Stockholders’ Equity, Comprehensive Income and Share-Based Compensation

Accumulated Other Comprehensive Income

Components of accumulated other comprehensive income, on an after-tax basis where applicable, were as follows:



	July 29, 2012			October 30, 2011
	(In millions)
Pension liability	$	(25	)	$	(25	)
Unrealized gain (loss) on investments, net	11			17
Unrealized gain (loss) on derivative instruments	(4		)	—
Cumulative translation adjustments	13			14
	$	(5	)	$	6

Stock Repurchase Program

On March 5, 2012, Applied's Board of Directors approved a new stock repurchase program authorizing up to $3.0 billion in repurchases over the next three years ending in March 2015. Under this authorization, Applied purchases shares of its common stock under a systematic stock repurchase program and may also make supplemental stock repurchases from time to time, depending on market conditions, stock price and other factors. Applied's stock repurchase program authorized on March 8, 2010 was terminated concurrent with the start of the new repurchase program.

The following table summarizes Applied’s stock repurchases for the three and nine months ended July 29, 2012 and July 31, 2011:



	Three Months Ended				Nine Months Ended
	July 29, 2012		July 31, 2011		July 29, 2012		July 31, 2011
	(In millions, except per share amounts)
Shares of common stock repurchased	47		2		81		20
Cost of stock repurchased	$	500	$	25	$	900	$	293
Average price paid per share	$	10.71	$	12.77	$	11.09	$	14.31

Dividends

The following table summarizes the dividends declared during fiscal 2012:



Date Declared	Record Date	Payable Date	Amount per Share	Aggregate Amount (In millions)
December 6, 2011	February 23, 2012	March 15, 2012	$0.08	$103
March 5, 2012	May 24, 2012	June 14, 2012	$0.09	$115
June 12, 2012	August 23, 2012	September 13, 2012	$0.09	$111

Unpaid dividends were estimated based on the number of outstanding shares at the end of the fiscal quarter prior to the applicable record date.

Applied currently anticipates that it will continue to pay cash dividends on a quarterly basis in the future, although the declaration and amount of any future cash dividend are 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 that cash dividends are in the best interest of Applied and its stockholders.

Share-Based Compensation

Applied has adopted stock plans that permit grants to employees of share-based awards, including stock options, restricted stock, restricted stock units, performance shares and performance units. In addition, the Employee Stock Incentive Plan provides for the automatic grant of restricted stock units to non-employee directors and permits the grant of share-based awards to non-employee directors and consultants. Applied also has two Employee Stock Purchase Plans, one for United States employees and a second for international employees (collectively, ESPP), which enable eligible employees to purchase Applied common stock.

During the three and nine months ended July 29, 2012 and July 31, 2011, Applied recognized share-based compensation expense related to stock options, ESPP shares, restricted stock units, restricted stock, performance shares and performance units. Total share-based compensation and related tax benefits were as follows:



	Three Months Ended				Nine Months Ended
	July 29, 2012		July 31, 2011		July 29, 2012		July 31, 2011
	(In millions)
Share-based compensation	$	42	$	38	$	138	$	110
Tax benefit recognized	$	12	$	11	$	39	$	33

The effect of share-based compensation on the results of operations for the three and nine months ended July 29, 2012 and July 31, 2011 was as follows:



	Three Months Ended				Nine Months Ended
	July 29, 2012		July 31, 2011		July 29, 2012		July 31, 2011
	(In millions)
Cost of products sold	$	13	$	13	$	40	$	36
Research, development, and engineering	14		12		40		35
Selling, general and administrative	15		13		58		39
Total share-based compensation	$	42	$	38	$	138	$	110

The cost associated with share-based awards that are subject solely to time-based vesting requirements, less expected forfeitures, is recognized over the awards’ service period for the entire award on a straight-line basis. The cost associated with performance-based equity awards is recognized for each tranche over the service period, based on an assessment of the likelihood that the applicable performance goals will be achieved.

At July 29, 2012, Applied had $286 million in total unrecognized compensation expense, net of estimated forfeitures, related to grants of stock options, restricted stock units, restricted stock, performance units, performance shares and shares issued under Applied’s ESPP, which will be recognized over a weighted average period of 2.6 years. On March 6, 2012, Applied's stockholders approved the amended and restated Employee Stock Incentive Plan, which included an increase of 125 million shares of Applied common stock available for issuance under the plan and other amendments to the plan. Also, upon approval of the amended and restated plan, the 2000 Global Equity Incentive Plan, which had approximately 76 million shares available for issuance, became unavailable for any future grants. At July 29, 2012, there were 194 million shares available for grants of stock options, restricted stock units, restricted stock, performance units, performance shares and other share-based awards under the Employee Stock Incentive Plan, and an additional 51 million shares available for issuance under the ESPP .

Stock Options

Applied grants options to purchase, at future dates, shares of its common stock to employees and consultants. The exercise price of each stock option equals the fair market value of Applied common stock on the date of grant. Options typically vest over three to four years, subject to the grantee’s continued service with Applied through the scheduled vesting date, and expire no later than seven years from the grant date. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. This model was developed for use in estimating the value of publicly traded options that have no vesting restrictions and are fully transferable. Applied’s employee stock options have characteristics significantly different from those of publicly traded options. There were no stock options granted in the nine months ended July 29, 2012 and July 31, 2011.

Stock option activity for the nine months ended July 29, 2012 was as follows:



	Shares		Weighted Average Exercise Price
	(In millions, except per share amounts)
Outstanding at October 30, 2011	30		$	13.05
Assumed in Varian acquisition	5		$	4.85
Exercised	(3	)	$	7.01
Canceled and forfeited	(9	)	$	16.70
Outstanding at July 29, 2012	23		$	10.73
Exercisable at July 29, 2012	22		$	11.00

Restricted Stock Units, Restricted Stock, Performance Shares and Performance Units

Restricted stock units are converted into shares of Applied common stock upon vesting on a one-for-one basis. Restricted stock has the same rights as other issued and outstanding shares of Applied common stock except these shares have no right to dividends and are held in escrow until the award vests. Performance shares and performance units are awards that result in a payment to a grantee in shares of Applied common stock on a one-for-one basis if performance goals and/or other vesting criteria established by the Human Resources and Compensation Committee of Applied’s Board of Directors (the Committee) are achieved or the awards otherwise vest. Restricted stock units, restricted stock, performance shares and performance units typically vest over four years and vesting usually is subject to the grantee’s continued service with Applied and, in some cases, achievement of specified performance goals. The compensation expense related to the service-based awards is determined using the fair market value of Applied common stock on the date of the grant, and the compensation expense is recognized over the vesting period.

Restricted stock units, restricted stock, performance shares and performance units granted to certain executive officers and other key employees are also subject to the achievement of specified performance goals (performance-based awards). These performance-based awards become eligible to vest only if performance goals are achieved and then actually will vest only if the grantee remains employed by Applied through each applicable vesting date.

For performance-based awards granted during fiscal 2011 and 2010, the performance goals require (i) the achievement of targeted annual, adjusted operating profit margin levels compared to Applied’s peer companies in at least one of the four fiscal years beginning with the fiscal year of the grant, and (ii) that Applied’s annual adjusted operating profit margin is positive in such year. An award that has become eligible for time-based vesting based on achievement of the performance goals will vest over approximately four years from the date of grant, provided that the grantee remains employed by Applied through each scheduled vesting date. Performance-based awards that do not become eligible for time-based vesting in a particular year may become eligible for time-based vesting in subsequent years up until the fourth fiscal year after grant, after which they are forfeited if the required performance goals have not been achieved.

During the nine months ended July 29, 2012, the Committee granted performance-based awards that require the achievement of positive and relative adjusted operating profit margin goals in a manner generally similar to the previously granted performance-based awards. For the fiscal 2012 awards, additional shares become eligible for time-based vesting depending on certain levels of achievement of Applied’s total shareholder return (TSR) relative to a peer group comprised of companies in the Standard & Poor’s 500 Information Technology Index measured at the end of a two-year period. The fair value of these performance-based awards is estimated on the date of the grant and assumes that the specified performance goals will be achieved. If the goals are achieved, these awards vest over a specified remaining service period of generally three or four years, provided that the grantee remain employed by Applied through each scheduled vesting date. If the performance goals are not met, no compensation expense is recognized and any previously recognized compensation expense is reversed. The expected cost of each award is reflected over the service period and is reduced for estimated forfeitures.

As of July 29, 2012, 100 percent of the performance-based awards granted in fiscal 2011 had been earned based on performance and became subject to the additional time-based vesting requirements. As of July 29, 2012, 82 percent of the performance-based awards granted in fiscal 2010 had been earned based on performance and became subject to the additional time-based vesting requirements. The remaining 18 percent of the awards may still be earned, depending on future performance in one or both of fiscal years 2012 and 2013.

Restricted stock unit, restricted stock, performance share and performance unit activity for the nine months ended July 29, 2012 was as follows:



	Shares		Weighted Average Grant Date Fair Value		Weighted Average Remaining Contractual Term
	(In millions, except per share amounts)
Non-vested restricted stock units, restricted stock and performance units at October 30, 2011	28		$	12.64	2.8	Years
Granted	19		$	10.61
Vested	(8	)	$	12.91
Canceled	(2	)	$	12.56
Non-vested restricted stock units, restricted stock and performance units at July 29, 2012	37		$	11.54	2.8	Years

At July 29, 2012, 2 million additional performance-based awards could be earned upon certain levels of achievement of Applied’s TSR relative to a peer group at a future date.

Employee Stock Purchase Plans

Under the ESPP, substantially all employees may purchase Applied common stock through payroll deductions at a price equal to 85 percent of the lower of the fair market value of Applied common stock at the beginning or end of each 6-month purchase period, subject to certain limits. Based on the Black-Scholes option pricing model, the weighted average estimated fair value of purchase rights under the ESPP was $2.89 and $3.61 for the nine months ended July 29, 2012 and July 31, 2011, respectively. The number of shares issued under the ESPP during each of the nine months ended July 29, 2012 and July 31, 2011 was 3 million. Compensation expense associated with the ESPP is calculated using the fair value of the employees’ purchase rights under the Black-Scholes model. Underlying assumptions used in the model are outlined in the following table:



	Nine Months Ended
	July 29, 2012	July 31, 2011
ESPP:
Dividend yield	2.94%	1.98%
Expected volatility	33%	27%
Risk-free interest rate	0.12%	0.17%
Expected life (in years)	0.5	0.5