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Applied Materials, Inc. (NASDAQ:AMAT)

Q1 2013 Earnings Call

February 13, 2013 4:30 pm ET

Executives

Michael R. Splinter – Chairman and Chief Executive Officer

Gary E. Dickerson – President

George S. Davis – Executive Vice President and Chief Financial Officer

Analysts

Terence Whalen – Citigroup

Krish Sankar – Bank of America Merrill Lynch

Steven Chin – UBS Securities LLC

Mahesh Sanganeria – RBC Capital Markets

Mark Delaney – Goldman Sachs

Edwin Mok – Needham & Company

Farhan Ahmed – Credit Suisse

Mehdi Hosseini – Susquehanna International

Patrick J. Ho – Stifel Nicolaus

Jagadish Iyer – Piper Jaffray

Ben Pang – B. Riley Caris

Vishal Shah – Deutsche Bank

Operator

Welcome to the Applied Materials Earnings Conference Call. During the presentation, all participants will be in listen-only mode. Afterwards, you will be invited to participate in a question-and-answer session. As a reminder, this conference is being recorded today, February 13, 2013.

Today’s call contains forward-looking statements, which refer to the company’s views of its market, industry trends, opportunities, 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 the risk factors is contained in the company’s SEC filings including Form 10-K for the fiscal year ended October 28, 2012.

Today’s call also includes non-GAAP financial measures. Reconciliations to GAAP measures are contained in today’s earnings release and financial slides available on the Investor page of the website at appliedmaterials.com.

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

Michael Sullivan

Thank you, Tiya, and good afternoon. Joining me today are Mike Splinter, our Chairman and CEO; Gary Dickerson, our Company’s President; and George Davis, our Chief Financial Officer.

Today we’ll discuss the results for our first quarter ended January 27. You can find a copy of our earnings release on our website, appliedmaterials.com. We will also find our quarterly financial highlights presentation, which provides additional details.

Before we begin, I’d like to share a calendar announcement. Applied plans to hold its next Investor and Analyst meeting on Monday, July 8 in Santa Clara, California. We hope to see many of you here at our headquarters for the event.

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

Michael R. Splinter

Thanks, Mike, and good afternoon, everyone. Applied’s first quarter of fiscal 2013 largely played out as we had expected. Thanks to solid execution and disciplined management of discretionary spending, we delivered $0.06 of non-GAAP earnings per share, which represented the high-end of our outlook.

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

Implementation of the restructuring plan, we outlined in the fall was progressing well. The actions we are taking include permanent shifts in the costs basis of the company, as well as the substantial reduction in our solar investments. By re-prioritizing our spending, we are able to strengthen customer facing technical resource and accelerate product development programs. This supports our strategic priorities to expand our share in wafer fab equipment and drive profitable long-term growth in display and solar. Now, let me provide an overview of our markets.

Global demand for mobile products remain strong, and we expect year-on-year growth of around 35% for smartphones and 55% for tablets. Growth at this level will support solid investment by the foundries and we believe these customers will represent around 45% of wafer fab equipment spending in 2013.

Mobile devices are also driving demand for NAND flash memory. However, some of the growth in this market is being suppressed by lower end smartphone and tablet models that are specifically tailored for emerging markets and equipped with less onboard memory.

Overall, NAND is growing and we believe that this growth rates will be in the range of 50% for 2013, which is sufficient to support investment in new capacity by the second half of the year. Our development teams are working closely with customers on 3D NAND technology, and when this inflection occurs, it will drive an additional investment cycle by memory manufacturers.

The DC market looks to be relatively flat this year as touch-enabled hybrid models verve the lines between traditional laptops and tablets, there is a potential upside to this scenario. For the time being, we remain cautious about logic investment expecting to see a modest increase in spending relative to 2012, primarily due to the timing of factory build outs.

DRAM prices are starting to rise, however, we still anticipate DRAM investment remaining at low levels. We are spending limited to technology conversions. In recent weeks, there have been some positive announcements from our largest customers. As a result, we now believe the 2013 wafer fab equipment will be flat to down 10% relative to 2012 spending of around $30 billion. In order to reach the high end of the range, we’ll need to see investment from a broader base of logic and foundry customers in the second half of the year as well as an up tick in land investment.

We believe that we can now grow wafer fab equipment in 2013 with share gains driven by strong demand for our transistor products, combined with application wins and inspection and a customer spending mix that’s favorable to applied materials.

In display, there is sense of renewed excitement in the TV market with 60 inch and larger models reaching attractive price points, and the introduction of new 4-K resolution. Following a two-year of capacity digestion, we expect investment in new display factories to resume in the second half of the year. Customers are still cautious and the timing of their factory builds will largely depend on their confidence in the macroenvironment. Orders for equipment to manufacturer touch panels and high performance mobile screens remain healthy and production is moving to larger substrate sizes, particularly Gen 6.

In solar, end markets continue to grow at between 10% and 20% annually and it looks like overall 2012 installations ended the year at around 31 gigawatts. However, conditions within the supply chain remain extremely challenging with consolidation and rationalization of manufacturing capacity, happening more slowly than we had anticipated. Our approach in solar is to be prudent. We are taking additional steps to scale back our investment until there are clear indications that the market conditions are improving.

Before I hand the call over to Gary, I would like to take this opportunity to wish George every success in his new role at Qualcomm and thank him on behalf of every one at Applied for all the contributions he had made to our company during the past 13 years. We are in the process of selecting a successor from a strong pool of internal and external candidates and we expect to appoint a new CFO in the coming weeks.

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

Gary E. Dickerson

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

As Mike outlined, the expected levels of capital investments by our semiconductor and display customers provide a solid foundation for the year ahead. Also, major trends within these markets create great opportunities for Applied to extend our leadership in precision materials engineering and grow faster than the markets themselves.

The most important component of our strategy for profitable growth is to increase our share of wafer fab equipment. In Q1, we built momentum for market share gains by winning several new development tool of record positions at the 20-nanometer node and converted a number of existing positions into volume orders.

Demand for better mobile products is driving innovation and we are seeing major inflections in device technology and the introduction of many new materials as customers strive to differentiate themselves with extended battery life, low power, and higher performance products. These inflections are enabled by precision, materials engineering applications, including precision films, material removal, material modification and interface engineering. This is where Applied has clear technology and market leadership, and will be a major factor in driving our growth in wafer fab equipment shares.

Over the past three months, we’ve been implementing import organizational changes to strengthen our teams and redeploy funding to accelerate our highest impact growth programs. We have restructured at workforce, we have scaled back our investment in solar, and we’ve carried out an extensive review of our R&D portfolio, stopping programs, where we believe we didn’t have valuable, sustainable differentiation, and increasing funding for programs where we do.

As a result, we are shifting approximately $200 million to key strategic priorities that drive profitable growth. Our strategy is to focus on allocating the appropriate level of investments to market segments where we believe we can achieve a leadership position. This means ramping investment in some areas, while reducing or eliminating investments in others.

On an ongoing basis, we will look at every aspect of our business through the length of profitable growth and prioritize every dollar toward our best opportunities. One area where we are investing is in field technical resources to upgrade the interfaces between customers, and our R&D teams. By strengthening our field technical teams, we will build stronger customer relationships and ensure we are the company, our customers seek out first to solve their highest value device performance and yield challenges.

In addition, we have combined the best product development practices across the company and to-date, we have trained 35 development teams in the application. This is improving our ability to define winning products and increasing the velocity of our development process.

Let me now provide an update for each of our businesses. In semiconductor, technology inflections that enable lower leakage transistors, low resistance interconnects, and advanced patterning are expanding our markets in providing a catalyst to grow our share.

Our market leadership in the overall transistor module combined with the most significant transistor device technology changes in the last 10 years, creates a great opportunity for Applied Materials. As foundry customers add capacity for the 28-nanometer node and start to ramp 20-nanometer technology, capital intensity is rising in the areas where Applied has the best technology and is a leader. As a result, we expect the strong 2012 performance that we demonstrated in our front-end products, implant, and PVD businesses to continue in 2013.

In addition, the adoption of new epitaxy steps at advanced family technology nodes will enable us to further grow our [App] business. We achieved important milestones in our first quarter, winning development and production tool of record selections at our top three customers.

The past two years have been a challenging period for our CMP business and we lost market share in 2012 due to an unfavorable customer spending mix, significant improvements to our latest generation tool delivers a clear architectural advantage for advanced nodes and we expect to start recapturing share in 2013.

Inspection represents an attractive growth driver for Applied and I am pleased with the progress our team is making. We had very strong customer pole for our wafer inspection and review products last year and we believe foundry and logic wins for our Brightfield tools will translate into continued momentum in 2013.

In Etch, we are focusing on key technology inflections in market segments where we believe we have opportunities to deliver technology with sustainable differentiation. With recent new application wins in logic, foundry and NAND flash, we are starting to demonstrate positive momentum.

Turning to display, larger TV sizes and 4K Ultra High Definition are important trends that create opportunities for us to increase share. These trends drive larger panels and smaller pixels that increase the value of the device performance and yield advantages of our technology. As 15-inch and larger TVs become a higher percentage of the market, we anticipate more manufacturers will move to Gen 10 substrates. This transition is an important inflection that plays to Applied’s advantage, and will enable us to leverage our leadership and particles and uniformity to gain market share on PVD and extend our leadership in CVD.

As we have previously announced, we have taken actions in EES to reduce our costs and restructure the organization. We continue to monitor industry conditions closely and based on our current market view, we decided to further lower our spending beyond the levels discussed in the last earnings call.

By the end of this fiscal year, our goal is to reduce EES operating expenses to a run rate below $25 million per quarter. We continue to invest what we can provide differentiated technology to enable higher sell efficiencies and lower cost per watt and remain confident that this business can deliver long-term profitable growth for Applied.

In summary, we are optimistic about our opportunities for the year ahead and we are confident that the strategy we are executing will drive profitable growth. We are focused on growing our share of wafer fab equipment and have strong momentum. We are making prudent investments in display and solar and we continue to strengthen the organization in areas that are critical to our success.

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

George S. Davis

Thank you, Gary, and good afternoon to everyone on the call today. To begin, I would like to thank Mike and Gary for their good wishes and partnership. I would also like to thank Applied’s employees, investors, and the analyst community for the opportunity to work with you. For more than a decade, it has been my privilege to work with some of the best and brightest minds in the industry.

and finally, I’m very proud of the finance team at Applied Materials. Now, I will cover our financial results for the first fiscal quarter of fiscal 2013. Orders increased 44% from the prior quarter to $2.1 billion, led by strong demand for semiconductor and display equipment.

Our backlog increased 31% to $2.1 billion and our book-to-bill ratio increased to $1.3 billion. Net sales of $1.6 billion were at the high end of our outlook due to stronger than expected performance in SSG.

Non-GAAP gross margin was 39.8%, up 1.4 point sequentially despite lower revenue driven by a higher mix of SSG revenue and lower inventory reserves. Total non-GAAP operating expenses were $514 million, excluding certain favorable items, our non-GAAP operating expense would have been approximately $535 million in line with our guidance.

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

For the year, we continue to expect non-GAAP operating expenses to be roughly $2.2 billion, essentially unchanged from 2012. This includes the sizable increase in growth funding for SSG enabled by operating cost improvements related to the workforce reductions announced in October, the EES restructuring and the integration of Varian.

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

Non-GAAP earnings per share of $0.06 were at the high end of the target range led by strong SSG performance and lower operating expenses. The cost today of the workforce reduction program announced in October is $110 million. We now expect the total cost to be in the range of $120 million to $160 million below the original estimate of $180 million to $230 million, the primary reasons for the change in estimates are lower relative participation levels in the voluntary retirement program and a reduced estimate of the final cost of benefits. We expect annual savings and headcount reductions to be within the ranges originally provided.

Cash from operations was approximately $16 million, reflecting lower revenue levels, severance payments related to workforce reductions and the timing of annual variable compensation payments. We expect cash from operations to trend back in line with historical performance over the remainder of the year. Cash and investments end of the quarter at $2.8 billion, a sequential decline of $177 million. Our capital allocation priorities continue to be investing an attractive opportunities in our core businesses increasing the dividend in line with the growth of the business and utilizing share repurchases as the preferred means of returning excess cash.

Next, I will comment on our segment results as compared to final quarter. SSG orders were up 84% to $1.4 billion driven by foundry and well above our outlook about more than 25%. 74% of the orders were from three customers, reflecting the concentration of investments in Q1 and our increasing momentum at the largest customers. Net sales increased to 11% to $969 million just above the high end of our outlook with an increase in foundry partially offset by lower NAND revenue. Again, we saw a very high concentration with 75% of revenue from our top three customers.

SSG’s non-GAAP operating margin grew to 18.6%. In AGS, orders were down 6% to $544 million. Net sales were down 24% to $471 million, due to the low-end of our outlook, excluding the thin film solar line recognized in the fourth quarter, net sales would have been down 12%.

The revenue decline reflected tight customer spending controls as wafer starts in overall utilization rates trended lower for the second consecutive quarter. Non-GAAP operating margin declined to 19.3%. In display, orders increased 66% to $138 million, reflecting ongoing mobility investments and the beginning of resurgence and TV equipment orders.

We continue to be optimistic for further TV and mobile equipment order strength in the second half. Net sales in the quarter were $87 million in line with our outlook with the vast majority of revenue from mobile display systems. Non-GAAP operating margin grew to 5.7% demonstrating the Group’s focus on remaining profitable in a low revenue environment.

In EES, orders were $68 million primarily due to strength in our wave equipment business while solar equipment orders remain depressed due to ongoing overcapacity issues for our customers. Net sales were $46 million in line with our outlook. EES had a non-GAAP operating loss of $44 million. We are on track to reduce the quarterly run rate or non-GAAP operating expense to below $30 million by the end of Q2, a 20% reduction from Q1 levels.

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

Michael R. Splinter

Thanks, George. As we look forward to our second quarter, net sales from our semiconductor business should be up 20% to 35%. We expect orders to remain strong approximately at the Q1 levels.

Net sales in AGS are expected to be flat to up 10%, reflecting a gradual recovery in wafer starts and utilization levels as the year progresses. We expect net sales and display to be flat to up 25%. Orders are expected to increase by more than 20% with the start of TV capacity additions and continued strength and mobility.

Net sales in EES are expected to be approximately flat remaining at low levels. Overall, we expect net sales for the company to be up 15% to 25% and our non-GAAP earnings per share to be in the range of $0.09 to $0.15.

Now, let me open the call for questions. Mike.

Michael Sullivan

Thank you, Mike. And help us reach as many of you as we can free to ask question and no more than one brief follow-up. Tiya, let’s please begin.

Question-and-Answer Session

Operator

(Operator Instructions) The first question will come from Terence Whalen with Citi.

Terence Whalen – Citigroup

Hi, good afternoon. Congratulations on the strong results and also wanted to pass my congratulations and best of luck after George as well. The first question then I have is related to comment that you made about, foundry spending being about 45% WFE, I believe that the comment you made. As I look at sort of the order profile, it looks like foundry was close to three quarters of your orders. So my question is, how do you see the transition from more foundry dominated order environmental memory order environment, how do you see that evolving and handing off throughout the middle to later part of the year? Thank you.

Michael R. Splinter

Sure, thanks for your questions, very good question. If you look inside our numbers close to three quarters of orders in Q1 are from foundry. As we think about the progression through the year, we do have to have broader foundry participation, but we also need to see logic investment pickup fairly dramatically in the second half along with NAND flash spending for capacity and then for 3D NAND technology. So that’s kind of the progression we should start to see that by the end of our Q2 or the beginning of our Q3 that transition as foundry comes down as a percentage overall in the other areas in WFE starting to rise.

Terence Whalen – Citigroup

Okay, terrific. And then the second question, the follow-up question is around a comment that I believe Gary made around some of the advances in transistor technology in FinFET creating a really good opportunity to gain some share and gain some tool record positions, that seems to be obviously showing up in some of the Taiwan order patterns that we are seeing with Taiwan being very strong. I am wondering if you feel like you have as good a competitive position with the other Korean partner in FinFET? Thank you.

Michael R. Splinter

Yeah, if you look at the key enabling technologies for the transistor after PVD implant thermal processes, many of these we have 70%, 75% market share overall. And in the area around the foundry customers that are ramping gate-last technology or FinFET technology, the market share is probably even higher. So this certainly provides a great opportunity for us to grow share. When I think about our overall share position in 2012 in 300 millimeter, we gain share a small amount of market share. We look at 2013 as an opportunity to even accelerate that and 2014 when the 20 nanometer gate-last is adopted by a number of foundry customers. We’ve said that creates an opportunity for our CapEx to go up 30% with those customers. So we’re really in a great position, building momentum through this year into 2014.

Operator

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

Krish Sankar – Bank of America Merrill Lynch

Yeah. Hi, thanks for taking my question and my congratulations to George too. The question I had was the first one, Mike if you take your wafer fabric equipment guidance lets assume we get to the upper end of the range driven by higher foundry, NAND coming back, would you still see the seasonality of a (inaudible) that we saw last year?

Michael R. Splinter

This year is certainly a different year than last year, the foundry part of the investment that’s driven by mobility and the mobility consumers that largely buying the latter half of the year really in the fourth quarter. That seasonality is still there. But especially in this kind of odd calendar year, we see more investments in logic to mute that. We think we’ll see more investment in NAND flash this year, which also mutes the accentuated seasonality that we had last year. And I would just echo the point about gaining momentum here as we move into this calendar year with the strong orders that we’re seeing on the front-end from the foundry.

Krish Sankar – Bank of America Merrill Lynch

Got it, that’s very helpful. and then just a quick follow-up for Gary, if I look at the 3D NAND, obviously the memory guys have been working on it for a while and we haven’t seen it yet to put into production. but let’s reveal that maybe it’s a 2014 opportunity, what is the incremental SAM expansion for Applied given the diverse product line?

Gary E. Dickerson

Yeah. So again, we do it as the 2014 timing similar to the 20-nanometer gate last ramp for our customers. So that’s one of things that make us very optimistic about building momentum from a market share perspective. In the 3D NAND technology, there are a number of very long deposition steps if you look at this multilayer stacks, that are very favorable to us. And lastly, we look at the incremental CapEx opportunity for Applied on the order of 25%, it gets better as there are more layers when you’re building these multilayer stacks around 25% increase in CapEx opportunity.

Operator

Your next question will come from Steven Chin with UBS.

Steven Chin – UBS Securities LLC

Thank you. Hi, Mike, also nice execution in the quarter and also [congrats] to George too.

George S. Davis

Thank you.

Steven Chin – UBS Securities LLC

My first question is just on the new 2013 WC outlook; I was wondering like you can kind of share more color on what customer type you’re slightly more positive on, and I think originally your estimate was for foundry and logic to be down and memory to be flat to up. Is the change mostly in foundries or this is for 20-nanometer?

Michael R. Splinter

Yeah, a little more positive there, Steve. It’s not a big change but I would say we’re incrementally more positive as we see the front end of this year and the announcements that some of the major customers have made. We really think DRAM spending is still going to be flat at low-level year-over-year, we think foundry will be down slightly, but perhaps not down as much as we had previously anticipated. And then NAND about 15% of the total with spending profile that stronger in the second half and then logic, we are thinking will be modestly up as well year-over-year.

So in total that makes that net sale have us move up from last time we said 5% to 15% down, now we are saying 5% to down 10%. So that’s how we’ve moved in the last few months.

Steven Chin – UBS Securities LLC

Okay thanks.

Michael R. Splinter

I would like to frankly move into the positive territorial in the next three months, we’ll see how the orders play out here.

Steven Chin – UBS Securities LLC

Can I just have a follow-up to Gary to just about the foundry 20-nm node. You talk about some of the design wins there Gary. What percentage of the decision do you think have been made at the 20-nm foundry node and how do you think Applied is set to compete at 20-nm foundry? Thanks.

Gary E. Dickerson

So I think several have been made, I’m the paranoid person and I’m comfortable once the tool is in the customer’s fab and paid for it. I think that we always have to be aggressive in looking at these types of situations. But certainly I think our order momentum, customers are also buying for multiple technology nodes as you know. So even when we are making 28-nm decisions there, they’re looking to 2016 and future technology nodes and what your position will be there. So I think the strong increase in orders in Q1 for us is a very good sign, certainly the discussions we’ve had with customers have been very positive and we are overall very optimistic, but again it’s not done until the tools are in the fab and take for and so we remain focused until happens.

Steven Chin – UBS Securities LLC

Thank you.

Operator

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

Mahesh Sanganeria – RBC Capital Markets

Thank you very much. Last quarter you saw in a little bit more cautious on the NAND side of the business I think you were saying that there won’t be any need for capacity addition. I hear a little bit more optimism and my question is that driven by what your discussion with your customers or you are more bullish on the end demand and consequently you are more bullish on NAND?

Michael R. Splinter

Well, there are several factors, here (inaudible) modestly more optimistic and I would tell you is the term modestly a couple of things we are of course, seeing strength in pricing for NAND, utilization and factories are improving. We went back and looked at our analysis of how much bid growth you need to see capacity increases and really have readjusted that, so we need to see about 45% bid growth before we seek capacity additions. And that of course, detailed discussions with customers and also we think that 3D NAND is progressing and the initial pilot line orders will come in for 3D NAND before the end of the year. So I think those things all total up to us being a little more positive on NAND flash getting stronger in the second half.

Mahesh Sanganeria – RBC Capital Markets

And Mike, one more question on your CFO search, if you can give us some color on what you are looking internally or externally or what’s the timing we can look for maybe in terms of, then you can bring something and what particularly you are targeting when you’re looking for CFO?

Michael R. Splinter

Sure. I have to tell you, we’re really motivated to do this quickly. We have I think a very thorough process between Gary and I and our Board of Directors to ensure that we select the best possible candidate. We think we have several internal candidates and of course, naturally we would rather take an internal candidate than have to go outside, but we think we or for the shareholders throughout this take a look externally.

We’re going to try to move through this process in a matter of weeks here, and so we’ll be getting back to you on that topic as soon as we make a decision. As far as what we’re looking for of course, we are looking for a very strong business partners somebody who can think strategically well experienced in financial management and acumen and somebody who can really drive shareholder return for all of our investors.

Operator

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

Mark Delaney – Goldman Sachs

Yeah, hi, it’s Mark Delaney calling on behalf of Jim Covello. Let me add my congratulations on the quarter and wish George success in his new role. I was hoping you guys could help understand a little bit more on the reorganization plan? How far along are you on implementing some of those steps and can you share with us what the employee response has been?

Michael R. Splinter

So some of the bigger changes we’ve made, certainly Ali Salehpour coming in and EES and Display was a big change. And I would say that, Ali has been here for two months and the response in internally and also externally has been extremely positive, very bright, very focused on technology leadership, driving profitable growth. Ali has really hit the ground running and he is doing a great job in ESS and Display.

Another major change we’ve made is in the SSG organization. We formed a new transistor group within the last month, pulling together all of the different technologies that we have under Steve Dinan. And as we’ve talked about many times that’s really a fantastic opportunity for Applied Materials. And so we’re organizing around that strategy and that will help us in terms of execution on that opportunity.

We brought in a lot of really good people to mix with already the tremendous talent we have within Applied Materials, both on the technology and marketing side, and we had just a tremendous team, great opportunities. We’re moving forward at a pretty high pace relative to these changes. So at this point, I would say many of them are in place and again we’re overall very optimistic.

Mark Delaney – Goldman Sachs

That’s helpful, thank you. So my follow-up, I wanted to talk on the announced our plan to reduce cost further at EES. Are there parts of the business that you are actually exiting or are you still going to be addressing the same markets with lower cost footprint?

Michael R. Splinter

We’re not announcing any changes in terms of the products that we have within the EES organization. We certainly driven the cost down pretty dramatically, I think in Q4 2012 we were $45 million, $50 million as we said exiting Q4 2013 and the Solar business will be down to about $20 million. So we’ve cut back in terms of the OpEx spending and that money is being reallocated into some great strategic opportunities we have to grow the company. But really no announcements at this time for any exits of major products within the Solar business.

Mark Delaney – Goldman Sachs

Thanks, Mike.

Operator

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

Edwin Mok – Needham & Company

Hi, thanks for taking my question and I want to wish you good luck George. So actually my first question is for you, particularly your earnings guidance, you kind of imply that you are expecting gross margins to just modestly increase in the coming quarter? I was just wondering why margins are not increasing that much and terms of also kind of just tied to that in terms of OpEx that you expect to – the OpEx guidance yeah, for the coming quarter within your current run rate for the year?

George S. Davis

Yeah. So let me first deal with gross margin. We do expect gross margin to improve in the quarter as we would expect with volume. And if you look at the EPS guidance, basically what you are seeing is all of the benefit from volume and margin improvement in the quarter, so midpoint of the guidance is up $0.06. And we do include in that obviously a significant increase in OpEx, but again on OpEx, you have to look at Q1 as an anomaly. We had 535 if you take out the favorable items in there, but we also had the shutdowns, which meant that our real run rate was much closer to 550. So the rates that were going up at 560 really just reflects incremental funding moving into again, primarily into SSG and I think that rate if you look at the second half of the year will look relatively flat with that rate.

Edwin Mok – Needham & Company

Great, that was very helpful. And then quick question for you Gary, I think firstly you talk about inspection, you have seen a lot of pools and etch it’s an area that lead a little more time for development rate in terms of regaining shares in those two markets. How do you tasking while two segment for after spending three moments in this company?

Michael R. Splinter

Okay. Let me go through inspection first, obviously this is an area I have a lot of experience. We have a really great team, incredibly strong customer pool in 2012. In wafer inspection and review; we’ve gained a few points of share. We’re winning, we had some good wins in Brightfield inspection with customers here recently that also create a market share momentum for us in 2013 in wafer inspection and review. So again, overall, I would say optimistic on wafer inspection, that’s a very good business for us in contributing profit to the company.

In the etch business, also we have a very good team some Customer Portal, some recent wins both in foundry and NAND Flash that make us more optimistic and again, as I’ve said before, both of these markets are multiple segments and our focus is not to blow the ocean, we want to focus to the areas where we can have differentiation and we can establish a strong market share position and we have a very clear strategy in both of these different businesses as inflection happen and some technology changes happen again, I am pretty optimistic in both of these different businesses.

Operator

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

Farhan Ahmed – Credit Suisse

Hi, this is Farhan calling in for Satya. I wish my best of luck to George as well and thanks for taking the question. I just wanted to check on the foundry capacity expectations for this year. If you can just tell like how much 28-nanometer (inaudible) do you expect and how much of 20-nanomee stockare for this year? If you could just tell that – nanometer be very helpful.

Michael R. Splinter

Sure, thanks. As we look at kind of foundry capacity and what we think of the added as we said at the outside of the primarily driven by strong demand in mobile and smartphones and tablets. So on the 28-nanometer area we think between 75,000 and 100,000 wafer starts per month will be added. And in 20-nanometer it’s a little harder to tell, because it also depends on how well those technologies move up the yield curve. Right now we are estimating about 25,000 wafers in 20-nanometer this year and that would be really in the second half – late in the second half of the year.

Farhan Ahmed – Credit Suisse

Thank you. And one question on the inflection and execution, Gary mentioned you have some reasons on (inaudible) I just wondering you understand how important these wins are on the inflection side, is it on 20-nanometer or 28-nanometer if you can just talk about that and whether this is like a small segment in the field or quite a big segment?

Michael R. Splinter

Well, I would say again, the customers are really working with us to cover a very large percentage of the applications for foundry and logic. And in the logic case, actually in both cases more than 50% of the applications, so I wouldn’t say that there are narrow. And again as I talked about earlier, customers will buy for multiple technology node, so they will focus on certainly 28-nanometer in fact, with the running in production today, but again they want technologies that can work for 28, 20, 16 all of these different technology nodes. We are in a very strong position with logic and foundry, especially with advanced transistor technologies and again that’s what makes us optimistic in that business.

Operator

The next question will come from Mehdi Hosseini with Susquehanna.

Mehdi Hosseini – Susquehanna International

Yeah, thanks for taking my question. Mike going back to the 3D NAND, can you help us understand what the current throughput is kind of wafer per hour, wafer per day? And at what point 3D NAND would become actually economical? And I have a follow-up.

Michael R. Splinter

Gary, maybe you can…

Gary E. Dickerson

Yeah. So I think on 3D NAND, I mean there’s a pretty significant increase in density. So I think as soon as the customers have those devices yielding, they’re going to try to ramp in as fast as they can. The biggest issue has been being able to get the yield what they wanted to be. As I said before again, this is a really great opportunity for us, if you look at the number of deposition steps in 3D NAND process, I mean Epi is a pretty low throughput application and you start approaching those types of throughputs on wafers per hour per chamber with some of the 3D NAND application. So again for us 25% increase in CapEx opportunity as customers move to that technology.

Michael R. Splinter

So maybe I would add just briefly here that there is two aspects here. First, 3D is huge trend here not just in NAND but in transistors and packaging. It’s one of the biggest inflections we are going to see over the next few years. But this is a huge change to move away from litho to find shrinking and really be able to move the process defined where precision materials engineering, interface engineering really, really matters and its why we are so excited about this area. And we think at 32 vertical bits are something like this, this is economical at 45, 50 nanometer node where companies are aiming the first generation here. But you have to believe once they solve the device and reliability issues, it will be very easy for them to move very fast both down the litho curve and increase the number of bids in the stock.

Mehdi Hosseini – Susquehanna International

Okay. And then I guess my follow-up for Gary, when you go bid for new business, how should we think about the catalyst that enables you to gain market share? What else is out there other than ASP? Is that the tool throughput, is that the service, is the whole bunch of other stock that you are bundling that is enabling you to gain that market share. I’m asking this because I hear from your customers that the biggest bottlenecks is now lithography. And I just wonder what is enabling you to gain market share other than pricing?

Gary E. Dickerson

Well, again, as we’ve talked about before, the biggest driver in the industry today is mobility. And all of the customers are trying to differentiate on low-power and battery life. The biggest changes we’ve seen in a decade and transistor technology are happening as customers move to 20-nanometer gate-last technology and FinFET. And these are areas where Applied is really riding this way. We have a very high share and the technologies that enable these new transistor structures, maybe Mike can comment. But first time in many, many years that you’ve seen this type of a change, that is the number one focus for the industry where Applied has a leadership position in enabling this capability.

Michael R. Splinter

Yeah, I would just add that you know how lithography has been the story for really in the last, at least 10 years. And now we are seeing many of the bottlenecks, the interface engineering, precision materials, how are you going to get the low-k values, how are you going to keep them, and this is really an advantage for Applied Materials.

George S. Davis

And again as we talked about before, this is an increase in our opportunity of around 30%. So again, as you are adding an epi step that’s worth hundreds of millions of dollars with one step that’s added to the transistor. So if you look at all of the technologies, where we have leadership around the transistor, this is really a fantastic opportunity for us to grow share.

Operator

The next question is from Patrick Ho with Stifel Nicolaus

Patrick J. Ho – Stifel Nicolaus

Thank you very much. Maybe first for Mike, excluding the largest foundry, how do you see the trends for spending for the second tier foundries or at least the rest of the group in terms of how 2013 plays out?

Michael R. Splinter

Yes. Well, certainly we’re expecting return of those other members of the foundry community to start spending in the second half of the year. This will be really a key for us and how our order momentum is occurring at the end of our second quarter. We’ve always expected them to really have their spending in our late Q2 or in the Q2 calendar year and in the Q3 calendar year. So that’s our current expectation on the remainder of the foundry group. I would say we need that spending to broaden out certainly to reach the high-end of our WFE estimate.

Patrick J. Ho – Stifel Nicolaus

Great, that’s helpful. Gary, maybe specifically on the technology side, when you are varying, you brought up the whole materials modification and a lot of technology synergy between iron, implant and etch. Can you maybe give a little bit of color on how some of – now that you two as a combined company, how that maybe giving you an advantage right now and particularly on the etch side and that being a driver of future share gains.

Gary E. Dickerson

Got to say, I kind of feel like a kid in the candy store here in Applied. We again, think to me that it’s so exciting is that we have leadership in many areas of precision materials engineering and this creates tremendous opportunities for us as a company. The one thing that we don’t talk about and unfortunately I can’t talk about here, but there are opportunities for us in the integrated processes, linking different parts of our product portfolio together that are creating positive momentum for us today and I think as you move forward to some of these future device structures and interface engineering and some of these areas becoming more critical, the magnitude of that opportunity is going to increase.

Gary E. Dickerson

Thanks, Patrick.

Operator

The next question will come from Jagadish Iyer with Piper Jaffray.

Jagadish Iyer – Piper Jaffray

Yeah, thanks for taking my question. Congrats George from side as well. So two questions, just wanted to highlight; first, on the logic spending, Mike, you did earlier to the fact that they would probably becoming bad. What is that – which is currently driving could potentially drive logic spending, given that the PC outlook seems to be pretty tempered for this year?

Michael R. Splinter

Well, first of all, it changed to the next-generation of technology where we’re seeing 25% to 35% increase in capital intensity, that movement of course is very important and very relevant to us. But then the other thing that can drive up logic spending is some growth in PCs this year. As I alluded to there has been an introduction of Windows 8. There is our touch Ultrabooks now. If these things start to catch on in the back-to-school time period, this could be very beneficial for us in logic spending in the latter part of the year.

Jagadish Iyer – Piper Jaffray

Okay, thanks. And just as a follow-up, I just wanted to understand on the Display side. How should we think about new fabs coming online? Can you give us some color in terms of how many Gen 10 fabs are coming, or is it going to be driven by Gen 8.5? Any color on the fabs and under generation would be very helpful and how Applied is going to be benefited this time versus the prior generations? Thank you.

Michael R. Splinter

Sure, maybe I can start and Gary can finish. On the – as we start this current generation of TV fabs will be Gen 8.5. But what we are seeing in primarily in China, we are starting to see the orders come in for those factories. So that’s really quite beneficial for us. We think that 60-inch TVs are starting to get to the price point that to a real volume price point are now starting to approach a $1,000 very soon, under $1,000. That kind of a price point will drive the industry to Gen 10 just because of how many TVs you can get on one sheet of glass and to make that economical. But it’s pretty clear to us now that while we haven’t had a glass size change in, I guess five years that there is one that’s really going to come. Gary, you might want to talk about with – also with the increased pixel density what we see as our advantages.

Gary E. Dickerson

Yeah, as customers go to larger area, larger panels, and smaller pixels, again it’s the same thing you see in the semiconductor industry, where you have to drive to lower particles to get acceptable yield, uniformity becomes more difficult in these larger areas. And that really plays to the device performance and yield advantages that we have in our CVD and PVD products and that will create very strong momentum for us from a share and margin standpoint in that business.

Michael R. Splinter

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

Michael Sullivan

Thanks, Jagadish.

Operator

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

Ben Pang – B. Riley Caris

Thanks for taking my question. In terms of the growth forecast that you have for the SSG business, you commented on your ability to outgrow the overall sector based on transistor and PDC, what’s the – I guess the wafer fab equipment if you split out transistor by itself? Is there a significant difference between 2013 and 2012?

Gary E. Dickerson

Transistor products I think are little over 50% of our total SSG business I think it’s roughly that in plant.

Michael R. Splinter

Yeah.

Ben Pang – B. Riley Caris

So I mean in terms of the industry growth rate is there – I am just trying to get a feel for 28-nanometer versus 20-nanometer, how much is really going to the transistor, is there a big growth difference?

Gary E. Dickerson

Again, what we are seeing for the transistors you go from 28-nanometer to 20-nanometer gate-last, the market opportunity goes up for us roughly 30% if you think an equivalent number of wafer start and then it goes up again maybe another 10% as you go to FinFET technology. So that’s again for equivalent number of wafer starts.

Ben Pang – B. Riley Caris

Okay, thank you very much and good luck to George as well.

George S. Davis

Thank you so much.

Michael R. Splinter

Thanks. And yeah I think we have time for one more question please.

Operator

Yes, sir. The final question will come from Vishal Shah with Deutsche Bank.

Vishal Shah – Deutsche Bank

Yeah, hi, thanks for taking my question. Just wanted to ask you a question on the OpEx guidance, does this guidance include spending on 450 millimeter or are you sort of thinking about 450 millimeter later this year or early next year?

Michael R. Splinter

It does. It’s our full OpEx picture.

Vishal Shah – Deutsche Bank

Okay, great. And then on the foundry spending expectations, when you think about the orders for the next couple of quarters, what percentage of your orders do you expect from 20-nanometer, I mean they are all going to be second half rated, or do you see some activity from customers even in the first half?

Michael R. Splinter

We think orders on 20-nanometer are certainly going to be, maybe we’ll see them in the fourth quarter drives in our fiscal first quarter as we think most of that capacity will be growing in mostly for the end of the year.

Vishal Shah – Deutsche Bank

Great. And just I mean how do you think 2014 foundry spending looks like, I mean do you see 20-nanometer keeping foundry spending relatively high, or do you see that is an area of weakness when you think about in the next year?

Michael R. Splinter

Yeah, I think we’ll hold off, but the mobility trends we believe is here to say, and I think you’re still will be strong growth in mobility of – that’s the case we’re going to see some foundry spending, a little too early for us to make a protection about 2014 right now.

Gary E. Dickerson

What I would say also…

Vishal Shah – Deutsche Bank

I appreciate it.

Gary E. Dickerson

Again on mobility, this is the major focus for our customers is where everyone is trying to differentiate in brad share and certainly looks like customer ramp 20-nanometer gate-last processes. The people that are there ramping those processes will have a competitive advantage and that’s what we would anticipate in 2014.

Vishal Shah – Deutsche Bank

I appreciate, guys. Thank you.

Michael Sullivan

Okay, thank you, Vish. And we would like to thank everyone for joining us this afternoon. A replay of this call will be available on our website beginning at 5 pm Pacific time today. Thank you for your continued interest in Applied Materials.

Operator

Ladies and gentlemen thank you for participating in today’s conference call. You may now disconnect.

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