應用材料 (AMAT) 2003 Q4 法說會逐字稿

Welcome to the Applied Materials fourth-quarter fiscal 2003 earnings release conference call.

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

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

If you have a question, press star and one on the telephone keypad.

As a reminder, this conference is being recorded today, Wednesday, November 12, 2003.

I would now turn the call over to Mr. Paul Bowman, Managing Director of Investor Relations, Applied Materials.

Please go ahead, sir.

Good afternoon.

And welcome to Applied Materials fourth-quarter 2003 earnings conference call.

With me today are Mike Splinter, President and CEO;

Joe Bronson, Executive Vice President and Chief Financial Officer; and Joe Sweeney, Group Vice President, Legal Affairs, and Intellectual Property, and Corporate Secretary.

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

Pacific daylight time.

You can obtain a copy of the news release on the investor section of our web site at www.appliedmaterials.com.

Today's earnings call contains forward-looking statements that 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.

Such risks and uncertainties include but are not limited to those set forth in today's earnings release, and in the company's filings with the Securities and Exchange Commission, including it's fiscal year 2003 forms 10Q and 8K and fiscal year 2002 form 10K.

The company assumes no obligation to update the information in this presentation.

The presentation contains non-GAAP financial matters, reconciliation of GAAP financial measures to non-GAAP financial measures are contained in our earnings press releases issued today and on August 12, 2003, for the prior quarter which are on the Applied Materials web site.

Today's call will begin with an update on the business by Mike Splinter, followed by Joe Bronson, who will provide an analysis of the fourth-quarter financial results followed by fiscal first-quarter 2004 financial targets.

We plan to limit our call to one hour.

After opening remarks, we will open the conference call for questions.

With that, I would like to introduce Mike Splinter.

Thanks, Paul.

Good afternoon.

And thank you all for joining us today.

Applied Materials' fourth-quarter results indicate what we believe is a turning point for the equipment industry.

As it marks significant positive change in our customers' confidence and investment plans.

In the fourth quarter orders were up, revenue was up, earnings were up, and we expect this momentum to carry through Q1.

It was the second quarter in a row of bookings growth, and we are projecting further growth for the next quarter.

Fab utilization continues to rise to the 90% level, requiring quick action on the part of our customers and ourselves to support capacity increases.

These are clear signs of an uptrend in worldwide wafer fabrication equipment spending.

As Joe will discuss in further detail, revenue for the fourth quarter was up 12% over the previous quarter.

New orders were up 21% from Q3, and ongoing earnings per share came in above our target range.

We are seeing an improved environment that cuts across most segments, markets, and geographies.

Customers made capacity buys in both 200 millimeter and 300 millimeter factories.

There are clear and broad efforts to increase the output of existing factories across the customer base.

Increased IC demand resulting in tightening capacity is broad based.

Improved yields and productivity of copper interconnects are leading customers to build out additional high-performance logic capacity.

Geographically, most of the regions were up, with spending in Japan particularly significant; as the Japanese semiconductor industry continues to renew itself.

DRAM spending was also significant in the quarter as a rapid move to 300 millimeters continued in that sector.

Foundry spending also showed an increase in the quarter, as all major industry segments participated in this uptrend.

What's driving this industry?

Several factors including a reinvigorated world and U.S. economy, strong wireless computing and PC growth in both business and consumer segments, and a pipeline of consumer devices including increased penetration of the flat-panel TV market.

Consumers of technology--personal, business, and industrial appear more ready to upgrade to products with more features, better performance, and wireless applications.

Of course, all at lower cost.

Strong end-user demand is giving our customers the impetus they need to invest in the future.

As I stated last quarter, we have effectively crossed into the 300 millimeter era.

We are now seeing increased momentum in the adoption of the 300 millimeters; 300 millimeter equipment hit over 60% of our orders for this past quarter.

The technical and economic benefits of 300 millimeter processing are clear.

And this represents an excellent opportunity for Applied Materials with our market-leading portfolio of 300 millimeter equipment.

At the same time, copper and low K films continue to ramp significantly to provide increased product performance.

Our broad set of copper tools leads the industry, and our new slim-cell electroplating system continues to gain ground and excite customers with it's low defect levels.

Our black diamond low k films have set the standard in the industry providing an outstanding technical solution to a very difficult integration problem.

As well as being produced on our cost-effective producer platform.

Our new dielectric etcher brings all-in-one capability to the platform.

Finally, our complus EB inspection tool is helping to solve many of the defect problems in our customers' factories, and our lineup of metrology and inspection tools are bringing enhanced capability to our partners.

We should not forget to mention our line of equipment we have for flat-panel displays.

This year has been a growth year for this business group.

The end-user market continues to grow as reduced prices stimulate increased sales.

Our next generation of deposition equipment facilitates the seventh generation of panel sizes.

In addition, we have introduced a new E-Beam inspection tool in this market which is gaining significant acceptance.

All these elements strategically position us to continue our positive movement and extend our leadership in the market.

Part of the story this quarter can be attributed to the steps we have taken over the past year to realign our business and organization, lower our cost structure, and focus on our core strengths.

These sometimes difficult steps have put Applied Materials in an excellent position for renewed growth.

While we worked hard to improve our costs and efficiency, we were able to enhance our ability to serve our customers, and we remain prepared and ready for the coming ramp.

Our Austin manufacturing operation is a great asset that will allow us to increase our output and maintain lead times on new equipment.

We are fully committed to our customers' success, as we have in place not only the capacity but also the technology and resources needed to excel in this next upturn.

We have a faster, more responsive organization with fewer management layers, faster decision making, and an account structure putting us closer to the customer.

Finally, we are leaving a difficult 2003 behind us.

We leave it with renewed level of optimism, and are looking forward to a stronger 2004.

I want to thank our shareholders, customers, and suppliers for their continued confidence in our company.

Most of all, I want to thank Applied Materials' employees around the world for their hard work and perseverance throughout this year.

I want to assure you Applied Materials is ready for the future.

Thank you very much.

And now I'll turn the call over to our CFO, Joe Bronson.

Joe?

Thanks, Mike.

Good afternoon, everyone.

We will now cover our financial performance for the fourth quarter ended October 26, 2003; and our outlook for the first quarter of the 2004 fiscal year.

The presentation of the fourth quarter's financial performance discusses GAAP as well as ongoing results.

Ongoing performance excludes charges incurred as a result of the company's realignment activities, and is presented as supplemental consolidated condensed statements of operations in the press release.

This quarter's realignment activities consisted primarily of continuing consolidation of facilities and the remaining reductions in work force.

The company's GAAP results as presented in today's earnings release will also be discussed.

Fourth quarter net sales were $1.22 billion, an increase of 12% over last quarter, and 16% lower than the prior year fourth quarter.

Reported gross margin was 40.5% in the fourth quarter as compared to 31.7% in the third quarter; and 41.7% in the fourth quarter of '02.

Ongoing gross margin was also 40.5% in the fourth quarter, versus 40.2% in the third quarter; and 41.7% in the fourth quarter of '02.

Reported operating expenses of $490 million, $56 million, or 13% higher than the prior quarter; and $23 million or 5% higher than the prior year fourth quarter.

Excluding the charges related to facilities consolidation and employee reductions associated with the realignment activities, ongoing operating expenses of $377 million in the fourth quarter of '03 were $13 million or 4% higher than the third quarter; and were $91 million or 19% lower than the prior year fourth quarter.

The current quarter's operating expenses include accruals for variable compensation costs, as the company achieved some profit thresholds required for incentives compensation payouts.

The realignment plan will be completed in the company's first fiscal quarter of 2004, and will generate over $400 million of annualized savings going forward.

Reported net income for the fourth quarter was $15 million or one cent per share compared to the third quarter '03 loss of $37 million or two cents per share.

And the fourth quarter '02 net income of $147 million or nine cents per share.

Excluding the $114 million charge related to realignment activities, ongoing net income for the fourth quarter was $95 million or six cents earnings per share.

Or 8% of total revenue, an increase from the third quarter of $78 million or five cents per share or 7% of total revenue.

For the full year, fiscal 2003, net sales of $4.48 billion were down 12% from fiscal '02 net sales of $5.06 billion.

The net loss for fiscal 2003 was $149 million or nine cents per share, down from $269 million net income or 16 cents per share for fiscal '02.

Ongoing income for fiscal 2003 was $223 million or 13 cents per share, down from $337 million or 20 cents per share fiscal '02.

New orders of $4.32 billion were received for fiscal 2003, down 30% from $6.14 billion for 2002.

New orders for the fourth quarter were $1.28 billion, 21% higher than last quarter and exceeded our target for the quarter.

Order percentages by geographic region for the fourth fiscal quarter were as follows -- Japan, 25%;

North America, 19%;

Southeast Asia and China, 17%;

Taiwan, 15%;

Europe 13%;

Korea, 11%.

Orders indicated strengthening of our customers' business in market share gains reflecting our strength in 300 millimeter and advanced technology applications.

Including low k dielectrics, CMP, copper barrier C, and front-end applications including implant and rapid thermal processing.

Japan orders reflected continued investments in memory logic and customers' transitions to 300 millimeter.

As Japan continued to invest for the consumer electronics market and advanced technology capacity.

Orders in southeast Asia and China represented an increased 300 millimeter investment similar to Japan.

Order activity in Taiwan from existing foundries was higher than the prior quarter as customers continued to evaluate the sustainability of the improvement in their business.

Total orders in Taiwan were lower than the prior quarter as a large DRAM order was booked in the third quarter.

Capacity utilization in both advanced and established technologies is high, and indicates that equipment purchases will be required to meet end-user demand if current trends continue.

The DRAM orders represented 26% of total orders compared to 47% in the third quarter. 300 millimeter orders represented more than 60% of total orders received in the quarter.

Orders were also up sequentially from the prior quarter in almost all of the company's product line.

In addition, orders were received in a number of areas for 200 millimeter incremental capacity, as utilization rates in the established technologies continued to improve due to end-customer demand.

The recovery in orders is broad based across the globe.

During the fourth quarter, 24 customers placed orders in excess of $10 million.

Of the 24 customers, one order was in excess of $100 million, same as the third quarter.

And three orders were in excess of $50 million, which is the same as the third quarter.

Backlog for the quarter was $2.5 billion, compared to $2.53 billion for the third quarter.

And $3.19 billion for the prior year fourth quarter.

Backlog adjustments totalled $92 million, consisting of cancellations $62 million, and other adjustments $30 million.

With respect to the balance sheet, cash equivalents and short-term investments, increased by $261 million from the prior quarter to $5.49 billion at the end of the year.

The increase in cash for the quarter primarily reflects continued excellent working capital management and the proceeds of a tax refund.

Cash requirements from realignment activities amounted to approximately $55 million this quarter.

Accounts receivable increased by $171 million or 23% from the prior quarter due to higher sales volume, with net collections of $1.07 billion and DSO at 68 days compared to 62 in the third quarter of '03, and 66 in the fourth quarter of '02.

Inventory decreased by $47 million from the third quarter, and by $323 million or a 25% reduction for the year.

Due primarily to product refocused efforts and ongoing inventory reduction management programs in both manufacturing and spares.

Capital expenditures in the fourth quarter totalled $72 million, compared to $46 million last quarter, and $71 million for the fourth quarter of '02.

Depreciation and amortization was $119 million compared to $93 million for the third quarter, and $99 million for the fourth quarter of '02.

Under the company's ongoing stock repurchase program, approximately 3.6 million shares of common stock were repurchased during the quarter for $75 million at an average price of $21.02.

We were pleased with the company's performance this quarter, particularly due to the success in positioning the company's 300 millimeter products and advanced technologies into the customers' production applications.

Our order patterns represent higher growth rates than our competitors'.

Highlights for the quarter were revenue and orders exceeded targets.

Growth gross margins continued to make good progress as 300 millimeter product costs declined during the quarter.

We believe that the company's leverage opportunities are just beginning to materialize as we complete the realignment activities.

Margins were impacted by a mix of service and spares business, which is still underperforming as compared traditional profitability rates for that business.

Manufacturing absorption improved for the prior quarter.

Manufacturing also reduced the level of system inventories by $26 million and continued to improve manufacturing cycle times, supplier lead times, and inventory times.

Spares inventories for the year were reduced by $163 million, resulting from the efforts of the realignment, product refocused efforts, and the implementation of the new spares distribution system.

Operating income rates at the current level of revenue are an indicator that realignment activities have been successful.

Product positioning in the back end interconnect application has been achieved with significant market-share gains in low k DVD with Black Diamond Films, PECVD, CMP, and PVD copper barrier and seed.

Customers are seriously evaluating our products in electroplating and dielectric etch, despite previously made equipment selections; and we are optimistic about further back-end market-share gain.

In addition, the number of new process and diagnostic tools are planned for introduction in 2004.

Balance sheet remains strong and $564 million in cash was generated in 2003.

A new electroplating product and several new processes in diagnostic and control products are making good progress.

To summarize, Applied is well positioned for the opportunities ahead.

Global business conditions showed signs of improvement as we concluded the 2003 fiscal year.

Our customers' business is improving in both sales and profitability, which will enable them to increase capital spending in 2004 if current trends continue.

Customer spending is now being augmented by corporate IT spending, driving a general across-the-board increase in capital spending.

Most industry estimates for calendar 2004 predict capital spending growth for our customers at approximately 25%.

Therefore, we are somewhat optimistic about the near term.

We have positioned our products well for 300 millimeter transition, and our operations have been restructured to allow for maximum leverage.

We also believe that our supply base is capable to meet the potential opportunities ahead.

We expect orders in the first quarter of 2004 to continue to grow sequentially by approximately 20% from fourth-quarter levels.

We expect further capacity buys for 300 millimeter from the large IDN's, foundry, and DRAM customers; as well as order strength from our new product offerings in electroplating, dielectric etch and prices diagnostic and control.

Regular and ongoing profitability are expected to improve over prior quarters with revenue up 5% to 8%; and ongoing profitability between six cents and eight cents per share depending on revenue achievement.

The first quarter of fiscal 2004 will have an extra week of operating expenses and a 53-week fiscal year, resulting in an impact of one cent per share, when compared to fourth-quarter performance.

The charges for the first quarter realignment activities are primarily for facilities and are expected to be approximately between $75 million and $125 million, as the company begins its fourth and final fiscal quarter of executing realignment activities.

With that, I'll turn it back over to Paul.

Thank you, Joe.

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

Because of our compressed schedule, we will be accepting only one question per firm.

I would also ask you to please avoid multiple part questions.

Operator, please begin with the first question.

Thank you.

Ladies and gentlemen, if you wish to register for a question for today's question-and-answer session, and you are on a speakerphone, please pick up your handset before entering your request.

To place a request, you will need to press star and then the number one on your telephone keypad.

You will hear a beep to acknowledge your requests.

If your question has been answered and you wish to withdraw your request, you may do so by pressing the pound key.

As a reminder, please limit yourself to one question.

Once you have asked your question, you will have the opportunity to requeue to register another question.

One moment, please, for your first question .

Your first question comes from Shekhar Pramanick with Prudential.

Congratulations on a good quarter.

Joe, did you mention that you're going to get a $400 million worth of annualized savings from these restructurings going forward from here on?

Yes.

And so one other thing, this quarter the gross margin leverage was not there.

You know, your costs increased by 11%.

And your revenue increased by about 11.5% sequentially.

So going forward, we should see a much stronger gross margin improvement?

We should see margin expansion going forward, yes.

And lastly, if you can a little bit talk on flat-panel side.

I mean, you know, CVD side, you are seeing amount of traction are we going to see new product introduction in that space?

How does the '04 look like on the flat-panel side?

Well, you will see -- this is Mike.

We will see growth in '04 in that business.

And you will see us take advantage of our current product offerings in CVD and E-beam inspection, whether we'll introduce other products in that line, we're exploring opportunities there.

Thank you.

Your next question comes from Steve O'Roark with U.S.

Bankcorp- Piper Jaffray.

Good afternoon.

Joe, I think you mentioned in your comments tha order growth rates were greater than competitors'.

How much of this do you attribute to share gains versus orders' timing?

Well, I think it's a combination of both.

We have been positioning in 300 millimeter and these back-end applications for quite a while.

And I think now that the products are positioned in the capacity buys have been let, I think we're seeing the benefit of that.

And I think that's why we're stronger than competitive reports.

Fair enough.

And the orders profile in Q4, was it very back-end-loaded?

Not really.

It was spread out reasonably well throughout the quarter.

Fair enough.

Can I ask one other question?

You mentioned some increased fab efficiencies with service in a press release.

Can you give us some detail on what you're doing with respect to that, as far as monetizing it?

That is, should we see improved gross margins in service as a result of value add in this particular area?

I think the service business, the key factors are to drive revenue growth.

There's actually two things.

First, to drive revenue growth, to satisfy the customers by -- by reducing their costs, and as far as margins are concerned, that's, you know, we've got to get the infrastructure right to take leverage opportunities where we can with our global structures.

So it's -- you know, it's a big task.

Thank you.

Your next question comes from Tim McCurry with Deutsche Bank.

Hi, guys.

Nice quarter.

Joe, can you kind of talk a little about what the sustainable incremental margins might be?

So what the drop-through going forward if you look out, say, six to nine months, what the drop-through will be on the gross line and on the -- and on the operating income line, as well?

Well, I've made a number of presentations for the investment community I think for three years.

You know, we've all been in a terrible downturn.

We've been -- when we did the realignment plan, there's a chart, in fact it's a public document-it's in all the presentations; and we're kind of sticking to that.

Basically it says that we had a 40% margin around the $1 billion level of business; and that at $2 billion our margins would be at 50%.

It's almost a linear progression with something like 1-5 being -- $1.5 billion per quarter would be at about 45%.

I think we're pretty close to tracking that model with our results.

And that's how we are going to perform.

Okay.

One followup to that.

You mention that you had some issues with margins on the spares and service business.

Can you go into more detail on that?

Well, there's a lot of issues -- we talked about this in prior quarters with respect to realignment activities.

Getting a new distribution started up, a new IT system started up, moving inventory from point A to point B, dealing with a new outsourcing logistics; this is what all the issues are.

We're working through those.

That's what's going on.

Do you think it's a temporary issue, really?

I think so.

I think it takes time.

We've been working at it.

It's a big business.

Thanks a lot.

Your next question comes from Mark Fitzgerald with Bank of America.

With 300 millimeter, 60% of the mix, is there any margin improvement on the 300 millimeter tool set still out there to be earned?

Well, Mark, I think as we look at our 300 millimeter tool set we really worked hard over the last year to get it into the right margin zone.

We made a lot of progress there.

I think we're getting close to margin levels that we're at on the 200 millimeter level.

Is that steady state for you?

Yeah, I think so.

You know, as we -- as we leverage our overall infrastructure, we get better margins overall.

But I think we're very close to where we want to be.

We're very close to our model now in 300 millimeter.

Okay.

Thank you.

Your next question comes from Byron Walker with UBS Warburg.

Good afternoon.

Back to the service and spares issue, Joe.

When do you think -- you said this takes a little time to get traction and get it fully resolved.

Do you have a rough target date when you think that -- that the drag is behind you?

I think we're looking for just continuous improvement.

As -- as things -- the revenue from the organization has continued to grow.

So we don't have an issue with growing revenues.

It's just a matter of putting all these issues behind us.

All the -- I mean, there's very detailed plans; very detailed operating plans in place to deal with all the issues.

And they're getting worked.

So we -- we expect improvement quarter on quarter.

Can you give us a rough quantification of what the drag was and then -- at some point uncertain in the future when you get it resolved, what kind of margin improvement we can look forward to?

Well, I said in my comments that we would get back to traditional margins.

We haven't disclosed margins by-product line because they're intricately linked to the product group.

So let's put it this way, we expect to get back to traditional capability by the end of next year.

And can you give some insight into your flat-panel display business, what the contribution was in -- in the current quarter?

It's about the same as it's been.

It's a steady state business.

It's a good business.

It's performing as it's been doing.

Refresh my memory.

Was that a few hundred million a quarter?

We don't give out revenue by-product area.

Roughly flat quarter over quarter?

Right.

Okay, thanks.

Your next question comes from Jim Covello with Goldman Sachs.

Good afternoon, thank you very much.

Two quick questions.

Any changes in pricing or lead times?

No.

In fact, you know, one of the things we worked so hard on in this downturn was to make sure that we had the manufacturing capacity and our supplier capacity, that we didn't have to extend lead times as more orders came in.

We're not extending lead times.

And in the spring of '02, the Applied Materials announced a price increase.

Any thoughts about doing that again as business begins to ramp back up?

We're in business.

So do we have thoughts about it?

We're not announcing any today.

Fair enough.

And finally, Mike, you know, shortly after you came on board, you started talking about a new reality for the business going forward.

Now that we're in the beginning part of the upturn here, what does the new reality really mean to you with the benefit of six to nine months' perspective?

It really means what it meant six months ago.

It -- you know, we have to be able to operate at a different level of productivity and efficiency in our company.

And heading into an upturn, we can't do the same things that we did in past upturns.

We can't solve old problems by just hiring people or throwing money at it.

We have to solve those problems with efficiency and effectiveness inside the company.

So that's why we're working hard on management structure.

Working hard on our capabilities in the regions, and restructuring there; so that we can meet the customers', and meet them without increasing our infrastructure and costs.

Great.

Thank you very much.

Your next question comes from Edward White with Lehman brothers.

Yes, my question is on market share dynamics.

In the past you noted that your market share in 300 millimeter tools is higher than it is in other tools.

As you start to see the ramp-up of 300 millimeter, particularly as we go through next year, do you think that will have a favorable impact on your market share?

Can you give a sense as to, you know, what those dynamics might be?

Yeah.

I don't recall saying that our 300 might have millimeter share was greater than 200 -- we had a pretty good share at 200 millimeter, an excellent share.

So we had a lot it lose in the transition if we didn't pull it off; and I think what we've done is basically improved our share.

But more importantly, the whole competitive landscape changed because it was not only 300 millimeter.

It was advanced technologies, particularly with low k films and things of that type.

So I think the dynamic is very different, and the competitive landscape was a whole different thing.

We had a lot to lose if we didn't execute well.

And I think that also with our newer offerings in the electroplating and the dielectric etch, that's what's going to position us for greater overall share gains in the 300 millimeter.

Okay.

Great.

Thanks.

Your next question comes from Theodore O'Neil with AG Edwards.

Thanks.

Mike, I wonder if you can give us an update on your entrance into the materials business.

There's been some discussion about getting involved in selling a slurry, a recommended slurry to go with your CMP tools.

I wonder if you could just give us some overview on that and what you think it's going to look like over the next 12 months.

Well, there are certain opportunities that we are taking advantage of.

But really the situation here is when we find a material that works very well with our equipment, we're going to recommend it to our customers to make sure our equipment runs the best it possibly can.

At this point, we are not providing slurry ourselves.

But I do recommend certain slurries with our machines.

But as far as going into the materials business in a bigger way, you know, that's -- an opportunity that is out there in the future.

And, you know, I think this --in handling it this way, and relating it to our equipment, may be having some IP in the materials area is a way for us to leverage both our intellectual property and our equipment sales.

Fair enough, thanks.

Your next question comes from Jay Diano with JP Morgan.

Very nice execution.

Congratulations.

Last cycle, semiconductor -- global semiconductor capital spending peaked at $63 billion.

Where do you see that peaking this cycle?

And secondly, do you expect North America orders in the next quarter to increase from the 19% in the October quarter?

You know, Jay, it's really hard to predict where the -- where the peak is going to be.

We can see out through the next quarter.

So our visibility's improved a bit.

But not a whole lot.

I think we'll let some of the professional prognosticators estimate where the next peak is going to be.

North America orders, you know, what's interesting about this particular turn of events is that it's very broad-based, actually we're -- you know, we've seen a strong Japan, we expect Japan to stay strong.

America -- North America is certainly filling out the available fabs that they have, whether they'll go above 19%; very difficult to say because, you know, this recovery is so broad based.

When you say filling out the available fabs, does that mean some of the fab conversions that are out there?

I mean, what fabs are you referring to in the US?

Well, anybody who has a fab and every person who has a 200 millimeter fab in the U.S. is adding equipment to fill out their -- maximize their capacity.

That's a short-term investment that they get quick return on, makes a lot of sense for them.

So that -- that's what we see happening.

That's what we'll see in the U.S.

Those people with more available fab space will be able to buy more.

Last question.

Do you see any 200 millimeter to 300 millimeter conversion fabs happening any time soon in the U.S.?

Well, I think we know about one, but it's hard to do.

So it's one of those things that the most 300 millimeter fabs are new investments, new buildings.

Right.

Thanks.

Your next question comes from John Pitzer with Credit Suisse First Boston.

Congratulations on a good fourth quarter.

Joe, can you help quantify, if service and spares have been running at sort of normalized gross margins, what would have gross margins have been in the quarter?

Secondly, I think I heard you right that depreciation grew sequentially in the quarter.

Can you help me with reconcile that against some of the realignment that's been going on, especially with facility consolidations?

And I have a quick followup.

The margins -- I can only tell you the margins would have been higher.

I'm talking sort of 1 or -- 1% or 2% points, Joe?

I would basically say if you look at my public chart, we'd be close to trending on that chart.

Okay.

Then depreciation growing sequentially?

That has to do with the timing of capitalization of certain items.

Particularly in the Madan Center -- there's a lot of equipment that goes into that.

It's a work in progress for three or four months then gets capitalized and depreciated over short loops.

That's primarily what that stuff is.

I think you should expect that depreciation will outrun capital spending.

Okay.

And then, Joe, you looked at the order book this quarter, the October quarter.

It broadened out nicely.

Kind of curious as to what the gross margin in the backlog looks like, it kind of goes back to the pricing question.

With the order book widening out, shouldn't you be get at least some pricing leverage?

Secondly, the January quarter tends to be a seasonably strong order quarter for services.

Can you help me understand the growth rate between service orders and product orders in your guidance?

Thanks.

John, that's five questions.

You're -- you're -- as far as the -- the margins are really more function, as Mike was talking about.

Where we have achieved the cost on the products.

It's going to be more a function of what the -- you know what the volumes turn out to be in terms of the -- there isn't what I would call significant difference in the price, the backlog for sure.

I'm not sure I remember -- I didn't write the other one down.

Service orders versus product orders.

Yeah, service orders are seasonably strong in the first quarter.

There were a few of those that actually came in in the 40s quarter.

But it will still be seasonably up in the first quarter.

Pretty normal pattern.

Perfect.

Thanks, guys.

Your next question comes from Glen Yeung with Salomon Smith Barney.

Thanks, Joe.

A quick one on Taiwan.

What do you expect what that will look like as you head into the first quarter?

Well, we just think that Taiwan will be up.

We don't know how much up.

But we believe Taiwan will be up.

They haven't invested much, and I think that's pretty well-known.

And I -- I do think they are going to be increasing capacity, you know, in the next --at least the next six months.

I wonder if you look at the next quarter or even two quarters of order potential and you think back to the first and second quarter of 2002.

Really the -- the macro environment is different, but from a bottoms up perspective, how does this feel different to you?

And does that tell you something about the order pattern we should expect in the next two quarters as compared what we saw in those two quarters last year?

Well, I think it's a significantly different feeling.

First of all, the economies are really performing a lot better.

And you know, during -- there was this cloud over the world, you know, with all the tough war talk in the second half.

And the other problem, there was no -- very little other than a couple of companies, a lot of 300 millimeter capacity installed.

So the -- when the -- when the business kind of spiked up, the customers had to add 200 millimeter capacity when -- because 300 wasn't -- you know, they weren't ready for 300.

And so they ended up, you know, in the sense over ordering when the economies rolled over.

And when the war clouds rolled over.

Now this time around it feels different from the standpoint of there are 300 millimeter projects all over the globe, and there is -- no one's going to build a 200 millimeter fab.

They are going to fill in on capacity.

The chip sales are strong.

Capacity utilization is so much higher.

We see it all over the globe, not just with the majors.

We see it in Malaysia, Singapore, we see it all over.

So it definitely feels different.

I mean, could some events crater it?

I suppose so.

It feels a lot different.

It feels like the industry is in a retooling effort.

You know, they're -- where the technologies that have been developed in the last three years are being harvested, and between 300 millimeter development and the advanced technologies being implemented in a capacity-like way, as opposed to an R & D-like way.

I guess the point, though, does that tell you that the order outlooks over a six or nine month period is more steep or less steep than what we saw --

I -- I really don't know.

I can only tell you how it feels.

I mean, it -- is everybody going to rush and order stuff at the same time?

Who knows?

We'll find out.

Nice try, though, wasn't it?

Yeah.

Next question, operator.

Your next question comes from Ali Arani with CIBC World Markets.

A couple of clarifications.

One, I'm hoping you can give us an idea of how the service business volume itself has been doing in the mix.

Especially given where capacity utilization stands.

And looking at again your gross margins coming back to that, Joe, do you expect depreciation to continue at these levels going forward?

And it seems there's a big distinction between where your gross margins were this quarter relative to that linear trend.

I'm thinking at $1.2 billion you should be around 42%.

So it just clarifying for me, is there a difference between your gross margins this quarter and what you see ahead relative to that linear trend?

Yeah, yeah.

We expect to get onto that trend in our view.

Based on what we know.

And based on the improvements we expect to achieve in the service business.

So we expect to stay on that kind of curve.

In fact, we would hope to maybe even do better than that.

We have some execution to do.

Joe, is there a difference between what you're seeing this week or last month and what you saw in July already?

Meaning has this been a linear quarter for --

I think we did just fine during the quarter.

Like I said, I think the service business still is not where it needs to be.

I think the other metrics of the company are on track.

Right.

And the depreciation?

I think that the savings from the realignment activities are going to certainly help as we -- as we go forward with this.

I don't think depreciation will be a major cost issue for us.

Okay.

And the mix on service?

If you could give us a general idea with utilization.

All I can say is it's about the same as it's been.

In the mid to high 20s still?

I don't want to comment on that.

We haven't disclosed that.

I don't want to disclose that.

But it's about the same as it's been from a revenue standpoint.

Great.

Thank you very much.

Your next question comes from Brett Hodess with Merrill Lynch.

Just a quick question on flat-panel display.

Since it did grow in the past year and you're looking for growth going forward, I know you don't like to break out the mix, but can you give an idea at least, you know, what the growth rates are in that business.

You know, versus the core semiconductor side of the business or what it was in the past year since is the end of the fiscal year numbers?

It's actually been -- it hasn't grown that much because this is from a -- from an end -- demand standpoint, the growth has been phenomenal as you know.

But a lot of the -- the equipment buys are very lumpy.

And the lead times for flat-panel equipment are a lot different than our process equipment.

In fact, lead times are out there.

If you've ever seen the size of one of these things.

So the business year over year has grown.

But it isn't -- hasn't grown what I would call substantially because the orders really are lumpy.

And it depends on the rate of expansion of the underlying fabs.

We kind of expect normalized growth rates, the total equipment business for flat-panel hasn't grown that much.

We'll grow again pretty much at normal rates next year.

And just a quicky on interest expense, Joe.

That was down quite a bit this quarter.

Did something go on in that?

I'm not aware if something -- we'll get back to if you there's something significant there.

Nothing that tickles me.

Okay.

Your next question comes from Patrick Hough with Moores Cabot.

Congratulations on a nice quarter.

Did I characterize it correctly that it seems like from your new product introduction that you presented -- it seems like you're getting market share gains at the current technology note -- the impression I got was that that was going to be focused on the next technology note, is that right to characterize it that way?

Well, it --.

But you have to realize that, you know, in our orders, almost all of our -- 90% of our orders were less than .15 micron technology.

Almost 30% of orders were for 100 nanometer and below.

So you can understand that people are buying the best technology they can get at 300 millimeter.

Great.

One last question.

What -- what is your take on the growth of the Chinese foundry market?

I -- I'm trying to get your take on the -- you know, the current -- do you see that progressing or migrating to 300 millimeters as anticipated?

I don't know about quicker than anticipated.

Those customers are investing.

And they see growth in their business.

So, you know, they're good customers of ours.

And we're happy they're investing.

Great.

Thanks a lot.

Your next question comes from Cristina Osmena with Needham & Company.

Hi.

I know the 300 millimeter shift has happened.

But what about the eight-inch market.

At what technology node can we expect you to stop offering a sufficient product line to allow your customers to do the -- you know, the necessary upgrades in order to participate in technology upgrades?

You certainly can't continue to invest in R & D or can you?

Well, it's very difficult, obviously.

Where our 300 millimeter tools can be easily changed over to 200, we can continue without excess R & D. But it's increasingly difficult at each node.

So it makes it very difficult beyond 90 nanometers.

Okay.

And also want to squeeze in two short ones.

Your quarter-ending headcount and foundries, as a percentage of your total order book.

Quarter-ending headcount was around 12,000 people.

And Joe, you want to answer --

Yeah, foundry was 32%, for the orders.

Next question, operator.

Your next question comes from Bill Lu with Morgan Stanley.

Actually, it's Steve Pelayo at Morgan Stanley.

Two topics here.

With the 20% bookings quarter and guidance for another 20, the next question we have to ask about is lead time stretching and the fear of double ordering.

I'm curious what you think about that.

Second part is, just your ability to meet that ramp.

Some of your competitors have unproven new outsourcing models.

I'm just wondering if this could actually be a competitive weapon for you guys to gain some market share and and your ability to deliver things quicker?

And a third question, if I can sneak one in.

The revenue ramp, you are guiding 5% to 8%, I think it was revenue guidance.

Yet two quarters at 20% booking.

So we expecting just revenues to then build momentum in the April quarter?

Sorry, three questions.

Like this one per firm.

I think so.

Steve, we can cut you off after whichever question we want.

But I think really the first two were one question.

So I'll give you a break.

Lead times as I said in my prepared remarks, that we really have worked hard on making sure that we have the manufacturing capacity and we have the supply base in good shape.

We're looking at every one of our suppliers in detail to make sure that they have the ability to support us.

And then you couple that with our capability in Austin.

We haven't outsourced that.

We -- we think it's a strategic element of our business.

We have excellent capability there to ramp up our tools.

We're not intending to stretch lead time.

And we don't think lead times will stretch any time over the horizon.

So I think the bigger issue will be -- will we be able to service the pull-ins, as well?

We're working on that right now.

Is it a competitive weapon?

We certainly think so.

We think that, you know, when people are looking at augmenting capacity quickly, they're going to -- wherever they can go with the solution that they can reach the quickest.

As far as the five-day percent growth revenue, revenue-growth, quarter over quarter, you know, that's the way we think -- that's the way we see the orders aging.

And so we'll see what happens in -- in Q2.

I guess it would be safe to assume two quarters at 20% bookings, you would expect to kind of deferred revenues to be building.

And you'd probably -- you'd probably build momentum in your April quarter, correct?

That's your analysis.

Thanks, Mike.

You bet.

Next question, operator.

Your next question comes from Raj Seth with SG Cowen.

Thank you.

Joe, I wonder if you could comment on your big deal pipeline.

You've mentioned in the past a number of large chunks.

But it's -- it's been difficult to predict the close rates of some of those orders.

At 20% guidance for January, are you -- what are you assuming in terms of very large deals, if any?

Well, we -- we're not going to be able to give you the specifics of that.

But there -- certainly Mike alluded to it earlier, that there's more visibility.

So there are larger deals that are potentially trying to get done.

The ability to get them done is a lot more predictable.

There certainly are a few of those in the -- in the order forecast.

All right.

Thanks.

One -- one other quick one, if I might.

Inventories here as you begin the ramp.

Do we start to see you invest meaningfully in inventory?

Well, I imagine we will some.

You know, the idea that the company has always had here is to generate cash and turn the inventory fast, so we'll see how we do.

I think the group in Texas has done an outstanding job, even with this quarter increasing inventories and -- I'm sorry, increasing revenue and decreasing inventory, I don't know if we can continue to pull that off.

But I think we're going to do a good job and still generate cash in this upturn.

Great.

Thank you.

Your next question comes from Nick Deshanko with Fulcrum Global Partners.

One question to Joe.

Joe, what is your current production capacity?

We think we can build -- we can build at a rate that's probably 2X our current at 300 millimeter.

We'd have to add temporary employees to do that.

But our -- we have at least that capability if not more.

Can you say it's in terms of dollar value?

No.

It's hard to do that.

So mixed --

With the mixed dependencies it's hard to do.

Thank you.

Your next question comes from Gerald Fleming with Fahnestock & Company.

Yes.

Two questions.

Can you characterize the cancellations; was there one big one in there, and was it transferred to find some other product?

Secondly, one name that we haven't heard today or one word is E-tec.

Can you give us an update there?

Cancellations and adjustments are very -- there isn't anything big.

There's probably 25 or 30 -- you know of adjustments and that type.

Nothing significant.

In those numbers.

In terms of E-tec, E-tec is making good technical progress.

We talked about last quarter engaging with the major a customer on advanced technology nodes from that.

So E-tec essentially has delivered what we expect it to.

And we believe they're making technical progress in what they're doing.

Which is kind of the way we've restructured it.

The underlying business is improving a bit.

But, you know, we're still at an early stage of what we think is a recovery.

We'll continue to execute the technology the way we've been trying to and hopefully that pays off for us.

Those were a commercial customer or --

A large good -- good customer of Applied.

And a very important strategic customer.

Thank you.

Operator?

We will take one last question.

And then we'll make our closing remarks.

Your last question is a followup question from Shuresh Valaramen from ThinkEquity Partners.

How many fabs are you tracking that can potentially place orders over the next four or six quarters?

Any thoughts on your revenue opportunity for fab given the current pricing scenario?

Thank you.

Well, we're tracking at least 30 fabs.

In terms of capability.

Some 300 and 200 millimeter fillouts.

In terms of revenue opportunities, well, you know, we'd like to get as much as we can; of all of it.

So that's typical of our behavior.

All right.

Thanks.

Operator?

I'd like now -- now lake to make our closing comments.

We'd like to thank everyone for listening to our fourth-quarter earnings announcement.

The webcast of this conference call is available on our website and it will remain there until November 26th.

If you would like to receive our fiscal 2003 filings electronically, you can sign up on our website.

I'd like to thank everyone for their interest in Applied Materials, and this concludes our call.

This concludes today's Applied Materials fourth-quarter fiscal 2003 earnings release conference call.

You may now disconnect.