Applied Materials’ (AMAT) fiscal third-quarter 2014 pro forma earnings per share of 28 cents were above the Zacks Consensus Estimate by a penny driven by higher gross margins.
Revenue
Applied reported revenues of $2.27 billion, down 3.7% sequentially but up 14.7% year over year, and within the guidance range. However, revenues were below the Zacks Consensus Estimate of $2.29 billion.
Revenue by Segment
Silicon segment (SSG) contributed 65% of revenues, down 6.8% sequentially but up 16.0% from the year-ago quarter.
The second-largest segment was Applied Global Services (AGS) with a 25% revenue share. Segment revenues were up 6.2% sequentially and 14.1% year over year. AGS revenues are correlated to system sales and benefited from stronger equipment sales in the reported quarter.
The Display segment was down 19.0% sequentially and 26.1% from the year-ago level. Segment contribution dropped from 6% to 5%.
Management stated that demand for mobile devices (high-resolution mobile displays for tablets and touch panels for ultrabooks) continues to increase, which is complementing the resurgence in the TV market. Also increasing demand for bigger TV screens will drive segment revenues going forward.
The Energy and Environmental Solutions (EES) segment accounted for 5% of total quarterly revenue, surging 17.0% sequentially and 128.9% from last year. Management continues to cut investment in the solar segment to align the cost structure with sales, thereby expecting the segment to perform well throughout the year.
Revenue by Geography
Around 63% of Applied’s quarterly revenue came from the Asia/Pacific region, with the largest contribution from Taiwan, which generated 26%, followed by China with 13% and both Korea and Japan with 10% each. Korea, Taiwan and China were the weakest in the last quarter, declining 35.6%, 23.4% and 32.7%, respectively on a sequential basis. All other regions saw growth, with the U.S. being the strongest (up 84.6% sequentially), followed by Southeast Asia (up 55.8%), Japan (up 6.5%) and Europe (up 2.6%).
Orders
Total orders were down 5.7% sequentially but up 24.3% year over year. On a sequential basis, SSG, EES and Display orders were down 5.9%, 25.0% and 12.9%, respectively, while AGS orders improved 2.8%. However, all segments increased on a year-over-year basis.
Backlog for the quarter increased 9.0% sequentially, with SSG building up the most, followed by AGS, Display and then EES.
Margins
Applied generated a gross margin of 43.8%, up 130 basis points (bps) from the previous quarter’s 42.5%. Applied’s gross margin improvement may be traced back to its improving mix of higher-value products in semiconductor and display, as well as material cost efficiencies. The gross margin was up 300 bps from the year-ago quarter.
Applied’s operating expenses of $601 million decreased 2.1% from the last quarter. All expenses declined as a percentage of sales from both the previous and year-ago quarters, except general and administrative expense which increased from the year-ago quarter. As a result, operating margin of 17.3% expanded 90 bps sequentially and 460 bps from last year.
Net Profit
On a pro-forma basis, Applied Materials reported a net income of $349 million, or 28 cents a share compared to $348 million, or 28 cents in the previous quarter and $222 million, or 18 cents in the third-quarter fiscal 2013.
Our pro-forma calculation excludes restructuring, acquisition-related, impairment and other charges as well as tax adjustments in the reported quarter.
On a fully diluted GAAP basis, the company recorded a net profit of $301 million (24 cents per share) compared with $262 million (21 cents per share) in the previous quarter and $168 million (14 cents per share) in the year-ago quarter.
Balance Sheet
Inventories decreased 1.1% during the quarter. Accounts receivables were $1.6 billion, flat sequentially. Cash and short-term investments balance was $2.87 billion at quarter end, up $272 million from the prior quarter. Goodwill was 25.6% of total assets in the last quarter.
Applied Materials generated $584 million of cash from operations, spent $65 million on capex and $121 million on dividends. At quarter end, the company had $1.95 billion of debt on its balance sheet, with a net cash position of $924 million. However, the debt cap ratio including long-term liabilities and short-term debt was just 23.9%.
Guidance
Applied provided guidance for the fiscal fourth quarter. Revenue for the quarter is expected to be flat to +/- 3% sequentially and up by approximately 10%-17% from the year-ago quarter. Non-GAAP EPS is expected to come in at 25–29 cents, up 32%-53% year over year. The Zacks Consensus Estimate for the Oct 2014 quarter was 27 cents, within the guided range, when the company provided guidance.
Conclusion
The third quarter was a moderately good one for Applied Materials, with most of the segments performing well. Though Display and SSG remained sluggish, strength in other areas compensated for it.
Applied Materials has a solid product line and management has stepped up investments here to prepare for the on-going transitions to larger wafer sizes and smaller process nodes. The ramp up in FinFET, 3D NAND and new display technology will likely be the next catalysts going forward. Management expects significant share gains through 2014.
There is also scope for share gains on the Display side of the business backed by the PVD tools. The drivers of this business are larger TV screens and better mobile displays that involve more complicated production processes and new tools. Also, management expects demand for DRAM chips, used mainly in personal computers, to improve in the upcoming quarter.
However, slowing sales in China, a slow personal computer market, high cost structure and customer concentration may keep the shares range bound in the near term.
Applied shares currently have a Zacks Rank #4 (Sell). Better-ranked stocks include Emulex Corp (ELX), Research Frontiers Inc. (REFR) and Garmin Ltd. (GRMN). All these stocks carry a Zacks Rank #2 (Buy).
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