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.

Good afternoon, everyone, and thank you for joining Applied's first quarter of fiscal 2022 earnings call. Joining me are Gary Dickerson, our President and CEO; and Bob Halliday, 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-K and 8-K filings with the SEC. Today's call also includes non-GAAP financial measures. Reconciliations to GAAP measures are found in today's earnings press release and in our quarterly earnings materials, which are available on the IR page of our website at appliedmaterials.com. Before we begin, I have a calendar announcement. Applied will hold its next master class on Thursday, April 21, at 9:00 Pacific Time. We'll cover patterning technologies for the chip-making industry, including 2D scaling with EUV lithography, materials-enabled patterning of gate-all-around transistors and 3D patterning control using e-beam technology and AI(x). We hope you'll join our technology experts for presentations and Q&A. And now, I'd like to turn the call over to Gary Dickerson.

Thank you, Mike. This is an unprecedented period for Applied Materials in the semiconductor industry. Demand for semiconductors has never been stronger or broader, and the supply chain's ability to fulfill this growing demand is constrained in the near term. While the supply environment remains challenging, we landed our first fiscal quarter of 2022 towards the high end of our guidance range and delivered our highest ever quarterly revenues. These results are a testament to the capabilities and commitment of our global team who are executing well and focused on doing everything possible to deliver for our customers. The industry clearly has a long way to go before supply catches up with demand. Applied's orders for the quarter were an all-time high, beating our previous record by $0.5 billion. To ensure our own manufacturing capacity is not a limiting factor, we've made and continue to make strategic investments in our global infrastructure. This includes our state-of-the-art logistics service center in Austin, Texas that we're bringing online this month. Like many in the industry, the biggest challenge we face today is the availability of certain silicon components that go into subsystems within our products. We are working closely with our suppliers to find solutions and eliminate bottlenecks. I would like to thank them for their partnership, as we collaborate in new ways to overcome near-term headwinds and build a stronger supply chain that better supports the future needs of the industry. In today's call, I'll talk about our demand outlook, which is very strong and strengthening. I'll provide our longer-term perspective on the secular trends reshaping the semiconductor industry. And I'll give you some updates on the progress we're making against our strategic goals and how we're positioned to outperform our markets over the coming years. Later in the call, Bob will share his perspective on the state of the industry and our financial outlook. Let me start with market demand. It's clear that wafer fab equipment spending in 2021 was limited by supply with some unmet demand pushing into 2022. If we look at our semiconductor systems revenues from the second quarter of 2021 to the end of Q1 2022, and compared to the prior 12-month period, they were up 43% year-on-year. We think this is a good approximation for industry growth in calendar 2021, which would put WFE in the mid-$80 billion range. Demand is very strong and continues to grow. We believe wafer fab equipment spending could reach $100 billion in 2022. And since we are already close to being sold out for the year, we also have a positive growth outlook for 2023. Within WFE, foundry/logic spending grew faster than memory in 2021, and we see it growing faster than memory again in 2022. We believe foundry/logic made up more than 60% of total WFE investments last year and will remain at these levels or increase as a percentage of the mix over the next several years. Innovation at the edge and in the cloud means that foundry/logic demand is broad-based and split relatively evenly between the most advanced nodes and ICAPS customers who serve the IoT, communications, automotive, power electronics and sensors markets. It's also important to put this near-term demand outlook in the context of the secular trends driving longer-term growth and structural changes in the industry. While digital transformation is already reshaping the global economy today, it will take decades to fully play out around the world, and that the foundation of this multitrillion-dollar inflection is advanced silicon. Today, 9 of the top 10 most valuable companies in the world either design or build chips. Eight of the nine are now designing their own customized silicon in-house, and the other one manufactures a large percentage of the world's chips by value. I think this is a great example of the fundamental role silicon plays in driving the system level, power, performance and cost improvements that will unlock the full potential of digital transformation and the metaverse. Back in 2018, we introduced our framework for describing the semiconductor industry's future technology road map. We call this the new PPACt playbook and said it had five key elements: new chip architectures like workload-specific ASICs; new 3D structures like gate-all-around transistors; backside power distribution; next-generation 3D NAND and 3D DRAM; new materials in gate, contact and interconnect; new ways to shrink from EUV lithography to advanced patterning; and advanced packaging from 2.5D silicon interposers to 3D chiplets and hybrid bonding. As the major technology inflections that make up the PPACt playbook take shape, it's clear this future road map is more multifaceted and complex than anything the industry has done before. This increasing complexity has positive implications for Applied Materials. First, we expect capital intensity to remain at the levels we have seen over recent years; and second, Applied's broad capabilities are more valuable because they allow us to address higher-order problems for customers and provide them with more complete solutions. On top of the opportunities created by the PPACt playbook, major supply chain inflections are underway that are also positive for industry economics. This starts with a shift from just-in-time to a just-in-case philosophy. The most visible example of this is the automotive industry where the major carmakers are quantifying the cost of lost business in 2021 and rapidly changing the way they work with suppliers of their most critical components. We're also working differently with our customers. They are providing us with longer-term visibility, and we are collaborating more closely on capacity planning. In addition, the strategic and economic importance of semiconductors is being recognized at a national level. In the coming years, government support and incentives in the US, Europe and Japan will translate into regionalization of supply. As I've highlighted before, these regional supply chains will be more resilient but also less capital efficient, which is an additional tailwind for us. Overall, our outlook for the next decade is very positive. We expect semiconductor and wafer fab equipment to grow significantly faster than the economy with outsized opportunities for Applied Materials. To be ready for this exciting future, we've aligned our organization and investments around three strategic pillars. First, to be the PPACt enablement company and provide the foundation for customers' road maps for power, performance, area, cost and time to market; second, to shift more of our business to subscriptions; and third, to generate incremental free cash flows and profitability from our businesses in adjacent markets. Earlier, I talked about key technology inflections that make up the PPACt playbook, gate-all-around, backside power distribution, 3D NAND, 3D DRAM, new materials and the gate contact and interconnect and advanced packaging. All of these inflections are primarily enabled by materials engineering, Applied's core strengths. And as a result, they grow our total available market. Thanks to our relentless focus on developing differentiated technology to enable these inflections, we are also in a great position to capture more of that growing TAM. For example, in the transition from FinFET to first-generation gate-all-around, our transistor TAM grows by more than $1 billion per 100,000 wafer starts per month. And based on our tool of record positions, we expect to capture the majority of the inflection. We will provide more details about these inflections and how we expect them to play out in our 2022 master classes. While our current supply constraints mean that we can't fully realize the strength in our business, we are executing very well against our product road map, and there are clear leading indicators of our future growth potential. I'll highlight a few recent examples. In etch, we've recently won multiple tool of record positions at advanced nodes and foundry/logic across all three leading-edge customers. This is significant because these wins are in areas we haven't served in the past and demonstrate how our next generation of etch solutions address customers' most challenging applications. In inspection and metrology, where we have fewer supply chain constraints, our trailing 12-month revenues were up 68% year-on-year, and our e-beam revenues nearly doubled in that period. We expect to outperform the market again in 2022 with especially strong growth in optical wafer inspection, combined with further extension of our e-beam leadership. Beyond unit process excellence, Applied is able to combine the industry's broadest technology portfolio and unique ways to create co-optimized and fully integrated solutions. For example, co-optimization of hard mask, deposition and etch is an enabling solution for high-aspect ratio structures. Adoption of our co-optimized Draco solution is accelerating generating an incremental $600 million of revenue this year. And we recently secured our first wins with a new carbon hardmask deposition and etch solution at a leading memory manufacturer. Another key component of our technology portfolio is our digital tools that accelerate R&D, technology transfer and ramp, and optimize productivity in high-volume manufacturing. We are engaged with a broad range of customers. In this quarter, we secured a new strategic penetration for R&D acceleration using our AI(x) actionable insight accelerator platform at a leading customer. As part of this engagement, we will use our unique sensor technology and proprietary machine learning algorithms for rapid process window tuning and process variability reduction. We're also making progress on our multi-year journey to increase subscription revenues. Within AGS, more than 60% of our parts and service revenue is generated from subscriptions in the form of long-term service agreements. The average tenure of these agreements is now 2.3 years, up from 1.9 years 12 months ago. And the renewal rate is over 90%. In addition, when we look at our combined software business in AGS and semi systems, which are also subscription-based, we expect them to generate more than $300 million of revenue this year. Before I hand the call over to Bob, I'll quickly summarize. Applied and our global teams are executing well in a challenging and dynamic environment, and our near-term focus is on doing everything we can to expedite deliveries to our customers. Demand for semiconductors and wafer fab equipment remains strong and continues to grow. There's still a long way to go before supply catches up with demand. Our outlook for 2022 and beyond is very positive as long-term secular trends drive our markets structurally higher. In addition, the major technology inflections that make up the industry's PPACt road map expand Applied's addressable market opportunities, and our broad and differentiated technology portfolio puts us in a great position to capture a larger portion of our served markets in years to come. With that, Bob, it's over to you.

Thanks, Gary. I'd like to begin by thanking our teams and our partners for doing everything they could in a challenging supply chain environment. We still have a lot of work to do to satisfy our customers' needs, and this is job one for all of us. I have three main messages for you today. One, demand for Applied's products is very strong and continues to grow. Two, we remain supply chain limited, and we forecast a gradual improvement over the course of the year. Three, we expect to grow our revenue and earnings each quarter through the end of the calendar year, and we believe it is increasingly likely that 2023 will be another growth year. Next, I'll summarize our Q1 results, then I'll provide details about the demand environment for Applied Materials, and finally, I'll share our guidance for fiscal Q2 and the rate of growth we expect to see throughout the year. In Q1, we delivered strong year-over-year revenue and earnings growth and exceeded the midpoint of our guidance. The supply chain environment was challenging. Our teams collaborate broadly with partners upstream and downstream of Applied to maximize the supply of components to our manufacturing sites and service locations. This work enabled us to deliver record semiconductor systems revenue, which we grew by 29% year-over-year. We grew fastest in foundry/logic year-over-year, and we continue to expect foundry/logic to outgrow WFE in 2022 with strength in both leading edge and ICAPS. From a product perspective in Q1, we generated record quarterly revenue in process control, CVD, and CMP. And we achieved our highest ever DRAM revenue. We also grew non-GAAP operating margin in semi by 280 basis points year-over-year. In AGS, we grew revenue by 14% year-over-year and increased non-GAAP operating margin by 110 basis points. About three quarters of AGS' year-over-year growth was in recurring revenue. Our AGS service revenues grew sequentially and year-over-year. We increased our tools under comprehensive service agreement by 13% year-over-year. And our subscription renewal rate was 92%. Our parts business met our expectations but could have been even higher. AGS includes our legacy 200-millimeter equipment revenue, which was below our expectations in Q1 due to supply chain constraints that prevented us from shipping to demand within the quarter. For the fiscal year, we continue to expect AGS to grow in the low double-digits, with potential upside depending on the supply chain recovery. In display, we exceeded our revenue goal in Q1 and increased non-GAAP operating margin by 280 basis points year-over-year. Summarizing Applied's Q1 results on a year-over-year basis. We increased revenue by 21%, non-GAAP gross margin by 140 basis points, non-GAAP operating profit by 270 basis points, and non-GAAP EPS by 36%. In addition, we generated record free cash flow and distributed over $2 billion to shareholders, with $1.8 billion in repurchases and $214 million in dividends. Next, I'll address the impact of the supply environment on our business in the near-term. Underlying demand for Applied's technology is very strong and growing. And we believe that as we work through the supply chain constraints, we will demonstrate the progress we're making toward our market share and gross margin targets. Although we don't usually report backlog on a quarterly basis, I'm going to give some further color on today's call to help you understand our confidence. In Q1, our semi systems backlog increased by more than $1.3 billion to a record $8 billion. Moreover, the backlog includes a rich mix of products that are highly enabling to our customers' road maps. What this tells us is that in an unconstrained environment, we would have produced substantially higher revenue and demonstrated a healthy share gain in calendar 2021. Also, absent the supply chain issues, our gross margin in fiscal 2022 will be very close to the targets in our 2024 financial model. We are laser-focused on improving the supply chain, which will enable us to support our customers and demonstrate the strength of our business. As Gary outlined, we expect the WFE market to grow by over 15% in 2022 to $100 billion or more. Even with the constraints, we expect to outgrow the market in our semi business and carry sizable backlog into 2023. Now, I'll share our guidance for Q2. We expect to increase revenue to $6.35 billion, plus or minus $300 million, which is up almost 14% year-over-year. We expect non-GAAP EPS in Q2 to be around $1.90, plus or minus $0.15, which is up around 17% year-over-year. Within this outlook, we expect semi systems revenue of around $4.6 billion, up 16% year-over-year; AGS revenue of around $1.35 billion, up 12% year-over-year; and display revenue of around $380 million. Applied's non-GAAP gross margin should decline to around 47% in Q2, as we absorb near-term cost pressures primarily related to expediting shipments to our customers. After Q2, we expect to gradually increase the gross margin by mitigating cost pressures and shipping a richer mix of high-margin products. Non-GAAP OpEx should be around $1.015 billion in Q2, and our non-GAAP tax rate should be around 12%. Looking ahead, we expect we can grow revenues by increasing mid-single-digit percentages each quarter through the end of the calendar year. And based on customer conversations about semiconductor demand and technology inflections, we're increasingly optimistic that 2023 will be another growth year for the industry and especially for Applied. Now Mike, let's begin the Q&A.

Thanks, Bob. 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 re-queue and we’ll do our best to come back to you later in the session. Operator, let's please begin.

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

Yes. Good afternoon. Thank you for taking the question. I guess a question on gross margins, particularly in the current challenging supply environment. You guided 47% and expectations for that to grow through the year. Can you speak to what it'll take to build out greater scale upstream for your key suppliers? What impact that might have on input cost for you and then your ability to pass those down to your customers? And what gives you the confidence that you can get to that 48.5% as part of the target model? And, I guess, as part of that, if you could frame what your expectations are when you might be able to hit that type of number? Thanks so much.

Let me address those six questions. Firstly, regarding gross margins, in Q4 of 2021, we achieved 48.2%. Our long-term model projects 48.5% at $87 billion and 48.8% at $100 billion. This quarter, we reported approximately 47.3%, and we expect around 47%. Typically, we see a half-point increase each year. We're currently facing two main challenges: one is cost increases from logistics and inefficient factory operations, including overhead and burn absorption, and the other is some issues with material costs. This is likely impacting our gross margin by about 1% to 1.5%, with a midpoint estimate of around 1.2%. However, most of these challenges are temporary; the factory absorption, logistics, and material costs should improve. I estimate that over two-thirds of these issues are transitory. The second factor is our product mix. We have strong orders and a substantial backlog, particularly in semiconductors. A higher ratio of semiconductor orders versus non-semiconductors would positively impact gross margins. Additionally, we've analyzed our semiconductor backlog, and the mix is quite favorable. When we normalize this against past backlog levels, we could potentially increase our gross margins by another 1 to 1.5 points. If we can achieve that, we're looking at being close to or potentially exceeding our model expectations. We're quite confident in our trajectory towards 48.5% at $87 billion and 48.8% at $100 billion in wafer fabrication equipment. Regarding cost increases, we're focusing on mitigating them and having conversations with customers. Our primary objectives are to improve our delivery times and ensure that we're shipping more tools on schedule. We have historically created valuable tools and shared the benefits, and while we face unique cost pressures now, I believe it's reasonable to discuss this with our customers. However, our top priority remains to ensure timely and voluminous shipments while continuing to provide value to our customers.

Great. Thanks, C.J.

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

Hi, guys. Thanks for taking my question. Bob, I just wanted to clarify and be crystal clear. So you said you saw through the year, you could grow by increasing mid-single digits. Do I read that as the actual percentage of sequential growth as we go through the year goes up every quarter? So the sequential growth is actually accelerating itself through the year?

Yes. It's roughly five to seven for now, and we expect it to be around nine in fiscal Q1. The figures for semi and AGS along with display are similar. Overall, the numbers are quite close.

Got it. That's helpful. And I guess any…

And I think that's a fair estimate. We still got to work through issues, but I think it's a good estimate.

Got it. And I guess along those lines, like what gives you confidence? Is that just your visibility on how the supply constraints themselves are easing? Like are you shipping, for example, like partially done tools, or you just have to supply like a final module or something to make it work? Like what gives you the confidence that the supply constraints will actually ease along that trajectory?

In the first quarter, our total material receipts increased significantly, although we didn't have a perfect match for parts. The increase was in the mid to high-single digits. We anticipate a similar increase in the second quarter, but we expect to have a better match for the parts. As mentioned last quarter, we are monitoring several factors, particularly semi-device components supplied through distribution channels to our customers. We believe our estimates are reasonable, as the issues we face are not due to internal capacity constraints but rather specific parts in the supply chain. Therefore, we feel confident in our projections.

Got it. That’s helpful. Thank you so much.

You’re welcome.

Yes, thank you, Stacy. Those numbers are accurate for semi systems. We can say that AGS grows year-over-year at a slower pace compared to semi systems, likely seeing an increase in the low double digits. Regarding display, our outlook suggests a slight year-over-year increase as well, which is also influenced by the supply chain. This information will assist you in understanding the revenue distribution for semi systems.

Got it. Very helpful. Thank you.

Thank you. Our next question comes from John Pitzer of Credit Suisse. Your question please.

Yes, good afternoon, guys. Thanks for letting me ask the questions and congratulations on the solid results. I guess, Gary and Bob, the bookings number and the backlog number in the Jan quarter were extremely impressive, but the cynic in me would argue that when your customers can't get what they want, they always order more than they need. And so from your perspective, how do you safeguard against the fact that you and all of your peers are having supply constraints right now? And if I'm your customer, I at the very least better get in line or I might not get what I need to kind of grow supply. How do you kind of safeguard against the dreaded double ordering?

I'll share my perspective, and Gary frequently speaks with customers to gather insights. First, the volume of orders and their growth rate is significant. We're not anticipating overbuilding inventory. Secondly, when we analyze the mix, especially regarding memory, it's telling. For context, over the last 15 to 20 years, some indicators of potential overbuilding include consistently high memory demand for three consecutive years, with 2017 and 2018 both exceeding 50% growth. Currently, memory constituted 40% of wafer fabrication equipment in 2021, declining a few points in 2022. We foresee moderate growth in memory without signs of double bookings. Another critical indicator we monitor is wafer starts and fab utilization. I mentioned last quarter that fab utilization reached a record high in our fiscal Q4, and it has increased slightly in Q1, remaining very high. Examining wafer starts from 2016 to 2021, we see that growth for DRAM and NAND memory was 19%, which is not an annual compounded rate but total growth over those years. In contrast, 200-millimeter growth was 70%, and there was a 100% increase in 300-millimeter logic and foundry from 2016 to 2021. Looking at TSMC, they have committed to long-term capital expenditures projected at $100 billion, with $40 billion to $42 billion this year alone. We have maintained close discussions with them, and they are dedicated to their spending plans. Similarly, Intel has announced new fabs and is also committed to spending. Last quarter, we saw an increase in the number of shells from 59 to 68, with projected expenditures rising from $300 billion to between $365 billion and $385 billion. With shell counts, growth in starts, high fab utilization, and the commitments from foundry and logic companies, along with a favorable memory mix, the outlook is positive. Regarding actual demand, we noted a 53% figure for ICAPS in 2021 and 2022. If we analyze 20-nanometer processes and above, especially older technologies like 28-nanometer, the percentage of wafer fabrication equipment has risen from 31% in 2020 to 43% in 2021 and 44% in 2022. This increase is driven by growing demand and fewer tools available for older technologies. Some might argue that this indicates an overheated market, but the rate of increase is actually slowing, moving from 31 to 43 to 44. In summary, while I've provided a lot of information, I do not believe we are currently overheated. We have a strong order flow, and the product mix appears stable. While we can look deeper into ICAPS in China, I feel confident about this year and likely next year as well.

Helpful. Thanks, guys.

Thanks, John.

Thank you. Our next question comes from Vivek Arya of Bank of America. Your question, please.

Thanks for taking my question. I just wanted to go back. So in Q4, I think you mentioned you were short by about $300 million or so that you were not able to fulfill. I'm wondering what that impact was in Q1, because when, Bob, I applied this 5% sequential growth through Q3, it only captures, I think, $300 million or so of sequential growth. Shouldn't you be growing more than that going into Q3, given the shortfalls you had in Q4 or Q1, or is this still kind of very supply constrained number?

It's completely supply constrained. We have more orders than we can ship. If you look at our backlog build was 1.3 billion in the quarter, and our backlog growth is pretty substantial in the next couple of quarters. So we are totally supply constrained as everyone is in the industry. I think $300 million was starting number for what it was in Q4. And I think Q1 could have been more if we weren't supply constrained. And the mix is really good for us in the backlog. Its products like MDP, APTD, and DDP and products like that.

Thank you.

You’re welcome.

Thanks, Vivek.

Thank you. Our next question comes from Krish Sankar of Cowen & Company. Your line is open.

Hi. Thanks for taking the question. Bob, I just wanted to touch base again on the supply constraint. The semi industry has been constrained for a while, but you and your equipment peers have been experiencing it for a few quarters now. And it seems like now you're talking not just to your suppliers, but their suppliers and also a few levels below that, and some of whom might end up being your direct customers as well. So I'm kind of curious, has that level of depth in your supply chain giving you better insight into when these issues could abate? And is that what is informing your mid single digit sequential for the next few quarters in semis?

Yes, I'll provide more details. Typically, an average tool consists of around 5,000 distinct parts, each of which has numerous subcomponents from our suppliers. Some of our suppliers operate on material requirements planning, while others use a build-to-stock method. Historically, our visibility into build and material processes along the supply chain has been limited. We have gained a deeper understanding of the suppliers’ suppliers, which links back to our customers. Often, they receive their parts through distributors rather than directly from our customers. With this enhanced visibility, we now have a much clearer understanding of the choke points and how to manage them both tactically and strategically in the long term. Our visibility has improved significantly, and our management is becoming more effective each quarter. This strategic perspective is a substantial advantage for the company. Overall, our understanding is deeper, and while we’re not completely out of the situation yet, I believe there will be long-term benefits for the company.

Thanks Bob.

Thanks Krish.

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

Good afternoon. Thanks so much for taking the question. Gary, in your prepared remarks, you talked about some wins in the etch market in areas where you historically didn't compete all that much. You talked about the advanced nodes across FoundryLogic. You also talked about inspection and metrology and how you've done well there on a trailing 12-month basis and the outlook into 2022. When you think about those wins and the momentum you have, how should we think about your overall WFE market share in 2022? I realize in the near-term, you're still supply constrained. But once supply eases, should we expect you guys to outperform the market this year and perhaps into 2023?

Thank you for the question, Toshiya. The areas you mentioned, etch and PDC, represent significant opportunities for us now and in the future. Our primary focus is on capturing the market shifts. We've previously discussed innovations like gate-all-around and wiring, and we introduced a new tool that integrates seven technologies to reduce wiring resistance by 50%. This combined platform is worth billions. We have the transistor to process data and wiring to connect it, along with technologies related to these market shifts. We provided examples around capacitors, scaling in DRAM, and CMOS logic, all of which present great opportunities for Applied. What sets us apart is our substantial market share, exceeding 50% in sectors like leading logic, ICAPS, and packaging, and we have a clear insight into these shifts. Our goal is to develop materials that enhance electrical performance and modify structures to improve outcomes for our customers. We are in an excellent position across all these areas. Regarding the products you referenced, etch is a key growth platform for us. The Sym3 etcher offers significant technical benefits, including higher conductance and better defect management with our unique materials. We are performing well in memory and increasing our market share across leading foundry/logic clients. In PDC, we've seen exceptional growth of 68% in overall revenue. We have solid leadership in E-beam inspection and measurement and anticipate continued expansion in optical wafer inspection. We're positioned strongly for growth in unit processes and are particularly excited about our capacity to capitalize on the major market shifts mentioned earlier. Concerning revenue growth, as Bob pointed out, visibility is limited due to our inability to ship fully, and our backlog is focused on 2023, particularly in core leadership areas, including metals for wiring. Additionally, we expect significant growth in epi and implant in 2022. Overall, we have never been better positioned than we are now, and our main challenge is to bridge the demand-supply gap.

Thank you so much.

Thanks, Toshiya.

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

Good afternoon. Thanks for taking my question. I assume that the team is placing orders for both subsystems, parts and chips, basically through the entirety of this year just given the extended lead times with your suppliers. And I assume that you guys have good visibility as to what those suppliers can ship against your orders. So if you put all of that together, can the team need its forward backlog and forecasted customer shipment requirements for this year, or do you think that there's a likelihood that you exit this calendar year with your shipments below your customers' demand requirements? In other words, is the 2022 WFE of $100 billion for you and peers below what your customers require? And if so, like what do you think is the true 2022 equipment demand profile?

Sure. You've asked a few questions, Harlan, about our mechanical processes, visibility, and our assessment of unconstrained demand for 2022. We send signals to the supply chain using MRP, and they indicate whether they can meet those demands. However, they find it challenging to predict their capacity more than a quarter or two into the future due to their suppliers. So, visibility is a bit uncertain. We are mechanically managing it, but there's no definitive answer. That being said, we do see some improvement. Regarding your question about unconstrained demand, it's possible that we will finish the year with demand exceeding supply. Our backlog is likely to grow throughout our fiscal year. Looking at the unconstrained demand, we defined WFE at 100 billion, which is what we ship for the industry. Our competitors are also facing constraints this year and are booking into 2023, so I believe unconstrained demand is several billion more than 100 billion—likely between 100 and 110 billion.

Yeah. Appreciate the insights. Thank you.

You’re welcome.

Thanks, Harlan.

Thank you. Our next question comes from Joe Quatrochi of Wells Fargo. Please go ahead.

Yes. Thanks for taking the question. You had mentioned that you're opening a new logistics center. I was wondering if you could help us understand, does that give you added capacity, or does that also help on the cost efficiency side? And then, are there some start-up costs that we should be thinking about that are embedded in this quarter's gross margin guidance?

That mainly improves the efficiency of shipping, receiving, and moving items. It doesn't significantly affect our costs since our volumes have increased, which means the costs are absorbed into the overall burden. Therefore, as a cost percentage, it doesn’t have much impact. We likely will pursue further expansions in the next year or two. However, I don’t believe it will negatively affect our costs; instead, it enhances our efficiency.

Yes. And Bob, just a follow-up. So what do you think gross margin does between Q2 and the end of the year? And is it impacted at all by that build-out?

Yes, I think gross margin is probably about 0.5 point from the Q2 guide to Q4. And I think what we just mentioned doesn't have really any impact.

Got it. That’s helpful. Thank you.

Thanks, Joe.

Thank you. Our next question comes from Timothy Arcuri of UBS. Please go ahead.

Thank you. I have a question regarding the timeline for WFE and its implications. Gary, you mentioned WFE intensity, and I’m curious about how much semiconductor revenue this can support. Based on various reports, it looks like we’re on track for around $45 billion in the first half and possibly $55 billion in the second half, totaling about $100 billion. In the past, you stated that 14% WFE intensity would support approximately $800 billion in semiconductor revenue. However, this year, if things go well, we might reach around $650 billion. I would like to know if you concur with this assessment and your thoughts on how far ahead we are in terms of semiconductor WFE. Thank you.

Thank you for the question, Tim. Regarding WFE or capital intensity, the figure is definitely above 14%. Considering the significant ramp-up from customers, the current capital intensity is likely around 18%. One example is in wiring resistance, which is a major focus for foundry-logic customers. The back-end interconnect steps are increasing about 2x from 5-nanometer to 3-nanometer. This increase is not only happening in foundry-logic but also in memory. Achieving a 50% reduction in wiring resistance is quite complex, which also affects system output. There's an increase in steps along with a reduction in output. For Applied, our metal deposition products, where we hold a substantial market share, are a key driver for us and a reason why we're booking into 2023 for those products. Bob, do you want to provide any additional insights?

Sure. That's a great question, Tim. I believe the numbers are currently at around 14% to 15%, which seems a bit high. However, I think a more sustainable figure would be around 15%. If we observe the trend lines and analyze WFE intensity, which is essentially WFE divided by customer revenues, we see that FoundryLogic, DRAM, and NAND reflect this most significantly, with FoundryLogic trending upward for a couple of reasons: the leading edge and the lack of tools for the trailing edge. This means that revenue requires more WFE, and our customers are also acknowledging this. We even see companies like TI, who haven’t made investments in years, now needing to add trailing capacity, which is causing capital expenditure as a percentage of WFE to rise. If we do a rough estimate, considering this FoundryLogic mix with more ICAPS and new technological advancements around 3D and gate-all-around, we can expect a bit more spending. I believe that 15% might become the new normal. By looking at electronics spending in 2025, projected at about $780 billion, applying 15% leads us to roughly $117 billion in WFE for that year. Thus, I think a sustainable growth rate for WFE is in the high single digits, driven partly by capital intensity and growth in wafer starts. If we maintain the capital intensity around 50%, the figures align well for a high single-digit sustainable growth rate for WFE.

Got it. Thank you Bob.

Thanks Tim.

Thank you. Our next question comes from Joe Moore of Morgan Stanley. Please go ahead.

Thank you. Could you provide some insight into the supply constraints? Last quarter, you mentioned that they were primarily related to programmable logic. Have these challenges expanded since then? Also, how is it that we have such clarity that these constraints will persist until the end of the year? Shouldn't you, as a major user of these chips, be able to move up in line and receive these products before the year ends?

Thank you, Joe. I experience this every day as we delve into the supply chain issues affecting our output. I believe the guidance we've provided, as Bob mentioned regarding improvements from quarter to quarter, is accurate for where we expect to land. Our visibility into these issues is much deeper than it was last quarter. As Bob indicated, many chips are embedded within various components and flow from our customers through distributors, who often don't know the final destination of those chips. As they identify where the constraints lie, they have responded to help address these challenges. However, there are numerous constraints impacting us, not just related to chips. For example, in our metal deposition products, demand has significantly increased beyond prior levels. Other components are also causing constraints. Nevertheless, our visibility has improved substantially. What Bob shared earlier is true; we will emerge from this situation stronger. There is no doubt we will have enhanced visibility and deeper relationships with our suppliers. In terms of our growth expectations, what Bob outlined regarding incremental quarter-on-quarter growth is generally correct. While the numbers may not be exact, the overall direction remains valid.

Great. Thank you.

Thanks, Joe.

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

Thanks for taking my question. My question is on the memory side of the WFE. I think you guys reiterated your view that memory WFE will grow but less than foundry and logic. But based on some of the comments you had earlier, you're looking at the kind of low teens growth rate for memory. Just curious, has your view changed much given the memory market seems to have improved in the past three months or they are so supplied constraint that you can really service the upside? And maybe just one more. I think last quarter, you talked about the demand side it's up but DRAM is down, is there any update to that as well? Thanks.

Sure. Good question, Sidney. I think there are two key areas influencing our perspective on DRAM and NAND: growth in foundry/logic and the overall mix. Our outlook has shifted slightly since last quarter; we were likely too conservative regarding China and particularly for DRAM. Currently, we believe that in a constrained environment, estimated at around $100 billion, DRAM and NAND are relatively stable compared to 2021, perhaps experiencing a slight decline, but mostly remaining flat. In contrast, foundry/logic is expected to see the most significant growth, increasing from 60% to a few points higher in terms of mix within the same $100 billion environment. Overall, we are more optimistic about DRAM and NAND than we were last quarter, especially regarding DRAM. We also have a more favorable outlook for overall WFE in 2022 compared to our previous assessment. While we still maintain a positive stance on foundry, DRAM shows the most notable change in our perspective since last quarter. In an unconstrained scenario, I don't believe growth is too rapid; fab utilization for memory and DRAM is performing well. I think things are in decent shape and appear to be weighted more toward the second half of the year.

Okay. Thanks, Sidney.

Thanks, Sid.

Thank you. Our next question comes from Mehdi Hosseini of SIG. Your line is open.

Thanks for taking my question. I have a couple of follow-ups. Bob, you mentioned the trading niche or ICAPS and highlighted that it was 43% of the WFE mix in 2021 and 44% in 2022. Did you mean to imply that this percentage refers to the trading niche or to the entire ICAPS?

What were the two choices, again, Mehdi?

You highlighted 31% mix for 2020, 43% for 2021 and 44% for 2022. I'm just trying to understand what you were referring to. What are those mixes?

We analyzed ICAPS, defining it as everything except the leading node, specifically 10-nanometer and above. I focused on 20-nanometer and larger, including 200-millimeter products, as sales in these areas have increased over the last three years. Notably, growth has been strongest in the 28-nanometer segment. In terms of foundry and logic, 31% of the WFE numbers were from 20-nanometer and above. Our revenue mix for foundry-logic was similar, with 43% in 2021 and 44% in 2022. The most significant year-on-year growth was seen in 28-nanometers and 45-nanometers, while 90-nanometer growth was modest. We examined the data by node and year. Additionally, it's worth noting that the rate of acceleration has slowed somewhat. Looking ahead, ICAPS is expected to grow in absolute volume alongside leading-edge DRAM and NAND. It's important to consider the source of ICAPS tools; although new devices are coming in, there has been equipment acquired specifically for this purpose. Historically, this equipment might have been transferred from the leading edge, where it would be utilized for a couple of years across two nodes, with 90% rolling forward and 10% being reused. However, if there isn't significant growth in trailing-edge ICAPS, most equipment will be fully depreciated and only available for use there. Thus, even a modest growth in ICAPS can lead to a significant increase in capital equipment requirements, potentially increasing tenfold relative to the growth, since there's less equipment rolling over from the leading edge and more new purchases are necessary for ICAPS.

Yes. I would say, Mehdi, just one more thing. A change over the last few years is that tools previously available for ICAPS are no longer accessible. More resources have shifted from 200-millimeter to 300-millimeter. As a result, these transitions have led to increased capital intensity for ICAPS.

Great. I have a quick follow-up and thank you for all the insights; they are very helpful. Regarding the mixes you mentioned, Bob, I understand that a significant portion is being installed in China. It seems that for most OEMs, domestic China now accounts for over a third. So I assume the investment in China for 20-nanometer and above for logic and foundry will continue and remain stable, regardless of external factors. Would that be accurate?

Yes. I think that's fair. The only thing you might look at, Mehdi, which is interesting is, where is the growth in WFE spend by application. And you've got a pretty big growth in the out years for automobiles, IoTs, some of the sensors stuff in phones. So I agree the China stuff will sustain stuff. I agree that the long-term demand is pretty good. I agree that they can't keep growing forever. But I think it's already started to decelerate a little bit in the relative growth rates from 2020 to 2021, 2021 to 2022. And you have to look at that availability of tools to roll over from the leading edge when you look at WFE, because it's a compounding factor.

Yes. Got it. Thank you so much.

You're welcome.

Yeah. Thank you, Mehdi. And operator, that's all the time that we have for questions. Bob, would you like to help us close off the call?

Sure, Mike. I'll give you my three-legged stool summary. Number one, demand continues to be very strong. We see our business trending up as we proceed through the year, and we believe 2023 will be even stronger. Number two, Applied's position is very strong. I'm confident that we really make progress with our supply chain; we'll be able to demonstrate that we are very much on track to our market share and our gross margin targets. And number three, even in this constrained environment, we're generating record revenue and operating cash flow, which is fueling strong shareholder returns. Now Mike, let's go ahead and close the call.

All right. Thanks, Bob. 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 o’clock Pacific Time. We'd like to thank you for your continued interest in Applied Materials.

This concludes today's conference call. Thank you for participating. You may now disconnect.