareholder letter and slides.

Switching to the balance sheet, KLA ended the quarter with $2.9 billion in total cash, cash equivalents and marketable securities, debt of $6.1 billion, a reduction of $200 million in the quarter and a flexible and attractive bond maturity profile supported by strong investment-grade ratings from all three agencies. Over the last 12 months, KLA has returned $5.2 billion to shareholders, including $4.5 billion in share repurchases and $689 million in dividends paid. Looking ahead to calendar 2023, we expect industry spending to slow with the continued expectation for CY 2023 WFE demand to be down approximately 20% in the year, down from approximately $94 billion to $95 billion in CY 2022, due to increasing global macroeconomic concerns highlighted by our customers in most end markets and widely reported customer CapEx expectations.

This WFE estimate reflects our current tops-down assessment of industry demand as follows; In memory, we expect WFE investment to decline by more than the market, with DRAM down more than NAV as memory customers respond to lower consumer demand by cutting production and factory utilizations to bring device supply in line with demand. We expect foundry logic to decline less than the overall market with leading-edge investment declining less than legacy. KLA’s unique broad portfolio differentiation and primary value proposition are focused on enabling technology transitions, which our customers continue to invest in regardless of the business environment. While capacity plans could change, technology road map investment tends to be more resilient and aligns with KLA’s highest value product offerings, where we continue to have supply chain constraints inhibiting our ability to add the additional volumes to meet current demand.

This demand adds additional confidence in our business expectations as customers align shipment slots with road map requirements. In this industry environment, we will continue to focus on meeting customer requirements, maintaining a high level of investment in R&D to advance our product road maps and KLA’s market leadership and align our operating structure with topline expectations, which we expect to be in line or better on a relative basis, while delivering strong relative financial performance. Our March quarter guidance is as follows. Revenue of $2.35 billion, plus or minus $150 million. Foundry logic is forecasted to be approximately 85%, and memory is expected to be around 15% of semi PC systems revenue. Within memory, DRAM is expected to be about 71% of the segment mix and NAND 29%.

We forecast non-GAAP gross margin to be in a range of 60.5% to 62.5% as product and segment mix and lower volumes dilute gross margins versus the 2022 baseline in the quarter. Based on current market demand assessments, we do not expect incremental inventory reserve requirements to be a factor in the quarter. For calendar 2023, based on our current industry outlook and the impact on overall volume, segment contribution and product mix within the semiconductor process control group, we are modeling gross margins to be greater than 60% with variability quarter-to-quarter attributable to product mix fluctuations. Operating expenses will decline in the March quarter to approximately $545 million. For calendar 2023, KLA will continue to balance investments in technology, headcount, and infrastructure to support our long-term growth objectives, while managing the business against the expectation of a softening near-term outlook.

As a result, we expect quarterly operating expense levels to decline as we move through the balance of the year. Other model assumptions for the March quarter include other income and expense net of approximately $62 million and an effective tax rate of approximately 13.5%. Based on our current assessment of geographic revenue and profit expectations, you should continue to use 13.5% as the tax finding rate for calendar 2023. Finally, GAAP diluted EPS is expected to be in the range of $4.06 to $5.46 and non-GAAP diluted EPS in a range of $4.52 to $5.92. EPS guidance is based on a fully diluted share count of approximately 139 million shares. In conclusion, though calendar 2023 will be a year of contraction after three strong years of growth, we remain confident that the secular trends outlined in our Investor Day last June are driving long-term semiconductor industry demand, and investments in WFE are durable and compelling.

Broad-based customer demand across multiple production nodes, increasingly strategic role semiconductors plan influencing national industrial policy, a robust design environment at the leading edge and growing semiconductor content across technology nodes remains important trends. These are long-term secular growth drivers for the industry as technology investment and node transitions reflect the value that semiconductors in our industry have in lowering costs for our customers and enabling a broader application universe for semiconductor-based technology across multiple end markets. For KLA, we have a strong historical track record of delivering relative outperformance across industry cycles. To be competitive over the long run, our customers must continue to invest in product roadmaps irrespective of market conditions.

Furthermore, KLA services has continued to grow consistently over multiple decades due to the critical nature of KLA products to improving yield learning and driving fab productivity. Our operational execution, coupled with the power of our portfolio strategy, positions us to continue to deliver sustainable relative performance over the next several years. We will continue to maintain our R&D investment and our product development roadmap to enable market share expansion, support customers’ technology roadmaps, and multiyear fab investment plans. This provides an element of stability that shores up our confidence in the demand outlook for the future. These factors, combined with the KLA operating model that guides our execution, positions us well as we execute our strategic objectives.

These objectives fuel our growth, consistent operational excellence and differentiation across the diverse product and services offering. They are also the foundation of our sustained technology leadership, consistent industry-leading financial performance and growing capital returns to shareholders. With that, I’ll turn the call back over to Kevin to begin the Q&A. Kevin?

Kevin Kessel: Thanks, Bren. Chelsea, if you could please give instructions to queue for questions.

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Q&A Session

Operator: Yes, sir. We’ll now take our first question from C.J. Muse with Evercore. Your line is open.

C.J. Muse: Thank you for taking the question. I guess first question, you talked about expectations to outperform WFE again here in calendar 2023. So curious, can you kind of walk through is that a comment on total revenues or just process control? And within that, how should we be thinking about the benefit from backlog/deferred revenues, particularly in the March quarter? Trying to make sure I calculate that right in my model.

Bren Higgins: Hey, C.J., so I’ll start, and I’ll let Rick chime in if there’s more. But I think there’s a few factors as you think about KLA’s performance generally as we’re looking at this year. Obviously, we had a very strong 2022 from a relative point of view. And when we talk about that, we’re really talking about the compares against WFE, right? Because there’s other industries we’re in, and it’s less clear. But given the semi PC compared to WFE, if you look back historically, we’ve always done well in down years for WFE, because our customers across all our segments pull back on capacity but continue to invest in technology and their technology road map. So that’s always a positive factor for us. We also see PC intensity moving up because it €“ where you generally see more cycling is in memory and so given the relative PC intensity in logic and foundry that tends to be something that’s good for us as well.

Relative to EUV and the dynamics around EUV, radical and our optical pattern inspection business are inflecting. So that gives us incremental, I think, support in terms of growth as we expect both those businesses to be better performers relative to the overall industry, and they’re big parts of KLA. China impacts another factor, right? I think if you look at some of the peer companies and some of the export control dynamics as a percent of the total, impacting some of our peers, perhaps at a little greater degree than KLA. So I think for all those factors, we feel pretty good about our position as we think about just our performance relative to the overall market despite the strength of what we saw in 2022. In terms of Q1 and backlog, I mean, the deferred revenue hasn’t really changed.

We haven’t had the issues that others have had in terms of €“ of having those €“ the deferred revenue bloat up related to some of the supply chain challenges that were well chronicled. So that’s fairly normal in terms of how we look at 2023. The backlog did come down. We did some scrubbing related to the China export principally. So we saw some reductions there. We’ll see the performance obligations come down about $1 billion overall. So, some of that being the effect of the China dynamic, but also we did revenue at a level that was above the new bookings. So, not a lot, and there’s still a significant amount of backlog, and I think that we’ll see that play through as we move forward here. So some of that is tied to longer term to facility projects out beyond 12 months.

45% to 55% of our backlog is for delivery outside the 12-month window. So hopefully, that gives you a little bit of color on the overall and our expectations for 2023.

Rick Wallace: And C.J., maybe just to add one thought. When we laid out our investor plan for ’26, at the time we did that, we actually anticipated that there would be a contraction between ’22 and ’26. We obviously didn’t know when, but we felt that, that was going to happen. And our assumptions for that model were based on our percent of WFE, which, as you know, is a combination of the process control intensity in our share. We don’t see any degradation of that in 2023 based on what we see. So we see holding percent of WFE or maybe continuing to make progress. So we still feel pretty good about the trajectory that we laid out in ’26. And even though there will be — these puts and takes based on projects that come and go, I think we feel pretty good, and we don’t think 2023 will be a problem relative to that longer-term plan.

C.J. Muse: Great. Very helpful. As my follow-up, you talked about expectations for gross margins north of 60% for the whole year, guided 61.5% for March. I guess this is kind of a two-part question. I guess, how do you see kind of a trough revenue quarter here? If you can answer that. And does that mean that we would be below 60% in the back half of calendar 2023, or you think you can stay north of 60% every quarter for the year? Thanks so much.

Bren Higgins: Yes, I think what we could stay above 60%. Look, there could always be quarter-to-quarter dynamics in a given quarter depending on the mix of the business that could drive us beneath that level, but our expectation is that for the year will be better than that overall. I would expect, and as we said over the course of last quarter, that we thought that Q1 was likely the higher quarter in the year and that we would see a drifting down in terms of the run rate. And just to make the math work, you would see a lower second half than the first half. So, I think you likely stay north of a couple of billion in terms of revenue levels, and we should be able to hold 60% in terms of a run rate from a gross margin point of view.

Operator: Thank you. Our next question will come from Joe Quatrochi with Wells Fargo. Your line is open.

Joe Quatrochi: Yes, thanks for taking the question. I wanted to kind of double click on your WFE expectations and then how do you think about your model. Are you thinking about first half or second half WFE being relatively balanced for the year and then within your kind of forward revenue expectations for KLA as well?

Bren Higgins: I think my statements earlier were more KLA-centric, but I don’t think we’re going to deviate that much from overall WFE. Obviously, that gets into the other businesses and markets that we don’t participate in. But generally, I would expect that we’re at a higher run rate, a WFE run rate, in the first part of this year than we are in the second. So yeah, I would think that it’s probably down. I don’t know how much it’s down, but it’s probably lower in the second half than the first half.

Joe Quatrochi: Got it. And then just kind of maybe bigger picture. But one of your larger customers have talked about a temporary decline in the 7-nanometer utilization rates, but at the same time, also talking about working with their customers to introduce to backfill capacity, introduce new products over the next few years. I guess how do we think about that dynamic in the context of like your print check business and the mass shop?

Rick Wallace: I think that it’s much more — it’s baked into our assumptions on the overall reduction in WFE that they’re going to be shifting. But I don’t think the mix between our products is really going to change for that period if you think about where logic is positioned. The other thing that Bren mentioned, as you know, as EUV gets increasingly adopted, even if it’s at lower capacity, we’ll see more demand for print check and in reticle in general. So the strength of those businesses, we think, continues on a relative basis, albeit in a declining overall market for some period of time. But those are product lines that right now, we don’t — we’re still supply-constrained in terms of our ability to support customer needs on those products.

Bren Higgins: Yeah. If 7-nanometer capacity demand falls off, right, and we don’t expect to impact, you would expect to see wafer starts maybe come down at that node. Most of the investment we expect to see is at the more advanced nodes. Customers are always looking to optimize the productivity of their capacity. Depending on their views, it could be temporary, in which case they’ll idle some of that capacity or run it at a lower utilization rate. And then if in the longer run, they feel like they can move it, they’ll try to move it. They do have the technical challenges though that if you were to move from 7 nanometer to 5 nanometer, you have the introduction of EUV from node to node. So the technical challenges of trying to reuse that capacity is much more difficult in this environment than it was, let’s say, 10 years ago.

Operator: Thank you. Our next question will come from Harlan Sur with JPMorgan. Your line is now open.