Applied Materials, Inc. — Fiscal 2018 Third-Quarter Form 10-Q
Reporting period: Three and nine months ended July 29, 2018; comparative periods ended July 30, 2017. Applied Materials supplies equipment, services and software to the semiconductor, display and related industries.
Financial performance
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Net sales | $4.468 billion | $3.744 billion | $13.239 billion | $10.568 billion |
| Gross margin | 45.4% | 45.4% | 45.6% | 44.9% |
| Operating income | $1.257 billion | $1.023 billion | $3.780 billion | $2.770 billion |
| Operating margin | 28.1% | 27.3% | 28.6% | 26.2% |
| Net income | $1.173 billion | $925 million | $2.437 billion | $2.452 billion |
| Diluted EPS | $1.17 | $0.85 | $2.35 | $2.26 |
- Revenue growth: Sales rose 19% in Q3 and 25% for the first nine months year over year. Management attributed growth to higher customer investment across segments.
- Segments, Q3 sales / operating income: Semiconductor Systems $2.748 billion / $930 million; Applied Global Services $954 million / $281 million; Display and Adjacent Markets $741 million / $214 million. Year-to-date sales grew 21%, 27% and 47%, respectively.
- Cash flow: Nine-month operating cash flow was $2.710 billion, down from $3.080 billion. Investing provided $700 million, while financing used $5.046 billion, primarily for repurchases, dividends and equity-award tax withholding. Capital expenditures were $457 million.
- Liquidity: Cash and cash equivalents were $3.374 billion; short- and long-term investments totaled $2.223 billion. Working capital was $6.6 billion, compared with $8.8 billion at October 29, 2017. Management said operating cash generation, cash balances and borrowing capacity should cover liquidity needs for the next 12 months.
- Debt: Long-term debt carrying value was $5.308 billion, with $5.350 billion aggregate principal outstanding. No amounts were drawn on credit facilities, which included a $1.5 billion committed revolver.
Changes versus comparable periods
- Q3 revenue increased $724 million; operating income increased $234 million. Quarterly gross margin was unchanged, while operating margin improved 0.8 percentage points.
- For nine months, gross margin improved 0.7 points and operating margin improved 2.4 points. Net income nevertheless declined $15 million, principally reflecting the much higher income tax provision.
- Q3 Display and Adjacent Markets revenue grew 81% year over year; Applied Global Services grew 21%; Semiconductor Systems grew 9%. For the nine-month period, Semiconductor Systems remained the largest business by sales.
- Cash and investments declined from $8.419 billion at fiscal year-end to $5.597 billion, alongside $4.532 billion of nine-month share repurchases. The company repurchased 84 million shares in the period, versus 20 million a year earlier.
Outlook, risks and unusual items
- Guidance: The filing excerpt provides no specific forward revenue or earnings guidance. Management described semiconductor and display equipment demand as variable and warned that results can fluctuate materially by quarter and year.
- Demand commentary: Management cited increased logic and DRAM investment and strong year-to-date NAND demand, while noting slightly lower NAND demand in Q3 and reduced foundry spending as customers optimized existing capacity. Display demand benefited from investment in larger LCD TVs and mobile-device equipment.
- Tax Act: The nine-month income tax provision was $1.259 billion, including approximately $1.1 billion of expense associated primarily with the transition tax and deferred-tax remeasurement under the U.S. Tax Cuts and Jobs Act. The reported nine-month effective tax rate was 34.1%, versus 7.7% a year earlier; Q3 rates were 5.3% and 5.4%. The company said tax accounting remained subject to completion of the measurement process. The tax item reduced diluted EPS by $1.05 for the nine-month period.
- Industry and customer risks: The business is cyclical and exposed to shifts in capital spending, technology transitions, customer concentration, inventory and supply-chain execution. Three customers accounted for at least 10% of nine-month consolidated sales: Samsung (15%), TSMC (12%) and Intel (11%). Approximately 86% of Q3 sales were to Asia-Pacific customers.
- Trade and geographic exposure: The filing identifies tariffs, trade-policy changes, export controls, local-government policies and political or economic conditions—particularly in China and Korea—as potential risks.
- Other items: The company reported $62 million of maximum potential payments under guarantee agreements and approximately $150 million of parent guarantees for subsidiary banking arrangements; it did not consider payment under the former probable. Management did not expect disclosed legal matters to materially affect consolidated financial condition or results. A new ERP system was implemented in certain units during the quarter; management reported disclosure controls were effective and no material adverse control change.
Investor verification points
- Assess whether semiconductor and display customer spending, including foundry and NAND trends, continued to support reported growth after July 29, 2018.
- Review the final accounting and cash-payment schedule for the Tax Act transition tax, and distinguish reported GAAP earnings from adjusted results; nine-month adjusted diluted EPS was $3.48 versus GAAP EPS of $2.35.
- Examine working-capital movements—especially receivables, inventories and deferred revenue—and the effect of $1.0 billion in receivables sold during the first nine months.
- Evaluate the pace and price of repurchases, remaining authorization of approximately $5.1 billion, dividend commitments and liquidity relative to debt.
- Monitor customer and regional concentration, trade-policy developments, and execution risks related to the ERP implementation and supply chain.