KLA Corporation (KLAC) Earnings Call Transcript

Good afternoon. My name is Stephanie, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the KLA Corporation September Quarter 2026 Earnings Conference Call and webcast. [Operator Instructions] I will now turn the call over to Kevin Kessel, Vice President of Investor Relations and [ Analytics ]. Please go ahead.

Welcome to the September 2026 quarterly earnings call. Joining me are our CEO, Rick Wallace and our CFO, Bren Higgins, we will discuss today's results as well as our outlook, which we released after the market close, and it is available on our website along with supplemental materials. We are presenting today's discussion and metrics on a non-GAAP financial based unless otherwise specified. All the full year [indiscernible] we make always refer to calendar years. The earnings material contains a detailed reconciliation of GAAP to non-GAAP results. Our comments today are subject to risk and uncertainties reflected in the disclosure of the risk factors in our SEC filings. Any forward-looking statements, including those we make on the call today, are also subject to those risks, and KLA cannot guarantee those forward-looking statements will come through. Our actual results may differ significantly from the projected in our forward-looking statements. For any subsequent updates, please refer to KLA's IR website, which also contain investor events, presentations, corporate governance information and links to our SEC filings. We will begin the call with Rick providing commentary on the quarter and our overall business environment, followed by Bren with financial highlights and our outlook. I'll pass the call now to Rick. Rick?

Thanks, Kevin. KLA's September quarter beat the midpoint of our guidance ranges across all key metrics. Revenue was another record $4.14 billion. This, coupled with our December quarter revenue guidance of approximately $4.7 billion demonstrates the growth acceleration we planned for the second half of 2026. KLA's performance in the quarter was supported the continued strength in leading-edge foundry/logic related to AI infrastructure investments and increasing process control intensity across leading-edge devices and advanced packaging. Other highlights for the quarter include KLA operating margins above 46% of the first time ever. Gross margin was 62.7%, and free cash flow was $1.34 billion. Over the course of calendar 2026, the AI demand environment has continued to strengthen as reflected in our performance. Additionally, our strong customer engagement has provided visibility into a more favorable outlook for wafer equipment investment for calendar 2026 and 2027. We see this reflected in our growing backlog and sales funnel forecast. We expect momentum across our business to continue into the December quarter and we're positioned to deliver significant growth in calendar 2027. We have been proactively working with our strategic supply chain partners over the past year to keep up with our demand. Advanced packaging remains increasingly critical to AI infrastructure expansion and advanced packaging road maps continue to incorporate more sophisticated wafer front-end processes, which drive additional process control requirements. KLA's leading process control portfolio enables the company to address these requirements across a growing range of applications. For calendar 2026, advanced packaging process control systems revenue remains on track to hit approximately $1.1 billion or more than 70% year-over-year growth, nearly twice the growth rate of the advanced packaging market. The growing complexity of KLA's installed base and lengthening tool life cycles continues to increase demand for services. KLA services revenue was $850 million in the quarter up 14% year-over-year, supported by a growing installed base and continued customer focus on tool performance, productivity and availability in this tight system utilization environment. Finally, KLA's process, PCB and component inspection businesses are also benefiting from technology transitions and the rigorous performance requirements of high-performance computing. In summary, KLA is experiencing strengthening momentum driven by growth across the semiconductor ecosystem. Pace of our backlog growth is a key signal of accelerating momentum and provides confidence in our visibility into calendar 2027. Our September quarter results demonstrate the strength of KLA's market position and operating model execution. Semiconductors continue to play an increasingly important role across global industries with growth driven by investment in AI infrastructure and expanding demand across a broader range of applications and markets. Together, these trends are supporting stronger and more durable and more diversified long-term growth for the industry. Additionally, the growing complexity of AI-enabled semiconductors is increasing process control intensity throughout the manufacturing flow, reinforcing KLA's long-term growth opportunity. KLA's differentiated portfolio is uniquely positioned to address these requirements, while sustained AI data center investment and broader adoption of advanced packaging architectures continue to expand the company's addressable market. As we look ahead, we remain focused on supporting customer road maps, investing in innovation and scaling our global capabilities to meet expected demand growth through calendar 2027. As we progress toward our 2030 target model we remain committed to disciplined execution, technology leadership and our proven capital allocation strategy and create -- which will allow us to create durable shareholder value. With that, I'll turn the call over to Bren to discuss the quarter's financial highlights.

Thank you, Rick. KLA delivered strong sequential and year-over-year growth in the September quarter. For the first time in our company history, KLA delivered operating margins over 46%. Our market leadership and disciplined execution, supported by our global team's dedication and focus on customer success. Revenue of $4.14 billion was above the point of guidance and rose 13% sequentially and 29% year-over-year. Non-GAAP diluted EPS was $1.22 and GAAP diluted EPS was $1.18 and each above the midpoint of the respective guidance ranges. Gross margin was 62.7%, slightly above the midpoint of the guidance range. Operating expenses were $688 million including $395 million in R&D and $293 million in SG&A. Operating margin rose 240 basis points sequentially to 46.1%. Net income was $1.60 billion, GAAP income was [ $1.5 billion ]. Cash flow from operations is $1.53 billion, and free cash flow was $1.34 billion. The company had [ 1.311 ] billion diluted weighted average shares outstanding for the quarter. The breakdown of revenue by reportable segments and markets, major products and regions, can be found within the shareholder letter and slides. Moving to the balance sheet, KLA ended the quarter with $4.7 billion in total cash, cash equivalents and marketable securities and $5.95 billion of debt. The company maintains a flexible and attractive bond maturity profile supported by investment-grade ratings from all 3 major rating agencies. The industry outlook continues to strengthen, with visibility improving as customers increase long-term investment plans. Despite these [ flat space ] limitations, customers have been very resourceful and are accelerating delivery expectations across all segments. We are, therefore, raising our expectation for the wafer equipment market, including advanced packaging to approximately the mid-$150 billion range in calendar 2026. KLA backlog continues to grow, and our sales tunnel visibility is unprecedented, supported by new fab investments by a broad base of customers. We continue to plan for significant growth in calendar 2027. While we'll have more to say about market and customer segment expectations for next year in our earnings call in late January, we currently expect the wafer equipment market to exceed $200 billion in calendar 2027. Customer engagement remains robust with numerous new fab projects and greenfield facilities scheduled to come online in the quarters ahead. The primary area of focus for our customers is on delivery urgency aligned with new project plans. Against this backdrop, KLA's business momentum and critical role in leading edge process control positions us to deliver accelerating growth for the remainder of calendar '26 and continuing into 2027. Our expectations of revenue growth acceleration in the second half of '26 are playing out as more capacity comes online in our long lead time supply chain areas. This is resulting in growth in the second half of calendar year '26 over the first half of approximately 25% and positions the company for continued sequential growth into calendar 2027. KLA's December quarter guidance is for revenue of $4.7 billion, plus or minus $200 million. Foundry/logic revenue for semiconductor customers is forecasted to be approximately 60%, and memory is expected to be about 40% of semiconductor process control systems revenue to semiconductor customers. Within memory, DRAM is expected to account for approximately 84%, with NAND representing the remaining 16%. As a reminder, these business mix approximations pertains solely to our semiconductor customers and do not fully reflect our total semiconductor process control systems revenue. Gross margin for the December quarter is forecasted to be 62.5%, plus or minus 1 percentage point. While the company is demonstrating expected operating leverage across the business as it grows, this being offset by persistently high memory costs for our system image processing requirements as we have discussed in prior quarters. We are actively engaged across the portfolio to optimize memory efficiency in our systems along with other product cost reduction initiatives. These efforts, coupled with driving our usual returns-based value sharing with our customers should offset this headwind over time. Operating expenses are forecasted to be approximately $710 million in the December quarter. We will continue to prioritize next-generation product development scaling our business execution and company infrastructure investments to support expected revenue growth over the next several years. And we anticipate these expenses to grow sequentially through 2027 but at a much slower pace than revenue growth and consistent with our business model for operating margin leverage. As a reminder, our business model is designed to deliver 40% to 50% incremental operating margin leverage on revenue growth over the long run. Other model assumptions include other income and expense, debt of approximately $25 million spent for the December quarter, and we expect it to remain at approximately this quarterly level. Planning tax rate is 14.5%. Our tax rate will vary quarter-to-quarter due to the geographic distribution of profit and various discrete items. The December quarter, non-GAAP diluted EPS is expected to be $1.44 plus or minus $0.11. And GAAP diluted EPS is expected to be $1.41 plus or minus $0.11. EPS guidance is based on a fully diluted share count of approximately 1.306 billion shares. In conclusion, process control and KLA in particular, remain critical to the AI ecosystem build-out and benefits from numerous ongoing relevance inflections, including increases in leading-edge designs across foundry and logic, device size and value, rising complexity and performance requirements and the growing importance of advanced packaging. KLA is experiencing strengthening momentum and a broader set of growth drivers across the semiconductor ecosystem. The rate and pace of our backlog growth is a key signal of our accelerating momentum and increased confidence in our visibility leading into calendar 2027. Our September quarter results demonstrate the strength of KLA's market position and operating model execution and support continued confidence in our performance moving forward. These recent results also illustrate the strength of KLA's market-leading portfolio, disciplined operating model execution and continued confidence in improving our performance moving forward. Looking ahead, we remain focused on supporting customer road maps, investing in innovation and scaling our global capabilities to meet expected demand growth throughout calendar '27 and beyond. As we progress towards our 2030 target model, we remain committed to disciplined execution, technology leadership, our proven capital allocation strategy and creating durable shareholder value. That concludes my prepared remarks. Kevin, please begin the Q&A. .

Operator, can you just give the instructions, and we'll get started.

[Operator Instructions] We will now take our first question from Jim Schneider with Goldman Sachs.

Good to see the accelerated growth in the back half. Relative to calendar 2027 in your view of $200 billion in WFE, obviously, you have some good things going for you with advanced packaging growth and so on. So can you maybe kind of articulate how you're thinking about the way calendar '27 shapes up and your level of confidence that you're going to be -- your ability to outgrow that 30% rough market number for 2027?

Jim, thanks for the question. When we look at 2027, and we've been saying this for quite some time as we think the construct for '27 sets up pretty favorably for us. First, we feel very good about our supply situation, right? We've been working at it for the last 12 months. We indicated we see an acceleration in the second half. Certain components [indiscernible] have very long lead times. And so getting that to come online was a bit of a challenge in the first half, and we're seeing that play through, and that certainly informs our confidence in the December quarter, but also our views into '27. The setup for 2 even around the leading edge, both in terms of the breadth of investment the lead edge, new node investment. We think that sets up very well for the company, greenfield investment in DRAM. The HBM dynamics and how that's affecting process control intensity. We're also seeing uplift in process control intensity and conventional memory. Advanced packaging has been a nice growth driver. I don't see any reason why as we look at next year that, that part of our business wouldn't continue to grow faster than the market. So we feel overall that the setup is very leading edge centric. Packaging is augmenting the growth, and we think we're well positioned, and our supply should be there to be able to enable us to meet the demand. Demand is strong. I would say that we're -- I'm still behind in supply, but I still -- I think that the trajectory is good, and we feel pretty confident about the guidance we've given.

Sorry. And sorry, just one quick follow-up. As you think about the way the shape of 2027 starts to materialize, anything to call out in terms of the back half of 2026 was certainly much stronger than the first half. Do you think it's going to be more ratable through 2027? Or you get, again, maybe being a little more back half loaded?

Right now, it's in the next several quarters, given the backlog growth and the visibility in the funnel that we'll see sequential growth for the next several quarters? Sort of implied second half stronger. I think it's more linear. I won't have the same, I don't think, as of now. The same significant uptick in half-to-half growth, it looks a little more linear to us, but we would expect sequential growth moving forward.

We'll take our next question from Harlan Sur from JPMorgan.

On the gross margin front, I know the team had some cost headwinds this year. Memory pricing headwinds, maybe GPU, CPU pricing headwinds as well. Moving into next year, I know the team has benefit of new platforms, which carry higher pricing? Obviously, you're going to be driving higher volumes, maybe you've got other value pricing initiatives taking place. Can we expect the team to buy back into that sort of 63% plus range on a strong WFE outlook in 2027?

Yes, Harlan, it's a good question. As you said, there are some new parts in it. When you look at the target range, right, our target range that we outlined back in March and Investor Day was 63% to 64%. Certainly, some of the cost inputs have been challenging. We're doing a lot of work inside the company, both in terms of broader input costs but also memory, I'll call memory optimization work in terms of our use of memory in our systems. There'll be some mix dynamics looking forward, right? We do have more advanced packaging growth. We have growth in our non-semi PC businesses. So that tends to be a bit of a headwind to the overall margin, although contributor to both revenue growth and gross margin growth. Scale will offset some of that. We'll see some manufacturing scale given the strong revenue growth environment. And some of our pricing initiatives, we think, similar to what we're hearing from peers, we think that, that will play through as we introduce new capabilities, and we're able to share in the value of those capabilities with our customers. So I think as we move forward, the memory environment will continue to be challenging. But I think as we go forward, we'll see improvement. I don't know exactly when we'll start to see it. But I think as we move through '27, certainly, as we move into the middle to the back half of '27 into '28 will be, I think, consistent with the operating model for gross margin that we laid out back in March.

I appreciate that. And then on the non-AI kind of more legacy node segments, auto, industrial, IoT, obviously, cyclical dynamics are strong. Supply is tightening at a very, very rapid pace. And we are seeing new capacity [indiscernible] has been announced since is this contributing to the strong growth outlook next year? And maybe what percentage of your process control systems business is mature and specialties.

Yes. I would say around power. I mean power is certainly something that is an area of focus in the industry and there was obviously -- there was a period of time where there was some overinvestment there, but I'm starting to see some indications of some recovery in that part of the market. Obviously, what's driving the business in a more significant way as everything related to high-performance compute. But when I look at the customers that we are serving, I do think that I'm seeing some improvement. So I think year-to-year, there's some growth. I don't think it will be at the level of what we expect from the leading edge. And you'll have activities in China, which will grow, but I don't think we'll grow -- we'll grow at a much slower rate. And so I think when you look at the overall legacy, I would expect to see some growth there. there. But the business is really being driven by what's happening at the leading edge. But I think that there's opportunities for us to augment growth moving forward from some more business in that part of the market. Process control intensity tends to be lower in legacy nodes. If an established node, it's fairly mature unless our customers are changing designs, or design rules or have new reliability requirements that could drive inflections in intensity. But the intensity levels in legacy are lower than what they are at the leading edge.

We will take our next question from C.J. Muse with Cantor Fitzgerald.

I guess a follow-up, Bren, on the gross margin side. If we isolate just to process control, you were north of 65% in June of '25. And obviously, as you've talked about, major headwinds from DRAM, in particular. But curious, as those contracts roll off and you kind of move to new contracts, should we start to see better pricing as you pass that incremental along? And is there kind of a time frame where you see process control getting back to kind of that mid-60s level?

On a consistent mix, I can see it trending there as we move into the second half of '27. We start to do deals around new products beyond the existing business that we have. It's very difficult to go increase prices on existing business and existing backlog. So I think as we move forward, I don't see any reason why assuming mix is consistent that we won't start to see some improvement in the process control part of the business apples-to-apples.

And also, C.J., Bren mentioned in the last answer, but I'm not sure you heard it was that there are -- there is work going on to utilize less memory in the systems engineering work, which takes some time to do it. But when we design these systems, nobody really imagined the kind of increase in memory costs. And I think the common response to that is to make the systems more efficient around using memory before that will drive that percent content down over time. It takes a while for those to get in.

Very helpful. And I guess as a follow-up, -- can you kind of talk about what you've seen in the last kind of 3 to 6 months from a lead time perspective and how that informs kind of your outlook into 2028? And how you're thinking about hiring and what kind of work specifically on the supply chain to get ready for this multiyear growth cycle?

Yes, C.J. The conversations we've had with covers the last few months have been very consistent in that there is a huge request that we prioritize their projects. And they're laying out multiple-year investment cycles with an expectation that will support them through those ramps. So when we look out at the 2030 model that we laid out before, obviously, the assumptions in that model are going to be exceeded before 2030. So there is a significant amount of investment that we need to do pretty much across the board with talent but also with facilities and our investment in supply chain. And so Bren can share some of his perspective on that.

Lead times, I would say, [ Lisa ], and they vary by product, but we're averaging right around 12 months or so. And I would say that on the margin, they're extending certain products, it can be even further out than that, for example, Gen 4 and Gen 5 product lines. will have longer lead time. So it does vary. But I think we're in a pretty good position, as Rick said, to support it. I mean, we're making investments across the board. We'll add head count, both in manufacturing and service in the volume-centric parts of the business and applications and engineering over the course of the next 12 months. We're investing in every factoring cap. And so there are expansion plans, not only near-term requirements and doing things quickly, but also supporting what we believe will be a multiyear investment cycle here. So we're encouraged by that in supply chain, particularly in those areas of long-term or long lead time items, particularly in the optics area, we are working with our key suppliers to make investments -- the investments show up in different forms, but also investing to support what we expect to be a very strong outlook over the next several years. So there's a lot of activity going on. Obviously, that flows through our numbers activity that's supporting future revenue streams. But we think that, first of all, contemplated in the model and the guidance we've given. But certainly, a lot of focus in those areas.

We'll take our next question from Timothy Arcuri with UBS.

Bren, you did a really nice job this year only losing like 20 basis points worth of WFE share despite what was a pretty bad mix actually. It sounds like you think WFE is going to grow like low to mid-30s next year. and your lead times are 12-plus months. So you know like exactly what you're going to ship next year. So are you going to grow more than that? Will you grow more than low to mid 30, so you'll grow so you're gaining share next year gain dilute share?

Yes, Timm, on '26. I think the second half momentum highlights where I think the business is trending now. I mean the first half was weaker. And wasn't so much mix of business as much as it was just our ability to supply it. The backlog is pretty significant. If I had -- I've been short all year, I'm short now. So I feel that as we look at 2027. We feel pretty good. I talked about the setup, which I think is encouraging, but we feel pretty good about our ability to maintain and drive the growing ALA relevant story that we outlined at Investor Day. The parts of the market that are inflecting are very good for process control, we think they uniquely benefit process control. And we think that, that as we are in a better position to supply and meet the demand that we can maintain the trajectory that we laid out. It doesn't mean it happens in every 6-month period or every quarter, but we think over time, similar to what we saw over the last 5 years, the next 5 setup is pretty strong. And we feel pretty comfortable about our views of share of market growth over the next -- between now and 2030.

So we think we can outgrow next year, Timm.

Got it. And then, Rick, I wanted to ask you about DRAM. So it's up like $450 million in December. I mean that's the plan. Your DRAM share is like 6% of WFE share. So that's like $10 billion of like DRAM WFE right there. Is there something unique going on? I know there's some big new fabs that are starting to get equipped. Is it as simple as that? Or is maybe your inspection intensity going up in DRAM. I mean that's just -- I mean I don't think I've ever seen you grow DRAM systems that much. So can you speak to that?

Yes. Intense definitely going up. I mean there's no question that we started seeing this a while ago, and I think it took a little while for our customers to fully understand and appreciate the challenges of making these advanced devices and given their supply shortages, the incremental value of yield. And so if you think back to how memory worked years ago, it's a pretty different world where anything they could squeeze out in terms of yield but also the performance expectations are much higher as these go into these mostly commercial operations. So yes, it's an intensity improving, and we see that continuing as we go forward.

I think the greenfield opportunity is also driving a retooling of fabs and retooling in a way where, to Rick's point, our customers' profitability levels are pretty high. And so yield is equivalent to printing money in some ways. So I think there's renewed focus there. I think that the road maps are driving the need for more investment, the performance requirements are more stringent, particularly when you look at like HBM, for example, and less redundancy, I/O counts, logic and base die, all these things are driving opportunities in this part of the market. In some products, we see intensity levels in DRAM that are similar to leading-edge logic. So the market is definitely shifting there. And I think the new fabs is an accelerant to our views of growth. If you look at the second -- in 2027, we expect overall memory to be about 60% of our -- of the business. And in an environment, where to Rick's point, we feel pretty confident about our ability to perform pretty well relative to the overall market. So it's definitely changing in terms of the way you used to think about the business historically and at least in terms of the DRAM impact.

We'll take our next question from Krish Sankar with TD Cowen.

I can follow up on the last question on DRAM. You said from [indiscernible] WFE next year. The 2 big drivers this year was design and leading-edge foundry, as will be the same next year. I understand -- so is this mainly because greenfield and DRAM is coming in and leading-edge foundry/logic is going to [indiscernible]. Others are 2 key early specific drivers for outperformance next year, besides advanced packaging? And then I have a follow-up.

So Krish, let me clarify. You're saying if the same drivers are the same, why would it be different? Is that your question?

I'm just wondering is the mix shift going from DRAM from brownfield greenfield and logic going from 3 to 2.

So I think -- yes, those are drivers. But the other thing is we just weren't set up in the first half to be able to support assumptions go back 12 months, we're not the kind of growth rate we saw in fact, we even talked about -- we thought the growth was going to be happening in '27, but '26 was going to be pretty flat. So it took a little while to get things going in '26, which is why you're seeing our accelerated growth. Now the demand is in there. And the demand will continue as the technology nodes continue. And as we said, packaging is growing and outgrow the market next year. So I think it was more -- it was not a demand question for us as much as in the first half of '26, the supply question. Bren?

No, I think you covered it, Rick. Look, the new facilities will, I think, create an opportunity for us that will drive some incremental as customers are setting up a new facility in a market environment that is both challenging from a complexity point of view, but also where yield is critical.

Got it. Super helpful. And then just my follow-up. I understand lead times are extending. But in general, like besides ASML, KLA is at of the unique position that you always have long lead times. I'm just kind of curious, one of the views from some folks in the industry is that [indiscernible] could be the peak WFE a few years out. I'm just wondering from what you are seeing, given the fact that you have embedded [indiscernible] than us, kind of like how high do you think WFE can grow? Obviously, there is [indiscernible] and Terafab, but obviously, it's also specific to how good the yield of your customers are. I'm just curious, from your vantage point, what do you see the WFE potential leading to.

For 2030. Look at Investor Day, we talked about a $220 billion plus or minus $20 billion view. And back then, where a lot of folks, I think, thought generally that was generally a middle of the road kind of plan. I would say today, it looks like a very conservative one. So we're certainly more optimistic about higher levels of industry investment. We think the flow-through and thesis in terms of KLA's participation in that is the same. And as we think about these growth scenarios, certainly given the lead times on some of our products and the parts that go into them, we have to contemplate those in terms of preparing our supply chain for those outcomes. We are having deep conversations with our -- some of our key suppliers about our needs in 2029 and 2030 in that time frame. So we're trying to [indiscernible] the company to make sure that we can continue to drive the company consistent with the way we laid it out and support those higher-end scenarios that are being discussed in industry.