Church & Dwight Q3 2022 Earnings Call Transcript

Quartr
Provided by Quartr
August 17, 2022

There are 13 speakers on the call.

Operator

I will now turn the conference over to Michael Sullivan, Corporate Vice President. Please go ahead, sir.

Speaker 1

Good afternoon, everyone, and thank you for joining Slide's Q3 of fiscal 2022 earnings call. Joining me are Gary Dickerson, our President and CEO and Bryce Hill, our Chief Financial Officer. Before we begin, I'd like to remind you that today's call contains forward looking statements, which are subject to risks and uncertainties that could cause our actual results to differ. Information concerning the risks and uncertainties is contained in Applied's most recent Form 10 Q and 8 ks filings with the SEC. Today's call also includes non GAAP financial measures.

Speaker 1

Reconciliations to GAAP measures are found in today's earnings press release and in our quarterly earnings materials, which are available on the IR page of our website at appliedmaterials.com. Before we begin, I have a calendar announcement. Applied plans to host our services masterclass 5 weeks from today, on Thursday, May 26 at 9 o'clock Pacific Time. We'll describe the market opportunity for our services business, explain why 87% of AGS revenue is truly recurring and give you the growth formula for the business through our 2024 financial model horizon and beyond. We hope you'll join team members of our Global Services team for presentations and Q and A.

Speaker 1

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

Speaker 2

Thank you, Mike. In our 3rd fiscal quarter, Applied Materials delivered results at the high end of our guidance range and record quarterly revenues. The actions we've been taking to mitigate supply chain challenges are beginning to have an impact and we expect steady incremental improvements from here. Resolving supply issues has required new levels of collaboration between our global teams, suppliers and customers. While all of this hard work is yielding results, global supply chains remain stretched.

Speaker 2

Demand for Applied's products It's still higher than our ability to fulfill it and our backlog continues to grow. In addition, our relentless focus on meeting customers' needs In this very difficult environment has created margin headwinds that we're working hard to overcome. We're driving actions to reduce costs and improve value capture, including price adjustments. In my prepared remarks today, I'll cover 3 key topics. 1st, our near term outlook on supply and demand dynamics 2nd, our longer term view of the markets And the industry's roadmap.

Speaker 2

And 3rd, Applied Materials strategy, priorities and progress. After that, Bryce will provide more color on our financial performance and key areas of operational focus. Let me begin with our near term perspective on the market. Due to large gaps between demand and supply, as well as equipment companies shipping partially finished systems In emerging components in the field, overall 2022 wafer fab equipment spending is difficult to quantify with precision. Our best estimate is that it will land somewhere in the mid $90,000,000,000 range.

Speaker 2

For Applied, the picture is clearer. If we use the midpoint of our Q4 guidance, we expect our wafer fab equipment revenues to be up approximately 15% for our fiscal year. As we look ahead at 2023, there are 3 major factors shaping our view of the market. 1st, 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. 2nd, Leading edge foundry logic looks strong with customers battling for leadership and racing to be first to implement Major technology inflections.

Speaker 2

3rd, iCAPS customers who serve IoT, communications, auto, power and sensor markets Our reporting areas of strength and weakness, these customers serve broad and diverse applications. They're seeing softness in consumer centric markets, which are being impacted by macroeconomic factors. Auto and industrial demand continues to be solid because those investments are driven by large inflections such as electric vehicles and industrial automation. In these areas, chipmakers are securing long term Capacity agreements that underpin their capital spending plans. While it's too early to provide a forecast for 2023, We believe our business will be more resilient than in the past if there is a demand to pull back in certain areas of the market.

Speaker 2

We expect Applied to remain supply constrained for the next several quarters. We're working through our very substantial backlog of orders, which provides a buffer to in year demand fluctuations. And in addition, customers are providing us With longer term visibility and commitments in response to their own customers' actions to lock in the strategic capacity they need. Although we're confident in our ability to perform well in a range of market scenarios, we're mindful of the current macroeconomic trends. As a result, we are slowing down hiring, while ensuring we fully fund the R and D programs And strategic operational capabilities that support our long term growth.

Speaker 2

Regionalization of supply chains It's 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 DC for the signing of the CHIPS Act And met with government officials and leaders from across the semiconductor and automotive ecosystems.

Speaker 2

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 Change 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 $1,000,000,000,000 before the end of the decade.

Speaker 2

That translates to a high single digit compound annual growth rate from today. In parallel, the technology roadmap It's becoming increasingly complex. As a result, we expect equipment intensity, the ratio of wafer fab equipment investment The semi revenues to remain at today's level or increase over this period. Then the major technology roadmap inflections, Including gate all around transistors, backside power distribution networks, new materials for interconnect and contact And heterogeneous integration of chips and chiplets are enabled by materials engineering, where applied materials is the leader and this shifts more dollars to our available market over time. We've invested ahead of these inflections to create a portfolio of differentiated solutions that positions us to outperform as these new technologies transition to volume manufacturing.

Speaker 2

Applied Materials strategy is built upon the breadth and strength of our technology and capabilities. This provides us with a unique ability to engineer, co optimize And integrate solutions that address our customers' highest value technology challenges. Co optimized solutions where we optimize Adjacent process steps and integrated material solutions or IMS where we optimize a combination of process steps In a single system under vacuum are becoming an increasingly important part of our product portfolio. In our recent master class, we talked about a breakthrough IMS approach for tungsten only contacts that are free of conventional barrier materials. This provides significant improvements in contact resistance and is critically enabling for smaller foundry logic nodes.

Speaker 2

The number of process steps are growing as these customers migrate to this pure metal technology And these low resistance integrated solutions for contact and wiring represent new multi $1,000,000,000 revenue opportunities. Over the past two quarters, we have secured multiple tool of record positions at all leading customers. Our ability to co optimize materials engineering solutions with novel inspection and metrology is also driving record performance In our Process Diagnostics and Control business, we expect PDC revenues to be up almost 40% in fiscal 2022 With broad based customer adoption of our EB metrology and new optical wafer inspection platforms. In the quarter, we also strengthened our iCats portfolio with a tuck in acquisition. Pico san is a leader in batch ALD technology We're delighted to welcome their talented team to the Applied Materials family.

Speaker 2

Turning to service, AGS delivered record quarterly revenues Despite headwinds for our transactional spares and 200 millimeter equipment businesses due to supply chain constraints, The subscription portion of AGS continues to demonstrate strength. Install based tools under long term service agreements Grew 9% over the past 12 months. Our renewal rate for these agreements continues to be strong and is currently running at 93%. Before I hand the call over to Bryce, I'll quickly summarize. We're beginning to see gradual improvements in our supply chain, Which enabled us to deliver record revenue for the quarter.

Speaker 2

We expect demand to remain higher than supply for the next several quarters And we're continuing to drive actions to close the gap. The changing macroeconomic environment is causing some customers to adjust the timing of their investments. However, we're confident that our business will be more resilient, Thanks to strong pull for a uniquely enabling technology, our large backlog, longer term visibility from our customers And industry wide investment in strategic regional capacity. Our long term view of the market remains unchanged As multiple parallel secular trends drive the semiconductor and wafer fab equipment markets structurally higher. At the same time, large technology inflections that are enabled by our core capabilities in materials engineering create Now, I'll hand the call over to Bryce.

Speaker 3

Thank you, Gary. I'd like to begin by saying thank you to our teams and our supply chain partners for helping to increase our output despite ongoing constraints And unexpected shortages. Our factory and logistics teams operated with agility, adjusting to almost daily changes in supply schedules. We are still not meeting all of our customers' demand and solving the supply chain shortages to increase our manufacturing output remains our top priority. Before I summarize our Q3 results, I'd like to emphasize 4 points.

Speaker 3

First, our overall demand remains healthy. Specifically, our orders remain strong in Q3, our backlog increased, overall factory utilization remains high and customers have added 4 new factory projects 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. 2nd, our supply chain improved incrementally in the quarter as Gary mentioned. We have added significant investments and talent to our supply chain teams to resolve bottlenecks and to improve our inventory and overall output.

Speaker 3

3rd, 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 4th, we are confident in the industry's underlying growth trajectory And our unique materials engineering capabilities for process innovation. While we are slowing our headcount growth, we have increased Our R and D spending by around 10% year to date and remain fully invested in enabling our customers' roadmaps.

Speaker 3

Turning to our Q3 results. We delivered record revenue of $6,520,000,000 which is in the high end of our guidance range. Non GAAP gross margin of 46.2 percent declined 80 basis points quarter on quarter. Non GAAP operating spending was 1 point $6,000,000,000 which is right on target and up $39,000,000 quarter on quarter as we increased R and D and added supply chain resources. Non GAAP operating margin declined 60 basis points to 30%, driven by the lower gross margin and headcount additions, primarily in engineering.

Speaker 3

Non GAAP earnings of $1.94 grew $0.09 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 $276,000,000 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 $37,000,000 or 3% quarter on quarter. We continue to deliver healthy year over year growth in subscription revenue, while the supply chain shortages constrained our growth in transactional parts and 200 millimeter systems.

Speaker 3

AGS non GAAP operating margin was 30.6% and slightly up quarter over quarter. I'll take a minute to share a few observations about AGS. Next month, we'll host the Services Master Class where you'll have an opportunity to learn more about our strategy to increase our recurring revenue. The 3 key drivers are the growth of our installed base, Equipment service intensity and long term service agreements. AGS is making excellent progress toward our 2024 financial model.

Speaker 3

We exited Q3 tracking around $500,000,000 ahead of the base case of our AGS revenue plan and around $250,000,000 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.

Speaker 3

Our display revenue declined by $48,000,000 or 13 percent to $333,000,000 The business contributed $70,000,000 of non GAAP operating profit, which is down sequentially by $12,000,000 or 15%. Turning to our cash flows. We generated $1,470,000,000 of operating cash flow during the quarter, which was 23% of revenue. We returned $1,230,000,000 or 97 percent of free cash flow to our shareholders, Deploying $1,000,000,000 to repurchase 9,800,000 shares of company stock and paying $225,000,000 in dividends. We also deployed around $440,000,000 for 2 strategic acquisitions.

Speaker 3

We expanded our ALD portfolio with the addition of PicoSun And we acquired a talented simulation software team. Year to date, we have produced over 4 point $5,000,000,000 in operating cash flow and nearly $4,000,000,000 in free cash flow and returned $5,250,000,000 to our shareholders. Now I'll share our guidance for Q4. We expect revenue to increase to $6,650,000,000 plus or minus $400,000,000 We expect non GAAP EPS to be $2 plus or minus $0.18 Within this outlook, we expect Semi Systems revenue to increase to $4,930,000,000 or up 14% year over year. We expect AGS revenue to increase to $1,430,000,000 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 $250,000,000 We expect to incrementally increase Our non GAAP gross margin to 46.4 percent.

Speaker 3

And we expect non GAAP operating expenses to increase slightly to $1,080,000,000 We are modeling a tax rate of 11.8%. Before we begin the Q and A, I'd like to summarize our company's position in the current environment. We continue to see very strong customer pull for advanced technology in all of our markets and our backlog continues to grow. We believe some of our customers will moderate their capacity additions in areas that have been impacted by weak consumer spending. However, I expect Applied's business to be more resilient than in past periods for three reasons.

Speaker 3

1, Is that we have strong exposure to technology investments, particularly in the foundry logic market, which has grown to become approximately 2 thirds of wafer fab equipment spending. 2nd, 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. 3rd, that our services business has grown to over 5 point And now, Mike, please begin the Q and A.

Speaker 1

Thanks, Bryce. To help us reach as many people as we can, please ask just one question on today's call. Operator, let's please begin.

Operator

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

Speaker 4

Yes. Hi. Thanks for taking the question. I guess, question for me would be in light of record backlog and extended lead times and Some of the puts and takes around customers moving out production plans. How are you thinking about The timing of easing of supply constraints, how you're thinking about internal tool production into 2023?

Speaker 4

And as part of that, Driving, I assume gross margins higher throughout that time. We'd love to hear your thoughts around that.

Speaker 3

Good afternoon, CJ. It's Bryce. Just, yes, good question on supply constraints And timing versus the demand environment, etcetera. So let me explain what we've done the last couple of weeks. We just went through a cycle where we Reconfirmed all of our 2023 demand with our customers, something we do once or twice per quarter on a regular basis and it 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.

Speaker 3

And in the constrained environment, that lets us balance Our supply across the customer base in the best way. So we've just completed that. And there are a number of changes, but what we see for 2023 and the next 3 plus quarters, as we said 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 and our secondary suppliers, so our expectation is that we'll increase output for the next several quarters And continue to work on that backlog, which as you highlighted has been has continued to grow.

Speaker 2

Hey, C. J, this is Gary. I guess also relative to supply chain, what we've been certainly the 0 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.

Speaker 2

We're doing everything we can, making investments, It's 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 that's really the direction both for supply chain and for margins is more incremental improvement throughout 2022 and going into 2023.

Speaker 1

Thank you.

Operator

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

Speaker 5

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, we're adjusting the 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 2? Or do you at some point, do you just say, listen, we can't push this back anymore, you've got to take it or go to the end of the line.

Speaker 5

If you could just provide some color about what you're seeing real time on the ground is like how many people are pushing back? Is it a quarter? Is it 2 quarters? And the mechanics operationally, how you guys manage that process? Thank you.

Speaker 3

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.

Speaker 3

We're not trying to demand Stay on the schedule that they have, etcetera. So we try to be flexible. And that was really the point of going out and retesting And reverifying all of the demand that we have across the customer base. So Gary, you may want to add to that.

Speaker 2

No, I think that's exactly right. Again, the challenge we face right now, again, many of our customers are really driving major technology inflections. And Mark, I think you see also especially in high performance logic, everyone is racing to these new inflections. So We just have tremendous demand from those customers, in iCAPS, automotive, industrial automation. So Unfortunately, we're not able to supply to that demand.

Speaker 2

And as Bryce said, memory is weaker And we try to manage and work with the customers to come up with The right outcome for them and for us.

Speaker 5

Very helpful. Thank you.

Operator

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

Speaker 6

I'm trying to reconcile the two things, right? 1, I think, Bryce, you mentioned you are going to be increasing capacity over the next several quarters. But then from a demand perspective, I believe, Gary, you said that memory could be down. I think you said kind of mixed views on ICAPS, but then leading edge should be up. So my specific question is based on I know you're not giving Next year's guidance per se, but based on what you see, are we looking at kind of a garden variety, flat to down 5%, 10% In terms of the spending environment or is it very different than that view?

Speaker 6

Just so that we have some baseline view of how you're thinking about the industry going into the next year given you do plan to increase supply.

Speaker 3

Hi, Vivek. It's Bryce. To reconcile those 2, I think the first thing to be clear on from our side is that demand for the next several quarters, 3 plus, It's far higher than supply. So we are going to concentrate like we say on increasing our And we'll do our best to do that over the next several quarters. And that's our expectation is demand will stay above where we can supply across that time Period.

Speaker 3

So I think someone said it before that we're underserving the market so far that Such that if there's a change in demand, it's still above where our supply line is. That's the perspective we have. And if you think about or if you're asking about 23, like we said, it's too early to make a call on 23, but what we would point out is Different areas of the market sure are having some weakness, some inventory issues. Other areas are very strong and are on schedule Build the processes that they need for customer products that are also on schedule. So we think those puts and takes More or less, we'll continue the demand signal for us into next year.

Operator

Our next question comes from Stacy Rasgon of Bernstein. Your line is open.

Speaker 7

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

Speaker 3

Yes, exactly right, Stacy, this is Bryce. Definitely the backlog is increasing and definitely the, Foundry Logic backlog is the strongest Yes, strongest component of that in terms of orders and adds to our order book. I'd say that's good. We know there has been reductions on the memory side. I don't actually know if the memory side is down in total overall, But I think that's a fair way to look at it.

Speaker 3

Some customers have reduced backlog on memory, but overall, foundrylogic and some of the ICAPS Customers are driving and outweighing increase on the positive side.

Speaker 2

Hey Stacy, this is Gary. So also the foundry logic is an increasing percentage of overall wafer fab equipment. So if you look at The percentages, foundrylogic is really around 2 thirds of total wafer fab equipment. And so Certainly, the race for competitiveness and high performance, you see that with companies Making significant investments. ICAPS, you've seen a lot of announcements with companies making long term investments In the ICAPS capacity, so certainly, you see that in the increasing percentage of foundrylogic in the overall market.

Speaker 2

So, yes, I think that what Bryce said and what you had also asked in your question, Certainly, foundrylogic is strong, and that backlog still unfortunately we're not able to meet demand.

Speaker 7

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

Operator

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

Speaker 6

Question for Bryce. Bryce, some of your U. S. Peers that talked about expanding China restrictions to sub-forty nanometer, did that impact your July or October quarter outlook? And if you can remind us of your total China sales, What is display systems versus silicon?

Speaker 3

Thanks, Atif. Yes. First of all, we did get the same notice as our peers did on that. So that is sub-fourteen nanometer shipments to China customers and it did not impact our July quarter and very small for October quarter and that's included in our guidance. So that part is clear.

Speaker 3

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 I'll take it.

Speaker 2

Atif, thanks for the question. So, we're not going to break out the exact amounts of our business in China, but Display, most of our display revenue does come from China and then you have the global customers and the domestic customers. 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 foundrylogic business in China is ICAPS, which is on the trailing nodes.

Speaker 1

Thank you. Very helpful.

Operator

Thank you. Our next question comes from Chris Sankar of Cowen. Your line is open.

Speaker 8

So, Bryce,

Speaker 9

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

Speaker 3

Sure. Thanks, Krish. 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 3 plus quarters, We'll just be working on raising our output and serving that backlog. But if you want to do a what if, if revenue goes down Or if WFE goes down, the first thing I would remind investors also is that our services business doesn't fluctuate or Correlate 100% with WFE.

Speaker 3

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 portion of our revenue tends to dampen any weakness that we would have from a lower WFE. I would just highlight that For people that are thinking models, so whatever would change on WFE and change on the equipment side, it would be a dampened signal on the services piece of the business. And then for overall modeling purposes, I would look at Probably as a proxy year 2019 to see how the business reacted to a lower revenue environment where you can look at the margin performance in 2019, which was down 1 or 2 points and you can look at spending where it was controlled relatively flat. I think those would be the same sort of reaction the company would be able to implement in that sort of environment if you were doing a what if, which again is in our forecast.

Speaker 9

Got it. Thanks a lot, guys. Really appreciate it.

Speaker 1

Thank you.

Operator

Thank you. Our next question comes from Toshiya Hari, Goldman Sachs. Your line is open.

Speaker 7

Hi, good afternoon. Thanks so much. Gary, I was hoping you could expand on some of the comments you made regarding the chipsets And 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 A small tailwind or a minor tailwind starting in late 2023. First of all, if you could sort of Quantify that for us for 2023 2024, that would be super helpful.

Speaker 7

And then more importantly, how has the conversations you're having with your customers Changed since the chipset has gone through. I guess the main question that I get from investors is If a big foundry in Taiwan decides to build capacity in the U. S, isn't it sort of a 0 sum game where You sort of subtract from what could have happened in Taiwan and you just kind of take that over to the U. S. So net net, isn't it sort of a zero sum, But how would you kind of respond to that?

Speaker 7

Thank

Speaker 2

you. Yes. Thank you, Toshiya. So on the CHIPS Act, first I'd say, I am very happy to see that CHIPS and Science Act pass and become law. That's really positive for United States and the overall industry.

Speaker 2

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, some ICAPS investments, those kinds of things. So as I mentioned earlier, again, 2 thirds of Wafer Fab equipment is in that foundry logic space Today, and so that's going to be incrementally positive going into late 2023 and beyond. Those investments also are time bound. If you look at the incentives, there are certain timeframes where The funding is available and investments have to be made. So that creates a higher degree of certainty.

Speaker 2

I would say, as those companies I've talked to many of them, and as they move to new locations, There is startup costs and some incremental less efficiency as they start those fabs and Especially for our service business, that's an incremental positive. So I think you'd see small incremental Spending late 2023 beyond, as all of those investments and those factories are starting up. Over time, Toshiya, I think it really as they it really depends on the scale of those factories. Bigger factory is more efficient than a smaller factory. And so until they build them out, which will take many, many years, There will be a degree of less efficiency, for some period of time.

Speaker 2

But again, if you look at it in the grand scale of overall WFE, It's not a huge tailwind, but it's definitely a tailwind.

Speaker 7

Got it. Thanks so much.

Operator

Thank you. Our next question comes from Holland Sur of JPMorgan. Your line is open.

Speaker 10

Good afternoon. Thanks for taking my question. I wanted to expand on some comments that Bryce had on services. Maybe this is a plug for your upcoming master class. But I mean, in the event of a weaker WFE environment next year, you have several positive buffers.

Speaker 10

I think the biggest one Is that your services business historically does not decline during downturns? In fact, over the past 11 years, and I think that's 4 WFE down cycles, I believe that there's only been 1 year that AGS was down and it's driven a pretty stable like 8% to 10% So the 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 a weak WFE environment. What is the team doing to ensure continued outperformance of services Doing WFE weakness and your confidence on driving growth in services if WFE is down next year?

Speaker 3

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 that grows every time we ship a tool. And then as you highlighted, our ability to serve that installed base both through transactional support, Spares and services and then the subscription agreements that we have with customers that offer spares Plus 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 really benefit from the intelligence that Applied has across the whole ecosystem of tools that they don't have potentially on their own.

Speaker 3

I think that's the focus area for the company and that's what gives us confidence that as that installed base grows, We'll be able to continue to grow our subscription agreements. And just the last piece is, you're right, we have the same analysis On, not being 100% correlated with WFE. And Even as if there's changes in WFE or weakness in the revenue and the rest of the business, it's really about the underlying utilization in the factories that exist and the need for services and intelligence in those factories. So I think those are the key drivers.

Speaker 2

Arlen, just thanks for reminding people about the master class coming up here next month. One thing that I think has helped us also. So if you talked about 10, 11 years, if you go back Over that time period, we've, I think close to doubled our percentage of subscription agreements, versus transactional. So Certainly, and we've increased the length of those agreements to 2.5 years. So that percentage of agreements being so much higher and it's still growing, Yes, that makes that business more resilient.

Speaker 2

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 managed part services, where people have the parts available versus competing for what's available from a transactional perspective, Along with all the things that Bryce talked about, I think that's really helped highlight the value of these longer term subscription agreements for our customers.

Operator

Our next question comes from Joe Quatro of Wells Fargo. Your line is open.

Speaker 10

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

Speaker 3

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.

Speaker 3

But I think the way we think about it for a leading edge foundry They're building processes that their customers are building products on and they need to be able to hit those schedules for the customer products. So they're fairly committed to getting that technology in place. And then you're right, the volumes will fluctuate depending on What the market is for those products, but if you're building a logic node for a product 2 years from now, you're really thinking about what the market is 2 years from now when you're putting that equipment in place. So it's not as simple as just looking at the current quarter's 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?

Speaker 3

We just retested all of the demand for next year and that's what all the customers are thinking about.

Speaker 7

Thank you.

Operator

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

Speaker 10

Around some of the mixed signals around what's happening this time around. And On one hand, customers are pushing out, but you also mentioned that you're getting long term commitments from some other customers. I was wondering what that means, Because it kind of sounds like you're confident that foundry logic is going to hold up this time even as memory pushes out and that's not usually how it works. Is it Is it simply that there's such a concentration of leading edge foundry capacity and there's going to be others such as your neighbor that are trying to compete to get back in the foundry business? Is that what's different this time?

Speaker 10

Because I'm hearing these mixed signals and there's something obviously different. So I'm just wondering if you can call on your past knowledge to help on that. Thanks.

Speaker 3

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

Speaker 2

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

Speaker 2

So again, for us that relative contribution and the relative investment And our types of technologies is going up and that's another thing that's helping us.

Speaker 8

Thanks, both.

Operator

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

Speaker 11

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

Speaker 3

Thanks, Joe. The first part, I guess, I haven't thought of it like that, but I would say that we Our resilient, more resilient philosophy or position would play to memory only. And The reasons that I would point to are 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.

Speaker 3

And the overall backlog is one of the reasons we're saying we're more resilient than in other periods. And the second is, the services business is One of the reasons that we're thinking that we're more resilient and that also applies to memory customers and customers that we service from a spares perspective, etcetera. I think that also is larger than it has been in the past and is more resilient relative to changes in WFE. And then the last piece, Just to make sure for everybody else, I wasn't implying that 2019 would be the P and 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.

Speaker 3

So

Speaker 2

Just to clarify that. Yes. Joe, this is Gary. I think if you say what's changed, what's the same and what's changed, Certainly, the percentage of foundrylogic is significantly higher than it was back in that timeframe. Again, it's tracking around 2 thirds.

Speaker 2

There's this race for leadership and high performance logic and significant investments are happening in that part of the market. And we see customers, our customers announcing longer term Agreements with their customers and that's something that we didn't see back in that timeframe. So I think the foundry logic percentage and the Relative strength there is definitely different than certainly than it was in the 2019 timeframe, relative to the overall wafer fab equipment market.

Operator

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

Speaker 10

My question is on the and then question is on China. When I look at the revenue from China, it came down about 7 percentage points quarter over quarter. I think that's more than some of their peers. Can you walk us through the dynamics there?

Speaker 3

Thanks, Sydney. This is Bryce. Yes, I think one specific driver and one just general observation, the specific driver is Most of the downside on our display business relates to customers in China. So that's the probably the primary change element. The rest is just the ins and outs, normal quarter activity.

Speaker 3

We don't think the China market, as we look forward is any weaker. We think the ICAPS investments that are being made there are largely on schedule. No real change in signal there. So it's just the ins and outs of having Different sized deliveries in the quarter. It happened to be a quarter overall that was a little smaller than the prior quarter.

Speaker 3

So we would point to display And then just general ups and downs for the rest of the change. And just reiterate, no change on the No change because of the trade rules, like we said before.

Speaker 10

Okay. Thank you.

Operator

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

Speaker 12

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

Speaker 3

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

Speaker 3

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

Speaker 12

And it's equally across the Raymond NAND?

Speaker 3

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.

Speaker 1

Understood. Thank you.

Operator

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

Speaker 5

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 your iCAF business in process control? Or is it entirely within the advanced node?

Speaker 2

Hi, Patrick. Thanks for the question. No, iCAHPS is very strong for our iCaTS is very strong overall for the company. PDC is up 67% In 2021 and we're up almost 40% in fiscal 2020 Hi, Patrick. Thanks for the question.

Speaker 2

No, iCAPS is very strong for our iCAPS is very strong overall for the company. PDC is up 67% in 2021 and we're up Almost 40% in fiscal 2022. What I would say relative to the breakdown of the different markets, Certainly, it's stronger in high performance logic than In any other part of the market, although we are seeing growth in memory and we are definitely also seeing growth in iCats. The biggest thing for us, if you look at our PDC business last year, e beam pretty much doubled. So we have Vertical integration with our electron optics, leadership and resolution and imaging technologies And that business is also very, very strong into 2022 and then also going forward, We are seeing incremental strength also in optical inspection and we believe we'll outperform The overall market in optical inspection and overall PDC has a really strong tie to PPAC T inflections.

Speaker 2

So when you look at gate all around or some of these other big inflections, Our unique imaging capability enables us to map out those processes and fingerprints faster And better than anyone else. So that synergy, not only do we see really strong growth in PDC, But real strong synergy with the rest of our semi portfolio.

Speaker 6

Thank you.

Speaker 1

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

Operator

Thank you. Our next question comes from Mehdi Rasi. Your line is open.

Speaker 8

Asking WFE question. Two follow ups. What would be your revenue guide if you had OLED components that you needed to shift to demand?

Speaker 3

That's a good question, Mehdi. Since it's It's been several quarters since we've been at that level. It's difficult to predict, but we did say I think 2 quarters ago that The supply constraints probably impacted us by $300,000,000 So I would say that and more if we had 0 supply constraints and we would be on a higher curve going forward.

Speaker 8

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

Speaker 3

Well, the changes for inventory, it's relatively balanced across the both across the entire inventory ecosystem. But the increase, I'm looking at the numbers, sorry, right now. Relatively balanced. I mean, here's what's happening on the here's what's happening dynamically. We have much more raw inventory coming in as we're trying to solve the supply chain issues and 95% or more of our parts are available and we're able to build inventory and that shows up In our WIP, in raw material.

Speaker 3

And on finished goods, what's happening is, we do have Material or tools that are complete or nearly complete that are awaiting one part or close to being shipped to customers and that inventory is also growing. So I think it's relatively balanced across all those components.

Speaker 8

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

Speaker 3

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

Speaker 8

Thank you. And thanks for the details.

Speaker 3

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

Speaker 1

Okay. Thanks, Mehdi, for your question. And Bryce, would you like to give us a summary?

Speaker 3

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 1 for us is to increase our output and meet our customer demand as quickly as possible. As we do this, we'll incrementally increase both our revenue and gross margin We're confident in the long term growth of the semi market and we're working to increase our investments in supply chain And especially to continue to focus on the R and D to drive the power, performance and area cost roadmaps of our customers.

Speaker 3

Okay. Mike, please close. A replay

Speaker 1

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

Operator

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

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Earnings Conference Call
Church & Dwight Q3 2022
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