Applied Materials Q3
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Applied Materials Q3
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(FOOL CONFERENCE CALL SYNOPSIS)* By Dale Wettlaufer (MF Raleigh)
Applied Materials <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: AMAT)") else Response.Write("(NASDAQ: AMAT)") end if %> BUFFALO, NY, August 26, 1996 /FOOLWIRE/--Applied Materials, Inc. reported (on August 13) results for the third fiscal quarter ended July 28, 1996, with net sales of $1.115 billion, which increased 24 percent from $898 million for the third fiscal quarter of 1995. Net income increased 21 percent to $169 million, or $0.92 per share, for the third fiscal quarter of 1996, from $139 million, or $0.78 per share, for the third fiscal quarter of 1995. New orders of $931 million were booked during the third fiscal quarter, down 7 percent from $1.006 billion in the third fiscal quarter of 1995. Backlog declined to $1.663 billion at the end of the third fiscal quarter of 1996 from $1.901 billion at the end of the second fiscal quarter of 1996.
Year-to-date revenues are up 58% to $3.28 billion; net income through three quarters equals $527 million (16% net margin), up 76%. EPS through three quarters is up 67% at $2.86. Q3 revenues were down about 1% sequentially. Sales breakdown was as follows: N. America, 29%; Europe, 9%; Japan, 26%; Korea, 21%; and Asia/Pacific, 15%. Shipments in the quarter, compared to Q2, were strong with both Japan and Korea.
Customer investment favored patterns seen earlier in the year with strong Asian shipments in multi-level interconnect at the 0.35 micron level for leading-edge capabilities in etch, CVD, and PVD tools. AMAT had record levels of revenue in metal CVD, high-temperature films, rapid thermal processing (RTP), and in PVDs.
Gross margin was 47.7%, down slightly from last quarter. Operating expense of $275 million (24.7%) was slightly above Q2 levels due to timing on a number of projects. An R&D spending increase of $3 million was due to spending on high-density plasma and other new products in CMP. Sales and marketing expense was up $2 million to support a new emerging-product division and added Asia/Pacific sales support.
General and administrative expenses included $4 million in several major lawsuits intended to protect the company's intellectual property and $3 million was spent on a global information systems project. Net income before tax was about 23.3%, just below the 23.9% set in Q3 1995.
Q3's new orders, at $931 million level, were nearly 30% below the bookings of Qs 1 and 2. This level of bookings was also 20% below management's expectations at the beginning of the quarter. The company's ability to predict customer investment decisions has diminished in this uncertain industry atmosphere. While demand for DRAMs is strong, exhibiting bit growth of 70%, customers are simply being cautious in the level and timing of capital expenditures due to the continuing inventory correction and unattractive pricing environment. For example, orders for 8 inch equipment, a key leading indicator of leading edge investment, were $827 million in Q2. In Q3, AMAT's orders for 8 inch systems fell to $528 million. This matches the level of orders not seen since Q3 1995. "Customers in memory are clearly curtailing their investments" in the short term.
Significant changes in order patterns were seen in Japan, where new orders decreased 60 percent from the levels of the first and second fiscal quarters of 1996. Geographically, North America new orders for the third fiscal quarter comprised 36 percent of the Company's total; Europe, 23%; Japan,15%; Korea, 7%; and Asia-Pacific, 19%.
All of AMAT's 8 inch products experienced softness except in high temperature films and RTP systems. 6 inch systems were a bright spot in the order pattern, with $200 million in orders matching Q2's order level. 6 inch systems' orders reflected strength in logic and non-commodity businesses. New order geographic breakdown was as follows: N. America, 36% up from $250 million in Q2 to $300 million in Q3; Europe, 23%; Japan, 15%; Korea, 7%; and Asia/Pacific, 19%. The big order falloff came from Japan, down 50% from last quarter and well below AMAT management expectations. Korea was as expected, with that region's investment being stronger in Q2. Asia/Pacific turned downward, missing expectations by 20%, and was down from the prior quarter.
On major orders, above $10 million, seven came from N. America; three from Europe; three from Japan; and six came from Korea/Asia/Pacific. Q2 saw 24 such orders and Q1 saw 29. Japanese orders above $10 million totalled 10 in Q1 and 8 in Q2. The dollar order mix for orders above $20 million dropped dramatically in Q3. In Q2, there were 13 $20 million+ orders; in Q1, there were 16 such orders. Q3 saw only eight such orders. In addition, Applied received only one $40 million+ order, the value of which was $80 million. In contrast, there were seven $40 million+ orders in Q2 and nine in Q1.
"The semiconductor industry is going through a period of significant transition with respect to reduced fab capacity investment and sharply lower memory pricing," said James C. Morgan, chairman and chief executive officer. "We are anticipating that the industry transition and related downturn in our business is likely to continue for some time." Numerous customer projects, especially DRAM-related ones in Japan and Taiwan, were put on hold in Q3. The company has shifted from a "slowdown mode" to a "downturn mode."
Net sales of $1.115 billion for the third fiscal quarter of 1996 declined modestly from second fiscal quarter net sales of $1.128 billion. Net income as a percentage of net sales for the third fiscal quarter was 15.2 percent versus 16.5 percent for the second fiscal quarter. Gross margins for the third fiscal quarter of 1996 were 47.7 percent, down slightly from 48.0 percent in the second fiscal quarter of 1996, but up from 45.5 percent in the third fiscal quarter of 1995.
In response to the changing environment, the Company implemented a significant number of cost reduction measures over the past two quarters. Due to the rapidity and depth of this downturn, Applied announced a reduction in the Company's workforce. As more fully outlined in a separate press release, this reduction in workforce will represent 7 percent of Applied Materials' global employee base, or about 830 employees worldwide. In addition, the Company will discontinue about 870 temporary positions globally. The goal of this reduction is to size the Company appropriately for estimated reduced production demand and to ensure an effective and competitive cost structure for future business. As a result of this reduction in workforce and related consolidation of facilities, the Company will incur an estimated $28-$32 million pre-tax restructuring charge, or approximately $0.10-$0.11 per share after tax, during its fourth fiscal quarter of 1996.
In addition, the company's officers and Directors will take a 10% reduction in their compensation, effective immediately. Certain leased real-estate will be consolidated into the company's Santa Clara campuses and their main Austin facility. An additional Austin facility and a Santa Clara campus will be mothballed in this move. When the downturn ends, the company will be able to bring back quickly these facilities.
"We are concerned about the severity of the semiconductor industry's current downturn, but we believe that the long-term outlook for the industry remains positive. The availability of less expensive memory devices should spur new applications which could lead to expanded capital equipment investment. During the remainder of the downturn, our strategy will be to continue our focus on developing world-class technology and providing outstanding global support to our customers while sustaining our financial strength," Morgan concluded.
Balance Sheet Comments
The company's goal is to maintain a solid balance sheet, which they see as a "powerful weapon" in the current environment. Cash increased $145 million, to $788 million, in Q3. Operating cash flow was "quite positive" and debt/capital structure dropped to 13% from 17% at year-end 1995. There were no unusual changes in the balance sheet during the quarter. "We have total assets of $3.5 billion, which are up $500 million from year-end 1995, all funded by cash flows from retained earnings." Receivables and inventories declined about $70 million during the quarter despite pushouts.
Capital expenditures were about as expected at $118 million. All major projects are nearly complete and should be finished by the end of Q4, meaning that the company can slow capital investment in 1997. Depreciation totalled $41 million in the quarter, up from $34 million in Q2. Most of this quarter's capital investment took place in N. America, with a modest $11 million investment in Japan and $16 million in Asia/Pacific to finish two technology centers in that region
CEO/Chair James Morgan:
"The next six months are going to be very difficult because of the overcapacity in the 0.9-0.5 [micron] range in the semiconductor industry and in 4 Mbit and 16 Mbit [pricing]...right now, the customer is about as unpredictable as I've ever seen them in the past 20 years." The dramatic drop in DRAM pricing has led that industry to stop and re-assess their strategies. "Unit demand is quite strong in DRAM, it's just a question of pricing....First of all, we all see a growing long-term demand; if anything, there appears to be more and more applications for chips, more and more complex chips, greater capability chips....In 64 Mbit, clearly there are several of the companies who are assessing movement to that level of technology. Virtually all the future players are focused on how fast and in what way they want to move to 0.35 and 0.25 micron technology. Also, there is assessment of the 300 mm. strategies for each of these companies."
Morgan also noted that their customers are able to get to higher yields more quickly with the quality of equipment coming out of Applied and the rest of the industry. Whereas it took longer for the semiconductor industry to bring fabs up to capacity, which means that capacity continued to come onstream as the industry realized that it was approaching overinvestment, capacity absorption may be happening more quickly now.
Applied has used past slowdowns to strengthen its position and intends to do that again in preparation for the eventual upturn. This slowdown allows Applied and its customers to evaluate systems about which both are excited. Higher-complexity chip needs are creating opportunities for integrated processing, where the company can capitalize upon the needs of the large-size market going toward the end of the decade. The company also has a strong installed base which will continue to generate revenue; these ongoing relationships also allow for excellent sales opportunities going forward.
There have been four major downcycles in the industry since 1980--Applied has outperformed the semiconductor industry peer-group (in revenue and earnings growth) in each of this period's upcycles and has performed well in the downcycles, particularly in the downcycle from 1984-87 and 1990-92. The company plans on managing the current downcycle through the introduction of new technologies and continuing with strong customer support.
Q4 Guidance
The company expects bookings to come in somewhere near $700 million in Q4. Revenues off a backlog of $1.5 billion will be about $850 million. Margins should be impacted by the lower revenue activity and operating expenses should be in the $250 million range, down $25 million from Q3. Earnings before tax should be in the 16% range and net should be around 10%. Those numbers are before the restructuring charge. Before the restructuring charge, Applied Materials expects to come in with $0.48 EPS in Q4 and $0.37 after restructuring charges.
Cost containment programs will include less travel, higher levels of signature authorization, and most importantly, the 7% reduction in force as well as the discontinuing of employment of 870 temporary employees. The total reduction in force will be somewhere in the area of 12% of Applied's workforce. Cost structure improvements will allow the company to continue its focus on strategic priorities in product development, market share growth, infrastructure enhancement, and its Asia/Pacific investments (in Korea, Taiwan and Singapore).
Inventory was down despite the pushouts which occurred during the quarter, the effect of which was higher than desired levels of work-in-process and finished goods. The company expects the inventory level to improve "significantly" by the end of Q4.
Q&A
The company's positioning for the next upturn encompasses many different product families. The first is etch--in high-density oxide-poly and metal on the Centura platform. Joining that product will be DPS/poly and metal chambers on the Centura. Customer response on the metal chamber has been "outstanding." The poly product is expected to be quite strong coming out of the downturn. The company also has very high hopes for its CMP business, where customers have slowed down investment of late.
Applied has made progress in CMP in terms of hardware and process reliability, as well as in integrated and stand-alone systems. In advanced CVD, Applied believes that its high-density CVD tools will be strong market entries. In the PVD area, the Vectra IMP Source was introduced at Semicon West this summer and has received "widespread market acceptance." The timing of new products will allow the company to divert resources from 850 support to supporting those new systems.
On gross margins, the company expects the cost-control program to allow them to keep margins up. In addition, Centura volumes are rising, which they hope will allow leverage across the income statement. Standardization across the Centura line will also create performance and cost benefits. Applied believes they can achieve success in dropping variable costs in line with decreases in revenues. Gross margin should drop into the 45% range in Q4. Looking into Q1 1997, the company said that the customer environment is too volatile to make revenue projections despite their "solid" 4.5+ month backlog.
There are numerous strategic issues for which Applied's customer base must plan. These include positioning for continued semiconductor growth [advancement in features and end-user growth]. The company sees good reasoning for the go-ahead of two Korean DRAM investments--in Austin by Samsung and in Portland by Hyundai. Some of the Japanese are beginning to come out of the evaluation stage and are starting to go ahead with investments in leading-edge systems, even in DRAM. Joint ventures in Asia/Pacific are still moving forward. In addition, US companies stand ready to go ahead with plans should the IC market improve. In Europe, if companies "get out of the queue, they may miss the next upturn." The customer environment there is difficult to forecast.
ASPs (average selling price) have actually increased over the last couple of quarters. The business should become more competitive on price in the coming quarters. Quality and service infrastructures will continue to be part of customers' investment criteria, though.
In R&D, investment will be slowed in selected, less strategic areas. As a percentage of revenues, R&D will be maintained in the 10-12%. "We will invest the right dollars in R&D to come out of this with the right product set." 300 mm. remains a focus.
A handful of CMP revenue-units [vs. R&D units] will be shipping in Q4. They have had an HDP product out for a year in their HDP/CVD Rev 1 unit and will be introducing an enhanced (process chamber) version of that product in the next few quarters. The speed of this program, which was a strategic investment to capture the early part of the cycle in these tools, is going as expected. Applied and its customers have planned for upgrades and retrofits since the origin of these investments.
Applied is gaining market share in the high temperature film markets as its customers move to implementation from the R&D stage. In mainstream markets, market share numbers will fluctuate according to whose customers (among established customer relationships) are most active in their purchases. James Morgan expressed his satisfaction with market share and pointed to new products in commenting on market share growth in the coming quarters. If 64 Mb DRAM become a factor next year, Applied expects to make market share gains in high temperature films/epy systems. Orders increased approximately 200% for high temperature films systems, particularly for 8", comparing Q3 1996 to 1995. This is a significant opportunity, as most DRAM customers do not yet use epy systems for DRAM fabrication.
The company expects N. American business to be stable in the coming quarter. Japan may be strong with consumer applications' IC demand and looks to be as strong, if not stronger, than N. America. Korean ordering activity was not strong in Q3--Q4 weakness would come from Asia/Pacific as various customers are expected to contemplate, but not commit to, new projects. Europe may be an area in which sequential comparisons will be difficult, due to the brisk rate of business in Q3. Business will slow down modestly in Europe with no loss of market position.
In integrated systems, the company wants to take the time to develop tools in which each piece works as well as stand-alone pieces. Following such a strategy, process steps on integrated systems will be added one or two at a time, rather than trying to spring right out of the box with a complete system.
The company sees growth opportunities ahead with its current product lines but is not feeling pressure to expand by acquisition. Nevertheless, they would consider any attractive opportunities (and have the cash) to do so. James Morgan: "I would not underestimate the opportunities we will have in high temperature films, RTP and CMP." "...Most everybody believes CMP will probably be an $800-1,000 million market by the end of the decade. We expect to do extremely well with rapid growth in 97." For flat panel systems, the company hopes demand will pick up as companies climb the learning curve on costs, At the same time, flat panel equipment demand is affected by the profitability of customers' semiconductor divisions. The opportunities in CVD, PVD, and etch for flat panels looks like it is accelerating.
In comparing previous downturns and reductions in force, the 1991-92 reduction was much smaller, as their PVD introduction bolstered revenues. The 1980 reduction effected about 10% of the company workforce.
Capital expenditures for 1996 will total $500 million, leaving $120 million room for Q4.
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ * A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. Note: Statements made by a company other than historical information may constitute forward-looking statements for which the company can claim protection under the Safe Harbor Act. Please consult the company's filings with the SEC for information on risk factors which might cause actual results to differ materially from the information contained in these forward-looking statements.
* A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. |
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Copyright 1996, The Motley Fool |