Applied Materials, Inc. — FY2016 Form 10-K
Business context and reporting period. Applied Materials supplies equipment, services and software to semiconductor, display and related industries. The fiscal year ended October 30, 2016 and contained 53 weeks; FY2015 contained 52 weeks. The filing reports three segments: Semiconductor Systems, Applied Global Services (AGS), and Display and Adjacent Markets. Segment presentation was changed during FY2016 and prior periods recast.
Financial results and position
| Metric | FY2016 | FY2015 | Change |
|---|---|---|---|
| New orders | $12.416 billion | $10.104 billion | +23% |
| Net sales | $10.825 billion | $9.659 billion | +12% |
| Gross profit / margin | $4.511 billion / 41.7% | $3.952 billion / 40.9% | Margin +0.8 points |
| Operating income / margin | $2.152 billion / 19.9% | $1.693 billion / 17.5% | Margin +2.4 points |
| Net income | $1.721 billion | $1.377 billion | +25% |
| Diluted EPS | $1.54 | $1.12 | +38% |
| Cash provided by operations | $2.466 billion | $1.163 billion | +$1.303 billion |
- Non-GAAP adjusted gross margin was 43.2% versus 42.9%; adjusted operating margin was 21.7% versus 19.6%; adjusted diluted EPS was $1.75 versus $1.19. These measures exclude specified acquisition, restructuring, tax and other items and are not GAAP substitutes.
- FY2016 sales by segment: Semiconductor Systems $6.873 billion (+12%); AGS $2.589 billion (+6%); Display and Adjacent Markets $1.206 billion (+28%). Segment operating income was $1.807 billion, $682 million and $245 million, respectively.
- Cash, cash equivalents and investments totaled $4.678 billion, down from $5.911 billion. Working capital was $4.7 billion. Total debt was $3.343 billion, compared with $4.542 billion; the company had no borrowings under its committed revolving credit agreement.
- Operating cash flow rose to $2.466 billion, reflecting higher earnings and increased customer deposits, deferred revenue, payables and accrued expenses; accounts receivable increases partly offset this. Capital expenditures were $253 million.
- Financing used $3.432 billion, principally for $1.892 billion of share repurchases, $1.207 billion of net debt repayments and $444 million of dividends. The quarterly dividend was $0.10 per share; $1.8 billion remained under the $2.0 billion repurchase authorization at year-end.
Quarterly performance and material changes
Fourth-quarter FY2016 sales were $3.297 billion, gross profit $1.399 billion, net income $610 million and diluted EPS $0.56. In Q4 FY2015, these were $2.368 billion, $959 million, $336 million and $0.28, respectively. FY2016 growth reflected increased customer investment in semiconductor and display equipment. Orders climbed particularly sharply in Display and Adjacent Markets, up 161% to $2.160 billion; its year-end backlog rose 157% to $1.539 billion. Total backlog increased 46% to $4.578 billion, though the company cautions that orders can be delayed or canceled.
Semiconductor Systems benefited from memory customers’ transition toward 3D architectures and foundry investment in advanced-node chips. Display growth was driven by mobile-display equipment, partly offset by lower TV equipment spending. AGS growth reflected spares and services demand. Semiconductor Systems remained the largest segment, contributing 64% of sales. Geographic exposure shifted further toward Asia-Pacific, which represented 83% of sales; the United States represented 11%.
Outlook, risks and unusual items
- Management expected FY2017 trends to support semiconductor demand, healthy spending on semiconductor spares and services, and increased display-equipment spending. No numerical earnings or revenue guidance is provided in the supplied filing text.
- Key risks include cyclical and difficult-to-forecast customer capital spending; concentrated customers and customer/geographic mix; rapid technology shifts and competitive pressure; dependence on suppliers, including limited-source components; and potential order delays or cancellations. Approximately 89% of FY2016 sales were outside the United States.
- Customer concentration is significant: TSMC was 16% of consolidated sales, Samsung 13%, Micron 11% and Intel 11%. In Display and Adjacent Markets, one customer represented approximately 44% of sales and 36% of new orders.
- Approximately $3.3 billion of foreign cash, cash equivalents and marketable securities was intended to remain indefinitely reinvested abroad; repatriation could trigger U.S. tax. Separately, the filing reports approximately $5.3 billion of cumulative undistributed foreign earnings for which U.S. tax was not provided.
- Unrecognized tax benefits increased to $320 million from $177 million. Tax outcomes and audit timing remain uncertain. The 14.5% effective tax rate benefited from foreign tax incentives; the filing quantifies the FY2016 benefit at $254 million, or $0.23 per diluted share.
- FY2016 included a $5 million loss on early debt repayment and an $8 million loss from discontinued cash-flow hedges. FY2015 included gains and costs related to the terminated Tokyo Electron business combination. A prior-period intercompany-sales tax error was corrected in FY2015, reducing tax provision by $28 million; management deemed it immaterial and did not restate prior periods.
- Management reported no material effect expected from disclosed legal matters; a Korean Supreme Court appeal related to former employees remained pending. Standby guarantees had a maximum potential payment of $52 million, with no payment considered probable. KPMG issued unqualified opinions on the financial statements and internal controls.
Investor verification priorities
- Check whether strong orders and the $4.578 billion backlog converted to revenue as planned, especially in display equipment; backlog is subject to timing changes and cancellations.
- Assess customer concentration, Asia-heavy sales, and the sustainability of memory, foundry and mobile-display capital spending.
- Reconcile GAAP results with adjusted results, including acquisition amortization, tax items and the FY2015 correction, and assess the recurring nature of the low effective tax rate.
- Review cash deployment, debt maturities and the effect of repurchases and dividends on liquidity; consider the availability and tax implications of foreign-held cash.
- Monitor supplier constraints, technology transitions, tax examinations, and the pending Korean legal appeal.