To the Applied Materials Earnings Conference Call. During the presentation, all participants will be in a listen only mode. Afterwards, you will 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 Q3, which ended on July 26. 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 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 8 ks filings with the SEC. All forward looking statements are based on management's estimates, projections and assumptions as of August 13, 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 dotcom. 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 Q3 results where we delivered our highest quarterly earnings in the past 4 years, the highest service revenue in our history and more than $2,000,000,000 of 300 millimeter 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 nanometer 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 nanometer node expands the available market for Applied and plays to the strengths of our leadership businesses.
With 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% to 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 nanometer upgrades and some capacity additions. Most significantly, we are increasingly optimistic about the pace of the transition from planar to 3 d 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 3 d 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 3 d NAND speeds up, it will become a more meaningful driver of Applied's growth.
Our etch and CVD share at these customers to grow between 7 10 points during the 3 d NAND inflection. 3 d NAND is also enabling us to expand the available market for by between 5% to 10%. In display, the shift to 4 ks 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 and the penetration of OLED displays is ahead of our prior forecast. We now believe that around 1 in 5 smartphones shipped in 2015 will use OLED technology.
Currently, mobility makes up a large part of industry investment and this spending mix is not as favorable for us. When combined with the weekend, our display business faces some margin pressures over the next few quarters. However, the overall market trends are positive and we are on track to grow in line with our financial models. As we discussed at Semicon, 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 and are demonstrating significant traction with new products.
Our etch SIM III chamber that we officially launched last month is one of the fastest ramping products in Applied's history. And by the end of our Q1 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 7 points of gains we made between 2012 2014. In the past few weeks, we secured major application wins in 3 d 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 nanometer device performance.
We are expecting to ship more than 50 chambers by the end of our Q1. 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 and 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 cost and the complexity of our organization. We recently made enhancements to Applied 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 and 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, Garrett. Good afternoon and thank you for joining today's call. Supply delivered strong results in the Q3, posting our highest revenue in the past 3 years. Over this period, we have repositioned the company to capitalize 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 nanometers 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 memory is on memory revenue is on track to grow by more than 100 and 50%. We are significantly outpacing the market and believe we are gaining 4 points of market share in both DRAM and NAND. Within NAND, the 3 d inflection is gaining momentum with a broader set of customers.
Based on new product positions across the customer base, our share of 3 d NAND spending is now approaching the are
the
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. Now I'll comment on our 3rd quarter 0.9% was slightly higher than expected. And non GAAP EPS of $0.33 was at the midpoint of our range. We used $625,000,000 to repurchase 32,000,000 shares of stock, deploying more than 20% of our 3 year $3,000,000,000 buyback authorization in the Q1 of the program. We will continue to be opportunistic with the buyback.
Including dividends, we returned nearly $750,000,000 to shareholders. Next, I will make some comments on our segments. Silicon system orders of $2,000,000,000 were up 18% sequentially and set a record. Performance was led by strong three d NAND momentum across multiple customers, notably in Japan, where revenue is recognized upon sign off. Backlog was at an 8 year high, net of an $84,000,000 reduction due mostly to posted a 2nd 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 CBD encapsulation tool for OLED displays. Next, let me provide some additional insight into our gross margin and OpEx patents. Over the past 2 years, we have made significant progress with our gross margins. But 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. And in display, our revenue mix is rapidly shifting to mobile. Taking these factors into we are modeling Q4 non GAAP gross margin to be down by about 2 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 $576,000,000 in Q3. In Q4, we plan to reduce it to $555,000,000 plus or minus $10,000,000 We took further actions in solar where discontinued our wafer saw and solar implant product lines, resulting in one time charges of approximately $51,000,000 in the 3rd 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. But 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 patents 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 4th quarter business outlook. We expect our overall net sales to be flat to down 7% sequentially. Within this outlook, we expect silicon system net sales to be down 6% to 12%.
AGS net sales should be approximately flat. We expect display net sales to be up by 25% to 35% and EES net sales should be approximately $55,000,000 We expect non GAAP earnings per share to be in the range of $0.27 to 0 point 3 $1 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
Your first question comes from the line of Farhan Ahmad from Credit Suisse. Your line is open.
Thanks for taking my question. And just regarding the October quarter, I wanted to probe you on the order trend. Like it seems that the revenue are declining despite very strong orders that you had in the July quarter. So I'm thinking like there is probably like a 25 percentage decline in the October quarter as the orders. So I just wanted to probe you like what segments are you seeing like the decline?
And 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? And or do you think like just because we are now in the 3 d era, we will just start to see much higher order run rate in NAND?
Sure. Let me take a shot at 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. And in Japan, we recognize revenue usually a quarter after we ship.
So some of the orders we booked this quarter will trail into the next several quarters in terms of shipments and revenue recognition. So that's a little bit of a 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 VNAND flash device is a superior device in terms of performance. And then the second thing is you can't sustain the plane or shrink effectively. So the push to go to V NAND is picking up momentum, if anything. And the second aspect to that is that we that is particularly good Applied on many levels. The first is that VNAND is much more deposition, etch, RTP, CMP and even some epi intensive than the 2 d.
The second thing is the tool mix is somewhat different. So the level of reuse for us is much less. So 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 to lithography to a VNAND mode where a lot of it is not available for use is about a 3x revenue opportunity for Applied. So 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, of the significant reasons why our gross margins in Q4 were down and less than we expected even couple of 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. And 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 very good ramps for their customers in the foundries in the last year or 2. 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. And the second thing we read about and hear about, they're continuing to improve yields, continuing to improve tool utilization is quite high too. So what we see in foundry is in our Q4, it's less than we anticipated. And we even saw, as we mentioned in my notes, that we had about $8,000,000 push out of foundry booking, right, or cancellation rather. Now what does that mean for prospectively?
We're not pessimistic on foundry at all. The question is when do they, a, get through this utilization full utilization of some of these tools and 2, how does 10 nanometer do. So we haven't spoken to November, December yet, but we are relatively positive actually on next year in 10 nanometer. And for Applied specifically, the mix of tools at 10 nanometer is very positive. And we think we're I think we're about 20% to 30% bigger opportunity.
And as we get through this reuse sort of gap, that should help us on our revenue, our share and our gross margins, frankly. But that's what we're getting through.
Thank you. And just looking at the stock repurchases, you had $625,000,000 of stock repurchases, which is quite a bit higher than what we would have expected at your $2,000,000,000 in 1st year sorry, dollars 3,000,000,000 over 2 years run rate. With stock at where it is, do you could you be like more opportunistic in near term?
Yes. 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, I hate to call myself thoughtful, but I think it was thoughtful, the Treasury Department was and a matrix. And what you do is a buyback grid. And you say at various stock prices, we will buy various dollar values per day.
And that is we will buy various dollar values per day. And 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 multiples of earnings. And when you cross certain price points, you buy more stock back. And we 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 enterprises. So 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 would I think that would naturally lead us to be opportunistic because we see long term value of the company.
Thank you. That's all I had.
Your next question comes from the line of Jim Cavallo.
Hey, guys. Thanks. Good afternoon. On the foundry issues, obviously, I think the questions from the market are going to be, are the foundry issues cyclical or secular? And obviously, you addressed a little bit of that.
And then the other question I think clients will have is, how do we know it's not share loss, right? Because I think some other companies have reported and 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. But obviously, those will be the questions. So could you help us out on the secular versus cyclical versus the share loss kind of question that I'm sure will come up tomorrow?
Sure.
If you go look at secular versus cyclical, I think some of its timing and some of it other people talked about, about high you see our customers talking about we're getting higher tool utilization. Samsung talked about early in the year, TSMC started to talk about that, higher tool utilization, more tool reuse. So that's across and even inventory in the channel, you see some data on that. So 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 sight to, right? So I think there's a good part of this that is sort of the cyclical thing, this window we're in here. In terms of why do we see another people aren't talking about it?
We are a month later, number 1. Number 2, if you do look at the mix of applied tools, sometimes they're about a little bit earlier and heavier in a cycle. For instance, our EPI tools take a while to qualify the complex tools and customers bought a little heavier earlier. PV tools tend to be back end and to connect a lot of that stuff. So these tools get bought a little bit earlier.
And then if you look at tools like that, our share is very strong and our tools are enabling in those areas. So there is no share loss there. We're seeing some volumes down there, frankly.
Yes. 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. Bob talked about this earlier several points in memory. So 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 of years, launching some great new products in those areas. And so that combined with our momentum with the in the etch business with the SEM3 highest ever CVD orders, new ALD position. We look at our position for 10 nanometer 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 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. We have 2 primary U. S. Competitors. One is generally thought of as more memory centric, one is thought of as more foundrylogiccentric.
And if you look at it, the person who was more memory centric is probably a month ago, so a little bit better outlook than we did. The one who was foundry, more foundry logic century are significantly less optimistic, I believe, outlook than we did. And because we repositioned the company, we're more closely towards the memory, whereas if you looked a couple of years ago, we were more closely to the foundry model. So I think, 1, 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 good representation memory too. But if you think about those 2 other companies too, it sort of kind of makes sense.
And so maybe kind of as a follow-up kind of picking up on that point, I know and I think everybody in the market knows that you guys are incredibly well positioned in 3 d NAND and it will be a good 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 going to 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 the company specific results?
Well, you have some indicators. I'll try and then Gary will jump in. You have some indicators now, Jim, they're not too bad. I mean, this year, people have said this year is kind of a sort of a different people have said different numbers, but some people have said $33,000,000,000 WFE. We haven't updated, but we're a little bit more conservative of that, frankly.
And so if you look at that, we had record orders this quarter. I think in SSG, we're going to be close to a record for the year on orders and I don't know if it would be exactly, but pretty damn good shape. If you look at our service businesses, which implies servicing more tools, that's a record and display is pretty good. Now you're talking mostly about semi. And if you look at share within product, up.
If you look at WFE share, last couple of years has been up. So there are some existing indicators. And then as we said on Analyst Day, we have some product positioning stuff that's going out. Now a little bit of wind in our back. There's a good finding in the last couple of years.
So I'll give you the math that's in my head. If you look at the it's 7 point 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 4 points on each, I think. And so if you take 4 points times $8,000,000,000 that's about $320,000,000 each that if we hadn't repositioned ourselves, we'd be short $640,000,000 there. 2 years ago with $2,000,000,000 in semi services, I mean, AGS initially will be close to 2.6 and couple of 100 that's positioning.
So 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 $600,000,000 $700,000,000 $900,000,000
Your next question 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 3 d NAND on new wafers and conversions as opposed to largely greenfield in 2015?
What was your point say it again about 3 d. What did you say about 3 d?
Well, in 3 d, next year is going to be more new for some conversions and this year is more greenfield. What does that do to the economics for you guys?
Yes. I think on the 3 d NAND, I'll start and then Bob can join in. Thanks for the question. So 3 d NAND, as we've talked about before, is really more materials enabled than litho enabled scaling. So if you look at the CapEx that is necessary for them to ramp those devices, it's very heavily weighted towards CVD, etch.
Also, we have epi there for the first time in memory, where we have a very strong position. So, as the customers are ramping those 3 d 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 3 d NAND. And if we look at the products that we're introducing, the SIM III etch, the record CBD orders, again, a number of our products are very well positioned as the customers ramp 3 d NAND spending. So we believe that 3 d 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.
Yes, I think that's true. I think the big inflection that's going on in the industry right now is 3 d NAND. It's going to go on for years. There's about 1,300,000 wafers out there, it'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. So a little bit more bullish than some of the outside folks on total DRAM spending next year.
And then as we mentioned earlier, our position in DRAM in the last couple of years have gained 4 points.
Great. Thank you. And can you maybe just dive a little bit deeper into gross margin and how much of the headwind is coming from display versus how much is coming from SSG?
Yes. Display is a good size gross margin headwind now. It could be up to a point for the company. And what's going on there is, historically for many years, 80 percent 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, your cell phone and stuff.
So 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 and that we are growing the TAM there, growing over this is the 3rd year in a row of growing display revenues and next year with the TV downturn, we're still pretty damn healthy. So the issue is gross margins there. So if you look at that, we're penetrating some new products in some new markets and some of our competition is Japanese yen based. So the display thing is bad probably through the 1st couple of quarters of fiscal 2016, but it gets a little better each quarter and then we pick it up.
And that's when our mix gets more normal. We start to get some TV business back and the product mix change a little bit. But it's about a point now. The other piece is SSG with a big mix delta for us is foundry versus memory and that's really just indicative of tool mix. And 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.
Yes. Hi. Thanks for taking
my question. 2 of them. First one Bob to follow-up on the gross margin side. So 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 going to continue? And so would like SSG pressures?
In other words, would revenues improve in January sequentially, but margins be under pressure? And then I also had a follow-up.
Sure. So 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 material, stuff we buy. So you don't get this big absorption boost or downtick either with volume. So our gross margins are predominantly a function of mix, mix between customers, mix between products.
So my 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? I think last quarter and even at Analyst Day, I was somewhat concerned about exactly this issue, frankly, in fiscal Q1 and Q2, the heavy volume of that and the display mix with small screen sizes. What's been a little bit different versus 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. And then the follow-up is, you guys had almost just shy of $800,000,000 in NAND bookings in July. Is there a way to parse it to say how much of that was 3 d
NAND? Yes, there is. It's going up significantly towards 3 d each quarter. I'd say the let's see if I have it here. I will look at for the data, but my guess is that in the quarter we just ended, the great majority of it was 3 d.
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. And I certainly get the
new product issue and the mix items and
the flat panel issues. But people are going to say, they're going to say, look, they're just buying market share or they're gaining sort of unprofitable low end share. So 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 going to say. And I guess maybe just talk about where gross margin would be kind of a year from today at this revenue level once you sort of normalize all these factors out?
Then I had a follow-up. Thanks.
Yes. Thanks for the question, Tim. A couple of things. I had cost our internal people the same questions to make sure it's not happening. So let me see if I can go through the details because I've been through the details.
As I was just asked, one full point of it in the short term is display. And 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, and CVD. So it's definitely mix in there.
That is making 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. So I went through the biggest delta is mix between some of our higher gross margin products are PVD, epi and inspection, right? And so some of the lower ones for us are etch. So you can see the mix is more weighted towards foundry for the first and for the etch, it's more weighted towards memory.
And you see the foundry memory mix happening. So you know we're getting a bigger mix. So then you'll drill into me and say, well, are you being hypercompetitive on etch, for instance? So 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.
So 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. So what we have to do is get cost out in our products and start to get the mix across all of our products. So the road map for us is let's get some more normal level of mix between memory and foundry. And particularly within foundry, let's get the normal level of things like epi, PVD inspection.
And then with that, let's get our cost down and continue to get cost down and configurations down.
Okay. Thanks a lot for that. And then I guess really for you Gary, this is a big picture question, but it really is about your thought process around really shaking things up a little bit. The has certainly underperformed. If you look at the next worst peer, it's underperformed the next worst peer by 1,000 basis points over the past 6 months.
I know that much of that is due to the failed merger and but you sort of can't be happy with that. So I guess my question is about really shaking things up, maybe cleaning off some of the businesses, maybe pulling in
the buyback, maybe getting out
of some 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. Yes. I think from we outlined the strategy at the investor meeting. As Bob talked about, we've been positioning the company around the major inflection. So if you look at 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, 2nd highest orders in the history of the company this last quarter. And our memory share is increasing. So 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 going to invest, how are we going to structure the company around those inflections so that we're positioned when those new devices ramp. So patterning, again, tremendous momentum there. We talked about the 450 SIM III chambers.
It's really from in 5 quarter period of time, we're going from 18 chambers in the field to 450. And you asked the question about the margins 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. So there are some real technical advantages of those products that again, we went through some of those at Semicon. So it's focusing in this patterning inflection, focusing around the transistor and interconnect area as 10 nanometer ramp 10 nanometer technologies ramp.
We're in very, 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. And we believe as these inflections happen for our customers, these are tough inflections. They have to ramp quickly, get to high yield fast. And so that's another area that we focused on where we've seen 100 of 1,000,000 of dollars in growth.
And we really believe that that's another area where we fundamentally reposition the company for a more sustainable growth going forward into the future. And then as Bob talked about in display, a few $100,000,000 of growth there, expanding as our customers move into some of these new technologies like OLED with thin film encapsulation. So 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. Now the other thing that we did is we cut $400,000,000 of OpEx. We cut G and 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 somewhere around at least a 20% operating profit, We have zero bias about being in those businesses. So 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 and for our customers.
And the model that we presented at Semicon, the $2 model, we believe we're on track. If you look at the indicators around the major areas of our business, we are gaining share. Now 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. But fundamentally, we're in a much better position and confident that we're going to achieve that model.
Okay, Gary. Thanks so much.
Your next question comes from the line of Romet Shah from Nomura. Your line is open.
Yes. Thank you. You guys have mentioned that WFE this year, your expectation now is that it's flat, but the risk is to the downside. And I wonder how does the weakness this year change your view on spending for 20
16? I'll take a shot at Gary could 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 because memory is pretty strong. I mean DRAM was strong in the beginning of the year. We're more bullish than your average outside guide for next year DRAM.
And NAND, I don't think anyone's too pessimistic right now. We're pretty optimistic actually. So it's kind of a discussion foundry spending and timing, right? So if you go look at it, we believe that and listening to our customers, 10 nanometer is going to be a pretty big spend year for them next year. So the rough mathematics is that if you look at node to node, so this 32, 28 versus 20, 16, 2014 versus sort of 10, wafer starts might be down a little bit, maybe 10% per launch.
But capital intensity per node is up about 20%. So the volume versus capital intensity is still not bad. I think the problem we have right now is we get this reuse. Now the other thing you have to go look at is all the macro stuff, which is beyond my pay grade, right? What's going to happen in China in phones and next Apple phone?
I don't know that stuff. But in a reasonable demand environment, the increasing capital intensity and the importance of 10 nanometer to our customers and the fact they're absorbing the tools at this point means probably okay.
If the PC and the smartphone TAMs remain under some pressure, Gary, do you are you more inclined to pursue growth via acquisitions?
I think that from a top level standpoint, if we are improving our position in memory, so that's the good news. If you look at 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. So 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. And we think that's going to happen. But certainly, if you look at our position in epi, PVD, implant, thermal products, CMP, 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.
So mix certainly plays a big role in the overall financials.
So is it I just want
to be clear on this point. Is it fair to say that M and A is no longer part of the company's growth strategy?
Yes. So M and A, basically what we've said is that there's 3 things that drive our M and A strategy. Number 1, can we get a good ROI? Number 2, can you is it an opportunity for a leadership business? Because in most areas, the one guy makes a lot of money, 2 breaks even, everybody else loses money.
And then the third area for us is synergy with our core businesses. So good ROI, opportunity for leadership business and synergy with the rest of our products. We look across semi today, there aren't many of those types of opportunities. So now around our core competencies in materials engineering, those are areas that we will continue to look at. But today, I would say there aren't that many attractive opportunities that we see that fit those three criteria.
Roman, I think, Gary, that's the essence of the feedback. I'll give you a little bit more color. One is the Teledale had the big tax leverage, right? So that was extra benefit, right? And that made everything easier.
But we still have some tax leverage that if we ever interest in a foreign company and use our foreign cash, you sort of get about 50% discount if you think about it. So I'm not saying we're doing that. I'm just saying that's another consideration, 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 JPMorgan. Your line is open.
Hi, thanks for taking my question. I honestly say at Semicon, you guys articulated a view of $2,200,000,000 of OpEx in fiscal year 2016. I think July quarter run rate was about $2,300,000,000 The October quarter guidance takes you guys down to that $2,200,000,000 annualized. So given the weaker fundamental environment, should we expect OpEx to trend even lower beyond the October quarter? And 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 2,228 actually in fiscal 2016. We trended up over that a little bit in the last year or so, so that our run rate last quarter was like 5.79%. So it was about the 2.3% or something like that. So we were a little bit above that because we had 1 more year of inflation.
And what we've done is we've and part of the reason are a little bit above those covers. 1, 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. But we've engaged more brighter microscope on OpEx. So next quarter, we're at $555,000,000 and we're working to get down our OpEx back to the original number we guided for 2016, which was the $22,200,000,000 said we'd have a number in 2018 of 2.4. So we're optimistic we'll hit that.
And we're we've got renewed vigor to be opportunistic on OpEx.
Okay, got it. And then on the display side, looking a lot of discussion on the gross margin front. But 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? And 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 sub-twenty percent 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. But I think longer term, those guys are going to 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 $400,000,000 revenue hole or whatever. So it's not where we want to be.
It will get better. But for the next couple of quarters, it's going to be around there.
Yes. I think as Bob said, the biggest headwind there for us is mix of mobility versus TV. And if you look at the normal mix that we've seen over the last few years, the operating profit there has been continuing to improve. The revenue is up. And we're in this situation where we believe it will come back to kind of a more normal mix.
And actually, we're bullish about the operating profit and revenue increasing as we've seen over the last few years. But this near term mix is certainly working against us.
Okay. Thanks a lot.
Your next question comes from the line of Stephen Chen from UBS. Your line is open.
Thank you. Hi, Bob and Gary. Just another follow-up question on NAND. Just wanting to know if you could share your early view on 3 d NAND wafer builds for next year. I just want to get a sense We believe
We believe the installed capacity exit for 2014 was about 60, 65. We think this year exit is about 150. We think exit 16 is about 300. So we think it's kind of doubling every year. This year they had about 85, 90.
After the year before they were like 40. So we're like $40,000,000 $90,000,000 next year is maybe $150,000,000 It's going up. Okay. Lot of that working stuff we got is next year NAND 3 to near.
Great. That helps. Thanks, Bob. My follow-up question was on foundry being the swing factor next year. I was just wondering what you think happens when foundry 10 nanometer pilot orders are eventually placed.
Do you think it's kind of a steady ramp with this foundry 10 nanometer? Or could there be a hockey stick type of spend given some of the complexity of 10 nanometer?
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? So it's not unusual that they might do sort of committed to 30,000 wafer stuff, say, roughly. And then where you get the vigorous or the extra is if it's yielding well and a lot of tape outs and extra sales.
So I think you've got a baseline the next year that you can count on and getting to the higher numbers, which we're all hope believe in is how's 10 NMA yield, how many customers buy it, what's the payback, all that stuff. So 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 Sandeep 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 nanometer to 16 nanometer? 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 the last year or 2 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 for a 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. And just as a follow-up on the 10 nanometer 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 3 d NAND?
No, 10 nanometer foundry.
Oh, 10 nanometer foundry. Well, we think that from sort of 20 16, 2014, when you go to 10, it's about 20% to 30%. It's higher process complexity, more layers, stuff like that. So the back end, they're going to redo at 10 nanometer and there's other things they're going to do. So it's 20% to 30% for the same number of wafer starts capital intensity.
So that's complexity. Then you got to get the volume stuff, which I talked about earlier. And we think the reuse thing has been largely wrung out of the system, we hope this year. And then finally, the last thing you got to put in your polynomial equation is what's the end user consumption of those devices, right?
Your
Your next question comes from the line of Sidney Ho from Deutsche Bank. Your line is open.
Thanks for taking my question. 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 peaking 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 spending growth going forward over the next few years rather than just next year? And is it just the spending being spread over a longer period of time?
Yes. I'll take a shot at it again. Let's segment the market. WFE, the 3 d NAND, we're pretty bullish on actually because this is a technology transition, which is more akin to wafer size transition because they have to switch from 2 d to 3 d for both device performance and how do you can't keep shrinking, right? Electrons in a cell, you can't get smaller, right?
And so you can't effectively. So they're going to go to 3 d. It's like 200 millimeter. Your new customer is going to go, it's just timing. So they sort of waited a year or 2, but it's happening.
You can see the numbers going up rapidly and everybody says it. So I think if anything, you've got a solid baseline of predictable spending that's pretty healthy in 3 d 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 you there is the number of layers, capital intensity is picking up for Greenfield, number 1. Number 2, the die size on average are getting bigger, particularly on mobile dies. And DRAM bit growth is pretty good, right?
So I think DRAM is okay, right? Logic might be and the other thing helping DRAM and memory in general is the whole data center, big data, cloud stuff is definitely a positive, definitely, okay? Now let's go to logic. Logic hasn't been high growth for a while. It's mostly driven by PCs and for Applied, it isn't that big either.
So that one, we don't think about it every single day because it hasn't been that volatile in the last few years. So then you go to foundry. Foundry, the big driver of foundry tends to be mobile devices. And mobile devices have had very good growth. Many people continue to believe they'll be going from 16%, 14% to 10%.
So 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, then you've got healthy foundry demand. So the one that this particular quarter is a little bit we were a little surprised on for next quarter was the founding, but doesn't mean we don't feel good about founding fundamentals given the capital intensity and end user demand we think is good. So I think it's okay.
Okay. My follow-up question is a little more near term. You've talked about gaining 4 points of share in DRAM, which is great. And you also mentioned you expect DRAM orders will come to 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 light of an oversupply situation this year?
And related to that, do you see any downside risk for DRAM CapEx this year?
Well, DRAM was more heavily weighted to the first half. I got a fancy PowerPoint run here that shows me that. And so if you look at DRAM this year, it was more 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 us.
We think it's probably down, but not down a lot. Maybe it's down 10%. Who the hell knows? But that's kind of where I'm leaning. In terms of timing next year, I have a little less visibility on that.
Your next question comes from the line of Weston Twigg from Pacific Crest. Your line is open.
Hi. Thanks for taking my question. Just first services, Global Services, op margin trended down a bit despite record revenue. Just wondering if you could help us understand that discrepancy?
Yes. I think it was the mix of what they sold. In other words, if you go look at those guys, they have 200 millimeter tools, spares, services. And as I remember, the mix was a little bit different between those. Let me see if I can look at this.
Yes, I think it was a mix change within their revenues more than anything else.
Okay. And then
Just one other thing on that one. Longer term, 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. And then just on the margin side, this would be gross margin. You mentioned that you need to get cost out of products, particularly in Edge when you're answering a question earlier. Can you just give us an idea of what some of the levers you actually have for that would be?
Yes. So it's mostly material cost. There's also some better opportunities in installation warranty and overhead costs, right? So if you go look at with a new tool, I'll do the last one first, installation warranty cost tends to run higher. So we can reduce that, number 1.
The second thing is the chamber which we've ramped really aggressively, even at Analyst Day, we said we're going to go from a year ago, 5 chambers a quarter or something to hundreds of chambers. And we said by the end of this calendar year at Analyst Day would be the 300. I don't know if you picked up on the script. I think Gary said by the end of fiscal Q1, which is 1 month later, January, we're sort of like 450 or something like that. So that chamber is ramping super aggressively.
So that's an opportunity to reduce cost. And many times you have 6 chambers on a tool. So there's 6 of those. So we'll work on that. And the other thing even the wafer handling equipment is probably an opportunity with the platform there.
So it's insulation warranty, it's burden and absorption with volume, which somewhat will come relatively naturally and then it's material cost reduction around both the chamber and the handling systems. And then also the other thing is configuration management. Can we have a little less heavily configured tools? Okay.
And 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?
Not too bad. It's getting better.
Yes. I think if anything, the ramp is way more aggressive than we've seen and applied for any product in the past. And so that's the good news. It makes it harder for us to drive these improvements and then have them in the bottom line as quickly. But the good news is that the product is ramping, if anything, much, much faster than we had anticipated.
The other thing that's a tactic to get some of the material costs to the P and L, you got to ship the tool and revenue it, right? So any inventory you have, if you ECO to cost reduce it, you got to first ship that inventory first.
All right. Thank you very much.
Thanks, Wes. And Kyle, we've got time for 2 more questions, please.
Your next question comes from the line of Tom Diffely from D. A. Davidson. Your line is open.
Yes, good afternoon. So I haven't heard you mention advanced packaging recently. Is that still a focus for the company? And if so, what's your outlook there?
Yes. 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 being as you look at real needle movers on 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. And then back on the bookings, you said that the foundries got weaker through the quarter. Is there a risk to any of the bookings you had for foundries early in the quarter, de booking over the next quarter or 2?
Well, there's some risk, but a lot of that stuff in those type 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, understand with the push outs of some of the 16, 14 nanometer capacity related to end user demand and the higher tool. Is there any change in their tenant given the better tool utilization at 14%
Patrick, you're fading on us. I think you said, is there any change in their what?
The 10 nanometer plans. Given the recent Given the better tool utilization and yields at 16 and 14?
No, I don't think so. 10 nanometer is still pushing aggressively. 10 nanometer, they'll probably change the back end. That will contribute to higher capital intensity. The tool utilization now, some of that tool utilization was getting better yields on their first FinFAT, right?
Because that was a tricky one. The second one is not quite as worrisome. And then the third thing is some of that higher tool reuse is kind of a natural progression from 2020 sort of the 2016 or 2020 to 2014.
Okay, great. And Bob, maybe as a specific question on the operator model for you, I think I've known you long enough and well enough that the gross margin is a big focus for you guys and you're not just going to sit idly by to let the product mix shift. Are there specific things you can do, particularly on the flat panel display side, given you mentioned the smaller mobile display product mix issues. Are there things you can do specifically to improve that over time?
Yes, there are. 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. So we're not being passive.
We're pushing it hard. It just it kind of came 1 quarter earlier than we expected, to be honest with you. And the other thing I'll say to you, 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. But the glass is half full on this thing. If you look at it, we've gained over 4 points of share in DRAM, over 4 points of share in NAND. We've gained we've expanded our TAM or SAM and display point 50% and we've expanded our service SAM and revenues and service quite a bit. If we hadn't done those things, you wouldn't be talking about gross margins being down 2 points.
You'd be talking about over $1,000,000,000 less of revenues probably this year. And 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 $300,000,000 hole in profit. So we're spectacularly unhappy with our gross margins. I don't disagree.
But it could have been a lot worse if we hadn't penetrated these markets, gained share and got some new products out there. You would have had a sustainable problem of $300,000,000 of profit a year, frankly. And 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 operating margin delta from 2012 today is greatest, it's probably etch, right, because we've scaled up so much volume at pretty good operating margins. So we are spectacular and happy with the gross margins. But if we hadn't gotten this stuff out and repositioned this stuff, it'd be an even worse call today.
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 p. M. Pacific Time today. Thank you for your continued interest in Applied Materials.
This concludes today's conference call. You may now disconnect.