ASML Holding's (ASML) CEO Peter Wennink on Q3 2016 Results - Earnings Call Transcript

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ASML Holding N.V. (NASDAQ:ASML) Q3 2016 Earnings Conference Call October 19, 2016 9:00 AM ET

Executives

Craig DeYoung - Vice President, Investor Relations Worldwide

Peter Wennink - President and Chief Executive Officer

Wolfgang Nickl - Executive Vice President and Chief Financial Officer

Analysts

Sandeep Deshpande - JP Morgan

C.J. Muse - Evercore ISI

Kai Korschelt - Bank of America Merrill Lynch

Timothy Arcuri - Cowen and Company

Andrew Gardiner - Barclays

Gareth Jenkins - UBS

Patrick Ho - Stifel Nicolaus

Amit Harchandani - Citigroup

Farhan Ahmad - Credit Suisse

Francois Meunier - Morgan Stanley

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the ASML 2016 Third Quarter Financial Results Conference Call on October 19, 2016. Throughout today’s introduction, all participants will be in a listen-only mode. After ASML’s introduction, there will be an opportunity to ask your questions.

I would now like to open the question-and-answer session queue. [Operator Instructions] I would now like to turn the conference call over to Mr. Craig DeYoung. Please go ahead, sir.

Craig DeYoung

Thank you, Patricia, and good afternoon and good morning, ladies and gentlemen. This is Craig DeYoung, Vice President of Investor Relations at ASML. Joining me today from our headquarters here in Veldhoven, The Netherlands are Peter Wennink, ASML's CEO; and Wolfgang Nickl, our CFO.

The subject of today’s call is ASML’s 2016 third quarter results. The length of the call will be 60 minutes and questions will be taken in the order that they are received. The call is also being broadcast live over the Internet at www.asml.com and a replay of the call will be available on our website.

Before we begin, I’d like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the Safe Harbor statement contained in today’s press release and presentation found on our website and in ASML’s annual report on Form 20-F and other documents as filed with the Securities and Exchange Commission.

Now with that, I’d like to turn the call over to Peter Wennink for a brief introduction. Peter?

Peter Wennink

Thank you, Craig. Good morning, good afternoon, ladies and gentlemen, and thank you for joining us for our third quarter 2016 results conference call.

Before we begin the question-and-answer session, Wolfgang and I would like to provide you with an overview and some commentary on the recent quarter and provide you on our few view on the coming quarters. Wolfgang will start with a review of the third quarter financial performance with some added comments on our short-term outlook. Then I will complete the introduction with some comments on our longer term outlook and our EUV status.

Wolfgang, if you will?

Wolfgang Nickl

Thank you, Peter, and welcome, everyone. For Q3, our net sales came in at a very strong EUR1.81 billion. System sales accounted for EUR1.24 billion, driven by logic which represented 84% of sales which memory softening temporarily to 16%.

System sales included partial revenue recognition of approximately EUR85 million for the one EUV system we shipped during the quarter. This EUV revenue was not forecasted at the beginning of the quarter and was made possible because EUV system installation timing became predictable earlier than expected. From this point forward, our new EVU systems, a majority of revenue can be recognized at completion of system shipment.

Service and field option sales for last quarter came in at a strong EUR577 million. Our gross margin for the quarter came in at 46%. Gross margin was negatively impacted by 1.4 percentage points due to the partial revenue recognition of the one EUV system not originally forecast in revenue. Non-EUV gross margins came in above our expectation.

R&D expenses came in at EUR273 million and SG&A expenses came in at EUR89 million, both essentially as guided.

At quarter end, we had to make a fair value adjustment for the foreign exchange hedging instruments that we end up into in connection with the planned acquisition of HMI. This adjustment reduced our net income by approximately EUR28 million and was recorded in the interest line of our P&L.

Shifting to the order book. Q3 system bookings came in just over EUR1.4 billion. This included more than EUR300 million in EUV orders. Strong bookings continued in the logic sector in support of the 10 nanometer ramps with memory bookings increasing from last quarter supporting stronger memory shipments expected in Q4.

Logic and memory booking strength was in part due to three new EUV orders received from both sectors. These orders bring our total EUV system order book for 3350s and 3400 to 12 systems valued at about EUR1.3 billion. Our overall system backlog grew by approximately EUR90 million to EUR3.5 billion.

Turning to the balance sheet. Quarter-over-quarter cash, cash equivalents and short-term investments came in at EUR4.31 billion. This includes the proceeds from two euro bonds that we issued in July to partially finance our acquisition of HMI which is expected to close later this year.

Free cash flow for the quarter was a negative EUR72 million driven by shipment linearity and shipments for which we had received partial prepayments during the prior quarter.

With that I would like to turn to our expectations and guidance for the fourth quarter of 2016.

We expect Q4 total net sales of between EUR1.7 billion and EUR1.8 billion. While logic shipments supporting 10 nanometer ramps will continue in Q4, we will see them a bit more balanced against memory shipments. We expect to ship one NXE:3300 EUV system in Q4 with an associated partial revenue recognition of approximately EUR60 million.

Furthermore, we expect recognition of differed EUV revenue of approximately EUR80 million in the quarter.

Total 2016 EUV shipments will then come in at four systems, two systems showed of our targeted minimum of six systems. The one system, the customer’s sector is not ready yet to receive the system and for the other system, we experienced a delay of inbound material. The two systems that will move to 2017 will be incremental to our 2017 plan.

As a reminder, we have a production capacity of around a dozen systems next year and expect the outstanding orders to fill up that capacity by the end of this year.

We expect Q4 service and field options revenue to come in above EUR600 million, driven by ongoing strong demand for holistic lithography options, high value upgrades and our growing install base.

Gross margin for Q4 is expected to come in between 47% and 48% benefiting from the recognition of the deferred EUV revenue I mentioned earlier.

R&D expenses for the fourth quarter will be about EUR275 million, and SG&A is expected to come in at about EUR100 million. SG&A is impacted by onetime costs which are related to the planned acquisition of HMI.

Regarding share buybacks as mentioned last quarter, they have been paused while we’re in the midst of the HMI acquisition process.

Let me conclude with a couple of comments on the status of our acquisition of HMI, which we announced on June 16. In early August, HMI shareholders have voted in favor of the acquisition. We have received regulatory approval from TKS and the United States from the Competition Commission in Singapore from the Taiwan FTC and from the Taiwan Investment Commission for our inbound investment.

We are awaiting approvals from the Korean FTC and the Taiwanese Investment Commission for an outbound investment related to the private placement in ASML shares. Closure of the acquisition is still planned for Q4 of this year and we have begun the transfer of funds to Taiwan for final execution of the purchase.

With that I would like to turn the call back over to you Peter.

Peter Wennink

Thank you, Wolfgang. As Wolfgang highlighted our business continues to perform well and as expected. We had discussed the most relevant point of the quarter and our outlook for the balance of this year. I would like to take a bit of time to talk about our initial view of 2017 and review the status of our EUV program and customer interaction.

Although it's too early to formulate a full quantitative view about next year, we started to develop a qualitative view based upon early customer forecasts and our own modeling capability. Both of the memory sectors are expected to show solid bit growth again next year not too dissimilar from this year. Given the available wafer capacity in the memory industry, this in turn should drive our memory sales to levels of little spend at slightly higher than this year.

We expect 10 nanometer logic ramps to continue in support of the healthy demand levels for this generation of devices as also recently confirmed by one of our large foundry customers. Service and field option sales is expected to continue to grow in 2017 well on track to support our 2020 target of around EUR3 billion. This is in part driven by significant sales of scanner system upgrades supporting the efficient capital deployment of customers in the leading edge node transitions.

Regarding EUV in 2017, we will start to see to the real impact of EUV system sales on our top line with recognition of system shipped in the calendar year as well as pieces of remaining revenue recognition from system shipped this year.

As Wolfgang mentioned, EUV system installation timing became predictable this quarter such that we are able to recognize a majority of system revenues upon shipment.

You all may have heard a significant amount of I would call it chatter this quarter about what we might call a go or no go issues with EUV in logic. This is understandable given the current status of EUV maturity and its related stability performance.

However, let me remind you at this point that our customers are facing unprecedented imaging and overlay challenges and that they're all convinced that this imaging technology will help to overcome those challenges. And as a result, it should be no surprise to you that our efforts are fully focused on the other translation of this technology, specifically on the system availability of these highly capable net complex tools.

We believe the commitment of our customers is evidenced by the fact that we now have 12 NXE:3250 and NXE:3400 production systems in our backlog. We will also ship the final two NXE:3300 systems one before year end and the other in early 2017 to two different customers that they may also begin their in-house qualification of EUV for eventual production insertion. This will bring the total number of customers qualifying EUV for mass production to six both in memory and logic sector.

All of our major customers have now publicly announced their intent to insert EUV into their production roadmaps. Final decisions on the exact timing of EUV insertion by our customers will vary from customer to customer. Next to the timing of customers development programs, the number of EUV specific layers and their related plans timing of the high volume ramp, it also depends on key tool performance metrics all within a fairly tight but well defined time window.

Given the current status of the aforementioned, we expect that the production insertion of EUV will require shipping systems in volume starting in the 2018-2019 timeframe.

Just to remind you of our production capability, we will be able to produce around 12 new NXE:3400 systems in 2017 doubling this in 2018 and again approximately doubling this in 2019. Currently our leading EUV adoption customers are executing real preproduction layer qualifications trusting that we will bring litho system reliability to an acceptable level for high volume manufacturing insertion into timeframes I just mentioned.

To finish, supporting our customer’s clear intent on moving EUV into a production is our number one priority in order to ensure that our customers can execute their plan next note in the translation. ASML remains committed through everything within our capability and power to bring EUV to manufacturing readiness as soon as possible.

And with those comments, I would be happy to take your questions.

Craig DeYoung

Thanks Peter. Ladies and gentlemen the operator will instruct you momentarily on the protocol for the Q&A session, but beforehand as I always do I would ask you kindly limit yourself to one question with one short follow-up if necessary. And this will allow us of course to get as many callers as possible.

Now, Patricia, could we have your final instructions and then the first question please?

Question-and-Answer Session

Operator

Thank you, sir. [Operator Instructions] The first question comes from Mr. Sandeep Deshpande. Please go ahead sir, state your company name followed by your question.

Sandeep Deshpande

Yeah, hi, JP Morgan. Thanks for letting me on. My first question is regarding EUV, Peter. I mean EUV seems to have reached many of the landmarks that you have talked about, you've highlighted today the 15,000 wafers per day; one of your tools is doing 90% availability. But the question I have is, is there a moment where TSMC or Intel or Samsung says well the EUV tools from ASML say NXE:3350 is now qualified by us and we will be implementing it or this is not your own day that that happens this qualification is announced and this is an ongoing process with the customer? And I have one quick follow-up.

Peter Wennink

Yeah, I think you've basically gave the answer. I mean this is basically an ongoing process and it has to do with the fact that yes we are reaching the targets that you just mentioned on the regular basis. Then it is the - it’s the variability of the tools in the field, in the entire installed base that is - that is not consistently at those levels. And I think this is really what customers and ourselves are now working on to execute on those programs that will bring that consistency. And it will be an ongoing - there will be an ongoing process.

And like I said in my introductory statement, the requirements for us to start shipping EUV tools for insertion in high volume is for us the 2018 and 2019 timeframe. So we have still some time and this is exactly what we're going to use to get that consistency there so that us and our customers can take that informed decision.

Sandeep Deshpande

Thank you. And I mean the follow-up, you’ve talked about what you expect for 2017, I'm sure you’ve heard a lot of your major foundry customers conference call last week where they said that they believed the 7 nanometer node for them is going to be as big as 28 nanometer node. I mean the 28 nanometer node as you’ve highlighted yourself was a very major node at the foundries as such. And have you taken that into account in terms of your views into 2017 in terms of growth from the foundry/logic customers?

Peter Wennink

Well I think we've always said that we believe that potentially a 7 nanometer node was going to be a real node and a real node in volume and we just get a confirmation from our customers that that is indeed the case. And that statement that was made last year is just the confirmation of what we have believed all along. So yes, we will see a continuation a strong continuation and but beyond 2016 was a strong logic year for us and we see that continuing into 2017. There's no sign of any waiting of our customers intense.

Sandeep Deshpande

Thank you.

Operator

The next question is from Mr. C.J. Muse. Please state your company name followed by your question.

C.J. Muse

Yeah. Good morning, good afternoon. Thank you for taking my question. I guess first question I wanted to get I guess a little bit deeper into differed revenues and how we should think EUV prospectively. So once you recognize the 80 million in Q4, can you share with us what deferred revenues will be remaining?

And then as part of that how we should think about what percentage of ASP will be revenue immediately upon shipment?

And then lastly, how should we think about gross margin trajectory, now that your revenue upon shipment in the calendar 2017 timeframe?

Wolfgang Nickl

Okay. I would take this C.J. Growth on deferred revenue; first of all it’s in our mind a significant achievement that we know have this predictability of the installation because that takes one of the big hurdles to recognize revenue in the same way as EUV away. So we basically have two elements, we have the shipment and then we have certain performance criteria that we have to achieve later on. So in this particular case, it was a 3350 you know what the price of that tool is. It’s in the mid 90’s. So you can do the math what we’re going to recognize for that tool in 2017, I guess.

The performance criteria is linked to the target that Peter mentioned in his remarks. So, as we are achieving these, you should expect us in the next year 2017 to also recognize that part closer to shipment. So also in Peter’s remark already we said that for the 2017 shipment, we’ll recognize the majority. And I have to tell you it’s a little bit different customer by customer, but it is the majority, as you have just seen from this 3350. We will be not only able to recognize the majority of revenue closer to the shipment, but we will also catch up from this year shipment. So we shipped units for instance in the first half of the year that will see no revenue in 2016, so you’ll see catch up there.

So we’re very pleased with that. In the meantime while we’re looking, so the last couple of bumps there to get to the DUV like revenue recognition, we will update you on a quarterly basis on what the revenue will look like, just like we did for Q4, we have we have one system at sixty but then we have deferred revenue coming in at an additional 80 million.

As it relates to the gross margin couple of points there. First of all, the objective is clear. By 2020, we want to be at 40% gross margin. If you pair that with our other businesses, DUV will somewhere in the 50% range and holistic lithography were north of 70% and then our CLS business that’s the Cymer service business which is also in the mid 50’s or so.

You can see that that gets us to the 50%. On a standard cost basis, we are very close to where we want to be right now, you can impute that from the information we gave you that the one shipment that we recognized last quarter at a 1.4% dilutive effect. If you do the math, you’ll figure out it’s somewhere in the mid-teens percentage-wise and that’s not full revenues. So you can you see from a standard perspective, we’re doing, okay, but of course we’re shipping only a few systems this year.

If you look at the total EUV business, isolated from one machine, you have to take several other considerations. Number one, we have the infrastructure to build many more systems. So we have - we have cost of under absorption. We have a service model where eventually we will charge per wafer the good wafer out. We provide the service already but there’s not many good wafers out. So you can imagine that that’s a very significant loss business for us right now.

The learning curve, we are still looking on cost not only internally but also with our suppliers. And then there are other are areas like we still have to go out in the field and bring these systems that we shipped up to the later stand-up which is also of work that we need to perform that is unpaid.

And lastly, we have of course shipped this year mainly shipped and will ship 3350s 3300s and then going starting next year, we have 3400s which come at a higher ASP. So you should take this all into consideration and you look at the overall EUV business, it is still significantly negative gross margin for us. But the standard is approaching where we needed to be and with the volume coming in, it really depends on volume and learning curve and we believe based on what we see in backlog and based on what we hear from our customers, I mean DSM for incidence was very explicit about their EUV plans going forward and Peter mentioned the ramp will be in 2018, 2019. We believe we can get to that 40% that gets the company to 50%. I hope that was not too much detail but you asked so.

C.J. Muse

That was fantastic. I greatly appreciate the detail and I guess there was multi-part, so well like it’s sneaking a quick second one.

Wolfgang Nickl

Yeah.

C.J. Muse

On the foundry logic side, your immerging shipments are going to grow probably 60% year-on-year this year. I’m just curious clearly 7 nanometer will be a meaningful node. But is that sort of shipment level sustainable and as part of that as you think of through calendar 2017, how do you think about linearity of spend? Thanks so much.

Peter Wennink

Yeah, C.J. I think like I said in my introductory statement, it’s too early for us that you will you will understand that, that’s to be quantitative on 2017 is not possible. But we do have very clear discussions with our customers on their requirements for 2017 and we do our own market forecast at simulations and we grow rate there to. And the way we’re looking at today is that we believe that the logic ramp will continue as strongly as we’ve seen in 2016 also in 2017.

Memory, given the wafer capacity situation and what we hear from customer’s dept, we believe the memory business will be at least at the same level if not slightly up. And I think in the services and options and update business I think we will grow up next year. So I think it’s currently from quarterly point of view, it’s very difficult for us to see, that let’s leave you a bit to decide that on the rest of the business that 2017 would be a lower year than 2016, very difficult for us to see there, because logic strong, memory is at least as good perhaps they are slightly up, we have a sale - service and option and upgrade business that will be up.

C.J. Muse

Very helpful. Thank you.

Operator

Our next question is from Mr. Kai Korschelt. Please state your company name followed by your question.

Kai Korschelt

Yes, good afternoon gents, it’s Bank of America. Thanks. I just had a follow-up on the EUV adoption question earlier and I think you had said it’s obviously an ongoing process and there’s not you know there’s probably moment where kind of your customers just sort of flick on a switch in their minds and say we’re going to go for it. But I’m just wondering in terms of maybe on the availability targets which seems to be the main criteria, you obviously said 90% is the key level but I guess the question that we all have, how long is that 90% availability, how long do the tools need to deliver that availability, is it a couple of months or six months, because I think you have mentioned you achieved it for about a month’s now with an old tools. I’m just wondering in a kind of high close, are we to that you know potentially critical availability level? Thank you.

Peter Wennink

Yeah I think - I think we’ve said in that in the past 85% is probably you have a threshold that the customers are going to say fine. Let’s go but it’s about the predictability. So when we talk about 85%, it is 85%, that is not for days or for months, it is with the constant use of the tool versus 85% ability of your installed base. So that is what it is today, for incidence we’re talking with Deep UV, we were talking about availability percentages are way over 90% and that's where the entire install base. It's at not over week, not over 13 week period, it is maybe ever.

Now that is - that's a very clear target, you see where we are today 2016 and where we will be in two years' time. We believe that having seen the levels of availabilities and the capability of individual tools in the field, not the entire installed base yet and looking at the projects and the programs that we will execute on, because we know what to do that given the fact that we can show that availability over really for long period, this is not days, it's weeks, it's in effect months. Then we believe that we can get there at 2018, 2019 when we start shipping them in volume.

And that will happen overtime, I mean if you - if you look at the number of programs and projects that we are running to get to that level there are dozens and all need to be executed one by one and everyone will actually call and contribute to a percentage point of increase or several percentage points of increasing that availability. So it's going to be an ongoing thing. Like it was an ongoing thing coming from 30% to where we are today, it's a continuous process together with our customers, but with a very clear roadmap.

Kai Korschelt

Okay, thank you.

Operator

Our next question is from Mr. Timothy Arcuri. Please state your company name and ask your question.

Timothy Arcuri

Cowen and Company. Thank you. I had two, I guess first of all looking, I'm still trying to understand margins on EUV. I think we have previously been talking about needing sort of 20 to 25 systems a year to get to roughly 40% margin and then I think that has gone to maybe having to ship 40 systems to get to 40% gross margin. So you're certainly making progress, but it seems like the supply chain is beginning to sort of hold you back. So I guess my question is really around your need to subsidize the - your suppliers because certainly your customers wrote you checks, but it seems like maybe you have to write your suppliers checks and what the impact that could have on margins? Thanks.

Peter Wennink

Okay, so Tim let me go. So one thing I can tell you clearly there, there is no additional COGS coming in from increased prices of suppliers. Yes, it's true that we have supported suppliers with certain prepayments, but those are basically financing transactions has nothing to do with gross margin and the P&L.

You are also right in a sense that volume clearly is the biggest contributor to the overall gross margin, you can I think you have been here you can look at the factory it’s there, and if you only ship three or four units, those units have to carry the burden of that entire infrastructure including the management that they're in and the quality systems and everything that’s in there. So in that sense, volume is clearly the greatest drive to get to the gross margin.

The bit of a debate in the last quarter call well, can you pinpoint it to an exact number, that it’s difficult because I can tell you we could ship 50 systems if we don't make any progress on the learning curve in all customers we may not achieve the 40%, but reversely we can be at 25 systems and we're making good progress on the learning and we'll be at the target early. So I don't want to link it to a specific volume, but it's very clear volume is the biggest contributor to getting to that 40% gross margin. I hope that helps, Tim.

Timothy Arcuri

Yes. Thanks, it does. I guess just as a last follow-up. Wolfgang, can you normalize the guidance, if you strip out both of the effects of the EUV, what is the gross margin in the fourth quarter minus effects with EUV?

Wolfgang Nickl

It’s roughly 2.5 point impact. So if you take 47.5% in the midpoint of our guidance, we would be somewhere in the - above 45% which is in line with what we've done before actually a little bit higher, because the field options in that is driven up this quarter and lot of it is options. So may - we will be over 45% without EUV.

Timothy Arcuri

Okay, thank you.

Wolfgang Nickl

You are welcome.

Operator

Our next question is from Mr. Andrew Gardiner. Please state your company name and ask your question.

Andrew Gardiner

Good afternoon and thank you. It's Barclays. I just had another one on EUV, Peter you reiterated the expectation of the sort of 12 units plus the additional two that slipped, but 12 units next year being manufactured doubling in 2018, doubling again in 2019 then I can see what you're saying in terms of the 2017 shipments being supported by the current backlog, but I'm just - you’ve given that but obviously we always want more. So I'm interested in trying to think about 2018 and when we might need to see orders start to come in, so where the lead times at the moment when would you need customers start to start committing?

So as another part of that would be the big volume purchase order made by Intel in the second quarter last year, clearly you’ve got that sort of hanging around there it’s outsized think still after the official backlog, but presumably starts to step in at some point over the next year or two because some of those tools will be destined for 2018. So any insight as you can provide on some of those moving parts will be very helpful? Thank you.

Peter Wennink

Yeah, I think clearly like Wolfgang said, by the end of the year I think we have in the backlog at least the 2017 outputs secure to orders. But also I think what we are seeing is that the next two quarters or so, we will see also the first orders for 2018 coming in filling that up, because doubling in 2018 with the lead times that we currently have means that we need to start booking those orders as we speak and that is also exactly the activity of our sales force as we speak with our major customers.

Having said that, because these are volume shipments it should not be a surprise to you and to others that we're in deep discussions with volume purchase agreements with those key customers as we speak. And I think the orders will be subset that will be let’s say an integral part of those volume purchase agreements so called VPAs. And that's happening as we speak.

Wolfgang Nickl

Can I time in for a second with a correction Tim for your question. I just got my calculator out. I misunderstood your question I believe. The - what I quoted to you was just taking the deferred revenue out but then of course you need to take the 3300 out as well. So if you take both aspects of EUV out, we would be more like 46.5% or something like that and that’s the increase that's driven by the increase in field options. I hope that is clear. I wanted to make sure that you have the full EUV effect because as I think what you had asked me.

Peter Wennink

Yeah this was an addition to the question.

Wolfgang Nickl

You understood?

Andrew Gardiner

Yeah I understood. So Peter, you suggesting that we can anticipate perhaps a mix of sort of ones and twos of orders, but also for some of the bigger customers you anticipate a similar type of announcement to that which we had from Intel in the second quarter last year?

Peter Wennink

Yeah, I think that that's normally how we work which is not typical for EUV that’s typical for the Deep UV and other businesses also. I mean we are actually have these volume purchase agreements over a longer period of time, could be a years, could be a node, could be 18 months. It depends on the customer where basically we say at this particular volume these are the conditions the terms and conditions under which we will ship. And that’s also true for EUV for 1Cs and 2Cs [ph], you don't need volume purchase agreements, that to be clear.

So that for volume we need volume purchase agreements, because that has an impact of pricing and customers would like to see that impact. So this is also another surprise they were in deep discussions as we speak on those volume purchase agreements, which will be the trigger you could say which will be the umbrella and which the individual deals will be issued.

Andrew Gardiner

Okay that's great. Thanks very much.

Operator

Our next question is from Mr. Gareth Jenkins. Please state your company name followed by a question.

Gareth Jenkins

Thanks. Just one quick one from me. On the customer co-investment plan, I wondered you’ve helpfully reiterated the EUR10 billion revenue target and tripping of EPS. Could you talk about the OpEx between and what your expectations are with the customer co-investment plan comes to end, do you think you'll roll this forward or you seeing the OpEx that you are currently enjoying the benefits from your peers like the core customers I should say.

Wolfgang Nickl

Again we’ll talk in more detail in one and a half weeks from now but we continue to forecast about 13% of revenue for R&D and that does not assume continuation of the customer co-investment plan. Having said that it also doesn’t really hit OpEx in terms of R&D, it’s actually in gross margin, part of it is other income, and part of it is balance sheet straight into equity transactions. So doesn’t impact R&D but we have not modeled a continuation of that plan.

Peter Wennink

If I may walk in, just refreshing memory, this discussion of co-investment program was specifically made to support ASML in the let’s say double in investment time we would - let’s say about five years where we had to invest in leading SDPV but also have to invest in EUV and initially we thought it could have been for 50. Now when you look at when that ends it will end in the end of next year. And when you look at when EUV start ramping in volume, well our plan is that you know doubling the 12 in 2018 and bearing in mind the discussion that we have on the very significant impact that volume has on the EUV margins, by the time we were in 2018, there will be margin inflow that actually pay for the R&D money that we need to spend for EUV going forward.

So I think it’s almost like a perfect match in the sense when the CCIP tails off and our EUV business for which the CCIP was intended actually it takes off. So it was well planned, well timed.

Gareth Jenkins

Great. And just month full of on Hermes [indiscernible], but could you talk about your aspirations in terms of market share for the combined product with HMI? Thanks.

Peter Wennink

You know we always have aspirations to drive market share up. I mean that in itself is not a goal and is a result. I mean we are focusing really with the HMI acquisition to combine the competencies of the two companies and create something which from a value point of view is not available in the market today. And so effectively means we’re looking for industrial products synergy. And this is the reason for the acquisition. You could argue that the product that we are focusing or that we’re envisaging is a product that does not exist today. And so in that sense, qualitative dream, but I think we think it’s a little bit more than a dream. I think it is a doable. It is executable. But it is something that is not available today.

You know how much of that will be valued by our customer base as being high value remains to be seen. We have high hopes, but we do believe that in this new product combination, we will create significant value for our customers to go through all their yields and their pattern in cost and the reason what we’re focusing on. And revenues successful, we’re grow market share, where we’re not successful and then we will sorry that’s not what we expect.

Wolfgang Nickl

And then well we cannot express it that well in market share to be disappoint, we’re planning in two weeks in when we meet in New York for the Investor Day to at least give you a sizing of what we expect business-wise in terms of revenue of these new products by 2020.

Gareth Jenkins

Thanks.

Operator

Our next question is from Mr. Patrick Ho. Please state your company name followed by your question.

Patrick Ho

Yes. Thank you. Stifel Nicolaus. Good afternoon, guys. First on the EUV side, you talked about the percentages and the increases there over the short period of time. But what are I guess some of the meaning key variables that will get you more consistently at that 90% level for an extended period of time. What are some of the final things that you need to do to get past that metric point?

Peter Wennink

Yeah, these things are basically looking at the - as you know I know I suppose that you know that the EUV plasma is created by using a high power CO2. So it’s in fact the continued laser stability which is a program that we’re running with our supply troop and the south of Germany. The second point is the tin management in the vessel, which basically which we need to contain any contamination are coming out of tin distribution over time. And we have several programs running there, so I would summarize it as those two. So it’s tin management in the vessel, and it’s the stability of the drive laser. And that’s a drive laser to basically create the EUV plasma out of tin. And that side is also of smaller projects and some bigger projects that we are running with our customer base and with our supply base, but those are very well defined.

Patrick Ho

Great that’s really helpful. And my follow-up question on in terms of your core business, at the DRAM industry migrates to the 1x nanometer node, how do you see capital intensity rising for lithography given the more patterning steps that are going to be involved?

Peter Wennink

It’s a good question. We’ve seen the introduction of first multiple patterning in DRAM because of that, that’s one. But I think when you talk about the 1x let’s say the mid node 1x, we see the introduction of the EUV being planned because of the complexities that come with the patterning strategies at that level of using to be simply not possible and the EUV is the way to go. So yes the density will where we go to 1x will go up but largely in the 1x note and 1x bit node as you know starting you’ll see the introduction of EUV.

Patrick Ho

Great thank you.

Operator

The next question is from Ms. Casey Lynn [ph]. Please state your company name followed by your question. Hello Ms. [Indiscernible] your line is open. Hello? We’ll follow with the next question.

The next question is from Mr. Amit Harchandani. Please state your company name followed by your question, sir.

Amit Harchandani

Hello everyone. It’s Amit Harchandani from Citigroup, London. Thanks for taking my question. My first question is, is really with respect to the demand evaluation for emerging tools. You have talked about strength from the 10 nanometer; you’ve touched up on memory. Could you maybe give us a granular insides into how does that breakdown between DRAM and NAND and whether the lead times for your tools have any role to play in terms of how you’re seeing the orders shaping up, you’ve talked about to pick up in Q4, you talked about memory being slightly higher next year. So I was wondering if you would share some more granularity in terms of DRAM and NAND and how you think that shapes up in Q4 and beyond. That could be my the first question.

Peter Wennink

Like I said, we gave you some qualitative indications. As Wolfgang said in his introductory comment that we see every shipments going up in Q4 as compared to Q3 and actually if you look at the total year 2016, we believe that memory shipments based on the installed wafer capacity and the customer demand and the bit growth assumption that we currently have that memory will be upwards, will be flat or slightly up next year. Now the split or the granularity that you are asking for between in DRAM and NAND is a bit difficult because what we’re seeing very much is that the DRAM tools currently leading DRAM tools are relocated to NAND. And then basically NAND litho is then growing in terms of installed base but then we ship to DRAM to replace the relocated tool that went to the NAND factory.

So it looks like a DRAM shipment, but in fact it’s a NAND shipment. So this is all why we basically combine this into, you know memory is very difficult to give you a detailed breakdown of what is DRAM capacity growth or NAND capacity growth. There’s a lot of relocation going on that between the two memory sectors.

Wolfgang Nickl

And as it relates to the lead time, we have about six monthly lead time also. And I want to remind you again that even though you may not see the order in the order book, we have VPAs, volume purchasing agreement with all of these customers where they also regularly provide us with sales forecast. So we will pay out with some variation to whatever the demand is going to be in 2017.

Amit Harchandani

Thank you. And maybe as a quick unrelated follow-up with respect to your service and field option sales, the idea was to get to I think 10% growth year-on-year, this year seems like you need a strong Q4 well above 600 to get there and even beyond that I appreciate will give us the road map in two weeks’ time. But should we expect more off sort of a linear trajectory going forward, is the best way to model it and how does reuse come into all of this?

Wolfgang Nickl

Okay, good question. First of all I made correct me, you did the math apparently if you get to 10% you need like 650. We have set that will be over 6% and up. So we'll be anywhere between 7% and 10%, we'll see how that goes. In terms of the makeup, a little bit less than half of this is service and in general if you take the full year and that is fairly predictable. I mean that there you know what your install bases and what the contracts are and that's a pretty steady state nicely growing but business for us.

Options have two portions to it, there are the upgrades and the upgrades need to be somewhat linear, because you've got to have the teams that perform the upgrades, so we need to schedule those and these will be growing overtime, but they - it will be more like a linear growth. But then you have various options and increasingly with holistic lithography software options that can be deployed at relatively short notice and that’s the difference that you see in a quarter like we have ended it now and there you can see that you have one quarter that’s stronger than the other.

So strong business for us, I think you'll see that we - whether it’s 7% or 10% will be over EUR2.1 billion, EUR2.2 billion this year, which is close to a sort of all business and when we're talking in 2020 and when we talk in two weeks at our Investor Day, you'll see that it will also continue to grow strongly. I think you'll see that business well over EUR3 billion by 2020.

Peter Wennink

And perhaps Amit, the term reuse is a kind of a - is kind of a cold peanut term that’s so much in there just to give you an indication, I mean you could do a reuse, but basically saying, okay I have a litho tool in a logic wafer fab and I'm going to add for the next node and the next generation litho tool, but I'm going to reuse some of those tools that are in there for that new node that is one. Reuse also is relocations you know you move one fab to the other tool to go to a different part it just gave the example of memory.

Reuse is also I have this tool sitting there which your leading edge tool I’m going to upgrade it to the next level. So it's actually that leading edge tools remains the leading edge tools, but not in the same shape, because it has a very significant upgrade that can be anywhere between EUR15 million to EUR35 million. So it's a heterogeneous cold term that you have to be careful with using in more general terms.

Amit Harchandani

That’s very helpful. Thank you, gentlemen.

Operator

Our next question is from Mr. Farhan Ahmad. Please state your company name followed by your question, sir.

Farhan Ahmad

Thank you, Farhan Ahmad from Credit Suisse. Thanks for taking my question. My first question is on EUV. You guys have been making very good progress on EUV, but some of the challenge seems like outside of what you guys doing more in the bucket of what your customers are doing. So I just want to get your perspective on three things that have come up from one of your customers have challenge. One is on the mask blank inspection. Second is on pellicle it seems like the transmission is very low like 30% losses right now and that is an extra quoting that needs to be applied which takes up even more of the EUV line. And third is on mask inspection or like actinic mask inspection if EUV have to be adopted in like high volume in multiple layers it seems some of your customers are asking for that. So I just want to hear your thoughts on how important these challenges are?

Peter Wennink

Yeah it's a good question. I think they're all important. Mask blank inspection that needs to happen clearly, but we have a solutions there. I think our partners calls ours, they start to ship the first mask blank inspection tools to actually do that. And I think that the first always in the shipment right now. So there are solutions there and they will go to the first customers.

I think that's the major issue.

If you ask me, Peter, is there tool to install right now, no, but it's in shipment and more will follow. The pellicle transmission, yes that is an issue, but the 30% loss that you just quoted there are better - there are better results you know as we speak. That is also something that has been develop or started to develop last year. And if you look at the curve of development, we've made clear progress. Now our biggest challenge is not so much the transmission of the pellicle, I think we're getting there - we're making progress there.

Now it is we need to start, we the industry need to start making pellicle as a kind of a volume product at the right specifications, and that production process is just starting up. So there we need to have improvements in the yields that the pellicle producer currently has, but that's all normal when you look at where we are in the initial stage of that volume production process. But we don't expect that to be a showstopper that's going to be just hard work on - basically in like to say with ASML, it's hard work of the industrialization.

And then mask inspection actinic inspection we said it before, 47 nanometer node, we don't need that. Going forward, five nanometer three that is a potential for some customers. Some customers won't need it, because they actually say we can't afford if you're a memory customer, you're not a sensitive if you're a high value logic customer. So for the upcoming nodes, let’s say till the end of the decade that is not a major issue and we need to find a solution beyond that where there is an actinic inspection tool or another solution that still remains to be seen, but that's not a hindrance for the initial introduction of EUV at the 7/10 nanometer node.

So yes they're all issues that need to be worked on. They are not signed off as absolutely you know for free. There are issues that you know need to be resolved, but that’s pretty normal when you look at when those development have started and where we are today.

Farhan Ahmad

Thanks Peter. And then as a follow-up on one question on EUV High NA system, I just want to understand if your OpEx level or R&D level of 13% assume that High NA system would be needed. And secondly like is that an opportunity for another customer co-investment program when you guys are get into those discussions?

Peter Wennink

Well it's a very good question. I mean if you think about EUV High NA, you talk about the next generation EUV tool that will be introduced somewhere in the course of the next decade that will require quite a significant investment in R&D. I think on average, the 13% R&D without 10 billion target should be able to deal with it, it's more a matter off, I mean if you take the cumulative planned R&D that we would need over the next five years or so, then cumulatively yes that would be that would suffice.

However when customers start telling us that they want this earlier, we need to put it in there you might see hump which then of course we will have to discussion with our customers how we will let’s say craft or stage the customer commitments to make sure that the interest of ASML with the increased R&D and the requirements of the customers are well aligned, and that of course always goes with some level of financial commitment and what that is we don't know yet. But when it is clear what customers want and what timeframe then we will definitely have those discussions, but on what format will take I don't know. It could be simple commitments of the placing purchase orders with high level of prepayment stuff like that could also be.

Farhan Ahmad

Got it. Thank you.

Peter Wennink

Ladies and gentlemen I think we are squeeze and one more short question. So Patricia, we can pick a short question. Just kidding, but anyway we do have time for one question. And by the way if you have trouble getting through, you had trouble getting through, as always feel free call the IR department and we’ll do our very best to get back to you as soon as possible with answer to your question. So Patricia, we can have the last question.

Operator

Okay. Our final question and it’s from Mr. Francois Meunier. Please state your company name sir followed by your questions.

Francois Meunier

Actually, it’s Francois Meunier from Morgan Stanley. So just a quick one actually on maybe something a bit more longer term well I know everyone is so focused on the gross margin. Is there market for laser spare parts going forward, so basically at some point, you will have a install base of I don’t know what I say 50, 100 EUV machines. So is there market for changing the laser from the Cymer business and how significant could it be from 2020 onwards?

Wolfgang Nickl

And on spare parts, the way how we are going to deal with is for EUV is we’re going to have sell this model that actually the customers cost is predictable for the customer and we’re going to set the amount of good wafer and that would of course then cover the labor and the parts required to keep the machine right.

Peter Wennink

If you want to make any connection or any comparison with the Cymer model which is the - those model, we are basically customer pays pulse and in that sense similar and we’d agreed with our customer that the paper wafer. So that would actually mean that the spare part usage would be our problem not the customer’s problem because the customer has a variable cost not for wafer.

Francois Meunier

Okay, very good, see you in two weeks.

Peter Wennink

Thank you. Along with thanking everybody joining the call, I would as Wolfgang referred to couple of times, we do have an Investor Day coming up on Halloween, October 31st in New York City and we hope that you would be able to join us in there if not at least be able to listen in. Now operator if you could formally conclude the call, we would appreciate it. Thanks.

Operator

Thank you, sir. Ladies and gentlemen, this concludes the ASML 2016 third quarter financial results conference call. Thank you for participating. You can disconnect your line now.

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