Hello, all. This is Ophir writing, but much of the story to follow was written by Tiernan, and I denote it as such.

LEDE
If ever there was a Q&A session to read to better understand all of technology, this is it. Whether you follow Applied Materials or not — reading this dossier makes you a better technology investor.

We call the company “The Pickaxe to Technology’s Pickaxes.”

 

PREFACE
Applied Materials (AMAT) reported earnings and the company continues to move through the ebbs and flows of certain parts of demand. But the future remains clear — ‘Big Data’ and artificial intelligence are bringing a wave of technological advances that are unlike anything the world has seen and should position Applied for tremendous opportunity.

In between the now and the long-term is a world of uncertainty that lies far outside of technology and well into the realm of global politics. But, like all true secular trends that are revolutionary, like e-commerce, for example, macro events both geopolitical and economic are simply the distractions to the true trends that are coming.

We added Applied Materials (AMAT) to Top Picks on 15-Nov-16 for $28.71. As of this writing it’s trading at $59.92 up 108.71%.

 

Highlights
Some highlights from our chat with CEO Gary Dickerson are included below, before the full transcription:

* From the Applied perspective, the opportunities going forward are much bigger than we’ve ever seen. The enabling infrastructure for the data economy is an enormous opportunity as technology transforms all these industries.

* 2018 was the first year that machines generated more data than people. At that rate, come 2025, if you just scale what you have today, you will need to add another ten percent power generation in the world just to process all that data.

* We had 20% peak-to-trough [referring to the decline in industry revenue this semiconductor cycle] versus 40% in the past. It’s so much much less volatile.

* Tech is transforming health care, education, retail, agriculture and everything, all the growth in sensors and IoT technology, all those things. It is meaningfully bigger than it’s ever been.

* As everything around us gets smarter, machines in a few years will generate ten times more data than people, and all this data infrastructure will be going out into every corner of the world.

The remainder of this dossier was written by Tiernan Ray and his meeting with the incomparable CEO of Applied Materials, Gary Dickerson.

STORY
Shares of chip equipment giant Applied Materials are up about 5% since the company announced better-than-expected fiscal Q4 revenue and profit, and said it sees a gradual recovery for chip making, despite some continued uncertainty about the memory-chip business.

The stock is now up 84% for the year.

As he often does, Applied chief executive Gary Dickerson sat down with Capital Market Labs to discuss the results and outlook.

Dickerson emphasized the “playbook” he has talked about in prior conversations his term for a host of new technological approaches that need to happen to make possible a much more pervasive computing infrastructure, “The biggest inflection of our lifetimes,” as he calls it.

The focus on the call was the shape of the turnaround in the semiconductor cycle, and Dickerson repeated the cautious optimism the company has maintained with the phrase “if the second calendar quarter of 2019 proves to be the low point of this spending cycle.”

That’s still just an “if,” but Dickerson is upbeat when pressed on the matter. A UBS report issued shortly after Applied’s conference call cut the stock to Sell on worries about spending actually peaking in the early part of 2020.

But when asked about it, Dickerson responded by going into an extended riff on how people underestimate ultimate demand for chips, given the spread of technology. “I would say that I believe strongly that the industry is much larger than it’s ever been and more pervasive.”

Dickerson also addressed issue of China’s homegrown chip development — it’s going to take a lot of time — and issues of tariff and trade.

About the ups and downs of trade talks, he didn’t make any predictions, he simply said, “It’s in all the ecosystem’s best interest to have a constructive resolution to things,” given the global interconnectedness of the electronics supply chain.

To recap, Applied reported revenue of $3.75 billion in the October quarter, down slightly from the prior-year period, and EPS of 80 cents. That was higher than the average estimate for $3.68 billion and 76 cents.

For the current quarter, the company sees revenue of $3.94 billion to $4.25 billion, and EPS of 87 cents to 95 cents, versus consensus for $3.71 billion and 75 cents.

Capital Market Labs: What do you think is most important for investors to take away from the results and outlook?

Gary Dickerson: It was really a very strong quarter, I think. The macro, if I look at our business and then the industry as a whole, you have these different waves of growth for the industry.

We went from mainframe to PC on every desktop to computer and camera in every pocket to this new AI and data wave. Technology has become much more pervasive, it’s transforming every industry. That’s the big opportunity for the company, certainly, as we look at the business today.

People don’t understand that the trailing geometry is now a bigger part of our business than they were in past. People talk about leading geometry, but that’s not the majority of automotive.

And trailing-edge devices is about half of the foundry business now. A few years ago, it was dramatically lower. This is technology becoming much more pervasive. That’s part of what’s driving our business going forward.

From the Applied perspective, the opportunities going forward are much bigger than we’ve ever seen. The enabling infrastructure for the data economy is an enormous opportunity as technology transforms all these industries.

You can’t just scale what’s there today. 2018 was the first year that machines generated more data than people. At that rate, come 2025, if you just scale what you have today, you will need to add another ten percent power generation in the world just to process all that data.

That’s an enormous challenge happening at the same time that Moore’s Law has slowed down. And it’s not just 2-D scaling; people are seeing new structures, new materials, new ways to connect chips, in addition to new [die] shrinks. Enabling that playbook is an enormous opportunity for the company.

We are engaged across the ecosystem. Also, cloud providers are designing their own chips. Those new architectures and structures, they are targeting a 1,000-times improvement in performance per watt. That’s really the big focus.

So, the trailing-edge is much larger now, and I think that’s resulted in it being a much less volatile, and more stable business. We had 20% peak-to-trough [referring to the decline in industry revenue this semiconductor cycle] versus 40% in the past. It’s so much much less volatile.

As everything around us gets smarter, machines in a few years will generate ten times more data than people, and all this data infrastructure will be going out into every corner of the world.

CML: In a recent research note, UBS Analyst Timothy Arcuri downgraded your stock to Sell from Neutral, citing a concern that wafer fabe equipment [WFE] spending is going to peak in coming quarters. Is Arcuri missing something that you see?

GD: Yeah, well, I would say that I believe strongly that the industry is much larger than it’s ever been and more pervasive.

Think about the PC on the desktop and the camera in your pocket. Tech is transforming health care, education, retail, agriculture and everything, all the growth in sensors and IoT technology, all those things. It is meaningfully bigger than it’s ever been. And capital intensity is going up.

From 2003 to 2010, it was the 200 millimeter [semiconductor wafers] to 300 millimeter transition. It was an increase of almost 2.3 times the area. In 2000, you had 8% penetration of 300 millimeter. By 2010, you had 88% penetration with 300 millimeter. You had this massive efficiency drive.

That is not coming in the future, there is no going to 450 millimeter. I travel, I engage with all the parties throughout the entire ecosystem. In discussions I’ve had with people, more on the systems side, they are seeing power efficiency is worth an enormous amount.

Think about the power you burn when processing data. You have to drive innovation in the future. I was talking with another customer in the ecosystem just a couple weeks ago, we were in talks about enabling new structures and a 1,000-times improvement in leakage current, a trade-off of either lower power or higher performance.

I asked him what’s it worth if I enable a 10% to 20% improvement in drive current for higher performance. And he said the value of higher performance is unlimited.

Think of area, cost, and power. We are at point in time where the value equation is transforming the competitiveness of these industries. So driving an improvement in power and performance is worth an enormous amount.

We are not going to be able to do that with what we did in the past, just scaling things the way they are today. That’s where I’m focused: how do we enable those major improvements.

CML: What do you make of the announcement in August by Cerebras Systems of its “wafer-scale engine,” the advent of making a chip out of the whole wafer?

GD: I think it’s very interesting. Most conferences where I appear, I like to ask a stimulating question, I say, Raise your hand if you think Moore’s Law is dead or not.

You almost get fist fights around that. But what’s extremely clear is, the future doesn’t look like today or the past. That’s incredibly clear.

2-D scaling in memory, you went from 2-D NAND to 3-D. You innovated with new structures and new architectures. How people combine chips today, the new architectures, is going to be really — I think what I would say is, there is going to be tremendous innovation in all those areas.

In-memory computing is going to happen. Heterogenous computing, these different functions on chips, all those things are doing to drive tremendous innovation going forward.

CML: But what about this wafer-scale business specifically?

GD: It’s one approach. We are engaged with many companies in the ecosystem, current and new companies, in terms of enabling that new playbook.

We have reorganized inside of Applied, we have tried to accelerate it. Think about materials to systems going dramatically faster, from materials to structures to chips to packages to systems, made up of hardware and software designs, that whole ecosystem.

We have brought in people where we have better insights. I was with a really large systems company here recently. As we are enabling some of these new capabilities, the insights for them [systems makers] to design to those new capabilities can accurate their time to market.

They want a four-times acceleration in edge and cloud infrastructure. That is worth an enormous amount of money.

Working with them directly gives them insights to what is the direction of things. You see it with those guys [system makers] adding tremendous numbers of people doing their own workload-specific designs. That’s definitely a big change in how we engage with the industry.

CML: But what about these comments regarding a potential downturn in WFE spending in the New Year? Is that something that people should be concerned about now?

GD: Look, we haven’t really commented on next year to a large degree, other than, we think the industry will be very healthy. Longer term, the industry is structurally much stronger, more stable than in past.

CML: In this last quarter, you noted that display continues to be under pressure, and that the outlook for TV panel sales is still weak. What’s going on with that industry? Are the people making TV panels pursuing the wrong strategy?

GD: I wouldn’t say they are doing something wrong. What we communicated for 2019 is we saw softness. It’s playing out pretty much as we thought.

If you look from a whole, the last five years, our display business went from $500 million to $2.5 billion, or roughly in that zip code. It was a great adjacent market to take our core technology, a market where you need structures and materials, whether mobile or TV.

That visual experience is an important part of the differentiation. We work with those systems companies, those consumer technology companies on a regular basis on those roadmaps. There are challenges.

With organic LEDs [OLED], really, you have one company in a strong position today to build those types of displays with high performance and lower cost and high yield. That’s a challenge in the industry.

The adoption [of OLED] on mobile is still around 30%. We see that there’s still a lot of opportunity to drive further adoption, and to empower customers to solve those technical barriers in that display business.

In TV, the economics are, if you go to larger panel sizes, you get eight sixty-five inch TVs rather than three. So there is a compelling driver.

That business has softened but it’s not directionally different. And then, I do think that people are looking toward new innovations in the display business. That’s back to where we work with these customers.

CML: We talked with you earlier this year about the fact the OLED display business in mobile is dominated by one company. [Samsung Electronics.] At the time of that conversation, you noted that over time, other suppliers will be able to come up to speed. So now, several months later, are we any closer to other suppliers being able to challenge that sole supplier of OLED mobile displays?

GD: I would say the timing — definitely, other people will be capable of achieving the yields and performance, but some of those technical challenges will take time.

People are making progress there, it’s just, you know, again, those are difficult challenges to overcome. I think that the good news for us is there are still technical challenges there. As you go to some of these, they are more intensive, there are more layers and more steps for Applied. That enables a bigger opportunity —

CML: Stacked die and such —

GD: I agree with you. That’s one of the five elements of the playbook. We have a sizable business in that market. We are working on some new technologies there.

The big thing for people when you connect those technologies together, is how fast can you transfer information and how much heat is generated. We are deeply, deeply connected to that part of the ecosystem. We have the most advanced packaging lab in the world.

CML: You returned something like 113% of free cash flow in this latest quarter, through your capital returns program. You’ve had a very generous capital returns program. Do you think you are investing in the business at the right level for the opportunities that you have?

GD: It’s interesting. If we went back to, not this quarter, but the prior, what we said on that call was, we are increasing our investment.

We guided we were increasing our operating expenses. Look at us versus competitors. They’ve been cutting, we’ve been increasing.

As a CEO, you have to have vision and courage. We have a perspective to opportunities in the next three to five years. The previous quarter, when we said we were increasing investment, people weren’t as excited about that! It comes back to vision and courage.

We have to have a point of view. We have a very clear vision of the future, what it will look like. We are increasing investment. None of the short term things. Nothing has changed our perspective. As I engage across the ecosystem, I am more confident we have the right vision and a really unique ability to enable this playbook.

So last quarter, the reaction was not so good. But we are really focused on making technology that shapes the future. And we talked about this before.

By 2025, if you don’t improve the power efficiency of edge and cloud, consuming ten percent more power — I want to create a sustainable future.

Our role is to lead. The biggest inflection of our lifetimes is important, but there is the sustainability aspect of all of this. We need to drive tremendous improvements in power and efficiency and performance per watt.

CML: Before we go, let’s talk about China. Both the question of where China’s homegrown semiconductor market is going, and also the outlook of tariffs and trade.

GD: I’ll try to tackle it. We have been in China for 35 years. We have a very strong relationships with customers. I’ve been to China twice in the last two months.

If we look at what I’ve been communicating the last two years, what we see is not so much hockey sticks. There is noise around many kinds of investment. This is going to be certainly strategically important, continued investment.

If you just did the efficiency of dollars versus bits produced, or computing power, it’s not going to be efficient for a long amount of time.

There will be incremental investment, there’s going to be a long journey. These technologies are very, very difficult. It’s half foundry logic, and half memory.

The whole IoT and sensors production is increasing, and that’s not based on small design rules. China can build those kinds of things. You see a very strong domestic effort in those kinds of technologies. But we look at the leading indicators.

We have a number of ways we look at technology and funding, and other leading indicators we look at. So, if we look at exiting 2019 and entering 2020, there hasn’t been big change in our sense of the investment, it’s in the same zip code, we haven’t seen significant changes in China investment.

It’s going to be a long period of time of investment with incremental growth in that region.

CML: And, as far as tariff and trade developments, should be concerned that there is going to be a dramatic impact on the industry, on your customers?

GD: It’s in all the ecosystem’s best interest to have a constructive resolution to things.

If you look at the technology ecosystem, the high performance and apps processors are in one area, and memory in a different part of the world, and sensors in yet another.

Lithography is in one part, and different process technologies are in another. It’s a global ecosystem that’s very much connected, from materials all the way to systems. It’s in everyone’s interest to have a constructive resolution.

You know, I was at the Bloomberg New Economy conference here a couple weeks ago. Nobody is going to be able to build all this. Never in in history was it the case that anyone can build all those components.

In China, the vested interests drive constructive collaborations. They have talked about a willingness in some areas for a more constructive collaboration platform.

I think it is in their best interest to drive that more collaborative platform. So, it’s in everyone’s best interest that we end up on a more constructive path.

I wouldn’t be able to say for sure that that will happen or not happen. The future doesn’t look like the past.

You can’t scale what exists today and enable the future. The companies and counties that collaborate the best and the fastest will be the winners. I really believe that. That’s what I said when I was there, that’s what I say in Washington when I’m there. That’s important for global growth and leaving the world in a better place.

CML: Thanks, Gary.