Stockholders' Equity, Comprehensive Income and Share-Based Compensation

6 Months Ended

May 01, 2011

Stockholders' Equity, Comprehensive Income and Share-Based Compensation [Abstract]

Stockholders' Equity, Comprehensive Income and Share-Based Compensation

Note 11   Stockholders’ Equity, Comprehensive Income and Share-Based Compensation

Comprehensive Income

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

	Three Months Ended						Six Months Ended
	May 1,			May 2,			May 1,			May 2,
	2011			2010			2011			2010
				(In millions)
Net income	$	489		$	264		$	995		$	347
Change in unrealized net gain on investments		(1	)		—			(2	)		2
Change in unrealized net gain on derivative instruments
qualifying as cash flow hedges		3			2			2			1
Change in defined benefit plan liability		(1	)		—			(1	)		—
Foreign currency translation adjustments		—			(2	)		—			(2	)
Comprehensive income	$	490		$	264		$	994		$	348

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

	May 1,			October 31,
	2011			2010
	(In millions)
Pension liability	$	(40	)	$	(39	)
Unrealized gain on investments, net		23			25
Unrealized gain on derivative instruments qualifying as cash flow hedges		6			4
Cumulative translation adjustments		12			12
	$	1		$	2

For further details on derivative instruments, see Note 5 of the Notes to Consolidated Condensed Financial Statements.

Stock Repurchase Program

On March 8, 2010, Applied’s Board of Directors approved a new stock repurchase program authorizing up to $2.0 billion in repurchases over the next three years ending in March 2013. Under this authorization, Applied renewed its systematic stock repurchase program and may also make supplemental stock repurchases from time to time, depending on market conditions, stock price and other factors. During the three months ended May 1, 2011, Applied repurchased 8 million shares of its common stock at an average price of $15.54 per share for a total cash outlay of $118 million. During the six months ended May 1, 2011, Applied repurchased 19 million shares of its common stock at an average price of $14.48 per share for a total cash outlay of $268 million.

During the three and six months ended May 2, 2010, Applied repurchased 8 million shares of its common stock at an average price of $13.10 per share for a total cash outlay of $100 million. In light of the planned Varian acquisition (discussed in Note 16 of Notes to Consolidated Condensed Financial Statements), Applied expects to temporarily reduce the amount of its stock repurchases.

Dividends

On March 8, 2011, Applied’s Board of Directors approved an increase in the quarterly cash dividend to $0.08 per share, payable on June 22, 2011 to stockholders of record as of June 1, 2011. In December 2010, Applied’s Board of Directors declared a quarterly cash dividend in the amount of $0.07 per share that was paid on March 23, 2011 to stockholders of record as of March 2, 2011. Applied currently anticipates that it will continue to pay cash dividends on a quarterly basis in the future, although the declaration and amount of any future cash dividend are at the discretion of the Board of Directors and will depend on Applied’s financial condition, results of operations, capital requirements, business conditions and other factors, as well as a determination that cash dividends are in the best interest of Applied’s stockholders.

Share-Based Compensation

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

During the three and six months ended May 1, 2011 and May 2, 2010, Applied recognized equity-based compensation expense related to stock options, ESPP shares, restricted stock units and restricted stock. Total equity-based compensation and related tax benefits were as follows:

	Three Months Ended				Six Months Ended
	May 1,		May 2,		May 1,		May 2,
	2011		2010		2011		2010
	(In millions)				(In millions)
Equity-based compensation	$	38	$	29	$	72	$	62
Tax benefit recognized	$	11	$	9	$	21	$	18

The effect of share-based compensation on the results of operations for the three and six months ended May 1, 2011 and May 2, 2010 was as follows:

	Three Months Ended				Six Months Ended
	May 1,		May 2,		May 1,		May 2,
	2011		2010		2011		2010
	(In millions)				(In millions)
Cost of products sold	$	13	$	8	$	24	$	13
Research, development, and engineering		12		10		22		22
General and administrative		9		7		18		16
Marketing and selling		4		4		8		11
Total share-based compensation	$	38	$	29	$	72	$	62

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 May 1, 2011, Applied had $253 million in total unrecognized compensation expense, net of estimated forfeitures, related to stock option, restricted stock unit, restricted stock grants and ESPP, which will be recognized over a weighted average period of 2.8 years. At May 1, 2011, there were 156 million shares available for stock option, restricted stock unit, and restricted stock grants and an additional 56 million shares available for issuance under the ESPP.

Stock Options

Applied grants options to purchase 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. Most options are scheduled to vest over four years and expire no later than seven years from the grant date. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. This model was developed for use in estimating the value of publicly traded options that have no vesting restrictions and are fully transferable. Applied’s employee stock options have characteristics significantly different from those of publicly traded options. There were no stock options granted in the six months ended May 1, 2011.

Stock option activity for the six months ended May 1, 2011 was as follows:

				Weighted
				Average
				Exercise
	Shares			Price
	(In millions, except per share amounts)
Outstanding, at October 31, 2010		51		$	15.04
Granted		—		$	—
Exercised		(4	)	$	9.39
Canceled and forfeited		(13	)	$	21.16
Outstanding at May 1, 2011		34		$	13.21
Exercisable at May 1, 2011		28		$	14.30

Restricted Stock Units and Restricted Stock

Restricted stock units are converted into shares of Applied common stock upon vesting on a one-for-one basis. Restricted stock has the same rights as other issued and outstanding shares of Applied common stock except these shares have no right to dividends and are held in escrow until the award vests. Restricted stock units and awards of restricted stock typically vest over three to four years. Vesting of restricted stock units and restricted stock usually is subject to the grantee’s continued service with Applied and, in some cases, achievement of specified performance goals. The compensation expense related to these 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. Beginning in fiscal 2007, Applied initiated a performance-based equity award program for named executive officers and other key employees. Awards of restricted stock units or restricted stock granted under this program vest only if specific performance goals set by the Human Resources and Compensation Committee of Applied’s Board of Directors (the Committee) are achieved and if the grantee remains employed by Applied through the applicable vesting date. The performance goals require the achievement of targeted adjusted annual operating profit margin levels as compared to Applied’s peer companies in at least one of the four fiscal years beginning with the fiscal year of the grant. The fair value of these performance-based awards is estimated using the fair market value of Applied common stock on the date of the grant and assumes that the specified performance goals will be achieved. If achieved, these awards vest over a specified remaining service period. 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. The Committee approved the grant of 2 million performance-based restricted stock units and 0.1 million performance-based shares of restricted stock under this program in the six months ended May 1, 2011. With respect to the performance-based awards granted in fiscal 2010, as of May 1, 2011, 40 percent of the awards had been earned, subject to additional time-based vesting requirements. The remaining 60 percent of the awards may still be earned, depending on future performance in one or more of fiscal years 2011 through 2013. With respect to most of the performance-based awards granted in fiscal 2008, as of May 1, 2011, 78 percent of the awards had been earned, subject to additional time-based vesting requirements. The remaining 22 percent of the awards may still be earned depending on performance during fiscal 2011.

Restricted stock unit and restricted stock activity for the six months ended May 1, 2011 was as follows:

				Weighted		Weighted
				Average		Average
				Grant Date		Remaining
	Shares			Fair Value		Contractual Term
	(In millions, except per share amounts)
Non-vested restricted stock units and restricted stock at October 31, 2010		18		$	13.33		2.8 Years
Granted		14		$	12.66
Vested		(3	)	$	13.59
Canceled		(1	)	$	13.27
Non-vested restricted stock units and restricted stock at May 1, 2011		28		$	12.96		3.0 Years

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 $3.61 and $3.00 for the three and six months ended May 1, 2011 and May 2, 2010, respectively. The number of shares issued under the ESPP during the three and six months ended May 1, 2011 and May 2, 2010 was 3 million and 2 million, respectively. Compensation expense is calculated using the fair value of the employees’ purchase rights under the Black-Scholes model. Underlying assumptions used in the model are outlined in the following table:

	Three Months Ended						Six Months Ended
	May 1,			May 2,			May 1,			May 2,
	2011			2010			2011			2010
ESPP:
Dividend yield		1.98	%		2.24	%		1.98	%		2.24	%
Expected volatility		27	%		33	%		27	%		33	%
Risk-free interest rate		0.17	%		0.18	%		0.17	%		0.18	%
Expected life (in years)		0.5			0.5			0.5			0.5