Applied Materials, Inc. — Q2 FY2017 Form 10-Q
Reporting period: Three and six months ended April 30, 2017. Fiscal 2017 first-half results cover 26 weeks; the comparable fiscal 2016 period covered 27 weeks. Amounts below are in U.S. dollars unless noted.
Business context and results
Applied Materials supplies manufacturing equipment, services, and software to the semiconductor, display, and related industries. Its reportable segments are Semiconductor Systems, Applied Global Services (AGS), and Display and Adjacent Markets (DAM).
| Metric | Q2 FY2017 | Q2 FY2016 | First half FY2017 | First half FY2016 |
|---|---|---|---|---|
| Net sales | $3.546 billion | $2.450 billion | $6.824 billion | $4.707 billion |
| Gross margin | 45.1% | 41.0% | 44.6% | 40.8% |
| Operating income | $940 million | $425 million | $1.747 billion | $779 million |
| Operating margin | 26.5% | 17.3% | 25.6% | 16.5% |
| Net income | $824 million | $320 million | $1.527 billion | $606 million |
| Diluted EPS | $0.76 | $0.29 | $1.40 | $0.53 |
Q2 revenue increased 45% year over year and 8% sequentially. Management attributed growth mainly to higher semiconductor equipment investment; gross-margin improvement reflected higher sales, favorable product mix, cost savings, and foreign exchange. The Q2 effective tax rate was 9.3%, versus 19.0% a year earlier, primarily reflecting tax-position developments and geographic income mix.
Segments and notable changes
- Semiconductor Systems: Q2 sales of $2.404 billion, up 51% year over year; operating income was $808 million and operating margin 33.6%. Growth reflected foundry and memory spending, including investment associated with the transition to 3D NAND.
- AGS: Q2 sales of $724 million, up 14% year over year; operating income was $194 million and margin 26.8%. Management cited higher spending on spares, services, and 200mm systems.
- DAM: Q2 sales of $391 million, up 109% year over year but down 7% sequentially; operating income was $84 million. The sequential decline reflected lower TV-display equipment investment, partly offset by mobile-display spending.
Non-GAAP adjusted Q2 diluted EPS was $0.79, compared with GAAP diluted EPS of $0.76. The principal adjustment was acquisition-related purchased-intangible amortization. The company cautions that non-GAAP measures are supplemental and not substitutes for GAAP results.
Cash flow, liquidity, and debt
- First-half operating cash flow was $1.544 billion, versus $688 million in the prior-year period. The increase reflected higher net income and customer deposits/deferred revenue, partly offset by a larger inventory build.
- Capital expenditures were $141 million. Investing activities used $1.648 billion, mainly reflecting net purchases of investments.
- Cash and cash equivalents were $4.944 billion; short- and long-term investments were $2.761 billion. Total cash, cash equivalents, and investments were $7.705 billion at April 30, 2017, up from $4.678 billion at October 30, 2016.
- Working capital was $7.9 billion. Current assets were $12.018 billion and current liabilities $4.097 billion.
- Total debt carrying value was $5.502 billion, including $5.302 billion long-term debt. The company issued $2.2 billion of senior notes in March, increasing long-term debt from $3.125 billion at fiscal year-end. It redeemed $200 million of notes in May 2017 for $205 million and expected to record a $5 million loss in Q3.
- No borrowings were outstanding under its credit facilities at quarter-end; the company reported compliance with applicable covenants. It stated that operating cash generation, existing liquidity, and borrowing capacity should cover requirements for the next 12 months.
Outlook, risks, and contingencies
Management anticipated healthy spending across semiconductor categories for fiscal 2017, citing memory technology upgrades and capacity expansion and foundry investment in advanced mobile chips. It expected display investment to continue through the rest of FY2017, including OLED/mobile capacity and equipment for larger LCD TVs. These are forward-looking expectations, not guarantees; the filing does not provide a numerical full-year revenue or EPS forecast.
- Results remain exposed to cyclical, volatile semiconductor and display spending, technology transitions, customer order timing, and supply-chain and inventory risks. DAM revenue can fluctuate materially from quarter to quarter.
- Customer concentration is significant: Taiwan Semiconductor Manufacturing Company represented 21% and Samsung Electronics 20% of first-half net sales. Approximately 89% of Q2 sales were to customers outside the United States.
- Inventory rose to $2.609 billion from $2.050 billion at October 30, 2016; finished goods included $365 million of newly introduced systems at customer sites for which revenue criteria had not yet been met.
- About $3.9 billion of cash, cash equivalents, and marketable securities held by foreign subsidiaries could be subject to U.S. tax if repatriated. Management intended to indefinitely reinvest approximately $2.9 billion abroad.
- Potential guarantee payments were approximately $66 million, with separate parent guarantees of approximately $140 million for subsidiary banking arrangements. Management did not consider payment under the guarantees probable. The filing stated that pending legal matters were not expected to materially affect consolidated financial condition or results.
- Interest-rate sensitivity: a 100-basis-point increase would reduce the fair value of the fixed-income investment portfolio by an estimated $23 million; a 100-basis-point decrease would increase the fair value of long-term debt by an estimated $592 million.
The filing also identifies tax, foreign-exchange, intellectual-property, cybersecurity, environmental, acquisition-integration, and goodwill-impairment risks. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Investor verification priorities
- Verify whether the anticipated FY2017 semiconductor and display investment levels materialized, especially in memory, foundry, OLED, and large-LCD markets.
- Track customer concentration and regional exposure, including TSMC and Samsung sales, and the impact of any change in major-customer spending.
- Assess inventory growth and systems awaiting revenue recognition against subsequent shipments, customer acceptance, and demand.
- Review the effect of the March debt issuance, May note redemption, and ongoing share repurchases and dividends on leverage and capital allocation.
- Monitor the unusually low effective tax rate, uncertain tax positions, and the tax implications of foreign-held funds.
- Compare GAAP and non-GAAP results and assess the recurring significance of acquisition-related adjustments.