KLA Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
January 25, 2024

There are 10 speakers on the call.

Operator

Good afternoon. My name is Chelsea, and I will be your conference operator Call and Webcast. All participant lines have been placed in a listen only mode to prevent any background noise. After the speakers' remarks, Thank you.

Speaker 1

Thank you for joining

Speaker 2

the earnings call to discuss the December 2023 results and the March quarter outlook. I am joined by our CEO, Rick Wallace and our CFO, We will discuss today's results release after the market close and available on our IR website along with supplemental materials. Today's discussion is presented on a non GAAP financial basis unless otherwise specified. Our full year references all relate to calendar years. A detailed reconciliation of GAAP to non GAAP results in the earnings material posted on our website.

Speaker 2

KLA's 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 10Q and 10 ks. Our comments today are subject to risks and uncertainties reflected in the respective 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. Rick will begin the call with some comments and quarterly highlights.

Speaker 2

Brent will conclude with our financial highlights, including our 3 calendar year and December quarter and then set up our view for 2024. For 2023, KLA revenue was almost $9,700,000,000 down 8 versus the prior year. This was higher than our expectations coming into the year as strength from legacy node customers and structure offset weaker than expected leading edge investments in both logic and memory. While overall WFE spending was down for the year, there were areas of growth in business segments, including the infrastructure business supporting wafer and mass manufacturers, automotive and specialty semiconductor process equipment. KLA's service business grew 7 percent to $2,200,000,000 for the year.

Speaker 2

The company continued to deliver strong industry leading margins With non GAAP gross margins of 62% and a non GAAP operating margin of 39%, free cash flow grew 6% in 2023 to record $3,200,000,000 Moving to KLA's December quarter results, which were ahead of expectations as revenue grew 4% sequentially to $2,490,000,000 Quarterly non GAAP net income was 839,000,000 GAAP diluted earnings per share was $4.28 and non GAAP diluted EPS was $6.16 We saw sequential growth in all three of KLA's business segments, and you can find specific details in our Shareholder Letter released earlier today. Additional highlights in the quarter include growing adoption for KLA's 8,900 series platform for high throughput macro inspection, Increased demand in the legacy node and advanced packaging categories made the platform one of the best performing product lines in our optical inspection portfolio in 2023. Continued growth in AI enables KLA's differentiation and helps drive industry growth.

Speaker 1

We continue to deploy deep learning

Speaker 2

and physics based algorithms across KLA's inspection and metrology product portfolio. This has improved signal and noise recognition and reduced process learning cycles as customers resolve critical yield challenges. Haley Service Business grew 1% on a sequential quarterly basis to $565,000,000 and remains on track to resume the targeted 12% to 14% annual revenue growth trajectory in calendar 2024. As we look at CY24, we're encouraged by recent reports from many of our customers that the demand environment is expected to continue to gradually improve throughout the Through collaboration with customers, KLA is focused on preparing our teams for our return to growth at the leading edge and leveraging the KLA operating model to ensure readiness to support our customers' needs as the demand environment improves. In the near term, we see the March quarter as a low point for the year.

Speaker 2

We expect business levels to improve as we progress throughout the year. The KLA team will as always prioritize commitments to our customers and executing on our product roadmaps. I'll now hand the call over to Brent to provide more specifics around the financials and our guidance.

Speaker 1

Thanks, Rick. Our results demonstrated the consistent execution of our global team. Despite the challenges and complexity of the current industry environment, KLA continues to show resourcefulness and the ability to adapt to meeting customers and fluid requirements. Revenue was $2,490,000,000 slightly above the guidance midpoint of 2,450,000,000 Non GAAP diluted EPS was $6.16 above the midpoint of guided range of $5.26 to 6.46 GAAP diluted EPS was $4.28 GAAP EPS was negatively impacted by 1.59 or goodwill and purchased intangible asset impairment charge. Non GAAP gross margin was 62.6%, just above the high end of the guidance range of 60.5% to 62.5%.

Speaker 1

Non GAAP operating margin was 40.7%. Quarterly non GAAP net income was $839,000,000 GAAP net income was $583,000,000 cash flow from operations was 622,000,000 Free cash flow was $545,000,000 As I just mentioned, during the quarter, KLA recognized a goodwill and purchased tangible asset impairment charge of $219,000,000 for the PCB and display reporting unit attributed to a weaker long term outlook, primarily for the flat panel Display Business. We have begun investigating strategic alternatives for this business, which accounted for 1.4% of total revenue in calendar 23. The breakdown of revenue by reportable segments and end markets and major products and regions can be found within the shareholder letter Turning to the balance sheet, KLA ended the quarter with $3,300,000,000 in total cash, cash equivalents and marketable securities, debt of $5,950,000,000 and a flexible and attractive bond maturity profile supported by strong investment grade ratings from all three agencies. In December 2023, Fitch rating upgraded KLA's debt rating to A from A- with a stable outlook.

Speaker 1

Moving to our outlook, looking ahead to calendar 2024, the exact timing of a meaningful and sustainable resumption in WFE investment growth continues to remain uncertain. Though there are signs of improvements in some end markets, this improvement is off low levels, impacting our customers' profitability near term. KLA's overall demand is stabilizing around current business levels plus or minus the guidance ranges. As of now, this translates into KLA revenue bottoming into March quarter, driven mostly by a customer project delay occurring in the last couple of months. Based on current fast schedules in our June quarter shipment plan, we expect sequential growth to return in the June quarter and continue for the remainder of the calendar year.

Speaker 1

For calendar 2024, we currently expect WFE demand to be in the mid to high $80,000,000,000 roughly flat to modestly up from the anticipated level in calendar year 23. We expect that

Speaker 3

the second half of the

Speaker 1

calendar year will be stronger than the first half for WFE Investment. This WFE estimate reflects our current top down assessment of industry demand as follows. In memory, we expect WFE investment to be slightly up from low levels investments focused on high bandwidth memory capacity and leading edge node development. Both NAND and DRAM fabs are still at low utilization levels, as consumer markets have not yet returned to the growth levels needed to bring factory utilization back to the high level seen in recent years. Once customers consume this excess capacity and focus on node migration, we would expect to see new investments.

Speaker 1

Foundry Logic is expected to be slightly up with leading edge investment returning to modest growth levels, legacy investment declining versus 23. And China legacy note investments remaining relatively flattish to current levels. As for guidance, KLA's March quarter guidance is as follows. Revenue is expected to be $2,300,000,000 plus or minus 125,000,000 Foundry logic is forecasted to be approximately 60%, and memory is expected to be 40% of semi process control systems revenue. Within memory, DRAM is expected to be about 85% of the segment mix and NAND the remaining 15%.

Speaker 1

Non GAAP gross margin is forecasted to be in a range of 61.5 percent plus or minus 1 percentage point as product mix weakens quarter to quarter due to lower overall semiconductor process control systems revenue. For calendar 2024 based on current industry outlook, Top line growth expectation, higher forecasted growth in services and expected systems product mix, we are modeling gross margins to be relatively stable around the mid-sixty 1 percent range to what we delivered in 2023. Variability quarter to quarter is typically driven by mix fluctuations. Operating expenses are forecasted in the March quarter to be approximately 545,000,000 relatively flat with the December quarter. For calendar 2024 operating expenses, we expect $5,000,000 to $10,000,000 incremental growth per quarter beyond the March quarter in line with expected sequential growth in revenue.

Speaker 1

Prototype material purchases can drive variability quarter to quarter. For the calendar 2020 4 tax rate, based on current forecast, we do not expect material changes. You should continue using the 13.5% effective rate for modeling purposes. Other model assumptions for the March quarter include other income and expense net of approximately $45,000,000 GAAP diluted EPS is expected to be $4.93 plus or minus $0.60 non GAAP diluted EPS of $5.26 plus or minus $0.60 EPS guidance is based on a fully diluted share count approximately 135,600,000 shares. In conclusion, we are optimistic that most end markets are showing signs of improvement.

Speaker 1

KLA will remain focused on supporting customers, executing on our product roadmaps and positioning the company for a return of growth at the leading edge. Though visibility into the precise timing of a sustainable demand recovery is still unclear, KLA is running the business to ensure delivery of a differentiated portfolio that meets customers' technology roadmap requirements and to execute our business in line with our longer growth expectations. The KLA operating model guiding best in class execution, KLA continues to implement strategic objectives, which are geared to drive outperformance. With a focus on customer success, delivering innovative and differentiated solutions and operational excellence, KLA is able to deliver industry leading financial and free cash flow performance and return capital consistently. The past few years have strengthened our confidence in the increasing importance of process control and enabling technology advancements and optimizing yield in a high design mix volume production environment.

Speaker 1

This bodes well for KLA's long term growth outlook despite still challenging near term demand trends. In the meantime, KLA business continues to stabilize and the long term secular trends driving semiconductor industry demand and investments in WFE remain very compelling. That concludes the prepared remarks. Kevin, let's begin the Q and A.

Speaker 2

Thanks, Brian. Chelsea, if you can just give the instructions and set up the

Operator

We'll take our first question from Harlan Sur with JPMorgan.

Speaker 4

Good afternoon. Thanks for taking my question. It looks like relative to your prior view, the March quarter came in lower by about $200,000,000 I know you talked about a customer project delay that materialized just over the last couple of months. It looks like based on your December quarter market mix and expected March quarter mix that it's a foundry logic customer. Was that a leading edge or mature node customer?

Speaker 4

Was the delay more technology related or just weak demand trends? And does the sequential growth outlook beyond March assume that this customer comes back this year?

Speaker 1

Harlan, it's Bren. So yes, as we said in the prepared remarks over the last couple of months, We had a project that we're planning to ship roughly a couple of $100,000,000 of business to that had a push out that's ended, I think somewhere around 12 months. So could we see it at the end of 'twenty four maybe, could be early 'twenty five as well. So it was more leading edge centric. And as a result of that, as we backfill that business with other business, We did see the percent of China go up a little bit higher than we had thought we would see when we were giving guidance at the beginning of the quarter.

Speaker 1

So it was late in the quarter, obviously affected didn't affect Q4 because of the moving around of other customers in slots, but certainly had an effect on Q1. As we think about sequential improvement into the June quarter, we also have Part of our revenue recognition policy is that when we ship to new customers, we have to go to acceptance to demonstrate We can set our tools or meeting specifications around reliability and matching and so forth. And there are some shipments that we shipped at the end Q4 and we're shipping in the March quarter that are aligned with a couple of projects for new customers where the fabs are opening late quarter. So our ability to get those acceptances and complete that process could be potentially constrained. So we'll see that revenue shift into the June quarter.

Speaker 1

Once get the established performance, then that revenue happens at shipment going forward with that customer. But we do have some unique dynamics that are affecting us here in the first half. So it does give me some comfort about the sequential growth guidance as we move into June. But it is affecting what we ultimately guided for the March quarter consistent with our revenue recognition policy.

Speaker 4

I appreciate the insights there. Your total process control Systems business outgrew WFE yet again, right, in calendar 'twenty three. Within that, inspection significantly outperformed, right? It was Only down 5%, but your patterning business was down almost 20%, which is actually worse versus WFE, right? And it looks like Most of that full year underperformance was due to the sharp drop off in Patterning just in the December quarter.

Speaker 4

So was that Tied to the customer push out dynamics as you mentioned or is it just the lumpy shipment trends in patterning? And I guess do you guys expect Process Control Systems business to outgrow WFE this year?

Speaker 1

Yes, great question, Harlan. I think If you think about our business and the composition and how it

Speaker 2

moves with customers, inspection, especially

Speaker 1

the leading edge inspection, is much more tied to development of new technology, whether it's in pilot or even ramp. And some of the metrology business is more tied to capacity. So when you see a fall off of capacity, it impacts metrology more than it

Speaker 4

would impact inspection. And that's what

Speaker 1

we saw in 2023. Hey, Harlan, it's Brad. On the relative perform, we do feel pretty good about the performance overall when you think how much legacy business was in the year and how the leading edge fell off, which typically drives higher process control intensity. Also in WFE this year, it was a little unique in that there was a lot of carryover WFE from 2022 for a number of peers. And so that showed up in 2023.

Speaker 1

It was really activity that we started in 2022. So when you take into account those factors and look at how well we performed in 22 relative to the overall market,

Speaker 2

but we were our growth rate

Speaker 1

was 4x what the market was. The fact that we're mostly I think in line maybe a little bit better than the overall market in 2023 is I think a pretty good indicator of the growing process control intensity We're excited about here, Kayla.

Operator

Thank you. Our next question will come from Joe with Wells Fargo.

Speaker 5

Yes. Thanks for taking the question. I just wanted

Speaker 4

to go back to the push out. So Just so

Speaker 5

I understand, if we were to adjust for the couple of $100,000,000 that's now pushed into the June quarter and assumed it was still in the March quarter, I guess, would you still expect that the June quarter would be up quarter over quarter or would it be more flattish like we were thinking or talking about Last quarter, just the first half kind of still being a similar run rate of the business?

Speaker 1

Yes, I think it's more the latter, Right. We've obviously, you've got a lot of moving parts and how it affects the quarters. But as we had talked about last quarter, we saw the business Generally continuing at guided level. Guidance was 2.4.5.0, right weighted up outperforming by 40 $1,000,000 or so. So it would have been probably flattish more or less.

Speaker 1

But this adjustment coming out obviously has the kind of impact and I cited earlier, so flattish and then we would expect to see the second half start to improve

Speaker 4

That's helpful. And

Speaker 5

then just as a follow-up, I know you're going to you'll file your 10Q probably tomorrow, but any color on where the RPO stood actually in the quarter?

Speaker 1

Yes. So RPO was down about 200,000,000 I expected you to ask that question, Joe. So yes, dollars 200,000,000 quarter to quarter and About 50% of so that takes you to about $10,600,000,000 45% to 50% of it to ship beyond 12 months. And then within that, we have about just short of $800,000,000 in customer deposits.

Operator

Thank you. Our next question comes from C. J. Muse with Cantor Fitzgerald.

Speaker 6

J. Muse:] Yes, good afternoon. Thanks for taking the question. I guess first question, can And your thoughts on how that progresses in 2024? And I guess with mix shift to perhaps Maybe incrementally more DRAM and I don't know in terms of the really core legacy, some shifts there.

Speaker 6

How you're seeing your kind of implied market share in 'twenty four versus 'twenty three?

Speaker 1

So for China, CJ, I think overall for China looks pretty flattish year to year. We did benefit from the infrastructure investment that I talk a lot about over the course of the last year or so. I would expect that part of the business to come down Some as some of the digestion is happening more so on the wafer side than the reticle side. And so that obviously will get made up by what I would expect to be slightly higher foundry. I think the memory piece will shift to potentially shift to another So I could see that being flattish overall.

Speaker 1

So feel pretty good about the trajectory of China. There is some lumpiness given our ASPs. I think through the year, it will be relatively consistent across the quarters, notwithstanding the timing of certain fab projects and construction schedules complete and so on. And then I think we'll start to see the percent come down as we move into the second half as you see other customers drive our expected growth as we move through the second half

Speaker 2

of the year? What was the second question?

Speaker 6

No, you covered it. I guess for my follow-up, as you think about kind of second half stronger than first half, How would you kind of rank order leading edge foundrylogic versus DRAM in terms of the key drivers for you?

Speaker 1

I think leading edge will be we'll see some growth in the year. It will be, I think, Fairly modest growth as we continue through the year. I would say I'm just kind of looking quickly here. I would say that It is reasonably balanced across the year. So I would think that we'll see I would expect to see DRAM probably be actually, I think it's going to be pretty balanced as well from a leading edge DRAM point of view.

Speaker 1

So I think it's pretty balanced on both fronts. And then just ticking up a little bit as you move into the second half. Thank you.

Operator

Our next question will come from Krish Sankar with TD Cowen.

Speaker 7

Hi, thanks for taking the question. I have 2 then 2. One is, I was just kind of curious, Rick, if you can kind of give color on how to think about China revenues this year ex EPC?

Speaker 1

Well, Brian just covered that, but in the last question, but essentially flattish. I mean, that's the general view for China this year. Flattish, a little less infrastructure than we saw, especially in wafer, reticle continues to remain reasonably level at

Speaker 8

Got it.

Speaker 7

Got it. And then just as a quick follow-up, If I look at kind of like very optical inspection, it's and you said that revenue should start improving over time. Where is the Lead times today for them today versus let's say 3 months or 6 months ago and where do you expect them to go over the next few months?

Speaker 1

Yes, I'll start on that one. On optical inspection, so we're still constrained on Gen 4 In terms of demand relative to our supply, I would expect to see supply increase this year. And that's part of our business.

Speaker 2

I would Expect to

Speaker 1

do better than overall market as we move into 2024. We have right now, I think we've seen the normalization around Gen 5 lead times, which tend to be somewhere between 7 9 months. The Gen 4 is still out over a year or so, but new capacity coming I think not enough for what we expect over the next year to year and a half, But then we have another tranche of capacity that will come in line as we move into the 'twenty six time frame. So we feel pretty good about what we have in terms of overall capacity both within KLA and our facilities, but also within our supply chain to support the growth that we expect as we move into 25 with more meaningful WFE growth and then as we target the 2026 financial plan that we laid out back at our Investor Day in 2022.

Speaker 7

Thank you very much.

Operator

Our next question will come from Brian Chin with Stifel.

Speaker 4

Hi there. Good afternoon. Thanks for letting us ask a few questions. Maybe just someone might have tried to ask this earlier in the queue, but taking your WFE sort of outlook for Flat to modest based on your 23 base level, flat to modest growth this year. Relative to sort of the pickup in maybe your revenue and WFE being sort of in the second half, they're kind of modest, right?

Speaker 4

You probably would need to see an acceleration in the back quarters of the year in order to kind of get to say even towards the mid below to mid single digit kind of growth that you're talking about for WFE at the moment. So I'm kind of curious, do you see Process control intensity, is that the profile spending this year sort of neutral in terms of WFE? Do you think intensity is higher, lower relative to Again, that profile staying this year and then how is that reflecting your revenue?

Speaker 1

Yes. No, you're right in terms of the math, right? As we look at the first half of year, which is, we'll call maybe slightly down versus the second half of twenty twenty three and then an acceleration in the second half, which puts you somewhere in, I'll call it, high single digit growth. That assumes that WFE is marginally up more or less from 2023. And so against that backdrop with slight improvement in memory, I would expect our process control intensity to be roughly flat.

Speaker 1

So we were in the $7,000,000 depending on your WFE number, but assuming $87,000,000,000 to $88,000,000,000 of WFE in 2023, about 7 0.6% or so. So I would expect it to be similar as we move into 'twenty four. And as we back to see more growth in leading edge investment as we move into 2025, then we'll start to see favorability in terms of leading edge dynamics that tend to drive our business and higher process control intensity overall. So I think that's how to think about it right now.

Speaker 4

Okay. Thanks. And then just given that emphasis this year on memory conversions and upgrade activity, Can you comment on the areas where KOA benefits and how meaningful a benefit that this sort of spending represents?

Speaker 1

You mean in terms of just where we benefit in memory investment, where we expect to see? I mean, certainly, you've got the DRAM with more DRAM investment, with the introduction of EUV, that tend to be a positive dynamic for our business. We saw process control intensity increases as we saw EUV introduced into DRAM. So that's probably one of the bigger positives for us. So you're right, as you start to do technology conversions instead of new capacity of being a little bit more muted investment, But we would expect to see our customers continue to invest

Speaker 4

in the in

Speaker 1

their leading edge development or for the next nodes. So I think that will be the biggest driver for our business.

Speaker 4

Okay. Thank you.

Operator

Our next question will come from Chris Caso with Wolfe Research.

Speaker 5

Thank you. Good evening. I guess the first question is kind of looking beyond the 2024 and obviously don't expect you to provide any guidance there, but Take any opinion that you have. Some of the other equipment suppliers that have had longer lead times, we're starting to A little more confidence on a turn on 25. I don't expect that you've seen that in your order book yet, but interested to see what your customers may be talking about?

Speaker 1

It's a great question and we have definitely had those conversations. Think that customers are looking at from a couple perspectives. 1, we do have long lead on the most advanced optical tools. But there's also a lot of development that we're doing right now to make those tools even better for the advanced logic ramps that are coming. So we're actually engaged quite a bit in R and D and in pilot with those customers.

Speaker 1

So we have a pretty good sense. They're all Bullish about 25%. I can't think of a customer we have on the leading edge that isn't bullish about 25%. But as you say, we're not going to see the orders for those yet, but we're certainly having those conversations. But more importantly, we're seeing the discussions happen around capability that we're demonstrating as they do pilot.

Speaker 1

The other thing is we're seeing a trend toward more designs. And we talked about this for the past several years. One of the leading indicators for us is the advanced designs because that's an indicator of how broad a node is going to be. And we're seeing continue and that will drive both radical business, but also is a good leading indicator for the strength in 2025. That's why one of the objectives for the company is to prepare for growth in the bleeding edge because that's what we believe will happen over the next 24 months.

Speaker 1

As Brent indicated, not the next 6 months, we should start to see the green shoots of that toward the end of the year and then we'll see it in 2020 5% is the way we're modeling the business and our investment right now.

Speaker 5

Got it. That's very helpful. As a start up, with With regard to the foundry logic business, would you characterize and I guess what you talked about in your WFE assumptions is some kind of slight growth this year. Is it safe to say that that growth is either tied to new node deployments and kind of technology upgrades and such as opposed to capacity at this point?

Speaker 1

It's a little bit of capacity too. I mean, 2023 was down, right? And so we're seeing some expansion of capacity. The big node ramps aren't really happening as much this year, which is part of why the WFE gets driven up. And you heard TSM's call and I think they're fairly bullish on their forecast, but we'd have to see what happens in The early parts of 2025 for those ramps on especially the newest technologies.

Speaker 1

And we would expect the legacy business non China to be lower in 'twenty four than 'twenty three. So there's so it's being offset. You've got some improvement with the leading edge investment offset by some of the non China legacy falling off a bit. So that's how we get to our forecast. And we'll see as we start to we're having these conversations with customers.

Speaker 1

We're certainly planning for it from a capacity point of view and we'll see as we progress through the year as we start to firm up when those shipments will actually start to take away.

Operator

Thank you. Our next question comes from Joe Moore with Morgan Stanley.

Speaker 5

Great. Thank you. You talked about memory utilization remaining low. And I guess I feel like you guys kind of talked about that relatively And then you saw it kind of static. We've heard from memory customers all kinds of things about different times that they brought it down.

Speaker 5

It's like someone brought it up. I just want to confirm that you're seeing that as kind of a steady trend. And then can you talk about how that affects your the services revenue you can get from those guys?

Speaker 1

Yes. But having met with a number of memory customers recently, there's a marked difference in their tone right now. And so when we talked to them last year, there was a lot of downcast looks about them because they had been ready for a much bigger consumption of memory. And now I think they're starting to turn the corner on that. We do see conversion technology, but utilization is hasn't really changed much.

Speaker 1

Service continues The higher than historically, our utilization rates on our equipment are higher than historically. But Because I think customers, even those that have the ability to flex down their utilization on our systems, have chosen not to. And so that's been a real strength for us and why services for KLA did so well in 2023 and we expect that growth to resume to the numbers we targeted a couple of years ago for 2024 and beyond. So I'd say the posture is different and we're going to we expect to see that continue to strengthen throughout the year. Yes.

Speaker 1

The customers don't have the same level of redundancy with what they buy from KLA versus a lot of process equipment. And when you're focused on trying to be as efficient with your capital as you can, You'll tend to really focus on trying to drive yield. So the way they buy process control, they don't buy a lot of extra. So if they take capacity offline For process, they tend to run process control much more consistently. The customers that cut more in terms of utilization earlier have come back more.

Speaker 1

I think overall, to Rick's statement, it's been fairly flat overall. I think DRAM has tightened a bit because of some of the AI drivers for that. But on the flash side, I think it's been fairly stable. And like I said, some improvement from folks who cut more aggressively early on.

Speaker 3

Thank you very much.

Operator

Our next question will come from Atif Malik with Citi.

Speaker 3

Hi, thank you for taking my question. And then you talked about strategic alternatives For the display business, can you help us out how big the display business was last year? And then in general on the EPC business, there are kind of Also, it's time to mobility is getting better. Can you just talk about how you're looking at the EPC business, excluding display?

Speaker 1

You're breaking up a little bit there, Atif. So in regards to the comments on Display, it's about 1.5% of the revenue of the company. And is there parts of display are more commodity based and there's aspects of that industry structurally where profitability is more challenged. And then there's some interesting parts of it too in terms of some of the future road map opportunities and where some of the higher end customers, customers are moving. So a lot more to say about that as we assess The alternatives we're considering.

Speaker 1

The rest of EPC is kind of a tale of 2 businesses overall. The Semiconductor business has done exceptionally well, as we talked about in the shareholder letter, really outperforming WFE overall, I think it's a combination of customer engagement, more applications, new products. So we're really pleased with where we're performing there and the ability to differentiate. And I would expect that to be roughly flat and with some mix shift. It has some diversity in terms of end markets between automotive and mobile and advanced packaging.

Speaker 1

So you could see a shift where automotive weakens, we'll see more investment on the advanced packaging side. So we're pretty positive on that. IQOS, we're already starting to see some improvement there, which tends A little bit of a leading indicator in terms of finished components. And so we're more optimistic about how that will translate back into the other parts of our business, Given that that's a short lead time more capacity centric business, so again back to our views of some improvement as we move into the second half. PCB has been more mobile centric in terms of and more consumer markets, more capacity centric.

Speaker 1

So that business has been weaker, but I would expect it to be a little bit better this year as well. And there are some product offerings that we have coming that start to take advantage of opportunities at in PCB and substrates as those integrate into Energenius packages. So we expect the APC business overall to be up, we'll call it mid to maybe high single digits, a little less lead time over there. So a little harder to forecast off of the year we had in 2023.

Speaker 3

Great. And then as my follow-up, Rick, You talked about uncertainty in leading edge with some push out. If your foundry customers decide to focus more in putting these Investments of fabs in Japan versus U. S, is there an impact to your business?

Speaker 1

Well, the work that they're doing in Japan is not at the leading edge, but it is part of their overall investment with the

Speaker 4

exception of the Japanese company

Speaker 1

that's investing there. So I would say, company that's investing there. So I would say, yes, of course, that's a different kind of business for us. It's important. But the leading edge business that's being done in the foundries isn't being done there right now, with the exception of 1.

Speaker 1

So We're talking about the what we're seeing and hearing is the development is going on for the leading edge work. The question is At what point will they be in a position to ramp that? So we've the reason we're confident of the growth that's coming is because of the engagements we've had, the design starts that we see and the plans that we know that they've been discussing. So we feel pretty good about the setup as we go toward the end of the year and into next year.

Speaker 5

Thank you.

Operator

Our next question will come from Charles Hsie with Needham.

Speaker 4

First off, I really want just want to ask for some clarification about the service business expectation for calendar 20 I think you talked about higher forecasted growth in service. Is it higher than what you thought, the top 14% this year? Or you're just talking about higher growth than compared with your systems business. Just a quick clarification. Thanks.

Speaker 1

Yes, more in line with the long term target model of 12% to 14% and closer to the high end of the target range. And that's really being driven by we talked about some of the improving utilization that we expect to see as we move through the year, which as you think about as their businesses get better, they have more demand, they start to consume the capacity they have, they have sustainability in that. And then as their profitability improves, then they to invest in new equipment. So we would expect to see that play through as we move through the year. But we also will start to benefit from the tools that we shipped in 2021 2022 as they move from warranty into contract.

Speaker 1

And so that should be a driver for service growth as we move into next year. So We'll be back in line with the overall target model in terms of how we're planning for the business next year. The great thing about service is This growth that happens pretty continuously, it does have a little bit of a dilutive effect on our overall margins, which is one of the factors in in the 24 gross margin color that I provided. So even if we would expect to see revenue increase a bit, I do think that you'll see a little bit of pressure margins. Now it tends to be based on the way we do the accounting accretive to operating margins.

Speaker 1

So it's At that level, it's pretty positive, but it does have an effect on the puts and takes within gross margin.

Speaker 4

Thanks, Bren. Maybe another question, maybe a little bit longer term. I think in the past, you talked about, particularly some of your leading edge Customers reusing their capacity in the past may put a little bit pressure a few cycles ago on your overall growth. Your largest customer, I think, last week, you talked about maybe converting some of the 5 nanometer to 3 nanometer. We don't know Whether they're going to continue to do that, but any thoughts there and looking a little bit ahead, do you you expect any sort of a negative impact going forward?

Speaker 4

Thanks.

Speaker 1

You're right. I mean, historically, customers have always Trying to reuse whatever they could. There's a couple of factors that impacted going forward. 1 is technology that they're going to need for 3 and then for 2 is upgraded from what they have at 5. And the second one is they still have volume at 5.

Speaker 1

So The question will be historically when this was the most pronounced was when there was

Speaker 2

a great fall off in existing node going to a new node.

Speaker 1

So in our conversations with them and our modeling of it, we see it pretty consistent from what we've seen in the last few years, not as high as the reuse was several years ago. But that factor drives us to continuously provide more capability in the tool to give them incentive to go to the new technology or to upgrade the existing. So there's nothing specifically new about this upcoming Next generation of new technology, but it is definitely something customers are always trying to optimize their footprint.

Operator

Thank you. Our next question will come from Timothy Arcuri with UBS.

Speaker 6

Thanks. Brent, I wanted

Speaker 9

to ask about book to bill. So, it's below 1 for the 5th quarter in a row. It's up a little bit. It's up to like 0.9. So you're reaching some sort of like steady state, but it's a much different dynamic what's sitting in RPO than what used to sit in backlog because you used to have 4 to 5 months worth of backlog.

Speaker 9

And now if you assume half of the stuff is parked outside of 12 months and half is inside of 12 months. I mean, it's not, I guess, that different than it was before, but you still have this 5 $1,000,000,000 plus it's parked beyond 12 months. And that was never there before. So as we look pre COVID and post COVID, What changed? Why is there this $5,000,000,000 worth of bookings or RPOs just parked beyond 12 months?

Speaker 9

Because It isn't like your lead times have gone out that far. And I understand that with those long lead times, but with those always been long So what's kind of changed for you?

Speaker 1

Yes. No, I think the easiest way to think about that part of it is it's related to Customers giving orders that are tied to facilities that they're planning, greenfield projects. And so the schedules are driving the orders. And so it's one of those where it isn't lead time centric. The customer has a project that's going to open in 2025.

Speaker 1

They want their tools when they have that scheduled planned opening. And so they've given us orders. In a lot of cases, you have some China business where you've given us orders and deposits that are tied to those schedules. So that's the biggest factor in the piece that's out. And you're right, it is a bit of a new phenomenon.

Speaker 1

I think that we started to see after the massive ramp that we saw from 2019 to 2022 or so. So And each quarter has been pretty consistent. And we've been keeping up a certain amount of that backlog every quarter, but it's been pretty consistent and it's been roughly 50% or so. So in the quarter we just completed, if you notice, if you look at the balance sheet, you'll see the deferred systems revenue is actually a little bit higher and that's related to the dynamic I talked about earlier where shipments were higher than revenue levels and that drove down the RPO. But the book to bill relative to the revenue was actually positive.

Speaker 1

So but I don't think that changes the nature of your question in terms of the trend line. It was a little bit better, more consistent kind of consistent with what we thought and a little bit positive in the December quarter.

Speaker 9

Yes. I mean, it got it was up, definitely. But I guess just my follow-up on that What's the advantage if I'm that customer and if your lead times are well inside of that, what's the advantage if I'm a Chinese customer to booking something that's going to sit in your backlog or be put partly on 12 months. I mean, unless I'm worried about export control and maybe think because I have something, I've given you a down payment that entitles me to get the tool. Like is that part of it?

Speaker 9

I still don't know why I would park something like way, way beyond your lead times?

Speaker 4

Well, if

Speaker 1

you're a new customer and you have new relationships with us, The demonstration of credibility in terms of, hey, we want this, we want to engage, we want you to put resources in place to support the FAP and that takes some time to do so. And then in a lot of cases that also comes with deposits for a portion of the orders. So I think it comes down to you don't want if you're one of those customers, you want to ensure that when fab opens that this isn't a bottleneck or an obstacle to your ramp in your plan. So And in a lot of cases, if they're newer customers to us, these aren't our I wouldn't say that the customers you know are booking orders that far in But there are certain customers that want to make sure that we're prepared to support their plans. And so they give us orders to ensure that they're credible on those lines.

Speaker 9

Well, that's a ton of customers that

Speaker 4

you actually never heard of before. So okay, okay, Brent. Thanks.

Operator

Our next question will come from Toshiya Hari with Goldman Sachs.

Speaker 8

Hi, thank you so much for taking the question. I have 2 as well. The first one is on high NA. There seems to be A bit of a disconnect among some of your customers in terms of, I guess, their appetite to take tools and Developed using those tools. Curious how you're thinking about potential insertion of high NA over the medium to long term?

Speaker 8

And how should we think about the positive impact to your business from an intensity standpoint?

Speaker 1

Our views haven't really changed in terms of the I mean for I and A, we're encouraged to see the shipments of the tools that were well publicized and I think that's great. It is going to take a while, of course, as with any new technology to get those up and into production. So really haven't changed in terms of our view of when that turns into pilot and then when it

Speaker 2

turns to the high volume. But

Speaker 1

one thing that's clear is the increased adoption of EUV is good for KLA and the broadening of it As we see it being more applicable in memory, also creates more opportunities, not only just in the reticle space, but Because we're now dealing with the defectivity challenges are greater as they start printing smaller features, it drives Both the number and intensity of the tools that we need, but also how they're run. So you need to run, For example, a BBP tool at a higher sensitivity, which as you know requires we keep capability, but it does require more capacity to cover the same amount of silicon to support that. So it's a very good trend for process control and ones that we're encouraged by. But from our standpoint, no change, which I guess is really good news because If we look back at EUV, it did delay several times. High NA seems to be on track with the schedule that has been out there for some time now.

Speaker 8

That's very helpful. Thank you. And then as my follow-up, maybe one for Bren. Just on the display business, so 1.5% of revenue last year. I'm curious if you could speak to the profitability of that business.

Speaker 8

I mean to the extent you do end up say selling the business, How should we think about accretion to gross margins and bottom line earnings? Thank you.

Speaker 1

Yes, profitability is less than 1.5 1.5% of KLA. So it's 1.5% of revenue, the profitability is less than 1.5% of KLA profitability.

Speaker 8

Okay. I figured that much, but thank

Operator

All right. And we have no further questions in the queue. So I'll turn the floor back over to Kevin Kessel for any additional or closing remarks.

Speaker 2

Thank you, Chelsea, and thank you again everyone for your time. We know it's a busy day of earnings, a busy week. We appreciate it. We'll be in touch with All of you over the coming days weeks. And with that, back to you, Chelsea, to provide any final instructions.

Speaker 2

Thank you.

Operator

This concludes the KLA Corporation December 3, 2023 Earnings Call and Webcast. Please disconnect your line at this time and have

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KLA Q2 2024
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