Q3 2022 Applied Materials Inc Earnings Call

August 18, 2022

Okay.

Welcome to the applied materials earnings conference call. During the presentation, all participants will be in a listen only mode. Afterwards, you'll be invited to participate in a question and answer session.

Okay.

Michael Sullivan corporate Vice President. Please go ahead Sir.

Good afternoon, everyone and thank you for joining applied third quarter of fiscal 2022 earnings call. Joining me are Gary Dickerson, our president and CEO and Brice Hill, our Chief Financial Officer before we begin I'd like to remind you that today's call contains forward looking statements, which are subject to risks and uncertainties that could cause our actual results to differ information concerning.

The risks and uncertainties is contained and apply its 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 apply.

<unk> plans to host our services Master class five weeks from today on Thursday may 26th at nine O'clock Pacific time, we will describe the market opportunity for our services business explain why 87% of Ags revenue is truly recurring and give you the growth formula for the business through our 2024 financial model Horizon <unk>.

We hope you'll join team members of our global services team for presentation, and Q&A and now I'd like to turn the call over to Gary Dickerson.

Thank you, Mike and our third fiscal quarter applied materials delivered results at the high end of our guidance range and record quarterly revenues.

<unk>, we've been taking to mitigate supply chain challenges are beginning to have an impact and we expect steady incremental improvements from here.

Resolving supply issues has required new levels of collaboration between our global teams suppliers and customers.

While all of this hard work is yielding results global supply chains remain stretched demand for applied products is still higher than our ability to fulfill it and our backlog continues to grow.

In addition, our relentless focus on meeting customers' needs in this very difficult environment has created margin headwinds that were working hard to overcome we're driving actions to reduce costs and improve value capture including price adjustments.

In my prepared remarks today I'll cover three key topics first our near term outlook on supply and demand dynamics second our longer term view of the markets and the industry's roadmap and third applied materials' strategy priorities and progress after that Brian will provide.

<unk> more color on our financial performance and key areas of operational focus.

Let me begin with our near term perspective on the market due to large gaps between demand and supply as well as equipment companies shipping partially finished systems and emerging components in the field overall 2020 to wafer fab equipment spending is difficult to quantify with precision.

Our best estimate is that we'll land somewhere in the mid $90 billion range.

For applied the picture is clear if.

If we use the midpoint of our fourth quarter guidance, we expect our wafer fab equipment revenues to be up approximately 15% for our fiscal year.

As we look ahead to 2023, there are three major factors shaping our view of the market first memory spending is expected to be lower than in 2022, as macro uncertainty and weakness in consumer electronics and Pcs causes these customers to defer.

Some capacity additions.

Leading edge foundry logic look strong with customers battling for leadership and racing to be first to implement major technology inflections third <unk> customers, who serve Iot communication auto power and sensor markets are reporting areas of strength in <unk>.

Weakness these customers serve broad and diverse applications. They are seeing softness in consumer centric markets, which are being impacted by macro economic factors auto and industrial demand continues to be solid because those investments are driven by large inflections such as electric.

It goes in industrial automation in these areas chipmakers are securing long term capacity agreements that underpin their capital spending plans.

While it's too early to provide a forecast for 2023, we believe our business will be more resilient than in the past. If there is a demand pullback in certain areas of the market.

We expect applied to remain supply constrained for the next several quarters, we're working through our very substantial backlog of orders, which provides a buffer to in year demand fluctuations and in addition customers are providing us with longer term visibility and commitments.

In response to their own customers actions to lock in the strategic capacity they need.

We're confident in our ability to perform well in a range of market scenarios. We're mindful of the current macroeconomic trends as a result, we are slowing down hiring while ensuring we fully fund the R&D programs and strategic operational capabilities that support.

Our long term growth regionalization of supply chain is also something new for the industry. We expect this will provide a small positive tailwind for overall wafer fab equipment spending starting in late 2023.

Also because of the time bound nature of government incentives in the U S Europe and Asia, we see a higher degree of certainty for these investments.

Last week I was in Washington D. C for the signing of the chips Act and met with government officials and leaders from across the semiconductor and automotive ecosystems.

I'm happy to see the critical role that semiconductors play in the economy being recognized and acted upon.

The need to build more resilient and flexible supply chains remains a key theme for these leaders and the chips Act will enable many companies to accelerate their investments in strategic capacity.

I'm also excited about the potential to create a new high velocity innovation platform in the United States to accelerate the development and commercialization of next generation technologies.

As I look further to the future I feel very positive about the direction of the industry and our long term opportunities at applied consensus within the industry is that semiconductor revenues can reach a trillion dollars before the end of the decade that translates to a high single digit compound annual growth.

Both rate from today.

In parallel the technology roadmap is becoming increasingly complex as a result, we expect equipment intensity the ratio of wafer fab equipment investment to semi revenues to remain at today's level or increase over this period.

Then the major technology roadmap inflections, including gate, all around transistors backside power distribution networks, new materials for interconnect and contact and heterogeneous integration of chips and chip loads are enabled by materials engineering, where applied materials is the leader in this shift.

It's more dollars to our available market over time with.

We've invested ahead of these inflections to create a portfolio of differentiated solutions that positions us to outperform as these new technologies transition to volume manufacturing.

Applied materials strategy is built upon the breadth and strength of our technology and capabilities.

This provides us with a unique ability to engineer co optimize and integrate solutions that address our customers' highest value technology challenges.

So optimized solutions, where we optimize adjacent process steps and integrated material solutions or IMS, where we optimize a combination of process steps in a single system under vacuum are becoming an increasingly important part of our product portfolio.

And our recent Master class, we talked about our breakthrough IMS approach for tungsten only contacts better free of conventional barrier materials. This provides significant improvements in contact resistance and is critically enabling for smaller foundry logic nodes. The number of process steps are.

Rowing as these customers migrate to this pure metal technology and these low resistance integrated solutions for contact and wiring represent new multibillion dollar revenue opportunities.

Over the past two quarters, we have secured multiple tool of record positions at all leading customers.

Our ability to co optimize materials engineering solutions with novel inspection and metrology is also driving record performance in our process diagnostics and control business, we expect PTC revenues to be up almost 40% in fiscal 2022 with broad based customer.

Option of our E beam metrology and new optical wafer inspection platforms in the quarter. We also strengthened our <unk> portfolio with a tuck in acquisition.

<unk> is a leader in batch AMD technology, and we are delighted to welcome their talented team to the applied materials family.

Turning to service Ags delivered record quarterly revenues, despite headwinds for our transactional spares and 200 millimeter equipment businesses due to supply chain constraints.

Subscription portion of HTS continues to demonstrate strength installed base tools under long term service agreements grew 9% over the past 12 months, our renewal rate for these agreements continues to be strong and is currently running at 93%.

Before I hand, the call over to Bryce I'll quickly summarize.

We're beginning to see gradual improvements in our supply chain, which enabled us to deliver record revenue for the quarter.

We expect demand to remain higher than supply for the next several quarters and we're continuing to drive actions to close the gap.

The changing macroeconomic environment is causing some customers to adjust the timing of their investments. However, we're confident that our business will be more resilient. Thanks to strong pull for our uniquely enabling technology, our large backlog longer term visibility from our.

Customers and industry wide investment in strategic regional capacity.

Our long term view of the market remains unchanged as multiple parallel secular trends drive the semiconductor and wafer fab equipment markets structurally higher.

At the same time large technology inflections that are enabled by our core capabilities in materials engineering create outsized growth opportunities for applied materials.

Now I'll hand, the call over to Bryce.

Gary I would like to begin by saying, Thank you to our teams and our supply chain partners for helping to increase our output despite ongoing constraints and unexpected shortages, our factory and logistics teams operated with agility adjusting to almost daily changes in supply schedules.

We are still not meeting all of our customers demand and solving the supply chain shortages to increase our manufacturing output remains our top priority.

Before I summarize our Q3 results I'd like to emphasize four points first our overall demand remains healthy specifically our orders remained strong in Q3, our backlog increased overall factory utilization remains high and customers have added four new factory projects to the long term roadmap.

There are pockets of weakness in the semiconductor market and a number of affected customers have asked us to reschedule their capacity additions at the same time, there are areas of strength and we have broad market exposure and strong customer pull for technology investments.

Second our.

Our supply chain improved incrementally in the quarter as Gary mentioned, we have added significant investments in talent to our supply chain teams to resolve bottlenecks and to improve our inventory and overall output.

Third.

We remain committed to our long term gross margin targets.

Today, we are still experiencing the effects of higher costs and unfavorable mix, which are being partially offset by pricing adjustments, we expect to incrementally improve gross margins over the coming quarters.

Driven by forecasted improvements in manufacturing volumes product mix pricing and logistics costs.

And fourth.

We are confident in the industry's underlying growth trajectory and our unique materials engineering capabilities for process innovation.

While we are slowing our head count growth, we have increased our R&D spending by around 10% year to date.

And remain fully invested in enabling our customers' roadmaps.

Turning to our Q3 results, we delivered record revenue of $6 $5 $2 billion, which is in the high end of our guidance range.

non-GAAP gross margin of 46, 2% declined 80 basis points quarter on quarter non-GAAP operating spending was $1.06 billion.

Which is right on target and up $39 million quarter on quarter, as we increased R&D and added supply chain resources.

non-GAAP operating margin declined 60 basis points to 30%.

Driven by the lower gross margin and head count additions primarily in engineering.

non-GAAP earnings of $1.94 grew nine <unk> quarter on quarter and matched our previous record.

Turning to the segments. The semi systems team did a great job maximizing shipments growing revenue by $276 million up 6% quarter on quarter.

Segment non-GAAP operating margin declined 100 basis points sequentially to 36, 1% due to higher materials freight expedite and labor costs, partially offset by price adjustments.

The Ags team delivered record quarterly revenue.

Growing $37 million or 3% quarter on quarter, we continued to deliver healthy year over year growth in subscription revenue.

The supply chain shortages constrained our growth in transactional parts and 200 millimeter systems.

Ags non-GAAP operating margin was 36% and slightly up quarter over quarter.

I'll take a minute to share a few observations about ags.

Next month, we'll host of services Master class, where you'll have an opportunity to learn more about our strategy to increase our recurring revenue.

The three key drivers are the growth of our installed base.

Equipment service intensity and long term service agreements.

<unk> is making excellent progress toward our 2024 financial model.

We exited Q3 tracking around $500 million ahead of the base case of our Ags revenue plan and around $250 million ahead of our high case.

In addition, the services business is capital light.

And produces excellent cash flow.

Moving on to display now.

The market is weaker due to its high exposure to consumer portion of the economy.

During the quarter, we lowered spending in line with the current market environment.

Our display revenue declined by $48 million or 13% to $333 million.

The business contributed $70 million of non-GAAP operating profit.

This is down sequentially by $12 million or 15%.

Turning to our cash flows we generated 1.4 dollars 7 billion of operating cash flow during the quarter, which was 23% of revenue.

We returned $1 $2 3 billion or 97% of free cash flow to our shareholders deploying $1 billion to repurchased nine 8 million shares of company stock and paying $225 million in dividends.

We also deployed around $440 million for two strategic acquisitions.

We expanded our <unk> portfolio with the addition of <unk>.

And we acquired a talented simulation software team.

Year to date, we have produced over $4 5 billion in operating cash flow and nearly $4 billion in free cash flow.

And returned $5 to $5 billion to our shareholders.

Now I'll share our guidance for Q4.

We expect revenue to increase to 665 billion plus or minus $400 million.

We expect non-GAAP EPS to be $2, plus or minus 18.

Within this outlook, we expect semi systems revenue to increase to $4 93 billion or up 14% year over year.

We expect to Ags revenue to increase to $1 $43 billion.

Or up 4% year over year.

With continued healthy growth in services and ongoing supply chain limitations in 200 millimeter systems and transactional parts.

Display revenue should decline to around $250 million.

We expect to incrementally increase our non-GAAP gross margin to 46, 4%.

And we expect non-GAAP operating expenses to increase slightly to 1.08 billion.

We are modeling a tax rate of 11, 8%.

Before we begin the Q&A.

I'd like to summarize our company's position in the current environment.

We continue to see very strong customer pull for advanced technology, and all of our markets and our backlog continues to grow.

We believe some of our customers will moderate their capacity additions in areas that have been impacted by weak consumer spending.

However, I expect the <unk> business to be more resilient than in past periods for three reasons one.

Is that we have strong exposure to technology investments, particularly in the foundry logic market, which has grown to become approximately two thirds of wafer fab equipment spending.

Second is that we have multiple quarters of backlog for products that are essential to our customers' technology Roadmaps and we expect to continue to increase supply over the next several quarters.

Third.

Is that our services business has grown to over $5 5 billion in size and generates 87% of revenue from recurring demand for parts services and software.

And now Mike Please begin the Q&A.

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

Thank you again, ladies and gentlemen, I'd like to ask a question. Please press star one one on your Touchstone telephone.

One moment for our first question.

Okay.

Our first question comes from C. J Muse of Evercore ISI. Your line is open.

Yeah, Hi, thanks, Thanks for taking the question.

I guess question for me would be in light of.

Record backlog and extended lead times and then some of the puts and takes around.

Customers moving out production plans, how are you thinking about that.

Timing of easing of supply constraints.

Youre thinking about internal tool production into 2023 and as part of that.

Driving I assume gross margins higher throughout that time, we would love to hear your thoughts around that.

Good afternoon C. J, it's it's price just yeah. Good question on supply constraints and timing versus the demand environment et cetera. So.

Let me explain what we've done in the last couple of weeks. We just went through a cycle, where we reconfirmed all of our 2023 demand with our customers something we do once or twice per quarter on a regular basis and it gives the customer base a chance to signal if they want to make changes they want to make ads they want to make drops.

And in a constrained environment that lets us balance.

Our supply across the customer base and the best way. So we've just completed that.

And there are.

There are a number of changes, but what we what we see for 2023.

Next three plus quarters as we said in our in our initial comments is that demand is still significantly above our ability to supply, but we've got the confidence that we just reconfirmed all of that and then when we think about supply our comments, we've invested significantly in the supply chain.

So we're working to.

Identify issues and loosen the supply chain and solve problems in the supply chain both at our direct suppliers in our secondary suppliers. So our expectation is that will increase output for the next several quarters and continue to work on that backlog, which as you highlighted has been.

Has continued to grow.

Hey, Sanjay this is Gary.

Yes.

So relative to supply chain, what we've been certainly the.

Zero Covid Lockdown in Shanghai March 28 that set us back relative to overall supply chain, we're continuing to make incremental progress and I just right now we see it still being incremental going forward.

We're doing everything we can making investments, adding manpower, but it's more incremental and I think the same thing is true on margins I think last quarter. We said that we would see incremental progress from where we were and I think thats really the direction in both of our supply chain and for our margins is more more incremental improvement.

Throughout 2002 and going into 'twenty three.

Thank you.

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

Question.

I guess the question I have is Gary maybe if you could help us understand.

The mechanics around what you guys do when your customers come in and say Oh, well, we're adjusting that I think you used the expression adjusting the timing.

<unk>.

The orders so.

Do you push there are you able to take the slot that you have allocated for them and push them back.

A quarter or two.

Or do you at some point do you just say listen we can't pushes back anymore, either got to take it or go to the end of the line.

If you could just provide some color about what youre seeing real time on the ground how how many people are pushing back is it a quarter or is it two quarters.

And the mechanics operationally, how you guys manage that process. Thank you.

Yes, I know Gary is going to comment I'll, just make a quick comment mark.

We go out and test the backlog with the customers if they want to make changes a lot of times that's mutually beneficial.

Beneficial change we have another customer that's interested in taking the tool because the demand is exceeding supply at this point. So the first thing we do is try to accommodate those changes.

We're not trying to demand the customer stay on the schedule that they have et cetera. So we tried to be flexible and that was really the point of going out and re testing and re verifying all of that demand that we have across the customer base. So Gary you may want to add to that no I think thats exactly right again.

The challenge we face right now.

Again, many of our customers are really driving a major technology inflections and mark thank.

I think youll see also especially in high performance logic.

Everyone is racing to these these new inflection. So we just have tremendous demand from those customers.

Kaps automotive industrial automation.

So unfortunately, we're not able to supply to that demand and as Brian said.

Memory is weaker.

We try to manage and work with our customers to come up with.

Yes.

The right outcome for them and for us.

Very helpful. Thank you.

Thank you. Our next question comes from a weak era of Bank of America. Your line is open.

I'm trying to reconcile the two things one I think Brian you mentioned you are going to be increasing capacity over the next several quarters, but then from a demand perspective, I believe Gary you said that memory could be down I think you said kind.

Kind of mixed views on on <unk>, but then leading edge should be up. So my specific question is based on I know, you're not giving next year guidance per se, but based on what you see are we looking at kind of a garden variety flat to down 5% in terms of the spending environment or does it vary.

Different than that you would just so that we have.

Some baseline view of how you are thinking about the industry going into the next year given that you do plan to increase supply.

Hi, Vivek, it's it's priced so <unk>.

To reconcile those two I think the first thing to be clear on from our side as the demand for the next several quarters three plus is far higher than supply. So we are going to concentrate like we say on increasing our supply and we'll do our best to do that over the next several quarters and Thats.

Our expectation is demand will stay above where we can supply across that time period. So I think someone said it before that.

Under serving the market so far.

Such that if theres a change in demand, it's still above where our supply line is.

That's the perspective, we have.

And if you think about or if youre asking about 23 like we said, it's it's too early to make a call on 23, but what we would point out is different areas of the market sure are having some weakness some inventory issues. Other areas are very strong and are on schedule to bill.

Build the processes that they need for customer products that are that are also on schedule. So we think those puts and takes more or less will continue the demand signal for us into next year.

Thank you. Our next question comes from Stacy <unk> of Bernstein. Your line is open.

Question I was wondering if you could comment separately on your memory and your foundry logic backlog. So I assume the memory backlog is coming down given its weaker but it sounds like your overall backlog is still increasing if your demand is still well exceeding supply. So is it a case that like your foundry backlog is increasing.

More than your memory backlog is shrinking or like how do I think about the different pieces of that.

Yes, exactly right Stacy this is Brian it's definitely the backlog is increasing and definitely the fall.

Foundry logic backlog is the strongest.

Yes, the strongest component of that in terms of orders and adds to our order book.

I'd say that's good we know there has been reductions on the memory side I don't actually know if the memory side is is down in total overall, but I think thats a fair way to look at it some customers have reduced backlog on memory, but.

Overall foundry logic and some of the <unk> customers are driving and outweighing increase on the positive side.

Stacy This is Gary So also the foundry logic is a increasing percentage of overall wafer fab equipment. So if you look at the.

Percentage of foundry logic is really around two thirds of total wafer fab equipment.

And so.

Certainly the race for <unk>.

Competitiveness in high performance, you'll see that with companies, making significant investments I caps, you've seen a lot of announcements with companies, making long term investments.

And the <unk> capacity. So certainly you see that in the increasing percentage of foundry logic in the overall market.

So, yes, I think that.

What Brian said and what you had also.

Asking your question certainly foundry logic is strong.

That backlog still unfortunately, we're not able to.

Meet demand.

Got it that's helpful guys. Thank you.

Thank you. Our next question comes from Keith <unk> of Citi. Your line is open.

A question for price by some of your U S peers talked about expanding China restrictions to sub 14 nanometer did that impact your July or October quarter outlook, and if you can remind us of your total China sales.

Display system versus silicon.

Thanks <unk>.

Yes first of all we did get the same notice as our peers did on that so that is sub 14 nanometer shipments.

To China customers and it did not impact our July quarter.

And very small for October quarter, and Thats included in our guidance.

So that part is clear and we will work to make sure that we're in full compliance with all the changes on trade rules.

As we always have so but nothing significant in July or October periods, and then could you repeat the display quite I'll.

I'll take it thanks.

Thanks for the question so.

We're not going to break out the exact amount of the of our business in China, but.

Display most of our display revenue does come from China, and then you have the global customers in the domestic customers.

So thats when Youll have systems and service.

For all of those different businesses.

So not going to break out all of those different percentages, but what I would say is that and I think we've talked about this before that by far the majority of our.

Semi foundry logic business in China, as I caps, which is on the trailing nodes.

Thank you very helpful.

Thank you. Our next question comes from Chris <unk> of Cowen Your line is open.

We'll drive.

Overall, <unk> down 10% next year, how should we think about a month's total revenue, including for me and services given the strong backlog and more importantly, how do you think about the EPS.

He's done in person.

Any color you could give there and how to think about revenue and operating leverage in that environment can be very helpful. Thank you.

Sure. Thanks, Chris So the first thing just to remind investors you kind of made the point in the question about our backlog.

We do have as you said.

A large backlog and we expect for the next three plus quarters, we'll just be working on raising our output and serving that backlog but.

If you want to do a what if.

Revenue goes down or if <unk> goes down and the first thing I would remind investors also is that our services business.

Doesn't fluctuate or correlate 100% with WMC, it's driven off.

Our installed base, which grows every time, we ship a tool.

And the utilization across the entire factory network that we're serving transactional spares and subscription service agreements across that so that that portion of our revenue tends to dampen any weakness that we would have from our lower <unk> I would just highlight that for people that are thinking models. So what.

Ever would change on WMC and change on the equipment side it would be a dampened signal on the services piece of the business and then for overall modeling purposes.

Would look at.

Probably up as a proxy year 2019 to see how the business reacted to a lower revenue environment, where you can look at the margin performance in 2019, which was.

Down one or two points and you can look at spending where it was controlled relatively flat I think those would be the.

Same sort of reaction that company would be able to.

Implement and that sort of environment, if you were doing or what if which again is in our forecast.

Thanks, a lot really appreciate it.

Thank you.

Thank you. Our next question comes from <unk> Hari.

Goldman Sachs. Your line is open.

Hi, good afternoon. Thanks, so much.

Gary I was hoping you could expand on some of the comments you made regarding the chip socs.

The implications for.

The broader industry, but more importantly, your business I think you stated in your prepared remarks that you expect it to be.

Small tailwind or a minor tailwind starting in late 2023.

First of all if you could sort of quantify that for us for 23, and 24 that would be super helpful. And then more importantly.

How has the conversations youre, having with your customers changed since.

The chip stock because they've gone through.

The main question that I get from investors is if.

<unk>.

Big foundry in Taiwan decides to.

To build capacity in the U S isn't it sort of a zero sum game, where you sort of.

Subtract from what could have happened in Taiwan, and you just kind of take that over to the U S. So net net isn't it sort of a zero sum, but how would you kind of respond to respond to that thank you.

Yes, Thank you Trisha.

On the chips out at first I'd say I am very happy to see the chips and Science Act passed and become law, that's really positive for United States and the overall industry and then relative to the investment question that you asked.

I would look at it as a small positive tailwind for.

For overall wafer fab equipment spending and really timing wise starting in late <unk>.

2023, if you look at the investments.

At least the ones that have been announced so far it's really in high performance logic.

<unk> investment so those kinds of things so.

I mentioned earlier again, two thirds of wafer fab equipment is in that foundry logic space today, and so that's going to be incrementally positive.

Going into late 'twenty, three and beyond.

Those investments also are time bound if you look at the incentives there are certain timeframes where the.

The funding is available and the investments have to be made so.

That creates a higher degree of certainty I would say as those companies I've talked to many of them.

And as they move to new locations.

There is startup costs and some incremental.

Less efficiency.

They start those fabs and especially for our service business, that's an incremental positive.

You'd see a.

Small incremental spending.

Late 'twenty three and beyond.

As all of those investments and those factories are starting up overtime Toshi I think it really as they it really depends on the scale of those factories bigger factory is more efficient than a smaller factory.

So until they build them out which will take many many years there will be a degree of less efficiency.

For some period of time, but again, if you look at it and the Grand scale of overall WSI, it's not a huge tailwind, but it's definitely a tailwind.

Got it thanks, so much.

Thank you. Our next question comes from Harlan sur of Jpmorgan. Your line is open.

Good afternoon, Thanks for taking my question.

I wanted to expand on some comments that it's had on services, maybe you can just a plug for our.

Upcoming Master class, but in the event of a weaker environment next year you have several positive buffer I think the biggest one.

Your services business historically does not decline.

In fact over the past 11 years, and I think thats for Wip down cycles, I believe that Theres only been one year that Ags was down.

We are in a pretty stable like 8% to 10% revenue CAGR over that period of time, so outside of the annuity like subscription contracts that I assume will be partially offset by let's say 200 millimeter equipment sales, which may fall off in that environment. What is the team doing to ensure continued outperformance of surfaces.

During WSB weakness and your confidence on driving growth in services.

WSI is down next year.

Yes. Thanks for the question Harlan if I got it there.

What we're focused on the two drivers for that business as you kind of hinted to are really the installed base grows every time, we ship a tool and then as you highlighted our ability to serve that installed base both through transactional.

Support spares and services and then the subscription agreements that we have with customers that offer.

Spares plus.

Plus insights that we have across the network on how to optimize for yield and how to optimize for capabilities. So I think what we're doing is increasing our portfolio of service offerings that make it more valuable to the customer and allows them to ramp more quickly reach higher yields.

And it really benefit from the intelligence that applied has across the whole ecosystem of tools.

They don't have potentially on their own I think thats the focus area for the company and that's what gives us confidence that as that installed base grows we'll be able to continue to grow our subscription agreements and just the last piece is.

Is.

Youre right, we have the same analysis on.

Not being 100% correlated with Wi Fi.

Right.

Even as even as if theres changes in Wi Fi or weakness in the revenue and the rest of the business. It's really about the underlying utilization in the factories that exist and the need for services and intelligence in those factories. So I think those are the key drivers.

Arlen just thanks for reminding people about the master class coming up here next month.

The one thing that I think has helped US also so you talked about.

10 11 years.

If you go back over that time period.

I think close to double doubled our percentage of subscription agreements versus.

Versus transactional so certainly and we've increased the length of those agreements to two and a half years, so that percentage of agreements being so much higher and it is still growing so that makes that business more resilient and I think that also relative to the environment, we've been and where everybody is focused with chip shortages.

Producing good ships out.

It really has also highlighted more value in our services things like managed part services, where people will have the parts available.

Versus competing for what's what's available from a transactional perspective, along with all the things that Bryan talked about I think thats really helped highlight the value of these longer term subscription agreements for our customers.

Yes.

Yeah, Yeah, Hey, Heartlands, Mike I think that earlier I gave the right timing for the next Masterclasses in five weeks from today, but I think I heard myself say may 26, which is the last date is September 22nd of course, so thank you.

Yes. Thank you.

Thank you. Our next question comes from Joe QUADRA.

As Fargo. Your line is open.

Okay.

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

Yes, thanks for the question Joe.

Yes, the way I would think about it first of all I think yes.

We've highlighted that demand is higher than our supply level. There's been changes I think in total that demand came down a little bit, but it's still above what we're able to supply for the out quarters.

But.

I think the way, we think about it for a leading edge foundry is they're building processes that their customers are building products on air.

And they need to be able to hit those schedules for the customer products. So they are fairly committed to getting that technology in place.

And then you are right the volumes will fluctuate depending on what the market is for those products, but if you are building.

Our logic node for our product two years from now you are really thinking about what the market is two years from now when you're putting that equipment in place. So it's a.

It's not as simple as just looking at the current quarters.

Macroeconomic environment GDP and lowering your demand you really have to think about that forward looking function.

But the dynamics you have the dynamics right. We just re tested all of the demand for next year and that's what all the customers are thinking about.

Thank you.

Next question comes from Timothy Arcuri of UBS. Your line is open.

Around some of the mixed signals around what's happening this time around in.

On one hand customers are pushing out but you also mentioned that youre getting long term commitments from some other customers I was wondering what that means.

Because it kind of sounds like Youre confident that foundry logic is going to hold up at this time, even as memory pushes out and that's not usually how it works is it is it simply that there is such a concentration of leading edge foundry capacity and theres going to be others, such as your neighbor that are trying to compete to get back in the Saudi business is that what's different this time, because I'm hearing mixed.

Signals and Theres, something obviously different so I'm just wondering if you can call on your on your on your past knowledge to help on that thanks.

Sure sure Tim just two comments the first is we've definitely expanded the horizon.

With all of our customers and from a planning perspective, theyre, giving us longer signals than before and giving us the opportunity to engage in the discussion on on capacity planning with them and second some customers are also giving us.

Our sense that.

Our our promise basically that they will.

Operate within a certain band of capacity, so theyre, giving us additional confidence to what we should plan for from a high confidence perspective, and that's a little bit different than what we've done before.

Hey, Tim This is Gary I would say one other thing that.

Is helping us in this timeframe if you look at the.

The relative investment for the upcoming inflections more of the dollars are going to new materials new structures.

Gate, all around we talked about that in the master class wiring.

For interconnect from seven to three goes up I think three X dollars per wafer.

As you go because you have more go to the three nanometer node theres more steps we have these integrated material solutions that combined seven technologies.

On one integrated platform to lower the wiring resistance by 50%.

Backside power distribution, if you look at one of our customers said recently they talked about <unk>.

A significant increase in materials and structures.

Relative to power performance for them.

Going to their future technology nodes backside power distribution is another one that has a significant.

Inflection you can reduce the area up to 30% without shrinking the features by placing some of the.

Structures on the backside of the wafer so again for us that relative contribution and the relative investment.

Our types of technologies is going up and Thats another thing thats, helping us.

Thanks, Bob.

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

Thank you in terms of.

View that you think more resilient going forward than you have been in the past.

Would you say that stream for sure.

Memory in isolation and I guess, if we sort of if we think this is it memory.

Downturn that looks similar to 2019 should we think about <unk> being down similarly to 2019, where do you think that would be too pessimistic.

Hi.

Thanks.

Thanks, Joe.

The first part I guess I haven't thought of it like that but I would say that we are resilient more resilient our philosophy our position.

Good play to memory only and the reason the reasons that I would point to our first.

The backlog that we've talked about even though memory may be.

Weaker than it was last quarter, we still have significant quarters of backlog for memory customers. So that dynamic is the same in the overall backlog strength as one of the reasons, we're saying we're more resilient than in other periods.

The second is.

The services business is one of the reasons that we're thinking that we're more resilient and that also applies to.

Memory customers and customers that we service from our spares perspective et cetera. So I think that also is larger than it has been in the past and is more resilient.

Relative to changes in Wi Fi and then the last piece just to make sure for for everybody else I wasn't implying that 2019 would be the P&L for the company.

We won't go back to 2019, but that it was a good proxy for how gross margin and spending would behave if.

We were in a weaker environment so.

Just to just to clarify that yes, Joe This is Gary I think if you say what's changed.

What's the same what's change certainly the percentage of foundry logic is significantly higher than it was back in that timeframe again is tracking around two thirds.

This race.

For leadership in high performance logic.

Significant investments that are happening in that part of the market.

And we see customers our customers announcing longer term agreements with their customers and thats something that we didn't see back in that timeframe. So I think the foundry logic percentage than that.

Relative strength, there is definitely different than certainly than it was in the 2019 timeframe.

Relative to the overall wafer fab equipment market.

Alright, thank you.

Thank you.

Our next question comes from Sidney Ho of Deutsche Bank. Your line is open.

For taking my question. My question is on the questions on China.

Look at the revenue from China. It came down about seven percentage points quarter over quarter I think that's more than some of your peers can you walk us through the dynamics there I know in answering a previous question you talk about the new export restriction has no impact in the July quarter, maybe you can talk about the demand strength from domestic Chinese customers towards its multinational.

And also the foundry.

Business memory that'll be great. Thanks.

Thanks, Sidney this is Bryce I think.

One specific driver in one just general observation. The specific driver is most of the downside on our display business relates to customers in China. So that's the probably the primary change.

Element. The rest is just the ins and outs normal quarter activity, we don't think the China market.

As we look forward as any weaker we think the <unk> investments that are being made there.

Our largely on schedule no real change in signal there. So it's just the just the ins and outs of having.

Different size deliveries in the quarter it happened to be a quarter overall that was a little smaller than the prior quarter. So we would point to display and then just general ups and downs for the rest.

For the rest of the change.

And just reiterate no change on the <unk>.

No change because of the trade rules.

Like we said before.

Okay. Thank you.

Thank you.

Our next question comes from Quinn Bolton of Needham <unk> Company. Your line is open.

Really ask a clarification and then a quick question a clarification is when you talk about memory rescheduled or are these memory customers just pushing out delivery dates by some number of quarters or are they canceling the tool entirely and youre, just taking that slot and reallocating it out towards the foundry logic.

Customers.

Question is just on the memory rescheduling is that equally happening across DRAM and NAND or is it predominantly on the DRAM side. Thank you.

Okay Quinn. Thanks on the clarification. There are both there are all three events happening with basically all customers. So theres adds theres drops in their schedule changes I think on the memory, there's more drops than there are ads in the short term window.

So those are counsels and there are plenty of rescheduled and there are even some ads for memory. So I hope that clarifies. It's a it's a mix, but overall, we would say memory cycle over cycle memory is lower than what it was the last cycle.

And it's equally across DRAM and NAND.

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

Understood. Thank you.

Yep.

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

For you Gary since a lot of the industry questions have been answered you talked about the above average growth in your process control business obviously.

Foundry logic is a big driver of it particularly on the advanced node side are you seeing any penetration in terms of the <unk> business in process control or is it entirely within the advanced nodes.

Patrick Thanks for the question no I caps is very strong for our.

<unk> is very strong overall for the company.

PDC is up 67% in 2021 and we're up.

Almost 40% in fiscal 2020.

Patrick Thanks for the question no I caps is very strong for our.

<unk> is very strong overall for the company.

PDC is up 67% in 2021 and we're up.

Almost 40% in fiscal 2022, what I would say relative to the breakdown of the different markets.

Certainly it's stronger in high performance logic then.

In any other part of the market although end.

In any other part of the market. Although we are seeing growth in memory and we are definitely also seeing growth in <unk>. The biggest thing for us. If you look at our PDC business last year E beam pretty much doubled so we have a vertical integration with our electron optics.

Our leadership in resolution and imaging technologies.

And that business is also very very strong.

222, and then also going forward.

We are seeing incremental strength also and.

Optical inspection and we believe will outperform the overall market and optical inspection and overall PDC has it really strong tie to <unk> inflections. So when you look at gate all around or some of these other big inflections are unique imaging.

<unk> enables us to map out those processes and fingerprints faster.

And better than anyone else, so that synergy not only do we see really strong growth in PDC, but real strong synergy with the rest of our.

Semi portfolio.

Thank you.

Great. Thanks, operator, we have time for one more question. Please. Thank you. Our next question comes from Mehdi <unk>. Your line is open.

That's W. A few questions to follow up what would be your revenue guide. If you have OLED components that you needed to ship to demand.

That's a good question Mehdi since it's been several quarters since we've been at that level.

It's difficult to predict but we did say I think two quarters ago that.

The supply constraints, probably impacted us by $300 million. So I would say that in more if we had zero supply constraints and we would be on a higher curve.

Going forward.

Thank you and a few inventory how should I think about the mix of width and finished system.

Finished goods.

Well the changes the changes for inventory.

It's relatively balanced across the both across the entire inventory ecosystem, but.

The.

The increase I'm looking at the numbers sorry, right now yeah.

Relatively balanced I mean, here's what's happening on that here's what's happening dynamically we have a much more raw inventory coming in is we're trying to solve the supply chain issues in <unk>.

95% or more of our parts are available and we're able to build inventory and that shows up in our whipped in raw material.

On finished goods, what's happening is we do have material.

Tools that are complete or nearly complete that are.

Awaiting one part or close to.

Being shipped to customers and that inventory is also growing so I think it's it's relatively balanced across all of those components.

The push out.

Our memory customers is another factor in driving the increase in days of inventory.

Yes, absolutely absolutely not.

We're still underserved in total relative to the market. So.

And when any customer delays that tool or cancels a tool at this point, we'll be moving that inventory in those parts to another customer and we expect that to be the dynamic for the next several quarters plus.

Thank you and thanks for the survey, yes, and just to emphasize for everybody. Yes. We that's what we're that's what our perspective is an output will be raising our output for the next several quarters and we expect to be able to ship that based on demand being higher than the current supply.

Okay. Thanks, Matt for your question and Brian would you like to give US a summary, absolutely. So we've talked about.

Puts and takes.

Weakness in areas of strength in the market.

The overall story is we have multiple quarters of backlog job one for us is to increase our output and meet our customer demand as quickly as possible as we do this will incrementally increase both our revenue and gross margin in coming quarters.

We're confident in the long term growth of the semi market and were working were working to increase our investments in supply chain and especially to continue to focus on the R&D to drive the power performance and area cost roadmaps of our customers.

I look forward to seeing many of you at the upcoming conferences, Gary and I will be at the Goldman Sachs Conference in San Francisco, and just before that I'll be in New York for the city and Evercore events.

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

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

Yeah.

The conference will begin shortly to raise your hand during Q&A you can dial star one one.

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Okay.

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.

Our next conference over to Michael Sullivan Corporate Vice President. Please go ahead Sir.

Good afternoon, everyone and thank you for joining applied third quarter of fiscal 2022 earnings call. Joining me are Gary Dickerson, our president and CEO and Brice Hill, our Chief Financial Officer before we begin I would 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.

Turning to 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 plans to host our services Master class five weeks from today on Thursday May <unk>.

26th at nine O'clock Pacific time will describe the market opportunity for our services business explain why 87% of Ags revenue is truly recurring.

Give you the growth formula for the business through our 2024 financial model Horizon and beyond we hope you'll join key members of our global services team for presentation, and Q&A and now I'd like to turn the call over to Gary Dickerson.

You Mike in our third fiscal quarter applied materials delivered results at the high end of our guidance range and record quarterly revenues.

The actions, we've been taking to mitigate supply chain challenges are beginning to have an impact and we expect steady incremental improvements from here.

Resolving supply issues has required new levels of collaboration between our global teams suppliers and customers.

All of this hard work is yielding results global supply chains remain stressed demand for applied products is still higher than our ability to fulfill it and our backlog continues to grow.

In addition, our relentless focus on meeting customers' needs in this very difficult environment has created margin headwinds that were working hard to overcome we're driving actions to reduce cost and improve value capture including price adjustments.

More color on our financial performance and key areas of operational focus.

Our best estimate is that we'll land somewhere in the mid $90 billion range.

For applied the picture is clear if.

If we use the midpoint of our fourth quarter guidance, we expect our wafer fab equipment revenues to be up approximately 15% for our fiscal year.

Some capacity additions.

It goes in industrial automation in these areas chipmakers are securing long term capacity agreements that underpin their capital spending plans.

While it's too early to provide a forecast for 2023, we believe our business will be more resilient than in the past. If there is a demand pullback in certain areas of the market.

In response to their own customers actions to lock in the strategic capacity they need.

Although we are confident in our ability to perform well in a range of market scenarios. We're mindful of the current macroeconomic trends as a result, we are slowing down hiring while ensuring we fully fund the R&D programs and strategic operational capabilities that some.

<unk>, our long term growth regionalization of supply chain is also something to do for the industry.

We expect this will provide a small positive tailwind for overall wafer fab equipment spending starting in late 2023.

Also because of the time bound nature of government incentives in the U S Europe and Asia, we see a higher degree of certainty for these investments.

Last week I was in Washington D. C for the signing of the chips Act and met with government officials and leaders from across the semiconductor and automotive ecosystems I'm happy to see the critical role that semiconductors play in the economy being recognized and acted upon.

The need to build more resilient and flexible supply chain remains a key theme for these leaders and the chip that will enable many companies to accelerate their investments in strategic capacity.

I'm also excited about the potential to create a new high velocity innovation platform in the United States to accelerate the development and commercialization of next generation technologies.

Annual growth rate from today.

More dollars to our available market over time, we.

We've invested ahead of these inflections to create a portfolio of differentiated solutions that positions us to outperform as these new technologies transition to volume manufacturing.

Applied materials strategy is built upon the breadth and strength of our technology and capabilities. This.

This provides us with a unique ability to engineer co optimize and integrate solutions that address our customers' highest value technology challenges.

Optimized solutions, where we optimize adjacent process steps and integrated materials solutions or IMS, where we optimize a combination of process steps in a single system under vacuum are becoming an increasingly important part of our product portfolio.

In our recent Master class, we talked about our breakthrough IMS approach for tungsten only contacts that are free of conventional barrier materials. This provides significant improvements in contact resistance and is critically enabling for smaller foundry logic nodes. The number of process steps are.

<unk> as these customers migrate to this pure metal technology and these low resistance integrated solutions for contact and wiring represent new multibillion dollar revenue opportunities over the past two quarters, we have secured multiple tool of record positions at all leading.

<unk>.

Adoption of our E beam metrology and new optical wafer inspection platforms in the quarter. We also strengthened our <unk> portfolio with a tuck in acquisition.

<unk> is a leader in batch ILD technology, and we are delighted to welcome their talented team to the applied materials family.

Turning to service Ags delivered record quarterly revenues, despite headwinds for our transactional spares and 200 millimeter equipment businesses due to supply chain constraints.

The subscription portion of Ags continues to demonstrate strength install base tools under long term service agreements grew 9% over the past 12 months, our renewal rate for these agreements continues to be strong and is currently running at 93%.

Before I hand, the call over to Bryce I'll quickly summarize.

We're beginning to see gradual improvements in our supply chain, which enabled us to deliver record revenue for the quarter.

We expect demand to remain higher than supply for the next several quarters and we're continuing to drive actions to close the gap.

Customers and industry wide investment in strategic regional capacity.

Our long term view of the market remains unchanged as multiple parallel secular trends drive the semiconductor and wafer fab equipment markets structurally higher.

At the same time large technology inflections that are enabled by our core capabilities in materials engineering create outsized growth opportunities for applied materials.

Now I'll hand, the call over to Bryce. Thank.

We are still not meeting all of our customers demand and solving the supply chain shortages to increase our manufacturing output remains our top priority.

Second our.

Third we remain committed to our long term gross margin targets.

We are still experiencing the effects of higher costs and unfavorable mix, which are being partially offset by pricing adjustments.

We expect to incrementally improve gross margins over the coming quarters.

Driven by forecasted improvements in manufacturing volumes product mix pricing and logistics costs.

And fourth.

We are confident in the industry's underlying growth trajectory and our unique materials engineering capabilities for process innovation, while we are slowing our head count growth, we have increased our R&D spending by around 10% year to date.

And remain fully invested in enabling our customers' roadmaps.

Turning to our Q3 results, we delivered record revenue of $6 $5 2 billion.

Which is in the high end of our guidance range.

non-GAAP gross margin of 46, 2% declined 80 basis points quarter on quarter non-GAAP operating spending was $1.06 billion.

Which is right on target and up $39 million quarter on quarter, as we increased R&D and added supply chain resources.

non-GAAP operating margin declined 60 basis points to 30%.

Driven by the lower gross margin and head count additions primarily in engineering.

non-GAAP earnings of $1 90, <unk> grew 9% quarter on quarter and matched our previous record.

Turning to the segments. The semi systems team did a great job maximizing shipments growing revenue by $276 million up 6% quarter on quarter.

Segment non-GAAP operating margin declined 100 basis points sequentially to 36, 1% due to higher materials freight expedite and labor costs, partially offset by price adjustments.

The Ags team delivered record quarterly revenue growing $37 million or 3% quarter on quarter, we continued to deliver healthy year over year growth in subscription revenue.

The supply chain shortages constrained our growth in transactional parts and 200 millimeter systems.

Ags non-GAAP operating margin was 36% and slightly up quarter over quarter.

I'll take a minute to share a few observations about ags.

Next month, we'll host of services Master class, where you'll have an opportunity to learn more about our strategy to increase our recurring revenue.

The three key drivers are the growth of our installed base.

Equipment service intensity and long term service agreements.

<unk> is making excellent progress toward our 2024 financial model.

We exited Q3 tracking around $500 million ahead of the base case of our Ags revenue plan and around $250 million ahead of our high case.

In addition, the services business is capital light.

And produces excellent cash flow.

Moving on to display now.

The market is weaker due to its high exposure to consumer portion of the economy.

During the quarter, we lowered spending in line with the current market environment.

Our display revenue declined by $48 million or 13% to $333 million.

The business contributed $70 million of non-GAAP operating profit, which was down sequentially by $12 million or 15%.

Turning to our cash flows we generated 1.4 dollars 7 billion of operating cash flow during the quarter, which was 23% of revenue.

We returned $1 $2 3 billion or 97% of free cash flow to our shareholders deploying $1 billion to repurchased nine 8 million shares of company stock and paying $225 million in dividends.

We also deployed around $440 million for two strategic acquisitions.

We expanded our <unk> portfolio with the addition of <unk>.

And we acquired a talented simulation software team.

Year to date, we have produced over $4 5 billion in operating cash flow and nearly $4 billion and free cash flow.

And returned $5 to $5 billion to our shareholders.

Now I'll share our guidance for Q4.

We expect revenue to increase to 665 billion plus or minus $400 million.

We expect non-GAAP EPS to be $2, plus or minus 18.

Within this outlook, we expect semi systems revenue to increase to $4 93 billion.

Are up 14% year over year.

We expect Ags revenue to increase to $1 $43 billion or up 4% year over year.

With continued healthy growth in services and ongoing supply chain limitations in 200 millimeter systems and transactional parts.

Display revenue should decline to around $250 million.

We expect to incrementally increase our non-GAAP gross margin to 46, 4%.

And we expect non-GAAP operating expenses to increase slightly to $1.08 billion.

We are modeling a tax rate of 11, 8%.

Before we begin the Q&A.

I'd like to summarize our company's position in the current environment.

We continue to see very strong customer pull for advanced technology, and all of our markets and our backlog continues to grow.

We believe some of our customers will moderate their capacity additions in areas that have been impacted by weak consumer spending.

However, I expect <unk> business to be more resilient than in past periods for three reasons one is.

Is that we have strong exposure to technology investments, particularly in the foundry logic market.

Which has grown to become approximately two thirds of wafer fab equipment spending.

Second is that we have multiple quarters of backlog for products that are essential to our customers' technology Roadmaps and we expect to continue to increase supply over the next several quarters.

Third.

Is that our services business has grown to over $5 5 billion in size and generates 87% of revenue from recurring demand for parts services and software.

And now Mike Please begin the Q&A.

Thank you again, ladies and gentlemen, I'd like to ask a question. Please press star one on your touch tone telephone.

One moment for our first question.

Our first question comes from C. J Muse of Evercore ISI. Your line is open.

Yeah, Hi, thanks, Thanks for taking the question.

I guess question for me would be in light of <unk>.

Our record backlog and extended lead times and then some.

Some of the puts and takes around.

Customers moving out production plans.

How are you thinking about.

The timing of easing of supply constraints, how youre thinking about internal tool production into 2023 and as part of that.

Driving I assume gross margins higher throughout that time, we would love to hear your thoughts around that.

Good afternoon C. J, it's it's price just yeah. Good question on supply constraints and timing versus the demand environment et cetera. So.

And in a constrained environment that lets us balance.

Our supply across the customer base and the best way. So we've just completed that.

And there are.

There are a number of changes, but what we what we see for 2023 in the next three plus quarters as we said in our in our initial comments is that demand is still significantly above our ability to supply, but we've got the confidence that we just reconfirmed all of that and then when we think about supply.

Our comments, we've invested significantly in the supply chain. So we're working to.

[noise] identify issues and looser in the supply chain and solve problems in the supply chain both at our direct suppliers in our secondary suppliers. So our expectation is that will increase output for the next several quarters and continue to work on that backlog, which as you highlighted has been.

It has continued to grow.

Hey, Sanjay this is Gary I guess also relative to supply chain, what we've been certainly the.

We're doing everything we can making investments, adding manpower, but it's more incremental.

The same thing is true on margins I think last quarter, we said that we would say incremental progress from where we were and I think thats really the direction both for supply chain and for our margins is more more incremental improvement.

Throughout 2002 and going into 'twenty three.

Thank you.

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

Question.

I guess the question I have is Gary maybe if you could help us understand.

The mechanics around what you guys do when your customers come in and say Oh, well, we're adjusting that I think you used the expression adjusting the timing of the orders so.

Do you push there are you able to like take the slot that you have allocated for them and push them back.

A quarter or two.

Or do you at some point do you just say listen we can't pushes back anymore, either take it or go to the end of the line.

If you could just provide some color about what youre seeing real time on the ground.

How many people are pushing back is it a quarter or is it two quarters.

And the mechanics operationally, how you guys manage that process. Thank you.

Yes, I know Gary is going to comment I'll, just make a quick comment mark when we go out and test the backlog with the customers.

If they want to make changes a lot of times that's.

Mutually beneficial change we have another customer that's interested in taking the tool because the demand is exceeding supply at this point. So the first thing we do is try to accommodate those changes.

We're not trying to demand and the customers stay on the schedule that they have et cetera. So we tried to be flexible and that was really the point of going out and re testing and re verifying all of the demand that we have across the customer base. So Gary you may want to add to that I think thats exactly right again.

The challenge we face right now.

Again, many of our customers are really driving a major technology inflections and mark thank.

Thank you see also especially in high performance logic.

Everyone is racing to these these new inflection. So we just have tremendous demand from those customers.

Kaps automotive industrial automation.

So unfortunately, we're not able to supply to the demand and as Brian said.

Memory is weaker.

And we try to manage and work with our customers to come up with.

The right outcome for them and for us.

Very helpful. Thank you.

Thank you. Our next question comes from a weak era of Bank of America. Your line is open.

I'm trying to reconcile the two things one I think Brian you mentioned you are going to be increasing capacity over the next several quarters, but then from a demand perspective I believe you said that memory could be down I think you said kind.

Different than that just so that we have.

Some baseline view of how youre thinking about the industry going into the next year given you do plan to increase supply.

Hi, Vivek, it's priced so.

To reconcile those two I think the first thing to be clear on from our side is that demand for the next several quarters three plus is far higher than supply. So we are going to concentrate like we say on increasing our supply and we'll do our best to do that over the next several quarters and that.

It's our expectation as demand will stay above where we can supply across that time period. So I think someone said it before that.

Under serving the market so far.

Such that if theres a change in demand, it's still above where our supply line is.

That's the perspective, we have and if you think about or if youre asking about 23 like we said, it's it's too early to make a call on 23, but what we would point out is different areas of the market sure are having some weakness some inventory issues. Other areas are very strong and are on schedule to.

<unk>.

The processes that they need for customer products that are that are also on schedule.

So we think those puts and takes more or less will continue the demand signal for us into next year.

Thank you. Our next question comes from Stacy <unk> of Bernstein. Your line is open.

More than your memory backlog is shrinking or like how do we think about the different pieces of that.

Yes, exactly right Stacy this is Brian it's definitely the backlog is increasing and definitely the funds.

Foundry logic backlog is the strongest.

Strongest component of that in terms of orders and adds to our order book.

Overall foundry logic and some of the <unk> customers are driving an outweighing increase on the positive side.

Stacy This is Gary So also the foundry logic is a increasing percentage of overall wafer fab equipment. So if you look at the.

Percentages foundry logic is really around two thirds of total wafer fab equipment.

So certainly the race for <unk>.

Competitiveness in high performance, you'll see that with companies, making significant investments in <unk>, you've seen a lot of announcements with companies, making long term investments in the <unk> capacity. So certainly you see that in the increasing percentage of foundry logic and the <unk>.

Overall market.

I think that.

What Brian said and what you had also.

Asking your question certainly foundry logic is strong.

And that backlog still unfortunately, we're not able to.

Meet demand.

Got it that's helpful guys. Thank you.

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

Okay.

So a question for Brian .

Some of your U S peers have talked about expanding China restrictions to sub 14 nanometer.

That impacts your July or October quarter outlook.

Remind us of your total China sales.

Display system versus silicon.

Thanks.

Yes first of all we did get the same notice as our peers did on that so that is sub 14 nanometer shipments.

To China customers and it did not impact our July quarter, and very small for October quarter, and Thats included in our guidance.

So that part is clear.

We will work to make sure that we're in full compliance with all the changes on trade rules.

As we always have so but nothing significant in July or October periods, and then could you repeat the display glass.

I'll take it thanks for the question so.

We're not going to break out.

Exact amounts of the of our business in China, but.

Play most of our display revenue does come from China, and then you have the global customers in the domestic customers.

So that's the and you have systems and service for all of those different businesses.

So not going to break out all of those different percentages, but what I would say is that and I think we've talked about this before that by far the majority of our.

Semi foundry logic business in China, as I caps, which is on the trailing nodes.

Thank you very helpful.

Thank you. Our next question comes from Chris <unk> of Cowen Your line is open.

We'll drive.

Overall, <unk> down 10% next year, how should we think about eight months total revenue, including semi and services given the strong backlog and more importantly, how do you think about the E.

<unk> gone to in person.

Any color you could give there and how do you think about revenue and operating leverage in that environment would be very helpful. Thank you.

Sure.

Chris So the first thing just to remind investors you kind of made the point in the question about our backlog.

We do have as you said.

Large backlog and we expect for the next three plus quarters, we'll just be working on raising our output and serving that backlog but.

If you want to do a what if.

Revenue goes down or FWS. He goes down in the first thing I would remind investors also is that our services business doesn't fluctuate or correlate 100% with WMC, it's driven off.

Our installed base, which grows every time, we ship a tool and the utilization across the entire factory network that we're serving.

Transactional spares and subscription service agreements across that so that that portion of our revenue tends to dampen any weakness that we would have from our lower <unk> I would just highlight that for people that are thinking models. So whatever would change on Wi Fi and change on the equipment side it would be a dampened.

On the services piece of the business and then for overall modeling purposes I would look at.

Probably up as a proxy year 2019 to see how the business reacted to a lower revenue environment, where you can look at the margin performance in 2019, which was <unk>.

One or two points and you can look at spending where it was controlled relatively flat I think those would be the <unk>.

Same sort of reaction that company would be able to.

Implement and that sort of environment, if you were doing or what if which again is in our forecast.

Thanks, a lot really appreciate it.

Thank you.

Thank you. Our next question comes from <unk> Hari.

Goldman Sachs. Your line is open.

Hi, good afternoon. Thanks, so much.

Gary I was hoping you could expand on some of the comments you made regarding the chest and the implications for you.

The broader industry, but more importantly, your business I think you stated in your prepared remarks that you expect it to be.

Small tailwind or a minor tailwind starting in late 2023.

<unk>.

First of all if you could sort of quantify that for us for 23, and 24 that would be super helpful. And then more importantly, how has the conversations youre, having with your customers changed since.

The chip stock because they've gone through.

I guess the main question that I get from investors is if.

Yes.

A big foundry in Taiwan, and decides to build capacity in the U S isn't it sort of a zero sum game, where you sort of.

Subtract from what could have happened in Taiwan, and just kind of take that over to the U S. So net net isn't it sort of a zero sum, but how would you kind of respond to respond to that thank you.

Yes, Thank you toshi.

So on the chips out first I would say.

I'm very happy to see that chips and Science Act passed and become law, that's really positive for the United States and the overall industry and then relative to the investment question that you asked.

I would look at it as a small positive tailwind for overall wafer fab equipment spending and really timing wise starting in late.

2023, if you look at the investments.

At least the ones that have been announced so far it's really in high performance logic.

<unk> investment so those kinds of things so.

As I mentioned earlier again, two thirds of wafer fab equipment is in that foundry logic space today, and so that's going to be incrementally positive going into late 'twenty three and beyond.

Those investments also are time bound if you look at the incentives there are certain timeframes where the.

The funding is available and the investments have to be made so.

That creates a higher degree of certainty I would say as those companies I've talked to many of them.

And as they move to new locations.

There is startup costs and some incremental.

Less efficiency.

They start those fabs and especially for our service business, that's an incremental positive.

You'd see a.

Small incremental spending.

Late 'twenty three and beyond.

Of less efficiency.

For some period of time, but again, if you look at it and the Grand scale of overall Wi Fi, it's not a huge tailwind, but it's definitely a tailwind.

Got it thanks, so much.

Thank you. Our next question comes from Harlan sur of Jpmorgan. Your line is open.

Good afternoon. Thanks for taking my question I wanted to expand on some comments that it's had on services, maybe you can just plug there.

Upcoming Master class, but in the event of a weaker wasd environment next year you have several positive buffers I think the biggest one.

Is that your services business historically does not decline.

Over the past 11 years, and I think that's for Wip down cycles.

Believe that Theres only been one year.

<unk> was down and it's driven a pretty stable like 8% to 10% revenue CAGR over that period of time, so outside of the annuity like subscription contracts that I assume will be partially offset by.

Let's say 200 millimeter equipment sales, which may fall off in the weeks Wi Fi environment.

What is the team doing to ensure continued outperformance of surfaces doing WSB weakness and your confidence on driving growth in services. If WSI is down next year.

Yes. Thanks for the question Harlan if I got it there.

What we're focused on the two drivers for that business as you kind of hinted to.

Really the installed base that grows every time, we ship a tool and then as you highlighted our ability to serve that installed base both through transactional.

Support spares and services and then the subscription agreements that we have with customers that offer.

<unk> plus.

Plus insights that we have across the network on how to optimize for yield and how to optimize for capability. So I think what we're doing is increasing our portfolio of service offerings that make it more valuable to the customer and allows them to ramp more quickly reach higher yields.

And it really benefit from the intelligence that applied has across the whole ecosystem of tools.

That they don't have potentially on their own I think thats the focus area for the company and Thats, what gives us confidence that as that installed base grows we will be able to continue to grow our subscription agreements and just the last piece.

You are right we have the same analysis on.

Not being a 100% correlated with Wi Fi.

Right.

Yes, thanks for reminding people about the master class coming up here next month.

The one thing that I think has helped US also so if you you talked about.

10, or 11 years.

If you go back over that time period, we have I think close to double doubled our percentage of subscription agreements.

Versus transactional so certainly and we've increased the length of those agreements to two and a half years, so that percentage of agreements being so much higher and it's still growing yes that makes that business more resilient and I think that also relative to the environment. We've been in where everybody is focused with chip shortages.

Producing good chips out.

It really has also highlighted more value in our services things like manage part services, where people will have the parts available.

Versus competing for what's what's available from a transactional perspective.

Along with all the things that Bryan talked about I think that's really helped highlight the value of these longer term subscription agreements for our customers.

Yes Harlan.

Yeah, Yeah, Hey, Harlan, it's Mike I think that earlier I gave the right timing for the next Masterclasses in five weeks from today, but I think I heard myself say may 26, which is the last date is September 22nd of course, so thank you.

Yes. Thank you.

Thank you. Our next question comes from Joe Quadri of Wells Fargo. Your line is open.

You talked about still seeing strength in especially in leading edge foundry logic investments, but theres also some consumer driven demand there as well. So I guess have you maybe seen a change in terms of like the capacity of that your customers are looking to put in place there.

Still not changed their technology Roadmaps.

Yes, thanks for the question Joe.

The way I would think about it first of all I think yes.

We've highlighted that demand is higher than our supply level. There's been changes I think in total that demand came down.

A little bit, but it's still above what we're able to supply for the out quarters.

I think the way, we think about it for a leading edge foundry is they are building processes that their customers are building products on and they need to be able to hit those schedules for the customer products. So they are fairly committed to getting that technology in place and then youre right the volumes of flux.

<unk>, depending on what the market is for those products, but if youre building a.

Our logic node for our product two years from now you are really thinking about what the market is two years from now when you're putting that equipment in place. So it's a.

It's not as simple as just looking at the current quarters.

Macroeconomic environment GDP and lowering your demand you really have to think about that forward looking function.

The dynamics you have the dynamics right. We just re tested all of the demand for next year and Thats, what all the customers are thinking about.

Thank you.

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

Around some of the mixed signals around what's happening this time around in one hand customers are pushing out but you also mentioned that youre getting long term commitments from some other customers I was wondering what that means.

And there is something obviously different so I'm just wondering if you can call on your on your on your past.

Knowledge to help on that thanks.

Sure sure Tim just two comments.

First is we've definitely expanded the horizon with all of our customers and from a planning perspective, theyre, giving us longer signals than before and giving us the opportunity to engage in the discussion on on capacity planning with them and second some customers are also giving.

Us.

Our sense that.

Or a promise basically that they will.

Hey, Tim This is Gary I would say one other thing that.

<unk> is helping us in this timeframe if you look at the.

The relative investment.

For the upcoming inflections more of the dollars are going to new materials new structures.

Gate, all around we talked about that in the master class wiring.

For interconnect from seven to three goes up I think three X dollars per wafer.

As you go because you have more go to the three nanometer node theres more steps we have these integrated material solutions that combined seven technologies.

On one integrated platform to lower the wiring resistance by 50%.

Backside power distribution, if you look at one of our customers said recently they talked about.

A significant increase in materials and structures.

Relative to power performance for them.

Going to there are future technology nodes backside power distribution is another one that's a significant.

Inflection you can reduce the area of up to 30% without shrinking the features by placing some of the.

Structures on the backside of the wafer so again for us that relative contribution and the relative investment in our types of technologies is going up and Thats another thing thats, helping us.

Thanks Bill.

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

Thank you in terms of the <unk>.

Do that using more resilient going forward than you have been in the past.

Would you say thats true for for memory in isolation and I guess, if we sort of if we think this is it memory.

Downturn that look similar to 2019 should we think about <unk> being down similarly to 2019, where do you think that would be too pessimistic and why.

Sure.

Thanks, Joe.

The first part I guess I haven't thought of it like that but I would say that we are resilient more resilient.

Philosophy, our position would play to memory only and the reason the reasons that I would point to our first.

The backlog that we've talked about even though memory maybe.

The second is.

The services business is one of the reasons that we're thinking that we're more resilient and that also applies to.

Memory customers and customers that we service from our spares perspective et cetera. So I think that also is larger than it has been in the past and is more resilient.

Relative to changes in Wi Fi and then the last piece just to make sure for for everybody else I wasn't implying that 2019 would be the P&L for the company.

We won't go back to 2019, but that it was a good proxy for how gross margin and spending would behave if.

We were in a weaker environment so.

I just just to clarify that yes, Joe This is Gary I think if you say what's changed.

What's the same what's change certainly the percentage of foundry logic is significantly higher than it was back in that timeframe again is tracking around two thirds.

This race.

For leadership in high performance logic and.

Significant investments that are happening in that part of the market.

We see customers our customers announcing longer term agreements with their customers and thats something that we didn't see back in that timeframe. So I think the foundry logic percentage than that.

Relative strength, there is definitely different than certainly than it was in the 2019 timeframe.

Relative to the overall wafer fab equipment market.

Alright, thank you.

Thank you.

Our next question comes from Sidney Ho of.

Deutsche Bank your line is open.

So we're taking my question my question is on the questions on China.

Revenue from China, It came down about seven percentage points quarter over quarter I think that's more than some of your peers can you walk us through the dynamics there I know in answering a previous question you talk about the new export restriction has no impact in the July quarter, maybe you can talk about the demand strength from domestic Chinese customers story. This multinational.

The foundry.

Versus memory that will be great. Thanks.

Thanks, Sidney this is Bryce I think.

One specific driver in one just general observation. The specific driver is most of the downside on our display business relates to customers in China. So that's the probably the primary change.

Element. The rest is just the ins and outs normal quarter activity, we don't think the China market.

As we look forward as any weaker we think the <unk> investments that are being made there.

Our largely on schedule no real change in signal there. So it's just the just the ins and outs of having <unk>.

For the rest of the change.

And just to reiterate no change on the.

No change because of the trade rules.

We said before.

Okay. Thank you.

Thank you.

Our next question comes from Quinn Bolton of Needham <unk> Company. Your line is open.

Customers.

Question is just on the memory rescheduling is that equally happening across DRAM and NAND or is it predominantly on the DRAM side. Thank you.

Okay Quinn. Thanks on the clarification. There are both there are all three events happening with basically all customers. So there's adds theres drops in their schedule changes.

On the memory, there's more drops than there are ads in the short term window. So those are counsels and there are plenty of rescheduled and there are even some ads for memory. So I hope that clarifies. It is a it's a mix, but overall, we would say memory cycle over cycle memory is lower than what it was the last cycle.

And it's equally across DRAM and NAND.

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

Understood. Thank you.

Yep.

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

For you Gary since a lot of the industry questions had been answered you talked about the above average growth in your process control business obviously.

Oh, Hi, Patrick Thanks for the question no I caps is very strong for our.

<unk> is very strong overall for the company.

PDC is up 67% in 2021 and we're up.

Almost 40% in fiscal 2022.

Patrick Thanks for the question no I caps is very strong for our.

Well <unk> is very strong overall for the company.

PDC is up 67% in 2021 and we're up.

Almost 40% in fiscal 2022, what I would say relative to the breakdown of the different markets.

Certainly it's stronger in high performance logic then.

In any other part of the market although end.

Vertical integration with our electron optics.

Our leadership in resolution and imaging technologies.

And that business is also very very strong.

222, and then also going forward.

We are seeing incremental strength also in optical inspection and we believe will outperform the overall market and optical inspection and overall PDC has it really strong tie to <unk> inflections. So when you look at gate all around or some of.

These other big inflections are unique imaging capability enables us to map out those processes and fingerprints faster and better than anyone else. So that synergy not only do we see really strong growth in PDC, but real strong synergy with the rest of.

Our semi portfolio.

Thank you.

Great. Thanks, and operator, we have time for one more question. Please. Thank you. Our next question comes from Mehdi <unk>. Your line is open.

That's W. A few questions to follow up what would be your revenue guide. If you have OLED components that you needed to ship to demand.

That's a good question Mehdi since it's been several quarters since we've been at that level.

It's difficult to predict but we did say I think two quarters ago that.

The supply constraints, probably impacted us by $300 million. So I would say that in more if we had zero supply constraints and we would be on a higher curve.

Going forward. Thank.

Thank you and your inventory how should I think about the mix of width and finished system.

Finished goods.

Well the changes the changes for inventory.

It's relatively balanced across the both across the entire inventory ecosystem, but.

The increase I'm looking at the number sorry right now.

Relatively balanced I mean, here's what's happening on that here's what's happening dynamically we have.

Much more raw inventory coming in is we're trying to solve the supply chain issues and.

95% or more of our parts are available and we're able to build inventory and that shows up in our whipped in raw material.

And on finished goods what's happening is we do have material are tools that are complete or nearly complete.

That are awaiting.

Awaiting one part or close to.

Being shipped to customers and that inventory is also growing so I think it's it's relatively balanced across all of those components.

Push out by memory customers is notice factor in driving the increase in days of inventory.

Yes, absolutely absolutely not.

We're still underserved in total relative to the market. So.

When when any customer delays that tool or cancels a tool at this point, we'll be moving that inventory in those parts to another customer and we expect that to be the dynamic for the next several quarters plus.

Thank you and thanks rich yes.

Yes, and just to emphasize for everybody, Yes suite. That's what we're that's what our perspective is an output will be raising our output for the next several quarters and we expect to be able to ship that based on demand being higher than the current supply.

Okay. Thanks, Matt for your question and Brian would you like to give us a summary.

Absolutely so we've talked about.

Hudson takes.

Weakness in areas of strength in the market.

Okay. Mike Please close the replay of the call is going to be available on our website I'd like to thank everybody for joining us today, a replay of the call is gonna be available on our website by five o'clock Pacific time today, and we would like to thank you for your continued interest in applied materials.

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

Q3 2022 Applied Materials Inc Earnings Call

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