Applied Materials Inc (AMAT) — Q4 2016 Earnings Call Transcript

Thank you. In a moment, we’ll discuss the results for our fourth quarter and 2016 fiscal year which ended on October 30th. 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 November 17, 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. And now, I’d like to turn the call over to Gary Dickerson.

Thanks Mike. I’m very delighted to report that Applied Materials delivered record revenue and earnings in our fourth quarter, capping off an outstanding year. In fiscal 2016, we grew orders, revenue, and earnings to the highest levels in the Company's history and made significant progress towards our longer-term strategic and financial goals. Some of our major accomplishments this year include our highest semiconductor orders in revenues since the year 2000 and record performance in display and service where both groups exceeded all-time highs for orders and revenue. I want to thank all of our employees for their passion to create value for our customers and for making 2016 a great year for Applied. Looking ahead, I see tremendous capabilities, momentum, and opportunities across the Company. This gives me increased confidence that we will again drive sustainable growth in 2017 and beyond. In today's call, I'll start by explaining some of the key factors contributing to our record performance and describe our strategy for long-term sustainable growth. I'll then provide our market view and describe why Applied has an increasingly positive outlook. I'll conclude with brief updates on our major businesses. After that, Bob will provide additional details about our results as well as historical perspective on our future outlook. At Applied, our strategy of inflection-focused innovation leadership is delivering profitable growth; in both semiconductor display, large multiyear inflections are enabled by materials innovation. Applied has by far the broadest and deepest capabilities in materials engineering. It's our ability to combine these competencies technologies and products that really sets us apart and allows us to sustainably grow faster than the markets we serve. To fuel growth, we focused our organization investments to deliver highly differentiated solutions that enable customers to build new devices and structures that were never possible before. At the same time, we've implemented a new operating system for the Company that's driving repeatable success and increasing our product hit rate. A key element of this is our product development engine. We've already trained more than 5,000 engineers how to use these methods and as a result, we now see inflection sooner, develop solutions faster and generate higher residual value from our large installed base of tools. Over the past few quarters, I talked about five major market drivers that are contributing to our record performance today and will fuel growth for years to come. These drivers are leading edge foundry in logic, 3D NAND, patterning, advanced display in China. At our analyst event in September, we gave comprehensive updates on these five drivers, so today I'll only cover two where we've new information to share. Let me start with patterning; at the analyst meeting we said we expect our patterning opportunity to expand to around $3 billion by 2019, growing 2.3 times since 2012. In recent weeks new details about EUV adoption have been made public and this gives us increased confidence in these projections. Our model is consistent with others and assumes that EUV will primarily be used for cuts and vias in foundry and logic applications. That's about 20% of the total patterning market. For the other 80%, we see customers expanding multi-patterning solutions and this significantly grows our addressable market. Pulling all this together, we believe that in the most aggressive case for EUV adoption, our 2019 patterning opportunity will still grow to around $3 billion as previously forecasted. In scenarios where EUV adoption rates are slower than the most optimistic case, our patterning growth could be significantly higher. Looking beyond 2019, we see cuts and vias remaining the primary application for EUV, and our patterning opportunity continuing to expand. Patterning is an area where Applied is making significant investments and has room to grow. We have already gained around 15 points of market share since 2012. We see strong customer pull for new materials-enabled patterning processes where we have innovated new technologies and believe we can gain another 15 points of share by 2019. My second update relates to display; we announced that our equipment has been selected for the world's first gen 10.5 LCD TV Fab. The push gen 10.5 is driven by rapid growth in the market for large format TVs, 60 inches and above. A gen 10.5 substrate is about 80% bigger than the current gen 0.85 standard allowing customers to optimize output for larger screens. In addition, demand for our OLED manufacturing equipment is broadening with this strength in both TV and mobile; we are increasing our estimate for 2017 display capital spending. We now believe customers will invest around $2 billion more than 2016. In the past few weeks, we have also increased our forecast for wafer fab equipment. We now expect 2016 wafer fab equipment spending will be at least 5% higher than in 2015, driven by additional foundry capacity and incremental investment in 3D NAND. At the same time, our view of 2017 is strengthening. We believe spending will be higher this year with logic and foundry investment remaining at robust levels and growth in memory spending. Looking further ahead, I am very excited about emerging trends in virtual and augmented reality, big data, artificial intelligence, and smart vehicles. These new drivers for semiconductor and display span consumer, enterprise, and industrial applications and layer on top of existing demand from mobility, PCs, and other consumer electronics. Our discussions with leading companies in these areas make it clear that these new applications create huge demand for memory and require major advances in silicon technology. These trends add to my view that demand for capital equipment is becoming less cyclical and normalized annual spending is increasing over time. I'll now talk about the progress we are making in each of our major businesses. In semiconductor, we are seeing robust demand across the board, and as we said in September, we expect 2016 to be a strong share gain year for Applied. Growth in our leadership business is being driven by foundry and logic inflections and also by memory, as Epitaxy, implants, and rapid thermal processing are adopted in 3D NAND. In particular, we see strong growth in CMP, where we have increased revenue around 60% since 2012, and metal CVD, where we expect double-digit share gain this year. Our leadership businesses are in a really great position to grow. In 2016, we converted well over 90% of our development positions to volume production wins. We’re also making significant market share gains in edge and CVD. Fiscal 2016 was our third consecutive year of growth in CVD and fourth consecutive year of growth in edge where revenues reached a nine-year high. Overall, our combined edge and CVD revenues exceeded $2.7 billion for the year. I’m very excited about our product pipeline in edge and ALD. We’re seeing rapid adoption of our innovative new solutions, including selective edge and Olympia ALD that together generated more than $230 million of revenue this year. I’m also pleased by the progress we’re making in advanced packaging. We have some great new products and based on the positions we’re winning, we expect to double our packaging revenues over the next 12 months. In inspection and process control, we also delivered our highest-ever orders and revenue this year. In 2016, we believe that we will gain 20 points in e-beam inspection, around 7 points of share in e-beam overall and secure the number one position in this market. E-beam is the fastest-growing segment in inspection, and we’re winning new applications that support sustainable share gain for years to come. In service, our strategy is to deliver more value to customers with our advanced service products. Our service teams are more tightly aligned with our products groups than ever before; they are reducing ramp times, improving device performance and yield, and optimizing output and operating costs for customers. In the fourth quarter, we set new records for both orders and revenue, and when we look at year-over-year comparisons, we’ve now grown our service business every single quarter for the past three years. Display is also setting records with two inflections driving growth. The first is large format TVs driving investment in new gen 10 capacity. Large format TV units are expected to grow at 50% to 20% annually over the next three years, compared to single-digit growth rates for TVs overall. The second is OLED, where investment is increasing as multiple customers start to ramp this technology and battle for leadership in next-generation mobile screens. At our Analyst Meeting, we said that our market opportunity in display is expanding significantly; up to 10 times in the case of OLED. We are focused on building our product portfolio to deliver the solutions our customers need to transition to new display products over the next few years. We have great traction with our new thin-film encapsulation and e-beam review products and have more significant new products that will be announced in 2017. In summary, I strongly believe this is Applied's time. We set new performance records in 2016 and we’re seeing the impact of the investment we’ve made in our organization and product pipeline over the past several years. As we look ahead to 2017 and beyond, we see strengthening markets as large multiyear inflections continue to evolve and new emerging demand drives layers on top of mobility and computing. Across the Company, we’re focused on extending our innovation leadership. Applied solutions are enabling customers to build new devices and structures that were never possible before. This puts us in a unique position to drive sustainable growth and raise the ceiling on our financial performance. Now, let me hand the call over to Bob, who’ll provide more details about our results and outlook.

Thanks, Gary. In September, we raised the ceiling on our expectations for our markets and our company. Since then, we've increased our 2016 WFE forecast to a range of $33.5 billion to $34 billion. Our internal projection for 2017 WFE is a $1 billion higher than that and it assumes only modest DRAM investment, China spending, and NAND penetration of hard drives. So, our early view on 2018 in the longer term horizon is positive as well. So while our Analyst Day was just eight weeks ago, I already feel more confident in our ability to hit our 2019 financial model. After the Analyst Day, the slide that sparked the most interest was the one comparing average WFE spending and the standard deviation around the average for two periods: 2000 through 2009 and 2010 through 2016. What really caught everyone's attention was that the one standard deviation fell from $8 billion in the earlier period to $2.07 billion. The WFE industry has evolved since 2010 and that preserves some discussion. I'll give you the major factors that lead me to believe it's a fundamentally more stable and attractive business. First, the semiconductor industry we serve has become larger, more diversified and less volatile. Specifically, semi-content has led by PCs, which have multiyear demand cycles tied to enterprise upgrades. Now we've added mobility which has annual consumer replacement cycles and generates more semi-revenues than PCs. And today, we are layering on additional semi-demand drivers including big data, IoT, cloud infrastructure, artificial intelligence, virtual reality, and self-driving cars. Second, the cycles of the past were mainly driven by PC DRAM, which was the largest, most competitive, and most generic technology. Today, DRAM is near the bottom in spending. There are fewer producers, and the designs have been tailored to servers and mobile devices including multichip stacks; it's no longer one-size-fits-all. Third, NAND spending has surpassed DRAM, and NAND continues to unlock growth potential as the gigabyte cost approaches hard drives. Fourth, foundry capacity additions tend to be contract-based and demand-driven rather than supply-driven, and foundry has gone from being the smallest category to the biggest today. Fifth, our customers now add capacity on a more flexible basis, building out lines and line extensions instead of entire mega fabs. Not only has the industry changed, but Applied has changed in ways to give us larger and much more diverse revenues and profits. Over the past few years, we have achieved relatively balanced market share across all of the semiconductor device types. Most of our businesses are now benefitting from 3D NAND, and our success in NAND has been a springboard to our new patterning wins in DRAM. At the same time, we have greatly expanded our service business whose revenues are up by over 30% in just the past three years. By 2019, there is a relatively stable business that should deliver almost a quarter of our revenue and an even greater percentage of our operating profits, and Applied is uniquely positioned as the equipment leader in display. We're on track to triple our overall opportunity with new display products, and we're accelerating our display pipeline by leveraging our semiconductor IP including e-beam, identifying new technologies through Applied Ventures and securing R&D co-funding. In both semi and display, we can point to specific inflections and winning products that will drive our growth through the model period and beyond. And in all of our markets, I believe we're demonstrating systemic improvements in our ability to outperform. The better allocation of spending, more efficient execution, and product development engine are now culturally ingrained. Now, what's the significance of this greater stability? I'll mention just three things. First, our order variations now reflect seasonality more than cyclicality. We're focused on driving year-over-year revenue and earnings growth, and we plan to stop reporting quarterly orders as of 2016. To help you feel comfortable with this change, I'm telling you now that I expect our Q1 of fiscal '17 orders to be meaningfully higher in both semi and display. I also plan to detail our Q1 orders on the February call, so you can have a complete set of data for your calendar '16 models. Second, this stability gives us a unique opportunity to get closer to our customers and here's why. The technology roadmaps are getting harder, so customers increasingly want to work with the most capable suppliers, and we're the broadest and most capable. Today, our customers are asking us to engage earlier and ramp new enabling technologies much sooner and more aggressively; this costs money. But the most stable business environment gives us confidence that we can invest more in our customers' roadmaps and generate more attractive risk-adjusted returns. Number three, the stability helps us deliver higher, more predictable profits and increased cash flow. It's great for our financial stability. Eight weeks ago, we showed you our 2019 financial model. Some of you realized that we plan to generate substantial free cash flow well beyond what's needed to achieve our share count objective. We regularly evaluate the best means of returning excess cash to shareholders, and we know some shareholders value dividend growth as much as buybacks. We're evaluating our options for this additional liquidity, and we're monitoring the tax policy environment for any changes that could influence our thinking about the mix. Now, I’ll shift gears and comment on our performance during Q4; I'll focus on our revenues and profits as compared to the same period last year. We grew company revenue by 39% year-over-year and more than doubled our non-GAAP earnings per share. We increased non-GAAP gross margin by 1.5 points year-over-year and our spending discipline helped us to increase non-GAAP operating profit by 82% year-over-year. The non-GAAP cash rate was a little lower than expected due to a favorable geographic mix. At the segment level, we grew semiconductor systems revenue by 42% year-over-year and segment non-GAAP operating margin by 9.1 points. We increased service revenues by 13% year-over-year and non-GAAP operating profit by 1.9 points, and we grew display revenue by 92% year-over-year and non-GAAP operating profit by 10.9 points. Moving to the balance sheet, we delivered strong operating cash flow of $797 million in Q4 or 24% of revenue. We grew total cash in investments to $4.68 billion after returning $279 million to shareholders through buybacks and dividends. For the year, we distributed 106% of free cash flow to shareholders. At year-end, about 14% of cash in investments were onshore. The onshore balance has increased to roughly 45%, reflecting the effects of intercompany transactions. Now, I’ll provide our guidance for the first quarter 2017. We expect our overall revenue to be close to the record levels set in Q4. Our expectation represents year-over-year growth of approximately 45%, plus or minus 3 points. Within this outlook, semiconductor systems revenue should be near the 15 year high achieved in Q4. This forecast represents year-over-year growth of about 55% plus or minus 3 points. Services revenue is seasonally lower in Q1, but we expect it to be up by about 10% year-over-year plus or minus 2 points. And display revenue should be up by about 65% year-over-year plus or minus 10 points. Our non-GAAP earnings per share should be in the range of $0.62 to $0.70. The midpoint of which would be up by 154% year-over-year. As a reminder, Q1 of 2016 was a 14-week quarter. Since it's the first quarter of a new year, I'll help you with your modeling question. In Q1, non-GAAP gross margin is likely to be up by about 0.1 from 43.7% in Q4 reflecting a very positive mix. For the full year, we expect gross margin to reach approximately 44%, which will bring us to within 60 basis points of the midpoint of our 2019 model. Non-GAAP OpEx is likely to be $625 million in Q1 plus or minus $10 million. Our quarterly run rate in the balance of the year may be approximately $635 million which will remain below the model. Our non-GAAP tax rate is likely to be around 11%, which is above the model. And we will continue to buy back shares to achieve the share count target in the model. In summary, we delivered new levels of revenue and profitability in 2016 and demonstrated the benefits of the strategy we have been working to implement over the past several years, but this is just the beginning. The industry is bigger and more attractive. Our opportunity set is larger. Our customer relationships are stronger and our new product pipeline is better than ever. We raised the ceiling with our 2019 target financial model, and we are making excellent progress already. Our stronger performance is sustainable and we are confident in our ability to deliver increasingly predictable cash returns to our shareholders. Now Mike, let's start the Q&A.

Thanks Bob. To help us reach as many of you as we can, please ask just one question at this time. If you have any additional questions later, please call the operator and we will do our best to answer that later in the call. Operator, let’s please begin.

If you look back to your or at least what the implied guide for calendar 16 for Q4, you're growing roughly 24% plus, and if you think about mix, next year I’m assuming growing display, growing NAND. How should we think about your relative outperformance to the rest of the industry?

Sure, in our fiscal year and our calendar year next year, we think in the semi, it’s going to be healthier in general for the environment. We feel good about the environment. We’re going to gain shares. We don’t want to give exact numbers right now, but we’re gaining WFE shares in a number of places. And then in display, we see display revenues up a significant amount next year. And then, we see the service business continue to grow. So we will outperform the markets we're in, but additionally we think the markets are pretty good next year. Our outlook is WFE up. Our outlook is that spending on capital on display equipment is up and service again.

Bob, you talked about the 2017 WFE being up about a $1 billion, based on modest expectations for the DRAM, China, and NAND. Can you dig a little bit deeper into those three items and give a little color as to what you're assuming in the model?

Sure, part of what we were answering is that we think it’s wended back into 2018 too. So, if you look at 2017, we think NAND is up next year. We think foundry is strong and we think logic is pretty good. DRAM is up some next year, but what we don’t see as high levels of absolute DRAM spending because this year is not too big. What we’re modeling and we might be a little conservative, is not a big change in China spending; we think that hits more in 2018 if you just look at buildings and shelves and stuff like that. We are big believers China is going to happen. So we think we’ve wended our back into 2018 based on our few things. We think China ramps fairly more in 2018. We think DRAM probably has upside in 2018; not to mention semis altered from memories we're starting to see early now. And thirdly, NAND might be end of next year probably going to get about 7,000 wafer starts; something about 1.4 million. And we think all of that eventually gets, virtually all of that gets converted. So, we think there is still strong NAND spending in 2018.

What are the key takeaways from the analyst meeting was the order trajectory, right? So specifically book to bill is a leading indicator of the revenue and earnings power momentum. Past four years you guys have had book to bill greater than one, and obviously clearly an indicator of the growth of the business. As you look at your customer and program pipeline for fiscal '17, combined with your view on growth in flat panel and WFE in which we're spending growth, is 2017 likely to be the fifth consecutive year of book to bill greater than one for the team?

Well while we said earlier on the call that we see our bookings continuing strong, but the relative books quarter-to-quarter in particular we’re going to stop reporting bookings after Q1. We're going to you in Q1; we see up meaningfully and what we mean by meaningfully is up more than strong double digits, okay, from Q4. So people have been worried that we peaked in Q3 bookings down some in Q4. We see a strong Q1 and we see a strong year overall. So, we think the momentum is still with us, and our revenues are going to be up, and our shares are going to be up next year. In terms of quarterly variability and orders, I'm not sure. In terms of book to bill next year, we don’t have clarity on the second half. Here, it's too early first to tell. But we see a strong WFE year share up, strong spending on display. Frankly, it's more strong in both of those than we saw it eight weeks ago for instance period that large TVs are doing well, the gen 10 stuff, the profitability at the displays guys is good. So, we see display is pretty strong next year, we see broadening demand for mobile display; up to nine or ten people trying to make OLED displays, not just the mobile. And then within WFE, we're getting a lot of pull from customers to increase production and shipments. So overall, we think next year we're going to get very healthy bookings whether it's relative to one I don’t know right now.

Bob, I'm curious about China; how much you are putting in? I know that you think China is sort of generally more of a 2018 thing than a 2017 thing, but I'm wondering if you can give us some numbers in terms of what is embedded in your WFE forecast for next year for China versus what it was this year? Thanks.

Well, I’ll provide some insights into the numbers and offer my qualitative assessment. We anticipate a slight decline next year, but we believe the figures will remain stable overall. I might be a bit conservative in my estimates. There is a small decrease reflected in the numbers, but we think there could be some upside potential. Gary disagrees and doesn’t believe there will be a decline next year.

Yes, I would say that Applied was strong in all regions including China. And as we've talked about before, it's one of the strongest regions in semi and display. Right now, it looks like '17 is going to be roughly the same as '16, but it's up a pretty significant amount from where we were a couple of years ago. In 2018, we think could be meaningfully up above the 2017 forecast. So those were my thoughts.

Question for Gary, Gary thanks for the update on the patterning with the base and double case on EUV. On the display side, can you just give us a little different update or preview on what are some of the new products that you are looking at on the OLED side plan to achieve? Are these products meant to remove the supply chain bottlenecks? Or are they going to target some of the cost ownership or other technology challenges?

Our strategy overall is inflection-focused innovation and what we've talked about in display is an opportunity to triple our served market over the next few years. The team in display is really an outstanding team driving innovative new products, targeting major customer inflections and you can already see growth in display with thin-film encapsulation and e-beam, two products that we've introduced in the last couple of years that are really generating meaningful revenue for the display business. And so, we're really continuing the same playbook; we're focused on selections that are meaningful for our customers. We have very strong pull and investment from customers in these new products and high confidence that these new businesses will add meaningful revenue for our display business and increased confidence that we're going to hit or exceed the model that we showed for 2019. We will disclose more about the specific products in 2017, next year.

And then I think Atif has asked two questions, even though I asked for one, and I wonder if you could comment on the EUV?

We talked about patterning at our investor meeting in New York and we see patterning as a great opportunity. We forecasted about $3 billion TAM by 2019, and when we look at EUV adoption we agree with others that the view of EUV is going to be mostly focused on vias and cuts in logic. So when you look at the leading customer roadmaps, vias and cuts in logic is about 20% of the total patterning TAM. 80% of the TAM will continue to add multi-patterning and that gives us increased confidence in the $3 billion estimate that we had at our investor meeting. Basically, if you take the most aggressive EUV assumption for adoption, something like 10 layers adopted at five nanometer logic for vias and cuts, you come up to the $3 billion estimate. Of course, if it's not in this most aggressive assumption then the TAM could be higher. And Applied is really in a great position to gain share; we talked about a $1 billion number in our model for 2019 for Applied, and we've great confidence in that number. We've already gained 15 points of share in patterning since 2012. We're forecasting at least 50% more between now and 2019, really great products in edge, in selective removal, CVD, ALD, CMP, really great new products and we've line of sight to the 2019 model with many application wins and increasing customer pull for these innovative new products.

So, I have a follow-up question on your 2017 view on foundry logic WFE. Does your 2017 view assume will be much foundry logic customer reuse of 10 nanometer equipment for the 7 nanometer node? Or is it assumed limited equipment reuse by foundry logic? Thanks.

Sure, let me provide some context on how we view the business before addressing your specific question, Stephen. We strongly believe in three points. First, the industry we operate in is becoming increasingly attractive; overall spending is rising, and volatility in both WFE and capital spending for displays is decreasing. Second, Applied is making progress with a broader range of product offerings and reduced volatility. We hold similar market share across NAND, foundry, DRAM, and logic, and we are gaining share with a robust product pipeline. The second point is that the industry trends are positive, and Applied is growing more appealing and stable. Third, these factors together generate very predictable cash flow, which we can discuss further later in the call, allowing us to return cash to our investors. Regarding risks, there will be some equipment reuse from 10 to 7 nanometers next year, but I view this as moderately impacting. I don’t expect 10 to be a significant node; there will be a shift to 7, but 10 nanometer devices will still ship next year, and 7 will follow the year after. Consequently, the ability to migrate equipment is somewhat limited. Additionally, when comparing past transitions like from 20 to 16 flash or 14, those were different in a few key ways. One major difference was that the largest consumers of computer chips switched vendors during a node transition. Furthermore, we moved from the last planar device to the last planar first FinFET device, which made the last device less appealing. So, will there be some equipment reuse from 10 to 7? Yes, but I don’t anticipate it happening next year, and I expect the transition to be much smoother than it was in 2015.

I'll make a two-part question Bob. One, as you mentioned, the business is getting more seasonal versus cyclical. When you look at the order trend, you had a dip in orders for semis in the October quarter. Is that the seasonality you are talking about on a go-forward basis? And along the same pattern you look into calendar '17; can you help us understand and dig a little deeper in how the WFE profile looks like first half versus second half for NAND, DRAM, foundry, and logic?

Yes, I do believe that as we said on the call previously, I do think it's more seasonal than cyclical. We have a lot of data that shows that some friends even if you look as we said, the script we got asked the most questions about at the Analyst Day was this average WFE spending since 2010 is up to like 31.7 billion. I think it is with the volatility about 2.8 versus 2009, it was like 25.5 with a volatility of 8 billion. I'll give you more details on that. If you look at memory as a sum because virtually every customer makes DRAM and NAND, the average before 2010 one standard deviation, one sigma was 6 billion on an average spent of 10.7. Since 2010, its $3 billion standard deviation on an average spent of 12 when you put DRAM and NAND together. The second thing is virtually every year there is 2012 I think it is; it’s a pretty much 1 billion to 2 billion every year total memory spending. Now if you get loss in the weeds between DRAM and NAND, it's all different. But the companies manage their budget that way. They’ve still got to put DRAM this year and NAND in that year, RAM fab this year, the other fab next year. And then on foundry, foundry spending before 2010, it was $2 billion on average; if the standard deviation was $2 billion FinFET was 1.5 billion on the spent of 12 brand, and the spend pre-2010 average was 4.5 billion. So the magnitude of these standard deviations the volatility is going down; really, it's seasonally not cyclical. In terms of your specific question about I guess this was about next year, we are not exactly sure; I'll give you some data for us. We think our Q1 bookings were up. We think our year WFE is up. We think our share is up. Just because the data, we think year-over-year it’s a chance that every quarter year-over-year is up. So I think in terms of the seasonality specifically asked on foundry; historically spending on WFE and foundry, foundry is the one that tends to be a little more seasonal because it's Christmas and Chinese New Year. They historically are taking equipment more March through August, end of February through August. And then they might have another spur if they need more latter in the year. This year it was a little different because one of the big foundry customers is trying to bring a lower level themselves and get head start on 10 nanometer. So we have a little bit different cycle in terms of spending because remember 10 NAND is shipping from next year. And then the other thing in May this year a little different is, there is just sustained demand for 3D NAND. So we had started at the beginning of the year; we have pull at the end of the year. So the seasonal which is kind of more cyclicality is being mapped to be a technology transition, which is very helpful too. Again, that’s not so much cyclical; it’s more of technology trends that are going to go in for years.

My first question is regarding the Jan quarter orders outlook; on the prior call you had indicated that orders would be flattish in the Jan quarter from October. I just want to understand what has improved and how do you see the orders will combine different segment evidence as switching?

I'm trying to overcome my usual habits, but I will try to clarify a bit. Last quarter, we established a baseline because we've seen significant increases across all metrics: orders, revenue, and EPS in recent quarters. We want to assure everyone that we will maintain strong performance; our share gains, revenue growth, and operating margin expansion are sustainable. We indicated last quarter that orders are not going to decline sharply. We expect the numbers to start with three in the next two quarters, Q4 and Q1, and indeed they will start with three. We anticipated Q4 would be slightly higher, and some of those figures shifted into Q1, so we believe we will see double-digit growth in Q1. It's mostly a matter of timing, and the overall figures are stronger than expected due to the demand for certain flash devices like 3D NAND. Overall, it's looking robust and even stronger than it did two months ago.

It just seems that AI machine learning and self-driving car adoption is coming along a lot faster than we thought at the start of the year. And we know these applications are iterative and very compute intensive. And I’m wondering if this could be, this all could be an incremental driver next year for your memory and logic businesses?

I don’t about next year but I would say that we’re definitely increasingly bullish about the longer term. We’ve talked about five drivers in our model between now and 2019. This multiyear way, so we’re very confident in those drivers, and we’ve talked about that in the prepared remarks. But I would say definitely increasingly bullish relative to the longer-term opportunity, as we’re engaged with some of the leading technology companies around cognitive computing, smart vehicles. You saw a big announcement from Samsung this week with an $8 billion acquisition. There is an incredible amount of money being spent. And when you look at these drivers: VR, AR, smart vehicles, cognitive computing, all of these different areas, you need higher performance computing. We had the CEO of one company that was here recently, and we were talking about logic devices; what are the sizes of those logic devices going to be? And basically he said: as big as I can build them, as big as I can fit them into radical field. And he was also talking about the amount of memory that's going to be needed for some of the future applications, and it’s much, much bigger than I think any of us could imagine. So I would think we are much more bullish about the longer term relative to the drivers for high-performance computing and for memory. I'm also bullish about the innovation pipeline that we have within Applied Materials. I really believe that the 500 million per year that we've moved in terms of innovation; we are already enabling people to design devices that they could not have dreamed of building a few years ago, and I strongly believe that the pipeline we have now, the best is still coming in that pipeline. So I'm really bullish about the market. Bob talked about where we compete being better, more stable, and upward trajectory, less volatile. Applied is in the best position we've ever been in to enable all of these great big inflections to happen.

I wanted to ask about your sort of multiyear commentary when you said you are still optimistic even beyond 2017. Can you talk about NAND in that context and either still very high capital intensity period of planar to 3D conversions and 3D greenfield, you'll get to the point where you are going sort of more layer account increases which is less capital intensive. Shouldn't NAND turn into a headwind at some point in the next couple of years? And how do you think about that in that multiyear context overall WFE?

Sure, Joe. This is a significant moment, and I'm going to share some insights that haven't been expressed by a CFO in an American public company before. So, let me reference a couple of slides I have that illustrate the growth of demand for solid state disk drives in both enterprise and PC markets. The numbers are certainly up for discussion, but I believe they are close to accurate. In 2015, the demand for solid state disk drives in the enterprise was around 12 petabytes, which is expected to rise to nearly 120,000 petabytes by 2020. On the PC side, the demand will increase from about 20,000 petabytes in 2015 to 140,000 petabytes in 2020. To provide another perspective, our estimates indicate that the penetration of solid state disk drives across all PCs, including workstations, was 21.8% in 2015, increasing from 15% in 2014, and is projected to reach 77.5% by 2020. For enterprise servers, the penetration was approximately 20% this year, up from 14% in 2014, and is set to reach 26% by 2020. Overall, we expect total petabytes to increase by over 100,000 from 2016 to 2020 in both PCs and enterprise sectors, demonstrating substantial demand for NAND. Additionally, for servers alone, we may need around 500,000 wafer starts of capacity, with the average NAND costing about $5 to $6 billion, leading to expenses of about $25 billion to $30 billion, plus another $25 billion to $30 billion for upgrades. This implies potential spending of $50 billion to $60 billion over the next five years, around 2020. If we spread it over four years, that translates to about $50 billion in net sales, or more than $10 billion a year. Our forecasts have been adjusted, and next year we anticipate exceeding $11 billion. It's likely that we will maintain sales above $10 billion for the next few years, especially as we observe demand for solid state disk drives overtaking hard disk drives. We are considering factors like capital intensity and customer feedback; shipments are set to increase over the short term. The transition from 2D to 3D NAND is ongoing, and this shift will accelerate the sales of 3D products, driving prices down to compete more effectively with hard disk drives. Overall, there are many factors to account for, and we could see sales consistently around $10 billion for an extended period.

Thanks, Joe.

And I'd like to say that I was proud to use the word petabytes today.

Bob, maybe if you can just clarify again the growth that you're expecting in total display spending in 2017, is that incrementally because of the gen 10.5 build-out that you're seeing or are you also anticipating a further increase in OLED spending next year?

I think we're observing several trends; in terms of actual spending, I believe we're experiencing an increase. It seems we're seeing a rise in TV sales compared to our expectations from two months ago. There is significant demand for OLED in mobile devices, but the challenge lies in how quickly they can increase production. It appears that supply is the main concern rather than demand. For TVs, they can enhance production of larger models, and they will likely ramp up quite aggressively, especially in China. The generation 10.5 production is expanding, and more developments are anticipated beyond that. We're projecting display capital expenditures to exceed 16.5 next year. While I don't have the figures from two months ago, there's growth in both areas. However, the most notable change for us over the past two months is in the TV segment, as the sizes are larger than we initially anticipated, and the profitability in the TV panel business is quite robust, which is a positive sign for spending and these large fabs. Both segments are generally healthy, but the increase is likely more pronounced in the TV sector.

My question is regarding the DRAM market. Bob, you seem to be somewhat cautious about DRAM, but we are noticing price increases and discussions among customers about transitioning to the next node. Are you being cautious for a reason, or what steps are you taking for the customer? Are you seeing any indicators that suggest it's time to advance to the next node?

We can do DRAMs up next year, but we think most customers who make DRAM and NAND are setting a priority on NAND right now because they're seeing an expansion in their addressable market for NAND, number one. And number two; it's a competitive situation that they don't want to miss that growing market. In DRAM, their pricing is pretty good, so I think the capital goals will go to NAND.

I'd like to know what your assumption is in terms of in-store capacity with softer nodes for 10 nanometer for next year?

Our line was quite for a moment. It sounded like you were talking about 10 nanometers and the capacity at the end of the year or something, so we can quite sure.

Yes.

Can you please just repeat, thank you.

Yes, can you share with us what is your assumption for the 10 nanometer node capacity that you have at the end of let's say Q4 2017 for the industry?

Sure, according to the chart I have, spending in foundry for 2016 is estimated to be 59% for 10/7, and we anticipate a similar percentage for next year due to continued strength in some trailing edge technologies, particularly at 28 nanometers, which we believe may see an increase next year. Regarding the split between 10 and 7, the total capacity for this year is estimated to be around 70,000 to 80,000 wafer starts, and we project that to rise to 110 to 130 next year, with the majority being in 10 nanometers.

You sound really positive regarding the demand drivers and you are going to stop providing booking numbers on a quarterly basis; if you’re so confident, why not provide an annual revenue and earnings target, so there we can better track this multiyear cycle that you are going through?

We never have it in the industry and I am not going to start now. I mean, we don’t give guidance out of a year.

But you stopped providing bookings so?

Here is all we gave you. We gave you a 2019 model. They gave you the WFE assumption, revenue assumption by product, share assumptions. We told you in the Analyst Day that our share gains were almost linear from now to 2019. And we told you that our service business was going to roll almost linearly by year. And we told you that display was going to be going up to that number too. So our growth in revenue from '15/'16 and 19, we think is pretty straight-lined. Now, giving absolute numbers a year in advance, we don’t have that level of precision.

When you look to the next few years and all the growth coming from both the flat panel OLED as well as China. What impact does that have on your both cost structure and your market structure?

I am sorry, Tom, could you repeat it please?

Yes, when you look at growth coming specifically from the couple of large markets like OLED and China. What impact does ramping revenue on those particular markets do to your cost structured margin structure overtime?

I’ll give it a try. Regarding our cost structures, most of our sales come from physical product resale, which share common factories mainly located in Singapore and the U.S. The material and product costs are similar, with Taiwan being a significant source for our displays. Our material cost structures and supply chains are global, so the sales locations are not overly influential for us. As for differentiation and product mix, various device types utilize different combinations of our hardware and products, which can affect gross margins. In the OLED display market, we see margin profiles for our existing products that are comparable to our TV markets across different regions. The real margin opportunity lies in the new products we plan to introduce over the next couple of years in displays, which we consider highly differentiated and appealing. Margins by region mainly depend on the product mix. Historically, we have offered a high level of service to customers in China, helping us maintain a strong market share there.

Yes, the incremental operating profit, if we look at China is pretty good for us. We have a very strong position, great relationships and then really great teams supporting customers both multinationals and the domestic companies and also the incremental profit for us in display is positive for the company overall.

And then operator, I think we have time for just one more question please.

Bob, I'm just trying to reconcile the flash segment. We had good spending this year, but why were your orders essentially flat between fiscal 2015 and fiscal 2016? I understand it's a fiscal year, but what does it mean for 2017? I mean, fiscal 2017 given the spending that you are seeing for the flash?

We had one particular customer in 2015 that gave us orders pretty far in advance because they want to lock in capacity deliveries from us. So, I think that was the aberration. I think the trend line is up; if you look at total WFE, it's up for just flash; and if you look at our sales are up and probably they are up next year too. So we're a little bit in 2015; one particular customer and particular want to get into their pipeline in terms of the queue for production.

Thanks Jagdish for your question and Bob; would you like to summarize before we close the call?

Sure, it seems like a year ago but we only had Analyst Day about six weeks ago here little more in New York, and I have to say even in the last eight to nine weeks, I increasingly believe that the industry we serve are becoming more and more attractive, growing, and more diverse and less volatile. Gary talked about some of the demand drivers for our customers whether it's autonomous cars, it's virtual reality, it's AI big data. You really feel that's driving Silicon Valley. You see it everywhere. We had some of the CEOs of these companies come in and talk to us, and it's real, it's happening. Look at some of the highest performing stocks in the states this year, that's what is driving them. So one, the industries we serve and displays also that way were just kind of doubled in terms of spending and becoming more and more attractive and more demand drivers will predict the less volatile for us. Second, Applied is performing better; I think we are more and more becoming more and more innovative and executing better in these compounding benefits from that. So, I think that's resulting in a broad range of opportunities. Our biggest promise is just picking and choosing among good opportunities at this point. So Applied is becoming broader, more diverse and less volatile, and more predictably we're going to do better. Alright. And then finally, those two things combined and potential with tax legislation that there's really good opportunity to return superior cash returns to investors including which we've said I think we said earlier today that we were conservative in the financial moving a lot, and we showed eight weeks ago in terms of the cash and we kept a little conservative within the cash and the model because we wanted to be opportunistic, if the world tax slot changes that we could return even greater return to the investors. So I think the industry is becoming more diverse and less volatile and more attract in terms of growth, more drivers. Applied is becoming that way and the leverage down to the cash line especially if you get some tax legislation less attractive is a pretty powerful combination for Applied.

Great. Okay, thanks Bob. 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 PM Pacific Time today. So thank you for your continued interest in Applied Materials.