Applied Materials Inc (AMAT) — Q1 2015 Earnings Call Transcript

Thank you, Dustin. Today, we'll discuss the results for our first quarter, which ended on January 25. Joining me are Gary Dickerson, our President and CEO; and Bob Halliday, our Chief Financial Officer. Before we begin, let me remind you that today's call contains forward-looking statements, including statements about Applied's performance, products, strategies, opportunities, announced business combination with Tokyo Electron, and business and industry outlook. These statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied, and they should be interpreted in that light. Information concerning these risk factors is contained in our most recent Form 10-Q and 8-K filings with the SEC. Forward-looking statements speak as of February 11, 2015, and we assume no obligation to update them. Today's call also includes non-GAAP adjusted financial measures. Reconciliations to GAAP measures are contained in today's earnings press release and in our reconciliation slides, which are available on the Investor page of our website at appliedmaterials.com. Now I'd like to turn the call over to Gary Dickerson.

Thanks, Mike, and good afternoon. Let me start by providing an assessment of our overall progress. First, our long-term strategy. We are driving profitable growth by enabling major technology inflections using our precision materials engineering leadership to gain share and grow faster than the markets we serve. Major transitions in semiconductor and display technology create great opportunities for Applied. We are making meaningful progress toward our long-term strategic goals, and this will be accelerated by our upcoming merger. In the midterm, we have been focused on opportunities that move the needle for customers and for Applied. We have strengthened our R&D and field teams while increasing investment in product development. We've also created a pipeline of new, differentiated products that accelerate Applied's growth as customers move new technology into high-volume production. And we're managing the effect on margins as we ramp these new products. In the short term, the forecasted levels of investment by our customers provide a solid foundation for the year ahead. While there are challenges inherent in our spending mix and some uncertainties about timing, we remain firmly on our trajectory of profitable growth. At the same time, we are completing our preparations to merge with Tokyo Electron. The Applied and Tokyo Electron teams are very excited about the strategic opportunity this merger creates and share a strong commitment to work together to achieve our performance goals for the new company. We believe we are making progress with regulators around the world on a coordinated proposal that would allow us to move forward with our business combination. We are working to secure the remaining approvals and complete the merger as soon as possible. During this phase, we've been advised not to provide details or answer questions about ongoing discussions. Turning to our market outlook, industry growth is fueled by evolving trends in mobility, connectivity, video, and wearable devices. This is accelerating innovations in mobile processors, solid-state storage, and interactive displays. Our customers are focused on winning share in these inflections, resulting in a period of sustained investment by semiconductor customers. We believe wafer fab equipment spending for calendar 2014 was approximately 15% higher than the previous year. As we look ahead, we maintain our view that the market could grow another 5% or more in 2015. In foundry, we expect investment to be maintained at the same healthy levels seen in 2014 with the potential to be slightly higher than last year. Our current view is that spending for advanced nodes will be heavily biased towards the second half of the year. While we see some timing uncertainty with the ramp of this complex technology, the FinFET inflection is highly beneficial for Applied, expanding the opportunity for our leadership products in FE, metal deposition, implants, anneals, and CMP. In memory, supply remains tight with a healthy pricing environment and robust investment. In the past quarter, we booked our highest orders from memory customers in over 7 years, including our highest quarterly DRAM orders since 2010. DRAM bit growth for 2015 is expected to be around 30%, with mobile DRAM standing out as the most significant driver. While technology conversions currently provide a large portion of the needed supply, increasing device complexity and additional process steps required at the smaller nodes are reducing effective factory output. In addition, mobile DRAM devices are typically larger than PC DRAM, and the combination of these factors is leading to new capacity additions this year. The market for NAND memory is also expanding, as leading smartphone makers have doubled the average bits per box over the past 12 months, and this, added to growth in solid-state drives, is supporting NAND bit growth in the range of 40%. Although we believe the majority of NAND investments will still be focused on advanced planar capacity, we see 3D NAND spending for the year at approximately twice the 2014 level, with more customers starting to move to this technology. The industry's transition to 3D NAND has been slower than forecast; however, it remains a positive inflection for Applied, expanding our served available market by 35% to 50%. The outlook for display also remains very healthy. Average TV sizes are growing faster than historic rates, and we are seeing a surge in unit sales, fueled by consumer spending on new 4K and OLED models. Demand for bigger, higher resolution, low-power screens for mobile applications is also a key factor behind display growth. In TV and mobile, supply is tight, and our customers are investing in new capacity and advanced technology. This quarter, our display business delivered its highest revenue in the past 3 years. As we have said before, major inflections like FinFET, 3D NAND, and new displays represent unprecedented technology advances that are enabled by materials innovation. We are still in the early stages of these inflections, and as they play out over the next several years, they create great, long-term growth opportunities for Applied. To fully capitalize on these transitions, we have aligned our structure and talent around key areas of value creation. We will continue to aggressively manage our product portfolio to quickly shift resources to areas that are truly enabling for customers and generate the best returns for us. We are starting to see the impact of these changes. In 2013, we won 1.4 points of share in wafer fab equipment while delivering innovative and enabling new products to customers. In 2014, we consolidated our new product positions and strengthened our product pipeline. We believe we gained or held share in almost all our businesses, and based on our current view of customer spending, we expect to grow our overall wafer fab equipment share again in 2015. We are making our largest gains in areas where the market is growing rapidly, including CVD and Etch. This past calendar year, we estimate that we won at least 3 points of share in CVD and 5 points of share in conductor etch. Etch is a business where we continue to build momentum. We have been focusing on key technology inflections in market segments where we believe we have sustainable technology differentiation. New wins in memory combined with our traction in foundry helped us deliver our highest Etch quarterly revenues in orders since 2007. Our latest generation Etch system has one of the fastest adoption rates of any new Applied product in recent years. We shipped 3 times as many chambers in the first quarter than we did in the prior quarter, and we expect to double shipment volumes again in Q2. We also see great opportunities to grow our service business. We are bringing together capabilities from across the company to develop expanded service offerings that help customers ramp complex new device technologies faster and at lower cost. At both leading and trailing nodes, wafer starts and fab utilization are at very high levels. We are winning new service contracts from a broad base of customers and growing faster than the market. Over the past 2 quarters, our service business booked its highest orders for any 6-month period in our history. In summary, while there are risks related to the timing of customer investments, our current view is that 2015 will be a year of solid market growth driven by robust memory spending in the first half and foundries ramping FinFET production in the second half. Applied Materials has a strong platform to gain share, driven by tremendous customer pull for enabling precision materials engineering products and services. And across the organization, we remain highly focused on improving execution. We are driving alignment, speed, and scale as we prepare to merge with Tokyo Electron and hit the ground running as we become one company. Let me now hand the call over to Bob, who will provide further details on our performance and outlook.

Thanks, Gary. Gary gave us an update on the market environment and the status of technology inflections. I'll begin by translating how we expect those patterns to play out in our business during the current fiscal year. First, you'll notice that memory spending is particularly strong in the first half of our year. In Q1, our memory orders topped foundry and logic orders for the first time in 5 years, and we could see a similar mix in Q2. Next, you will notice that while our foundry customers are intensely focused on ramping FinFETs, the order pattern is shaping up to be back half loaded, also for the first time in years. We expect this mix to put more revenue and margin in our fiscal second half. The high mix of memory in Etch resulted in gross margins being below our expectations for the quarter. Specifically, Etch grew 90% sequentially, higher than our previous goal of 60%. Gary spoke about our focus on portfolio management. Like we discussed, some of the results we're seeing in our efforts to generate profitable growth across our businesses. In AGS, we've strengthened the linkages to SSG and operations, invested in higher-value offerings, and focused on delivering long-term service contracts that could help customers with uptime, yields, and cost. After 2 years of declining sales, AGS posted 9% growth in fiscal 2014. AGS delivered near-record orders in Q1 and is on track for continued revenue growth and margin expansion. Our Display business was the first one to fully deploy our product development engine best practices and received internal funding to capture share in CVD, PVD, and new products based on large area precision materials engineering. In Q1, the Display group posted a second sequential quarter with operating margins above 25%. Display also had strong momentum, with new Gen 6 PVD products for advanced mobile displays and new CVD encapsulation systems for OLEDs. In FSG, the increased investments we made beginning in the second half of 2012 are starting to pay off by giving us memory share gains during a period of renewed memory investment. In calendar 2014, memory spending drove the growth of the Etch and CVD markets at a higher rate than overall WFE. We believe Applied's Etch and CVD businesses grew more than 50% combined in calendar 2014, which is 1.5 times the rate of the Etch and CVD markets and over 2 times the rate of our largest competitor in these areas. Our latest Etch platform is generating traction in foundry as well as memory. We have a task force in place to drive our Etch gross margins to higher levels as we mature our new chamber technology and increase our scale. In foundry, our investment in advanced deposition techniques are enabling strong adoption of CVD cobalt for interconnects and new Epi steps in emerging nodes. In Logic, we have nearly doubled the number of D2R wins in the past 2 years, which is a good leading indicator of share gains in next-generation transistors. And finally, over the last 2 years, we have tripled our corporate technology group's funding of disruptive new products and markets for our longer-term growth. In short, we are seeing strong early returns for our growth initiatives within FSG, Display, and AGS that will allow us to grow revenues and profitability, particularly as our customers ramp new nodes into higher volumes. Next, I'll summarize our first quarter results as compared to the prior quarter. Orders of $2.3 billion were up 1% sequentially, with increases in FSG and EES, offsetting decreases in AGS and Display. Although AGS orders were down from our Q4 record, they were the second highest ever and up 16% from Q1 of 2014. Net sales of $2.4 billion were near the high end of our expectations. Non-GAAP gross margin was 42.3%. Non-GAAP operating expenses of $552 million were near the low end of guidance. As a reminder, many of our groups had a holiday shutdown during the quarter. Non-GAAP EPS of $0.27 was at the midpoint of our guidance. Operating cash flow of $60 million reflected high revenue from Display tools that were previously secured with cash in advance. In Q1, we also had annual incentive compensation and withholding tax payments. Absent the timing of these items, operating cash flow remains strong. Now I'll comment on our segment results as compared to the prior quarter. FSG orders of $1.4 billion were up 7%, with increases in memory, offsetting decreases in foundry and Logic. FSG net sales of $1.4 billion were slightly above the midpoint of our expectations. FSG non-GAAP operating margin decreased slightly to 24.2%. AGS orders of $690 million were down 8% and remained at near-record levels. AGS net sales of $583 million were in line with our expectations, and AGS non-GAAP operating margin increased by 1.7 points to 26.4%, reflecting favorable product mix. Display orders declined to $107 million, and we expect the booking pattern to remain lumpy. Display net sales of $275 million were up 45% as customers began to ramp the new TV capacity booked over the last 6 to 9 months. Display non-GAAP operating margin was 26.5%. EES orders grew slightly to $50 million, and net sales of $55 million were below our expectations. EES both posted a small non-GAAP operating loss, and we continue to monitor the solar market closely. Now I'll provide our second quarter business outlook. We expect our overall net sales to be flat to up a couple of points sequentially. Within this outlook, we expect FSG net sales to be up by about 4% to 8%. AGS net sales should be up by about 5% to 10%. We expect Display net sales to be approximately $160 million, and EES net sales should be approximately $75 million. Non-GAAP gross margin should be approximately flat. Non-GAAP operating expenses should be in the range of $570 million, plus or minus $10 million. We expect non-GAAP earnings per share to be in the range of $0.26 to $0.30. Now let me turn the call back over to Mike for questions.

Thank you, Bob. Dustin, let's begin.

Bob, can you give us the specific SSG order breakout by memory, foundry? And then maybe within memory, can you give us DRAM and NAND?

Sure. Let me take it out. Yes, in Q1, foundry was a little under 500. Memory total was about 700, a little over, and Logic and other was about 200.

Okay, great. And then, Bob, I just wanted to ask about margins. You talked about the second half being stronger. It sounds like fiscal second half revenue is going to be up versus fiscal first half, but the margins in the fiscal first half have been a little bit under pressure. Can you speak to why that's been the case? And will the margin pressure lift during the fiscal back half the year? Of course, this is on a standalone basis excluding the merger, obviously. But will that margin pressure lift during the fiscal back half of the year?

Yes, it should. The main factor affecting us is the mix within SSG. We're performing well and gaining market share in Etch, especially in memory. In fact, over 50% of our orders in the first couple of quarters are memory-related, which is a record for us. Much of this increase is driven by Etch and CVD. We're successfully shipping new tools, and our C3 chamber is performing exceptionally. However, this is slightly impacting our margins. Typically, we expect foundry to strengthen a bit earlier and the tool mix there to be more favorable for our margins. This mix is causing some challenges for us. We experienced similar dynamics in the early part of last year, but foundry began to recover early last year. Therefore, we anticipate an improvement in the second half, but that's the situation we're currently facing.

Yes, Tim, one thing I'd say is that, I think, the good news is that we're getting great traction with some of our new products, including products in Etch and CVD, and some of the fastest ramp rates that we've ever seen for new products. But the startup costs there are also higher, and then over time, we can work those back down.

First, Gary or Bob, if I look at foundry spending over the last few years, it's always been front half loaded, which kind of makes sense given end consumer products release in the second half. What is different this time around that foundry is actually back half loaded?

Yes, we've discussed that question quite a bit. In my view, spending generally tends to be heavier in the first half, and last year it even started a bit earlier than in previous years. This was mainly because a key foundry had the Apple business and aimed for an effective ramp-up. For instance, they took our Epi tools a bit earlier to ensure everything was functioning well and to facilitate a smooth ramp. This year, it's uncertain when the transition to FinFET devices will occur. Customers have indicated plans to ramp up FinFET production and invest significantly, but it appears the ramp-up might happen later this time. Additionally, the rate at which tools are reused is also influencing this timeline. Last year probably had an early ramp, while this year seems to be later than usual.

Got it, got it. All right. And then as a follow-up, on the conductor etch side, you guys mentioned significant wins last year. I'm kind of curious, when you quantify wins, is it by revenue shift or is it by units share? And also, which specific segments? Was it more on the DRAM NAND side or was it more on the foundry side?

It was revenue dollars as measured by Dataquest, and it was primarily in memory. We did pretty well in DRAM and NAND. And we're pretty optimistic we'll do well again in calendar '15.

Yes, we also have traction in foundry. But as Bob said, the majority of the share gains right now were in memory. If you look over the last couple of years, in Etch and conductor etch, we talked about 5 points of conductor etch share gain this year. We had 6 points of share gain last year in 2013. So we have really significant momentum. Certainly, memory is where we see the largest revenue now, but we also have traction outside of memory that provides an opportunity for growth going forward. And the other thing, as we talked about, the Etch and CVD revenues combined increased greater than 50% in 2014. So if you look at the growth rates of those markets, in both of those areas, we're significantly outgrowing the market.

I appreciate your comments on the transaction. Having said that, a lot of people are sort of stumped as to why the transaction is taking so long. And I realize that you guys are limited in what you can say. But I'm kind of hopeful that you can provide us some additional color. And I guess just what gives you confidence that this process isn't going to continue to drag on beyond the first half of the year? That's my first question.

I believe the reason for the complexity is our multifaceted business. When comparing us to Tokyo Electron, you can see there are numerous segments and products involved, which contributes to a higher level of complexity than is typically encountered in similar situations. As we mentioned earlier, we are making progress with regulators and aim to finalize the merger as soon as possible. Unfortunately, there's not much more we can share on this matter at the moment.

Okay. My other comment is regarding the mix. You mentioned that memory is performing well in the first half. How should we view memory in the second half? Are there concerns that we might see a significant decline that could offset some of the growth you're anticipating in foundry?

Well, we all have our opinions. I think you have to look at the fiscal halves and the calendar halves. As you know, our fiscal half ends in October 31. My belief is that the second half foundry is stronger than typical, as I said before. We think memory is stronger in the first half although I think there's a little upside to the memory outlook, quite frankly. So I don't think memory is going to follow off if you look at pricing. I'll give you another data point. Utilization across all the fabs is running pretty high right now. So, I think the forecast is pretty good; just timing and mix issues really.

My first question is regarding the foundry investment this year. I just wanted to make sure I understand the linearity of it a little bit better. You mentioned that's stronger in the second half. Just given the timing of the end consumer devices and the ramp associated with it, is it fair to think like the strength would be stronger in the July quarter than the October quarter?

Yes, I'll try and take that one. Right now, we think that July and October quarters are pretty strong. We think right now that they're pretty close actually. I'm looking at the data. July might be a little stronger than October, but they're pretty close.

One other thing I would say on the foundry business is that this is a huge competitive battle for our customers. I would expect there's going to be more technology buys also than we would normally see. There's certainly the race to the first generation FinFET, but there's also, in parallel, a tremendous pull from customers as they drive to the second generation FinFET from a technology perspective. So that's another thing that we see very strong pull from customers that could play out. And we're talking about the second half of our fiscal year, so it could play out a little bit more in the second half of our fiscal year.

Got it. And then one question on the market share. You mentioned that Applied gained share in WFE this year. But when I look at your revenues, they're up 12% year-on-year, like just for the calendar year, and I'm kind of using the Jan ending revenues for the last 12 months. They're up 12% year-on-year and you mentioned that WFE was up 15%. So I just wanted to understand, if WFE is up 15% and your revenues are up 12%, then how are you gaining share?

Yes, I can help with that. In 2013, we gained market share according to Dataquest, approximately 1.4. For WFE, we maintained our market share in calendar year 2014. I don't believe we gained additional share, but we either gained or maintained share in every product group where we competed. However, some of our larger product groups did not grow faster than WFE. Therefore, for WFE, I think we remained flat. In all other product groups, we either gained or held our position, with one exception where we lost share.

Yes, let me add one final point regarding the last question. We also had a strong performance in November and December, which will help clarify things as well.

Bob, if I look at your outlook for SSG, up 48%. Is that in line with your peers given your mix is a little bit more foundry-centric, but the non-semi markets are, like you said, a bit lumpy. So can you provide a bit more color on what's happening in the Display market near term in its seasonality? And then on the EES, is that being impacted by oil prices being lower? And then I have a follow-up.

Sure. Let's start with solar. We're managing that quite well, and the market for solar panels and cells is doing reasonably, although there is still some excess capacity that needs to be absorbed. Overall, the market feels fairly stable with only minor fluctuations from quarter to quarter. In the Display market, our position is robust. We've gained market share and introduced new products, with solid execution. This market primarily consists of two types of customers: Display equipment for TVs and equipment for smaller devices like cell phones and iPads. This year, bookings seem to be leaning more towards the smaller devices. We are also working on increasing TV production, which is boosting revenue. Last year, we had significant bookings due to shipping, and while we anticipate slightly lower TV bookings this year, we expect increased bookings in the smaller form factors. That's the current transition we're experiencing.

Okay. And then you had $63 million in adjustments in your backlog on FX. Can you talk about the headwinds from here on FX in your exposure?

Yes, that's a good question, too. As you know, the yen is down significantly, and euro softened up. So no. The yen is the bigger impact for us. Now as a practical matter, the way we sell, most of our costs are in dollar-denominated and our revenues are fundamentally dollar-denominated. Now when we price in Japan, we are somewhat competitive to Japanese competitors, but we largely price in dollars and translate that into yen and largely hedge the impact. So we can somewhat differ the impact. So I'd say that the yen to Applied alone is not a big impact. It's a little bit more impactful to Tokyo Electron, who bills in yen.

I know you talked about a stronger second half driven by foundry and continued memory and within that, a strong July quarter. So just to clarify, you guys are seeing foundry and memory being strong contributors in July? And if foundry is indeed starting to become stronger in July, is it more than just one customer? Is it a little bit more broad-based than that?

Yes, we are noticing that foundry activity is increasing in the second half of the year. The spending distribution varies by half, with foundry more concentrated in the calendar and fiscal second halves, while memory is more focused on the calendar and fiscal first halves. This indicates the overall spending mix. I believe there is some potential upside for memory in the second half, especially for DRAM. In terms of dollar amounts, since memory has a heavier weighting in the first half, the total is likely greater in that period. Additionally, there may be opportunities with 3D NAND later in the year.

Yes, that's a great point. Broadly speaking, we strongly support the foundry business being robust in the second half of 2015 as we move forward.

I have a couple of questions that might seem repetitive. Regarding foundry demand, I'm trying to understand the contrast between what TSMC reported, indicating a 24% increase in capital expenditures, and Samsung's statement that foundry capital expenditures would rise year-over-year. Given your perspective that foundry spending may remain steady or even increase in 2015, how can we reconcile these differing views? Are you receiving different information than what these companies are suggesting? Additionally, I have a follow-up question.

I think global foundry is probably down year-on-year in my opinion, while UMC is either slightly up or flat. Additionally, we tend to be a bit conservative with our calendar fiscal since our fiscal year ends in October. This could result in some delays to November or December, which is a bit concerning. However, overall, we are seeing a slight increase in foundry demand.

Okay, good. And then just on the other side, back to the currency question. It seems like you should get maybe a little bit of gross margin uplift from some of your foreign production. But yet, you're modeling gross margin kind of flattish. And I am wondering why you're not getting a little bit of uplift maybe from the foreign exchange or currency discrepancy?

We do not engage in heavy manufacturing overseas. The majority of our product costs are related to materials, and most of these costs are dollar-denominated. As a result, we haven't experienced significant benefits from this aspect. We are actively seeking ways to gain some advantages, but overall, most of our product costs are in dollars.

Gary, maybe just, first, from an industry perspective. Given some of the uncertainty and the timing of this foundry FinFET ramp. Do you believe it's weighted more towards the uncertainty in terms of the customer allocation of the capacity to the foundries or the yield challenges that the industry is facing right now?

That's a great question, Patrick. This is a significant competitive challenge for our customers, and everyone is focusing on both first and second generation FinFET technologies. As I mentioned, companies like TSMC and Samsung are optimistic about capital expenditures. For us, the uncertainty lies in allocation – where those funds will be directed. They could end up with any number of different firms, which creates uncertainty. This situation represents a major investment for all involved, as we are experiencing the most significant shift in transistor technology in quite some time. All these companies are very concentrated on this transition and are investing heavily in technology to reduce the time between the first and second generations, which is beneficial for us. Our total addressable market is expanding greatly, and we are well-positioned around transistor technologies. Our businesses, such as Epi and PVD, are performing exceptionally well, and implants and various other sectors are strong as well. Therefore, we’re in a favorable position regardless of which company secures that business due to the significantly larger market opportunity for us. The uncertainty I mentioned earlier pertains directly to this discussion.

That's helpful. I want to follow up on the uncertainty regarding the foundry ramp. How are you handling the supply chain and inventory in light of these uncertainties? What strategies are you employing to manage those factors?

Yes, that's a good question, Patrick. We actually think our demand on the supply chain is going to be pretty high for 2 reasons. One, our sales of spare parts are pretty strong, as you can see in our AGS business, and with fab utilization running pretty high. We think the spare parts that we ship a lot of will be pretty high, so we'll buy those from suppliers. And the second thing is that if we get this steep way up in this second half, we'll get a lot of pull. So overall, demand on suppliers is going to be pretty high. Some of those tools and inventory we have brought in now to mitigate the risk of the ramp, so you see our inventory is up a little bit. The third thing we're going to take a look at is we're spending a lot of time hand-holding, working closely with suppliers to make sure that ramp goes okay.

This is Shawn Yuan for Mahesh. You mentioned that WFE is expected to increase by 5% or more this year, which is relatively lower than what some of your peers are suggesting, and certainly less than the 5% to 10% range that many people seem to be anticipating. Are you seeing anything different from your peers in this regard? Additionally, in your long-term model, are you looking at 30 17 in WFE? Do you think we might see one or two quarters of WFE run rate reach that level this year or next?

No, I think we're pretty close on the WFE. We're sort of around the $34 billion number. I think everybody else is pretty close to that.

Yes, I think what we said was 5% or more. I think LAM was 0% to 13%, if I remember correctly. So we're really in the same range.

Okay. And then another comment you made in the prepared remark is that 3D NAND spending will be about twice of 2014 level. And some of your customers in their earnings indicate that they're planning to reuse some tools for 3D NAND development. I'm just wondering, can you talk about your assumptions on your 3D NAND spending for 2015?

Yes, that's a good question. So 3D NAND is really, for us, really a major opportunity from a growth perspective. It is very focused on Etch and deposition and not so much on litho. So the feature sizes are actually increasing as they go from planar to 3D NAND, but there is a lot of spending on Etch and deposition systems. The process is very different than the planar NAND. So it is true that there's reuse, but for us in our business, there's a huge opportunity for TAM growth.

Yes, I think it's related to the tool mix. There's more Etch and deposition compared to lithography. Additionally, due to this different tool set, the level of reuse is reduced. When looking at the reuse model they have been effectively pursuing, it shifts to a pseudo-Greenfield model with a different device type, making the tool mix much more advantageous for us and for other Etch and deposition companies.

So just a longer-term question here. Curious what you think the current spending patterns are in China? And if you expect them to go up materially over the next couple of years. And then what your percentage of that market is on a relative basis.

Thank you for the question. We don't anticipate any significant changes in capital expenditures in China. Our position there remains very strong, and we have established a great relationship with the leading foundry, where our market share is high. Overall, we maintain a strong presence with all our customers in foundry, but our standing in China is particularly robust. If spending increases, that would benefit us. However, we do not expect any major changes in the next year or two.

Okay. And then maybe switching gears to the Display business. If the manufacturers were to switch to OLED TVs, does that materially impact the equipment market size?

Yes, OLED represents a significant opportunity for us. When comparing the number of deposition steps and the market potential between amorphous silicon and OLED, it reveals that OLED presents about twice the overall market opportunity. Therefore, an increase in OLED production would greatly benefit our Display business. The Display team has performed exceptionally well, gaining market share and adhering closely to the company model we outlined a couple of years ago. They are focused on facilitating technology transitions from amorphous silicon to LTPS and metal oxide. OLED stands out as the best opportunity for us as that technology advances.

So just a quick follow-up on gross margin. I think you guys guided for flattish this quarter. And I noticed you have some pretty strong DRAM orders; I mean, DRAM is very concentrated in the space. Now do those big orders have any effect on gross margin for this quarter? And also, does the timing of the Chinese New Year maybe have an effect on the timing of the shipments, which impact gross margin?

Sure. The largest factor affecting us within the SSG business is the types of tools we ship. We are gaining market share in Etch, especially in memory. We're securing more D2R positions and making progress in foundry among other areas. Our sales in Etch are strong, particularly in high aspect ratio Etch and various Etch and deposition steps used in NAND and DRAM. The tool mix is different for us in memory compared to foundry. In foundry, we usually hold very high market shares and strong positions in tools like Epi, PVD, and implants. The difference in tool mix between the two sectors is the main driver for us.

Okay. That's helpful. Regarding your comment about Etch and CVD growing by 50% last year, I recall someone asking about your other business, and you mentioned that you maintained market share while some segments may have contracted. I'm curious to explore that further. Is this due to the nature of spending influencing those other markets, or is there something else happening? Are customers simply directing their investments elsewhere? Can you provide more insight on this?

Sure. We held overall WFE share. We gain in Etch CVD. We lost some in wafer defect and inspection. Frankly, that will come out in a month or 2. So we'll share that with you. Some of the others we held share or gained share, but the TAMs didn't grow as fast as Etch and CVD. So we're getting share in Etch and CVD, holding very high share in some other strong markets. But a couple of the other markets, like implant, didn't grow quite as fast as some of the other markets. So it's a mix within the businesses as much as anything.

Yes. One of the things relative to the overall market, the overall wafer inspection business actually grew less than we had thought it would in 2014 and slower than the overall market growth. So that was a negative. Optical wafer inspection, as Bob said, we lost some share due to the customer mix in 2014. E-beam, where we have technology leadership, we actually gained share in e-beam review, about 15 points of share, we think, in e-beam review. We gained share in CD metrology, and we think that e-beam inspection is also an opportunity for us. So in 2015, what we think is that the mix will be more favorable for us and really, the area that is growing the fastest in e-beam technology, we have a very, very strong position with some new products, and we look at that as a growth opportunity for us in 2015.

You and your competitors in the past have talked about, I guess, over the next few years FinFET and 3D NAND are the bigger incremental opportunities than more like in DRAM and advanced packaging. Yet, most of the upside in recent quarters have been coming from DRAM. So do you think this is just a timing issue because FinFET and 3D NAND are being pushed out? Or do you think the capital intensity for DRAM is higher than you previously thought?

I believe DRAM is indeed increasing, and we've discussed the factors driving the DRAM business. However, the timing for 3D NAND is later than some anticipated. There is a strong demand for 3D NAND, with customers attracted to its performance. Looking at bit scaling in the long term, this is the direction all our customers are heading. There's significant focus on this area, and while it's delayed, we expect the second half of this year to see a more substantial shift towards 3D NAND. Additionally, FinFET presents a great opportunity and is a key competitive area among foundry customers. We expect all customers to adopt this technology more heavily in the second half of this year and into 2016.

Well, we think this year is heavily weighted towards FinFET versus 28. In terms of 20, some of the tool sets are the same for 20 and FinFET. So it's a little hard to make a clear delineation of that, but we think it's mostly FinFET, 16- to 14-nanometer ramping, but some of the tools you could use between 20 and 16 or 14. So I think it's just heavily weighted towards FinFET. The issue is I think it's a little later in the year than last year. Last year was a little early than normal. This year is a later than normal, I'd say.

My first question is what gives you any confidence that the merger will go through? And based on the prior approvals, what were the main points that you have to win to get the approval, assuming that I have not gotten a memo that you cannot talk on the merger.

Thank you for the question. As mentioned previously, we cannot provide any additional details beyond what has already been discussed. We have indicated that we are making progress with regulators and believe that merging is the right strategy for our companies. We view this as a significant strategic opportunity, and everyone involved is quite enthusiastic. Unfortunately, we cannot share any further information at this time.

Sure, no problem. What are the basic differences between the first generation FinFET and the second generation FinFET? How would you benefit from transitioning to the next generation FinFET?

The FinFET technology is significantly advanced, especially in terms of Epi, where the number of Epi steps continues to increase, presenting a substantial opportunity for us. NDP steps also represent a considerable market for us alongside FinFET. We are observing next-generation FinFET technologies and more opportunities in areas like implant. Our customers are highly focused on reducing the costs associated with multiple patterning, although the number of steps is definitely on the rise. We have technologies, such as selective material removal, that we anticipate will experience considerable growth, and we believe this will be a major area of focus for our customers as they transition to second-generation FinFETs. Our strength lies specifically in transistors, which is the essence of FinFET, allowing us to leverage our technology leadership in numerous areas.

Gary, I want to better understand your assumption for 3D NAND. When I talk to your customers, they all argue that when 3D NAND is still in commercialized, the CapEx for that is actually going to go down because the density per wafer is going to go up dramatically. So how can I reconcile your growth expectations with what your customers are saying? Especially when we think about CapEx per wafer compared to bits of NAND manufacturer per wafer? And I have a follow-up.

Thanks for the question. As I mentioned earlier, we've highlighted during Investor Day that at least two customers have publicly discussed their CapEx spending and the breakdown between planar and 3D NAND. The major change is that for the lithography segment, CapEx spending is expected to decrease. However, we are observing growth in the Etch, deposition, and even Epi areas for 3D NAND. Therefore, the shift in CapEx spending from planar to 3D NAND will be significant. In the areas I mentioned, we have a strong position as customers adopt these new technologies, and we anticipate robust demand as they transition to the first and second generation FinFET technologies.

Yes, related to that is the tool mix; it's more Etch and deposition compared to lithography. Additionally, because of this different tool set, the level of reuse is lower. If you consider the reuse model they have been effectively pursuing, it is transitioning to a pseudo-Greenfield model with a different device type. The tool mix is much more favorable for us and other Etch and deposition companies.

Well, thanks, Mehdi, for your question. And we'd like to thank everyone for joining us this afternoon. A replay of this call will be available on our website beginning at 5:00 p.m. Pacific time today. Thank you for your continued interest in Applied Materials.