Applied Materials, Inc. — Q2 FY2015 Form 10-Q
Reporting period: Quarter ended April 26, 2015; six-month results cover the 26 weeks ended that date. Comparatives are the quarter and six months ended April 27, 2014, unless noted. Amounts are in U.S. dollars.
Business context and results
Applied Materials supplies manufacturing equipment, services and software to the semiconductor, display, solar and related industries through four segments: Silicon Systems Group (SSG), Applied Global Services (AGS), Display, and Energy and Environmental Solutions (EES). Results are sensitive to cyclical customer investment, end-market demand and technology transitions.
- Q2 revenue: $2.442 billion, up 4% year over year. Six-month revenue was $4.801 billion, up 6%.
- Q2 earnings: Gross profit was $1.016 billion and gross margin 41.6%; operating income was $416 million and operating margin 17.0%; net income was $364 million and diluted EPS was $0.29. Six-month net income was $712 million and diluted EPS $0.57.
- Orders and backlog: Q2 orders were $2.515 billion, down 4% year over year; six-month orders were $4.788 billion, down 3%. Backlog ended the quarter at $2.782 billion, approximately flat sequentially and down 5% from October 2014. Management expected about 85% of backlog to ship within the next two quarters; backlog may be rescheduled or canceled.
- Segment picture, Q2: SSG revenue was $1.560 billion (operating income $374 million); AGS $646 million ($170 million); Display $163 million ($40 million); and EES $73 million (operating loss $5 million). SSG and AGS were the largest businesses; EES remained loss-making.
Cash flow, balance sheet and liquidity
- Six-month cash flow: Operating cash flow was $358 million, down from $809 million a year earlier. Investing activities used $140 million, including $113 million of capital expenditures; financing activities used $152 million, principally reflecting $245 million of dividends.
- Cash and investments: Cash, cash equivalents and investments totaled $4.166 billion at April 26, 2015, versus $4.097 billion at October 26, 2014. Cash and cash equivalents alone were $3.067 billion.
- Debt and liquidity: Long-term debt was $1.947 billion. No amounts were outstanding under credit facilities or the commercial-paper program. Current assets were $7.447 billion and current liabilities $2.696 billion; reported working capital was $4.8 billion. Management said available cash, operating cash generation and borrowing capacity should meet liquidity needs for the next 12 months.
- Approximately $2.8 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 about $2.3 billion abroad.
Material changes and unusual items
- Compared with Q2 FY2014, revenue rose 4%, operating income rose from $387 million to $416 million, and net income rose from $262 million to $364 million. Gross margin declined from 42.5% to 41.6%; management attributed the year-over-year margin pressure mainly to unfavorable product mix. For the first half, operating income increased to $874 million from $717 million, while gross margin edged down to 41.1% from 41.6%.
- AGS revenue grew 21% year over year in Q2, while Display orders fell 65% and EES orders fell 43%. SSG orders rose 2%; segment demand differed substantially by product and customer mix.
- On April 26, 2015, Applied and Tokyo Electron (TEL) mutually terminated their proposed business combination. Neither party owed a termination fee. Applied sold the related foreign-exchange option contracts after quarter-end. Gains on those contracts contributed $14 million to Q2 operating results and $92 million for the first half.
- A tax-related out-of-period adjustment corrected an error in U.S. intercompany-sales tax accounting dating back to fiscal 2010. It had no effect on consolidated cost of sales; management said effects on originating periods were immaterial and did not restate them. The adjustment reduced Q2 tax expense by $39 million and first-half tax expense by $35 million; Q2 diluted EPS increased by $0.03. Q2’s 6.4% effective tax rate also reflected prior-year tax resolutions, deductible acquisition costs following the TEL termination and geographic income mix.
- The Board authorized a new share-repurchase program of up to $3.0 billion through April 2018; no shares were repurchased in the quarter. The quarterly dividend was $0.10 per share.
Outlook, management commentary and risks
The filing provides no specific numerical revenue or earnings guidance. Management described first-half semiconductor-equipment demand as supported by memory technology upgrades and foundry investment for advanced mobile chips. It characterized solar equipment investment as low because of excess industry capacity, and noted that display demand and investment remain cyclical. Management said it intends to sustain substantial research and development investment.
Key risks include cyclical and difficult-to-forecast customer spending; concentrated customers and geographic exposure; order delays, cancellations and backlog conversion; intense competition and rapid technology change; supply-chain, manufacturing and inventory risks; foreign-exchange, interest-rate and investment risks; tax uncertainty; and potential impairment of goodwill or intangible assets. Samsung and TSMC accounted for 20% and 13%, respectively, of first-half consolidated sales. Semiconductor customers and Display customers were also highly concentrated. The Korea criminal case involving former employees remained under appeal to the Korean Supreme Court; Applied was not a party, and management said the legal matters described were not expected to materially affect financial condition or results.
Most important facts for investors to verify
- How much reported earnings and EPS depended on the tax adjustment and the unusually low effective tax rate, and how tax rates may change in later periods.
- Whether order trends and the $2.782 billion backlog convert to revenue as expected, given cancellations, negative first-half backlog adjustments and quarter-to-quarter customer mix.
- Whether working-capital movements and weaker operating cash flow persist; receivables, inventories and other assets absorbed cash during the first half.
- Whether semiconductor demand offsets weaker display orders and continued solar overcapacity, particularly given customer and regional concentration.
- The financial and operating consequences of ending the TEL transaction, including final disposition of related derivatives and acquisition costs, and any execution or impairment risks.