Applied Materials, Inc. (NASDAQ:AMAT) Citi 2022 Global Technology Conference September 7, 2022 3:15 PM ET
Company Participants
Brice Hill – Chief Financial Officer
Conference Call Participants
Atif Malik – Citi
Atif Malik
Good afternoon, everyone. Welcome to day one of Citi Global Technology Conference. My name is Atif Malik, I cover U.S. semiconductors and semiconductor equipment stocks here at Citi. It’s my pleasure to welcome Mike Price — Brice Hill, SVP, CFO from Applied Materials and our friendly neighborhood, Michael Sullivan, Investor Relations IR from Applied Materials virtually. The team had a COVID exposure and just to keep our conference safe, we’re doing this fireside chat virtually. Welcome, Brice and Mike.
Brice Hill
Thank you very much. Nice to be here. And thanks for accommodating our changes.
Question-and-Answer Session
Q – Atif Malik
No worries. Thank you for joining us. Brice, I’m going to start with the Silicon Group and the cycle discussion. And I thought you did a tremendous job and kind of explaining us what’s really going on in the industry, because it seems to be that the semiconductor equipment companies are sounding a lot more constructive on the fundamentals versus some of the semiconductor peers, particularly on the consumer semiconductor side.
And on the earnings call, you were trying to draw these two lines for us, basically saying that the demand line for you guys is still above what you can supply. The demand line is coming down maybe in areas like memory, which is more consumer centric, but the supply line is improving for you guys. So the question I have for you is, if you can talk about the supply demand dynamics and the delinquency gap, is that gap closing? And when should we expect the supply line to kind of meet the demand line?
Brice Hill
Right. Yes, I think you hit some of the high points and certainly captured some of our messages there. The first thing from a demand perspective is, if we think about it long-term, we’re absolutely convinced that semiconductors over the long-term will continue to grow at a high-single-digit rate across all of the device types. And the end markets for IoT, the end markets for phones, the end markets for automotive, cloud, continuing to grow all these markets, new sensors, more data, that’s the logic so we’re convinced in the long-term.
In the short-term, what we see in our business is a continued significant order flow with a growing backlog, which we called three plus quarters of backlog, booked orders and unbooked orders when we went through the call, and that hasn’t changed. And what we emphasize also was that we just went through an exercise of over the last few weeks, asking all of our customers to reconfirm the backlog. And the reason we’re doing that is, if there are customers where whose business is weakening a little, we want to change those orders and be able to shift those tools to other customers where the business is growing or is more stable. And so that was the whole purpose. And after going through that entire process, we still have a backlog that’s significantly higher than what we can ship over the next few quarters. So that’s the dynamic.
And when you ask about delinquency, I would say that it’s not yet improving or it’s still, if you’re — if that’s referring to the amount of time customers will have to wait for a new order, that’s still not shrinking. We would expect to be making progress on the backlog over the next year. So I guess I would say, delinquencies would start to shrink as we get towards the end of next year would be our expectation.
Atif Malik
Great. And then before I dive into other questions on your backlog and lead times, I have a big picture question. I think a lot of times when we see macro softness, a lot of investors tend to forget the secular drivers, the rising capital density that kind of pegs the equipment group. And you and the team have done a masterful job of hosting these master classes talking about inflections like be it, all around advanced packaging, ICAPS or trailing edge technologies. And the reason we have a climate change as a topic is because you guys are not only agnostic to the memory or logic end market mix, but you play very well on all these mega trends and it’s hard for us to not rank you higher in all these categories. So, my question to you is, if you were to wear your hat as ex-chipmaker and you came from Intel, like which one of these technology inflections are you most excited about and where you think Applied is the most well positioned in the next couple of years?
Brice Hill
It’s a great question. And thank you for asking, I’ll just say for investors in general, when you’re a designer of a chip your performance comes generally from more transistors. So you’re trying to figure out how to put more transistors on a chip, and there’s a lot of things that block that. If your wiring is too thick, the things that connect the transistors, then it’s hard to pack them densely. If it takes too much power, it’s — the device becomes too hot and won’t work.
And so what Applied is doing is helping our customers solve these blocking functions, if you will, wiring is a great example. And that I guess I would say, I’m most excited about wiring because it’s great on top of us and that’s being deployed, new wiring techniques are being deployed now. But in general for the investor, I just want to emphasize what Applied is doing is working with the customers and that’s one of the reasons I came to Applied and love the company, its focused on working closely with customers solving customer problems.
So the wiring’s a good example where the techniques being developed will make the wiring more power efficient, and take up less area and that allows our customers to put more transistors in the same space at lower area and lower power, which are all things that they’re looking for. And so I guess I would say wiring, but to your point, gate all around is another example that’s a different type of transistor design, and that transistor design will be more efficient and more power efficient and it’s enabled by some of the technologies that Applied is offering to the customers from a capability perspective to build that new device.
And so I think those are great examples, Atif, of things were Applied is working with the customer solve customer problems and essentially offering advances in the technology. We always look for between 10% and 25%, performance advantage, an area of strength or an area of advantage and then a power advantage to call — to advance the technology. And that’s what Applied is working on, and I think those are good examples of new offerings that do exactly that for our customers.
Atif Malik
And Brice on your last earnings call, you guys commented that next year’s equipment fundamentals should be more resilient than then in the past? Can you talk about your reasons?
Brice Hill
The first reason we pointed out was just the backlog. And I think it’s kind of like a — if you think of a retail business that’s going into a downturn with no inventory, that’s sort of a good time for them, and that they’ll be able to restock inventory during that process, and not have as many write offs. Maybe in a similar way, if there is a downturn for us we’re going into it with a very strong backlog and very high utilization. And that backlog gives us a tailwind or a buffer, if you will, to the very short-term demand signal.
So the first point is high backlog, high visibility with customers, our customers are giving us their expectations for 23, 24, sometimes at a high-level even beyond that. So it’s the strength of that demand signal. The second is we mentioned that our Services business is growing larger as a component of applied. And our Services business unlike the core business that are semi business that goes with the WFE and the equipment market, the Services business is driven by our installed base. So every time we ship a tool, our installed base gets larger. And that’s an opportunity for us to sell services and subscription services to that tool, and to that customer. So our Services business tends to be less volatile and more associated with utilization of the fact of the equipment in place and the installed base.
And then the last piece is as foundry logic continues to grow, the business is more proportionately — more proportionately oriented to the foundry logic business, which has been less volatile in the past than the memory business. All of those are factors that we pointed out together, Atif, that we think make us more resilient if we were headed into a slower environment.
And let me just say, I understand — we totally understand that there’s signals of recession, that the recession risks has raised. There’s some pockets in the market where it’s absolutely weaker, we see that in our Display business. But so far we’ve continued to see strong orders, whether it’s the government incentives that are being put in place or just some of the business pockets that are stronger, we’ve continued to see strong orders.
Atif Malik
Brice, just to touch on the record backlog coverage point that you made, and I understand you can rebook some of these orders if your tools get cancelled in some areas of markets, maybe like memory. The question I get asked from investors is like some of your peers take down payments on long lead time tools, do you have incentives in place or kind of downside protection if some of these orders are to go away because of deteriorating demand?
Brice Hill
At this point, we do take deposits on some tools, it’s mostly in our Display business, but that’s generally not been the practice. I think the focus right now, I mentioned that we went back through our entire backlog with the entire customer base looking to find any trades that would be win-win for the customer base. So at this point, I don’t think there is something structural, like you’re suggesting, we are evaluating we are looking at what others companies do, and we are evaluating that, but no changes at this point. So at this point, customers could change their dates or could cancel a tool. And then yes, what we’ve seen so far is that we rebook those acts for other customers.
Atif Malik
Got it. And most investors these days are looking at equipment end markets into three buckets. They’re looking at leading edge logic, foundry then they’re looking at trailing edge logic investments and then memory. Can you talk about what do you see both this year, maybe next year, in these three markets?
Brice Hill
Yes. In the near-term like you’re suggesting, we see significant strength in foundry logic for multiple reasons. But I guess just for investors, that market is driven by leading edge technology. So if you’re customers of our customers, and you’re designing new product on a new process technology, those products are being designed and our customers have to put in the process to meet those products. So if you’re designing a new chip two years from now on a new process technology then that process technology has to be ready to manufacture that chip. So it’s a roadmap, and our customers tend to be committed to that roadmap, because they’re investing billions of dollars in the chip R&D to be made on that equipment. So that leading edge logic foundry business is probably the top driver right now from a demand function.
If we switch to the more mature nodes, we saw ICAPS, what we call our IoT, communications, auto, power and sensors business, those are more mature technologies, that grew significantly over the past couple of years. We think that will be a stable part of the of our portfolio for the next period of time. Meaning it will be roughly the same level it is today, and we see fairly consistent demand from those customers. And then if we switch to memory, we have seen — that’s one of the places in the business where we see some weakness and we expect potentially some more weakness as we look at the orders in that space.
So, as we look in the near future, I divided that way, continued growth in leading edge logic, ICAP’s relatively stable and then some weakening in memory.
Atif Malik
Great. Brice, the market is going to do what the market is going to do. In terms of your own products, where are you most constructive on in terms of gaining share? I think Gary alluded to 40% plus growth in the PDC products this year which are outperforming the WFE market. So where are you most optimistic in terms of your share gain opportunities, what products end markets?
Brice Hill
I think it’s fairly broad, because those new techniques and device types that you talked about gate all around and wiring and backside power is another one, those new techniques we think will be more driven by materials engineering and precision engineering, the things that Applied does in working with its customers. But I’m glad you highlighted our inspection business, the eBeam technology that we offer is definitely something that’s a high growth area for the company and a focus growth area for the company.
And I think that business in general has been growing fast. And we think what’s behind that, just to let the investors know is as these technologies are more and more complex and more and more difficult to build, it requires more inspection techniques and more ability to look into the wafer and see the devices and see if there’s any defects in the devices so you can retune the design or retune the tools. Those inspection tools and metrology tools, that’s what they’re called, that we sell are becoming more and more required in the process.
And even some of our integrated toolsets will have integrated metrology or integrated inspection so that as layers are being built on the wafer, they can be inspected in the same process to make sure you’re making the progress that you want to make on the wafer. So I think that’s a great business to highlight and we have seen significant growth and expect that business to continue to outgrow the rest of the WFE.
Atif Malik
And what is the impact of CHIPS Act to Applied Materials directly? Obviously, you guys are benefiting from it indirectly from your customers, getting funding to build more fabs and other components of the law that will help you to apply for subsidies for your manufacturing or R&D facilities?
Brice Hill
The first is on the R&D side, we do think — on the R&D facility side, we do think there may be grants available that we will apply for that will help us with R&D facilities that we’ve been desirous of building. So we will apply for — help with new facilities that will have from that perspective. The second direct impact will be, we’re also able to apply for tax credits related to manufacturing facilities that we would add in the United States. And because the business is growing and because we would invest in manufacturing facilities, we think there’s opportunity there.
And the last is there is specific dollars available for development, innovation and development, both in the semi and the packaging side and related talent programs. And we have programs in all those spaces that we’re working on analyzing whether we can invest in that and whether they fit the government’s proposals. So we think those are four direct spaces, R&D facilities, manufacturing facilities on the tax credit side, and then help with R&D and talent management. We think those there are 4 areas where we may get direct assistance.
Atif Malik
Okay. Brice, a common concern I hear from investors on Applied Materials is that you have significantly more exposure to what you call ICAPS, IoT, communications, automotive, power and sensors business, which is roughly half of your foundry logic sales. How sustainable are the ICAPS investments?
Brice Hill
So we saw large growth the last couple of years in ICAPS. And again, these are the more mature nodes. And just for our investors, a lot of the demand we see are on nodes actually larger than 40-nanometer, if you think about the timing for those process technologies. But the dynamic has just changed in those — in that market. The dynamic years ago was that used equipment may become available. The company is running those process technologies so it could scoop up some of that used equipment and continue growing with that dynamic, or they were comfortable in the footprint that they had that may have been cascaded from a product road map.
What we see today is the companies that are building on those process technologies are growing. They’re needing to expand their footprint because they’re building sensors or they’re building power devices or they’re building older FPGAs, or products that are on the more mature nodes, and they need to expand. And so now it’s new facilities and new equipment with a higher intensity than what we were used to seeing.
And when we talk specifically to some of those larger customers, they confirmed to us that they’re growing. They’re expanding their CapEx, and they’re having to grow their footprint. So I think, Atif, it goes back to our confidence in the demand function, our confidence that those devices have a place in the ecosystem, like video sensors are a great example, there’s just going to be an explosion of video sensors and video computation that goes with that. So when we look at the automotive market and the phone market, there’s just a huge amount of silicon that’s growing in those 2 markets as the — as there’s more content in the newer devices. So we’re fairly comfortable with the demand profile and in the stability of that market.
And the last thing I would say is we have looked to see if there’s idle equipment. I think you know we measure the utilization of the equipment across our installed base. And we see high utilization across the entire installed base, including on the more mature nodes, so — and we see that through our Services business.
Atif Malik
Great. And many investors are excited about new materials like silicon carbide, gallium nitride to meet the growing EV demand. You announced a few products last year in implant and CMP. How big is the auto piece within your ICAPS business? And how fast is this piece growing?
Brice Hill
Yes. So on the automotive side, we don’t specify how much it is. And I’m not sure we know how much it is in total of our ICAPS portfolio. But we do have a perspective on the speed of growth in that business. I guess a couple of comments, and these are — these might be well-known data points.
The first is that the content in autos, as you move from combustion engine to EV, goes up I think, a factor of 4x if that EV is an automated driving solution or has those capabilities. And so this — it’s kind of like the same as we see in cellphones. So the content and concentration of compute is going up in those devices. So when we look at automotive, we think that grows in the mid-teens over the coming years as the fleet changes over more to electric vehicles and the content in all vehicles, but especially electric vehicles goes up. So you’re right, that’s a big grower.
And when you look across the device types: video sensors, radar, LIDAR, the extra compute that goes with that, comms, there’s a significant amount of silicon components that go in those devices.
Atif Malik
Sounds good. Brice, moving on to Services business, and I don’t want to front run your upcoming Master Class, but I was surprised to hear that your renewal rates are running above 90% for the long-term service agreements. What makes this business so sticky? Are there unique drivers in this business versus your peers?
Brice Hill
Right. So unique drivers. First, let me just remind, I mentioned earlier, but when people are thinking about — when investors are thinking about the company, this business is growing we said low double digits. It is based on the installed base. So every time we ship a new tool, we’re growing our installed base, and we’re growing the services opportunity.
And why is it more sticky? I think there’s probably a number of reasons. There’s 2 primary reasons. One, customers have better availability of service and parts if they’re — if they’re part of one of our subscription agreements. And so that helps them from an app perspective.
The second piece is there’s a competition for labor across the entire globe. And so one of the things that Applied is able to offer is we have a skilled workforce that knows the tools, knows the maintenance, knows the best techniques and can help the customers on demand. So that reliability is another component that I think adds stickiness to our subscription agreements with the customers.
And then the last piece, it’s part of our road map and our plan over time to continue to add what Gary calls actionable insights, machine learning, other observations we can make from our entire fleet of tools on how to optimize the settings, optimize the yields, ramp them as quickly as possible, match up, but all those things are capabilities we can offer our customers. And that’s part of our road map is to continue to give them intelligence that will allow them to get the best value from the equipment that they’ve invested in.
So I think those are the 3 primary drivers of stickiness, Atif, and why we’re getting more customers that want to do — renew a subscription or even want to enter a new subscription agreement.
Atif Malik
Okay. And then moving on to display market, you’re expecting the market to be down this year, with expectations maybe 2024 isn’t up here. I was with Universal Display, a materials OLED company before this session, and they’re also sounding positive on 2024 being a pivotal year for OLED investments. Can you talk about Display segment? Is it still strategic to the company? And what drives your confidence, if you’re seeing any green shoots in terms of any capacity plans into 2024?
Brice Hill
Yes. Thank you. So first is it is a strategic business for Applied. Using our technology in sort of this large format form factor, if you will, sheets instead of wafers, that’s something that’s important for the company to continue developing from a technology perspective and the technologies involved give us other insights to the rest of our business. And the market is a good market for Applied when we make good cash returns on the investments made in that business. So I would say it’s still — it’s strategic for the company, and we’re happy to stay in that business.
I think the dynamic is right. It’s very consumer-focused. So all the third parties have cut the forecast for next year for both the equipment and, of course, the production of displays worldwide, whether it’s the laptop market, the cellphone market or the TV market, all of those have lower forecasts next year. But they do start increasing when you look out to ’24. So that’s — so most of the industry is looking at inventory corrections, slowdown in ’23, and that accelerates again in ’24.
And there’s one other thing I would add in there. We are hoping, and one of the reasons that this business is important to us, we are hoping that the OLED technology takes off and accelerates. And there are some signs that companies are considering investing in that from a road map perspective that has — it’s been more expensive, but it has significant benefits from a quality, and life and power perspective. So if OLED takes off then we think that business has — will benefit significantly for Applied.
Atif Malik
Okay. And moving to the target model, it looks like you guys are going to hit the top line of your fiscal ’24 base model almost 2 years ahead with the team and maybe a bit behind gross margins and operating margins. Nothing was normal this year, last year with respect to supply and you incurred higher costs. What do you think are good targets for profitability levels in the next 2 to 3 years?
Brice Hill
Yes. What we’ve talked about in gross margin is we’re committed to the target that we highlighted in the last Investor Day, which is 48.5% for gross margins. So our recent quarter of — Q3 of 46.2%, and obviously we’re off that mark. To your point, we were impacted by everything that has to do with inflation and supply chain issues.
We think some of those — over the next 2 years, some of those will dissipate what we call transitory costs like air freight, expedite fees, paying special brokerage fees for certain components. Overtime, we think some of those things will just actually naturally dissipate. And then we think that our price adjustments and our ability to do cost engineering will bend the rest to the curve and get us back to the 48.5% target.
So we think — we think we’ll walk that back incrementally over the course of the next several quarters as we head back in that direction. So the way we described it, Atif, was incremental improvements over the next many quarters heading in that direction. And then from a spending perspective, I think our model articulated spending to be in the order of 16% from an operating spending perspective. We think that’s a good model for the company for the foreseeable future. So if you put those together, I think that’s the P&L dynamic that we’re focusing on.
Atif Malik
Okay. Let me stop here and see if there are any questions in the audience. If you have a question, there’s a mic up front here. You’ll have to ask the question in the mic.
Unidentified Analyst
Quick question on just geopolitics. Given some of the commentary around EDA and chips — AI chips, do you expect any of your kind of Chinese-based customers to potentially pull forward or even forward some equipment as a result of fearing kind of a broader U.S. export policy? Thank you.
Brice Hill
Thank you. I don’t expect that, but maybe not because I think the behavior is something that we shouldn’t wonder about. The reason I don’t expect it is, one, we’ve looked to see if there are pockets of unutilized equipment or hoarded equipment. And we don’t see any evidence of that. So we don’t think anybody — globally, anybody is doing that.
And the second piece is, unfortunately, it’s really not possible for someone to pull forward orders right now to exercise that strategy. So just environmentally, we don’t think that will happen, if that makes sense. But thank you.
Atif Malik
Questions?
Unidentified Analyst
You mentioned you still have strong visibility on the foundry logic side and leading edge and kind of stable on the trailing edge, but weakening on the memory side, with some concerns about data center potentially slowing down. Do you think that’s naturally going to impact 2023 on the foundry logic side? And just was wondering how much visibility do you have right now in terms of those orders? And if you can relate that to the previous cycles, what actually happened? And typically, how quickly these things change?
Brice Hill
So on the first part of the question, I don’t know if I said data center slowdown, but if I did, I didn’t mean to say that. The signals that we see from data center are increasing CapEx and increasing investments. I haven’t checked the rates. So if it’s — is the rate slowing down? In other words, it’s still growing but at a slower rate. I actually didn’t check that. All I checked was that we have increasing demand across the cloud base and across data center. So I think that is actually 1 area that we would look at like auto or like industrial that would be a continued driver of growth for us and for our customers going forward.
And so when we look at previous cycles, I guess what I would think about is what cloud is doing is consolidating a lot of the hybrid data centers or the privately owned data centers, company-owned data centers. So the more consolidated that model gets where more of the world’s compute is on the cloud, then I think the more stable that environment is. So if I compared it to prior cycles or I compare it going forward to prior cycles, I think it will be a lot like the consolidation in semis in general, where you’re getting — that consolidation is getting us to a more well-managed ecosystem or more well-managed supply base instead of lots of pockets of data centers, you’ve got big pools of data centers that are highly utilized. I think that will be a more stable signal for the growth and a more stable investment path for cloud and for data centers going forward. So I hope that answers most of the question.
Atif Malik
Any questions here?
Unidentified Analyst
With some of your customers beginning to reconsider where they’re building their fabs and maybe building in areas that they wouldn’t otherwise and the kind of absence of geopolitical issues and government incentives, do you anticipate any kind of cost headwind or maybe even CapEx headwind on having to build up infrastructure or talent in places that you might not otherwise have if customers continue to build up the ecosystem in Asia?
Brice Hill
Is that — when you ask that question, is it direct for Applied? In other words, Applied like hiring service people and putting in a service operation close to the customer?
Unidentified Analyst
Yes, exactly. You have to colocate with your customers and maybe labor is more expensive in some of the new areas where fabs are being built.
Brice Hill
Yes. That’s absolutely a challenge. So to your point, for any of these fab projects, you’re kind of making a point, there’s definitely challenges to overcome whether it’s the availability of construction labor, skilled labor. And those same challenges happen for us if it’s a new location where we’ll have to find the people, train the people, staff up, put in office locations, et cetera, if it’s the new location. That’s a challenge.
But on the flip side, we are prepared to do that. We’re good at doing that. We ramp our people successfully. We’re able to leverage our infrastructure in order to quickly ramp people and get them up to speed on existing customers and existing networks. So it’s not something that we’re worried about. But to your point, it’s a challenge.
And then just in general, I know this wasn’t your question, but I’ll just — in general, we think these government incentives will — they’re not going to significantly change the WFE curve. It’s not like any of our customers are going to invest in equipment that they don’t need. We do think that there’ll be a catalyst to invest in the next few years. And it will stimulate — there’ll be a slight bump in the WFE, but we think that in general, that this will just fit in the WFE curve that we see going forward. And these facilities will be utilized, maybe not perfectly over time, but they’ll be highly utilized.
Atif Malik
Brice, I have a final question before we wrap up the session. As a relatively new CFO of the company and given your background at Intel, what are the areas where Applied Materials can improve upon?
Brice Hill
Okay. So the reason I came to the company was — I think I mentioned earlier, I just love the win-win perspective it has with its customers, work on those Materials engineering solutions that help the customers win. As I think you know, where we need to work to improve is really on our ability to deliver for the customers. So we’re focused on supply chain, we’re focused on cost reductions to help offset some of the inflation that we’ve seen. And we’re focused on speed of execution and ensuring that we can deliver the things that we’re promising our customers for their road map. So I would think it would be those elements that the environment, be it COVID or be it the supply chain or be it our ability to have sort of linear manufacturing every day is the same in the factory. Those are things that we want to improve and get to basically so that we can be the top provider for our customers.
Atif Malik
Great. And with that, we’ll wrap it up. Brice and Mike, thank you for joining our conference virtually.
Brice Hill
Thanks so much. Appreciate it, Atif. Thank you.
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