UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

 

 

Commission File Number 000-06920

Applied Materials, Inc.

(Exact name of registrant as specified in its charter)

 

 

(Registrant’s telephone number, including area code)

(408) 727-5555

 

 

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 o

 

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 o

 

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):

 

(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 o     No þ

 

Number of shares outstanding of the issuer’s common stock as of July 26, 2009: 1,333,714,002

 

 

PART I. FINANCIAL INFORMATION

 

 

APPLIED MATERIALS, INC.

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

 

 

See accompanying Notes to Consolidated Condensed Financial Statements.

APPLIED MATERIALS, INC.

CONSOLIDATED CONDENSED BALANCE SHEETS*

 

 

 

 

See accompanying Notes to Consolidated Condensed Financial Statements.

APPLIED MATERIALS, INC.

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

 

 

See accompanying Notes to Consolidated Condensed Financial Statements.

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(Unaudited)

 

 

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 26, 2008 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 26, 2008 (2008 Form 10-K). Applied’s results of operations for the three and nine months ended July 26, 2009 are not necessarily indicative of future operating results.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (United States) 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.

 

Prior period amounts for customer deposits and deferred revenue have been reclassified to conform to the current period presentation.

 

During the first quarter of fiscal 2009, Applied elected to implement Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R).” As a result of this implementation, Applied changed the measurement date for its defined and postretirement benefit plan assets and obligations from an interim date to Applied’s fiscal year end. Accordingly, Applied recorded a $2 million (after tax) adjustment to the fiscal 2009 beginning balance of retained earnings.

 

Equity-Based Compensation

 

Applied has adopted stock plans that permit grants to employees of equity-based awards, including stock options, restricted stock and restricted stock units (also referred to as “performance shares” under the Applied Materials, Inc. 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 equity-based awards to consultants. Applied also has two Employee Stock Purchase Plans (ESPP) for United States and international employees, respectively, which enable eligible employees to purchase Applied common stock.

 

During the three months ended July 26, 2009 and July 27, 2008, Applied recognized equity-based compensation expense related to stock options, ESPP shares, restricted stock units and restricted stock of $43 million and $46 million, respectively. During the three months ended July 26, 2009 and July 27, 2008, Applied recognized income tax benefits related to equity-based compensation of $12 million and $13 million, respectively. During the first nine months of fiscal 2009, Applied recognized total equity-based compensation expense of $116 million and a tax benefit of $33 million. During the first nine months of fiscal 2008, Applied recognized total equity-based compensation expense of $135 million and a tax benefit of $38 million. The equity-based compensation expense related to restricted stock units and restricted stock for the three months ended July 26, 2009 and July 27, 2008 was $31 million and $34 million, respectively, and for the nine months ended July 26, 2009 and July 27, 2008 was $94 million and $101 million, respectively. The estimated fair value of Applied’s equity-based awards, less expected forfeitures, is amortized over the awards’ service periods on a straight-line basis.

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

Stock Options

 

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 three to 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 stock options have characteristics significantly different from those of publicly traded options. The weighted average assumptions used in the model are outlined in the following table:

 

 

The computation of the expected volatility assumption used in the Black-Scholes calculations for new grants is based on a combination of historical and implied volatilities. When establishing the expected life assumption, Applied periodically reviews historical employee exercise behavior with respect to option grants.

 

Applied granted 13,000 and 24,514,000 stock options during the three and nine months ended July 26, 2009, respectively. Applied granted 6,000 and 7,000 stock options during the three and nine months ended July 27, 2008, respectively. The weighted average grant date fair value of options granted during the three months ended July 26, 2009 and July 27, 2008 was $2.99 and $5.05, respectively, and for options granted during the nine months ended July 26, 2009 and July 27, 2008, the value was $2.52 and $5.05, respectively.

 

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 of the applicable offering period or at the end of each applicable purchase period. Effective March 2, 2009, the length of offering periods under the ESPP was reduced to 6 months, from a maximum of 24 months in duration. The incremental compensation cost associated with this modification was insignificant. Based on the Black-Scholes option pricing model, the weighted average estimated fair value of purchase rights under the ESPP was $2.99 and $4.88 for the nine months ended July 26, 2009 and July 27, 2008, respectively. No shares were issued under the ESPP during the three months ended July 26, 2009 and July 27, 2008, respectively. The number of shares issued during the nine months ended July 26, 2009 and July 27, 2008 was 3,536,000 and 2,294,000, 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:

 

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

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 units typically vest over three to four years. Vesting of restricted stock units usually is subject to the grantee’s continued service with Applied. 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. There were 2,811,000 and 1,603,000 restricted stock units granted in the three months ended July 26, 2009 and July 27, 2008, respectively, and 3,383,000 and 3,752,000 restricted stock units granted in the nine months ended July 26, 2009 and July 27, 2008, respectively.

 

Beginning in fiscal 2007, Applied initiated a performance-based equity award program for named executive officers and other key employees. These awards 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 relative 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. There were no performance-based awards granted in the nine months ended July 26, 2009. The Committee approved the award of 1,565,000 performance-based restricted stock units under this program for fiscal year 2008. The Committee also approved an award of 100,000 shares of performance-based restricted stock for fiscal year 2008 to Applied’s President and Chief Executive Officer at a purchase price of $0.01 per share. The fair value of the performance-based restricted stock units and restricted stock is estimated using the fair market value of Applied common stock on the date of the grant and assumes that the performance goals will be achieved. If achieved, the award vests 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. As of July 26, 2009, 70% of the performance goals associated with the fiscal 2008 awards were achieved. The performance goals associated with the remaining 30% may still be achieved, depending on future performance, during the remaining three fiscal years.

 

 

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. During the nine months ended July 26, 2009, shares of treasury stock were issued in connection with Applied’s ESPP at an aggregate value that was less than the treasury stock’s acquisition price, resulting in $20 million being recorded against retained earnings.

 

 

Basic earnings (loss) 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 ESPP shares) outstanding during the period.

 

Applied’s net income (loss) has not been adjusted for any period presented for purposes of computing basic or diluted earnings (loss) per share due to the Company’s non-complex capital structure.

 

For purposes of computing diluted earnings per share, weighted average potential common shares do not include stock options with an exercise price greater than the average fair value of Applied common stock for the period, as the effect would be anti-dilutive. Accordingly, options to purchase 25,022,000 shares of common stock for the three months ended July 27, 2008, and 27,512,000 shares of common stock for the nine months ended

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

July 27, 2008, were excluded from the computation. Potential common shares have not been included in the calculation of diluted net loss per share, as the effect would be anti-dilutive. As such, the numerator and the denominator used in computing both basic and diluted net loss per share for the three and nine months ended July 26, 2009 are the same. The number of potential common shares that could dilute basic earnings per share in the future was 91,655,000 for the three and nine months ended July 26, 2009.

 

 

Investments

 

Investments by security type at July 26, 2009 were as follows:

 

 

Investments by security type at October 26, 2008 were as follows:

 

 

Cash and cash equivalents included investments in debt and other securities of $189 million at July 26, 2009 and $224 million at October 26, 2008. Other debt securities consist primarily of investment grade asset-backed and mortgage-backed securities.

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

Contractual maturities of investments at July 26, 2009 were as follows:

 

 

 

 

At July 26, 2009, Applied had a gross unrealized loss of $6 million due to a decrease in the fair value of certain fixed income securities primarily as a result of the continuing turmoil in the global financial markets. Applied regularly reviews its investment portfolio to identify and evaluate investments that have indications of possible impairment. Factors considered in determining whether a loss is temporary 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 the investments do not permit settlement at prices less than the amortized cost of the investments. Applied has determined that the gross unrealized losses on its investments at July 26, 2009 are temporary in nature. Accordingly, Applied does not consider the investments to be other-than-temporarily impaired at July 26, 2009.

 

The following table provides the gross unrealized losses and the fair market value of Applied’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of July 26, 2009.

 

 

Applied manages its cash equivalents and investments, excluding strategic investments, as a single portfolio of highly marketable securities that is intended to be available to meet Applied’s current cash requirements. For the three months ended July 26, 2009, gross realized gains on sales of investments and gross realized losses were each $1 million. For the three months ended July 27, 2008, gross realized gains on sales of investments were $1 million and gross realized losses were $2 million. For the nine months ended July 26, 2009, gross realized gains on sales of investments were $6 million and gross realized losses were $10 million. For the nine months ended July 27, 2008,

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

gross realized gains on sales of investments were $11 million and gross realized losses were $8 million. There were no credit losses for the three and nine months ended July 26, 2009.

 

On October 27, 2008, Applied adopted the provisions of Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157), with respect to financial assets and liabilities. SFAS 157 defines fair value, establishes a framework for measuring fair value and enhances disclosure requirements for fair value measurements. Fair value is defined under SFAS 157 as the exchange price that would be received for an asset, or paid to transfer a liability (an exit price), in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last is considered unobservable, which may be used to measure fair value:

 

 

Applied’s investments are comprised primarily of debt securities that are classified as available-for-sale and recorded at their fair value. 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.

 

In general, 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 26, 2009, a substantial majority of Applied’s available-for-sale, short-term and long-term investments were recognized at fair value that was determined based upon observable inputs.

 

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.

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

Financial Assets/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 26, 2009:

 

 

At July 26, 2009, the fair value of Level 3 assets measured on a recurring basis was $2 million, representing approximately 0.1% of the total fair value of Applied’s investment portfolio. Level 3 assets consisted of asset-backed and mortgage-backed securities totaling $2 million, which values were based on non-binding, broker-provided price quotes and may not have been corroborated by observable market data.

 

Financial Assets/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 $90 million at July 26, 2009, of which $48 million of investments were accounted for under the cost method of accounting and $42 million of investments had been measured at fair value on a non-recurring basis during fiscal 2009 due to an other-than-temporary decline in value. The following table presents the balance of equity securities at July 26, 2009 that had been measured at fair value on a non-recurring

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

basis, using the process described above, and the impairment charges recorded during the three and nine months then ended:

 

 

Impairments associated with financial assets for the nine months ended July 26, 2009 totaled $79 million and consisted of the following: equity method investment in Sokudo Co., Ltd., a Japanese joint venture company, $45 million; publicly traded equity securities, $20 million; and equity investments in privately-held companies, $14 million.

 

Derivative Financial Instruments

 

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 accounts payable and accrued expenses.

 

Applied conducts business in a number of foreign countries, with certain transactions denominated in local currencies, such as Japanese yen, euro, Israeli shekel and Swiss francs. 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.

 

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. 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 accumulated other comprehensive income or loss at July 26, 2009 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 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 July 26, 2009 and was $25 million for the nine months ended July 26, 2009. 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 27, 2008. Gains and losses on foreign exchange contracts designated as cash flow hedges are presented in general and administrative expenses.

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

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.

 

Fair values of derivative instruments were as follows:

 

 

The effect of derivative instruments on the Consolidated Condensed Statement of Operations for the three and nine months ended July 26, 2009 was as follows:

 

 

 

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, 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 liability position was immaterial as of July 26, 2009.

 

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.

 

For further details, see Note 11 of Notes to Consolidated Condensed Financial Statements.

 

Fair Value of Financial Instruments

 

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 26, 2009, the carrying amount of long-term debt was $202 million and the estimated fair value was $217 million. At October 26, 2008, the carrying amount of long-term debt was $203 million and the estimated fair value was $198 million. 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.

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

 

 

Applied has agreements with various financial institutions to sell accounts receivable from selected customers. Applied also discounts letters of credit through various financial institutions. Under these agreements, Applied sold accounts receivable and discounted letters of credit in the amounts of $102 million and $20 million for the three months ended July 26, 2009 and July 27, 2008, respectively, and $179 million and $218 million for the nine months ended July 26, 2009 and July 27, 2008, respectively. 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 $67 million at July 26, 2009 and $5 million at October 26, 2008.

 

Applied sells principally to manufacturers within the semiconductor, display and solar industries. As a result of extremely 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 at July 26, 2009, Applied will continue to closely monitor customer liquidity and economic conditions, which may result in changes to Applied’s estimates regarding collectability.

 

 

Inventories are stated at the lower of cost or market, with cost determined on a FIFO basis. Components of inventories were as follows:

 

 

Included in finished goods inventory is $118 million at July 26, 2009, and $165 million at October 26, 2008, 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 of Notes to Consolidated Financial Statements in Applied’s 2008 Form 10-K.

 

Applied adjusts inventory carrying value for estimated obsolescence equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. Applied fully reserves for inventories and noncancelable purchase orders for inventory deemed obsolete. Applied performs periodic reviews of inventory items to identify excess inventories on hand by comparing on-hand balances to anticipated usage using recent historical activity as well as anticipated or forecasted demand. If estimates of customer demand diminish further or market conditions become less favorable than those projected by Applied, additional inventory adjustments may be required.

 

 

Goodwill and Purchased Intangible Assets

 

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

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

indicate that the carrying value of an asset may not be recoverable. For goodwill, Applied performs a two-step impairment test. In the first step, Applied compares the fair value of each reporting unit to its carrying value. Applied’s reporting units are consistent with the reportable segments identified in Note 15, 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. Under the market approach, Applied estimates the fair value based on market multiples of revenue or earnings for comparable companies. 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 representing 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 loss equal to the difference.

 

Applied conducted these impairment tests in the fourth quarter of fiscal 2008, and the results of these tests indicated that Applied’s goodwill and purchased intangible assets with indefinite useful lives were not impaired.

 

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 a reporting unit 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.

 

Details of indefinite-lived intangible assets were as follows:

 

 

From October 26, 2008 to July 26, 2009, goodwill decreased by $3 million due to an adjustment in the purchase price allocation of an acquisition as a result of a change in estimate of Applied’s ability to utilize tax net operating loss carryforwards associated with this acquisition. Other intangible assets that are not subject to amortization consist primarily of a trade name. As of July 26, 2009, indefinite-lived intangible assets by reportable segment were: Energy and Environmental Solutions, $654 million; Silicon, $224 million; Applied Global Services, $196 million; and Display, $116 million.

 

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 MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

Applied evaluates long-lived assets, such as property, plant and equipment, and purchased intangible assets with finite lives, 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.

 

Details of amortized intangible assets were as follows:

 

 

Aggregate amortization expense was $22 million and $37 million for the three months ended July 26, 2009 and July 27, 2008, respectively, and $67 million and $90 million for the nine months ended July 26, 2009 and July 27, 2008, respectively. As of July 26, 2009, future estimated amortization expense is expected to be $22 million for the remainder of fiscal 2009, $65 million for fiscal 2010, $51 million for fiscal 2011, $47 million for fiscal 2012, $43 million for fiscal 2013, and $80 million thereafter. As of July 26, 2009, amortized intangible assets by reportable segment were: Energy and Environmental Solutions, $229 million; Applied Global Services, $44 million; Display, $30 million; and Silicon, $6 million.

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

 

 

Components of accounts payable and accrued expenses were as follows:

 

 

 

Warranty

 

Changes in the warranty reserves during the three and nine months ended July 26, 2009 and July 27, 2008 were as follows:

 

 

Applied products are generally sold with a 12-month warranty 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

 

During the ordinary course of business, Applied provides standby letters of credit or other guarantee instruments to certain parties as required for certain transactions initiated by either Applied or its subsidiaries. As of July 26, 2009, the maximum potential amount of future payments that Applied could be required to make under these guarantee arrangements was $96 million. Applied has not recorded any liability in connection with these guarantee arrangements beyond that required to 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 arrangements.

 

Applied also has agreements with various global banks to facilitate subsidiary banking operations world-wide, including overdraft arrangements, bank guarantees and letters of credit. As of July 26, 2009, Applied Materials, Inc. has provided parent guarantees to banks for approximately $175 million to cover these arrangements.

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

Legal matters

 

Jusung

 

Applied has been engaged in a number of lawsuits and patent and administrative proceedings in Taiwan and South Korea since 2003 with Jusung Engineering Co., Ltd. (Jusung Engineering) and/or Jusung Pacific Co., Ltd. (Jusung Pacific, referred to together with Jusung Engineering as Jusung) involving technology used in manufacturing LCDs. Applied believes that it has meritorious claims and defenses against Jusung that it intends to pursue vigorously.

 

In 2004, Applied filed a complaint for patent infringement against Jusung in the Hsinchu District Court in Taiwan seeking damages and a permanent injunction for infringement of a patent related to chemical vapor deposition (CVD) equipment, and this case remains pending. Jusung Pacific unsuccessfully sought invalidation of Applied’s CVD patent in the Taiwanese Intellectual Property Office (TIPO). Jusung Pacific’s initial appeal of the TIPO’s decision was denied, and it has filed a further appeal to the Taipei High Supreme Administrative Court. In 2006, Applied filed an action in the TIPO challenging the validity of a patent owned by Jusung Engineering related to severability of the transfer chamber on a CVD tool. Jusung Engineering filed a lawsuit against Applied and AKT America in Hsinchu District Court in Taiwan alleging infringement of the same patent. The TIPO granted Applied’s request for invalidation and revoked Jusung Engineering’s patent. In March 2009, the Hsinchu District Court dismissed Jusung Engineering’s lawsuit, and in April 2009, the Ministry of Economic Affairs overruled Jusung Engineering’s administrative appeal of the decision revoking its patent. Jusung has appealed both decisions. In 2006, Jusung Engineering filed a complaint of private prosecution in the Taipei District Court of Taiwan alleging that Applied’s outside counsel received from the Court and used a copy of an expert report that Jusung had filed in the ongoing patent infringement lawsuits that Jusung had intended to remain confidential. The complaint names as defendants Applied’s outside counsel in Taiwan, as well as Michael R. Splinter, Applied’s President and Chief Executive Officer, as the statutory representative of Applied. The Taipei District Court dismissed the private prosecution complaint, and the matter was transferred to the Taipei District Attorney’s Office. The Taipei District Attorney’s Office has issued three successive rulings not to prosecute, each of which Jusung Engineering has appealed to the Taiwan High Court District Attorney. In each instance, the Taiwan High Court District Attorney has returned the matter to the Taipei District Attorney’s Office for further consideration, where it remains pending.

 

In 2007, Jusung Engineering filed a complaint against AKT America in Seoul Central District Court in Seoul, Korea, alleging infringement of a Jusung patent involving the showerhead assembly of plasma enhanced chemical vapor deposition (PECVD) equipment. After the Korean Intellectual Property Office (KIPO) ruled that Jusung’s patent was invalid, the District Court dismissed Jusung Engineering’s infringement action, which Jusung Engineering has appealed. On July 9, 2009, the Korean Supreme Court dismissed Jusung’s appeal of the KIPO’s determination that the PECVD patent is invalid, and Jusung has no further right of appeal in this matter. On July 30, 2009, Jusung Engineering’s related confirmation-of-scope action was dismissed based on the Supreme Court’s invalidation of the PECVD patent. Applied has submitted notice of the Supreme Court’s invalidity decision to the High Court considering Jusung’s appeal in the infringement action. In 2007, Applied filed a complaint against Jusung Engineering in the Seoul Central District Court for infringement of an Applied patent involving the housing for a substrate supporting pin used in PECVD equipment. The KIPO subsequently ruled in favor of an action by Jusung to invalidate Applied’s substrate patent. The Patent Court dismissed Applied’s appeal and Applied has appealed to the Supreme Court. The District Court has dismissed Applied’s complaint, and Applied’s appeal was also dismissed. Applied’s related confirmation of scope case was dismissed, and Applied’s appeal of that ruling was also dismissed.

 

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 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.

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

Although the outcome of the above-described matters cannot be predicted with certainty, Applied does not believe that any of these proceedings or other claims will have a material adverse effect on its consolidated financial condition or results of operations.

 

 

On November 12, 2008, Applied announced a restructuring program to reduce its global workforce by approximately 1,800 positions. During the first quarter of fiscal 2009, Applied recorded restructuring charges of $133 million associated with this program. The restructuring charges consisted of employee termination costs to reduce the Company’s workforce through a combination of attrition, voluntary separation and other workforce reduction programs. During the second quarter of fiscal 2009, Applied expanded the scope of the restructuring program by approximately 200 positions, resulting in an additional cost of $12 million, for an aggregate cost of $145 million.

 

Changes in restructuring reserves related to severance under this restructuring program for the nine months ended July 26, 2009 were as follows:

 

 

Changes in restructuring reserves for the nine months ended July 26, 2009 related to other restructuring plans and facilities realignment programs initiated in prior periods were as follows:

 

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

During the nine months ended July 26, 2009, Applied determined that the carrying value of certain fixed assets to be sold exceeded the estimated fair value and, as a result, recorded a $15 million impairment charge. In addition, Applied incurred expenses of $1.5 million in connection with ceasing use of certain leased facilities.

 

 

Comprehensive Income

 

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

 

 

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

 

 

For further details on derivative instruments, see Note 4 of the Notes to Consolidated Condensed Financial Statements.

 

Stock Repurchase Program

 

On September 15, 2006, Applied’s Board of Directors approved a stock repurchase program for up to $5.0 billion in repurchases over the three years ending in September 2009, of which authorization for $2.3 billion of repurchases remained as of July 26, 2009. Under this authorization, Applied implemented a systematic stock repurchase program and also has made supplemental repurchases of its common stock from time to time in the open market, depending on market conditions, stock price and other factors. In November 2008, Applied announced that it had temporarily suspended stock repurchases in light of uncertain global economic and market conditions.

 

Applied did not repurchase any shares of its common stock during the three months ended July 26, 2009. During the three months ended July 27, 2008, Applied repurchased 15,611,000 shares of its common stock at an average price of $19.22 per share for a total cash outlay of $300 million. During the nine months ended July 26, 2009, Applied repurchased 1,942,000 shares of its common stock at an average price of $11.80 per share for a total

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

cash outlay of $23 million. During the nine months ended July 27, 2008, Applied repurchased 64,263,000 shares of its common stock at an average price of $18.67 per share for a total cash outlay of $1.2 billion.

 

Dividends

 

In June 2009, Applied’s Board of Directors declared a quarterly cash dividend in the amount of $0.06 per share payable on September 3, 2009 to stockholders of record as of August 13, 2009. In March 2009, Applied’s Board of Directors declared a quarterly cash dividend in the amount of $0.06 per share that was paid on June 4, 2009 to stockholders of record as of May 14, 2009. In December 2008, Applied’s Board of Directors declared a quarterly cash dividend in the amount of $0.06 per share that was paid on March 5, 2009 to stockholders of record as of February 12, 2009. 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 interest of Applied’s stockholders.

 

 

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 and nine months ended July 26, 2009 and July 27, 2008 is presented below:

 

 

 

Applied has credit facilities for unsecured borrowings in various currencies of up to $1.2 billion, of which $1.0 billion is comprised of a 5-year revolving credit agreement with a group of banks that is scheduled to expire in January 2012. 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 26, 2009. In May 2009, Applied amended certain terms of this credit agreement, including (i) replacing the funded-debt-to-adjusted-earnings ratio financial covenant with a minimum liquidity covenant and a funded-debt-to-total-capital ratio covenant and (ii) increasing the facility fee and applicable interest rate margins on advances. Remaining credit facilities in the amount of approximately $160 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 July 26, 2009.

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

 

 

Applied’s effective income tax rate for the third quarter of fiscal 2009 was a benefit of 26.0 percent, and the income tax rate for the third quarter of fiscal 2008 was a provision of 32.1 percent. The tax provision for the third quarter of fiscal 2008 included $19 million of tax expense for certain corrections pertaining to tax items prior to fiscal 2008. The impact of the corrections recognized during the third quarter of fiscal 2008 was not considered material to the prior reporting periods.

 

During the second quarter of fiscal 2009, the Internal Revenue Service began an examination of Applied’s federal income tax returns for fiscal years 2007 and 2006. Applied believes it has adequately reserved for any income tax uncertainties that may arise as a result of this examination.

 

Applied’s future effective income tax rate depends on various factors, such as tax legislation, the geographic composition of Applied’s pre-tax income, and the tax rate on equity compensation. Management carefully monitors these factors and adjusts the interim effective income tax rate accordingly.

 

 

Applied’s four reportable segments are: Silicon, Applied Global Services, Display, and Energy and Environmental Solutions. 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 July 26, 2009 and the distinctive nature of each segment. Future changes to this internal financial structure may result in changes to the Company’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 equity-based compensation and certain components of variable compensation, the global sales organization, corporate functions (certain management, finance, legal, human resources, marketing, and research, development and engineering), 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. Segment operating income excludes interest income/expense and other financial charges and income taxes according to how a particular reportable segment’s management is measured. Management does not consider the unallocated costs in measuring the performance of the reportable segments.

 

The Silicon segment includes semiconductor capital equipment for etch, rapid thermal processing, deposition, chemical mechanical planarization, and metrology and inspection.

 

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, and remanufactured equipment. 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.

 

APPLIED MATERIALS, INC.

 

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS — (Continued)

 

The Display segment encompasses products for manufacturing LCDs for TVs, personal computers and other video-enabled devices. The Display segment also includes the design and manufacture of differentiated stand-alone equipment for the Applied SunFab^tm Thin Film Line.

 

The Energy and Environmental Solutions segment includes products for fabricating solar photovoltaic cells and modules, high throughput roll-to-roll coating systems for flexible electronics and web products, and systems used in the manufacture of energy-efficient glass.

 

Net sales and operating income (loss) for each reportable segment for the three and nine months ended July 26, 2009 and July 27, 2008 were as follows: