Analyst Conference Call Summary

semiconductors

conference date: August 18, 2016 @ 1:30 PM Pacific Time
for quarter ending: August 1, 2016 (third quarter, Q3 fiscal 2016)

Forward-looking statements

Overview: Record EPS. Record new orders. Looking bright and undervalued.

Basic data (GAAP) :

Revenues were $2.82 billion, up 15% sequentially from $2.45 billion and up 13% from $2.49 billion in the year-earlier quarter.

Net income was $505 million, up 58% sequentially from $320 million and up 53% from $329 million year-earlier.

EPS (diluted earnings per share) were $0.46, up 59% sequentially from $0.29 and up 70% from $0.27 year-earlier.

Guidance:

Fiscal Q4 2016 revenue up 15% to 19% sequentially. Non-GAAP diluted EPS between $0.61 and $0.69. Semiconductor revenue up 19-26%, AGS 3-6%, display 30 to 40%.

Conference Highlights:

“We are in the early stages of large, multi-year industry inflections that are driving our business today and creating new opportunities for future growth.” said Gary Dickerson, CEO. "Can beat this earnings record again in the fourth quarter. . . our strategy positions Applied for sustained long term growth." Believes gaining market share, and particularly in new technologies like its e-beam inspection system.

Dramatic advances are taking place in display and semiconductor technologies. Move to 10 nm and then 7 nm favors Applied Materials, as does 3D NAND. China is also a long-term growth opportunity. Believes 2017 wafer fab equipment spending across the industry will be up from both 2016 and 2017.

New order total was $3.66 billion, up 6% sequentially from $3.45 billion and up 26% from $2.89 billion year-earlier.

Non-GAAP numbers: net income $550 million, up 46% sequentially from $376 million, and up 34% from $410 million year-earlier. EPS $0.50, up 47% sequentially from $0.34, and up 52% from $0.33 year-earlier. 43.7% gross margin. 22.8% operating margin.

The backlog was $4.95 billion, up 19% sequentially from $4.17 billion. 50% was in Silicon Systems, 15% in Services, 33% in Display, and 2% in other. Silicon Systems backlog is the highest in 9 years.

GAAP gross margin was 42.3%, operating margin was 21.1%.

Silicon Systems Group (SSG) segment sales were $1.79 billion, up 13% sequentially from $1.59 billion, and up 9% from $1.64 billion year-earlier. Orders were $2.22 billion, up % from $2.01 billion year earlier. Orders by type: Foundry 57%, DRAM 14%, Flash 15%, Logic and other 14%, representing a shift from Flash to Foundry.

Applied Global Services (AGS) revenue was $657 million, up sequentially from $648 million and up from $646 million year earlier. Orders were $590 million, down sequentially from $636 million, but up y/y from $543 million.

Display segment revenue was $313 million, up 87% sequentially from $167 million and up 69% from $185 million year-earlier. New orders were $803 million. Moving to OLED. Thin film encapsulation is a difficult technology that Applied Materials leads in. Expects display orders to continue strong for rest of year.

Energy and Environmental Solutions (EES) [solar] revenue will no longer be reported, moved in part to Display and the rest to Corporate and Other.

Cash and equivalents (including long-term investments) balance ended at $4.26 billion, up sequentially from $3.57 billion. Cash flow from operating activities was $981 million. Capital expenditures were $50 million. $108 million was used for cash dividends. Long-term debt was $3.34 billion. $196 million was used to repurchase stock in the quarter. Non-cash share-based compensation was $48 million.

Cost of goods sold was $1.63 billion, leaving gross margin of $1.19 billion. Operating expenses of $596 million consisted of: research and development $386 million; selling and marketing, $107 million; general and administrative $103 million. Leaving income from operations of $596 million. Interest and other expense net $32 million. Income tax $59 million.

Q&A:

Are you gaining market share in semiconductor? Shipments tend to be strong to foundry in Q1 and Q2, but shifted to later this year. We gained share in memory, DRAM, NAND. So we benefit from both our own share improvement, which we will not specify, and the general seasonal improvement in the market.

TAM is growing significantly in 7 nm and 10 nm, and we are early in the adoption of those. We have many products that are being strongly adopted for these new nodes. 3D NAND is materials enabled, not lithography enabled, so it should be a great share gain year for us.

Strong Q4 and Q1 statement, does that mean there won't be sequential declines? I'm not sure that Q4 and Q1 will be quite as strong as Q3.

DRAM was down a little bit this year, could be up a little bit next year. But it is now the smallest memory part, NAND is bigger and is growing.

Memory orders decline in Q3? That is just lumpy. We had a huge number in Q2 because people wanted into the production queue. Q3 was not as strong, but demand is still strong, with there still being a rush to change over to 3D NAND.

Gross margins? We have been improving, but the mix of display, which has lower margins, has slowed down progress. We still could hit 2018 goals, it depends on the mix of products.

Any further opportunity in LCD? Core LCD display orders have held up better than we expected, but the opportunity is in OLED. We are in pretty early innings in OLED. We have enriched that opportunity for us by developing new products for it.

All of our customers are targeting 7 nm as a big node. They are in a race to be in position as the node ramps. Their customers are taping it out. Foundry is in pretty good shape for next year and appears more sustainable than was thought a few years ago.

China is looking to increase domestic content and also provide security. So it looks like a good opportunity going forward.

We have been guiding EPS for Q3 significantly ahead of Street consensus. So what changed? The market in terms of type of equipment needed to be at the leading edge. Our products are very well positioned now. We believe we will outgrow by several points the markets in which we are competing, as a result of higher R&D investments and better new products, even disruptive products. Plus we can see our own products in our pipeline. Materials innovation is the fundamental driver.

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