Ladies and gentlemen, thank you for standby. And welcome to the KLA Corporation Third Quarter Fiscal 2020 Earnings Conference Call. [Operator Instructions] I would now like to hand the conference over to Mr. Kevin Kessel, Vice President of Investor Relations with KLA Corporation. Thank you, sir. Please go ahead.

Thank you, Charlie. And welcome to KLA's earnings conference call to discuss the results of the March 2020 quarter and the outlook for the June quarter. Joining me today is Rick Wallace, our Chief Executive Officer; and Bren Higgins, our Chief Financial Officer. During today's conference call, we will discuss quarterly results for the period ended March 31, 2020, that we released today after the market close and can be found on the Investor Relations section of our website. Today's discussion and our financial results and outlook 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 press release and the earnings slide presentation posted on the KLA IR website, along with our newly published shareholder letter. Our IR website also contains a calendar of future virtual investor events and presentations, corporate governance information, including our quiet period policy as well as links to KLA's 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. I'd like to now turn the call over to our President and Chief Executive Officer, Rick Wallace.

Thank you all for joining us today in these extraordinary times. I hope you and your families are safe and healthy. KLA delivered strong results in the March 2020 quarter. Revenue finished at the midpoint of our guidance, and non-GAAP EPS was above the midpoint of the guidance range, demonstrating strong demand from our customers and exceptional execution across our global KLA operations. KLA's performance in the March quarter highlights how the company's operating model and long-term strategic objectives provide a strong and resilient framework to guide our execution and consistently deliver on our commitments even during unprecedented challenges. In our prepared remarks today, we will discuss how KLA's unique and sustainable competitive advantages helped us consistently deliver strong relative results, while showcasing the enduring strength of the KLA investment thesis. We will also discuss how KLA is positioned to confidently navigate through these periods of uncertainty. To lead off, I want to highlight KLA's priorities and actions in addressing the COVID-19 crisis. Please turn to Slide 4. First and foremost, we are prioritizing the health and safety of our employees, their families and our partners. We began taking proactive measures for our teams as soon as we saw the outbreak begin in China, including immediately eliminating nonessential travel, canceling our annual sales conference, our global engineering conference as well as the KLA Lithography Users Forum at SPIE. A large percentage of our workforce is in China and the Pacific region, and we initiated a global crisis management team to ensure we had insight into needs and activities at the local levels to provide assistance as needed. As information and shelter-in-place orders began to roll out across the globe, we prioritized rapid communications to our employees. And we immediately instituted guidelines and policies to ensure that our essential workforce could…

Thank you, Rick. Please turn to Slide 11 for quarterly financial highlights. KLA delivered a solid quarter in March with revenue at the midpoint and non-GAAP EPS finishing at the upper end of the company's guidance ranges. Total revenue was $1.424 billion. Non-GAAP gross margin was 61.2%, at the upper end of the guided range for the quarter of 59.5% to 61.5%, driven by a richer product mix than was modeled at the beginning of the quarter. Non-GAAP operating margin was 34.6%. GAAP EPS was $0.50 and non-GAAP EPS was $2.47. At the guided tax planning rate of 13%, EPS would have been $2.52. The reconciliation between the GAAP and non-GAAP EPS includes an impairment of goodwill of $257 million and a $22.5 million loss related to the extinguishment of our November '21 notes that we refinanced in a new bond offering in February. Let me briefly provide more context on the goodwill impairment. During the March quarter, and consistent with our policy, KLA conducted its annual goodwill impairment assessment based on the discounted cash flows for each reporting unit. Given the uncertainty of the current environment and the associated unknown long-run trajectory of economic growth, we recorded a noncash impairment charge of $257 million in the third quarter to write down a portion of the carrying value of the goodwill associated with the Orbotech acquisition. Before going into further detail on quarterly results, I want to echo Rick's comments and say that while the COVID-19 situation is unprecedented and presents new challenges to running our business, one thing remains clear. KLA has a resilient business model underpinned by a rock-solid investment-grade balance sheet. We will continue to be agile in the marketplace and actively manage and responsibly navigate our way through this crisis. Additionally, we remain committed to maintaining…

Thank you, Bren. [Operator Instructions] Okay. Charlie, we're ready for the first question.

[Operator Instructions] Your first question comes from the line of Harlan Sur with JPMorgan.

Solid job on the quarterly execution. On the increased revenue guidance range for June, $280 million range versus $200 million for last quarter. You called out the COVID-19-related impact. It sounds like it's still more operational, logistics, personnel support. But I wondered if there's some part of that, that is demand related, potential pushing out of the business by customers either in your process control or Orbotech businesses on the potential for maybe some second half macro demand weakness. I'm just trying to figure out where the bias is skewed towards the larger range.

Harlan, it's Bren. I hope you're doing well. So the bias is more around just the operational constraints. As I mentioned in the prepared remarks, we are having to support the tools with our local teams, particularly around installations, and that can take a little bit longer. And as a result of that and the ability to handle escalations faster and so on, we've essentially put in some incremental risk -- or tried to account for some incremental risk in our overall execution. Clearly, the environment is very fluid by country. And so we have to be sensitive to navigate through that. There is a component of supply chain. But as I said in the prepared remarks, we feel very good about our supply chain positioning. So it's mostly more about the general uncertainty and what we're having to do operationally to deal with it.

Okay. Great. And then congrats on the 300 basis points of share gain in process control last year. I think now you're about 5x larger than your nearest competitor. On your commentary on the sustainability of process control intensity for this year, where are you seeing the biggest sustainable increases of this intensity? Is it China and NAND? Or is it just across all of the sectors given rising complexity? And then it also looks like your large logic customer is executing and finally getting back to sort of this 2-, 2.5-year cadence on node migrations after a long pause and much reuse. How does this also change your longer-term view on intensity for the team?

Yes. Great question, Harlan. I think that the biggest difference we see right now, I think, in the process control intensity is the realization that EUV and those in support of it really need more capability. And specifically, we've talked about Gen5 in the past being used for print check, and that's definitely driving adoption. In addition, we believe the sustainability is there based on new products that we introduced that we outlined in our Investor Day. And so it's really not one particular customer. It's really now we have Gen5 is really humming at every major customer and is growing in adoption. And maybe in the last couple of years, we went from being in the development phase to people actually expanding their footprint with that. But we also saw strength in laser scanning. And so I think even optical metrology, we mentioned in there, it's really pretty broad-based across the portfolio. And I do think in times like this, even if customers are going to back off capacity, which could happen later in the year, they're going to continue to invest in capabilities that allow them to bring out new technologies, which is always favorable for process control.

Your next question comes from the line of John Pitzer with Crédit Suisse.

Glad to hear that everyone is doing well. I guess, Bren, I want to go back to just the COVID-19 impact and whether or not you have a number that quantifies the March quarter impact. And was it an impact to shipments and rev rec or just rev rec? And I guess is the broader range for June just a realization that you're expecting the impact to be larger in the June quarter than the March quarter?

So John, on March, when we go back to when we gave guidance, we certainly felt that there would be some potential risk of pushout related to tools that were going into the affected areas in China, particularly in Hubei province. And so we tried to account for that in our guidance and expected that independent of the COVID effect that our guidance would have been higher. As the quarter went along, our issues were more -- we were able to ship a little bit into that area, which was positive for us. And we had some other puts and takes across the business. The challenge we had is with quarantine periods and travel restrictions, it is taking us some time to line up resources. And if you don't have the resources for installations, customers will want to readjust some of those delivery dates. So we did have some of those issues in the quarter, and it was more shipment based than it was revenue. So as we look at the June quarter, though, I mean, it's a pretty challenging situation out there. And as I said in the demand -- or in the prepared remarks, I mean, demand from customers has been pretty consistent. We think that carries forward in June. And so we widened the risk to be prudent -- or the range to be prudent just given the circumstances we think we're now facing. But we did the same exercise tool by tool, and we feel pretty comfortable with the guidance. But just overall, we're learning things every day about what's going on, and so we wanted to account for some of this uncertainty that's out there.

And then just as my follow-up, despite the wider range for June, I think we all appreciate the fact that you're trying to give us a guidance number out there with all the puts and takes, even more so, Bren, your commentary about the full year. But I'm kind of curious. I think 90 days ago, you would have characterized calendar year '20 as sort of an above trend year for growth for you guys, trend being sort of the 7% to 9% that underpins your 2023 target model. Relative to the puts and takes you talked about in your prepared comments, should we think about 2020 as being more of a trend growth year? Or is there not enough visibility to even say that?

Well, I think the visibility question is challenging. We have peer companies that couldn't even guide the quarter given some of the challenges. So when we look at it, I mean, it's hard to believe that we wouldn't see some impact into the second half from the environment we're now operating in. We do expect, based on our current view, that it will be a growth year for the company. But as I look at it today, again, a lot of moving parts. But I would say that it would probably likely be below that trend line. Not much below, but I think it'd be below.

Your next question comes from the line of Krish Sankar with Cowen and Company.

I had 2 of them. First one, either Bren or Rick, can you give a little bit color on the sales into China that you saw in March? What is the split between domestic and multinational and split between foundry and memory? And any kind of color into the June quarter on geography would be helpful. Then I have a follow-on.

Yes. Krish, I don't think I have it by -- broken down that way. As we said, revenue mix for China was 25%. I don't -- it's something we'll have to get back to you at this point for the March quarter.

Got it. Got it. That's fine. And then the second question I had was, when you look into your June guidance, when you look at the numbers, it looks like foundry is probably slowing a bit and memory is coming back. I understand no one has a crystal ball at this point, but would you expect the trend to continue to the calendar second half? Or is it more a function of just customer CapEx spending in Q2?

Yes. I mean I think our base assumption is that we'll see stronger memory environment in the second half. Obviously, that's part that might be -- part of the business that might be more impacted by what happens in the overall economy. But our base assumption is that we would see memory recover in the second half or be stronger in the second half. Now foundry seems -- the foundry and logic seems to be pretty consistent over the course of the year, at least at this point. So I wouldn't say it's weighted to 1 half or the other right now.

Your next question comes from the line of C.J. Muse with Evercore.

I guess first question, Bren, to go back to John's earlier question on COVID and the impact there. Can you share with us what kind of, I guess, impact to revenues you're embedding in the guide? Or should we take the midpoint as indicative of what you would do with or without indicating no supply chain issues? And then as part of the challenges around supply chain management and logistics, can you share with us what impact that might have on your cost structure as well?

So C.J., at some point, it becomes a little challenging to be -- to speculate on with and without given the environment we're operating in today and the adjustments we've had to make. If I just go back a few months, I mean, I would think that our revenue would be $100 million higher at the midpoint from a guidance perspective for the quarter in a normalized environment. Now we're far from a normalized environment and don't know when we'll get back there. So most of our adjustments, though, are related to just our ability to cadence our resources to be able to support customers. As we said in the prepared remarks, for the year, demand is virtually unchanged. We have seen some impact in some of the -- with customers that are closer to some consumer markets. But generally, our customers, particularly our largest customers, are still very focused on executing their plans and we're maintaining the flexibility to be as flexible as we can to respond to them. So I don't feel like I have significant supply issues to be able to make that happen, and we're running the factories to be able to respond to that. So they want to be in the right position to respond to their customers, and so we're managing our supply chain and our factory resources to have the flexibility to do that. If the business were to fall off in a meaningful way, of course, we're carrying a lot more resources than the -- that business level would suggest. And so there would be some adjustment required in terms of just the overall cost impact of that. But right now, that's how we're running the business, and we'll adjust as we go. We've done this before.

Very helpful. If I could follow up regarding the Department of Commerce ruling, and I know it's still very early, and I'm sure you're waiting clarity on how broad or narrow the rules will be pursued. But if you think about what's been written to date, the major ruling is for manufacturing in the U.S. And considering you do make tools and assemble tools offshore, is your first interpretation that you will not be impacted in terms of shipping into China based on kind of what you've read today?

Sure, C.J. I think that, to your point, it's relatively new. And we're still unpacking it. And as we said, we're working to gain clarity. But our understanding at this point is this will impact the tools that are manufactured in the U.S., which are manufactured for us in California. We have 3 major manufacturing sites: Israel, Singapore and here. So there's a potential impact depending on the customer in our final understanding of the ruling that will impact tools that come out of California. But even that, based on the words we had and the comments we made, it's still unclear. And we're getting guidance on that and actually working through it. So we haven't been able to come up with more than that at this point. But we still -- as we look to the year, we feel -- as Bren said, we understand that risk and potential risk, and we feel good about the year.

Your next question comes from the line of Vivek Arya with Bank of America Securities.

So sticking with this China export control, and again, I appreciate that it's somewhat earlier in the process. But I think you mentioned you already restrict shipments for military end use. So I'm curious, what else do you need to do to satisfy these new requirements, right? Whether or not you ship the end product from the U.S. or from overseas, if according to you, you're not shipping something for military end use, what more do you need to do? Like what is the mechanical process, I mean, going and asking for a license if you are not shipping anything for a military end use already?

So there's a couple of aspects of this as we understand it, but one of them is a rigorous process we're going through to make sure we understand the intent and the -- how to execute on this rule. And we're working with outside counsel, inside counsel to do that. And as we said, we already have some of the constraints. This was a broad policy, not simply about semiconductor equipment, and semiconductor equipment just happens to be included in this. So we will work through that process. But that is why we say that we already take steps to handle some of the questions that are being put forward, and we will continue to work through it. When we have more clarity -- and frankly, the rule is still -- there's still a period where further definition is happening until the end of June. So once we have more clarity, of course, we're going to share that.

Got it. And for my follow-up, I'm curious, what have you seen from a demand perspective and just from any supply chain issues in the first few weeks of the quarter? Because just from the outside looking at it, it seems as if, right, there are expectations that second half would get better, that macro conditions could improve, that people are slowly starting to get back. That's why I'm curious, but is it fair to say that June is the trough for the year? Just what -- how would you characterize what you have seen for the first few weeks of the quarter from a demand and a supply perspective?

So I think Bren -- this is Rick. Bren talked about the demand, but I'll give some color to it. I've had a number of conversations with customers. And I would say that everyone is continuing with their plan. The notable exception, as Bren mentioned, consumer facing and anybody that's dealing directly, for example, with automobile, I think that's an area where there's been constraint. But it's been compensated for by some of our other customers who actually see increase in demand driven by some of the work-from-home trends. So I think that in balance, we're seeing that. The supply chain actually got better in terms of some of the supply that we had in Asia, specifically China, where coming out of Chinese New Year, part of what we weren't sure about was the supply chain that we had in China, how effective they were going to be and how efficient. That's fully recovered, and we're back actually above the level of supply for some of those parts. And we've pretty definitely moved through the different opportunities for supply, and we feel very good about our ability to navigate that. As Bren said, it's not easy, but we're confident of our ability to do it. So we don't really see a reason to change it. So then what we're backing up to is what are the macro implications of the economic downturn and subsequent recovery. And since we don't have a way to really understand that long term because I don't think anybody really knows, we just model different scenarios for what that might look like. But we have no leading indicators right now of any real change in behavior.

Yes. And just an additional point here is the internal forecast would suggest that the second half is stronger. I think the challenge we have to Rick's point is what ultimately happens with our customers' demand profile and what that means to supply. Now there are lead times with -- and so on, and those issues are things that customers have to contemplate as they think about how they're managing their capacity. But that's essentially where we're at. So we'll have to see how that plays out, what that ultimately means to them and then ultimately what that means to their demand for our products. We do have a certain amount of investment that happens in supporting technology road maps. Those are continuing on a normalized pace. And so we would expect that for products that are particularly focused on enabling technology transitions that those products would be more resilient than more capacity-centric products depending on one environment. But I'm not ready to call a trough here in the June quarter until we get better visibility about what ultimately thing -- how things will look in the September quarter is, I think, one of the challenges that we're facing here. We don't talk about it very much, but I think that the way we manage the supply chain is a competitive advantage for KLA. We talk about our operating model, and a lot of that has to do with how we manage supply chains, how we run our factories. We work with suppliers that provide very high end capability for us, and we engage very closely with them. We buy parts earlier. We commit earlier. So we're able to navigate through, certainly for key components, potential disruptions and working with them to make sure they're in a place to be able to support us in whatever environment we might end up in. We have the service business. It's very contract based. The products live a long time. So having extra parts from time to time is the least of my concerns generally as a CFO running this company. So I think that, that situation works for us. And with the extension of demand in terms of how it's affecting, how long products are living, we tend to work our way through the parts that we do have. So it slows down inventory turns, but it is fundamental to the operating model of the company. And I think the margin profile reflects that.

Your next question comes from the line of Timothy Arcuri with UBS.

Bren, I also wanted to ask on the Commerce changes. It certainly looks like you have some cover on the direct product rule for the stuff being made outside the U.S. when you sort of look through the CCL list and at the ECCN categorizations. But the language around end use and end user seems to be very ambiguous. And I guess -- we obviously hope to get clear interpretation from Commerce before June 29. But the experts that I've talked to indicate that it's sort of purposely ambiguous. So I guess the question is, if you have to apply when in doubt, would you agree that the risk might be more on the foundry/logic side and less on the memory side?

Tim, I think it's too early to speculate. I mean I -- yes, it's too early to speculate.

Okay. And then, Bren, I guess, a follow-up on the impairment. So 15% of the acquired goodwill was written down. So can you just quantify, did that have any impact on the sort of long-term growth prospect for the Orbotech businesses? Or do you think that even though that was written down that long-term numbers that were put into the model at Analyst Day still hold?

Yes. Tim, as you know, these are asset-light businesses. And so there's a fair amount of purchase consideration that shows up in goodwill. And what that reflects really is when you do valuations, as we all know, and you do a discounted cash flow that -- as cash flows push out and what discount rates you use have an effect on ultimate value. Certainly, in the near term, in some of those businesses, if you look at the specialty semiconductor business, being impacted by trade last year and some of the automotive dynamics into this year, that did affect some of our near-term focus -- forecast. So over the long run -- and then I think the second part is around flat panel where we saw -- we expected to see more recovery in flat panel CapEx into '20, and we're not seeing that. So there were some modest adjustments related to COVID and some of these issues that I mentioned and then just the general uncertainty in terms of how that affects an ultimate discount rate that you use. But to be clear, we do feel very comfortable with the growth rate trajectory that we presented at Investor Day back in September. And it's really a function of the things I talked about, just given the uncertainty of the current environment that we're operating in.

Your next question comes from the line of Quinn Bolton with Needham & Company.

Bren, just wanted to ask on the gross margin. You guided 59% to 61%. Wondering if there's any impact from spacing requirements and social distancing on that manufacturing capacity or your cycle times within your own facilities.

Yes. That's a good question. I mean in our facilities, most of our builds are bay builds, and so we're able to comply with some of the social distancing challenges there pretty effectively. So it's not really related to that. I think from a cycle time point of view, we're executing generally in line with our plans. Quarter-to-quarter, it's really more around just some of the mix of products that we expect to see this quarter versus last quarter. And the service profitability levels were particularly strong last quarter, I think, with some of the delays in just activity out there and so how that affected our cost structure. So I would expect some of those costs to come back as we move into this quarter. So overall, it was a little bit richer than we expected in the March quarter, and we're seeing some adjustment into the June quarter. But the long-term view at the current sort of expected revenue levels is to see gross margins between 60% and 61%, with the biggest factor being mostly around the mix of products.

Great. And then a follow-up question. You mentioned the 3 main manufacturing sites: Israel, Singapore and U.S. Wondering if you have redundant capacity to build the same tool at multiple sites. And if you don't have that capacity today, does the export control action and just the COVID outbreak make you rethink whether having redundant manufacturing capacity is -- would be part of a long-term 3- to 5-year plan?

Yes, it's a great question. We have definitely the ability -- the similarity in what we do in these different sites allow us some flexibility, which over time has caused us actually to transition more to the sites out of the U.S. in both the case of Israel and also in Singapore. So that's something that we're always evaluating in terms of our ability and flexibility to manufacture different products in different locations based on customer needs, supply chain and our staffing. So of course, that's a lever and an option that we have as we look out and think about where the best place to be positioned is.

Your next question comes from the line of Joe Quatrochi with Wells Fargo.

Yes. Looks like you're thinking about a nice sequential increase in implied memory revenue for the June quarter. I was wondering, can you help us understand the drivers of that? Is it more of a market recovery? Or are there also some kind of embedded assumptions around new product shipments that you've launched recently?

It's funny, I went back and I looked at -- if you looked at the March quarter revenue levels for memory, it was probably our lowest since about 2016. So in some ways, there was a bit of a trough there in terms of just the overall business level for memory. So we do see a pickup. The pickup is pretty balanced across the -- it's about 50-50 overall of what we expect in the quarter from flash and DRAM. So I wouldn't say it's related to anything in particular other than just we're seeing a stronger revenue profile this quarter versus a very low one last quarter.

Okay. And then just on the record backlog, when we think about your comments around the long-term target for growth rate for 2020, how do we think about the backlog covering that relative to prior years?

Well, we have record backlog today. So we had a very strong order quarter, record backlog this quarter. So that certainly gives us some comfort. I mean customer demand is there. We have the backlog. We have the parts. So as I said, we're in a position where we can deliver to any scenario. So we feel pretty confident about that. But we really just have to see where our customers are ultimately in what they do. But certainly, the backlog does give us confidence really across the businesses to -- with a certain expectation. But again, depending on what happens with their business, then sometimes they do push dates and things like that. But given the lead time for our products, the backlog gives us some comfort about what we see in front of us over the next 6 months or so.

I think, John, as you think about the longer term, the 2023 plan, the biggest variable in that from our standpoint is really what happens in the macro economy because when we look at all the trends that we've said, the new products, the market share, the secular dynamics, everything is really working the way we had envisioned. And we're executing -- and we feel really great about that. What we can't forecast at this point is how deep and how long any kind of economic disruption is. So that's the thing that will really ultimately determine the pace of the overall industry. I do think that there are aspects of the semiconductor and semiconductor equipment industry that are actually going to do quite well. So unlike general recessions we've had or the '08, '09, there's aspects of what we do that are enabling people to actually continue to function through this time period. But ultimately, if there's macroeconomic shock, it's going to -- depending on how long it goes, it will alter those plans in terms of the length of the time it will take to come out of this. And that's the thing we're in no position to forecast.

Ladies and gentlemen, that concludes our Q&A session for today. I'll now turn the call over back to the presenters.

Thank you very much, and we appreciate everybody tuning in today. We look forward to chatting with you going forward. This ends the call.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating, you may now disconnect.