Stockholders’ Equity, Comprehensive Income and Share-Based Compensation

Accumulated Other Comprehensive Income (Loss)

Components of accumulated other comprehensive income (loss), on an after-tax basis, were as follows:



	October 28, 2012			October 30, 2011

	(In millions)
Unrealized gain (loss) on investments, net	$	16		$	17
Unrealized gain (loss) on derivative instruments qualifying as cash flow hedges	1			—
Pension liability	(90		)	(25		)
Cumulative translation adjustments	12			14
	$	(61	)	$	6

The increase in accumulated other comprehensive income (loss) associated with pension liability amounted to $65 million, net of income tax effect of $23 million, and was primarily a result of lower discount rates used to determine the benefit obligation, taking into account prevailing interest rates.

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. At October 28, 2012, $1.8 billion remains available for future stock repurchases under the new repurchase program.

The following table summarizes Applied’s stock repurchases:



	2012		2011		2010

	(In millions, except per share amounts)
Shares of common stock repurchased	126		36		29
Cost of stock repurchased	$	1,416	$	468	$	350
Average price paid per share	$	11.22	$	12.88	$	12.15

Applied records treasury stock purchases under the cost method using the first-in, first-out (FIFO) method. Upon reissuance of treasury stock, amounts in excess of the acquisition cost are credited to additional paid in capital. If Applied reissues treasury stock at an amount below its acquisition cost and additional paid in capital associated with prior treasury stock transactions is insufficient to cover the difference between the acquisition cost and the reissue price, this difference is recorded against retained earnings.

Dividends

During fiscal 2012, Applied’s Board of Directors declared three quarterly cash dividends in the amount of $0.09 per share each and one quarterly cash dividend in the amount of $0.08 per share. During fiscal 2011, Applied’s Board of Directors declared three quarterly cash dividends in the amount of $0.08 per share each and one quarterly cash dividend in the amount of $0.07 per share. During fiscal 2010, Applied’s Board of Directors declared three quarterly cash dividends in the amount of $0.07 per share each and one quarterly cash dividend in the amount of $0.06. Dividends declared during fiscal 2012, 2011 and 2010 amounted to $438 million, $408 million and $361 million, respectively. 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.

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 generally for United States employees and a second for employees of international subsidiaries (collectively, ESPP), which enable eligible employees to purchase Applied common stock.

During fiscal 2012, 2011, and 2010, Applied recognized share-based compensation expense related to stock options, ESPP shares, restricted stock, restricted stock units, performance shares and performance units. Total share-based compensation and related tax benefits were as follows:



	2012		2011		2010

	(In millions)
Share-based compensation	$	182	$	146	$	126
Tax benefit recognized	$	52	$	42	$	38

The effect of share-based compensation on the results of operations for fiscal 2012, 2011, and 2010 was as follows:



	2012		2011		2010

	(In millions)
Cost of products sold	$	54	$	48	$	32
Research, development, and engineering	54		46		43
Selling, general and administrative	74		52		51
Total	$	182	$	146	$	126

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 October 28, 2012, Applied had $259 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 2.5 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 October 28, 2012, there were 195 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 47 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 during fiscal 2012, 2011 and 2010. As part of the Varian acquisition, stock options to purchase 5 million shares of Applied common stock were assumed during fiscal 2012. The weighted average assumptions used in the model for the stock options assumed are outlined below:



	2012
Stock Options:
Dividend yield	2.6	%
Expected volatility	38.7	%
Risk-free interest rate	0.52	%
Expected life (in years)	3.3

Information with respect to stock options is as follows:



	2012		2011		2010
	(In millions)
Aggregate intrinsic value of outstanding stock options	$	43	$	58	$	73
Total intrinsic value of stock options exercised	$	21	$	23	$	15
Total fair value of stock options vested	$	41	$	17	$	21
Cash received from stock option exercises	$	33	$	41	$	78
Actual tax benefit realized from options exercised	$	7	$	11	$	4

Stock option activity for fiscal 2012, 2011 and 2010 was as follows:



	2012				2011				2010
	Shares		Weighted Average Exercise Price		Shares		Weighted Average Exercise Price		Shares		Weighted Average Exercise Price

	(In millions, except per share amounts)
Outstanding, beginning of year	30		$	13.05	51		$	15.04	73		$	14.72
Assumed in Varian acquisition	5		$	4.85	—		$	—	—		$	—
Exercised	(4	)	$	7.30	(5	)	$	9.21	(7	)	$	10.88
Canceled and forfeited	(10	)	$	16.76	(16	)	$	20.28	(15	)	$	15.64
Outstanding, end of year	21		$	10.53	30		$	13.05	51		$	15.04
Exercisable, end of year	20		$	10.71	24		$	14.23	37		$	17.39

The following table summarizes information with respect to options outstanding and exercisable at October 28, 2012:



	Options Outstanding						Options Exercisable
Range of Exercise Prices	Number of Shares	Weighted Average Exercise Price		Weighted Average Remaining Contractual Life	Aggregate Intrinsic Value		Number of Shares	Weighted Average Exercise Price		Aggregate Intrinsic Value
	(In millions)			(In years)	(In millions)		(In millions)			(In millions)
$3.09 — $9.99	15	$	7.68	1.80	$	43	14	$	7.80	$	40
$10.00 — $19.99	6	$	17.11	0.57	—		6	$	17.11	—
	21	$	10.53	1.43	$	43	20	$	10.71	$	40
Options exercisable and expected to become exercisable	21	$	10.53	1.43	$	43

Option prices at the lower end of the range were principally attributable to stock options assumed in connection with the Varian acquisition in fiscal year 2012.

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 is usually 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. 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.

For performance-based awards granted during fiscal 2011 and 2010, the performance goals require (i) the achievement of targeted adjusted annual 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.

In fiscal 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 Committee approved the grant of 3 million performance-based restricted stock units and 1 million performance-based shares of restricted stock under this program in fiscal 2012. In each of fiscal 2011 and 2010, the Committee approved the grant of 2 million performance-based restricted stock units and 0.1 million performance-based shares of restricted stock. With respect to the performance-based awards granted in fiscal 2012, as of October 28, 2012, no awards had been earned. With respect to the performance-based awards granted in fiscal 2011, as of October 28, 2012, 100 percent of the awards had been earned, subject to additional time-based vesting requirements. With respect to the performance-based awards granted in fiscal 2010, as of October 28, 2012, 82 percent of the awards had been earned, subject to additional time-based vesting requirements. The remaining 18 percent of the awards may still be earned, depending on performance in fiscal 2013.

A summary of the changes in restricted stock units, restricted stock, performance shares and performance units outstanding under Applied’s equity compensation plans during fiscal 2012 are presented below:



	Shares		Weighted Average Grant Date Fair Value		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value

	(In millions, except per share amounts)
Non-vested restricted stock units, restricted stock, performance shares and performance units at October 25, 2009	12		$	16.16	2.4 Years	$	157
Granted	13		$	12.36
Vested	(5	)	$	17.13
Canceled	(2	)	$	15.41
Non-vested restricted stock units, restricted stock, performance shares and performance units at October 31, 2010	18		$	13.33	2.8 Years	$	227
Granted	17		$	12.62
Vested	(5	)	$	14.64
Canceled	(2	)	$	13.11
Non-vested restricted stock units, restricted stock, performance shares and performance units at October 30, 2011	28		$	12.64	2.8 Years	$	345
Granted	19		$	10.61
Vested	(9	)	$	12.87
Canceled	(2	)	$	12.26
Non-vested restricted stock units, restricted stock, performance shares and performance units at October 28, 2012	36		$	11.53	2.6 Years	$	376
Non-vested restricted stock units, restricted stock, performance shares and performance units expected to vest	34		$	11.81	2.3 Years	$	357

At October 28, 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.

The actual tax benefit realized for the tax deductions from vested restricted stock units totaled $27 million in fiscal 2012 and $22 million in each of fiscal 2011 and 2010.

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 $2.73 per share for the year ended October 28, 2012, $3.03 per share for the year ended October 30, 2011 and $2.76 per share for the year ended October 31, 2010. The number of shares issued under the ESPP during fiscal 2012, 2011 and 2010 was 7 million, 6 million and 5 million, respectively. At October 28, 2012, there were 47 million available for future issuance under the ESPP. Compensation expense is calculated using the fair value of the employees’ purchase rights under the Black-Scholes model. Underlying assumptions used in the model for fiscal 2012, 2011 and 2010 are outlined in the following table:



	2012		2011		2010
ESPP:
Dividend yield	3.01	%	2.53	%	2.44	%
Expected volatility	29.6	%	31.1	%	33.3	%
Risk-free interest rate	0.13	%	0.09	%	0.19	%
Expected life (in years)	0.5		0.5		0.5