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Applied Materials, Inc. (NASDAQ:AMAT)

Cowen & Co. Technology, Media & Telecom Conference Call

May 29, 2013 9:30 am ET

Executives

Robert J. Halliday – Senior Vice President and Chief Financial Officer

Analysts

Tim M. Arcuri – Cowen & Co. LLC.

Tim M. Arcuri – Cowen & Co. LLC.

I think we’ll get started. Thank you for joining us I’m Tim Arcuri, I am the semiconductor and the semi-equipment analyst here at Cowen and we’re very happy to have Applied Materials with us for this key note Bob Halliday is here, he is the recently appointed CFO of Applied Materials, of course long time CFO of Varian Semiconductor, very happy to have Bob with us today.

I’m going to ask a bunch of questions and then we’ll open it up to the audience for some questions as well. So, I guess maybe we can start Bob, by just talking a little bit in terms of being the newly appointed CFO some of the opportunities you see at Applied somethings that you’d like to do differently something’s the company has done well and so how do you think about the opportunity at Applied as CFO, where things can be done differently going forward?

Robert J. Halliday

Sure, let me see, if I can talk about two groups of things one, we talked a little before Tim, I’ll talk a little about the technology changes that favor Applied, then I’ll talk about some product changes then operational things.

So, if you look at technology changes we have customers more and more playing to our sweet spot which is going to deposition and etch technologies that have to do with FinFET and (inaudible) both of those played very well for us, so I think the depth of the technology people in Applied has been very impressive for me.

I think we can build great products, I think the next thing is can we execute more quickly. And so, if you look at internally Applied as a complex company, I think there is a lot opportunities to move quickly within Applied, so I think there’s opportunities in terms of supply chain as some of you may have know my [business current appearance] as CFO, but I was also in charge of manufacturing supply chain, HR, legal, finance, IT and stuff like that, so I think how we interface between ourselves at Applied there is an opportunity for more rapid change and opportunity for some cost reduction and profit improvement. So I think on the technology side, very impressed with the depth of the engineering capacity to build great products.

I think on the operational side, I think how we interact, how we optimize the businesses I think there is opportunity for profit improvement and then the front end of that whole product, before we develop products, we have to know what the customers high value prod is, better technical marketing, so Gary Dickerson the President of Applied now, he is very good at that, we already know how to engineer great products just to get the market requirements right. And then third how to generate superior profit for investors and fund these profitable product development efforts, that’s where I come in on the how we interact operationally.

Tim M. Arcuri – Cowen & Co. LLC.

Can you talk a little bit about business during the back half of the year, there is, if you look at July quarter, you didn’t guide bookings, but certainly bookings sound like will be down a bit simply because there is some decline at some of your big foundry customers and in all likelihood that’s going to come back during the back half of the year, business begins to broaden out a bit during the back half of the year, you begin to see some NAND orders coming back particularly for 3D, the sort of onside of that happening. So can you talk a little bit about your confidence in the fact that the business picks back up during the back half of the year from a bookings perspective and sort of how you see maybe the trajectory of the business towards the end of the year and sort of into next year?

Robert J. Halliday

Yeah, let me just appose the last couple of years in this sort of seasonality we’ve got used to number one, number two, let me tell you about customer technology types and what they do within this year going to next year. so if you think of last couple of years, it’s been very strong foundry years, the foundries have been dominated more by a seasonal spending because they are making products for consumer consumption, so around Christmas shipments and Chinese New Year shipments, they buy the equipment earlier in the year sort of the March to October, within foundry that’s been true for one of the very biggest foundries this year, but one of the other big foundries because there’s some changes in supply chain has been not spending too much, that other big foundry is focus particularly on technology transitions with that CapEx might be more laid in toward the end of the calendar year. So, the seasonality we’ve had in foundries in the last couple of years, we’ve had that for one, but not so much for the other, where the other one might spend a little bit heavier to the back end of the year driven by technology changes especially 14-nanometer FinFET.

So that would help the end of the calendar year within foundry more than last couple of years. The other place as you might see there is DRAM. DRAM has been slowed the last couple of years, but while we have reached after a number of years is that mobile DRAM is actually growing in greater numbers than PC based DRAM and the rate of growth is faster. So, you see we’re getting incrementally more optimistic about DRAM because of the mobile DRAM transitions, so that might help us in the second half versus the first half and frankly with that rate of growth, they’ll probably give us some optimism going into the future beyond this year.

So NAND is a technology transition where most of the shrinks have been done plainer and now they are looking at vertical NAND, where [you’ve stress this] go to a 24 layers stack and down the road you go to more, the reasons are going to VNAND are commercial and technical if you know multi-bid cells and you are just doing a plainer shrink, I think you’ve done like 8 electrons at a time, right, so the reliability is a problem plus the cost of doing that shrink particularly [LIFO] cost is very high, so what you might see is the transition to VNAND people debate whether it’s end of this year, early next year, but again, that’s a incremental positive from the first half of VNAND and it gives you some momentum into next year. So foundry because of changes and supply chain and technology raised you see the fourth quarter gives us some optimism, VNAND the technology change going to VNAND, for NAND the technology change of VNANDs more the end of the year and DRAM is transitioned to mobile DRAM is giving us incremental positive and helps us into next year hopefully.

Tim M. Arcuri – Cowen & Co. LLC

And just on some of DRAM front, we’ve seen some recent signs that there are actually shortages developing on the PC DRAM side there are actually instances where boxes are not shipping, because they can’t get enough PC DRAM, because I think that there’s some of the PC manufacturers don’t want to de-load the boxes like they would have in the past because, so they’re trying to compete with increasingly functional tablets, so do you see any signs that your customers are beginning to while they’ve talked publicly about not wanting to expand wafers in PC DRAM, are you seeing any signs that maybe you could actually see some wafer capacity expansion in the DRAM industry?

Robert J. Halliday

Yeah. In terms of sort of the statistics on box loading and things like that just close to that than I’m and I see their behavioral changes right, so their behavior is incrementally positive now so they’re talking to us lot of ordering equipment, more positive than in the past, so I think that’s a function of some of things you’re just saying, but its a little hard for me to measure how to connect those dots on my level, so I’d say the body language support what you’re saying quantifying s a little hard for me.

Tim M. Arcuri – Cowen & Co. LLC

And may be you can talk a little bit about 20-nanometer if you compare and contrast some of semi-equipment companies, you look at a company like LAM is uniquely levered to 3D NAND, whereas Applied leverage is probably more than 20-nanometer foundry, so can you sort of compare and contrast where your lever points are between all the different moving parts out there and can you also talk a little bit about 20-nanometer timing, do you think that there is order start just happen in Q3 or in Q4 and sort of the phase of that ramp?

Robert J. Halliday

Sure, so the transition of 28 to 20-nanometer is really positive for us, we think RTM grows up about 25% and so why because they really get some of things they are doing whether it’s a High-k/Metal Gate in volume, some of the PVD steps those are all very positive for us, FE is good for us in 20-nanometer, so 20-nanometer is a very good thing for Applied, if you think that technology changes, they’re facing now, it’s hard to put down from material FinFET’s then later on, where they go to 3.5, all those things played very well for Applied in our tool set, whether it’s FE, PVD, implant things like that.

So RTM grows from a 25% around the transistor at 20-nanometer and 28-nanometer. So that mix change for 28-nanometer to 20-nanometer is good for us, if you look at timing, of they’ve done some early pilot lines earlier this year, right around now for 20-nanometer and they’re going to ramp more aggressive production, later in the calendar year, if you’re answering my qualitative buyers, I think some of the foundry thing, I’m more qualitatively, positively buyers and negatively buyers, I think if anything that race between them is going to pulls in and push out, so I think from what they say and in their stated dialog, I think I feel a little bit more positive.

Tim M. Arcuri – Cowen & Co. LLC.

Great. Maybe we can ask the audience, if there is any questions?

Question-and-Answer Session

Tim M. Arcuri – Cowen & Co. LLC.

Can we talk then about maybe about solar and about EES just for a moment, you’ve been cutting OpEx thereby a lot now it’s gone to $20 million a quarter, can you maybe talk about getting that business to breakeven and whether there is any signs that the revenue could grow from $38 million to $40 million where it is now, up to a level, where that business could breakeven say in the next year or so?

Robert J. Halliday

Sure. Let me give you some background context it might be helpful. So people will ask me, well, what do you think, I’ll go back to one of your earlier questions, what do you think about your first three months at Applied numbers in order everything, so I can’t give you a specific answer to certain things, but I will address the solar one. But I’ll tell you the focus; the focus has changed in my mind in three levels, right. One, I think the focus is significantly more on the semi-market versus non-semi like solar. The second thing I think the focus as you could see in our finances release is much more on investing in to the products whether it’s R&D or the technical marketing guys in the field versus non-product focus.

The third area of focus I’ll say for us is speed, rate of change has really picked up, so those three areas of focus I think played very well for us. If you think about specific question on solar, in solar, we have – these is three issues in solar, one, where is the market and when does it come back, the second one is do you, is it a very good market for you when it comes back and treat you in economic scale all of those are very good question.

So if you look at it I think the solar market for CapEx were very pretty conservative on it right now, so let me give you that point and then I’ll tell you what I think we’re going to do. Two if you look at we basically have four products within solar and those have varying degrees of very strong intellectual property. So if you see a market where the market may not come back next week then you won’t have very strong positions when it comes back so you make money, I would say that in several of our products we have very strong product positions and some of the others okay, product positions.

And then the third is do you have economic scales you make a bunch of money when it does come back, and so what we’re doing is lowering our costs, increasing our concentrations so that we have scale that goes back I would say that punch line is I think we’re optimizing our solar business focusing where we have differential products reducing the cost, but watching it very closely, will it come back to a $100 million a quarter? I don’t see our businesses hitting a $100 million a quarter at the short-term. So I think we have to be open to deep thinking around the whole thing.

Tim M. Arcuri - Cowen & Co. LLC.

Can we talk maybe about the display business a little bit, certainly, you’ve had some success in OLED, but we haven’t seen too much impact yet from the 4k2k transition. So can you talk a little bit about display, and the business is sort of bounce here up the bottom, but how many more quarters of growth can we see in that business, if you sort of normalize revenue, the business in the last five, seven years is averaged 715 million give or take a year. So you are you optimistic that the combination of OLED plus 4k2k can cause the business to expand beyond that sort of $750 million a year normalized level what’s been in the last seven years?

Robert J. Halliday

Sure. Let me give some background for people don’t know our display business tool, I like our display business, yeah I like the economic model, I like the differentiation there. so our display business, what we do for, those of you don’t follow it closely is we make equipment to make display, so those displays have got increasingly complex, when you think of touch screens, so where the people use displays starting simply, TVs, iPads, PCs and then smaller form factors which are your cellphones, right.

So to a certain extent, the most complex and differentiated screens are the smallest ones, because your iPhone, your Samsung Galaxy the display is a pretty big differentiator for them and it’s not big surface area, so they can add differentiation with under the high cost, if you think of a TV market which is big screens, they are most cost sensitive, but it’s biggest surface area, so if you think us as equipment guys, we sell equipment in the biggest demand drivers, big surface areas TVs to a lesser extent it’s iPads and lower end, where we have the most differentiation probably in some of the technology changes are the cellphones, so if you look at demand for equipment this year for us, it’s growing significantly, I like the display business for us for two reasons, the economic model for us is good, when business and it’s a cyclical business like selling perhaps even more cyclical, when it cycles down, we have a very long cost structure.

So we basically don’t loose money in the downturn and in the upturn the incremental profit falls through pretty heavily, so it’s a good economic model, the second thing is our differentiation is pretty good, so our share is quite high, where we compete in display, so display is an attractive business for us, the next question is what are the opportunities, so if you look at technology, we’ve been doing the traditional displays now mostly for TVs, but what’s happening this year is the growth in surface area is going up significantly for one reason that’s going up about a inch and a half in terms of TV size pretty big jump and two the complexity they are going to more pixels is going up which is good for us, so overall surface area, I think it’s up in low double digits, 12% to 16% between more mix of big TVs and the average big TV getting bigger.

So that plays for us as equipment suppliers, the second question related to this which Tim asked us, what about technology changes are they going to go to LTPS which stands for low temperature polysilicon or they’re going to go to an alternative like [IGCO] which is a metal oxide, that is more of an technology trend you see for your cellphone maybe for your iPad a little while, where it’s not as constant, so that’s a pretty costly change, we can get a better display quality, but not as costly. So like punch line are one I like I display this, because it’s very attractive, due to the economic model and our differentiation. Our display business today is focused more on the large TV’s and with an increase in the screen size, more pixel density and when they go to this scaling of more pixels that will play for us too. Some of that changes in technology, which are LTPS and IZTO vest a little bit more in the smaller sub segment of the market today. You probably just heard more about display than you’re going to get for the rest of the year.

Tim M. Arcuri – Cowen & Co. LLC

Well, do you think, just on the topic, do you think that the combination of those factors as you sort size the business? Do you think the display can be $1 billion business next year?

Robert J. Halliday

I think it’s going to be a pretty good business, (inaudible) $1 billion business next year. I think the incremental drops or profits pretty I think the cash flow is pretty good. I think it is very high 100s of million of dollars but not just a billion.

Tim M. Arcuri – Cowen & Co. LLC

Any audience questions? Can we…

Robert J. Halliday

We have 37 minutes more to go, so we pay for questions in this period.

Tim M. Arcuri – Cowen & Co. LLC

I have plenty. Can we just go shift back to the wafer fabric equipment?

Robert J. Halliday

Sure.

Tim M. Arcuri – Cowen & Co. LLC

This is for – if there is a couple moments, if you look at run rate for wafer fabric equipment and you look at what the run rate was? You add up all the company revenue for Q1. Q1 run rate was about $23 billion, 5.3 billion times for your – you’re sort of in that $23 billion range maybe 23.5. And based on where all the companies guided Q2 to you’re at roughly $28 billion, $27.5 billion. And yet most companies are saying that wafer fabric equipment is going to be $28 billion, $29 billion, some even say $30 billion, I’m at $30.5 billion even this year. So that would imply that the back half of the year has to be quite a bit better than the front half of the year even to get to a $29 billion, $30 billion number. So can you just talk a little bit about what your wafer fabric equipment outlook is for the back half versus the front half maybe some of the waiting is it 60-40 back half front half and having begun to think about how big the market could be next year at all?

Robert J. Halliday

Sure, I think this is like we referenced on the call was 45-55 in terms of the halves, so heavier in the second half 55%. And then if you look at, I think you’re in the ballpark. We said flat to down 10%, last year it was about $30 billion number, so that would get you $27 billion to $30 billion. So we’re in the middle there somewhere. I think the news is incrementally a little bit more positive in the last month or so, so it could drift up a little bit. I think there is reasonable momentum into next year between technology commercial drivers.

In terms where we see the second half, as I said earlier, I kind of feel better about the fourth quarter and the third quarter for a couple of reasons the technology changes and DRAM and NAND that I talked about earlier. And then if you look at transitions within foundry a lot of the 28 nanometers spend is more in the first half of the year, 20 starts to kick in towards the second half of the end of the year. So I think you’ve got a third calendar quarter which is an okay quarter looking at strong first half and then in the fourth quarter it picks up some maybe.

I think if you look at high customer that I’ve touched on that earlier, I think you could see the DRAM and NAND a little bit stronger. I think foundry spreads out. So we see 55-45 second half stronger overall. Finally, we still feel is okay and the second half might be up even though the first half was strong when you spread out more. I think NAND and DRAM were both up in the second half, first half was pretty easy to compare I think you can see those changes that I saw at the end of the year. And then logic I think is probably an easy compare to the first half, so I think second half is okay.

Tim M. Arcuri - Cowen & Co. LLC.

Questions here in the audience.

Unidentified Analyst

(Question Inaudible)

Robert J. Halliday

That depends on customers, so customer is always trying to reuse equipment. There is two things that limit their ability to reuse equipment. One is technology changes and the second is that they just adding capacity. So if you look at a very logic manufacturer, there we use equipments pretty heavy for a couple of reasons. One then number of squarer miles or leaders of silicon, they produce incrementally there isn’t huge right there more of a technology change than a capacity change. Historically, the big capacity growers in terms of just area were tending to be memory. Now, you’ve had a big growth in foundry over the last couple of years. So if you look at new fabs, Greenfield fabs, wafer fabric, wafer start that historically has been memory in the foundry recently. So reuse of equipment has been pretty prevalent logic because the number of wafer starts to grow that much.

The second thing, so there wasn’t as much reuse percentage wise in memory and foundry because they were just growing at surface here. The second is technology changes. If you look at the technology changes, it’s really been standard change of types of equipment they use. If you look at Epi and ALD, those types of things are growing some, Epi has been very good for us. Epi stands for epitaxial growth, so it’s a slow process. We’re growing things on the surface first as the positive and that’s because of the greater precision you have. So the two things that limit reuse of equipment are scale of capacity additions, which is pretty strong particularly was memory now foundry and second technology changes. So if you think at fin fabs DAND, there is different sets of equipment being used there, so not just a straight plain or shrink. So I think that’s limiting some of the reuse.

Unidentified Analyst

(Question Inaudible)

Robert J. Halliday

Well, I’m not, I mean I’m not employed by Intel, so what I just read about is from the outside and some discussions that I can’t disclose everything, but I think Intel has with great justification long time consumables, sales and technology and the manufacturing leader, the new CEO is from that background. So I think they believe in a lot of people believe with them that their technology lead particularly around things like FinFET and how they do some of back in line is quite powerful. I think what they would argue is they can leverage that technology and manufacturing power to get a technology in a cost advantage on some of these areas, so I think that’s what we’re focused on.

Tim M. Arcuri – Cowen & Co. LLC.

Can you talk about maybe a little bit about R&D expense, R&D now is up to a record high, I think that the company is trying to take savings and cost and OpEx and Rob more or so G&A and trying to reallocate that to development. So, can you maybe break R&D down a bit for us, how much of it’s going into SSG? And is it really sort of a one-for-one where you’re taking every dollar you save in our COGS and in G&A and it’s actually going right into R&D or how much of that’s going into your pocket versus being reinvested into R&D?

Robert J. Halliday

Great question. So I mentioned earlier that the three things in focus were within Applied are focused on semi versus non-semi, the focus on product development versus non-product development, the focus on speed and we talk about the money resource allocation. I think we’re going to focus on profitable growth, so I think there is two people that have given us the big opportunity in the last year or two.

One I think, customers are giving us a big opportunity and so, they are giving us an opportunity where we might penetrate in some of the big camps we haven’t been as strong whether it’d be in inspection and we have to be able to execute. I think the other people that have given us a big opportunity quite honestly are people in the investor base, so I think for those two people for the customer base, we need to invest in the product development cycle, for the investors we have to invest in profitability, we have to get more profitable, right.

So, I think things I mentioned earlier whether it’s supply chain or service business or organization structures and maybe down the road little bit, I can work on the tax rate too, those things are things that we can use to fund growth or profitability.

I think we have to do some incremental funding in R&D to drive the opportunity that customers have given us to gain share and I think for the investors who have given us share, we have to drive profitability.

So, we’re going to be talking at our Analyst Day which is at SEMICON, July 8, in much more detail how we’re going to drive both, but we’re not doing our straight anything we saved and overhead or manufacture goes completely in R&D the percentages have switched and the focus is R&D, but the other big focus is driving higher levels of profitability in today’s revenue levels.

I don’t want to just sell to you that we’ll be more profitable in the up turn, we have to be more profitable at all levels of operations.

Tim M. Arcuri – Cowen & Co. LLC.

And can you talk a little bit about 450 millimeter as it plays into that theme, you said that, you’re going to be spending around $100 million and it sounds like it’s not going to go up very much this year, which is little bit of a surprise to me, given the fact that well there is not a great ROI to invest in 450, there is a big push from at least one of your big customers should be investing in 450.

So, maybe talk a little bit about, how much of a byte out of the potential profitability of the company 450 investment could take the next year or two or sort of where that R&D number has to go from a 100 is that have to go to $200 million or $300 million, or is a 100 all, we should expect you to be investing in R&D and also just talk generally about 450 because it seems to be a very puzzling problem from your point of view because there is probably only going to be 4, maybe 5, 450 millimeter fabs ever built, so you know on the surface is not something that you’re probably very excited about putting money into it. So maybe just talk a little bit about that.

Robert J. Halliday

Yeah, it’s a good question, I think there is three observations, I will make on 450, one we are supporting the 450 millimeter ramp, but we’re trying to do it very cost effectively, so that’s second observation, third the one that is part of the reason you’re disconnected, is we have gross levels of R&D spend of 450 and some of that, we get some credits from other sources where these consortiums or suppliers, so our gross spend is probably up some but our net spend of 100s above constant in the year, what we’re trying to do is do 450 very cost effectively, and support the ramp and get some credits, wherever possible, I think the other thing that’s relevant is not just the wafer size, but what kind of devices around that 450 millimeter wafer, we do have highly differentiated products there. So 450 might be under 7-nanometer devices.

So what time there, so if you look at what a 7-nanometer device on that 450 millimeter wafer that plays pretty well to us whether it’s different types of deposition process, metals things like that. So those things play pretty well for us in terms of spending next year we haven’t forecast 450 spend for 2014, we’d like to do it very cost effectively because the ROI is out of few years, but we are supporting it, we’re getting credit where we can and we’re focused on higher differentiation in terms of what devices are on the wafer.

Tim M. Arcuri - Cowen & Co. LLC.

Question at the back?

Unidentified Analyst

(Question Inaudible)

Robert J. Halliday

Yeah I think we talked about on the call couple of weeks ago that in inspection which we call BDC we had our second biggest orders quarter ever last quarter and we had I think our biggest Brightfield orders ever I think in things like Brightfield it works pretty intriguing, if you look at the number of different steps or applications we can do there, it looks more optimistic there, I would say that the inspection customers are giving us an opportunity, and I think the product covers some of that space pretty well.

I think on edge customers are giving us an opportunity, I think you’re talking more about [DTOR] type stuff there where the opportunity is if we can make the tool work to their specifications, we have a real opportunity.

I think the inspection opportunity is little ahead of the hedge opportunity in terms of the product, but both of those we’re getting more leading edge customers support for qualification and potential wins than we had in the past, but I put inspection a little ahead of action in terms of maturity of the product for those wins.

Unidentified Analyst

(Question Inaudible)

Robert J. Halliday

Yeah I’m sorry, I do in HyperSpace, SemiCap, so if you want to get into making sales there is several steps on the process you make sales when you get volume, but the first step is you got to get [PTR] which is production tool of record or process tool of record and before that you could design tool of record, so the sequence is you get design tool of record wins which on big volume, then you get production tool of record and then you get production volumes that’s a continuum, we’re far that down that continuum on inspection that we are on that (inaudible).

Unidentified Analyst

(Question Inaudible).

Robert J. Halliday

Well, what we’re doing is doing things like improving our tool performance around particles and things like that which are iterative design changes, it’s execution things, it’s what you use for liners stuff like that, so if we can solve those things and I think we have a real opportunity. We have new product we’ve introduced to [patch] also.

Tim M. Arcuri – Cowen & Co. LLC.

Can you talk about just about that relative to your inspection market opportunity, is that more on the foundry logic side or more on the memory side?

Robert J. Halliday

Yeah, right now it’s more on foundry logic, because of the requirements and the other thing is they do more than buying right now, I think it’s more in foundry logic, if you look at DRAM for instance, DRAM has got the (inaudible) appropriate as logic like, but a couple of notes behind on the foundry logic, so the requirements for inspection out is demanding there the more demanding the requirement is tend to be foundry logic and I’d say that’s where our leading opportunity is, now if you do well there and memory tends to follow them and I think you have an opportunity there and so, I think on etch we make have an opportunity in NAND which is interesting.

Tim M. Arcuri – Cowen & Co. LLC.

So, if you can compare and contrast there is a lot of investors that have that I have been talking to the last couple weeks since, everyone had earnings and gave guidance and your primary competitor in the inspection space gave fairly cautious guidance for June, I think there is a lot of factors to that. But, people are drawing the conclusion that you are already gaining share in Brightfield given that they had very weak guidance and you had your best Brightfield bookings score ever. So do you think that there is already share shifting in Brightfield to Applied?

Robert J. Halliday

So what we’ve said publicly and just to connect the dots, our biggest quarter ever in Brightfield, second biggest overall inspection, we’ve also said that we feel optimistic about share particularly in inspection of shares, we haven’t given numbers, but I think it’s a real opportunity.

Tim M. Arcuri – Cowen & Co. LLC.

Maybe, can we shift our focus a little to the balance sheet and if you look at the cash balance of the company it has come down quite a bit, there was a lot of cash used in the Varian deal, you have about $1.5 billion give or take right now in cash. Certainly, you’re committed to the dividend; buybacks have come down quite a bit. You were buying back $300 to $500 million a quarter previously and now you’re sort of more like a $100 million a quarter or even a bit less. So, how do you think about, is there a magic cash balance, which you would like to build the cash backup to a certain level, before you increase the dividend or you get more aggressive on the buyback. How do you think about what the optimal cash level of the company is?

Robert J. Halliday

Sure a couple of things. One, we actually have a little more cash that was down long-term investments or investments more than one year in period. We got about $1.1 billion so you sort of go 1.5 to 1.8 upper in cash type stuff and then overall to one, our target historically from these three months right. It tends to be around $3 billion number to keep a credit rating, which is a good thing to do, in terms of returning money to investors, I’m a big believer in that, I mean you guys own the company, I don’t own the company, so if you go look at Varian, we are pretty aggressive to trying to get returns to investors, we’ve bought back $750 million of our own stock and then when the, we were purchased by Applied we had several 100 million, we hadn’t done too much during the last six months of the purchase by Applied, but we generated a lot of cash, if you look at the history of Varian down cycle never lost, generally a lot of cash on the up cycle how we do it, big time focus on reducing fix cost and optimizing the financial model.

I think my focus would be on a, generating more cash downturn and upturn and then return it to investors, how we choose to return its up to you guys right, its your cash, we raised the dividend last quarter by another penny, our buybacks are opportunistic in the last calendar quarter, I think our capital allocation philosophy has not changed, we didn’t buy quite as much last quarter, but we are committed to getting cash back to investors, there is [tangently] inside base ball, one other thing we have to manage is just our offshore versus onshore cash balances, we’ll work on that, we are driving down our tax rate partly with an offshore strategy. So we are very committed to returning cash to investors, I wouldn’t read too much into quarterly buybacks, I tend to be somewhat opportunistic, but we are committed.

Unidentified Analyst

So is there some, do you feel like you want to build the cash back up more from the current level before you begin to buyback more or increase a dividend or you are pretty happy with where overall cash is right now?

Robert J. Halliday

Where we just increased the dividend the last month I think, so we did that, so we do that sort of annually right and the next thing what we are going to do on the buyback and the cash, I think we would probably like to get the cash drift up a little bit more probably because we got offshore and onshore cash right, so some that might be drifting up offshore where it’s hard to use that the dividends and buyback. I do think that’s a good thing because it’s driving down our overall tax rate and increasing our profitability. If we have a choose to bring that cash and buyback stock dividends we can’t, but I think it would be wise to be opportunistic on that. So I think the cash went drift up a little bit, but I think the buyback that we’d continue to buybacks and trying to be opportunistic on it.

Tim M. Arcuri – Cowen & Co. LLC

Can you remind us how much of the cash is offshore?

Robert J. Halliday

I don’t remember (inaudible) I think it’s less than half and it might be a third of…

Tim M. Arcuri – Cowen & Co. LLC

It’s actually…

Robert J. Halliday

I don’t remember precise number…

Tim M. Arcuri – Cowen & Co. LLC

Okay, okay. Can you talk a bit about tax I know certain of your peers have certainly undergone some fairly significant restructurings of their tax structure. So what can you do on tax, your tax rates among the highest of your peers, so what sort of strategies do you think if you can employ in tax and over the longer-term where should we expect your tax rate to go?

Robert J. Halliday

Yeah, so the opportunity is how much of your substance is overseas, so that those revenue and profit generating opportunities are overseas and you use the local tax rate. So Applied has got some pretty significant substance overseas because one of our biggest manufacturing facilities is in Singapore and a lot of our senior manufacturing people are there. So that gives us a strong argument for economic substance for and we’re discussing this in the U.S. a little bit with the foreign governments.

The second thing you need to do is how you transact stuff and so we’re increasingly doing transactions overseas, right. So I think that the economic substance supports our position that we will have a greater mix of low tax rate earnings than U.S. tax rate earns. And we setup a couple of years ago some of the transfer of intellectual property overseas and funding of R&D from the overseas operation. So the structure is largely in place with some incremental and progress to be made that would support some reduction of tax rate. Now what you have to do is have this discussion with the IRS who is trying to take in more conservative view of that, I think our economic substance bodes pretty well for us in terms of favorable outcome of that debate, but we have to go through that discussion phase before we walk in our way, but I think I would be hopeful that our rate could go down.

Unidentified Analyst

And do you think we are talking about couple of 100 basis points reduction over the next couple of years, if not going to be…

Robert J. Halliday

If we are successful in the discussion, yeah I would like to get it down similar numbers to that.

Tim M. Arcuri – Cowen & Co. LLC.

Any question.

Unidentified Analyst

(Question Inaudible).

Robert J. Halliday

Sure, I like the service business a lot, so I would like to think of the economic environment [we’re in], right. Sale, comparing to trends in 1990s to the 2000 teens whatever in right now, the growth at equipment as you all noted over and over it was probably higher in the 90s right than it is today, but install base was lower, there were more customers, less customer concentration than there is today. So, if you think of industry dynamics like that, (inaudible) you got a big install base, I’ll give you some data for interest you, so if you sell a big tool like an edge tool, you might sell that tool for $4 million, it’s all within the range, but pick a number 4 million, there is a reasonably heavy R&D investments and we have a next generation tools, if you think about the service business and something like that it could be as much as 10% a year, okay, and those tools could last 10 years or more and the gross margin on those products is pretty attractive and the operating margin is very attractive, because there is a lot of R&D expense, distribution expense.

So if you think of the industry dynamics optimizing that service business is very attractive, so you guys are all really smart, so if you think of Applied Materials you think of us as kind of a complex company try to figures out. So, if you want to evolve us, we’re stack of different products and a stack of different risks. So you start to think of risk adjusted returns, if I want to go into a new market, new technology that’s five years out, I got to put a big discount right on that thing, right, I got a big number, right.

But if you look at my service business, we’re virtually no technology risk, it’s mostly execution commercial risk, that’s a low discount rates, you guys have really got this stuff, so you think about optimizing that business in this maturity of the industry, I like that business a lot, okay, so it’s not (inaudible) guys, but if you think of generating cash, generating profit, funding R&D it’s very attractive, the tools at your disposal, so in that stack of products in the service business there is really three or four different products, you got to look at the business models, I got a spare parts business, I got a services business and then I got a 200 millimeter used tool business, each of those are very interesting business model.

In the spare parts business, I have say three levels of intellectual property, I got high IP parts which is like picking your car, your car might have high IP around a new engine, right, you got to get it from General Motors or Toyota whoever, you might have a large system which you could get from General Motors, you could get from (inaudible) right, we could get tires and oil changes. So all of those have very attractive incremental profits, but different gross margins stacks, if I can optimize my profitability in commercial strategy for each of those the spare parts, I can significantly increase the operating margin, operating profit and very good risk adjusted returns.

So I think of that as a very interesting business with three different types of business models, that’s just the parts business, so then if you go to the 200 millimeter business, that’s [refurbing] our own tools, so you would say well that’s kind of interesting that’s, but think of it 200 millimeter businesses, is like running a used car lot with marketing people right, you are saying why you want to low your cost [refurb] your tools. So if you are very competitive on the 200 millimeter marketing data, really want marketing people who buys 200 millimeter tools, its people we don’t deal with a 300 millimeter, so just power devices, analog devices, some CIS. So if you get a little bit marketing expertise and how they use those tools like PVD deposition stuff like that, they use different types of devices, you can optimize your market share and when they buy 300 millimeter tools you have a very good opportunity, so that’s another stack of profitability.

And then if you think of services, you have a very interesting model where you can help on them yield; you could help them on the software, if you think Gary came from KLA that’s a very interesting business. So this serves business which folks don’t look at as super sexy, I think as a very interesting business, its about a $2.2 billion business for us, the incremental risk adjusted returns are very attractive to return to people in this room or to fund the product development cycle, if we can optimize the service business, I can return profit to you, fund R&D, gain share with that funding, get more service business and then you get into a right just circle where this a very attractive model, just for (inaudible) service business, you now know a lot about display and service

Tim M. Arcuri - Cowen & Co. LLC.

Well just on that point, maybe we can talk a little bit about as you sort of look and Applied in your and you are looking where the company could go in the next two to three years. There is a couple of pools hat you don’t play in, everyone focuses on the wafer fab equipment pool and if you just look at wafer fab equipment, everyone shows the same charge that it sort of peaks out at $30 to $33 billion every cycle whether it was 2000 or 2007 or this year although I think next year is going to be quite a bit higher than that, but that pool hasn’t really grown very much, but there are other pools that are growing, that is the, there is the unit pool you look at materials that’s actually grown quite a bit, you look at the chip company cumulative R&D pool has growing a lot, you look at design costs are actually going up a lot, some of these [EDA] companies are playing in growing pools.

So as you think about where the company can go, there is the service opportunity that you just highlighted, but are there other pools that maybe if you think outside the box that you can make an acquisition to get into the software business for example, and you could maybe plan in that development pool are there other ways to sort of think about what Applied can be the next say two, three, five years?

Robert J. Halliday

Yeah so, that’s another really good question. So, I think in outlines right, so when we connect the dots for a couple of questions you guys asked me today, what are our opportunities, what are sort of our risk adjust opportunities and then how do you realize them? So what I said to you earlier in the day is in SemiCap for us to succeed we need to do three things well. One, we have to know what the customers want, their high value problems, we want to know their problems not their solutions, because if they tell us the solutions at a problem it’s a comodatized solution. So that’s technical market applying there is knowing the market. So knowing the market is number one to succeed, number two is building good engineered products, differentiated products; and three is funding which I come in right.

So that how we succeed in SemiCap. So now think of Applied as a company we are really at three dimensional model, right, one dimension on I’d say the Y axis is products and technologies. On the X axis is markets and the third axis I call is what we do. Okay, we build equipment we are materials [guidance] today, right.

So if you think of this X, Y, axis and you think of every axis has got two states a home state and a new state right. So in technology I can make today’s products like suppose I am making a PVD tool, where I can may believe I got in the list of new products same market right or an evolution front. The second one is, I go to new markets, I could go take my technology from semi to solar or make it up medical right that’s the new state.

Or third, I could take equipment or I could materials, right, in my mind when you think a risk adjusted return those three axis is not the same ways, suppose the home axis for all of those is one. So it’s a three dimensional axis 111, if you go to new market that’s the highest risk because why don’t we miss, we don’t know the customers, we don’t know the markets. So I want to know that customer and market really well, I know the semi market really well, I know those customers very well.

So the lowest risk for me is probably taking some new technologies in an adjunct into the current market, so market share gains where I know the market is the battle over the next three years. The second battle ground in my mind this is intellectual thinking is new product like materials into that market that’s an interesting concept, but we’ve got to work on it. Because I kind of know the customers, but I would sell that product in that axis, the Z axis it is a bigger difference than incremental products into that market, but it’s not as big as the whole new market going to solar or medical or something right.

So that’s the second in my mind sequential opportunity, the other reason why that’s interesting is, if you think there’s a big changes in semi market, what do we do? We sell equipment, we sell process and we sell support, process more and more is a materials, it’s chemistry right which plays for us, so if you think the materials that sort of a chemistry thing play, if you think have (inaudible) deposition is chemistry so materials plays kind of well for some of these changes and expertise in chemistry are big deal right.

So what do I like? I like winning the next three years the battle in SemiCap because staying in the current market, current product, lowest risk profile for me on that Y axis, X axis going into new markets, I want to get marketing guys who know that business before I go in there and make build the wrong products materials is kind of interesting so now you go what are our opportunities gain share current, gain new things in current market is the next risk adjusted so if you think when I went through a little while ago we’re stack of complex products, risk adjusted returns where I do business now I really like optimizing my cash flow in the service businesses which is one of my products today low risk commercialized execution.

My second risk adjusted return is today’s customer, share gains of equipment, my third one might be chemistry material same customer in different type of product, my fourth one down the road is figured out new markets for current technology, I don’t want to go there and telling all the market, right, so if you think of opportunities today three years, five years risk adjusted returns, lowering the risk of execution that’s all I think about it right, stacking all the products, the risk adjusted returns and how to execute it, long-winded answer again but X, Y axis like three dimensions, [not worse itself]

Tim M. Arcuri – Cowen & Co. LLC.

That was great, the question here in the back.

Unidentified Analyst

(Question Inaudible)

Robert J. Halliday

Yeah, I think in the SemiCap we got to get more competitive in my opinion and actually I think we’re working on that hard just see that’s where our investment is and that’s where our strength in the field organization. We do three things the hardware process support in the field; we’re beefing up both those, so I think we will be more competitive there. I think on the material stuff it’s an idea, right, I mean I haven’t, we haven’t done too much and I think it’s really interesting idea, I think the service business lot of focus on how to maintain gain share there, how to optimize the profitability, I think that’s largely within our domain to execute I think we will do that, I think you guys, think a lot about equipment share, I think a lot of equipment share, I also think about service share, because if you think of incremental profit which you guys like, that profit is pretty good right, pretty good.

Tim M. Arcuri – Cowen & Co. LLC.

So, about how much just to sort of size that service opportunity service grew from $1.5 billion up to it actually peaking about $2.5 billion now it’s back down to about $2.2 billion. Just from her what sort of incremental revenue opportunity if things and service went the way that you think that they could go and you generate a lot of incremental revenue from the business. Are we talking about $300 million, $400 million that you think you could grow that business even if units been really grow very much just sort of just getting smarter about how you execute in that business, is that the right way to think about the business could grow call it 10%, 15% on top of where it is today.

Robert J. Halliday

Yeah.

Unidentified Analyst

Just by doing things…

Robert J. Halliday

Yeah. And I think this might drop through, there is no other expenses right, I mean I think you can grow, I think you can grow that business in the next few year, those types of numbers think about it, we would ship, we would ship on about 1,000 tools a year roughly or maybe more, I guess more lets put in Varian and everything, so we ship over a 1,000 tools a year but tam for that that’s pretty good, right and high profitability, the thing is just focused on really to nail it, right, so I think it’s pretty good opportunity.

Tim M. Arcuri – Cowen & Co. LLC

Any more questions from the audience?

Unidentified Analyst

(Question Inaudible)

Robert J. Halliday

Yeah, Gary Dickerson our President, he use to be President of KLA, he’s there for like 18 years I think. And it’s an area that he likes; there is just couple of reasons why it’s good. One, you would get some profit and revenue out of it. The second one as you gets title with the customers. So I think what we’re doing now is increasing our capacity in the field technical people, very much, so that’s we’re investing with that low some of the product on the guys and that’s like to increase our capacity for our it’s an area of focus, it’s a little hard for me to predict how fast and take off. I saw somebody stretched...

Tim M. Arcuri – Cowen & Co. LLC

One more question from the audience, maybe we have time for one more question. Well maybe we should end there the time is just about out. But very, very happy to had you here Bob, thank you for [attending].

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