With most semiconductor manufacturers reducing their capital spending on lower demand, Applied Materials (NASDAQ:AMAT) witnessed more than a 40% reduction in its semiconductor equipment sales. Applied’s silicon wafer equipment business accounts for 57% of the company’s valuation, as per our estimate, and the slump in equipment sales was the primary reason for the significant decline in its quarter earnings.
Applied reported its Q4 2012 earnings on November 15, and the 31% decline in revenue is reminiscent of a further slowdown in the semiconductor industry. It registered a marginal decline in gross margins in Q4 due to lower sales, inventory reserves and lower factory utilization.
Facing an adverse macro environment and witnessing a steep decline in orders, Applied took a number of steps to lower its cost base this year: a restructuring plan for its Energy and Environmental Solutions (EES) business and a workforce restructuring plan. With a 19% sequential decline in Q4 orders, the company intends to take further actions such as higher reduction in solar spending, workforce restructuring, re-prioritizing existing spending, etc., to ensure operational efficiencies.
While the challenging industry conditions persist in all three business segments – semiconductor, solar and display – Applied believes that the orders bottomed out in Q4 and expects the situation to improve 2013 onwards. Though the macro headwinds continue to suppress demand, we remain optimistic on Applied’s long-term prospects as we think that the accelerated changes in device technology and the adoption of new materials in the industry will fuel top-line growth for the company.
Focus On Increasing Market Share In Wafer Fab Equipment
At $870 million, Applied’s silicon system group revenue posted a 44% sequential decline across foundry, memory and logic customers. Weak market conditions in the second half of 2011 caused pullbacks in expansion plans throughout the industry as manufacturers adjusted their production levels to match end-user demand. Thus, the industry witnessed a slump in demand for semiconductor manufacturing equipments.
Significantly reducing its operational expenses and increasing its market share in wafer fab equipments remain the primary focus of the company in the years ahead.
While the wafer fab equipment (WFE) market saw spending increase by 13.3% in 2011, Gartner forecasts the same to decline by 13.3%, totaling $31.4 billion in 2012. It expects capacity utilization to decline into the low 80% range before slowly increasing to about 87% by the end of the year. Though the situation is expected to improve in 2013, Gartner does not estimate the market to return to positive growth in the year. 
Mobility Trend Favorable For Industry Spending
With the current slowdown in growth of global PC shipments, the increasing adoption of smartphones and tablets is expected to fuel future growth in the semiconductor industry. The growing mobility trend is compelling Applied’s customers to deliver high-performance, low-power processors and affordable solid-state storage in a small form factor. The company considers the above trends to be favorable as they create spending shifts that are favorable to its business.
“Increased competition is fueling innovation throughout the supply chain, and we see demand for advanced application processors, driving the foundries to build out their 28-nanometer capacity and ramp investment for the 20-nanometer node. We expect healthy investment by foundry customers in 2013, albeit at a lower level than 2012.”
Smartphones & Tablets Fuel Display Demand
Marking a 35% sequential decline in revenue, the display segment was probably at its weakest. However, despite lower revenues, the display business remained profitable on account of operational efficiencies. On the positive side, Applied’s mobility related business accounted for close to 80% of Applied’s display revenue in the year. The company expects robust capacity investment in the future, fueled by growing demand for smartphones, tablets as well as ultrabook PCs. Display orders were up 24% in Q4 2012.
Applied Materials has a significant presence in the smartphone and tablet market. It expects to generate more than $250 million in revenue from products that serve new applications in this area in the future. The global appetite for mobile devices with new features, longer battery life and brighter, higher resolution displays continue to strengthen. As these devices drive demand for leading-edge foundry capacity, the market leaders are aggressively accelerating ramps at advanced nodes.
Solar Business To Be A Long Term Growth Driver
Applied’s EES revenues were down 19% sequentially as the industry struggles with excess manufacturing capacity and soft end demand. Driven by demand for roll-to-roll deposition equipment, the EES orders increased by 86% from low levels. Applied claims that demand growth is starting to consume the excess manufacturing capacity in the solar industry. However, its consumers are still uncertain about end market demand and thus investment in new capacity remains low.
We believe that, given the long-term growth prospects in the solar industry, the business could be an important long-term growth driver for the company. While we believe the slower than anticipated revival in the market would lead to a significant decline in the solar PV equipment market in the current year, we estimate the situation to stabilize thereon.
Applied believes that with its current product portfolio, it can capture approximately $100 million of revenue for each gigawatt of new capacity the industry adds.  However, in the short term, until the demand-supply mismatch corrects, the company intends to take cautious steps to reduce its cost structure and associated losses.
Q1 2013 Outlook
– Overall net sales to be flat to down 15%
– Net sales for semiconductor business will be flat to up 10%, orders to increase by 25% as customers increase capacity
– Net sales in ASG to be down 15% to 25% due to absence of thin-film solar revenue & effects of lower factory utilization
– Net sales in display to be flat to down 30%
– Net sales in EES to be down in excess of 30%
– Wafer starts and utilization rates to trend lower
– Non-GAAP Operating Expenses: $525 to $545 million, slightly higher than Q4 2012
We are in the process of updating our current price estimate of $14.99 for Applied Materials.Notes:
- Gartner Says Worldwide Semiconductor Manufacturing Equipment Spending to Decline 11.6 Percent in 2012, Gartner Press Release, March 21, 2012 [↩]
- Applied Materials Management Discusses Q4 2012 Results – Earnings Call Transcript, Seeking Alpha, November 15, 2012 [↩]