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

Okay. I think we're on. We'd like to get started. Welcome back to the Goldman Sachs Communacopia and Technology Conference. My name is Toshiya Hari. I cover the semiconductor and semi-cap equipment space at Goldman. Very honored, very excited to kick off the semiconductor portion with Applied Materials. We have Gary Dickerson, President and CEO. I don't think Gary needs an introduction, but for those who have not had the pleasure to meet him, Gary is a long-time industry leader with more than 35 years of semiconductor experience and a strong track record of delivering profitable growth and gaining market share while achieving recognition for outstanding customer satisfaction. He joined Applied Materials through Applied's acquisition of Varian in 2011, where he was CEO there for 7 years. Prior to Varian, he spent 18 years at KLA-Tencor, where he held a variety of operations and product development roles before serving as President and Chief Operating Officer. For each of the past 3 years, Gary has been named one of the world's best CEOs by Barron's for delivering solid performance and a compelling growth strategy. He also ranked among Forbes list of America's Most Innovative Leaders for 2019 and Harvard Business Reviews Best Performing CEOs in the world for 2018. Gary also currently serves on the Board of Directors of the U.S.-China Business Council. With that, Gary, thank you very much for supporting the conference.

Thank you, Toshiya. Really happy to be here today.

Great. I definitely want to spend most of our time on longer-term, more strategic aspects of your business, but I was hoping to spend a little bit of time on the near-term. It's been about a month, a month plus since you reported earnings. You guided your core semiconductor systems business up mid-single digits sequentially. You also spoke about visibility beyond the October quarter, both from a demand perspective as well as a supply perspective. Can you give us an update in terms of what you're seeing in the marketplace today?

Thank you, Toshiya. Yes, we have the earnings on August 18, and I would say, overall, the shape of what we're seeing today is pretty similar to what we talked about on the earnings call. Unfortunately, demand is still far above supply. I had a meeting with one of our ICAPS, IoT Communication Auto Power sensors, top CEOs on Friday, and we're still just not able to supply to demand. So that's the overall situation. We guided the wafer fab equipment in the mid-90s for the year. And if you take the midpoint of our guidance, we're up about 15% in our fiscal 2022. So that's -- the shape of all of that is pretty similar to what we talked about before, still working really hard to close the demand-supply gap. Memory, as we talked about on the call, is weaker than foundry logic. Foundry logic, certainly, you see Epic battle in the leading-edge foundry logic, TSMC, Intel and Samsung. And all of those companies really focused on being competitive in power, performance and cost. So there's really a tremendous race there in leading-edge foundry logic. And again, I think everyone sees the investments that are being made between all of those different companies, just tremendous demand in the leading edge, the ICAP space, again, similar to what we talked about in our last earnings. We see areas of strength and areas of weakness. Certainly, automotive, industrial automation, those areas are very strong. And those are the areas where I'm in very frequent conversations with CEOs on supply gaps with those customers, and we see some areas of weakness in consumer. But roughly, that's the shape of what we're seeing.

Okay. That's great. And I guess as a quick follow-up to that, again, to your point, for 2022, you're guiding WFE to sort of a mid $90 billion range, primarily due to supply constraints.

That's correct.

I kind of went through the pluses and minuses from a device type perspective. I know it's really early to talk about 2023, and it's more typical for you to give a 2023 number on your January or February call. But to the extent you have visibility, what are your preliminary expectations for the [ out year ]?

Yes. Again, consistent with what we're seeing from customers now, we think memory will be down in '23. But we still see in terms of wafer fab equipment, relative strength in foundry logic, overall foundry logic. So that's memory, certainly weaker foundry logic for us at least, we're still supply constrained in that part of the market.

And then on your point on supply, not just yourselves but also broader across the industry. Supply has been an issue. Can you talk about some of the key pain points what's preventing you from shipping more? And I know this is sort of a $6 million question, that's really hard. But at what point do you expect supply to catch up the demand?

So we're. This is priority 1, 2 and 3 for me and the entire team is closing that gap. Relative to what's holding us back, actually, ironically, chips are one of those things. That are constrained. Basically, our chip consumption in the components in our supply chain are relatively small. You can -- for some of these really important chips and components, you may be talking 10 or 15 wafers. So the chip companies many times shipped to brokers, that ship to our suppliers, then they ship components to us. And so the priority for those chips are very low. The revenue obviously is very, very low for the brokers. So that's been one of the big issues for us is that visibility. Now we've made a lot of improvements. And our customers, once they know, they're very fast to respond, but there's still a number of those types of issues that we're dealing with. There are some other electrical components and other things. But really, the key issue for us right now is chips. And then relative to the progress -- we did achieve record revenue last quarter. We did guide up a few percent into the current quarter, and we continue to see incremental progress as we move forward. Some areas for us that are most constrained are in our leading-edge products, our strongest areas. Wiring, for instance, with our metal deposition products is an area that has been constrained. And really, the reason is that the foundry logic certainly is very strong across the board, but wiring is one of the biggest technology barriers for our customers, and we have really unique technology there. And so again, if you look from 7 nanometer to 3 nanometer, the dollars per wafer go up by a factor of 3. So there are many more steps there as our customers are working on as the wires become thinner and longer the resistance goes up. And so engineering solutions for those types of technology challenges are very, very difficult. We have -- and we've talked about that in the master classes that Mike Sullivan and his team puts together, we have very unique solutions where we integrate Toshiya 7 technologies into a single platform. PVD, ALD, CVD, copper reflow, interface engineering, many, many different technologies. So those parts of our business just took off at a very high rate. And those are the areas where we have the biggest constraint. But again, we are making progress. Certainly, I'm still on multiple calls per week with CEOs relative to supply gaps but we are making incremental progress.

Okay. Got it. But given that it shifts when they complain, you can kind of complain back at them in some cases.

Well, that was the nature of my discussion on Friday. 2 of the chips that were most constrained were from that particular company. So they certainly understand. But for them, that particular CEO, has just come from Detroit and then was -- with a very -- well, [ Detroit and the Automotive ], another automotive customer here in the Valley and then another very large customer here. And so for them, they're not able to supply demand, which really has a tremendous impact on the number of units those customers can [ chip ]. So we're all working together and doing everything we can to close that gap.

Got it. Shifting gears a little bit. I wanted to ask you a couple of questions on the CHIPS Act and the geopolitical landscape. The passage of the CHIPS Act and its implications have been top of mind for many, many investors. I know you played a critical role in getting the bill over the finish line. For context, what were some of the catalysts behind the bill to begin with. Do you see this as a onetime event? Or could there be a [ CHIPS Act 2, 3, 4 ]? And how do you see the distribution of semiconductor manufacturing capacity across geos? I know the big headline is in the U.S., it's 12% today, it should be significantly higher. Over the next 5 to 10 years, do you see the balance changing in a meaningful way?

So I think that. First thing is that many people are now understanding how critical semiconductors are in many aspects of the global economy. So -- and we're certainly through the pandemic, Toshiya, our teenagers were learning remotely, many people working remotely. And I think many of these technology inflections, those were going to happen, but many of them are accelerated through this kind of unusual time that we've been living in. So -- and if you look at -- I mentioned the automotive industry, the change in competition from gas to electric vehicles. And again, when people are talking about supply constraints, the biggest issue is that having -- being in the right position as those inflections happen if you don't have supply, that has an enormous long-term implication for those companies. But industrial automation, preventative health care, retail, with tiny eyes, tiny [ ears ]. So many different things are going to be transformed this decade. And really, semiconductors at the foundation of a digital infrastructure with the right power, performance and cost is really crucial to every industry. It has a big impact on economic growth and employment growth. So I think everyone recognizes the importance of semiconductors. And I've been in discussion certainly with the U.S. government, but EU and also Japan. A number of governments. Korea, a number of governments are extremely focused on semiconductors. And another thing that has become very apparent is supply chain resilience. So I think certainly, we are impacted from supply chain today. And it wasn't through a lack of investment in our own operations. We can ship much -- many more systems. We have the physical infrastructure. We have enough people. It's just supply chain, really, that's constraining us. So I think the focus around supply chain resilience is at a very high priority for every government today. And so that's really what you're seeing with the CHIPS Act and other incentives that -- other governments are putting in for the overall resilience. And I do think the other thing is that there's a multiplying effect in having leading-edge semiconductors, from edge computing, innovation to cloud innovation. So again, having access to those technologies have an enormous impact on economics and employment. So I think that was really the basis for the focus, and again, there's just a tremendous increasing awareness of all of that. So bringing supply chain into the United States was certainly one of the priorities. This gets back to the resilience of the supply chain, especially on the leading edge, high-performance computing. So that's what you've seen with Samsung in Taylor, Texas; Intel in Ohio, TSMC in Arizona; a number of investments that from a wafer fab equipment standpoint will come maybe more towards the end of '23 and into '24 relative to having an additive impact on overall wafer fab equipment spending. The other thing that there is a big -- where there's a big focus is making sure that we stay on the leading edge. So as you know, the technology in this industry moves very, very fast. And I talked earlier about this kind of epic battle on leading edge, high-performance computing. So having a high velocity innovation platform where our coalition partners, the U.S. companies and coalition partners can be a part of that ecosystem is a very, very, very high priority. And certainly, for Applied Materials, we're planning to make incremental investments in our operations and supply chain as semis move to $1 trillion. And we certainly believe that capital equipment intensity will remain very high. Capital equipment can outperform semis and then Applied really is in a sweet spot relative to these technology inflections. So we will add investments in terms of our operations in the U.S. and then also in R&D. So that aspect of the innovation, the tax credits, grants, those types of things, where operations and R&D will be important for Applied Materials.

Okay. So I guess, based on what you just said, Gary, you probably don't see this as sort of a onetime thing where we had this massive shortage. The administration suddenly got really focused on semis and you've got subsidies, this is more of a sustained effort on the part of the government to localize as much as possible.

Yes, Toshiya, I really do think that's the case. Again, semiconductors really have a tremendous impact. If the automotive content is going up, and all of these edge devices, the edge computing devices, people talk about maybe as many as the trillion edge devices by 2030, the edge computing innovation, cloud innovation, all of those things are -- I think that there will be even increased awareness of the importance of that semiconductor digital infrastructure. And certainly, the people -- some of the people I've talked to in the U.S. and outside the U.S. are talking about 10-year plans with significant levels of investments.

Got it. The geopolitical tensions between the U.S. and China is a topic that we get questions on all the time from investors. You have restrictions on high-end data center GPUs that were announced a couple of weeks ago. There were a couple of headlines this morning, about further restrictions on equipment exports into China. Based on what you've heard, what you know, how do you think about the setup from a geopolitical standpoint vis-a-vis U.S. versus China?

Yes. So for us, really not much has changed since our August 18 earnings call. For Applied, the profile for us in China is all of our display business or a high percentage of our display business is in China. And then you have domestic companies and global companies, Samsung and Xian, Hynix and Wuxi, Intel in Nanjing or Intel and Dalian [ CSSC ], and Nanjing. So you have the global companies and the domestic companies or display business. And then if you look at our profile around the foundry logic business, which is the largest part of the domestic China wafer fab equipment. The vast majority of that is trailing edge, what we call ICAP, IoT, communication, auto, power, sensors, type of market, which, by the way, as I talked about earlier, you'll have maybe 0.5 trillion connected edge devices. So that's a big market. But the -- that's really the majority of our business in China for the domestic part -- and we really haven't seen anything to talk about today, Toshiya, from what we talked about on the August 18 earnings call.

Okay. Got it. So it's probably fair to assume that any restrictions should be limited to the bleeding edge where your exposure is very small at the [indiscernible].

Yes, I think that's right.

Okay. All right. Got it. more to the fun stuff, technology inflections.

I love that.

Yes, exactly. I spent 20 minutes without going there, so apologies. So Gary, you spent a lot of time with CEOs and R&D leaders, talking about next-gen, next next-gen technology, both in terms of logic and memory, get all around [ 3D ] DRAM, everything in between is a big focus for you guys. Can you talk about some of the things that you're most excited about over the next several years? And how are you positioned relative to your peers as you begin to address some of those inflections.

So Toshiya, one thing I would really recommend for anyone that wants to understand the inflections. Again, Mike Sullivan and his team in Investor Relations, they've put together these master classes. I think we're up to 6 or 7 of those master classes. So they cover everything from high-performance logic to memory to the ICAP, the edge computing innovation, packaging, many, many different areas of our business. And so in that -- in those master classes, over the last little over a year, we've talked about $10 billion of inflection. And if you look at the all of these markets, more and more of the inflection spending is going to materials and structures. So certainly, this is one of the things that we've talked about and also TSMC and others have talked about that relative to power, performance and cost or we say PPACT, power, performance, area, cost and then time, how fast you accomplish power, performance and cost. The more of those inflections are moving to materials, structures, the way you connect chips together with advanced packaging. Certainly, there's still design innovations and then also shrinks. But more and more moving to materials engineering. In fact, if you go to TSMC's earnings call, Mark Liu, the Chairman talks about more spending in new structures, new materials. Customers have talked about what's called design technology co-optimization. And a significant percentage moving to new transistors with [ gate ] all around. I talked about where that's a $1 billion opportunity Applied and the FinFET transistor had a little less than 50% overall share of non-litho. It's moving to more than 50%. We said over 5% gain for us in this transition in the transistor wiring. Again, that was another master class that we had here in May recently. I mentioned the [ 3x dollar ] per wafer from 7 to 3. Again, as these wires are becoming thinner, resistance is the biggest problem in the industry. So there are these integrated platforms under vacuum, we call Integrated Materials Solutions where Applied has very unique technologies enabling a 50% reduction in wiring, enabling contacts with no barriers, those types of things. So that part of our business, Applied has extremely high market share, extremely well-positioned in memory. Certainly, the DRAM -- high-speed DRAM is going in the IO part of the logic part of the DRAM, more towards logic-like processes, that's really good for Applied Materials. A combination of new hard masks, new etching. Those are areas that are important to NAND and DRAM. And then in packaging, that's another area where Applied has real strength in our -- we have the broadest portfolio of packaging technologies. That business is around $1 billion for us this year. And that area, people talk about heterogeneous integration. It will be very, very, very important. So we have key technologies in that segment of the market. Again, that's another one we had in May in a master class where we talked about all of the innovations happening in advanced packaging and new capabilities like hybrid bonding, where you can bond 2 chips together or a chip and a wafer together to shorten the interconnect length, which improves the speed, the bandwidth and lowers resistance, so power and performance basically in that inflection. So Applied is extremely well positioned in many of these different areas I believe what you will see as you go to 3-nanometer ramping, 2-nanometer ramping, these materials innovations and structure innovations will be incredibly important and Applied is really, really well-positioned. One last one I would add, again, we did this in the May master class is a backside power distribution network. So basically, you're taking the -- you have signal lines and power lines in a chip, you take out the power lines, put them on the backside of the chip, which is more wiring stats where Applied has real strength. And then that once you remove those power lines, you can shrink the area, 30% with 0 change in feature size or you can pack more functions into that same chip on the front side. So those are -- that's the direction the industry is moving, Toshiya, more towards materials innovation, structure innovation, and then connecting chips and chiplets or IP blocks together through advanced packaging. And those are areas where Applied has tremendous strength.

Gary, we tend to spend a disproportionate amount of our time on the leading edge, just because your customers there spend a larger percentage of the WFE globally. But you do have a long tail of customers. You guys call it your ICAPS business. It's roughly half of your logic and foundry business today. What are some of the inflections there that could help accelerate growth and help you from a competitive position standpoint.

So Toshiya, about 3.5 years ago, we formed our ICAPS group. And I'm super happy we did that. We have very, very deep relationships across all of those different customers. And that part of our business has grown, our share has grown a significant amount. Again, this is all based on materials and structures, innovations. And if you look at power devices with silicon carbide or sensors or RF analog, all of those different areas, and edge computing innovation, there's a lot happening there. And again, that's another master class that we talked about. And just 1 example on our implant business, we introduced 10 new products just for ICAP in the last 5 years. So there are additional steps happening as innovation is being driven in that ICAP space. And again, that's an area where Applied is growing share, very, very strong position. The only thing I would say that maybe people may not know is that for a long time, if you go from 2000 to a little more than a decade, many people do know that there was a movement to foundries, TSMC and others. And there were a large number of fabs and a lot of excess equipment on the market. So if you look at the ICAPS capital intensity in that time frame, it was in the low single digits. And so there are no more whole fabs that are available and equipment available. So the capital intensity in ICAP has risen as there are no more -- there's no more used equipment or they call them cores that you could refurbish. All of that has dried up. So in 200-millimeter today, it's really all building new systems. And so you have that, that's another factor relative to capital intensity.

Okay. Got it. Shifting gears a little bit. We talked about the supply side frictions. We talked about the technology inflections and the amazing work that you guys are doing. It's literally rocket science, right? The natural question that we have, and we get from investors is how come gross margins are where they are today. I don't think people complain too much about operating margins, but there tends to be a disproportionate focus on gross margins from investors who cover semis and semi-cap. I know you're having conversations on pricing with customers. I guess, how are those going? And how should we think about the gross margin trajectory over the next, call it, 5 years as some of these inflections play out?

Yes, Toshiya. Certainly, right now, we're having -- we're experiencing significant headwinds relative to gross margins. We're a little over 46% right now. We guided, I believe, around 46.5% in the current quarter, maybe a little bit higher than that, somewhere in that ZIP code. But in the situation that we're in, the #1, #2 and #3 priority is really closing that demand gap and really maintaining customer trust. So we've spent hundreds of millions of dollars in supply chain with our investments in suppliers. Certainly, it's very frustrating, but chip shortages, we're paying huge premiums for chips and other components. In logistics, logistics costs have went up a significant amount. So those are headwinds that we're facing. Some of those are transitory. Some of those are more sticky. And so those are things that have impacted us near-term. What we've indicated is that we still have very high confidence that will hit our model that we've talked to investors about the mid- to high 48% range relative to gross margins. We are driving -- I think one thing I think about is never waste a crisis. So we are driving some significant changes in our supply chain, multi-tier visibility within the supply chain, we've moved hundreds of engineers into the supply chain certainly near-term to close our gap so that we have the capacity and agility into the supply chain. So that's another headwind that we're facing from a cost standpoint. But all of that will pay off for us over a longer period of time. And as you also mentioned, we have implemented price increases with our customers. And I think longer-term, I believe the value of our technology is increasing. I talked about these inflections in wiring and other segments within the market, where I believe we have never been in a stronger position relative to value creation. So I understand the disappointment on the gross margin. And I certainly also understand the expectations from all of us that we need to make improvements going forward. Near-term, I think we will see incremental improvement. And then we have communicated, we're committed to hitting the investor model that we've communicated.

Got it. Okay. We have a little under 10 minutes left. I've got more questions, but I wanted to pause here and see if we had any questions from the audience. If you do, just please raise your hand, and I think we have mics going around. No questions. Okay. I'll keep going. I wanted to ask about your services business. AGS, it's a very strong business. It's extremely consistent, generates [indiscernible] of free cash flow. Can you talk about your growth expectations there and how you're sort of transforming the mix within AGS?

So AGS, when we think -- one of the things that we've talked about, Toshiya, as being more resilient as a company. And certainly, the backlog right now is part of that. The technology buys and our position around technology buys are also part of that. And then the service business is around $5.5 billion. What we've communicated is that we also believe that we'll hit that investor model early relative to the service growth rate. Over the last few years, we've transformed that business from -- it was more transactional service and spares to more service agreements, subscription-type revenue. So today, the agreements are around 60% of our spares and services business and the tenure of those agreements have also increased to about 2.5 years. So very, very strong pull. If you think about what customers are focused on, it's really good chips out. So they get more good chips out by ramping faster, ramp acceleration. Certainly, they get faster time to market through R&D acceleration. So the t of PPACt is very, very important. And I think there's tremendous opportunity to accelerate the compound annual growth rate in services in that front end of R&D and ramp. And we'll be talking more about that as we go forward. Then another part of getting more good chips out is improving productivity of our systems, the yield, especially the edge die yield, the availability of tools with smart PMs and accelerating green to green when a tool goes out of -- you needs to have preventative maintenance and you want to bring it back faster. All of those things are creating significant service opportunities for us. I think you see the pull when you look at the percentage of agreements that we have from our customers and the renewal rates are around 93%. So I really think that we have an opportunity to accelerate the compound annual growth rate for our services. And certainly, we're well on track to hit that investor model, a fair amount before that 2024 time frame.

And then on your display business, it's a relatively small part of your business at this point just given the growth that you've seen on the semiconductor side. Competitively, you're very strong in the markets you serve. Unfortunately, the market itself has been a little bit tougher. What's sort of the perception of that business unit, if you will, within the context of your overall portfolio? How committed are you to display? I know there's overlapping technologies between semis and display. So you do have clear synergies, but what are your most updated thoughts there?

So display is -- as you said, it's really an adjacent market for us. You go from wafers to these larger panels for TVs or smartphones or laptops, those types of things. And in that -- in the display business, our largest part of that is CBD. And that -- in that segment of that market, we have very, very, very high market share, a strong position with every leading display company in the world, a very high differentiation. We also have PVD. We have eBeam technologies in that market. All of those areas, the market shares there are as high as any of our high market share segments within our semi business. So our position there is very strong. But today, there isn't a real technology inflection that is driving demand. So really, it's directly connected to consumer demand, which obviously is weak in this environment. So what we've done -- what we talked about in our Investor Day in 2021 was really a focus in that business on free cash flow. And we've made -- we've made investments so that we're in a very strong position in the segments that we're participating in. And we have taken steps to reduce spending, a fair amount, especially from an OpEx and COGS perspective so that we can maintain the free cash flow from that business. So our strategy there is to run that business between 20% and 30% operating profit and free cash flow. Now it's going to be lumpy at different periods of time. But if we look at the range of where we run the business, it's really in that range. There is one big inflection. I just met one of the top leading edge display consumers recently. And in organic LED, there has always been a desire to have technology that would enable these new displays at the right tipping point for cost. That has been difficult for anyone to achieve. There are technologies that are being pursued for those types of large area displays for IT and TVs. If that happens, that would make a big difference in the display market because for us, even in our current core business, the dollars per panel that's produced there goes up a significant amount. Now again, that's not something that we're going to see in the near-term, that business will be weak going into 2023, but very, very focused on free cash flow for that adjacent business for us. The other thing, I would say, is that, that large area processing capability, if you look at what will happen in advanced packaging going forward, there are companies that are looking at and investing significant amounts in panel processing for packaging. So having those capabilities not only for wafers, but also for these larger substrates can position us for a semi inflection that will come over the next several years. But the #1 thing is free cash flow.

Of course. In the last 90 seconds, Gary, I wanted to give you the opportunity to speak to anything that we may have missed or I think Applied is a very well-covered stock. But collectively, if there's anything that we underappreciate or miss, we'd love you to close out the session for us.

Well, thanks, Toshiya. Certainly, the situation that we're in right now, with the overall macro situation and the supply chain. Those are headwinds for us. But longer-term, I think everyone forecasts Toshiya, that semi is going to grow mid- to high single digits, that will hit $1 trillion in the semi market by 2030. And if you look at equipment, wafer fab equipment, I think, again, there's a lot of people that believe the wafer fab equipment can grow slightly faster than semis, capital intensity will remain high as we've talked about all of these really difficult technology inflections. And then I look at Applied's position around those major inflections. All the things, the $10 billion of inflections that we covered in the master classes, I really believe we've never been in a better position that we're in today, Toshiya. So I've never had so much fun and really appreciate everyone coming here today and your interest in Applied Materials.

Awesome. Thank you so much.

Thank you.