應用材料 (AMAT) 2009 Q3 法說會逐字稿

Welcome to the Applied Materials fiscal 2009 third quarter 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, August 11, 2009. Please note that today's call will contain forward-looking statements which are all statements other than those of historical facts including statements regarding economic and industry conditions as well as Applied's business outlook, strategic position, operating efficiencies, cost reductions, products, growth opportunities and Q4 targets. 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 August 11, 2009, and that the Company assumes no obligation to update such statements. Today's call also contains non-GAAP financial measures, reconciliations of the non-GAAP measures to GAAP measures are contained in today's earnings release in our financial highlights slides, which are on the investor page at our website at www.appliedmaterials.com. I'd now like to turn the conference over to Mike Sullivan, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Tara. Good afternoon and welcome to our call. Joining me today are Mike Splinter, our Chairman and CEO, George Davis, Chief Financial Officer, and Joe Sweeney, our General Counsel and Corporate Secretary. Today we will discuss the results for our third quarter of fiscal 2009, which ended on July 26th. Our earnings release was issued at 1:05 pacific time and you can find a copy of it on Business Wire and on AppliedMaterials.com.

Mike Splinter will lead off the call with comments on the market environment and our Company's strategies. George will follow with a discussion of our financial performance for the third quarter and our expectations for the fourth quarter. After these remarks from Mike and George, we'll open the call for questions. Before we begin, I have a quick calendar announcement. Applied will attend the PV Sets conference in Hamburg, Germany and will make several detailed presentations about its solar businesses on September the 21st. The presentations are scheduled from about 4 p.m. Central European time and will be webcast live for those of you who are interested but not traveling to the conference. We'll be sure to provide you with further details in the coming weeks, and with that I'd like to turn the call over to Mike Splinter.

Thanks, Mike. And welcome everyone to the call.

Last quarter, we outlined encouraging signs in the global economy and in our customers' end markets. Today, there are more indications that demand is growing and for the first time in a long while, we see positive trends in our business. Economic decline in the US, Europe and Japan appears to be moderating. In China, GDP is now growing by about 8% with government stimulus driving increased demand for semiconductors, flat-panel displays and solar cells. This quarter, our financial results improved in almost every category, and we're seeing order growth following the steep declines of the first half of our fiscal year. We now believe the pick up in wafer fab equipment will be followed by a ramp of display orders over the next few quarters. We also expect solar fundamentals to improve over the next 12 months and we see potential for a larger upturn in wafer fab equipment next year.

While encouraged, we're clearly building off a small base, and it's too soon to conclude that a broad based recovery is at hand. We are maintaining our cost reduction programs and preserving our financial strength, while investing to ensure our position as the number one equipment supplier to the semiconductor, display, and solar PV industries.

Moreover, we believe this is the right time to consider the lasting changes the unprecedented downturn has made in the industries we serve. Our long range strategic planning is now under way and our focus is to align our products, cost structure, and capabilities with market opportunities to deliver outstanding profitability. We expect to complete our analysis over the next few months and incorporate these changes in our operating plan for fiscal 2010.

Next, I'll comment more specifically on our industries and business segments. In semiconductors, we were encouraged to see IC demand improve over 15% in revenue and over 25% in units in the second calendar quarter. Across the industry, average utilization improved to above 75%. Foundries benefited from a doubling in wafer shipments, and DRAM experienced stronger ASPs on a bid shipment growth of about 9% year-over-year. We believe that by the end of 2010, the DRAM industry will need to transition fully to DDR3, and this will create a served market opportunity of about $2 billion for Applied Materials.

NAND bit growth was about 36% year-over-year driven, primarily by smart phones and portable media players. For calendar 2009, Applied has raised its wafer fab equipment spending estimate from a previous range of $8 billion to $11 billion to a new range of $10 billion to $12 billion. Our Silicon Systems Group's performance exceeded expectations. While calendar 2009 is clearly a year of depressed wafer fab equipment spending, we do expect to gain share virtually across-the-board. Positive trends for us include the adoption of immersion lithography, advanced transistors and a memory conversion to copper. Leading logic customers are doubling the number of selective epi steps and moving to gate last structures. While immersion lithography users need more advanced mask and wafer inspection techniques.

During the quarter, we saw investments by leading edge foundries that favor our CVD and PVD solutions, increasing our share leadership and process extendibility to the 3X node. In etch, we expect a whole share in 2009. Based on our customer footprint, we've achieved repeat buys this quarter in double patterning etch. In Applied Global Services, our silicon service and spares business was up modestly. While factory utilization rates were higher, we've seen customer consolidation and a significant amount of 200-millimeter capacity being taken off line. As a result, wafer starts among our semiconductor customers are down about 30% from a year ago, which is limiting growth. Over the next few quarters, we expect moderate improvement in Applied's service opportunity, driven primarily by increased wafer starts.

In display, a number of leading edge customers are now operating fabs above 90% utilization, and the industry's outlook for profitability has improved. Panel ASPs grew about 15% from their trough in the spring of this year. Global LCD TV unit demand is expected to increase over 20% in 2009, with growth driven primarily in China and the US. During the quarter, we saw the bulk of investment coming from Chinese panelmakers at Gen 6 which is suited for 32-inch TVs, and in the second half of calendar 2009 we expect the next phase of the Gen 8.5 buildout to begin. In this cycle, we expect our pivot PVD share to grow from single digits at one leading customer to more than 20 points at three or more customers.

Turning to solar, strength in the Chinese market, feed and tariff support in Italy, Greece, and France and modest growth in the US Are offsetting some of the cutbacks in Spain. From today's level, we expect annual PV solar installations to grow at a 30% compound rate with China poised to grow at twice the rate of the industry. In 2010, we estimate more than 4-gigawatts of capacity will be added.

In Crystalline Silicon, polysilicon prices are flattening and module prices are falling. In China and Taiwan, utilization at major manufacturers rose to the 80 to 100% range. In this environment, customers need to improve module efficiency, reduce materials usage and achieve greater economies of scale. Applied's products are providing that differentiation. As a result, the momentum of our Crystalline Silicon solar equipment has been stronger than anticipated. Our new Max Edge Wafering System achieved first sign off at a major Chinese customer and we're in the process of shipping 55 wafering systems to another major customer in the region.

And in thin film, we've talked about 2009 being the year to improve operational efficiency, as some fab sites move up the learning curve. We're now seeing factory start ups in half the original time and are rolling significant material cost reductions out to customers. We've demonstrated 8.6% stable modules at tandem junction customers and achieved 10% stable modules in the lab. During the quarter, we achieved factory sign off at a six on fab customer, whose modules are targeted for European utilities. Tandem junction Sunfab panels are now entering the market, with over a megawatt of modules already installed. While new Sunfab projects are still being held back by project financing and market obstacles, we're engaged with a number of new manufacturers and with single junction customers who are exploring the timing of tandem junction upgrades.

One upside development in EDS this quarter was an order to supply transparent conductive oxide systems to a major glass supplier to the solar industry. Before I hand the call over to George, I'd like to observe that Applied delivered a solid third quarter, including a number of key accomplishments in each of our businesses. As a Company, we've done a good job navigating this unprecedented economic downturn, and I'd like to thank all of our employEES for staying focused and doing their part to support our customers and exceed our goals.

Now let me pass the call on to George, who will share our financial results and targets. George?

Thank you, Mike, and good afternoon to everyone on the call today. Applied Materials' performance for the third quarter exceeded our targets for revenue and earnings per share. Directionally, the quarter unfolded much as we expected with order and revenue growth up off the bottom in our semiconductor and services businesses, and revenue declines in display and solar. Semiconductor equipment was the biggest contributor to our performance, as we experienced a strong surge in revenue and orders during the second half of the quarter. While overall sales for Applied remained well below historical levels, our cost initiatives and other efficiency actions lead to earnings breakeven on a non-GAAP basis and positive cash from operations of $194 million.

Now we'll go into more detail on our results. For the quarter, we reported a GAAP loss of $55 million or $0.04 per share. The $0.15 improvement from our Q2 reflected higher revenue and gross margins along with lower charges from impairments, restructuring and severance, and the absence of bad debt provisions. Gross margin improved 13 points to 29%, which shows the margin leverage associated with SSG revenue growth. Factory absorption improved on higher units and we had lower inventory write-offs.

Operating expenses were lower by $47 million as restructuring and other charges take in in Q2 rolled off this quarter and we generated additional savings from our cost reduction program announced in November. Year-over-year, operating expenses, excluding restructuring, M&A charges and equity expensing were down by $107 million, reflecting both permanent and temporary cost savings activities.

Let me take a moment to summarize the results against our cost initiatives. Last November, we set a goal to lower our non-GAAP earnings breakeven point to $1.2 billion in quarterly revenue. And our operating cash breakeven to $1 billion. Clearly, we operated ahead of those goals in Q3. We raised our cost savings objective last quarter to $460 million and that will be fully reflected in our Q4 2009 run rate. Our early and significant actions in cost management have allowed us to maintain R&D investments in our key markets and fund a major expansion into the energy space while delivering strong financial performance during a difficult time. We continue to look at how we can architect the Company to adapt to changes in our major end markets and to reduce or eliminate our reliance on temporary cost measures such as shut downs, bonus eliminations, and other pay cuts.

Turning to the balance sheet, our cash and investments balance of $3.1 billion was up quarter-over-quarter by $64 million. We paid dividends of $80 million and had capital spending of $60 million. Cash from operations was 17% of revenue while investing nearly $0.25 billion or 21% of revenue on R&D. Strict working capital discipline was a key factor in this performance. Day sales outstanding improved from 82 days to 68, and we lowered inventory by $150 million, most notably in SSG and AGS. I would like to thank employEES throughout our Company for their dedication to working capital management.

Our backlog at quarter end was $3 billion, down from $3.2 billion at the end of Q2. 36% of the backlog is related to our EES business and the remainder is about evenly split between Silicon, Services, and Display. Backlog adjustments totaled $141 million and included $146 million in cancellations and $51 million of debookings, partially offset by currency and other adjustments of $55 million. The cancellations were primarily related to semiconductor memory and foundry customers with the biggest impact from memory customers changing their investment strategy to place orders for more advanced nodes in response to competitive requirements. The debookings primarily reflect AGS and EES orders that have not been cancelled but are now expected to be realized outside of our 12 month bookings window.

Now I'd like to review our segment results. Silicon Systems had a very strong quarter on several fronts, including orders in revenue growth and outstanding working capital management in the turns environment. Orders of $542 million more than doubled from Q2. Orders by semiconductor type can be found in our earnings release but nearly 70% came from foundry and DRAM customers. SSG revenue was $498 million, up 91% sequentially, and well ahead of our expectations of flat to up 40%. SSG's manufacturing team was able to deliver approximately 60% of the revenue in the quarter on a turns basis. The last month of the fiscal quarter was particularly strong for SSG, both in orders and revenue. A month that competitors will reflect in their September quarter results.

SSG's operating profits were $56 million or 11% of sales, which demonstrates the benefit of our operational changes and cost reduction actions. Looking forward, leading customers are continuing to rely on short cycle ordering, which results in limited visibility beyond the current quarter. Customer concentration in orders and revenue remains very high and a change in plans by any one of the leading customers could have a material impact on a given quarter. In AGS, orders were up 26% sequentially to $298 million, reflecting higher factory utilization and spares demand. Revenue of $343 million was up 7% sequentially, due primarily to higher Silicon spares revenue which was offset by lower revenue from other services. Operating profit was $24 million or 7% of sales. Display orders increased to $96 million after bottoming at $13 million in Q2, and we see display customers beginning to accelerate their Gen 8.5 investments in response to strong consumer demand.

Revenue decreased as expected, with sales of $69 million including our first Gen 10 system revenue. While revenue for display was the lowest since the second quarter of fiscal 2002, our highly outsourced operational model for that business resulted in only a modest loss. In EES, orders of $135 million were down 4% from Q2, as solar customers are still faced with difficult market conditions and a tight credit environment. We are seeing strong demand for our new wafering products, particularly from China. EES revenue was down 37% from Q2 to $224 million. Crystalline Silicon revenue declined in line with the industry, while Sunfab revenue reflected our sixth customer sign off. EES revenue over the first three quarters of fiscal 2009 is already more than $50 million above total EES revenue for fiscal 2008, despite challenges in the end markets. EES had an operating loss of $53 million or 24% of sales.

Excluding M&A charges, the Crystalline Silicon business was operating margin positive in Q3 and has been for every quarter this year. Our latest Sunfab factory sign off reflected cycle time and other learning curve performance improvements. As a reminder, the EES operating loss includes R&D investments in solid state lighting and other energy and environmental opportunities that represent both near term and exploratory investments in broadening our growth portfolio in this space.

Now let me talk about our expectations for fiscal Q4. The economic and industry trends are generally more favorable than last quarter. Our customers remain cautious and are focused on near term opportunities. Visibility beyond one to two months remains limited. We expect that a number of factors may cause customers to change their investment plans. In particular, consumer behavior in the back-to-school and holiday selling seasons and changes in the global economic outlook, and we are seeing an unusually high concentration of business in a small number of customers. As a result of all of these factors, our target ranges will remain somewhat wide.

While we are not giving a company target for orders we do expect growth in orders quarter-over-quarter, driven primarily by higher display and EES orders. We expect revenue to be up 10 to 20% in our fourth quarter lead by Display, SSG, and AGS. We expect earnings to return to profitability in our fiscal Q4 and our EPS target to be within a range of breakeven to a positive $0.04 per share. Now Mike, let's open the call for questions.

Thanks, George. To help us reach as many of you as we can, please ask just one question and no more than one brief follow-up. Let's begin, Tara.

(Operator Instructions). Your first question comes from the line of Jim Covello with Goldman Sachs.

Great, guys. Good afternoon. Thanks so much forgiving me a chance to ask the questions. I guess first question specific to the semi equipment business, is around kind of the order composition. I know you're not giving specific order guidance, but in terms of the number of customers for calendar Q3 and calendar Q4, do you see that broadening out at all in semi equipment or do you see the same kind of high level concentration that you saw in calendar Q2?

Hi, Jim. We still see a very concentrated outlook. I think we'll certainly be less foundry concentrated, Q3 was clearly dominated by foundry activity and we'll see a few new players coming in. We expect logic, for instance, to be a little bit stronger in Q4, but in general it's still very concentrated.

And what do you think given that some customers are now off the schnide, so to speak, what do you think it would take to get the other customers?

Well, Jim, this is Mike.

Hi, Mike.

I think that the big thing is what's going to drive DRAM bid growth I think we'll see some investments start to come back and we already seen some foundry come back, as George mentioned, logic should perk up a little bit but I think the big thing is what's going to really drive DRAM bid growth. We can see DDR3 conversion as I mentioned in my prepared remarks as a big push but primarily that's a technology push as opposed to capacity push.

Thanks a lot.

Thank you.

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

Hi, Mike and George. Just a follow-up question on the display group orders. If we look back we've seen the peak quarterly display orders in the cycle were about $500 million. Do you think we could see a higher peak in this display cycle since you have this tool, and my follow-up question would be have you put systems in place that would allow display's operating margin to be higher than the prior cycle? I think you had 32 net operating margin? Thanks.

Maybe I can answer the first part of the question and George can answer the second part. I think the order pattern over the next few quarters is a little bit hard to predict, but certainly we're gaining share with Pivot, so if you integrate over the cycle, we should do better, assuming that overall investment let's say over the next 12 months reaches $12 billion or so which was the total flat-panel display capital investment during the last cycle.

On operating margin, I think there's no reason why we can't get back to the kind of normalized 25 to 35 range that display operates in. On orders in general, we were particularly peaky and lumpy in the last cycle, as Mike said it's going to be hard to know whether we see it that way and whether revenue is going to be as concentrated as well but if we get to a basic run rate of recovery, we should see strong operating margins out of display.

But one of the things, Stephen, that we're seeing is really a conversion of the Chinese TV market to flat-panels. Basically, doubling the flat-panel purchase, almost doubling the flat-panel purchases in China and probably the bigger surprise there is the US is up over 25% in flat-panel purchases this year. Thanks, Stephen.

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

A couple actually. If CapEx were to only get back to two-thirds of the prior peak and revenues in the peak year stay between $6 billion and $7 billion, what type of restructuring can you do to get your operating margins? Can you get back to the prior peak operating margins of the high 20s?

Yes. I mean, I think what we're seeing, Satya, is the ability to drive operational improvements throughout the Company. As you know, initially, we started with a strong refocusing of our portfolio. We've taken actions within the semiconductor group to really restructure that business and we are, as Mike said, taking a look at longer term actions that we can take in light of various scenarios that we see for our end markets over the next two to three years. So there's no reason why we can't operate at very similar operating margins going forward. You can already see in this quarter the tremendous improvement from the operational initiatives within SSG at a very low level, their gross margin was approximately 45% in Q3 which really reflects the kind of earnings leverage that we're going to have as revenue comes back.

Okay, and on the memory front, clearly foundry orders and logic orders are helping you guys a lot in July and October. Several memory customers of yours have talked about a particularly unique improvement in capital efficiency as they shrink below the 5X node and go to 3X and 4X. Given that and the lumpy nature of your current orders in october, could you have some quarters which are non-linear as you go out beyond into january, could silicon orders be down for example, in January?

Well, Satya, almost anything is possible. I think the information that we're really looking for first of all is how does back-to-school sales flow through? If that's strong I think people will have confidence to build forward for Christmas and Chinese New Year, so that could carry us right through the end of the year and then it's how do they view 2010's economy. If back-to-school is weak, all bets are off, so I think that we're kind of looking for these next points of data as they become visible in the next four to six weeks.

Satya, thanks for your questions.

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

Hi, thank you, good afternoon. Just as a quick follow-up, Mike, I think you made a comment that you could potentially see a larger wafer fab equipment upturn next year. What kind of drives that view? How are you looking at next year from that perspective and what could happen between now and then?

Well, what drives that view is the economic recovery and consumers coming back, in particular in Asia where we would expect to see continued growth in PCs, smart phones, media players, and the beginning of adoption of solid state drives, so if semiconductor companies kind of get back up to that closer to that $250 billion run rate, we think they are going to have to replace capacity that came off line either because of consolidation, or because 200-millimeter factories are no longer viable, and some of that capacity will have to be replaced. So that's really the thought process behind a more significant semi upturn some time next year.

Okay, and one quick follow-up. Were there any Sunfab bookings in the quarter?

We had bookings in the quarter related to bonuses as opposed to factories.

But I think he's really asking the contracts.

Oh, okay. Let me just clarify, if you're asking were new contracts signed on new factories there were none signed in the quarter.

Thank you.

Okay. Thanks, Stephen.

Your next question comes from the line of CJ Muse with Barclays Capital.

Good afternoon. Thank you for taking my question. I guess first question, Mike, can you help me reconcile your outlook for share gains across all segments with also your talk about realigning your cost structure?

Sure. I think our products right now are satisfying customer needs, but when you boil it all down, this is the way I'd like you to think about it. In film and CMP, we'll hold or have modest gains. In our PVD FEP, and PVC segments we should have relatively significant gains, and I think those are driven by some of the things I said in my comments. but specifically in PVD the move to copper or at least for one layer in memory sometimes two, we'll have a positive effect on our pvd and then move to more advanced transistors, helps there also with the metal gate share that we have and advanced transistors also helps our front end group because of epi and because of our millisecond anneal product and then I think PVC has been well chronicled what progress we're making there.

CJ, let me just add something. I've seen this in a couple comments. The connection between the idea of looking at our business for the long run and trying to really think about what the implications are of this economic restructuring and somehow or economic crisis that we're all dealing with, and looking at that in terms of what our cost structure should be going forward, and we're seeing in our industry customer consolidation, you're seeing higher capital efficiency, plus we've done things like make investments in enterprise systems that allow us to do things more efficiently so we're really just looking at the architecture of the Company and saying how can we continue down this path of operational and financial improvement, given the fact that the world has changed somewhat. Now, we're looking at different scenarios for how much the world has changed and what the scenario is, but that's what's driving our analysis. It's not a market share issue. It's really prudent long range planning.

Very helpful. Just a quick follow-up George. The EPS guidance you gave is that pro forma or GAAP?

That is GAAP.

Great. Thank you.

Thanks, CJ.

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

Hi, guys. Two things. First of all, George, on one hand, you guys sound pretty bullish about next year but on the other hand you're also speaking about a pretty big cost cutting program that you're going to kind of get into, so I'm wondering if you were so confident that business was going to get that much better next year, why would you embark upon a significant cost cutting program at this point, and then sort of what you think about breakeven, with the proper breakeven of the Company should be and then as a follow-up, now that you have a megawatt of Sunfab modules at customers that are actually installed, I was wondering whether you have any balance of system data that you could share with us. Thanks.

Sure, Tim. Maybe I can take the first part of this. George kind of touched on this a bit, but what we're going through right now is a real fundamental look at the first of all the markets that we serve, and what has happened to them in this economic downturn. We think that they're fundamentally changed. We think as a Company, as an industry frankly, we have to adjust to the fundamental changes of the industry, and both align our products with that and our investment with that, so this is really about how to be competitive and how to be focused in the markets that we want to play in, but as much an industry thing as it is an applied thing. George, maybe you want to talk about breakeven.

Sure. As we said, our goal was to get our breakeven this year down to $1.2 billion a quarter. We've clearly we've done that, and again, I would just point you to, Tim, that the exercise that we're going through is not a cost cutting exercise in the classical sense. This is a how should the Company be structured, given the fact that the customers and the markets that we serve are being restructured in response to what they've been facing over the last 12 months. That's really what our focus is, and I think trying to turn this into it's a cost cutting issue, driven by some operational issue within the Company is missing the point. We're very focused on continuous improvement, and we're going to continue to look for opportunities to be more effective.

And Tim, I think you also had a follow-up question that there was a-- It's pretty difficult for us to comment on what our customers are doing, but the designs that we've done internally pretty much verify our estimates of 15 to 20% improvement between big panels and smaller size panels. Okay, thanks, Tim for your questions.

Your next question comes from the line of Atif Malik with Morgan Stanley.

Atif, can you hear us?

Can you hear me?

We can hear you now.

Hi, thanks for taking my questions and a nice quarter. On the utilization you gave a blended utilization number of 75%. Curious where you think NAND memory utilization is running at, and between NAND and DRAM, will it be fair to say that for capacity orders, you see NAND before DRAM and then I have a follow-up.

Yes, maybe I can add a little bit of color to that. What we said was about 75 blended in calendar Q2 with NAND, foundry and DRAM pretty much all in that same range. What we see progressing here through the next quarter or so is both NAND and foundry, most factories will be very full, 90% plus utilization, while logic and DRAM will lag a little bit. And we see total utilization getting close to 90% blended to compare those numbers.

Okay.

Do you have a follow-up at all?

Yes, on the display side I'm curious even the high brightness LED is a growing trend for the display screens. I'm curious the strength you're seeing in the display how much of it is conventional versus panels for high brightness LED and where you guys are at in terms of internal LED development to target the LED market?

So most of the display demand is conventional TVs are driving it and 32-inch in China in particular is driving the increase in utilization in factories and some of the capacity adds. As far as the high brightness LEDs, this is still a market penetration time, we think that will be much bigger next year, maybe 10 to 20% of the totals next year. We don't have any real big announcements about our LED program internally, other than we continue to look at unique capabilities that we can add to customers that will give them differentiation and drive down cost and improve the performance of the manufacturing LEDs.

Thanks for your questions.

Your next question comes from the line of Chris Shankar, with Banc of America, Merrill Lynch.

Thanks for taking my questions. Last quarter when you gave the guidance for sales you kind of gave more instrumental color on the different segments. Is there any way you can break it down, you're up 10 to 20% by display, AGS and EDS?

As we said, we think on the revenue side that we expect both AGS and display to be up. We expect silicon kind of to be up in line with the overall guidance, so EES is probably the big swing factor and we'll just see how that plays out.

Okay, and just to follow-up on the EES side, do you have any expectations for how many Sunfab you'll revenue in October and in terms of July quarter, if I assume about $100 million of the revenue came from Sunfab, what percentage of it was the actual sign off and how much was the bonus?

Yes, I'm not going to quite go to that much detail, but in terms of, we do expect to sign off an additional factory in Q4. We also expect to achieve at least one bonus pay off or sign off in Q4 as well, so we're basically continuing on the pace and at the sign off schedule that we expected.

Thank you, Chris.

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

Thanks a lot. First question, some clarification on your orders outlook of being up. You mentioned AGS, the flat-panel display as well as your solar business. Can you just provide a little bit of color in terms of the silicon systems? Is that going to also contribute to the I guess the orders outlook in October?

I don't see it having any big detrimental impact, but orders were up over 100% in our Q3 and again, we had a very strong last month of our quarter which the rest of the industry doesn't see until their quarter they report in September, so we had, we've seen a very big, if you average the two quarters, I think it will look very goodbye industry standards.

That will help a lot.

The other thing we're dealing with right now is very much a turns environment and exactly how the end of September and October are going to turn out, we think our manufacturing and supply chain is in line to do whatever our customers need us to do over these next three-month period.

Great. My second question in terms of the operational plan you're trying to set for fiscal 2010, is a lot of that just trying to make your overall operations more flexible and I guess adjustable to these kind of swings that we've seen where in future downturns you won't see I guess the declines or the pressures on the business model that we saw this time around?

I think we're just taking a look at how we can maintain a very strong competitive approach to the market but be more efficient in the way that we do it, and those are the questions that we're asking ourselves, so we'll look at different ways to organize parts of the Company that will allow us to be more efficient. One of the things that we have with multiple lines of business that a number of our competitors will struggle with, and you can see it in their load for SG&A and other things, is we have the ability to drive efficiencies and scale within the Company and we want to make sure that we're taking full advantage of that going forward. So this is really part of an ongoing long term continuous improvement and it's really not just about 2010. This is part of our three year plan. These are changes in initiatives that we think will take place over the next few years and will have a very positive impact.

Thank you, Patrick.

Your next question comes from the line of Gary Hsueh with Oppenheimer & Company.

Thanks for taking my question. Just two questions here just to get a better handle on what you're exactly saying about SSG orders in the October quarter. Could we get the break down of SSG orders by DRAM, flash, foundry logic and IDM in the July quarter and what you think that might be in the October quarter and just a second question was just based on your cost structure here, I might have missed it, but just wondering what exactly drove I guess such good operational performance in the EES business? I mean, revenue dropped around 40%, but you actually improved in terms of your operating marginal though it's still negative. If you can help me understand what the lever points are in terms of driving improved operating margin, is iT Crystalline Silicon, is it cost reduction, is it trimming R&D somewhere? Just help me understand that number there.

Sure. Let me start by on the silicon orders by summarizing Q3 as a reference point to Q4. I'm not going to guide specifically because on a turns environment trying to overly predict orders is going to be a little bit difficult. We've got, we had 25% DRAM, 15% flash, 18% logic and other and 42% foundry orders. That was our composition in Q3. We expect foundries to lighten up a little bit proportionally just because they were so strong in the quarter. We actually think that you'll see logic increase as a percent in the fourth quarter, and then flash and DRAM there's some volatility around those numbers and that will really, they will determine exactly how the numbers come out. I wish I could be more specific Gary but it's just not knowable beyond that level. And then on EES operating margin, what you're seeing is primarily that was the impact of the Sunfab sign off and the improved margin relative to some of the learning curve improvements that we're seeing in that space.

Gary, thanks.

Your next question comes from the line of Chris Blansett with JPMorgan.

Thanks for letting me on the call. I had a quick question related to the Sunfab customers. Obviously there's a lot of uncertainty in the solar side but one thing that's true is if you can get financing you can get projects put into Germany and some of the other countries in Europe. I wasn't sure if you guys had thought about potentially putting a program together to help your specific Sunfab customers initially finance some of their projects to help them grow their own businesses?

Chris, we've been pretty clear that we're not a bank, and we don't operate effectively as a bank. We're certainly willing to work with our customers and help make their project as financeable as possible but if a project is not financeable primarily on its own merits we don't think it makes sense for us to play that role and I think vendor finance of that nature has been problematic for many years.

Second question, just related to your cost of goods sold, could you give a little more clarity on your cost of goods actually declined even though your revenue increased, just kind of give a little description of what caused that?

That was a mix issue, and silicon was the primary, again it's a mix issue where you have a higher margin business taking a larger share of our overall pool, so it's that effect.

All right, thank you very much.

Thanks.

Your next question comes from the line of Mehdi Hosseini with FBR

George, you talked about selling off another thin film fab in the October quarter. Can you help us understand what's the average size of these fabs or fabs that you sign up?

Actually the factories are all different sizes, and so any one quarter you can get a very different outcome. We're expecting one of the smaller factories to sign off in Q4.

Because for EES, to drive up equipment, to drive up booking in the October quarter, that is something that has to be a significant size.

We're confusing orders and revenue. The orders that we say that EES is going to contribute to will be for items that will be revenued within a year of Q4 of 2009, and what we talk about sign off which is FAT, factory acceptance, and maybe that wasn't clear enough, my apologies for that, the sign off that we expect to be in Q4 will be a revenue event for the Company.

Okay, so to the extent that the bookings in the October quarter could be up driven by the EES, could you help us understand what is going to be the mix between thin film and the crystalline?

I'm not going to go to that level of granularity right now, because what I said was that really, we know that display and AGS are going to be clear drivers and that EES will be a swing factor and part of that will be what things are booked and the mix of that, and those numbers, there's a fair amount of volatility in those numbers so we're not able to guide on that.

Thanks for your questions.

Thank you.

Your next question comes from the line of Peter Wright with Global Crown Research.

Thanks for taking my questions and congratulations. Mike, my first question is if you could help comment and give us some clarity on capacity growth in 2009 in terms of kind of $11 billion of wafer fab equipment spend, what we can expect kind of gross capacity growth to be and with 200-millimeters coming off line if you could give us some perspective on where you think actually net capacity growth will be for the year, and George, my second question or follow-up is kind of clarity on the fixed versus variable cost of your business. It looks like very reliably your Silicon business, your display business, you've been able to get the costs down to roughly kind of a third of what a normalized rate or 20 quarter average run rate would be. How should we think of your EES business? Should we think of it the same way in that you'll be able to manage that, and if so do you think you'll be growing your way into that to kind of a $4 billion number over the next two or three years? That seems like a fairly tough and what type of cost cuts have to happen in that segment.

Okay. Hi, Peter. Good to talk to you. When you look at the kind of investments that's anywhere that's in our range, most if that almost all is technology transition investments and not capacity investments, so if you just look inside of the companies who have taken factories off line, 200-millimeter coming off line and a small amount of capacity coming online, we think the net on wafers is going to be down about 15% this year.

And on the EES, Peter, first off, welcome back. Good to hear your voice. On EES, the way I would think about EES, and the way I'd differentiate it from our other businesses is that it is really in the investment phase. This is addressing a series of markets which we think looks like very attractive growth businesses and so the cost structure there reflects the fact that we're still investing heavily in the initial positioning of Sunfab. We're investing in that area to get the 10% efficiency by year-end and so we're not at a run rate level as we will be over time in that space and crystalline silicon, we're continuing to expand our product portfolio that supports that market. We already have two strong as you know product positions there but there's a lot of opportunities for us to address other critical issues for customers and so we have product investments in that as well so I think the key thing is I think the focus there is investments and new product penetration and we'll continue to talk about that over time.

Thank you, Peter.

Thank you.

Your next question comes from the line of Edwin Mok with Needham & Company.

Hi, thanks for taking my question. A question on the crystalline silicon side of your solar business. You mentioned that you were shipping I think you said 50 equipment to a customer, wafering equipment to a customer. I was just wondering is that customer or are those customers adding capacity or are they just converting the line orders to wafers or higher throughput equipment?

So what we're seeing, particularly in China, is the addition of new capacity and it's been the opportunities are increasing and seem to be quite aggressive in the wafer space but this is all new wafering capacity.

I see, great. And then just a follow-up question for George. I notice how your cost has gone up based on your report numbers. I was wondering is that just a one quarter event and how do we look at that going forward and also if you can help remind us how much temporary savings did you have in the last quarter?

Okay. So the unallocated costs, it's just a temporary item, it's down significantly year-over-year, so that, we'll see that continue to trend downward over time and we have some severance charges that are in there and some one-time adjustments. In terms of our temporary cost reductions and I'll just remind everybody that we've had temporary cost reductions in place now for some period of time and in fact we're running at about $80 million a year if you look at the reduction in base bonus levels and the impact of shut downs and other pay cuts on our cost for salaries, so about $320 million annualized, but if you look back a year, we're probably net-net only $26 million down on those temporary expenses because we already cut back on bonuses and it already began shut downs because we were in the middle of an SSG downturn last year, so this has been a long and difficult time and our employees have just been unbelievably supportive and responsive throughout this time period.

Edwin thanks for your questions and it looks like we have time for about two more questions and at the end I'd like to save just a few seconds for some concluding remarks, okay?

Yes, sir. Your next question will come from the line of Mahesh Sanganeria with RBC Capital.

Thank you, guys. Just want to follow-up on that comment on operating expenses. If you can help us work through that, I think the temporary cost comes off in October, how does the r & d which is 234 for the last quarter and marketing and SG&A that is 168, how will that trend, some help on that would be good.

R&D has been remarkably resilient intentionally because we're trying to do whatever we can to reduce costs in all other places of the Company, so we'll continue to invest heavily in R&D. Again, I think if we look back year-over-year, as I said operating expenses and again we've had a lot of cost savings in COGS too, but OpEx cost reductions have been about $107 million, when you take out the noise from restructuring and from M&A and equity expense, so this is really a pure look at OpEx, and of that 107, about 81 are what we would call permanent savings and 26 or so reflect the temporary, the impact of the temporary savings which as the business recovers further will be restored.

And do you have a follow-up at all?

The other one, if you have time. If you can, I'm a little bit confused about the statement you made about the revenues by segment. Did you say AGS and display will be higher than Company average SSG, in line with Company average and EES lower than Company average in terms of October quarter revenue growth?

I didn't say it quite that specifically. I did say that silicon would be in line with what we're targeting for revenue growth.

Okay, thank you.

Okay, thanks, Mahesh.

Your final question will come from the line of Daniel Berenbaum with Auriga USA.

Hi, guys. Just a couple of administrative questions on tax rate, how should we be thinking about that for the rest of this year and moving forward, and then I'm sorry to ask the question again, I didn't quite capture on the OpEx, how much is going to come back and over what time, how much of the temporary cost cuts will come back and over what time period do those start to come back and then taking that the next step further once those temporary cost reductions are put back into the P&L, what do you think the operating drop through, the incremental operating margin of the model should be?

Okay. So on the tax rate, obviously we're running at a negative tax rate this year. We were at minus 26% for this quarter and expect for the full year to be around minus 34%, so obviously that isn't our normalized tax rate. We normally run at a positive in the low 30s trending down over time, we think to the mid 20s. On OpEx, we've said in our program this year we have a $460 million reduction. That's permanent cost reduction, so that's about $115 million a quarter run rate of which roughly two-thirds is OpEx, one-third is cost of goods. In terms of when temporary comes back, it certainly will come back as the business recovers. The pace of that we'll talk about what the new year looks like on our fourth quarter call, and I can give you a little bit more of an insight into that, but that's as we've said about $80 million a quarter and will come back as the Company gets back to stronger earnings.

Great. Thanks, Dan, and with that, I'd like to ask Mike Splinter to just share some concluding remarks with us.

Thanks, Mike. In closing, we're encouraged by initial signs of economic recovery that point to an improvement in our business. We see positive near term demand trends and consumer electronics and a sharply improved outlook for flat-panel displays. We also see building strength in solar. Still, we remain cautious and balanced in our optimism.

The equipment sector needs a sustained recovery that keeps customer factories at high utilization and encourages new capital investments. In the meantime, we're preserving our financial strength and improving operating efficiency while broadening opportunities for our nanomanufacturing technology and I'd like to say thank you everybody for joining the call today. Thank you very much.

Thanks, Mike and we would like to thank everyone for joining us. A replay of this call and a supporting slide package will be available on our website beginning at 5 p.m. Pacific time and will be there until August 25th. Thank you for your continued interest in Applied Materials.

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