應用材料 (AMAT) 2013 Q1 法說會逐字稿

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  • Operator

  • Welcome to the Applied Materials earnings conference call.

  • During the presentation, all participants will be in listen-only mode.

  • Afterwards, you will be invited to participate in a question-and-answer session.

  • As a reminder, this conference is recorded today, February 13, 2013.

  • Today's call contains forward-looking statements, which refer to the Company's views of its markets, industry trends, opportunities and business outlook.

  • These statements are subject to known and unknown risk and uncertainties that could cause actual results to differ materially from those expressed or implied, and they should be interpreted in that light.

  • Information concerning the risk factors is contained in the Company's SEC filings, including form 10-K for the fiscal year ended October 28, 2012.

  • Today's call also includes non-GAAP financial measures.

  • Reconciliations to GAAP measures are contained in today's earnings release and financial slides, available on the investor page of the website, AppliedMaterials.com.

  • I would like to turn the conference over to Michael Sullivan, Vice President of Investor Relations.

  • Please go ahead, sir.

  • - VP of IR

  • Thank you Tia, and good afternoon.

  • Joining me are Mike Splinter, our Chairman and CEO, Gary Dickerson, our Company's President, and George Davis, our Chief Financial Officer.

  • Today we will discuss the results for our first quarter ended January 27.

  • You can find a copy of our earnings release on our website, AppliedMaterials.com, where you will also find our quarterly financial highlights presentation, which provides additional details.

  • Before we begin, I like to share a calendar announcement.

  • Applied plans to hold its next investor and analyst meeting on Monday, July 8, in Santa Clara, California.

  • We hope to see many of you here at our headquarters for the event.

  • And now, let me turn the call over to Mike Splinter.

  • - Chairman & CEO

  • Thanks Mike, and good afternoon everyone.

  • Applied's first quarter of fiscal 2013 largely played out as we had expected.

  • Thanks to solid execution and disciplined management of discretionary spending, we delivered $0.06 of non-GAAP earnings per share, which represented the high-end of our outlook.

  • Overall, I am pleased with how we navigated the bottom of this industry investment cycle, and with our semiconductor orders up over 80% in the first quarter, we are more optimistic about the potential of our markets this year.

  • Implementation of the restructuring plan we outlined in the fall is progressing well.

  • The actions we are taking include permanent shifts in the cost basis of the Company, as well as a substantial reduction in our solar investments.

  • By reprioritizing our spending, we are able to strengthen customer-facing technical resources and accelerate product development programs.

  • This supports our strategic priorities to expand our share in wafer fab equipment, and drive profitable long-term growth in display and solar.

  • Now, let me provide an overview of our markets.

  • Global demand for mobile products remains strong, and we expect year-on-year growth of around 35% for smartphones and 55% for tablets.

  • Growth at this level will support solid investment by the foundries and we believe these customers will represent around 45% of wafer fab equipment spending in 2013.

  • Mobile devices are also driving demand for NAND flash memory.

  • However, some of the growth in this market is being suppressed by lower-end smartphone and tablet models at are specifically tailored for emerging markets, and equipped with less onboard memory.

  • Overall, NAND is growing, and we believe that bit growth rates will be in the range of 50% for 2013, which is sufficient to support investment in new capacity by the second half of the year.

  • Our development teams are working closely with customers on 3D NAND technology, and when this inflection occurs, it will drive an additional investment cycle by memory manufacturers.

  • The PC market looks to be relatively flat this year, as touch-enabled hybrid models blur the lines between traditional laptops and tablets, there's a potential upside to this scenario.

  • For the time being, we remain cautious about logic investment, expecting to see a modest increase in spending relative to 2012, primarily due to the timing of factory build-outs.

  • DRAM prices are starting to rise, however we still anticipate DRAM investment remaining at low levels, with spending limited to technology conversions.

  • In recent weeks, there have been some positive announcements from our largest customers.

  • As a result, we now believe that 2013 wafer fab equipment will be flat to down 10%, relative to 2012 spending of around $30 billion.

  • In order to reach the high end of the range, we will need to see investment from a broader base of logic and foundry customers in the second half of the year, as well as an uptick in NAND investment.

  • We believe that we can outgrow wafer fab equipment in 2013, with share gains driven by strong demand for our transistor products, combined with application wins in inspection, and a customer spending mix that's favorable to Applied Materials.

  • In display, there is a sense of renewed excitement in the TV market, with 60-inch and larger models reaching attractive price points, and the introduction of new 4K resolution.

  • Following the two-year period of capacity digestion, we expect investment in new display factories to resume in the second half of the year.

  • Customers are still cautious, and the timing of their factory builds will largely depend on their confidence in the macro environment.

  • Orders for our equipment to manufacture touch panels and high-performance mobile screens remain healthy, and production is moving to larger substrate sizes, particularly Gen6.

  • In solar, end markets continue to grow at between 10% and 20% annually, and it looks like overall 2012 installations ended the year at around 31 gigawatts.

  • However, conditions within the supply chain remain extremely challenging, with consolidation and rationalization of manufacturing capacity happening more slowly than we had anticipated.

  • Our approach in solar is to be prudent.

  • We are taking additional steps to scale back our investment, until there are clear indications that the market conditions are improving.

  • Before I hand the call over to Gary, I'd like to take this opportunity to wish George every success in his new role at Qualcomm and thank him on behalf of everyone at Applied for all the contributions he has made to our Company during the past 13 years.

  • We are in the process of selecting a successor from a strong pool of internal and external candidates, and we expect to appoint a new CFO in the coming weeks.

  • Now, let me hand the call over to Gary for additional comments about our business and strategic priorities.

  • Gary?

  • - President

  • Thanks, Mike.

  • I would also like to wish George well in his new position at Qualcomm, and thank him for everything he has done to help get Applied to the position of financial strength that we enjoy today.

  • As Mike outlined, the expected levels of capital investment by our semiconductor and display customers provide a solid foundation for the year ahead.

  • Also, major trends within these markets create great opportunities for Applied to extend our leadership in the precision materials engineering, and grow faster than the markets themselves.

  • The most important component of our strategy for profitable growth is to increase our share of wafer fab equipment.

  • In Q1, we built momentum for market share gains by winning several new development tool of record positions at the 20-nanometer node, and converted a number of these existing positions into volume orders.

  • Demand for better mobile products is driving innovation, and we are seeing major inflection in device technology and the introduction of many new materials, as customers strive to differentiate themselves with extended battery life, low-power, and higher-performance products.

  • These inflections are enabled by precision materials engineering applications, including precision films, material removal, material modification, and interface engineering.

  • This is where Applied has clear technology and market leadership, and will be a major factor in driving our growth in wafer fab equipment shares.

  • Over the past three months, we've been implementing important organizational changes to strengthen our teams, and redeploy funding to accelerate our highest-impact growth programs.

  • We have restructured our workforce.

  • We have scaled back our investment in solar, and we've carried out an extensive review of our R&D portfolio, stopping programs where we believe we didn't have valuable, sustainable differentiation, and increasing funding for programs where we do.

  • As a result, we are shifting approximately $200 million to key strategic priorities that drive profitable growth.

  • Our strategy is to focus on allocating the appropriate level of investment to market segments where we believe we can achieve a leadership position.

  • This means ramping investment in some areas, while reducing or eliminating investments in others.

  • On an ongoing basis, we will look at every aspect of our business through the lens of profitable growth, and prioritize every dollar toward our best opportunities.

  • One area where we are investing is in field technical resources to upgrade the interfaces between customers and our R&D teams.

  • By strengthening our field technical teams, we will build stronger customer relationships, and ensure we are the Company our customers seek out first to solve their highest-value device performance and yield challenges.

  • In addition, we have combined the best product development practices across the Company, and to date, we have trained 35 development teams in their application.

  • This is improving our ability to define winning products and increasing the velocity of our development process.

  • Let me now provide an update for each of our businesses.

  • In semiconductor, technology inflections that enable lower linkage transistors, low-resistance interconnects and advanced patterning, are expanding our markets and providing a catalyst to grow our share.

  • Our market leadership in the overall transistor module, combined with the most significant transistor device technology changes in the last 10 years, creates a great opportunity for Applied Materials.

  • As foundry customers add capacity for the 28-nanometer node and start to ramp 20-nanometer technology, capital intensity is rising in the areas where Applied has the best technology, and is a leader.

  • As a result, we expect the strong 2012 performance that we demonstrated in our front-end products, implant, and PVD businesses to continue in 2013.

  • In addition, the adoption of new epitaxy steps and advanced foundry technology nodes will enable us to further grow our epi business.

  • We achieved important milestones in our first quarter, winning development and production tool of record selections at our top three customers.

  • The past two years have been a challenging period for our CMP business, and we lost market share in 2012, due to an unfavorable customer spending mix.

  • Significant improvements to our latest generation tool delivers a clear architectural advantage for advanced nodes, and we expect to start recapturing share in 2013.

  • Inspection represents an attractive growth driver for Applied, and I'm pleased with the progress our team is making.

  • We have very strong customer pull for our wafer inspection and review products last year, and we believe foundry and logic wins for our right field tools will translate into continued momentum in 2013.

  • In etch, we are focusing on key technology inflections, in market segments where we believe we have opportunity to deliver technology with sustainable differentiation.

  • With recent new application wins in logic, foundry, and NAND flash, we are starting to demonstrate positive momentum.

  • Turning to display, larger TV sizes and 4K ultra high definition are important trends that create opportunities for us to increase share.

  • These trends drive larger panels and smaller pixels, that increase the value of the device performance and yield advantages of our technology.

  • As 60 inch and larger TVs become a higher percentage of the market, we anticipate more manufacturers will move to Gen10 substrates.

  • This transition is an important inflection that plays to Applied's advantage, and will enable us to leverage our leadership in particles and uniformity, to gain market share in PVD and extend our leadership in CVD.

  • As we have previously announced, we have taken actions in EES to reduce our cost and restructured the organization.

  • We continue to monitor industry conditions closely, and based on our current market view, we decided to further lower our spending beyond the levels discussed in the last earnings call.

  • By the end of this fiscal year, our goal is to reduce EES operating expenses to a run rate below $25 million per quarter.

  • We continue to invest where we can provide differentiated technology to enable higher cell efficiencies and lower cost per watt and remain confident that this business can deliver long-term, profitable growth for Applied.

  • In summary, we are optimistic about our opportunities for the year ahead and we are confident that the strategy we are executing will drive profitable growth.

  • We are focused on growing our share of wafer fab equipment and have strong momentum.

  • We are making prudent investments in display and solar, and we continue to strengthen the organization in areas that are critical to our success.

  • Let me now hand the call over to George for further details on our performance.

  • George?

  • - CFO

  • Thank you, Gary, and good afternoon to everyone on the call today.

  • To begin, I would like to thank Mike and Gary for their good wishes and partnership.

  • I would also like to thank Applied's employees, investors, and the analyst community for the opportunity to have worked with you.

  • For more than a decade, it has been my privilege to work with some of the best and brightest minds in the industry.

  • And finally, I'm very proud of the finance team at Applied Materials.

  • Now, I will cover our financial results for the first fiscal quarter of fiscal 2013.

  • Orders increased 44% from the prior quarter to $2.1 billion, led by strong demand for semiconductor and display equipment.

  • Our backlog increased 31% to $2.1 billion and our book-to-bill ratio increased to 1.3.

  • Net sales of $1.6 billion were at the high end of our outlook, due to stronger than expected performance in SSG.

  • Non-GAAP gross margin was 39.8%, up 1.4 points sequentially despite lower revenue, driven by a higher mix of SSG revenue and lower inventory reserves.

  • Total non-GAAP operating expenses were $514 million, excluding certain favorable items, our non-GAAP operating expense would've been approximately $535 million, in line with our guidance.

  • In Q2, we expect non-GAAP operating expense to increase to $560 million, plus or minus $10 million, reflecting the absence of holiday shutdown savings of $15 million, along with increased investment in SSG, partially offset by increased savings from our various cost reduction programs.

  • For the year, we continue to expect non-GAAP operating expenses to be roughly $2.2 billion, essentially unchanged from 2012.

  • This includes a sizable increase in growth funding for SSG, enabled by operating cost improvements related to the workforce reductions announced in October, the EES restructuring, and the integration of Variant.

  • Our non-GAAP effective tax rate was 24.2%, and we now expect a rate of 24% to 26% for the year, an improvement of 1 point from our previous estimate, primarily from the benefit of the R&D tax credit.

  • Non-GAAP earnings per share of $0.06 was at the high end of the target range, led by strong SSG performance and lower operating expenses.

  • The cost to date of the workforce reduction program announced in October is $110 million.

  • We now expect the total cost to be in the range of $120 million to $160 million, below the original estimate of $182 million to $230 million.

  • The primary reasons for the change in estimate are lower relative participation levels of the voluntary retirement program, and a reduced estimate of the final cost of benefits.

  • We expect annual savings and headcount reductions to be within the ranges originally provided.

  • Cash from operations was approximately $16 million, reflecting lower revenue levels, severance payments related to workforce reductions, and the timing of annual variable compensation payments.

  • We expect cash from operations to trend back in line with historical performance over the remainder of the year.

  • Cash and investments ended the quarter at $2.8 billion, a sequential decline of $177 million.

  • Our capital allocation priorities continue to be investing an attractive opportunities in our core businesses, increasing the dividend in line with the growth of the business, and utilizing share repurchases as the preferred means of returning excess cash.

  • Next, I will comment on our segment results as compared to the prior quarter.

  • SSG orders were up 84% to $1.4 billion, driven by foundry and well above our outlook of up more than 25%.

  • 74% of the orders were from three customers, reflecting the concentration of investments in Q1, and our increasing momentum at the largest customers.

  • Net sales increased 11% to $969 million, just above the high end of our outlook, with an increase in foundry, partially offset by lower NAND revenue.

  • Again, we saw a very high concentration with 75% of revenue from our top three customers.

  • SSG's non-GAAP operating margin grew to 18.6%.

  • In AGS, orders were down 6% to $544 million.

  • Net sales were down 24% to $471 million, near the low end of our outlook.

  • Excluding thin film solar line recognized in the fourth quarter, net sales would have been down 12%.

  • The revenue decline reflected tight customer spending controls, as wafer starts in overall utilization rates trended lower for the second consecutive quarter.

  • Non-GAAP operating margin declined to 19.3%.

  • In display, orders increased 66% to $138 million, reflecting ongoing mobility investments, and the beginning of a resurgence in TV equipment orders.

  • We continue to be optimistic for further TV and mobile equipment order strength in the second half.

  • Net sales in the quarter were $87 million, in line with our outlook, with the vast majority of revenue from mobile display systems.

  • Non-GAAP operating margin grew to 5.7%, demonstrating the group's focus on remaining profitable in a low revenue environment.

  • In EES, orders were $68 million, primarily due to strength in our web equipment business, while solar equipment orders remained depressed, due to ongoing overcapacity issues for our customers.

  • Net sales were $46 million, in line with our outlook.

  • EES had a non-GAAP operating loss of $44 million.

  • We are on track to reduce the quarterly run rate for non-GAAP operating expense to below $30 million by the end of Q2, a 20% reduction from Q1 levels.

  • Now I would like to turn the call back over to Mike for our Q2 outlook.

  • Mike?

  • - Chairman & CEO

  • Thanks, George.

  • As we look forward to our second quarter, net sales from our semi conductor business should be up 20% to 35%.

  • We expect orders to remain strong, approximately at the Q1 levels.

  • Net sales in the AGS are expected to be flat to up 10%, reflecting a gradual recovery in wafer starts and utilization levels, as the year progresses.

  • We expect net sales in display to be flat to up 25%.

  • Orders are expected to increase by more than 20%, with the start of TV capacity additions, and continued strength in mobility.

  • Net sales in EES are expected to be approximately flat, remaining at low levels.

  • Overall, we expect net sales for the Company to be up 15% to 25%, and our non-GAAP earnings per share to be in the range of $0.09 to $0.15.

  • Now, let me over the call for questions.

  • Mike?

  • - VP of IR

  • Thank you Mike, and to help us reach as many of you as we can, please ask one question, and no more than one brief follow-up.

  • Tia, let's please begin.

  • Operator

  • (Operator Instructions)

  • The first question will come from Terence Whalen with Citi.

  • - Analyst

  • Congratulations on the strong results, and I also wanted to pass my congratulations and best of luck off to George, as well.

  • The first question that I have is related to a comment that you made about -- you see foundry spending being about 45% of WFE, I believe that was the comment you made.

  • As I look at the order profile, it looks like foundry was close to 0.75 of your orders, so, my question is, how do you see the transition from a more foundry-dominated order environment to a memory order environment?

  • How do you see that evolving and handing off throughout the middle to later part of the year?

  • Thank you.

  • - Chairman & CEO

  • Thanks for your questions.

  • Very good question.

  • If you look inside our numbers, close to 0.75 of orders in Q1 are from foundry.

  • As we think about the progression through the year, we do have to have broader foundry participation, but we also need to see logic investment pick-up fairly dramatically in the second half, along with NAND flash spending for capacity, and then, for 3D NAND technology.

  • So, that's the progression.

  • We should start to see that by the end of our Q2, or the beginning of our Q3, that transition as foundry comes down as a percentage overall, and the other areas in WFE starting to rise.

  • - Analyst

  • Okay.

  • Terrific.

  • Then, the second question, the follow-up question is around a comment that I believe Gary made about some of the advances in transistor technology in finFET creating a really good opportunity to gain some share and tool of record position.

  • That seems to be obviously showing up in some of the Taiwan order patterns that we are seeing, with Taiwan being very strong.

  • I'm wondering if you feel like you have as good a competitive position with the other Korean partner in finFET?

  • Thank you.

  • - President

  • If you look at the key enabling technologies for the transistor, [at the] PVD implant, thermal processes, many of these, we have 70%, 75% market share overall, and in the area around the foundry customers that are ramping gate-last technology or finFET technologies, the market share is probably even higher.

  • So, this certainly provides a great opportunity for us to grow share.

  • When I think about our overall share position, in 2012, in 300-millimeter, we gained share, a small amount of market share.

  • We look at 2013 as an opportunity to even accelerate that, and '14, when the 20-nanometer gate-last is adopted by a number of foundry customers, we've said that creates an opportunity for our CapEx to go up 30% at those customers.

  • So, we are really in a great position building momentum through this year into 2014.

  • Operator

  • The next question will come from Krish Sankar with Bank of America.

  • - Analyst

  • My congratulations to George, too.

  • The question I had, the first one, Mike, if you take your wafer fab guidance, let's assume we get to the upper end of the range driven by higher foundry NAND coming back.

  • Would you still see the seasonality of the front half-loaded year that you saw last year?

  • - Chairman & CEO

  • This year is certainly a different year than last year.

  • The foundry part of the investment that's driven by mobility, and the mobility consumers that largely buy in the latter half of the year, really in the fourth quarter, that seasonality is still there.

  • But especially in this kind of odd calendar year, we see more investment in logic to mute that.

  • We think we'll see more investment in NAND flash this year, which also mutes the accentuated seasonality that we had last year.

  • I would just echo the point about gaining momentum, here, as we move into this calendar year, with the strong orders that we are seeing on the front-end from the foundry.

  • - Analyst

  • Got it.

  • That's very helpful.

  • And just a quick follow-up for Gary.

  • I look at the 3D NAND, obviously the memory guys have been working on it for a while, and you haven't seen it yet put into production.

  • But let's assume that maybe it's a 2014 opportunity.

  • What are the incremental SAM expansion for Applied, given your diverse product line?

  • - President

  • So, again, we do see it as a 2014 timing, similar to the 20-nanometer gate-last ramp for our customers.

  • So, that's one of the things that makes us very optimistic about building momentum from a market share perspective.

  • In the 3D NAND technology, there are a number of very long deposition steps.

  • If you look at these multilayer stacks, that are very favorable to us, and roughly, we look at the incremental CapEx opportunity for Applied on the order of 25%.

  • It gets better as there are more layers, when you are building these multilayer stacks, but, around a 25% increase in CapEx opportunity.

  • Operator

  • Your next question will come from Stephen Chin with UBS.

  • - Analyst

  • Nice execution in the quarter, and also send my thanks and best to George, too.

  • My first question is just on the new 2013 WFE outlook.

  • I was wondering, Mike, if you could share more color on what customer type you are slightly more positive on?

  • I think originally, your estimate was for foundry and logic to be down and memory to be flat to up.

  • Is the change mostly in foundry?

  • Is this for 20-nanometer?

  • - Chairman & CEO

  • Yes, a little more positive there, Stephen.

  • It's not a big change, but I would say we are incrementally more positive as we see the front-end of this year and the announcements that some of the major customers have made.

  • We really think DRAM spending is still going to be flat at a low level, year-over-year.

  • We think foundry will be down slightly, but perhaps not down as much as we had previously anticipated.

  • Then, NAND, about 15% of the total with spending profile that is stronger in the second half.

  • Then, logic, we are thinking will be modestly up, as well, year-over-year.

  • So, in total, that nets out to have us move up from, last time we said 5% to 15% down, now we are saying flat to down 10%.

  • So, that's how far we've moved in the last few months.

  • - President

  • I'd like to frankly move into the positive territory in the next three months.

  • We will see how the orders play out, here.

  • - Analyst

  • Could I ask a follow-up to Gary, just about the foundry 20-nanometer node?

  • You talked about some of the design wins there, Gary.

  • What percentage of decisions do think have been made at the 20-nanometer foundry node, and how do you think Applied is set to compete at 20-nanometer foundry?

  • Thanks.

  • - President

  • Well, I think several have been made, and I'm a paranoid person.

  • I'm comfortable once the tool is in the customer's fab and paid for.

  • So, I think that we always have to be aggressive in looking at these types of situations.

  • But, certainly I think our order momentum -- customers are also buying for multiple technology nodes, as you know.

  • So even when they are making 28-nanometer decisions, they are looking to 20, 16 and future technology nodes, and what your position will be there.

  • I think the strong increase in orders in Q1 for us is a very good sign.

  • Certainly, the discussions we've had with customers have been very positive, and we are overall very optimistic.

  • Again, it's not done until the tools are in the fab and paid for, and so, we will remain focused until that happens.

  • Operator

  • The next question will come from Mahesh Sanganeria with RBC Capital Markets.

  • - Analyst

  • Last quarter, you sounded a little bit more cautious on the NAND side of the business.

  • I think you were saying that there won't be any need for capacity additions.

  • I hear a little bit more optimism, and my question is, is that driven by what your discussion with your customers?

  • Or, you are more bullish on the end demand and consequently, you are more bullish on NAND?

  • - Chairman & CEO

  • Several factors here that played into us getting modestly more optimistic.

  • I would still use the term modestly.

  • A couple of things we are, of course, seeing strength in pricing for NAND utilization, and factories are improving.

  • We went back and looked at our analysis of how much bit growth you need to see capacity increases.

  • And really have readjusted that, so we need to see about 45% bit growth before we see capacity additions.

  • Then, of course detailed discussions with customers.

  • Also, we think that 3D NAND is progressing, at least initial pilot line orders will come in for 3D NAND before the end of the year.

  • So, I think those things all total up to us being a little more positive on NAND flash getting stronger in the second half.

  • - Analyst

  • Mike, one more question on your CFO search.

  • If you could give us some color on what you are looking internally or externally, or what's the timing we can look for?

  • Maybe in terms of -- maybe you can bring something in, what you are particularly targeting when you are looking for a CFO.

  • - Chairman & CEO

  • Sure.

  • I have to tell you, we are really motivated to do this quickly.

  • We have, I think, a very thorough process between Gary and I and our Board of Directors, to ensure that we select the best possible candidate.

  • We think we have several internal candidates, and of course, naturally, we would rather take an internal candidate then have to go outside, but we think we owe it to the shareholders to at least take a look externally.

  • We are going to try to move through this process in a matter of weeks, here.

  • So, we will be getting back to you on that topic as soon as we make a decision.

  • As far as what we are looking for, of course, we are looking for a very strong business partner.

  • Someone who can think strategically, well experienced in financial management and acumen, and somebody who can really drive shareholder return for all of our investors.

  • Operator

  • The next question will come from Jim Covello with Goldman Sachs.

  • - Analyst

  • It's Mark Delaney calling on behalf of Jim Covello.

  • Let me add my congratulations on the quarter, and wish George success in his new role.

  • I was hoping you could help me understand a little bit more on the reorganization plan.

  • How far along are you on implementing some of those steps and can you share with us what the employee response has been?

  • - Chairman & CEO

  • So, some of the bigger changes we have made are certainly Ali Salehpour coming in, and EES and display was a big change, and I would say that Ali's been here for two months and the response internally and also externally has been extremely positive.

  • Very bright, very focused on technology leadership, driving profitable growth.

  • Ali has really hit the ground running, and is doing a great job in EES and display.

  • Another major change we've made, is in the SSG organization.

  • We formed a new transistor group within the last month, pulling together all of the different technologies that we have under Steve Ghanayem.

  • As we have talked about many times, that's really a fantastic opportunity for Applied Materials and, so, we are organizing around that strategy and that will help us in terms of execution on that opportunity.

  • We have brought in a lot of really good people to mix with already the tremendous talent we have within Applied Materials, both on a technology and marketing side, and, we have just a tremendous team, great opportunities.

  • We are moving forward at a pretty high pace, relative to these changes.

  • So, at this point, I would say many of them are in place.

  • Again, we are overall, very optimistic.

  • - Analyst

  • That's helpful.

  • Thank you.

  • For my follow-up, I wanted to talk on the announced plans to reduce costs further in EES.

  • Are there parts of that business that you are actually exiting?

  • Or are you still going to be addressing the same markets, but with a lower-cost footprint.

  • - Chairman & CEO

  • We are not announcing any changes in terms of the products that we have within the EES organization.

  • We have certainly driven the cost down pretty dramatically.

  • I think in Q4 of 2012 we were $50 million -- $45 million, $50 million, as we said, exiting Q4 of '13, and the solar business will be down to about $20 million.

  • So, we've cut back and in terms of the OpEx spending, and that money is being reallocated into some great strategic opportunities we have to grow the Company, but really no announcements at this time for any exits of major products within the solar business.

  • Operator

  • The next question will come from Edwin Mok with Needham & Company.

  • - Analyst

  • Wanted to wish you good luck, George.

  • Actually, my first question is for you.

  • Particularly on your earnings guidance.

  • You kind of imply that you expect gross margins to just modestly increase in the coming quarter.

  • I was just wondering why margins are not increasing that much, and also just tied to that, in OpEx you expect the OpEx guidance you have for the coming quarter being your current run rate for the year?

  • - CFO

  • So, let me first deal with gross margin.

  • We do expect gross margin to improve in the quarter, as we would expect with volume.

  • And, if you look at the EPS guidance, basically, what you are seeing is all of the benefit from volume and margin improvement in the quarter.

  • So, midpoint of the guidance is up $0.06.

  • And, we do include in that, obviously, a significant increase in OpEx.

  • Again, on OpEx, you have to look at Q1 as an anomaly.

  • We had $535 million if you take out the favorable items in there.

  • But, we also had the shutdowns, which meant that our real run rate was much closer to $550 million.

  • The, the rate that we are going up to at $560 million, really just reflects incremental funding moving primarily into SSG.

  • I think that rate, if you look at the second half of the year, will look relatively flat with that rate.

  • - Analyst

  • Great.

  • That was very helpful.

  • Then, quick question for you, Gary.

  • I think previously you talked about inspection, you are seeing a lot of pools in etch and it's an area that is a little more time for development, in terms of regaining shares in those two markets.

  • How do you think about those two statements for after spending three more months in this company?

  • - President

  • Okay.

  • Let me go through inspection, first.

  • Obviously, this is an area I have a lot of experience, we have a really great team.

  • Incredibly strong customer pull in 2012, in wafer inspection and review, we gained a few points of share.

  • We are winning -- we had some good wins in brightfield inspection, with customers here recently, that also create market share momentum for us in 2013, in wafer inspection and review.

  • So, again, overall, I would say optimistic on wafer inspection.

  • It's a very good business for us, in contributing profit to the Company.

  • In the etch business, also we have a very good team, some customer pulls, some recent wins both in foundry and NAND flash that make us more optimistic.

  • Again, as I have said before, both of these markets are multiple segments, and our focus is not to blow the ocean.

  • We want to focus in the areas where we can have differentiation and we can establish a strong market share position, and we have a very clear strategy in both of these different businesses.

  • As inflections happen, and some technology changes happen, again, I'm pretty optimistic in both of these different businesses.

  • Operator

  • The next question will come from Satya Kumar with Credit Suisse.

  • - Analyst

  • This is Farhan calling in for Satya, I wish my best regards to George, as well.

  • And thanks for taking the question.

  • I just wanted to check on the foundry capacity expectations for this year.

  • If you could just comment on 28-nanometer wafer starts you expect, and how much of 20-nanometer capacity by the end of the year?

  • That would be very helpful.

  • - Chairman & CEO

  • Sure.

  • Thanks.

  • As we look at the foundry capacity and what we think will be added, as we said at the outset, it will be primarily driven by strong demand in mobile and phones and smartphones and tablets.

  • So, in the 28-nanometer area, we think between 75,000 and 100,000 wafer starts per month will be added.

  • In 20-nanometer, it's a little harder to tell, because it also depends on how well those technologies move out the yield curve.

  • Right now, we are estimating about 25,000 wafers in 20-nanometer this year.

  • That would be, really in the second half, late in the second half of the year.

  • - Analyst

  • One question on the inflection and etch win.

  • Gary mentioned that you had some recent wins on brightfield.

  • I just wanted to understand how important are these wins on the inspection side, is that on 20-nanometer or 28-nanometer, if you could just talk about it, and whether this is a small segment in the brightfield or quite a big segment.

  • - Chairman & CEO

  • Well, I would say, again, the customers are really working with us to cover a very large percentage of the applications for foundry and logic.

  • In the logic case, actually in both cases, more than 50% of the applications.

  • I wouldn't say they are narrow.

  • Again, as I talked about earlier, customers will buy from multiple technology nodes, so they will focus on certainly 28-nanometer, if that's what they're running in production today.

  • Again, they want technologies that can work for 28, 20, 16, all of these different technology nodes.

  • We are in a very strong position with logic and foundry with -- especially with advanced transistor technologies, and again, that's what makes us optimistic in that business.

  • Operator

  • The next question will come from Mehdi Hosseini with Susquehanna.

  • - Analyst

  • Mike, going back to the 3D NAND, can you help me understand what the current throughput is?

  • Wafer per hour, wafer per day?

  • At what point would 3D NAND would become actually economical?

  • I have a follow-up.

  • - Chairman & CEO

  • Gary, maybe you could --

  • - President

  • I think on 3D NAND, there is a pretty significant increase in bit density.

  • So, I think as soon as the customers have those devices yielding, they're going to try to ramp them as fast as they can.

  • The biggest issue has been being able to get the yields where they want it to be.

  • As I said before, again, this is a really great opportunity for us.

  • If you look at the number of deposition steps in a 3D NAND process, I mean, epi is a pretty low throughput application.

  • You start approaching those types of throughputs on wafers per hour per chamber with some of the 3D NAND applications.

  • Again, it's for us, 25% increase in CapEx opportunity as customers move to that technology.

  • - Chairman & CEO

  • I would just add briefly, that there's two aspects here.

  • First, 3D is a huge trend here, not just in NAND, but in transistors and packaging.

  • It's one of the biggest inflections we are going to see over the next few years.

  • But, this is a huge change to move away from litho-defined shrinking and really be able to move to process-defined, where precision materials engineering, interface engineering, really matters.

  • It's why we are so excited about this area, and we think, at 32 vertical bits or something like this, this is economical at the 45, 50-nanometer node, where companies are aiming the first generation, here.

  • You have to believe, once they solve the device and reliability issues, it will be very easy for them to move very fast, both down the litho curve, and increase the number of bits in the stack.

  • - Analyst

  • Okay.

  • And my follow-up for Gary, when you go for new business, how should we think about the catalyst that enables you to gain market share?

  • What else is out there other than ASP?

  • Is it the tool throughput, is it the service, there's a whole bunch of other stuff that you are bundling that is enabling you to gain that market share?

  • I'm asking this, because I hear from your customers that the biggest bottleneck is now lithography.

  • I just wonder what is enabling you to gain market share other than pricing?

  • - President

  • Well, again, as we talked about before, the biggest driver of the industry today is mobility.

  • All of the customers are trying to differentiate on low power and battery life.

  • The biggest changes we've seen in a decade in transistor technology are happening, as customers move to 20-nanometer gate-last technology and finFET.

  • These are areas where Applied is really riding this wave.

  • We have a very high share in the technologies that enable these new transistor structures.

  • Mike can comment, but the first time in many years that you've seen this type of a change, that is the number-one focus for the industry, where Applied has a leadership position in enabling this capability.

  • - Chairman & CEO

  • I would just add, that lithography has been the story for really the last at least 10 years.

  • Now, we are seeing many of the bottlenecks, the interface engineering, precision materials, how you're going to get the low-K values.

  • How you are going to keep them.

  • This is really an advantage for Applied Materials.

  • - President

  • Again, as we talked about before, this is an increase in our opportunity of around 30%.

  • Again, as you are adding an epi step, that's worth $100 millions with one step that's added to the transistor.

  • If you look at all the technologies where we have leadership around the transistor, this is really a fantastic opportunity for us to grow share.

  • Operator

  • The next question is from Patrick Ho with Stifel Nicolaus.

  • - Analyst

  • First for Mike.

  • Excluding the largest foundry, how do you see the trends for spending for the second tier foundries or at least the rest of the group, in terms of how 2013 plays out?

  • - Chairman & CEO

  • Well, certainly, we are expecting return of those other members of the foundry community to start spending in the second half of the year.

  • This will be a really key for us in how our order momentum is occurring, and at the end of our second quarter.

  • We've always expected them to really have their spending in our late Q2 or in Q2 calendar year, and into Q3 calendar year.

  • So, that's our current expectation, on the remainder of the foundry group.

  • I would say, we need that spending to broaden out, certainly to reach the high-end of our WFE estimate.

  • - Analyst

  • Great.

  • That's helpful.

  • Gary, maybe, specifically on the technology side.

  • When you were at Variant, you brought up the whole materials modification and a lot of the technology synergies between ion implant and etch.

  • Could you maybe get a little color, now that you two, as a combined company, how that may be giving you an advantage right now, particularly on the etch side and that being a driver of future share gains?

  • - President

  • I kind of feel like a kid in a candy store here at Applied.

  • The thing to me that it's so exciting is that we have leadership in many areas of precision materials engineering and this creates tremendous opportunities for us as a Company.

  • One thing that we don't talk about, and unfortunately I can't talk about here, there are opportunities for us in integrated processes, linking different parts of our product portfolio together that are creating positive momentum for us today.

  • I think as you move forward to some of these future device structures, and interface engineering, and some of these areas becoming more critical, the magnitude of that opportunity is going to increase.

  • Operator

  • The next question will come from Jagadish Iyer with Piper Jaffrey.

  • - Analyst

  • Congrats, George, from my side, as well.

  • Two questions.

  • Just wanted to highlight.

  • First, on the logic spending, Mike, you did allude to the fact that they would probably be coming back.

  • What is that which is currently driving, could potentially drive logic spending, given that the PC outlooks seems to be pretty tempered for this year?

  • - Chairman & CEO

  • First of all, it's changed in the next generation of technology, where we are seeing 25% to 35% increase in capital intensity.

  • That movement, of course, is very important, and very relevant to us.

  • But, then, the other thing that can drive up logic spending is some growth in PCs this year.

  • As I alluded to, there's been an introduction of Windows 8, there are touch ultrabooks now, if these things start to catch on, in the back-to-school time period, this could be very beneficial for us and logic spending in the latter part of the year.

  • - Analyst

  • Thanks.

  • Just as a follow-up, I just wanted to understand on the display side, how should we think about new fabs coming online.

  • Can you give us some color in terms of how many Gen10 fabs are coming or is it going to be driven by Gen8.5?

  • Any color on the fabs and on the generation would be very helpful, and how Applied is going to benefit this time, versus the prior generations?

  • Thank you.

  • - Chairman & CEO

  • Maybe I can start and Gary can finish.

  • As we start -- this current generation of TV fabs will be Gen8.5.

  • What we are seeing, and primarily in China, we are starting to see the orders come in for those factories, so that's really quite beneficial for us.

  • We think that 60-inch TVs are starting to get to the price points that, to a real volume price point, now starting to approach $1000.

  • Very soon, under $1,000.

  • That kind of price point will drive the industry to Gen10, just because how many TVs you can get on one sheet of glass, and to make that economical.

  • It's pretty clear to us now, that while we haven't had a glass size change in, I guess, five years, that there is one that's really going to come.

  • Gary, you might want to talk about also with the increased pixel density, what we see as our advantages.

  • - President

  • Yes.

  • As customers go to larger area, larger panels, and smaller pixels, again, it's the same thing.

  • You see the semiconductor industry where you have to drive to lower particles to get acceptable yield, uniformity becomes more difficult in these larger areas.

  • That really plays to the device performance and yield advantages that we have in our CVD and PVD products, and that will create very strong momentum for us, from a share and margin standpoint in that business.

  • - Chairman & CEO

  • We've also really been investing in these next generations of technology, as these new fabs eventually convert to metal oxide, we are going to be in a very good position to be able to take advantage of that, as well.

  • Operator

  • The next question will come from Ben Pang with B. Riley Caris.

  • - Analyst

  • In terms of the growth forecast that you have for the SSG business, you commented on your ability to outgrow the overall sector, based on transistor and PVC.

  • What's the wafer fab equipment if you split out transistor by itself?

  • Is there a significant difference between 2013 and 2012?

  • - Chairman & CEO

  • Transistor products, I think, are a little over 50% of our total SSG business.

  • I think it's roughly that.

  • - President

  • In plant in there.

  • - Analyst

  • I mean in terms of the industry growth rate.

  • I'm just trying to get a feel for 28-nanometer versus 20-nanometer, how much is really going through the transistor?

  • Is there a big growth difference?

  • - Chairman & CEO

  • Again, what we are seeing, for the transistor, you go from 28 to 20-nanometer gate-last, the market opportunity goes up for us, roughly 30%, if you take an equivalent number of wafer starts, and then it goes up again maybe another 10% as you go to a finFET technology.

  • So, for an equivalent number of wafer starts.

  • - Analyst

  • Okay.

  • Thank you very much and good luck George, as well.

  • - CFO

  • Thanks so much.

  • - VP of IR

  • I think we have time for one more question, please?

  • Operator

  • The final question will come from Vishal Shah with Deutsche Bank.

  • - Analyst

  • Just wanted to ask you a question on the OpEx guidance.

  • Does this guidance includes spending on 450-millimeter or are you thinking about 450 later this year or early next year?

  • - President

  • It does.

  • It's our full OpEx picture.

  • - Analyst

  • Okay.

  • Great.

  • Then, just around the foundry spending expectations.

  • When you think about the orders for the next couple of quarters, what percent of you orders do you expect from 20-nanometer.

  • Is it all going to be second-half weighted or do you see some activity from customers in the first half?

  • - President

  • We think orders on the 20-nanometer are certainly going to be small.

  • Maybe we will see them in the fourth quarter, rise in our fiscal fourth quarter, as we think most of that capacity will be closer to the end of the year.

  • - Analyst

  • Great.

  • How do you think 2014 foundry spending looks like?

  • Do see 20-nanometer keeping foundry spending relatively high, or do you see that as a weakness as you think about the next year?

  • - Chairman & CEO

  • I think we will hold off.

  • The mobility trend, we believe, is here to stay.

  • I think there's still -- there will be strong growth in mobility.

  • If that's the case, we are going to see strong foundry spending.

  • A little too early for us to make a projection about 2014, right now.

  • - President

  • What it would say also, is again, on mobility, this is a major focus for our customers, it's where everyone is trying to differentiate and grab share.

  • Certainly, it looks like, as customers ramp and the 20-nanometer gate-last processes, the people that are there, ramping those processes will have a competitive advantage, and that's what we would anticipate in 2014.

  • - Analyst

  • I appreciate that.

  • Thank you.

  • - VP of IR

  • 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 PM Pacific Time today.

  • Thank you for your continued interest in Applied Materials.

  • Operator

  • Ladies and gentlemen, thank you for participating in today's conference call.

  • You may now disconnect.