Applied Materials, Inc. — Q3 FY2020 Form 10-Q
Reporting period: Three and nine months ended July 26, 2020; comparisons are to periods ended July 28, 2019. Amounts are in U.S. dollars. Financial statements are unaudited.
Business context and results
Applied Materials supplies manufacturing equipment, services and software to the semiconductor, display and related industries. Its three reportable segments are Semiconductor Systems, Applied Global Services (AGS), and Display and Adjacent Markets (DAM).
| Metric | Q3 FY2020 | Q3 FY2019 | First nine months FY2020 | First nine months FY2019 |
|---|---|---|---|---|
| Net sales | $4.395 billion | $3.562 billion | $12.514 billion | $10.854 billion |
| Gross margin | 44.5% | 43.7% | 44.4% | 43.8% |
| Operating income | $1.108 billion | $802 million | $3.082 billion | $2.486 billion |
| Operating margin | 25.2% | 22.5% | 24.6% | 22.9% |
| Net income | $841 million | $571 million | $2.488 billion | $2.008 billion |
| Diluted EPS | $0.91 | $0.61 | $2.69 | $2.11 |
Q3 revenue increased 23%, net income 47% and diluted EPS 49% year over year. For the first nine months, revenue rose 15%, net income 24% and diluted EPS 27%. Gross and operating margins improved in both comparisons.
Segment and geographic performance
- Semiconductor Systems: Q3 sales of $2.916 billion, up 28%; operating income of $958 million, up 56%, with a 32.9% margin. Advanced foundry and logic investment led growth; memory spending also increased in the quarter.
- AGS: Q3 sales of $1.034 billion, up 11%; operating income of $273 million, up 5%. Margin declined to 26.4% from 27.8%, in part due to added headcount, COVID-related site-access limits and higher freight costs.
- DAM: Q3 sales of $425 million, up 25%; operating income of $83 million, up 102%. For the first nine months, sales declined 6% year over year, mainly reflecting weaker TV-related equipment investment.
- Asia Pacific represented 86% of Q3 sales. China accounted for 33% and Korea 24%. TSMC and Samsung represented 21% and 19%, respectively, of first-nine-month sales.
Cash flow, liquidity and debt
- For the first nine months, operating cash flow was $2.489 billion versus $2.421 billion; capital expenditures were $260 million. Operating cash flow less capital expenditures was approximately $2.229 billion, a derived measure.
- Cash and cash equivalents were $4.350 billion; short- and long-term investments totaled $1.944 billion. Total cash, cash equivalents and investments were $6.294 billion.
- Working capital was $8.0 billion. Current assets were $12.248 billion and current liabilities $4.285 billion.
- Long-term debt was $5.447 billion, with no current debt outstanding. The $5.5 billion principal balance of senior notes exceeded cash and investments by approximately $847 million, before other obligations.
- Q3 financing activity included issuing $1.5 billion of 2030 and 2050 notes and redeeming $1.35 billion of notes due in 2020 and 2021. The company recorded a $33 million early-extinguishment loss. It also repurchased $599 million of stock and paid $587 million in dividends during the first nine months.
Management stated that operating cash generation, existing cash and borrowing capacity should be sufficient for liquidity needs over the next 12 months. No quantified company-wide revenue or earnings guidance is provided in the supplied filing text.
Management commentary, risks and unusual items
- Management reported continued progress in supply-chain recovery and strong semiconductor customer demand, while emphasizing that the pandemic and its effects remained fluid and uncertain. COVID-19 restrictions affected logistics, manufacturing, travel to customer sites and employee availability, and increased costs.
- Semiconductor growth was led by advanced foundry-logic demand. Services grew with the installed base and long-term service agreements. Display demand remained uneven, with mobile-related investment improving but TV-related investment weak over the nine-month period.
- Applied extended the Kokusai Electric acquisition agreement’s outside date to September 30, 2020, with regulatory approvals still pending. The proposed transaction is for $2.2 billion in cash; specified termination circumstances could require a $154 million termination fee.
- New U.S. export controls may require licenses for certain sales to China; the filing also identifies possible indirect effects on customer demand from restrictions involving Huawei. Other prominent risks include semiconductor-industry cyclicality, customer and regional concentration, trade tensions, supply-chain disruption and changing technology requirements.
- Other notable items include a $44 million tax expense from settlement of certain unrecognized tax benefits in FY2020, compared with a prior-year tax expense related to GILTI rule changes. Management said the CARES Act had no material effect on the tax provision. Approximately $139 million of unrecognized tax benefits could be recognized over the next 12 months; $857 million of transition-tax payments remained payable over six years.
- Guarantees could require payments of up to $148 million under specified agreements; separate parent guarantees to banks totaled approximately $151 million. Management did not consider payment under the former probable. The company stated that pending legal matters were not expected to materially affect consolidated financial condition or results.
Important facts for investors to verify
- Whether the Kokusai Electric transaction received required approvals by the extended deadline, and the consequences if it did not close.
- Whether COVID-related restrictions, supply-chain recovery and export-license rules changed customer demand, delivery timing or costs after July 26, 2020.
- The sustainability of semiconductor demand and margins, especially given customer concentration and the 86% Asia Pacific sales share.
- Inventory rose to $3.952 billion from $3.474 billion at the fiscal year-end; verify subsequent inventory levels, demand and cash conversion.
- Debt, dividends and repurchases relative to cash generation, including the company’s stated liquidity outlook and remaining transition-tax payments.
- Reported GAAP results versus non-GAAP measures: Q3 non-GAAP diluted EPS was $1.06, and excludes specified acquisition, COVID-related, investment, debt and tax items.