Applied Materials Inc (AMAT) — Q1 2021 Earnings Call Transcript

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 2021 Earnings Call. Joining me are Gary Dickerson, our President and CEO; and Dan Durn, 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. On April 6, Applied plans to host a virtual investor meeting to discuss our markets, strategies, and financial targets. We hope you'll save the date. And now, I'd like to turn the call over to Gary Dickerson.

Thanks, Mike. I'm very pleased to report another quarter of record performance for Applied Materials. Since the beginning of our fiscal year, we've seen a continued acceleration of demand in our semiconductor business as major macro and industry trends fuel increasing consumption of silicon across a wide range of markets and applications. 2020 was an excellent year for Applied as we outperformed our markets, while growing our earnings nearly twice as fast as revenue. We carry this strong momentum into 2021. Our broad portfolio and exposure to technology inflections, combined with the traction of our new products, put us in a great position to substantially outgrow our markets, again this year and into the future. I want to thank our employees and suppliers for everything they are doing to deliver for our customers and shareholders. Our operations and field teams are doing an incredible job, as we run the company at record levels and successfully overcome significant logistics and other challenges created by the pandemic. In R&D, our teams are working in new ways to accelerate the time to market of critical innovations for our customers and we're doing all of this while maintaining a relentless focus on keeping our colleagues and families safe. As Mike outlined, we plan to hold an investor meeting in early April. At that event, we will provide our in-depth analysis of the major growth drivers and inflections that will shape our markets over the next 5 to 10 years and describe our strategy to deliver innovative new technologies to enable our customers' power performance and cost road maps, accelerate their time to market and drive Applied's long-term profitable growth. In today's call, I will focus my comments on the near-term, first, covering the dynamics we currently see in the market and then highlighting some of our recent accomplishments that illustrate the momentum we have across the business. Starting with a high-level view of our markets, we are seeing a diverse combination of macro and technology factors fueling very strong and sustainable demand for semiconductors. As the world continues to navigate the current challenges and prepares for a post-pandemic era, the digital transformation of the economy is being accelerated. Companies are rethinking and reengineering the way they operate and there's an immense pull for advanced technology. In addition, consumers are making different choices about the way they spend their time, and the products and services they buy. I strongly believe many of the changes we're seeing today are irreversible, since new ways of working offer compelling advantages in terms of time and productivity. Within the electronics ecosystem itself, key technology inflections are driving increasing silicon consumption. I'll highlight three examples. Cloud service providers are forecasting data center CapEx growth of more than 15% this year on top of record spending in 2020. With the broader adoption of 5G handsets, silicon content in smartphones is growing at double-digit rates. And in automotive, where there are known supply shortfalls, total semi consumption is expected to expand more than 15% this year, translating these factors to industry investments. In foundry/logic, leading-edge investments are very strong and have been well articulated by our customers. On top of that, our ICAPS business that serves the IoT, communications, automotive, power, and sensor markets is expected to grow even faster and is on track to exceed $3 billion of revenue for the fiscal year. And then, 2020 was a strong recovery year, with spending up more than 30%. And in 2021, we expect customers to invest at modestly higher levels. In DRAM, supply-demand fundamentals look more favorable than NAND. And as a result, we still expect DRAM investments to outgrow NAND this year. All of this adds up to a very strong demand environment for wafer fab equipment and we believe this strength is sustainable well beyond 2021. Digital transformation touches every sector of the economy and is nondiscretionary for many industries. In addition, industry investments appear disciplined. When you look at wafer fab equipment intensities, that's wafer fab equipment revenues as a percentage of semiconductor industry revenues, they are well below recent peaks in all three of the device segments: foundry/logic, NAND, and DRAM. Turning to Applied's business performance. Our Semiconductor Systems revenues for the first fiscal quarter were up 26% compared to the same period last year. At the midpoint of our Q2 guidance, Semi Systems will be up around 50% year-on-year. And based on our current outlook, we expect to grow faster than the market for the year as a whole. There are a number of factors contributing to this outstanding performance. First, our business is very well balanced across devices and customers. Second, we have the broadest portfolio of products and capabilities, spanning materials creation, modification, removal, and analysis. These technologies, combined with our ability to connect them in unique ways, are fundamental to enabling our customers' power, performance, and cost road maps. And third, we have an incredible pipeline of new products and integrated solutions that are winning applications, expanding our served opportunities, and reducing the time it takes our customers to bring important new innovations to market. Node-over-node opportunity growth in both foundry/logic and memory favors Applied's leadership businesses, including epi, thermal processing, CMP, and PVD. In fact, we believe our PVD business can grow more than 40% this year and generate more than $3 billion of revenue. Our latest-generation products have strong momentum and more than 25% of our 2021 revenues will come from critical applications that we've targeted and won since 2018. Some highlights include: CVD, where we grew revenues 30% in 2020 and have strong customer pull for new differentiated material solutions that are highly enabling for advanced patterning; conductor etch, where we're winning new applications in DRAM and foundry/logic that contributed to our 32% revenue growth in this market last year; process diagnostics and control, where we believe we can grow more than 25% this fiscal year on top of the 45% growth we delivered in 2020, thanks to new optical wafer inspection and e-beam products that are still in the early stages of adoption; in packaging, where we expect revenues to be up 50% year-on-year on top of strong growth in 2020. Also, over the past few years we've started introducing a new class of highly differentiated products that we call Integrated Materials Solutions or IMS. Our IMS products can combine multiple process technologies with onboard metrology and sensors within a single system that are capable of enabling unique films, structures, and devices. We have numerous IMS engagements with our leading customers. And this year we will generate meaningful revenues from our initial IMS products. Moving to service, AGS delivered another record quarter. Over the past five years, we've grown our services business at a compound annual growth rate of 12%, which is twice as fast as our installed base growth. In this period, we've increased the percentage of service and parts revenue generated by service agreements from around 40% to more than 60%. These long-term agreements enable us to deliver more value to customers with our advanced service products, while providing us with stickier and more predictable recurring revenue streams. Our renewal rates for these agreements are also very high at over 90%. Finally, in display. Our outlook remains consistent with the view we shared in November. We expect 2021 revenues to be similar to 2020 as we continue to manage through the current market trough. We do see encouraging leading indicators of future growth including higher OLED adoption in the smartphone market with the vast majority of 5G handsets being equipped with OLED screens and increasing OLED consumption beyond phones in TVs and IT applications. We still believe OLED is a compelling technology and this inflection is a great catalyst for the display market that will create expanded opportunities for Applied. Before I hand the call over to Dan, I want to again thank all our employees for their outstanding contributions to Applied's success. 2021 is off to a great start with record results and outlook. We see strong and sustainable demand in our semiconductor business fueled by a combination of macro and technology drivers. We have great momentum thanks to our broad market exposure and differentiated portfolio of new products. And we believe we're in a great position to outperform our markets again this year. Finally, we're looking forward to sharing our long-term vision for the industry and Applied Materials at our investor event in April. Now Dan will give his perspective on the business environment and provide more color on our financial results and operational performance.

Thanks, Gary. Today I'll begin by summarizing Applied's performance in Q1 and then I'll share some of the key drivers of our growth relative to the markets in calendar 2020 and I'll finish with our guidance for Q2. Beginning with our Q1 performance. Applied delivered record revenue and non-GAAP earnings per share. We grew revenue by 24% year-over-year and exceeded the high end of our guidance. I'm pleased that we increased gross margin by around 100 basis points year-over-year, particularly since we are still experiencing COVID-related manufacturing protocols and logistics costs. We also generated record non-GAAP operating profit of nearly $1.5 billion, which was up 40% year-over-year. We increased non-GAAP EPS by 42% year-over-year to $1.39. Our teams operated with discipline and this enabled Applied to deliver record free cash flow of $1.3 billion, which was up 47% year-over-year. We increased cash and investments on the balance sheet by nearly $950 million to $8.22 billion as we await the regulatory decision for the Kokusai Electric transaction. I look forward to updating you on our capital allocation plans when we get together for the investor meeting in April. Turning to the segments. Our Semi Systems group increased revenue by 26% year-over-year including new quarterly records in Etch, metal deposition, and CMP. Operating margin grew by 320 basis points year-over-year. Applied Global Services also delivered revenue above our expectations, while reporting its highest operating margin over the past two years despite ongoing challenges related to COVID. The display group exceeded its revenue target and increased operating margin by 590 basis points year-over-year. Looking ahead, our demand outlook calls for growth. We currently expect all three of our segments to post higher revenue in the second-half of our fiscal year. Next I'll comment on our semiconductor equipment revenue performance in calendar 2020, which is equal to our Q2 of fiscal 2020 through Q1 of fiscal 2021. As I previewed on our November earnings call, 2020 was a memory growth year in which NAND equipment spending grew at nearly twice the rate of the overall market. DRAM customer spending also grew faster than the market and foundry/logic investments grew slower than the overall market, but still accounted for over 55% of total spending. Applied has balanced share and our revenue profile resembled the overall mix with our highest growth in NAND at 34%. We grew by 27% in DRAM and 23% in foundry/logic and we believe we significantly outperformed in both of these end markets. Within the semi systems group our growth was strongest in areas where we've made significant investments to drive the new playbook, to develop integrated material solutions for our customers and introduce new products where we have significant room to gain share. One of our fastest-growth areas was in advanced packaging, where we have the industry's broadest portfolio and by far the highest share. As Gary said, we expect this momentum to continue into 2021. Our dollar growth was highest in CVD and etch, which reflects the success we've had co-optimizing new CVD films with our Sym3 etch system to create unique patterning solutions across 3D NAND, DRAM, and foundry-logic. Among new products, our latest optical wafer inspection system grew by 44% in 2020, achieving over $400 million in cumulative revenue. We'll officially introduce the new system in the near future to explain its unique architectural features, along with breakthrough AI capabilities, that are generating strong customer pull. Turning to calendar 2021. We expect strong foundry-logic spending to continue. We also expect DRAM spending to grow at a faster pace than NAND. This 2021 mix expectation plays particularly well to Applied's technology innovations and strong product roadmap. Now I'll share our Q2 business outlook. We expect company revenue to be approximately $5.39 billion plus or minus $200 million. The midpoint would be up about 36% year-over-year. We expect non-GAAP EPS to be about $1.50 plus or minus $0.06 or up about 70% year-over-year. Within this outlook, we project Semiconductor Systems revenue of $3.85 billion, up around 50% year-over-year and AGS revenue of about $1.14 billion, up around 12% year-over-year. These forecasts do not include any revenue from shipments that still require government licenses. We expect Display revenue of around $370 million, with growth resuming in the second-half. We expect Applied's non-GAAP gross margin to be approximately 47%, or up around 240 basis points year-over-year and we expect non-GAAP OpEx to increase to $890 million. Our Q2 guidance assumes a non-GAAP tax rate of 12% to 13% and a weighted average share count of around 929 million. In summary, I'm pleased that Applied delivered another quarter of record performance in Q1, with strong year-over-year growth in revenue and profitability. I'd like to join Gary in thanking our teams for supporting our customers under challenging circumstances and operating with discipline to generate higher margins and free cash flow. Execution by our employees has been and continues to be nothing short of superb in what is still a challenging COVID environment. We look forward to giving you more insights into our markets and our company's growth plans at the investor meeting in April. Now Mike let's begin the Q&A.

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

Yes. Good afternoon. Thank you for taking the question. I guess, if you look back to 2020, it looks like you outperformed WFE by about 8 percentage points. And obviously, you talked about favorable mix coming into 2021 led by foundry and DRAM as well as I assume your strong position on the legacy side. So curious if you can kind of speak to what kind of outperformance we should be thinking about relative to WFE in 2021, and if you can point to the particular drivers that we should be focused on? Thank you.

Yes. Thanks, C.J. So in 2020, if we say the markets around $60 billion in 2020, and I would say, it's up a little more than 16% against that backdrop. If you look at our Semi Systems segment, we grew our Semi Systems segment revenue by 26.5%, so significant outperformance as you've called out. As we look at the drivers in 2020 foundry/logic grew below the industry average. It was really a memory-driven growth year; NAND about 2x; DRAM a little more than the industry average. So the company performed really well in that environment. As you go to 2021, we view the spend mix to be a more favorable environment for us as a company. Foundry/logic will continue to be strong in 2021. We see DRAM outgrowing NAND. And so against that more favorable spend mix, we would expect to significantly outperform the market again this year. So we feel really good about how we're positioned against the market opportunity. We've got robust end markets and strong product momentum within those end markets so we feel good. And then as we look beyond 2021, we see from an overall market standpoint and a company-specific momentum standpoint, we see continued strong performance into 2022. So, again, we like how well we're positioned. 2021 is a more favorable mix and I would expect us to significantly outperform again.

Yes, this is Gary. Thank you for your question. I’d like to share more about our specific opportunities. The technology sector is transforming many aspects of our lives, which is sustainably boosting overall business. We've mentioned that the era of 2D scaling is ending. We've observed in recent discussions with our largest clients their public conversations about future plans involving new chip architectures, structures, materials, and innovative methods for connecting chips, as well as design technology co-optimization focused on certain structures and materials. This is where our focus lies. To enable future advancements, it truly revolves around introducing new structures and materials. We previously discussed 50% of new approaches to chip connectivity. We are well-positioned given our available technologies. When considering the creation of these new structures and materials, physical vapor deposition is a significant factor for us. Our epi business is expected to perform strongly this year. Areas such as thermal processing and chemical vapor deposition are also thriving. We continue to achieve success in etching. When shaping these structures, our Selectra product leads the industry. Moreover, modifications using chemical mechanical polishing and implantation are essential. As I mentioned in the prepared remarks, our PDC business is on the rise. I can provide further details later in the call, but we are excited about our strong position. Considering the upcoming inflections in power and performance for future infrastructure, we have never been better positioned.

And C.J. maybe one more point to add to what Gary is saying. And as I went through the profile of spend one data point I left out was the aggregate size of the market in 2021. I think we'll have more to say in a point-specific way around overall WFE size in 2021 and beyond at the investor meeting coming up here in about six weeks. But if the overall industry consensus today, is call it, high 60s, $70 billion, I'd say our view is a bit higher than that as we sit here today.

Thanks, C.J.

Yes, good afternoon, guys. Thanks for letting me ask the questions and congratulations on the solid results and guide. Dan, it's probably not all that surprising that half-on-half growth is expected both in services and display. But in the Semi System businesses, that's a little bit different than kind of the tone that some of your peers have talked about with kind of a first-half weighting of WFE. And it might be explained by your last comment to C.J.'s question about having a little bit higher view on overall WFE. But I'm kind of curious given that your fiscal year doesn't match up with the calendar year, do you think on a calendar year basis that we're going to have a stronger second-half than first-half? And just relative to your fiscal year commentary, what gives you the bottoms-up confidence of half-on-half growth specifically in the Semi Systems business?

Yes. Sure John. Thanks for the question. Let me try to unpack it a little bit, so we can talk about sort of what we're seeing in our business versus maybe what others see in theirs. So, I guess, the first thing I'd point to is, we've got very broad end-market exposure. We're very balanced across all three device types; foundry/logic, NAND, DRAM really strong positions in each of those end markets. But within those markets, we've got product breadth and momentum around a number of our businesses. So we've got more balanced end-market exposure than, say, some who are more narrowly focused. Second thing, I'd point to and this ties into the answer I just gave to C.J.'s question, we've got a more favorable mix setup in 2021 with foundry/logic continuing to be strong, DRAM outgrowing NAND. So I think that serves us well for continued and significant outperformance. And then we talked about carrying the momentum, both from a market and product standpoint into 2022. So I feel good about how that transition looks. And then lastly, as you rightfully pointed out, within the fiscal year, we see back-half momentum with each of our respective reporting segments. So again, where we sit today, we think we're really well set up for strong performance throughout the year.

Thank you, John.

Thanks for taking my question. For either Gary or Dan, there's a lot of talk of chip shortages these days. Do you think this $70 billion WFE for the industry is sufficient to address these shortages? Or can the WFE number be higher? Or do you think that this actually could push out some of the demand into next year as well before the shortages are fully met? Thank you.

Yes. There are a few points to consider, Vivek. First, our estimate for the total size in 2021 is somewhat higher than the industry consensus. We see strong positive momentum, and our customers' capacity investments are aligned with multi-year demand projections. To ensure these investments yield returns over the long term, there needs to be significant, lasting demand supporting these customer expenditures. We believe there will be a degree of catch-up spending, particularly due to shortages in the auto industry, which should create a favorable market. However, I don't think that market alone is large enough to sustain the type of demand we are discussing. For 2021, we are looking at a demand statement exceeding $70 billion, which is diverse and includes various end markets—NAND, DRAM, and foundry/logic—all of which are performing well, with some growing faster than others. This is based on the ongoing trends we've observed, and we believe we are just at the beginning of a long-term investment cycle. Semiconductors will play a crucial role in supporting significant global trends. Our customers will be methodical in their capacity additions, ensuring they align with a more robust long-term demand rather than any short-lived market fluctuations.

Thank you.

Thank you.

Hi. Good afternoon, and thanks for taking the question. I wanted to ask about gross margins. Dan you showed nice upside in the January quarter. I was curious what drove that. And then for April, you're guiding up margins nicely both sequentially and year-over-year. Where are the puts and takes there? And I guess going into the second-half of the fiscal year, would it be fair to assume sort of a gradual progression higher given potentially faster growth in your leadership products and hopefully COVID inefficiencies going away? Thank you.

Thank you, Toshiya. When I consider gross margins, the company is doing quite well. We're up 100 basis points year-over-year in the latest quarter's results. In our guidance, we anticipate an increase of about 240 basis points year-over-year, despite facing significant challenges related to pandemic safety protocols and logistics costs for moving materials globally. The company is performing exceptionally well in this current environment. The improvements are driven by specific actions taken to enhance discipline and efficiency in our core operations. Although I'm never fully satisfied with our gross margins, we've implemented numerous initiatives aimed at boosting efficiency and instilling discipline within our operations, and we're starting to see positive results. We are optimistic about the diligent work being done within the company to improve efficiency. There will always be fluctuations based on customer mix and sales in any given quarter, but there are many substantial actions in place that we believe are benefiting the company right now. Looking ahead to the latter half of the fiscal year, we do not view this as a temporary trend. Our long-term target for gross margin was set at 47%, and we have managed to maintain that level even during the COVID situation. I expect that in the second half of the year, we will continue to remain in the range of 46.5% to 47%. At our Analyst Day, we will discuss our outlook for the coming years and the opportunities we see to further improve gross margins beyond these figures, reaffirming that this is not simply a short-term occurrence. The company is performing well.

Thank you, congrats.

Hi, thank you for taking my question. Question is for Gary. Gary we've heard European Union looking into building or redeveloping fabs in Europe. There is a great deal of buzz among investors that semiconductors have become strategic. Are you engaged with any kind of discussions with Washington D.C. on this topic?

Yes. I believe everyone can observe that economic and employment growth will look different moving forward. The ongoing digital transformation across all industries is being accelerated in the current environment. This is a strategic consideration from an economic and employment perspective. From Applied's standpoint, we have been working with customers and engaging in government initiatives concerning investments in various locations. One key point to note is that as companies relocate, the scale of their new factories tends to be smaller and less efficient, at least based on what has been announced. Although supply and demand will eventually balance out, this less efficient factory size benefits Applied. Additionally, we have noticed that whenever a company shifts from a geographic location with a high concentration of talent and experience, it creates opportunities for our service business as they establish themselves in new areas. Both the factory efficiency and our service agreements tend to be much more favorable in these situations. This will unfold over time, but it is clear from a strategic viewpoint that there is a strong demand.

Great. Thanks.

Hi, thanks for taking my question and congrats on the strong results especially the op margins in Jan quarter, given I think it was a 14-week quarter. The question I had for Gary was, you spoke about process control growing over 40% last year and possibly over 20% this year which is very impressive, given you're outgrowing peers. Just kind of curious is it all primarily coming from the new optical inspection tool? Or is e-beam patterning adding some extra fuel to it? Or can you give some puts and takes around the PDC growth this year?

Thank you, Krish. I would say there are three main drivers. First is the new optical wafer inspection system, which has experienced significant demand, particularly in leading foundries where we've seen a notable increase in adoption. This system provides customers with excellent performance at a more favorable cost of ownership, allowing for more inspection points along the production line, which greatly accelerates yield ramp. We are still in the early stages of adoption for this system. Our e-beam products are also performing exceptionally well. In 2021, our e-beam growth surpassed all previous years for the total systems business, except for 2020. This sector remains robust, and we hold a leading position in electron optics. We've launched a new source technology that delivers higher resolution and faster imaging in one segment of the electron beam market. We plan to leverage this core technology across all our platforms, which presents a significant opportunity for us to further cement our leadership in the e-beam market, which is expanding rapidly. It's crucial to consider how quickly our customers can enhance their key performance metrics in the power performance area and related costs. Accelerating these processes is vital for both us and them, particularly regarding PPACt. Our e-beam products allow for the generation of significantly more data at a much faster rate. When we focus on optimizing new materials and structures using advanced imaging and algorithms, we can expedite both our internal research and development at Applied and the PPACt roadmap for our customers. The synergy from this perspective is growing stronger for the overall company. We are in the early stages of adopting optical inspection, and we intend to further our leadership in e-beam imaging with new capabilities. The synergies across our business have never been better, making it more important than ever for both us and our customers.

Thanks, Gary.

Good afternoon, and great job on the quarterly execution. The chip shortages in the industry are across leading-edge and lagging-edge technologies probably more so on lagging edge just to support analog, mixed signal, microcontroller products that feed into the auto and industrial markets. And I think these customers are scrambling to add capacity. What's order activity been like for lagging-edge tools? And it looks like lagging-edge and IoT contributed about 25% of your systems business last year. Do you guys expect that mix to grow this year? And how do operating margins for these tools compare to the overall systems segment?

Yes, thanks, Harlan. Let me share some statistics on the split. This year, we see a continuation of the 70-30 split: 70% leading-edge and 30% trailing-node geometries. We've discussed this trend quite a bit over the last couple of years. The strength in trailing-node geometries is not new. From 2010 to 2020, the foundry business grew nearly 90%, while trailing-node geometries exceeded that average with over 110% growth. In comparison, leading-edge growth was a little over 75%. This trend has been consistent for a while, and we are well positioned in this segment. We are delivering key technologies, and the company is performing well. As this market segment continues to grow and surpass WFE, it will be very beneficial for us.

Yes. Harlan, I can add just maybe a little bit to this. I think this opportunity in what people refer to as specialty semiconductor is significant. About two years ago, we formed an organization we call ICAPs focused on IoT communication auto power sensors, pulling together all of our capabilities across the company. And we now see this as one of the fastest-growing opportunities within Applied Materials. And when you think about what drives those markets, whether it's sensor technologies or power devices, RF any of those types of businesses, it really plays to our leadership products: epi, PVD, CVD, implant, thermal, CMP, etch, and PDC. So we really have a good position there. We pulled together an incredibly strong group within Applied and we also have a focused device integration team just on those particular devices. So we talk about Integrated Material Solutions and we have some really dynamite integration engineers beyond the unit processes so that our strategic role in enabling that market has been increasing as we've refocused the organization. So, as Dan said, we're really optimistic, and we think some of these markets could be some of the fastest-growing markets over the next several years.

Great insights. Thank you.

Thanks, Harlan.

Great. Thank you. My question's on the services business. You had a lot of upside there relative to the commentary, the guidance on the quarter. Can you talk about what's driving that? Is that telling us that customer utilizations are better? Or just what should we infer by the upside there and how sustainable those trends could be?

Yes. So thanks, Joe. So we talked about in the prepared comments growing this business at twice the rate of our overall installed base. So this has been playing out over multiple years. The company has done a good job outgrowing the installed base. We're outgrowing it 2:1 over, an extended period of time. Embedded in that growth are a couple of things. Service entitlement on the new technologies is greater than what we used to ship, say a decade ago or more. The technology is more complex. The customers' integration windows, process windows are tighter, so it requires continually tighter specs and the performance of our equipment and tighter windows. And so that creates a nice adder as well. And then when you think about the strategy, five years ago we had around 40% of our revenue covered by long-term service agreements. The vast majority of those service agreements had a tenor of about one year in duration. Fast-forward to today, we've penetrated over 60% of the revenue covered by long-term service agreements. A third of those long-term service agreements have now stretched out their tenor beyond one year so we feel really good about the value that we're adding to customers. And it's underpinning nice growth for the business. So we feel good about the strategy. We feel good about the execution of the opportunity and it's a nice stable source of profitability, cash flow and value creation for our shareholders. So business is performing well.

It seems like a really good business. I'm surprised by the significant upside compared to 14 weeks ago. Specifically, you guided to $1.07 billion, but it came in at $1.155 billion. What is driving that upside?

So if it's a specific comment around the most recent quarter, everybody puts assumptions into their models about how you respond in a current environment, where you're seeing some spikes with respect to the pandemic in different geographies and just making sure that we recovered from an execution standpoint on unknowable things, as we extrapolate those data points to different populations around the globe. We went into that quarter a bit more conservative than we typically would, as a result of those pandemic statistics we are seeing in the fall.

Great. Thank you.

Thanks, Joe.

Hey, guys. I wanted to ask you a clarification and a question. The clarification is just does your guidance incorporate any shutdown at the Austin manufacturing site due to the deep freeze going on in Texas? And then my follow-on question is a follow-on to Atif's question about the US and European Union to the extent that they provide local support for local supply chains for advanced semiconductor manufacturing, would you see that that WFE spending being additive? Or is that just sort of a reallocation of WFE spending from what otherwise would have taken place in Asia to either the US and Europe? Thank you.

Yes, thanks, Quinn. From the perspective of manufacturing in Austin, our operations have experienced power fluctuations similar to other commercial and manufacturing businesses in the area. However, we do not anticipate a significant impact on our operations. We believe that as the weather improves and power stabilizes, we will be ready to respond efficiently. We have been in close communication with our local team, implemented risk-mitigation strategies, and ensured our labor resources are prepared. The guidance we provided takes into account the current situation in the region, and we feel confident about our ability to ramp up production once power is stable. Regarding the localization of supply chains and changes in our manufacturing footprint, I see a positive alignment between global supply and demand. The point Gary made about two smaller 50,000 wafer start factories being less capital-efficient than one large 100,000 wafer start facility is valid. While I don't expect a drastic change in overall wafer fab equipment, it seems likely that the demand for wafer fab equipment will increase due to the rise of multiple smaller facilities. Additionally, as supply chains become more localized, our global service organization is well-positioned to support customers as they expand their capacity outside their home regions. This has historically added value and led to increased service opportunities, which I believe will continue as this trend advances.

Thanks Quinn.

Hey guys, thanks for taking my question. Dan, I just want to ask you on OpEx and I feel a little guilty asking given the op margin performance. But considering OpEx in the quarter is up a decent amount. So just maybe what's driving that other than I guess higher commissions? And then just any thoughts on the rest of the fiscal year?

Yes. Thank you for the question, Blayne. Regarding the transition from Q1 to Q2, I want to highlight a few points. In Q1, we experienced a holiday shutdown at the end of the calendar year, which also included a one-month impact from annual merit increases. As we enter Q2, we won't have the shutdown, and we will see the full quarter impact of those merit increases. This will create a natural cost escalation during this period. Additionally, as Gary mentioned, there is a significant shift occurring in our industry. Traditional 2D Moore's Law is facing limitations, and the industry is adapting to a new approach where we will play a crucial enabling role. We are committed to being disciplined while investing for growth, driving innovation, and supporting our customers' evolving needs. Our company has a solid history in this regard. Nearly 70% of our operating expenses are directed toward growth-oriented R&D, with careful management of discretionary spending. Over the past year, we've achieved 340 basis points of operating expense leverage, and over the last eight quarters, that figure has increased to 460 basis points. This demonstrates our ability to deliver innovations efficiently while providing substantial value for shareholders. Overall, we are optimistic about our direction.

Thanks Blayne.

Thanks a lot. Gary, I guess I had a longer-term question for you. So, we're going to see gate-all-around maybe late next year, but definitely in 2023. And then we go to FinFETs maybe in '24 or definitely '25 which seems like a long way away, but it's not really that far out there. And there seems to kind of be a broad view that litho is going to be a big headwind for the films companies like you. But it actually seems like the same thing could happen in logic that happened in NAND, where you start to stack transistors, so that you could capture the incremental dollars versus litho, if you look out say three to five years. So can you just kind of talk about what's happening in logic? Thanks.

Thanks for the question, Tim. I regularly meet with CEOs and R&D leaders from leading foundries and logic companies, and I actually do this more now than I did before the pandemic due to the virtual nature of our interactions. I strongly believe, as evidenced by our leading customers discussing their technology roadmaps, that we're centered around five key elements: new structures, new chip architectures with everyone designing their own application-specific chips, new materials, and innovative ways to shrink chips. I have mentioned the growth potential in packaging as well, and I believe we are in a strong position. As we look ahead, power performance and cost will undoubtedly revolve around these new structures and materials. There is significant attention on the various markets, particularly regarding new transistor structures like gate-all-around or nanosheets, as well as the wiring and resistance—these areas are crucial for enabling future power and performance. Overall, we are in an outstanding position with the materials required to develop those nanosheets, wiring, 3D DRAM, and other significant advancements on the horizon; we possess the best portfolio of materials for creating these structures. We are focusing on shaping the structures, and we have a strong position in conductor etch and memory, with growth in foundry and logic where our share is expected to continue rising. The shaping process with the Selectra product is crucial for nano sheets and other new structures, allowing modifications and speeding up time-to-market. I've mentioned the synergies with our PDC and notably our e-beam business. When constructing a new transistor, having the ability to see the materials and residuals inside that structure during R&D, rather than having to cross-section it, drastically increases the learning rates. These unique imaging capabilities, combined with our expertise in creating, shaping, and modifying structures, align perfectly with what our leading customers are presenting. I am incredibly excited about our opportunities to support the roadmap ahead.

Totally, Gary. Thank you.

Thank you.

Yes. Thanks for taking the question. I was curious in your WFE outlook for this year, what's your assumption around domestic China? And does your WFE outlook for this year include the assumption that we don't see any license from customers that are required by the government right now?

Yes. Hi, Joe, thanks for your question. So from a domestic China standpoint, we think we ended the year 2020 around $10 billion. We think we're up a few billion off of that level. So we'll see this year what we've been seeing for several years now, which is slow-steady ecosystem development. You're going to see some investment in technology roadmaps and still some pretty modest capacity additions that sit behind those technology roadmaps. And then from a licensing standpoint just given where we sit in the process, we think it's prudent to forecast and guide revenue and market sizing, assuming the licenses do not come through. And when we receive the licenses then we'll adjust the expectations. I would expect revenue to go up, and I would expect the market sizing to go up. But the current forecast expectations of greater than $70 billion this calendar year for the overall market size does not assume that those licenses come through. That will be upside to the numbers we've talked about.

Thanks Joe. And operator we have time for two more questions please.

Hi, guys, thanks for taking my question. Obviously a very great quarter and great guide. My only little nitpick here, just on the display business, I feel like every quarter we kind of try to call a bottom here. But then, you made comments about all of the segments kind of being up, in the second-half. Can you maybe just help us understand, what the magnitude is at for the display business? And then secondly, if you've got, any sort of like actual visibility into that and confidence around display being up in the second-half of the year. Thank you.

Thank you, Mitch. Regarding the display business, we've been consistent over time. We understand that there can be fluctuations from quarter to quarter. However, we have indicated for several quarters that the overall market spending in 2021, particularly in TV and mobile, will resemble 2020. This is exactly what we are observing. Consequently, we expect the revenue from our display business in fiscal 2021 to be very similar to what we achieved in fiscal 2020. You can see the numbers from fiscal Q1 and the guidance for fiscal Q2, which reflect our expectations for growth in the latter half of the year. As we look ahead to 2022, we are observing several promising signs, and our confidence in the investment climate for that year is strengthening. We feel optimistic based on the guidance provided for fiscal Q2. We anticipate seeing growth in orders in the latter half of the year, as well as positive trends in customer deposits. Overall, we are confident about shaping our expectations for this market and have no concerns about the second half being stronger than the first half for this business.

Hey, thanks Mitch.

Thank you very much and congrats on a nice finish, to the calendar year. Gary, maybe just to follow up on some of the questions and given the strength that you had in the advance packaging business that looks like it's another growth opportunity for you. Are you able to leverage the products from your, "leadership and existing portfolio?" Or are you also developing new products, given the changes that are going on in advance packaging, particularly as they become more front-end manufacturing-like?

Thank you for the question, Patrick. I want to start by emphasizing that we've identified this as one of the five key drivers for the PPAC roadmap moving forward. Leading customers emphasize that packaging is crucial for power, performance, and cost. Personally, I've engaged more with R&D leaders in this specific industry than ever before. Regarding your question about existing products versus new products, I believe it's a combination of both. We are the leader in wafer-level packaging, especially in advanced wafer-level packaging with PVD, CVD, and CMP plating. We also have a new Sym3 via etcher and have secured one of our largest customers in that area. Our products in packaging are well-rounded. Recently, we announced a new integrated hybrid bonding system through collaboration with another company, which has garnered strong interest from our leading customers. Therefore, we are innovating with our existing products while also addressing significant shifts in packaging, with hybrid bonding being a prime example. This presents a tremendous opportunity for our company, and I believe it will become increasingly important as we advance. We are uniquely positioned with our varied capabilities.

Thank you.

Thank you, Patrick for your question. And Dan, would you like to help us wrap the call?

Yes. Sure Mike. Thanks. So as I look at this quarter, a few things stand out for me. First, the growing strength of our end markets, second, really strong outperformance in calendar 2020 and I guess third, an even better setup for Applied, as we look forward into 2021. I see strength throughout the year. And that includes fiscal second-half growing across all three reporting segments: Semi Systems, AGS, and display. I really like the gross margin improvement. It's been a lot of hard work, especially during COVID-19 and I really want to thank all of our teams one more time, for this great progress. We all hope that the regulatory decision on Kokusai goes in our favor. And Gary and I along with the rest of the management team look forward to seeing you in about six weeks, during the investor meeting. Mike, let's close the call now.

Okay. Thanks Dan. And we'd like to thank everybody for joining us today. A replay of the call will be available on our website by 5:00 Pacific Time. And we'd like to thank you for your continued interest in Applied Materials.