10-Q 1 amat-form10xqq12014.htm FORM 10-Q AMAT-Form 10-Q (Q1 2014)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)

þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended January 26, 2014
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,
95052-8039
P.O. Box 58039
Santa Clara, California
(Address of principal executive offices)
(Zip Code)

(408) 727-5555
(Registrant’s telephone number, including area code)

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files).    Yes  þ        No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
 
Accelerated filer ¨
 
 
Non-accelerated filer ¨ (Do not check if a smaller reporting company)
 
Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨        No  þ
Number of shares outstanding of the issuer’s common stock as of January 31, 2014: 1,211,068,250




APPLIED MATERIALS, INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JANUARY 26, 2014
TABLE OF CONTENTS
 
 
 
Page
 
PART I. FINANCIAL INFORMATION
 
Item 1:    
 
 
 
 
 
 
Item 2:    
Item 3:    
Item 4:    
 
 
 
 
PART II. OTHER INFORMATION
 
Item 1:    
Item 1A:
Item 2:    
Item 6:    
 




PART I. FINANCIAL INFORMATION

Item 1.    Financial Statements

APPLIED MATERIALS, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
 
Three Months Ended
 
January 26,
2014
 
January 27,
2013
 
(Unaudited)
 
(In millions, except per share amounts)
Net sales
$
2,190

 
$
1,573

Cost of products sold
1,299

 
991

Gross margin
891

 
582

Operating expenses:
 
 
 
Research, development and engineering
356

 
304

Marketing and selling
109

 
105

General and administrative
89

 
125

Restructuring charges and asset impairments
7

 
9

Total operating expenses
561

 
543

Income from operations
330

 
39

Impairment of strategic investments
3

 

Interest expense
25

 
24

Interest and other income, net
13

 
3

Income before income taxes
315

 
18

Provision (benefit) for income taxes
62

 
(16
)
Net income
$
253

 
$
34

Earnings per share:
 
 
 
Basic and diluted
$
0.21

 
$
0.03

Weighted average number of shares:
 
 
 
Basic
1,206

 
1,198

Diluted
1,225

 
1,212

See accompanying Notes to Consolidated Condensed Financial Statements.

3



APPLIED MATERIALS, INC.
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
 
Three Months Ended
 
January 26,
2014
 
January 27,
2013
 
(Unaudited)
 
(In millions)
Net income
$
253

 
$
34

Other comprehensive income (loss), net of tax:
 
 
 
Change in unrealized net gain on investments
(3
)
 

Change in unrealized net gain on derivative investments
(1
)
 
5

Change in defined benefit plan liability

 
(3
)
Change in cumulative translation adjustments
(2
)
 
(3
)
Other comprehensive income (loss), net of tax
(6
)
 
(1
)
Comprehensive income
$
247

 
$
33

See accompanying Notes to Consolidated Condensed Financial Statements.



4


APPLIED MATERIALS, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
 
January 26,
2014
 
October 27,
2013
 
 
 
 
 
(In millions)
ASSETS
Current assets:
 
 
 
Cash and cash equivalents
$
2,144

 
$
1,711

Short-term investments
145

 
180

Accounts receivable, net
1,510

 
1,633

Inventories
1,533

 
1,413

Other current assets
682

 
705

Total current assets
6,014

 
5,642

Long-term investments
833

 
1,005

Property, plant and equipment, net
846

 
850

Goodwill
3,294

 
3,294

Purchased technology and other intangible assets, net
1,057

 
1,103

Deferred income taxes and other assets
155

 
149

Total assets
$
12,199

 
$
12,043

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
 
 
 
Accounts payable and accrued expenses
$
1,576

 
$
1,649

Customer deposits and deferred revenue
901

 
794

Total current liabilities
2,477

 
2,443

Long-term debt
1,946

 
1,946

Other liabilities
535

 
566

Total liabilities
4,958

 
4,955

Stockholders’ equity:
 
 
 
Common stock
12

 
12

Additional paid-in capital
6,178

 
6,151

Retained earnings
12,619

 
12,487

Treasury stock
(11,524
)
 
(11,524
)
Accumulated other comprehensive loss
(44
)
 
(38
)
Total stockholders’ equity
7,241

 
7,088

Total liabilities and stockholders’ equity
$
12,199

 
$
12,043

Amounts as of January 26, 2014 are unaudited. Amounts as of October 27, 2013 are derived from the October 27, 2013 audited consolidated financial statements.
See accompanying Notes to Consolidated Condensed Financial Statements.

5


APPLIED MATERIALS, INC
CONSOLIDATED CONDENSED STATEMENT OF STOCKHOLDERS’ EQUITY
 
Common Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Treasury Stock
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
 
Shares
 
Amount
 
 
 
Shares
 
Amount
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Unaudited)
 
(In millions)
Balance at October 27, 2013
1,204

 
$
12

 
$
6,151

 
$
12,487

 
717

 
$
(11,524
)
 
$
(38
)
 
$
7,088

Net income

 

 

 
253

 

 

 

 
253

Other comprehensive loss, net of tax

 

 

 

 

 

 
(6
)
 
(6
)
Dividends

 

 

 
(121
)
 

 

 

 
(121
)
Share-based compensation

 

 
46

 

 

 

 

 
46

Issuance under stock plans, net of a tax benefit of $18 and other
7

 

 
(19
)
 

 

 

 

 
(19
)
Balance at January 26, 2014
1,211

 
$
12

 
$
6,178

 
$
12,619

 
717

 
$
(11,524
)
 
$
(44
)
 
$
7,241

See accompanying Notes to Consolidated Condensed Financial Statements.



6


APPLIED MATERIALS, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
 
Three Months Ended
 
January 26,
2014
 
January 27,
2013
 
 
 
 
 
(Unaudited)
 
(In millions)
Cash flows from operating activities:
 
 
 
Net income
$
253

 
$
34

Adjustments required to reconcile net income to cash provided by operating activities:
 
 
 
Depreciation and amortization
94

 
106

Restructuring charges and asset impairments
7

 
9

Unrealized gain on derivative associated with announced business combination
(24
)
 

Share-based compensation
46

 
42

Other
(16
)
 
(78
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
123

 
112

Inventories
(119
)
 
(6
)
Other assets
37

 
80

Accounts payable and accrued expenses
(86
)
 
(248
)
Customer deposits and deferred revenue
107

 
(77
)
Other liabilities
(50
)
 
42

Cash provided by operating activities
372

 
16

Cash flows from investing activities:
 
 
 
Capital expenditures
(48
)
 
(49
)
Proceeds from sales and maturities of investments
364

 
445

Purchases of investments
(163
)
 
(143
)
Cash provided by investing activities
153

 
253

Cash flows from financing activities:
 
 
 
Proceeds from common stock issuances and others
28

 
18

Common stock repurchases

 
(48
)
Payments of dividends to stockholders
(120
)
 
(108
)
Cash used in financing activities
(92
)
 
(138
)
Increase in cash and cash equivalents
433

 
131

Cash and cash equivalents — beginning of year
1,711

 
1,392

Cash and cash equivalents — end of year
$
2,144

 
$
1,523

Supplemental cash flow information:
 
 
 
Cash payments for income taxes
$
26

 
$
32

Cash refunds from income taxes
$
9

 
$
65

Cash payments for interest
$
39

 
$
39



See accompanying Notes to Consolidated Condensed Financial Statements.

7


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)

Note 1    Basis of Presentation
Basis of Presentation
In the opinion of management, the unaudited interim consolidated condensed financial statements of Applied Materials, Inc. and its subsidiaries (Applied or the Company) included herein have been prepared on a basis consistent with the October 27, 2013 audited consolidated financial statements and include all material adjustments, consisting of normal recurring adjustments, necessary to fairly present the information set forth therein. These unaudited interim consolidated condensed financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in Applied’s Annual Report on Form 10-K for the fiscal year ended October 27, 2013 (2013 Form 10-K). Applied’s results of operations for the three months ended January 26, 2014 are not necessarily indicative of future operating results. Applied’s fiscal year ends on the last Sunday in October of each year. Fiscal 2014 and 2013 each contain 52 weeks, and the first three months of fiscal 2014 and 2013 each contained 13 weeks.
Certain prior year amounts have been reclassified to conform to current year presentation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ materially from those estimates. On an ongoing basis, Applied evaluates its estimates, including those related to accounts receivable and sales allowances, fair values of financial instruments, inventories, intangible assets and goodwill, useful lives of intangible assets and property and equipment, fair values of share-based awards, and income taxes, among others. Applied bases its estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.
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; seller’s price to buyer is fixed or determinable; and collectability is probable. Applied’s shipping terms are customarily FOB Applied shipping point or equivalent terms. Applied’s revenue recognition policy generally results in revenue recognition at the following points: (1) for all transactions where legal title passes to the customer upon shipment or delivery, Applied recognizes revenue upon passage of title for all products that have been demonstrated to meet product specifications prior to shipment; the portion of revenue associated with certain installation-related tasks is deferred, and that revenue is recognized upon completion of the installation-related tasks; (2) for products that have not been demonstrated to meet product specifications prior to shipment, revenue is recognized at customer technical acceptance; (3) for transactions where legal title does not pass at shipment or delivery, revenue is recognized when legal title passes to the customer, which is generally at customer technical acceptance; and (4) for arrangements containing multiple elements, the revenue relating to the undelivered elements is deferred using the relative selling price method utilizing estimated sales prices until delivery of the deferred elements. Applied limits the amount of revenue recognition for delivered elements to the amount that is not contingent on the future delivery of products or services, future performance obligations or subject to customer-specified return or adjustment. In cases where Applied has sold products that have been demonstrated to meet product specifications prior to shipment, Applied believes that at the time of delivery, it has an enforceable claim to amounts recognized as revenue. Spare parts revenue is generally recognized upon shipment, and services revenue is generally recognized over the period that the services are provided.


8


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)



When a sales arrangement contains multiple elements, such as hardware and services and/or software products, Applied allocates revenue to each element based on a selling price hierarchy. The selling price for a deliverable is based on its vendor specific objective evidence (VSOE) if available, third party evidence (TPE) if VSOE is not available, or estimated selling price (ESP) if neither VSOE nor TPE is available. Applied generally utilizes the ESP due to the nature of its products. In multiple element arrangements where more-than-incidental software deliverables are included, revenue is allocated to each separate unit of accounting for each of the non-software deliverables and to the software deliverables as a group using the relative selling prices of each of the deliverables in the arrangement based on the aforementioned selling price hierarchy. If the arrangement contains more than one software deliverable, the arrangement consideration allocated to the software deliverables as a group is then allocated to each software deliverable using the guidance for recognizing software revenue.
Recent Accounting Pronouncements
In July 2013, the Financial Accounting Standards Board (FASB) issued authoritative guidance that will require an unrecognized tax benefit to be presented as a reduction of a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward, with certain exceptions. The authoritative guidance becomes effective for Applied in the first quarter of fiscal 2015, with early adoption permitted. The guidance is not expected to have an impact on Applied's financial position or results of operations.


Note 2
Earnings Per Share
Basic earnings per share is determined using the weighted average number of common shares outstanding during the period. Diluted earnings per share is determined using the weighted average number of common shares and potential common shares (representing the dilutive effect of stock options, restricted stock units, and employee stock purchase plans shares) outstanding during the period. Applied's net income has not been adjusted for any period presented for purposes of computing basic or diluted earnings per share due to the Company's non-complex capital structure.
 
 
Three Months Ended
 
January 26,
2014
 
January 27,
2013
 
 
 
 
 
(In millions, except per share amounts)
Numerator:
 
 
 
Net income
$
253

 
$
34

Denominator:
 
 
 
Weighted average common shares outstanding
1,206

 
1,198

Effect of dilutive stock options, restricted stock units and employee stock purchase plan shares
19

 
14

Denominator for diluted earnings per share
1,225

 
1,212

Basic and diluted earnings per share
$
0.21

 
$
0.03

Potentially dilutive securities
1

 
8


Potentially dilutive securities attributable to outstanding stock options and restricted stock units were excluded from the calculation of diluted earnings per share because the combined exercise price, average unamortized fair value and assumed tax benefits upon the exercise of options and the vesting of restricted stock units were greater than the average market price of Applied common stock, and therefore their inclusion would have been anti-dilutive.




9


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




Note 3
Cash, Cash Equivalents and Investments
Summary of Cash, Cash Equivalents and Investments
The following tables summarize Applied’s cash, cash equivalents and investments by security type:
 
January 26, 2014
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair  Value
 
 
 
 
 
 
 
 
 
(In millions)
Cash
$
872

 
$

 
$

 
$
872

Cash equivalents:
 
 
 
 
 
 
 
Money market funds
1,267

 

 

 
1,267

Municipal securities
5

 

 

 
5

Total Cash equivalents
1,272

 

 

 
1,272

Total Cash and Cash equivalents
$
2,144

 
$

 
$

 
$
2,144

Short-term and long-term investments:
 
 
 
 
 
 
 
U.S. Treasury and agency securities
$
74

 
$

 
$

 
$
74

Non-U.S. government securities*
14

 

 

 
14

Municipal securities
380

 
2

 

 
382

Commercial paper, corporate bonds and medium-term notes
148

 
1

 

 
149

Asset-backed and mortgage-backed securities
234

 
1

 
2

 
233

Total fixed income securities
850

 
4

 
2

 
852

Publicly traded equity securities
22

 
28

 

 
50

Equity investments in privately-held companies
76

 

 

 
76

Total short-term and long-term investments
$
948

 
$
32

 
$
2

 
$
978

Total Cash, Cash equivalents and Investments
$
3,092

 
$
32

 
$
2

 
$
3,122

 _________________________
* Includes agency debt securities guaranteed by non-U.S. governments, which consist of Germany and Canada.

10


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




October 27, 2013
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair  Value
 
 
 
 
 
 
 
 
 
(In millions)
Cash
$
611

 
$

 
$

 
$
611

Cash equivalents:
 
 
 
 
 
 
 
Money market funds
1,095

 

 

 
1,095

Municipal securities
5

 

 

 
5

Total Cash equivalents
1,100

 

 

 
1,100

Total Cash and Cash equivalents
$
1,711

 
$

 
$

 
$
1,711

Short-term and long-term investments:
 
 
 
 
 
 
 
U.S. Treasury and agency securities
$
170

 
$

 
$

 
$
170

Non-U.S. government securities
11

 

 

 
11

Municipal securities
379

 
2

 

 
381

Commercial paper, corporate bonds and medium-term notes
218

 
2

 
1

 
219

Asset-backed and mortgage-backed securities
268

 
2

 
2

 
268

Total fixed income securities
1,046

 
6

 
3

 
1,049

Publicly traded equity securities
27

 
33

 

 
60

Equity investments in privately-held companies
76

 

 

 
76

Total short-term and long-term investments
$
1,149

 
$
39

 
$
3

 
$
1,185

Total Cash, Cash equivalents and Investments
$
2,860

 
$
39

 
$
3

 
$
2,896


 Maturities of Investments
The following table summarizes the contractual maturities of Applied’s investments at January 26, 2014:
 
 
Cost
 
Estimated
Fair  Value
 
 
 
 
 
(In millions)
Due in one year or less
$
127

 
$
128

Due after one through five years
489

 
491

No single maturity date**
332

 
359

 
$
948

 
$
978

 _________________________
** Securities with no single maturity date include publicly-traded and privately-held equity securities, and asset-backed and mortgage-backed securities.
 

11


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




Gains and Losses on Investments
During the three months ended January 26, 2014, gross realized gains on investments were $12 million and gross realized losses on investments were not material. During the three months ended January 27, 2013, gross realized gains and losses on investments were not material.
At January 26, 2014 and October 27, 2013, gross unrealized losses related to Applied's investment portfolio were not material. Applied regularly reviews its investment portfolio to identify and evaluate investments that have indications of possible impairment. Factors considered in determining whether an unrealized loss is considered to be temporary, or other-than-temporary and therefore impaired, include: the length of time and extent to which fair value has been lower than the cost basis; the financial condition, credit quality and near-term prospects of the investee; and whether it is more likely than not that Applied will be required to sell the security prior to recovery. Generally, the contractual terms of investments in marketable securities do not permit settlement at prices less than the amortized cost of the investments. Applied determined that the gross unrealized losses on its marketable securities at January 26, 2014 and January 27, 2013 were temporary in nature and therefore it did not recognize any impairment of its marketable securities during the three months ended January 26, 2014 or January 27, 2013. Applied recognized $3 million of impairment charges on its equity investments in privately-held companies during the three months ended January 26, 2014, and did not record any impairment charges on its equity investments in privately-held companies during the three months ended January 27, 2013.
Unrealized gains and temporary losses on investments classified as available-for-sale are included within accumulated other comprehensive income (loss), net of any related tax effect. Upon realization, those amounts are reclassified from accumulated other comprehensive income (loss) to results of operations.


Note 4
Fair Value Measurements
Applied’s financial assets are measured and recorded at fair value, except for equity investments in privately-held companies. These equity investments are generally accounted for under the cost method of accounting and are periodically assessed for other-than-temporary impairment when events or circumstances indicate that an other-than-temporary decline in value may have occurred. Applied’s nonfinancial assets, such as goodwill, intangible assets, and property, plant and equipment, are recorded at cost and are assessed for impairment when events or circumstances indicate that an other-than-temporary decline in value may have occurred.
Fair Value Hierarchy
Applied uses the following fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:
 
Level 1 — Quoted prices in active markets for identical assets or liabilities;
Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Applied’s investments are comprised primarily of debt securities that are classified as available-for-sale and recorded at their fair values. In determining the fair value of investments, Applied uses pricing information from pricing services that value securities based on quoted market prices and models that utilize observable market inputs. In the event a fair value estimate is unavailable from a pricing service, Applied generally obtains non-binding price quotes from brokers. Applied then reviews the information provided by the pricing services or brokers to determine the fair value of its short-term and long-term investments. In addition, to validate pricing information obtained from pricing services, Applied periodically performs supplemental analysis on a sample of securities. Applied reviews any significant unanticipated differences identified through this analysis to determine the appropriate fair value.
Investments with remaining effective maturities of 12 months or less from the balance sheet date are classified as short-term investments. Investments with remaining effective maturities of more than 12 months from the balance sheet date are classified as long-term investments. As of January 26, 2014, substantially all of Applied’s available-for-sale, short-term and long-term investments were recognized at fair value that was determined based upon observable inputs.


12


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




Assets Measured at Fair Value on a Recurring Basis
Financial assets (excluding cash balances) measured at fair value on a recurring basis are summarized below as of January 26, 2014 and October 27, 2013:
 
 
January 26, 2014
 
October 27, 2013
 
Level 1
 
Level 2
 
Total
 
Level 1
 
Level 2
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
(In millions)
Assets:
 
 
 
 
 
 
 
 
 
 
 
Money market funds
$
1,267

 
$

 
$
1,267

 
$
1,095

 
$

 
$
1,095

U.S. Treasury and agency securities
33

 
41

 
74

 
66

 
104

 
170

Non-U.S. government securities

 
14

 
14

 

 
11

 
11

Municipal securities

 
387

 
387

 

 
386

 
386

Commercial paper, corporate bonds and medium-term notes

 
149

 
149

 

 
219

 
219

Asset-backed and mortgage-backed securities

 
233

 
233

 

 
268

 
268

Publicly traded equity securities
50

 

 
50

 
60

 

 
60

Foreign exchange derivative assets

 
43

 
43

 

 
20

 
20

Total
$
1,350

 
$
867

 
$
2,217

 
$
1,221

 
$
1,008

 
$
2,229

There were no transfers between Level 1 and Level 2 fair value measurements during the three months ended January 26, 2014 or January 27, 2013. Applied did not have any financial assets measured at fair value on a recurring basis within Level 3 fair value measurements as of January 26, 2014 or October 27, 2013.
Assets and Liabilities Measured at Fair Value on a Non-recurring Basis
Equity investments in privately-held companies are generally accounted for under the cost method of accounting and are periodically assessed for other-than-temporary impairment when an event or circumstance indicates that an other-than-temporary decline in value may have occurred. If Applied determines that an other-than-temporary impairment has occurred, the investment will be written down to its estimated fair value based on available information, such as pricing in recent rounds of financing, current cash positions, earnings and cash flow forecasts, recent operational performance and any other readily available market data. At January 26, 2014 and October 27, 2013, equity investments in privately-held companies totaled $76 million, of which $66 million of investments were accounted for under the cost method of accounting and $10 million of investments had been measured at fair value on a non-recurring basis within Level 3 fair value measurements due to an other-than-temporary decline in value. Applied recognized $3 million of impairment charges on its equity investments in privately-held companies during the three months ended January 26, 2014, and did not record any impairment charges on its equity investments in privately-held companies during the three months ended January 27, 2013.
Other
The carrying amounts of Applied’s financial instruments, including cash and cash equivalents, accounts receivable, notes payable, and accounts payable and accrued expenses, approximate fair value due to their short maturities. At January 26, 2014 and October 27, 2013, the carrying amount of long-term debt was $1.9 billion and the estimated fair value was $2.1 billion. The estimated fair value of long-term debt is determined by Level 2 inputs and is based primarily on quoted market prices for the same or similar issues.


13


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)



Note 5
Derivative Instruments and Hedging Activities
Derivative Financial Instruments
Applied conducts business in a number of foreign countries, with certain transactions denominated in local currencies, such as the Japanese yen, euro, Israeli shekel, Taiwanese dollar and Swiss franc. Applied uses derivative financial instruments, such as forward exchange contracts and currency option contracts, to hedge certain forecasted foreign currency denominated transactions expected to occur typically up to the next 24 months. The purpose of Applied’s foreign currency management is to mitigate the effect of exchange rate fluctuations on certain foreign currency denominated revenues, costs and eventual cash flows. The terms of currency instruments used for hedging purposes are generally consistent with the timing of the transactions being hedged. Applied does not use derivative financial instruments for trading or speculative purposes.
Derivative instruments and hedging activities, including foreign currency exchange contracts, are recognized on the balance sheet at fair value. Changes in the fair value of derivatives that do not qualify for hedge treatment, as well as the ineffective portion of any hedges, are recognized currently in earnings. All of Applied’s derivative financial instruments are recorded at their fair value in other current assets or in accounts payable and accrued expenses.
 
Hedges related to anticipated transactions are designated and documented at the inception of the hedge as cash flow hedges and are typically entered into once per month. Cash flow hedges are evaluated for effectiveness quarterly. The effective portion of the gain or loss on these hedges is reported as a component of accumulated other comprehensive income or loss (AOCI) in stockholders’ equity and is reclassified into earnings when the hedged transaction affects earnings. The majority of the after-tax net income or loss related to derivative instruments included in AOCI at January 26, 2014 is expected to be reclassified into earnings within 12 months. Changes in the fair value of currency forward exchange and option contracts due to changes in time value are excluded from the assessment of effectiveness. Both ineffective hedge amounts and hedge components excluded from the assessment of effectiveness are recognized in earnings. If the transaction being hedged is no longer probable to occur, or if a portion of any derivative is deemed to be ineffective, Applied promptly recognizes the gain or loss on the associated financial instrument in general and administrative expenses. The amount recognized due to discontinuance of cash flow hedges that were probable not to occur by the end of the originally specified time period was not significant for the three months ended January 26, 2014 and January 27, 2013.
Additionally, forward exchange contracts are generally used to hedge certain foreign currency denominated assets or liabilities. These derivatives are typically entered into once per month and are not designated for hedge accounting treatment. Accordingly, changes in the fair value of these hedges are recorded in earnings to offset the changes in the fair value of the assets or liabilities being hedged.
During the fourth quarter of fiscal 2013, the Company purchased foreign exchange option contracts to limit its foreign exchange risk associated with the announced business combination with Tokyo Electron Limited (TEL). The derivatives used to hedge our currency exposure did not qualify for hedge accounting treatment. These derivatives are marked to market at the end of each reporting period with gains and losses recorded as general and administrative expenses. At January 26, 2014, the fair value of these foreign exchange option contracts was approximately $41 million. The Company recorded an unrealized gain of $24 million during the first quarter of fiscal 2014 related to such contracts. The cash flow impact of this derivative has been classified as operating cash flows in the Consolidated Condensed Statements of Cash Flows. To further mitigate credit exposure in connection with these foreign exchange option contracts, the Company entered into security arrangements with certain counterparties, which require the counterparties to post collateral amounting to the approximate fair value of the derivative contracts. The cash collateral is included in cash and cash equivalents in the Consolidated Condensed Statements of Financial Position, with the corresponding liability included in accounts payable and accrued expenses.
Other than the foreign exchange option contracts discussed in the preceding paragraph, the fair values of other derivative instruments at January 26, 2014 and October 27, 2013 were not material.


14


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




The effects of derivative instruments on the Consolidated Condensed Statements of Operations for the three months ended January 26, 2014 and January 27, 2013 were as follows:
 
 
 
Three Months Ended January 26, 2014
 
Three Months Ended January 27, 2013
Effective Portion
 
Ineffective Portion and Amount
Excluded from
Effectiveness
Testing
 
Effective Portion
 
Ineffective Portion and Amount
Excluded from
Effectiveness
Testing
 
Location of Gain or
(Loss) Reclassified
from AOCI into
Income
 
Gain or
(Loss)
Recognized
in AOCI
 
Gain or (Loss)
Reclassified
from AOCI into
Income
 
Gain or (Loss)
Recognized in
Income
 
Gain or
(Loss)
Recognized
in AOCI
 
Gain or (Loss)
Reclassified
from AOCI into
Income
 
Gain or (Loss)
Recognized in
Income
 
 
 
(In millions)
Derivatives in Cash Flow Hedging Relationships
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Cost of products sold
 
$
5

 
$
3

 
$

 
$
10

 
$
2

 
$
(1
)
Foreign exchange contracts
General and administrative
 

 
3

 
(1
)
 

 

 

Total
 
 
$
5

 
$
6

 
$
(1
)
 
$
10

 
$
2

 
$
(1
)

 
 
 
Amount of Gain or (Loss) 
Recognized in Income
 
 
Three Months Ended
Location of Gain or
(Loss) Recognized
in Income
 
January 26, 2014
 
January 27, 2013
 
 
 
(In millions)
Derivatives Not Designated as Hedging Instruments
 
 
 
 
 
Foreign exchange contracts
General and
administrative
 
$
39

 
$
13

Total
 
 
$
39

 
$
13

 

Credit Risk Contingent Features
If Applied’s credit rating were to fall below investment grade, it would be in violation of credit risk contingent provisions of the derivative instruments discussed above, and certain counterparties to the derivative instruments could request immediate payment on derivative instruments in net liability positions. The aggregate fair value of all derivative instruments with credit-risk related contingent features that were in a net liability position was immaterial as of January 26, 2014.
Entering into foreign exchange contracts with banks exposes Applied to credit-related losses in the event of the banks’ nonperformance. However, Applied’s exposure is not considered significant.


15


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




Note 6    Accounts Receivable, Net
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 factored accounts receivable of $45 million during the three months ended January 26, 2014 and none during the three months ended January 27, 2013. Applied did not discount promissory notes or utilize programs to discount letters of credit issued by customers during the three months ended January 26, 2014 and January 27, 2013. Financing charges on the sale of receivables and discounting of letters of credit are included in interest expense in the accompanying Consolidated Condensed Statements of Operations and were not material for all periods presented.
Accounts receivable are presented net of allowance for doubtful accounts of $74 million at both January 26, 2014 and October 27, 2013. Applied sells principally to manufacturers within the semiconductor, display and solar industries. While Applied believes that its allowance for doubtful accounts is adequate and represents Applied’s best estimate as of January 26, 2014, Applied continues to closely monitor customer liquidity and other economic conditions, which may result in changes to Applied’s estimates regarding collectability.


Note 7
Balance Sheet Detail
 
 
January 26,
2014
 
October 27,
2013
 
 
 
 
 
(In millions)
Inventories
 
 
 
Customer service spares
$
280

 
$
274

Raw materials
335

 
325

Work-in-process
292

 
283

Finished goods
626

 
531

 
$
1,533

 
$
1,413

 
Included in finished goods inventory are $194 million at January 26, 2014, and $136 million at October 27, 2013, of newly-introduced systems at customer locations where the sales transaction did not meet Applied’s revenue recognition criteria as set forth in Note 1. Finished goods inventory includes $190 million and $177 million of evaluation inventory at January 26, 2014 and October 27, 2013, respectively.

 
January 26,
2014
 
October 27,
2013
 
 
 
 
 
(In millions)
Other Current Assets
 
 
 
Deferred income taxes, net
$
315

 
$
323

Prepaid expenses
161

 
135

Prepaid income taxes and income taxes receivable
147

 
178

Other
59

 
69

 
$
682

 
$
705

 

16


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)



 
Useful Life
 
January 26,
2014
 
October 27,
2013
 
 
 
 
 
 
 
(In years)
 
(In millions)
Property, Plant and Equipment, Net
 
 
 
Land and improvements
 
 
$
167

 
$
167

Buildings and improvements
3-30
 
1,230

 
1,217

Demonstration and manufacturing equipment
3-5
 
815

 
792

Furniture, fixtures and other equipment
3-15
 
592

 
589

Construction in progress
 
 
43

 
52

Gross property, plant and equipment
 
 
2,847

 
2,817

Accumulated depreciation
 
 
(2,001
)
 
(1,967
)
 
 
 
$
846

 
$
850


 
January 26,
2014
 
October 27,
2013
 
 
 
 
 
(In millions)
Accounts Payable and Accrued Expenses
 
 
 
Accounts payable
$
645

 
$
582

Compensation and employee benefits
326

 
417

Warranty
106

 
102

Dividends payable
121

 
121

Income taxes payable
49

 
73

Other accrued taxes
31

 
41

Interest payable
14

 
30

Restructuring reserve
28

 
39

Other
256

 
244

 
$
1,576

 
$
1,649

 
 
January 26,
2014
 
October 27,
2013
 
 
 
 
 
(In millions)
Customer Deposits and Deferred Revenue
 
 
 
Customer deposits
$
147

 
$
175

Deferred revenue
754

 
619

 
$
901

 
$
794

 
Applied typically receives deposits on future deliverables from customers in the Display and Energy and Environmental Solutions segments. In certain instances, customer deposits may be received from customers in the Applied Global Services segment.
 
January 26,
2014
 
October 27,
2013
 
 
 
 
 
(In millions)
Other Liabilities
 
 
 
Deferred income taxes
$
65

 
$
71

Income taxes payable
200

 
174

Defined and postretirement benefit plans
192

 
193

Other
78

 
128

 
$
535

 
$
566


17


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




Note 8
Business Combination
On September 24, 2013, Applied and Tokyo Electron Limited (TEL) entered into the Business Combination Agreement, which was amended on February 14, 2014, to effect a strategic combination of their respective businesses into a new combined company. TEL, a Japanese corporation, is a global supplier of semiconductor and flat panel display production equipment, and a provider of technical support and services for semiconductor, flat panel display and photovoltaic panel production equipment. Under the terms of the Business Combination Agreement, TEL shareholders will receive 3.25 shares of the new combined company for every TEL share held. Applied shareholders will receive one share of the new combined company for every Applied share held. Based on the number of shares of Applied common stock and shares of TEL common stock expected to be issued and outstanding immediately prior to the closing of the transaction, it is anticipated that, immediately following the transaction, former Applied stockholders and former TEL shareholders will own approximately 68% and 32%, respectively, of the new combined company.
The new combined company will have a new name, dual headquarters in Tokyo and Santa Clara, and dual listing of its shares on the Tokyo Stock Exchange and NASDAQ, and will be incorporated in the Netherlands. The closing of the transaction is subject to customary conditions, including approval by Applied’s and TEL’s shareholders and regulatory approvals. It is expected that the combined company will commence a $3.0 billion stock repurchase program targeted to be executed within 12 months following the closing of the transaction.
The Business Combination Agreement contains mutual pre-closing covenants, including the obligation of Applied and TEL to conduct their businesses in the ordinary course consistent in all material respects with past practices. The agreement also contains termination rights for Applied and TEL and provides that upon certain events, such as a termination due to a change in recommendation by the other party or a termination relating to certain tax rulings, a termination fee of $400 million is payable.


18


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




Note 9
Goodwill, Purchased Technology and Other Intangible Assets
Goodwill and Purchased Intangible Assets
Applied’s methodology for allocating the purchase price relating to purchase acquisitions is determined through established and generally accepted valuation techniques. Goodwill is measured as the excess of the purchase price over the sum of the amounts assigned to tangible and identifiable intangible assets acquired less liabilities assumed. Applied assigns assets acquired (including goodwill) and liabilities assumed to one or more reporting units as of the date of acquisition. Typically, acquisitions relate to a single reporting unit and thus do not require the allocation of goodwill to multiple reporting units. If the products obtained in an acquisition are assigned to multiple reporting units, the goodwill is distributed to the respective reporting units as part of the purchase price allocation process.
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 whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The process of evaluating the potential impairment of goodwill and intangible assets requires significant judgment, especially in emerging markets. Applied regularly monitors current business conditions and other factors including, but not limited to, adverse industry or economic trends, restructuring actions and lower projections of profitability that may impact future operating results.
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. Applied determines the fair value of each of its reporting units based on a weighting of income and market approaches. If the carrying value of a reporting unit exceeds its 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’s reporting units are consistent with the reportable segments identified in Note 16, Industry Segment Operations, which are based on the manner in which Applied operates its business and the nature of those operations.
The evaluation of goodwill and intangible assets for impairment requires the exercise of significant judgment. In the event of future changes in business conditions, Applied will be required to reassess and update its forecasts and estimates used in future impairment analyses. If the results of these future analyses are lower than current estimates, a material impairment charge may result at that time.
Details of goodwill and other indefinite-lived intangible assets as of January 26, 2014 and October 27, 2013 were as follows :
 
 
Goodwill
 
Other
Intangible
Assets
 
Total
 
 
 
 
 
 
 
(In millions)
Silicon Systems Group
$
2,151

 
$
142

 
$
2,293

Applied Global Services
1,027

 

 
1,027

Display
116

 

 
116

Carrying amount
$
3,294

 
$
142

 
$
3,436

Other intangible assets that are not subject to amortization consist primarily of in-process technology, which will be subject to amortization upon commercialization. The fair value assigned to in-process technology was determined using the income approach taking into account estimates and judgments regarding risks inherent in the development process, including the likelihood of achieving technological success and market acceptance. If an in-process technology project is abandoned, the acquired technology attributable to the project will be written off.


19


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)



A summary of Applied's purchased technology and intangible assets is set forth below:
 
January 26,
2014
 
October 27,
2013
 
 
 
 
 
(In millions)
Purchased technology, net
$
709

 
$
748

Intangible assets - finite-lived, net
206

 
213

Intangible assets - indefinite-lived
142

 
142

Total
$
1,057

 
$
1,103


Finite-Lived Purchased Intangible Assets
Applied amortizes purchased intangible assets with finite lives using the straight-line method over the estimated economic lives of the assets, ranging from 1 to 15 years.
Applied evaluates long-lived assets for impairment whenever events or changes in circumstances indicate the carrying value of an asset group may not be recoverable. Applied assesses the fair value of the assets based on the amount of the undiscounted future cash flow that the assets are expected to generate and recognizes an impairment loss when estimated undiscounted future cash flow expected to result from the use of the asset, plus net proceeds expected from disposition of the asset, if any, are less than the carrying value of the asset. When Applied identifies an impairment, Applied reduces the carrying value of the group of assets to comparable market values, when available and appropriate, or to its estimated fair value based on a discounted cash flow approach.
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. Applied evaluates the useful lives of its intangible assets each reporting period to determine whether events and circumstances require revising the remaining period of amortization. In addition, Applied reviews intangible assets for impairment when events or changes in circumstances indicate their carrying value may not be recoverable. Management considers such indicators as significant differences in actual product acceptance from the estimates, changes in the competitive and economic environments, technological advances, and changes in cost structure.
 
Details of finite-lived intangible assets were as follows as of January 26, 2014 and October 27, 2013:
 
 
January 26, 2014
 
October 27, 2013
 
Purchased
Technology
 
Other
Intangible
Assets
 
Total
 
Purchased
Technology
 
Other
Intangible
Assets
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
(In millions)
Gross carrying amount:
 
 
 
 
 
 
 
 
 
 
 
Silicon Systems Group
$
1,301

 
$
252

 
$
1,553

 
$
1,301

 
$
252

 
$
1,553

Applied Global Services
28

 
44

 
72

 
28

 
44

 
72

Display
110

 
33

 
143

 
110

 
33

 
143

Energy and Environmental Solutions
5

 
15

 
20

 
5

 
15

 
20

Gross carrying amount
$
1,444

 
$
344

 
$
1,788

 
$
1,444

 
$
344

 
$
1,788

Accumulated amortization:
 
 
 
 
 
 
 
 
 
 
 
Silicon Systems Group
$
(599
)
 
$
(63
)
 
$
(662
)
 
$
(562
)
 
$
(58
)
 
$
(620
)
Applied Global Services
(24
)
 
(42
)
 
(66
)
 
(23
)
 
(42
)
 
(65
)
Display
(110
)
 
(30
)
 
(140
)
 
(110
)
 
(29
)
 
(139
)
Energy and Environmental Solutions
(2
)
 
(3
)
 
(5
)
 
(1
)
 
(2
)
 
(3
)
Accumulated amortization
$
(735
)
 
$
(138
)
 
$
(873
)
 
$
(696
)
 
$
(131
)
 
$
(827
)
Carrying amount
$
709

 
$
206

 
$
915

 
$
748

 
$
213

 
$
961



20


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)



Details of amortization expense by segment for the three months ended January 26, 2014 and January 27, 2013 were as follows:
 
Three Months Ended
 
January 26,
2014
 
January 27,
2013
 
 
 
 
 
(In millions)
Silicon Systems Group
$
42

 
$
44

Applied Global Services
1

 
1

Display
1

 
2

Energy and Environmental Solutions
2

 
6

Total
$
46

 
$
53

For the three months ended January 26, 2014 and January 27, 2013, amortization expense was charged to the following categories:
 
Three Months Ended
 
January 26,
2014
 
January 27,
2013
 
 
 
 
 
(In millions)
Cost of products sold
$
40

 
$
43

Marketing and selling
5

 
8

General and administrative
1

 
2

Total
$
46

 
$
53

As of January 26, 2014, future estimated amortization expense is expected to be as follows:
 
 
Amortization
Expense
 
(In millions)
2014
135

2015
175

2016
169

2017
165

2018
163

Thereafter
108

Total
$
915



21


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




Note 10
Borrowing Facilities and Long-Term Debt
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 May 2017. This agreement provides for borrowings in United States dollars at interest rates keyed to one of the two rates selected by Applied for each advance and includes financial and other covenants with which Applied was in compliance at January 26, 2014. Remaining credit facilities in the amount of approximately $77 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 January 26, 2014 and October 27, 2013 and Applied has not utilized these credit facilities.
Long-term debt outstanding as of January 26, 2014 and October 27, 2013 was as follows:
 
 
Principal Amount
 
Effective
Interest Rate
 
Interest
Pay Dates
 
(In millions)
 
 
 
 
2.650% Senior Notes Due 2016
$
400

 
2.666%
 
June 15, December 15
7.125% Senior Notes Due 2017
200

 
7.190%
 
April 15, October 15
4.300% Senior Notes Due 2021
750

 
4.326%
 
June 15, December 15
5.850% Senior Notes Due 2041
600

 
5.879%
 
June 15, December 15
 
1,950

 
 
 
 
Total unamortized discount
(4
)
 
 
 
 
Total long-term debt
$
1,946

 
 
 
 

Applied has debt agreements that contain financial and other covenants. These covenants require Applied to maintain certain minimum financial ratios. At January 26, 2014, Applied was in compliance with all such covenants.


22


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)



Note 11
Restructuring Charges and Asset Impairments

From time to time, Applied initiates restructuring activities to appropriately align its cost structure relative to prevailing economic and industry conditions and associated customer demand as well as in connection with certain acquisitions. Costs associated with restructuring actions can include termination benefits and related charges, in addition to facility closure, contract termination and other related activities.
The following table summarizes major components of the restructuring and asset impairment charges during the three months ended January 26, 2014 and January 27, 2013:
 
 
Three Months Ended
 
January 26,
2014
 
January 27,
2013
 
 
 
 
 
(In millions)
2012 Global Restructuring Plan
 
 
 
Severance and other employee-related costs
$
7

 
$
4

2012 EES Restructuring Plan
 
 
 
Asset impairments

 
3

Others
 
 
 
Severance and other employee-related costs

 
2

 
$
7

 
$
9


Restructuring and asset impairment charges were recorded as follows:
 
Three Months Ended
 
January 26,
2014
 
January 27,
2013
 
 
 
 
 
(In millions)
Silicon Systems Group
$

 
$
1

Applied Global Services

 
1

Energy and Environmental Solutions

 
3

Corporate Unallocated
7

 
4

Total
$
7

 
$
9


2012 Global Restructuring Plan
On October 3, 2012, Applied announced a restructuring plan (the 2012 Global Restructuring Plan) to realign its global workforce and enhance its ability to invest for growth. Under this plan, Applied implemented a voluntary retirement program and other workforce reduction actions. The voluntary retirement program was available to certain U.S. employees who met minimum age and length of service requirements, as well as other business-specific criteria. Applied implemented other workforce reduction actions globally across multiple business segments and functions, the extent of which depended on the number of employees who participated in the voluntary retirement program and other considerations. A total of approximately 1,300 positions were affected under this plan.
During the three months ended January 26, 2014 and January 27, 2013, Applied recognized $7 million and $4 million, respectively, of employee-related costs in connection with the 2012 Global Restructuring Plan. These costs were not allocated to the segments. As of January 26, 2014, principal activities related to this plan were complete. Total costs incurred in implementing this plan were $152 million.


23


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)



Restructuring Reserves
Changes in restructuring reserves during the three months ended January 26, 2014 were as follows:
 
 
2012 Global Restructuring Plan
 
2012 EES Restructuring Plan
 
Others
 
 
 
Severance and Other Employee-Related Costs
 
Severance and Other Employee-Related Costs
 
Contract Cancellation and Other Costs
 
Severance and Other Employee-Related Costs
 
Contract Cancellation and Other Costs
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
(In millions)
Balance, October 27, 2013
$
26

 
$
5

 
$
5

 
$
2

 
$
1

 
$
39

Provision for restructuring reserves
7

 

 

 

 

 
7

Consumption of reserves
(15
)
 
(1
)
 

 
(1
)
 

 
(17
)
Reclassification of restructuring reserves

 
(1
)
 

 

 

 
(1
)
Balance, January 26, 2014
$
18

 
3

 
5

 
$
1

 
$
1

 
$
28



24


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




Note 12
Stockholders’ Equity, Comprehensive Income and Share-Based Compensation
Accumulated Other Comprehensive Income (Loss)
Changes in the components of AOCI, net of tax, were as follows:
 
 
Unrealized Gain on Investments, Net
 
Unrealized Gain on Derivative Instruments Qualifying as Cash Flow Hedges
 
Pension Liability
 
Cumulative Translation Adjustments
 
Total
 
(in millions)
 
 
Balance at October 27, 2013
$
25

 
$
2

 
$
(72
)
 
$
7

 
$
(38
)
Other comprehensive income before reclassifications
2

 
3

 

 
(2
)
 
3

Amounts reclassified out of AOCI
(5
)
 
(4
)
 

 

 
(9
)
Other comprehensive loss, net of tax
(3
)
 
(1
)
 

 
(2
)
 
(6
)
Balance at January 26, 2014
$
22

 
$
1

 
$
(72
)
 
$
5

 
$
(44
)

The effects on net income of amounts reclassified from AOCI for the three months ended January 26, 2014 were as follows:
Comprehensive Income Components
Location
 
Gains (Losses) Reclassified from AOCI
 
 
 
(in millions)
Unrealized Gain on Investments, Net
Interest and other income, net
 
$
8

 
Provision for income taxes
 
(3
)
 
Net of tax
 
$
5

 
 
 
 
Unrealized Gain on Derivative Instruments Qualifying as Cash Flow Hedges
Costs of products sold
 
$
3

 
General and administrative
 
3

 
Provision for income taxes
 
(2
)
 
Net of tax
 
$
4

 
 
 
 
Total amount reclassified from AOCI, net of tax
 
 
$
9



25


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)



Stock Repurchase Program

On March 5, 2012, Applied's Board of Directors approved a 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 on the open market. Applied did not repurchase any shares of its common stock during the three months ended January 26, 2014. At January 26, 2014, $1.6 billion remained available for future stock repurchases under this repurchase program.
The following table summarizes Applied’s stock repurchases for the three months ended January 27, 2013:
 
 
 
Three Months Ended
 
 
January 27,
2013
 
 
 
 
(In millions, except per share amounts)
Shares of common stock repurchased
 
4

Cost of stock repurchased
 
$
48

Average price paid per share
 
$
11.15

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
In December 2013, Applied's Board of Directors declared a quarterly cash dividend in the amount of $0.10 per share to be paid in March 2014. Dividends declared during the three months ended January 26, 2014 and January 27, 2013 were $121 million and $108 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.

26


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




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 the three months ended January 26, 2014 and January 27, 2013, 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:
 
 
Three Months Ended
 
January 26,
2014
 
January 27,
2013
 
 
 
 
 
(In millions)
Share-based compensation
$
46

 
$
42

Tax benefit recognized
$
13

 
$
12

The effect of share-based compensation on the results of operations for the three months ended January 26, 2014 and January 27, 2013 was as follows:
 
 
Three Months Ended
 
January 26,
2014
 
January 27,
2013
 
 
 
 
 
(In millions)
Cost of products sold
$
14

 
$
12

Research, development, and engineering
17

 
12

Marketing and selling
6

 
5

General and administrative
9

 
8

Restructuring charge

 
5

Total
$
46

 
$
42

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 January 26, 2014, Applied had $305 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 2.8 years. At January 26, 2014, there were 177 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.


27


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




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.
 
Stock option activity for the three months ended January 26, 2014 was as follows:
 
 
Shares
 
Weighted
Average
Exercise
Price
 
 
 
 
 
(In millions, except per share amounts)
Outstanding at October 27, 2013
6

 
$
9.12

Granted

 
$

Exercised
(1
)
 
$
8.45

Canceled and forfeited
(1
)
 
$
18.93

Outstanding at January 26, 2014
4

 
$
8.98

Exercisable at January 26, 2014
3

 
$
7.18

 
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, generally 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.

28


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




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 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.
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 January 26, 2014*
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%
___________________
* subject to additional time-based vesting requirements

29


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




A summary of the changes in restricted stock units, restricted stock, performance shares and performance units outstanding under Applied’s equity compensation plans during the three months ended January 26, 2014 is presented below:
 
 
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, performance shares and performance units at October 27, 2013
38

 
$
11.11

 
2.4 years
Granted
8

 
$
16.10

 
 
Vested
(9
)
 
$
10.79

 
 
Canceled
(1
)
 
$
11.28

 
 
Non-vested restricted stock units, restricted stock, performance shares and performance units at January 26, 2014
36

 
$
12.07

 
2.8 years
At January 26, 2014, 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.


Note 13    Employee Benefit Plans
Applied sponsors a number of employee benefit plans, including defined benefit plans of certain foreign subsidiaries, and a plan that provides certain medical and vision benefits to eligible retirees. A summary of the components of net periodic benefit costs of these defined and postretirement benefit plans for the three months ended January 26, 2014 and January 27, 2013 is presented below:
 
Three Months Ended
January 26,
2014
 
January 27,
2013
(In millions)
Service cost
$
4

 
$
5

Interest cost
4

 
4

Expected return on plan assets
(3
)
 
(3
)
Amortization of actuarial loss
1

 
2

Net periodic benefit cost
$
6

 
$
8



30


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




Note 14    Income Taxes
Applied’s effective tax rates for the first quarter of fiscal 2014 and 2013 were 19.7 percent and (88.9) percent, respectively.
The effective tax rate for the first quarter of fiscal 2014 was higher than in the same period in the prior year primarily due to an $11 million benefit in the first quarter of fiscal 2013 related to the resolution of income tax filings for Varian, a $10 million benefit in the first quarter of fiscal 2013 related to reinstatement of the U.S. federal research and development (R&D) tax credit retroactive to January 1, 2012, expiration of the U.S. federal R&D tax credit during the first quarter of fiscal 2014 and changes in the geographical composition of income.
During the next twelve months, it is reasonably possible that existing liabilities for unrecognized tax benefits could be reduced by up to $127 million as a result of agreements with taxing authorities and the expiration of statutes of limitation. Applied expects that such reductions will not have a material impact on its annual effective tax rate.

Note 15
Warranty, Guarantees and Contingencies    
Warranty
Changes in the warranty reserves during the three months ended January 26, 2014 and January 27, 2013 were as follows:
 
 
Three Months Ended
 
January 26,
2014
 
January 27,
2013
 
 
 
 
 
(In millions)
Beginning balance
$
102

 
$
119

Provisions for warranty
27

 
24

Consumption of reserves
(23
)
 
(34
)
Ending balance
$
106

 
$
109

 
Applied products are generally sold with a warranty for a 12-month period following installation. The provision for the estimated cost of warranty is recorded when revenue is recognized. Parts and labor are covered under the terms of the warranty agreement. The warranty provision is based on historical experience by product, configuration and geographic region. Quarterly warranty consumption is generally associated with sales that occurred during the preceding four quarters, and quarterly warranty provisions are generally related to the current quarter’s sales.
Guarantees
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 January 26, 2014, the maximum potential amount of future payments that Applied could be required to make under these guarantee agreements was approximately $43 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 January 26, 2014, Applied Materials, Inc. has provided parent guarantees to banks for approximately $102 million to cover these arrangements.

31


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




Legal Matters
Korea Criminal Proceedings
In 2010, the Seoul Eastern District Court began hearings on indictments brought by the Seoul Prosecutor's Office for the Eastern District of Korea (the Prosecutor's Office) alleging that employees of several companies improperly received and used confidential information belonging to Samsung Electronics Co., Ltd. (Samsung), a major Applied customer based in Korea. The individuals charged included the former head of Applied Materials Korea (AMK), who at the time of the indictment was a vice president of Applied Materials, Inc., and certain other AMK employees. Neither Applied nor any of its subsidiaries was named as a party to the proceedings. Hearings on these matters concluded in November 2012 and the Court issued its decision on February 7, 2013. As part of the ruling, nine AMK employees (including the former head of AMK) were acquitted of all charges, while one AMK employee was found guilty on some of the charges and received a suspended jail sentence. The Prosecutor's Office and various individuals filed notices of appeal, and hearings are underway in the appeals. A ruling is expected later in 2014.

Other Matters
From time to time, Applied receives notification from third parties, including customers and suppliers, seeking indemnification, litigation support, payment of money or other actions by Applied in connection with claims made against them. In addition, from time to time, Applied receives notification from third parties claiming that Applied may be or is infringing or misusing their intellectual property or other rights. Applied also is subject to various other legal proceedings and claims, both asserted and unasserted, that arise in the ordinary course of business.
 
Although the outcome of the above-described matters, claims and proceedings cannot be predicted with certainty, Applied does not believe that any will have a material effect on its consolidated financial condition or results of operations.



32


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)



Note 16
Industry Segment Operations
Applied’s four reportable segments are: Silicon Systems Group, Applied Global Services, Display, and Energy and Environmental Solutions. As defined in the accounting literature, Applied’s chief operating decision-maker has been identified as the President and Chief Executive Officer, who reviews operating results to make decisions about allocating resources and assessing performance for the entire Company. Segment information is presented based upon Applied’s management organization structure as of January 26, 2014 and the distinctive nature of each segment. Future changes to this internal financial structure may result in changes to Applied’s reportable segments.
Each reportable segment is separately managed and has separate financial results that are reviewed by Applied’s chief operating decision-maker. Each reportable segment contains closely related products that are unique to the particular segment. Segment operating income is determined based upon internal performance measures used by Applied’s chief operating decision-maker.
Applied derives the segment results directly from its internal management reporting system. The accounting policies Applied uses to derive reportable segment results are substantially the same as those used for external reporting purposes. Management measures the performance of each reportable segment based upon several metrics including orders, net sales and operating income. Management uses these results to evaluate the performance of, and to assign resources to, each of the reportable segments. Applied does not allocate to its reportable segments certain operating expenses that it manages separately at the corporate level, which include costs related to share-based compensation; certain management, finance, legal, human resources, and research, development and engineering 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. Segment operating income excludes interest income/expense and other financial charges and income taxes. Management does not consider the unallocated costs in measuring the performance of the reportable segments.
The Silicon Systems Group segment includes semiconductor capital equipment for etch, rapid thermal processing, deposition, chemical mechanical planarization, metrology and inspection, wafer packaging, and ion implantation.
The Applied Global Services segment includes technically differentiated products and services to improve operating efficiency, reduce operating costs and lessen the environmental impact of semiconductor, display and solar customers’ factories. Applied Global Services’ products consist of spares, services, certain earlier generation products, remanufactured equipment, and products that have reached a particular stage in the product lifecycle. Customer demand for these products and services is fulfilled through a global distribution system with trained service engineers located in close proximity to customer sites.
The Display segment includes products for manufacturing LCDs, organic light-emitting diodes (OLEDs), and other display technologies for TVs, personal computers, tablets, smart phones, and other consumer-oriented devices.
 
The Energy and Environmental Solutions segment includes products for fabricating solar photovoltaic cells and modules, as well as high throughput roll-to-roll deposition equipment for flexible electronics and other applications.


33


APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (Continued)




Net sales and operating income (loss) for each reportable segment for the three months ended January 26, 2014 and January 27, 2013 were as follows:
 
 
Three Months Ended
 
Net Sales
 
Operating
Income  (Loss)
 
 
 
 
 
(In millions)
January 26, 2014:
 
 
 
Silicon Systems Group
$
1,484

 
$
314

Applied Global Services
507

 
125

Display
159

 
26

Energy and Environmental Solutions
40

 
(11
)
Total Segment
$
2,190

 
$
454

January 27, 2013:
 
 
 
Silicon Systems Group
$
969

 
$
134

Applied Global Services
471

 
89

Display
87

 
3

Energy and Environmental Solutions
46

 
(54
)
Total Segment
$
1,573

 
$
172


Operating results for the three months ended January 26, 2014 and January 27, 2013 included restructuring charges and asset impairments as discussed in detail in Note 11, Restructuring Charges and Asset Impairments.

Reconciliations of total segment operating results to Applied consolidated totals for the three months ended January 26, 2014 and January 27, 2013 were as follows:
 
 
Three Months Ended
 
January 26,
2014
 
January 27,
2013
 
 
 
 
 
(In millions)
Total segment operating income
$
454

 
$
172

Corporate and unallocated costs
(117
)
 
(129
)
Restructuring charges and asset impairments
(7
)
 
(4
)
Income from operations
$
330

 
$
39


The following customers accounted for at least 10 percent of Applied’s net sales for the three months ended January 26, 2014, which were for products in multiple reportable segments.
 
 
Percentage of Net Sales
Taiwan Semiconductor Manufacturing Company Limited
27
%
Samsung Electronics Co., Ltd.
24
%



34



Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following management's discussion and analysis is provided in addition to the accompanying consolidated condensed financial statements and notes to assist in understanding Applied's results of operations and financial condition. Financial information as of January 26, 2014 should be read in conjunction with the financial statements for the fiscal year ended October 27, 2013 contained in the Company's Form 10-K filed December 4, 2013.
All statements in this report and those made by the management of Applied, other than statements of historical fact, are forward-looking statements. Examples of forward-looking statements include those regarding Applied’s future financial or operating results, 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 joint ventures, the proposed business combination with Tokyo Electron Limited, growth opportunities, restructuring activities, customer demand and spending, backlog, working capital, liquidity, investment portfolio and policies, and legal proceedings and claims, as well as industry trends and outlooks. 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. These forward-looking statements are based on management’s estimates, projections and assumptions as of the date hereof and include the assumptions that underlie such statements. Any expectations based on forward-looking statements are subject to risks and uncertainties and other important factors, including those discussed in Part II, 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. Applied undertakes no obligation to revise or update any forward-looking statements.

Overview
Applied provides manufacturing equipment, services and software to the global semiconductor, flat panel display, solar photovoltaic (PV) and related industries. Applied’s customers include manufacturers of semiconductor wafers and chips, flat panel liquid crystal and other displays, solar PV cells and modules, 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 operates in four reportable segments: Silicon Systems Group, Applied Global Services, Display, and Energy and Environmental Solutions. A summary of financial information for each reportable segment is found in Note 16 of Notes to Consolidated Condensed Financial Statements. A discussion of factors that could affect Applied’s operations is set forth under “Risk Factors” in Part II, 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 worldwide demand for semiconductors, which in turn depends on end-user demand for electronic products. Each of Applied’s businesses is subject to highly cyclical industry conditions, as demand for manufacturing equipment and services can change depending on supply and demand for chips, display technologies, solar PVs 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. In light of this cyclicality, Applied's results can vary significantly year-over-year, as well as quarter-over-quarter.





35


The following table presents certain significant measurements for the periods indicated:
 
 
Three Months Ended
 
Change
 
January 26,
2014
 
October 27,
2013
 
January 27,
2013
 
Q1 2014
over
Q4 2013
 
Q1 2014
over
Q1 2013
 
 
 
 
 
 
 
 
 
 
 
(In millions, except per share amounts and percentages)
New orders
$
2,285

 
$
2,092

 
$
2,113

 
$
193

 
$
172

Net sales
$
2,190

 
$