應用材料 (AMAT) 2008 Q2 法說會逐字稿

Welcome to the Applied Materials fiscal quarter 2008 second quarter earnings conference call.

During the presentation, all participants will be in listen-only mode.

Afterwards, you will be invited to participate in the question and answer session.

As a reminder this conference is being recorded today, May 13th, 2008.

I would now like to turn the conference over to Linda Heller, Vice President of Investor Relations, Applied Materials.

Please go ahead.

Thank you, Kara.

Good afternoon, and welcome to Applied Materials fiscal 2008 second quarter earnings call.

I'm happy to be participating in my first quarterly call here at Applied.

For those of you who I have not yet met, I'm looking forward to speaking with you soon.

Before we begin, let me remind you that we will be hosting our traditional analyst briefing at this year's Semicon West show on Tuesday morning, July 15th.

This year's event will be focused specifically on the silicon systems group.

More details on this will be coming to you soon.

Joining me on the call today are" Mike Splinter, President and CEO, George Davis, Chief Financial Officer, and Joe Sweeney, Senior Vice President, General Counsel, and Corporate Secretary.

Today we will discuss our results for the period ending April 27th, 2008.

The financial results were released this afternoon at 1:05 PM pacific time.

A copy of the news release is available on Business Wire and on our website, www.appliedmaterials.com.

Today's earnings call contains forward-looking statements, including those relating to: Applied's performance, products, growth opportunities, strategic position, display in solar momentum, operational efficiencies, cash generation and deployment, and financial targets, customer spending, and the outlook for the semiconductor display and solar industry.

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.

Forward-looking statements are based on information as of May 13th, 2008, and the company assumes no obligation to update such statements.

Mike Splinter will lead off the call with highlights on the current industry environment and Company progress.

George will follow with a discussion on our financial performance for the second quarter, and our targets for the third fiscal quarter of 2008.

After George and Mike's remarks, we will open the call for questions.

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

Thank you, Linda.

I'd like to take a moment to welcome Linda Heller as Vice President of Investor Relations.

Linda joined Applied the day before our annual meeting in March and she has been getting acquainted with many of you since that time.

She's already a great addition to our team.

As we report on the second quarter, Applied Materials is growing in our display and solar businesses, and managing effectively through the current wafer fab equipment downturn.

The overall business environment is clearly marked by a shifting global economy with uncertain macro economic conditions.

Based on recent conversations with customers, we expect to see a further slowdown in semiconductor capital expenditures.

We now anticipate wafer fab equipment spending to be down 25% to 35% in calendar '08, down considerably from our earlier view that called for a second half recovery led by foundry and flash.

Our current view is more negative than what you might derive solely from spending cuts announced during this past quarter.

Within the key markets for semiconductors in calendar '08 we see DRAM investment down 50%, NAN flash down more than 15%, and foundry and logic both slowing by more than 20%.

So the real questions on everyone's mind are, is this the bottom?

What will drive a recovery?

And, of course, when will it happen?

I see a number of factors.

First, yes, we think this is the bottom.

However, the return to growth we must see sustained increases in DRAM unit prices that translate into improved profitability and cash flow.

While average DRAM contract prices increased more than 15% in the last 30 days, it's still well below levels necessary to support meaningful investment.

In addition, these difficult market conditions have reduced plans for industry consolidation that could allow for a more rational future capacity growth.

Supply and demand looks to be in better balance in the second half of the calendar year as demand outgrows bid supply led by growth in PCs and significant adoption of DDR3.

Second, we expect next phase of capacity build-out for NAN flash to meet the growing demand for new applications.

The most exciting application on the horizon is the adoption of solid state drives which offer significant value in power, space, and performance for PCs and enterprise systems.

Beginning in '09, and over the next several years, we expect NAN flash manufacturing to ramp up to an incremental three million to four million 12-inch wafers per year at the 4X nanometer generation to enable this market.

And third, we're closely monitoring foundries to see when they will ramp capacity for 65 nanometer, and increase leading edge investment at 45 nanometers.

As I said at the beginning of this year, this is a year of execution for Applied Materials, and that's where we are focusing our attention.

Our silicon management is navigating through a very rough cycle, while driving new product introductions and substantially improving operating efficiency.

We have recently announced the applied Aera2 for mask inspection, Tetra for mask clean, and the Inflexion for bevel polish.

We're pleased with the early customer reaction, in particular our mask inspection system is already running production at multiple customers.

Together, these three products provide more than $.5 billion in new market opportunity.

2007 was not a great year for our CMP product line.

Our served available market declined due to substantial productivity improvements delivered by our systems, and we failed to capture the business at a major flash manufacturer.

Today, improvements in our reflection CMP products are being recognized by key customers as we minimize defects and deliver high productivity.

We continue to pursue long-term opportunities in etch and inspection.

In 2007, overall etch share, as well as our share in inspection, was essential flat.

We expect that etch share will be lower in 2008, impacted by the reduction of spending by memory companies where we hold the majority of our positions.

In 2008 we expect gains in inspection through the further adoption of UVision and Aera2, as the defects related to immersion lithography become even more difficult to detect.

We have improved our position with flash customers in order to be ready for the future capacity build-out.

We shipped our 200th producer for advanced patterning films which is used in nearly all advanced memory fabs for as many as 10 lithographic layers.

In solar, our team is focused on multiple simultaneous SunFab start-ups and growing our equipment business with crystalline silicon customers.

This is an exciting time as we move through the launch phase of a global business that is changing the dynamics of solar energy.

We are facing the challenges of the start-up of multiple factories simultaneously and performing critical R&D to boost cell efficiency and reduce cost.

At the same time we are using the power of Applied Materials to deploy 500 people in the field, putting the right expertise in the right place to help customers succeed with fast ramps of their factories.

Our thin film SunFab offering has strong market momentum as evidenced by the disclosure in March of our first contract for a gigawatt scale project.

Solar customers understand the cost benefits that come with the combination of technology and scale.

SunFab 5.7 square meter solar panels are expected to start rolling off production lines by midyear.

There are currently four factories in start-up mode.

Two of them are already depositing silicon and glass.

Soon we will have eight lines in start-up.

Our internal manufacturing and supply chain is executing on schedule for each of our customers' factories, and is ramping on pace with growth.

We've made great progress over the quarter with improved efficiency and uniformity of both the single and tandem junction films.

We are getting excellent results on tests and have established a reliability lab in [Shian].

We are pleased to announce today that sun film awarded applied a contract for a second tandem junction SunFab line.

While our SunFab product has captured a lot of attention, I want to also highlight the significant business that we have established in crystalline silicon equipment.

We're not providing equipment for the highest value-added steps of the crystalline silicon process flow, from wafering to antireflective coating and metallization to test and sort.

In fact, our ATON PVD system is the tool of choice for lines with capacity greater than 50 megawatts and is shipping at record rates.

In precision wafer systems, integration is on track, and as of the close of Q2, we had increased manufacturing capacity about 90% since the acquisition in June 2007.

Our [Baccini] team had a record quarter for shipments as our capacity improvements started to catch up to demand.

The market acceptance for solar PV is growing.

The cost of photovoltaic solar electricity at $0.15 to $0.25 per kilowatt hour has already reached grid parity with the peak rates of several important markets including California.

And as our 5.7 square meter SunFab panels start to move to the field in volume by year end, we'll begin to see the installation advantages of these larger panels and expect a 15% to 20% decrease in install costs.

Our service team is growing its capabilities for solar and display customers while maintaining strong financial performance.

AGS continues to perform well despite the difficult conditions related to semiconductor equipment.

Revenue's up modestly year-over-year, largely from the impact of new business areas.

AGS is making good progress in the downturn, capturing six new silicon service penetrations this quarter with three of them in Taiwan.

Despite the closing of some 200 millimeter memory fabs, we see 200 millimeter as an area of strength for the next six months for both aftermarket upgrades and refurbished tools.

In addition, we recently introduced our SunFab performance service program and just announced a multi-year agreement with T-Solar in Spain.

Our display team is meeting the demands of an unprecedented ramp.

Orders in the first six months of the fiscal year have already topped our full year record achieved in 2006.

Q2 orders stayed strong after the record quarter in Q1.

Industry capital spending is estimated to be up more than 50% in calendar 2008, and we expect our revenue to be up roughly the same percentage in our fiscal year and continuing to ramp into 2009.

The pivot PVD system is gaining acceptance as customers are seeing a significant improvement in up time and cost of ownership due to improved target utilization.

PVD almost doubles our available market and should provide growth opportunities as we move to the gen 10-size systems.

Overall, Applied is executing well in a very dynamic environment.

In silicon we are substantially improving our operating model while maintaining our commitment to invest in R&D, shifting the targets of some programs and reprioritizing others, and ensuring that we feel innovation.

In solar and display, we are in a period of rapid growth and experiencing the inherent execution challenges that come with it.

We are focused on our cost structure and will continue to keep costs in line with our business model.

It our employees have shown considerable dedication and resolve to get results in our different businesses and flexibility to meet the demands of changing conditions.

Discipline and execution are critical to capitalizing on this environment, and I'm pleased with how our teams have performed to date.

Now I will turn the call over to George to comment on the company's results for Q2 and to provide our targets for Q3.

George.

Thank you, Mike, and good afternoon, everyone.

As Mike noted, we met our Q2 targets while managing the challenge of multiple businesses that are facing very different market conditions.

Steep ramps in solar and display are in sharp contrast with the challenging conditions for silicon equipment.

Our services business continued to show solid performance during the period.

Given the leverage of our silicon segment to overall performance we have taken both short-term and long-term cost reduction actions.

We are taking additional measures in the third quarter including shutdown time and those businesses affected by lower demand, discretionary spending reductions and executive pay cuts.

Now I will summarize our second quarter performance.

Q2 orders totaled $2.4 billion, a 3% reduction from Q1, and we're at the low end of our target.

The lower orders were primarily due to a decrease in display orders from the record levels achieved in Q1.

Backlog for Q2 increased to $4.6 billion.

Backlog adjustments for the quarter were positive at $210 million comprised of additions of $367 million and beginning backlog from the Baccini acquisition and $80 million in currency adjustments offset by $238 million of debookings primarily for silicon equipment.

Our backlog is at the highest level it has been in many years as the impact of the ramp in display and the growth of our solar bookings have more than offset the drop in silicon orders.

As a result, we currently have backlog that is relatively evenly distributed across the segments.

Revenue for the quarter increased 3% to $2.1 billion and was within our target range, reflecting higher display and silicon sales partially offset by lower EES sales, which I will discuss shortly.

Gross margin for Q2 increased modestly to 45% from 44.8% in Q1, reflecting slightly higher revenue levels.

Second quarter operating expenses were $529 million and reflect savings from the cost reduction plan we announced in January, partially offset by increased investment for our ramp in solar and display.

Operating income increased to $438 million or 20% of revenue compared to 18% reported for the first quarter.

The increase reflected higher revenue, the absence of restructuring costs, and the operating expense improvements I just mentioned.

Net income was $303 million, or $0.22 per share, meeting the high end of our target range.

Let's now look at second quarter results by segment.

In silicon, orders were down slightly as expected.

Our order composition was: DRAM 40%, foundries 22%, flash memory 13%, logic and other 25%.

Orders for 70 nanometer and below technology represented 94% of silicon orders.

Q2 silicon net sales were up 2% compared to the prior quarter as increased demand from foundry customers offset weakness in DRAM and logic spending.

Operating income was $448 million or 35% of net sales.

Our performance clearly shows the benefits of the many actions taken to improve the operational and financial performance.

The silicon management team has done an excellent job over the last three-quarters of capturing the benefits both operationally and commercially from the formation of a single silicon organization.

one, prioritization of R&D resources to the most critical projects and portfolio management leading to exit of unprofitable businesses and projects.

Two, improved cycle times in our manufacturing lines and a continuous push to lower material costs through global sourcing and various supply chain initiatives.

And three, headcount reductions to increase synergies and eliminate redundancies while flexing our temporary work force and discretionary spending to absorb volatility.

To put the impact of these actions in context, this quarter's operating profit is eight percentage points higher than Q1 '06 when revenue was at similar levels.

We are continuing to invest in long-term margin improvement through our global sourcing activities, and made further progress in Q2 on our strategy to reduce costs and move certain manufacturing and procurement functions offshore.

During the quarter we set plans in place for an Asian-based emerging transit and manufacturing site in Singapore.

Orders in energy and environmental solutions totaled $257 million for the second quarter, down slightly from Q1 due to lower orders from PWS.

Q2 orders included $152 million for our Applied SunFab thin film lines, and a modest amount from the first month of Baccini results.

Net sales of $85 million were down $37 million due to lower sales quarter over quarter in solar and glass products.

Q2 sales do not yet include amounts for Baccini.

We will report our first full quarter of revenue for Baccini in Q3.

Our combined crystalline silicon solar products are now on an estimated shipment run rate of approximately $200 million per quarter.

The operating loss for EPS of $71 million increased from Q1 reflecting the lower revenues and increased operating costs associated with the buildout of our solar business including multiple simultaneous start-ups and certain acquisition-related charges for Baccini.

In our services business, Q2 orders were down 1% from Q1 due primarily to lower orders for spares in line with semiconductor industry conditions.

Net sales increased 1% from Q1 due to higher display service sales offset by lower sales of refurbished equipment and factory software.

Operating income was $159 million or 26% of sales, a slight increase from Q1 due to improved margins and product mix.

As a reminder, in Q1 '08 we now, as of Q1 '08, we now reflect service results for display and solar under AGS.

A segment level reconciliation of this change is available on our website.

In display orders in Q2 remain high but were down 11% from the record level last quarter.

Still, Q2 ranks as the second best order quarter ever at $493 million.

LCD customer investment to meet expected in use demand remains high.

In just two quarters display has already exceeded its previous annual record for equipment orders of $883 million that was achieved in fiscal year '06.

Display's net sales of $198 million for Q2 reflected the increased level of order activity that began in the latter part of fiscal year '07.

Display operating income increased to $59 million, or 30% of net sales due to higher revenue and product mix, partially offset by higher costs.

Display is ramping PE CVD equipment manufacturing capability to supply both display and solar requirements with new capacity in our [Tainon] facility.

This facility will enable the manufacturing organization to support ramp requirements of these two businesses and leverage our primarily Taiwan-based supply chain.

We expect to continue with a heavily outsourced model even as we more than triple our production of CVD and PVD tools.

Next I would like to discuss our balance sheet and cash flow.

We ended the quarter with a cash and investment balance of $3.85 billion, an increase of $484 million.

Cash flow performance was very strong this quarter as we generated $874 million in cash from operations, or 41% of revenue.

Working capital performance for the quarter reflected strong receivables and collection performance, partially offset by an inventory build of approximately $200 million in solar-related businesses.

We are taking a prudent approach to managing our working capital requirements in solar.

SunFab contracts typically require cash payments and letters of credit that roughly coincide with the timing and magnitude of working capital investments.

In Q2, Applied returned $381 million, or 44% of operating cash flow to its stockholders.

Of this amount, $300 million was for the repurchase of 15 million shares at an average price of $19.97, and $81 million was for cash dividends.

$260 million in cash was generated from the exercise of [14 million] stock options.

We expect to spend between $200 million and $400 million on share repurchases in Q3 '08.

Before I give our Q3 targets I want to recap three major themes.

One, our business groups are performing well, showing strong financial and operational results, while executing to very different growth opportunities.

Two, we are seeing a steep decline in SSG indicating a cyclical bottom in our fiscal Q3 and will continue to manage both cost, while fully funding R&D.

Three, we continue to benefit from a strong ramp in display and solar and we are pleased with the progress of our SunFab lines and are seeing the first repeat orders from our early customers.

Now I'd like to move on to our guidance.

Our targets for Q3 are: we expect orders to be down in the range of 15% to 25%, driven by a very weak quarter for silicon equipment and lower display orders coming off back to back record quarters for display.

We expect revenue to be down in the range of 10% to 18% due to a decrease in silicon, partially offset by increases in our other segments.

We see a strong pull back by both flash and DRAM memory customers in our third quarter.

We believe this near-term caution by our customers will impact silicon equipment sales by more than 40% versus Q2.

We expect EPS to be in the range of $0.10 to $0.14 per share, reflecting lower revenue, the mix impact of reduced silicon business, growth in spending in solar and display, partially offset by continuing focus on our cost initiatives.

With that Linda, let's open the call for questions.

Kara, please begin with the first question.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Gary Hsueh with Oppenheimer and Company.

Hi.

Yes.

Thanks for taking my question.

A lot of controversy here over cost per watt and the kind of models you enable with your customers.

Mike, you talked in relative terms about cost per watt for the industry and the benefits of installation costs for the 8.5G format.

But could you give us an idea on single junction and tandem junction technologies?

What's your assessment of cost per watt for their customers in terms of their manufacturing model?

And number two, what of some of the big levers in reducing cost per watt for your customers over next two or three years?

Sure, Gary.

Thanks.

Okay.

So I think what we'll see over -- first of all what I think we'll see over a period of time are a pretty strong trend to tandem junction, even those customers that current have single junction with see upgrades over a period of time to tandem.

We're already in fact seeing that.

So the big focus is how fast will tandem junction costs come down.

We have a target to improve efficiency over the next few years to 10% or more.

We have a target to get to the cost per watt produced of cost in a standard line.

We think the big lines, gigawatt-scale lines, will see another significant reduction because of the capital efficiency there.

We haven't quite quantified that, but you can -- it's expected to be kind of in the 15% to 25% range of cost improvements.

One of the -- so as you know we're just starting the factory so these numbers are all projections.

One of the good things that we believe that we'll see across our factory network is very fast learning as multiple factories, many engineers around the world, start to run these factories in production.

So we're already encouraged by what we're seeing in the companies that are starting up their factories now and driving fast start-up and improved operation.

So that's kind of where we are, and for right now, I think the big thing for us is to get these factories into production, and really start learning at a very fast rate.

Okay.

And Mike, what about the levers beyond efficiency, I've got to assume up time and availability service division is another big lever in reducing cost per watt.

Is that right?

And can you give me a sense of what percentage or relative reduction we could see with increasing ability and up time as you -- learning curve?

Sure.

I'm it not sure I can give you all -- the kind of data that you want.

Probably we'd have to go through the spreadsheet.

There are all kinds of things, gas usage, up time, panel yield, obviously efficiency, productivity of our systems, basically speed of deposition.

We're working very hard to improve the speed of deposition.

The microcrystalline layer's quite thick so improving that speed is critically important to the cost.

Electricity use of the machines, one of the things we've done to work with customers, and it's a hallmark of our service agreement is structured is that if the cost per watt goes down, we win.

We essential get paid more in the service agreement if the cost per watt goes down for our customers, so this really aligns our motivations with the motivations of the customers.

They win, we win and hopefully the market wins.

Okay.

Thanks a lot.

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

Thank you.

My question is on the guidance.

Given that you believe the silicon sales will be down, I think you said 40% sequentially in July quarter.

It appears that silicon is approaching some of the levels seen back in 2005 and maybe even 2002.

When do you think the company will see a recovery in the semiconductor equipment orders?

Do you expect orders in October to see some sort of recovery in silicon?

We do.

I would say that we're seeing levels that are kind of like '03 levels, but anyway, yes this is -- these are -- this quarter is especially soft.

We think there will be improvement in the next quarter and into the first quarter of -- our first fiscal quarter of 2009, but again I think we have to see return to profitability by memory companies for them to have real confidence to invest and also have the wherewithal to acquire the kind of money that major fab requires.

Okay.

If I could just follow up on a question on the solar.

Are any of these solar equipment orders being recognized in the July quarter from the large gigawatt customer that was announced in early March?

And if not, when can we expect orders to be signed off for that very large project?

Yes.

We're not going to guide by specific customer.

The orders that we booked for this quarter were for the contracts that we announced last year.

Okay.

Thank you.

Your next question comes from the line of Weston Twigg with Pacific Crest.

Hi.

Yes.

I just had a couple of questions here.

One, jumping over to the semicap equipment side, radical inspection, wondering how many tools you've shipped so far and how many of those have gone to fabs and how many to mask shops?

Almost all have gone to mask shops, at this point we'd just be starting to fabs.

We have four current customers at the current time.

Okay, great.

Also just wondering, how big do you think that market is and how much do you think you could get by the end of '09?

Well, we think it's over 300 -- over $300 million to $400 million.

And I'm not going to make an estimate of how fast this product will ramp.

I think we really to have get through this initial phase, but we like our machine for both in fab as well as radical inspection and mask shops.

So I think the focus of our efforts here right now are going to be on really advanced masks where people are especially defect sensitive and have to figure out what's going to print on the wafer before they either ship it to fabs or ship it to a scanner.

Okay.

Great.

And I just had a question jumping back over to the solar side.

Just wanted a clarification.

Did you say your target is $1 a watt in standard thin film lines, and that you might get a 15% to 25% improvement over larger scale?

That's what I said.

Yes.

Okay.

Great.

Thanks.

Your next question comes from the line of Jay Deahna with JPMorgan.

Thanks very much.

Good afternoon.

Couple questions here.

The first one I believe would be for George.

George, when do you expect to shift your revenue recognition policy for SunFab tools to shipment-based in line with the rest of the company from acceptance based now?

And the second question I believe for Mike, can you give us a little more detail about the progress of your first set of customers and some of the challenges and optimism in terms of getting working single junction panels mid year and when you would expect the first working tandem junction panels?

And then last but not least, when you're calling the bottom in 3Q is that an order and a shipment/revenue bottom for some equipment?

Thank you.

Okay.

Why don't I take the first and the third and -- Hi, Jay.

On the shipments based question for our solar fabs, I think it's early days on that.

We -- we're -- it's a little different than our standard, because it's -- we're basically selling a full line as opposed to single piece of equipment.

Today we're signing off based on customer acceptance after we get through the first few fabs, then we'll take a look at what makes the most sense, but it's different than our existing business, and so we'll be looking at everything from sign off on shipment to percentage of completion, things along those lines.

Just a quick follow-up on that one until you answer the other two.

If you sell -- if you ship two 60 megawatt tandem junction lines per month in calendar '09, I estimate that's roughly $2.5 billion in revenue.

Now if that's recognized on shipment versus acceptance that could have a huge difference in the expectations for revenue and earnings from solar in calendar '09.

So to put it a little bit differently, do you think by the time we get into calendar '09 that it would be a little bit more in line with the normal company revenue recognition policy?

I really -- I go back to what I said before, Jay, I think it's really too early to make that call.

But we're certainly focused on that.

And our real attention now is on getting these initial lines up and running and performing to our customer commitments.

Okay.

Then the other two, please?

You want me to jump into the bottom of -- I'll take your third question which is, do we see Q3 as a bottom in revenue and orders?

It's clearly a bottom in revenue.

Orders are down, we're seeing orders down fairly substantially as well for silicon, whether -- so, -- looks, both look like a bottom, but revenue, clearly.

Hey, Jay, it's Mike.

On the progress on single junction, as I mentioned, we're seeing two factories, two customers already depositing silicon.

That's a great sign as it's the most critical element of making the sales.

And I -- we just have great set people distributed around the world it at every one of our customers' factories.

These are experienced people from -- with experience in installing semiconductor equipment or display equipment.

So we haven't had to train these people from the beginning, but they have factory experience, they know how factories are supposed to run.

So it gives me a lot of confidence we are going to be able to get the equipment up, get it running, test out the cells and really see output over the next few months.

And then on tandem shipping, obviously going to be later in the year.

We expect to see output before the end of the fiscal year.

Before the end of the fiscal year?

Yes.

Okay.

Thank you.

Your next question comes from Satya Kumar with Credit Suisse.

-- my question.

George, I don't know if you tried to quantify the silicon orders in the July quarter.

Should I think of back to bill approaching about one in the quarter?

Yes, I think it's a little volatile to be that specific, but it's coming down inline with the revenue drop-off.

What sort of driving that decline?

When I look at your other U.S.

equipment peers they're sort of having a peak to trough decline of 40%.

For the (inaudible) materials it's a lot a lot higher, at down 60%.

What sort of is driving that underperformance in silicon for you relative to other semi cap companies?

I think you're going to have -- I'm not going to talk about other companies, but talk about what we've seen in the last several weeks.

I think the big shift is change in our view about what's happening with flash.

We had expected flash memory to have a pretty strong second half.

In fact, that's not going to happen.

It's going to be down 15% on the year.

We see 50,000 wafers being pushed out.

And so I think when others consider that, I'm not sure whether you saw Tokyo Electron's announcement earlier today but their view is pretty much in line with where ours is, and so this is not just -- the big shift is flash, but pretty much everybody is down.

There's only one company investing in foundries, and they're investing very incrementally at a pretty low level DRAM, we all know the story, and logic has been cautious.

There's not a good story in the total.

We see 10 factories in total that have pushed out major -- either pushed out or lowered their capacity goals for their factories.

So --

Okay.

That's helpful, Mike.

If I could follow up on solar a little bit, one for Mike, and one for George.

When do you expect your customer to first ship (inaudible) panels from the get-go and when do you expect that will happen with tandem?

And to George, there's been some deterioration in the balance sheet metrics, inventory levels are increasing to sort of the highest levels in five years and so are payables.

How should we model that as we go forward as you ramp solar?

And also if you could just remind us what your break-even is now in solar and how the profitability will develop any solar revenues.

So to answer the first part of the question, we expect production panels in single junction coming off the line by midyear, so we expect them to be selling in the second half of the year.

In tandem junction, we expect late in the year for panels to be coming off their lines, and so they'll sell around -- they'll start selling production panels at the end of the year.

And selling full panels, or are these cut panels from the gen 8.5?

They'll sell whatever customers demand.

As you may know, our line allows for three sizes of panels: quarter size, half size, full size.

As we get into production, we'll see more and more of -- as our customers get into production, we'll see more and more of the full-size panels just because as the infrastructure develops, they'll be less costly to install.

Let me address -- I'll start with the balance sheet.

Actually, I think we have a very good story on the balance sheet, and in the way that we're running our solar contracts.

Virtually all of the solar contracts operate on the same basic principle of deposits and LCs to line up with the commitments that the company is making.

So the fact is, we are ramping very heavily, and we do have to build revenue.

I think would you're seeing in the accounts payable and other liabilities line is really the growth of our deposits, which are carried there on the balance sheet.

So I think that's a good story for us.

We haven't had to draw down our cash balances to fund this ramp.

We probably had above expectation cash flow from operations this quarter because of the working capital discipline in our other businesses.

So I think all in all we're very comfortable with where that's going and the approach that we've taken.

In terms of the break-even, I said that we expected EES to be break even in '09, despite all of the build-outgoing on this year, as revenue picks up in the second half of this year we think we've closed the gap on that very quick.

So they're performing as expected despite very, very strong growth in spending to meet customer demand.

Thank you.

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

Hi, guys.

Couple things.

First of all, if I take your silicon revenues down about 40% in the July quarter, that's down roughly 44% year-over-year.

That's like two ex what the average of the other large peers are.

So yet if I look at your margins your margins are actually better than they've really ever been at this revenue level.

So I'm wondering, is there some element of you kind of selectively walking away from some business that you -- that just isn't as profitable, or is this kind of a customer mix issue, and particularly how do the margins look coming out of this in the silicon business?

And then I had a follow-up question.

Yes.

Do you want me to go, or you --

I'll start, you finish.

Hey, Tim, I think if you look at this lots of things are at play, of course.

I went to argue that.

We exited some businesses, and as I commented in certain areas we've been challenged by competitors, but those are very small percentages, and we're talking about major change in demand here, and major change in orders quarter over quarter.

So I think this is what's happening in the industry, and others will update over a period of time.

I think also we should remember, too, that we report revenue on shipment, and others on sign-off.

So we tend to be going down earlier on a down cycle, so that's -- that may be part of the factor in your math.

I will say that the decision to exit certain businesses and the portfolio realignment work that the semiconductor team has done over the last year satisfying real impact on the profitability and on the margins.

And as we talked for a long time, the implant business was chronically unprofitable for us.

And so you're seeing the impacts of that, the departure from the ECP business as well as having a positive impact.

But really, it's also about cycle time reductions that we've gotten in the factory, continuous push for material cost savings.

So there's a lot of things going on in cost of sales that are quite positive.

And then, of course, the formation of the single silicon group, we're also seeing some OpEx benefits on top of that.

Okay.

George, I guess just on that front, so what sort of incremental margins should we expect given some of the cost savings?

What sort of incremental margins should we expect in the silicon business coming out of this?

And then I had a question on solar relative to the timing of that cost per watt road map.

If you look at one of the major peers out there, they are going to be at $0.90 incremental per watt this summer.

So if you're saying that gigawatt scale fab is roughly say $0.80, if I take the mid range of your guidance that you had said before.

What sort of timing do you think that that number will be achieved by, given that peers are going to be at $0.90 incrementally by this summer?

Thanks.

Let me talk about the margin coming out.

I think this quarter gives you a good example of the leverage that we're seeing.

As we've pointed out, in Q2 over a comparable period, as we roll through some of the improvements that we've seen, we're eight points of operating margin to the good.

Five points of that, from a waiting standpoint, five points of that was in the gross margin area, and three points in OpEx.

So I think we can -- we'll continue to see leverage both in gross margin and operating expense and coming out of this.

I think we're -- we announced the fact that we're moving some of our manufacturing and merchant transit activity to a hub within Singapore, so I think there's things that we're going to continue to do that should add to the benefit that we're already seeing.

So Tim, on the second question on the cost road map, the answer is, as soon as we have a gigawatt factory up and run -- one of our customers has a gigawatt factory up and running in large scale volume, which is going to take some periods, it's going to take probably a couple years to get at very high volume.

I really think specific, very precise cost numbers are hard to make at this time when we're just first starting up initial factories.

I think we're going to learn an awful lot, and as we do we can update with real numbers.

Our numbers are theoretical certainly at this point.

It isn't that we haven't analyzed them in detail.

We have, our customers have, our customers have confidence in them and have confidence in improving over what we've projected, but we've got to get into real production and move up the real learning curve, and that's what I think everybody in our company is so excited about.

Now is the time to really get after that and do it for real.

And, Tim, I think you see with a lot of competitive estimates, that -- particularly on the smaller form factors, that it's always about cost per watt, but you never get cost per watt installed, and that's a big factor.

Okay.

Pricing is certainly different than cost.

Of course.

Thanks.

Your next question comes from the line of Jesse Pichel with Piper Jaffray.

Hi.

Good afternoon, Mr.

Splinter, Mr.

Davis, team.

Thanks for taking my call.

Can you explain why the sales in your environmental division was down quarter other quarter?

Yes.

It was really pretty minor, down $37 million.

And it was really our sales out of our PWS group.

And PWS is what exactly?

That's the wafer selling business.

Yes.

I'm hearing the solar customers complaining of long lead times for the HCT equipment, which I guess is PWS.

So is there any decline in output there at HCTS to explain that decline in sales?

No, I think what you're seeing is quite frankly, just kind of a timing of sales.

And we expect the second half, quite frankly, sales to be up significantly in that area.

I think all of the -- everybody in the space is dealing with very significant ramp in customer demand, and so lead times are certainly impacted somewhat, but that's really not the issue here.

And we feel quite good about the outlook for the second half of the year.

That's great.

What are lead times today?

And on the call, in the prepared remarks, you mentioned that higher capacities are in progress.

So what are lead times now, and what do you think they will be in about six months' time?

Well, I mean, we've got a number of different solar products, all of which have different lead times.

On the crystalline silicon side, it's --.

It's crystalline in particularly I'm interested in.

I think six to nine months on the outside and four to six months on certain products.

So it just -- it depends on which products and then obviously on the bigger tools for the SunFabs we have a little longer lead times.

Right.

And where would those six to nine months lead time on the crystalline product go in another six months?

Could you reduce that to three months to six months?

Yes.

I won't forecast.

We certainly see a road map to bring it down, and I think that's one of the advantages that both HCT and Baccini saw in joining with Applied, is our ability to help them manage the ramp, bring the cycle times down, all the things that we've done in numerous businesses.

That's great.

And one more question, if I could.

Sharp recently announced a triple junction in some product using [tell].

Do you see triple as a future upgrade in your road map, similar to the way that your single junction customers now are upgrading to tandem?

Actually, I believe Sharp's triple junction -- Sharp has had a triple junction for long time.

They have used their own CVD equipment.

They created a enjoyment venture with Tokyo Electron to do -- to execute this.

Again, people are going to explore lots of things to improve the performance and efficiency, but really, it depends whether adding that complexity results in reduced cost per watt.

So there's lots of things you can do to improve efficiency, but if they don't reduce cost per watt, they won't get implemented into production.

So --

That's great.

Thank you very much.

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

Good afternoon.

Couple of questions.

First, I want to make sure I just understand, the energy environmental solutions operating loss, it kind of increased quarter over quarter pretty substantially.

How should we expect that to trend over the next couple quarters and what's fundamentally driving that?

Yes, I think most of it is growth in operating expenses, and again, you had a little lighter revenue offsetting that.

I think you are going to see revenue pick up and absorb a lot of that expense.

So again, we're trending towards break-even pretty rapidly.

But are costs rising pretty substantially with the start-ups that you have in progress now?

Oh, yes, we're supporting basically eight start-ups all over the world, and then building out the -- just the normal capability to run a business.

Okay.

Fair enough.

And as far as the Baccini business goes, are you able -- how much can you increase shipments this year over last year, just on a percentage basis?

And considering the market position you have, do you have any pricing strength there that you could execute on?

Yes.

I think on Baccini it's -- we're seeing substantial increases over last year as you would expect.

We haven't -- we're not trying to guide to specifics, but certainly we've seen very, very strong revenue increases, and we're going to be booking -- we'll take our first revenue in Baccini in Q3, and you'll get a sense from what we report the impact there.

Fair enough.

And one last question, if I may.

How do you expect FPD orders to trend over the next couple quarters?

I think clearly we have been pleased all year with the strength of the flat panel display business, and so we had record orders in Q1 followed by the second best quarter ever in Q2.

We see it coming off throughout the year as we see, then we'll start to see revenues ramping as they meet the order pattern.

But again, it's been a substantially stronger demand pattern than we thought we would see coming into the year.

Thank you.

Kara, we'll take one last question, and then we'll make our final remarks.

Yes, ma'am.

And your final question comes from the line of CJ Muse with Lehman Brothers.

Hi.

This is [Olga Robinson] calling for CJ.

Couple questions.

When you mentioned that you're taking additional cost cutting measures to reflect the even weaker industry and outlook, is that actually in addition to the OpEx reductions you talked about at your analyst day?

And if so how should we think about your OpEx levels throughout the rest of the calendar year?

Yes, I think OpEx levels, we've been able to manage the expansion of OpEx in our growing businesses, and OpEx has been coming down as we've gotten the benefits of consolidating our single silicon group, and really rationalization of spending across the company.

So I would -- we've taken a lot of action already, and I would say the stuff that we're doing now in Q3 really is taking down temporary employees, shutdowns and things along those lines, given the fact that it looks to be a bottom, and we would expect revenue and orders to begin coming up in Q4.

And then in terms of solar, you mentioned that the second half of the calendar year should be up.

Given the fact that you are taking revenue recognition on acceptance basis, do you see one of the quarters actually being a step function in revenue recognition, or should this kind of trend linearly and then heading into '09 as well?

Yes.

No, we -- I think it's still too early to give a guidance on the pattern.

Again, we're -- we expect the bulk of the revenue for the orders that we've talked about, or the contracts that we've talked about, to be in '09, and the exact pattern of that will really depend on how well the sign-offs go in our first fabs.

And we're right in the middle of that, so it's too early to call that.

Okay.

Thanks a lot.

Okay.

We'd like to thank you for joining us in our discussion on Applied Materials' financial results.

We would like to remind you that a replay of this call and the supporting slide package will be available on our website starting at 5:00 PM today and will remain posted until May 28th.

Thank you for your interest in Applied Materials.

This concludes our call.

This concludes today's conference call.

You may now disconnect.