Applied Materials Inc (AMAT) — Q3 2016 Earnings Call Transcript

Welcome to the Applied Materials Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards you will be invited to participate in a question-and-answer session. As a reminder, this conference is being recorded. I’d now like to turn the conference over to Michael Sullivan, Vice President of Investor Relations. Please go ahead, sir. Thank you. In a moment, we’ll discuss the results for our third quarter which ended on July 31. Joining me are Gary Dickerson, our President and CEO; and Bob Halliday, our Chief Financial Officer. Before we begin, let me remind you that today’s call contains forward-looking statements including Applied’s current view of its industries, performance, products, share positions, profitability and business outlook. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements, and are not guarantees of future performance. Information concerning these risks and uncertainties is contained in Applied’s most recent Form 10-Q and 8-K filings with the SEC. All forward-looking statements are based on management’s estimates, projections and assumptions as of August 18, 2016, and Applied assumes no obligation to update them. Today’s call also includes non-GAAP adjusted financial measures. Reconciliations to GAAP measures are contained in today’s earnings press release and in our reconciliation slides, which are available on the Investor’s page of our website at appliedmaterials.com. Next, I’d like to remind everyone that Applied Materials plans to hold its 2016 Analyst Meeting in New York City on Wednesday, September 21. Those of you joining us in New York will have the option to attend technology sessions with our general managers. The main event will be webcast live. And now, I’d like to turn the call over to Gary Dickerson.

Thanks, Mike, and good afternoon, everyone. I’m very pleased to report that Applied Materials delivered record earnings in Q3. And with our orders also at an all-time high, I’m confident that we can beat this earnings record again in our fourth quarter. I want to thank our employees for all their hard work that has contributed to these outstanding results and their passion to keep raising the bar. I’ll start today by outlining the key factors supporting these record levels of performance and describe how our strategy positions Applied for sustainable long-term growth. I’ll also share our latest view on our markets and explain why Applied has a positive outlook for 2017 and beyond. I’ll conclude with brief updates on each of our major businesses. After that, Bob will provide additional details about our results and outlook. In both semiconductor and display, we see dramatic advances in technology taking place. We are in the early stages of large multi-year industry inflections that are driving growth in our business today and creating new opportunities for the future. First, foundry and logic customers are making significant innovations in transistors and interconnect for 10 and 7-nanometer devices. This plays to the strengths of our leadership businesses, including Epi, PVD, Implant, CMP and RTP, where we lead the industry with our unique capabilities and high market share. As customers move to 10-nanometer technology, the available market for these leadership businesses grows by around 25% compared to the previous node. The second key inflection is 3D NAND. This is a materials-enabled technology that significantly expands our addressable market with innovative new products we are providing customers with the advanced solutions they need for depositing, removing, and modifying materials with incredible precision. As a result, we are winning significant share gains as the industry shifts from planar to 3D technology. By the end of this year, we will have grown our share of total NAND spending by almost 7 points above our 2012 baseline. The third big wave of investment is China, which represents an important long-term growth opportunity for the industry. Applied has been working in China for 32 years and during this time, we’ve established the strongest position in the region. While the build-out of China’s semiconductor industry has only just begun, our semiconductor orders and revenue have already doubled over the past two years, and we’re on track for a record 2016. The fourth big driver for Applied is organic LED displays. OLED is also enabled by materials innovation, which makes our available market opportunity more than three times larger than for traditional LCD. OLED is the key for high-resolution, low-powered screens with faster refresh rates. We expect it to become the standard for virtual reality-capable phones and headsets. At Applied, our strategy is to develop highly differentiated materials engineering products and services that make new technologies possible. As our customers' technical challenges become more complex, it’s the breadth and depth of our capabilities that sets us apart. By building on these strengths, we are outperforming our markets today and creating a foundation for sustainable growth over the years to come. We are making great progress with all of the key elements of our strategy. In the past three years, we have increased the number of technologists and engineers directly supporting customers by 50%. This allows us to see inflections earlier and define winning products in a more repeatable way. Second, we have increased R&D to accelerate new product development to provide the materials innovations that our customers need. We have a strong pipeline of differentiated enabling technologies that are winning in the marketplace and extending our innovation leadership. Third, we’ve increased our focus on advanced service products. We are delivering more value to our customers, and as a result, our service business is growing to record levels. Fourth, we are successfully applying materials engineering beyond semiconductor. In display, we’re on track to deliver more than $1 billion of revenue in fiscal 2016 with significant opportunities for future growth. I strongly believe this is Applied’s time. We are performing better than ever, delivering new records, and in a great position to sustainably outperform our markets. There are a combination of factors that are contributing to our success. We identified large multi-year inflections early. We are making great progress with the major elements of our strategy, enabling us to unlock the full potential of Applied. We’ve made significant investments in our capabilities and products to extend our innovation leadership and we are executing well across the organization.

Thanks, Gary. In Q3, Applied demonstrated that we are growing faster than our markets and accelerating our profitability. We delivered the company’s highest earnings per share surpassing our record set more than 15 years ago. Gary talked about the strategies that are helping us to anticipate major inflections, deliver more valuable products and services and grow in attractive new markets. I’ll describe some of the benefits that our strategies and execution are having on our financial performance. We’ve put our services business on a growth trajectory and increased our display net sales by over 50%. We have significantly reduced our investment in solar, which is down from 22% of revenue to only 2% today. And we’ve increased our non-GAAP gross margin by 1.8 points. We’ve also cut our tax rate and reduced our share count. As a result of these and other improvements, we delivered a 32% increase in non-GAAP earnings per share this quarter versus Q2 of 2011. In Q3, we generated record orders of $3.7 billion and we now have record backlog of $4.9 billion. We’ve grown our semiconductor orders and backlog to the highest level in 15 years, and our display orders and backlog to the highest level ever. We’ve grown our service orders by 9% year-over-year and our backlog by 18% year-over-year. We’re also making excellent progress towards our 2018 financial model. We expect our overall net sales to be up by 15% to 19%, sequentially. Within this revenue outlook, we expect semiconductor systems to be up by 19% to 23%, sequentially, AGS should be up by 3% to 6%, and display should be up by 30% to 40%. On a year-over-year basis, each of our businesses is on track for strong quarterly revenue growth. Using the midpoints of our Q4 guidance, we forecast that semiconductor systems revenue will be up by 45% year-over-year, with AGS up 12%, and display up 80%. This earnings guidance represents a new record for the company and a doubling of last year’s Q4 performance. In closing, I believe our momentum is sustainable. Our Q4 guidance reflects how uniquely well-positioned the company is at major inflections, including in 10-nanometer and 7-nanometer, 3D NAND, OLED and the Chinese market.

Thanks, Bob. To help us reach as many of you as we can, please limit yourself to one question and feel free to reach out later if you have any additional questions. Let’s please begin.

Thank you very much. So guys, obviously, great quarter, and obviously big opportunity in display. I guess, I want to ask a question on SSG. So if I take the orders you booked last quarter and I take this quarter's orders, it’s about $4.2 billion. And if I use your SSG share model of roughly 22%, that implies that the overall WFE market is sort of run rating in the first half of roughly $40 billion. So that begs the conclusion that either this year is pretty front-half loaded or you guys are gaining a lot more share and that you’re going to end the year quite a bit higher than 22%, it has to be several hundred basis points higher than that. So, I guess, I’m wondering if you can comment on whether the numbers imply that the year is a little front-half loaded, or whether it implies that you’re gaining that much share?

Sure. Tim, let me see if I can help. In terms of the loading of the year, historically what you see is that the foundry is particularly good at the end of Q1, Q2 in terms of shipments and bookings. This year, it was later in the year, as you remember, so we’ve been strong in foundry as they’re wrapping things like 10 and early 7. We’ve gained share in memory, in DRAM and in NAND. For instance, historically, the last couple of years, we were about 38% to 40% for full-year numbers for foundry, but we were only about 37% in Q2. We’re up over 50% now in foundry in Q4 and Q1. So what you’re seeing is, we’re benefitting from secular improvement in Applied but also some seasonal strengthening in foundry.

I guess, what I’d add also is that in 10 and 7-nanometer foundry, we have – while our TAM is growing significantly, if you look at those two nodes together about 30%. We’re actually winning more market share also in 10 and 7-nanometer, and we’re still in the early innings of some of these new platforms that are being adopted. So overall, this is going to be a great share gain year for Applied Materials and we’re incredibly well-positioned going forward.

Thanks, Tim.

Thank you, and yes congratulations on the excellent results. Bob, you mentioned that you expected orders to remain strong in Q4 and Q1. Does that mean that we shouldn’t expect orders to decline from these levels? And I was hoping you could talk specifically around your expectations for display orders seeing them at $800 million here?

Sure. I think at the end of last call, when we had orders in Q2 of $3.451 billion, I said our orders would sustain, and that we would continue to have strong orders. In fact, we beat this order with $3.658 billion. I think Q4 and Q1 are both pretty strong. I’m not sure they’re quite as strong as we were the last two quarters, but they’re bigger than probably any quarter we had last year.

Thanks for taking my question. I just have a quick one. In terms of the 2017 outlook, Gary, you mentioned that the WFE is expected to be up year-on-year. Can you just provide us some color in terms of the overall spending by the transition system in terms of flat memory versus foundry and on NAND, if you see those – how you see they’re expanding in those segments and also for display?

So, this is Bob, I can kick it off and then Gary can jump in, too. In terms of this year, what you see is trends that are helping us a lot. You see strong spending in NAND, whereas last year NAND was about, and I’ll go into 2017 for you too. In 2015, NAND was about $6.8 billion, this year it’s up 40% to 45%, about $9.7 billion. And that is 90% for V-NAND. What we see next year is NAND is going to be up a little more actually, and is going to be like 98% V-NAND, and our position is very strong.

Yes, I think it’s actually more than 30%. In terms of foundry, we think foundry could be flat to up 5% next year. We think it’s going to be very good for us in the leading edge, and we also think it’s going to be good for us in the trailing edge in China and things like that.

Thanks. Hi, Gary, Bob, also congrats on the results. My question is on the memory orders. So the memory orders declined pretty meaningfully in the July quarter. I was just wondering if you think that was just timing related, or do you think it’s a function of the more rational spend by customers, and could we see a snapback in memory orders in the October quarter?

Yes. I think that stuff is lumpy. We still see very strong demand for customers, particularly around V-NAND stuff. So we had a huge number in Q2 for V-NAND, because people frankly want to get in our production queue. In Q3, we have reasonable NAND orders, but not as big as they were in Q2. So I’d say, the demand is still strong. We’re getting a lot of pull in NAND still, and I wouldn’t read too much into the orders lumpiness.

Yes, I think the demand for 3D NAND is certainly extremely strong. Customers can sell everything that they can build. And if you look at where we’re at in terms of that transition to 3D NAND, we’re still not that far along in the overall transition.

Thanks for taking my question and congratulations on a good quarter. Bob, on the gross margins, I understand that great job from Q2 of 2011. But if I compare it to your 2018 financial model like flat gross margins versus 44.6% at 33.5% in WFE, a little bit below that mark. What will get the gross margins higher from these levels? I understand the display mix helps the gross margins, but does the foundry mix help them?

Sure. I think, we’re making progress. I thought earlier in the year, we would stay sort of flat to last year, were up a little bit. Last year was 42.9, we were about 43.2. And this was a particularly strong year for display and also etch very well. Now, let me just say display and etch are adding a lot to the operating profits of the company. Their model is a little bit different. In terms of the specific question of 44.6, we said we’d do 44.6 in 2018. If you took the mix we had and if you took the gross margins we had by individual product and compared it to 2014 mix, we’re like 44.7.

Thanks for taking my question. I just wanted to follow-up on the gross margin question. With the second-half with more foundry logic investments coming up with 10-nanometer, I was under the assumption that should be extremely positive for your gross margin profile. So I’m just curious if that is going to be more back-half loaded and into 2017, should we, at least, expect gross margins to improve into the fiscal Q1, given that it’s flat in fiscal Q4?

They might depend on the mix. Remember in Q3 and Q4, we’ve been growing a lot very strong in terms of revenues for both display and our etch business and memory. So if in Q1, we probably are going to be strong pretty much across the board. So foundry, I think, has a potential to be strong.

Hey, guys, congratulations on the solid quarterly results and execution. Another focus by the market on display has been on OLED, but it seems like even in the core or large screen LCD segment, there’s a lot of opportunity. So I’m just wondering, if you’re trying to see that in your pipeline? And is it something that you would expect orders for this year, or is this something more kind of 2017, 2018 timeframe?

Yes, I’ll start and Gary can jump in. Actually, the core display orders for LCDs and related TVs have held up probably a little better than we thought and it looks like there might be an opportunity there.

I guess, I could also add that display is a great opportunity for Applied Materials. We’re still in the early innings of this smartphone transition to OLED. Display is a key differentiator for mobile devices.

Thank you very much and also congratulations. Gary, as you look at the 3D NAND market share gains you have made to-date, which process segments do you believe you’ve made the most gains? And as the industry goes to say 64 layers and higher, where do you see incremental gains for the company on a going-forward basis?

I think the most important thing for people to think about on 3D NAND is that this is a materials-enabled inflection, not litho-enabled. And it’s the biggest change in memory technology in decades. Our CVD business is growing significantly. This year, we expect strong revenue growth in CVD gaining several points of overall share.

Yes. Hi, thanks for taking my question. Just – I just wanted to touch on the logic spending being down this year, wondering why you think it’s down if that’s related to slowing node transitions, and just maybe gauge your conviction in it being up next year.

We have – the numbers we have now, remember we have in logic, we have a major U.S. company and also some Japanese companies. Our numbers show that it’s down 5% to 10% this year and up 5% flat to 5% next year. Let me pull up the detail.

In foundry, what we see is that all of our customers are targeting 7-nanometer as a big node, very big node. There’s a lot of customers that are taping out. So the pull we’re getting on customers on 10/7 is extremely strong.

Great. Thank you. Bob, I think your comments are making good progress towards the 2018 model where you stated, your Silicon Systems business is kind of approaching the size that you talked about for 2018 on the type of WFE number that sort of midpoint that you talked about. So is that – are you doing better earlier, because you’re taking more market share at the TAM expanding faster?

Yes, on the semi stuff, two things have really compounded for us. So and in fairness to us, we kind of predicted, that’s what we’re positioned. But one, the market changes have really come out frankly as we expected in terms of the transition from 2D to 3D.

Hey, thanks for taking my question. So, I guess, I have a question about sustainability or how sustainable this ramp of multiple areas. And I guess, it specifically relates to customer concentration. So it seems like leading edge foundry 10/7-nanometer foundry and also OLED are big drivers now or definitely a big driver for you last quarter.

There are several inflections we’ve noted. One is NAND, one is OLED, one is China, and the other one which is going on right now is foundry leading edge, in particular. In terms of OLED, they’re in pretty early innings on the transition to OLED on the phones.

Hi, thanks, and congratulations on very strong orders. I think you have two consecutive quarters in China over $800 million of orders. If you back that out, do you feel that the $400 million to $500 million per quarter of order run rate is the base case now and start moving up from here? Or do you think there’s still some lumpiness in orders in China?

Well, again, we have a strong semi business in China and a strong display business. So I do display first. We see the trends where the Chinese are heavily invested in display business and want to share there, probably continuing for a number of years.

We’re in a very strong position with both multinational and domestic companies. We think this is a multi-year wave. Certainly, we see strong growth in 2016, but we think it’s a great growth opportunity also going forward.

Yes, congratulations on the results and outlook and thanks for sneaking me in. I wanted to switch from a more model intensive question maybe to a more qualitative question. Bob it was helpful to get a lot of the longer-term context on the financial performance of the business. And the question as we look at the ability of the company to redirect to some new opportunities like OLED is.

If you go look at it, our guide for Q3 was frankly significantly north of the street. Now, we’re guiding to about $0.65, roughly, and the street was $0.48. And now we’re saying we’re going to – we have 3.5, almost $3.5 billion of orders last quarter, almost $3.7 billion this quarter. Next two quarters, we’re hoping to have around three each. So there’s something’s changed here. The key for us, I really do believe, we can grow as fast as we can qualify. So I would say that we for sure are going to grow share. The rate of that growth is really up to us relative from an execution perspective.

The fundamental driver for our businesses today from a market standpoint is materials innovation. We’re broader, deeper, have more competencies, more technology, more talent than anyone in the world.

Thank you, Atif for your question, and we’d like to thank everyone for joining us this afternoon. We do hope to see you at the Analyst Day in New York on September 21. And in the meantime, thank you for your continued interest in Applied Materials.