Applied Materials, Inc. — Q2 FY2014 Form 10-Q
Reporting period: Fiscal quarter ended April 27, 2014; comparisons are with the quarter ended April 28, 2013 unless otherwise noted. Fiscal first-half figures cover six months.
Financial performance
| Metric | Q2 FY2014 | Prior-year quarter | First half FY2014 | Prior-year first half |
|---|---|---|---|---|
| Net sales | $2.353 billion | $1.973 billion | $4.543 billion | $3.546 billion |
| Gross margin | $1.001 billion; 42.5% | $808 million; 41.0% | $1.892 billion; 41.6% | $1.390 billion; 39.2% |
| Operating income (loss) | $387 million; 16.4% margin | ($68 million); (3.4%) margin | $717 million; 15.8% margin | ($29 million); (0.8%) margin |
| Net income (loss) | $262 million | ($129 million) | $515 million | ($95 million) |
| Diluted EPS | $0.21 | ($0.11) | $0.42 | ($0.08) |
| Operating cash flow | Not separately stated for the quarter | $809 million | $240 million |
- Sequentially, Q2 sales rose 7%, gross margin increased 1.8 percentage points, operating income increased to $387 million from $330 million, and net income rose to $262 million from $253 million.
- Management-reported non-GAAP Q2 adjusted gross margin was 44.2%, adjusted operating margin 20.5%, adjusted net income $348 million, and adjusted diluted EPS $0.28. These measures exclude specified acquisition, restructuring, impairment, merger-related and tax items and are not GAAP measures.
- Q2 new orders were $2.629 billion, up 16% year over year; six-month orders were $4.914 billion, up 12%. Backlog was $2.735 billion at quarter-end, with about 80% expected to ship within the next two quarters. Backlog can be rescheduled or canceled.
Balance sheet, liquidity and capital allocation
- At April 27, 2014, cash and cash equivalents were $2.453 billion; short- and long-term investments totaled $982 million. Combined cash and investments were $3.435 billion, versus $2.896 billion at October 27, 2013.
- Long-term debt was $1.947 billion. The company reported no borrowings under its credit facilities and compliance with debt covenants; available credit facilities totaled up to $1.6 billion.
- Working capital was $3.7 billion. Current liabilities included $999 million of customer deposits and deferred revenue, up from $794 million at fiscal year-end.
- Six-month capital expenditures were $113 million and cash dividends paid were $242 million. The quarterly dividend was $0.10 per share. No shares were repurchased in the first half; $1.6 billion remained under the existing repurchase authorization.
- Approximately $2.1 billion of cash, cash equivalents and marketable securities held by foreign subsidiaries could be subject to U.S. tax if repatriated; Applied intended to permanently reinvest approximately $1.6 billion outside the U.S.
Material changes and business trends
- First-half sales increased 28% year over year, led by Silicon Systems Group sales growth of 36%; Display grew 43%, Energy and Environmental Solutions 52%, and Applied Global Services 5%.
- Q2 sales grew 19% year over year. Silicon Systems Group remained the largest business, representing 67% of Q2 sales. Semiconductor demand was supported by advanced mobile chips and improved memory investment. Display orders rose sharply, primarily on demand for TV manufacturing equipment in China.
- Solar equipment orders and sales improved from low levels, but management said excess industry manufacturing capacity continued to constrain investment. Prior-year results included a $278 million goodwill and intangible-asset impairment, chiefly affecting Energy and Environmental Solutions.
- Management attributed improved margins to higher sales, lower inventory charges and manufacturing costs, partial recovery of a regional customs-duty assessment, and sales of solar tools written down in prior years.
- Q2 GAAP results included a $23 million unrealized loss on foreign-exchange options related to the proposed Tokyo Electron transaction; the prior quarter included a $24 million unrealized gain on those contracts.
Outlook, transaction, risks and contingencies
- The filing provides no specific consolidated revenue or EPS guidance. Management described semiconductor demand as supported by mobility, foundry investment and improving memory demand; display demand as supported by larger TVs and mobile displays; and solar-equipment investment as still weak because of overcapacity.
- The proposed combination with Tokyo Electron remained subject to shareholder and regulatory approvals. Shareholder meetings were scheduled for June 2014. The agreement contemplated a $3.0 billion stock repurchase program within 12 months after closing; specified termination events could trigger a $400 million fee.
- Key risks include cyclical and difficult-to-forecast customer spending, concentrated customers and markets, order cancellations or delays, technology transitions and competition, supply-chain interruptions, and the weak solar equipment market. Two customers represented 42% of consolidated first-half sales; Taiwan Semiconductor Manufacturing Company and Samsung represented 25% and 17%, respectively. About 84% of Q2 sales were to customers outside the U.S.
- Other exposures include currency and interest-rate risk, customer collectability, inventory obsolescence, impairment of goodwill and intangibles, tax judgments, and legal matters. The Korea criminal-proceeding appeals were ongoing, with a ruling expected later in 2014; Applied stated it did not expect the described legal matters to materially affect consolidated results or financial condition.
- Management said existing cash, operating cash generation and borrowing capacity should be sufficient for liquidity needs over the next 12 months. The filing also notes risks from global economic uncertainty and customer or supplier financial weakness.
Important facts for investors to verify
- Whether the Tokyo Electron combination obtained required shareholder and regulatory approvals, and the transaction’s final terms, timing and integration costs.
- Whether the strong order and backlog trends converted to recognized sales, particularly given customer cancellation/rescheduling rights and the high proportion of Asian sales.
- Whether semiconductor and display spending remained strong and whether solar overcapacity continued to constrain equipment demand.
- How much reported profitability depended on non-GAAP adjustments, prior-period impairments, duty recoveries, inventory charges and merger-related foreign-exchange movements.
- Whether customer concentration, foreign-held cash repatriation exposure, warranty and inventory estimates, and the Korea appeal or other contingencies changed materially after the filing date.