(AMAT) Applied Materials Sees 50% Growth in 2010

Applied Materials’ (AMAT) first quarter earnings were in line with the Zacks Consensus Estimate.

Revenue

Revenue of $1.85 billion was up 21.1% sequentially and 38.7% year over year. The year-over-year increase in revenue came after seven quarters of double-digit decline and was reflective of the turnaround in the capital equipment market.

Revenue by Segment

Display was the weakest segment in the last quarter, declining both sequentially and on a year-over-year basis. All other segments grew both sequentially and year over year.

Silicon Systems (SSG) remains the largest segment, with a 52% revenue share. Segment revenue increased 47.9% sequentially and 77.7% year over year. Strength at memory customers was the primary reason for the very strong growth in this segment, as memory manufacturers’ transition to more advanced processes and products also see very strong demand at end customers. The scarcity of products is in fact driving memory manufacturers to consider capacity expansions, which should drive further growth in this segment. Additionally, the company’s advanced technologies are helping it gain market share. The above conditions are also resulting in steady DRAM and NAND prices, providing an impetus to investment by flash memory and foundry customers.

The second largest segment was Applied Global Services (AGS), which generated 23% of total revenue. Segment revenue increased 9.2% sequentially and 23.5% year over year. The company saw strength in spares sales, especially in Asia.

Energy and Environmental Systems (EES) was the third, with a 17% revenue share Incorporatedreasing 14.6% sequentially and declining 9.6% year over year. The solar photovoltaic market started looking up in the fiscal fourth quarter, with module prices continuing to stabilize in the last quarter and financing opportunities continuing to open up. Management is beginning to see demand in China and European countries other than Germany (which was an early adopter of solar technology).

The smallest segment, Display, generated around 7% of revenue, down 34.0% sequentially and 11.4% year over year. The decline in the last quarter was partly due to seasonality and partly due to the fact that customers are preparing for the ramp of 8.5 generation LCD panels, which are expected to start ramping in the fiscal second quarter. Management stated that demand for TVs and LCD monitors was very strong, especially in China. With utilization rates remaining high (in the 90% range) and its largest customers returning to profitability, strength in this market should be sustained.

Revenue by Geography

Around 70% of revenue came from the Asia-Pacific region, with the largest contribution from Taiwan, which generated 28% of revenue and grew 61.5% sequentially. Europe accounted for 17% of revenue in the last quarter (up 105.9% sequentially) and North America the remaining 13% (up 5.0%). There were pockets of weakness in Asia, due to the same reasons as explained in the segment discussion above.

Orders

Total orders were up 33.5% sequentially and 117.6% year over year. The SSG segment was the major driver of orders, registering a sequential growth of 80.4%. Display and EES orders declined with book-to-bill ratios below unity. The overall backlog increased 6.2% sequentially, after declines in the preceding three quarters.

Taiwan witnessed the strongest sequential increase in orders (up 174.6%), followed by Europe (69.6%), Japan (36.3%), Korea (21.1%) and North America 12.5%. Orders from other South East Asian countries including China declined 45.8%.

Margins

Gross margin for the quarter was 39.9%, up 179 basis points (bps) from the previous quarter’s 38.1%. The gross margin improvement was due to higher volumes and a better mix of business, as the higher-margin businesses performed relatively better. Gross margin was up 855 bps from the year-ago quarter, mainly due to higher volumes.

Operating expenses of $481.1 million were a bit higher than the previous quarter’s $389.6 million. However, the operating margin expanded 129 bps sequentially and 1,664 bps year over year. The sequential improvement was primarily attributable to lower S&M expenses (as a percentage of sales), helped by the higher gross margin and lower R&D (as a percentage of sales), partially offset by higher G&A (as a percentage of sales). All expenses as a percentage of sales were down from the year-ago quarter.

On a sequential basis, the SSG operating margin improved 746 bps, while AGS, Display and EES declined 162 bps, 256 bps and 50 bps, respectively.

Net Profit

On a pro forma basis, Applied Materials had a net income of $179.0 million, or a 9.7% net income margin compared to $154.9 million, or 10.1% in the previous quarter and loss of $27.7 million or 2.1% in the first quarter of last year.

Fully diluted pro forma earnings per share (EPS) were 13 cents compared to 11 cents in the October 2009 quarter and -2 cents in the comparable prior-year quarter. Our pro forma estimate excludes restructuring charges, acquisition-related charges and impairment of investments on a tax-adjusted basis in the last quarter. Our pro forma estimate may not match management’s presentation due to the addition/exclusion of some items not considered by management.

On a fully diluted GAAP basis, the company recorded a net income of $82.8 million (6 cents per share) compared to $137.9 million (10 cents per share) in the previous quarter and a net loss of $132.9 million (10 cents per share) in the prior-year quarter.

Balance Sheet

Inventories were up 2.3% sequentially, with inventory turns increasing from 2.3X to 2.7X. Days sales outstanding (DSOs) were flat at around 62 days in the January quarter. The cash and short term investments balance was $2.15 billion at quarter-end, down $60.6 million during the quarter. The company generated $366.9 million of cash from operations, spent $53.2 million on capex, $322.6 million on the Semitool acquisition and paid $80.5 million in dividends. At quarter-end, Applied Materials had $210.5 million of debt on its balance sheet, or a net cash position of $1.94 billion.

Guidance

Management provided guidance for the second quarter. Accordingly, revenue is expected to increase 15?25%, with SSG growing more than 25%, AGS more than 10%, display to more than double and EES to decline by more than 25%. The non-GAAP EPS is expected to be 17?22 cents a share.

Full year sales are expected to be up 50% (better than the previous forecast of 30%), with SSG growing more than 100%, AGS growing by around 30%, Display up by around 30% and EES flat to +/-10%. The tax rate for the year is expected to be 31?33%.

Estimate Revisions

The Zacks Consensus Estimate was 15 cents for the second quarter and 63 cents for the year when Applied Materials released guidance. However, 17 of the 21 analysts covering the stock have already raised estimates for the quarter and 12 have raised for the year. There were no downward revisions for the upcoming quarter (April), although five analysts have lowered estimates for the next quarter (July) and four for the year. The revisions resulted in the Zacks Consensus estimates for the next quarter and the year going up to 20 cents and 69 cents, respectively.

Given the strong results and encouraging guidance, it is not surprising that most analysts have made upward revisions to their estimates. Moreover, market research firms have also forecasted significant revenue growth opportunities for equipment companies in 2010. Therefore, the positive effect has now been factored into the estimates.

Additionally, although the earnings surprise history is encouraging, averaging a positive 104.45% in the last four quarters, there was no surprise in the last quarter. We believe the accuracy of estimates for AMAT is increasing, due to an increasing clarity about market demand. Therefore, we believe near term upside will be limited.

Thus we have a Zacks Rank of #3 allotted to the shares, indicating a short term Hold recommendation.

Zacks Investment Research

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