Q2 2020 Earnings Call

May 14, 2020

So again momentarily. Thank you for your patience.

[music].

Welcome to build pod materials earnings conference call during.

During the presentation, all participants will be in listen only mode.

Afterwards, well be invited to participate and the question and answer session.

I'd now like to turn the conference over to Michael Sullivan Corporate Vice President. Please go ahead Sir.

Good afternoon, and thank you for joining applied second quarter fiscal 2020 earnings call, which is being recorded joining me are Gary Dickerson, our president and CEO and Dan during 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 applies form 10-Q, an 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 presentation, which are available on the IR page of our web site at applied materials dotcom.

And now I'd like to turn the call over to Gary Dickerson.

Thanks, Mike I'd like to start todays call by addressing the topic at the forefront everyone's mind, the cobot 19, pandemic, which has created unprecedented challenges around the world.

My thoughts and best wishes go out to all of you and especially those whose families have been directly affected by the illness.

The situation has evolved over the past several months our actions that applied materials have been guided by two key principles first maintaining the trust of our employees customers suppliers and partners and second focusing on driving initiatives that will allow us to emerge stronger over there.

Longer term.

As always our number one priority is the health and wellbeing of our employees and their families. Our workforce remains highly productive many are working effectively from home and for those working on site. We've implemented strict safety protocols in close collaboration with our medical advisors customers and suppliers.

And our factories labs, and logistics centers, we've changed physical layouts to allow for social distancing introduced enhance cleaning and sanitation procedures implemented health screenings and mandated the use of personal protective equipment.

All our employees and contingent workers have continued to receive full pay and we've introduced additional incentives and benefits for employees supporting our critical operations well, we've been working through certain supply chain constraints. We have remained laser focused on the needs of our customers and doing what it takes to keep their fact.

He's running smoothly and their R&D programs on track.

Across the company I see amazing examples of our manufacturing logistics and field operations teams going above and beyond to keep our customers and the industry moving forward in a difficult set of circumstances.

We're also to finding new ways of working with customers that not only provide solutions today, but will also create significant benefits over the long term.

Finally in line with Applieds long held values to make a positive contribution to the communities, where we live and work we've created a global charitable covert fund. The purpose of this fund is to address immediate humanitarian needs and combat long term effects on local communities and the nonprofit sector.

We've also donated masks and equipment to medical facilities and in addition, there have been numerous employee driven initiatives across the company. It's inspiring to see these employees stepping forward to help volunteering their time skills and resources to demonstrate our shared passion to.

Make a difference.

Now, let me turn to the agenda for todays call I'll begin with a summary of our second quarter performance and near term outlook, then I'll provide a longer term perspective on our markets and all finished with a summary of our strategy highlighting some of our recent accomplishments later, Dan will give more color on our financial results.

Operational performance and business environment.

Starting with our near term business outlook demand from our semiconductor customers remains strong.

In fiscal Q2, our financial performance was negatively affected by our ability to ship systems to customers as shelter in place and locked down orders impacted some of our suppliers operations, particularly in the Bay area in Malaysia.

However, we're in a much better position today, thanks to the flexibility in our global operations footprint, we've been able to make adjustments and we continue to work closely with our suppliers to ensure they can meet our needs.

Our supply chain remains a critical area of focus as we enter our third quarter with record orders and a record backlog for our semiconductor and service businesses combined.

In terms of the semiconductor industry environment I will focus my comments on what we currently see in the market and what we're hearing from customers.

And foundry logic demand at the leading edge remains very healthy with a strong commitment from these customers to build out their factories and push forward with their development Roadmaps.

However, we're seeing some pockets of weakness in specialty markets, mainly as a result of a pullback in the automotive and industrial sectors.

In memory there are no major changes to the outlook, we provided last quarter, we continue to see a positive progression in the market with inventory levels approaching normal and improvements in pricing trends.

As a result, we're seeing incremental strengthen investment by memory customers as we move through the year.

Based on the visibility that we have today underlying demand for semiconductor equipment is robust and even when kobin related effects are taking into account, we still believe that our semiconductor business can deliver strong double digit growth for our fiscal year.

And display we expect our F. why 20 revenues to be close to F. why 19 as the industry navigates the bottom of this spending cycle our display business remains solidly profitable even as we invest in next generation products ready for when the market picks up.

Looking further out we're well aware of global economic concerns.

Well I'm not going to speculate on possible macro scenarios I will share some of the key assumptions that were using to guide our strategy, which are based on carefully monitoring market indicators and staying very close to our customers clearly consumer spending as a potential headwind for many sectors include.

During the electronics industry at the same time, the global pandemic is acting as an accelerator for key technology inflections that were already underway.

Working from home learning from home and E. Commerce are driving investments in cloud data centers and communications infrastructure.

We expect companies to build stronger business continuity plans, which will include geographic redundancy and increased use of automation and Aiotv technologies and the adoption of AI and big data remains nondiscretionary for many companies as I've said before these game changing technologies.

Well transform entire industries, and there will be big winners and losers through the transition.

My personal view is that we will see significant and permanent changes in the wake companies operate and prioritize their investments in fact, this is already happening in our business and the ways, we're working with customers over the past several years, we made significant investments in state of the art digital infrastructure.

Sensors in metrology data science machine learning and simulation.

The combination of these technologies enables us to reduce product development cycles speed up transfer of new technologies from lab to fab and optimize cost output and yield for our customers and volume production.

In the past few months, our field and R&D teams have been working with customers to further expand secure data sharing to enhance remote support and accelerate the deployment of these powerful new tools in our own labs. We also have many examples of R&D teams, increasing utilization and productivity of lab assets.

By applying creative new strategies for mode operations.

While near term actions are being driven by necessity. The long term benefits of working this why are compelling as they provide significant time to market and cost advantages for applied and our customers.

Our long term perspective about AI and big data shaping the next decade is unchanged and we see strong potential for certain elements of these inflections to scale faster than previously expected.

As I've said before to enable these new computing systems and unlock the potential of AI technologies major advances in the power performance and area of cost or P.A.C. of semiconductor devices are needed.

Based on recent input from customers, we've updated our pp AC framework to P.P.A.C.T., where t. stands for time to market acknowledging the enormous value of speed.

Applied has by far the largest broad portfolio of technologies and products to accelerate the pp HPP playbook, which spans creating shaping modifying analyzing and connecting structures and devices were the only company with processing metrology under one roof and we.

Of highly differentiated silicon and packaging lab capabilities.

As a result, we have a significant advantage and our ability to accelerate new P.A.C.T. innovations for the semiconductor ecosystem.

The capabilities, we have built in a multi year investments. We've made are yielding results. According to Vlsiresearch has recently published report we outperformed the market in both semiconductor equipment and services last year.

Our performance in deposition technology was especially strong with our PBD business, gaining seven points of share.

We also have great momentum in metrology and inspection our process diagnostics and control group delivered record revenue in the first half of the year one of the key contributors to this record performance is our new optical inspection system that we will be officially launching later this year.

Before I hand, the call over to Dan I will quickly summarize first as we navigate the challenges created by Cobot 19, Weve rally the company around two guiding principles maintain the trust of employees customers suppliers and partners and focus on driving actions that ensure applied materials emerge.

Stronger over the long term.

Second while we're mindful of potential macro economic headwinds based on what we see in here today semiconductor equipment demand remains robust and our supply chain is getting healthier.

Third we remain fully committed to our strategy to accelerate the P.P.J.C.T. playbook and our pipeline of new innovative products and integrated processes has never been better now I will turn the call over to Dan.

Thanks, Gary.

Today, I'll summarize our second quarter results and activities give you an update on the environment and share our current expectations for the second half of our fiscal year.

As a reminder, on March 20, Threerd, we suspended our Q2 guidance because of the global response to covert 19 is creating significant challenges across our supply chain manufacturing operations and logistics due to the extreme uncertainty. We also decided to borrow against our revolving credit facility, we promised to provider and best.

Letters with an update on this earnings webcast and I'll do that in a moment.

This afternoon, we announced our Q2 results, which were below our original guidance, but solid considering the extreme challenges our teams faced due to coated I'm proud of our employees for putting health and safety first and still doing everything possible to support our customers both in keeping our factories running and by keeping our R&D.

Grams moving.

Despite the incremental challenges we experienced in the last six weeks of our quarter, we delivered AG escan display revenue that was higher than our original expectations in February.

Our semi systems revenue was below our original outlook and that was entirely due to coded related supply constraints.

End demand remains strong and while the environment remains fluid we exited the quarter with the second highest company backlog in our history and record backlog for semi systems plus HGS combined.

For the company as a whole in Q2 on a year over year basis. We grew revenue by 12% increased non-GAAP operating profit by 23% and grew non-GAAP EPS by 27% to 89 cents.

During the quarter, we returned $392 million to shareholders and buybacks and dividends and announced a dividend increase of nearly 5%.

We ended Q2 with nearly $7.4 billion on the balance sheet, including $1.5 billion and credit facility proceeds.

Now I'll share my assessment of the code that environment, which includes several encouraging developments.

Our industry has been designated critical infrastructure in many parts of the world all of our suppliers has now been able to resume operations and they were covering to normal output.

We've been very close communications with our customers and their demand indications remains strong.

We're mindful of the macro economic impacts of coded including job losses in the consumer and industrial sectors of the global economy.

But governments have provided strong financial support to workers businesses and the banking system.

As a result of our assessment of the environment, we fully repaid our revolving credit facility borrowings subsequent to the end of the quarter.

We currently have approximately $5.9 billion of cash and investments on the balance sheet, which is an increase of about $200 million compared to our Q1 balance.

We are continuing to prepare for the planned acquisition of Coca say electric during Q2, we receive Taiwan's clearance for the transaction and we have one final approval pending from China.

Turning to the business outlook, while I see positive signs there is still potential for coated related disruptions around the world and we're not providing revenue and earnings guidance for Q3, I know there is concern about the risk of further economic impacts and changes in customer investment patterns, but rather than speculate.

Now I'll attempt to help our investors by providing visibility into what we are seeing across our operating segments.

In semiconductor systems, our Q2 revenue would have been nearly $650 million higher absent cove it related constraints.

We hope to recover this revenue in Q3 in Q4 as the supply chain improves in the second quarter, our semi systems orders were up significantly and demand is broadening to more customers.

Based on what we're hearing from our customers. We believe Q3 semi revenue could be up in the high single digits sequentially and higher again in Q4, resulting in strong double digit growth for the fiscal year.

Our services business has proven highly resilient during the crisis and we continue to generate a growing proportion of revenue from subscription like long term service agreements.

Yes posted its first billion dollar quarter ever in Q2, with nearly 60% of revenue coming from service agreements.

In Q3, we believe agius revenue could be flat to slightly higher sequentially and higher again in Q4.

Within AG, yes, our semi parts and services business has grown to $3.2 billion or 24% of our company semi related revenue.

Yes, I research has begun to sizing compare the parts and service revenue of companies in the industry.

Ours is the strongest among our peers both on a dollar basis and as a percent of our semi related revenue.

Our total semiconductor installed base business, which includes parts services 200 millimeter systems, and 300 millimeter upgrades and Refurbs has grown to become 38% of our semi related revenue. This ratio is about five points higher than our peers.

As Gary indicated we still expect our display revenue to be nearly the same this year as last.

We believe revenue is likely to be flat to slightly higher sequentially in Q3 and higher again in Q4.

In short if the demand indications from our customers hold and our supply chains continued to improve then we should have second half weighted revenue in each segment.

Based on everything we see today this would translate to sequential revenue growth and earnings growth in Q3, and then again in Q4.

So in summary, while the situation remains fluid and macroeconomic impacts are still unknown, our customers remain committed to their technology roadmaps and our signaling growth for applied.

We will remain vigilant stay close to our customers and be ready to respond quickly if the environment changes.

Once again I'm incredibly proud of our employees for their strong commitment to health and safety and their strong support of our customers. Both in meeting today's demand at our factories and theirs.

And innovating in our R&D labs to enable the technology of the future now Mike let's begin the acuity. Thanks, Dan there a lot of people on the call today, so to help US reaches many of you as we can I'm going to ask you to please ask just one question and not more than one brief follow up operator, let's please begin.

Thank you ask a question do we need to press Star then one I get telephone to withdraw your question. Please pass that's how key our first question comes on the line CJ Muse Evercore. Your line is now open.

Yes. Good afternoon. Thank you for taking the question.

I guess first question you talked about expectations for incremental straight for memory three to calendar year.

So perhaps you could elaborate on that in terms of the mix between both NAND and DRAM as.

As well as a new wafer starts versus strengths and what gives you to competence that that is sustainable in this world of cobot.

Thanks, CJ as we look in the year, we see the year profiling pretty similar from a proportion of spend standpoint that we talked about a quarter ago, we see strength in foundry logic continuing throughout the year as our order book.

Customer base broadens and we feel good about that as we profile to memory, we talked about seeing some incremental strength this year.

Both on DRAM and NAND I think it's too early to call the magnitude of that but we do see balance across the device types from the spend standpoint, and I do think there's going to be similarities in terms of 2019 being in investment year, primarily.

Focused on technology, Roadmaps, and we actually saw wafer starts per month.

Last year 2019, actually go down year over year in both DRAM and NAND and as we look into this year, we don't really see strong capacity adds we continued to see our customers driving their technology roadmaps because that is in effect their cost structure. It allows.

To drive margins and cash flow when industries recover.

So we see continued investments from a technology roadmap standpoint, but we see probably less wafer starts per month coming out of this system than we did the year before so it's sort of on the margin. We continue to stay close we will watch it and we'll continue to be open and transparent in an environment that.

And by uncertainty what we want to try to do is be is helpful. As possible share with investors are the things, we're seeing and hearing from our customers and we'll let you know what we see each quarter as the situation evolves.

That's helpful could stick a quick follow up like.

Our gross margins.

Can you speak to how you see the trajectory into the second half considering.

What looks to be are positive mix from both silicon in AG us.

It also as it relates to supply chain I think you took out 8 billion of Kobin related expenses is that something that should sustain into the back half how we should we be thinking about that thanks.

Thanks, CJ I'll take both as we think about the actions. The company took in the current environment. We made conscious decisions about how we were going to position ourselves from an operating in manufacturing standpoint.

And decisions were made very early in the process, we implemented our business continuity team in the middle of January and as part of contingency planning and mapping out potential points of risk we made decisions to put in place surge capacity from the personnel standpoint and that decision was made.

Probably the first week of February so clearly there is an impact to maintain.

Cycle times, and Throughputs that are on par with where we were before cove it.

That's a result of really strong teamwork and execution and planning, but it certainly has a headwind from a margin standpoint, and we're optimizing around serving our customers and taking care of the things that we can take care of so we can better withstand the things we can't control, which is what we saw from.

A supply chain disruptions standpoint, and the rate and pace of that recovery. So we feel good about that.

But certainly it does create a bit as a headwind than you see that profiling through some of the segments and I'm happy to share more of that thinking, but it's definitely there from a gross margin standpoint.

As we look into next quarter, what we signaled was a favorable segment mix and in a normal environment that would create.

Improvement from a gross margin standpoint, what I'd also say is what we experienced in our most recent quarter was six weeks of impact other material supply chain disruption driven by a concurrent shelter in place order in the Bay area and Malaysia.

It affected a material part of our supply chain, but it was a six week impact going into Q3, we've got a full 13 week impact as the supply chain becomes healthier.

And.

That will sort of offset a bit as the favorable segment mix. So I think the best way to think about our gross margin as we look into Q3 from a planning assumption standpoint is to think about it flat. If we can do better we certainly will.

But we'll take it one quarter at a timing give investors our best view of what we see and the pluses and minuses as we manage the business to the best of our ability in this environment.

Thanks Vijay.

Thank you. Our next question comes from the line Atif Malik with Citi. Your line is now open.

Thank you for taking my questions I had two plus 200, Gary company gain half a point.

Ill be kookmin share last year in served available markets led by deposition.

Which end markets of technologies are you more confident to show outsize growth. This year in next year and as a follow up Dan I'm curious what's your take is on recent department of Commerce chime that group and licensees.

For the future shipments.

Thanks for the question I think I'll take both of those so.

Let me start with a market share and.

Starting from an overall company perspective, one of the things that we've discussed before is that we have very good balance across all device segments, including leading and trailing logic DRAM and NAND. This enables us to perform well really regardless of the device mix. It gives us a ability to pull performed well in pretty.

Much any environment. So if we look at overall 2019 was a good year for us a your question I think is related to 2020. We look at 2020 is also a very good set up for us a as I said in the prepared remarks, we anticipate strong double digit growth for applied in 2012.

I mean, and what I would say is that you know in this in this new environment I used to travel.

A significant amount and a I'm still on the phone very frequently with Ceos R&D leaders in fact, I had a call with one of the Ceos.

This morning.

And one of the things that the real advantage for applied as the traction we have with customers to accelerate their P.A.C.T. roadmaps and that really is both for memory and also for foundry and logic.

So you know performance in 2019, we gained about two points in the Mark in the markets that we serve and a half a point overall Wi Fi share. So if we look at the set up for 2020, we continue to see strong foundry logic investments, where we have leadership products PVD app.

The strong traction a new etch applications.

We see currently double digit growth in our memory business strong double digit growth in memory.

Gaining traction with new capabilities that are key for scaling and strong growth in memory patterning applications. So overall again, we have balanced across all of these different segments I would say that our pipeline of our new products in our integrated material solutions has never been bay better.

Relative to accelerating piece P.C.T. roadmaps for customers.

Then the second question is around I think the export controls. So let me start with perspective of the overall geopolitical situation and I've said before on this one apply believes unfair trade and intellectual property protection or the semi ecosystem in innovation roadmap.

Rely on these principles so regarding the new regulations that were recently announced by the Department of Commerce, We're working very closely with U.S. government trade associations, and our advisors to better define the requirements for the industry and to be able to comply with the new regulations. We have some very good people working on us and.

Based on our work today, our current expectation is applied is going to be able to meet the government's required standards. When the rules come into effect at the end of June without significant disruptions to our business.

If needed we have significant flexibility in our global operations footprint and were developing contingency plans that we could implement but again overall, we believe we're going to be able to meet the government's required standards when the rules become effective.

Thanks Isaac.

Thank you. Our next question comes on the line.

Hi, Sheila.

Harry with Goldman Sachs. Your line is now open.

Good afternoon, and thank you very much for taking the question Gary I was hoping you could give us an update on your business in China.

Both on the memory side as well as the logic and foundry side one of your foundry customers. Just raised Capex I think was yesterday about by 1 billion plus I'm guessing activity on the memory such incentives to be pretty robust as well, but if you can give us an update on what you're seeing near term and what your expectations are for the second half there will be grit and I've got a quick follow up.

Hi, Toshi I'll jump in on that question. So as we think about China, Let's talk about where we ended 2019 and use that as a jumping off point to talk about what we see incrementally into 2020 as it relates to domestic China spend.

So if we look back into 2019, the market sizing was about six and a half billion dollars.

In a quarter ago, we set our expectation for 2020 was an incremental two to 300 I'm sorry, two to 3 billion of domestic China spend.

Our expectation in 2020 is still two to 3 billion, but now given.

The customer news overnight, we're probably at the high end of that range.

And so a quarter ago as we think about the decomposition of that incremental spend we said about one third 200 millimeter trailing node foundry specialty logic.

Spend two thirds of it was 300 millimeter and as you decompose. The 300 millimeter spend it was roughly split 50 50 between foundry logic and memory.

With balance among device types in memory.

And as you think about us at the higher end of the range now think about incrementally more spend in 300 millimeter trailing at foundry logic and I think that gives you an evolution of that spend profile of how the now.

Two and a half to $3 billion is spend towards the high end of that incremental range. That's the best insight we have at this point based on everything we see in the market and what we're talking with our customers about.

That's helpful down. Thank you and then I think this one's for for dairy I just wanted to follow up on some of your market share comments.

I think you said you gained seven percentage points of share and TBD.

I was curious what you're seeing on the upside.

In terms of market share and you also spoke to your new products and optical inspection.

If you can kind of speak to the differentiating factors for your tool that the some of the competition and what your aspirations over the next couple of years in terms of market share that would be great. Thank you.

Yeah sure let me start with the PTC business overall, and then I'll then I'll answer the question. So our inspection measurement business is one of the segments, where we have strongest momentum we talked about the record last quarter, we had and the first half of F. White 2020, and this is far.

Our above our previous best half year for the business.

We've got strong where we will achieve strong double digit growth overall in 2020 and semi and this segment will be one of the highest growth businesses for us this year, the inspection and measurement business relative to the new optical inspection system, we have tremendous momentum with that system will launch at a later this year.

Very very strong adoption in foundry and logic I'd say the other thing that is positive relative to our PDC businesses in E beam Oh, we have a strong leadership position. We have also some new capabilities. There are the highest resolution imaging technology in the industry and very strong initial adoption.

With new capability, there a with leading customers. So again, we're off to a great start in 2020, and PTC and I would say the best position that we've ever had relative to that business. That's also I think as you know we've had tremendous growth in the conductor etch business about fivex.

In terms of revenue growth between 2020 and 2018 and this is also where we have the probably the best product most successful product ever in the history of applied materials. The Sem three relative to 2019, we gained about a half a point of overall at share.

And in 2020, we also anticipate strong double digit growth in etch, a we have good momentum in memory significant traction with all leading customers and foundry logic, where we haven't had a very high share has been very low in the past, we have really significant traction there and a new product and packaging that also.

Strong strong momentum. So overall, we anticipate strong growth in 2020, and we have good momentum with new capabilities and confident in order to continue to grow.

Rich share going forward.

Thanks to Shia.

Thank you. Our next question comes on the line of John Pitzer will credit Suisse. Your line is now open.

Yes. Good afternoon, guys. Thanks, Let me ask question, Dan I think I, just want to try to better understand the impact of the supply constraints, you're seeing from Covidien you talked about impacting the April quarter by like 650 million and you said you'd be able to make that up in both the fiscal third and fourth quarter. But then you also said in an extra question.

That.

You'd have some gross margin headwinds in the fiscal third quarter, because you'd have 13 weeks of sort of these supply issues, which I guess my question is supply also impacting what's you can shift in the fiscal third quarter. If so by how much and what do you think we get to a situation where were you guys can actually meet.

The demand that's on your books.

Yeah. Thanks, John.

Let me try to on pocket, a little bit for you and give you a sense of how we think about it hopefully that gives you insight that addresses the question and if I missed something please let me know and I'll definitely follow up so as we think about where the supply chain is and how the supply chain gets healthier overtime I think.

Turning to break it up into three components and we'll deal with each of these three buckets in sequence.

The first our suppliers back in business, raising their staffing levels and getting back to pre coded levels of output.

That's sort of a set of issues bucket one bucket to how quickly can they make up for lost volumes.

And then the third bucket is logistics channels and how they get healthier overtime.

And so as we think about the time sequence and an overlay of each of those three vectors.

All of our suppliers are back in the game.

They are working back to 100% staffing levels.

And getting back to pre cobot levels of output I think exiting our fiscal Q3.

I think a good portion a disproportionate share of that will be behind us.

That leaves then the second bucket, which is how quickly can you make up for lost volumes.

I think that happens given the robust environment, we see I think that happens over our fiscal Q4, and our fiscal Q1, so exiting the calendar year. It should be a direct read through on true end market demand in terms of our business activity based on what we can see today.

That looks like the trajectory.

The third.

Bucket. The logistics this is something that's going to be a longer term.

Term issue.

To get back to normal and the reason I say that is theres a correlation between the commercial airline industry and the logistics channels. What I mean is if we're not shipping a full system.

So full systems they'll go on special freighter aircraft.

A lot of what we do short of a full system will ride in the belly of a commercial aircraft. We've had the pivot that to alternative freight and logistics channels and the costs associated with that have arisen.

And create a margin headwind given the correlation to the health of the commercial industry. I think this one is with us for the foreseeable future and we're likely to have a those increased freight and logistics cost stick with us until we can see the degrees of freedom and commercial aviation begin to get much.

Healthier and more active versus the levels today. So if you hear my comments about that margin headwind being around for a while I sort of disconnect that from the fundamental health of the supply chain I think we're back our suppliers are back to pre cove at levels of output exiting the current fiscal quarter I thought.

The balance of the calendar year, we make up for lost volumes hard to predict at this point when the commercial aviation channels Beacon to free up.

To something similar to what we saw pre cove it hopefully that shed some light on how we're seeing things John and answers your question.

That's really helpful. And then my follow up Gary there's been a lot of investor focus on the opportunities you might have in China, and maybe some of the risks associated with that from just the geopolitical perspective over the weekend, we kind of got a different flavor that with some arguments about perhaps more domestic manufacturing of leading edge semiconductors and.

Not only here in the U.S., but there were some articles out of Japan, I guess I'd be curious I know, it's early I'd love to get your thoughts on this potential drive for more sovereign manufacturing of leading edge chips and as you think about that opportunity would this be sort of redundant capacity in your.

Estimation or would it be growth capacity or how do you think that plays out over the coming years.

Yeah. Thanks for the question John So this has been discussed for a while.

But the focus certainly has been increasing with the current geopolitical situation.

I can't of course share any details of any discussions I've had with anyone on the topic, but for sure. This is a good opportunity for the United States and also for applied.

And would be very supporting supportive of making the concept of success. If we look at when our customers go into different geographic regions. A it does create a good opportunity for us if we look at some of our major customers I'm not going to talk about anyone and specific but it creates a really great service opportunity for us as they.

Moving to a different geographic location.

Where they don't have the same nucleus or critical mass of technical horsepower. So as we've had discussions with some of the customers that are thinking about moving into different geographic locations support of course is one of the key aspects of their decision making.

And so again I think it can be a really good opportunity for applied materials and certainly from a geopolitical standpoint, a good thing for the United States a.

For this opportunity.

Thanks, John.

Thank you next question how from the line of Krish Sankar with Cowen and company. Your line is now open.

Hi, Thanks for taking my question and congrats on all putting in such a tough environment, but the disclosed.

So first question either put done.

When I look at the second half you said the view that there's going to be 650 million that got impacted in April that's going to flow through in the second half of this year.

If you strip all that 650 million does it fit as you can have revenues would be lower than the first half revenue from that had a follow up.

Yeah, Chris Schott, just give me a second to a pull up the model.

Yeah, I wouldn't necessarily say, that's true and here's why go there per.

We talked about supply chain getting back to pre cove at levels of output throughout our fiscal Q3. So that's an exit rate complement and implicit in that exit rate comment is the fact that they're not able to supply true end market demand throughout Q3.

And we exit Q3, as Gary talked about in his prepared comments with record backlog in our semi related business.

SSG, plus AG gas and actually record orders in Q2 as well so demand continues to be strong and the supply chain will get healthier exiting Q3, and then make up volumes from.

Unmet demand to date through Q3, or I'm, sorry fiscal Q4 and fiscal Q1. So we think we exit the calendar year shipping to true end market demand. So theres a bit of a bleed over of this dynamic into the next fiscal year.

Sure and so I think given what we've seen from an order standpoint, and what we're entering Q3 with from a backlog perspective, I still think we see strength in the back half of our year. If we break that down by device type what do we see we see continued strength throughout the year.

In foundry logic, we talked about a broadening of our order book in foundry logic, we talked about multiple customers multiple nodes.

We talked about some softness as it relates to things like auto and industrial and consumer end markets.

And that's more trailing nude.

Geometries, what we're seeing on the leading edge continues to be strong as we think about memory.

A quarter ago, we talked about second half of the year being the swing factor.

And that construct still holds from a memory standpoint calendar year Q4 is still beyond the horizon of visibility and so we do think we're in a strong environment and we think the company performed pretty well in the back half of the year.

Even without the 650 million that the Oh, we were unable to meet in the most recent a fiscal quarter.

Got it so it's really helped to them and then just as a follow up thanks to the color on your view on the cuomo's deployment drooling computers in the food services side, how much of your revenue comes from China, and it feels view things go negative with the cuomo's apartment building.

Well you are for the you assumed makeup company what happens to the service revenue associated officially in the phone. Besides when you have existing two very good.

Mhm.

So thanks Krish, let me just try to walk through a little bit of the construct as we think about the business. We do in China. Today. There you know, we do both semiconductor business and display business some of the walk it bit of through a bit of a framework of how to think about it.

You get a sense of how much service business is done in China. So just bear with me as I walk you through this framework.

So we could do both display and semiconductor business as you know in China.

So if we take 2019, you had about 29% of our overall company revenue.

Done in China.

We've got a large display business.

One point.

Six almost 1.7 billion in fiscal year 2019, the vast vast majority of that business goes into China. So if you extract that from the overall China business that gives you a pretty good look at the size of the.

Semi systems and service business, that's done in China.

If I then disaggregate it and take the service segment out of that revenue pool, and you think about kind of the corporate average service to semi systems. It's kind of a 70 30 split give or take and so I think that gives you a sense when you when you.

To extract the display revenues you Gotta clean look too on the semi related business in China, and then you think about it as a 70 30 split gives you a sense, but you also have to keep in mind that that service business and systems business service both multinationals.

And the domestic industry.

And the rough order of magnitude of how the systems business splits up across those two dimensions think of it may be 65% domestic 35% multinational that gives you a rough framework of how to think about the de composition of the China business and hopefully that.

Helps give you a little insight into how to think about that business without being point specific because we don't disclose that level of detail.

Thanks, Chris.

Thank you. Our next question comes on the line of Harlan sur of JP Morgan. Your line is now open.

Good afternoon, Thanks for taking my question on.

On the foundry logic side, you know the leading foundries supplier has steadily moved down the path of Moore's law and the equipment industry certainly benefited from the aggressive technology migration cadence.

It looks like that you are large logic customers also getting back on track to executing to a two two and a half year cadence on node migration after about a three or four year paused and probably a lot of you. So that they do you have multiple large customers in foundry and logic movie at an aggressive cadence over the next few years, how are you guys thinking about them.

Mix of WP spin foundry logic versus memory over the next few years.

Yeah. Thanks, Harlan so as we take a look at what happened in.

2019, and then talk about what we see in 2020, but then I also want to project forward. So I'm, just kind of breaking it down a little bit.

We talked about a quarter ago.

Wi Fi being about 50 152 billion in 2019, we think we see the market pretty well.

Subsequent to our earnings call a quarter ago Veal ESI came out and sized 2019 at 51.5 billion. So right in the middle of how we were thinking about it. So we feel good about that view and it's a good number around 2019, we think about how you decompose that.

WFP number in 2019 by device type and it's roughly 60% foundry, 40% memory.

Balance across the two device types in memory that gives you a rough order of the structure of the market in 2019.

And while I think it's premature to date to size the market for a variety of reasons that we can go into premature to size. The market. In 2020, we think the rough order of split by device type looks and feels similar to what we saw in 2019, so again another year.

Of six foundry logic, 40% memory with balance between device types.

As we look forward.

We talk about the new playbook, we talk about the suite of innovation that this company is bringing to market the ability to integrate those technologies the ability to drive onboard sensors and metrology is to dial in process rappers recipes faster.

There's.

A clear and enable men's strategy by this company to drive our customers power performance area cost and time Roadmaps, We think we're incredibly well positioned to do that against the backdrop of rising capital intensity overtime with time being a real.

Certain elements of this we play we have the opportunity to play a really valuable role with our customers and driving that time to market dimension across that new playbook and that puts us in a really strong position competitively and we.

I think the dynamic of the position the innovation, where the market's going in terms of time to market as well as rising capital intensity, we feel good about where the spend profile in foundry logic is going over time, so while I can't be point specific going forward I think I give you some insight in terms of how we.

As a company our thinking about this trend off of where we sit today.

Yep extremely hopeful thanks for the insights there and then within your framework for the fiscal second how severe from a revenue perspective, how should we think about the trajectory of opex for the remainder of the fiscal year from the Q2 levels.

So if we go back a quarter, we said for the last three quarters of our fiscal year, we would.

<unk> planning assumption standpoint think about 820 million of Opex per quarter as you can see in the current environment clearly their savings from a travel standpoint, but the company also did a good job from a discretionary spend perspective, and R&D as a percent of Opex and the most recent quarter is almost 70.

Percent, 69.5% the companies doing a really good job controlling discretionary spend and we were able to do better than that original guidance around 820, I think given where we sit today in an environment that defined by a little bit higher operating expenses I think a good planning.

Sumption for US is is to keep the 820.

As the right way to think about it.

This is a company that will always be disciplined around what we do and how we do it.

Theres no sacred cows, and no entitlement to spend we will be very disciplined around discretionary spend and make sure that we channel that those resources to bridge fuel for future growth.

But 820 is the right assumption in the back part of our fiscal year, there's an opportunity to do better we certainly well.

Thanks Harlan.

Thank you. Our next question comes on the line of Pierre Fair I will initiate research. Your line is now open.

Hi, Thanks for taking my question.

It's very very refreshing to hear you.

Talking about the rest of the year with.

I would say agreed though.

Nice does it have opinions I mean, it's a it's nice to see that's the vendor chain itself.

It.

Seems to be when engaged.

I was just trying to think through.

It would be the downside risk.

Against you.

To occur in June so if you're thinking twentytwenty.

Nine we spent two nine team.

That's in the context of it or not that's incessantly being out there and to me is a big incident.

And demand in the general macroeconomic environment.

So I was wondering at world in which.

Things did not.

Recover in the second half and make sure the macro environment is very decision.

Sure no demand from opportunities for Oh.

Consumer electronics kit that.

Oh do you think it's going to affect investment plans, Oh sure clients and maybe another way to pretty teas.

The revenues you see between now and the end of your fiscal year.

How much do you think is driven by you know what exit technology train and it's going to have the I need to go through and how much predictor, yet just down the industry has to scale down significantly on the.

Manufacturing Williams thank you.

Okay, Pierre let me just try to.

There's a lot in there.

Let me try to hit these so.

First I want to just maybe address the framing of the question. When we said profile in 2020 similar to 2019 that was kind of per percent split a cross device types. I think it's too early to be point specific on the aggregate dollar amount of WFP.

Spend but what we want to do though is communicate in an attempt to be helpful. Communicate about what we seeing here from our customers and what we've seen here in our business and then extrapolate that towards a view on a market.

So what do we see an hour business, we see Q1 of our fiscal year, our semi related businesses, SSG and AG S up 18% year over here.

Q2, we saw strong demand.

We're actually supply chain limited despite that we were up 13% year over year in those two businesses. So the first half of our fiscal year, we're up about 16% year over year and our semi related business. We enter Q3 record backlog in those two businesses.

And based on what we're seeing and hearing for customers. We're planning for Q3 to be up sequentially.

And then we're expecting it to be up again in Q4, and our view for the fiscal year is strong double digit growth of our systems business.

Now as we think about Wi Fi in the back half the year the best framing that I can give you independent of what we see in here from our customers because we feel good about our business what we seen here I'm sorry, what we the best way to frame the back half of Wi Fi I think theres going to be too.

Factors that influence Wi Fi in the back half of the year.

There is what the customers do and then there is what the supply chain does as it gets healthier.

And we know and are aware of the.

Economic macroeconomic environment, we're aware of what's going on we see pluses and minuses.

Cloud data center PC calm infrastructure are still showing signs of strength.

It's offset by softness in things like auto industrial consumer travel leisure. So we do have that push and pull from a macro environment standpoint, and we see those pluses and minuses playing out in the market.

Too early for us to decide.

How that ultimately plays out then you have to overlay. The comments, we made on the supply chain. The combination of those two will influence the shape of Wi Fi in the back half of the year.

That said, we feel good about where we sit looking into our Q3 and our Q4.

Thanks, Dan.

Thing I'm not really of comes on it yet.

Operator, if you don't mind I just wanted to let you know that we have time for just one more question. Thank you.

No problem I last question comes on the line of Joe Moore with Morgan Stanley. Your line is now open.

Yes, Thank you I.

I Wonder just in terms of the way that you.

Characterize the coming quarter, you Didnt give guidance within you gave fairly specific segment guidance can you just talk about the message we should be taken away from that is that just the rigor in that segment guidance, but there is uncertainty around that and why not just guide with a wider range thats the case.

Yeah, Thanks, Joe I wouldn't read anything into it other than if we were to go back three months and think about our Q1 earnings call. What we knew at the time was we had a hot spot in China. The rest of the Globe was fine based on what we saw.

We de risked Star guide by 300 million and we talked about it being 150 million semi systems 100 million in display and 50, an AG S and against that backdrop, we executed really well in display and AG S., we fell short in semi systems.

And then you ask yourself why we fell short there was a concurrent shelter in place order issued for six weeks of our quarter that impacted the material part of the supply chain that was unknowable at the time, we guided a quarter ago and given the potential for other aspects of this.

Coded pandemic. This spring up an unexpected places we felt it was prudent to knock guide.

But share in an attempt to be helpful share what we're seeing in the business and we tried to strike the right balance between openness and transparency and trying to be helpful. Without putting a number out there that there's you know things that could potentially happen. We have no control of we can't execute.

At our way out of a complete shutdown of our supply chain and nursing it back to help that impacted six weeks of our quarter that wasn't unknowable event at the time, we guided so it's nothing more than trying to strike the right balance between that transparency and prudent in an environment.

Recognizing the elevated macro risk of where we sit today around the world.

Okay. That's helpful. Thank you and then in terms of the second half memory spending.

I guess when I talk to them that your memory customers. There is basically sounding like Q2 is is pretty solid still but most of them are our conveying a fair amount of uncertainty as to the back half and talking about memory companies not being a leading indicator and you know seem to be getting ready for a variety of scenario.

So as you think about that spending pattern.

It is enough of it technology spending that you feel like this is pretty solid kind of you know regardless of the the memory pricing environment or or some of it I guess, just whats any vulnerability to conditions worsening in the second half.

So what I would say to that is we shared with you what we're seeing and hearing from customers. Today I think we recognize that there's pluses and minuses that play in the market. We tried to be open about what we're seeing on both sides of that ledger.

And what I would say is we're just going to continue to be very vigilant at the business. We're gonna be ready to respond quickly as the situation evolves, we'll continue to be transparent and we will let you know what we see each quarter.

But a hard at this point to call it with a precision exactly how that unfolds and profiles in the back part of the year and so let's take it one quarter at a time and we'll share with you what we see along the way.

Great. Thank you so much.

Alright, Thanks, Joe I'm, Dan anything you like say before we close the call sure Mike.

I'd like to share best with it.

I'd like to share best wishes.

To everyone, who has been affected by the Covance situation I'd also like to sincerely. Thank our employees for adapting to a difficult environment and showing strong support for our customers they've done a truly strong job and we appreciate it.

Our company is privileged privilege to pay a big role and enabling the work from home and the learn from home and enabling those technologies that the world needs right now.

We're mindful of the macroeconomic risks, but our business is broader more resilient than it has in the past and we continue to see strength throughout the second half of our fiscal year, we will stay close to the investors throughout this situation, Gary and I were going to be at the Bernstein conference in a couple of weeks on.

Going to a 10 events hosted by Needham and Cowen and be a day. So we hope to see many of you soon stay safe be healthy like with close the call.

Okay, Thanks, Dan and we'd like to thank everybody for joining us today, a replay of our call is going to be available on the website by five PM Pacific time, and we would like to thank you for your continued interest in applied materials.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.

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Yes.

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Okay.

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Welcome to the applied materials harness alcohol.

During the presentation, all participants will be analysts and only low.

Afterwards, well be invited to participate and the question and answer session I.

I would now like turn the conference over to Michael Sullivan.

Life's President. Please go ahead Sir.

Good afternoon, and thank you for joining applied second quarter fiscal 2020 earnings call, which is being recorded.

Joining me are Gary Dickerson, our president and CEO and Dan during 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 it applies form 10-Q, an 8-K filings with the FCC.

Today's call also include non-GAAP financial measures reconciliations to GAAP measures are found in today's earnings press release and in our quarterly earnings presentation, which are available on the IR page of our web site at applied materials Dot com.

And now I'd like to turn the call over to Gary Dickerson.

Thanks, Mike.

At the start todays call by addressing the topic at the forefront everyone's mind, the cobot 19, pandemic, which has created unprecedented challenges around the world.

My thoughts and best wishes go out to all of you and especially those whose families have been directly affected by the illness.

The situation has evolved over the past several months are actually I was it applied materials have been guided by two key principles first maintaining the trust of our employees customers suppliers and partners and second focusing on driving initiatives that will allow us to emerge stronger over there.

Longer term.

He's running smoothly and their R&D programs on track.

Across the company I see amazing examples of our manufacturing logistics and field operations teams going above and beyond the keep our customers and the industry moving forward in a difficult set of circumstances were all sort of finding new ways of working with customers that not only provides solutions today I will.

Also creates significant benefits over the long term.

Finally in line with Applieds long held values to make a positive contribution to the communities, where we live in work we've created a global charitable Cobot fund. The purpose of this fund is to address immediate humanitarian needs and combat long term effects on local communities and the nonprofit sector.

Make a difference.

Now, let me turn to the agenda for todays call all began with a summary of our second quarter performance and near term outlook, then I'll provide a longer term perspective on our markets and all finished with a summary of our strategy highlighting some of our recent accomplishments later, Dan will give more color on our financial results.

Its operational performance and business environment, starting with our near term business outlook demand from our semiconductor customers remains strong.

Our supply chain remains a critical area of focus as we enter our third quarter with record orders and a record backlog for our semiconductor and service businesses combined.

In terms of the semiconductor industry environment I will focus my comments on what we currently see in the market and what we're hearing from customers.

And foundry logic demand at the leading edge remains very healthy with a strong commitment from these customers to build out their factories and pushed forward with their development Roadmaps.

However, we're seeing some pockets of weakness in specialty markets, mainly as a result of a pull back in the automotive and industrial sectors.

And memory there are no major changes to the outlook. We provided last quarter, we continue to see a positive progression in the market with inventory levels approaching normal and improvements in pricing trends.

As a result, we're seeing incremental strengthen investment by memory customers as we move through the year.

Based on the visibility that we have today underlying demand for semiconductor equipment is robust and even when kobin related effects are taking into account.

We still believe that our semiconductor business can deliver strong double digit growth for our fiscal year.

And just why we expect our appetite 20 revenues to be close to half why 19 as the industry navigates the bottom of this spending cycle. Our display business remained solidly profitable even as we invest in next generation products ready for when the market picks up.

Looking further out we're well aware of global economic concerns well I'm not going to speculate on possible macro scenarios I will share some of the key assumptions that we're using the guide our strategy, which are based on carefully monitoring market indicators and staying very close to our cost.

Summers.

Clearly consumer spending as a potential headwind from many sectors, including the electronics industry at the same time the global pandemic is acting as an accelerator for key technology inflections that were already underway.

Working from home learning from home and E. Commerce are driving investments in cloud data centers and communications infrastructure, we expect companies to build stronger business continuity plans, which will include geographic redundancy and increased use of automation and aiotv technologies and the adopt.

Option of AI and Big data remains Nondiscretionary for many companies as I've said before these game changing technologies will transform entire industries and there will be big winners and losers through the transition.

My personal view is that we will see significant and permanent changes and the way companies operate and prioritize their investments.

In fact, this is already happening in our business and the ways, we're working with customers over the past several years, we made significant investments and state of the art digital infrastructure sensors, and metrology data science machine learning and simulation.

The combination of these technologies enables us to reduce product development cycles speed up transfer of new technologies from lapped the fab and optimize cost output in yield for our customers and volume production.

By applying creative new strategies for remote operations.

While near term actions are being driven by necessity. The long term benefits of working that's why are compelling as they provide significant time to market and cost advantages for applied and our customers.

Our long term perspective about AI and big data shaping the next decade is unchanged and we see strong potential for certain elements of these inflections the scale faster than previously expected.

As I've said before to enable these new computing systems and unlock the potential of AI technologies major advances in the power performance and area cost or pp a C of semiconductor devices are needed.

Based on recent input from customers, we've updated our PB IC framework to Pp AC T, where t. stands for time to market acknowledging the enormous value of speed.

Applied has by far the largest broad portfolio of technologies and products to accelerate the pp HCT playbook, which spans creating shaping modify analyzing and connecting structures and devices, where are the only company with processing metrology under one roof and we.

Highly differentiated silicon and packaging lab capabilities.

As a result, we have a significant advantage in our ability to accelerate new pp HCT innovations for the semiconductor ecosystem.

The capabilities, we have built in a multi year investments. We have made are yielding results. According to Vlsiresearch has recently published report we outperformed the market in both semiconductor equipment and services last year.

Our performance in deposition technology was expansion really strong with our PBD business, gaining seven points of share.

We also have great momentum in metrology and inspection.

Our process diagnostics and control group delivered record revenue in the first half of the year.

One of the key contributors to this record performance is our new optical inspection system that we will be officially launching later this year.

Stronger over the long term.

Okay, well, we're mindful of potential macro economic headwinds based on what we see in here today semiconductor equipment demand remains robust and our supply chain is getting healthier third we remain fully committed to our strategy to accelerate the P.P.J.C.T. play.

And our pipeline of new innovative products and integrated processes has never been better now I will turn the call over to Dan.

Thanks, Gary.

Today, I'll summarize our second quarter results and activities give you an update on the environment and share our current expectations for the second half of our fiscal year.

As with an update on this earnings webcast and I'll do that in a moment.

Grams moving.

Despite the incremental challenges we experienced in the last six weeks of our quarter, we delivered EPS in display revenue that was higher than our original expectations in February.

Our semi systems revenue was below our original outlook and that was entirely due to coded related supply constraints.

End demand remains strong and while the environment remains fluid we exited the quarter with the second highest company backlog in our history and record backlog for semi systems plus HGS combined.

For the company as a whole in Q2 on a year over year basis. We grew revenue by 12% increase non-GAAP operating profit by 23% and grew non-GAAP EPS by 27% to 89 cents.

During the quarter, we returned $392 million to shareholders and buybacks and dividends and announced a dividend increase of nearly 5%.

We ended Q2 with nearly $7.4 billion on the balance sheet, including $1.5 billion in credit facility proceeds.

Now I'll share my assessment of the coven environment, which includes several encouraging developments our industry has been designated critical infrastructure in many parts of the world all of our suppliers has now been able to resume operations and they are recovering to normal output.

We've been very close communications with our customers and their demand indications remains strong.

We're mindful of the macro economic impacts of coded including job losses in the consumer and industrial sectors of the global economy.

But governments have provided strong financial support to workers businesses and the banking system.

As a result of our assessment of the environment, we fully repaid our revolving credit facility borrowings subsequent to the end of the quarter.

We currently have approximately $5.9 billion of cash and investments on the balance sheet, which is an increase of about $200 million compared to our Q1 balance.

We are continuing to prepare for the planned acquisition of Coca say electric during Q2, we receive Taiwan's clearance for the transaction and we have one final approval pending from China.

Turning to the business outlook, while I see positive signs there is still potential for coated related disruptions around the world and we're not providing revenue and earnings guidance for Q3, I know there is concern about the rest of further economic impacts and changes in customer investment patterns, but rather than speculate.

Now I'll attempt to help our investors by providing visibility into what we are seeing across our operating segments.

In semiconductor systems, our Q2 revenue would have been nearly $650 million higher absent coven related constraints.

We hope to recover this revenue in Q3 in Q4 as the supply chain improves in the second quarter, our semi systems orders were up significantly and demand is broadening the more customers.

Our services business has proven highly resilient during the crisis and we continue to generate a growing proportion of revenue from subscription like long term service agreements.

Yes posted its first billion dollar quarter ever in Q2, with nearly 60% of revenue coming from service agreements.

In Q3, we believe HGS revenue could be flat to slightly higher sequentially and higher again in Q4.