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Applied Materials, Inc. (NASDAQ:AMAT)

F1Q07 Earnings Call

February 13, 2007 4:30 pm ET

Executives

Randy Bane - VP, Investor Relations

George Davis - CFO

Mike Splinter - President and CEO

Joe Sweeney - SVP, General Counsel and Corporate Secretary

Analysts

Jay Deahna - J.P. Morgan

Satya Kumar - Credit Suisse

Tim Arcuri - Citigroup

Stephen Chin - UBS

Edward White - Lehman Brothers

Harlan Sur - Morgan Stanley

Gary Hsueh - CIBC World Markets

Brett Hodess - Merrill Lynch

Mark Bachman - Pacific Crest Securities

Robert Maire - Needham and Company

Kate Kozlowski - Goldman Sachs

Mark Fitzgerald - Banc of America

Steven O'Rourke - Deutsche Bank Securities

Mehdi Hosseini - FBR

Patrick Ho - Stifel Nicolaus

Presentation

Operator

Good afternoon and thank you for standing by. Welcome to the Applied Materials First Quarter Fiscal Year 2007 Earnings Call. During the presentation, all participants will be in a listen-only mode. Afterwards you will be invited to participate in a question-and-answer session. As a reminder this conference is being recorded today February 13, 2007.

I would now like to turn the conference over to Mr. Randy Bane, Vice President of Investor Relations, Applied Materials. Please go ahead, sir.

Randy Bane

Thank you, Marvin. Good afternoon and welcome to Applied Materials fiscal 2007 first quarter conference call. Joining me on the call today are Mike Splinter, President and CEO; George Davis, Chief Financial Officer and Joe Sweeney, Senior Vice President, General Counsel and Corporate Secretary.

Today we will discuss our results for the period ending January 26, 2007. The financial results were released this afternoon at 1:05 pm Pacific Time. A copy of the news release is available on Business Wire and on our website at www.appliedmaterials.com.

Today's earnings call contain forward-looking statements, including those relating to Applied's performance, technology leadership, growth opportunities, operating efficiencies, tax rate, cash generation and deployment, restructuring activities, financial targets, our customers' fab utilization trends and capital spending and the outlook for semiconductor, display and solar industries.

Our 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. Forward-looking statements are based on information as of February 13, 2007 and the company assumes no obligation to update such statements.

Today's call also contains non-GAAP financial measures, reconciliation of these measures to GAAP are contained in our earnings press release issued today and in our Earnings Call Highlights document, both of which are available on the investor page of our website.

George Davis will open the call with a discussion of our financial performance for the first fiscal quarter. After George, Mike will highlight the current industry environment and the company progress. George will close our commentary with our targets for the second fiscal quarter of 2007. After these remarks we will open the call for questions.

With that I would like to turn the call over to George. George?

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George Davis

Thank you, Randy. Good afternoon everyone, and thank you for joining us. Today, I will cover Applied's results for the first quarter of fiscal 2007. Our Q1 performance was within the range of our targets. Overall Q1 was a solid quarter for the company and represents one of the strongest first quarters in our history. We continue to execute on the strategies we put in place last year to strengthen our financial and operating performance. I would like to thank our employees for their contributions in making this happen. It is their commitment to delivering results that led to the strong performance.

As you know, we are now reporting our financial results with additional information provided by segment. We're disclosing orders, revenue and operating income for each of our four segments and we will continue to provide quantitative targets at the corporate level for our orders, revenue, and EPS outlook.

Now, let me review our financial performance in more detail. Beginning first, with a summary of total company results, orders totaled $2.54 billion for the quarter, up 24% year-over-year and down 5.6% from the prior quarter. Orders in Q1 reflected record levels for Fab Solutions and an increase in silicon orders which partially offset a significant decline in display orders. Q1 orders included seven orders in excess of 100 million. Backlog for Q1 increased to $3.55 billion, compared to $3.4 billion for Q4. Backlog adjustments totaled $111 million as certain display and silicon customers pushed out shipment dates beyond our 12-month booking window.

Revenue for Q1 was $2.28 billion, representing a 23% increase year-over-year, but 10% lower than last quarter. Silicon, Display and Fab Solutions segments all reported quarter-over-quarter revenue declines with Display the most impacted on a relative basis with a reduction of over 20%.

Gross margin for the first quarter decreased slightly to 46.7% compared to 47.1% for the fourth quarter. The decline in gross margin was due primarily to lower revenue levels and product mix. Equity-based compensation charges of $6 million were included in this quarter's gross margin.

First quarter operating expenses, consisting of RD&E, marketing and selling and G&A were $516 million, 6% lower than Q4. These expense levels reflected savings from cost control initiatives in Q1, our shutdown in December, and lower equity-based compensation cost. Operating income was $550 million or 24.1% of revenue compared to 25.2% reported for the fourth quarter. Net income was $403 million or $0.29 per share compared to $449 million or $0.30 per share for the fourth quarter. Non-GAAP net income was also $0.29 per share as equity compensation expense was partially offset by the positive effects of tax settlements relating to prior year audits. Net interest income for the quarter was $20 million, $8 million lower than the previous quarter as a result of lower average cash balances.

Now I would like to discuss our balance sheet and cash flow. During the quarter, cash, cash equivalents and investments increased $199 million to $3.41 billion. The company generated $381 million in cash from operations, partially offset by $132 million paid to settle the price adjustment on the accelerated stock buyback initiated in the fourth quarter and by $70 million paid in dividends.

Free cash flow generation for Q1 was $322 million, down from $600 million in Q4. While Q4 was a particularly strong quarter for free cash flow, Q1 is below our 15% to 20% of revenue trend due to higher working capital balances in response to changing customer requirements experienced during the quarter. We expect to be back within that range over the balance of the year.

During Q1, accounts receivables increased modestly and day sales outstanding grew to 82 days on lower revenue levels and changes in regional mix. Inventory increased by $112 million, principally due to increases in raw materials and work-in-process inventories.

The company completed the accelerated share repurchase in the first fiscal quarter of 2007. Including the affects of the price adjustment taken in Q1, we repurchased 145 million shares under the accelerated stock buyback program at an average price of $18.08 per share. Total share repurchases initiated in Q4 resulted in a 10% reduction in shares outstanding at the beginning of that period. We have a 5 billion three-year share repurchase authorization in place.

In Q2, we plan to reinitiate our share repurchase activity and expect to purchase between 300 million and 400 million in stock. In December, the company declared a quarterly cash dividend in the amount of $0.05 per share.

Capital spending for the quarter was $59 million and depreciation and amortization totaled $61 million. Headcount at the end of Q1 was 14,003 regular full time employees.

Now I would like to discuss our segment results, starting first with silicon. Silicon orders of $1.76 billion were up 5% over Q4. Silicon orders had the following mix: DRAM was 51%, Flash Memory 20%, Logic and other 18%, and foundries 11%. 300 millimeter tools accounted for over 90% of segment orders, virtually all of which were at 100 nanometer and smaller process technology levels. Orders for 65 nanometer and smaller process technology represented over 50% of silicon orders.

Silicon net sales of $1.49 billion were up 22% year-over-year and down 8% from Q4. This reflects continued strength in memory offset by lower spending by foundry and logic customers. Operating income was $520 million or 35% of sales, a decrease of $52 million or 9% from Q4, primarily due to lower revenue and product mix.

Now Fab Solutions. Fab Solution's orders of $686 million were up 13% year-over-year and 10% over Q4, driven by costumer renewals of annual service contracts. Q1 orders were a record for this segment. Fab Solution's net sales of $525 billion were up 12% year-over-year continuing the track record of double-digit growth in this segment. Net sales were down 11% over the preceding quarter due to lower wafer starts and utilization and the seasonal reduction in fab-wide spending typical of the first quarter. Operating income was $146 million or 28% of sales, a decrease of $23 million or 14% from Q4, again primarily due to lower revenue and product mix.

Let's turn to Display. Display orders of $67 million were down $288 million or 81% from Q4. Display net sales of $230 million were up 39% year-over-year, but down 22% over the previous quarter as LCD panel makers delayed their build plans due to excess inventory levels and strong capacity additions in 2006. Operating income for this segment was $64 million or 28% of sales, a decrease of $30 million or 32% from Q4 primarily due to lower revenue and product mix.

Now Adjacent Technologies, Adjacent Technologies' net sales of $32 million were up 60% over Q4 due to the timing of revenue recognition of previously shipped equipment.

I want to talk about unallocated expenses now. Unallocated expenses of $169 million were down 15% over the previous quarter. These expenses fall into three buckets of spending of similar size. First, equity compensation and certain components of variable compensation; second, corporate marketing and sales; and third other corporate general and administrative functions. So, looking at these groupings' of costs, equity and variable compensation is down from Q4 and up slightly year-over-year. Corporate sales and marketing is essentially flat quarter-over-quarter and year-over-year. Costs in corporate general and administrative areas are flat from Q4, but increased year-over-year primarily reflecting investment in our business transformation initiative.

Now I will turn the call over to Mike Splinter to provide the CEO's prospective. Mike?

Mike Splinter

Thanks George, and good afternoon. Our first quarter results demonstrate our success in meeting our operational objectives even in a challenging environment. At this point in the year, we are where we thought we would be, and I remain confident that our team will execute effectively throughout the year and deliver on the results we forecast for 2007.

Let me begin with some comments about the business environment. In our Fab Solutions segment, the semiconductor industry is experiencing a seasonal slowdown as anticipated. Wafer starts drop during the quarter with fab utilization in logic and foundry fabs approaching 80%, which is slightly lower than we had anticipated. The lower levels of fab utilization to a downward pressure on spares and service revenue. We expect to return to revenue growth in Q2, as fab loadings bottom out and begin to increase and ramp through the remainder of the year. Wafer start outlook is good for 2007 projected at 8% to 10% growth. And our Fab Solutions results are expected to exceed that level.

Our Silicon segment bookings were up in Q1 and we expect them to grow again in Q2. Memory orders were strong demonstrating the success of our new products that are growing share in this critical market segment. We expect our overall memory business to remain relatively strong and balanced over the year with NAND flash growing in the second half.

As we look out over the next three years, we see more than 20 new memory fabs being planned for production enabling new applications for both DRAM and flash to replace disk drives and enhance user experience in cell phones, PCs and game platforms.

The foundries, however, continue to hold back on capital investment and are very much in the bottom of the trough at only 11% of our bookings in Q1. From our analysis and dialogue with our customers, we expect the foundries to come back in Q3, as 65 nanometer RAMs enter high volume production.

Longer-term, we remain confident in the foundries as they concentrate additional industry R&D programs referenced in recent announcements by several top device manufacturers. We view this as a positive for the industry and especially for Applied Materials. As this allows greater efficiencies, aligns with where we have been deploying our R&D resources and should focus the industry more on device design and increase system innovation.

In December, we hosted a technical symposium with executives and technologists from leading chip companies and universities, including AMD, IBM, Intel, TI and MIT. To discuss the imminent move to 32 nanometer device and manufacturing as well as the critical design and process issues that must be resolved. More recently industry announcements on the accelerated adoption of high-k dielectrics and metal gates starting at the 45 nanometer node, clearly signal that the way forward will require new integration solutions and new materials. Applied's strong market share position in PVD, oxynitride gates and our core product capabilities and deposition at CMP and other technologies is helping us enable this industry transition.

Now let's turn to the Display business. It's clear that customers are hesitating or are in between investments. During 2006, LCD TV volume grew by more than 100% and for the first time LCD TVs pass plasma TVs in the 40 to 44 inch sweet spot. We expect TV volume to continue to grow at around 60% in '07, and therefore we do expect orders to be up slightly in Q2 with a more full recovery in orders by Q3 and in revenues by Q4.

For 2007, we expect the Display equipment market to be down 25% or more. However, our Display segment will perform better than the industry as we grow our product position in PVD color filter and e-beam test.

Let's review some of our strategic programs for 2007. In the quarter, our UVision brightfield product captured another repeat order at a key memory customer and is building on the gains achieved in 2006. We launched several new products including a metal etch product targeted at memory technology, the Applied Opus AdvantEdge. It delivers 50% improved CD control and a 50% improvement in throughput. This product is doing very well. Since its release in December, we shipped multiple systems that are already running in production.

We also launched Producer GT, a new high productivity CVD product. This system is exceeding expectations setting a record for rapid adoption and displacing the competition in multiple customers. We have 23 Producer GT systems in the field and we expect to more than triple our installed base by the end of Q2. Both the Opus and the Producer GT demonstrate the advantage of using our common platforms and software, to quickly bring new products to the market.

In an announcement released earlier today, we stated that we will cease future development of beamline implant products, and we will be closing our operations in Horsham, England. Unfortunately, the implant equipment market has changed over the past few years, and moved more towards commoditization. We don't see future returns that warrant future investments in next generation beamline products. I have assured all our customers that we are committed to their support of our installed base, and we will continue to provide capacity needs through Applied Global Services.

In our Adjacent Technologies segment, we are making solid progress to complete multiple contracts for solar equipment, working toward our objective of more than 200 million in contracts this year. We are seeing a significant rise in activity as more customers understand the impact of our technology to effectively decrease the cost of producing solar power.

Summing it up; with our improved position in Memory, expanding served market in Display, and overall strengthening market position node-to-node, I see three factors that will benefit Applied and support our success through the remainder of 2007.

First, continued investments by memory manufacturers, particularly NAND Flash in the second half. So far these investments are progressing as planned. Next, that our foundry customers commit and spend their CapEx as announced. We should have a clear picture of this by the end of Q2. Finally, that the Display producers return to capacity expansion to fulfill the needs for holiday '07 and beyond.

In the longer-term, we see plenty of opportunities where Applied can demonstrate our strengths. We are developing cutting-edge technology solutions to continue to extend Moore's Law well into the future. We are gaining in service and reinventing by delivering world class solution means for our customers.

We are expanding our Display products. Our solar efforts are gaining traction and are poised to takeoff as the market for green tech grows. We are investing in exciting high growth areas that should pay dividends to our investors for years to come.

Thank you very much, and now I'll turn the call back over to George Davis. George?

George Davis

Thank you, Mike. Our targets for the second quarter reflect the industry dynamics that Mike just discussed. With that as a foundation, we expect orders to be up in the range of 2% to 7%. We expect revenue to be flat to up 5%. We expect EPS to be in the range of $0.27 to $0.28, with a tax rate assumption of approximately 34%. These targets do not include the effects or the impacts associated with the announced closure of our implant operations in the United Kingdom, or the costs incurred as a result of a comprehensive move to managed services in our IT function and some additional minor costs for operational efficiency improvements. The total cost of these initiatives is expected to be in the range of $105 million to $145 million, and will be expensed over the next few quarters.

Thank you. And Randy, let's now open the call for questions.

Randy Bane

This completes our prepared remarks we will now begin our question-and-answer session. Operator let's begin with the first question please.

Question-and-Answer Session

Operator

Our first question comes from the line of Jay Deahna with J.P. Morgan

Jay Deahna - J.P. Morgan

Thank you, congratulations on your execution there Mike, George, couple of questions. First of all on the cycle -- we've heard some of your competitors characterize it as the memory is front half loaded and IDM and foundry comeback in second half. Just wondering to what extent you see the foundry, any idea if it's coming back. You said flash might be backend loaded as well. Just wondering whether you see kind of shipments being higher in the second half of the calendar year than the first half and what is the risk in memory in the first half? That's the first question.

Then the second question is, Intel and IBM recently made some announcements about metal gates, potentially coming in at 45 nanometers, just wondering if you can explain what that means for Applied Materials? Thank you.

Mike Splinter

Sure. Jay, well I think you asked more than a couple. At any rate, on the -- a few comments on how the memory foundry -- how we view that. Right now as you could tell from George's comments, the front half of our year is very DRAM intensive and 50% of our orders were DRAM. We are shipping heavily to the DRAM manufacturers. That seems to be going along. We expect DRAM to phase down a little bit going into our second half and a few very big flash projects to go through and that's really what we are counting on. We do expect foundry to come back. It has been trending down over the last three quarters. Last quarter if you recall it was 16% of our orders, this quarter it's 11%. I don't think I can get a whole lot lower, we are seeing some signs now that there are some 65 nanometer and 45 nanometer buys. We see roughly 300 -- almost 300 new 65 nanometer designs in the foundries and that's usually the point where the volume really starts to take off. So, we are pretty confident about the foundries coming back in the second half of the year, it just depends how much. And if they spend what they say they were going to do, we will meet our objectives for the year.

You asked at the end of your question there about risk in the first half. For us I see very little risk in the first half, we are building to commitments and shipping our mix here for the next 13 weeks. I don't think we see much risk there.

As far as high-k metal gates and what it means for us by metal gates, I think we are in very-very good position, not only with those two customers, but we've been doing our own R&D in this area and working with customers across the industry. I think we are going to see accelerated adoption here and I think we will win all the metal gates, high-k dielectrics I think is -- high-k dielectrics is a story where we have very good technology as well and you will see us be strong as more and more companies announce their capability in that area.

Jay Deahna - J.P. Morgan

Mike is that a situation where a batch oxide deposition could -- from one of your competitors could transition into a single wafer tool sold by Applied?

Mike Splinter

It mostly, Jay, in the dielectric area we have a very-very strong share with our DPM product. So, where we see some potential changeover, maybe in the memory area, where most of the capacitor dielectrics are done in a batch system. But, I think most of the people who are working on advanced logic are using single wafer for this layer today.

Jay Deahna - J.P. Morgan

Okay, thanks Mike.

Operator

Our next question comes from the line of Satya Kumar with Credit Suisse.

Satya Kumar - Credit Suisse

Hi, thanks for taking my call. Mike, I am totally with you in thinking that the memory guys have to spend a lot between now and 2008 in terms of trying to hit their opportunities. But, if I look at the pricing in the memory market more recently, particularly focusing on DRAM. It has been down more like 25% to 30% in just the last six weeks and in all debatable with what's really going on. But, when you are saying that you don't see much risk for memory in the first half, is that based on what you are hearing from your customers today? Are you handicapping that to any extent for the big memory prices?

Mike Splinter

We have to look at the memory pricing over a little bit longer-term, and if you look back to 2006, DRAM prices were incredibly strong, I think probably set a record for strength. And so seeing 20% plus downside here in the first part of 2007, I don't think is very surprising at all as some additional capacity comes on. But I think people are going to continue to put on this capacity with the projected big growth as the conversion to Vista occurs. And I think there has been a lot written lately about Vista hasn't spurred any increased demand in PCs, I don't think it would. I do think that it will spur increased growth in DRAMs and PCs over the year as more and more of the computers are incorporated with Vista onboard and the experience improves with utilizing increased DRAM onboard with those machines. So that's our view, and I think that's going to drive an awful lot of bit growth in DRAM in the second half of the year. Also if you look at the DRAM makers' profitability also set records last year. I think they have a lot of room to move down in pricing without much affecting their profitability.

Satya Kumar - Credit Suisse

Okay. Specifically looking out into the April quarter, when you are guiding up for bookings. What are you assuming for Silicon bookings and within Silicon what's the assumption for Memory and Logic and Foundry?

George Davis

Yes. Satya, hi, this is George. We are not going to be guiding on a segment basis. So overall I think the general industry trends that we talked about are going to have to suffice.

Satya Kumar - Credit Suisse

Okay. Thank you

Operator

Our next question comes from the line of Tim Arcuri with Citigroup

Tim Arcuri - Citigroup

Hi guys, couple of things. First of all, if I listen to your biggest customers in the memory space and I listened to their public conferences calls last month, they pretty strongly indicated that the CapEx would be front-half loaded this year by about two to one and since then NAND pricing has gotten worse than what they even thought it would be in Q1. And of course as the prior question indicated, DRAM price was worse as well. But do you see memory splitting being more balanced for the year, so you don't actually agree with what they said, is that kind of what I should read from this?

George Davis

You should take our call -- Tim you should take our comments on our fiscal year and the way we see our revenue playing out here in our delivery discussions with them, we think that over the year, it's going to be pretty balanced. DRAM will be loaded in the front-half and more flash in the second half.

Tim Arcuri - Citigroup

Okay. I guess then, just as a follow-up, George. If you are not going to give out what silicon orders will be in the April quarter, which is embedded in your up two to seven. You did say that silicon orders would be up, is that right? And I just want to confirm that also that means that memory orders will be up as well?

George Davis

Yeah I think that's right. Tim, you can assume -- one thing that you are going to assume is our AGS orders will follow their traditional seasonal pattern with Q1 being by far the highest quarter.

Tim Arcuri - Citigroup

Okay guys, thanks.

Operator

Our next question comes from the line of Stephen Chin with UBS

Stephen Chin - UBS

Okay, hi thank you. So Mike, is it fair to assume that you think that just January quarter was the trough order quarter in this cycle? I guess that's my first question.

Mike Splinter

Well I believe it was certainly trough orders for logic and foundries. Yes.

Stephen Chin - UBS

Okay and --

George Davis

And Display.

Mike Splinter

Yeah, and display thanks.

Stephen Chin - UBS

Okay. Fair enough. And then, could you please share with us what your estimates for 2007 semiconductor CapEx could be? And do you think AMAT can grow faster than that?

Mike Splinter

Sure. We think semiconductor CapEx is going to be roughly a little over 4% increase year-over-year. We think WFE will grow a little faster than that, closer to 6. So, pick a small range there. And then we think Applied Materials will grow faster than that, primarily because during the last year and half we've gained an awful lot of share in the memory area and we are gaining node-to-node. So as 65 nanometer builds out and 45 nanometer starts to get a little bit beyond the R&D stage, I think we'll see positive effects.

Stephen Chin - UBS

Great, thank you.

Operator

Our next question comes from the line of Edward White with Lehman Brothers.

Edward White - Lehman Brothers

I was wondering if you could talk a little bit about -- more about the dynamics of logic trends. We've talked about some of the memory trends, but how do you see that playing out as the year unfolds?

Mike Splinter

What we think you want is calendar Q1 will be the bottoming out of the utilization fall. We have seen it fall to 80% and probably go a little bit below that before it starts to come back in particular, in the foundries. But then I believe with a number of products, and you've heard announcements in the last few days from the likes of QUALCOMM and Broadcom how they are moving their product line to 65 nanometer. We think that build out of the 65 nanometer and ramp-up of those products is going to help drive the rest of the year for the foundries. And really that will be the thing that gets them to spend their projected capital that they've talked about earlier in the year. As far as logic -- as the big logic players go there, they seem to be dwindling as more companies announce that they're going to depend more on foundries. That kind of -- that will also help push more volume to the foundries as well. But we see the two big logic makers continuing on their plans to spend their capital. And we think that will be more balanced over the year.

Edward White - Lehman Brothers

Okay. And then secondly, do you see any lasting cost benefit from the Horsham shutdown? In other words, any financial benefit that goes beyond the one-time charges you've talked about?

George Davis

Hi, this is George. Yes we certainly do. Clearly that business was going to be operating at a loss this year and based on the investment that would have been required competitively, it would have been operating at a loss for at least the next few years after that as well. So, in essence, that's an avoidance obviously you have the cost structure associated with that as well, that was talked about in the release.

Edward White - Lehman Brothers

Great, thank you.

Operator

Our next question comes from the line of Harlan Sur with Morgan Stanley.

Harlan Sur - Morgan Stanley

Hi, good afternoon. Mike, you talked a lot about the chip design and tape-out activity at 65 nanometers and we have seen quite a few of the leading fabless semiconductor companies, as you mentioned, making aggressive moves to that technology node. My guess is that with the design cycle times as they are, the foundries will need more capacities to put all these tape-outs by the middle of this year. And so with that in mind are you expecting the foundry order contribution for 65 nanometer in the April quarter to be up significantly, or is that more of a July quarter ramp?

Mike Splinter

We believe it will be up in this quarter, but we believe it will be up modestly and then we think it will be strong in our July quarter -- our quarter that ends in July.

Harlan Sur - Morgan Stanley

Okay, great. And along those same lines, do you still expect memory to represent about 50% to 60% of the semi-product mix for the foreseeable future or do the foundry and logic guys start to increase as a part of the mix, second half?

Mike Splinter

Our current projection, Harlan, is for -- for memory spending this year to be about half of the overall WFE spending. And obviously when you look at the overall mix that the percentages are higher in the front half because foundry and logic is so relatively low. So, I think that covers it.

Harlan Sur - Morgan Stanley

Okay great. And then question for you George. With the reestablishment of the R&D tax credit, I thought your tax rate would have dropped by a percent or two but you are guiding 34%, is that correct going forward?

George Davis

Yeah it's -- the R&D tax credit Harlan, is a little less than 1% benefit for us and so obviously we have -- we will have the full year effect of the refund spread out over the year, but that was all taken in the first quarter.

Harlan Sur - Morgan Stanley

Got it. And what was responsible for the -- just last question, what was responsible for the lower than expected tax rate in the first quarter?

George Davis

In Q1, we had a settlement of some prior years Federal Tax Audits that resulted in about a four point impact on our tax rate and again about $0.02 per share on EPS.

Harlan Sur - Morgan Stanley

Great, thank you very much.

George Davis

You're welcome.

Operator

Our next question comes from the line of Gary Hsueh with CIBC World Markets

Gary Hsueh - CIBC World Markets

Hi guys. I am going to switch gears a little bit here and focus down on cost. You guys have done a pretty good job here in Q1 on renting and cost, if I look at your Silicon business, your core business, you are hitting around 35% gross margin and if I look at a comparable run-rate in the last fiscal year, you are 200 basis points lower. So you are obviously doing something in the right direction in your core Silicon business.

Now, I just wanted to ask a quick question George, it sounds like a lot of the equity compensation seems to have affected or benefited in the quarter, the unallocated costs. Just wondering what specifically drove margins up in the silicon business in Q1, whether the shutdowns or anything else that you might be doing. And a follow-up to that would be, at the current $1500 million revenue run-rate throughout the rest this year, given that you are cutting the ion implant business. How much can you grow margins with that sort of flattish revenues?

George Davis

Yeah, let me just talk about the cost picture in general and again we don't break out gross margin by saying that, but I think the answer is instructive across all of our groups. First of, in the first quarter we knew that revenue was going to be down for the quarter. So, its going to be a little bit of a challenging quarter. So, across the Board, cost controls were put into place and these are cost cutting in addition to shutdown. But, longer-term we also have a number of initiatives that you are aware of, will be in manufacturing and their moves to modular tests and the merge and transit. Obviously, we constantly are working on lowering our material costs, which also impacts gross margin and in particular for Silicon and for Fab Solutions.

And then on the OpEx side, we are actually in an investment mode right now on business transformation. So, we will be investing in that and you see that, that shows up in unallocated expenses in '07, but we expect to start to see the real benefits from that in '08. So in general, in a period particularly -- quarter where we were challenged like Q1, we are going to be very cost conscious, which means we have to be very thoughtful about it. But at the same time, we are going to continue to invest in the new product introductions that Mike talked about and other strategic priorities of the company.

Gary Hsueh - CIBC World Markets

George, I guess my question was that, basically the knife on AMAT has been that its going straight from its former financial target and now you've had one quarter where it looks like you are making up or gaining some lost ground there. Are you going be able to kind of give us some targets here by the different segments in terms of revenue run-rate and what your targeted operating margins should be in those businesses? I think that would be pretty helpful?

George Davis

As you noted, we are right on model this quarter. But I think the -- I mean you have to take into account that the model when it was established, the company had a very different mix, it had a different capital structure, and it didn't take in to account anything -- it didn't have a option expensing in place. And so, one of the things that people struggle with is, doing the adjustments to the model. But the fact to the matter is segment reporting really makes the comparison to the old model less relevant. You have far more visibility into the business than you've had, and I don't think we intend to put targets out for each segment. But rather I think it gives you -- you'll have an opportunity to really see how the segments improve overtime, and I think that will be the indicator whether the improvements that we are driving through the organization are making it to the bottom-line which is a key priority for me.

Gary Hsueh - CIBC World Markets

Okay. And finally George, if I just can try and pin you down here on operating margins for the Silicon business, you hit 35% operating margins. Now if revenues were to be flat at the current $1.5 billion and you are cutting your implant business. Just on cutting the implant business, how much more could you see your operating margin expand off 35% in Q1?

George Davis

And Gary, we'll have a lot better view of that after we go through the process of evaluating all of our customer commitments and working with our customers over this quarter as we wind down Horsham. Why don't we talk about this next quarter?

Gary Hsueh - CIBC World Markets

Alright, perfect. Thank you so much.

George Davis

You bet.

Operator

Our next question comes from the line of Brett Hodess with Merrill Lynch.

Brett Hodess - Merrill Lynch

Good afternoon. Just a follow-up on the -- it sound like that the cost savings from shutting down Horsham and changing the ion implant business, aren't necessarily built in sort of to the forecast yet?

George Davis

That's correct.

Brett Hodess - Merrill Lynch

Okay. And then if you look at the process you went through in deciding to shutdown the ion implant development Mike, are there other product lines that you think might not be meeting your hurdle rates going forward or is that pretty much yet?

Mike Splinter

Well we don't -- we are not going to make any announcements today Brett. We made one I think that's -- that kept us pretty busy, but we are looking at all of our underperforming businesses and evaluating their strategic position in the company and whether we think that they can grown and be significant contributors to the overall company and to our shareholders. So I don't have much to say on that other than we are going to use the same kind of process and we are using that same kind of process to evaluate every one of our businesses.

Brett Hodess - Merrill Lynch

Very good thing --?

George Davis

And that applies to our products as well, we are taking a look at whether or not a new product investment is likely to provide a sufficient return.

Mike Splinter

Now this is a good thing, George is driving throughout the company. So you can expect kind of better performance or else kind of --

Brett Hodess - Merrill Lynch

Thank you.

Operator

Our next question comes from the line of Mark Bachman with Pacific Crest Securities.

Mark Bachman - Pacific Crest Securities

Hi Mike. In the press release today, there was a comment attributed to you, and I think you mentioned again on this call that you felt that the implant market had moved towards commoditization. Can you explain what this means and how the implant segment would be any different than the other segments of the cap equipments space, say at your planarization or deposition?

Mike Splinter

Well ion implant is -- I think there is very little differentiation between the five suppliers in the market, and everybody can accelerate ions and embed them in Silicon in relatively similar ways. The difference between almost any other area is the other areas are very application intensive and whether that -- just an example in our CVD area, advanced patterning films or stressed nitride, these kind of things are very difficult, very interactive. And unlike implant, where you can see prices under pressure and the end market not getting the kind of gross margins that we would expect short-term or long-term.

Mark Bachman - Pacific Crest Securities

I was just wondering there, if the products are so much alike, wouldn't there be equal market share then across all the competitors there?

Mike Splinter

Then it get's down to who is really in pricing games. So -- but that's what it ends up being.

George Davis

Mark, this is George. I think also if you just look historically at the financial returns for all the players within the implant segment. I think it kind of supports that view as well.

Mark Bachman - Pacific Crest Securities

Okay, let me see. Also in that press release today, the only location that was mentioned was Horsham. Is there going to be any changes to your implant activities at Beverly, Massachusetts?

George Davis

Well Beverly is incorporated into the overall implant division that's correct, so there will be changes there as well.

Mark Bachman - Pacific Crest Securities

Okay. And then just the last thing there, on the release also you only discussed beamline architectures. Does this suggest here that Applied has not given up on its non-beam technologies?

George Davis

Yes that's correct.

Mark Bachman - Pacific Crest Securities

Thank you so much.

Mike Splinter

Also I want to add, we have a very healthy and growing service business -- service and spares business that's supporting implant and that will continue.

Operator

Our next question comes from the line of Robert Maire with Needham.

Robert Maire - Needham and Company

Yes, by the way congratulations on some nice numbers. Two questions, given that we've gone through what to me appears at least to be a relatively benign down cycles, you can call it a down cycle really more like a soft period. And the upper part of the cycle was relatively benign as well. Are we moving into a sort of a new period here where the delta between the peak operating revenue is off by perhaps 20% 30% from what we would experience during the weak period as compared to the bad old days when we had 60%, 70%, 80% variations?

Mike Splinter

I guess I would answer the question in two different ways Robert. In this particular part of the cycle that we've -- let's just kind of go back over the last few quarters. The downside and the depth of the trough of the foundries have been massed by continued investment by the memory manufacturers, and a significant growth in the memory manufacturers. So, I think that in part, the trough has been massed.

Now, lots of things have happened in the industry, including shorter lead-times, better management of inventory. All those kind of elements that help mute the peaks and the troughs. I think because we see better management in our customers, we are trying to do a better job of running our operations and being more responsive in allowing our customers to add capacity quicker. So, I do think that peaks and troughs will be muted. I don't know how to give you an estimate, if we take a look at 2005 to 2006. I think that -- and then 2007, I think 2005 capital spending was off 10%, but it wasn't off as much because memory was spending more. 2006 was up 25%, nominally 20% to 25%, but that was probably up a little more than we might think, because memories were spending and then at the end of the year it massed the troughs. So, I think once we get through this big growth cycle in memory, we will be able to tell. I do expect peaks and troughs to be more muted. But hard to judge whether that means plus or minus 20%. I am much more apt to think it's in that range than plus or minus 60 or bigger percentages that we saw in the past.

Robert Maire - Needham and Company

Okay. And the other question was, in terms of the assets from Horsham and your beamline implant, any potential thoughts about selling any of those assets or would you be holding on to those, given perhaps other technologies or any disposition of those?

George Davis

Sure, hi Rob, it's George. Our view on that is it's really a function of -- we needed to take action today we felt and going down a path of selling or an acquisition just was inconsistent with that time table, but that's certainly something that we can consider overtime. Our key thing is to meet our customer requirements and to make sure that commitments that we made are fully met and their needs going forward are anticipated. Once we get through that process and are obviously making sure that our employees are treated as fairly as possible. Then we can consider some other alternatives.

Robert Maire - Needham and Company

Okay, great. Thank you, congrats again.

George Davis

Thanks.

Operator

Our next question comes from the line of Jim Covello with Goldman Sachs.

Kate Kozlowski - Goldman Sachs

Hi, this is [Kate Kozlowski] on behalf of Jim Covello. Most of my questions have been answered, but I was hoping to get a clarification in terms of what your non-GAAP gross margins were during the quarter? I noticed there was 13 million items associated with the write-up of the inventory fair value. I was wondering if that's something we should be taking out of the gross margin line?

Mike Splinter

Yeah, I would say that the impact on gross margin was less than half a point from acquisition activities.

Kate Kozlowski - Goldman Sachs

Okay. And then just one other question. In terms of your services bookings, how did that do quarter-over-quarter compared to your product bookings?

Mike Splinter

Service bookings were up. Again the service business has their peak orders in Q1, whilst customers renew their service contracts. Silicon orders were also up but to a lesser extent.

Kate Kozlowski - Goldman Sachs

Okay, thank you.

Operator

Our next question comes from the line of Mark Fitzgerald with Banc of America.

Mark Fitzgerald - Banc of America

Thanks. The guidance about the $200 million in bookings in for the Solar business, is that into the traditional Solar markets or is there evidence here that this amorphous Silicon application that you guys have been working on is taking off?

Mike Splinter

That $200 million will be mostly -- if not all, in flat -- in thin film amorphous silicon. We will and we already do have orders for nitride deposition systems for the crystalline silicon. But we are very focused on thin film solar cells which we think will drive cost down, Mark. So we are excited about that.

George Davis

Hey Mark, it's George. Just let me add one point to that, you used the term bookings. So we have been very careful to use the term contracts. These are -- this is a new market that we are entering and new business models will be used and so we are not using the term bookings, we are really reflecting to contractual commitments that we make with customers.

Mark Fitzgerald - Banc of America

Okay. And just a follow-on to that. In this -- the contract that you guys have written here, is there any evidence that people -- that this -- what you are selling here is into these large megawatt facilities that somebody is actually putting in other than development [minds] your capacity for this amorphous silicon application?

Mike Splinter

No, this will be real capacity Mark. In fact one of the things that we -- one of the indicators we intend to give you as we start mounting these up is how many megawatts of capacity we have sold. In my mind, this is kind of the measure of how much progress there we will be making over the year. So you can look forward to us, keeping a running indicator on how many megawatts of solar power we are selling.

Mark Fitzgerald - Banc of America

Okay. And then just one quick follow-up question here, on the share count for your EPS, for the guidance here what are you using?

George Davis

We are not giving a guidance, I can give you the weighted average shares for the quarter if that would be helpful?

Mark Fitzgerald - Banc of America

For the April quarter?

George Davis

No for the January quarter?

Mark Fitzgerald - Banc of America

Okay I have got that one. I am sorry, okay.

George Davis

Okay.

Mike Splinter

We have to buy the shares back first Mark. Well I am not sure how many, but we have got a range.

George Davis

We have said 300 million to 400 million in shares.

Operator

Our next question comes from the line of Steven O'Rourke with Deutsche Bank Securities.

Steven O'Rourke - Deutsche Bank Securities

Thank you. What drove the Silicon segment backlog adjustments, and can you quantify what they were?

George Davis

Most of the adjustments were deep bookings, and so again just being pushed outside, we had minor cancellations, about 25 million in cancellations, which was split between the Silicon business and the [refer] business in our Fab Solutions.

Steven O'Rourke - Deutsche Bank Securities

Can you say what segments? Was this a memory segment, was it logic, foundry or --?

George Davis

No we don't break it out to that level of detail.

Steven O'Rourke - Deutsche Bank Securities

Okay. And one other follow-up. On the 45 nanometer metal gates, is there a way to quantify the incremental opportunity per fab that Applied Materials can address?

Mike Splinter

It's a little bit difficult, I haven't really done it in the average of a 30,000 wafer fab, but you can expect that there will be a different system for P-channel transistors, different systems for N-channel transistors as these products start to move out into production.

Steven O'Rourke - Deutsche Bank Securities

Fair enough, thank you.

Operator

Our next question comes from the line of Mehdi Hosseini with FBR .

Mehdi Hosseini - FBR

Yes, thank you for taking my question. Two, one is a follow-up. Mike in your prepared remarks, you were talking about the one large flash order that could possibly materialize in the second half of calendar year. Could you give us some idea as to what are the milestones for these large orders to actually take place? Is that mostly driven by a strategic investment or is something else out there? And then also the markets in the Silicon business, the markets still are strong, I assume CVD, PVD. What is the growth projection you are seeing if the WFE is going to grow at 6% plus this year? Would you expect a double digit growth out of the CVD, PVD segments?

Mike Splinter

Well we don't really give that kind of projection down to the product level. But on your first question Mehdi the -- actually what I said was there were several orders. A small number of major factor of flash factories are going in, in the second half of the year and that's really where -- what we are counting on is the three big flash guys, I don't think there is any secret about who they are or where their big fabs are. We are expecting them to -- those three companies to continue their capacity expansion as planned. So I don't think its any more fancy than that. I will say that we do expect CVD to continue to grow faster than the overall WFE market by a substantial amount. As there is so many more applications coming in the CVD space.

Mehdi Hosseini - FBR

Okay. And then going back to the flash commentary, Micron was talking about maybe as much as a 40% reduction in the dye costs, but they have to get their fab capacity up to 40-k to 50-k per month. And so to that extent, these three flash projects that are scheduled for second half, it seems to me is more a strategic and as long as flash prices don't drop to zero or less than zero, they are going to go ahead and execute that. Could you share your opinion on that?

George Davis

I believe they are going to execute their plans. I don't know that I would use the word strategic, these companies are very competitive and hard driving, trying to capture share in a fast growing mark. At least the unit is -- at least units are fast growing. We still expect that growth to be 150% this year, so as still our thought process I think that's much the thought process of many other customers and why they are investing.

Mehdi Hosseini - FBR

Okay, thank you.

George Davis

Excuse me, operator, we have time for one more question.

Operator

Okay. Our last question comes from the line of Patrick Ho with Stifel Nicolaus.

Patrick Ho - Stifel Nicolaus

Thanks a lot. You answered a lot of my questions already, but hearing from some of your competitors this earning season about near-term order trends, some of which are guiding flat to down sequentially. Can some of your upside be attributed to your strength or your better than expected market share gains, particularly in the memory market. Am I correct to assume that?

Mike Splinter

Patrick we believe that you would be correct in assuming that, that if we look back to 2005, our share in memories was -- I don't want to use the word dismal, but maybe it's the best description and we have worked very hard on the applications that are affective for the memory makers. We have actually made more progress with the flash manufacturers than the DRAM manufacturers, but we have made very-very good progress there as well.

Patrick Ho - Stifel Nicolaus

Okay great, and I guess as a follow-up to the market share story is this also correct to assume that you remain highly leveraged to the foundry group and once they pickup their spending trends as you are forecasting, perhaps in the second half of this calendar year. That should also allow you guys to benefit from that recovery?

Mike Splinter

Yes we feel like we have maintained and even strengthened our position with the foundries a bit. We have invested and worked hard in particular with the IBM group and invested in Albany. We have very solid and strong relationship with DSMC, UMC Chartered and SMIC. So, if they comeback in the second half in the year in a way we expect, it should be very positive for us.

Patrick Ho - Stifel Nicolaus

Great, thank you.

George Davis

Thank you. We would like to thank you all for joining us today. We would also like to remind you that there will be a replay of this call available to you on our website beginning at 5:00 pm today, and will be there and remain posted until February 28. Thank you for your interest in Applied Materials this concludes our call.

Operator

This concludes today's conference call, you may now disconnect.

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