應用材料 (AMAT) 2008 Q3 法說會逐字稿

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  • Operator

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

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

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

  • We ask that you please limit your question to one per firm and one follow-up.

  • As a reminder, this conference call is being recorded today, August 12, 2008.

  • Please note that today's earnings call contains forward-looking statements including those relating to Applied Materials' performance, products, growth opportunity, strategic position, solar strategy and RAM, operational initiative, cost controls, acquisition, share repurchases and financial targets, customer spending, and industry outlook.

  • All forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements.

  • Information concerning these risk factors is contained in today's earnings press release and in the company's filings with the SEC.

  • Forward-looking statements are based on information as of August 12, 2008, and the company assumes no obligation to update such statements.

  • Today's call also contains non-GAAP financial measures.

  • Reconciliations of the non-GAAP measures to GAAP measures are contained in today's earnings release and in our financial highlights slide, which are on the Investor page of our website at www.appliedmaterials.com.

  • I would now like to turn the conference over to Robert Friess, Vice President and Treasurer of Applied Materials.

  • Please go ahead, sir.

  • Robert Friess - VP, Treasurer & Interim Head of IR

  • Thank you, Tara.

  • Good afternoon and welcome to Applied Materials' fiscal 2008 third quarter earnings call.

  • I am happy to be participating in this quarter's webcast as interim head of Investor Relations.

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

  • Before we begin, let me remind you we'll be hosting an analyst briefing at the European Photovoltaic Solar Energy Conference in Valencia, Spain, on Monday, September 1st.

  • More details on this event will be provided soon.

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

  • Today we will discuss the results for the period ending July 27, 2008.

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

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

  • Mike Splinter will lead off the call with highlights on the market environment and commentary on the company and each segment.

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

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

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

  • Mike Splinter - President & CEO

  • Thank you, Robert.

  • As many of you know, Robert has assumed responsibility for Investor Relations while we recruit a new executive to lead our Investor Relations function.

  • Robert, thank you for stepping in.

  • Applied Materials' third quarter financial results can be characterized as optimizing our company's performance in a challenging economic environment, with the semiconductor equipment market being particularly tough.

  • During the quarter we saw continued softening of world economies as oil prices spiked, credit tightened, and then the US housing values fell further and unemployment increased.

  • It is no surprise that US consumer confidence is at its lowest level in more than a decade.

  • Over the past few months forecasts for 2008 wafer fab equipment spending moved in line with our view of down 25% to 35% year-over-year as memory prices weakened and investments were delayed.

  • While there were some signs of strength in the PC market that showed double-digit unit growth, it is not translated to investment broadly by our customer base.

  • In this light, our team executed every opportunity for orders and revenue in each of our businesses to achieve our results.

  • The silicon systems group remains focused on financial and operating results, and the group performed well in the most challenging quarter since Q4 2003.

  • Let me highlight a few examples of the team's achievements in the quarter.

  • In mask inspection, with the Aera2's unique aerial imaging capability, we're now running production at six customers with significant wins at chip makers, mask, and wafer fab operations.

  • Interest in this new product continues to be strong, and in bright field inspection, our UVision product is in line to increase shipments by 60% in fiscal '08.

  • In edge, we're focused on becoming the tool of record in key applications for critical dimension control in high aspect ratio features.

  • In these areas we've racked up 23 new tool of record positions at major memory manufacturers to date in fiscal '08, and we expect these to translate into orders and revenue as customers move to advanced nodes over the next year.

  • Our HARP gap fill solution won a production tool of record position at a major flash manufacturer due to its superior performance at the high aspect ratios needed in shallow trench isolation applications.

  • Another important win came as Epi earned positions at two major logic manufacturers, gaining share and making our selective Epi solution the virtual industry standard.

  • As memory transitions to copper interconnects, we expect gains in copper PVD applications and Applied is well-positioned at nearly all flash and DRAM development lines making that transition this year.

  • Overall in SSG, bookings for the fourth quarter are moving positively and should increase by more than 30% from the floor in Q3.

  • Display had an all time record revenue quarter, inching past $310 million as we delivered the largest volume of product in our display group's history.

  • At the same time we recorded revenue on the first PiVot Array PVD system.

  • Pivot significantly improves target utilization to greater than 70% and lowers costs of ownership through an innovative rotary target concept.

  • For energy and environmental solutions, revenue doubled and orders were up 25% in the quarter.

  • Our focus in crystal and silicon over the past several months has been to build production capability to meet the rapid expansion of product demand in our precision wafering systems and Baccini cell system business units.

  • Delivery performance is improving, and we expect to be current to backlog by October.

  • Products from PWS and BCS are market leaders, and we expect to expand operations and move along the road map to reduce costs for solar cell production.

  • A key component in reducing these costs is to use fewer grams of silicon for each watt of output produced and Applied Materials is leading the industry in that challenge.

  • In fact, our entire crystalline silicon product portfolio is now capable of producing wafers as thin as an average sheet of paper, only 120 microns thick.

  • That's 60% thinner than today's industry standard wafer.

  • We are pleased with the progress this past quarter in our SunFab thin film business.

  • We're in the investment cycle in this rapidly developing business, and our focus is on the successful start up of our first customers' factories.

  • We believe our process technology and full line solution provide customers the ability to rapidly expand capacity while partnering with the technology leader to provide the long-term improvement in cost per watt necessary to succeed.

  • We are simultaneously starting up multiple SunFab lines while integrating an end-to-end suite of newly developed process tools.

  • The scale and operational complexity of these lines presents a tremendous challenge.

  • This is just the kind of challenge that Applied Materials excels in and our teams have performed exceptionally well by drawing on the overall resources throughout the company and from among our partners to support these new factories.

  • We now have four customers that are producing solar panels.

  • If you saw one of these panels at Intersolar in Europe or in California, you understand how overall cost efficient our 5.7 square meter form factor is for large scale solar applications.

  • We expect to get our first SunFab signed off this quarter with more to follow in the first part of fiscal '09.

  • The SunFab technology platform made dramatic progress in the quarter as our tandem junction process demonstrated production feasibility.

  • We were pleased to learn the European patent office just issued a provisional opinion finding invalid the key claims of a patent related to tandem junction solar technology that is the basis of a lawsuit recently filed against one of our solar customers.

  • The solar industry continues to gain momentum, and investment prospects remain strong with particularly rapid growth in Europe and Asia.

  • During the quarter we announced two new contracts and one follow-on for SunFab, earning new customers in important emerging solar markets like Italy and the Middle East.

  • For SunFab, interest remains strong, and our customer pipeline is robust.

  • Governments around the world are implementing policies favorable to renewable energy in helping to build a strong market for solar, and we're working with US policy makers to eventually pass and sign into law an effective incentive program to build the market in America at a time when we clearly need a sensible and proactive response to the global energy crisis.

  • Regardless of incentives, however, our focus is to apply our technology and production know how to enable solar to compete with all conventional forms of electricity generation.

  • We still expect that our fiscal Q3 was the trough in semiconductor equipment orders and revenue.

  • However, we remain cautious in our expectations for a revenue recovery through the end of the year.

  • We are in close communication with customers on more than 4,300 millimeter projects that we believe will be going forward, but in the current environment there is uncertainty around the timing of those investments.

  • We're watching bit growth, pricing, and inventory indicators in the memory area to help judge when we will see the next wave of investment in either DRAM or flash.

  • Our expectations are for the industry to start adding additional NAN capacity for solid state drive applications in 2009 and beyond.

  • Growth rates for 65-nanometer foundry capacity have been slower than expected due to design complexities.

  • Foundries are now seeing growth in 65-nanometer revenues as the ramp gains strength and utilization exceeds 90%.

  • In 2008 we see capital intensity down to 15% to 16%.

  • This is below its typical range of 18% to 22%.

  • This represents a near term correction from memory over spending.

  • Longer term, we see capital intensity growing back to approximately 20% over the next 1 to 2 years.

  • After reaching historic levels in the first two quarters, our orders for display products were strong at $374 million, but down 25% over Q2.

  • We believe this represents the end of the first phase of the gen 8.5 order cycle, and we should expect orders in display to be down significantly for the next few quarters until the gen 10 technology and capacity cycle begins.

  • Meanwhile, we see the major capital projects moving ahead.

  • The top panel makers are expanding capacity to meet demand for large TVs over the next few years, despite signs of the TV market softening in the short-term.

  • We expect revenue to continue at a high level for the next few quarters.

  • In our service business, we see much less volatility than experienced in the capital equipment businesses they support.

  • AGS has weathered the downturn in silicon and shown solid revenue and financial performance.

  • Our service group has developed a strong proposition for expanding in Asia, signing five major contracts for silicon service and three for display in the period.

  • Applied's SunFab performance service program has strong momentum at leading solar manufacturers in Europe and in Asia.

  • We have now exceeded $100 million in service contracts for both single and tandem junction SunFab lines.

  • In order to capitalize on growth opportunities, we're making significant investments in infrastructure to enable the company to be more cost effective and efficient in expanding capacity to meet customers' needs.

  • During the quarter, we announced our new Asian operation center in Singapore that will primarily focus on SSG products.

  • The expansion of our Tainan manufacturing center focused on display and solar products, and we continue to invest in developing our solar reliability lab and our other capabilities in Changi, China.

  • Overall, Applied Materials is executing to our strategy in today's difficult economic environment.

  • We are focused on our core businesses in silicon and service, making significant R&D investments in new products and technology for the next node of integrated circuits.

  • The display team is executing at the top of the revenue cycle and expanding their product line.

  • Our solar organization is rapidly developing capability on the two fronts of crystalline and thin film silicon products, and at the same time we're investing in the right infrastructure for the future.

  • With that, I would like to turn the call over to George to comment on the Company's results for Q3 and to provide our targets for Q4.

  • George.

  • George Davis - CFO

  • Thank you, Mike, and good afternoon, everyone.

  • Applied Materials delivered results that were well within our target range during a period of significant weakness for the semiconductor equipment industry and in a period of heavy investment in our burgeoning solar businesses.

  • Our silicon business is Applied's strongest earnings and cash flow engine, so we're pleased with the financial and operating performance achieved in the third quarter, although revenue declined 40% in that segment quarter over quarter.

  • Display and solar continued to ramp capacity and capability throughout the quarter while our services business remained relatively strong despite the difficult environment in its major end market.

  • During the quarter, we continued to execute on our operational improvement strategies both to address the cyclical environment as well as to achieve our long-term cost road map.

  • Now I will summarize our performance for the third quarter.

  • Orders of $2 billion were at the high-end of our target range as all businesses performed in line with our expectations despite significant volatility in the underlying markets.

  • Backlog increased to $4.7 billion.

  • Backlog adjustments for the quarter were negative at $37 million comprised of $75 million of debookings -- primarily related to cancellations from a few memory customers -- and $46 million of unfavorable currency adjustments, partially offset by $83 million of adjustments, primarily for precision wafering system orders that now meet our order recognition criteria but were in PWS's backlog at the time of acquisition.

  • Bookings for display and EES have exceeded revenue for three and six quarters respectively.

  • Revenue of $1.8 billion for the quarter was down $302 million or 14%, which was at the mid-point of our Q3 target range of down 10% to 18%.

  • Growth in the display and EES segments helped mitigate the significant decline in silicon revenue.

  • Gross margin decreased to 40.2% from 45% in Q2.

  • The decrease is attributable to lower silicon revenue, our highest margin business, along with some minor effects from lower factory absorption.

  • It is noteworthy that our gross margin performance benefited from the substantial improvements in operating performance in SSG, which earned a gross margin in excess of 50% during the quarter.

  • Operating expenses were $514 million, down slightly from Q2, and reflect our rapid increase in spending in solar, partially offset by savings from the cost reduction plan we announced in January and lower variable compensation costs.

  • We continue to drive each of our business groups to manage operating expenses prudently while meeting the investment requirements of their respective businesses.

  • Operating income decreased to $228 million or 12% of revenue, reflecting lower revenue levels partially offset by progress on our cost control measures and other operating performance programs.

  • Net income was $165 million or $0.12 per share at the middle of our target range.

  • Non-GAAP EPS was $0.17 per share, with M&A charges primarily related to our solar acquisitions impacting EPS by $0.02.

  • Let's now look at third quarter results by segment.

  • In silicon, orders were down on decreased demand from DRAM and flash customers.

  • This is the first quarter in the past ten quarters that orders from memory makers accounted for less than 50% of the total semiconductor related orders, led by a significant falloff in flash memory orders.

  • Our order composition was logic and other 37%; DRAM 34%; foundries 20%; and flash 9%.

  • Orders for 5X nanometer and below technology represented more than 55% of semiconductor related orders.

  • Silicon net sales were down 40% from Q2.

  • Continued weakness in DRAM and flash spending were compounded by further delays in foundry investment.

  • Leading foundry utilization rates improved sequentially from the second quarter and are now higher than 92%.

  • Silicon operating income declined to 23% of net sales, due primarily to the steep decline in revenue.

  • Operating performance continued to improve relative to historical levels, showing 10 points of operating margin improvement relative to Q4 of fiscal 2003, when revenue was at a similar level.

  • The initiatives arising from the formation of a single silicon organization, the exit from under performing products, and our cycle time and M cost improvements over time achieved by our Austin team have enabled this result.

  • In addition, the silicon group has established a foundation for further operating leverage with supply chain and sourcing initiatives.

  • During the quarter we broke ground on our new Asia operations center in Singapore, which will support our merchant transit and low cost regional sourcing strategies.

  • Energy and environmental solutions.

  • Orders in energy and environmental solutions increased 25% over Q2 due to orders in PWS and PCS being reflected for a full quarter.

  • We also recognized orders for two SunFab lines.

  • EES net sales more than doubled from the Q2 level, driven by higher sales of crystalline silicon solar and glass products.

  • During Q3, we began to see real movement towards a normalized flow through of revenue from PWS and BCS.

  • We believe the convergence between shipments and revenue will happen in the next two quarters.

  • Our crystalline silicon products are now contributing the majority of our EES revenues and orders.

  • Operating loss for EES increased slightly over Q2 despite higher revenue, partly due to support in spending associated with the eight simultaneous SunFab lines that are in various phases of implementation.

  • Quarterly results in this segment are also impacted by acquisition and related charges of approximately $25 million to $30 million for PWS and Baccini.

  • We are pleased with the progress we've made to date with integrating these acquisitions, and excluding acquisition charges, both the businesses were profitable in the third quarter.

  • We expect that operating and gross margins in our thin film business will be low in our initial SunFab projects due to learning curve related spending.

  • We are simultaneously ramping multiple first of their kind plants in different locations around the world.

  • Our priority is and will continue to be the success of our customers.

  • We do expect to rapidly proliferate our early learnings, and we should see increasing profitability from this business in the second half of 2009.

  • Applied global services.

  • In Q3, despite a difficult industry environment in its core semiconductor service and spares market, our services business showed signs of resilience, while orders were down 10% and net sales were up slightly at $607 million.

  • In the current environment, while customers are tightly controlling spending on spares, we are seeing increasing demand for our service capability, including in underpenetrated markets in Asia.

  • Operating income was slightly lower than Q2 due to an unfavorable product mix and some one-time charges related to a legal settlement and related exit of the legends product line obtained in the Metron acquisition.

  • In display, orders remain high but were down 24% from last quarter.

  • As Mike described, the order cycle which started in Q4 '07 appears to have reached an inflection point in Q3 '08, and we expect the downswing in orders to be as significant as the upswing was.

  • Display achieved record revenue with net sales of $311 million, an increase of 57% from Q2, and included recognition of the first PiVot PVD tool from a leading customer.

  • Display also generated record operating profit of $103 million or 33% of net sales, resulting from the increase in revenue and favorable product mix partially offset by higher spending.

  • In Q3 we made further progress ramping our Taiwan facility, and we're shipping more than one third of our display systems from Tainan.

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

  • We ended the quarter with a cash and investment balance of $3.72 billion, a decrease of $124 million.

  • Cash flow performance was good, as we generated $320 million in cash from operations or 17% of revenue.

  • Working capital performance for the quarter benefited from solid receivables performance, and inventory increases of approximately $227 million were driven by display and solar.

  • Customer deposits associated with our SunFab and other EES contracts substantially offset our increased inventory requirements.

  • In Q3, Applied returned $381 million or 119% of operating cash flow to its stockholders.

  • Of this amount, $300 million was for the repurchase of 15.6 million shares at an average price of $19.22, and $81 million was for cash dividends.

  • We expect to spend between $200 million and $400 million on share repurchases in our fiscal Q4.

  • Before I outline our Q4 targets, I would like to reiterate some of the key market issues that are impacting our outlook for the coming quarter.

  • First, semiconductor capital equipment demand is expected to remain flat and any revenue increase over the prior quarter appears to be modest.

  • We do expect orders to strengthen somewhat based on customer forecasts.

  • Flat panel display shipment demand will remain strong as customers add capacity, although the order cycle is expected to decline sharply in Q4.

  • We expect further progress integrating our crystalline silicon solar businesses, which will bring revenue rates closer in line with shipment rates.

  • We also expect that services markets will be relatively flat, with movement around last quarter's level being a function of demand for spares and used equipment from our semiconductor customers.

  • Now let me provide our Q4 targets.

  • We expect orders to be up in the range of 5% to 10% overall, with increased EES and silicon orders partially offset by a sharp decline of about 75% in display.

  • We expect revenue to be up in the range of 2% to 10% overall, driven by revenue from crystalline silicon and thin film solar products.

  • As we previously forecasted, we expect to recognize our first SunFab revenue in Q4 '08.

  • We expect EPS to be in the range of $0.12 to $0.15 per share, up in line with revenue overall.

  • Operating margin will continue to be impacted somewhat by our investment in the solar buildout and our investment in SSG R&D to position our silicon equipment products during the downturn.

  • We believe there will be substantial upside in our earnings over time as silicon recovers and we see increased profitability in solar.

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

  • Robert Friess - VP, Treasurer & Interim Head of IR

  • Thanks, George.

  • As a reminder, please limit your questions to one per firm and one follow up.

  • Tara, let's begin with the first question.

  • Operator

  • (OPERATOR INSTRUCTIONS) Your first question comes from the line of Jay Deahna with JPMorgan.

  • Jay Deahna - Analyst

  • Okay.

  • Can you hear me?

  • Mike Splinter - President & CEO

  • We can.

  • Hi.

  • Jay Deahna - Analyst

  • Good afternoon.

  • Two questions.

  • The first one is in the May conference call I believe if I remember correctly, you stated that your customers would demonstrate working single junction panels by the end of the July quarter and tandem junction panels by the end of the October quarter.

  • We got the first part of that done.

  • Just wondering if the second part of that is on track?

  • And in line with that, you made a statement about a release from the European patent office in your prepared remarks.

  • Wondering if you can expand on that a little bit and indicate what that means relative to the Oerlikon lawsuit against Sunfilm?

  • Mike Splinter - President & CEO

  • Thanks, Jay.

  • I am going to have to say this in a way, but you'll have to ask our tandem junction customers specifically about their progress.

  • But we feel our technology is online and we're quite excited about the progress we've made there this quarter.

  • I would say definitely on track to your definition.

  • On the patent, we're really as I said quite happy with the progress we've made on tandem junction.

  • I think this provisional -- and it is a provisional opinion from the European patent office -- confirms our view that the Neuchatel patent is not valid.

  • And in addition, of course, as we stated publicly, we believe our unique and proprietary structure does not infringe that patent in the first place.

  • Jay Deahna - Analyst

  • Thank you.

  • Operator

  • Your next question comes from the line of Krish Shankar with Banc of America Securities.

  • Mr.

  • Shankar, your line is open.

  • Mike Splinter - President & CEO

  • Krish, can you hear us?

  • Krish Shankar - Analyst

  • Hello.

  • Mike Splinter - President & CEO

  • Now we can hear you.

  • Krish Shankar - Analyst

  • Hi.

  • George, a couple of questions.

  • One, I wanted to follow-up.

  • Did I miss something when you said what are EES operating margin excluding the one time charges for acquisition?

  • And are you still -- besides that are you still focused that the overall photo business will be breakeven in '09 or any upside to that?

  • George Davis - CFO

  • On your first question, Krishna, the M&A charges are running about $30 million a quarter in EES.

  • So you can adjust that for the ongoing.

  • And then in terms of breakeven, we're still saying that we believe it will be breakeven in 2009, and I don't really want to update our guidance on that any further at this point.

  • But we feel very good about what we can do to improve profitability there over time.

  • We really expect the bulk of the learning curve that we're going to experience is going to be over during really through the first half of '09, we'll have seen virtually everything you can see in starting up one of these factories.

  • All right.

  • Next question.

  • Operator

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

  • Stephen Chin - Analyst

  • Thank you.

  • Mike, I was wondering if you could elaborate more.

  • I think you said on the silicon order guidance, you expected silicon orders to grow about 30% sequentially.

  • What's giving you that confidence level?

  • Is that mostly a few customer projects, product market share gains or what else can you share there?

  • And how sustainable do you think that -- it looks like it will be about $1 billion a quarter?

  • How sustainable do you think silicon bookings could be past this October quarter?

  • Thanks.

  • Mike Splinter - President & CEO

  • Thanks, Stephen.

  • What I said was that silicon orders would be up in the quarter greater than 30%.

  • It pretty much is really focused on just a few customers increasing at this point, particularly in flash and DRAM still in this area -- a little bit of foundry, we expect to see some foundry order increase.

  • I think the big question is how sustainable is that into Q1, and I think you know how cautious I am about this at this point.

  • And I think it is just too early to forecast what Q1 is going to be like.

  • But because I primarily think that depends on what the consumers are going to do in the second half of the year, and I really can't predict that at this point.

  • If I thought the current trends would continue and inventories would continue down, I would be a lot more bullish than I currently am.

  • Stephen Chin - Analyst

  • Great.

  • Thanks, Mike.

  • Robert Friess - VP, Treasurer & Interim Head of IR

  • Next question.

  • Operator

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

  • Gary Hsueh - Analyst

  • Just continuing the theme on your SSG order guidance for up above 30% quarter on quarter, Mike, from a bottoms up perspective, exactly how much is that driven by your market share gains and how much is that just an industry phenomena happening here in calendar Q4?

  • Mike Splinter - President & CEO

  • I think most of it is industry, Gary.

  • I think that these are projects -- but again it depends on spending pattern of certain customers, so these are customers that we have very strong share with.

  • So it gives us a little bit of accelerated benefit than maybe we'd normally have if it was other customers.

  • Gary Hsueh - Analyst

  • Okay.

  • You were just somewhat hesitant about the trajectory, but you're walking a fine line here in terms of calling an inflection point off of a very low low in the July quarter, and moving up in the October quarter.

  • It doesn't sound like you're willing to put a stamp on your view for the January quarter.

  • But what specifically or quantitatively is your view for capital spending in '09?

  • You talked about capital intensity basically shifting back up over the next one or two years.

  • Is it fair to say you expect capital spending in absolute terms up year-over-year in '09?

  • Mike Splinter - President & CEO

  • Yes, I think it is fair to say I expect capital spending to be up year-over-year in '09.

  • As you know, last time I said that I really felt our Q3 was the bottom of the trough, and that we would see a modest recovery.

  • I am sticking to that at this time.

  • I think all of those things are coming to be fact.

  • But my big question still is the first part -- if we're talking about calendar 2009 right now, my big question about 2009 is the first four months.

  • What happens after the end of the year selling season, how well inventories are brought down and controlled?

  • And I think if you look at overall utilization in the industry, it is very high still and increasing.

  • So there is not a lot of capacity out there, and if overall economies gets better, I think the second half of 2009 will be good.

  • All that far is very qualitative.

  • I just think too early for us to give any kind of quantitative estimate at this point.

  • Gary Hsueh - Analyst

  • Last question here for George.

  • George, if you look at the EES numbers, the revenue number's somewhere around $200 million in the October quarter and roughly $500 million in terms of orders.

  • There is a pretty big gap between orders and revenue.

  • How should we model basically revenue trailing behind orders for EES?

  • And you mentioned in the second half better profitability.

  • Is that sheerly by an increase or big increase in revenue?

  • Or do you expect to start to tail off the amount of OpEx increase in EES in the second half of '09?

  • What's really driving that profitability?

  • Revenue?

  • OpEx growth slowing or combo of both?

  • George Davis - CFO

  • Let me deal with the orders question really from a backlog perspective, because the backlog performs differently in the solar business than it does in the traditional semiconductor equipment business.

  • So whereas the orders are coming on, we'll see them much more spread out over the year than the front loaded order conversion to revenue that you're used to seeing in the semiconductor space.

  • I think that is probably the biggest difference there.

  • In terms of improving profitability, I think we'll come at it from two angles.

  • I think there is a lot of spending that's really bundled up in impacting gross margin that -- on these early projects where we're working to integrate all of these tools coming together for the first time in the factory, and making the adjustments that are necessary to get the production worthiness of these factories to where we both would like them to be.

  • So that's one track and we're making a lot of progress on that front, going through a lot of learning, but we're very pleased with the progress there.

  • And the other piece of course is the OpEx not only to support the start up of these factories, but the initial installations on these things.

  • So there is a lot going on that will -- that I think will become far more efficient over time in subsequent factories.

  • And so depending on the growth OpEx may actually increase over time, but the effectiveness and efficiency and the flowthrough to operating margin will be substantially better.

  • Gary Hsueh - Analyst

  • Thank you.

  • Operator

  • Your next question comes from the line of Jim Covello with Goldman Sachs.

  • Jim Covello - Analyst

  • Good afternoon, guys.

  • Thanks so much for taking the question.

  • Question on the flat panel display segment.

  • If I heard you right, I think you said real significant decline in orders, 75%, but increase in shipments.

  • I just wonder -- isn't that a little inconsistent?

  • If customers are cutting orders because of excess capacity why do they need to take more shipments?

  • And therefore is there any risk to the shipment guidance or shipment pushouts for flat panel display over the next couple of quarters?

  • George Davis - CFO

  • Thanks, Jim.

  • Our view is yes, orders are going to be down substantially, and we didn't say that revenue was going to be up quarter over quarter, but flat plus or minus.

  • It is not -- the big contributor we said on the upside for the quarter for revenue would be EES, and that AGS and display and silicon all are flat plus or minus around the mean.

  • So what you tend to see with the big order pullbacks in display is that the backlog holds up very well.

  • You can see some stretching in the pattern of the revenue over time, but we don't see any reason to think that we won't have a similar pattern in this go round.

  • We're expecting strong revenue, but we're not forecasting growth.

  • Mike Splinter - President & CEO

  • Jim, I'd just add into that, this is Mike, that these factories do take a long time to start up.

  • And also those customers do make down payments on their machines.

  • So they're quite motivated to take those machines, work the bugs out of the factory, make sure it is running so that they can ramp up the factories as demand shows.

  • Jim Covello - Analyst

  • Thank you.

  • Operator

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

  • Wes Twigg - Analyst

  • Going back to SunFab for a minute, one of your customers -- Signet Solar -- commented that the majority of its customers want half or quarter size solar modules rather than the full size gen 8 modules.

  • It seems like that takes away the AMAT value proposition, which is to lower the total balance of systems costs by reducing the number of panels installed.

  • I was just wondering if maybe you can give us your view on how long it might take to change the customer mindset to the idea of using the larger gen 8 panel and how much success you're having there?

  • Mike Splinter - President & CEO

  • If you had the opportunity -- hi, Wes.

  • If you had the opportunity to attend Intersolar, you may have seen our installation video.

  • So people have to get used to installing the bigger panels.

  • This will take a little bit of time.

  • We're working with those installers now so they understand the handling and how to do this, but there is no real technology here.

  • So as time has passed, we're seeing pretty dramatic increased interest in handling the full size panels.

  • I think that will be a trend that we'll see over the next year or so.

  • But we also have thought about this from the very start to offer the flexibility to cut panels in one quarter and one half size, but I think what we'll see is mostly one quarter and then full size panels as the handling techniques get more familiar to all the installers.

  • Wes Twigg - Analyst

  • Great.

  • Just wondering if I can ask one more on the [PWS] and Baccini side.

  • I believe last quarter you mentioned that orders were tracking about $200 million.

  • Is that consistent with this quarter?

  • And then also just wondering how the manufacturing capacity expansion is progressing in terms of total capacity for those two projects?

  • George Davis - CFO

  • The capacity expansion is progressing very well, and the rates in Q3 were similar to that level that the $200 million level we talked about in terms of shipments.

  • We expected actually to be up fairly substantially in Q4 on a shipment basis because of the -- primarily driven by increase -- actually pretty much driven by increases in both locations.

  • So that's really a reflection of the capacity additions and also just the timing of some shipments.

  • Wes Twigg - Analyst

  • Okay.

  • Thanks.

  • George Davis - CFO

  • Sure.

  • Operator

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

  • Tim Arcuri - Analyst

  • Hi, guys, a couple things.

  • First of all, George, now that you're pretty far into your solar business, can you give us some sort of an update in terms of what the breakeven will be in the business?

  • I think you talked about crossing over to profitability previously sometime in the first half of '09.

  • It sounds like that might be more like maybe mid-year to back half of '09 now.

  • And I am wondering can you give us some kind of idea as to what the breakeven revenue level is, number one?

  • And, number two, I wanted to know when you think you're going to recognize the revenue on tandem junction?

  • George Davis - CFO

  • Well, number one, on the solar profitability as we said, Baccini and PWS want to take out the M&A charges -- they are pretty much breakeven now on an ongoing or better, and we see that improving over time immediately.

  • It is really the timing of when thin film makes the turn, and that will be a function of a couple things -- one, timing of revenue recognition, and again how rapidly we're able to basically proliferate the learning curves.

  • Since we're right in the middle of that, I am not ready to forecast that right now.

  • I think the overall picture is as we said, and we still think the 2010 profitability outlook that we've discussed of 25% to 35% operating margins in this business overall is still very viable.

  • So we'll continue to update and inform as we go along, and we're going to get every quarter we're just going to be that much further along on the learning curve.

  • Also, within EES we have the glass and web businesses which are already profitable, albeit at lower margins than some of our established equipment businesses.

  • And then we have some R&D activities on new generation opportunities that we're looking at that also impact the overall operating performance.

  • Tim Arcuri - Analyst

  • George, can you answer the question about tandem junction?

  • When do you think (multiple speakers)?

  • George Davis - CFO

  • Sure.

  • We're not going to forecast that.

  • I haven't changed on that one, Tim.

  • Thanks, though.

  • Operator

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

  • Patrick Ho - Analyst

  • Two questions.

  • First, George, on the acquisition related charges of $41 million, where are they on the line items?

  • And secondly for I guess either you or Mike, in terms of the silicon orders for the fourth quarter, what type of linearity are you seeing?

  • Are you seeing some of these orders come in the month of October and is that what's giving you confidence versus some of your equipment peers?

  • Thanks.

  • George Davis - CFO

  • On M&A you've got of the $41 million, about $35 million of it is in cost of sales, and the balance is in OpEx.

  • And in terms of within the segments, the majority of it as I said is in the EES segment.

  • Mike Splinter - President & CEO

  • Hey, Patrick.

  • I think that the orders are pretty lumpy because there are a few big orders, but I would not say that they're all in the last month of our quarter, not at all.

  • Patrick Ho - Analyst

  • Great.

  • Thank you.

  • Operator

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

  • Satya Kumar - Analyst

  • Hi.

  • Question on margins.

  • I guess if I look into the October quarter, your guiding revenues up despite the 30% growth in silicon, which is high margin, it sounds like flat panel is flat.

  • What's the mix factor driving EPS slightly lower at the mid-point?

  • George Davis - CFO

  • Yes, I think the biggest impact is that most of the revenue increase as we said is coming out of EES, and so you have less flowthrough to profitability at this time.

  • So the way I would describe Q4 is we're still in the investment phase for solar.

  • We expect silicon to stay at low levels similar to where we were in Q3, so we're keeping strong cost controls in place and quite frankly our established businesses are all performing very well given their respective cycles.

  • So that's I think really to see the upside which we expect to be quite considerable, in EPS we're going to have to see SSG recover and then the flowthrough of the profitability in solar.

  • Satya Kumar - Analyst

  • And final question on orders.

  • You're guiding up 5% to 10%, and you talked about silicon and display and I think fab solutions is somewhere in between the last couple of quarters for orders, I get about $100 million increase for the [adjacent] groups?

  • Is that about right?

  • And could you give a little bit more granularity in terms of what the contribution might be from the SunFab portion and the non-SunFab portion for bookings in October?

  • George Davis - CFO

  • I am not going to give you that detail of breakout, but let me characterize overall what we see the moving pieces are for the coming quarter.

  • We said we think it will be up 5% to 10%, AGS is flattish generally around this quarter, display we said is going to be down 75% or so.

  • So really all of the orders uptick is coming from silicon and EES.

  • Mike said silicon is going to be greater than 30% up on orders, so then the rest really is coming out of EES.

  • We have talked about Baccini and PWS contributing the majority of the orders, and we see that continuing.

  • Satya Kumar - Analyst

  • Thanks.

  • Operator

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

  • Jesse Pichel - Analyst

  • Good afternoon.

  • Thank you for taking my call.

  • Mr.

  • Splinter, you mentioned 120 micron wafers in your prepared remarks.

  • Does that represent a new wire saw or is that simply qualifying a new process on existing equipment?

  • And to that end, is AMAT developing new device structures for crystalline solar cells?

  • Mike Splinter - President & CEO

  • Okay.

  • So first of all let's hit on the 120 micron.

  • We are developing new products for 120 micron capability and are working with customers on those today.

  • Our machines are now capable across the board through all of our products from saws to deposition to metallization to testing, et cetera.

  • So I think that explains where we are there.

  • And part of our strength is to be able to keep the technology rolling and keep it moving fast, and that's the ideas we want to bring to not these acquisitions so that we really stay ahead in this field.

  • And then on developing device structures, we're certainly interested in supporting customers in that area, but at this point that's what we're doing -- we're working with various customers on improving different cell structures, but aren't doing independent work in that area at this point.

  • Jesse Pichel - Analyst

  • Do you anticipate new AMAT offerings for the crystalline solar cell equipment near term?

  • Mike Splinter - President & CEO

  • Sure, yes.

  • Jesse Pichel - Analyst

  • Thank you very much.

  • Mike Splinter - President & CEO

  • Thank you.

  • Operator

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

  • Mehdi Hosseini - Analyst

  • Thanks for taking my question.

  • Going back to the Sunfilm, I want to get an update on the certification process.

  • Back in the Semicon West, I think Mark was talking about certification starting towards October timeframe, and could you give us an update?

  • And would it be fair to assume that as these lines are certified at the customer side, we would see an acceleration in those efforts and would that help with a faster than expected revenue recognition?

  • George Davis - CFO

  • Well, okay, first of all certification is on track, no change from what Mark talked about a few weeks ago; both tandem junction and single junction are in the certification loop.

  • And I think before the end of the year on single junction shortly after the end of the year on tandem junction after -- once we have those certifications done, then customers just have to demonstrate that their panels are equivalent to that certification, so that takes substantially less time.

  • But right now I think customers are having no problem getting contracts for buying their panels.

  • Demand is significantly higher than supply at the current time.

  • That might change next year or the year after, but right now customers are able to find people to take their -- to sign off, take agreements that are completely selling out their factories.

  • Mehdi Hosseini - Analyst

  • My follow-up question is is there any relationship between certification and revenue recognition and then of all your thin-film customers, how many have come back with a significant second set of orders?

  • George Davis - CFO

  • I will let Mike -- let me first address the revenue recognition question, and then Mike will come back on the customer profile.

  • So in terms of revenue recognition, each of our contracts is slightly different for what constitutes customer acceptance.

  • Some of the contracts have some form of certification anticipated as part of the signoff, and some do not, so it varies by customer.

  • So it is one factor.

  • I wouldn't say it is necessarily a gating or deciding factor for our contracts.

  • Mike Splinter - President & CEO

  • We've had two customers come back for follow-on orders at the current time.

  • Mehdi Hosseini - Analyst

  • Thank you.

  • Robert Friess - VP, Treasurer & Interim Head of IR

  • Next question.

  • Operator

  • I apologize.

  • Your next question comes from C.J.

  • Muse of Lehman Brothers.

  • C.J. Muse - Analyst

  • Good afternoon.

  • Thank you for taking my question.

  • When you look out over the next four quarters for EES, what do you think the mix will look like between crystalline silicon and thin film?

  • George Davis - CFO

  • Certainly thin film is going to start to close the gap, and again for the next few quarters for sure, the crystalline silicon will be well ahead of the thin film.

  • C.J. Muse - Analyst

  • Okay.

  • When do you think that will surpass that level?

  • George Davis - CFO

  • Sometime in 2009, but it is not -- I don't have a point in time estimate for you.

  • C.J. Muse - Analyst

  • Okay.

  • And then I guess on the operating margin side for the service business, it looks like it is tracking a little bit lower.

  • Can you help I guess help me understand what's going on there?

  • Is that display in solar entering the mix at lower margins, or is it something else at work there?

  • George Davis - CFO

  • No.

  • As I said in my prepared remarks, there was some settlement activities and other items.

  • If you look at the ongoing operating margin for them, it is right in line with history.

  • So that was more of a one-time item, so it will be -- they came in at 26% on an ongoing basis.

  • C.J. Muse - Analyst

  • Okay.

  • Thank you.

  • Mike Splinter - President & CEO

  • You bet.

  • Operator

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

  • Atif Malik - Analyst

  • My questions, George, nice job on the gross margins for SSG business.

  • The gross margins appear better than your peers like [Lambry] and Novellus.

  • Where do you think you can take these gross margins once the revenues come back?

  • George Davis - CFO

  • It is interesting.

  • What we tried to do is increase the variability and improve the cycle time over time and it is really -- I just applaud you're seeing over time a lot of the great work our team in Austin has done reducing their cycle times.

  • And we're much more variable in that sense.

  • So we do expect it to -- we do expect to have some leverage obviously as revenue comes up, but what you're really seeing is we have tremendous ability to ride down a difficult environment and still preserve very attractive profitability overall.

  • It is one of the reasons why we're able to continue to fund R&D at a high level and still basically preserve our overall business model as a company.

  • Atif Malik - Analyst

  • Got it.

  • One follow-up for Mike.

  • Mike, you spoke about credit tightening in the markets, and I can see memory makers getting impacted from it, but can you talk about credit tightening with your solar customers?

  • Are you seeing any signs there or are you baking in any worst case scenarios in your models?

  • Mike Splinter - President & CEO

  • We haven't seen anybody that can't get money at this point, but I would say the hurdles to get it have gone up dramatically.

  • The amount of information, the detail at which the lending or financing institutions are looking at the various projects are much more severe than they were six months ago.

  • But I think fundamentally they still believe it is a great place to invest and there is money to be made.

  • Atif Malik - Analyst

  • Thank you.

  • Robert Friess - VP, Treasurer & Interim Head of IR

  • We'll take one more question and then move to final remarks.

  • Operator

  • Your final question will come from Edwin Mok of Needham & Company.

  • Edwin Mok - Analyst

  • I didn't mean to squeeze in.

  • A question on the solar side.

  • You mentioned you have eight lines that is in startup right now, but do I assume, of what you reported in loss for your quarter, you have only booked six line.

  • How do I reconcile the difference there, and does it mean you can book these lines or what happened there?

  • George Davis - CFO

  • What we said is when we believe when we're within one year of sign off that we'll go ahead and book the order.

  • And so we've gone ahead and that's been the basis and will continue to be the basis at this time.

  • Edwin Mok - Analyst

  • I see.

  • Great.

  • And then my follow-up is on display side.

  • You mentioned that it appears that the current GEN 8 cycle investment is largely over.

  • How do we visualize this cycle?

  • Do we expect a down cycle or very low booking level for the next few quarters?

  • And if you look at last cycle, it looks like you lost like four or five quarters.

  • Should I look at it that way or how do you visualize that?

  • Mike Splinter - President & CEO

  • Yes.

  • I think you should largely visualize it in that way.

  • I don't know about five quarters, but we think that in the second half of next year we're going to start to see increased orders for the GEN 10 build out.

  • And along the way here of course some of the smaller suppliers will invest in increased capacity in GEN 8.5 -- but I think this is kind of the trend in the display business, very big cycles of ordering, pretty smooth acceptance of equipment, and startup of those factories.

  • Meanwhile a big dropoff until the next generation is ready.

  • I would say that one of the things that in talking with customers is that they are all very clear about moving to GEN 10.

  • So there's I don't think any question in our mind now about the viability of a GEN 10 or a GEN 12 for that matter in the display business.

  • So the cycle continues here, everybody believes this will continue to drive costs out.

  • And the market, the TV market continues to move to bigger and bigger LCD panels.

  • And I just think it is a matter of time until LCD is basically 100% of the TV market.

  • Edwin Mok - Analyst

  • Great.

  • Thanks.

  • Robert Friess - VP, Treasurer & Interim Head of IR

  • We would like to thank you for joining us in our discussion of Applied Materials' financial results.

  • We would like to remind you that a replay of this call and the supporting slide package will be available on our website starting at 5 PM today and will remain posted until August 26th.

  • Thank you again for your interest in Applied Materials.

  • Operator

  • That concludes this evening's teleconference.

  • You may now disconnect.