Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Applied Materials, Inc. (NASDAQ:AMAT)

F3Q 2013 Earnings Conference Call

August 15, 2013 16:30 ET

Executives

Michael Sullivan - Vice President, Investor Relations

Mike Splinter - Chairman and Chief Executive Officer

Gary Dickerson - President

Bob Halliday - Senior Vice President and Chief Financial Officer

Analysts

Jim Covello - Goldman Sachs

Tim Arcuri - Cowen & Company

Stephen Chin - UBS

John Pitzer - Credit Suisse

Wes Twigg - Pacific Crest Securities

Mehdi Hosseini - SIG

Terence Whalen - Citi

Vishal Shah - Deutsche Bank

Edwin Mok - Needham & Company

Jagadish Iyer - Piper Jaffray

Patrick Ho - Stifel Nicolaus

Krish Sankar - Bank of America Merrill Lynch

Operator

Welcome to the Applied Materials’ Earnings Conference Call. During the presentation, all participants will be in a 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, August 15, 2013.

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, Dustin. Today, we will discuss the results for our third quarter ending July 28. In a moment, I will turn the call over to Mike Splinter, Gary Dickerson, and Bob Halliday.

But first, let me remind you that today’s call contains forward-looking statements including the company’s current view of its industry outlooks, growth opportunities, product, share and profitability targets and Q4 business outlook. These statements are known to contain unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied and they should be interpreted in that light. Information concerning the risk factors is contained in our company’s SEC filings including our most recent Form 10-Q.

Today’s call also includes non-GAAP adjusted financial measures. Reconciliations to GAAP measures are contained in today’s earnings press release and in our quarterly earnings presentation, both of which are available on the Investor page of our website at appliedmaterials.com.

And now, I’d like to turn the call over to Mike Splinter.

Mike Splinter

Thanks, Mike, and good afternoon to everyone on the call today. Before we get to our earnings discussion, I want to make a few comments about the CEO succession plan that we released today. I am very pleased to announce that we have appointed Gary Dickerson, President, CEO, and a Member of the Board of Directors effective September 1. I will be serving as Executive Chairman. And together with the rest of the Board, we will be supporting Gary as he leads our company to execute on our strategy. As President, Gary has proved to be an outstanding leader and partner focusing on Applied on new strategies for profitable growth. Having worked side-by-side with him for more than a year now, I have every confidence that his vision and personal drive will translate into remarkable success in leading Applied Materials as our next CEO.

A top responsibility for any Board is to ensure that there is a strong succession plan in place and that the company can affect a smooth leadership transition at the right time. I think we have done a very good job of this at Applied. By making this transition now, Gary will be in position to prepare this year’s annual operating plan, so we can keep up our momentum for profitable growth.

As this is my last earnings call as CEO, I’d like to say thank you to all of our investors and analysts for their support of applied materials over the years. So Gary would like to make a comment?

Gary Dickerson

Thanks Mike. I’m honored and excited to be given the opportunity to lead this great company into the future. On behalf of the execute team employed I would like to thank mike for his decade of service as CEO. Today thanks to Mike’s leadership Applied enjoys a strong foundation than ever before on which to build momentum for profitable growth. I really believe that our opportunities have never been greater and I’m excited to have the chance to lead applied materials into a new era of growth and success.

Mike Splinter

Thanks Gary and congratulations. Let’s begin our earnings discussion. We’re pleased to report solid financial results for our third fiscal quarter; we delivered earnings at the mid-point of our range with global appetite for mobile devices and larger TVs driving healthy demand for our semi-conductor and display equipment. As we outlined at our recent analyst event across the company we’re building momentum for profitable growth, industry trends and semi-conductor and display flavor applied materials leadership areas and at that same time we’re seeing results from changes to the organization and our spending profile designed to strengthen customer collaborations and speed up product development.

We’re increasing investment in 300 millimeter R&D and field technical resources to support our strategic priority of growing shares and wafer fab equipment by winning at market inflections. We’re stepping up our R&D spending to ensure we have the strong product pipeline we need to drive growth, we’re equally focused on reducing operating expenses and organizational complexity to improve profitability. We will provide an update on our progress later on today’s call. As the mobility build-out gathers pace device makers are engaged in a battle for leadership, consumers are making buying decisions based on battery life, features, form factor and visual experience which means that our customers’ ability to deliver winning products requires new device technology at the right yield and cost. Performance improvements in mobile chips and displays are becoming increasingly dependent on materials innovation. Applied is uniquely positioned to enable next generation transistors and interconnects 3D memory and high resolution, low powered displays.

In addition to robust demand for mobile devices we’re seeing strength in the TV market and as a result our display business booked it's highest orders in over two years. TV unit sales are growing and average TV sizes are increasing significantly faster than historical trends. We anticipate that an average increase of two inches in 2013 versus a typical annual increase of about a 0.5 an inch. To put this in perspective for every inch of growth one new Gen 8.5 factory is needed to fulfill the incremental area of demand.

Now let me turn to our outlook, through the third year in a row seasonal buying patterns are evident as consumers wait for new smartphone and tablet models to be released in the fall, as a result we’re seeing a near term slowdown in investment by our foundry customers as they focus on ramping new capacity installed over the past two quarters. This will deliver product for the holiday season and readying their next generation of technology. We expect investment levels to recover in the fourth calendar quarter.

Unit growths of mobile devices is also driving healthy demand for NAND flash memory and bit (ph) growth for 2013 is expected to be in the 40% to 50% range. The transition of 3D NAND technology into production is underway and we expect investment to accelerate in 2014 and 2015 as more manufacturers adopt this technology. In the DRAM market conditions are improving with average selling prices recovering to levels last seen in 2010 as a result of increasing bit (ph) demand for mobile applications combined with structural changes in the market and several years of underinvestment, customers are taking actions to increase bit supply. Today, these investments are primarily focused on technology conversions for the 3X to 2X node. We expect some new capacity will be added if these favorable market conditions continue into 2014. While mobility related demand remains strong, PC sales are still challenged and consequently, we are seeing some minor reductions in logic investment for the year.

Looking at industry investment as a whole, while there has been spending mix shifts towards memory in the second half of the year we are maintaining our 2013 wafer fab equipment forecast of $27 billion to $30 billion. We believe that wafer fab equipment investment will be higher in 2014, up 10% to 20% relative to this year. This will be driven primarily by the foundries building out there 20-nanometer node, investment in 3D NAND capacity, and some increase in DRAM spending. This is the spending mix that is favorable for Applied Materials.

In summary, the market environment in both semiconductor and display provides a firm foundation for profitable growth. At the same time, major industry trends are playing to Applied Materials strength in Precision Materials Engineering presenting us with an unprecedented number of opportunities. Most importantly, I am confident that we have the right strategy, the right talent, and the right new CEO to take Applied to new levels of performance.

Let me now hand the call over to Gary who will provide more details about our strategy and the progress we are making against our goals. Gary?

Gary Dickerson

Thanks Mike. Today, I will focus on three areas, where we are building momentum for profitable growth. First, we are shaping a more competitive company that can execute better, faster, and at lower cost. Second, the major industry trends translate into positive momentum for our leadership business segments that are enabling the key technology inflections in the mobility war. And finally, we have positive momentum in growth businesses that can drive significant incremental contribution to our financial performance.

As Mike discussed, mobility is the major driver in electronics and all our customers want to be the first to introduce new technology that will help them win. Applied capabilities in Precision Materials Engineering are strategically important for our customers. And this has resulted in employing us into much earlier and deeper engagements. Today, our customer relationships have never been better. And this combined with our strong pipeline of new products is providing us with significant opportunities to grow market share as new transistor, interconnect, memory and display technologies are adopted.

To realize these great opportunities, we are making changes to execute better, faster and at lower cost. We have added very strong talent in management, product development, and the field. We have been implementing changes in our structure and business processes to improve the speed and quality of our execution. We have been increasing R&D for products that can drive future profitable growth. R&D spending as a percentage of combined R&D plus SG&A has increased from 55% a year ago to 62% today. In line with our strategic priorities, we have increased focus on our semiconductor business. By shifting overhead dollars, managing our product portfolio, and improving productivity, we increased our annualized funding for 300 millimeter R&D and field support by almost $170 million since the start of the fiscal year. All these actions are enabling us to create a pipeline of new highly differentiated products that have significant pull from the industry technology leaders and will drive future profitable growth in our leadership areas and in other markets, where we have a lot of room to grow our share and profit. Our customers were for mobility leadership is intensifying and materials innovation is their most significant levered to drive performance gains in transistor, interconnect, memory and display. In foundry the major battle is to introduce new transistor technology to enable enhanced performance and longer battery life for mobile devices, this really plays to the sweet spot of our leadership in EPI, implant, thermal, CVD, PVD and CMP. So selective epitaxy combined with our implant and new technologies improves transistor speed by more than 30% while our integrated PVD Metal Gate delivers a 100x improvement in device leakage and lower power consumption. As a result we expect to gain 5 to 10 points of PVD market share this year.

IN CMP we expected gross share about 3 points in 2013 and see future market growth as foundries and 3D NAND customers integrate additional steps. Looking ahead two inflections that will have a positive impact on our business in 2014 are foundries transiting to the 20 nanometer node and first generation 3D NAND, these new devices are very positive for Applied because the performance gains are enabled by our leadership and precision materials engineering. They grow our available market and we are in a strong position to gain share when these new devices ramp into volume manufacturing. As foundries move to 20 nanometer technology Applied served market opportunity grows approximately 25% relative to the 28 nanometer baselines.

When transistors are introduced at the 1x node we expect our served market to incrementally grow by an additional 5% to 10%. In memory the 3D NAND inflection also leverages our leadership and precision materials engineering. With the transition from plainer to 3D NAND the performance gains are driven by deposition and etch and as a result we expect our available market to grow by about 25% for first generation 3D NAND devices.

Another positive trend in 3D NAND is the adoption of EPI and thermal products, two areas where we have clear and sustainable differentiation. Overall we have a strong position in 3D NAND and anticipate our served market and share will grow as these factories ramp into volume production. We’re also building momentum in additional segments including etch, inspection and display.

We’re focusing on areas where we have strong pull from customers can help enable inflections and have sustainable differentiation. The talent and investment we have added in these areas are resulting in positive market share momentum. In etch our strategy has been to target areas of the market where we believe we have valuable and sustainable differentiation and this has started to yield results. In the quarter we secured important process tool of record positions in memory that provide a platform to drive significant gains in market share this year.

In inspection we have been investing an R&D and field technical support enabling us to increase our layer qualification at logic and foundry customers both at 28 and 20 nanometer technologies. We expect to translate these qualifications into shared gains for our Brightfield products this year.

Another area where we see positive momentum is display; displays have a huge influence on the desirability of mobile devices affecting user experience, power consumption and form factor. Advanced low temperature polysilicon and metal oxide transistors are being used to deliver high resolution LCD and organic LED displays that consume less power and have new form factors. These high-resolution mobile displays increased the opportunity for our CVD and PVD equipment in this market by more than 30%.

In TV, the introduction of 4K ultra-high definition and OLED is driving more complex and capital intensive manufacturing processes. Our differentiated large area, precision deposition equipment, provides device performance and yield advantages. We won 100% of the CVD and PVD business for the last two new TV factories. And we anticipate our overall share in display PVD will increase by about 25% this year. We see a pathway to grow display revenues to $1 billion or more with high operating leverage.

In summary, 2013 is shaping up to be a year, where we are building momentum for profitable growth for 2014 and beyond. We are making great progress building a more competitive company that executes better, faster, and at lower cost. We are bringing new talent and investments to key areas while implementing structural and process changes that improve the speed and quality of our execution. We have positive momentum from the major trends in semiconductor and display markets, that plays to the strengths of our leadership businesses and we have positive momentum in edge, inspection, and display that we anticipate will drive incremental contributions to profitable growth. We are very excited about our technology pipeline and laser focused on execution to make sure we take advantage of the great opportunities we have to drive profitable growth.

Now, let me hand the call over to Bob.

Bob Halliday

Thanks, Gary and good afternoon everyone on the call. Before I cover our results for the quarter, I want to reinforce two very important points that Mike and Gary made. One, our leadership in Precision Materials Engineering creates a unique opportunity for us with our customers. And two, we are driving the necessary changes in the organization to capture this opportunity while improving the overall profitability of the company. To fund these changes and improve our profitability, we are significantly reducing the cost of doing business. We are rapidly eliminating organizational complexity and reducing the investment in the areas with lower returns and reallocating these dollars into our product pipeline for the highest value opportunities. We are already seeing the shift in our financials.

On a GAAP basis, G&A as a percentage of R&D plus SG&A has decreased from 24.3% a year ago to 21.4% in Q2 to 17.9% in Q3. At the same time, R&D as a percentage of R&D plus SG&A has increased from 54.8% a year ago to 58.5% in Q2 to 61.6% in Q3. The net result is a 4% year-over-year decline in the spending while increasing R&D by 8%. We will see fluctuations quarter-to-quarter, but the trends reflect of the systematic reallocation of our spending that is taking place. This reallocation is driving incremental momentum with customers. One simple leading indicator of this momentum is the number of our semiconductor evaluation tools is expected to increase more than 20% in the next two quarters. In addition, a leading indicator of future spending is headcount and our total headcount is down 6% or approximately 900 employees from a year ago with most of that reduction coming out of EES and the corporate functions.

The Applied functional organizations are doing a great job of driving these rapid changes. The teams are doing extensive benchmarking, quickly adopting best known methods and working to improve the velocity of the company. I have been really pleased and grateful for everyone’s efforts. The job is getting reallocated into additional R&D investments are going into semiconductor and display. These are business that have high share or they are growing share with strong product pipelines, in SSG we’re extremely well leveraged to the transistor technology inflections occurring over the next few years. It is possible that the great majority of our business units will gain or hold the share. The plan is pretty straightforward, get more efficient in the cost of doing business and invest in markets and products that we know very well. The early results are very encouraging, overhead cost and solar spending are down substantially. Investment in core SSG (ph) display product is up. We’re gaining share in most of those markets and the other the indicators like evaluation tools and our product pipeline are up.

These cost savings and harvested R&D investments will drive sustainable growth and profitability for Applied Materials. The money we’re reinvesting is going into our highest value opportunities, markets we know and business was very good incremental margins and high and/or growing the share.

Now I’ll cover our third quarter results and comment on changes from the prior quarter. Orders were approximately $2 billion down 12% sequentially on lower semiconductor equipment demand partially offset by strength in display and AGS. We generated net sales of approximately $2 billion which was about as we expected. Our non-GAAP EPS was $0.18 which was at the mid-point of our guidance.

Non-GAAP gross margin was 42.9% down slightly due to a less favorable product mix within SSG partially offset by less inventory charges and lower variable compensation. Over the next two quarters we expect gross margins to decline slightly as products which traditionally have had lower share and therefore less scale become a larger percentage of SSG revenue. Non-GAAP operating expenses were $535 million below the low end of our guidance primarily due to reduced corporate spending. Our effective tax rate was 23.9% on a non-GAAP basis. We now expect the non-GAAP four year rate to be between 24% and 25%.

Cash from operations was $364 million or 18% of revenue. Our capital allocation priorities remain unchanged. We returned $170 million to our stockholders in Q3; we used $50 million to repurchase 3.3 million shares and paid out $120 million in dividends reflecting the 11% quarterly dividend increase we announced in March.

We ended the quarter with cash and investments of just over $3 billion. Next I will comment on our Q3 segment results as compared to the prior quarter. SSG orders were down 22% to $1.2 billion due to lower but comparatively strong foundry spending. This reduction was partially offset by an increase in NAND, DRAM and logic orders. SSG net sales declined 1% to $1.3 billion with increases in NAND and logic offsetting most of the seasonal decline in foundry. SSGs non-GAAP operating margin decreased to 22.2% reflecting a less favorable product mix relative to Q2 and slightly higher operating expenses. In AGS orders were up 7% to $517 million due to improvements in customer utilization rates and wafer starts, AGS net sales were down 4% to $497 million due to a slightly less favorable wafer start by device type than expected. Non-GAAP operating margin was essentially flat at 23.3% despite slightly low revenue.

Our display orders increased 31% to $256 million with record orders in array PVD. The increase was driven by TV fab investments in China and reflects our share gains with those customers.

Display net sales increased 27% to $161 million consistent with the order ramp we experienced over the past few quarters. Display’s non-GAAP operating margin increased 4.6 percentage points to 21.1% which is our highest operating margin at this level of revenue since the first quarter of fiscal 2008.

EES orders were $19 million and net sales were $45 million, up $7 million from Q2. The non-GAAP operating loss declined $15 million due to lower inventory charges and our cost reduction efforts. Non-GAAP operating expenses were below $30 million in Q3 and we remain on track to lower OpEx to the low $25 million exiting the fiscal year.

Now, I will provide our fourth quarter business outlook. Overall, we expect the company’s net sales to be flat relative to third quarter with a little more risk than opportunity. We expect our non-GAAP operating expenses to be in the range of $525 million plus or minus $10 million, and non-GAAP earnings per share to be in the range of $0.16 to $0.20. Within this outlook, we expect net sales from our semiconductor business to be flat to down slightly. AGS net sales are expected to be flat to up slightly. Display net sales should be down slightly with EES net sales up slightly.

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

Michael Sullivan

Thanks Bob. And to help us reach as many of you as we can, please ask just one question and no more than one brief follow-up. Dustin, let’s please begin.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Jim Covello with Goldman Sachs.

Jim Covello - Goldman Sachs

Yes, good afternoon. Thanks so much for taking the question. I appreciate it. Congratulations to both Gary and Mike. Great job to both of you guys.

Mike Splinter

Thank you.

Gary Dickerson

Thanks Jim.

Jim Covello - Goldman Sachs

I guess, first question just relative to kind of the nearer term environment, I guess and this isn’t specific to Applied, because we have had the same questions as an industry for the competitors as well. It seems like what we were hearing at SEMICON West doesn’t quite match what’s happening in the very near-term, was that just a function of us misinterpreting the comments of SEMICON West to be near-term or have there been some pushes since those meetings relative to what we are looking at in terms of the third and fourth quarter today?

Mike Splinter

Maybe I can comment from the industry standpoint, I think the foundry spending profile was quite predictable and pretty much in third calendar quarter is following what happened very similarly over the last three quarters. I think there is a fair difference as we look into our Q1 or into the fourth calendar quarter, we think foundry spending will pick up as they start driving towards their 20-nanometer nodes and/or it might be teen nodes for some suppliers and we’ll have a littler broader investment by a broader number of customers. I think if there is any modest surprise, it’s around a little higher memory investment in the second half of the year, Jim, but I think the foundry spending was pretty predictable.

Jim Covello - Goldman Sachs

And then I guess this is follow-up how long visibility do you have into the memory piece. So, theoretically, memory spending is picking up over the next several quarters, I mean how much confidence do we have that, that’s a or one or two quarter phenomenon versus the two or three or four quarter phenomenon in terms of better spending there to go along with the seasonal recovery in the foundries?

Mike Splinter

Yes, I think the hedge is what’s going to happen with the PC market exiting the year and going into 2014. If it was just the mobility market, we can see the compounded annual growth rate of bps per box, that’s been pretty aggressive, but it’s tempered by what’s been happening in PCs. So, if I knew what was happening in PCs, I’d be more confident that we’d say that you could think of a four – especially in DRAM a four quarter run, but I’d be quite hesitant to say that today. Flash memory, I think is a different story. There is technology investments here that need to be made. And I think we are seeing them being made both in 3D NAND as well as in plainer NAND.

Jim Covello - Goldman Sachs

Terrific. Thanks very much.

Mike Splinter

Thank you.

Operator

Our next question comes from the line of Krish Sankar with Bank of America-Merrill Lynch. And Krish, your line is open.

Michael Sullivan

Okay, Dustin. Maybe we will move to the next questioner and hope that Krish can pull us again.

Operator

Our next question comes from the line of Tim Arcuri with Cowen & Company.

Tim Arcuri - Cowen & Company

So couple of things first of all Mike you talked about things snapping back in fiscal Q1, January quarter can you give a sense of how much you think revenue will snap back in January are we talking a few $100 million?

Mike Splinter

Well I don’t think we’re ready to forecast our Q1 Time there is a lot of moving part so but I would say that we’re quite certain foundry spending coming back to previous levels.

Tim Arcuri - Cowen & Company

And then maybe a question for Bob, Bob if I look at SSG gross margins they are down about 300 basis points on flat revenue also at it sounds like SSG margins are going to hold back overall margins a bit even as revenue grows here into January. If you look back maybe 5, 6, 7 years ago you guys are having definitely a lot more success now gaining share in this two big markets that you’re focused on an SSG but back you know years and years ago there was some effort to sort of see the market by I don’t want to say giving away tools but pricing tools are very low and so is there any sort of metric that you can give us to sort of hold our hand that you’re not doing the same thing time and that infact margins will come back in SSG as we get into next year. Thanks.

Bob Halliday

Yeah there is a lot of moving parts Tim, in terms of I think the single biggest thing that has having impact in the next couple of quarters is mix, we’re actually gaining share and some in one or two segments one particular we haven't gained share a long time, I think we will gain share but without the scale our margins are lower. I think in the strong businesses the margins are holding up pretty well, so I think it's mostly a mix, we got a little bit of issues too out there with mix of customer type and I can’t point any explicit impact we can probably in the background in terms of how aggressively customers negotiated. So overall I would say we’re probably going to still in the ballpark but a bunch of mix issues right now we’re sorting through.

Mike Splinter

On the areas where we’re growing share and it's actually one of our highest margin businesses, as I talked about earlier we definitely have momentum there very strong pull from customers in all markets for current and future technology. Again one of the major cases I have ever seen in my career of customer pull for products. We have a lot of momentum and foundry and logic, we’re increasing layer penetration at 28 nanometer, 20 nanometer and also since that with the technology leader on that particular device.

We have really strong pull from customers on the unique imaging and defect capture capabilities, especially for patterning applications. We're ramping investment R&D in the field and as I said a lot of momentum there. The other thing I would say about the inspection business is we have the best e-beam technology in the world, very strong in terms of e-beam review and we can leverage this technology for growth in new markets. But overall inspection is one of our highest margins one of our most profitable businesses.

In etch, the good news is that we're making tremendous progress and share this year, we’re penetrating new applications and foundry planar NAND and we’re extremely well-positioned and the first customer that's ramping 3D NAND. So, we are making very significant penetration, strong growth in the business. The margin’s there aren’t as good, they are not really different from where they were so there is no change in terms of the pricing behavior there it's just as we’re ramping especially with new customer where we haven't been for a long time those initial margins are not great. The other thing I would say in etch is that we’re working with technology leading companies, all of the technology leading companies on very differentiated products that have potential for significant share growth for us in the future.

So certainly we're penetrating today as I said in foundries and planar and 3D NAND but we also have very, very strong technology around some of the key future inflections in the etch business.

Tim Arcuri - Cowen & Company

Great, thank you. That was very, very helpful. Thanks Gary.

Operator

Our next question comes from the line of Stephen Chin with UBS.

Stephen Chin - UBS

Thanks. I also want to share my congrats to both Gary and Mike.

Mike Splinter

Thank you.

Gary Dickerson

Thanks Stephen.

Stephen Chin - UBS

Just a follow-up question on planning for 2014 wafer fab equipment spending to be up 10% to 20%, I was just wondering if you could share kind of your latest color on how you think that may trend across memory, foundry, and logic, is it kind of memory and foundry or up, but maybe logic not up as much next year?

Mike Splinter

Yes, certainly. Maybe I can just kind of run it down briefly for you, Stephen. I think if we would say that wafer fab equipment spending is up 10% to 20%, we think logic spending is probably going to be down as a percentage of the total. DRAM will probably be flat as a percentage of the total NAND and foundry up a bit as ahead of that 10% to 20%. And I think you can kind of relate that what’s happening in the end market as well and with the technology inflections in 3D NAND and then the continued build out in the mobility area in the foundry space.

Stephen Chin - UBS

Okay, thanks Mike. And then maybe a follow-up question, I think Bob called out that the number of evaluation tools are about 20% higher, maybe you can talk about where those evaluation tools are out is a mostly action inspection tools, is that what’s given you some of the confidence that you can clearly gain share in those two new areas? Thanks.

Gary Dickerson

Well, certainly in the etch market as I talked about earlier, we have some very, very strong technology around some major inflections. And we are penetrating logic, foundry, and memory customers with that new technology, so that certainly is one of our major areas of focus. We also in other areas like CVD, we are bringing to market new technology targeted at inflections, and we also have very strong pull from technology leading customers for these products. And so we believe and CVD will build momentum for share gains in 2014 and 2015 with some of these products and new applications. So, that’s another area, but I would also say that as I mentioned we are increasing 300-millimeter R&D by $170 million run rate well along with some on the field support. And that really is translating into a great technology pipeline. So, it’s certainly not just etch and CVD there are other areas where we have disruptive technology, but those are two of the prime areas.

Stephen Chin - UBS

Thanks, Gary.

Operator

Your next question comes from the line of John Pitzer with Credit Suisse.

John Pitzer - Credit Suisse

Yes, good afternoon guys. Let me add my congratulations to both Mike and Gary. So, my first question guys, I kind of going to go back to one of the presentations at the Analyst Day over a month ago, will you talk about WFE spending being kind of $37 billion, I believe out in ‘16. I think I understand the positive impact of capital intensity on that number. I am wondering if you can help me understand how you guys think about spurring to the silicon growth and/or the profitability of the customers over time relative to that number. And I guess what I am really trying to get out is we have seen this pretty significant mix shift down in the consumer market from the high end to the mid-range to the low-end, which probably doesn’t reverse itself. I am kind of curious as how that dynamic need attraction in longer term forecast on capital spending?

Mike Splinter

Thanks, John. That was a long question, but and a little further out question, I think how we tried to describe it at Analyst Day was really looking at process complexity increasing over these next few nodes to create the – we talked about the number of increased steps in 3D NAND, and those that would favor us, we also talked about the increased steps for vertical transistors, thin fabs, everybody is racing in that direction. And how much more difficult it is to be going to be to create these 10-nanometer or 7-nanometer patterns that our customers are going to be driving towards at that time. That’s by far the biggest effect. And then the second part of it is really a continued build out of the smartphone and mobility mobile tablets over that period of time. We expect that growth rate is going to continue that way until essentially all phones are smartphones.

And I think we explained that in the event that there is just a significant amount more silicon that's been employed in one of those smartphones. And those are by far the biggest effects that kind of get us up to $37 billion wafer fab equipment spending range from where we’re today. Also I think you know there has been pretty significant under investment in DRAM over the last few years. We certainly don't think DRAM is going away as a category.

And as the mobile build out happens it's going to return to a little bit larger bit growth than we've seen in the last few years.

John Pitzer - Credit Suisse Securities

At Analyst Day, you also talked about some development tools of record of 3D NAND and some in the last couple of weeks. Give us a little more insight into the 3D NAND performance metric that at the (inaudible) this week, I am kind of curious as if the (inaudible) have turned into product tools of record yet if they have how are you fairing and if they haven't when do you expect that to occur?

Mike Splinter

Yeah we're very, very positive on our opportunity as the first customer ramps from planar to 3D NAND. We're seeing significant increase in market share especially in etch but our overall time and market share is definitely going up in that planar to 3D NAND transition. So I would say that the overall increase that we talked about around 25% in terms of the application or the total available market is about what we expected to be honest we’re doing even better in etch in that transition than we had anticipated.

Operator

Our next question comes from the line of Wes Twigg with Pacific Crest Securities.

Wes Twigg - Pacific Crest Securities

Just real quickly I had a follow-up on the foundry orders the 20 nanometer foundry orders in particular. I’m just wondering given the conviction that 20 nanometer foundry spending should rebound, are you seeing orders beyond the first large customer yet?

Mike Splinter

On 20 nanometer orders, we're certainly seeing orders from more than one customer at this time. And maybe I can help you, our view is that by the end of '13 there'll be about 30,000 wafer starts capacity in the 20 nanometer range and we expect that growth rate upto over a 100,000 in 2014. So, I think we'll see acceleration as we approach the end of the year and then into 2014.

Wes Twigg - Pacific Crest Securities

And are you viewing 20 nanometers the same thing as the 16-14 nanometer the synthetic extension?

Mike Splinter

Yeah. This is always a confusing thing is that everybody seems to be naming their own dimension. So we're kind of lumping all that kind of 20 to 16, 14 into one bucket so that we can obviously hide the specific name of the customer. It's going to be a big category and a big over the next few years the biggest part of the growth in wafers and in spending.

Wes Twigg - Pacific Crest Securities

This sounds a little tricky, but do you think given that would include the feel that extension would, do you think demand would be strong in the back half of 2014 than in the first half?

Mike Splinter

I think it is probably bit too early for us to judge that right now I think right now our estimate really is that foundry spending will be up a little bit ahead of the overall 10% to 20% that we're thinking?

Wes Twigg - Pacific Crest Securities

Okay and then just finally one thing that caught my attention was on the e-beam comment that you could leverage growth for that technology in new markets and I'm wondering if you could give us an idea of what new markets are you talking about moving into inspection or maybe even into (inaudible)?

Mike Splinter

Yes again I really believe that we have the best e-beam technology, we haven’t really capitalized on that as much as we could, but we have just introduced a new product and e-beam review. That’s getting very strong poll and acceptance by customers. And definitely, I think we can leverage that into litho and we also can leverage that into e-beam inspection.

Wes Twigg - Pacific Crest Securities

Alright, very helpful. Thank you.

Operator

Our next question comes from the line of Mehdi Hosseini with SIG.

Mehdi Hosseini - SIG

Yes, thanks for taking my question. The first part of the question is for Mike, net interest income in about 20-nanometer and below, the size of the market could be about 100K, I am trying to better understand the thought process behind it, and let me get your view on the assumptions behind it, outside of Korea, I am sorry outside of Taiwan, Koreans are going to have rich production starting in December. And then at some point in ‘14 they are going to have puddle line, the same thing with global foundry. So, if the risk production for ‘14 is not going to happen until December, what gives you the confidence that 20 and below which going to have ‘14 in it could be as big as 100K unless you are making assumptions that 20 will dominate the 100K and I have a follow-up?

Mike Splinter

Well, I think we have confidence that we get over 100K by the end of 2014, because the device makers need a refresh on technology. So, there will be a strong push to get that capability from the foundry suppliers. And whether we call it 20 or as I said 2016, ‘14 it will – the suppliers will – the foundry suppliers will meet demand, and we think there is a need for more than 100,000 wafers. And what we can see already from how the customers are lining up to buy product, it looks quite real to us.

Mehdi Hosseini - SIG

So, are you implying that the device-makers would, for the first time, would go from risk production to volume production in less than two quarters?

Mike Splinter

Well, I think they have more than two quarters to do that actually.

Mehdi Hosseini - SIG

So, that means ‘14 especially for foundry could be pretty much back end loaded?

Mike Splinter

I think ‘14 probably would be back end loaded, I agree, but certainly, 2016 is the major focus for most of our customers and most of them are planning pretty aggressive buys in 2014 for those nodes.

Mehdi Hosseini - SIG

And Gary for you, you highlighted your confidence in gaining market share in etch, what’s the confidence there that gross margin there is not going to be sacrificed like what we are seeing in the process diagnostic?

Gary Dickerson

Well, number one I wouldn’t say the gross margin is being sacrificed in the process diagnostic space. That’s actually one of our highest gross margin businesses in the whole company, very good gross margins, very profitable. And if I look out over the next few quarters that business is extremely profitable. In terms of the etch business, we have confidence in share based on what’s happening with customers. We have strong poll in foundries for new applications and extremely strong poll in NAND technologies both for planer and especially as I said earlier for a 3D NAND. So, that is very strong. We know what the pricing is there. Again it is that one is at the lower end in terms of our gross margins today, but there is a lot of leverage as we grow that business. Also as I said, we have very strong technology around future inflections. We are working with all of the leading semiconductor companies in areas that have potential for extremely high growth. So, that’s why we are optimistic on that business. Mike, you could also maybe give some color you have been in this for a while and maybe give a perspective on where we are today versus where we have been over the last 10 years.

Mike Splinter

Well, I think on the opportunities for share gain Gary, I don’t think we have ever had greater opportunity and how well we are positioned towards the real key inflections when you look across what needs to be done just in logic, we have to get to help our customers get to fit in production over the next 12 months. And I think we’ve significant products there. We have to help reduce or improve the performance of interconnect and I think we’ve great products there. Transistors are now being defined with metal gates. We see a big shift there as we move from gate first to gate last across the industry and then in 3D NAND, we got 3D NAND in time with really I think game-changing application. So as I said I don’t think we have ever been in better position here.

Todd Sloan

I will say again on etch that is one of lower gross margin product today. As we're growing that business with new customers, that's going to be a drag on our overall margins but the incremental profitability there is very, very good and we have tremendous traction around some of these major inflections and a very strong technology pipeline, good team. So, we have a lot of confidence that we're going to build this business into a strong contributor to profitable growth.

Operator

Our next question comes from the line Terence Whalen with Citi.

Terence Whalen - Citi

This question is question is on 3D NAND. Gary I think you said that the engagements with the customers are shifting fundamentally, occurring earlier and also developing more depth around the technology inflections. My question is, does this translate to better visibility or not in terms of actual slots? And also in terms of 3D NAND specifically, why would you have two customers up and running in terms of revenue? Thanks.

Gary Dickerson

So in terms of visibility, one particular customer is leading the pack relative to the transition from planar to 3D NAND. They are very positive on the reliability and cost and moving forward very quickly. Visibility there relative to moving from development tool of record positions to production tool of record positions is very clear, that's happening. And as I said we’re very positive on what's happening in that transition and maybe even it's little better than what we had expected. Relative to the other customers, the timing for the transition from planar to 3D NAND is little a behind the first customer I don't know that we want to comment right now on exactly when that transition would happen but definitely behind the first customer, we’re working with those other customers on the technology development and we're also very optimistic in our opportunities as those customers make that transition.

Terence Whalen - Citi

My other question is related to the China regional breakdown information you've shown for both revenue and orders. We saw a pretty significant increase in revenue sequentially in the July quarter and also a decent increase in orders. My question is, what is that reflective of? Is it reflective of display or is it actually reflective of some orders and shipments into China perhaps for an international customer thanks and 3D NAND. Thanks.

Gary Dickerson

I think that was the China display orders. We got some big TV business in China.

Operator

Our next question comes from the line of Vishal Shah with Deutsche Bank.

Vishal Shah - Deutsche Bank

I wanted to just understand better understand your thoughts on restructuring given in the ES business your targets for the next year. Do you have any plan of change in your thought process given the progress you've made so far?

Mike Splinter

Well we've made significant cuts in OpEx there in the last year. I think it's on the order of about a $120 million in the run rate OpEx cuts and in the solar business. The web business is actually doing very well. We don't talk about that very much, but that business is exceeding our expectations and pretty profitable.

Relative to the solar businesses or any businesses within the company, we're not married to any particular business. We’ve operating profit goals that we have for businesses, businesses that meet those goals. We're going to invest and grow businesses that don’t meet that threshold. We will not continue in those businesses over the long-term.

Vishal Shah - Deutsche Bank

Great, thank you. And then you had talked about $800 million of orders for your display business, can you share and then you also mentioned today that you see a path to above $1 billion of revenue and record margins in that segment. So, can you share your thoughts on how we should think about display spending in 2014 and also whether you can see double-digit growth in that segment in 2014? Thank you.

Mike Splinter

I think we are very encouraged by the level of orders right now in this phase of the cycle. They are really showing our share gains in PVD, in particular. As you know, we have always been strong in CVD, but right now we see that TV investments going to continue. We have been pleasantly surprised by the growth in the size of TVs, but at Gen 8.5, this kind of 55 to 60 plus inch TVs are very, very cost effective now. We think in the marketplace we are going to see the prices come down and continue to see this very fast expansion in size of TVs. And then if you look in our display business, we have the foundation on the mobile business that corresponds to the rest of our mobility products. So, that really creates the floor on revenue in our display business. So, I think with the growth in PVD share, we are going to see significant performance next year. And I think Bob loves this business, because he just thinks that we are going to be able to get great leverage on the bottom line here as we amortize that infrastructure.

Bob Halliday

Yes, I think this is good business model. I mean, these folks manage really tightly in downturns and really optimize the business in the upturn. So, I like the business.

Operator

Our next question comes from the line of Edwin Mok with Needham & Company.

Edwin Mok - Needham & Company

Thanks for taking my question. A follow-up question on display, if I look at your booking year-to-date has been pretty up – it’s a lot higher than your revenue year-to-date, why you are guiding down for the October quarter?

Mike Splinter

Just lead time issue Edwin. I think you are going to see continued strong orders over the next few quarters. But as you know, this business is quite lumpy with long lead times. We are working those down, but it’s still from the time our customers ordered till the time they startup their factories. So, oftentimes over a year or so, it’s all about lead time versus the orders.

Edwin Mok - Needham & Company

I see. Okay, great. And then a question for you Bob, if I look at your OpEx guidance for the coming quarter and I contrast that against what your longer term target right it seems like your OpEx guidance is really at the long-term OpEx target of $2.1 billion, right. I guess to my question or one is, is that any kind of one-time statement you are realizing this quarter or are we done with OpEx, and I guess the other point I want to figure out is how much more do you think you can spend in R&D as a percentage of total OpEx?

Bob Halliday

Yes, I think we have made pretty good progress. There is three buckets I guess of OpEx is the cost of doing business that which is all the support functions and is the R&D investment which is what you choose to invest in. And we have a lot of good investment opportunities right now Gary talked about. The third which is the field a lot of that is pushing some of our growth with the technical marketing guys in the field, so, I think in the R&D and the technical marketing guys as investments and the rest is the cost of doing business. And the cost of doing business, I can sort of see over the next two years sustainably keep improving our performance in the area, and I can sort of see the roadmap.

So, I think on the R&D investments, those are choices we select. And I think if you think of that, those kind of investments, it’s like a pipe. What you are seeing in the short-term right now is we are really optimizing the investments that were halfway down that pipeline of products. What we have done now is we have increased the diameter of the pipe by funding, but we have also increased the velocity going through the pipe. So, in terms of spending, I think the cost of doing business will keep improving that over the next two years. I think the velocity of stuff out of the pipeline in terms of R&D, I am pretty excited about once those things start to hit. And right now, we are optimizing things, we’re half way down the pipe whether it's inspection or etch but we have some very some aggressive plans right now for stuff coming out of the pipe, so when those come out of pipe which will be over the next year to two, what you'll see is the red (ph) line will start to grow the OpEx spending as a percentage that goes. So right now we're spending on R&D a little bit higher than our revenue line, we’re funding with the G&A stuff but as we get that pipe really flowing the R&D will probably stay more constant and G&A will get optimized and revenues the margins will go up.

Operator

Our next question comes from the line of Jagadish Iyer with Piper Jaffray.

Jagadish Iyer - Piper Jaffray

Two questions, how should we be thinking about 3D NAND orders sustainability in calendar '14 given that capital intensity is very high and the customers besides one customer are looking at second half '15 or into 2016. How should we think about this as one customer tries to debug the ire challenges as well as the retention challenges some things like that? And I have a follow up.

Mike Splinter

Yeah. I don't want to talk for any specific customer relative to what their plans are. What I would say is that, what we’re hearing is that, they are pretty positive in terms of the progress they've made on that particular device and I think it's pretty well known that first stage is ramping and certainly if that is successful, they are going to continue to be fairly aggressive.

Jagadish Iyer - Piper Jaffray

Okay. And then for as a follow up then. Mike, given your commentary that 2014 WFE spend is going to be up 10% to 20% and Gary's commentary about the increasing SAM opportunities, how should be think about silicon system orders overall for calendar '14 in terms of looking at vis-a-vis calendar '13 and how should be looking at it's overall profitability? Thank you.

Mike Splinter

Well, maybe I should let Bob answer this question but I would just say that with our share gains and with the mix of spending at least the way we think of it now with foundry growing a bit faster than the main and our NAND flash growing faster than the main these are two good things for Applied Materials. So we’re not trying to forecast our full 2014 right now but I think the growth and the mix and the share gain are all heading in our direction.

Operator

Our next question comes from the line of Patrick Ho with Stifel Nicolaus.

Patrick Ho - Stifel Nicolaus

First, in terms of the process control opportunities you see ahead, you've talked a lot about the share gain opportunities. How do you see that TAM (ph) particularly on the foundry and logic side increasing as you go from 20 nanometers to the 16 and 14 nanometer FinFET notes?

Mike Splinter

Well. I think that the TAM more than likely will go up as you go to those different technology notes. I think the key thing for us the really key thing that moves the needle for us is our layer qualification. That's one of the things that we watch very, very closely. And what we talked about was a significant increase in the layers when you look at the 28, 20 and also we're working very closely with leaders in FinFET technology. So that layer qualification for us went up something like 30% this year and that we believe is very positive for us. It gives us very positive momentum from a market share perspective

Patrick Ho - Stifel Nicolaus

And my follow up question maybe for Bob in terms of the operating model specifically with the AGS business. And I think that this is an opportunity you've mentioned in the past where you can improve the overall margins of that business segment. One, what kind of improvements have you made to-date and two what are some of the longer term I guess efforts or initiatives you want to put in place to get those margins higher in that segment?

Gary Dickerson

Sure. I think the opportunity on AGS is a pretty good revenue opportunity which drops down a high percentage of that drops down. So if you look at that business we sell a lot of spare parts, our own tools. So I think we could probably hold better share in that business and that's a function of sourcing correct – optimizing programs with customers and internal alignment on how that you do that when you first design the tools and then also as the tools released. I look at that as a really good opportunity, because the drop from profit in that business is pretty good. It’s also a really good cash flow business frankly, because the operating expenses once you set up the infrastructure are pretty low incremental cost. I like that business a lot. I think we got to implement some of things, which we are working on right now, again, good coordination internally. And we just keep chopping away at it, hacking away at it, or building one maybe that’s the right word, because I think it’s more of a building revenue thing on this side.

Michael Sullivan

Thanks Patrick. And then Dustin, I know we have run past hour, but would you please poll Krish Sankar and see if he might still be back on the line?

Operator

And the question line is open.

Krish Sankar - Bank of America Merrill Lynch

Yes. Hi, can you hear me?

Mike Splinter

Yes.

Krish Sankar - Bank of America Merrill Lynch

Yes, sorry about the earlier technical issue and congrats again to Gary and Mike. Two quick questions. One, Mike, you mentioned about DRAM capacity adds next year, I know they are just like one, two, three DRAM customers out there. Do you expect one or more than one customer to add capacity? And I had a quick follow up to Bob.

Mike Splinter

We would expect one or two to add and the third one to optimize their overall capacity.

Krish Sankar - Bank of America Merrill Lynch

Got it. That’s very helpful. And then a quick one for Bob, Bob you spoke about the increase in eval tools next quarter. I just wanted to figure out are these one year evals and how will it affect the expenses over the next year or so given that you won’t be generating revenue from them, but still supporting them?

Gary Dickerson

Yes. Most of it are approximately one year, still the somewhat of an incremental expense, but the leverage on these things is pretty high, because remember, when you put an eval tool into a fab, the customer mix just as big in economic commitment as we do. So, it is a really positive indicator that they are going to buy your tools in some volumes. So, we kind of like high leverage eval tools. The cost of these is not here, it’s sort of in the marketing budget we talked about in terms of investing and most of these are in that forecast.

Krish Sankar - Bank of America Merrill Lynch

Great.

Michael Sullivan

Thanks Krish.

Gary Dickerson

Thanks.

Michael Sullivan

We would like to thank everyone for joining us this afternoon. A reply of this call will be available on our website beginning at 5:00 PM Pacific Time today. Thank you for your continued interest in Applied Materials.

Operator

And ladies and gentlemen, this concludes today’s conference call. We thank you for your participation. You may all disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Applied Materials' CEO Discusses F3Q 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts