Applied Materials’ (NASDAQ:AMAT) equipment sales have continuously declined in the last three quarters as most semiconductor manufacturers lowered their capital spending on account of a weak macro environment. Witnessing a 30% decline in Q4 2012 earnings, Applied believed its orders bottomed out in the quarter. While Applied’s revenue further declined in Q1 2013, the rate of decline slowed considerably compared to the previous quarter to 5% sequentially and 28% annually. However, despite lower revenues, a growing mix of silicon system revenue and lower inventory reserves led to a 1.4% sequential improvement in gross margins. Additionally, owing to strong execution and efficient management of its discretionary spending, Applied posted net income of $34 million in Q1 2013 compared to a net loss of $515 million in Q4 2012.
Led by strong demand for semiconductors and display equipment, Applied saw orders climb 44% (reaching $2.1 billion) in Q1 2013 compared to Q4 2012. While the expected rise in capital investment by its customers provides a strong foundation for the year ahead, Applied remains cautious on the industry outlook. However, the company is confident of growing its market share in wafer fab equipment in 2013 and intends to continue investing in its display and solar businesses to leverage potential growth in these markets.
Here we discuss some of the factors that can revive demand for Applied’s equipment in the future.
Rising Capital Spending By Semiconductor Manufacturer
Applied’s semiconductor manufacturing systems are used by integrated device manufacturers and foundries to build and package memory, logic and other types of chips. Weak market conditions in 2012 caused pullbacks in expansion plans throughout the industry as manufacturers adjusted their production levels to match the end-user demand. However, Applied’s silicon system group (SSG) revenue increased by 11% and it witnessed a greater than 80% increase in semiconductor orders in Q1 2013.
Applied scored significant application wins in Q1 2013, witnessed strong demand for its transistor products and converted a number of existing positions into volume orders. The company strongly feels that it has the requisite capacity to build momentum for a higher market share in wafer fab equipment (WFE) in 2013.
Some of the factors that can revive demand for semiconductor equipment are:
- Growing capacity for the 28-nanometer node and ramp-up of 20 nanometer technology by semiconductor companies.
- Better global demand for mobile products: Since these devices drive demand for leading-edge foundry capacity, the market leaders are aggressively accelerating ramps at advanced nodes. Applied believes that mobile customers will account for approximately 45% of wafer fab spending in 2013. 
- Higher NAND demand: Applied believes that the NAND demand will grow by close to 50% in 2013, which it feels is sufficient to drive investment in new capacity addition.
While the wafer fab equipment (WFE) market saw spending increase by 13.3% in 2011, Gartner estimated 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%. 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 & Increase In TV Equipment Orders To Drive Display Business
Net display sales in Q1 2013 stood at $87 million, marginally lower than the previous quarter. Revenues from mobile display systems accounted for the majority of display revenues. Applied witnessed a 66% increase in orders from the display segment in Q1 2013 on account of the ongoing mobility investments and the beginning of resurgence and TV equipment orders.
Though its customers still remain cautious about the end-demand, Applied believes that with the larger models in the TV industry reaching attractive prices and the introduction of new 4-K resolution technology, there could be a marginal increase in investment in display factories this year.
Additionally, with the increasing number of touch-enabled hybrid (notebook-tablet) models hitting the market, orders for equipment to manufacturer touch panels and high performance mobile screens remain strong as production moves to larger substrate sizes.
Solar Division Reamins A Long-Term Growth Driver
Revenue from Applied’s Energy and Environmental Solutions (EES) division declined drastically last year as the solar industry struggled with excess manufacturing capacity and soft end demand. Its EES revenue marked a 35% sequential decline in Q1 2013. Though the company claims that the growth in demand is starting to consume the excess manufacturing capacity in the solar industry, it maintains a cautious approach as the investment in new capacity remains low.
Applied announced a restructuring plan for its EES business in Q3 2012 to lower its cost structure and operating breakeven level to approximately $500 million. As the demand in the solar industry remains sluggish, it plans to take additional steps to reduce its cost base and minimize associated losses. By the end of fiscal 2013, the company aims to reduce EES operating expenses to $25 million per quarter.
Applied claims that the solar end market continues to grow between 10% and 20% annually. However, the supply conditions remain challenging until the industry further consolidates and rationalizes its manufacturing capacity.
Given the growth potential of the solar industry, we believe that the solar business could be an important long-term growth driver for the company. While the slower-than-anticipated revival has led to a significant decline in the market in 2012, we estimate the situation to stabilize in the future.
Q2 2013 Outlook
- Non-GAAP operating expenses to increase to $560 billion, +/- $10 million
- Net sales to increase by 15%-25%.
- Net sales in semiconductor business to increase by 20%-35%.
- Net sales in AGS to be flat to up 10% with a gradual recovery in wafer starts and utilization levels.
- Net display sales to be flat to up 25%: Increase in orders on account of TV capacity additions and continued strength and mobility.
- Net EES sales to remain flat.
- Non-GAAP EPS to be between $0.09 and $0.15.Notes:
- Applied Materials’ CEO Discusses F1Q13 Results – Earnings Call Transcript, Seeking Alpha, February 13, 2013 [↩]
- Gartner Says Worldwide Semiconductor Manufacturing Equipment Spending to Decline 11.6 Percent in 2012, Gartner Press Release, March 21, 2012 [↩]