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Financial Results

Statement of Operations

This was another great quarter for Applied. Total revenue was $4,395M, an increase of 11% Q/Q and 23% from the same quarter a year ago. Gross margin increased 80 bps in the quarter to 44.5%. Mid-40% is where Applied’s gross margin stays over time. It is their revenue that continues to impress, up 23% in this quarter compared to a year ago. Overhead grew, but at a lower rate than revenue, so operating margin expanded Y/Y, to 25.2%. Net income was $841M, up almost 50% from a year ago. Almost $0.20 of every dollar of Applied’s sales this year has made it to the bottom line. Share count decreased 1.6% Y/Y. The performance of WFE companies follows the semiconductor cycles. Applied’s financials bottomed a year ago in this quarter and have trended up since. Their best quarter was nine quarters ago, in 2Q’18, and their guidance for 4Q’20 is to beat that previous record.

Statement of Cash Flows

Cash from operations was $2,489M for the first nine months of 2020. Depreciation and amortization were in balance with capex. AR and inventory have consumed a combined $740M in cash so far this year. Some of that is because of higher sales but COVID-19 has also delayed tool releases at customers, which increases inventory. I won’t make a correction for this in calculating cash flow available to equity holders, but it is worth noting that cash flow is lower because of this, and it will reverse at some point in the next two or three quarters. They made acquisitions this year that consumed a net of $107M in cash. Applied has harvested $378M in cash from selling more investments than they purchased, which I will back out for the purpose of understanding sustainable cash flow. They turned over about $3B in debt for better terms this year, but net debt has stayed the same. Year to date they have bought back $599M worth of stock, but almost half of these repurchases ($234M) were to offset dilution from equity grants to employees. Correcting for this (and other stock-related cash flows) leaves $1,768M of cash flow available to owners. Carrying this forward for the last quarter of the year (an underestimate, to be sure) gives a run rate of $2,669M in annual cash for equity holders. Dividing over the 922M diluted shares outstanding gives a cash flow available to equity holders of $2.89 per share, or 4.7% on a share price of $61.63. For the first nine months, Applied returned $877M to shareholders, between dividends and net equity buybacks. This works out to 41% of the $2,122M of cash flow generated (which subtracts out cash from selling investments) in the year so far.

Balance Sheet

Applied’s cash balance has increased $1.2B so far this year, to $4.35B. They are generating a lot of cash and have returned less than half of it to shareholders, thus it is piling up on their balance sheet. Inventories and AR have also grown, in part because of delayed tool releases related to COVID-19. AP has increased by a similar amount to AR, so that is a wash. Total debt is up this year to $5.5B, though it has shifted completely out of the short-term window because of refinancing. Book value now stands at $10.37 per share. Applied carries a net debt balance of about $750M, but their cash flow is quite strong, so this is not a concern.


Earnings Call Notes

Unless otherwise specified, financial information is non-GAAP

Gary Dickerson (CEO) prepared remarks

• Both their manufacturing facilities and R&D labs are operating at pre-COVID capacity
• They expect overall WFE demand to grow in 2020 relative to 2019, despite weakness in some sectors, such as automotive
• For the year, memory is expected to grow “slightly more” than foundry logic, with DRAM and NAND having similar growth rates
• At the midpoint of Q4 guidance, Applied’s revenue growth will have grown at 25% over last fiscal year
• 60% of Applied Global Service’s sales are from recurring revenue sources, and renewal rates on this business are greater than 90%
• Display revenue for 2020 is expected to be $1.6B with 2021 to be similar. They “remain optimistic” about the long-term future for the display industry
• 2021 is forecasted to have higher revenue than 2020

Dan Dern (CFO) prepared remarks

• In Q3 they shipped a “significant” portion of the backlog that couldn’t be shipped in Q2 because of COVID. Continued strong demand kept their current backlog at a similar level to last quarter
• Revenue this year is expected to be second half weighted
• Q4 outlook (non-GAAP): Revenue = $4.6B +/- $200M, EPS = $1.17 +/-$0.06, Systems revenue = $3.025B (up 31% Y/Y), Services revenue = $1.07B (up 10% Y/Y), Display revenue = $475M, GM = 45.7% (up 200 bps Y/Y)

Question and Answer

• For the year, they believe 55% of Applied’s systems revenue is from foundry/logic vs. memory. In 2021 they expect a similar split for system revenue between foundry/logic and memory, for Applied. They expect memory spending to be stable into next year.
• They continue to see no meaningful impact on their business from the new US government restrictions on sales to China
• Investment they are seeing from their memory customers is on technology transitions and not into additional wafer starts
• Calendar 2020 first half; their DRAM was up 20% and NAND was up 14%, both compared to the same period the year before


Summary

It is still early in the WFE-purchase part of the memory cycle and Applied is threatening to break their previous record for quarterly revenue. Growth in sales and earnings is quite strong, up 23% and almost 50%, respectively, from a year ago. Gross margin percent is, and will continue to be, in the mid-40s. The company is a combination of a WFE sales business (two-thirds of revenue), equipment maintenance services (about a quarter of revenue), and display equipment (the rest). WFE is growing the fastest, followed by Services. Services is subscription-like and will naturally trail WFE sales, because buyers don’t need to purchase service contracts immediately on new equipment. Their display business is flat. In the coming year, the company is forecasting memory and logic to grow at similar rates. I think they are being conservative here, as I believe memory, particularly DRAM, will start to recover in early calendar 2021. Memory companies will start to make plans for higher capital equipment spending when the recovery becomes clear, leading to an increase in orders in the Spring of 2021. Whatever the exact timing turns out to be, I think by this time next year sales to memory companies will be brisk and outgrowing foundry sales. The next upturn in memory will lead to Applied handily beating their previous financial performance records. The future continues to be bright for this company.


-S. Hughes (no AMAT position)
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