KLA (KLAC) Q2 2026: Advanced Packaging Surges 70%, Extending Share Gains in AI-Driven Market
KLA’s December quarter marked a pivotal acceleration in advanced packaging and process control, fueled by AI infrastructure demand and broadening customer adoption. Service revenue hit another record, and the company’s share of the advanced packaging market approached 50%, reflecting both execution strength and a structural shift in semiconductor manufacturing. Management signals continued outperformance in 2026, but persistent supply constraints and DRAM cost pressures temper near-term margin expansion.
Summary
- Advanced Packaging Outpaces Market: KLA’s advanced packaging revenue grew over 70%, driving material share gains.
- Process Control Intensity Rises: AI and high-bandwidth memory adoption are increasing demand for inspection and metrology solutions.
- Supply Chain and Cost Headwinds Persist: Component shortages and DRAM price inflation will constrain gross margin through 2026.
Performance Analysis
KLA delivered record revenue and profitability in the December quarter, with broad-based strength across its core segments. Total revenue reached $3.3 billion, exceeding guidance, and was underpinned by robust demand for process control systems, particularly in advanced logic, high-bandwidth memory (HBM), and advanced packaging. The process control business, KLA’s largest segment, outgrew the overall wafer fab equipment (WFE, semiconductor manufacturing tools) market, supported by AI-driven technology transitions and rising process control intensity—meaning, customers are investing more in inspection and yield optimization per chip produced.
Service revenue rose to $786 million, up 18% year over year, marking the 16th consecutive year of annual growth for this high-margin, recurring business line. Free cash flow hit a record $1.26 billion, supporting $797 million in capital returns this quarter. Gross margin of 62.6% beat guidance, but management flagged that rapidly rising DRAM costs—essential for KLA’s image processing hardware—will pressure margins by up to 100 basis points through 2026. Operating margin remained robust at 42.8%, reflecting disciplined cost control and efficiency gains.
- Advanced Packaging Growth Surges: Revenue in this segment exceeded $950 million for 2025, up more than 70% year over year, with KLA’s share of the market approaching half.
- Process Control Systems Lead: Outperformance in inspection and patterning tools was driven by AI, HBM, and broader technology roadmaps.
- Service Business Resilience: Recurring revenue from service contracts continues to compound at a double-digit rate, underpinned by a growing installed base and higher tool utilization.
Despite strong execution, KLA faces supply constraints, especially in optical components and DRAM, limiting near-term shipment growth. The company expects accelerating revenue in the second half of 2026 as these constraints ease and customer facility readiness improves.
Executive Commentary
"AI remains a core driver of KLA's performance and a key factor for and our growing industry leadership. As KLA solutions enable our customers to deliver products needed for AI, our systems are also applying AI-driven analytics to deliver actionable insights that streamline chip manufacturing and accelerate innovation and time to yield for next-generation AI applications."
Rick Wallace, Chief Executive Officer
"Gross margin was 62.6%, 60 basis points above the midpoint of guidance due to stronger-than-modeled service performance and manufacturing efficiencies... As DRAM capacity additions accelerate over the next several quarters, we expect this cost dynamic to improve as we exit the calendar year, and we are modeling a return to a normalized pricing environment for our memory requirements and our longer-term business forecasts."
Brent Higgins, Chief Financial Officer
Strategic Positioning
1. Advanced Packaging as a Growth Engine
KLA’s rapid expansion in advanced packaging, which integrates multiple chips into a single package for AI and high-performance computing, positions it as a critical enabler for next-generation semiconductors. The company’s share in this market has grown from roughly 10% in 2021 to nearly 50% in 2025, with management expecting continued double-digit growth as customer adoption broadens and new facilities come online.
2. Process Control Intensity and AI Infrastructure
Increasing complexity in semiconductor design—driven by AI, larger die sizes, and high-mix manufacturing—demands more inspection and metrology per wafer. KLA’s portfolio is well-aligned with these trends, and the company is capturing outsized share in both logic and memory (especially DRAM/HBM) as customers seek to maximize yield and accelerate time to market.
3. Resilient Service Model and Installed Base Leverage
The service business, underpinned by a growing installed base and high tool utilization, provides recurring revenue and cushions cyclicality in new equipment sales. KLA expects service revenue to grow at a 12% to 14% compound annual rate, with upside from higher utilization and expansion into adjacent markets via acquisitions.
4. Supply Chain Navigation and Margin Management
While KLA’s differentiated product portfolio supports pricing power, the company faces near-term gross margin headwinds from DRAM cost inflation and long lead times for optical components. Management is prioritizing supply continuity and expects normalization as capacity ramps later in 2026, with a longer-term gross margin target of 63% plus.
5. Geographic and Customer Diversification
China represented a mid- to high-20% share of revenue, with expectations for modest growth in 2026 after a flat 2025. KLA’s customer base is broadening, and facility readiness in multiple regions is expected to unlock additional demand in 2027 and beyond.
Key Considerations
This quarter underscores KLA’s ability to capitalize on secular semiconductor trends while navigating operational headwinds. The company’s success is built on process control leadership, recurring service revenue, and an expanding role in advanced packaging.
Key Considerations:
- Share Gains in Advanced Packaging: KLA’s outsized growth and share in advanced packaging reflect a structural shift in semiconductor manufacturing toward chiplet and heterogeneous integration.
- AI and HBM Demand Tailwind: The proliferation of AI workloads and high-bandwidth memory is driving higher process control intensity, expanding KLA’s addressable market.
- Supply Constraints and Component Costs: Optical component lead times and DRAM price inflation are limiting short-term shipment growth and margin expansion.
- Service Revenue as a Stability Anchor: Recurring service contracts provide resilience and margin support, especially as customer utilization rates rise.
- China Exposure and Policy Risks: China remains a large market, but regulatory and competitive dynamics could impact future growth and market access.
Risks
KLA faces ongoing risks from supply chain bottlenecks, particularly in optics and DRAM, which could constrain revenue and margin in the near term. Regulatory uncertainty in China and potential for increased domestic competition may affect market share. The company’s exposure to cyclical semiconductor capital spending also introduces volatility, especially if macro or geopolitical conditions shift.
Forward Outlook
For Q1 2026 (March quarter), KLA guided to:
- Revenue of $3.35 billion, plus or minus $150 million
- Gross margin of 61.75%, plus or minus one percentage point
- Non-GAAP EPS of $9.08, plus or minus $0.78
For full-year 2026, management expects:
- WFE market growth in the high single to low double digits, reaching the low $120 billion range
- Advanced packaging market to grow at a similar rate, surpassing $12 billion
- Gross margin to average 62%, plus or minus 50 basis points
Management highlighted:
- Customer lead times are extending, with most new orders slated for late 2026 or 2027 delivery.
- Revenue growth will accelerate in the second half of 2026 as supply constraints ease and customer facility readiness improves.
Takeaways
KLA’s quarter showcases the company’s ability to capture secular growth in AI and advanced packaging, while recurring service revenue provides ballast against near-term volatility.
- Advanced packaging is now a material growth engine, with KLA’s share nearing half the market and further expansion likely as new facilities come online.
- Process control intensity is structurally rising, supported by AI, HBM, and a shift to more complex logic and memory designs.
- Investors should watch for easing supply constraints, DRAM cost normalization, and continued service revenue growth as key levers for margin and cash flow in 2026 and beyond.
Conclusion
KLA’s December quarter confirms its leadership in process control and advanced packaging, with strong cash generation and capital returns. While short-term headwinds persist, the company is structurally positioned to outgrow the market as AI adoption and advanced packaging accelerate across the semiconductor value chain.
Industry Read-Through
KLA’s results reinforce the centrality of process control and advanced packaging in the semiconductor equipment landscape. As AI and high-bandwidth memory drive new chip architectures, inspection and metrology intensity are rising across both logic and memory. The rapid growth and rising share of advanced packaging suggest a multi-year industry shift toward heterogeneous integration, benefiting suppliers with deep process control expertise. Persistent component shortages and DRAM cost inflation are likely to impact peers, while recurring service revenue is emerging as a critical buffer for cyclical volatility across the sector.