ASML: Mainland China business to fall to around 20% (FY24Q3 conference call minutes)

ASML released its 2024 third-quarter financial report (as of September 2024) ahead of schedule during the US stock market trading on the evening of October 15, 2024 Beijing time, with the following key points:

The following is a summary of the ASML 2024 third-quarter performance conference call. For a detailed interpretation of the financial report, please refer to " ASML: "Bone-breaking" spectacle, becoming the first killer of AI again? 》

I. $ASML(ASML.US) Financial Report Highlights:

II. Detailed Content of ASML Financial Report Conference Call

2.1. Key Points Stated by Management:

1) Business Progress

a. EUV Technology Progress:

Low Numerical Aperture (Low-NA) Technology: The NXE:3800E system was rapidly deployed in the third quarter, with significant performance improvements. Compared to the NXE:3600 system, the throughput increased by 37%. Currently, it can process 220 wafers per hour, with most shipments in the fourth quarter being NXE:3800E systems.

High Numerical Aperture (High-NA) Technology: All customers have ordered High-NA, and the High-NA systems have been put into use at customer sites, with revenue expected to be recognized by the end of the year. Approximately 10,000 wafers have been processed for multiple logic and memory customers, demonstrating significant imaging, overlay, and cost advantages.

b. Market Dynamics and Customer Demand

Logic Market: Some customers have postponed the introduction of new nodes and adjusted their lithography demand schedules due to the slow recovery of the mobile device and PC markets and competitive dynamics.

Memory Market: Due to slow market recovery and limited capacity expansion, the focus remains on technology transitions to support high-bandwidth storage related to AI and DDR5 demand.

Mainland China Business: It is expected that the mainland China business will return to a more normal level in 2025, in line with the backlog ratio.

c. Long-term Outlook

Industry Drivers: Long-term driving factors such as AI, energy transformation, and electrification remain strong, with future demand expected to drive lithography demand for advanced and mainstream nodes. ASML will continue to increase capacity to meet the demand growth of future global new wafer fabs.

Future Outlook: ASML will provide a detailed overview of its 2030 business expectations at the Investor Day in November 2024, along with more long-term development scenario analyses

2) Financial Performance

a. Revenue Side

Total Sales: Reached 7.5 billion euros, higher than expected, mainly due to the increase in DUV system sales and growth in IBM-installed equipment management sales.

Net System Sales: Totaling 5.9 billion euros, with EUV system sales at 2.1 billion euros and non-EUV system sales at 3.8 billion euros.

Logic Market Contribution 64%, Storage Market Contribution 36%. Basic Equipment Management Sales: Exceeded expectations, reaching 1.54 billion euros, mainly driven by server-grade revenue.

Gross Margin: In line with expectations, at 50.8%.

R&D and Operating Expenses: R&D expenses were 1.1 billion euros, slightly lower than expected; SG&A (Sales and General Administration Expenses) were 297 million euros, in line with expectations.

Net Income and Earnings Per Share: Net income of 2.1 billion euros, accounting for 27.8% of total sales, with earnings per share of 5.28 euros.

b. Cash Flow and Asset-Liability Side

Cash Flow: Free cash flow was 534 million euros, showing some improvement compared to the previous quarter, but cash flow pressure remains due to lower order volumes and rising inventory levels.

Inventory Increase: Mainly due to extended production cycles of EUV systems (high numerical aperture and low numerical aperture) and inventory requirements to support production ramp-up.

c. Order Situation

Net System Bookings: Orders for this quarter amounted to 2.6 billion euros, with EUV orders at 1.4 billion euros, non-EUV orders at 1.2 billion euros, and orders from the storage and logic markets accounting for 54% and 46% respectively.

Low Orders: Reflecting a slow recovery in traditional end markets, with customers remaining cautious in the current environment.

Backlog Orders: As of the end of the third quarter, backlog orders exceeded 36 billion euros.

d. Fourth Quarter Guidance

Fourth Quarter Sales Expectations: Sales are expected to be between 8.8 billion and 9.2 billion euros, with IBM sales accounting for around 1.9 billion euros.

Gross Margin Expectations: The gross margin is expected to be between 49% and 50%, lower than market expectations, mainly due to revenue recognition from two high numerical aperture lithography systems that will lower the gross margin (impact of approximately 3.5%).

R&D and SG&A Expense Guidance: R&D expenses are expected to be around 1.09 billion euros, and SG&A expenses around 300 million euros.

Full-Year Outlook: Estimated total revenue for 2024 is around 28 billion euros, with a gross margin of approximately 50.6%, slightly lower than 2023, in line with expectations.

f. 2025 Outlook

Revenue Guidance: Revenue for 2025 is expected to be between 30 billion and 35 billion euros, lower than the expectations from the 2022 Investor Day, mainly due to reduced shipments of low numerical aperture systems (less than 50 units) and declining sales in the mainland China market Gross Margin Expectation: Due to the decrease in EUV unit shipments and the reduced sales contribution from the Chinese mainland market, the gross margin expectation for 2025 is expected to decrease to 51%-53%, lower than the 54%-56% estimated during the 2022 Investor Day.

Operating Expenses: The operating expenses for 2025 are expected to be between 5.6 billion to 6.1 billion euros, consistent with previous guidance, with research and development expenses planned as originally scheduled.

2.2 Q&A Analyst Questions and Answers

Q: Can you provide a detailed explanation of the reasons for the normalization of demand in the Chinese mainland? Additionally, in the 2025 guidance, the non-Chinese mainland DUV revenue seems to indicate a significant year-on-year growth, what are the driving factors behind this?

A: The normalization of demand in the Chinese mainland is mainly due to two factors. Firstly, over the past three years, we have been dealing with backlog orders from the Chinese mainland, which accumulated due to lower order fulfillment rates in previous years. Therefore, with changes in the global market environment, we are able to deliver these orders in 2023 and 2024, resulting in higher sales in the Chinese mainland in these two years. We now expect the demand in the Chinese mainland to gradually return to normal, which is one of the reflections in the current data.

Secondly, speculation in the external market regarding export controls is also one of the reasons why we are more cautious about sales in the Chinese mainland. We expect that Chinese mainland sales will account for approximately 20% of our total sales in 2025.

As for the non-Chinese mainland DUV business, although the overall DUV (Deep Ultraviolet Lithography System) business may experience a slight decline, the decline in the Chinese mainland market implies a corresponding growth in the non-Chinese mainland DUV business. The main driving factor is the development of more advanced nodes, especially in the EUV business (Extreme Ultraviolet Lithography System), including a combination of low numerical aperture and high numerical aperture. The non-Chinese mainland DUV business will follow the growth trend of the EUV business, as the two are closely related, so we expect the non-Chinese mainland DUV business to rise in sync with the growth of the EUV business.

Q: Please further explain the specific factors behind the gross margin guidance for 2025. Although it is understood that the decrease in the proportion of low numerical aperture systems may have an impact, with total revenue still at the lower end of the target range, does this mean that although your immersion lithography machine shipments have decreased year-on-year, their performance is still better than the target model? Does this offset some of the mixed effects? Can you provide a detailed explanation of the performance of the immersion lithography machine compared to the 2022 expectations, and its impact on the gross margin?

A: Regarding the performance of the immersion lithography machine, the difference compared to the 2022 Investor Day expectations is not significant. Although there has been a slight upward adjustment in the expectations for the immersion lithography machine, considering our view of the Chinese mainland market, the overall change is not substantial. Therefore, the 2025 gross margin guidance compared to 2022 is mainly affected by the EUV business The impact of EUV on gross margin has two key factors: one is shipment volume, the current model's EUV system shipment volume (about 50 units) is significantly lower than analysts' expectations for 2022 Analyst Day; the other is the product mix effect, we originally expected higher-end 3800 and a small number of 4000 systems to dominate, but the market in 2025 will include more 3600 systems, although 3800 will still dominate. This has led to changes in the combined effect of average selling price (ASP) and gross margin.

Therefore, the decrease in EUV system shipment volume and the change in product mix have become the main reasons for the expected decline in gross margin in 2025, with the impact of shipment volume being particularly significant.

Q: You have reduced the EUV shipment volume for next year. It is expected that the low numerical aperture systems will be 20 to 25 units. How many of these are likely to be extended to 2026?

A: Because in the past few months, we have received feedback from customers that the delivery of some EUV systems has been delayed. Mathematically speaking, these orders may be extended to 2026. We need to reconfirm the market dynamics in the second half of 2025 and 2026 in the future.

The current delays are mainly due to customers delaying the construction plans of wafer fabs, rather than abandoning these projects. Therefore, it is possible to see a return in demand for these systems in 2026. However, there is still some time until 2026, and we will continue to monitor changes in the market.

Q: To what extent is the delay in delivery due to a slowdown in end demand rather than customers facing technical challenges or difficulty in attracting enough customers to support these projects?

A: This is the result of a combination of factors. First, the slower market recovery is the main reason affecting all customers, especially in areas such as PCs and automobiles, where the recovery rate is lower than expected. Although we remain optimistic about the prospects for AI, the market situation would be more severe without the drive of AI. This slow recovery has affected customers' investment decisions in multiple areas and applications.

In addition, the competitive dynamics in the logic market are also part of the reason for the delay, as mentioned in reports over the past few months. Therefore, these two major factors have prompted customers to make more conservative decisions on overall market expectations and share estimates in the logic chip market, leading to delayed deliveries.

Q: The significant revenue growth in the fourth quarter, can it be considered as a new normal? Especially regarding the guidance for 2025, the previously mentioned DUV revenue looks optimistic. Can we expect a significant growth in Installed Base business by IBM in 2025 to partially offset the decline in EUV?

A: I wouldn't call it a "new normal." As we have explained before, part of the revenue growth in the fourth quarter is due to the achievement of certain performance targets, which is a one-time factor. Therefore, this does not represent a continuous trend in the future. However, we do believe that the Installed Base business, including services and upgrades, will experience quite healthy growth in 2025. We expect IBM to achieve double-digit healthy growth in 2025 compared to 2024. Q: A few weeks ago at the SPIE conference, there was an increase in demand from major customers for larger mask sizes. How do you view the development of this change and its impact on High-NA orders? Will the change in mask size lead to delays in 5200 system orders?

A: Customer interest is indeed increasing. At the conference, preliminary data shared by ASML and some customers received positive feedback, demonstrating significant improvements in imaging performance with High-NA technology, as well as good cost advantages at the DRAM and logic levels. Therefore, customer interest in High-NA is high and continues to grow.

The discussion about 12-inch masks is more about how to further increase the productivity of High-NA and other tools in the future. This conference mainly focused on technical discussions, with customers showing active participation, but this is not directly related to the current 5000 to 5200 systems. This is a long-term technical issue and will not have an impact on current High-NA business or orders.

Q: How is the progress of the current internal production capacity target? In light of the 2025 goals, how do you view the changes in the production capacity targets set for 2022? What is the current manufacturing capacity situation for DUV and EUV? Have there been any adjustments to the additional capacity targets set for 2022?

A: Currently, we are mainly focused on the 2025 goals. Due to the slow market recovery, the number of equipment deliveries to customers next year will be lower than the capital markets in 2022 and a few months ago. However, in the long term, we and our peers remain optimistic about the long-term market opportunities, which means there will be a future demand for more capacity.

Therefore, we continue to work on long-cycle projects, such as construction and equipment development. However, due to the short-term market performance being relatively weak, we have slowed down short-term investments, especially in personnel and materials. We will accelerate these investments when demand increases. Nevertheless, we are progressing with capacity construction to ensure timely delivery of more equipment when the market recovers.

Q: Can you specify the changes in the past 90 days? How do you assess the impact of factors such as mainland China, storage spending, logic chip spending, and wafer fab shipments on the 2025 guidance? What are the additions compared to the last earnings conference?

A: Regarding the mainland China market, as mentioned in the previous quarter's conference, we expect the mainland China market to gradually return to normal levels. However, recent discussions in the media about export restrictions have made us more cautious about our expectations for the mainland China market, mainly due to market developments over the past few months.

For other customers, we previously mentioned some uncertainties, which have now largely materialized. Previously questionable demands are now more clear, and some customers' demand expectations have not been met. Therefore, we have adjusted the revenue target for 2025 from the previous range of 30 to 40 billion euros to the lower end of that range. This is mainly due to the risks and uncertainties mentioned earlier being confirmed, leading us to lower our expectations

Q: Regarding the follow-up on the mainland China market, no new export restrictions have been announced at the moment. Can we understand that you have evaluated the potential impact on the 2025 revenue based on the expected export restrictions, even though these restrictions have not been fully implemented yet?

A: We are also paying attention to media reports and have seen continuous speculation about possible new measures being introduced. Therefore, we choose to take a more cautious approach. This is one factor in adjusting expectations, along with the gradual reduction of order backlog in the mainland China market and expectations of more export controls. Based on these factors, we believe that adjusting the proportion of the mainland China market to 20% is a prudent decision.

Q: You mentioned that the growth rate in the smartphone and PC markets has slowed down, compared to three months ago. However, the adjustment in EUV shipments from 15 to 20 units is significant, exceeding market expectations of weakness. According to media reports, it seems that two major customers are facing issues. We expected orders to be adjusted, and other customers may fill these order gaps. Have you seen an upward trend in orders or demand from other customers to partially offset the impact of these customers? Or is it possible that customers' expectations are overly optimistic, considering the recent EUV supply shortages, leading to longer-than-expected order adjustments?

A: Your question touches on two key driving factors for our expectations of demand changes next year. Firstly, as you mentioned, the recovery in the mobile and PC markets is weaker than initially expected, which has impacted capacity planning and expectations. We have mentioned multiple times the cautious attitude of customers, which not only affects the short term but also has a certain impact on the medium term, resulting in a double impact.

Secondly, we have also mentioned the growth potential brought by AI applications. We still believe that the overall demand for these applications is continuing to grow, especially in the server market where AI-related applications are performing well. Therefore, we believe that the overall market dynamics are still at play, and we have updated our expectations for next year based on the latest developments. Of course, we are not entirely certain about the specific direction of the market in the coming months, especially the second part you mentioned, which may not have fully materialized yet. In conclusion, we still believe that the demand for AI in the coming years will remain strong.

Q: My follow-up question is about High-NA technology. Could you briefly update on the latest progress of High-NA technology? Especially in the areas of logic and storage applications, has there been any changes compared to three or six months ago, and what new developments have there been since the wafers passed testing?

A: We are currently in a critical phase of generating data for customers. Many High-NA systems have been ordered by our customers for research purposes. When generating data, the results may not meet expectations or may be very good, and currently, we are in the latter scenario.

We are continuously generating data and have processed around 10,000 wafers, demonstrating the performance of High-NA technology in logic and storage. This data has helped customers further clarify their technical applications and adoption plans, setting some specific milestones. Therefore, we are very satisfied with the progress and performance of High-NA and will continue to work with customers in the coming months to translate these initial positive results into actual manufacturing plans

Q: Can you talk about the order levels that need to be achieved in the next few quarters to meet the midpoint target in the new guidance? Previously, you mentioned that a 60 billion euro order volume is needed in the second half of this year to achieve the midpoint of the previous target. Now we see that the order volume for this quarter is 25 billion euros, but the target has been lowered. How should we view this change? Also, considering the potential impact of the production cycle, is there still room to obtain orders in the first quarter to benefit the performance in 2025?

A: As you pointed out, in addition to the overall decrease in order volume, some orders have been postponed to 2026, which is a factor we need to consider. These orders were originally planned for 2025 but have been deferred to later years.

Regarding the current situation, especially with EUV orders, this is a key point in our discussions. In comparison, DUV with its shorter order cycle has a smaller impact. For EUV, it can be said that we have already fully booked for the low-end target in the guidance. To achieve the midpoint target, we still need to increase orders by approximately 20 billion euros by the end of this year.

As for flexibility, there is still some flexibility in first-quarter orders. If we receive orders in the first quarter, we are likely to meet the demand for these orders in 2025. We have reserved some flexibility for this.

Q: Regarding the mainland China market, you mentioned that due to various reasons, the mainland China business will gradually return to normal levels. Can it be understood that the mainland China business in 2025 will become the new baseline level, meaning we should not expect further declines of 20% or 30% in 2026?

A: We believe that 20% is the normal level of mainland China business as a proportion of our overall business, so we consider this proportion to be reasonable in the future as well. Of course, this still depends on external factors such as export controls, which are beyond our control. From a market perspective, however, we believe that the mainland China market can maintain a revenue share of approximately 20%.

Q: Regarding the issue of two major customers delaying orders this quarter, when you formulated the revenue forecast for 2025, did you already estimate further reductions in orders from these customers? Or did you only consider the order postponements for this quarter? In other words, when providing the revenue guidance for 2025, did you already include potential order reductions from these two major customers in the future, or did it only reflect the current quarter's order adjustments?

A: Our current revenue forecast is based on the latest communication with these customers. Although you mentioned two customers, the actual number of customers involved is more than two. The current forecast reflects our latest discussions with these customers. However, you can also understand that as the year approaches, customer demand becomes more certain. Therefore, our current forecast is based on the latest and more accurate estimation of these customer demands as a benchmark for next year.

Q: You expect the mainland China market to account for 20% of revenue, implying a 30% year-on-year decline. I would like to know if this 20% only reflects market normalization, or if you have already considered anticipated regulatory pressures? If so, how much amount or proportion has been affected by preventive measures, rather than being driven by changes in end-demand trends? **

A: We are cautious about the mainland China market for two main reasons. Firstly, we believe the mainland China market will return to a more normal level at some point as we will not overdeliver on backlogged orders. Secondly, due to discussions in the media about potential regulations, we have become more cautious. The specific impact of these two factors is difficult to separate, so we expect the mainland China market to account for 20% of revenue, which is not far from the 30% decrease you mentioned.

Q: With the current challenges faced by the two leading logic chip manufacturers, the main customers for EUV are actually TSMC, SK Hynix, and Micron. Considering this monopoly and changes in the market environment, are you considering adjusting your pre-production plans? Especially considering the possible conflicts between pricing power and pre-production. Could you share your thoughts and strategies on this issue?

A: Our primary task is to meet customer demand, and we hope to fulfill this commitment regardless of the total demand from customers. Especially as the sole supplier of EUV equipment, it is our responsibility. The discussion on pre-production began when we realized that the production volume for a single year may not meet demand. Pre-production is a way to address this situation and maintain consistency.

Of course, the quantity of pre-production will be adjusted based on market conditions. If market demand is low, unless there are specific customer requirements, we do not see the need to continue pre-production. However, we have seen in the past that market conditions often change, and the mix of customer demands also evolves.

Q: The growth of DUV outside mainland China in 2025 seems to be very strong. Over the years, ASML has been quite accurate in providing one-year guidance. Considering that the delivery cycle for DUV is usually shorter than EUV, how confident are you in achieving significant growth in DUV business outside mainland China next year?

A: As I mentioned earlier, the growth you mentioned is indeed significant. For DUV business outside mainland China, we expect its growth to be roughly equivalent to the growth of EUV. Additionally, we have seen significant DUV demand at leading process nodes, so it is a reasonable assumption that there is a strong correlation between EUV capacity expansion and DUV capacity expansion outside mainland China. Based on this, we believe the foundation for this demand growth is solid.

Q: Regarding your 25% forecast, is this consistent with your forecasting method in previous years?

A: Overall, it is still the same. You could say we are slightly ahead this time, as based on the market dynamics mentioned by Christophe, we believe that achieving the high-end targets in the current stage is not realistic. Therefore, we have cautiously set the target within a lower range. Of course, in the coming months, we will continue to communicate with customers to understand their plans, etc. But overall, our outlook for next year and the forecasting method in the past few years are not significantly different

Q: Will the top three customers of the company quickly sign High-NA orders? Or will some customers delay decisions due to the uncertainty of EUV, which will certainly have corresponding impacts?

A: Over the past few quarters, we have consistently emphasized that all customers have already placed orders for High-NA tools, and all customers are closely collaborating with us in the High-NA laboratory. Currently, all customers are utilizing this time to collect data. In terms of data, in fact, all customers have already reviewed it. At this stage, all EUV customers are showing active participation in High-NA, and the insertion and adoption timelines are still generally consistent with what we previously discussed. The good data generated on the initial tools only further supports this process.

Q: You previously mentioned that issues faced by some customers have led to downside risks in 2025, but the upside opportunities from the increasing market share from logic chip customers have not materialized yet and have not been factored into your 2025 forecast.

A: Yes, this is also why we mentioned some upside factors in certain parts of the market.

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