Applied Materials, Inc.

Welcome to the Applied Materials Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, you'll be invited to participate in a question and answer session. I will turn the conference over to Michael Sullivan, Corporate Vice President. Please go ahead, sir.

Good afternoon, everyone, and thank you for joining Applied's third quarter of Fiscal 2022 Earnings Call. Joining me are Gary Dickerson, our President and CEO, and Bryce Hill, our Chief Financial Officer. Before we begin, I'd like to remind you that today's call contains forward-looking statements which are subject to risks and uncertainties that could cause our actual results to differ. Information concerning the risks and uncertainties is contained in Applied's most recent Form 10-Q and 8-K filings with the SEC. Today's call also includes non-GAAP financial measures. Reconciliations to GAAP measures are found in today's earnings press release and in our quarterly earnings materials, which are available on the IR page of our website at AppliedMaterials.com. Before we begin, I have a calendar announcement. Applied plans to host our services masterclass five weeks from today on Thursday, May 26th at 9 o'clock Pacific time. We'll describe the market opportunity for our services business, explain why 87% of AGS revenue is truly recurring, and give you the growth formula for the business through our 2024 financial model horizon and beyond. We hope you'll join key members of our global services team for presentations and Q&A. And now I'd like to turn the call over to Gary Dickerson.

Thank you, Mike. In our third fiscal quarter, Applied Materials delivered results at the high end of our guidance range and record quarterly revenues. The actions we've been taking to mitigate supply chain challenges are beginning to have an impact, and we expect steady, incremental improvements from here. Resolving supply issues has required new levels of collaboration between our global teams, suppliers, and customers. While all of this hard work is yielding results, global supply chains remain stretched. Demand for applied products is still higher than our ability to fulfill it, and our backlog continues to grow. In addition, our relentless focus on meeting customers' needs in this very difficult environment has created margin headwinds that we're working hard to overcome. We're driving actions to reduce costs and improve value capture including price adjustments. In my prepared remarks today, I'll cover three key topics. First, our near-term outlook on supply and demand dynamics. Second, our longer-term view of the markets and the industry's roadmap. And third, applied materials strategy, priorities and progress. After that, Bryce will provide more color on our financial performance and key areas of operational focus. Let me begin with our near-term perspective on the market. Due to large gaps between demand and supply, as well as equipment companies shipping partially finished systems and merging components in the field, overall 2022 wafer fab equipment spending is difficult to quantify with precision. Our best estimate is that it will land somewhere in the mid $90 billion range. For applied, the picture is clearer. If we use the midpoint of our fourth quarter guidance, we expect our wafer fab equipment revenues to be up approximately 15% for our fiscal year. As we look ahead to 2023, there are three major factors shaping our view of the market. First, memory spending is expected to be lower than in 2022 as macro uncertainty and weakness in consumer electronics and PCs causes these customers to defer some capacity additions. Second, leading-edge foundry logic looks strong, with customers battling for leadership and racing to be first to implement major technology inflections. Third, ICAPS customers who serve IoT, communications, auto, power, and sensor markets are reporting areas of strength and weakness. These customers serve broad and diverse applications. They're seeing softness in consumer-centric markets, which are being impacted by macroeconomic factors. Auto and industrial demand continues to be solid because those investments are driven by large inflections, such as electric vehicles and industrial automation. In these areas, chipmakers are securing long-term capacity agreements that underpin their capital spending plans. While it's too early to provide a forecast for 2023, we believe our business will be more resilient than in the past if there is a demand to pull back in certain areas of the market. We expect Applied to remain supply constrained for the next several quarters. We're working through our very substantial backlog of orders which provides a buffer to in-year demand fluctuations. And in addition, customers are providing us with longer-term visibility and commitments in response to their own customers' actions to lock in the strategic capacity they need. Although we're confident in our ability to perform well in a range of market scenarios, we're mindful of the current macroeconomic trends. As a result, We are slowing down hiring while ensuring we fully fund the R&D programs and strategic operational capabilities that support our long-term growth. Regionalization of supply chains is also something new for the industry. We expect this will provide a small positive tailwind for overall wafer fab equipment spending starting in late 2023. Also, because of the time-bound nature of government incentives in the U.S., Europe, and Asia, we see a higher degree of certainty for these investments. Last week, I was in Washington, D.C., for the signing of the CHIPS Act and met with government officials and leaders from across the semiconductor and automotive ecosystems. I'm happy to see the critical role that semiconductors play in the economy being recognized and acted upon. The need to build more resilient and flexible supply chains remains a key theme for these leaders, and the CHIPS Act will enable many companies to accelerate their investments in strategic capacity. I'm also excited about the potential to create a new high velocity innovation platform in the United States to accelerate the development and commercialization of next generation technologies. As I look further to the future, I feel very positive about the direction of the industry and our long-term opportunities that applied. Consensus within the industry is that semiconductor revenues can reach a trillion dollars before the end of the decade. That translates to a high single digit compound annual growth rate from today. In parallel, the technology roadmap is becoming increasingly complex. As a result, we expect equipment intensity the ratio of wafer fab equipment investment to semi-revenues to remain at today's level or increase over this period. Then, the major technology roadmap inflections, including gate all-around transistors, backside power distribution networks, new materials for interconnect and contact, and heterogeneous integration of chips and chiplets, are enabled by materials engineering. where Applied Materials is the leader, and this shifts more dollars to our available market over time. We've invested ahead of these inflections to create a portfolio of differentiated solutions that positions us to outperform as these new technologies transition to volume manufacturing. Applied Materials Strategy is built upon the breadth and strength of our technology and capabilities. This provides us with a unique ability to engineer, co-optimize, and integrate solutions that address our customers' highest value technology challenges. Co-optimized solutions, where we optimize adjacent process steps, and integrated material solutions, or IMS, where we optimize a combination of process steps in a single system under vacuum, are becoming an increasingly important part of our product portfolio. In our recent master class, we talked about a breakthrough IMS approach for tungsten-only contacts that are free of conventional barrier materials. This provides significant improvements in contact resistance and is critically enabling for smaller foundry logic nodes. The number of process steps are growing as these customers migrate to this pure metal technology and these low resistance integrated solutions for contact and wiring represent new multi-billion dollar revenue opportunities. Over the past two quarters, we have secured multiple tool of record positions at all leading customers. Our ability to co-optimize materials engineering solutions with novel inspection and metrology is also driving record performance in our process diagnostics and control business. We expect PDC revenues to be up almost 40% in fiscal 2022 with broad-based customer adoption of our EB metrology and new optical wafer inspection platforms. In the quarter, we also strengthened our ICAPS portfolio with a tuck-in acquisition. PicoSun is a leader in batch ALD technology, and we're delighted to welcome their talented team to the Applied Materials family. Turning to service, AGS delivered record quarterly revenues despite headwinds for our transactional spares and 200-millimeter equipment businesses due to supply chain constraints. The subscription portion of AGS continues to demonstrate strength. Install-based tools under long-term service agreements grew 9% over the past 12 months. Our renewal rate for these agreements continues to be strong and is currently running at 93%. Before I hand the call over to Bryce, I'll quickly summarize. We're beginning to see gradual improvements in our supply chain, which enabled us to deliver record revenue for the quarter. We expect demand to remain higher than supply for the next several quarters, and we're continuing to drive actions to close the gap. The changing macroeconomic environment is causing some customers to adjust the timing of their investments. However, we're confident that our business will be more resilient thanks to strong pull for a uniquely enabling technology, our large backlog, longer-term visibility from our customers, and industry-wide investment in strategic regional capacity. Our long-term view of the market remains unchanged as multiple parallel secular trends drive the semiconductor and wafer fab equipment markets to structurally higher. At the same time, large technology inflections that are enabled by our core capabilities in materials engineering create outsized growth opportunities for applied materials. Now, I'll hand the call over to Bryce.

Thank you, Gary. I'd like to begin by saying thank you to our teams and our supply chain partners for helping to increase our output despite ongoing constraints and unexpected shortages. Our factory and logistics teams operated with agility, adjusting to almost daily changes in supply schedules. We are still not meeting all of our customers' demand, and solving the supply chain shortages to increase our manufacturing output remains our top priority. Before I summarize our Q3 results, I'd like to emphasize four points. Our overall demand remains healthy. Specifically, our orders remain strong in Q3, our backlog increased, overall factory utilization remains high, and customers have added four new factory projects to the long-term roadmap. There are pockets of weakness in the semiconductor market, and a number of affected customers have asked us to reschedule their capacity additions. At the same time, there are areas of strength, and we have broad market exposure and strong customer pull for technology investments. Second, our supply chain improved incrementally in the quarter, as Gary mentioned. We have added significant investments and talent to our supply chain teams to resolve bottlenecks and to improve our inventory and overall output. Third, we remain committed to our long-term gross margin targets. Today, we are still experiencing the effects of higher costs and unfavorable mix, which are being partially offset by pricing adjustments. we expect to incrementally improve gross margins over the coming quarters, driven by forecasted improvements in manufacturing volumes, product mix, pricing, and logistics costs. And fourth, we are confident in the industry's underlying growth trajectory and our unique materials engineering capabilities for process innovation. While we are slowing our headcount growth, we have increased our R&D spending by around 10% year to date, and remain fully invested in enabling our customers' roadmaps. Turning to our Q3 results, we delivered record revenue of $6.52 billion, which is in the high end of our guidance trades. Non-GAAP gross margin of 46.2% declined 80 basis points quarter on quarter. Non-GAAP operating spending was $1.06 billion, which is right on target, and up $39 million quarter on quarter, as we increased R&D and added supply chain resources. Non-GAAP operating margin declined 60 basis points to 30%, driven by the lower gross margin and headcount additions, primarily in engineering. Non-GAAP earnings of $1.94 grew 9 cents quarter on quarter and matched our previous record. Turning to the segments, the SEMI systems team did a great job maximizing shipments. growing revenue by $276 million, up 6% quarter on quarter. Segment non-GAAP operating margin declined 100 basis points sequentially to 36.1% due to higher materials, freight, expedite, and labor costs, partially offset by price adjustments. The AGS team delivered record quarterly revenue, growing $37 million at 3% quarter on quarter. We continued to deliver healthy year-over-year growth in subscription revenue, while the supply chain shortages constrained our growth in transactional parts and 200-millimeter systems. AGS non-GAAP operating margin was 30.6% and slightly up quarter-over-quarter. I'll take a minute to share a few observations about AGS. Next month we'll host a services master class where you'll have an opportunity to learn more about our strategy to increase our recurring revenue. The three key drivers are the growth of our installed base, equipment service intensity, and long term service agreements. AGS is making excellent progress toward our 2024 financial model. We exited Q3 tracking around $500 million ahead of the base case of our AGS revenue plan and around $250 million ahead of our high case. In addition, the services business is capital light and produces excellent cash flow. Moving on to display now. The market is weaker due to its high exposure to consumer portion of the economy. During the quarter, We lowered spending in line with the current market environment. Our display revenue declined by $48 million at 13% to $333 million. The business contributed $70 million of non-GAAP operating profit, which is down sequentially by $12 million or 15%. Turning to our cash flows. We generated $1.47 billion of operating cash flow during the quarter, which was 23% of revenue. We returned $1.23 billion or 97% of free cash flow to our shareholders, deploying $1 billion to repurchase 9.8 million shares of company stock and paying $225 million in dividends. We also deployed around $440 million for two strategic acquisitions. We expanded our ALD portfolio with the addition of PicoSun, and we acquired a talented simulation software team. Year to date, we have produced over $4.5 billion in operating cash flow and nearly $4 billion in free cash flow, and returned $5.25 billion to our shareholders. Now I'll share our guidance for Q4. We expect revenue to increase to $6.65 billion, plus or minus 400 million. We expect non-GAAP EPS to be $2, plus or minus 18 cents. Within this outlook, we expect semi-systems revenue to increase to $4.93 billion, or up 14% year-over-year. We expect AGS revenue to increase to $1.43 billion, or up 4% year-over-year, With continued healthy growth in services and ongoing supply chain limitations in 200 millimeter systems and transactional parts, display revenue should decline to around $250 million. We expect to incrementally increase our non-GAAP gross margin to 46.4%. And we expect non-GAAP operating expenses to increase slightly to $1.08 billion. We are modeling a tax rate of 11.8%. Before we begin the Q&A, I'd like to summarize our company's position in the current environment. We continue to see very strong customer pull for advanced technology in all of our markets, and our backlog continues to grow. We believe some of our customers will moderate their capacity additions in areas that have been impacted by weak consumer spending. However, I expect Applied's business to be more resilient than in past periods for three reasons. One is that we have strong exposure to technology investments, particularly in the foundry logic market, which has grown to become approximately two-thirds of wafer fab equipment spending. Second is that we have multiple quarters of backlog for products that are essential to our customers' technology roadmaps, and we expect to continue to increase supply over the next several quarters. Third, that our services business has grown to over $5.5 billion in size and generates 87% of revenue from recurring demand for parts, services, and software. And now, Mike, please begin the Q&A.

Thanks, Bryce. To help us reach as many people as we can, please ask just one question on today's call. If you have another question, please re-queue, and we'll do our best to come back to you later in the session. Operator, let's please begin.

Thank you. Again, ladies and gentlemen, if you'd like to ask a question, please press star 11 on your text tone telephone. One moment for our first question. Our first question comes from CJ Muse of Evercore ISI. Your line is open.

Yeah, hi. Thanks for taking the question. I guess the question for me would be in light of record backlog and extended lead times and then some of the puts and takes around customers moving out production plans, How are you thinking about the timing of easing of supply constraints, how you're thinking about internal tool production into 2023, and as part of that, driving, I assume, gross margins higher throughout that time? We'd love to hear your thoughts around that.

Good afternoon, CJ. It's Bryce. Just, yeah, good question on supply constraints and timing versus the demand environment, et cetera. Let me explain what we've done the last couple of weeks. We just went through a cycle where we reconfirmed all of our 2023 demand with our customers, something we do once or twice per quarter on a regular basis. And it gives the customer base a chance to signal if they want to make changes, they want to make ads, they want to make drops. And in the constrained environment, that lets us balance our supply across the customer base in the best way. So we've just completed that and you know, there, there are a number of changes, but what we, what we see for 2023 and the next, you know, three plus quarters, as we said in our, in our initial comments is that demand is still significantly above our ability to supply, but we've got the confidence that we just reconfirmed, you know, all of that. And then when we think about supply, you know, our comments, we've invested significantly in the supply chain. So we're working, you know, to identify issues and loosen the supply chain and solve problems in the supply chain, both at our direct suppliers and our secondary suppliers. So our expectation is that we'll increase output for the next several quarters and continue to work on that backlog, which as you highlighted has been, you know, has continued to grow.

Hey, ACJ, this is Gary. I guess also relative to supply chain, Certainly, the zero COVID lockdown in Shanghai March 28th, that set us back relative to overall supply chain. We're continuing to make incremental progress. Right now, we see it still being incremental going forward. We're doing everything we can, making investments, adding manpower, but it's more incremental. I think the same thing is true on margins. I think last quarter we said that we would see incremental progress from where we were, and I think that's really the direction, both for supply chain and for margins, is more incremental improvement throughout 22 and going into 23. Thank you.

Thank you. Our next question comes from Mark of Jefferies. Your line is open.

I guess the question I have is, Gary, maybe if you could help us understand the mechanics around what you guys do when your customers come in and say, oh, we're adjusting, I think you used the expression, adjusting the timing of the orders. So do you push their, are you able to take the slot that you have allocated for them and push them back up? a quarter or two, or at some point you just say, listen, we can't push this back anymore. You've got to take it or go to the end of the line. If you could just provide some color about what you're seeing real time on the ground is like how many people are pushing back. Is it a quarter? Is it two quarters? And the mechanics operationally about how you guys manage that process. Thank you.

Yeah, I know Gary's going to comment. I'll just make a quick comment, Mark. When we go out and test the backlog with the customers, if they want to make changes, a lot of times that's a mutually beneficial change. We have another customer that's interested in taking the tool because the demand is exceeding supply at this point. So the first thing we do is try to accommodate those changes. We're not trying to demand the customers stay on the schedule that they have, et cetera. So we try to be flexible. And that was really the point of going out and retesting and reverifying all of the demand that we have across the customer base. So, Gary, you may want to add to that.

No, I think that's exactly right. Again, the challenge we face right now, again, many of our customers are really driving major technology inflections. And, Mark, I think you see also, especially in high-performance logic, everyone is racing to these new inflections. So, We just have tremendous demand from those customers in ICAPS, automotive, industrial automation. So unfortunately, we're not able to supply to that demand. And as Bryce said, memory is weaker. And we try to manage and work with the customers to come up with the right outcome for them and for us.

Very helpful. Thank you.

Thank you. Our next question comes from Vivek Arad of Bank of America. Your line is open.

I'm trying to reconcile the two things. One, I think, Bryce, you mentioned you are going to be increasing capacity over the next several quarters. But then from a demand perspective, I believe, Gary, you said that memory could be down. I think you said kind of mixed views on ICAPs, but then leading edge should be up. So my specific question is, you know, based on, I know you're not giving, you know, next year's guidance per se, but based on what you see, are we looking at kind of a garden variety, you know, flat to down 5%, 10% in terms of the spending environment? Or is it, you know, very different than that view? Just so that we have, you know, some baseline view of how you are thinking about the industry going into the next year, given you do plan to increase supply.

Hi, Vivek. It's Bryce. So To reconcile those two, I think the first thing to be clear on from our side is that demand for the next several quarters, three plus, is far higher than supply. So we are going to concentrate, like we say, on increasing our supply and we'll do our best to do that over the next several quarters. And that's our expectation is demand will stay above where we can supply across that time period. So I think someone said it before that we're underserving the market so far such that if there's a change in demand, it's still above where our supply line is. That's the perspective we have. And if you think about or if you're asking about 23, like we said, it's too early to make a call on 23, but what we would point out is Different areas of the market sure are having some weakness, some inventory issues. Other areas are very strong and are on schedule to, you know, build the processes that they need for customer products that are also on schedule. So we think those puts and takes, you know, more or less will continue the demand signal for us into next year.

Thank you. Our next question comes from Stacy Raskin of Bernstein. Your line is open.

question. I was wondering if you could comment separately on your memory and your Foundry logic backlog. So I assume the memory backlog is coming down given it's weaker, but it sounds like your overall backlog is still increasing if your demand is still well exceeding supply. So is it a case of like your Foundry backlog is increasing more than your memory backlog is shrinking? Or like, how do I think about the different pieces of that?

Yeah, exactly right, Stacey. This is Bryce. Definitely the backlog is increasing and definitely the Foundry Logic backlog is the strongest component of that in terms of orders and adds to our order book. I'd say that's good. We know there has been reductions on the memory side. I don't actually know if the memory side is down in total overall. But I think that's a fair way to look at it. Some customers have reduced backlog on memory, but overall, Foundry Logic and some of the ICAPS customers are driving an outweighing increase on the positive side.

Hey, Stacey, this is Gary. So also, the Foundry Logic is an increasing percentage of overall wafer fab equipment. So if you look at you know, the percentages, foundry logic is really around two-thirds of total wafer fab equipment. And so certainly the race for competitiveness and high performance, you know, you see that with companies making significant investments. ICAPS, you've seen a lot of announcements with companies making long-term investments in the ICAPS capacity. So certainly, You know, you see that in the increasing percentage of FoundryLogic in the overall market. So, yeah, I think that, you know, what Bryce said and what you had also asked in your question, certainly FoundryLogic is strong in that backlog still. Unfortunately, we're not able to meet demand.

Got it. That's helpful, guys. Thank you.

Thank you. Our next question comes from Atif Malik of Citi. Your line is open.

Question for Bryce. Bryce, some of your U.S. peers talked about expanding China restrictions to sub-40 nanometer. Did that impact your July or October quarter outlook? And if you can remind us of your total China sales, what is display systems versus silicons?

Thanks, Atif. Yeah, first of all, we did get the same notice as our peers did on that. So that is sub 14 nanometer shipments to China customers. And it did not impact our July quarter and very small for October quarter. And that's included in our guidance. So that part's clear. And, you know, we will work to make sure that we're in full compliance with all the changes on trade rules as we always have, but nothing significant in July or October periods. And then could you repeat the display question?

Yeah, I'll take it. Thanks for the question. So we're not going to break out the exact amounts of our business in China, but display, most of our display revenue does come from China. And then you have the global customers and the domestic customers. And you have systems and service for all of those different businesses. So not going to break out all of those different percentages. But what I would say is that, and I think we've talked about this before, that by far the majority of our semi-foundry logic business in China is ICAPS, which is on the trailing nodes. Thank you. That's helpful.

Thank you. Our next question comes from Chris Fincar of Calwin. Your line is open.

So, Bryce, if overall WFE is down, say, 10% next year, how should we think about AMAP's total revenues, including FEMI and services, given the strong backlog? And more importantly, how to think about the EPS if, say, WFE is down 10%? Bryce, any color you could give there and how to think about revenue and operating leverage in that environment would be very helpful. Thank you.

Sure. Thanks, Chris. So the first thing, just to remind investors, you kind of made the point in the question about our backlog. We do have, as you said, you know, a large backlog and we expect for the next, you know, three plus quarters, we'll just be working on raising our output and serving that backlog. But if you want to do a what if, you know, if revenue goes down or if WFE goes down, the first thing I would remind investors also is that our services business doesn't fluctuate or correlate a hundred percent with WFE. It's driven off, you know, our installed base, which grows every time we ship a tool and the utilization across the entire factory network that we're serving, you know, transactional spares and subscription service agreements across that. So that, That portion of our revenue tends to dampen any weakness that we would have from a lower WFE. I would just highlight that for people that are thinking model. So whatever would change on WFE and change on the equipment side, it would be a dampened signal on the services piece of the business. And then for overall modeling purposes, I would look at probably as a proxy year 2019 to see how the business reacted to a lower revenue environment where, you know, you can look at the margin performance in 2019, which was down one or two points, and you can look at spending where it was controlled relatively flat. I think those would be the, you know, same sort of reaction the company would be able to implement in that sort of environment if you were doing a what-if, which, again, isn't our forecast.

Got it. Thanks a lot, Bryce. Really appreciate it. Thank you.

Thank you. Our next question comes from Tashia Hari. Goldman Sachs, your line is open.

Hi, good afternoon. Thanks so much. Gary, I was hoping you could expand on, you know, some of the comments you made regarding the CHIPS Act and the implications for, you know, the broader industry, but more importantly, your business. I think you stated in your prepared remarks that you expect it to be a small tailwind or a minor tailwind starting in late 2023. first of all, if you could quantify that for us for 23 and 24, that would be super helpful. More importantly, how has the conversations you're having with your customers changed since the chip stack has gone through? I guess the main question that I get from investors is if a big foundry in Taiwan decides to build capacity in the U.S., isn't it sort of a zero-sum game where you sort of subtract from what could have happened in Taiwan and you just kind of take that over to the U.S. So net-net, isn't it sort of a zero sum? But how would you kind of respond to that? Thank you.

Yeah, thank you, Toshia. So on the CHIPS Act, first I'd say I am very happy to see that CHIPS and Science Act pass and become law. That's really positive for the United States and the overall industry. And then relative to the investment question that you asked, you know, I would look at it as a small positive tailwind for overall wafer fab equipment spending and really timing-wise starting in late 2023. If you look at the investments, at least the ones that have been announced so far, it's really in, you know, high-performance logic, some ICAPS investments, those kinds of things. So, As I mentioned earlier, again, two-thirds of waiver FAB equipment is in that foundry logic space today. And so, you know, that's going to be incrementally positive, you know, going into late 23 and beyond. Those investments also are time-bound. If you look at the incentives, you know, there are certain timeframes where the funding is available and investments have to be made. So, you know, that creates a higher degree of certainty. I would say as those companies I've talked to, many of them, and as they move to new locations, there is startup costs and some incremental less efficiency as they start those fabs. And especially for our service business, that's an incremental positive. So I think you'd see small incremental spending, late 23 and beyond, as all of those investments and those factories are starting up. Over time, Toshiya, I think it really depends on the scale of those factories. A bigger factory is more efficient than a smaller factory. And so until they build them out, which will take many, many years, there will be a degree of less efficiency for some period of time. But again, if you look at it in the grand scale of overall WFE, It's not a huge tailwind, but it's definitely a tailwind.

Got it. Thanks so much.

Thank you. Our next question comes from Holland, sir, of J.P. Morgan. Your line is open.

Good afternoon. Thanks for taking my question. I wanted to expand on some comments that Bryce had on services. Maybe this is a plug for your upcoming masterclass. But I mean, in the event of a weaker WFE environment next year, you have several positive buffers. I think the biggest one is that your services business historically does not decline during downturns. In fact, over the past 11 years, and I think that's four WFE down cycles, I believe that there's only been one year that AGS was down and it's driven a pretty stable, like eight to 10% sort of revenue kicker over that period of time. So outside of the annuity-like subscription contracts that I assume will be partially offset by, let's say, 200-millimeter equipment sales, which may fall off in a weak WFE environment, what is the team doing to ensure continued up-performance of services during WFE weakness and your confidence on driving growth in services if WFE is down next year?

Yes, thanks for the question, Harlan. If I got it there, you know, what we're focused on The two drivers for that business, as you kind of hinted to, are really the installed base that grows every time we ship a tool. And then, as you highlighted, our ability to serve that installed base, both through transactional support, spares, and services, and then the subscription agreements that we have with customers that offer spares plus service. plus insights that we have across the network on how to optimize for yield and how to optimize for capabilities. So I think what we're doing is increasing our portfolio of service offerings that make it more valuable to the customer and allows them to ramp more quickly, reach higher yields, and really benefit from the intelligence that Applied has across the whole ecosystem of tools that they don't have potentially on their own. I think that's the focus area for the company, and that's what gives us confidence that as that installed base grows, we'll be able to continue to grow our subscription agreements. And just the last piece is, you know, you're right. We have the same analysis on not being 100% correlated with WFE. And, you know, even as, you know, if there's changes in WFE or weakness in the revenue and the rest of the business, it's really about the underlying utilization in the factories that exist and the need for services and intelligence in those factories. So I think those are the key drivers.

Arlan, just, yeah, thanks for reminding people about the master class coming up here next month. You know, the... You know, one thing that I think has helped us also, so you talked about, you know, 10, 11 years. If you go back over that time period, we've, I think, close to doubled our percentage of subscription agreements versus transactional. So certainly, and we've increased the length of those agreements to two and a half years. So that percentage of agreements being so much higher, and it's still growing, you know, that makes that business more resilient and And I think that also relative to the environment we've been in, where everybody is focused with chip shortages producing good chips out, you know, it really has also highlighted more value in our services, things like managed parts services where people have the parts available versus competing for what's, you know, what's available from a transactional perspective, along with all the things that Bryce talked about. You know, I think that's really helped highlight the value of these longer-term subscription agreements for our customers.

Yeah, and Harlan, this is Mike. Thank you for the insight. Yeah. Yeah. Hey, Harlan, it's Mike. I think that earlier I gave the right timing for the next master class. It's in five weeks from today, but I think I heard myself say May 26th, which is the last date. It's September 22nd, of course, so thank you. Yeah, thank you.

Thank you. Our next question comes from Joe Quattri. Of Wells Fargo, your line is open.

You talked about still seeing strength and especially in leading edge Foundry logic investments, but there's also some consumer driven demand there as well. So I guess, have you maybe seen a change in terms of like the capacity that your customers are looking to put in place there, but still not change their technology roadmaps?

Yeah, thanks for the question, Joe. Yeah, the way I would think about it, first of all, I think, yes, you know, we've highlighted that demand is higher than our supply level. There's been changes. I think in total that demand came down a little bit, but it's still, you know, above what we're able to supply for the out quarters. But I think the way we think about it for a leading edge foundry is, you know, they're building processes that their customers are building products on. And they need to be able to hit those schedules for the customer products. So they're fairly committed to getting that technology in place. And then you're right, the volumes will fluctuate depending on what the market is for those products. But if you're building a logic node for a product two years from now, you're really thinking about what the market is two years from now when you're putting that equipment in place. So it's not as simple as just looking at the current quarters you know, macroeconomic environment, GDP, and lowering your demand. You really have to think about that forward-looking function. But the dynamics, you have the dynamics right. We just retested all of the demand for next year, and that's what all the customers are thinking about.

Thank you. Thank you. Our next question comes from Timothy Arkery of UBS. Your line is open.

around some of the mixed signals around what's happening this time around. And, you know, on one hand, customers are pushing out, but you also mentioned that you're getting long-term commitments from some other customers. I was wondering what that means, because it kind of sounds like you're confident that Foundry logic is going to hold up this time, even as memory pushes out. And that's not usually how it works. Is it simply that there's such a concentration of, you know, And there's going to be others, you know, such as your neighbor that are trying to compete to get back into the business. Is that what's different this time? Cause I'm hearing these mixed signals and there's something obviously different. So I'm just wondering if you can call on your, on your, uh, on your, you know, past knowledge to help on that. Thanks.

Sure. Sure. Tim, just, uh, two comments. Uh, the first is we've definitely expanded the horizon, uh, with all of our customers, uh, in, from a planning perspective. They're giving us longer signals than before and giving us the opportunity to engage in the discussion on capacity planning with them. And second, some customers are also giving us a sense or a promise, basically, that they'll operate within a certain band of capacity. So they're giving us additional confidence to what we should plan for from a high-confidence perspective, and that's a little bit different than what we've done before.

Hey, Tim, this is Gary. I would say one other thing that is helping us in this time frame. If you look at the relative investment for the upcoming inflections, more of the dollars are going to new materials and new structures. You know, gate all around, we talked about that in the master class. Wiring for interconnect from 7 to 3 goes up, I think, 3x dollars per wafer. As you go to the three nanometer node, there's more steps. We have these integrated material solutions that combine seven technologies on one integrated platform to lower the wiring resistance by 50%. Backside power distribution, if you look at what one of our customers said recently, they talked about significant increase in materials and structures relative to power performance for them going to their future technology nodes backside power distribution is another one that's a significant inflection you can reduce the area up to 30% without shrinking the features by placing some of the structures on the backside of the wafer so again for us that relative contribution and the relative investment in our types of technologies is is going up, and that's another thing that's helping us.

Thanks, both.

Thank you. Our next question comes from Joseph Moore of Morgan Stanley. Your line is open.

Thank you. In terms of the view that you've been more resilient going forward than you've been in the past, would you say that's true for memory and isolation? And I guess if we think this is a memory issue, downturn that looks similar to 2019? Should we think about WFE being down similarly to 2019? Or do you think that would be too pessimistic and why that? Thanks.

Thanks, Joe. The first part, I guess I haven't thought of it like that. But I would say that we are resilient, more resilient philosophy or position would play to memory only. And the reason the reasons that I would point to our first the backlog that we've talked about. Even though memory may be weaker than it was last quarter, we still have significant quarters of backlog for memory customers. So that dynamic is the same. And the overall backlog strength is one of the reasons we're saying we're more resilient than in other periods. And the second is the services business is one of the reasons that we're thinking that we're more resilient. And that also applies to memory customers and customers that we service from a spares perspective, et cetera. So I think that also is larger than it has been in the past and is more resilient relative to changes in WFE. And then the last piece, just to make sure for everybody else, I wasn't implying that 2019 would be the P&L for the company. We won't go back to 2019, but that it was a good proxy for how gross margin and spending would behave. if we were in a weaker environment. So just to clarify that.

Yeah, Joe, this is Gary. I think if you say what's changed, what's the same and what's changed, certainly the percentage of foundry logic is significantly higher than it was back in that timeframe. Again, it's tracking around two-thirds. There's this race for leadership and high-performance logic and, you know, significant investments that are happening in that part of the market. And, you know, we see customers, our customers announcing longer-term agreements with their customers, and that's something that we didn't see back in that timeframe. So I think the foundry logic percentage and the, you know, relative strength there is definitely different than, certainly than it was in the 2019 timeframe, you know, relative to the overall wafer fab equipment market.

Great.

Thank you.

Thank you. Our next question comes from Sydney Ho of Deutsche Bank. Your line is open.

Thank you for taking my question. My question is on China. When I look at the revenue from China, it came down about seven percentage points quarter over quarter. I think that's more than some of the peers. Can you walk us through the dynamics there I know in answering a previous question to talk about the new export restriction have no impact in the July quarter, maybe you can talk about the demand strength from domestic Chinese customers versus multinationals and the foundry versus memory. That would be great. Thanks.

Thanks, Sidney. This is Bryce. Yeah, I think one specific driver and one just general observation, the specific driver is Most of the downside on our display business relates to customers in China. So that's probably the primary change element. The rest is just the ins and outs, normal quarter activity. We don't think the China market, as we look forward, is any weaker. We think the ICAPS investments that are being made there are largely unscheduled. No real change in signal there. So it's just the ins and outs of having different size deliveries in the quarter. It happened to be a quarter overall that was a little smaller than the prior quarter. So we would point to display and then just general ups and downs for the rest of the change. And just reiterate, no change because of the trade rules like we said before.

Okay, thank you.

Thank you. Our next question comes from Quinn Bolton of Needham and Company. Your line is open.

Really ask you a clarification and then a quick question. The clarification is when you talk about memory reschedules, are these memory customers just pushing out delivery dates by some number of quarters or are they canceling the tool entirely and you're just taking that slot and reallocating it out to one of the Foundry Logic customers? The question is just on the memory rescheduling. Is that equally happening across DRAM and NAND, or is it predominantly on the DRAM side? Thank you.

Okay, Quinn. Thanks. On the clarification, there are all three events happening with basically all customers. So there's ads, there's drops, and there's schedule changes. I think on the memory, there's more drops than there are ads in the short-term window. So, you know, those are cancels. And there are plenty of reschedules, and there are even some ads for memory. So I hope that clarifies. It's a mix. But overall, we would say memory, cycle over cycle, memory is lower than what it was the last cycle.

And it's equally across the remandant?

That part I don't have off the top, but I don't think we would specify that, so I can't answer that one. Understood. Thank you. Yep.

Thank you. Our next question comes from Patrick Ho of Steve Lee. Your line is open.

For you, Gary, since a lot of the industry questions have been answered, you talked about the above-average growth in your process control business, and obviously Foundry Logic is a big driver of it, particularly on the advanced node side. Are you seeing any penetration in terms of your ICAPS business in process control, or is it entirely within the advanced nodes?

Hi, Patrick. Thanks for the question. No, ICAPS is very strong overall for the company. PDC is up 67% in 2021, and we're up. almost 40% in fiscal 2022. Oh, hi, Patrick. Thanks for the question. No, ICAPS is very strong for our... ICAPS is very strong overall for the company. PDC is up 67% in 2021, and we're up almost 40% in fiscal 2022. What I would say relative to the breakdown of the different markets Certainly it's stronger in high performance logic than in any other part of the market, although we are seeing growth in memory and we are definitely also seeing growth in ICAPS. The biggest thing for us, if you look at our PDC business last year, eBeam pretty much doubled. So we have vertical integration with our electron optics. leadership and resolution and imaging technologies. And that business is also very, very strong into 22. And then also going forward, we are seeing incremental strength also in optical inspection. And we believe we'll outperform the overall market in optical inspection. And overall, PDC has a really strong tie to PPAC-T inflections. So when you look at gate all around or some of these other big inflections, our unique imaging capability enables us to map out those processes and fingerprints faster and better than anyone else. So that synergy, not only do we see really strong growth in PDC, but real strong synergy with the rest of our SEMI portfolio.

Thank you.

Great, thanks. And operator, we have time for one more question, please.

Thank you. Our next question comes from Maddy Racine. Your line is open.

I'm asking WFE question. Two follow-ups. What would be your revenue guide if you had all the components that you needed to shift to demand?

That's a good question, Mehdi. Since it's been several quarters since we've been at that level, it's difficult to predict. But we did say, I think, two quarters ago that the supply constraints probably impacted us by $300 million. So I would say that and more if we had zero supply constraints and we would be on a higher curve going forward.

Thank you. And of your inventory, how should I think about the mix of WIP and finished goods?

Well, the changes for inventory, you know, it's relatively balanced across the entire inventory ecosystem. But, you know, the increase – I'm looking at the numbers, sorry, right now. Yeah. Relatively balanced. I mean, here's what's happening dynamically. We have much more raw inventory coming in as we're trying to solve the supply chain issues. And 95% or more of our parts are available, and we're able to build inventory. And that shows up in our WIP in raw material. And on finished goods, what's happening is we do have tools that are complete or nearly complete. that are awaiting one part or close to being shipped to customers, and that inventory is also growing. So I think it's relatively balanced across all those components.

So the push out by memory customers is not a factor in driving the increase in days of inventory?

Yeah, absolutely not. We're still underserved in total relative to the market. You know, when any customer delays a tool or cancels a tool at this point, we'll be moving that inventory and those parts to another customer, and we expect that to be the dynamic for the next, you know, several quarters plus.

Thank you, and thanks for the details.

Yeah, and just to emphasize for everybody, yes, that's what our perspective is on output. We'll be raising our output for the next several quarters, and we expect to be able to ship that based on demand being higher than the current supply.

Okay, thanks, Matty, for your question. And Bryce, would you like to give us a summary? Absolutely.

So we've talked about puts and takes, weakness and areas of strength in the market. The overall story is we have multiple quarters of backlog. Job one for us is to increase our output and meet our customer demand as quickly as possible. As we do this, we'll incrementally increase both our revenue and gross margin in coming quarters. We're confident in the long-term growth of the semi-market. and we're working to increase our investments in supply chain, and especially to continue to focus on the R&D to drive the power, performance, and area cost roadmaps of our customers. I look forward to seeing many of you at the upcoming conferences. Gary and I will be at the Goldman Sachs Conference in San Francisco, and just before that, I'll be in New York for the Citi and Evercore events. Okay, Mike, please close the call.

Replay of the call is going to be available on our website. We'd like to thank everybody for joining us today. A replay of the call is going to be available on our website by 5 o'clock Pacific time today, and we would like to thank you for your continued interest in applied materials.

Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect.