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November 12, 2020

Financial Results

Statement of Operations

Quarter-over-quarter revenue for Applied grew almost 25% (to $4.69B), and year-over-year revenue grew 17% (to $17.2B). Gross margin expanded 190 bps Q/Q and 100 bps Y/Y, to 45.4% and 44.7%, respectively. Operating expenses grew more slowly than sales, leading to a 50% increase in operating income in the quarter. Applied’s tax rate of 13% for the year is down significantly from 2019. EPS for the quarter was $1.23 and for the year it was $3.92. Share count declined 2.3% from a year ago. This was a record for quarterly and annual earnings per share. While sales and earnings are at similar levels to the last peak in Spring of 2018, they have reduced the share count 13% from that time, leading to higher EPS. These record results are encouraging for the future as Applied should continue to scale up revenue at a faster pace than their operating expenses, and to some degree their COGS.

Statement of Cash Flows

Applied generated a lot of cash this year and let much of it pile up on their balance sheet. Cash from operations was $3.8B, up 20% from last year, even with 4x higher investment in working capital compared to 2019. As I mentioned last quarter, much of this is COVID-related and will reverse over coming quarters, but some is investment in a fast-growing business. For the year, they harvested a net of $300M from investments and kept debt about the same (thought they turned over $2.9B for better terms). They invested about 10% more in capital expenditures than was shed in depreciation and amortization, similar to last year. This is also to be expected in a business that is growing revenue as quickly as Applied is. For the year, the company generated $2,968M in cash flow available to owners. This figure starts with cash from operations, adds the cash cost of share-based compensation back in, and nets out investment and debt changes. I want this number to be an estimate of how much cash flow would be available to me if I owned the whole company. This $2,968M is $3.21 per share in cash generation, or 3.6% at a share price of $88.30. For fiscal year 2020, management returned half of this (48%) to shareholders in dividends and share buy-backs.

Balance Sheet

Applied has allowed their cash balance to swell to $5,351M, up by two-thirds from a year ago. Debt is about the same as at this point last year, $5,448M, so net cash for the company is about zero. PP&E and working capital both increased some, as expected in a growing business like this one. The increase in their cash balance, and the steady-state of the rest of their balance sheet, means book value increased by a similar amount as their cash balance did. Book value now stands at $10,578M, or $11.46 per share.

Earnings Call Notes

Unless otherwise specified, financial information is non-GAAP

Gary Dickerson (CEO) prepared remarks

• Specialty foundry markets underperformed the rest of the industry because of weakness in automotive and industrial this year, and they anticipate a recovery in this sector in the coming year
• Memory grew slightly faster than logic in 2020, with NAND outgrowing DRAM. They expect DRAM to significantly outgrow NAND in 2021.
• Overall, Applied is outgrowing the market. The midpoint of their guidance will be up 12% quarter-over-quarter.
• Applied global services reached record levels this year. 60% of their parts and services businesses is from contracts and the renewal rates on these contracts is greater than 90%.

Dan Dern (CFO) prepared remarks

• They have now shipped all of the backlog from earlier in the year, thus current forecasts are a clean look a demand today
• Q4 revenue and Q1 guidance was reduced by the new restrictions from the U.S. government on shipments to SMIC. They have applied for licenses to ship to this customer.
• Share repurchases for the year were at an average price of $56.32
• The $2B increase in their cash balance is in anticipation of the closing of the Kokusai Electric purchase transaction
• They are now seeing the leading indicators of the recovery of the display business
• Q1 outlook (non-GAAP): Revenue = $4.95B +/- $200M, EPS = $1.26 +/-$0.06, Systems revenue = $3.45B (up 23% Y/Y), Services revenue = $1.07B (up 7% Y/Y), Display revenue = $400M, GM = 45.3%. Slightly lower sequential GM is from changes in product mix. Their tax rate is expected to be 12%.

Question and Answer

• DRAM is “a couple points higher” in growth rate than the rest of the industry, so they are growing market share currently in DRAM
• Spend in China is slightly weighted to domestic companies vs. multinationals. Overall growth in 2021 will slow down vs. 2020 with spending from multinationals outpacing domestic manufacturers.
• They expect their long-term gross margin to be 45% +/- 2%, depending where they are in the cycle
• Their CEO said several times how they believe classic Moore’s Law scaling is at an inflection point and the technologies and products Applied creates position them uniquely to benefit from this. Said another way, they believe they will gain WFE market share in the new paradigm.
• Domestic China for the year in the $9B to $10B range
• They “remain optimistic” that the final regulatory approval of the Kokusai purchase will be granted by the end of calendar 2020
• 12% is a good number for WFE spending capital intensity. The all-time high was 17% during the 300mm conversion. The low was 9% in 2013 and it has been on a steady upward trend since then. They believe there is a secular trend upward since the low in 2013.
• In 2020, NAND is growing 2x the industry, making 2020 a growth year for memory. This seems a bit of an exaggeration to me, given the low level of DRAM spending in 2020. Foundry/logic spending is 55% of total in 2020 and expected to be similar in 2021. DRAM is expected to outgrow the market in 2021.


The WFE companies are all running together for me in the past few quarters. It seems every release they are breaking records for revenues and earnings. This year for Applied was a record in revenue and earnings per share, near the peak levels reached in 2018. They have reduced share count since then so the EPS record has a little financial engineering in it, but not much. The fraction of Applied’s business that comes from the recurring revenue of services continues to grow. Their long-term gross margin target is 45%. During the Q&A, their CEO intimated that WFE intensity in the semiconductor business (the fraction of annual semiconductor revenue that is spent on WFE) will continue the trend up that started in 2013. I can think of two reasons this would happen. First, to continue scaling process technology will require equipment spending per wafer to increase faster than productivity, leading to the fraction of fab wafer cost going to equipment to increase. The companies that build and run fabs will do everything they can to slow or stop this phenomenon, as it erodes their margins. The second reason capital intensity could be growing is the installed base of fabs in the world is outrunning global semiconductor sales right now. This seems more plausible, given the diversification in end-uses for semiconductors that is happening. If this is the reason for the trend up in capital intensity, it has to end eventually, when fab capacity catches up with the overall needs of the industry. I think China is a significant driver of that growth in capital intensity as well, a subset of my second reason. China’s semiconductor ambitions are funding the construction of many fabs in the Middle Kingdom that aren’t supported by revenue. I think many of these would-be Chinese semiconductor companies are going to have a hard landing in the next couple years as they continue to miss production milestones and bleed out rivers of money. That will be a one-time shock to the WFE makers as several billion dollars a year of revenue ceases. However, I don’t think that year is next year. With DRAM in recovery and the foundry/logic market oversubscribed right now, 2021 is setting up to be a record year across the semiconductor space, for equipment makers, manufacturers, and fabless companies.

-Smooth Hughes (no AMAT position)
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