Applied Materials Inc (AMAT) — Q4 2018 Earnings Call Transcript

Good afternoon. We appreciate you joining us for our fourth quarter of fiscal 2018 earnings call, which is being recorded. Joining me are Gary Dickerson, our President and CEO; and Dan Durn, 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, and business outlook. These statements are subject to risks and uncertainties that could cause actual results to differ materially, 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 November 15, 2018, and Applied assumes no obligation to update them. Today's call also includes non-GAAP 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 Relations page of our website at AppliedMaterials.com. And now, I'd like to turn the call over to Gary Dickerson.

Thanks, Mike. In our fourth fiscal quarter, Applied Materials posted solid results, in line with our guidance. Despite challenging market conditions in the second half of the year, each of our major businesses delivered double-digit growth in fiscal 2018. This would not have been possible without the hard work and dedication of our employees around the world. And I would like to thank them for all their contributions over the past year. While we expect market headwinds to continue in the near term, we're not seeing the large fluctuations that characterized the semiconductor and display equipment industries in the past. At the same time, we are demonstrating that we have built a more resilient company with diversified revenue streams that can execute well in a range of market conditions. Looking further ahead, we are confident that longer-term growth drivers in both semiconductor and display remain firmly in place and will continue to create great opportunities for Applied. During the call today, I'll start with our perspective on near-term market dynamics. Then I'll summarize Applied's performance and priorities, and finish by talking about the future growth drivers reshaping our industry, and describing the company's strategy and investments to address the evolving needs of our customers, and the substantial opportunities ahead. Over the past several years, I've shared my perspective that the wafer fab equipment industry has fundamentally changed. Today, it is structurally larger and less volatile than it was in the past. These changes are due to increasingly diverse market drivers, spanning consumer, enterprise, and industrial applications. In recent months, however, we've seen several factors negatively impacting industry spending. These include elevated macroeconomic risks, global trade tensions, and specific to our industry, a pullback in memory investments. Recent commentary by memory makers has painted a consistent picture. Overall demand in the server, PC, and mobile markets is weaker than it was earlier in the year, and memory prices are softening in the near term. Our customers tell us they expect demand to pick up and pricing to stabilize in the second half of 2019. I believe the pullback in memory spending we're going through today is different from the down cycles of the past. There are several reasons for this. Supply and demand are relatively well balanced. Customers' investments in capacity are rational and disciplined. And the overall economics of the memory industry remain healthy. In foundry and logic, overall spending levels are strong, as customers optimize capacity at the current nodes, while concurrently pushing forward the leading edge. After a long time in development, the first EUV tools are expected to enter volume production in 2019. To support the initial adoption of EUV, we are seeing additional investments in these long lead-time systems in 2018 and 2019, creating share headwinds for Applied during this period. In aggregate, even with the current challenges I've just described, overall wafer-fab equipment spending remains at consistently high levels. We still believe that 2018 and 2019 combined spending will be around $100 billion. Relative to our prior view, we now see 2018 as slightly higher than 2019. While we are cognizant of macroeconomic and global trade factors, our long-term perspective on major technology trends is unchanged. Fundamental growth drivers are firmly in place as more industries are becoming increasingly dependent on technology, data, and specifically, silicon to define their futures...

Thanks, Gary. I'd also like to thank the teams for delivering record revenue and operating profit in fiscal 2018. Today, I'll share my perspective on our industry outlook, then summarize our Q4 financial results, provide our Q1 business outlook, and discuss the growth investments we're making in upstate New York. As Gary said, overall industry demand is weaker today than in the first half of 2018, and we expect our first quarter results to be lower sequentially. Our guidance includes the impact of a recent export restriction. Without this, we would have guided our semiconductor revenue to be higher sequentially. While we're not ready to call the bottom of the current cycle, we are optimistic that we're not going to see the same kind of volatility we saw in the past, as an industry or as a company. Our semi equipment guidance for Q1 implies annualized WFE in the mid-$40 billion range. It's important to note that this is about $10 billion higher than in all of the years prior to the current cycle. And it reinforces our positive industry thesis, which is based on three core beliefs. First, we see a large market for PCs and mobile devices plus the emergence of a big wave of new demand drivers related to A.I. and Big Data. Second, we believe that after a long downtrend, the capital equipment intensity has stabilized. And third, our customers are more profitable and taking proactive steps to keep supply and demand in balance. We believe the industry is more attractive and the company is more attractive. Over the past six years, Applied has built a bigger, more diverse, and more resilient business. In fact, in both 2017 and 2018, we delivered more than twice the operating profit of any other year in the past decade. Looking forward to 2019, our customers point to an improving demand outlook in the second half of the year, even if the shape of the recovery off of our Q1 guidance is shallower and more gradual. We believe we will generate higher earnings this fiscal year than in 2017. Our improved profitability enables us to continue making disciplined investments in our future growth opportunities, while simultaneously delivering attractive cash returns to shareholders.

Yeah, good afternoon. Thank you for taking my question. I guess a question in terms of market share and positioning. So you talked about EUV as a likely headwind into 2019, but also investments you're making in terms of technological inflection. So, curious, can you kind of walk through the timing where we could see a resumption of share gains on the WFE side? And also, as you think about mix in 2019, does that allow you to perhaps at least grow in line? Would love to hear your thoughts, I guess, both 2019 as well as inflections beyond that.

Yeah, thanks for the question, C.J. Let me give you some color on market share. And I think it's useful to think about three timeframes, what we've done, what we see today, and where we're going. When I joined Applied in 2012, we substantially shifted investment towards big inflections. As a result, in the 6 years to 2017, we held or increased share for 6 consecutive years. I think we were up five years and flat one. And also, we increased share in memory, where we had a big focus. So we increased our total share of memory spending by about 10 points. So in the near term, as I talked about in the prepared remarks, 2018 we're gaining or holding share in the vast majority of our businesses, but we also see rapid growth in EUV and also in other markets where we don't compete. So as a result, we do expect our share to decline in 2018. After many years of development, we expect to see the first EUV tools used in production beginning in 2019. Those tools have very long lead times and to support the initial adoption, we expect high spending in 2018 and 2019, creating a mix headwind for our overall WFE share. Of course, those long lead-time shipments also are a positive indicator for our future business.

And it's fair to say the mix is hard to predict right now, C.J. So it will depend on what happens in 2019, 2020 in terms of things like 3D NAND like Gary said. So I think we'll stay tuned on trying to make that prediction this early in the year.

Hi. Thanks for taking my question. Gary, I have a question for you on display. Can you talk about the puts and takes for your down 20% display outlook next year? We hear LG and Samsung ramping and converting capacity on Gen 8 OLED TVs with some weakness on the flexible Gen 6 lines. Also, you guys launched a couple of new products at OLED World Summit, where e-beam, CD metrology and e-beam inspection were discussed, so just your thoughts on the display market next year?

Thanks for the question, Atif. So happy to give you some color on our display business, as we've said before we've grown display a tremendous amount over the last six years, at about 25% compound annual growth rate. For 2019, we've talked about the business declining in the range of 15% to 20%. And given the elevated risk, I believe we're likely to be at the low end of that range. So then, if you go into the different segments, in the TV segment, I continue to expect our customers will transition to Gen 10.5 technology, because it's strategically important for them to deliver lower costs for large screen TVs. And as we've previously communicated with Gen 10.5 panels, you can produce 8 65 inch TVs and you only get 3 on a Gen 8.5 panel. So for large screen TVs, it is strategically compelling to move to those larger panel sizes. And recent discussions with customers, we don't see any change in customers' plans. In the smartphone area, demand is going to be flat year-over-year. But we continue to see OLED as the best technology for the future for a number of different reasons. And we believe that OLED will recover as more suppliers are able to produce at a higher yield. So overall, we see a lot of good opportunities that continue to drive our display business, despite 2019 for the first time in I think 7 years seeing a decline in the business.

Hey, thank you for taking my question. Gary, I have a question for you, a follow-up on your comments about share movements and EUV. And then, I have a quick follow-up for Dan. So I'm trying to reconcile what you just described and that makes a lot of sense, so EUV is ramping. You're mechanically losing share in that context. But you're expecting to regain share when you bring materials technology that will go along with EUV lithography. But at the same time, in the last few weeks, I heard like TSMC, I mean, reiterating they said, that's for longer, so like a large foundry player that they don't expect CapEx to grow significantly. Then your peer ASML is saying the same. And so, does that mean you have a different perspective and you think overall CapEx is going to continue to grow in foundry significantly and even grow faster than revenues?

Yeah, thanks for the question. So I think our perspective longer term, Pierre, hasn't changed. And I've spent many, many meetings with customers over the last couple of months. We strongly believe that the industry needs a new playbook. And that, all of those five techniques I talked about earlier are absolutely crucial to deliver power, performance, area, and cost needed for this Big Data-A.I. era. Now, silicon and electronics are going to be at the foundation of all of those major industry transformations, changing in a profound way all the aspects of our life. We still definitely believe that. And if you look at where we need to go with a 1,000 times improvement of performance per watt, you can look certainly at what we've said in the past. You can look at what other people are saying also that they talk about those five areas of focus. And I deeply believe we're in a better position longer term than we've ever been. Now, certainly there's a headwind in 2018 and 2019. After a long time, you have the initial adoption of long lead-time EUV tools. They'll go into production for the first time in 2019. That's going to certainly provide a headwind for us in the near term, but longer term, I definitely believe the industry is not going to get where we need to go with doing what we've done in the past.

Yeah. Hi, thanks for taking my question. Gary, it looks like the general view that next year the mix of WFE is going to skew more towards foundry and logic versus memory. In that scenario, is it fair to assume that your profitability profile or your margin profile should be better selling into foundry, logic versus memory? And then a quick housekeeping for Dan. What's the impact from export control on Fujian? Was it about $100 million for you guys? Thank you.

Thanks, Krish. Let me share with you a little bit of what we're seeing around the WFE market and then come to the profitability implications that this has for the profitability of the company. So in the prepared comments, we talked about 2018 and 2019 combined being around $100 billion. I would say, given the elevated risk profile of the environment, we find ourselves in, that's - our expectations around 2019 have probably softened in the last three months. We now see 2019 below 2018. If I were to - and I think it's premature to be point specific on either 2018, 2019, or the device types. But again, to just share a little bit of what we're thinking to help shape a view of the market. 2019 feels more like 2017 than it does 2018. And if I look at where we sit today in 2018 WFE, all-time high, in terms of aggregate spend and strength across each of the four device types. And as I profile off of that view into 2019, we would expect memory to be down and foundry, logic to be up. And then if I were to rank order the four device types as we look into 2019, given everything we see today, foundry would be the strongest, then followed by logic, then followed by DRAM, then followed by NAND. In terms of profitability, I think the best way to think about our business is less about end-market profiling the four device types and more about the mix amongst our businesses, the more of our leadership businesses and equipment that we sell, you'll see that be a favorable segment mix or a favorable product mix within the segment.

Yeah. Okay. And then the other part of the question was around this recent action that was directed by a particular Chinese customer. From what we see today, this feels like business as usual for the other customers in the region. And then regarding the geopolitical situation, we certainly believe in fair trade. And we think it's important for the overall ecosystem to have a constructive relationship between the U.S. and China. We can't speculate on any other actions that could take place. And, of course, we continuously monitor the situation and we're going to respond appropriately. And then, Dan, do you want to give color on the magnitude of the impact?

Sure, Gary. So as we think about our guide into Q1 and we think about the export action that was taken against one specific customer, we - a quarter ago were expecting our semi business to be flat to up sequentially. We guided down a bit. In the absence of this export restriction, we would have been up sequentially in our semi systems business into Q1. And I would say that our revenue with that one customer in Q1 is a meaningful number. So the EPS guidance we provided into Q1 reflects a significant reduction in semiconductor revenue along with an unfavorable mix within the product portfolio. And I think that gives you a sense of the impact of that action on the one customer. I don't think we want to be more specific, since it's a direct read-through on one customer. But I think that's enough to give you a sense of what the impact to our company was in our fiscal Q1.

Yeah, good afternoon, guys. Thanks for letting me ask the question. Gary, Dan, to the extent in your prepared comments, I think you said you're not prepared to call the January quarter - January guidance a bottom. I'm wondering was that relative to the overall Applied revenue stream, the silicon business? Was that a sequential comment or a year-over-year comment? I guess, specifically with the silicon business, Dan, being down over 20% year-over-year, I believe, relative to your January guidance. Do you think that that will represent a year-over-year bottom that we can start to build off of? Or how should we think about that?

Thanks, John. Let me share with you a little bit of what we're seeing in the market, and hopefully, it helps provide some context and color that gets at the essence of what you're asking about. I would say based on our customer conversations, and the guidance we gave about not calling the bottom is specifically related to our semi business because I think that's where the biggest question in the market is today. Based on the customer conversations we're having, we think that first half of 2019 would likely be higher than the second half of 2018. But we also think given the elevated risk profile, we - or the elevated risk environment, we find ourselves in geopolitical trade, handsets industrials being on the weaker side, that certainly offsets by decent markets in PC, comm infrastructure, cloud CapEx. But as a package creates an elevated risk profile, we think it's prudent to create an expectation around a shallow, gradual U-shaped recovery of the semi business into 2019. And so for a variety of reasons, I don't think we want to put a stake in the ground and call it a definitive bottom.

Good afternoon. Thanks for taking my question. Despite the equipment, Dan, on this China domestic DRAM that you guys are talking about here in Q1, there are - these two other major programs in China, one in NAND, one in DRAM that are potentially looking to kind of ramp next year. I think, last quarter you guys said that 2019 China domestic was looking more kind of heavily weighted towards foundry, has your view changed in light of this activity with some of the other memory suppliers that are looking to potentially ramp both NAND and DRAM capabilities, maybe starting second half of next year?

Yeah. Thanks for the question, Harlan. Yeah, as I said earlier, we don't really see any change in the activities with the other customers in the region. Of course, we're going to continuously monitor that and respond to anything that we need to respond to, but one thing, I may be helpful if I give you color on our China business, how it's composed. So our Display, we have a large display business in China and a little less than half of our revenue is semi systems, roughly half of that is multinational, the other half is domestic and for domestic, we're fairly balanced between foundry, logic, and memory. And when we look ahead to 2019 and beyond, consistent with what we've said before, we didn't see a hockey stick, in terms of growth in the domestic market and we continue to see modest growth in the semi market going forward. So, I would say, at least today, we don't see any change in behavior with our customers, and that's basically the profile of the different parts of our business, which is pretty consistent with what we've said before.

Yes, thank you. Good afternoon. My question is on services. So services had a pretty strong year in fiscal 2018, looks like it was up about 25% year-on-year, and you're guiding it down sequentially a bit for January, if I interpret it your comments correctly. My question is, does the services at some point in fiscal 2019, start to track the performance of SSG in fiscal 2018, and should we be cognizant of that as we model out the quarters of this coming fiscal year?

Hi, Romit. Thanks for the question. I think the best way to think about services growth, certainly the installed base is an influencer, but it's not a direct read through. So I don't think that business will directly track the following year, what our systems business does the prior year. But there is a growth vector around the installed base, there is a growth vector around the increasing complexity that the industry is facing and the challenges our customers are increasingly asking for help with their drive yields. And the third is the strategy we have around comprehensive service agreements to get a bit more predictability in the business versus the transactional nature, and so it's a multi-vector approach and strategy to grow in the business. You point out that the company has done a great job executing that strategy, 2018 was a strong year. And our goal will be to grow that, continue to grow that business at a 15% CAGR on a go-forward basis. So it's a business we feel good about, but I don't think you can make a direct read through based on systems in any one year.

Thanks for taking my question. Gary, if I look longer term, what is your relative exposure to the smartphone market directly, indirectly versus the enterprise or data center, because when I look over the last five years of growth in the semi-cap equipment industry, it kind of coincided with the growth of high-end smartphones. But as they are slowing down, when can the enterprise and data center will be big enough to offset those declines? And do you think it is possible that WFE kind of stays flattish for the next two to three years, because of this dynamic?

Yeah. Thanks, Vivek. As we take a step back from what drives WFE, if we were to go back a decade in our industry, vast majority of WFE was narrowly focused in and around the PC platform. Since then we've diversified into mobility compute handsets, we've got a lag in the data center, you can see big data cloud service providers beginning to influence that, IoT is playing an increasingly large portions of semiconductor consumption as is - as are things like autonomous driving and Industry 4.0. It's really hard to disaggregate those long-term technology trends that are increasingly depending on silicon and consuming silicon to a direct read through on WFE, that chain is extremely hard to disaggregate and attribute one to the other.

Thanks, Tim. So what we said about our capital allocation strategy is, we're going to focus our excess cash on growing the company, maintaining a strong and healthy balance sheet, and then returning excess cash to shareholders. I think what you see is us executing against that strategy. If you narrow the timeframe to any given quarter, the share repurchase may or may not be above where we trade on any given day. If we take a look at what the company has done over a long period of time in the last two decades, we've given back close to 90% of our free cash flow back to shareholders.

Great. Thank you very much for taking the question. I wanted to follow-up on your market share comments. You talked about headwinds given the insertion of EUV. But, Gary, do you have any expectations for your positioning in the markets that you do participate in, etch, CMP, Epi. Is it fair to say that your competitive positioning is still improving in the markets that you actually serve?

Yeah. Thanks for the question, Toshiya. We actually, in 2018, were gaining or holding share in the vast majority of our businesses that where we compete today. There are markets that we don't compete and we have initiatives in those areas that where we have very strong pull from customers and we're optimistic that over time that that will provide a significant increase in business for us. And then, the other thing I would say probably the biggest factor longer term is this new playbook, I mentioned, with the five different drivers, that is really playing to the strengths - uniquely to the strength of Applied Materials with the breadth of our products, all the different materials creation, materials removal, materials modification and also the ability to combine all of these different technologies together in a single platform, where you manage these interfaces that is a really, really, really valuable capability.

Thanks, Toshiya. And, operator, I think we have time for one more question.

Great, thank you. My question is on DRAM. I guess, it seems like your DRAM numbers year-to-date have been quite strong in terms of you sales to DRAM company despite the push-outs that we've seen. And if we aggregate kind of three equipment companies who shift to DRAM there, they are all showing pretty significant strength up in aggregate, I think over 60%. So, I guess, I understand capital intensity is increasing, but it doesn't seem like it was inflecting that much in any one year. So how is DRAM despite even with push-outs having such a robust year? And, I guess, does that mean supply would accelerate next year? Does it - anything that you would tell us about the sustainability of that into 2019 would be helpful?

Thanks, Joe. As we look at our position in DRAM, it gets back to a bit of the journey that gets us to where we're at from a market share standpoint today. As Gary talked, since he came into the company or when he came into the company, we had one end-market that was over 20% from a market share standpoint. All others were 15% or below. And the company has done a very good job diversifying across those device types to where we're almost diagnostic across the device types from a market-share standpoint. And DRAM has been one of the beneficiaries. The company's worked really hard with customers to deliver innovation when their roadmaps require it. And it's allowed us to increase our market share with those customers. We're increasingly seeing in the periphery transistors logic-like processes being adopted to drive I/O speeds on the devices. And that accrues benefits to us as well in some of our higher market share businesses. And so, the setup around DRAM going forward is a good one for us. It's been good over the last several years. And as you pointed out, we've done a good job driving market share there. And we like that setup going forward as well. So we like the progress we're making in DRAM.

And then, Joe, if you're looking for the year-over-year in DRAM, we've been planning for it to be sort of into 2019, maybe not quite the 20% that we've seen, maybe it's high teens to 20%. And very good job right now for the customers, doing very proactive supply and demand management, and also a lot of pull for DRAM, especially the high-speed versions in the server market. So from the customer conversations, it feels pretty good, it feels not as tight as it was. But really proactive steps and it looks like a decent outlook for next year. We think it's still going to be a strong year.

Thank you very much. Gary, maybe just a follow-up on the playbook, you're talking about with the five key factors in terms of the architecture and the structures within chips and continued materials innovation. Given your strong exposure to the foundry logic segment, do you believe some of these variables would come into play at the 5-nanometer node? Or is this something that, I guess, past 5-nanometers that we will see it more in the next decade?

Patrick, I think the great thing about many of those drivers is they're not only for future technology nodes; you can use those in - some of those drivers can make a big difference, move the needle on current devices, and also on trailing geometries, even planar transistors. So that's - and we are seeing strong pull from customers across the board for some of those major drivers at the A.I. Design Forum in July and at the Electronics Resurgence Initiative, the DARPA Conference in July. One of the examples we gave was 1,000 times improvement in leakage current. Again, many of these new technologies that we're driving can be used in trailing geometries and even current geometries. So we don't need to wait for the adoption of 3-nanometer or - and, certainly, some of those technologies will be targeted for leading technology nodes, but some of them can be used today.

Okay, great. Sidney. Thanks for the question. Dan, before we close the call, anything else you'd like to add, just so we wrap up on time?

Yeah, thanks, Mike. I guess I want to close with a couple of thoughts. First, we all know that we're in a challenging environment. I think the company has delivered strong results in 2018. But we're definitely not satisfied. We know we still have a lot of work to do, and we're going to work aggressively to achieve the goals we set for the company. I guess the second thing is, if we fast forward to a year from now, when we look back at our Q1 results, they may prove to be the low point of the year. But we're not ready to call Q1 the bottom until we have collected multiple proof points across a variety of our businesses. I think if you look at sort of the company's and the way we've engaged in the past, many of you that follow our journey, you know our style is to be transparent. Our goal, our intent is to help you see what we see. As tougher as the environment feels right now, the industry is substantially higher than it was even compared to prior peaks. We're confident that our long-term thesis around the industry, the long-term technology trends are going to be favorable and they're firmly in place. We also believe we've built a more resilient business. A company that is more profitable. It allows us to invest and uniquely be well positioned to drive the industry inflections that we already see on the horizon. I guess lastly, finally, look forward to seeing many of you at the Credit Suisse conference in a couple of weeks. Thanks very much.

All right. Thanks, Dan. And we'd like to thank everybody for joining us today. A replay of the call will be available on our website by 5:00 PM Pacific Time today. And we'd like to thank you for your continued interest in Applied Materials.