Analyst Conference Call Summary

semiconductors

conference date: May 17, 2018 @ 1:30 PM Pacific Time
for quarter ending: April 29, 2018 (second quarter, Q2 fiscal 2018)

Forward-looking statements

Overview: Record quarter with very rapid increase in revenue growth.

Basic data (GAAP) :

Revenues were $4.57 billion, up 9% sequentially from $4.20 billion and up 29% from $3.55 billion in the year-earlier quarter.

Net income was $1.13 billion, way up sequentially from $135 million and up 37% from $824 million year-earlier.

EPS (diluted earnings per share) were $1.09, up sequentially from $0.13 and up 43% from $0.76 year-earlier.

Guidance:

"In the third quarter of fiscal 2018, Applied expects net sales to be in the range of $4.33 billion to $4.53 billion; the midpoint of the range would be an increase of approximately 18 percent, year over year. Non-GAAP adjusted diluted EPS is expected to be in the range of $1.13 to $1.21; the midpoint of the range would be an increase of approximately 36 percent, year over year."

On track to reach over $5.00 non-GAAP EPS in 2020.

Conference Highlights:

Gary Dickerson, CEO, said "“Applied’s performance in the second fiscal quarter was another all-time record for the company, which demonstrates strong execution and customer pull for materials solutions that help accelerate roadmaps and bring new devices to market faster. Applied has the broadest opportunity across major technology trends, and our markets are strong, with long-term growth drivers firmly in place.”

Smartphone sales have been below expectations, particularly at high end, resulting in some rational demand reduction for Applied and its customers. The long-term trend is still for higher semiconductor content per device over time. Artificial Intelligence, however, is driving new growth, and cloud service providers have increased their capital investments. Server DRAM growth is outpacing mobile DRAM growth. Shift from general purpose computing to customized for specific tasks. Reduced expectations for NAND spending in 2018, but still growing. China spending is expected to continue to ramp for Applied. Internet of Things and Automotive are also high growth areas for semiconductors.

"Long-term demand drivers [are] firmly in place." Applied's customers are adding capacity in a disciplined manner.

Non-GAAP numbers: net income $1.27 billion, up 11% sequentially from $1.14 billion, and up 48% from $861 million year-earlier. EPS $1.22, up 15% sequentially from $1.06, and up 54% from $0.79 year-earlier. 46.7% gross margin, up from 46.3% year-earlier. 30.2% operating margin, up from 27.8% year-earlier.

Semiconductor Systems sales were $3.00 billion, up 5% sequentially from $2.85 billion, and up 25% from $2.40 billion year-earlier. Revenue by type, as % of total: Foundry 21%, DRAM 31%, Flash 37%, logic and other 11%. Segment operating income was $1.07 billion or $1.12 billion non-GAAP, margin was 35.7% or 37.2% non-GAAP.

Applied Global Services (AGS) revenue was $943 million, up 7% sequentially from $880 million and up 30% from $724 million year earlier. Operating income was $278 million or $278 million non-GAAP.

Display segment revenue was $600 million, down 32% sequentially from $455 million and up 53% from $391 million year-earlier. Non-GAAP operating income was $166 million, with a 27.7% gross margin. Demand being driven by Gen 10.5 and OLED displays. Display equipment ramp has been slower than expected due to slower sales of high-end phones, but OLED should continue to gain ground. Sees 30% growth in 2018, followed by a slight drop in 2019.

Cash and equivalents (including long-term investments) balance ended at $6.90 billion, up sequentially from $8.67 billion. Cash flow from operating activities was $611 million. Capital expenditures were $121 million. $105 million was used for cash dividends. Long-term debt was $5.3 billion. $2.5 billion was used to repurchase stock in the quarter.

Total backlog was $ billion, consisting of: Semiconductor $ billion; services $ billion; display $ billion.

Cost of goods sold was $2.48 billion, leaving gross profit of $2.09 billion. Operating expenses of $763 million consisted of: research and development $509 million; selling and marketing, $130 million; general and administrative $124 million. Leaving income from operations of $1.33 billion. Interest and other expense net $80 million. Income tax $166 million.

Q&A:

Smartphone weakness vs. WFE $100 billion 2018-2019 outlook? We believe our end markets are sustainably strong. We are seeing balanced markets, strength across all device types. Fundamentals are strong into 2019.

LCD vs. OLED mix in Q3? It is a good adjacent market for Applied. Looks like greater than 30% revenue growth in 2018, then a drop of 15 to 20% in 2019, based on customer feedback. There are long lead times for Gen 10.5 projects, but each machine produces more screens. We have a pipeline of new display capabilities.

"Disciplined" industry comments? Using memory to illustrate, end-market demand is strong. Customers are healthy, investing a lot but very profitable. Investments are lead by demand. DRAM supply growth was below demand growth in 2017, in 2018 expected to be balanced. "China is emerging as a spender; their strategic intent is clear."

2020 target reiteration v. display lowered guidance? We have new products that will be introduced. We are well on track to go over $5.00 EPS in fiscal 2020.

Lots of repetition.

Guided sequential declines in semi vs. competitors? WFE is up y/y. We see strong double digit growth in each segment. We see a dip in semi in Q3, followed by being back up in Q4. Don't read to much into any one quarter.

Margin differences between LCD and OLED? No consistent difference in the margins. We are driving our long-term margins.

What is the potential downside? We model many scenarios. Even a downside scenario in 2019 would leave earnings above 2017 levels.

China is growing, but it is not yet investing much at the leading edge. It is growing is capability in older, higher nm tech.

Inventory increase? Just to deal with a growing business, including the growth of our services business.

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