XNAS:AMAT Applied Materials Inc Quarterly Report 10-Q Filing - 7/29/2012

Effective Date 7/29/2012

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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 July 29, 2012
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. (Check one):
Large accelerated filer þ
Accelerated filer ¨
 
Non-accelerated filer ¨
Smaller reporting company ¨
 
 
(Do not check if a 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 July 29, 2012: 1,237,495,151




APPLIED MATERIALS, INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JULY 29, 2012
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:    
 


2


PART I. FINANCIAL INFORMATION
Item 1.    Financial Statements
APPLIED MATERIALS, INC.
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
 
Three Months Ended
 
Nine Months Ended
 
July 29,
2012
 
July 31,
2011
 
July 29,
2012
 
July 31,
2011
 
(Unaudited)
(In millions, except per share amounts)
Net sales
$
2,343

 
$
2,787

 
$
7,073

 
$
8,336

Cost of products sold
1,413

 
1,603

 
4,347

 
4,827

Gross margin
930

 
1,184

 
2,726

 
3,509

Operating expenses:
 
 
 
 
 
 
 
Research, development and engineering
309

 
282

 
933

 
850

Selling, general and administrative
255

 
240

 
839

 
679

Restructuring charges and asset impairments (Note 11)
44

 
3

 
44

 
(30
)
Gain on sale of facilities, net (Note 7)

 
(28
)
 

 
(27
)
Total operating expenses
608

 
497

 
1,816

 
1,472

Income from operations
322

 
687

 
910

 
2,037

Impairment of strategic investments (Notes 3 and 4)

 

 
3

 

Interest and other expenses
24

 
25

 
72

 
35

Interest and other income, net
4

 
7

 
13

 
33

Income before income taxes
302

 
669

 
848

 
2,035

Provision for income taxes
84

 
193

 
224

 
564

Net income
$
218

 
$
476

 
$
624

 
$
1,471

 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.17

 
$
0.36

 
$
0.49

 
$
1.11

Diluted
$
0.17

 
$
0.36

 
$
0.48

 
$
1.10

Weighted average number of shares:
 
 
 
 
 
 
 
Basic
1,257

 
1,318

 
1,282

 
1,321

Diluted
1,268

 
1,330

 
1,292

 
1,333






See accompanying Notes to Consolidated Condensed Financial Statements.

3


APPLIED MATERIALS, INC.
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
 
Three Months Ended
 
Nine Months Ended
 
July 29,
2012
 
July 31,
2011
 
July 29,
2012
 
July 31,
2011
 
(Unaudited)
(In millions)
Net income
$
218

 
$
476

 
$
624

 
$
1,471

Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Change in unrealized net gain (loss) on investments
(9
)
 
(1
)
 
(6
)
 
(2
)
Change in unrealized net gain (loss) on derivative investments
(4
)
 
(6
)
 
(4
)
 
(4
)
Change in defined benefit plan liability

 

 

 
(1
)
Change in cumulative translation adjustments
1

 
1

 
(1
)
 
1

Other comprehensive income (loss)
(12
)
 
(6
)
 
(11
)
 
(6
)
Comprehensive income
$
206

 
$
470

 
$
613

 
$
1,465







See accompanying Notes to Consolidated Condensed Financial Statements.

4


APPLIED MATERIALS, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
 
 
July 29,
2012
 
October 30,
2011
 
(In millions)
ASSETS
Current assets:
 
 
 
Cash and cash equivalents (Notes 3 and 4)
$
1,529

 
$
5,960

Short-term investments (Notes 3 and 4)
635

 
283

Accounts receivable, net (Note 6)
1,535

 
1,532

Inventories (Note 7)
1,380

 
1,701

Deferred income taxes, net
498

 
580

Other current assets
288

 
299

Total current assets
5,865

 
10,355

Long-term investments (Notes 3 and 4)
1,058

 
931

Property, plant and equipment, net (Note 7)
917

 
866

Goodwill (Notes 8 and 9)
3,939

 
1,335

Purchased technology and other intangible assets, net (Notes 8 and 9)
1,410

 
211

Deferred income taxes and other assets
131

 
163

Total assets
$
13,320

 
$
13,861

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
 
 
 
Accounts payable and accrued expenses (Note 7)
$
1,410

 
$
1,520

Customer deposits and deferred revenue (Note 7)
937

 
1,116

Income taxes payable
61

 
158

Total current liabilities
2,408

 
2,794

Long-term debt (Note 10)
1,946

 
1,947

Deferred income taxes and income taxes payable
386

 
104

Employee benefits and other liabilities
241

 
216

Total liabilities
4,981

 
5,061

Stockholders’ equity (Note 12):
 
 
 
Common stock
12

 
13

Additional paid-in capital
5,772

 
5,616

Retained earnings
13,323

 
13,029

Treasury stock
(10,763
)
 
(9,864
)
Accumulated other comprehensive income (loss)
(5
)
 
6

Total stockholders’ equity
8,339

 
8,800

Total liabilities and stockholders’ equity
$
13,320

 
$
13,861


Amounts as of July 29, 2012 are unaudited. Amounts as of October 30, 2011 are derived from the October 30, 2011 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 30, 2011
1,306

 
$
13

 
$
5,616

 
$
13,029

 
573

 
$
(9,864
)
 
$
6

 
$
8,800

Net income

 

 

 
624

 

 

 

 
624

Other comprehensive income (loss)

 

 

 

 

 

 
(11
)
 
(11
)
Dividends

 

 

 
(330
)
 

 

 

 
(330
)
Share-based compensation

 

 
138

 

 

 

 

 
138

Stock options assumed in connection with acquisition

 

 
11

 

 

 

 

 
11

Issuance under stock plans, net of tax detriment of $15 and other
12

 

 
7

 

 

 

 

 
7

Common stock repurchases
(81
)
 
(1
)
 

 

 
81

 
(899
)
 

 
(900
)
Balance at July 29, 2012
1,237

 
$
12

 
$
5,772

 
$
13,323

 
654

 
$
(10,763
)
 
$
(5
)
 
$
8,339







See accompanying Notes to Consolidated Condensed Financial Statements.

6


APPLIED MATERIALS, INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
 
Nine Months Ended
 
July 29,
2012
 
July 31,
2011
 
(Unaudited)
(In millions)
Cash flows from operating activities:
 
 
 
Net income
$
624

 
$
1,471

Adjustments required to reconcile net income to cash provided by operating activities:
 
 
 
Depreciation and amortization
325

 
187

Net loss (gain) on dispositions and fixed asset retirements
11

 
(24
)
Provision for bad debts
9

 

Restructuring charges and asset impairments
44

 
(30
)
Deferred income taxes
105

 
(100
)
Net loss on investments and amortization on debt securities
16

 
13

Impairment of strategic investments
3

 

Share-based compensation
138

 
110

Changes in operating assets and liabilities, net of amounts acquired:
 
 
 
Accounts receivable
183

 
17

Inventories
571

 
(310
)
Other current assets
43

 
(36
)
Other assets
4

 
1

Accounts payable and accrued expenses
(356
)
 
(92
)
Customer deposits and deferred revenue
(230
)
 
498

Income taxes payable
(49
)
 
4

Employee benefits and other liabilities
(1
)
 
19

Cash provided by operating activities
1,440

 
1,728

Cash flows from investing activities:
 
 
 
Capital expenditures
(121
)
 
(136
)
Cash paid for acquisition, net of cash acquired
(4,189
)
 

Proceeds from sale of facilities and dispositions, net of cash sold

 
126

Proceeds from sales and maturities of investments
765

 
1,173

Purchases of investments
(1,152
)
 
(945
)
Cash provided by (used in) investing activities
(4,697
)
 
218

Cash flows from financing activities:
 
 
 
Debt borrowings (repayments), net
(1
)
 
1,744

Payments of debt issuance costs

 
(14
)
Proceeds from common stock issuances
52

 
64

Common stock repurchases
(900
)
 
(293
)
Payments of dividends to stockholders
(323
)
 
(291
)
Cash provided by (used in) financing activities
(1,172
)
 
1,210

Effect of exchange rate changes on cash and cash equivalents
(2
)
 
4

Increase (decrease) in cash and cash equivalents
(4,431
)
 
3,160

Cash and cash equivalents — beginning of period
5,960

 
1,858

Cash and cash equivalents — end of period
$
1,529

 
$
5,018

Supplemental cash flow information:
 
 
 
Cash payments for income taxes
$
233

 
$
661

Cash refunds from income taxes
$
5

 
$
4

Cash payments for interest
$
87

 
$
7

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 30, 2011 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 30, 2011 (2011 Form 10-K). Applied’s results of operations for the three and nine months ended July 29, 2012 are not necessarily indicative of future operating results. Applied’s fiscal year ends on the last Sunday in October of each year. Fiscal 2012 and 2011 each contain 52 weeks, and the first nine months of fiscal 2012 and 2011 each contained 39 weeks.
In November 2011, Applied completed its acquisition of Varian Semiconductor Equipment Associates, Inc. (Varian). Beginning in the first quarter of fiscal 2012, the acquired business is included in Applied’s consolidated results of operations and the results of the Silicon Systems Group and Applied Global Services segments.
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, Applied recognizes revenue upon shipment 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, 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 2012, the Financial Accounting Standards Board amended its existing guidance for goodwill and other intangible assets. This authoritative guidance gives companies the option to first perform a qualitative assessment to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired. To perform a qualitative assessment, a company must identify and evaluate changes in economic, industry and company-specific events and circumstances that could affect the significant inputs used to determine the fair value of an indefinite-lived intangible asset. If a company determines that it is more likely than not that the fair value of such an asset exceeds its carrying amount, it would not need to calculate the fair value of the asset in that year. This authoritative guidance becomes effective for Applied in the first quarter of fiscal 2013, with early adoption permitted. The implementation of this authoritative guidance is not expected to have a material 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 plan 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
 
Nine Months Ended
 
July 29,
2012
 
July 31,
2011
 
July 29,
2012
 
July 31,
2011
 
(In millions, except per share amounts)
Numerator:
 
 
 
 
 
 
 
Net income
$
218

 
$
476

 
$
624

 
$
1,471

Denominator:
 
 
 
 
 
 
 
Weighted average common shares outstanding
1,257

 
1,318

 
1,282

 
1,321

Effect of dilutive stock options, restricted stock units and employee stock purchase plan shares
11

 
12

 
10

 
12

Denominator for diluted earnings per share
1,268

 
1,330

 
1,292

 
1,333

Basic earnings per share
$
0.17

 
$
0.36

 
$
0.49

 
$
1.11

Diluted earnings per share
$
0.17

 
$
0.36

 
$
0.48

 
$
1.10

Potentially dilutive securities
11

 
17

 
12

 
17

 

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:
July 29, 2012
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
(In millions)
Cash
$
734

 
$

 
$

 
$
734

Cash equivalents:
 
 
 
 
 
 
 
Money market funds
758

 

 

 
758

Municipal securities
19

 

 

 
19

Commercial paper, corporate bonds and medium-term notes
18

 

 

 
18

Total Cash equivalents
795

 

 

 
795

Total Cash and Cash equivalents
$
1,529

 
$

 
$

 
$
1,529

Short-term and long-term investments:
 
 
 
 
 
 
 
U.S. Treasury and agency securities
$
399

 
$
1

 
$

 
$
400

Non-U.S. government securities*
55

 

 

 
55

Municipal securities
386

 
2

 

 
388

Commercial paper, corporate bonds and medium-term notes
413

 
3

 

 
416

Asset-backed and mortgage-backed securities
305

 
4

 
1

 
308

Total fixed income securities
1,558

 
10

 
1

 
1,567

Publicly traded equity securities
45

 
21

 
12

 
54

Equity investments in privately-held companies
72

 

 

 
72

Total short-term and long-term investments
$
1,675

 
$
31

 
$
13

 
$
1,693

Total Cash, Cash equivalents and Investments
$
3,204

 
$
31

 
$
13

 
$
3,222

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


10

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



October 30, 2011
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair  Value
 
(In millions)
Cash
$
297

 
$

 
$

 
$
297

Cash equivalents:
 
 
 
 
 
 
 
Money market funds
5,663

 

 

 
5,663

Total Cash equivalents
5,663

 

 

 
5,663

Total Cash and Cash equivalents
$
5,960

 
$

 
$

 
$
5,960

Short-term and long-term investments:
 
 
 
 
 
 
 
U.S. Treasury and agency securities
$
184

 
$
1

 
$

 
$
185

Non-U.S. government securities
40

 

 

 
40

Municipal securities
371

 
2

 

 
373

Commercial paper, corporate bonds and medium-term notes
216

 
3

 
1

 
218

Asset-backed and mortgage-backed securities
307

 
3

 
1

 
309

Total fixed income securities
1,118

 
9

 
2

 
1,125

Publicly traded equity securities
8

 
19

 

 
27

Equity investments in privately-held companies
62

 

 

 
62

Total short-term and long-term investments
$
1,188

 
$
28

 
$
2

 
$
1,214

Total Cash, Cash equivalents and Investments
$
7,148

 
$
28

 
$
2

 
$
7,174


Maturities of Investments
The following table summarizes the contractual maturities of Applied’s investments at July 29, 2012:
 
Cost
 
Estimated
Fair  Value
 
(In millions)
Due in one year or less
$
600

 
$
600

Due after one through five years
652

 
658

Due after five years
1

 
1

No single maturity date**
422

 
434

 
$
1,675

 
$
1,693

______________
**
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
Gross realized gains and losses on sales of investments during the three and nine months ended July 29, 2012 and July 31, 2011 were as follows:
 
Three Months Ended
 
Nine Months Ended
July 29,
2012
 
July 31,
2011
 
July 29,
2012
 
July 31,
2011
(In millions)
Gross realized gains
$
1

 
$
1

 
$
2

 
$
14

Gross realized losses
$
1

 
$
1

 
$
2

 
$
2

At July 29, 2012, Applied had a gross unrealized loss of $1 million due to a decrease in the fair value of certain fixed income securities. 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 was 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 July 29, 2012 and July 31, 2011 were temporary in nature and therefore it did not recognize any impairment of its marketable securities for the three and nine months ended July 29, 2012 and July 31, 2011. During the nine months ended July 29, 2012, Applied determined that certain of its equity investments held in privately-held companies were other-than-temporarily impaired and, accordingly, recognized impairment charges of $3 million. Applied did not recognize any impairment on its equity investments in privately-held companies for the three months ended July 29, 2012 or for three and nine months ended July 31, 2011.
The following table provides the fair market value of Applied’s investments with unrealized losses that were not deemed to be other-than-temporarily impaired as of July 29, 2012.
 
In Loss Position for
Less Than 12 Months
 
Total
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross
Unrealized
Losses
 
(In millions)
Asset-backed and mortgage-backed securities
$
42

 
$
1

 
$
42

 
$
1

Publicly traded equity securities
14

 
12

 
14

 
12

Total
$
56

 
$
13

 
$
56

 
$
13

The following table provides the fair market value of Applied’s investments with unrealized losses that were not deemed to be other-than-temporarily impaired as of October 30, 2011.
 
In Loss Position for
Less Than 12 Months
 
Total
Fair Value
 
Gross
Unrealized
Losses
 
Fair Value
 
Gross
Unrealized
Losses
 
(In millions)
Commercial paper, corporate bonds and medium-term notes
$
32

 
$
1

 
$
32

 
$
1

Asset-backed and mortgage-backed securities
77

 
1

 
77

 
1

Total
$
109

 
$
2

 
$
109

 
$
2

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.


12

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



Note 4    Fair Value Measurements
Applied’s financial assets are measured and recorded at fair value, except for equity investments held 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 July 29, 2012, 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.
 

13

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



Assets and Liabilities Measured at Fair Value on a Recurring Basis
Financial assets and liabilities (excluding cash balances) measured at fair value on a recurring basis are summarized below as of July 29, 2012 and October 30, 2011:
 
July 29, 2012
 
October 30, 2011
Level 1
 
Level 2
 
Total
 
Level 1
 
Level 2
 
Total
(In millions)
Assets:
 
 
 
 
 
 
 
 
 
 
 
Money market funds
$
758

 
$

 
$
758

 
$
5,663

 
$

 
$
5,663

U.S. Treasury and agency securities
123

 
277

 
400

 
109

 
76

 
185

Non-U.S. government securities

 
55

 
55

 

 
40

 
40

Municipal securities

 
407

 
407

 

 
373

 
373

Commercial paper, corporate bonds and medium-term notes

 
434

 
434

 

 
218

 
218

Asset-backed and mortgage-backed securities

 
308

 
308

 

 
309

 
309

Publicly traded equity securities
54

 

 
54

 
27

 

 
27

Total
$
935

 
$
1,481

 
$
2,416

 
$
5,799

 
$
1,016

 
$
6,815

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Deferred compensation
$
6

 
$

 
$
6

 
$

 
$

 
$

Total
$
6

 
$

 
$
6

 
$

 
$

 
$

The deferred compensation liability represents our obligation to pay benefits under a non-qualified deferred compensation plan. The related investments, held in a rabbi trust, consist of equity securities, primarily mutual funds, and are classified as Level 1 in the valuation hierarchy.
There were no transfers between Level 1 and Level 2 fair value measurements during either the three or nine months ended July 29, 2012 and July 31, 2011. Applied did not have any financial assets or liabilities measured at fair value on a recurring basis within Level 3 fair value measurements as of July 29, 2012 or October 30, 2011.
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. Equity investments in privately-held companies totaled $72 million at July 29, 2012, of which $55 million of investments were accounted for under the cost method of accounting and $17 million of Level 3 investments had been measured at fair value on a non-recurring basis due to an other-than-temporary decline in value. At October 30, 2011, equity investments in privately-held companies totaled $62 million, of which $40 million of investments were accounted for under the cost method of accounting and $22 million of Level 3 investments had been measured at fair value on a non-recurring basis due to an other-than-temporary decline in value. During the three months ended July 29, 2012 and July 31, 2011, there were no transfers in and out of Level 3 equity investments in privately held companies. During the nine months ended July 29, 2012, Level 3 equity investments in privately-held companies of $5 million were transferred to Level 1 assets measured at fair value on a recurring basis due to change in investee structure which improved price transparency. During the nine months ended July 31, 2011, there were no transfers in and out of Level 3 equity investments in privately held companies.

14

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



During the nine months ended July 29, 2012, Applied determined that certain of its equity investments held in privately held companies were other-than-temporarily impaired and, accordingly, recognized impairment charges of $3 million. Applied did not recognize any impairment on its equity method investments in privately-held companies for the three months ended July 29, 2012 and for the three and nine months ended July 31, 2011.
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 the short maturities of these financial instruments. At July 29, 2012, the carrying amount of long-term debt was $1.9 billion and the estimated fair value was $2.3 billion. The estimated fair value of long-term debt is determined by Level 2 inputs and is based on quoted market prices for the same or similar issues.

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 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 within 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 July 29, 2012 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 promptly 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 selling, 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 and nine months ended July 29, 2012 and July 31, 2011.
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 promptly in earnings to offset the changes in the fair value of the assets or liabilities being hedged.
The fair values of derivative instruments at July 29, 2012 and October 30, 2011 were not material.
 

15

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



The effect of derivative instruments on the Consolidated Condensed Statement of Operations for the three and nine months ended July 29, 2012 and July 31, 2011 was as follows:
 
 
 
Three Months Ended July 29, 2012
 
Three Months Ended July 31, 2011
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
 
$
(8
)
 
$

 
$
(1
)
 
$
(7
)
 
$
1

 
$
(2
)
Foreign exchange contracts
General and administrative
 

 
(2
)
 

 

 
2

 

Total
 
 
$
(8
)
 
$
(2
)
 
$
(1
)
 
$
(7
)
 
$
3

 
$
(2
)

 
 
 
Nine Months Ended July 29, 2012
 
Nine Months Ended July 31, 2011
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
 
$
(3
)
 
$
5

 
$
(1
)
 
$
5

 
$
6

 
$
(5
)
Foreign exchange contracts
General and administrative
 

 
(3
)
 
(1
)
 

 
5

 
(1
)
Total
 
 
$
(3
)
 
$
2

 
$
(2
)
 
$
5

 
$
11

 
$
(6
)
 
 
 
 
Amount of Gain or (Loss) Recognized in Income
 
 
Three Months Ended
 
Nine Months Ended
Location of Gain or
(Loss) Recognized
in Income
 
July 29, 2012
 
July 31, 2011
 
July 29, 2012
 
July 31, 2011
 
 
 
(In millions)
Derivatives Not Designated as Hedging Instruments
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
General and
administrative
 
$
(11
)
 
$
(5
)
 
$
3

 
$
(2
)
Total
 
 
$
(11
)
 
$
(5
)
 
$
3

 
$
(2
)

16

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



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 July 29, 2012.
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.


Note 6    Accounts Receivable, Net
Applied has agreements with various financial institutions to sell accounts receivable and discount promissory notes from selected customers. Applied also discounts letters of credit through various financial institutions. Applied sells its accounts receivable without recourse. Details of discounted letters of credit, factored accounts receivable and discounted promissory notes for the three and nine months ended July 29, 2012 and July 31, 2011 were as follows:
 
Three Months Ended
 
Nine Months Ended
July 29,
2012
 
July 31,
2011
 
July 29,
2012
 
July 31,
2011
 
(In millions)
Discounted letters of credit
$

 
$
38

 
$

 
$
211

Factored accounts receivable and discounted promissory notes

 
25

 
70

 
80

Total
$

 
$
63

 
$
70

 
$
291

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 both periods presented.
Accounts receivable are presented net of allowance for doubtful accounts of $82 million at July 29, 2012 and $73 million at October 30, 2011. Applied sells principally to manufacturers within the semiconductor, display and solar industries. As a result of challenging economic and industry conditions, certain of these manufacturers may experience difficulties in meeting their obligations in a timely manner. While Applied believes that its allowance for doubtful accounts is adequate and represents Applied’s best estimate as of July 29, 2012, Applied will continue to closely monitor customer liquidity and other economic conditions, which may result in changes to Applied’s estimates regarding collectability.


17

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



Note 7    Balance Sheet Detail
 
July 29,
2012
 
October 30,
2011
 
(In millions)
Inventories
 
 
 
Customer service spares
$
318

 
$
328

Raw materials
302

 
407

Work-in-process
301

 
336

Finished goods*
459

 
630

 
$
1,380

 
$
1,701

 _______________
*
Included in finished goods inventory is $88 million at July 29, 2012, and $224 million at October 30, 2011, 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, Basis of Presentation. Finished goods inventory also includes $180 million and $140 million of evaluation inventory at July 29, 2012 and October 30, 2011, respectively.

 
Useful Life
 
July 29,
2012
 
October 30,
2011
 
(In years)
 
(In millions)
Property, Plant and Equipment, Net
 
 
 
 
 
Land and improvements
 
 
$
169

 
$
163

Buildings and improvements
3-30
 
1,195

 
1,155

Demonstration and manufacturing equipment
3-5
 
749

 
686

Furniture, fixtures and other equipment
3-15
 
733

 
722

Construction in progress
 
 
46

 
12

Gross property, plant and equipment
 
 
2,892

 
2,738

Accumulated depreciation
 
 
(1,975
)
 
(1,872
)
 
 
 
$
917

 
$
866


During the third quarter of fiscal 2012, fixed asset impairment charges of $11 million were recorded in relation to the Energy and Environmental Solutions segment restructuring plan, as discussed in Note 11, Restructuring Charges and Asset Impairments.

In the third quarter of fiscal 2011, Applied received $60 million in proceeds from the sale of a property located in North America and recognized a gain of $28 million on the transaction. Applied also completed the divestiture of certain assets held for sale for proceeds of $27 million, net of cash sold. In the first quarter of fiscal 2011, Applied received $39 million in proceeds from the sale of a property located in North America and incurred a loss of $1 million on the transaction.

18

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



 
July 29,
2012
 
October 30,
2011
 
(In millions)
Accounts Payable and Accrued Expenses
 
 
 
Accounts payable
$
443

 
$
484

Compensation and employee benefits
396

 
455

Warranty
137

 
168

Dividends payable
111

 
104

Other accrued taxes
49

 
81

Interest payable
14

 
31

Restructuring reserve
26

 
11

Other
234

 
186

 
$
1,410

 
$
1,520


As of July 29, 2012, other accrued expenses included a $13 million acquisition obligation for untendered Varian shares.
 
July 29,
2012
 
October 30,
2011
 
(In millions)
Customer Deposits and Deferred Revenue
 
 
 
Customer deposits
$
229

 
$
249

Deferred revenue
708

 
867

 
$
937

 
$
1,116


Applied typically receives deposits on future deliverables from customers in its Energy and Environmental Solutions and Display segments. In certain instances, customer deposits may be received from customers in the Applied Global Services segment.

Note 8    Business Combination
On November 10, 2011, Applied completed the acquisition of Varian, a public company manufacturer of semiconductor processing equipment and the leading supplier of ion implantation equipment used by chip makers around the world, for an aggregate purchase price of $4.2 billion in cash, net of cash acquired and assumed earned equity awards of $27 million, pursuant to an Agreement and Plan of Merger (the Merger Agreement) dated as of May 3, 2011. Applied’s primary reasons for this acquisition were to complement existing product offerings and to provide opportunities for future growth. Varian designs, markets, manufactures and services ion implantation systems. These systems are primarily used in the manufacture of transistors, which are a basic building block of integrated circuits (ICs) or microchips. Ion implantation systems create a beam of electrically charged particles called ions, which are implanted into transistor structures at precise locations and depths, changing the electrical properties of the semiconductor device. These implantation systems may also be used in other areas of IC manufacture for modifying the material properties of the semiconductor devices, as well as in manufacturing crystalline-silicon solar cells.
Applied allocated the purchase price of this acquisition to tangible and identifiable intangible assets acquired and liabilities assumed, based on their estimated fair values. Applied recorded $2.6 billion in goodwill, which represented the excess of the purchase price over the aggregate estimated fair values of the assets acquired and liabilities assumed in the acquisition. Of this amount, $1.8 billion of goodwill was allocated to the Silicon Systems Group segment, and the remainder was allocated to the Applied Global Services segment. Goodwill associated with the acquisition is primarily attributable to the opportunities from the addition of Varian's product portfolio which complement Applied's Silicon Systems Group's suite of products, including providing integrated process solutions to customers. Goodwill is not deductible for tax purposes. A discussion of the revision made during the second quarter of fiscal 2012 to the initial preliminary purchase price allocation is included in Note 9, Goodwill, Purchased Technology and Other Intangible Assets. During the three months ended July 29, 2012, Applied completed the purchase price allocation for the Varian acquisition and no changes were made since the second quarter of fiscal 2012.

19

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



The following table summarizes the allocation of the assets acquired and liabilities assumed at the acquisition date:
Estimated Fair Values
Acquisition
2012
 
(In millions)
Cash and cash equivalents
$
632

Short-term investments
56

Accounts receivable, net
194

Inventories
250

Deferred income taxes and other current assets
66

Long-term investments
62

Property and equipment, net
104

Goodwill
2,604

Purchased intangible assets
1,365

Other assets
10

Total assets acquired
5,343

Accounts payable and accrued expenses
(134
)
Customer deposits and deferred revenue
(52
)
Income taxes payable
(60
)
Deferred income taxes
(211
)
Other liabilities
(25
)
Total liabilities assumed
(482
)
Purchase price allocated
$
4,861

 
The following table presents details of the purchase price as allocated to purchased intangible assets of Varian at the acquisition date:
 
Useful
Life
 
Purchased
Intangible  Assets
2012
 
(In years)
 
(In millions)
Developed technology
1-7
 
$
987

Customer relationships
15
 
150

In-process technology
 
 
142

Patents and trademarks
10
 
69

Backlog
1
 
7

Covenant not to compete
2
 
10

Total purchased intangible assets
 
 
$
1,365


20

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



The results of operations of Varian are included in Applied’s consolidated results of operations, primarily in the results for the Silicon Systems Group and Applied Global Services segments, beginning in the first quarter of fiscal 2012. For the three months ended July 29, 2012, net sales of approximately $294 million and operating income of approximately $14 million attributable to Varian were included in the consolidated results of operations. For the nine months ended July 29, 2012, net sales of approximately $829 million and operating loss of approximately $117 million attributable to Varian were included in the consolidated results of operations. For the three and nine months ended July 29, 2012, results of operations included charges of $53 million and $275 million, respectively, attributable to inventory fair value adjustments on products sold, amortization of purchased intangible assets, share-based compensation associated with accelerated vesting, deal costs and other integration costs associated with the acquisition. Of these amounts, deal costs and other acquisition-related costs of $1 million and $38 million were not allocated to the segments for the three and nine months ended July 29, 2012, respectively. Deal costs are included in selling, general and administrative expenses in Applied's consolidated results of operations.
The following unaudited pro forma consolidated results of operations assume the acquisition was completed as of the beginning of the fiscal reporting periods presented. The pro forma consolidated results of operations for the three and nine months ended July 31, 2011 combine the results of Applied for the three and nine months ended July 31, 2011, with the results of Varian for the three and nine months ended July 1, 2011.
 
Three Months Ended
 
Nine Months Ended
 
July 29,
2012
 
July 31,
2011
 
July 29,
2012
 
July 31,
2011
 
(In millions, except per share amounts)
Net sales
$
2,343

 
$
3,115

 
$
7,073

 
$
9,276

Net income
$
227

 
$
495

 
$
730

 
$
1,453

Basic earnings per share
$
0.18

 
$
0.38

 
$
0.57

 
$
1.10

Diluted earnings per share
$
0.18

 
$
0.37

 
$
0.56

 
$
1.09

The pro forma results above include adjustments related to the purchase price allocation and financing of the acquisition, primarily to increase depreciation and amortization with the higher values of property, plant and equipment and identifiable intangible assets, to increase interest expense for the additional debt incurred to complete the acquisition, and to reflect the related income tax effect. The pro forma results for the three and nine months ended July 31, 2011 include costs of $4 million and $121 million, respectively, which reduced net income due to inventory fair value adjustments on products sold, share-based compensation associated with accelerated vesting and acquisition-related costs, which are not expected to occur in future quarters. The pro forma information does not necessarily reflect the actual results of operations had the acquisition been consummated at the beginning of the fiscal reporting period indicated nor is it necessarily indicative of future operating results. The pro forma information does not include any potential revenue enhancements, cost synergies or other operating efficiencies that could result from the acquisition.


21

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 cost of the acquisition 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.
In fiscal 2011, Applied adopted authoritative guidance which allows entities to use a qualitative approach to test goodwill for impairment. This authoritative guidance permits an entity to first perform 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, it is necessary to perform the two-step goodwill impairment test. Otherwise, the two-step goodwill impairment test is not required. In the first step of the two-step goodwill impairment test, Applied would compare the estimated fair value of each reporting unit to its carrying value. Applied’s reporting units are consistent with the reportable segments identified in Note 16, Industry Segment Operations, based on the manner in which Applied operates its business and the nature of those operations. Applied determines the fair value of each of its reporting units based on a weighting of income and market approaches. Under the income approach, Applied calculates the fair value of a reporting unit based on the present value of estimated future cash flows. Estimated future cash flows will be impacted by a number of factors including anticipated future operating results, estimated cost of capital and/or discount rates. Under the market approach, Applied estimates the fair value based on market multiples of revenue or earnings for comparable companies, as appropriate. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not impaired and no further testing is performed. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then Applied would perform the second step of the impairment test in order to determine the implied fair value of the reporting unit’s goodwill. Applied would then allocate the fair value of the reporting unit to all of the assets and liabilities of that unit, as if Applied had acquired the reporting unit in a business combination, with the fair value of the reporting unit being the “purchase price.” The excess of the “purchase price” over the carrying amounts assigned to assets and liabilities represents the implied fair value of goodwill. If Applied determined that the carrying value of a reporting unit’s goodwill exceeded its implied fair value, Applied would record an impairment charge equal to the difference.
Applied performed a qualitative assessment to test goodwill for impairment in the fourth quarter of fiscal 2011, and determined that it was more likely than not that each of its reporting units’ fair value exceeded its carrying value and that it was not necessary to perform the two-step goodwill impairment test. Applied tested goodwill of the Energy and Environmental Solutions reporting unit for potential impairment during the second quarter of fiscal 2012 in light of second quarter developments that included current industry trends, financial performance, weaker short-term outlooks, and other adverse operating conditions within the solar industry. The results of the first step of the impairment test indicated that goodwill of the Energy and Environmental Solutions reporting unit was not impaired.

 


22

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



Applied utilized an equal weighting of both the discounted cash flow method of the income approach and the guideline company method of the market approach to estimate the fair value of the Energy and Environmental Solutions reporting unit. The results of the first step of the impairment test indicated that goodwill within the Energy and Environmental Solutions reporting unit was not impaired, as the estimated fair value in excess of carrying value was approximately $700 million (or 73 percent over the carrying value of the reporting unit) at April 1, 2012. The evaluation of goodwill for impairment requires the exercise of significant judgment. The estimates used in the impairment testing were consistent with the discrete forecasts that Applied uses to manage its business, and considered the significant developments that occurred during the quarter. Under the discounted cash flow method, cash flows beyond the discrete forecasts were estimated using a terminal growth rate, which considered the long-term earnings growth rate specific to the Energy and Environmental Solutions reporting unit. The estimated future cash flows were discounted to present value using a discount rate that was the value-weighted average of the reporting unit's estimated cost of equity and debt derived using both known and estimated market metrics, and was adjusted to reflect risk factors that considered both the timing and risks associated with the estimated cash flows. The tax rate used in the discounted cash flow method reflected the international structure currently in place, which is consistent with the market participant perspective. Under the guideline company method, market multiples were applied to forecasted revenues and earnings before interest, taxes, depreciation and amortization. The market multiples used were consistent with the median multiples based on comparable publicly-traded companies. While there are inherent uncertainties related to the significant assumptions used and management's application of these assumptions in conducting the goodwill impairment analysis, Applied believes that the assumptions used provide a reasonable estimate of the fair value of the Energy and Environmental Solutions reporting unit. As discussed in Note 11, Restructuring Charges and Asset Impairments, on May 10, 2012, Applied announced a plan to restructure the Energy and Environmental Solutions segment. The restructuring did not have a significant impact on the fair value of the Energy and Environmental Solutions reporting unit.
Applied also tested goodwill of the Display reporting unit for potential impairment during the second quarter of fiscal 2012 in light of second quarter developments that included current industry trends, the Display reporting unit's financial performance and short-term outlook. The results of the first step of the impairment test indicated that goodwill of the Display reporting unit was not impaired and that the estimated fair value of the reporting unit was more than 100 percent over the carrying value of the reporting unit.
Although the business conditions in the industries in which the Display and Energy and Environmental Solutions reporting units operate remain weak, Applied is not aware of changes in the industries that would significantly impact the last impairment test performed in the second quarter of fiscal 2012. 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 analyses are lower than current estimates, a material impairment charge may result at that time.
During the first nine months of fiscal 2012, goodwill and other indefinite-lived intangible assets increased by $2.7 billion due to the acquisition of Varian as discussed in Note 8, Business Combination. Of this amount, an adjustment of $64 million to increase goodwill was recorded in the second quarter of fiscal 2012 related to the changes in net assets acquired from the Varian acquisition during the measurement period as Applied obtained the necessary information to compute the U.S. tax liability on undistributed earnings of non-U.S. subsidiaries as of the acquisition date. Of the total adjustment in the second quarter of fiscal 2012, $44 million was allocated to the Silicon Systems Group segment and the remainder was allocated to the Applied Global Services segment.
A summary of Applied's purchased technology and intangible assets follows:
 
 
July 29, 2012
 
October 30, 2011
 
 
(In millions)
Purchased technology, net
 
$
988

 
$
127

Intangible assets - finite-lived, net
 
280

 
84

Intangible assets - indefinite-lived
 
142

 

Total
 
$
1,410

 
$
211



23

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



Details of indefinite-lived intangible assets were as follows:
 
July 29, 2012
 
October 30, 2011
Goodwill
 
Other
Intangible
Assets
 
Total
 
Goodwill
 
Other
Intangible
Assets
 
Total
 
(In millions)
Silicon Systems Group
$
2,151

 
$
142

 
$
2,293

 
$
381

 
$

 
$
381

Applied Global Services
1,027

 

 
1,027

 
193

 

 
193

Display
116

 

 
116

 
116

 

 
116

Energy and Environmental Solutions
645

 

 
645

 
645

 

 
645

Carrying amount
$
3,939

 
$
142

 
$
4,081

 
$
1,335

 
$

 
$
1,335

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 based on 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.
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 environment, technological advances, and changes in cost structure.
 

24

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



Details of finite-lived intangible assets were as follows:
 
July 29, 2012
 
October 30, 2011
Purchased
Technology
 
Other
Intangible
Assets
 
Total
 
Purchased
Technology
 
Other
Intangible
Assets
 
Total
 
(In millions)
Gross carrying amount:
 
 
 
 
 
 
 
 
 
 
 
Silicon Systems Group
$
1,300

 
$
252

 
$
1,552

 
$
310

 
$
20

 
$
330

Applied Global Services
28

 
44

 
72

 
28

 
40

 
68

Display
110

 
33

 
143

 
110

 
33

 
143

Energy and Environmental Solutions
105

 
232

 
337

 
105

 
232

 
337

Gross carrying amount
$
1,543

 
$
561

 
$
2,104

 
$
553

 
$
325

 
$
878

Accumulated amortization:
 
 
 
 
 
 
 
 
 
 
 
Silicon Systems Group
$
(373
)
 
$
(29
)
 
$
(402
)
 
$
(256
)
 
$
(8
)
 
$
(264
)
Applied Global Services
(21
)
 
(38
)
 
(59
)
 
(20
)
 
(31
)
 
(51
)
Display
(105
)
 
(27
)
 
(132
)
 
(102
)
 
(25
)
 
(127
)
Energy and Environmental Solutions
(56
)
 
(187
)
 
(243
)
 
(48
)
 
(177
)
 
(225
)
Accumulated amortization
$
(555
)
 
$
(281
)
 
$
(836
)
 
$
(426
)
 
$
(241
)
 
$
(667
)
Carrying amount
$
988

 
$
280

 
$
1,268

 
$
127

 
$
84

 
$
211

During the nine months ended July 29, 2012, the change in gross carrying amount of the amortized intangible assets was approximately $1.2 billion due to the acquisition of Varian as discussed in Note 8, Business Combination.
Details of amortization expense were as follows:
 
Three Months Ended
 
Nine Months Ended
July 29,
2012
 
July 31,
2011
 
July 29,
2012
 
July 31,
2011
(In millions)
Silicon Systems Group
$
45

 
$
3

 
$
138

 
$
10

Applied Global Services
1

 
2

 
8

 
6

Display
2

 
2

 
5

 
6

Energy and Environmental Solutions
6

 
6

 
19

 
18

Total
$
54

 
$
13

 
$
170

 
$
40


25

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



For the three and nine months ended July 29, 2012 and July 31, 2011, amortization expense was charged to the following categories:
 
Three Months Ended
 
Nine Months Ended
July 29,
2012
 
July 31,
2011
 
July 29,
2012
 
July 31,
2011
(In millions)
Cost of products sold
$
44

 
$
9

 
$
141

 
$
27

Research, development and engineering

 

 
1

 

Selling, general and administrative
10

 
4

 
28

 
13

Total amortization expense
$
54

 
$
13

 
$
170

 
$
40

 
As of July 29, 2012, future estimated amortization expense is expected to be as follows:
 
Amortization Expense
 
(In millions)
2012
$
54

2013
209

2014
198

2015
184

2016
175

Thereafter
448

 
$
1,268


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 was extended by one year in May 2012 and is scheduled to expire in May 2016. 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 July 29, 2012. Remaining credit facilities in the amount of approximately $103 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 the credit facilities at July 29, 2012 or October 30, 2011 and Applied has not received any advances from these credit facilities.
Long-term debt outstanding was as follows:
 
Principal Amount
 
 
 
 
 
July 29,
2012
 
October 30,
2011
 
Effective
Interest Rate
 
Interest Payment Dates
 
(In millions)
 
 
 
 
2.650% Senior Notes Due 2016
$
400

 
$
400

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

 
200

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

 
750

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

 
600

 
5.879%
 
June 15, December 15
Other debt

 
1

 
 
 
 
 
1,950

 
1,951

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

 
$
1,947

 
 
 
 
Applied has debt agreements that contain financial and other covenants. These covenants require Applied to maintain certain minimum financial ratios. At July 29, 2012, Applied was in compliance with all such covenants.

26

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



Note 11    Restructuring Charges and Asset Impairments

Applied records restructuring charges and asset impairments associated with management-approved restructuring plans to either reorganize one or more of Applied's business segments, or to remove duplicative headcount or infrastructure associated with business acquisitions.
On May 10, 2012, Applied announced a plan to restructure its Energy and Environmental Solutions segment in light of challenging industry conditions affecting the solar photovoltaic and light-emitting diode (LED) equipment markets. As part of the EES Restructuring Plan, Applied expects to relocate manufacturing, business operations and customer support functions of its precision wafering systems business and cease LED development activities. The EES Restructuring Plan also impacts certain LED support activities in the Applied Global Services segment. The total estimated pre-tax cost of implementing this plan is expected to be in the range of approximately $70 million to $100 million, which will be incurred over a period of 12 to 18 months beginning in the third quarter of fiscal 2012, and will be reported primarily in the Energy and Environmental Solutions segment. This estimate consists of: (i) up to $30 million in fixed asset impairment charges; (ii) up to $15 million of inventory-related charges; (iii) up to $15 million in charges arising from lease terminations and other obligations, and (iv) up to $40 million in severance and other employee-related costs. The EES Restructuring Plan will impact up to approximately 250 positions globally.
 
During the third quarter of fiscal 2012, Applied recognized $9 million of severance and other employee-related costs in connection with the integration of Varian. These costs were reported in the Silicon Systems Group and Applied Global Services segments.

The following table summarizes the major components of restructuring charges and asset impairments:
 
 
Three and Nine Months
Ended July 29, 2012
 
 
(In millions)
EES Restructuring Plan
 
 
Severance and other employee-related costs
 
$
24