APPLIED MATERIALS INC /DE : Administration’s Dialogue and Evaluation of Monetary Situation and Outcomes of Operations (kind 10-Ok)

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APPLIED MATERIALS INC /DE : Management's Discussion and Analysis of Financial Condition and
Results of Operations (form 10-K)

Introduction

Management’s Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) is intended to facilitate an understanding of Applied’s
business and results of operations. This MD&A should be read in conjunction with
Applied’s Consolidated Financial Statements and the accompanying Notes to
Consolidated Financial Statements included elsewhere in this Form 10-K. The
following discussion contains forward-looking statements and should also be read
in conjunction with the cautionary statement set forth at the beginning of this
Form 10-K. MD&A consists of the following sections:

•Applied’s Pandemic Response
•Overview: a summary of Applied’s business and measurements
•Results of Operations: a discussion of operating results
•Segment Information: a discussion of segment operating results
•Recent Accounting Pronouncements: a discussion of new accounting pronouncements
and its impact to Applied’s consolidated financial statements
•Financial Condition, Liquidity and Capital Resources: an analysis of cash
flows, sources and uses of cash
•Off-Balance Sheet Arrangements and Contractual Obligations
•Critical Accounting Policies and Estimates: a discussion of critical accounting
policies that require the exercise of judgments and estimates
•Non-GAAP Adjusted Results: a presentation of results reconciling GAAP to
non-GAAP adjusted measures
Applied’s Pandemic Response
Applied Materials’ business has been identified by the U.S. Department of
Homeland Security as part of the Critical Infrastructure Sectors that the
Federal government deems “essential to ensure the continuity of functions
critical to public health and safety, as well as economic and national security”
and that have “a special responsibility in these times to continue operations.”
Applied responded quickly to put in place precautionary measures to keep its
workplaces healthy and safe, while ensuring compliance with orders and
restrictions imposed by government authorities, everywhere Applied operates in
the world.
Applied’s top priority during the ongoing COVID-19 pandemic remains protecting
the health and safety of its employees and their families, customers and
community. Applied continues to maintain workplace flexibility such as working
remotely where possible to reduce the number of people who are on campus each
day. Applied is keeping its critical labs and operations active and continuing
to support customers. In the interest of public health, all onsite operations
are utilizing the minimum number of people to safely execute tasks and following
enhanced safety and health protocols-including screenings, social distancing,
and use of personal protective equipment.
Applied has a multi-phase plan to return to working on-site, which takes into
consideration factors such as Applied’s business needs, local government
regulations, community case trends, and recommendation from public health
officials. The plan involves multiple phases that gradually allow additional
workers to return onsite while practicing social distancing and other safety
measures.
Applied Materials is committed to helping those most impacted by the ongoing
COVID-19 pandemic. In regions around the world, Applied and its Foundation are
addressing immediate humanitarian needs while investing resources to combat the
long-term effect of the virus on the nonprofit organizations in its communities.
Applied has shared masks and equipment with medical facilities, provided blood
analysis systems to medical professionals and sent emergency support to food
banks.
Applied will continue to monitor and evaluate the ongoing COVID-19 pandemic and
will work to respond appropriately to the impact of COVID-19 on its business,
its customers’ and suppliers’ businesses and its communities.
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Overview

Applied provides manufacturing equipment, services and software to the
semiconductor, display, and related industries. Applied’s customers include
manufacturers of semiconductor wafers and chips, liquid crystal and organic
light-emitting diode (OLED) displays, and other electronic devices. These
customers may use what they manufacture in their own end products or sell the
items to other companies for use in advanced electronic components. Each of
Applied’s businesses is subject to variable industry conditions, as demand for
manufacturing equipment and services can change depending on supply and demand
for chips, display technologies, and other electronic devices, as well as other
factors, such as global economic and market conditions, and the nature and
timing of technological advances in fabrication processes.
Applied operates in three reportable segments: Semiconductor Systems, Applied
Global Services, and Display and Adjacent Markets. A summary of financial
information for each reportable segment is found in Note 17 of Notes to
Consolidated Financial Statements. A discussion of factors that could affect
Applied’s operations is set forth under “Risk Factors” in Part I, Item 1A, which
is incorporated herein by reference. Product development and manufacturing
activities occur primarily in the United States, Europe, Israel, and Asia.
Applied’s broad range of equipment and service products are highly technical and
are sold primarily through a direct sales force.
Applied’s results are driven primarily by customer spending on capital equipment
and services to support key technology transitions or to increase production
volume in response to worldwide demand for semiconductors and displays. Spending
by semiconductor customers, which include companies that operate in the foundry,
logic and memory markets, is driven by demand for advanced electronic products,
including smartphones and other mobile devices, servers, personal computers,
automotive devices, storage, and other products. The growth of data and emerging
end-market drivers such as artificial intelligence, the Internet of Things, 5G
networks, smart vehicles and augmented and virtual reality are also creating the
next wave of growth for the industry. As a result, products within the
Semiconductor Systems segment are subject to significant changes in customer
requirements, including transitions to smaller dimensions, increasingly complex
chip architectures, new materials and an increasing number of applications.
Demand for display manufacturing equipment spending depends primarily on
consumer demand for increasingly larger and more advanced TVs as well as larger
and higher resolution displays for next-generation mobile devices, and
investments in new types of display technologies. While certain existing
technologies may be adapted to new requirements, some applications create the
need for an entirely different technological approach. The timing of customer
investment in manufacturing equipment is also affected by the timing of
next-generation process development and the timing of capacity expansion to meet
end-market demand. In light of these conditions, Applied’s results can vary
significantly year-over-year, as well as quarter-over-quarter.
Applied’s strategic priorities include developing products that help solve
customers’ challenges at technology inflections; expanding its served market
opportunities in the semiconductor and display industries; and growing its
services business. Applied’s long-term growth strategy requires continued
development of new materials engineering capabilities, including products and
platforms that enable expansion into new and adjacent markets. Applied’s
significant investments in research, development and engineering must generally
enable it to deliver new products and technologies before the emergence of
strong demand, thus allowing customers to incorporate these products into their
manufacturing plans during early-stage technology selection. Applied works
closely with its global customers to design systems and processes that meet
their planned technical and production requirements.
The following table presents certain significant measurements for the past three
fiscal years:

Change
2019 over
2020 2019 2018 2020 over 2019 2018

(In millions,

except per share amounts and percentages)

Net sales $ 17,202$ 14,608$ 16,705$ 2,594$ (2,097)

Gross margin 44.7 % 43.7 % 45.0 % 1.0 points (1.3) points
Operating income $ 4,365$ 3,350$ 4,491$ 1,015$ (1,141)
Operating margin 25.4 % 22.9 % 26.9 % 2.5 points (4.0) points
Net income $ 3,619$ 2,706$ 3,038 $ 913 $ (332)
Earnings per diluted share $ 3.92$ 2.86$ 2.96 $ 1.06 $ (0.10)

Fiscal 2020, 2019 and 2018 each contained 52 weeks.
Fiscal 2018 included a one-time expense related to the enactment of U.S. income
tax law that reduced diluted earnings per share by $1.08.

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During fiscal 2020, COVID-19 was designated a pandemic and the resulting
restrictions put in place worldwide impacted Applied’s supply chains and
manufacturing operations. The semiconductor industry was deemed to be part of a
U.S. Critical Infrastructure Sector, allowing Applied to continue operations,
while ensuring compliance with orders and restrictions imposed by government
authorities by putting additional precautionary measures in place to keep its
workplaces healthy and safe, everywhere Applied operates in the world.
Even with the unprecedented challenges faced during the pandemic, semiconductor
equipment customers continued to make strategic investments in new technology
transitions during fiscal 2020. Foundry and logic spending increased in fiscal
2020 compared to fiscal 2019 led by customer investment in advanced
foundry-logic nodes. Spending by memory customers increased in fiscal 2020
compared to fiscal 2019, as the market began to recover from excess supply and
inventory levels and customers invested in new technology development. Applied
saw continued growth in its services business in fiscal 2020 compared to fiscal
2019 driven by an increase in the installed base of equipment and in long-term
service agreements. Applied’s display and adjacent markets revenue declined
slightly in fiscal 2020 compared to fiscal 2019, due to weak demand for display
manufacturing equipment for TVs.
In response to the ongoing COVID-19 pandemic and evolving conditions and
worldwide response, Applied made adjustments to its global operations and
continues to see recovery within its supply chain and strong demand from
semiconductor customers. However, the situation remains fluid and uncertain.
Applied is actively managing its responses in collaboration with its employees,
customers and suppliers. For additional risks associated with the ongoing
COVID-19 pandemic, see the risk factor entitled “The ongoing COVID-19 pandemic
and global measures taken in response thereto have adversely impacted, and may
continue to adversely impact, Applied’s operations and financial results” in
Part I, Item 1A, “Risk Factors.”

Results of Operations
Net Sales
Net sales for the periods indicated were as follows:
Change
2019 over
2020 2019 2018 2020 over 2019 2018

(In millions, except percentages)
Semiconductor Systems $ 11,367 66% $ 9,027 62% $ 10,577 63% 26 % (15) %
Applied Global Services 4,155 24% 3,854 26% 3,754 22% 8 % 3 %
Display and Adjacent Markets 1,607 9% 1,651 11% 2,298 14% (3) % (28) %
Corporate and Other 73 1% 76 1% 76 1% (4) % – %
Total $ 17,202 100% $ 14,608 100% $ 16,705 100% 18 % (13) %

Net sales in fiscal 2020 compared to fiscal 2019 increased primarily due to
increased customer investments in semiconductor equipment and spending on
services. Net sales in fiscal 2019 compared to fiscal 2018 decreased primarily
due to decreased customer investments in semiconductor and display manufacturing
equipment. The Semiconductor Systems segment continued to represent the largest
contributor of net sales.
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Net sales by geographic region, determined by the location of customers’
facilities to which products were shipped, were as follows:

Change
2019 over
2020 2019 2018 2020 over 2019 2018

(In millions, except percentages)
China $ 5,456 32% $ 4,277 29% $ 5,047 30% 28 % (15) %
Korea 3,031 18% 1,929 13% 3,539 21% 57 % (45) %
Taiwan 3,953 23% 2,965 20% 2,504 15% 33 % 18 %
Japan 1,996 11% 2,198 15% 2,396 14% (9) % (8) %
Southeast Asia 411 2% 548 4% 797 5% (25) % (31) %
Asia Pacific 14,847 86% 11,917 81% 14,283 85% 25 % (17) %
United States 1,619 10% 1,871 13% 1,413 9% (13) % 32 %
Europe 736 4% 820 6% 1,009 6% (10) % (19) %
Total $ 17,202 100% $ 14,608 100% $ 16,705 100% 18 % (13) %

The changes in net sales in all regions in fiscal 2020 compared to fiscal 2019
primarily reflected changes in semiconductor equipment spending. The increase in
net sales to customers in China, Taiwan and Korea for fiscal 2020 compared to
fiscal 2019 was primarily due to increased investments in semiconductor
manufacturing equipment and customer spending on comprehensive service
agreements. The increase in China was partially offset by a decrease in customer
spending in display manufacturing equipment. The decrease in net sales to
customers in Japan and United States for fiscal 2020 compared to fiscal 2019
primarily reflected a decrease in investments in semiconductor and display
manufacturing equipment. The decrease in net sales to customers in Southeast
Asia and Europe for fiscal 2020 compared to fiscal 2019 primarily reflected a
decrease in investments in semiconductor manufacturing equipment and customer
spending on legacy systems and spares.
The changes in net sales in all regions in fiscal 2019 compared to fiscal 2018
primarily reflected changes in semiconductor and display manufacturing equipment
spending and customer and product mix. The increase in net sales to customers in
Taiwan and United States for fiscal 2019 compared the prior year was primarily
due to increased investments in semiconductor manufacturing equipment. The
decrease in net sales to customers in all other regions for fiscal 2019 compared
to fiscal 2018 primarily reflected a decrease in investments in semiconductor
and display manufacturing equipment.

Gross Margin
Gross margins for the periods indicated were as follows:
Change
2020 2019 2018 2020 over 2019 2019 over 2018

(In millions, except percentages)
Gross margin 44.7 % 43.7 % 45.0 % 1.0 points (1.3) points

Gross margin in fiscal 2020 increased compared to fiscal 2019 year primarily due
to the increase in net sales and favorable changes in customer and product mix,
partially offset by higher freight costs, and higher personnel costs due to
increase in headcount to provide manufacturing capacity and flexibility,
underutilization of headcount due to COVID-19 restrictions preventing travel to
customer site and incremental employee compensation related to the COVID-19
pandemic. Gross margin in fiscal 2019 decreased compared to fiscal 2018,
primarily due to the decrease in net sales and unfavorable changes in customer
and product mix.
Gross margin during fiscal 2020, 2019 and 2018 included $103 million, $89
million and $87 million, respectively, of share-based compensation expense.
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Research, Development and Engineering
Research, Development and Engineering (RD&E) expenses for the periods indicated
were as follows:
Change
2020 2019 2018 2020 over 2019 2019 over 2018

(In millions)
Research, development and engineering $ 2,234$ 2,054$ 2,022 $

180 $ 32

Applied’s future operating results depend to a considerable extent on its
ability to maintain a competitive advantage in the equipment and service
products it provides. Development cycles range from 12 to 36 months depending on
whether the product is an enhancement of an existing product, which typically
has a shorter development cycle, or a new product, which typically has a longer
development cycle. Most of Applied’s existing products resulted from internal
development activities and innovations involving new technologies, materials and
processes. In certain instances, Applied acquires technologies, either in
existing or new product areas, to complement its existing technology
capabilities and to reduce time to market.
Management believes that it is critical to continue to make substantial
investments in RD&E to assure the availability of innovative technology that
meets the current and projected requirements of its customers’ most advanced
designs. Applied has maintained and intends to continue its commitment to
investing in RD&E in order to continue to offer new products and technologies.
Applied continued its RD&E investments across Semiconductor Systems and Display
and Adjacent Markets on the development of new unit process systems and
integrated materials solutions. Areas of investment include etch, deposition,
inspection, patterning, packaging and other technologies to improve chip
performance, power, area, cost and time-to-market. In Display and Adjacent
Markets, RD&E investments were focused on expanding the company’s market
opportunity with new display technologies.
The increases in RD&E expenses during fiscal 2020 compared fiscal 2019 were
primarily due to additional headcount and higher expense associated with
share-based compensation and variable compensation. RD&E expenses increased
slightly in fiscal 2019 compared to the prior year primarily due to additional
headcount and increased research and development spending in Semiconductor
Systems and Display and Adjacent Market segments. These increases reflect
Applied’s ongoing investments in product development initiatives, consistent
with the Company’s growth strategy. Applied continued to prioritize existing
RD&E investments in technical capabilities and critical research and development
programs in current and new markets, with a focus on semiconductor technologies.
RD&E expense during fiscal 2020, 2019 and 2018 included $116 million, $99
million and $96 million, respectively, of share-based compensation expense.
Marketing and Selling
Marketing and selling expenses for the periods indicated were as follows:
Change
2020 2019 2018 2020 over 2019 2019 over 2018

(In millions)
Marketing and selling $ 526$ 521$ 521 $ 5 $ –

Marketing and selling expenses remained relatively flat in fiscal 2020 compared
to fiscal 2019 and 2018. Marketing and selling expenses for fiscal years 2020,
2019 and 2018 included $36 million, $31 million and $31 million, respectively,
of share-based compensation expense.
General and Administrative
General and administrative (G&A) expenses for the periods indicated were as
follows:
Change
2020 2019 2018 2020 over 2019 2019 over 2018

(In millions)

General and administrative $ 567$ 461$ 483 $ 106 $

(22)

G&A expenses in fiscal 2020 increased compared to fiscal 2019 primarily due to
higher expense associated with acquisition integration and deal costs, variable
compensation, and share-based compensation. General and administrative expenses
in fiscal 2019 decreased slightly compared to fiscal 2018 primarily due to lower
variable compensation expenses.
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G&A expenses during fiscal 2020, 2019 and 2018 included $52 million, $44 million
and $44 million, respectively, of share-based compensation expense.
Interest Expense and Interest and Other Income (loss), net
Interest expense and interest and other income (loss), net for the periods
indicated were as follows:

Change
2020 2019 2018 2020 over 2019 2019 over 2018

(In millions)
Interest expense $ 240$ 237$ 234 $ 3 $ 3

Interest and other income, net $ 41$ 156$ 139 $

(115) $ 17

Interest expenses incurred were primarily associated with the senior unsecured
notes. Interest expense in fiscal 2020 remained relatively flat compared fiscal
2019 and fiscal 2018.
Interest and other income, net primarily includes interest earned on cash and
investments, realized gains or losses on sales of securities and impairment of
strategic investments. Effective the first quarter of fiscal 2019, unrealized
gains and losses on investments classified as equity investments are recognized
in other income (expense), net in the Consolidated Statement of Operations.
Prior to the adoption of Accounting Standards Update (ASU) 2016-01 Financial
Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial
Assets and Financial Liabilities in the first quarter of fiscal 2019, these
unrealized gains and temporary losses were included within accumulated other
comprehensive income (loss), net of any related tax effect. Interest and other
income, net in fiscal 2020 decreased compared to fiscal 2019, primarily driven
by lower interest income and a loss on early extinguishment of debt. In
addition, unrealized gains on equity investment securities from investments
during fiscal 2020 was lower compared to fiscal 2019. Interest and other income,
net in fiscal 2019 increased compared to fiscal 2018 primarily driven by
unrealized gains on equity investment securities.
Income Taxes
Provision for income taxes and effective tax rates for the periods indicated
were as follows:
Change
2020 2019 2018 2020

over 2019 2019 over 2018

(In millions, except percentages)
Provision for income taxes $ 547$ 563$ 1,358$ (16)$ (795)
Effective income tax rate 13.1 % 17.2 % 30.9 % (4.1) points (13.7) points

Applied’s provision for income taxes and effective tax rate are affected by the
geographical composition of pre-tax income which includes jurisdictions with
differing tax rates, conditional reduced tax rates and other income tax
incentives. It is also affected by events that are not consistent from period to
period, such as changes in income tax laws and the resolution of prior years’
income tax filings.
On June 14, 2019, the U.S. government released regulations that significantly
affect how the global intangible low-taxed income (GILTI) provision of the Tax
Cuts and Jobs Act (Tax Act) is interpreted. As a result, Applied reversed a tax
benefit of $96 million in the third quarter of fiscal 2019 that had been
realized in the first half of fiscal 2019. An accounting policy may be selected
to treat GILTI temporary differences in taxable income either as a
current-period expense when incurred (period cost method) or factor such amounts
into the measurement of deferred taxes (deferred method). Applied has chosen the
period cost method.
On March 27, 2020, the U.S. government enacted the Coronavirus Aid, Relief, and
Economic Security Act (CARES Act). The enactment of the CARES Act does not
result in any material adjustments to Applied’s provision for income taxes.
Applied’s effective tax rate for fiscal 2020 was lower than fiscal 2019
primarily due to a decline in the tax expense from changes to uncertain tax
positions year-over-year, an increased tax benefit from tax credits, and
increased excess stock compensation tax benefits. This benefit was partly offset
by an unfavorable settlement of an uncertain tax position in fiscal 2020.
The effective tax rate for fiscal 2019 was lower than fiscal 2018 primarily due
to tax expense of $1.1 billion in fiscal 2018 for the transition tax and
remeasurement of deferred tax assets as a result of the Tax Act. Excluding the
tax expense of $1.1 billion, the effective tax rate for fiscal 2019 was higher
than fiscal 2018 primarily due to certain provisions in the Tax Act becoming
effective in fiscal 2019, tax expense of $87 million in fiscal 2019 related to
changes in uncertain tax positions and the excess tax benefit from share-based
compensation in fiscal 2019 being $42 million less than the prior fiscal year.
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Segment Information
Applied reports financial results in three segments: Semiconductor Systems,
Applied Global Services, and Display and Adjacent Markets. A description of the
products and services, as well as financial data, for each reportable segment
can be found in Note 17 of Notes to Consolidated Financial Statements.
The Corporate and Other category includes revenues from products, as well as
costs of products sold, for fabricating solar photovoltaic cells and modules and
certain operating expenses that are not allocated to its reportable segments and
are managed separately at the corporate level. These operating expenses include
costs for share-based compensation; certain management, finance, legal, human
resource, and RD&E functions provided at the corporate level; and unabsorbed
information technology and occupancy. In addition, Applied does not allocate to
its reportable segments restructuring and asset impairment charges and any
associated adjustments related to restructuring actions, unless these actions
pertain to a specific reportable segment.
The results for each reportable segment are discussed below.
Semiconductor Systems Segment
The Semiconductor Systems segment is comprised primarily of capital equipment
used to fabricate semiconductor chips. Semiconductor industry spending on
capital equipment is driven by demand for advanced electronic products,
including smartphones and other mobile devices, servers, personal computers,
automotive electronics, storage, and other products, and the nature and timing
of technological advances in fabrication processes, and as a result is subject
to variable industry conditions. Development efforts are focused on solving
customers’ key technical challenges in transistor, interconnect, patterning and
packaging performance as devices scale to advanced technology nodes.
Semiconductor equipment customers continued to make strategic investments in new
technology transitions during fiscal 2020. Foundry and logic spending increased
in fiscal 2020 compared to fiscal 2019 led by customer investment in advanced
foundry-logic nodes. Spending by memory customers increased in fiscal 2020
compared to fiscal 2019, as the market began to recover from excess supply and
inventory levels and customers invested in new technology development. Overall
semiconductor systems revenue increased in fiscal 2020 compared to the prior
year.
Certain significant measures for the periods indicated were as follows:
Change
2020 2019 2018 2020 over 2019 2019 over 2018

(In millions, except percentages and ratios)

Net sales $ 11,367$ 9,027$ 10,577$ 2,340 26 % $ (1,550) (15) %

Operating income $ 3,714$ 2,464$ 3,441$ 1,250 51 % $ (977) (28) %
Operating margin 32.7 % 27.3 % 32.5 % 5.4 points (5.2) points

Net sales for Semiconductor Systems by end use application for the periods
indicated were as follows:

2020 2019 2018

Foundry, logic and other 59 % 52 % 36 %
Dynamic random-access memory (DRAM) 20 % 22 % 27 %
Flash memory 21 % 26 % 37 %

100 % 100 % 100 %

Net sales for fiscal 2020 increased, in absolute dollars, compared to fiscal
2019 primarily due to higher spending from foundry, logic and other customers.
Operating margin for fiscal 2020 increased compared to fiscal 2019, primarily
reflecting higher net sales and favorable changes in customer and product mix
and lower travel related spending due to COVID-19 travel restrictions, partially
offset by increased RD&E expenses, higher freight costs, higher personnel costs
due to additional headcount to provide manufacturing capacity and flexibility,
and incremental employee compensation related to the COVID-19 pandemic.
Net sales for fiscal 2019 decreased compared to fiscal 2018 primarily due to
lower spending from memory customers, partially offset by increased spending
from foundry, logic and other customers. Operating margin for fiscal 2019
decreased compared to the prior year, primarily reflecting lower net sales,
unfavorable changes in customer and product mix.
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In fiscal 2020, two customers each accounted for more than 10 percent of this
segment’s total net sales.
There was no single region that accounted for at least 30 percent of total net
sales for the Semiconductor Systems segment for any of the past three fiscal
years.

Applied Global Services Segment
The Applied Global Services segment provides integrated solutions to optimize
equipment and fab performance and productivity, including spares, upgrades,
services, certain remanufactured earlier generation equipment and factory
automation software for semiconductor, display and solar products.
Demand for Applied Global Services’ service solutions are driven by Applied’s
large and growing installed base of manufacturing systems, and customers’ needs
to shorten ramp times, improve device performance and yield, and optimize
factory output and operating costs. Industry conditions that affect Applied
Global Services’ sales of spares and services are primarily characterized by
increases in semiconductor manufacturers’ wafer starts and continued strong
utilization rates, growth of the installed base of equipment, growing service
intensity of newer tools, and the company’s ability to sell more comprehensive
service agreements.
Certain significant measures for the periods indicated were as follows:
Change
2020 2019 2018 2020 over 2019 2019 over 2018

(In millions, except percentages and ratios)

Net sales $ 4,155$ 3,854$ 3,754 $ 301 8 % $ 100 3 %

Operating income $ 1,127$ 1,101$ 1,102 $ 26 2 % $ (1) – %
Operating margin 27.1 % 28.6 % 29.4 % (1.5) points (0.8) points

Net sales for fiscal 2020 increased compared to fiscal 2019 primarily due to
higher customer spending on comprehensive service agreements, semiconductor
spares and legacy systems. Operating margin for fiscal 2020 compared to fiscal
2019 decreased primarily due to an increase in headcount to support business
growth, underutilization of headcount due to COVID-19 restrictions preventing
travel to customer sites, higher freight costs and incremental employee
compensation related to the COVID-19 pandemic. In fiscal 2020, three customers
each accounted for more than 10 percent of this segment’s total net sales.
Net sales increased slightly in fiscal 2019 compared to the prior year primarily
due to higher customer spending for comprehensive service agreements and legacy
systems, partially offset by lower customer spending on semiconductor spares.
Operating income for fiscal 2019 remained flat compared to the prior year
primarily due to higher net sales, offset by higher expenses related to an
increase in headcount. Operating margin for fiscal 2019 decreased slightly
compared to fiscal 2018 primarily due to an increase in headcount to support
revenue growth.
There was no single region that accounted for at least 30 percent of total net
sales for the Applied Global Services segment for any of the past three fiscal
years.
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Display and Adjacent Markets Segment
The Display and Adjacent Markets segment encompasses products for manufacturing
liquid crystal and OLED displays, and other display technologies for TVs,
monitors, laptops, personal computers, electronic tablets, smart phones, and
other consumer-oriented devices, equipment upgrades and flexible coating
systems. The segment is focused on expanding its presence through
technologically-differentiated equipment for manufacturing large-scale LCD TVs,
OLEDs, low temperature polysilicon (LTPS), metal oxide, and touch panel sectors;
and development of products that provide customers with improved performance and
yields.
Display industry growth depends primarily on consumer demand for increasingly
larger and more advanced TVs as well as larger and higher resolution displays
for next generation mobile devices. Uneven spending patterns by customers in the
Display and Adjacent Markets segment can cause significant fluctuations
quarter-over-quarter, as well as year-over-year.
Certain significant measures for the periods presented were as follows:

Change
2020 2019 2018 2020 over 2019 2019 over 2018

(In

millions, except percentages and ratios)

Net sales $ 1,607$ 1,651$ 2,298$ (44) (3) % $ (647) (28) %

Operating income $ 291$ 294$ 574$ (3) (1) % $ (280) (49) %
Operating margin 18.1 % 17.8 % 25.0 % 0.3 points (7.2) points

Net sales for fiscal 2020 decreased compared to fiscal 2019 primarily due to
lower customer investments in display manufacturing equipment for TVs, partially
offset by higher customer investments in display manufacturing equipment for
mobile products. Operating margin for fiscal 2020 increased compared to fiscal
2019, reflecting favorable changes in customer and product mix and lower travel
related spending due to COVID-19 travel restrictions. In fiscal 2020, four
customers each accounted for at least 10 percent of this segment’s net sales,
and together they accounted for approximately 74 percent of this segment’s total
net sales, with one customer accounting for approximately 32 percent of net
sales.
Net sales for fiscal 2019 decreased compared to fiscal 2018 primarily due to
lower customer investments in mobile and TV display manufacturing equipment.
Operating income and operating margin for fiscal 2019 decreased compared to
fiscal 2018, reflecting lower net sales and unfavorable changes in customer and
product mix.
The following region accounted for at least 30 percent of total net sales for
the Display and Adjacent Markets segment for one or more of the periods
presented:
Change
2020 2019 2018 2020 over 2019 2019 over 2018

(In millions, except percentages)

China $ 1,343 84 % $ 1,469 89 % $ 1,957 85 % $ (126) (9) % $ (488) (25) %

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Recent Accounting Pronouncements
For a description of recent accounting pronouncements, including the expected
dates of adoption and estimated effects, if any, on Applied’s consolidated
financial statements, see Note 1, “Summary of Significant Accounting Policies,”
of the Notes to Consolidated Financial Statements.
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Financial Condition, Liquidity and Capital Resources
Applied’s cash, cash equivalents and investments consist of the following:

October 25, October 27,
2020 2019

(In millions)
Cash and cash equivalents $ 5,351$ 3,129
Short-term investments 387 489
Long-term investments 1,538 1,703

Total cash, cash-equivalents and investments $ 7,276$ 5,321

Sources and Uses of Cash
A summary of cash provided by (used in) operating, investing, and financing
activities is as follows:

2020 2019 2018

(In millions)
Cash provided by operating activities $ 3,804$ 3,247$ 3,787
Cash provided by (used in) investing activities $ (130)$ (443)$ 571
Cash used in financing activities $ (1,337)$ (3,115)

$ (5,928)

Operating Activities
Cash from operating activities for fiscal 2020 was $3.8 billion, which reflects
net income adjusted for the effect of non-cash charges and changes in working
capital components. Non-cash charges included depreciation, amortization,
share-based compensation and deferred income taxes. Cash provided by operating
activities increased in fiscal 2020 compared to fiscal 2019 primarily due to
higher net income and better cash collections. Cash provided from operating
activities in fiscal 2019 decreased compared to fiscal 2018 due to lower net
income, cash collections, change in income taxes payable and higher payments to
suppliers, offset by a decrease in inventories.
Applied has agreements with various financial institutions to sell accounts
receivable and discount promissory notes from selected customers. Applied sells
its accounts receivable without recourse. Applied, from time to time, also
discounts letters of credit issued by customers through various financial
institutions. The discounting of letters of credit depends on many factors,
including the willingness of financial institutions to discount the letters of
credit and the cost of such arrangements. Applied sold $1.2 billion, $1.5
billion and $1.6 billion of accounts receivable during fiscal 2020, 2019 and
2018, respectively. Applied discounted letters of credit issued by customers of
$105 million, $48 million and $37 million in fiscal 2020, 2019 and 2018,
respectively. There was no discounting of promissory notes in each of fiscal
2020, 2019 and 2018.
Applied’s working capital was $8.9 billion at October 25, 2020 and $5.8 billion
at October 27, 2019.
Days sales outstanding at the end of fiscal 2020, 2019 and 2018 was 57 days, 61
days, and 58 days, respectively. Days sales outstanding varies due to the timing
of shipments and payment terms. The decrease in days sales outstanding at the
end of fiscal 2020 was primarily due to higher accounts receivable factoring and
favorable revenue linearity compared to the end of fiscal 2019. The increase in
days sales outstanding at the end of fiscal 2019 compared to the end of fiscal
2018 was primarily due to lower factoring of accounts receivable.
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Investing Activities
Applied used $130 million and $443 million of cash in investing activities in
fiscal 2020 and 2019, respectively. Applied generated $571 million in cash from
investing activities in fiscal 2018. Capital expenditures in fiscal 2020, 2019
and 2018 were $422 million, $441 million and $622 million, respectively. Capital
expenditures in fiscal 2020 were primarily for investments in demonstration and
testing equipment, real property acquisitions and improvements, and network
equipment. Capital expenditures in fiscal 2019 and 2018 were primarily for real
property acquisitions and improvements in North America and Taiwan, as well as
investments in demonstration, testing and laboratory tools. Proceeds from sales
and maturities of investments, net of purchase of investments were $399 million,
$26 million and $1.2 billion for fiscal 2020, 2019 and 2018, respectively.
Investing activities also included investments in technology to allow Applied to
access new market opportunities or emerging technologies.
Applied’s investment portfolio consists principally of investment grade money
market mutual funds, U.S.Treasury and agency securities, municipal bonds,
corporate bonds and mortgage-backed and asset-backed securities, as well as
equity securities. Applied regularly monitors the credit risk in its investment
portfolio and takes appropriate measures, which may include the sale of certain
securities, to manage such risks prudently in accordance with its investment
policies.
Financing Activities
Applied used $1.3 billion of cash in financing activities in fiscal 2020,
consisting primarily of the repayment of $1.4 billion senior notes, repurchases
of common stock of $649 million, cash dividends to stockholders of $787 million
and tax withholding payments for vested equity awards of $172 million, offset by
net proceeds received from the issuance of senior unsecured notes of $1.5
billion and proceeds from common stock issuances of $174 million.
Applied used $3.1 billion of cash in financing activities in fiscal 2019,
consisting primarily of repurchases of common stock of $2.4 billion, cash
dividends to stockholders of $771 million and tax withholding payments for
vested equity awards of $86 million, offset by proceeds from common stock
issuances of $145 million.
Applied used $5.9 billion of cash in financing activities in fiscal 2018,
consisting primarily of repurchases of common stock of $5.3 billion, cash
dividends to stockholders of $605 million and tax withholding payments for
vested equity awards of $164 million, offset by proceeds from common stock
issuances of $124 million.
In February 2018, the Board of Directors approved a common stock repurchase
program authorizing up to an aggregate of $6.0 billion in repurchases. At
October 25, 2020, $1.3 billion remained available for future stock repurchases
under this repurchase program.
During fiscal 2020, Applied’s Board of Directors declared one quarterly cash
dividend of $0.21 per share and three quarterly cash dividends of $0.22 per
share. During fiscal 2019, Applied’s Board of Directors declared one quarterly
cash dividend of $0.20 per share and three quarterly cash dividends of $0.21 per
share. During fiscal 2018, Applied’s Board of Directors declared one quarterly
cash dividend of 0.10 per share and three quarterly cash dividends in the amount
of $0.20 per share. Dividends paid during fiscal 2020, 2019 and 2018 amounted to
$787 million, $771 million and $605 million, respectively. Applied currently
anticipates that cash dividends will continue to be paid on a quarterly basis,
although the declaration of any future cash dividend is at the discretion of the
Board of Directors and will depend on Applied’s financial condition, results of
operations, capital requirements, business conditions and other factors, as well
as a determination by the Board of Directors that cash dividends are in the best
interests of Applied’s stockholders.
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 (Revolving Credit Agreement) with a group of banks. Applied
entered into the Revolving Credit Agreement in February 2020, which replaced
Applied’s prior $1.5 billion revolving credit agreement that was scheduled to
expire in September 2021. The Revolving Credit Agreement includes a provision
under which Applied may request an increase in the amount of the facility of up
to $500 million for a total commitment of no more than $2.0 billion, subject to
the receipt of commitments from one or more lenders for any such increase and
other customary conditions. The Revolving Credit Agreement is scheduled to
expire in February 2025, unless extended as permitted under the Revolving Credit
Agreement. The Revolving Credit Agreement provides for borrowings in United
States dollars that bear interest for each advance at one of two rates selected
by Applied, plus an applicable margin, which varies according to Applied’s
public debt credit ratings. The Revolving Credit Agreement includes financial
and other covenants with which Applied was in compliance as of October 25, 2020.
In March 2020, Applied borrowed the full $1.5 billion available under the
Revolving Credit Agreement in order to increase its cash position and preserve
financial flexibility in light of the uncertainty in the global markets
resulting from the COVID-19 outbreak. In May 2020, Applied repaid the full
$1.5 billion of borrowings under the Revolving Credit Agreement. Applied may at
any time and from time to time, borrow, repay and reborrow under the Revolving
Credit Agreement during the term of the facility. The interest rate for the
March 2020 borrowing under the Revolving Credit Agreement was one-month LIBOR
plus a margin of 0.875%, based on Applied’s public debt credit ratings.
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Remaining credit facilities in the amount of approximately $76 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.
In August 2019, Applied entered into a term loan credit agreement with a group
of lenders. Under the agreement, the lenders have committed to make an unsecured
term loan to Applied of up to $2.0 billion to finance in part Applied’s planned
acquisition of all outstanding shares of Kokusai Electric, to pay related
transaction fees and expenses and for general corporate purposes. The
commitments of the lenders to make the term loan will terminate if the
transactions contemplated by the Share Purchase Agreement are not consummated on
or before December 30, 2020. The term loan, if advanced, will bear interest at
one of two rates selected by Applied, plus an applicable margin, which varies
according to Applied’s public debt credit ratings, and must be repaid in full on
the third anniversary of the funding date of the term loan.
No amounts were outstanding under any of these facilities at both October 25,
2020 and October 27, 2019.
Applied has a short-term commercial paper program under which Applied may issue
unsecured commercial paper notes of up to a total amount $1.5 billion. As of
October 25, 2020, Applied did not have any commercial paper outstanding but may
issue commercial paper notes under this program from time to time in the future.
The commercial paper program is backstopped by the Revolving Credit Agreement
and borrowings under the Revolving Credit Agreement reduce the amount of
commercial paper notes Applied can issue.
In May 2020, Applied issued $750 million aggregate principal amount of 1.750%
senior unsecured notes due 2030 and $750 million aggregate principal amount of
2.750% senior unsecured notes due 2050, in a registered public offering. In June
2020, Applied used a portion of the net proceeds from the offering to redeem the
outstanding $600 million in aggregate principal amount of its 2.625% senior
unsecured notes due October 1, 2020 and $750 million in aggregate principal
amount of its 4.300% senior unsecured notes due June 15, 2021, at a total
aggregate redemption price of $1.4 billion. As a result, Applied recognized a
$33 million loss on early extinguishment of these senior unsecured notes.
Applied had senior unsecured notes in the aggregate principal amount of $5.5
billion outstanding as of October 25, 2020. See Note 11 of the Notes to the
Consolidated Condensed Financial Statements for additional discussion of
existing debt. Applied may seek to refinance its existing debt and may incur
additional indebtedness depending on Applied’s capital requirements and the
availability of financing.
Others
On December 22, 2017, the U.S. government enacted the Tax Cuts and Jobs Act (Tax
Act). The Tax Act requires a one-time transition tax on certain unrepatriated
earnings of foreign subsidiaries. For fiscal 2018, Applied realized tax expense
of $1.1 billion associated with the Tax Act, primarily due to the transition
tax. The transition tax expense is payable in installments over eight years,
with eight percent due in each of the first five years starting with fiscal
2018. As of October 25, 2020, Applied had $857 million of total payments
remaining, payable in installments in the next six years. Before the Tax Act,
U.S. income tax had not been provided for certain unrepatriated earnings that
were considered indefinitely reinvested. Income tax is now provided for all
unrepatriated earnings.
Although cash requirements will fluctuate based on the timing and extent of
factors such as those discussed above, Applied’s management believes that cash
generated from operations, together with the liquidity provided by existing cash
balances and borrowing capability, will be sufficient to satisfy Applied’s
liquidity requirements for the next 12 months. For further details regarding
Applied’s operating, investing and financing activities, see the Consolidated
Statements of Cash Flows in this report.
For details on standby letters of credit, guarantee instruments and other
agreements with banks, see Off-Balance Sheet Arrangements below.
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Off-Balance Sheet Arrangements
In the ordinary course of business, Applied provides standby letters of credit
or other guarantee instruments to third parties as required for certain
transactions initiated by either Applied or its subsidiaries. These include
agreements with various banks to facilitate subsidiary banking operations
worldwide, including overdraft arrangements. As of October 25, 2020, the maximum
potential amount of future payments that Applied could be required to make under
these guarantee agreements was approximately $233 million. Applied has not
recorded any liability in connection with these guarantee agreements beyond that
required to appropriately account for the underlying transaction being
guaranteed. Applied does not believe, based on historical experience and
information currently available, that it is probable that any amounts will be
required to be paid under these guarantee agreements.
Applied also has agreements with various banks to facilitate subsidiary banking
operations worldwide, including overdraft arrangements, issuance of bank
guarantees, and letters of credit. As of October 25, 2020, Applied has provided
parent guarantees to banks for approximately $153 million to cover these
arrangements.
Contractual Obligations
The following table summarizes Applied’s contractual obligations as of
October 25, 2020:

Payments Due by Period
Less Than 1-3 3-5 More Than
Contractual Obligations Total 1 Year Years Years 5 Years

(In millions)
Debt obligations $ 5,500 $ –

$ – $ 700$ 4,800
Interest expense associated with debt
obligations

3,416 205 410 409 2,392
Operating lease obligations 271 68 103 75 25
Income tax from change in U.S. tax laws1 857 82 163 357 255
Purchase obligations2 2,443 2,283 143 17 –
Other long-term liabilities3,4 20 – 2 2 16
Total $ 12,507$ 2,638$ 821$ 1,560$ 7,488

______________________
1Represents the transition tax liability associated with the deemed repatriation
of accumulated foreign earnings as a result of the enactment of the Tax Cuts and
Jobs Act into law on December 22, 2017.
2Represents Applied’s agreements to purchase goods and services consisting of
Applied’s outstanding purchase orders for goods and services.
3Other long-term liabilities in the table do not include pension, postretirement
and deferred compensation plans due to the uncertainty in the timing of future
payments. Applied evaluates the need to make contributions to its pension and
postretirement benefit plans after considering the funded status of the plans,
movements in the discount rate, performance of the plan assets and related tax
consequences. Payments to the plans would be dependent on these factors and
could vary across a wide range of amounts and time periods. Payments for
deferred compensation plans are dependent on activity by participants, making
the timing of payments uncertain. Information on Applied’s pension,
postretirement benefit and deferred compensation plans is presented in Note 14,
Employee Benefit Plans, of the consolidated financial statements.
4Applied’s other long-term liabilities in the Consolidated Balance Sheets
include deferred income tax liabilities, gross unrecognized tax benefits and
related gross interest and penalties. As of October 25, 2020, the gross
liability for unrecognized tax benefits that was not expected to result in
payment of cash within one year was $485 million. Interest and penalties related
to uncertain tax positions that were not expected to result in payment of cash
within one year of October 25, 2020 was $74 million. At this time, Applied is
unable to make a reasonably reliable estimate of the timing of payments due to
uncertainties in the timing of tax audit outcomes; therefore, such amounts are
not included in the above contractual obligation table.
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Critical Accounting Policies and Estimates
The preparation of consolidated financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States of
America requires management to make judgments, assumptions and estimates that
affect the amounts reported. Note 1 of Notes to Consolidated Financial
Statements describes the significant accounting policies used in the preparation
of the consolidated financial statements. Certain of these significant
accounting policies are considered to be critical accounting policies.
A critical accounting policy is defined as one that is both material to the
presentation of Applied’s consolidated financial statements and that requires
management to make difficult, subjective or complex judgments that could have a
material effect on Applied’s financial condition or results of operations.
Specifically, these policies have the following attributes: (1) Applied is
required to make assumptions about matters that are highly uncertain at the time
of the estimate; and (2) different estimates Applied could reasonably have used,
or changes in the estimate that are reasonably likely to occur, would have a
material effect on Applied’s financial condition or results of operations.
Estimates and assumptions about future events and their effects cannot be
determined with certainty. Applied bases its estimates on historical experience
and on various other assumptions believed to be applicable and reasonable under
the circumstances. These estimates may change as new events occur, as additional
information is obtained and as Applied’s operating environment changes. These
changes have historically been minor and have been included in the consolidated
financial statements as soon as they became known. In addition, management is
periodically faced with uncertainties, the outcomes of which are not within its
control and will not be known for prolonged periods of time. These uncertainties
include those discussed in Part I, Item 1A, “Risk Factors.” Based on a critical
assessment of its accounting policies and the underlying judgments and
uncertainties affecting the application of those policies, management believes
that Applied’s consolidated financial statements are fairly stated in accordance
with accounting principles generally accepted in the United States of America,
and provide a meaningful presentation of Applied’s financial condition and
results of operations.
Management believes that the following are critical accounting policies and
estimates:
Revenue Recognition
Applied recognizes revenue when promised goods or services (performance
obligations) are transferred to a customer in an amount that reflects the
consideration to which Applied expects to be entitled in exchange for those
goods or services. Applied performs the following five steps to determine when
to recognize revenue: (1) identification of the contract(s) with customers, (2)
identification of the performance obligations in the contract, (3) determination
of the transaction price, (4) allocation of the transaction price to the
performance obligations in the contract, and (5) recognition of revenue when, or
as, a performance obligation is satisfied. Management uses judgment to identify
performance obligations within a contract and to determine whether multiple
promised goods or services in a contract should be accounted for separately or
as a group. Judgment is also used in interpreting commercial terms and
determining when transfer of control occurs. Moreover, judgment is used to
estimate the contract’s transaction price and allocate it to each performance
obligation. Any material changes in the identification of performance
obligations, determination and allocation of the transaction price to
performance obligations, and determination of when transfer of control occurs to
the customer, could impact the timing and amount of revenue recognition, which
could have a material effect on Applied’s financial condition and results of
operations.
Warranty Costs
Applied provides for the estimated cost of warranty when revenue is recognized.
Estimated warranty costs are determined by analyzing specific product, current
and historical configuration statistics and regional warranty support costs.
Applied’s warranty obligation is affected by product and component failure
rates, material usage and labor costs incurred in correcting product failures
during the warranty period. As Applied’s customer engineers and process support
engineers are highly trained and deployed globally, labor availability is a
significant factor in determining labor costs. The quantity and availability of
critical replacement parts is another significant factor in estimating warranty
costs. Unforeseen component failures or exceptional component performance can
also result in changes to warranty costs. If actual warranty costs differ
substantially from Applied’s estimates, revisions to the estimated warranty
liability would be required, which could have a material adverse effect on
Applied’s business, financial condition and results of operations.
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Allowance for Doubtful Accounts
Applied maintains an allowance for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. This
allowance is based on historical experience, credit evaluations, specific
customer collection history and any customer-specific issues Applied has
identified. Changes in circumstances, such as an unexpected material adverse
change in a major customer’s ability to meet its financial obligation to Applied
or its payment trends, may require Applied to further adjust its estimates of
the recoverability of amounts due to Applied, which could have a material
adverse effect on Applied’s business, financial condition and results of
operations.
Inventory Valuation
Inventories are generally stated at the lower of cost or net realizable value,
with cost determined on a first-in, first-out (FIFO) basis. The carrying value
of inventory is reduced for estimated obsolescence by the difference between its
cost and the estimated net realizable value based upon assumptions about future
demand. Applied evaluates the inventory carrying value for potential excess and
obsolete inventory exposures by analyzing historical and anticipated demand. In
addition, inventories are evaluated for potential obsolescence due to the effect
of known and anticipated engineering change orders and new products. If actual
demand were to be substantially lower than estimated, additional adjustments for
excess or obsolete inventory may be required, which could have a material
adverse effect on Applied’s business, financial condition and results of
operations.
Goodwill and Intangible Assets
Applied reviews goodwill and intangible assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of these assets may
not be recoverable, and also annually reviews goodwill and intangibles with
indefinite lives for impairment. 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. If actual product acceptance differs significantly from the
estimates, Applied may be required to record an impairment charge to reduce the
carrying value of the reporting unit to its estimated fair value.
To test goodwill for impairment, Applied first performs a qualitative assessment
to determine whether it is more likely than not that the fair value of a
reporting unit is less than its carrying value. If it is concluded that this is
the case, Applied then performs the two-step goodwill impairment test.
Otherwise, the two-step goodwill impairment test is not required. Under the
two-step goodwill impairment test, Applied would in the first step compare the
estimated fair value of each reporting unit to its carrying value. If the
carrying value of a reporting unit exceeds its estimated fair value, Applied
would then perform the second step of the impairment test in order to determine
the implied fair value of the reporting unit’s goodwill. If Applied determines
that the carrying value of a reporting unit’s goodwill exceeds its implied fair
value, Applied would record an impairment charge equal to the difference.
Applied determines the fair value of each reporting unit based on a weighting of
an income and a market approach. Applied bases the fair value estimates on
assumptions that it believes to be reasonable but that are unpredictable and
inherently uncertain. Under the income approach, Applied estimates the fair
value based on discounted cash flow method.
The estimates used in the impairment testing are consistent with the discrete
forecasts that Applied uses to manage its business, and considers any
significant developments during the period. Under the discounted cash flow
method, cash flows beyond the discrete forecasts are estimated using a terminal
growth rate, which considers the long-term earnings growth rate specific to the
reporting units. The estimated future cash flows are discounted to present value
using each reporting unit’s weighted average cost of capital. The weighted
average cost of capital measures a reporting unit’s cost of debt and equity
financing weighted by the percentage of debt and equity in a reporting unit’s
target capital structure. In addition, the weighted average cost of capital is
derived using both known and estimated market metrics, and is adjusted to
reflect both the timing and risks associated with the estimated cash flows. The
tax rate used in the discounted cash flow method is the median tax rate of
comparable companies and reflects Applied’s current international structure,
which is consistent with the market participant perspective. Under the market
approach, Applied uses the guideline company method which applies market
multiples to forecasted revenues and earnings before interest, taxes,
depreciation and amortization. Applied uses market multiples that are consistent
with comparable publicly-traded companies and considers each reporting unit’s
size, growth and profitability relative to its comparable companies.
Management uses significant judgment when assessing goodwill for potential
impairment, especially in emerging markets. Indicators of potential impairment
include, but are not limited to, challenging economic conditions, an unfavorable
industry or economic environment or other severe decline in market conditions.
Such conditions could have the effect of changing one of the critical
assumptions or estimates used for the fair value calculation, resulting in an
unexpected goodwill impairment charge, which could have a material adverse
effect on Applied’s business, financial condition and results of operations. See
Note 10 of Notes to Consolidated Financial Statements for additional discussion
of goodwill impairment.
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Income Taxes
Applied’s provision for income taxes and effective tax rate are affected by the
geographical composition of pre-tax income which includes jurisdictions with
differing tax rates, conditional reduced tax rates and other income tax
incentives. It is also affected by events that are not consistent from period to
period, such as changes to income tax laws and the resolution of prior years’
income tax filings.
Applied recognizes a current tax liability for the estimated amount of income
tax payable on tax returns for the current fiscal year. Deferred tax assets and
liabilities are recognized for the estimated future tax effects of temporary
differences between the book and tax bases of assets and liabilities. Deferred
tax assets are also recognized for net operating loss and tax credit
carryforwards. Deferred tax assets are offset by a valuation allowance to the
extent it is more likely than not that they are not expected to be realized.
Applied recognizes tax benefits from uncertain tax positions only if it is more
likely than not that the tax position will be sustained upon examination by the
taxing authorities based on the technical merits of the position. The tax
benefits recognized from such positions are estimated based on the largest
benefit that has a greater than 50% likelihood of being realized upon ultimate
settlement. Any changes in judgment related to uncertain tax positions are
recognized in Applied’s provision for income taxes in the quarter in which such
change occurs. Interest and penalties related to uncertain tax positions are
recognized in Applied’s provision for income taxes.
The calculation of Applied’s provision for income taxes and effective tax rate
involves significant judgment in estimating the impact of uncertainties in the
application of complex tax laws. Resolution of these uncertainties in a manner
inconsistent with Applied’s expectations could have an adverse material impact
on Applied’s results of operations and financial condition.

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Non-GAAP Adjusted Financial Results
Management uses non-GAAP adjusted financial measures to evaluate the Company’s
operating and financial performance and for planning purposes, and as
performance measures in its executive compensation program. Applied believes
these measures enhance an overall understanding of its performance and
investors’ ability to review the Company’s business from the same perspective as
the Company’s management and facilitate comparisons of this period’s results
with prior periods on a consistent basis by excluding items that management does
not believe are indicative of Applied’s ongoing operating performance.
The non-GAAP adjusted financial measures presented below are adjusted to exclude
the impact of certain costs, expenses, gains and losses, including certain items
related to mergers and acquisitions; restructuring charges and any associated
adjustments; certain incremental expenses related to COVID-19; impairments of
assets, or investments; gain or loss on sale of strategic investments; loss on
early extinguishment of debt; certain income tax items and other discrete
adjustments. Additionally, non-GAAP results exclude estimated discrete income
tax expense items associated with U.S. tax legislation. Reconciliations of these
non-GAAP measures to the most directly comparable financial measures calculated
and presented in accordance with GAAP are provided in the financial tables
presented below. There are limitations in using non-GAAP financial measures
because the non-GAAP financial measures are not prepared in accordance with
generally accepted accounting principles, may be different from non-GAAP
financial measures used by other companies, and may exclude certain items that
may have a material impact upon our reported financial results. The presentation
of this additional information is not meant to be considered in isolation or as
a substitute for the directly comparable financial measures prepared in
accordance with GAAP.
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The following tables present a reconciliation of the GAAP and non-GAAP adjusted
consolidated results for the past three fiscal years:

APPLIED MATERIALS, INC.

UNAUDITED RECONCILIATION OF GAAP TO NON-GAAP ADJUSTED RESULTS
(In millions, except percentages)

2020 2019 2018

Non-GAAP Adjusted Gross Profit
Reported gross profit – GAAP basis

$ 7,692$ 6,386$ 7,517
Certain items associated with acquisitions1

37 37 179

Certain incremental expenses related to COVID-192 23 – –

Non-GAAP adjusted gross profit

$ 7,752$ 6,423$ 7,696
Non-GAAP adjusted gross margin

45.1 % 44.0 % 46.1 %
Non-GAAP Adjusted Operating Income
Reported operating income – GAAP basis

$ 4,365$ 3,350$ 4,491
Certain items associated with acquisitions1

54 55 197
Acquisition integration and deal costs 80 22 5
Certain incremental expenses related to COVID-192 30 – –

Non-GAAP adjusted operating income

$ 4,529$ 3,427$ 4,693
Non-GAAP adjusted operating margin

26.3 % 23.5 % 28.1 %
Non-GAAP Adjusted Net Income
Reported net income – GAAP basis

$ 3,619$ 2,706$ 3,038
Certain items associated with acquisitions1

54 55 197
Acquisition integration and deal costs 80 22 5
Certain incremental expenses related to COVID-192 30 – –

Realized loss (gain) on strategic investments, net (1) (6) (25)
Unrealized loss (gain) on strategic investments, net (8) (30) –
Loss on early extinguishment of debt 33 – –

Income tax effect of changes in applicable U.S. tax laws3 – (24) 1,112

Income tax effects related to intra-entity intangible asset
transfers

114 62 –

Resolution of prior years’ income tax filings and other tax
items

(41) 95 (26)

Income tax effect of non-GAAP adjustments4 (35) (5) (7)
Non-GAAP adjusted net income $ 3,845$ 2,875$ 4,294

1 These items are incremental charges attributable to completed acquisitions, consisting

of amortization of purchased intangible assets.
2 Temporary incremental employee compensation during the COVID-19 pandemic.

3 Charges to income tax provision related to a one-time transition tax as a result of

U.S. tax legislation.
4 Adjustment to provision for income taxes related to non-GAAP adjustments reflected in

income before income taxes.

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APPLIED MATERIALS, INC.
UNAUDITED RECONCILIATION OF GAAP TO NON-GAAP ADJUSTED RESULTS

(In millions, except per share amounts) 2020 2019 2018

Non-GAAP Adjusted Earnings Per Diluted Share
Reported earnings per diluted share – GAAP basis $ 3.92$ 2.86$ 2.96
Certain items associated with acquisitions 0.05 0.05 0.18
Acquisition integration and deal costs 0.07 0.02 –
Certain incremental expenses related to COVID-19 0.03 – –

Realized loss (gain) on strategic investments, net – – (0.02)

Unrealized loss (gain) on strategic investments, net (0.01) (0.03) –
Loss on early extinguishment of debt 0.03 – –
Income tax effect of change in applicable U.S. tax laws – (0.03) 1.08

Income tax effects related to intra-entity intangible
asset transfers

0.12 0.07 –

Resolution of prior years’ income tax filings and other
tax items

(0.04) 0.10 (0.02)

Non-GAAP adjusted earnings per diluted share

$ 4.17$ 3.04$ 4.18
Weighted average number of diluted shares

923 945 1,026

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The following table presents a reconciliation of the GAAP and non-GAAP adjusted
segment results for the past three fiscal years:

APPLIED MATERIALS, INC.

UNAUDITED RECONCILIATION OF GAAP TO NON-GAAP ADJUSTED RESULTS
(In millions, except percentages)

2020 2019 2018

Semiconductor Systems Non-GAAP Adjusted Operating Income
Reported operating income – GAAP basis

$ 3,714$ 2,464$ 3,441
Certain items associated with acquisitions1 41 43 183
Acquisition integration costs 3 – –
Certain incremental expenses related to COVID-192 20 – –

Non-GAAP adjusted operating income $ 3,778$ 2,507$ 3,624
Non-GAAP adjusted operating margin 33.2 % 27.8 % 34.3 %

AGS Non-GAAP Adjusted Operating Income
Reported operating income – GAAP basis

$ 1,127$ 1,101$ 1,102

Acquisition integration costs – – 2
Certain incremental expenses related to COVID-192 8 – –

Non-GAAP adjusted operating income $ 1,135$ 1,101$ 1,104
Non-GAAP adjusted operating margin 27.3 % 28.6 % 29.4 %

Display and Adjacent Markets Non-GAAP Adjusted Operating
Income
Reported operating income – GAAP basis

$ 291$ 294$ 574
Certain items associated with acquisitions1 12 12 14
Acquisition integration costs – 1 1
Certain incremental expenses related to COVID-192 1 – –
Non-GAAP adjusted operating income $ 304$ 307$ 589
Non-GAAP adjusted operating margin 18.9 % 18.6 % 25.6 %

1 These items are incremental charges attributable to completed acquisitions, consisting

of amortization of purchased intangible assets.
2 Temporary incremental employee compensation during the COVID-19 pandemic.

Note: The reconciliation of GAAP and non-GAAP adjusted segment results above
does not include certain revenues, costs of products sold and operating expenses
that are reported within corporate and other and included in consolidated
operating income.
54

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