Applied Materials, Inc. — Q1 FY2011 Form 10-Q
Reporting period: Three months ended January 30, 2011. Fiscal Q1 2011 had 13 weeks versus 14 weeks in Q1 FY2010. Amounts below are in U.S. dollars; financial statement figures are in millions unless stated otherwise.
Business context and results
Applied Materials supplies manufacturing equipment, services and software to the semiconductor, display, solar photovoltaic and related industries. It reports four segments: Silicon Systems Group (SSG), Applied Global Services (AGS), Display, and Energy and Environmental Solutions (EES). Management attributed the quarter’s improvement to stronger demand across segments amid more favorable economic and industry conditions.
| Metric | Q1 FY2011 | Q1 FY2010 | Change |
|---|---|---|---|
| New orders | $2,971 | $1,965 | +51% |
| Net sales | $2,686 | $1,849 | +45% |
| Gross margin | $1,136; 42% | $711; 38% | +4 percentage points |
| Operating income | $674; 25% margin | $116; 6% margin | +$558; +19 percentage points |
| Net income | $506 | $83 | +$423 |
| Diluted EPS | $0.38 | $0.06 | +$0.32 |
| Cash from operations | $425 | $372 | +$53 |
Gross-margin improvement reflected higher sales, favorable product mix, better factory utilization, manufacturing-transition savings and cost controls. Operating results included a net $29 restructuring benefit: $32 of favorable reserve adjustments, partly offset by $3 of asset impairment charges. The prior-year quarter included $104 of restructuring charges. The differing quarter lengths should be considered when comparing year-over-year results.
Segments and material changes
| Segment | Sales | Operating income (loss) | Notable year-over-year change |
|---|---|---|---|
| SSG | $1,496 | $543 | Sales +54%; operating income +78% |
| AGS | $567 | $85 | Sales +33%; operating income +34% |
| Display | $147 | $28 | Sales +11%; operating income +11% |
| EES | $476 | $144 | Sales +48%; prior-year operating loss was $36 |
SSG growth was led by logic and foundry customers. EES growth reflected stronger crystalline-silicon solar demand; Q1 FY2010 EES sales included $208 of SunFab thin-film revenue. Applied discontinued sales of fully integrated SunFab lines to new customers in FY2010, while continuing to support existing customers. Effective Q1 FY2011, thin-film products and related support were reported in AGS rather than EES; this segment reclassification affects comparisons.
Backlog was $3.5 billion at January 30, 2011, up from $3.2 billion at October 31, 2010. Management cautioned that backlog is not necessarily indicative of future sales because of possible schedule changes or cancellations. The largest quarterly sales were to customers in China ($674), Taiwan ($635) and North America ($610).
Cash, debt and liquidity
Cash, cash equivalents and investments totaled $4.097 billion at quarter-end, versus $3.892 billion at October 31, 2010. Cash and cash equivalents were $1.974 billion; short- and long-term debt was $205 million, with $1 million current. No amounts were drawn under the company’s credit facilities, which provided up to approximately $1.1 billion in unsecured borrowing capacity. The $1.0 billion revolving facility was scheduled to expire in January 2012; the company reported compliance with its covenants.
Current assets were $7.142 billion and current liabilities $2.914 billion; reported working capital was $4.2 billion. Operating cash flow was $425 million. Investing activities used $79 million, including net investment purchases of $94 million, while financing activities used $230 million, principally $150 million of share repurchases and $93 million of dividends. Capital expenditures were $24 million; proceeds from a property sale were $39 million. Management believed cash generated, existing liquidity and borrowing capacity would meet requirements for the next 12 months.
Accounts receivable increased to $1.946 billion from $1.831 billion, and inventory rose to $1.647 billion from $1.547 billion. Days sales outstanding increased to 66 days from 58 days at fiscal year-end. The company discounted $123 million of customer letters of credit and factored or discounted $36 million of receivables and promissory notes during the quarter. Customer deposits and deferred revenue increased to $1.055 billion from $847 million.
Outlook, risks and contingencies
- No specific quantified forward guidance was provided. Management cited cyclical demand and industry conditions; its liquidity assessment covered the next 12 months.
- Key risks include volatility in semiconductor, display and solar equipment spending; customer order delays or cancellations; solar manufacturing overcapacity and reliance on government incentives; execution and supply-chain risks; rapid technology change; and customer concentration. Taiwan Semiconductor Manufacturing Company, Samsung and Intel represented 14%, 13% and 10% of consolidated sales, respectively.
- Customer concentration was also significant by segment: four semiconductor customers accounted for 66% of SSG sales and four display customers for 89% of Display sales. The three named large customers represented 16%, 14% and 15% of receivables, respectively.
- Investment portfolio interest-rate exposure: management estimated an immediate 100-basis-point rate increase would reduce fixed-income portfolio fair value by approximately $28 million. The portfolio had $3 million of gross unrealized losses, deemed temporary; no investment impairment was recorded in the quarter.
- Guarantees could require up to approximately $57 million in future payments; the company did not consider payment probable. It also provided approximately $185 million of parent guarantees for subsidiary banking services.
- Legal matters include ongoing patent and administrative disputes with Jusung, criminal proceedings in Korea involving individuals including a former Applied Korea executive, and a pending court hearing on the Semitool shareholder settlement. Applied stated it did not believe the described proceedings would materially adversely affect consolidated financial condition or results.
- Applied and Samsung entered a settlement effective November 1, 2010 resolving potential civil claims related to the Korean confidential-information matter; criminal proceedings continue. The filing also identifies tax examination, warranty, customer-credit and other ordinary-course risks.
Most important facts for investors to verify
- Whether the strong order and sales growth persists, accounting for the prior-year quarter’s extra week and the cyclical nature of customer capital spending.
- How much reported profitability benefited from the $32 million restructuring reserve adjustment and how the SunFab segment reclassification affects comparisons.
- Whether the $3.5 billion backlog converts to revenue as expected, given cancellation and delivery-schedule risks.
- Whether receivables, inventory, and customer-credit conditions remain manageable, including reliance on discounted letters of credit and receivables factoring.
- Customer concentration, particularly in SSG and Display, and the impact of Samsung’s volume-based rebates and incentives.
- Progress and outcomes in the cited legal matters, tax examinations, solar-market risks, and the January 2012 revolving-credit-facility renewal.