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

Greetings, and thank you for attending JPMorgan's 49th Annual Technology, Media and Communications Conference. My name is Harlan Sur, semiconductor and semiconductor capital equipment analyst here for the firm. Very pleased to have Gary Dickerson, President and Chief Executive Officer for Applied Materials. We also have Dan Durn, Chief Financial Officer, here with us today. The team reported strong April quarter results in July quarter outlook last week. So what I've asked Gary and Dan to start us off with is Applied's view of the wafer equipment spending environment this year, Applied's growth outlook within that. And then we'll go ahead and kick off the Q&A. And so gentlemen, thank you for joining us today and let me turn it over to you.

Yes. Thank you, Harlan, and thanks for inviting us to the conference here today. I think the setup for Applied has never been better. If we look at our markets, certainly, the basis of competition for the future, trillions of dollars of economic value, is about the explosion of data, AI, big data, transforming every industry. We see the way we work, the way we learn, retail, health care, transportation. Certainly, we see automotive constraints in the world today. The basis of competition is changing. And at the foundation are semiconductors. And that infrastructure is also -- winning the infrastructure is driven by power, performance and cost, being there ahead of others. And that road map -- the technology road map, winning the future is about new materials, new structures, new ways to connect chips together, new ways to shrink, new application-specific architectures. And Applied -- our position in enabling winning the future has never been better. And you see that data explosion, the -- this year, data will have increased 150 times over the last 6 years. You see that in 2018, it was the first year machines generated more data than people. But 2025, machines will generate 99% of the data. So we're really, Harlan, in the first inning of this major inflection in every industry -- trillions of dollars of economic value are at stake in this race to win the future. And again, that's really what we're seeing today is really driving our business within Applied Materials. I don't know, Dan, if you want to add anything to that.

Yes. Sure, Gary. So if you take a look at the results and you take a look at our outlook, I think it validates and confirms a number of the trends we've been talking about. When you talk about the fourth wave of compute, the data economy, traditional Moore's Law slowing down, a new playbook driving the PPACt road map and the demand for compute power greater today than it's ever been just really validates the perspective that we've put forward here over the last several years, setting out for how vision for how this industry would evolve. And so we feel good about the current environment validating that perspective. The next thing I'd say is, is for the first time, I think, in the history of the industry, you're seeing customers, multiple customers, come out with multiple year forecasts, taking a point of view of where they're going to drive their business. And I think that sets the industry up well. And then against -- I guess the third thing I'd say is against that backdrop, Applied's ability to outperform. We saw it in 2019, saw it again in 2020. We think we're set up to outperform again this year. And this year actually plays out better than it did for us last year. So we feel good about the momentum. And then as we look forward into 2022, we're planning for our business to be up again off of these levels. So we feel good about the ability to drive revenue growth. Certainly, you see it from a strong margin performance. We're going to generate a lot of cash, and we're going to return a lot of cash to shareholders over time. So we think we are very well set up against the opportunity Gary's talking about to outperform going forward and generate a lot of cash.

Awesome. Thanks for those opening remarks. And so I guess kind of within that, this is a longer-term question, and I believe this does encompass the acceleration of the digital transformation that we're seeing in all end markets and driving the need for your PPACt playbook, lower power consumption, higher performance, smaller area, lower cost, faster time to market by your customers. So if I look at wafer equipment intensity, that bottomed in 2013 at about 9%. Starting in 2014, interestingly enough, the first year of 3D NAND production ramp, and up until last year, WFE intensity increased monotonically to 14%. So another way to think about it is that over the past 7 years, wafer equipment spending has grown at an 11% CAGR versus semiconductor industry revenue growth at a 6% CAGR. Applied has grown its revenues at a 12% CAGR. So good outperformance there. But just given the complexity challenges, the PPACt challenges, do you guys anticipate WFE continuing to outgrow industry revenues over a multiyear period of time? And what are going to be the major drivers?

Yes. So I think our perspective on this, we've been pretty consistent. We do see -- and I think there's a third-party perspective consensus that's being formulated right now that semiconductor industries is going to be close to $1 trillion industry by the end of the decade, 2030. And we do think that there is a natural upward bias to our industry, kick WFE intensity to semi revenues. We do think there's a natural upward bias. Part of it is the embedded complexity in the road map that we talk about, the way the new -- the PPACt road map is going to be driven. Power performance road map is going to be driven by a new playbook. And then when you see the efficient scale of factories as supply gets regionalized around the globe, you're going to have more smaller scale factories as a result. We think that creates a nice upward bias. So we do think there is an embedded ability of our industry to outgrow the overall semi industry over time as that natural upward bias in capital intensity plays out. And I would say our ability to outperform against that environment given the new playbook, how the power performance road map is going to be driven, not only do we have the industry's best point technology solutions, but we've got unique ways to combine those technologies under vacuum to solve high-value problems of our customers. It's led to outperformance in '19, again in '20. We see it again this year. We think we are very well set up to outperform the industry as these trends play out.

Yes. Harlan, I would also add, if you ask, really, what is going to drive this? And it really is what you talked about, the power, performance, area, cost, time. And you look at what's been happening, the 2D to 3D NAND transition, you ran out of electrons in the cell and you went vertical, I think there's going to be tremendous innovation around the new materials, the new structures. Packaging is an over $800 million business for us this year. People under appreciate how important that is. So we've been driving strong performance in unit processes. We talked about 50% growth in many of our leadership areas where we have much more breadth than anyone on PVD, CVD, the implant, epi, many of those different areas where we have very, very strong positions, these integrated solutions -- we showed in our investor meeting the ability to combine different technologies in a single platform, PVD, CVD, ALD, surface preparation, integrated metrology, where you can improve wiring resistance by 50%. So I think we have, again, this very strong position, whether it's in the chip manufacturing or wafer level packaging where we're also #1, tremendous strength and breadth in the unit processes with the ability to deliver innovations like this 50% improvement in wiring with integrated systems is also unique for Applied. And then the other thing I would say is the T. Time to market is really, really important. And we're seeing real strength in our e-beam business, over $900 million in revenue this year, 50% growth in our PDC business. And that's about mapping out these processes much faster. And we talked about accelerating R&D 2x, 30% bigger process windows, that leadership in electron beam, we're the only company that can combine that with our leadership in unit and integrated material solutions, that is really positioning Applied to outperform. As Dan said, we outperformed in '19, '20. We're on track to outperform this year, but the setup for us going forward is even better.

When we talk with investors, and we know the team didn't provide a precise view of out-year WFE expectations for 2022, but you did provide a 2-year, 2021, 2022 combined spending outlook of more than $160 billion. So that does imply that you expect further WFE spending growth next year. But at a high level, what reasons can you provide that should address investors' fears of some sort of peaking of spending this year, especially as many of your semiconductor companies are saying that supply-demand gap is not going to close this year? I know there's a lot of other dynamics that we just talked about. But how can you address this fear by some of your investors that this is potentially a peak spending year for Applied and for the industry I should say?

Yes. Maybe I could start, and then Dan could also jump in on this. I think, Harlan, it really is a point of view that at the foundation of the competition for every industry is this technology transformation with data. I talked about this explosion of data going forward. And really, it is at the foundation of trillions of dollars of economic competition in the companies that drive those transformations. First, are going to win the future. I think there's no question about that. So we -- again, that is the biggest economic race of our lifetimes, what we will see happening this particular decade. And so that's kind of the macro from my perspective. And Dan can add his thoughts.

Yes. So just to build on what Gary is saying, I do think this environment does validate a perspective that we've had for quite some time. So as you think about the driver of semiconductor growth going forward, becoming the largest companies exposed to the largest industries as part of the data economy, the incremental benefit our customers' customers get from those investments is tremendous. As these industries transform digitally -- digital transformation of the industries, it's going to be a very substantive driver of the industry over time. And if you take a look at the impact of the pandemic, it's absolutely a tragedy, but what we've seen come out of companies' response to the pandemic, we think it's a multi-year pull forward of this digitization trend of businesses and industries. And it's going to create a very robust environment for the foreseeable future. We do think the trend line on this industry is upward sloping. We do think it's going to be characterized by higher highs and higher lows. And we do think the amplitude of that cyclicality comes down over time. And so not only conversations with customers that give multiple year outlooks on how they want to build out their node profile, satisfy their customers' demand for compute power, but these macro trends we're talking about, the fourth wave of compute, we actually have seen an acceleration of those trends in the last year as part of the pandemic response. And I do think it's nondiscretionary spend by these largest companies. In fact, I call it existential. These companies will invest, survive and thrive or they won't, and I do think that they will cease to exist. So I do think the driver of demand is increasingly substantive, and it's nondiscretionary. I actually think it's existential. We are in the very early innings of this playing out. Every year won't be up into the right, there will be that cyclical overlay, but you will see higher highs and higher lows as this plays out. We feel good about how we're positioned.

Well, clearly, we're seeing a very strong foundry/logic spending environment. And clearly, that's at the leading edge. But with things like IoT and automotive and industrial applications, we're seeing silicon shortages and capacity additions to address those silicon shortages, but we're also seeing very strong content gains, right, by a lot of these mature and specialty technology nodes. And at the investor meeting, on your earnings call, you called out your ICAPS business, right, your mature and specialty semi equipment business as targeting fast-growing markets. You discussed ICAPS business is on track to generate over $3 billion this year. So in order for us to understand sort of the growth of that collection of businesses, what did ICAPS generate last year? And how should we think about the drivers of the ICAP business into next year and actually over the next several years?

So thanks for the question, Harlan. So ICAPS is IoT, communications, auto, power, sensors. And the way I would think about it -- people talk about 0.5 trillion to 1 trillion connected devices by the end of the decade. I gave the statistic that machines generated more data than people for the first time in 2018. And by 2025, it's 99% machines, 1% humans downloading videos or mobile or any of those types of applications. So this is just really unprecedented. I think it's really also hard for people to wrap their brains around that type of a transformation of everything around us. So we made the decision over 2 years ago to pull together teams across Applied Materials to focus on this ICAPS space. So -- and the response from customers has been really tremendous. We have this broad technology portfolio from 200-millimeter to 300-millimeter. And pulling all of that together, I spend more time myself significantly more with those R&D leaders and with those CEOs, response has really been tremendous. And so the driver is really this 0.5 trillion, 1 trillion, everything around us getting smarter with all of those sensor technologies. There are specific technologies that enable power, performance and cost in competition in each one of those different segments. We have some real strong combined technology horsepower focused on those specific customers. So I can tell you, I'm super happy, we made the changes we have. We have a very talented team that are focused on those particular markets. Quantifying the size of that market, we're a little bit reluctant to give too much color because we see that better than anyone because we have this critical mass, we have this breadth, but I can tell you that sensors -- many of those different areas are growing at a very high pace. And I would just think about this explosion of data at the edge and the number of connected devices you have going forward, everything around us is much higher, as you mentioned, technology, content and just tremendous opportunity. The number is actually much bigger than $3 billion, but we really don't want to quantify the specific number or the growth rates. I don't know, Dan, if you want to add anything to that.

Yes. I think that was well said, Gary. I don't have anything incremental to add to that. I think that was well said.

Great. Well, this is a great business because we certainly -- I mean we cover 26 semiconductor companies. I mean we're certainly seeing the analog, microcontroller, sensor, content growth every single year, right, in industrial applications, in automotive applications, in IoT applications. So this is shaping up to be a great business for the Applied team. Dan, during the April quarter earnings call last week, you guys raised the 2021 WFE outlook from low $70 billion to high $70 billion this year. So question is, in what segments of the market are you seeing the incremental strength versus your expectations at the beginning of the year? And for this year as a whole, what type of growth are you seeing across foundry/logic, DRAM and NAND?

Sure. So our point of view on 2020, the industry was sized at about $61.2 billion. So high 70s gets you to a high 20% year-over-year growth profile for the overall industry. As you pointed out, 3 months ago, we said low 70s. Now we're high 70s. And if I were to rank order foundry/logic, DRAM, NAND in terms of contribution to that incremental size of the industry, foundry/logic has the most contribution to that delta, followed by DRAM, followed by NAND. And so if I were to take that high 20% growth profile and rank order year-over-year growth of those 3 end markets, foundry/logic significantly outgrows overall WFE. DRAM is an in-line grower with the overall market, in line plus or minus, probably a little more plus than minus, but in line. And then NAND is going to significantly undergrow the overall market. And then what we also offered from a -- but it will -- NAND will grow. But what we also offered on the call was a shape and a profile around each of those 3 end markets throughout the year. And we said foundry/logic and DRAM are going to be back half loaded growers. So second half will be greater than first. Three months ago, we said NAND was a first half loaded. First half will be greater than second half. We've seen a little bit of incremental strength. And like I said, NAND will grow year-over-year, but the shape and profile of NAND throughout the year, I think, has a question mark on it right now. Calendar Q1 was very strong. We see things moderating off of those levels. And I think it's too early to tell whether the first half or second half will be greater throughout the year. So we'll watch it, and we'll update it on subsequent earnings calls. But that I think gives you a shape of the market profile and how we're thinking about things given where we sit today.

Just given the strong demand environment -- your customers' demand environment, the strong orders and outlook that they're placing on Applied, and you combine that with the COVID-19 impacted manufacturing dynamics last year -- what we're hearing from a lot of your customers is that equipment lead times are extending. If they place orders today, they can't get equipment until next year. And this is both for leading edge and for lagging edge. And so I'm curious as to how have your lead times trended and how is the Applied team seemingly being in a good position to respond quite rapidly to increasing its manufacturing capabilities.

Yes. So what I would say is, is we had a point of view of where our industry was going, and we have conviction -- Gary likes to say you need a point of view, and you need conviction. And this is how Gary's point of view and vision has really served the company well. We had a point of view and conviction 3, 4 quarters ago. We didn't skip a beat. We actually leaned into the problem. You can see spending a bit more from a CapEx standpoint, making sure we have the physical infrastructure ready to go as we got into this rapid growth profile. You saw us invest more in headcount in our factories so that as you got pockets of nonlinearity from a supply standpoint, we could control our own destiny and serve our customers. We've engaged with the supply chain and got them to walk up their capabilities over time. And in the most recent quarter, you see the results that it produced. And this is a quarter, mind you, where weather event in Austin shut that factory for 2 weeks. We were able to, beyond our front foot, playing offense on this dynamic, being very aggressive in how we're pushing the business forward. And our gross margin was up 310 basis points year-over-year. Our operating margin was up 700 basis points year-over-year. And what we'll do -- any time you have a positive grade in an industry, you're going to get pockets of nonlinearity. It's incumbent upon us to really stay aggressive, work closely with our suppliers and make sure that we're satisfying the customers. And so it's just a mindset around how we're managing the business. We're going to manage it for the growth profile that we see. You'll see some incremental investments throughout the year from a CapEx standpoint, making sure we've got the right footprint in place to serve our customers as this industry grows. So grow our capabilities along the way, aggressively manage those pockets of nonlinearity and engage deeply with our suppliers to make sure they are ready to run alongside of us as we serve our customers and grow alongside with them. And so we've taken an approach and a philosophy here that I think is serving the company well right now.

This morning, we were fortunate enough to have Dr. Lisa Su, CEO of AMD. We're fortunate enough to have Pat Gelsinger, CEO of Intel, with us. And they talked a lot about advanced technologies, but they also stressed quite a bit on the advanced packaging side, like 2.5D packaging, 3D packaging, chiplet strategy, die stacking. I mean this is a big part of how they're going to unlock performance for their customers on a go forward basis. And on this discussion that we're having today on the last earnings call, at Analyst Day, I mean, the team has discussed advanced packaging revenues for Applied are on track to exceed $800 million this year. That's nearly doubling the, I think, annual run rate in 2019. So as Moore's Law continues to slow, packaging is becoming a key enabler. How should we think about the packaging market growth over the next few years for Applied? And for -- well, for the market in general, how should we think about the advanced packaging market growth? And then within that, I mean, can Applied continue to grow faster than the market?

Yes. Harlan, this is Gary. So I -- we've talked a lot about the 5 drivers of the road map going forward. And certainly, advanced packaging is absolutely important. You can see some companies coming to market with packages that improve the speed 3x, the power performance 50% just by the package. And I really believe that we're just scratching the surface of what you can do with packaging technology. Certainly, taking GPU surrounding stacked high-bandwidth memory is something that has been done. Going forward, you'll see that those combinations from a standpoint of chips, chiplets or IP blocks coming together. And I really believe that when you look at the opportunity, the more we can drive, the faster we can drive low power, high performance at the right cost, the adoption will accelerate for this 0.5 trillion, 1 trillion connected devices all the way to the cloud and everything in between. Now for Applied Materials, we do have tremendous strength in wafer level packaging. We're #1. We have leadership in PVD, CVD, CMP. We have the new Sym3 via etch where we've won the business with one of our largest customers. We have plating. So that -- we have all of that unit process strength. We announced recently a new integrated product for hybrid bonding, and that's where you can combine chips together to shorten the interconnect length and the I/O density to improve the performance there significantly in power and performance. So we have those unit processes, by far, the broadest capabilities of anyone in the industry. We've got this new hybrid bonding capability that we've just announced. There are a number of other innovations we're driving. We're the only company in the industry that has a full flow integrated packaging lab. So we actually have some of our leading customers putting their engineers into our packaging lab as we work together to enable those new packaging architectures. And I just believe there's going to be tremendous innovation going forward in how you connect the chips together and the IP blocks together. And with our breadth, our integrated capabilities, our full flow lab, Applied is in, by far, better positioned to outperform. And we saw this. This is another thing, Harlan, that we've been talking about this new playbook for the last 3 years. So we've put in place these capabilities and these investments. And I personally spend a tremendous amount of time with leading the R&D leaders for our customers in packaging by far more in the last 2 years than I ever have had before, and the innovations there are going to be profound relative to the entire ecosystem going forward and very, very important. And certainly for Applied, we're in a great position to continue to outperform.

Yes. And on that note, on the outperformance and looking back historically, and we can take a snapshot of last year where you guys outperformed the market last year, and if we look at the recent market share statistics for Applied, you grew your market share by almost 100 basis points last year. You actually outgrew WFE by almost 400 basis points last year, and you gained slight share in deposition action process control. So overall, a very solid showing by the team. How do you expect your market share is going to trend this year in etch deposition and process control?

Well, I think, Harlan, so we outperformed in 2019. We outperformed in 2020. The setup for us this year, if you think about -- we're actually the most balanced company when you look at our position in the leading foundry/logic, ICAPS, DRAM, NAND, wafer level packaging, all of those areas we have tremendous strength. But the setup this year where foundry/logic -- Dan talked about this earlier -- is going to be the fastest-growing market, we have a lot of strength there. When we're enabling these new structures, new materials, our performance will improve as you go forward with these future technology nodes. We're designed in when you go to 3-nanometer or 2-nanometer or these plus nodes. And ICAPS, our share there is increasing. DRAM is another area where we've outperformed. And our customers are implementing higher speed memory where they need logic-like processes in the periphery, that goes back to our strength in the foundry/logic market now coming into DRAM, that positions us very well. We've introduced new integrated solutions. We talked about in our investor meeting Draco in our memory master class that we had just recently. That capacitor shrinking, enabling that with new materials, new etching technology, our strength in e-beam where we can map out those processes and accelerate the T, the time to market, that combination, Harlan, for us is really unmatched in the industry. But the mix setup this year is even better than what we've seen in the last 2 years where we outperformed. And certainly, when we look at the inflections -- and that's really where we're focused, enabling these new structures, new materials, new packaging architectures. We're really in great position. Certainly, in 2021 with the mix, but going forward, we're even in a better position. I don't know, Dan, if you want to add anything to that.

No. I think that's really well said. I don't really have any additional color context. The company has got a lot of momentum right now and showing lots of strength, and it's broad-based strength. And so we're really encouraged by what we see.

So let's go to what I feel like is one of the more underappreciated parts of the business, which is AGS. It's a great annuity-like business. Your subscription-like service agreements are continuing to grow over time. AGS operating margins were 27% in fiscal year '20. I think you guys put forth a target model of low 30% operating margins by fiscal year '24. So 300 basis points of percentage improvement. So what is the team doing to drive gross and operating margins higher in the business?

Yes. So I think it's important to maybe just offer a little bit of context around 2020, how we got there. You go back to 2019, it's a business that was, I think, 28.6% operating margin. And so we're in that neighborhood. What you saw play out in 2020 as a result of the pandemic and some of the inefficiencies, logistics costs, whatnot, you saw the business just over 27%, 27% -- just over 27%. But if you see what we're doing in the last couple of quarters, so the most recent quarter, it was 29.8%. And so you can see the team driving more efficiency into the scale of the operations, overcoming some of the COVID headwinds that we think are holding us back. And hopefully, we'll see the incremental progress as we march towards 30% and then over 30% over time. I think a couple of things come into play. There's obviously a scale element of the footprint that we've built out around the globe. We think that serves us well. But there's an embedded complexity around the equipment that's being sold today. And the things that we do to address our customers' time to market, delivering their technology road map and their time to market and increasing the size of the process windows so you get a more stable process that yields better, there's an element with the complexity of the equipment we see today. And this really important part of the PPACt equation called time, time to market, that's really going to play out and serve this business well over time. I think the last element of the strategy around the subscription agreements to go from a transactional-based business where customer wants some parts or some service. We pick up the phone and we serve our customers. We'll always do that, and we'll serve our customers, and serve them well. But over 60% of the revenues today are in the form of these longer-term subscription agreements. And in the most recent quarter, 70% of our bookings were under subscription agreements, and half of those were for 3 years or more. You see a strategy playing out that gets more visibility into that business, our ability to preposition parts around the globe, our ability to preposition resources around the globe, give our customers better outcomes, but also plan our business so that we can drive more levels of efficiency. So they get better outcomes. We get more visibility in the business and can run a more efficient operation. I think you see all of these elements coming to play that are leading to an upward bias over time as we continue to grow that business and generate enhanced levels of profitability and cash flow. We think the opportunity is great. We think the team is executing well, and we're really looking forward to driving that business even higher from a profitability standpoint off the levels we see today.

Just about out of time, but I've got one more question, and this is something that's very interesting, which is Applied and your peers help some of your semiconductor customers develop some of the most advanced chips in the world. These are AI and deep learning and machine learning processors. And yet, you guys are also taking advantage of AI and machine learning and deep learning to improve your tools, to improve your customers' time to market. And so the Applied team has increased [ has driven new AI ] in order to drive PPACt enhancements to customers. So first, how is Applied using AI in its own process equipment? And in process control, specifically, can you just give us some examples of how your Applied extract AI capabilities is helping customers improve yields and improve time to market?

So Harlan, when I look at our service business, subscription revenue, Dan talked about the growth of our service agreements, it's really driven -- has been driven largely by high-volume manufacturing, optimizing yield output and cost. I think there is an enormous opportunity, and we talked about this in our investor meeting, to accelerate the T in the PPACt. So accelerating R&D and ramp and technology transfer every time a new device node is going into high-volume manufacturing. So there, our goal is really 2x faster and 30% bigger process margins because that translates into faster and higher yield for our customers. And when you think about this playbook, when I go to gate-all-around or we have this integrated system that includes the PVD, CVD, ALD, all of these technologies in a single platform, these are very complex. And dialing in all of those unit process, knobs and then those structures across many processes is very complex. And this is where I believe we're just scratching the surface of what we can do with technology. Applied has real strength in driving sensor technologies, integrated metrology. We've built this high-speed computing platform and analytics as part of our actionable insight acceleration platform that has tremendous pull inside Applied. Our goal -- my goal is actually much more than 2x faster time to market for our unit processes and our integrated material solutions. And then the connectivity with our customers with instantaneous technology transfer and speeding the optimization, that's an enormous opportunity for Applied in our service business to accelerate the compound annual growth rate and the overall economics of that business. So again, that's really a lot of what we've been driving. The e-beam aspect that you mentioned is really being able to map the process window many times faster with our leadership in resolution and those technologies. And some people get confused. They think about e-beam versus optical wafer inspection. The e-beam inspection is actually a very small part of this -- over 900 million will generate an e-beam this year. The strength, and really gets back to the complexity, is being able to map out those fingerprints across the wafer, across the chip, into isolated and dense structures, and Applied is the only company that combines this computing platform and the sensors, the metrology in our platforms and systems with this leadership in electron beam technology where we can map out those signatures and then drive to accelerate time to market for our unit processes, integrated material solutions. And again, that just drives our overall business and PPACt for our customers. So that's really the way I think about it, Harlan. Tremendous, tremendous opportunity for Applied. And the pull with increasing complexity has never been larger.

Okay. Well, we're about out of time. Gary, Dan, I want to thank you guys for joining us today. Look forward to another very strong year in financial performance for the Applied team. Thank you very much.

Well, thanks, Harlan, for inviting us. Thank you so much.

Thank you.