Ladies and gentlemen, thank you for standing by, and welcome to the KLA Corporation Fourth Quarter Fiscal Year 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to Mr. Kevin Kessel, Vice President of Investor Relations. Please go ahead, sir.

Thank you, and welcome to KLA’s fiscal Q4 2020 quarterly earnings call to discuss the results of our June quarter and the outlook for the September quarter. Joining 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 ended June 30, 2020 that we released today after the market close in the form of a press release, Shareholder Letter and slide deck. All these documents can be found on the IR section of our website. Today’s discussion of 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 materials posted on the KLA IR website. Our IR website also contains a calendar of future virtual investor events as well as presentations, corporate governance information, including our quiet period policy and links to KLA’s SEC filings, including the 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 disclosed 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 we mentioned last quarter, we are changing the format of these calls to provide deeper insights into KLA and our business performance and also a lot more time for Q&A. beginning of this quarter, we will provide some highlights from our full prepared remarks, which can be found in the shareholders’ letter before beginning our Q&A session. I encourage you all to read the letter. It can be accessed on our KLA IR website. And with that, I’d like to turn the call over to our President and Chief Executive Officer, Rick Wallace.

Thanks, Kevin and thank you all for joining us today. On behalf of all of us at KLA, we hope you and your families are safe and in good health, and we thank you for your continued interest and support of our company. In many ways, our performance in the June quarter, once again, highlights how the KLA operating model and long-term strategic objectives provide a dependable framework to guide our execution and help us consistently deliver on our commitments. Thanks to the dedication, engagement and perseverance of our global workforce in the face of the challenges posed by the COVID-19 pandemic. KLA delivered strong results in the June 2020 quarter. Revenue and non-GAAP EPS each finished above the midpoint of our guidance ranges, demonstrating strong consistent demand from our customers, exceptional execution by our teams and the enduring strength and resiliency of the KLA operating model under today’s extraordinary circumstances. For my opening remarks today, I plan to touch on some of the key messages from our letter to shareholders. I’ll start with an update on our priorities related to COVID-19, touch on the industry demand environment, and then cover five highlights from the quarter before passing it to Bren, who will review our financial highlights and our outlook. In terms of COVID-19, we continue to take proactive measures to ensure the health and safety of our employees, their families, and our partners. Our action to date have been successful and effective as reflected in our strong financial results in the first half of calendar 2020, but more importantly, in our safety record to this point in this pandemic. It’s also important is that our worldwide teams have never lost sight of what our customers need. Our teams have been exceptionally resourceful and committed to executing for our customers…

Thanks, Rick. KLA’s June quarter results highlight both the soundness and strength of our ongoing strategy. We are demonstrating our ability to meet customer needs and expand our market leadership all while growing operating profits generating strong free cash flow and maintaining our robust capital return strategies. Total revenue was $1.46 billion. non-GAAP gross margin was 60.3%, slightly above the midpoint of the guided range of the quarter of 59% to 61%. Non-GAAP EPS was $2.73 towards the high end of the guiding range of $1.81 to $2.87. GAAP EPS was $2.63. Revenue for the Semiconductor Process Control segment was modestly above expectations for the quarter. Foundry was once again strong at approximately 50% of semiconductor process control systems’ revenue. logic was about 10% of semiconductor systems revenue and memory customers were roughly flat at 40% in the June quarter. Within memory, the business was evenly split about 50/50 between DRAM and NAND. revenue for the specialty semiconductor process segment was a record $100 million, up 18% sequentially and 50% year-over-year is on track for double-digit growth in calendar 2020. PCB, display and component inspection revenue was also a record at $202 million, up 26% sequentially, and 10% year-over-year and above internal plans. In terms of balance sheet highlights, KLA ended the quarter with $2 billion in cash, total data, $3.5 billion and a flexible and attractive bond maturity profile supported by investment grade ratings from all three agencies. From a cash flow and capital returns perspective, free cash flow was $411 million in the June quarter. free cash flow conversion was 96.5% and free cash flow margin was 28.2%. for capital returns over the past 12 months, we have returned $1.35 billion to shareholders or 83% of free cash flow, including $522 million in dividends paid and $829 million…

Charlie, please provide the instructions for the queuing and begin the Q&A.

Sure, sir. [Operator Instructions] Your first question comes from the line of Harlan Sur with JPMorgan. your line is now open.

good afternoon, solid job on the quarterly execution. Three months ago, the industry’s supply chain, as well as demand trends looked pretty uncertain. You fast forward to today, supply chain has come back semiconductor fundamentals while we can, June or as fully showing signs of improvement entering the second half of the year. If I look at your results and guide and make some assumptions on December, it looks like you will be towards the upper end of your pre-COVID-19 revenue outlook or sort of in that low-double digits percentage revenue goal for this calendar year first. is that a fair assumption and maybe some commentary on your WFE spending outlook today versus pre-COVID-19 earlier this year?

Hey, Harlan, it’s Bren and I’ll go first here. So, I think your conclusions are generally correct. As we said in the prepared remarks, we see our view on the year to be generally at the – within our long-term target growth range of 7% to 9% or above. And so as we look at the year overall, I don’t think things have changed all that much. I mean, you’re right. There was a lot that had to be done back in March and June in terms of managing supply chain and supporting customers, but we’ve worked through all that and we’ve got some consistency now in our overall view. So in general, I would say that our views overall are virtually unchanged. on WFE, everybody counts it up a little bit differently, but I would – so I don’t want to put a point number out there, but I would say that somewhere in the mid-to-high single-digit type growth, 55 to – or mid-50s to high-50s, probably the right way to think about it.

Great. Thanks for that. And you entered the June quarter, I remember what the view of strong specialty semiconductor trends, but maybe, more meta trends within some of your other EPC segments like PCB and display as these are more consumer and sort of auto focused – automotive focus segments for you guys and probably, more impacted by COVID-19. but you’ve got it delivered strong double-digit sequential and year-over-year growth in the PCB, display and component inspection business. So, what drove these solid trends and how are you thinking about this particular segment as you move through the second half of this year?

Yes. thanks, Harlan. We’re really pleased with their performance in EPC and I think you have to – when you think about the different divisions, we saw a strong continuing momentum in packaging, and that’s really the ICOS business. We’re also seeing SPTS, the specialty semi business had a very strong showing and we mentioned that set a record there for revenue. PCB was earlier in the year, looked like it was going to soften and it strengthened and driven a lot by 5g infrastructure build out and we feel really good about the execution in that team. display is still in a tough spot and that’s not one that really, we saw a lot of strength and we’re following through on the conversations we’ve had on display, where we’re working on the cost structure and being positioned for when the recovery happens there. But I think the other business is – the other thing that’s really notable is SPTs had a very strong quarter in spite of no automotive business. So that’s really upside as we go forward. I think it’s pretty fair to say automotive semiconductors have bottomed. And so we feel pretty good about – it’s pretty much all upside from here as the spending has probably been curtailed, but showed signs toward the end of next year – this year and then into 2021, we’ll see some resumption of investment as the electrification projects continue. So yes, we feel good about where we are with that and we are definitely getting traction, having those under one organization and engaging with customers at a high level.

Hey, Harlan, it’s bren. The only other thing I’ll add to that is we go back to April, when we were thinking about the quarter, it was unclear what the handset environment would look like in the second half of the year. And so I think one of the encouraging signs that we did see to Rick’s point was the PCB business was really driven by 5G and the preparation for the handset introductions that are to come. So, that was a bit of a surprise for us or perhaps had someone known built into it just related to overall COVID. So, I drove the SPTS business as Rick said, but also drove incremental upside in PCB.

Your next question comes from the line of John Pitzer with Credit Suisse. Your line is now open.

Yes. good afternoon, guys. Congratulations on the solid results. Thanks for letting me ask the question. Bren, just on the gross margin guide into September, pretty good sequential growth. I’m wondering if you could just unpack that a little bit. Is this a larger percent coming from the semi process control or is it mixed within SPC? And I guess importantly, do you think that the June quarter and now growth into September is a trend that you can sustain going forward? Or is this kind of an anomaly quarter relative to mix?

Yes. Hey, John. So, I would say that, yes, I mean, quarter-to-quarter, we’re seeing sequential growth in semi PC. and so that’s having a positive effect on gross margins. And so I think that what we’re seeing there, I’m encouraged as I said in the shareholder letter, we talked a lot about driving cost and efficiency improvements in new platforms and customer section has been strong. So, we feel pretty good about the product portfolio we have and the margin position. So, let me just say that I have more confidence around our margin trajectory moving forward, although quarter-to-quarter, the mixed dynamic tends to be the biggest factor that drives our margin around this range. But certainly, as we look forward, we feel pretty confident that we should be able to maintain this sort of 61% and above type trajectory that that we’re experiencing right now.

Helpful. And then as my follow-up, Rick, you talked about second half of the calendar year growing over the first half, I’m kind of curious if you could break that down between sort of memory and logic/foundry, and how might that have changed over the last 90 days? I don’t want to words in your mouth, but it sounds like maybe, you’re less optimistic about a memory uptick in the back half of the year and perhaps more optimistic about logic/foundry sustaining, and if that’s the case in any read as we go into calendar year 2021.

Yes. We do see we see – we think there’s a lot of evidence that the foundry-logic is going to hold through the second half. And I think that also now, we’re getting indications of strength going into 2021. Part of the uncertainty, I think around the year that everybody has is the memory recovery probably towards the end of the calendar year. And that’s really where we would expect it to Q4 to strengthen there. So that’s I think maybe the less certain part of that, but the setup for logic looks really good. I think the progress that customers and designs, and the ongoing investment by our customers and in multiple design wins and multiple proliferation of devices and multiple players. So, we’re also getting breadth and our products are doing really well. So, we feel pretty strong about how the logic/foundry is going to hold up.

Your next question comes from the line of Krish Sankar with Cowen and company. Your line is now open.

Yes. Hi, thanks for taking my question. I have two of them. First one either Rick or Bren, clearly, like two of your largest logic and foundry customers have spoken about push out of either the 7-nanometer or potentially even the 3-nanometer on the foundry side. with the backdrop, how do you think of KLA’s process control revenue opportunity over the next year or two, given that some of the leading-edge nodes are getting pushed out and then I have a follow-up?

Yes. There’s really nothing that’s been discussed publicly that hadn’t been the way we’d been factoring and forecasting our business. So, it’s pretty much consistent with what we’ve seen. I think some of the public announcements are catching up with some of what was going on. you have to look at why there are delays; when there are delays and the delays tend to come from it’s much more an inability to execute than it is a demand. There’s plenty of demand at the leading edge. It’s the challenges associated with yield management with process control with the overall process integration and those are factors that we’re heavily involved in. So, we think that there’s a lot of continued momentum for us and process control both metrology and inspection on the leading nodes. And so that’s part of why our earlier comments in the last Q&A question, where about the strength that we see through the calendar year and then into 2021. So, we feel pretty good about how that’s going. And I think our in partnership with our customers; we’re helping them work through some of the most challenging metrology and effectivity issues. Some of which frankly, they did not anticipate, but we did and we’ve been showing some value and getting adoption as a result. Does that make sense?

Yes, yes. that does. thanks a lot, Rick. And then just to follow-up on the product side, you guys introduced pattern wafer e-beam inspection to look semicon. I’m just trying to figure it out, is your e-beam tool still focused on defect detection, or you feel looking at pattern facility of voltage contract, and your competent isn’t going to like multi-beam tools. You guys are still at single beam. So, you just want to figure out the e-beam roadmap. Thank you.

Yes. So, what we wanted to make sure is that we could provide differentiated performance for – to address the market gaps that existed and that we could provide customers a complimentary solution along with our optical tools, because what they’re really trying to balance is how do they get all the characterization understanding and product development that they’re looking for out of a portfolio? So, we have some unique capabilities in our e-beam inspection tool. We think that the coverage it provides and the uniqueness, in addition to the fact that it’s closely coupled with our optical tools, it gives a very strong advantage to our customers by using them in parallel. And that’s what we’re seeing. We have mapped out and we have a lot of confidence that we understand what the roadmaps look like in terms of the different e-beam architectures and we feel very confident about our ability to be competitive in e-beam. We wouldn’t have reentered the market if we didn’t feel like we had a differentiated solution. And so that’s the ability both to find the defects of interest and to find them as throughputs that are compelling for our customers and we – as we map out the future, we don’t see any gap between us and competitors. In fact, we see that we have the ability to continue to differentiate our solution.

Your next question comes from the line of CJ Muse with Evercore ISI. your line is now open.

Yes. Good afternoon. Thank you for taking the question. I guess first question, I was hoping you could provide a little more color on your prepared comments, regarding memory and a greater breadth of spending into Q4 and then beyond into 2021. We’d love to hear kind of what you’re hearing in dialogue with customers there.

Yes, CJ. it’s bren. So I mean, judging by our percent of business for the September quarter’s memory. It’s lighter than in June. So, most of what we see in the second half, and this was one area, where it wasn’t all that clear if you back up three months ago and say, okay, we thought we’d see some memory recovery in the second half of the year wasn’t exactly sure when we’d see it. But as we’ve – so it looks like it’s more December focused. And it – I would say, it is probably heavier on the flash side, although there is fluidity in terms of how customers are thinking about investment plans, but I think you can look at all the players that are out there that we would expect to see business start to improve in that timeframe. And then I think there’s solid momentum as we move into next year. I don’t want to provide a color on 2021, but I think as we take a step back and look at where memory has been, I mean, starting in the middle of 2018, we’ve seen a pullback and very disciplined management of memory capacity and most of the investment focused on technology transition. So, as that market continues to recover, I think that the market’s in a pretty healthy place overall as we move into 2021.

That’s helpful. As my follow-up for the PCB display and component business including service, how are you thinking about second half calendar year versus the first half? And then as part of that, how should we be thinking about seasonality in terms of peak quarter Q3 versus Q4 given how dominant PCB is within the construct there. Thank you.

Yes, SPTS, I would – it potentially could be flattish half to half. We’ll have to see how it plays out. I think PCB second half will be slightly – it will probably be lower in the second half, given what’s driven that the strength we saw in the June quarter, I would expect a lot of focus on execution as we move into the second half there. on the flat panel business, I wouldn’t expect much to change on that front. It is a 100% consumer focus. There’s virtually no LCD investment out there. And so there’s a fair amount of digestion of that capacity that’s still being worked through. So, I don’t expect any growth; in fact, maybe, second half might be flat to modestly down in that business.

Your next question comes from the line of Patrick Ho with Stifel. Your line is now open.

Hi. thank you very much and congrats on the nice quarter. Just maybe, following up CJ’s question about the memory span and timing, typically memory is a little bit more metrology biased versus say logic and foundry being a little more inspection biased. Is there any difference on the timing of your tool deliveries, because what I’m trying to get at is inspection tends to lead some of the process tools, but metrology may come in conjunction with process tools? So, am I looking at that correctly or are there still “lead time” in terms of metrology shipments relative to process tools?

that’s a good question. Certainly metrology, certain parts of metrology, like in film measurement and overlay tends to scale with capacity, but you also have on patterned inspection that scales also with capacity on the patterned inspection side, it tends to be a little bit more front-end in terms of just the development process itself. So now, I think from a lead time point of view, I don’t think the lead times on the products are all that much different a few months or so, but generally, that’s how it plays out.

Great. That’s helpful. And maybe, Bren as a follow-up, in terms of the opex management, you probably have gotten some savings over the last several months due to COVID-19 and the diminishing of travel and things of that nature, as we get back to a more normalized environment, how do you balance some of the increases that will come from that versus these attractive OpEx levels that you’re achieving today?

Yes, that’s a good question. And we’re probably operating right now, $10 million to $15 million below what I’d considered to be normalized run rates. We certainly wish we could add people faster, both in terms of new heads, but also a replacement head count. And so this process – this situation has slowed us down from that perspective. So, I think if you just look at overall spending levels today, relative to revenue or size in the company in that $380 million to $385 million range. I mean, ultimately, the way we’re going to run the company over the long-term is to drive a 1.5X drop through – 1.5X the revenue growth rate drop through to earnings. And so that implies 40% to 50% incremental operating margins. So, for every incremental dollar of revenue, we’re probably going to increase costs $0.10 to $0.15 or so. So that’s the way that if our incremental gross margins are above 60%. So, it’s a way to think about it. So, we’re going to look at the opportunities to invest. We always invest in our portfolio, that’s why our market share is almost 5X, our nearest competitors. Why we introduce products faster than our competitors is that we want to make sure we’ve got the best products out there and we continue to innovate. And so we’re going to look at the opportunities first and foremost and then size over time, consistent with our long-term model.

Your next question comes from the line of Timothy Arcuri with UBS. your line is now open.

Thanks a lot. So Bren, I guess that my first question is on the process control revenue. So, [Technical Difficulty] down in June, and I know that, there was maybe, some difficult comps, because of the Q4 last year. but WFE in the first half of this year is definitely up and your process control shipments have been down in March and June, and – but it sounds like you think that you’re going to at least keep up with the WFE for the year. So that would imply a pretty big back half of the year, given what’s happened here in the first half? Can you maybe, hold our hand a little bit and tell us why you seem to have lost like a little bit of share in the first half and maybe, why process control will be up so much and maybe, help us gauge how much will it be up in September? Are you talking 10% to 15% Q-on-Q? thanks. And then I have a follow-up.

So Tim, we don’t really look at WFE spent half-to-half years. I just look at overall expectations and the way we laid out the year at the beginning of the year, and we’re mostly in line with the plan that we had and against the backdrop of, let’s say WFE levels that are mid, single-digit growth for the year. I would expect our process control business to outperform the market. So, as I said earlier around since it’s such a big part of our business, that we would expect it to be within our target revenue range for the year is slightly above process control that statement’s consistent for a process control segment as well.

Bren, I guess to sum up…

But half-to-half, I would expect it to be up. I would expect it to be up half-to-half.

And I guess just on that point, can you give us a sense for where you think it’ll be in September and then I guess my follow-up was, you didn’t really purchase any shares in the quarter, which is kind of interesting, why not. Thanks.

September, we guide the overall company and we manage and deploy resources across all of our businesses to meet our expectations. And so I don’t want to guide the semi PC business, but in terms of just overall expectations, I’d expect that business to grow mid single digits versus the June quarter. But that being said, if I’ve got strength in other parts of the company, and I may deploy resources in a different way that that helps us sort of manage to our overall numbers, but at the end of the day, what we’re really trying to do is drive to our expectations and to continue to ship and support customers according to their timing. But I would expect that mid single digit sort of quarter-to-quarter growth in that segment.

your next question comes from the line of Vivek Arya with Banc of America Securities. Your line is now open.

Thank you for taking my question. I think, Rick or Bren, you mentioned some signs of foundry demand perhaps sustaining into next year. I was hoping if you could give us some more color, because I think consensus seems to be that foundry demand could actually – possibly decline next year. And I realize it’s early, but from what you see today, is it possible that foundry demand could actually be positive next year?

Yes, it’s really early for next year, but what we do see is, multiple customers making investments in foundry. And so far this year, it’s been largely a smaller group, so one. and so the expansion of that is really in the conversations we’ve been having and the commitment to that is what gives us the confidence for the second half of the year, and then the following projects that are coming after that, or why we think it’s a good setup for 2021. But obviously, there’s a long time between now and then. but I think the notion that there is success at these advanced nodes that you have the 5G infrastructure building out, you have a lot going on in the advanced computing and high performance computing along with the work toward AI is all very positive for what we’re seeing in terms of the continued investment in foundry and logic. And a lot of that is driven by the additional capability people are getting from the advanced nodes. So, that’s what gives us confidence that plus the conversations we’re having and the – our challenge in meeting some of the slot demands through the rest of the year, just to keep up with what customers are talking about needing, and we have pretty good ways of judging their actual intent. There are also a number of projects in China that are IoT RF sensor focused. And so it’s made foundry a higher percentage of the mix overall this year and we would expect some sustainability in that as we move into next year. So, to Rick’s point, there’s a fair amount of diversification, really across all end markets. we would expect automotive and industrial, and those areas that sort of fits back with the China statement or more trailing edge to be better next year and there’s enough in-market demand at the leading edge that’s driving incremental customer investment and mitigating reuse, and so on. So, I think the setup as we continue this year and the rest of the year, but also, has been moving to next year, it looks pretty good. Hey, there was a question earlier, Tim’s question on share repurchase. I just want to spend a second on it. So, we – as we started the quarter, we focused on overall liquidity and wanted to see how the market shaked out, given all the unknowns on COVID. So, as we progressed through the quarter, we did pause our share repurchase plan. We did buy back a fair amount of shares in the March quarter and we’d expect that we’ll start our capital allocation program. We’ll begin at this quarter again, at least around share repurchases and should finish the year in line with our objective of returning at least 70% of the cash flow we generate to shareholders. So, I would expect this year to be above that baseline.

And if I could ask a quick follow-up, there are two big trends going on. So, TSMC appears to be getting stronger. So, there are fewer, perhaps a high-end, leading edge customers to go after. And then there is also this trend of more sovereign manufacturing, but I understand it’s probably same demand, but maybe, scattered across a more places that could cause some cyclicality and I don’t know, how do you think KLA is positioned, when there are fewer leading edge foundry customers, and then if there is more sovereign manufacturing, does it shift more of the spending towards your competitors, who are exposed more to capacity rather than do technology ships or yield improvement? Just how do these two big trends play out for KLA over the next few years? Thank you.

I wouldn’t say there are fewer. So, I think if you look at leading edge investment and certainly, our expectations for what we’ve seen in this business, and what we expect going forward is to Rick’s earlier point, is no correlation between any of the announcements or conjecture that’s in the marketplace versus what we’re doing internally. So, we feel very good about the leading edge adoption that’s out there. And I think that as you see the end markets adopt, I think that that deploys more capacity. And with foundries – if foundries are providing more of that capacity, then that tends to be a higher process control intensity and as those customers have to deliver a lot of yielded product to type market windows. So, we feel pretty good about that. There’s a lot of end demand and there’s specific designs for those – for that demand. And so I think on the trailing edge side, there’s some start-up costs for new projects or maybe, inefficiency in the market. but over time, they’re building to specific markets and you might see some trading of capacity there. But overall, I think we feel pretty good about the leading edge environment, particularly end demand, but also the technology scaling that’s now happening with EUV.

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

Yes. Thanks for taking the question. In the past, you’ve talked about opportunities for higher metrology intensity at NAND flash at higher layer counts. So, I’m just curious, as we go into this next memory spending cycle, relative to the half cycle, how do we – how should we think about just your opportunity there for kind of the peak cycle revenues relative to the last cycle?

Yes. I’ll take the first part and then Bren can fill in the number, thinking that industry, Joe, I mean, what we’ve seen in two things; one as the design rules have or the design complexity has pushed both in flash and of course, in DRAM, that does create more opportunity. In some cases, the opportunity was already there. What was missing from us was necessarily a solution. So, a part of it was having the capability and tools to support the advanced node and the needs, and that’s something that we’re pretty happy with in terms of, as we laid out in the past, our ability to drive up process control, intensity, and memory, and we’ve already seen the first part of that. So, we feel validated in that approach. The other thing that’s interesting and we didn’t necessarily know is going to happen, but on DRAM, the introduction of EUV for DRAM driving more defectivity needs and capability, and the usage of that. So, there are some really positive trends in terms of driving process control intensity well above what it was in the past for memory. We really went backwards when the first move to NAND was first introduced, because they went back a couple of design rules, and now they’re back moving forward, we have some product capability. We’ve learned how to solve some of these problems and we’re engaged closely with customers. So, we feel good about the progression of process control intensity as the design rules continue to move forward with the technology nodes continue. It’s not just design rules as you know, but the challenges in the increased number of layers. So, Bren from a standpoint of the numbers.

Yes. I think we’ve seen process control share of WFE increased two to three points from the transition from planar NAND to vertical NAND. To Rick’s point, we do have some new products in the pipeline that if these products are effective and can be deployed in multiple units across fabs, give us an opportunity to improve that intensity, even higher, both in terms of metrology with some x-ray capability that we’re working on, but also if we can help solve the deep activity challenge, and defects within the stack and locating defects within the depth dimension of the stack. So, there is no shortage of opportunities, and I think we’ve seen it improve so far and we look to see a little bit of improvement moving forward. On the DRAM side, with the introduction of EUV, there is infrastructure for UV, whether it’s one layer or more, you still have to have a radical inspector to be able to qualify radicals, you have to qualify blanks. And then of course, you have to do print check to validate radical fidelity in the fab itself. So, there’s also infrastructure investment that needs to happen to support EUV in the DRAM side.

Thanks for that. And then as a follow-up, I just wanted to clarify in your prepared remarks; you talked about the new U.S. restrictions. Is there a change in that at all, relative to what you’ve talked about last quarter, in terms of, I think in the prepared remarks, you talked about difficult to predict the near-term dynamics relate to those?

Well, and it was – and we had to go through the exercising, the exercise as did our peer companies, of determining whether or not we were, how to be compliant with the regulations. And I think, all the peer companies have gone through that exercise and we’ve been able to navigate that. As we said, we’re going to obviously follow the law. It was just – there was some uncertainty as to what exactly how to interpret it. So, we’ve had the benefit of working through those details and feel like we’ve moved on from that.

Your next question comes from the line of Joe Moore with Morgan Stanley. Your line is now open.

Great. Thank you. I wonder if you could talk a little bit about your business in China, it’s been pretty stable as a percentage of revenues. How is that mix shifting between multinationals and China sovereign kind of customers? And what are you seeing specifically from China sovereign customers?

We’re seeing growth this year. And so you’ve got the pieces that are part of PCB and display. So, my growth statement is more WFE-centric. But I would expect it to be 20% or more. So, I think WFE levels in China, for the native China customers are – is probably somewhere in the $9 billion to $10 billion range. So, it certainly is growth this year and it’s more foundry, and I would call it infrastructure centric.

Okay, great. Thank you very much.

Your next question comes from the line of Atif Malik with Citi. Your line is now open.

Hi, guys. Thank you for taking my questions and good job on the results and guide. Good to see EPC delivering records in the June quarter. I have a question on 5G, your 5G smartphone exposure on the PCB side gives you an edge over your peers, have based on our work and perhaps the higher stock multiple, how much of the PCB system and services revenues are 5G exposed on an annual basis?

So, when we’re looking at it right now, it’s about 50%, and it feels like the success that we’ve had there, as you point out, we’ve got good exposure, we’ve got good products to serve those customers. And we feel like that’s, this is early days where the 5G build-out. So, we think there’s continued opportunity there as we go forward.

Great. And then Rick, there was a question earlier on delay at the U.S. logic maker. longer-term, I see you have better exposure to foundry versus that logic maker based on your 10-K, is that shipped up capacity from the U.S. logic maker to Taiwan foundry, potentially neutral for your logic opportunity or a modest positive?

It’s really hard to say. I mean, I think part of what we’ve experienced over time is that there are customers that historically, we’ve seen a high correlation between their ability to stay on leading edge and their engagement and investment in KLA process control equipment. So, what we’re seeing now is, people that feel like they’re needing to catch up are investing more to do that. But I think it’s pretty clear, if you want to stay on the leading edge of a lot of logic and foundry, and you don’t have the ability to fully understand and the learning cycles in the fab, you’re going to struggle. So anybody, that’s trying to get into a lead or maintain a lead ends up changing their investment profile. That’s why – what’s really good for us as people that want to do advanced node technology, because they need to invest. And so I would say that if it moves it’s because that they’ve struggled, and if they want to be successful, then they end up investing more. So, I think that what’s really good for KLA’s advanced nodes and the desire people have to support them. I think in – as you know, in a foundry, especially, a multiproduct foundry, the other challenge they have is their multiple process flows. So, it also is a challenge for inspection and metrology to be able to support so many flows, because all the designs aren’t all going through the same process flow. So, we generally feel really excited when we see the large number of increasing designs that advanced nodes that’s what’s really been encouraging. The other thing on the sustainability of it just – the one thing we would have wondered earlier this year was if we were to see utilization in the fabs of logic and foundry go down and we haven’t. So, we feel pretty good about the sustainability of the investments across the board.

Your next question comes from the line of Blayne Curtis with Barclays. Your line is now open.

Hey guys, thanks for taking our question and nice results. Just curious on the service side, you had delays getting in and actually doing service, you talked about record number. I’m just kind of curious; sort of you mentioned earlier whether you actually are caught up or plan to catch up as you look into September?

Well, we installed a record number of tools in the June quarter. and so we feel very good about that on the circumstances and being able to transition to more localized teams to handle the installation requirements for our tools. And of course, our guidance for the September quarter contemplates those plans. Overall, service has been – has done extremely well. And Rick talked about utilization rates at foundry and logic. We’ve also seen very strong utilization rates and memory, which is another indicator of health of the market. So, we feel pretty good about all of that. We think we’re going to grow our long-term growth rate expectation – annual growth rate expectation per service is 9% to 11% and we think we’ll be in our target range and because of the scale that we’re now able to drive and some of the investments we made over the years, in China, in particular, but also in Taiwan and Korea. and so on we’re able to drive more economies of scale in our profit structure as well. So that’s – it’s a pretty good situation right now for service and I think we’ve adapted pretty well. And we’re trying to leverage some of the remote capability tools that that are out there today, for us to position this business from an efficiency and support point of view even better going forward.

Yes. I’ll just add to that. I mean, our service guys are really heroes, service guys and girls, this last quarter and this year, they’ve done an amazing job. When we look at all our customers, even back in Wuhan during the early stages of this crisis, the only people that we’re going anywhere inside of fabs were our service guys, and they were there to support our customers. And so often with our customers, when they don’t want to have visitors of any kind, that the exception is service, because they want to keep these fabs up and running. So really, it’s been remarkable to see the resiliency of that. And as Bren said, the long-term trend looks good and this year, we feel really good about services ability to hit the targets we’d set out pre-COVID for them. So, we feel really good about that.

Thanks. I just want to ask on the recovery you’re targeting in memory, just kind of curious on the DRAM side; it was always going be late year. I was just curious if that’s part of any of the recovery you’re targeting?

I think DRAMs a little bit, I think flash is better in the – as I said earlier, I think flash is better in the second half of the year, and that DRAM is probably stronger than the first half of the year overall. But I mean, again, that can move around a little bit, but that’s how we see it right now.

Your next question comes from line of Quinn Bolton with Needham and Co. Your line is now open.

Thanks for letting me ask you a question. Just wanted to come back to the China business, obviously, you haven’t seen a major impact from the commerce department actions. But wondering if you’ve seen any increased threat of de-Americanization of equipment in China, especially, from the domestic suppliers and probably more on the metrology side than the inspection side of your business, where I think you guys are pretty well entrenched?

So Quinn, this is Rick, I think since KLA started doing business internationally, when I’ve been in the company back in Japan and whatever, the late 80s, there have always been attempts by our customers in different regions to have supply base. So, there’s never been a lack of interest and motivation that happened in Japan, of course, that happened in Korea, not quite as much in Taiwan, but definitely, happened in China. So for sure there is interest and desire to have their own capability. But, like as you know, this business, that’s – the impetus on us is to keep driving performance capability and making sure we’re competitive, so that we’re more than competitive, we’re compelling, so that we win that business. But yes, of course, there is interest in trying to have alternatives other than U.S. But I think the practical business of running semiconductors is you got to be competitive on a worldwide basis. And so you’ve got to have the capabilities to compete worldwide. And that’s always been, our belief is we have to win overall, because any opportunity, any region has to go with another solution they’re going to do it. So, we don’t see that as particularly different than it’s been in the past.

Thanks. And then quick follow-up for Bren, just a nice gross margin guidance in September. I’m wondering if there are any lingering COVID-19 costs that are still affecting that the gross margin possibly in the freight and logistics shipping would be one area.

Yes. I don’t think it will – there are. And I don’t think it’ll change in the September quarter and probably, not in the December quarter. So there is a bit of a headwind there about 40 basis points the last quarter. And so the revenue is up a little bit, so a similar impact. Well, this quarter artifacted in the margin guidance. So yes, I think as we start to normalize, whenever that might be, we’ll start to – we’ll get a tailwind from increasing competition in the freight market overall but yes, inbound freight is costs have gone up there.

[Operator Instructions] Your next question comes from the line of Sidney Ho with Deutsche Bank. Your line is now open.

Great. Thanks. You talk about the setup is pretty good for next year for foundry and logic. Is it mostly driven by the five-nanometer ramble? Are you expecting any contribution from three-nanometer development? I know it’s still early, but maybe broadly speaking, do you have a view when you’re going to start seeing the revenue relate to three nanometers?

Yes, both. For sure, we’ll see. I mean, as you know, these things go in cycles of the early – the early work and then you get the build-out and we also have some of the – as Bren mentioned earlier, we have a fair amount of logic that’s a trailing that continues to be the investment. But on the leading edge, sure, we’ll see early and already in those conversations about that early capability. And that will be of course, our leading edge tools, not as many early on, but that’s really in the debugging phase of that. And I would expect to follow on there. I would expect the broader levels of investment into the first half of next year. The breadth that we talked about this year, we would expect some continuation of that into next year. So, a lot of compelling opportunities for a number of players and in the foundry/logic space.

Great. Then maybe, my follow-up to – a follow-up question. Historically, you see process control strength early in the process, and then at phase once the products are in volume production. Do you expect this pattern to continue or do you see more sustainable strength through tech transitions going forward, given what you talked about earlier about the dynamics happening in the memory market?

It really – it is true. I mean, that trend is true. It’s especially true when there’s fewer – there’s less innovation. I think the difference now on the leading edge is what EUV has done is brought back scaling. And so that was really more pronounced in a period, where we have that long gap where there was no EUV, there was not another lithography technology for several years. And so that really exacerbated that trend. So, the two other factors now you’ve got additional designs, which is kind of a surprise from where maybe, the world was a while ago, and then you have multiple players trying to – so the phase of that is different, where you have different players trying to cut in, and since there’s a leader and then the other folks are behind, that gives another way of at a different location. So, I think the net of all that is it tends to be more sustainable, plus we have more products that are more tied to production. An example would be overlay, which is much more correlated to production and the number of layers that get measured and overlay, doesn’t really decrease that much now, given the challenges. So, you don’t have that same reduced sampling and reduced the number of tools and in some of these product areas as we might have had in the past.

Operator, I think we have time for one last question.

Yes, sir. We have a question for Weston Twigg with KeyBanc Capital Markets. Your line is now open.

Hey, thanks for taking my question. I just – there was something you said earlier that really resonated with me for KLA, which – it’s a more [indiscernible], which intuitively makes sense for the foundry side. You see more chips, more AI, special there’s 5G chips, chips going into different things that are all sort of custom. Can you help us think about how that provides uplift for clack overall over the next few years?

Yes, sure. I mean, think about the worst-case scenario for us is there’s one device made by one person, right? And they dial that process in and they lock it in for three years and they don’t change anything, right? That would be the worst case, because as you know, what they really want to do is dial on the process, get everything under control and have it be just grump and then not pay any attention and let the thing run, have all the CPKs in line. So, the other end of that continuum is lots of process designs. What’s interesting about foundry is they don’t force one process. In fact, part of their selling proposition is you have multiple process flows through a foundry. So, if you look and you can publicly go do this and look at TSMC, you can pick tons of different process flows, which that means is the large number of change. The other thing that we’ve seen in the reverse trend in the last few years, as you have hyperscalers, data center people designing their own chips, because they want to have an advantage in their own design. So, we have a lot of customers. We have our customers – customer traditionally is far greater than it used to be, which is why there’s so many designs happening at advanced nodes. When the view was at some point that it was going to keep restricting the number of designs that’s not what’s happened. So that creates more and more flow of process and change, and the need to manage that is all upside. So, we’re really excited when we started seeing the number of relevant designs become more and more successful, because that that’s a factor that favor is process control in order for people to be so successful at producing those. Does that make sense?

Okay, Charlie.

Yes, sir. We have no further question at this time, I will now turn the call back to the presenters.

Okay. We wanted to thank everybody for their time and interest. And this concludes the call and Charlie, please provide the final instructions.

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