Applied Materials, Inc. — Q3 FY2019 Form 10-Q
Reporting period: Three and nine months ended July 28, 2019; comparisons are to the periods ended July 29, 2018. Amounts are in U.S. dollars unless stated otherwise.
Business context and results
Applied Materials supplies semiconductor and display manufacturing equipment, services and software. Results are sensitive to customer capital spending, technology transitions and cyclical industry conditions.
| Metric | Q3 FY2019 | Q3 FY2018 | Nine months FY2019 | Nine months FY2018 |
|---|---|---|---|---|
| Net sales | $3.562B | $4.162B | $10.854B | $12.946B |
| Gross margin | 43.7% | 44.8% | 43.8% | 45.3% |
| Operating income | $802M | $1.093B | $2.486B | $3.600B |
| Operating margin | 22.5% | 26.3% | 22.9% | 27.8% |
| Net income | $571M | $1.016B | $2.008B | $2.281B |
| Diluted EPS | $0.61 | $1.01 | $2.11 | $2.20 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $2.421B | $2.710B |
Financial position and capital allocation
- At July 28, 2019, cash and cash equivalents were $3.014B and investments were $2.197B, for total cash, cash equivalents and investments of $5.211B, down from $5.598B at October 28, 2018.
- Working capital was $6.3B, versus $6.7B at fiscal year-end. Current assets were $10.042B and current liabilities were $3.785B.
- Long-term debt was $5.312B carrying value; aggregate principal was $5.35B. No commercial paper or credit-facility borrowings were outstanding.
- Nine-month capital expenditures were $344M. Financing cash outflow was $2.490B, including $1.903B of repurchases and $577M of dividends. The company repurchased 50M shares for $1.903B in the nine months; about $2.4B remained authorized.
- Operating cash flow declined year over year, which management attributed primarily to lower cash collections and higher supplier and tax payments, partly offset by a smaller inventory-related cash use.
Changes versus prior comparable periods
- Q3 sales fell 14% and nine-month sales fell 16%. Management cited lower semiconductor and display equipment investment. Gross margin and operating margin also declined, reflecting lower sales and less favorable customer and product mix.
- Semiconductor Systems sales fell 12% in Q3 and 19% for nine months; nine-month operating income fell 36%. Memory spending was weaker, while foundry, logic and other demand partly offset the decline.
- Applied Global Services sales were down 2% in Q3 but up 4% for nine months; nine-month operating income rose 2%. Demand for comprehensive service agreements supported growth.
- Display and Adjacent Markets sales fell 45% in Q3 and 33% for nine months, with lower customer investment in mobile and TV display equipment; nine-month operating income fell 57%.
- Q3 effective tax rate rose to 27.0% from 5.7%. Nine-month rate was 17.3% versus 35.2%, with the prior-year period including $1.1B of Tax Act-related expense.
Outlook, commentary and notable items
- Management expected semiconductor-market softness to continue through 2019, primarily due to lower memory spending. Foundry and logic spending was expected to increase year over year, but customers were prioritizing longer-lead-time equipment outside Applied’s product portfolio.
- Management expected lower display equipment spending in FY2019 and continued growth in Global Services. It cited long-term semiconductor and display demand drivers but did not provide numerical company-wide guidance in the filing text.
- On June 30, 2019, Applied agreed to acquire Kokusai Electric for $2.2B cash, subject to regulatory approvals and customary closing conditions. After quarter-end, it secured a commitment for up to $2.0B of unsecured term financing; the loan would mature three years after funding. The filing describes a potential $154M termination fee in certain circumstances involving failure to obtain regulatory approvals.
- New U.S. GILTI regulations led to a $96M reversal of tax benefits in Q3. The company reported a $115M Q3 tax adjustment related to amortization of intra-entity intangible asset transfers in its non-GAAP reconciliation. Q3 non-GAAP adjusted diluted EPS was $0.74 versus GAAP EPS of $0.61; these measures are not interchangeable.
- Revenue recognition guidance was adopted retrospectively in FY2019, and comparative periods were recast. Management said the main effect was fewer constraints on equipment revenue recognition upon shipment.
- Management stated cash from operations, cash balances and borrowing capacity should be sufficient for liquidity needs over the next 12 months. Approximately $961M of Tax Act transition-tax payments remained, payable over the next seven years.
Risks and contingencies
- Key risks include cyclical and volatile semiconductor and display spending, customer concentration, trade restrictions and export licensing, global economic uncertainty, and supply-chain or manufacturing interruptions. About 80% of Q3 sales were to Asia Pacific; China represented 31% of total Q3 sales.
- Four customers each represented at least 10% of nine-month sales, together accounting for 46% (TSMC 13%, Intel 13%, Toshiba 10%, and SK Hynix 10%). Customer concentration and order delays or cancellations could materially affect results.
- Acquisition risks include regulatory approval, integration, financing and execution. The transaction could affect debt, cash available for other uses, and credit ratings.
- Guarantees had a maximum potential payment of approximately $74M; Applied also provided $151M of parent guarantees for subsidiary banking arrangements. Management did not consider payment under the guarantee agreements probable. It did not believe the described legal matters would materially affect financial condition or results.
- Interest-rate sensitivity: an immediate 100-basis-point increase was estimated to reduce the fair value of the fixed-income portfolio by approximately $28M. Management reported disclosure controls were effective and no material Q3 change in internal control over financial reporting.
Important facts for investors to verify
- Whether semiconductor and display customer spending followed the expected FY2019 trajectory, especially memory, display and equipment categories outside Applied’s portfolio.
- Progress, regulatory approvals, financing and integration plans for the Kokusai Electric acquisition, including any termination-fee exposure and effect on leverage.
- Whether operating cash flow, working capital and receivable-sale activity remain sustainable; nine-month receivables sold were $1.3B.
- The recurring tax rate and cash-tax burden after the $96M GILTI-related reversal, including the remaining transition-tax payments.
- Customer and geographic concentration, margin trends, and the impact of trade or export restrictions on sales and supply chains.