應用材料 (AMAT) 2016 Q3 法說會逐字稿

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  • Operator

  • 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.

  • - VP of IR

  • Thank you, in a moment we'll discuss the results for our third quarter, which ended on July 31. Joining me are Gary Dickerson, our President and CEO, and Bob Halliday, our Chief Financial Officer.

  • Before we begin, let me remind you that today's call contains forward-looking statements, including Applied's current view of its industries, performance, products, share positions, profitability, and business outlook. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements, and are not guarantees of future performance. Information concerning these risks and uncertainties is contained in Applied's most recent Form 10-Q and 8-K filings with the SEC. All forward-looking statements are based on management's estimates, projections, and assumptions, as of August 18, 2016, and Applied assumes no obligation to update them.

  • Today's call also includes non-GAAP adjusted financial measures. The reconciliations to GAAP measures are contained in today's earnings press release, and in our reconciliation slides, which are available on the investors page of our website at www.AppliedMaterials.com.

  • Next, I would like to remind everyone that Applied Materials plans to hold its 2016 analysts meeting in New York City on Wednesday, September 21. Those of you joining us in New York will have the option to attend technology sessions with our general managers. The main event will be webcast live. And now, I would like to turn the call over to Gary Dickerson.

  • - President & CEO

  • Thanks, Mike, and good afternoon, everyone. I'm very pleased to report that Applied Materials delivered record earnings in Q3. And with our orders also at an all-time high, I'm confident that we can beat this earnings record again in our fourth quarter. I want to thank our employees for all their hard work that has contributed to these outstanding results, and their passion to keep raising the bar.

  • I'll start today by outlining the key factors supporting these record levels of performance, and describe how our strategy positions Applied for sustainable long-term growth. I will also share our latest view on our markets, and detail why Applied has a positive outlook for 2017 and beyond. I will conclude with brief updates on each of our major businesses. After that, Bob will provide additional details about our results and outlook.

  • In both semiconductor and display, we see dramatic advances in technology taking place. We are in the early stages of large multi-year industry inflections that are driving growth in our business today, and creating new opportunities for the future.

  • First, foundry and logic customers are making significant innovations in transistor and interconnect for 10 and 7 nanometer devices. This plays to the strengths of our leadership businesses, including epi, PVD, implant, CMP and RTP, where we lead the industry with our unique capabilities and high market share. As customers move to 10 nanometer technology, the available market for these leadership businesses grows by around 25%, compared to the previous node.

  • The second key inflection is 3D NAND. This is a materials-enabled technology that significantly expands our addressable market. With innovative new products, we are providing customers with the advanced solutions they need for depositing, removing, and modifying materials with incredible precision. As a result, we are winning significant share gains, as the industry shifts from planar to 3D technology. By the end of this year, we will have grown our share of total NAND spending by almost 7 points above our 2012 baseline.

  • The third big wave of investment is China, which represents an important long-term growth opportunity for the industry. Applied has been working in China for 32 years, and during this time, we have established the strongest position in the region. While the build-out of China's semiconductor industry has only just begun, our semiconductor orders and revenue have already doubled over the past two years, and we're on track for a record 2016.

  • The fourth big driver for Applied is organic LED displays. OLED is also enabled by materials innovation, and that makes our available market opportunity more than 3 times larger than for traditional LCD. OLED is the key for high resolution, low power screens, with faster refresh rates. We expect it to become the standard for virtual reality capable phones and headsets.

  • At Applied, our strategy is to develop highly differentiated materials engineering products and services, that make new technologies possible. As our customers' technical challenges become more complex, it's the breadth and depth of our capabilities that sets us apart. By building on these strengths we are outperforming our markets today and creating a foundation for sustainable growth over the years to come.

  • We are making great progress with all of the key elements of our strategy. First, we have strengthened our organization and processes in the field. In the past three years, we have increased the number of technologists and engineers directly supporting customers by 50%. This allows us to see inflections earlier and define winning products in a more repeatable way.

  • Second, we have increased R&D to accelerate new product development, to provide the materials innovations that our customers need. We have a strong pipeline of differentiated enabling technologies, that are winning in the marketplace, and extending our innovation leadership.

  • Third, we have increased our focus on advanced service products. We are delivering more value to our customers, and as a result, our service business is growing to record levels.

  • Fourth, we are successfully applying materials engineering beyond semiconductor. In display, we're on track to deliver more than $1 billion of revenue in FY16, with significant opportunities for future growth.

  • I'll now provide our market outlook. In our discussions with customers, they describe near- and longer-term drivers for their business, that support sustainable growth in investment. These include increasing silicon content in smartphones to support advanced features. Explosive growth of data for social media, 4K video, and IoT, that is fueling demand for memory. And most exciting of all, emerging categories such as virtual and augmented reality, artificial intelligence, and smart vehicles that create new platforms that demand high-performance computing, advanced memory, and better displays.

  • Within this environment we see customers battling for leadership and making strategic investments to ensure they're in winning positions, as demand shifts to these new device technologies. This is especially true in memory, where we see a broad base of customers accelerating their 3D NAND road maps. As a result, NAND investment is getting stronger, and we now anticipate that spending in 2016 will be 40% higher than last year.

  • We're also seeing foundry investments strengthening, and now expect spending for the year to be 5% to 10% higher than in 2015. While more than half of this spending is focused on leading edge 10 and 7 nanometer technologies, the foundry customer mix is broadening, as investments in trailing geometries increase, particularly in China.

  • In logic, we now believe 2016 spending will be marginally lower than in 2015. And in DRAM, we still see spending coming down at least 25% from the very high level of investment last year. Overall, we now expect 2016 wafer fab equipment investment to be slightly above 2015, and as we look further ahead, our early view is that 2017 could be higher.

  • I will now talk about the progress we're making in each of our major businesses. In semiconductor, we see strong demand across the board. Our quarterly orders and revenue are at a 15-year high, and for FY16, we expect our revenue will be around $770 million higher than 2015. This gives me high confidence that this will be a strong share gain year for us.

  • What I'm most excited about is our pipeline of innovative new products. Two great examples are the products we launched last month.

  • Our Selectra system is the industry's first extreme selectivity etch tool. This disruptive etch technology enables precision materials removal, that does not damage the increasingly delicate structures in advanced logic and memory devices. Selectra has great customer pull, and we see significant growth in applications at future technology nodes. By the end of the year, we expect to have shipped more than 350 chambers to a broad set of customers.

  • I am equally excited about our PROVision system, which is the industry's most advanced e-Beam inspection tool. E-Beam is the fastest growing segment in the inspection market. The market doubled in size from 2011 to 2015, and is set for significant future growth. We see very strong demand for PROVision, and have already shipped more than a dozen systems.

  • In service, our strategy is to deliver more value to customers, with advanced service products that are focused on improving device performance, yield and cost. Our team is doing a great job. In the third quarter, revenues were at an all-time high. When we look at year-on-year comparisons, we have grown our service business for 11 consecutive quarters.

  • In display, our capabilities in large area materials engineering set us apart, and we have tremendous momentum. The major display inflections are made possible by materials innovation, and our available market is expanding significantly. We are in the initial phase of OLED investment, and this opportunity is layered on top of solid demand for our leadership display products for TV and mobile. As a result, for the second quarter in a row, orders in display are at an all time record.

  • Looking further ahead, we're increasingly excited about DR and AR, as it has broad implications not only for display, but also for semiconductor. Leading companies in Silicon Valley and around the world are making big investments in this area, and our technologists are engaged with them as they develop their road maps. We will spend more time covering this topic at our analyst meeting in September.

  • In summary, I strongly believe this is Applied's time. We are performing better than ever, delivering new records, and in a great position to sustainably outperform our markets.

  • There are a combination of factors that are contributing to our success. We identified large multi-year inflections early. We are making great progress with the major elements of our strategy, enabling us to unlock the full potential of Applied. We have made significant investments in our capabilities and products to extend our innovation leadership, and we are executing well across the organization.

  • Now, let me hand the call over to Bob, who will provide more details about our quarterly results and performance. Bob?

  • - CFO

  • Thanks, Gary. In Q3, Applied demonstrated that we are growing faster than our markets, and accelerating our profitability. We delivered the Company's highest earnings per share, surpassing a record set more than 15 years ago.

  • Gary talked about the strategies that are helping us to anticipate major inflections, deliver more valuable products and services, and grow in attractive new markets. I will describe some of the benefits that our strategies and execution are having on our financial performance, and I'll do this by comparing our most recent quarter to Q2 of 2011. I think this is an interesting comparison, because Q2 of 2011 was our best quarter since 2000, and because revenue was nearly the same in both periods.

  • Under our new strategy, we've increased our semiconductor systems revenue by 23% to the highest level in 15 years. We have put our services business on a growth trajectory, and increased our display net sales by over 50%. We have significantly reduced our investment in solar, which is down from 22% of revenue to only 2% today. And we have increased our non-GAAP gross margin by 1.8 points. We've also cut our tax rate and reduced our share count.

  • As a result of these and other improvements, we delivered a 32% increase in non-GAAP earnings per share this quarter, versus Q2 of 2011, and we did this while investing 30% more in R&D. In short, we demonstrated momentum in Q3, delivering higher earnings power at similar revenue, even while investing significantly more in new products for future growth.

  • And today, our momentum is accelerating. In Q3, we generated record orders of $3.7 billion, and we now have record backlog of $4.9 billion. We've grown our semiconductor orders and backlog to the highest level in 15 years, and our display orders in backlog to the highest level ever. We've grown our service orders by 9% year over year, and our backlog by 18% year over year.

  • We're also making excellent progress towards our 2018 financial model. We're approaching our targets for revenue across semiconductor, services, and display. Today, we feel even more confident that we can hit or exceed our goal for WFE market share.

  • We're making additional progress in gross margin, coming in at the high end of Q3 expectations. We're improving our efficiency, even as we significantly increase R&D funding for new projects. In fact, we reduced our OpEx to sales ratio to the lowest level in five years.

  • We increased our non-GAAP operating margin by 3.6 points this quarter to 22.8%, which is the highest in five years. We made further progress with our tax structure. If our geographic sales patterns continue, we now believe that we can sustain a non-GAAP tax rate of 12.5%.

  • We achieved our share count objective ahead of schedule, and we remained opportunistic with the buy-back program, repurchasing 9 million shares in the quarter at an average price of $21.88. I hope you'll join us for the analysts meeting where I will give you more progress into our progress and momentum.

  • Next, I'll explain our segment reporting changes. Effective in Q3, we expanded our display segment to include roll to roll web coating systems, which were previously in EES. The segment is now called display and adjacent markets. We have also moved display equipment upgrades from AGS to display. These changes will enable us to realize technology, market, and management synergies.

  • Applied's remaining solar business is now included in corporate and other, and we no longer report EES as a segment. The semiconductor systems segment is unchanged, and 200 millimeter equipment continues to be included in AGS. Our earnings release includes the information you'll need for your models.

  • Here are some of our segment highlights for Q3. We grew semiconductor systems revenue to the highest level in 15 years. We increased the non-GAAP operating margin by more than 5 points sequentially to 31.1%, which is the highest level in four years.

  • In Applied Global Services, we set a new revenue record of $657 million. In Display, we recorded record orders of $803 million, with more than half coming from projects in China. Compared to last quarter, we increased display revenue by 67%, and display operating margin by 3.5 points to 20.1%.

  • Moving to the balance sheet, we generated $981 million of cash from operations. Profitability and cash flow management were stronger in the quarter, and our year-to-date operating cash flow was $1.7 billion, or 22% of sales. In the quarter, operating cash flow was 35% of sales.

  • Now, I'll provide our fourth-quarter guidance. We expect our overall net sales to be up by 15% to 19% sequentially. Within this revenue outlook, we expect semiconductor systems to be up by 19% to 23% sequentially, AGI should be up by 3% to 6%, and Display should be up by 30% to 40%.

  • On a year-over-year basis, each of our businesses is on track for strong quarterly revenue growth. Using the midpoints of our Q4 guidance, we forecast that semiconductor systems revenue will be up by 45% year over year, with AGS up 12%, Display up 80%, and the total Company up 39%.

  • We expect Q4 non-GAAP gross margin to be approximately flat sequentially. Non-GAAP operating expenses should be $600 million, plus or minus $10 million, and lower as a percentage of sales, and we expect non-GAAP EPS to be in the range of $0.61 to $0.69. This earnings guidance represents a new record for the Company, and a doubling of last year's Q4 performance.

  • In closing, I believe our momentum is sustainable. Let me explain why. Our Q4 guidance reflects how uniquely well positioned the Company is in major inflections, including in 10 nanometer and 7 nanometer, 3D NAND, OLED, and the Chinese market. While customers' spending patterns will continue to vary from quarter to quarter, we are growing faster than our markets, and accelerating our profitability. And we're just beginning to see the positive effects of a stronger product pipeline and better execution across the Company.

  • Based on customer pull for our products and services, I believe we'll have strong orders in Q4 of 2016, and Q1 of 2017. And while it is too early to know our earnings in Q1 of 2017, I believe we can double our Q1 non-GAAP EPS year-over-year. Now, let me turn the call over to Mike for questions.

  • - VP of IR

  • (Caller Instructions)

  • Operator

  • (Operator Instructions)

  • Tim Arcuri, Cowen and Company.

  • - Analyst

  • So obviously, great, great quarter and obviously, big opportunity in display. I guess, I want to ask a question on SSG. So if I take the orders you booked last quarter and I take this quarter's orders, it's about $4.2 billion, and if I use your SSG share model of roughly 22%. That implies that the overall WFE market is run rating in the first half of roughly $40 [billion].

  • So that begs the conclusion, either this year is pretty front half loaded or you guys are gaining a lot more share, and that you're going to end the year quite a bit higher than 22%, and it has to be several hundred basis points higher than 22%. So I guess, I'm wondering if you can comment on whether the numbers imply that the year is a little front half loaded, or whether it just implies that you're gaining that much share? Thanks.

  • - CFO

  • Sure, Tim, let me see if I can help. In terms of the loading of the year, historically what you see is that the foundry is particularly good in calendar end of Q1, Q2, in terms of shipments. I'm doing shipments and bookings is close for them.

  • This year, though, it was later in the year, as you remember. So we have been strong in foundry as they're ramping things like 10 and early 7, and then memory was stronger in the beginning of this year. If you look at Applied specifically, we benefited earlier in the year, because we've gained share in memory, we've gained share in DRAM, we've gained share in NAND, and that kept us strong.

  • For instance, historically, the last couple of years, we were about 38%, 40%, for full-year numbers for foundry, but we were only about 37% in Q2. We're up over 50% now in foundry in Q4 and Q1. Okay?

  • So what you're seeing is we're [benefiting] from secular improvement in Applied, but also some seasonal strengthening in foundry. So both things are working for us. So we will gain share this year, pretty significant. We don't want to say the specific number.

  • In terms of WFE, the $40 billion run rate, I don't think WFE is that high. I think we're having some strength now. Last quarter we said it was [$31.6 billion-plus], and this quarter it's probably up closer to [$32.6 billion] is my guess.

  • But what you're seeing is secular gains for Applied across particularly memory, strong positions in foundry, and also the China thing is helping us, a lot of things are working for us. That secular stuff is working for us, and also the seasonality in foundry is helping in the next couple of quarters.

  • - President & CEO

  • What I would add also is that in 10 and 7 nanometer foundry, our TAM is growing significantly, if you look at those two nodes together, about 30%, and we have the initial adoption of many new platforms. We're actually winning more market share also in 10 and 7 nanometer, and we're still in the early innings of some of these new platforms that are being adopted. The Selectra product, Olympia, PROVision, LK Prime, Precision CVD, very, very strong adoption of those new platforms.

  • And then in memory, as Bob talked about, we're gaining share in memory and especially in 3D NAND. 3D NAND is materials-enabled, not litho-enabled. So our TAM is expanding significantly, and there also we have many new innovative products, including the Sym3 which is the fastest-ramping product in the history of the Company. So overall, this is going to be great share gain year for Applied Materials, and we're incredibly well-positioned going forward.

  • - VP of IR

  • Thanks, Tim.

  • Operator

  • Romit Shah, Nomura.

  • - Analyst

  • Thank you, and congratulations on the excellent results. Bob, you mentioned that you expected orders to remain strong in Q4 and Q1. Does that mean that we shouldn't expect orders to decline from these levels? I was hoping you could talk specifically around your expectations for display orders, seeing them at $800 million here?

  • - CFO

  • Sure, we, I think at the end of last call, when we had orders in Q2 of $3.451 billion, that I said our orders would sustain and that we would continue to have strong orders. In fact, we beat this quarter with $3.658 billion, $3.6 billion, $3.7 billion, I think Q4 and Q1 are both pretty strong. I'm not sure they're quite as strong as we were the last two quarters, but they're bigger than probably any quarter we had last year, yes, it's going to be pretty big, still. So, it is probably going to have a $3 billion handle on it, frankly.

  • - Analyst

  • Can you talk just about -- ?

  • Operator

  • Farhan Ahmad, Credit Suisse.

  • - Analyst

  • I just have a quick one. In terms of your 2017 outlook, Gary, you mentioned that the [WFE] is expected to be up year-on-year. Can you just provide us some color in terms of the overall spending by the transition to [3D NAND], in terms of like memory versus foundry, and NAND, if you see those, how you see that expanding (inaudible), and also for display?

  • - CFO

  • This is Bob. I could kick it off, and then Gary can jump in, too. In terms of this year, what you see is trends that are helping us a lot frankly.

  • You see strong spending in NAND. Whereas last year NAND was about -- and I'll go into 2017 for you, too -- in 2015 rather, NAND was about [6.8] This year it's up 40% to 45%, about [9.7]

  • And that is 90% for V-NAND. What we see next year is that NAND is going to be up a little more actually, and it's going to be like 98% V-NAND. And our position is very strong. In fact, some of the share gains we're seeing this year, you didn't quite see them last year, because last year was about 50% 2D, and our gains are really strong on the transition to 3D, so that will continue for us next year.

  • So NAND up some next year. Almost all V-NAND, and our position very strong. In terms of foundry, we think foundry could be flat to up 5% next year. We think it's going to be very good for us on the leading edge, and we also think it's going to be good for us on the trailing edge in China, and things like that.

  • DRAM, we think it could be up a little bit. This year was down 25% to 30%, maybe 25%, we said in the call. Next year, maybe up a little bit.

  • But it's the smallest of our numbers, pretty much now, except for logic is a little less. So it's about 5.9[%] this year, up a little bit next year. And then logic is probably up a little bit next year, also. So overall we see an opportunity to go up some next year, but it particularly plays for us around NAND and foundry.

  • The second thing that you asked about was display. Display CapEx, you guys don't follow as closely. 2015 display CapEx, and there's not as good of estimates, but we think it was a little bit over $8 billion maybe. This year it could be around $14.5 billion. We think next year continues at similar numbers, maybe a little bit more.

  • Operator

  • Steven Chin, UBS.

  • - Analyst

  • Gary, Bob, also congrats on the results. My question is on the memory orders. The memory orders declined pretty meaningfully in the July quarter. I was just wondering if you think that was just timing related, or do you think it's a function of the more rational spend by customers? Could we see a snap back in memory orders in the October quarter? Thanks.

  • - CFO

  • Yes, so I think that stuff is lumpy. We still see very strong demand from customers, particularly around V-NAND stuff. So we had a huge number in Q2 for V-NAND, because people frankly want to get in our production queue. In Q3, we have reasonable NAND orders, but not as big as they were in Q2. So I would say the demand is still strong. We're getting a lot of pull in NAND, still. I wouldn't read too much into the orders' lumpiness.

  • - President & CEO

  • Yes, I think the demand for 3D NAND is certainly extremely strong. Customers can sell everything that they can build. And if you look at where we're at in terms of that transition to 3D NAND, we're still not that far along in the overall transition, and so every customer is moving as fast as they can from planar to 3D, and so our thinking for 3D NAND going forward is still very strong, certainly in 2017, still very strong.

  • - VP of IR

  • Thanks, Steven.

  • Operator

  • Atif Malik, Citigroup.

  • - Analyst

  • Congratulations on a great quarter. Bob, on the gross margins I understand a great job from Q2 of 2011, but if I compare it to your 2018 financial model, [slap] gross margins versus 44.6% at $33.5 billion WFE, a little bit below that mark. What will get us, what will get the gross margins higher from these levels? I understand the display mix hurts the gross margins, but the foundry mix helps them.

  • - CFO

  • Sure, I think we're actually making progress. I thought earlier in the year we would stay flat to last year, and we're up a little bit. Last year was 42.9%, we're about 43.2%, and this was a particularly strong year for display and also etch did very well, too.

  • Now let me just say, display and etch are adding a lot to the operating profits of the Company. Their models are a little bit different. For instance, display has a little lower gross margins, very comparable as they mature, operating margin profile. And then etch has significantly grown their operating profit for the Company the last several years, and their operating margins have gone up a fair amount.

  • In terms of the specific question of 44.6%, we said we would do 44.6% in 2018. If you took, I think I said last quarter, if you took the mix we had, and if you took the gross margins we had by individual product, and compared it to 2014 mix, we were like 44.7%. This quarter we did the same analysis, we're like 44.9%. So we're beating it if the mix didn't change.

  • So what we face is mix. We can offset a bunch of the mix. I don't know if we can offset all of it. So I think we'll make progress to the 44.6% the next two years. 44.6% was a 2018 number.

  • Will we get there, I'm not quite sure, because of the mix, but I feel very good about the top line, the gross profit dollars, the operating profit, and the EPS of the Company. The main issue is just the mix on the gross margin because things like cost reduction are doing well. Our negotiations are going well. It's just the mix is the issue. And the operating margin doesn't get impacted as much as the gross margin with those businesses.

  • - VP of IR

  • Thanks, Atif.

  • Operator

  • Krish Sankar, Bank of America.

  • - Analyst

  • I just wanted to follow up on the gross margin question. With the second half with more foundry logic investments coming up for 10 nanometer, I was under the assumption that should be extremely positive for your gross margin profile. So I'm just curious if that is going to be more back half loaded and into 2017, should we at least expect gross margins to improve into the fiscal Q1 given that it is flat in fiscal Q4? Thank you.

  • - CFO

  • They might. Depends on the mix. Remember that in Q3 and Q4, we've been growing a lot, very strong, in terms of revenues, for both display and our etch business, and memory, for instance. So if in Q1 -- we probably are going to be strong, pretty much across the board.

  • So foundry, I think, has a potential to be strong, but I also think we'll be strong in display and probably in revenues and memory, because some of the revenues we ship into NAND in Japan are delayed about a quarter after the shipment. So my guess is a little bit of upside opportunity in Q1, but I don't want to be too specific now.

  • Operator

  • Harlan Sur, JPMorgan.

  • - Analyst

  • Congratulations on the solid quarterly results and execution. I know the focus by the market on display has been on OLED. But it seems like even in the core the large screen LCD segment, there's a lot of forward opportunity, there's still a lot of focus on 4K UHD. I think one of your peers recently in their call talked about three customers that have plans for Gen 10.5 LCD plant investments in the not too distant future. So I'm just wondering if you're starting to see that in your pipeline, and is it something that you would expect orders for this year, or is this more something 2018 or 2019 time frame?

  • - CFO

  • Yes, I'll start and Gary can jump in. Actually the core display orders for LCDs and related TVs have held up probably a little better than we thought, and it looks like there might be an opportunity there. Now what's the big inflection is the OLED stuff. But I do agree with you that the LCD and TV stuff has held up a little better than we expected.

  • - President & CEO

  • I guess, I can also add that in display is a great opportunity for Applied Materials. We're still in the early innings in this smartphone transition to OLED. And the display is a key differentiator for mobile devices. So in the near-term, near-term being over the next couple years, this is going to be a great driver for us.

  • If we think longer term, we also see large technology companies making huge investments in new areas like VR, AR and automotive, where display can be significant. We're also developing new innovative products that will significantly expand our served market, over the next several years. So normalized spending in display can be higher than in the past, and also our TAM is expanding on top of that.

  • And the last thing on this one I'd like to say is that really the display is an example of where we can take materials engineering into a new market, an adjacent market, and Applied is really unique in our ability to enable this big inflection, and drive growth. So really overall, great, great opportunity for the Company.

  • Operator

  • Patrick Ho, Stifel.

  • - Analyst

  • Thank you very much, and also congratulations. Gary, as you look at the 3D NAND market share gains you have made to date, which process segments do you believe you have made the most gains? And as the industry goes to, say, 64 layers and higher, where do you see incremental gains for the Company on a going-forward basis?

  • - President & CEO

  • So I think the most important thing for people to think about on 3D NAND is that this is a materials-enabled inflection, not litho-enabled. It is the biggest change in memory technology in decades. So when you think materials-enabled, it really, the products that we have targeted for 3D NAND, the Sym3 etch tool, is the fastest ramp we've ever had for any system in Applied Materials, and we're still in the early innings.

  • One of the things that I believe is that we can grow as fast as we can qualify. We have so much pull from customers on Sym3. There is still an opportunity for growth there.

  • Our CVD business is growing significantly. This year, we expect strong revenue growth in CVD, gaining several points of overall share, very, very strong position in 3D NAND. So that's another area where, when you look at the 64 layers, or you're going forward, there is a tremendous opportunity.

  • The number of CMP steps also double in, maybe two or even in some cases 3 times number of CMP steps. So that's another area where we have really, really a great position. And this is the first time, also, for us to introduce epi into a memory device. So there are a number of different areas where we have innovative new platforms, innovative new products, and really tremendous pull from customers, that give us a great opportunity as 3D NAND goes forward.

  • Operator

  • Weston Twigg, Pacific Crest.

  • - Analyst

  • Thanks for taking my question. I just wanted to touch on the logic spending being down this year. Wondering why you think it is down, if that is related to slowing node transitions, and to maybe gauge your conviction in it being up next year, like you commented? And if the softness is related to slowing node transitions, I'm just wondering if you could comment on any risk that that spills over into the foundry segment?

  • - CFO

  • Yes, we have, the numbers we have -- now remember we have in logic, we have a major US company and also some Japanese companies, and things like that. So our numbers show it is down 5% to 10% this year, and up 5% -- flat to 5% next year. Let me pull up the details.

  • - President & CEO

  • Let me take the second part of that, while Bob is pulling up the information on logic. Relative to foundry, what we see is that all of our customers, all of our customers, are targeting 7 nanometer as a big node, very big node. There is a lot of customers, of their customers, that are taping out, and so that is a big opportunity, and every single one of our customers are in a race to be in the right position, as that node ramps.

  • So the pull we're getting from customers on 10/7 is extremely strong. And as Bob said earlier, we see strong business in the trailing nodes, also in foundry, and we see that, China being a big part of that. But we see that also continuing, going forward in the future. So at least from what we're seeing today, our customers in terms of advanced foundry, and also relative to the trailing nodes in foundry, it looks like, and what customers are saying, is that the business will be good for the next few years.

  • Operator

  • Joe Moore, Morgan Stanley.

  • - Analyst

  • Great, thank you. Bob, I thought your comments about making good progress towards the 2018 model, where you stated your silicon systems business is approaching the size that you talked about for 2018 on the type of WFE number, the midpoint that you talked about.

  • So is that, are you doing better earlier, because you're taking more market share, is the TAM expanding faster? If you could just talk about that? And if, obviously, we'll wait till next month to get the full forecast, but any thoughts on, will that continue to move higher from here on both share and TAM? Thanks.

  • - CFO

  • Yes, on the semi stuff two things have really compounded for us. So in fairness to us we kind of predicted, that is why we are positioned. But, one, the market changes have come up, frankly, as we expected in terms of the transition from 2D to 3D, and also, the products they need and the transition on foundry has been going that way. And also China has helped somewhat, and we've always been strong in China. We kept our strength there.

  • So those market inflections in semi, and also we'll talk about display market inflections, we had a pretty good feel for those coming, but we didn't have exactly the right products there. So we strengthened our product positions in places like etch, CVD, ALD, inspection, we're going to be talking about more, because we think you need more and more of that, particularly eBeam as you get through foundry and logic in places like that. So it's a compounding of the market, turned out pretty close to what we expected, and we had the right products there.

  • The reason you're seeing acceleration this year frankly, is the market inflections are happening this year. For instance, this year, you're seeing a big spend increase in NAND, and it's 90% V-NAND, that's where the share opportunities are. And we're seeing a fair amount of spending at 10 and 7, where we're strong. And you see OLED spending in display, and we've introduced new products in each one of those markets to capitalize on it. So we are probably ahead of plan, frankly.

  • Operator

  • Edwin Mok, Needham & Company.

  • - Analyst

  • So I just have a question about sustainability, of how sustainable this ramp of multiple areas, and I guess specifically related to customer concentration. So it seems like leading edge foundry, 10 and 7 nanometer foundry and also OLED are big drivers now, or definitely a big driver for you this last quarter, and you said those are sustainable. So I was wondering, are you seeing like broadening or increased number of customer, both from leading edge 10/7 foundry, as well as (inaudible) increased number of display customers placing orders for OLED, or is it still concentrated at one or two customer, just that those customers are aggressively ramping? That's all I have. Thanks.

  • - CFO

  • I'll start and Gary can jump in again. So there's several inflections we've noted. One is NAND, one is OLED, one is China, and the other one, which is going on right now is foundry, leading edge in particular. So let me speak to those.

  • NAND is -- there is about 1.4 million wafer starts in the world. By the end of this year, it's going to be around 400,000 transition to V-NAND. We think the vast majority of those get transitioned for many reasons. We think the spending on NAND probably is up next year, and our position is strong, and we think that transition remains strong for a number of years, and plays very well for us. We think in OLED, they're in pretty early innings on the transition to OLED on the phones. In fact, the orders we're showing that we've been booking, and we have some more to come, those things will ship through 2017 into early 2018.

  • So we're going to see revenues from that for a while. And that's just what we have been booking, okay? And we believe there is more down the road, okay? So this OLED transition is going to go on for a while, and we have enriched the opportunity for us by developing new products there, just as we have in semi.

  • In terms of China as an inflection, I mean, just listen to the Chinese government, they're in this for the long term, and their interest in investing in the semiconductor is probably only going to increase, okay? And our position is strong.

  • Finally the foundry one you asked about, Edwin, which we're particularly focused on, right now the leading edge is strong, and it's strong into early next year. And that one does have some seasonality, but if you look at the longer term trends there and just listen to the voice of our biggest customer, about 50% of their growth is going to be come from more features in phones, and about 50% is everything else that you see in Silicon Valley, whether it's autonomous cars, virtual reality, machine learning, AI, all these things, driving about 50%. And it isn't just one big thing, it's a whole slew of things.

  • I think we're going to do a Investor Day, a very interesting discussion about virtual reality, and not just what it drives in display, but what it drives in memory, and what it drives in advanced processors. So in foundry, on the leading edge, it isn't just phones. 50% of leading-edge customers is content in phones going up, but 50% is all this other stuff, which you can see, okay?

  • Now, in terms of the other thing that's going on in foundry is the trailing edge is very strong, and that is the China phenomenon, but it's also the content in phone, when you are talking about all the cameras and sensors and things like that. So I think foundry is in pretty good shape next year and I think it has got probably more sustainability overall than people said a few years ago. In terms of other companies at the leading edge, I think others will want to compete, because it's a big market, and they want to be at the leading edge, and the timing and magnitude of the spending on that we haven't disclosed.

  • Operator

  • Sidney Ho, Deutsche Bank.

  • - Analyst

  • Congratulations on very strong orders. You have two consecutive quarters in China, over $800 million of orders. I understand that some of that comes from display.

  • I think, Bob, you mentioned display was half of the orders this quarter from China. So if you back that out, do you feel that the $400 million to $500 million per quarter of order run rate is the base case now, and it starts moving up from here, or do you think there is still some lumpiness in orders in China? Have you seen much order activity from local foundries or are they mostly still coming from multi-nationals at this point?

  • - CFO

  • Sure, well, again, we have a strong semi business in China, and a strong display business. So I'll do display first. We see the trends where the Chinese are heavily invested in the display business, and want to have share there, probably continuing for a number of years. They are not heavily into OLED, yet, but their interest in display is very strong.

  • In terms of semi, the government has obviously said their interest is very strong and sustainable. So I think that you may have lumpiness, but I think you've raised the baseline, particularly in semi, and the display baseline has already been going up for a while now. So I think that you're going to see pretty sustainably strong orders in China.

  • - President & CEO

  • Yes, let me add on this one, we're in a very strong position with both multi-national and domestic companies. Relative to share, China is one of the strongest regions for Applied Materials.

  • Relative to the investment, you hear the word strategic, when you think about China. There's a focus on growing the percentage of domestic content, and building a secure supply chain. And as Bob said, there has been announcements around huge investments over the next decade in China.

  • So, again, we're in a very strong position. We think this is a multi-year wave. Certainly, we see strong growth in 2016, but we think it's a great growth opportunity also, going forward.

  • Operator

  • Craig Ellis, B. Riley.

  • - Analyst

  • Yes, congratulations on the results and outlook, and thanks for sneaking me in. I wanted to switch from a more model intensive question, maybe to a more qualitative question. Bob, it was helpful to get a lot of longer term context on the financial performance of the business. And the question, as we look at the ability of the Company to redirect to some new opportunities like OLEDs, relative to the longer-term history of the Company, where do you think the product development engine is, and how much further upside do you have, as we look ahead for SAM expansive type of products, that would be on the road map? Thank you.

  • - CFO

  • That's a really good question. Let me just spend a couple of minutes on it, if you don't mind. If you go look at it, our guide for Q3 was frankly significantly north of the street. I think we guided to $0.48, and the Street at three months ago was at $0.36.

  • Now we're guiding to $0.65, roughly, and the Street was at $0.48. And now, we're saying we're going to -- we have $3.5 billion, almost $3.5 billion of orders last quarter, almost $3.7 billion this quarter. Next two quarters, we're hoping to have around $3 billion each. So there is something's changed here.

  • So the question you're really asking is, what has changed disruptively, either in the market or at Applied Materials? I think there is really three answers.

  • One, I think the market has changed, and it really has, in terms of what type of equipment people need to make leading edge devices and leading edge displays. For instance, in 2012, 53.5% of the CapEx WFE spending by semi customers was in places where we competed. Now, this year, we think it's 63.5%. And in those markets, where we compete in semi, we're gaining in share, where we had weaker share.

  • So in the market changes, to make leading edge devices, they need to buy different sets of leading edge equipment, and frankly, they need it from very strong, big capable suppliers, because the problems are just getting harder. They're putting things into production earlier than ever before and ramping faster.

  • In display, you see the same thing. Making an OLED display is harder than making an LCD display. So having the right products, we're introducing new products.

  • So in the marketplace, there is big inflections, V-NAND devices, totally different architecture. So big inflections, number one, in the market. But number two, the products are very well-positioned now for us. So I can see this going on for a while.

  • Now the third thing is, well, how are you doing it at Applied? I honestly believe that we will outgrow by several points the markets in which we are competing. You might be saying, well, how can you possibly know that? For several reasons.

  • One, we've redefined the financial model here, right? The spending we put into products is significantly more than we used to, relative to our total spending. So we invest more than we used to in products, versus just maintain the lights in the building, and operating the place. So the investment relatively speaking, is heavier in product development, and that batting average on new products is going up.

  • We have put 50% more technical guys in the field, I think, we've invested in R&D. And the products we're coming out with are not just iterative products, they're disruptive innovative products. And if you go look at leading edge logic and foundry customers, the number of [D2R] positions we have, the number of new platforms we have. We've changed the model, the investment model and the batting average on the new products.

  • And the other reason I'm pretty confident, I can see the products coming down the pipe. So I think that Applied is going to outgrow the markets that we compete in for the next several years. Now, 5, 10 years from now I can't see. But in the next number of years, I feel good about where we're investing, how we're executing, and the market opportunities.

  • - President & CEO

  • Let me add to this one. The fundamental driver for our businesses today, from a market standpoint, is materials innovation. So if you look at 3D NAND, it is materials-enabled scaling. If you look at how people are trying to solve edge placement errors in litho, there is a lot of materials innovation that can dramatically reduce edge placement errors, and that's a big deal for our customers going forward in multi-patterning.

  • So that is the core competency of Applied Materials. We're broader, deeper, have more competencies, more technology, more talent than anyone in the world. And relative to semi, you see today, we're in the early adoption of some great innovative products, not incremental products, innovative products, and the pipeline we have there is also tremendous. We have great products in the pipeline.

  • If you look at display, Applied is unique in our ability to take these technologies into large areas, and into new markets, and we've also innovated with new TAM growth. Thin film encapsulation is an example, where we have hundreds of millions of dollars in business enabling the transition to organic LED and mobile. And we have other capabilities that are also in the pipeline, that are as significant relative to growth drivers for us longer term, outside the semiconductor industry.

  • So this is personally what I love about Applied. This is where I love to spend my time. The Company has so much talent, so much capability, I really believe that we're still in the early innings, relative to innovation in semi, in materials-enabled scaling, with disruptive new platforms, and also outside the semiconductor business, into adjacent markets.

  • - VP of IR

  • Thanks, Craig.

  • Operator

  • Amit Daryanani, RBC Capital Markets.

  • - Analyst

  • Congrats on a great quarter, guys. I guess, my question is around the gross margin trajectory, as you guys see it from here for the next few quarters. It seems like a lot of the growth drivers you've talked about on display are in CVD and etch. It seems like they might be somewhat headwinds to your gross margin expansion. So could you maybe just talk about what are the offsets or the levers you might have to negate the mix headwinds, and enable margin expansion as you go forward from here, over the next few quarters?

  • - CFO

  • Sure, there's several things. One is the cost reduction, which is the best we've done in years. The second one is, we just hammer away at every single product to get better, and offset the mix that might be a little harder.

  • And then the third one is continuing to introduce disruptive products. For instance, we think we're going to grow our inspection business in terms of market share this year and probably next year, and we have new products coming out, and those products tend to be strong gross margins. So we do have -- we have mix that's pushing back at us a little bit, but we have other things that could counter that.

  • Operator

  • Mehdi Hosseini, SIG.

  • - Analyst

  • I have a very short question for Gary. You talked about this display CapEx, flattish next year. In that context, I see the growth for AMAT coming from share gain, especially encapsulation. When do you think we're going to learn more about this? Is this something that you're going to discuss at Analyst Day? Or are we going to learn more as those share gains materialize?

  • - President & CEO

  • Thanks for the question, Mehdi. Yes, we will definitely talk more about display at the Analyst meeting, and really also focus on some of these longer term opportunities, where some very large technology companies are making huge investments, and where we have great opportunities in display going forward. So we definitely will cover that in more detail at the Analyst Day.

  • - VP of IR

  • Thanks, Mehdi.

  • Operator

  • Jagadish Iyer, Summit Redstone.

  • - Analyst

  • Thanks for taking my questions. So if I look -- if I look at your display revenues growing about well over 50% year-over-year in calendar 2016 versus calendar 2015, what percentage has come from OLED, and how should we think about it as we look at calendar 2017?

  • - CFO

  • Sure, the revenue growth has been obviously very strong, and with the bookings we have, we believe we have momentum into 2017 on the revenue line. If you look at the bookings this year in display, they have been probably about two-thirds or more, around OLED, and about one-third, roughly, around LCD stuff. So then if you look at the revenue split, it's probably about 30%, 40% LCD, and about 60% OLED this year. So last year was probably closer to two-thirds LCD, I think, and one-third, or not too big OLED.

  • And here it is. Yes, it's probably 70% last year was LCD. So it's flipped. It was 70/30 one way last year, and this year, it is probably 60/40 roughly, 65.

  • Operator

  • Jerome Ramel, Exane BNP.

  • - Analyst

  • What kind of capacity are you modeling for 10 nanometer node and 7 nanometer node in foundry going forward? Total installed capacity with [start amounts]?

  • - CFO

  • Yes, so capital intensity at 10 nanometer is up over 25% from 16/14. And at 7, we think it's up again, but we haven't said a specific number yet.

  • - President & CEO

  • Yes, Bob is referring to our TAM opportunity, and I think the combination 10/7, something like 30%. Somewhere in that range.

  • - CFO

  • I think it's actually more than 30%.

  • - President & CEO

  • Yes.

  • Operator

  • Toshiya Hari, Goldman Sachs.

  • - Analyst

  • This is Charles on for Toshiya, and congrats on a great quarter. Given that you guys seem to be firing on all cylinders, what are maybe couple of idiosyncratic risks that we should be monitoring?

  • - CFO

  • Well, that's a good question. Let's think.

  • - President & CEO

  • I think the, I think for us, we have tremendous opportunities. The key for us, I really do believe we can grow as fast as we can qualify. We have great platforms. We're totally targeted on major inflections, very, very innovative products, where we have tremendous customer pull.

  • So I think the tension for us really is to make sure that we can qualify with customers, work with customers, because there's just incredible pull for us, in a number of different areas. So I would say that we, for sure, are going to grow share. The rate of that growth is really up to us, relative -- from an execution perspective.

  • - CFO

  • Yes, maybe I'll pile on a little bit. You always have, it's not idiosyncratic, the macro risk, which I think is moderate, but that's a risk. I think the other one, to add to what Gary said, there has really been a change in my opinion at Applied, that we didn't have as much growth stuff being considered a few years ago. So we have really built a funnel of great ideas with customers. Customers are pulling for us big time now.

  • So our issue is, how do we optimize all of the opportunities? So it's like, how good can we be? And that's a tension we have every single day, which projects do we follow up?

  • Which ones we push faster. Which ones -- So it becomes, how many different things we realize, how fast. So it's optimizing the portfolio, really.

  • - VP of IR

  • Thanks, Charles. And Sean, we've got time for maybe two more questions, please?

  • Operator

  • Tim Arcuri, Cowen and Company.

  • - Analyst

  • Gary, I'm just, looking at these numbers, and I'm sitting here listening to you, talk about all the market share gains. I guess, I just wanted to give you a chance to talk about how this has happened? Because was some of this in the pipeline before the Tokyo Electron merger, or did the merger fall apart, and you just completely decided to totally reposition the Company? I guess, just give us a sense of sort of the genesis of this success to maybe help people deconstruct how this might look going forward? Thank you.

  • - President & CEO

  • Thanks for the question. So we focus on big inflections, and I think Bob talked about this earlier. We could see the big inflections a few years in advance.

  • And we made a decision that we would shift hundreds of millions of dollars in spending in the Company. So, we cut G&A a significant amount. We significantly, dramatically reduced our spending in solar.

  • And all of those -- all of that money we shifted, keeping OpEx relatively flat, into areas where we have great opportunities. Applied has great talent, and great competencies, and great technologies, but we needed to make the investments and fuel the growth. So, that happened, frankly maybe three or four years ago, where we started that shifting of resources, and really focussed in the areas where we knew that we had great opportunities. We also have added talent into the Company to help us execute on those opportunities, and that's really the playbook. And we're still driving that playbook today.

  • So I look at the semiconductor business in the pipeline, we have some phenomenally valuable and disruptive products still in the pipeline where we have great opportunities going forward. And also outside semi, we have some great, great opportunities that are sizeable opportunities, where we can still drive growth for the Company. So those are the things we did.

  • It wasn't something that -- frankly, with the Tokyo Electron merger, we kept our eye on the ball. We were laser-focused on these opportunities all through that process, and we were ready basically, when these inflections were ramping, with the right products and the right team to execute. I don't know, Bob, if you want to add anything?

  • - CFO

  • I think that's true. I think you have two-part question there, Tim. One is, how come this stuff is so apparent now? And, two, did Tokyo Electron have any impact, or the end of the merger have an impact?

  • I think the answer to the first question is, if you're going to gain share in an equipment business like ours, whether it's semi or display, the opportunity is on inflections, big changes on how they make chips, or they make displays. And you've got to have the right product at that inflection or change or node or new OLED device. So you can look at stuff, we even did in the public domain.

  • There are a number of people who said that, we should be less aggressive investing in display and solar. Now we decided they were two very different business models, and so we increased our investment in display, because we saw the inflection. But you got to wait the two or three years for the inflection, or the product won't be ready. You can't shoot behind the duck, right? The duck has got to be two years ahead of you, three years ahead of you.

  • And then, second one we saw coming was NAND. And in fact, maybe even at your conference in 2014, I thought V-NAND at the end of the calendar was going to be a little bigger than it ended being, because we saw the inflection. So we were betting on it, even if you go back to your conference in 214, early 2014, we had the product that was doing pretty well.

  • So now what you have is these inflections, products take two or three years to come along. The hard part, frankly, was bridging this period. And now what's going to happen is, the products are in the pipeline, and the inflections are happening, and we have more products in the pipeline for more inflections, if you go look at areas like inspection and things like that.

  • So the momentum is building up. We had to get through two or three. In terms of Tokyo Electron, Gary forced everybody to stay focused on the business.

  • - VP of IR

  • Thanks, Tim.

  • Operator

  • Atif Malik, Citigroup.

  • - Analyst

  • I have a question for Gary. Gary, given your background in process diagnostics and control, what is Applied's strategy moving forward, in terms of integrating the eBeam success you're having, as well as other products with etch and the process reactors. We've seen Hermes and ASML getting together, KLA and Lam are still trying to get together. I wonder if you could talk on, how much closed loop control and integrated metrology can you benefit from in your process and etch reactors?

  • - President & CEO

  • Yes, let me talk a little bit about the inspection business. So this is going to be a very strong year for us, in that business. We could have a record year, our FY16 revenue in this business, and very, very strong pull from customers.

  • As you said, I have a lot of history relative to this business, and what I would say is that eBeam, what I hear from customers is that eBeam is really at an inflection point. If you look at the changes in the devices, the device structures, there is a bigger problem with systematic types of problems, where eBeam is the best solution. So we see tremendous pull from customers, really an inflection, relative to eBeam technology, especially focussed on these systematic defects. So that is what we're seeing from a market perspective.

  • Applied Materials, over half of our revenue is eBeam. We have the strongest technology in the market in eBeam. We are the leader in eBeam review. We're gaining share in CD SAM, and we've just launched this PROVision product and I think there is just tremendous, tremendous opportunity with PROVision.

  • In the first year of launching the product, we're already getting reorders from leading foundry and memory customers, and I believe what we talked about before was achieving 20% share in eBeam inspection in the first year. So we see tremendous growth opportunities in eBeam, in an area where Applied is the strongest, relative to technology. So overall, in PDC, we have great technology, very strong customer pull, and a great opportunity to drive growth.

  • - VP of IR

  • Well, thank you, Atif for your question, and we'd like to thank everyone for joining us this afternoon. We do hope to see you at the Analyst Day in New York on September 21. And in the meantime, thank you for your continued interest in Applied Materials.

  • Operator

  • And this concludes today's conference. You may now disconnect.