Business context and reporting period
Lam Research supplies wafer fabrication equipment and services, including deposition, etch and clean systems, to semiconductor manufacturers. This Form 10-Q covers the fiscal third quarter ended March 26, 2017 (13 weeks) and the first nine months of fiscal 2017. Although the request metadata says “2016 Q3,” the filing period is fiscal 2017 Q3; comparable periods ended March 27, 2016.
Financial performance and liquidity
| Metric | Quarter ended Mar. 26, 2017 | Prior-year quarter | Nine months ended Mar. 26, 2017 | Prior-year nine months |
|---|---|---|---|---|
| Revenue | $2.154 billion | $1.314 billion | $5.669 billion | $4.340 billion |
| Gross margin | $971 million; 45.1% | $571 million; 43.5% | $2.534 billion; 44.7% | $1.920 billion; 44.2% |
| Operating income | $538 million | $191 million | $1.294 billion | $765 million |
| Net income | $575 million | $143 million | $1.171 billion | $655 million |
| Diluted EPS | $3.10 | $0.82 | $6.40 | $3.76 |
| Operating cash flow | Quarterly amount: approximately $423 million, per management | $1.300 billion | $926 million |
Quarterly revenue rose 64% year over year and 14% sequentially; shipments increased 67% year over year and 25% sequentially. Memory represented 73% of system shipments, versus 70% a year earlier. Management attributed growth mainly to increased memory-customer investment. Quarterly gross margin improved from 43.5% to 45.1%, principally on favorable product mix and higher factory utilization.
For the nine-month period, operating cash flow increased to $1.300 billion. Working-capital changes used $342 million, including a $374 million increase in receivables and a $197 million increase in inventory. Investing activities used $2.118 billion, largely reflecting net purchases of available-for-sale securities; financing activities used $2.093 billion, including $1.686 billion of debt payments, $286 million of treasury-stock purchases and $170 million of dividends.
At March 26, 2017, cash and cash equivalents were $2.129 billion, investments $3.755 billion and restricted cash and investments $256 million—about $6.14 billion combined. Total current assets were $8.876 billion and current liabilities $2.757 billion. Debt carrying value was $2.676 billion, against $2.881 billion principal outstanding. The company had no borrowings under its $750 million revolving facility and reported compliance with its covenants. Approximately $4.2 billion of total cash and investments was held outside the United States.
Changes, outlook, and risks
- Revenue and earnings rose sharply year over year, with stronger demand, improved factory utilization and favorable product mix. Nine-month gross margin increased to 44.7% from 44.2%.
- Management expected demand to continue strengthening in the following quarter but provided no specific numerical revenue or earnings guidance in this filing. It said current cash, investments and expected operating cash flows should support operations, investment, debt service, capital expenditures, capital returns and dividends for at least 12 months.
- The effective tax rate was unusually low: a tax benefit of $44 million in the quarter (8.3% negative effective rate) contributed to quarterly net income. Management cited income in lower-tax jurisdictions and recognition of previously unrecognized tax benefits following expiration of statutes of limitation. Nine-month tax expense was $37 million, a 3.0% effective rate.
- The failed KLA-Tencor merger resulted in redemption of the 2023 and 2026 senior notes and termination of a term-loan commitment in October 2016. The nine-month results included a $36 million debt-extinguishment loss and $9.8 million in acquisition-related costs. No termination fee was payable by either company.
- In November 2016 Lam authorized up to $1 billion in share repurchases. It repurchased $205 million under that authorization through March 26; additional share withholding for employee tax obligations was separate. On April 19, 2017, it entered into $500 million of accelerated repurchase agreements, a subsequent event.
- Key risks include semiconductor-industry cyclicality and rapidly changing customer spending, concentration in a small number of customers (three customers generated 52% of nine-month revenue), international exposure (92% of nine-month revenue), technology and competitive pressures, supplier dependence, export and geopolitical risks, foreign-exchange exposure, and potential dilution from convertible notes and warrants.
- Operating-lease residual-value guarantees were generally capped at approximately $220 million, with specified default circumstances potentially raising aggregate exposure to $250 million. Standby letters of credit and other guarantees had a maximum potential payment of $15.3 million. Management reported no material litigation loss as probable and estimable.
Most important facts to verify
- Confirm the period is fiscal 2017 Q3, ended March 26, 2017, rather than 2016 Q3.
- Assess whether the strong memory-led shipments and management’s expectation of further demand strengthening persisted after quarter-end.
- Separate underlying earnings growth from the $44 million quarterly tax benefit and assess the sustainability of the unusually low effective tax rate.
- Review debt repayment and redemption cash flows, remaining convertible-note dilution exposure, and the location and accessibility of offshore cash.
- Check subsequent settlement of the $500 million accelerated repurchase agreements and remaining authorization, and monitor warranty reserves, inventory and receivables as shipments expand.