ASML Holding N.V. (NASDAQ:ASML) Q3 2017 Earnings Conference Call October 18, 2017 9:00 AM ET
Executives
Craig DeYoung – Vice President-Investor Relations
Peter Wennink – Chief Executive Officer
Wolfgang Nickl – Chief Financial Officer
Analysts
Dave Mulholland – UBS
Farhan Ahmad – Credit Suisse
C.J. Muse – Evercore ISI
Mehdi Hosseini – Susquehanna Financial Group
Jagadish Iyer – Summit Redstone Partners
Andrew Gardiner – Barclays
Francois Meunier – Morgan Stanley
Sandeep Deshpande – JPMorgan
Adithya Metuku – Bank of America Merrill Lynch
Weston Twigg – KeyBanc Capital Markets
Douglas Smith – Agency Partners
Amit Harchandani – Citi
Operator
Ladies and gentlemen, thank you for standing by. Welcome to ASML 2017 Third Quarter Financial Results Conference Call on October 18, 2017. Throughout today’s introduction, all participants will be in a listen-only mode. After ASML’s introduction, there will be an opportunity to ask questions. I would now like to open the question-and-answer queue. [Operator Instructions].
I would now like to turn the conference call over to Mr. Craig DeYoung. Go ahead, please sir.
Craig DeYoung
Thank you, Peter. Good afternoon and good morning, ladies and gentlemen. This is Craig DeYoung, Vice President of Investor Relations at ASML. Joining me today from ASML headquarters in Veldhoven, Netherlands is ASML’s CEO, Peter Wennink; and ASML’s CFO, Wolfgang Nickl.
The subject of today’s call is ASML’s 2017 third quarter results. The length of this call will be 60 minutes and questions will be taken in the order that they are received. This call is also being broadcast live over the Internet at asml.com. A transcript of management’s opening remarks and a replay of the call will be available on our website shortly following the conclusion of the call.
Before we begin, I’d like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of the Federal Securities Laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the Safe Harbor statement contained in today’s press release and presentation found on our website and in ASML’s Annual Report on Form 20-F and other documents as filed with the Securities and Exchange Commission.
With that, I’d like to turn the call over to Peter Wennink for a brief introduction. Peter?
Peter Wennink
Thank you Craig. Good morning and good afternoon, ladies and gentlemen, and thank you for joining us for our Q3 results conference call. Before we begin the Q&A session, Wolfgang and I would like to provide an overview and some commentary on the recent quarter as well as provide our view of the coming quarters.
Wolfgang will start with a review of our Q3 financial performance with added comments on our short-term outlook. And I will complete the introduction with some additional comments on the current business environment and our future business outlook.
Wolfgang, if you will.
Wolfgang Nickl
Thank you, Peter, and welcome everyone. I would like to first highlight some of the third quarter financial accomplishments and then provide our view for the coming quarter.
Q3 net sales exceeded our guidance coming in at €2.45 billion, largely due to the revenue recognition of an additional EUV system. Net system sales of €1.82 billion was nicely balanced between foundry, memory and IDM, and was more than €400 million higher than in Q2.
Installed base management revenue for the quarter came in at €628 million, slightly above our expectation. Our gross margin for the quarter came in at 42.9%. This margin was diluted by the additional EUV revenue recognized, but compensated by higher-than-expected DUV and Holistic Lithography sales.
Overall OpEx came in slightly below guidance, with R&D expenses at €315 million and SG&A expenses at €103 million. Turning to the balance sheet. Quarter-over-quarter cash, cash equivalents and short-term investments came in at €2.68 billion.
As highlighted during our July call, we resumed share buybacks in Q3. During the quarter, we purchased €169 million worth of shares. Since January 2016, we have purchased shares of approximately six million shares with a value of €569 million against our 2016 and 2017 authorization of €1.5 billion.
Moving to the order book. The three system bookings came in at €2.15 billion. The growth in the immerse and KrF order intake is an indication of the strength of our EUV business. Last quarter's strong bookings were driven by the memory sector, which represented 77% of orders compared to 40% in Q2.
Our EUV backlog now reflects 23 systems valued at €2.6 billion. As for EUV orders, we are working closely with our customers to understand the EUV demand through 2020 and use this as the basis for our shipment planning. Actual order intake is always lumpy, and we do expect to take additional orders in Q4.
Our overall system backlog now totals a record €5.69 billion. With that, I would like to turn to our expectations and guidance for the fourth quarter of 2017. We expect continuing sales trend in Q4, with total net sales of around €2.1 billion. While we target to ship six NXE:3400s in the December quarter, we expect revenue recognition of about €300 million for our EUV business.
We expect our Q4 installed base management revenue to come around €600 million. This revenue guidance for Q4 brings our total revenue expectation for 2017 to approximately €8.6 billion which reflects a greater than 25% year-on-year increase. Installed base revenue will account for almost €2.7 billion for the year, also reflecting a 25% increase.
Total EUV revenue for 2017 will be around €1 billion, which represents more than 2.5 times the 2016 level. Gross margin for Q4 is expected to be around 44%, R&D expenses for Q4 will be about €315 million, and SG&A is expected to come in at about €110 million. With this guidance for Q4, our total operating income for the year is expected to exceed €2.25 billion reflecting a greater than 35% year-on-year increase.
With that I would like to turn the call back over to you, Peter.
Peter Wennink
Thank you, Wolfgang. As Wolfgang highlighted, our business continues to perform very well, and demand for our products is very strong. Based on our guidance for the upcoming quarter, we expect to deliver another record year with net sales growth of at least 25% over 2016.
The positive industry environment across multiple end market segments continues to fuel strong demand for our products as we move into 2018. While Wolfgang reviewed our current performance and outlook for the coming quarter, I would like to provide some commentary on the longer-term outlook of our market drivers, followed by an update of the progress and plans for our product groups.
This year's memory strength will translate into a record memory revenue year for us. This, in combination with our strong memory backlog, seems to serve as a solid foundation for further growth into 2018. As our customers further migrate next year to the sub-20-nanometer DRAM nodes, we benefit from a significantly increasing litho intensity for those nodes, driving litho intensity up over 30%.
Additionally, we do not see significant near-term completion of new DRAM fabs. This is amidst a healthy mid-20s DRAM bit demand growth scenario, largely driven by demand for performance memory in the service space. All in all, a strong base for our 2018 DRAM business. In 3D NAND, litho demand is also strong with a number of greenfield fabs ramping.
The ramp greenfield fabs take approximately 10% more litho spend than the previous 2D NAND fabs. As this technology scales vertically, there are challenges in building these very tall stacks. In response on NAND memory, manufacturers are implementing so- called stacks of stacks, where every new stack needs additional litho, driving litho intensity up by another 20%.
But adding the NAND opportunity to the DRAM business outlook for next year, we can see another strong memory year ahead of us. Logic demand remains solid, driven by the continued ramp of 10-nanometer as well as the start of the 7-nanometer node. Litho intensity continues to increase as we migrate to future nodes, and further strengthens with the adoption of EUV at 7-nanometer.
As expensive multiple patterning schemes keep driving up the cost of every new node, EUV provides process simplification, cycle time reductions and yield improvement, ultimately resulting in customer cost benefits, which clearly explains the stated desire to introduce EUV for the next nodes. With regards to China, we continue to see revenue increase throughout the year, and are on pace to set a new net revenue from this region in 2017.
This trend of increasing sales to the Chinese region will continue in 2018, as we see strong demand from notable customers building out fabs in China, including additional system orders from new domestic Chinese customers. We expect to see a number of new customers starting pilot ramps next year, and are further expanding our customer support footprint in order to meet the future significant demand growth in this region.
As we mentioned last quarter, we estimate the initial lithography opportunity on these new domestic Chinese customers to be around €3 billion over the next three years. On the ASML product side, let me start with an update of our EUV business. In EUV, availability continues to make progress in both average performance as well as reducing variation. In addition to delivering zero defect pellicles, we also demonstrated the capability of these pellicles to withstand 250 watts of power in support of 125 wafers per hour and beyond targets.
We continue to work closely with our customers to align on their EUV demand plans and the required timing of tool shipments. Supporting our customers' delivery timing requirements depends predominantly on the ramp-up speed of our supply chain, specifically optics. Long lead time for EUV systems, combined with the inherent fluctuations of our customers' ramped plants poses significant planning challenges.
To address these challenges, we continue to work intensely with our supply chain to bring the lead times for EUV down from 24 to 18 months. Taking all of the aforementioned into account, we currently have a production plan of 20 EUV systems next year, at least 30 in 2019 and 40-plus in 2020. Also, in support of EUV production implementation, we shipped the first e-beam EUV reticle inspection tool, the eXplore 6000, to a logic foundry customer. This system enables improved defect detection, as optical inspection has resolution challenges on EUV reticles.
In deep UV, we see continued revenue growth across the product lines, driven by immersion and KrF technology. We provided early access to our latest TWINSCAN NXT:2000 immersion system for initial development of the 5-nanometer node. This new system features several hardware innovations that deliver improved imaging and overlay performance in support of aggressive matched machine overlay to EUV, which is required for future nodes. The very high demand for our immersion systems equals the fastest ramp of our NXT platform industry as we shipped the 100th NXT:1980 system in Q3.
Strong demand for our KrF product is across multiple market segments, primarily driven by 3D NAND. In Holistic Lithography, we shipped our first jointly developed product less than one year after closing of the HMI acquisition. This product, the ePfm5, is a Pattern Fidelity Metrology system that leverages HMI's high-resolution e-beam metrology with ASML's computational lithography technology.
This product's high-resolution capability enables a high capture rate or systematic patterning defects, so customers can accelerate the yield learning curves and drive higher production yields. This integrated system enables the first-ever guided metrology, delivering faster, effective throughput to support volume production.
In summary, we have demand growth continuing across our entire product portfolio. And we expect another record year, at least 25% revenue growth, largely driven by continued strength of memory demand, alongside solid logic demand. Although it's too early to fully quantify 2018, our current view is that the positive business trends that we're seeing in 2017 will continue in 2018.
With that, we'll be happy to take your questions.
Craig DeYoung
Thank you Peter. Ladies and gentlemen the operator will instruct you momentarily on the protocol for the Q&A session. [Operator Instructions] Now Peter, could you have your final instructions, and then the first question, please?
Question-and-Answer Session
Operator
Yes sir, thank you. [Operator Instructions] First question comes from Mr. Dave Mulholland [UBS]. Please state your company name followed by your question.
Dave Mulholland
Thanks for taking the question and just firstly, I think one of the interesting comments you made on the 3D NAND shifting to wondering if you could just help us to understand how broadly you see that happening throughout the customer base in 3D NAND. Is this selectively or all of your customers are moving towards that trend? And then secondly, on EUV, just one quick update.
So for, if you could, I think on the last call, you mentioned there was potentially going to be €500 million of revenue to be caught up or unrecognized at the end of this year. Is that still the case? And could you help us understand when we should expect that to be recognized into 2018?
Peter Wennink
Yes. I will answer the first one. I'll give the second question to you, Wolfgang.
Wolfgang Nickl
Yes.
Peter Wennink
Yeah the 3D NAND how broadly do we see that? We see that with a few customers, not with all of them. But what we understand is that customers have similar issues. Now you can always argue, at what level of specs do they encounter those issues? And that might be different from customer to customer. But I think it's our belief, based on the that we get from customers, that ultimately, they will all have to get to some kind of stack-of-stack approach. But it has started. And it has started not with all of them, but with a few customers.
Wolfgang Nickl
And Dave, on the deferred revenue on EUV, you're correct, same thing, like what we said last quarter. We will carry significant a deferred revenue balance into next year, which means that our total revenue for next year will be higher than what the 20 shipments that we have planned and, of course, the four upgrades that we also still plan to do.
So the total revenue will include some of that deferred revenue. And there will be a little bit of revenue deferred of the 20 systems, but the majority will be recognized. Therefore, we continue to say that for next year, you should use a planning assumption of around €2.5 billion for total EUV revenue.
Dave Mulholland
And if I may just quickly follow up on the profitability of the deferral, is that still quite dilutive on where you're recognizing for the three tools in Q4? And then is it very profitable next year? Or is there less difference in the deferral this time around?
Wolfgang Nickl
It is very different by different line items. But for your defining purposes, just assume the same profitability.
Dave Mulholland
Thanks so much.
Operator
The next question comes from Mr. Farhan Ahmad [Credit Suisse]. Please state your company name followed by your question.
Farhan Ahmad
Farhan Ahmad from Credit Suisse. Thanks for taking my question. My question is on the memory. You're seeing very strong orders in Q3, and I just want to understand what's the sustainability in that business. And is there any concern that there might be too much additions? And if you can give some color on how much of it is revenue capacity versus just conversion, that will be helpful.
Peter Wennink
The answer on the new capacity is a difficult one. Like I said, let me first answer your first question on the sustainability. On DRAM, like as I said in my prepared remarks, there are no significant new fab plants that will take tools in 2018. So next year. So in other words, in terms of new fab capacity, it will be pretty limited what you will see in terms of wafers out in 2018, which actually means that the bit demand, which is currently around the mid-20s, needs to come from shrink, from innovation, which actually happens. I mean, there's a lot of innovation happening in DRAM.
So we got sub 20- nanometer, and then we'll provide those bits. At least that is what the expectation is. And I would support that, I mean, that the innovation drive should be sufficient to deal with the demand, but there would be no relief. On 3D NAND, a lot of greenfield fabs, and that means that there's a lot of shipments to those greenfield fabs. Now when we look at the forecasted bit growth on NAND, it is the reason really where the big question is whether that bit growth is going to be able to absorb all that new capacity in 2018.
We don’t know yet. I mean, currently, we've been surprised also this year about a bit stronger bit demand growth that we originally anticipated. That's where probably a bit of a question is probably too early to answer. But all our memory customers, they indicate that, also, on 3D NAND, they see significant bit growth next year from the demand side.
So if anything, if you would want to place a question on sustainability, now start asking our customers on what they believe how much capacity is now added or will be added in 2018 and what they think about the demand situation. And the demand situation, of course, we're further away from that, so it's more difficult for us to give you an answer in that direction.
Now what is new capacity? Well, I actually answered. I said a lot of new capacity is being added in the 3D NAND space, not a lot of new capacity in the DRAM space. But all in all, if we look, like I said in my prepared remarks, what the drivers are, very much the end drivers that customers tell us are server markets are the markets for the take-up of the new 3D NAND products all looks very healthy. And customers are very upbeat, as also evidenced by the intake in our order book in Q3.
Farhan Ahmad
Thank you and then a quick question on EUV. Can you just remind us what are the main bottlenecks that you have in terms of the supply chain, which you are working on?
Peter Wennink
The main bottlenecks, as I mentioned also in my prepared remarks, are the lenses, the optics. The optics are the gating item right now. So we're working very hard with ZEISS to make sure that we can get a bit more output. But as we currently see it, I mean, we've mentioned in all of the numbers, which are up 20 for next year, at least 30 for 2019 and 40 plus for 2020. That is what our current planning is. But we also have started to run programs with our supply chain to shorten the lead time and to shorter the cycle time in their factory. So the total lead time for EUV can come down from 24 to far up to 2019 of around 18 months. So we are working hard but it's currently optics.
Farhan Ahmad
Thank you that is all I have.
Operator
The next question comes from Mr. C.J. Muse. [Evercore ISI] Please state your company name followed by your question.
C.J. Muse
Yeah, good afternoon. C.J. Muse with Evercore ISI. Thanks for taking my question. I guess, first question, on the EUV front, and specifically the memory, can you provide an update on where we are in terms of DRAM adoption at 1Y? And as part of that, are you including a meaningful number of tool shipments in your 30 shipment outlook for calendar 2019?
Peter Wennink
Memory specific.
C.J. Muse
Yeah, just DRAM specific yes.
Peter Wennink
I think we don’t single out the DRAM memory customer or customers. And 2019 would be, that would be not wise to do that because it would pinpoint to specific customers, and we won't do that. But for EUV memory DRAM, the adoption is currently target – initial adoption is currently targeted at the end of next year. So that means drivers for that are, of course, the productivity of the tool. But those targets are in our outlets. So that would mean initial adoption for initial production at the end of 2018 going into 2019 in that time frame.
C.J. Muse
Very helpful. And I guess, as my follow-up, Wolfgang, can you talk about gross margin trajectory for EUV as well as the entirety of the company? I think you talked about 20%, if my memory serves me right, for calendar 2018. I'm curious, does that include the benefit of deferred revenues in the mix? And then as a second part to that, when do you think at high volume, call it, 6, 7, 8 EUV tools per quarter, can you get to kind of a 45-plus percent gross margin overall.
Wolfgang Nickl
Okay C. J. Our plan stands as we have communicated it before if the target is to get to close to breakeven or breakeven this year, and that includes everything. All the numbers I give you include everything. It includes service. It includes the systems, includes the deferred revenue rollover. And then for 2018, we're targeting 20%, and our objective for 2020 is 40%. So we haven't quite spelled out 45% yet. We have also said that 40% is not the end of the road. If you look at our other businesses, they return more than 40% gross margin. But that would always include the deferred pieces as well. So breakeven this year, 20% in 2018, 40% in 2020, and 2019, somewhere in between 20% and 40%.
C.J. Muse
Thank you.
Operator
The next question comes from Mr. Mehdi Hosseini [Susquehanna Financial Group]. Please state your company name followed by your question.
Mehdi Hosseini
Thanks for taking my question. The first one has to do with your EUV manufacturing. What would be your shipment forecast if your manufacturing cycle time has actually been reduced to 18 months? Specifically, where would the 30 and 40-plus unit in 2019 and 2020 would go to?
Peter Wennink
That’s a good question, that’s an interesting question. And in fact, I think what we can see is that the customer demand that we're seeing for 2019 is in excess of that 30. Now we can just add it all up, and then think about two years ahead and what customers indicate to us. That is I would say decently above that 30 number. And that decently means that it's at least 30% from that number. But how much it, in fact, would be in 2019 is a bit difficult because it is still two years out. So but what we're currently seeing is that would be about 30% higher than the number that we – that I quoted you.
Mehdi Hosseini
And then it has been a few quarters since you have broken out the metrology inspection. Maybe this is more for Wolfgang. Can you help us? How should we think about revenue contribution in 2017? And where would it go into 2018? Is there any parameter? Is there any metrics that you can offer so we could better model this?
Wolfgang Nickl
Yeah the one thing that we have been clear on is a good chunk of that is, of course, the newly acquired HMI business. And there, we said that revenue this year will significantly increase, almost double, albeit from a relatively low level last year. So it will be somewhere in the 2.20, 2.30 somewhere in that range. And then that business will continue to strongly grow next year based also on the eXplore product and the ePfm5 product that Peter had in his introductory remarks.
It's a little bit early to put a number in, but it's a significant step-up, all in support of a business that is going to be around €1 billion in 2020.
Mehdi Hosseini
Yeah I think, what I was trying to get at is if there are two buckets, EUV and DUV, which one of these two buckets or factors are going to be critical in sustaining the growth and hitting that €1 billion revenue target in 2020?
Wolfgang Nickl
It is not that easily to tie it to one or the other. It has to do with the total production process and the total development process of our customers. So we don't look at it this way. We just look at it as a total pattern and metrology business.
Mehdi Hosseini
Got it thank you.
Operator
The next question comes from Mr. Jagadish Iyer [Summit Redstone Partners]. Please state your company name followed by your question.
Jagadish Iyer
Yes, Summit Redstone Partners. Two questions, Peter. First on the, in terms of the Pattern Fidelity Metrology that you provided, how big can the market be? And can you clarify in terms of the adoption between foundry, logic, as well as memory customers? And then I have a brief follow-up.
Peter Wennink
Yeah, on the last question, it is predominantly being used initially, I would say initially, by logic, yes, because that's where the biggest challenges are because of the more random patterns that you see there. So that will be the first area where you would see the introduction. But as we've seen with all the solutions that ultimately provide customers with more certainty, what happens on the wafer and gives them the ability to make changes, so that it can really manage yield, that also crosses over to the memory products also. We've seen the same with YieldStar and that Star between logic, and it also moves now over into the memory space.
And how big is that market? Well, that's a good question because we're actually is a product for which a market does not exist yet, because it's a product that actually – or the Pattern Fidelity Metrology where you have, where you use the predictive capability that manage yield through the scanner is a completely new area. So we have our ideas of what it can mean, and we think it can create, there's a lot of value. If you look at the first PFM, the Pattern Fidelity tool – metrology tool that we're shipping this year, we're shipping a few, but the first one we did in Q3, I mean, that has a high level of interest with our logic customers.
So how big is that market? It depends on the value that we're going to provide. We have high hopes and expectations, but that needs to be basically worked out together with the customer because that really – you really show the value of all the wafer. So that is – that jury is still have been out, but we have high hopes, and actually because it provides an efficacy tool loop that nobody else does.
Jagadish Iyer
Thanks for that and just as a follow-up, you had an e-beam inspection product rollout for these EUV mask. When do you see the insertion point for this product? What time frame? And where do you see that ramping through 2020 and beyond? Thank you.
Peter Wennink
Well, I think it's – we see that ramping at the same time as we ramp EUV. I mean, you need EUV masks. You need the inspection of EUV masks. So that's why we are – start shipping the first tools now. So those are not going to volume production because volume production really initially start at the end of next year, in the course of next year and going into 2019. So it is the time frame where you also need to see the ramp of this product.
Jagadish Iyer
Thank you.
Operator
Next question comes from Andrew Gardiner [Barclays]. Please state your company name followed by your question.
Andrew Gardiner
Good afternoon gentlemen, it's Andrew Gardiner from Barclays. I just had a couple of modeling questions for you, Wolfgang. Just as we sit here towards the end of 2017, I was just wondering if you could start to give us a bit more of a steer on some of the OpEx items in 2018, particularly around R&D. You guys have been pretty consistent this year at about €315 million a quarter.
Just interested how to – sort of how that might step up, particularly when we consider the contribution to ZEISS next year, and also likewise on capital spending, particularly as you're continuing to fit out for the EUV ramp. And then finally, just do you have any thoughts on tax? I know that some of the tax proposal by the coalition government in Ireland are not yet finalized, but have you guys looked at how that might impact your ongoing tax rate? Thanks very much.
Wolfgang Nickl
Hello Andrew, OpEx first. Let's start with SG&A. SG&A should grow only very modestly. I mean, we have very few variable pieces in there, but we invest a bit in sales. We invest a bit in HR, a little bit in IT systems. But I think that we'll be growing at a much lower rate than the revenue, and we'll stay around that 1.10 rate, probably a little bit up, if you look – and our objective there for 2020 is 4% of revenue.
For R&D, we're going to add up to 1.25 or 1.26 for this year, which is based on our revenue guidance now in the fourth quarter is somewhere just shy of 15%. And if you contrast that to 2014, 2015, 2016, it was 18%, 17%, 16%, the spend respectively. Now we're around 15%. We will spend more in absolute terms next year, exactly for the reasons that you mentioned. High NA, both on our premises, but then also on Zeiss SMT's premises. And then we do continue to invest strongly also in the Holistic Lithography field. We're actually accelerating investments there. A bit too early to give a number. It will be up, but I think it will be 14%.
So it will be up in absolute terms. It will come down in relative terms towards our target of 13% in 2020. CapEx, we're not that super CapEx intense ourselves. We spend around €200 million for the first nine months. I usually don't guide, but assume that we're getting out somewhere we're in €270 million, €280 million. The last four years, we're somewhere between €310 million and €370 million. So this year, we'll be around 3% only of revenue. Our long-term model is 4%. And there you should expect it to come up a little bit over the next two or three years, but not beyond the 4%, I think, that we have in our 2020 model. And that is, indeed, to prepare the site for high NA prototypes and high NA manufacturing later on.
Tax rate model is 14%. The innovation box, negotiations have been going very well. We're in the documentation phase. So we have a principal agreement. We're in the documentation phase that very well supports our 14% model. As it relates to the outcome of the coalition negotiations here in the Netherlands, they're – and there's no law yet. That's just a proposal. But if that comes through, the benefit of the innovation box will reduce slightly – without going into the technical details, will reduce slightly, but it's accompanied with a reduction in the corporate tax rate. So both are literally offsetting to each other, there may be a slight timing difference that the reduction of the benefit comes earlier than the reduction of the corporate tax rate, but I think that will not be a significant impact on the 14% model, Andrew.
Andrew Gardiner
Okay, that’s great detail. Thanks very much.
Wolfgang Nickl
You’re welcome.
Operator
The next question comes from Mr. Francois Meunier [Morgan Stanley]. Please state your company name followed by your question.
Francois Meunier
Yes. I've got questions regarding the ecosystem of EUVs. In your opening remark, you talked about the pellicle withstanding a 250 watt EUV e-beam, which is really good. Hopefully, it doesn't get too dark too quickly. If you could give us a bit of an update regarding the other elements of the ecosystem, like the photoresist, the mask manufacturing, but also maybe more longer term, the actinic mask inspection tool that we've been waiting for a very long time now.
Peter Wennink
Yes. To start with your last one, the actinic inspection tool is not an issue where we are today, and I don't think it's going to be an issue for the 7-nanometer ramps either. I mean, we're going to patent the inspection. So we basically print the photomask, and you inspect the pattern on the repeatable defects. And then you can now weigh this on the photomask. And you inspect the photomask with e-beam preferably, and then you can do the correction.
So masks, I think we have all the solutions that we can think of for the 7-nanometer introduction. Photoresist actually makes some good progress, and especially on the sensitivity side. I mean, we're seeing continuous numbers coming back out of the industry and industry participants on sensitivity of the photoresist, which is good, because the more sensitive the photoresist is, the faster you can move the wafer, the higher the throughput. So pellicles, you just mentioned, pellicles being able to withstand 250 watts of EUV power is very good. So I think from an ecosystem point of view, all those elements are increasingly coming to phase, where you can call them mass production-ready.
Francois Meunier
Great. Thank you.
Operator
The next question comes from Mr. Sandeep Deshpande [JPMorgan]. Please state your company name followed by your question.
Sandeep Deshpande
Yes, hi, JPMorgan. My question is regarding DRAM, Peter. I mean, DRAM is possibly likely to use EUV in 2019. But I mean, there haven't been new DRAM fabs built in the last decade with DRAM capacity having internal demand, et cetera. Do you see the two actually – for the footprint of the EUV tool, et cetera, that to get the EUV tool into DRAM fabs, that do you need actually new DRAM capacity rebuilt? Or based on what your field application is, you know already that these existing fabs can be actually upgraded to EUV once the conversion starts? And how quick do you expect a memory DRAM conversion to happen? And I want a follow-up after that.
Peter Wennink
Yes. I think on the first shipment to DRAM fabs will be to existing fabs. So we don't need to build new fabs to house an EUV tool. However, if you say we're going to use EUV more broadly and widely in DRAM in the next decade, I'm pretty sure it's going to be fabs built that can accommodate a larger number of EUV tools.
Now as a matter of fact, when you said the last decade, no new DRAM fabs, I may remind you that we have in Korea L17 and M14, which we're completing new fabs, which actually are very large fabs that actually drove up the available capacity a couple of years ago, three or four years ago, to quite significant heights, which I think also led to an oversupply of DRAM at that time. Well, that's not happening today. Well, we're not seeing the announced results of any major new DRAM fab. So that means that the EUV tools that we will be shipping will be shipping to existing fabs that will be able to take them.
Sandeep Deshpande
And quickly following up, I mean, you've taken a stake now in Carl Zeiss and how that will be showing up on your P&L maybe for the full year this year or next year, because there will probably be a dividend payment from Carl Zeiss, and then there's going to be outgoing payments from you regarding funding their CapEx plans for high NA as well as the R&D for high NA.
Wolfgang Nickl
Okay. I'll take that, Sandeep. If you recall, we have entered into two separate contracts. We have an equity investment, and then we have a high NA agreement. The equity investment is €1 billion for 24.9%. That is already showing on the line equity method investments. If you look to our U.S. GAAP statements, you already see that there. And that will show a P&L contribution from Carl Zeiss' profit to us. So that's basically 24.9% of the profit is going to show in our P&L. It will show for the first time in Q4.
So you see the investment already, but you don't see any contribution in Q3. And that simply has to do with our close process being faster than SMT's close process. So the accounting rules allow us there to do a three month offset. And for Q2, we only really had four days. So we didn't bother to put that in Q3 because it's not material. We will walk you through the math on how that profit will show up in our P&L because it wouldn't be accounting if it would be easy, because we'll have to do a lot of adjustments here.
First of all, they are IFRS. We have to translate that into U.S. GAAP. Believe it or not at 24.9%, you need to do like a mini purchase price allocation. So there will be some amortization of intangibles, write-up of inventories, all the good stuff that you know. So it will be slightly convoluted at the beginning. But the end result, and from a cash perspective, SMT is a very, very healthy profitable business, and we'll get solid returns on our investment there.
As it relates to the high NA agreement, we will make R&D contributions and we will make CapEx contributions. The R&D contributions will show up in our R&D line. Again, it gets complicated. Some of it has to go through the equity piece because we're a partial owner as well, but the CapEx piece will be recorded on our assets, PP&E repayments.
And as a reminder there, the return on our investment, other than getting a high NA tool, is that we get these investments back through adjustments to the price of the lenses later on when we take delivery of the lenses, similar to what we have done previously with our partner there. So right now, you have just R&D in there, a couple of prepayments and the investment. And then starting next quarter, you'll have some of the profits in there as well. And we'll walk you through in more details in January.
Sandeep Deshpande
Thanks Wolfgang.
Wolfgang Nickl
You’re welcome.
Operator
The next question comes from Mr. Adithya Metuku [Bank of America Merrill Lynch]. Please state your company name followed by your question.
Adithya Metuku
Good afternoon, guys. It's Bank of America Merrill Lynch. So I have basically a quick question on EUV gross margins in the third quarter. Maybe if you could give us some color around that, and if you still expect EUV to be at a breakeven level this year, given you're deferring a lot more revenue – EUV revenues than you expected to defer at the end of the last quarter.
And secondly, just as a follow-up, if you could give us some color on what drove these deferrals. Last quarter, I was thinking you'd be doing around €1.1 billion in EUV revenues, and that looks like it's going to be a bit lower than that. Thank you.
Wolfgang Nickl
Yes. First of all, I'll check if it's still together after the year to breakeven level. And then like we said, 20% next year, 40% in 2020. We have always said we will be above €1 billion. I think at the beginning of the year, we said €1.22 billion. It always depends on which customers do you ship to and when do you ship. I mean, admittedly, the 12 shipments this year are back-end loaded. And then from that perspective, a little bit more goes into next year.
Deferrals, in general, I'll address them by multiple different items. I mean, it could be that you have a new component in the system, which you can demonstrate in your factory. But you have to replicate in the customer factory to take full revenue. And that is the main reason why the revenue this year came down. We have made an adjustment to some systems. It's not a performance adjustment. It's a maintainability adjustment, which is good news because it will help us down the road with service profitability, which, if you recall, is a main contributor to get to the 14%. But since it's a new feature, we cannot go straight to what we achieved last year.
Revenue recognition at shipment, we've got to replicate it at what we call SAT, which is the Site Acceptance Test that the customers require. It's a little bit deferred. That's the difference from the beginning of the year. But it's good news. I think the rest we said earlier. We have a deferred balance that we will start netting into the number in 2018.
Adithya Metuku
Very clear. Just a quick clarification on the R&D next year. Did I hear you correctly? Did you say it was going to be 14% of revenues?
Wolfgang Nickl
Yes. So this year is around 15%. Next year will be around 14%. So it will go up in absolute terms. But right now, if you model 14%, you should be okay.
Adithya Metuku
This year, it's – I mean, looking at it so far, it looks like it's more around 13.5%, not 15%, unless – actually, no, no, that's fine. Sorry, apologies.
Wolfgang Nickl
We made progress, but I don't think we made that much profit.
Adithya Metuku
No, no. Of course. Ignore me. Sorry, that was my bad.
Wolfgang Nickl
No worries.
Operator
Next question comes from Mr. Weston Twigg [KeyBanc Capital Markets]. Please state your company name followed by your question.
Weston Twigg
Hi, thanks for taking my question with KeyBanc Capital Markets. I had a couple questions. First, just on the uptick in IDM revenue. I was wondering if that was more EUV revenue recognition related or if you're seeing a pickup in the 10-nanometer ramp? And is that increase in demand levels sustainable moving forward?
Peter Wennink
Mainly driven by 10-nanometer, but there was a system shipped there as well in EUV that follows.
Weston Twigg
Okay, thanks. And then as a follow-up, the installed base revenue, it's coming down quite a bit in the second half from the first half. Just wondering if you can help us understand what kind of growth you expect in 2018 on that line item.
Wolfgang Nickl
Yes. I don't think that we're going to do that detail. Probably, in general, on 2018, there have been a lot of questions there as well lately. I can't be completely quantitative on this right now, but I think we can give you a few pieces that will help you form an opinion. And certainly, I don't want to go down to a customer level here, but we already talked about EUV. We get to €1 billion this year, and then we get to €2.5 billion next year. So that's a €1.5 billion increase. You will have seen an extremely strong installed base revenue this year.
I mean, we're going to almost €2.7 billion, which is up 25%. And if you recall, we said in our longer-term trajectory, we see that business going up in average by 10%. Of course, the service part of it is a pretty stable growth. It's a function of the installed base, but then the options and upgrades are a little bit more volatile. But I would, right now, assume that, that business is flat to slightly up next year.
And then for the rest of the business, the combination of EUV, holistic, in memory and in logic, we have experienced an extremely strong year this year, and we see 2018 at approximately the same level. And you have a bit of evidence there also when you look at our backlog, we've got €5.7 billion in backlog. And even though we don't guide to backlog, I think the sweet expectation was about just over €1 billion in the orders for last quarter, and we took almost twice as much, €2.1 billion. So I think, without going into customer details, but you should expect another very strong 2018 from us.
Weston Twigg
That’s very helpful. Thank you.
Operator
The next question comes from Mr. Douglas Smith [Agency Partners]. Please state your company name followed by your question.
Douglas Smith
Yes, it's Doug Smith from Agency Partners. Wolfgang, I was wondering if you could perhaps give us an approximate breakdown of the R&D spend between the EUV, metrology and inspection and DUV.
Wolfgang Nickl
I'll be – if we get to about €1.25 billion, roughly, you see about half of that being spent on EUV. I don't know how far we have gone, but then on the other half, you have a good chunk of what I would call fundamental research that benefits all businesses. And then the – but it's less than €100 million, and then the balance of €500 million is all the way towards DUV. But from a directional perspective, EUV – we're still investing by the way, because we still have significant innovation.
You heard about the 2000 coming out, for instance, now. We're just having upgrade of the first system to this 2000 level. But the rest is a bit more overlaid to deep UV, which over the next couple of years will start to come down. But applications, we're investing very heavily, like I said earlier in metrology.
Douglas Smith
Right. And it's getting pretty close to the anniversary of the analyst meeting last year, where you provided the 2020 model update. I was wondering, when would you expect to update that again? A lot of other companies have provided some 2020 models based on an upwardly revised WFE market.
Wolfgang Nickl
Yes. I mean, we haven't scheduled that yet, but we did one in 2014. We did one in 2016. So it's probably a good assumption that somewhere in 2018, we're going to do one. I think we gave you quite a bit to work with because we pinpointed an €11 billion revenue, but we gave some sensitivities, both around the market vector and the EUV intensity vector. And we're not updating this today. But I think what you can say is that the EUV adoption is well underway, and the lay accounts are not on the low end, as we talked before.
And also, if anything, the market is very enthusiastic about end demand. So without updating it today, I think the probability on the low-low or the lower combination has gone down since the year. But expect we haven't picked a date yet, but I would say somewhere next year, we're going to do a session.
Peter Wennink
If I may add, Doug. I think we actually gave you, also at the Analyst Day last year, a few scenarios. And Wolfgang alluded to it that you could argue that the, let's say, low scenario has become less likely. But I think you guys – looking at where the market is, I think we gave you enough information to just pick whatever you feel is more appropriate, right. And right now, I think an update on that model is really something we will do next year. And I think you have enough to work with.
And by the way, when we first started to talk about 2020 two years ago, I think it's good that we have some followers now. That's no reason for us to come out with something different. May I remind you to – of the fact that a year, a year and a half ago, people were saying we were way too optimistic on our 2020 targets. And now people seem to indicate that we're too pessimistic on the target. We just stay very consistent on what we've said, and I think we've given you enough to work with to the upside, if you believe in that.
Douglas Smith
Very clear and that is quite correct. Okay, thanks a lot.
Operator
The next question comes from Mr. Amit Harchandani [Citi]. Please state your company name followed by your question.
Amit Harchandani
Hello everyone. Amit Harchandani from Citi and thanks for taking my question. I really wanted to touch upon the topic of high NA EUV. Given the enthusiasm and the strong progress you made around EUV, how are your conversations happening right now with your customers? What kind of traction or commitment are they showing towards high NA EUV? Do they want you to accelerate adoption? If so, what would make you do that? And also, what would that mean in terms of the supply chain besides the ZEISS deal that you've already carried out? I'm very keen to understand how the thought process is right now around high NA EUV adoption. Thank you.
Peter Wennink
Yes, I think that's a very good question. I think in the latest discussions we've had with customers, there is no doubt they see the benefit of EUV full-stop. Now the question is about timing. And then we do see that from a timing point of view, there are some different requirements from customers from when they want to have the first tool. Now some of those customers would indicate, and then we have also pretty decent and deep discussions with them on what we could do there.
So those customers indicated they would like to have this capability rather sooner than later. And if that would mean that we would have to set up an accelerated program, that actually means that we would also ask our customers to commit also in the acceleration and the cost of that acceleration. And that would be, I think, a precondition for us to accelerate.
Now this is the level of discussion that we are having today. Now – and I think – and it's not superficial. Those are pretty deep discussions. And we're pretty clear also on what it would take to accelerate and what our commitments from the customers, how that would have to look like, which, by the way, we haven't reached an agreement yet. So it's just an information.
Now on the supply side, the gating item here is really the new optics, the optics that comes from ZEISS. This is exactly why we did what Wolfgang explained earlier. With the investment in ZEISS, we signed the R&D and the CapEx program. That's the gating item. Both will get from an EUV source of point of view, the EUV high NA tool will have the same EUV source. No source difference. The tool will be bigger, but we know how to deal with that. The real challenge is in the optics, and this is why we have started to go into disagreements with Carl Zeiss. And I would say that from this point onwards and from this moment onwards, that's really the gating item in this project.
Amit Harchandani
Thank you, Peter. And just maybe as an unrelated follow-up. You obviously have no EUV orders in this quarter, but I understand that you work on a commitment basis. You're in close touch with your customers. You could potentially still be doing some work in progress even if the administrator stuff hasn't happened. But at what stage does it become a balance sheet risk and you say, okay. We really need these orders. Otherwise, we cannot just keep on working based on the conversation. Is there is some kind of limitation or some hard line? I guess, where it's coming from is what's the minimum level of orders that I would need to see next quarter in order to ensure you'll still end up shipping 30 – or at least 30 shipments in 2019?
Peter Wennink
I think what you would then need to see is that 2018 is fully booked and the first part of 2019 also. And like I said, we're also working closely with our supply team to get some of the cycle times down. And actually, that should result over the next couple of quarters into at least a lead time reduction. Don't get – I mean, the order pressure is really driven by the fact that we have a 24 month lead time in total, which is, of course, very, very long if you look at the planning process of our customers. So – but I have no worry that we will be at that point where we close our 2018 and moving nicely into 2019, also as a result of the order intake in Q4.
Amit Harchandani
Thank you for the clarification, Peter. Thank you for the questions.
Craig DeYoung
Ladies and gentlemen, with that, well, we've run out of time. If you are unable to get through on the call and still have a question, feel free to contact that ASML investor relations department with your question. And with that, I'd like to say it's been my great pleasure to host 60 or so of these quarterly conference calls over the last many years. But with this call, it will be my last. As previously shared, I will be turning over my global IR management responsibilities with this quarter's results to Skip Miller and therefore, you'll be hearing his voice instead of mine each quarter going forward.
With that, I'd like to thank you for your mostly strict adherence to my call instructions and your kind patience in any safe harbor references I might have made over these many years. Now on behalf of ASML's board of management, I'd like to thank you all for joining us today. Peter, if you could formally conclude the call, I'd appreciate it.
Operator
Sure. Ladies and gentlemen, this concludes the ASML 2017 third quarter financial results conference call. Thank you for participating. You may now disconnect your line. Thank you.