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 September Quarter 2023 Earnings Conference Call and Webcast. I will now turn the call over to Kevin Kessel, Vice President of Investor Relations and Market Analytics. Please go ahead.

Thank you for joining us for our earnings call to discuss the results of the September 2023 quarter and our December quarter outlook. I'm joined by our CEO, Rick Wallace, and our CFO, Bren Higgins, to discuss our results released today after the market close, which are available on our IR website, along with the 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 is in the earnings materials 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 disclosures 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 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. Bren will conclude with our financial highlights, including our guidance and outlook. I will now turn the call over to our CEO, Rick Wallace. Rick.

Thanks, Kevin. Before we cover KLA's September quarter and outlook, I'd like to address the situation in Israel as it pertains to KLA. We have many KLA employees based in Israel. We're deeply saddened by the unspeakable acts of terrorism in the Middle East and the resulting war underway. Our heartfelt condolences are with all the victims and their families, friends and loved ones. At KLA, we're focused on employee safety and well-being and are making efforts to assist our teams through these terrible circumstances, including resources and support for our employees and broader humanitarian support through the KLA Foundation. We all hope for a peaceful solution soon. Moving on to our September quarter results, which exceeded expectations. Specifically, revenue of $2.4 billion finished at the upper end of the guidance range. GAAP EPS was $5.41 and non-GAAP EPS was $5.74, both also finishing at the upper end of the respective guidance ranges. These results were driven by the strength and relevance of KLA's process control portfolio. Additionally, focused execution enabled continued free cash flow generation and capital returns. We are proud of how the KLA teams continue to outperform in the marketplace and deliver on customer commitments. The overall business environment remains relatively stable for KLA. We continue to see strength in markets served by legacy nodes, despite softness in Memory and Logic & Foundry investments. As the industry continues to navigate the slowdown in the electronics market, we are closely monitoring any adjusting results that affect our customers' capacity. KLA continues to outperform the industry on a relative basis because customer investment in R&D for technology advancement and transition has proven to be more resilient to market pressures. If we look at some specific highlights in the quarter, revenue was driven by strength in legacy node investment globally and industry infrastructure investment. KLA's market leadership, product success, and unpatterned wafer, optical, and macro inspection also demonstrate the power of the KLA portfolio. Rapid growth of AI both enables KLA's differentiation and helps drive industry growth. KLA is a pioneer in adopting AI to improve the performance of our systems and create differentiation. And KLA has a long track record of employing deep learning and physics-based algorithms in our core technologies. As the cost of compute has declined, we are now able to deploy this capability more broadly across our product portfolio, leveraging our AI expertise. KLA's inspection, metrology, and data analytics systems help customers solve challenges associated with current process technologies and critical industry inflections, including gate all around, 3D memory, EUV Lithography, and advanced packaging. KLA Service business grew both sequentially and year-over-year, ending at $560 million in the September quarter and remains on track for high single-digit percent year-over-year growth in 2023. Finally, the September quarter was another excellent period from the cash flow and capital returns perspective, quarterly free cash flow was $816 million, which drove the last 12 months free cash flow up 3% year-over-year to $3.2 billion. Total capital returns over the past 12 months were $2.4 billion. In summary, KLA's September quarter results demonstrate our continued process control leadership and the success of our portfolio strategy. Our consistent execution despite challenges in the marketplace highlights the resiliency of the KLA operating model, driven by the dedication of our global teams. I'll now hand it over to Bren to cover more details on our financial performance and our outlook. Bren?

Thank you, Rick. KLA delivered a strong September quarter, demonstrating consistent execution despite a challenging marketplace. Revenue was $2.4 billion, non-GAAP diluted EPS was $5.74, and GAAP diluted EPS was $5.41, with all three coming in at the upper end of the guided ranges. Non-GAAP gross margin was 62.4%, 40 basis points above the guidance range due to benefits from a richer product mix and better service cost performance than modeled. Non-GAAP operating expenses were $534 million, in line with guidance. Total non-GAAP operating expenses comprised $311 million of R&D and $223 million in SG&A. Non-GAAP operating margin was 40.2%, and non-GAAP other income and expense was $47 million, while the quarterly effective tax rate was 14%. At the guided tax rate of 13.5%, non-GAAP EPS would have been $0.03 higher or $5.77. Quarterly non-GAAP net income was $786 million, while GAAP net income was $741 million. Cash flow from operations was $884 million, and free cash flow was $816 million, resulting in a free cash flow conversion of 104% and a free cash flow margin of 34%. The company had approximately 137 million diluted weighted average shares outstanding at the end of the quarter. The breakdown of revenue by reportable segments, end markets, major products, and regions can be found within the shareholder letter and slides. Turning to the balance sheet, KLA ended the quarter with $3.35 billion in total cash, cash equivalents, and marketable securities, with debt principal outstanding of $5.95 billion and a flexible and attractive bond maturity profile supported by strong investment-grade ratings from all three agencies. KLA has an impressive history of consistent free cash flow generation, high free cash flow conversion, and strong free cash flow margins across all phases of the business cycle and economic conditions. Over the last 12 months, KLA has returned $2.4 billion to shareholders, including $1.7 billion in share repurchases and $726 million in dividends paid. I also wanted to highlight that on September 5, KLA announced an increase in the quarterly dividend level to $1.45 per share from $1.30, marking the 14th consecutive annual dividend increase. Since its inception in 2006, KLA has grown the quarterly dividend level at approximately 15% compound annual growth rate. Additionally, on that date, KLA announced an incremental $2 billion share repurchase authorization. These capital return actions reflect confidence in our business model and growth strategy as we progress along the path to our 2026 financial targets. Moving to our outlook. As we review the market and assess the relative performance of our peers across the industry, we are adjusting our Wafer Fab Equipment outlook for 2023 up to approximately $80 billion, reflecting a decline of approximately 16% from the $95 billion level in calendar 2022. While the timing of a meaningful resumption in WFE investment growth remains unclear as most underlying end markets remain soft, we continue to see KLA's overall demand stabilizing around current business levels, and we expect this demand profile to continue into the first half of calendar 2024. KLA's primary value proposition is focused on enabling innovation through technology advancements and transitions, which our customers continue to prioritize across all business environments. While capacity plans are often adjusted due to changing demand expectations, technology roadmap investments are more resilient. This adds additional confidence to our business expectations as customers align shipment slots with roadmap requirements. In this environment, we will continue to focus on meeting customer requirements, maintaining our high level of investment in R&D to advance our product roadmaps and KLA's market leadership, and delivering strong relative revenue growth and financial performance. As for guidance, our December quarter guidance is as follows: total revenue is expected to be $2.45 billion, plus or minus $125 million; Foundry/Logic is forecasted to be approximately 68%, and memory is expected to be around 32% of Semiconductor Process Control systems revenue to semiconductor customers. Within memory, DRAM is expected to make up about 85% of the segment mix, and NAND 15%. We forecast non-GAAP gross margin to be 61.5%, plus or minus one percentage point, as product mix expectations are modestly weaker versus the September quarter and service period cost benefit realized in the September quarter normalizes. Inclusive of this guidance, calendar 2023 gross margins are expected to end up in the mid-61% range. Non-GAAP operating expenses are expected to be approximately $540 million. Other model assumptions for the December quarter include non-GAAP other income and expense, net, of approximately $45 million and an effective tax rate of approximately 13.5%. Finally, GAAP diluted EPS is expected to be $5.54, plus or minus $0.60, and non-GAAP diluted EPS of $5.86, plus or minus $0.60. EPS guidance is based on a fully diluted share count of approximately 136 million shares. In conclusion, we remain focused on driving differentiation through innovation as we execute our successful portfolio strategy that supports our customers' technology roadmaps. Though the industry is correcting in calendar 2023 and sustainable demand recovery remains unclear, we are sizing our business to ensure that we deliver a differentiated product portfolio that meets our customer technology roadmap requirements and have the capacity to execute our business in line with our long-term growth expectations. With the KLA operating model guiding our best-in-class execution, we continue to implement our strategic objectives, which are here to drive outperformance. Our focus on customer success, delivering innovative and differentiated solutions, and operational excellence is what enables us to deliver industry-leading financial and free cash flow performance and return capital consistently. We are confident that Process Control's importance to enabling technology advancements bodes well for KLA's long-term growth outlook despite challenging near-term demand trends. KLA is well-positioned to deliver strong near-term relative financial performance driven by better-than-market performance in our Semiconductor Process Control and Specialty Semiconductor businesses, as well as continued growth in service. KLA is also uniquely exposed to wafer and reticle infrastructure investments that are contributing to our relative outperformance in calendar 2023. Our business continues to stabilize, and the long-term secular trends driving semiconductor industry demand and investments in WFE remain intact and compelling. That concludes our prepared remarks. Kevin, let's begin the Q&A.

Thanks, Bren. Chelsea, if you could please provide the instructions to queue for Q&A, and we'll begin now.

Our first question will come from Vivek Arya with Bank of America Securities.

I wanted to revisit your suggestion that the first half could be stable at the December quarter levels. So does it mean you're not expecting any change to your China shipment? Or if you could just give us how you are thinking about the mix in different end markets and geographies? And then part B of that is, what assumptions are you making about the timing of memory recovery? Is that still kind of second half awaited and can it be incremental to this kind of conceptual first half outlook?

Vivek, it's Bren. I'm not going to provide specific guidance for the first half of the year regarding which regions or customers might be driving sales. When we look at the overall sales funnel and how we're sizing the factories, our stabilization comment applies to the total company. We see the business operating at approximately the guided levels over the next few quarters, and we will see how things develop. It's a dynamic environment, and I expect the semi PC business to remain consistent. The EPC segments may be more capacity-oriented with shorter lead times, so we'll need to monitor how that unfolds. As we aggregate and look ahead, we anticipate the business to maintain these levels in the first half.

And anything on the potential recovery in memory? If, let's say, memory were to be recovering in Q1, Q2, or Q3, is that visibility you would necessarily have? Or if I ask it in a different way, what is kind of the difference between when you start to see it and when it actually starts to show up in your sales numbers?

Vivek, Rick here. When we talk to customers, and we have had several conversations with memory customers recently, they've all echoed the same thing in terms of historical lows right now in the market, and utilization continues to be less than what they're hoping for, although stabilized. So we don't have any indication of any near-term change in that. And they will certainly let us know because we do have long lead items. So there are some products we're still shipping based on the fact that they're for R&D work. But in terms of capacity increases, we have no indication of any near-term changes.

On your Services business, close to 25% of your sales, you'll be driving high single-digit percentage growth this year, and that's with your customer production activity at an all-time low. But in your shareholder letter, you guys say that you expect growth in Services to accelerate to your target range of 12% to 14% next year. I know you've got to wave off tools and systems coming off of warranty and onto contract. This would be a big driver. But what else are you guys assuming on the strong growth outlook for next year? And what are your assumptions for industry manufacturing utilization?

Yes, Harlan. So there have been drivers or long-term drivers around service growth that are implicit in our modeling and are continuing, right? In terms of the level of utilization of the installed base customers using tools for longer periods of time and so on. But, you did hit on the biggest driver in terms of our expectations for growth into next year, is that we will have a number of tools that we shipped in 2021 and 2022, where we significantly outperformed the market. Those tools will be coming off of warranty and moving into contract, and our attach rate is pretty high. So it does give us some visibility into that service stream. As you know, our contract percent of the total revenue of service is over 75%. And so that visibility allows us to not only be able to plan for, but also to optimize the cost structure underneath it in terms of how we deliver to our customers.

Yes. One other thing, Harlan, is that, as you know, our services isn't dependent on consumables. And so customers want to keep these tools up and running even when they have slower utilization in other parts of the fab, but then they definitely want to ramp them as they're bringing on new nodes and starting to ramp new technology. So it's kind of the best of all worlds in the sense we don't slow down that much when it goes down, but then they're going to want to ramp as activity continues, whether it's on new technology or beginning capacity ramps on new technology nodes.

I think the final thing I'll mention is that Rick discussed memory utilization. In terms of foundry utilizations today, we are observing some improvement in utilization at the leading edge, while the legacy utilizations vary based on location. The N-1 nodes are somewhat softer, but the more mature nodes are showing stability. Therefore, utilization rates are stabilizing and increasing in certain areas of our business. This serves as a positive indicator for us as we look ahead to 2024 regarding potential growth in our service business.

Great. That's hugely insightful. Given the strong lineup and aggressive cadence of tech transitions, especially in foundry and logic, and that's obviously driving more EUV layer adoption, right, which is driving demand for both your optical inspectors and reticle inspection, your entire portfolio of metrology products as well. If we look into next year with more tech inflections, gate all around, introduction of backside power distribution, and next-gen advanced packaging architecture, is that wave of new tools and systems adoptions to support these transitions still in front of the KLA team? Or are you actually starting to see quite a bit of that now?

Well, so it's good insight, Harlan. I think there's two ways to think about it. One is we're definitely seeing R&D development around that, and we have for some time, but many customers have stalled their expansion and delayed. And as you know, there's been quite a lull in especially the leading-edge companies out there in terms of really much CapEx at all as it goes towards new technology expansion, but that's coming. And when that comes, we can map out layer accounts. We know we have a pretty good sense of deployment once it goes on the run card for these ramping up new nodes. And it's both on films. It covers both metrology but also it covers inspection. And so I'd say it's in front of us as we get into calendar 2024 and beyond.

First is for Bren, I know it will come out in the queue, but can you help us with the RPO where that was exiting the quarter?

It came down a little over $500 million quarter-to-quarter. So you'll get the specifics in the 10-Q, which we'll be filing here in the next few days, but somewhere just north of $500 million. So still pretty high levels, north of $10 billion overall, but did come down a little bit quarter-to-quarter.

Okay. That's helpful. And then just in that context, how do we think about the optical inspection lead times? I think you mentioned that the demand remains stronger than supply, your ability to supply, but how do we think about that looking into this first half of '24? Do we expect that you'll start to see maybe some of that alleviate in the first part of next year as we get into more demand in the second half?

Because we've got some new supply coming on related to some extremely long lead time parts, I would expect that we'll ship more in '24 than we have in '23. And so we still have a fair amount of imbalance here between where our customer demand is and our ability to supply. But there is some catch-up that's happening there. But those lead times are still pretty long. The rest of the company somewhere around various across different products, more capacity-centric products. Lead times are very normal today, and around some of the unique products that are critical in terms of industry requirements, those are still a little bit longer.

I wonder if you can speak a bit about the China business right now. A little more color on the strength that you're seeing, and you've obviously heard this from your peers as well. I think the investor questions right now are about the sustainability of the China revenue at these areas. I wonder if you could address that.

Yes, certainly. I have a few insights regarding KLA's situation in China. Due to recent actions, most of our investments, nearly all, are focused on legacy nodes. This is primarily to support industries in China that aim for self-sufficiency, like electric vehicles, where numerous projects require new infrastructure. There is substantial inspection and measurement needed across these sectors. Additionally, there is ongoing infrastructure investment in China linked to legacy nodes, particularly in wafer manufacturing. I believe these projects will persist for some time. We do not see any indication that leading-edge investments are being pursued, as that has already been halted for various reasons. However, the legacy investments are broad and we expect them to remain stable in terms of scale and purpose; these projects are at different stages of development. Overall, we feel optimistic about the sustainability of our business in China currently, and Bren can provide further details.

In the near term, in the September quarter, we saw the level as more elevated than what I'd call a run rate as we had other customers that were moving around in terms of deliveries. And so we were able to backfill that with some of this demand in China. So it did push up a little bit. I would expect it would drop somewhat in Q4, but certainly remain at elevated levels. And it's certainly something that has strengthened over the course of the year, consistent with Rick's commentary. So as we look at next year, we've got meaningful backlog with these customers, I've got in excess of $800 million in deposits for shipments for these customers. So I would expect that we'll see some sustainability of that demand as we move into next year. And I think it's really across the segments that Rick talked about. So as I think about growth into next year in that part of the business, I think from a baseline point of view, we see it's more or less flat. You have greenfield projects, as you have construction dynamics that are influencing some timing issues. But in general, I would expect it to continue more or less at that level over a broader period of time. A lot of these orders we booked over the last couple of years and frankly, in the expansion period of '21 and '22, are more strategic and larger customers consume the bulk of our slots. So as we've seen some slowdown over the course of 2023, that's created a lot of availability for these shipments, and these customers are performing in line with the commitments that they make.

Just as a follow-on to some of the other things you said, as you're starting to fill some of those orders for, say, some of those Chinese customers that you weren't able to fulfill because of some of the shortages before, what effect has that had on the backlog? And is your backlog visibility going out in time about the same as it was last quarter, or a quarter before? Or is that backlog visibility starting to shrink as you catch up on some of those orders that you weren't able to fulfill before?

I would say with new business coming into backlog, that it's not changing all that much.

Right. So about the same.

I'd say it’s about the same. Visibility is pretty consistent. Like I said, construction issues would be probably the bigger factor of whether projects would push or not. In a lot of cases, these are our new customers that are getting established. And so aren't necessarily exposed to some of the economic sort of supply-demand drivers that would affect more established customers. Now there are those kinds of customers also, and we're seeing normal behavior from them in terms of how they're balancing their capacity given their customer demand.

Bren, in the past, you have talked about the China domestic spending as one-third memory makers, one-third kind of mature foundries, and one-third as a new entrant into the market? And my question is like you're talking about China to drop somewhat in Q4, which segment of the China market are you seeing the drop-off in Q4?

I don't have that detail here. There is also another aspect related to the infrastructure investment that Rick mentioned, including the wafer and reticle infrastructure. So, there is a component of investment occurring in that area. We provide guidance at the company level regarding customer-specific activities, but I'm not going to delve into that.

Got it. And then, Rick, I have a question on gate all around. Historically, you guys have benefited when the transistor moves to FinFET architecture. And as we start to see initial orders on gate all around for some of the deposition companies, can you talk about what that gate all around opportunity means for both inspection and metrology for KLA? Yes, great question. It means a couple of things. One, obviously, gate all around has been in development for a while. So we had to start in terms of some of the architectures that we need to modify to support it. Specifically, we're leveraging Gen 4 technology instead of Gen 5 because of the nature of the contrast ability of Gen 4 to see the defects that are relevant to gate all around architecture. We've made those investments and seen those results, and that's been one where we've leveraged existing technology but also leverage the work we talked about with AI to provide capability. So we're well prepared for that when it comes to the inspection challenges associated. Metrology, big opportunities there because you're looking both for increased level of precision when it comes to the actual measurement, larger sample size because of the concerns about consistency across the wafers and across wafer and wafers, and also some of the specifics around the High-K Metal Gate control that people are looking for. So more capability. Again, we had a head start because, as you know, that technology has been in development. So we've worked with development partners on that, feel well-positioned to be able to support that as it expands. So it's going to help both process control intensity when it comes to both inspection and with metrology, and we're well-positioned to support our customers to do that.

I would like to inquire about the strength in DRAM that you are experiencing. It appears to have been the primary driver of revenue growth this quarter, but based on your comments, it seems to be slightly decreasing in the upcoming quarter. How much of that strength is attributed to shipments to DRAM customers in China that you mentioned previously? Additionally, how much is related to advanced DRAM technology, such as high bandwidth memory? Looking ahead to the fourth quarter, which aspects of that segment are expected to decline?

Yes. When I examine the details, the shipments to China, which were anticipated, contributed to the baseline. For the December quarter, in DRAM, I expect to see some variation among customers, but I don't think the overall number will decline significantly. Most of the investment is focused in that area or on supporting some of the AI demand that's present. Additionally, there is some general R&D investment taking place. Overall, it's a relatively low level, with most of it stemming from a catch-up related to the China customer we mentioned.

We are observing some developments regarding the interposer in the packaging area. Although it is currently a smaller driver, the growth outlook is promising. As DRAM begins to utilize EUV with renewed investment, it presents a significant opportunity for us to deepen our involvement in research and development, even though that is not the current driving factor.

Okay. Great. And maybe a follow-up for me. If you look at the SPC systems revenue, it looks like it's going to be down 5% to 7% in calendar '23. I think a quarter ago, that number was like down 10% to 12%. Can you talk about what has changed? Is it just that the WFE market has improved somewhat? Or are there other KLA specific reasons that you will point out. But more importantly, how do you think that outperformance will do next year considering some of the areas that you are strong in this year may see some moderation?

I'm sorry, for EPC or that was SPTS? We have seen some ongoing strength, particularly in the optical sector. The intensity of process control has not decreased among our customers, and we are still experiencing strong demand for wafers. The overall macro environment appears robust as well, which reflects positively across our leading-edge portfolio. However, the areas experiencing the most decline in capacity are those closely related to wafer starts, such as overlay and films. On the other hand, we continue to see strong demand in technology inspection.

Yes. And I think the infrastructure parts of the business as well. We've seen that hold up fairly well, both in China, as we talked about in terms of doing mature, we're building capability to not only provide wafers, but also to do mature reticle sets for all the design activity that is happening. So you've got that. But then on the wafer side, you also have investments that are happening globally as those customers prepare for not only as capacity comes out fairly slowly in that industry, preparing for the resumption in demand that we're expecting here in the near future, but also different strategies around inventory stocking, more wafer-to-wafer bonding, and other demand for wafers. So that's also been a driver that we've seen hold together fairly well as we move through this year. Process control intensity is helping in, and I've been pretty open with it over the course of the last year that despite some catch-up that might happen with some peers related to challenges in '22 with supply, we felt pretty good about our positioning and our exposure to some of the fastest-growing markets overall. The mix of business that's more logic/foundry-centric and this infrastructure exposure that I referred to.

Rick or Bren, I'm curious, you mentioned the demand profile stays in the first half of next year. But some of your peers have called calendar '24 like a transition year. And how do I overlay the fact that memory could rebound in the back half of next year, how to think about these industry WFE or KLA revenue profile next year?

So I'll take part of it, and Bren can answer. We don't know what '24 is going to look like. We just don't know. And we know what our customers are saying right now. But they don't really know yet either. So we're talking about a sustained level of business kind of being similar to what it is right now until we have a reason to believe it's going to go up. Customers talk about things improving. We have meetings, and they talk about asking us to get ready. But until we actually see it happening, we don't really know. So it's very hard to talk about the levels. What we do know is you have historically low levels of investment company right now in memory, and we see the same thing as you do in terms of pricing. And then we're well positioned for ramping when it does ramp. We also know we have some very good indications on some of our long-term products that are products that have long lead times. But as Bren said, like an optical inspection or capacity constrained, not demand constrained on those. So that's kind of how we're looking at it. We don't really have any unique visibility into '24 than those general trends and the fact that utilization seems to have stabilized and is increasing on some of our market segments, but not much visibility beyond that.

Yes. Look, I made the comment about utilization rates, and I think that's encouraging in terms of the stabilizing environment that we're articulating here. That's certainly a factor. Well, of course, we watch our customers' business models, their profitability, and their cash flows. That will, okay, you're seeing the industry digest the capacity that was added and then get sort of healthy again and see pricing and all those things improve. But then one of the catalysts that are going to drive growth into next year. In our near term, as we said in the prepared comments, we see roughly this level of business as we move through the first half of the year. One of the things that we really focus on is we've got to make sure that we're flexible enough to be able to respond. And so we've made a lot of investments over the last few years in our supply chain and our own capacity to make sure that we have the flexibility to respond because I would expect that we could get surprised. We usually do. And so we want to make sure that we're in a position that we're not constrained in our ability to supply and meet that when it happens. So that's our focus. And I think the color we provided in terms of how to think about the company and how we're sizing the company in the near term is reflected in how we've positioned our supply chain, we believe. Yes, we are reviewing the situation and making progress. It's quite complex. However, based on the baseline established in October of last year, we do not currently anticipate any significant changes to our business expectations due to the new regulations. We are continuing to navigate through it, as it is complex.

Bren, everyone's asking about 2024 WFE, but I guess I'm still a little confused as to what the right baseline is for this year because pretty much everyone has now guided for Q4. So if I take you, plus Applied, plus Lam, yes, it's down 13%. So that would mean that your $80 billion number might be in the ballpark off of that mid-90s last year. But if I include ASML, it's like flat. I mean even if you exclude the fast shipments, it's fairly down. So how is WFE down this year? I guess I'm just trying to get some understanding of how you get to that $80 billion number. Is it excluding ASML somehow?

Yes, Tim, we're not experts on this. What we do is examine the peer companies and how they report. Based on customer feedback and our modeling, we come up with an estimate. This year is a bit challenging due to fast shipments, and I don’t fully grasp all the details, so that's for you to analyze. Additionally, there were issues affecting some other providers in late 2022 regarding their delivery capabilities, and we’re seeing how that plays out in 2023. Overall, we believe our performance aligns with those lower estimates. Certainly, with our market position in mind, the decline feels significant. In terms of the Semi PC guidance we've provided, it suggests we might be down about 9% or 10%, which doesn’t seem flat to me.

Okay, Bren. My second question is about inventory, which has now increased to nearly 300 days and has risen by about $500 million in the last six months. However, we are uncertain about when WFE will pick up next year. I understand you have a substantial $10.8 billion in purchase orders that you are managing. Why is this inventory scheduled so far into the future? If that's the case, why maintain the inventory now? What is causing the hold-up? Is there a bottleneck on your end, or are the orders primarily waiting for the fabs to be ready to receive the equipment, which is contributing to the inventory buildup? I'm unclear on the rationale for increasing inventory if it is still set for such a distant timeline.

Yes, Tim, that's a great question. It reflects a trade-off we've made, and I've discussed how we've consistently outperformed the industry over the past couple of years in light of supply chain challenges that others have faced. This has a lot to do with our supplier management. We rely on many long lead time parts, and if we look back about 15 months, we anticipated that 2023 would be a growth year following what we projected to be a $100 billion year in 2022. As a result, we made long-term commitments and encouraged our suppliers to invest by partnering with them on capacity expansions. We prioritize these commitments to suppliers and have been able to manage what we can, but we often uphold our agreements. We believe that in the long term, our platforms are positioned well to meet anticipated demand for those parts. Our strategy involves optimizing our supply chain collaboration, acknowledging that we will remain reliable customers by fulfilling our commitments. We feel optimistic about our potential for growth when the industry rebounds. Additionally, our service business continues to expand annually, generating significant demand. It is a complex, highly customized, low-volume business, leading us to make end-of-life purchases and buy numerous parts to support it. Overall, when considering our company's margin profile, we believe the trade-offs we've made are valid, significantly contributing to our relative success.

This morning, I think one of your smaller peers in Europe, they talked about seeing some weakening of the mature in foundry/logic side of the WFE. I wonder if KLA is seeing something similar. I mean either through your process control business or the EPC business? If not, why is that? And I have a second question.

Not really. Look, we're watching for certain parts of, I'll call non-China legacy exposure to automotive, industrial, some of those markets to see if that has an effect on customer demand. But right now, our expectations around legacy in the near term has been fairly consistent.

Got it. So Bren, maybe a question on OpEx. Both of your peers in the Bay Area, they are raising their OpEx for basically the next calendar year. How should we think about KLA's OpEx going into next year? Say, you talked about you're expecting revenue to be run rating at the current level, should we be thinking OpEx is kind of flat until you see the uptick in the revenue? I mean before you really raise the OpEx.

Run rating at the current level does give you a little bit of growth into next year. And as I said, we would expect to see growth in Service. I actually think EPC probably has some modest improvement off of pretty depressed levels. Our incremental operating margin model drives how we're running the business in terms of expectations for leverage on incremental revenue. So I would expect to see a modest uptick in OpEx. We're also balancing sort of near term in terms of how we're sizing for the current environment, but also our long-term investment requirements. And given our market position and our desire to go to market with the portfolio that we think is a competitive advantage for KLA does drive some requirements for investment. And we'll do that independent of topline when appropriate. But as we're looking out going forward, I would say that we'll probably see OpEx tick up a little bit as we move through '24, but not a big change, more in line with general kind of cost of living type adjustments overall.

You mentioned some potential weakness in the cutting edge of foundry logic. Could you elaborate on that? Additionally, considering we're in a landscape with significant investment in gate all around and backside power, but with limited wafer requirements in the first year for those technologies, it seems this would benefit KLA in terms of percentage of wafer fabrication equipment. Can you explain how much of your spending will be allocated to developing those processes compared to expanding wafer capabilities?

We do receive initial investment primarily for development, but the significant increase occurs during the ramp phase. The investment starts early during development, and then it begins to grow more substantially. As production volume increases, we see a reduction in incremental investment across the portfolio. While this investment supports the new nodes, it's common for companies to also be expanding their older nodes concurrently, often with one or two generations involved. Overall, the situation tends to look similar across these companies as they ramp up. The initial investment is in place, but regarding process control intensity, it remains fairly consistent year-over-year in the foundry and logic sectors since companies invest in various areas.

The biggest change has come from the mix of foundry/logic to memory. And memory is increasing some. So yes, there are more layers, there's more investment going on, but it's still balanced by they're going to ramp. We hope not just the R&D, but they're going to be ramping in terms of across the board. That's how we get to the model that we found for 2026, is based on process control intensity inching up over time as processes just get more challenging.

I just wanted to follow back up on the comments you just made on foundry logic. So it was flat. It seems like China is probably up within that mix, and then you said leading-edge is weak. I'm just kind of curious how that changes for December. It seems like the outlook is fairly flat. So is that weakness in leading-edge kind of stabilize, and then kind of any perspective as to where leading-edge goes next year?

So I feel like where we are today, I think your stabilization comment is the right one. I think we've derisked it and given that we tend to be more of a long lead-time provider. I think we've made a lot of the adjustments that we needed to make already in terms of how we're planning for this year. And as we move into next year, right, I think if you just sort of aggregate leading-edge activity, we'll see as customers start to provide a little bit more insight. But again, back to the stabilization comment, I don't see it declining from here. Yes, it's the latter. I think we're expecting utilization to slowly improve, but the bulk of it will come from new tools coming into contract. I think to expect to start to see overall industry improvement into '24, the first thing you'll see is utilization start to improve. So we would expect that and then once you see that, and then eventually, utilization gets to a place where customers need new capacity, and then those decisions happen.

Yes. Just a quick follow-up. As you think about the R&D price, especially you highlighted gate all around at some point, we have to change the narrative to High-NA. And I want to just get an update, how do you see kind of opportunities as it relates to High-NA specifically on the patterning? And I have a follow-up.

High-NA enables continued scaling, which is positive for KLA. The intensity of process control has increased, particularly as EUV technology is being adopted, leading to scaling beyond traditional Moore's Law. High-NA signifies that more scaling will occur, which is beneficial for KLA as it aligns with our strengths in high-performance requirements. While our projections for 2026 don't show significant High-NA developments, we anticipate early-stage progress before then, creating additional opportunities for us in higher process control intensity.

Are you suggesting that the use of Gen 5 could be extended to High-NA for patterning?

For sure, absolutely. We're still using Gen 4. We're using Gen 4 now because of the extensions that we made in the platform, not just in terms of wavelength but adding more processing capability, the leveraging of AI, the use of both Gen 4 and Gen 5. Actually, Gen 4 will out-ship Gen 5 this year, and we'll continue to see that adoption. So it really is talking about the critical layers, and we have more extensions in mind in the works that we're doing right now for Gen 5 that will extend it well into the even in the High-NA, then hyper-NA, which is going to come after that. So we feel very good about our optical product portfolio.

Many customers operate at a small scale and are working to build process capabilities and showcase these to their clients, while also investing in long-term viability related to advancements in their production nodes. During the initial stages of scaling up, you will notice a significant investment in process control. As these companies create their roadmaps, there may be a continuous focus on this area since they often don't have substantial capacity at each node. However, we see an increased adoption rate early in the process because acquiring a few process tools is not enough; a full suite of process control is necessary. This is why we observe more activity in this space. Given the ambition to progress along these roadmaps, I anticipate ongoing investment overall. Nevertheless, as operations mature, and if they are working with a limited number of designs, the intensity of process control will be greater during production compared to previous stages, but still not as high as during the ramp-up phase of a project.

I have just one question before we finish. If I'm not mistaken, it seems that the strong demand in the infrastructure bear wafer and reticle inspection business in China this year might decrease a bit in 2024 compared to its performance last year. Is this what you are anticipating for the first half of next year? Additionally, do you think this is related in any way to the pace of fab construction activity in China that you expect to see next year?

I don't think the overall wafer infrastructure investment will continue to grow at the same pace as WFE this year; I expect it to level off as we head into next year. Specifically regarding China, I don't expect much change. I don't anticipate significant growth next year, but I also don't see it declining. This applies to both silicon wafers and reticle capability.

Thank you, Brian, and thank you, Chelsea. I just wanted to thank everyone again for their time and turn the call back over to you for any final instructions.

This does conclude the KLA Corporation's September Quarter 2023 Earnings Call and Webcast. Please disconnect your line at this time, and have a wonderful day.