Applied Materials Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 18, 2023

There are 13 speakers on the call.

Operator

Welcome to the Applied Materials Earnings Conference Call. During the presentation, all participants will be in a listen only mode. Afterwards, you will be invited to participate in a question and answer session. I would now like to turn the conference over to Michael Sullivan, Corporate Vice President, please go ahead, sir.

Speaker 1

Good afternoon, everyone, and thank you for joining Applied's Q2 of fiscal 2023 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 This is contained in Applied's most recent Form 10 Q filing 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 appliedmaterials.com.

Speaker 1

Before we begin, I have a calendar announcement. On July 11, Applied plans to host the SEMICON West Technology Breakfast From 7:30 to 9 a. M. Pacific Time, we plan to announce a major new platform and lead a heterogeneous integration panel Featuring executives from AMD, Intel and Qualcomm, along with Besse and the EV Group. You can register by visiting the Events page of our IR website.

Speaker 1

There won't be a webcast, so we hope you'll join us in San Francisco. And with that introduction, I'd like to turn the call over to Gary Dickerson.

Speaker 2

Thank you, Mike. Applied Materials delivered strong results in our 2nd fiscal quarter with revenues in the high end of our guidance range. Across the business, our teams are executing well, successfully managing a dynamic near term environment, making progress with our longer term strategic initiatives and introducing enabling new products and solutions for our customers. Despite macro headwinds, our outlook remains favorable and we expect to outperform our markets In 2023, thanks to our balanced market exposure, our strong position at key technology inflections, which is driving demand for our differentiated products, especially in metal deposition, CVD, etch, implant, thermal processing and E beam, and our growing service business, which is increasingly subscription based. In my prepared remarks today, I'll cover Our perspective on the market, both the near term dynamics and our longer term secular growth thesis, How Applied is positioned to outgrow the industry this year and over the longer term.

Speaker 2

And finally, the investments we are making To create more value for our customers and productively scale the company, in 2023, challenging and evolving macro conditions are impacting the Semiconductor industry both negatively and positively. Demand that is directly driven by consumer electronics is clearly weak, While demand driven by inflections in technology and strategic regional supply chain investments remains robust. This contrast can be seen in our customers' investment levels. Weakness in PCs and smartphones is a key factor for memory customers who have significantly reduced their investments in 2023. Measured as a percentage of total wafer fab equipment, Memory spending is tracking at its lowest level in more than a decade.

Speaker 2

In leading edge foundrylogic, We also have seen customers trimming their spending plans for the year. We see these changes as timing adjustments as these companies remain fully committed To their long term roadmaps to win the race for technology leadership in this market. Push outs in leading edge investments Are being offset by increased strength from customers who serve the IoT, communications, automotive, power and sensors markets. Over the past quarter, we revised our 2023 iCAPS forecast upwards with demand being driven by 2 interconnected factors. 1st, iCAPS customers are delivering critically enabling technology for large global inflections That will play out over the next decade.

Speaker 2

These include clean energy, electric vehicles and industrial automation. These inflections are driving significant innovation. At Applied, we have released more than 20 major new iCAPS products since we formed our iCAPS group 4 years ago. 2nd, there is a clear trend towards regionalization of supply chains As countries seek to build resilient local capacity to support industry verticals that are central to their economies. We currently see around $400,000,000,000 of government incentives being deployed globally over the next 5 years, A significant portion of which will be directed towards ICAPS markets.

Speaker 2

While China currently leads in ICAPS spending, We see other countries increasing their investments at a higher rate. In fact, the fastest growing regions for Our iCAPS business in 2023 are the U. S, Europe and Japan. Looking beyond 2023, Our long term growth thesis for the industry remains unchanged. Semiconductors are the foundation of the digital economy, which is driving demand and puts the industry on a path to become a $1,000,000,000,000 market by the end of the decade.

Speaker 2

At the same time, chip technology complexity is increasing significantly as traditional 2 d scaling slows And the industry transitions to a new PPAC T playbook to drive improved performance, power, area cost and time to market. Increasing complexity means that wafer fab equipment can grow at a higher rate than semiconductor revenues. And then within equipment spending, major technology inflections are increasingly enabled by materials engineering, Expanding the available market for Applied Materials. I'll highlight a few examples of how major materials engineering inflections Contribute to our growth. 1st, gate all around transistors are a great example of a new 3 d device structure that is enabled by materials engineering in areas where Applied has leadership products, including epi and selective removal.

Speaker 2

In addition, we've developed differentiated conductor etch solutions specifically for gate all around applications. We expect shipments of our gate all around products to begin ramping in 2024 as leading customers move into high volume production. For Applied, this inflection creates an incremental opportunity of around $1,000,000,000 for every 100,000 wafer starts 2nd, in wiring, we're seeing significant innovation in new materials. Adoption of new low resistance metals for contact and interconnect Enabled us to grow our PVD revenues at 3 times the rate of wafer fab equipment in 2022. High speed data connectivity remains a key focus for all our customers, fueling further growth at future nodes.

Speaker 2

3rd, applied technology is providing our customers with new tools to drive their scaling roadmap. Recently, we launched Sculpta, A breakthrough pattern shaping technology, which provides a simpler, faster and more cost effective alternative to EUV double patterning. It decreases customers' capital cost by about $250,000,000 for each layer of adoption per 100,000 wafer starts. We are already shipping repeat systems and expect this business to grow to multiple 100 of 1,000,000 of dollars of annual revenue in the next Several years. The final example is advanced packaging.

Speaker 2

While we are still in the early phases of industry adoption, This inflection is already a great growth area for us. Our packaging revenue has doubled in the past 3 years to over $1,000,000,000 We have strong leadership positions in key enabling technologies, including through silicon via micro bumping and hybrid bonding. We believe we can double revenues again in the next few years with further adoption of 3 d multi die packaging. The increasingly complex solutions our customers are deploying to move from one technology node to the next Are also a key growth driver for our service business. Customers are seeing value in our solutions to support their R and D, Rapidly transfer and ramp new technologies and drive device performance yield output and cost in high volume manufacturing.

Speaker 2

Our service business is on track to grow in 2023 even with lower utilization rates in certain nodes And after absorbing the impact of U. S. Export control rules, more than 60% of our service revenue It's generated from subscriptions in the form of long term agreements. These agreements are growing at a faster rate Then the installed base and have a high renewal rate of more than 90%. Given our confidence in the trajectory of the industry and Applied Materials, We are taking actions and making associated investments to support our growth, accelerate our customers' roadmaps and drive productivity and efficiency as the industry scales.

Speaker 2

On May 22, we will formally announce A major strategic investment in a new high velocity innovation platform focused on next generation Equipment and Process Technologies. As innovation in the industry is increasingly driven by new materials, Structures and devices. Our goal is to change the way we collaborate with customers, universities, suppliers and other partners To bring new manufacturing technologies to market faster and optimize the overall economic returns. We'll look forward to sharing more details next week. Before I hand over to Bryce, let me quickly summarize.

Speaker 2

While 2023 is a challenging year for the economy and areas of the semiconductor market, Applied's business performance remains resilient, Thanks to our broad exposure to secular trends, strong product positions at key technology inflections Become a larger and more strategically important market globally and industry trends create outsized opportunities for Applied. To position ourselves for the opportunities ahead, we are making strategic investments in R and D and infrastructure, while driving improvements in productivity and Now, Bryce, it's over to you.

Speaker 3

Thank you, Gary. On today's call, I'll summarize our Q2 results, provide our guidance for Q3 and discuss the investment we're making in our R and D infrastructure. Before covering the near term, I'd like to remind you of 4 key points. 1st, the semiconductor industry is on track for secular growth with expectations of a $1,000,000,000,000 market by 2,030. 2nd, materials engineering is increasingly critical to our customers' roadmaps.

Speaker 3

3rd, Applied's broad and differentiated portfolio, market diversity and growing services business make us more resilient today than in the past and set us up to outperform our markets. And 4th, we have an efficient business model that generates strong profitability and free cash flow, which enables us to invest in growth and provide attractive shareholder returns. In fact, in March, We signaled our confidence in the long term growth of the semiconductor market and in our ability to deliver the new materials and manufacturing innovations required to drive the industry. The Board of Directors approved a 23 percent dividend per share increase, which is the largest increase in 5 years and supplemented our share buyback program with a new $10,000,000,000 repurchase authorization. We believe our free cash flow can continue to grow and support Increasing the dividend at an accelerated rate over the next several years, which would double our previous dividend per share.

Speaker 3

As our services business grows along with our installed base of equipment, it alone produces more than enough operating profit to pay the company's dividend. Moving now to Q2 business highlights. Our team did a great job navigating supply and schedule challenges during the quarter, enabling us to grow revenue and earnings per share on a year over year basis. We mitigated most of the supplier cybersecurity situation we described last quarter, And this helped us deliver higher than expected revenue in both semi systems and AGS. Most of our businesses caught up to demand and our lead times and inventory levels declined.

Speaker 3

Growth in our iCAPS business helped to offset year over year declines in memory as it did in Q1. And our services business generated record revenue Growing year over year and offsetting headwinds created by the trade rules announced last October. Now I'll summarize our Q2 financial results. Company revenue in Q2 was $6,630,000,000 up 6% year over year and non GAAP EPS was $2 up 8% year over year. These results were in the upper end of our guidance range and only slightly below last quarter's near record results.

Speaker 3

Non GAAP gross margin was flat sequentially at 46.8%, remaining resilient as we offset headwinds related to trade restrictions, inflation, Supply Chain and Logistics. Non GAAP OpEx rose slightly quarter over quarter to $1,170,000,000 Turning to the segments. Semi Systems revenue grew 12% year over year to $4,980,000,000 Segment non GAAP operating margin was 35.6%. AGS revenue grew 3% year over year to nearly $1,430,000,000 In fact, This is AGS' 15th consecutive quarter of year over year growth. Segment non GAAP operating margin increased sequentially to 29%.

Speaker 3

In display, revenue was approximately flat sequentially at $168,000,000 and segment non GAAP operating margin increased sequentially quarter, which is nearly 35 percent of revenue. We produced over $2,000,000,000 in free cash flow, which is nearly 31% of revenue, which demonstrates the efficiency of our business model. Shareholder returns in the quarter were over $1,000,000,000 including $219,000,000 in dividends and $800,000,000 in share buybacks. Now I'll share our guidance for Q3. We expect company revenue to be $6,150,000,000 Plus or minus $400,000,000 We expect non GAAP EPS of $1.74 plus or minus $0.18 Within this guidance, we expect Semi Systems revenue to be around $4,500,000,000 which is down nearly 5% year over year.

Speaker 3

We expect AGS revenue to be about $1,430,000,000 which is up 1% year over year. Display revenue should be around $170,000,000 We expect Applied's non GAAP gross margin to be about 46.3 percent, And we expect non GAAP operating expenses to be approximately flat sequentially at $1,170,000,000 We are modeling a tax rate of 12.3%. Finally, I'll comment on the new innovation platform Gary discussed in his remarks. We're planning to make a multi $1,000,000,000 investment in new infrastructure over the next several years to significantly expand our capacity to more closely and productively with our customers as we develop next generation materials, process technologies and equipment. We'll provide more details about the amount and timing next week.

Speaker 3

What I'd like you to know today is that the investment is consistent with our company's existing long term strategic plans. Also, the scale will depend on our ability to secure government support. While we expect our capital expenditures to be higher over the next several years, There is no change to our longer term financial model and our strong commitment to shareholder returns. In summary, Applied Materials is executing well In demonstrating the advantages of our broad and diverse portfolio, markets and customer base, this year demonstrates Our business has become less volatile and more resilient. We are growing year over year in semiconductor systems and services and generating healthy profitability.

Speaker 3

We are in a great position to invest for technology leadership and growth, Mike, please begin the Q and A.

Speaker 1

Thanks, Bryce. To help us reach as many people as we can, Operator, let's please begin.

Operator

Our first question comes from the line of C. J. Muse from Evercore ISI. Your question please.

Speaker 4

Yes. Good afternoon. Thank you for taking the question. So I was hoping you could speak to the sustainability of spending for lagging edge in China. There are many players that I think we're all aware of like SMIC, Huawei, Huawei, etcetera.

Speaker 4

But it sure sounds like there are 2,030 Emerging new players that are in their first three rounds of DC funding. And the question we get often is, how sustainable is that Spending beyond 2023. So we'd love to hear the visibility that you have to their build plans and how you're thinking about that spending beyond this year. Thank you.

Speaker 3

Great. CJ, thanks for the question. We've looked into this ourselves quite in-depth. We're very bullish and the customers are bullish about the end markets that are driving the investments that are being made in China. So specifically, we've looked at the equipment that we're selling.

Speaker 3

We've looked to see that it's being installed. We've looked to see that it's actually being ramped. And that's what we do see in China. So people have asked us about, is there pre ordering or stocking of equipment? We don't see that.

Speaker 3

You're right that it's mostly iCAPS And it's mostly focused on the end markets that we all know that are growing, the power markets, the video processors, the sensors And power, those types of end markets. When we we also think about the government incentives In China, so a lot of there is a long tail of investors in China. They are being incentivized, but they are ramping and installing equipment and we don't see any Unused areas, anything to add there, Gary?

Speaker 5

No. Thank you.

Speaker 1

Thank you, CJ.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Stacy Rasgon from Bernstein Research. Your question please.

Speaker 4

Hi guys. Thanks for taking my question. I guess to follow-up on that, I know you said that like the non Chinese regions are growing faster, but is that because just they're smaller? Like how big, how much like even qualitatively is China as a percentage of your total iCAHPS revenue and like how much is the China piece of it growing relative to those other regions

Speaker 3

Yes. Thanks, Stacy. It is the largest country in the iCAP space, but I think there are 3 other countries that are growing faster and it's not because it's a lot of small numbers, they're pretty significant. So if you think of North America, China, Europe, People will recognize a lot of the investments that are being made in the mature technologies in those spaces. So, China is not the fastest grower, but they're the largest country.

Speaker 3

And when we look across the world and we look at all those investments, There are government stimulus programs that help encourage the customers to make those investments, but we believe there's real demand behind that. When we look at utilization in the iCAP space, we see utilization to be in a healthy range. So this looks like an ongoing trend. When we think forward, We had if we look back to 'twenty two, we had 40 plus percent growth rate in iCAPS. It's only accelerated this year.

Speaker 3

And our view from all the accounts is that it won't grow at the same rate, it won't accelerate at the same rate, but that demand is stable. We expect over the Coming years that that market will stay about the same size.

Speaker 2

Yes, Stacy, this is Gary. Especially I would say in the U. S. And Europe, When I talk to those CEOs and those companies, they're in a very strong position and those investments that they're making will be

Speaker 6

Thank you, Stacy.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Vivek Arya from Bank of America. Your question please.

Speaker 7

Thank you for the question. Maybe kind of 2 very related ones. What's your backlog in semi systems and where does it get to exiting the year? And then a number of your peers have suggested The second half of the calendar year, so essentially your Q4 and Q1 could be better than the first half. Is that similar to the trends Applied is seeing or what would create that difference between you and your peer group?

Speaker 3

Okay. Thanks, Vivek. First of all, backlog, We still have an elevated backlog. What we've tried to talk about last quarter and this quarter is the dynamics under that. We have caught up in most of the business groups to the underserved demand that we had from the prior year.

Speaker 3

So that's a good thing. Our lead times are returning to more normal. Having said that, the backlog is still elevated. We think that's because Many customers are placing orders over a longer period of time. They're planning longer in the future than they have in the past.

Speaker 3

So we when you see our backlog published at the end of the year, it will probably still be at an elevated level. On the second half, we're not guiding the second half, but The story for Applied has been that the, iCAPS business has grown so much this year that it's offset weakness in the memory market And any slowness that we've seen in the leading logic market and we expect that dynamic You can see in the next quarter that we don't have growth in the next quarter, but overall, we expect that dynamic that we've seen for the business to continue in future quarters. So We can't call that second half or even 24 yet because the large markets of memory and leading logic are Pretty exposed to macros and pretty exposed to consumer end markets. We'll just have to see how that looks for Q4 and for next year.

Speaker 1

Thank you, Vivek.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Chris Sankar from TD Cowen. Your question please.

Speaker 5

Yes. Hi. Thanks for taking my question. I had a big picture and a quick clarification Bryce, 2. One is for Gary.

Speaker 5

When you look at all these leading edge spending and all the regionalization, it seems like is it all tied to really chip that Funding or other factors in play like in the permitting order it might be that's causing some relative delay in those leading edge investments. And Bryce, did you say anything about some of those China export controlled recovery that some of your peers have spoken about in

Speaker 6

the back half? Thank you.

Speaker 2

Yes. Chris, thanks for the question. On Leading Edge, there is intense competition for leadership. So, all of those companies are trying to drive their roadmaps as fast as they can on power, performance and cost. So, we certainly see that continuing to play out over the next few years.

Speaker 2

What I would say also is that the perspective that we have right now is that 3 nanometer is going to be a big node where there's a lot of Tape outs and customer demand, so we think that's going to be pretty robust. For Applied, we're in a really good As our customers move to 3 nanometer, the number of steps for us go up, I think it's more than 20% and that transition from 5 nanometer to 3 nanometer. But again, you have this really significant competition in that leading edge Again, we continue to see that that's going to be sustainable going forward. And then relative to government incentives, There's also a lot of competition there. So you see every region where we do business today, A significant amount of incentives that are being supplied, really for Leading Edge and for ICAPS.

Speaker 2

But I think that So that's definitely true. That will be an adder for our systems and service business over the next few years. I think the bigger factor in the leading edge is just there is pretty significant demand and you have significant competition for leadership. And I'll let Bryce answer the next question.

Speaker 3

Thanks, Gary. And Chris, on the China export controls, we see the same thing as our peers do. We'll be able to ship to some factories in the second half that were clarified recently.

Speaker 1

Okay. Thank you, Greg.

Operator

Thank you. One moment for our next question. And our next question comes from the line Tif Malik from Citi. Your question please.

Speaker 7

Hi. Thank you for taking my question. Gary, I have a question on your comment on Gate All Around. You talked about gaining 5 points of transistor share from FinFET To get all around, my question is, the share gain, is that because the TAM is growing Or are the dollars coming out from other areas like lithography and does that statement include contribution from Calcutta?

Speaker 2

Yes. Thanks for the question. So I would say gate all around, there's both higher process complexity of existing steps Plus addition of new steps, if I and we've said that's again a $1,000,000,000 opportunity for Applied and we're really in a great position, Because the steps that are growing, the increased complexity is in areas where we have very, very strong Products and technology, and again, we're deeply engaged with every single one of those companies. In any of those areas for deposition, selective removal, we have very good visibility relative to Overall competitive physicians and not just in the 1st generation of gait all around, but subsequent generations. And so again, I think we still see the same thing relative to the size of the market and the share gains Really are relative to FinFET.

Speaker 2

So what customers were spending for the we're spending as a percentage of total Transistor from FinFET to gate all around, that's where the 5 points of share comes from. And then relative to the roadmaps going forward, What I would say is that we definitely see an increasing relative contribution In materials engineering, so if you look at certainly the transistor innovation, wiring resistance is one of the biggest issues In the whole industry, that's an area that's growing very fast. I talked about the MDP growth Earlier, so again, that wiring is a really great opportunity for us. Backside power distribution There you can get up to 30% area savings without changing the feature size And also improvements in power and performance. In the future, you'll see people stacking nanosheets for another Transistor technology in future nodes.

Speaker 2

So again, more and more of those dollars are moving to materials engineering as we go

Speaker 6

forward. All right. Thank you, Atif.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Mark Lipacis from Jefferies. Your question please.

Speaker 8

Gary, for you, you guys got It seems way ahead of the curve on iCap. It's been a phenomenally successful Investment for you guys is really paying off. What you know on these calls, you always talk about all these other investments I think you went through 3, 4 or 5 of them. Which one of those has the chance to be the biggest? Is there Does one of those have a chance to be the size of iCAPS is right now?

Speaker 8

How should we think about the next Big driver for you guys, if you were to single out one, if you could. Thank you.

Speaker 2

So Mark, just and thanks for the question, but I just want to understand, are you talking about within CAPS or are you talking beyond ICAPS?

Speaker 8

Beyond ICAPS, all the things that you guys are investing in right now, you guys You made a great decision to invest heavily in iCap and it's paying off in a major way. So that was a precious investment from my view. And I'm trying to understand like you're making a lot of investments. You talk about a lot of things that you're investing in. Just of the 4 or 5 things that you talked about on the calls that you've been investing in, do any of these have the chance to be as big as ICAAS or what has chance to be as close to ICAPS in terms of the amount of revenue and profitability it could deliver to Applied Materials.

Speaker 8

Thank you.

Speaker 2

Okay. Yes. Thanks, Mark. I would say 2 things. 1, as customers are going forward, I mentioned this on the previous question.

Speaker 2

Materials engineering, I think if you look at the percentage of spending going forward, Just really tremendous, everybody knows that 2 d Moore's Law scaling is challenged. And so The innovations in transistor, innovations in wiring, innovations in memory technology, all of those areas and I mentioned the increase in the number of steps and the increase in complexity from one technology node to the next. We're in a really great position, again, relative to what's going to drive our customers' roadmaps in the future and there tremendous innovations that will bring, their Sculpta was one example of another way that you can achieve area scaling At a much, much lower cost with this directional etch technology. So and there's many material modification steps, Double digit numbers going from one technology node to the next that are growing. Those are areas where we have extremely high share And we're innovating to drive performance and power and cost for customers.

Speaker 2

So that would be one area I would say. The other one that I'm pretty excited about longer term is packaging and all the innovations going from system on chip to system in package. I think that's going to be a tremendous inflection. That's about $1,000,000,000 Business for us today, I mentioned earlier that we could see that doubling in the next few years. I think that and there's We have a very strong position in the served markets that we have today.

Speaker 2

We have pretty high share And there are other areas we're focused on. We mentioned hybrid bonding as one, but there are others that we're focused on that will create really big So that would be the other area. I think that whole movement to chiplets and heterogeneous integration.

Speaker 1

Thank you, Mark.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Toshiya Hari from Goldman Sachs. Your question please.

Speaker 9

Hi, good afternoon. Thank you so much for taking the question. Gary, I had a question on your memory business. Clearly, it's going through a pretty rough patch at the moment, consistent with industry trends. I'm curious both in terms of your AGS Business as well as your systems business.

Speaker 9

At what point do you expect your memory business to recover? I know you're Pretty close and you're going back and forth with CEOs and CTOs, but just curious on the timing there. And as a quick follow-up, your business in Korea in the Quarter was quite strong, if I'm not mistaken. Korea obviously is over indexed to memory. So, I was hoping you could reconcile The weakness you're seeing in memory, but the strength in Korea.

Speaker 9

Thank you.

Speaker 3

Yes. Hi, Toshiya, it's Bryce. I'll just say a couple of things and Gary can add on that. So on the memory side, we do think it's at sort of historical lows. We've thought about our long term balance of Memory and logic, over time, we do think the market from an equipment perspective should be about 1 third memory and 2 thirds Logic, that 2 thirds would be split between relatively evenly between iCAPS and Leading Edge.

Speaker 3

So on the memory, we do think it's at a low. However, in the quarter, we monitor pricing, we monitor utilization, we monitor inventories. Those are still moving in the wrong direction in this past quarter. So it hasn't quite turned yet, but we do think With the iCAPS business growing and with the outlook long term outlook strong for leading edge, we do think memory will have turnaround. It's hard to call the exact moment, but we expect that to happen.

Speaker 3

And then Korea, I think It's just good shipments in the quarter. I don't think it portends anything unique from a trend perspective. We see We do still see weakness in the market.

Speaker 2

Yes, Bryce, I don't really have too much to add. Again, we do see long term foundry logic. We've mentioned this before, 2 thirds, 1 third, certainly continuing strength in the race for leadership and the leading edge And sustainable strength in iCAFs going forward, we don't think it comes back to that 2 thirds, 1 third You know, soon, but longer term, that's kind of where we think that's going to end up.

Speaker 1

Great. Thank you, Toshiya.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Harlan Sur from JPMorgan, your question please.

Speaker 6

Yes, good afternoon. Thanks for taking my question. Typically during periods of It stabilizes and your shipments soon follow that stable trend. I know last earnings, you were still seeing quite a bit of rescheduling and push out activity on

Speaker 10

the backlog. Has this activity stabilized?

Speaker 3

Hi, Harlan. Thank you. I don't think so. We still saw in this quarter, we still saw weakness In NAND, we saw weakness, as defined as push outs on the leading edge, and that's partly why you see our guide for the next quarter, A little bit bumpy, taking account and taking into account some of those push outs. So I think customers are still reacting to the current environment and Checking the roadmaps and trying to optimize those roadmaps.

Speaker 3

And for us, just to sort of reiterate, over the course of this year, The iCAPS business has been so strong that it overcame most of that noise. The growth of iCAPS overcame most of that noise. Plus, We had several business units that we're still catching up on back orders. The first part, the iCAP strength, we expect to continue As the year goes on, as we've said and be an important component of demand going forward. And the business units that were behind have mostly caught up with the exception of implant, which where we're still working to catch up.

Speaker 1

Thanks, Arlen.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Timothy Arcuri From UBS, your question please.

Speaker 11

Thanks a lot. Hi. I just kind of wanted to go to this back to this China lagging edge topic. And you guys do such good demand modeling and I'm kind of wondering what you think the underlying demand is that's kind of backing all this. The kind of easy conclusion is that this just all kind of coincided with leading edge bands.

Speaker 11

And so they're just pivoting to pouring money into lagging edge. So So when you think about the demand backing this, was this just demand that like wasn't being met by the U. S. And the European chip guys? I ask because EV is not new and the Penetration is actually pretty high in China already, and units haven't been great anyway.

Speaker 11

So that's the first part of the question. And then also, is that really like This year WFE thing or is it all more going to be part of next year's WFE? Thanks.

Speaker 3

Okay, great. Thanks, Tim. The second part of the question first, so we definitely think it will be a continuing trend. So we raised our expectations of demand in China during the quarter, and we raised our expectations over time from China during the quarter. And as I may have said in the first question, when we track fab projects in China, There is quite a number.

Speaker 3

The overall list for the globe is approximately 100 now, and there is a significant amount in China. So when it's mostly in the iCAP space and when we think about the end markets, I guess the perspective I have is that they are localizing as Supply for, if you think of sensors, power chips, analog chips, Microcontrollers, we believe they're building out those capabilities internally, and I think there's been confirmation recently that some of the imports of those components China have declined even though demand is growing. So our perspective is the capacity that's being put in place in China, It isn't extraordinary at this point. If you think of China trying to build a local ecosystem of Capacity that matches their demand function, if you will, over time, they're not there yet. So these investments make sense if that's the goal, and we know they have government incentives

Speaker 2

Yes. Tim, this is Gary. One other thing I would say is and we do, as you said, a lot of modeling of each one of those vertical within iCAPS. We look at fab utilization, wafer starts, all of those things. The one other thing I would say is that we look at good chips out for each one of these different factories.

Speaker 2

And so when you look at yield as another factor, That's when we look at the overall market, it's roughly in line

Operator

Our next question comes from the line of Joe Quatrochi from Wells Fargo. Your question please.

Speaker 6

Yes. Thanks for taking the question. And Kind of as a follow-up to Gary's comment. I guess, how do we think about, if you were to look at like domestic China's capital intensity For mature nodes relative to maybe some of your more experienced customers, is that a multiple higher Then you're more experienced customers. And I guess how do you think about that kind of normalizing over time?

Speaker 3

Yes, I can start, Joe. The capital intensity, since it's mostly ICAPS, what we see in ICAPS is the capital intensity This is sort of like LeadingLogic was 5 or 8 years ago. So That whole discussion about there being a lack of reuse, especially in China, those are mostly greenfield sites. They're new equipment sets. So the capital intensity is fairly high, and we think that's consistent by the way with most of the, iCAPS additions going on across the globe.

Speaker 3

And that's a major factor as to why overall intensity, as we measure intense WFE intensity to semiconductors is going up over time is The fact that ICAPS is so much

Speaker 6

higher. Thank you, Joe.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Sidney Ho from Deutsche Bank. Your question please.

Speaker 10

Thank you. I want to ask about the AGS business. Gary, you talked about AGS still growing this year despite the many different headwinds. If you kind of just look at the upside in the AGS in the quarter, can you speak to what drove the upside given the underutilization across foundry and logic and memory? And also I also want to ask about how do you expect the segment to perform in the second half of the year now that all the memory suppliers have been taking down the utilization?

Speaker 10

And is there a range of AGS growth we should be thinking about this year? Thank you.

Speaker 2

Yes. Thanks for the question. So AGS, if you look at the way that business breaks out, about 85% is spares and service And a significant percentage over 60% is long term agreement, subscription types of agreements With a length of 2.6 years, we're still seeing very, very high renewal rates. So one thing that helps us in this type of market environment There's a lot of that business is still based on those longer term agreements. So that's helping giving us A level of stability in this type of a market.

Speaker 2

And then the other part of AGS, kind of mid teens is the 200 millimeter business. That's really focused on ICAPS and that business is very robust. So I would say that our business, again, relative to the agreements, Pretty stable, continuing to grow, strong renewal rates. And then the 200 millimeter business is also very stable and growing In 2023, I don't know, Bryce, if you want to add anything else.

Speaker 3

I think that's a major thing and we've said that we expect it to grow So it's growing year over year and we expect it to grow for the year and our outlook does include, you see it slower growth in Q3. So our outlook does Assume that there'll be lower utilization in some of the factories. So we've accounted for that, Sydney, but we do expect it to grow year over year.

Speaker 2

Yes. I guess the other thing I would add is that we certainly we're growing this year and we still we're still on track To this model that we had talked about a couple of years ago with low double digit growth for AGS longer term.

Operator

And our next question comes from the line of Brian Chin from Stifel. Your question please.

Speaker 12

Hi, good afternoon. Thanks for letting us ask a question. Yes. I guess sort of doubling back on sort of ICAPS for the year, obviously, it's almost like a one for one offset to some of The industry weakness in memory and advanced logic foundry, but I guess can you talk maybe to linearity a bit because you have talked about how Backlog maybe the backlog didn't increase this quarter, but still at pretty robust levels. Lead times have sort of normalized.

Speaker 12

And I think the expectation was that there'd be a little bit of a gearing towards calendar first half in terms of that business. I'm kind of curious how you see that still for calendar second half and whether some of this China that's been discussed is part of maybe A wild card relative to how you view that second half?

Speaker 3

Yes. Thanks, Brian. Without getting specific about Trends quarter over quarter, it has been gradually increasing. So, if we look back to, I think, Q3 of last This year, Q3, Q4, Q1, Q2, I think we have an increased trend across each of those quarters. And so we're not going to guide the second half, but I don't think there's I don't think there was a front loaded phenomenon in iCAPS.

Speaker 2

Yes, Brian. The other thing I would add is that Implant, as Bryce mentioned earlier, is one of our most supply constrained businesses. We have Very significant demand. We've launched around 10 new products in iCAPS over the last few years. So that business is going to continue to ramp through the year as we close that supply demand gap.

Speaker 2

So That is a significant portion of ICAPS, an area where we have real strength with the customers. The demand there for the inflections is very strong. So again, that's another factor driving our iCap strength.

Speaker 6

Okay, great. Thank you. Thank you, Brian.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Quinn Bolton from Needham. Your question please.

Speaker 6

I guess I have a clarification on the question. Just a clarification on the China export clarifications that we received. I think some of your larger cap peers have talked about benefits $200,000,000 to $300,000,000 in the second half. You have higher market share. I think in China, can we expect that those export clarifications Probably have at least a $300,000,000 benefit for you in the second half.

Speaker 3

Hi, Quinn. Since it's a small Number of customers, we're not going to be specific about the number, but we definitely see the same situation. We have factories that we will be able to ship to in the second half. And At least for Q3, that's in our guide.

Speaker 6

Okay. And then the question just for the iCAP strength and relative weakness in Advanced Foundry Logic. I think you've talked about ICAPS being about half of foundrylogic. I assume for 2023, that's probably more than half of the business, but wondering if you might be able to give us a range Where do you think ICAPS falls out for 2023, given the relative strength?

Speaker 3

Yes, it is larger. The growth has been significant both last year and this year as we talked about, and we think it's stable. And then the only thing we've really guided is long Term, we think foundrylogic is a little bit weakened this year. So we think that gets in more of a balance in the long term on the logic side of WFE. But, so long term, we would say it's relatively equal.

Speaker 3

This year, iCAPS is the largest market.

Speaker 6

Thank you.

Speaker 7

Thanks, Sven.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Blayne Curtis from Barclays. Your question please.

Speaker 6

Hey, thanks for letting me ask a question. Maybe just a follow-up on that last one. I was curious at the leading edge, if you could just walk us through the extent of the push outs and really just trying to figure out You're still seeing quite low utilizations at the leading edge. Some of the markets may recover in the second half, but I'm just kind of curious your visibility into when that Leading edge segment may rebound.

Speaker 3

Hi, Blaine. For the low utilization, it is relatively low. I think it's For Leading Edge Factories, I saw somebody quoting around 70%. I think that's probably a good range right now for Leading Edge. And the push outs are really site specific and project specific.

Speaker 3

I don't think they You know, since our signal change in direction of any of our customers in terms of their intent to build out new process technologies And what's ahead for us that's most important is this, transition to Gate All Around, and We think that will start in earnest as we get into 2024 and that's one of the big inflections that we think will drive value for Applied. So anyway, that's what I would say on the push outs.

Speaker 2

Yes, Blaine, I would say that a couple of things. 1, the 3 nanometer, we still Everything that we see, that's going to be an important technology node. And so certainly next year, we think that's going to be a Meaningful contribution to revenue for Applied. And then as Bryce said for Gate All Around, we'll see the initial ramping That spending in a meaningful way also in 2024.

Speaker 6

Thanks guys. Thanks Blayne.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Vijay Rakesh from Mizuho. Your question please.

Speaker 7

Yes. Hi, Gary and Bryce. Just a quick question on the government funding. I know you mentioned 400,000,000,000. How much do you expect that to add to global WFE if you look at 'twenty three second half 'twenty three or 'twenty four?

Speaker 3

Hi. Thanks, Vijay. That's the right number, global phenomenon as you talked about. The way we think about it is, it will add about 3% to 7% of WFE over the next 5 years. We don't think that $400,000,000,000 will be incremental WFE.

Speaker 3

What we think it does is Set the locations. Our customers will be putting their assets in place. And because some of those locations will be new, you won't have Quite the economies of scale as they might have in their larger facility areas, and that will drive A small amount of incremental equipment since there's a little bit less economies of scale. So we estimate that to be 3% to 7% over the next 5 years. And then in the very short term, we do see companies that are starting to accrue for some of the tax Benefits were included in that group.

Speaker 3

So I think the incentives are already starting to encourage investment.

Speaker 7

Got it. And then on the China side, Adi, would it be fair to assume that next year iCAPS continue to hold up, but might be memory spending It could be down again year on year for China?

Speaker 3

On the iCap side, we do expect it to hold up. And then memory, I think memory is more market driven. So what we're saying for both the memory and the leading Edgelogic, for next year, it's going to be more dependent on macro and some of those consumer markets. So TBD on that piece.

Speaker 7

Got it. Thank you.

Operator

Thank you. One moment for our next question. And our next question comes from the line of Mehdi Hosseini from SIG. Your question please.

Speaker 5

Yes. Thanks for letting give me a chance. Two questions. For Bryce, I'm just trying to better think about Earnings given opportunities with iCAPS and other areas, and in that context, should I assume that Like if I were to use FY 2022, WFE was closer to $100,000,000,000 and you guys did almost 703 quarter In earning and looking forward, can you hit those kind of revenue targets without having W, if you will, above $90,000,000,000 And then for Gary, I understand the government incentives, so that is very good for the equine industry. But in the longer term, don't you think that these subsidies could make the cycles actually more volatile?

Speaker 5

And perhaps I could reference what happened past few years, demand got pulled in and Then we had some correction in semiconductor. Just want to understand how you think about these subsidies in the context of Form of the cycle or shape of the cycles and volatilities.

Speaker 3

Hi, Mehdi. On the earnings question, I If I understand that, yes, dollars 90,000,000,000 would support larger earnings as we go forward because Our AGS business will continue to grow. We expect upsides in our display business as we go forward. So if you're looking to model those, I would look at Modeling the continued growth in AGS and thinking about upsides in display on top of where we are today. And that should give you a perspective on, if there's no growth in WFE, where the model could get to over the next Couple of years.

Speaker 3

And then Gary on subsidies.

Speaker 2

Yes. I think that the Bryce Talked about 3% to 7% medi incremental spending over the next several years. Certainly, there's a tremendous amount of competition between different geographies. But customers we think will invest based on where they see the demand. So the Timing of those investments, I don't think they're going to be significantly different than the way they thought about it in the past.

Speaker 2

The one thing I would say That should be a benefit is that as these companies move into new regions, and they're starting up new factories, The initial efficiency of those factories is going to be lower, for sure as they're moving into the new locations. And that's also incremental help for our service business because they don't have all the trained personnel and all of the infrastructure in place

Speaker 1

Okay. Thank you, Mehdi. And operator, I think we have time for one more question or a follow-up, please.

Operator

Certainly. Then our final question for today is a follow-up question from the line of Stacy Rasgon from Bernstein Research. Your question please.

Speaker 4

Hi, guys. Thanks for taking my follow-up. I had a question on the investment plans that you're going to be talking about next week. I know you gave us the details then, but I was wondering if you could give us just a little bit of breadcrumbs here on what the purpose of this is. You talked about gains in like gate all around like 5 points.

Speaker 4

Do you need these kind of investments to get those market share gains? Or is this something that kind of gives you an edge Like into the second half of the decade, like with like resources and support that you can offer that others are not going to be able to offer. Just anything you could tell us in advance of maybe the details next week,

Speaker 2

Yes, Stacy, thanks for the question. So what I would say is that, one of the most important factors For any company, is the time to innovation, time to commercialization and innovation success rate. So we've been and as you know, it takes many, many years from concept to high volume manufacturing. And that's somewhat of a serial process. And so working with some of our largest Customers, we think there's opportunities to drive some of those steps in parallel and significantly accelerate time to innovation.

Speaker 2

So that's what we're going to be talking about next It's really exciting. Again, I definitely do think there's opportunities there. And I do believe that materials inflections, New structures, some of the things I've talked about, that's going to be a bigger and bigger percentage of gains. Some So I think Stacy, we'll cover more of this next week, but we have been working with our largest customers on some of these concepts. And I definitely think there's ways to Accelerate innovation and as you know, if you think about how much money companies spend on each R and D dollars on each technology node, There's a tremendous opportunity for economic optimization, both on cost and then value creation.

Speaker 2

Anyway, we'll cover more of that next week and then we will also cover this at the Semicon event that Mike talked about earlier.

Speaker 4

So is this just like a new maiden fab or is it more than that?

Speaker 2

I'd say it's more than that. The concepts certainly, The scale of what we're talking about is pretty significantly bigger than what we're doing today. And the concepts of how we're going to work through the entire ecosystem, I think are pretty exciting.

Speaker 4

Thank you, guys.

Speaker 1

All right. Thanks, Stacy, for your question. Bryce, would you like to help us close out the call today?

Speaker 3

Thank you, Mike. My takeaway today is, while there are areas of weakness in our markets this year, Applied is making good operating progress and outperforming the markets, thanks to our unique breadth and diversity. We're confident about the industry's long term growth opportunity, and we're in a great position to make significant investments in our future and increase cash returns to shareholders. On Monday, we look forward to detailing the strategic investment we're making to collaborate closely and productively with our customers that Gary just described. Gary will see many of you at the Bernstein Conference in New York on June 1, and I hope to see you at the BofA Conference in San Francisco June 7.

Speaker 3

Mike, please go ahead and close the call.

Speaker 1

Okay. Thanks, Bryce, and we'd like to thank everybody for joining us today. A replay of today's call is going to be available on the IR page of our website By about 5 o'clock Pacific Time, we'd like to thank you for your continued interest in Applied Materials.

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Earnings Conference Call
Applied Materials Q2 2023
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