Applied Materials Grows But Misses

Applied Materials’ (AMAT) third quarter earnings missed the Zacks Consensus by 8 cents. This was in spite of the revenue beat of 6.1% and mainly on account of a higher-contribution from the loss-making EES unit (even excluding the one-time inventory adjustments, EES segment margins declined 309 bps).

Analysts are generally more positive about Applied Materials after the company announced its decision to close down Sunfab. This is evident from the fact that more than a third of the analysts providing estimates for the July quarter raised their expectations over the last 30 days and around half of the analysts have nudged up estimates for the following quarter. Moreover, expectations for 2010 and 2011 have also improved. The net change in estimates was minimal however.

Revenue

Revenue of $2.52 billion was up 9.7% sequentially and 122.1% year over year. The year-over-year increase was reflective of the turnaround in the capital equipment market and supports Gartner’s expectations for triple-digit growth for the segment in 2010.

Revenue by Segment

Silicon Systems (“SSG”) remains the largest segment, with a 57% revenue share. Segment revenues increased 3.1% sequentially and 190.6% year over year. Applied Material’s advanced technologies enabled it to gain market share exiting the recession. Management mentioned that foundries were performing significantly better than previously expected, resulting in a solid backlog. Additionally, DRAM prices were stable, with bid demand and supply rates increasing 50% to 60%. Although NAND prices slipped 5% in the quarter, they have grown 70% to 80% over the past year. The solid pricing environment in the memory market has encouraged them to continue investment for capacity addition/expansion. Applied’s etching and CMP products continue to gain share, with a few key wins in the last quarter. Its inspection products are seeing a record demand (although some orders were pushed out into the followig quarter). Additionally, Semitool, through which the company holds a leadership position in the advanced packaging segment, also had a solid quarter, with record orders and key customer wins.

The second largest segment was Applied Global Services (“AGS”), which generated 19% of total revenue. Segment revenues increased 2.6% sequentially and 36.4% year over year. Management stated that growth was reflective of overall increase in wafer fab utilization rates. As expected, the used equipment market was strong , with the segment seeing orders for 200mm used equipment picking up.

The Energy and Environmental Systems (“EES”) segment made a 15% contribution to quarterly revenues, posting sequential and year-over-year increases of 133.1% and 72.8%, respectively. The company is now focused on the crystalline silicon business, which is showing signs of a strong demand, especially in Germany. Panel makers are sold out for the rest of the year and already booking for 2011. Management stated that although this strength in Germany could taper off next year, a considerably strong demand from other European countries, as well as Japan, China and parts of the U.S. would double revenues in 2010. Sales for the Baccini platform were at record levels (Baccini is expected to drive 60% of the capacity additions in 2010).

Growth rates in the Display segment dropped off after the solid second quarter. As a result, display sales fell 20.0% sequentially, but grew 213.0% from the year-ago quarter to 9% of total revenue. Management stated that although TV units increased overall, the segment was impacted by inventory buildup, especially in China, which had a seasonally soft quarter. The company’s CVD and PVD tools are picking up orders in China and touchscreens for tablets and smartphones are opening up new opportunities. With industry-wide utilization rates at over 90%, equipment spending should be robust (projected by management to grow 75-80% over 2009 levels, up from previous expectations of around 70% growth). Capacity additions by existing customers in Korea, Taiwan and Japan, as well as prospective customers building fabs in China are expected to boost results going forward.

Revenue by Geography

Around 77% of quarterly revenues came from the Asia/Pacific region, with the largest contribution from Taiwan, which generated 28% of revenues, while growing just 1.1% on a sequential basis. China was the second largest, with a 19% share, growing 102.2% sequentially. Korea and SE Asia followed, with 16% and 6% contributions, respectively. However, while SE Asia grew 54.3%, Korea declined 37.0%. Both North America and Europe grew in the last quarter, although the 72.7% increase in Europe was much more significant than the 27.8% growth in North America. North America and Europe generated 12% and 11% of revenues, respectively, in the last quarter.

Orders

Total orders were up 7.6% sequentially and 154.2% year over year. AGS witnessed the strongest sequential growth, followed by SSG. The Display and EES segments declined. However, all except AGS (which increased 99.7%) witnessed triple-digit increases from the year-ago quarter.

Order strength was the most in Europe (up 52.5%) and then in Japan (up 47.5%). North America and Taiwan also grew. Chinese orders declined the most (down 24.7%), followed by Korea and SE Asia (likely because of the softness in Display).

The book-to-bill was positive across all product lines except EES.

Margins

Gross margin for the quarter (excluding inventory adjustments) was 35.0%, down 670 basis points (bps) from the previous quarter’s 41.7%. The gross margin improvement was primarily due to unfavorable mix changes. The gross margin was up 436 bps from the year-ago quarter.

The operating expenses of $542.1 million were up 1.9% from the previous quarter’s $532.1 million, with the operating margin shrinking 505 bps sequentially, although expanding 1,829 bps year over year. The sequential decline was due to the lower gross margin that was partially offset by lower R&D and helped by slightly higher SG&A (as a percenatge of sales). S&M, as a percentage of sales, was down sequentially. Higher volumes drove down all expenses (as a percentage of sales) from the year-ago quarter.

The operating margin declined sequentially in all except the SSG segment, which saw the operating margin increase 81 bps.

Net Profit

On a pro forma basis, Applied Materials had a net income of $233.6 million, or a 9.3% net income margin compared with $292.2 million, or 12.7% in the previous quarter and a loss of $44.9 million or 4.0% in the third quarter of last year.

Fully diluted pro forma earnings per share (EPS) were 17 cents compared with earnings of 22 cents in the previous quarter and loss of 3 cents in the comparable prior-year quarter. Our pro forma estimate excludes restructuring charges, acquisition-related charges and impairment of investments on a tax-adjusted basis, as well as other one-time tax adjustments in the last quarter. Our pro forma estimate may not match management’s presentation due to the addition/exclusion of some items not considered by management.

On a fully diluted GAAP basis, the company recorded a net income of $123.1 million ($0.09 per share) compared with $264.0 million ($0.20 per share) in the previous quarter and a net loss of $54.9 million ($0.04 per share) in the prior-year quarter.

Balance Sheet

Inventories were down 5.9% sequentially, with inventory turns increasing from 3.2X to 4.1X. Days sales outstanding (DSOs) were up from 57 to 62. The cash and short term investments balance was $2.35 billion at quarter-end, up $13.3 million during the quarter.

The company generated $298.9 million of cash from operations, spent $36.2 million on capex, $99.9 million on share repurchases and $94.0 million on dividends. At quarter-end, Applied Materials had $204.4 million of debt on its balance sheet, with a net cash position (excluding short and long term debt) of $2.14 billion. The debt cap ratio including long term liabilities and short term debt was 7.1%. The debt position has not changed much over the past year.

Guidance

Management provided guidance for the fourth quarter. With SSG to be flat sequentially, AGS to increase more than 10%, Display to increase 20% and EES to decline 10-20%, total revenue is expected to increase 0-5% sequentially. The non-GAAP EPS is expected to come in at 28-32 cents a share.

Total revenue for the year is expected to be $9.2-9.3 billion, up more than 80% from 2009 levels. Management expects non GAAP earnings of 80-84 cents for the year.

The Zacks rank for the stock is #3, signifying a short-term Hold recommendation. Despite solid growth prospects, we believe investors are likely to discount the shares based on near-term uncertainties in the solar business. We also do not see any catalysts that could drive the shares higher in the next 1-3 months.

Under the circumstances, we continue to believe that other equipment providers, such as ASML Holding (ASML) – Zacks rank #1, Varian Semiconductor (VSEA) – Zacks rank #1, KLA Tencor Corp. (KLAC) – Zacks rank #2 and Novellus Systems (NVLS) – Zacks rank #2 represent better plays in the semi equipment market.

APPLD MATLS INC (AMAT): Free Stock Analysis Report

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