Applied Materials, Inc. — Q1 Fiscal 2019 10-Q
Business context and period: Applied Materials supplies manufacturing equipment, services and software to the semiconductor, display and related industries. This unaudited quarter covered the three months ended January 27, 2019; the comparable quarter ended January 28, 2018. Amounts below are in U.S. dollars and millions, except per-share data and percentages.
Key financial metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net sales | $3,753 | $4,205 | Down 11% |
| Gross profit / margin | $1,665 / 44.4% | $1,940 / 46.1% | Margin down 1.7 points |
| Operating income / margin | $908 / 24.2% | $1,215 / 28.9% | Margin down 4.7 points |
| Net income | $771 | $165 | Up $606 |
| Diluted EPS | $0.80 | $0.15 | Up $0.65 |
| Cash provided by operations | $834 | $1,466 | Down $632 |
| Capital expenditures | $133 | $203 | Down $70 |
Net income and EPS comparisons are heavily affected by the prior-year U.S. tax legislation charge: Q1 FY2018 included approximately $1.0 billion of tax expense, reducing diluted EPS by $0.94. The effective tax rates were 13.2% and 86.1%, respectively. On a non-GAAP adjusted basis, net income was $779 million versus $1,165 million and diluted EPS was $0.81 versus $1.08.
At January 27, 2019, cash and cash equivalents were $3.192 billion and investments were $2.108 billion, for combined cash, cash equivalents and investments of $5.300 billion (down from $5.598 billion at October 28, 2018). Working capital was $6.5 billion. Long-term debt on the balance sheet was $5.310 billion; aggregate principal was $5.35 billion. No commercial paper or revolving-credit borrowings were outstanding. The company reported $1.6 billion of available credit facilities. Cash declined by $248 million during the quarter.
Material changes and segment results
- Semiconductor Systems sales fell 20% to $2.268 billion; operating income fell 38% to $631 million and margin declined to 27.8% from 35.9%. Management attributed the decline to weaker semiconductor equipment spending, unfavorable customer/product mix and increased R&D.
- Applied Global Services sales rose 9% to $962 million; operating income rose 12% to $285 million. Higher service and legacy-system demand supported results.
- Display and Adjacent Markets sales rose 14% to $507 million; operating income increased to $115 million. Higher investment in TV display manufacturing equipment was a principal driver.
- R&D expense increased $27 million to $516 million, reflecting headcount and program spending. Overall gross margin declined, primarily because of lower sales and unfavorable mix.
- Operating cash flow declined primarily because of lower collections and higher supplier payments. The company sold $464 million of receivables without recourse, versus $376 million in the prior-year quarter; days sales outstanding rose to 59 days from 47.
- Share repurchases were $750 million for 22 million shares, and cash dividends paid were $192 million. The quarterly dividend declared was $0.20 per share.
Outlook, commentary and risks
Management said semiconductor customers continued investing in new capacity and technology transitions, but overall spending was lower year over year. Memory spending was weaker, while foundry and logic customers prioritized longer-lead-time equipment outside Applied’s product portfolio. Management expected lower display equipment spending in fiscal 2019, while anticipating continued growth in semiconductor services spending and citing long-term semiconductor technology trends as demand drivers. The filing provides no specific numerical revenue or earnings guidance.
Key exposures include the cyclical and unpredictable nature of semiconductor and display capital spending; concentrated customers and geographic exposure; trade restrictions, tariffs and export licensing; changes in technology and competitive conditions; supply-chain and manufacturing interruptions; and customer liquidity. Approximately 88% of quarterly sales were to customers outside the United States, and four customers each represented at least 10% of total sales. Management stated existing cash, operating cash generation and borrowing capacity should meet liquidity requirements for the next 12 months.
Tax uncertainty includes a $46 million Q1 tax benefit related to proposed GILTI regulations that could reverse if regulations are finalized as proposed. The company also disclosed $68 million of maximum potential payments under standby guarantees and approximately $150 million of parent guarantees for subsidiary banking arrangements; it did not consider payment under the standby guarantees probable. Management did not believe the disclosed legal matters would materially affect financial condition or results, though outcomes cannot be predicted with certainty.
Applied adopted the new revenue recognition standard retrospectively in Q1 FY2019. Management identified fewer constraints on revenue recognition upon shipment of manufacturing equipment as its most significant effect. A separate accounting-standard adoption increased deferred tax assets by approximately $1.6 billion, with a corresponding retained-earnings adjustment.
Investor verification priorities
- Assess the underlying earnings trend separately from the unusually high prior-year tax expense; compare GAAP and adjusted results and review the adjustments.
- Track semiconductor equipment demand, customer spending plans, product mix and the resulting gross- and operating-margin pressure.
- Monitor cash conversion, receivables and DSO, including the scale and terms of receivable sales without recourse.
- Review capital allocation and liquidity: buybacks, dividends, cash and investments, debt maturities, and available credit facilities.
- Follow the potential reversal of the $46 million GILTI-related tax benefit and other uncertain tax positions.
- Evaluate customer and regional concentration, particularly the reported major-customer exposure and international sales dependence.