應用材料 (AMAT) 2005 Q3 法說會逐字稿

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  • Operator

  • Good afternoon and thank you for standing by. Welcome to the Applied Materials third-quarter fiscal 2005 earnings release conference call. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded today, August 16, 2005. I would now like to turn the conference over to Mr. Paul Bowman, Managing Director of Investor Relations, Applied Materials. Please go ahead, sir.

  • Paul Bowman - Managing Director of Investor Relations

  • Good afternoon, everyone, and thank you for joining the Applied Materials third-quarter 2005 earnings conference call. With me today are Mike Splinter, President and CEO; Nancy Handel, Senior Vice President and Chief Financial Officer; and Joe Sweeney, Senior Vice President, General Counsel and Corporate Secretary.

  • Financial results for our third quarter were released on Business Wire shortly after 1:05 PM Pacific time. You can obtain a copy of the news release on the investors’ section of our website at www.appliedmaterials.com.

  • Today's earnings call contains forward-looking statements, including those relating to demand for electronics, semiconductor and flat-panel display products, the outlook for the semiconductor equipment industry, fab utilization trends and customer capital spending, Applied Materials technology and market leadership, growth opportunities, scheduled shipments, cash generation, financial strength, cost controls and operational efficiencies, and delivery of stockholder value and fourth fiscal quarter financial targets. Such 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 Securities and Exchange Commission, including its Form 10-K for fiscal 2004 and its most recent Forms 10-Q and 8-K. Forward-looking statements are based on information as of August 16, 2005 and the Company assumes no obligation to update any such statement.

  • Today's call will begin with an update on the business by Mike Splinter, followed by Nancy Handel, who will provide an analysis of third-quarter financial results, followed by fourth-quarter 2005 financial targets. After the opening remarks we will open the conference call for questions. With that, I would like to turn the call over to Mike Splinter. Mike?

  • Mike Splinter - President & CEO

  • Thanks Paul. Good afternoon, and I wanted to add my thank you to everyone joining this afternoon.

  • Q3 was a very busy quarter for Applied Materials with the introduction of significant new products, new agreements, and other important announcements. At the same time, industry conditions remained challenging. We executed well during the quarter, met our financial targets, continued to generate strong cash flow and returned value to our shareholders through share repurchase and a dividend. Our efforts to make Applied Materials fast and flexible have enabled us to deliver earnings in line with our model, and we are driving for continuous improvement beyond that point.

  • The macroeconomic environment remains healthy and the electronics industry continues to expand. PC unit volume exceeded expectations in the calendar quarter and cell phone unit growth also was ahead of forecast. This led to strong unit demand for semiconductors, resulting in increased fab loading.

  • With utilization rates continuing to increase, several customers have raised CapEx projections in anticipation of strength in the second calendar half and into next year.

  • During the quarter memory prices began rising, with supply and demand expected to be in balance in the second half of the year as volume grows and the move to 512 Mb and DDR2 accelerate. Flash bit growth has been steadily increasing with customers forecasting strong demand through year end as we move into the consumer selling season. Our customers view capacity expansion as a strategic decision and remain optimistic about long-term prospects for growth in both DRAM and the flash markets.

  • Foundries are beginning to see higher factory loading with wafer starts increasing at the leading edge and across older technologies. In calendar Q2 foundry utilization rose approximately 5 points quarter-over-quarter and is expected to rise further in Q3, triggering the need for additional investment.

  • In general we see the trend for more powerful, portable and affordable consumer products with more memory and new features driving our customers to use additional layers in chips and more process steps to make them. This increases overall equipment intensity, which we believe point toward continued semiconductor equipment growth.

  • Demand for flat-panel displays continues to be healthy. Panel makers are forecasting a rise in LCD prices based on strong demand for PCs, TVs and other display applications. Our flat-panel business had another record revenue quarter and our outlook for this business is generally positive as customers increase their confidence to build and equip Gen 7.5 and Gen 8 fabs in 2006.

  • Applied Materials is well prepared to benefit from these trends. You can see the building blocks of our growth strategy coming together in some of our recent achievements. Interest in our UVision bright field inspection system since our June introduction continues to be excellent with penetration at DRAM, logic and foundry customers, placements in almost all regions and some repeat orders.

  • Our new advanced edge etch product delivers the industry's most advanced and uniform silicon edge technology, reducing wafer edge exclusion and maximizing die real estate to allow more chips per wafer. This product was recently recognized by Solid State Technology as the most innovative product at Semicon West. It has generated strong customer interest with more than 40 chambers already in the field in just a short number of months. Our enabler etch system received Semiconductor International's Editor's Choice Product Award during the quarter as it continues to gain momentum at key customers.

  • I should also note that the magazine also recognized our Applied SEMVision G2 FIB metrology and inspection system with an Editor's Choice Best Product Award. This system has already been installed in virtually all advanced fabs worldwide.

  • The introduction of our Black Diamond II CVD system with nano-cure extends our market leadership by providing films with a dielectric constant below 2.5. This product delivers a compelling combination of low k films and manufacturability for high-volume production, a critical enabling technology for our customers who are moving to the next level of high-performance copper and low k chips.

  • During the quarter we acquired key intellectual property to complement our current wet cleaning product and provide an opportunity to expand our range of advanced cleaning solutions. We recently shipped our first system with this new technology incorporated.

  • In addition to our growing range of service offerings, a new alliance we announced with GE Global Electronic Solutions will provide financing benefits for customers selecting Applied Materials' services and tools.

  • Our continued investment in China and the establishment of our holding company which was recently approved by the government in China allows us to enhance our operations and capabilities in one of the fastest-growing electronics markets in the world and provides an additional vehicle for growth as China's industry expands in years ahead.

  • These are just a few examples of how Applied is working to broaden our capabilities and offer more to customers as they look ahead to the 65 and 45 nm nodes.

  • During the quarter Applied Materials was once again recognized by Business Ethics Magazine and was named on its list of 100 Best Corporate Citizens. Applied owes its long-standing dedication to corporate social responsibility to the leadership of our chairman, Jim Morgan, who started our community involvement program decades ago. And we're proud of his many contributions that have set high standards for the industry.

  • Applied Materials is committed to responsible leadership in environmental protection by working closely with our customers on innovative improvements. You can read about our progress in our recently published 2005 environmental performance report which you can access on our website. By working with customers on solutions such as our Ecosys abatement system line, we continue to press forward to help the industry enhance its environmental performance.

  • Of course the heart of Applied Materials is the technical talent that makes our technology and products possible. From transistors to interconnect, to inspection and flat-panels, our engineers and technologists are working with our customers to deliver performance and productivity. The theme we introduced this quarter, think it, apply it, sums up our desire to work in partnership with our customers at every level. Whatever innovative approaches our customers may need, we want Applied Materials to be the partner to apply it and turn those concepts into reality, driving the momentum of electronics products that put chips in the hands of consumers and business users around the world.

  • The opportunities have never been greater for Applied Materials as we look to apply our core competencies across the technology spectrum and deliver new levels of performance and productivity to the semiconductor and flat-panel industry. I would like to acknowledge the excellent performance and dedication all of our employees around the world who are creating the foundation for our future growth and increasing shareholder value.

  • Thank you very much, and now I will turn the call over to our Chief Financial Officer, Nancy Handel.

  • Nancy Handel - SVP & CFO

  • Good afternoon, everyone. I will now cover Applied's financial performance for the third fiscal quarter, the Company's financial goals and challenges, and finally our outlook for the fourth fiscal quarter of 2005.

  • Orders of 1.5 billion were in line with our target and were 5% lower than the second quarter of 2005 and 40% lower than the third quarter of 2004. Revenue for the third quarter was also in line with our target at 1.6 billion, 12% lower than Q2 of 2005 and 27% lower than Q3 of 2004. Operating income for the third quarter was 19% of revenue at 303 million compared to 22% for Q2 of 2005 and 27% for Q3 of 2004. Net income was 370 million, or $0.23 per share, compared to 305 million, or $0.18 per share, for Q2 of 2005 and net income of 441 million, or $0.26 per share, for Q3 of 2004. The results for the third fiscal quarter of 2005 included a favorable tax adjustment of 132 million, or $0.08 per share, principally due to the resolution of a multi-year tax examination.

  • Gross margin for the quarter was 43.9% compared to 44% in Q2 of 2005 and 47.4% for Q3 of 2004.

  • Orders by geographic region were as follows -- Japan, 23%; Korea, 19%; North America, 19%; Taiwan, 15%; Europe, 12%; and Southeast Asia and China, 12%.

  • During the third quarter system orders from Korea increased as customers invested in 300 mm DRAM and flash capacity, and Europe increased driven by investment in logic. Japanese investment, while still healthy, was at a reduced level from last quarter. Service orders grew this quarter, demonstrating continued customer acceptance for both our core and our new fab-wide service products. Flat-panel orders were also higher than prior-quarter levels.

  • DRAM orders represented 23% of total systems orders. Flash memory orders were 14% and foundry orders were 10%. Logic and other orders comprised the remaining 53% of total systems orders for the quarter. 300 mm orders represented approximately 70% of total systems orders received in Q3. 84% of systems orders was for 100 nm and below process technology.

  • During Q3 of 2005 2 orders were in excess of 100 million, 4 orders were between 50 to 100 million, and 10 orders were between 10 to 50 million.

  • Backlog for the quarter was 2.61 billion compared to 2.85 billion for the second quarter of 2005. Backlog adjustments totaled 79 million, consisting primarily of cancellations. Greater than 80% of the systems backlog is scheduled for shipment in the next two fiscal quarters, and approximately 80% of the systems backlog is for 300 mm.

  • The Company's financial performance during the third fiscal quarter met our targets. System revenue, as expected, was lower than the prior quarter as foundries continue to balance capacity additions with rising utilization levels. Service revenue remained relatively flat with the prior quarter. And we had our fifth consecutive record quarter of flat-panel equipment sales.

  • Gross margin of 43.9% was comparable to the previous quarter on 229 million of lower sales. Favorable product mix and reduced materials cost offset lower factory absorption on decreased systems volume.

  • Total operating expenses of 414 million were up $7 million, or 2%, reflecting increased R&D investment, partially offset by continued tight control of spending. Our operating margin and net margin, excluding onetime tax benefits, were in line with our model.

  • The third-quarter tax rate was a benefit of 8.9% that included a onetime benefit of 118 million from the favorable resolution of a multi-year tax examination and 14 million relating to a change in estimate with respect to export tax benefits. We anticipate that the effective tax rate for the fourth fiscal quarter will be approximately 31%.

  • The Company delivered a return on invested capital above 25%. We define return on invested capital as operating profit after tax, excluding onetime tax benefits, calculated on an annualized basis, divided by the average invested capital, less cash, cash equivalents and short-term investments. Our free cash flow generation for the quarter was 287 million, and we define free cash flow as cash provided by operating activities, less capital expenditures.

  • Our balance sheet continues to be strong, positioned as a strategic asset to enable the Company's growth. Cash, cash equivalents and short-term investments decreased to 6.23 billion. During the third fiscal quarter of 2005 cash generation from operations continued to be strong. Accounts receivable decreased by 70 million during the quarter, reflecting continued focus on credit and collection management and a lower business volume. Inventory decreased by 12 million during the quarter.

  • Capital spending for the quarter was 59 million and depreciation and amortization totaled 72 million. Headcount at the end of the quarter was 12,605 regular employees.

  • The Company repurchased 27 million shares of its common stock at an average price of $16.62 for $450 million during the quarter. Over the last four quarters repurchases have totaled 106 million shares with a cash outlay of $1.75 billion.

  • In June, the Company declared its second quarterly cash dividend in the amount of $0.03 per share, payable on September 7th to stockholders of record as of August 17. In Q4, we plan to repurchase shares in the range of 300 to $500 million.

  • Through ongoing asset management and operational focus we intend to continue to deliver strong free cash flow and we're positioned to return stockholder value through a quarterly dividend payment and continued share repurchase.

  • As we enter our fourth fiscal quarter and the second half of the calendar year 2005, we remain focused on company-wide initiatives to reduce material costs and cycle times and to increase our use of common platform architectures and common parts. We will maintain our efforts to deliver financial performance that is in line with our model.

  • Our fourth-quarter fiscal quarter targets are -- orders up 5 to 10% from Q3 levels; revenue flat to down slightly from Q3 levels; and earnings per share in a range of $0.13 to $0.14. Our product and services portfolio is strong and we're well positioned globally to benefit from our customers' increased capital spending.

  • I will now turn the call back to Paul for questions and answers.

  • Paul Bowman - Managing Director of Investor Relations

  • We will now begin our question-and-answer session. We would like to entertain questions from as many callers as possible. As such, I would ask you to please limit your questions to one per firm. Amy, please begin with the first question.

  • Operator

  • (OPERATOR INSTRUCTIONS) Jay Deahna, JPMorgan.

  • Murali Abburi - Analyst

  • This is actually Murali Abburi for Jay Deahna. I had a question regarding memory. It looks like most of the long leadtime suppliers like ASML and KLA indicated in their recent conference calls that they see memory orders picking up in the September quarter. I just wanted to get your thoughts on the health of the overall memory market and also your expectations for orders for memory for your October and January quarters. Thanks.

  • Mike Splinter - President & CEO

  • As I said in my prepared remarks, we think that DRAM and memory capacity and demand are in balance. We think there's a strong move in the second half to buy 12 Mb DDR2. We see our orders in the next quarter in memory moving up, and we see our customers -- memory customers being quite positive on both flash and DRAM for our foreseeable future.

  • Murali Abburi - Analyst

  • Thanks a lot.

  • Operator

  • Brett Hodess, Merrill Lynch.

  • Brett Hodess - Analyst

  • Following along the same vein, I'm wondering if you can talk about the 5 to 10% order rise outlook in a little broader terms. What are the strongest areas driving order growth beyond memory? Is foundry coming back and does the expectation for flat-panel continue to grow as well?

  • Mike Splinter - President & CEO

  • In this recent quarter foundry kind of hit a recent or maybe even an all-time low as a percentage -- recent history low as a percentage of our overall orders of just below 10%. So we're seeing that their factories are filling up and there's need to add capacity. So we think that we're going to see increase in orders from foundries during this next quarter and also in the memory area, both flash and DRAM.

  • Operator

  • Timothy Arcuri, Citigroup.

  • Timothy Arcuri - Analyst

  • If you look at your payables, they are on kind of a days basis, there are about double what most other companies are. Is there any particular reason for that? And do you plan to start to bring payables down a little bit?

  • Nancy Handel - SVP & CFO

  • I don't think there's anything particularly noteworthy on net balance. It's just really the timing of product flowing through our factory that gives rise to our payables balances. So I wouldn't attribute anything unusual to that.

  • Timothy Arcuri - Analyst

  • Okay, thanks.

  • Operator

  • Bill Lu, Piper Jaffray.

  • Bill Lu - Analyst

  • You talked about margins that are being product mix related. I wonder if you can just talk a little more about that. Also, related to it, can you talk more specifically about service margins in the quarter? Did that improve as expected?

  • Nancy Handel - SVP & CFO

  • In the current quarter the gross margin was approximately flat from the prior quarter on lower revenue coming through the factory. We got benefit from some favorable product mix and the reduced material cost that partially offset or offset some of the under-absorption of our factory overhead. There was some mix here. AGS was a little bit higher percentage of revenue, and some of that came through at a better margin.

  • Bill Lu - Analyst

  • When you say mix, is that 200 versus 300, or is that different product lines or what?

  • Nancy Handel - SVP & CFO

  • It is really different product lines.

  • Bill Lu - Analyst

  • Okay great. Thanks.

  • Operator

  • John Pitzer, Credit Suisse First Boston.

  • John Pitzer - Analyst

  • Just real quickly, when you look at the order guidance for October, can you help me understand directionally which way flat-panel service and equipment is moving in that number? And then out of curiosity, just kind of curious giving up orders why revenues would be flat to down. Thank you.

  • Mike Splinter - President & CEO

  • Generally our silicon business and service business will be up. We've had quite a number of good quarters in flat panels. We're thinking that's going to flatten out a little bit here at a positive level for us. So I think that's the major differentiation in our order book.

  • And, John, the second part of your question was?

  • John Pitzer - Analyst

  • Just given your quick leadtime, I'm just kind of curious -- order inflection in October, but revenues still flat to down?

  • Mike Splinter - President & CEO

  • Yes. I think you just have to look back at our order book for the last few quarters to understand that we're not going to see the flow-through quite yet on orders going up in this quarter.

  • John Pitzer - Analyst

  • Thanks guys.

  • Operator

  • Suresh Balaraman, ThinkEquity Partners.

  • Suresh Balaraman - Analyst

  • It's nice to see a positive order guidance. Do you guys have any sense whether this is one of the blips as you guys bounce along the bottom or are we in a sustainable upturn from here on?

  • Mike Splinter - President & CEO

  • We think certainly from our view that this quarter is going to be 5 to 10% up. We think Q1, with the information we have today, looks like it will -- order guidance will be up again in Q1. I don't want to venture anything beyond that. I think that's probably far enough for right now.

  • Suresh Balaraman - Analyst

  • Great. Thanks.

  • Operator

  • Jim Covello, Goldman Sachs.

  • Jim Covello - Analyst

  • A quick question on the DRAM side. You're talking about supply-demand being in balance, but with one or two exceptions most of your DRAM companies are actually losing money even with the recent uptick in DRAM pricing. How do we think about that related to a stabilization in the supply-demand equation?

  • Mike Splinter - President & CEO

  • I think you know you have got to kind of go back and look over the last cycle of DRAM pricing. We saw in the first half of this year pretty dramatic decline in DRAM pricing. We saw it hit the bottom and start to increase. I think that story on profitability with the DRAM makers will be told over the next few quarters. But the real part of the story that affects us is whether they're optimistic and willing to invest, and that's really what we're reporting. We think that from our view their outlook is optimistic and they have willingness to invest in capacity.

  • Jim Covello - Analyst

  • So would your view be that if they are -- that they need to start making money and continue to invest, or do you think they will continue to invest even if they continue to lose money?

  • Mike Splinter - President & CEO

  • It of course depends on the company, but my view is as long as they believe that they're going to make money and there is demand out there to be fulfilled that capacity is a strategic weapon for them.

  • Jim Covello - Analyst

  • Thanks a lot.

  • Operator

  • Robert Maire, Needham & Company.

  • Robert Maire - Analyst

  • Congrats on a nice quarter, by the way. In terms of your upward order guidance looking out for the remainder of the year, is the majority of the upside that we're looking at primarily the foundries coming back with memory staying flattish and logic staying flattish? Or are you looking at foundry coming back stronger and perhaps logic being a little bit weaker? Maybe you can give us your sense of the mix going forward.

  • Mike Splinter - President & CEO

  • Yes, I tried to do a little bit of that, Robert. We think foundry will be up quite a bit from a low point. We think memory and DRAM and flash will be up a little bit and overall logic will be down a bit.

  • Robert Maire - Analyst

  • Is this because of guidance given to you by foundry customers -- foundry customers suggesting that, hey, we're getting to a higher utilization rate and we're expecting to release orders, or -- ?

  • Mike Splinter - President & CEO

  • Sure, we are in detailed discussions with every customer about their forecasts on when they're going to release orders. We have those kind of discussions on an ongoing daily basis with the executives from our customer base.

  • Robert Maire - Analyst

  • Okay great. Thank you.

  • Operator

  • Patrick Ho, Moors & Cabot.

  • Patrick Ho - Analyst

  • In terms of the type of orders -- as this I think follows Robert's most recent question -- can you provide some color whether you're beginning to see any more types of mature technology node buys or are they leading-edge stuff? And I guess just as a follow-up, are you seeing any market share gains that are built into this order guidance for Q4?

  • Mike Splinter - President & CEO

  • We saw a little bit of increase in Q3 on 200 mm orders where people are filling out a factory or getting an upgrade on their 200 mm capacity. It's not really significant. All the 300 mm orders are on the advanced nodes, and that varies between 70 and 85% of our orders, depending on the quarter. I don't think that's really significant. I'm certain that people will continue to try and optimize the performance of their existing assets, 200 mm fabs. So once in a while we will see some increase there. But most of -- the lion's share of our orders are on leading-edge 300 mm 0.1 micron and below.

  • Patrick Ho - Analyst

  • Do you feel that part of your guidance for Q4 is due to market share gains or is it just from the return of capacity buying?

  • Mike Splinter - President & CEO

  • We continue -- we think the biggest part of the 5 to 10%, the lion's share is because of order patterns of our customers.

  • Patrick Ho - Analyst

  • Thank you.

  • Operator

  • Ed White, Lehman Brothers.

  • Ed White - Analyst

  • Wondering if you talk qualitatively about which product areas are doing relatively better or worse. Apart from flat panel, which we talked about, any specific product trends in the quarter?

  • Mike Splinter - President & CEO

  • Not really. I think that most of our silicon equipment products have been doing reasonably well, and so as orders come back we think that there will be orders across the board. The advanced technologies where we have strong share are in next generation low k and existing Black Diamond products continue to be very, very popular. Our ECMP tool is a hit and really separates us from the rest of the competition. So I think on those new products we've introduced we're seeing strong interest by many different customers.

  • Ed White - Analyst

  • Great. Thanks.

  • Operator

  • Mark Fitzgerald, Banc of America.

  • Mark Fitzgerald - Analyst

  • Nancy, on the options can you give us the option expense hit for the quarter? And given the accelerated vesting period here, can you give us any kind of guidance what option expense might be going on in next year's numbers?

  • Nancy Handel - SVP & CFO

  • Sure. The option expensing for us begins in Q1 of '06. We're estimating that with the changes that have occurred as a result of the acceleration it will run about $0.02 a quarter. When we filed our 8-K on our acceleration, that took about 138 million of aggregate expense out of the future options coverage.

  • Mark Fitzgerald - Analyst

  • Thank you.

  • Operator

  • Stephen O'Rourke, Deutsche Bank.

  • Stephen O'Rourke - Analyst

  • Have you begun to formulate your view on capital spending for '06? And if so, could you share it with us?

  • Mike Splinter - President & CEO

  • Not really, Stephen. I would rather reserve my view on capital spending for '06 until we get closer to '06 (multiple speakers) ask me next quarter.

  • Stephen O'Rourke - Analyst

  • Can I follow-up on one question, then? Can you give us some color on the cancellations and were there any pull-ins?

  • Nancy Handel - SVP & CFO

  • On the cancellation, there was essentially one -- one large order made up a larger piece of that where a customer made a real change in the processes that they were going to use their factory for. So they took that order -- we took that order off the books, but we expect it to reappear in the not-too-distant future. There were some minor pull-ins, but nothing of any significance.

  • Stephen O'Rourke - Analyst

  • Thank you.

  • Operator

  • Stuart Muter, RBC Capital Markets.

  • Stuart Muter - Analyst

  • Good afternoon. A question for Mike. 200 mm orders popped up a little bit in the July quarter. Where do you think the mix goes in October and January?

  • Mike Splinter - President & CEO

  • You're right, the 200 mm was up a little bit, as I said, due to some upgrades of 200 mm capacity. But we think that in the upcoming quarter that 300 mm will be in the 80% range, plus or minus a little bit.

  • Stuart Muter - Analyst

  • Okay, thank you.

  • Mike Splinter - President & CEO

  • As I said, all that will be 0.1 micron and below.

  • Stuart Muter - Analyst

  • Thank you.

  • Operator

  • Stephen Chin, UBS Warburg.

  • Stephen Chin - Analyst

  • On your characterization of the improvements of the foundry customers in the fourth quarter, are these improvements at multiple foundries, or do you see improvement in just a few with an expectation of seeing further improvement from the others later on?

  • Mike Splinter - President & CEO

  • We're seeing improvements in multiple foundries, but yes, I am still expecting more improvement. Assuming that utilization continues on the trend it's been on for the last number of months, if that's the case, then we should see further improvements.

  • Stephen Chin - Analyst

  • Thank you.

  • Operator

  • Bill Ong, American Technology Research.

  • Bill Ong - Analyst

  • If you compare the peak to trough order decline, it is about 45% versus industry average of down 30, 35%, so can you point to any particular product line or region that saw maybe a little bit greater weakness in this current cycle? Also, just to be fair, from your prior trough in early '03 to '04 you made a substantial gain relative to industry average. So it looks like you have gained a lot of share and maybe given a little bit back in this current cycle.

  • Mike Splinter - President & CEO

  • I think you really have to look at the mix here. Primarily we have very strong share in the foundry segment of the industry, has been down pretty dramatically for us, as well as China investment being substantially off. When you look at those two areas, it pretty much explains the differential -- any differential that you could look at between us and anyone else in the industry.

  • Bill Ong - Analyst

  • Thanks.

  • Operator

  • Mark Bachman, Pacific Crest Securities.

  • Mark Bachman - Analyst

  • I'd just like to take you back three months ago. On your last conference call you were pretty adamant that the foundries here were going to have to reduce their CapEx budgets in 2005. Given that you have tools in every fab in the world, I guess one could assume that you'd have some of the most important guidance out there. My question is what happened here? Where did your information let you down, and why haven't we seen the reductions that you suggested three months ago?

  • Mike Splinter - President & CEO

  • I think we have. If you take a look at our revenue, and I think when you look at where we are with foundries, there's a reduction in spending.

  • Mark Bachman - Analyst

  • I would just beg to differ. TSMC here reaffirms the top end of their range. You saw SMIC come back in and get financing. UNC guided down a tad, but where are the large -- you were suggesting last time that there were going to be some large reductions, and we just haven't seen those.

  • Mike Splinter - President & CEO

  • I think you have to look at the timing of how things get taken as revenue and how -- it's a complicated equation. But you know, look at our revenue is my final kind of point on that topic.

  • Mark Bachman - Analyst

  • Do you think they will spend to their stated CapEx budgets they have out there right now?

  • Mike Splinter - President & CEO

  • If they say they're going to spend to it, I'm sure they're going to spend to it. I'm sure they're going to say what they're going to do.

  • Mark Bachman - Analyst

  • Thank you.

  • Operator

  • Gus Richard, First Albany Capital.

  • Gus Richard - Analyst

  • Just to get a better handle on your flat-panel business, would it be -- since it's a record quarter and it's roughly 10% of revenues last quarter, is it running about 200 million a quarter at this point?

  • Mike Splinter - President & CEO

  • Nancy, you want to comment or how directly do you want to answer that question?

  • Nancy Handel - SVP & CFO

  • It's in line with the prior quarters.

  • Gus Richard - Analyst

  • Can you talk a little bit more about the UVision, your penetration? Have you seen more repeat orders since you announced the product in June?

  • Mike Splinter - President & CEO

  • Yes. We continue to see strong excitement by the customer base, both repeat orders and an increased number of new orders from new customers.

  • Paul Bowman - Managing Director of Investor Relations

  • I'm going to keep moving along here.

  • Gus Richard - Analyst

  • Sorry, go ahead.

  • Paul Bowman - Managing Director of Investor Relations

  • Next question, operator.

  • Operator

  • Ben Pang, Prudential Securities.

  • Ben Pang - Analyst

  • You mentioned that you were seeing some increased capital spending budgets from your customers. How much of the order improvements through the next quarter is due to them satisfying the budget for 2005?

  • Mike Splinter - President & CEO

  • I don't know. You would have to ask them that question. But we're seeing them come back and start to spend as utilization increases in their factories, and I think that's really the key factor they're trying to judge how much capacity they're going to need.

  • Ben Pang - Analyst

  • Are they asking for faster delivery now, or the delivery schedules remain as they were, let's say, six months ago?

  • Mike Splinter - President & CEO

  • Our delivery times are pretty short now. We have done a great job in shrinking our cycle times from order to turn on in their factory. So there's not much need to have accelerated delivery times over that capability.

  • Ben Pang - Analyst

  • Thank you.

  • Operator

  • Timm Schulze-Melander, Morgan Stanley.

  • Timm Schulze-Melander - Analyst

  • Congratulations on the quarter. Nancy, I was just wondering, could you just maybe spend a minute just maybe going into slightly more detail on the favorable tax adjustment, just kind of how it came about? And I'm guessing given that it wasn't highlighted as even a possibility in the guidance going into the quarter just kind of how much visibility you have on these things and how they've sort of come back in such a short space of time because obviously it's a pretty sizable adjustment. Thank you.

  • Nancy Handel - SVP & CFO

  • That's no problem. The tax adjustment came through in terms of 118 million that was related to the -- the joint committee review of the tax returns for '98 to '01 is basically something that we know has been going on for a while. But until the final resolution was achieved and documentation was received here at the Company, the ability to book those entries was nonexistent and make those adjustments. So we basically were waiting to see if it would show up in Q3 or it would show up in Q4. It actually showed up in Q4 during the time we were closing our books. So there's nothing unusual about that timing in terms of working with a government.

  • Timm Schulze-Melander - Analyst

  • Great, thank you.

  • Operator

  • Tim Summers, Sanford Financial Group.

  • Tim Summers - Analyst

  • You guys have talked about the concept of merge in transit now for the past couple quarters. I'm curious have you started to do that, or do you anticipate to start to do that in this calendar year? And as we move into '06, could this be a favorable impact on your gross margin going through the year? Thank you.

  • Mike Splinter - President & CEO

  • I'm not sure who is talking about merge in transit from Applied Materials, but we do have a program on integrate to order which dramatically helps to shrink our manufacturing time and customize at the end of our manufacturing cycle. So we are progressing on that quite well. And it's one of those things that help us with our material costs and our factory cost and absorption.

  • Tim Summers - Analyst

  • Thanks Mike.

  • Operator

  • Medhi Hosseini, Friedman Billings Ramsey.

  • Medhi Hosseini - Analyst

  • When you look at opportunities in flat-panel display, 7.5 and 8G, would you expect the total market to exceed the 2004 level as you go forward? And also, with the services, would you expect the services to exceed the 2 billion -- million -- 2000 or 2 billion level?

  • Mike Splinter - President & CEO

  • 2005 revenue is going to be bigger for us in flat-panels than 2004. So for flat-panel 2004 was not a peak. Right now it's hard for me to judge what 2006 is going to be like in the flat-panel business only because we've had such a strong run here and how long will the run last?

  • But what I would say about flat-panels is that we continue to gain share with our flat-panel products. Our e-beam tester is very popular. We're going to continue to increase our exposure to that market because we do think it's going to be a strong market over the future. There is great opportunity for the Company there.

  • On service, I think the only thing limiting us in service is our ability to develop new products that customers want and deliver them in a way that improves the productivity of our customers' factories. And we're working hard to do that. I don't see any limit in our revenue. There's no cap on revenue growth in the service area. It's growing now and should continue to grow.

  • Medhi Hosseini - Analyst

  • If I may, just one follow-up to the flat-panel. When you say market share, are you referring to having products that would get you outside of the CVD and measurement like PVD or other areas?

  • Mike Splinter - President & CEO

  • Whatever will help our flat-panel customers reduce -- the key here is to help them reduce the cost of making flat-panels. That is the absolute paramount thing we're working with our customers on, because this market is quite elastic and allows us to grow the market if we can help lower cost. We're working on increased productivity, and we're gaining share in our CVD area, and we're gaining share in e-beam tester and we're working on some new products that will help lower costs.

  • Medhi Hosseini - Analyst

  • Thank you.

  • Operator

  • Steven Pelayo, Fulcrum Global Partners.

  • Steven Pelayo - Analyst

  • A couple a quick questions here. Service as a percentage of booking, is that running roughly 25 to 30% now? Do we have a number there? I had last quarter down at 24%. Does that sound about right, Nancy?

  • And then second question is going to be Mike, your comment about foundries being up quite a bit. Are they going to snap to being 25 to 30% of system orders, do you think, next quarter?

  • Nancy Handel - SVP & CFO

  • I think your AGS (ph) comment is in the right range. What was the second piece?

  • Mike Splinter - President & CEO

  • The second part was about foundries snapping all the way back to 25% or something like that. No, I don't think so.

  • Steven Pelayo - Analyst

  • You don't think it's going to be that high? And then last, Nancy, if I could just get one more. On the flat-panel you mentioned about 10% of revenues. Is it also about in that range on a booking perspective?

  • Nancy Handel - SVP & CFO

  • Yes.

  • Steven Pelayo - Analyst

  • Yes, it is?

  • Nancy Handel - SVP & CFO

  • The answer is yes.

  • Steven Pelayo - Analyst

  • Thank you.

  • Operator

  • Manish Goyal, Neuberger Berman.

  • Manish Goyal - Analyst

  • Actually it's (indiscernible) investments. Thanks for taking my call. Two questions, one on leadtime. Mike, do you think your leadtimes are likely to remain where they are today as bookings improve in the next six months?

  • Mike Splinter - President & CEO

  • Yes. I think we have put in systematic methods to keep our leadtimes down and work with our suppliers to ensure that they can support those kind of leadtimes. We think we can have quite a significant increase in capacity without extending leadtimes.

  • Manish Goyal - Analyst

  • Second question, Mike, was on incremental margins on gross margin line. If revenues were to grow from January quarter onward, is it reasonable to think incremental margin on gross margin line to be in the range of 65 to 70% range?

  • Nancy Handel - SVP & CFO

  • We expect to be able to deliver financial performance in line with our model. Clearly as we're able to put more systems through the factory, there's the opportunity to take up some of this unabsorbed overhead that should yield some improved financial results, in line with the model, though. That's really -- the model takes into account the factory pickup.

  • Manish Goyal - Analyst

  • Thank you.

  • Paul Bowman - Managing Director of Investor Relations

  • We will take one last question and then we will make our closing remarks.

  • Operator

  • Timothy Arcuri, Citigroup.

  • Timothy Arcuri - Analyst

  • Just to kind of clarify what you had just said, are you saying that in the July quarter both flat-panel and service were both up sequentially on a revenue and an order basis?

  • Mike Splinter - President & CEO

  • Yes.

  • Timothy Arcuri - Analyst

  • And you expect them both to be up again sequentially in October on both the revenue and an order basis?

  • Mike Splinter - President & CEO

  • No, I said flat-panel -- in the earlier question I said flat-panel. I expect service and systems to be up and flat-panel to be roughly flat.

  • Timothy Arcuri - Analyst

  • Great. Thanks Mike.

  • Paul Bowman - Managing Director of Investor Relations

  • We'd like to thank everyone for listening to our third-quarter earnings announcement. The webcast of this call is available on our website and will remain there until August 30th. I'd like to thank everyone for your interest in Applied Materials. This concludes our call.

  • Operator

  • This does conclude today's conference. You may now disconnect.