Q4 2022 Applied Materials Inc Earnings Call
Okay.
Welcome to the applied materials earnings conference call.
During the presentation all participants.
It will be going after.
Words, you will be invited to participate in a question and answer session.
I would now like to turn the conference over to Michael Sullivan Corporate Vice President. Please go ahead Sir.
Good afternoon, everyone and thank you for joining applied to fourth 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 applied plans to hold an E beam technology and new product webcast on Wednesday December 14th at nine a M. Pacific time, Please stay tuned for an invitation to join our presenter Keith Wells, who as group Vice President and general manager of our imaging and process control group.
With that introduction I'd like to turn the call over to Gary Dickerson. Thank you, Mike applied materials delivered a strong finish to our fiscal year with record quarterly performance.
2022, the company has demonstrated solid execution, while navigating COVID-19 related restrictions supply chain shortages, and a challenging geopolitical and macroeconomic environment.
I would like to recognize the hard work and commitment of our global team and our suppliers, who are doing everything possible to meet our customers' needs.
As this is our year end call I'll begin my prepared remarks with a quick review of our performance and progress over the past 12 months Oh, They didn't give our latest outlook for 2023 before describing our longer term growth thesis for the industry and applied after that Brian will provide more color on our financial performance.
And key areas of operational focus.
Like many others in the technology sector, our performance and priorities in 2022 have been shaped by an unprecedented set of challenges our top priority has been mitigating supply chain constraints that prevented us from fully meeting customer demand.
Q4, we made incremental progress and we expect to continue closing supply gaps over the next few quarters.
As well as finding creative short term solutions. Our team has been addressing root causes and building a more resilient and scalable supply chain and stronger strategic relationships with our suppliers.
In addition, we're strengthening our own manufacturing logistics and supply chain management.
While I'm pleased with the recent improvements in supply chain performance, we are still supply chain limited across a number of key product lines and our backlog grew in Q4.
Biggest supply constraints are in our metal deposition business, where customer demand is very strong. This is our largest business unit and where we have highly differentiated solutions for advanced foundry logic and DRAM the market for these products, which enable next generation wiring is.
Banding considerably.
In addition to supply shortages, we're also navigating a difficult geopolitical environment as reflected in the new export control regulations enacted by the U S. Government on October seven these new rules are complex and cover a broad range of semiconductor technology that includes wafer fabrication equipment.
And related parts and services, we've taken all the necessary actions to comply with these new roles, including suspending shipments and support where required.
We estimate that the unmitigated impact to our fiscal 2023 revenues could be up to $2 $5 billion. We believe the actual impact can be reduced to one $5 billion to $2 billion.
This will depend in part on how quickly the government provides licenses and approvals as well as how impacted companies refocus their investments.
We're also mindful of the macroeconomic headwinds, including inflation and softening consumer demand.
To offset the inflationary cost increases we are facing we are driving multiple initiatives that include reengineering, our products and implementing price adjustments.
While it's too early to forecast 2023 with any precision I can describe what we're currently seeing in the market and hearing from our customers starting with memory spending is expected to be down year on year as weakness in consumer electronics and Pcs prompt some customers to defer.
The additions in leading edge foundry logic demand looks strong with customers racing for leadership and driving major technology inflections that determine their relative competitive positions and I caps chips for the Iot communication auto power and sensor markets demand is mixed.
Consumer driven markets are clearly softer while the automotive industrial and power markets remain robust those investments are underpinned by large inflections, including the transition to electric vehicles accelerated adoption of industrial automation and growing demand for renewable energy solutions.
Especially in Europe .
While all of this adds up to an expected pullback in overall wafer fab equipment spending next year, we believe that appliance business will be more resilient than the underlying market for three key reasons.
We have a significant backlog the highest in our history measured on both an absolute and percentage of revenue basis second demand for some of our most differentiated product lines, where we have uniquely enabling technology remains much higher than our capacity to fulfill that demand and third.
Our service business is positioned for steady growth with an increasingly large portion of this business being converted to subscriptions over the past 12 months, our installed base of systems grew 8% and the number of tools under comprehensive long term service contracts grew 16%.
The renewal rate for these agreements is well over 90%, which demonstrates the value customers see in our subscription services.
Looking further ahead, our long term growth thesis for the industry and applied materials has not changed semiconductors are the foundation of digital transformation that will touch almost every sector of the economy over the coming years.
This puts the semiconductor industry on a path to a trillion dollar market by the end of the decade, and while every year will not be an up year. The overall trajectory is clear.
We also like where applied materials plays within the ecosystem.
As technology complexity is increasing we expect equipment intensity to remain at today's levels or rise. Further this means wafer fab equipment is likely to grow faster than the overall semiconductor market.
Within equipment spending major technology inflections are enabled by materials engineering shifting more dollars to applied available markets over time, we think about the industry's future roadmap in terms of power performance area cost and time to market. The Pea pack T playbook has five pillars.
New architectures, new <unk> structures, new materials, new ways to shrink and advanced packaging with each pillar it made up of multiple technology inflections.
For example, new three D structures like gate, all around transistors, and backside power distribution networks, our materials engineering enabled inflections that grow applied to total available market as I referenced earlier wiring is a key bottleneck for chip performance and power at advanced nodes and.
And this is driving significant innovation in new materials between the seven and three nanometer node contact metallization staffs are growing more than 50% and our total available market is expanding almost 80%.
For interconnect layers process steps are being added even faster and we expect our revenue opportunity to approximately tripled through these node transitions.
Advanced packaging represents a new era for integrated circuit design that opens a major new vectors of innovation for chip designers advanced packaging is also enabled by new materials Engineering solutions.
Although the industry is still in the early stages of adoption, we have already grown our packaging equipment business to nearly $1 billion or process diagnostics and controls business also has broad exposure to these inflections and delivered significant growth in 2022.
Our progress and opportunities in E beam will be the focus of our December technology briefing.
Given our positive long term view of the semiconductor market the outsized opportunities for applied materials within the market and favorable global government incentives, we're making investments in R&D and infrastructure to support industry growth and position the company for future success, we will provide more details about our specific.
Plans in the coming months at.
At the same time with the current macroeconomic conditions, we are carefully managing discretionary spending and limiting hiring to only strategic positions.
Before I hand, the call over to Bryce I'll quickly summarize applied materials ended the year strong with record performance in the past quarter, we made incremental progress overcoming the supply challenges that have constrained our performance in fiscal 2022. However, there is still work to do in our backlog contained.
Use to grow.
We expect 2023 to be a down year for wafer fab equipment spending, but we believe that appliance business will be more resilient. Thanks to our large backlog growing service business and strong customer demand for our leadership products that enable key technology inflections.
Longer term secular trends create opportunities for applied to outgrow the semiconductor market by enabling the Pea pack T Road map with our differentiated portfolio of materials Engineering solutions, we are making strategic investments for the future while slowing spending growth in the near term now I'll hand over to Bryce.
Thank you Gary I'd like to start by thanking our team and our supply chain partners for helping to further increase our output for our customers.
On today's call I'll summarize our results for the fiscal year and Q4 as well as provide our guidance for Q1.
I'll also discuss the impact of recent U S export regulations on our revenue and gross margin.
Before going into the results I'd like to make three points first despite a weaker customer demand outlook, we generated strong orders in Q4 and ended the year with record backlog, particularly in some of our leadership product areas.
Combined with the resiliency of our Ags business the strong backlog puts us in a good position to offset some of the market weakness expected next year.
Second we have not changed our view of a one trillion dollar semiconductor market by 2030 with a high single digit CAGR for semiconductors, and similar or faster growth for equipment due to added process complexity.
We grew our head count in R&D spending significantly in 2022 to develop new leadership products and further expand our broad portfolio.
Well, we are slowing our spending growth in the current environment, we remain committed to research and development and enabling critical inflections that support our customers' roadmaps.
And third we returned nearly $7 billion to shareholders. This past year, including buybacks equivalent to 6% of shares outstanding at the beginning of the period with record demand in financial results in 2022, a strong growth opportunity through 2030, and our broad and unique portfolio of systems and services.
We're confident in our financial position and our future.
Next I'll summarize our fiscal year results, although supply chain constraints impacted our output all year, we delivered record annual revenue and EPS on a year over year basis revenue increased nearly 12% to $25 8 billion non-GAAP gross margin decreased by around 90 basis points to <unk>.
46, 6% non.
non-GAAP operating profit grew by over 7% to 7.86 billion non-GAAP operating margin decreased by 120 basis points to 35% and non-GAAP EPS increased nearly 13% to $7.70 we.
We generated about $5 $4 billion in operating cash flow this past year and over $4.6 billion and free cash flow.
We returned 151% of free cash flow to shareholders, including $873 million in dividends and $6 $1 billion in share repurchases. Our cash returns for the past three years were equivalent to over 100% of free cash flow.
In the year demand for our products and services was very strong with record annual bookings in semi systems and Ags.
On a year over year basis, our total ending backlog increased 62% to $19 billion, our semi systems backlog increased 90% to nearly $12 $7 billion.
We expect to reduce our semi systems backlog as supply chain performance improves.
Our H S backlog increased 30% to over $5 $6 billion.
The strong Ags backlog reflects a large increase in long term service agreements, which gives us confidence in the continued growth of this business.
Moving to our Q4 results.
We delivered record quarterly net sales of nearly $6 $75 billion and record non-GAAP EPS of $2 three.
non-GAAP gross margin declined 20 basis points sequentially to 46% and non-GAAP Opex grew three 5% sequentially to nearly $1.1 billion with most of the increase in R&D.
Turning to the segments semi systems revenue grew more than 6% sequentially to five points there of $4 billion.
non-GAAP operating margin increased 80 basis points sequentially to 36, 9%.
Ags revenue was flat quarter over quarter at $1.42 billion segment.
Segment non-GAAP operating margin declined to 28, 3%.
A G S key performance indicators continue to be positive with strong year over year growth in installed base systems service intensity and subscription agreements.
As a result, Ags continues to grow faster than the pace needed to achieve our long term revenue targets.
Moving on to display revenue declined as expected to $251 million.
non-GAAP operating margin also declined to 13, 5%.
Turning to our cash flows we generated $857 million in operating cash flow during the quarter, which was 13% of revenue.
We returned over $1.72 billion to shareholders, including $223 million in dividends and $1.5 billion in buybacks.
We repurchased 17 million shares at an average price of $88.05.
Next I'll discuss the impact of the new U S export regulations to applied materials. We currently expect that the unmitigated revenue impact of the new rules could be up to two $5 billion in fiscal 2023.
We continue to work through the regulatory requirements, including seeking licenses and approvals where appropriate.
We hope to reduce the revenue impact by between $500 million and $1 billion to a net impact of one $5 billion to $2 billion.
We also expect the rules to reduce our non-GAAP gross margin by up to one percentage point.
While this creates a headwind to meeting our gross margin targets for 2024, we remain committed to our goals and believe we can achieve and exceed them overtime.
In Q4, the new rules reduced our semi systems and Ags revenue by approximately $280 million, which is in the range of our expectation on October 12.
Inventory charges in Q4 were lower than our preliminary assessment.
In Q1, we expect the new rules to reduce semi systems in Ags revenue by approximately $490 million combined and reduced our gross margin by around one percentage point, both on an unmitigated basis.
Now I'll share our guidance for Q1, we expect revenue to be $6 $7 billion, plus or minus $400 million Andrew.
And we expect non-GAAP EPS of $1 93.
Plus or minus 18 sets.
Within this outlook, we expect semi systems revenue to be about $5.15 billion, which is up nearly 13% year over year, we expect ags revenue to be about $1.33 billion, which is slightly up year over year disk.
Display revenue should be around $170 million.
We expect non-GAAP gross margin to be approximately 46, 1% and we expect non-GAAP operating expenses to be $1.16 billion.
We are modeling a tax rate of 13%, which is up from 11, 8% last year, primarily due to mandatory capitalization of R&D expenses effective in our new fiscal year.
Before we begin the Q&A I'd like to summarize our company's position in the current environment.
We have record backlog.
Notably in the highly enabling technologies for next generation nodes.
Our supply chain and manufacturing output are incrementally improving.
We expect our services business will continue to grow and generate strong recurring revenue and free cash flow.
And our longer term growth outlook for the semiconductor industry remains strong apply.
Applied is in a great position to invest in future growth and deliver strong profitability free cash flow and shareholder returns.
Now Mike please begin the Q&A.
Thanks, Bryce to help us reach as many people as we can please ask just one question on today's call. If you have another question. Please re queue and we'll do our best to come back to you later in the session operator, let's please begin.
Thank you, ladies and gentlemen to ask a question you will need to press star one one on your telephone once again to ask a question. Please press star one one.
Okay.
And our first question comes from the line of C. J Muse with Evercore ISI.
Yes. Good afternoon. Thank you for taking the question I was hoping to clarify one thing first.
China.
And really the question is what changed between October 12th What's your press release, and then October 30th where it looks like there really wasn't much of an impact at all.
And then my.
The real question is as you think about calendar 'twenty three WSB.
It sounds like companies are providing kind of a top down view that things for W. R. R look weak and declining however.
Every company bottoms up.
Based on deferred revenues and backlogs are are much more optimistic on the outlook. So can you kind of talk through the moving parts there.
What kind of range or outcome you see today for.
Year over year Silicon declines in calendar 'twenty three thanks, so much.
Sure Hi.
Hi, C. J, it's price I'll I'll start on this one so relative to the pre announcement that we did we talked about a $400 million impact plus or minus a $150 million for the China trade change and then as we work through it that impact ended up being less around $280 million and it's just you know.
Estimating the transactional elements at the end of the quarter. It was an initial element estimates. So we did a little bit better from that perspective. The other thing that really happened was execution and the end of the quarter was.
Almost flawless from a logistics perspective, we got more supply chain parts and at the end of the quarter and so over $200 million of good news from a execution and delivery perspective, finishing product and completions in the field. So it was really those two things it was a little bit better than our <unk>.
Sure estimate and execution was excellent in the last couple of weeks of the quarter and then in 'twenty three.
Wi Fi question for 'twenty three.
We think that you know its preliminary it's too it's too early to give an estimate of 23. So what were trying to share is what we're seeing in our order patterns and in our business for Q1 and Q2, we talked about you know in the script, how in Q1 or in our bookings for Q4.
<unk> they were really solid we did see push outs, we did see weakness in the memory business, but our backlog has grown to a record level of backlog. So when we think about our Q1 and Q2, we're still supply constrained we still have a number of different equipment lines that we have a significant backlog we're trying to.
That's up to customer orders and so the signals to us really are that we have to work on supply chain work on improving our output and work on catching up with our customers. So beyond that we're.
We're just not able to make a call yet on Wi Fi for 'twenty three.
Yeah T. J this is Gary.
As Brian said the.
The we can certainly give a perspective on our business, we're not going to guide on overall W. I favor twenty-three, but we're in a very strong position. If you look at our the kind of profile of the business, it's more weighted towards foundry logic versus memory and we have some.
Very strong products, where we have significant backlog and we're still working to close the.
The supply demand gaps in those areas. So from applied standpoint, as you know, it's all about the race for power and performance for all of our customers and we're really well positioned.
With leading products and in those big inflections and again, our number one focus is on closing the supply chain gaps.
Thank you.
Thank you.
And our next question comes from the line of Stacy <unk> with Bernstein.
Hi, guys. Thanks for taking my question I wanted to ask you about the mitigated versus unmitigated impact from China. So you gave the numbers $2 5 billion and hoping to bring that down to like you know one and a half but.
I gathered that a big element of that was getting licenses.
Where do you expect those licenses to be gotten is that only to the multinationals do you guys expect licenses to be given to some of the Chinese folks I mean, how what how could that happen what is the mechanism.
By which you come in at the unmitigated number versus the covenant the mitigated number versus the unmitigated number.
I am Stacy it's price, yeah, and it's important probably to say that this unmitigated versus mitigated it has everything to do with the impact to the China shipments and Chinese customers in other words, it's not referring to whether we can ship you know.
Product, we are making for those customers to a non China customers.
So the unmitigated Cal.
Calculated that says we looked at the orders that we have for the affected customers and that's what you see as the total $2 $5 billion.
Does that order.
Yeah.
Say again.
I'm sorry does that include multinationals too or is that just the local Chinese guys.
Got it.
It does not.
So just thoughts.
Yeah, and so the way we looked at that there are some customers that were trying to clarify that we can apply for licenses for or we can get authorizations for once they establish a that their technology as you know within the guidelines. So so we have a process to do that and on the other side.
We expect some customers may decide to change their plan or change their technology. So it does not go.
The threshold that's a that's a you know.
Affected by the rules at this point so it's really those two elements that we'll be able to.
Clarify that some customers were able to ship with our ship to or some customers changing their plans on the technology side that would allow them to.
Qualify for shipments.
Well, what would that mean, though would that suck up like supply that would've ordinarily gotten built by somebody else, though because otherwise you're just adding like lagging edge supply into a vacuum essentially right. How do we think about like the second order effects here.
We don't think so we expect all of that equipment to be utilized and so in fact equipment has moved to a different use then we expect it will be back filled somewhere else.
For its original <unk>.
Demand purpose, if that makes sense.
Got it and I guess, just one one last one right now I guess you are running at the at the on mitigated level.
When do you think.
The level of like like how likely do you think it'll be that you ended up at the mitigated level at some point.
It's hard to say, it's a process you can imagine there's a large number of people working on this in fact, the whole industry is working on this so.
You know it's job job to at this point behind increasing output so I.
I would say, it's still a good estimate today and where we'll be working throughout the year on improving the number of customers and plants that we can ship.
Got it okay. Thank you guys.
Thank you.
And our next question comes from the line of Vivek Arya with bankable.
Thanks for taking my question I, just wanted to clarify I thought Brian you said somewhere that you provided some look for Q2 I don't think I caught that and then several of your memory customers that said that theyre spending could be down over 50% next year.
Micron said it could be down even more than that have you noticed.
So 50% cancellation of orders.
You know from them because I'm just trying to reconcile.
Your commentary that sounds you know outside of China of course, you know more benign and more supportive versus.
Just the very guidance that your memory customers that are providing I understand you're less exposed to memory versus foundry logic, but there's it's a reasonable sized exposure. So I'm curious.
How does that 50% cut in capex translated to any reduction in your backlog, but any change in your thinking about memory for.
For next year.
Okay.
Thanks Vivek so.
We're not giving a guide for Q2, we are highlighting the record backlog and the fact that we're constrained and the fact that you know and several equipment lines. We're behind on customer orders. So we're going to try to increase output and I'd say that comment is true for both Q1 and Q2 so that.
That's as much shaping as we're providing for Q2 on the memory side.
To kind of click back and think about the overall demand environment. We we we are positioned last quarter that we had a significant amount more demand than we have the ability to supply for twenty-three what did happen. During the course of this quarter is there is a significant amount of push outs and reductions in that.
Demand now you can see the end result, we still had solid bookings in Q4, we still have we created a record backlog.
That's now disclosed so I would say that you know some of those push outs and some of those reductions were definitely in the memory space and I wouldn't I'm not going to characterize what percentage. It was but I would say that that's the most affected area in the business in terms of push outs and reductions for 423.
So you are seeing a 50%.
Right reduction I'm I'm, just trying to align what you're hearing from those customers versus what you are seeing on the ground in your business.
Oh, sorry, I can't quantify exactly what it is I'll just say that that is where you know it's biased the reductions were biased in that area.
Okay. Thank you.
Yep.
Thank you.
And our next question comes from the line of Krish Shankar with Cowen.
Yeah, Hi, Thanks for taking my question, Gary I, just wanted to find out that you mentioned are lagging edge is still pretty strong, especially auto analog in China.
And I Wonder if that's changed at all kind of look at the next shoe to drop but in other words memory is only going to be down next year, but lagging edge holds up what is the risk that lagging edge. It rolls over into 2024 and you have two years of lackluster WP. Thank you.
Okay, I'll I'll start maybe Gary wants to say something you know we don't we don't have a specific guide for what we call eye caps are our mature node businesses. What we would say is there was significant growth in 2022, and when we think about all the end markets. We think the end markets are mixed we know some of the consumer.
<unk> markets and even industrial have seen some weakening but on the positive side.
Automotive and the power market that feeds EV in solar and other areas has been really strong.
So.
For Us this is a critical market, where we're continuing to invest and continuing to focus in this area and we would just highlight to investors that the growth has been very strong.
Yeah, Chris the other thing I would add is that where we made a change in our organization more than three years ago are forming our I cats group and we have just very very deep.
Engagements with our customers both on a technical and a support.
Side of our business and we have the broadest set of innovative products for our caps are if I look at where we're at today. Those are some of the areas that where we have a significant backlog M. D. P and implant a N F Y twenty-three are very very strong for us those are areas where we.
Have significant demand from customers and I caps is similar in that to the all of the rest of our business. This is always a race for all of these customers relative to power performance and cost.
And I kept Israeli materials enabled a we have a really strong team. There we have a great pipeline of products I will guarantee you every year will not be up that's for sure Oh, we're not going to guide 24, but we are in a very good position and I caps relative to enabling technology.
For future inflections.
Thanks, a lot Gary Thanks Bye.
Thank you.
Thank you and our next question comes from the line of Mark <unk> with Jefferies.
Hi, Thanks for taking my question.
Gary maybe maybe for you.
It seems like the consensus for Wi Fi. This year is somewhere in the $65 billion to $75 billion range and I'm not I'm not asking you to.
Give a guidance or an outlook for.
For next year, but I'm wondering in a scenario where that is proven to be too.
Cautious of a of a.
Of an outlook for next year based on the conversations that you have with your customers would you say that that that would be because lead times are long and customers. Just they don't want to cancel orders or theres, new secular drivers like bigger chips or advanced packaging or trailing node like some of the things.
You've talked about or just.
Just competition at the at the leading edge is driving people to invest more than enabled by subsidies.
What are your what are your customers, suggesting to you are you know what I mean, your backlog grew even as memory came down like what is what do you think is the are the biggest drivers into next year, regardless of whatever the end number is and what could surprise on the upside. Thank you yeah.
Mark Thanks for the question so yeah.
All of our customers in any of these different markets.
The technology is moving very very quickly so they're all racing against each other for power performance cost our relative competitive position. So you know certainly as you mentioned in the leading edge foundry logic, there's a tremendous amount of.
Focus their high performance computing in a number of those different markets and you know again for applied what we've talked about is a real strength and enabling new structures that are critical to competitive positions for our customers. Our gate all around as an incremental billion dollars for apply.
<unk> for 100000 wafer starts more than.
What were currently capturing with Finfet, we're on a path to gain five points of share in the transition from a finfet to gate all around wiring is probably the number one focus and I don't know that everyone really understands how important that inflection is for our customers.
That's an area, where we have tremendous strength.
We're enabling.
50% reduction in wiring resistance with integrated platforms that combine many technologies together. So that's another one where applied is really well positioned packaging has grown.
For applied to nearly a $1 billion and we have over 50% share in the Bronx and in our served markets and we have by far the broadest our position in advanced packaging and we're still in the early innings of that inflection, but again, that's all part of this technology race for all of our customers.
I caps I mentioned that earlier on the call are those are also markets, where I think it's surprising to people, including you've seen some of our peers talking about <unk> growth over a longer period of time.
There are technology inflections, there and that's as I mentioned earlier metal deposition implants are those are areas, where we're very very very strong enabling positions with our customers I think the other thing for applied beyond all of these different areas high speed DRAM with logic like structures all of those big.
Our PDC business grow I think it was 67% and our FY 'twenty one we're up around 35% in FY 'twenty two a that business is also outperforming and we think that will continue to outperform as we go forward. So at least from an applied standpoint.
It's really all around those big inflections and how we're positioned for those major inflections. So I don't know if price if you want to add anything.
Yes.
Comment that the we highlighted that we still have to catch up.
Two customer demand in several areas so that adds.
Some momentum into 'twenty three and then the other piece is just it seems clear that productivity to drive productivity in the world a lot of these things like in the energy market datacenter market et cetera, still have a resilient demand.
Yeah.
Thank you very helpful.
C Q.
Next question comes from the line of <unk> Malik with.
With Citi.
Alright. Thank you for taking my question, Gary I have a question on long term impact of China restrictions to both domestic and multinational spend.
Look at China spending over the last five years. It has outgrown WSB by two to four times.
What replaces this in terms of spending capital intensity and above average profitability for you.
Yeah.
Yeah, Hi, I'll start. This is this is bryce I think on the on the China side, when we look at that impact.
The larger part of the business has been on the trailing nodes for us and we expect that to still be a very strong business.
For applied and we see that in both the factory projects that we monitor and also in the different end markets, where there is investments and then on the on the leading edge you know if it's a question of do we expect that demand to be taken away from <unk>.
<unk> feed demand globally and permanently.
Don't it'll either be satisfied in some way a in China, either by multinationals or in some other way or it'll move to another you know geography. So so we don't believe that that will be an impact and just circling back around I would just focus on over time, we expect the China market to be a strong grower, especially in the.
I caps mature node space.
Thank you. Thank you.
Thank you.
And our next question comes from the line of Toshi Hari with Goldman Sachs.
Hi, Thank you so much for taking the question.
Wanted to ask about the Ags business going into next fiscal year and calendar year. Obviously, it's been a very steady grower for you guys and for the overall industry.
Many of your leading edge memory customers in logic and foundry customers I believe are in the process of putting wafer starts.
You know potentially over the next couple of quarters. So I guess the question is when you when you say services one of the reasons.
So while you'll outperform into next year is the baseline assumption that business continues to grow.
The installed base growth and given how you transport the mix of that business or could it be down but still.
Thank you.
Okay. Thanks Toshi. Thank you yeah, a couple of drivers here, you'll see in our outlook for Q1 are that we have a down quarter for age, yes, which is unusual and the reason is we've got a full quarter impact are approximately 100 million for the reduction of.
The China customers that we won't be able to serve.
For the rest of the year. So so that's definitely a headwind in Q1, but you hit the nail on the head with respect to the dynamics. Thereafter every time, we ship a tool that grows our installed base of equipment.
We grew the installed base, 8% last year.
Beyond or after that our ability to provide services and put those services on subscription agreements. We we typically outgrow the installed base than we did last year. So that is the driver for the reason the services business is sticky we have more equipment to serve the equipment becomes.
More intensive in terms of our.
Service needs and over time that grows the business not to your point a portion of the business is transactional we do see a lower utilization this quarter and next quarter what.
What we would point to what we have pointed to is you know even in 19, where there was lower utilization. We still grew the services business and besides the headwind of China that I pointed out we expect that to be the dynamic this year and going forward.
Yeah. This is Gary I'll add a little bit more color. So we do expect services to be up in 'twenty three.
<unk>.
As Bryce mentioned transactional will be down based on capacity utilization, but our profile with a significant amount of our service and spares business being agreements Ah gives us stickiness going forward and that is continuing to increase the comprehensive agreements.
16% last year the tenure of our agreements the length of the agreements are up to 2.6 years renewal rates at 93%, So where it was an interesting thing through the all of the chip shortage period of time, we were able to demonstrate value for our customers with ramp services to ask.
All right chip output managed part services, so that people could increase tool availability and output managed services for yield and optimizing productivity. So all of that helped us position, our service business and a higher value for our customers and again, that's what gives us.
The ability to continue to grow into 'twenty, three and then the longer term model, we've communicated as double digit growth and we still have high confidence we'll achieve that.
Thank you so much.
Thank you.
Next question comes from the line of Harlan Soar.
J P Morgan.
Hi, Good afternoon. Thanks for taking my question is a follow up on the Ags So looking back on fiscal 'twenty two.
Youre, saying systems operating margin declined about 200 basis points on strong revenue growth, obviously due to the inflationary cost pressures.
Sustained near record operating margins of 30%.
How has the team been able to sustain the record or near record Ags operating profitability in this inflationary environment and more importantly in a down year or potential down. Your next year you guys talked last call this call and sustainability with a GFS from a revenue perspective, how should we think about the sustainability of operating margins for <unk>.
Yes.
Yeah Harlan it's thank you. So one thing I would call out as you know we did have lower gross margins and operating margins in Q4, and that's largely due to looking at the specific inventory we had for China customers are that we will have to.
Either reposition or or or move somewhere else or scrap but to your point on operating profit.
One of the plans the business has there is to improve the amount of a repair that we do for products that we bring back to customers and so that helps us lower the cost and cost of goods sold with customers and that's one of the ways that we improve.
Our gross margins and the ultimate profit of that business and the other is just increased efficiency as we as we demonstrate more and more capability with the customers and we provide more services with the same.
Spending profile, then that helps us maintain the profitability those are the two key drivers.
Thank you.
Okay.
Thank you.
And our next question comes from the line of Joe <unk> with Wells Fargo.
Yes, thanks for taking the question I wanted to ask about the gross margin impact from the China restrictions can you talk about what's driving that one percentage point impact and then how do we think about what you could potentially recapture and the mitigated scenario that you outlined.
Yes. Thank you. So so two things it depends on which time period, you look at but if we if we look forward. The gross margin impact is really that they're generally smaller customers. So the profitability of those customers for applied is higher.
And you know when we talk about mitigation as we go forward, it's going to be TBD as to who.
Who we sell that product to and what the profitability is so at this point, we're expecting a the impact that we described and if you look at the current quarter. We did have specific a specific inventory for our customers. That's unique we are working to qualify some of that inventory and.
And we were successful to a degree but we did have specific inventory that we had to take.
Take a demand reserve on.
Got it thank you.
Yes.
Thank you.
And our next question comes from the line of Timothy Arcuri with UBS Securities.
Thanks, a lot Gary.
I had a question about Wi Fi intensity.
So we're exiting this year at 15, 5% and you were saying that through 2030, you think that'd be if he is going to grow faster than semiconductors, you've certainly been beating that drum now for a while that debate phenotypes, he's going to keep going up and obviously there are some underlying upward pressures, but China has obviously been ordering tools and building.
Capacity well it had a demand now in part due to the fear of these bands. So if China becomes a little more of a lagging tier region wouldnt that lower WC intensity, a bit and maybe argue that maybe it has to reset a bit thanks Gary.
Yeah.
I'll jump in for a second here just because I I have you know the picture of the graph in my mind that we use. So we do think intensity is gradually increasing and it's because of the reasons. Gary described a lot of steps in the process are becoming more complex and require more equipment and we see that and then when we think about.
China and I caps are specifically.
In the past, there's been a lot of reuse of existing.
Fabs and existing process tools and that.
Allowed for a low intensity and that's not been what's happening in the past few years and with recent additions I mean, we've talked about the number of factory projects that we see so as capacity gets added even in the cap space. What you see is an intensity level. That's more like what we were experiencing on the leading edge just a few years ago.
And that's also serving to raise the overall average of intensity. So so we're pretty confident that intensity will continue to rise.
Yeah, a camera on a relative to I cats, just reminding people that there was a time period, where you had a lot of movement of business two foundries and during that time period. There are many factories.
And to us that came on the market all of that stuff is gone. So that's what price was referring to relative to I caps capital intensities and then if you look at all of the I went through a list of key inflections.
Technology inflections for our customers and I gave some color around wiring and the number of steps that are increasing and that's why we're seeing a really in all the all of the different segments of the business. So I think that capital intensity is probably the right ZIP code if we look through 2030.
Thanks, Gary.
Right.
Thank you and our next question comes from the line of Joseph Moore with more.
Against it.
Great. Thank you.
Wonder if you could talk about the environment in China with the multinationals obviously.
They need to get a license they did immediately get license, but it's a 12 month license. So what would you say that you would generally see.
Foot print moving away from China with those multinational customers did you see any potential for that to become an issue down. The road can you just talk generally to the fact that the multinationals were included in this.
Yeah. Joe This is Gary Thanks for the question. The multinationals are not impacted today relative to their strategies, we'd really rather have them comment on that so again just today.
They're not impacted how they are how they position their businesses geographically.
It's really up to them.
Thank you.
Thank you.
And our next question comes from the line of Sidney Ho with Deutsche Bank.
Thanks for taking my question I wanted to follow up on the earlier question on the longer term W. E. As you think about the growth of <unk> in the next call. It three to five years, how do you think about the mix between the different type of tools that how that could change, meaning deposition and etch versus litho versus process control.
As you talk to your customers about their roadmap and technology inflections and I also want to ask about I assume your your served addressable market will continue to expand but maybe help us understand how much would that go.
Oh, yeah. Thanks for the question. So if you look at what our customers are talking about relative to their roadmaps.
Really there are five big drivers of the of the technology's going forward workload specific architectures are there are our new structures, new materials, new ways to shrink new advanced packaging.
Inflections for our customers and so what we see if you look at the advanced foundry logic roadmap.
You see a tremendous focus on new structures and new materials, the transistor innovations around gate, all around or essential relative to power and performance wiring I've talked a lot about wiring our largest business is our metal deposition.
And the wires are getting thinner.
And there is a resistance goes up so you're seeing more dollars are moving in that direction. Our advanced packaging is an area, where we see for sure. That's another big one of the big five drivers for the Roadmaps for our customers and that's still in the early innings around 1 billion.
Business for us today over 50% served market for the areas we participate.
And so we see that one you know that's an area that well attract a tremendous amount of investment relative to competition between customers.
It is very very important Ah and memory, you certainly see material scaling and three D. NAND as customers are moving to a.
More layers or are other ways to include logic and memory together through different technology inflections DRAM is moving to high speed and so you'll have high K metal gate and a logic like structures. There so a lot of that investment.
You know is moving more towards materials enabled AR technologies, and that's where applied has a really a tremendous strength I don't know, Brian do you want to add anything there.
Good thanks.
Alright, thank you.
Thank you and our next question comes from the line of Quinn Bolton with Needham <unk> Company.
Thanks for taking my question just had a question with a chipset applications expected to be received your submitted beginning in sort of the February temporary I'm wondering as you look.
23, WCS do you expect to see any benefits from from chipset spending in 2003 or do you think it's really more of a 'twenty four and beyond before it hits the <unk> spending thanks.
We do expect we do expect Quinn, a small really small amount in 'twenty three on the equipment side, it'll likely really start in 'twenty four as a number of those projects are you know start with construction. There are a few that will start with equipment, but it'll really for us be more of the 'twenty four time frame.
Yeah, Ken the one thing I'd add is that those investments are time bound and so as Bruce said not so much in 'twenty three starting in 'twenty four but they are there are there is timing associated with the with those incentives.
Got it thank you.
Thanks, Quintin and operator, we have time for two more questions today.
Certainly.
And our next question comes from the line of Pierre for Ragu with New Street.
Thank you for taking my question.
Gary I'd like to come back to the comments you made about capital intensity in the.
The specifics of that.
It was a trailing edge.
Part of your portfolio and so you described there I think like three reasons why.
I mean, two reasons why is that.
Okay.
Very high there.
The first one is.
But that was more innovation going on so.
No.
Capital intensity.
And then you mentioned if I got that used to be like a secondhand market sitting here.
The trailing edge.
That's just kind of going away and my question is did.
Most of you saw the third element that justifies a very high tech. So you can see.
Today, we see that.
We've been growing very very fast.
And last year.
He can share the capacity grows you're at some point going to slow down or even two codes and so I'd like to hear your thoughts about that and give you a sense of how.
How much it could impact the shelf just.
So you mentioned you.
Hi, This is Gary thanks for the question. So I will say that for 100% sure certain that all of these markets will not be up every year.
But what we do see if you think about it.
Pick a number in terms of edge computing devices by 2030.
These technologies are becoming much much more pervasive there really if you think about industrial automation or a gas to smart electric vehicles, you know a number of different inflections.
A lot of these <unk> technologies.
<unk> are going to grow at a.
Fair compound annual growth rate and I think that's what other people are saying also so you know how that what the shape of that looks like every single year, we're not going to forecast that but we do think that that that business is going to see healthy growth and that's why also we formed the <unk>.
Organization three years ago, we saw that that market was going to be a significant from a growth perspective and pulled together all of our different technologies. So.
Again, if I look across all of those segments with ni caps, we think over the longer term are there will be a.
Significant compound annual growth rates, we have very very strong positions in enabling some of those technology inflections and I caps, but you know we're not going to give a specific profile on a year by year basis.
Thanks, Gary.
Yeah.
Thank you.
And our final question comes from the line of David O'connor with Exxon BNP.
Great. Good afternoon. Thanks for taking my question a follow up on the backlog to a previous question.
Gary or Bryce, how should we think about the timeframe of getting the backlog back to a kind of a more normalized level or when do you expect to get caught up on demand for those products that are running pretty hot on the <unk> side. Thank you.
Yeah. Thanks, David.
We're expecting it's going to take us more than two quarters. So it depending on the line of equipment I would say between two and four quarters as our internal estimate and so that's what we're focused on we are behind with the customers and we're working on increasing output.
Every week.
Thanks for the question.
Thank you.
Yeah. Thanks, David for your question and Bruce would you like to give us your closing thoughts today, absolutely clearly there are questions about the market in the near term, but for our part we had healthy Q4 orders and we have record backlog that we described and it's mostly in our leadership product areas that drive the big technology inflections.
Job one for us is increasing our output to meet customer demand. We're in a strong financial position to continue to develop our broad portfolio of technology and to drive the critical inflections and to support eventually a one trillion dollar semiconductor market.
I hope we get to see many of you at the upcoming credit Suisse and Wells Fargo conferences in the meantime, we hope you enjoy a safe and happy Thanksgiving. Thank you, Mike let's close it up.
A great price.
So we'd like to thank everybody for joining us today, a replay of the call is going to be available on our website by five o'clock Pacific time, and we would like to thank you for your continued interest and applied materials.
Okay.
The conference will begin shortly to raise your hand during Q&A you can dial star one one.
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