Applied Materials, Inc. (AMAT) Morgan Stanley Technology, Media and Telecom Conference (Transcript)

Applied Materials, Inc. (NASDAQ:AMAT) Morgan Stanley Technology, Media and Telecom Conference Call March 8, 2023 11:00 AM ET

Company Participants

Brice Hill - Chief Financial Officer

Conference Call Participants

Joe Moore - Morgan Stanley

Brice Hill

We'll get started. I'm Joe Moore from the Morgan Stanley semiconductor team. Very happy to have with us here today, Brice Hill, the CFO of Applied Materials. I'm going to read a quick safe harbor, and then I'll go straight into it. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales rep. I know you've heard me say that 25x now, but I apologize. Anyway, Brice, thank you for joining us. I think you just told me that you just passed your one-year anniversary as CFO of Applied. So, maybe just kind of talk big picture about what your experience has been like, what your thoughts on the role and then we'll go into the business.

Brice Hill

Great. Yes. Thanks, Joe, and thanks for hosting us here. It's nice to be here. Nice to see the interest in Applied. So, from an industry perspective, we think that the world has recognized how important semiconductors are. You see that with all the government programs and incentives going on. And when I joined Applied, I was interested in understanding more about sort of the engine of innovation and how it works on the leading edge of transistors and semiconductors. And that's – recently, we made some product announcements.

You could go to our website. You can see some of the technology. That's really what you invest in when you invest in Applied. We've got a footprint that works collaboratively with the customers to identify leading innovations that are required to push technology 5, 6, 7, 8 years in the future.

And so what you're investing in when you invest in Applied is that group of PhDs, that footprint of R&D globally, the patents, the knowledge that allows the company to identify with customers, new innovations, 6, 8 years down the road that will push the edge of technology. And I think our recent announcements in the Sculpta tool is a good example of that, gives you an idea of what type of technologies come out, where they – how they push the leading edge.

And the engine of the company, it's something I was interested in seeing because I was worried before I came to the company that Moore's Law might be slowing down, but what you see internally is just a long pipeline of continued innovation where we can continue to make transistors better, to make transistors more efficient, and really push the edge of technology so that we can get more GDP growth, more productivity growth, and allow humans to sort of bridge the gap between – you see in the U.S. where we have a gap between labor and jobs needed.

Technology is one of those gap fillers. We'll be able to do more with less. And that's why I think the company is important, what we do is important, and the business model is very efficient and effective.

Joe Moore

Great. Well, there's a lot to unpack there. I think maybe we could start-off with the nearer term. You just reported really good numbers. And I think, I guess, help us put those into context. A lot of companies are having a good, kind of December quarter, March quarter because they're, sort of catching up to the level of demand that they were unable to ship prior. You guys, kind of in contrast built backlog in the January quarter. I know you're going to bring it down in the April quarter, but it seems like you're seeing generally a better trajectory than some of the peers. Can you just talk to some of the reasons for that?

Brice Hill

Sure. So, the thing we tried to highlight in our recent earnings, our Q1 earnings, is that every quarter we go through and we scrub our book with our customers. So – and there's a lot of movement in our bookings. And overall, our backlog did rise in the quarter, as Joe said. And there was tons of movement there, pushouts, cancellations, mainly on memory and leading edge that we saw during the quarter, but we also saw a lot of strength.

And what we tried to communicate and emphasize is that in Q1, our material process technologies, what Applied calls the ICAPs end markets, so IoT, communications, auto, power, sensors, things that are built on 10-nanometer node and larger, if you will, those markets grew. They grew very quickly last year and they're actually accelerating this year. And that growth was strong enough to actually offset some of the weakness we saw in leading logic and memory.

And then focusing – drilling down on the backlog for a second. We still have several business units that are trying to catch up to orders that we had from 2022. So, it will take us a few quarters to catch back up and it's really just been the supply chain issue, navigating supply chain. We've talked about semiconductor chips in the past that have constrained us. There's been many other components because of COVID, because of COVID shutdowns, because of transportation issues, over the course of the year that we've been working through.

And so, our backlog did increase because of the strength primarily of the ICAPs business. As we go forward through the year, we'll expect that to come down as supply chain continues to get more healthy, and we can catch up on those orders that we're really trying to catch up to that some of which are from last year.

Joe Moore

And why is it still a couple more quarters to resolve those issues? It seems like at least the semiconductor supply chain part of it seems like it should be right now quite a bit easier, but how much of that is, sort of more – some of the other lingering issues? And how much of that, when you talk about stuff that's in backlog, is already being assembled on the customer floor and things like that?

Brice Hill

Sure. So, on the last question, we don't have an enormous amount of what some companies called deferred revenue, where we have mostly completed equipment at customers. We have some that's not going to be a big revenue driver for Applied. But to your point, that's the way we manage. If we're missing one part in a tool, we will complete the production of the equipment, except for that one part. And then when that one part comes in, we'll ship it and qual it with the customer.

So, I think what's happened with the supply chain in general is with the growth of the industry over the past few years, Applied has doubled over a 5-year time frame. There are some suppliers and some tools that have grown faster than the average rate. And in some of those tools, there are components where there's multiple of those components in a tool.

So, you may be a supplier who's not seen a [doubling] [ph] in 5 years, but you might see a quadruple or even higher in 5 years. And so getting your entire supply chain to upgrade their capacity at the same speed as the industry has grown and Applied has grown, it's just a big lift because we've got thousands and thousands of individual components in one of the Applied tools.

So, we're still catching up to this and – but the slower environment overall has allowed some of the suppliers to begin catching up. And that's why we say, depending on the business unit, 1 to 4 quarters should get us there.

Joe Moore

Great. And then in terms of the year, I mean, you guys have, kind of gone away from forecasting WFE, but you've talked generally about memory being down, ICAPs being up, maybe foundry down a little bit. It doesn't seem like you're far off from the, sort of consensus or like a mid-70s type of WFE a year?

Brice Hill

Well, it's hard to say. So, the reason we didn't do or say WFE or communicated WFE is just with the strength in orders and the growing backlog, it's difficult probably for us to see the raw signal that we're still working on. For us, this is customer service and trying to catch up to what the customers are asking us to deliver right now. We still feel behind.

So that's what we're focused on. But from an investor perspective, what we tried to communicate is just what signals are we getting now. So, backlog is one signal. When we look at our – we talked about the movement in backlog, which end markets were strong, which end markets were weaker. We talked about utilization. So, when we look at the different markets, memory utilization was lower, speaking across all the different factories that we monitor from that perspective. Inventories were still rising in memory.

So, we could see that. In leading logic, utilization was also lower. But in ICAPs, utilization was normal. So, those are the things that we can see. So, what we try to do, Joe, is just communicate what are the real-time signals we have in our business. And then hopefully, the investors and analysts will help, sort out where WFE is.

Joe Moore

Great. And with the first couple of cap equipment sessions like this I did, I didn't really ask about calendar 2024 because I feel like the answer is, always it's kind of early, but people have asked the question. So, it seems like there's interest. Can you talk to that? And I know you have a view of $1 trillion industry end of the decade, supporting well north of 100 billion WFE, but what does the path to that look like? Can you – is it too early to talk about 2024 being up or down?

Brice Hill

Well, it's definitely early to talk about 2024. We do expect that at some point, because that long curve, we forecast a $1 trillion semiconductor industry in 2030, we expect Applied to grow faster than the industry overall because as we think the overall semi-cap intensity level relative to that semi-revenue will be flat or up. We think that the equipment required it will be more complex because the technologies are more complex as they go.

So, that's an adder for us from a growth perspective. And then we think there'll be more materials engineering innovations in the mix of technology. So, just like the Sculpta tool that was announced, there'll be more of the things that Applied does to help move forward the process technologies over the next 10 years. And so, those are all adders that tell us we used to grow faster long-term than the semi-cap industry or semi altogether.

Now, within that, picking 2024, we don't get – we're still early to get raw signals for customers, but we do expect at some point, the memory – there will be a recovery in memory. We think leading logic is a consistent demand that we expect to be stronger than it is this year. And then the ICAPs, we expect to be stable demand going forward. So, within that mix, we'll have to figure out.

Joe Moore

Sounds like up, you didn't have – there was no downs in there. Okay, cool. Can you talk a little bit to China and both from the perspective of your original assessment of the impact of the export controls was 2.5 billion, I think, but you talked about potentially mitigating some of that? What's that been like? And then it seems like generally, there has been strength in China in the areas where people are allowed to spend principally ICAPs, and things like that. Can you talk to both of those effects?

Brice Hill

Absolutely. So, when the new trade rules came out, we anticipated a 2.5 billion unmitigated – 2.5 billion on mitigated impact to Applied for FY 2023. And we said also that if we are effective at mitigating it, we'll get it down to $1.5 billion to $2 billion, sort of mitigated risk. We think we're right in that range. And if you say what's happening? Well, what's happening is we're doing diligence with our customers that should not be blocked.

So, there are some customers that aren't running a leading-edge technology, they're not affiliated with an entity, they're operating independently and so we go through an assurance process. We go through a diligence process with these customers. We get a letter of assurance. We also benchmark with our peers and we also communicate our decisions with the government.

And so that's a lengthy process, but what happens is we've been able to unblock customers that shouldn't be blocked for the trade rules. And that brings down that unmitigated impact to a lower level, which we've been effective at doing. So, I'd say we're right in that range of probably $1.5 billion to $2 billion, less demand from China customers than we would have anticipated before the trade rules. And then the signal from China, you're right.

When you look at Applied's revenues for Q1, I think 17% was China. And so, it's still a very strong business for Applied and almost all of that business, except for our services business and a little display, almost all of that business is our ICAPs business. So, you see Chinese companies that are investing in primarily 28-nanometer and more mature nodes to build their own foundry business and their own ecosystem on all the chips and all the end markets that we talk about with ICAPs, and that's what's underway.

Joe Moore

Great. Yes, I mean I've known a lot of the Chinese foundry companies. I'm still seeing names that I don't know really well that are placing pretty big orders. So, it's a lot of activity. Can you talk to the multinationals in China? They have a rule where they need to get a license from commerce to get tools. They immediately got those licenses. They're getting assurance that those licenses will be renewed at least one time, but none of us know who the President is going to be in 2 years, I would think that there's a little bit of hesitation to make those investments. Given that backdrop, that 2 years from now, they're going to need to get a renewal of a license.

Brice Hill

Well, I think location is a question mark. And I don't have new information on this, so I don't have any new information about whether there'll be more grants of licenses or not, but what we will – the way we think about it from an Applied perspective is, we never expected there to be incremental capacity in China that isn't used or incremental capacity anywhere in the world that isn't used. Even when we look at government incentives, we don't think people are going to build factories and underutilize those factories.

The incentives aren't strong enough. And so for us, there's not a difference in the demand signal. If a multinational company cannot put that capacity in China, then they'll put it somewhere else. And so, we're not making a trade-off from that perspective. It's just a location issue. Yes.

Joe Moore

Great. Okay. In terms of advanced foundry, you talked about the, kind of arms race to 2-nanometer and the Applied's positioning there. Maybe if you could start with the Sculpta announcement from last week, kind of describe for us what that does and then just generally speak to as you think about these new structures gate-all-around. Is Applied well-positioned to take advantage of that?

Brice Hill

Well, we definitely think so, and that's what I tried to point out in the beginning. When you invest in Applied, you're investing in this collaborative relationship with customers where our PhDs and our R&D teams are working closely with the customers to think about nodes that are 4, 6, 8, 10 years in the future, what innovations are most difficult. That's what we've been working on. That's what we invest our R&D on. And then you monitor that as you go and you get signals whether you're succeeding in the R&D and whether it will be implemented and implemented in time to run real product from third-party customers that are doing designs. So, that's the cycle.

We talk about investing in inflections. That's the way we've described those innovations. So, the company talks about interconnects and wiring. It's got a lot more difficult to provide all the wiring that go on top of transistors and connect the transistors for power and signal that's become tighter and tighter and tighter. And so, we have innovations that make that much more power efficient and much easier for designers.

We talked about new transistor types like gate-all-around. We think we do have a strong position in the tools required to actually make the device. So, we think we'll gain share with gate-all-around and customers will deploy our tools. And there's future innovations like backside power that the company has talked about. That's another way of removing some of that nest of interconnects and putting it underneath the transistor instead of on top of the transistor.

That's another way of allowing more room for transistors that we're innovating on. And at some point, that will be part of the road map for customers, and that will be another area where we expect to gain share. And then on the Sculpta tool that was announced, that's a particular type of technology that allows a customer to change the shape, elongate the shape of a pattern that they have in silicon. And so, if they have a circular hole, a via, and they want to expand that to make it more oblong, they can do that with this technology.

If they have a trench and they want to just extend the line of the trench to be closer to another line that you're going to fill and make essentially interconnect or wiring with that, that this tool allows you to do and what it – it's an example of materials engineering. It's an example of a tool that will allow customers to hopefully, with high yield, avoid a second pass of litho if that makes sense in a process for them.

And we went through the math on that and say, for a customer, they will look, we think they will look at places where they're doing multi-patterning, which is very difficult with litho. And in some cases, we expect them to be able to use this tool to accomplish the same goal with hopefully a really good result from a yield and cost perspective. And so, that's an example of the company.

We articulated that we've been working on that tool for 6 years, and you have evals with customers for a long period of time. So that gives you a little bit of insight into what's really happening with our collaborative R&D, and we had two customers come out with us in the announcement and say they think this will be an important technology for them. So, it's just a good example of the way the machine works at Applied.

Joe Moore

Yes, you had the quotes from Intel and Samsung. So, obviously this is not just an academic exercise. There's real demand here. This kind of announcement, I think in the stock market since pitted you against ASML a little bit. And I feel like it's, kind of forced everyone to take a stand one way or the other. It feels like you've been working on it for 6 years. It feels like there's obviously going to be instances of double patterning on EUV.

There's also going to be areas where you strive to do it more economically. So, it feels like this is kind of part of the continuum rather than something where we woke up last week and suddenly the ASML opportunity has shrunk, although it also seems like a great opportunity for Applied. Is that a fair characterization?

Brice Hill

I think it's absolutely fair. The customers, like I said, have been evaluating the technology for a period of time. This is no secret. We've been working on this. So, I don't think – you're right. You can't imagine a situation where this is a shocking announcement and customers are replotting their plans. That's not happening. They have their plans for technologies. They've been evaluating this tool. They'll have places where they plan on implementing this tool. And from that perspective, it shouldn't be disruptive.

Joe Moore

Great. Great. ICAPs, I think a lot of people have been somewhat skeptical that after the, kind of two years of significant strength that, that would persist. I may have been one of those people. At the same time, we're now hearing Texas Instruments describe a much higher capital spending regime for the next 3, 4 years, somewhat geopolitical in nature.

We talked about China being strong. There's areas like silicon carbide, where there's kind of a gold rush to get in front of some of these big trends. So, it does feel to me like there's a lot more reason to think that ICAP is sustainable. Can you talk about how Applied thinks of it and how flexible can you be for different scenarios?

Brice Hill

Sure. So, we do think – so last year, we talked about significant growth in ICAPs. And this year, it's accelerating. And when we look at those end markets that are underneath that, people have talked about the EV market, electric vehicles, people have talked about the power market where installing electrical vehicle chargers, putting in renewable energy plants, these require tons and tons of power chips as an example, as well as other electronics.

When we think about sensors, for factories, sensors for phones, and then all the compute that goes with those sensors, that drives demand. We just tick through each of the end markets and then we look at companies that are customers that are making analog chips or making RF chips or making power chips, and we see more demand. And when we look at the third-party forecast for those end markets, every single component on the list is forecasted at either 6%, 7%, 8%, or 9% growth for the foreseeable future.

And so Joe, then you go back and say, okay, well, what's happening from a capacity perspective because a lot of those companies didn't use to invest at a high level of capital. And what we think has happened is if you go back 10 years to 20 years, we think there were a lot of 200-millimeter factories and a lot of perhaps memory factories that had equipment that became available on the market and some of these ICAPs businesses could absorb that equipment and absorb those factories and avoid spending capital at sort of a normal intensity rate, maybe 10% or higher.

And as we go forward, our expectation is the end companies that are building those products in those markets when they're investing, they're going to have to invest at what used to be the intensity level for leading edge, probably in a low teens perspective to build new plant and equipment for those businesses. And so, if you believe in the 1 trillion and you believe the ICAPs markets that are going to go along and support that compute demand then those companies will have to make those investments in order to deliver those products.

Joe Moore

Great. Thank you. And then in terms of memory, the – it seems weaker. I've been really bearish on memory since July. And I'm continually surprised by how challenging the end market conditions have become, but you still talked about it. I think on the call, you sort of said it could be better in the second half. You said, during this conversation that you think it could be up next year. What makes you think that? And I guess, I know it's always kind of darkest before the dawn for these types of things, but what gives you confidence that memory will – I feel like it's bottoming out, but it gives you confidence that it will resume in terms of bounce back?

Brice Hill

Well, on the second part, what gives us confidence that it will resume. I mean I'm not a system architect, but I am aware of no fundamental changes in the need for memory or in the architectures of systems that I'm aware of that would change the balance of memory versus logic. In fact, when you think about AI and you think about some of the new machine learning capabilities that are expanding quickly, you need a lot of memory to run those models and store the information from those models. So, it seems like it would be more intensive in the future.

So, our belief, at least the reason it's logical is the balance that we used to have. I don't think anything's changed in that balance. So that should come back. Now, when we look at our macroeconomic signals, I think I mentioned we see memory prices still declining. We see inventories increasing and we see utilization in the factories going down. So, at the very moment, it hasn't turned.

When Gary made the comment in our earnings call, I think it's anecdotally with the community and the semiconductor memory companies as you said, we're getting closer to that point where you'll normalize the inventory system and pricing will normalize. And so, it's impossible to call exactly when that point will be, but because of that long-term demand, we think it will turn and anecdotally, people are expecting that later this year.

Joe Moore

Great. Thank you. So, I'll ask one more question and then we can open it up to the audience. The services business for you guys has been really good. And I think it's increasingly a focus as there's anxiety about the tools businesses. I think I've, sort of noted that all 5 of the big public companies are talking about services growth in excess of the installed base.

So, obviously, that's partly because everyone is trying to grow that, but can you give us a sense of what that looks like when you're trying to expand the scope of that business. Where is that spending showing up? Why are customers more willing to spend money servicing those tools than they were historically?

Brice Hill

Well, it's a real – the way we look at it, Joe, is a win-win. And so, there's the business component of this, which I'll describe for a second, and then there's the investor perspective of this and what it does for the company. But on the services side, it's a pretty basic equation. If we can provide more uptime, more yield, more availability of spare parts and more expertise in servicing equipment then it can be a win-win for customers because we've got the scale.

We've got the knowledge. We train our employees. We've got a larger network to buy those spare parts inventory, deliver those on time. So, when a customer signs up for services, sort of the base level is a more confident access to parts and maintenance. And as they go up the curve from the types of agreements that we have, they can scale that upfront to actually running the tool better and using some of the data that we have available to essentially get better yield and better output from the equipment.

And depending on the customer, that can be extremely valuable and that's what we work on is, building the strength of that network to provide the availability of parts, building the strength of the engineers that do that work so that they have the technology and concepts to provide to the customers and then also providing information to help tune the equipment so it operates at a high level. That's, kind of the pyramid from our perspective. And then from a business perspective, what's interesting about our services business is it's on a different driver.

So, the equipment business, it's semi cap and it's – our company's building factories just like we were talking about. In the services business, we have 45,000 tools in the field. Every day that we ship a tool, the installed base grows. So, it's really driven off that installed base and the installed base getting larger. We have an opportunity to sell transactional spares to that. And then for a lot of customers, they want that higher level of service come help us run the tool and get better yield, which is what we focus on.

So, we think it's a real win-win. And then financially, that gives us a stable cash flow because a lot of those are subscription agreements that we have with customers. And again, it's on that growing installed base. So, it's just – it's almost like having a different type of business within Applied than the semi cap business.

Joe Moore

Great. Thank you. We have time for one audience question if we have one, up in the front.

Question-and-Answer Session

Q - Unidentified Analyst

Good morning. I have a question on Sculpta. So, you announced that Intel and Samsung liked this tool, but I was wondering if you can explain [Technical Difficulty], whether they also test it. And if they don't mind they are not [Technical Difficulty] Samsung and Intel? Thank you.

Brice Hill

Sure. We think that all the customers will test this technology and evaluate this technology. And from our perspective, it's a good opportunity. I think some companies were in the position to desire to be part of the announcement and some companies maybe don't want to make that choice. But we think it will be evaluated by all customers.

Joe Moore

We have time for one more question? Right. I'll go forward. Maybe with the services, can you talk to this year the impact from utilizations coming down? And can you talk to the impact of export controls on that business? What are the prospects for growing that business with those headwinds?

Brice Hill

Great. So, first of all, export controls did impact that business. We said $100 million per quarter is what we expected. So, we just saw the services business in a quarter that lower than the prior quarter, and it was really because of that impact, although we made up some of that ground. As we clear some of those companies and unblock that, that will make that impact smaller as we go through the course of the year.

And we did say that we think that despite that setback from the trade rules that we'll be able to grow the services business this year. And then again, just going back to the logic, we expect that footprint of tools to continue to grow. And so that installed base will give us a TAM to sell against, and we'll continue to grow that business over time, and we set at low double-digit rates.

Joe Moore

Great. And we appreciate you giving us a good segmentation on that, that doesn't include other stuff. So, thank you for that. All right. Great. Well, Brice, we'll wrap it up there. Thank you so much for your time today.

Brice Hill

Thanks, Joe. Appreciate it. Thank you.