MARKET DIGEST ARGUS. Independent Equity Research Since DJIA: 19, MONDAY, AUGUST 21, 2017 AUGUST 18, DJIA 21, DOWN 76.

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1 ARGUS Independent Equity Research Since DJIA: DJIA: 19, MONDAY, AUGUST 21, 2017 AUGUST 18, DJIA 21, DOWN Good Morning. This is the Market Digest for Monday, August 21, 2017, with analysis of the financial markets and comments on Baker Hughes, a GE Company, NetApp Inc., Applied Materials Inc., Cheesecake Factory Inc., Parker-Hannifin Corp., Johnson Controls Ltd., The Kraft Heinz Company, and PACCAR Inc. IN THIS ISSUE: * Initiation of Coverage: Baker Hughes, a GE Company: Launching coverage with a BUY rating and $43 target (Bill Selesky) * Change in Rating: NetApp Inc.: Upgrading to BUY with $46 target (Jim Kelleher) * Growth Stock: Applied Materials Inc.: Boosting target to $52 following strong 3Q (Jim Kelleher) * Growth Stock: Cheesecake Factory Inc.: Maintaining HOLD on slowing comps (John Staszak) * Growth Stock: Parker-Hannifin Corp.: Raising estimates for Industrial blue-chip (John Eade) * Value Stock: Johnson Controls Ltd.: Looking for upgrade opportunity (John Eade) * Value Stock: The Kraft Heinz Company: Recent weakness offers buying opportunity (John Eade and Annie Petrino) * Value Stock: PACCAR Inc.: Boosting EPS estimates but reiterating HOLD (John Eade) MARKET REVIEW: After spending much of the day in positive territory, stocks weakened in the final hour of trading on Friday and closed lower to extend Thursday s heavy losses. The Dow Jones Industrial Average was down 0.4%, while the S&P 500 declined 0.2% and the Nasdaq Composite lost 0.1%. Stocks fell for the second week in a row, with full week declines of 0.8% for the Dow, 0.7% for the S&P 500 and 0.6% for the Nasdaq. Year-to-date gains are now 15.5% for the Nasdaq, 9.7% for the Dow and 8.3% for the S&P 500. Politics took center stage again last week, with concerns that the Trump agenda (healthcare & tax reform, deregulation and infrastructure spending) would be stalled on worsening relations between the president and members of Congress and continuing White House staff shuffles. With partisan politics at extremes, sweeping reform was never going to be easy. We believe the overriding positives of still historically low interest rates, healthy employment growth, and strong consumer/business confidence levels should remain far more of a market driver. The 10-year Treasury yield ended the week at 2.20%, virtually unchanged from 2.19% the prior week. Yields have been largely in retreat since early July, after a late-june spike (which brought the 10-year to nearly 2.4%) evaporated. The 10-year yield now sits near lows of the year. Meanwhile, a flight to safety has been evident in gold, which at $1,290/oz. is up 10.7% in 2017 and sits near highs for the year. Minutes from July s Federal Open Market Committee meeting released last week indicated some concerns from members about recent low inflation readings. We think the recent lower pace of inflation, as well as a slowdown in weekly leading indicators, combined with upcoming Fed balance sheet reduction, provides the Fed with reasons to delay or moderate interest-rate tightening. As equity weakness played out last week, our market indicators fell. Our technical composite slipped closer to the bearish zone as NYSE breadth fell further on fewer stocks above their 150-day moving average and weakness in the bullish percentage, while CBOE trading indexes saw a small dip on put/call hedging and an adverse move in the NYSE TRIN. Our strategic composite also fell but remained in neutral territory, with market internals hurt by relative weakness in energy, consumer cyclicals and strength in defensive consumer staples. Market externals were little changes as relative weakness in crude oil versus industrial commodities was offset by weak U.S. dollar-driven gains in emerging stocks and debt. We note that small caps are near March- April lows. We expect to see some support for the market at the 3%-5% decline level (or about 2,400 on the S&P 500), while a break below would point to a deeper correction. A R G U S R E S E A R C H C O M P A N Y 6 1 B R O A D W - A 1 Y - N E W Y O R K, N. Y ( ) LONDON SALES & MARKETING OFFICE TEL / FAX

2 Small caps have indeed struggled of late, with the Russell 2000 down 5.4% over the past month and the index now flat for the year-to-date period. Mid-caps have not fared much better, with the S&P 400 down 4.6% over the past month and up only 1.9% for the year. Typically, large-cap strength would eventually lift small/mid-caps as investors searched out better bargains. But large-cap companies are enjoying several edges that include generally better pricing power, international exposure with benefits from a weaker dollar, larger share-buyback programs that provide ongoing support for share prices, and ongoing shifts from active management to passive (mostly large cap) index funds. Meanwhile, small caps contend with a higher risk level, where even slight earnings misses can be devastating to share prices amid lower trading liquidity. Large-cap favoritism is unlikely to change. Looking at this week s economic calendar, the Chicago Fed national activity index for July will be released on Monday. Tuesday brings the FHFA house price index for June and the Richmond Fed manufacturing index for August. On Wednesday, new home sales for July will be released. Thursday will bring existing home sales for July, and the PMI composite flash and Kansas City Fed manufacturing index for August. On Friday, durable goods orders for August will be released

3 BAKER HUGHES, A GE COMPANY (NYSE: BHGE, $32.77)... BUY BHGE: Launching coverage with a BUY rating and $43 target * Baker Hughes and General Electric s oil and gas business completed their merger on July 3, GE has a 62.5% interest in the new company and legacy Baker Hughes shareholders have a 37.5% stake. * We expect GE s strength in digital technology to complement Baker Hughes traditional energy services and equipment offerings. We also expect the combined company to compete more effectively with close rivals Halliburton and Schlumberger. * We are establishing EPS estimates of $0.36 for 2017 and $1.62 for 2018 for the new BHGE. Our estimates assume a gradual increase in crude oil prices, increased drilling activity and modest margin growth, with stronger improvement in * Our target of $43 implies a potential total return, including the dividend, of 32% from current levels. ANALYSIS INVESTMENT THESIS We are initiating coverage of Baker Hughes, a GE company (NYSE: BHGE) with a BUY rating and a price target of $43. The company was formed in early July from the merger of the former Baker Hughes Inc. and General Electric s oil and gas business. We expect GE s strength in digital technology to complement Baker Hughes traditional energy services and equipment offerings. We also expect the combined company to compete more effectively with close rivals Halliburton and Schlumberger. Our target of $43 implies a potential total return, including the dividend, of 32% from current levels RECENT DEVELOPMENT Baker Hughes and General Electric s oil and gas business completed their merger on July 3, The new company, now called Baker Hughes, a GE company, is the third-largest oil field services company in the world. Under the terms of the merger, initially announced last October, Baker Hughes converted to a partnership and GE contributed its oil and gas business to that partnership. Former BHI shareholders received a special, one-time cash dividend of $17.50 per share on July 6, covered by a $7.4 billion contribution from GE. GE has a 62.5% interest in the new company and legacy Baker Hughes shareholders have a 37.5% stake. Management expects the merger to generate total annual synergies of $1.6 billion by We have a favorable view of the transaction. We expect the new company to compete more effectively with Halliburton and Schlumberger, and believe that GE s digital technology complements BHI s service and equipment offerings. On July 28, in its last report as an independent company, Baker Hughes Inc. reported an adjusted 2Q17 net loss of $46 million or $0.11 per share, compared to an adjusted net loss of $392 million or $0.90 per share in the prior-year quarter. The adjusted net loss was wider than our net loss estimate of $0.04 per share and the consensus loss estimate of $0.02 per share. Secondquarter revenue of $2.404 billion was comparable to the prior year and up 6% sequentially. EARNINGS & GROWTH ANALYSIS We are establishing EPS estimates of $0.36 for 2017 and $1.62 for 2018 for the new BHGE. Our estimates assume a gradual increase in crude oil prices, increased drilling activity and modest margin growth, with stronger improvement in The current consensus forecasts are $0.40 for 2017 and $1.64 for Our projections parallel our estimates for the company s close competitors Halliburton and Schlumberger. FINANCIAL STRENGTH & DIVIDEND We rate BHGE s financial strength as Medium, the midpoint on our five-point scale. The company s debt is rated A+/ stable by Standard & Poor s and A3/stable by Moody s. At the end of 2Q17, the company s total debt/capitalization ratio was 19.5%, well below the peer average. Short- and long-term debt totaled $3.009 billion, consisting of $331 million in short-term borrowings and $2.678 billion in long-term borrowings. BHGE had cash and equivalents of $4.133 billion at the end of 2Q17. BHGE pays a quarterly dividend of $0.17 per share, or $0.68 annually, for a yield of about 2.0%. Our dividend estimates are $0.68 for both 2017 and MANAGEMENT & RISKS Martin Craighead, the former chairman and CEO of Baker Hughes, is the vice chairman of BHGE. Lorenzo Simonelli, the former CEO of GE Oil & Gas, is the company s new chairman. The primary driver of BHI s business is capital spending by customers. Demand for the company s services is largely dependent on commodity prices, the number of oil rigs in operation, the number of oil and gas wells being drilled, the depth and condition of those wells, production volumes, and well completions

4 COMPANY DESCRIPTION Baker Hughes, a GE Company was formed from the merger of Baker Hughes Inc. and GE s oil and gas business in July The new company is 62.5% owned by General Electric, and 37.5% owned by former BHI shareholders. The new BHGE is the world s third-largest oil services company, with annual pro forma revenues of $23 billion and approximately 70,000 employees. INDUSTRY Our rating on the Energy sector is Market-Weight. While oil prices are moving higher, the Energy sector is not yet rebounding in terms of capital investment or the replacement of lost production. But we believe those are the next steps in the recovery process. The sector accounts for 6.0% of the S&P 500. Over the past five years, the weighting has ranged from 5% to 14%. We think that investors should consider allocating 5%-7% of their diversified portfolios to the Energy group. The sector includes the major integrated firms, as well as exploration & production, refining, and oilfield & drilling services companies. By our calculations, the projected P/E ratio on 2018 earnings is 21.2, above the market multiple of 16.6 given the challenging sector earnings outlook. We forecast that West Texas Intermediate crude will average $52 per barrel in 2017, up from $43 in 2016 but well below the average price of $93 set in We also expect oil prices, which have been lower this year than we initially projected, to remain volatile. We look for a full-year price range of $42-$60, down from our prior estimate of $43-$66. Our 2017 forecast for the wellhead price of Henry Hub natural gas remains $2.50-$3.60 per MMbtu. VALUATION BHGE shares have trended lower since they began trading on July 3, The shares are trading at a high 91.1-times our 2017 EPS estimate, reflecting weak current-year earnings, and at a more reasonable 20.3-times our 2018 estimate, below the peer group average of BHGE is also trading at a trailing price/book multiple of 2.0, below the peer average of 2.7; at a projected 2018 price/sales multiple of 2.7, compared to 2.6 for peers; and at a projected 2018 price/cash flow multiple of 6.3, well below the peer average of Our target price of $43 implies a multiple of 26.5-times our 2018 EPS forecast, and a total potential return, including the dividend, of 32% from current levels. On August 18, BUY-rated BHGE closed at $32.77, down $0.03. (Bill Selesky, 8/18/17) - 4 -

5 NETAPP INC. (NGS: NTAP, $39.35)... BUY NTAP: Upgrading to BUY with $46 target * NTAP shares have retreated from a recent peak above $45 and appear attractive at current prices near $39. * In our view, NTAP is positioned for at least a year of revenue and earnings growth, driven by improving product sales. * NTAP also has the potential for multiyear growth as service & maintenance revenues, starved by stagnant product sales in recent years, begin to benefit from an increase in the installed base. * NTAP shares trade at significant discounts to historical comparables, peer-group metrics, and DFCF valuations. At the same time, NetApp is poised to deliver EPS growth exceeding that of direct peers, the technology sector, and the broad market. ANALYSIS INVESTMENT THESIS We are raising our near-term rating on NetApp Inc. (NGS: NTAP) to BUY from HOLD, and setting a target price of $46. The shares have retreated from a recent peak above $45 on a combination of nonfundamental weakness (the summer Tech sector correction) and a generally negative response to fiscal 1Q18 results. We see value in the stock at current prices near $39. In our view, NTAP is positioned for at least a year of revenue and earnings growth, driven by improving product sales. NTAP also has the potential for multiyear growth as service & maintenance revenues, starved by stagnant product sales in recent years, begin to benefit from an increase in the installed base. NetApp has long targeted user adoption of its Clustered Data ONTAP operating system for fiber-attached storage (FAS). The company is now equally focused on several key growth drivers, most notably all-flash arrays, converged infrastructure, and data management across hybrid cloud environments. Our new BUY rating comes with caveats. NetApp is currently benefiting from integration issues at Dell EMC and turmoil at Hewlett Packard Enterprise; those dislocations will likely diminish in the coming quarters. All-flash niche players such as Pure Storage also represent a competitive threat. In addition, previously easy comparisons at NetApp will become more challenging as FY18 progresses. At the same time, we believe that NetApp has substantial opportunities to promote its all-flash products; to develop the converged market and promote its upcoming hyper-converged solution; and to help enterprises manage data resources and storage across hybrid environments. Having pulled back from recent peaks, NTAP is trading within 12% of its average five-year price of $35.50 and appears attractive at current levels. NTAP s two-year forward P/E of 11.8 is below the trailing five-year P/E of 13.8, an anomaly among high-profile tech stocks. In a rising market, the two-year forward relative P/E of 0.68 is also below the five-year trailing relative P/E of The stock looks equally attractive based on peer group comparisons and our 2- and 3-stage discounted free cash flow models. The Street projects average two-year forward EPS growth of 12%, while we look for 13% growth. That is better than our outlook for most direct peers, the technology sector, and the broad market. Reflecting this positive outlook, we calculate a blended value in the low $50s. Appreciation to our 12-month target price of $46, along with the current 2.0% dividend yield, implies a risk-adjusted 12-month return in the mid-teens, and is thus consistent with a BUY rating. RECENT DEVELOPMENTS NTAP is up 12% year-to-date in 2017, compared with a 7% gain for the Argus Information processing & storage peer group. NTAP rose 33% in 2016, while the (greatly reduced) storage peer group was up 41%. NTAP shares declined 36% in 2015, while the old peer group of Argus-covered storage equities declined 27%. NTAP rose 1% in 2014, rose 23% in 2013, fell 8% in 2012, declined 34% in 2011, and rose 60% in 2010, following a 146% surge in 2009 from cycle lows in We believe that NetApp has a strong near-term opportunity to grow product sales amid industry consolidation and challenges at competitors. Storage has long been dominated by spinning disk arrays; the transition to all-flash is following the usual tech sector pattern of initial low adoption followed by an accelerated adoption period that confounds industry pundits. Large full-service competitors such as Dell EMC and Hewlett Packard have all-flash offerings. But Dell EMC has been saddled with integration issues, while HPE is struggling to keep its server business relevant in the cloud era. And at both of these companies, storage must fight for a place at a table already crowded by PCs, servers, enterprise services, networking, and other offerings

6 NetApp s focus on storage may be an advantage during a period of industry turmoil and consolidation. The company also has a clear strategy under CEO George Kurian. After a first phase of shifting its business to growth areas while building a cost-efficient operating structure, NetApp is now delivering sustained revenue growth, higher margins, and stronger returns to shareholders. For fiscal 1Q18, NetApp reported revenue of $1.33 billion, which was up 2% year-over-year but down 11% sequentially from seasonally strong 4Q17; above the $1.32 billion midpoint of management s wide $1.24-$1.39 billion guidance range; and above the $1.32 billion consensus estimate. Non-GAAP earnings of $0.62 per diluted share were up 36% year-over-year, though down $0.24 from 4Q17; above the high end of management s guidance range of $0.49-$0.57; and above the $0.55 consensus estimate. In fiscal 1Q18, NetApp s all-flash business achieved an annual revenue run rate in the $1.5 billion range, while rising 95% year-over-year. Smoothing out all seasonal variation, annualized revenue would translate to about $375 million in quarterly revenue, or approximately 28% of total revenue for 1Q18. This figure includes some service sales; however, all-flash product sales are approaching 50% of total array product sales. NetApp has two significant growth opportunities in all-flash: converting the existing installed base of customers, and displacing competitors legacy disk-based arrays. NetApp is also focused on enabling data management across hybrid cloud environments. NetApp has long targeted user adoption of its Clustered Data ONTAP operating system for its fiber-attached storage (FAS). The proprietary cdot OS is now shipping on most product sales, including NetApp s all-flash arrays. The company s data fabric simplifies and integrates data management in the cloud and in on-premises environments, which is a key customer requirement. The company s channel partners (who drive four-fifths of sales) and direct sales force have shifted from product-based sales to solutions-based sales to address what management sees as a $55 billion opportunity. The GreenQloud niche acquisition adds cloud orchestration to the company s toolkit. Another market opportunity is growth is converged infrastructure, in which multiple IT components (storage, Ethernet networking, servers, etc.) share a single network or data center space. NetApp got into this business by pairing with Cisco (and earlier with VMWare. The (now EMC-free) partnership provides FlexPod converged infrastructure solutions that pair NetApp FAS gear with Cisco networking gear. All-flash FlexPod strengthened NetApp s #2 position in converged infrastructure, according to the CEO. FlexPod revenues advanced 26% year-over-year in calendar 1Q17, according to IDC. In 1Q18, NetApp introduced FlexPod SF, which incorporates elements of NetApp s SolidFire technology, enabling programmable agility and scale-out. In fiscal 2018, NetApp and the FlexPod partnership plan to launch a hyper-converged solution, which adds a software layer to create a fully softwaredefined IT infrastructure. These three key product areas all-flash, converged infrastructure, and enabling hybrid cloud should drive product sales growth in the low to mid-single digits in FY18-FY19. We believe that NetApp will be able to sustain total top-line growth over a longer period, however. That will require NetApp to use the current period of above-average product growth to rebuild its installed base, and thus strengthen the long-term outlook for recurring revenues in software and hardware maintenance, and professional services. Revenue from these service-related areas has been impaired, however, by years of declining product revenue. NetApp last grew product revenue in fiscal 2012, to a peak of $4.21 billion. Product revenue declined 3% in FY13, 4% in FY14, 7% in FY15, and 18% in FY16, before edging up 1% in FY17. Product revenue was $3.01 billion in FY17, or about 71% of the peak level in FY12. Non-Product revenue including software maintenance, hardware maintenance, professional and other services coasted for years on earlier product strength. Non-Product has also become a more important revenue source, rising from 32% of sales in FY12 to 46% in FY16 and FY17. But as product sales have weakened, growth in non-product revenue has been decelerating, from 11% in FY13, to 6% in FY14, and to the low single digits in FY15 and FY16. The non-product category swung to negative (down 2%) in FY17, with software service (up 2%) doing better than hardware maintenance & professional services (down 4%). Non-Product revenue was down 5% annually in 1Q18. As product growth improves, we expect the services and maintenance-related contribution to gradually turn positive, although we do not have a near-term timetable on this shift. Our new BUY rating comes with caveats. NetApp is currently benefiting from integration issues at Dell EMC and turmoil at Hewlett Packard Enterprise; those dislocations will likely diminish in the coming quarters. All-flash niche players such as Pure Storage also represent a competitive threat. In addition, previously easy comparisons at NetApp will become more challenging as FY18 progresses

7 In 1Q18, the formerly fast-growing Strategic Products category declined more than overall revenue on a sequential basis. There is a high degree of seasonality in NetApp s business, and margins compress in low-revenue periods. Finally, product revenue growth is likely benefiting from elevated NAND and DRAM prices; that strength may not last, as memory is the most volatile technology niche when it comes to price. That said, we believe that NetApp has substantial opportunities to promote its all-flash products; to develop the converged infrastructure market and promote its upcoming hyper-converged solution; and to help enterprises manage their data resources and storage across hybrid environments. As accelerating product sales increase the installed base, growth should follow in service & maintenance revenue (nearly half of total revenue). For 2Q18, NetApp guided for revenue of $1.31-$1.46 billion, which at the midpoint would be up about 4% year-overyear. We expect product revenue to grow faster than non-product revenue for both the quarter and the full year. Management projects non-gaap EPS of $0.64-$0.72, which at the midpoint of $0.68 would be up 14%. NTAP appears attractive at current levels, based on historical comparable, peer group, and discounted free cash flow valuation. The stock has been a multiyear laggard, but may now be positioned for multiyear outperformance based on management s sound strategy, competitive market factors, prospects for above-average product growth in the near term, and the potential to restore growth in non-product revenue over time. EARNINGS & GROWTH ANALYSIS For fiscal 1Q18, NetApp reported revenue of $1.33 billion, which was up 2% year-over-year, but down 11% sequentially from a seasonally strong 4Q17; above the $1.32 billion midpoint of management s wide $1.24-$1.39 billion guidance range; and above the $1.32 billion consensus estimate. The non-gaap gross margin expanded sequentially to 64.1% in 1Q18 from 62.7% in 4Q17 and from 61.2% in 4Q16. NetApp s significant restructuring program, which includes a 12% headcount reduction, has reduced operating costs. The non- GAAP operating margin narrowed sequentially on lower volume leverage, to 15.8%, down from 20.7% in fiscal 4Q17, but expanded from 12.1% in the year-earlier quarter. Non-GAAP earnings of $0.62 per diluted share for 1Q18 were up 36% year-over-year but down $0.24 from 4Q17; above the high end of management s guidance range of $0.49-$0.57; and above the $0.55 consensus estimate. For all of FY17, NetApp posted revenue of $5.52 billion, down less than 1% from $5.55 billion in FY16. Non-GAAP EPS totaled $2.73, up 28% from $2.14 in FY16. For 2Q18, NetApp guided for revenue of $1.31-$1.46 billion, which at the midpoint would be up about 4% year-overyear. We expect product revenue to grow faster than non-product revenue for both the quarter and the full year. Management projects non-gaap EPS of $0.64-$0.72, which at the midpoint of $0.68 would be up 14%. Given improving margins and the strong product-sales profile, we are increasing our FY18 non-gaap EPS forecast to $3.25 per diluted share from $2.99 and our FY19 estimate to $3.42 from $3.30. The Street projects average two-year forward EPS growth of 12%, while we look for 13% growth. That is better than our outlook for most direct peers, the technology sector, and the broad market. Both estimates are contingent on the company achieving its strategic transformation and end markets remaining healthy. Our GAAP forecasts are $2.57 per diluted share for FY18 and $2.68 for FY19. Our long-term EPS growth forecast is 10%. FINANCIAL STRENGTH & DIVIDEND Our financial strength rating for NetApp is Medium-High. NetApp took on short-term debt to finance the $870 million purchase of SolidFire in Total debt was $2.39 billion at the end of 1Q18. Debt was $2.41 billion at the end of FY17, $2.40 billion at the end of FY16, and $1.49 billion at the end of fiscal 2015, following the issuance of $500 million in senior notes due Debt/cap was 46.4% at the end of fiscal 2017, 44.8% at the end of FY16, and 30.3% at the end of fiscal Cash was $5.32 billion at the end of 1Q18. Cash was $4.92 billion at the end of FY17, $5.46 billion at the end of FY16, and $5.33 billion at the close of FY15. Net cash was $2.93 billion at 1Q18. Net cash was $2.56 billion at the end of FY17, $2.95 billion at the end of FY16, and $3.85 billion at the end of FY15. Cash flow from operations was $986 million in FY17, $974 million in FY16, and $1.27 billion in FY15. In February 2015, NetApp announced a $2.5 billion share repurchase authorization. The company is committed to completing this program by May In May 2017, the company hiked its quarterly dividend by 5% to $0.20 per common share. NetApp increased its quarterly dividend by 6% to $0.19 per share in May 2016, by 9% to $0.18 in May 2015, and by 10% to $0.165 in May

8 We are now modeling a 5% hike in the quarterly dividend in May We estimate annual dividends of $0.80 per share in FY18 and $0.84 in FY19. MANAGEMENT & RISKS George Kurian has been CEO since June Ron Pasek, formerly of Altera, replaced Nick Noviello as chief financial officer in March The acquisition of SolidFire represents a new risk, particularly given the poor performance of Engenio, the prior major acquisition. Only time will tell if NetApp has bought a redundant or complementary asset. An additional risk comes from funding the integration of this asset while simultaneously reducing investment in traditional businesses. The latest restructuring program, along with the program from early 2014, highlights risks related to reduced hardware intensity in the next-generation, cloud-enabled data center. It also specifically raises questions about the wisdom of the Engenio acquisition. We could see impairments in goodwill and intangible assets as a result of business reassessment. Competition is always a risk in the storage industry, particularly from EMC. NetApp also faces competition from Hewlett-Packard, Dell and Hitachi, as well as from smaller companies in the all-flash space. We regard NetApp s ability to offer all its products around a common operating system (Data ONTAP) as a competitive advantage, particularly as data management is dispersed across internal IT and external cloud-based resources. We note that the financial services sector typically contributes 14%-15% of NetApp s total revenue and that the U.S. government has also been a major NetApp customer, contributing 11%-12% of revenues. While sector concentration remains a risk, the impact appears to be diminishing. COMPANY DESCRIPTION NetApp Inc. is a pure-play data storage company, providing enterprise network storage and data management solutions, including storage hardware, software and services. NetApp has several powerful partners, including IBM, VMware, Cisco, Microsoft, and Fujitsu. In May 2011, at the beginning of FY12, NetApp acquired Big Data hardware provider Engenio; and in February 2016, it acquired all-flash array maker SolidFire. In FY17, NetApp generated $5.52 billion in revenue. INDUSTRY We have raised our rating on the Technology sector to Over-Weight from Market-Weight. Technology is showing clear investor momentum, topping the market in the year-to-date and trailing one-month and three-month periods. At the same time, the average two-year-forward EPS growth rate exceeds our broad-market estimate and sector averages. This has kept technology sector valuations from becoming too rich, and resulted in PEG ratios that are below the median for all sectors. Over the long term, we expect the Tech sector to benefit from pervasive digitization across the economy, greater acceptance of transformative technologies, and the development of the Internet of Things (IoT). Healthy company and sector fundamentals are also positive. For individual companies, these include high cash levels, low debt, and broad international business exposure. In terms of performance, the sector rose 12.0% in 2016, above the market average, after rising 4.3% in The sector is strongly outperforming thus far in 2017, with a gain of 17.1%. Fundamentals for the Technology sector look reasonably balanced. By our calculations, the P/E ratio on projected 2017 earnings is 18.7, slightly above the market multiple of Earnings are expected to grow 30.2% in 2017 following low singledigit growth in The sector s debt ratios are below the market average, as is the average dividend yield. VALUATION Having pulled back from recent peaks, NTAP is trading within 12% of its average five-year price of $35.50 and appears attractive at current levels. NTAP s two-year forward P/E of 11.8 is below the trailing five-year P/E of 13.8, an anomaly among high-profile tech stocks. In a rising market, the two-year forward relative P/E of 0.68 is also below the five-year trailing relative P/E of The stock looks equally attractive based on peer group comparisons and our 2- and 3-stage discounted free cash flow models. Reflecting our more positive near- and long-term growth outlook for NetApp, particularly as increasing product sales rebuild the service & maintenance revenue opportunity, our revised discounted free cash flow analysis suggests a value in the mid- $50s, in a rising trend from the mid-$40s one year ago. Reflecting its superior growth prospects, NTAP trades at a significant discount to the peer average PEG multiple, and at a smaller discounts on P/E, price/sales, and price/book value. We have calculated a blended value for NTAP in the mid-$50s, in a rising trend. Appreciation to our 12-month target price of $46, along with the 2.0% dividend yield, implies a risk-adjusted 12-month return in the mid-teens, and is thus consistent with a BUY rating. On August 18, BUY-rated NTAP closed at $39.35, down $0.21. (Jim Kelleher, CFA, 8/18/17) - 8 -

9 APPLIED MATERIALS INC. (NGS: AMAT, $44.30)... BUY AMAT: Boosting target to $52 following strong 3Q * Applied Materials delivered a fifth consecutive record quarter, with fiscal 3Q17 sales and EPS growing sharply and topping expectations. * Management expects 20% growth in global wafer fab equipment demand in 2017, up from its 15% growth forecast in May, and looks for further growth in * In the first nine months of FY17, the company posted cash flow from operations of $2.91 billion, up from $1.67 billion a year earlier and well above the full-year total of $2.47 billion in FY16. * The company s increasingly efficient operations and growing volume leverage are leading to expanded margins and accelerating profit growth. As such, we believe the shares remain undervalued even after their strong recent run-up. ANALYSIS INVESTMENT THESIS BUY-rated Applied Materials Inc. (NGS: AMAT) delivered a fifth consecutive record quarter, with fiscal 3Q17 sales and EPS growing sharply and topping expectations. Revenue of $3.74 billion grew 33% year-over-year, while non-gaap EPS of $0.86 grew 70%. AMAT saw double-digit revenue growth in its three operating segments Semiconductor Systems, Global Services and Display and margins and earnings expanded in all businesses. In Semiconductor Systems, where overall revenue growth topped 40%, DRAM-related revenue nearly doubled from the prior year, while NAND and Foundry were also strong. Revenue growth was positive in nearly all regional markets, with especially strong growth in Korea. In what we regard as a key metric, cash flow from operations thus far in FY17 already exceeds the full-year total in FY16. CEO Gary Dickerson believes that AMAT currently has more opportunities than at any time in its history, given strong markets that include nontechnology verticals and are expanding to accommodate IoT, AI and big data. The company also believes its operations and platform give it sustainable advantages. Management expects 20% growth in global wafer fab equipment demand in 2017, up from its 15% growth forecast in May; the company looks for further WFE growth in Semiconductor companies and their merchant fab partners are seeking to execute challenging transitions to new technologies, including 3D NAND, FinFET (3D) CPUs, and 10 nm DRAM. These companies are counting on AMAT s advanced solutions and expertise in materials innovation to facilitate these transitions. We believe that Applied Materials ability to address significant technology transformations bodes well for AMAT shares going forward. The company s increasingly efficient operations and growing volume leverage are leading to expanded margins and accelerating profit growth. As such, we believe the shares remain undervalued even after their strong recent run-up. We are reiterating our BUY rating on AMAT to a 12-month target price of $52, raised from $43. RECENT DEVELOPMENTS AMAT is up 37% year-to-date versus a 15% gain for Argus-covered semiconductor stocks, a 19% gain for the SOX semiconductor index, and a 9% rise for the S&P 500. The shares advanced 30% in 2016, compared to a 70% gain for Argus-covered semiconductor stocks. AMAT declined 25% in 2015, while semiconductor stocks in Argus coverage rose 9% for the year. AMAT shares rose 41% in 2014, compared to an average 18% gain for the peer group. In 2013, AMAT advanced 55%, while the Argus Semiconductor peer group rose 22%. For fiscal 3Q17 (ended July 31), Applied Materials reported revenue of $3.74 billion, which was up 33% year-over-year and 6% sequentially; toward the high end of management s guidance range of 3.60-$3.75 billion; and above the consensus call of $3.69 billion. Non-GAAP earnings of $0.86 per diluted share were up 70% year-over-year and $0.07 on a sequential basis; near the high end of management s guidance range of $0.79-$0.87; and two cents above consensus expectations. For 3Q17, Semiconductor Systems revenue of $2.53 billion (68% of total) was up 42% annually and 6% sequentially. Operating profit grew 71% annually and the operating margin of 34.5% expanded from 28.6% a year earlier and from 33.6% in 2Q17. Within Semiconductor Systems, Foundry revenue (39% of SS total sales) was up 49%, and NAND (38% of SS total) was up 31%. DRAM (15% of SS total sales) showed even stronger demand, with revenue up 93% annually amid industry memory shortages. Logic (8% of SS total) edged up 3% from the prior year

10 Global Services revenue (21% of total revenue) advanced 20% year-over-year; segment profit grew 22% and the operating margin of 27.1% expanded by 50 points. Display revenue (11% of total) advanced 31% year-over-year; segment profit grew 44% and the operating margin of 22.2% rose by 201 basis points. Regionally, AMAT experienced solid annual sales growth in almost every major market. Except for Southeast Asia and Taiwan, which each posted declines, sales in all other major markets grew in the high double digits, led by Korea, where revenue nearly tripled. Total Asian revenue (85% of company total) rose 33%; non-asian (13% of total) was also up 33%. Applied Materials delivered a fifth consecutive quarter of record revenue and earnings. Management expects continued new record levels of activity, and believes that growth can accelerate from current levels based on AMAT s strong positioning. AMAT believes that it has more opportunities at present than at any time in its history. Amid pervasive demand for electronics, traditional technology markets are strong and getting larger, which is serving to smooth out historical seasonality. New demand drivers, including IoT, AI and big data, are layering on traditional markets such as computing and mobility. As companies engage in digital transformation enabled by new technologies, technology demand is exploding across multiple nontechnology verticals, including transportation, healthcare, manufacturing, retail, and others. Applied believes it is better positioned than at any time in its history, with a portfolio of assets uniquely levered to industry inflections, according to CEO Dickerson. AMAT is levering and combining its skills in deposition, removal, materials modification, inspection and metrology. Management has put in place a company-wide operating system that delivers repeatable success, enabling efficient operations and margin expansion. Beyond AMAT s core operations, its markets remain healthy. The company expects continued healthy investment in memory semiconductor-fabrication equipment, driven by explosive data growth around IoT, big data and AI. In NAND, the transition to 3D scaling has several major levers reducing film and stack heights, lateral scaling, multi-tier schemes enabled by advanced materials engineering, which plays to AMAT s market strengths. In foundry, advances in AI are beginning to drive significant architectural changes. AI-enabled data centers and HPC (high performance computing) environments require logic content that is growing at twice the rate of memory content. In DRAM, amid the ever-pressing drive to attain smaller form factors, dimensional scaling of devices remains an ever-present challenge. AMAT technology delivers new innovations in patterning, such as self-aligned multi-patterning techniques, in conjunction with EUV lithography to deliver the necessary resolution. Applied has gained significant market share in patterning since 2012 as the challenge of shrinking process nodes drives competitors from the market. Given positive demand factors, AMAT now expects semiconductor wafer fabrication equipment (WFE) spending to increase by 20% in That is up from the company s 15% growth forecast offered in May. It also expects further spending growth in 2018, suggesting that the demand drivers benefiting the company have legs. These estimates also incorporate very conservative expectations for China, which many expect to emerge as a leading demand driver in coming years. China has accounted for 21% of AMAT s revenue in FY17, up from 16% in FY16. Display fabrication equipment demand is growing even faster than wafer fab equipment, according to the CEO. Growth is being fueled by the arrival of Gen 10.5 substrates (10 meters square), which are ideal for producing large-screen TVs. In the compute and mobility space, OLED enables new form factors that result in larger display areas for smartphone and mobile devices. EARNINGS & GROWTH ANALYSIS For fiscal 3Q17 (ended July 31), Applied Materials reported revenue of $3.74 billion, which was up 33% year-over-year and 6% sequentially; toward the high end of management s guidance of 3.60-$3.75 billion; and above the consensus call of $3.69 billion. The non-gaap gross margin expanded sequentially to 46.6% in 3Q17 from 46.3% in 2Q17 and from 43.7% a year earlier. Reflecting mix and volume leverage along with cost discipline, the non-gaap operating margin expanded to 28.6% in 3Q17 from 27.7% in 2Q17 and from 22.8% in 3Q16. Non-GAAP earnings of $0.86 per diluted share were up 70% year-over-year and $0.07 sequentially, near the high end of management s guidance range of $0.79-$0.87, and two cents above consensus expectations. For all of fiscal 2016, revenue of $10.83 billion rose 12% from $9.66 billion in fiscal Fiscal 2016 non-gaap earnings totaled $1.76 per diluted share, up 56% from $1.13 per diluted share in fiscal For 4Q17, AMAT projects revenue of $3.85-$4.0 billion and non-gaap earnings of $0.86-$0.94 per diluted share. At the respective guidance midpoints, revenue of $3.93 billion would be up 19% annually and 5% sequentially, and non-gaap EPS of $0.90 would be up 38%. The prereporting consensus forecast for 4Q17 had called for non-gaap EPS of $0.82 on revenue of $3.71 billion

11 We are raising our FY17 earnings forecast to $3.25 per diluted share from $3.14 and our FY18 forecast to $3.59 per diluted share from $3.36. Our GAAP forecasts are $3.14 for FY17 and $3.42 for FY18. Our five-year average annual earnings growth rate estimate remains 11%. FINANCIAL STRENGTH & DIVIDEND Our financial strength rating on Applied Materials is Medium-High. AMAT issued $2.2 billion in debt in March 2017 to increase onshore liquidity. Since the end of 2Q17, AMAT has used some proceeds to retire debt. Cash & investments were $8.3 billion at the end of 3Q17, $4.7 billion at the end of FY16, $6.1 billion at the end of FY15, and $4.1 billion at the end of FY14. Total debt was $5.30 billion at the end of 3Q17, $3.34 billion at the end of FY16, $4.54 billion at the end of FY15, and $1.95 billion at the end of FY14. Net cash was $2.99 billion at the end of 3Q17, compared to $1.34 billion at the end of FY16 and $1.37 billion at the end of FY15. Reflecting recent operational strength, cash flow in the first nine months of FY17 was $2.91 billion versus $1.67 billion a year earlier. Cash flow from operations was $2.47 billion in FY16, $1.12 billion in FY15, and $1.80 billion in FY14. In April 2015, Applied Materials announced a three-year, $3 billion share repurchase authorization, beginning in 3Q15. In 1H17, it spent $412 million to repurchase shares. AMAT spent $1.89 billion to repurchase shares in FY16 and $1.3 billion in FY15. We expect a steady pace of buybacks going forward. The current annualized dividend of $0.40 yields about 0.9%. Although major acquisition plans have been scrapped, we are not looking for a dividend hike. Our dividend estimates are $0.40 per share for both FY17 and FY18. MANAGEMENT & RISKS Gary Dickerson became CEO in September Former CEO Mike Splinter is executive chairman. In August 2017, new CFO Dan Durn replaced Bob Halliday, who had been CFO since Randhir Thakur is the EVP and general manager of the Semiconductor Systems Group. The fallout from the failed combination with Tokyo Electron entails risks, such as loss of customers future business that was predicated on combination synergies. On the other hand, AMAT no longer has risks associated with integration issues. An additional risk for Applied Materials is that strong multiyear growth in foundry orders could be coming to an end. We see limited risk on that front. More and more companies are adopting a fully fabless or fab-light strategy in which they use foundries to build their products. The explosive growth not only in mobile devices but in mobile broadband ensures that demand for high-performance semiconductors will continue to strengthen on both a cyclical and structural basis. AMAT strained its balance sheet to pay for Varian. Cash was reduced from nearly $7 billion to $2.5 billion, and the company took on approximately $2 billion in debt. Fortunately, it appears that recent softness in semiconductor capital spending is ending. We will continue to monitor this situation, which remains fluid. We believe that Applied Materials, strengthened by Varian, is well positioned to gain market share. In our view, global demand for digital solutions is strong and will remain so going forward, keeping AMAT s book of business healthy. Offsetting strength in semiconductor capital equipment are cyclical declines in the display and solar PV businesses due to overcapacity. Despite near-term challenges, we believe that the display business provides AMAT with additional avenues for growth over the long term. The fate of the solar PV business hangs in the balance, in our view. COMPANY DESCRIPTION Applied Materials produces semiconductor fabrication equipment, including products used in deposition, etching, ion implantation, metrology, wafer inspection and mask-making. Acquisitions expanded AMAT s presence in flat-panel display fabrication equipment and in the solar semiconductor market. The $4.9 billion Varian acquisition enabled AMAT to build share in high-performance and low-power applications processors. The company s plans to combine with Tokyo Electron have now been cancelled. AMAT generated FY16 revenue of $10.83 billion. INDUSTRY We have raised our rating on the Technology sector to Over-Weight from Market-Weight. Technology is showing clear investor momentum, topping the market in the year-to-date and trailing one-month and three-month periods. At the same time, the average two-year-forward EPS growth rate exceeds our broad-market estimate and sector averages. This has kept technology sector valuations from becoming too rich, and resulted in PEG ratios that are below the median for all sectors

12 Over the long term, we expect the Tech sector to benefit from pervasive digitization across the economy, greater acceptance of transformative technologies, and the development of the Internet of Things (IoT). Healthy company and sector fundamentals are also positive. For individual companies, these include high cash levels, low debt, and broad international business exposure. In terms of performance, the sector rose 12.0% in 2016, above the market average, after rising 4.3% in The sector is outperforming thus far in 2017, with a gain of about 11.5%. Fundamentals for the Technology sector look reasonably balanced. By our calculations, the P/E ratio on projected 2017 earnings is 18.1, near the market multiple of Earnings are expected to grow 31.9% in 2017 following low single-digit growth in The sector s debt ratios are below the market average, as is the average dividend yield. VALUATION AMAT trades at 13.7-times our FY17 non-gaap EPS estimate and at 12.4-times our FY18 non-gaap forecast; the twoyear average forward P/E of 13.0 is well below the five-year ( ) average of The shares trade at an average 27% discount to the market multiple, well below the five-year historical premium of 17%. Other comparable multiples signal undervaluation by historical standards, and our price-based historical comparable valuation points to a value in the mid-$50s, in a clearly rising trend. AMAT trades in line with peers on forward P/E and price/book ratio, but at a nice discount to peers on PEG. Our discounted free cash flow analysis suggests a value in the $100s, also in a rising trend and well above current prices. Our blended valuation estimate is now above $90, up from the $60s in less than a year. Including the current dividend yield of about 0.9%, appreciation to our $52 target implies a risk-adjusted total return of about 16%, better than our forecast return for the broad market and consistent with a BUY rating. On August 18, BUY-rated AMAT closed at $44.30, up $1.18. (Jim Kelleher, CFA, 8/18/17)

13 CHEESECAKE FACTORY INC. (NGS: CAKE, $42.88)... HOLD CAKE: Maintaining HOLD on slowing comps * Management has reduced its 3Q same-store sales guidance from growth of 0.5%-1.5% to a decline of 1%. * Cheesecake s earnings are driven by same-store sales, and we expect declining comps to weigh on EPS. * We are lowering our EPS estimates to $2.80 from $2.90 for 2017 and to $3.00 from $3.10 for * We believe that CAKE is fairly valued at 14.8-times our revised 2017 EPS estimate, below the average for other casual dining chains. ANALYSIS INVESTMENT THESIS We are maintaining our HOLD rating on Cheesecake Factory (NGS: CAKE). The company recently posted lower second-quarter comp sales, and cut its third-quarter comp sales guidance from growth of 0.5%-1.5% to a decline of 1%. The second-quarter decline follows 29 straight quarters of growth in same-store sales. Management attributed the weakness in part to unfavorable weather in the East and Midwest, which it believes resulted in less outdoor dining. We are disappointed that the revised guidance comes just six weeks after management s initial forecast and believe that the weak comps will continue into the third quarter. RECENT DEVELOPMENTS On August 2, Cheesecake Factory reported 2Q17 adjusted EPS of $0.78, flat with the prior-year period but below management s $0.85-$0.88 guidance range. EPS topped the consensus forecast by $0.02. Same-store sales declined 0.5%, as 2.4% lower traffic and 0.3% less favorable mix outweighed a 2.2% contribution from higher pricing. Management had forecast a 1.0% decline in comp sales, and the Street had called for a decline of 0.9%. On average, other casual dining chains saw same-store sales decline 70 basis points in the second quarter. In 2Q17, total revenues rose nearly 2.0% to $570 million, below the consensus estimate of $573 million. For 2017, management now projects EPS of $2.62-$2.70, down from a prior $2.93-$3.02. The company expects comps to decline 1% this year, down from a prior estimate of 0.5%-1.0% growth. It plans to open up to 8 new restaurants in 2017 (compared to a prior estimate of 8-9), and expects labor costs to rise 5%. In 2016, revenue increased 8.3% to $2.3 billion and earnings rose from $2.38 to $2.83. EARNINGS & GROWTH ANALYSIS Cheesecake Factory s earnings are driven by same-store sales, and we expect declining comps to weigh on EPS. In view of soft casual-dining demand and an excess of casual-dining restaurants, we believe a return to strong comp growth is unlikely. Wage inflation has also weighed on earnings this year. Looking ahead, prospects for Cheesecake Factory appear unimpressive. Management said the company has outperformed the casual dining industry. However, it now expects a 1% decline in full-year same-store sales. We look for comp sales to decline 0.5% this year after previously projecting 0.3% growth. We are lowering our third-quarter EPS estimate from $0.74 to $0.64 and our full-year estimate from $2.90 to $2.80. We are also lowering our 2018 estimate from $3.10 to $3.00. Based on ongoing cost-cutting efforts and management s guidance, our long-term earnings growth rate estimate is 15%. Over the long term, we also expect the company to exceed its goal of operating 200 Cheesecake Factory restaurants and 150 Grand Lux Cafes. FINANCIAL STRENGTH & DIVIDEND Our financial strength rating on Cheesecake Factory remains Medium-High, the second-highest rank on our five-point scale. Operating income covered interest expense of $1.3 million by a factor of 31.4 in the second quarter, up from 25.1 in the prioryear period. In June 2017, the company raised its quarterly dividend by 21% to $0.29, or $1.16 annually, for a yield of about 1.7%. Management has targeted a payout ratio of 25%. Our dividend estimates are $1.06 (reduced from $1.12) for 2017 and $1.32 for RISKS Higher food and beverage costs are an ongoing risk for restaurant companies. Dairy costs, in particular, affect Cheesecake Factory, as cream cheese is the primary ingredient in the company s namesake product. In addition, increased labor turnover, as well as higher wage and benefit costs, may reduce the company s earnings