Applied Materials Inc (AMAT) — Q2 2016 Earnings Call Transcript

Thank you. In a moment, we'll discuss the results for our second quarter which ended on May 1. Joining me are Gary Dickerson, our President and CEO; and Bob Halliday, our Chief Financial Officer. Before we begin, let me remind you that today's call contains forward-looking statements including Applied's current view of its industries, performance, products, share positions, profitability and business outlook. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements, and are not guarantees of future performance. Information concerning these risks and uncertainties is contained in Applied's most recent Form 10-Q and 8-K filings with the SEC. All forward-looking statements are based on management's estimates, projections and assumptions as of May 19, 2016, and Applied assumes 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's page of our website at appliedmaterials.com. Next, I'd like to share a calendar announcement. Applied Materials plans to hold its 2016 analyst meeting in New York City on Wednesday, September 21. Those of you joining us in New York will have the option to attend technology sessions with our general managers. The main event will be webcast live. And now, I'd like to turn the call over to Gary Dickerson.

Thanks, Mike and good afternoon everyone. I'm very pleased to report that we are making great progress with all the major elements of our strategy and expect to deliver record earnings in fiscal 2016. We're focusing our investments on key customer inflections that are growing Applied Materials today and creating exciting opportunities for future growth. Our record performance is made possible by the outstanding team we have at Applied. I want to thank our employees around the world for their tremendous passion to create value for our customers and shareholders. I'll begin today's call by summarizing our strong results and outlook in the context of our longer-term strategy for sustainable, profitable growth. Then I will outline our updated view on the market environment and what this means for us. I'll conclude with a short summary of progress in each of our major businesses. After that Bob will provide additional details about our results and the improvements we're making to the company's operating performance. At Applied Materials, our strategy is to develop highly differentiated materials engineering products and services that make technology inflections possible. In semiconductor and display, the substantial changes in device technology that are taking place require significant materials innovation. I believe this puts Applied in a unique position. We have the broadest and deepest capabilities in materials engineering and our technology is unmatched. These advantages are helping us deliver the innovations that enable our customer success and move the industry forward. In recent years, we shifted $400 million of annual spending to improve our organizational capabilities and accelerate product development. Today, these investments are creating significant value for our customers and for Applied. When I look at our results and outlook, there are five key drivers of our performance I'd like to highlight. First, in semiconductor, our leadership businesses are delivering key enabling technology for logic and foundry customers. These businesses have high market share and highly differentiated products and are benefiting from robust levels of foundry investment in the second half of the year. Second, our growth businesses are making significant market share gains as the 3D NAND ramp accelerates. Our combined Etch and CVD revenues for Q2 are at a 9-year high. Third, we are very well positioned in China. Domestic Chinese manufacturers are ramping up their investments and multinational customers are expanding their footprint in the region. As a result, we are setting new records for quarterly semiconductor orders in China. The fourth driver is our sustained growth in service, where we are building upon 10 consecutive quarters of year-on-year growth. And fifth, we are successfully applying our advanced materials engineering capabilities beyond semiconductor, specifically in display. New display technology such as OLED is enabled by materials innovation. This is creating significant new market opportunities for Applied. I'll now give you our latest views on the market environment. While we're paying close attention to the global economy, at Applied, we continue to see strong demand for our products and services. This is because our semiconductor and display customers are focused on developing and ramping new technologies rather than simply building capacity. The inflection-driven investment our customers are making is highly strategic. They are battling for leadership and investing to ensure that they are ready as market demand shifts to these new technologies. In foundry, we expect investment levels for the year to be similar to 2015. We anticipate more than half of 2016 spending will be focused on the 10-nanometer node, as well as 7-nanometer pilot production. In addition, as new projects ramp in China, we see the foundry customer mix broadening and increasing investment in trailing geometries. This is positive for Applied because we have a 30-year history of leadership in China and we've built very strong customer relationships and a great regional team there. This quarter, our revenues in China are at an all-time high. In memory, we expect overall spending to be more or less flat year-on-year. However, there are important changes in the mix that play well for Applied. Investment is shifting from DRAM demand and we see DRAM down at least 25% following very high investment levels in 2015. In contrast, we see NAND strengthening as the year progresses. Our latest adding will be 35% than 2015 as multiple customers accelerate their 3D NAND ramps. 3D NAND is a great example of materials-enabled scaling that plays directly to Applied's strengths. As I've said before, 3D NAND is all about depositing, removing, and modifying materials with incredible precision. Because of this, our available market at 3D NAND factory can be up to three times greater than for planar NAND. In the quarter, we booked nearly $1 billion of NAND orders, which is a record for us. In logic, we believe that spending levels will be very similar to last year and when we take all of these factors into consideration, we believe that 2016 wafer fab equipment investments will be similar to 2015 with some upside potential. I will now talk about the progress we're making in each of our major businesses. In semiconductor, I'm very pleased with our strategy and how our product pipeline is shaping up. We made solid wafer fab equipment share gains in 2015, even though the spending mix was not as favorable for us as it is in 2016. Based on the positions we're winning, I expect much stronger share gains this year. Across our semiconductor businesses, I see tremendous customer pull for our latest generation products. In CMP, our new LK Prime System now has over 130 units at customer sites. This product is winning market share resulting in our highest quarterly CMP orders for a decade. We are also seeing a broader adoption of Cobalt in advanced interconnect schemes and this is driving demand for our Cobalt CVD systems. This is one of the factors that is contributing to strong share gains in CVD this year. We continue to see rapid adoption of our SIM 3H platform launched at last year's SEMICON West. We project that we will ship around 700 chambers by the end of our fiscal year fueling strong conductor add share gains in 2016. I'm also very excited that customers are beginning to transition a number of our highly disruptive new technologies from pilot to high-volume manufacturing. These include our selective removal products and Olympia ALD System. In service, we are making significant investments in our organization and capabilities so that we can deliver more value to our customers. These investments are generating a strong pipeline of new service products that help customers improve their device performance, yield, and costs. We're on track to grow this business for the third year in a row, which I believe is strong evidence that our service strategy is working. In display, I'm increasingly excited about our opportunities and the unique position we have in this market. The major technology inflections that are taking place require materials innovation so our available market is expanding significantly. One great example of this is thin film encapsulation that protects an OLED device from air and moisture. The precision deposition of this film stack is incredibly challenging and relies on Applied's advanced materials engineering capabilities. Overall, we estimate that our opportunity in OLED is more than three times larger than for traditional LCD. I believe we're still in the very early innings of OLED, but we're already seeing a significant impact on our business. This quarter, our orders in display were an all-time record. To summarize, as I look ahead, I'm increasingly confident that we are in a great position to drive sustainable profitable growth at Applied Materials. Across the company, I believe we have greater opportunities and a stronger pipeline of enabling technologies than at any point in our history. We're investing more than ever to accelerate materials-enabled innovations for our customers. We are maintaining a very positive outlook for 2016 because our customers aren't making inflection-driven investments as they race to introduce new technologies. These investments are both highly strategic and play directly to Applied's strengths. Now let me hand the call over to Bob, who will provide more details about our quarterly results, performance, and priorities.

Thanks, Gary. Applied Materials is extremely well-positioned to deliver profitable growth this year and for the foreseeable future. In Q2, we generated orders of $3.5 billion, the highest in 15 years. Our strength is led by silicon systems which had $2 billion in orders with nearly half demand. And by display, which had record orders of $700 million. Our backlog now stands at $4.2 billion and is broad-based with nearly half in silicon systems, and roughly a quarter each in services and display. Our silicon systems backlog is the highest in at least 9 years. Looking ahead, I'm confident that the investments we're making in differentiated products and services combined with our cost efficiency programs will drive record earnings. And I expect sustained performance as we help our customers drive their technology roadmaps forward, particularly in foundry, NAND, and advanced displays. We have momentum in services, and we're improving our execution and operational performance across the board. Today, I'm confident that we're on track to achieve the earnings targets in our 2018 financial model. I'll provide a detailed update at our Analyst Day in September. But with the disruptive nature of our order strength, I'd like to give you some insights during this call. We're making very good progress growing our revenues. If recent demand trends continue, which seems likely, and by 2018 I believe we can meet or exceed our targets in Silicon Systems and Services. Through 2018 and beyond, we believe display, NAND, and China will grow by more than we anticipated last year, and our positions in these growth areas are becoming stronger. I'm also confident that we will meet or exceed our goals for tax rate, weighted average share count, and earnings per share. Relative to gross margins, we're focused on our overall cost structure and on optimizing the gross margins within our product lines. Even as our display business strengthens this year, I believe we can hold our overall gross margins flat with last year. Over the near horizon, we now see faster than expected growth in display. The net profitability gains from this revenue growth should be very positive for us and we're committed to achieving our operating margin targets even with the impact of this mix change on our overall gross margin percentage. Regarding operating expenses, Gary outlined how we are gaining share in our existing markets and expanding our served addressable markets with strong customer pull. Today, several of our customers are asking us to develop new technologies to support their road maps and we are choosing to increase our R&D investments in certain areas this year notably in display. As we ramp up to support these new projects, we expect OpEx to increase by about $10 million sequentially in Q3 and stay at this level in Q4. At the same time, we'll continue to be very aggressive in controlling and optimizing our spending to invest in sustainable revenue growth while increasing our profitability. Let me give you some insights into how we optimize our operating expenses. Between 2012 and 2015, we cut spending in G&A organizations by 27%. In the same period, we boosted the funding of new and disruptive products by $400 million. We did this by using G&A savings to fund R&D and by shifting spending from underperforming areas to areas where we can grow and gain share by enabling major technology inflections. Today our R&D to OpEx ratio is 67%, which is up over 10 points relative to 2012. Now I'll comment on our second quarter results. Revenue of $2.5 billion was at the high end of the guidance range led by Silicon Systems. Non-GAAP gross margin of 42.7% was slightly higher than expected. Non-GAAP operating expenses of $575 million were within the range. Our non-GAAP tax rate declined to 14.4% as more profits were generated in lower tax jurisdictions. We believe 15% is an achievable rate for the balance of the year. Non-GAAP EPS of $0.34 was the highest in four years and the highest in eight years when accounting for previous adjustments. Next, I'll update you on our cash returns during the period. In Q2, we returned more than $1 billion to our shareholders. We used $900 million to repurchase over 45 million shares of our stock and paid $113 million in cash dividends. We ended the quarter with 1.1 billion shares outstanding which is the level we targeted in our 2018 model. We've now completed 95% of the $3 billion authorization we announced last April and we expect to complete the program in the current quarter. We remain committed to returning excess cash to shareholders using dividends and buybacks and we plan to discuss the buyback program with the Board of Directors at our upcoming meeting. Before I turn to guidance, let me share some observations and expectations surrounding our display business. Disruptive technology changes are happening in the display market that will increase customer spending this year and beyond. In the TV market, while there is sufficient overall capacity at this time, we expect additional investments in certain regions. In the longer term, I believe that technologies now being piloted in mobile will also be attractive in TVs. Such adoption would be very positive for us. Today, customer demand for our display products is increasing, particularly in the mobile segment. As a reference point, over the past three years, our display orders averaged $750 million per year. Our display orders were $883 million in the first half of this year alone. The growth we're now seeing in display comes largely from new products we've funded and developed over the past few years. Based on conversations with our customers, we expect display order strength to continue for the remainder of 2016. Most display systems are very large and also take two to three quarters to build, deliver, install, and generate revenue. Customers are pulling for Applied to develop new display technology that I believe will significantly expand our market opportunities over the next several years. We will invest further in new and disruptive products to capture these opportunities. And while our display orders and revenues will continue to be lumpy from quarter to quarter, I believe we will deliver sustainable growth over time. We will have more to say about display opportunities at our analyst meeting in September. Now I will provide the business outlook for the third quarter. We expect our overall net sales to be up by 14% to 18% sequentially. Within the revenue outlook, we expect Silicon Systems net sales to be up by 10% to 15%. AGS net sales should be up by 5% to 8%, and we expect display net sales to rise by 70% to 90% to approximately $300 million. AES net sales should be flat to up slightly. We are modeling the non-GAAP gross margin percentage to be up by 50 to 100 basis points. Non-GAAP operating expenses should be $585 million plus or minus $10 million. The mid-point is up just 1.6% from the same period last year. And we expect non-GAAP EPS to be in the range of $0.46 to $0.50. The mid-point is up 45% from the same last year. This EPS guidance represents a new record that is significantly above any previous performance for Applied Materials. To summarize, while overall economic and semiconducting industry conditions are relatively flat this year, Applied Materials is uniquely well positioned. We plan to set new records in a number of areas including EPS for the full year. We have significantly biased our spending to disruptive new products and customer support. I believe we now have a great pipeline of new and emerging products focused on the key technology inflections. We also have strong customer pull in markets and regions that give us sustainable opportunities to deliver profitable growth in the years ahead. Now let me turn the call over to Mike for questions.

Thanks, Bob. To help us reach as many of you as we can, please ask just one question and no more than one brief follow-up. Let's please begin.

Hi, thank you for taking my question and congrats on a very strong guide. My first question is on the display side of the business. In the past you guys have talked about increasing your stand by three times over the next couple of years. I guess my question is how much have you realized already and how much is still coming going forward?

Sure, let me see if I can start and Gary can jump in. What we are seeing is two or three things helping us here. One, the overall market is going for spending. Two, competition is growing. I don't think we have reached the culmination of our ability to grow and I think that's going to go on for the next several years.

Okay. That's helpful. My follow-up is on the core SSG side of things. In the quarter, you just reported obviously NAND orders were up sequentially and I was surprised to see foundry down a little bit. On the NAND side, where are you picking up share and on the foundry side is it starting to assume that orders start to pick up in the current July quarter? Thank you.

Yes, on the NAND business there is very strong pull from the customers as NAND moves from litho-enabled scaling to materials-enabled scaling. So we see very strong pull for Etch; we are gaining new steps and very strong performance. Overall, we believe this will be a strong year for the Etch business; we will gain share and certainly in 3D NAND, the growth there is significant. Deposition is another area; CVD is an area that's very strong in NAND. We have additional Epi steps in NAND. There are many additional CMP steps, so there are a number of areas where there is significant growth for us in 3D NAND, and we look at this as a wave that will continue over the next few years. So it is really a great opportunity for Applied where our TAM is going up as we move up from litho to materials, and we are also significantly increasing our share in 3D NAND.

Thank you very much.

Yes, good afternoon. Thank you for taking my question. I guess the first question is on the Silicon front. You talked about upside potential till you flagged WFEL look. I would love to hear your thoughts there and then as you think about growing share and Etch, very favorable mix in terms of Foundry as well as China and what you are doing around 3D NAND, how should we think about your growth in calendar 2016 relative to that flat to slightly up WFEL look?

Yes, I will try if I can jump in. We agree it's flat up this year. The year hasn't unfolded as we had hoped last November; it's gone better and better for us frankly. If you look at it, NAND has picked up; we now think it's up about 35% year-over-year. While DRAM is probably down about 25%. Foundry is not up a lot this year; up somewhat but if you look at our position within foundry, it is really strong, and then DRAM is also gaining. So if you go look at our position with each, we are gaining share. I will give you a fact you may not have picked up on. Pre-2012, we were only over 15% in one of the four major groups when you look at NAND, DRAM, foundry, and logic. This year we project to be over 20%. So if you look at the NAND spending at $9.2 billion, our share is going up from probably under 15% to north of 20% this year and the spending is up to $9.2 billion whereas in the base shift from 2012, it was about $4.2 billion. So the market is up and our share is up significantly. The NAND strength goes on for a number of years; as you know, by the end of this year we are only going to have about 375,000 wafer stacks converted. There are another million wafer stacks out there just playing on. If you go look at foundry, we anticipate being a reasonable year in foundry, but our position is doing really well, whether it's in Taiwan or a lot of the activity going on in China. So we are gaining, we are doing very strongly. And then also logic, we are doing well; leading into logic, so the way the year is laid out, our positioning of our products in the market is at the fastest growing, whether it is NAND strength in leading edge in foundry, strength in China, and also strength in display is playing very well for Applied. So we expect within the year to gain share.

Thank you, I will take the Etch question. So as I said earlier, we think that 2016 is going to be a really strong year for us in growing our Etch share. We have a very strong position and a very strong position in 3D NAND conductor edge. So as that business continues to grow, as that wave moves forward over the next few years, we are in a really great position and we have some of the most exciting products in this group that I have seen in my whole career. The same three, tremendous pull from customers in 3D NAND and also in other segments, we are winning new steps and really across the board for same three, so very strong position there and also in selected material removal. We have a very strong focus from customers and that business is also growing for us at a strong rate. So overall, we think 2016 is going to be a great year for Etch and again some of the strongest products I have seen in my career.

That's very helpful, thank you. Sneak one quick one on OLED. I thought your commentary on the TV set was interesting. When do you think you will start to see your first Gen 8 plus orders for OLED?

Right now what's driving the market in 2016, as we said earlier in the year, we said earlier over 60% in our orders in revenues this year were going to be Mobile versus TV, in fact that's probably turned up to now over 70% now in terms of order rate. If you look at the big inflection that's taking place around mobile and OLED, that inflection may come sometime in TVs but it's not unforeseeable to me in the future.

That's very helpful, thanks.

Thanks. Hi Gary, Bob, congrats on the execution. Question Bob on the comment that there may be display orders strength for the rest of 2016. Is the display visibility from a follow on order to a big Korean customer or do you have visibility from other display customers, perhaps in China who are constructing a lot of new display fabs? It just sounds like the message is AMAT's total orders could be strong in the second half of the year. Just trying to get some color on that, thanks.

Well, I think as Gary sort of referred to the waves, things that are happening for us now are not one quarter advanced; there are several inflections going on. In display, it's around OLED, in NAND it's around V-NAND even in the China thing, this has been going on for years and in the foundry strength we have seen on severance; that's going to go on for the next couple of years. So these big inflections are going to go on for a number of years. For instance, in display we think it's going to go on for a while; it's not a one-quarter event and we see the concentration in mobile in terms of your specific question on TVs, I guess in China, was that the specific question? Yes, we think the display order rate will be fixed around this year.

Okay, thanks Bob. Just a follow-up question on the foundry orders. Just to clarify do you think second half foundry orders because foundry orders are up in the second half, it is possible that total orders remain quite strong in the second half of the year too?

We think in our fiscal year, we think our orders in foundry remain quite strong. We think in the calendar year, because of the split for the business we think foundry has second half weighted also. So we think the second half is pretty good on foundry.

Thanks a lot, I have two. I guess I am just looking at the upside to the orders and it really seems like it was driven from purely OLED and it looks like China memory stuff, so it seems like you are finally beginning to see these China memory projects move within your 12 month shipment window. So I guess my question really is how much can China add to WSE say next year because if you booked like an income of $400 million to $500 million this quarter from those projects, that would argue that you could add maybe couple of billion to WSE next year. So I am wondering if that math works with you.

Yes, let me give you, you said have two questions. Let me strike them both. First, in terms of the second quarter just ended we were pretty strong across the board in orders. We had a very strong quarter, almost a billion dollars as Gary mentioned. And in terms of the other devices foundry, D-RAM and logic we were reasonably strong actually across the board and display was very strong and services did well too. So our strength was pretty broad in terms of the China impact, the Chinese talk about spending $20 billion to $30 billion over four to five years. We are seeing record revenue for ourselves in China this period and it's gone up and our expectations have gone up every quarter basically so in terms of they spend $20 billion to $30 billion over four to five years. How much is incremental? That's about $4 billion a year roughly, $5 billion a year. I would say for the next three years you could see some, maybe half of it incremental. I think it provides an underpinning for overall demand so that you feel pretty comfortable that next year is probably a good year if you guess because you got this underpinning of good NAND, good China, I think the second wave of 10-7 is okay. D-RAM I'm not sure about.

Yes, one other thing I would say is that China is probably our strongest region relative to our position with both the domestic companies and multi-national companies and as Bob said, the momentum just keeps building. We have doubled revenue in China over the last two years and I am spending a fair amount of time there myself and certainly you look at what's happening there now and discussions for future projects. As Bob said, this is a multi-year wave opportunity in terms of China. Hard to say exactly what the number would be but it is definitely going to be up a fair amount.

Got it. Thank you for that, and then I guess follow-up is I know previously you guys talked about 3D-NAND installed target of 350,000 and 400,000 industry-wide actually this year, so it seemed like maybe the industry was going to add roughly 200,000 this year. So my question is how much of that is conversion versus how much of that is Greenfield? Thanks.

Sure. This year we came into the year with 150,000 installed. We think the year goes up to 350,000 to 400,000. In terms of the mix, we think ads capacity adds probably a 100 to 150 converts to 100 to 150 in a year.

Hi guys, congrats on the great quarter. One question on your spending pattern on NAND. Do you still think it's a first-half dated this year or do you think it will go away in second half and the incremental strength in NAND is stronger in the, is it more in the second half you're seeing the uptake or was it already captured in the bookings in your first half?

Yes, in terms of the NAND split, the first half is stronger for the NAND but the second half is pretty good so we think it's more first-half weighted but does strengthen for the second half pretty good. What was your second question?

Just the global uptake you're seeing in NAND, you mentioned the NAND spending is now, you expect it to be stronger than your last quarter call and I just wanted to understand is I take more in the first half or the second half?

Yes, we are up to $9.2 billion on NAND right now and I think last quarter we brought half a billion less maybe. We are seeing broad-based spending; some stuff was pulled into the first half and second half is staying strong.

Got it. And then regarding China, obviously it's the strongest region this quarter but even going back it seems like it's tracking to the second strongest region for you guys for a while. I just wanted to understand in terms of your exposure to China how much of that this quarter was display versus semi-conductors, if you can provide some color on that it would be really helpful?

Yes, we were particularly strong in semi-conductor this quarter in China. We see displays have been very strong but right now, the TVs in China, the order rates are not as high as they were.

Thank you very much. First, Gary and Bob in terms of the foundry orders and outlook that you have, have you started seeing any pickup in 10 nanometers or are you still seeing like the first quarter, some of the orders coming in from the 28-nanometer nodes?

Yes, we are going to have a strong 10 year and then going to have some at 7 also. In terms of the split, we think you came into the year with 10&7 at about 10,000. We think you would go out of the year maybe 60,000 or some may add 50 concentrated in Taiwan and then if you look at it, what's unusual about this Patrick, is that some of the trailing edge stuff is pretty strong. You see a fair amount of over 40 and above and you see pretty good 28-year also and a lot of that is Chinese impact. Yes, we are going to talk about this at the Board of Directors meeting. Share is obvious. We are very committed to shareholders returns, cash returns; in fact, in the last year, we have returned 250% of free cash flow, so we can't stay at that level. We are already committed and we also said in the call we will beat our targets of weighted average share in the model in 2018, so you know we are almost there now, so we will continue to get better on that. In terms of the magnitude of the debt, we have to talk to the board but we are committed to shareholder returns. We are committed to beating the weighted average shares in the model, and the details of it will have to go through with the board in June.

Yes, thank you and congratulations on the success here. Bob, you have kind of given us pieces but obviously just hoping you could overall give us a sense of how you are thinking about second-half calendar revenues over the first half on one hand with the strong July guide you've got, arguably a tough comp. On the other hand, I did notice that your revenue growth guidance for July is well below your growth in your backlog, which kind of implies that sales should be strong for the balance of the year. So just how are you thinking about the second half calendar year versus the first half overall?

To provide additional context, our backlog at the end of the quarter stood at $4.2 billion, with 73% of it expected to be shippable within the next six months. In terms of the semiconductor side, lead times are generally shorter, while historically, display lead times have ranged from six to nine months. We are optimistic about increasing our display revenue outlook for the next quarter due to efforts to enhance the supply chain, which should allow for strong display revenues throughout the remainder of the calendar year. Overall, we believe the second half will outperform the first half. The strength in our display orders supports this outlook, and we anticipate share gains in the semiconductor sector, along with robust demand for equipment and services, continuing for the rest of the year. Thus, we are confident about the prospects for the second half.

Great. And then just on display, as the revenues improve how do we think about incremental margins on this business? I think it's averaged about 20% but we know that it does bounce around.

Yes, we think the operating margins prospectively for display are pretty positive. Right now we're ramping a lot of things; we're ramping new products and ramping production. So we think over time, as we basically said or implied in the financials of the company, the display operating margins for the company will be similar to the overall average for the company. Now both display and AGS have slightly different business model in FSG; the gross margin tends to be little higher in FSG but the operating expenses metrics are less in AGS and display. So your net-net come down about the same operating margins.

Hi, thanks for taking my question, I have two of them. First one either Bob or Gary, out of the $700 million in display orders, how much of them was for OLED specifically? And would most of these be revenues in fiscal '17? Can you give some color on that and then I had a follow-up.

Sure. What we said earlier in the year was that of our display business this year, over 60% was going to be mobile and in fact, it's probably over 70% now and the vast significant majority of that — the great majority of that is focused on the OLED market this year in terms of the order rate. In terms of when it comes to revenues, we anticipate as we guided that our revenues will be up next quarter; we are positive about revenue opportunities for Q4 and we think we’ll do very well in display next year too; there won't be all obviously revenue in the next three to six months, but we feel good about our opportunity on a long-term basis in display.

Got it. And then as a follow-up question for Gary, you guys are getting some traction in Etch, especially on the 3D NAND side. Can your current Etch tools actually do 96 or 128-layer 3D NAND or do you need to develop new tools? I'm just trying to figure out the R&D profile on Etch or FSG like two years down the road.

Sure. Let me first also add to Bob's comments on display and then I'll get to Etch. I really think it's important for people to understand where we are in the early innings of this opportunity in terms of the OLED wave. And relevant to the questions on sustainability, if you look at the waves that are really driving our business in display, NAND, China; we're in the early innings of all of those different waves. We are continuing to invest and we've expanded our TAM by a factor of three; we have an opportunity to expand our TAM more in the future. So that went out really, very optimistic that we're going to continue to drive significant growth in display going forward. And then in Etch, we're in a very strong position in Etch to gain share in 2016 and beyond. As I said before, the products that we have; SIM3, selective material removal products, it's almost on a weekly basis I hear new opportunities, very strong pull from customers for these new technologies. So relative to 96-layers or over 100-layers, we have pull from customers in some of the most critical applications with PTOR/DTOR in some of the most critical applications. So I'm extremely optimistic that we're going to continue to gain share in Etch in 2016 and beyond.

Thank you. Can you provide insights on how R&D will impact gross margin in the second half of the year? I expect that the increase in 3D and Etch, along with the shift towards memory, will likely serve as challenges to gross margin. How should we view this?

Sure, that's a good question. We are working a lot on gross margins; let me give you a year-end analysis you might find interesting. So the company gross margins as you know were 40.9 in 2012, 42.1 in 2013, 44.1 in 2014, and then we went down a little bit around 43 last year; I think it would be probably about the same next year. I guess we're 42 last year. And so I feel when we're making traction or not, so I have the guys run all of our BUs and all of our segment with current gross margins by BU segment with mix. And if you take the 14 mix, when we were in 44.1, the gross margins this year would be 44.7 which is up six times from NAND and north of our committed model 44.6. So what you see is within virtually all the product groups, and within — exercise the cost reduction and negotiation, we're doing pretty well actually, and it is in fact mix the challenge for us. So I do think that, as I said earlier, for instance, display is similar operating margins to company but lower gross margins. In Etch we're doing great in terms of growing profitability and market share; it was all lower gross margin also at this stage. So those are headwinds in our phase this year but we think we'll offset them and still hit the roughly 43% on the end as we said earlier in the year.

Hey guys, good job on the quarterly execution and the strong guide. Getting the personal environment in DRAM, there seems to be more pressure on your DRAM customers to move to the 1X nanometer node. So I guess the question here is, are you starting to see of the early spending for 1X in your second-half pipeline? And how do you see DRAM spend second half versus first half?

I'll start and Gary can jump in if he wants. We think DRAM was front-end loaded, first half loaded on a calendar year, softer in the second half. In terms of our outlook for DRAM specifically, we think it's stronger in the first half than second half. We have speculation about some of that early spend in DRAM but it's not in our line of sight yet.

Thanks for the question. So you mentioned thin film encapsulation, and certainly that's a great example of materials engineering enabling new capabilities for our customers and also growth for Applied. So as you said, we talked about that being a great opportunity and that part of what we're seeing in terms of very, very strong opportunity in display. We do have other areas that we're working on but we're not really ready to forecast or signal when those technologies will be ready. But I would say that that team in display is an incredible team of people; they've demonstrated that they can grow in these major inflections and I'm very optimistic that this wave we are seeing in display OLED is a multi-year wave and then I really believe that we have a great opportunity to not only ride that wave but expand our TAM and share in display. So very, very optimistic about that business.

I'll just add, the team's done a great job, number one. Number two, the market is going to grow for a while and are going to capture with products we're still pushing down the pipe and look very optimistic it's going to grow. So the addressable market looks good too.

Hi, thank you for taking my question and great job on the quarter. I noticed that your foundry orders have declined year-over-year for the last six quarters, and I'm trying to understand this in relation to your expectations for better second-half performance in foundry. You mentioned that 10-nanometer could see reduced demand as customers are prioritizing 7-nanometer products. I would like to clarify the risks associated with your foundry expectations for the second half; are they primarily influenced by China or more dependent on Tier-1 foundry customers?

You asked three questions regarding the annual trend over the past few years, noting that projections for next year are half of what they were. If you examine the trend, it's true that total foundry spending decreased from 2014 to 2015, remained relatively flat, and saw a slight increase in 2016. I don't have the 2013 figures available, but I believe it was similar to 2014; overall, there wasn’t much change. Both 2013 and 2014 were comparable, with slight declines in 2015 and 2016. That encapsulates the annual trend. For the current year, we are fairly confident that foundry will show strength in the second half due to the specific summit timing. What we are seeing this year is somewhat different from concerns that arose from the transition between 2014 and 2015, and what might occur in 2016 going into 2017. In 2014, when we moved to 2015, there was latent excess capacity. There was a 28-nanometer business purchased a year or two earlier and significant capacity was added in 2014 for 20-nanometers for the same foundry. This additional capacity impacted us in 2015 and affected another foundry customer as well. However, this year doesn’t present the same dynamics because we are still in the early stages of ramping up for 10-7, unlike the previous nodes from 2014 to 2016 which had overcapacity. Additionally, they haven’t ramped capacity much at this point. By the end of 2014, they had about 100,000 wafer starts installed for 20-nanometer, whereas this year they might have around 50,000 on PAN alone, possibly reaching 55,000 or 60,000. We are in the early stages of development; the trend has been downward due to capacity issues and slightly reduced growth. Yes, the second half looks positive this year because we can observe it happening. As for next year, we don't anticipate significant capacity issues due to the differences in dynamics, along with unusually high foundry spending this year primarily in the 40-nanometer and above range, while 28-nanometer remains strong due to challenges in China. In summary, the situation in China is a key factor impacting foundry spending.

Thank you for taking my question. Could you just give us a little bit of color on your...

Yes, we have a very strong momentum with ALD and we are pretty much on track with what we have previously communicated. Very strong position and leading logic and foundry customers. They are seeing device advantages as they are going to the most advanced technology nodes so we look at this as a very good opportunity. One of the areas that will fuel our share gains in 2016.

Okay, great. Jerome, thanks for your question. We would like to thank everyone for joining us this afternoon. A replay of this call will be available on our website beginning at 5 PM Pacific Time today, and thank you for your continued interest in Applied Materials.