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Not calling the bottom, but memory recover next year

In semiconductor systems, revenue was down 15% from a year ago. Foundry and logic are almost half the business. NAND dropped from 39% of revenue a year ago to 24% today. This surprised me as I thought NAND had already declined by this time last year. Operating income was down 25% to $631M. Operating margin declined 520 bps to 27% (GAAP) and was down 620 BPS to 27.5% on a non-GAAP basis. Services revenue was $931M compared to $952M a year ago. Operating margin reduced 160 bps to 27.8%, similar to the op margin on systems. Display revenue was almost halved to $339M, similarly cutting operating margin by more than half, to 12.1% from 25.3% a year ago. Overall company revenue was 15% lower than a year ago at $3.56M. COGS was also down 15%, combining to reduce gross profit to $1.56B. Applied’s control of their costs kept gross margins good at 43.7% (vs. 44.7$ a year ago). The Company continued to tightly control expenses, brining down overhead by $16M to $755M. Income taxes were more than 3x higher than a year ago. This, combined with $300M less in gross margin dollars, brought down net income by 40% to $571M.

Cash from operations went up from a year ago, because the comp was a high quarter for change in operating assets and liabilities. CFO was $787M, CapEx was $93M, and they bought $64M more in assets than they sold, giving cash from investing activities of ($162M). $724M was returned to shareholders, about 70% via share repurchases. Overall, they took about all the cash they made and paid it out to owners. Their cash position declined by $102M in the quarter. Applied has $3B in cash, $547M in ST investments against $5.3B in LT debt, thus their net cash position is about zero.


Earnings Call Notes

Unless otherwise specified, financial information is non-GAAP

Gary Dickerson (CEO) prepared remarks
• Logic and foundry continue to be strong while memory and display are soft. Their views are largely unchanged. Memory WFE demand has soften slightly since their May call. NAND price elasticity is being seen in higher content per PC and per phone. They remain optimistic about 2020 and believe NAND will recover ahead of DRAM.
• Demand in logic and foundry strength is driven by a broad range of products. Their overall view of WFE is unchanged from the last call. They see 2020 being a year of recover in investment for memory and they forecast continued strength in logic and foundry.
• Integrated Materials Solutions is a new tool they recently introduced that deposits several films (more than 20, based on Gary’s description of the tool) within the same machine, including on-board metrology
• Their view of 2019 is unchanged from last quarter

Dan Dern (CFO) prepared remarks
• Again, Dan is not ready to call the bottom, but he is seeing positive leading indicators. Memory makers continue to lower output to bring supply and demand back to balance.
• Their four financial priorities are: controlling spending, developing their portfolio, returning cash to shareholders, and helping customers succeed through their services business
• They announced their intent to acquire Kokusai Electric during the quarter
• Applied used $528M to repurchase shares at an average price of $42. For they year, they have repurchased $68M in shares at an average prices of “below $39 per share.” They have $2.4B remaining on their share repurchase authorization.
• Services revenue was below the midpoint of their guidance. This is because their transactional business in parts and services slowed down because of the pull-back in memory. Their “subscription-like” long-term-contract services business grew right in line with their forecast.
• Guidance for Q4: revenue of $3.685B +/-$150M, EPS of $0.72 to $0.80, GM of 43.5%. In 2020, they continue to expect growth in their business and a U-shaped recovery
• They believe the bottom of the display business has passed

Question and Answer
• They don’t expect to see a recovery of the memory market in 2019. They do expect it in 2020, led by NAND. Memory is under shipping compared to true end-market demand which is bringing down inventories
• Capital intensity continues to increase for WFE required to advance technology nodes
• In China, they see spending in 2019 similar to 2018, with slightly higher levels in foundry/logic and slightly lower in memory
• More mature (older) nodes are being used longer, which they see in the form of higher investment by customers in these older technologies
• MRAM will be a replacement for some NOR, EEPROM, and embedded DRAM applications, but it will be long, shallow adoption curve. The technical challenges are vast.


Summary

I do all the WFE companies in a group, and at this point in the consolidation of the space, they all start to run together. Applied, ASML, Lam, and KLA are all income investments masquerading as high tech companies. They all make GM between 40% and 50% and operating margin in the mid-to-high 20%. They are all disciplined operators running growing business with pretty stable financials and low capital expenditures. They return most or all of their free cash flow to shareholders. I analyzed the results of these four companies every quarter because I am a Micron investor, and if it weren’t at what I believe is the low point in the memory cycle, I would buy a basket of these four WFE companies and sit on it for ten years.


- SmoothHughes (no real-money AMAT position, but long in CAPS)
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