UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark one)
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended October 28, 2018
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 000-06920
Applied Materials, Inc.
(Exact name of registrant as specified in its charter)
Delaware | 94-1655526 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
3050 Bowers Avenue, P.O. Box 58039 Santa Clara, California | 95052-8039 (Zip Code) |
(Address of principal executive offices) | |
Registrant’s telephone number, including area code:
(408) 727-5555
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class | Name of Each Exchange on Which Registered |
Common Stock, par value $.01 per share | The NASDAQ Stock Market LLC |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit). Yes þ No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ | Accelerated filer ¨ | |
Non-accelerated filer ¨ | Smaller reporting company ¨ | |
Emerging growth company ¨ | ||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No þ
Aggregate market value of the voting stock held by non-affiliates of the registrant as of April 29, 2018, based upon the closing sale price reported by the NASDAQ Global Select Market on that date: $49,674,881,854
Number of shares outstanding of the registrant’s Common Stock, $.01 par value, as of December 7, 2018: 958,606,093
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of Part III will be provided in accordance with Instruction G(3) to Form 10-K no later than February 25, 2019.
Caution Regarding Forward-Looking Statements
This Annual Report on Form 10-K of Applied Materials, Inc. and its subsidiaries, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7, contains forward-looking statements that involve a number of risks and uncertainties.
Examples of forward-looking statements include those regarding Applied’s future financial or operating results, customer demand and spending, end-use demand, market and industry trends and outlooks, cash flows and cash deployment strategies, declaration of dividends, share repurchases, business strategies and priorities, costs and cost controls, products, competitive positions, management’s plans and objectives for future operations, research and development, strategic acquisitions and investments, growth opportunities, restructuring activities, backlog, working capital, liquidity, investment portfolio and policies, taxes, supply chain, manufacturing, properties, legal proceedings and claims, and other statements that are not historical facts, as well as their underlying assumptions. Forward-looking statements may contain words such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “potential” and “continue,” the negative of these terms, or other comparable terminology. All forward-looking statements are subject to risks and uncertainties and other important factors, including those discussed in Part I, Item 1A, “Risk Factors,” below and elsewhere in this report. These and many other factors could affect Applied’s future financial condition and operating results and could cause actual results to differ materially from expectations based on forward-looking statements made in this document or elsewhere by Applied or on its behalf. Forward-looking statements are based on management’s estimates, projections and expectations as of the date hereof, and Applied undertakes no obligation to revise or update any such statements.
The following information should be read in conjunction with the Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements included in this report.
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APPLIED MATERIALS, INC.
FORM 10-K FOR THE FISCAL YEAR ENDED OCTOBER 28, 2018
TABLE OF CONTENTS
Page | ||
PART I | ||
Item 1: | ||
Item 1A: | ||
Item 1B: | ||
Item 2: | ||
Item 3: | ||
Item 4: | ||
PART II | ||
Item 5: | ||
Item 6: | ||
Item 7: | ||
Item 7A: | ||
Item 8: | ||
Item 9: | ||
Item 9A: | ||
Item 9B: | ||
PART III | ||
Item 10: | ||
Item 11: | ||
Item 12: | ||
Item 13: | ||
Item 14: | ||
PART IV | ||
Item 15: | ||
Item 16: | ||
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PART I
Item 1: | Business |
Incorporated in 1967, Applied Materials, Inc. (Applied) is a Delaware corporation. A global company with a broad set of capabilities in materials engineering, Applied provides manufacturing equipment, services and software to the semiconductor, display and related industries. With its diverse technology capabilities, Applied delivers products and services that improve device performance, yield and cost. Applied’s customers include manufacturers of semiconductor chips, liquid crystal and organic light-emitting diode (OLED) displays, and other electronic devices. These customers may use what they manufacture in their own end products or sell the items to other companies for use in advanced electronic components. Applied’s fiscal year ends on the last Sunday in October.
Applied operates in three reportable segments: Semiconductor Systems, Applied Global Services, and Display and Adjacent Markets. A summary of financial information for each reportable segment is found in Note 15 of Notes to Consolidated Financial Statements. A discussion of factors that could affect operations is set forth under “Risk Factors” in Item 1A, which is incorporated herein by reference.
Semiconductor Systems
Applied’s Semiconductor Systems segment develops, manufactures and sells a wide range of manufacturing equipment used to fabricate semiconductor chips, also referred to as integrated circuits (ICs). The Semiconductor Systems segment includes semiconductor capital equipment used for many steps of the chip making process including the transfer of patterns into device structures, transistor and interconnect fabrication, metrology, inspection and review, and packaging technologies for connecting finished IC die. Applied’s patterning systems and technologies address challenges resulting from shrinking pattern dimensions and the growing complexity in vertical stacking found in today’s most advanced semiconductor devices. Applied’s transistor and interconnect products and technologies enable continued device scaling of 3D transistors. Applied’s metrology, inspection and review systems’ imaging capabilities and algorithms employ optical and e-beam technologies to meet the most advanced technical demands, such as self-aligned double and quad patterning, extreme ultraviolet layers, measurement-intensive optimal proximity correction mask qualification, and new 3D architectures. Applied’s packaging technologies address challenges resulting from the increasing integration of multiple IC dies in a single package. Applied delivers leading-edge capabilities that enable chipmakers to establish accurate statistical process control, ramp up production runs rapidly, and achieve consistently high production yields. The majority of Applied’s new equipment sales are to leading integrated device manufacturers and foundries worldwide.
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Technologies | Product(s) | |
Epitaxy Epitaxy (or epi) is a technique for growing silicon (e.g. silicon with another element) as a uniform crystalline structure on a wafer to form high quality material for the device circuity. Epi technology is used in device transistors to enhance chip speed. | Centura RP Epi | |
Ion Implant Ion implantation is a key technology for forming transistors and is used many times during chip fabrication. During ion implantation, wafers are bombarded by a beam of electrically-charged ions, called dopants, which can change the electrical properties of the exposed semiconductor material. | VIISta Systems | |
Oxidation/Nitridation Applied’s systems provide critical oxidation steps - like memory gate oxide, shallow trench isolation and liner oxide - for advanced device scaling. | Vantage, Radiance and Centura Systems | |
Rapid Thermal Processing (RTP) RTP is used primarily for annealing, which modifies the properties of deposited films. Applied’s single-wafer RTP systems are also used for growing high quality oxide and oxynitride films. | Vantage Systems | |
Physical Vapor Deposition (PVD) PVD is used to deposit high quality metal films. Applications include metal gate, silicides, contact liner/barrier, interconnect copper barrier seed and metal hard mask. | Endura Systems | |
Chemical Vapor Deposition (CVD) CVD is used to deposit dielectric and metal films on a wafer. During the CVD process, gases that contain atoms of the material to be deposited react on the wafer surface, forming a thin film of solid material. | Endura, Centura and Producer Systems | |
Chemical Mechanical Planarization (CMP) CMP is used to planarize a wafer surface, a process that allows subsequent photolithography patterning and material deposition steps to occur with greater accuracy, resulting in more uniform film layers with minimal thickness variations. | Reflexion Systems | |
Electrochemical Deposition (ECD) ECD is a process by which metal atoms from a chemical fluid (an electrolyte) are deposited on the surface of an immersed object. | Raider and Nokota Platforms | |
Atomic Layer Deposition (ALD) ALD technology enables ultra thin film growth of either a conducting or insulating material with uniform coverage in nanometer-sized structures. | Olympia System | |
Etch Etching is used many times throughout the IC manufacturing process to selectively remove material from the surface of a wafer. Applied offers systems for etching dielectric, metal, and silicon films to meet the requirements of advanced processing. | Centris and Producer Systems | |
Selective Removal Selective removal is a new etch technology intended to remove a material of a particular composition without damaging materials of different composition that coexist on the wafer. | Producer Systems | |
Metrology and Inspection Metrology and inspection tools are used to locate, measure, and analyze defects and features on the wafer during various stages of the fabrication processes. Applied enables customers to characterize and control critical dimension (CD) and defect issues, especially at advanced generation technology nodes. | SEMVision G7 Defect Analysis PROVision eBeam Inspection UVision 8 Inspection VeritySEM 5i Metrology Aera4 Mask Inspection | |
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Applied Global Services
The Applied Global Services (AGS) segment provides integrated solutions to optimize equipment and fab performance and productivity, including spares, upgrades, services, remanufactured earlier generation equipment and factory automation software for semiconductor, display and other products. Customer demand for products and services is fulfilled through a global distribution system with 93 locations and trained service engineers located in close proximity to customer sites in more than a dozen countries to support over 40,000 installed Applied semiconductor, display and other manufacturing systems worldwide. Applied offers the following general types of services and products under the Applied Global Services segment.
AGS Solutions and Technology |
Technology-enabled Services A comprehensive service product portfolio that combines service technology and tool specific performance commitments in order to optimize customer factory productivity. |
Fab Consulting Experts using advanced analytical tools to solve production problems that have the greatest impact on customer fab productivity. |
Supply Chain Assurance Programs Spare parts product portfolio offers options to balance inventory, cost and risk to efficiently meet fab requirements. |
Subfab Equipment Applied SubFab solutions lower costs, save energy, reduce environmental impact, and meet Environmental Protection Agency reporting regulations for greenhouse gas emissions. |
Legacy Equipment Comprehensive 200mm equipment and upgrades portfolio to address a full spectrum of production needs and extend tool lifetime. Applied 200mm equipment supports market inflections and new technology for a broad variety of devices including analog, power, and MEMS. |
Automation Software Applied SmartFactory automation software portfolio coordinates and streamlines every aspect of a factory-the processes, equipment and people-to provide competitive advantage to customers. |
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Display and Adjacent Markets
The Display and Adjacent Markets segment is comprised of products for manufacturing liquid crystal displays (LCDs), organic light-emitting diodes (OLEDs), and other display technologies for TVs, monitors, laptops, personal computers (PCs), electronic tablets, smart phones, and other consumer-oriented devices as well as equipment for processing flexible substrates. While similarities exist between the technologies utilized in semiconductor and display fabrication, the most significant differences are in the size and composition of the substrate. Substrates used to manufacture display panels and other devices are typically glass, although newer flexible materials are entering the market. Display and Adjacent Markets industry growth depends primarily on consumer demand for increasingly larger and more advanced TVs and high resolution displays for mobile devices as well as new form factors, including thin, light and curved displays, and new applications such as virtual reality. The Display and Adjacent Markets segment offers a variety of technologies and products, including:
Display and Adjacent Markets Technologies | Product(s) | |
Array Test LCD display substrates are inspected at many stages of production to maximize yield, minimize scrap, optimize equipment utilization, and monitor manufacturing processes. At the completion of the array stage, the performance of the millions of individual pixels on each display is tested. | Electron Beam Array Tester | |
Defect Review Defects are identified during inspection steps and reviewed by a scanning electron microscope and other analyses to determine defect root cause and composition. | Electron Beam Review (EBR) | |
Chemical Vapor Deposition (CVD) During CVD processing, gases containing atoms or molecules are introduced into the process chamber. The gases form reactive radicals or ions, which undergo chemical reactions to form thin films on the heated substrate. | AKT PECVD Systems | |
Physical Vapor Deposition (PVD) PVD is used to deposit high quality films of metals, alloys, transparent conductors and semiconductors. In Display, these films are used for contact, interconnect, transparent electrodes and transistor materials in TFT-LCD and OLED display backplanes, as well as for transparent electrodes in color filters and touch panels. | AKT Aristo and PiVot Systems | |
Flexible Technologies Flexible coating systems utilize physical vapor deposition, thermal evaporation, chemical vapor deposition, and e-beam technology to deposit thin layers of metal onto flexible substrates. | TopBeam, TopMet and SmartWeb Systems | |
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Backlog
Applied manufactures systems to meet demand represented by order backlog and customer commitments. Backlog as of October 29, 2017 consisted of: (1) orders for which written authorizations have been accepted and assigned shipment dates are within the next 12 months, or shipment has occurred but revenue has not been recognized; and (2) contractual service revenue and maintenance fees to be earned within the next 12 months.
Backlog by reportable segment as of October 29, 2017 was as follows:
2017 | ||||||
(In millions, except percentages) | ||||||
Semiconductor Systems | $ | 2,991 | 49 | % | ||
Applied Global Services | 1,130 | 19 | % | |||
Display and Adjacent Markets | 1,847 | 31 | % | |||
Corporate and Other | 63 | 1 | % | |||
Total | $ | 6,031 | 100 | % | ||
In anticipation of the adoption of the new revenue recognition standard in the first quarter of fiscal 2019, Applied has removed the 12 month threshold in relation to backlog in order to more closely align backlog to performance obligations as defined under the new revenue recognition standard. As such, backlog as of October 28, 2018 consists of: (1) orders for which written authorizations have been accepted, or shipment has occurred but revenue has not been recognized; and (2) contractual service revenue and maintenance fees.
Backlog by reportable segment as of October 28, 2018 was as follows:
2018 | ||||||
(In millions, except percentages) | ||||||
Semiconductor Systems | $ | 2,479 | 41 | % | ||
Applied Global Services | 1,751 | 29 | % | |||
Display and Adjacent Markets | 1,836 | 30 | % | |||
Corporate and Other | 26 | — | % | |||
Total | $ | 6,092 | 100 | % | ||
Of the total backlog as of October 28, 2018, approximately 15% is not reasonably expected to be filled within the next 12 months.
Applied’s backlog on any particular date is not necessarily indicative of actual sales for any future periods, due to the potential for customer changes in delivery schedules or order cancellations. Customers may delay delivery of products or cancel orders prior to shipment, subject to possible cancellation penalties. Delays in delivery schedules or a reduction of backlog during any particular period could have a material adverse effect on Applied’s business and results of operations.
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Manufacturing, Raw Materials and Supplies
Applied’s manufacturing activities consist primarily of assembly, test and integration of various proprietary and commercial parts, components and subassemblies that are used to manufacture systems. Applied has implemented a distributed manufacturing model under which manufacturing and supply chain activities are conducted in various countries, including Germany, Israel, Italy, Singapore, Taiwan, the United States and other countries in Asia. Applied uses numerous vendors, including contract manufacturers, to supply parts and assembly services for the manufacture and support of its products, including some systems being completed at customer sites.
Although Applied makes reasonable efforts to assure that parts are available from multiple qualified suppliers, this is not always possible. Accordingly, some key parts may be obtained from only a single supplier or a limited group of suppliers. Applied seeks to reduce costs and to lower the risks of manufacturing and service interruptions by selecting and qualifying alternate suppliers for key parts; monitoring the financial condition of key suppliers; maintaining appropriate inventories of key parts; qualifying new parts on a timely basis; and ensuring quality and performance of parts.
Research, Development and Engineering
Applied’s long-term growth strategy requires continued development of new materials engineering capabilities, including products and platforms that enable expansion into new and adjacent markets. Applied’s significant investments in research, development and engineering (RD&E) must generally enable it to deliver new products and technologies before the emergence of strong demand, thus allowing customers to incorporate these products into their manufacturing plans during early-stage technology selection. Applied works closely with its global customers and ecosystem partners to design systems and processes that meet planned technical and production requirements.
Applied’s product development and engineering organizations are located primarily in the United States, as well as in Canada, China, Europe, India, Israel, Singapore and Taiwan. In addition, certain outsourced RD&E activities, process support and customer demonstrations are performed in the United States, India, China, Singapore and Taiwan.
Marketing and Sales
Because of the highly technical nature of its products, Applied markets and sells products worldwide almost entirely through a direct sales force.
Applied has operations in many countries, with some of its business activities concentrated in certain geographic areas, and global and regional economic conditions can impact the company’s business and financial results. Applied’s business is based on capital equipment investments by major semiconductor, display and other manufacturers, and is subject to significant variability in customer demand for Applied’s products. Customers’ expenditures depend on many factors, including: general economic conditions; anticipated market demand and pricing for semiconductors, display technologies and other electronic devices; the development of new technologies; customers’ factory utilization; capital resources and financing; and government policies and incentives. In addition, a significant driver in the semiconductor and display industries is end-demand for mobile consumer products, which is characterized by seasonality that impacts the timing of customer investments in manufacturing equipment and, in turn, Applied’s business.
Information on net sales to unaffiliated customers and long-lived assets attributable to Applied’s geographic regions is included in Note 15 of Notes to Consolidated Financial Statements. The following companies accounted for at least 10 percent of Applied’s net sales in each fiscal year, which were for products and services in multiple reportable segments.
2018 | 2017 | 2016 | |||
Samsung Electronics Co., Ltd. | 13% | 23% | 13% | ||
Taiwan Semiconductor Manufacturing Company Limited | 11% | 15% | 16% | ||
Micron Technology, Inc. | * | * | 11% | ||
Intel Corporation | 11% | * | 11% | ||
______________________________
* Less than 10%
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Competition
The industries in which Applied operates are highly competitive and characterized by rapid technological change. Applied’s ability to compete generally depends on its ability to commercialize its technology in a timely manner, continually improve its products, and develop new products that meet constantly evolving customer requirements. Significant competitive factors include technical capability and differentiation, productivity, cost-effectiveness and the ability to support a global customer base. The importance of these factors varies according to customers’ needs, including product mix and respective product requirements, applications, and the timing and circumstances of purchasing decisions. Substantial competition exists in all areas of Applied’s business. Competitors range from small companies that compete in a single region, which may benefit from policies and regulations that favor domestic companies, to global, diversified companies. Applied’s ability to compete requires a high level of investment in RD&E, marketing and sales, and global customer support activities. Management believes that many of Applied’s products have strong competitive positions.
The competitive environment for each segment is described below.
The semiconductor industry is driven by demand for advanced electronic products, including smartphones and other mobile devices, servers, personal computers, automotive devices, storage, and other products. The growth of data and emerging end-market drivers such as artificial intelligence, augmented and virtual reality, the Internet of Things and smart vehicles are also creating new opportunities for the industry. As a result, products within the Semiconductor Systems segment are subject to significant changes in customer requirements, including transitions to smaller dimensions, increasingly complex chip architectures, new materials and an increasing number of applications. While certain existing technologies may be adapted to new requirements, some applications create the need for an entirely different technological approach. The rapid pace of technological change can quickly diminish the value of current technologies and products and create opportunities for existing and new competitors. Applied offers a variety of technologically-differentiated products that must continuously evolve to satisfy customers’ requirements to compete effectively in the marketplace. Applied allocates resources among its numerous product offerings and therefore may decide not to invest in an individual product to the same degree as competitors who specialize in fewer products. There are a number of competitors serving the semiconductor manufacturing equipment industry, which has experienced increasing consolidation. Some of these competitors offer a single product line and others offer multiple product lines, and range from suppliers serving a single region to global, diversified companies.
Products and services within the Applied Global Services segment complement Semiconductor Systems and Display and Adjacent Markets segments’ products in markets that are characterized by demanding worldwide service requirements and a diverse group of numerous competitors. To compete effectively, Applied offers products and services to improve tool performance, lower overall cost of ownership, and increase yields and productivity of customers’ fab operations. Significant competitive factors include productivity, cost-effectiveness, and the level of technical service and support. The importance of these factors varies according to customers’ needs and the type of products or services offered.
Products in the Display and Adjacent Markets segment are generally subject to strong competition from a number of major competitors primarily in Asia. Applied holds established market positions with its technically-differentiated LCD and OLED manufacturing solutions for PECVD, color filter PVD, PVD array, PVD touch panel, and TFT array testing, although its market position could change quickly due to customers’ evolving requirements. Important factors affecting the competitive position of Applied’s Display and Adjacent Markets products include: industry trends, Applied’s ability to innovate and develop new products, and the extent to which Applied’s products are technically-differentiated, as well as which customers within a highly concentrated customer base are making capital equipment investments and Applied’s existing position at these customers.
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Patents and Licenses
Applied’s competitive position significantly depends upon its research, development, engineering, manufacturing and marketing capabilities, as well as its patent position. Protection of Applied’s technology assets through enforcement of its intellectual property rights, including patents, is important. Applied’s practice is to file patent applications in the United States and other countries for inventions that it considers significant. Applied has approximately 12,500 patents in the United States and other countries, and additional applications are pending for new inventions. Although Applied does not consider its business materially dependent upon any one patent, the rights of Applied and the products made and sold under its patents, taken as a whole, are a significant element of its business. In addition to its patents, Applied possesses other intellectual property, including trademarks, know-how, trade secrets, and copyrights.
Applied enters into patent and technology licensing agreements with other companies when it is determined to be in its best interest. Applied pays royalties under existing patent license agreements for the use, in several of its products, of certain patented technologies. Applied also receives royalties from licenses granted to third parties. Royalties received from or paid to third parties have not been material to Applied’s consolidated results of operations.
In the normal course of business, Applied periodically receives and makes inquiries regarding possible patent infringement. In responding to such inquiries, it may become necessary or useful for Applied to obtain or grant licenses or other rights. However, there can be no assurance that such licenses or rights will be available to Applied on commercially reasonable terms, or at all. If Applied is not able to resolve or settle claims, obtain necessary licenses on commercially reasonable terms, or successfully prosecute or defend its position, Applied’s business, financial condition and results of operations could be materially and adversely affected.
Environmental Matters
Applied maintains a number of environmental, health, and safety programs that are primarily preventative in nature. As part of these programs, Applied regularly monitors ongoing compliance with applicable laws and regulations. In addition, Applied has trained personnel to conduct investigations of any environmental, health, or safety incidents, including, but not limited to, spills, releases, or possible contamination.
Compliance with federal, state and local environmental, health and safety laws and regulations, including those regulating the discharge of materials into the environment, remedial agreements, and other actions relating to the environment have not had, and are not expected to have, a material effect on Applied’s capital expenditures, competitive position, financial condition, or results of operations.
The most recent report on Applied’s environmental, health and safety activities can be found in Applied’s latest Citizenship Report on its website at http://www.appliedmaterials.com/news/citizenship_report.html. The Citizenship Report is updated periodically. This website address is intended to be an inactive textual reference only. None of the information on, or accessible through, Applied’s website is part of this Form 10-K or is incorporated by reference herein.
Employees
At October 28, 2018, Applied employed approximately 21,000 regular employees. In the high-technology industry, competition for highly-skilled employees is intense. Applied believes that its future success is highly dependent upon its continued ability to attract, retain and motivate qualified employees.
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Executive Officers of the Registrant
The following table and notes set forth information about Applied’s executive officers:
Name of Individual | Position |
Gary E. Dickerson(1) | President, Chief Executive Officer |
Ginetto Addiego(2) | Senior Vice President, Engineering, Operations and Quality |
Daniel J. Durn(3) | Senior Vice President, Chief Financial Officer |
Steve Ghanayem(4) | Senior Vice President, New Markets and Alliances Group |
Thomas F. Larkins(5) | Senior Vice President, General Counsel |
Omkaram Nalamasu(6) | Senior Vice President, Chief Technology Officer |
Prabu Raja(7) | Senior Vice President, Semiconductor Products Group |
Ali Salehpour(8) | Senior Vice President, Services, Display and Flexible Technology |
Charles Read(9) | Corporate Vice President, Corporate Controller and Chief Accounting Officer |
(1) | Mr. Dickerson, age 61, was named President of Applied in June 2012 and appointed Chief Executive Officer and a member of the Board of Directors in September 2013. Before joining Applied, he served as Chief Executive Officer and a director of Varian Semiconductor Equipment Associates, Inc. (Varian) from 2004 until its acquisition by Applied in November 2011. Prior to Varian, Mr. Dickerson served 18 years with KLA-Tencor Corporation (KLA-Tencor), a supplier of process control and yield management solutions for the semiconductor and related industries, where he held a variety of operations and product development roles, including President and Chief Operating Officer. Mr. Dickerson started his semiconductor career in manufacturing and engineering management at General Motors’ Delco Electronics Division and then AT&T Technologies. |
(2) | Dr. Addiego, age 59, has been Senior Vice President, Engineering, Operations and Quality since June 2015. He served as Senior Vice President, Engineering from March 2014 to June 2015. He previously was with Applied from 1996 to 2005, leading various product groups as well as global organizations, including Global Operations, Facilities and Real Estate, Foundation Engineering, and Information Technology. From March 2011 to March 2014, Dr. Addiego was President and Chief Operating Officer of Ultra Clean Technology Corp., a public company listed on NASDAQ and a supplier of critical subsystems for the semiconductor capital equipment, medical device, energy, research, and flat panel industries. From February 2005 to March 2011, Dr. Addiego worked at Novellus Systems, Inc., a provider of advanced process equipment for the semiconductor industry, where he served as Executive Vice President of Corporate Global Operations responsible for Central Engineering, Facilities, Real Estate, Human Resources and Information Technology, and Chief Administrative Officer. |
(3) | Mr. Durn, age 52, has been Senior Vice President and Chief Financial Officer of Applied since August 2017. Previously, Mr. Durn was Executive Vice President and Chief Financial Officer of NXP Semiconductors N.V., a semiconductor manufacturer (NXP), from December 2015 to August 2017. Mr. Durn served as Senior Vice President of Finance and Chief Financial Officer of Freescale Semiconductor, Inc., from June 2014 until its merger with NXP in December 2015. Prior to Freescale, Mr. Durn was Chief Financial Officer and Executive Vice President of Finance and Administration at GlobalFoundries, a semiconductor foundry, which he joined in December 2011. |
(4) | Mr. Ghanayem, age 53, has been Senior Vice President, New Markets and Alliances Group of Applied since November 2017. He has served in various senior management, product development and operational roles since joining Applied in 1989, including Group Vice President and General Manager of the Transistor and Interconnect Group. |
(5) | Mr. Larkins, age 57, has been Senior Vice President, General Counsel of Applied since November 2012 and was Corporate Secretary from November 2012 to March 2018. Previously, Mr. Larkins was employed by Honeywell International Inc., a diversified global technology and manufacturing company, where he was Vice President, Corporate Secretary and Deputy General Counsel from 2002 until joining Applied. Mr. Larkins served in various other positions at Honeywell (formerly AlliedSignal) after joining the company in 1997. |
(6) | Dr. Nalamasu, age 60, has been Senior Vice President, Chief Technology Officer since June 2013, and President of Applied Ventures, LLC, Applied’s venture capital arm, since November 2013. He had served as Group Vice President, Chief Technology Officer from January 2012 to June 2013, and as Corporate Vice President, Chief Technology Officer from January 2011 to January 2012. Upon joining Applied in June 2006 until January 2011, Dr. Nalamasu was an Appointed Vice President of Research and served as Deputy Chief Technology Officer and General Manager for the Advanced Technologies Group. From 2002 to 2006, Dr. Nalamasu was a NYSTAR distinguished professor of Materials Science and Engineering at Rensselaer Polytechnic Institute, where he also served as Vice President of Research from 2005 to 2006. Prior to Rensselaer, Dr. Nalamasu served in several leadership roles at Bell Laboratories. |
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(7) | Dr. Raja, age 56, has been Senior Vice President, Semiconductor Products Group of Applied since November 2017. He previously served in various senior management, product development and operational roles since joining Applied in 1995, including Group Vice President and General Manager of the Patterning and Packaging Group. |
(8) | Mr. Salehpour, age 57, has been Senior Vice President, Services, Display and Flexible Technology since September 2013. He previously served as Group Vice President, General Manager Energy and Environmental Solutions and Display Business Groups, since joining Applied in November 2012. Prior to Applied, Mr. Salehpour worked at KLA-Tencor for 16 years, where he served as a Senior Vice President and General Manager and worked for 10 years in senior management positions at Schlumberger Test Systems. |
(9) | Mr. Read, age 52, has been Corporate Vice President, Corporate Controller and Chief Accounting Officer of Applied since joining the Company in September 2013. Prior to Applied, Mr. Read worked at Brocade Communications Systems, Inc., a provider of semiconductor and software-based network solutions, since October 2002, where he most recently served as Vice President, Corporate Controller. Prior to Brocade, Mr. Read worked at KPMG LLP, an audit, tax and advisory firm, from 1996 to 2002. |
Available Information
Applied’s website is http://www.appliedmaterials.com. Applied makes available free of charge, on or through its website, its annual, quarterly and current reports, and any amendments to those reports, as soon as reasonably practicable after electronically filing such reports with, or furnishing them to, the SEC. The SEC’s website, www.sec.gov, contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. These website addresses are intended to be an inactive textual references only. None of the information on, or accessible through, these websites is part of this Form 10-K or is incorporated by reference herein.
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Item 1A: | Risk Factors |
The following risk factors could materially and adversely affect Applied’s business, financial condition or results of operations and cause reputational harm, and should be carefully considered in evaluating the Company and its business, in addition to other information presented elsewhere in this report.
The industries that Applied serves can be volatile and difficult to predict.
As a supplier to the global semiconductor and display and related industries, Applied is subject to variable industry conditions, as demand for manufacturing equipment and services can change depending on several factors, including the nature and timing of technology inflections and advances in fabrication processes, the timing and requirements of new and emerging technologies and market drivers, production capacity relative to demand for chips and display technologies, end-user demand, customers’ capacity utilization, production volumes, access to affordable capital, consumer buying patterns and general economic conditions. Applied’s industries historically have been cyclical, and are subject to volatility and sudden changes in customer requirements for new manufacturing capacity and advanced technology. These changes can affect the timing and amounts of customer investments in technology and manufacturing equipment, and can have a significant impact on Applied’s net sales, operating expenses, gross margins and net income. The amount and mix of capital equipment spending between different products and technologies can have a significant impact on the Company’s results of operations.
To meet rapidly changing demand in the industries it serves, Applied must accurately forecast demand and effectively manage its resources and production capacity across its businesses, and may incur unexpected or additional costs to align its business operations. During periods of increasing demand for its products, Applied must have sufficient manufacturing capacity and inventory to meet customer demand; effectively manage its supply chain; attract, retain and motivate a sufficient number of qualified employees; and continue to control costs. During periods of decreasing demand, Applied must reduce costs and align its cost structure with prevailing market conditions; effectively manage its supply chain; and motivate and retain key employees. If Applied does not effectively manage these challenges during periods of changing demand, its business performance and results of operations may be adversely impacted. Even with effective allocation of resources and management of costs, during periods of decreasing demand, Applied’s gross margins and earnings may be adversely impacted.
Applied is exposed to risks associated with an uncertain global economy.
Uncertain global economic and business conditions, along with uncertainties and volatility in the financial markets, national debt and fiscal concerns in various regions, pose challenges to the industries in which Applied operates. Markets for semiconductors and displays depend largely on business and consumer spending and demand for electronic products. Economic uncertainty and related factors exacerbate negative trends in business and consumer spending and may cause certain Applied customers to push out, cancel, or refrain from purchasing for equipment or services, which may have an adverse impact on Applied’s revenues, results of operations and financial condition. Uncertain market conditions, difficulties in obtaining capital, or reduced profitability may also cause some customers to scale back operations, exit businesses, merge with other manufacturers, or file for bankruptcy protection and potentially cease operations, which can also result in lower sales, additional inventory or bad debt expense for Applied. Economic and industry uncertainty may similarly affect suppliers, which could impair their ability to deliver parts and negatively affect Applied’s ability to manage operations and deliver its products. These conditions may also lead to consolidation or strategic alliances among other equipment manufacturers, which could adversely affect Applied’s ability to compete effectively.
Uncertain economic and industry conditions also make it more challenging for Applied to forecast its operating results, make business decisions, and identify and prioritize the risks that may affect its businesses, sources and uses of cash, financial condition and results of operations. If Applied does not appropriately manage its business operations in response to changing economic and industry conditions, it could have a significant negative impact on its business performance and financial condition. Applied may be required to implement additional cost reduction efforts, including restructuring activities, which may adversely affect Applied’s ability to capitalize on opportunities. Even during periods of economic uncertainty or lower revenues, Applied must continue to invest in research and development and maintain a global business infrastructure to compete effectively and support its customers, which can have a negative impact on its operating margins and earnings.
Applied maintains an investment portfolio that is subject to general credit, liquidity, market and interest rate risks. The risks to Applied’s investment portfolio may be exacerbated if financial market conditions deteriorate and, as a result, the value and liquidity of the investment portfolio, as well as returns on pension assets, could be negatively impacted and lead to impairment charges. Applied also maintains cash balances in various bank accounts globally in order to fund normal operations. If any of these financial institutions becomes insolvent, it could limit Applied’s ability to access cash in the affected accounts, which could affect its ability to manage its operations.
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Applied is exposed to the risks of operating a global business.
Applied has product development, engineering, manufacturing, sales and other operations distributed throughout many countries, and some of its business activities are concentrated in certain geographic areas. Moreover, in fiscal 2018, approximately 91 percent of Applied’s net sales were to customers in regions outside the United States. As a result of the global nature of its operations, Applied’s business performance and results of operations may be adversely affected by a number of factors, including:
• | uncertain global economic and political business conditions and demands; |
• | political and social attitudes, laws, rules, regulations and policies within countries that favor domestic companies over non-domestic companies, including customer- or government-supported efforts to promote the development and growth of local competitors; |
• | global trade issues and changes in and uncertainties with respect to trade policies, including the ability to obtain required import and export licenses, trade sanctions, tariffs, and international trade disputes; |
• | customer- or government-supported efforts to influence Applied to conduct more of its operations and sourcing in a particular country, such as Korea and China; |
• | variations among, and changes in, local, regional, national or international laws and regulations, including contract, intellectual property, cybersecurity, data privacy, labor, tax, and import/export laws, and the interpretation and application of such laws and regulations; |
• | ineffective or inadequate legal protection of intellectual property rights in certain countries; |
• | positions taken by governmental agencies regarding possible national commercial and/or security issues posed by international business operations; |
• | fluctuating raw material, commodity, energy and shipping costs; |
• | delays or restrictions in shipping materials or finished products between countries; |
• | geographically diverse operations and projects, and our ability to maintain appropriate business processes, procedures and internal controls, and comply with environmental, health and safety, anti-corruption and other regulatory requirements; |
• | supply chain interruptions, and service interruptions from utilities, transportation, data hosting or telecommunications providers, or other events beyond our control; |
• | a diverse workforce with different experience levels, languages, cultures, customs, business practices and worker expectations, and differing employment practices and labor issues; |
• | variations in the ability to develop relationships with local customers, suppliers and governments; |
• | fluctuations in interest rates and currency exchange rates, including the relative strength or weakness of the U.S. dollar against the Japanese yen, euro, Taiwanese dollar, Israeli shekel, Chinese yuan or Singapore dollar; |
• | the need to provide sufficient levels of technical support in different locations around the world; |
• | performance of third party providers of outsourced functions, including certain engineering, software development, manufacturing, information technology and other activities; |
• | political instability, natural disasters, pandemics, social unrest, terrorism or acts of war in locations where Applied has operations, suppliers or sales, or that may influence the value chain of the industries that Applied serves; |
• | challenges in hiring and integration of an increasing number of workers in new countries; |
• | the increasing need for a mobile workforce to work in or travel to different regions; and |
• | uncertainties with respect to economic growth rates in various countries, including for the manufacture and sale of semiconductors and displays in the developing economies of certain countries. |
International trade disputes could result in increases in tariffs and other trade restrictions and protectionist measures that could have an adverse impact on our operations.
We sell a significant majority of our products into countries outside of the United States and we purchase a significant portion of equipment and supplies from suppliers outside of the United States. The United States and other countries have levied tariffs and taxes on certain goods. Increases in tariffs, additional taxes or other trade restrictions and retaliatory measures may impact end-user demand and customer investment in manufacturing equipment, increase our manufacturing costs, decrease margins, reduce the competitiveness of our products, or inhibit our ability to sell products or purchase necessary equipment and supplies, which could have a material adverse effect on our business, results of operations, or financial condition.
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Certain international sales depend on our ability to obtain export licenses, and our inability to obtain such licenses could potentially limit our markets and impact our business. In addition, government authorities may impose conditions that require the use of local suppliers or partnerships with local companies, require the license or other transfer of intellectual property, or engage in other efforts to promote local businesses and local competitors, which could have a significant adverse impact on Applied’s business. Many of these challenges are present in China and Korea, markets that represent significant long-term growth opportunities for Applied businesses.
Applied is exposed to risks as a result of ongoing changes in the various industries in which it operates.
The global semiconductor, display and related industries in which Applied operates are characterized by ongoing changes affecting some or all of these industries that impact demand for and the profitability of Applied’s products and its consolidated results of operations, including:
• | the nature, timing and degree of visibility of changes in end demand for electronic products, including those related to fluctuations in consumer buying patterns tied to seasonality or the introduction of new products, and the effects of these changes on customers’ businesses and on demand for Applied’s products; |
• | increasing capital requirements for building and operating new fabrication plants and customers’ ability to raise the necessary capital; |
• | trade, regulatory or tax policies impacting the timing of customers’ investment in new or expanded fabrication plants; |
• | differences in growth rates among the semiconductor, display and other industries in which Applied operates; |
• | the increasing importance of establishing, improving and maintaining strong relationships with customers; |
• | the increasing cost and complexity for customers to move from product design to volume manufacturing, which may slow the adoption rate of new manufacturing technology; |
• | the need for customers to continually reduce the total cost of manufacturing system ownership; |
• | the heightened importance to customers of system reliability and productivity and the effect on demand for fabrication systems as a result of their increasing productivity, device yield and reliability; |
• | manufacturers’ ability to reconfigure and re-use fabrication systems which can reduce demand for new equipment; |
• | the increasing importance of, and difficulties in, developing products with sufficient differentiation to influence customers’ purchasing decisions; |
• | requirements for shorter cycle times for the development, manufacture and installation of manufacturing equipment; |
• | price and performance trends for semiconductor devices and displays, and the corresponding effect on demand for such products; |
• | the increasing importance of the availability of spare parts to maximize the time that customers’ systems are available for production; |
• | the increasing role for and complexity of software in Applied products; and |
• | the increasing focus on reducing energy usage and improving the environmental impact and sustainability associated with manufacturing operations. |
Applied is exposed to risks as a result of ongoing changes specific to the semiconductor industry.
The largest proportion of Applied’s consolidated net sales and profitability is derived from sales of manufacturing equipment in the Semiconductor Systems segment to the global semiconductor industry. In addition, a majority of the revenues of Applied Global Services is from sales to semiconductor manufacturers. The semiconductor industry is characterized by ongoing changes particular to this industry that impact demand for and the profitability of Applied’s semiconductor equipment and service products, including:
• | the increasing frequency and complexity of technology transitions and inflections, and Applied’s ability to timely and effectively anticipate and adapt to these changes; |
• | the increasing cost of research and development due to many factors, including shrinking geometries, the use of new materials, new and more complex device structures, more applications and process steps, increasing chip design costs, and the increasing cost and complexity of integrated manufacturing processes; |
• | the need to reduce product development time, despite the increasing difficulty of technical challenges; |
• | the growing number of types and varieties of semiconductors and number of applications across multiple substrate sizes; |
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• | the increasing cost and complexity for semiconductor manufacturers to move more technically advanced capability and smaller geometries to volume manufacturing, and the resulting impact on the rates of technology transition and investment in capital equipment; |
• | challenges in generating organic growth given semiconductor manufacturers’ levels of capital expenditures and the allocation of capital investment to market segments that Applied does not serve, such as lithography, or segments where Applied’s products have lower relative market presence; |
• | the importance of increasing market positions in segments with growing demand; |
• | semiconductor manufacturer’s ability to reconfigure and re-use equipment, and the resulting effect on their need to purchase new equipment and services; |
• | shorter cycle times between order placements by customers and product shipment require greater reliance on forecasting of customer investment, which may lead to inventory write-offs and manufacturing inefficiencies that decrease gross margin; |
• | competitive factors that make it difficult to enhance position, including challenges in securing development-tool-of-record (DTOR) and production-tool-of-record (PTOR) positions with customers; |
• | consolidation in the semiconductor industry, including among semiconductor manufacturers and among manufacturing equipment suppliers; |
• | shifts in sourcing strategies by computer and electronics companies that impact the equipment requirements of Applied’s foundry customers; |
• | the concentration of new wafer starts in Korea and Taiwan, where Applied’s service penetration and service-revenue-per-wafer-start have been lower than in other regions; |
• | investment in semiconductor manufacturing capabilities in China, which may be affected by changes in economic conditions and governmental policies in China; and |
• | the increasing fragmentation of semiconductor markets, leading certain markets to become too small to support the cost of a new fabrication plant, while others require less technologically advanced products. |
If Applied does not accurately forecast, and allocate appropriate resources and investment towards addressing, key technology changes and inflections, successfully develop and commercialize products to meet demand for new technologies, and effectively address industry trends, its business and results of operations may be adversely impacted.
Applied is exposed to risks as a result of ongoing changes specific to the display industry.
The global display industry historically has experienced considerable volatility in capital equipment investment levels, due in part to the limited number of display manufacturers, the concentrated nature of end-use applications, production capacity relative to end-use demand, and panel manufacturer profitability. Industry growth depends primarily on consumer demand for increasingly larger and more advanced TVs, and on demand for advanced smartphones and mobile device displays, which demand is highly sensitive to cost and improvements in technologies and features. The display industry is characterized by ongoing changes particular to this industry that impact demand for and the profitability of Applied’s display products and services, including:
• | the importance of new types of display technologies, such as organic light-emitting diode (OLED), low temperature polysilicon (LTPS), flexible displays and metal oxide, and new touch panel films; |
• | the increasing cost of research and development, and complexity of technology transitions and inflections, and Applied’s ability to timely and effectively anticipate and adapt to these changes; |
• | the timing and extent of an expansion of manufacturing facilities in China, which may be affected by changes in economic conditions and governmental policies in China; |
• | the importance of increasing market positions in products and technologies with growing demand; |
• | the rate of transition to larger substrate sizes for TVs and to new display technologies for TVs and mobile applications, and the resulting effect on capital intensity in the industry and on Applied’s product differentiation, gross margin and return on investment; and |
• | the variability in demand for display manufacturing equipment, concentration of display manufacturer customers and their ability to successfully commercialize new products and technologies, and uncertainty with respect to future display technology end-use applications and growth drivers. |
If Applied does not successfully develop and commercialize products to meet demand for new and emerging display technologies, or if industry demand for display manufacturing equipment and technologies slows, Applied’s business and its results of operations may be adversely impacted.
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The industries in which Applied operates are highly competitive and subject to rapid technological and market changes.
Applied operates in a highly competitive environment in which innovation is critical, and its future success depends on many factors, including the development of new technologies and effective commercialization and customer acceptance of its equipment, services and related products, and its ability to increase its position in its current markets, expand into adjacent and new markets, and optimize operational performance. The development, introduction and support of a broadening set of products in a geographically diverse and competitive environment, and that may require greater collaboration with customers and other industry participants, have grown more complex and expensive over time. Furthermore, new or improved products may entail higher costs and lower profits. To compete successfully, Applied must:
• | identify and address technology inflections, market changes, new applications, customer requirements and end-use demand; |
• | develop new products and disruptive technologies, improve and develop new applications for existing products, and adapt products for use by customers in different applications and markets with varying technical requirements; |
• | differentiate its products from those of competitors, meet customers’ performance specifications, appropriately price products, and achieve market acceptance; |
• | maintain operating flexibility to enable responses to changing markets, applications, customers and customer requirements; |
• | enhance its worldwide operations across its businesses to reduce cycle time, enable continuous quality improvement, reduce costs, and enhance design for manufacturability and serviceability; |
• | focus on product development and sales and marketing strategies that address customers’ high value problems and strengthen customer relationships; |
• | effectively allocate resources between its existing products and markets, the development of new products, and expanding into new and adjacent markets; |
• | improve the productivity of capital invested in R&D activities; |
• | accurately forecast demand, work with suppliers and meet production schedules for its products; |
• | improve its manufacturing processes and achieve cost efficiencies across product offerings; |
• | adapt to changes in value offered by companies in different parts of the supply chain; |
• | qualify products for evaluation and volume manufacturing with its customers; and |
• | implement changes in its design engineering methodology to reduce material costs and cycle time, increase commonality of platforms and types of parts used in different systems, and improve product life cycle management. |
If Applied does not successfully anticipate technology inflections, develop and commercialize new products and technologies, and respond to changes in customer requirements and market trends, its business performance and results of operations may be adversely impacted.
Applied is exposed to risks associated with a highly concentrated customer base.
Applied’s customer base is highly concentrated, and has become increasingly concentrated as a result of continued consolidation. Applied’s customer base is also geographically concentrated. A relatively limited number of manufacturers account for a substantial portion of Applied’s business. As a result, the actions of even a single customer can expose Applied’s business and results of operations to greater volatility. The mix and type of customers, and sales to any single customer, including as a result of changes in government policy, may vary significantly from quarter to quarter and from year to year, and have a significant impact on Applied’s net sales, gross margins and net income. Applied’s products are configured to customer specifications, and changing, rescheduling or canceling orders may result in significant, non-recoverable costs. If customers do not place orders, or they substantially reduce, delay or cancel orders, Applied may not be able to replace the business, which may have a significant adverse impact on its results of operations and financial condition. The concentration of Applied’s customer base increases its risks related to the financial condition of its customers, and the deterioration in financial condition of a single customer or the failure of a single customer to perform its obligations could have a material adverse effect on Applied’s results of operations and cash flow. To the extent its customers experience liquidity constraints, Applied may incur additional bad debt expense, which may have a significant impact on its results of operations. Major customers may also seek pricing, payment, intellectual property-related, or other commercial terms that are less favorable to Applied, which may have a negative impact on Applied’s business, cash flow, revenue and gross margins.
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Applied is exposed to risks associated with business combinations, acquisitions and strategic investments.
Applied engages in acquisitions of or investments in companies, technologies or products in existing, related or new markets for Applied. Business combinations, acquisitions and investments involve numerous risks to Applied’s business, financial condition and operating results, including but not limited to:
• | diversion of management’s attention and disruption of ongoing businesses; |
• | contractual restrictions on the conduct of Applied’s business during the pendency of a proposed transaction; |
• | inability to complete proposed transactions due to the failure to obtain regulatory or other approvals, litigation or other disputes, and any ensuing obligation to pay a termination fee; |
• | the failure to realize expected returns from acquired businesses; |
• | requirements imposed by government regulators in connection with their review of a transaction, which may include, among other things, divestitures and restrictions on the conduct of Applied’s existing business or the acquired business; |
• | ineffective integration of operations, systems, technologies, products or employees, which can impact the ability to realize anticipated synergies or other benefits; |
• | failure to commercialize technologies from acquired businesses or developed through strategic investments; |
• | dependence on unfamiliar supply chains or relatively small supply partners; |
• | inability to capitalize on characteristics of new markets that may be significantly different from Applied’s existing markets and where competitors may have stronger market positions and customer relationships; |
• | failure to retain and motivate key employees of acquired businesses; |
• | the potential impact of the announcement or consummation of a proposed transaction on relationships with third parties; |
• | potential changes in Applied’s credit rating, which could adversely impact the Company’s access to and cost of capital; |
• | reductions in cash balances or increases in debt obligations to finance activities associated with a transaction, which reduce the availability of cash flow for general corporate or other purposes, including share repurchases and dividends; |
• | exposure to new operational risks, rules, regulations, worker expectations, customs and practices to the extent acquired businesses are located in regions where Applied has not historically conducted business; |
• | challenges associated with managing new, more diverse and more widespread operations, projects and people; |
• | inability to obtain and protect intellectual property rights in key technologies; |
• | inadequacy or ineffectiveness of an acquired company’s internal financial controls, disclosure controls and procedures, cybersecurity, privacy policies and procedures, or environmental, health and safety, anti-corruption, human resource, or other policies or practices; |
• | impairment of acquired intangible assets and goodwill as a result of changing business conditions, technological advancements or worse-than-expected performance of the segment; |
• | the risk of litigation or claims associated with a proposed or completed transaction; |
• | unknown, underestimated or undisclosed commitments or liabilities; and |
• | the inappropriate scale of acquired entities’ critical resources or facilities for business needs. |
Applied also makes strategic investments in other companies, including companies formed as joint ventures, which may decline in value or not meet desired objectives. The success of these investments depends on various factors over which Applied may have limited or no control and, particularly with respect to joint ventures, requires ongoing and effective cooperation with strategic partners. In addition, new legislation or additional regulations may affect or impair our ability to invest in certain countries or require us to obtain regulatory approvals to do so. The risks to Applied’s strategic investment portfolio may be exacerbated by unfavorable financial market and macroeconomic conditions and, as a result, the value of the investment portfolio could be negatively impacted and lead to impairment charges.
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Applied’s indebtedness and debt covenants could adversely affect its financial condition and business.
Applied has $5.4 billion in aggregate principal amount of senior unsecured notes outstanding. Under the indenture governing the senior unsecured notes, it may be required to offer to repurchase the notes at a price equal to 101% of the principal amount, plus accrued and unpaid interest, upon a change of control of Applied and a contemporaneous downgrade of the notes below investment grade. Applied also has in place a $1.5 billion committed revolving credit agreement. While no amounts were outstanding under this credit agreement at October 28, 2018, Applied may borrow amounts in the future under the agreement. Applied may also enter into new financing arrangements. Applied’s ability to satisfy its debt obligations is dependent upon the results of its business operations and subject to other risks discussed in this section. Significant changes in Applied’s credit rating or changes in the interest rate environment could have a material adverse consequence on Applied’s access to and cost of capital for future financings, and financial condition. If Applied fails to satisfy its debt obligations, or comply with financial and other debt covenants, it may be in default and any borrowings may become immediately due and payable, and such default may also constitute a default under other of Applied’s obligations. There can be no assurance that Applied would have sufficient financial resources or be able to arrange financing to repay any borrowings at such time.
Applied is exposed to risks associated with expanding into new and related markets and industries.
As part of its growth strategy, Applied must successfully expand into related or new markets and industries, either with its existing products or with new products developed internally, or those developed in collaboration with third parties, or obtained through acquisitions. Applied’s ability to successfully expand its business into new and related markets and industries may be adversely affected by a number of factors, including:
• | the need to devote additional resources to develop new products for, and operate in, new markets; |
• | the need to develop new sales and technical marketing strategies, cultivate relationships with new customers and meet different customer service requirements; |
• | differing rates of profitability and growth among multiple businesses; |
• | Applied’s ability to anticipate demand, capitalize on opportunities, and avoid or minimize risks; |
• | the complexity of managing multiple businesses with variations in production planning, execution, supply chain management and logistics; |
• | the adoption of new business models, business processes and systems; |
• | the complexity of entering into and effectively managing strategic alliances or partnering opportunities; |
• | new materials, processes and technologies; |
• | the need to attract, motivate and retain employees with skills and expertise in these new areas; |
• | new and more diverse customers and suppliers, including some with limited operating histories, uncertain or limited funding, evolving business models or locations in regions where Applied does not have, or has limited, operations; |
• | new or different competitors with potentially more financial or other resources, industry experience and established customer relationships; |
• | entry into new industries and countries, with differing levels of government involvement, laws and regulations, and business, employment and safety practices; |
• | third parties’ intellectual property rights; and |
• | the need to comply with, or work to establish, industry standards and practices. |
In addition, Applied from time to time receives funding from United States and other government agencies for certain strategic development programs to increase its research and development resources and address new market opportunities. As a condition to this government funding, Applied may be subject to certain record-keeping, audit, intellectual property rights-sharing and/or other obligations.
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Manufacturing interruptions or delays, or the failure to accurately forecast customer demand, could affect Applied’s ability to meet customer demand, lead to higher costs, or result in excess or obsolete inventory.
Applied’s business depends on its timely supply of equipment, services and related products that meet the rapidly changing technical and volume requirements of its customers, which depends in part on the timely delivery of parts, including components and subassemblies, from suppliers, including contract manufacturers. The inability to timely obtain sufficient quantities of parts can have an adverse impact on Applied’s manufacturing operations and ability to meet customer demand for equipment, spares and services. Some key parts are subject to long lead-times or obtainable only from a single supplier or limited group of suppliers, and some sourcing or subassembly is provided by suppliers located in countries other than the countries where Applied conducts its manufacturing. Variable industry conditions and the volatility of demand for manufacturing equipment increase capital, technical, operational and other risks for Applied and for companies throughout its supply chain. These conditions may cause some suppliers to scale back operations, exit businesses, merge with other companies, or file for bankruptcy protection and possibly cease operations. Applied may also experience significant interruptions of its manufacturing operations, delays in its ability to deliver products or services, increased costs or customer order cancellations as a result of:
• | the failure or inability to accurately forecast demand and obtain sufficient quantities of quality parts on a cost-effective basis; |
• | volatility in the availability and cost of materials; |
• | difficulties or delays in obtaining required import or export approvals; |
• | shipment delays due to transportation interruptions or capacity constraints; |
• | information technology or infrastructure failures, including those of a third party supplier or service provider; and |
• | natural disasters or other events beyond Applied’s control (such as earthquakes, floods or storms, regional economic downturns, pandemics, social unrest, political instability, terrorism, or acts of war), particularly where it conducts manufacturing. |
If a supplier fails to meet Applied’s requirements concerning quality, cost, protection of intellectual property, socially-responsible business practices, or other performance factors, Applied may transfer its business to alternative sources, which could entail manufacturing delays, additional costs, or other difficulties. If Applied is unable to meet its customers’ demand for a prolonged period due to its inability to obtain certain parts or components, it could affect its ability to manage its operations, and have an adverse impact on Applied’s business, results of operations and customer relationships. In addition, if Applied needs to rapidly increase its business and manufacturing capacity to meet increases in demand or expedited shipment schedules, this may exacerbate any interruptions in Applied’s manufacturing operations and supply chain and the associated effect on Applied’s working capital. Moreover, if actual demand for Applied’s products is different than expected, Applied may purchase more/fewer parts than necessary or incur costs for canceling, postponing or expediting delivery of parts. If Applied purchases inventory in anticipation of customer demand that does not materialize, or if customers reduce or delay orders, Applied may incur excess inventory charges.
The ability to attract, retain and motivate key employees is vital to Applied’s success.
Applied’s success, competitiveness and ability to execute on its global strategies and maintain a culture of innovation depend in large part on its ability to attract, retain and motivate employees with key skills and experience. Achieving this objective may be difficult due to many factors, including fluctuations in global economic and industry conditions, management changes, Applied’s organizational structure, increasing global competition for talent, the availability of qualified employees, cost reduction activities (including workforce reductions and unpaid shutdowns), availability of career development opportunities, the ability to obtain necessary authorizations for workers to provide services outside their home countries, and the attractiveness of Applied’s compensation and benefit programs, including its share-based programs. The loss or retirement of employees present particular challenges to the extent they involve the departure of knowledgeable and experienced employees and the resulting need to identify and train existing or new workers to perform necessary functions, which may result in unexpected costs, reduced productivity, and/or difficulties with respect to internal processes and controls.
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Applied is exposed to various risks related to protection and enforcement of intellectual property rights.
Applied’s success depends in significant part on the protection of its patents, trade secrets, copyrights and other intellectual property rights. Infringement of Applied’s rights by a third party, such as the unauthorized manufacture or sale of equipment or spare parts, could result in uncompensated lost market and revenue opportunities for Applied. Policing any unauthorized use of intellectual property is difficult and costly and Applied cannot be certain that the measures it has implemented will prevent misuse. Applied’s ability to enforce its intellectual property rights is subject to litigation risks, as well as uncertainty as to the protection and enforceability of those rights in some countries. If Applied seeks to enforce its intellectual property rights, it may be subject to claims that those rights are invalid or unenforceable, and others may seek counterclaims against Applied, which could have a negative impact on its business. If Applied is unable to enforce and protect intellectual property rights, or if they are circumvented, invalidated, rendered obsolete by the rapid pace of technological change, it could have an adverse impact on its competitive position and business. In addition, changes in intellectual property laws or their interpretation, such as recent changes in U.S. patent laws, may impact Applied’s ability to protect and assert its intellectual property rights, increase costs and uncertainties in the prosecution of patent applications and enforcement or defense of issued patents, and diminish the value of Applied’s intellectual property.
Third parties may also assert claims against Applied and its products. Claims that Applied’s products infringe the rights of others, whether or not meritorious, can be expensive and time-consuming to defend and resolve, and may divert the efforts and attention of management and personnel. The inability to obtain rights to use third party intellectual property on commercially reasonable terms could have an adverse impact on Applied’s business. In addition, Applied may face claims based on the theft or unauthorized use or disclosure of third-party trade secrets and other confidential business information. Any such incidents and claims could severely harm Applied’s business and reputation, result in significant expenses, harm its competitive position, and prevent Applied from selling certain products, all of which could have a significant adverse impact on Applied’s business and results of operations.
Applied is exposed to risks related to cybersecurity threats and incidents.
In the conduct of its business, Applied collects, uses, transmits and stores data on information technology systems, including systems owned and maintained by Applied or third party providers. These data include confidential information and intellectual property belonging to Applied or its customers or other business partners, as well as personally-identifiable information of individuals. All information systems are subject to disruption, breach or failure. Applied has experienced, and expects to continue to be subject to, cybersecurity threats and incidents ranging from employee error or misuse to individual attempts to gain unauthorized access to these information systems, to sophisticated and targeted measures known as advanced persistent threats, none of which have been material to the Company to date. Applied devotes significant resources to network security, data encryption and other measures to protect its systems and data from unauthorized access or misuse. However, depending on their nature and scope, cybersecurity incidents could result in business disruption; the misappropriation of intellectual property, and corruption or loss of confidential information and critical data (Applied’s and that of third parties); reputational damage; litigation with third parties; diminution in the value of Applied’s investment in research, development and engineering; data privacy issues; and increased cybersecurity protection and remediation costs. Compliance with, and changes to, laws and regulations concerning privacy and information security could result in significant expense, and any failure to comply could result in proceedings against Applied by regulatory authorities or other third parties.
Applied is exposed to various risks related to legal proceedings.
Applied from time to time is, and in the future may be involved in legal proceedings or claims regarding patent infringement, intellectual property rights, antitrust, environmental regulations, securities, contracts, product performance, product liability, unfair competition, misappropriation of trade secrets, employment, workplace safety, and other matters. Applied also on occasion receives notification from customers who believe that Applied owes them indemnification or other obligations related to claims made against such customers by third parties.
Legal proceedings and claims, whether with or without merit, and associated internal investigations, may be time-consuming and expensive to prosecute, defend or conduct; divert management’s attention and other Applied resources; inhibit Applied’s ability to sell its products; result in adverse judgments for damages, injunctive relief, penalties and fines; and negatively affect Applied’s business. There can be no assurance regarding the outcome of current or future legal proceedings, claims or investigations.
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The failure to successfully implement enterprise resource planning and other information systems changes could adversely impact Applied’s business and results of operations.
Applied periodically implements new or enhanced enterprise resource planning and related information systems in order to better manage its business operations, align its global organizations and enable future growth. Implementation of new business processes and information systems requires the commitment of significant personnel, training and financial resources, and entails risks to Applied’s business operations. If Applied does not successfully implement enterprise resource planning and related information systems improvements, or if there are delays or difficulties in implementing these systems, Applied may not realize anticipated productivity improvements or cost efficiencies, and may experience interruptions in service and operational difficulties, such as its ability to track orders, timely manufacture and ship products, project inventory requirements, effectively manage its supply chain and allocate human resources, aggregate financial data and report operating results, and otherwise effectively manage its business, all of which could result in quality issues, reputational harm, lost market and revenue opportunities, and otherwise adversely affect Applied’s business, financial condition and results of operations.
Applied may incur impairment charges to goodwill or long-lived assets.
Applied has a significant amount of goodwill and other acquired intangible assets related to acquisitions. Goodwill and purchased intangible assets with indefinite useful lives are not amortized, but are reviewed for impairment annually during the fourth quarter of each fiscal year, and more frequently when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The review compares the fair value for each of Applied’s reporting units to its associated carrying value, including goodwill. Factors that could lead to impairment of goodwill and intangible assets include adverse industry or economic trends, reduced estimates of future cash flows, declines in the market price of Applied common stock, changes in Applied’s strategies or product portfolio, and restructuring activities. Applied’s valuation methodology for assessing impairment requires management to make judgments and assumptions based on historical experience and projections of future operating performance. Applied may be required to record future charges to earnings during the period in which an impairment of goodwill or intangible assets is determined to exist.
Applied is exposed to risks associated with operating in jurisdictions with complex and changing tax laws.
Applied is subject to income taxes in the United States and foreign jurisdictions. Significant judgment is required to determine and estimate worldwide tax liabilities. Applied’s provision for income taxes and effective tax rates could be affected by numerous factors, including changes in applicable tax laws, interpretations of applicable tax laws, amount and composition of pre-tax income in jurisdictions with differing tax rates, and valuation of deferred tax assets. An increase in Applied’s provision for income taxes and effective tax rate could have a material adverse impact on Applied’s results of operations and financial condition.
On December 22, 2017, the U.S. government enacted tax legislation referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The U.S. government may issue regulations that significantly affect how the Tax Act is interpreted. The U.S. Securities and Exchange Commission issued Staff Accounting Bulletin No. 118 (SAB 118), which provides guidance on accounting for income tax effects of the Tax Act. SAB 118 provides a measurement period for companies to complete this accounting, which will not extend beyond one year from the Tax Act enactment date. Pursuant to SAB 118, provisional adjustments were recorded when reasonable estimates could be determined. No adjustments were recorded when reasonable estimates could not be determined. These provisional estimates will be revised as information becomes available and guidance is issued by the Internal Revenue Service, and changes in Applied’s provision for income taxes and effective tax rates could have a material impact on Applied’s results of operations and financial condition.
Consistent with the international nature of its business, Applied conducts certain manufacturing, supply chain, and other operations in Asia, bringing these activities closer to customers and reducing operating costs. In certain foreign jurisdictions, conditional reduced income tax rates have been granted to Applied. To obtain the benefit of these tax incentives, Applied must meet requirements relating to various activities. Applied’s ability to realize benefits from these incentives could be materially affected if, among other things, applicable requirements are not met or Applied incurs net losses in these jurisdictions.
In addition, Applied is subject to examination by the Internal Revenue Service and other tax authorities, and from time to time amends previously filed tax returns. Applied regularly assesses the likelihood of favorable or unfavorable outcomes resulting from these examinations and amendments to determine the adequacy of its provision for income taxes, which requires estimates and judgments. Although Applied believes its tax estimates are reasonable, there can be no assurance that the tax authorities will agree with such estimates. Applied may have to engage in litigation to achieve the results reflected in the estimates, which may be time-consuming and expensive. There can be no assurance that Applied will be successful or that any final determination will not be materially different from the treatment reflected in Applied’s historical income tax provisions and effective tax rates.
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Applied is subject to risks associated with environmental and safety regulations.
Applied is subject to environmental and safety regulations in connection with its global business operations, including but not limited to: regulations related to the development, manufacture and use of its products; handling, discharge, recycling and disposal of hazardous materials used in its products or in producing its products; the operation of its facilities; and the use of its real property. The failure or inability to comply with existing or future environmental and safety regulations could result in: significant remediation or other legal liabilities; the imposition of penalties and fines; restrictions on the development, manufacture, sale or use of certain of its products; limitations on the operation of its facilities or ability to use its real property; and a decrease in the value of its real property. Applied could be required to alter its manufacturing and operations and incur substantial expense in order to comply with environmental and safety regulations. Any failure to comply with environmental and safety regulations could subject Applied to significant costs and liabilities that could adversely affect Applied’s business, financial condition and results of operations.
Applied is exposed to various risks related to the global regulatory environment.
As a public company with global operations, Applied is subject to the laws of the United States and multiple foreign jurisdictions and the rules and regulations of various governing bodies, which may differ among jurisdictions, including those related to financial and other disclosures, accounting standards, corporate governance, intellectual property, tax, trade, antitrust, employment, immigration and travel regulations, privacy, and anti-corruption. Changing, inconsistent or conflicting laws, rules and regulations, and ambiguities in their interpretation and application create uncertainty and challenges, and compliance with laws, rules and regulations may be onerous and expensive, divert management time and attention from revenue-generating activities, and otherwise adversely impact Applied’s business operations. Violations of law, rules and regulations could result in fines, criminal sanctions, restrictions on Applied’s business, and damage to its reputation, and could have an adverse impact on its business operations, financial condition and results of operations.
Item 1B: | Unresolved Staff Comments |
None.
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Item 2: | Properties |
Information concerning Applied’s properties is set forth below:
(Square feet in thousands) | United States | Other Countries | Total | ||
Owned | 4,530 | 2,417 | 6,947 | ||
Leased | 1,037 | 1,341 | 2,378 | ||
Total | 5,567 | 3,758 | 9,325 | ||
Because of the interrelation of Applied’s operations, properties within a country may be shared by the segments operating within that country. The Company’s headquarters offices are in Santa Clara, California. Products in Semiconductor Systems are manufactured in Santa Clara, California; Austin, Texas; Gloucester, Massachusetts; Kalispell, Montana; Rehovot, Israel; and Singapore. Remanufactured equipment products in the Applied Global Services segment are produced primarily in Austin, Texas. Products in the Display and Adjacent Markets segment are manufactured in Alzenau, Germany and Tainan, Taiwan. Other products are manufactured in Treviso, Italy.
Applied also owns and leases offices, plants and warehouse locations in many locations throughout the world, including in Europe, Japan, North America (principally the United States), Israel, China, India, Korea, Southeast Asia and Taiwan. These facilities are principally used for manufacturing; research, development and engineering; and marketing, sales and customer support.
Applied also owns a total of approximately 269 acres of buildable land in Montana, Texas, California, Israel and Italy that could accommodate additional building space.
Applied considers the properties that it owns or leases as adequate to meet its current and future requirements. Applied regularly assesses the size, capability and location of its global infrastructure and periodically makes adjustments based on these assessments.
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Item 3: | Legal Proceedings |
The information set forth under “Legal Matters” in Note 14 of Notes to Consolidated Financial Statements is incorporated herein by reference.
Item 4: | Mine Safety Disclosures |
None.
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PART II
Item 5: | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
Market Information
Applied’s common stock is traded on the NASDAQ Global Select Market under the symbol AMAT. As of December 7, 2018, there were 2,854 registered holders of Applied common stock.
Performance Graph
The performance graph below shows the five-year cumulative total stockholder return on Applied common stock during the period from October 27, 2013 through October 28, 2018. This is compared with the cumulative total return of the Standard & Poor’s 500 Stock Index and the RDG Semiconductor Composite Index over the same period. The comparison assumes $100 was invested on October 27, 2013 in Applied common stock and in each of the foregoing indices and assumes reinvestment of dividends, if any. Dollar amounts in the graph are rounded to the nearest whole dollar. The performance shown in the graph represents past performance and should not be considered an indication of future performance.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Applied Materials, Inc., the S&P 500 Index
and the RDG Semiconductor Composite Index
*Assumes $100 invested on 10/27/13 in stock or 10/31/13 in index, including reinvestment of dividends.
Indexes calculated on month-end basis.
Copyright© 2018 Standard & Poor’s, a division of S&P global. All rights reserved.
10/27/2013 | 10/26/2014 | 10/25/2015 | 10/30/2016 | 10/29/2017 | 10/28/2018 | ||||||||||||
Applied Materials | 100.00 | 121.04 | 96.67 | 171.69 | 343.16 | 198.27 | |||||||||||
S&P 500 Index | 100.00 | 117.27 | 123.37 | 128.93 | 159.40 | 171.11 | |||||||||||
RDG Semiconductor Composite Index | 100.00 | 128.42 | 126.26 | 154.41 | 232.29 | 221.61 | |||||||||||
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Issuer Purchases of Equity Securities
The following table provides information as of October 28, 2018 with respect to the shares of common stock repurchased by Applied during the fourth quarter of fiscal 2018 pursuant to a publicly announced stock repurchase program approved by the Board of Directors in February 2018, which authorized up to an aggregate of $6.0 billion in repurchases.
Period | Total Number of Shares Purchased | Average Price Paid per Share | Aggregate Price Paid | Total Number of Shares Purchased as Part of Publicly Announced Programs * | Maximum Dollar Value of Shares That May Yet be Purchased Under the Programs | ||||||||||||
(In millions, except per share amounts) | |||||||||||||||||
Month #1 | |||||||||||||||||
(July 30, 2018 to August 26, 2018) | 7.9 | $ | 46.69 | $ | 369 | 7.9 | $ | 4,709 | |||||||||
Month #2 | |||||||||||||||||
(August 27, 2018 to September 23, 2018) | 3.7 | $ | 40.13 | 148 | 3.7 | $ | 4,561 | ||||||||||
Month #3 | |||||||||||||||||
(September 24, 2018 to October 28, 2018) | 6.5 | $ | 35.78 | 234 | 6.5 | $ | 4,327 | ||||||||||
Total | 18.1 | $ | 41.43 | $ | 751 | 18.1 | |||||||||||
Item 6: | Selected Financial Data |
The following selected financial information has been derived from Applied’s historical audited consolidated financial statements and should be read in conjunction with the consolidated financial statements and the accompanying notes for the corresponding fiscal years:
Fiscal Year(1) | 2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||
(In millions, except percentages and per share amounts) | |||||||||||||||||||
Net sales | $ | 17,253 | $ | 14,537 | $ | 10,825 | $ | 9,659 | $ | 9,072 | |||||||||
Gross profit | $ | 7,817 | $ | 6,532 | $ | 4,511 | $ | 3,952 | $ | 3,843 | |||||||||
Gross margin | 45.3 | % | 44.9 | % | 41.7 | % | 40.9 | % | 42.4 | % | |||||||||
Research, development and engineering | $ | 2,019 | $ | 1,774 | $ | 1,540 | $ | 1,451 | $ | 1,428 | |||||||||
Operating income | $ | 4,796 | $ | 3,868 | $ | 2,152 | $ | 1,693 | $ | 1,520 | |||||||||
Operating margin | 27.8 | % | 26.6 | % | 19.9 | % | 17.5 | % | 16.8 | % | |||||||||
Income before income taxes | $ | 4,694 | $ | 3,731 | $ | 2,013 | $ | 1,598 | $ | 1,448 | |||||||||
Net income | $ | 3,313 | $ | 3,434 | $ | 1,721 | $ | 1,377 | $ | 1,072 | |||||||||
Earnings per diluted share | $ | 3.23 | $ | 3.17 | $ | 1.54 | $ | 1.12 | $ | 0.87 | |||||||||
Long-term debt | $ | 5,309 | $ | 5,304 | $ | 3,143 | $ | 3,342 | $ | 1,947 | |||||||||
Cash dividends declared per common share | $ | 0.70 | $ | 0.40 | $ | 0.40 | $ | 0.40 | $ | 0.40 | |||||||||
Total assets | $ | 17,773 | $ | 19,419 | $ | 14,588 | $ | 15,308 | $ | 13,174 | |||||||||
(1) | Each fiscal year ended on the last Sunday in October. Fiscal 2018, 2017, 2015, and 2014 each contained 52 weeks, and fiscal 2016 contained 53 weeks. |
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Item 7: | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Introduction
Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to facilitate an understanding of Applied’s business and results of operations. This MD&A should be read in conjunction with Applied’s Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements included elsewhere in this Form 10-K. The following discussion contains forward-looking statements and should also be read in conjunction with the cautionary statement set forth at the beginning of this Form 10-K. MD&A consists of the following sections:
• | Overview: a summary of Applied’s business and measurements |
• | Results of Operations: a discussion of operating results |
• | Segment Information: a discussion of segment operating results |
• | Recent Accounting Pronouncements: a discussion of new accounting pronouncements and its impact to Applied’s consolidated financial statements |
• | Financial Condition, Liquidity and Capital Resources: an analysis of cash flows, sources and uses of cash |
• | Off-Balance Sheet Arrangements and Contractual Obligations |
• | Critical Accounting Policies and Estimates: a discussion of critical accounting policies that require the exercise of judgments and estimates |
• | Non-GAAP Adjusted Results: a presentation of results reconciling GAAP to non-GAAP adjusted measures |
Overview
Applied provides manufacturing equipment, services and software to the semiconductor, display, and related industries. Applied’s customers include manufacturers of semiconductor wafers and chips, liquid crystal and organic light-emitting diode (OLED) displays, and other electronic devices. These customers may use what they manufacture in their own end products or sell the items to other companies for use in advanced electronic components. Each of Applied’s businesses is subject to variable industry conditions, as demand for manufacturing equipment and services can change depending on supply and demand for chips, display technologies, and other electronic devices, as well as other factors, such as global economic and market conditions, and the nature and timing of technological advances in fabrication processes.
Applied operates in three reportable segments: Semiconductor Systems, Applied Global Services, and Display and Adjacent Markets. A summary of financial information for each reportable segment is found in Note 15 of Notes to Consolidated Financial Statements. A discussion of factors that could affect Applied’s operations is set forth under “Risk Factors” in Part I, Item 1A, which is incorporated herein by reference. Product development and manufacturing activities occur primarily in the United States, Europe, Israel, and Asia. Applied’s broad range of equipment and service products are highly technical and are sold primarily through a direct sales force.
Applied’s results are driven primarily by customer spending on capital equipment and services to support key technology transitions or to increase production volume in response to worldwide demand for semiconductors and displays. Spending by semiconductor customers, which include companies that operate in the foundry, memory and logic markets, is driven by demand for advanced electronic products, including smartphones and other mobile devices, servers, personal computers, automotive devices, storage, and other products. The growth of data and emerging end-market drivers such as artificial intelligence, augmented and virtual reality, the Internet of Things and smart vehicles are also creating new opportunities for the industry. As a result, products within the Semiconductor Systems segment are subject to significant changes in customer requirements, including transitions to smaller dimensions, increasingly complex chip architectures, new materials and an increasing number of applications. Demand for display manufacturing equipment spending depends primarily on consumer demand for increasingly larger and more advanced TVs as well as larger and higher resolution displays for next-generation mobile devices, and investments in new types of display technologies. While certain existing technologies may be adapted to new requirements, some applications create the need for an entirely different technological approach. The timing of customer investment in manufacturing equipment is also affected by the timing of next-generation process development and the timing of capacity expansion to meet end-market demand. In light of these conditions, Applied’s results can vary significantly year-over-year, as well as quarter-over-quarter.
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Applied’s strategic priorities include developing products that help solve customers’ challenges at technology inflections; expanding its served market opportunities in the semiconductor and display industries; and growing its services business. Applied’s long-term growth strategy requires continued development of new materials engineering capabilities, including products and platforms that enable expansion into new and adjacent markets. Applied’s significant investments in research, development and engineering must generally enable it to deliver new products and technologies before the emergence of strong demand, thus allowing customers to incorporate these products into their manufacturing plans during early-stage technology selection. Applied works closely with its global customers to design systems and processes that meet their planned technical and production requirements.
The following table presents certain significant measurements for the past three fiscal years:
Change | |||||||||||||||||||
2018 | 2017 | 2016 | 2018 over 2017 | 2017 over 2016 | |||||||||||||||
(In millions, except per share amounts and percentages) | |||||||||||||||||||
Net sales | $ | 17,253 | $ | 14,537 | $ | 10,825 | $ | 2,716 | $ | 3,712 | |||||||||
Gross margin | 45.3 | % | 44.9 | % | 41.7 | % | 0.4 points | 3.2 points | |||||||||||
Operating income | $ | 4,796 | $ | 3,868 | $ | 2,152 | $ | 928 | $ | 1,716 | |||||||||
Operating margin | 27.8 | % | 26.6 | % | 19.9 | % | 1.2 points | 6.7 points | |||||||||||
Net income | $ | 3,313 | $ | 3,434 | $ | 1,721 | $ | (121 | ) | $ | 1,713 | ||||||||
Earnings per diluted share | $ | 3.23 | $ | 3.17 | $ | 1.54 | $ | 0.06 | $ | 1.63 | |||||||||
Fiscal 2018 and 2017 contained 52 weeks, and fiscal 2016 contained 53 weeks.
Fiscal 2018 included a one-time expense related to the enactment of recent U.S. tax legislation that reduced diluted earnings per share by $1.08.
Investment in semiconductor and display manufacturing equipment and services continued to be a strong driver of revenue during fiscal 2018. Semiconductor equipment customers made investments in new capacity and technology transitions, and Applied’s overall semiconductor systems revenue increased as compared to the prior year. Demand for dynamic random-access memory (DRAM) and NAND increased in fiscal 2018 although overall spending by memory customers was lower towards the second half of the year. Logic customers’ spending remained strong while foundry customers’ spending decreased compared to the prior year and Applied continues to see these customers optimize existing capacity and re-prioritize their capital spending plans on longer lead-time equipment not in Applied’s product portfolio. Display equipment spending during fiscal 2018 reflected continued investment in new technology and manufacturing equipment for producing larger LCD TVs and in new equipment for mobile devices. Applied also continued to see strong growth in demand for spares and services from customers as compared to the prior year.
While Applied anticipates major technology trends to continue driving long-term growth in the semiconductor industry, the trends characterizing the second half of 2018 are likely to continue into early fiscal 2019, with lower spending by memory customers, and foundry customers prioritizing spending on longer lead-time equipment not in Applied’s product portfolio. Applied also expects lower spending for display manufacturing equipment in fiscal 2019, although long-term demand drivers remain in place. Applied anticipates continued growth in semiconductor spares and services spending in fiscal 2019.
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Results of Operations
Net Sales
Net sales for the periods indicated were as follows:
Change | |||||||||||||||||||||
2018 | 2017 | 2016 | 2018 over 2017 | 2017 over 2016 | |||||||||||||||||
(In millions, except percentages) | |||||||||||||||||||||
Semiconductor Systems | $ | 10,903 | 63% | $ | 9,517 | 65% | $ | 6,873 | 64% | 15% | 38% | ||||||||||
Applied Global Services | 3,754 | 22% | 3,017 | 21% | 2,589 | 24% | 24% | 17% | |||||||||||||
Display and Adjacent Markets | 2,498 | 14% | 1,900 | 13% | 1,206 | 11% | 31% | 58% | |||||||||||||
Corporate and Other | 98 | 1% | 103 | 1% | 157 | 1% | (5)% | (34)% | |||||||||||||
Total | $ | 17,253 | 100% | $ | 14,537 | 100% | $ | 10,825 | 100% | 19% | 34% | ||||||||||
Net sales in fiscal 2018 compared to fiscal 2017 increased due to increased customer investments across all segments. The Semiconductor Systems segment continued to represent the largest contributor of net sales and to the increase in net sales.
Net sales in fiscal 2017 compared to fiscal 2016 increased due to increased customer investments in all segments, with the majority of the increases resulting from investments in semiconductor equipment.
Net sales by geographic region, determined by the location of customers’ facilities to which products were shipped, were as follows:
Change | |||||||||||||||||||||
2018 | 2017 | 2016 | 2018 over 2017 | 2017 over 2016 | |||||||||||||||||
(In millions, except percentages) | |||||||||||||||||||||
China | $ | 5,113 | 30% | $ | 2,746 | 19% | $ | 2,259 | 21% | 86% | 22% | ||||||||||
Korea | 3,603 | 21% | 4,052 | 28% | 1,883 | 17% | (11)% | 115% | |||||||||||||
Taiwan | 2,732 | 16% | 3,291 | 23% | 2,843 | 26% | (17)% | 16% | |||||||||||||
Japan | 2,405 | 14% | 1,518 | 10% | 1,279 | 12% | 58% | 19% | |||||||||||||
Southeast Asia | 802 | 4% | 640 | 4% | 803 | 7% | 25% | (20)% | |||||||||||||
Asia Pacific | 14,655 | 85% | 12,247 | 84% | 9,067 | 83% | 20% | 35% | |||||||||||||
United States | 1,532 | 9% | 1,474 | 10% | 1,143 | 11% | 4% | 29% | |||||||||||||
Europe | 1,066 | 6% | 816 | 6% | 615 | 6% | 31% | 33% | |||||||||||||
Total | $ | 17,253 | 100% | $ | 14,537 | 100% | $ | 10,825 | 100% | 19% | 34% | ||||||||||
The changes in net sales in all regions other than Korea for fiscal 2018 compared to fiscal 2017 primarily reflected changes in semiconductor equipment spending, including product and customer mix, and increased spending in semiconductor spares and services. The increase in net sales to customers in China also reflected increased investments in display manufacturing equipment. The decrease in net sales to customers in Korea primarily reflected decreased investments in display manufacturing equipment.
The changes in net sales from customers in all regions for fiscal 2017 compared to fiscal 2016 primarily reflected increased investments in semiconductor equipment and changes in semiconductor equipment customer mix. In addition, the increase in net sales from customers in China also reflected increased investments from display manufacturing equipment customers.
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Gross Margin
Gross margins for the periods indicated were as follows:
Change | ||||||||||||
2018 | 2017 | 2016 | 2018 over 2017 | 2017 over 2016 | ||||||||
Gross margin | 45.3 | % | 44.9 | % | 41.7 | % | 0.4 points | 3.2 points | ||||
Gross margin in fiscal 2018 increased slightly compared to fiscal 2017, primarily due to higher net sales and materials cost savings. Gross margin in fiscal 2017 increased compared to fiscal 2016, primarily due to higher net sales, favorable product mix and materials cost savings.
Gross margin during fiscal 2018, 2017 and 2016 included $87 million, $69 million and $62 million, respectively, of share-based compensation expense.
Research, Development and Engineering
Research, Development and Engineering (RD&E) expenses for the periods indicated were as follows:
Change | |||||||||||||||||||
2018 | 2017 | 2016 | 2018 over 2017 | 2017 over 2016 | |||||||||||||||
(In millions) | |||||||||||||||||||
Research, development and engineering | $ | 2,019 | $ | 1,774 | $ | 1,540 | $ | 245 | $ | 234 | |||||||||
Applied’s future operating results depend to a considerable extent on its ability to maintain a competitive advantage in the equipment and service products it provides. Development cycles range from 12 to 36 months depending on whether the product is an enhancement of an existing product, which typically has a shorter development cycle, or a new product, which typically has a longer development cycle. Most of Applied’s existing products resulted from internal development activities and innovations involving new technologies, materials and processes. In certain instances, Applied acquires technologies, either in existing or new product areas, to complement its existing technology capabilities and to reduce time to market.
Management believes that it is critical to continue to make substantial investments in RD&E to assure the availability of innovative technology that meets the current and projected requirements of its customers’ most advanced designs. Applied has maintained and intends to continue its commitment to investing in RD&E in order to continue to offer new products and technologies.
In fiscal 2018, Applied increased its RD&E investments across Semiconductor Systems and Display and Adjacent Markets, including etch, e-beam inspection and other materials engineering solutions to improve chip performance and enable advanced displays. Applied’s investments in etch were focused on supporting the adoption of precision etch technology for enabling continued scaling of 3D logic and memory chips. The investment in e-beam inspection was in support of strengthening our e-beam portfolio, which helps achieve higher yields at advanced nodes by detecting the most challenging defects and monitoring and controlling process marginality. Applied also invested in materials engineering solutions to support patterning applications as well as to improve transistor performance and device power efficiency. In Display and Adjacent Markets, RD&E investments were focused on expanding the company’s market opportunity with new display technologies.
RD&E expenses increased in fiscal 2018 compared to the prior year and also in fiscal 2017 compared to fiscal 2016, primarily due to additional headcount and increased research and development spending in Semiconductor Systems and Display and Adjacent Market segments. These increases reflect Applied’s ongoing investments in product development initiatives, consistent with the Company’s growth strategy. Applied continued to prioritize existing RD&E investments in technical capabilities and critical research and development programs in current and new markets, with a focus on semiconductor technologies.
RD&E expense during fiscal 2018, 2017 and 2016 included $96 million, $83 million and $76 million, respectively, of share-based compensation expense.
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Marketing and Selling
Marketing and selling expenses for the periods indicated were as follows:
Change | |||||||||||||||||||
2018 | 2017 | 2016 | 2018 over 2017 | 2017 over 2016 | |||||||||||||||
(In millions) | |||||||||||||||||||
Marketing and selling | $ | 521 | $ | 456 | $ | 429 | $ | 65 | $ | 27 | |||||||||
Marketing and selling expenses increased in fiscal 2018 compared to fiscal 2017 primarily due to additional headcount. Marketing and selling expenses increased in fiscal 2017 compared to fiscal 2016, primarily due to additional headcount, partially offset by the reduction in bad debt provision recorded during fiscal 2017.
Marketing and selling expenses for fiscal years 2018, 2017 and 2016 included $31 million, $28 million and $26 million, respectively, of share-based compensation expense.
General and Administrative
General and administrative (G&A) expenses for the periods indicated were as follows:
Change | |||||||||||||||||||
2018 | 2017 | 2016 | 2018 over 2017 | 2017 over 2016 | |||||||||||||||
(In millions) | |||||||||||||||||||
General and administrative | $ | 481 | $ | 434 | $ | 390 | $ | 47 | $ | 44 | |||||||||
General and administrative expenses in fiscal 2018 increased compared to fiscal 2017 primarily due to additional headcount and unfavorable impact from foreign exchange fluctuation, partially offset by lower variable compensation expense. General and administrative expenses in fiscal 2017 increased compared to fiscal 2016, primarily due to higher variable compensation and additional headcount.
G&A expenses during fiscal 2018, 2017 and 2016 included $44 million, $40 million and $37 million, respectively, of share-based compensation expense.
Interest Expense and Interest and Other Income (loss), net
Interest expense and interest and other income (loss), net for the periods indicated were as follows:
Change | |||||||||||||||||||
2018 | 2017 | 2016 | 2018 over 2017 | 2017 over 2016 | |||||||||||||||
(In millions) | |||||||||||||||||||
Interest expense | $ | 234 | $ | 198 | $ | 155 | $ | 36 | $ | 43 | |||||||||
Interest and other income, net | $ | 132 | $ | 61 | $ | 16 | $ | 71 | $ | 45 | |||||||||
Interest expenses incurred were primarily associated with the senior unsecured notes issued in June 2011, September 2015, and March 2017. Interest expense increased in fiscal 2018 compared to the prior year and also in fiscal 2017 compared to fiscal 2016 due to the issuance of senior unsecured notes in March 2017.
Interest and other income, net primarily includes interest earned on cash and investments, realized gains or losses on sales of securities and impairment of strategic investments. Interest and other income, net in fiscal 2018 increased compared to fiscal 2017 primarily driven by realized gains on sales of securities and higher interest income from investments. Interest and other income, net in fiscal 2017 increased compared to the prior year primarily due to higher interest income from investments, partially offset by higher impairment of strategic investments in fiscal 2017.
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Income Taxes
Provision for income taxes and effective tax rates for the periods indicated were as follows:
Change | |||||||||||||||||||
2018 | 2017 | 2016 | 2018 over 2017 | 2017 over 2016 | |||||||||||||||
(In millions, except percentages) | |||||||||||||||||||
Provision for income taxes | $ | 1,381 | $ | 297 | $ | 292 | $ | 1,084 | $ | 5 | |||||||||
Effective income tax rate | 29.4 | % | 8.0 | % | 14.5 | % | 21.4 points | (6.5) points | |||||||||||
Applied’s provision for income taxes and effective tax rate are affected by the geographical composition of pre-tax income which includes jurisdictions with differing tax rates, conditional reduced tax rates and other income tax incentives. It is also affected by events that are not consistent from period to period, such as changes in income tax laws and the resolution of prior years’ income tax filings.
On December 22, 2017, the U.S. government enacted the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act includes a reduction to the U.S. federal corporate tax rate from 35.0 percent to 21.0 percent and requires a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries payable over eight years. U.S. deferred tax assets and liabilities were subject to remeasurement due to the reduction of the U.S. federal corporate tax rate. Applied has a blended U.S. federal corporate tax rate of 23.4 percent for fiscal 2018 based on the number of days before and after the effective date of the Tax Act.
The U.S. Securities and Exchange Commission issued Staff Accounting Bulletin No. 118 (SAB 118), which provides guidance on accounting for the income tax effects of the Tax Act. SAB 118 provides a measurement period for companies to complete this accounting. Pursuant to SAB 118, provisional adjustments were recorded when reasonable estimates could be determined. These provisional estimates will be revised as information becomes available and as guidance is issued by the Internal Revenue Service. The accounting for the income tax effects of the Tax Act will be completed during the measurement period, which will not extend beyond one year from the Tax Act enactment date. Applied continues to evaluate certain unrepatriated earnings of foreign subsidiaries used to calculate the transition tax. The remeasurement of U.S. deferred tax assets and liabilities is complete.
The effective tax rate for fiscal 2018 was higher than fiscal 2017 primarily due to tax expense of $1.1 billion for the transition tax and remeasurement of deferred tax assets as a result of the Tax Act, partially offset by changes in the geographical composition of income, tax benefits from the lower U.S. federal corporate tax rate, adoption of authoritative guidance for share-based compensation, and the resolution of tax liabilities for uncertain tax positions. In addition, fiscal 2017 included tax benefits from the recognition of previously unrecognized foreign tax credits.
The effective tax rate for fiscal 2017 was lower than fiscal 2016 primarily due to the recognition of previously unrecognized foreign tax credits and changes in the geographical composition of income. In addition, fiscal 2016 included unfavorable resolutions and changes related to income tax liabilities for uncertain tax positions as well as the reinstatement of the U.S. federal R&D tax credit retroactive to its expiration in December of 2015 which did not reoccur in fiscal 2017.
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Segment Information
Applied reports financial results in three segments: Semiconductor Systems, Applied Global Services, and Display and Adjacent Markets. A description of the products and services, as well as financial data, for each reportable segment can be found in Note 15 of Notes to Consolidated Financial Statements.
The Corporate and Other category includes revenues from products, as well as costs of products sold, for fabricating solar photovoltaic cells and modules and certain operating expenses that are not allocated to its reportable segments and are managed separately at the corporate level. These operating expenses include costs for share-based compensation; certain management, finance, legal, human resource, and RD&E functions provided at the corporate level; and unabsorbed information technology and occupancy. In addition, Applied does not allocate to its reportable segments restructuring and asset impairment charges and any associated adjustments related to restructuring actions, unless these actions pertain to a specific reportable segment.
The results for each reportable segment are discussed below.
Semiconductor Systems Segment
The Semiconductor Systems segment is comprised primarily of capital equipment used to fabricate semiconductor chips. Semiconductor industry spending on capital equipment is driven by demand for advanced electronic products, including smartphones and other mobile devices, servers, personal computers, automotive devices, storage, and other products, and the nature and timing of technological advances in fabrication processes, and as a result is subject to variable industry conditions. Development efforts are focused on solving customers’ key technical challenges in transistor, interconnect, patterning and packaging performance as devices scale to advanced technology nodes.
Investment in semiconductor manufacturing equipment continued to be a strong driver of revenue during fiscal 2018. Semiconductor equipment customers made investments in new capacity and technology transitions, and overall semiconductor systems revenue increased. Demand for logic, DRAM, and NAND increased during fiscal 2018. Foundry customers’ spending decreased compared to the prior year and Applied continues to see these customers optimize existing capacity and re-prioritize their capital spending plans on longer lead-time equipment not in Applied’s product portfolio.
Certain significant measures for the periods indicated were as follows:
Change | |||||||||||||||||||||||
2018 | 2017 | 2016 | 2018 over 2017 | 2017 over 2016 | |||||||||||||||||||
(In millions, except percentages and ratios) | |||||||||||||||||||||||
Net sales | $ | 10,903 | $ | 9,517 | $ | 6,873 | $ | 1,386 | 15% | $ | 2,644 | 38% | |||||||||||
Operating income | $ | 3,634 | $ | 3,173 | $ | 1,807 | $ | 461 | 15% | $ | 1,366 | 76% | |||||||||||
Operating margin | 33.3 | % | 33.3 | % | 26.3 | % | —% | 7.0 points | |||||||||||||||
Net sales for Semiconductor Systems by end use application for the periods indicated were as follows:
2018 | 2017 | 2016 | ||||||
Foundry | 24 | % | 41 | % | 40 | % | ||
Dynamic random-access memory (DRAM) | 27 | % | 16 | % | 16 | % | ||
Flash memory | 36 | % | 34 | % | 31 | % | ||
Logic and other | 13 | % | 9 | % | 13 | % | ||
100 | % | 100 | % | 100 | % | |||
Net sales for fiscal 2018 increased compared to fiscal 2017 primarily due to higher spending from memory and logic customers, offset by lower spending from foundry customers. Although operating margin remained flat, operating income for fiscal 2018 increased compared to fiscal 2017 primarily due to favorable changes in product mix and higher net sales, partially offset by higher RD&E expenses. Six customers represented at least 10 percent of this segment’s net sales, and together they accounted for approximately 76 percent of this segment’s net sales for fiscal 2018.
Net sales for fiscal 2017 increased compared to fiscal 2016 primarily due to higher spending from foundry and memory customers. Operating income and operating margin for fiscal 2017 increased compared to prior year primarily due to favorable changes in product mix and higher net sales, partially offset by higher RD&E expenses.
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The following regions accounted for at least 30 percent of total net sales for the Semiconductor Systems segment for one or more of past three fiscal years:
Change | |||||||||||||||||||||||||||||
2018 | 2017 | 2016 | 2018 over 2017 | 2017 over 2016 | |||||||||||||||||||||||||
(In millions, except percentages) | |||||||||||||||||||||||||||||
Korea | $ | 2,886 | 26 | % | $ | 2,962 | 31 | % | $ | 1,177 | 17 | % | $ | (76 | ) | (3)% | $ | 1,785 | 152% | ||||||||||
Taiwan | $ | 1,895 | 17 | % | $ | 2,638 | 28 | % | $ | 2,165 | 32 | % | $ | (743 | ) | (28)% | $ | 473 | 22% | ||||||||||
Applied Global Services Segment
The Applied Global Services segment provides integrated solutions to optimize equipment and fab performance and productivity, including spares, upgrades, services, certain remanufactured earlier generation equipment and factory automation software for semiconductor, display and solar products. Customer demand for products and services is fulfilled through a global distribution system with trained service engineers located in close proximity to customer sites.
Demand for Applied Global Services’ service solutions are driven by Applied’s large and growing installed base of manufacturing systems, and customers’ needs to shorten ramp times, improve device performance and yield, and optimize factory output and operating costs. Industry conditions that affect Applied Global Services’ sales of spares and services are primarily characterized by increases in semiconductor manufacturers’ wafer starts and continued strong utilization rates, growth of the installed base of equipment, growing service intensity of newer tools, and the company’s ability to sell more comprehensive service agreements.
Certain significant measures for the periods indicated were as follows:
Change | ||||||||||||||||||||||||
2018 | 2017 | 2016 | 2018 over 2017 | 2017 over 2016 | ||||||||||||||||||||
(In millions, except percentages and ratios) | ||||||||||||||||||||||||
Net sales | $ | 3,754 | $ | 3,017 | $ | 2,589 | $ | 737 | 24% | $ | 428 | 17 | % | |||||||||||
Operating income | $ | 1,102 | $ | 817 | $ | 682 | $ | 285 | 35% | $ | 135 | 20 | % | |||||||||||
Operating margin | 29.4 | % | 27.1 | % | 26.3 | % | 2.3 points | 0.8 points | ||||||||||||||||
There was no single region that accounted for at least 30 percent of total net sales for the Applied Global Services segment for any of the past three fiscal years.
Net sales increased in fiscal 2018 compared to the prior year and also in fiscal 2017 compared to fiscal 2016 primarily due to higher customer spending for spares and services. Two customers represented at least 10 percent of this segment’s net sales, and together they accounted for approximately 23 percent of this segment’s net sales for fiscal 2018.
Operating income and operating margin for fiscal 2018 increased compared to the prior year and also in fiscal 2017 compared to fiscal 2016, reflecting higher net sales partially offset by increased headcount to support business growth.
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Display and Adjacent Markets Segment
The Display and Adjacent Markets segment encompasses products for manufacturing liquid crystal and OLED displays, and other display technologies for TVs, monitors, laptops, personal computers, electronic tablets, smart phones, and other consumer-oriented devices, equipment upgrades and flexible coating systems. The segment is focused on expanding its presence through technologically-differentiated equipment for manufacturing large-scale LCD TVs, OLEDs, low temperature polysilicon (LTPS), metal oxide, and touch panel sectors; and development of products that provide customers with improved performance and yields. Display industry growth depends primarily on consumer demand for increasingly larger and more advanced TVs as well as larger and higher resolution displays for next-generation mobile devices.
The market environment for Applied's Display and Adjacent Markets segment in fiscal 2018 was characterized by increased demand for manufacturing equipment for TV and mobile devices. Uneven demand patterns in the Display and Adjacent Markets segment can cause significant fluctuations quarter-over-quarter, as well as year-over-year.
Certain significant measures for the periods presented were as follows:
Change | |||||||||||||||||||||||
2018 | 2017 | 2016 | 2018 over 2017 | 2017 over 2016 | |||||||||||||||||||
(In millions, except percentages and ratios) | |||||||||||||||||||||||
Net sales | $ | 2,498 | $ | 1,900 | $ | 1,206 | $ | 598 | 31% | $ | 694 | 58% | |||||||||||
Operating income | $ | 679 | $ | 502 | $ | 245 | $ | 177 | 35% | $ | 257 | 105% | |||||||||||
Operating margin | 27.2 | % | 26.4 | % | 20.3 | % | 0.8 points | 6.1 points | |||||||||||||||
Net sales for fiscal 2018 increased compared to fiscal 2017 primarily due to higher customer investments in TV display manufacturing equipment. Operating income and operating margin for fiscal 2018 increased compared fiscal 2017, reflecting higher net sales and favorable product mix, partially offset by higher RD&E spending. Three customers, that represented at least 10 percent of this segment’s net sales, accounted for approximately 58 percent of net sales for this segment in fiscal 2018, with one customer accounting for approximately 33 percent of net sales.
Net sales for fiscal 2017 increased compared to prior year primarily due to higher customer investments in mobile and TV display manufacturing equipment. Operating income and operating margin for fiscal 2017 increased compared to the prior year, reflecting higher net sales and favorable product mix, partially offset by increased RD&E spending.
The following regions accounted for at least 30 percent of total net sales for the Display and Adjacent Markets segment for one or more of the periods presented:
Change | |||||||||||||||||||||||||||||
2018 | 2017 | 2016 | 2018 over 2017 | 2017 over 2016 | |||||||||||||||||||||||||
(In millions, except percentages) | |||||||||||||||||||||||||||||
China | $ | 2,004 | 80 | % | $ | 961 | 51 | % | $ | 449 | 37 | % | $ | 1,043 | 109% | $ | 512 | 114% | |||||||||||
Korea | $ | 211 | 8 | % | $ | 750 | 39 | % | $ | 492 | 41 | % | $ | (539 | ) | (72)% | $ | 258 | 52% | ||||||||||
Recent Accounting Pronouncements
For a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on Applied’s consolidated financial statements, see Note 1, “Summary of Significant Accounting Policies,” of the Notes to Consolidated Financial Statements.
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Financial Condition, Liquidity and Capital Resources
Applied’s cash, cash equivalents and investments consist of the following:
October 28, 2018 | October 29, 2017 | ||||||
(In millions) | |||||||
Cash and cash equivalents | $ | 3,440 | $ | 5,010 | |||
Short-term investments | 590 | 2,266 | |||||
Long-term investments | 1,568 | 1,143 | |||||
Total cash, cash-equivalents and investments | $ | 5,598 | $ | 8,419 | |||
Sources and Uses of Cash
A summary of cash provided by (used in) operating, investing, and financing activities is as follows:
2018 | 2017 | 2016 | |||||||||
(In millions) | |||||||||||
Cash provided by operating activities | $ | 3,787 | $ | 3,789 | $ | 2,566 | |||||
Cash provided by (used in) investing activities | $ | 571 | $ | (2,526 | ) | $ | (425 | ) | |||
Cash provided by (used in) financing activities | $ | (5,928 | ) | $ | 341 | $ | (3,532 | ) | |||
In March 2016, the Financial Accounting Standards Board issued authoritative guidance that simplifies several aspects of the accounting for share-based payment transactions, including forfeitures, income tax, and classification on the statement of cash flows. Applied adopted this guidance in the first quarter of fiscal 2018. Upon adoption, Applied elected to apply the presentation requirements for cash flows related to excess tax benefits and employee taxes paid for withheld shares retrospectively. Adopting this guidance increased cash provided by operating activities by $180 million and $100 million with corresponding net decreases in cash provided by financing activities for fiscal 2017 and 2016, respectively. See Note 1 of Notes to Consolidated Financial Statements for additional discussion of this adoption.
Operating Activities
Cash from operating activities for fiscal 2018 was $3.8 billion, which reflects net income adjusted for the effect of non-cash charges and changes in working capital components. Non-cash charges included depreciation, amortization, share-based compensation and deferred income taxes. Cash provided from operating activities remained flat from fiscal 2017 to fiscal 2018 due to the increase in income taxes payable, offset by lower deferred revenue and higher increase in accounts receivable. Cash provided by operating activities increased from fiscal 2016 to fiscal 2017 primarily due to higher net income, offset by a smaller increase in customer deposits and a greater increase in inventory in fiscal 2017.
Applied has agreements with various financial institutions to sell accounts receivable and discount promissory notes from selected customers. Applied sells its accounts receivable without recourse. Applied, from time to time, also discounts letters of credit issued by customers through various financial institutions. The discounting of letters of credit depends on many factors, including the willingness of financial institutions to discount the letters of credit and the cost of such arrangements. Applied sold $1.6 billion, $746 million and $75 million of accounts receivable during fiscal 2018, 2017 and 2016, respectively. Applied discounted letters of credit issued by customers of $37 million in fiscal 2018. There was no discounting of promissory notes in fiscal 2018. Applied did not discount letters of credit issued by customers or discount promissory notes during fiscal 2017 or 2016.
Applied’s working capital was $6.7 billion at October 28, 2018 and $8.8 billion at October 29, 2017.
Days sales outstanding at the end of fiscal 2018, 2017 and 2016 was 58 days, 54 days, and 63 days, respectively. Days sales outstanding varies due to the timing of shipments and payment terms, and the increase from fiscal 2017 to fiscal 2018 was primarily due to better revenue linearity in fiscal 2017. Days sales outstanding decreased from fiscal 2016 to fiscal 2017 primarily due to better collections performance and increase in factoring of accounts receivable.
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Investing Activities
Applied generated $571 million in cash from investing activities in fiscal 2018. Applied used $2.5 billion of cash in investing activities in fiscal 2017 and $425 million in fiscal 2016. Capital expenditures in fiscal 2018, 2017 and 2016 were $622 million, $345 million and $253 million, respectively. Capital expenditures in fiscal 2018 were primarily for real property acquisitions and improvements in North America and Taiwan, as well as investments in demonstration, testing and laboratory tools. Capital expenditures in fiscal 2017 and fiscal 2016 were primarily for demonstration and test equipment and laboratory tools in North America. Proceeds from sales and maturities of investments, net of purchase of investments was $1.2 billion for fiscal 2018. Purchases of investments, net of proceeds from sales and maturities of investments were $2.1 billion and $156 million for fiscal 2017 and 2016, respectively. Investing activities also included investments in technology to allow Applied to access new market opportunities or emerging technologies.
Applied’s investment portfolio consists principally of investment grade money market mutual funds, U.S. Treasury and agency securities, municipal bonds, corporate bonds and mortgage-backed and asset-backed securities, as well as equity securities. Applied regularly monitors the credit risk in its investment portfolio and takes appropriate measures, which may include the sale of certain securities, to manage such risks prudently in accordance with its investment policies.
Financing Activities
Applied used $5.9 billion of cash in financing activities in fiscal 2018, consisting primarily of repurchases of common stock of $5.3 billion, cash dividends to stockholders of $605 million and tax withholding payments for vested equity awards of $164 million, offset by proceeds from common stock issuances of $124 million.
Applied generated $341 million of cash from financing activities in fiscal 2017, consisting primarily of net proceeds received from the issuance of senior unsecured notes of $2.2 billion, proceeds from common stock issuances of $97 million, partially offset by cash used for repurchases of common stock of $1.2 billion, cash dividends to stockholders of $430 million and debt repayments of $205 million.
Applied used $3.5 billion of cash in financing activities in fiscal 2016, consisting primarily $1.2 billion in debt repayments, $1.9 billion in repurchases of its common stock, and $444 million in cash dividends to stockholders, offset by proceeds from common stock issuances of $88 million.
In September 2017, Applied’s Board of Directors approved a common stock repurchase program authorizing up to $3.0 billion in repurchases. In February 2018, the Board of Directors approved a new common stock repurchase program authorizing up to an additional $6.0 billion in repurchases. At October 28, 2018, $4.3 billion remained available for future stock repurchases under this repurchase program.
During fiscal 2018, Applied's Board of Directors declared three quarterly cash dividends of $0.20 per share and one quarterly cash dividend of $0.10 per share. During each of fiscal 2017 and 2016, Applied’s Board of Directors declared four quarterly cash dividends in the amount of $0.10 per share. Applied currently anticipates that cash dividends will continue to be paid on a quarterly basis, although the declaration of any future cash dividend is at the discretion of the Board of Directors and will depend on Applied’s financial condition, results of operations, capital requirements, business conditions and other factors, as well as a determination by the Board of Directors that cash dividends are in the best interests of Applied’s stockholders.
Applied has credit facilities for unsecured borrowings in various currencies of up to $1.6 billion, of which $1.5 billion is comprised of a committed revolving credit agreement with a group of banks that is scheduled to expire in September 2021. This agreement provides for borrowings in United States dollars at interest rates keyed to one of two rates selected by Applied for each advance and includes financial and other covenants with which Applied was in compliance at October 28, 2018. Remaining credit facilities in the amount of approximately $71 million are with Japanese banks. Applied’s ability to borrow under these facilities is subject to bank approval at the time of the borrowing request, and any advances will be at rates indexed to the banks’ prime reference rate denominated in Japanese yen. No amounts were outstanding under any of these facilities at both October 28, 2018 and October 29, 2017, and Applied has not utilized these credit facilities.
In fiscal 2011, Applied established a short-term commercial paper program of up to $1.5 billion. At October 28, 2018 and October 29, 2017, Applied did not have any commercial paper outstanding, but may issue commercial paper notes under this program from time to time in the future.
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In March 2017, Applied issued senior unsecured notes in the aggregate principal amount of $2.2 billion. Applied had senior unsecured notes in the aggregate principal amount of $5.4 billion outstanding as of October 28, 2018. The indentures governing these notes include covenants with which Applied was in compliance at October 28, 2018. In May 2017, Applied completed the redemption of the entire outstanding $200 million in principal amount of senior notes due in October 2017. See Note 10 of Notes to Consolidated Financial Statements for additional discussion of existing debt. Applied may seek to refinance its existing debt and may incur additional indebtedness depending on Applied’s capital requirements and the availability of financing.
Others
During 2018 and 2017, Applied reduced $1 million and $17 million, respectively, of its allowance for doubtful accounts as a result of an overall lower risk profile of Applied’s customers. Applied recorded a bad debt provision of $3 million in fiscal 2016. While Applied believes that its allowance for doubtful accounts at October 28, 2018 is adequate, it will continue to closely monitor customer liquidity and economic conditions.
On December 22, 2017, the U.S. government enacted the Tax Cuts and Jobs Act. The Tax Act requires a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries payable over eight years, with eight percent due in each of the first five years starting with fiscal 2018. For fiscal 2018, Applied realized tax expense of $1.1 billion associated with the Tax Act, primarily due to the transition tax. The transition tax eliminated the requirement that cash, cash equivalents and marketable securities held by certain foreign subsidiaries be subject to U.S income taxes if repatriated for U.S. operations. Accordingly, cash, cash equivalents and marketable securities held by all foreign subsidiaries may be repatriated for U.S. operation without being subject to further U.S. income taxes.
Although cash requirements will fluctuate based on the timing and extent of factors such as those discussed above, Applied’s management believes that cash generated from operations, together with the liquidity provided by existing cash balances and borrowing capability, will be sufficient to satisfy Applied’s liquidity requirements for the next 12 months. For further details regarding Applied’s operating, investing and financing activities, see the Consolidated Statements of Cash Flows in this report.
For details on standby letters of credit and other agreements with banks, see Off-Balance Sheet Arrangements below.
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Off-Balance Sheet Arrangements
In the ordinary course of business, Applied provides standby letters of credit or other guarantee instruments to third parties as required for certain transactions initiated by either Applied or its subsidiaries. As of October 28, 2018, the maximum potential amount of future payments that Applied could be required to make under these guarantee agreements was approximately $58 million. Applied has not recorded any liability in connection with these guarantee agreements beyond that required to appropriately account for the underlying transaction being guaranteed. Applied does not believe, based on historical experience and information currently available, that it is probable that any amounts will be required to be paid under these guarantee agreements.
Applied also has agreements with various banks to facilitate subsidiary banking operations worldwide, including overdraft arrangements, issuance of bank guarantees, and letters of credit. As of October 28, 2018, Applied has provided parent guarantees to banks for approximately $149 million to cover these arrangements.
Applied also has operating leases for various facilities. Total rent expense for fiscal 2018, 2017 and 2016 was $50 million, $34 million and $38 million, respectively.
Contractual Obligations
The following table summarizes Applied’s contractual obligations as of October 28, 2018:
Payments Due by Period | |||||||||||||||||||
Contractual Obligations | Total | Less Than 1 Year | 1-3 Years | 3-5 Years | More Than 5 Years | ||||||||||||||
(In millions) | |||||||||||||||||||
Debt obligations | $ | 5,350 | $ | — | $ | 1,350 | $ | — | $ | 4,000 | |||||||||
Interest expense associated with debt obligations | 3,137 | 219 | 422 | 342 | 2,154 | ||||||||||||||
Operating lease obligations | 173 | 50 | 68 | 33 | 22 | ||||||||||||||
Income tax from change in U.S. tax laws1 | 1,001 | 80 | 160 | 160 | 601 | ||||||||||||||
Purchase obligations2 | 2,044 | 1,914 | 115 | 15 | — | ||||||||||||||
Other long-term liabilities3,4 | 20 | — | 2 | 2 | 16 | ||||||||||||||
Total | $ | 11,725 | $ | 2,263 | $ | 2,117 | $ | 552 | $ | 6,793 | |||||||||
______________________
1 | Represents an estimate of a provisional tax amount for the transition tax liability associated with the deemed repatriation of accumulated foreign earnings as a result from the enactment of the Tax Cuts and Jobs Act into law on December 22, 2017. |
2 | Represents Applied’s agreements to purchase goods and services consisting of Applied’s outstanding purchase orders for goods and services. |
3 | Other long-term liabilities in the table do not include pension, post-retirement and deferred compensation plans due to the uncertainty in the timing of future payments. Applied evaluates the need to make contributions to its pension and post-retirement benefit plans after considering the funded status of the plans, movements in the discount rate, performance of the plan assets and related tax consequences. Payments to the plans would be dependent on these factors and could vary across a wide range of amounts and time periods. Payments for deferred compensation plans are dependent on activity by participants, making the timing of payments uncertain. Information on Applied’s pension, post-retirement benefit and deferred compensation plans is presented in Note 12, Employee Benefit Plans, of the consolidated financial statements. |
4 | Applied’s other long-term liabilities in the Consolidated Balance Sheets include deferred tax liabilities, gross unrecognized tax benefits and related gross interest and penalties. As of October 28, 2018, the gross liability for unrecognized tax benefits that was not expected to result in payment of cash within one year was $374 million. Interest and penalties related to uncertain tax positions that were not expected to result in payment of cash within one year of October 28, 2018 was $26 million. At this time, Applied is unable to make a reasonably reliable estimate of the timing of payments due to uncertainties in the timing of tax audit outcomes; therefore, such amounts are not included in the above contractual obligation table. |
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Critical Accounting Policies and Estimates
The preparation of consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates that affect the amounts reported. Note 1 of Notes to Consolidated Financial Statements describes the significant accounting policies used in the preparation of the consolidated financial statements. Certain of these significant accounting policies are considered to be critical accounting policies.
A critical accounting policy is defined as one that is both material to the presentation of Applied’s consolidated financial statements and that requires management to make difficult, subjective or complex judgments that could have a material effect on Applied’s financial condition or results of operations. Specifically, these policies have the following attributes: (1) Applied is required to make assumptions about matters that are highly uncertain at the time of the estimate; and (2) different estimates Applied could reasonably have used, or changes in the estimate that are reasonably likely to occur, would have a material effect on Applied’s financial condition or results of operations.
Estimates and assumptions about future events and their effects cannot be determined with certainty. Applied bases its estimates on historical experience and on various other assumptions believed to be applicable and reasonable under the circumstances. These estimates may change as new events occur, as additional information is obtained and as Applied’s operating environment changes. These changes have historically been minor and have been included in the consolidated financial statements as soon as they became known. In addition, management is periodically faced with uncertainties, the outcomes of which are not within its control and will not be known for prolonged periods of time. These uncertainties include those discussed in Part I, Item 1A, “Risk Factors.” Based on a critical assessment of its accounting policies and the underlying judgments and uncertainties affecting the application of those policies, management believes that Applied’s consolidated financial statements are fairly stated in accordance with accounting principles generally accepted in the United States of America, and provide a meaningful presentation of Applied’s financial condition and results of operations.
Management believes that the following are critical accounting policies and estimates:
Revenue Recognition
Applied recognizes revenue when all four revenue recognition criteria have been met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; sales price is fixed or determinable; and collectability is probable. Each sale arrangement may contain commercial terms that differ from other arrangements. In addition, Applied frequently enters into contracts that contain multiple deliverables. Judgment is required to properly identify the accounting units of the multiple deliverable transactions and to determine the manner in which revenue should be allocated among the accounting units. Moreover, judgment is used in interpreting the commercial terms and determining when all criteria of revenue recognition have been met in order for revenue recognition to occur in the appropriate accounting period. While changes in the allocation of the estimated sales price between the units of accounting will not affect the amount of total revenue recognized for a particular sales arrangement, any material changes in these allocations could impact the timing of revenue recognition, which could have a material effect on Applied’s financial condition and results of operations.
Warranty Costs
Applied provides for the estimated cost of warranty when revenue is recognized. Estimated warranty costs are determined by analyzing specific product, current and historical configuration statistics and regional warranty support costs. Applied’s warranty obligation is affected by product and component failure rates, material usage and labor costs incurred in correcting product failures during the warranty period. As Applied’s customer engineers and process support engineers are highly trained and deployed globally, labor availability is a significant factor in determining labor costs. The quantity and availability of critical replacement parts is another significant factor in estimating warranty costs. Unforeseen component failures or exceptional component performance can also result in changes to warranty costs. If actual warranty costs differ substantially from Applied’s estimates, revisions to the estimated warranty liability would be required, which could have a material adverse effect on Applied’s business, financial condition and results of operations.
Allowance for Doubtful Accounts
Applied maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. This allowance is based on historical experience, credit evaluations, specific customer collection history and any customer-specific issues Applied has identified. Changes in circumstances, such as an unexpected material adverse change in a major customer’s ability to meet its financial obligation to Applied or its payment trends, may require Applied to further adjust its estimates of the recoverability of amounts due to Applied, which could have a material adverse effect on Applied’s business, financial condition and results of operations.
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Inventory Valuation
Inventories are generally stated at the lower of cost or net realizable value, with cost determined on a first-in, first-out basis. The carrying value of inventory is reduced for estimated obsolescence by the difference between its cost and the estimated net realizable value based upon assumptions about future demand. Applied evaluates the inventory carrying value for potential excess and obsolete inventory exposures by analyzing historical and anticipated demand. In addition, inventories are evaluated for potential obsolescence due to the effect of known and anticipated engineering change orders and new products. If actual demand were to be substantially lower than estimated, additional adjustments for excess or obsolete inventory may be required, which could have a material adverse effect on Applied’s business, financial condition and results of operations.
Goodwill and Intangible Assets
Applied reviews goodwill and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable, and also annually reviews goodwill and intangibles with indefinite lives for impairment. Intangible assets, such as purchased technology, are generally recorded in connection with a business acquisition. The value assigned to intangible assets is usually based on estimates and judgments regarding expectations for the success and life cycle of products and technology acquired. If actual product acceptance differs significantly from the estimates, Applied may be required to record an impairment charge to reduce the carrying value of the reporting unit to its estimated fair value.
To test goodwill for impairment, Applied first performs a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If it is concluded that this is the case, Applied then performs the two-step goodwill impairment test. Otherwise, the two-step goodwill impairment test is not required. Under the two-step goodwill impairment test, Applied would in the first step compare the estimated fair value of each reporting unit to its carrying value. If the carrying value of a reporting unit exceeds its estimated fair value, Applied would then perform the second step of the impairment test in order to determine the implied fair value of the reporting unit’s goodwill. If Applied determines that the carrying value of a reporting unit’s goodwill exceeds its implied fair value, Applied would record an impairment charge equal to the difference.
Applied determines the fair value of each reporting unit based on a weighting of an income and a market approach. Applied bases the fair value estimates on assumptions that it believes to be reasonable but that are unpredictable and inherently uncertain. Under the income approach, Applied estimates the fair value based on discounted cash flow method.
The estimates used in the impairment testing are consistent with the discrete forecasts that Applied uses to manage its business, and considers any significant developments during the period. Under the discounted cash flow method, cash flows beyond the discrete forecasts are estimated using a terminal growth rate, which considers the long-term earnings growth rate specific to the reporting units. The estimated future cash flows are discounted to present value using each reporting unit’s weighted average cost of capital. The weighted average cost of capital measures a reporting unit’s cost of debt and equity financing weighted by the percentage of debt and equity in a reporting unit’s target capital structure. In addition, the weighted average cost of capital is derived using both known and estimated market metrics, and is adjusted to reflect both the timing and risks associated with the estimated cash flows. The tax rate used in the discounted cash flow method is the median tax rate of comparable companies and reflects Applied’s current international structure, which is consistent with the market participant perspective. Under the market approach, Applied uses the guideline company method which applies market multiples to forecasted revenues and earnings before interest, taxes, depreciation and amortization. Applied uses market multiples that are consistent with comparable publicly-traded companies and considers each reporting unit’s size, growth and profitability relative to its comparable companies.
Management uses significant judgment when assessing goodwill for potential impairment, especially in emerging markets. Indicators of potential impairment include, but are not limited to, challenging economic conditions, an unfavorable industry or economic environment or other severe decline in market conditions. Such conditions could have the effect of changing one of the critical assumptions or estimates used for the fair value calculation, resulting in an unexpected goodwill impairment charge, which could have a material adverse effect on Applied’s business, financial condition and results of operations. See Note 9 of Notes to Consolidated Financial Statements for additional discussion of goodwill impairment.
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Income Taxes
Applied’s provision for income taxes and effective tax rate are affected by the geographical composition of pre-tax income which includes jurisdictions with differing tax rates, conditional reduced tax rates and other income tax incentives. It is also affected by events that are not consistent from period to period, such as changes to income tax laws and the resolution of prior years’ income tax filings.
Applied recognizes a current tax liability for the estimated amount of income tax payable on tax returns for the current fiscal year. Deferred tax assets and liabilities are recognized for the estimated future tax effects of temporary differences between the book and tax bases of assets and liabilities. Deferred tax assets are also recognized for net operating loss and tax credit carryforwards. Deferred tax assets are offset by a valuation allowance to the extent it is more likely than not that they are not expected to be realized.
Applied recognizes tax benefits from uncertain tax positions only if it is more likely than not that the tax position will be sustained upon examination by the taxing authorities based on the technical merits of the position. The tax benefits recognized from such positions are estimated based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Any changes in judgment related to uncertain tax positions are recognized in Applied’s provision for income taxes in the quarter in which such change occurs. Interest and penalties related to uncertain tax positions are recognized in Applied’s provision for income taxes.
The calculation of Applied’s provision for income taxes and effective tax rate involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent with Applied’s expectations could have an adverse material impact on Applied’s results of operations and financial condition.
Non-GAAP Adjusted Financial Results
Management uses non-GAAP adjusted financial measures to evaluate the Company’s operating and financial performance and for planning purposes, and as performance measures in its executive compensation program. Applied believes these measures enhance an overall understanding of its performance and investors’ ability to review the Company’s business from the same perspective as the Company’s management and facilitate comparisons of this period’s results with prior periods on a consistent basis by excluding items that management does not believe are indicative of Applied's ongoing operating performance.
The non-GAAP adjusted financial measures presented below are adjusted to exclude the impact of certain costs, expenses, gains and losses, including certain items related to mergers and acquisitions; restructuring charges and any associated adjustments; impairments of assets, or investments; gain or loss on sale of strategic investments; certain income tax items and other discrete adjustments. Additionally, fiscal 2018 non-GAAP results exclude estimated discrete income tax expense items associated with recent U.S. tax legislation. Reconciliations of these non-GAAP measures to the most directly comparable financial measures calculated and presented in accordance with GAAP are provided in the financial tables presented below. There are limitations in using non-GAAP financial measures because the non-GAAP financial measures are not prepared in accordance with generally accepted accounting principles, may be different from non-GAAP financial measures used by other companies, and may exclude certain items that may have a material impact upon our reported financial results. The presentation of this additional information is not meant to be considered in isolation or as a substitute for the directly comparable financial measures prepared in accordance with GAAP.
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The following tables present a reconciliation of the GAAP and non-GAAP adjusted consolidated results for the past three fiscal years:
APPLIED MATERIALS, INC.
UNAUDITED RECONCILIATION OF GAAP TO NON-GAAP ADJUSTED RESULTS
(In millions, except percentages) | 2018 | 2017 | 2016 | |||||||||
Non-GAAP Adjusted Gross Profit | ||||||||||||
Reported gross profit - GAAP basis | $ | 7,817 | $ | 6,532 | $ | 4,511 | ||||||
Certain items associated with acquisitions1 | 179 | 172 | 167 | |||||||||
Inventory reversals related to restructuring2 | — | — | (2 | ) | ||||||||
Non-GAAP adjusted gross profit | $ | 7,996 | $ | 6,704 | $ | 4,676 | ||||||
Non-GAAP adjusted gross margin | 46.3 | % | 46.1 | % | 43.2 | % | ||||||
Non-GAAP Adjusted Operating Income | ||||||||||||
Reported operating income - GAAP basis | $ | 4,796 | $ | 3,868 | $ | 2,152 | ||||||
Certain items associated with acquisitions1 | 197 | 191 | 188 | |||||||||
Acquisition integration and deal costs | 5 | 3 | 2 | |||||||||
Reversals related to restructuring, net2 | — | — | (3 | ) | ||||||||
Other gains, losses or charges, net | — | (12 | ) | 8 | ||||||||
Non-GAAP adjusted operating income | $ | 4,998 | $ | 4,050 | $ | 2,347 | ||||||
Non-GAAP adjusted operating margin | 29.0 | % | 27.9 | % | 21.7 | % | ||||||
Non-GAAP Adjusted Net Income | ||||||||||||
Reported net income - GAAP basis4 | $ | 3,313 | $ | 3,434 | $ | 1,721 | ||||||
Certain items associated with acquisitions1 | 197 | 191 | 188 | |||||||||
Acquisition integration and deal costs | 5 | 3 | 2 | |||||||||
Reversals related to restructuring, net2 | — | — | (3 | ) | ||||||||
Loss on early extinguishment of debt | — | 5 | 5 | |||||||||
Impairment (gain on sale) of strategic investments, net | (25 | ) | (3 | ) | 3 | |||||||
Other gains, losses or charges, net | — | (12 | ) | 8 | ||||||||
Income tax effect of changes in applicable U.S. tax laws3 | 1,112 | — | — | |||||||||
Resolution of prior years’ income tax filings, reinstatement of federal R&D tax credit and other tax items | (26 | ) | (79 | ) | 45 | |||||||
Income tax effect of non-GAAP adjustments5 | (7 | ) | (14 | ) | (19 | ) | ||||||
Non-GAAP adjusted net income | $ | 4,569 | $ | 3,525 | $ | 1,950 | ||||||
1 | These items are incremental charges attributable to completed acquisitions, consisting of amortization of purchased intangible assets. |
2 | Results for fiscal 2016 included adjustments associated with the cost reductions in the solar business. |
3 | Charges to income tax provision related to a one-time transition tax and a decrease in U.S. deferred tax assets as a result of the recent U.S. tax legislation. |
4 | Amounts for fiscal 2017 included the recognition of the previously unrecognized foreign tax credits. |
5 | Adjustment to provision for income taxes related to non-GAAP adjustments reflected in income before income taxes. |
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APPLIED MATERIALS, INC.
UNAUDITED RECONCILIATION OF GAAP TO NON-GAAP ADJUSTED RESULTS
(In millions, except per share amounts) | 2018 | 2017 | 2016 | |||||||||
Non-GAAP Adjusted Earnings Per Diluted Share | ||||||||||||
Reported earnings per diluted share - GAAP basis | $ | 3.23 | $ | 3.17 | $ | 1.54 | ||||||
Certain items associated with acquisitions | 0.18 | 0.16 | 0.16 | |||||||||
Impairment (gain on sale) of strategic investments, net | (0.02 | ) | — | — | ||||||||
Income tax effect of change in applicable U.S. tax laws | 1.08 | — | — | |||||||||
Other gains, losses or charges, net | — | (0.01 | ) | 0.01 | ||||||||
Resolution of prior years’ income tax filings and other tax items | (0.02 | ) | (0.07 | ) | 0.04 | |||||||
Non-GAAP adjusted earnings per diluted share | $ | 4.45 | $ | 3.25 | $ | 1.75 | ||||||
Weighted average number of diluted shares | 1,026 | 1,084 | 1,116 | |||||||||
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The following table presents a reconciliation of the GAAP and non-GAAP adjusted segment results for the past three fiscal years:
APPLIED MATERIALS, INC.
UNAUDITED RECONCILIATION OF GAAP TO NON-GAAP ADJUSTED RESULTS
(In millions, except percentages) | 2018 | 2017 | 2016 | |||||||||
Semiconductor Systems Non-GAAP Adjusted Operating Income | ||||||||||||
Reported operating income - GAAP basis | $ | 3,634 | $ | 3,173 | $ | 1,807 | ||||||
Certain items associated with acquisitions1 | 183 | 184 | 184 | |||||||||
Non-GAAP adjusted operating income | $ | 3,817 | $ | 3,357 | $ | 1,991 | ||||||
Non-GAAP adjusted operating margin | 35.0 | % | 35.3 | % | 29.0 | % | ||||||
AGS Non-GAAP Adjusted Operating Income | ||||||||||||
Reported operating income - GAAP basis | $ | 1,102 | $ | 817 | $ | 682 | ||||||
Certain items associated with acquisitions1 | — | 1 | 1 | |||||||||
Acquisition integration costs | 2 | 3 | — | |||||||||
Non-GAAP adjusted operating income | $ | 1,104 | $ | 821 | $ | 683 | ||||||
Non-GAAP adjusted operating margin | 29.4 | % | 27.2 | % | 26.4 | % | ||||||
Display and Adjacent Markets Non-GAAP Adjusted Operating Income | ||||||||||||
Reported operating income - GAAP basis | $ | 679 | $ | 502 | $ | 245 | ||||||
Certain items associated with acquisitions1 | 14 | 5 | — | |||||||||
Acquisition integration costs | ||||||||||||