Earnings Call Transcript - KLAC Q2 2021

Operator, Operator

Good day. My name is Priscilla, and I will be your conference operator today. At this time, I would like to welcome everyone to the KLA Corporation December Quarter 2020 Earnings Conference Call and Webcast. All participants’ lines have been placed in a listen-only mode to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you. I would now turn the call over to Kevin Kessel, Vice President of Investor Relations. Please go ahead.

Kevin Kessel, Vice President of Investor Relations

Thank you. And welcome to KLA’s Fiscal Q2 2021 Quarterly Earnings Call to discuss the results of the December Quarter and our Outlook for the March Quarter. With me today is Rick Wallace, our Chief Executive Officer; and Bren Higgins, our Chief Financial Officer. During today’s call, we will discuss quarterly results for the period ending December 31, 2020, that we released today after the market closed in the form of a press release, shareholder letter and slide deck. All are available on the KLA IR section of our website. Today’s discussion is presented on a non-GAAP financial basis, unless otherwise specified. A detailed reconciliation of GAAP to non-GAAP results is in today’s earnings materials posted on our website. Today’s call also represents the end of the calendar year. We will make references to both 2020 and 2021. Please note all references are for the calendar year. Our IR website also contains future virtual investor conferences, as well as presentations, corporate governance information, and links to our SEC filings, including our most recent annual report and quarterly reports on Forms 10-K and 10-Q. Our comments today are subject to risks and uncertainties reflected in the Risk Factor disclosure in our SEC filings. Any forward-looking statements, including those we make on the call today, are 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. As many of you now know, we changed the format of our earnings two quarters ago to include pre-publishing a detailed shareholder letter that provides updates on our business performance. The pre-publishing allows this call to be efficient by providing more streamlined comments while also freeing up more time for your questions and answers. With that, I’d like to turn the call over to our President and Chief Executive Officer, Rick Wallace.

Rick Wallace, CEO

Thank you for joining us today and for your interest in KLA. As we look back on 2020, I want to take a moment to express my appreciation for the global KLA team. Your resilience, ambition, and dedication allowed KLA to meet challenges and serve our customers effectively. This past year was unprecedented, and although our teams were physically apart for much of it, we showcased the KLA culture of collaboration and innovation, emerging stronger than ever. We achieved exceptional financial results in the December quarter, closing out a robust year for the company. In our shareholder letter published today, we explain how KLA’s record performance resulted from multiple successes, including our global workforce's resourcefulness, the strength of our business model, and our commitment to delivering value to our shareholders. As you have seen from our results, 2020 was a remarkable year for KLA across various areas. We experienced significant growth, profitability, and free cash flow while adapting to the challenges posed by COVID. Throughout this period, we focused on fulfilling customer needs and providing strong returns to shareholders within the expanding semiconductor market. Bren will provide more insights into our financials for the quarter and the year, but I want to highlight some key annual milestones. For the year, KLA’s revenue rose 15% to $6.1 billion, marking five consecutive years of growth. We also achieved notable profitability growth, with non-GAAP operating profit and non-GAAP earnings per share increasing by 28% and 32% year-over-year, respectively. Our free cash flow rose 44% to $1.8 billion, and we returned $1.2 billion to shareholders through share repurchases and dividends. In the December quarter, we observed widespread strength across all segments. Semiconductor Process Control revenue exceeded expectations once again. The Electronics, Packaging, and Components group met its performance targets, and our Services business continued to grow, demonstrating strong operational leverage. We closed the year with a healthy backlog, positioning us for double-digit growth in 2021 as we maintain high execution standards. We are in a strong position to meet and likely exceed our 2023 financial objectives, reflecting our global teams' dedication and KLA's critical role in supporting our customers' technology strategies and enhancing their returns on capital investments. Regarding the current demand landscape, we are witnessing accelerated adoption of various growth drivers in the Semiconductor and Electronics sectors that we have highlighted over the years. Technology continues to change the way we live and work, while the data-driven economy is transforming business operations and value delivery. This digital transformation fuels demand trends such as high-performance computing, artificial intelligence, and rapid expansion in automotive electronics and 5G communications markets. Each trend spurs investment and innovation in advanced memory and logic semiconductor devices, as well as complex advanced packaging and PCB technologies. With our leadership in process control and expansion into new markets, such as specialty semiconductor process equipment, PCB, and finished die inspection within our EPC Group, KLA is essential in enabling our increasingly digital world. Despite the changes over the past year, our KLA operating model remains a constant. This model serves as the enduring framework we depend on to guide long-term strategic execution. We use it to unify the company on a consistent strategy, hold ourselves accountable for results, drive product development, adapt to market changes, and encourage continuous improvement, all while maintaining strong financial discipline as we strive for long-term performance and profitability objectives. Now, let's review five key highlights from our results for the quarter and 2020. First, we experienced ongoing strength and breadth in foundry and logic demand during the quarter. Memory demand also grew as customers planned for equipment investments in 2021 to align with anticipated end demand. We foresee increased business levels from a broader customer base in the March quarter, with demand momentum continuing throughout 2021 across our key end markets. This demand strength underscores KLA’s vital role in supporting our customers' innovation and investment in future technology advancements. Second, marketplace momentum from new products is contributing to market growth and share opportunities in both the Semiconductor Process Control and EPC Groups. Supported by increased customer investment and EUV lithography, the Semiconductor Process Control business is advancing adoption with new optical inspection applications, such as EUV print check for GEN5, and expanding our presence in new markets, like the eSL10 e-beam inspection platform and the emerging use of X-ray technologies for metrology applications. Third, Services revenue rose to $1.56 billion, accounting for 25% of total sales in 2020. This growth stemmed from an expanded install base, higher utilization rates, and an increasing variety of service opportunities in the trailing edge and EPC Group. The 2020 results highlight the Services team’s effectiveness in leveraging the KLA operating model while collaborating closely with customers and partners. The Services business launched new initiatives to tackle unprecedented COVID challenges, gaining customer praise and increasing our contact penetration from 70% to over 75% in 2020, which enhances recurring revenue and strengthens operating leverage and cash flows. Fourth, the newly established EPC Group had a promising year, showcasing success in KLA’s growth strategies and demonstrating how the execution of the KLA operating model promotes market leadership and improved operational efficiency in acquired businesses. Revenue growth was strong, and we believe that it will surpass our $50 million annual acquisition cost synergy target by at least an additional $30 million. Through EPC, KLA now offers a broader product portfolio, targeting rapidly growing new markets in the Electronics value chain, including RF, automotive, 5G wireless connectivity, and display. Concerning 5G adoption, KLA has exposure to various key components within the Electronics value chain as well. The EPC Group closed the year with a record backlog, setting the stage for double-digit growth in 2021 and enhancing operating margins on that growth in alignment with overall company goals. Finally, to fulfill our commitment to delivering substantial and consistent capital returns to our shareholders, we repurchased $177 million of common stock and paid out $140 million in dividends during the December quarter. Back in July, KLA’s Board of Directors approved the 11th consecutive annual dividend increase to a yearly rate of $3.60 per share. Since 2006, KLA's dividend payout has seen a compound annual growth rate of around 15%. In 2020, KLA returned $1.23 billion to shareholders, constituting 70% of free cash flow. Before Bren goes into further detail about our financial highlights, let me summarize briefly. Despite the disruptions and challenges presented by COVID throughout the year, KLA benefited from its global workforce's adaptability. We finished 2020 strongly, achieving record results and laying the groundwork for our sixth consecutive year of growth. KLA is exceptionally well-positioned at the forefront of technological innovation, offering a comprehensive portfolio of products to meet demanding customer needs while balancing sensitivity and throughput. The Semiconductor and Electronics landscape is continually evolving, and we are noticing increased customer interest applied to more technological innovations than ever at the cutting edge. The demand drivers we identified at our last Investor Day are even more relevant now, enhancing our ability to meet and likely exceed our 2023 financial targets. Simultaneously, our strategy of pursuing diversified growth with strong long-term operating leverage should ensure consistent capital returns to our shareholders. I will now pass the call over to Bren.

Bren Higgins, CFO

Thanks, Rick, and good afternoon, everyone. KLA’s results for the December quarter and 2020 demonstrate the strength of our ongoing strategy. We continue to meet customer needs and enhance our market leadership while increasing operating profits, achieving record free cash flow, and adhering to our long-term capital allocation strategy. 2020 was a year of significant growth and profitability across various business segments. This was accomplished alongside returning substantial capital to shareholders. Total revenue for the December quarter reached $1.65 billion, which is at the top of the guided range of $1.51 billion to $1.66 billion. Non-GAAP gross margin was 61.8%, slightly below the midpoint of the guided range of 61% to 63%. Non-GAAP EPS stood at $3.24, likely above the midpoint guidance of $2.82 to $3.46. GAAP EPS was $2.94. If the tax rate was set at 13%, non-GAAP EPS would have been $0.03 higher, at $3.27. Total operating expenses exceeded the guided range of $393 million, including $228 million for R&D and $165 million for SG&A. Non-GAAP operating income as a percentage of revenue was robust at 38%, aligning with expectations. The increase in operating expenses this quarter was partly due to adjustments in variable compensation programs and the timing of prototype material purchases for product development. Based on revenue expectations for 2021, product development requirements—which include next-generation reticle inspection capabilities and enhanced customer engagement resources—will lead to operating expenses around $400 million for the March quarter, with budgeting for quarterly expenses roughly between $400 million and $405 million in the near term. Given our anticipated top-line performance for 2021, we expect the business to exceed its target operating model regarding overall profitability and operating margin leverage. Other interest and expenses for the December quarter amounted to $43 million, with an effective tax rate of 13.8%. While there may be some variability in our tax rate from timing and discrete items, we will adjust our long-term tax planning rate slightly to 13.5% going forward. We are also tracking corporate tax discussions in the U.S. and will update on their impact on KLA as needed. Non-GAAP net income reached $504 million, while GAAP net income was $457 million. Cash flow from operations was $561 million, and free cash flow hit a record $502 million, resulting in nearly 100% free cash flow conversion and a healthy free cash flow margin exceeding 30%. Our Semiconductor Process Control business drove strong revenue growth this quarter. The EPC Group performed according to our expectations entering the quarter. Revenue for the Semiconductor Process Control segment, including its Service business, was $1.38 billion—a sequential quarterly increase of 9% and a 15% rise for 2020. The approximate customer segment mix was 49% foundry, 10% logic, and 41% memory, up from 32% in the December quarter. Within the memory segment, the split was about 60% NAND and 40% DRAM. Going forward, we will combine the foundry and logic segments for clarity and to align with industry reporting practices. Revenue for the Specialty Semiconductor Process segment in December was $91 million, a 2% sequential increase and a 24% rise in 2020, driven by growth in RF, MEMS, and advanced packaging. PCB, display, and component inspection revenue totaled $179 million, down 1% sequentially yet up 12% for 2020, as PCB and component inspection strength countered a softer display market. Regarding our balance sheet, KLA concluded the quarter with $2.3 billion in cash and total debt of $3.46 billion, supported by a favorable bond maturity profile and investment-grade ratings from all agencies. In the December quarter, we repurchased $177 million of common stock and distributed $140 million in dividends. For 2020, KLA returned $1.2 billion to shareholders, amounting to 70% of free cash flow, including $547 million in dividends and $681 million in share repurchases. Our commitment to delivering strong capital returns is a vital aspect of the KLA investment proposition, ensuring predictable value creation for shareholders. Looking ahead as we enter the New Year, we anticipate that the wafer fab equipment market will grow in the mid-teens, plus or minus a few percentage points, in 2021, starting from a baseline of $59 billion to $60 billion. The year is projected to see robust demand and growth across major end markets, particularly in memory, fueled by DRAM investment, and solid growth in foundry/logic segments. Based on our current backlog and visibility in sales over the next few quarters, we feel positive about the sustainability of our demand profile for the year. Consequently, we expect company revenue to remain consistent quarter-to-quarter throughout the year. Our guidance for the March quarter is as follows: total revenue is expected to range between $1.74 billion, plus or minus $75 million; foundry/logic is forecasted to account for about 68% of semiconductor process control systems revenue, with memory expected to make up around 32%. We forecast non-GAAP gross margin between 61.25% and 63.25%, anticipating a more favorable product mix, continued service leverage, and higher volume to bolster gross margins compared to the December quarter. Based on expectations for revenue and product mix in 2021, we are modeling gross margins between 61.5% and 62%, leaning towards the higher end due to structural trends in costs and product positioning. Assumptions include operating expenses around $400 million, interest and other expenses of roughly $43 million, and an effective tax rate near 13.5%. Finally, we expect GAAP diluted EPS to range between $2.98 and $3.66, and non-GAAP diluted EPS to range from $3.23 to $3.91, based on a fully diluted share count of approximately 155 million shares. In conclusion, the market dynamics driving semiconductor demand and investments in wafer fab equipment are strong, with solid demand across various end markets and multiple technology nodes. 2021 is shaping up to be a second consecutive year of double-digit growth for both wafer fab equipment and KLA. We are executing well and remain confident that we will meet and likely exceed our 2023 financial targets. The KLA operating model positions us adeptly to outperform while guiding our strategic objectives, which drive our growth, operational excellence, and differentiation across an increasingly diverse product and service offering. They also support our sustained technology leadership, strong competitive advantage, and solid track record of generating free cash flow and returning capital to shareholders. Now, I will turn the call over to Kevin to begin the Q&A.

Kevin Kessel, Vice President of Investor Relations

Thanks, Bren. Priscilla, if you could provide the instructions for Q&A?

Operator, Operator

We will now take our first question from Patrick Ho with Stifel. Please go ahead.

Patrick Ho, Analyst

Thank you very much and a belated Happy New Year and congrats to you guys. Rick, maybe first off, in terms of process control intensity, we have seen foundry and logic continue to grow as we go through these node migrations. And NAND flash has obviously seen intensity rise with the increasing layer counts. As we look at DRAM and the projected pickup that you mentioned in your prepared remarks, what types of process control intensity increases are you seeing in that marketplace? Maybe even excluding some of the EUV options that are out there, what other types of process control intensity trends are increasing in DRAM?

Rick Wallace, CEO

Sure. When considering DRAM, it is indeed challenging to continue scaling as they strive to do. We anticipate some EUV technology will be introduced, and it's evident that scaling is occurring, which leads to increased process control intensity. Additionally, the overlay requirements in DRAM are becoming increasingly difficult. We're observing efforts to maximize the capabilities of existing lithography equipment. We also expect some EUV adoption, which suggests that there will be greater emphasis on our advanced optical inspection tools to accommodate that trend. While DRAM is not as EUV-centric as foundry and logic, there is still some EUV presence. Does this address your question, Patrick?

Patrick Ho, Analyst

Hey. It does, Rick. Thank you. Bren, as a follow-up to that question, you guys as you are seeing demand pickup and revenues grow, your working capital metrics have actually also improved. What changes have you made, particularly given that you have added Orbotech over the last few years, but you see the inventory turns actually improving even as demand picks up. What are some of the dynamics there?

Bren Higgins, CFO

That's a great question, Patrick. We have done a solid job of enhancing overall asset velocity in the business since incorporating Orbotech. While there’s still potential for further improvement, on the KLA side, we have mechanisms in place that support our model and contribute to our profitability. This includes our unique component differentiation, which enhances our product offerings and our service operations. We typically maintain a high level of inventory to support tools that have a long lifespan in the field and rely on strong, exclusive relationships with key suppliers to maintain our differentiation. This approach results in higher inventory commitments, and although it comes with some risk, we don’t find ourselves stuck with excess systems. Thanks to the strength of our service business, we generally manage to move the parts efficiently, making this strategy worthwhile. We believe this sacrifices ultimately pay off in terms of our profit structure. The volume we've experienced has allowed us to make some improvements in this area. However, it’s important to recognize that this isn’t primarily a business focused on quick inventory turnover, so there may be an upper limit to our enhancements. Nonetheless, we have made some progress over time.

Patrick Ho, Analyst

Thank you very much.

Joe Quatrochi, Analyst

Yeah. Thanks for taking the question. I wanted to go back to your comment about revenues should be relatively consistent quarter-to-quarter in 2021. Is that a process control tool comment as well, I guess what I am trying to understand is, what you are seeing relative to maybe peers talking about WFE being a little bit more first half weighted?

Bren Higgins, CFO

Yeah. Joe, so it’s a good question. So what we are trying to do, first of all, it’s really for both groups of our business, if you look at the EPC Group and as well as the process control equipment part of the business. I was really trying to do a few things. First, obviously, we are guiding March and we have got a nice sequential increase to the March quarter. We wanted to provide our view of WFE growth for ‘21 and expectations for KLA in the year. And the third thing was to provide just some context on the demand profile as we move through the year. And as I said in the prepared remarks, it looks relatively consistent. Now I am not guiding the June quarter, I am not guiding September, I am not guiding December, but what I wanted to do is provide a little bit more context. Now we do have tools that cost from $10 million to $20 million, sometimes even more than that. So there is the usual variability that you have related to the timing of a shipment, the customer acceptance, the consignment buyout and so on. But when we look across our business, it looks relatively consistent from a demand profile point of view, and I think starting with the backlog we have, the visibility we have in the funnel and then just the general lead time dynamics of our products, it gives me some comfort with that statement.

Joe Quatrochi, Analyst

Okay. That’s helpful. And then you talked about the other investments you are making on the product development side, and clearly, you guys are strongly outperforming your long-term profitability targets. I was curious, how do you think about opportunities to maybe even spend a little bit more and accelerate some of the product development projects you have got going on?

Bren Higgins, CFO

Sounds like you have been talking to some of our guys inside it. Sometimes Rick and I are the only two people in the company, I think, we ought to spend less. But anyway, to answer your question, look we have a rigorous process where we look at the portfolio of the business and look at how we get returns on that portfolio. So we have ramped up our investments in R&D and product development over the last few years. We think that there are opportunities. One of the biggest drivers that’s driving the uptick that I articulated here as we look at ‘21 is investment in multiple programs supporting reticle inspection, qualification and so on. So I think that that’s been an area of focus for us. But we feel pretty comfortable with our process around R&D and the timing of our road map related to our customer requirements and it’s worked pretty well for KLA. I think what’s driving more of our model upside is more of a gross margin dynamic than a cost dynamic. And so, I think, the gross margin is reflective of the differentiation that we have with our products in the field and I think the value we are adding to our customers. So hopefully that answers your question.

Joe Quatrochi, Analyst

Yeah. Perfect. Thank you.

CJ Muse, Analyst

Yeah. Thank you for taking the question. I guess two questions if I could put them together. The first one would be around EUV shortages at ASML, is that impacting GEN5 optical demand at all? And then, I guess, secondly, I am a little bit surprised that you are guiding Orbotech business is flat half-on-half, typically there is a seasonal uplift into the back half. I am curious if that’s a conservative outlook, whether seasonality has changed or there is something that we should be kind of thinking about? Thank you.

Bren Higgins, CFO

Yeah. CJ, nicely done, those are not related at all, those two questions, as you know. But I will take them. The first one, no, we don’t see any slowdown in the EUV impact if the delays that were outlined by ASML in terms of the demand for GEN5, if anything, it’s kind of gone the other way. What’s happened in the last few months is, I think, the realization that some of the yield challenges associated with the EUV are best approached by having more GEN5 capacity and so we are actually maxed out and trying to ramp that in order to support it. So we have very strong GEN5, we don’t see any delay in that and we have a lot of conversations with customers about our ability to support that. In terms of Orbotech, in terms of that, I would say, it’s a complicated business overall to aggregate and so we don’t really see anything, any signs of concern. We do see continued growth in that business. We feel good about where we set out our plans for 2023 in terms of the original model that we outlaid at the Investor Day and we are on track to meet or exceed those. So we feel good about it. We will have to see. This is a little bit newer for us to understand just the dynamics of the Orbotech business. But we feel good about the signs that we are seeing, and as we said, we ended with a strong backlog coming out of 2020. So we feel really good about this year.

Rick Wallace, CEO

So, CJ, I want to add that our guidance remains accurate. There continues to be variability from quarter to quarter, although it’s at a different scale compared to our Semiconductor Process Control equipment business. Looking at the overall business drivers, including 5G infrastructure, mobile and 5G handsets, various dynamics within specialty, and the shifting trends in PCBs related to integration, packaging, and high-performance computing, all these factors are contributing to solid growth in those areas. While I anticipate the display business will have a downturn in 2021 compared to 2020, the other sectors are more than compensating for that. Overall, it appears to be consistently progressing as we advance through the year.

John Pitzer, Analyst

Yeah. Good afternoon and thanks for letting me ask the question. First one is for Bren. Bren, I am wondering if you just give a little bit more detail around what happened to mix in the December quarter that drilled gross margins a little bit light relative to revenues being at the high end of the range and as we look out beyond March, are there any other mix considerations we should think about as we think about gross margins?

Bren Higgins, CFO

Yeah. John, it’s the usual quarter-to-quarter variability. So it was a little bit weaker in the December quarter and you see a bit of a bounce back into the March quarter. So we were 20 basis points below and we just guided 25 basis points over the midpoint or over that 62%. And as I look at the next several quarters and why I put the comments in the prepared remarks that I feel like we are operating in the 61.5% to 62% range. So it was really just a function of the products that actually revenue in the quarter. It’s a customer acceptance timing dynamic and not any other reason.

Rick Wallace, CEO

Yeah. That’s helpful. And then, Rick, as my follow up, maybe I will go back to the memory question that Patrick asked first, but ask it a little bit differently. If we are doing the math right, December quarter memory was a new record. You have to go back to kind of June of 2018 to see memory this high, and as you know, we in the investment community always think about that space is being kind of hyper-cyclical. We are willing to underwrite some of the structural drivers in logic and foundry, maybe not as much in memory. When you look at the level of memory business today, how do you kind of parse out where we are in the quote-unquote CapEx cycle for memory versus some of the structural drivers you outlined in Patrick’s answer? Sure, John. As you know, our dependence on technology transitions affects our perspective differently compared to volume. Our focus is primarily on the migration and yield challenges that come with advanced nodes, and we observe a consistent commitment from various players to enhance capabilities for the next generation. This leads to less variability in KLA's exposure. Consequently, volume considerations related to capital expenditures affect us to a lesser degree. Maybe Bren can provide more insight on how this will unfold over the year.

Bren Higgins, CFO

Well, John, it was fairly weak for most of 2020, but we saw an increase in the December quarter, which was expected. Looking ahead to 2021, we anticipate overall growth. We believe the DRAM market will likely grow at a higher percentage than the flash market, but we do expect to see growth in the business into 2021. The recovery has been quite disciplined, and seeing it bounce back in the December quarter with some sustainability at these levels as we progress through the beginning of 2021 is encouraging.

Krish Sankar, Analyst

Yeah. Hi. Thanks for taking my question. I had two of them to Rick. Just to follow along the thought process on memory, it seems like KLA the way it is today is relatively more exposed to NAND than DRAM. Do you think that exposure or process control intensity increases in DRAM as DRAM goes more EUV? And if so, how should we think about KLA’s revenue mix and then I had a follow-up.

Rick Wallace, CEO

The differences are quite minor regarding the underlying drivers. What we see is that different products are affected. In the case of DRAM, scaling plays a significant role, which is evident in our developments like GEN5. However, this isn't the case with NAND, though we do have new products to address some challenges, such as the X-ray technology related to metrology. Additionally, it influences our wafer and Surfscan business due to the strict requirements for flatness and cleanliness in NAND wafers, which are intensified by the vertical dimensions and the stress this places on semiconductor manufacturers to manage yields. While both areas are experiencing similar increases, the pressure in NAND is currently somewhat greater than in DRAM.

Bren Higgins, CFO

Krish, I want to add that with the introduction of EUV, we need to see how it develops, as it drives infrastructure requirements. This represents one level of investment, and I believe the challenge for our teams is whether this investment is sustainable over time. However, as customers begin to implement EUV, it will necessitate EUV-related infrastructure to help manage that. So, this is an important factor to consider that may indicate a change moving forward.

Krish Sankar, Analyst

Fair enough, Bren. And then another follow up for you on Services. In the shareholder letter, you spoke about how the Services attach rate grew from 70% to over 75% through the course of last year. I am just curious how high can it realistically get or put it another way, Service is running at 25% of total sales, can it get to over 30%? Thank you.

Bren Higgins, CFO

It will because it’s growing faster than the underlying systems business. If you look at our service model, it has a growth rate of 9% to 11%, which is what we discussed at Investor Day. I believe the increase in demand we’ve seen on the system side will support that growth rate moving forward. Customers are clearly valuing the service offerings, especially as demand increases, which leads to a necessity for them to maintain their tools. Many of these customers, particularly in the automotive sector, are facing higher reliability requirements, driving more investment in process control and the information derived from the tools. These factors have all been positive for us. I estimate that aiming for a service attach rate of around 80% to 85% is reasonable. However, there are always dynamics with certain customers who prefer a billable model, and we will need to navigate that resistance in moving to a contract structure. Ultimately, contract structures allow us to optimize the cost structure underneath and enhance profitability through different cycles. Therefore, while there are opportunities, some limits will remain as certain customers will prefer a total structure for parts of their installed base.

Rick Wallace, CEO

To add to that, the complexity of the tools being shipped today means that, similar to servicing a car, it is now much more necessary for customers to rely on us, unlike 15 years ago. Over time, our systems have increasingly included custom-designed parts, making it more economical for customers to depend on our services. There’s no doubt that a service model benefits customers through long-term contracts, reducing the risks of occasional issues and ensuring more reliable uptime. I agree with Bren that this trend will continue to rise, but progress in the services sector is typically slow due to the size of the installed base. It takes time for these figures to gradually increase, yet we remain dedicated to pursuing this goal.

Vivek Arya, Analyst

Thanks for taking my question. I had two as well. First is, if I take your March quarter outlook and annualize it, it suggests this calendar year growth in line with WFE growth. But when I look at some of the investments that are being made and 5-nanometer and then 3-nanometer on the foundry side and then the DRAM, which is more kind of logic-like. I am curious what are the prospects of outgrowing WFE? I guess it’s the process control intensity question just asked in a different way, like, what would help you grow above or below WFE this year?

Rick Wallace, CEO

When I consider the situation, it seems that we have made a slightly larger memory investment this year compared to 2020, which is affecting the intensity of process control. However, you are correct about the opportunities in foundry and logic, as well as the product offerings we anticipate for 2021. I believe we will at least keep pace with the market and may perform somewhat better. There are challenges and advantages to consider for this year, but overall, this is where the intensity of process control stands. Additionally, if we execute effectively, there are potential opportunities for modest improvements in our market share. Therefore, I anticipate KLA's share of WFE will remain stable or see slight growth in 2021 based on our current position.

Vivek Arya, Analyst

I understand. I have a follow-up question regarding cash returns to shareholders. Your profitability is quite similar to analog semiconductor companies, with operating margins around 37% to 38%. However, the free cash flow returns indicate there is significant room for improvement. Also, I noticed that the buybacks you executed in December were lower than the average over the past two years. I'm interested in your plans for cash returns moving forward. Given the strong growth expected this year and the positive long-term trends, why not consider aiming for 100% free cash flow returns and increasing dividends or buybacks?

Bren Higgins, CFO

If we reference Investor Day, we've consistently communicated our approach to capital allocation and our perspective that cash typically isn't valued until it's put to productive use. Moving forward, we anticipate being able to return at least 70%, which investors can factor into their long-term return expectations. Although we were close to that this year, it was somewhat unusual due to early COVID-related impacts. Our cash balance did increase a bit. However, considering the business's growth, I believe we can deploy more cash. We conduct a thorough analysis of the company's liquidity needs and currently operate at that level, which requires us to weigh those against growth opportunities for the business. I think we've handled this well. Generally, the 70% return is a baseline, and with the growth we are experiencing, I expect our share repurchases to rise quarter by quarter as we move forward. Regarding dividends, we've increased them for 11 consecutive years, targeting a payout ratio of about 35% to ensure we can keep raising it annually, even in challenging years. We plan to grow the dividend in line with our free cash flow growth. Therefore, over time, you can expect the dividend payout ratio to rise roughly in line with the growth in free cash flow. That's our strategy, and we will continue to evaluate it annually without any changes anticipated.

Vivek Arya, Analyst

Great. Thank you.

Sidney Ho, Analyst

Thank you for taking my question. My first question is regarding China. If my calculations are correct, the revenue from China decreased by about 20% quarter-over-quarter after a strong third quarter but is still up by a solid 20% for the year. What are your expectations for your opportunities in China this year?

Bren Higgins, CFO

I would expect WFE in China to be flat to up. The business levels we are observing align with that expectation. I would say it's very consistent with the profile of 20%, maybe slightly better, with different customers making investments. In general, that's how we see it.

Sidney Ho, Analyst

Okay. Great. Maybe my follow-up question is related to your target model. You printed operating margin 38%, guiding up to 39% plus, well ahead of your target model and it sounds like you are comfortable with that, you will continue to exceed that. But are there things that we should be aware of that may bring down operating margin as your revenue continue to grow either in next few years in terms of either cost of goods sold side of things, gross margin obviously, offerings expenses side, then we try to normalize a little bit over the next few years? Thanks.

Bren Higgins, CFO

There are always fluctuations from quarter to quarter. However, when considering our long-term plan, we aim to grow our top line by at least 7% to 9% and achieve an earnings per share growth rate that is 1.5 times that revenue growth. This approach results in an incremental operating margin of between 40% and 50%, and this is how we intend to operate the company over time. There are factors that influence our margins, such as gross margin and product mix, with services typically having a dilutive effect on the gross margin. We take these factors into account when developing our model. Yes, we are currently outperforming our public model, and the strong growth we have experienced in recent years has provided significant leverage for the business. I believe much of this growth is sustainable, as I mentioned earlier in my prepared remarks. This is our model, and we are exceeding it, with expectations to continue doing so in the coming quarters as outlined.

Timothy Arcuri, Analyst

Hi, guys. Thanks a lot. Bren, I am sorry, you might have already talked about this, but I actually jumped on late. So it seems like if you are going to hold WFE share pretty flat, which I think is pretty reasonable in the 6.3% or 6.4% range. It seems like your process control shipments are going to be or revenue is going to be in the 1.05% range for March and then it’s going to sort of stay in that range throughout the rest of the year. So you are not going to see this pronounced half-on-half decline that maybe some others will. Is that sort of the right way to think about the semis process piece?

Bren Higgins, CFO

So, Tim, you missed it. I covered it earlier and mentioned some prepared remarks about a consistent demand profile over the next few quarters. This isn't guidance, but just to provide context on how we see the year shaping up. Despite the issue we have regarding the general average selling prices of our tools, which can cause some variability from quarter to quarter, if you look at the March quarter, my expectations for the semi process control business are between 1.435% and 1.455%, including Service, somewhere in that range.

Timothy Arcuri, Analyst

Including service. Okay. Okay. Got it. Thanks.

Rick Wallace, CEO

And then, I had a question on NAND, so I know you don’t have a ton of visibility there. But your commentary that NAND is going to be sort of the weakest in terms of the relative end markets on a year-over-year basis this year is kind of interesting. I think some others are beginning to try to say the same thing, it sounds like about flat as the growing consensus. There was a pretty big budget flush from one of the big customers in the fourth quarter, so that was higher. But I guess my question is, is your view on NAND is it, because things have been cut, so because the procurement has been cut later on in the year as to why it’s flat or is it because the number’s the same, it’s just as off of the bigger base in 2020? Thanks.

Bren Higgins, CFO

Yeah. I think there is some growth in NAND. It’s the lowest percentage growth rate of the three segments that we articulated. So I think it’s probably a mid-single-digit type growth rate and that’s obviously off a bigger base as we look at ‘21.

Harlan Sur, Analyst

Good afternoon. Great job on the quarterly execution and strong results. In 2019 in Semiconductor Process Control, you guys gained about 300 basis points of share on the systems side. Revenue-wise you were about 5 times larger than your nearest competitor. It looks like your process control systems business grew about 17% in 2020. Do you guys think you sustained or gained overall process control market share in 2020 and then what areas do you think you drove the most share gains, then on your view of double-digit percentage revenue growth in 2021, what are going to be the fastest growing segments within process control?

Rick Wallace, CEO

Harlan, there are two aspects to address. First, we need to consider what drove our performance and which products were involved. EUV has significantly influenced our BBP performance, but it's not the sole factor for BBP's applications. We are pleased with how we concluded the year, as we gained market share and believe we maintained it. We'll wait for the final numbers, but recall that during Investor Day, we projected slower growth in share than what we are actually experiencing. We're optimistic about our BBP adoption and had a strong year in optical inspection in 2020. Looking ahead to 2021, we believe we are well-positioned to continue expanding our share and the adoption of our processes, driven by both end demand and new products entering the market. The strength in optical inspection is impressive, and we feel confident about our position there. We gained more in 2019 than in 2020, held our gains, and possibly built on them. We are poised to maintain this growth trajectory as we approach our plans for 2023, starting with 2021. That's how our plans are shaping up currently.

Bren Higgins, CFO

Yeah. The product families overall, all of them are showing growth. I would think that Rick talked a lot about the broadband plasma in the strength there. Because of the memory uptick we are seeing and after a couple of years now of digesting, we are seeing more patterned inspection or unpatterned inspection investment and so that’s a good indicator both to support the wafer output, but also which memory tends to drive wafer so that drives that business. And then the tool monitoring that is done with un-patterned inspectors for any monitor wafers in memory. And then in reticle inspection, I expect to see growth year-over-year above market kind of growth levels in that business as well.

Rick Wallace, CEO

Great. Thank you.

Kevin Kessel, Vice President of Investor Relations

Priscilla, looks like we are coming up on time here, I think we have time for one last question.

Operator, Operator

We will take our final question today from Quinn Bolton with Needham & Company. Your line is open.

Quinn Bolton, Analyst

Hey, guys. Someone addressed it in answering Harlan’s question there, but I was looking at the wafer inspection business up 32%. Just wondering if you could give a little bit more detail on what’s driving that strength. Is it mostly GEN5? Is it Surfscan? And in the script, I think you also mentioned some new applications in optical inspection? So I was just looking for some more color there.

Bren Higgins, CFO

It’s really connected to the optical inspection in GEN4 and GEN5. We're not only seeing this in GEN5, but GEN5 is where we notice the increased application specifically for supporting EUV. We discussed this idea at Investor Day. At that time, we hadn't observed the print check situation we anticipated. When customers print using EUV and validate that image, we recognize that as a significant application demand, and it’s proving to be accurate, which is fueling much of our business success moving forward. Additionally, as EUV becomes more common, scaling becomes increasingly important, making even small defects more critical. This shifts the focus more toward GEN5 compared to GEN4, benefiting us from both trends: new applications and enhanced scaling.

Rick Wallace, CEO

All right. We appreciate everybody’s time and interest. And I will pass the call back over to Priscilla to end.

Operator, Operator

This concludes the KLA Corporation December quarter 2020 earnings call and webcast. Please disconnect your line at this time and have a wonderful day.