應用材料 (AMAT) 2006 Q1 法說會逐字稿

Welcome to the Applied Materials first quarter fiscal year 2006 earnings conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to Mr. Paul Bowman, Managing Director of Investor Relations, Applied Materials.

Please go ahead, sir.

Thank you.

Good afternoon everyone and welcome to Applied Materials' first quarter 2006 earnings conference call.

With me today are Mike Splinter, President and CEO, Nancy Handel, Senior Vice President and Chief Financial Officer, and Joe Sweeney, Senior Vice President, General Counsel and Corporate Secretary.

Financial results for our first fiscal quarter were released on Business Wire shortly after 1:05 p.m.

Pacific Time.

For your convenience, a copy of the news release, as well as a presentation that contains highlights of today's call is currently available on the Investors Section of our Website at www.appliedmaterials.com.

Today's earnings call contains forward-looking statements including those relating to Applied Materials'; financial performance, cash generation, cash deployment strategies, operational efficiency, margins, financial model, tax rate, technology leadership, strategic position, product momentum, growth opportunities, delivery of stockholder value, and financial targets.

Also, customer fab utilization trends, capital spending and investments in advanced technology and services, end use demand for flat panel displays and other electronic products and the global, economic and industry outlook.

All forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements.

Information concerning these risk factors is contained in today's earnings press release, and in the Company's filings with the SEC, including its Forms 10-K for fiscal 2005, and its most recent Forms 10-Q and 8-K.

Forward-looking statements are based on information as of February 15, 2006 and the Company assumes no obligation to update any such statements.

Today's call also contains non-GAAP financial measures.

Reconciliation of non-GAAP financial measures to GAAP financial measures are contained in our earnings press release, issued today, and in the document entitled "Earnings Call Highlight", both of which are available on the Applied Materials Website.

Today's call will begin with an analysis of first quarter financial results by Nancy Handel followed by Mike Splinter who will provide an update on the industry environment Applied's strategic position.

Following Mike's comments, Nancy will provide the second quarter 2006 financial targets.

We will then open the call for questions.

With that, I would like to turn the call over to Nancy.

Nancy?

Thank you, Paul.

Good afternoon, everyone and thank you for joining us.

Today, I will cover the results of the first fiscal quarter of 2006.

As we entered 2006, business conditions strengthened and drove improved performance for Applied.

Demand, coupled with customer's needs for our most advanced solutions, resulted in higher orders and strong profitability.

Our continued focus on improving overall efficiency is yielding financial success.

Our employees' commitment to delivering technological innovations and value-added services that enhance customers' productivity is what makes us the leader in our industry.

Highlights for the first quarter were strong order performance, and an increase in -- an 8% increase in revenue, flowing through to gross margin at 56%.

In addition, we continue to deliver leading -- industry leading cash flow and returned value to our stockholders through increased efficiencies.

For the first fiscal quarter, orders of 2.04 billion surpassed our target and were 21% higher than the fourth quarter of 2005.

Revenue for the first quarter was 1.86 billion, 8% higher than the last quarter and exceeded our target.

Operating income was 144 million, or 8% of revenue, compared to 21% for the fourth quarter of 2005.

Net income was 143 million, or $0.09 per share, compared to 247 million or $0.15 per share for the fourth quarter.

Results for the first fiscal quarter included asset impairment and restructuring charges of approximately 215 million or $0.08 per share, and equity-based compensation expenses of 52 million or $0.02 per share.

Of this 52 million, 9 million was reflected in gross margin and 43 million in operating expense.

Excluding these charges, the Company would have reported net income of 312 million, or $0.19 per share.

Reported gross margin for the first quarter was 45.1%, compared to 44.2% for the fourth quarter of 2005.

Equity-based compensation programs decreased this quarter's gross margin by 0.5%.

Increased customer demand drove higher than expected order growth.

In the quarter, DRAM orders represented 28% of silicon systems orders, flash memory orders were 18% and foundry orders were 19%.

Logic and other orders comprised the remaining 35%. 300-millimeter orders represented approximately 84% of total systems orders.

And 89% of the systems orders were for 100-nanometer and below, process technology.

Three orders were in excess of 100 million.

Four orders were between 50 and 100 million.

And 14 orders were between 10 and 50 million.

Historically, many service and parts contracts have been renewed during the first fiscal quarter.

This quarter was no exception, and we had very strong service and parts orders.

Flat panel demand for generations 5 through 7.5 was also strong.

During the first quarter, orders increased from customers in Korea, Europe, North America and Southeast Asia and China.

Orders by major geographic areas were;

Taiwan 24%, North America 22%, Korea 18%, Europe 15%, Japan 13%, and Southeast Asia and China 8%.

Backlog for the quarter increased to 2.73 billion, compared to 2.57 billion for the fourth quarter of 2005.

Backlog adjustments totaled $30 million, consisting primarily of currency adjustments and a few cancellations.

During the first quarter, broad-based customer demand, rising fab utilization and investments in advanced technology drove the revenue increase.

Our continued focus on improving operating efficiency is paying off in the form of increased gross margins.

During the first quarter, we saw a 20% reduction in cycle times on 300-millimeter products that were delivered utilizing an integrate to order manufacturing process.

Excluding asset impairment, restructuring charges and equity-based performance Applied's financial performance exceeded our targets and met our Company model.

Operating expenses of 694 million included asset impairment, restructuring charges and equity-based compensation expenses totaling 258 million.

Excluding these items, operating expenses increased approximately 27 million, primarily as a result of increases in variable compensation.

The effective tax rate for the first quarter of 22.4% was lower than forecast, primarily as a result of the benefit from the asset impairment and restructuring charges.

We anticipate the effective tax rate for the second quarter will be be approximately 31.5%.

Excluding asset impairment restructuring charges and equity-based compensation expenses, Applied's return on invested capital would have been 34%.

We define return on invested capital as operating profit after tax, excluding one-time tax benefits calculated on annualized basis, divided by the average invested capital; less cash, cash equivalents and short-term investments.

Our free cash flow generation for the quarter was 372 million.

We define free cash flow as cash provided by operating activity less capital expenditures.

During the quarter, cash, cash equivalents and short-term investments decreased 127 million, to 5.8 billion, and included the repurchase of 27 million shares of our common stock for $500 million.

Since the beginning of fiscal 2005, the Company has repurchased approximately 128 million shares for a cash outlay of 2.2 billion.

During the second fiscal quarter of 2006, we plan to repurchase shares in the range of 400 to 600 million.

In December of 2005, the Company declared a cash dividend in the amount of $0.03 per share, payable on March 9 to stockholders of record as of February 16.

Accounts receivable increased by 139 million, an inventory decrease by 11 million during the quarter.

Capital spending for the quarter was 49 million and depreciation and amortization totaled 70 million.

Headcount at the end of the quarter was 12,584 regular employees.

As we enter our second fiscal quarter of 2006, we remain focused on driving gross margin performance through Company-wide material cost reduction initiatives such as common platform architecture in parts, lower cost sourcing, integrate to order initiative and continued cycle time reductions.

Our continued focus on improving operating efficiency is driving increased profitability and strong free cash flow.

Mike will now provide his perspective on the market environment and the Company's strong strategic position.

Mike?

Thanks, Nancy.

Good afternoon.

And I would like to add my welcome to all of you joining the call today.

As you can see from our press release, we have an exciting start to 2006.

We experienced a significant increase in customer demand at year-end, which is extended through the quarter.

And translated into higher than expected order growth and strong financial performance for Applied Materials.

This was the second quarter if a row of increasing revenue and bookings.

As we predicted last quarter, Q1's service orders were up, primarily due to annual renewals of service and parts contracts.

However, the upside to our revenue and order projections came from semiconductor systems, which rose significantly during the quarter.

We are seeing momentum across our system product portfolio for both high volume production, as well as leading edge 65 and 45-nanometer chip development applications.

We are gaining market share and are in a good position to continue these gains.

I'm confident that our innovative technology solutions are driving Applied to outgrow and outperform the industry.

With the opportunity to deliver strong financial results throughout 2006.

Discussions with customers about the prospects for 2006 leave me feeling really quite optimistic.

The basic building blocks for demand in our end market are in place.

Global macroeconomics are stable, with the major world economies growing at respectable rates, while emerging markets like China and India continue to boom.

Demand for semiconductors and semiconductor related technology continues to increase.

Fueled by the continued ramp of broadband around the world, the pervasiveness of PC's and cell phones, with complex chip and display applications, and new must-have consumer products with increasing amounts of digital content.

The worldwide popularity of consumer applications translates directly into strong chip demand and the need for new fabs to feed those markets.

The Olympics and the adoption of high-definition TV are driving a surge in new generations of flat panel TV's, which are extremely attractive in terms of picture quality and price.

Our technology is directly linked to making those TV's possible and more affordable.

We shipped the world's first Gen 8 PECVD system in January.

The glass substrate size is over 5 square meters and capable of producing six, 52-inch LCD TV's.

While we expect flat panel orders to be lower for the next two quarters, manufacturers are set to start the next phase of capacity expansion in the second half of the calendar year.

In addition to expanding consumer electronics, corporate investment in IT is strengthening.

The emphasis on security, server consolidation and the transition to more robust IP infrastructures is expected to bolster the spending for products with increased silicone content.

Together these drivers result in a strong demand for memory and our customers are investing to produce increasing quantities of NAND flash and DRAM.

Continued double digit growth in PC's, strength in cell phones, the shift of game consoles to the cell architecture and increasing die sizes around the industry are expected to have a positive impact on our market in '06.

These industry factors, coupled with low inventories, high fab utilization rates, add up to a very positive environment for wafer fabrication equipment spending.

High fab utilization also translates into demand and opportunity for growth in the service products that we offer, through Applied Global Services and Metron Technology.

When we look across the landscape, we believe the potential exists for an extended upturn.

Of course, this view depends on continued U.S. consumer spending on high-tech devices, as well as rapid expansion of consumer electronics spending in both China and India.

Demand for broadening technology applications is producing opportunities and market share gains for Applied in memory, logic, flat panel and service solutions.

Third-party forecast for semiconductor industry revenue have an upward bias and in our view, the outlook is currently 7% to 10% year-over-year.

We are revising the view we discussed in our November call for CapEx to be up now between 10% and 15%.

And we see WFE spending rising some 15% or 20% in 2006.

This demonstrates that there's increasing equipment intensity in our industry.

This year we're focusing on several key areas.

First, we help our customers continue to drive Moore's Law by offering them solutions that enable them to shrink from technology node to technology node.

Our CVD business has been expanding applications significantly over the last year, which has shown up in the near doubling of orders over the last two quarters.

We have made significant gains in Low-K dielectrics.

This is where our Black Diamond I and II reside.

We have strong leadership in advanced patterning films, strain engineering and the need for Harp and other SACVD films and flash memory is expanding.

Basically, we are winning all the new applications for our CVD product line.

We have won every major PVD runoff since last August in both memory and logic.

Our thin film technology and capability to do differentiated contact and via cleaning optimizes the contact resistance, the reliability and the yield.

Giving us a growing technology and market lead.

Our CMP system set the standard in the marketplace and our ECMP system is leading the way for 45 nanometer, where the combinations of Low-K dielectrics and small metal features requires new technology to reach our customers' yield and defect goals.

At Applied, we have a new attitude about Etch, with new leadership in place, we are putting renewed focus and resources towards winning in the Etch market.

Our Etch business order growth this year is expected to be significant and is on track to achieve levels not seen since 2000.

This is particularly driven by the growth of our Conductor Etch, and the increasing acceptance of our dielectric Etch processes and systems.

At smaller dimensions, discovering defects becomes more important.

The new ComPlus 3 Darkfield inspection system is targeted at 65-nanometers.

Our UVision system provides the resolution required to deduct 30 nanometer resist defects and has shipped to a dozen top chip companies.

We are seeing momentum for both our UVision and ComPlus products and we are winning repeat business at advanced nodes.

To meet the accelerating demand for flash memory, we are gaining share with new applications that increase density and drive cost effectiveness.

Flash is a huge opportunity for us.

Our flash served available market is the fastest growing end market segment we have.

And there are a lot of emerging technical requirements as the designs migrate to these advance nodes.

In transitioning from 90 to 70-nanometers, when you look at the number of wafer passes and corresponding number of tools required, our opportunity increases by about 20% to 30%.

Our Quantum X single wafer implant has increased its share in flash and DRAM with multiple orders for several key customers.

Significant improvements in defect performance of our systems should enable us to improve our market share during 2006.

We have been investing heavily in transistor performance over the last few years.

Our products in and around the transistor have been growing rapidly.

Recessed epi is going into production.

The industry has moved to our DPN technology for gate oxides and the flash memory world is quickly moving to our RadOx solution.

This part of our family of RTD systems that continues to lead the industry.

In service, our recent acquisition of ChemTrace and its integration into Metron has created what we call, our chamber performance services line.

That includes cleaning, kitting, coating and analysis.

These services rely on fundmental technology and IP developed in our product groups that can translate into greater tool productivity for our customers as these capabilities are proliferated worldwide.

Metron's EcoSys division is also building an unsurpassed portfolio of gas and PFC abatement technologies to help customers meet their challenging environmental emissions requirements.

Our success is linked to our ability to develop future technology.

We recently announced a joint effort with IMEC, the industry-leading nanoelectronic research center, to develop 32-nanometer and 22-nanometer interconnects.

IMEC has purchased a comprehensive suite of our leading edge interconnect system.

We also launched Applied Ventures, our in-house VC program, to support breakthrough technology that can potentially be developed for future products.

And we have already made an investment in a fuel cell start-up Company.

We're seeing significant growth in bookings and revenue.

We have renewed confidence about the strength of the year as end market demand is strong, inventories continue to be low, fab utilization is high and customers have recently announced increases in their CapEx plans for the year.

Flash and DRAM continue to be constrained.

And we expect foundries to increase their investments in the second half of the year.

In addition, our service and flat panel orders and revenues should grow in the second half as well.

In service, we are offering new products virtually every month.

And as more 300-millimeter products come off our warranty, our service business should strengthen.

In flat panels, orders for the next phase of capacity will come in during the second half of the calendar year.

And we should once again reach a new high-water mark as the industry grows and our footprint expands.

With the continued commitment of our employees, I'm confident that this should be and outgrow and outperform year for Applied Materials.

Thank you very much.

And now I'll turn the call back over to Nancy to provide our second quarter targets.

Thank you Mike.

Our fiscal second quarter targets are as follows.

Orders should be up approximately 15% to 20% from Q1 levels.

Revenues should be up 13% to 15% from Q1 levels.

Earnings per share at $0.22 to $0.23 includes an estimated $0.02 per share for equity-based compensation.

We expect strong customer demand for flash, DRAM and logic orders this quarter, with service and parts below last quarter's seasonally high contract renewals.

And we expect flat panel to be at a lower level as customers absorb equipment deliveries.

With that, I'll turn the call over to Paul.

Thank you Nancy.

We will now begin our question and answer session. [OPERATOR INSTRUCTIONS]

[OPERATOR INSTRUCTIONS] Our first question comes from Jay Deahna with J.P. Morgan.

Thank you.

Good afternoon.

Mike, two questions.

If you look at your systems orders in the April quarter, excluding flat panel and service, what's kind of the apples-to-apples comparison on the order growth there?

And do you expect something similar in the July quarter?

That's the first question.

And then the second part is; one of your competitors seems to think that there's an abnormal pricing environment in the industry but it looks like your margins are pretty normal compared to previous levels.

I was wondering if you could kind of expand on that a little bit?

Thank you.

Sure, thanks, Jay.

First of all, I think as we said during the call, flat panel orders will be down in Q2, even though kind of our historic pattern on service orders with Q4 being by far the largest.

And so the strength is really in semiconductor systems here and that is -- that's what's driving the -- more than the entire growth of 15% to 20%.

We're really seeing the strength in many areas.

But if we look back to 2005, there was strong memory investment but our share there was low.

We really worked hard to improve our share in the memory area, and we're starting to see some of the early results from that work, particularly in the CVD area with our ABF films, our Harp films, as shallow translation isolation comes into flash memory.

So we are really seeing, strong, strong, orders in semiconductor systems.

As far as abnormal pricing, if you look at our margin, at similar revenue levels, it's between 1 and 2 points better than it had been in previous times.

So, I don't think there's really any abnormal pricing situation here.

Our ASD's are solid and it really -- technology drives -- technology differentiation drives pricing.

Thank you.

Your next question comes from John Pitzer with Credit Suisse.

It's Satya Kumar for John Pitzer.

When I look at your orders by geography, in January orders from Korea have increased substantially.

And just recently, there's been some concern that flash memory, density is high seasonal and some chip companies are looking to front half load their CapEx.

What kind of linearity are you seeing for the second half in terms of orders given this type of seasonality and are you seeing that impact your business in terms of orders at this point?

Well, Kumar, as you know, we are not really projecting the second half.

But my scenario for the second half kind of goes like this.

I think that there's going to be continued investment in flash and DRAM into the second half.

Actually DRAM generally is stronger in the second half to catch up.

We see VISTA coming on hopefully before the end of the year and having an impact on DRAM.

We see that there's going to be continued -- more and more products with increased density in flash.

So I don't see this as -- the flash memory thing slowing down.

But for us going into the second half, we're quite hopeful that foundries where we have very strong share are going to come back and invest at a higher level than they are today.

And then, of course, our traditional service business and flat panel business will also be stronger in the second half.

Okay.

If I could ask a very quick follow-up here.

It looks like your margins came in better than expected and that's been sort of a trend that you guys are having.

Given all the efforts that you're doing for cycle time improvement and operational execution and the consolidation, do you see a potential that you could perhaps re-address your target models in the near future?

Thanks.

We are actually quite pleased with the margin improvement that we have seen in this quarter.

And it is the result of a continuous effort we have across many disciplines, like we've discussed before, with our cycle time reductions and our focus on material cost sourcing from lower cost regions, and a lot of work in common platforms and parts.

So, we have got good initiatives underway that we expect to continue to deliver benefits to the Company.

And so as revenue levels increase, we would expect our margins to increase at the gross margin level.

And we have reflected that in the model, though as the volumes increase.

Okay.

Thanks.

One thing I might add about the gross margins, in previous revenue -- when we reached previous similar revenue levels, our service percentage was much smaller than it is today in the mid-20's.

Next question.

Your next question comes from Edward White with Lehman Brothers.

Hi.

I was wondering, when you look at the foundries, do you have any sense as to what is driving them?

What sort of kept them from investing more now?

And what the key factors would be for them to invest in the second half of the year?

Sort of what they seem to be telling you.

And what about the situation in China?

How do you see the foundries there trending as we go through the year?

Ed, I think it's difficult to make a general statement here because it's almost different by every one of the major foundries.

I'd encourage you to go ask my compatriot CEO's in those companies.

But when you look around from area to area, part of it is just ramp on 90-nanometers and how high the utilization is there.

How fast they can move products off 130, down to 90 and to the advanced nodes.

I think that's the biggest part of it.

And then to your question about China, which is also largely a foundry question, we think that there will be -- we'll see some increase in China investment in Q2.

We'll see that growth continue in Q3 and Q4.

It won't -- we don't expect it to be back to 2004 levels yet but it will be pretty good.

Great.

Thank you.

Your next question comes from Timothy Arcuri with CitiGroup.

Hi.

Actually, I had two things.

Number one, Mike, can you give us an idea in the guidance of up 15% to 20% sequentially, what you think the customer bucket breakdown might look like; so memory, logic, foundry.

Thanks.

And then I have a follow-up.

Thanks.

We think that memory, that's flash and DRAM together, will be about half the orders.

And then logic will be around 30.

And then the remainder will be -- foundries will be just slightly under 20.

Okay.

Great.

And then I guess --

Tim, typically in the past, foundries have been above -- on average, when we look at our historic, above 30, right?

Right.

Of course.

Thanks.

Nancy then, can you actually break out -- if you -- it would seem to me that if I go back, it would seem that service plus flat panel, if you add up both of those as a group, that they are roughly 35% to 40% of the total orders.

So if you take those down pretty significantly in the April quarter, it would seem that if you isolate the semiconductor product orders; that they are up something in excess of 30% sequentially as per the guidance.

Is that the right way to think about it?

That's the right way to think about it.

We -- as we've talked before, we don't provide that product kind of level of detail.

But the business in the second quarter is going to be driven strongly by the systems area of investment.

So, your conclusions were headed the right direction.

Thanks.

Your next question comes from Jim Covello with Goldman Sachs.

Thank you very much.

Basically one quick question or two parts.

On the -- for both the NAND flash and then for the foundries, is there a pricing expectation or bid growth expectation for NAND flash that you are using to base your CapEx estimates on?

And then for the foundries, when you talk about improving foundry CapEx in the second half, is there a foundry utilization rate assumption that you're making to drive that CapEx expectation, thank you?

We're thinking that bid growth in flash is going to be in the 150% range.

And for the foundry utilization, something approaching 90%.

Okay.

So first on the NAND flash, is there a pricing assumption that you have along with the bid growth?

You mean a price per bid?

Well, price decline.

Yes, there's a normal price decline per year that always happens in memory.

Is there an assumption that you're making there?

What I'm trying to say is, is there an expectation on pricing that we think that these guys can go ahead and raise their CapEx?

Or is there a price level at which you think some of the CapEx numbers would be at risk if the pricing falls off a little more than we expect?

And then on the foundries, you answered the question on the utilization rate side.

I don't -- the volume right now, I think is more key and the popularity of the end products.

Right now, as long as they get more density for a stable price, I think that for the various consumer products, they will absorb all the flash that's available.

So, until volume really -- until the total volume in memory catches up with the demand, I think we're going to see a fairly stable pricing environment.

Unlike last year, where pricing in DRAM's dropped in half in the first six months of the year.

We still saw a good trend on investment.

I think we're going to be in a fairly stable pricing environment, which creates a very positive investment landscape.

Terrific.

Thanks so much.

Thanks Jim.

Your next question comes from Patrick Ho with Stifel Nicolaus.

First a housekeeping question.

Can you give a breakdown of the stock options in the OpEx line, what was it between like G&A and R&D?

No, we're going to -- we're providing that at sort of an aggregate level in the OpEx line.

It was about 83% of the charge went to the OpEx line, and about 17% of the charge went to the margin.

Okay.

And is that something that can be relatively consistent going forward?

I think you could presume that that's pretty consistent.

We'd expect it to astay in that range.

Okay.

Great and just my one question, in terms of lead times, have you noticed any discernible changes in lead times over the past few months and looking ahead, over the next few quarters?

No.

No -- Nancy talked earlier about our integrate to order program, and strong work from our operations team to reduce cycle times.

So, we're pretty much right on where we expect to be.

It varies a little bit by machine type but lead times are holding.

Thank you.

Your next question comes from Mike O'Brien with Bear Stearns.

Yes, I just wanted to probe a little bit into the Etch side of the equation.

You are pretty low -- well, I think you are pretty low levels now.

So it's just conductor Etch that you are expecting to see this surge in orders or this very strong growth in orders, is that really from a low base?

And what is going to be the differentiation in order to be able to get that business back?

And when do you think you can get back some dielectric business?

Thanks.

Actually, it's both conductor and dielectric Etch.

And we said that orders and -- of course, we expect revenue to follow, to be the highest it's been since 2000.

The mark has grown certainly since 2000, so -- in those areas so we are not where we want to be.

But we think that in both of those areas, we have differentiation.

We think that our enabler has really excellent dielectric Etch characteristics for etching not only the difficult films like the the hard mass films but for etching our Black Diamond II films and block.

We are optimizing that between our product groups.

We think that can give us a significant differentiation there.

And then in our conductor and Metal Etch area, we believe that our matchup of our stripping and etching technology provides the best productivity and yields in the industry.

Are these -- the orders increases of the business share that you are gaining back or are these are already customers of yours that are just ordering again?

Some of both.

Could you bias it one way or the other?

Pardon me?

Could you bias it one way or the other?

I'm just trying to understand if your --

Mostly customers or reorders, certainly, that's the largest percentage of it.

Okay.

Thank you.

You bet.

Your next question comes from Robert Maire with Needham.

Those are good numbers, by the way.

If I look at the memory market, there's been some pressure taken off the DRAM market by migration of capacity over to flash.

And we have heard one of your subsuppliers talk about tracking five 300-millimeter projects out of Taiwan and such.

Do you expect that to continue?

Or would we expect going forward that rather than migrating DRAM facilities over to flash production, that we'll just focus on building new NAND flash capacity?

Or how do you see the balance of power between those two shaping up?

The biggest supplier is going to have the most flexibility.

I think in the first name of the game.

Probably number two is more focused strictly on flash.

Number three has got flexibility.

And number four will be focused strictly on flash.

So it's kind of different by company.

So, I think that the DRAM guys who have big flash investments are going to keep their flexibility as high as they possibly can, and move to where the market is.

It only makes sense.

And are you tracking a similar number of fabs or how many fabs do you think are there being built for flash and/or DRAM?

Is the question before the end of the year?

Yes.

Or -- for which equipment is being ordered in '06?

I don't have a number like that.

All the projects total that we track are -- we are tracking over 50 projects around the world but those are all DRAM flash.

That's the total, total number.

I don't have a good number for you, Robert.

And those are primarily 300-millimeter?

Yes, 85% of our business is 300.

All of those 53 are 300-millimeter.

Just one thing relating to that, in terms of the fall-off of 200, it seems that it has kind of held in there.

Do you expect that to fall off to a lower number by the end of the year or are some of the older foundries going to keep that number up?

I don't really know.

It's kind of been in the 10% to 15% range for a while.

Eventually, it's going to fall off.

I don't know whether it's going to be by the end of the year or not.

If there's strong capacity pull this year, I don't think it's going to fall off, because there's still space in a number of the foundries, particularly in China, where they can fill up a little capacity.

And the second tier foundries are still at 200-millimeters.

So they could easily be 10% or 15% of the business.

Great.

Thank you.

Your next question comes from Gary Hsueh with CIBC World Markets.

Hi guys.

Can you hear me?

Yes, go ahead, Gary.

Okay.

Just a couple of questions here.

Can you actually kind of walk us through what integration of order means for you?

Not only in terms of kind of reducing cycle times but is there any impact to gross margins?

The integrate to order process is one that allows us to basically divide our manufacturing process into lower level of subunits and so -- or submodules that can be put together in a more, what I call generic form.

And then integrated with the product customizations coming in later in the manufacturing process.

It allows us to do better inventory management.

It allows us to bring the movement of product to the factory floor in a more efficient manner.

And we believe that through the cycle time improvement, it gives us -- it allows to us get some margin improvement.

So it's a comprehensive strategy for really improving the cycle on the manufacturing.

So Nancy, I take that to mean no kind of uplift to gross margin then on products that are made integration to order?

We're seeing benefit in the gross margin area currently.

And so we expect to continue to reap those benefits as we go forward and bring more products through that.

But I would say it's reflected in the margin model that we've already put in place.

Okay.

One last question, kind of longer reaching question here Mike.

I'm actually here in Taiwan, and things are sizing up pretty well for DRAM in 2007.

I'm just wondering, specific to DRAM, can you kind walk us through some products that will help you gain or increase your already strong exposure in DRAM even stronger in '07?

Sure.

What we're doing in DRAM is pretty akin to what we're doing in flash.

We think that all of our CVD products -- first of all for shallow trans isolation.

And then we're seeing DRAM guys starting to adopt strain films for DRAM's as well.

Evidently it improves the performance of the cell.

And as they move to more advanced lithography, CMP starts to come in, both for oxides and for those that are moving -- those that move to copper, of course, get a whole new array of our products from PVD, to ECP, to CMP.

So, we're seeing that happening as well in a few of the DRAM manufacturers.

Thank you.

The next question comes from Timm Schulze-Melander with Morgan Stanley.

Hi.

Congratulations on a very strong set of numbers there.

Two quick things, maybe for modeling purposes.

The first, you have obviously seen very strong FPD orders.

Nancy, could you just help us understand when you expect these to float through into revenue?

And then secondly, just following on the question on the flat memory order strength.

Mike, as you look at those projects where you have won those bookings, can you share with us when you would expect that equipment to shift and when you would expect it to actually become productive?

Is it still going to be in '06 or is really that going to be an output of flash memory in '07?

Thank you.

Yes, I will comment on the panel business.

The cycles are longer in the panel business.

They tend to run maybe upwards of nine months for the products.

Because we have so many new generations of technology in the field that it runs a little bit longer in cycle times.

So for the new products out there, it takes about three quarters.

Great.

So that would be -- the orders you just got in January would basically be sneaking in in the October, November time frame?

Right.

That's the kind of timeframe associated with turning those into the revenue.

Mike?

On the flash memory point, we already see our revenue going up in Q2, primarily because -- more than primarily, because of semiconductor systems.

So, we should see some capacity coming line in the second half of the year.

But most of these orders and the orders that we're going to get in the next quarter will really end up being capacity in 2007.

Terrific.

Thanks very much.

Units out in 2007.

Your next question comes from Raj Seth with SG Cowen.

Hi.

Thanks for taking my question.

Mike, one of the features of this market over the last couple of years has been more incremental capacity additions.

I'm curious if you think this is now a permanent feature of this market?

Or do you think with the more positive backdrop that you outlined that there was a willingness to make larger forward investment here?

Well, I think the foundation is incremental capacity investment.

And we could see, if you look back to 2005 -- the drop off in 2005, ended up being at a higher level than back in 2003.

So that foundation is incremental capacity addition.

I think we're starting to see some companies really willing to make big investments , but it's generally the big five, the top five customers in the industry.

Yes.

Are you seeing now as you I think have in previous cycles a real broadening of participation or is it still pretty much the usual suspects that are driving the business?

Actually, it's getting quite broad.

It really is.

As -- when you look up and down the top 25 or 30 semiconductor companies, you are starting to see them much more interested in investing at this point.

And in part that's why we think we are still in the early phases of this cycle.

Because people are just starting to think this through and getting -- and starting to make some investments that -- some of the big guys are making big investments and the little guys are making little investments.

But in the end it gets down to products and technology that we're offering for all the semiconductor companies.

Thanks.

Your next question comes from Steven Chin with UBS.

Hi, Mike.

In terms of the orders by geography, I was a little surprised to see that bookings from Japan were down sequentially.

The question is; why do you think that was?

And what would your expectation be in terms of the orders by geography next quarter?

Yes, Japan has kind of been in a lull the last two quarters after having a very strong 2005.

And we think in the next quarter, they are going to rebound substantially.

Okay.

And if I could sneak a second one in, it sounded like, Mike, you were implying in one of your answers that some of the gross margin improvement was due to the services division.

Can you give us an idea of how material of an impact that had this quarter and is this improvement sustainable?

No, my -- that was not my point.

My point was that we are showing higher gross margin with an increase -- with the service business being a larger portion of our overall business.

As we've said in the past, our service gross margin is substantially lower than our equipment gross margin.

That's why we have been trying to focus everybody on operating margin and results.

But my point was that the -- we're showing gross margin improvement even though our lower margin service business is a bigger part of the overall business.

Okay.

Thank you.

Your next question comes from Brett Hodess with Merrill Lynch.

First, if the foundry business picks up given your historically high share there and whatnot, does that have a favorable impact relative to some of the other segments on margins?

Or is there really no difference in profitability as you see the different end markets' strength?

I'm not sure I really understand your question, Brett.

Are the foundry customers better margin customers since you've typically have very high share there?

I think that the gross margin that we get across all of our customers is in a similar area.

It's not -- we don't look at it as a customer specific kind of discussion.

Okay.

And then secondly, on the operating expenses, it looks like about two-thirds of the growth was the stock compensation sequentially.

So, the absolute level grew very little -- or the core level, grew very little.

Should we continue to see very slow growth in the core SG&A and R&D levels?

Well, I think if you look at the aggregate, what I said in my prepared remarks was that our operating expenses; if you look at the -- if you take out the stock-based compensation, went up, I think it was $27 million.

Right.

That was primarily in the area of variable comps.

So if you look at it associated with that level of expense, we're going to work very diligently to hold expenses in that area.

Now, we have a few things coming in and out.

We announced our real estate restructuring and we get some savings associated with our buildings and that we announced -- our building restructuring we announced.

But we also have investment going on in our -- as we've mentioned previously, our enterprise transition to SAP.

So, we've got some flawless in and out in the OpEx line.

But it might go up slightly but we generally try to hold it in this range.

Thank you.

Your next question comes from Steven Pelayo with Soleil Securities.

Nancy, when I turn to apples-to-apples, in the fourth quarter of '04, fiscal 4Q, the October quarter, you didn't have options impact in there.

And so, when I add the 55 more to your gross margin line, if you exclude the options in your January, just reported quarter; it likes like you had an incremental gross margin of about 62% drop through.

And so then I'm going to focus on GAAP going forward, apples-to-apples here.

Do you think that type of incremental drop through is still possible here, especially as the mix shifts to the semi side on the gross margin line?

If so that has you approaching maybe 47% gross margins at the midpoint of your revenue guidance next quarter.

I think your math is pretty good.

We certainly expect to be able to improve our gross margins as our revenue increases.

And we've gotten some very good efficiencies here that we're passing through, in terms of drop through, flow through from the incremental revenues.

So, your math is pretty good.

Okay.

Great.

Thank you.

Your next question comes from Steve O'Rourke with Deutsche Bank.

Thanks for taking my call.

Two questions.

If wafer fab equipment is up 15% to 20% in '06, how much can Applied revenue grow?

And secondly, can you give us an update on your ion implant business, particularly high current?

There's a fair amount of rhetoric out there about market share shifts.

Sure.

We think that we will grow substantially faster than the WFE market.

And we'll grow faster than the WFE market because of -- we are expanding our SAM, and expanding our share.

I'm not going to give you a specific number there but I think you can figure it out from what we have already said.

But we think that that projection will continue to grow throughout the year.

Our ion implant business has been relatively flat.

And so that's about as exciting as it is.

And while this transition from -- we only have a high current business, by the way.

We are not participating in any other segments of the implant business at the current time.

But as the transition from single wafer to -- or from batch to single wafer, we haven't really gained share in this transition, which is not exactly where we want to be.

Next question, operator.

Your next question comes from Bill Lu with Piper Jaffray.

Yes, hi.

Thank you.

I've got a clarification and a question.

Earlier in the call, I think either Michael or Nancy said that flat panels would reach a new watermark later on this year.

Is that a high watermark on a quarterly basis or was that high watermark in terms of 2006 over 2005?

Bill, it would be on a quarterly basis.

What we're -- what I said -- what we said was orders will be down for the next two quarters and then start to pick up in the second half of the year.

I think that's pretty consistent with the overall industry and what Display Search is saying these days.

And then by our fourth quarter we should have a record quarter.

So what's the overall outlook theb for flat panel capital spending year-over-year?

We're pretty much in line with Display Search and they are saying kind of 0% to 10%.

Okay.

Great.

And then just a question.

I seem to be hearing more and more stuff about how there's a need for better manufacturing in the silicon arena.

Is that something you guys might get into?

Can you just talk a little bit about that, if you do, what are the decision matrices?

We don't have really anything to say about that at this time.

Okay.

Thank you.

Your next question comes from Shekhar Pramanick with Moores & Cabot.

Hi good afternoon.

Question for Mike.

You kind of talked about Etch management changes.

Is it a new hire?

And the second, recently you had a pretty high profile win, like a processor guys, when you were existing there but you were doing non-critical Etch.

Now suddenly, you are doing all critical Etches and what really changed on the dielectric Etch that precipitated it?

And then I have one more -- another question.

Well, Tom St. Dennis came in -- joined us a few months back, four or five months back now.

He's really been revamping the organization there and instilling some new purpose and momentum.

And the difference at the customer that you are talking about was we -- our technical performance was outstanding in being able to perform the various critical Etches.

So that's -- it was just technical differentiation.

Aren't you adding another key etching initiative or have added in most recent times?

We have added several people.

I'm not discussing any other people besides Tom.

All right.

My other question was on flat panel.

We have been waiting for much bigger products such as DVD's and Etches for some time, but we haven't heard it yet.

Is it still in kind of a developmental stage or should we be seeing it more in the near future?

When we're ready to announce a product, it will be ready for high volume production.

So, I think you should take that as my commitment both to the industry that when we're going to introduce a product, it's really going to be ready to ramp.

And be ready to serve the needs of the customers to drive costs down and technology improvement.

We have time for one more question and then we'll make our closing remarks.

So, if you could take the last question, please.

Your next question comes from Stuart Muter with RBC Capital Markets.

Yes, thanks for sneaking my question in.

A question for Mike on the UVision product, earlier in your prepared remarks you said that you have shipped the product to about a dozen or so customers.

Have you received multisystem orders from some of these customers?

Yes, we have.

I'm sorry I didn't mention that during my remarks.

I must have forgot.

But yes, we have received multiple orders and we've taken revenue from a number of machines already.

And we're on target for our year-end goals.

To give you an idea, for our target, for the year, we have surpassed 15% of our target for the year in the first quarter.

So, with this machine ramping during the year, we are pretty confident we are going to get there.

Excellent.

Thank you.

Well, we'd like to thank everyone for listening to our first quarter 2006 earnings announcement.

The Webcast of this call is available on our Website, and will remain posted there until March 1.

Applied Materials will hole its annual meeting of stockholders on Wednesday, March 22, 2006, starting at 11 a.m.

Pacific Time at Applied Materials Building One, located at 3050 Bowers Avenue, Santa Clara, California.

A live Webcast of the meeting will be available on our Website and will remain posted there through April 5.

For further information regarding the annual meeting, please prefer to the proxy statement, which will be mailed to stockholders and posted on our Website on or about February 21.

As a reminder, if you would like to receive our fiscal 2006 filings electronically, you can sign up on our Website.

Thank you for your interest in Applied Materials and this concludes our call.

This concludes today's conference call.

You may now disconnect.