應用材料 (AMAT) 2013 Q4 法說會逐字稿

Welcome to the Applied Materials earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded today, November 14, 2013.

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

Please go ahead, sir.

Thank you, Rachel.

Today we'll discuss the results for our fourth quarter and fiscal year ending October the 27th.

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 will also contain forward-looking statements, including those about our announced business commission with Tokyo Electron and at our current view of Applied's markets, operational improvements, products, share positions, profitability, growth targets, and Q1 business outlook.

These statements are subject to known and unknown risks 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 our Company's SEC filings, including our most recent Form 10-Q.

These are our expectations as of today and we assume no obligation to update the forward-looking statements.

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

Reconciliations to GAAP measures are contained in today's earnings release and in our earnings summary presentation, both of which are available on our IR website at AppliedMaterials.com.

Now I'd like to turn the call over to Gary Dickerson.

Thanks, Mike, and good afternoon.

At the end of September, we announced that Applied Materials and Tokyo Electron are combining to create a new global innovator for the semiconductor and display industries.

This merger will enable us to accelerate the strategic visions of our two Companies and to accelerate our momentum for profitable growth.

We will bring together complementary leading technologies and products to create an expanded set of capabilities in precision materials engineering and patterning to solve our customers' high-value problems better, faster, and at lower cost.

Since the announcement, we have started integration planning and we are pleased with the constructive engagement.

We've also been meeting with our customers to discuss the specific ways the merger will create value for them and their responses have been positive and supportive.

We expect to file our S-4 securities registration statement in January, which will provide you with additional information.

And we remain confident that we will receive approval for the merger in the mid- to second half of 2014.

The rest of today's call will focus on Applied Materials' quarterly and year-end results, as well as our outlook.

In the fourth quarter, Applied delivered earnings toward the high end of our range and we enter our new fiscal year with momentum in bookings, and new product penetrations.

I would like to thank all our employees for their contributions over the past year.

This is a team with tremendous passion to create value for customers and investors.

I would also like to thank Mike Splinter, whose leadership, guidance, and support enabled a seamless CEO transition.

Mike and I will continue to work closely as we plan and implement the integration with Tokyo Electron.

2013 was a transformative year for Applied Materials, a year of building momentum for profitable growth.

First, we focused our growth strategy and investment on leveraging our precision materials engineering leadership to enable major technology transitions for our customers.

As part of this focused strategy, we increased annual run rate investment in 300-millimeter product development by more than $200 million.

Second, we took steps to shape a more competitive Company.

We reduced overhead spending by $130 million through efficiency improvement in Corporate functions and made significant additional reductions in solar operating expenses.

We strengthened the Organization in many critical areas, attracting top technical talent in etch, inspection, and other groups, while adding new leadership in solar and Display, finance, operations, marketing, and strategy.

We introduced a new operating rhythm and strengthened our business processes to improve execution and enable Applied to effectively scale as we drive profitable growth.

Third, we built positive momentum in our growth businesses including etch, inspection, and Display.

Fourth, and most significantly, major industry trends are fueling positive momentum for our leadership businesses.

Our precision materials engineering technology is enabling key inflections in the mobility war by providing our customers with solutions that improve device performance and yield.

With smartphone sales expected to exceed 1 billion units this year, the mobility trend remains the main growth driver for the electronics industry.

Smartphones and tablets now generate more semiconductor and display revenue than all other categories of consumer electronics combined.

We estimate that our customers will need to add manufacturing capacity for more than 500 million incremental smartphone and tablet units in the next two years.

Demand for advanced mobile chips is fueling strong foundry investment in leading-edge processes, as they build out 20-nanometer and race to be first with finFET technology.

Mobility is also a driver for NAND flash and when combined with the stronger adoption of solid-state drives, bit growth remains in the 40% to 50% range.

We expect investment to grow by more than 30% in 2014 with incremental spending in advanced planar NAND and strong spending for 3D NAND.

DRAM content in smartphones is approximately doubling with each generation, boosting consumption of mobile DRAM.

Prices have risen more than 120% over the past year and due to supply constraints that we expect to extend until mid-2014, there's a good foundation for new capacity investments.

Based on these factors, we are maintaining our view that wafer fab equipment spending for calendar 2013 will be in the range of $27 billion to $30 billion.

As we are at the beginning of major technology transitions, driven by finFET and 3D NAND, we believe wafer fab equipment investment will be higher in 2014, up 10% to 20%.

We expect to see a year-over-year increase in foundry, NAND, and DRAM investment, with logic and other spending flat to down.

In Display, TV unit growth is being impacted by the elimination of subsidies in China.

However, this is being offset by global demand for larger TVs.

Shipments of 50-inch and bigger screens are up nearly 70% year-on-year and this is driving area growth of around 10%, which is enough to sustain healthy investment levels.

In mobile, new display technology is being adopted.

The use of low temperature polysilicon backplanes enables higher resolution and lower power consumption and is migrating from smartphones to tablets.

In addition, smartphones with curved OLED flexible displays are starting to appear.

These trends are very positive for Applied as LTPS, OLED, and flexible display technologies increase the total available market for our large area precision materials engineering equipment by more than 30%.

As we outlined at our July analyst meeting, customers are locked in a battle for mobility leadership and this is driving major technology inflections in transistor, interconnect, memory, patterning, and display.

Materials innovation and cost-effective scaling are driving performance gains for our customers and are increasingly enabled by Applied's strengths in precision materials engineering.

In foundry, transistor performance remains a critical focus and we have very strong pull for collaboration in this area.

As customers build out high-k/metal gate capacity, we are increasing our share of their spending through a combination of expanded market opportunity and new positional wins.

As a result, we anticipate that we will grow our PVD share more than 5 points in 2013, as well as making significant gains in CMP.

The next battleground for foundries is finFET, and customers are pushing hard to begin pilot production in 2014.

Our strong position in the critical transistor technologies, including epi, implant, anneals, and CMP, provides us with a platform for further share gains at this inflection.

In memory, technology trends also play to our strengths.

And with the transition from planar to 3D NAND, we see our opportunity for wafer starts increasing by more than 30%.

In addition to market expansion, we are also winning share in 3D NAND as leading customers select our differentiated solutions for high aspect ratio etch and critical deposition process steps.

In recent weeks, we secured a major win in staircase deposition applications at one of our largest memory customers.

In the past year, we have started to demonstrate excellent progress beyond our traditional leadership areas.

Our process diagnostics and control group grew 20% relative to 2012 and our UVision brightfield inspection product line delivered record net sales for the year.

Overall, we believe we will gain over 4 points of inspection share in 2013 and we are in a strong position with the leading companies as they ramp next-generation finFET devices.

In etch, our focused strategy is yielding results and we are gaining share based on the new conductor etch positions we have secured.

In Display, equipment demand rebounded in 2013, and more importantly, we were able to significantly outgrow the market.

We expect to gain more than 20 points of PVD share this year while holding position in CVD where we were already very strong.

In summary, fiscal 2013 was a year when we built momentum for profitable growth and made Applied Materials more competitive.

Today, we have positive momentum in our markets, as major trends play to our strengths, and we have a very strong pipeline of differentiated products to grow our wafer fab equipment share and enter new markets.

We have positive momentum with customers and strong pull for earlier, broader, and deeper collaborations to enable their future devices with our materials engineering solutions.

We also have positive momentum with employees.

Our engagements scores are at an all-time high, and we are adding very strong talent in critical areas to improve execution and enable us to successfully integrate with Tokyo Electron.

As we look to 2014, we are very excited.

We have great opportunities to accelerate our momentum for profitable growth and we remain highly focused on execution to ensure we take full advantage of these opportunities.

Now Bob will provide additional details about our performance and outlook.

Thanks, Gary.

In the fourth quarter our orders grew sequentially and revenue was in line with our expectation.

We maintained our spending discipline in the quarter, which helped us to achieve EPS in the upper end of the guidance range.

We enter fiscal 2014 with momentum, especially in both orders and revenue for SSG.

Since this is our Q4 report, I'll make some observations about fiscal 2013.

We have been transforming the financial profile of the Company by, one, aggressively reallocating our spending priorities; two, increasing the funding and velocity of new and disruptive products; and three, strengthening our gross margin performance even as we introduce new products.

Beginning with spending, we have reallocated dollars from solar to semi and from overhead to products.

For example, we reduced solar spending by about $120 million in 2013 and we shifted that spending, plus another $40 million in overhead savings, to R&D programs within SSG.

For the year we grew R&D, as a percentage of R&D plus SG&A, by 6 points, from about 54% in 2012 to nearly 60% in 2013.

To help fund the increase we reduced our overall G&A spending by $130 million or 22% over the same period.

These are major changes to our Organization.

Now let me give you some insight into how we're deploying these additional dollars to strengthen our technology and product pipeline, especially in disruptive products, which are a key driver of future profitable growth.

In 2013, we moved over two-thirds of the incremental R&D investment into disruptive products.

These are new products, such as selective material removal, that give our customers new ways of solving high-value problems.

Disruptive products expand our addressable market and give us the chance to change the market share landscape.

A good indicator of our progress is evaluation tool shipments, which are projected to increase significantly in Q1 of 2014.

For our customers, clean room space and engineering expertise are precious resources and their strong pull for more of our evaluation tools speaks to the value of our latest products.

Another example of our progress is our manufacturing pilot line in Santa Clara.

With this new capability, along with other changes, we will reduce our deployment cycle time by approximately four months and significantly improve our initial product quality.

Another key indicator of progress is that we are beginning to see these disruptive products in our backlog in both SSG and Display.

We expect this investment in faster development of new and disruptive products to increase our market share and operating leverage.

In 2013, we gained market share with our many of our existing products by improving our customer responsiveness and application footprint.

We are gaining more traction with our customers, particularly with those that are pushing the leading edge in logic, foundry, and 3D NAND.

Our orders from the leading foundry customer were the highest in Applied's history this year and we expect our strong SSG order momentum to continue into 2014, in foundry and overall.

Now I'd like to give you some background on our gross margin performance.

In 2013, while our overall revenue was down 14%, we increased our non-GAAP gross margin by 120 basis points.

The mix between our segments was beneficial in 2013, as solar declined and semi, Display, and AGS all increased as a percentage of our revenue.

We see this segment mix benefit continuing in 2014, which should be a strong year for us in semi.

Now let me give you some color on our non-GAAP gross margins within each of our segments for 2013.

In SSG, we maintained our gross margins during a year in which we penetrated new markets.

In Display, we gained share and improved our gross margins.

In AGS, gross margins were flat excluding the impact of a PV solar line sale in 2012.

In EES, gross margin improved despite a weak year for solar demand.

Although it is still early to make precise forecasts, we currently project our non-GAAP gross margin to be up sequentially in Q1 of 2014, down slightly in Q2, and up again in Q3 and Q4.

Overall, we expect our product and customer mix to become more favorable as we proceed through the year.

We also have initiatives underway to lower our material costs and higher volume for the year will help the absorption of our fixed cost.

Our goal for 2014 is to once again deliver over a point of non-GAAP gross margin improvement for the year, even as we ramp new products.

Next I'll summarize our fourth-quarter results and comment on changes from the prior quarter.

Orders were approximately $2 billion, up 5% sequentially on higher orders in SSG, AGS, and EES, offset by a decline in Display.

Net sales were approximately $2 billion, in line with our expectations.

Our non-GAAP EPS was $0.19, in the upper end of the guidance range.

Non-GAAP gross margin was 42%, down about 1 point due in part to items in AGS and Display that I'll touch on in a moment.

Non- GAAP operating expenses were $512 million, which was a bit below our guidance.

Our non-GAAP effective tax rate was 24.8% for the quarter and 24.5% for the year.

We expect the rate to be approximately 23% for the first quarter.

Cash from operations was $19 million, driven by increased working capital requirements.

Our shipments were weighted to the latter half of the quarter, resulting in higher accounts receivable and inventories grew to support Q1 projected customer demand.

We returned $167 million to stockholders in Q4, paying $120 million in dividends and using $47 million to repurchase 3 million shares.

We ended the quarter with cash and investments of approximately $2.9 billion.

Next I'll comment on our Q4 segment results as compared to the prior quarter.

SSG orders were up 16% to $1.4 billion, with growth in foundry, NAND, and logic and a decline in DRAM.

SSG net sales declined slightly to $1.2 billion, in line with guidance, with increases in logic and DRAM, offsetting a seasonal decline in foundry.

SSG's non-GAAP operating margin decreased slightly to 20.8%, reflecting higher investments in new product development.

In AGS, orders were up 6% to $548 million and included several large contract renewals, which tend to be higher in our Q4.

AGS net sales were up 8% to $538 million, which is a bit better than our expectation due to higher than expected equipment sales.

AGS non-GAAP operating margin declined to 21.6%.

We recorded a $20 million charge for a customs duty assessment that we hope to recover in the future.

Our Display orders decreased 55% to $114 million.

We expect orders to be higher in Q1 and we expect the overall TV and mobility investment cycle to continue in 2014.

Display net sales were flat at $163 million.

The non-GAAP operating margin declined by about 9 points to 12.3%, reflecting a $10 million inventory charge.

EES orders increased to $40 million and net sales were approximately flat at $44 million.

EES non-GAAP operating loss was $22 million.

We will continue to look for opportunities to lower EES spending and losses.

Now I will provide our Q1 business outlook.

We expect our overall net sales to be up by 3% to 10%.

Within this outlook, we expect SSG net sales to be up by 15% to 20%.

AGS net sales should be down 5% to 10%.

AGS revenues tend to be seasonally lower in Q1.

We expect Display net sales to be down 15% to 30%.

And EES net sales should be approximately flat.

We expect our non-GAAP operating expenses to be in the range of $540 million, plus or minus $10 million.

Many of our groups will observe a two-week holiday shutdown, which will save us approximately $10 million in the quarter.

We expect non-GAAP earnings per share to be in the range of $0.20 to $0.24.

In summary, 2013 was a transformative year for Applied Materials and we anticipate that 2014 will be a strong year for the Company and the industry.

We enter our new year with increasing customer and product momentum.

We are excited about our planned combination with Tokyo Electron, which will accelerate our strategy, increase our profitability, and provide strong cash returns to our holders.

Now let me turn the call over to Mike Sullivan for questions.

Thanks, Bob.

As a reminder, today's call will be focused on Applied's business and financials and we do look forward to providing you with more information about the planned combination with Tokyo Electron over time.

(Caller Instructions)

Rachel, let's please begin.

(Operator Instructions)

John Pitzer, Credit Suisse.

Congratulations.

Bob, last quarter you guys talked about a specific increase in eval tools over a two quarter period of, I believe, 20%.

This quarter you're just talking about a significant increase sequentially in the January quarter.

I'm curious, relative to that initial target, are you getting close to that 20% increase over two quarters, or is there something about the TEL proposed merger which is slowing the rate of eval for you guys in the field?

Actually, I think the eval number is going to be bigger than 20% so I feel it's bigger than that number but we just didn't put a number in here today.

And then guys, as my follow up real quick, Bob, appreciate the quarterly progression of gross margins for the fiscal year.

I'm curious, is that all being driven by mix as you gain market share in new segments at perhaps lower gross margin or do you think as you go throughout the year, even with those share gains, you should be able to bring margins up in some of the new markets you're penetrating?

Yes, John, I intentionally gave everybody some guidance by quarter because there's so many moving pieces here that I want to try and help.

Last quarter, if you remember, I voiced some conservatism about the Q1 gross margins.

I looked ahead a quarter and in fact if you look at what we're saying today, it's probably a little bit more optimistic than TheStreet interpreted last quarter, and in fact, frankly, than I thought.

It's got a little bit better.

So a lot of mix things going on here.

If you look Q1, probably a little bit better than people thought last quarter and even I thought, down a little bit from -- up a little bit actually from this quarter but not quite as conservative as I thought last quarter.

As you look to Q2, I project the mix to be a little bit negative.

I project, as you go through the year, Q3 and Q4, the product and customer mix to be more positive and I project some of the material costs and absorption to be more positive later in the year.

Additionally, the question you asked about new product penetrations, we're pretty optimistic about the new product penetrations including the disruptive ones in the evals and the customer engagement.

Those are not big levers in terms of the gross margins this year.

We're more enthusiastic about them as leading indicators of share gains.

Thanks, guys.

Jagadish Iyer, Piper Jaffray.

Bob, two questions.

First, your silicon revenues essentially were flat year-over-year, if I take your guidance of what you have given for the January quarter.

So if WFE is going to be up somewhere in the vicinity of 10% to 20% for next year, can we expect some significant outperformance given the share gains that you have been talking about for next year?

Jagadish, we think overall environment next year, wafer fab equipment is pretty good.

We also think we'll do well next year.

We don't project that far in advance at this point, but we're getting some good penetrations.

We think we gained share in some significant markets in 2013 and we see the momentum continuing into 2014 but we haven't projected full-year 2014 share and revenues yet but we think we have pretty good momentum.

Okay and this is a question for Gary.

Gary, you had made in your prepared remarks about penetration in etch particularly with regard to NAND customers -- 3D NAND.

I just wanted to get a sense from you is how much -- what magnitude are we thinking about and how much is the proliferation going to be for other 3D NAND customers?

Thank you.

We definitely are making progress in etch this year.

We really have strength in the team.

Focused strategy in the areas where we have good opportunities and we anticipate that we'll gain somewhere around 5 points of share overall in etch in 2013, really focused in conductor etch.

That is in certainly planar and 3D NAND, where we're making a lot of our progress, and also in foundry.

Those are the key areas.

In addition, we have some strong technology around inflections for our customers and we're getting good pull in those areas also.

Vishal Shah, Deutsche Bank.

I wanted to just follow-up on your comments on orders.

You said DRAM orders were down sequentially in the fourth quarter.

Can you talk about what's going on there?

It sounds like the supply constraints should continue in next year and you were pretty positive about [ds] running into 2014.

How should we think about the order pattern in DRAM, as well as some of the NAND and logic customers into 2015?

Thank you.

The overall orders, which were up, and where we said DRAM was down, we said the others were up.

And we alluded to the fact we feel pretty strongly about orders into the near-term particularly in foundry and places like that.

I know a lot of people have commented in the public domain that this information that as a very large foundry, we did remarkably well in the last few months.

We don't dispute that notion that's out there in the public domain.

Some of that we think falls into our Q1.

So we see a fair amount of momentum for ourselves, particularly at the leading edge customers.

We do think DRAM, which we mentioned on the phone, not too much momentum right now in the marketplace.

So we feel good about foundry, particularly for Applied.

We feel NAND looks pretty good, particularly for Applied.

And DRAM we are little more conservative, frankly.

Thank you.

Just a follow-up on the solar segment, you saw some improvement in orders, but the segment is still losing money.

You said you're going to try to release spending there in 2014.

Are you seeing any change at all in terms of fundamentals in orders from your customers?

Do you have any plans to -- divesting of that business or are you still looking to find ways to optimize that business?

Thank you.

In solar, as we mentioned, we've reduced the operating expenses in the last year by about $120 million.

Certainly our goal is to, while we're in this period of time where the demand is soft, continue to reduce the earnings drag and we see additional opportunities to do that.

There is some incremental improvement.

We see a couple of opportunities that could get us much closer to breakeven in the EES business in 2014, but really, we think 2014 is going to remain relatively soft in EES overall and we continue to look for ways to cut cost.

As I talked about in the last earnings call, we set a hurdle relative to the operating profit and ROI in each one of the businesses.

And we continually evaluate all of the different businesses against that criteria and make decisions that are appropriate based on that information.

Terence Whalen, Citi.

Actually a couple regional questions.

If I look at your order pattern by region, we saw a pretty meaningful decline in Japanese orders in the fiscal fourth quarter.

I was wondering, given that there has been some DRAM [drop there] in Japan, I was wondering do you expect future orders to come in future quarters because of that disruption in the DRAM?

Thanks.

DRAM, what we believe, is that it will be somewhat higher.

There's some strength in mobile DRAM, and as you said, there's some capacity that was taken offline that will provide some incremental lift in the DRAM business.

We really don't expect to see that to be a significant change in 2014.

We see stronger incremental business in NAND flash, both in planar and the first factory ramping 3D NAND, so that, we think, will be stronger.

And we see incremental CapEx in foundry also.

DRAM, we think will be up slightly in 2014, but not a significant amount.

Okay.

Terrific.

Switching gears to Taiwan, obviously, you're in the middle phases of a pretty large order ramp in Taiwan.

In terms of your experience last year, thinking about the seasonality of orders, are you confident that after the fiscal first and second quarters, there are enough positive offsets in foundry and logic to compensate for the more pronounced seasonality that we're again seeing this year from Taiwan?

Thanks.

Again, if we look at the market overall in 2014, as I mentioned, we think NAND will be up, both in planar and 3D NAND.

Foundry, the ramp in 20-nanometer, we think will be pretty significant in 2014, and there is a big focus for all of the foundries to move to FinFET technology as quickly as possible.

So we see incremental spending there from the foundries in Taiwan and elsewhere on that technology transition in FinFET.

So overall we think the foundry spending will also be up in 2014.

Terrific.

Thank you.

And then relative to your question on the seasonality, certainly we have seen that pattern over the last couple of years, relative to the first half, second half.

We're really not making any forecasts right now relative to first half and second half of 2014.

Timothy Arcuri, Cowen & Company.

Bob, the numbers don't always relate perfectly with the [MOPS] filings that are filed by one of your big customers in the foundry space, but they announced that there was $900 million worth of orders that got filed during your quarter for you and yet you're reporting Taiwan orders of something like $720 million.

Is that just an order timing issue, so we should expect a very strong Taiwan order number for SSG also in January?

Thanks.

I pulled out of the historical data, Tim, on that one, because I saw that obviously.

And what you see is it doesn't always tie tightly in the individual quarters but the pattern is usually pretty consistent over time.

And we remain optimistic about our opportunity there in the next quarter so there is some linkage.

Okay and then, just, Bob you said last quarter you talked about the eval tools in SSG.

It seems like they're constraining revenue guidance a bit.

So can you give some sense in terms of what the absolute dollar magnitude is that that issue is constraining SSG revenue guidance by?

I don't think it's a big revenue constraint.

There's mid-level -- it's a good number of double-digit tools, right?

And the growth is pretty good, too.

But they are more a leading indicator of share gains than revenue slippage.

So I'm really happy we're doing them because they are a really good indicator of share opportunities but they're not a big short-term problem for revenues.

Okay.

Thanks so much.

Jim Covello, Goldman Sachs.

Gary, you talked about 4 points of share gain in inspection in this year.

Could you give us a little more granularity on that?

How much of that might be what you would consider leading edge versus trailing edge and what tools are driving that?

Thank you very much.

Thanks.

So as I've talked about before, we see very, very strong -- continue to see very strong pull from customers in the inspection market.

A lot of momentum, especially in foundry and logic, layer penetration increasing at 20-nanometer and 28-nanometer and we also see a very strong position as the customers move to FinFET technology.

In the leading FinFET companies, the layer penetration for us is increasing.

So really the strength is in the foundry and logic business.

There's some areas where the technology is superior to the competitors, especially in some of the patterning types of applications.

We have imaging capabilities that really leverage our strengths.

So that's one area that is growing for us and I mentioned in the prepared remarks that our UVision brightfield sales were a record in this last year.

We also have a strong position in e-beam technology.

The e-beam review business is a few hundred million dollars and we're strengthening our position there.

And then as customers are moving to the 3D NAND, there is more demand for e-beam types of applications in the defect review.

We're actually seeing traction both in foundry and logic with some unique e-beam imaging capability in metrology so we're seeing some more pull there.

And e-beam inspection, especially in 3D NAND, is increasing.

That's a small number for us today, but we see that longer-term as an increasing opportunity.

That's terrific.

Thank you.

Maybe for my follow-up, on the 3D NAND opportunity, obviously, there's one big customer that's being very aggressive early on there.

Would you expect to see significant orders from other 3-D NAND customers at some point in calendar year 2014 or would it be beyond that in your estimation?

I think that we'll see certainly technology buys in 2014.

The one customer, as you mentioned, is really -- has been pretty optimistic relative to the performance of the device and certainly all of the customers have that transition on their roadmap.

So for the other customers, 2014, we would see technology buys not so much high-volume production.

Mahesh Sanganeria, RBC Capital Market.

Bob and Gary, I'm looking at your order by segment for last five years and it looks like NAND this quarter was a record for -- if I go just last five years and I'm assuming that's a result of increase in content of dep and etch in 3D NAND.

If you can confirm that?

And on foundry, your last first half of year, your run rate was $1 billion per quarter and we're still only at $650 million and assuming that since you're commenting that foundry will be stronger next year, I would think that the first half of next year will probably grow year-over-year.

Is that a fair assumption?

I'll take the NAND question first.

The opportunity for us, as I talked about, there's more dollars per wafer start for us in the transition from planar to 3D NAND.

Dep and etch are areas that are good opportunities for us and other areas that are also increasing -- CMP steps are increasing in the transition from planar to 3D NAND.

There also epi steps in 3-D NAND.

And of course, we have a very strong position there.

So that's adding incremental opportunity in the transition from planar to 3D NAND.

Those of the areas where we see the largest growth.

And then the foundry question, what was the foundry question again?

The foundry question -- you're indicating that the foundry spending is going to increase next year.

And if I go look at this year's first half, your order run rate was about $1 billion and you're ending at $650 million.

I would assume that the order run rate in the next fiscal year, which is the current quarter, should be increasing beyond $1 billion run rate for you -- foundry to grow in 2014?

Yes, I don't know that we are going to give any specific numbers.

What Bob had mentioned is correct relative to incremental strength in foundry orders in Q1, as many people have reported.

There was a question on the call today relative to the orders last quarter that were reported in Taiwan and our numbers being below that.

As Bob said, that, we think will come into alignment and we look incrementally in Q1 for the orders to be very positive.

Yes, we think our Q1 looks pretty good and we think our share looks pretty good there.

I haven't projected beyond the first quarter or so but the visibility in the near-term next quarter still looks pretty good.

Stephen Chin, UBS.

Just a follow-up question on the lower DRAM orders that you're currently seeing.

Do you get the sense that this is due to the higher capital intensity of going sub 20-nanometer or is it from lower yields that are making the larger die sizes for mobile DRAM?

And maybe you could talk about where you think the DRAM spend will head as you go into 2014?

Thanks.

The data we have, which always jumps -- first you asked a qualitative question and then a quantitative question.

I'll do the quantitative one first.

We see it has the potential to be up year-on-year but not dramatically up.

We see the first part of the year is at Q1, not super.

We think it gets a little stronger during the year.

We think it is driven more by mobile DRAM.

In terms of capital intensity [daunting them], it's more of a capacity -- do they need the capacity?

If you read stuff that folks like you even write, they're benefiting from a little bit of pricing improvement now and they seem to be showing more discipline around that than they have historically.

Weston Twigg, Pacific.

Was wondering if maybe you could give us a little bit more color on some of these evaluation tools you are placing.

Really specifically, I'm wondering if some of these are the selective removal products and whether or not you have any new inspection platforms under evaluation?

Well, we definitely have opportunities in selected material removal, as we had talked about in the July meeting.

That market we believe will grow very significantly over the next few years.

We are always introducing new models and new products, including in inspection.

We typically won't talk a lot about some of these new tools.

What we've been doing is really targeting the high-value problems for customers, as they are making these technology changes around FinFET, 3D NAND, there are some new areas that we are pursuing that are good opportunities for us long-term and not ready to talk about those in detail.

It does take time, as you know, for those new tools to be adopted in the technology roadmap for the customers.

So, as Bob said, it's really a leading indicator of opportunities for us in the future.

And our $200 million that we're spending in SSG really are focused on these major technology transitions and the highest value problems for our customers.

Most of the places you'd speculate that we have them, we do have them there.

So I'd say (multiple speakers)

Okay.

Good, that's helpful.

And then just as my follow-up -- this is related to OpEx -- you mentioned that around $10 million -- the OpEx may have been $10 million higher without the shutdown this quarter.

Does that mean OpEx goes up another $10 million the following quarter?

Yes, I'll try to give you color on that.

There's a little risk it goes up.

Here's what's going on.

The beginning of calendar year, January 1, we do our annual raises and reviews for everyone.

And then we also accrue the incentive comp a little bit higher rate, so there is a little bit of a step up.

I referred to that last quarter, too, on the spending.

Now what -- if you look at structural spending underpinning that, there's a fair amount of continued structural cost savings that we're going through.

So there's a little of opportunity that expenses trend up a little bit in the second quarter, mostly in products again, and we're trying to mitigate that with continually tightening of our belts.

But I would say it's a little bit of upward bound risk.

Okay.

Thanks.

Edwin Mok, Needham and Company.

First, just follow-up question on the eval tool.

I was wondering maybe a different way to ask that is are those eval tools targeting the 20-, 16-nanometer and foundry or some of the 3D NAND opportunity or are they targeting for longer-term opportunities that you expect to be successful for 2015, 2016 and beyond?

There's a combination of opportunities in these major technology transitions at 16-nanometer or the first-generation FinFET.

There are some opportunities there for us -- and then also in 3-D NAND.

I would say that it's a mix of products that are going into those nearer-term technologies and also ones that we're looking out further as there are even bigger changes with new materials that will be necessary for those devices.

I see.

Okay.

Great.

And then just a question on your R&D spending.

Given that you are working towards a merger with Tokyo Electron, are you guys starting to allocate your R&D spending and look at your product portfolio and how it could match over the next year -- match with TEL and shift your R&D dollars in areas that you felt you might be able to get some incremental savings once the deal is done?

Right now, we're separate companies and we're driving -- really no change in our strategy, no change in our investment profile.

We really can't work on a deeper understanding of products, technologies, roadmaps, all of those kinds of things until we're together.

Krish Sankar, Bank of America Merrill Lynch.

I have two of them.

One either for Gary or Bob.

Can you help us quantify how much more capital intensive or expensive is 3D NAND relative to planar NAND for, let's say, 10,000 or 100,000 wafer starts per month?

Well, I'll tell you some of the things that are going on there.

Its capital [intensity] is located in deposition and etch.

So our numbers we've said are 30% to 50% and increasing capital intensity going from 2D to 3D NAND for deposition and etch.

In lithography, it's actually less intensive because you're going down to 50-nanometer rules, so it's heavily located in deposition and etch.

Got it.

All right, and then a follow-up on the--

Their official number we put out a little while ago is 50% from planar to 3D for etch and CVD.

Okay.

All right.

And then on the 3D NAND, your etch market share gain, is that -- are you guys sole source for it or are you splitting it with the planar NAND [income and supplier]?

Yes, definitely.

All of these applications -- etch -- or all these markets, etch and inspection -- many, many, many different [segments].

And so the share for us is increasing in the conductor etch types of applications, but there are maybe four different companies, five different companies, that are competing for that business.

Patrick Ho, Stifel Nicholas.

Nice quarter again, guys.

Bob, maybe first on the global services business and in the past you talked about some of the opportunities there to improve the margin profile in that business segment.

Can you give us what your thoughts are about some of the efforts and measures you are going to take in 2014 to improve that segment?

Sure.

We talked about earlier on the call, that the revenues are down a little bit in Q1, which is seasonality.

If you look at the gross margin opportunity in AGS, which is our global services, we're optimistic that we can make improvements next year.

Some of the improvements are going to be some higher value services, but we also think there's an opportunity for cost reduction on materials, which will save us some money.

So we think we have an opportunity to improve gross margins across services and products [like sale].

We talked about for the Company an overall increase of over 1% on gross margins.

Within AGS, we see similar types of opportunities.

Great.

Maybe just going to the display side for a second, you guys have seen the pick up in orders in 2013, which will lead to the revenues.

Maybe again, Bob, how do you manage the inventory, just given that that's a very lumpy business and what gives you confidence that the investment cycle will continue, just given some of the lumpiness of that business overall?

Sure.

If you add up our orders numbers we've reported throughout the year, you'll figure out we have a pretty damn big backlog in display and the lead times on those tools tend to be pretty long, months and months, in terms of lead times to buy the parts and assemble the tools.

So we have pretty good visibility into the shipment pattern.

Now the risk you have on that tends to be a little bit, do they slip it out a little bit.

But in terms of the visibility into the shipment plan over the next six months, it's pretty good.

The inventory charge, we noted on this, that was related to a specific type of tool.

We're still hopeful that we are going to end up in good territory on those tools but right now we took the position that it was -- we're going to take a reserve against it.

I would say on display, as we talked about earlier, a few things driving the business.

One is the increase in TV sizes, that's a very positive driver for us.

And really the new technology in display technology and mobile is also positive, with LTPS, OLED, flexible displays, this is really a big part of the battleground for the consumers.

And we see a lot of technology transitionings happening this Christmas season and then really tremendous focus from very big companies around technology that would be positive for us from a total available market standpoint.

Thanks, Patrick.

Rachel, we have time for about two more callers, please.

Mehdi Hosseini, Susquehanna Financial Group.

Gary, I want to go back to your earlier comment.

Your largest 3D NAND customer was saying last week that the China fab is actually a 2D and eventually in the second half of next year, they will convert it to 3D NAND.

So I wanted to get your overview on what gives you the confidence that today's booking on the NAND is actually 3D when your customers are saying it's more of a conversion when the China fab is up and running on the 2D NAND?

And I have a follow-up for Bob.

Yes, it's just based on the conversations we've had with them around very specific applications.

So are you saying that it is going to be a conversion?

Or do you still think it's going to be a greenfield 3D NAND?

Well, there's some technology that's similar between 2D and 3D but certainly what we've seen is buying for some applications that are very specific for 3D NAND.

So again, what we've heard in talking with the customer is the time frame in terms of the ramp and the specific tools that are being purchased for 3D NAND applications are consistent with what we've talked about.

And the time frame for the ramp -- does it start today or does it start some time next year?

I don't think we want to get into specific details of what customers have told us.

Mehdi, did you have a follow-up for Bob?

Mehdi, did you want to follow that up?

We'd be happy to.

Yes, question for Bob -- I'm looking at your operating margin for the SSG.

Right now, a year or two ago a similar revenue run rate was generating about 30% operating margin.

With the structural changes in your cost structure, when do you expect those margins materialize?

Or is this going to be on pause until the merger is completed?

We strive to get higher gross operating margins there, so I agree with you.

Right now we've talked a lot about where -- we've been reducing costs and overhead areas, particularly ones that aren't in SSG and investing in product development, which is heavily focused in SSG.

Those new products are starting to come out, whether it be eval tools or D2R positions.

As we start to get revenue ramps on those tools, you'll see our margins drop through much more effectively.

So we see it going up next year with some volume.

We see it improving over time as we start to get penetrations and our goal is to be much more similar to the numbers you've referenced.

We just are in somewhat of an investment mode in R&D in SSG right now and we're funding that by cutting back in a lot of other places, whether it's solar or overhead.

So our overall approach is somewhat balanced right now but in SSG we're in investment mode right now.

Harlan Sur, JPMorgan.

Nice to see the strong foundry order momentum.

On the last earnings call, you provided a view that by the end of this year there would be about 30,000 foundry wafer starts of capacity at the 20-nanometer node, growing to over 100,000 in 2014.

Given your recent discussions with customers and the strong order momentum, has this view changed?

No.

Good answer, Gary (laughter).

Great.

I'd say we're consistent on that one.

And then, given the increasing complexity of these next-generation manufacturing processes, the frustration that we're hearing from customers is that their throughput to the fab is now increasing anywhere from 15% to 30%, and as we know, throughput is a key driver of wafer cost.

So how is Applied addressing better throughput on their tools and does the upcoming acquisition of TEL enable you to make even further improvements and optimizations on throughput?

Well, the first thing really for the customers is to make the technology work.

And that's been a huge focus, whether it's 20-nanometer ramp to get the yield and device performance targets or FinFET technology or the transition from planar to 3D NAND.

What I would say is that those technology transitions are very big transitions -- many new materials, very difficult for the customers.

And so the first thing, really, in working with them is to hit the device performance targets and those are the things that we're working on.

And then after that, really, it's trying to optimize the overall capability of the systems and we are certainly working with customers on that too.

But the key thing is trying to enable these major changes in device performance and yield as they go through the initial stages of these new device technology transitions.

Great.

Thanks, Harlan 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 pm Pacific time today.

Thank you for your continued interest in Applied Materials.

Ladies and gentlemen, this does conclude today's conference call.

You may now disconnect.