Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Applied Materials, Inc. (NASDAQ:AMAT)

F3Q09 Earnings Call

August 11, 2009 4:30 pm ET

Executives

Michael Sullivan – Vice President of Investor Relations

Michael R. Splinter – Chairman and Chief Executive Officer

George S. Davis – Chief Financial Officer

Joseph J. Sweeney – General Counsel and Corporate Secretary

Analysts

James Covello - Goldman Sachs

Stephen Chin - UBS

Satya Kumar - Credit Suisse

Steve O'Rourke - Deutsche Bank Securities

C. J. Muse - Barclays Capital

Timothy Arcuri - Citi

Atif Malik - Morgan Stanley

Krish Sankar – BAS/MIL

Patrick Ho - Stifel Nicolaus & Company Inc.

Gary Hsueh - Oppenheimer & Co.

Christopher Blansett - J.P. Morgan

Mehdi Hosseini - FBR Capital Markets

Peter Wright – Global Crown Research

Edwin Mok - Needham & Company

Mahesh Sangareria - RBC Capital Markets

Daniel Berenbaum - Auriga USA

Operator

Welcome to the Applied Materials fiscal 2009 third quarter conference call. (Operator Instructions)

Please note that today’s call will contain forward-looking statements which are all statements other than those of historical fact including statements regarding the economic and industry conditions, as well as Applied’s business outlook, strategic position, operating efficiencies, cost reductions, products, growth opportunities and Q4 targets.

All forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. Information concerning these risk factors is contained in today’s earnings release and in the company’s filings with the SEC. Forward-looking statements are based on information as of August 11, 2009 and the company assumes no obligation to update such statements.

Today’s call also contains non-GAAP financial measures. Reconciliations of the non-GAAP measures to GAAP measures are contained in today’s earnings release or in our financial highlight slides, which are on the investor page of our website at www.appliedmaterials.com.

I would now like to turn the conference over to Michael Sullivan, Vice President of Investor Relations. Please go ahead sir.

Michael Sullivan

Thank you and good afternoon and welcome to our call. Joining me today are Mike Splinter, our Chairman and CEO; George Davis our Chief Financial Officer and Joe Sweeney our General Counsel and Corporate Secretary.

Today we will discuss the results for our third quarter of fiscal 2009 which ended on July 26. Our earnings release was issued at 1:05 Pacific Time today and you can find a copy of it on Business Wire and on our website at appliedmaterials.com.

Mike Splinter will lead off the call with comments on the market environment and our company’s strategies. George will follow with a discussion of our financial performance for the third quarter and our expectations for the fourth quarter. After these remarks from Mike and George, we will open the call for questions.

Before we begin I have a quick calendar announcement. Applied will attend the PVSEC conference in Hamburg, Germany and will make several detailed presentations about its solar businesses on September 21st. The presentations are scheduled from about 4:00 p.m. Central European Time and will be webcast live for those of you who are interested but not travelling to the conference. We will be sure to provide you with further details in the coming weeks.

With that I would like to turn the call over to Mike Splinter.

Michael Splinter

Thanks Mike and welcome everyone to the call. Last quarter we outlined encouraging signs in the global economy and in our customers’ end markets. Today there are more indications that demand is growing and for the first time in a long while we see positive trends in our business. Economic decline in the U.S., Europe and Japan appears to be moderating. In China GDP is now growing by about 8% with government stimulus driving increased demand for semiconductors, flat panel displays and solar cells.

This quarter our financial results improved in almost every category and we are seeing order growth following the steep declines of the first half of our fiscal year. We now believe the pickup in wafer fab equipment will be followed by a ramp of display orders over the next few quarters. We also expect solar fundamentals to improve over the next 12 months and we see potential for a larger upturn in wafer fab equipment next year.

While encouraged, we are clearly building off of a small base and it is too soon to conclude that a broad based recovery is at hand. We are maintaining our cost reduction programs and preserving our financial strength while investing to ensure our position as the number one equipment supplier to the semiconductor, display and solar PV industries.

Moreover, we believe this is the right time to consider the lasting changes the unprecedented downturn has made in the industries we serve. Our long range strategic planning is now underway and our focus is to align our products, cost structure and capabilities with market opportunities to deliver outstanding profitability. We expect to complete our analysis over the next few months and incorporate these changes in our operating plan for fiscal 2010.

Next I will comment more specifically on our industries and business segments. In semiconductors we were encouraged to see IC demand improve over 15% in revenue and over 25% in units in the second calendar quarter. Across the industry average utilization improved to about 75%. Foundries benefited from a doubling in wafer shipments.

DRAM experienced stronger ASP’s on a bit shipment growth of about 9% year-over-year. We believe that by the end of 2010 the DRAM industry will need to transition fully to DDR3 and this will create a served market opportunity of about $2 billion for Applied Materials. Nan bit growth was about 36% year-over-year driven primarily by Smart Phones and portable media players. For calendar 2009 Applied has raised its wafer fab equipment spending estimate from a previous range of $8-11 billion to a new range of $10-12 billion.

Our silicon systems group’s performance exceeded expectations. While calendar 2009 is clearly a year of depressed wafer fab equipment spending, we do expect to gain share virtually across the board. Positive trends for us include the adoption of emersion lithography, advanced transistors and the memory conversion to copper. Leading logic customers are doubling the number of selected [epi] steps and moving to gate last structures. While emersion lithography users need more advanced mask and wafer inspection techniques.

During the quarter we saw investments by leading edge foundries that favor our CVD and PVD solutions increasing our share leadership and process extensibility to the 3X node. In etch we expect to hold share in 2009 and based on our customer footprint we have achieved repeat buys this quarter in double patterning etch.

In applied global services our silicon service and spares business was up modestly. While factory utilization rates were higher we have seen customer consolidation and a significant amount of 200 mm capacity being taken offline. As a result, wafer starts among our semiconductor customers are down about 30% from a year ago which is limiting growth. Over the next few quarters we expect moderate improvement in applied service opportunity driven primarily by increased wafer starts.

In display a number of leading edge customers are now operating fabs above 90% utilization and the industry’s outlook for profitability has improved. Panel ASPs grew about 15% from their trough in the spring of this year. Global LCD TV unit demand is expected to increase over 20% in 2009 with growth driven primarily in China and the U.S. During the quarter we saw the bulk of investment coming from Chinese panel makers at Gen 6 which is suited for 32” TV’s. In the second half of calendar 2009 we expect the next phase of the Gen 8.5 build out to begin. In this cycle we expect our pivot PVD share to grow from single digits at one leading customer to more than 20 points at three or more customers.

Turning to solar, strength in the Chinese market, feed in tariff support in Italy, Greece and France and modest growth in the U.S. are offsetting some of the cut backs in Spain. From today’s level we expect annual PV solar installations to grow at a 30% compound rate with China poised to grow at twice the rate of the industry. In 2010 we estimate more than 4 gigawatts of capacity will be added.

In crystalline silicon, polysilicon prices are flattening and module prices are falling. In China and Taiwan utilization at major manufacturers rose to the 80-100% range. In this environment, customers need to improve module efficiency, reduce materials usage and achieve greater economies of scale. Applied’s products are providing that differentiation.

As a result of the momentum of our crystalline silicon solar equipment has been stronger than anticipated. Our new MaxEdge wafering system achieved first sign off at a major Chinese customer and we are in the process of shipping 55 wafering systems to another major customer in the region.

In thin film we have talked about 2009 being a year to improve operational efficiency as SunFab sites move up the learning curve. We are now seeing factory start ups in half the original time and are rolling significant cost material reductions out to customers. We have demonstrated 8.6% stable modules at tandem junction customers and achieved 10% stable modules in the lab. During the quarter we achieved factory sign off at a sixth SunFab customer whose modules are targeted for European utilities.

Tandem junction SunFab panels are now entering the market with over a megawatt of modules already installed. While new SunFab projects are still being held back by project financing and market obstacles, we are engaged with a number of new manufacturers and with single junction customers who are exploring the timing of tandem junction upgrades. One upside development in EES this quarter was an order to supply transparent conductive oxide systems to a major glass supplier to the solar industry.

Before I hand the call over to George I would like to observe that Applied delivered a solid third quarter including a number of key accomplishments in each of our businesses. As a company we have done a good job navigating this economic downturn and I would like to thank all of our employees for staying focused and doing their part to support our customers and exceed our goals.

Now let me pass the call on to George who will share our financial results and targets. George?

George Davis

Thank you Mike. Good afternoon to everyone on the call today. Applied Material’s performance for the third quarter exceeded our targets for revenue and earnings per share. Directionally the quarter unfolded much as we expected with order and revenue growth up off the bottom in our semiconductor and services businesses and revenue declines in display and solar.

Semiconductor equipment was the biggest contributor to our performance as we experience a strong surge in revenue and orders during the second half of the quarter. While overall sales for Applied remained well below historical levels, our cost initiatives and other efficiency actions led to earnings break even on a non-GAAP basis and positive

cash from operations of $194 million.

Now we will go into some more detail on our results. For the quarter we reported a GAAP loss of $55 million or $0.04 per share. The $0.15 improvement from our Q2 reflecting higher revenue and gross margins along with lower charges from impairments, restructuring and severance and the absence of bad debt provisions.

Gross margin improved 13 points to 29% which shows the margin leverage associated with SSG revenue growth. Factory absorption improved on higher units and we had lower inventory write offs. Operating expenses were lower by $47 million as restructuring and other charges taken in Q2 rolled off this quarter and we generated additional savings from our cost reduction program announced in November.

Year-over-year operating expenses excluding restructuring, M&A charges and equity expensing were down by $107 million reflecting both permanent and temporary cost savings activities.

Let me take a moment to summarize the results against our cost initiatives. Last November we set a goal to lower our non-GAAP earnings breakeven point to $1.2 billion in quarterly revenue and our operating cash break even to $1 billion. Clearly we operated ahead of those goals in Q3. We raised our cost saving objective last quarter to $460 million and that will be fully reflected in our Q4 2009 run rate.

Our early and significant actions in cost management have allowed us to maintain R&D investments in our key markets and fund a major expansion into the energy space while delivering strong financial performance during a difficult time. We continue to look at how we can architect the company to adapt to changes in our major end markets and to reduce or eliminate our reliance on temporary cost measures such as shut downs, bonus eliminations and other pay cuts.

Turning to the balance sheet, our cash and investments balance of $3.1 billion was up quarter-over-quarter by $64 million. We paid dividends of $80 million and had capital spending of $60 million. Cash from operations was 17% of revenue while investing nearly a quarter of a billion dollars or 21% of revenue on R&D. Strict working capital discipline was a key factor in this performance. Day sales outstanding improved from 82 days to 68 and we lowered inventory by $150 million most notably in SSG and AGS. I would like to thank employees throughout our company for their dedication to working capital management.

Our backlog at quarter end was $3 billion down from $3.2 billion at the end of Q2. 36% of the backlog is related to our EES business and the remainder is about evenly split between silicon, services and display. Backlog adjustments totaled $141 million and included $146 million in cancellations and $51 million of de-bookings partially offset by currency and other adjustments of $55 million. The cancellations were primarily related to semiconductor memory and foundry customers with the biggest impact from memory customers changing their investment strategy to push orders for more advanced nodes in response to competitive requirements.

The de-bookings primarily reflect AGS and EES orders that have not been cancelled but are now expected to be realized outside of our 12-month bookings window.

Now I would like to review our segment results. Silicon systems had a very strong quarter on several fronts including orders and revenue growth and outstanding working capital management in a turn’s environment. Orders of $542 million more than doubled from Q2. Orders by semiconductor type can be found in our earnings release but nearly 70% came from foundry and DRAM customers.

SSG revenue was $498 million, up 91% sequentially and well ahead of our expectations of flat to up 40%. SSG’s manufacturing team was able to deliver approximately 60% of the revenue in the quarter on a turn’s basis. The last month of the fiscal quarter was particularly strong for SSG both in orders and revenue, a month that competitors will reflect in their September quarter results.

SSG’s operating profits were $56 million or 11% of sales which demonstrates the benefit of our operational changes and cost reduction actions. Looking forward, leading customers are continuing to rely on short-cycle ordering which results in limited visibility beyond the current quarter. Customer concentration in orders and revenue remains very high and a change in plans by any one of the leading customers could have a material impact on any given quarter.

In AGS orders were up 26% sequentially to $298 million reflecting higher factor utilization and spares demand. Revenue of $343 million was up 7% sequentially due primarily to higher silicon spares revenue which was offset by lower revenue from other services. Operating profit was $24 million or 7% of sales.

Display orders increased to $96 million after bottoming at $13 million in Q2. We see display customers beginning to accelerate their Gen 8.5 investments in response to strong consumer demand.

Revenue decreased as expected with sales of $69 million including our first Gen 10 system revenue. While revenue for display was the lowest since the second quarter of fiscal 2002, our highly outsourced operational model for that business resulted in only a modest loss.

In EES orders of $135 million were down 4% from Q2 as solar customers are still faced with difficult market conditions and a tight credit environment. We are seeing strong demand for our new wafering products particularly from China. EES revenue was down 37% from Q2 to $224 million. Crystalline silicon revenue declined in line with the industry while SunFab revenue reflected our sixth customer sign off.

EES revenue over the first three quarters of fiscal 2009 is already more than $50 million above total EES revenue for fiscal 2008 despite challenges in the end markets. EES had an operating loss of $53 million or 24% of sales. Excluding M&A charges, the crystalline silicon business was operating margin positive for Q3 and has been for every quarter of this year. Our latest SunFab factory sign off reflected cycle time and other learning curve performance improvements.

As a reminder, the EES operating loss includes R&D investments in solid state lighting and other energy and environment opportunities that represent both near-term and exploratory investments in broadening our growth portfolio in this space.

Now let me talk about our expectations for fiscal Q4. The economic and industry trends are generally more favorable than last quarter. Our customers remain cautious and are focused on near-term opportunities. Visibility beyond one to two months remains limited. We expect that a number of factors may cause customers to change their investment plans.

In particular, consumer behavior in the back to school and holiday selling seasons and changes in the global economic outlook and we are seeing an unusually high concentration of business in a small number of customers. As a result of all these factors, our target ranges will remain somewhat wide. While we are not giving a company target for orders we do expect growth in orders quarter-over-quarter driven primarily by higher display and EES orders.

We expect revenue to be up 10-20% in our fourth quarter led by display, SSG and AGS. We expect earnings to return to profitability in our fiscal Q4 and our EPS target to be within a range of break even to a positive $0.04 per share.

Now Mike let’s open the call for questions.

Michael Sullivan

Thanks George. To help us reach as many of you as we can please ask just one question and no more than one brief follow-up. Operator, let’s begin.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of James Covello - Goldman Sachs.

James Covello - Goldman Sachs

Specific to the semi equipment business around the order composition. I know you are not giving specific order guidance but in terms of the number of customers for calendar Q3 and calendar Q4 do you see that broadening out at all in semi equipment or do you see the high level of concentration you saw in calendar Q2?

George Davis

We still see a very concentrated outlook. I think we will certainly be less foundry concentrated. Q3 was clearly dominated by foundry activity. We will see a few new players coming in. We expect Logic, for instance, to be a little bit stronger in Q4. In general it is still very concentrated.

James Covello - Goldman Sachs

Given that some customers are now off the [snide] so to speak, what do you think it would take to get the other customers?

Michael Splinter

I think the big thing is what is going to drive DRAM bit growth. I think we will see some flash start investment start to come back and we have already seen some foundry come back. As George mentioned, logic should perk up a little bit but I think the big thing is what is really going to drive DRAM bit growth. We can see DDR3 conversion as I mentioned in my prepared remarks as a big push but primarily that is a technology push as opposed to a capacity push.

Operator

The next question comes from the line of Stephen Chin – UBS.

Stephen Chin - UBS

A follow-up question on the display group orders if we look back we see that peak in the display orders in the prior cycle were about $500 million. Do you think we could see a higher peak in this display cycle since you have this [inaudible] tool? My follow-up question would be have you put systems in place that would allow display’s operating margin to be higher than the prior cycles and margins?

Michael Splinter

Maybe I can answer the first part of the question and George can answer the second part. I think the order pattern over the next few quarters is a little bit hard to predict but certainly we are gaining share with pivot. So if you integrate over the cycle we should do better assuming that overall investment let’s say over the next 12 months reaches $12 billion or so which was the total flat panel display capital investment during the last cycle.

George Davis

On operating margin I think there is no reason why we can’t get back to the more normalized 25-35% range that display operates in. On orders in general we were particularly peaky and lumpy in the last cycle. As Mike said it is going to be hard to know whether we see it that way and whether revenue is going to be as concentrated as well. If we get to a basic run rate of recovery we should see strong operating margins out of display.

Michael Splinter

One of the things we are seeing is we are really seeing a conversion of the Chinese TV market to flat panels, basically almost doubling the flat panel purchases in China and probably the bigger surprise there is the U.S. is up over 25% in flat panel purchases this year.

Operator

The next question comes from the line of Satya Kumar - Credit Suisse.

Satya Kumar - Credit Suisse

If CapEx were to get back to the prior peak and AMAT’s revenues in the peak between $6-7 billion what type of restructuring can you do to get your operating margins? Can you get back to the prior peak operating margins of the high 20’s?

George Davis

Yes. I think what we are seeing is the ability to drive operational improvements throughout the company. As you know initially we started with a strong refocusing of our portfolio. We have taken actions within the semiconductor group to really restructure that business. We are, as Mike said, taking a look at longer-term actions we can take in light of various scenarios that we see for our end markets over the next 2-3 years.

So there is no reason why we can’t operate at very similar operating margins going forward. You can already see in this quarter the tremendous improvement from the operational initiatives within SSG. At a very low level their gross margin was approximately 45% in Q3 which really reflects the kinds of earnings leverage that we are going to have as revenue comes back.

Satya Kumar - Credit Suisse

On the memory front, clearly your foundry orders and logic orders are helping you a lot in July and [October]. Several memory customers of your have talked about a particularly unique improvement in capital efficiency as they shrink from the 5X node and go to the 3X and 4X. Given that and the lumpy nature of your current orders in October could you have some quarters that are non-linear as you go out beyond January? Could silicon orders be down, for example, in January?

Michael Splinter

Almost anything is possible. I think the information we are really looking for first of all is how does back to school sales flow through. If that is strong I think people will have confidence to build forward for Christmas and Chinese New Year. So that could carry us right through the end of the year and then it is how do they view the 2010 economy. If back to school is weak all bets are off. We are kind of looking for these next points of data as they become visible in the next 4-6 weeks.

Operator

The next question comes from the line of Steve O'Rourke - Deutsche Bank Securities.

Steve O'Rourke - Deutsche Bank Securities

As a quick follow-up, Mike I think you made a comment that you could potentially see a larger wafer fab equipment upturn next year. What kind of drives that view? How are you looking at next year from that perspective and what could happen between now and then?

Michael Splinter

What drives that view is the economic recovery and consumers coming back in particular in Asia where we would expect to see continued growth in PC’s, Smart phones, media players and the beginning of adoption of solid state drives. So if semiconductor companies kind of get back up to closer that $250 billion run rate we think they are going to have to replace capacity that came off line because of consolidation or because 200 mm factories are no longer viable and some of that capacity will have to be replaced. That is really the thought process behind a more significant semi upturn sometime next year.

Steve O'Rourke - Deutsche Bank Securities

Were there any SunFab bookings in the quarter?

George Davis

We had bookings in the quarter related to bonuses as opposed to factories.

Michael Splinter

I think he is really asking contracts.

George Davis

Let me just clarify if you are asking were new contracts signed on new factories there were none signed in the quarter.

Operator

The next question comes from the line of C. J. Muse - Barclays Capital.

C. J. Muse - Barclays Capital

Can you help me reconcile your outlook for share gains across all segments with also you talk about realigning your cost structure?

Michael Splinter

Sure. I think our products right now are satisfying customer needs but when you boil it all down this is the way I would like for you to think about it. In etched, film and CMP we will hold or have modest gains. In our PVD, FEP and PDC segments we should have relatively significant gains. I think those are driven by some of the things I said in my comments but specifically in PVD the move to copper or at least for one layer in memory and sometimes two will have a positive effect on our PVD and then a move to more advanced transistors helps there also with the metal gate share that we have. Advanced transistors also helps our front end group at the end because of our millisecond and [yield] product. I think PDC has been well chronicled what progress we are making there.

George Davis

Let me just add something. I have seen this in a couple of comments; a connection between the idea of looking at our business for the long run and trying to really think about what the implications are of this economic restructuring or economic crisis we are all dealing with and looking at that in terms of what our cost structure should be going forward. We are seeing in our industry customer consolidation, higher capital efficiency, plus we have done things like making investments in enterprise systems that allow us to do things more efficiently. So we are really just looking at the architecture of the company and saying how can we continue down this path of operational and financial improvements given the fact that the world has changed somewhat. Now we are looking at different scenarios for how much the world has changed and what the scenario is but that is what is driving our analysis. It is not a market share issue. It is really prudent long-range planning.

C. J. Muse - Barclays Capital

The EPS guidance you gave is that pro forma or GAAP?

George Davis

That is GAAP.

Operator

The next question comes from the line of Timothy Arcuri – Citi.

Timothy Arcuri - Citi

First of all George, on one hand you sound pretty bullish about next year but on the other hand you are also talking about a cost cutting program that you are going to get into in the next few quarters. I am wondering if you are so confident business was going to get that much better next year why would you embark upon a significant cost cutting program at this point? What the top or break even of the company should be. Then as a follow-up now that you have a megawatt of SunFab modules at customers that are actually installed I was wondering if you had any balance of systems data that you could share with us?

Michael Splinter

Maybe I can take the first part of this. George kind of touched on this a bit but what we are going through right now is a real fundamental look at first of all the markets that we serve and what has happened to them in this economic downturn. We think that they are fundamentally changed. We think as an industry, frankly, we have to adjust to the fundamental changes of the industry and both align our products with that and our investment with that. So this is really about how to be competitive and how to be focused in the markets that we want to play in.

This is as much an industry thing as it is an Applied thing. George maybe you want to talk about break even?

George Davis

As we said our goal was to get our break even this year down to about $1.2 billion a quarter. We clearly have done that. Again, I would just point you to the exercise we are going through is not a cost cutting exercise in the classical sense. This is a how should the company be structured given the fact that the customers and the markets that we serve are being restructured in response to what they have been facing over the last 12 months. That is really what our focus is. I think trying to turn this into it is a cost cutting issue driven by some operational issue in the company is missing the point.

We are very focused on continuous improvement and we are going to continue to look for opportunities to be more effective.

Michael Sullivan

I think he also had a question that was a balance issue?

Michael Splinter

It is pretty difficult for us to comment on what our customers are doing but the designs we have done internally pretty much verify our estimates of 15-20% improvement between big panels and smaller size panels.

Operator

The next question comes from the line of Atif Malik - Morgan Stanley.

Atif Malik - Morgan Stanley

On the utilization you gave a blended utilization number of 75%. I’m curious where you think NAN memory utilization is at and between NAN and DRAM would it be fair to say that the capacity you see in NAN before DRAM? Then I have a follow-up.

Michael Splinter

Maybe I can add a little bit of color to that. What we said was about 75 blended in calendar Q2 with NAN foundry and DRAM pretty much all in that same range. What we see progressing through the next quarter or so is both NAN and foundry most factories will be very full, 90% plus utilization while logic and DRAM will lag a little bit.

We see total utilization getting close to 90% blended to compare those numbers.

Atif Malik - Morgan Stanley

On the display side I am curious given the high brightness LEDs and the growing trends for the display screens, I am curious if the strength you are seeing in display how much of it is conventional panels versus panels for high brightness LED and where you are in terms a bright panel LED development to target the market?

Michael Splinter

Most of the display demand is conventional TV’s. TV’s are driving it. 32” in China in particular is driving the increase in utilization in factories and some of the capacity adds. As far as the high brightness LED’s this is still a market penetration time. We think that will be much bigger next year, maybe 10-20% of the totals next year. We don’t have any real big announcements about our LED program internally other than we continue to look at unique capabilities we can add to customers that will give them differentiation and drive down cost and improve the performance of manufacturing LEDs.

Operator

The next question comes from the line of Krish Sankar – BAS/MIL.

Krish Sankar – BAS/MIL

Last quarter you gave guidance for sales. You kind of gave some more incremental color on the different segments. Can you maybe break it down between the top 10-20% by display versus EES?

Michael Splinter

As we have said we think on the revenue side we think both AGS and display to be up. We expect silicon to kind of be up in line with the overall guidance. EES is probably the big swing factor and we will just see how that plays out.

Krish Sankar – BAS/MIL

Just to follow-up on the EES side do you have any expectations for how many SunFab [inaudible] revenue in October and in terms of July quarter if I assume about $100 million of the revenue came from SunFab. What percentage of it was the actual sign off and how much was the bonus?

George Davis

I’m not going to go to quite that much detail but we do expect to sign off an additional factory in Q4. We also expect to achieve at least one bonus pay off or sign off in Q4 as well. So we are basically continuing on the pace at the sign off schedule that we expected.

Operator

The next question comes from the line of Patrick Ho - Stifel Nicolaus & Company Inc.

Patrick Ho - Stifel Nicolaus & Company Inc.

Some clarification on your orders outlook of being up. You mentioned the flat panel display as well as your solar business. Can you provide a bit of color in terms of the silicon systems? Is that going to also contribute to the orders outlook in October?

George Davis

I don’t see it having any big detrimental impact but orders were up over 100% in our Q3 and again we had a very strong last month of our quarter which the rest of the industry doesn’t see until their quarterly report in September. So we have seen a very big, if you average the two quarters I think it will look very good by industry standards.

Michael Splinter

The other thing we are dealing with right now is it is very much a turn’s environment and exactly how the end of September and October are going to turn out, we think our manufacturing and supply chain is in line to do whatever our customers need us to do over this next 3 month period.

Patrick Ho - Stifel Nicolaus & Company Inc.

In terms of the operational plan you are trying to set for fiscal 2010 is a lot of that just trying to make your overall operations more flexible and I guess adjustable to these kinds of swings we have seen where in future downturns you won’t see I guess the decline or the pressures on the business model that we saw this time around?

George Davis

I think we are just taking a look at how we can maintain a very strong competitive approach to the market but be more efficient in the way we do it. Those are the questions we are asking ourselves. We will look at different ways to organize parts of the company that will allow us to be more efficient. One of the things we have with multiple lines of business that a number of our competitors will struggle with and you can see it in their SG&A and other things is we have the ability to drive efficiencies and scale within the company. We want to make sure we are taking full advantage of that going forward. This is really part of ongoing, long-term continuous improvement and it is really not just about 2010. This is part of our three year plan. These are changes and initiatives we think will take place over the next few years and will have a very positive impact.

Operator

The next question comes from the line of Gary Hsueh - Oppenheimer & Co.

Gary Hsueh - Oppenheimer & Co.

Just to get a better handle on what you are exactly saying about SSG orders in the October quarter, can we get the breakdown of SSG orders by DRAM, flash foundry, logic, and IDM in the July quarter or do you think that will be in the October quarter?

Just a second question, based on your cost structure here, I might have missed it but I am just wondering what exactly drove such good operational performance in the EES business? Revenue dropped around 40% but you actually improved in terms of your operating margins although it is still negative. If you could help me understand what the lever points are in terms of driving improved operating margin on the EES side. Is it crystalline silicon, cost reduction, distributing R&D somewhere? Just help me understand that number there.

George Davis

Let me start on the silicon orders by summarizing Q3 as a reference point to Q4. I’m not going to guide specifically because again on a turns environment trying to overly predict orders is going to be a little bit difficult. We had 25% DRAM, 15% flash, 18% logic and other and 42% foundry orders. That was our composition in Q3. We expect foundries to lighten up a bit proportionately just because they were so strong in the quarter. We actually think you will see logic increase as a percent in the fourth quarter.

Flash and DRAM there is some volatility around those numbers and they will determine exactly how the numbers come out. I wish I could be more specific but it is just not knowable beyond that level.

On EES operating margin what you are seeing is primarily that was the impact of the SunFab sign off and the improved margin relative to some of the learning curve improvements we are seeing in that space.

Operator

The next question comes from the line of Christopher Blansett - J.P. Morgan.

Christopher Blansett - J.P. Morgan

I had a quick question related to the SunFab customers. Obviously there is a lot of uncertainty in the solar side but one thing that is true is if you can get financing you can get projects put into Germany and some of the other countries in Europe. I wasn’t sure if you had thought about putting a program together to help your specific SunFab customers initially finance some of the projects to help them grow their own businesses.

George Davis

We have been pretty clear that we are not a bank and we don’t operate effectively as a bank. We are certainly willing to work with our customers and help make their project as financeable as possible. If a project is not financeable primarily on its own merits we don’t think it makes sense for us to play that role. I think vendor finance of that nature has been problematic for many years.

Christopher Blansett - J.P. Morgan

Related to your cost of goods sold could you give a little more clarity on your cost of goods actually declined even though your revenue increased? Just kind of give a little description of what caused that.

George Davis

That was a mix issue. Silicon was the primary, again it is a mix issue where you have a higher margin business taking a larger share of our overall pool. It is that effect.

Operator

The next question comes from the line of Mehdi Hosseini - FBR Capital Markets

Mehdi Hosseini - FBR Capital Markets

You talked about signing up another system fab in the October quarter. Can you help us understand what is the average size of these fabs or SunFabs that you signed off?

George Davis

The factories are all different sizes. So any one quarter you can get a very different outcome. We are expecting one of the smaller factories to sign off in Q4.

Mehdi Hosseini - FBR Capital Markets

For EES to drive up booking in the October quarter that means something has to be of a significant size?

George Davis

We are confusing orders and revenue. The orders we say EES is going to contribute to will be for items that will be revenued within a year of Q4 2009. When we talk about sign off, which is FAT (factory acceptance) maybe that wasn’t clear enough. My apologies for that. The sign off we expect to be in Q4 will be a revenue event for the company.

Mehdi Hosseini - FBR Capital Markets

To the extent the bookings in the October quarter could be up driven by the EES could you help us understand what is going to be the mix between [inaudible] and the [cush] line?

George Davis

I am not going to go to that level of granularity right now. What I said was we know that display and AGS are going to be clear drivers and that EES will be a swing factor and part of that will be what things are booked and the mix of that. Those numbers, there is a fair amount of volatility in those numbers. We are not able to guide on that.

Operator

The next question comes from the line of Peter Wright – Global Crown Research.

Peter Wright – Global Crown Research

If you could help comment and give us some clarity on capacity growth in 2009 in terms of kind of $11 billion of wafer fab equipment spend what we can expect kind of gross capacity growth to be and with 200 mm coming off line if you could give us some perspective of where you think actually net capacity growth could be for the year. My second question is kind of clarity on the fixed versus variable costs of your business. It looks like very reliably your silicon business and your display business you have been able to get the cost down to roughly kind of 1/3 of what a normalized rate or a one-quarter average run rate would be. How should we think of your EES business? Should we think of it in the same way you will be able to manage that and if so do you think you are going to be growing your way into that $4 billion-ish number over the next 2-3 years? That seems like it is fairly tough and what type of cost cuts have to happen in that segment?

Michael Splinter

When you look at the kind of investments that anywhere that is in our range, most if not almost all is technology transition investments and not capacity investments. If you just look inside of the companies who have taken factories off line, 200 mm coming off line and a small amount of capacity coming online we think the net on wafers is going to be down about 15% this year.

George Davis

On EES, first off welcome back. It is good to hear your voice. On EES the way I would think about EES and the way I would differentiate it from our other businesses is that it is really in the investment phase. This is addressing a series of markets which we think look like very attractive growth businesses. The cost structure there reflects the fact that we are still investing heavily in the initial positioning of SunFab. We are investing in that area to get the 10% efficiency by year-end. We are not at a run rate level as we will be over time in that space.

In crystalline silicon we are continuing to expand our product portfolio that supports that market. We already have two strong, as you know, product positions there but there is a lot of opportunities for us to address other critical issues for customers. So we have product investments in that as well.

I think the focus there is investment and new product penetration and we will continue to talk about that over time.

Operator

The next question comes from the line of Edwin Mok - Needham & Company.

Edwin Mok - Needham & Company

A question on the crystalline silicon side of your solar business, you mentioned that you were shipping I think you said 50 equipment to a customer, wafering equipment to a customer. I was wondering if that customer or those customers are they adding new capacity or just converting their lines in order to enable this in their wafers or high [frequent] equipment?

Michael Splinter

What we are seeing particularly in China is the addition of new capacity. The opportunities are increasing and seem to be quite aggressive in the wafer space but this is all new wafering capacity.

Edwin Mok - Needham & Company

A follow-up for George. I noticed that your unallocated costs have gone up based on your reported numbers. I was wondering is that just a one-quarter event and how do we look at that going forward? Also if you can help remind us how much temporary savings did you have in the last quarter?

George Davis

Unallocated costs is a temporary item. It is down significantly year-over-year so we will see that continue to trend downward over time. We have some severance charges that are in there and some one-time adjustments. In terms of our temporary cost reductions, I will just remind everybody we have had temporary cost reductions in place now for some period of time and in fact were running at about $80 million if you look at the reduction in base bonus levels and the impact of shut downs and other pay cuts on our costs for salaries. So about $320 million annualized but if you look back a year we are probably net/net only $26 million down on those temporary expenses because we had already cut back on bonuses and had already began shut downs because we were in the middle of a SSG downturn last year. So this has been a long and difficult time and our employees have just been unbelievably supportive and responsive throughout this time period.

Operator

The next question comes from the line of Mahesh Sangareria - RBC Capital Markets.

Mahesh Sangareria - RBC Capital Markets

I just want to follow-up on the comment on operating expenses. If you can help us work through I think the temporary cost comes up in October. How does R&D which was 234 for the last quarter and marketing and SG&A was 168. How will that trend? Some help on that would be good.

George Davis

R&D has been remarkably resilient intentionally because we are trying to do whatever we can to reduce costs in all other places of the company. So we will continue to invest heavily in R&D. If we look back year-over-year as I said operating expenses, and we have had a lot of cost savings in COGS too, but OpEx cost reductions have been about $107 million when you take out the noise from restructuring, M&A and equity expense. So this is really a pure look at OpEx. Of that $107 million about $81 million are what we would call permanent savings and $26 million or so reflect the impact of the temporary savings which as the business recovers further will be restored.

Mahesh Sangareria - RBC Capital Markets

I am a little bit confused about the statement you made about revenues by segment. Did you say that AGS and display would be higher than company average, SSG in line with company average and EES lower than company average in terms of the October quarterly revenue growth?

George Davis

I didn’t say it quite that specifically. I did say silicon would be in line with what we were targeting for revenue growth.

Operator

The next question comes from the line of Daniel Berenbaum - Auriga USA.

Daniel Berenbaum - Auriga USA

On tax rate how should we be thinking about that for the rest of this year and moving forward? I’m sorry to ask the question again, I didn’t quite capture it on the OpEx, how much of the temporary cost cuts are going to come back and over what time period do those start to come back?

Taking that the next step further once those temporary cost reductions are put back into the P&L what do you think the operating drop through, the incremental operating margin of the model should be?

George Davis

On the tax rate obviously we are running at a negative tax rate this year. We were at -26% for this quarter and expect for the full year to be around -34%. Obviously that isn’t our normalized tax rate. Low 30’s trending down over time we think to the mid 20’s.

On OpEx, we have said in our program this year we have a $460 million reduction. That is permanent cost reduction so that is about $115 million per quarter run rate of which roughly 2/3 is OpEx, 1/3 is cost of goods. In terms of when temporary comes back it certainly will come back as the business recovers. The pace of that, we will talk about what the new year looks like on our fourth quarter call and give you a little bit more of an insight into that, but that is as we said about $80 million a quarter and will come back as the company gets back to stronger earnings.

Michael Sullivan

Thanks Dan. With that I would like to ask Mike Splinter to share some concluding remarks with us.

Michael Splinter

Thanks Mike. In closing, we are encouraged by initial signs of economic recovery that point to an improvement in our business. We see positive near-term demand trends in consumer electronics and a sharply improved outlook for flat panel displays. We also see building strength in solar. Still we remain cautious and balanced in our optimism. The equipment sector needs a sustained recovery that keeps customer factories and high utilization and encourages new capital investments.

In the meantime we are preserving our financial strength and improving our operating efficiency while broadening the opportunities for our nano manufacturing technology. I would just once again like to say thank you everybody for joining the call today. Thank you very much.

Michael Sullivan

Thanks Mike. We would like to thank everyone for joining us. A replay of this call and a supporting slide package will be available on our website today beginning at 5:00 p.m. PT and it will be there until August 25th. Thank you for your continued interest in Applied Materials.

Operator

This concludes today’s conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Applied Materials, Inc. F3Q09 (Qtr End 07/26/09) Earnings Call Transcript
This Transcript
All Transcripts