Key takeaways from AMAT: Silicon strong, memory floats, solar sags May 24, 2010 – Comments in Applied Materials’ fiscal 2Q10 conference call (May 19), and from analysts examining them and the numbers, highlights several key observations for company’s various businesses (semiconductors, solar, FPD) and overall market observations. Overall the company’s sales rose to $2.3B (vs. $1.85B in 1Q10 and $1.02B in 2Q09), and profits rose considerably ($264M vs. $83M in 1Q10 and -$164M in 2Q09). Gross margins improved to 41.7% (from 40.4%); operating margins for silicon were 33% above targets. Total backlog increased by $59M to $2.99B. EPS (even with an inventory charge, see below) and bookings were well above guidance of >10% Q/Q. For its next quarter (fiscal 3Q10), AMAT sees sales declining -2% to -5%, with EPS around $0.22-$0.26 (flat to slightly up). The company did not provide orders guidance, perhaps due to limited visibility; Deutsche Bank’s Steve O’Rourke suggests an -11% decline in orders for the next quarter. –> Chips looking up. Sales in its silicon group (i.e. chipmaking equipment) saw 45% growth, helped by the addition of Semitool and demand from foundry and DRAM customers. New orders were $1.42B. Based on industry expectations of total wafer-fab equipment ($26B-$28B, vs. earlier range of $21B-$24B), AMAT probably will enjoy higher outlook in 2010 for its own silicon biz sales — it is now tracking 11 fab expansions, two more than prior views, and Splinter says foundry spending "seems sustainable" through the end of the year. Samsung’s massive capex increase will certainly help, not only in chips but in FPDs as well where Applied has a play — in fact the company said FPD orders are >70% from 2009, and has secured a second order for its Pivot tool. While goosing its industry WFE capex numbers, AMAT didn’t raise its own guidance of $8.0-$8.5B, though Credit Suisse’s Satya Kumar is "comfortable" raising that to $9.2B. And the good times are here for a little while longer, apparently. "We’re seeing a multi-year cycle in our view in both semiconductors and display," Splinter told listeners, and "we expect orders will reflect that." He agreed with one caller (Citigroup’s Tim Arcuri) that AMAT’s customer base for silicon/chip tools is a little too narrow, and needs to broaden out to support a multiyear cycle. Nevertheless, "up until really the last week or so, I wouldn’t have thought that we could exceed kind of 2006 and ’07 levels or be in that ballpark. "If the economy stays strong and all the normal caveats, I think we could certainly be in that range that we were in for wafer fab equipment spending in 2006 and ’07." –> Solar looking down. Its solar group, meanwhile, suffered a -48% sequential drop in sales to $166M and a -$145M loss; prime culprit was a sluggish thin-film business, which also resulted in a $83M inventory charge. During the conference call, AMAT CFO George Davis confirmed that the thin-film/SunFab contribution to backlog had shrunk from ~$650M to approximately ~$400M. (He also noted that currency changes, particularly in the euro, carved out another $36M.) Demand for crystalline-silicon (c-Si) products, on the other hand, were up 64% Q/Q, mainly by demand from China and for wafering (saws) and metallization (Baccini) products. "There is ordering going on as if there is no tomorrow out of China," observed Barclays’ CJ Muse — but noted this also heightens concern about sustainability. Even AMAT seems to see the writing on the wall, now admitting that the division won’t be breakeven in the current year (estimated $1B), though possibly in 2011. "We are taking decisive steps to realign the business with a lower market output," noted AMAT chairman/president/CEO Mike Splinter, in the company’s quarterly results call. (Note that not everyone sees AMAT’s thin-film problems as an indictment of the technology’s potential.) The reaction seems to be loud & clear from analysts. "Cancellations (KSK), de-bookings (many), and insolvencies (Sunfilm) are the order of the day, with even client companies that are producing TF solar panels not being able to pay bonus performance payoffs," notes Muse. "We think that AMAT needs to go back to the drawing board and re-think its Sunfab strategy with a preference (in our minds) for exiting the market." "Applied’s SunFab business has fallen well short of expectations, and has deteriorated further since the company’s analyst meeting in late March," notes O’Rourke. "We remain skeptical that SunFab can be made competitive in the near term." Kumar expects more write offs and restructuring charges in AMAT’s solar unit (as does Muse), and on top of that he sees a -30% Y/Y decline in c-Si (which at least in 2Q10 seems to have helped cover the company’s thin-film missteps). His verdict: "AMAT should exit SunFab, and pro-actively resize c-Si to breakeven at < $500mm/year — which will be very difficult to achieve in the next 6 months," he writes. –> Memory push, with a caveat. With all the talk about DRAM expansions, AMAT is seeing not just DRAM players but also new business from flash memory as well; flash accounted for 10% of silicon orders in 2Q10, according to the company, and Splinter foresees them up 50% in the next quarter, with "a lot of turns business." Keep an eye on memory pricing — declining ASPs could leave memory firms with less money to throw into near-term capex plans. And strained supplier availability, particularly for lithography tools, also is "a natural brake against wanton spending in the memory sector" and makes 2011 more likely to be positive, notes Muse. –> It’s a turns, turns world. Following up on comments that AMAT sees its current & near-term business as very much a "turns business," Splinter called this "the new normal" where customers (especially larger ones) "believe that they can work with us ahead of time, but order at a very short lead time." Improving operations speed, quality, and cost will be a differentiator, he said. Davis reiterated, pointing to investments in the company’s Pan-Asian supply chain, specifically in logistics and light manufacturing capabilities in Singapore. "Cycle time is very important to our customers, and that’s not likely to change.