Applied Materials' (AMAT) fourth quarter pro forma earnings of 6 cents beat the Zacks Consensus Estimate by 3 cents. Revenues were partly responsible, beating consensus expectations by 4.2%.

Revenue

Applied reported revenue of $1.65 billion, which was down 29.7% sequentially and 24.6% year over year, at the low end of the 25-40% decline. The outperformance versus expectations was on account of better-than-expected results in the SSG segment, which offset the worse-than-expected results in the other segments.

Revenue by Segment

The SSG segment revenue slid 43.7% sequentially and 18.5% year over year to 53% of total revenue. The decline was broad-based across foundry, memory and logic customers. Logic appears to be the most steady at the moment, though foundry is also expected to be up in the next quarter.

Intel's (INTC) Ultrabook partners and Microsoft's (MSFT) Windows 8 adopters may be expected to help demand. The transition to smaller geometries will continue to drive demand in fiscal 2013. Applied generally sees seasonal strength in the second and fourth quarters of its fiscal year, with weakness in the fourth and first.

The second largest segment was AGS with a 38% revenue share. Segment revenue was up 7.3% sequentially and down 1.3% year over year, missing the mid-point of Applied's expectations of a 5-15% sequential increase, despite a $10 million outperformance in the thin film line. Segment weakness was related to lower wafer starts and lower utilization rates at semiconductor fabs.

The 34.5% sequential and 45.6% year-over-year declines in the Display segment was within management's very broad guidance range of a sequential decline of 25-40%. Segment contribution remained at 6%. Demand for mobile devices (high-resolution mobile displays for tablets and touch panels for ultrabooks) were again the driver for the segment in the last quarter, which was however offset by weakness on the TV side.

However, management appeared optimistic about resurgent TV demand in the next quarter. Applied's expanding product line is partly responsible for the increased total available market (TAM), which will spur growth in following quarters.

The EES segment accounted for 4% of total quarterly revenue, down 19.5% sequentially, 80.3% from last year and more or less in line with management's guidance of a 10-30% sequential decline. The weakness in the last quarter was because of protracted weakness in solar (due to overcapacity and weaker-than-expected demand), which had management write down EES goodwill by $425 million.

Revenue by Geography

Around 73% of Applied's quarterly revenue came from the Asia/Pacific region, with the largest contribution from Taiwan, which generated 28% and followed by China, which generated 12%. Applied saw double-digit sequential declines across all regions in Asia. North America also declined 15.4%. Europe was the bright spot, growing 47.3%.

Orders

Total orders were down 18.6% sequentially and 8.2% year over year. Orders grew across all except the SSG segment (in line with normal seasonality). SSG was down 36.4% sequentially and 19.9% year over year.

The AGS, Display and EES segments increased 8.5%, 23.9% and 85.7%, respectively on a sequential basis, while growing 2.1%, 315.0% and -24.4%, respectively from last year. The net result was a negative BTB across all except the EES segment, with SSG coming in weakest, followed by Display and then AGS.

Orders declined across all geographies except Japan and North America, which were up sequentially by 43.8% and 3.6%, respectively.

Margins

Applied generated a gross margin of 38.4%, down 317 basis points (bps) from the previous quarter's 41.6%, hurt by weaker volumes. The gross margin was down 125 bps from the year-ago quarter. 

Applied's operating expenses of $518 million were down 4.6% from the June 2012 quarter, but not enough to prevent the operating margin sliding 1,147 bps sequentially (1,067 bps year over year) to 6.9%. Lower volumes impacted results, with all expenses increasing as a percentage of sales.  

Net Profit

On a pro forma basis, Applied Materials had a net income of $70 million, or a 4.3% net income margin compared to $300 million, or 12.8% in the previous quarter and $271 million, or 12.4% in the fourth quarter of fiscal 2011.

The fully diluted pro forma earnings were 6 cents a share compared to earnings of 24 cents in the previous quarter and 20 cents in the comparable prior-year quarter. Our pro forma estimate excludes restructuring, acquisition-related, goodwill impairment and other charges and tax adjustments 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 loss of $515 million (-$0.42 per share) compared to income of $218 million ($0.17 per share) in the previous quarter and $466 million ($0.35 per share) in the year-ago quarter.

Balance Sheet

Despite the 7.8% decline in inventories, inventory turns dropped from 4.0X to 3.2X. Days sales outstanding (DSOs) went from 60 to 67. The cash and short term investments balance was $1.94 billion at quarter-end, having dropped $227 million during the quarter. Goodwill was 29.1% of total assets in the last quarter.

The company generated $411 million of cash from operations, spent $41 million on capex, $516 million on share repurchases and $111 million on dividends. At quarter-end, Applied had $1.95 billion of debt on its balance sheet, with a net debt position of $9 million. The debt cap ratio including long term liabilities and short term debt was just 26.5%.

Guidance

Applied expects revenues and orders to bottom in the fiscal fourth quarter unless there is further weakening of the global economy. It currently expects SSG to be up 0-10% sequentially, AGS to be down 15-25% (as the $85 million contribution from the thin film solar line will be absent in the next quarter), Display to be down 0-30% (due to the TV capacity ramp being pushed out another quarter) and EES to be down more than 30%. The net effect will be a 0-15% sequential decline in revenue.

The non-GAAP EPS (excluding 5 cents of acquisition-related charges) is expected to come in at 0-6 cents a share. The Zacks Consensus Estimate for the October quarter was 10 cents when the company provided guidance, much above the high end of the guided range.

Conclusion

Applied's results in the last quarter were better than expected, although both revenue and earnings projections for the next quarter were well below expectations. While management did show optimism about a turnaround and order rates do look positive (especially in Display), growth is likely to remain muted for another quarter.

The last two years have seen revenue decline across all segments, as the company continues to battle with the cyclical industry, as well as caution and increased efficiency at customers. Since Applied is a company with significant fixed costs, the bottom line has also taken a beating.

Additionally, the solar business has shrunk 90.3% from over 22% of its revenue in the January quarter of 2011 to a little over 4% in the last quarter. If the solar business had taken off, it would have been a competitive edge for Applied, but in the current environment, it is actually turning into a negative for the company.

In contrast, companies like KLA Tencor (KLAC) and Lam Research (LRCX) are not weighed down by solar exposure. KLA in particular has gained from the demand for increased efficiency in the soft demand environment. These Zacks #3 Rank stocks are therefore better plays on the equipment sector.

The fact that guided numbers were below expectations will tell on Applied's earnings estimate revisions, which will therefore keep the Zacks Rank under pressure Applied shares currently have a Zacks Rank of #4 (Sell rating in the next 1-3 months).



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