Applied Materials, Inc. — Q2 FY2019 Form 10-Q
Reporting period: Three and six months ended April 28, 2019; fiscal 2019 first half comprised 26 weeks. Amounts below are in millions of dollars unless stated otherwise.
Business context and results
Applied Materials supplies semiconductor and display manufacturing equipment, services, and software. Its three reportable segments are Semiconductor Systems, Applied Global Services (AGS), and Display and Adjacent Markets (DAM). Results are sensitive to cyclical customer capital spending, technology transitions, and end-market demand.
| Metric | Q2 FY2019 | Q2 FY2018 | First half FY2019 | First half FY2018 |
|---|---|---|---|---|
| Net sales | $3,539 | $4,579 | $7,292 | $8,784 |
| Gross margin | 43.2% | 44.9% | 43.8% | 45.5% |
| Operating income | $776 | $1,292 | $1,684 | $2,507 |
| Operating margin | 21.9% | 28.2% | 23.1% | 28.5% |
| Net income | $666 | $1,100 | $1,437 | $1,265 |
| Diluted EPS | $0.70 | $1.06 | $1.50 | $1.20 |
Financial position, cash flow and capital allocation
- First-half operating cash flow was $1,634, down from $2,077 a year earlier. Capital expenditures were $251; cash used in investing activities was $195.
- Cash and cash equivalents were $3,116 at April 28, 2019; short- and long-term investments totaled $2,116. Combined cash and investments of $5,232 compared with $5,350 of debt principal. Long-term debt, net of discounts and issuance costs, was $5,311.
- Working capital was $6.5 billion, versus $6.7 billion at October 28, 2018. Current assets were $10,062 and current liabilities $3,605. The company reported no borrowings under its credit facilities and no commercial paper outstanding.
- Financing activities used $1,763, including $1,375 of share repurchases, $381 of dividends, and $80 of tax withholding on vested equity awards. The company repurchased 38 million shares in the first half. Approximately $3.0 billion remained under its $6.0 billion repurchase authorization.
- First-half accounts-receivable sales without recourse were $1.1 billion, compared with $766 million in the prior-year period; the filing says related financing charges were not material.
Material changes and segment performance
- Q2 sales fell 23% year over year; first-half sales fell 17%. Management attributed the declines mainly to reduced customer investment in semiconductor and display equipment, partly offset by services growth. Lower sales and unfavorable customer/product mix reduced gross and operating margins.
- Semiconductor Systems: Q2 sales declined 25% to $2,184 and operating income fell 42% to $579. Memory spending was lower; foundry, logic, and other demand partly offset this. First-half segment sales declined 23% to $4,452.
- AGS: Q2 sales increased 4% to $984 and operating income rose 1% to $283. First-half sales increased 7% to $1,946, supported by services and legacy-system demand.
- DAM: Q2 sales fell 52% to $348 and operating income fell 80% to $42, reflecting weaker mobile and TV display equipment spending. First-half sales declined 26% to $855.
- Asia Pacific represented 81% of Q2 sales. Korea sales fell 64% year over year in the first half; China sales fell 13%. Taiwan and Japan first-half sales increased 3% and 19%, respectively.
- First-half net income and EPS increased versus the prior year despite lower operating income, largely because prior-year results included $1.1 billion of tax expense associated with U.S. tax legislation. Prior-year first-half EPS was reduced by $1.02 from that one-time expense.
Outlook, commentary and risks
- Management expected the semiconductor demand softness that began in the second half of 2018 to continue through 2019, primarily due to lower memory spending. Foundry and logic spending was expected to increase year over year, though customers were prioritizing longer-lead-time equipment outside Applied’s portfolio.
- Management expected lower display-equipment spending in FY2019, while anticipating continued growth in AGS. The filing provides no clear quantified full-year or next-quarter earnings guidance.
- Applied said it intended to maintain substantial R&D investment to support technology development. First-half R&D expense was $1,024, up from $998.
- A $96 million tax benefit recognized in the first half could reverse if proposed U.S. tax regulations are finalized as proposed. The company also had $961 million of remaining transition-tax payments due over the next seven years.
- Management believed cash generated from operations, existing liquidity, and borrowing capacity would meet liquidity needs for the next 12 months. A $1.5 billion revolving facility expires in September 2021; the company reported compliance with its covenants.
- Key risks include cyclical and volatile customer spending, concentrated customers and geographic exposure, trade restrictions and export licensing, competition and technology transitions, supply-chain constraints, foreign exchange and interest-rate exposure, tax uncertainty, and potential impairment of goodwill or intangible assets. Approximately 87% of Q2 sales were to customers outside the United States.
- Guarantees could require up to $77 million in future payments; Applied said payment was not probable. It also provided $149 million of parent guarantees for subsidiary banking arrangements. The company stated that pending legal matters were not expected to materially affect its financial condition or results.
Important facts for investors to verify
- Whether semiconductor and display equipment spending stabilizes, especially memory and China/Korea demand, and whether AGS growth continues.
- Whether margin pressure from lower volume and product/customer mix persists, and how R&D investment affects operating leverage.
- Cash conversion and working-capital trends, including the extent and sustainability of accounts-receivable sales without recourse.
- The status and potential reversal of the $96 million tax benefit, remaining transition-tax payments, and the impact of tax rules on future effective tax rates.
- Debt and capital deployment relative to cash needs, including buybacks, dividends, and the unused repurchase authorization.
- The impact of the new revenue-recognition standard, adopted retrospectively, and the $1.6 billion deferred-tax-asset increase recorded on adoption of intra-entity transfer tax guidance; these changes affect comparability and reported balance-sheet amounts.