Applied Materials’ (AMAT) second quarter pro forma earnings beat the Zacks Consensus Estimate by 3 cents or 12.5%. Revenues were partly responsible, beating consensus expectations by 5.9%.
Applied reported revenue of $2.54 billion, which was up 16.1% sequentially and down 11.2% year over year. The silicon business did better than expected, driving most of the upside. The Display business also rebounded, with revenues coming in much higher than management’s expectations.
Applied stated that its etching and implantation product lines posted record revenue, but deposition was probably the most encouraging, generating the strongest quarterly revenue in over a decade.
Revenue by Segment
Because of the solid growth in the last quarter, the SSG business jumped from 61% to 70% of Applied’s total revenue. Segment revenue was up 32.2% sequentially and 22.3% year over year. Management had expected segment revenue to be up 15-25% sequentially, so revenue was well above expectations.
Foundry strength continued for the second straight quarter, accounting for most of Applied’s SSG strength. Foundry manufacturers are ramping production strongly because of the strong demand for mobile devices. Applied currently expects mobile phone unit sales of 660-710 million this year, with tablets growing 60%.
We think that foundry investment is likely to be front-end loaded, with equipment demand dropping off in the second half of the calendar year. 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.
Intel’s (INTC) ultrabook and Microsoft’s (MSFT) Windows 8 are other positives that will further drive demand for all the three segments toward the end of the year.
The second largest segment was AGS, which generated 22% of total revenue. Segment revenue was up 3.2% sequentially and down 10.3% year over year, short of Applied’s expectations of a 5-10% sequential increase.
Despite higher utilization rates and increasing wafer starts across the industry, Applied continues to expect spending on wafer fab equipment (“WFE”) to decline 0-10% this year, better than Gartner’s expectations of a 22.9% decline. The weakness this year is not surprising, given that 2011 was a very big year for WFE.
The Display segment also did well, with the sequential growth of 28.8% much better than management’s expectations of a 0-25% decline. While there was a decline of 15.2% from the year-ago quarter, the sequential growth is reflective of growing demand for high-resolution mobile displays for tablets and touch panels for ultrabooks.
TV demand remains depressed, however, and we currently do not expect much improvement until the end of the year. Additionally, 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.
The EES segment dropped to 3% of total quarterly revenue, from 9% in the previous quarter. Segment revenue was down 61.8% sequentially and 87.6% year over year (guidance was a sequential decline of more than 40%). 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. Some positive trends include the improving module efficeincies and lower manufacturing costs, which would make solar offerings more affordable.
Applied is now focused on the crystalline silicon business, which is proving beneficial for the company. Applied did not update its expectations with respect to the market, so we assume that they remain the same. Accordingly, panel demand is expected to increase 4-30% in 2012 and installations to touch 28-35 gigawatts.
Increasing competition is driving down module prices, which is pushing 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.
Revenue by Geography
Around 73% of Applied’s quarterly revenue came from the Asia/Pacific region, with the largest contribution from Korea, which generated 30% and followed by Taiwan and Japan, which generated 26% and 7%, respectively. While China dropped 12.8% sequentially to 6%, Korea and Taiwan continued to grow very strongly at 19.4% and 33.7%, respectively. North America and Europe were up 24.2% and 27.9%, respectively to 20% and 9% of revenue, respectively.
Total orders were up 37.7% sequentially, while declining 13.2% year over year. The SSG and AGS segments were up 14.8% and 7.8%, respectively, while the other segments declined on a year-over-year basis. All segments saw sequential growth in orders. The strong BTB in SSG (1.11) and AGS (1.18), offset negative BTBs in Display (0.63) and EES (0.78). As may be expected, backlog increased.
The increase in orders was broad-based across all geographies except Japan. The strongest growth was in Taiwan (up 120.7%), followed by North America (up 44.1%) and China and South East Asia (up 40.9%).
Applied generated a gross margin of 42.1%, up 145 basis points (bps) from the previous quarter’s 40.7%, mainly on account of the richer mix of SSG. The gross margin was up 57 bps from the year-ago quarter.
Applied’s operating expenses of $581 million were up 6.4% from the December 2011 quarter, with the operating margin of 19.2% expanding 353 bps sequentially and declining 469 bps year over year. All expenses were down sequentially as a percentage of sales, although they were up from last year. Specifically, R&D declined 125 bps sequentially and increased 267 bps year over year, while G&A declined 82 bps sequentially and increased 632 bps year over year.
On a pro forma basis, Applied Materials had a net income of $348 million, or a 13.7% net income margin compared to $240 million, or 11.0% in the previous quarter and $493 million, or 17.2% in the second quarter of fiscal 2011.
The fully diluted pro forma earnings were 27 cents a share compared to earnings of 18 cents in the previous quarter and 37 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 $289 million ($0.22 per share) compared to $117 million ($0.09 per share) in the previous quarter and $489 million ($0.37 per share) in the prior-year quarter.
Inventories were down 10.0% sequentially, with inventory turns increasing from 2.9X to 3.7X. Days sales outstanding (DSOs) went from 66 to 64. The cash and short term investments balance was $2.18 billion at quarter-end, having grown $173 million during the quarter. Goodwill was 28.4% of total assets in the last quarter.
The company generated $603 million of cash from operations, spent $39 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 $223 million. The debt-cap ratio including long term liabilities and short-term debt was just 22.4%.
Applied provided guidance for the third quarter. It currently expects SSG to be down 5-10% sequentially and AGS to be up 0-10%. It also provided a very broad guidance range of flat to +/-20% (albeit off a much smaller base) for the Display and EES segments, netting a total revenue decline of 0-10% sequentially.
The non-GAAP EPS (excluding 4 cents of acquisition-related charges) is expected to come in at 21-29 cents a share. The Zacks Consensus Estimate for the July quarter was 26 cents when the company provided guidance, above themid-point of the guided range.
The SSG and AGS segments are expected to benefit from the Varian acquisition in fiscal 2012, despite uncertainties in the core business. The LCD and touch panel equipment market is expected to remain extremely weak, pulling down Display sales by 10-20%. The EES business is expected to decline at least 50%.
Applied also stated that net sales for the year would come in at the high end of the previously-guided revenue range of $9.1-$9.5 billion and non-GAAP EPS of 85 to 95 cents.
The Zacks Rank for Applied Materials shares is #3, signifying a short-term Hold recommendation. Given that the last quarter’s results and forward guidance were not too different from expectations, we think that estimate revisions will be limited and more in the nature of fine-tuning than correction.
The positive news for SSG and AGS is related to builds that are mostly done (although Varian will result in positive comps this year). For Display, we are looking at improvement in 2012-end and 2013, as limited by the macro situation and consumer confidence. EES, too, will be sluggish this year.
We therefore continue to believe that Applied shares are unlikely to see much appreciation this year and reiterate our Neutral recommendation for the long term (3-6 months).
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