Applied Materials, Inc. — Q1 Fiscal 2017 Form 10-Q
Business context and period. Applied Materials supplies equipment, services and software to the semiconductor, display and related industries. This quarter ended January 29, 2017, and comprised 13 weeks; the comparable prior-year quarter comprised 14 weeks. Results are unaudited and may not indicate future performance.
Financial performance and condition
| Metric | Q1 FY2017 | Prior-year quarter | Change |
|---|---|---|---|
| Net sales | $3.278 billion | $2.257 billion | +$1.021 billion (45%) |
| Gross profit / margin | $1.445 billion / 44.1% | $916 million / 40.6% | Margin +3.5 points |
| Operating income / margin | $807 million / 24.6% | $354 million / 15.7% | Margin +8.9 points |
| Net income | $703 million | $286 million | +$417 million |
| Diluted EPS | $0.65 | $0.25 | +$0.40 |
| Operating cash flow | $646 million | $207 million | +$439 million |
All amounts are in U.S. dollars. The shorter current-year quarter is an important comparability consideration. Management attributed year-over-year margin improvement chiefly to favorable product mix; sequential gross-margin gains also reflected material cost savings. GAAP results included $48 million of purchased-intangible amortization associated with acquisitions. Adjusted non-GAAP diluted EPS was $0.67; the company’s reconciliation excludes specified items and should be considered alongside GAAP results.
Segments: Semiconductor Systems sales were $2.150 billion, up 57% year over year, with a 32.1% operating margin. Applied Global Services sales were $676 million, up 12%, with a 26.3% margin. Display and Adjacent Markets sales were $422 million, up 66%, with a 27.3% margin. Sequentially, total sales fell 1%: Semiconductor Systems rose 1%, while Services declined 2% and Display declined 7%.
Cash, liquidity and debt: Cash and cash equivalents were $3.491 billion; short- and long-term investments totaled $1.565 billion, for combined cash, cash equivalents and investments of $5.056 billion. Working capital was $5.3 billion. Current liabilities were $3.808 billion against current assets of $9.094 billion. Debt carrying value was $3.325 billion, including $200 million short-term debt and $3.125 billion long-term debt; principal debt was approximately $3.4 billion. No revolving-credit-facility borrowings or commercial paper were outstanding. The company reported $1.6 billion of credit facilities available, including a $1.5 billion committed revolver. Management said liquidity should meet requirements for the next 12 months.
Investing cash use was $367 million, including $64 million in capital expenditures; financing cash use was $194 million, including $130 million of repurchases and $108 million of dividends, partly offset by $44 million of excess tax benefits. Operating cash flow less capital expenditures was $582 million, calculated from the reported figures. Cash increased $85 million during the quarter.
Material changes and management commentary
- Compared with Q1 FY2016, growth was driven by increased customer investment across all segments, particularly semiconductor foundry and memory equipment and mobile-display manufacturing equipment. Semiconductor Systems represented 65% of sales.
- Sequential sales were nearly flat as stronger semiconductor equipment investment was offset by weaker display equipment and services spending. Management cited memory technology upgrades and capacity additions, including the transition to 3D NAND, and foundry investment for advanced mobile chips.
- Management anticipated healthy spending across semiconductor categories for fiscal 2017. It expected display investment to continue for the remainder of the year, including mobile/OLED capacity and equipment for larger LCD TVs. These are qualitative outlook statements, not quantified guidance.
- Two customers accounted for 42% of consolidated sales: Taiwan Semiconductor Manufacturing Company, 24%, and Samsung Electronics, 18%. Approximately 84% of sales were to Asia Pacific; Taiwan alone represented 34%.
- The effective tax rate was 8.8%, versus 8.9% a year earlier and 17.6% in the prior quarter. Management cited favorable resolutions and changes in uncertain tax positions and expected geographic income mix; the low rate and period-to-period tax adjustments affect earnings comparability.
Risks, contingencies and unusual items
- The business is cyclical and exposed to changes in semiconductor and display capital spending, technology transitions, end-user demand, customer capacity plans and global economic conditions. The filing emphasizes that demand and results can vary significantly by quarter.
- Customer and regional concentration heighten exposure to order delays, cancellations, pricing pressure and customer financial health. Display sales are especially uneven: three customers represented approximately 77% of that segment’s sales, with one at approximately 50%.
- Inventory increased to $2.281 billion from $2.050 billion at October 30, 2016. Finished goods included $315 million of newly introduced systems at customer locations that did not yet qualify for revenue recognition. Days inventory outstanding rose to 113 from 98 sequentially; management linked higher inventory to expected business volume.
- Approximately $3.2 billion of cash, cash equivalents and marketable securities held by foreign subsidiaries could be subject to U.S. tax if repatriated. The company intended to indefinitely reinvest approximately $2.1 billion outside the U.S.
- Potential guarantee payments were approximately $50 million, with about $100 million of parent guarantees supporting subsidiary banking arrangements. Management did not consider payment under the former probable. The company reported no material expected effect from disclosed legal matters; the Korean criminal proceeding involving former and current employees remained on appeal, and Applied was not a party.
- The filing identifies risks involving supply-chain interruptions, competition and technology execution, foreign exchange and interest rates, cybersecurity, intellectual property, tax, regulation and possible impairment of goodwill or intangible assets. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the reported spending outlook for semiconductor and display markets translated into subsequent orders, revenue and margins, especially given the industry’s cyclical nature.
- How customer concentration and exposure to Taiwan, Korea and China affected later-period demand, collections and customer credit risk.
- Whether inventory growth and systems awaiting revenue-recognition criteria converted into sales without material write-downs or delays.
- Whether the 8.8% effective tax rate and favorable uncertain-tax-position resolutions were sustainable, and the potential tax implications of foreign-held funds.
- Subsequent debt maturities, capital returns, and actual cash generation relative to the company’s liquidity expectations.
- Non-GAAP-to-GAAP reconciliations and acquisition-related amortization when assessing underlying profitability.