Applied Materials’ (AMAT) fourth quarter pro forma earnings were in line with the Zacks Consensus Estimate. Revenues were slightly more positive, beating consensus expectations by 1.5%.
Revenue
Applied reported revenue of $2.18 billion, which was down 21.7% sequentially, 24.4% year over year and within the guided range of a 15-30% sequential decline.
Only the SSG segment performed in line with expectations in the last quarter. AGS exceeded expectations, while the other two segments fell short.
Revenue by Segment
SSG remains Applied’s largest segment, with a 49% revenue share. Segment revenue was down 23.7% sequentially and 28.1% year over year. Management had expected segment revenue to be down 20-30% sequentially, so revenue was within expectations.
Management stated that given the strength in tablets and smartphones, NAND manufacturers could be encouraged to spend on capex through the rest of the year. DRAM on the other hand is not capacity constrained, so spending would remain sluggish.
Applied expects foundry spending to pick up next quarter and through the rest of the year, driven by strength in mobile devices that continue to push up utilization rates. Logic remains strong for Applied. Management stated that Applied had a few big wins at important logic and foundry customers.
The second largest segment was AGS, which generated 29% of total revenue. Segment revenue was up 4.3% sequentially and 21.9% year over year, better than Applied’s expectations of a 5-10% sequential decline. The softening in 200mm continued in the last quarter, with some customers also transferring portions of their capacity to 300mm instead.
However, Applied’s penetration in Asia increased significantly, helping revenue. Applied expects that both utlization rates and wafer starts bottomed in the last quarter after three quarters of decline. The December quarter is now expected to be stable.
The EES segment made a 14% contribution to quarterly revenue, representing a sequential decline of 44.0% (guidance was at least a 30% decline) and a year-over-year decline of 48.0%. 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. Solar panel installations are expected to be up 25% this year to the 22-24GB range. Applied currently expects panel demand to increase 10-30% in 2012.
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 much worse than management expectations. Applied’s Display business was down 23.3% and 39.1% from the previous and year-ago quarters. The segment remained at just 8% of revenue in the last quarter. Softness in display is primarily on account of considerable capacity in the LCD TV market, where the 10% expected growth rate for 2011 is not enough to drive capex spending.
Therefore, demand will remain weak until growth returns in both the developed and emerging markets. Capacity adds in other display markets, such as mobile is also weak, since capacity added earliler in the year remains under-utilized.
Revenue by Geography
Around 68% of Applied’s quarterly revenue came from the Asia/Pacific region, with the largest contribution from China, which generated 19% and followed by Korea and Taiwan, which generated 17% and 16%, respectively. However, while China dropped 45.7% sequentially, the declines in Korea and Taiwan were smaller at 16.0% and 22.2%, respectively. Japan was down 10.2% and North America 3.8%. Europe (up 4.6%) was the only region to have grown sequentially.
Orders
Total orders were down 33.3% sequentially and 47.3% year over year. All segments declined both sequentially and year over year. The order declines were most significant in the Display and EES segments. Therefore, while the BTB was negative in all segments, it was most disappointing in the Display (0.12) and EES (0.27) segments.
Other than Korea and North America, which saw high single-digit declines, all other regions were down double digits. The softness was greatest in Japan (down 53.5%) and lowest in Korea (down 8.8%). Korea and Japan were the strongest regions in the preceding quarter, growing 44.5% and 36.5%, respectively.
Margins
Applied generated a gross margin of 39.6%, down 284 basis points (bps) from the previous quarter’s 42.5%, as lower volumes impacted cost absorption in the last qurter. The gross margin was down 299 bps from the year-ago quarter.
Applied’s operating expenses of $481.0 million were down 4.0% from the June quarter, with the operating margin of 17.6% shrinking 691 bps sequentially and 702 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 $271 million, or a 12.4% net income margin compared to $467.0 million, or 16.8% in the previous quarter and $475.8 million, or 16.5% in the fourth quarter of fiscal 2010.
The fully diluted pro forma earnings were 20 cents a share compared to earnings of 35 cents in the previous quarter and 36 cents in the comparable prior-year quarter. Our pro forma estimate excludes restructuring charges, acquisition-related 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 $466.0 million ($0.35 per share) compared to $476.0 million ($0.35 per share) in the previous quarter and $468.0 million ($0.36 per share) in the prior-year quarter.
Balance Sheet
Inventories were down 8.0% sequentially, with inventory turns dropping from 3.5X to 3.1X. Days sales outstanding (DSOs) went from 59 to 64, reflecting poorer collections. The cash and short term investments balance was $6.24 billion at quarter-end, having increased $486 million during the quarter. The recent increase in debt was with the intention of funding the Varian acquisition that closed in the last quarter.
The company generated $698 million of cash from operations, spent $73 million on capex, $175 million on share repurchases and $106 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 $4.30 billion. The debt cap ratio including long term liabilities and short term debt was just 20.5%.
Guidance
Management provided guidance for the first quarter. With SSG (including Varian) to be up 5-20% sequentially, AGS to be down 10-20% (the combined effect of lower 200mm sales, lower utilization rates and the absence of thin film revenue), and Display and EES to be down 40-60%, total revenue is expected to be down 5-15% sequentially.
The non-GAAP EPS is expected to come in at 8-16 cents a share. The Zacks Consensus Estimate for the next quarter was 18 cents when the company provided guidance, above the guided range.
Applied provided limited guidance for 2012 due to the significant uncertainties in the market. While they did not comment on the total revenue expectations, they did explain the conditions across the served markets. Accordingly, the SSG and AGS segments are expected to benefit from the Varian acquisition, although the performance of the core business remains uncertain.
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 #5, signifying a short term Strong Sell recommendation.
The main factor driving share prices right now is the weakness in the display and solar markets. Not only did the two segments perform dismally in the last quarter, but the outlook into 2012 remains extremely weak. Add to this the uncertainties in the semiconductor business, which is however expected to benefit from the Varian acquisition.
The one positive appears to be that the semiconductor business is expected to see the same December quarter order increase as other equipment companies, such as KLA-Tencor (KLAC), Novellus Systems (NVLS) and Teradyne (TER).
Of course, we remain positive about Applied’s strong position in the semiconductor market, the solar business in China, the huge portfolio and strategic relationships, which will however be less effective in the current market scenario.
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