應用材料 (AMAT) 2014 Q2 法說會逐字稿

Welcome to the Applied Materials earnings conference call.

(Operator Instructions)

As a reminder this conference is being recorded.

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

Please go ahead, sir.

Thank you, Jennifer.

Today we'll discuss the results for our second quarter which ended on April 27.

Joining me on the call are Gary Dickerson, President and CEO, and Bob Halliday, our Chief Financial Officer.

Before we begin, let me remind you that today's call contains forward-looking statements, including our current view of the Company's industries, our performance, products, share positions, profitability, announced business combination with Tokyo Electron, and 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 these risk factors is contained in our most recent Form 10-Q, Form 8-K and other SEC filings.

Forward-looking statements speak as of May 15, 2014, and we assume no obligation to update them.

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

Reconciliations to GAAP measures are contained in today's earnings press release and in our reconciliation slides which are available on the investor page of our website at appliedmaterials.com.

Before we begin I'd like to make a calendar announcement.

On the afternoon of Monday, July 7, Applied will hold its 2014 Analyst Briefing in San Francisco with a live webcast for anyone whose not traveling to SEMICON West this year.

We'll provide you with more details as we get closer to the event.

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

Thanks, Mike.

And good afternoon.

In our second fiscal quarter of 2014, Applied Materials delivered earnings near the high end of our guidance.

And we expanded our operating margins for the sixth quarter in a row.

These results reflect healthy investment by our semiconductor and display customers, strong execution against our strategic plans, and significant improvements in our financial performance.

Across the Company we are focused on accelerating our momentum for profitable growth.

We are strengthening our field technical engagements with customers, our R&D capabilities and our ability to ramp new products faster with lower cost and better quality.

At the same time, we are making great progress getting the organization ready for our merger with Tokyo Electron.

We continue to believe that we will receive regulatory approval for the merger in the second half of this year.

Our S-4 securities registration statement has become effective.

And our shareholder meeting to approve the combination with Tokyo electron is scheduled for June 23.

The detailed plans to integrate our two companies are taking shape.

The level of engagement and strong working relationships within the integration teams are tremendous.

This gives us high confidence that we can rapidly bring together the critical areas that will enable the new Company to achieve its strategic and financial goals.

We have also been developing the mission, vision and values that will be the foundation of the combined companies culture.

And we will share more information about our progress at SEMICON in July.

As we work through the integration planning process, we are even more confident that we can accelerate materials innovation for the industry and increase the value we deliver to our customers and shareholders.

Turning to our market outlook, evolving trends in mobility and connectivity are driving industry growth and accelerating innovation in mobile chips, solid state storage, and interactive displays.

The advanced processors, sensors, and memory needed to enable high-end smartphones have driven significant growth in the silicon content of these devises.

Consequently, the foundries continue to make substantial investments as they ramp 20-nanometer capacity and accelerate their pilot lines for 16- and 14-nanometer finFET technology.

We expect foundry spending to increase 10% to 20% in 2014, and be distributed over a broader customer base compared to recent years.

Mobility and cloud computing are also driving demand for NAND memory, and we expect bit growth to be about 40% this year.

As a result of strong investment in advanced planar NAND, we believe total NAND spending could reach $7 billion for this year.

Adoption of 3D NAND is progressing at a slower pace than previously anticipated.

But we still see increasing investments as customers work to solve technical challenges in the transition from planar to 3D devices.

DRAM customers are also investing more as they upgrade capacity at their advanced nodes to meet demand for mobile DRAM.

We expect 2014 DRAM spending to be 10% to 15% higher than last year.

Overall, while there have been some adjustments in customers' investment plans in recent months, we maintain our view that 2014 wafer fab equipment could be up 10% to 20% relative to last year.

In the display market, there are two primary factors driving growth.

The first is TV, where average screen sizes are increasing at 1.5 to 2 inches annually, which is significantly higher than historic rates.

Three new Gen 8.5 factories are being built in China as our customers race to meet this growing TV area demand.

The second is mobile where displays are an important area of differentiation for smartphones and tablets.

Higher definition screens are driving demand for low temperature polysilicon backplanes.

And we expect multiple new Gen 6 factories to be built in the next two years to meet the market's needs.

These strong market drivers in display have enabled us to book $340 million of new orders in our second fiscal quarter.

And while we expect our revenue patterns to be uneven due to shipment timing, our outlook for the display business remains positive.

In semiconductor and display, new materials innovations are enabling key inflections by providing our customers with solutions that improve device performance, yield, and cost.

We see tremendous customer pull for Applied's differentiated technology in precision film deposition, materials modification, materials removal, and interface engineering, which are at the heart of key transistor inflections.

We are also working with our customers to drive significant materials innovation in interconnect.

Earlier this week, we launched our Volta CVD Cobalt system.

This precision film deposition technology can be used to form CVD-based cobalt liners and selective cobalt capping films that allow customers to overcome critical yield-limiting issues as they scale copper interconnects at advanced nodes.

This breakthrough strengthens our leadership position in interconnect, while growing the available market for Applied's CVD products.

Over the past 18 months we have taken actions to support our growth strategy by shifting spending to our best opportunities, strengthening our processes, and adding talent in critical areas of the organization.

We have increased our technical capabilities in the field to better support new applications development for our customers.

We strengthened our product development engine to accelerate new precision materials engineering innovations.

And we aligned our product portfolio to increase our focus on those programs that make the biggest impact for our customers and for Applied.

We are starting to convert these actions and investments into market share momentum.

In calendar 2013, we gained 1.4 points of wafer fab equipment market share, ending the year at our highest level since 2006.

We delivered positional share gains across the majority of our leadership businesses.

Our PVD business gained 7 points of share in the year.

Epitaxy gained 5 points.

While our implant, thermal and CMP businesses all delivered strong gains.

We also built positive momentum in areas that are large growth opportunities for us.

We won 6 points of share in overall edge, driven by gains in conductor etch.

We continue to build momentum and expect to gain additional conductor etch share in 2014.

Equally, our process diagnostics and control group is demonstrating its growth potential.

We gained 5 points of share in wafer inspection and 3 points in lithometrology in 2013.

And this past quarter the group delivered its second highest revenue on record.

We continue to see strong customer pull for our inspection technology, particularly in defect review.

We are extending our leadership in this market with the strong adoption of our new G6 e-beam review tool.

This market is also one of the fastest growing segments, with customers using the G6 more extensively to solve defect problems as they ramp new foundry and memory device technologies.

Across the organization we are focused on creating a strong pipeline of new highly differentiated products to enable future inflections in logic, memory and display.

While we are making the required investments to grow, we are also driving superior financial performance.

And, as Bob will explain in a few minutes, we are making good progress towards our 2013 Analyst Day models.

We have reduced the impact of our solar business on our overall performance, and expect our EES group will achieve breakeven or better performance for the year.

We continue to strengthen the organization in many critical areas, attracting top talent in engineering and the field.

We're increasing our focus on high value services for our large install base of tools.

Our customers are planning to ramp challenging new devices in existing fabs.

We see an opportunity to work with them to accelerate yield, improve performance, and drive lower cost for these new device technologies.

And we are driving improvement in performance, time, cost, and quality across the Company so that we can execute better, and be ready to effectively scale, after we combine with Tokyo Electron.

In summary, as we approach the mid point of the year, 2014 is playing out largely as expected, with global trends in mobility, connectivity and display, providing a strong foundation for customer investments in capacity and technology.

We remain focused on applying our unique capabilities in precision materials engineering to enable major technology inflections for our customers.

We are driving profitable growth, gaining market share, and making progress towards our long-term financial model.

Our preparations to combine with Tokyo Electron are accelerating.

And we are incredibly excited by the opportunities this merger will bring for our customers, shareholders, and employees.

Now, I will hand the call over to Bob who will provide additional details about our performance and outlook.

Thanks, Gary.

We've been highly focused on investing to drive profitable growth over the short, medium, and long term.

We have also very tightly managed our spending to increase our product development and field technical support, while simultaneously driving for higher levels of profitability.

As Gary discussed, we gained market share in 2013.

This progress was made with limited leverage from the new and disruptive products that have been funded and are making their way through the development pipeline to our customers.

In fiscal 2014, we are on track for profitable growth.

Compared to the same period in 2013, second quarter orders were up 16%, with SSG backlog at the highest level in the past six years.

Revenue was up 19%.

On a non-GAAP basis, gross margin was at the highest level in six years.

Operating profit exceeded 20% for the first time in nearly three years.

And earnings per share increased 75%, significantly outpacing revenue growth.

We continue to focus on margin improvement, even as we invest for growth.

Our non-GAAP gross margin in the second quarter was 44.2%, up 1.7 points sequentially, including 0.5 point of one-time benefits.

And we now expect to increase it by approximately 1.5 points in 2014 versus the prior year.

R&D as a percentage of net sales has been running several points higher than in recent years.

This is a head wind to our operating margins, which will become a tail wind, as we introduce new and disruptive products in the future.

Even with this higher level of investment, we are making progress towards our target operating model.

All of our business segments delivered sequential operating margin improvement this quarter and the best performances in some time.

On a non-GAAP basis, SSG operating margins were the highest in seven quarters.

AGSs were the highest in seven years.

Display had its second highest result in 10 quarters.

And EES was profitable for the first time in 2.5 years.

By focusing our margin improvement, even as we invest for growth, we believe we can deliver approximately 5 points of non-GAAP operating profit expansion for the year.

Next I'll provide more color on some of the changes in our Q2 results versus the prior quarter.

Orders of $2.6 billion were up 15% as growth in display and SSG orders were partially offset by a decline in AGS orders, which reflected the seasonal timing of service contract renewals.

Net sales of $2.4 billion were in line with our guidance.

Non-GAAP gross margin of 44.2% grew 1.7 points, including 0.5 points of benefit from the partial recovery of a custom's assessment charge we recorded in Q4 of 2013.

Non-GAAP operating expenses of $559 million were within our guidance, and higher sequentially, due to the absence of Q1 shutdown savings and the addition of merit increases.

We expect quarterly OpEx to be about $555 million, plus or minus $10 million, for the remainder of the year.

Our non-GAAP effective tax rate was 24.7%, which was up from 22.5% in Q1.

Both the quarterly rate and the expected annual rate have been impacted by a change in our forecasted regional revenue mix for the year.

As a result we expect the full year rate to be approximately 24%.

Non-GAAP EPS of $0.28 was in the high end of our guidance.

Cash from operations of $437 million, or 19% of revenue, grew 17%, reflecting higher profitability.

We paid $122 million in dividends and ended the quarter with cash and investments up $313 million to $3.4 billion.

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

SSG orders of $1.7 billion were up 6%, with increases in DRAM and logic more than offsetting declines in foundry and NAND.

SSG net sales of $1.6 billion were up 7%, in line with our expectations as increases in DRAM and foundry offset decreases in NAND and logic.

SSG non-GAAP operating margin increased 3 points to 27.3% on higher volume.

AGS orders of $537 million were down 10% due mainly to the seasonal timing of service contract renewals.

AGS net sales of $534 million were up 5%, in line with our expectations.

AGS non-GAAP operating margin increased over 3 points to 28.1%, driven by higher revenue, favorable mix and the recovery of customs assessment charges.

In display, orders grew substantially to $340 million, reflecting large orders related to new TV facilities in China.

These orders should result in revenue growth later in the year.

Display net sales of $147 million were down 8%, in line with our expectations.

Display non-GAAP operating margin increased by 1 point to approximately 18%, reflecting operational improvements.

EES orders were $88 million and net sales more than doubled to $88 million, in line with expectations.

EES non-GAAP operating income was $7 million.

Now I will provide our third-quarter business outlook.

We expect our overall net sales to be flat to down 5% sequentially.

This range represents expected growth of 13% and 19% year over year.

Within this outlook, we expect SSG net sales to be down 2% to 6%.

This range represents expected growth of 17% to 22% year over year.

AGS net sales should be flat to up 5%.

We expect display net sales to be down approximately 20%.

And EES net sales should be up 5% to 10%.

We expect non-GAAP earnings per share to be in the range of $0.25 to $0.29.

In summary, we are investing for profitable growth and on track for year-over-year increases in revenue and profitability.

We are very excited about our planned merger with Tokyo Electron, which will provide us with more strong products and technologies to enable our customers road maps, a larger install base of systems to service, substantial economies of scale, and a unique opportunity to return more value to our shareholders.

Applied and Tokyo Electron hope to see many of you in San Francisco on July 7. After the Applied Materials Analyst Briefing, we plan to hold a joint briefing to provide you with an update on our progress.

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

Thanks, Bob.

To help us reach as many of you as we can, please ask just one question and no more than one brief follow-up.

Jennifer, let's please begin.

(Operator Instructions)

Jim Covello with Goldman Sachs.

There's been a lot of controversy in the market relative to how the year was going to play out, especially relative to people's expectations.

There's a couple of the bigger suppliers in the industry that have talked about weaker trends.

And then Lam and yourself have talked about things staying pretty much as they were.

Do you guys have any views as to what the differing views would be or why there's differing views from the major suppliers?

Thanks.

I'll take it shot at it, Jim.

I'll give you some data points, number one.

We did have strong orders in the quarter for both SSG and display.

And we ended the quarter with our highest backlog in years.

So that feels pretty good about a little bit of wind at our back.

Positionally we're doing very well as a Company on these transitions, whether they be VNAND or finFET.

There's been speculation on a couple concerns, I think.

One is some of the VNAND things may have pushed out.

I think there's a general consensus a little less spending in the short term on that, although we said it's a very powerful longer-term trend.

But, on the other hand, we do see a serious commitment by our customers to getting their own finFETs.

So, there might be a little bit of optimism coming on that in the intermediate term.

And then I think specific to Applied, as I mentioned we have a strong backlog.

We have a very strong display wind at our back, also, for both TVs and the smaller displays.

And our solar business is doing okay for us.

So, overall, I'd say there's a little bit of pushes and shoves, maybe a little bit of softness people have talked about.

But overall we feel pretty good about our position.

Yes, I would say also, if we look across the market with what we're hearing from customers, the foundry spending is expanding to additional customers above what they were in 2013.

So, based on what we're seeing from customers, and even some increase in demand short-term from some customers, we see that business being pretty good for 2014.

NAND demand is pretty strong.

And, again, we see that up.

DRAM, we also believe is up.

Logic we think may be flat or down.

But if you look at all of the different customers in the segment and you add it all up, based on what we're seeing, we're still in the range of 10% to 20%.

Maybe it's more towards the bottom end of that range but still in that range.

That's helpful, thanks.

And if I could just ask one quick follow-up.

You guys had commented last quarter that you saw pretty healthy margin trends over the course of the year.

Obviously there's pushes and pulls based on what segments are spending and customers and timing, and things of that nature.

But how do you feel about the margin trajectory over the course of the year at this point?

I think we're making progress, Jim.

You have to segment it.

Obviously you segmented by our segments, that's obvious.

And if you look at it, solar is doing a lot better.

I think the costs have come down.

We're into the black there.

Display is doing really well as a business.

If you also look at AGS, the margins were up.

Then you look within semi, and we're making sustainable progress on some of the underlying things, which are the costs are somewhat down, the positioning is good, the new products are starting to appear.

And then you have some mix issues that helped us a little bit on the quarter.

And we had a little bit less etch, and we had that one-time Korean thing.

But I'd say underlying progress is pretty good.

We think we'll be pretty good next quarter and up on the year.

That's great.

Thanks so much.

Good luck.

CJ Muse with ISI Group.

Good afternoon.

Thank you for taking my question.

I know you guys don't guide to orders, but curious if you could talk about your visibility there, expectations for volatility there, and then how you see spending linearity for WFE first half versus second half of the year?

We don't honestly, CJ, we don't give explicit guidance on orders.

We feel that the business environment is okay.

I think it's not as big a concern as people say.

We see pretty good strength in the second half.

We see the finFET stuff okay, as Gary said.

The foundry spending is more spread out.

I think to get greater visibility into the mix you've got to look below the top three guys, you've got to look at all those other spenders, the next four or five.

And that strength year on year is more powerful than sometimes people focus on with the top three.

So, I think the second half is okay.

Traditionally the last few years the fourth calendar quarter tends to be a little bit bigger than the third calendar quarter, but it's a little too early to say.

That's helpful.

And then as my follow-up, as you build on the market share gains in silicon in 2013, how do you see yourselves in 2014 relative to the market?

Can you give some color on what kind of outperformance you think you can do in silicon?

Yes, sure.

We've had a really good start to 2014 in a number of different businesses.

This last quarter was very good.

And we look over the next two quarters -- it's hard to see beyond the next six months -- the next two quarters also look pretty good for us.

A major driver for the next few years is the transition customers are making in foundry and memory to dramatically different device architectures with finFET and 3D NAND.

These transitions are very good for us, really enabled by materials innovation.

And we're optimistic that these transitions will grow our business and share as they happen.

And beyond those leadership businesses, we're also seeing momentum in etch and PDC.

So, you combine all those factors together, we believe we're in a good position to grow our market share in 2014 and beyond.

TImothy Arcuri with Cowen and Company.

Can you give us the SSG order breakdown by customer bucket?

Tim, sorry, your phone was on mute for just a moment.

Do you mind repeating the question so we can make sure we have it?

Sure, Mike.

Can you provide the order breakdown by customer type for SSG?

Yes, let me look it up.

I think what we said on the call was from quarter to quarter, foundry was -- I'm flipping pages here -- if you look at quarter to quarter, as we said on the call, we had pretty strong orders overall but we found foundry Q1 -- that's the wrong year.

If you want to hear about 2013, I'll tell you right now.

Why don't we come back.

Tim, do you have any other questions?

When we get the data we can come back.

Okay, sure Gary.

Bob, then, the question, I'm trying to stick to the guidance.

It looks like you're guiding OpEx about flat.

So, to get to the middle of the EPS range it implies gross margin has to be up 100 basis points sequentially on down revenue.

Is that the right math?

For Q2 to Q3?

Yes.

We had pretty strong gross margins in Q2 and we think in Q3 we're pretty strong too.

I don't want to be specific but I think it's in the ballpark, slightly up a little bit.

I don't know if it's 100 basis points.

The other thing you've got going, Tim, we said the tax rate in the quarter next quarter is probably a little lower because we guided for the year at 24.1%, and this quarter was 24.7%.

So, if you figure some benefit probably on gross margin, some benefit on tax, the math starts to work.

Okay.

And if you guys get those SSG order breakout, that would be great.

Thanks.

I'll give some color.

So, Q1 to Q2, as we said on the call, foundry was pretty strong in Q2 but not as strong as in Q1 bookings -- our fiscal quarters, right?

We had -- DRAM was up a fair amount.

Flash was down slightly.

And logic and other was up.

Romit Shah with Nomura.

I wanted to ask about just the deal with Tokyo Electron.

It seems like the market's maybe a little bit more skeptical about the deal closing versus how you guys are thinking about it, and particularly around just the regulatory approval process in some of these major countries.

Gary, could you just share with us your thoughts on getting regulatory approval and then what milestones we should be focused on beyond?

I know you mentioned the filing as well as the shareholder approval meeting later in June.

What else should we be focused on?

Thank you.

Again, as we have more to announce we will.

But relative to the process, we really continue to expect the merger to close within the second half of 2014.

The process is proceeding pretty much as we expected and we look forward to closing within the original timeline.

The other thing I would say is that the level of engagement and working relationships within the integration teams are really tremendous.

And as I also mentioned earlier, that we really have increasing confidence that we can rapidly bring together the critical areas and enable the new Company to achieve its strategic and financial goals.

So, again, from a timing standpoint pretty much similar to what we had originally communicated and no real change in expectations there.

And as you've spoken to some of your top customers about this deal, what's been the reception?

We aren't going to comment on all of those discussions.

What we've said before is those discussions went pretty much as we expected.

I've engaged with pretty much all of our top customers in the last month and there really have been no surprises in any of those discussions.

Thank you.

Krish Sankar with Bank of America Merrill Lynch.

I think in your prepared comments you mentioned that your gross margin year over year should be up about 1.4 points and op margin around 5 points.

If that is the case, is it fair to assume that op margin level Q3 and Q4 would be flattish?

And would it imply sales will be flat compared to Q4, or am I reading too much into it?

Yes, this is the trap I get into when I give full year numbers.

I don't want to give Q4 guidance, Krish, but we want to give you some color.

So, I think our gross margins, op margins in Q3 are in pretty good shape.

I wouldn't see why they would go down in Q4 but I don't want to give specifics yet.

Got it.

Fair enough.

And then a question for Gary.

Good job on the share gains last year.

I'm curious, you guys definitely had some pretty good share gain momentum in etch and process control last year and overall net share gain last year.

I'm curious, after the deal was announced, has that share gain momentum continued the first five months of this year or over the last six months?

Or do you think that share gain momentum has slowed down?

Let me talk about etch first.

We're really happy about the progress we're making in conductor etch.

We focused on investing in areas where we had the best opportunities to grow.

And as we discussed, this is paying off, as we discussed earlier, with the 6 points of share gain last year.

We've added great talent into the team.

The level of excitement is tremendously high.

In the second quarter we had the highest conductor etch revenue in the last seven years.

And based on the interactions with customers, we believe that we'll have further conductor etch share wins this year and continue to grow share in 2014 and beyond.

So very good momentum in conductor etch.

Inspection, last quarter we also had the second highest revenue quarter for PDC.

And we anticipate 2014 could be a record year for this business.

So, very strong pull from customers in all segments, including inspection and defect review.

I think one thing that people really maybe are not fully aware of is that we have leadership in e-beam review.

We introduced the G6 e-beam review tool this year.

Very strong pull from customers, extending our leadership.

And this is also one of the segments that is the fastest growing, as customers are focusing on how to solve defect problems as they make these major transitions in foundry and memory.

So very strong growth in the total available market in e-beam review.

And very strong share position.

So, really, in both of those businesses in 2014, the perspective is very positive.

Got it.

Thank you very much, Gary.

Weston Twigg with Pacific Securities.

First, just on the foundry piece, I was wondering if you could give us an idea of roughly how much of the foundry spend this year you think will be on 28-nanometer and above, and how much might be on, say, 20-, 16- and 14-nanometer?

I think we think the fin stuff is around 25%.

Is the 20-nanometer grouped in there, or is that above that?

That 25% is going to be 28-nanometers still.

I would say 25% or so around finFET technology this year.

And, really, the bulk of the rest is 20-nanometer in 2014.

Got it.

Okay, that's helpful.

And then I was just wondering, on the cobalt cap announcement, it's really interesting.

Can you give us an idea of what you think the incremental revenue opportunity might be, and then what the rate of adoption is by customers, maybe just roughly by node, which nodes it might be introduced into?

Sure, absolutely.

Interconnect scaling is really a major challenge for customers.

They need to fill smaller and higher aspect ratio structures with good device performance and high yield.

And this is getting really hard for future devices.

So, to address these issues, we developed the integrated cobalt liner and also a selectively deposited capping layer to enable customers to continue to use copper for future nodes.

The cobalt liner is integrated on the same platform with our PVD chambers, which is a really great opportunity to expand our market in interconnect.

And the capping layer is really a unique selective film similar to epi where we have huge growing business in enabling new capabilities for customers.

If you look at the size of the markets, you have these two steps that will go across five different layers, so it's about 10 steps.

And it's about a couple million dollars for every 1K wafer starts, roughly, in terms of the size of the business.

And this year in CVD, we anticipate this is going to be a strong year.

We anticipate gaining several points of share.

And part of that is this new cobalt CVD film.

So we anticipate very strong adoption in logic and foundry for really all of the customers.

And that will add a fair amount of business in 2014.

Very helpful, thank you.

Patrick Ho with Stifel Nicolaus.

Maybe first going to the DRAM market and seeing the pick up in CapEx spending.

As you look over the next couple of quarters and even into 2015, with some projected projects that are out there, can you discuss the type of capital intensity you may be seeing in future DRAM spending as it relates to your process segment versus some of the market share gains you may be able to expect a gain in that customer segment?

DRAM we think is up this year, Patrick.

As we said, Q2 was up on Q1 for us in bookings.

Q3 and Q4 we feel are better than Q1 but maybe not quite as good as Q2 for us.

If you look at what's going on there, on the periphery stuff we're benefiting, particularly in medium-current and high-current implant as it gets more logic like.

There's also the gap-fill stuff going on that's helping us.

We're going to be introducing cobalt with our PVD tools.

Dialectric mesh looks good.

And etch we're making pretty good progress, too.

So there's a bunch of transitions going on for us on the periphery, which is, gain, more logic like.

And also some of this capacitor stuff looks good too.

Great, that's helpful.

And maybe my follow-up question on the NAND side of things, without getting customer-specific how do you see the challenges for most of the other players in terms of deciding to go to planar or NAND versus their time of adoption or their rate of adoption of next-generation 3D NAND?

What we see, Patrick, is really all of the customers are focused on the transition from planar to 3D NAND because of the bit scaling opportunity they have.

Now, there are challenges in that transition.

And we actually have a very strong position in etch.

That is really our strongest market segment, the planar and 3D NAND.

And we have new applications that we're growing in that segment.

We also have some unique technology that is focused on addressing the major challenges, yield challenges that customers have as they're making this transition from planar to 3D NAND, some new deposition technology.

So, we really look at that as being a really great opportunity, as we've talked about before.

The switch from planar to 3D NAND is really focused on thermal deposition in etch products.

And we have made a lot of investments in those areas.

We see this as a great opportunity for us to grow share as these transitions happen.

What we've said is that our available market growth is 25% or 30% in the first generation.

And then as you continue to scale the number of layers, as they drive bit scaling, that growth is even stronger for us.

So, we believe we're in a very good position as that transition happens.

Now, it is a tough transition.

But every single one of our customers are very focused really on technology buys to drive the development of that technology.

Certainly we see 2015 the spending ramping a fair amount above what we see in 2014.

So, most of the customers are really planning to ramp in 2015 and 2016.

And this, as we said, is a very good opportunity for us.

Great, thank you.

John Pitzer with Credit Suisse.

Gary, my first question, as it's becoming clearer that Moore's Law capital intensity is going up, you're starting to see your customers and your customers' customers evolve their strategy.

Last week SanDisk talked about a 3D CapEx spend that seems to be targeting flat dollars off their 2014 spend level intentionally, talking about a longer period to ramp 3D.

You've got Samsung this week talking about fully depleted SLI.

I'm just curious, as the economics start to become challenging, and customers do things to extend nodes or slow progress, how does that impact your view that you had at your Analyst Day in 2013 about a WFE number that could approach $37 billion?

Patrick, as we talked about at the Analyst Day, we really size our business at $30 billion.

So, we are improving our profitability and our profile.

We are really driving improvements in our business model at $30 billion.

So, relative to the increasing CapEx spending, if you look at the planar to 3D NAND, more spending is in the areas that are where we participate, and really where we have enabling technologies.

So you look at deposition etch and thermal processes, that CapEx is going up.

And litho as a percentage is going down.

So, that is a really very good opportunity for us.

The other thing I would say, just as I travel around and I visited pretty much all of the major customers in the last month or two, the drive -- this is a real war for mobility leadership that's happening.

So, if you look at the memory area, the transition from planar to 3D NAND, it is a big bet that these different customers are focused on.

And, so, they are all trying to get there first with the best technology.

And the foundry competition is even more fierce because people are focused on driving low power, higher performance, more features.

And, so, you look at this battle that's going on, we absolutely see stronger pull from those customers And, as you said, the CapEx does go up as they are moving to those new devices.

Fortunately for us they are very heavily leveraged with our materials, precision materials, engineering technologies, so the transitions are good for us.

But it is a big battle and a big bet for all of these different customers as they go through this transition.

Anyway, John, those are my thoughts.

I don't know, Bob, do you have any?

I think that's accurate.

We do see increase in capital intensity.

We do see them playing well in the areas where we compete.

We do see that our customers are competing, and things line finFET VNAND are very powerful devices down the road.

VNAND where they go to second generation probably becomes more cost effective than first generation.

FinFET will have to play out a little bit.

One of the more intriguing things that's starting to pop-up on the finFET stuff, too, is the interconnect, which we talked about a little on the call.

So, how it all plays out commercially in a couple years I'm not sure.

The other thing I think I said during an earlier call, John, we're managing the Company to achieve significant levels of profitability at $30 billion wafer fab equipment, so that we're a very attractive Company in terms of growing market share and profitability at $30 billion to $37 billion.

Helpful, guys.

And then, Gary, for my follow-up, you guys have historically been well levered to the largest foundry in the world over in Taiwan.

I'm just curious, how I should think about your relative share at some of the other foundries, like Samsung Global Foundrie?

As you talked about in your prepared comments, the foundry customer base broadens out in the back half of the year.

How different is your share position with the number two and number three guys versus the number one guy?

John, really the foundry segment is our strongest segment across the board.

So, the more foundry is growing, that's really great for us.

And we have a great opportunity.

As customers are introducing these new technologies, you have more epi steps, you have a number of other areas that we talked about -- the cobalt CVD.

A lot of these technologies we're seeing a broad adoption across all of these different customers.

So, as this broadens out that is very good for us as that mix shifts towards stronger foundry spending.

Perfect, thanks, guys.

Steven Chin with UBS.

Thank you.

Maybe if I could just follow-up on that last question of the sustainability of foundry orders coming from multiple customers.

In your quarter we saw two of your foundry customers announce a major strategic collaboration.

I was just wondering, historically have you seen these customer collaborations typically help improve order visibility in the near term, but maybe this becomes a head wind for orders later on if you build less fabs and do more sharing?

Yes, we've had some of this in the past, Steven.

You worry about all these things because it's a reasonably big deal.

But in the end it hasn't had huge impact.

There's a few things going on that touch on what Gary just said.

We do very well at places like foundry because we're an enabling technology.

If you look at PVD, it's a metal gauge.

Look at epi.

Our products really help them solve, again, as Gary says, high-value problems.

So, the benefit and value of our products is really high in foundries, and particularly at inflections around metal gates, finFETs, and also inflections in VNAND, frankly.

The inflection we're pursuing in DRAM is a little bit more on the periphery.

So, then if you go to customers consolidating, we have strong share at all of the foundries.

And our enabling technology we have very high market share in those because we are enabling.

So I think it will work out.

Okay.

And then maybe for my follow-up question, just on the general silicon order trends, do you get the sense that your silicon customer overlap is now close enough with Tokyo Electron that you're seeing the same big picture industry trends for silicon orders?

The reason I ask this, Tokyo Electron talked about a short order pause in the June quarter with the recovery, and maybe July.

Just wondering if you think you're close enough to them that you see the same big picture trends.

Thanks.

We really don't -- we're not sharing any of that kind of information at this point, so I don't think we would have a perspective on that.

Mahesh Sanganeria with RBC Capital Markets.

On your backlog, it looks like you're getting better visibility in terms of orders on silicon SSG.

Your orders were up 6% and you're guiding revenue down 4%.

Is it specific to a customer or some segment that you're getting better visibility on the orders?

I think we just have some good timing on backlog.

We have pretty good positions in share.

Typically, there are typical customers who give you more backlog and lead time, it tends to be logic and a little bit more foundry, a little less so memory.

But I wouldn't read too much into that.

Okay.

And another question on DRAM.

We have seen a pretty interesting trend in DRAM.

Have seen lithography and process control guys have not seen the strength you and Tokyo Electron and Lam has seen.

Is there anything going on technologically in terms of the transition to 25- and 20-nanometer that is driving more of deposition in etch versus litho in process control?

Those are the areas that we see that are the strongest.

As Bob mentioned, the periphery is really changing to be more logic like.

It's lagging, certainly, the foundry and logic people by a couple nodes but we're seeing really strong pull for implant.

I was just in Asia with one of our customers, and really very strong pull as they're moving to next-generation DRAM devices.

We talked about cobalt, some other films for the capacitors, etch, different etch steps.

So, I would agree that those areas we're seeing pretty strong pull.

Okay, thank you very much.

Chad Dillard with Deutsche Bank.

Thanks for taking my question.

Can you compare your market share in 3D NAND today to where you are in planar NAND?

And if you can't give numbers just some general sense.

And then also, of that $7 billion in NAND spending for this year, how much does that break out to 3D?

My memory is we're gaining share in both plainer and 3D NAND.

And I think our percentage of wafer fab equipment is slightly higher in 3D NAND because it's more deposition than etch.

So, our share of wafer fab equipment is up in both.

Our share is up in both but relative share is up more in 3D for two reasons -- we're winning positions and it's more deposition and etch intensive.

In terms of the spending mix between the two, there's about 30%.

30% this year.

But, as we've talked about before, there's maybe 25%, 30% growth just in first generation.

Some people will also quote what the growth is from planar to 3D NAND.

But you really have to look at the number of layers in the stack.

For us, it's 25%, 30% as you go to first-generation 3D NAND devices.

And we did see an increase in market share in the first customers that were moving from planar to 3D NAND.

We didn't give an exact number in how much that share was going up, but there was a fair increase as we went through that transition.

And then I just wanted to probe further into AGS margins, which were pretty strong this past quarter.

Can you talk a little bit more about what's driving that margin out-performance?

Is it mix, is there something else going on?

And is this how to think about the segment as a new normal?

The margins for AGS were strong.

They were the beneficiary of that 0.5 point of gross margin improvement for the overall Company.

That was a recovery of a Korean customs audit that we did well on that we reserved in Q4 2013.

So there's a little bit of a one-time item in there.

Generally, our AGS margins are doing better.

I don't know if the current quarter is exactly going to stay the same for the foreseeable future, probably because of that Korean customs audit.

One thing I'd say -- a couple things -- on AGS, if you think of what is happening with our customers in foundry and memory and in logic, they are making major transitions in device technology.

So, as they're moving to finFET, they're moving from planar to 3D NAND, as they're shrinking these devices, defects become a bigger issue, uniformity becomes a bigger issue, edge dye yield, tool stability.

So, for our customers to extend our large install base of tools as they're making these transitions, they are really pulling on us more and more, and that really gives us an opportunity in AGS.

The other thing is we really are making major changes in our organization to drive lower cost, and also improve our ability in the parts business to grow that parts business, lower cost for customers, and also providing parts that do give lower defects, better uniformity, these types of capabilities.

So, we're making -- really it's a big drive for us and we see this as an opportunity for us to grow that business.

Great, that's all for me.

Thanks guys.

Edwin Mok with Needham & Company.

Just wondering, your book-to-bill or booking versus revenue for SSG, it's been 1 point for three quarters.

But you guys guided down for that.

I was just wondering, is it just based on timing of shipment?

And then maybe some color on the linearity of shipment in the June quarter.

The book-to-bill has been north of 1, as you said, Edwin.

We're guiding down on revs because even though we don't think there's any big time pause, typically the last few years the Q3 in terms of order trend isn't quite as high as other quarters.

So I don't think it's a big time pause.

I think we're being helped by second-tier buying.

But it's probably off a little bit on orders.

Actually, that's very helpful.

And then just talk a little bit about the action inspection share gain.

Obviously very impressive.

Just curious, is there any way you can quantify where is it coming from, any particular area like foundry, memory, or logic that you are seeing stronger pull on your customer side for those products?

And as you integrate with TEL, do you see those two areas being further rooms for gain share and areas with the most opportunities, or do you see other areas that you might have a lot of opportunity to gain share?

I think the big picture for us is that these major technology transitions that are happening within in-foundry, logic, memory, huge changes in the transistor from planar to 3D NAND, that's the big picture.

And we talked about significant growth in PVD and epi and a number of different areas.

And we really see that continuing.

There really are more steps that are being added as the customers are trying to drive device scaling.

And it is very hard for them to make these transitions.

And, really, more and more focus on materials innovation.

So, I would say that is the major theme for us.

And that provides a very good environment over the next few years as the customers ramp those new devices.

Now, within etch, we were fortunate last year that we had the 6 points of share gain in overall etch, and really based on our gains in conductor etch.

And as I said earlier, we had last quarter the highest conductor etch revenue in seven years.

And we really have very strong pull from customers.

Certainly in NAND flash, we see that market being very strong.

We also anticipate that we'll grow our business in foundry this year.

And then the other area that is an inflection is around selective material removal where we have very strong products.

And we see that technology continuing adoption as the customers are implementing these new device structures.

So we really see a really great opportunity in etch for us to continue to grow in conductor etch.

One of the things I talked about also is that we're not trying to boil the ocean.

We focused on the areas where we thought that we had the best opportunities.

And certainly we saw that conductor etch was a great opportunity.

We had very strong pull from customers in conductor etch.

And we've increased our investment, shifted money into that segment.

And that's where we see continued growth in 2014 and beyond.

Thanks.

That's all I have, thank you.

Mark Heller with CLSA.

Good afternoon.

Thanks for taking my question.

I have a question on the foundry orders, the mix within that, and also when you noted broader foundry spending in the second half.

Is this mostly on finFET spending or is it 20-nanometer or 28-nanometer?

What you're seeing in the second half, you're starting to get a little bit bigger pull recently for finFET stuff.

So, we said on the year it was about 25% finFET stuff across foundries and about 75% planar.

The planar stuff was more weighted to the beginning of the year and the finFET stuff is more weighted to the end of the year.

Recently -- it's been in the public domain a lot, the last month or so -- people have become a little bit more worried about VNAND timing this year versus next year.

I think there's a little bit more pull recently for finFET.

But are you seeing any increase in more lagging-edge demand, like 28-nanometer?

A little bit.

And another question, any thoughts on the recent Samsung ST announcement with Silicon-on-Insulator?

What is your view on that technology and the potential implications for equipment spending?

We've know about Silicon-on-Insulator technology for awhile now.

It's been around for awhile.

It's hard for us to see a big inflection here but we haven't spent a lot of time on it either.

Thank you.

Ben Pang with Northland Capital.

Thank you for taking my question.

On the outlook for spending, I think you mentioned in answer to a previous question that you were looking at the low end now rather than the high end of the range.

What's the change -- what segment has changed the most year to date?

I don't think we changed a lot.

We didn't change our range.

We're probably a little bit lower in the range.

I think it's just stuff people have talked a little bit.

The total NAND is a little bit off, probably.

Not big time.

We're still around the $7 billion number.

But a little bit and I think it's mostly timing between years also.

Okay.

So, it's primarily NAND spending is where you see, just to be clear, that's where you guys also -- this is not based on -- I guess this is based on your own view from your customers, correct?

Yes, absolutely.

And, again, I think that, as Bob talked about, timing really can make a difference, as you get to an end of the calendar year and someone pushes out any of these technologies by one quarter.

But we basically are in constant communication with our customers.

And the forecast that we have right now is pretty much aligned with what we hear from them.

And then on the flip side, what gets you to 20%?

If you pull in and get more aggressive on finFET or pick up NAND back to where they were.

Okay.

And then one quick follow-up.

On the capital intensity, you commented on lithography having lower capital intensity.

Is that because the number of critical layers is slowing down as you go to finFET?

No, we talked about really on 3D NAND versus planar.

And the feature sizes are increasing, as that's the reason why they're going -- again, they're going to the 3D scaling versus 2D scaling.

So, it's not shrinking the dimensions as the transition from planar to 3D NAND.

So, again, what we see from our large customers, etch, deposition, thermal processes are going up.

And litho, because you're scaling vertically, not horizontally, the feature sizes are not as demanding, and that is reducing the percentage of litho CapEx in 3D NAND.

It was more of a NAND discussion, Ben.

So, you might look at it for the total WFE space, you guys' NAND, 3D NAND outlook is like 5% of total?

Like $2 billion or 7% or something of the total.

So the overall WFE weighting, do you really expect a big change in your developable market because litho goes down for this year?

Ben, you're saying you think NAND spending is only 5% of where fab equipment is this year?

Ben, again, what we're seeing --.

You guys have 7% and then 30% of that, right?

Yes, so what we're saying is basically when that transition happens, we're not talking specifically about the mix.

We did give those numbers on 2014, but as the 3D NAND ramps our total available market goes up.

Then it's just a function of how much of that spending is happening in 2014 versus 2015 and 2016.

But definitely as that device ramps, that's good for us.

Tom Diffely with DA Davidson & Company.

In your outlook for the next year, how many new greenfield fabs do you see versus just upgrades to existing facilities?

I don't know off hand.

Typically, again, when you say -- what ends up happening is the customers now will divide these investments into multiple phases.

Yes, they are counting differently.

Let me give you some color.

They're going to these mega fabs for a bunch of reasons.

If you look at the [Geon] fab, the total Geon fab is, I think, 220,000 wafer starts, but it could be multiple phases.

The total fab 14 buildout eventually is over 200,000 wafer starts, I think.

So, these mega fabs make it a little bit harder to count a greenfield fab because they do them in phases now.

If you look at wafer starts we probably have that data.

That's a fair amount.

Do you have the wafer starts?

So, if you look at -- we think 3D is up to about 80,000 by the end of the year.

That's including about 30,000 from last year in 3D NAND.

So, wafer starts are up a fair amount.

Do you have foundry there?

Foundry is up quite a bit too.

But it's more about wafer starts than greenfield fabs, I think.

Okay, thank you.

Mehdi Hosseini with SIG.

Yes, thanks for taking my question.

Most of the good questions have already been asked.

I just have a couple of follow-ups.

The first one has to do, to break then of the backlog, Bob, I'm looking at your display backlog is up 65% Q over Q, and up almost 30% year over year.

And then on SSG, backlog is down 7% year over year.

How should we think about the margin profile, especially as some of these display equipments are shipped in the latter part of the year?

And I'm asking this because I'm under the assumption that display margins are much lower than SSG.

So, if nothing happens, or nothing dramatic happens to the SSG backlog, how does the larger mix of display going to impact your overall margin.

And then I have a follow-up.

There's a couple things.

Display backlog is up significantly.

But year on year I think the SSG backlog is also up.

So, we're in pretty good shape on both.

In terms of the mix, gross margins are higher, as you know, in SSG versus display.

But display operating margins have been trending up reasonably well, so the gap isn't as big as it used to be.

Third, the lead times for display equipment are much longer.

So, I don't think we're going to have a big bump in our operating margins in any given quarter because of unusual display disparities, either in operating margins or in huge volume of business.

I think it will be manageable.

Got it.

And then one follow-up to your commentary about managing the business for WFE of $30 billion.

Should I assume that your SSG operating margin would go back towards low 30%?

I'm looking at July of 2012.

For the same revenue as you did in April of this year, operating margin was about 400 basis points higher.

So should we think about cost cutting to the point that you would be able to squeeze that much margin expansion?

If you go look at the model we showed you last Analyst Day, July 7 or 8 last year, we trended up to 25% operating margins at a $37 billion number.

And now some people, including John earlier on the call, was worried that it wouldn't be a $37 billion environment.

Our model we showed also on that day was in a $30 billion environment we were going to do about 22.5%.

And, so, to make that model work between the $30 billion and a $37 billion, you'd need to have an improvement in SSG operating margins.

And as we said today earlier, across the whole Company, if you look at our spending in an $8 billion revenue environment, which is 2004-2008, and 2012-2013, we're spending about 4 points higher as a Company on R&D as a percentage of sales.

And most of that is in SSG.

So we expect not only that our spending as a percentage of sales will be more favorable but we'll start to get growth in, sales especially in SSG, as these new products hit the market.

So, the short answer to your question is yes.

Mehdi, the other thing I would say is that we've talked before about shifting over $200 million, maybe as much as $300 million of OpEx spending.

EES is now getting back into the black.

We shifted a lot of money out of that.

We've shifted a lot of money out of headquarters' functions into semiconductor R&D.

So the operating margins, as you pointed out correctly, are lower.

But we really believe that those investments that we're making in SSG are important for our customers as they move to these new device technologies, finFET, first generation, future generation, the interconnect technologies, new memory technologies.

We really think those investments are important for our customers, for the industry.

And we believe we'll get a good return on those investments.

So, there's not going to be any reduction in that R&D spending in the near term.

I think the operating -- to resonate what both of you said -- I believe we can get to the type of numbers you're seeing in a moderate spending environment.

And I believe the way we'll do it will largely be we'll start to kick in some revenue growth that we're investing in for now.

Mehdi, thanks for your question.

And we would like to thank everyone for joining us this afternoon.

A replay of this call will be available on our website by 5 PM Pacific Time today.

And we would really hope to see many of you in San Francisco for the SEMICON West briefing on July 7, the afternoon of July 7. So, thank you for your continued interest in Applied Materials.

Thank you, ladies and gentlemen.

This does conclude today's conference call.

You may now disconnect.