Updated from Aug. 12

Applied Materials

(AMAT) - Get Report

posted slight gains a day after delivering financial results that underscored that the leading chip-equipment maker remains stuck in slow recovery mode. While analysts mostly greeted the news with a yawn, the stock was up 39 cents or 2.1% to $18.84 in midafternoon trading.

Yesterday Applied said it saw sales drop 25% in the most recent quarter, while it swung to a loss after shelling out for inventory write-downs and a restructuring. It forecast sales will stay flattish in the quarter under way, issuing guidance that fell below Wall Street's hopeful 10% growth outlook.

Needham, which has a hold rating on shares, noted that AMAT managed to deliver sequential improvement in third-uarter orders (though cancellations remained large) and guided for more order growth in the fourth quarter. "However, news out of the conference call was largely anticipated, and further upside to expectations is not apparent, leaving little compelling news to drive shares higher, particularly in light of the stock's cycle-high valuation of 6.5 times trailing sales," wrote analyst Cristina Osmena. Her firm doesn't do any banking for AMAT.

"There was little in the call to change our view of a modest recovery," wrote Banc of America analyst Mark FitzGerald. "2004 Street estimates need to go significantly higher to justify a $19 stock price, in our opinion. There is good value below $15."

The order flow continues to be generated by a handful of large projects making the October quarter uncertain. We expect order patterns to remain lumpy into 2004, a risk to investors who play the order momentum game." Banc of America hasn't done any recent banking for Applied.

The leading chip-equipment manufacturer posted sales of $1.09 billion, about even with the $1.097 billion consensus estimate and a quarter below last year's $1.46 billion.

The company sank into the red by $37 million after taking a $164 million charge to write off inventory, cut staff and consolidate facilities. The company lost 2 cents per share, according to generally accepted accounting principles. In the same quarter last year, it posted a profit of $115 million, or 7 cents a share. On a pro forma basis, net income amounted to 5 cents per share, a penny above analyst expectations.

The quarter offered few surprises, said Lehman's Edward White. "It was about in line with what people were looking for." On the plus side, order growth of 9% for the July quarter was "modestly better than expected. Normally in summer you wouldn't get results this good from the orders side; typically orders for many companies are down in the summer."

"It's really only a little better than expected but consistent with the idea that at last for the near term

we're seeing a gradual recovery," he said. He has an outperform rating on the stock; Lehman hasn't done recent banking for AMAT.

At UBS, analyst Byron Walker said the quarter was "maybe marginally better" than expected. "

New CEO Michael Splinter has an excellent grip on what's going on; he's not waiting; he's moving ahead expeditiously," said Walker. "But at the end of the day they made their quarter by eating into backlog and better expense control. Two-thirds of the

upside penny came out of spending less R&D than we had modeled."

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Walker has a neutral rating on the stock based on valuation; his firm hasn't done any investment banking for AMAT.

Based on recent meetings with customers around the world, said Splinter, "We see incremental improvements in the operating environment. Fab utilization for advanced factories continues to improve, and if you look at history, when utilization rates rise our orders start increasing as well."

Today the company guided for October quarter orders to grow about 10% from July quarter levels of $1.05 billion, though orders remain 41% below last year's levels.

Also on the conference call, management guided for revenues in the October quarter to be flat to slightly up, with EPS of 4 cents to 5 cents per share. Realignment charges should total between $75 million and $100 million.

"We're cautiously optimistic about our prospects," said chief financial officer Joseph Bronson.

But the guidance falls below current consensus estimates, which call for 9.5% sequential sales growth to $1.2 billion, with earnings of 6 cents in the October quarter.

One near-term worry is that a strong source of orders in the just-ended quarter is likely to diminish.

AMAT has lately drawn about twice as many sales as usual from customers that make dynamic random access chips. DRAM orders accounted for a hefty 47% of total system orders in the July quarter, up from 25% in the preceding quarter. Bronson said DRAM more typically accounts for 15% to 25% of total business. "I think the order pattern will be kind of reverting to a more normal pattern," he said.

But if DRAM orders drop off sequentially, Applied would presumably need plenty of large non-DRAM orders to make up the difference and meet its guidance of flattish revenues, pointed out Morgan Stanley analyst Steve Pelayo, who asked management if the company expects large non-DRAM orders to be placed soon.

"There are still a lot out there; we just don't know when exactly they're going to come," replied Bronson.

In a separate question, Pelayo pointed out the disparity between expectations for the overall wafer fab equipment market to stay flat this year and his own model for Applied's revenues, which suggests they could fall 5% to 10% in calendar year 2003. He asked whether Applied expects to see a hockey stick recovery in what's left of the year.

"The

wafer fab market estimates are based on the publicly announced plans of customers. We'll have to see how those come out," said Bronson.

Separately, Bronson said the company is currently projecting an overall increase in semi equipment investment next year, following this year's expected flat sales.

"We believe 2004 will be a major investment for 300 millimeter equipment spending," Bronson said.

Indeed, for the first time ever, AMAT said more of its orders (60%) were for new-generation 300 millimeter equipment than the more standard 200 millimeter gear. In the preceding quarter, only about a third of orders were for 300 millimeter equipment.