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

Great. So I'm Joe Quatrochi, the semi cap analyst here at Wells Fargo. I'm happy to welcome Applied Materials CFO, Dan Durn; as well as Mike Sullivan from IR. I have a list of questions to go through, but if anyone on the webcast would like to ask a question, feel free to e-mail me.

So maybe -- Dan, thanks, and Mike, for joining us. Maybe first, walk us through kind of your view in terms of how do you think about the Applied Materials story and maybe what investors are misunderstanding or underappreciating the most. And as you look out at the next 3 to 5 years relative to that and relative to today, what do you see as the biggest opportunities for the company?

Sure. Thanks Joe, and I really appreciate the opportunity to join you and others in this session. So thank you for the invitation. We appreciate it. So a couple of things I'd point to. As I think about maybe what's underappreciated about the story, I think the end market we operate in, I think there was a period of time where it was no-growth cyclical market. Growth of our industry was decoupled from the overall semi industry. I don't think that's the case anymore. The industry hit an inflection point, I think about in 2012, where it fully absorbed the efficiency gains of the transition to 300-millimeter wafer size transition, customer base consolidated. All of those efficiency gains are now behind us, and our industry for almost a decade, not quite, but almost a decade, is back on a growth trajectory along with the semi industry. I don't think that's fully appreciated yet, but we're going to continue to post more growth going forward. And I think pretty soon, it will be understood that this is an upward sloping trend line. You'll still have a cyclical overlay, but it will be higher highs, higher lows over time. And for the first 35 -- 3.5 -- 35 years, 3.5 decades, our industry grew in line with the overall semi industry. Then we went no-growth cyclical. Now I think we're back on a trend line consistent with overall semis, and we get pretty excited about that as an industry. Second thing I would say is I think foundry/logic is a historical position of strength for us as a company. But I think we're narrowly viewed through that lens of being strong foundry/logic and underserved in memory. And what I would observe in a year like 2020, where memory was the predominant growth driver, foundry/logic 55% of the spend but it undergrew the overall industry. DRAM grew in line maybe a little bit more than the overall industry and NAND outgrew the industry 2 to 1. If the industry is a 15% grower this year, NAND outgrew the industry 2 to 1. Against that backdrop of 15% growth for the overall industry where foundry/logic undergrew the industry, our systems business is going to be up over 25% at the midpoint of our guide for fiscal Q1 or calendar Q4, however you want to describe it. So I think -- and you look at our share position in markets like DRAM, significantly outperforming the market. It's a great pocket of strength for us and I just think that's an underappreciated part of the portfolio. And as I look forward into 2021, foundry/logic strong again, DRAM the predominant driver of growth next year in memory, and NAND being flattish from a spend standpoint, that's set up around us as a company and the strength we see across our portfolio. I don't think it's fully appreciated today in the market. The third thing I'd say is we get a lot of questions about display. And while it's at a cyclical low, as we sit today, we think from a planning standpoint, we're planning for return to a more attractive point in the investment cycle in 2022. But we're seeing green shoots and we think the bias is towards the upside as those green shoots take hold. I think it's prudent to set expectations that, that materializes in 2022 but if it happens faster, we'll certainly benefit from that. And so display is going to be very quickly a good adder to growth, revenue, earnings, cash flow and I just think it's an underappreciated part of the portfolio as we sit here today, given the fact it's poised for a bias to the upside. From an opportunity standpoint, I guess what I would point to is classic Moore's Law is hitting a wall. It's run its course. You no longer get simultaneous benefit of power performance area cost as you shrink in a 2 dimensional plane. And what's that meaning is, is the industry is going to a much broader portfolio of innovation to drive the power performance roadmap. Gary will call it the new playbook. You'd look at what customers are saying. I think Intel has 6 elements, TSMC has 5 elements. They all mirror the same thematic drivers of growth, new architectures, new materials, new structures, new forms of packaging and different ways to shrink in a 2 dimensional plane. So the innovation is broadening and given the breadth of our portfolio, creating, shaping, modifying, analyzing, we've observed this trend now early, we've been talking about it for probably 3 or 4 years. Gary has for 3 or 4 years. We were on it. We've got an innovation of -- pipeline of innovation that's targeted at these new inflections, and we really like how we're sitted -- or seated next to this opportunity as it grows, really like how this company is positioned, given the inflection we see. We are on it early, and I think we're well positioned to win.

Okay. That's really helpful. And I think over the past couple of quarters, it seems like you guys have started to provide more metrics around some of the subcategories within your semi systems business, I think you talked about metal deposition, up 32% last year, last fiscal year, record etch revenue, up 30%. Can you talk about your confidence in that competitive position? And then how do we think about your positioning for some of the application wins or penetration and subsequent technology nodes relative to maybe what's an actual high-volume manufacturing today?

Yes. So I think we're really well positioned across multiple fronts. We talk about metal deposition. The business is up over 40%. It was 42% in the fiscal year. You see our etch business up 30%. You can see the combination of PVD, CVD, epi, up 8 points of share gain. You can see our inspection business up over 40%, it was 46% in this recent fiscal year. You can see momentum on the DRAM front. You see continued momentum on the foundry/logic front. And we think we're well positioned in NAND, and we've got the #1 position in packaging. And so we think the portfolio is performing really well. As we disaggregate the market and whether we're talking about foundry/logic or memory, node over node, 5-nanometer over 7-nanometer, our opportunity increases significantly. 3-nanometers over 5-nanometers, we see it increasing again fairly substantially. As you look at our revenue opportunity per wafer start of installed capacity in the industry, node over node, we see momentum, we see our revenue opportunity increase in node over node. Because of the product portfolio, it all starts with best-in-class technology, then the opportunity with the breadth of the portfolio to stitch those together in the integrated systems where our customers can manage the interfaces between the different layers of the chip in a way that drives better performance of the semiconductor devices. It gives us a very unique position in the industry as these roadmaps progress down the node profile, technology is becoming harder, and we're positioned to be more influential in how the -- in terms of how the industry solves those difficult challenges given the breadth of the portfolio and the ability to help our customers manage the interface, and we call it interface engineering. Super important principle going forward. And so we see our opportunity -- strong momentum today and the opportunity increasing. We like how we're positioned.

That's perfect. And so maybe going back to some of the demand side, one of the pushbacks that we get from investors a lot is the sustainability of foundry/logic spending, just given how high of a level of spending we've reached currently over the past 18 months or so, so maybe talk about what you're seeing there as we look into next year. And maybe how do we think about just capacity utilization at some of your foundry customers and the demand they're seeing. And I guess, how should we think about maybe the number of customers spending, the broadened aspect of that spending?

So 2020 is playing out very consistently with how we thought 4, 5 quarters ago. We said that foundry/logic is going to be strong throughout the year. We said there's going to be a broadening of the customer spend, multiple customers, multiple nodes. And so the current environment is playing out as we expect. And as I think about what's driving the current environment and what gets us excited as we look forward, go back to fundamental demand for semiconductors. There is more demand for compute power today than there's ever been. And what's driving that? There is a handoff in terms of end market growth that's from a consumer-oriented device called a handset to something that's far more substantive material, a secular theme around the data economy. It's the largest companies making substantive investments in their own capabilities so that they can serve their customers better, manage their supply chain better, drive more efficiency into their operation. I think it's existential for these companies. They either invest or they don't. And if they don't, it becomes an existential issue for them. And the total economic pull that's being tapped into is much, much larger, probably orders of magnitude larger than a consumer-oriented device. I call it, nonconsumer discretionary spend. And so at the core of that is the demand for compute power that's greater today than it's ever been. And this is something that's going to play out over several decades as the data economy takes hold and develops more momentum. And if I look at the drivers today versus where we were, say, 4 quarters ago, pre-pandemic, they're stronger and clearer today than they were back then. We think these trends are accelerating as a result of the current environment not slowing down. And so it doesn't surprise us that there's robust demand on the leading edge. It doesn't surprise us that there's tightness in the system around 7 nanometers and 5 nanometers, and there's a strong pull to get 3 nanometers online as soon as possible. Our customers' roadmaps are accelerating, not slowing down. There's a stronger pull to get that technology online. What we've also observed is part of use case specific architectures. You're seeing a broadening of investments across node profiles, trailing node geometries, leading edge geometries, you're seeing intelligence push to the edge. You're seeing sensors, data generation is accelerating. You're seeing a substantive broadening of those demand drivers, which dampens volatility over time. So we don't think this is a 1-year phenomenon. We don't think this is an 18-month phenomenon. In fact, I've been having the same conversation for the entire time I've been sitting in this seat, [ whence ] the foundry/logic spend is unsustainable. We see that strength continuing into next year. And what we see is a multi-decade secular trend playing out in our industry. Semiconductors are going to go structurally larger. We are back on a growth trajectory with the overall industry, and that has structural growth aspects for our industry. If we were sitting here 5 years from now and talking about high 50s WFE, I would be disappointed. I think you're pushing into the 60s. And then I think you're going to push into the 70s on your way to 100 billion plus types of WFE in support of these trends we're talking about. This is what gets us excited going forward.

That's helpful. And I think looking into 2021, one of the things you highlighted last quarter is some of the specialty markets as maybe being kind of impacted from COVID maybe being some sort of kind of maybe an upside driver in 2021. How big of a revenue contribution is that? And I guess, what type of projects are these? Are these more R&D type projects that have been delayed? Or are they production type products? Just trying to help us maybe understand a little bit better what those exactly are.

Sure. So as we take a look at trailing versus leading-edge technologies, I think definitions are important. This is one area where everybody will have their own definition of what they mean. And so for us, when we talk leading-edge technologies, today, it's the 3 leading nodes that customers are investing in. So we see investments at 7, 5 and 3 nanometers today. Everything 10-nanometer and above, we consider trailing-node geometries. When you talk about specialty nodes for us, that's 28 nanometers and above. And so definitions are important. When we look at leading versus trailing-node geometries, you go back a decade, 80%, 90% of the spend was on the leading-edge, very little of it was on trailing-node geometries. And then over the last decade, as trailing node became more prominent from an investment standpoint, broadening that demand and dampening the volatility you saw it go from 80-20 to 70-30, 60-40. There was a couple of years where it was fully split 50-50 in the market. For the last 2 years, we see it coming back to more 70% leading-edge, 30% trailing-node but given the aggregate size of the industry and how it's grown, the trailing-node investments at 30% are still very substantive. And we think the growth profile of the trailing-node geometries probably is greater over time than overall WFE. So we really like our historical position across these node profiles. And we think we're well set up to win as this industry continues to further diversify demand drivers, dampen volatility and drive structural growth off these levels. I think this is an industry that's in the process of maturing in a very material way. And the long-term implications of that for an industry that historically has seen a lot of volatility, I think, bodes really, really well to investable themes around structural growth in a super important industry that's at the foundation of all the technology trends that are shaping the way people live their lives. We think we're incredibly well positioned to do well against that backdrop.

That's helpful. And with the demand that you see on the trailing-edge side, is that -- how do you think about the mix of -- when you sell into that demand, is that mostly new equipment? Or is there also some refurbished in that? And then just maybe how do you think about the split of that? And I assume there's also kind of a price differential in that equipment as well.

Yes. So the way we see it, if you were to go back in time, up until maybe a couple of years ago, we think there was enough used equipment out on the market where we would take the cores off the market in the used equipment market, refurbish them, put them back into the market. And it was a very nice profitable business for us, but there was enough availability of that used equipment to support the growth and development of the market. And something happened a couple of years ago where you were seeing a lot more robust activity in these older trailing-node geometries. And we're -- actually, a couple of years ago, we started building new systems, brand-new systems to support the demand from our customers. From a profitability standpoint, gross margin on this segment of the market is probably a step down versus what we would see on the leading-edge. But because there's less investment from an R&D standpoint, from an operating margin and a cash flow standpoint, we're fairly indifferent. It's a very nice business for us to drive. And so as that matures, I really like the aspect of dampening overall industry volatility and still providing a nice driver of operating profit and cash flow for us based on our strong position historically in this industry.

That's helpful. Maybe kind of switching gears a little bit to the memory side. In DRAM, you talked about -- you feel really good about your competitive positioning. Maybe talk about that and how do we think about your position going into kind of, let's call it, a higher spending cycle for DRAM equipment relative to maybe the last one. And are there certain types of, I guess, applications or areas where you've gained share that we should be thinking about?

Yes. So a great question, and I think it's one of the underappreciated parts of the story of Applied lately. Let's start in 2012. In DRAM, we had less than 15% share. Today, it's 20-plus percent share. So the team has done a great job since Gary has been here, really building out our footprint and innovation platform serving that segment of the market. And as I look at the strong outperformance this year in that market and the setup into next year, I think we're going to continue that momentum as we look into next year. What's driving the growth? Since 2016, we've gotten -- we've gained 30 points of conductor at share in the last 4 years alone. Then you look at what's happening from a multi-patterning standpoint, this is a multiyear growth story for the industry. Our position, co-optimizing CVD patterning films with our Sym3 etcher, really important part of the story. We're delivering great performance enhancements for customers and get them to accelerate their road maps as part of this co optimization of steps between CVD and etch. When you look at the uplift that, that provides from a CMP standpoint, it's a nice adder from a CMP perspective, and as high-k/metal gate gets driven into the periphery of the logic transistors to create higher I/O speeds on and off the chip, traditional source of strength. It's great for our metals business. Our PVD business is up over 40% this year. And it's just been a real strong driver for us. So I think how we're situated, the innovation we're bringing to market and what's happening in that segment of the marketplace really sets us up well to continue strong performance going forward. And again, given the setup around next year and the growth of the DRAM market, that, I think, is a really nice setup as we look into next year, given that momentum that we're seeing.

That's super helpful. And then maybe on the NAND side, Dan, I thought you made an interesting comment a couple of quarters ago, where you talked about the inefficiency of spending for bit production back in 2017, 2018 time frame. From your vantage point, I mean how do you think about us getting back to a point where the industries maybe absorb that capacity, and we're starting to kind of move to a situation where we need to add net new wafer starts to drive -- really drive big growth?

So I think we're in the early innings of absorbing that level of spend. And as I take a look at bit production today, it's far more efficient than it was 2, 3 years ago, level of investment in productive bits out. You saw concurrent investments in planar and 3D technologies at the time, much like you saw in 2000 with concurrent investment in 200-millimeter and 300-millimeter geometries. Concurrent investments in technology tends to spike capital intensity. And we saw that in the 2000 time frame. I think we saw that in the memory market in '17 and '18 when bit production for the level of spend I think was fairly inefficient for the industry. And I think what you've seen since then is the roadmaps have become a lot more efficient in driving bit supply growth, and you haven't seen the industry need to add wafer starts to dial in bit supply, commensurate with bit demand. And I would say that it's probably going to be that way for several more years. I think you're going to be in a technology node transition mode. You lose wafer starts out of the factory as you migrate to the next node, you add a little bit of greenfield back. So implicit in this is there will always be a little bit of greenfield adds. But the overall manufacturing footprint in the industry, wafer starts per month, feels pretty consistent at this level for several more years as the customers just continue to push the technology roadmaps and the node migrations.

So on that, right, I would think, and maybe you're -- interested in your thoughts is that the plans of your customers to transition to next-generation nodes or higher layer counts. I assume that visibility is maybe a little bit better than some of the greenfield wafer expansion plan. So does that give you, I guess, additional confidence or visibility in the demand profile on the NAND side?

Yes. So I think from our perspective, what really shapes our perspective is, where is the demand in the end markets. For NAND, mid-30% bit growth, plus or minus, depending on which customer you talk to. DRAM, it's mid-teens, plus or minus. But mid-30s -- we don't see that changing. And so now the question is, how is the industry going to respond to that. And so as long as that demand statement holds together, and I don't see any reason why it wouldn't, as a result of these secular trends we were talking about earlier. That's going to create a strong demand statement that our customers will meet with supply. And the interesting thing is, today, you see it happening through node migrations. But when you build new capacity, what is the longest lead time item? It's the shell. It's the clean room space. It's the utility footprint. And the industry has built a clean room footprint to support a structurally larger semiconductor industry, so they can add that capacity very quickly as the demand materializes. And you see it across all the device types. That is a strong lead indicator, again, getting back to all of the data points that continue to point along the line of structural growth of the semi industry. Today, $500 billion on its way to $750 billion, on its way to $1 trillion industry. The infrastructure is being put in place to support that level of structural growth. So we see no migrations today. But eventually, you're going to see the wafer start adds. And you see it consistently in foundry/logic, you're going to see it over time in DRAM, and you're going to see it over time in NAND. And again, it's another thing that just gives us a lot of strong confidence that we've got a good read on where we think the industry is going, and we see this as a strong lead indicator confirming that view.

Perfect. And maybe switching gears a little bit. I think let's talk about something that I think is still kind of underappreciated for semi cap in general. And that's the services business. You guys have continued to report some pretty impressive revenue growth on that side of the business. Talk about what are the drivers of the outperformance. And maybe is some of it some easier comps from last year as we kind of start to increase our capacity utilization at some of the fabs that we're taking down on the memory side?

Yes. So we think we've got a great service business. And as I look at the growth of the business, the team is executing really, really well on the strategy. It's a business that over the last, I think, 4 years has outgrown the overall WFE industry by about 50%. And so the team has been executing against the opportunity. What are the drivers of growth? It all starts with installed base, largest -- industry's largest installed base, very large footprint. In a good year and a bad year that installed base footprint grows. And right now, we do about 2,000 systems a year, give or take, in a good year, we'll do more than that. In a down year in WFE, we may do slightly less than that. But the installed base grows about 5% per year. Then you think about the increasing complexity of what we sell today versus what we sold a decade ago. That has a higher service entitlement on it. So there's a natural upward bias on the service business based on the complexity of the systems that are shipped today versus what we've done historically. The last thing I'd point to is, again, this gets back to the strategy of the business. We're going towards more long-term service agreements that have a subscription-like revenue model versus what we used to do, which was more transactional. Even though services is a steadier part of the portfolio, what we're driving today drives more consistency in that revenue stream. If you were to go back in time a few years, 40% of the spares and service revenue was from long-term service agreements. In 2018, we crossed above 50%. Today, it stands at 60% is in the form of long-term service agreements. And then the other dynamic you see is, if you were to go back in time, the vast majority of what we would sign with customers had about a 1-year duration. In 2020, a full 1/3 of what we signed from a long-term service agreement had a tenor of 3 years or more. And it's a really strong proof point that we're adding a lot of value to the customer base willing to sign up for multiyear journeys. So I like the strategy. I like the execution against the opportunity. And today, as we look at our installed base business, which is the AGS reporting segment, plus 300-millimeter upgrade, it's a full 1/3 of our revenue. And so I really like the set-up, the execution and what that means for the profile of the company over time as we continue to grow that segment.

That's helpful. And maybe for some that aren't as familiar with the services business, I mean, we're talking a lot about a lot -- more than just delivering spare parts, replacement parts. I mean, talk about some of the value that the services brings and why a customer would want to sign a long term contract?

Yes. So the interesting thing is, is when we sell a new system, what we do is -- it's on a warranty. And what we'll do is we'll put a data server, high-speed data server, right along that tool. What we'll do is for the first year it's on warranty, we'll be extracting data off the tool, and we'll understand based on a global footprint and fleet of systems what's operating in spec, what's operating really, really well and what's lagging from a performance standpoint. And you get an opportunity to drive performance, throughput, yield, performance characteristics of the tool based on a global footprint and experience. What happens when it comes off warranty, a customer has a choice, sign a long-term service agreement, keep the data server in place and drive higher performance, or not sign a long-term service agreement, and then the data server comes out. So there's a strong incentive to drive much higher levels of performance. The other thing I'd say is we've got customers who operate in a home geography, and then have fabs built in other geographies. And what we've observed is a service entitlement outside the home geography is higher than what we see inside the home geography. And the interesting thing is the tools that are under that higher level of service, in many respects, operate at higher levels of performance than what they're able to drive in their home geography. And so it changes the nature of the dialogue with customers when they see that difference in performance. So this is a real high value-added part of what we offer to our customers. It's definitely not just transactional. The phone rings, we pick up the phone, we take an order and we ship a part. There's much, much more going on in this business.

That's perfect. Unfortunately, I think I can go on for another hour, but we're out of time. So guys, I appreciate you attending the conference, and look forward to speaking soon.

Great seeing you, Joe. Take care, everyone. Thanks for joining us. Enjoy the holidays.

Thanks a lot.