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New Multi E Beam tool answers ASML & AMAT!

Robert Maire

KLAC reported Q1, 2018 revenues of $970M and EPS of $1.80 versus street of $943M and $1.63 in EPS. Guide was flattish at $930M to 990M and $1.59 to $1.83 versus street $978M and $1.69 EPS. Importantly management guided to $4B in revenues in 2018. The mix was 40% foundry in the current quarter with a balance between DRAM and NAND with memory jumping to 66% of business in the current quarter. The company is increasing spend with a number of new products which may weigh on EPS a bit over the next year. Gross margin at 63.7 remains the highest in the industry. Given the current financial position it's likely that buybacks may increase and/or dividends.

An Unofficial Product Announcement...

One of the most important releases on the call was the announcement of a multi E Beam reticle inspection tool. This tool has obviously been in the skunk works for a while and there is obviously high enough confidence to give it a "soft" roll out on the call.

This is the answer to several years of E Beam tools by Hermes, now ASML as well as Applied , to which KLA had no answer.
While this is not the "actinic" tool that was canceled a while ago, it is none the less aimed at EUV reticle inspection. We would not be surprised to see the actinic tool restarted at some point now that EUV seems inevitable.

While we have heard of another company making an actinic tool, we think it will be very difficult without KLA's experience and history of mask inspection. Wether E Beam or Actinic, that is only half the equation which involves gathering the image. Equally, if not more critical is the analysis of the gathered image which KLA has more experience than the rest of the industry put together. So while KLA may have had a late start, we think they can likely make a 5NM insertion point where true EUV HVM will start, somewhere around 2020.

Though obviously not impactful to revenues for several years, it is none the less important as it reassures customers and investors of KLA's commitment to the industry.

Good mix of business and memory growth...
KLA had historically been more logic/foundry biased, so we are happy to see that the advent of 3D NAND has increased the process control intensity which benefits KLA, and provides more balance between logic/foundry and memory. With an expectation of 66% of business in the current quarter being for memory, KLA is following the industry pattern but not going to the unusually high 77% we saw at ASML.
While we don't expect KLA's mix to be as heavily weighted to memory over time as compared to others it will be higher than their historic exposure. Given the volatile nature of memory we get more nervous about a sustained high exposure we have seen in some companies and feel a more balanced weighting is more sustainable.

Financials remain excellent...
With industry leading gross margins, its clear that KLA has a very dominant position in its markets. We feel this is very important in the long term as we expect more price and margin pressure over time especially from emerging Chinese tool makers. We think there is a lot more risk on the dep and etch side which has less of a proprietary content with more competition which is reflected in the lower margin structure in those sectors.
We expect KLA to use the strong financials and cash generation to buy back shares and/or increase dividends as well as continued retiring of debt in their leveraged business model

The stock...

While results were at record levels nicely above both guidance and street expectations, guidance was not quite as stellar and we would not be surprised to see softness in the stock because of the conservative outlook.

We think that $100 is an important support level for the stock. If the stock pulled back too much we would be more aggressive in adding to our position in KLA. In our view, KLA remains undervalued as compared to the rest of the group yet sports the best financial model and most balanced/conservative business model with reasonable risk exposure as compared to others in the industry. We continue to view KLA as a core holding in the group.