Q2 2022 Applied Materials Inc Earnings Call
Welcome to the applied materials earnings conference call. During the presentation, all participants will be in a listen only mode. Afterwards, you will be invited to participate in a question and answer session. I would now like to turn the conference over to Michael Sullivan Corporate Vice President. Please go ahead Sir.
Good afternoon, everyone and thank you for joining applied second quarter of fiscal 2022 earnings call. Joining me are Gary Dickerson, our president and CEO and Brice Hill, our Chief Financial Officer before.
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 <unk>. 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 applied materials Dot com before we begin I have a calendar announcement applied will host its next master class one week from today on Thursday May 26 at nine o'clock Pacific time, we'll introduce you to new IMS <unk>.
<unk> for chip wiring that solve the resistance challenges of scaling will detail how the industry can build backside power distribution networks that increase logic density by up to 30% at the same lithography.
We will introduce you to new developments in hybrid bonding and heterogeneous integration and will translate these inflections to our product roadmaps and growth targets, we hope youll join our technology experts for presentations and Q&A and now I'd like to turn the call over to Gary Dickerson.
Thank you, Mike the global semiconductor industry and applied materials continue to navigate an unprecedented set of challenges.
<unk> for semiconductors has never been stronger or broader while the industry's ability to fulfill this growing demand remains constrained by ongoing supply chain issues.
I would summarize applied second fiscal quarter of 2022 as a two part story during February and March we successfully resolved some key component bottlenecks only for this progress to be offset in April as Covid related shutdowns further disrupted already stretched supply.
These shutdowns are impacting a small number of our suppliers and ultimately delayed around $150 million of revenue in the quarter.
Today, our number one priority is to work quickly and creatively across the supply chain to bring more industry capacity online I would like to recognize the hard work and commitment of our global team and our suppliers, who are doing everything possible to meet our customers' needs.
In my prepared remarks, I'll cover three key topics first the supply situation and how we see this evolving over the coming months.
The near term demand environment and why we believe this remains strong and sustainable and third our long term view of the markets the industry's roadmap and applied materials' unique and differentiated capabilities that together create a rich landscape of opportunities for our company.
After that Brian will provide more color on our financial performance and share. Some of his initial impressions, Brian has been with us for eight weeks and we are delighted to have him on board. He brings deep and broad experience to our leadership team at this critical time for applied in the industry.
Let me begin with the supply side of the equation, which is our biggest area of focus in the near term. The supply situation continues to present multiple challenges that we are working hard to address our key issues are shortages of silicon components as well as certain other parts that go into the sub systems.
Of our tools, we are doing whatever it takes to deliver for our customers from sending applied resources to supplier sites qualifying alternative parts investing in our supply chain to working with customers and creative ways to accelerate shipments, including merging system modules out there.
Sites.
In addition, we're collaborating with customers using our technology enabled services to fast track the startup and qualification of equipment. Once it arrives at their Fabs for reference if you map out a typical timeline starting with the shipment of a tool from our factory and ending with the first production wafer out in the call.
Customers factory, the time to install and qualify tools for high volume production can take months, we are seeing strong customer pull for new ramp acceleration services to cut down that valuable time significantly.
Positive consequence of our current challenges is that our supplier engagements are becoming much stronger not only are we partnering with our suppliers to overcome near term constraints. We are also building more robust solutions to support industry growth over the coming years.
As we focus on the needs of our customers by addressing part scarcity expediting deliveries and adding labor in our factories in the field. We are incurring additional costs that are impacting applied near term financial performance.
As issues are resolved and we implement effective long term solutions transitory cost headwinds will abate, we're also taking actions to improve value capture including price adjustments.
Turning to the demand side of the equation our outlook remains positive the picture for 2022, it's clear we have the orders booked a full build plan and a large and growing backlog.
We believe unconstrained demand for wafer fab equipment would be $100 billion or more the key question is how quickly supply issues can be mitigated and how much the industry will actually be able to ship this year.
The primary focus for our customers is now securing supply for 2023, the visibility our customers are providing us both longer term and more detailed than in the past on this basis. We currently see 2023 remaining strong and being higher than 2022.
There are several additional factors that give us confidence in this assessment first and demand for silicon continues to grow driven by content growth in existing and new applications second fab utilization is very high even as newly installed capacity comes online.
Based on almost 10 years of analytics. This is the highest quarter for industry utilization on record and third customers are starting up new capacity faster than ever essentially all tools are being installed by our applied materials service team as soon as they arrive at customer Fabs, which we have not seen before.
As we think about demand sustainability, we also take into consideration the broad based composition of wafer fab equipment spending in 2022, we expect foundry logic to make up more than 60% of total Wi Fi investments.
This spending was split relatively evenly between the most advanced nodes and <unk> production for the Iot Communications automotive power electronics and sensors markets I kept demand has grown significantly over the past several years and we see sustainable investment by these customers.
Applications are consuming more and more silicon. One example is automotive where the global average silicon content is now $600 per unit almost twice as much as in 2015 and this will continue to grow with the adoption of electric vehicles. Another example is a <unk> phone.
That has 40% more RF content than a <unk> handset.
The need for extreme power efficiency and battery powered edge applications is enabled by innovation in materials and structures.
Driving an increase in layers and process steps over the longer term advanced packaging and heterogeneous integration also support sustainable demand for <unk> nodes as chip designers can use the optical node for power performance and cost for each chip late in our system.
<unk> customers are more focused on innovation than ever and we are meeting these needs with new application specific products. One example is an implant where over the past five years. We've introduced 10, new systems developed for specific high caps applications.
While navigating near term challenges remains our top priority today, we are not losing sight of the bigger picture and long term opportunities.
It's now consensus within the industry that there's a clear path to a trillion dollar semiconductor market before the end of the decade that would represent a high single digit compound annual growth rate from where we are today in other words it took the industry more than five decades to reach half a trillion.
Dollars of annual revenues and we will add another half trillion within the next six to eight years.
We feel even better about where applied materials sits within the ecosystem because technology complexity is increasing we expect equipment intensity will remain at today's level or increase further over that period as a result, Wi Fi will grow in line or faster than the overall semiconductor market.
Then within equipment spending major technology inflections are enabled by materials engineering shifting more dollars to our available market over time, we described the industry roadmap that will deliver future improvements and performance power and cost of semiconductor devices as the Pea pack T playbook, while <unk>.
Different companies have their own version of the <unk> playbook. The fundamental components of the roadmap are the same new architectures, new <unk> structures, new materials, new ways to shrink and advanced packaging.
Within each of these five pillars clear technology inflections are emerging that can be quantified in terms of impact value and timing.
At our recent Master class, we described the industry's transition from Finfet to gate, all around which is a new three D structure apply.
Applied has the broadest portfolio of solutions to enable next generation transistor technology with.
With the gate all around inflection that total available market for our transistor product portfolio grows by more than 15%.
Based on our tool of record positions, we expect to increase our share of that available market by more than five points and in terms of timing, we expect to start ramping shipments next year.
And our next master class at the end of the month, we'll talk about wiring and chip integration innovations.
Contact and interconnect or in both major focus areas for our customers as they develop new materials, and new <unk> structures, including backside power distribution networks between the seven nanometer and three nanometer node contact mobilization steps are growing more than 50% and our total.
The market is expanding almost 80% for interconnect layers process staffs are being added even faster and we expect our revenue opportunity to approximately tripled.
We will also provide an update on our momentum in advanced packaging at the Investor meeting a year ago. We said, we expected to double our packaging revenue between 2020 and 2024 today. We believe we're on track to hit our 2020 for packaging revenue goal one year early buy.
Winning more than 60% share of our served market.
Beyond equipment, we are delivering in capturing more value with advanced services.
I think both supply constraints and record fab utilization customers are seeing significant benefits from using our proprietary parts management and service agreements.
We see this reflected in our results as Ags delivered record revenue in the quarter up 15% year on year.
Before I hand, the call over to Bryce I'll quickly summarize semiconductors are the building blocks of the modern world, making them more strategically and economically important than ever.
Today, the entire industry is working hard to keep up with the world's rapidly growing consumption of silicon demand for applied products and services is strong sustainable and broad based we anticipate our ability to fulfill this demand will remain constrained by ongoing supply chain challenges in the near term with <unk>.
Incremental improvements beginning in our fourth quarter.
Our number one priority is to continue working collaboratively with customers and suppliers to bring more industry capacity online.
We're making progress in key areas, although it is not yet visible in our results longer term, we see incredibly exciting opportunities as secular trends create opportunities for applied to outgrow the semiconductor market by enabling the Pea pack T roadmap with our differentiated portfolio of materials engineering.
Solutions now I'll hand, the call over to Bryce.
Thanks, Gary.
First I want to thank the applied materials team for such a warm welcome across the company and manufacturing R&D the business unit's operations and functions people have shared their enthusiasm for the business and invested in helping me get quickly up to speed the company's dedication to its mission and its customers is tangible in every setting and I'm thrilled.
To be included.
I've been working in the industry for almost 30 years, now and being new to applied I'll share a few of my observation so far.
For most of my career semiconductor technology advanced almost like Clockwork and became the engine of global economic growth and productivity, we all knew the playbook.
Looking to the future the semiconductor roadmap is fundamental to rapid advances and competitive differentiation in all fields, including health care transportation and education.
Where we will leverage massive data collection and analysis and do so using less energy and resources.
But today many people are concerned that the growth in benefits, we envision our at risk because the traditional playbook has stalled making progress more difficult and uncertain.
Applied focuses on exactly this problem working closely with its customers to identify and invest in the materials innovations, we need to create a new playbook and a new roadmap and enable higher semiconductor performance lower power consumption and lower cost.
So it feels great to be a part of this team and this important mission.
Now I'll share three of my first impressions first the company is highly execution focused.
The team has used its in depth understanding of the global semiconductor ecosystem to battle almost daily challenges the chip the component availability.
Manufacturing teams have been flexible and relentlessly hard working to deliver for customers in a way that inspires my confidence that we will resolve these issues over time.
Like us to smooth out the heavy quarter and production schedules to make us less vulnerable to supply disruptions.
Second.
Slides roadmap extends well beyond the emerging technologies, we are talking about today and this gives me confidence in the industry's ability to continue to drive performance power and cost for many generations into the future when.
When I was on the customer side I didn't realize just how much capability there is.
Third.
The business is highly efficient in terms of capital intensity and operating spending.
It's a great model with an excellent return on invested capital I am excited to work with suppliers investors and analyst community and I hope to meet many of you in the near future.
On today's earnings call I'll provide more context on applied financial performance position and outlook and emphasize three key messages. One demand is very strong both in the short term and long term.
Two we.
We our supply chain constrained, but we are poised for growth as the situation improves.
And three.
We are confident in the future of the industry and increasing our capacity to support the growth, we and our customers see ahead.
Now I'll summarize Q2 results.
First we generated revenue of $6, two 5 billion, which is up 12% year over year. However.
Revenue was 2% below the midpoint of our guidance because of Covid Lockdown in a key region resulted in factory and shipping closures for a number of our suppliers.
The size of the impact for you if the Covid shutdowns had not occurred.
We would have exceeded the midpoint of our revenue guidance.
We met our non-GAAP gross margin target of 47%, which was down 70 basis points year over year as the higher input costs, we have been experiencing flowed through inventory.
And into our revenue shipments.
We increased non-GAAP operating profit dollars by 8% year over year to $1 $91 billion.
Benefiting from revenue growth.
Operating margin of 36% decreased 110 basis points year over year due to higher R&D and infrastructure spending.
We grew non-GAAP earnings per share by 13, 5% year over year to $1 85, which is <unk> <unk> below the midpoint of guidance due to the supply chain constraints.
Operating cash flow declined to $415 million in Q2, because shipments were back end weighted during the period and because we increased raw material and work in process inventory year to date operating cash flow as a percent of revenue was in line with our historical performance.
During the quarter, we returned over $2 billion to shareholders deploying $1 8 billion to repurchase 15 million shares of company stock and paying $211 million in dividends.
During the quarter, we announced a new $6 billion stock buyback authorization and increase the dividend by eight 3%, marking our fifth consecutive annual dividend increase.
Next I'll summarize our segment results.
We continued to generate strong orders in Q2 in both semi systems and Ags our backlog continues to grow and we have visibility from our customers extending into 2023 and beyond.
Our semi systems revenue grew 12% year over year, but it was about 3% below our expectation due to the COVID-19 related supplier shutdowns.
Semi systems non-GAAP operating margin declined 200 basis points year over year due to increases in manufacturing costs and R&D program spending.
And Ags our teams went to extraordinary lengths to keep customer factories running at high utilization, which is particularly difficult in the regions impacted by Covid Lockdowns.
We delivered record revenue and exceeded our segment revenue guidance growing 15% year over year.
We also increased our non-GAAP operating margin by 70 basis points year over year the.
The ability of Ags to deliver sequential growth in Q2 demonstrates the recurring nature of applied services business.
As a reminder, around 87% of Ags revenue comes from services parts and software and this strong services mix enabled ags to grow despite the supply chain disruptions affecting wafer fab equipment.
Our strategy is to grow the subscription portion of our services business, which gives us predictable revenue brings us closer to our customers and generates over three times the revenue per tool.
Sure some of the metrics, we use to gauge our progress in Q2, the applied materials installed base grew by 8% year over year.
And is over 40000 systems.
The systems under subscription agreement grew by 11% year over year to over 15000.
The average tenure of our agreements grew from two three years last quarter to two five years in Q2.
And the subscription renewal rate was 92%.
Next our display revenue was at the midpoint of our revenue guidance up 2% year over year, and we increased non-GAAP operating margin by 390 basis points year over year.
Recently, however, there has been weakness in consumer demand for products like smartphones Pcs and Tvs as a result display.
Display equipment demand has softened and we're making adjustments to our revenue outlook and curtailing our spending in line with the demand environment.
We will manage the business with the goal of maintaining healthy cash flow, even at lower levels of revenue and operating margin.
Next I'll address how we are preparing for our longer term growth opportunity today.
Today, we are working with our customers using much longer planning horizon, and receiving better long term visibility.
We are working closely with our supply chain partners to remove bottlenecks and increase capacity.
And we are adding incremental capacity at our R&D and manufacturing sites to increase longer term efficiency and output.
As a result of these efforts, we expect to achieve a more robust supply chain and manufacturing capability along.
Long with deeper strategic relationships with our customers and suppliers.
Now I'll turn to our guidance for Q3.
We expect revenue to be $6 25 billion with.
With a wider range of plus or minus $400 million.
We expect non-GAAP EPS to be around $1, 77, plus or minus 18.
Within this outlook, we expect semi systems revenue of $4 $48 billion, a number that is well below demand in.
And assumes the supply chain constraints will persist during the quarter.
We expect Ags revenue of $1 43 billion up 11% year over year and display revenue of $310 million.
We project non-GAAP gross margin of 46% non-GAAP opex of $1.06 billion.
And our non-GAAP tax rate of 12%.
Finally, I'll comment on our gross margin outlook beyond Q3.
We expect to gradually increase our gross margins beginning in Q4 through a number of actions that include.
Pricing adjustments manufacturing cost reductions logistics improvements and product reengineering.
Overtime as the supply chain recovers, we expect a number of transitory costs to abate and to ship higher volumes and a richer product mix.
We are fully committed to achieving our longer term gross margin targets.
In summary, our demand outlook is very strong in the short term and in the long term and we are investing to further strengthen our strategic customer relationships.
And drive profitable growth and shareholder returns.
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 and as a reminder to ask a question you will need to press star one on your telephone.
Good question first of all Keith.
First question comes from C J Muse with Evercore.
Christine.
Yes. Good afternoon. Thank you for taking the question.
I guess the question is given supply constraints and rising backlog how are your commitments with key subsystem suppliers evolving.
And given these commitments how are your contracts and engagements with your customers are evolving as well it sounds like.
Prepared remarks, you talked about smoothing out build and shipment plans and Im curious does this mean a vision to work from a longer lead time permanently.
Does this mean upfront payments from customers would love to hear your thoughts there. Thank you.
Great C. J. Thanks for the question question about supply constraints and commitments from suppliers and commitments to our customers starting with the supply side of the equation.
We have been working tirelessly with the entire supply chain to improve output to get towards the levels that we see.
Later in the year and through the horizon on the growing <unk> demand.
On the commitment side, we've definitely made lots of progress we look at.
We look at the situation as frustrated by the Lockdowns that we've described.
But most of these problems are being solved and we expect to gradually increase output as we get past this quarter, that's right in front of us if we think about our customers.
Talked about how orders are at the highest level they've ever been we've talked about how our backlog is increasing.
We're not intending to change the commitment in terms of deliveries to our customers. We're working instead to open the aperture on supply and begin working down the backlog as we start to get more of the critical components in and we've described how our Q4 as we think past Q3 and into Q4, we expect to.
Gradually increase revenue from that point on so no changes from the customer commits we'll work on.
Improving the performance as we get the supply chain open and we've made tons of progress with our suppliers.
I C. J this is Gary.
Yes, what I would add is that relative to the.
The customer visibility, it's better than ever a lot of our customers do have longer term contracts with their customers and so we're unfortunately booking all the way into 2024 at this point in time, but as Brian said, where we're definitely driving.
Our supply chain to improve delivery times for our customers that's priority one.
But I would say our visibility is significantly better and actually the conversations that we have with customers relative to visibility is further out.
Than we've ever seen.
Thank you very much.
Thanks Vijay.
Thank you. Our next question comes from Stacy <unk> with Bernstein Research you May proceed.
<unk>.
Hi, guys. Thanks for taking my questions I wanted to ask about the backlog and the orders. So you said the backlog is strong.
Is the backlog at record levels right now or has it been has it been stronger in any of the prior quarters in the past and I know.
You talked about obviously youre shipping some tools theyre missing modules.
Revenue would you have in that backlog that may be represented by tools that have already been shipped and actually we're just waiting for final modules.
In order to recognize that revenue I guess I'm trying to get some feeling for how much like where the backlog is and how much of it is actually like really baked at this point.
Okay.
Yes. Thank you for the question I think the first question.
We're not we've actually seen the backlog continuing to grow so that's been a dynamic that's been consistent for the last quarters and it's not something we're celebrating.
We're looking to open the aperture and begin supplying at a faster rate and work the backlog down but at this point, we still have.
More than two quarters of backlog looking forward as far as the missing modules go we won't specify exactly what the overhang from quarter to quarter is but <unk> got the right dynamic we are shipping a number of tools that.
Our missing one or two parts for the accountants and the investors we cannot recognize revenue until we complete those tools. So as we work through the quarter.
We work to complete all of the tools, we've shipped at customer there are some that.
Our incomplete we haven't recognized revenue for those those go into the next quarter as we get the critical components.
Not a significant overhang and I wouldn't look at it as necessarily a head start into the next quarter. When we think about our guidance to the next quarter.
We have carefully mapped out all of the supplies from our supply chain and how they will help us close the machines that we need to complete in the field and also the orders for the quarter and so when you think about that overhang, it's it's not overly significant but it does exist.
Thanks for the question.
Thank you.
Thank you. Our next question comes from Vivek Arya with Bank of America. You May proceed.
Thanks for taking my question I think you quantified $115 million.
Correct me in terms of demand and output for Q2 and semi systems I was hoping you could give us that data for.
Q3, and given that we're kind of past the halfway mark for your fiscal year.
How should we think about the floor for <unk>. This year is it something closer to $90 billion. Instead of 100 billion or is it a different number assuming the supply situation doesn't dramatically improve even in your Q4.
Yes, thanks for the question Vivek.
On the on the overhang for the quarter or on the under ship for the quarter of approximately $150 million. That's the right number we think if and that goes specifically toward the lockdowns in April that.
That hit us in the last month of the quarter. It affected we have a significant number of our builds in the last month of the quarter. So it definitely put a bump in the supply chain for us.
And we think we would have exceeded our guidance had that not happened when we think about Q3 again, we've mapped out.
All of the key components into Q3.
I want to communicate here is we are forecasting and relying on the factories are supplier factories to continue to reopen continued to be staffed and the shipping lanes to continue to open from that area of the world and we have intelligence, we have the ramp plans we have the.
<unk> plans. So our forecast is built on that so when you think about the delta for Q3.
I would say that we've done our best on the guidance side, our capability and our demand is much higher than our guidance for Q3. So what you see there is a forecast that's.
Metered, if you will by the speed the supply chain is going to pick back up and that's why we're also saying we expect in Q4.
Say for today that we expect incremental improvements and we'll see how this resolves for the quarter and then on the last piece on Wi Fi.
We're sort of running at the same rate you can look at our last few quarters, we've sort of been running at the same rate.
But last year was $87 billion wf fee, we're probably running today at today's speed in the low nineties from AWS fee perspective, So we would say that's the floor.
Because as you know we continue to get orders, we have a long backlog.
So at this point, it's just how much can we crank it up as the supply chain is open in the Q4 Q1 timeframe.
Thanks for the question yes.
Yes.
Thank you. Our next question comes from Mark <unk> with Jefferies. You May proceed.
Hi, Thanks for taking my question.
Excuse me.
Gary you said that.
I believe you said that you were building tighter relationships with your suppliers.
And Brian .
Used an expression that.
I was not familiar with opening up the aperture on supply.
I was wondering could you just spell that out what does that mean to open up the aperture on supply and how does that help.
You closed the gap between the demand you had and.
Your ability to supply and Gary when you talked about building tighter relationship with your suppliers miners.
My understanding is you get sub systems offset so then you have suppliers and their suppliers have suppliers.
And I'm wondering if you could just kind of spell that out like how how.
How does.
That manifest in.
Mechanically and helping to avoid the situation you're in right now in the future. Thank you.
Thanks, Mark as Brian So I'll just make a quick comment on the open the aperture concept there. So what I'm thinking is if you look at our inventory position, our inventory increased $500 million quarter over quarter, our capacity as high higher than where we're operating today in our backlog is very large so for.
My perspective, we're poised to grow quickly and what we need to do is get the supply chain on the key components operating we need to ramp the factories in.
Shanghai get the supply chain is opening keep going so the concept. There was just if you think about the aperture of nozzle or a hose or something like that just open it up faster. So that we can actually execute what we're prepared to execute and I think the best place you can see that is in our inventory position looking forward.
Yes, Mark on the supplier relationships, probably the biggest thing that we're.
We're doing differently now as the multi tier visibility in our supply chain so pre.
Previous to this situation, we never really had to focus on chips and components that are deep in our supply chain. So now we have that.
That visibility.
And just very strong and fast support from our biggest customers to close those gaps, but again those gaps frankly are still coming.
One of the one of those situations, we just encountered in this.
Lockdown covered locked down that happened on March March 28, we had wafers that were completed from one of our big customers and they were packaged in that region and again prior to this situation. We would have never known those wafers, we're going into that region, but I would say that what's encouraging to me.
<unk> is the the engagements we have with those suppliers.
Also extending our.
Planning horizons with those suppliers, we have tremendous focus within all of our different business units with tremendous engineering horsepower focused into the supply chain. So we've made actually some tremendous improvements in fundamental bottlenecks over the last few months, but you can't see it again.
Because of the Covid Lockdown that started for <unk> for.
For some of our suppliers on March 28.
And that went on for several weeks really with no <unk>.
People in those factories and even today some of those some of those suppliers have significantly less than 50% of the people back in the factory.
So this multi tier visibility is dramatically better.
Engineering horsepower, we have focused in.
And really the joint problem solving I'd say with our suppliers.
It's really been great theres been tremendous support.
Joint problem solving I just have tremendous appreciation.
For the focus and the work that all of our suppliers are doing and Mark we are making progress again as Bryan said the biggest uncertainty right now.
Isn't this COVID-19 lockdown, how quickly is that going to resolve it.
It was really the gating factor for us in terms of incremental improvement.
Very helpful. Thank you guys.
Sure.
Thank you. Our next question comes from Krish Shankar with Cowen You May proceed with your question yes.
Yes, hi, Thanks for taking my question and congrats Bryce on the new role.
I have a big picture question for Gary Gary clearly demand has been strong and as you've been supply constrained for a long time. It seems like there has been the team from semi and semi cap companies for the last nine months or so now lets just assume for argument sake demand actually slows down in calendar 'twenty three so from your.
<unk> got <unk>, where would you see that impact <unk> would it be mature nodes would it be China or would it be memory WP or something else.
Thank you.
Chris Thanks for the comments, it's Brian So I'll take a shot at this first and see if Gary wants to add anything.
The first thing I want to say in case in case someone joined and didn't hear that here the situation early.
The situation that we see today is that we're getting more and more orders each quarter. Our backlog is increasing our customers are calling us telling us to speed up and our customers' customers are calling us and telling us to speed up.
And when we look at utilization we've talked about this.
In previous calls and Gary mentioned it in his overview when we look at utilization, we track utilization of equipment across the entire industry.
In all applications in memory, and foundry and I caps et cetera, we see utilization at record levels.
Finding my way back to your question, you ask where would we see any change if the environment turns.
We think the first place we would see that as you wouldn't get new orders. So the fact that we're getting such a high degree of new orders says that not only arent customers trying to reschedule their orders are thinking about a different schedule on their own they are actually adding to it the second place we would see it is theirs.
There's been discussion of some of the.
Consumer demand companies may be having less.
Demand, but the second place you would see it is actually wafer starts and we're not seeing it there either so we're not getting any of those signals, but to answer directly we would see it in.
In the new orders slowing down I think that would be the first place we see it we're not seeing that today.
Yes, Chris This is Gerry what I would add is that I have numerous conversations with a number of different Ceos.
<unk>.
Really the focus of those conversations is on.
Supply and in many cases, they do have long term agreements multiyear agreements with their customers and the first priority is tools that they need to qualify for that incremental capacity with all of those customers but.
The thing I would say that's different from what I've seen in the past.
Meeting some of our customers' customers and they are describing.
Really what they need relative to chip content and innovation.
And then leading edge certainly again a lot of the conversations are also in the high cap space, where those customers have multi year contracts and visibility again with with those customers. So I think thats, probably the biggest thing I've never seen that in my entire career.
Industry.
Thanks, guys, Thanks, Brian really.
Really appreciate it.
Thank you. Our next question comes from Toshi Hari.
Goldman Sachs you May proceed.
Hi, good afternoon. Thank you so much for taking the question I wanted to ask about pricing both the timing of some of the adjustments that you guys talked about and also the scope of some of the adjustments on the timing dynamic.
So I guess youre guiding fiscal Q3 gross margin to 46% any pricing adjustment or the impact from pricing embedded in that number and if not should we expect some of the tailwind to show up in fiscal Q4 and into fiscal 'twenty three.
And then on the scope of some of the pricing adjustments, maybe one for Gary.
These discussions with your customers should we expect positive pricing in your leadership products, primarily and not so much in the areas, where you have more competition or our customers are receptive to price with pricing adjustments in areas like etch and say process control. Thank you.
Thanks, Thanks, Toshi I'll start with that so on the pricing.
First I would like to communicate that.
We're doing everything we can to offset the cost side of the equation. So we've got more than a couple of points of headwind over the last few quarters.
And being off our model and those things go into things that we've described as we've gone along its the.
Labor and overtime Thats higher expense, it's the materials inputs.
The freight and expedite that we're having to pay in because we can't get all the tools out right now there's a little bit of a mix impact when we think forward in our 46% gross margin guide. It does include some pricing improvements in Q3 and those will grow over time is as they get more tracks.
And we work those across along with the cost reduction.
Efforts, we have for the company so.
As we think about Q4, we're focused on improving logistics, improving the supply chain, making cost reductions as some of our key projects.
In terms of reengineering and finding more commodity solutions for some of our products. So those are all things that we'll do to bend back the cost side of the equation and help us and help our customers and then on the pricing side Youll see that increase over the coming quarters gradually helping each of Q3.
<unk> Q4, and then Q1.
And then on the scope I think the scope is very broad and I'll, let Gary comment on that.
Yes toshi.
What customers are really focused on.
With applied.
Really the first focus is accelerating capacity and really closing the gap.
Between supply and demand.
So as Bryce mentioned, there's a number of different headwinds there customers all understand that they want us, making those investments and everything that we can do to help them accelerate chip output.
As a major focus and then the other thing I would say that.
And by the way the May 26.
Master class I would really encourage many of you to come and see that the wiring.
Innovations are really one of the biggest bottlenecks in the entire industry and applied.
He has many differentiated unique technologies.
To solve maybe what's the biggest.
Bottleneck in the entire industry for power and performance, but obviously technology innovation and value pricing Toshi is also.
The key for our customers in terms of driving innovation and creating value. So anyway. Those are the things that our customers are focused on.
As bright bright said.
Not really.
Limited in terms of scope.
Thanks, Gary.
Thank you. Our next question comes from Harlan sur with Jpmorgan you May proceed.
Good afternoon, Thanks for taking my question.
Given all of the supply chain disruptions.
Component shortages that you and your peers are going through.
How is this impacting the overall semiconductor industry in other words <unk>.
And logic, all had plans to expand capacity to a certain level.
To close the industry supply demand gap, but how much slower will capacity grow with all of the equipment shipment delays this year.
And next year relative to your customers' targets and getting memory rate for DRAM do you think that your customers are going to be able to expand the supply by targeted 15% to 17% or NAND output by 28% to 30% it seems as if.
All of this is just going to result in a longer time to close the semi industry supply demand gap I don't know you guys have a good sense and a large team that monitors industry capacity expansion. So wanted to get your views.
Yes. Thanks, Harlan this is Bryan I'll start on that one so so we do think we.
We do think Youre right from the perspective of.
The growth has been metered this year for sure and so I think we talked about one of the earlier questions kind of the level, we're running from a Wi Fi versus what the natural level will be if we can open things up in speed up in.
In Q4 and Q1 so.
I think the way we would think about it is we're a few quarters behind what rod demand is and thats, probably whats happening across the industry.
When we think about the sustainability of the demand. We study all the end markets. As you have described all of the different <unk> markets the edge devices, leading edge logic.
<unk> et cetera, including the memory components, and we see no change we see a consistent growth across the horizon from a demand perspective. So this just looks like.
The supply chain situation is going to meet or at the beginning of the cycle.
And it gives us confidence as we think forward over.
Gary mentioned that we're starting to look at demand into 'twenty four.
We have high confidence that as we ramp up that demand will continue.
Through 2003, and even into 'twenty four as the industry works to work on its backlog and working on catching up to the real demand thats underneath.
Helpful. Thank you very much.
Thank you. Our next question comes from Joseph <unk> with <unk>.
Wells Fargo you May proceed.
Yes. Thanks for taking the question I think this is the fourth straight quarter, you've had hired over 1000 people.
Added to your head count and I assume a lot of these are manufacturing on site.
Semi systems revenue, obviously hasn't really changed over that time period. So.
I guess.
Think about the margin structure, how do we think about the cost absorption or the magnitude of that cost absorption.
Relative to maybe the price adjustments that youre, putting through as we think about the improvement in margin over the next several quarters.
Yes, thanks for the question.
I think first of all on the hiring youre right that theres, a significant amount of manufacturing hiring as the flow and manufacturing isn't perfect. At this point is we have to react to.
Sort of less predictable inventory in supply and we have burst of manufacturing.
To meet the customer needs.
We also highlighted earlier in the call that.
We're actually working a number of reengineering projects to improve both the cost profile and the use of alternative parts for some of our products and we have to do the Reengineered engineering in the qualifying of those products. So that takes personnel were also actually helping.
Some of the suppliers.
With improved their supply situation that takes personnel and then excuse me then of course, we're continuing our growth trajectory.
At the Wi Fi going forward, we have lots of projects underway from an innovation perspective to continue the roadmap. So we're continuing on that path and it's a fair question, whether we should in the current environment, but we are definitely looking at the environment as supply constrained, we're going to solve those problems and.
Get back to the growth that we've been forecasting and we're ready to do that with both inventory and manufacturing capabilities.
And on the last point from a gross margin perspective. It is one of the headwinds in the gross margin I listed for headwinds just say them again, it's freight and expedite its labor and overhead and material cost and mix. So as one of those components. We look at those as are approximately equal in.
Strengths, if you want to think about how that looks against our our gross margin.
Thanks for the question.
Very helpful. Thank you.
Thank you. Our next question comes from Timothy Arcuri with UBS you May proceed.
Thanks, a lot.
I was wondering if you can help us shape revenue through the rest of the year.
You had kind of equal to $6 35 billion and you said that this is three or so months ago I know that you werent.
You weren't there then.
Company had said that revenue would grow kind of mid singles off of that level throughout the rest of the calendar year. So off that baseline that sort of implied 665 for July and about $7 billion for October . So we're coming in about $400 million light of that for July . So the question is can I push that $400 million into October so that October .
<unk> is sort of maybe in the low to mid Sevens I guess I'm, just asking you to help us sort of like reshaped the year, just given that you had shaped it three months ago. Thanks.
Thanks for the question Tim.
When we think about.
Let's start with the guide for this quarter when we think about the guide for this quarter at $6. Two five what we did was we carefully have worked through the supply chain to find out.
How quickly will the factories, our suppliers' factories re staff.
How quickly will the supply lanes open when are the exact delivery dates that we will get through the quarter. When we get them early enough to make the quarter et cetera.
So and we've got a slightly wider range youll see to recognize that.
We're we're forecasting based on our continued and accelerating reopening schedule that.
As our best intelligence today, So we've got some risk there when we think forward to the next quarter, we're going to enter the next quarter with also no inventory on those critical components, because we will have used all of that inventory.
To satisfy our Q3 demand. So when we think about Q4, we're saying it is gradually or incrementally larger than Q3, So I think.
Thinking of the previous discussion we.
Don't know yet what Q4 will look like which is one of the reasons, we won't guide it it will be metered, depending on how quickly the supply chain opens up in Q3.
We have the manufacturing capability in Q4 to go much faster we have the inventory on the non constrained components to go much faster. So there's there's a wide range of possibilities for Q4, and we just need to continue progress on the key components and locked down factories in Q3, if that makes sense.
The last thing I will say, though that there is not any perishable demand for us as you think about one of your questions would you push that forward I, absolutely think youll push it forward nothing will perish.
In this in this situation, it's just going to be metered in Q4 by where we are with the supply chain.
Thanks for the question.
Right. Thank you.
Thank you. Our next question comes from Joe Moore with Morgan Stanley You May proceed.
Great. Thank you.
Talk a little bit about weakness in display in this coming quarter quite the smartphone can you just talk about it looks like youre going to attract to down double digits. This year, what what is going to return that business to growth is it a smartphone.
Anything from kind of an application or a technology perspective.
That will lead that business to go out on the road.
Thanks, Joe This is Brian So I'll start maybe Gary I'll make a comment about the long term. There. So this is the one place in the business, where we have seen.
Some impact from the change in consumer demand at this point, so definitely weakness and the outlook for display for the next few quarters sort of corresponding to what's been characterized as weakness in smartphone and PC and TV et cetera, and so what we're doing is.
Re sizing the business from a spending perspective to make sure that we can deliver the amount of cash returns that we've been delivering for the past few years and still leave us ready to grow as the demand picks back up in some of the new applications pick back up so youll see us.
Youll see us make those adjustments as we go forward in the next few quarters will be a lower revenue number but it'll still be a good return on investment. The last thing I'll say there is most of our investment has largely been made in that business. So we're able to deliver to customers and execute against investments that <unk>.
It made so it's a good cash flow business, good cash returns and Thats sort of our perspective and it does leave us ready for four new demand on some of the new applications, Gary If you want to comment.
Yes.
Joe Thanks for the question. So as you mentioned this year double digit well will probably be down roughly 10%.
Versus where we've been.
And we'll be down about 10% this year and as Brian said.
Really have resized, our spending we've made a lot of investments I think as you know we have very very high share in the parts of the market that we participate in.
We are.
<unk> as we've discussed in our Investor meeting to returning free cash flow from this business and so we'll be able.
We're able to deliver similar free cash flow, even at a lower level I would say right now.
If we looked out into 'twenty three.
Yes, we don't really see strengthening.
Today in terms of where that market is going.
We will be able to continue to deliver similar levels of free cash flow with a re sizing.
That's in progress and that business really is leveraging semiconductor deposition technology into larger panels, one thing Thats also.
Another synergy for us if you look at the advanced packaging roadmap going to larger substrate sizes. There is technology in display that will strengthen our already strong position in packaging in the longer term. So there are synergies there its a good free cash flow of business.
Longer term.
Some of the OLED technology barriers once those are solved we could see a step up back in that market, but we really don't see that over the next several quarters.
Great. Thank you.
Thank you. Our next question comes from Sidney Ho with Deutsche Bank You May proceed.
Great. Thanks for taking my question. My question is on the services business.
Yes revenue.
Q2 came in better than you expected and I appreciate all of the metrics you disclosed in your prepared remarks, but considering last quarter you talked about supply constraints impacting the 200 millimeter product line can you talk about what drove the upside and the follow up to that.
<unk>.
Previously suggested low double digit growth for <unk> in fiscal 'twenty two.
<unk> changed there can you touch on the risk that Covid Lockdowns may have an AGM. Thanks, yes.
Operator.
Our last question that we'll have time for just so you know thanks Bryce.
Okay. Thanks for the question Yeah on the services business.
Thanks for the question I think it is important to recognize that the business did grow quarter over quarter, 5% and it did grow 15% year over year.
And our investors probably know it's been a key part of our strategy to shift.
More and more of our services business to the subscription format, because thats better for our customers and it lets US plan better also in provides them more technology advice and capability.
So.
When we think about.
The indicators that we give for that business that portfolio is getting stronger and stronger and when we see the supply constraints for the rest of the business, it's not surprising to us that that recurring revenue. The way that business is set up is low beta or a little bit more resistant to change.
As in the rest of the business.
What drove the upside was really the high utilization across the ecosystem. There is still a transactional element to that business and when we talk about utilization across 200 millimeter or 300 millimeter all of the different product types. There. Its just 92 to $93, 94% record levels, we talked about in that dry.
<unk>.
Spares and parts and service components across the entire ecosystem, So that's where really where you see the strength in the quarter, we would've been even higher had we had more supply but.
We're working on that.
And the last piece on Covid Lockdown, I guess that was related to supply so.
We do think that business could have been stronger in Q2.
And we would have served more parts on the parts side of the business but.
That's the first priority for us and we're working on improving that as we look forward. Thanks for the question yes.
Sidney This is Gary just.
Another 0.1 of the things, that's driving our growth and subscription.
Revenue subscription services, our customers are really focused on an increased output. So we have part management services and I can tell you that many of those customers that have those services are very happy they don't have shortages and their increasing chip output.
We have managed services to increase yield and optimize productivity for good chip output. That's another one we see tremendous pull.
From our customers and by the way this is driving increased head count as we're supporting.
Some of these service opportunities and then the other thing is ramped services ramp acceleration services time to ramp as I said in my prepared remarks is months for many of our customers. So every week that we can accelerate the time for those tools to dry.
Ive chip output everybody is focused on that so there are a number of these services.
That are increasing our subscription percentage, increasing our subscription revenue.
Again, that's really on the theme of everybody's focused on good chips out as fast as they can.
Great Thanks, Gary and thanks Sidney.
So I'd like to give us your closing thoughts for today's call absolutely. Thanks, Mike. Thanks, everybody for joining important messages today demand very strong sustainable we're committed to improving our gross margins and committed to our long term model.
Working hard to improve our supply situation every day and I just want to say I'm eager to meet some of our investors I'll be at the Bofa conference in San Francisco and looking forward to that and Gary will be at the Bernstein Conference in New York in two weeks, thanks, everybody for joining.
Okay. Thank you Bryce and we'd like to thank everybody for joining us today, a replay of the call is going to be available on our website by five PM Pacific time today, and we'd like to thank you for your continued interest in applied materials.
Thank you. This concludes today's conference call. Thank you for participating you may now disconnect.
Yeah.
Okay.
Sure.
Sure.
Okay.
Okay.
[music].
Okay.
[music].
[music].
[music].