Business context and reporting period
Applied Materials, Inc. filed this Form 10-K for fiscal 2015, ended October 25, 2015 (52 weeks). The company supplies manufacturing equipment, services and software to semiconductor, display, solar PV and related industries. Its four reportable segments are Silicon Systems, Applied Global Services (AGS), Display, and Energy and Environmental Solutions (EES).
Key financial metrics
| Metric | FY2015 | FY2014 |
|---|---|---|
| Net sales | $9.659 billion | $9.072 billion |
| Gross profit / margin | $3.952 billion / 40.9% | $3.843 billion / 42.4% |
| Operating income / margin | $1.693 billion / 17.5% | $1.520 billion / 16.8% |
| Net income | $1.377 billion | $1.072 billion |
| Diluted EPS | $1.12 | $0.87 |
| Operating cash flow | $1.163 billion | $1.800 billion |
| Cash, cash equivalents and investments | $5.911 billion | $4.097 billion |
| Total debt | $4.542 billion | $1.947 billion |
Working capital was $5.5 billion. New orders rose 5% to $10.104 billion and year-end backlog rose 8% to $3.142 billion; approximately 70% of backlog was expected to ship in the first two quarters of FY2016. Capital expenditures were $215 million. The company repurchased $1.325 billion of shares and paid $487 million in dividends. Quarterly FY2015 fourth-quarter results were sales of $2.368 billion, net income of $336 million and diluted EPS of $0.28.
Material changes versus the prior period
- Sales increased 6%, with growth in AGS (+15%), Display (+27%) and Silicon Systems (+3%); EES sales declined 24%.
- Net income increased to $1.377 billion, while gross margin fell 1.5 percentage points. Management attributed the margin decline primarily to product mix and the absence of a prior-year customs-duty assessment recovery.
- Operating cash flow declined by $637 million, principally due to higher inventories and deferred taxes and decreases in payables, accrued expenses, customer deposits, deferred revenue and taxes payable.
- Debt increased following a $1.8 billion senior-notes issuance and an $800 million short-term foreign-subsidiary borrowing. The balance sheet included $1.2 billion of short-term debt and $3.342 billion of long-term debt.
- EES returned to an operating loss of $61 million, versus operating income of $15 million in FY2014, amid weak solar-equipment investment and excess industry capacity.
Outlook, management commentary, risks and unusual items
For FY2016, management expected mobility to remain the main semiconductor growth driver, with foundry and memory spending supporting equipment demand. It expected semiconductor spares and services and display investment to remain healthy. Management also cautioned that gross-margin challenges were expected in the first half of FY2016, primarily due to higher memory-equipment and mobility-display demand. These statements are outlook, not a quantified earnings forecast.
Applied and Tokyo Electron mutually terminated their proposed business combination in April 2015; neither party paid a termination fee. The company recorded an $89 million gain on related derivatives in FY2015 and incurred related transaction costs. FY2015 also included $35 million of solar-related inventory charges and $17 million of restructuring and asset-impairment charges; management expected total costs for the solar cost-reduction actions of $45–$55 million, with principal activities expected to be completed by Q2 FY2016. A $28 million tax provision adjustment increased reported FY2015 net income and EPS by $0.02; the company described the underlying intercompany-sales accounting error as immaterial in each affected year since FY2010. Non-GAAP adjusted EPS was $1.19, compared with GAAP diluted EPS of $1.12.
Principal risks include cyclical and difficult-to-forecast customer spending, intense competition and fast technology change, customer and geographic concentration, order delays or cancellations, and supply-chain constraints. Two customers represented 33% of consolidated sales; approximately 83% of sales were to customers outside the U.S. The company noted that backlog may not convert to sales as scheduled. Solar market overcapacity remains a material risk. Other disclosed exposures include foreign exchange, interest rates, taxes, intellectual property, cybersecurity, legal proceedings and impairment of acquired assets. Management believed available cash, operating cash generation and borrowing capacity would meet liquidity needs for the next 12 months. The independent auditor issued an unqualified opinion on the financial statements and internal controls; management also concluded controls were effective.
Important facts for investors to verify
- Assess the sustainability of FY2015 earnings and margins, including the effect of the $28 million tax adjustment, derivative gains and non-GAAP exclusions.
- Track cash conversion and working capital, particularly inventory growth and the decline in operating cash flow.
- Review debt maturities and financing details, including the $800 million subsidiary borrowing and the November 2015 redemption of $400 million of notes, which produced a $5 million loss expected in FY2016 Q1.
- Test backlog quality and conversion assumptions against cancellations, delivery delays and the high share expected to ship early in FY2016.
- Monitor customer concentration, semiconductor spending mix, and continued losses or restructuring costs in EES and the solar business.