Applied Materials, Inc. — Form 10-Q
Reporting period: Fiscal third quarter and first nine months ended July 31, 2011. Comparatives are the three and nine months ended August 1, 2010; the prior-year nine-month period had one additional week.
Business context and results
Applied Materials supplies equipment, services and software to the semiconductor, display and solar industries through four segments: Silicon Systems Group, Applied Global Services, Display, and Energy and Environmental Solutions. The company reported strong year-over-year revenue and earnings growth, but quarterly orders weakened amid softer industry conditions and customers delaying capital spending.
| Metric | Q3 2011 | Q3 2010 | First 9 months 2011 | First 9 months 2010 |
|---|---|---|---|---|
| Net sales | $2.787bn | $2.518bn | $8.336bn | $6.662bn |
| Gross margin | $1.184bn; 42% | $860m; 34% | $3.509bn; 42% | $2.498bn; 37% |
| Operating income | $687m; 25% margin | $183m; 7% margin | $2.037bn; 24% margin | $685m; 10% margin |
| Net income | $476m | $123m | $1.471bn | $470m |
| Diluted EPS | $0.36 | $0.09 | $1.10 | $0.35 |
| New orders | $2.390bn | $2.725bn | $8.547bn | $7.723bn as stated in MD&A summary |
Cash flow, liquidity and debt
- For the first nine months, operating cash flow was $1.728bn, investing cash flow was positive $218m, and financing cash flow was positive $1.210bn. Capital expenditures were $136m.
- Cash, cash equivalents and investments totaled $6.809bn at July 31, 2011, up from $3.892bn at October 31, 2010. Working capital was $7.0bn.
- Long-term debt was $1.947bn, versus $204m at October 31, 2010, primarily following the issuance of $1.75bn in senior unsecured notes to help fund the proposed Varian acquisition. No amounts were drawn on credit facilities or the commercial paper program at quarter-end.
- Management said operating cash generation, cash balances and borrowing capacity were expected to meet liquidity needs for the next 12 months. The company anticipated continuing quarterly dividends, subject to board discretion.
Material changes and segment trends
- Quarterly sales rose 11%, but orders fell 12% year over year. Nine-month sales rose 25%. The filing attributes the quarterly order decline to softer demand for semiconductor, crystalline-silicon solar and LCD equipment.
- Silicon Systems Group Q3 sales were $1.398bn, down 3%, and orders were $1.239bn, down 19%. Nine-month sales increased 14% to $4.348bn.
- Applied Global Services Q3 sales increased 29% to $603m, driven mainly by refurbished equipment; nine-month operating results included $24m of impairment charges.
- Display Q3 sales rose 3% to $223m, while nine-month sales fell 15% to $528m amid an LCD downturn.
- Energy and Environmental Solutions Q3 sales increased 45% to $563m, mainly due to crystalline-silicon equipment. The segment’s comparison with 2010 was affected by substantial prior-year restructuring and impairment charges and by favorable 2011 restructuring adjustments.
- Backlog was $3.2bn at July 31, down from $3.9bn at May 1; quarterly adjustments were negative $248m, primarily financial debookings. Management cautioned that backlog may change through rescheduling or cancellation.
Outlook, unusual items and risks
- No quantified forward guidance for future revenue or earnings is provided in the supplied filing text. Management cited a softening macroeconomic environment, industry cyclicality and customer capital-spending delays.
- Q3 2011 operating income included a $28m net gain on facility sales, partly offset by $3m of asset impairment charges. Prior-year Q3 results included significant SunFab-related inventory, restructuring and impairment charges. Nine-month 2011 results included $60m of favorable restructuring-reserve adjustments, $30m of impairment charges and a $27m facility-sale gain.
- The proposed $4.9bn acquisition of Varian remained subject to regulatory and other closing conditions. Varian shareholders approved the agreement on August 11, 2011; the Justice Department’s additional-information request extended the antitrust review. Applied issued $1.75bn of notes for the transaction; if it is not completed by May 31, 2012, the notes must be redeemed at 101% of principal plus accrued interest. Termination fees may also apply, including a $200m fee payable by Applied in specified antitrust-failure circumstances.
- Applied disclosed a recommended $240m federal tax refund, plus interest, subject to congressional approval; it had not yet been recognized. Key risks include cyclical demand, customer concentration, inventory and collection exposure, solar-market oversupply and reliance on policy support, foreign-exchange and interest-rate risks, acquisition execution and regulatory approval, and ongoing legal proceedings.
- Management stated that the LMPERS Varian shareholder lawsuit was without merit and intended to defend it. The filing also discusses other patent, employment-related criminal proceedings and ordinary-course claims; management did not expect the described matters to materially adversely affect consolidated results or financial condition.
Important facts for investors to verify
- Reconcile the order comparison: MD&A reports nine-month 2010 orders of $7.723bn, while the segment and regional tables in the supplied filing text appear to total $7.223bn. The source figures are inconsistent.
- Track order trends, backlog reductions and debookings, especially in Silicon Systems and solar, and assess whether reported sales growth is supported by new demand.
- Monitor Varian antitrust approval, closing conditions, financing use and potential redemption or termination costs.
- Confirm the timing and final amount, if any, of the proposed $240m tax refund.
- Assess inventory growth, including $281m of newly introduced systems at customer locations that had not met revenue-recognition criteria, and customer concentration in major segments.