Applied Materials third quarter financial results can be characterized as optimizing our company’s performance in a challenging economic environment with a semiconductor equipment market being particularly tough. During, the quarter we saw continued softening of world economies as oil prices spiked, credit tightened and then the US housing values fell further and unemployment increased,” commented Applied president and CEO Mike Splinter.
By Ann Steffora Mutschler, Senior Editor — Electronic News, 8/13/2008

Reflecting a difficult semiconductor industry environment, Santa Clara, Calif-based semiconductor manufacturing equipment leader Applied Materials Inc reported Tuesday afternoon that net sales for its Q3 ended July 27 were $1.85 billion, down 28% from $2.56 billion in Q3 2007, and down 14% sequentially from $2.15 billion in Q2.

Applied’s Q3 gross margin was 40.2%, down from 47.5% in Q3 2007, and down from 45% in Q2. Meanwhile, Q3 net income was $165 million, or 12 cents per share, down from net income of $474 million, or 34 cents per share, for Q3 2007, and downfrom net income of $303 million, or 22 cents per share, for Q2.

The capital equipment giant brought in $2.03 billion in new orders for Q3, which was an 11% decrease from Q3 2007 new orders of $2.28 billion, and was 16% lower than Q2 orders of $2.41 billion.Regional distribution of Q3 new orders was: Japan, 21%; North America, 19%; Korea, 17%; Southeast Asia and China, 17%; Europe, 16%; and Taiwan, 10%. Backlog at the end of Q3 was $4.74 billion, compared to $4.59 billion at the end of Q2.

“Applied Materials delivered financial and operational performance that was in line with our quarter forecast during a difficult semiconductor industry environment. While our silicon business was down, revenues increased in our display, service and solar businesses. We made significant progress in our solar division during the quarter, substantially increasing the number of crystalline silicon systems shipped and enabling start-up production on the first four SunFab Thin Film lines at customer sites. We are focused on operational execution, and we are taking advantage of opportunities to expand our leadership with next-generation innovations in silicon, display and solar,” commented Mike Splinter, president and CEO of Applied, in a statement.
Applied reiterated that effective in Q1, the company changed its management reporting system for services, with all service results reported in the Applied Global Services segment. Fiscal 2007 segment information has been reclassified to conform to the fiscal 2008 presentation.
During a conference call with financial analysts, Splinter said further, “Applied Materials third quarter financial results can be characterized as optimizing our company’s performance in a challenging economic environment with a semiconductor equipment market being particularly tough. During, the quarter we saw, continued softening of world economies as oil prices spiked, credit tightened and then the US housing values fell further and unemployment increased. It’s no surprise that US consumer confidence is at its lowest level in more than a decade.”
“Over the past few months forecast for 2008 wafer fab equipment spending moved in line with our view of down 25% to 35% year-over-year as memory prices weaken and investments were delayed. While, there were some signs of strength in the PC market that showed double-digit unit growth is not translated to investment broadly by our customer base. In this light our team executed every opportunity for orders and revenue in each of our businesses to achieve our results. The Silicon Systems Group remains focused on financial and operating results and the group performed well in the most challenging quarter since Q4 2003,” he noted.

In terms of its energy and environmental solutions division, Applied’s revenues doubled and orders were up 25% in Q3. Splinter explained, “Our focus in crystal and silicon over the past several months has been the bill production capability to meet the rapid expansion of product demand in our precision wafering systems and Baccini’s cell systems business units. Delivery performance is improving and we expect to be current to backlog by October.”

“Products from PWS and BCS are market leaders and we expect to expand operations and move along the road map to reduce costs for solar cell production. A key component in reducing these costs is the use of fewer grams of silicon for each watt of output produced and Applied Materials is leading the industry in that challenge. In fact, our entire crystal and silicon product portfolio is now capable of producing wafers as thin as an average sheet of paper, only a 120 microns thick. That’s 60% thinner in today’s industry standard wafer,” Splinter continued.

The company is pleased with the progress in Q3 in the SunFab business and said it is in the investment cycle in the business with focus on the successful start up of customer factories, he explained.

“We’re simultaneously starting up multiple SunFab lines while integrating an end to end suit of newly developed process tools. The scale and operational complexity of these lines presents a tremendous challenge, but this is just the kind of challenge that Applied Materials excels in and our teams have performed exceptionally well by drawing on the overall resources throughout the company and from among our partners to support these new factories. We now have four customers that are producing solar panels. If you saw one of these panels at inter solar in Europe or in California, you understand how overall cost efficient our 5.7 square meter form factor is for large scale solar applications. We expect to get our first SunFab signed off this quarter with more to follow in the first part of fiscal ’09,” Splinter said.

Further, Applied said its SunFab technology platform made dramatic progress in the quarter as its tandem junction process demonstrated production feasibility. “We were pleased to learn that the European patent office just issued a provisional opinion finding invalid to key claims of a patent related to tandem junction solar technology that is the basis of a law suit recently filed against one of our solar customers,” he noted.
We are watching bid growth, pricing and inventory indicators in the minimal area to help judge when we will see the next wave of investment in either DRAM or Flash. Our expectations are for the industry to start adding additional NAN capacity for solid state drive applications in 2009 and beyond.

Growth rates for 65-nanometer foundry capacity have been slower than expected due to design complexities. Foundries are now seeing growth in 65-nanometer revenues as the ramp gained strength and utilization exceeds 90%.

In 2008, we see capital and intensity down to 15% to 16% which is below its typical range of 18% to 22%. This represents a near term correction from memory overspending, longer term we see capital intensity going back to approximately 20% over the next 1 to 2 years.

After reaching historic levels in the first two quarters our orders for display products was strong at $374 million, but down 25% over Q2, we believe this represents the end of the first phase of the GEN8.5 order cycle and we should expect orders in display to be down significantly for the next few quarters until the GEN10 technology and capacity cycle begins. Meanwhile, we see the major capital projects moving ahead, the top panel makers are expanding capacity to meet demand for large TVs over the next few years despite signs of the TV market softening in a short term. We expect revenue to continue at a high level for the next few quarters.

In our service business, we see much less volatility than experience in the capital equipment businesses they support. AGS has weathered the downturn in silicon and shown solid revenue and financial performance. Our service group has developed a strong proposition for expanding in Asia, signing five major contracts for silicon service and three for display in the period. Applied SunFab performance service program has strong momentum at leading solar manufacturers in Europe and in Asia. We have now exceeded a $100 million in the service contracts for both single and tandem junctions SunFab lines.

In order to capitalize on growth opportunities, we are making significant investments in infrastructure to enable the company to be more cost effective and efficient and expanding capacity to meet customers’ needs. During the quarter we announced our new Asian operations center in Singapore that will primarily focus on SSG products. The expansion of our Thai None manufacturing center focused on display and solar products and we continue to invest in developing our solar reliability lab and other capabilities in Xian, China.

Overall, Applied Materials is executing to our strategy in today’s difficult economic environment focused on our core businesses and silicon and service making significant R&D investments in new products and technology for the next node of integrated circuits. The display team is executing at the top of revenue cycle and expanding their product lines. Solar organization is rapidly developing capability on the two fronts of crystalline and thin film silicon products and at the same time we are investing in the right infrastructure for the future.

Looking ahead to Q4, George S. Davis, senior VP and CFO of Applied noted that some of the key market issues impacting the outlook include semiconductor capital equipment demand expected to remain flat and any revenue increase over the prior quarter appears to be modest, with orders expected to strengthen somewhat based on customer forecasts.

Also, Applied believes flat panel display shipment demand will remain strong as customers add capacity although the order cycle but that is expected to decline sharply in Q4. “We expect further progress integrating our crystalline silicon solar businesses which will bring revenue rates closer in line with shipment rates,” Davis said.

Applied also expects services markets to be relatively flat with movement around last quarter’s level being a function of demand for spares and used equipment from our semiconductor customers.

That said, Davis said Applied expects Q4 orders to be up in the range of 5 to 10% overall with increased DES and silicon orders partially offset by a sharp decline of about 75% in display. “We expect revenue to be up in the range of 2% to 10% overall driven by revenue from crystalline silicon and thin film solar products. As we previously forecasted, we expect to recognize our first SunFab revenue in Q4,” he said.

Q4 EPS is expected to be in the range of 12 to 15 cents per share, up in line with revenue overall. Operating margin will continue to be impacted somewhat by investment in the solar build out and investment in SSG R&D to position its silicon products during the downturn. Finally, Davis said the company believes there will be substantial upside in earnings over time as silicon recovers and increased profitability happens in solar.

Following the results, C.J. Muse, semiconductor equipment/display technologies analyst at Lehman Brothers Equity Research noted that Applied’s order bottom call combined with the uplift in solar is likely a positive catalyst for shares, but said he has reservations about true earnings power of solar and with shares trading more than 17x the firm’s CY09 EPS estimate of $1.05, and therefore was hard pressed to be more aggressive.

Muse added that while the call for order bottom combined with uplift in solar and a relatively solid order outlook across the board in all segments likely a positive catalyst for shares near term, however, his reservations about true earnings power of solar are still not addressed, and, are most likely a 2H09 story. Muse reiterated his 2-Equal Weight rating, meaning that the stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a 12-month investment horizon, with a $20 price target.

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