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Applied Materials' (AMAT - Analyst Report) fiscal second-quarter 2014 pro forma earnings of 28 cents were in line with the Zacks Consensus Estimate.

Revenue

Applied reported revenue of $2.35 billion, up 7.4% sequentially and 19.3% year over year, at the high end of the guidance range. Revenues were slightly below the Zacks Consensus Estimate of $2.36 billion.

Revenue by Segment

The SSG segment contributed 67% of revenues, up 6.7% sequentially and 22.7% from the year-ago quarter. Logic and DRAM sales helped segment sales in the second quarter, with NAND and foundry remaining weak.

The second-largest segment was AGS with a 23% revenue share. Segment revenues were up 5.3% sequentially and 3.3% year over year. AGS revenues are correlated to system sales and benefited from stronger equipment sales in the reported quarter.

The Display segment saw a 7.5% sequential decline, though sales were 15.7% above year-ago levels. Segment contribution dropped from 7% to 6%. Management stated that the segment performed better than expected due to share gains. Higher demand for bigger TV screens drove segment revenues. Demand for mobile devices (high-resolution mobile displays for tablets and touch panels for ultrabooks) also continues to increase, which is complementing the resurgence in the TV market. Applied Materials’ expanding product line is partly responsible for the increased total available market (TAM).

The EES segment accounted for 4% of total quarterly revenue, soaring 120.0% sequentially and 131.6% from last year. Management continues to cut investment in the solar segment to align the cost structure with sales, thereby expecting EES segment to perform well throughout the year.

Revenue by Geography

Around 77% of Applied’s quarterly revenue came from the Asia/Pacific region, with the largest contribution from Taiwan, which generated 33% of revenues and was followed by China with 18%, Korea with 15% and Japan with 9%. Southeast Asia, China and Europe were the weakest in the last quarter, declining 40.2%, 27.3% and 4.9%, respectively on a sequential basis. All other regions saw positive growth, with Korea being the strongest (up 74.6% sequentially), followed by the U.S. (up 32.1%), Japan (up 31.1%) and Taiwan (up 10.8%).

Orders

Total orders were up 15.1% sequentially and 16.0% year over year. On a sequential basis, SSG, EES and Display orders were up 6.1%, 120.0% and 330.4%, respectively, with AGS orders declining 10.1%. However, all segments increased on a year over year basis.

Backlog for the quarter increased 12.0%, with SSG building the most, followed by AGS, Display and then EES.

Margins

Applied generated a gross margin of 44.2%, up 170 basis points (bps) from the previous quarter’s 42.5%. A lower mix of EES sales were beneficial for the gross margin in the last quarter and will likely remain so throughout 2014. Applied’s gross margin improvements may be traced to its improving mix of higher-value products in semiconductor and display, as well as material cost efficiencies. The gross margin was up 100 bps from the year-ago quarter.

Applied’s operating expenses of $612 million increased 19.9% from the last quarter. All expenses, except general and administrative, declined as a percentage of sales from both the previous and year-ago quarters. As a result, operating margin of 20.5% expanded 310 bps sequentially and 610 bps from last year.  

Net Profit

On a pro-forma basis, Applied Materials had a net income of $348 million, or a 14.8% net income margin compared to $279 million, or 12.7% in the previous quarter and $199 million, or 10.1% in the second-quarter fiscal 2013.

Fully diluted pro-forma earnings were 28 cents a share compared with 23 cents in the previous quarter and 16 cents in the comparable prior-year quarter. Our pro-forma estimate excludes restructuring, acquisition-related, impairment and other charges as well as tax adjustments in the reported quarter.

On a fully diluted GAAP basis, the company recorded a net profit of $262 million (21 cents per share) compared with income of $253 million (21 cents per share) in the previous quarter and loss of $129 million (11 cents per share) in the year-ago quarter.

Balance Sheet

Inventories increased 2.0% during the quarter, with inventory turns down slightly from 3.4x to 3.3x. Accounts receivables were $1.6 billion, up $105 million from the prior quarter. Cash and short-term investments balance was $2.60 billion at quarter-end, up $310 million from the prior quarter. Goodwill was 26.2% of total assets in the last quarter.

Applied Materials generated $437 million of cash from operations, spent $65 million on capex and $122 million on dividends. At quarter-end, the company had $1.95 billion of debt on its balance sheet, with a net cash position of $652 million. However, the debt cap ratio including long-term liabilities and short-term debt was just 24.4%.

Guidance

Applied provided guidance for the fiscal third quarter. Revenue for the quarter is expected to be flat to down 5% sequentially and up by approximately 13%-19% from the year-ago quarter. Non GAAP EPS is expected to come in at 25-29 cents a share, up 39%-61% year over year. The Zacks Consensus Estimate for the Jul 2014 quarter was 27 cents when the company provided guidance, within the guided range.

Conclusion

The second quarter was a moderately good one for Applied Materials, with most of the segments performing well. Though the Display side remained sluggish, strength in other areas compensated for it.

Applied Materials has a very strong product line and management has stepped up investments here in preparation for the on-going transitions to larger wafer sizes and smaller process nodes. Management expects significant share gains through 2014.

There is also scope for share gains on the Display side of the business backed by the PVD tools. The drivers of this business are larger TV screens and better mobile displays that involve more complicated production processes and new tools.

However, slowing sales in China, a slow personal computer market, high cost structure and customer concentration may keep the shares range bound in the near term.

Applied shares currently have a Zacks Rank #4 (Sell). Other stocks that are performing well at current levels include NetScout Systems, Inc. (NTCT - Snapshot Report), Infinera Corp. (INFN - Snapshot Report) and QLogic Corp. (QLGC - Analyst Report). All these stocks sport a Zacks Rank #2 (Buy).
 

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