Daniel Durn - IR Michael Sullivan - VP of IR Robert Halliday - CFO & Senior VP Gary Dickerson - CEO, President and Executive Director

Weston Twigg - KeyBanc Capital Markets Romit Shah - Nomura Securities Joseph Moore - Morgan Stanley Atif Malik - Citigroup Farhan Ahmad - Crédit Suisse AG Harlan Sur - JPMorgan Chase & Co. Christopher Muse - Evercore ISI Craig Ellis - B. Riley & Co. Jagadish Iyer - Summit Redstone Partners Patrick Ho - Stifel, Nicolaus & Company Toshiya Hari - Goldman Sachs Group Krish Sankar - Bank of America Merrill Lynch Edwin Mok - Needham

Welcome to the Applied Materials Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Michael Sullivan. Please go ahead, sir.

Good afternoon, everyone. I'm Mike Sullivan, Head of Investor Relations at Applied Materials. We appreciate you joining us for our third quarter of fiscal 2017 earnings call, which is being recorded. Joining me are Gary Dickerson, our President and CEO; Bob Halliday, our current Chief Financial Officer; and Dan Durn, who will be our next 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, product road map, share positions, revenue growth, profitability and business outlook. These statements are subject to risks and uncertainties that could cause actual results to differ materially 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 August 17, 2017, 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 Relations page of our website at appliedmaterials.com. And now I'd like to turn the call over to Gary Dickerson.

Thanks, Mike. With revenue and profits at all-time highs, I'm pleased to report that Applied Materials has now delivered earnings records for the past 5 quarters. We have tremendous momentum and a very positive outlook for the future. Our markets are growing with a broader set of demand drivers. Across a wide variety of industries, companies are making huge investment to drive transformative changes that shift economic value towards technology. At the very foundation of these emerging trends is Applied. And we are playing a larger and more valuable role advancing the innovation road maps in semiconductor and display. Our broad portfolio of technologies and businesses, combined with our strategy and investments, means that Applied has never been in a better position. This gives me confidence that we will continue to expand our available opportunity, gain share and outperform our markets. In today's call, I'll outline key industry trends as well as our strategy for sustainable, profitable growth. I'll then provide additional details about our markets and major businesses. Bob will then discuss how we're translating our broad portfolio of capabilities and products into differentiated performance for Applied. And after that, Dan will provide his initial impressions about our future opportunities as well as our outlook for the next quarter. I'll start with the backdrop for today's discussion. These are incredibly exciting times for Applied, and I strongly believe that we have more opportunities today than at any point in our history. There are 3 main reasons for this. First, our markets are strong and getting stronger. Pervasive demand for electronics means that our markets are getting larger and substantially less cyclical. New demand drivers are emerging that layer on top of traditional computing and mobility. The Internet of Things, Big Data and Artificial Intelligence will transform industries over the coming years. In health care, transportation, manufacturing and retail, competition is increasingly dependent on capturing, transmitting, understanding and storing data and images. In these industries and many more, value is shifting towards semiconductors and displays. To realize the potential of IoT, Big Data and AI, major technology inflections are needed to advance the road maps in logic, memory and display. These inflections are enabled by materials innovation, and as the leader in materials engineering, Applied has a fundamental role to play. Second, Applied is better positioned than ever before. We've aligned the company around our innovation leadership strategy, and we've made significant investments to accelerate R&D. We have developed a strong portfolio of differentiated products, with more in the pipeline. It's the company's breadth and depth of products and capabilities that sets us apart from the competition. We have, by far, the largest exposure to industry inflections, and we're combining our skill sets in deposition, removal, materials modification, inspection and metrology to deliver innovative, new solutions. Third, we built a platform that gives us sustainable advantages over the long term. We've done this by strengthening our technical and management teams and putting in place a company-wide operating system, the product the management engine, that delivers repeatable success. Across the organization, I see stronger execution. Our product success rate is higher, we are transferring new technology to market faster and we're using our breadth more effectively. I'll now describe the major inflections and investments within our markets. In memory, near-term market fundamentals remain strong, driven by high-performance storage for data centers and increasing smartphone content to support new features, including 3D cameras. We expect healthy investment in memory to continue as the explosion of data storage requirements created by IoT, Big Data, AI and streaming video has only just begun. To keep up with demand, customers are aggressively pursuing their 3D NAND scaling road map, which has 4 major levers: increasing number of pairs, shrinking film and stack heights, multi-tier schemes and lateral scaling. All these approaches are enabled by advanced materials engineering and expand Applied's opportunity. In foundry, market dynamics are equally healthy. In the near term, we see capacity additions at trailing geometries to meet growing demand for sensors and IoT devices as well as strong investment in the leading edge. Looking ahead, advances in Artificial Intelligence are beginning to drive significant architectural changes, and customers are positioning themselves to win the major inflections in high-performance computing. In data centers designed for AI workloads, we see logic content growing at least twice as fast as memory. And as technology complexity increases, capital intensity is also growing about twice the rate of memory. In foundry logic and DRAM, dimensional scaling of devices remains a challenge, with 2 primary areas of focus: resolution and placement accuracy. New innovations in patterning are becoming increasingly important as customers move to advanced nodes. First, self-aligned multi-patterning techniques, SADP and SAQP, are needed in conjunction with EUV lithography to drive the resolution road map. Regardless of the rate of EUV adoption, we expect our opportunity in traditional multi-patterning to grow. Applied has great momentum in this market and has gained 16 points of shares since 2012. Second, new patterning approaches are being developed to address placement errors. As devices scale, the accuracy of vertical alignment between interconnect layers has a significant impact on performance and reliability. Placement errors cannot be addressed by advanced lithography alone and will require materials-enabled solutions. Applied has unique technology in this area, and we expect our opportunities to grow significantly over the next several nodes. Looking at the market as a whole, our outlook is incrementally more positive. We now believe that wafer fab equipment spending for the calendar year will be up 20% or more compared to 2016. We also expect 2018 spending to be higher than our current estimate for 2017. And in these forecasts, we made conservative estimates for spending in China. In addition, within wafer fab equipment, the ongoing shift to materials-enabled solutions in memory and logic opens up new opportunities for Applied. We now address 64% of the total market compared to 53% in 2012. Beyond semiconductor, our outlook for the display market has also strengthened. Display is growing even faster than wafer fab equipment as customers make multi-year investments to address large inflections in both TV and mobile. In TV, a major push to new Gen 10.5 substrates is other way. These huge, 10 square meters substrates are ideally suited for manufacturing larger format screens, 60 inches and bigger. We now expect [30] new Gen 10.5 factories to be built over the next several years. At the same time, mobile OLED investment is getting stronger as customers prepare for broad adoption of OLED in smartphones. oLED enables new form factors that result in a larger display area for smartphone, further expanding the overall market. I'll now provide brief updates for our major business groups. Our semiconductor leadership businesses, where we have strong market share and highly differentiated products, are having an outstanding year, fueled by investment in leading-edge foundry and expanding applications in memory. Demand for our PVD and CMP products is especially strong. We expect the PVD market to grow by around 45% in 2017 as foundry customers adopt new interconnect technology. And the CMP market is on track to grow 40% this year on top of 40% growth in 2016. Our CMP revenues were at an all-time high this quarter and on track to exceed $1 billion for the fiscal year. In our semiconductor growth businesses, we have great momentum in markets that are growing rapidly. Over the past several years, we have gained significant market share in both etch and CVD. Our combined etch and CVD revenues are at record levels, and we're in a great position to drive further growth. Service is an important part of Applied's portfolio that has grown significantly. This year, we're seeing acceleration of that growth. We delivered record performance this quarter, and for the year, we expect revenues to be up more than 15% over 2016. Demand for our Service Solutions is driven by our rapidly growing installed base, plus our customers' need to shorten ramp times, improve device performance and yield and rapidly optimize their factory output and operating costs. We are investing to expand the services we offer, and we are confident in our ability to sustain our growth in this business. In display, as technologies and manufacturing are becoming more complex, Applied is in a unique position to enable the road map. This year, display revenues are on track to increase more than 50% over 2016, and based on our strong position, we expect to grow display at least another 30% in 2018. Before I hand the call over to Bob, I'll quickly summarize. Applied is executing well, setting new records, growing our available market and gaining market share. I would like to thank our employees for their passion to create value for customers and Applied. I'm confident that together, we will raise the bar further. Applied is in a great position, working at the sweet spot of major trends that will drive tremendous shifts in economic value over the coming years. Finally, our breadth and depth differentiate us from our competitors. We have wider exposure to major industry inflections, and we are bringing together the broadest skill sets and technology portfolio to create new solutions for our customers and accelerate innovation. Now let me hand the call over to Bob.

Thanks, Gary. Today, I'll add my comments about the business environment, describe how our capabilities and products are driving competitive and financial performance and invite Dan to share his perspective, along with our Q4 guidance. As you contemplate the markets, including record levels of demand for semiconductors and displays, I'd like you to note 3 things. First, I feel increasingly confident that our markets are becoming materially and sustainably larger. Gary explained the big picture, and I'll add some data regarding the near-term environment. In semiconductor, 2/3 of NAND demand is driven by smartphones and SSDs. NAND demand for these devices is projected to grow by more than 40% in 2017 and 2018. Smartphones and service drive the majority of the DRAM market. And demand from these devices should be up by 30% or more in both 2017 and 2018. In foundry, our largest customer recently announced that its 7-nanometer tape-out expectations have nearly doubled. And we continue to see new investment at trailing geometries as well. So the largest drivers of WFP demand are strong. In display, OLED is quickly becoming the preferred technology for leading brands. Yet, the installed capacity supports less than 40% of the smartphone market. An increasing technical complexity in semi and display gives us a growing opportunity in services. In short, I expect sustainable growth for our markets and particularly for Applied. Second, Applied is uniquely well positioned in this improving environment, and we're driving growth and competitive performance across our markets. Applied has incredible breadth. And we're taking advantage of it across our semi and display businesses to help our customers solve their highest-value problems, with solutions based on unique combinations of our technologies. The investments we've made in our new product pipeline are already impacting the market. In 2017, we're delivering strong, double-digit revenue growth in every semiconductor device type. We project our share to be up for the sixth year in a row. And our share is balanced at greater than 22% across memory, logic and foundry. In patterning, we see continued growth and share gains because we're shipping newly designed products that address both line shrinks and edge placement errors. We've also put our services business on a growth trajectory, adding $1 billion in annualized revenues since 2013. And we built a unique and more diverse growth engine in display. In 2012 and 2013, our annual display revenue averaged $657 million. We expect to deliver a similar amount in the current quarter. Our display business is also becoming more profitable, and we're now targeting operating margins in the high 20s. So Applied has the broadest capability, largest served market opportunity and strongest new product pipeline of any company in the industry. Third, and perhaps best of all, Applied's innovation engine and operating discipline are driving higher profitability. The value that our technology brings to the industry is increasing, and that's reflected in our gross margin, which has grown by 5 points over the past 5 years. In Q3, our gross margin was the highest in 9 years. At the same time, we remain focused on expense control. In Q3, our non-GAAP OpEx-to-sales ratio was 17.9%, a record low. As a result, we delivered our first quarter with $1 billion in operating profit, and we had record cash from operations equal to 36% of revenue. Next, I'll comment on our Q3 performance on a year-over-year basis. We grew company revenue by 33% and non-GAAP gross margin by 2.9 points. We grew non-GAAP operating profit by 67% and increased non-GAAP operating margins by 5.9 points to a 16-year high of 28.7%. And we grew non-GAAP EPS by 72% to a record of $0.86 per share. Turning to the balance sheet. We grew cash and investments to $8.3 billion, and 40% was onshore. We repurchased 9 million shares of our stock and returned $482 million to shareholders, including dividends. Turning now to our segment performance on a year-over-year basis. We grew semiconductor systems revenue by 42% to a record $2.5 billion and grew non-GAAP property profit dollars to a record of $920 million. We grew services revenue by 20% to a record $786 million and increased non-GAAP operating profit dollars to a record of $215 million. We grew display revenue by 31% and increased non-GAAP operating margin by 2.6 points. In summary, I'm proud of the accomplishments of our teams, and I'm pleased with our top and bottom line growth. Applied's innovation engine is delivering sustainable momentum our profitable growth. Now I'll hand the call over to Dan.

Thanks, Bob and Gary and the entire team here at Applied Materials. You've given me a warm welcome and a great introduction to the technologies we're preparing to launch into a growing market for our products. I'm incredibly impressed by the depth of our technical talent. Applied has a world-class team, and I believe we can do anything we set our minds to. Gary and Bob talked about new advances in technology that are going to make dramatic change to our industries and to our lives. I saw this unfolding at my previous companies, and I'm excited to be here because these changes are enabled by semiconductors and displays, which begin with what we do at Applied Materials. I'll share more of my impressions about Applied at our Analyst Day in New York. One thing that's already clear to me as a financial person is that Applied has a tremendous portfolio. The leadership semi business, as Gary talked about, has some of the strongest product positions and profitability I've seen anywhere in this industry. The semiconductor growth businesses, as Gary mentioned, are dramatically outpacing their markets. Etch is up 5x over the past 5 years, growing at 2.5x the rate of the market, and that's just one example. Display is growing faster than semi, and we have technologies in the pipeline that will enable us to grow beyond what we can do in OLED smartphones and LCD TVs. And services are a great way to drive growth and diversify the company in areas that are particularly stable and cash-generative. Applied's portfolio is incredibly valuable. I'm excited to be a part of this team, and I'll use all of my energy to help drive Applied's innovation engine and growth. Now I'll provide our fourth quarter guidance. In Q4, we expect our overall revenue to be in the range of $3.85 billion to $4 billion. The midpoint would be up nearly 19% year-over-year. We expect our semiconductor systems revenue to increase by about 14% year-over-year. We expect services revenue to grow about 17% year-over-year, and display revenue should be up by about 48% year-over-year. We expect non-GAAP gross margin of about 46%. Non-GAAP operating expenses should be $685 million, plus or minus $10 million. And we expect non-GAAP EPS to be in the range of $0.86 to $0.94, the midpoint of which would be up by 36% year-over-year. To help you with your models for the calendar year, I'll share some of our early views on Q1 of fiscal 2018. We believe semiconductor systems revenue in Q1 is likely to be higher sequentially and higher year-over-year, and we believe our display revenue in Q1 is likely to be lower sequentially but higher year-over-year. Now I'll summarize by putting the company's guidance and momentum into context. In Q4, we expect the second highest semiconductor equipment revenue in our history, with continued double-digit growth momentum year-over-year. We also expect to set new record levels in services, display and for the company as a whole. We expect record earnings per share. We also look forward to another year of growth in 2018 based on strong customer pool across the portfolio as we supply our enabling technologies to drive the new data economy. I look forward to sharing our longer-term financial targets at the Analyst Day in New York September 27 and especially look forward to meeting many of you there. Now let me turn the call back to Mike to start the Q&A.

Thanks, Dan. [Operator Instructions]. Operator, let's please begin.

[Operator Instructions]. Your first question comes from C.J. Muse from Evercore ISI.

I guess, biggest question here is sustainability in memory. And it looks like you're guiding [indiscernible] around $43 billion plus or minus this year. And roughly 70% of that looks like it's coming from NAND. And so curious, as you look at that part of the market, can you talk to your visibility to both greenfield and shrink plants as well as your thoughts around demand elasticity and how you're thinking about spend from that business over the next 5-plus years?

Sure, I'll take a shot. Overall, we expect WFE in '18 -- I'll drill into the memory, too. We expect overall WFE in '18 to be up from '17. By device type, we think logic and DRAM should be higher next year. And we think foundry and NAND should both be strong next year. I think the 70% of total spend, the NAND, I thought you said, C.J., sounds a little high because we have NAND at less than 50% of total spend. But I'll drill into a bit deeper dive on what's going on in the memory markets. So let me talk about DRAM and NAND together, and I'll drill into NAND also. I think there's 3 important disturbance customers what about Applied in both NAND and DRAM. One, if you look at NAND rum customers, very profitable now, and I'll give you the numbers. Two, second thing to remember is demand is strong for both DRAM and NAND. Looks sustainable. The third thing is, actually, wafer starts additions have been modest, and I'll give you the numbers. And finally, think about the member that Applied Materials we've gained 8 points of WFE share in both DRAM and NAND over the last 4 years. So let me give you more specifics. In terms of customer profitability, which was the first talking point I made, DRAM WFE spending as a percentage of total EBITDA for our customers used to be about 26% on average. That's DRAM WFE spending, the total EBITDA. And we think that's going to go down about half, 14% this year and next. You know they're very profitable. When you look at the numbers, it's very profitable. The NAND similarly has gone down. Used to be about 26%. We did about 1/3 this year or next to 19%. But that's also sustaining more higher growth rates in NAND, okay? The second thing to remember is bit demand. So if you look for smartphones and servers in both 2017 and '18, we see 30% bit growth demand. Now it goes down a point or 2 when you layer in PCs and start, but the big drivers are smartphones and service, and we see 30% bit growth demand or gigabytes. Second, and NAND bit demand, we see 40% growth rate in '17 and '18 each for smartphones and [indiscernible]. Then on capacity additions, if you look at the data over the last, basically, 5 years, and we see this year basically the same, NAND DRAM wafer capacity has been basically flat. They got some bit growth but because of their more layers, the actual wafers out of the building kind of goes down. So it's kind of flat, not a lot of capacity added. Then if you look at NAND capacity additions, you spend at the money but actually give as the visions have been somewhat modest, a couple of hundred thousand wafers up to 1.6 now. And we project that we need about 2 billion [indiscernible] years, 2 million, [indiscernible] wafer starts, 2 billion a couple of years after that. But if you look at the 3 big things, customers are very profitable in both DRAM and NAND. Secondly, bit growth and bit demand. Bit demand is still very healthy, and we see it next year, too. And three, actual wafer liver additions have been moderate. So we think I think NAND's pretty good for the foreseeable future.

The next button comes from Farhan Ahmad from Crédit Suisse.

Just quick clarifications. On the Jan quarter, do you think it will be a record level for SSD or not? And secondly, any color on the first half of next calendar year? Your commentary on 2018 seems to be fairly confident. Is it fair to say that the only things that you're seeing in 2018, they are looking pretty strong right now?

Yes, it's strong. And we said in the call that Q1 was going to be a good fiscal quarter for us. So we said semi was going to be incrementally stronger than the comp. And display, not quite as strong as the comp in Q4 that we just guided to. So if you look at where we're close to reckon SSG this quarter, I think the record was last quarter, Q3. I think there's a pretty good chance that the record in Q1. Theres' a second question. Did you have a second part?

Yes, I was just -- calendar first year, is there any visibility that you have that makes you confident on the first half -- on the next year overall?

What we said on the call, number one, was that we think next year, WFE is up. We also think our position's really good. And we have a strong degree of confidence in our fiscal Q1, and we don't see that problematic after that. We think it's a pretty good year.

The next question comes from Atif Malik with Citigroup.

I just want to clarify the 30% year-over-year growth for display, is that for fiscal '18 or calendar '18?

Fiscal revenues. Calendar's good, too. I just don't a -- at that closer on the calendar basis.

Okay. And can you help us out, how much of that is kind of market growth? I think, in the past, you've talked about an $18 billion display spending this year. Is that mostly market growth? Or are you baking in contributions from new products?

Yes. If you look at it in '17 and '18, our total revenues are going to be up in about 30%. If you go look at the market in '17, '18, it's going to be healthy. And our position's going to strengthen. And what the alluded to a little while ago that we're going to have some new product introductions. In fact, we already had 1 about a year or so ago. We're going to have more. So I think we'll get some contributions from the market and our position.

Your next button comes from Harlan Sur of JPMorgan.

You guys discussed the growing number of programs for large-screen LCD in your pipeline. A few weeks ago under earnings call, LG display discussed spending about KRW 20 trillion of bullet CapEx over the next 4 years. That's about USD 18 billion. And what actually for large-screen OLED? And I think the view is that OLED TV volume's going to grow from 2.5 million, 3 million next year to something like 6 million by 2020. Can you remind us on your position and large-screen OLED, your views on how you see the market evolving? Clearly, I think feel like it's been expect ever after mobile adoption.

Sure. I'll give us some factoids on the overall market, which is touch on, Harlan, and a little bit on the OLED and then Gary might join on that one, too. So in terms of I do for you mentioned them, from our call, which, I think, was 3 months ago, our expectations for the total market of display equipment has gone up for all 5 years in our window, '17, '18, '19 and '20 and '21, all 5 have gone up. And we see strength across the board, basically, in both TV and mobile. A lot of big TV factories and increasing strength in mobile. So it's a very strong market position even more so than 3 months ago. In terms of our product positions, we're going to continue to traditional price. In terms of OLED TVs, kind of my stuff color filter I guess. So it's not the same OLED as you have in mobile, but it is a version of OLED. And our position is pretty good there. But it's not that big technology inflection, which is as much percentage growth in for everybody as you have some back in the mobile phones.

We've been -- this is Gary. We've been increasing our share with pretty much all of the customers. And certainly, in this inflection also, we have an increasing position. So it's a very positive driver for us longer term. Relative to the inflections and kind of the market outlook, we're still in the early innings operating OLED mobile. So as that continues to get built out, that's a big positive driver for us. This adoption of larger screens in TV, we talked about the 13 Gen 10.5 factories, that will be built out over the next several years. And then if you look at the investments that large technology companies are making, VR, AR, automotive, those are -- there are other types of display technologies, portable displays, those other inflections that could be more significant if you look at it on the 3- to 5-year time frame. But we have good exposure to all of those changes.

Your next button comes from Krish Sankar with Bank of America Merrill Lynch.

I had a question on display. Something has been going on seeing the display CapEx is going to be down next year, but you guys are guiding to up 30% for revenue. And I understand you're getting some new products introductions. So a 2-part question. How much of the growth next year is driven by a new products versus the existing product line? And along the same path, can you split up of your revenue display revenue by LCD versus OLED for this year and next year?

Well, first, I'll do the market then I'll do a little bit on us. So with it of the total spending by display manufacturers is up this year and up again next year. We think it's pretty strong in both TV and mobile. So the big TVs are driving the CapEx spending on TV, and then mobile is mostly the OLED driver. So we see upside. In total, we see upside in TVs next year. And we also see some upside potential in mobile next year. And part of that is you see a proliferation to mobile phone display manufacturers beyond the big one in Korea. So if you think about the factoid we gave you over the last couple quarters, if you go back to our sales of OLED equipment in fiscal '16, roughly 2/3 was to the biggest manufacturer of OLEDs. We've now proliferated to 10 different people buying some equipment from us. And the big guy, in terms of commitments of orders this year, fiscal '17, is significant less than 50%. So what you're seeing is next year can grow because TVs are good, and you have a proliferation of more people making the mobile phones.

The next question comes from Toshiya Hari from Goldman Sachs.

Gary, I was hoping you could elaborate a little bit on your view on China into 2018. You talked about having relatively conservative assumptions embedded in your WFE forecast for 2018. But what exactly are those assumptions? And what would be the bulk case over the next 12 to 18 months?

Thanks for the question. China is one of our strongest regions in both semiconductor display. Our business is growing a significant amount. If you look at '17 versus '15, we're up 2x in semi, 50% growth in service and 50% in display. In '16 to '17, we anticipate we're going to be up more than 20% overall in China. We track all the projects. We have very close relationships and very high share in China. So we're talking on the projects for all of the customers. And we have leading indicators for the most likely investments. There's a lot of discussion about investment, but we qualify that based on these leading indicators. And based on all of that, 2018, we think, will be up an incremental at least $1 billion, probably in the range of $1 billion to $1.5 billion in 2018. Longer term, we think that this number is going to continue to grow because of the strategic nature of the investment. In China, they're trying to grow the present domestic content, build a secure supply chain and it's a long-term strategy. The investments are not as efficient. Many of the investments next year will be in pilot plants in China, but we believe that this market will continue to grow over time, and our position is very, very strong in both semiconductor and display.

Your next question comes from Joe Moore with Morgan Stanley.

I want to ask about the growth in services. You talked about 15%, which is pretty good. I know you had a strategy operating kind of trying to move that opportunity. Can you talk about how you see is just because of the significant increase in the installed base tools versus some of the other things you might be doing to drive that growth?

Sure. If you look at it, you go back in a longer-term, historical perspective, we used to be kind of flat around $2 billion a year back around '13. This year, we're going to do about $3 billion. If you look at the rate of growth year-on-year, it's 15.9%. But if you look at the quarters of momentum picks up even throughout the year. So I'm pretty confident that the next year is a strong year for us, and probably the momentum is as strong, maybe a little better than this year for some reasons. One, if you look at your service business, it's a function of 2 things: the market, your position and your strategy to attack the market. 3 things, I guess. Market, product and session and strategy. So if you look at the market, WFE is pretty damn strong. It's a pretty big number this year and next year, so that provides a toolset that you can service. Then if you look at a percentage of the market for us, we used to be 17.8% of WFE just for [300-millimeter] tools back in 2013. And this year -- last year, we grew, what, 22, and we're going to go up again this year. So to the bigger piece of the market. Thirdly, if we would gain a lot of share a lot of share of literature in place of entitlement for service. So all the dynamics are on the market, our position, the products we're selling is raising our service settlement. And then secondly, what we have done -- or thirdly, that was market and our position, thirdly, in terms of our strategy is improved more and more. So if you look at it instead of seeing parts and ad hoc labor, we are selling long-term service contracts. We talked about getting 1,000 extra service contracts per year. And that means we have a more predictable, more sustainable and greater value for the customers and ourselves that again raises our service entitlement. So my guess, the rate of growth and service business continue pretty strong next year.

The next question comes from Romit Shah with Nomura Instinet.

It seems like the DRAM industry is at a crossroads here, whereby with the conversion to 1x, bit supply growth is going to decelerate into the teens range. And that's well below what people are thinking in terms of DRAM bit demand, call it, 25%, 30%. So it would seem like next year, we do see capacity increase. And I know you guys are positive in that segment for 2018. And I was hoping you could just share your assumption for capacity additions in DRAM.

I'll give you my opening, and then Gary can jump in. So if you look at the dynamics, 3 of our 4 big memory customers do both DRAM and NAND. I personally believe there's slightly different strategies in DRAM and NAND. If you look at NAND, like to see demand for NAND is probably pretty damn big. There's a lot of growth in NAND than [indiscernible] hard disk drives. Then if you look at spend there and grow their market and make a bunch of money. If you look at DRAM, I don't think quite as big. So -- and then if you look at shrinking, you nominally get 28% more bits, roughly, per wafer, but because there's partners to get this wafers out of the same building basically more steps, and that's what it comes in sort of 14% growth in kind of output of our factory. So it's getting expensive to keep growing effective bits. So now what do you do? Well, if you have a total company strategy, you're probably going to invest heavily more heavily at a bit in greenfield NAND of visible marketing make money more heavily around conversions for DRAM. So what we see, our estimates is in 2017, you probably got about 75,000 wafer starts as in convert to 2.40 to 2.50. But the net adds is probably even a little less because it's like 50 or a little less because you kind of effectively shrinking your output that we could all those others because of more layer count. And we look at '18 similar numbers kind of 75 ads and convert 2 90 maybe. But it's more weighted to conversions than adds because of economics.

Your next button comes from Patrick Ho with Stifel.

Looking at the foundry market, clearly, you're benefiting right now from capital intensity trends going to the 10- and 7-nanometer node. But could you just discuss maybe how that node may develop over time? And could you see that node being potentially as large as the 28-nanometer node, which has been very profitable for the chipmakers? Is it possible that this is the next big node that we see and this could be a multiyear event for the foundry segment?

I think the answer is yes, yes, and yes, more than one-word answer. So if you look at [indiscernible] 28 NAND, where I think peaked out at 335,000 wafer starts, earlier in the year, about 9 months ago, our estimate 7-nanometer would peak out, it's kind of 10 going to 7, 7 call it would peak out really quickly said 2 50 then 2 60 -- then 2 80. We're currently at 300,000 wafer starts. Might the upside to that because what you get more and more applications for 7-nanometer devices. There's going to be all the typical process mobilephone stuff what they're going to get more and more into this cloud they're going to the cars probably 7-nanometer device. So probably go long and big, right? Sort of like 20-nanometer. Now the good news much of goodness 1 is big that's obvious. Two, it's kind of long. So then you start to roll 4, and you say, "Hey, there's a lot of this roll to 5 stay at 7 of the product lines big now you stay at the Node 4 a while. So additionally as much guess down to 5, right? The third thing, which is really interesting is if you look at capital intensity picking up from 28 to 7, you'd say, "Well, okay, Bob, it's 3 35 to 300. You're down 10%." Capital intensity from 28 to 7-nanometer nodes is up over 90%. So to make those wafers, a lot more equipment sales and to our position's really good them is not to be a bunch of equipment sold it comes money big long note.

Your next question comes from Edwin Mok from Needham.

Just quickly on margin, two-part question. One, revenue said just marginally coming down actually the lower.

Edwin, could you repeat the question, please? I just couldn't hear it clearly.

Sure, no problem. So I guess, 2-part question on margin. First is service margin, I noticed it came down this quarter. Wondering what what's irreverent that? And then display, with the revenue increase in this quarter and you guys guiding for higher revenue, is it possible to display get to the city marginal level sometime in the future?

Okay. So first, I'll do service margins. Yes, operating margins. So there's the trendline, and they can pull up service that they get the data here. Q3, Q4. Yes. I think service growth and operating margins are up a little bit in Q3 and up more in Q4, actually. And our trendline is they're going to go up. So I think what you'll see, I'll give you some longer-term perspective and where we're going on that might help. We used to be 23%, 24% operating margins in service. And then in full year '16, we're probably 26.5 or 7. This year, the guide is like 28%, frankly, and we're going to trend up a little bit more. So our optima did end up gross margin trending up some, too. So I think generally, the trends but a good what's driving the trendline and margins? Revenue gross but it on good. Gross margins are coming up, and you got dropped to us to get the percentage gross margin and you get the leverage of the revenue growth. So I think operating margin's going to trend up in gross margins trend up as well.

One other thing I would add in terms of service is we've really done a great job in driving lower cost. We're moving a lot more content into lower cost regions. And customers are also facing big challenges in the technology ramps for logic and also for memory. Our opportunity, Bob talked about earlier, in service contract is also increasing our revenue growth. So we're driving lower costs. We're driving greater value for customers. And that is increasing our overall operating margins and giving us momentum going forward in service business.

So then display. Display Edwin also operative margins and gross margins trending up. If you look at operating margins for display, from 2012, they're about 9.8%. '13 was 16 8. '14 is 24. About 25 in '15. '16 was about 20, 21, we're investing. This year will be about 26%. Next year should be up with the volume. So I think we're going to do pretty well in display. And now if you look at the longer-term model, which will show an Analyst Day, last year unless they model we showed that generally, our operating margins and gross margins are higher in semi, but services and display are both -- they're all increasing. And what you probably get is high 20s in service and display and higher 30-somethings in semi, and overall average goes up.

Your next question comes from Weston Twigg with KeyBanc capital parts.

I just wanted to dig back into the visibility habits are large memory customers. And the reason I ask is just 6 to 9 months ago, your outlook for the year was substantially different. And so it implies very low visibility at some of these large customers. I'm wondering if that visibility has actually improved or you're really commenting on the trends are you're looking into 2018?

That's a heck of a good question. So I'll give you some historical perspective. We do forecast historically, based on -- we talk to the account guys with of the marketing guys, look at trend data and underlying drivers. When we do a kind of a 1-year forecast, it's a little bit more weighted to the start account guys. And the customers communication of second-half visibility to us is moderate. Sometimes they don't know, and sometimes they don't want to disclose it, frankly because it's a competitive issue for them. So my belief is that the semicap industry probably underestimated the second half of this year. And if we'd done a lot more deep thinking on it, we might have estimated at a little higher number than the second half. And it is one particular customer much bigger than expectations. So if you go we spent me percent and included been a lot more time on root cause drivers, what not just what customers tell us, but what are they selling, what are you device go into what is the content of the phone, what is the content of the PC, what's the content of the cloud? So, for instance, if you look at the from, what we thought ended '16 was content, wasn't unit phones it's content of the phones, content of the cloud. That is continuing for this year. And if you say, what device type is up this year from early expectations? Across the board, but it's NAND, DRAM and foundry, but NAND probably the biggest increase one particular customer. So we're spending a lot more time going to root cause drivers of what's driving the NAND. So i probably have more confidence than I did a year ago about the outlook.

Your next question comes from Craig Ellis with B. Riley.

I'm going to ask you to take another longer-term view on the end user is as you did with foundry, DRAM. And what I was hoping you could you do is just click out beyond the next few shrinks that we're likely to get to some of the alternative architectures. And the question is really around the equipment intensity that might be seeing with any of the successor architectures that would be there for DRAM. Is it higher? Is it lower? Is it a mix? What's the company seeing longer term for the extension to nonvolatile memory as we know it or volatile memory as we know it?

I'll start with more general stuff, and Gary will do the more technical stuff. I generally am optimistic about the industry and the various device types, but there's going to be granularity to some of that. So I believe that these drivers that this greater and greater valuable applications for silicon at the need to be basically, A, leverage on the fiscal assets and universe more efficiently through silicon. And two, I think a lot of the incremental consumption of entertainment meets health care will be leveraged by silicon. So I think the cosmic drivers, whether it's on automobiles, hotels, health care, you name it, silicon's going to play a big role in this. Okay? So that drivers now that said, how to make money in life is 2 ways: scale and differentiation. So if you look at the scale of these things be a big increase scale up at the cloud with huge volumes. And the differentiations of these solutions what does that mean? I think you're going to have more different tape out some are different type of devices and you have before. I think you'll see the A6 chips. You'll see the graphics processor units at the guilty different types of high end, low end, different types of DRAM. And I think you'll see different types of memory. So I think the proliferation, more devices and more design, which is all good for us, frankly. And NAND, if you go to, but I think about altered memory? I think NAND is going to grow for a while. Hard disk drive. I think DRAM and memory was that segment the market the products because of volume of the differentiator so valuable that you can go to different design times. I don't think it's going to be one shoe fits all feat. And then thirdly, in terms of capital intensity, capital intensity by device type is up across the board from a few years ago, 30% to 90%, right? And I don't see that trend changing for all new devices either.

So I would also agree with Bob that the -- you got big investments being made by leading companies to drive transformative changes that shift economic value in major industries. That's going to create a great opportunity for memory, for high-performance computing, all of those different areas. I also -- if you look at what's happened in memory over the last few years and what's driving the market today, tremendous innovation in architecture, driven by materials innovation, what we do better than anyone else. And we're working with very large companies on, certainly, extending current memory technologies, scaling 3D NAND. But we're also working on new memory technologies. And I really believe that the pace of innovation is going to accelerate. And really, at the foundation of that is Applied Materials with materials innovation. So I'm pretty optimistic on the overall market opportunity, and I'm also even more optimistic about our position to grow as these changes happen.

And next question comes from Jagadish Iyer with Summit Redstone Partners.

Gary, you talked about Gen 10 fabs in the display side. So I was wondering how is it often to be OLED. And as a bigger picture, is this large-scale transformation to OLED happens, are you going to see a new baseline to your display revenues?

So the Gen 10.5 factories are really focused on TV and all of the [13] projects that we're tracking right now are not OLED factories. They're, again, large area. We're seeing an increase in terms of the area consumption for large screens. And it's way more efficient to go to these larger factories from a cost perspective. So that's what's driving that. I mean, certainly, we're certainly very optimistic about mobile OLED and the opportunities that we have there. We're still in the early innings. But the driver for Gen 10.5 is larger TV screens. Bob, if you want to add anything else?

Yes, I think that's true. I do think there's a hell of a lot the upper directional errors in general for the market. And so the new baseline revenue is increasing for display, which is one particular question, Jagdish. And if you look at the inflections, there's just as bigger TV I mind not just OLED a little those are really other infectious like simple phone you have now is you go to the wraparound to get up at the bottom of the you get 40% more surface area we sell service area whether it's layers are size. And I think you're going to have foldable in a few years, which doubles that service area over the phone or an iPod, I guess. And then eventually you going to have some OLED proliferation, as you mentioned, the [indiscernible] we're something further down the road. All of these lead to more spending now the question people would ask a year or 2 ago is, geewhiz historically, you might have $32 billion in WFE spending and $8 billion and display spending and shouldn't stay at 25%? No. Because the drivers are very different. I mean, display as you huge application across the world and TVs, mobile phones, everyone has and the layer account to increase in their visual content of that is doubling. So I think there potential is pretty big.

The next question comes from Toshi Hari with Goldman Sachs.

I had a question on gross margin heading into next fiscal year. Bob, you talked about display growing 30% year-over-year. I'm guessing, at least at this point, you don't have as high expeditions for the semiconductor business. Did you thank you can improve gross margins in the next fiscal year?

Our goal is to increase gross margins every year. I think this year we've done particularly well and going to be up a couple of points, almost 3. We're going to be up like 2.9 this year or something like that. We're up a lot, okay? And no that's a lot of things. I mean, I think we've executed [5] product across the line. So if you look at our gross margin, every single product and the company, every be even the company, which number between service and semi, like 13 businesses, every one of the gross margins is up from '13 to '17. So good execution. Mix this year is pretty good. It's a good semi pretty big display and services here. So my take there's an opportunity to grow up next year, but we haven't from the models. But it would be hard to do it as well as you do this year. So my average goal at the end is done through the numbers past average goal kind of [7x] of a point a year. And if we do anything like that, we're already kind of ahead of me '19 model. So I think there's still room.

Sure Mica cutting is probably good. Summarize a few key points from today's call. First, I hope you share excitement that Applied's markets are substantially larger and more attractive than they've been historically. We expect another record quarter in Q4. With that line of sight, the continued momentum in Q1 and far beyond. Second, Applied is uniquely positioned to outperform our core market, further building on our leadership in semis, growing the unique opportunity we have in front of us in display and expanding the service businesses. Last -- third, we're more profitable than we've been, and we have many levers to keep driving the profitable growth. And lastly, I look forward to meeting all of you in your current Analyst Day on the 27th. And personally, I can't wait to show you how we can to get raising the ceiling on our performance in the years to come. Mike, now back to you.

Thanks, Dan. We would like to thank everybody for joining us this afternoon. A replay of this call is going to be available on our website beginning at 5:00 p.m. Pacific Time today. And thank you for your continued interest in Applied Materials.

That does conclude today's conference. You may now disconnect.