Applied Materials Inc., Q3 2007 Earnings Call, Aug-14-2007 - SEHK:4336

SEHK:4336

George S. Davis, the Chief Financial Officer of Applied Materials, Inc., provided key insights and details during the Q3 2007 earnings call. Here is a detailed summary of his comments:

Opening Remarks

• Financial Performance Overview:

  • Results were within the forecasted range for orders and revenue.
  • Exceeded the target for earnings per share (EPS).
  • Orders came in at the low end of the expected range.
  • Weakness in orders from foundry and display customers.
  • Strong financial results driven by the Silicon Systems Group.
  • Showed strong cash flow and improved balance sheet performance.

• Orders:

  • Down 14% year-over-year and quarter-over-quarter.
  • Expected orders to be down in the range of 10% to 15%.

• Backlog:

  • Decreased slightly, in line with the book-to-bill ratio.
  • Positive backlog adjustments of $34 million.
  • Backlog does not include solar contracts for thin film production lines.

• Revenue:

  • Up 1% in Q3 compared to both the previous quarter and Q3 of the previous year.

• Gross Margin:

  • Increased 2.6 points to 47.5%.
  • Q2 gross margin included charges of $50 million related to the decision to cease development of beamline implant products.

• Operating Expenses:

  • Essentially flat with Q2.

• Headcount:

  • 14,465 employees at the end of Q3.

• EPS:

  • $0.34 per share, $0.02 above the target range.
  • Increase both quarter-over-quarter and year-over-year.
  • Non-GAAP EPS of $0.37 per share.

Segment Results

• Silicon Systems:

  • Orders down 17% from Q2 levels.
  • DRAM customers lowered capacity additions.
  • NAND Flash orders increased at expected levels.
  • Logic customers maintained their order pattern for the year.
  • Memory accounted for 74% of orders.
  • Orders for 65-nanometer and below technology represented 58% of silicon orders.
  • Net sales up 2% versus Q2 and 8% year-over-year.
  • Operating income increased to just under 40% of revenue.

• Fab Solutions:

  • Orders declined 6% from Q2.
  • Sales increased 2% over Q2 due to higher software revenue.
  • Sales decreased 8% year-over-year due to lower sales of re-manufactured equipment.
  • Operating income slightly lower than Q2 due to product mix and increased operating expenses.

• Display:

  • Orders were $90 million, up modestly from Q2 but down 61% from Q3 of the previous year.
  • Revenue up 2% from Q2.
  • Operating income increased to 25.2% of revenue from the trough experienced in Q2.

• Adjacent Technologies:

  • Orders and sales were down from Q2.
  • Operating loss of $29 million due to lower revenue and increased R&D investment.

• Corporate and Unallocated Expenses:

  • $189 million, up 17% over the previous quarter.

Balance Sheet and Cash Flow

• Cash Flow Performance:

  • Generated $638 million in cash from operations.
  • Free cash flow of $565 million, or 22% of revenue.
  • Defined as cash provided by operating activities less capital expenditures.

• Capital Spending:

  • $73 million for the quarter.
  • Depreciation and amortization totaled $63 million.

• Stock Repurchases and Dividends:

  • Returned $483 million, or 76%, of operating cash flow to stockholders.
  • $400 million for share repurchases.
  • $83 million used for dividends.

• Cash and Investments:

  • Grew by $390 million to $3.76 billion.
  • Net cash proceeds related to employee stock option exercises was approximately $270 million.

Q4 Guidance

• Orders:
  • Expected to be in the range of flat to down 5%.
  • Reductions in silicon orders partially offset by improved orders in display and fab solutions.
• Revenue:
  • Expected to be down in the range of 5% to 10%.
  • Lower revenue predominantly from DRAM and foundry customers.
  • Partially offset by increases in fab solutions.
• EPS:
  • Expected to be down in line with revenue.
  • Range of $0.26 to $0.29.

Closing Remarks

• Summary:

  • Q3 was a strong quarter financially and operationally despite a soft order environment.

  • Passed the call to Mike Splinter for further commentary.

Randy Bane, Vice President of Investor Relations at Applied Materials, made the following comments during the Q3 2007 Earnings Call:

1. Opening Remarks:

   • Thanked the operator and welcomed attendees to the Applied Materials’ fiscal 2007 third quarter conference call.
   • Introduced Mike Splinter, President and CEO; George Davis, Chief Financial Officer; and Joe Sweeney, Senior Vice President, General Counsel, and Corporate Secretary, who joined him on the call.
   • Mentioned that the financial results for the period ending July 29, 2007 were released at 1:06 P.M. Pacific Time.
   • Noted that a copy of the news release is available on Businesswire and the company's website, www.appliedmaterials.com.
   • Indicated that a slide presentation supporting the discussion is available on the investor relations section of the company's website.

2. Forward-Looking Statements Disclaimer:

   • Reminded listeners that the call contains forward-looking statements, including those related to the company's performance, technology leadership, operational efficiencies, business strategy, growth opportunities, cash generation and deployment, solar strategy and planned acquisitions, customer spending and fab utilization trends, and the industry outlook and drivers.
   • Stated that all forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements.
   • Mentioned that information concerning these risk factors is contained in the company’s filings with the SEC.

3. Non-GAAP Financial Measures:

   • Noted that the call contains non-GAAP financial measures and that reconciliations of these measures to GAAP measures are available in the earnings press release and the earnings call highlights presentation on the investor page of the company's website.

4. Call Agenda:

   • Announced that George Davis would lead the call with a discussion of the financial performance for the third quarter, followed by highlights on the current industry environment and company progress by Mike Splinter.
   • Indicated that George would close the commentary with targets for the fourth fiscal quarter of 2007.
   • Mentioned that after these remarks, the call would be opened for questions.

5. Handover to George Davis:

   • Turned the call over to George Davis to discuss the financial performance for the quarter.

6. Closing Remarks:

   • Thanked everyone for joining the discussion of Applied Materials' financial results.

   • Reminded listeners that a replay of the call and the supporting slide package would be available on the company’s website until 5:00 p.m. on the day of the call and would remain posted until August 28th.

   • Announced that the company would hold an analyst day on January 17, 2008, in New York City, with more details to be published during the fourth quarter.

   • Thanked attendees for their interest in Applied Materials and concluded the call.

Michael R. Splinter, the Former Executive Chairman of Applied Materials, made a series of comments during the Q3 2007 Earnings Call. Here is a detailed summary of his statements:

Opening Remarks

• Overview of Strategy: Applied's strategy focuses on utilizing nano-manufacturing technology to solve key technical challenges, drive higher returns for customers, and accelerate growth in new markets.
• Quarter Highlights:
  • Memory was the primary driver of business in Q3, while foundry orders were weaker than expected.
  • Service and display remained flat.
  • Demand for solar is growing, and the company is building capabilities to become the solar technology leader.

Achievements

• Strategic Move: Creation of the silicon systems group under Tom St. Dennis to consolidate semiconductor equipment divisions, aiming to extend leadership in innovation, improve customer satisfaction, and operational efficiencies.
• Customer Challenges:
  • Customers face increased process complexities and shortened product lifecycles, leading to higher R&D costs for introducing new technology nodes.
  • Applied is addressing these challenges with innovative solutions, such as high-K metal gate and double patterning technologies.
• Product Highlights:
  • Released the Carina Etch system for high-K metal gate and made first customer shipments.
  • The Producer GT system saw unprecedented demand, with 100 systems shipped within nine months of launch.
  • Sokudo joint venture began shipments of an upgraded track system focused on leading-edge immersion lithography applications.

Service and Display

• Service Solutions: Enabling customer success through superior service solutions and transforming the service business with new products that improve the efficiency and lessen the environmental impact of semiconductor manufacturing.
  • Wafer reclaim center in Taiwan processed over 8,500 wafers using a patented process and is qualifying five new customers this quarter.
• Display Environment:
  • Despite significant growth in sales of LCD TVs (up 65% YoY), capital spending by display manufacturers is expected to be down 30% to 40% this year.
  • Expansion into new product lines and share gains in existing products will help results as display orders start to improve in Q4, although revenue improvement is not expected until the second half of FY '08.
  • Positive note: Leading panel maker announced intention to move to gen 10, the next larger glass size.

Adjacent Technologies and Solar

• Solar Leadership:
  • Thin film technology gaining broad acceptance, and the company recently started shipping equipment for its first thin film solar production line.
  • Agreement to acquire HCT Shaping Systems to broaden capabilities in crystalline solar cell technology.
  • With solutions for both crystalline and thin film, Applied is rapidly becoming the technology leader in solar.
  • Raised 2007 goal for solar contracts from over $400 million to over $600 million.

Market Environment

• Memory Market:
  • Bit growth is well ahead of expectations, and despite price reductions, customers have confidence to invest in advanced capacity to lower process costs and enable higher density devices.
  • End-unit demand is strengthening, not only due to seasonality but also new applications like the iPhone, which requires more flash memory per unit.
  • DRAM pricing is improving as excess capacity is consumed, and cell phone and PC demand is driving robust bit growth.
  • Adoption of Microsoft Vista OS is driving DRAM bit growth, with corporate adoption expected to be significant next year and continue into 2009.
• Foundry Market:
  • Foundries report record sales with positive momentum expected to continue into Q4.
  • Industry consolidation and R&D favor the foundry model.
  • Utilization at foundries is moving into the 90% range, indicating the need to add capacity, although little capacity has been added this year.
  • 65-nm ramp is taking longer to develop than anticipated.
• Fab Solutions Market:
  • Flat revenue reflects lower-than-expected utilization in logic and foundry as well as lower remanufactured equipment sales.
  • Expectation of a return to growth in upcoming quarters with new products and increased focus in Asia.

Closing Remarks

• Preparedness for Opportunities:
  • Applied is well-prepared for growing opportunities in new critical applications and semiconductors, gaining traction on new service products, navigating through an investment downturn in display, and increasing its product offerings and penetration in the fast-growing solar market.

Question and Answer Session

• Silicon Business Unit Orders: Uncertainty around foundry orders and anticipation that DRAM and flash will continue to show strength due to strong unit demand and bit growth.

• Sustainability of Operating Margins: Confidence in the silicon systems group's ability to drive improvements in operating profit and margin.

• HCT Acquisition Revenue Impact: No revenue from HCT baked into Q4 guidance.

• Memory Bookings: Expectation that memory bookings will remain in the range seen in recent quarters.

• 65-nm Adoption Delays: Cost crossover and yield considerations delaying full-scale adoption.

• NAND Capacity Transition: Expectation of increased movement to 300-mm wafer capacity over the next couple of years to replace aging 200-mm factories.

• Foundry CapEx Trends: Structural changes in utilization levels and 65-nm adoption, but expectation of increased orders as 65-nm ramps.

• Gen 10 Equipment Readiness: Gen 10 equipment expected to ship late in fiscal year 2008.

• Building Integrated Photovoltaics: Importance of gen 10 for handling larger sizes of architectural glass.

• Spares and Service in Solar: Attractive business opportunity, but details to be provided at a later analyst meeting.

• Foundry Order Timing: Guidance includes very low orders for foundries in Q4.

• Foundry Trends: Differences between current trends and expectations from three months ago, with lower foundry orders than anticipated.

• Dual Junction Solar Lines: Only one dual junction contract so far, but single junction lines can be upgraded.

• Solar Revenue Recognition: Revenue recognition for solar lines expected at the tail-end of 2008.

• 65-nm Ramp and 45-nm Take-outs: Phenomenon of customers skipping generations of technology due to costs of redesigning products and starting up new products.

• Share Performance: Continued share gains in memory, especially in memory etch, and in EPI (epitaxy).

• DRAM Outlook: Expectation of a longer tail for DRAM demand due to corporate adoption of Vista starting mid-next year.

• Foundry Utilization Rates: Both end-market demand and customer migration to fab-less or fab-light models contributing to utilization rate increases.

• Memory Spending: Confidence that memory manufacturers will continue to invest in capacity if there is bit demand, despite some guiding to lower CapEx.

• Solar Development Activities: Focus on crystalline silicon and thin film silicon approaches, with the goal of being the technology leader in solar and driving down the cost per watt.

• Solar Fab Solutions Opportunity: Expectation of an excellent opportunity for fab solutions in the solar market, including service, abatement, and consumables.

• Market Divergence: Different factors driving different markets, such as mobile storage driving NAND Flash, new operating systems driving DRAM, and supply-and-demand dynamics affecting display.

• Available CapEx Growth in 2008: Expectation of relatively similar growth to 2007, but too early to make a solid projection.