Applied Materials, Inc. — Form 10-Q Summary
Reporting period: Third quarter and first nine months of fiscal 2017, ended July 30, 2017. Comparatives ended July 31, 2016; the first nine months comprised 39 weeks in 2017 versus 40 weeks in 2016. Applied Materials supplies equipment, services and software to semiconductor, display and related industries.
Financial results and key metrics
| Metric | Q3 FY2017 | Q3 FY2016 | First 9 months FY2017 | First 9 months FY2016 |
|---|---|---|---|---|
| Net sales | $3.744 billion | $2.821 billion | $10.568 billion | $7.528 billion |
| Gross margin | 45.4% | 42.3% | 44.9% | 41.3% |
| Operating income / margin | $1.023 billion / 27.3% | $596 million / 21.1% | $2.770 billion / 26.2% | $1.375 billion / 18.3% |
| Net income | $925 million | $505 million | $2.452 billion | $1.111 billion |
| Diluted EPS | $0.85 | $0.46 | $2.26 | $0.99 |
- Q3 sales rose 33%, operating income rose $427 million and diluted EPS increased $0.39 year over year. Nine-month sales rose 40% and operating income more than doubled.
- Management attributed stronger margins primarily to higher sales and favorable product mix. Semiconductor Systems generated $2.532 billion of Q3 sales and $874 million operating income; Applied Global Services generated $786 million and $213 million; Display and Adjacent Markets generated $410 million and $91 million.
- For the first nine months, operating cash flow was $2.910 billion, versus $1.669 billion in the prior-year period. Investing used $1.997 billion and financing provided $959 million. Capital expenditures were $221 million.
- At July 30, cash and cash equivalents were $5.278 billion, short- and long-term investments totaled $3.012 billion, and total cash, cash equivalents and investments were $8.290 billion. Working capital was $8.4 billion.
- Long-term debt was $5.303 billion, up from $3.125 billion at October 30, 2016; debt principal was approximately $5.4 billion. The increase mainly reflects $2.2 billion of notes issued in March. The company redeemed $200 million of notes due in 2017 and recorded a $5 million early-extinguishment loss. No amounts were outstanding under its credit facilities.
- Inventory increased to $2.876 billion from $2.050 billion; customer deposits and deferred revenue rose to $2.116 billion from $1.376 billion. The company noted that operating cash flow benefited from higher customer deposits and deferred revenue, partly offset by the inventory build.
- The company repurchased $787 million of shares and paid $323 million in dividends during the nine months. The quarterly dividend was $0.10 per share; $995 million remained under the $2.0 billion repurchase authorization.
Material changes, outlook and risks
- Growth reflected increased customer investment across all segments, especially semiconductor equipment. Semiconductor Systems sales rose 42% in Q3; Display and Adjacent Markets rose 31%, and Applied Global Services rose 20%.
- Management described semiconductor spending as healthy and anticipated healthy spending across semiconductor categories to continue, citing 3D NAND scaling and foundry investment in leading-edge and trailing geometries. Display investment was supported by OLED and mobile applications and larger LCD TVs. The filing provides no specific numerical financial guidance.
- The effective tax rate was 5.4% for Q3 and 7.7% for the first nine months, versus 10.5% and 12.7%, respectively, a year earlier. Lower rates primarily reflected previously unrecognized foreign tax credits, changes in income geography and, for the nine-month period, favorable tax-position resolutions. Management cautioned that tax rates can vary with jurisdictional income and tax developments.
- Approximately $5.0 billion of cash, cash equivalents and marketable securities held by foreign subsidiaries could be subject to U.S. tax if repatriated; the company intends to indefinitely reinvest approximately $4.0 billion abroad. Management believes existing cash, operating cash generation and borrowing capacity will meet liquidity needs for the next 12 months.
- Key risks include cyclical and difficult-to-forecast semiconductor and display spending, technology transitions, customer and geographic concentration, competition, supply-chain and manufacturing disruptions, inventory exposure, global economic and geopolitical conditions, currency and interest-rate movements, cybersecurity, intellectual-property and regulatory matters, and execution and impairment risks from acquisitions. Samsung and TSMC accounted for 22% and 17% of nine-month sales, respectively; Asia Pacific represented 84% of sales.
- Potential payments under standby letters of credit and other guarantees were approximately $67 million; the company also provided approximately $140 million of parent guarantees for subsidiary banking arrangements. Management did not consider payment under the guarantees probable. A Korean criminal proceeding involving former and current employees had been appealed to the Korean Supreme Court; Applied Materials itself was not a party. The company stated it did not believe the described legal matters would materially affect consolidated financial condition or results.
- Disclosure controls were concluded effective at quarter end, with no material change in internal control over financial reporting reported during the quarter.
Most important facts for investors to verify
- Whether strong semiconductor and display customer spending and favorable product mix persist, particularly given the industries’ cyclicality and the 39-week versus 40-week comparison.
- Whether the elevated inventory balance converts to recognized sales and cash, and how much reported operating cash flow depends on customer deposits and deferred revenue.
- How the $2.2 billion debt issuance affects interest expense, capital allocation and future net cash; also verify compliance with debt covenants and access to committed credit facilities.
- Whether the unusually low tax rate and foreign tax credits are sustainable, and the potential tax consequences of repatriating foreign-held funds.
- Customer concentration, especially Samsung and TSMC, and geographic exposure to Korea, Taiwan and China.
- Developments in the Korean Supreme Court proceeding, guarantees, and other legal or contingent matters.