應用材料 (AMAT) 2006 Q4 法說會逐字稿

Welcome to the Applied Materials 2006 fourth quarter and fiscal year end earnings conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to Mr. Randy Bane, Vice President of Investor Relations, Applied Materials.

Please go ahead sir.

Thank you, Derek.

Good afternoon and welcome to Applied Materials fiscal 2006 fourth quarter and year end conference call.

Joining me today on the call are Mike Splinter, President and CEO;

George Davis, Chief Financial Officer;

Nancy Handel, Senior Vice President;

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

Today we will discuss our results for the period ending October 29, 2006.

The financial results were released this afternoon at 1:05 p.m.

Pacific Time and a copy of the news release is available on Business Wire and on our Website at www.appliedmaterials.com.

Today's earnings call contains forward-looking statements including those related to Applied's financial performance, our technology leadership, served markets, growth, strategy and opportunities, new product development, operational efficiencies, tax rate, cash generation and deployment, financial targets, and the outlook for the semiconductor industry, display and solar industries.

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

Information concerning these risk factors is contained in today's earnings press release and in the Company's filings with the SEC.

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

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

A reconciliation of these measures to GAAP are contained in our earnings press release issued today and in our earnings call highlights document, both of which are available on the Investor's page of our Website.

George Davis will open with some remarks on our new segmentation reporting and then hand it over to Nancy who will discuss financial results for the fourth quarter and year end.

After Nancy, Mike will highlight Company results for 2006 and outline our strategy for the upcoming year and provide some insight into the industry dynamics that may affect our Company.

George will then close with commentary with our first fiscal quarter 2007 targets.

After these remarks, we will open the call for questions.

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

George?

Thank you, Randy.

Good afternoon, everyone, and thank you for joining us.

First, let me say how pleased I am to be named Applied Materials' CFO.

This is a homecoming for me, having spent the majority of my seven years at Applied working in finance.

Over these past years, I've been focused on further building Applied's corporate business development capability.

While it's been an exciting and busy two weeks since stepping into the CFO role, I am inheriting a strong leadership team in finance from Nancy.

And I would like to thank her for her efforts through this transition period and her commitment to making this process as seamless as possible.

Our global finance team has benefited from Nancy's leadership over the past two years and the Company has benefited from her two decades of service.

I know that I speak for everyone in finance when I wish her the best in retirement.

But before she goes, we have one more job for her and that's to detail our financial results for the period on this call.

She will also participate in the Q&A session to address the strong '06 results delivered on her watch.

As described in our press release, we will be reporting our results with additional information going forward.

After the acquisition of Applied Films, we made certain changes to our internal financial reporting structure during the fourth quarter.

And as a result, we are now reporting four segments, Silicon, Fab Solutions, Display, and Adjacent Technologies.

The Silicon segment manufactures and sells equipment to fabricate semiconductor chips.

The Fab Solutions segment offers a broad range of products to maintain and optimize customers' semiconductor fabs, including total parts management, spare parts, remanufactured equipment, maintenance agreements, total support programs, and environmental and software solutions.

The display segment manufacturers, sells and services equipment used to make flat panel displays.

And finally, the Adjacent Technologies segment, manufactures, sells and services equipment used to fabricate solar else, flexible electronics, and energy efficient glass.

A description of each of these segments is included in our press release and in the financial highlights presentation available on our Website.

We are limiting our segment commentary on this call to fourth quarter net sales.

In mid-December, additional segment information, including orders and income from operations for the fiscal year will be presented in our Form 10-K filing, which will be made available on our Website and will be followed by a special conference call to answer your questions.

And so I'd now like to ask Nancy to discuss the results for both our fourth quarter and fiscal year 2006.

Following her remarks and Mike's comments, I'll be back to deliver our targets.

Nancy?

Thank you, George.

Good afternoon, everyone, and thank you for joining us.

In my remarks, I'll discuss the financial results for the fourth quarter and the fiscal year.

Orders totaled $2.69 billion for the quarter, up slightly from the prior quarter, with gains from coming from our industry-leading interconnect solutions, such as advanced patterning films, gains in Etch, record orders for Fab Solutions, and strong demand for our new generation 8.5 flat panel display system.

Bookings for new Silicon systems this quarter had the following mix.

DRAM was 34%; logic and other, 31%;

Flash memory, 19%; and Foundry, 16%.

Approximately 92% of orders for new Silicon systems were for 300mm and virtually all for 100 nanometer and below process technology.

During the first quarter, nearly 81% of our orders were from outside North America.

Demand from North America, Japan, Southeast Asia and Europe strengthened.

Orders by major geographic areas were, Japan, 22%;

Taiwan, 21%;

North America, 19%;

Korea, 15%;

Southeast Asia and China, 13%; and Europe, 10%.

Fourth quarter bookings included six orders in excess of $100 million. 10 orders between $50 and $100 million.

And 12 orders between $10 and $50 million.

Backlog for the fourth quarter increased to $3.4 billion, compared to $3.32 billion for the third quarter of 2006.

Backlog adjustments totaled $97 million, consisting primarily of orders from a display customer that were rescheduled for shipment beyond 12 months.

Revenue for the fourth quarter was $2.52 billion, 1% lower than last quarter and within our published target with particular strength in system sales to memory customers and record revenue from Fab Solutions.

Net sales by segment for the fourth quarter were, Silicon, $1.61 billion.

Fab Solutions, $590 million.

Display, $296 million.

And Adjacent Technologies, $20 million.

Reported gross margin for the fourth quarter decreased 100 basis points to 47.1%, compared to 48.1% for the third quarter of 2006.

As expected, the decline in gross margin was primarily due to charges related to the amortization of purchase technology and lower margins on certain Applied Films products.

Equity-based compensation charges of $9 million were included in this quarter's gross margin.

Fourth quarter operating expenses, consisting of R&D, marketing and selling, and G&A, were $550 million, 1% higher than last quarter.

These expenses included $20 million for Applied Films and some increased spending on the Company's multiyear business transformation initiative, offset by adjustments in incentive compensation and benefits.

Operating income was $635 million or 25.2% of revenues, 160 basis points lower than the 26.8% reported for the third quarter of 2006.

Net interest income for the quarter was $28 million, $14 million lower than the previous quarter as a result of lower average cash balances after the $2.5 billion accelerated stock buyback.

The effective tax rate for the fourth quarter was 32%, in line with expectations and 3% higher than the third quarter.

We anticipate the effective tax rate for the next quarter will be approximately 34.5%, as a result of decreases in the export tax credit.

Net income was $449 million or $0.30 per share, compared to $512 million or $0.33 for the third quarter.

We met our earnings per share target for this quarter.

The reduction in outstanding shares as a result of the accelerated stock buyback had a positive $0.01 impact on earnings per share for the quarter, offsetting the decrease in interest income mentioned previously.

Our financial model based on non-GAAP metrics was developed to enhance understanding of ongoing operational performance.

The model excludes items deemed by management to be unusual or nonrecurring.

Non-GAAP net income of $482 million or $0.33 per share was slightly lower than our financial model.

Excluding the impacts of a higher effective tax rate and Applied Films, as we discussed last quarter, we would have met our model.

The reconciliation of our reported earnings per share of $0.30 to our non-GAAP earnings per share of $0.33 was included with our press release.

Now, I would like to discuss highlights of our balance sheet and cash flow.

During the quarter, cash, cash equivalents, and investments decreased $1.95 billion to $3.21 billion.

The Company used $2.64 billion in cash for share repurchases, which included the accelerated stock buyback.

And paid cash dividends of $77 million, partially offset by $660 million in cash generated from operations.

During the fourth quarter, the Company repurchased 154 million shares of our common stock for $2.64 billion, at an average purchase price of $17.15 per share.

Since the beginning of fiscal 2005, the Company has repurchased approximately 340 million shares, representing approximately 20% of the shares outstanding at October 31, 2004, for a cash outlay of $5.8 billion.

During the first quarter of 2007, we do not plan to repurchase additional shares.

Beginning in the second quarter, we do expect to restart our systematic repurchase program.

In September, 2006, the Company declared a cash dividend in the amount of $0.05 per share, payable on December 7 to stockholders of record as of November 16.

Accounts receivable decreased by $268 million and day sales outstanding decreased by 9 days to 73 days, principally due to strong receivables collection.

Inventory increased by $65 million, principally due to increases in raw materials and work in process inventory.

Capital spending for the quarter was $59 million.

And depreciation and amortization totaled $73 million.

Free cash flow generation for the quarter was $600 million, up from $322 million in the prior quarter, reflecting strong accounts receivable performance.

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

Head count at the end of the quarter was 14,072 regular employees.

Fiscal 2006 was the second-best year in the Company's history.

New orders were $9.89 billion, a 55% increase from $6.39 billion for fiscal 2005.

Net sales for fiscal 2006 were $9.17 billion, a 31% increase from $6.99 billion for fiscal 2005.

Net income for fiscal 2006 was $1.52 billion, or $0.97 per share, up from $1.21 billion or $0.73 per share for fiscal 2005.

Non-GAAP net incomes for fiscal 2006 was $1.8 billion or $1.15 per share, up from $1.12 billion or $0.68 per share for fiscal 2005.

I would like to thank our employees for a great quarter that finished an outstanding year.

And I would also like to thank the investment community for their support during my years as Chief Financial Officer.

With that, I would like to turn the call over to Mike Splinter to provide the CEO's perspective.

Mike?

Thanks, Nancy.

Good afternoon. 2006 was an excellent year for Applied Materials.

We grew revenue, gained share, and delivered on our objectives.

The dedication of our employees and their commitment to deliver for our customers was demonstrated throughout the year.

And I would like to acknowledge their contributions to these strong results.

For 2006, we set three clear objectives.

First, extend our leadership in our core business through differentiated products.

Our main focus was to increase our presence at memory manufacturers, particularly those in the fast-growing Flash market.

In 2006, we improved our position across multiple product lines as our technology-leading solutions drove broader market acceptance.

Our thin films group continues to demonstrate strength, for example winning over PVD runoff in 2006.

We are delivering innovative solutions, like advanced patterning films, selective EPI, and strained silicon.

And these differentiated products led to major market share gains in the memory area.

In 2006, we improved our overall Etch market share, gaining -- growing faster than the competition.

Looking forward, we expect gains in 45 nanometer development decisions, where specific technology inflections favor Applied's Etch products.

We made significant progress with our UVision Brightfield inspection system.

We now have repeat orders at three companies of the 13 now having a UVision installed.

In display, we gained share with both our PECVD and EV and tester products as AKT set records for revenue, bookings and profits this year.

In fact, with strong '04 bookings, total orders exceeded $1 billion for the year.

We announced a Gen 8.5 product line that processes 5.6 square meters of glass in a single chamber.

In addition, we acquired Applied Films to provide significant growth in the PVD arena.

Applied Global Services delivers solutions that boost productivity and reduce costs for customers and that success is showing up in our growth metrics for AGS.

Our revenue per wafer start is up 9% year-over-year.

In 2006, we also expanded our significant portfolio of environmental solutions with new systems that improve performance, reduce emissions, and lower energy consumption.

Our second objective was to grow in new markets, utilizing our nano manufacturing technology.

We delivered by entering the markets for flat panel color filter and array PVD, photoresist coaters and solar photovoltaic cells.

Our chamber performance systems expanded through the acquisition of ChemTrace and we are now addressing the market for specialty coatings for semiconductor equipment.

Also, our proposed acquisition of Brooks Software, when completed, will further expand our opportunities in Fab software solutions and enhance our core service offerings.

With the addition of these new products and markets, our total market opportunity increased by over 30% since the beginning of 2006.

Our third objective was to deliver world-class operational and financial performance.

As Nancy reviewed in detail, we made good progress operationally over the year, delivering higher margins and improved asset utilization, while ensuring that we are investing in the future.

Looking to 2007 and beyond, we'll build on our 2006 momentum.

We are confident that our market opportunities in the silicon segment are growing significantly.

The semiconductor industry continues to see strong unit growth, particularly in the memory segment.

The industry should see revenue growth in the 5% to 10% range as we enter a period of accelerated DRAM bit growth created by several factors including Microsoft's VISTA operating system.

While we expect a short-term order pause in Q1, we believe 2007 will see an increase in wafer fab equipment spending.

With our forecast estimate forecasting an increase a roughly of approximately 6%.

With our focus on creating advanced systems and solutions, as we move through each node, the buildout of 65 nanometers and the technology buys for 45 nanometers will be positive for Applied Materials.

Therefore we expect to grow our Silicon business by more than 10% in 2007 despite a rather slow start.

We are projecting memory customers to represent more than 50% of our Silicon Systems orders for the foreseeable futures as foundries and logic companies investments will be up only slightly, with increased spending expected to come in the second half of 2007 as they come our of a low investment period.

During the past several years, we have put significant emphasis on a creating a robust, new product pipeline.

We have now have over 50 products and application projects in development, compared to fewer than 30 a year ago.

This increase is, in part, due to our more efficient use of our existing platforms, software and the development of new applications on existing products.

We are improving parts commonality to enable faster new product development and to reduce material and development costs.

In addition, our development centers in Bangalore, India, and Xi'an, China, are enabling round the clock development to reduce time to market.

New products like the recently-introduced producer GT, the industry's most productive and cost effective CVD platform, are a key to our continued growth, as it dramatically improved our competitiveness in the $700 million dielectric commodity films market.

In Fab Solutions, increasing wafer starts and our large and expanding installed base provide a solid foundation for growth.

This business is expected to be up in 2007 by capturing an increasing amount of fabs' operational spend.

As customers look for improved productivity, they are demanding technically differentiated service products.

Coating, cleaning, wafer reclaim, abatement, and software all become more valuable to customers who will be looking for better utilization of their factories.

In 2007, we expect an incremental $100 million of revenue just from these new products alone.

In display, market forecasts predict a declining equipment investment in 2007 as the industry rationalizes its current capacity and assesses the holiday sell-through.

With the addition of PVD color filter and array systems to our product line, we expect to perform better than the industry in this area.

In our solar division, our large-scale PVD and PECVD systems will provide the speed, conversion efficiency, and factory productivity to lower the cost per watt from just over $3 today to less than $1 in the future.

During 2007, we expect to gain significant traction in the solar market as demand grows for cleaner, more environmentally power solutions.

Solar unlocks an opportunity for us to provide leadership and productivity at a time when the industry is poised to take off.

We expect customer contracts in excess of $200 million in '07.

2006 was a very good year for Applied Materials.

We executed on our strategies and are poised to continue the positive momentum in 2007.

I am confident our strategies will take advantage of the opportunities ahead of us.

As we close fiscal 2006, I would like to take the opportunity to thank Nancy Handel for her long and excellent service to Applied Materials, as a leader in finance for more than 21 years and for the last two years as CFO.

Nancy, we wish you the best in retirement and thank you for your many, many contributions in making Applied Materials the great Company it is today.

I'll now turn the call over to George Davis to provide our first fiscal quarter 2007 targets.

George?

Thank you, Mike.

Our strategy is based on continuing the momentum we have built in 2006.

As Mike mentioned, fiscal 2007 is expected to be a positive growth year for Applied Materials.

In our first fiscal quarter, however, we expect to experience a modest pullback as our silicon and display customers adjust their spending and take a reading on their markets.

Coming off a record year and fourth quarter in our display segment, we are expecting customers in that segment to significantly reduce orders in the first half of the year.

Q1 display orders are expect to be down approximately $200 million from Q4.

We expect the normal seasonal increase in the Fab Solutions segment orders as customers renew their annual service contracts.

Given this background, our targets reflect a more cautious, near-term industry condition.

For the first quarter, we expect orders to be down in the range of 5% to 10%.

We expect revenue to be down 5% to 10% as well.

We expect EPS to be $0.26 to $0.27, which includes an estimated $0.02 for equity-based compensation, and approximately $0.01 related to Applied Films and Sokudo.

Thank you.

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

Okay.

We will now begin our question-and-answer session.

Derek, let's begin with the first question.

Operator?

[OPERATOR INSTRUCTIONS] Your fist question comes from the line of Gary Hsueh with CIBC World Markets.

Just a quick question here on the order breakdown.

Could you try and qualitatively talk about where you're seeing most of the decline, is it down 5% to 10%?

Is that mostly coming from flat panel display or silicon?

What's the split here?

I think what you're seeing is clearly a big drop in display, as we said, a more modest -- certainly a much more modest drop on the Silicon side, and then a seasonal uptick, as you would expect, in the Fab Solutions segment.

Okay.

Because it looks like bookings are probably dropping around -- on a gross basis around $200 million and that's exactly the drop in flat panel display.

So you're just seeing a slight drop here in Silicon Systems, right?

Yes.

I think we're comfortable with the guidance.

Okay.

George, quick, a longer term question here.

When can we expect you to kind of emerge out of the woods in terms of integration of these dilutive deals?

And when do you think you'll be able to articulate a longer term financial model that's somewhat back on track with what the model was pre-options?

Pre-options.

Well, you've got a fair amount of moving parts there.

But I think we're very comfortable with the M&A activity that's taking place this year.

We think it's very positive towards our growth.

We're committed to model performance and we'll talk about the model later, but we don't anticipate the model changing.

We anticipate performing to that.

And I think the -- I'm not sure what your point was on the options?

No, it was just the model prior to FAS 123.

Last question here, real quick, how much are you baking in for the Brooks automation in terms of OpEx in the January quarter?

It's, we -- well, first off, we have to close the number -- or close the deal.

So, there's nothing in the forecast at this time.

Okay, thank you.

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

Hi.

Thank you, for going through the disclosures by segment, I think it's extremely useful.

A couple of questions.

I have in my notes here back in 2000, in the fourth quarter, service was about 12% of your revenues.

Is it fair to say it has approximately doubled in percentage terms from back then to now?

If you go back to 2000 and then look at where we are today, it's roughly doubled.

The '04 -- I can grab that a second here, yes.

We have basically have doubled since 2000 and the numbers in '04 would have kind of been the midpoint in that transition.

Right.

I know you're going to talk about the profitability in your K but can you give us a sense whether this doubling was neutral or accretive or dilutive to your overall margins?

You're referring to the service business?

Right.

The service business really contributes very strongly to the bottom line because it doesn't have the same kind of BLE and R&D infrastructure that the equipment business has.

So, the profitability there is a strong contributor for the Company.

Okay.

And a final question here.

When you look out to your bookings guidance for January, can you give me a sense as to what the order composition is [doing in] memory for the semiconductor portion?

Well, the order book will be over 50% on memory.

Again, it was 53% in the last quarter.

We don't think there's going to be major shifts there.

Memory is going to continue to be over 50% of the orders.

Thanks.

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

Thanks.

Looking at the Silicon business for a moment, I think you mentioned that you have about 50 new products in the pipeline.

Can you talk about the area that you'll focus on in terms of product market share in the Silicon business over the next year?

What are the real goals and objectives as you look at 2007?

Sure, Ed.

A couple of things I'd say about that.

First and foremost, we want to continue to make progress in Etch.

We've increased our investment there.

We've increased the number of products we have in the pipeline there.

So, that's a very important area to us because of the size and size of the overall market and the fact that we think that that market is going to continue to grow.

The other area is that we're investing heavily in is inspection from our PDC unit.

We're growing that -- the solutions there in a number of products in applications we'll have out of that area.

And then you can expect us to continue to invest across our broad array of products and renew all those.

But then, we're expanding in display.

And then we're going into solar area, which is going to require some significant new product ideas, concepts.

And we right now have a number of new products coming up in that area that you've already seen a few of those but you'll see a few more of those as we go through the year.

Those are our big equipment areas.

But I don't want to shortchange our service area, where we have a lot of new service products and are efficiently developing those products as well.

I think when you sum it all up, we're renewing our product line and expanding it at the same time, so that we really get the growth of the Company moving ahead with new products as well as our existing products.

Okay.

And then finally, with the growth prospects, at least in the first half of the year for the whole semiconductor capital equipment industry coming from memory, how do you feel about your position now with memory manufacturers?

I know that was the focus to gain the share there.

You've done that.

Where do you think your position with them today?

And does that need to change as you -- does that need to be enhanced further as you go ahead?

We've made a lot of progress in 2006.

We want to continue to enhance that in 2007 but it's no longer the major disadvantage it was for us in 2005.

So, we're pretty happy with the excellent progress that we've made there in 2006.

And Ed, as we move from really 90 to a buildout on 65 to technology buys on 45, we're gaining share in each one of those nodes.

Great, thank you.

Your next question comes from the line of Jay Deahna with J.P. Morgan.

Hi.

A couple of questions.

First of all, for the tax rate in the first quarter, should we be using a similar tax rate for the rest of the year?

And then the second question is, if you look at the midpoint of your order guidance, it's down $200 million, so display accounts for all of that.

So it sounds like the pickup in service orders and the dip in Silicon Systems is a wash.

My question on that is, if that's a pause, do we see some sort of a dip in Silicon Systems orders before they turn up in order to drive that 6% away from equipment growth in '07?

And I presume you were talking calendar '07 and not fiscal.

I was talking about calendar '07 for the projection, Jay.

But I don't think that we're going to see particularly anymore drop than what we're thinking about in Q1 because of our share movement.

The thing I tried to express was that with our share gains, despite the fact that we think that the wafer Fab equipment spending will be up 6%, our Silicon business should be over 10% really in our fiscal year.

So we're -- I'm kind of talking about the growth in the market and the growth in our Company.

As you know, we always mix those on calendar year and fiscal year.

What's important in what you're saying, then, is that you really are talking about an incredibly mild pause.

Because if that's what you're going to deliver and orders most likely, it sounds like you're saying they flatlined in April at worst, if I'm reading you correctly, that's not really even a downturn.

The way I'm looking at this is, there's really two things that are going on.

One is, the foundry and logic guys are really in the downturn.

In fact, I think they're approaching the bottom of the downturn in spending.

Meanwhile, memories have continues increase investment as the bit growth has continued to expand at a very fast rate.

When we look at their CapEx to revenue, we don't think it's particularly out of line because revenue is expanding and bit growth is so dynamic.

So it feels like we almost have to separate these two trend lines from what's happening in memory and what's happening in logic and Foundry.

Right.

Interesting.

I was just wondering if the logic buildout, 65 nanometer for the industry including foundry, Intel at 45, that was going to start later in the year, that maybe you had a void as memory settled down and that came up.

But it sounds like it's going to be rather simultaneous from your perspective with a little share gain.

Yes, I think that's the story.

And the tax rate?

Hi, Jay, it's George.

The tax rate assumption of 34.5% is good for the full year.

It does assume, though, that we have not got an extension of the R&D tax credit.

So, if you see some legislative activity finally take place there, then that should impact 1% to 2% on the tax rate.

Perhaps a congressperson from your district can help you with that.

We're working on it.

Thank you.

Operator?

Your next question comes from the line of James Covello with Goldman Sachs.

Thanks again for the segment detail.

I find that really helpful.

Mike, big picture question.

If you go back from your experience in the industry, and I know you were at a different company, but just from an industry perspective back to the mid-90's.

Before the industry recognized that there was kind of excessive DRAM capital spending that we weren't going to see again for another decade, we didn't see that coming.

Why can't what's going on in NAND now be a repeat of that, from the standpoint of, you never see it while it's going on?

It's only in retrospect that you realize there was an awful lot of excess capacity.

And with pricing in NAND having been down a lot more in '06 than we expected.

And now margins in NAND being worse than margins in DRAM, there's no cushion for the NAND manufacturers.

If the excess capacity sustains into '07, these guys are going to have to take a more conservative approach with the capital spending.

And how do we know we're not looking back two years now now saying; "the '05, '06 period was a lot like the '95, '96 period in DRAM"?

You can look at this a number of different ways.

What's been happening, the big growth has been going up at a very dramatic rate.

And we've been trying to look at, NAND particular, at CapEx versus revenue.

And it's nowhere near the '95 peak, which was, I think, almost 80% CapEx to revenue numbers back then and it almost hit that high again in 2000.

I think the key here is;

Do the applications and do the bit growth continue?

So far they have and the excess demand has been able to be absorbed by pricing declines.

And I think as you know, the last, I think, four months or so pricing on NAND has flattened out and even up slightly in the past two months.

But if I can interrupt for a second, the difference between last year and this year is that there was a lot of cushion in NAND margins starting '06.

That cushion has been arbitraged away, as we've gone throughout the year because margins have come down so much because pricing has come down so much.

There is a ramification of the elasticity.

You cut prices, you cut margins.

And there's no margin leeway or cushion as we enter '07 to see the kind of price declines that we had in '06 and still continue to spend on the capital spending.

Well, then you have to look at who's actually spending and so we know that there are big companies here.

But they're moving very fast to the next generations of technology, which give them, again, a lower cost per bit and are moving as fast as they can to preserve those margins.

Terrific.

One quick follow-up and then I'll go away.

On the stock buyback, did I understand you said no buyback in January but resuming in April?

And if I got that right, how come no buyback in January?

The buyback is a result that the agents that we had completing the ASB in the market.

So, we're going to wait and turn our repurchase program back on in Q2.

Terrific.

Thanks so much.

Your next question comes from the line of Stephen Chin with UBS.

Okay, great.

Thank you.

The commentary you gave about fiscal 1Q flat panel orders being down about $200 million.

Is this due mostly to one customer or is it spread basically evenly across multiple customers?

And as a follow-up to that, how do you see the flat panel display spending for '07 trending after this record year in 2006?

So, it's in part due to a couple of things.

One, we have very strong orders in Q4 and so it's coming down off a high.

So one big customer placed their Gen 8.5 orders in Q4.

And I think you know that there's another -- there's two other manufacturers that are in a state of reassessment.

One in Korea, one in Taiwan, one due to a merger.

So, I think we're kind of in a wait and see mode on flat panels.

The estimates that we look at say down roughly 20% on the year.

But when I look back at a year ago, we also said that it was going to be down 20% and then after great sell-through during the holiday period through Chinese New Year, the orders picked right back up and we had a terrific year.

But right now, we're thinking that the spend in the industry is going to be down 20% year-over-year.

And if I could take a second question.

So you've made some comments about spending in the equipment market being up about 6% and you called out some specific market share gains that you've had, Mike, in some of the thin film groups and in the Etch segment.

Do you think some of those market share gains there will let you outperform some recovery in the industry faster than prior cycles, given the strength you're seeing here in 65 nanometer and 45 nanometer?

Well, yes, we think so.

Anytime you change the profile of your Company, which we've pretty much been able to do in getting into much better position with a memory manufacturers, it allows us to -- no matter who's spending the money now to move a little faster than the market and have much better balance than we previously have.

Okay, thank you.

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

Good afternoon.

First question for Mike.

If I look at the EDA companies or the chip design software suppliers, they're currently tracking about anywhere from 250 to 365 nanometer chip design starts.

And many of these designs are being done by the major fab with semi companies.

And I think most of these design starts today are going to be resulting in tapeouts sometime middle of next year.

And so given that and given your commentary about sort of the foundry spending in the second half of the year, I think -- just wanted to get your thoughts about what your foundry customers are saying about 65 nanometer in 2007?

They're -- right now, we expected -- if I look back six months or a year ago, we expected them to be running a lot more 65 nanometer than they are today.

So they're already in a delay mode on 65 nanometer.

But the real question is, when do the big volume designs get into high volume production?

That's the real question.

At two of the major foundries right now, the 65 nanometer lines are not full.

So I do expect new designs to come in and for those to start filling up the lines in the second quarter and then on through the year.

And they're going to make investments along with that.

I think you probably have the data on foundry utilization at this point projected to be in the middle to low 80's for this next quarter.

So that's not a point where they're going to be making aggressive investments.

Great, thanks.

And then just one other question, if I may.

Looking at your overall -- the overall possibility of the business, just wanted to know the percentage of your R&D workforce that are located in low-cost geographies currently and how you see that growing over the next one to two years?

So today, we have about 1,000 people in outside -- in those regions in Bangalore and Xi'an China.

We'll increase that a bit over time but our main R&D centers are going to remain in Santa Clara and Rehovot, Israel and Horsham.

Great, thank you.

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

Hi, Mike.

Maybe if I can just run for a second here with your scenario on the downturn.

I'm not sure that I agree.

But if memory is down, just as logic and foundry picks back up, just like it argues that there's not much of a downturn, it also argues that there's not much of an upturn.

And if you look at your business and you look at the stock, you spent about $5 billion on acquisitions and on buybacks during the last 12 months and the stock hasn't really gone anywhere.

So, if the same downturn scenario argues that there's not going to be much of an upturn, what's going to make the stock go up?

The kind of big picture question here is, if you look at your competitors, they're kind of looking at the business and they're eliminating product lines that have less -- lower margins.

And I'm wondering, could we see a shift in your strategy?

So the question is, Tim, about strategy.

But first of all, I don't think what we said was anything about a memory downturn.

And we're still expecting memory to be strong for the foreseeable future.

Of course, if the way it plays out is memory goes down when foundry goes up, there won't be much of a downturn but there won't be much of an upturn either.

We're always looking at our products that don't meet our profitability objectives, believe me.

And trying to understand either how to get them healthier or how to disposition them out in other ways.

So I don't think that that's necessarily a new strategy, that's just taking care of business.

But we are really looking at being strong on portfolio management in the Company.

I think that's a key part of our overall strategy.

Well, to that point, do you think that, given all the money you've spent the last four quarters and the fact that the stock hasn't really gone anywhere; do you think that maybe we have to rethink the business and rethink some of the segments that you're actually in?

Let me just say, this is George.

Let me make a comment about the investment as you're describing it.

I think number one, we need to separate the activity for the balance sheet and the investments in M&A.

The balance sheet activity is really a reflection of returning excess cash on the balance sheet to our stockholders.

And that's a decision that I think we're comfortable that our investors are encouraging, just as they've -- they're encouraged by a higher dividend.

And we believe that our cash needs are in the $3 to $4 billion range going forward and we're positioned well for that now.

On the M&A front, we are in an investment mode and I think when we -- if we could find more opportunities like Applied Films, we would do them in our current business model.

We have, through this process significantly strengthened our PVD capability in flat panel and in solar.

And we've brought new technologies and flexible electronics.

So we're comfortable that we have to at times invest and go through an investment period, which is really what we're experiencing through '07 with Applied Films.

But we're encouraged by what we're seeing.

Okay, George, thanks.

Your next question comes from the line of Steven Pelayo with HSBC.

Steve?

Can you hear me?

Yes, Steve.

Go ahead.

One second here.

Can you guys here me?

Yes, we can.

Sorry about that.

Just some clarification, first of all.

I'm looking at your assumption for growth, about 10% in the Silicon business.

I'm looking at it relative to the composition of what you just showed your break out.

About 2/3 of that was your Silicon business.

About 20%, 25% service business.

And then your expectation for flat panel to be down about 20%.

If you roll those up, based on the kind of composition that we saw for this last quarter, you're thinking that Applied Materials can grow more than 10% net year.

Now, then we've got to talk about;

Well, what's the profile in 2007?

You said you didn't expect to see much more of a drop.

If you're talking about 10% growth in 2007, that's like an incremental $1 billion versus the $9.5, $9.6 or you're doing this calendar '06.

So, can you talk a little bit about the profile of '07?

And then I just have one more follow-up question.

I think you have it pretty close to right, Steve.

We expect our service business to grow substantially faster than 10%.

Silicon business to grow 10%.

And our display business not to decline as much as the market.

We're pretty -- we're positive on '07.

So essentially, you're saying that growth resumes starting in your April quarter?

Yes.

Okay.

And then my last follow-up was, congrats to Nancy and George on the $0.40 per share in free cash flow.

That's great.

What's your expectation for the first quarter?

Can you pull more from the working capital counts?

It looks about $400 million, excluding the working capital counts, so that would be pretty good.

In terms of free cash flow generation, we're at about $2.5 billion.

We've been generating plus or minus, right around $500 million.

And so I think you can kind of scale it down a little bit from there.

Okay.

And your expectation for share count in January, that's my last question?

It should be on the order of what we have now, maybe a few for the stock option activity or whatever but we won't be doing any buybacks.

So we're at about $1.48 billion.

I just didn't know what the timing of the last buyback, if the weighted average worked out, it actually went lower again next quarter.

Thank you, I'll model flat.

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

I would like to go back to that last question, George.

I think that Steven was onto something there.

Didn't you buy back at the middle of the quarter and shouldn't you have a lower share count in January?

We did do a buyback at the second week of -- beginning -- middle of September and I think they're looking at a projected share count here of about 1.4, 1.3 maybe something like that.

It was down a little bit or so from the year end here.

I'm sorry, I gave a year end number.

My apologies.

So we should be looking at 1.4, 1.3, is what you're saying?

Yes.

Looking at it as reflecting the old quarter's worth of share versus the average over the fourth quarter.

Perfect, thanks.

Mike, can you discuss some of the share gains in your Etch segment?

In particular, can you give us some qualitative commentary on both the dielectric metal and the poly segments, where you think you won and maybe where you might have lost?

Well, sure.

I think that we've had strong metal, reasonably strong -- I wouldn't say any of our segments are overly strong but we've been able to gain, particularly with the memory guys, coincident with our other efforts with the memory companies during this year.

We started out stronger with the memory guys in our Etch area as well.

So, what we've been working on in dielectric Etch, most of the gains have been in the less intense areas in [Via] and [Bonn pad] opening, some of those areas.

We're starting to win more in the dual [damascene] area, as we go through time.

As our machines show good uniformity, better uptime, less cost of ownership, those are things that customers are particularly interested and are particular strengths of our machine.

Our introduction in the Silicon area this year that pretty dramatically improved uniformity for gate Etch has helped us also quite a bit in the logic area.

Okay.

So I just want to -- when you talk about share gains, when the Gartner numbers come out at the end of the year, at the start of next year, should we be looking for share gains in each one of those segments from you?

It will vary, but, yes.

Okay.

And then on -- just one last question for Mike or George, whoever wants to take this.

Any thoughts on not supplying order guidance going forward?

Kind of along the same lines of what Lam has already done?

No, we haven't -- we're not considering that at this time.

Okay.

Thank you so much.

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

Two questions.

First, I know that FPD was record for the year, but was the growth rate in FPD similar to the Silicon business?

And the second question is, have the 45 nanometer decisions started to be made?

How far long are we in that process?

Because, you did mention that you expected to pick up more share there.

First of all, Brett, in the flat panel area, the growth there was very similar within 1 point or 2 of the overall growth of the Company.

So it was pretty substantial and it really makes three consecutive record years for our AKT division.

On 45 nanometer, of course it depends on the company, but the leading logic companies are already making major decisions here, have made a lot of the decisions on 45.

The Foundry guys are in the process of making them.

And the memory guys have a little different dimension but let's just say 50 to 55 nanometers, they'll be in the selection process here over the next six to nine months.

Great, thank you.

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

Thank you.

Can you break down backlog by reporting segment as well?

No, we don't plan on doing that.

Not in the 10-K either?

I don't think so.

No.

Okay.

And one other question.

We've talked a lot about market share on this call, can you give us an update on where you think you are with respect to ion implants and market share?

Well, in our implant area, we haven't really been particularly happy with what has transpired this year but we continue to work hard in that area.

It's one of those areas that we have a focused R&D program on.

Our strengths are in beam purity and high dose implant.

We're working to utilize some of our platform strengths in software and in robotics to help improve the productivity that we really need to enhance to be competitive there.

Okay.

You mentioned backlog adjustments of $97 million.

Was that just the one customer, or was there some other dynamic here too with other customers?

Steve, it was mostly normal puts and takes and then one large customer in the display area.

Fair enough.

Thank you.

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

Congratulations to Nancy and George on future and past roles.

And question, I seem to be hearing from people in the industry and other equipment companies of a shift in the memory segment away from flash to DRAM with the anticipation of the rollout of VISTA and such.

And we've heard some manufacturers of that fungible capacity, perhaps moving capacity in that direction.

Given that -- first of all, I'd like to hear your comments on that, if you are seeing that reflected in the order book?

And secondarily, related to that, would that perhaps soften any potential for excess capacity in the Flash market and where do you see capacity in the Flash versus the DRAM market?

Okay.

So, I think there were a number of questions there, Robert.

Let me see if I can comment on a few things.

First on fungible capacity, this is a thing we've discussed with the customers quite a lot.

The two major Korean DRAM manufacturers have varying degrees.

One has a lot more ability to move from DRAM to Flash and back again.

The other one has a small amount of ability to move.

Most people, at the current time are -- the DRAM manufacturers and those two companies that have the flexibility are moving more of their investments to DRAM in the current time, for the obvious reason of DRAM prices are holding.

There seems to still be a shortage of supply and VISTA is coming and more DRAM's are going in cell phones.

So all those things make you tend to think that DRAM's are going to continue to be strong for the foreseeable future.

So, yes, we're seeing more DRAM play.

But then there are pretty much peer play Flash manufacturers in Japan and the U.S. that are pretty focused on growing their Flash demand.

So, we haven't seen them do any real changes at all.

So the order book mix hasn't shifted over the last quarter or so?

Yes, it's moved more towards DRAM, particularly from those Korean manufacturers.

Okay.

And just a follow-on question, if I may.

After this sort of flat couple quarter period we're talking about and the expectation of the foundries coming back, are the foundries -- the orders that you're anticipating coming back in spring of '07, orders primarily to add capacity for the second half of the year normal seasonal rush of production?

Is that sort of the -- should we be looking at this in more of a seasonal rather than a cyclical behavior?

It's hard for me to judge exactly how they're capacity and growth of their company is going to go, but the answer to their question is yes.

That we've worked hard with them to shorten lead times so they can add capacity quickly.

And we certainly think that that's the season, that they've been adding capacity for the last few years.

Okay, great.

Thanks.

Great job.

Thank you.

Operator, we have time for one more question.

Your final question comes from the line of Mark Fitzgerald with Bank of America Securities.

Thanks.

Given your outlook for the different segments in 2007, is there any implications for margin impact on the model?

No, not at this time.

We see the mix affect being immaterial.

Thank you.

Okay.

Thank you very much.

We would like to thank all of you for joining us in our discussion on Applied Materials financial results and outlook for the upcoming year.

We would also like to remind you that a replay of this call will be available on our Website starting at 5:00 p.m. today and will be remain posted until November 30.

Thank you for your interest in Applied Materials.

This now concludes our call.

This concludes the Applied Materials Q4 fiscal year 2006 conference call.

You may now disconnect.