Applied Materials, Inc. (AMAT) Presents at BofA Securities Global Technology Conference (Transcript)

Applied Materials, Inc. (NASDAQ:AMAT) BofA Securities Global Technology Conference Call June 7, 2023 4:20 PM ET

Company Participants

Brice Hill - SVP and CFO

Conference Call Participants

Vivek Arya - Bank of America

Vivek Arya

Welcome to this session. Really delighted to have the team from Applied Materials, Senior Vice President and CFO, Brice Hill joining us this afternoon. I’ll go through a list of my questions. But if you have anything you’d like to bring up, please feel free to raise your hand. And I’ll be sure to get you in.

Brice Hill

Thanks for hosting, Vivek.

Question-and-Answer Session

Q - Vivek Arya

Welcome, Brice. Really happy to have you here. So, maybe let’s start at the top. Maybe give us a State of the Union, what’s going well, what’s different than what your assumptions were at the start of the year?

Brice Hill

Well, I see a lot of familiar faces. So, maybe people know some of the story already. But this year for Applied, it really emphasized the strength of a broad portfolio for the Company. So, people have known our services business in the past, helps give us breadth, our wide portfolio selling to both memory segments, selling the leading logic. The other thing that’s been driving this year is our exposure to what we call the ICAPS business. So the mature process technologies that power IoT, communications, auto, power, sensors. And that business has been so strong this year that it’s been able to help the company offset the weakness we’ve seen in the memory market and the leading logic market.

So, when we think about the dynamics, even looking forward, we expect that ICAPS business to still be strong and we can talk more about that. It’s a global phenomenon. A lot of people have asked us whether it’s just a China customer phenomenon. It’s global, it’s public companies that are having to invest in technologies. There’s multiple geographies that are growing faster than China.

So that business we feel has real durability and it matches to underlying demand trends in the market that we think are stable and long-term. But that’s been the story of the year, Vivek. It’s really since there is a good portfolio coverage across broad markets, where we’ve had weakness we’ve seen some offsetting strength and that’s been good for the Company.

Vivek Arya

Makes sense. One thing on just this one metric that we all kind of relate to Wafer Fab Equipment, WFE. Some of your peers have given very specific numerical, I guess, kind of a range, one said low-70s, one said kind of mid-70s. Applied has been hesitant in giving a specific point estimate. What is the reason for that?

Brice Hill

Yes. I think there’s two dynamics that make our business this year look different than any of the peers. I mean, every company has a different perspective on the market. But for us, the strength in ICAPS may have been different from other companies are seeing, as the Company four years ago set up that division has been sort of focused in selling into those markets.

The second thing is, it’s sort of bad news, good news. The bad news is we’re still trying to catch up to orders from last year. And so, we’ve had the tailwind this year, if you will, is still servicing business, because our catching up the supply chain, where we had orders for last year. So, those two things sort of distort what we’re seeing as revenue for the year versus maybe what other people are seeing. So, the strength of ICAPS and the tailwinds of last year’s business.

If you annualize our first half, I think you’ll get something in the high-80s. We’re not saying that’s representative of what the market is. You kind of have to sort out those impacts. And, so we haven’t sorted that out. And when we think about the full year, and even into next year, we feel ICAPS will continue to be strong. We feel display will get better. We feel the services business will continue to grow. What we can’t really call is leading logic and memory, because that’s more exposed to macro factors and inventory digestion in those markets. So, we just haven’t put a number on it.

Vivek Arya

Got it. So, you mentioned ICAPS a few times, right? That’s certainly a very important part of Applied’s portfolio. Talk to us about what makes your portfolio more unique? Is it just that as a percentage of sales it’s a higher mix, or is it something more unique to your portfolio versus -- because many people sell right trailing edge tools. So, what’s so special about Applied’s portfolio?

Brice Hill

Well, I think for the Company, they started the business group four years ago, ICAPS, and we’ve invented more than 20 tools, new tools in the space in the course of those four years. So, I don’t know if there’s anything that’s uniquely beneficial for Applied, other than focus. We’ve been focused on the market, we have focused sales teams. We have focused development plans across the different business units. And that’s allowed us to, A, understand that this market should be growing and B, develop solutions, specifically for the market. And we do think it’s accretive for us on a share perspective, as that market grows.

Vivek Arya

Got it. Now, this is also the place where you’re capturing the need of the market extremely well, because these were the places where there were the most shortages. But how are you making sure that there is the right level of utilization of these tools that some customers are not just buying and holding them and not actually putting them in use? Because I’ve heard of some scattered examples where, they ordered tool, because there were shortages. Now they have them, but they just haven’t put them in operation yet.

Brice Hill

So, that’s a good question, and we’ve had the question, are customers warehousing those tools, are they preordering them too far in advance. And what I can tell you is because we differ the install revenue for those tools and then we help with install, we track that for our equipment. And we do not see that across our tool set. We see it being installed in a reasonable amount of time. And we’re not aware of any pools of equipment or warehousing of equipment that isn’t being utilized.

Vivek, one thing that we think -- and this is more intuitive than data, but we think that the equipment being installed in China is likely operating at a lower yield. It takes a while to get up to world class foundry yields for anybody that’s putting in new process technology. So, we think part of what’s happening is, there’s a long list of customers in China, in some cases, they’re new to the business, it’s going to take a while for them to get those yields up to world class levels. And so, there’s probably some inefficiencies there in the equipment base. But going back, we don’t see the hoarding or inventory of the equipment.

Vivek Arya

That’s a very good point that you can track, right, to as much real time as possible.

Brice Hill

We do.

Vivek Arya

Do you have the same install kind of attach in China also, or is it only in the west that you have the same…

Brice Hill

No. We have the same.

Vivek Arya

So, you have the same insight?

Brice Hill

Same insight. Correct.

Vivek Arya

Okay. That makes no sense. And then the second part of ICAPS you mentioned is that you see this trend as being sustainable, right, over the next few years. So, what are kind of the leading indicators, what what’s giving you the confidence that it can sustain/ Because this is one of the biggest push backs, right, against this part of the business.

Brice Hill

Well, this is one part we’re not surprised. We were surprised by the magnitude last year and this year, but we’re not surprised by the trend. Because we think power -- I think, one of our estimates is by -- if we have a $1 trillion market in 2030, we think 9% or 10% of the semiconductor chips are going to be powered chips. So, that’s a significant market. Electric vehicles, electrification in general, green power solutions, all of these, plus analog, plus the build out of IoT, which in a lot of cases is video sensors and video processors, that’s one of the largest runners, we understand how those are being deployed. We see the end markets growing. We know from public company documentation of why they’re building factories and why they’re investing. Basically, all those things fit together for us. So, we do not think -- can always be surprised, but we do not think what we see in ‘22 and ‘23 is a cliff of some sort and unrepresentative of the end market.

Vivek Arya

So, you would not be surprised to see the trailing edge market opportunity grow next year?

Brice Hill

Next year is a question, we’ve said we think it’s stable, because it’s grown a lot the last two years. So, what we’ve said is relatively stable next year, in terms of it’s still that size. But if you stretch that horizon out to 10 years, all of the device types that we just talked about and that are in the ICAPS space, the forecasted CAGRs for those device types are 6%, 7%, 8%, 9%, depending on the device type, by third-party estimates. And what’s happened is, the reality is there’s just no longer, companies have run out of brownfield space that they’ve had that’s been expandable. They’ve run out of used equipment to buy, so they’re having to put new equipment in place to serve greater and greater demand as that semi demand continues to grow.

And we think, where does that money come from. Because you can have semiconductor business grow faster than GDP forever, but we still think is providing productivity. And so it’s shifting real resources from other areas to semiconductors.

Vivek Arya

Got it. One thing you mentioned on the last call was some push-outs on the leading edge side. And then a few days later we saw, right, a large foundry mention that CapEx would be at the lower. So from that perspective, I guess, it wasn’t that big of a surprise, right, because you have already kind of baked that in. But given all the excitement around AI, do you think that leading edge from this point onwards is a little more sustainable, or you still think that AI is a lot more hype and it’s as accretive to the business in the near to medium term?

Brice Hill

Well, we definitely think it’s a tailwind, for sure. I was recounting with a few people here today. I mean, it’s come upon the consciousness pretty recently. I think it was February, Meta put out their model, and then March, the OpenAI announcement was made. And then there’s been tons of innovation and experimentation since then. So, I think the industry is still digesting what is this going to mean from a system perspective, from the individual chips that scale into these systems. But we absolutely think it’s a complex workload, it runs on leading edge, it’ll drive cloud and data center. It’ll drive new solutions in terms of accelerators and GPUs and CPUs. There’ll be a lot of innovation to optimize these workloads. So it’s a positive. As far as you know, what’s the net effect over a long period of time, it’s hard to say, because it’s a positive by itself, but it also adds a lot of productivity to semiconductors. And so, in a good way, it can help make semiconductors more efficient and more productive, and basically improve the benefit and lower the cost of semiconductors, if that makes sense.

Vivek Arya

Got it. No, absolutely. We had the team from Synopsis and Cadence yesterday, and I think they kind of -- they made the same point that -- but does it mean that money gets taken out of the WFE by -- and goes more into the upfront design side, because it’s more effective to do it there or it’s too early…?

Brice Hill

It’s a good question. It’s way too early to call. And so, then the question would be, well, if you make the -- by definition, if you make the leading edge semis and cloud more efficient and more productive, then do you use more of it or less? I don’t know the answer to that. But I just -- I think we have to be cognizant that it’s doing both things. And I would just say it’s exciting. It’ll be a whole new path of innovation. I sort of believe in some of the end user models where you’re going to get -- we’re personally going to get more productivity from some of these solutions. And so, you’ll be willing to pay more for the software that includes those things. So, I think it’ll be a real driver. And then, whether we eventually change our $1 trillion into 2030, up or down, I don’t know.

Vivek Arya

On the memory side, that’s been the real, I think, problem area for your customers this year. What’s the visibility right now in terms of when memory utilization can start to improve? You think that’s even possible in ’23, or one should defer that to ‘24?

Brice Hill

Well, it’s certainly possible in ‘23. Since we work with memory customers, we track utilization, we track inventory levels, we track prices, as they -- spot market prices and other things. And one thing we would say is looking back into our last quarter that we just reported, all those trends are still moving in the wrong direction. So, if we’re at the bottom or if it’s turning, at least it wasn’t turning last month. We didn’t see that yet.

Now, having said that, we said in our earnings call, when we look forward multiple years and we think about the WFE market, we think the WFE market will be two-thirds foundry and logic and one-third memory. And it’s less than that right now. So by definition, we do think memory should come back up to get into balance with foundry and logic. And we do think what will drive that even in the medium-term is company’s customers will continue to upgrade their nodes in order to get the bit growth that’s required.

One of the things we recently looked at is just the wafer starts across memory over the last number of years, say five to seven years. Wafer starts have increased at a very low rate, maybe 1% or 2% per year. So the way there’s more bit growth is those companies upgrade their processes, the processes deliver more bit density and that’s what provides enough bits in order to service the increasing -- the ever-increasing demand. And so, then you say, well, if they don’t need any wafer starts, then what is Applied doing? Well, what -- the way they’re getting that bit growth is they’re upgrading their process technologies to the next node. And that does take a reasonable amount of capital investment and equipment investment to make those upgrades.

So, we think actually, that dynamic has been in play for a number of years. And so, we’re expecting -- I guess, at the end of the day, we’re expecting that market to improve. Calling the moment, it’s hard to call the moment.

Vivek Arya

What’s historically been the nature of the memory industry? Does it give enough of an early warning? Like, let’s say conceptually, if it were to turn, three months from now, would you know it now, or you find out that, oh, it’s just going to turn up in the next month? Like, does it give you that kind of early…?

Brice Hill

I personally don’t think so. And I don’t have as much exposure to memory as I do to logic. But I -- what I do know is the people in a company that are thinking about building factories and buying equipment, they have a two to three to four year horizon in making those decisions. You -- of course, it’s a factor what your current utilization is and what your current market is, but you really have to be looking down the road. And so I think it’s relevant but it’s not definitive as to how they’re going to make their equipment purchase decisions.

Vivek Arya

And just the last one on memory DRAM versus NAND, do you see any differences? Because you’re more indexed to DRAM, which, by the way, has better correlation with AI and compute, than NAND does.

Brice Hill

I guess, I would say, no. I just looked at the pricing curves, I just looked at the utilization. It’s hard to point -- in fact, the only difference that I can talk about or recognize is that the NAND market seems to be much more depressed than DRAM. And so, I don’t really understand that. I don’t think there’s a system architecture change or something that’s really driven out. So, it must be unique to the business in terms of inventory or something that happened. So, we would expect it to improve and get back into balance, but hard to call the time.

Vivek Arya

Understood. Applied also got approvals to ship incrementally more to China. Can you give us more color on what those approvals were for? And, importantly, is this now the new baseline of that China engagement? So whatever China WFE is, you can then grow with that, or are these like one-off type of rules?

Brice Hill

Okay. So, there’s been a clarification on what process you’re allowed to ship to in terms of DRAM. And that’s really what that changes. And so, we should have some business in the second half of the year that has been held up. So, like I talked about, in the first half of the year for us, we had 22 orders that we’re still trying to ship and catch up to. This will sort of, I think, be the last part of this where we had some DRAM business that we couldn’t ship that now we’ll be able to ship. It’ll take us, again, a little time to catch up to that. But that’s a clarification.

Then, as far as the overall process with rules, we have a number of licenses pending, we have a number of places where we’re working to clarify specific factories or specific companies, whether we can ship to them. So, I think this is an ongoing process with the government. When we started the year, we said there was a $2.5 billion impact to Applied from the change in trade rules in October. We’ve probably got that down to a $1.5 billion now by clearing customers and putting -- taking them off the block list, if you will. We do that by our own diligence. We get assurance letters from the customers. We compare notes with our peers. We share that information with the government. So, it’s a whole process to get there. But there’s been a lot of action and a lot of improvements since it started. But I would say it’s still work to do.

Vivek Arya

Now, backlog levels are still quite elevated, right, for Applied and some of your peers as well. What’s driving this behavior? Because I would have assumed that your lead times would have come down as there’s been this push and pull in demand. So, what’s keeping backlog levels still quite elevated?

Brice Hill

Well, I think it’s really important to separate those two things. So lead times have come down. I think if customers call us now, for most of our business units and ask us to order a tool fast, then we’ve got a shorter lead time, it’s almost back to normal from that perspective. So that’s a good thing. And we expected that, because of that, when we were talking last quarter and the quarter before, we expected our backlog to come down based on that dynamic. It really hasn’t come down, it’s remained elevated. And so, what’s happening is, customers are giving us a longer view of their demand than they gave before. So, we have visibility and we have orders that are extending longer in time period, up to two years in some cases. So, it’s kind of a declining order pattern, if you will, as you roll forward each quarter visibility into that.

And we think it’s just -- I don’t know, if that’s permanent, it’s probably a consequence of when we were constrained. It would -- customers were concerned whether they were going to be able to get their equipment shipped to them. And so, that is sort of leaked over into now. So, it’s still elevated. It’s one of the reasons we don’t provide it in our calls. We don’t think that the backlog is the best indicator of the next quarter or the next business. We’ll report it at the end of the year, you’ll see the number but it’s just still elevated.

Vivek Arya

Applied Global Services, right, I think you -- the last I recall, you mentioned that you still expect that to grow this year? That has a 200 millimeter tools part, right, and then what is -- what one would describe as more kind of services and spares in support of tools? So, are both those growing year-on-year, or is it one growing…?

Brice Hill

Well, the services business, we removed a significant amount of that business, because of the China trade rule change in October. So, we said $400 million came out of that business by tools that were actually taken offline, that we can’t serve us anymore, and then we can’t sell spares et cetera into that. So I think under the covers, for sure the 200 millimeter business has grown year-over-year and it’s grown pretty significantly year-over-year, I think the services business is just short of growth year-over-year. Together its year-over-year growth as a whole. And then, now as we move forward, we’ll expect the services business to move into year-over-year growth. So, basically, it’s overcome the removal, its growth has overcome the removal of that business, and the fact that we’ve been able to clear some of those customers and get them off the block list has also helped cure some of that situation. But in general, what I would just say for people that aren’t that close to the services business, it runs -- its driver is the installed base. So, every day we ship a tool, even if we’re having a down quarter in semi, every day we ship a tool, it grows the installed base. We have an opportunity to sell spares and subscription agreements against those tools, offer insights as to how that customer can get it at high yields. So that drives on a different driver, if you will, then the equipment WFE.

And when we raised our dividend, just this cycle, we raised, the Board approved a 23% dividend increase. One of the things we were thinking about back was our services business is much more stable growth than the WFE because of that dynamic because the installed base is constantly growing. And so, we said, you know what, that can afford the entire dividend. Not only that, we could probably double the dividend over a period of years, which is our intent. And so, we kind of looked at it that way. And then, the WFE business is a little bit more volatile. So we said that will be primarily a buyback return model.

We didn’t tie them mathematically that way. But that’s conceptually how we’re thinking about it. And so, that services business is a really good anchor for the Company from a stability and profit returns.

Vivek Arya

No, I’m glad you brought that up. Very strong dividend announcement. I think it’ll help to kind of walk through why, because that’s even a faster growth than dividend growth, than I assume what your services business is going at?

Brice Hill

That’s right. We got a lot of feedback that some investors couldn’t invest in Applied because the dividend was lower than a certain level. And so -- and we think with that services business and the solidity of it, that we should have a larger dividend for it. So, we try to -- moving those things into alignment.

Vivek Arya

Are you targeting a certain yield or certain range of yield…?

Brice Hill

We haven’t said that. But I would just say -- what we said is, we should -- it’s an intent, barring any unforeseen circumstances. But we should do three more increases, at least in a similar range and get us to doubling the previous dividend that we add. And then, we’ll -- other information will come later.

Vivek Arya

Three more on a monthly basis or…?

Brice Hill

No, no, no. Each year, each year. Yes.

Vivek Arya

Then on gross margins, 46 to 47, they have actually been better than, right, some of your peers. So what’s helped maintain the gross margin? Is it something in the mix? And then what takes you to the target of 48.5?

Brice Hill

So first thing is, we had a glide path -- or I shouldn’t say it a glide path. We had a path to find to 48, 48.5. We’ve got hundreds of engineers working on cost improvements, for the things that we can control on the supply chain. We expect in some of our inflators, like chip price premiums, like expedite fees, because the supply chain challenges, those sorts of things, we expected them to recede.

And then we’re -- for the things that we couldn’t drive back, permanent inflation, if you will, those are the things we’re working on price adjustments on our products for to sort of share that with the customers. And those things all take time, the engineering programs, if you will, it takes time to design a new solution, then it takes time to qualify that solution with a customer. So that takes some time to do the price increases, that takes some time, and then actually to just beat back the inflation that can be beat back. So those three elements are kind of what I would focus on.

And then when we lost that China business, that China business was accretive. So that put us basically 100 basis points behind where we thought we were right. Now some of that has come back, which has helped us sort of be ahead of where we thought we would be. But if you’re modeling that, I think it’s going to be a slow improvement where that’s still our target 48 to 48.5 in the medium term. We think we can get there. It’s going to be reengineering products and it’s going to be price adjustments as we go.

Vivek Arya

And then Applied announces really interesting tool earlier, the Sculpta, pattern shaping tool. Can you give us an update on the traction with customers, so that there is one early adopter customer? When you see the largest foundries kind of adopt it also?

Brice Hill

So, we are shipping that tool for revenue. We do expect it to be at least $1 billion product for Applied. We think it’ll be in the years that it ships, in the next few years, we think it’ll be hundreds of millions. That’s what we said. So that’s really all the detail that we can offer. And for people that may not know, that is a tool that offers a litho like solution. And it can be an alternative for customers to define specific design shapes in a product. And so, a customer could literally decide whether using that tool or using EUV layer is the best solution for them. And so if they decide that they can use the Sculpta tool, then they can save a significant amount of money from not using an EUV tool on that particular layer. So, it’s a cost advantage. And it’s designed to give -- and its effect on the transistor design, it’s designed to give exactly the same output or result that EUV tool would, at least for that part of the project.

Vivek Arya

Can Applied achieve those kinds of growth targets, if the largest foundry is not yet involved in the tool?

Brice Hill

It’s a good question. I don’t think we’ve provided information. What we have said is we expect all of the customers to look at that as an opportunity and evaluate it. So, that’s as much as we’ve said.

Vivek Arya

Then on the chip side, it wasn’t interesting that -- Gary mentioned that when you look at the overall benefit, right, it’s going to be somewhat more modest than I think many, which I think is like the practical view. So, it would help to understand how Applied came out with some of those assumptions. Because when we look at the large customers announcing tens to hundreds of billions of project, why won’t a lot more of that flow through into WFE?

Brice Hill

Good. We think it’s location, it’s -- so our internal estimates are that those CHIPS Act monies and all the monies across the world, $400 billion right now of subsidies, they’re really deciding the location that customers will put their factories. We don’t think anybody’s going to build a factory like in advance, or just in case. We just think that if they had it on the roadmap, instead of building it in place A, they’ll build it in place B and take advantage of some of the subsidies. We do think the fact that there’s 3% to 7% of sort of lost economies of scale, because it’s in a different location than they wanted to put it. So, there will be certain types of equipment where they’ll have to have -- they won’t be at a perfect matched set, and they’ll need to have an extra tool. And we think that will drive some uplift, but not significant.

A place that’s slightly different where we could see some benefits is on the services side. To the extent that companies are putting factories in places that they’re not familiar with, or they don’t have an established workforce, they’re more likely to look at Applied services and have us help with getting the tools up to yield and help with all the transactional activities to keep that equipment running.

Vivek Arya

And then lastly, Brice, Applied has also announced R&D centers, materials innovation centers. How will they start to impact? I assume it’s -- these are longer term investments. But can you take advantage of some of the other provisions of the CHIPS Act, whether it’s on the investment tax credit side or other grant side?

Brice Hill

Absolutely. Thanks for bringing that up. It’s a big investment for the Company, that EPIC design center. We had a lot of customers with us at that announcement. It’s designed to accelerate development activity across the ecosystem. And so customers that previously might wait to get a tool from us before they have access to it and before they can experiment, now they’ll be able to be in the facility with us getting access to the tool and collaborating faster than what we would normally do. And so, that’s why there’s so much excitement about it. The numbers that we quoted, $3 billion to $4 billion, those are gross numbers. We will be applying for CHIPS Act funding. You saw the Vice President at the event. We think we’re very much aligned with what the government has in mind for CHIPS Act funding. So, we’re going to go through that process. And we expect to be able to get some benefits from that process.

And the other thing I would say is, from investor perspective, it will be a couple of years before you see any impact on the P&L. It’s a capital project, it’ll be capitalized as we go, and it won’t start depreciating until we put it into commission. So, it’ll be a while before you see that impact. Other than the CapEx, whatever we end up with as net CapEx that’ll, of course, be our investment. But the Company has grown a lot. If you look at our CapEx versus depreciation the last 10 years, you’ll see that -- I think depreciation might actually be a little bit higher than the CapEx. And so, it’s time we have to expand our lab space, we have to modernize some of it. So this is going to be a great investment for the Company and I think it will set us up for the next 20 years of growth.

Vivek Arya

Makes sense. Perfect. Thank you so much, Brice. Really appreciate your time. Thanks.

Brice Hill

Thank you. Very nice. I appreciate it. Thank you.