I'll be your conference operator today. At this time, I would like to welcome everyone to the KLA Corporation December Quarter 2021 Earnings Conference Call and Webcast. [Operator Instructions].

I will now turn the call over to Kevin Kessel, Vice President of Investor Relations and Market Analytics. Please go ahead. .

Thank you, Leo, and welcome to KLA's Fiscal Q2 2022 Quarterly Earnings Call to discuss the results of the December quarter and the outlook for the March quarter. With me on today's call is Rick Wallace, our Chief Executive Officer; and Bren Higgins, our Chief Financial Officer. .

During this call, we will discuss quarterly results for the period ended December 31, 2021, released this afternoon after the market closed. You can find the press release, shareholder letter, slide deck and infographic on the KLA IR section of our website. .

Today's discussion is presented on a non-GAAP financial basis unless otherwise specified. And whenever we make references to full year business performance, it can be understood to be a calendar year. A detailed reconciliation of GAAP to non-GAAP results is in the earnings materials 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 the most recent annual report and quarterly reports on Forms 10-K and 10-Q. Our comments today are subject to risks and uncertainties reflected in the risk factors 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. .

Let me now turn the call over to our Chief Executive Officer, Rick Wallace.

Rick?.

Thanks, Kevin. Before summarizing KLA's results for calendar year 2021 and for the December quarter, I'd like to first acknowledge and thank the global KLA team.

The dedication and hard work of our teams never wavered despite challenging conditions, delivering for customers and managing around a complex global supply chain during a period of unprecedented industry shortages. .

It was the day-to-day drive to be better that drove KLA's market leadership, resulting in record growth and financial performance across the board for the company in the December quarter and for 2021.

KLA also delivered record returns to shareholders in 2021 through our dividend and share repurchase programs with returns to shareholders totaling over $2 billion. .

KLA's strong results demonstrate our track record of relative strength and revenue growth and superior financial performance compared with semiconductor industry peers in a dynamic and growing wafer fab equipment industry as well as the long-term value created by employee and consistently refining our KLA operating model.

Since our founding in 1976, KLA's mission has been focused on using our expertise and innovative thinking to overcome monumental technological challenges. .

KLA is advancing humanity with technologies and ideas that inspire action. Our results in the December quarter and for 2021, demonstrate ongoing success of these strategies. So thank you to all our teams for contributing to KLA's enduring success.

2021 was another year of record growth, profitability and free cash flow for KLA, as we successfully navigated unprecedented challenges in the marketplace, responding to record demand across the vast majority of our markets, while adapting to the evolving operational complexities associated with the global pandemic. .

Through it all, we remained focused on delivering to our customers' requirements and driving strong returns to shareholders in a rapidly growing industry demand environment. In 2021, revenue grew 34% to $8.2 billion, marking the sixth consecutive year of revenue growth. .

KLA's strong revenue growth in 2021 was driven by 46% growth in the semiconductor process control systems. Revenue from the services business grew 14% in the year, with over 75% of the revenue generated from recurring subscription-like contracts, reflecting the growing value of added process control systems and services in our product portfolio. .

KLA also demonstrated strong operating leverage on our revenue growth in 2021 with non-GAAP operating profit and non-GAAP earnings per share growing 54% and 61%, respectively. Incremental operating margin on the revenue growth in 2021 was 57%, consistently above our target operating leverage model of 40% to 50% for the second year in a row. .

Free cash flow also grew a healthy 43% in 2021 to a record $2.5 billion. Consistent with our long-term strategic objectives, KLA delivered on our ongoing commitment to return value to shareholders, including our 12th consecutive dividend increase announced in July 2021, along with an additional $2 billion share repurchase program. .

Total returns to shareholders in 2021, including dividend and share repurchases, topped just over $2 billion or approximately 79% of free cash flow. This growth demonstrates success in strengthening our market leadership across our business that we can continue to build upon to drive adoption of KLA solutions in the critical markets we serve.

Within the Electronics, Packaging and Component inspection or EPC Group, the Specialty Semiconductor Process segment grew 11% in 2021, and the Printed Circuit Board Display and Component Inspection grew 17% in the year. .

The strong relative performance for KLA reflects our market leadership and diversification and was driven by secular industry growth trends across multiple end markets. We ended 2021 with an exceptionally strong backlog and began what we anticipate being a seventh consecutive year of growth for KLA.

We enter 2022 executing at a high level and operating from a position of strength in our marketplace despite persistent supply chain challenges. .

This momentum sets the stage for KLA to continue to outperform the market while demonstrating superior financial performance and maintaining our capital returns. Turning now to focus on the December quarter results where we saw diversified strength across our business.

Today, demand environment continues to demonstrate accelerated adoption of a broad spectrum of semiconductor and electronic industry growth trends. .

Technology is transforming how we live and work and the data-driven economy is fundamentally changing how businesses operate and deliver value.

This digital transformation is enabling secular demand drivers such as high-performance computing, artificial intelligence, growth in new automotive electronics and strong growth in data centers and 5G communication markets. .

Each of these secular trends are driving investment and innovation and advanced memory and logic semiconductor devices as well as new and increasingly more complex advanced packaging and PCB technologies.

With our market leadership in process control, and growth and expansion in new markets like Specialty Semiconductor Process equipment, PCB and finished die inspection in our EPC group, KLA is essential to enabling our increasing digital world. .

To make this happen, KLA continues to prioritize and invest in R&D, which totaled $1 billion in calendar 2021, double the level of 5 years ago and growing at a 15% compound annual growth rate.

With this favorable backdrop and our demonstrated track record of investing heavily in R&D to drive product differentiation and consistently meeting or exceeding our commitments to customers and shareholders, our performance enabled KLA to outperform the 2023 long-term financial model targets that we set 2 years ago, 2 years ahead of expectations. .

Moving along to the top highlights from the December 2021 quarter. First, we saw continued strength and consistency in foundry logic customer revenue for both leading edge and legacy technologies in the December quarter. As expected, memory demand also grew in the period. Calendar 2022 is setting up to be another year of strong growth for WFE. .

We see demand momentum throughout 2022 across our major end markets. The strength in demand we're seeing reflects KLA's essential role in supporting our customers' drive to innovate and continue to invest in future technology nodes.

In foundry and logic, simultaneous investments across multiple nodes and rising capital intensity continues to be a tailwind.

In memory, demand remains broad-based across multiple customers, and we expect another year of double-digit growth in 2022 with NAND growing faster than DRAM; second, KLA is seeing strong demand across the breadth of our industry-leading optical inspection portfolio as we have maintained our momentum in one of the fastest-growing markets in WFE. .

Wafer inspection systems revenues grew 54% in 2021, far outpacing the WFE market, which is estimated to have grown 40%. We're experiencing strong growth across our wafer inspection portfolio from broadband plasma, laser scanning, unpatterned bare wafer inspection, macro inspection and e-beam products. .

This quarter, we highlight macro inspection, which is growing at a pace of 1.5x WFE driven by growth in automotive and other specialty markets where KLA has defensible market leadership with a platform uniquely positioned to address growing technical complexity and tighter design rules; third, success in KLA's strategic growth and market diversification strategies are being demonstrated by growth in EPC.

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Systems revenue from KLA's Electronics, Packaging and Components, or EPC group, grew 20% in 2021.

With EPC, KLA is diversifying our market leadership with a portfolio of solutions addressing fast-growing new markets in the electronics value chain, including RF, specialty semiconductors, automotive, PCB, advanced packaging and display; fourth, service revenue grew 14% in 2021 to $1.8 billion and continues to sustain a growth rate above its long-term target of 9% to 11%.

For the quarter, services revenue was $457 million or 19% of total revenue. Annual services revenue is quickly approaching $2 billion and has grown 81% in the past 3 years. .

This growth has been driven by the rising installed base and increasing adoption of subscription-like contracts. Over 75% of service revenue in the Semiconductor Process Control segment, and over 90% of services in the printed circuit board business come from recurring subscription-like contracts. .

Finally, the December quarter was another exceptional one from a free cash flow perspective, capping a year in which KLA generated over $2.5 billion in free cash flow and returned over $2 billion to shareholders.

In the December quarter, we generated strong quarterly free cash flow of $746 million, which helped drive 43% growth in free cash flow in 2021. We've also maintained focus on returning capital to shareholders via our dividend and share repurchase program, which rose 63% year-over-year on a combined basis. .

Before Bren gets into greater detail on our financial highlights and guidance, let me briefly summarize.

Despite the persistent disruption and continued challenges associated with the pandemic, particularly around the supply chain and component availability, KLA is consistently delivering strong revenue growth, financial results and returns to shareholders. .

KLA is well positioned at the forefront of technological innovation with a comprehensive portfolio of products targeting the most demanding inspection and measurement challenges in the marketplace. I also want to provide a quick update on our ESG activities.

On December 16, KLA announced setting a goal to use 100% renewable electricity across our global operations by 2030. Managing the impacts of our business in terms of ESG stewardship is an integral part of KLA's mission to advance humanity. This includes contributing to creating a more sustainable future. .

With that, I'll pass the call over to Bren to cover our financial highlights, outlook and guidance.

Bren?.

Thank you, Rick. KLA's December quarter and 2021 results highlight the continuation of strong execution in a dynamic and challenging market environment.

We continue to demonstrate our ability to meet customer needs and expand our market leadership, while growing operating profits, generating record free cash flow and maintaining our long-term strategy of productive capital allocation. .

The December quarter capped off a year in 2021 that was defined by strong growth and profitability across multiple areas of our business. We also invested almost $1 billion in R&D to sustain our success and $250 million in capital expenditures to grow our global infrastructure to support our industry growth thesis.

All this was accomplished while simultaneously continuing to return high levels of capital to shareholders. .

Total revenue in the December quarter was $2.35 billion, above the midpoint of the guided range of the quarter of $2.225 billion to $2.425 billion and up 13% sequentially versus the September quarter. Non-GAAP gross margin was 63.1%, just above the midpoint of the guided range of 62% to 64%.

GAAP diluted EPS was $4.71 and non-GAAP diluted EPS was $5.59, each within the guidance range. .

Gross margins were 63.1% and in line with expectations as product mix and factory expenses ended the quarter mostly as planned. KLA's gross margin reflects the value we deliver to the marketplace and our competitive differentiation.

To improve on our ability to meet our customer needs, we are also making meaningful investments in our global workforce, supply chain and factory infrastructure to position KLA to deliver our products in this growing demand environment. .

Total non-GAAP operating expenses were slightly below the midpoint of the guided range of $465 million, including $265 million of R&D expense and $200 million of SG&A. Non-GAAP operating income as a percentage of revenue was 43.4% in the December quarter. KLA's innovation is fundamental to our go-to-market strategy focused on differentiated solutions.

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R&D is at the heart of what we do and remains a key element in driving our portfolio strategy, new product introduction cadence and product differentiation. This in turn helps sustain our technology and market leadership.

Given the rapid growth of the business over the last couple of years and our revenue expectations going forward, we expect the company's operating expenses to continue to grow as we invest in global infrastructure and systems to scale the KLA operating model, as well as new product development programs and volume-dependent resources to support our business expansion.

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Furthermore, we, as most companies are seeing a strong labor market driving cost pressure across our global workforce and within outsourced partners.

As a result, we expect operating expenses to grow sequentially to approximately $495 million in the March quarter, and we forecast sequential growth in operating expenses to continue through calendar 2022. .

While operating expenses are modeled higher going forward as we will make the necessary investments to scale our business to support our long-term structural industry growth thesis, we will continue to size the company based on our target operating model, which delivers 40% to 50% incremental operating margin leverage on revenue growth over a normalized time horizon.

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Other interest and expense in the December quarter was $39 million, and the non-GAAP effective tax rate was 13.3%.

Though we always have some variability in our tax rate, given the timing and impact of discrete items and the geographic distribution of revenue and profit, we believe it remains prudent to maintain our long-term tax planning rate at 13.5% going forward. .

Non-GAAP net income was $851 million. GAAP net income was $717 million. Cash flow from operations was $811 million, and free cash flow was $746 million. This resulted in a free cash flow conversion of 88% and a very healthy free cash flow margin of 32%.

The company had approximately 152 million diluted weighted average shares outstanding exiting the quarter. .

Revenue for the Semiconductor Process Control segment, including its associated service business, was $2.05 billion, up 49% compared with the December 2020 quarter and up 15% sequentially. Semiconductor Process Control systems and service grew 39% in calendar '21 versus calendar 2020. .

Foundry logic was 71% of the approximate Semiconductor Process Control system customer segment mix in the December quarter and memory was 29%. Within memory, the business was split roughly 54% DRAM and 46% NAND.

Revenue for our Electronics, Packaging and Components Group continues to be driven by strength in 5G mobile and infrastructure as well as continued demand in automotive. .

More specifically, the Specialty Semiconductor Process segment, which includes its associated service business generated record revenue of $113 million, up 24% over the prior year and up 10% sequentially. Specialty Semiconductor Process systems and service grew 11% for calendar '21.

PCB, display and component inspection revenue was $188 million, up 5% year-over-year, but down 7% sequentially. On a full calendar year basis, it grew 17%. .

Our breakdown of revenue by major products and region can be found in the shareholder letter, so I won't cover those here. Turning to the balance sheet. KLA ended the quarter with $2.8 billion in total cash, total debt of $3.4 billion and a flexible and attractive bond maturity profile supported by investment-grade ratings from all 3 agencies.

We remain committed to our long-term strategy of cash returns to shareholders, executing a balanced approach split between dividends and share repurchases, targeting long-term returns of 70% or more of free cash flow generated. .

In 2021, KLA exceeded our long-term capital returns target, returning over $2 billion to shareholders, including $601 million in dividends paid and $1.4 billion in share repurchases.

We believe our track record of delivering strong capital returns is a key component of the KLA investment thesis and offers predictable and compelling value creation for our shareholders. .

KLA has a history of consistent free cash flow generation, high free cash flow conversion and strong free cash flow margins across all phases of the business cycle and economic conditions. During the December quarter, we repurchased $430 million of common stock and paid $160 million in dividends. .

As we begin the new year, our view is that the WFE market will grow in the high teens, topping $100 billion off a baseline of approximately $86 billion for 2021. WFE demand is still constrained by the industry's ability to supply.

Strong industry growth momentum in 2022 across all end markets is expected to drive growth with the strongest percentage growth coming from foundry logic customers. And memory investment will be led by 3D NAND. .

Now wrapping up with our outlook and guidance. Looking ahead, our backlog remains strong and sales funnel visibility over the near-term horizon is good. However, rising product lead times driven by increased supply chain constraints is limiting our near-term output. These issues are reducing our revenue expectation by 8% to 10% for the March quarter. .

Specifically, COVID-related disruptions at a number of single-source suppliers have exacerbated what has already been a difficult supply situation where these suppliers have been challenged to meet demand by running their production at max capacity. These disruptions are causing delays in parts delivery timing across multiple product platforms.

In addition, numerous electronic component sourcing challenges have become more acute over the past month as these are standardized parts and in demand across multiple industries. .

We expect that the COVID-related impact will begin to abate shortly and new capacity or supply alternatives are expected to become available as we move through the calendar year.

While these issues can be fluid and difficult to predict in the short run, we expect the March quarter revenue to represent the low point for calendar 2022, and we remain exceedingly confident in the sustainability of our current demand profile for the year. .

Given current expectations for growth in WFE and other electronics markets, we feel confident in our ability to grow throughout the year with total company revenue growth exceeding 20% and semiconductor process control systems revenue to outperform WFE growth again.

Our confidence is based on current backlog levels, competitive positioning, strong customer engagement, and steps we continue to take to add capacity to address output constraints in what continues to be a robust demand environment. .

Total revenue is expected to be in a range of $2.2 billion, plus or minus $100 million. Foundry logic is forecasted to be about 59% of Semiconductor Process Control systems revenue. .

Memory is expected to be approximately 41%. We forecast non-GAAP gross margin to be in a range of 61.5% to 63.5% as overall revenue levels declined modestly on a sequential basis and product mix dilutes gross margins by roughly 50 basis points versus the prior quarter.

To provide some color for the calendar year, given higher revenue volume, product mix expectations across our various segments offset by expected cost pressures within our supply chain, we are modeling gross margins to be approximately 63% for the year, plus or minus 50 basis points. .

Other model assumptions for the March quarter include operating expenses of approximately $495 million, interest and other expense of approximately $41 million and an effective tax rate of approximately 13.5%. .

Finally, GAAP diluted EPS is expected to be $4.54, plus or minus $0.45, and non-GAAP diluted EPS of $4.80 plus or minus $0.45. The EPS guidance is based on a fully diluted share count of approximately 151 million shares.

In conclusion, we have exceptionally strong and diversified end market dynamics propelling semiconductors and the essential WFE investments required to make them. .

Furthermore, we are seeing revenue growth opportunities as more innovation occurs and technology complexity increases in specialty semiconductors, advanced packaging and other electronics markets.

Finally, our services offerings continue to deliver more value to our customers in our Semiconductor Process Control business, and their evolving opportunities to further expand our value proposition in our acquired businesses. Our record backlog is supported by solid customer demand across end markets and at multiple technology nodes. .

2022 is setting up to be the third consecutive year of double-digit growth for WFE and the seventh consecutive year of growth for KLA. The KLA operating model fuels KLA's strategic objectives and positions us to outperform the industry in terms of growth and financial performance.

These objectives fuel our growth, operational excellence and differentiation across an increasingly more diverse product and service offering. .

They also underpin our sustained technology leadership, wide competitive moat and strong record of free cash flow generation and capital returns to shareholders. With that, I'll now turn the call back over to Kevin to begin the Q&A session.

Kevin?.

Go ahead and queue for questions. Sorry about that. .

No worries. [Operator Instructions].

We'll now take our first question from John Pitzer of Credit Suisse. .

Rick, as you pointed out in your prepared comments, you guys have been dealing and the industry has been dealing with a difficult supply situation all year, but this is the first quarter that you and others have seen to have a meaningful impact on the business. .

And I'm kind of curious as to what specifically happened in the last 90 days to make things worse.

And I guess, more importantly, as you call March as the bottom, what gives you confidence that these problems won't persist even longer?.

John, thanks for the question. Yes, we feel pretty good about how we've navigated through the pandemic. A couple of factors for KLA specific, I think, to think about. One is we were up in the December quarter. And again, huge customer demand, so working to work that off.

We talked in the past about securing critical components, critical parts from key suppliers. That actually continues to be in good shape, where we had some challenges in the last few weeks. .

And right now, as we're actually working through them, had to do with not necessarily our critical supply but just generalized supply across the industry. I think as most companies are talking about. So we're seeing some of that, that are not unique, as Bren said in his comments, to KLA.

The reason we feel more confident is even in the last few days, we've seen some pressure being released in that system, that it won't be in time for what we would have preferred to ship in this quarter, we obviously have the backlog, we could have shipped more if we'd had it. .

But it's being resolved. So we feel pretty good about the go forward after we get through March. And I'll let Bren add some color since he's spending a good part of his time working some of these issues himself. .

Hey John, how are you? So just to add to Rick's comments. I think one of the things you have to consider is most of our strategic buffer that we've built, whether we have it in inventory levels at the company, whether it's at inventory or long lead time materials that we've either procured or suppliers have procured.

Over the last 15 months or so, given the strength of demand, we have worked through a fair amount of that. And that's one of the challenges we have is we are more dependent today on the predictability of timing, first of all, but also volume of quality. And so I think those are issues that we continue to work through.

As Rick said, in our complex systems, we generally have a pretty transparent view of where that demand is, although everyone is struggling to meet the demand environment that we're facing today. .

But it's in our higher volume but single sourced type products where we've seen some of these pressures. We did not anticipate a COVID variant and what that would do to those factories in terms of people having to leave either because of contact or exposure.

So you had facilities that are already running 100% max that all of a sudden had to deal with this disruption in a lot of cases, a pretty meaningful disruption in the first part of the month. .

We think that, that's abating. And we're getting a sense that that's improving. And this COVID environment, we'll have to figure out and navigate our way through. We don't know what the future holds. But at least in terms of the near-term environment, we feel pretty good about that. .

And then trying to source and find all the electrical components, which are deeper in our build of material and within our supply chain.

There's less visibility, but there's also alternative, either alternative supplies, qualifying new parts in some cases, leveraging third parties, which we've been doing, and that's even becoming more challenged in terms of distributors and others that might be out there that have those parts. .

So we're managing through this. We're escalating where appropriate.

And as we look at it and walk through what we expect to see moving forward, we think the March quarter sets up as the bottom, and we expect -- given the guidance we gave that we would see growth through the year and expect the company to be somewhere in excess of 20%, as we said in the prepared remarks.

So there's always some questions or unpredictability here in terms of just where things are, but that's the best of how we see it today. .

And then, Bren, just as my follow-up. You gave some very specific guidance for OpEx even beyond the March quarter, growing sequentially throughout the year, but still within the model of 40% to 50% incremental gross -- operating margin, sorry.

I'm just kind of curious, I have to imagine that this year, the supply constraints are causing some excess costs that might bleed down over time as supply gets better. .

And there's a bigger mismatch, I'm assuming between revenue collection and investment this year.

So as you start to recapture some of this revenue as supply gets better, should we assume that incremental op margins closer to the higher end of that 40% to 50%? Or how should we think about that as revenue growth accelerates beyond March?.

Yes. No, you're thinking about it right. As we see revenue growth, it should accelerate to the higher end of the range. The commentary was really about how we look and size the company on an annual basis or over a longer-term horizon.

And if you look at '19 to our '22 planning, we will have had incremental operating margins given the growth we've seen in excess of 50%, about 52%. So my point was that we would expect revenue to grow. We're also expecting OpEx to grow. But at the end of the day, as we're sizing 2022, we expect to be in our target range of 40 to 50. .

We'll take our next question from Harlan Sur of JPMorgan. .

Great execution by the operations team. In calendar '21, your Process Control Systems business outgrew WFE by about 8 percentage points. So strong performance there.

So as we look at your WFE outlook for this year, right, up 16% to $100 billion, taking into account rising cost of control intensity, your portfolio of new products, how should we think about your Process Control Systems growth profile relative to WFE this year? It's clearly going to outperform, but should we expect a similar type of outperformance like you saw in '21 or maybe even better, just given the customer mix and the complexity challenges? And is it going to again be led by wafer inspection?.

Harlan. Good question. Yes, '21, we feel really good about how we performed in '21. I think we talked about several times, just the strength, especially of optical wafer inspection was extraordinary in the year. And also, when we look to our order book, we got tremendous interest in those products that we're seeing great opportunities in '22 as well. .

I think that's a favorable mix for the year for '22 and -- based on the success we've had with some of our new products and the way that they're being received by customers, we anticipate that we'll be in a good position to build on our market leadership position as we go forward. .

So we are anticipating continued growth in share, albeit at the kind of rate that we outlined a few years ago. So I think the combination of those factors plus the continuation of the drive in design roles are all good indicators and good drivers for KLA to outperform, which is what we're forecasting.

We never really know at this point in the year, how it's actually going to -- the details of what it's going to look, but we think Process Control is in a great position for '22, and we're in a great position within Process Control. And Bren can add some color to that. .

Yes, Harlan. I think that what we'll see in terms of mix, I would expect foundry logic to grow faster this year than it grew -- or faster than the growth rate in WFE. And as a result of that, that will be a favorable mix. So to Rick's point, I think that, that will be a driver for us. From a share point of view, we feel pretty good about where we are.

Certainly, wafer inspection, as you mentioned, has been the biggest driver. It's been the fastest-growing business in the company. We have a very strong position there. I've said many times, I think it might be one of the fastest-growing markets in all of WFE. .

I would expect to continue to see momentum in that overall market. So as we said in the prepared remarks that we were about -- we thought we were around 46% for semiconductor systems in 2021. It gets the market of 40% or 41%.

And then as we look at high teens type growth rates in WFE this year, I would expect we'll have a similar improvement over the market or similar outperform, somewhere in that mid-single-digit range based on how we're looking at it today. .

And I appreciate the insights there. And then on the gross margin front, I understand the supply challenges and other logistics-related dynamics that are impacting your shipments here.

But relative to your peers, I mean, your gross margins are holding up extremely well, right? I mean you guys are only guiding for roughly a 50 basis point decline sequentially in gross margins here in the March quarter.

And it actually looks like that's more mix and volume related, right? And in the midst of all of these potential cost dynamics, you're still guiding full year gross margins to 63%. .

So help us understand the better sustainability of gross margins in this challenging period.

I mean, are you guys just passing along exercising some pricing power and just passing along some of these cost to your customers?.

That's a great question, Harlan, and I'll start and maybe Rick will want to add a few comments here. But our pricing model is really based on pricing to value. It's priced on the value we believe that our tools add to our customers. And so that's ultimately how we price the products. It isn't a cost-based model. It's more of a value-based.

You're right, as you look at the March quarter, what's declining is Semiconductor Process Control revenue quarter-to-quarter, we're actually expecting some growth in our EPC business and every quarter service grows. .

So it is a bit of a mix effect and a volume effect on the March quarter. Going forward, we are seeing pressure on costs. We're not implying that we aren't and I've been pretty open with the fact that I think there's 100 basis point headwind related to cost increases as we all know, everything seems to be costing more. .

Labor is costing more and certainly the ramp in investments our customers -- or suppliers are having to make is driving incremental cost into the model but that's factored in.

So absent that, I think given the mix expectations we would have moving into '22 with the growth rate of semi PC consistent with what your last question, then we would see margins improve. But we are feeling a little bit of pressure. .

So I think we hold 63%, plus or minus in any given quarter, you'll see a little bit of variability. But at the end of the day, I also think it's just -- it's a reflection of the value that we're adding, I think it's also a reflection of the differentiation that we have across the portfolio in the marketplace. .

Yes. Just one other thing to add to Bren, I mean I think it's really important that we continue to understand the value we're creating for our customers, and we share in that value in our pricing. I think that's the way to think about it.

For them, they're very, very motivated to get these products in as soon as they can because the payback is extremely quick. .

What you would probably see in a more normalized -- if you didn't have an environment that was a supply constrained -- with the increase in volume, you'd actually see the cost dynamics go the other way.

So I think what Bren talked about the little bit of headwind that we get is because of some of the pricing increases, but it's not much in our overall business. .

But in a historical context, if you went up as much as our revenues have, we would see volume discounting happening with our suppliers, which would bring down some of the costs, and that's not really happening in this environment. But our starting point is really good, and our new products are incredibly well received by our customers.

So not only do we like the margin profile, but our customers really want to get the new products. So we're in a pretty good position as it stands right now. .

We'll take our next question from C.J. Muse of Evercore. .

I guess another gross margin question, if we really drilled down just the process control, you grew gross margins there, 64% in 2020 to 65% in 2021. And I'm cognizant of the fact that there's clearly some challenges near term.

But as you think about the mix that you're seeing and the value add that you're bringing, where do you think process control gross margins can go in a more normalized environment once the supply chain normalizes?.

Yes, C.J., it's a great question. You're right. We're in the mid-65% range, if you look at the process control segment overall. So as we move into certainly '22, I would expect that to be roughly flat given what we just said, maybe a little bit better, but generally in that range and just given the things we just talked about.

A lot of it depends overall on -- you've got the service mix, which service gross margins have improved over time as that business scales, but it is dilutive. .

So in the long run, if service is growing faster than systems, that does put a little bit of pressure on margins. So I think we're pretty comfortable with the levels that they're at. I can see them ticking up. .

We always talk about 60% to 65% type incrementals on our semi process control business. So I would expect to see something consistent with that. But if you're approaching 65% or maybe a little bit higher at the top end of that, you start to hit the ceiling in terms of how high you can go.

So I think we're probably in that mid-60s range, maybe creeping up a little bit from there. But I don't see it improving much more than that. .

That's helpful.

As my follow-up, I guess, can you comment on whether you expect to be constrained in the June quarter? And as we think about kind of second half total revenues versus first half on a calendar basis, should we be thinking kind of low- to mid-double-digit growth half-on-half?.

Yes, I think that's the way to think about it. Certainly, the second half will be stronger than the first half. And look, I think we're all constrained right now in terms of the ability to get parts. What we've provided is our expected probability of all the various issues we're managing in terms of an overall view. .

But given that March will be lower, I would expect sequential growth as we move through the year. And the second half overall for the company, yes, low- to mid-double digits is a reasonable way to think about it. .

We'll take our next question from Vivek Arya of Bank of America Securities. .

I actually wanted to ask the last question in a slightly different way. So as you go into June, so I think you're suggesting about a $200 million impact in the March quarter.

Are you able to recognize that $200 million in June? Or is that spread into the back half of the year?.

Yes. Vivek, it will show up in the June quarter. So these are shipments that slipped out and then are in the June quarter.

But when you have suppliers that are running at max capacity in a lot of cases, and they have a disruption, I think the making up of that lost time will take some time through the year, right? I don't think that they'll be able to make it all of it once.

So there's a little bit of a cascading that happens whenever you have a disruption in a facility that's already running full out, I mean, equipment is running 24/7, people are working up to legal limits in terms of overtime. .

So trying to squeeze more capacity in the short run is a little bit harder. But over time, I would expect that we'll see that creep out. We also expect capacity to improve or have alternatives to materialize as we move through the year. So it's a combination of those effects. But yes, I would expect it to move into the June quarter. .

So just one -- just a little more color to think about. What we saw with Omicron is more people being impacted and losing work days, fortunately not severely impacted, but enough that they had to not be at the workforce. And as Bren said, these factories were ramped up. So it's hard to make that up, but it's also -- they're already coming back.

So we have a lot of confidence in the supply chain, returning to more supportive levels for our business going forward. .

All right. And for my follow-up, I realize it's super, super early, but I was just hoping if you could give us a flavor of customer discussions about 2023? WFE in the past has kind of grown for 2 to 3 years, and there is a period of absorption. This time, we have already had -- or this will be the third year of growth.

Do you think it's possible to have a fourth year of growth? And what would be the high-level kind of puts and takes, just so that investors get a sense for is this the peak year for WFE? Or are there still prospects for additional growth next year?.

Vivek, great question. I think, ironically, perhaps the current slowdown in our ability as an equipment industry to provide will stretch this out into '23 anyway.

And so you see that plus a number of high-profile projects, which have been discussed recently by our customers don't really order equipment in '22 or maybe they place POs, but we certainly don't see deliveries. .

So if you think about some of the big new greenfield projects that have been announced, those are '23 projects, not '22. So I think the combination of those that are related to both support from the regionalization efforts driven by things like the CHIPS Act in the U.S. should that come to pass.

But even the other projects, which aren't dependent on that, are really much more about '23 than they are about '22. So as we look at it now, we do have pretty good visibility out through the end of the year and even into the first part of next year for the demand to continue to be very supportive of our business. .

Yes. Vivek, the only other thing I would add to that is that we have very high levels of backlog. In a lot of cases, we're booking slots for customers into 2023 now. And so as a result of that, we feel pretty confident in the sustainability of what we're seeing.

I made some comments earlier about the second half and as we model in terms of how we're planning the company and how we're planning capacity, we expect to see that -- those levels of business sustain as we move forward. So it's a long way out and things can change. .

But certainly, we don't see anything that shows any slowing down anytime in the horizon. And certainly, customers are asking for more and faster. .

We'll take our next question from Timothy Arcuri of UBS. .

I had 2, Bren, one kind of on the same tack as the last question. So it seems like the WFE in the first half of the year were sort of entering March a bit lower than what -- most of us would have thought just because of some of these constraints. But the back half is going to be a lot bigger.

If you just take your number, you're going to do like 18 -- I mean, maybe even 19 in terms of process control shipments -- system shipments in the back half of the year. And if you basically take your WFE share, that's like a $110 billion annualized WFE. .

So my question is, when you sort of think about that number and you go back and you try to determine what the demand really supports in terms of WFE, sort of looking at the projects and looking at the technology transitions and what not.

How do you handicap sort of -- where you cry uncle on sort of where the WFE run rate becomes too high? And do you agree with the [ 185 ] or somewhere in that range of system number for the back half of the year?.

Tim, on the last part of your question, given the guidance we gave around second half, you're probably not that far off. It's probably in that 18 range, plus or minus, more or less. So we'll have to see how it plays out. Look, we spent a lot of time looking at the various leading indicators of what we're seeing from customers.

And of course, we look at our customers, the discussions we have with them, there is the profitability levels. We look at these end markets and some of the challenges that exist there. .

So as we go through it, you look at our customers are spending more than they ever have. They're more profitable than they've ever been. So we feel pretty good about where they're at and where the demand is. So we're going to -- we'll continue to watch it. But right now, at this point, we -- our customers are continuing to ask for systems.

As I said earlier, I think WFE is constrained by supply. And over the long run, we believe that WFE, given rising capital intensity will grow faster than semiconductor revenue in terms of a long run trend. .

So I think that's how we're modeling the company. Certainly, it's how we're planning when we think about supply and investments we need to make. But that's how we're thinking about it right now. .

And then just maybe a bigger picture, Rick, I'm sort of curious what your view is. I get a lot of questions around as you go to sort of scaling that's a little more verticalized versus using litho to scale, whether you're talking about [indiscernible] or 3D DRAM, things like that.

It isn't exactly what happened in NAND, but litho does become a little bit maybe less of a driver for actually to scale going forward.

Can you just talk about how you think about how that affects you either positively or negatively sort of in terms of your ability to keep on gaining WFE share? And maybe what you're attach to litho is sort of how you think about that bigger picture?.

Yes. Thanks, Tim. Good question. I think that it's interesting if you use the example of NAND as a -- there, you actually went backwards in lithography. And yet the process control intensity, it went down a little bit, but we actually thought it would go down more because what happened was 2 things.

And if we'd had solutions, it probably wouldn't have gone down at all because there were other integration problems that we were unable to solve at that time. But even there, it went backwards and there was not a huge change in process control intensity, albeit at lower levels. .

What we're seeing now already in conversations with customers as we look at new device types. The process control challenges are going to be enormous. And many of them, yes, defect is a big part of it, but you have EUV, which is driving additional use cases.

You have the registration overlay challenges, which has created quite a significant market, and we also see the need for more and more inspection layers using different wavelengths. So that Gen 4 is being extended. I think we mentioned last quarter, Gen 4 actually outperformed Gen 5 in terms of revenue in 2021. .

And we actually see that continuing because of the usefulness of that product and that wavelength. So we actually think the real question is, are there going to be integration challenges that are going to drive our customers. When there's multiple players competing at the leading edge, that's always a good thing for KLA.

I think we went through a period where there was really one main driver, and they had one real end device driving that logic, that's no longer the case. .

So we feel pretty good about the architectures that we're seeing. We have process control teams that are working with our customers.

And as far as we can see out through several years, we think we're well positioned with plenty of opportunity and we have a lot of solutions we're investing in, as Bren said, we're investing at a significant level in R&D to be positioned to support those going forward. .

So we don't see really a relaxation in process control intensity as we go forward. Will it continue to rise? We're not anticipating that it goes up a lot. And so that's not in our models, that would be upside to our model if that happened, but that's not what we're working off of. .

Tim, 2 things. First, when we move from planar to vertical and NAND, if you use NAND as a proxy, we saw a couple of point improvement overall in process control intensity. And it came really in our metrology businesses because if you think you're starting to build the structures vertically, it creates a whole new set of metrology challenges.

So we saw an inflection there for metrology and then you also have defect mechanisms related to high-aspect layers -- high-aspect ratio structures and so on.

So that is -- if it's a proxy, we feel pretty good about opportunities there as some of the defect mechanisms, and metrology challenges change, but process control intensity overall is a positive. .

Our 2023 plan in terms of process control or KLA share of WFE was to see process control intensity improve, KLA share of WFE to grow about 75 to 100 basis points from 2019. And we feel like we're right on that trajectory as we go forward here.

So as Rick said, we don't expect it to grow a lot, but we do expect to see it continuing to grow, and that should create opportunities for us to, for the most part, consistently outgrow the market here over the next few years. .

We'll move next to Patrick Ho of Stifel. .

Rick, maybe just following up on that question by Tim in terms of process control intensity in terms of device architecture. As we look at gate all around, and I know you've talked about it from a big picture perspective of some of the opportunities there.

But given the materials intensity, how do you see, I guess, more semiconductor engineering materials type of trends benefiting process control intensity? And especially, I'm just thinking gate all around, the gates now being surrounded by a lot of materials.

How do you look at it from both an inspection and probably from an overlay metrology perspective? Do you see one or the other "benefiting" from these changes on the materials front?.

Yes, Patrick, good question. I think that, again, we've been in conversations with customers about these advanced architectures for some time and the challenges that they face. .

Fortunately, we often have more time than we originally thought to get our solutions ready because these often take longer to get to market than were originally anticipated. So we're actually in pretty good shape in terms of providing solutions for that.

Specifically to gate all around, remember, for inspection, there are really a couple of things that we have to -- problems that we have to solve. .

The most significant one often lost on people is it's a contrast question. It's not as much as a resolution as contrast and gate all around with different materials creates a different contrast challenge, which is why the wavelength matters a lot, which is why we're extending Gen 4, and we're seeing good modeling results from that.

The other thing that happens, of course, is the registration, every generation, I think, may be lost on people are the additional challenges in registration and overlay every device technology and the increase in sampling is just dramatic in that business and in films in general. .

Again, more challenges associated with that. We have a good modeling effort that goes on very, very strong in the company so we can model and understand what those devices are going to look like and what they're going to need in terms of capability. .

So we're very well positioned to handle that. I think that you're going to see increases in both inspection needs, but also in metrology slightly in different ways. And in metrology, you're already sampling at so many levels. It's more about increasing the sampling at those levels.

In other words, more steps or more measurement points per die and per wafer. In inspection, it ends up you add a number of inspection steps in the process as opposed to the area inspected, which is usually already predetermined and that probably won't change. .

So I think that they'll both grow but for different reasons in that.

And again, our customers -- our relationship with our customers is such that we've been working on these problems for a while because now they know they need the support of inspection and metrology early in the development phase if they have a chance of ramping these new technologies. So we feel pretty good about our insight into those. .

Great. That's helpful. And as a quick follow-up. The current environment obviously is seeing very high utilization across fabs for both leading edge and trailing edge.

Given the supply chain issues, and I know not all parts and components are the same for both new systems and "your spare parts business, your installed base business." But how are you balancing some of the procurement issues that you're dealing with today in terms of where do I take this component or parts? Should it go into the spare parts bucket? Or should it go into a new system? How are you balancing that today?.

Yes, Patrick, it's a great question and it's something that we spend a lot of time on internally, particularly as Brian Lorig runs our service business points out to me all the time that don't forget about spares. So it is absolutely a balancing act.

Fortunately, we have pretty good idea of when things will fail that -- around certain components, and we can plan for that. But we -- in terms of stocking levels.

But we're very -- we have had situations where we will pull parts off of systems, if we have to, to support the field, we've made commitment to customers, those customers value these systems, and we've got to keep them up and running. .

So in a lot of those cases, we're going to generally prioritize service if we can't figure out a way to work around it, which we've for the most part been able to do. But it's a constant balancing act, and it's something that we watch very closely. .

We have time for one last question, and we'll take Joe Moore of Morgan Stanley. .

I wonder if you could talk a little bit more about the supply constraints in terms of how much planning were you able to do around it? Did you get surprised by these component issues? And are you generally just kind of meeting commitments to your customers but the lead times are getting pushed out? Or was there kind of a decommitment because of disruptions in your own supply chain?.

Yes. Joe, that's a great question. So I'll say a couple of things here. First, yes, there were some surprises, right? As we were moving through December and into the early part of January, the COVID impact was a surprise in terms of the impact on some of these suppliers.

So we also had some issues that materialized, as I said in the prepared remarks around, I'll call them, more lower-value commodity parts that we also procure in a lot of cases, where those are as we have supplier suppliers that are trying to acquire those parts to then send them to us to our direct suppliers before it gets to us.

So it's a little bit harder to have visibility down at those levels. .

Now with enough time, you can typically manage around some of those issues, either by finding alternatives, qualifying alternatives.

It does have an impact on on-time delivery, to your point, and so the reason we were able to quantify the impact of 8% to 10% on the results in March was really what we thought we were looking at as we ended the December quarter and where we ended up today. So we had a pretty good visibility to the impact and so we're able to quantify it.

On-time delivery is what's suffering though. But we're managing around it to the extent we can. .

And I think customers, while there's tremendous pressure in the system, there's a reality check of the challenges that I think I can speak for everybody that we're all dealing with here. .

Great. Thank you, Joe and thank you, everybody, for joining us. We know it's a busy week of earnings, a busy day of earnings. We really appreciate everyone's time and attention. I'm sure we'll be catching up with many of you throughout the quarter. With that I'll pass the call back over to Leo to end the call. .

This concludes the KLA Corporation December Quarter 2021 Earnings Call and Webcast. Please disconnect your line at this time. Have a wonderful day..