Ladies and gentlemen, thank you for standing by. Welcome to the ASML 2017 third quarter financial results conference call on October 18th, 2017. Throughout today's introduction, all participants will be in the listen-only mode. After ASML's introduction, there will be an opportunity to ask questions. I would now like to open the question and answer queue. If you would like to ask a question, please press star one to register. If you would like to withdraw a question, please press star two at any time during the call. Your questions will be answered in the order that they are received. If any participant has difficulty hearing the conference, please press star zero for operator assistance. I would now like to turn the conference call over to Mr. Craig DeYoung. Go ahead please, sir.
Thank you, Peter. Good afternoon, good morning, ladies and gentlemen. This is Craig DeYoung, vice president of investor relations at ASML. Joining me today from ASML headquarters in Veldhoven, the Netherlands, is ASML's CEO, Peter Wennink, and ASML's CFO, Wolfgang Nickl. The subject of today's call is ASML's 2017 third quarter results. Questions will be taken in the order that they are received. This call is also being broadcast live over the internet at asml.com. A transcript of management's opening remarks and a replay of the call will be available on our website shortly following the conclusion of this call. Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve material risks and uncertainties.
For a discussion of risk factors, I encourage you to review the safe harbor statement contained in today's press release and presentation found on our website and in ASML's annual report on Form 20-F and other documents as filed with the Securities and Exchange Commission. With that, I'd like to turn the call over to Peter Wennink for a brief introduction. Peter.
Thank you, Craig. Good morning, good afternoon, ladies and gentlemen. Thank you for joining us for our Q3 results conference call. Before we begin the Q&A session, Wolfgang and I would like to provide an overview and some commentary on the recent quarter as well as provide our view of the coming quarters. Wolfgang will start with a review of our Q3 financial performance with added comments on our short-term outlook. I will complete the introduction with some additional comments on the current business environment and on our future business outlook. Wolfgang, if you will.
Thank you, Peter, and welcome everyone. I would like to first highlight some of the third quarter financial accomplishments and then provide our view for the coming quarter. Q3 net sales exceeded our guidance coming in at EUR 2.45 billion, partially due to the revenue recognition of an additional EUV system. Net system sales of EUR 1.82 billion was nicely balanced between foundry, memory, and IDM, and was more than EUR 400 million higher than in Q2. Installed base management revenue for the quarter came in at EUR 628 million, slightly above our expectations. Our gross margin for the quarter came in at 42.9%. Gross margin was diluted by the additional EUV revenue recognized but compensated by higher-than-expected DUV and Holistic Lithography sales. Overall, OpEx came in slightly below guidance with R&D expenses at EUR 315 million and SG&A expenses at EUR 103 million. Turning to the balance sheet.
Quarter-over-quarter cash equivalents, and short-term investments came in at EUR 2.68 billion. As highlighted during our July call, we resumed share buybacks in Q3. During the quarter, we purchased EUR 169 million worth of shares. Since January 2016, we have purchased a total of approximately 6 million shares with a value of EUR 569 million against our 2016 and 2017 authorization of EUR 1.5 billion. Moving to the order book. Q3 system bookings came in at EUR 2.15 billion. The growth in immersion and KrF order intake is an indication of the strength of our DUV business. Last quarter's strong bookings were driven by the memory sector, which represented 77% of orders compared to 40% in Q2. Our EUV backlog now reflects 23 systems valued at EUR 2.6 billion.
As for EUV orders, we are working closely with our customers to understand the EUV demand through 2020 and use this as the basis for our shipment planning. Actual order intake is always lumpy, and we do expect to take additional orders in Q4. Our overall system backlog now totals a record EUR 5.69 billion. With that, I would like to turn to our expectation and guidance for the fourth quarter of 2017. We expect continuing sales strength in Q4 with total net sales of around EUR 2.1 billion. While we target to ship 6 NXE:3400s in the December quarter, we expect revenue recognition of about EUR 300 million for our EUV business. We expect our Q4 installed base management revenue to come in around EUR 600 million. This revenue guidance for Q4 brings our total revenue expectation for 2017 to approximately EUR 8.6 billion, which reflects a greater than 25% year-on-year increase.
Installed base revenue will account for almost EUR 2.7 billion for the year, also reflecting a 25% increase. Total EUV revenue for 2017 will be around EUR 1 billion, which represents more than 2.5 times the 2016 level. Gross margin for Q4 is expected to be around 44%. R&D expenses for Q4 will be about EUR 315 million, and SG&A is expected to come in at about EUR 110 million. With this guidance for Q4, our total operating income for the year is expected to exceed EUR 2.25 billion, reflecting a greater than 35% year-on-year increase. With that, I would like to turn the call back over to you, Peter.
Thank you, Wolf. As Wolf highlighted, our business continues to perform very well, and demand for our products is very strong. Based on our guidance for the upcoming quarter, we expect to deliver another record year with net sales growth of at least 25% over 2016. Positive industry environment across multiple end market segments continues to fuel strong demand for our products as we move into 2018. While Wolfgang reviewed our current performance and outlook for the coming quarter, I would like to provide some commentary on the longer-term outlook of our market drivers, followed by an update on the progress and plans for our product groups. This year's memory strength will translate into a record memory revenue year for us. This, in combination with our strong memory backlog, seems to serve as a solid foundation for further growth into 2018.
As our customers further migrate next year to the sub 20-nanometer DRAM nodes, we benefit from a significantly increasing litho intensity for those nodes, driving litho intensity up over 30%. Additionally, we do not see significant near-term completion of new DRAM fabs. This is amidst a healthy mid-20s DRAM bit demand growth scenario, largely driven by demand for performance memory in the server space. All in all, a strong base for our 2018 DRAM business. In 3D NAND, litho demand is also strong with a number of greenfield fabs ramping. Current greenfield fabs take approximately 10% more litho spend than the previous 2D NAND fabs. As this technology scales vertically, there are challenges in building these very tall stacks. In response, some NAND memory manufacturers are implementing so-called stacks of stacks, where every new stack needs additional litho, driving litho intensity up by another 20%.
When adding the NAND opportunity to the DRAM business outlook for next year, we can see another strong memory year ahead of us. Logic demand remains solid, driven by the continued ramp of 10-nanometer, as well as the start of the 7-nanometer node. Litho intensity continues to increase as we migrate to future nodes and further strengthens with the adoption of EUV at 7-nanometer. As expensive multiple patterning schemes keep driving up the cost of every new node, EUV provides process simplification, cycle time reductions, and yield improvement, ultimately resulting in customer cost benefits, which clearly explains their stated desire to introduce EUV for their next nodes. With regards to China, we continue to see a revenue increase throughout the year and are on pace to set a new record net revenue from this region in 2017.
This trend of increasing sales to the Chinese region will continue in 2018, as we see strong demand from multiple customers building out fabs in China, including additional system orders from new domestic Chinese customers. We expect to see a number of new customers starting pilot ramps next year and are further expanding our customer support footprint in order to meet the future significant demand growth in this region. As we mentioned last quarter, we estimate the initial lithography opportunity of these new domestic Chinese customers to be around EUR 3 billion over the next few years. On the ASML product side, let me start with an update of our EUV business. In EUV, availability continues to make progress in both average performance as well as reducing variation.
In addition to delivering zero defect pellicles, we also demonstrated the capability of these pellicles to withstand 250 watts of power in support of 125 wafers per hour and beyond targets. We continue to work closely with our customers to align on their EUV demand plans and the required timing of tool shipments. Supporting our customers' delivery timing requirements depends predominantly on the ramp-up speed of our supply chain, specifically optics. Long lead time for EUV systems, combined with the inherent fluctuations of our customers' ramp plans, pose significant planning challenges. To address these challenges, we continue to work intensely with our supply chain to bring the lead times for EUV down from 24 to 18 months. Taking all of the aforementioned into account, we currently have a production plan of 20 EUV systems next year, at least 30 in 2019, and 40 plus in 2020.
In support of EUV production implementation, we shipped the first e-beam EUV reticle inspection tool, the eXplore 6000, to a logic foundry customer. This system enables improved defect detection as optical inspection has resolution challenges on EUV reticles. In DUV, we see continued revenue growth across the product lines driven by immersion and KrF technology. We provided early access to our latest TWINSCAN NXT:2000i immersion system for initial development of the five nanometer node. This new system features several hardware innovations that deliver improved imaging and overlay performance in support of aggressive matched machine overlay to EUV, which is required for future nodes. The very high demand for our immersion systems equals the fastest ramp of our NXE platform in history as we shipped the 100th NXT:1980Di system in Q3. Strong demand for our KrF products is across multiple market segments, but primarily driven by 3D NAND.
In Holistic Lithography, we shipped our first jointly developed product less than one year after closing of the HMI acquisition. This product, the ePfm5, is a pattern fidelity metrology system that leverages HMI's high-resolution e-beam metrology with ASML's computational lithography technology. This product's high-resolution capability enables a high capture rate of systematic patterning defects so customers can accelerate their yield learning curves and drive higher production yields. This integrated system enables the first-ever guided metrology, delivering faster, effective throughput in support of volume production. In summary, with demand growth continuing across our entire product portfolio, we expect another record year with at least 25% revenue growth, largely driven by continued strength of memory demand alongside solid logic demand. Although it's too early to fully quantify 2018, our current view is that the positive business trends that we're seeing in 2017 will continue in 2018.
With that, we'll be happy to take your questions.
Thanks, Peter. Ladies and gentlemen, the operator will instruct you momentarily on the protocol for the Q&A session. Beforehand, I'd like to ask that you kindly limit yourself to one question with one short follow-up, if necessary. This will allow us to get as many callers in as possible. Peter, could you have your final instructions and then the first question, please?
Well, sir. Thank you. Ladies and gentlemen, at this time, we will begin the question and answer session. Again, if you have a question, please press star one to register for a question and star two to withdraw a question from the queue. If you're using speaker equipment today, please lift the handset before making your selections. One moment please for the first question. First question comes from Mr. David Mulholland. Please state your company name, followed by your question.
Hi. Thanks for taking the question. Just firstly, I think one of the interesting comments you made on the 3D NAND shifting to customer stacking. I wonder if you could just help us to understand how broadly you see that happening throughout the customer base in 3D NAND. Is it selectively or all of your customers are moving towards that trend? Secondly, on EUV, just one quick update. As a follow-up, if you could, I think on the last call you mentioned there was potentially going to be EUR 500 million of revenue to be caught up or unrecognized at the end of this year. Is that still the case? Could you help us understand when we should expect that to be recognized into 2018?
Yeah. I'll answer the first one. I'll give the second question to you, Wolfgang.
Yep.
The idea of 3D NAND, how broadly do we see that? We see that with a few customers, not with all of them. What we understand is that customers have similar issues. You can always argue at what level of stacks do they encounter those issues, and that might be different from customer to customer. I think it's our belief based on the feedback that we get from customers that ultimately they will all have to get to some kind of a stack approach. It has started, and it has started not with all of them, but with a few customers.
Dave, on the deferred revenue and EUV, you are correct. Same thing like what we said last quarter. We will carry a significant deferred revenue balance into next year, which means that our total revenue for next year will be higher than what the 20 shipments that we have planned. Of course, the four upgrades that we also still plan to do. The total revenue will include some of that deferred revenue, and there will be a little bit of revenue deferred of the 20 systems, but the majority will be recognized. Therefore, we continue to say that for next year, you should use a planning assumption of around EUR 2.5 billion for total EUV revenue.
If I may just quickly follow up on the profitability of the deferral. Is that still quite dilutive on what you are recognizing for the three tools in Q4? Is it very profitable next year, or is there less difference in the deferral this time around?
It's very different by different line items, for your planning purposes, just assume the same profitability.
That's great. Thanks very much.
You're welcome.
The next question comes from Mr. Farhan Ahmad. Please state your company name, followed by your question.
Farhan Ahmad from Credit Suisse. Thanks for taking my question. My question is on the memory. You're seeing very strong orders in Q3. I just want to understand what's the sustainability in that business. Is there any concern that there might be too much additions? If you can give some color on how much of it is new capacity versus just conversions, that will be helpful.
The answer on the new capacity is a difficult one, like I said. Let me first answer your first question on the sustainability. On DRAM, like as I said in my prepared remarks, there are no significant new fab plans that will take tools in 2018, so next year. In other words, in terms of new fab capacity, it will be pretty limited what you will see in terms of wafers out in 2018, which actually means that the bit demand, which is currently around the mid-20s, needs to come from a shrink, from innovation, which actually happens. There's a lot of innovation happening in DRAM. We go sub-20 nanometer, and that will provide those bits. At least that is what the expectation is. I would support that the innovation drive should be sufficient to deal with the demand, but it would be no relief.
On 3D NAND, a lot of greenfield fabs. That means that there's a lot of shipments to those greenfield fabs. When we look at the forecasted bit growth in NAND, this is really where the big question is, whether that bit growth is going to be able to absorb all that new capacity in 2018. We don't know yet. Currently, we've been surprised also this year about a bit stronger bit demand growth than we originally anticipated. That's where probably a bit of a question is, probably too early to answer. All our memory customers, they indicate that also on 3D NAND, they see significant bit growth next year from a demand side.
If anything, if you would want to place a question on sustainability, start asking our customers on what they believe, how much capacity is now added or will be added in 2018, and what they think about the demand situation. The demand situation, of course, we're further away from that, so it's more difficult for us to give you an answer in that direction. What is new capacity? Well, I actually answered. I said new capacity is, a lot of new capacity is being added in the 3D NAND space. Not a lot of new capacity in the DRAM space. All in all, if we look, like I said in my prepared remarks, what the drivers are, very much the end drivers, as customers tell us, are server markets, are the markets for the take-up of the new 3D NAND products.
All looks very healthy, and customers are very upbeat, as also evidenced by the intake in our order book in Q3.
Thank you. A quick question on EUV. Can you just remind us what are the main bottlenecks that you have in terms of the supply chain, which you are working on?
The main bottlenecks, as I mentioned also in my prepared remarks, are the lenses, the optics. The optics are the gaining item right now. We're working very hard with ZEISS to make sure that we can get a bit more output. As we currently see it, we've mentioned the numbers, which are about 20 for next year, at least 30 for 2019, and 40 plus for 2020. That is what our current planning is. We also have started to run programs with our supply chain to shorten the lead time and to shorten the cycle time in their factory. The total lead time for EUV can come down from 24 to our target by 2019 of around 18 months. We're working hard, but it's currently optics.
Thank you. That's all I have.
The next question comes from Mr. C.J. Muse. Please state your company name, followed by your question.
Good afternoon. CJ Muse with Evercore ISI. Thanks for taking my question. I guess first question, on the EUV front, specifically to memory, can you provide an update on where we are in terms of DRAM adoption at 1y? As part of that, are you including a meaningful number of tool shipments in your 30 shipment outlook for calendar 2019?
On memory specific?
Yeah, just DRAM specific. Yeah.
Yeah, I think we don't single out the DRAM memory customer or customers in 2019. That would be not wise to do that because it would pinpoint to specific customers, and we wouldn't do that. For EUV memory DRAM, initial adoption is currently targeted the end of next year. That means the drivers for that are, of course, the productivity of the tool, but those targets are in our roadmaps. That would mean initial adoption for initial production at the end of 2018, going into 2019, in that time frame.
Very helpful. I guess as my follow-up, Wolfgang, can you talk about gross margin trajectory for EUV as well as the entirety of the company? I think you talked about 20%, if my memory serves me right, for calendar 2018. I'm curious, does that include the benefit of deferred revenues in the mix? Then as a second part to that, when do you think at high volume, call it six, seven, eight EUV tools per quarter, can you get to kind of a 45-plus % gross margin overall?
Okay. CJ, our plan stands as we have communicated it before. The target is to get to close to breakeven or breakeven this year, and that includes everything, all the numbers. If you include everything, you include service, it includes the systems, includes the deferred revenue rollover. For 2018, we're targeting 20%, and our objective for 2020 is 40%. We haven't quite spelled out 45% yet. We have also said that 40% is not the end of the road. If you look at our other businesses, they return more than 40% gross margin. That would always include the deferred pieces as well. Even this year, 20 in 2018, 40 in 2020, and 2019 somewhere in between 20 and 40.
Very helpful. Thank you.
You're welcome.
The next question comes from Mr. Mehdi Hosseini. Please state your company name, followed by your question.
Thanks for taking my question. The first one has to do with your EUV manufacturing. What would be your shipment forecast if your manufacturing cycle time is actually being reduced to 18 months? Specifically, where would the 30 and 40+ units in 2019 and 2020 would go to?
That's a good question. That's an interesting question. I think what we can say is that the customer demand that we're seeing for 2019 is in excess of that 30. We can just add it all up and then think about two years ahead and what customers indicate to us. That is, I would say, decently above that 30 number, and decently means that it's at least 30% from that number. How much it in fact would be in 2019 is a bit difficult because it is still two years out. What we're currently seeing is that would be about 30% higher than the number that we quoted you.
Got it. It's been a few quarters since you have broken out the metrology and inspection. Maybe this is more for Wolfgang. Can you help us? How should we think about revenue contribution in 2017, and where would it go into 2018? Is there any parameters or any metrics that you can offer us so we could better model this?
Yeah, the one thing that we have been clear on is, a good chunk of that is, of course, the newly acquired Hermes Microvision, Inc. business. There we said that revenue this year will significantly increase, almost double, albeit from a relatively low level last year. It will be somewhere in the $220, $230, somewhere in that range. That business will continue to strongly grow next year, based also on the eXplore product and the ePfm5 product that Peter Wennink had in his introductory remarks. A little bit too early to put a number in, but it is a significant step up, all in support of a business that is going to be around $1 billion in 2020.
I think what I was trying to get at is, if there are two buckets, EUV and DUV, which one of these two buckets or factors are going to be critical in sustaining the growth and hitting that EUR 1 billion revenue target in 2020?
It is not that easy to tie it to one or the other. It has to do with the total production process and the total development process of our customers. We do not look at it this way. We just look at it as a total inspection and metrology business.
Got it. Thank you.
The next question comes from Mr. Jagadish Iyer. Please state your company name, followed by your question.
Yes, Samit at Stone Partners. Two questions. Peter, first, in terms of the pattern fidelity metrology that you provided, how big can the market be, and can you clarify in terms of the adoption between foundry logic as well as memory customers? I have a brief follow-up.
On the last question, it is predominantly being used initially, I would say initially, by logic because that's where the biggest challenges are because of the more random patterns that you will see there. That will be the first area where you would see the introduction. As we've seen with all these solutions that ultimately provide customers with more certainty what happens on the wafer and gives them the ability to make changes so that they can really manage yield, that also crosses over to the memory products also. We've seen the same with YieldStar that started in logic, and it also moves now over into the memory space. How big is that market?
Well, it's a good question because we're actually, it's a product for which a market does not exist yet because it's a product that actually, the pattern fidelity metrology, where you use the predictive capability to actually manage yield through the scanner is a completely new area. We have our ideas on what it can mean. We think it can create a lot of value. If you look at the first PFM, the pattern fidelity tool, metrology tool that we're shipping this year, we're shipping a few, but the first one we did in Q3. That has a high level of interest with our logic customers. How big is the market? Depends on the value that we're going to provide. We have high hopes and expectations, that needs to be basically worked out together with the customer, because you really show the value on the wafer.
That jury is still a bit out, but we have high hopes, and especially because it provides a feedback and feedforward loop that nobody else does.
Okay. Thanks for that. Just as a follow-up, you had an e-beam inspection product rollout for this EUV mask.
Yeah.
Where do you see the insertion point for this product? What time frame, and where do you see that ramping through 2020 and beyond? Thank you.
Well, I think we see that ramping at the same time as we ramp EUV. You need EUV masks, you need the inspection of EUV masks. That's why we are start shipping the first tools now. Those will not go into volume production because volume production really initially starts at the end of next year, of course, of next year and going into 2019. This is the time frame where you also need to see the ramp of this product.
Thank you.
Next question comes from Andrew Gardiner. Please state your company name, followed by your question.
Good afternoon, gentlemen. It's Andrew Gardiner from Barclays. I just had a couple of modeling questions for you, Wolfgang. As we sit here towards the end of 2017, I was just wondering if you could start to give us a bit more of a steer on some of the OpEx items in 2018, particularly around R&D. You guys have been pretty consistent this year at about EUR 315 million a quarter. Just interested how that might step up, particularly when we consider the contribution to ZEISS next year. Likewise on capital spending, particularly as you're continuing to fit out for the EUV ramp. Finally, just do you have any thoughts on tax? I know the tax proposal by the coalition government in Holland, not yet finalized, but have you guys looked at how that might impact your ongoing tax rate? Thanks very much.
Very good. Hello, Andrew. OpEx first. Let's start with SG&A. SG&A should grow only very modestly. We have very few variable pieces in there, but we invest a bit in sales, we invest a bit in HR, a little bit in IT systems. I think that will be growing at a much lower rate than the revenue, and we'll stay around that 110 rate, probably a little bit up. If you look and our objective there for 2020 is 4% of revenue. For R&D, we're going to add up to EUR 125 or EUR 126 for this year, which is based on our revenue guidance now with the fourth quarter somewhere just shy of 15%. If you contrast that 2014, 2015, 2016, it was 18%, 17%, 16% respectively. We're around 15%. We will spend more in absolute terms next year, exactly for the reasons that you mentioned.
High-NA both on our premises, but then also on ZEISS SMT's premises. We do continue to invest strongly also in the Holistic Lithography field. We're actually accelerating investments there. A bit too early to give a number. It will be up, but I think it will be 14%. It will come down in relative terms towards our target of 13% in 2020. CapEx, we are not that super CapEx intense ourself. We spent around EUR 200 million for the first nine months. We usually don't guide that, but assume that we're getting out somewhere within EUR 270-EUR 280. The last three years were somewhere between EUR 310 and EUR 370. This year will be around 3% only of revenue.
Our long-term model is 4%. There you should expect it to come up a little bit over the next two or three years, but not beyond the 4%, I think, that we have in the 2020 model. That is indeed to prepare the site for High-NA prototypes and High-NA manufacturing later on. Tax rate model is 14%. The innovation box negotiations have been going very well. We're in the documentation phase, so we have a principle agreement. We're in the documentation phase that very well supports our 14% model. As it relates to the outcome of the coalition negotiations here in the Netherlands, there's no law yet. That's just a proposal. If that comes through, the benefit of the innovation box will reduce slightly. Without going into the technical details, will reduce slightly, but it's accompanied with a reduction in the corporate tax rate.
Both are literally offsetting to each other. There may be a slight timing difference that the reduction of the benefit comes earlier than the reduction of the corporate tax rate. I think that will not be a significant impact on the 14% model, Andrew.
Okay. That's great detail. Thanks very much.
You're welcome.
The next question comes from Mr. Francois Meunier. Please state your company name, followed by your question.
Yes, thanks. My question is regarding the ecosystem of EUV. In your opening remark, you talked about the pellicle withstanding 250 watts
EUV beam, which is really good. Hopefully, it doesn't get too dark too quickly. If you would give us a bit of an update regarding the other elements of the ecosystem, like the photoresist, the mask manufacturing, also maybe more long-term, the actinic mask inspection tool that we've been waiting for a very long time now.
Yeah. To start with your last call with the actinic inspection tool, it is not an issue where we are today. I don't think it's going to be an issue for the 7-nanometer ramp either. We're going to do pattern inspection, so you basically print the photo mask, and you inspect the pattern on the repeatable defects, then you can know where it is on the photo mask, and you inspect the photo mask with e-beam, preferably. Then you can do the correction. Masks, I think we have all the solutions that we can think of for the 7-nanometer introduction. Photoresist actually makes some good progress, especially on the sensitivity side.
We're seeing continuous numbers coming back out of the industry and industry participants on the sensitivity of the photoresist, which is good because the more sensitive the photoresist is, the faster you can move the wafer, the higher the throughput. Pellicles you just mentioned, pellicles being able to withstand 250 watts of EUV power is very good. I think from an ecosystem point of view, all those elements are increasingly coming to the phase where you can call them mass production-ready.
That's great. Thank you.
The next question comes from Mr. Sandeep Deshpande. Please state your company name, followed by your question.
Hi, JP Morgan. My question is regarding DRAM, Peter. DRAM is possibly likely to use EUV in 2019, but there haven't been new DRAM fabs built in the last virtually in the last decade, with DRAM capacity having been converted to NAND, et cetera. Do you see that to actually, with the footprint of the EUV tool, et cetera, that to get the EUV tool into DRAM fabs, do you need actually new DRAM capacity built? Or based on what your field application engineers know already, that these existing fabs can be actually upgraded to EUV once the conversion starts? How quick do you expect a memory DRAM conversion to happen? I have one quick follow-up after.
Yes. I think on the first shipment to DRAM fabs will be to existing fabs. We don't need to build new fabs to house in EUV tool. However, if you say we're going to use EUV more broadly and widely in DRAM in the next decade, I'm pretty sure there's going to be fabs built that can accommodate larger number of EUV tools. Now, as a matter of fact, when you said the last decade, no new DRAM fabs, I may remind you that we had in Korea L17 and M14, which were completely new fabs, which actually are very large fabs. That actually drove up the available capacity a couple of years ago, three, four years ago, to quite significant heights, which I think also led to a oversupply of DRAM at that time.
Well, that's not happening today, where we're not seeing the announcements of any major new DRAM fab. That means that the EUV tools that we will be shipping, we'll be shipping to existing fabs that will be able to take them.
Quickly following up, you've taken a stake now in Carl Zeiss, and how that will be showing up on your P&L maybe for the full year this year or next year? There will probably be a dividend payment from Carl Zeiss, and then there's going to be outgoing payments from you regarding funding their CapEx plans for High-NA as well as the R&D for High-NA.
Okay. I'll take that, Sandeep. If you recall, we have entered into two separate contracts. We have an equity investment, and then we have a High-NA agreement. The equity investment is EUR 1 billion for 24.9%. That is already showing on the line equity method investment. If you look to our US GAAP statement, you already see that there. That will show a P&L contribution from Carl Zeiss's profit to us. There's basically 24.9% of the profit is going to show in our P&L. It will show for the first time in Q4. You see the investment already, but you don't see any contribution in Q3. That simply has to do with our close process being faster than SMT's close process. The accounting rules allow us there to do a three-month offset.
For Q2, we only really had four days, so we didn't bother to put that in Q3 because it's not material. We will walk you through the math on how that profit will show up in our P&L because it wouldn't be accounting if it would be easy, because we'll have to do a lot of adjustments here. First of all They are IFRS. We have to translate that into US GAAP. Believe it or not, at 24.9%, you need to do a mini purchase price allocation, so there will be some amortization of intangible, the write-up of inventories, all the good stuff that you know. It will be slightly convoluted at the beginning, but the end result, and from a cash perspective, SMT is a very healthy, profitable business, and we'll get solid returns on our investment there.
As it relates to the High-NA agreement, we will make R&D contributions, and we will make CapEx contributions. The R&D contributions will show up in our R&D line. Again, it gets complicated. Some of it has to go through the equity piece because we're a partial owner as well. The CapEx piece will be recorded on our assets, PP&E prepayments. As a reminder there, the return on our investment, other than getting a High-NA tool, is that we get these investments back through adjustments to the price of the lenses later on when we take delivery of the lenses. Similar to what we have done previously with our partner there.
Right now you have just R&D in there, a couple of prepayments and the investment, and then starting next quarter, you'll have some of the profits in there as well, and we'll walk you through in more detail then in January.
Thanks, Woflgang.
You're welcome.
The next question comes from Mr. Adithya Metuku. Please state your company name, followed by your question.
Yeah. Good afternoon, guys. It's Bank of America Merrill Lynch. I have basically a quick question on EUV gross margins in the third quarter. Maybe if you could give us some color around that and if you still expect EUV to be at a break-even level this year, given you are deferring a lot more EUV revenues than you were expecting to defer at the end of the last quarter. Secondly, just as a follow-up, if you could give us some color on what drove these deferrals. Last quarter, I was thinking you'd be doing around €1.1 billion in EUV revenues, and now it looks like it's going to be a bit lower than that. Thank you.
First of all, objective is still to get the year to break-even level. Then, like we said, 20% next year, 40% in 2020. We've always said we will be above EUR 1 billion. I think at the beginning of the year, we said EUR 1.22 billion. It always depends on which customer do you ship to and when do you ship. Admittedly, the 12 shipments this year are back-end loaded. From that perspective, a little bit more goes into next year. Deferrals, in general, are driven by multiple different items. It could be if you have a new component in the system, which you can demonstrate in your factory, but you have to replicate in the customer factory to take full revenue. That is the main reason why the revenue this year came down. We have made an adjustment to some systems.
It's not a performance adjustment, it's a maintainability adjustment, which is good news because it will help us down the road with service profitability, which, if you recall, is the main contributor to get to the 40%. Since it's a new feature, we cannot go straight to what we achieved last year, revenue recognition at shipment. We got to replicate it at what we call SAT, which is the Site Acceptance Test at the customer. It's a little bit deferred. That's the difference from the beginning of the year, but it's good news. I think the rest we said earlier, we have a deferred balance that we will start netting into the number in 2018.
Very clear. Just a quick clarification on the R&D next year. Did I hear you correctly? Did you say it was going to be 14% of revenues?
Yes, I said this year is around 15%, next year will be around 14%, it will go up in absolute terms. Right now, if you model 14%, you should be okay.
This year, looking at it so far, it looks like it is more around 13.5%, not 15, unless I am Actually, ignore me. That is fine, thank you. Sorry. Apologies.
We made progress, but I don't think we made that much progress.
No, of course. Ignore me. Sorry, that was my bad.
No worries.
Next question comes from Mr. Weston Twigg. Please state your company name, followed by your question.
Hi. Thanks for taking my question, with KeyBanc Capital Markets. I had a couple questions. First, just on the uptick in IDM revenue, I was wondering if that was more EUV revenue recognition related, or if you're seeing a pickup in the 10 nanometer ramp, is that increase in demand level sustainable moving forward?
Mainly driven by 10 nanometer, there was a system ship there as well in EUV, a little bit of both.
Okay, thanks. As a follow-up, the install base revenue, it's coming down quite a bit in the second half from the first half. Just wondering if you can help us understand what kind of growth you expect 2018 on that, the line item.
I don't think they were going to that detail, probably in general on 2018. There have been a lot of questions there as well lately. Can't be completely quantitative on this right now, but I think we can give you a few pieces that help you form an opinion, and certainly don't want to go down to a customer level here. We already talked about EUV. We get to EUR 1 billion this year, we get to EUR 2.5 billion next year. That's a EUR 1.5 billion increase. You will have seen an extremely strong install base revenue this year. We're going to almost EUR 2.7 billion, which is up 25%. If you recall, we said in our longer-term trajectory, we see that business going up an average by 10%.
Of course, the service part of it is a pretty stable growth as a function of the install base. The options and upgrades are a little bit more volatile. I would, right now, assume that that business is flat to slightly up next year. For the rest of the business, the combination of EUV, Holistic, in memory and in logic, we had experienced an extremely strong year this year. We see 2018 at approximately the same level. You have a bit of evidence there also when you look at our backlog. There's a EUR 5.7 billion in backlog. Even though we don't guide to backlog, I think the Street expectation was about just over EUR 1 billion in new orders for last quarter, we took almost twice as much, EUR 2.1 billion.
I think, without going into customer details, but you should expect another very strong 2018 from us.
That is very helpful. Thank you.
The next question comes from Mr. Doug Smith. Please state your company name, followed by your question.
Yeah. It is Doug Smith from Agency Partners. Wolfgang, I was wondering if you could perhaps give us an approximate breakdown of the R&D spend between the EUV metrology and inspection and DUV.
If we get to about EUR 1.25 billion, roughly, you see about half of that being spent on EUV. I do not know how far we have gone. On the other half, you have a good chunk of what I would call fundamental research that benefits all businesses. It is less than EUR 100 million, and then the balance of EUR 500 million is overweight towards DUV. From a directional perspective, EUV. We are still investing, by the way, because we still have significant innovation. You heard about the 2000 coming out, for instance, now, with us having upgraded the field system to this 2000 level. The rest is a bit more overweight to DUV, which over the next couple of years will start to come down. Applications, we are investing very heavily, like I said earlier, in metrology.
Right. It is getting pretty close to the anniversary of the analyst meeting last year, where you provided a 2020 model update. I was wondering, when would you expect to update that again? A lot of other companies have provided some 2020 models based on an upwardly revised WFE market.
Yeah. We haven't scheduled that yet. We did one in 2014, we did one in 2016, it's probably a good assumption that somewhere in 2018, we're going to do one. I think we gave you quite a bit to work with because we pinpointed at EUR 11 billion revenue, we gave some sensitivities both around the market vector and the EUV intensity vector. We're not updating this today, but I think what you can say is that the EUV adoption is well on the way, the layer counts are not on the low end as we talked before. Also, if anything, the market is very enthusiastic about end demand. Without updating it today, I think the probability on the low-low or the lower combination has gone down since the year.
Expect we haven't picked a date yet, I would say somewhere next year we're going to do a session.
If I may add, Doug. I think we actually gave you, also at the analyst day last year, a few scenarios, Wolfgang alluded to it, that you could argue that the, let's say, low scenario has become less likely. I think you guys, looking at where the market is, I think we gave you enough information to just pick whatever you feel is more appropriate right now. I think an update on that model is really something we will do next year. I think you have enough to work with. By the way, we first started to talk about 2020 two years ago. I think it's good that we have some followers now. No reason for us to come out with something different.
May I remind you of the fact that a year, a year and a half ago, people were saying we were way too optimistic on our 2020 targets, now people seem to indicate that we're too pessimistic on that target. We just stay very consistent on what we've said, I think we've given you enough to work with to the upside if you believe in that.
That's very true, and that's quite correct. Okay, thanks a lot.
The next question comes from Mr. Amit Harchandani. Please state your company name, followed by your question.
Hello, everyone. I'm Amit Harchandani from Citi, and thanks for taking my question. I really wanted to touch upon the topic of High-NA EUV. Given the enthusiasm and the strong progress you have made around EUV, how are your conversations happening right now with your customers? What kind of traction or commitment are they showing towards High-NA EUV? Do they want you to accelerate adoption? If so, what would make you do that? What would that mean in terms of the supply chain besides the ZEISS deal that you have already carried out? Very keen to understand how the thought process is right now around High-NA EUV adoption. Thank you.
Yeah, I think it's a very good question. I think in the latest discussions we've had with customers, there is no doubt they see the benefit of EUV, full stop. The question is about timing. We do see that from a timing point of view, there are some different requirements from customers from when they want to have the first tool. Some of those customers would indicate, and we have had some pretty recent and deep discussions with them on what we could do then. Some of those customers indicated they would like to have this capability rather sooner than later. If that would mean that we would have to set up an accelerated program, that actually means that we would also ask our customers to commit also in the acceleration and the cost of that acceleration.
That would be, I think, a precondition for us to accelerate. This is the level of discussion that we are having today. It's not superficial. Those are pretty deep discussions, and we're pretty clear also on what it would take to accelerate and what our commitments from the customers, how that would have to look like. Which, by the way, we haven't reached an agreement yet, just for your information. On the supply side, the gating item here is really the new optics. The optics that comes from ZEISS, this is exactly why we did what Wolfgang explained earlier. With the investment in ZEISS, we signed the R&D and the CapEx program. That's the gating item. Don't forget, from an EUV source point of view, the EUV High-NA tool will have the same EUV source. No source difference.
The tool will be bigger, but we know how to deal with that. The real challenge is in the optics, and this is why we have started to go into this agreement with Carl Zeiss. I would say that from this point onwards and from this moment onwards, that's really the gating item in the supply chain.
Thank you, Peter. Just maybe as an unrelated follow-up, you obviously had no EUV orders in this quarter, but I understand that you work on a commitment basis. You're in close touch with your customers. You could potentially still be doing some work in progress, even if the administrative stuff hasn't happened. At what stage does it become a balance sheet risk and you say, "Okay, we really need these orders, otherwise we cannot just keep on working based on the conversations." Is there some kind of limitation or some hard line? I guess where it's coming from is what's the minimum level of orders I would need to see next quarter in order to ensure you to still end up shipping 30 or at least 30 shipments in 2019?
Well, I think what you would then need to see is that 2018 is fully booked and the first part of 2019 also. Like I said, we're also working closely with our supply chain to get some of the cycle times down. Actually, that should result over the next couple of quarters into at least a lead time reduction. Don't forget, the order pressure is really driven by the fact that we have a 24-month lead time in total. Which is, of course, very, very long if you look at the planning process of our customers. I have no worry that we will be at that point where we close out 2018 and moving nicely into 2019 also as a result of the order intake in Q4.
Thank you for the clarification, Peter. Thank you for the questions.
Ladies and gentlemen, with that, we've run out of time. If you were unable to get through on the call and still have a question, feel free to contact the ASML investor relations department with your question. With that, I'd like to say it's been my great pleasure to host 60 or so of these quarterly conference calls over the last many years. With this call, it will be my last. As previously shared, I will be turning over my global IR management responsibilities with this quarter's results to Skip Miller, therefore, you'll be hearing his voice instead of mine each quarter going forward. With that, I'd like to thank you for your mostly strict adherence to my call instructions and your kind patience in any safe harbor references I might have made over these many years.
Now, on behalf of ASML's Board of Management, I'd like to thank you all for joining us today. Peter, if you could formally conclude the call, I'd appreciate it.
Sure. Ladies and gentlemen, this concludes the ASML 2017 third quarter financial results conference call. Thank you for participating. You may now disconnect your line. Thank you.