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Executives

Michael Splinter - Chairman, Chief Executive Officer and President

Michael Sullivan - Vice President of Investor Relations

George Davis - Chief Financial Officer and Executive Vice President

Analysts

Darice Liu - Brigantine Advisors

James Covello - Goldman Sachs Group Inc.

Wenge Yang - Oppenheimer

Edwin Mok - Needham & Company, LLC

Christopher Muse - Barclays Capital

Stephen Chin - UBS Investment Bank

Patrick Ho - Stifel, Nicolaus & Co., Inc.

Krish Sankar - BofA Merrill Lynch

Satya Kumar - Crédit Suisse AG

Stephen O'Rourke - Deutsche Bank AG

Raj Seth - Cowen and Company, LLC

Jagadish Iyer - UBS

Timothy Arcuri - Citigroup Inc

Atif Malik - Morgan Stanley

Applied Materials (AMAT) Q2 2010 Earnings Call May 19, 2010 4:30 PM ET

Operator

Thank you for standing by. Please note that today's call will contain forward-looking statements which are all statements other than those of historical fact, including statements regarding industry outlooks, customer spending and Applied's opportunities, strategic position, operational initiatives, cost reduction activities, Semitool acquisition and Q3 and fiscal year 2010 guidance. 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 press release and in the company's filings with the SEC, including it's most recent Form 10-Q. Forward-looking statements are based on information as of May 19, 2010 and Applied assumes no obligation to update such statements.

Today's call also contains non-GAAP financial measures, both historical and forecasted. The non-GAAP measures exclude one or more of the following items, as applicable for the period referenced: restructuring and asset impairments, certain acquisition-related costs, investment impairments and/or amounts associated with income tax audits. Reconciliations to the GAAP and non-GAAP measures are contained in today's earnings release and in the financial highlights slides which are available on the Investor page of Applied's website at amat.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, Marcelo, and good afternoon. 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'll discuss our results for our second quarter, which ended on May 2. Our earnings release was issued at 1:05 p.m. Pacific Time, and you can find a copy on Business Wire and on our website at amat.com.

Mike Splinter will be off the call with comments on our business environment, performance and strategies; George will follow with a look at our financial performance for the second quarter, along with our expectations for Q3. We'll then open the call for your questions. With that, I'd like to hand the call over to Mike Splinter.

Michael Splinter

Thanks, Mike, and welcome to today's call. Let me start by saying it feels much better to be talking about this year's second quarter than it did just a year ago, while we were experiencing the bottom of the downturn and the global economic recession.

Our employees have done a terrific job responding to the challenge of the steep ramp over the last three quarters, and our results reflect their commitment to excellence. Our customers are responding to growing demand for consumer electronics in emerging markets. And after a long period of underinvestment by our semiconductor and display customers, we now see a multi-year up cycle in both industries. This improved outlook has given us the confidence to increase our cash dividend and resume our stock buyback program.

We generated strong results in Q2 led by our Silicon Systems Group, which grew sales by over 40%, well above our expectations. The Display business also exceeded our goals for sales and profitability. We saw a quarter-over-quarter sales growth and profit improvement across all of our major businesses except for thin film solar, where we are taking decisive steps to realign the business with a lower market output.

I'll now comment on each of our businesses and the markets they serve. In Silicon, we are again raising our wafer fab equipment spending projection to a new range of $26 billion to $28 billion for the calendar year. This new estimate is $5 billion higher than our forecast just three months ago. We also have increased confidence that we are in a multi-year up cycle that began three quarters ago. We are now tracking 11 new fabs and fab expansions, which alone would support $35 billion to $40 billion of WFE spending over the next six to eight quarters.

Our customers now have higher confidence in the cycle. And their focus is shifted with more than half of overall spending now targeted at capacity additions. We're also seeing spending from a broader base of our foundry and memory customers. We have ongoing strength from foundry and DRAM this quarter. And the supply of advanced memory has remained tight with prices holding firm.

The initial success of the Apple iPad is a good leading indicator that tablet computers are emerging as a major new category and then driver of NAND flash capacity. In fact, we believe that incremental demand for iPads and smartphones will absorb about 60% of the new NAND capacity coming online in 2011.

As we said at our Analyst Meeting, our goal is to gain share in the recovery, and third-party market research released this quarter shows that we are well on track. Applied gain more than two points of WFE share in calendar '09, more than any of the other top 10 suppliers.

The addition of Semitool to our advanced packaging lineup has also given us the number one position in this fast growing market. Growth in advanced packaging is outpacing WFE, and we are the only equipment supplier to have a full suite of products for this market.

Applied is on track to gain another two points of WFE share in 2010, which should bring our total share above our 2006 peak. In Etch, our sales in this quarter alone were equivalent to all of our sales last fiscal year.

Moving to Display. The industry is seeing strong demand for flats panel TVs and notebooks, particularly in China, where consumer demand for flat panels is outgrowing the U.S. market. High factory utilization of about 95% is leading our customers to invest in new capacity. We expect the current Display cycle to be broader and longer than previous cycles, with the first lag consisting of orders from major customers in Korea, Taiwan and Japan. And the second lag driven primarily by new factories in China based on Gen 7.5 and Gen 8 technology.

We are raising our industry forecast for Display equipment spending to be up by more than 70% from calendar '09. I'm proud with the solid profitability achieved by our Display business this quarter during the demanding ramp. And in PiVot PVD, we recently secured repeat orders at a leading flat panel customer, while achieving sign offs at our third customer sign.

In solar, total industry PV installations have accelerated and are now expected to be in the range of eight to 10 gigawatts for the year, and module prices have stabilized. Capacity additions are also trending higher with 10 to 12 gigawatts expected in 2010, driven primarily by customers in China. While demand signals for crystalline silicon equipment remains strong in the near term, we are closely watching the longer-term capital spending outlook, given the growing potential for overcapacity, the changing value of the euro and uncertainty about future European incentives.

This year, over half of all solar panels will be made in China and Applied is favorably exposed in this opportunity. Q2 was our highest-ever quarter for crystalline silicon bookings, which was led by our Baccini Cell Systems, and we expect to gain several points of metallization share this year.

We're seeing strong demand for our new Baccini Esatto system with double-printing technology that boosts sale efficiency by up to a half a point. We shipped a gigawatt of nameplate capacity in Esatto systems this quarter, and we expect to increase that run rate by an additional 50% during Q3. We're managing a steep ramp in our Wire Saw business, while closely monitoring the demand from a concentrated customer base.

Turning to thin film. The second quarter was very difficult in all respects. A large customer filed for insolvency, a major new customer failed to secure financing and several other customers experienced weaker outlooks and reduced their spending plans. These events have significantly reduced our thin film solar revenue expectations for the year and lowered our demand forecast for new factories. As a result, our thin film performance for 2010 will be well below expectations, and we now expect that EES will not meet its goal to achieve break even for the year on a non-GAAP basis.

We have viewed break even is an important milestone for EES that would contribute a substantial improvement to our company's profitability. Since the goal is no longer achievable, I've asked our team to develop a plan that will accelerate reductions in our thin film cost structure beyond the levels we discussed at our recent Analyst Meeting.

These reductions will bring our costs in line with a lower demand profile, while allowing Applied to meet our commitments to existing customers. I expect the plan to be finalized by the middle of June, and I expect EES to make a positive contribution to our company's financial performance in fiscal 2011.

Going forward, we will continue to sell some fabs, but only where we see an acceptable return on investment. Our confidence in the long-term potential of the thin film solar market remains high, and we know that Applied has the technology and people needed to drive excellence excellent solutions. However, we must have a business that stands on its own.

In closing, Q2 was an exciting quarter for Applied Materials, with a significant ramp and a bright outlook for our Silicon, Display and Crystalline Silicon Solar businesses. At the same time, we are taking decisive action to address the shortfall in demand for our thin film solar equipment.

I'll now hand the call over to George Davis for more details on our financial results and targets. George?

George Davis

Thank you, Mike, and good afternoon to everyone joining us today. Applied delivered financial results in the upper end of our target ranges for both net sales and earnings per share, with strong operating performance in our Silicon and Display groups. Order growth was 29% quarter-over-quarter with better-than-expected increases in Silicon and EES. Net sales were up 24% led by better-than-expected Silicon growth. Non-GAAP net income was $292 million or $0.22 per share. This performance included the impact of an operating loss of $145 million in our EES segment, which I will discuss in a few minutes.

Before covering our sequential results in detail, I want to share a few comparisons with the second quarter of 2009. Compared to our results from one year ago, orders increased 290% and net sales grew by 125%. Non-GAAP net income in the quarter was up over $450 million from the loss position of a year ago, increasing earnings per share by $0.34. These numbers showed just how difficult 2009 was for our businesses and how rapidly demand for our products has ramped in 2010.

Now I will return to sequential comparisons of our results. Gross margin increased almost two points from Q1 of this year, reaching 40.4%, driven by higher net sales in our most profitable business segments. This improvement included the impact of an $83 million inventory charge relating to thin film solar, which lower gross margin by 3.6 points. Non-GAAP operating expenses of $527 million were within our targeted range. We still expect quarterly non-GAAP operating expenses to remain between $520 million and $540 million through the end of the fiscal year.

We opened our new manufacturing and logistics center in Singapore this quarter and expanded production in our display facility in Tainan, bringing our operations closer to more of our customers. Throughout our transition to these new sites, we are meeting the steep ramps in our Silicon and Display businesses.

The consolidation of worldwide operations is a critical element of our long-term productivity program. The operations group has 2,500 employees worldwide, supporting 17 manufacturing centers in eight countries. With approximately $4 billion in annual receipts, we expect that our initiatives in these areas will yield tangible cost improvements across all of our businesses.

Backlog increased slightly to $3 billion, reflecting a healthy order book across all of our segments. Backlog adjustments were negative and totaled $184 million driven by cancellations, debookings and currency adjustments, primarily within EES.

Operating cash flow performance for the quarter was very healthy, reaching 23% of sales or $527 million. Strong working capital management resulted in record low days sales outstanding, and only a modest increase in inventory despite a significant increase in our net sales. Our cash flow also benefited from a tax refund of approximately $130 million related to 2009 operating losses.

We announced a 17% increase in the dividend earlier this quarter and resumed our share buyback program, requiring 7.6 million shares in the quarter. Total cash used for repurchases and dividends in Q2 was $181 million, and we added $365 million to our cash and investment portfolio, which ended the quarter at approximately $3.6 billion.

Now turning to the segments. Silicon orders increased 25% from Q1 led by memory and logic customers. Customer lead times remain short with over 65% of silicon sales coming from orders received within the quarter. Our supply chain was able to respond to the increased demand despite short lead times, global air traffic delays and transitions to the new manufacturing site.

Net sales were much higher than expected, growing 45% quarter-over-quarter. We are seeing a broadening of customers spending with approximately 60% of sales expected to come from five to six customers in the second half of this year, compared to only three in the first half of the year.

With the higher forecast for wafer fab equipment spending, our improving market share position and the addition of Semitool, we expect to significantly exceed the net sales growth target for silicon that we provided at our recent Analyst Meeting. We are well into our integration process with Semitool and expect to achieve GAAP accretion early in fiscal 2011.

Applied Global Services orders were approximately 2% higher than in Q1, net sales grew 7% and operating margin increased almost five points to just below 20%. Spares availability, along with our performance to customer delivery goals, improved significantly during the quarter.

Display delivered an exceptional quarter. Orders increased over 100% driven by customer investments in China, sales also more than doubled and operating margin increased 14 points to 33%, reflecting strong flow through and a favorable product mix. During the quarter, the Display team made significant progress toward completing the volume manufacturing transition to our new facility in Taiwan.

EES reported a segment loss of $145 million, primarily driven by losses in our Thin Film Solar business. Challenging market conditions, associated with the growing supply of low-cost crystalline silicon panels and a limited expansion of utility-scale opportunities, are impacting demand from our current and prospective customers. The inventory charge, the impact of a major customer insolvency and diminished demand overall will result in EES posting a non-GAAP operating loss for the year. We are committed to taking the necessary actions for EES to reach profitability in 2011.

Moving to the outlook for our third fiscal quarter, we see continuing strength in our most profitable businesses. We expect silicon net sales will be roughly in line with a very strong Q2 levels. AGS net sales were expected to increase in line with wafer starts and higher used equipment demand.

Display expects another solid quarter, but we expect net sales to be down at least 20% below a very strong Q2. We expect EES net sales to be up by more than 25%, primarily as a result of higher crystalline silicon sales.

With that segment mix, we expect the company's overall net sales in Q3 to be in the range of down 2% to up 5%. We also expect our non-GAAP quarterly earnings per share to be between $0.22 and $0.26 per share. This forecast does not include any potential charges related to EES restructuring, as a plan for that is being developed and will not be completed until later in this quarter. Now Mike, let's open the call for questions.

Michael Sullivan

Thank you, George. And to help us reach as many of you as we can, please ask just one question and no more than one brief follow up. Marcelo, let's please begin.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from the line of Jim Covello with Goldman Sachs.

James Covello - Goldman Sachs Group Inc.

I guess maybe as a start on the Silicon business and look at the composition of orders this quarter. I think press release said about 10% of the orders were from flash. Obviously, there's been some good recent announcements from customers there. What percent of orders do you think would be made up by flash maybe in the next fiscal quarter and then maybe in the back half of the calendar year? That would be the first part of the question. Then, I guess, maybe my follow up would be, how much of the increase in wafer fab equipment expectation for the year relative to the forecast from the analyst meeting is due to a single customer versus a more broad increase in expectations from the customer base?

Michael Splinter

On flash, first of all, I would say, the bookings trend, our projection for the next quarter is quite strong, but off a pretty small base. We think flash orders will be up about 50% in the quarter. We're having a lot of turns business as George talked about, so it could vary a little bit depending on where the turns business comes from in the quarter. We expect that to continue to strengthen through the rest of the year. Then to the second part of your question on, is our increase in projection all due to one customer? No, we're thinking that actually from our last quarter outlook that there's a broader base of spending that's happening as confidence grows across the customer base.

Operator

Our next question is from the line of Stephen Chin with UBS.

Stephen Chin - UBS Investment Bank

If I annualized the April quarter silicon bookings for 2010, we get something in bookings up about 115% year-over-year in calendar '10, and that looks like, Mike, your new WFE outlook is up about 100%. So my question is, do you think Applied's higher silicon bookings from greater [ph] (27.37) function of better exposure in memory customers or share gains, or is there something else there? Then my follow-up question is on the July Display sales guidance, that's down 20% sequentially. Is that simply because the flat panel bookings take longer to turn into revenue?

Michael Splinter

But on the bookings for the year, I think there's a couple of factors just how different companies recognize things, but we think that we will gain share. Won't account for 15% or 20% or some number like that in difference between us and others. So I think we're more confident about our share gain and I think you can factor that into the number. I think other things have to be on timing and how orders are received from customers. On the flat panel display, it's just a lumpy business and I think the market is strengthening. We're very -- and actually, the way the cycle is going in flat panel display is, it's broadening. And quite different than the last cycle where there was just a rush to buy capacity in one quarter, I think our orders went up to 500 million in one quarter, we're seeing a much broader and stronger effect that's going on right now as different customers are in different places. And then, who's going to actually get the build in China and who's not. I think those factors are all playing into the flat panel display order and revenue trends. But I would say that, that market is strong and literally, as strong as I've seen at any time. George?

George Davis

I would agree, Mike. I wouldn't view the fact that we see Display down as a trend point. It's really more a function of the lumpiness of the business. It's still -- even down 20% would be a very strong quarter by any measure, and we expect it to continue to show strength over the next several quarters.

Operator

Our next question is from the line of C.J. Muse with Barclays Capital.

Christopher Muse - Barclays Capital

The first one is, what is your order outlook overall for the July quarter, as well as if you could provide by segment, that'd be very helpful. And then the second part of the question is on the OpEx front. Looks like you had some pretty good savings there. I'm curious what kind of absolute run rate you projected there for both the July and September quarters?

George Davis

On the order outlook, we're not giving order guidance. I think the way I would think about our orders is obviously, our quarter, we got a month off of the calendar quarter, so our order book, if you try and make comparisons to competitors, you got to adjust for the lag. We think orders, again, particularly since we've been working on such a turns basis and SSG will be hard to forecast with a lot of accuracy. If you step back and say, "What do we really seeing here?" We're seeing a multi-year cycle in our view in both semiconductors and display. We expect orders will reflect that. We expect to continue to gain share and actually in both of those markets, so we're quite positive. It's not a lack of optimism that is keeping us from guiding orders. In terms of OpEx, I think what you saw in terms of saving this quarter was really the absence of restructuring cost that took place. If you look at non-GAAP OpEx, which is really what we've been guiding to, is we were up about $50 million. All of it can be explained by the addition of Semitool into our financials and increase in variable comp in line with the increase in revenue. So I think the $520 million to $540 million range for non-GAAP OpEx is the right range.

Operator

Our next question is from the line of Atif Malik with Morgan Stanley.

Atif Malik - Morgan Stanley

George, if I look at your silicon revenue guidance flat and given that the turns business is still quite high, is it fair to assume silicon orders will be flat to down for Applied?

George Davis

Again, I don't really want to -- we won't really forecast orders. But I think we should see very strong both revenue and orders in the quarter, whether it'll be up or down marginally will be a function of individual -- it's pretty concentrated, as well as pretty short term. So I would put any movements around the edges just a function of timing. We still see multiple quarters of strong demand coming in that area.

Michael Splinter

One thing I'd add, Atif, is that our operations group right now is in certainly much better shape. The supply chain has kind of got itself healed quite a bit from the blows it took last year during the downturn. So our ability to respond to turns business is much better than it was even a few months ago.

Atif Malik - Morgan Stanley

One follow up on the EES business. Your comments that on some SunFab projects, the return on investment can make sense. Can you provide some more color on the scale of those projects? And are there currently any projects of that size on regions like China or India where the return on investment does make sense right now?

Michael Splinter

There is actually a number of different kinds of projects that make sense. Certainly, large projects, with the likes of utility companies in China or major companies in India, where it makes sense. We're certainly having discussions with a number of those companies. But also upgrades, both capacity expansions and tandem junction upgrades make very good sense and have excellent ROIs for us in the business. So you can imagine that we're having those discussions with those customers.

Operator

Our next question is from the line of Tim Arcuri with Citi.

Timothy Arcuri - Citigroup Inc

First of all, George, I think you said six months ago that of the backlog, roughly $650 million was SunFab. And I think, probably most of your cancels were in SunFab. So is it right to think that of the backlog right now, maybe $400 million is thin film related?

George Davis

In our backlog?

Timothy Arcuri - Citigroup Inc

Yes.

George Davis

Yes, that's a reasonable approximation.

Timothy Arcuri - Citigroup Inc

And secondly, Mike, can you give us some idea of sort of the breadth of the silicon customer base? It still sounds very narrow. And I'm sort of wondering if you can give us some data around how that might be broadening out or not broadening out, and how you might think that might change, going forward? If it is going to be a multi-year cycle, it would seem that, that would be needed.

Michael Splinter

I agree, it's certainly needed. And even as it broadens out, it's still narrower than has been in the past. But maybe one comment that I think is illustrative is if we just look at foundry bookings and kind of how we're thinking about it quarter-over-quarter, I think I said earlier, I think those will remain flat. And I think you know that there's a shift there in the ordering from different foundry customers. And that's the kind of positive shifts of broadening out that we're seeing, and surprising strength among the other customers beyond just the leader in that group. And I think we could say that in DRAM as well. And we really haven't seen much from flash yet for the second half of the year. So on a real magnitude basis, flash has still been small, and my belief is that supply is very tight. Those factories are running flat out. And I think we're going to see some significant expansion as we go through the second half of the calendar year.

Operator

Our next question is from the line of Satya Kumar with Crédit Suisse.

Satya Kumar - Crédit Suisse AG

I was wondering, related to foundries, some of the large GPU customers of foundries have talked about some [indiscernible] (37:10), and there were general concern about inventories, potentially some softening in PC data point. So I was wondering if any of this is having an effect, in terms of what foundry customers are thinking in terms of orders if you look beyond the July quarter. And secondly, my follow-up is on NAND flash. At what point is the lower level of orders that you're getting from NAND flash would be considered not a cyclical fact, but something [indiscernible] (37:42) the productivity is higher for NAND flash for some reason, if you look into the CapEx investment?

Michael Splinter

We try to watch inventory pretty closely because we do think it's a leading indicator. But this is Q2. It's generally the softest quarter for our customers' demand. And we've been trying to see if there's really any place where there's something that's out of line from a days of inventory or from a historic days of inventory, and we still see inventories in a pretty healthy range. Now could one product be out of line and we missed it? I guess that's possible. When we look at the seasonality through Q2, we haven't seen anything that would raise alarm bells at this point. On the NAND flash question, of course, NAND has great productivity, and it depends whether the growth is going to be on two-bits or three-bits-per-cell or one-bit-per-cell kind of devices, how much productivity they get. But frankly, I think that the capacity is quite stretched right now. If the iPad or products like it -- I assume some other major computer companies are coming out with similar products in that category. If they just sell something close to 7 million to 10 million units in the second half of the year, it will seriously stretch NAND flash capacity. We think that to supply that, you need something between 250,000 and 300,000 wafers. I'm not sure where those are going to come from because everyone today is pretty much already utilized.

Operator

Our next question is from the line of Gary Hsueh with Oppenheimer & Co.

Wenge Yang - Oppenheimer

This is Wenge Yang for Gary. Couple of questions. First one, is regarding your $27 billion WFE guidance. And if I use '06 market share of 30% for AMAT, we are looking at about $8 billion sales in Silicon revenues, maybe Silicon plus AGS. So based on FQ2 and FQ3, does that indicate upper kind of sales volume for October and January quarter? That's my first question.

Michael Splinter

Well, I wish we would've had 31% share in 2006. I think we had 21% share in 2006. So when we say that by the end of this year, we should have exceeded that, it's in that range, not in the 30-plus percent range. So if we redo the math and say, $27 billion times 20-plus percent, I think you get in the middle fives. And if that goes up a little bit, our revenue will go up with it.

Wenge Yang - Oppenheimer

If we look at the supply constraint to be relieved, and also, you have some additional savings in terms of SunFab costs, is it an indication that your guidance for OpEx at $520 million to $540 million has some additional improvement rooms in the coming quarters?

George Davis

Wenge, the $520 million to $540 million is with today's run rate. Obviously, if there's actions that accelerate reductions, it might come outside of that range. But you've got a little bit of room in that range anyway. So we'll leave it at $520 million to $540 million for right now.

Operator

Our next question is from the line of Edwin Mok with Needham & Company.

Edwin Mok - Needham & Company, LLC

First question is regarding operating expense. So you guys guided for $520 million to $540 million by end of this fiscal year. And previously, you talked about your cost reduction program being 18 month. Care to kind of give some color in term of what you expect your OpEx can be in the first half of fiscal '11?

George Davis

We had said that we were looking for OpEx savings, on an annualized run rate, of $200 million to $250 million by the end of the program. When we started and announced the program, our revenue outlook for the year was well more than $2 billion lower than the outlook that we have today. And so some of the -- what we said is that the programs, while they're continuing, we see the gains from those programs in the latter part of the 18-month program, mainly because, quite frankly, it's all hands on deck meeting customer ramps and also just the higher OpEx that comes with the additional revenue. As you've seen from our flow-through, we're passing a lot of profitability through, but there is incremental OpEx that comes with higher revenue. But we still believe that the approximate $450 million in overall savings from our program initiatives is achievable. But again, it's going to be back-end loaded, and the absolute level of OpEx will reflect both the benefits of those savings and whatever the underlying revenues is for the company.

Edwin Mok - Needham & Company, LLC

And then just a quick follow-up on Display. You guys have talked about that expect maybe to see more orders come in more like kind of fourth quarter of this year, and so maybe more like fiscal first quarter for you guys. Is that still the expectation for Display that [ph] (44:06) you report better result this quarter, or was that some pull in that might moderate that? How do we look at that?

George Davis

The movements around are really not push-out pull-in type. It is a number of factors, not the least, but which is just -- it's very broad-based, so you have a lot of customers that are making their plans. You have a number of customers who are looking at both capacity expenses in their traditional manufacturing locations, but also looking at getting permission or making the arrangements to open manufacturing in China. The timing of that is just more uncertain, and so that really accounts for most of the movements.

Operator

Our next question is from the line of Steve O'Rourke with Deutsche Bank.

Stephen O'Rourke - Deutsche Bank AG

Were the backlog adjustments of $184 million, was that all SunFab? And secondly, with your present SunFab customers, do you have production data from them that gives you high confidence that it can be competitive within the next year or so?

George Davis

So let me take the backlog question first. No, the backlog adjustments were mostly EES and the thin film was the largest of the cancellations. But you also have some push-outs heavily weighted towards wafering, whereas you have some movements in and out of our one year booking cycle there. And then you have FX adjustments of $36 million, which quite frankly, was mostly euro, which is all crystal and Silicon sales, which are made out of Europe. You have some minor contributions, minor cancellations and debookings, normal puts and takes in the services and Silicon area. But it was really EES that was the dominant contributor overall, thin film, the largest of that, in terms of cancellations.

Michael Splinter

To your question about SunFab production data. Yes, we have quite a bit of data now on how the factories are running, how the yields and efficiencies are going, how tightly they're distributed. So I think we have a very good assessment of what size factories have to be, and what efficiency and performance productivity has to be at for them to be competitive.

Operator

Our next question is from the line of Krish Sankar with Bank of America Merrill Lynch.

Krish Sankar - BofA Merrill Lynch

I had a couple of them. One is, Mike, what percentage of your orders do you think in April was capacity driven? And where do you think that's going to be in July or maybe in the second half of the year?

Michael Splinter

Sure. This relates to semiconductor, so we think that close to 60% were capacity driven. And this quarter, we think that will increase a bit yet over the next couple of quarters. And there's a fairly big shift from Q1, and certainly, from any time last year where almost all the orders were technology driven.

Krish Sankar - BofA Merrill Lynch

And in terms of the wafer fab equipment, you said that you expect it to be a multi-year cycle. Given that you're kind of heading towards the middle of 2010, would you care to take early [ph] swag at where you think 2011 wafer fab equipment or CapEx would be?

Michael Splinter

I don't really want to take much of a swag. But I'd just say, up until really the last week or so, I wouldn't have thought that we could exceed kind of 2006 and '07 levels or be in that ballpark. If the economy stays strong and all the normal caveats, I think we could certainly be in that range that we were in for wafer fab equipment spending in 2006 and '07, and in [ph] (48:20) 2011.

Operator

Our next question is from the line of Patrick Ho with Stifel, Nicolaus.

Patrick Ho - Stifel, Nicolaus & Co., Inc.

I know you don't want to talk specifically on customers. But with the recent public announcement by Samsung of its increased CapEx for 2010, how have other interactions with your other DRAM customers gone? And is this the majority of the broadening of the customer base that you're seeing, as we progress into midyear and the second half?

Michael Splinter

I think as you look at what's happening in this market, we're seeing broadening, and really, in most spaces, from DRAM to flash to foundry. Obviously, in Logic, there's not that many players anymore. That there's just a few of them that are the biggest part of Logic, so -- but I think we're seeing broadening in all of the different segments. It's hard to tell what the impact of Samsung's announcement will have on the broader industry. But I think, if I was going to characterize it, I would characterize it as representative of growing confidence across the industry and willingness to invest heavily again in semiconductor capacity.

Patrick Ho - Stifel, Nicolaus & Co., Inc.

And my follow-up question is, you mentioned another quarter where you expect a high-level of turn business. When do you think that things return to a more, I guess, normal conditions where you typically see that lag of a quarter or two between orders and revenue? Or do you believe that you can sustain this type of turns business for your customers on a going forward basis?

Michael Splinter

I kind of think this is the new normal. That customers are believing, especially the larger customers which is the bulk of the business, believe that they can work with us ahead of time, but order at a very short lead time. And we've really worked hard and will continue to work hard on our operations to drive speed, quality and cost. And on the speed front, this is really, I think, going to provide some differentiation over time in the industry, because customers are going to want to have those short lead times to add capacity.

George Davis

And Patrick, it's one of the reasons why we've invested in logistics and light manufacturing capability in Singapore, and are putting a lot of effort into our Pan Asia supply chain development, because all those element are critical to cycle time. And I think you've observed an important trend. Cycle time is very important to our customers, and that's not likely to change.

Operator

Our next question is from the line of Raj Seth with Cowen and Company.

Raj Seth - Cowen and Company, LLC

Mike, you mentioned that you see now 11 semi fabs over the next couple of years. I'm wondering if you can give a little color on what type those fabs are. And I'm curious, in the LED space, how many fabs you're tracking. And I guess as a follow-up, I'm curious in LED, if you think that you stand to gain sort of meaningful market share in the LCD TV backlighting kind of transition or going through, sort of what your ambition and investment levels are in that area.

Michael Splinter

So on the semiconductor side, on the fabs we're tracking, it is a mix. But I would say, the largest additional wafers would be in NAND, in part, just because they build such huge factories. Next would be in DRAM and then in foundry. But it's pretty broad-based overall. And there's some in every one of the segments. The number of fabs are pretty balanced by segment, it's just the size that puts NAND out in the lead. In LED, there are quite a number of fabs that are being built. But what we're really trying to do right now is focus in on working with customers to qualify our machine. And we believe that we have differentiation and can add value to customers, and as our machine gets qualified in production, we'll see significant growth in that area.

Raj Seth - Cowen and Company, LLC

Any sense for how long? Or what's your expectation for how long it may take for LED to represent anything meaningful for you from either, I guess, in the order perspective first?

Michael Splinter

Well, we haven't introduced the product yet. So I think, when we introduce the product, we'll talk about the market and a lot of detail on our expectations of where we're going. So it's just a little difficult for me to be more precise than that, considering where we are at this point in our public position on the product.

Operator

Our next question is from the line of Jagadish Iyer with Arete Research.

Jagadish Iyer - UBS

First, is that in your EES bookings, how should we think about crystalline silicon versus thin film? And as a follow-up here, how should we think about the sustainability of crystalline silicon bookings going into the back half of the year?

George Davis

The bookings right now are predominantly coming from crystalline silicon today. So we were seeing very strong demand, again, mostly from China, both from wafering and from customers for metallization. And that, as Mike said, this was the strongest order quarter for us. And it was really defined by crystalline silicon.

Michael Splinter

Jagadish, I would just add. We are really trying to watch the indicators here very closely, mostly because of those items that I mentioned. Is the devaluing of the euro going to have an impact on demand? Are the austerity programs and some of the countries in Europe going to have impact on incentives? Is there really overcapacity? We're trying to watch all these things very closely, so we adjust if we see something. But right now, demand is very, very strong.

Jagadish Iyer - UBS

On the foundries, how should we think about the second half, in terms of foundry orders, versus your first half? Do you see kind of sustainable spending in the foundries going into the back half of the year?

Michael Splinter

Yes, so far, it seems sustainable. If you look at our Q3, looks as good as Q2 for foundries. So we aren't making any projections about our Q4 yet, but so far, so good.

Operator

Our next question is from the line of Darice Liu with Brigantine Advisors.

Darice Liu - Brigantine Advisors

With the decision for further cuts in EES to achieve profitability next year, can you provide what you're target breakeven will be for that segment? And the follow-up is, now that you are shifting your focus less on SunFab, can you provide some color on where and what products you expect growth to stem from in the EES segment this year and next?

George Davis

Let me deal with the breakeven. We said we had looked to get to breakeven around the $1 billion level. We'll address breakeven for 2011 when we complete the plan that's being developed currently, and we'll have a better sense for what it looks like next year.

Michael Splinter

On the products that we expect to continue to grow in EES, crystalline silicon. Just the products like the sidewell double patterning product, customers are very, very interested in that. We have over 50 customers in China, and we're really, I think, have very good relationships with all of them. And I think that gives us a significant opportunity, as that part of the industry grows, to grow with it. I think, as we talked about LEDs earlier, we have very high aspirations there as we introduce the product and get it into the marketplace. Those would be, by far, the two biggest areas.

Operator

And our final question is a follow-up from the line of Tim Arcuri with Citi.

Timothy Arcuri - Citigroup Inc

Relative to your SunFab business, you still have $400 million sitting in backlog. And I'm sort of wondering, given that you're winding the business down, it seem like you were spending maybe $30 million to $40 million per quarter on OpEx in that business. And I'm sort of wondering what you're winding it down to? That's my first question. I.e. What will be left? And secondly, whether there's any potential liability issues with the remaining systems there sitting in backlog? So is there any potential that there are sort of negative equity value that a customer could come back at you for closing the business down or not meeting any sort of specification that you promised in those bookings?

George Davis

Well, as Mike said, one of our key criteria for the plan is that we meet all existing customer commitments. We've signed up virtually -- we've met factory acceptance on virtually every factory installed to date. In fact, the revenue shortfall that we're seeing is typically coming from customers being unable to pay bonus obligations that reflect performance in the factories above original specification. The majority of the inventory that we have today is associated with installed equipment in factories that we expect to sign up at the end of this year. So we have every intent to continue to support our existing customers and to meet our commitments, and don't believe that's going to be a source of major risk for the company.

Michael Splinter

And George, I think Tim's second part of his question was about OpEx. And I think, until our plan is done.

George Davis

Right. Same answer to that is in the previous situation. We really have to complete the plan. We'll discuss the results of that as soon as it's available.

Michael Sullivan

And at this point, we'd like to thank everyone for joining us this afternoon. A replay of today's call will be available on our website beginning at 5:00 p.m. Pacific time today. The replay and our earnings slide package will remain on our website until the 2nd of June. Thank you for your continued interest in Applied Materials.

Operator

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

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Source: Applied Materials Q2 2010 Earnings Call Transcript
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