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 second quarter, which ended on April the 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 8-K filings with the SEC. All forward-looking statements are based on management's estimates, projections, and assumptions as of May 14th, 2015, and Applied assumes no obligation to update them. This webcast 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. Also, as a reminder, Applied will hold its next analyst meeting in San Francisco on Monday afternoon, July 13th, preceding the SEMICON West trade show. We hope to see many of you there. Now I'd like to turn the call over to Gary Dickerson.
Thanks, Mike. Good afternoon. In our second quarter of fiscal 2015, Applied delivered our highest quarterly revenue in the past three years and earnings near the top of our guidance range. These results reflect robust customer investment in both semiconductor and display, and most significantly, that Applied is delivering the enabling products and services our customers need as they transition complex new devices into volume production. The magnitude of the technology change facing our customers is unprecedented, and this creates incredible opportunities for Applied Materials now and in the future. Our core competencies and unmatched talent in materials engineering provide a great platform for profitable growth. Applied has a compelling strategy. We are investing in that strategy and making meaningful progress towards our goals.
The traction we are demonstrating is made possible by our employees' relentless focus on moving the company forward and their tremendous passion to create value for customers and investors. Over the past few years, we have been driving significant changes across the company, strengthening our capabilities and processes while aligning the organization to take advantage of our best opportunities. We have aggressively shifted spending within the company to better support our customers, provide additional fuel for product development, and improve our financial performance. By increasing investment in key areas, we have created a pipeline of differentiated products that will accelerate Applied's growth, and we are already seeing a positive impact. Starting with our semiconductor equipment business, the trend is clear. We are winning market share. Over the past two years, we have increased our overall share in wafer fab equipment around one and a half points.
Based on our current view of customer spending, we expect to build on those gains this year. Our traditional leadership businesses, where we have high share, remain strong. In 2014, we added around three points of share in both PVD and EPI. We have our strongest momentum in areas of the market that represent large growth opportunities for us. Our combined revenues in CVD and etch were up over 50% year-over-year, significantly outgrowing the market. This past year, we gained two points of share in CVD, and we have highly differentiated products in our pipeline that will expand our addressable market. We are very excited about how our new products are positioned and will provide more details about our progress at our analyst meeting in July. Since 2012, we gained seven points of market share in etch, including 12 points in conductor etch.
In the past two quarters, the installed base for our latest generation etch system has grown from 10 chambers to more than 160. This is one of the fastest adoption rates for any new Applied product, and customers are telling us they see technical advantages in uniformity and defect performance. We believe our technical position is getting stronger, and this provides a foundation for future share gains. We're also driving growth in our service business, where we delivered our highest-ever quarterly revenue, and we're on track for a record year. At both the leading and trailing edge, our customers face incredible challenges as they strive to bring new innovations to market faster and more efficiently.
By helping our customers solve their device performance, yield, and cost challenges, we believe that service can be a meaningful component of our long-term growth. We have adapted our strategy, strengthened our team, and are bringing together capabilities from across the company to deliver expanded service offerings that provide more value for our customers. Service and spare parts revenues have grown more than 17% from this time last year. During this period, we have significantly increased the number of tools under service contract, which we believe is one indicator of our growth potential. Turning to display, we expect 2015 to be a third consecutive year of double-digit revenue growth and to increase our overall share by about two points. As we've highlighted before, our revenue and margin profiles in this business can be uneven.
While we see some margin headwinds in 2016 due to customer mix and a weak yen, overall market trends remain positive. As the display industry introduces new technologies, customers' manufacturing processes are becoming more complex and capital-intensive. We have invested in a strong portfolio of products aimed at enabling next-generation TVs and mobile displays. One example of this is organic LED, which expands our served available market. We recently received a large order for our OLED encapsulation tool, and in 2015, we expect to book about $200 million in this new application. Overall, our growth trajectory in semi and display is supported by a sustained period of industry investment in both capacity and technology. Even after recent customer announcements have been taken into account, we still believe 2015 wafer fab equipment investments will be up slightly over 2014, driven by increased memory spending.
Sustained NAND bit growth in the 35%-40% range, similar to 2014, enables these customers to maintain their investment levels. We expect 3D NAND to represent more than 40% of NAND investment in calendar 2015, and installed capacity should exceed 120,000 wafer starts per month by year-end, which is only around 10% of total NAND capacity. This inflection not only increases our available market but is also enabling us to gain share. Based on the positions we have won, we believe that in the transition from planar to 3D NAND, we will increase our served market share by at least five points at these customers. In DRAM, supply and demand remain well-balanced. We anticipate bit growth of 25%-30%. We are expecting this to translate to an increase in customer spending of 15%-25% relative to 2014.
These investments are primarily focused on 20-nanometer upgrades for mobile DRAM with some capacity additions. In foundry, the leaders are engaged in a fierce battle to ramp FinFET technology at the right yield and cost. The intense pressure for our customers to accelerate volume production of their FinFET devices is a major area of focus for Applied and creates a great growth opportunity over the next few years. In summary, our customers are making incredible advances in technology enabled by materials innovation, and this plays directly to Applied's strengths. Across the company, we are making meaningful progress towards our growth goals and driving opportunities to accelerate our strategy. Going forward, we are prioritizing three areas to further improve execution. First, we feel very positive about our new product pipeline and our ability to drive growth at Applied.
In the near term, as we ramp these new products, we see some effects on our margins, particularly in cases where rapid adoption has exceeded our expectations. Bringing margin performance back in line with our financial model is a major company-wide focus. Second, we will continue to actively manage our product portfolio to ensure we are deploying our investments and resources towards our most promising growth opportunities. In the past two weeks, based on our view of future market potential, we have taken actions to further lower the break-even level of our solar business. Third, we are taking additional steps to optimize our structure, making sure that the organization is aligned to major areas of value creation for our customers and that we have the right talent in the right areas.
Now, let me hand the call over to Bob, who will provide additional detail about these priority areas and our financial performance.
Thanks, Gary. I'll add my comments about how we're doing in the transition underway at Applied Materials. Gary talked about how we've moved money from headquarter functions and underperforming businesses to higher growth opportunities, notably in etch, CVD, display, and AGS. We've also strengthened the linkages between SSG and AGS for growth. SSG plus AGS revenue grew 20% in FY 2014, and we expect both businesses to outpace WFE in 2015. Focusing on the total life cycle of our products will increase both our revenue and profit growth. When excluding EES, Applied's trailing four-quarter revenue was the highest in seven years. Now let's look at profitability. You'll recall that our non-GAAP gross margin was 40.9% in 2012, grew to 42.1% in 2013, and reached 44.1% in 2014, or 43.6% when excluding non-run-rate items. Our progress is trending ahead of plan.
This year, we've faced some headwinds due to mix and the higher initial cost of fast ramping new products. In Q1, our non-GAAP gross margin was 42.3%, and in Q2, it increased to 43.2%, which was nearly a point better than our forecast. We expect gross margin to be flat to up a little in Q3. Looking ahead to FY 2016, gross margin remains a key challenge to financial model performance. Within SSG, if we have similar demand and new product ramp times, we could experience gross margin headwinds in the first half. In display, Gary mentioned some of the margin challenges associated with the strong mobile ramp, along with JPY-based competition. However, leaders throughout the company are intensely focused on gross margin improvement.
Based on our gross margin initiatives, we believe we can achieve year-over-year improvement in fiscal year 2016, but we expect it to be below model performance for the year. We are equally focused on managing our operating expenses. Quarterly non-GAAP OpEx should be around $575 million through the end of this year. We have a number of new products to launch, which require additional support, but we'll stay focused on our cost structures and continue to optimize our portfolio investments. Last week, we further reduced our solar spending, and we will continue to monitor the market closely. Looking to our overall model, we continue to believe the non-GAAP EPS of $1.70 is the right level of profitability for the company when WFE spending is at $33.5 billion. With the merger pending, we were unable to take certain actions, including share repurchases.
Next week, we'll begin to buy back stock under our three-year, $3 billion repurchase authorization. We plan to be opportunistic, and we could execute the program in under two years. As the buyback and other initiatives take hold, we believe that we are on a path to $1.70 in 2017, assuming WFE demand of $33.5 billion. We'll share our detailed model with you at the analyst meeting in July. I'll summarize our second quarter results as compared to the prior quarter. Orders of $2.5 billion were up 11%, led by SSG. Net sales of $2.4 billion were up 4%, which was above our expectations. Non-GAAP gross margin was 43.2%, which was better than expected due to a favorable customer mix. Non-GAAP operating expenses were $579 million, in line with guidance. Non-GAAP EPS of $0.29 was a penny above the midpoint of our guidance.
We ended the quarter with approximately $4.2 billion of cash and investments, and about $2.8 billion of this was offshore. In SSG, orders of $1.7 billion were at a three-year high and were up 19% on increases in foundry and IM. SSG net sales of $1.6 billion were up 8%, at the high end of our expectations. SSG's non-GAAP operating margin grew by almost three points to 26.8%, driven by higher volume and a favorable product mix. AGS orders of $641 million were down 7% sequentially due to a seasonal decline in service contract renewals. AGS orders were up 19% from the second quarter of 2014. AGS achieved record net sales of $646 million. The 11% increase was driven by growth in spares and services, along with 200-millimeter equipment. AGS non-GAAP operating margin was 26.3%.
Display orders increased slightly to $120 million, and net sales declined to $163 million as expected. Display non-GAAP operating margin decreased to 24.5% on lower volume. EES orders were $50 million, and net sales grew to $73 million as expected. EES posted a non-GAAP operating loss of $4 million. I will provide our third quarter business outlook. We expect our overall net sales to be up 2%-6% sequentially. Within this outlook, we expect SSG net sales to be up 3%-8% sequentially. AGS net sales should be up 2%-7%. We expect display net sales to be approximately flat, and EES net sales should be approximately $50 million. We expect non-GAAP earnings per share to be in the range of $0.31-$0.35, which would be up 18% year-over-year at the midpoint.
Let me turn the call back 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.
At this time, I'd like to remind everyone, in order to ask a question, press star, then the number 1 on your telephone keypad. Your first question comes from the line of Jim Covello from Goldman Sachs. Your line is open.
Hey, guys. Good afternoon. Thanks so much for taking the question. I guess, Bob, first question is on the margins. If I think about what's going to be necessary to get you back in line with the target model, of the three, mix, scale or lower component costs. How would you rank order those drivers in terms of the importance of getting your margin model back to where you want it to be?
I'd say in the short to intermediate term, which is the next year and a half, maybe, mix hurts us the most quarter to quarter. In terms of the second one, probably margin cost, because most of our component costs, most of our product cost is materials. Then the third one is the scale issue, which is like overhead absorption . Now, longer-term, if you can make progress on that, those are sort of time sequenced also.
Okay, that's helpful. If I could follow up, Gary, on the 3D NAND ramp, it really seems like that's gaining some incremental traction in the back half of this year. What is it that's finally making customers feel more comfortable to ramp the 3D NAND? Is it that yields are where they need to be? Is it that the opportunity in enterprise solid-state drives is bigger? Is it just the customers trying to make sure one doesn't get too far ahead of the other? Why are we starting to see this inflection? Because it's been kind of a while in the making. Thank you.
Yeah, I think, good question, Jim. The yield was certainly a big challenge. This is the biggest change in memory technology in decades, going from planar scaling to 3D. That was a big challenge. All of the customers were focused on making the transition, as we had discussed before, the yield is getting to the point where more volume is going towards 3D NAND. All the customers have been focused with heavy technology investments in that area, more customers now are moving to that technology into manufacturing. That certainly is a big transition. What we said for Applied Materials is that the transition from planar to 3D NAND is really good for our business, because planar is more litho-intensive, 3D NAND is more in the sweet spot of materials engineering types of technologies, etch, deposition. We have additional Epi steps there.
We talked about the opportunity for us on an equivalent wafer start basis, going up 35%-50%, what we're seeing, we are very optimistic more towards the top end of that range, relative to the opportunity for us in growth. The other aspect is not only is the TAM increasing, we believe that we will increase, as I talked about in the script, our share of that TAM. That's another incremental growth driver for us within Applied. We see the 3D NAND ramping certainly in 2015, really the majority of spending in NAND beyond 2015 is really towards 3D NAND. We also said that the capacity for 3D NAND is really 10% of total NAND capacity by the end of this year.
There's still opportunity as customers make that transition and really good tailwinds for us in terms of TAM and market share.
That's really helpful. Thank you so much. Good luck.
Your next question comes from the line of C.J. Muse from Evercore ISI. Your line is open.
Good afternoon. Thank you for taking my question. I guess first question, can you walk through your latest thoughts on linearity, first half, second half, in terms of you and industry shipments?
Sure. We think the second half's a little stronger than the first half. We think foundry's up second half versus first half. I'm doing revenues. DRAM's a little soft. NAND's stronger. Logic's about neutral.
Very helpful. I guess as a follow-up, as you look at the handoff from DRAM to NAND going first half, second half, can you walk through what your intensity looks like in one sector versus the other? Also how we should think about the implications to gross margins? Thank you.
If you look at historically in the last year or so, our share in DRAM versus NAND overall is comparable. If you go look at the transition, though, at NAND, as Gary said earlier, the growth at 3D for a company like Applied is, we said 35%-50% increase in the greenfield. It's probably a little more even. If you look at our share gains are about five points in that transition. We gained five points of that TAM. The transition from DRAM to 2D NAND is somewhat better for us. The transition to 3D is substantively better for us.
The other thing I would say is that we're gaining share in memory in both NAND and DRAM. Last quarter, what we had discussed was we had our highest DRAM orders since 2010. We actually exceeded that this quarter. For the last two quarters, the DRAM business for us is up significantly, and we are gaining share in both of those different areas.
Your next question comes from the line of Timothy Arcuri from Cowen and Company. Your line is open.
Thank you. Couple things. I guess, Bob, first, a question on OpEx. Did I hear you say that OpEx will be down $35 million quarter-on-quarter between April to July?
No. I said it'll be about $575 million.
Oh, $575 million. Okay. All right. I guess to follow onto that, if you look at that element relative to your financial model, that seems to be the area where, given where your revenue is, that's the line item that's sort of the most out of whack. Either you have to grow revenue without growing OpEx, or you have to cut OpEx to sort of bring that in line to where revenue is. Can you just talk about that? Can you talk about which of those two you think is more likely? Thanks.
Sure. Yeah. The model was a 2016 model, we actually see revenues growing next year. We think this year's probably a little under a $33 billion year for WFE. Next year, the model's at $33.5 billion, WFE is a little better in that model. Second, we think our share will be up in WFE, this year and next somewhat. We think AGS is showing good growth momentum, and display should be pretty good in revenues next year. We think the revenues could be an uptick and approach the model next year. In terms of the biggest discrepancy, in my opinion, frankly, is a little bit of gross margins, right? 44.5% was the model. If you look at the documents, it said 45%, but the math says 44.5%. We're up to 44.1% in fiscal 2014. The quarter just ended, we were at 43.2%.
We go up a little bit, maybe the second half, in the first half, etch is heavy, and there's a little bit of display mix problems. We're not up. I'd say the biggest delta is probably the gross margin line. If you look at expenses, we're at $575. If we hold at that line, which is what we're saying, we'll be at $23. The model is $2.228 billion, we're $72 million over, a lot of that's related to all the new products coming out. I think the biggest discrepancy is probably the gross margin line, personally.
Thanks, Tim.
Okay, Bob. Thanks much.
Thanks.
Your next question comes from the line of Farhan Ahmad from Credit Suisse. Your line is open.
Thanks for taking my question. My first question is regarding the backlog. I saw that there were some debookings in the quarter. Can you talk about what those were? Was some of the impact from the recent cuts that we have seen from TSMC and Intel?
From the backlog, there was some debookings of stuff that either slipped out of the quarter, turned around. There was cats and dogs in there, too, frankly. There was a little bit of foundries, some of the miscellaneous. There was foreign exchange, was $10 million of that, so that was just FX. I wouldn't draw too many conclusions on it.
Got it. Another long-term question, just talking about the balance sheet structure. Have you given any thought to what level of debt you need, or you can support on the balance sheet and try to recapitalize your balance sheet and return some cash to shareholders?
Yeah, we've given a lot of thought to everything, especially the last few weeks. Look at the $3 billion. I'm actually pretty optimistic we can get the $3 billion done in less than two years. I'm actually reasonably optimistic that we can continue a significant buyback for a number of years, without going into heavy debt. I think we'll go into moderate debt. I'm actually kind of getting optimistic on the tax and the cash flow. If we need to take on some debt to continue significant share returns to investors, we're willing to look at that too. We plan to do some of that, too. I'm actually getting more optimistic on the foreign cash lately.
Thank you. That's all I have.
Your next question comes from the line of Krish Sankar from Bank of America Merrill Lynch. Your line is open.
Yeah. Hi, thanks for taking my question. Two of them. First one's for either Bob or Gary. As you look ahead and focus on both trying to gain share and renewed focus on gross margin, I'm kind of curious, is there going to be a difference in the pricing philosophy for the company? Are you going to look at pricing differently, be more rational, or is this going to be status quo? Just kind of curious on that, and I also had a follow-up after that.
Yeah. Let me talk a little bit about the model. Bob, Tim had asked this question earlier. In semi, we're very optimistic. We talked about the growth in our business as these new memory technologies are ramping into production and certainly in FinFET, first generation, 10 nanometer. That's a great opportunity for us with the products we have enabling those transitions. We gained one and a half points over the last two years. We indicated we believe we'll gain share again this year. As these transitions ramp, we're still in the early innings in terms of some of these transitions in the semiconductor area. We're optimistic in that area. Display, I talked earlier today about three years of double-digit gains in revenue in the display market. Again, there are major technology transitions there.
We talked about a new area where that will generate $200 million in revenue this year. Again, we have some good growth opportunities in display and service. Our service and spares was up 17% in our service and spares from last year, record revenue. We have really good growth opportunities. When you look at the model, the top-line revenue growth, if you look at where we were when we published that model to where we think we'll be, we're going to be in the range of that number for top-line revenue growth, which was an incredible accomplishment versus what we said we would do. We still believe these opportunities are great opportunities for us. One of the things I also talked about was in etch, we're introducing a new chamber that customers are telling us technically has advantages in uniformity and defect performance.
As you're ramping these many new areas simultaneously, we have great new products that are targeted at these inflections. There's going to be some margin pressure with startup in some of these areas, and frankly, they're going even faster than we'd expected due to the pull from the customers. The key thing in any business is to have value, technical value and differentiation you're delivering to our customers. Our focus is to enable these inflections for our customers in semiconductor and display. In that process, we will drive market share higher and hopefully the value for the customer with these differentiated products will also go up over time. As Bob had said earlier, in 2016, due to mix, we believe that the margins are going to be behind, but we are still driving to achieve those margin goals.
The timing may be a little bit later than what we've talked about, but the momentum for the company relative to revenue growth is in the range of what we discussed when we published the model. Again, the margins are going to be off, as Bob talked about, but we are driving. There are a number of opportunities for us to drive to close and exceed that gap from a gross margin standpoint.
Got it. Just as a follow-up along the same path, if I look at the SSG products, the one that has the biggest potential for share gain is conductor etch, but that also looks like has probably one of the lower gross margin. Would the conductor etch product, do you think, get to the same level as some of your other dominant products like PVD, or do you think that is going to be structurally a lower gross margin product division?
Over time, we see a lot of opportunity for us to drive higher margins in that business. Certainly, the share gains over the last couple of years have been pretty significant. Our business went from, I think, 2012, from $350 million to about $1 billion last year. Just dramatic gains in the etch business. We think over time, there's still a lot of upside potential, and it really, as I said, comes back to how are you technically positioned in the markets, and there are some significant advantages that customers are seeing. It's in the early innings of that being validated with customers, but you really look for architectural advantages in your products where you can solve high-value problems for customers in these inflections.
We believe there are those areas that we can drive over time, and certainly, a lot of opportunity for us to improve our margins in that area.
Got it. Thanks, Gary.
Thanks, Krish.
Your next question comes from the line of Atif Malik from Citigroup. Your line is open.
Hi, thanks for taking my question, and good job on the results. Gary, if I look at the foundry spending of one of your customers that cut the CapEx, if I look at the CapEx divided by the capacity, their CapEx per unit capacity is kind of flat over last year, and that's partly because the [inaudible] demand wasn't strong and they're reusing more equipment. My question is, if I look at 10-nanometer, how should we think about that ratio of CapEx to capacity as you move to 10-nanometer for the equipment makers?
10-nanometer is. We'll talk more about this at SEMICON. I've heard some customers say that this is the most important node in the history of their company. You look really at where the pull is from an end-user perspective in terms of mobile devices, certainly there is a lot of value. People are trying to pack more performance, more features, and drive lower power for those devices. 10-nanometer is a big battle for all of the different companies, and there's tremendous focus there, and the engagement with the customers are very deep and very broad. When we look at the opportunity for the CapEx, if you take equivalent number of wafer starts, it goes up a significant amount versus what we're looking at for the 16- and 14-nanometer node.
We'll talk more about this at SEMICON, but it is a great opportunity, and there is a significant change in that device as the customers are ramping 10-nanometer, and we look at that being a great opportunity for us. In the transistor area, we have more Epi steps, real strength in PVD, implant, a number of different areas, and then also the interconnect structures there will also change. This, as we've said many times, is the sweet spot relative to materials engineering, and we look at 10 being a really, really great opportunity to drive our business over the next few years. I don't know, Bob, if you want to add anything else on that one.
Yeah, maybe I could, if you don't mind. If you want to look at sort of this capital intensity and reuse and nodal transitions, you have to look at three things, really. One is, what's the relative capital intensity of the node? Two, where are they in the transition to a node? Three, how big is the node? What is worrisome to some people right now is, geez, they're getting a lot of reuse, and is that not as good for you on capital intensity? I'm not actually too worried. If you look at the data, we think this year is probably a $33 billion year, and if you adjust for foreign exchange with the weaker JPY and weaker EUR, it's probably north of $33.5 billion. The year is pretty good. Now look at what they're spending on.
For three years in a row, 2012-2013, 2013-2014, and 2014-2015, the percentage of the spending that's going to companies like Applied, actually Applied, has gone up as a percentage of 100%. This PME thing has really taken traction. Third, if you look at where they are in the nodal transition, 16 to 14, they're pretty early. 20 wasn't a big node, and they're doing some reuse. If you look at it, as they get later into the node, the percentage reuse probably goes down somewhat. Two, as Gary said, 10 is a big node. If you look at the capital intensity, which we'll talk to you more about at Analyst Day, it looks like 10 mix again plays for companies like us. I'm actually not too upset about the nodal transition or the mix for us.
Thanks. Very helpful. As a follow-up, Bob or Gary, your services growth is outstanding if I compare it to the wafer start growth, which is about 3%-4% year-over-year. Can you provide us a percentage of your install base that's currently under contract so we can see how much headroom you have?
What I would say on the service contracts, that we are making really significant progress relative to service contracts. All of those tools under contract really provide a great forward momentum for us in the service business. We've made a lot of changes relative to our strategy, our structure, bringing new talent into the organization, also the connection between the service business and the semiconductor business units. We've relocated people. It's really stronger than ever in terms of those value roadmaps for customers. That's translating into significant growth in our service and spares business. What I talked about earlier, 17% growth in service and spares year-over-year. We believe there is a huge opportunity. If you look at the share, it's still very low. We have a lot of momentum there, and we think the growth opportunity there is, for us, is significant.
Let me add something, connect the dots with a question that was asked earlier. The point question that was asked earlier is, can etch gross margins get to be where some of your higher product gross margins are? I think the answer is they can certainly improve from where they are. Even if you look at other etch companies in our industry, the overall etch gross margin is not as high as some of our other high gross margin business, higher share businesses. What is very attractive about etch is a few things. One, if you look at our growth in operating profits since 2012 in etch, it's outstanding in terms of what's dropped through to the bottom line. It's very good.
Second thing is, if you look at etch in the aftermarket, we're focused more and more at the total product life cycle profitability of a business, etch is probably the biggest opportunity because these tools, as Gary said many times, eat themselves. In terms of driving long-term profitability and predictable profitability, etch is a very attractive business.
Thanks.
Your next question comes from the line of Harlan Sur from JPMorgan. Your line is open.
Good afternoon, nice job on the quarterly execution, guys. As a follow-up to the previous question on 10-nanometer, sounds like another solid move up in intensity for the Applied team. We've heard pilot production later this year to kind of first half of next year. Question is, are you guys seeing the 10-nanometer spending in your order pipeline for this quarter, the July quarter, or is it more targeted to come into your order pipeline more kind of in the second half of this year?
It's really not amounting to a large number right now. Certainly, the engagement that we have with the customers is really better than ever across all of our different products. Certainly, in the transistor area with Epi PVD, more Epi steps, that's a great opportunity for us. In the patterning space, one of the things that we did in the organization is pull all of the patterning groups together. We have etch, the selective material removals, CVD, ALD. The synergy is there for us as we are delivering these new materials, our ability to deliver those materials and etch them and remove them, that's a great synergy that we're driving as part of the organization change that we made.
The opportunity for us there, the engagements we have are great leading indicators of where we're going to be when that ramps, and they're broader and deeper than we've ever had. From a revenue standpoint right now, it's not a significant number for us. It's a very small number for us.
Got it. Okay. I was talking more about orders there, but I understand where you're going with that. On the NAND segment, obviously very strong orders up, I think 40% sequentially. How much of this order mix in the April quarter was 3D, or is it still being focused on planar? I'm assuming that the 3D spending mix is moving higher here in the July quarter. Are you seeing this order trajectory spread across multiple customers?
On NAND in total, we had a good bookings quarter, as you said, we think it's pretty strong for the rest of the year, as we told you earlier. The second thing we told you earlier was by the end of the year, we see 120,000 wafer starts installed, which is about 10% of overall capacity, up from about 60,000 at the end of last year. We see a heavier weighting of the 3D in the second half spending.
Great. Thanks, guys.
Thanks. Our next question comes from the line of Stephen Chin from UBS. Your line is open.
Thanks. Hi, Gary and Bob. Just a follow-up question on the gross margin next year. Is the gross margin issue mostly because of the display margin headwinds and less from these new etchers? What is the display margin issue? Is it mostly from this new OLED display win that you're just ramping for the first time?
Yeah. If you go look at it, I'm looking at the data actually, so I can be more accurate. If you look at it, we're a little below where we want to be. We'll be up next year, we believe, in SSG in absolute gross margin percentages, but not as far up as we want. Now, the reason we're not getting as far as we want is mostly mix. The reason we're improving in absolute dollars is within each product, we're doing better. Okay? The mix is still a little bit off, particularly in the first half. Within display, again, it's a mix thing that's next year. Our business predominantly for many years has been driven by TV equipment. We sell equipment to make TV panels or TV screens.
Next year is a disproportionate number of sales of very high, I think the highest ever, and probably the highest we will have for the foreseeable future, sales of smaller screen sizes. Which is somewhat different mix of tools, somewhat different mix of customers. This is for cell phones mostly. That's the mix that's hurting us in display next year, and it's unprecedented in the volume.
Okay, thanks for sharing that. My follow-up question is just a general question on multiple patterning. There seems to be a perception that once EUV tools are put into production, there'll be a big decline in some of these etch and deposition sales for multiple patterning. I was just hoping you could share your thoughts on this, given the big EUV order that we saw recently. Thanks.
Yeah. Thanks, Stephen. I think our position on EUV is consistent with what we've said in the past. We think it's post 10-nanometer when you would start seeing any real volume on EUV. As we said, over the next few years, the real big driver for us will be the 10-nanometer node and maybe the second generation of the 10-nanometer node. That we anticipate to be a big node, a real important competitive battle for our customers, and we'll talk more about this at SEMICON, but really a great driver for us from a TAM standpoint. EUV is out beyond that timeframe, it's out beyond the next few years. The other aspect is when EUV comes in, we believe that will also come in potentially with multiple patterning.
The timeframe for EUV to really have any impact on our business is out there several years. We don't see anything really near term. Certainly, again, the big driver for us over the next, I would say two, three years, is going to be the 10-nanometer node and maybe the shrink of that node.
Okay. Thanks, Gary.
Your next question comes from the line of Romit Shah from Nomura. Your line is open.
Thank you. Gary, you've mentioned that revenue growth in this industry is hard to come by, given that and the developments over the last couple of weeks, why can't you guys do better than the OpEx run rate of $2.3 billion?
Well, I'm not sure I completely understand the question. The revenue growth, as I talked about earlier, we have a lot of momentum around these inflections in semiconductor and display. In semi, we gained one and a half points over the last couple of years. We expect that we will gain share again this year. As these new technologies ramp, we're still in the early innings in terms of the change in memory technology and the whole FinFET battle that is happening with our customers. We're very optimistic based on the investments we've made and our teams, that we will continue our momentum in growing our share of WFE in the semiconductor business through those transitions. As I said earlier, the display, three years of double-digit revenue gains in the display business. We have very good opportunities there.
Also in display, that market is undergoing significant changes from a technology standpoint, including this new area in OLED that we're ramping. Again, we have a lot of confidence in the growth longer term in our display business, a great team. They're gaining share, and also we're expanding our TAM with these new applications. That part, we're very happy with the progress that we're making, in all of the major parts of our business. The OpEx question, relative to the 575 number, where we're at right now. Our number 1 focus is that we want to capture these inflections with our products in semiconductor and display and continue to grow the service business. As I said earlier, we're pretty much on track for significant top-line growth.
If you looked at where we were at when we talked about the model versus the momentum that we have, we're in the range of what we talked about earlier for top-line revenue growth. As you said, it's really hard, but I am very proud of this team that we have at Applied and what we've been able to accomplish and the momentum that we have in these different businesses. We will continue to look for opportunities to optimize the business. We moved hundreds of millions of dollars over the last couple of years, into areas that will drive longer-term shareholder value. Bob talked about the action that we are taking in the solar business right now, and there are probably more opportunities for us to continue to optimize the portfolio longer term.
We will continue to look at structural changes that will lower our overall spending in the company, and improve productivity. In the next year, we are very focused on top-line revenue growth. As you said, that's very difficult to come by.
Thank you for that. One of the things you highlighted in your monologue was just the strength of the services business. If I look at that as a percentage of SSG, it's around 41% sort of attach rate. Is that the right way to think about it, services as a percentage of SSG, and is that 41% a number that you think you can improve on?
Yeah. Again, the 17% growth in service and spares in the last year. Think about the service business, around $2.5 billion. This year, we'll be north of $2.5 billion. I think in the model, we had something like $2.6, $2.7 billion for 2000.
Oh, no, the original model was only $2.561.
Oh, $2.561. anyway.
We beat it.
We'll beat that. If you can achieve double-digit revenue growth in service as we are this year, that's $250 million, $300 million. That's almost 1% of WFE. Through a lot of changes in our strategy, our structure, we are increasing our service and spares business. We're adding value to the products. That can be a great revenue driver as we're adding more value for our customers. Certainly, that's an area that the whole company is focused on, is really creating more value for customers and then driving growth in that area.
Thank you.
Thanks, Romit.
Your next question comes from the line of Patrick Ho from Stifel Nicolaus. Your line is open.
Thank you very much. Gary, first, in terms of the share gains you've garnered on the memory space, can you give a little more color on the foundry space where you've traditionally have had strong exposure in many of your process segments? Can you give a little bit of color of where you see some of the gains?
You're talking about in foundry, Patrick?
Yes.
Yeah. In the last year, certainly PVD and Epi, we talked about both of those areas being up 3%, those are great growth drivers for us. All of the different areas around the transistor, if you look at our implant business, for instance, that business is very strong. The switching cost in the memory is much higher than in any other market. That area, our high current share-
Of foundry.
In foundry. Our high current share in foundry is in the 90% range. That area is extremely strong. Last quarter, we said that our etch business had the highest revenue in foundry since 2007. We are making some progress there. We are making more significant progress, certainly in V-NAND and the memory space, but that's an area that we think longer term is a really great opportunity for us. There's a number of areas. I don't know, Bob, if you want to add anything on this one. There's a number of different areas, and I think as you go to these future nodes in FinFET, our TAM opportunity will increase a significant amount around transistor interconnect in a number of different areas.
Yeah, I think the three things you look at here are how big is your product footprint in foundry and how strong is it, and two and three, are you getting DQR wins, right? If you go look at our foundry footprint, it's very strong, and they're highly differentiated products. That's why it stays strong as a share position. In terms of gaining share, because they run so many different devices and so many different customers, and they're so complex, turning DQRs into PQRs takes a little longer, but we've got some pretty damn good DQR positions that we've worked on the last two years, which very well could turn into PQRs later this year.
Yeah. The other thing I would say in our PDC area, we're stronger in foundry and logic, and this last quarter, we had some good wins in a couple of major foundries. One of the things also, if you look at our 2015 business in PDC, it's about 60% E-beam and 40% optical. In E-beam, we have very high share in the E-beam review area with the SEMVision. You look at the different areas of the segments within E-beam, of CD-SEM, E-beam inspection, and defect review, those are all areas that are growing very fast, and our technology there, especially electron optics imaging capability, is really world-class. That's another area we look at as we go forward, where we see a potential for growth.
Great. That's helpful. Maybe, Bob, a specific question for you in terms of the margin impacts on some of these new product ramps. Obviously, you mentioned that the faster-than-expected traction has obviously put some pressure on the near term. When do you expect to see some of those supply chain efficiencies kick in in terms of, I guess, supply agreements and volume buys that will help margins improve over time?
Yeah. What we're doing, Patrick, is what's driving us down is mix, where we're gaining some share a little faster probably than we expected, and the new products are starting to track in. Now what we're doing to mitigate that is get the new products up the gross margin curve faster and also to get gross margins up everywhere else across the company, and that's through material cost absorption. The cost reduction efforts across the whole company in terms of PPV are picking up reasonably, not heroically yet. We're getting better. In terms of the new products, it's picking up faster. My guess is you're seeing progress now. It'll pick up more next year. What's killing us in the first half of next year is mix again.
Great. Thank you.
Your next question comes from the line of Sidney Ho from Deutsche Bank. Your line is open.
Thanks for taking my question. First, a clarification. Did I hear correctly that earlier, Bob, you said, you expect the 2016 WFE market to be 33.5? Are you just referring to your operating model that you've talked in the past?
We don't have an official forecast. That's our model. We don't have any detailed analysis of that. If you ask, take me out for a beer, it's a working model that's okay to work with, but we don't have a real number yet.
Okay. My first question then is, in the DRAM side, obviously very strong bookings in first two quarters and record level last quarter. I know you've talked about the second half DRAM revenue will be lower than the first half. I know you're not giving 2016 guidance yet, but are there any reasons why this strength would not continue in 2016 given the increased complexity and multiple patterning steps used in advanced nodes?
In terms of DRAM, you said?
Correct.
Yeah. I'll tell you my guess. I don't know if you get it here, but I'll tell you my guess. I think the V-NAND thing is going to pick up momentum because I think you're going to see more and more go to 3D. Patterning doesn't play there. In fact, if you look at the mix of etch and deposition plays particularly well for us. If you go to DRAM, patterning does play an increasing role there. I agree with that. If you look at DRAM, prices are down a little bit, so they're very driven by economics in that business. The cost is getting a little higher to make those devices. The patterning is positive for them, but the cost is an issue in the pricing. I think the DRAM capacity adds will be moderate.
Okay. My follow-up question is, now that the deal is over and the reason being future product roadmap, can you talk about what areas within etch and deposition that you are not currently strong in, but you're expecting to gain share in the future?
Well, the DOJ certainly was confident, I'll tell you that.
Yeah, I think, as we've talked about last year, we had just tremendous momentum in etch and CVD with 50% revenue growth. We really are optimistic about the momentum we have in both of those different areas. We continue to believe that the opportunity for us for share gains, growing those businesses is very good. Another area that we see as a great opportunity is ALD. We've been investing in new technology there, and we believe that has potential for significant future growth. We have very strong pull from customers for this new technology that we've developed, but we're not in a position really to give any more color at this time. That's certainly another area on top of the momentum that we have in etch and CVD, where we see a great opportunity.
Okay, great. Thanks.
Your next question comes from the line of Mark Heller from CLSA. Your line is open.
Thanks for taking my question. Gary, I didn't quite catch it, but the display mix in, I guess, fiscal 2016, did you say if that's LCD or OLED related?
I'll start at the higher level. Most of it's weighted towards smaller feature sizes. That'll be the cell phones versus TVs. When you look within it, most of those are all OLED, and it's particularly LTPS, a lot of it.
Yeah, the mix, as Bob talked about, the mobility mix versus TV, the percentage of the mobility is up about 2x if you look year-over-year, and then it goes back down to kind of a normalized mix between the two different markets for us. That particular year, we see the mix of mobility up a significant amount, double what it was the year before, and we think the year after, it will go back down to this more normalized mix that we've seen for a number of years.
Okay, got it. Going back to this WFE question, I remember, in 2013, you gave the financial model before the TEL deal was announced, talking about WFE maybe as high as $37 billion. I know you're not giving an official forecast for next year, but is there something that's tempering how high WFE can go in a given year, I guess? Has something changed there?
Well, I'll give you my observations. When we put the model on July 13, one of the biggest reasons for that number was that was Dataquest number, basically, at that time. We didn't know 2017, or 2016 rather. We put up three numbers at that time, 30, 33 and a half, and 37. A fair amount of our focus was on the 33 and a half. In terms of what next year will be, we really haven't spent much time. I think it's a pretty healthy year. Could be north of that. I honestly don't know. I don't even know what Dataquest says. Do we know Dataquest next year? It's up a little more than that. Yeah, I think Dataquest is maybe 34 or something.
Yeah, I think certainly what we can see relative to our business, if you look at what's going to happen over the next two or three years, this transition in 3D NAND, as we said, by the end of this year, you only have 10% of the capacity with 3D NAND. That transition is really a good one for us. The 10-nanometer transition, we believe, is a great opportunity. Those are going to be some of the major drivers for us over the next two or three years. We try to size the business relative to kind of a normal run rate on WFE, and certainly, there could be drivers to make it higher than that, but from a planning standpoint, we're sizing it around the $33 billion, $33.5 billion level. Thank you.
Your next question comes from the line of Mahesh Sanganeria from RBC Capital Markets. Your line is open.
Yes, thank you. I just want to have a follow-up question on 3D NAND. Right now, you have a couple of customers adding capacity for production, and the yields are probably not at the highest level, and different customers are working on different structures. My question is that at a maturity on 3D NAND, 48 layer TLC, what kind of bit density do you get on the wafer compared to planar? Are they closer to getting 3 to 1 or they're far behind that?
I'll do from memory. I don't have this in front of me, Mahesh. Our take on it was the initial transition from planar to 3D, they got traditional type of bit growth that they get in the planar shrink. They got the bigger capital efficiency and bit growth going from first generation to second generation 3D. What we used to run in models was a lot of 32 to 64. At 32 to 64, you get over 100%, because you get the scaling and also the size, I don't even know if the shrinks, they're 40, 50 nanometer stuff. I think the big opportunity for them is 64. At 48, it's sort of a midway, I'd say. I'd say it's moderate. It's better than first generation, not as good as 64.
On your WFE number, I suppose the last quarter, you had a little bit higher number than now, and of course, there are a lot of changes has happened since last quarter. Can you articulate what you have seen changes in the segment-wise from last quarter to this quarter in terms of DRAM, flash, and logic and foundry?
We haven't actually changed a lot. We were sort of about a 33.5 last quarter, kind of about a 33 now. Some of that's just FX as you run it through the euro on WFE. Euro doesn't affect us much, but euro and yen. The second thing is, there's been some announcements like TSMC seems a little less, but I'm actually kind of feeling like maybe NAND's a little stronger later in the year. Net-net, I'm kind of neutral on the year. In terms of how we feel specifically by space, we're a little higher on DRAM now than we were last quarter, a little higher on NAND than we were last quarter. We're a little lower on foundry, and logic, we're probably a little negative too from last quarter.
That's very helpful. Thank you very much.
You're welcome.
Your next question comes from the line of Tom Diffley from D.A. Davidson. Your line is open.
Good afternoon. As it pertains to growth, you talked a lot today about 3D NAND and talked about the 10-nanometer transition. What about DRAM? Is DRAM, in your mind, a growth market for you in the next couple of years?
Yeah, I think so. I think that if you'll look at it, what's driving it? Number 1, wafer starts. Number 2, capital intensity. Number 3, our position there. If you go look at 2015, we think overall spending is up, I don't know, 15% or something like that, 15%-25%. If you look at our position there, it's been improving. We gained share in DRAM in the last year or two, and we think that'll continue this year. Yeah. Go ahead, Gary.
No, I think, look, DRAM, mobile DRAM especially, has been driving incremental investment, and we're happy that our share of that market is increasing, that is a positive driver. You don't have the same-
Inflection stuff
inflection in the DRAM business going forward that you have in 3D NAND and you have certainly in the FinFET technologies. The 3D NAND, the litho CapEx is declining, the areas that we're participating in are going up a significant amount. We have an opportunity there with not only the CapEx increase, but more of the CapEx being spent on our area of the market, a significant change from what was there in the planar technology node. The same thing is true on the FinFET technology. Again, that really leverages our materials engineering, some of our strongest products, as those technology inflections are happening. The DRAM opportunity is a good one for us, but it's not the same order of magnitude driver for us as the transition to 3D NAND and FinFET. That's my feeling.
Yeah, I agree with you. Most of what they're doing this year is conversions versus capacity adds.
Okay. No, that's helpful. On the display side, is the move of OLED to TVs, is that the sweet spot for you going forward, or do you think margins might be an issue at that point as well?
Yeah, we think the OLED is more focused on mobile right now. These smaller screens for mobility types of applications, not so much on TV.
It's pretty expensive for TVs.
Yeah, I was just thinking out the next couple years when it does ultimately move to TVs, if that is more of a sweet spot for you versus next year's mobility.
Yeah, there's no question. As you know, OLED in general, we've said, if you look at amorphous silicon compared to OLED, our TAM grows about 2x.
Yeah.
Certainly, as OLED is adopted, both in mobility and in the future in the TV market, that is a really great transition for us. You really can see it also in the thin-film encapsulation. We talked about the incremental opportunity there are more deposition steps as you go to OLED technology. The adoption in any of these different markets for us is a really good driver.
Okay, thank you.
Thanks, Tom. Kyle, we have time for just one more question, please.
Your last question comes from the line of Edwin Mok from Needham. Your line is open.
Hey, thanks for squeezing me in, guys. First question, in terms of just directionally, maybe on the second half of the year versus first half, how do you kind of see your bookings trending between the DRAM, flash, foundry and logic buckets?
We think foundry's up in the second half. Yeah, bookings?
Yes.
Foundry's up, DRAM's down a little bit, NAND's up, logic's flat.
Okay. Great. That's helpful. Then, I guess a question on PDC. We saw some of the data from Gartner that they published around kind of market share, and it seems like the PDC may be down a little bit last year. Can you maybe help us with that a little bit? Is it due to mix? How do you guys see your position? I think you talk about 10-nanometer being an opportunity, and obviously, the much higher process control intensity. How do you think you position there? Do you think that could drive some incremental growth there, potentially starting in 2016?
Again, relative to the intensity of the % WFE, this area has not been a great driver over the last couple of years, and it's not Relative to some of the other inflections that we're focused on, we don't see this as being as large an inflection in our markets as some of the other areas. As I talked about earlier, our business is really, if we look at 2015, more heavily weighted towards e-beam segments, where we have a lot of strength, really great technology. That segment of the market is growing fast, and we really see a great opportunity for us to leverage that strength in growing that part of the market. In the optical inspection area, last year, certainly, the mix of customers worked against us. We recently had a really strong quarter relative to orders from a couple of large foundries.
We look at our technology position there as incrementally better than where we were at before. We're optimistic overall PDC growth in 2015 will be good for us. Then really being positioned, from a technical standpoint going forward in PDC, where we think this can be a growth driver. I wouldn't say this is on the same scale as some of the other opportunities we have on the inflections in the 3D NAND and 10-nanometer FinFET. Certainly, incrementally, it's a positive for us. The incremental profit from that business is also very good overall.
Great. Thanks.
Thank you, Edwin, for your question, and we'd like to thank everyone for joining us this afternoon. A replay of this 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.
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