Applied Materials, Inc. (AMAT) Earnings Call Transcript & Summary

Welcome to day 1 of Citi Virtual Technology Conference. My name is Atif Malik. I cover U.S. semiconductor and equipment stocks here at Citi. With us today are Dan Durn, CFO, Applied Materials; and Michael Sullivan, VP, Investor Relations. The format of our discussion is a fireside chat. Dan is going to open with a few comments, and I'll go with my questions first. If you have any questions for the AMAT management team, please e-mail them to me, that's atif.malik@citi.com. Over to you, Dan.

Thanks, Atif, and good morning, good morning to everyone. So very quickly, just taking a step back, a lot going on with respect to pandemic, geopolitical environment. But this has been an incredible year with respect to semiconductors and semiconductor capital equipment. Demand remains strong with our customers. The strength is broad-based. We're seeing strength in our business across all device types. And this is one of the best years on record for our industry. And we think that next year has the opportunity to be as good, if not better, than what we're seeing this year. So we feel really good about how the overall market is performing in a difficult environment. From a company-specific performance standpoint, our company is performing extremely well. We significantly outgrew the market and our peers in 2019. We see that same setup of significant outperformance in 2020. In fact, our business in the first half of the year is significantly outperforming both end markets and our competitors. We see each of our reporting segments being back-half weighted, second half versus first half in calendar 2020. And again, we see that strength continuing into next year. Our performance, broad-based. You saw 8 points of market share gain in our PVD, CVD and epi business in 2019. We talked about having the fastest-growing etch business this year. And our inspection business, process control inspection business is growing at over 40%. So the strength we're seeing is across multiple device types, and it's across multiple elements of our business. I guess the last thing I'd say is I want to give a big shout out to both our employees and our suppliers. I've been driving the COVID response at Applied Materials when we set up our team back in January to deal with the current environment. And I just could not be more proud and impressed by what our employees have accomplished in a difficult environment. We're back to pre-COVID levels of output. Supply chain is responding very, very well. And likely this company is set up against the backdrop of the market and as we look into 2021. So I just wanted to express that appreciation for a job well done by the company and employees.

Thank you, Dan. Dan, Gary showed an interesting slide at SEMICON West in July where the semiconductor sales are expected to grow 2x the rate that we have seen in the last 20 years. In the next 10 years, they expected to grow 2x. What does that mean for wafer fab equipment spending over time? And the question I get asked quite frequently is like what is the new base line for wafer fab equipment investments?

Sure. Thanks, Atif. The setup behind that slide was a recognition by third party research. And I think there was 2 separate firms that said the overall semiconductor industry is going to hit $1 trillion, and it's going to do it by 2030. And so what Gary was showing was with a $1 trillion semiconductor industry and what was a 4 decade-long ratio of the size of our industry to the overall semi industry, it's about 11.5%, plus or minus. And what you clearly see on that slide, as the industry grows to $1 trillion, our industry is going to be $100 billion plus. And so while today, we're in the mid- to high 50s. We haven't called next year. Does next year, is it $60 billion, maybe a little more. We haven't come out with our official estimate yet. But we think the follow-through into next year is good. So that puts you very close to maybe $120 billion over a 2-year period. And I wouldn't say $60 billion is a new normal for our industry. I think it's a stepping stone on the way to a structurally larger industry in support of overall semiconductor growth. And we've been saying for a while that the growth trajectory on the industry will still have a cyclical overlay, but what we'll see is higher highs and higher lows on our way to structural growth. And the amplitude of a cyclical overlay will become more compressed as a percentage over time. And so we feel really good about the growth setup of the industry, and we feel particularly good about our position relative to the overall growth of the industry. Today, we're about a 20% market share company. We would expect that to grow as the industry goes larger, given what we see happening with our customers' road maps and the proof points are playing out. We see the proof points in 2019. We see the proof points in 2020. And I think we'll see those same proof points again playing out in 2021. So we like how we're positioned against that industry growth profile.

Great. And Dan, if I can just dive into different end markets within the wafer fab equipment and starting with memory. Can you reconcile elevated inventory, softer demand expected in the memory market in back half this year versus the outlook that you provided on your last earnings call, which I thought was far more realistic than some of the peers where you're expecting no major spike in memory investments in second half, given the weaker pricing environment?

Sure. So what we see in the memory market, first of all, from a company-specific standpoint, in the first half of the calendar year, our memory business is up 17% and our closest peers are up 3% each. So clearly, we're showing signs of strength relative to the overall market and relative to the competition. And you pointed out, we're not calling for a big spike in the back half of the year. We're not calling for a precipitous fall off. We see foundry/logic being greater than 55% of the spend this year, but we do see the memory market stronger this year versus last year. What we see customers doing is investing in technology road maps. We're not seeing capacity additions come into the industry. And we do see the efficiency bit production coming from that spend. You see that efficiency better than we did in 2017 and 2018 when a new architecture was introduced. And so by definition, the bit production was inefficient. We see that efficiency coming back into the market. Customers are dialing in bit supply with true end market bit demand, trying to maintain health and balance in those end markets. And as we profile into next year, while we haven't called for an overall size of the WFE market, we see the setup around that market being very similar. Foundry/logic being more than 55% of the spend next year and continued progress from a memory standpoint, progressing down the road maps and putting additional capacity in place to make sure that there's a disciplined additional capacity and bit supply to meet bit demand. So we're not calling for anything dramatic to the upside, nothing dramatic to the downside. And our business performance against that opportunity has been really, really strong. We feel good about our position.

Great answer. Just on that point on the foundry/logic staying at 55% of the mix, again, I thought your view was a bit different than your peers. You're expecting this part of the market to be stable in second half and even growing into next year. What's some of the drivers to explain the higher foundry/logic investments?

Yes. So our perspective is shaped by a couple of things. First, from a customer footprint standpoint, we've got a broader portfolio than anyone in the industry, which gives us a level of insight that we think is an advantage. We've got a #1 position in foundry/logic. We've got a #1 position in DRAM. We've got a #1 position in packaging. We got a #2 position in NAND, but that position is growing. So our position is, without question, stronger than anyone else in the industry seeing the breadth of the market. So that gives us a level of insight based on what we're hearing from our customers. So we feel good about that. The continued strength of foundry/logic is what we've been talking about now for several years. The data economy is playing out, things like artificial intelligence and pushing intelligence to the edge as part of IoT is a really important trend. It's being driven by the largest companies, exposed to the largest industries and what I call nondiscretionary spend. There is a handoff between a consumer-oriented device being the predominant driver of semiconductors, and we're watching that handoff take place real-time to the largest companies driving greater understanding and insight in their own business and their supply chain and the agility of their business and better insights of how to service their customer and asset utilization, physical asset utilization around the globe. What are these companies are tapping into is an enormously deep economic pool that will make things like a consumer device cellphones pale in comparison. So that is going to be a strong driver of compute power. The demand for compute power has never been greater than it is today. 5 years from now, it's going to be significantly greater than it is today. And a decade from now, it's going to be tremendously greater than it is today. So it is nothing more than the recognition that these trends we've been talking about for a while are playing out as expected. Every day that goes by, our confidence interval around these trends go up, not down. And I would say they're stronger today than they were 9 months ago, pre-COVID. The trend towards localization of supply chain and intelligence and automation in those supply chains is just another driver. And it's -- and again, it's going to be nondiscretionary spend. So it's playing out as we expected. We like how we're positioned. The other thing I would say is as the road map changes from 2D shrinks to what we call the new playbook, new architectures and new structures, one vertical in the chip, new types of materials, new types of packaging. All of that is materials engineering related. And no company is better positioned -- as that road map plays out, no company is better positioned than Applied Materials to be that key enabler of the power performance road map for our customers.

Great. Dan, moving on to China, which is 15% to 18% of wafer fab equipment in our WFE model. You and your peers have talked about $9 billion to $10 billion of domestic investments this year. You and other equipment suppliers, they have been able to ship to China despite the mid-May Department of Commerce regulations. Can you just talk about this market? How do you see it, the China piece?

So if we take a look at the China market, I'll go back to what we've been saying for a while. We see a slow, steady development of the ecosystem. We see spend this year being about $9.5 billion. Spend last year was about $6.5 billion, give or take. So it's roughly a 50% increase. But if you look at that $3 billion of incremental spend, it's going to technology road maps. It's going to 200-millimeter investments, 300-millimeter investments. And within 300-millimeter investments, you're seeing foundry/logic, NAND and DRAM. So it's a very broad base of spend. And if you think about the global supply of semiconductors, you've got very large installed bases around the 3 device types: foundry/logic, NAND, DRAM. And while $3 billion of incremental spend on the surface seems like a lot, when you disaggregate it across its markets and you look at what cost to build a leading-edge foundry/logic fab, $15 billion, $16 billion for just the factory floor equipment, that's not including the clean room shell. It's not including the utilities and the infrastructure to support that production. And the equivalent for a memory factory is $8-plus billion. And so the incremental capacity that comes online relative to that spend is still very, very small. And so it's slow, steady development of the ecosystem. And all things being equal, we see China continuing down in slow, steady, disciplined build of an ecosystem that they hope stands the test of time and forms the foundation of an industry.

Great. And then moving on to the display part of your business. What are the puts and takes on the flattish guidance for next year? Historically, we have seen a wave of higher display spending and after 2 to 3 years of a slower spend period, when should we expect that kind of investment in the display market?

Sure. So here's the set up on display. In 2018, we saw concurrent strong investments in both TVs and handsets. The overall market size was $18-plus billion, and the company performed really well against that environment. Then what we saw is an out-of-phase investment cycle in '19. We see it again in '20. You'll see it again in 2021. We think 2021 looks and feels a lot like 2020 in terms of both aggregates size and split between TVs and handsets. And it's a digestion period from a very robust market in '17 and '18. But it's also reflective of the fact that consumers have been impacted to some extent from government containment actions of the pandemic. We think the setup going into 2022 is for concurrent strong investment cycles again, so we would expect to go from a cyclical bottom to a cyclical strength in 2022. And then as I look at the road map going forward, every day that goes by, you're seeing more and more talked about OLED coming to TV. And you're seeing more about flexible and foldable displays coming to the handset. What I like about each of those technologies is they're more capital-intensive than the current generation of technologies. And while $18 billion plus is sort of the cyclical high point of the current generation of technologies, I think you've got an opportunity, as those road maps play out, to go into the mid-20s from a structural size standpoint. And we like how our company is positioned against those opportunities and the portfolio of technologies we have. So while we're bumping along the cyclical bottom today, we expect this to become a tailwind for us here in the near future.

Great. And then the services business, a big reason why investors are looking at these stocks differently because it's become 1/3 of your sales, so a fairly stable baseline. How much of this business is the fixed annuity type sales versus variable? And can this be a double-digit grower versus your SSD business?

Yes. So this is a great business for us. Like you pointed out, the installed base business, it's about 1/3 of our revenues. It's the AGS reporting segment plus our 300-millimeter upgrades. And so when we look at the business, all of it is recurring in nature, given the fact that it's built on top of our industry-leading installed base. So largest installed base in the industry, upgrades are about taking capabilities of that installed fleet and bringing current to today's more capable technologies. And that's a really good business for us. The spares and service part of the business, that's what we see reported in the AGS segment. And when we break that apart, there's a transactional component and then there's the long-term service agreements. 60% of our spares and service revenue today is long-term service agreement like. So that's more subscription-like and very predictable in nature. And the company has done a good job. A handful of years ago, it used to be 30% of spares and service for long-term service agreements. We grew that penetration to 40% and then 50%, and now we're at 60%, and we're going to continue to grow that penetration. And our customers are happy taking the journey because they see better performance from tools that are under longer-term service agreements. The transactional spares and service, the part that's not under long-term service agreement, is leveraged to industry utilization. Industry utilization is pretty robust. We talked about the data economy, the need for data, storage, compute power, industry utilizations are good. And so anytime you're monetizing an installed footprint, it has a recurring nature. So we feel good about how that business is positioned. And then taking a step back from how we operate the business and just taking a look at the journey over time, this is a business that in 2013, I think, was $2 billion. We've doubled the size of that business in the last half a dozen years. New management team, new strategy, Gary put focus on it. We knew it was a great business, and it was an untapped diamond for us. And so we've done a much better job running that business, driving the strategy. Management team has done a great job executing against it. We've doubled the size of that business. I think it's grown at a compound rate of 12% over that time period. So we feel really good about the execution against the opportunity. We'll come out with a revised model as soon as we close the Kokusai transaction, talk about how that business grows longer term. But we expect to be able to grow the services business faster than we do our installed base given the strategy we're executing against and the way our customers are responding.

Great. Dan, just moving back to the silicon business, now Gary talked about growing this business faster than the wafer fab equipment for next year. He highlighted new etch and process control products. What are some of the key products or end markets you're looking at to outgrow the wafer fab equipment market?

Yes. So if we take a snapshot of where we are today in time, we talked about significantly outperforming the market and our peers in 2019. We're significantly outperforming. And again in 2020, we'd expect that to continue in 2021. We've talked about CVD, PVD, epi growing 8 points a share in 2019. Gary spent a lot of time on the most recent call talking about the fastest-growing etch business, #1 conductor etch in the DRAM market. Inspection and process control growing greater than 40%. The product cycles in those businesses, it's broad-based. It's more than just etch and inspection. Those are an important part of the story, but the outperformance today is more broad-based than that. And again, if you look at our memory business in the first half of calendar '20 versus first half of calendar '19, our business is up 17% versus the competition that are up 3% each. Foundry business, we got the fastest-growing foundry business in the industry. And what it comes down to is how we're positioned from a key-enabling technology standpoint. We talked about the power performance road map being driven by a number of elements, not just 2D shrinks anymore. A number of elements are driving that. And our position at 5 nanometers is much greater than it was at 7. Our position at 3 is going to be much greater than 5, the number of applications that we're opening up. And the way we're positioned against those opportunities, you can see node over node momentum. We see the same thing in DRAM, and that's playing out very, very strongly in the current environment. We would expect that to continue. When we take a look in NAND, we're making good progress and we like the momentum that we see there from a technology standpoint. When you take a look at etch, we've got a traditional source of strength in the staircase in NAND. You see that in patterning, playing out in patterning in DRAM. We're moving that position to foundry/logic now and you see us opening up applications with that momentum. We really like the way that story is playing out and building on a source of strength we had in NAND, moving into DRAM and now moving it to foundry/logic. And we'll see that play out here in the next several years. So it comes down to just a number of the elements that we've been talking about coming together. The strength we see in the end market is continuing. Semis are going larger, semiconductor capital equipment is going larger. The power performance road map is changing. Nobody is better positioned against that new road map than we are as a company. And you see significant outperformance in '19. You see significant outperformance in the first half of '20. You're going to see significant outperformance for the full year calendar 2020. You see that follow through going into 2021. And as these trends play out, we would expect to continue to make progress given the technology portfolio and what we see on the opportunities increasing node over node in a lot of different markets.