Welcome to the Applied Materials Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, you'll be invited to participate in a question-and-answer session. As a reminder, this conference is being recorded. I'd now like to turn the conference over to Michael Sullivan, Vice President of Investor Relations. Please go ahead, sir.
Thank you, Kyle. Today, we'll discuss the results for our third quarter, which ended on July 26th. Joining me are Gary Dickerson, our President and CEO, and Bob Halliday, our Chief Financial Officer. Before we begin, let me remind you that today's call contains forward-looking statements, including Applied's current view of its industry's performance, products, share positions, profitability, and business outlook. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements and are not guarantees of future performance. Information concerning these risks and uncertainties is contained in Applied's most recent Form 10-Q and Form 8-K filings with the SEC. All forward-looking statements are based on management's estimates, projections, and assumptions as of August 13th, 2015, and Applied assumes no obligation to update them. Today's call also includes non-GAAP adjusted financial measures.
Reconciliations to GAAP measures are contained in today's earnings press release and in our reconciliation slides, which are available on the Investors page of our website at appliedmaterials.com. Now, I'd like to turn the call over to Gary Dickerson.
Thanks, Mike, and good afternoon. At our recent analyst event at SEMICON West, we outlined how Applied Materials is focused on delivering profitable growth. Overall, the company is executing well, as seen in our third- quarter results, where we delivered our highest quarterly earnings in the past four years, the highest service revenue in our history, and more than $2 billion of 300 mm semi equipment orders, which is also a record. While progress towards our strategic goals and financial model remains on track, changes in the business environment over the past few weeks have created some near-term headwinds. Looking at the market as a whole, we now see 2015 wafer fab equipment spending being approximately flat relative to 2014, with potential downside risk.
The most substantial revision to our outlook is foundry spending, where we have lowered our estimates for the remainder of the calendar year. This is primarily due to customers managing excess inventory, improving their yields, and reusing equipment. While we see a pause in capacity additions, the leading foundries are still aggressively pursuing 10 nm technology, and we expect this to become a key battleground in 2016 with the build-out of pilot production. As we have discussed before, the 10 nm node expands the available market for Applied and plays to the strengths of our leadership businesses. With the majority of development tool selections already made, we are confident about our growth opportunities at this node. In logic, we do not see any major changes to our previous outlook, and the cadence of our development roadmap remains tightly aligned with our customers' needs.
In memory, 2015 continues to be a year of strong investment. DRAM bit growth is in the 20%-30% range, with supply and demand more or less balanced. We maintain our view that 2015 DRAM spending will be around 20% higher than last year, driven by 20 nm upgrades and some capacity additions. Most significantly, we are increasingly optimistic about the pace of the transition from planar to 3D NAND. Our customers are telling us they are under significant pressure to ramp this technology faster because of its performance and reliability advantages. Consequently, we see the build-out of 3D broadening and accelerating. We expect installed capacity will now surpass 150,000 wafer starts per month by the end of calendar 2015.
While this number is higher than anticipated at the start of the year, it only represents around 15% of total NAND capacity. These are still the early phases of the build-out, and as the adoption of 3D NAND speeds up, it will become a more meaningful driver of Applied's growth. Our NAND orders were at an all-time high this quarter, and we expect our [combined and etch] and CVD share at these customers to grow between seven and 10 points during the 3D NAND inflection. 3D NAND is also enabling us to expand the available market for our EPI products by between 5%-10%. In display, the shift to 4K TVs and larger average screen sizes is sustaining area growth in the 10% range, which supports ongoing investment in new TV capacity.
In mobility, our customers continue to invest in LTPS for high-resolution screens. The penetration of OLED displays is ahead of our prior forecast. We now believe that around one in five smartphones shipped in 2015 will use OLED technology. Currently, mobility makes up a large part of industry investment. This spending mix is not as favorable for us. When combined with the weak yen, our display business faces some margin pressures over the next few quarters. The overall market trends are positive. We are on track to grow in line with our financial models. As we discussed at SEMICON West, the entire Applied organization is focused on delivering for our customers and shareholders. Our strategy and investments are aligned so that Applied is in the best position to address major materials innovation challenges in semiconductor and display.
We have developed a very strong product portfolio targeting key inflections and are demonstrating significant traction with new products. Our etch Sym3 chamber that we officially launched last month is one of the fastest ramping products in Applied's history. By the end of our first quarter of 2016, we expect to have shipped around 450 chambers. This product is enabling us to grow our overall etch market share, and this year, we believe we are adding to the seven points of gains we made between 2012 and 2014. In the past few weeks, we secured major application wins in 3D and patterning, giving us increased confidence that we will continue to make gains in 2016.
We also have very strong pull for our Olympia ALD tool as customers are telling us that ALD film quality is one of their top issues for 10 nm device performance. We are expecting to ship more than 50 chambers by the end of our first quarter. Our service business is also delivering profitable growth. Our AGS revenues were at record levels again this quarter, and 2015 remains on track to be the biggest year in our history. We have made some significant improvements to our service business and aligned our strategy to enable customer success. We have brought together capabilities from across the company so that we can deliver and capture more value with our service products. We believe that this momentum is sustainable and service is a meaningful component of our long-term strategy for profitable growth.
While we are maintaining investment in development programs that support our strategic priorities to increase share in wafer fab equipment, grow our service business, and expand our total available market, we are equally focused on reducing operating costs and the complexity of our organization. We recently made enhancements to Applied's structure that will enable us to accelerate those opportunities that are most critical to our growth. By aligning the organization around key areas of value creation, we are improving the way we collaborate with customers and speeding up the delivery of new products and services to meet key technology inflections. In parallel, as we navigate the near-term industry environment, we remain highly focused on managing our expenses and financial performance. We are carefully prioritizing R&D investments while reducing discretionary spending.
To provide you with more details about the actions we are taking, as well as our financial results and outlook, let me now hand the call over to Bob.
Thanks, Gary. Good afternoon, and thank you for joining today's call. Applied delivered strong results in the third quarter, posting our highest revenue in the past three years. Over this period, we have repositioned the company to capitalize on key inflections in foundry, logic, and memory, and increase our share of WFE. As Gary has already mentioned, our strong position in foundry will drive further growth when 10 nm ramps next year. I'll take a moment to summarize how the changes we've made to our strategy and investments have improved our position in today's memory-driven environment. We expect memory spending to make up nearly 50% of WFE in 2015, compared to less than 25% in 2012. Over the same timeframe, Applied's memory revenue is on track to grow by more than 150%.
We are significantly outpacing the market and believe we are gaining four points of market share in both DRAM and NAND. Within NAND, the 3D inflection is gaining momentum with a broader set of customers. Based on new product positions across the customer base, our share of 3D NAND spending is now approaching the high levels of share we have in foundry. At the product level, our substantial investments in etch and CVD are having a positive impact on our results. This past quarter, we secured our second-highest etch orders in the past 15 years, as well as our highest CVD orders ever. Importantly, through our strong engagements with customers, we have developed a deep pipeline of new and disruptive products that give us further opportunities for share gains and profitable growth as semiconductor and display technology inflections play out over the next several years.
I'll comment on our third quarter results. Revenues of $2.5 billion were up 10% year-over-year. non-GAAP gross margin of 43.9% was slightly higher than expected. Non-GAAP EPS of $0.33 was at the midpoint of our range. We used $625 million to repurchase 32 million shares of stock, deploying more than 20% of our three-year, $3 billion buyback authorization in the first quarter of the program. We will continue to be opportunistic with the buyback. Including dividends, we returned nearly $750 million to shareholders. I will make some comments on our segments. Silicon Systems' orders of $2 billion were up 18% sequentially and set a record.
This performance was led by strong 3D NAND momentum across multiple customers, notably in Japan, where revenue is recognized upon sign-off. Backlog was at an eight-year high, net of an $84 million reduction, due mostly to an order cancellation in Foundry. We also significantly reduced our Q4 Foundry forecasts. AGS posted a second consecutive quarter record revenue and remains on track for a record year. Display orders more than doubled sequentially, including a large order for our new CVD encapsulation tool for OLED displays. Let me provide some additional insight into our gross margin and OpEx patterns. Over the past two years, we have made significant progress with our gross margins. This year, we are experiencing headwinds due to mix effects and the higher initial cost of new products.
As Gary explained, overall WFE demand is trending lower versus earlier forecasts, with memory higher and foundry lower. We are seeing exceptionally strong pull for our new semiconductor products. In display, our revenue mix is rapidly shifting to mobile. Taking these factors into consideration, we are modeling Q4 non-GAAP gross margin to be down by about two points sequentially. We are driving actions to improve gross margins, particularly for our new products in high-growth markets. We are also reducing our operating expenses. Our non-GAAP OpEx was $576 million in Q3. In Q4, we plan to reduce it to $555 million ±$10 million. We took further actions in solar, where we discontinued our wafer saw and solar implant product lines, resulting in one-time charges of approximately $51 million in the third quarter.
In summary, 2015 wafer fab equipment spending is trending lower than our prior expectations. Our focus on technology inflections and new products is producing revenue and share growth opportunities, notably in memory. The demand mix presents gross margin challenges in the short term. Over the model horizon, we expect the mix to return to levels that are more consistent with historical patterns and more favorable from a gross margin perspective. In the meantime, we are heavily focused on gross margin improvements and operating expense reductions. Now I will provide our fourth-quarter business outlook. We expect our overall net sales to be flat to down 7% sequentially. Within this outlook, we expect Silicon Systems' net sales to be down 6%-12%. AGS net sales should be approximately flat.
We expect display net sales to be up by 25%-35%, and EES net sales should be approximately $55 million. We expect non-GAAP earnings per share to be in the range of $0.27-$0.31. Now let me turn the call over to Mike for questions.
Thanks, Bob. To help us reach as many of you as we can, please ask just one question and no more than one brief follow-up. Kyle, let's please begin.
Your first question comes on the line of Farhan Ahmad from Credit Suisse. Your line is open.
Thanks for taking my question. Just regarding the October quarter, I wanted to probe you on the order trend. Like, it seems that the revenue is declining despite very strong orders that you had in the July quarter. I'm thinking like there is probably like a 25% decline in the October quarter as are the orders. I just wanted to probe you, like what segments are you seeing, like, the decline? Considering that you have very strong orders in NAND, just wanted to understand how sustainable are the order trends. Do you think that they are peaking in July or do you think like, just because we are now in the 3D era, we will just start to see much higher order run rate in NAND?
Sure. Let me take a shot and Gary can join in. We had really strong orders in Q3, so you might say, shouldn't your revenues be a little stronger in Q4? As you go look at our press release we put out today, we get a fair amount of orders in Japan, in fact. In Japan, we recognize revenue usually a quarter after we ship. Some of the orders we booked this quarter will trail into the next several quarters in terms of shipments and revenue recognition. That's a little bit of a disconnect between our strong orders this quarter and the revenues, which are a little less robust next quarter, but give you higher than typical backlog from this quarter that will sustain into Q1. Okay. The second thing, in terms of what's our outlook, I'll give you my observations.
I think you have a couple of different things going on. In V-NAND, which I think more and more people are resonating, there's a lot of momentum around that for several reasons. One, there's more and more data that suggests that the V-NAND Flash device is a superior device in terms of performance. The second thing is you can't sustain a planar shrink effectively. The push to go to V-NAND is picking up momentum, if anything. The second aspect to that is that is particularly good for Applied on many levels. The first is that V-NAND is much more deposition, etch, RTP, CMP, and even some EPI-intensive than the 2D. The second thing is the tool mix is somewhat different, the level of reuse for us is much less.
We actually do say, and I believe it's very accurate, and you're starting to see it in the bookings, that the opportunity for Applied from the planar shrink mode, which was primarily reuse, and most of the incremental CapEx might have been tilted toward lithography, to a V-NAND mode where a lot of it is not available for use, is about a 3x revenue opportunity for Applied. That's my outlook that I think V-NAND, sort of bullish on for a while, including next year. In terms of foundry, we are saying we're seeing a little softer. In fact, one of the significant reasons why our gross margins actually slowed down and less than we expected even couple months ago, was that the mix has changed on us.
We're seeing strong memory, but we're not quite seeing the foundry we might have anticipated. We had to scratch our own heads on that because how does that tie to the outside world? What we're coming up with is that the things that have been talked about in the last couple of months in the outside world, that is customers are reusing equipment more effectively and efficiently, particularly as they bought a little conservatively to have a very good ramps for their customers in the foundries in the last year or two. That tool reuse is creating a little bit of a slowdown at this point. Now, that doesn't mean we think it's not positive next year, but they're more effectively using those tools they bought earlier in this cycle.
The second thing we read about and hear about, you know, they're continuing to improve yields, continuing to improve, tool utilization is quite high, too. What we see in foundry is, in our fourth quarter, it's less than we anticipated, and we even saw, as we mentioned in my notes, that we had, you know, about an $8 million push out of a foundry booking, right? Or a cancellation, rather. What does that mean for, you know, prospectively? We're not pessimistic on foundry at all. The question is when do they, a, get through this full utilization of some of these tools, and two, how does 10 nm do? We haven't spoken to November, December yet, but we are relatively positive actually on next year in 10 nm .
For Applied specifically, the mix of tools at 10 nm is very positive, I think we're about 20%- 30% bigger opportunity. As we get through this reuse sort of gap, that should help us on our revenue, our share, and our gross margins, frankly. You know, that's what we're getting through.
Thank you. Just looking at the stock repurchases, you had $625 million of stock repurchases, which is quite a bit higher than what we would have expected at your $2 billion in first year, sorry, $3 billion over two years run rate. With stock at where it is, could you be, like, more opportunistic in near term?
Yeah. Mechanically, let me tell you how we do this. We, at the beginning, before we started the stock buyback plan, we put together a thoughtful, we, I hate to call myself thoughtful, but I think it was thoughtful, the treasury department was, and a matrix. What you do is a buyback grid, and you say at various stock prices, we will buy various dollar values per day. That pricing grid has given a lot of analysis to long-term valuation of the company in terms of net present value, intrinsic value, short-term valuations versus multiple earnings. When you cross certain price points, you buy more stock back. The stock went down this quarter, and it triggered a more aggressive buyback.
At the end of this quarter, we will revisit with our board, the price grid and the volume grid and will we reset it or not. You don't typically reset them a lot because a lot of the valuation there is what do you think the intrinsic and long-term value of the enterprise is. My guess is that our pricing grid, as it exists, gives us a fair amount of flexibility to be aggressive at the type of stock prices we're seeing, and I think that would naturally lead us to be opportunistic because we see long-term value in the company.
Thank you. That's all I have.
Your next question comes from the line of Jim Covello.
Hey, guys. Thanks. Good afternoon. On the foundry issues, you know, obviously, I think the questions from the market are gonna be, you know, are the foundry issues cyclical or secular? You know, and obviously, you addressed a little bit of that. Then, you know, the other question I think clients will have is, you know, how do we know it's not share loss, right? I think some other companies have reported and, you know, they haven't seen the declines to this extent. Maybe it's a calendar issue where you guys are a month later and you've seen it. You know, obviously, those will be the questions. You know, could you help us out on the secular versus cyclical versus the share loss kinda question that I'm sure will come up tomorrow?
Sure. If you go look at secular versus cyclical, I think some of it's timing and some of it other people have talked about how you see our customers talking about we're getting higher tool utilization. Samsung talked about it earlier in the year. TSMC started to talk about that. Higher tool utilization, more tool reuse. That's across and even inventory in the channel, you see some data on that. I think what you have right now is a problem in fuller utilization, more efficient utilization of tools. Now I think they're getting through that. Now you might argue, could you have seen some of this? Maybe higher tool utilization, greater reuse of tools. It's hard for us to measure it because it factors in with yield and all that stuff, which we have no insight to, right?
I think there's a good part of this that is sort of the cyclical thing, this, you know, this window we're in here. In terms of, you know, why do we see and other people aren't talking about it, you know, we are a month later, number one. Number two, if you do look at the mix of Applied tools, sometimes they're bought a little bit earlier and heavier in a cycle. For instance, our EPI tools take a while to qualify. They're complex tools, customers bought a little heavier earlier. PVD tools tend to be backended to connect a lot of that stuff. You know, these tools get bought a little bit earlier. If you look in tools like that, our share is very strong, and our tools are enabling in those areas.
There is no share loss there, and we're seeing some volumes down there, frankly.
Yeah. I think, also, Jim, if you look at from a market share perspective, in foundry, that's our strongest position. Now, the good news is that as the memory business is ramping, also our share is up. I've talked about this earlier, several points, in memory. That's helping us offset some of the weakness in the foundry business. But if you look at our leadership products, we talked about this at Investor Day, we're up 5% in the leadership products over the last couple years, launching some great new products in those areas. That combined with our momentum with the etch business with the Sym3, highest ever CVD orders, new ALD position.
We look at our position for 10 nm and we're very optimistic about our ability to continue to grow share in foundry. Right now, the mix is working against us in terms of foundry versus the memory. Good news again is we have gained share in memory. We have good momentum there, but we also have a very strong position in foundry.
Jim, I'll tell you the other way you could triangulate on what we're saying. you know, we have two primary U.S. competitors. One is generally thought of as more memory-centric, one is thought of as more foundry logic-centric. If you look at it, the person who's more memory-centric is probably a month ago, saw a little bit better outlook than we did. The one who's more foundry logic-centric saw significantly less optimistic, I believe, outlook than we did. Because we've repositioned the company, we're more closely towards the memory, whereas if you looked couple years ago, we were more closely to the foundry model. I think, one, if you look at our peers and sort of say, what is our position in those?
We're somewhere in the middle, but we've moved a lot more holistically towards a good representation of memory too. If you think about those two other companies too, it sort of, kind of makes sense.
So maybe kind of as a follow-up, kind of picking up on that point, you know, I know and I think everybody in the market knows that you guys are incredibly well-positioned in 3D NAND, and it'll be a good, you know, really positive inflection for you all. And I believe you're gaining share in the other segments, as you commented. At what point is it fair for us to look at the company's revenue on a year-over-year basis versus the overall industry revenue and kind of see those share gains coming through? Is that, is the idea that that's just gonna be a little bit further out, where we can look at Applied's revenue growing significantly in excess of the overall industry growth rate to kind of, measure that share gain in, in the company's specific results?
Well, you have some indicators. I'll try, then Gary will jump in. You have some indicators now, Jim, they're not too bad. I mean, this year, you know, people have said this year's kind of a, different people have said different numbers, but some people have said $33 billion WFE. We haven't updated, we're a little bit more conservative than that, frankly. If you look at that, we had record orders this quarter. I think in SSG, we're gonna be close to a record for the year on orders. I mean, I don't know what it will be exactly, but pretty damn good shape. If you look at our service businesses, which implies that we're servicing more tools, that's a record, display is pretty good. You're talking mostly about semi.
If you look at share within product, it's up. If you look at WFE share the last couple of years, it's been up. There are some existing indicators. Then as we said on Analyst Day, we have some product positioning stuff that's going up. Now, a little bit of wind at our back, you know, there was a good foundry in the last couple of years. I'll give you the math that's in my head. You know, if you look at the, you know, it's 7.7 or 7.8, whatever the number is, between 7.5 and 8 for both DRAM and NAND this year, WFE. We've kind of gained over four points on each, I think.
If you take four points times, you know, $8 billion, that's about $320 million each, that if we hadn't repositioned ourselves, we'd be short $640 there. Two years ago, we had $2 billion in semi services. I mean, AGS initially will be close to $2.6 billion and, you know, a couple of hundred, that's positioning. I think through repositioning the company and the products we have in the pipeline, you can see more robust revenues of arguably, with this mix of probably, you know, $600 million, $700 million, $900 million.
Great. Thank you so much.
You're welcome.
Your next question comes from the line of C.J. Muse from Evercore ISI. Your line is open.
Hi, this is Ada calling in for C.J. Can you guys talk a little bit about how the economics for AMAT change in memory in 2016, given that more of the DRAM CapEx will be spent on shrinks as opposed to new wafer starts, and in 3D NAND on new wafers and conversions, as opposed to largely greenfield in 2015?
What was your point? Say it again about 3D. What'd you say about 3D?
Well, in 3D, it's next year is going to be more new wafers and conversions, and this year is more greenfield. What does that do to the economics for you guys?
I think on the 3D NAND, I'll start, and then Bob can join in. Thanks for the question. 3D NAND, as we've talked about before, is really more materials-enabled than litho-enabled scaling. If you look at the CapEx that is necessary for them to ramp those devices, very heavily weighted towards CVD, etch. Also, we have EPI there for the first time in memory, where we have a very strong position. As the customers are ramping those 3D NAND factories, the areas that are growing are the areas where we are gaining share. That's part of what Bob talked about earlier, where he said we're gaining several points of share in 3D NAND.
We look at the products that we're introducing, the Sym3 etch, the record CVD orders, you know, again, a number of our products are very well-positioned as the customers ramp 3D NAND spending. We believe that 3D NAND is at about 15% of the total NAND capacity. We believe that that is going to continue to ramp in 2016 as a percentage of total spending, and we're in a very, very, very strong position there. I don't know, Bob, if you want to add anything.
Yeah, I think the big inflection that's going on in the industry right now is 3D NAND. It's gonna go on for years. There's about 1.3 million wafers out there. There's about 150 by the end of this year that are done. I think that's a bigger inflection than DRAM. Within DRAM, we're a little bit more bullish than somebody like Dataquest. We see that they didn't really add that much capacity this year. If you look at die sizes, they're bigger. If you look at more process steps so that they really didn't add that much capacity this year. A little bit more bullish than some of the outside folks on total DRAM spending next year.
As we mentioned earlier, our position in DRAM in the last couple of years, we've gained four points.
Great. Thank you. Can you maybe just dive a little bit deeper into the gross margin and how much of the headwind is coming from display versus how much is coming from SSG?
Yeah. Display is a good-sized gross margin headwind now. It could be up to a point for the company. What's going on there is, you know, historically, for many years, you know, 80%, and even a few years ago, 90% of our business in display was for TVs, equipment for making displays for TVs. We project that next year, over 50% will be for small screens, you know, your cell phone and stuff. The good news is, if you go back a few years ago, if TVs had turned down like this, we'd be losing a lot of money in display because there'd be no revenues.
In fact, we think revenues will be pretty strong next year in display because over 50% of our business will be small screen sizes. We are growing the TAM there, growing over, you know, this is the third year in a row of growing display revenues, and next year, with the TV downturn, we're still pretty damn healthy. The issue is gross margins there. If you look at that, we're penetrating some new products and some new markets, and some of our competition is Japanese yen based. The display thing is bad probably through the first couple of quarters of fiscal 2016, but it gets a little better each quarter, and then we pick it up. That's when our mix gets more normal. We start to get some TV business back, and the product mix changes a little bit.
It's about a point now. The other piece is SSG, where the big mix delta for us is foundry versus memory, and that's really just indicative of tool mix. The tool mix is stronger for us right now, things like etch and memory, whereas in foundry, we're a little stronger in places like EPI, PVD, Inspection.
Great. Thank you so much.
You're welcome.
Your next question comes from the line of Krish Sankar from Bank of America. Your line is open.
Yeah. Hi, thanks for taking my question. Two of them. First one, Bob, to follow up on the gross margin side. If your January revenues might come up because of the Japanese revenue recognition, should we assume gross margins will still be under pressure given the fact that display is gonna continue and, so, you know, would like SSG pressures? In other words, would revenues improve in January sequentially, but margins be under pressure? I also had a follow-up.
Sure. Just to give you the economic model of Applied Materials, in some industries, if volumes go up, gross margins naturally benefit because they get absorption issues in their factories. A company like Applied Materials and our peers, predominantly our product cost is materials, stuff we buy, so you don't get this big absorption boost or downtick either with volume. Our gross margins are predominantly a function of mix between customers, mix between products. I don't have a clear view into Q1 yet, but given I've got pretty good backlog right now, I'm concerned that the mix issues we're seeing in Q4 will stay into Q1, and we'll have the same type of challenges in Q1. Now, if you say, Bob, what have you been saying along?
You know, last quarter, even maybe at Analyst Day, I was somewhat concerned about exactly this issue, frankly, in fiscal Q1 and Q2, the heavy volume of etch and the display mix with small screen sizes. What's been a little bit different for us is this Q4 I thought would be a little bit heavier foundry mix than it turned out to be.
Got it. Got it. That's very helpful. Now you guys had almost just shy of $800 million in NAND bookings in July. Is there a way to parse it to say how much of that was 3D NAND?
Yeah, there is. It's going up significantly towards 3D each quarter. I'd say, let's see if I have it here. We're looking for the data, but my guess is that in the quarter we just ended, the great majority of it was 3D.
Got it. Thank you, guys.
Your next question comes from the line of Timothy Arcuri from Cowen and Company. Your line is open.
Thanks a lot. Bob , I guess my first question is again on gross margin. It really isn't different than it was a few years ago at this revenue level, you know, I certainly get the new product issue and the, you know, mix items and the, you know, flat panel issues. People are gonna say, they're gonna say, "Look, they're just buying market share or they're gaining sort of unprofitable low-end share." I just wanted to give you a chance to say, "Hey, that's not what's actually happening here," because that's what people are gonna say. I guess maybe just talk about where gross margin would be kind of a one year from today at this revenue level once you sort of, you know, normalize all these factors out. I had a follow-up. Thanks.
Yes, thanks for the question, Tim. Couple of things. I accost our internal people with the same questions to make sure it's not happening. Let me see if I can go through the details because I've been through the details. As I was just asked, you know, one full point of it in the short term is display. You know, display, you're not hearing that from display competitors of us. It's mostly mix. You can see we're selling a lot more into the small screen sizes, a little bit more in PVD, for instance, than CVD. It's definitely mix in there. Does it make it a little worse that our competitors are Japanese? Maybe, but mix is the biggest single delta in there. The second issue is semi, where you hear more contrarian views from other people.
I went through. The biggest delta is mix between some of our higher gross margin products are PVD, EPI, and Inspection, right? Some of the lower ones for us are etch. You can see the mix is more weighted towards foundry for the first, and for the etch, it's more weighted towards memory. You see the foundry memory mix happening, so you know we're getting a bigger mix. Then you'll drill into me and say, "Well, are you being hypercompetitive on etch, for instance?" I went through by deal, what we've been doing in etch cost, pricing, and our prices were, our peers, our competitors were very much the same type of prices, arguably higher. What we got there is a cost issue, right, and a mix issue.
Our competitors have a different mix of products, and frankly, they have a more mature product. What we have to do is get cost out in our products and start to get the mix across all of our products. The roadmap for us is, let's get some more normal level of mix between memory and foundry, and particularly within foundry, let's, you know, get the normal level of things like EPI, PVD, Inspection. Then with etch, let's get our cost down and continue to, you know, get cost down and configurations down.
Okay. Thanks a lot for that. Then I guess, really for you, Gary, this is a big picture question, but, you know, it really is about your thought process around really shaking things up a little bit. The stock has certainly underperformed. You know, if you look at the next worst peer, it's underperformed the next worst peer by 1,000 basis points over the past six months. You know, I know that, you know, much of that is due to the failed merger, you know, you sort of can't be happy with that. I guess my question is about really shaking things up, maybe cleaving off some of the businesses, maybe, you know, pulling in the buyback, maybe getting out of some, you know, big markets you're in that are not as high margin.
Really a question around your thought process around that, because the stock has significantly underperformed, I think, even your expectations. Thanks.
Yeah. I think from, you know, we outlined the strategy at the investor meeting. As Bob talked about, we've been positioning the company around the major inflection. If you look at, you know, the way we structure the organization, the way we move the investment within the company, in patterning, for instance, in etch and CVD, we've got the highest CVD orders ever in the history of the company. Etch, second- highest orders in the history of the company this last quarter. Our memory share is increasing. We look at each of these different markets and really try to figure out, like you talked about, what moves the needle? Where are we gonna invest?
How are we gonna structure the company around those inflections so that we're positioned when those new devices ramp? Patterning, again, tremendous momentum there. We talked about the 450 Sym3 chambers. It's really from, in five-quarter period of time, we're going from 18 chambers in the field to 450. You know, you asked the question about the margins, you know, relative to buying market share. We're winning in critical applications with a higher price than the competitors in many of the cases where Bob and I went through the analysis. There are some real technical advantages of those products that, again, we went through some of those at SEMICON West.
It's focusing in this patterning inflection, focusing around the transistor and interconnect area, as 10 nm ramp, 10 nm technologies ramp. We're in very strong DTOR positions. In service, we also made a number of changes there to really drive higher value and lower cost in our service business.
We believe as these inflections happen for our customers, these are tough inflections. They have to ramp quickly, get to the high yield fast. That's another area that we focused on, where we've seen hundreds of millions of dollars in growth, and we really believe that that's another area where we fundamentally repositioned the company for a more sustainable growth going forward into the future. As Bob talked about in display, you know, a few hundred million dollars of growth there, expanding as our customers move into some of these new technologies like OLED with thin-film encapsulation. You know, we believe all of those areas are fundamentally stronger than where we've been in the past around all of those different segments of the business.
The other thing that we did is we cut $400 million of OpEx. We cut G&A by about 25%. We've cut many areas that were low- performing. We continue to look for those areas. We talked about some other businesses that we're ramping down right now, and we will continue to look for those lower- performing businesses. Anything that we don't see that is going to be a good return, and generate, you know, somewhere around at least a 20% operating profit, we have zero bias about being in those businesses. From a top-level standpoint, we've moved the money, we've structured the company around the areas that we believe will move the needle for Applied Materials and for our customers.
The model that we presented at SEMICON West, the $2 model, you know, we believe we're on track. If you look at the indicators around the major areas of our business, we are gaining share. The mix in the near term, you look at that long-term model, but the mix in the near term, the foundry versus memory, mobility versus TV, those are things that are headwinds for us. Fundamentally, we're in a much better position and confident that we're gonna achieve that model.
Okay, Gary. Thanks so much.
Your next question comes from the line of Romit Shah from Nomura. Your line is open.
Yes, thank you. You guys mentioned that WFE this year, your expectation now is that it's flat, but the risk is to the downside. I wonder, you know, how does the weakness this year, you know, change your view on spending for 2016?
I'll take a shot at it. Gary can jump in. We think some of the weakness we're seeing towards the end of this year is this tool reuse, increasing yields, and absorption of the capacity they have as they go in the foundries in particular, 'cause memory's pretty strong. I mean, DRAM was strong in the beginning of the year. We're more bullish than your average outside guy for next year DRAM, and NAND, I don't think anyone's too pessimistic right now. We're pretty optimistic, actually. It's, it's kind of a discussion of foundry spending and timing, right? If you go look at it, we believe that in listening to our customers, 10 nm is gonna be a pretty big spend year for them next year.
The rough mathematics is that if you look at node to node, there's 32 nm, 28 nm versus 20 nm, 16 nm, 14 nm versus sort of 10 nm, wafer starts might be down a little bit, maybe 10% per bunch, but capital intensity per node is up about 20%. The volume versus capital intensity is still not bad. I think the problem we have right now is we get this reuse. The other thing, you know, you have to go look at is, you know, all the macro stuff, which is beyond my pay grade, right? You know, what's gonna happen in China and phones and next Apple phones? I don't know that stuff.
In a reasonable demand environment, the increase in capital intensity and the importance of 10 nm to our customers and the fact they're absorbing the tools at this point means it's probably okay.
If the, you know, if the PC and the smartphone TAMs remain under some pressure, Gary, are you more inclined to pursue growth via acquisitions?
You know, I think that, from a top-level standpoint, if we are improving our position in memory, that's the good news. If you look at, you know, the point, the share gain that we have in both DRAM and flash, that's helping us offset some of the near-term weakness in foundry. You know, for us to hit the financial model, you have to believe that the mix comes back to some normal relationship between the foundry and the memory. We think that's gonna happen, certainly, if you look at our position in EPI, PVD, implant, thermal products, CMP, you know, you have to have a more normal mix that we've seen over the last few years, for that part of our product portfolio to work.
Mix certainly plays a big role in, you know, in, the overall financials.
I just wanna be clear on this point. Is it fair to say that, you know, M&A is no longer part of the company's growth strategy?
M&A, you know, basically what we've said is that there's three things that drive our M&A strategy. Number one, you know, can we get a good ROI? Number two, you know, is it an opportunity for a leadership business? In most areas, the number one guy makes a lot of money, number two breaks even, everybody else loses money. And then the third area for us is synergy with our core businesses. Good ROI, opportunity for leadership business, and synergy with the rest of our products. You know, we look across semi today, there aren't many of those types of opportunities. Now, around our core competencies in materials engineering, you know, those are areas that we will continue to look at.
Today, I would say, you know, there aren't that many attractive opportunities that we see that fit those three criteria.
You know, Romit , I think Gary's, that's the essence of the feedback. I'll give you a little bit more color. One is the TEL deal had the big tax leverage, right? That was extra benefit, right? That made everything easier. We still have some tax leverage that if we're ever interested in a foreign company and use our foreign cash, you sort of get about a 50% discount, if you think about it. I'm not saying we're doing that. I'm just saying that's another consideration. You know, all the financial and tax leverage is sometimes there.
Okay. Helpful. Thank you very much.
Your next question comes from the line of Harlan Sur from JP Morgan. Your line is open.
Hi. Thanks for taking my question. At Analyst Day at SEMICON West, you guys articulated a view of $2.2 billion of OpEx in fiscal year 2016. I think July quarter run rate was about $2.3 billion. The October quarter guidance takes you guys down to that $2.2 billion annualized. Given the weaker fundamental environment, should we expect OpEx to trend even lower beyond the October quarter? Do you guys have sort of a new view on OpEx for fiscal year 2016?
I'll give you some color without being too specific. The model we put up in July of 2013 was a [$228], actually, in fiscal 2016. We trended up over that a little bit in the last year or so that our run rate last quarter was like $579. It was, you know, it was about [$23] or something like that. We were a little bit above that because we had one more year of inflation. What we've done is we've, and part of the reason we're a little bit above those companies, one, you know, you're tied up in the merger, certain things you couldn't address, and we have a lot of products coming out of the pipeline right now. We've engaged more lighter microscope on OpEx.
You know, next quarter we're at [$555], we're working to get down our OpEx back to the original number we got it for 2016, which was the [$228]. We said we'd have a number in 2018 of [$24], we're optimistic we'll hit that, we've got renewed vigor to be opportunistic on OpEx.
Okay. Got it. Then on the display side, you know, lot of discussion on the gross margin front, at the operating margin level, your display margins declined by over 700 basis points. Is the operating margin pressure more the revenue decline? Is it the yen? Is it the mix? Then on your commentary on sort of margins being sort of bad for the next few quarters in display, do you expect operating margins here to kind of trend in this kind of sub-20% range going forward?
I think the next couple of quarters through kind of Q2 are a little challenging, because we got so much of this new product, new market stuff.
I think longer term, those guys are gonna do well. I mean, it's unprecedented for us to have over 50% of our revenues in display next year. I mean, the good news is, think about it, if you didn't have that, you'd have another, you know, $400 million revenue hole or whatever. It's not where we want to be. It'll get better, but for the next couple of quarters, it's gonna be around there, I think.
Yeah. I think as Bob said, the biggest headwind there for us is mix of mobility versus TV. If you look at the normal mix that we've seen over the last few years, you know, the operating profit there has been continuing to improve. The revenue is up. You know, we're in this situation where we believe it will come back to kind of a more normal mix. Actually, we're bullish about the operating profit and revenue increasing as we've seen over the last few years. This near term mix is certainly working against us.
Okay, thanks a lot.
Your next question comes from the line of Steven Chin from UBS. Your line is open.
Thank you. Hi, Bob and Gary. Just a another follow-up question on NAND. Just wanting to know if you could share your early view on 3D NAND wafer builds for next year. I just want to get a sense of how comfortable you were that, you know, this year is not the peak year for 3D NAND spend for Applied.
I'll take a shot at it. We believe the installed capacity exit for 2014 was about 60, 65. We think this year exit is about 150. We think exit 2016 is about 300, we think it's kind of doubling every year. This year they had about 85, 90. The year before, they were like 40. We're like 40, 90, next year's maybe 150. It's going up.
Okay.
A lot of that booking stuff we got is next year NAND, 3D NAND.
Great. That helps. Thanks, Bob. My follow-up question was on foundry being, you know, the swing factor next year. I was just wondering what you think happens when foundry 10 nm pilot orders are eventually placed. Do you think it's kind of a steady ramp with this foundry 10 nm? Or could there be a hockey stick type of spend given some of the complexity of 10 nm ? Thanks.
I'll give you my best wrong answer. Typically what happens is that customers will buy X amount of capacity pretty early on, so they have it, and then they'll see how well it yields and demand for it, right? It's not unusual that they might do sort of committed to 30,000 wafer starts, say roughly. Where you get the vigorish or the extra is if it's yielding well and a lot of tape outs and extra sales. I think you got a baseline the next year that you can count on in getting to the higher numbers, which we're all believe in, is how's 10 nm yield, how many customers buy it, what's the tape outs, all that stuff. You got a baseline that you're probably okay, and then the rest we don't know yet.
Great. Thanks for sharing the color, Bob.
You're welcome.
Your next question comes from the line of Sundeep Bajikar from Jefferies. Your line is open.
Hi. Thanks for taking my question. A question on foundry again. Can we attribute the majority of the foundry weakness you described, primarily to one of your large customers' public commentary about CapEx reduction and tool reuse from 20 nm- 16 nm ? Or are you describing much more broad-based weakness across multiple customers here?
Well, I think the general notions that customers have improved yields, that customers are getting more effective tool utilization this year versus last year to where they bought a little heavier because some of them shared the same concerns about ramping FinFETs and ramping for big customers. Those are common, more efficient utilization yield from number of customers, right? The cancellations we had in Q3 out of our backlog was one specific customer. The softness we see in our Q4 forecast versus what we expect is a couple of customers.
Thanks so much. That's helpful. Just as a follow-up, on the 10 nm opportunity, how much of the size of the opportunity growth you're looking at would be driven by capacity expansion, compared to a higher process complexity next year?
On 3D NAND?
No, 10 nm foundry.
10 nm foundry. We think that from sort of 16 nm, 14 nm, when you go to 10 nm, it's about 20%-30%, it's higher process complexity, more layers, stuff like that. The back end, they're gonna redo at 10 nm , and there are other things they're gonna do. It's 20%-30% for the same number of wafer starts capital intensity. That's complexity. You got to get the volume stuff, which I talked about earlier. We think the reuse thing has been largely wrung out of the system, we hope this year. Finally, the last thing you got to put in your polynomial equation is, you know, what's the end user consumption of those devices, right?
Great. Very helpful. Thank you.
You're welcome.
Your next question comes from the line of Sidney Ho from Deutsche Bank. Your line is open.
Thanks for taking my question. Well, I guess similar to a question asked earlier, but looking a little longer term. If you look at the demand side, PC is declining year-over-year, smartphones is kind of peeking out, and now, Moore's Law seems to be pushing out, which I'm curious about your view there. How should we think about the WFE spending growth going forward over the next few years rather than just next year? Is it just the spending being spread over a longer period of time?
Yeah, I'll take a shot at it again. Let's segment the market. WFE, 3D NAND, we're pretty bullish on actually, because this is a technology transition which is more akin to wafer size transition, because, you know, they have to switch from 2D to 3D for both device performance and you can't keep shrinking, right? Electrons in a cell, you can't get any smaller, right? You can't effectively. They're gonna go to 3D. It's like 200 mm. Your new customer is gonna go, it's just timing. They sort of waited a year or two, but it's happening. You can see the numbers going up rapidly. Everybody says it. I think if anything, you've got a solid baseline of predictable spending that's pretty healthy in 3D NAND for a number of years.
On DRAM, we're a little bit more optimistic than some of the other folks because the things that are helping you there is the number of layers, capital intensity is picking up for greenfield, number one. Number two, the die size on average is getting bigger, particularly on mobile dies. DRAM bit growth is pretty good, right? I think DRAM's okay, right? Logic might be The other thing helping DRAM and memory in general is the whole data center, big data, cloud stuff is definitely a positive. Definitely, okay? Let's go to logic. Well, logic hasn't been high growth for a while. It's mostly driven by PCs, for Applied, it isn't that big either. That one, we don't think about it every single day because it hasn't been that volatile in the last few years.
You go to foundry. Foundry, the big driver at foundry tends to be mobile devices, and mobile devices have had very good growth. Many people continue to believe they'll be pretty good. If they're pretty good, you're in good shape because capital intensity continues to go up. You know, as we said, it's, you know, 20%-30% going from 16 nm, 14 nm- 10 nm. If you get pretty good consumption of mobile devices and related things like that, and even some of this Internet of Things stuff is picking up, frankly, you've got healthy foundry demand.
The one that this particular quarter is a little bit, we were a little surprised on for next quarter was the foundry, but doesn't mean we don't feel good about foundry fundamentals, given the capital intensity and end user demand we think is good. I think it's okay.
Okay. My follow-up question was a little more near term. You've talked about gaining four points of share in DRAM, which is great, and you also mentioned you expect DRAM orders will be lower in the second half versus first half, which we are seeing. What are your thoughts right now as it relates to when DRAM orders will start to grow again, especially in light of an oversupply situation this year? Related to that, do you see any downside risks for DRAM CapEx this year?
Well, DRAM was more heavily weighted to the first half. I got a fancy PowerPoint around here that shows that. If you look at DRAM this year, it was like 55%, 45% on the calendar year for us, so it was more heavily weighted to the first half. We think DRAM next year, we're not as pessimistic as others. We think it's probably down, but not down a lot. Maybe it's down 10%. Who the hell knows? That's kind of where I'm leaning. In terms of timing next year, I have a little less visibility on that.
Great. Thank you.
Your next question comes from the line of Weston Twigg from Pacific Crest. Your line is open.
Hi. Yeah, thanks for taking my question. Just first, services, global services, operating margin, trended down a bit despite record revenue. Just wondering if you could help us understand that discrepancy?
Yeah, I think it was the mix of what they sold. In other words, if you go look at those guys, they have 200- mm tools, spares, services, and as I remember it, the mix was a little bit different between those. Let me see if I can look at this. Yeah, I think it was a mix change within their revenues more than anything else.
Okay.
I think longer term, just one other thing on that one, the longer term, you know, we've seen tremendous growth in terms of revenue in the service business. We think that's sustainable, that the growth is sustainable, and we think margin growth will also improve there as we're bringing more valuable services and then focused on the key inflections for our customers.
Okay. That's helpful. Then just on the margin side, this would be gross margin. You mentioned that you need to get cost out of products, particularly in etch when you were answering a question earlier. Can you just give us an idea of what some of the levers you actually have for that would be?
Yeah. There's mostly material costs. There's also some opportunities in installation warranty and burden, overhead costs, right? If you go look at with a new tool, I'll do the last one first. Installation warranty costs tends to run higher, so we can reduce that, number one. The second thing is the chamber, which we've ramped really aggressively. Even at Analyst Day, we said we're going to go from, you know, a year ago, five chambers a quarter or something to hundreds of chambers, and we said by the end of this calendar year at Analyst Day would be to 300. I don't know if you picked up on the script. I think Gary said by the end of fiscal Q1, which is one month later, January, so like 450 or something like that.
That chamber is ramping super aggressively, so that's an opportunity to reduce cost. Many times you have six chambers on a tool, so there are six of those. We'll work on that. The other thing, even, you know, the way for handling equipment is probably an opportunity with the platform there. It's installation warranty, it's burden and absorption with volume, which some of it'll come relatively naturally, and then it's material cost reduction around both the chamber and the handling systems.
And just-
Also the other thing is configuration management. Can we have a little less heavily configured tools?
Okay. Just along those lines, have you run into any unexpected issues with installations, or reliability as you've been installing these chambers that might be weighing down the gross margin?
It's not too bad. It's getting better.
Yeah, I think if anything, the ramp is way more aggressive than we've seen in Applied for any product in the past. That's the good news. You know, it makes it harder for us to drive these improvements and then have them in the bottom line as quickly. You know, the good news that the product is ramping, if anything, much faster than we had anticipated.
The other thing that's a tactical thing is to get some of the material costs to the P&L, you gotta ship the tool and revenue it, right? Any inventory you have, if you ECO it or cost reduce it, you gotta first ship that inventory first.
All right. Thank you very much.
Thanks, Weston. Kyle, we've got time for two more questions, please.
Your next question comes from the line of Tom Diffely from D.A. Davidson. Your line is open.
Yes, good afternoon. I haven't heard you mention advanced packaging recently. Is that still a focus for the company? If so, what's your outlook there?
Yeah. We definitely have a focus on packaging. We have a pretty good position with our plating business. MVP is also a strong one for us. We don't see that as you look, real needle movers on the EPS, it's not a really big opportunity for us in the next year. Longer term, we look at it as a growth opportunity. Relative to the other things that we're talking about, it's not in the same category.
Okay. That's helpful. Back on the bookings, you said that, you know, the foundries got weaker through the quarter. Is there a risk to any of the bookings you had for foundries early in the quarter of de-booking over the next quarter or two?
Well, there's some risk, but a lot of that stuff in those types of customers is book and ship. The stuff in other customers are more backlog weighted.
Okay. Thank you.
You're welcome.
Your next question comes from the line of Patrick Ho from Stifel Nicolaus. Your line is open.
Thank you very much. Maybe as a follow-up to some of the foundry questions you've answered today, you know, understand with the push outs of some of the 16 nm, 14 nm capacity related to end user demand and the higher tools, is there any change in their intent given the, you know, the better tool utilization at 14 nm?
Patrick, you were faded out us. I think you said, is there any change in their what?
Their 10 nm plans.
Given, given the recent-
Given the better tool utilization and yields at 16 nm and 14 nm.
No, I don't think so. 10 nm , they're still pushing aggressively. 10 nm , they'll probably change the back end. That'll contribute to higher capital intensity. The tool utilization now, some of that high tool utilization was getting better yields on their first FinFET, right? 'Cause that was a tricky one. The second one's not quite as worrisome. Then the third thing is some of that higher tool reuse is kind of a natural progression from 20 nm sort of to 16 nm or 20 nm- 14 nm.
Okay, great. Bob, maybe as a specific question on the operating model for you. I think I've known you long enough and well enough that, you know, the gross margin is a big focus for you guys, and you're not just gonna sit idly by to let the product mix shift. Are there specific things you can do, particularly on the flat panel display side, you know, given, you know, you mentioned the smaller mobile display product mix issues? Are there things you can do specifically to improve that over time?
Yeah, there are, and that's what we're doing. We're taking down costs, and material costs and overhead and installation warranty. I have to admit that the shift in mix in the current quarter surprised me a little bit. We're not being passive. We're pushing it hard. It kinda came one quarter earlier than we expected, to be honest with you. The other thing I'll say to you know, the good news, the gross margins, we definitely are committed to get them up. We definitely believe we should have higher gross margins, no doubt about it. Gary and I rail about this every day, basically. You know, the glass is half full on this thing. If you look at it, we've gained over four points of share in DRAM, over four points of share in NAND.
We've gained, you know, expanded our TAM or SAM in display by 50%, and we've expanded our service SAM and revenues in service quite a bit. If we hadn't done those things, you wouldn't be talking about gross margins being down two points. You'd be talking about over $1 billion less of revenues probably this year. Even the revenues, if you don't like the gross margins, those are probably incremental operating margins of 30% or so. You'd be talking about a $300 million hole in profit. You know, we're spectacularly unhappy with our gross margins. I don't disagree. It could have been a lot worse if we hadn't penetrated these markets, gained share and got some new products out of it.
You know, you would've had a sustainable problem of, you know, $300 million of profit a year, frankly. If you look at the etch business, for instance, where we don't like the gross margins, believe it or not, the 1B business where our operating margin delta from 2012 to today is greatest, it's probably etch, right? 'Cause we've scaled up so much volume at pretty good operating margins. We are spectacularly unhappy with the gross margins. If we hadn't gotten this stuff out and repositioned the stuff, it'd be an even worse call today, you know?
Right. Thank you very much.
That's my answer.
All right, Patrick, thank you for your question, and we'd like to thank everyone for joining us this afternoon. A replay of the call will be available on our website beginning at 5:00 P.M. Pacific Time today. Thank you for your continued interest in Applied Materials.
This concludes today's conference call. You may now disconnect.