Q3 2019 Earnings Call

Afterwards, we will be invited to participate in a question and answer session.

I would now like to turn the conference over to Michael Sullivan Corporate Vice President. Please go ahead Sir.

Good afternoon, and thank you for joining applies third quarter of fiscal 2019 earnings call, which is being recorded joining me are Gary Dickerson, our president and CEO and Dan <unk>, Our Chief Financial Officer before we begin I'd like to remind you that today's call contains forward looking statements, which are subject to risks and uncertainties that could cause our actual results to differ information concerning the risks and uncertainties is contained in Applieds. Most recent Form 10-Q , and 8-K filings with the FCC. Today's call also includes non-GAAP financial measures reconciliations to GAAP measures are found in today's earnings press release and in our reconciliation slides, which are available on the IR page of our website at applied materials Dot com and now I'd like to turn the call over to Gary Dickerson. Thanks, Mike.

Our results for the third fiscal quarter demonstrates strong execution in an environment that remains challenging for the time being.

Overall, our view of 2019 is consistent with what we've previously communicated.

Within our served markets foundry logic spending is strong while investments by memory and display customers are significantly lower than last year.

We also remain mindful of the broader macro economic risk.

During this industry down cycle. My primary focus is ensuring the organization is executing on the initiatives that will put applied materials in the best position for the future.

I believe the opportunities for applied are compelling as powerful new demand drivers emerge in the form of Aiotv big data and artificial intelligence.

So even though we are prudently managing discretionary spending in the near term we are fully funding R&D to accelerate customers' roadmaps and building new products and capabilities that will underpin the company's growth in the years ahead.

And today's call I'll begin with a brief update on the near term market dynamics. I'll, then talk about emerging technology trends and applied strategy to address them, then I'll finish by highlighting some of our recent accomplishments starting with the current environment our views of the semiconductor and display markets are largely unchanged.

In memory spending has softened slightly since our may call.

On the supply side, we still see customers, making disciplined investments, while adjusting factory output to reduce inventory levels on the demand side. We believe the price elasticity of demand is starting to take effect in the form of increases in the average bits per box for both smartphones and Pcs.

Based on our current visibility we remain optimistic about 2020 with an expectation that NAND investments well recover ahead of DRAM.

In foundry logic demand has strengthened as the year has progressed.

As we see customers accelerating the ramps of their leading edge nodes.

Demand for specialty nodes that serve the IOTV communications automotive power and image sensor markets is also driving robust investments in capacity a new technology.

Taking these factors into account our view of overall wafer fab equipment spending for 2019 remains the same down mid to high teens on a percentage basis relative to last year, we see 2020 as a more positive set up for the industry and applied with the start of a recovery and memory investment and sustained strength.

In foundry logic spending.

And the supply there are no significant changes to the outlook, we provided last quarter and we still anticipate or 2019 revenue being down by about a third relative to 2018.

Just as in semi we're excited about the inflections taking place in display and the opportunities. These create we're getting ready for the future by ensuring we have the right portfolio of products to help our customers accelerate the introduction of next generation technologies, including rigid and flexible OLED and larger substrates for manufacturing.

A few weeks ago applied hosted our second Hey, I design forum with more than 700 attendees, representing leading companies from across the ecosystem.

My main take away from this conference is strong alignment around four key themes first AI in big data are driving new approaches to computing that require new system architectures built from new types of semiconductor devices.

Second at a time when improvements in power performance area and cost are Paramount.

Classic Moore's law scaling is running out of gas.

Third to address this new approaches for semiconductor design and manufacturing are needed.

In our view the new industry playbook has five elements, new architectures, new devices, and threed structures, new materials, new ways to shrink feature geometries and new ways to connect chips together.

Fourth to accelerate implementation of the new playbook companies need to connect and work together differently by breaking down traditional silos.

At applied we're aligning our strategy and investments around this vision of the future for example, new types of memory, including M. Ram piece, the Ram and Ram or high potential technologies that can enable new architectures and provide significant P.P.A.C. benefits at the edge and in the cloud.

But these three d. devices are also incredibly challenging to make at high volume and yield in the case of M. Ram. The device is based on a film stack of more than 30 thin layers some of which are only eight Adams high.

Missing items or imperfections in materials have a significant impact on the performance and endurance of the device.

To help drive adoption of these advanced memories, we recently introduced one of the most sophisticated products we've ever created combining many of our leadership technologies in one integrated system.

This new system has nine different wafer processing locations and each process chamber can deposit up to five different materials. The entire process flow takes place under ultra high vacuum to keep impurities out and we use cryogenics in heat to very process temperatures by hundreds of degrees. All of this is critical to optimize material structures and interfaces.

The system also includes.

Unique onboard metrology that allows us to measure a key properties of the materials to 107 nanometer as they're being created and modified.

This next generation of equipment that we call integrated material solutions is one of the ways applied is bringing to bear our broad technologies and capabilities to address our customers' most complex challenges.

Another area, where applied has unique technology and Brad is advanced packaging.

Applied has the most comprehensive portfolio solutions to support customers advanced packaging, Roadmaps and new heterogeneous integration approaches.

In the past quarter, we won important process tool of record positions at leading customers securing over 80% of the applications. We competed for including CVD PVD CMP and edge, where we have a highly differentiated new products or inflection focused innovation strategy is also yielding results with our unit process tools that enable new threed structures, the introduction of new materials and new ways to shrink.

For example, we've been building on our strength in conductor etch for memory by winning new steps in both DRAM and NAND as well as new positions for critical etch applications in foundry logic.

We're also finding new ways to deliver more value to customers through our service business.

One example of this is using advanced metrology sensors data science and simulation to speed up the transfer of new technologies from Applieds labs to customers' factories, and then reduce the time it takes to optimize yield output and cost.

Well both in applied global services is slightly below our prior expectations, we still anticipate our combined spares and service revenues being up this year.

Even as customers pull back on their capital spending and operating expenses.

Before I turn the call over to Dan I'll quickly summarize.

Our view of 2019 is relatively unchanged.

Thanks to the hard work of our employees across the company, we are delivering solid performance, even with the current weakness in memory and display demand.

During this industry down cycle, we are focused on driving R&D programs and building new capabilities that will move the needle for customers and applied in the <unk> era.

And we remain excited about our long term opportunities as these powerful secular demand drivers start to take shape.

Now Dan will provide his perspective on our results and outlook.

Thanks, Gary.

In Q3 applied delivered solid financial results with revenue margins and earnings above the midpoint of our guidance our semi related business continues to feel stable and while I'm still not ready to call. The bottom of the cycle I see positive leading indicators of future growth.

In memory, our customers reported significant output reductions during the quarter.

They discussed inventory reductions in their end markets and demand elasticity across smartphones Pcs and servers in foundry logic demand is strong both in the leading nodes and in trailing geometries, driven by Aiotv communications automotive power and sensor applications. We believe our markets will become significantly larger as powerful new demand drivers kit Kat.

And we're positioning applied to generate strong shareholder value by focusing on our four financial priorities.

One we are tightly managing our overall spending well to fully funding and expanding our product roadmap and customer technology engagements to fuel growth.

Three increasing the recurring revenue, we earn by helping our customers maximize their returns from the installed base and for delivering attractive cash returns to shareholders.

For example, this quarter, we held overall spending flat, but increased the R&D portion of non-GAAP opex to 69%.

This outcome demonstrates how we're controlling our discretionary spending while fueling innovation and future growth.

We announced plans to acquire Cook OSI electric to expand our presence into batch technology and accelerate innovation for our customers. This will also strengthen our services and customer support capabilities in the memory markets and throughout Asia.

And we delivered on our commitment to return cash to shareholders, including while the Coca site transaction is being reviewed.

During the quarter, we paid 21 cents per share in dividends, including the 5% increase our board approved in March.

And we used $528 million to repurchase over 12 million shares at an average price of around $42 per share.

Over the past year, we've repurchased 68 million shares at an average price below $39 and we have $2.4 billion remaining on our buyback authorization in short we're excited about our opportunities and we're focused on taking actions that will generate significant shareholder value in the years ahead now I'll summarize our Q3 results, we deliver company revenue of $3.56 billion and non-GAAP gross margin of 44%.

Both above the midpoint of our outlook.

We held non-GAAP opex to $746 million and generated non-GAAP earnings of 74 cents, which was near the top end of our guidance range.

Turning to the segments.

Semiconductor systems revenue was $2.27 billion, which was above the midpoint of our outlook and non-GAAP operating margin increased to 27.5%.

Global services revenue was $931 million, which was below the midpoint of our outlook and non-GAAP operating margin declined to 27.8%.

I'll take a moment to explain what we're seeing in AG S.

Last quarter I explained that we have two kinds of service business long term agreements that give us subscription like revenue and transactional parts and services.

In Q3 and in our outlook for Q4.

Long term service agreement revenue is growing right in line with our forecast.

But our transactional business is being impacted by the output reductions in memory.

We still expect a record year for AG <expletive> , but we're lowering our growth target to low single digits.

Revenue from our overall semi installed base business, which includes parts and services along with upgrades and Refurbs will grow even faster and set a new record.

Moving to display Q3 revenue and operating margin both declined slightly as we expected.

Next I'll provide our Q4 guidance.

We expect company revenues to be approximately $3.685 billion, plus or minus 150 million.

And we expect non-GAAP earnings to be in the range of 72 cents to 80 cents per share.

Within this outlook, we expect semiconductor systems revenue to be approximately $2.25 billion.

Services revenue should be about $955 million and display revenue should be around $455 million, which would be up 34% sequentially.

We expect non-GAAP gross margin to be about 43.5%.

And non-GAAP opex should be about $755 million.

Looking ahead to 2020, we continue to expect growth across our markets and a gradual U shaped recovery.

Well, we only guide one quarter at a time I'll offer you some planning assumptions for the early part of fiscal 2020 to help with your models.

On a quarterly basis, we view $2.2 billion is a good baseline for semiconductor systems revenue until we see evidence of a recovery.

We expect AG ESS revenue to be flat with our Q4 guidance, which is a bit better than seasonal.

And we expect display to be about flat with our Q4 guidance, which demonstrates our expectation that we've passed to the bottom of the display cycle.

Gross margin should remain approximately flat versus Q4 on the mix we foresee.

And our Opex should increase to around $800 million as we layer in the annual merit increases along with R&D for new products and the new technology initiatives Gary described.

In short, we see structural growth in the years ahead positive leading indicators for 2020 and the opportunity to drive strong shareholder value by investing in breakthrough innovations that applied materials is uniquely positioned to deliver.

Now Mike let's begin the <unk>. Thanks, Dan now to help us reach as many of you as we can please ask just one question and not more than one brief follow up operator lets please begin.

Thank you if you have a question at this time. Please press the Star then the one key on your Touchtone telephone. If your question has been answered or you wish him lose yourself from the queue press the pound key.

And our first question comes from CJ Muse with Evercore. Your line is open.

Yes. Thank you thanks for taking the question.

I guess first question in your prepared remarks, you talked about expectations for NAND to recover sooner than DRAM and so I guess on that front. How are you thinking about that coming back in terms of both timing and magnitude as well as as we move from single stack to multi stack and there's clearly clean room availability.

How are you thinking about conversions versus new capacity as as that comes on line into 2020 and beyond.

Thanks, TJ, maybe I'll start and see if it Gary wants to offer anything from a technology standpoint towards the end. So when we think about the memory market and you called out NAND, specifically, but let me broaden the comments just a little bit more to encompass the entire memory market. We don't expect to see a recovery in 2019, we see it as a 2020 event and as you pointed out we expect to see NAND first then followed by DRAM.

If we think about where we sit today from an overall Wi Fi standpoint, the memory markets are clearly down in 2019 versus where we were in 2020. So this is clearly a correction here, but we are seeing early signs of improvement output across the industry has come down we are under shipping true end market demand from a supply standpoint, as we exit the year. This is bringing our customers inventories down it's bringing our customers customers inventories down and we do see the early signs of demand elasticity beginning to kick in and signs of price stability. When we net all of this together, we definitely see a 2020 as a recovery year in the memory market and again, we see it as a man led event followed by DRAM in terms of magnitude I think it's premature to be point specific on any ended.

Visual market right now in the 2020, but we like the set up of what we say we take a step back and we think about the long term in these markets beyond 2020.

We do see that there is a data explosion as the data economy kicks in and the value of that data is increasingly going up as companies learn how to monetize it we see capital intensity going up we need we see new forms of memories, which really plays to our strengths in materials, we see our customer base being rational and disciplined we net all that together, we think theres a real opportunity to go structurally larger as a memory market off of the levels were currently seeing in the current environment. So we feel good about the long run.

Yeah, maybe I can add something relative to.

Our position in memory and also in NAND.

You know I think many of you know that we have a much more balanced overall share across memory and foundry logic and memory, we increased our share of total spending from less than 15% in 2013 to around 20% today and we're confident we're going to continue to drive gains into the future.

Another thing that's really positive for applied as memory is very much driven driven by materials enabled scaling.

And I think everyone's aware capital intensity has been increasing Oh. We are also engaged with all the major memory companies with integrated material solutions again, it's all about new structures, new materials, how far, especially in NAND or you can scale vertically. So we have very strong pull from customers for new materials, new products to enable a their product cost and performance Roadmaps in NAND, specifically, we're winning new etch applications in NAND and to get more layers and and one of the most important things is new materials, especially high selectivity hard masks, where we have very strong capability.

I I talked last quarter about hard mass that increase etch selectivity by 50%.

And we're seeing strong adoption of those new capabilities across multiple customers with new stops that give us a significant tam growth. So again, we've been increasing our share in NAND, we have new materials and new products that make us very optimistic we're going to continue to drive strong momentum into the future.

Thanks Vijay.

Thank you.

Thank you and our next question comes from.

Touchy Haro with Goldman Sachs. Your line is open.

Hi, guys. Thanks for taking the question and congrats on the solid execution.

Gary I was hoping you could talk a little bit about what you're seeing in China from a technology progression perspective, both on the DRAM side as well as announced side.

There continues to be a pretty big part of your business as well as your peers businesses in the near term as well. So if you can talk about.

The rate of progress on the technology front.

As well as your expectations in terms of Wi Fi for 2019, and preliminary thoughts on 2020 that will be helpful and I've got a follow up.

Okay, great Yeah. Thanks for the question. So our view on China is similar to what we communicated before we don't see any major inflection and spending 2019, we see relatively flat versus 2018.

If you look at domestic China, our views a little stronger over the past few months with some increases in memory for the year as a whole we see slightly higher spending on foundry logic versus memory with foundry logic focused on Aiotv communications sensors or those types of devices in our display business in China. We believe that's going to be down roughly in line with our global display forecast.

Overall in China, we have a great position Sammy service, we've been in China for 35 years. The display is a great team for us a very very strong customer relationships and engagements relative to the technology progression <unk> I don't really think again anything has changed from what we communicated before as I said, we believe the foundry logic on the trailing nodes.

Is where we will see over half of the domestic investment. This year, we think that market is going to continue to grow if you look at image sensors, that's going to be a very strong market and you know we see the investment there as being rational and aligned with the increase in demand for those types of products memory is a well those are very difficult technologies and it's a long road.

To be able to produce those technologies, a at a competitive level for performance and cost.

As we've communicated before we don't see any big hockey sticks, I really don't see much different than what we saw before we think it's going to be a long.

Journey and incremental spending going forward.

Great. Thank you and then as my follow up I wanted to ask about market share. If we take your October quarter guide for the semiconductor systems business and.

The guide from from Dan.

Into into the January quarter.

Yes, we we Gotta COVID-19 segment revenue number that's slightly better than what you described for overall Wi Fi.

Is the slate market share gain implied in your guidance a function of you know your sound acting a little bit better than than prior years or are you actually picking up share within within the within the markets that you serve thank you.

Yeah. Thanks, Toshiya. So there's no question in 2019 as a more favorable set up for applied.

And I have really very strong confidence that we're in a great position to keep keep the momentum going into the future. If you look at the third party data for overall spend and you'll see that we've been on a trend of higher or flat share all the way back to 2012, except last year, where the mix was very heavy in places like batch processing die electric actually thought where we don't participate so absolutely. The if the mix is more favorable for us this year.

So we're not going to make any specific predictions, but the set up for sure as much better for us. This year, we're winning many head to heads and especially in new applications. We have a very strong pipeline of new products, including products that expand our positions in the markets that we don't currently serve some of those products are already gaining traction with major customers.

You know I spend a lot of my time with customer and R&D leaders, that's what I love to do more than anything else.

And in discussions with them, it's clear that they're struggling to deliver improvements in power performance and cost and I think it's also clear and this was evident that the I. design forum or last month that the future is not going to look like the past the classic two d. scaling isn't working.

All my interactions with R&D leaders, they talk about new materials threed structures, new ways to connect chips together in new ways to drive cost and I really deeply believe applies in the best position we've ever been in to enable this new playbook.

With a breadth of products, we have to create shape modify and analyze new structures. Our combined capabilities unique enables us to deliver integrated material solutions, we talked last year about a thousand X improvement in leakage current we talked this year about this amazing MRM capability.

And those are new ways to drive performance and power performance area and cost and also were currently engaged with all major customers in memory and foundry logic with these new integrated materials solutions. So that combination of new Imus solutions, our capability to enable the new playbook, new products put us in a great position to accelerate roadmaps for customers and drive future growth for applied so again I like to set up for 2019 and also into the future.

Thanks, Jeff.

Thank you. Our next question comes from a T. Smith with Citi. Your line is open.

Hi, Thanks for taking my questions and good job on the execution Gary.

Couple of memory makers have talked about capex being down for next year, you sound optimistic on NAND and your peers have said the same how does it reconcile these two and what is your view based on a is it based on recovery and maybe pricing or shall availability.

Hi, Tim This is Dan I think I'll jump in and take this so.

All we can bake into our forecast and the expectations. We set into the market are the things we see the conversations we have with our customers about expectations out into the future as well as the bottom up modeling, we do from an industry and end market device standpoint, and the consumption of bits in those boxes as well as top down economic modeling and forecasting and as you can imagine on forecast comes together, it's a triangulation of those events, but we spend a lot of time talking to customers and based on all of the information that we have to date, our best view out into the future is for 2020 to be a recovery year in the memory market and for W.F. fee to be up year over year.

That said in this environment.

We are setting an expectation and we think it's prudent to do this setting an expectation for a gradual you shape recovery if the industry does better than we're currently contemplating then we as a company will benefit the very material way and we like that set up but when we net it all out to us it's a matter of when not if and in our view, it's a 2020 event for memory.

Thank you Dan.

Thank you. Our next question comes from John Pitzer with Credit Suisse. Your line is open.

Yes, good afternoon, guys. Congratulations on the solid results given all the uncertainty in the macro Kerry wondering if you could spend a little bit more time talking about the market opportunity for for sort of the N minus one at the foundry is being driven by industrial auto Aiotv, how big do you think that is and I guess importantly, with trailing edge nodes staying stronger longer what does that do for reuse at the foundries at leading edge is that actually driving a bigger and spend because reuse is slowing down.

Yeah. Thanks for the question Yeah, I think for sure we see that this especially market growth is going to continue to increase for the future. If you think about people talk about a trillion connected devices and generating significant amounts of data you know that's right smack Dab in the middle of that type of market and this is a really a great growth opportunity for applied we have a great portfolio of products across 203 hundred millimeter technology. If you look at foundry logic again, maybe some people don't understand.

The dynamics about 50% is growing in areas like Aiotv communications auto power devices and sensors and innovation. There is really driven by materials innovation. So again those are areas, where applied has a significant strength. We've increased focus on these markets and we have a great team of leaders across the company to work with customers to enable their roadmaps I mean, I'm I personally have visited a lot of these key customers over the last two or three months.

Tremendous poll for the technologies that we're developing a I'll give you. One example of a situation that happened. This last quarter. We won two thirds of the revenue opportunities at a major customer in this specialty market, where the selections are very sticky over many many years. Once you are qualified you're in for a long period of time. So you know again that was the case where in terms of the spending we were winning a huge percentage of those opportunities and this is again all about materials innovations and structures and we have a lot of technologies. Currently that are unique in a forum for these particular markets and we have an increased focus there and developing new technologies are our culture is really focused on being a preferred strategic partner for all of our different customers, enabling their technology roadmaps, enabling their future for those different markets.

Going forward. This is a great opportunity for us to partner with these customers the breadth of technologies combined with integrated material solutions, I think really puts us in a really good position.

And John just to follow up and add a little bit to what Gary said, which talks about reuse and the implications that has for spend on the leading edge.

I do think we're seeing a different pattern involved in the industry when I walked in the front door. A couple of years ago. I think we had a point of view on what the total capacity footprint in 28 nanometers was for the industry and that has gone up significantly in the last couple of years, we're looking at mature nodes and the way the industry used to work as you know you'd introducing new node you'd have a big investment cycle to put the capacity statement in place and then you'd see the investment level fall off on that node and then our customers would opportunistically look to reuse equipment as they build out the next node I think what we're seeing is investment profiles. Many years. After the introduction of the node being much larger than we've seen historically and I do think that that's going to impact the rate of reuse as these more mature nodes continue to grow in size relative to our original expectations.

So we really like the way the industry is broadening and diversifying and the implications that has long terms on the attractiveness of this market for us.

That's helpful. Then quickly as my follow up I know you guys only guide one quarter out, but you gave us some sort of signposts for entering fiscal 20, which would suggest that revenue and gross margin kind of flattish at these levels.

But on Opex going up I'm, just kind of curious are you clearly signaling to us that that op margin start off a little bit weaker into fiscal year 2020 or are these more rounding errors and if it's the former when do you start to reestablish kind of operating leverage in the model.

Thanks, John So just a little perspective on how we view opex and operating margin and maybe the commentary gets at the point that you're that you're asking. So this is a company. We are very focused on increasing operating margin percentage over time I think what you saw in the most recent quarter is a very disciplined approach to the opex or compressing discretionary spend and we're.

Channeling more of our opex towards the R&D engine, the things that are going to fuel growth growth that the company overtime and so 69% is a record high for the company and we feel good about that discipline, which you see profiling into Q1 is the annual merit increase that we get every year, but it's also a statement around the opportunities. We see Moore's law is hitting a wall Gary's talked about a new play book that is going to increasingly define the power performance road map of this industry that creates an enormous set of opportunities for us we're going to invest in R&D were going to drive growth and drive leadership into this industry over the next decade as it fundamentally influx and drives the power performance road map in a very different way than we've seen that we've seen historically.

The way from where we sit today.

We expect our semi business to be up year over year, we expect our services business to be up off of these levels year over year, and we expect our display business to also grow into next year and as the industry recovers and we take our company structurally larger I think you're going to see the operating margins expand as we grow the company and the investments that we're making today to drive that future leadership should allow us to outperform as that industry recovers.

Thanks, John .

Thank you. Our next question comes from Harlan sur with Jpmorgan. Your line is open.

Good afternoon, and nice job on the quarterly execution on the strong sequential growth outlook in display in Q4 and the steam levels into early next fiscal year can you guys. Just help us understand the mix large screen versus mobile OLED and how do you see that mix as you look into next fiscal year.

Sure absolutely.

All right yeah. Thanks. Thanks for the question. So let me give color on the display business and this gets out your question.

You know as we said in the prepared prepared remarks, we still see this play down about one third versus 2000 and.

19.

Yeah, We don't guide display fab equipment, but this is basically what customers are telling us about next year, we see 2020 for applied being higher than 2019, we also expect TV investment to be roughly flat next year.

Many of these are Gen 10.5, there are long lead times and so we have pretty good visibility into that that part of the market and we do expect mobile to increase as a percentage of the overall market next year. So we do see the overall display business being up next year.

Longer term, we believe the market is still going to be cyclical, but we continue to be optimistic about the market based on trends, including TV size and Buildout of Gen 10.5, that's going to take many years, the mobile OLED conversion and invention eventually innovations like RGB OLED TV foldable smartphones all of those different areas for applied the adoption of OLED.

Many of you know is also more capital intensive so as those technologies are adopted in more types of devices. That's good for us from a capital intensity standpoint.

We're also investing to drive new products to expand into very large tam growth areas, we're not going to give any more color today about those specific products, but but again the pull from customers is still very strong.

And we're making progress in those areas together take all this together, we see good opportunities to drive growth in our display business into 2020 and beyond.

Great. Thanks for the insights there and then maybe as a follow up to one of the prior questions on your new mm in storage class memory PVD platforms, just given the increasing content in microcontrollers.

And I will tee industrial and automotive applications and the growing need for higher embedded memory density per M.C. you seems like there's just as much opportunity on legacy semi MCQ processes. As there is for high performance storage class memory architectures as has the team tried to size the Sam opportunity here for your two new platforms sort of looking out over the next two to three years.

Yeah. Thanks for the question. So you know we take this market's going to start small its around $100 million for us so far but as you mentioned, it's very strategic and future future customer applications. We see this type of device moving from nor flash replacement to bigger applications like L. Three cash replacement specialty DRAM replacement.

You know again, it's not something that's going to ramp overnight, but we do see incremental growth in the market and then I think you know for us when I was at Semicon and this was one of the things for me personally I was most excited to talk about.

Because when you think about these new devices I think many of you know.

It takes many many many years to go from a single structure that you published a paper with certain kinds of performance to making billions of those devices.

At the right cost high yield speed power endurance all of those things and so you know talking about the system that we had at semicon.

You have all of this amazing technology into one integrated material solution and ultra high vacuum.

You have a structure, it's like an atomic layer threed printer, almost where you're you have a structure with more than 30 layers. So I'm only eight Adams high 10 different materials temperatures on the wafer that range about 500 degrees C.

In ability to measure the key properties of the materials as they are being created to one 107 nanometer.

And all of this all of this is really critical to optimize the material structures and interfaces. So so again.

Certainly the better you can drive the performance yield reliability. The more applications you can win and the faster the market ramps and so you know what we're excited about and certainly the companies that were working with they're very excited about is being able to scale a technology like this into high volume high yield and right cost and ride performance. So so again, we see this market small today, but certainly relative to future compute architectures. It is very very very important.

Thanks, Gary.

Thanks Harlan.

Thank you. Our next question comes from Timothy Arcuri with Qbs. Your line is open.

Thanks, a lot I had a question on service I don't know if scare you want to take it or if Dan you want to take it but.

If I look at July service was like $60 million late in July and then October .

You had been saying kind of like high single digit for the year. So that would imply that the October number is like coming in about 150 million light of where you thought it would be so that's like a $200 million number over a six month period. So that's like 10% of the entire Asia segment revenue, but I think you had also said previously that the spares and service portion of HGS is like half the revenue. So really it's like 20% of the spares and service portion. So so I get the memory production cuts, but that's a huge number for a business that I think people consider to be quite stable and I think your peers are sort of seeing a little bit better trends. There. So I'm wondering if you could talk about that thanks.

Thanks, Tim.

Let me share with you a little bit of my views about the business and hopefully that it gives some color and perspective.

If we take a look at our services business. This is a business. The team has really tuned the strategy. We've got a great strategy strong execution over the last call. It four years, it's a business we've grown at a compound rate of about 15% last year. We grew at over 20%. This year expectation coming into the year was high single digits as we look at the underlying components of the business. There's an element of the business. That's long term service agreements, that's more subscription like and its revenue as we look at performance of that business in Q3, and Q4, it's profiling exactly like we thought and so a mid teens grower into Q3 and Q4, when we look at the other part of the business. The other half of the business being more transactional spares and service related that has.

A connection to industry utilization and factory output.

Clearly, we saw US a fall off in Q3 and Q4.

As the memory industry has structurally brought down its factory output to work through the industry inventory correction. We initially thought this was going to be a flattish business for the year. It now looks like it's down low double digits for the year. The combination of a mid teens grower and down low double digits gets you a low single digit grower as an overall business. If we were to classify our business similar to others in the industry. In addition to growing low single digits added our 300 millimeter refurbs and upgrades to the business. This is an all time record year for us and it's something that's growing quite a bit stronger than the segment reported services business. So I don't I wouldn't necessarily look at our absolute performance or relative performance and think that there's you know something deficient in the way. The business is profiling. We think we've got a great business, the team's executing well and as industry.

Realisation recovers into next year should provide a nice leg of growth to the business going forward.

Yeah, maybe just let me add a little bit of color on the service business.

You know as Dan talked about you know certainly there has been a reduction of wafer starts and then you also mentioned this.

In the question with memory customers. So that's impacting the spare parts business, but one thing that's been a major change in our strategy. Starting in 2013 was to drive more subscription type revenue with with customers and that's been very successful. If you go back to 13, we had net zero ads in terms of certain service contract. Since then that part of the business has been growing very very fast Dan talked about even in this year with Wi Fi down a fair amount that part of our business is still growing at a very high rate and that subscription revenue from longer term agreements is now larger than our transactional spares and service business.

And that's really because we can see continue to see strong pull from customers accelerating R&D accelerating fab ramps optimizing yield out putting cost in high volume manufacturing. We also have a very strong strategy and data analytics, we have over thought thousands of tools connected and customers fabs, that's creating value for customers today and that creates a great opportunity for us to continue to drive that data enabled strategy to create value for customers and also to drive growth for applied just one more data point.

If you look at our spares and service business and again this is separating out upgrades refurbishments and other things that are counted by some people.

If you look at just our subscription revenue and our spare parts business transactional business that business has grown 27% over the last two years with wafer fab equipment being flat.

So that shows that even in a case, where wafer fab equipment is not growing that service business is growing so we're very optimistic that we're going to drive this business at a high rate going forward.

At applied and also create more value for our customers.

Awesome great. Thank you for that just as a follow up.

There was a major memory maker in China running around flash memory summit. They were talking about spending $10 billion on Wi Fi between 2019, and 20 very very big numbers that I don't think anybody's modeling can you talk just more generally about China memory efforts and weather.

Next year could be a pretty big year from from the from the indigenous China guys. Thanks.

Yeah, we're not really giving any color on 2020 right now I think what what I had said earlier on the call relative to 19, and so we see 19 relatively flat with 18 and you know I honestly don't see a big hockey stick I've said this in the past over the last few years also.

I haven't seen a big hockey stick I think that the spending certainly in foundry logic is rational around aiotv sensors or communications all of those kinds of devices.

That's a little over half of the domestic spending this year.

And certainly we believe that there will be some incremental spending but you know we're not going to give any color on the call today relative to forecasting 2020 for China.

Okay, great. Thanks much.

Thank you. Our next question comes from Kirsch, Thank <unk> with Cowen and company. Your line is open.

Yeah, Hi, Thanks for taking my question I had two of them are done given that just semi business is stabilizing at these revenue levels, but the mix is shifting more towards foundry logic with his memory I would've thought your gross margin profile. It would have been better can you just help eliminate some of that and whats going on the gross margin side and then as a follow up I'll ask it right away.

You guys gave some color on fytwenty display revenue flow through to 2019, given that you have almost nine month lead time visibility how should we think of a flight 20 display though news relative to if why 18, well you did about two and half billion. Thank you.

Thanks Krish.

Let's let's let's take them in order.

First on the gross margin in the foundry logic showing signs of strength.

Let me start by saying this is a company that is laser focused on driving gross margins up over time, and if we were talking about a business mix from maybe a few years ago. I think maybe we would be seeing incrementally higher gross margins, but let me help you a little bit with some of the mix factors that we see going into gross margin given who we are today. So as we take a look at our services and display business and growing it as a part of our portfolio. We know that those two businesses and we've done a great job growing then those two businesses have a gross margin.

That's lower than the corporate average, but we expect each of those businesses and we expect each of those businesses to be up as we look into 2020 and then within our semi.

Portfolio, our leadership businesses are doing really really well, but the profile of our semi business is changing as we grow and there's a couple of things I would point to first our etch footprint.

These are gross margins a products with gross margins that are not as high as maybe other parts of the portfolio, but we are doing a great job driving that business works expanding that business into new opportunities and beyond memory in the foundry logic.

And that's certainly changes the profile of our business as we grow forward second thing I'd point to and we talked about it on this call is foundry logic spend diversifying there was a time a decade ago. When it was 90% on the leading edge and then it evolve to 80 2060 40 and now for the last three years 17, 18 and 19, it's fully split 50, 50 between leading edge technologies and trailing no geometries, and where we compete in the trailing no geometries with differentiated equipment and and are key enablers of some of the technologies and products that are being brought to market that super attractive business for us, but theres also opportunities in that market, where we compete with 300 millimeter Refurbs 200 millimeter systems and while those products offer really attractive operating margins and cash flow the gross margins might be a lower a little bit lower.

That we see in some of the other businesses. We pursue so we're going to continue to stay focused we're going to continue to drive gross margin over time, particularly as we see the industry recover we drive revenue higher from this point going forward. We do think we're going to be able to grow the semi business in the next year grow the AG s. business into next year and the display business.

Sort of stay focused on execution and we feel good about how the business is profile.

And then the second part of your question was on display.

Could you repeat the question I apologize I lost.

I can I can do it I mean basically on display relative to 2020.

Yeah, what we said earlier as we think 2020 is going to be a little higher than 2019.

You know I I don't think we're going to give anything more specific at this at this point in time.

Okay. Thanks, both.

Thanks, Chris.

Thank you. Our next question comes from Vivek ARIA with Bank of America Merrill Lynch. Your line is open.

Thanks for taking my question I think when you started the call you mentioned that you're still not comfortable calling the bottom and I'm curious what in the environment is preventing you from doing that is it order visibility is it is it the macroenvironment and from what you see when do you think your memory customers start to add incremental capacity.

Yeah, Thanks, a the vac.

I think.

I'll come back to the comments, we made a little earlier that in an environment defined by what we see today, we do think it's an elevated risk profile around some macro.

And buyer bought in the macro environment as well as geopolitical I just think it's prudent in an environment that is characterized like the one we're in to set expectations in a modest way we have conversations with customers. If I would give a direct read through on those conversations I think you would see expectation set at a different level.

But I, just and again and come back to in an environment like this I just don't think that's a prudent place to be so we want to set expectations in a more modest way, we're setting expectations for gradual and U shaped off these levels certainly if the industry recovers faster than where we're setting the expectations given our broad portfolio and how we're positioned in all of the markets. This is a company that is going to benefit in a very material way if that happens. So we feel good about the position we feel good about finding stability in the business and we do think it's just a matter of when not F and we'll be ready to take advantage of those opportunities when they materialize.

Okay and as a quick follow up on the market share side I know last year, you guys were down two points, but you are starting to recover that in recent quarters.

Heading into 2020, which areas do you think amat is best position to gain share and what would be the impact of you. We actually have progression in terms of how your time is impacted thank you.

Yeah. Thanks for the question.

So you know if you look if you look at the we still see applied growing in patterning and we also see a growth and overall Wi Fi even as you view finds areas of adoption.

As we've communicated before last year you'd be was ahead headwind.

As you look forward do you have to look at different segments UBI has a very small impact on memory when memory recovers that's going to be very positive for applied relative to the Tam opportunity. A memory is really about materials enabled scaling and we have gained share in memory, a very deep engagement with our customers and good opportunities to continue to drive share gains and NAND, we have a great opportunity to enable threes scaling I talked about new hard Max masks, our etch position continues to grow in DRAM, they're adding metal gate in the periphery and this is where we have a high share as those processes are are adopted I talked earlier about the I O T communications sensors, a that's an area where I talked about we won two thirds of the Tam opportunity here recently with the customer and that's up about 50% of the foundry logic spending. So we have momentum in all of these different areas and then the other thing I would say is that.

We've talked about this new playbook.

New architectures, new materials, new structures, new ways to connect things together and new ways to shrink, we really havent technologies, and new products and many of those different areas.

And so I have given color today on the call about many of those different opportunities.

And that's also why we're investing more going forward, we have a very strong point of view the market driven by AI Big data is going to be strong in the future. We believe that the new playbook with new structures new materials.

New ways to connect devices all of those areas are areas, where applied has unique technologies unique capabilities. We have products that some of which are already seeing adoption with customers, where we have traction.

We're going to invest in those areas and my main focus as CEO is to make sure. We're in the right position when those markets grow in the future.

Okay. Thank you.

Thanks for that and we're getting close to the end of our schedule time so.

Dan would you like to help us close the call.

Thanks, Mike sure. Let me just share a couple of quick comments to end the call first I'm encouraged I'm encouraged by the stability, we're seeing in our business and encouraged by the positive leading indicators that we're seeing in memory, but I'm still not ready to call the bottom, especially given the macro risks that we need to keep an eye on at the same time, we've been in this industry, a very long time and long enough to know that something new and big is happening in computing and it's happening just as Moore's law is slowing down so we see growth coming and we believe applied is in a special position to help this industry. So we're going to invest we're going to create value and grow this company and outperformed the market.

And finally, we're going to stay close to investors, Gary and I were going to be hosting some meetings here in Santa Clara throughout the quarter and I personally look forward to seeing many of you in the beginning of September in New York at the Citi Conference. So Mike Let's go ahead and close the call.

Great. Thanks, Dan and we'd like to thank everybody for joining us today, a replay of this call will be available on our website by five o'clock Pacific time, and we would like to thank you for your continued interest in applied materials.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program you may all disconnect everyone have a great day.

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