Applied Materials’ (AMAT) first quarter pro forma earnings beat the Zacks Consensus Estimate by 6 cents or 50%. Revenues were partly responsible, beating consensus expectations by 11.1%.
Revenue
Applied reported revenue of $2.19 billion, which was flat sequentially and down 18.5% year over year. Varian’s full-quarter contribution came in at $202 million. All except the AGS business did better than expected.
Revenue by Segment
SSG remains Applied’s largest segment, with a 61% revenue share. Segment revenue was up 26.0% sequentially and down 10.2% year over year. Management had expected segment revenue to be up 5-20% sequentially, so revenue was well above expectations.
Applied saw very strong growth in the foundry segment, where revenue increased 75%. foundry manufacturers are ramping production strongly because of the strong demand for mobile devices. Applied currently expects mobile phones and tablets to grow 35% and 60%, respectively in 2012. We think that the investment is likely to be front-end loaded. NAND manufacturers are benefiting from the growth in mobile phones and tablets, but they are also investing with a view to help the production transition to smaller geometries. DRAM on the other hand is not capacity constrained, so is likely to remain soft through 2012.
The second largest segment was AGS, which generated 24% of total revenue. Segment revenue was down 15.1% sequentially and 5.8% year over year, in line with Applied’s expectations of a 10-20% sequential decline. The softening in 200mm continued in the last quarter and Applied expects this to continue through the first half.
The EES segment made a 9% contribution to quarterly revenue, representing a sequential decline of 34.3% (guidance was a 40-60% decline) and a year-over-year decline of 56.5%. The weakness in the last quarter was expected, since there is significant excess capacity. However, Applied’s market position remains strong due to customers picked up earlier in the year.
Applied is now focused on the crystalline silicon business, which has started to prove beneficial for the company. Applied expects panel demand to increase 4-30% in 2012 and installations to touch 28-35 gigawatts. Increasing competition is driving down module prices, which is driving manufacturers to cost-efficient technologies. These are the secular forces driving demand in all the big solar markets, such as the U.S., Germany, Italy, China and Japan.
Performance in the Display segment was slightly better than Applied’s expectations of a 40-60% sequential decline. The Display business was down 39.2% and 29.3% from the previous and year-ago quarters, respectively. The segment dropped from 8% to just 5% of revenue in the last quarter. The softness in display is on account of the over-capacity in the market that should keep the lid on growth through most of the year. However, customer transition to new technologies, such as metal oxide transistors and low-temperature polysilicon for OLED and high-resolution LCDs is expected to expand the SAM by 30%, which is a positive.
Revenue by Geography
Around 73% of Applied’s quarterly revenue came from the Asia/Pacific region, with the largest contribution from Korea, which generated 29% and followed by Taiwan and Japan, which generated 22% and 10%, respectively. While China dropped 55.9% sequentially to 8%, Korea and Taiwan grew very strongly at 73.0% and 38.5%, respectively. North America and Europe were down 3.9% and 33.9%, respectively to 19% and 8% of revenue.
Orders
Total orders were up 25.9% sequentially and down 32.4% year over year. All segments declined on a year-over-year basis. However SSG and Display orders grew 53.3% and 100.0%, respectively. However, the BTB was negative in all except the SSG segment (1.06). Display and EES were particularly weak at 0.38 and 0.16, respectively. As may be expected, backlog declined doube-digits.
Japan, South East Asia and China drove the decline in orders, with other regions growing. Korea saw a triple-digit increase, followed by the North America and Taiwan, both of which were up double-dgits.
Applied generated a gross margin of 40.7%, up 102 basis points (bps) from the previous quarter’s 39.6%, mainly on account of the richer mix of SSG. The gross margin was down 212 bps from the year-ago quarter.
Applied’s operating expenses of $546 million were up 13.5% from the September quarter, with the operating margin of 15.7% shrinking 188 bps sequentially and 882 bps year over year. All expenses were up as a percentage of sales, compunding the effect of higher cost of sales.
Net Profit
On a pro forma basis, Applied Materials had a net income of $240 million, or a 11.0% net income margin compared to $271 million, or 12.4% in the previous quarter and $484 million, or 18.0% in the first quarter of fiscal 2011.
The fully diluted pro forma earnings were 18 cents a share compared to earnings of 20 cents in the previous quarter and 36 cents in the comparable prior-year quarter. Our pro forma estimate excludes restructuring, acquisition-related and other charges and 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 $117 million ($0.09 per share) compared to $466 million ($0.35 per share) in the previous quarter and $506 million ($0.38 per share) in the prior-year quarter.
Balance Sheet
Inventories were up 4.2% sequentially, with inventory turns dropping from 3.1X to 2.9X. Days sales outstanding (DSOs) went from 64 to 66. The cash and short term investments balance was $2.0 billion at quarter-end, having declined $4.2 billion during the quarter due to the cash paid for the Varian acquisition during the quarter. Goodwill was 28.5% of total assets in the last quarter due to the acquisition.
The company generated $181 million of cash from operations, spent $37 million on capex, $200 million on share repurchases and $104 million on dividends. At quarter-end, Applied had $1.95 billion of debt on its balance sheet, with a net cash position (excluding short and long term debt) of $48 million. The debt cap ratio including long term liabilities and short term debt was just 22.1%.
Guidance
Applied provided guidance for the second quarter. With SSG (including Varian) to be up 15-25% sequentially, AGS to be up 5-10%, Display flat to down 25% and EES to be down more than 40%, total revenue is expected to be up 5-15% sequentially. The non-GAAP EPS is expected to come in at 20-28 cents a share. The Zacks Consensus Estimate for the next quarter was 17 cents when the company provided guidance, below the guided range.
Applied did not update guidance for 2012. Accordingly, we assume that guidance remains the same, with SSG and AGS segments expected to benefit from the Varian acquisition, despite uncertainties in the core business. The LCD and touch panel equipment market is expected to remain extremely weak next year, pulling down Display sales by 10-20%. The EES business is expected to decline at least 50%.
Conclusion
The Zacks Rank for Applied Materials shares is #3, signifying a short term Hold recommendation. Given the positive results and outlook, we expect upward revision to estimates that could improve the rank.
The weakness in the display and solar markets continues to plague the company. Not only did the two segments perform dismally in the last quarter, but the outlook into 2012 remains weak. However, the semiconductor business appears to be improving, both on account of strengthening end markets and the Varian acquisition. The positive trend in semi orders looks similar to other equipment companies, such as KLA-Tencor (KLAC), Novellus Systems (NVLS) and Teradyne (TER).
We are also positive about Applied’s strong position in the semiconductor market, the solar business in China, the huge portfolio and strategic relationships.
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