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spk00: Good afternoon. My name is Brittany and I will be your conference operator today. At this time, I would like to welcome everyone to the KLA Corporation September quarter 2022 earnings conference call and webcast. All participant lines have been placed in a listen-only mode to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question at that time, please press star 1 on your telephone keypad. If you wish to remove yourself from the queue, please press star 2. Please limit yourself to one question and one follow-up. Lastly, if you should need operator assistance, please press star 0. Thank you. I will now turn the call over to Kevin Kessel, Vice President of Investor Relations and Market Analytics. Please go ahead.
spk11: Thank you and welcome to KLA's fiscal Q1 2023 earnings call to discuss the results of the September quarter and our December quarter outlook. Joining me is Rick Wallace, our chief executive officer, and Brent Higgins, our chief financial officer. During this call, we will discuss our results released today after the market closed in the form of a press release, shareholder letter, and slide deck, which can all be found on the KLA IR website. Today's discussion is presented on a non-GAAP financial basis unless otherwise specified. Whenever references are made to full-year business performance, they are calendar year references. A detailed reconciliation of GAAP to non-GAAP results is in the earnings material posted on our website. Our IR website also contains future investor events, as well as presentations, corporate governance information, and links to our SEC filings, including our most recent annual report and quarterly reports on Forms 10-K and 10-Q. Our comments today are subject to risks and uncertainties reflected in the risk factor disclosure in our SEC filings. Any forward-looking statements, including those we make on the call today, are also subject to those risks, and KOA cannot guarantee those forward-looking statements will come true. Our actual results may differ significantly from those projected in our forward-looking statements. Our CEO, Rick Wallace, will begin the call with some brief quarterly comments and highlights before discussing the semiconductor industry demand environment, including our business in China. Brent Higgins, our CFO, will conclude with the financial highlights as well as our guidance and outlook. I will now turn the call over to our CEO, Rick Wallace. Rick?
spk12: Thank you all for joining us today. I'll spend some time sharing highlights of KLA's performance in the quarter, touch on our business in China, and provide a brief perspective on the overall semiconductor demand environment. Before we get into details, I'd like to first acknowledge our global KLA teams who have continued to demonstrate perseverance in navigating dynamic challenges to deliver for our customers. Their commitment is evident in our results. KLA's September quarter demonstrates strong customer demand across major product groups. Specifically for this quarter, record revenue of $2.7 billion was at the top of the guidance range, growing 31% on a year-over-year basis, and 10% sequentially. Quarterly non-GAAP net income topped $1 billion for the first time. GAAP earnings per share was $7.20, and non-GAAP EPS was $7.06, each above guidance ranges. Our performance is a reflection of the increasingly essential role process control plays in the development of enabling technology and the long-term product roadmaps of our customers. As drivers for semiconductor demand continue to diversify beyond traditional PC and consumer-facing markets, process control is considered critical in enabling customers to execute on node and technology transitions. As this demand backdrop continues to evolve, our KLA operating model ensures focus on delivering for our customers, navigating supply chain challenges, and continued investment in R&D. Now I will quickly summarize key highlights for the quarter. First, KLA continues to deliver strong relative outperformance versus peers and is positioned to be one of the fastest growing tier one WFE equipment suppliers in calendar 2022, substantially outperforming expected overall WFE market growth. Second, our patterning systems revenue grew 49% sequentially and 67% on a year over year basis. Third, KLA delivered strong quarterly revenue in our SPTS segment. KLA has intensified efforts in advanced packaging and automotive electronics, leveraging the combined portfolios of both the semiconductor process control and EPC groups. Fourth, the KLA services business grew to $529 million in the September quarter, up 16% year over year. Finally, operating cash flow topped $1 billion for the first time, and we generated quarterly free cash flow of $927 million and free cash flow margin of 34%. For the 12 months ended September 30, 2022, total free cash flow grew from 37% to $3.14 billion. Total capital returns in the quarter were $278 million, comprising $90 million in share repurchases and $188 million in dividends paid. Total capital returns over 12 months ended September 30th were $5.2 billion, or 166% of free cash flow, and included $4.6 billion in share repurchases and $664 million in dividends. Early in October, the U.S. government issued new regulations to control aspects of the U.S. semiconductor industry trade with China. Specific to KLA, a meaningful amount of our business in China is focused on legacy node investment, which is not the focus of the recent export restrictions. However, our system and service revenue will be adversely impacted going forward as we are unable to provide systems and support to certain customers for certain end uses. We are assessing the broader implications and engaging collaboratively with the U.S. government to provide the necessary information about our products and services to fully determine the impact on our business operations moving forward. As we look at the industry demand environment, growth for the semiconductor industry has evolved to be more strategic with more diverse and market mix. For the near term, The recognized excess inventories driven by a slowdown in consumer electronics markets such as PC and mobility is having an impact on semiconductor device pricing, particularly in memory. As a result, semiconductor customers are adjusting CY23 CapEx budgets lower, with the largest impact to date coming from memory customers. However, long-term growth for the semiconductor equipment industry continues due to the prioritization of R&D investment at the leading edge, continued investment in legacy nodes, and growth in enabling technologies such as advanced packaging. Considering all factors, KLA's long-term targets announced at our investor day in June remain intact. In summary, KLA's September quarter's results demonstrate sustainable outperformance and highlight the critical nature of KLA's products and services. Our teams continue to navigate and execute against dynamic challenges and KLA remains well-positioned with a comprehensive portfolio to meet evolving customer requirements. The KLA operating model and our strategic objectives are the foundation for our sustained technology leadership, wide competitive moat, leading financial performance, strong cash flow generation, and consistent returns to shareholders. Now, our CFO, Bren Higgins, will review our September quarterly financial highlights and outlook. Bren?
spk13: Thank you. As you hear from Rick, KLA's September quarter results were strong, better than expected, and demonstrated our consistent, successful execution. While supply chain challenges continue in certain areas and are still limiting output, we have seen marginal improvement as new supplier capacity has come online to meet our requirements. Our continued focus on meeting customer needs, while expanding market leadership, growing revenue, sustaining industry-leading growths and operating margins, Generating strong free cash flow and maintaining our long-term strategy of assertive capital allocation is what makes us successful. Quarterly revenue was $2.724 billion at the top of the guided range of $2.475 to $2.725 billion. Non-GAAP diluted EPS was $7.06, above the guided range of $5.70 to $6.80. GAAP diluted EPS was $7.20. Non-GAAP gross margin was 40 basis points above the midpoint of guidance at 63.4% at semiconductor process control systems, which carry stronger gross margins, delivered virtually all the revenue upside from the guidance midpoint. Non-GAAP operating expenses were $526 million, slightly below our expectation of $530 million for the quarter. Non-GAAP operating margin was strong at 44.1%. Portally non-GAAP net income topped the $1 billion level for the first time ever. GAAP net income was $1.03 billion. Cash flow from operations was $1.01 billion, and free cash flow was $927 million, resulting in a free cash flow conversion of 92% and a free cash flow margin of 34%. The breakdown of revenue by reportable segments and end markets in major products and regions can be found within the shareholder letter and slides. Switching to the balance sheet, KLA ended the quarter with almost $3 billion in total cash, debt of $6.3 billion, and a flexible and attractive bond maturity profile supported by strong investment grade ratings from all three agencies. Our balance sheet offers a unique capability to fund our growth strategies, both organic and inorganic, and providing ongoing attractive capital returns to shareholders. Over the last 12 months, KLA has returned $5.2 billion to shareholders, including $4.6 billion in share repurchases and $664 million in dividends paid, with total capital returns amounting to 166% of free cash flow. Turning to our outlook, KLA continues to deliver sequential growth and strong relative financial performance. Based on the midpoint of our December quarter guidance, KLA is positioned for mid-20th percent revenue growth for the total company in calendar 22, with semiconductor process control systems growing several points faster than the company average. Furthermore, this business is expected to significantly outperform the overall WFE industry growth, which is currently projected to be up mid to high single digits to the low $90 billion range. Looking ahead, we expect industry spending to slow. Though early, we are planning our business based on the expectation of CY23 WFE declining approximately 20% based on increasing global macroeconomic concerns and recent public statements from several customers, particularly in memory, and the impact of the new U.S. government regulations on native China investment. This WFE estimate reflects our current top-down assessment of industry demand as follows. In memory, we expect WFE investment to decline by more than the market, as memory customers respond to lower consumer demand by cutting production and factory utilizations to bring device supply in line with demand. We expect foundry logic to decline less than the overall market. Specific to KLA, we are still assessing the impact of the new China export regulations. Our preliminary assessment for the combined gross direct impact on our revenue based on our existing backlog and sales funnel forecast is in the range of approximately $600 to $900 million in calendar 23. This reflects systems and service impact, with service representing approximately 10% to 15% of the total. This estimate is before any potential system reallocation for products where supply is meaningfully below current demand, which has resulted in significant lead time to other customers. Given our backlog and forecast, we expect that we will be able to reallocate certain tools to other customers as we move through next year. ALA's unique broad portfolio differentiation and primary value proposition is focused on enabling technology transitions, which our customers continue to invest in regardless of business environment. While capacity plans can change, technology roadmap investment tends to be more resilient. This adds additional confidence in our business expectations as customers align shipment slots with roadmap requirements. In this environment, we will continue to focus on meeting customer requirements, maintaining a high level of investment in R&D to advance our product roadmaps and KLA's market leadership, and delivering strong relative revenue growth and financial performance. Our December quarter guidance is as follows. Total revenue is expected to be in the range of $2.8 billion, plus or minus $150 million. The gross direct impact of the new China regulations on the December quarter revenue guidance is approximately $100 million. Boundary logic is forecasted to be approximately 76%, and memory is expected to be around 24% of semi-PC systems revenue. Within memory, DRAM is expected to be about 55% of the segment mix and NAND 45%. We forecast non-GAC gross margin to be in a range of 61.5% to 63.5% due primarily to expected product and segment mix. Looking ahead, KLA will continue to balance investments in technology and infrastructure to support our long-term growth objectives with the expectation of a softening near-term outlook. As a result, operating expenses will grow to approximately $550 million in the December quarter, with growth in quarterly operating expenses expected to flatten out as we move through calendar 23. Other model assumptions for the December quarter include other income and expense net of approximately $66 million and an effective tax rate of approximately 13.5%. Finally, GAAP-diluted EPS is expected to be in a range of $5.94 to $7.34 and and non-GAAP diluted EPS in a range of $6.30 to $7.70. EPS guidance is based on a fully diluted share count of approximately 140 million shares. In conclusion, although the CY23 outlook for WFE demand has softened, we remain confident that the secular trends driving long-term semiconductor industry demand and investments in WFE are durable and compelling. Broad-based customer demand, The increasing strategic role semiconductors are playing in influencing national industrial policy and simultaneous investment supporting growing semiconductor content across technology nodes remain important trends. These are long-term secular growth drivers for the industry as technology investment and node transitions reflect the value that semiconductors in our industry have in lowering costs for our customers and enabling a broader application universe for semiconductor-based technology across multiple end markets. For KLA, considering our strong track record of execution and the power of our portfolio strategy, we have confidence in our ability to continue to deliver sustainable relative outperformance. We will continue to maintain a high-level investment in our product development roadmaps to enable market share expansion and support customers' technology roadmaps and multi-year investment plans. This provides an element of stability that shores up our confidence in the demand outlook for the future. These factors, combined with the KLA operating model that guides our execution, positions us to continue to deliver strong relative performance as we execute our strategic objectives. These objectives fuel our growth, consistent operational excellence, and differentiation across a diverse product and service offering. They are also the foundation of our sustained technology leadership, wide competitive mode, industry-leading financial performance, and history of robust free cash flow generation, and consistent and growing capital returns to shareholders. And with that, I'll turn the call back over to Kevin to begin the Q&A session. Kevin?
spk11: Thanks, Brent. Operator, can you please queue for questions?
spk00: At this time, if you would like to ask a question, please press the star, then the number one on your telephone keypad. If you wish to remove yourself from the queue, you may do so by pressing star two. We remind you to please unmute your line when introduced, and if possible, pick up your handset for optimal sound quality. In the interest of time, we ask that you please limit yourself to one question and one follow-up. We'll now take our first question from Harlan Sir with JP Morgan. Your line is now open.
spk10: Hi, good afternoon. Congratulations on the solid quarterly execution and strong free cash flow. As you mentioned, you know, the team has been outperforming WFE in process control spending growth for the last few years. No different this year, right? I mean, it looks like, given your December quarter guidance, your process control systems business is going to be up like 30%, 35% when WFE is only up high single digits. I know in the last downturn, like 2019, not as severe, but as potentially 2023 is, but you guys actually grew your process control and services revenues when WFP was down back then. So kind of given all of this, can you guys just provide some sort of rough framework for thinking about the team's revenue and earnings power potential with industry spending down about 20% next year?
spk13: Yeah, Harlan and Fran, thank you for the comments, and I'll start here and Rick can join after. So I think, you know, the way to think about KLA performance is typically historically most of the volatility we've seen in WFE has been in the memory space. And as you know, process control intensity in memory is quite a bit lower than it is in boundary logic. So I think you have to go back a couple of decades. I think we've outperformed WFE in any down year that WFE has had. So I think that that's always been an anchor for us. We also tend to support customers that are investing in their roadmaps, right? So as they pull back on their capacity investments, they continue to invest in technology and And so there's a certain amount of business with KLA that continues to happen almost irrespective of their revenue levels. So that tends to be a factor for us as well. And then finally, customers usually continue to run the install base, and so service continues to operate. We have a contract stream that is the majority of the revenue, or 75% plus of the revenue. And so while they're pulling back on CapEx investments, they still tend to run the install bases pretty heavily. And given how they buy process control generally in terms of buying what they need and relying on us to maximize uptime for those systems, that it tends to also be an anchor as we move through down periods in the CapEx environment.
spk10: Great. Thanks for that. And then I'm going to follow up. You know, good to see the strong UV mask inspection shipments. You know, your patterning segment was up almost 70% every year. I think that's reflective of the strong UV adoption this year. And despite the weaker WFE backdrop for next year, I think that the UV lithography outlook continues to be strong, right? I mean, continued penetration of UV into memory and logic and foundry. And so this should bode well or continue to bode well for your mask inspection demand. I know last year, the mask inspection segment underperformed process control on growth. What's the team's outlook for your mask inspection business this year and next year, given the relatively better fundamental outlook in lithography?
spk13: So, yeah, Harlan, you have it right. So, this year is actually a very strong year for reticle inspection. I would expect reticle inspection to outperform the overall semi-PC business within the company. So, Very strong year and certainly driven by EUV as 90% plus of EUV reticles in production are running through KLA systems. As we look at next year, I think that there will be continued demand there as you start to see more investment in the three nanometer node. So I would expect the rapid business to probably continue to perform better than semi-PC. There's also some investment in infrastructure that's happening in some of the legacy mass conspection and new infrastructure that's being built in China to support the legacy radicals. And so there's also an aspect of investment that's happening there as well. So I would expect it to have another good year this year, a strong year in 22, but also a strong year in 23 as well. Yeah, and one other thing, Harlan, I think that one of the things that contributed to our strength is share gain due to new capabilities on our products. So part of what we were in development for was continuing extending the 6XX product to be able to serve more of the EUV market. So as we do that, we saw some performance. So overall, the segment's good, and then we had the benefit of some share gain as well.
spk10: Thank you.
spk00: We will take our next question from Krish Sankar with Cowan & Company. Your line is open.
spk01: Hi, thanks for taking my question. And Rick, just wanted to follow up on the earlier question. I understand you guys typically outperform process consumers like a normal cyclical downturn. But if you overlay the fact that some of your peers had supply issues, which you folks did not, and process control tends to be more early cyclical. If you overlay those two components, do you still expect your process control revenues to outperform WFP next year in another follow-up?
spk13: We do for two reasons. One, it's true that some of them had more challenges than we did, but we had our own. We could have shipped, you know, we built backlog. We could have shipped more if we'd had more capacity. But the other thing is, The decline in WFD is going to be based more in memory than in Foundry logic. So that alone helps us in terms of the mix. So I think we're in pretty good position now to perform WFD. Nobody really knows, of course, what 23 is going to look like. But with that setup, we're in pretty good shape.
spk01: Got it, got it. Very helpful, Rick. And then just a follow-up on services. What percentage of your services is from China or domestic China? And also, if WP is down 20%, what do you think happens to service business next year? Thank you.
spk13: Yeah, I don't think we've broken that out. I would say it's less than, you know, if our systems business in China and MEPC is, somewhere between 20% and 25%, I would expect the service stream is less because it's less developed, right? It's newer in terms of the investment that's happened. And so it would be lower as a mix of service revenue than as a mix of systems revenue. I would expect service to continue to grow next year. I think it'll be below in that WFE environment. It'd be below what our long-term growth rate target of 12-14%. I think you'd probably be Somewhere in single digits, there is a little bit of an FX headwind that happens to service as you have the strong dollar, but you have a lot of service revenue denominated in local currencies. You get a little of a natural hedge because you also have cost denominated as well. But there is a little bit of a headwind that's coming on service revenue growth from FX. But I think we'll probably be somewhere in kind of mid-high single-digit service growth, given expectations of WFE that are down 20% or more. You know, Chris, when we set the 26 plan in our investor day, we didn't know when, but we anticipated there'd be this digestion period of WFE just based on the historic growth. So we're still modeling the targets that we set out for 26. And we didn't know when, but it seems like it's coming in 23, and we weren't sure if it was 23 or 24, but it was going to be in that period. But overall, we feel pretty good about where we are positioned relative to that longer-term trend line. And as Brent said, we'll go under it, but then, you know, we've got a lot of systems that are shipping now, for example, that will come off warranty.
spk12: And so they'll be going into services as we move forward. We feel pretty good about where we are relative to the long-term services plan.
spk01: Got it. Thanks, Rick. Thanks, Brent. Very helpful.
spk00: We will take our next question from CJ Muse with Evercore. Your line is open.
spk09: Yeah, good afternoon. Thank you for taking the question. I guess first question, I was hoping you could speak to changes in backlog over the last three months, how you're kind of incorporating the changes around domestic China embargo, and when you're expecting to get back to kind of your normalized lead times of six to seven months.
spk13: SCJ, it's a good question, and we'll have the specific numbers in the 10-Q, which we'll likely file on probably by the end of this week. But we did grow backlog a little bit, so remaining performance obligations will be somewhere in the mid. 13 range, so some modest growth. It was 13.1 as a reference point in the June quarter. We did scrub a little bit of the backlog given the new China regulations. I think there's more work to be done there as we move into the December quarter. It's still fairly fluid, and we're working through our own assessment of the new regulations and engaging with the government about how to think about certain Certain situations there. So I would expect to see a little bit come out or certainly we grew it a little bit this quarter and I expect a little bit more effort or a little bit more there as we move into the summer quarter. So I think from a lead time point of view, it's going to vary across certain products. So we have certain products that are high-end sort of technology-enabling products like broadband plasma inspection, our retinal inspection tools, our Voyager laser scanning system, SP7 surf scan products. Those lead times remain very extended. I think it will take some time because we're dependent on incremental capacity to come online. to be able to work through some of that backlog. And I would expect those customers to stay in the queue, given the long-term sort of demand dynamics around those particular products. As it relates to some of our more capacity-centric products, I would expect some normalization as we move into 23. I think, you know, certainly we're still constrained today in a lot of areas, and I would expect that we'll see that continue for a little while. But I think as we move through 23, we'll end up with a little bit more flexibility and more normalization on certain more capacity-centric products.
spk09: Very, very helpful. As a quick follow-up, I think you talked about 100 million of gross risk related to the China impact for December. And I guess, you know, what does the net number look like there? I mean, should we just be pulling out kind of 10 to 15 million from service to reflect that and that you're perhaps repurposing the remaining tools so the net effect is much less? Or how should we think about that?
spk13: No, I think the easiest way to think about it is approximately – without the new regulations, our guidance would have been approximately $100 million higher, right? I think the mix that I talked about earlier in terms of service versus system is about the same in this quarter versus the longer term. The ability to reallocate those systems in the short run a little bit harder – So I think that, you know, as we move into next year, I think we'll be able to reallocate more, including some of what we expected here. But I think in the shorter run, much harder for us to do. So I think the easiest way to think about it is the way I described it.
spk09: Thank you.
spk00: We'll take our next question from Vavis Arya with Bank of America Securities. Your line is open.
spk02: Thank you for taking my question. Just one more on China. Can you help us put this $600 million to $900 million in context with what you're currently doing? In the last 12 months, China saved about $2.8 billion. Obviously, it's both domestic and multi. So is this $600 million to $900 million de-risked enough? And how much is left and what is left once this $600 million to $900 million goes out of your addressable opportunity next year?
spk13: Yeah, I think it's de-risk. We try to provide a range to give you some perspective. Certainly there's some forecast that's part of that. But as we looked at what we have in backlog and we looked at what we expect to book over the course of 23 for the affected customers, we were able to go tool by tool to come up with the range that I provided. And service is roughly 10% to 15% of that. We will see as we move forward. Again, we're in a very preliminary stage in terms of working through the regulations and also engaging with customers. There's the possibility that we're able to get some of that back as we move forward, but we'll have to see how that plays out. As I said in the prepared remarks, it is tied to the legacy parts of our business, which are really unaffected by the new regulations. Most of what was considered 14 nanometer and below was already de-risked from our plans because we were dealing with similar guidance back in the June quarter. And so the biggest part of the change was the restrictions on the memory business. And so I think we feel pretty good about the range given where we are, the range we provided.
spk02: Okay. And just as a follow-up, I had a longer-term, more conceptual question. I know we are far away from 24, but as people look forward, and especially this topic of WFE intensity, in the last two years, it goes about 15% to 16%. But before that, the industry used to be around the 13%, 14% level. Do you think as the industry recovers, we kind of stay at the 13%, 14%? Or do you think this is the case
spk13: be made that wf density can start to recover back to the levels that we have seen in in the last two years yeah i mean when we look at the longer term and uh it's a great question and actually that's the one that i think is the the one that we've been spending a lot of time thinking about The intensity is related to a couple factors, obviously, but one of them is the challenge with the advanced technology nodes associated with it. And I think part of why it went back up was that scaling resumed. And scaling has resumed both in what we've seen in Logic Foundry, but also in memory. So I do think it is going to trend slightly higher than it was uh and you know that it'll be in 19 or 23 but it'll go back up whether it goes all the way back up it's not exactly clear but i do think there's going to be pressure on that for people, everybody that's trying to move forward in technology.
spk12: And the one thing that we know will happen during 23, if there's a slowdown in capacity, there won't be a slowdown in technology advancement because everybody knows the way you get out of a downturn is by having newer products.
spk13: So I think it does trend back up, whether it goes back all the way, you know, we'll wait and see, but I think there's some improvement in capital intensity and then We're of the strong belief that process control intensity will hold on to some of the gains that we've made and potentially build on them as we bring new products in. Fundamental to our thesis was that we would see semiconductor revenue grow and WFE would grow slightly faster. So you'd have a flat to up trend line and WFE intensity that would be faster than semiconductor revenue. predicated on the things that Rick talked about, but also that a lot of the dynamics in the industry that drove significant efficiency in WFE have been worked out of the system. And what I mean by that is things like wafer transitions, there are no more wafer transitions, the consolidation that we saw in the industry, and so on is some of the bigger factors. So our view is that there will be a lot of pressure for customers to try to keep it from growing, but that we were growing faster than it is. But most of what is talked about today from customers is to keep it from growing faster, not to keep it from, you know, to drive it down. And so I think that there's – we think the long-term assumption that's there is – is, I think, a fairly straight down the middle assumption in terms of how we think about long-term growth. Yeah, and just one additional fact. When you look at the regionalization efforts and you think about new fabs around the world, they will tend to be slightly less efficient, which will drive up the efficiency. And those numbers are not really in anything in calendar 23. Thanks very much.
spk00: We will take our next question from Joe Moore with Morgan Stanley. Your line is open.
spk05: Great. Thank you. I wonder if you could talk a little bit about the export restrictions You guys have talked about seeing the logic restrictions coming, I think, before I heard it from anyone else. Where were you surprised on the logic side? And then as a bigger picture question, the fact that this could affect the multinationals, but the multinationals immediately have a license for a year, do you think that gives any kind of pause to investing in Chinese fabs for the multinationals who could find themselves with large assets that they're unable to to upgrade if there's a change in policy. Just can you kind of assess how your customers are talking about all of this?
spk13: Yeah, Joe, this is not an area where we're going to provide much insight. I think, you know, from the standpoint, I think what you meant is that we see the memory restrictions coming, right, because we talked about the logic ones. We were not surprised by the export controls that were implemented.
spk11: And as, you know, as we've mentioned, we've been working with working with the government officials as they've implemented those.
spk13: So we're not surprised by that. When I talk to customers about their plans in China, I think a lot of what they're doing is trying to figure out what are the implications of those extensions and what's the long-term viability. So I would say that it's a much better question to ask them than us. And ultimately, from our standpoint, frankly, it doesn't matter that much because if they choose not to invest there... What they're doing is investing to support demand, and they'll move that investment to where they can do it. So that's kind of the way they're talking about it and what we're seeing. So I think, you know, from our standpoint, a lot of the – now that this has happened, we're in a much better position to not speculate but to support as we move forward.
spk05: Great. Thank you very much.
spk00: We'll take our next question from Joe Kawatroki with Wells Fargo. Your line is open.
spk03: Yeah, thanks for taking the question. Last quarter you talked about productivity of your manufacturing staying at relatively similar rates in the second half into the first half of next year. Is that still how you're thinking about it? And maybe in that context, how do you think about that relative to gross margin?
spk13: Yeah, look, as you see in the guidance, right, we have another step up in output expectations out of the factories and are still driving to deliver into the first part of the year. I mean, certainly there's been some customer churn that we've seen. Most of of our sort of adjustments to our outlook are more from a top-down perspective in terms of engagement with certain customers and also public information. I think we'll have to see how it plays through. But right now, we are driving the factories to continue to deliver against what our customers have asked us for. So I think we'll have to see how it plays out, that we start to see some rescheduling as we move into 23. I think those are still questions out there, given just the dynamics we're seeing on the macro front and what we're hearing from customers. But for now, I think, you know, our view on the first part is somewhat consistent with what I've said in the past. But I'll have more to say about, you know, half to half and the March guidance when we get there.
spk03: That's helpful. And just as a follow-up, maybe going back to the investor day, now with the new China export restrictions and limiting some of the emerging China customers, how do you think about that maybe changing the long-term growth CAGR that you outlined at the analyst in terms of WFE or capital intensity? Does it change given those guys are maybe trying to ramp up on the technology front and suspending a little bit more than, say, some of the more mature customers?
spk13: Well, it really goes back to the – it's a good question. And we had contemplated a rationalization of WFB in support of the overall industry. So that's really how I think about that is that, you know, ultimately most of our customers end up having pretty strict investment forecasts based on their belief of, the capital intensity that they can afford, and you aggregate that up to the industry. And it kind of goes back to, well, what are your assumptions about semiconductor industry growth? What are your assumptions about capital intensity? And what are your assumptions about process control? Those are all in the band of what we considered when we looked at the investment that was going to happen there. So, yeah, it may be that there was some investment without the revenue to support it, but eventually it was going to get rationalized. And then we go back to leaving the semiconductor industry Industry growth, you believe in overall the question we answered earlier on capital intensity. So it's pretty much baked in the numbers. The reason we set it out for 26 instead of sooner was, as I mentioned before, we felt like there was going to be some kind of digestion period, which we're now facing into. So you kind of get there.
spk11: As I mentioned, there will be some investment that when you look at some of this regionalization that It hasn't happened yet that would have been upside to that plan, and now I think it kind of all blends together.
spk13: So if you believe it's having vector growth, I don't think capital intensity goes down, and we feel pretty good about process control in our share. That's supportive of the numbers that we laid out. In addition, Brent already talked about the services, which is another big part of it. So a very long way to say we feel like we're still on target for our 26 plans. Yeah, you left out the EPC part, too. I think that's one where certainly we're feeling pressure this year and would expect to see more volatility in that part of the business given its proximity to consumers. But we still have an expectation that through SAM growth there that we will see similar growth rates there as well. We talked about 21 to 26 overall. As Rick said, we modeled some softness in between, but we still feel good about the underlying assumptions of what we laid out.
spk14: Perfect. Thank you.
spk00: We will take our next question from Sydney Ho with Deutsche Bank. Your line is open.
spk04: Thanks for taking my question. So I have two questions. The first one is a near term. If I look at your December quarter guidance, can you help us with the growth difference between SPC and EPC? And I know this EPC was down quite a bit quarter by quarter, maybe just seasonality in Q1. And then related to that, if you can unpack the guidance for gross margin a little bit, it's down about 100 basis points. At the midpoint, can you talk about the pluses and minuses and specifically related to revenue impact of the China regulation? Does that have an adverse impact on gross margin? And I'll follow up.
spk13: Good question. So in terms of guidance for December, all the incremental revenue is coming, just about all is likely to come from our semi-process control business. I would think there'd be some impact from the new China regulations on service and the ability to go service quarter to quarter. EPC was down. I think it'll be up modestly quarter to quarters, but the bulk of the revenue increase will come from EPC. from Semi-PC. So I think in terms of gross margin in the September quarter, it was most of the upside. And I think we did better overall in Semi-PC than we expected. EPC was a little bit weaker on the margin that we thought going into the quarter. So we had a very strong mix of business We had a significant sequential growth in patterning. Patterning includes reticle inspection, which tends to be a richer product line from a gross margin point of view. So that was the biggest impact that drove the upside. I think as we look at December, again, it will come back to mixed dynamics in terms of how we model the business. You know, we're kind of operating in line with the long-term range that I've talked about. It's somewhere between, you know, 63% plus or minus. 50 basis points or so and we've been operating fairly consistent with that if you look at the broader picture of calendar 22 so we'll see how it plays out um we've certainly been driving the business at a higher level in terms of output expectations if you just go back to june what was you know, what was the consensus expectation for WFE both this year but also into 23. So that's certainly been a factor in terms of how we've been sizing our business in terms of our ability to support and to ship. And, you know, as we move into 23 and we see some of that size, it could create a little bit of inventory exposure from an excess inventory point of view. So it could have some incremental reserve exposure there as well that we contemplated as we thought about December. So those are the puts and takes. I think the China regs in terms of impact on gross margin, it's more of a revenue impact. I don't think there's anything incremental from a gross margin point of view, one way or the other.
spk04: That's helpful. Great. My follow up question is back to a cycle question here. In prior down cycles, KLA usually outperform initially because customers want to improve yields, maybe continue to invest in R&D. But essentially, the downturn would eventually, the downturn would catch up after several quarters, maybe just memory capex got touched first and then time period logic comes later. Remind us why you think this time could be different, and what kind of visibility into 2023 do you have right now, just based on cancellation, rescheduling, those kind of things? Thank you.
spk13: We haven't had any cancellations. And there has, you know, the rescheduling, there's been, I'll call it churn in our backlog management, but backlog grew quarter to quarter. I would expect that we'll see more cancellations as we move into 23. But what we said in terms of guidance of the industry down approximately 20% or so, and given our expectations around the mix of business and so on in the history, that we would expect KLA to perform well in that environment from a share of WFG point of view. So I think to your other point, look, it depends on how long these soft periods last in terms of how customers ultimately adjust and then what are the demand drivers as they come out of it. But as I said before, we're much more levered to our customers' technology roadmaps. than the increment of capacity. We're certainly doing much better in capacity investment than we used to do, particularly around some of the issues we talked about at Investor Day due to higher design starts and less reuse and so on. So those are all factors for us that are positive from a capacity point of view. But at the end of the day, the biggest part of KLA's business is exposed to development and ramping up production. So as long as technology roadmaps hold together, we feel pretty good about how we're positioned. Yeah, and let me even add to that. I mean, yesterday we talked more about our exposure, as Brent said. and the ability we have to scale when there's capacity.
spk12: I think the other thing that's changed, particularly with EUV, is we're actually more in enabling technology now.
spk13: And before, we might have been more about yield management. And now with some of our products, particularly in BBP and in Rapid, those are the tools that our customers have repeatedly said, no matter what happens in this downturn, keep us on your list.
spk12: We want those tools. So I think that we've broadened from being primarily a company associated with ramping yields to one of enabling technology, particularly around EUV,
spk13: and then in capacity. So I think we have better exposure, which is why we feel pretty good about how our products are holding up and the fact that we are getting very clear signals from customers that are saying, we understand we're slowing overall, but please do not take us out of the list.
spk12: We need those tools, and we need them as soon as we can get them.
spk04: Great. Thank you very much.
spk08: will take our next question from timothy curry with ubs your line is now open thanks a lot um brent i also had a question on process control systems um and and i asked because 2023 is going to be kind of a weird year because there's about four to five billion dollars worth of deferred wfe just from two of your peers that should have been wfe this year but really is going to become wfe next year And that sort of optically creates maybe like a little bit of a headwind for your WFE share. So I'm wondering if you can sort of help sift through that and maybe size what your PC systems would be for calendar 23. It seems like $6 billion is a pretty reasonable bogey, but I'm wondering if you like that number or not.
spk13: Well, Tim, I don't want to guide 23 yet. We're a little bit early on that. I think you're right that there is some of this deferred revenue dynamic that will maybe skew the numbers a bit. But I think also even the things that we just said about how we're positioned into 23 from a backlog point of view and from a technology point of view, that we feel pretty comfortable with our share of WFE continuing. Also, I think we feel very good about the actual market share within process control and the – We think some tailwinds there as well. So I think against the backdrop that you're talking about, if you're thinking WFE somewhere in the $75 billion-ish range or so, the kinds of numbers are reasonable that you're mentioning. But I'll have the ability, I think, to provide a little bit more clarity around how we see that as we move into guidance for 23 in January. Okay.
spk08: Cool, thanks. And then, Rick, I had one for you. There was a question earlier about WFE intensity. And the China restrictions are taking between $7 billion and $9 billion out of WFE for next year. Maybe some of that gets replaced somewhere else. But you see all the wafers and all the yields. So, would you agree that maybe domestic China WFE has sort of inflated WFE intensity to some degree over the past couple years, and maybe it's fair to take like a 50% multiplier. I mean, you know, I don't want a number, but just the idea that you should take a, you know, some sort of a handicap to what the WFE is, you know, dollars, because the productivity of those dollars is not equivalent to dollars being spent beyond China. I'm just sort of, you know, wondering how you kind of think about that. Thanks, Rick.
spk13: Yeah, Tim, no, I think that's true. I think that is absolutely the case that you have a situation where there was additional WFE. But it's interesting because that investment didn't really utilize EUV. So that wasn't particularly capital-intensive investment on a relative basis. So in fact, they were prevented from it. So I think over time, there is going to be more pressure on everybody that stays on the technology roadmaps to invest in technology that leverages, frankly, more to KLA, whether it's in logic, boundary, or memory. And so that's why, you know, as we said, we modeled that. It is true that'll come out, but it will, over time, be replaced. So I think, sure, the capital intensity was probably running a bit hot because of that, but that's going to get reset. So I don't think we go back into where we were, but I don't think we go all the way down either. I think it's somewhere in between. And that's how we modeled our 2026 plan. Yeah, I would say it's more efficient today than it was in 2016 when we saw this escalation in investment. So there is a little bit more maturation there than before. than what we had, let's say, five, six years ago. But generally, I would also agree. I think you also have to remember that there's investment that's happening in infrastructure to support legacy domestic consumption, right? And so you have wafer investment that's happening. You have some radical investment that's happening as well. So... I think when you look at that, there is that question about how much of that is meeting real demand versus more strategic investment. I think that that's There is some adjustment factor there, but it's probably a little bit different than what you might have thought five years ago or so. As you think about process control intensity, typically in legacy nodes, we tend to do fairly well as facilities are starting up. But the process control intensity in the trailing edge, unless they're big drivers of some major change, doesn't really – isn't really as high as it is at the leading edge. So when you think about foundry logic process control intensity at the trailing edge, it's more like memory, maybe a little bit better than that in China, but it isn't like a leading edge investment would provide. So it's a little bit different environment there from a KLA point of view.
spk08: Thank you both.
spk00: We will take our next question from Tal Shia Hari with Goldman Sachs. Your line is open.
spk07: Great. Thanks so much. I had two questions as well. Bren, on the China impact in calendar 23, which you sized at $600 to $900 million, I think that was a gross number. So just curious, given the fungibility of your tools and based on your current pipeline, roughly what percentage of that do you think you can repurpose and ship to other customers, at least on the system side?
spk13: Yeah, I think it's too early to tell, Tashia. What we tried to do, and I purposely used those words, that it was gross. I think as we move forward, there are certain products that we will be able to repurpose fairly easily, and there are other ones that might be a little bit more difficult, depending back to the sort of capacity versus technology discussion we had earlier. So I'll have a clearer picture on how to think about that. But the way I thought about it was, as I said earlier, I looked at the backlog and I looked at our forecast in terms of expectation of timing of revenue and added up what we, absent the new regulations, how much revenue we would have. And that drove the range that I provided. And then we'll have to see also, as I said earlier, how how as we progress here moving forward, what is truly kind of out and what isn't as we start to work our way through and engage with customers and get a clearer picture from the government as we go through. So I think that's the best way I can size it right now is that impact, and I would expect for our more higher-end products where these times are extended that we'll be able to reallocate some of those tools.
spk07: Got it. That's helpful. And then as my follow-up, I wanted to get your thoughts on OpEx into calendar 23. I think it's fair to say that WFE Outlook has deteriorated over the past three months or so, given memory weakness and and the export controls, your business is going to be a lot more resilient than the overall market. But just given how the trajectory has potentially changed from a revenue perspective, I'm sure you're sort of thinking through and revisiting your footprint into 2023. How should we think about OPEX? I think you talked about, on a quarterly basis, things moderating into Q1, but for the full year, if you can provide some context, that would be helpful. Thank you.
spk13: Yeah, I think the easiest way to think about it right now is the flattening out. So as we get a clearer picture on what the revenue profile looks like for 23, I'll have a better – level of sort of quarter to quarter guidance. We've invested a lot over the last couple of years to support the revenue growth and to continue to invest in driving innovation and differentiation, which is so critical to KLA's go-to-market. And so we've made those investments. We want to get returns on those investments. So we'll be careful and judicious about how we think about it. Obviously, the reality of the business environment is a factor, but also ensuring that we have the right products to meet our customers' roadmap requirements over the next few years is really critical. And I think the history at KLA has shown that in soft periods that our ability to invest and deliver what our customers need when they need it It's been fundamental to our ability to go to market, to have the portfolio, and to share the value that we deliver. So it'll be a balancing act across all of those kinds of dynamics. But I think from a modeling point of view, you've got to model that it flattens out. There's also inflation pressures, right? We'll have a merit cycle, so we'll have to work through all of that as well. But my expectation right now is that we're tapping the brakes and you'll see it flatten out.
spk07: Thank you.
spk00: And we do have time for one final question. We will take our final question from Atif Malik with Citi. Your line is now open.
spk14: Hi, thank you for taking my question. First, I just want to clarify if you and your peers cannot ship the spare parts and services to these projects, will these projects kind of like halt sometime next year as they run out of spare parts and then have a follow-up?
spk13: The ability to support the tools, I can't speak for the peers, but I can just say for KLA systems, given the nature of our tools and the maintenance that's required to support them and the supply chain, which is fairly custom, that the ability to do maintenance is important to keeping the tools up and performing as designed and at spec. So without service, it becomes very hard to utilize the tools that we've shipped.
spk14: Great. And then the team talked about very nice bookings momentum on auto-related products, on advanced packaging and silicon carbide at the investor day. Can you update us what you're seeing in the auto market? That end market seems to be holding quite well right now into next year.
spk13: Yeah, I think in automotive, it's been a nice driver for our business, and we've seen meaningful growth really across not just what's gone on in our EPC group, but also, and you have exposure in a few different places, right? We have exposure in our SPTS business, which is for process. in power semiconductors, but also in our semi-PC business. And so we have a few offerings that we've tailored to support that market. And so we've seen nice growth there, and we're encouraged by the rising semiconductor content, just basic content in cars, let alone EUV-enhanced content. assisted capabilities moving forward. So I don't have the exact number in terms of where it is. I want to say it's about $700 million or so this year in 2022 in terms of what we'll call kind of auto exposure from a revenue point of view. And we would expect to see that grow over time. And we're engaging at levels with our customers today. that are driving a different way of thinking about process control given the reliability requirements in auto and the margin structure, the cost of defectivity, the cost of recall, and so on.
spk11: All right. We appreciate it. Yeah, thanks so much for the questions, everyone. Appreciate your time on a busy earnings week, and we will be in touch. I'll turn the call back over to the operator to conclude.
spk00: This concludes the KLA Corporation September quarter 2022 earnings call and webcast. Please disconnect your line at this time and have a wonderful day.
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