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Still not ready to call the bottom

Compared to the year-ago quarter, revenue decreased by $1B to $3.53B, or 23%. Costs declined $500M (20%) and overhead was flat. Sales dropping more than costs means a larger percent decrease in operating income, which decreased 40% from a year ago to $776M. Interest expense and income had little effect and income taxes were 12% in both periods. Net income was $666M for the quarter, or 18.8% of sales. Net margin was 24% of sales a year ago. They brought down the share count by 8.8% in the last year. Diluted EPS was $0.70. For the upcoming quarter, Applied expects sales of $3.525B (+/-$150M) and non-GAAP diluted EPS of $0.67 to $0.75.

Applied’s balance sheet is still solid, compared to six months ago. Cash and equivalents were down about $400M. AR and inventories are flat; impressive in a slowing market. AP actually dropped $500M from six months ago. Long-term debt was flat over the same time. The deteriorating market had little effect on the Company’s balance sheet. Cash flows were similarly uneventful. These comparisons are to a year ago. Cash provided by operating activities was actually more than a year ago by >30%, because Applied managed their working capital to wring out some more cash. CFO was $800M vs. $611M a year ago. Capital expenditures were $118M against $94M in D&A in the current quarter. Net CFI was ($129M), almost all explained by Cap Ex. They were “opportunistic” with share repurchases in the second quarter, buying back $625M worth at an average price of $39 per share. They paid out $189M in dividends in the quarter. All together, their net cash position was little-changed. Applied paid out all their cash from operations for the quarter to shareholder, 75% of which was returned in share repurchases.


Earnings Call Notes

Unless otherwise specified, financial information is non-GAAP

Gary Dickerson (CEO) prepared remarks

• Results were at the top-end of their guidance range, and their outlook is unchanged from last quarter
• Last five years of investment was driven by mobile. Investment in the coming years will be increasingly to serve cloud providers and 5G build out
• NAND prices are stabilizing and inventories are down from their peak, though inventories are still above normal. DRAM is not as far into the cycle with prices continuing to decline.
• They expect inventory levels in memory to normalize later in 2019, setting up 2020 to be a year of increasing investment
• Foundry and logic customer plans are “firming up” and investment in WFE here is expected to be up from last year
• WFE revenue is forecasted to be down mid-to-high teens from last year
• Display investments are slower this year than last year as customers push out investment
• Deposition, implant, and etch technologies in memory are key areas they are focusing equipment development on
• They are growing their services business to stabilize financial performance through the semiconductor cycle


Dan Dern (CFO) prepared remarks

• Still not ready to call the bottom of the cycle, though in this down year for the memory cycle, WFE equipment could be $10B higher than the peaks of all the prior cycles
• Dan is focused on four key priorities during this down cycle: managing expenses, fully funding new product development, increasing their recurring revenue streams (services) and returning cash to shareholders
• OPEX was $745M in Q2, which was lower than in Q1
• Applies had more than 40,000 systems in the field, and 140,000 chambers, the largest fleet. They expect 40% of their semiconductor revenue to be from services. 20% of their installed base is covered by long-term agreements. He is proposing this part of the business to be a subscription business.
• They announced a 5% dividend increase this quarter
• During Q2, they repurchased $625M worth of shares, at total of 16M shares. They have bought back 8% of the shares outstanding in the past four quarters. Over the last five years they have bought back 28% of the shares
• Systems revenue was $2.18B and 27.8% operating margin. Services revenue was an all-time record. Display non-GAAP margin was down but they expect it to recover in the current quarter
• They have “nearly $3B left in their share buyback authorization
• Guidance for Q3: revenue of $3.525B +/-$150M, 0.3% GM increase forecasted from Q2, $0.67 to $0.75 EPS

Question and Answer

• They don’t see a memory correction this year, but expect to see this in 2020
• CEO said 2019 product mix (EUV vs. non-EUV, where AMAT participates) is more favorable for them than 2018 was, and 2020 will continue this trend
• Display revenue expected to be down about a third compared to 2018. Looking at 2020, TV is expected to be stable and mobile will grow.
• They see China domestic customers investing in trailing edge products. More investment in logic vs. memory. Memory scaling is difficult, especially at the leading edge. CEO said leading edge scaling is “very, very, very difficult,” implying again, as he did in last quarter’s call, that the Chinese memory makers are a long way from being competitive in this area
• For 2019, their outlook is down mid-to-high teens, mid-$40B total WFE revenue for the industry
• Their largest business is WFE, then display equipment, then services. In 2019 they expect the latter two to grow and WFE to be flat, creating a GM headwind. The Company hopes to keep GM flat for the year, despite this headwind
• Both DRAM and NAND makers are being cautious with capacity additions. They are seeing capacity in wafers down slightly, with spending focused on technology transitions.
• They prioritize, in order; investment in organic and inorganic growth for the Company, maintaining a strong balance sheet, then returning the “vast majority” of excess cash to shareholders
• A year ago on their Q2 call was when they started to see NAND investment pull back. At that point margins hadn’t yet peaked, a first for the industry.
• Applied is tracking 31 total 300mm greenfield fabs around the globe, with an estimated addressable WFE market of $180B
• While not ready to call the bottom of the semiconductor cycle, the CFO believes they are seeing the early signs of price stability


Summary

Applied is an efficient, disciplined company. Their balance sheet and cash flow statements are simple and unexciting because of this. The Company managed their working capital to make up for a slowing market and comfortably returned all excess cash to investors, mostly through stock repurchases. They do not see the memory industry recovering this year. NAND is ahead of DRAM in the cycle, with NAND prices stabilizing but inventory still above normal. DRAM prices are still dropping and that is not expected to stop soon. They believe the end of 2019 will see more stability, setting the industry up for a good 2020. Applied continues to see a bright future for semiconductors. There are 31 300mm greenfield fabs around the world, a massive TAM for Applied. The AI/ML/5G revolution, they believe, will drive the next wave of semiconductor demand. Between this secular trend and the continuing increase in difficulty in technology migrations, Applied and the other semiconductor participants have a bright future. I like Applied as an investment. They are a disciplined operator and have a large moat in a consolidated WFE space. Considering share buybacks, their “owners yield” is something like 8% and the stock trades at a P/E of 10. While I don’t have a position in Applied, I think buying here, especially a basket approach with KLA-Tencor, LAM, and ASML, will be a market-beater for the next five years and beyond.


-S. Hughes (no AMAT position)
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