Analyst Conference Call Summary

semiconductors

conference date: February 15, 2017 @ 1:30 PM Pacific Time
for quarter ending: January 29, 2017 (first quarter, Q1 fiscal 2017)

Forward-looking statements

Overview: Record orders and revenue (for a Q1) as strategy continues to pay off.

Basic data (GAAP) :

Revenues were $3.28 billion, down 1% sequentially from $3.30 billion and up 45% from $2.26 billion in the year-earlier quarter.

Net income was $703 million, up 15% sequentially from $610 million and up 146% from $286 million year-earlier.

EPS (diluted earnings per share) were $0.65, up 16% sequentially from $0.56 and up 160% from $0.25 year-earlier.

Guidance:

"In the second quarter of fiscal 2017, Applied expects net sales to be in the range of $3.45 billion to $3.60 billion; the midpoint of the range would be an increase of approximately 44 percent, year over year. Non-GAAP adjusted diluted EPS is expected to be in the range of $0.72 to $0.80; the midpoint of the range would be an increase of approximately 124 percent, year over year."

Conference Highlights:

"Our inflection-focused innovation strategy is delivering results and we are increasingly confident that we can maintain our trajectory of sustainable growth and raise the ceiling on our performance,” said Gary Dickerson, CEO. Display opportunity in 2017 is likely a billion dollars above prior estimate.

There are five large inflections taking place driving Applied Materials' growth. 7 nm technologies; 3D NAND; patterning on smaller chip geometries, excluding EUV; advanced display in large format TVs with GEN 10.5 and OLED for mobile screens; and China.

Results reflect the past decision to invest in specific new products to address the changing semiconductor materials landscape.

New order total was $4.24 billion, up 40% sequentially from $3.03 billion and up 86% from $2.28 billion year-earlier.

Non-GAAP numbers: net income $732 million, up 1% sequentially from $722 million, and up 142% from $302 million year-earlier. EPS $0.67, up 2% sequentially from $0.66, and up 158% from $0.26 year-earlier. 45.4% gross margin, up from 42.4% year-earlier. 26.0% operating margin, up from 17.8% year-earlier.

The backlog was $ billion, down % sequentially from $4.58 billion. % was in Semiconductor Systems, % in Services, % in Display, and % in other.

GAAP gross margin was %, operating margin was %.

Semiconductor Systems [formerly Silicon Systems Group] segment gained about 2 points of market share in 2016. Fiscal Q1 sales were $2.15 billion, up 1% sequentially from $2.13 billion, and up 57% from $1.37 billion year-earlier. Orders were $2.76 billion, up 116% from $1.28 billion year earlier. Orders by type: Foundry 41%, DRAM 14%, Flash 37%, Logic and other 8%. Highest orders ever in Etch, CVC, and diagnostics.

Applied Global Services (AGS) revenue was $676 million, down 2% sequentially from $693 million and up 12% from $606 million year earlier. Orders were $826 million, up sequentially from $794 million, and up y/y from $755 million.

Display segment revenue was $422 million, down 7% sequentially from $452 million and up 66% from $254 million year-earlier. New orders were $632 million. Moving to OLED. Thin film encapsulation is a difficult technology that Applied Materials leads in.

Cash and equivalents (including long-term investments) balance ended at $5.1 billion, up sequentially from $4.68 billion. Cash flow from operating activities was $646 million. Capital expenditures were $64 million. $108 million was used for cash dividends. Long-term debt was $3.13 billion. $130 million was used to repurchase stock in the quarter. Non-cash share-based compensation was $54 million.

Cost of goods sold was $1.83 billion, leaving gross profit of $1.45 billion. Operating expenses of $638 million consisted of: research and development $417 million; selling and marketing, $118 million; general and administrative $103 million. Leaving income from operations of $807 million. Interest and other expense net $36 million. Income tax $68 million.

Addressed investor concerns about the past highly cyclic nature of the industry. Believes is more steady and less cyclic now.

Q&A:

We see 2017 as another good year, with rapid growth in all three segments.

Display linearity by quarter? We thought 16 would be about the same as 17, but the total market is going up faster than the earlier prediction. TV is coming back strong, 55% vs. 45% mobile, with mobile also growing. Revenue should be strong for the year, with Q3 a bit stronger than Q2. We took materials engineering into an adjacent market. We have had a 5x increase in Display orders in 4 years. As we go forward we can see tripling our served market. We will announce some new products in 2017, with tremendous customer interest.

Second half of the year, given predictions of full industry? We are on track to get to 25% market share. We are implying the first half is strong, but the second half is firming up with orders as we go along. We also see 2018 and 2019 having major growth drivers.

Investor scepticism on China spending in 2018? In 2017 we are seeing spend in China up maybe 10% up over 2016, led by display. In 2018 and 2019 we see very strong semi growth. We hear there is a big strategic drive in investment to address the domestic demand situation. There is a long term strategy to advance the technologies and production volumes.

How much of display guidance orders are from China? $2 billion in display total will include a lot of orders out of China for TVs. In fact "the majority of the display stuff is probably China ... no ... maybe half is China."

Book to Bill for display? Will be north of 1 in 2017. In 2016 it was like 1.6 to 1.7, but that will trend down after a while. OLED bookings were 65% of total in 2016.

We had a base model of 44.6% gross margin, and had not gained much until this quarter, and we think we will at least keep that in 2017. We also are making progress on the operating margin. But we are not going to redo the model today, but we are confident we can hit or exceed the model.

3D NAND market opportunity? We gained 2 points of share in 2016, strongest gains were in 3D NAND. It is materials enabled scaling vs. litho enabled. CEOs of NAND companies are very bullish about demand. We increased our TAM by a factor of 3. We focus on inflections, delivering new capabilities, so 40% of our revenue is from products introduced in the last 3 years. E-beam products were up 33%. Future generations of 3D NAND are about materials innovation. Pull from customers is "earlier, deeper and broader."

This was an interesting year in foundry. Trailing edge, 20 nm and larger, will be 40%. The foundry leader is spending strong in 2017. In 2018 we expect more trailing edge spending, but leading edge for 10 nm and 7 nm should continue and broaden beyond the largest foundries.

Beyond 7 nm, customers will be able create devices in ways never done before. The opportunies for our new products will become even larger.

We will be returning more money to investors. We are waiting for clarification of the tax laws.

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