使用警語:中文譯文來源為 Google 翻譯,僅供參考,實際內容請以英文原文為主
Operator
Good afternoon and thank you for standing by. Welcome to the Applied Materials third quarter fiscal year 2006 earnings conference call.
During the presentation, all participants will be in a listen-only mode. Afterwards, you will be invited to participant in the question-and-answer session. As a reminder, this conference is being recorded today, August 15, 2006.
I would now like to turn the conference over to Mr. Randy Bane, Vice President of Investor Relations Applied Materials. Please go ahead, sir.
- VP Investor Relations
Thank you, Ian. Good afternoon and welcome to Applied Materials fiscal third quarter conference call.
Joining me today is Mike Splinter, President and CEO, Nancy Handel, Senior Vice President and Chief Financial Officer, Joe Sweeney, Senior Vice President, General Counsel and Corporate Secretary.
Today we'll discuss our results for the period ending July 30, 2006. We released these results this afternoon at 1:05 p.m. Pacific time. A copy of the news release is available on Business Wire and posted to our Web site, www.appliedmaterials.com.
Today's earnings call contains forward-looking statements including those relating to applied financial performance, operational efficiencies, tax rate, cash generation and deployment, acquisitions and joint ventures, growth and opportunities and financial targets, end use demand for semiconductors and flat panel displays and our customer's capacity plans. All forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements.
Information containing these risk factors is contained in today's earnings press release and in the Company's filings with the SEC. Forward-looking statements are based on information as of August 15, 2006, and the Company assumes no obligation to update such statements.
Today's call also contains non-GAAP financial measures. A reconciliation of these measures to GAAP measures are contained in our earnings press release issued today and in our earnings call highlights document, both of which are available on the Investor Page of our Web site.
Nancy will lead off with a discussion on select financial results for the third quarter and provide insight into the Company's initiatives. After Nancy's remarks, Mike will discuss current industry and Company developments followed by our fourth fiscal quarter targets. He will then turn it back to Nancy and then we will go ahead and open the call for questions.
With that, I would like to turn the call over to Nancy. Nancy?
- SVP, CFO
Thank you, Randy. Good afternoon, everyone, and thank you for joining us.
Today I will discuss the results for the third fiscal quarter of 2006 and provide you with an overview of the strategic initiatives that enable us to continue delivering world-class operational and financial performance.
During the third quarter, orders reached a near-record level driven by continued strength in end user demand for integrated circuits and by increased customer requirements for advanced silicon and display solutions. Orders totaled $2.67 billion for the quarter, up 7% from the prior quarter with significant competitive gains as demonstrated by year-over-year growth in etch and processed diagnostics and controls that was faster than the market.
We also had stronger than expected order growth in our display products. Increased customer demand in memory and foundries drove slightly higher than expected order growth.
Of our systems bookings this quarter, flash memory increased to 29%, DRAM was 24%, with logic and other at 27% and foundries at 20%. Approximately 87% of systems orders were for a 300-millimeter, virtually all for 100-nanometer and below process technology.
Six orders were in excess of $100 million. Six orders were between 50 and $100 million, and 16 orders were between 10 and $50 million.
During the third quarter 82% of our orders were from outside North America. Demand from Japan, Southeast Asia and China, and Taiwan strengthened. Orders by major geographic areas were Taiwan, 21%, Japan, 20%, North America, 18%, Korea, 16%, Southeast Asia and China, 16%, Europe, 9%.
Revenue for the third quarter was $2.54 billion, 13% higher than last quarter exceeding our target. Revenue upside was driven by higher customer utilization rates and improved competitiveness in our silicon products and our display products.
Backlog for the third quarter increased to $3.32 billion compared to $2.93 billion for the second quarter of 2006. Backlog adjustments totaled $264 million consisting primarily of the addition of $285 million of Applied Films backlog, offset partially by $20 million of customer cancellations. The majority of the cancellations were associated with 200-millimeter systems for flash memory.
Reported gross margin for the third quarter improved 160 basis points to 48.1% compared to 46.5% for the second quarter of 2006. Improvements were driven by increased factory loading and continued progress on cycle time and material cost reductions. Equity-based compensation charges reduced this quarter's gross margin by 40 basis points.
Operating expenses for the third fiscal quarter were $543 million, 12% higher than last quarter. Operating expenses included increased spending for incentive compensation programs and early investment in the Company's business transformation initiative, which we mentioned on last quarter's call. Our continued focus on improving operating efficiencies positively impacted both our gross margin and our operating profit.
Operating income was $681 million, or 26.8% of revenue, 180 basis points higher than the 25% reported for the second quarter of 2006, with flow through of 41%. Non-GAAP operating income was in line with our financial model, demonstrating increased operational efficiency that enables the funding of strategic initiatives within the model.
We exceeded our net income target for this quarter. Net income was $512 million, or $0.33 per share compared to $413 million, or $0.26 per share for the second quarter.
These results included a benefit of $34 million, or approximately $0.02 per share from the resolution of audits of prior year's tax filings, partially offset by an in-process R&D charge of $14 million, or approximately $0.01 per share associated with the acquisition of Applied Films.
Our financial model, based upon non-GAAP metrics, was developed to enhance understanding of ongoing operational performance. The model excludes items deemed by management to be unusual or non-recurring. The reconciliation of our reported earnings per share of $0.33 to our non-GAAP earnings per share of $0.35 was included with our press release.
The effective tax rate of 29.1% for the third quarter was lower than the forecasted rate of 31.5%, primarily due to the resolution of audits of prior year's tax filings. We anticipate the effective tax rate for the fourth quarter to be approximately 32.2%.
Now I would like to discuss some highlights of our balance sheet and cash flows. During the quarter cash, cash equivalents and investments decreased $672 million to $5.2 billion.
The Company used cash for its purchase of Applied Films, our investment in the Sokudo joint venture and for share repurchases and cash dividends. This was partially offset by cash generated from operations.
Accounts receivable increased $345 million and day sales outstanding increased slightly to 82 days. Inventory increased by $259 million, principally due to $151 million from the acquisition of Applied Films.
Capital spending for the quarter was $40 million and depreciation and amortization totaled $62 million.
Free cash flow generation for the quarter was $332 million, down from $471 million in the prior quarter. This decline reflects $180 million estimated tax payment and other increases in working capital items associated with increased business volumes.
We define free cash flow as cash provided by operating activities less capital expenditures. This strong free cash flow and financial position enables us to continue our history of returning cash to shareholders while simultaneously reinvesting in our business.
During the third quarter the Company repurchased 31 million shares of our common stock for $500 million at an average price of $16.30 per share.
Since the beginning of fiscal 2005 the Company has repurchased approximately 186 million shares representing approximately 11% of the shares outstanding at October 31, 2004 for a cash outlay of $3.2 billion. During the fourth fiscal quarter of 2006 we plan to repurchase shares in the range of 400 to $600 million.
In June 2006, the Company declared a cash dividend in the amount of $0.05 per share payable on September 7 to stockholders of record as of August 17th.
Headcount at the end of the quarter was 13,884 regular employees. The increase of 1,094 employees was primarily related to Applied Films acquisition.
As part of our growth strategy, we completed the acquisition of Applied Films for approximately $484 million, or $328 million net of Applied Films cash. Applied Films is the leading supplier of thin film deposition equipment used in manufacturing flat panel displays, solar cells, flexible electronics and energy efficient glass.
This acquisition compliments our thin film nanomanufacturing capabilities and provides an opportunity to expand into new high growth markets. At July 30, 2006 Applied Films had assets of $549 million including net accounts receivable of $15 million, inventories of $151 million, plant and equipment of $16 million, goodwill of $201 million, intangible assets of $140 million and other assets of $26 million.
Also in this quarter we invested $147 million into our joint venture with Dainippon Screen called Sokudo. Sokudo brings together the complementary resources and capabilities of Screen and Applied Materials to deliver advanced, technically differentiated track solution for customer's critical semiconductor manufacturing requirements.
Now I'd like to conclude with our long-term strategic initiatives that will enable us to continue delivering world-class operational and financial performance. These initiatives are designed to leverage commonality, to achieve R&D productivity gains, improve engineering, manufacturing and sourcing capabilities, and enhance world-class management and organization capability.
For example, we are driving material cost reductions and have instituted programs such as our recently expanded international procurement office based in Shanghai, China to enable global material sourcing. In addition, we are consolidating the direct materials supply base to improve the Company's buying power, which has resulted in a 34% reduction in the number of suppliers from the beginning of the year.
In manufacturing, we continue to reduce cycle time through our integrate to order, modular final tests, and merge in transit programs. Integrate to order is a combined business process and product design approach to reduce the order to ship cycle time for configured systems.
Modular final tests is a process that fully tests products in their modular form before they are crated and shipped, eliminating the requirement for a system to be fully assembled, tested and then dismantled before transport. Merchant transit is a process of accumulating modules at an alternate site outside of Applied Materials factory prior to shipment.
In the third fiscal quarter, more than 80% of systems shipped were manufactured using the integrate to order process.
And finally, we have launched our business transformation initiative, a multi-year global initiative to improve our business processes, replace multiple software systems with a single enterprise system and streamline the sharing of real-time operating data across the Company. As you can see from this list of initiatives, we are firmly committed to improving profitability.
Our success is dependent on the outstanding contributions of our employees. I would like to thank our employees for it is through their efforts that we will continue to deliver excellent results and expand our leadership in the industry.
Now I'll turn the call over to Mike who will provide an update on our growth strategy as well as his perspective on the market environment and the Company's strong strategic position. Mike will also provide the guidance for the fourth quarter. Mike?
- CEO, President
Thank you, Nancy. I'd like to also my welcome to all of you and thank you for joining us on the call this afternoon.
My remarks are going to start with a review of our overall strategy then move to discuss our third quarter performance and our current view of the industry, and finally, our fourth quarter financial targets.
Our activities in the third quarter demonstrate that we're making real progress on Applied Materials' strategy. First, central to our strategy is growing in our core semiconductor business, both systems and services, but we have great opportunity to expand in multiple directions.
Our technology-leading products and new offerings are aimed at market share gains, particularly in the memory space where we believe we have made excellent progress this year.
Second, on top of this strong base, we are entering adjacent and new markets that leverage our core competencies and provide opportunities to further grow the Company over the long-term. We will do this by aggressively pursuing organic expansion and through M&A activities.
Finally, we will enhance our business processes and synergies working across the Company to achieve operational and financial efficiencies that increase margins and deliver higher levels of profitability in returns for our shareholders.
The near-term goal of our growth strategy is to expand our opportunities and move Applied Materials from serving an addressable market of $17 billion back in 2004 to approximately $37 billion by 2008. We'll do this by significantly expanding our core semiconductor business, enhancing our flat panel display offerings and initiating new solutions in solar and clean energy.
Now let's review our progress. In the quarter we saw significant sales increases throughout our business from core markets as well as adjacent markets.
Revenue grew 54% over the same period one year ago demonstrating our ability to drive share through product innovation and bringing new technologies into the marketplace. We saw market share gains in etch, inspection, global services, and across our thin film product line and we continue to drive better returns across all of our product lines.
Let's look at the core product areas more closely. Leading up to SEMICON, we introduced technology solutions that will enable our customers to advance to the 45-nanometer generation.
We've enhanced our advanced patterning films, one of the industries most successful emerging CVD applications. This revolutionary application allows customers the ability to cost effectively pattern nanoscale features with increasing complexity while reducing their reliance on next generation lithography solutions.
We also announced Sokudo, our joint venture with Dainippon Screen. We intend to make a significant difference in patterning by helping customers maximize the lithography process window and improve overall litho cell economics, especially in high density chips like flash and DRAM.
For critical device contact structures, we introduced the Endura integrated liner/barrier 2 system which reduces resistance by up to 40%, a key element in increasing chip speed and improving power performance.
We've also improved interconnect technology, introducing Active Preclean on our Endura copper barrier/seed system. This new process helps customers confidently transition to next generation Low k films such as our innovative BlackDiamond II.
Our Endura copper barrier/seed system is the tool of record for critical 45-nanometer development at all leading chipmakers.
In [aps] we had a strong quarter, growing revenue on pace with the rest of the Company. In addition, we are making progress on our strategic plan to expand our customer base and applications served. During the quarter we had strategic wins in key memory and foundry customers with our industry leading AdvantEdge silicon and metal products.
Another area where our products are showing strength is in the high growth nanflash market. Specifically, we've made progress with RadOx, CMP and advanced patterning films.
Here memory makers benefit from significant performance gains at a price that keeps memory affordable for the customers propelling that market. We are going to continue our efforts in this space to make memory-specific applications and gain share in this critical market.
Applied global services set a new revenue record. We made significant breakthroughs in our service agreements at major Asian manufacturers.
We introduced our Metron Aquarius system for copper abatement adding to our leading range of innovative point-of-use abatement technologies and energy saving solutions that enable chipmakers worldwide to meet their most stringent environmental goals.
UVision, our bright field inspection system with DUV laser 3-D technology continues to gain momentum in line with our expectations. UVision is now installed at virtually every major customer and has been winning repeat orders at customers and real-lifing the potential of rapidly finding nanometer scaled defects never seen before.
In terms of expanding into new markets, we completed the application of Applied Films in the quarter. This acquisition integrates new capabilities into our flat panel display group and positions us for further growth in line with our corporate objectives.
Through this acquisition, we now have an entrance into the PVD color filter area, which currently is more than a $200 million market opportunity. It also provides key products and capabilities for the solar market as well as other applications.
We are committed to achieving the promise of this acquisition and using our cross organizational capabilities in large area thin film processing to drive product differentiation and business efficiencies. Mark Pinto, our CTO, will be overseeing the integration efforts where Applied Films capabilities will be incorporated into our new business and new products group.
The key to success here will be to quickly integrate the product lines and raise the gross margins to the Applied Materials expected range, making the acquisition accretive sometime late next year or in early 2008.
Now let's turn to the industry outlook. The third quarter saw semiconductor environment with continued strong growth in overall unit demand, particularly for memory products.
The semiconductor industry continues to grow overall revenue in the 8 to 10% range year-over-year, but units are growing at a much faster clip, greater than 20% this year, with flash memory units growing over 60% year-on-year. This is a very positive trend, both for Applied Materials and the entire equipment industry, however, we are entering what looks to be a challenging period for equipment bookings as inventories are rising at our customers in some segments and both foundries and flat panel display companies reassess their investments.
After an excellent record-setting revenue quarter in our display division, we expect a pull back in revenue of roughly 20% as major firms manage their capacity expansion plans. Meanwhile, orders will stay relatively flat as a couple of the major players continue to pursue their Gen 8.5 factories. Overall, we expect this reset to be short-lived as both the laptop and TV end markets continue to expand at a very rapid pace.
What we've heard from our semiconductor customers in recent weeks indicates that there is inventory building in the PC market affecting some customer's outlook for wafer capacity expansion. The PC story will be told over the next few months as we enter the back-to-school and holiday sales periods.
In the short-term, we see inventory growing in this segment, but we are also seeing manufacturers reacting quickly to ensure this inventory doesn't continue to expand further. Foundries have maintained their cautious investment policies throughout the year.
If we look at what foundries are expected to spend this year in equipment, it's about $6 billion, down about 30% from their 2004 peak levels. Foundries are demonstrating prudence and model flexibility in adjusting utilization rates to bring supply and demand back into balance.
On the other hand, memory manufacturers have remained optimistic and even aggressive about their capacity expansion plans. Profitability in DRAM market segment improved for many manufacturers during the quarter while business trends and outlook held strong.
This has given these manufacturers continued confidence for investment. This confidence appears sound as new high-content memory applications are due to ramp into the marketplace over the next year or so.
Our customer's investments in memory are aimed at capturing share for this fast growing market, with growth likely driven by the advent of the instant-on and platforms with Microsoft's new operating system, Vista, for consumers next year.
The memory manufacturers continue to drive investments in capacity with an eye on supply demand outlook over the long-term. In the current environment, memory will continue to be over 50% of our revenue and bookings.
Over the long-term, we remain optimistic. New fab build plans expanded and we are now tracking 55 projects over the next two years. This level of planned capacity expansion is rational given the demand picture and if these projects stay on track next year, it will be a positive year for capital spending in 2007.
Our targets for fourth quarter reflect the current market dynamics and some cautiousness about the near-term. We expect orders to be flat with a range of plus or minus 2% driven primarily by strength in memory orders.
We expect revenue to be also flat within a range of plus or minus 2%. We expect EPS to be 29 to $0.30 which includes an estimated $0.03 for equity-based compensation and approximately one penny for the dilution of AFCO and Sokudo.
Looking past short-term issues, we are confident that many market opportunities are developing longer term. As such, we are firmly committed to our investments and long-term initiatives that build on our core technologies and help us expand in the adjacent markets. Building upon our current strengths, these areas are expected to provide significant growth potential for Applied Materials.
Going forward, we are confident about the driving forces of our business. We are gaining market share with new and better applications to meet our customer's critical requirements.
We are also growing our served available market and now have more opportunity for growth than at any time in our Company's history. And we expect our business process and efficiency initiatives will build on our performance and deliver new levels of gross margin and profitability over time.
This was a strong quarter for Applied Materials and our employees deserve thanks for their efforts in delivering the results you can see in our margin improvements and continued ability to deliver differentiated and innovative products to the industry. The events of this quarter demonstrate our ability to grow organically by utilizing our financial strength to expand the Company while generating strong cash flow in returns for our shareholders.
Thank you very much. Now I'd like to turn the call back over to Nancy for a moment. Nancy?
- SVP, CFO
Thank you, Mike.
What I'd like to discuss is that on a personal note, I'd like to announce to you today what I'd been discussing with Mike and with the board and that is the fact that I will be retiring from Applied Materials at the end of this calendar year after more than 21 years with the Company. I have to say that I really thoroughly enjoyed my opportunity to grow my career at Applied, particularly this opportunity over the past two years to serve as Chief Financial Officer and to lead a fantastic group of people around the world that make up our global finance team.
I believe that I've done my best to position the Company and the finance organization for continued success in our important strategic initiative. And it's now a good time to transition and really to focus and expand my long-standing interest in the non-profit community and to make a little bit of extra time for some fun.
It's been a great ride, but we still have more work to do. We've got another quarter to close here and then some. So I appreciate your continued support and trust.
So now I'd like to turn the call back to Randy.
- VP Investor Relations
Thank you, Nancy. Operator, we will now begin our question-and-answer session. We would like to entertain questions from as many callers as possible, as such, please limit your questions to one per firm. Operator, please begin with the first question.
Operator
[OPERATOR INSTRUCTIONS] Your first question comes from the line of Jay Deahna with JPMorgan.
- Analyst
Thanks very much and good afternoon.
Mike, on the outlook for capital spending for next year, how much of it is dependent upon some fairly decent chip inventory depletion between now and the end of the year? How do you feel about the prospects for that?
If you look at the different segments, foundry, flash, processors and DRAM, how do you feel relatively on each one of those in terms of the outlook for next year? I think Vista should be good for DRAM and maybe some of the pushouts in foundries might shove that into next year as they start 65-nanometer expansion, but I'd love to get your thoughts on that. Thanks.
- CEO, President
Sure, Jay. Excellent point.
So when we look at the Cap Ex for next year, really what we feel that this is hinging on is how well the inventory gets drained during this next six months, because that will determine really what the first half of next year looks like.
What we're seeing is -- where we think the big issue is primarily in the PC space and not necessarily in DRAM-related PC space, but overall in the PC space. So we want to watch a couple of critical areas. In particular, the foundries are very important to us.
One of the things that you can kind of assess from the call is that our orders from foundries for the upcoming quarter are projected to be pretty low, maybe in the 10 to 15% range. So how fast they're able to cut back on that -- cut back on their starts and diminish that inventory, excuse me, is really the key for us.
I think in flash memory the players are going to continue to spend and put in the capacity that the longer term volume and applications are going to present themselves. I think the DRAM guys are seeing -- especially in Taiwan -- are seeing an opportunity right now to make investments and grow their position in the market.
So I'm pretty confident that DRAM flash memory in general is going to be positive in 2007 and where the hinge factor will be is in the foundries and some of the PC-related IDMs and that's the thing to watch over the next few months on how those inventories trend as we see the sell-through numbers in back-to-school and then in Christmas and Chinese New Year.
- Analyst
Pulling it together, are you still expecting some level of up Cap Ex next year?
- CEO, President
I'm certainly less optimistic than I was three months ago, Jay, but it really depends on what happens in the next three months and what happens in the foundries.
- Analyst
Great. Thanks.
Operator
Your next question comes from the line of James Covello with Goldman Sachs.
- Analyst
Good afternoon, guys. Thanks a lot. A couple quick questions.
Mike, could you talk a little bit about the kinds of pricing discussions you're having at the end of the quarter with your customers, particularly some of the customers in the memory space who are seeing a little bit of a squeeze in their margins? And I have a follow-up after that. Thanks.
- CEO, President
Jim, really, the pricing has been -- you can see a lot of the big deals that we've made in the quarter. It really gets discussed through the quarter.
I don't think we really had any big gigantic push at the end of the quarter, so I think our pricing has been pretty steady for the whole year, really, and when you look at how stressed our factory was to make deliveries in this quarter, I think that it is consistent with that. So I wouldn't say much about pricing and you can see it reflected in our gross margin numbers.
You take that gross margin number apart a little bit and I think it indicates some pretty strong equipment gross margin.
- Analyst
Now, to that end, that was kind of my follow-up question on the margins. If the revenue guidance is flat and EPS guidance is down a little bit, can you talk about the components, revenue guidance flat, EPS guidance down a little bit, can you talk about the components that's causing the EPS to be down a little bit?
- SVP, CFO
The overall earnings outlook for the next quarter has some, obviously, some unique items in it. One is the focus on the integration of Applied Films so it will be the first time they show up and we've given an indication that the kind of impact that they might have on our reported earnings in the fourth quarter.
We also, in light of the outlook for the revenue guidance and targets that Mike has discussed, you see that the factory loading should be sort of on par with what we've had this quarter and so the efficiency gains that we've had in previous quarters now are kind of leveled out a little bit in terms of their factory loading.
We expect, though, to continue to gain some of the benefits that we have from our initiatives in our global sourcing and material cost reduction and some of the ones I described are modular final tests and ITOs so we're putting an acceleration on bringing those benefits in. At the same time, we get a little bit of the other opposite pressure from the integration and from the -- a little bit of a change in the pace of ramp of the business.
- Analyst
I'm sorry, just on that point, did the factory loadings would be flattish, though?
- SVP, CFO
The factory loadings should be flattish.
- Analyst
But if the factory loadings are flattish, I understand you're not going to get a benefit from the factory loadings in the out quarter, but that shouldn't be a drag, I wouldn't think. And so the only delta between this quarter and next quarter would be the acquisition plus what else?
- SVP, CFO
Well, there's a little bit of mix in there, in terms of our business between the panel business, the display business, as well as our AGS operation and our systems business, that's not a huge factor in the coming quarter. In addition, we had a good throughput through the factory in Q3 and we've got a fair amount of product that's going to ship in the first month of this quarter. So the factory loading was a little bit stronger in the third quarter.
- Analyst
Okay. And then just final question on that.
If the flat panel typically has lower margin associated with it so with sales being down in flat panel, I would have thought that that mix would have been positive a little bit.
- SVP, CFO
Well, I think that the discussion around contribution is at the bottom line level with the panel business. The display business area really contributes strongly at the bottom line so it wouldn't have been a big impact on earnings per share.
- Analyst
Okay. Thanks very much.
- VP Investor Relations
Next question please?
Operator
Your next question comes from the line of Edward White with Lehman Brothers.
- Analyst
I was wondering if you could talk a little bit about the outlook for sort of the non-foundry IDM logic, both the PC side and the non-PC side in this environment? You talked quite a bit about with the memory being strong, foundry being weak, but if you look at the logic IDMs, how are they looking?
- CEO, President
It, again, kind of divides along the product segment lines. We still see that those companies that are making DSPs, for instance, or communication products are still doing quite well and will continue their spending on track.
The race in the processor space is still, the two major companies there have been going along, both, I think, are tightening up a bit, but they're going ahead with their expansions as far as we can tell.
And then kind of the other spot is in Japan where we still have a fair number of IDMs of various types and from our results, you can see Japan's still quite strong and we expect them to continue to make investments across the next couple of quarters.
- Analyst
Okay. And then one quick follow-up.
Nancy, you gave the percentage of revenues for integrate to order but can you give some sense as to where it might be for modular final test and merchant transit so we can get some idea as to how pervasive that is in your revenue mix?
- SVP, CFO
We're making good progress, but those two initiatives are a little bit earlier in their life cycle than the integrate to order. And naturally, the integrate to order success is almost a precursor to the ability to do the modular final test and emerging transit so they should begin to continue to increase their contribution to our profitability, but they're a little bit further in the pipeline than the ITO is.
- Analyst
Okay. Great. Thank you.
Operator
Your next question comes from the line of Steve O'Rourke with Deutsche Bank.
- Analyst
Thank you. Good afternoon. A couple of questions.
First, you mentioned lower cycle times. What are they now, what have they come down from, and where can they go? And can you comment also on the utilization of your Austin manufacturing facility?
- SVP, CFO
The cycle times, let me see if I've got a fact here, the cycle times have reduced significantly. Overall cycle time is down 100 days. We keep trying to pull that down a few days at a time in terms of our build to, basically, order to customer fulfillment cycle time.
In terms of our Austin factory, we've really been able to get the utilization at a higher level there, although certainly we still have capacity in our Austin manufacturing site that is available for use. One of the things that I think is important is that you can look at how we've been able to be productive in our Austin site, that we've put revenue through there that was comparable to the kind of revenue that we saw in the years 2000 on a quarterly basis, some of our quarters in there, and we basically did it with a third as many people.
We've got a high degree of productivity in our Austin site and it's got some additional capacity available to it, but it's really running at a high level of efficiency.
- Analyst
And one follow-up. How should we be looking at operating expenses out into next quarter?
- SVP, CFO
Operating expenses in the next quarter are going to be up some. The addition of Applied Films certainly just kind of drops right into that line item, although it drops into many elements of the profit statement, but it's going to be a contributor to our increase there.
We also have some initial investment that's continuing in our business transformation initiative. We've talked about that. That ultimately is a investment that will be capitalized but some of these early dollars during the design phase are part of the expenses.
We're driving everyone to look at the budgets in terms of efficiency and manage that project tightly, but there's a few dollars that will come into the operating expense line.
- Analyst
Thank you.
Operator
Your next question comes from the line of Satya Kumar with Credit Suisse.
- Analyst
When I look at your July revenues, was there any AFCO revenues in there?
- SVP, CFO
No, there were not. The transaction closed at the end of that period and they will appear in our fourth quarter for the first time.
The balance sheet came on at the end of July, but the P&L statement will come in during Q4. There was only one impact and that was the in-process R&D write-off that was noted in the supplemental schedule with the press release.
- Analyst
Could you help quantify that a little bit for October from AFCO?
- SVP, CFO
Well, it's going to come in -- there's significant changes that are occurring with the way that we will recognize the revenue and the profitability for Applied Films. They previously had a revenue process that was percentage completion and our revenue process is really either revenue at shipment for standards products or revenue at signoff and so they will be making changes to come to our revenue process, which is going to basically in the near-term reduce their revenue, at the same time their expenses are still coming in as an incurred basis.
There will be a little bit of a dampening affect and that's why we called them out on the targets that we gave for the quarter.
- Analyst
And, Nancy, a quick follow-up.
If I look at your average memory orders year-to-date it looks like they're up almost 100% from last year's levels. Seems like that's a lot more than Cap Ex, which is up about 30% or so.
What's really driving the faster growth rate in orders versus Cap Ex? Are you seeing some customers front loading their orders and have you seen backlog growth as a result of that?
And more specifically, if you're looking beyond the October quarter, should we expect these orders to pull back more sharply because of these factors?
- CEO, President
Satya, I'll take the question.
One of the things that we've been trying to emphasize, really, since the big spending shift of 2005 towards memories is our applications and share in the memory space. So we've been reasonably successful this year at gaining footholds and manufacturing tool of record at most of the memory manufacturers, both for specific products, new products that we're offering as well as some of the existing products that we've already introduced for logic that now as the memory guys shrink dimensions are really important. So most of the run ahead of the growth in Cap Ex at memories by the memory makers is share gains.
Now I itemized some of those applications and I don't want to go over them again here, but what we should expect after October, I still think the memory guys are going to continue to invest. They see their opportunity and see the growth for the applications they're making. You can see how strong the DRAM pricing has been over this year.
I think we're probably all surprised at how strong that's been this year and it's given incentive to those memory makers to continue to grow their capital and grow their capacity.
Operator
Your next question comes from the line of Stephen Chin with UBS.
- Analyst
Great. Thank you.
I wanted to get back to the guidance. I think I heard you say that the flat panel orders would be flat quarter-over-quarter. If that was the case, is it fair to assume that the systems bookings are going to be up somewhere on the order of perhaps 5 to 10% quarter-over-quarter?
And the other remaining category, services, is typically seasonally down in the fourth quarter? Is that a fair assessment?
- CEO, President
Well, I think it's certainly a fair assessment. We gave you the information about the flat panel revenue being down while orders will be flat.
Our service in both revenue, we expect services revenue and orders to kind of move up modestly in our Q4. Of course in Q1, services moves up, order move up quite a bit more.
But I think you can draw the conclusion between our semiconductor segment and our flat panel segment. I think beyond that, I don't think there's that much differentiation.
- Analyst
Okay. Thank you.
Operator
Your next question comes from the line of Brett Hodess with Merrill Lynch.
- Analyst
Good afternoon.
Mike, given the number of new areas that you've moved in in the service side of the business, do you think that the service side of the business if we get into a little slower period here will have the affect of finally having some offsetting impact on your revenue line relative to the equipment, or is it still a small enough piece of the business to slow, enough growing piece of the business that the equipment is just going to dominate the revenue pattern?
- CEO, President
Well, Brett, I think you've studied pretty closely what's happening in our service business and the percent of revenue now is now up close to 25% of our overall revenue, and certainly that's quite different than it was three or four years ago when it was in the low teens. That as a percentage of our overall revenue, it's doubled.
Equipment both in flat panels and in semiconductors is still the major part of our business. While we are better buffered against that severe downturn, I don't think there's anything that we can do or hope to do in the short-term that saves us from having to take appropriate action if there's a severe equipment downturn.
But Applied Materials has been through these kind of ups and downs before. We have a pretty good formula for cutting back on spending, we have a variable workforce, we've been moving a lot of elements to Asia to ensure we have our best possible efficiency.
So I think the summary is, our service business is growing, it's a better buffer, but it's certainly not a gigantic buffer.
- Analyst
Great. Thank you.
Operator
And your next question comes from the line of Timothy Arcuri with Citigroup.
- Analyst
Hi, Mike.
Two things. I guess first of all, if you kind of look at the industry on two broad metrics, if you look at chip capacity, utilization and you look at that relative to two orders and you also look at something like equipment orders per chip being produced, if you just look at two very broad metrics like that, we have a situation that we haven't seen in 2000 or 1996 and both of those ended pretty badly.
So I'm wondering, do those two metrics kind of from a really top level perspective worry you in terms of how long a downturn, be it in January or be it in April, could be and what actions are you potentially taking that could mitigate that? Thanks.
- CEO, President
So of course those indicators concern us and we watch them. I think one of the things that's different in this go around, if you think back, you're familiar with the '96 situation, this was another memory situation, but the situation today is quite different than that in that the number of applications is expanding so much for the various types of memories, whether it's in cell phones, growth in density in cameras, et cetera, et cetera.
So I think the foundation -- the ability to grow and have that capacity go into real applications where there's real need is much different than '96 and certainly different than 2000 where the underlying demand was quite false. And I don't feel like the underlying demand in this particular situation is way off base. I think that's the big difference.
As far as actions inside the -- if you're saying actions inside the Company, we're very much looking -- it's kind of one foot on the gas, one foot on the brake, we want to make sure we're capturing every opportunity we can, but we also want to make sure we're controlling our spending, especially our spending growth, we control our headcount, we watch our temporary workforce, these kind of things that really allow us to scale back our spending quickly. What we would not be willing to do is compromise our growth initiatives and efficiency initiatives for the future because those are the future growth of the Company.
- Analyst
Mike, thanks.
I guess just on that point, is there some change potentially to the operating model? I think before you said that at $2 billion, operating margins would be about 26% and net margins would be about 19%. So with the investments in solar and with AFCO, has there been any change in that model?
- SVP, CFO
Yeah, I would like to just comment that we really are working on looking at refreshing the model. This model's been out here since the summer of '03 and we're looking through at our initiatives in the solar and the new business areas.
We're looking at the timeframe for bringing AFCO into our kind of profitability model. We're looking at the contributions from our display business and also just some of the realities now of the tax rate changes that have occurred. Our old model had a lower tax rate in it than we're dealing with now.
So the team here is actually working on refining the model during this fourth quarter as well as working on the disclosure materials that we're looking at in terms of how we're going to describe our business going forward. We're trying to make sure that we've integrated those two ways of looking at the business and that at the end of the quarter we come out with a new view we can share with Wall Street.
- Analyst
Okay. Thanks.
Operator
And your next question comes from the line of Stuart Muter with RBC Capital Markets.
- Analyst
Thanks for taking my question and good afternoon.
Following up on some of the earlier questions about service. I'm hearing you're making good progress on spares and consumables. Could you talk a little bit about the profitability trend in service, how that's played out this year and how you see it going forward?
- CEO, President
Actually, this is a good point. In our service area, we've seen growth in profitability every quarter this year. I'm not sure it's at all-time Applied Materials highs, but it's certainly at recent times highs they've gained about a point a quarter on the gross margin line in our service area.
- Analyst
Excellent, Thank you.
- CEO, President
Thanks, Stuart.
Operator
And your next question comes from the line of Robert Maire with Needham.
- Analyst
Just a clarification. The order number reported did not include AFCO, but the order guidance going forward includes AFCO?
- SVP, CFO
Yes, that's true. The orders numbers for this quarter, there wasn't any AFCO in the orders or revenue for this quarter.
- Analyst
Okay. So if I back out the AFCO in the orders, would that suggest that orders minus AFCO or core applied business is down 5% in orders? No, that would be an incorrect assumption.
- SVP, CFO
AFCO really is -- with their, you know, timing of their business practices, I think we reflected them sort of in our plus and minus 2% that we'd given in terms of how their orders come in.
- Analyst
So they're not accounting for more than 2% of your business because it's kind of like we're comparing apples and oranges, I'm not understanding that.
- SVP, CFO
It's a relatively small contribution in terms of orders in revenue in the fourth quarter. So the guidance is really considered around the core Applied Materials business that we've been reporting throughout.
- Analyst
But the forward guidance orders does include AFCO as part of that number.
- SVP, CFO
Yes.
- Analyst
Okay.
And would that be a more significant percentage going forward? You're indicating that there's some timing thing here with AFCO, or --?
- SVP, CFO
We would expect its business to continue to increase. We also expect its profitability to continue to improve as we are able to go in and get some of those synergies that were part of the desirability of completing the acquisition.
As we stated when we did the acquisition, that we expect by the beginning of '08, we should be seeing some contribution from AFCO going forward. But we've got a little bit of work to do in the near-term.
- Analyst
And the earnings guidance has no -- AFCO has no significant impact on that, I would imagine?
- SVP, CFO
That's the comment we made about the $0.01 per share that was part of Mike's comment. That Applied Films coming in now in the fourth quarter, with the change in revenue practice, that would be delaying revenue into the future and the fact that their operating expenses are here today, that's why we noted that they could have almost a penny or so impact on our fourth quarter.
- Analyst
Okay. And one last clarification.
Given that a significant piece of their business is flat panel related, you just said that you expect their orders to increase, but flat panel is sort of weakening here. Is there something different about their business in the near-term versus Applied's flat panel business?
- CEO, President
One thing, Robert, one thing I think you may have noticed watching AFCO or Applied Films during this last quarter is that they got a significant order in solar market, the order I think was published at $30 million or so and we expect the penetration there continue to grow over the upcoming quarters.
- Analyst
So solar would offset flat panel weakness perhaps. Okay, thank you.
Operator
And your next question comes from the line of Gary Hsueh with CIBC World Markets.
- Analyst
Hi, Nancy. Congratulations on retiring. I've got a quick question.
I realize that the model is under scrutiny here, but looking at the $0.01 dilution from AFCO and Sokudo next quarter, if you look at revenues flexing down from the January quarter and if you kind of try to assess what the downside risk near-term is in terms of dilution from these two businesses, assuming the timing is pretty tight and you can't really do anything about the current cost structure, what's the ultimate downside risk in terms of EPS dilution from Sokudo and AFCO at, say, let's say prior trough levels in those two businesses?
- SVP, CFO
Well, I think that -- you mean just specifically related to them?
- Analyst
Yeah, like if you cherry pick like the two recent troughs for both the respective businesses, whatever they might be, what does it mean in terms of EPS dilution to the model for AMAT near-term?
- SVP, CFO
I look at the horizon that we've got projections for, for the business and their impact on our business is really -- it will improve overtime, but the kind of impact they're having on us today I think really represents sort of the downside for them.
This is kind of that stage where their revenue is maybe at its point where it's being adjusted for our revenue cycle and their expenses haven't been brought in line with our financial model yet. I think the kind of impact that we're talking about now should represent the downside for them.
- Analyst
So you're saying, Nancy, that I really shouldn't be modeling much more dilution than a penny a quarter over the next two or three quarters, let's say, if revenues start to go down?
- SVP, CFO
I don't think so. I guess I'd have to see what the impact of the action was, but we really think we've got the business targeted to be accretive beginning in '08 so we should with able to move in that direction during '07.
- Analyst
Okay.
So no matter what happens, the worst-case scenario for these two businesses in terms of EPS dilution for the full year of '07 is like 4 to $0.05?
- SVP, CFO
I think that's a good place to start.
- Analyst
Okay. All right. Thanks, Nancy.
- VP Investor Relations
Operator, we have time for one more question.
Operator
Okay, sir. Your final question comes from the line of Michael O'Brien with Bear Stearns.
- Analyst
Thanks.
I'm just curious, Michael, on the memory side of things, you're saying it continues to be strong. Is everyone right now, would you say, spending at the same time? Is it more staggered? I'm trying to get an idea of how likely we're going to see a peak in memory, even if memory demand if they all take a break in a quarter.
And then with regard to the severe downturn that you've talked about and you're a little less confident in 2007, when can we start seeing that flow through? I mean it sounds like if this is as bad as it gets, plus or minus 2%, that's not so bad.
- CEO, President
If all -- you're right, Michael, if all it gets is plus or minus 2%, that's not so bad but you know our industry generally has bigger swings than that. The memory spending, when you just go talk to these guys, they are almost to a person or to a company very bullish right now about their opportunity -- either about their near-term opportunity in the DRAM area or about their longer term opportunity in the flash area and they're willing to push through the clear pricing pressure there is today in the flash memory space.
So pretty much, every one of those memory guys has new fab on the books and is in one stage of ramping it or another. So I think this thing kind of keeps cycling on pace unless somebody loses their courage.
On the severe downturn scenario, again, the timing from -- if your question -- maybe I don't quite understand the question, but if your question is what's the timing kind of from seeing an orders downturn to seeing a revenue impact, today in our industry is very fast because throughput times are fast, our backlog doesn't extend very long like it used to when cycle times were much, much longer. So the timing from orders to impact is very short, three, four, five months kind of impact.
- Analyst
I think that that was kind of my question, but if I kind of look at the -- you're saying the memory guys almost to a company are still quite bullish, and the foundries, you're already baking in a pretty negative scenario for October, you know, Intel and others were at pretty low levels. I'm just trying to see here in the near-term what's going to take that for that big step function down in orders.
- CEO, President
The thing that I believe, in order to see a big step function down, the foundries have to continue their kind of negative bias on capacity, and the memory guys have to have some kind of an event that doesn't -- that takes away their courage for investment. And I think that would likely -- when you look at the various players, if it was going to happen, it would happen in the DRAM space before it happens in the flash space.
- Analyst
Okay. Thanks. Good luck.
- CEO, President
Thanks.
I think that was the last question and I just wanted to finish offer by saying thank you to Nancy and acknowledge her 21 years at Applied Materials and making a huge impact on our Company through the good times and the bad and she has done all different kinds of jobs in management and demonstrated leadership across the Company. So Nancy, thank you, and thank you for your contributions. You'll be sorely missed. Thank you.
- SVP, CFO
Thank you.
- VP Investor Relations
Thank you, Mike, and thank you, Nancy. Now we'd like to thank everyone for listening to our third quarter 2006 earnings announcement.
The replay of this call will be available on our Web site at 5:00 p.m. today and will remain posted there until August 30th. Thank you for your interest in Applied Materials. This concludes our call.
Operator
That concludes today's conference call. You may now disconnect your lines.