Applied Materials’ (AMAT) first quarter earnings beat the Zacks Consensus by 3 cents, or 9.1%. Revenue came in higher than management expectations and exceeded the Zacks Consensus by 3.7%.
Revenue
Applied Materials reported revenue of $2.69 billion, which was down 6.9% sequentially and up 45.3% year over year. Increase from the year-ago quarter suggests that growth drivers remain on track.
The Applied Global Services (“AGS”) and Energy and Environmental Systems (“EES”) segments outperformed management guidance. The Silicon Systems Group (“SSG”) segment was in-line with guidance, while Display missed.
Revenue by Segment
SSG remains Applied’s largest segment, with a 56% revenue share. Segment revenue increased 0.9% sequentially and 54.2% year over year, fueled by growth in the smartphone and tablet markets that increased demand for mobile chipsets and solid-state storage.
Management had expected the segment to be flat sequentially, so revenue was more or less within expectations. Management stated that new products and relationships are driving the segment. The memory market remains a mixed bag, with DRAM softening and NAND accelerating.
Foundries continued to spend in the last quarter, as did logic customers. Applied’s reticle inspection tools helped share gains at foundry and logic customers, according to management.
Applied Materials now expects its SSG business to grow 10-15% in 2011, better than Gartner’s 10% growth projection for the semiconductor equipment market. This seems to indicate further share gains in 2011.
The second largest segment was AGS, which generated 21% of total revenue. Segment revenue increased 9.9% sequentially and 33.1% year over year, better than Applied’s expectations of a slight sequential increase. Management stated that strength in the 200mm tools and the parts & services business drove the performance in the last quarter. Applied expects wafer starts to increase 5-7% in 2011.
The EES segment made an 18% contribution to quarterly revenues, representing a sequential decline of 21.5% (guidance was a 30% decline) and a year-over-year increase of 48.3%. The thin film equipment business generated $230 million.
However, Applied Materials is now focused on the crystalline silicon business, which reached record levels in the last quarter. Sales for the Baccini and PWS platforms were at record levels. Despite falling prices, utilization rates remain high and capacity expansions continue.
Applied Materials continues to be a major beneficiary of capacity builds in China, since the company’s market share in the country is significantly higher than in other parts of the world. Management has projected crystalline silicon capex increase of around 30% in 2011, with 90% of the spending in China and Taiwan, which should be highly beneficial for the company given its position in these markets.
Performance in the Display segment was below management expectations of a 40% sequyential decline. The segment generated just 5% of revenue in the last quarter, dropping 47.7% sequentially, although growing 11.4% from last year.
Management attributed the decline to the cyclical nature of the LCD market and stated that the market should turn around in the second half. However investment in new techologies, such as touch panels and OLED for use in smartphones and tablets continue. Applied believes the LCD market will shrink 30% this year, partially offset by technology purchases.
Revenue by Geography
Around 67% of Applied’s quarterly revenue came from the Asia/Pacific region, with the largest contribution from China, which generated 25% and closely followed by Taiwan, which generated 24%. However, while China declined just 5.6% sequentially, Taiwan was down 23.4%. Korea was also down 58.5%. North America saw the most significant increase (up 60.5%), followed by Europe (up 24.7%).
Orders
Total orders were down 1.8% sequentially and up 51.2% year over year. All except the EES segment declined sequentially. EES increased 22.3%. All segments grew from last year, although EES increased the most (190.4%).
Order growth was strongest in North America (up up 50.9%). Europe increased 5.8%. Asia was mostly down, with the exception of Taiwan and Japan that were up single-digits.
The book-to-bill was positive in the SSG and EES segments.
Margins
Applied generated a gross margin (excluding inventory adjustments) of 42.8%, up 14 basis points (bps) from the previous quarter’s 42.6%. The gross margin improvement was the combined effect of higher volumes in the EES segment, offset by lower prices and volumes, as well as a negative mix in the other segments. The gross margin was up 291 bps from the year-ago quarter.
Applied’s operating expenses of $490.0 million were down 5.8% from the previous quarter’s $520.1 million, with the operating margin of 24.5% dropping 8 bps sequentially and increasing 1,069 bps year over year. Higher R&D as a percentage of sales was the reason for the sequential decline. Expansion from the year-ago quarter was driven by decreases in all expenses as a percentage of sales.
Net Profit
On a pro forma basis, Applied Materials had a net income of $484.0 million, or a 18.0% net income margin compared to $475.8 million, or 16.5% in the previous quarter and $179.0 million, or 9.7% in the first quarter of fiscal 2010.
The fully diluted pro forma earnings were 36 cents a share compared to earnings of 36 cents in the previous quarter and 13 cents in the comparable prior-year quarter.
Our pro forma estimate excludes restructuring gains, acquisition-related charges, loss on sales of a facility 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 $506.0 million ($0.38 per share) compared to $468.0 million ($0.35 per share) in the previous quarter and $82.8 million ($0.06 per share) in the prior-year quarter.
Balance Sheet
Inventories were up 6.4% sequentially, with inventory turns dropping from 4.3X to 3.7X. Days sales outstanding (DSOs) went from 58 to 66. The cash and short term investments balance was $2.75 billion at quarter-end, having increased $161.4 million during the quarter.
The company generated $425 million of cash from operations, spent $24 million on capex, $150 million on share repurchases and $93 million on dividends. At quarter-end, Applied had $205 million of debt on its balance sheet, with a net cash position (excluding short and long term debt) of $2.54 billion. The debt cap ratio including long term liabilities and short term debt was 6.2%. The debt position has not changed much over the past year.
Guidance
Management provided guidance for the second quarter. With SSG to be flat sequentially, AGS to be up 3% (in-line with the increase in wafer starts), Display to decline around 67% and EES to increase at least 10%, total revenue is expected to up 0-5% sequentially.
The non-GAAP EPS is expected to come in at 34-38 cents a share. The Zacks Consensus Estimate for the next quarter is 32 cents, below the guided range.
Full-year revenue is expected to come in at $11 billion (up 15% from 2010). Previous expectations were for revenue in line with 2010 (+/- 10%). The non-GAAP EPS is expected to be $1.50 a share, much better than the Zacks Consensus, which was at $1.29 when the company reported.
Conclusion
The Zacks Rank for Applied Materials shares is #3, signifying a short term Hold recommendation. We think the company’s strong position in the semiconductor market and focus of the solar business on China are the biggest positives right now.
We expect the strong portfolio and strategic relationships to drive share gains here. Momentum in the NAND segment and Intel Corp’s (INTC) spending on Fab 4 (logic segment) will be incremental for Applied, offsetting some of the cyclical pressure. The timing and extent of the LCD market recovery is also a concern.
Given the cyclical slowdown in the equipment sector, other semi equipment companies, such as Novellus Systems (NVLS) and KLA Tencor Corp. (KLAC) are also Zacks #3 ranked.
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