Earnings Call Transcript
APPLIED MATERIALS INC /DE (AMAT)
Earnings Call Transcript - AMAT Q4 2022
Michael Sullivan, Corporate Vice President
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’d now turn the conference over to Michael Sullivan, Corporate Vice President. Please go ahead, sir. Good afternoon, everyone, and thank you for joining Applied's Fourth Quarter of Fiscal 2022 Earnings Call. Joining me are Gary Dickerson, our President and CEO; and Brice Hill, our Chief Financial Officer. Before we begin, I'd like to remind you that today's call contains forward-looking statements, which are subject to risks and uncertainties that could cause our actual results to differ. Information concerning the risks and uncertainties is contained in Applied's most recent Form 10-Q and 8-K filings with the SEC. Today's call also includes non-GAAP financial measures. Reconciliations to GAAP measures are found in today's earnings press release and in our quarterly earnings materials, which are available on the IR page of our website at appliedmaterials.com. Before we begin, I have a calendar announcement. Applied plans to hold an eBeam technology and new product webcast on Wednesday, December 14 at 9:00 a.m. Pacific Time. Please stay tuned for an invitation to join our presenter, Keith Wells, who is Group Vice President and General Manager of our Imaging and Process Control Group. And with that introduction, I'd like to turn the call over to Gary Dickerson.
Gary Dickerson, President and CEO
Thank you, Mike. Applied Materials delivered a strong finish to our fiscal year with record quarterly performance. Throughout 2022, the company has demonstrated solid execution while navigating COVID-related restrictions, supply chain shortages, and a challenging geopolitical and macroeconomic environment. I would like to recognize the hard work and commitment of our global team and our suppliers who are doing everything possible to meet our customers' needs. As this is our year-end call, I'll begin my prepared remarks with a quick review of our performance and progress over the past 12 months. I'll then give our latest outlook for 2023 before describing our longer-term growth thesis for the industry and Applied. After that, Brice will provide more color on our financial performance and key areas of operational focus. Like many others in the technology sector, our performance and priorities in 2022 have been shaped by an unprecedented set of challenges. Our top priority has been mitigating supply chain constraints that prevented us from fully meeting customer demand. In Q4, we made incremental progress, and we expect to continue closing supply gaps over the next few quarters. As well as finding creative short-term solutions, our team has been addressing root causes and building a more resilient, scalable supply chain and stronger strategic relationships with our suppliers. In addition, we are strengthening our own manufacturing, logistics and supply chain management. While I'm pleased with the recent improvements in supply chain performance, we are still supply chain limited across a number of key product lines and our backlog grew in Q4. The biggest supply constraints are in our metal deposition business, where customer demand is very strong. This is our largest business unit and where we have highly differentiated solutions for advanced foundry/logic and DRAM. The market for these products, which enable next-generation wiring, is expanding considerably. In addition to supply shortages, we're also navigating a difficult geopolitical environment as reflected in the new export control regulations enacted by the U.S. government on October 7. These new rules are complex and cover a broad range of semiconductor technology that includes wafer fabrication equipment and related parts and services. We have taken all the necessary actions to comply with these new rules, including suspending shipments and support where required. We estimate that the unmitigated impact to our fiscal 2023 revenues could be up to $2.5 billion. We believe the actual impact can be reduced to $1.5 billion to $2 billion. This will depend in part on how quickly the government provides licenses and approvals as well as how impacted companies refocus their investments. We are also mindful of the macroeconomic headwinds, including inflation and softening consumer demand. To offset the inflationary cost increases we are facing, we are driving multiple initiatives that include reengineering our products and implementing price adjustments. While it's too early to forecast 2023 with any precision, I can describe what we're currently seeing in the market and hearing from our customers. Starting with memory, spending is expected to be down year-on-year as weakness in consumer electronics and PCs prompts some customers to defer capacity additions. In leading-edge foundry/logic, demand looks strong, with customers racing for leadership and driving major technology inflections that determine their relative competitive positions. In ICAPS, chips for the IoT, communications, auto, power and sensor markets, demand is mixed. Consumer-driven markets are clearly softer, while the automotive, industrial and power markets remain robust. Those investments are underpinned by large inflections, including the transition to electric vehicles, accelerated adoption of industrial automation and growing demand for renewable energy solutions, especially in Europe. While all of this adds up to an expected pullback in overall wafer fab equipment spending next year, we believe that Applied's business will be more resilient than the underlying market for three key reasons. First, we have a significant backlog, the highest in our history, measured on both an absolute and percentage of revenue basis; second, demand for some of our most differentiated product lines where we have uniquely enabling technology remains much higher than our capacity to fulfill that demand; and third, our service business is positioned for steady growth with an increasingly large portion of this business being converted to subscriptions. Over the past 12 months, our installed base of systems grew 8% and the number of tools under comprehensive long-term service contracts grew 16%. The renewal rate for these agreements is well over 90%, which demonstrates the value customers see in our subscription services. Looking further ahead, our long-term growth thesis for the industry and Applied Materials has not changed. Semiconductors are the foundation of digital transformation that will touch almost every sector of the economy over the coming years. This puts the semiconductor industry on a path to a $1 trillion market by the end of the decade. And while every year will not be an up year, the overall trajectory is clear. We also like where Applied Materials plays within the ecosystem. As technology complexity is increasing, we expect equipment intensity to remain at today's levels or rise further. This means wafer fab equipment is likely to grow faster than the overall semiconductor market. Within equipment spending, major technology inflections are enabled by materials engineering, shifting more dollars to Applied's available markets over time. We think about the industry's future road map in terms of power, performance, area cost and time to market. The PPACt playbook has five pillars: new architectures, new 3D structures, new materials, new ways to shrink and advanced packaging, with each pillar made up of multiple technology inflections. For example, new 3D structures like gate-all-around transistors and backside power distribution networks are materials engineering enabled inflections that grow Applied's total available market. As I referenced earlier, wiring is a key bottleneck for chip performance and power at advanced nodes. And this is driving significant innovation in new materials. Between the 7- and 3-nanometer node, contact metallization steps are growing more than 50% and our total available market is expanding almost 80%. For interconnect layers, process steps are being added even faster, and we expect our revenue opportunity to approximately triple through these node transitions. Advanced packaging represents a new era for integrated circuit design that opens major new vectors of innovation for chip designers. Advanced packaging is also enabled by new materials engineering solutions. Although the industry is still in the early stages of adoption, we have already grown our packaging equipment business to nearly $1 billion. Our process diagnostics and controls business also has broad exposure to these inflections and delivered significant growth in 2022. Our progress and opportunities in e-beam will be the focus of our December technology briefing. Given our positive long-term view of the semiconductor market, the outsized opportunities for Applied Materials within the market and favorable global government incentives, we are making investments in R&D and infrastructure to support industry growth and position the company for future success. We will provide more details about our specific plans in the coming months. At the same time, with the current macroeconomic conditions, we are carefully managing discretionary spending and limiting hiring to only strategic positions. Before I hand the call over to Brice, I'll quickly summarize. Applied Materials ended the year strong with record performance. In the past quarter, we made incremental progress overcoming the supply challenges that have constrained our performance in fiscal 2022. However, there is still work to do and our backlog continues to grow. We expect 2023 to be a down-year for wafer fab equipment spending, but we believe that Applied’s business will be more resilient thanks to our large backlog, growing service business and strong customer demand for our leadership products that enable key technology inflections. Longer-term, secular trends create opportunities for Applied to outgrow the semiconductor market by enabling the PPACt roadmap with our differentiated portfolio of materials engineering solutions. We are making strategic investments for the future, while slowing spending growth in the near-term. Now, I’ll hand over to Brice.
Brice Hill, Chief Financial Officer
Thank you, Gary. I'd like to start by thanking our team and our supply chain partners for helping to further increase our output for our customers. On today's call, I'll summarize our results for the fiscal year and Q4 as well as provide our guidance for Q1. I'll also discuss the impact of recent U.S. export regulations on our revenue and gross margin. Before going into the results, I'd like to make three points. First, despite a weaker customer demand outlook, we generated strong orders in Q4 and ended the year with record backlog, particularly in some of our leadership product areas. Combined with the resiliency of our AGS business, the strong backlog puts us in a good position to offset some of the market weakness expected next year. Second, we have not changed our view of a $1 trillion semiconductor market by 2030 and with a high single-digit CAGR for semiconductors and similar or faster growth for equipment due to added process complexity. We grew our headcount in R&D spending significantly in 2022 to develop new leadership products and further expand our broad portfolio. While we are slowing our spending growth in the current environment, we remain committed to research and development, enabling critical inflections that support our customers' roadmaps. And third, we returned nearly $7 billion to shareholders this past year, including buybacks equivalent to 6% of shares outstanding at the beginning of the period. With record demand and financial results in 2022, a strong growth opportunity through 2030 and our broad and unique portfolio of systems and services, we're confident in our financial position and our future. Next, I'll summarize our fiscal year results. Although supply chain constraints impacted our output all year, we delivered record annual revenue and EPS. On a year-over-year basis, revenue increased nearly 12% to $25.8 billion. Non-GAAP gross margin decreased by around 90 basis points to 46.6%. Non-GAAP operating profit grew by over 7% to $7.86 billion. Non-GAAP operating margin decreased by 120 basis points to 30.5%. And non-GAAP EPS increased nearly 13% to $7.70. We generated about $5.4 billion in operating cash flow this past year and over $4.6 billion in free cash flow. We returned 151% of free cash flow to shareholders, including $873 million in dividends and $6.1 billion in share repurchases. Our cash returns for the past three years were equivalent to over 100% of free cash flow. In the year, demand for our products and services was very strong with record annual bookings in semi systems and AGS. On a year-over-year basis, our total ending backlog increased 62% to $19 billion. Our semi systems backlog increased 90% to nearly $12.7 billion. We expect to reduce our semi systems backlog as supply chain performance improves. Our AGS backlog increased 30% to over $5.6 billion. The strong AGS backlog reflects a large increase in long-term service agreements, which gives us confidence in the continued growth of this business. Moving to our Q4 results. We delivered record quarterly net sales of nearly $6.75 billion and record non-GAAP EPS of $2.03. Non-GAAP gross margin declined 20 basis points sequentially to 46%. And non-GAAP OpEx grew 3.5% sequentially to nearly $1.1 billion, with most of the increase in R&D. Turning to the segments. Semi Systems revenue grew more than 6% sequentially to $5.04 billion. Segment non-GAAP operating margin increased 80 basis points sequentially to 36.9%. AGS revenue was flat quarter-over-quarter at $1.42 billion. Segment non-GAAP operating margin declined to 28.3%. AGS key performance indicators continue to be positive with strong year-over-year growth in installed base systems, service intensity and subscription agreements. As a result, AGS continues to grow faster than the pace needed to achieve our long-term revenue targets. Moving on to Display. Revenue declined as expected to $251 million. Segment non-GAAP operating margin also declined to 13.5%. Turning to our cash flows. We generated $857 million in operating cash flow during the quarter, which was 13% of revenue. We returned over $1.72 billion to shareholders, including $223 million in dividends and $1.5 billion in buybacks. We repurchased 17 million shares at an average price of $88.05. Next, I'll discuss the impact of the new U.S. export regulations to Applied Materials. We currently expect that the unmitigated revenue impact of the new rules could be up to $2.5 billion in fiscal 2023. We continue to work through the regulatory requirements, including seeking licenses and approvals where appropriate. We hope to reduce the revenue impact by between $500 million and $1 billion to a net impact of $1.5 billion to $2 billion. We also expect the rules to reduce our non-GAAP gross margin by up to 1 percentage point. While this creates a headwind to meeting our gross margin targets for 2024, we remain committed to our goals and believe we can even exceed them over time. In Q4, the new rules reduced our Semi Systems and AGS revenue by approximately $280 million, which was in the range of our expectation on October 12. Inventory charges in Q4 were lower than our preliminary assessment. In Q1, we expect the new rules to reduce Semi Systems and AGS revenue by approximately $490 million combined and reduce our gross margin by around 1 percentage point, both on an unmitigated basis. Now I'll share our guidance for Q1. We expect revenue to be $6.7 billion, plus or minus $400 million, and we expect non-GAAP EPS of $1.93, plus or minus $0.18. Within this outlook, we expect Semi Systems revenue to be about $5.15 billion, which is up nearly 13% year-over-year. We expect AGS revenue to be about $1.33 billion, which is slightly up year-over-year. Display revenue should be around $170 million. We expect non-GAAP gross margin to be approximately 46.1% and we expect non-GAAP operating expenses to be $1.16 billion. We are modeling a tax rate of 13%, which is up from 11.8% last year, primarily due to mandatory capitalization of R&D expenses effective in our new fiscal year. Before we begin the Q&A, I'd like to summarize our company's position in the current environment. We have record backlog, notably in the highly enabling technologies for next-generation nodes. Our supply chain and manufacturing output are incrementally improving. We expect our services business will continue to grow and generate strong recurring revenue and free cash flow. And the longer-term growth outlook for the semiconductor industry remains strong. Applied is in a great position to invest in future growth and deliver strong profitability, free cash flow and shareholder returns.
Michael Sullivan, Corporate Vice President
Thanks, Brice. To help us reach as many people as we can, please ask just one question on today's call. If you have another question, please requeue and we'll do our best to come back to you later in the session. Operator, let's please begin.
Operator, Operator
And our first question comes from the line of C.J. Muse with Evercore ISI.
C.J. Muse, Analyst
I would like to clarify something regarding China. Specifically, what changed between the press release on October 12 and October 30 that resulted in seemingly little impact? My main question is related to the outlook for calendar year 2023 in the wafer fabrication equipment sector. It appears that companies are presenting a top-down perspective indicating weakness and decline for WFE, yet their bottom-up analyses based on deferred revenues and backlogs suggest a more optimistic view. Could you elaborate on these dynamics? Additionally, what range or outcome do you foresee for year-over-year silicon declines in calendar 2023?
Brice Hill, Chief Financial Officer
Sure. Hi, C.J., it's Brice. I'll begin with this. In relation to our prior announcement, we indicated an impact of around $400 million, plus or minus $150 million, due to changes in China trade. As we assessed the situation, we found that the actual impact was closer to $280 million. This adjustment comes from estimating the transactional aspects towards the quarter's end. Our initial estimates were slightly better than anticipated. Additionally, our execution during the quarter was nearly flawless in terms of logistics. We received more supply chain parts late in the quarter, resulting in over $200 million of positive outcomes related to execution and delivery, particularly in completing products in the field. Thus, it was these two factors at play—our performance exceeding the initial estimate and excellent execution in the final weeks of the quarter. Regarding 2023, it's still early to provide a WFE estimate. Instead, we're sharing insights based on our order patterns and business outlook for Q1 and Q2. As mentioned, our bookings for Q4 were robust, even though we experienced delays and some weaknesses in the memory sector. However, our backlog has reached a record level. For Q1 and Q2, we continue to face supply constraints and have substantial backlogs across various equipment lines, indicating that we need to focus on supply chain improvements and increasing our output to meet customer demand. Consequently, we are not yet in a position to make predictions on WFE for 2023.
Gary Dickerson, President and CEO
Yes. C.J., this is Gary. As Brice said, we can certainly give a perspective on our business. We're not going to guide on overall WFE for '23. But we're in a very strong position. If you look at the kind of profile of the business, it's more weighted towards foundry/logic versus memory. And we have some very strong products where we have significant backlog, and we're still working to close the supply-demand gaps in those areas. So from Applied's standpoint, as you know, it's all about the race for power and performance for all of our customers, and we're really well positioned with leading products and those big inflections. And again, our #1 focus is on closing the supply chain gaps.
Operator, Operator
Thank you. Our next question comes from the line of Stacy Rasgon with Bernstein.
Stacy Rasgon, Analyst
I wanted to ask about the difference between the mitigated and unmitigated impact from China. You mentioned the figures, $2.5 billion and the goal to reduce that to around $1.5 billion. I understand that obtaining licenses is a key factor. Where do you expect to acquire those licenses? Will they only be available to multinationals, or do you think some will also be issued to Chinese companies? How does this process work in determining the unmitigated and mitigated numbers?
Brice Hill, Chief Financial Officer
Stacy, it's Brice. Yes, and it's important probably to say that this unmitigated versus mitigated, it has everything to do with the impact to the China shipments and Chinese customers. In other words, it's not referring to whether we can ship a product we are making for those customers to non-China customers. So the unmitigated, the way we calculated this is we looked at the orders that we have for the affected customers, and that's what you see as the total, $2.5 billion. In order to mitigate that...
Stacy Rasgon, Analyst
Does that include multinationals, too?
Brice Hill, Chief Financial Officer
Say again?
Stacy Rasgon, Analyst
I'm sorry. Does that include multinationals, too? Or is that just the local Chinese guys…?
Brice Hill, Chief Financial Officer
It does not. It does not.
Stacy Rasgon, Analyst
So just local semis, okay.
Brice Hill, Chief Financial Officer
Yes. And so the way we looked at that, there are some customers that we're trying to clarify that we can apply for licenses for or we can get authorizations for once they establish that their technology is within the guidelines. So we have a process to do that. And on the other side, we expect some customers may decide to change their plan or change their technology, so it does not go above the threshold that's affected by the rules at this point. So it's really those two elements that we'll be able to clarify that some customers were able to ship with or ship to or some customers changing their plans on the technology side that would allow them to qualify for shipments.
Stacy Rasgon, Analyst
What would that mean though? Would that suck up like supply that would have ordinarily gotten built by somebody else though? Because otherwise, you're just adding like lagging-edge supply into a vacuum, essentially. How do we think about like the second order effects here?
Brice Hill, Chief Financial Officer
Yes. We don't think so. We expect all that equipment to be utilized. And so if that equipment has moved to a different use, then we expect it will be backfilled somewhere else for its original demand purpose, if that makes sense.
Stacy Rasgon, Analyst
Got it. And I guess just one last one. Right now, I guess, you're running at the unmitigated level. When do you think it would be at the mitigated level? Like, how likely do you think it will be that you end up at the mitigated level at some point?
Brice Hill, Chief Financial Officer
It's difficult to provide a precise answer. It's an ongoing process, and there are many people involved in this effort, including the entire industry. Currently, this is our second priority after increasing output. I believe our estimate remains valid, and we will continue to work throughout the year to enhance the number of customers and plants we can supply.
Operator, Operator
And our next question comes from the line of Vivek Arya with Bank of America.
Vivek Arya, Analyst
I just wanted to clarify. I thought, Brice, you said somewhere that you provided some look for Q2. I don't think I caught that. And then several of your memory customers that said that their spending could be down over 50% next year. Recently, Micron said it could be down even more than that. Have you noticed almost 50% cancellation of orders from them? Because I'm just trying to reconcile your commentary that sounds outside of China, of course, more benign and more supportive versus just the very horrific guidance that your memory customers are providing. I understand you're less exposed to memory versus foundry/logic, but still, it's a reasonable size exposure. I'm curious, has that 50% cut in capex translated to any reduction in your backlog or any change in your thinking about memory for next year?
Brice Hill, Chief Financial Officer
Thanks, Vivek. We are not providing guidance for Q2. However, we want to emphasize our record backlog and the constraints we are facing, particularly as we are behind on customer orders in several equipment lines. Our goal is to increase output, and this situation is applicable for both Q1 and Q2. Regarding memory, we previously indicated a significant demand exceeding our supply capabilities for 2023. During this quarter, we experienced a considerable number of pushouts and reductions in that demand. Despite that, we had solid bookings in Q4, contributing to a record backlog. I would note that the pushouts and reductions were notably prevalent in the memory sector, though I won't specify the percentage. It is clear that this is the area most affected by the changes in demand for 2023.
Vivek Arya, Analyst
So you are seeing a 50% type reduction? I'm just trying to align what we are hearing from those customers versus what you are seeing on the ground in your business.
Brice Hill, Chief Financial Officer
Yes. Sorry, I can't quantify exactly what it is. I'll just say that the reductions were biased in that area.
Operator, Operator
Your next question comes from the line of Krish Sankar with Cowen.
Krish Sankar, Analyst
Brice or Gary, I just wanted to find out, you mentioned how lagging edge is still pretty strong, especially auto analog in China. And I wonder like do you ever think that auto analog could be the next to drop? But in other words, if memory is going to be down next year, but lagging edge holds up, what is the risk that lagging edge rolls over in 2024 and you have two years of lackluster WFE?
Brice Hill, Chief Financial Officer
Okay. I'll start, maybe Gary wants to say something. We don't have a specific guide for what we call ICAPS, our mature node businesses. What we would say is there was significant growth in 2022. And when we think about all the end markets, we think the end markets are mixed. We know some of the consumer markets and even industrial have seen some weakening. But on the positive side, automotive and the power market that feeds EV and solar and other areas has been really strong. So for us, this is a critical market. We're continuing to invest and continuing to focus in this area, and we would just highlight to investors that the growth has been very strong.
Gary Dickerson, President and CEO
Yes. In addition, I want to mention that we established our ICAPS group over three years ago, which has allowed us to engage deeply with our customers on both technical and support aspects. We offer a wide range of innovative products for ICAPS. Currently, we have a significant backlog in some areas, particularly MDP and implant in FY '23, where customer demand is very strong. ICAPS shares similarities with the rest of our business, as there's always competition among customers regarding power, performance, and cost. Our ICAPS team is robust, and we have a promising product pipeline. We can assure you that we will not see an increase every year. While we're not providing guidance for '24, we believe we are well-positioned in ICAPS, particularly concerning enabling technology for future growth.
Operator, Operator
And our next question comes from the line of Mark Lipacis with Jefferies.
Mark Lipacis, Analyst
Gary, it appears that the general expectation for WFE this year falls between $65 billion and $75 billion. While I'm not asking you to provide guidance or forecasts for next year, I'm curious about what conversations you've had with your customers. If next year's expectations turn out to be too conservative, would that be due to long lead times where customers prefer not to cancel orders, or are there new driving factors at play, such as larger chips, advanced packaging, or trailing nodes? Additionally, is competition at the leading edge prompting increased investments supported by subsidies? What insights do your customers share with you, and despite the drop in memory, your backlog has still grown. What do you believe will be the significant drivers for next year, regardless of the final figures, and what could potentially lead to positive surprises?
Gary Dickerson, President and CEO
Yes, Mark, thank you for your question. Our customers across various markets are experiencing rapid technological advancements and are competing fiercely for power, performance, and cost, as well as to enhance their competitive standing. As you pointed out regarding the leading-edge foundry and logic markets, there is significant focus there, particularly in high-performance computing. For Applied, we have demonstrated strong capabilities in facilitating new structures that are essential for our customers' competitive edge. The introduction of gate-all-around technology can generate an additional $1 billion for us based on 100,000 wafer starts, which surpasses our current FinFET captures. We are on track to capture an additional 5 points of market share during the shift from FinFET to gate-all-around. Wiring is a primary concern, and it may not be fully recognized how critical this shift is for our customers. This is an area of considerable strength for us, as we are achieving a 50% reduction in wiring resistance through our integrated platforms that incorporate various technologies. Furthermore, our packaging segment has grown nearly to $1 billion, and we hold over 50% market share in our served market. We possess the most extensive offerings in advanced packaging and are still in the early stages of this transition. These developments are all crucial in the ongoing technology race among our customers. Additionally, regarding ICAPS, which I mentioned earlier, there are significant technology transitions happening that may surprise some, including our peers discussing ICAPS growth over more extended periods. In areas such as metal deposition and implant, we have strong enabling positions with our customers. Moreover, Applied is also focused on high-speed DRAM with logic-like structures. Our PDC business grew by 67% in FY '21 and around 35% in FY '22, showing exceptional performance that we expect to continue. Overall, our strategy is centered around major technological shifts and our positioning to capitalize on them. Brice, would you like to add anything?
Brice Hill, Chief Financial Officer
I would just comment that we still need to catch up to customer demand in several areas, which adds some momentum for 2023. Additionally, it seems clear that there is resilient demand in the productivity-driving sectors, such as the energy and data center markets.
Operator, Operator
And our next question comes from the line of Atif Malik with Citi.
Atif Malik, Analyst
Gary, I have a question on long-term impact of China restrictions to both domestic and multinational spend. If I look at China spending over the last five years, it has outgrown WFE by 3x to 4x. What replaces this in terms of pending capital intensity and above-average profitability for you?
Brice Hill, Chief Financial Officer
Yes. Atif, I'll start. This is Brice. I think on the China side, when we look at that impact, the larger part of the business has been on the trailing nodes for us, and we expect that to still be a very strong business for Applied. And we see that in both the factory projects that we monitor and also in the different end markets where there's investments. And then on the leading-edge, if it's a question of do we expect that demand to be taken away from WFE demand globally and permanently? We don't. It will either be satisfied in some way in China, either by multinationals or in some other way or it will move to another geography. So we don't believe that, that will be an impact. And just circling back around, I would just focus on over time, we expect the China market to be a strong grower, especially in the ICAPS mature node space.
Operator, Operator
And our next question comes from the line of Toshi Hari with Goldman Sachs.
Toshiya Hari, Analyst
I wanted to ask about the AGS business going into next fiscal year and calendar year. Obviously, it's been a very steady grower for you guys and for the overall industry. Many of your leading-edge memory customers and logic and foundry customers, I believe, are in the process of cutting wafer starts, potentially over the next couple of quarters. So I guess the question is, when you cite services as one of the reasons why you'll outperform into next year, is the baseline assumption that business continues to grow given the installed base growth and given how you transform the mix of that business? Or could it be down but it’s less?
Brice Hill, Chief Financial Officer
Thank you. There are a couple of factors to consider. In our outlook for Q1, we are expecting a decline for AGS, which is atypical. This is largely due to the full quarter impact of losing approximately $100 million in revenue from our customers in China, which we will not be able to serve for the remainder of the year. This is certainly a challenge in Q1. However, you accurately pointed out the dynamics moving forward. Each time we ship a tool, it increases our installed base of equipment. Last year, we experienced an 8% growth in that installed base. Additionally, our capacity to provide services and place those services on subscription agreements typically allows us to grow faster than the installed base, and we did achieve that last year. This is what makes our services business resilient. We have an increased amount of equipment requiring service, and the need for service intensifies over time, contributing to business growth. It is true that part of our business is transactional, and we anticipate lower utilization in this quarter and the next. However, even in 2019, when we faced lower utilization, our services business still grew. Besides the challenges related to China that I mentioned, we believe this trend will continue this year and into the future.
Gary Dickerson, President and CEO
Toshiya, this is Gary. I'll provide some additional details. We anticipate an increase in services for 2023. As Brice noted, transactional services will decline due to capacity utilization. However, our business model, which relies heavily on service and spare parts agreements, provides us with stability moving forward. This model is continuing to strengthen, with comprehensive agreements growing by 16% last year. The average length of these agreements has increased to 2.6 years, and our renewal rate stands at 93%. Throughout the chip shortage, we were able to showcase value for our customers by offering ramp services to boost chip production, managed part services to enhance tool availability and output, and managed services for yield improvement and productivity optimization. This has positioned our service business as higher value for our customers, which supports our growth strategy for 2023. Long-term, we anticipate achieving double-digit growth, and we remain highly confident in this outlook.
Operator, Operator
And our next question comes from the line of Harlan Sur with JPMorgan.
Harlan Sur, Analyst
Another follow-up on AGS. So looking back on fiscal '22, your Semi Systems operating margin declined about 200 basis points on strong revenue growth, obviously due to the inflationary cost pressures. But your AGS business sustained near record operating margins at 30%. So I guess how has the team been able to sustain the record or near-record AGS operating profitability in this inflationary environment? And more importantly, in a down year or potential down year next year, you guys talked last call, this call, sustainability of AGS from a revenue perspective. How should we think about the sustainability of operating margins for AGS?
Brice Hill, Chief Financial Officer
Thank you, Harlan. I want to highlight that we experienced lower gross margins and operating margins in Q4, primarily due to the specific inventory we held for our customers in China, which may need to be repositioned, relocated, or scrapped. Regarding operating profit, one of our strategies is to enhance the repairs we perform on products returned by customers. This approach helps reduce costs and the cost of goods sold, ultimately improving our gross margins and profitability in that segment. Additionally, increased efficiency plays a role. As we showcase greater capabilities to our customers and offer more services without increasing expenses, it helps us sustain profitability. These are the two main factors driving our performance.
Operator, Operator
And our next question comes from the line of Joe Quatrochi with Wells Fargo.
Joe Quatrochi, Analyst
I wanted to ask about the gross margin impact from the China restriction. Can you talk about what's driving that 1 percentage point impact? And then how do we think about what you could potentially recapture in the mitigated scenario that you outlined?
Brice Hill, Chief Financial Officer
Thank you. There are two aspects to consider, depending on the time period in question. Looking ahead, the impact on gross margin primarily comes from our smaller customers, who tend to be more profitable for Applied. As we move forward, the specifics of who we sell our products to and their profitability remain undetermined. Thus, we are anticipating the impact we've mentioned. In the current quarter, we also had specific inventory tailored for certain customers that was unique. We are in the process of qualifying some of this inventory, and while we have seen some success, we ultimately needed to reserve demand for that specific inventory.
Operator, Operator
And our next question comes from the line of Timothy Arcuri with UBS Securities.
Timothy Arcuri, Analyst
Gary, I had a question about WFE intensity. So we're exiting this year at 15.5%, and you were saying that through 2030, you think WFE is going to grow faster than semiconductors. You've certainly been beating that drum now for a while that WFE intensity is going to keep going up. And obviously, there are some underlying upward pressures. But China has obviously been ordering tools and building capacity well ahead of demand now, in part due to the fear of these bans. So if China becomes a little more of a lagging tier region, wouldn't that lower WFE intensity a bit and maybe argue that maybe it has to reset a bit?
Brice Hill, Chief Financial Officer
Tim, I'll jump in for a second here, just because I have the picture of the graph in my mind that we use. So we do think intensity is gradually increasing, and it's because of the reasons Gary described. A lot of steps in the process are becoming more complex and require more equipment, and we see that. And then when we think about China and ICAPS specifically, in the past, there's been a lot of reuse of existing fabs and existing process tools. And that allowed for a low intensity. And that's not been what's happening in the past few years and with recent additions. We've talked about the number of factory projects that we see. So as capacity gets added, even in the ICAPS space, what you see is an intensity level that's more like what we were experiencing on the leading-edge just a few years ago. And that's also serving to raise the overall average of intensity. So we're pretty confident that intensity will continue to rise.
Gary Dickerson, President and CEO
Tim, just a reminder that there was a time when there was significant movement of business to foundries, during which many factories and tools entered the market, but that is no longer the case. This is what Brice was highlighting concerning ICAPS capital intensities. Additionally, I reviewed a list of important technological developments for our customers and provided some insights regarding wiring and the increasing number of steps, which we are observing across all business segments. Therefore, it seems that capital intensity is likely to be in the right range as we look towards 2030.
Operator, Operator
And our next question comes from the line of Joseph Moore with Morgan Stanley.
Joseph Moore, Analyst
Great. I wonder if you could talk about the environment in China with the multinationals. Obviously, they need to get a license, they did immediately get a license, but it's a 12-month license. So would you say that you generally see the footprint moving away from China with those multinational customers? Do you see any potential for that to become an issue down the road? Can you just talk generally to the fact that the multinationals were included in this?
Gary Dickerson, President and CEO
Yes, Joe, this is Gary. The multinationals are not impacted today. Relative to their strategies, we'd really rather have them comment on that. So again, just today, they're not impacted. How they position their businesses geographically, that's really up to them.
Operator, Operator
Our next question comes from the line of Sidney Ho with Deutsche Bank.
Sidney Ho, Analyst
I want to follow up on the earlier question regarding the long-term wafer fabrication equipment (WFE). Looking ahead to the next three to five years, how do you view the mix of different types of tools and any potential changes? Specifically, I am curious about the balance between deposition and edge tools compared to lithography and process control as you engage with your customers about the roadmap and technological advancements. Additionally, I assume your served addressable market will continue to expand, so could you help us understand the extent of that growth?
Gary Dickerson, President and CEO
Yes, Sidney, thank you for your question. When considering our customers' roadmaps, there are five main drivers for future technologies, particularly workload-specific architectures. This includes new structures, materials, and advanced packaging techniques. In the advanced foundry and logic roadmap, there is significant attention on these new developments. Innovations in transistors, particularly gate-all-around technologies, are crucial for improving power and performance. There's also a lot of discussion around wiring, as our primary business involves metal deposition, with wires becoming thinner and resistance increasing, which is attracting more investment. Advanced packaging stands out as another key area for our customers, currently representing a $1 billion market for us with over 50% market share, and we anticipate substantial investment in this area as competition intensifies. In memory technologies, we're seeing material advancements in 3D NAND with customers increasing layer counts and integrating logic with memory. Meanwhile, DRAM is progressing towards higher speeds with implementations of high-K metal gates and logic-like structures. Overall, much of the investment is shifting towards materials-driven technologies, where Applied has a strong competitive advantage. Brice, would you like to add anything?
Brice Hill, Chief Financial Officer
No. Good. Thanks.
Operator, Operator
And our next question comes from the line of Quinn Bolton with Needham & Company.
Quinn Bolton, Analyst
Just had a question with the Chips Act applications expected to be received or submitted beginning sort of the February timeframe. I'm wondering as you look at your '23 WFE outlook, do you expect to see any benefits from Chips Act spending in '23? Or do you think it's really more of a '24 and beyond before it hits WFE spending?
Brice Hill, Chief Financial Officer
We do expect a very small amount in 2023. On the equipment side, it will likely really start in 2024 as several of those projects will begin construction. There are a few that will start with equipment, but for us, it will mainly be more in the 2024 timeframe.
Gary Dickerson, President and CEO
Quinn, I want to point out that those investments are tied to specific timelines. As Brice mentioned, we don’t anticipate significant impact in '23, but there are associated timelines for those incentives.
Michael Sullivan, Corporate Vice President
Thanks, Quinn. And operator, we have time for two more questions today.
Operator, Operator
And our next question comes from the line of Pierre Ferragu with New Street.
Pierre Ferragu, Analyst
Gary, I want to revisit your comments about capital intensity and the specifics related to the trailing edge of your portfolio. You outlined three reasons for the higher capital intensity compared to the past. The first is the lack of innovation, which increases capital intensity. You also mentioned that the secondary market that used to support the trailing edge is diminishing. My question is whether there is a third factor contributing to the current high capital intensity, which is our rapid capacity growth this year and last year. There is a substantial possibility that this capacity growth may slow down or even halt at some point. I would like to hear your thoughts on this and how it might affect capital intensity in the short term.
Gary Dickerson, President and CEO
Thank you for the question, Pierre. While we are completely aware that not all markets will experience growth every year, we anticipate significant growth in edge computing devices by 2030. These technologies are becoming increasingly widespread, with various applications like industrial automation and smart electric vehicles contributing to this growth. Although we cannot predict the exact growth patterns for each year, we believe the business will continue to grow healthily. This belief led us to establish the ICAPS organization three years ago, recognizing the substantial growth potential in this market and consolidating our technologies accordingly. Overall, we expect to see notable compound annual growth rates across all segments within ICAPS, though we are not providing specific annual growth projections.
Operator, Operator
And our final question comes from the line of David O'Connor with Exxon BNP.
David O'Connor, Analyst
Great. Following up on the backlog from a previous question, Gary or Brice, what is the expected time frame for bringing the backlog back to a more normalized level, and when do you anticipate catching up on demand for the products that are experiencing high demand on the PPACt side?
Brice Hill, Chief Financial Officer
Yes. Thanks, David. We're expecting it's going to take us more than two quarters. So depending on the line of equipment, I would say between two and four quarters is our internal estimate. And so that's what we're focused on. We are behind with the customers, and we're working on increasing output every week. Thanks for the question.
Michael Sullivan, Corporate Vice President
Yes. Thanks, David, for your question. And Brice, would you like to give us your closing thoughts today?
Brice Hill, Chief Financial Officer
Yes. Absolutely. Clearly, there are questions about the market in the near term. But for our part, we had healthy Q4 orders, and we have record backlog that we described and it's mostly in our leadership product areas that drive the big technology inflections. Job one for us is increasing our output to meet customer demand. We're in a strong financial position to continue to develop our broad portfolio of technology and to drive the critical inflections and to support, eventually, a $1 trillion semiconductor market. I hope we get to see many of you at the upcoming Credit Suisse and Wells Fargo conferences. In the meantime, we hope you enjoy a safe and happy Thanksgiving. Thank you. Mike, let's close it up.
Michael Sullivan, Corporate Vice President
Okay. Great, Brice. So we'd like to thank everybody for joining us today. A replay of the call is going to be available on our website by 5:00 Pacific Time. And we would like to thank you for your continued interest in Applied Materials.