Applied Materials F4Q07 (Qtr End 10/28/07) Earnings Call Transcript

Applied Materials, Inc. (AMAT)

F4Q07 (Qtr End 10/28/07) Earnings Call

November 14, 20074:30 pm ET

Executives

Randy Bane - Vice President of Investor Relations

Mike Splinter - President and Chief Executive Officer

George Davis - Chief Financial Officer

Joe Sweeney - Senior Vice President, General Counsel, and Corporate Secretary

Analysts

Satya Kumar - Credit Suisse

Gary Hsueh - CIBC World Markets

Timothy Arcuri - Citigroup

Stephen Chin - UBS

Jay Deahna - JPMorgan

Harlan Sur - Morgan Stanley

CJ Muse - Lehman Brothers

Patrick Ho - Stifel Nicolaus

Brett Hodess - Merrill Lynch

Jesse Pichel - Piper Jaffray

Mark FitzGerald - Banc of America Securities

Stephen O’Rourke - Deutsche Bank

Stephen Pelayo - HSBC

Presentation

Operator

Good afternoon and thank you for standing by. Welcome to the Applied Materials Fourth Quarter Fiscal Year 2007 Earnings Call. During the presentation all participants will be in a listen-only mode. Afterwards, you'll be invited to participate in the question-and-answer session. As a reminder, this conference is being recorded today, November 14, 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 fourth 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 October 28, 2007. 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, www.appliedmaterials.com.

You can also access our slide presentation supporting today's discussion on the Investor Relations section of our site. Before we begin, let me remind you that we will be hosting an Analyst Day on January 17, 2008, in New York City. Information regarding this event can be found on the investor page of our website.

Today's earnings call contains forward-looking statements, including those related to Applied's performance, growth opportunities, operational efficiencies, cash generation and deployment, business acquisitions, strategic positions, solar contracts, financial targets, customer's 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 containing 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 November 14, 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 measures are contained in our earnings press release issued today and on our earnings call slides, both of which are available on the investor page of our website.

George Davis will lead the call with a discussion of our financial performance for the full fiscal year and our fourth quarter. Mike will follow with comments on company progress in 2007 and our outlook on the industry environment.

George will close our commentary with our targets for the first fiscal quarter of 2008. After these remarks, we will open the call for questions.

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

George Davis

Thank you, Randy and good afternoon everyone. Fiscal 2007 was a strong year for Applied Materials, both financially and operationally. We grew revenue to record levels, achieved a 24% increase in earnings per share, and generated record levels of operating cash flow that allowed the company to return substantial cash to stockholders, while at the same time investing in R&D on pace with the highest levels in our history.

Now I will comment on: both our fiscal 2007-year and fourth quarter results and then discuss the performance of our four segments. For fiscal 2007, Applied's net sales were up 6% over 2006, led by strength in semiconductor memory capacity expansion throughout the year.

Earnings per share were up 24% year-over-year and non-GAAP EPS was up 16%. Improving operating efficiency and portfolio management activities were key factors in achieving this performance in a year where we began making substantial investments in our solar business.

Non-GAAP adjustments are detailed in the press release. New orders at $9.68 billion were 2% below fiscal 2006, as foundry and display customers reduced their capital spending plans.

Cash from operations increased 13% from fiscal 2006, reaching a record $2.22 billion or 23% of net sales.

2007 was also our year of entry into the solar market. We have been pleased by the strength of this market and the level of demand for our SunFab product. During the year, we revised our 2007 expectations for thin film solar contracts from an initial estimate of $200 million to more than $600 million. And we have now exceeded that number as well.

For the fourth quarter, our results were within the range we forecasted for orders and revenue and exceeded our target for earnings per share. The company showed strong cash flow and improved balance sheet performance as well.

Orders totaled $2.21 billion for the quarter, down 3% from Q3, with lower orders in silicon partially offset by order increases in our other three segments. Backlog at the end of Q4 increased to $3.65 billion.

Backlog adjustments for the quarter were positive at $383 million, composed primarily of $311 million of HCT orders. We also benefited from adjustments in display orders and foreign currency.

Q4 revenue was 8% lower than Q3, and within our published target. Lower silicon revenue in Q4 was partially offset by increases in all our other segments. Gross margin decreased by two points to 45.5% in Q4, primarily due to the impact of lower revenue, product mix, plus the one-time cost associated with the facility closure and asset impairment.

Q4 operating expenses were $30 million lower than Q3, with headcount essentially flat at 14,550 employees. The reduction in OpEx came from lower equity compensation expenses. Amounts received from the research and development collaboration agreement, and continuing cost focus, partially offset by increased operating expenses related to the HCT acquisition and the solar business expansion.

Now, I will discuss our segment results. As anticipated, silicon orders for Q4 were down 17% from Q3, as customers decreased their capacity additions. Our order performance was substantially above the semiconductor equipment industry, due in part to a large order that was booked at the end of our fourth quarter.

In Q4, memory accounted for 67% of orders. Our order composition was DRAM 45%, flash memory 22%, foundries 14%, logic and other, 19%. Orders for 65 nanometer, and below technology represented 81% of silicon orders.

The growing concentration of orders at the leading edge is being driven by NAND flash and logic customers’ technology buys at the 5X nanometer and below applications.

Q4 silicon net sales were down 15% compared to Q3 as anticipated, primarily due to lower spending by foundry and DRAM customers. Operating income was $550 million or 36% of sales, down in line with lower revenue levels and lower factory absorption.

We formed the Silicon Systems Group in Q3 to drive both productivity and effectiveness in the semiconductor equipment business. We are already starting to see the benefits of this change in all aspects of the business, from shorter manufacturing cycle times and lower material costs, to increased focus on commonality and engineering efficiency.

Tom St. Dennis and his team have plans for continuing to improve the productivity and operating efficiency of this organization, while fully funding its product initiatives. We will cover the potential of this new structure in more detail at our January analyst meeting.

In fab Solutions, Q4 orders were up 14% over Q3 as customers’ fab utilization increased. Net sales increased 3% over Q3 to $572 million, due to higher spares and refurbished equipment sales. Operating income was up slightly, primarily due to higher revenue levels and product mix.

Display orders for Q4 were up 80% from the low levels experienced in Q3, as panel makers began to experience more favorable market conditions. Net sales were up 7% over the previous quarter. Operating income increased slightly from Q3, reaching 26% of net sales. Cost reduction measures and product mix changes accounted for the bulk of the operating improvement.

Adjacent technology orders totaled $98 million in Q4, up 83 % from Q3. Net sales of $62 million reflected increased solar and web equipment sales. The Q4 operating loss for adjacent technologies of $30 million, reflect the charges of $9 million related to the HCT acquisition and increased spending in solar research and development, partially offset by higher revenue levels.

Next, I would like to discuss our balance sheet and cash flow. We continued to have strong cash flow performance, generating $693 million in cash from operations, which represented 29% of revenue.

Free cash flow in Q4 was $632 million or 27% of revenue, up from 22% in Q3. Working capital performance benefited from $191 million reduction in accounts receivable and a $49 million inventory decrease.

Capital spending for the quarter was $61 million, depreciation and amortization totaled $81 million, and DSO was at 79 days.

Cash and investments decreased by only $25 million despite several large cash outlays, including $463 million for the HCT acquisition and $200 million for a scheduled debt retirement

Applied returned $483 million or 70% of operating cash flow to its stockholders. Of this $483 million, $400 million was for share repurchases that retired 19 million shares at an average price of $20.95, and $83 million was for cash dividends. Net cash proceeds related to employee stock programs was $450 million during the quarter.

We remain committed to generating strong cash flows and funding our investing needs, while returning excess cash to our stockholders. Since the beginning of fiscal 2006, we have returned $6.1 billion to stockholders through share repurchases and dividends. We expect to spend between $500 million and $600 million on share repurchases in Q1 '08.

Now I will turn the call over to Mike Splinter for his perspective on the year and his view of the industry environment. Mike?

Mike Splinter

Thanks, George, and good afternoon, everyone. Our strategy for 2007 was clear: growing the core, expand into new markets and achieve a new level of operating performance. And we delivered on all three!

In 2008, with changing market dynamics, we will focus on execution and efficiency in all of our businesses and on expanding the building wave in solar. First, let me summarize a few key achievements of 2007.

Applied Materials surpassed our prior peak revenues and at the same time, delivered double digit increases in profitability and earnings per share.

This performance was particularly good considering the weakness in display CapEx and the modest growth of wafer fab equipment spending. In our year-end call last November, I said that we would grow our Silicon Systems business by roughly 10% in '07 and that's exactly what we did, even though wafer fab equipment spending was expected to be up only about 6%.

In Display, we nearly doubled our served market with the release of our PiVot PVD system, and we grew share in CVD and our testing product line. Our solar business within our energy and environmental systems group is off to a good start with over $700 million in contracts.

In Silicon Systems, share gains in etch and inspection, were the top priorities. We realized new product traction in etch, winning nine of 14 run-offs at the leading edge of technology nodes, and we gained share driven by applications for silicon and metal etch.

We also beat our target for repeat orders for UVision, by winning at four of the top five memory makers. This year, our PDC division delivered record revenue and profit, to improve performance and enhance customer satisfaction; we took a major step and streamlined the organization by combining all the semiconductor equipment divisions into the Silicon Systems Group.

Recently, Hans Stork joined that team as Chief Technology Officer, further enhancing our capability. Silicon Systems has momentum, with increased customer collaboration and focus on operational efficiency.

In fab solutions, customer factory utilization was lower than we thought it would be over the year. And as a result, our service business did not meet our growth expectations. We remain confident about the growth opportunities for this business due to our expanding install base and fab-wide breadth of services.

We are earning a larger share of the business in Asia, a region that is traditionally been a challenge for service penetration. Today's announcement of our agreement with Elpida is one example of that growth. We expanded our software product portfolio to offer complete application stack for customers to manage and optimize fab performance.

And we broadened our capabilities for chambered cleaning, a growing market, as smaller geometries require even more stringent control.

In Energy and Environmental Solutions, 2007 was a year of establishing our position in solar. We launched our SunFab integrated production line for thin film solar, and we have announced a significant number of contracts. In addition, we acquired HCT and have increasing traction with our ATON deposition system. As a result, bookings and revenues in the adjacent technology segment are starting to reach meaningful levels as our crystalline silicon glass products grow

.

Operationally, we achieved success and we are making progress on efficiency and cost improvement. We have shown that we can acquire key technologies and capabilities and smoothly integrate them into the company and get results.

We're actively managing our portfolio of products, as evidenced by our decision to exit beamline implant and electrochemical plating. And we continue to invest more than $1 billion in R&D, to grow our market position and shareholder returns.

Before I comment on the upcoming year, I'd like to commend and thank the entire Applied Materials’ team for their achievements during 2007. I am confident we have a great team and a solid foundation for the years ahead.

We see the first part of fiscal 2008 as challenging, particularly in the silicon businesses. It's a dynamic environment and caution signals from customers reflect uncertainty. We expect semiconductor CapEx to be down roughly 5% to 15% during the year.

We expect investment in DRAM to pull back, while flash should continue to be strong. Investment by foundries was weak in 2007 and we expect that foundries will remain cautious until their demand picture gains clarity.

Logic and foundry will follow roughly the same trend as in '07, with a focus around ramping production volumes in 65-nanometer and completing development of 45-nanometer technology. But, we expect to build on our momentum in etch and inspection and we are targeting our Silicon Systems business to outperform the market at a similar pace as last year.

Our new organizational structure in Silicon Systems is expected to improve operating expenses and margins through many projects, including further globalization of the supply chain.

In these times of uncertainty, it is especially important to drive costs down systematically, concentrating on both short-term and long term actions to improve the performance of the business. We are focused on both.

The environment for display is recovering; as factories are full with high demand for large sized flat-panel TV's. The industry spend is expected to increase more than 20% in 2008, with considerable upside and an approaching product transition to Gen 10 systems.

Orders are already improving, but revenue will only begin real recovery in our second quarter. We expect to gain leadership in all four of our product categories.

The prospects for our Energy and Environmental Solutions business are promising. The move we are making in solar is like a bow wave, broadening out as we move forward.

There is broad customer demand as thin film solar is now a compelling value proposition. Today's announcement of a new SunFab contract with XinAo in China signifies the breadth of the adoption of our 5.7 square meter format.

We are focusing our team on execution, and we are shipping machines and working with our customers to start up SunFabs around the world. We aim to create a worldwide solar farm standard with our 5.7 square meter module format.

In addition, we are developing our product portfolio in crystalline silicon by enabling thinner wafers and higher factory productivity in module efficiency.

Overall, we delivered a record year in 2007 and we have set the stage for 2008. We expect Silicon Systems will perform better than the market in a very difficult environment.

FAB solutions will expand share in Asia. Display will grow faster than FPD CapEx, and solar will effectively execute their SunFab start-ups around the world.

2008 is our time to demonstrate the power of applying nanomanufacturing technology to grow the company not only in our core but beyond. Thank you.

And now I'll turn the call back over to George for his comments about Q1. George?

George Davis

Thank you, Mike. Our targets for the first quarter of fiscal 2008 reflect a first half softening in the semiconductor equipment markets for orders and revenue, compounded by a bottoming of display revenue in line with the trough order levels experienced in the first three quarters of 2007.

At the same time, the display team must prepare its supply chain and manufacturing resources to meet the requirements of upturns in both flat-panel and solar. In light of this outlook, we are maintaining strict controls on costs across the company to manage the near term risk and are looking to accelerate productivity improvements that are designed to capture permanent cost reductions.

Our targets for Q1 are; we expect orders to be down in the range of 5% to 15%, the impact of the large order I discussed before has the single biggest impact on our guidance relative to others in the industry. Our target does not include any orders for our SunFab thin film production lines.

We expect revenue to be down in the range of 13% to 18%. The drop in display revenue expected in Q1 '08 has a negative impact of approximately three points on our estimate.

We expect EPS to be down in line with revenue, and in the range of $0.16 to $0.20.

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

Randy Bane

That 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 Satya Kumar with Credit Suisse.

Satya Kumar - Credit Suisse

Yes, hi, can you hear me?

George Davis

Yes, say Satya.

Satya Kumar - Credit Suisse

Sorry about that. Just a quick question on your fiscal first half comments on semiconductor orders: Most of your peers have actually guided orders up sequentially into December and even talk about scenarios of increasing orders in March.

Your orders were actually down in October in silicon. Why is it that you're not actually seeing that recovery in silicon?

Mike Splinter

I think it's primarily one major order. As we’ve looked at the ups and downs of this thing, we looked at it in many different ways, really narrowed it down to one very big memory order in October.

Satya Kumar - Credit Suisse

Okay.

Mike Splinter

That’s really a timing issue, Satya.

Satya Kumar - Credit Suisse

Okay. And a quick follow-up to that on margins: The gross margins were down 200 bps sequentially. If I look back to fiscal Q2 of '06, you had lower revenues with similar mix between the different product groups, but higher margins: how would you sort of explain the year-over-year decline in gross margins? Are there any, meaningful, changes to the pricing environment for semiconductor products?

George Davis

No. We had some higher M&A impacts that would be reflected year-over-year, but it was primarily due to, we had some one-time effects that had greater than a one point impact on gross margin. So, if you look at our operating margin, it was at least a point and a half above what we had as a GAAP margin.

Satya Kumar - Credit Suisse

Okay, thank you.

Operator

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

Gary Hsueh - CIBC World Markets

Hi, guys. Thanks for taking my question. If I kind of look at your bookings guidance and continued softening in semis off of a $1.3 billion mark, $1.3 billion was sort of the low point in terms of semi bookings by my calculations in '05, and if we're really looking for CapEx down 5% to 15%, I would have thought we could see some stabilization here off of your October number. Now, should we interpret this as some market share loss or is there some rotation happening here that you guys are a little bit less exposed to? I mean: what's going on in terms of semi orders seeing further softness versus the bottom in '05?

Mike Splinter

Well, you asked a little bit of a complex question and I don't necessarily want to go back and analyze '05, but if we look at what's happening in the market today, I think what you will find is that it was a big order of timing. If we look forward and look into our Q2, we've gone over this project-by–project, what's happening product-by-product, what's happening, customer-by-customer, our bottoms up look is for increase in orders in Q2.

But, and I can't be too specific about that at this point, because there's a long road ahead and a lot of both economic and financial data that will happen at the year-end, as well as how the whole selling season goes during the holiday period, but there's no real share loss in these numbers. And really there, when we look at the order picture, usually we think that there will be multiple big orders during a quarter. It looks to us like everybody is pretty cautious during this yearend period.

Gary Hsueh - CIBC World Markets

Yes, okay. So it's just really a timing issue and lumpiness in the business? I mean your October quarter was pretty lumpy in terms of that one customer booking at the tail end, so I guess that's really it. Just on something a little bit more positive here, I understand that basically, you're going through an installation of the SunFab on the thin film side here in Asia. Can you give us any kind of detail or any kind of granularity on how that's proceeding and if you've got any more visibility on the lead time between an install and revenue recognition in the back off of '08?

Mike Splinter

I will let, George comment on revenue recognition. I was just out at that operation. It's in India. Our CVD system is on the floor. Our PVD system is there. The automation systems are all there. Our team is set to go. The customer is finishing up the building. They have a ton of people just working to complete it, so as far as any published schedule, we're on track there. We have everybody scheduled down to the hour on these kinds of projects and that goes for pretty much everyone. I'm really quite excited about how fast I think we're going to learn as we build more and more of these SunFabs around the world

George Davis

So, on the revenue recognition and really on bookings as well, might as well cover both at this point, our position really hasn't changed. We expect to begin booking these contracts some time in the first half of our fiscal year. We've said that we believe that first revenue would come at the tail end of our fiscal year, but the bulk of the revenue that we see from contracts today would be in early '09.

Gary Hsueh - CIBC World Markets

Great! Thank you, George.

George Davis

You welcome.

Operator

Our next question comes from the line of Timothy Arcuri with Citigroup.

Timothy Arcuri - Citigroup

Hi, guys. Just kind of a big picture question: If you compare your solar business to the semi business, and you look at your business model there, solar seems like more of a commodity than is semiconductor. It's really all about cost, and it seems like your tools represent about 70% of the cost of the line in solar versus only maybe 10% to 15% of the cost of the line in semi. So, if you also look at the customers, they're all trying to vertically integrate as well, so: would it seem logical that you also try to become more vertically integrated in that segment?

Mike Splinter

Hi, Tim. At some time you'll have to explain to me in more detail your thoughts on this, I'm quite interested in them, but really, the way we're thinking about this is if we can get many, many customers building SunFabs, we're going to be able to have thousands of engineers working on driving the cost down. That's what's really going to make the market accelerate and expand and if we can be successful in establishing our 5.7 square meters as a worldwide solar farm standard, there's a very, very powerful business concept, so that's pretty much the path we are moving down. As you know, we've really moved a step beyond our normal equipment only horizontal business segment, but now selling really the technology and starting up the entire fab for customers, guaranteeing output basically, and participating together with the customers, and enhancing the performance of those factories.

Timothy Arcuri - Citigroup

Okay, yes, I guess to me it just, if your tools really are that value added, it just seems like it would be better over the long term for you to actually make the panels yourself. I guess just as a quick follow-up, George, whatever your bookings for or your contracts were for solar in fiscal '07, you said they were more than $700 million. Can we assume that all of that number, at least that number, will become orders during fiscal '08?

George Davis

We are not going to give out a specific guidance on that, but unless there is something that comes up on them that we don't see today, I would expect to be able to book them this year.

Timothy Arcuri - Citigroup

Okay, thanks a lot.

Operator

Our next went comes from the line of Stephen Chin with UBS.

Stephen Chin - UBS

Thank you. Mike, how should we think about your commentary about the flat-panel equipment orders improving? Should we expect flat panel orders to be a gradual improvement for Q3 2008 or is it possible that we can see a big step function increase in one quarter given that AMAT is still gaining share in CVD and is expanding to PVD? How do you before see this flat panel recovery occurring?

Mike Splinter

Well, what we see so far, we already saw a pretty good jump quarter-over-quarter, and if you look year-over-year at our numbers they are, I think we said 80% quarter-over-quarter; year-over-year they're up way over 100 %. So, that's the definition of a jump. From Q2 on out, I think it's hard to say. It depends a little bit how fast Gen 10 factories come on, if one of the other major companies commit to a Gen 10, obviously we could see another major jump in orders. In the shorter term, it's mostly filling in existing factories as fast as they can fill them in with equipment.

Stephen Chin - UBS

Okay. And if I could just change the topic to solar, can you guys give us an update regarding the synergies across the flat panel equipment and the thin film solar equipment? Can we assume that AMAT successful flat panel Gen 8.5 process results? Or: can we assume those are repeatable in the thin film solar equipment?

Mike Splinter

Well, the equipments are basically the same, Stephen, and that's one of the things that gives us so much confidence that we're going to be able to expand this factory base and grow the capacity very quickly is the CVD system is pretty much the same CVD system we use in the flat-panel area. We're shipping already and the deposition system is the similar as we use in the glass business. So, we're quite confident about our equipment capability and our thin film capability in those two areas. Other products that we're buying from third party suppliers are less sophisticated and are add-on process steps, so the critical ones we control so we're pretty confident about that.

Stephen Chin - UBS

Okay. Thank you very much.

Operator

Our next question comes from the line of Jay Deanah with JPMorgan.

Jay Deahna - JPMorgan

Good afternoon. Can you hear me okay?

Mike Splinter

Yes.

Jay Deahna - JPMorgan

Okay, Good afternoon, Mike. A couple of questions on solar: First of all: it looks like the bookings in applied technology has almost doubled to $98 million in the fourth quarter from $55 million. I am just wondering: what drove that increase? And: over time, what is your strategy for crystalline silicon? And: how do you see sort of your revenues balancing up between those two over time? And then the last question is: can give me your sense on the competitive landscape in thin film solar equipment, in particular with [Erlicon] and sort of identify who else is out there that could potentially do a whole line? Where is Allvac, etcetera?

Mike Splinter

Sure. So, on the silicon, crystalline silicon bookings are up to $98 million, really two factors. One is HCT, and the other is traction on ATON, and as the crystalline silicon lines have gotten bigger, the productivity of ATON has really come into play. You have to have a fab 50 megawatts or above for ATON to really be effectively utilized and we're starting to see that now. It also helps with efficiency and color uniformity, so it has multiple benefits for customers. What we're trying to do in the crystalline silicon area right now is to really get focused in those areas that really are critical to moving the technology forward. Thinning wafers it was really the reason why we went after HCT, because we felt that their technology was critical to both handling and moving to thinner wafers. This is important, because silicon is still so much of a cost per watt. And we think if we keep going on a road map, we cut the number of [grams] for silicon in to half and then if we keep moving on that road map over the next few years, in half again, and then with our ATON tool as I just described, it really is another major factor in the performance of the crystalline silicon.

Now: how we view the relative revenue? Because our participation in crystalline silicon is small and there's more competition there, and the popularity of our thin film lines right now, our thin film lines will far exceed our crystalline silicon revenue by 2009, or in 2009.

On the competitive landscape, the key here is the 5.7 square meter. No one else is in our 5.7 square meter space. Why is that important? It's important, because in the solar farm, and really in any solar installation, but where these products are aimed at is the solar farm area. You got to reduce the installation cost, the bracketing, the cabling, the inverter costs, the mounting costs and that's really why we chose the larger size. Because we know that in an industrial-like installation or a major roof top installation on a big box building, you'll be able to drive those installation costs down with the larger panels, and get an even bigger effect over just raw efficiency. So, if the cost per watt and efficiency are equal, the larger format will win in any major industrial application. So that's kind of it but Erlicon and Allvac are the big other players in thin film, both at the 1.4 square meter size.

Jay Deahna - JPMorgan

And just one quick follow-up: Do you see kind of a Moore's Law, to use an analogy, road map to get the efficiencies on thin film down to the point where that could actually accelerate the market? Is that sort of by your technologists, a clearly defined road map that your engineers can execute to with some level of confidence?

Mike Splinter

Yes, and I think Mark Pinto at our January 17th analyst meeting will kind of go overall of the elements of how we are thinking about what technology we have to develop and create to keep the efficiency rolling on thin film silicon. Silicon is a material people know, they can handle it and know how to deposit it and we just think that the flexibility of that and the number of engineers we're going to have working on it are going to all help us drive the efficiency up and the productivity up as well to reach the best cost per watt produced in the industry.

Jay Deahna - JPMorgan

Thanks a lot, Mike.

Mike Splinter

Thanks, Jay.

Operator

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

Harlan Sur - Morgan Stanley

Hi, good afternoon. Mike, within your view of growing Silicon Systems business faster than the market in '08, I'm just wondering: if you can articulate which segments will be the drivers of that growth?

Mike Splinter

Sure. I pretty much noted it, but we're going to continue to focus on our etch and PDC area for share growth and we expect to be competitive in all of our other areas. We fiercely compete in those areas over a long period of time; we expect to do well there.

In PDC, as I said, we've gained additional traction in UVision; we think that's going well. We have a mask inspections system out there that perhaps will get a little revenue in 2008. In etch if we look at, I highlighted some of the really critical leading edge kind of applications we won, but if we look at the broader number, we participated in 60 run-offs, won 41 of them, that are quite a bit above our historic average. So, we're pretty encouraged in those areas, and EPI has just been great as more and more of the DRAM guys have to use EPI. They use a lot more wafers than the logic guys, so EPI is a big play there.

Harlan Sur - Morgan Stanley

Okay. Great, thank you. And then given your CapEx, the wide range of the CapEx outlook for next year, maybe you could just articulate, which segment is going to be this biggest swing factor in determining what end of the range we come in. Is it going to be logic and foundries or is going to continue to be memory in your view?

Mike Splinter

Harlan, the way I'm looking at this right now is: the DRAM guys are going to pull back. We already see them pull back, so I think they're going to be down in something 20% to 30% range. We think flash will be up, but DRAM is so much bigger at this point, it's not going to make up for that. And then the foundries and logic kind of looking at their factory as you kind of listening to them you'd think they are going to be down 10% to 15%. When you look at their factories, their factories are full, filling up and you'd think from that standpoint, they would be more down like 5% on the year. But, I think we have to wait till January and listen to the announcements that they're going to make and modify our view at that point.

Harlan Sur - Morgan Stanley

Okay. Last question for George: George, what's the tax rate outlook for 2008?

George Davis

Harlan, well we're looking at the low 30s, so 30, 31.

Harlan Sur - Morgan Stanley

Okay. Great! Thank you very much.

George Davis

You're welcome.

Operator

Our next question comes from the line of CJ Muse with Lehman Brothers.

CJ Muse - Lehman Brothers

Yes, good afternoon. Thank you for taking my question. I guess a couple questions here. First off, just directionally: can you comment on order outlook by segment?

Mike Splinter

Well, I mean, I think, we've given some indication clearly silicon is down. We're not going to obviously guide by segment, but display is clearly showing positive momentum. Adjacent we'll have to see how that plays out. Obviously they have HCT fully embedded in there now. And then so that brings you to fab solutions and we expect to see usually Q1 is kind of a peak order quarter for them, but for the outlook, we have a more moderate order scenario for them.

CJ Muse - Lehman Brothers

Typically, you'd show growth in that 1Q off of 4Q and you had a pretty nice quarter in 4Q. Did you see sort of a pull-in from 1Q?

Mike Splinter

No, the way I would look at it, we always pull in, so I don't know what that means other than nothing out of the ordinary in my view. I think it's really more of a function of the outlook that we have for the early part of '08 and how that trickles over from the silicon equipment side into the services side.

CJ Muse - Lehman Brothers

Got you. And then I guess on the display and solar front you moved a number of employees from AKT over to solar and now we're staring at probably at least a two year up cycle for display, so I guess my question here is: do you have the wherewithal to service both clientele? And: can you comment on what impact it will have in terms of a ramp in both segments? Will have on your OpEx structure?

Mike Splinter

Well, I'll take the first part and George can handle the second part of the question. What we're doing here is basically the display division is supplying a couple pieces of equipment to the solar division. So they're staying very focused on developing their supply chain, but we got great suppliers in this space. We know how to ramp this. We've been thinking about it for some time and being prepared here. I don't have any worries about being able to supply the capacity. Almost whatever, we think it could be in solar plus display. And part of the strength of this is that we not only move some employees from AKT, we moved a lot of employees from around the company to be able to help solar become a real company and grow fast. That's one of the benefits and strengths of Applied Materials.

George Davis

And in terms of the OpEx, we do see the OpEx continuing to expand. This is obviously the critical execution phase, so we'll continue to build our capability globally to support that. But what you're seeing is in both the underlying web and glass businesses that have been in that segment for the last year and then the addition of our precision wafering capability through HCT acquisition, you're going to see more revenue along with again as Mike talked about the increasing traction on the ATON tool in crystalline silicon you'll see more revenue helping to fund some of that activity well within its own segment.

CJ Muse - Lehman Brothers

Got you, and last question for me: Can you give a sense of the magnitude of that large order that came in the last month of the quarter? Is it 100-200? Just give us a sense.

George Davis

The way I would describe it is that it certainly explains the differences that you might see comparing quarter-to-quarter differences between us and the industry.

CJ Muse - Lehman Brothers

Got you. Thank you.

Operator

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

Patrick Ho - Stifel Nicolaus

Thanks a lot. A couple of questions: First, and I think it's clear that you're going to see some initial margin pressures in the solar business as you ramp up over the next 12 months to 18 months, but: what can you do in your other businesses in terms of their respective margin profile to sort of offset some of the ramp up costs associated with solar?

George Davis

Well, I think you've already seen that this year. We've done a lot of things to take a hard look at our portfolio across the company, but, again, each business has their own business model that they're going to operate to. We've talked about the Silicon Systems Group coming together and part of that is quite frankly, because we saw efficiencies that we could gain while at the same time improving their competitiveness. So, the only problem I have, your question sort of structures the position of are we going to in some way damage or under invest in our other businesses, while we rollout the solar business, and we have to compete fiercely in all of our segments and we'll invest fully in those. But we're going to look to make sure that we're as productive and efficient as we can, because we do know that the business model is going to be tested a little bit during this build out and we want to make sure that we manage that carefully.

Patrick Ho - Stifel Nicolaus

Yes, I don't think, I wanted to say that you were going to be under pressure as a whole company. I am just wondering, you have made a lot of improvements. Can there be continued improvements that I guess help offset any of the initial pressures you'll see in the solar ramp? Because it sounds like you guys have plans in place to do that.

George Davis

No, I think we do and we've talked about some of the bigger ones before, but we're really under-penetrated in terms of our global supply chain and particularly in lower cost regions. That will have a big impact over time on a company and that's quite frankly one of the things that Tom and his team are very focused on in the silicon segment.

We're investing this year and it will continue into next year into improving our systems infrastructure, which will also make us more efficient on all of our businesses, but also allow us to bring in new businesses a lot more effectively. So, we're looking at a lot of things along those lines. We've got kind of a continuous improvement road map.

Patrick Ho - Stifel Nicolaus

Great! Mike, this question is maybe more for you: You expressed that there's this cautious sentiment from chip makers right now that's obviously looking out into 2008.

Are there any near term events, say like the holiday season sell-through and the outcome of that, that could change the sentiment over the next two to three months that may make either the outlook better or worse?

Mike Splinter

Sure. Absolutely! Depending on how things go over the holiday period through Chinese New Year, it will especially dictate what or how aggressive the flash and foundry guys are going to be. Computer sales have been okay this year, so that's kind of a positive. And frankly, if you watch the news of the last couple of days, Wal-Mart and Macy's both have positive retail numbers, which I think, kind of, surprised everybody. Maybe it's a trend and if it is, I think, we could see some positives going into the first part of the year. I just think, we got to stay calm and watch everything and then inside our company we have to do all of those things to execute cost control, long term and short term.

Patrick Ho - Stifel Nicolaus

Great! And then final question for George, just two financial questions: You mentioned a one-time charge in the cost to goods line and facility closures. Do you have that number? And: what was the total dollars of stock options expensing?

George Davis

Total dollars for stock option expensing I believe was about 33, I think it's about 33 but we can verify that for you. And then on the asset, the combination of asset impairment and facility closure was about a $24 million impact.

Patrick Ho - Stifel Nicolaus

And: that was all in cost to goods?

George Davis

Yes.

Patrick Ho - Stifel Nicolaus

Great! Thanks a lot, guys.

George Davis

Yes.

Operator

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

Brett Hodess - Merrill Lynch

Good afternoon. Mike, you mentioned that you thought your Silicon Systems performance in the coming year would be similar relative to the market versus last year, so if the market is down 5 to 15 this year, you were up 10 versus six or so as you said. Would that mean that your silicon systems business might be between say, flat and down 10? Or: something like that given the range?

Mike Splinter

Yes, I'm really not prepared to quite give you a range, because I don't know exactly where the wafer fab equipment’s spending is going to end up, but I think if we take that variable out, we should be plus three or four to the market.

Brett Hodess - Merrill Lynch

Okay. And then a quick follow-on: If you look at the logic side of the business in aggregate, so foundry, IDM's and micro processors, they haven’t really grown in the last four or five years on CapEx. It's been sort of stable to slightly down actually, yet they've grown their capacity pretty well. So: do you think that they've changed their productivity capabilities if you will relative to the memory side of the market and that continues going forward?

Mike Splinter

Well, companies like ours and our competitors are delivering a lot of productivity to the customer base, and almost any of our machines, the number of wafers that go through it today is substantially more than what went through five years ago. So, that's a big part of it and then there's Moore's Law which is another big part of it. And then there's the third factor of what's really driving the leading edge of the technology and how vast are products moving on to the end generation of technology and we're seeing that go slower than in the past. So, that ramp gets spread out a little longer, gives them more time to get more productivity improvement in that ramp. And I think that's why we're largely seeing their CapEx be able to stay pretty stable versus their overall business continues to grow between 5% and 10%.

Brett Hodess - Merrill Lynch

Okay, thank you.

Operator

Our next question comes from the line of Jesse Pichel with Piper Jaffrey.

Jesse Pichel - Piper Jaffray

Good afternoon. I'm sorry if I missed this, but: when can solar equipment sales start to get recognized as revenue?

George Davis

Yes, I answered that earlier, but it was first for revenue we believe the earliest will be at the end of our fiscal year and the both of the revenue recognition would be in the first half of FY '09.

Jesse Pichel - Piper Jaffray

'09.

George Davis

As it relates to the contracts that we've announced.

Jesse Pichel - Piper Jaffray

HCT had about a 15-month lead-time on equipment prior to your acquisition. Have you sought to reduce that lead-time and what is it today?

George Davis

Sure. I don't have a specific lead-time number for you today, but it is continuing to improve. We're working very closely with the management team there. This is an area obviously where we can help with our manufacturing expertise. So, we expect to reduce that significantly throughout the year.

Jesse Pichel - Piper Jaffray

And: could you shed some light on Flextronics or you're not able to talk about that at this time?

George Davis

No, It’s an investment from our venture fund. That's it.

Jesse Pichel - Piper Jaffray

Okay, and my last question is: AMAT carries some significant political might there in the West Coast and I'm wondering if AMAT has a position there on supporting potential U.S. legislation and given that the potential positive solar provisions within the Energy Bill are at risk at current? Thank you.

Mike Splinter

Yes. I don't know how much political might we have, but we've certainly been weighing in on this on the Energy Bill for some time as you know, we all expected a good Energy Bill to be passed some time in late June or early July. It hasn't happened. I have confidence though that our legislators are going to pass an Energy Bill that's meaningful and in an environment with $100 of oil per barrel, it's hard to imagine that they can pass an Energy Bill without clean energy and renewable energy as a major part of it.

I believe people do support the incentive tax credit, but there's other issues with the Bill on how to pay for those and they have to work through those issues, but I think in the end, they have to find a way to do the right thing for the country. Today, the U.S. isn't much of a market for solar. Most of the solar installations are in Europe expanding in China and India. The U.S. few roof tops, but roof tops never going to be, residential roof top is never going to be a market that is cost effective.

Jesse Pichel - Piper Jaffray

Thank you very much.

Operator

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

Mark FitzGerald - Banc of America Securities

Thank you. Mike, the company has done a great job diversifying the product base here. The LED market looks like it should be a big opportunity given your focus on nanotechnology. Any comments there on opportunities you see?

Mike Splinter

Well, we form the Energy And Environmental Solutions business to really start to take a look at not only creating energy, but saving it and storing it, so if we could come up with a solution that would help lighting that, that would certainly fit into that group, but other than a desire, we don't have a product to announce yet, Mark. But it is an important area for us in the future.

Mark FitzGerald - Banc of America Securities

All right, and then just, I guess for George: on the expense side here, given the near term outlook in semiconductors: can we expect cuts coming in R&D and SG&A from the levels that we're at in the fourth quarter just reported?

Mike Splinter

Yes, we're looking at all areas of spending and making sure that obviously we take care of the critical projects. But yes, we're going to look, nothing is completely sacred here.

Mark FitzGerald - Banc of America Securities

Okay, and then just final question: George you said there was no orders for the SunFab in the first quarter. Is that because there's none going to fall? Or: because you don't know exactly if they're going to fall or not in the quarter?

George Davis

Yes, what I said was in our targets for orders, we did not include any orders for the SunFab lines. But the right answer is until we have a clear picture that for sure we will see some in the first quarter; we just didn't feel we could include it.

Mark FitzGerald - Banc of America Securities

Okay. Thank you.

George Davis

Yes.

Mike Splinter

Thanks Mark.

Operator

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

Steve O’Rourke - Deutsche Bank

Thank you. Mike, you mentioned that your crystalline silicon strategy in Solar PV is to focus on areas that move the technology forward. What in your view are those areas? You mentioned thinner wafers but what are some of the others?

Mike Splinter

Well, there are a couple of others. One, which I also mentioned and that's controlling the passivation layer of backside contact, and one of the key things that when you go into a solar fab often times color gets beamed in 20 different beams, so getting that color uniformity is incredibly important for the performance of the line, so those are several of them.

How exact, there's a big tradeoff between complexity and efficiency, and this is something that we're fortunate enough to have quite a few people from the industry with great expertise that are really looking at that area of how do you create the simplest process with the highest efficiency. Most of the turnkey lines today are in the 13% to 15% kind of efficiency range. You got to do something really special to get up to 20% in design of the way you make the diodes. So, but that always costs you a lot of money to do that. And so you wouldn't do it unless you're space constrained, so we have people looking at all those kinds of things that are going to improve the technology.

Steve O’Rourke - Deutsche Bank

Fair enough and on the silicon business side, you mentioned that with the “bottoms up” analysis, it indicates that orders should increase in fiscal 2Q, just preliminarily looking at things? Of that “bottoms up” analysis: how much is memory as a percent?

Mike Splinter

Well, memory is still a big part more than 50% of that. So it's not like we're going to expect overall memory to drop off gigantically, because we think DRAM is going to be down, flash is going to be up. So, it ends up on that “bottoms up” more than 50%.

Steve O’Rourke - Deutsche Bank

Were there any cancellations in the quarter?

Mike Splinter

George?

George Davis

Minor.

Steve O’Rourke - Deutsche Bank

Thank you.

Randy Bane

Operator, we'll take one last question and then make our closing remarks.

Operator

Our last question comes from the line of Steven Pelayo with HSBC.

Stephen Pelayo - HSBC

Great. Just a couple quick ones, George, housekeeping ones here: I'm impressed with the 27% of revenue, the free cash flow margin there; I think it's some of the best numbers Applied has seen. What's your outlook for CapEx and depreciation in '08? And, perhaps more importantly: can you just talk a little bit about what's structurally different? It looks like you guys are generating cash flow from operations quite better than what you did in 2000 and 2001 and it's growing faster than revenue growth for example. What are we thinking, as we look out to '08? And: can we kind of maintain greater than 20% free cash flow margin?

George Davis

Yes, I think that's certainly our objective, and number one is we're much more asset efficient than we were back then. And as you know we've been reducing our asset footprint for some time even as our revenue has grown, the cycle times and our manufacturing operations are far shorter. So, the requirements, they are less, so we'll continue to  -- our working capital management is a real focus. And so, you've seen inventories come down, so all these things are adding up to better cash flow performance and I think that's the requirement that we put on the organization. We're going to continue to return cash flow to the shareholders and at the same time we're going to continue to fully invest in the business and if you don't manage cash flow you're just not going to get there.

Stephen Pelayo - HSBC

And I'm sorry, the outlook for CapEx and depreciation in '08?

George Davis

I would say that we don't see any substantial increase in CapEx required. Most of the CapEx this year has really been around the investment in business transformation and some minor lab and other facilities for the solar business, but I don't see any major change from the run rate today.

Stephen Pelayo - HSBC

And then the last quick question is just on: the absolute cash balance, $3.7 billion or so. Looks like you've been just returning as a percentage of operating cash flow and still managing to really hold your cash relatively flattish or so. Do you think, as we look out maybe a year from now, that we won't need to carry this high level -- cash level where we think actual cash balance declines?

George Davis

Sure, we've said that we're comfortable with the cash balance lower than today's level. Quite frankly, option exercises the last couple of quarters has added to the cash portfolio at a fairly substantial level, so we'll take that down, that will come down and we don't intend to even keep it at this level. So, something around the $3 billion mark is kind of where we said we would like to operate on and we haven't changed our view on that.

Stephen Pelayo - HSBC

Okay. And I should just apply all of that change in cash and whatever cash you generate over '08 into buybacks and dividends right?

George Davis

That's right.

Stephen Pelayo - HSBC

Thank you.

Randy Bane

Okay. We would like to thank you for joining us in our discussion on Applied Materials financial results and we would like to remind you that a replay of this call and the supporting slide package will be available on our website starting at 5 p.m. today, and will remain posted until November 30. Thank you for your interest in Applied Materials. I hope to see you in New York on January 17th. This concludes our call.

Operator

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

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