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 one on your telephone keypad. If you wish to remove yourself from the queue, please press star two. Please limit yourself to one question and one follow-up. Lastly, if you should need operator assistance, please press star zero. Thank you. I will now turn the call over to Kevin Kessel, Vice President of Investor Relations and Market Analytics. Please go ahead.
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 Bren 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 KLA 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. Bren 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.
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 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 a twelve-month ended September thirtieth 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 in the semiconductor industry has evolved to be more strategic with more diverse end 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 CY 2023 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 free cash flow generation, and consistent returns to shareholders. Now, our CFO, Bren Higgins, will review our September quarterly financial highlights and outlook. Bren?
Thank you. As you heard 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 gross 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 billion-$2.725 billion. Non-GAAP diluted EPS was $7.06, above the guided range of $5.70-$6.80.
GAAP diluted EPS was $7.20. Non-GAAP gross margin was 40 basis points above the midpoint of guidance at 63.4%, as 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%.
Quarterly 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 and 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, in 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-20s percentage revenue growth for the total company in calendar 2022, 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 percentage 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 CY 2023 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 million-$900 million in 2023. This reflects systems and service impact, with service representing approximately 10%-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. KLA'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 ± $150 million.
The gross direct impact of the new China regulations on the December quarter revenue guidance is approximately $100 million. Foundry 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-GAAP gross margin to be in a range of 61.5%-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 2023.
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-$7.34, and non-GAAP diluted EPS in a range of $6.30-$7.70. EPS guidance is based on a fully diluted share count of approximately 140 million shares.
In conclusion, although the CY 2023 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 investments supporting growing semiconductor content across technology nodes remain important trends.
These are long-term secular growth drivers for the industry, as technology investment in 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 of investment in our product development roadmaps to enable market share expansion and support customers' technology roadmaps and multiyear 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 moat, industry-leading financial performance, history of robust free cash flow generation, and consistent and growing capital returns to shareholders. With that, I'll turn the call back over to Kevin to begin the Q&A session. Kevin?
Thanks, Bren. Operator, can you please queue for questions?
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 Sur with JP Morgan. Your line is now open.
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 and process control spending growth for the last few years. No different this year, right? I mean, it looks like giving your December quarter guidance, your process control systems business is gonna 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 WFE was down back then. Kind of given all of this, like, 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?
Yeah, Harlan Sur, it's Bren. Thank you for the comments, and I'll start here and Rick can join after. 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. As you know, process control intensity in memory is quite a bit lower than it is in foundry and logic.
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. I think that that's always been an anchor for us. We also tend to support customers that are investing in their roadmaps, right? As they pull back on their capacity investments, they continue to invest in technology.
There's a certain amount of business that with KLA that continues to happen almost irrespective of their revenue levels. That tends to be a factor for us as well. Finally, customers usually continue to run the installed base, and service continues to operate. We have a contract stream that is the majority of the revenue, 75% plus of the revenue. While they're pulling back on CapEx investments, they still tend to run the installed bases pretty heavily. 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.
Great. Thanks for that. Then on my follow-up, you know, good to see the strong EUV mask inspection shipments. You know, your patterning segment was up almost 70% year-over-year. I think that's reflective of the strong EUV adoption this year. Despite the weaker WFE backdrop for next year, I think that the EUV lithography outlook continues to be strong, right?
I mean, continued penetration of EUV 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?
Yeah, Harlan, you have it right. 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. Very strong year and certainly driven by EUV as 90% + 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 see the start to see more investment in the 3 nm node. 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 mask inspection and new infrastructure that's being built in China to support the legacy reticles.
There's also an aspect of investment that's happening there as well. I would expect it to have another good year this year or strong year in 2022, but also strong year in 2023 as well. Yeah, 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. Part of what we were in development for was continuing extending the 6XX product to be able to serve more of the EUV market. As we do that, we saw some performance. Overall, the segment's good, and then we had some benefit of some share gain as well.
Oh, insightful. Thank you.
We will take our next question from Krish Sankar with Cowen and Company. Your line is open.
Yeah. Hi, thanks for taking my question. Rick, just wanted to follow up on the earlier question. I understand you guys typically outperform process control in, like, a normal cyclical downturn. 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 revenue to outperform WFE next year? Then I have a follow-up.
We do for two reasons. One, it is 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. The other thing is the decline in WFE is gonna be based more in memory than in foundry logic. That alone helps us in terms of the mix. I think we're in pretty good position to outperform WFE. Nobody really knows, of course, what 2023 is gonna look like. With that setup, we're in pretty good shape.
Got it. Very helpful, Rick. Then just to follow up on services, you know, what percentage of your services is from China or domestic China? Also, if WFE is down 20%, what do you think happens to service business next year? Thank you.
Yeah. I don't think we've broken that out. I would say it's less. Our systems business in China and EPC is somewhere between 20%-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.
It'd be lower than 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'll 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 that's denominated in local currencies. You get a little of a natural hedge because you also have costs denominated as well. There is a little bit of a headwind that's coming on service revenue growth from FX.
I think we'll probably be somewhere in kind of mid high single digits of service growth, given expectations of WFE that are, you know, down 20% or more. You know, Krish, when we set the 2026 plan on 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.
We're still modeling the targets that we set out for 2026, and we didn't know when, but it seems like it's coming in 2023, and we weren't sure if it was 2023 or 2024, but it was gonna be in that period. Overall, we feel pretty good about where we are positioned relative to that longer term trend line. As Bren said, we'll go under it, but then, you know, we've got a lot of systems that are shipping now, for example, that'll come off warranty, and so they'll be going into services as we move forward. We feel pretty good about where we are relative to long-term services planning.
Got it. Thanks, Rick. Thanks. Been very helpful.
We'll take our next question from C.J. Muse with Evercore. Your line is open.
Yeah, good afternoon. Thank you for taking the question. I guess first question, 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.
Yeah, C.J., 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. We did grow backlog a little bit, so remaining performance obligations will be somewhere in the mid-$13 range. Some modest growth. It was $13.1 as a reference point in 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 situations there. I would expect to see a little bit come out.
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 December quarter. I think from a lead time point of view, it's gonna vary across certain products. We have certain products that are our high-end sort of technology-enabling products like Broadband plasma inspection, our reticle inspection tools, our Voyager laser scanning system, SP7 Surfscan 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. 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 2023. 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. I think as we move through 2023, we'll end up with a little bit more flexibility, and more normalization on certain more capacity-centric products.
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 million-$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?
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 the same in this quarter versus the longer term. The ability to reallocate those systems in the short run a little bit harder.
I think that, you know, as we move into next year, we'll be able to reallocate more, including some of what we expected here. I think in the shorter run, much harder for us to do. I think the easiest way to think about it is the way I described it.
Thank you.
We'll take our next question from Vivek Arya with Bank of America Securities. Your line is open.
Thank you for taking my question. Just one more on China. Can you help us put this $600 million-$900 million in context with what you're currently doing? You know, in the last twelve months, China sales were about $2.8 billion.
Obviously, it's both domestic and multi. Is this $600 million-$900 million de-risked enough? You know, how much is left and what is left once this $600 million-$900 million goes out of your addressable opportunity next year?
Yeah, I think it's de-risked. We try to provide a range to give you some perspective. Certainly, there's some forecast that's part of that. As we looked at what we have in backlog, and we looked at what we expect to book over the course of 2023 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%-15% of that.
We will see as we move forward, again, we're at 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 nm and below was already de-risked from our plans, because we were dealing with similar guidance, back in the June quarter. What the biggest part of the change was, the restrictions on the memory business. I think we feel pretty good about the range given where we are, the range we provided.
Yes. Just as a follow-up, I had a longer-term, you know, more conceptual question. I know, you know, we are far away from 2024, but as people look forward, you know, and especially this topic of WFE intensity, in the last two years, it grows about 15%-16%.
But before that, you know, the industry used to be, you know, around the 13%-14% levels. Do you think as the industry recovers, we kind of stay at the 13%-14%? Or do you think there's a case to be made that WFE intensity can start to recover back to the levels that we have seen in the last two years?
Yeah. I mean, when we look at the longer term, it's a great question, and actually that's the one that I think is 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.
I think part of why it went back up was that scaling resumed. Scaling has resumed both in what we've seen in foundry logic, but also in memory. I do think it is going to trend slightly higher than it was, you know, in 2023, 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 gonna be pressure on that for people, everybody that's trying to move forward in technology. The one thing that we know will happen during 2023, 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. I think it does trend back up.
Whether it goes back all the way, you know, we'll wait and see. 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. Yeah.
Fundamental to our thesis was that we would see semiconductor revenue grow, and that WFE would grow slightly faster. You'd have a flat to up trend line in 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.
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. Our view is that there'll be a lot of pressure for customers to try to keep it from growing, but that we were growing faster than it is.
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. I think we think the long-term assumption that's there is a, I think, a fairly straight down the middle assumption in terms of how we think about long-term growth. Yeah. 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. Those numbers are not really in anything in calendar 2023.
Thanks very much.
We will take our next question from Joe Moore with Morgan Stanley. Your line is open.
Great. Thank you. I wonder if you could talk a little bit about the export restrictions. You know, you guys had talked about seeing the logic restrictions coming, I think, before anyone else. You know, where were you surprised on the logic side?
As a bigger picture question, you know, 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 upgrade if there's a change in policy? Just can you kind of assess how your customers are talking about all of this?
Yeah. Joe, this is not an area where we're gonna provide much insight. I think from the standpoint, I think what you meant is did 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. As we've mentioned, we've been working with the government officials as they've implemented those.
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? I would say that it's a much better question to ask them than us.
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. That's kind of the way they're talking about it and what we're seeing. 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. Great. Thank you very much.
We'll take our next question from Joe Quatrochi with Wells Fargo. Your line is open.
Yeah, thanks for taking the question. Last quarter, you had talked about productivity, your manufacturing staying at relatively similar wafer rates in the second half of into the first half of next year. Is that still how you're thinking about it? Maybe in that context, how are you thinking about that relative to gross margin?
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 our sort of adjustments to our outlook are more from, you know, a top-down perspective in terms of engagement with certain customers and also public information. I think, you know, we'll have to see how it plays through. Right now, we are driving the factories to continue to deliver against what our customers have asked us for. I think we'll have to see how it plays out.
Do we start to see some rescheduling as we move into 2023? 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. For now, I think, you know, our view on the first part is somewhat consistent with what I've said in the past. I'll have more to say about, you know, half to half in the March guidance, when we get there.
That's helpful. Then just as a follow-up, maybe going back to the Investor Day. You know, now with the new China export restrictions and limiting some of the emerging China customers, how do you think about that maybe changing the, you know, long-term growth CAGR that you outlined at the Investor Day in terms of WFE or capital intensity? Does it change given those guys are, you know, maybe trying to ramp up on the technology front, so spending a little bit more than, say, some of the more mature customers?
It really goes back to the. It's a good question, and we had contemplated a rationalization of WFE in support of the overall industry. 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 were all in the band of what we considered when we looked at the investment that was gonna happen there. Yeah, it may be that there was some investment without the revenue to support it, but eventually it was gonna get rationalized.
Then we go back to, do you believe in the semiconductor industry growth? Do you believe in overall the question we answered earlier on capital intensity. It's pretty much baked in the numbers. The reason we set it out for 2026 instead of sooner was, as I mentioned before, we felt like there was gonna be some kind of digestion period, which we're now facing into. You kind of get there.
As I mentioned, there will be some investment that, when you look at some of this regionalization, that hasn't happened yet, that would've been upside to that plan, and now I think you end up, it kind of all blends together. If you believe the semiconductor growth, I don't think capital intensity goes down, and we feel pretty good about process control and our share.
That's supportive of the numbers that we laid out. In addition, Bren already talked about the services, which is another big part of it. Very long way to say we feel like we're still on target for our 2026 plan. 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. You know, we talked about 2021 to 2026 overall.
As Rick said, we modeled, you know, some of the softness in between, but we still feel good about the underlying assumptions of what we laid out.
Perfect. Thank you.
We will take our next question from Sidney Ho with Deutsche Bank. Your line is open.
Thanks for taking my question. I have two questions. The first one is the near term. If I look at your December quarter guidance, can you help us with the growth difference between SPC and EPC? I know this EPC was down quite a bit quarter-over-quarter, maybe just seasonality in Q1.
Then related to that, if you can unpack the guidance for gross margin a little bit, it's down by 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? I'll follow up.
No, good question. 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 do service quarter to quarter. EPC was down. I think it'll be up modestly quarter to quarter, but the bulk of the revenue increase will come from SEMI PC.
I think in terms of gross margin in the September quarter, it was, you know, 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 than we thought going into the quarter. 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. That was the biggest impact that drove the upside. I think as we look at December, again, it will come back to mix 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 is somewhere between 63% ±50 basis points or so, and we've been operating fairly consistent with that if you look at the broader picture of calendar 2022. We'll see how it plays out. 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 the consensus expectation for WFE both this year but also into 2023. 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. If, as we move into 2023 and we see some of that soften, it could create a little bit of inventory exposure from an excess inventory point of view.
It could have some incremental reserve exposure there as well that we contemplated as we thought about December. 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.
Okay. That's helpful. Great. My follow-up question is back to a cycle question here. In prior down cycles, KLA usually outperformed initially because customers want improved yields, maybe continue to invest in R&D. Essentially the downturn would eventually catch up after several quarter, maybe just memory CapEx got cut first, and then foundry 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, maybe rescheduling, those kind of things? Thank you.
We haven't had any cancellations. There has, you know, been rescheduling that there's been a. 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 2023.
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 WFE point of view. I think, you know, to your other point, 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.
As I said before, you know, 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.
Those are all factors for us that are positive from a capacity point of view. At the end of the day, the biggest part of KLA's business is exposed to, you know, development and ramping of production. 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, at Investor Day, we talked more about our exposure, as Bren said, and the ability we have to scale when there's capacity. I think the other thing that's changed, particularly with EUV, is we're actually more an enabling technology now, and before we might have been more about yield management.
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. We want those tools." I think that we've broadened from being primarily a company associated with ramping yields to one of enabling technology, particularly around EUV, and then in capacity.
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. We need those tools, and we need them as soon as we can get them.
Great. Thank you very much.
We will take our next question from Timothy Arcuri with UBS. Your line is now open.
Thanks a lot. Bren, I also had a question on process control systems. I ask because 2023 is gonna be kind of a weird year because there's about $4 billion-$5 billion worth of deferred WFE just from two of your peers that should have been WFE this year, but really is gonna become WFE next year. That sort of optically creates maybe like a little bit of a headwind for your WFE share. I'm wondering if you can sort of help sift through that and maybe size what your WFE systems would be for calendar 2023. It seems like $6 billion is a pretty reasonable bogey, but I'm wondering if you like that number or not.
Well, Tim, I don't want to guide 2023 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. I think also given the things that we just said about how we're positioned into 2023 from a backlog point of view and from a technology point of view, that we feel pretty comfortable with our share of WFE continuing. We also, I think, feel very good about the actual market share within process control, and then we think some tailwinds there as well.
I think against the backdrop that you're talking about, you know, if you're thinking, you know, 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 2023 in January.
Cool. Thanks. Rick, I had one for you. There was a question earlier about WFE intensity. If you take the China restrictions are taking, like, between $7 billion and $9 billion out of WFE for next year, maybe some of that gets replaced somewhere else. You see all the wafers and all the yields.
Would you agree that maybe domestic China WFE has sort of inflated WFE intensity to some degree over the past couple of 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.
Yeah. Tim, no, I think that's true. I think that is absolutely the case that you have a situation where there is additional WFE. It's interesting because that investment didn't really utilize EUV, so that wasn't particularly capital intensive investment on a relative basis. In fact, they were prevented from it.
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, foundry, or memory. That's why, you know, as we said, we modeled that. It is true that'll come out, but that it will over time be replaced. I think, sure, the capital intensity was probably running a bit hot because of that, but that's going to get reset.
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've modeled our 2026 plans. Yeah. I would say it's more efficient today than it was in 2016 when we saw this escalation in investment. There is a little bit more maturation there 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? So you have wafer investment that's happening. You have some reticle investment that's happening, as well.
You know, I think when you look at that, you know, there is that question about how much of that is meeting, you know, real demand versus, you know, more strategic investment. I think that, you know, that 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, you know, we tend to, I think, do fairly well as facilities are starting up. The process control intensity in the trailing edge, unless they're big drivers of some major change, isn't really as high as it is at the leading edge.
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. It's a little bit different environment there from a KLA point of view.
Thank you both.
We will take our next question from Toshiya Hari with Goldman Sachs. Your line is open.
Great. Thanks so much. I had two questions as well. Bren, on the China impact in calendar 2023, which you sized at $600 million-$900 million, I think that was a gross number. So just curious, given the fungibility of your tools and based on your current pipeline, you know, roughly what percentage of that do you think you can repurpose and ship to other customers, at least on the systems side?
Yeah. I think it's too early to tell, Toshiya. 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, that brings us back to the sort of capacity versus technology discussion we had earlier. I'll have a clearer picture on how to think about that.
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, absent the new regulations, how much revenue we would have, and that drove the range that I provided.
Then we'll have to see also, as I said earlier, how as we progress here moving forward, what is truly kind of out and what isn't as we, you know, as we start to work our way through, engage the customers and get a clearer picture from the government as we go through. I think that's the best way I can size it right now is that impact. I would expect for our higher end products where lead times are extended, that we'll be able to reallocate some of those tools.
Got it. That's helpful. As my follow-up, wanted to get your thoughts on OpEx into calendar 2023. I think it's fair to say that WFE outlook has deteriorated over the past, you know, three months or so, given memory weakness and the export controls.
You know, your business is gonna be a lot more resilient than the overall market, but just given how, you know, the trajectory has potentially changed from a revenue perspective, you know, I'm sure you're sort of, you know, 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.
Yeah. I think the easiest way to think about it right now is it's flattening out. As we get a clearer picture on what the revenue profile looks like for 2023, we'll have a you know 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. We've made those investments. We wanna get returns on those investments. 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. 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 has been fundamental to our ability to go to market, to have the portfolio, and to share the value that we deliver.
It'll be a balancing act across all of those kinds of dynamics. I think from a modeling point of view, you've got a model that 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. My expectation right now is that we're tapping the brakes, and you'll see it flatten out.
Thank you.
We do have time for one final question. We will take our final question from Atif Malik with Citi. Your line is now open.
Hi. Thank you. 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? Then I have a follow-up.
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, this ability to do maintenance is important to keeping the tools up and performing as designed and expected. Without service, it becomes very hard to utilize the tools that we've shipped.
Great. Then the team talked about very nice booking 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 and into next year.
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. You have exposure in a few different places, right? We have exposure in our SPTS business, which is for process and power semiconductors, but also in our Semi PC business. We have a few offerings that we've tailored to support that market. 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 and assisted capabilities moving forward. I don't have the exact number in terms of where it is.
I wanna 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. We would expect to see that grow over time. We're engaging at levels with our customers that are, you know, 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.
All right. Great. Thank you.
We appreciate
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.
This concludes the KLA Corporation September quarter 2022 earnings call and webcast. Please disconnect your line at this time.
Goodbye.
Have a wonderful day.