Stockholders’ Equity, Comprehensive Income and Share-Based Compensation

Accumulated Other Comprehensive Loss

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



	October 27, 2013			October 28, 2012

	(In millions)
Unrealized gain on investments, net	$	25		$	16
Unrealized gain on derivative instruments qualifying as cash flow hedges	2			1
Pension liability	(72		)	(90		)
Cumulative translation adjustments	7			12
	$	(38	)	$	(61	)

The decrease in accumulated other comprehensive loss associated with pension liability amounted to $18 million, net of income tax effect of $7 million.

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. At October 27, 2013, $1.6 billion remains available for future stock repurchases under this repurchase program.

The following table summarizes Applied’s stock repurchases:



	2013		2012		2011

	(In millions, except per share amounts)
Shares of common stock repurchased	18		126		36
Cost of stock repurchased	$	245	$	1,416	$	468
Average price paid per share	$	13.60	$	11.22	$	12.88

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 2013, Applied’s Board of Directors declared three quarterly cash dividends of $0.10 per share each and one quarterly cash dividend of $0.09 per share. During fiscal 2012, Applied’s Board of Directors declared three quarterly cash dividends of $0.09 per share each and one quarterly cash dividend of $0.08 per share. During fiscal 2011, Applied’s Board of Directors declared three quarterly cash dividends of $0.08 per share each and one quarterly cash dividend of $0.07. Dividends declared during fiscal 2013, 2012 and 2011 amounted to $469 million, $438 million and $408 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 a stockholder approved equity plan, the Employee Stock Incentive Plan, which permits grants to employees of share-based awards, including stock options, restricted stock, restricted stock units, performance shares and performance units. In addition, the 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. Share-based awards made beginning in March 2012 under the plan may be subject to accelerated vesting under certain circumstances in the event of a change in control of Applied. 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 2013, 2012, and 2011, 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:



	2013		2012		2011

	(In millions)
Share-based compensation	$	162	$	182	$	146
Tax benefit recognized	$	45	$	52	$	42

The effect of share-based compensation on the results of operations for fiscal 2013, 2012, and 2011 was as follows:



	2013		2012		2011

	(In millions)
Cost of products sold	$	50	$	54	$	48
Research, development, and engineering	53		54		46
Marketing and selling	20		22		16
General and administrative	34		52		36
Restructuring charge	5		—		—
Total	$	162	$	182	$	146

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 27, 2013, Applied had $250 million in total unrecognized compensation expense, net of estimated forfeitures, related to grants of share-based awards and shares issued under Applied’s ESPP, which will be recognized over a weighted average period of 2.4 years. At October 27, 2013, there were 183 million shares available for grants of share-based awards under the Employee Stock Incentive Plan, and an additional 40 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. The weighted average assumptions used in the model for the stock options granted and assumed are outlined below:



	2013		2012
Stock Options:
Dividend yield	2.7	%	2.6	%
Expected volatility	29.5	%	38.7	%
Risk-free interest rate	1.44	%	0.52	%
Expected life (in years)	4.5		3.3

Information with respect to stock options is as follows:



	2013		2012		2011
	(In millions)
Aggregate intrinsic value of outstanding stock options	$	49	$	43	$	58
Total intrinsic value of stock options exercised	$	63	$	21	$	23
Total fair value of stock options vested	$	4	$	41	$	17
Cash received from stock option exercises	$	88	$	33	$	41
Actual tax benefit realized from options exercised	$	19	$	7	$	11

Stock option activity for fiscal 2013, 2012 and 2011 was as follows:



	2013				2012				2011
	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	21		$	10.53	30		$	13.05	51		$	15.04
Granted and assumed in Varian acquisition	1		$	15.06	5		$	4.85	—		$	—
Exercised	(11	)	$	8.16	(4	)	$	7.30	(5	)	$	9.21
Canceled and forfeited	(5	)	$	17.62	(10	)	$	16.76	(16	)	$	20.28
Outstanding, end of year	6		$	9.12	21		$	10.53	30		$	13.05
Exercisable, end of year	5		$	7.90	20		$	10.71	24		$	14.23

The following table summarizes information with respect to options outstanding and exercisable at October 27, 2013:



	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	5	$	7.23	1.47	$	46	4	$	7.26	$	44
$10.00 — $19.99	1	$	15.00	5.55	3		1	$	14.77	1
	6	$	9.12	2.38	$	49	5	$	7.90	$	45
Options exercisable and expected to become exercisable	6	$	8.95	2.25	$	49

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 generally 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, performance shares and performance units granted to certain executive officers 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. These performance-based awards require the achievement of targeted levels of relative adjusted annual operating profit margin. For the fiscal 2013 and fiscal 2012 performance-based awards, additional shares become eligible for time-based vesting if Applied achieves certain levels of 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.

In September 2013, the Committee approved the amendment of certain outstanding performance-based awards, so that applicable performance goals will be deemed satisfied at target levels effective as of either three days prior to the closing of the announced business combination between Applied and TEL, or the date the proposed business combination is terminated. The vesting of the awards will remain subject to time-based vesting. In addition, the Committee also approved the amendment of certain outstanding awards held by executive officers to provide that if the award is outstanding and subject solely to time-based vesting as of three trading days prior to the closing of the business combination agreement with TEL, vesting of the portion of the award that is otherwise scheduled to vest during calendar year 2014 will accelerate.

The fair value of these performance-based awards is estimated on the date of 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 remains 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.

A summary of the performance-based awards approved by the Committee is presented below:



	Number of Performance-Based Awards Granted		Percent of Performance-Based Awards Earned as of October 27, 2013*
Fiscal Year Granted	Performance Shares/Performance Units	Shares of Restricted Stock
	(in millions)
2013	3	—	0%
2012	3	1	14%
2011	2	0.1	100%
2010	2	0.1	82%

___________________

* subject to additional time-based vesting requirements

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 2013, 2012 and 2011 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 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
Granted	19		$	10.55
Vested	(11	)	$	11.44
Canceled	(6	)	$	11.28
Non-vested restricted stock units, restricted stock, performance shares and performance units at October 27, 2013	38		$	11.11	2.4 years	$	662
Non-vested restricted stock units, restricted stock, performance shares and performance units expected to vest	34		$	10.93	2.4 years	$	594

At October 27, 2013, 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 $42 million in fiscal 2013, $27 million in fiscal 2012 and $22 million in fiscal 2011.

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 $3.08 per share for the year ended October 27, 2013, $2.73 per share for the year ended October 28, 2012 and $3.03 per share for the year ended October 30, 2011. The number of shares issued under the ESPP during fiscal 2013, 2012 and 2011 was 7 million, 7 million and 6 million, respectively. At October 27, 2013, there were 40 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 2013, 2012 and 2011 are outlined in the following table:



	2013		2012		2011
ESPP:
Dividend yield	2.80	%	3.01	%	2.53	%
Expected volatility	24.8	%	29.6	%	31.1	%
Risk-free interest rate	0.09	%	0.13	%	0.09	%
Expected life (in years)	0.5		0.5		0.5