Applied Materials Q3 2021 Earnings Call Transcript

Quartr
Provided by Quartr
August 18, 2021

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 Q3 of fiscal 2021 earnings call. Joining me are Gary Dickerson, our President and CEO and Dan Dern, 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 On the 8th September at 9 a. M.

Speaker 1

Pacific Time, we plan to host the 3rd event in our Master Class series, this time focusing on the iCAPS markets and also on heterogeneous design and advanced packaging. Then on the 18th October, also at 9 a. M. Pacific Time, we plan to hold our 4th master class. We'll focus on process control and process optimization, including AIX platform technologies like e beam and AI.

Speaker 1

We hope you'll join us. And now I'd like to turn the call over to Gary Dickerson.

Speaker 2

Thank you, Mike. In our Q3 of '21, Applied Materials again delivered record performance, capitalizing on strong broad based demand for our semiconductor products and services, while navigating a challenging supply environment. Over the past 18 months, the pandemic has accelerated the digital transformation of the economy And adoption of advanced technology creating a permanent structural shift for the industry. At the same time, COVID-nineteen has disrupted global supply chains and logistics, a transitory challenge we'll continue navigating over the coming quarters. Across the company, I want to thank our teams for doing an incredible job to successfully overcome these near term disruptions, provide outstanding support to customers and keep our R and D roadmap on track.

Speaker 2

In today's call, I'll focus on 3 main topics. First, I'll provide our perspective on the market, starting with our near term outlook and then recapping our longer term thesis. 2nd, I'll summarize the 3 pillars of Applied's growth strategy. And 3rd, I'll explain how Applied is outperforming our markets today and is well positioned to play an even bigger, broader and more valuable role in the future. I'll begin with our near term outlook.

Speaker 2

Overall, there is no significant changes to our view of the market. Demand is strong and sustainable with customers making strategic investments to address long term secular trends. In 2021, foundrylogic is the fastest growing wafer fab equipment market and we believe it will represent more than 55% of total customer investment for the year. This spending is split relatively evenly between leading edge, the 3 most advanced nodes in foundry and logic And technologies for IoT, communications, automotive, power electronics and sensor applications or what we call iCAPS. We expect DRAM spending to be the 2nd fastest growing WFE market this year and we see a positive setup for sustained investment In capacity and new technology, supply side inventories remain below normal levels and long term demand drivers are strong fueled by memory intensive AI computing.

Speaker 2

On an absolute basis, we expect NAND investments to be similar to DRAM for the year. We believe NAND inventories are at normal levels both on the supply side and demand side. Looking further ahead, I strongly believe there has never been a more exciting time for semiconductor companies. We are only at the beginning of decade long trends that will underpin secular industry growth. As I've said before, digital transformation is built on silicon and broadens the drivers for semiconductor innovation.

Speaker 2

Demand for semiconductors is no longer about 1 or 2 killer applications, but rather an expansive structural shift in the economy Towards digitization and automation, smart and connected devices at the edge not only consume more silicon, They are driving exponential growth in machine generated data. To make sense and create value from the vast volumes of data available, New AI computing approaches are needed fueling further demand for current and next generation semiconductors. While global consumption of silicon is accelerating, adoption rates of new technology vary considerably by region. As we showed at our investor meeting, we estimate that by 2025, China will have only reached the same levels of silicon spend per capita The U. S.

Speaker 2

Saw in 2015 and India trails China by another 8 to 10 years. Since the impact of digital transformation is so wide reaching, national governments are increasingly recognizing the strategic importance of semiconductors. As government incentives become available in the U. S, Asia and Europe, they can provide multi year support As the industry moves from lean and just in time supply chains to more resilient, flexible and secure approaches, including regionally distributed capacity. However, putting the right manufacturing infrastructure in place is only one piece of the puzzle.

Speaker 2

Investment in innovation infrastructure to lead in the development and commercialization of next generation technologies It's even more critical to winning the future. Early access to superior semiconductor technologies Or what I refer to as winning the PPAC T race will determine the countries and companies that thrive and those that won't. At Applied, we have a strong point of view that the industry's future will not be like the past and we've aligned our strategy and investments Our strategy has 3 pillars. 1st and foremost, we are focused on being the PPAC T enablement company To provide the foundation for customers' power, performance, area, cost and time to market roadmaps, We have the broadest and most enabling portfolio of process technologies that we can co optimize and combine in unique in highly enabling ways. 2nd, we're shifting more of our business to subscriptions as we believe this model provides significant benefits to customers and for us.

Speaker 2

We have already converted a meaningful portion of our installed base business to recurring revenues And we are starting to monetize new products and services using subscription approaches. And third, We continue to optimize our portfolio of businesses that serve adjacent markets, including display to drive profitable growth and higher free cash flows. This strategy is yielding results and 2021 It's shaping up to be a strong year of outperformance for Applied. Starting with our unit process tools, We are seeing very strong demand for our leadership products. For example, taking the midpoint of our 4th quarter guidance, Both our epi and thermal businesses are on track to grow more than 70% this fiscal year, while CMP will grow more than 60% and implant more than 50%.

Speaker 2

We're also seeing outperformance in our growth areas, Especially process diagnostics and control where we expect to grow more than 60% in calendar 2021. On top of this, we have strong momentum with our co optimized and integrated solutions. By revenue, about 70% of the semiconductor products we sell today have already been co optimized at some level. Co optimization allows us to see and solve Higher value problems for customers speed up technology transition to high volume manufacturing and make our solutions stickier. Beyond co optimization, our integrated material solutions called IMS combine multiple processes with customized metrology and sensors In a single system, typically under vacuum, our latest IMS product that lowers interconnect resistance by 50% And Advanced Foundry Logic directly addresses a multi $1,000,000,000 opportunity over the next 5 years.

Speaker 2

With IMS, we can target the most complex and valuable challenges in the new PPAC T playbook And we have an exciting pipeline of new solutions for both foundry logic and memory. Another area where we're seeing strong and sustainable growth is our iCAPS business that serves a broad spectrum of customers and applications in IoT, communications, automotive, Power and sensors. Within iCAPS, demand for 28 nanometer and larger nodes is especially robust. Revenue from products serving these applications is expected to double this year. By acting early and forming a Dedicated iCAPS team in 2019, we've been able to increase our focus on these customers and accelerate our share of this market.

Speaker 2

We're developing new products specifically designed for ICAPS markets, including integrated and co optimized solutions. As a result, we're deepening our partnership and collaborations with these customers. For example, we recently signed a 5 year contract with a leading iCAPS customer designed to provide more assured supply for them and more predictable revenues for Applied. Today, we are demonstrating strong momentum in our leadership and growth businesses, IMS and iCAPS. And as I look ahead, I'm confident our opportunities are even better.

Speaker 2

It's clear that advances in materials engineering Our foundational to the industry's PPAC T roadmap, the PPAC T playbook has 5 key elements, New architectures, including workload specific ASICs and new memories 3 d structures, including gate all around transistors, Varied power rail and 3 d DRAM, new materials for gate, contact and interconnects, new geometric shrink and advanced packaging. We believe that the relative contribution of these five elements to PPAC T at future nodes Is evolving in ways that create opportunities for Applied to play an even larger and more valuable role. Let's take advanced packaging as an example. We identified this inflection early and began investing in differentiated technology years ago. Today, we enjoy a clear leadership position in the advanced packaging equipment with more than 60% share of our served market.

Speaker 2

We will generate more than $800,000,000 of revenue from our equipment business this year and through a combination of organic R and D and strategic We're also developing highly enabling future technologies. We are very excited about our opportunities and pipeline And we'll share more details with you at our upcoming packaging master class. Finally, when we talk to customers about PPAC T, they consistently highlight the importance of T, time to market. Time to market acceleration is a critical component Of our PPAC T enablement strategy, we've developed a proprietary suite of solutions to accelerate every stage of the product lifecycle from R and D to technology transfer and high volume manufacturing. Our actionable Insight Accelerator or AIX platform That we officially launched in May brings together process tools, sensors, metrology, data analytics and machine learning.

Speaker 2

We have strong momentum and are adding new installations at multiple leading customers. For example, AppliedPro is our process recipe optimizer within AIX and used to accelerate R and D qualification of individual chambers and tools as well as enable larger process windows and higher chip yields. Over the next 12 months, we expect to double the number of Applied Pro customer engagements from around 25 this year to more than 50. Before I hand the call over to Dan, I'll quickly summarize. We see strong and sustainable demand for our semiconductor business underpinned by a wide range of positive macro and technology drivers.

Speaker 2

While COVID related supply chain disruptions persist, Our teams are doing a great job working through these challenges. We believe Applied Materials will outperform our markets again this year, Thanks to our strong portfolio of differentiated unit process tools for both leading edge and iCAPS markets, combined with accelerating adoption of our IMS and advanced packaging products. As we look ahead, we're confident that the strength Of longer term secular trends will drive semiconductor and wafer fab equipment markets structurally higher and we believe Applied Is in the best position to accelerate our customers, PPAC T roadmaps and grow significantly faster than our markets. Dan, over to you.

Speaker 3

Thanks, Gary. Today, I'll begin by summarizing Applied's overall performance in Q3. Then I'll discuss our semi systems results, including new details about our foundrylogic business. I'll also give you a number of metrics surrounding the large recurring revenue portion of Applied's Global Services segment. Then I'll add my perspective on the demand trends in our markets and provide our guidance for Q4.

Speaker 3

Beginning with our Q3 performance, Applied generated the strongest revenue in company history with each of the segments exceeding guidance. We increased gross margin to 48%, which is the highest in 14 years despite the ongoing cost headwinds related to COVID. We also delivered the company's highest ever operating profit, operating margin and earnings per share. Our results included record operating cash flow and record free cash flow of $1,500,000,000 In fact, We've generated nearly $5,000,000,000 in cumulative free cash flow over the past 4 quarters. At the Investor Meeting in April, We made a long term commitment to return 80% to 100% of free cash flow to shareholders.

Speaker 3

And in Q3, the buyback window was available to us for the full quarter. We repurchased $1,500,000,000 of applied stock during the quarter and returned 111% of free cash flow to shareholders, including dividends. We ended the quarter with around $6,500,000,000 remaining in our share buyback authorization. Given the secular growth trends in our end markets and our view of the intrinsic value of the company, we expect to continue to be active in the market for our shares. Finally, last quarter, I mentioned that Moody's upgraded Applied's credit rating to A2.

Speaker 3

I'm pleased that earlier this month, Standard and Poor's also upgraded our rating from A- to A. Now I'll provide some insights into the strong performance of our semi systems business, which generated its highest ever revenue in Q3. Our demand is broad based across foundrylogic and memory. And within foundrylogic across a wide variety of nodes, we're increasing our technology leadership in many areas and that's being reflected in our operating margin, which crossed 40% for the first time. About half of our foundrylogic revenue is being generated by our iCAPS business, which focuses on all but the 3 most leading nodes.

Speaker 3

Our iCAPS business has a large global presence and serves a very large number of customers throughout North America, Europe and Asia. Many of the ICAPS applications have long product cycles, which generates lasting opportunities for us, both in equipment And services. We have high share and the margins are accretive to the company. We look forward to giving you more insights into the iCAPS markets and our strategies at the Master Class next month. Turning to Applied Global Services.

Speaker 3

We're building a solutions based recurring revenue business that delivers predictable free cash flow across market cycles. Our segment reporting gives you good insights into the business, and I'll continue to help you with key performance indicators that demonstrate The unique qualities of Applied Services business and the progress of our strategies. From our segment reporting, You know that AGS delivered record revenue of $1,290,000,000 in Q3, up 24% year over year. 87 percent of AGS revenue was recurring services, parts and software. The remaining amount was primarily legacy 200 millimeter equipment.

Speaker 3

Supply generated $1,100,000,000 in recurring revenue this quarter. This is by far the highest among our process peers and demonstrates our progress in generating lifetime value from the industry's largest installed base. Today, our semi installed base is just over 40,000 systems And we have over 160,000 chambers in the field. At the Investor Meeting, we shared our goal to increase revenue per system by 20% between 2020 2024. As of Q3, we're already halfway to achieving our goal.

Speaker 3

Now I'll put some metrics to our strategies for adding customer value to further grow our recurring revenue. Connecting the installed base to our AIX servers enables us to perform data enabled services for our customers. Today, we have just over 4,300 connected tools, which is up over 30% from our 2020 baseline. We're also growing the number of secure remote connections, which allows us to connect our best experts to the installed base to perform remote analytics, Diagnostics and optimization from anywhere in the world. The number of remote connected tools now exceeds 3,200, which is up over 36 percent from our 2020 baseline.

Speaker 3

Another key focus is transitioning our recurring revenue to subscriptions in the form of long term service agreements. Today, we're generating 60% of our recurring revenue from subscriptions and our goal is to reach around 70% by 2024. We also have a subscription renewal rate of around 90%. Another sign of customer value is the tenure Of the agreements, across the entire base of subscription agreements, we've increased the tenure from 1.9 years at the end of 2020 To 2.2 years today. In fact, of our subscriptions booked in Q3, 77% were multi year agreements.

Speaker 3

We track all of these KPIs very closely. I hope they give you a good sense of the size and growth of our recurring revenue And the strong customer pool we're generating by focusing on customer time to market as well as cost output and yield. Finally, another key metric we disclose is AGS segment operating margin, which provides a good indicator of the value our services bring to customers. In Q3, it crossed 30% for the first time in 15 years. Next, I'll add my perspective on the demand environment.

Speaker 3

While Q3 was a record quarter, we see further growth ahead. In fact, our overall backlog is close to $10,000,000,000 with record levels in both semi systems and AGS and strength across all of our geographies. I still expect equipment spending to be higher in the second half of calendar twenty twenty one for both foundrylogic and DRAM. I expect WFE to be up in 2022 and I expect all of our reporting segments to be higher. Now I'll share our Q4 business outlook.

Speaker 3

We expect to increase company revenue to approximately $6,325,000,000 plus or minus $250,000,000 or up around 35% year on year. We've widened the revenue range this quarter because of near term risks within our supply chain. We expect non GAAP EPS to be around $1.94 plus or minus 0 point 0 $7 or up around 55% year on year. Within this outlook, we project Semiconductor Systems revenue of about $4,600,000,000 up around 50% year over year and AGS revenue of about $1,301,000,000 up nearly 18% year over year. We expect display revenue to be around $400,000,000 Applied's non GAAP gross margin should be flat sequentially at 48% or up around 2 30 basis points year over year.

Speaker 3

We plan to increase non GAAP OpEx to $960,000,000 which is around 15.2 percent of revenue and below our longer term target of 16%. Our guidance assumes a slightly higher non GAAP tax rate of around 12.5%. In summary, I'm pleased that Applied delivered another record quarter of financial Performance in Q3 with strong margins and free cash flow. The demand environment continues to be strong. And I'd like to join Gary in thanking all of our teams and partners for their hard work in a robust but challenging environment.

Speaker 3

Now Mike, let's begin the Q and A.

Speaker 1

Thanks, Dan. To help us reach as many people as we can, please ask just one question on today's call. If you have a second question, please just re queue and we'll do our best to come back to you later in the session. Operator, let's please begin.

Operator

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

Speaker 4

Muse:] Yes, good afternoon. Thank you for taking the question. I Was hoping to dig a little bit deeper into your iCap business. You talked about foundrylogic being 55 plus percent of the mix this year in iCap, Perhaps half of that. And so I guess, did I hear that correctly?

Speaker 4

And as you think about the spending there, Can you walk a little bit in more detail around leadership versus growth penetration for you and How we should think about the sustainability of spending there into 2022 as well as the positive mix shift to gross margins? And then finally, as part of that, is there a subscription angle that's a greater part of the story there given lagging edge or no? Thanks so much.

Speaker 1

Hi, C. J, this

Speaker 3

is Dan. I'll start and Gary can jump in with some perspectives after I'm done. So as we think about the ICAPS That's market and the setup around foundrylogic. I think the contours you drew create the right perspective. Greater than 55 Percent of WFE this year is foundrylogic.

Speaker 3

When we look into foundrylogic and look at leading edge versus iCAPS nodes, You're seeing balance in those two markets. We had balance in those 2 markets in 2020. We've got balance again in 2021. So we're really encouraged by the strength we're seeing across the entire node Courage by the strength we're seeing across the entire node profile and geometries within foundrylogic, we think we're incredibly well positioned on the leading edge To drive key enabling technologies as the new playbook rolls out, we're equally well suited in the iCAPS nodes To drive those roadmaps going forward, innovation is back across the entire node profile as our customers Pursue unique opportunities in IoT, communications, auto, power, sensors, there's very unique Technologies and capabilities that need to be driven as intelligence finds its way to the edge, Those roadmaps are vibrant. We've got key enabling technologies that's driving really good market positions for us at attractive margin.

Speaker 3

So we think we're really well set up to perform extremely well as both of these sides of foundrylogic profile going forward in a very balanced way. So we like how well we're positioned.

Speaker 2

Yes. CJ, this is Gary. Thanks for the question. So I think, iCAPS, maybe some people would think as trailing technology nodes, but If you really think about the digitization of everything and this big inflection, people are talking about the future having A half trillion or a trillion connected devices at the edge. And certainly, as we talk to system companies That are deploying those eyes and ears and sensors, in all of those different applications that are transforming every industry, There needs to be a tremendous amount of innovation in power, performance, cost, in both the chips and the packages.

Speaker 2

So, And we will cover this some more in the September 8th Master Class, but I would think about edge innovation. Certainly, in the cloud, You need high performance to extract the actionable insights, but that latency, power, Cost, all of those things on the Edge, that innovation is really important. And I think relative to the sustainability, Certainly, you can see the explosion of data, especially machine generated data. This market It's very, very strong and we think as you go to a half trillion connected devices at the edge in the future, it's going to stay very strong. And as Dan talked about, we made a strategic change in our organization in 2019, pulling together Key parts of our company, 200 millimeter, 300 millimeter unit process innovation, we have some dynamite technologists Focus on these markets.

Speaker 2

And again, we'll share more of that at our September 8 Master Class.

Speaker 1

Okay. Thank you, CJ. Operator, can we have the next question, please?

Operator

Thank you. Our next question comes from the line of Stacy Rasgon from Bernstein Research. Your line is now open.

Speaker 5

Hi, guys. Thanks for taking my question. I I had a question on memory. First on DRAM. So obviously, it grew pretty nicely sequentially in the quarter.

Speaker 5

It sounds like you're still pretty positive though on the trajectory and it's still below prior peak levels. And given the strength of your positioning and everything you've talked about, Is there any reason to believe that like whenever we hit DRAM peak, like whenever that is, is there any reason to believe that, That level where it is shouldn't be higher potentially significantly higher than where we saw the prior peak, which was several years ago. And I think on the other piece of memory, NAND, you talked about foundry logic and DRAM, you didn't really mention NAND at all. I know last quarter, Your views on NAND were a little more muted than the rest of it. Have your views on the trajectory of that market into the back half on downtick at all versus where you were 3 months ago because one of your competitors down ticked a little bit.

Speaker 3

Yes. Thanks, Stacy. Let me take a crack at those So first, I think our view around WFE this year, there's very little change. We said it's now over $80,000,000,000 We think it's a mid-thirty percent grower plusminus and embedded within that we see strength across all device types, your fastest growing foundry logic, 2nd half weighted, next fastest growing DRAM, 2nd half weighted, still see strong demand and pull from customers there. So we feel good about that.

Speaker 3

Last quarter, we put a question mark on the profile of NAND. Is it flat? Is it down a bit? We needed a bit more time to tell. I think we're still in that category.

Speaker 3

I think there's question mark. Is it flattish? Is it down a bit? So very little has changed in terms of the shape of the profile throughout the year. Taking a step back and taking a look at our DRAM progress, this is a business that we've had strong momentum in now for Several years.

Speaker 3

And as we take a look at the roadmap, we talk about increasing our opportunity node over node and that seems to be playing out in the market. Right now, you're adopting logic like structures within the DRAM market and this plays to a traditional source of strength for us. And so we're playing a key enabling role for our customers and you see that playing out in the most recent results and we would expect that strength to continue through the back half of the year. As we look into 2022, we do see the overall WFE market up year over year. We see continued strength in all three device types, foundry, logic, DRAM, NAND, and so we like how well we're positioned against That opportunity and the way we see it, right now we're planning for all three of our reporting segments to be up So the concept of peak is a really interesting one in this context.

Speaker 3

If we take a step back And look at the secular trends shaping this industry. We know industries are going through a digital transformation, increasingly going to drive adoption Of semiconductors and I'd say the demand for semiconductors 5 years from now is going to be greater than it is today and certainly greater than it was 5 years ago. So all of that is playing out nicely. What I would also say in the DRAM market that your node over node shrinks Are producing less bit growth than they have historically. So you're seeing capital intensity rise in that market.

Speaker 3

You're seeing capital intensity rise in all device types, frankly. But when I look at the investments our customers are making in this

Speaker 1

environment and I compare it on a historical basis

Speaker 3

as a percent of And I compare it on a historical basis as a percent of profitability to what we've seen historically. You go back about a decade And the customers are spending more from a WFE standpoint, but WFE as a percent of EBITDA is down 40% over the last Decade. So the monetization of these investments is greater today than it's ever been. So we really like the long term And while every year may not be a peak, the trend line is definitely up And we do think it leads to higher highs and higher lows as this industry continues to drive its roadmap and deliver the power performance roadmap. We think we're incredibly well set up to perform really well as those trends play out.

Speaker 5

That's helpful. Thank you. Thanks, Stacy.

Operator

Thank you. Our next question comes from the line of John Pitzer from Credit Suisse. Your line is now open.

Speaker 6

Yes. Good afternoon, guys. Thanks for letting me ask the question. Gary, sort of notwithstanding the comments you made in your prepared comments About how world governments have finally figured out how strategically important semi production is and we're going through a period of regionalization of semi production. If you look over the last two quarters, you've grown revenue over $1,000,000,000 and the biggest chunk of that by far has been China.

Speaker 6

And so I'm wondering if you can help us just better understand the makeup of spend in China today. And to the extent that we're all expecting this regionalization of supply, When and how do you think that takes place?

Speaker 3

Yes. Thanks, John. Let me take a crack at it. And so what we would say is, We take a look at the business we do in China. We've got 3 reporting segments.

Speaker 3

The numbers we report Our both semi systems to domestic China market participants as well as the international market participants that are building facilities there, All of the services that go into supporting those facilities as well as the display equipment that we ship into the market. And so there's a lot of moving pieces that As I take a step back and look at what's going on this year and we compare it to maybe The $10,000,000,000 of domestic China spend in WFE last year, what I would say is, is that you're seeing meaningful Spend across all three device types, foundry logic, DRAM, NAND. I would say the weighting this year is towards ICAPS market In China and from a growth perspective, I would say it's probably growing a little bit above the overall industry average. So we feel really good about how well we're set up against this opportunity with long standing relationships, key enabling technology, We've got a broad and diverse business that serves this market across 3 reporting segments. And so we feel good about how we're positioned and continue You know, drive strong performance as the market evolves.

Speaker 2

Yes, John, on the other part of your question about when do those investments happen from a regional perspective, There's no question, I'm involved in a number of different discussions. There's tremendous pull Across many different regions, U. S, Europe, Asia. And what I would say is that certainly It's important from a supply chain continuity to have more regional capacity. I think that's a big area of focus.

Speaker 2

But personally, I think even more important is having not just physical infrastructure or manufacturing infrastructure, but innovation infrastructure. And if you think about the infrastructure that's going to enable this multi $1,000,000,000,000 digital inflection, It really gets back to, as I talked about earlier, edge innovation, cloud innovation, everything in between for power, Performance cost ahead of others. So as I we certainly see an opportunity and that is moving forward relative to Physical infrastructure and regionalizing capacity, also certainly for Applied, the United States, and many governments, Having those foundational technology puzzle pieces for innovation, to win this PPAC T Race of the Future is incredibly important and certainly Applied is in a position where we're going to continue to invest On top of what we've already done in the United States with the Made in Technology Center in Silicon Valley, the META Center in New York, But this is the race of our lifetimes and this innovation infrastructure, I think, is another key aspect of what needs to happen, to win the future.

Speaker 3

And then very quickly, John, just from a timing perspective on impact of the markets, we're not counting on anything from government spend in 2022. Our view is, as you start to see it in 2023 2024, if it happens faster than that, then it's upside to the perspective we have from a market standpoint, but 2023, 2024 is what we're currently seeing as the right timing about around that spend to regionalize capacity.

Speaker 6

Perfect. Thank you, guys.

Speaker 1

Hey, thanks,

Operator

John. Thank you. Our next question comes from the line of Vivek Arya from Bank of America Securities, your line is now open.

Speaker 7

Thanks for taking my question. You mentioned that you expected or you expect WFE to grow next year. I'm curious how much additional capacity are you planning to bring online Next year and as part of that, how does it impact your margin structure? Because when I look at your gross and EBITDA margins, they are pretty In some cases, have even exceeded your fiscal 2024 targets. If you could give us some insight into how much Additional capacity, you're planning to bring online and then where do margins go from here?

Speaker 7

Thank you.

Speaker 3

Yes. Thanks, Vivek. So, if you notice, we've been investing, at a nice rate as a company now for Multiple quarters, you saw us begin to take that up, invest in our infrastructure. We took a point of view on where we saw this industry going was going And we made sure that we had capacity in place to serve our customers and make them successful. So we'll continue to do that along the way.

Speaker 3

We won't be point specific about how much capacity that we're bringing online as you can imagine for competitive reasons, but we'll invest Ahead of that materializing and continue to do what we've been doing now for several years as this industry continues to go structurally larger And we put a capacity statement in place to support it. From a margin standpoint, what I would say is, as the company is performing really well in this environment, you see it in Despite the near term headwinds we see from a COVID environment. And so, as those headwinds begin to dissipate, I think you see an upward bias Off of these levels on a like for like basis, from a margin standpoint. And then I'd also say, the long term model that we put out at our Analyst Day talked about 48.5%.

Speaker 8

I

Speaker 3

think we're making good progress against that. It's a good way to think about the company. But no matter what Our gross margin is, I would say, we'll never be satisfied with it. We'll be constantly looking for ways to increase the baseline level of productivity at the company and do even better than we're doing today. So we feel good about how we're set up.

Speaker 3

We'll continue to make investments to support the business and we'll continue to drive results.

Speaker 7

Thank you, Ben.

Speaker 1

Thanks, Vivek.

Operator

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

Speaker 8

Good afternoon. Thanks so much for taking the question. Gary, I wanted to ask about your leadership products. You gave some growth rates in your prepared remarks. I think for epi and thermal, you said above 70% growth this year, above 60% for CMP and above 50% for implant, all three outperforming What I believe is your full year implied guide for First Hemi Systems.

Speaker 8

I guess my first question is, what are some of the key drivers There and my second part is how should we think about sustainability into fiscal 2022 based on what's in your backlog today and based on the conversations you're having with

Speaker 2

Yes. Toshiya, thanks for the question. So when I I'm in constant with R and D leaders, many hours actually in each of the last 2 weeks and also CEOs for our leading customers. And what I would say, when you think about the PPAC T roadmap, power, performance and cost And time, getting there ahead of others, that's what determines who wins and loses, in the industry. And when you think about The relative the key drivers for that, we've talked about 5 drivers, new chip architectures, New materials, new structures, new ways to shrink and new ways to connect chips together.

Speaker 2

So if you look at what our customers are saying Even I think earlier today, but in many different forms, people are talking about new materials in the periodic table of elements and Packaging technologies and new structures like gate all around or design technology co optimization With technologies like buried power rails or contact over active gate, and in some of those cases, With no smaller pitch, you can drive a significant area savings. So when I look at The roadmap and you see this today in our leadership businesses, and we also talked about In our investor meeting, a new innovation where we can enable 50% reduction in wiring With integrated materials solution, we're combining many technologies under vacuum ALD, PVD, CVD, copper reflow, Surface Prep Technologies to drive a 50% reduction in wiring across many different levels, That is enormous when you think about power and performance and that one integrated system is worth 1,000,000,000 of dollars. That's what we've communicated. So, Toshiya, I think that the opportunity for Applied has never been better. When you think about Really, the relative contribution of power, performance and cost going forward, whether it's in the leading edge where you're Processing all of that data in the cloud, the edge innovation that we've I've talked about earlier today, new memory technologies, We're it's really in the sweet spot for Applied for materials innovation, structure innovation.

Speaker 2

We have a very strong Position in advanced packaging, we're driving innovations not only with our breadth in our unit processes, But also in combinations with partners with new integrated material solutions, we're going to share more of that In our master class on September 8th. So, I think the strength that you're seeing, if I look out for the next few years And I look at the relative contribution to PPAC T, I just think we've never been in a better position and our leadership areas and the strategies and investments That we've been driving are paying off now. They'll pay off even a bigger way going forward.

Speaker 8

Very helpful. Thank you.

Operator

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

Speaker 7

Hi, thank you for taking my question. I have a question for Jerry on the display industry. When should we expect an inflection on the display And how long we're going to go through this LCD to OLED conversion phase and when should the new capacity come on for display?

Speaker 3

Yes. Thanks, Alex. Let me jump in on that one. So we talked for several quarters now about strengthening fundamentals In the overall display market, capacity coming out, strengthening panel prices, screen sizes continued to increase, you see 5 gs OLED penetration in the handset and then future roadmap foldable displays in the handset. You talked about OLED penetration of larger format displays, IT TV, all of the strengthening market fundamentals, I think, give us a good sense that In 2022, you're probably going to enter a more attractive point of the investment cycle.

Speaker 3

I don't think it's going to be a dramatic Tell exactly when it hits in the beginning of 2022, in the back half of 2022, but we're on the cusp of entering that more attractive point. I think there's technical solutions that need to be solved in the OLED market to drive it into large format displays and start to replace LCD. So I think that's a little ways out, but we're certainly watching the customer's roadmap, the success with the Technology inflection and then putting capacity behind that inflection. Once that happens, I think you've got an opportunity to take this market structurally larger and it will be a long term technical shift in the industry's roadmap on those large format displays. Those solutions will be more capital intensive than LCD Technologies today.

Speaker 3

And from an Applied Material and Display business standpoint, It'll be an attractive piece of business for us when it happens, but I still think we're a little ways away of that inflection actually hitting the market and customers putting capital behind it.

Speaker 7

Thanks, Matt. Thanks, Atif.

Operator

Thank you. Our next question comes from the line of Krish Sankar From Cowen and Company, your line is now open.

Speaker 4

Yes. Hi. Thanks for taking

Speaker 9

my question. Dan, I had a question on inventory. Your sales have grown the last few quarters on a sequential basis, yet your inventory dollars have stayed roughly flat around the $4,000,000,000 give or take. And with some of your component and subsystem suppliers being constrained due to Malaysia and other factors, are you pulling from hub inventory? And are you worried at some point your suppliers challenge could kind of manifest into curtailing your own revenue potential down the road?

Speaker 9

Thank you.

Speaker 3

Yes. Thanks, Krish. So what I would say is, is I think we all know that Supply chain as the global economy begins to fire back online, there's pockets of non linearity and some disruption. And certainly, our industry is no different on that front. I think what you see is a disciplined efficient operation of the company in the challenging environment.

Speaker 3

We feel good about how we're operating. My expectation in the current quarter given what we see going forward is, as you would begin to see that inventory rise in anticipation of what we see on the horizon. But we'll take it 1 quarter at a time, make smart decisions about how we engage with our supply chain to make sure we're set up to successfully satisfy our customers' needs and make them successful. So as I look back on the last several quarters, really comfortable and pleased with the way the company is

Operator

Thank you. Our next question comes from the line of Harlan Sur from JPMorgan. Your line is now open.

Speaker 10

Hi, good afternoon and congratulations on the solid results and execution. The team did very well in the $6,000,000,000 Process Control segment last year. I think your prior view was that you were going to grow this segment by 50% this year. Now the team is staying up 60% plus this calendar year, Clearly sustaining the strong momentum from last year. Obviously, we know there's a strong focus on new process debug and production yield improvements as Time to market for these new processes is so critical.

Speaker 10

What areas is the team going to see the strongest growth or Potential share gains this year in process control and how does the growth prospects look for process control into next year?

Speaker 2

Hi, Harlan. Thanks for the question. So when I think about our PDC business, there are really 2 aspects. 1 is certainly We're seeing tremendous growth within PDC, and that's our certainly e beam leadership. We're extending our e beam leadership.

Speaker 2

I'll talk about that. We have the new optical product, the nLIGHT. We're expanding traction of that Product, but the other aspect that's really important is the synergy with those technologies And our unit and IMS innovations, I talked about in the prepared remarks the Applied Pro Process recipe optimization, extending that from 25 different engagements to more than 50 next year. And so basically what we're doing is taking our e beam leadership, we have the highest resolution, and we can generate Massive data with unique imaging and algorithms, so we can look at fingerprinting across a chip for things like pattern loading or across the wafer and really dialing those recipes in for our unit process and IMS innovations, whether it's Wiring or gate all around or capacitor structures and DRAM or any of those kinds of things, that's worth 1,000,000,000 of dollars to us and it's worth a Tremendous amount for every one of our customers. So that combination in the synergy is also very powerful.

Speaker 2

And relative to the revenue growth within PDC, again, that's been really great to see. Our e beam portfolio of products is extremely strong. We're also deploying new technology and we'll talk more about that at the upcoming To extend our leadership from a resolution perspective, certainly across all of our products, across EUV types of applications, so that's very strong. The optical part is also growing where we have real strength with some leading Foundry, logic customers across a broader set of customers. So, I'm very optimistic.

Speaker 2

Your question about sustainability, Very, very optimistic about the sustainability of revenue growth within PDC and I'm even more excited about the synergy for R and D acceleration and big process windows and higher yield for the rest of the Applied portfolio.

Speaker 10

Thanks, Gary.

Operator

Thank you. Our next question comes from the line of Timothy Arcuri From UBS, your line is now open.

Speaker 11

Thanks a lot. I just wanted to get both of your view on maybe some of the longer term puts and takes on the Systems business, if we just look at the commentary here into the back half of this calendar year, it seems like we're doing about $45,000,000,000 in WFE for the back half of the year, sort of run rating around $90,000,000,000 And if you just take the cumulative Street Consensus for semiconductor revenue, it's in the $290,000,000 to $295,000,000 range. So WFE intensity seems a bit above 15% here in the And I think you've sort of said that you think 14% is

Speaker 12

the right longer term number.

Speaker 11

So I guess my question is sort of how do you think about the puts and takes Where the systems business could go on the downside because as you say, Dan, we do have subsidy driven WFE coming on beginning in 2023. So I guess I'm just wondering how you think about the puts and takes around all of that. Thanks.

Speaker 3

Yes. Thanks, Tim. So When you think about run rates and you think about market share and you think about quarterly run rates, first of all, you're going to see Things move from quarter to quarter, so it's hard to extrapolate what happens in any given quarter, with a broad trend. The second thing I'd say is depending on what you assume from a market Share standpoint, you can get some pretty big swings in the analysis. So from my perspective, we got a market We think is over $80,000,000,000 this year, mid-thirty percent grower.

Speaker 3

Our systems business in the first two quarters of actual results, 1 quarter of guide, Those three quarters, our semi systems segment is going to be up over 50% against that market opportunity. We're seeing strength across all three device types and node over node momentum. We see our opportunity increasing. As we look into 2022, we see WFE up. Our confidence interval on that has gone up in the last 3 months.

Speaker 3

And so we feel good about that perspective. Then you see regionalization of capacity. And so, hard to always call With precision of the profile in any given year, as I take a step back and think about the importance of semiconductors to digital transformation of virtually every segment of the economy, you think about rising capital intensity. I think there's an upward bias on capital intensity over time As a result of traditional 2 d Moore's Law, traditional 2 d shrinks hitting a wall, the new playbook that has multiple elements to it, We're certainly going to play a key enabling role to each element of that new playbook. I see there being an upward bias of capital intensity over time and I don't think it Tops out at 14%.

Speaker 3

And then you think about regionalization of capacity to create a secure supply of semis. I think that provides an even further upward bias. And so and we've been on this observation for a while. If you go back a decade and The 2 year rolling averages of WFE, every year won't be up, but each successive 2 year window has been up Over the prior and as we look forward over the next decade, we see those secular trends shaping our industry, showing nice signs of strength. You will get a cyclical overlay on top of that trend line.

Speaker 3

It's going to lead to higher highs, higher lows, But it's hard to call with precision the timing of when those peaks and valleys hit.

Speaker 11

Thank you, Dan. Appreciate it.

Speaker 1

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

Operator

Thank you. Our next question comes from the line of Joe Quatrochi from Wells Fargo, your line is now open.

Speaker 12

Yes, thanks for taking the question. Congrats on the results as well. Just curious on the WFE outlook, you talked about increasing confidence in the 2022. Can you give us any sort of update on we think about it, I think last quarter you talked about over $160,000,000 for 2021 plus 2022. I think we're a little bit higher now for 2021.

Speaker 3

Yes. Thanks, Joe. Here's what we see. So we said over $160,000,000 for 2021 2022. We see 2021 being over $80,000,000,000 and we see up year over year.

Speaker 3

So we won't be point specific To update that over $160,000,000 but clearly we've got a lot of confidence that you're pushing higher to those levels, Higher than that level if 2021 is over $80,000,000,000 already and you're up into 2022. So we feel good about the setup, And certainly, our opportunity given the momentum we outperformed in 2019, we're going to outperform again in 2020, 2021. We think we're set up to continue that as we look into 2022 and we're planning for each of our reporting segments as we look into 2022 to be up. So we feel good about how the company is executing against that opportunity, but it probably won't update in a point specific way the 2 years, But I think what I just shaped for you gives you a sense of what we see.

Speaker 12

Fair enough. Thank you.

Speaker 1

Okay. Thanks, Joe, and thanks for your question. Dan, would you like to

Speaker 7

help us close-up today's call?

Speaker 3

Yes. Thanks, Mike. Sure. So as I look at the most recent quarter, one big takeaway from the quarter is just how much the foundry logic market has broadened. What used to be a leading node only spend in the past is now evenly balanced between leading edge and iCAPS markets today.

Speaker 3

I think that speaks to the momentum we see of edge computing IoT. When you put intelligence at the edge, Memory in the cloud. It's a nice virtuous cycle. Another observation, despite the supply chain headwinds the industry is seeing, Our teams are working incredibly hard in driving gross margin initiatives and they're delivering some of the best results the company has ever had. I also like the strong free cash flow being generated, really sets us up well to deliver even more cash to shareholders over time.

Speaker 3

Hopefully, I'll see many of you at the Needham, Deutsche and Citi conferences in the coming weeks. And so with that, Mike, let's go ahead and close the call.

Speaker 1

Okay, great. Thanks, Dan. And we'd like to thank everybody for joining us today. A replay of the call is going to be available on our website by 5 p. M.

Speaker 1

Pacific Time. Thank you for your continued interest in Applied Materials.

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Earnings Conference Call
Applied Materials Q3 2021
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