Applied Materials, Inc. — Q3 FY2014 Form 10-Q
Reporting period: Three and nine months ended July 27, 2014. Fiscal 2014 year-to-date represents 39 weeks. Amounts are in U.S. dollars.
Business context
Applied Materials supplies manufacturing equipment, services and software to the semiconductor, display and solar industries. Its four segments are Silicon Systems Group (SSG), Applied Global Services (AGS), Display, and Energy and Environmental Solutions (EES). Results are exposed to cyclical customer investment and technology demand.
Financial performance
| Metric | Q3 FY2014 | Q3 FY2013 | 9M FY2014 | 9M FY2013 |
|---|---|---|---|---|
| Net sales | $2.265B | $1.975B | $6.808B | $5.521B |
| Gross margin | $992M; 43.8% | $806M; 40.8% | $2.884B; 42.4% | $2.196B; 39.8% |
| Operating income | $391M; 17.3% | $250M; 12.7% | $1.108B; 16.3% | $221M; 4.0% |
| Net income | $301M | $168M | $816M | $73M |
| Diluted EPS | $0.24 | $0.14 | $0.66 | $0.06 |
Q3 revenue rose 15% year over year but declined 4% sequentially from $2.353B. Operating income increased 56% year over year. Nine-month results improved substantially, partly because the prior-year period included a $278M goodwill and intangible-asset impairment charge. The effective tax rate was 18.6% in Q3 and 22.3% for nine months, versus 26.3% and 53.2%, respectively, in the comparable prior-year periods.
Management also reported non-GAAP adjusted Q3 revenue-independent metrics of gross margin 45.5%, operating margin 21.1%, net income $349M and diluted EPS $0.28. These exclude specified acquisition, integration, business-combination, restructuring, impairment and tax items; they are not GAAP measures.
Cash flow, liquidity and debt
- Operating cash flow was $1.393B for nine months, versus $604M a year earlier. Investing activities used $108M; financing activities used $270M.
- Cash and cash equivalents were $2.726B at July 27, 2014, up from $1.711B at October 27, 2013. Total cash, cash equivalents and investments were $3.828B, up from $2.896B.
- Long-term debt was $1.947B, essentially unchanged from fiscal year-end. No amounts were drawn under credit facilities; available facilities totaled approximately $1.6B. The company reported compliance with debt covenants.
- Working capital was $3.9B. Management said operating cash generation, existing liquidity and borrowing capacity should meet requirements for the next 12 months. Approximately $2.4B of foreign-subsidiary cash and marketable securities could be subject to U.S. tax if repatriated; $1.8B was intended to remain permanently invested abroad.
- Nine-month capital expenditures were $178M and cash dividends paid were $363M. The quarterly dividend was $0.10 per share. No shares were repurchased in the first nine months; $1.6B remained under the existing authorization.
Material changes and operating trends
- Year-to-date sales increased 23%, driven mainly by semiconductor equipment demand. SSG sales rose 29% and AGS sales 8%; Display rose 13% and EES 79% from low prior-year levels.
- Q3 new orders were $2.479B, down 6% sequentially but up 24% year over year. Backlog grew to $2.968B from $2.735B in Q2; approximately 85% was expected to ship within the next two quarters. Backlog may be rescheduled or canceled and is not a guarantee of future sales.
- SSG remained the largest business, generating $1.476B of Q3 sales. Its Q3 orders declined 6% sequentially, primarily on lower memory and foundry demand. AGS orders and sales increased sequentially, supported by semiconductor services and spares.
- Display Q3 sales fell 19% sequentially, while orders fell 13%; segment backlog increased 37% sequentially to $651M, largely reflecting shipment timing. EES orders fell 25% sequentially and its book-to-bill ratio was 0.6; management noted continued solar-industry overcapacity.
- Gross margin improved year over year partly due to higher sales, lower inventory charges and manufacturing costs, recovery of a regional customs-duty assessment, and sales of previously written-down display and solar tools. Sequential margin improvement also reflected product mix and previously written-down display tools.
Outlook, risks and unusual items
- No specific company-wide revenue or earnings guidance is provided in the supplied filing text. Management described demand drivers including advanced mobile-chip production, foundry investment and memory technology upgrades; solar equipment investment remained constrained by excess capacity.
- The proposed combination with Tokyo Electron (TEL) had shareholder approval from both companies, but remained subject to customary conditions, including regulatory approvals. The planned combined company was expected to launch a $3.0B share-repurchase program within 12 months after closing. The agreement includes a $400M termination fee under specified circumstances; completion and anticipated benefits were not assured.
- Q3 G&A included TEL integration-planning costs and a $10M unrealized loss on currency options associated with the transaction. Favorable litigation proceeds also reduced G&A and contributed to EES margin improvement; the filing does not provide a clear amount for those proceeds. Certain acquisition-related amortization and other items were excluded from non-GAAP results.
- Key risks include volatile and difficult-to-forecast semiconductor, display and solar cycles; customer and geographic concentration; order delays or cancellations; technology transitions and competition; supply-chain interruptions; and the uncertain completion and integration of the TEL transaction. TSMC and Samsung represented 23% and 14% of nine-month consolidated sales, respectively.
- Potentially material estimates include revenue timing, warranty costs, customer collectability, inventory obsolescence, goodwill and intangible-asset impairment, and income taxes. The filing also identifies interest-rate and foreign-exchange exposure. A 100-basis-point rate increase was estimated to reduce fixed-income portfolio fair value by approximately $15M.
- The Korean Supreme Court appeal in proceedings involving former Applied Materials Korea employees remained pending; the High Court had found all defendants not guilty. The company said other described legal matters were not expected to materially affect its financial condition or results.
Important facts for investors to verify
- Whether TEL obtained required regulatory approvals, closed on expected terms, and realized anticipated integration benefits.
- Whether Q3 backlog converts to shipments and revenue as expected, particularly Display backlog, and whether customer changes or cancellations affect conversion.
- Whether semiconductor investment and memory demand sustain SSG growth, while monitoring the sequential decline in orders and the low EES book-to-bill ratio.
- How much reported profit growth reflects recurring operating performance versus the prior-year impairment comparison, favorable litigation proceeds, previously written-down tool sales, customs-duty recovery and excluded non-GAAP items.
- Whether customer concentration, working-capital needs, foreign-held cash, and cyclical or solar-market risks alter liquidity, margins or capital returns.