Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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:

• 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

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 16 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, augmented and virtual reality, the Internet of Things and smart vehicles are also creating new opportunities 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						2018						2017						2019 over 2018						2018 over 2017
			(In millions, except per share amounts and percentages)
Net sales			$	14,608					$	16,705					$	14,698					$	(2,097)					$	2,007
Gross margin			43.7		%				45.0		%				45.0		%				(1.3) points						— points
Operating income			$	3,350					$	4,491					$	3,936					$	(1,141)					$	555
Operating margin			22.9		%				26.9		%				26.8		%				(4.0) points						0.1 points
Net income			$	2,706					$	3,038					$	3,519					$	(332)					$	(481)
Earnings per diluted share			$	2.86					$	2.96					$	3.25					$	(0.10)					$	(0.29)

Fiscal 2019, 2018 and 2017 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.

Customer investments in semiconductor and display manufacturing equipment and services continued to be the primary contributor of revenue during fiscal 2019. Semiconductor equipment customers continued to make strategic investments in new technology transitions. Spending by memory customers, compared to fiscal 2018, was lower as they delayed new capacity additions and lowered their fab utilization rates in response to excess industry supply and inventory levels. Foundry and logic spending increased year-over-year led by customer investments in both advanced and mature foundry-logic nodes. Overall semiconductor systems revenue for fiscal 2019 decreased as compared to the prior year. Despite the overall wafer fab equipment market being down in 2019, Applied saw modest growth in its services business as compared to the prior year. This was driven by an increase in the installed base of equipment and continued growth in revenues from long-term service agreements, offset by a weaker demand for transactional spares due to lower memory fab utilization. Applied’s display and adjacent markets revenue declined during fiscal 2019 due to weak demand for display manufacturing equipment for mobile products and TVs.

Results of Operations

Net Sales

Net sales for the periods indicated were as follows:

																																																			Change
			2019																								2018																								2017																		2019 over 2018						2018 over 2017
			(In millions, except percentages)
Semiconductor Systems			$	9,027					62%												$	10,577					63%												9,544						65%						(15)		%				11		%
Applied Global Services			3,854						26%												3,754						22%												3,014						20%						3		%				25		%
Display and Adjacent Markets			1,651						11%												2,298						14%												2,042						14%						(28)		%				13		%
Corporate and Other			76						1%												76						1%												98						1%						—		%				(22)		%
Total			$	14,608					100%												$	16,705					100%												$	14,698					100%						(13)		%				14		%

Net sales in fiscal 2019 compared to fiscal 2018 decreased primarily due to decreased customer investments in semiconductor and display manufacturing equipment. Net sales in fiscal 2018 compared to fiscal 2017 increased due to increased customer investments across all segments. The Semiconductor Systems segment continued to represent the largest contributor of net sales.

Net sales by geographic region, determined by the location of customers’ facilities to which products were shipped, were as follows:

																																																			Change
			2019																								2018																								2017																		2019 over 2018						2018 over 2017
			(In millions, except percentages)
China			$	4,277					29%												$	5,047					30%												$	2,758					19%						(15)		%				83		%
Korea			1,929						13%												3,539						21%												4,087						28%						(45)		%				(13)		%
Taiwan			2,965						20%												2,504						15%												3,369						23%						18		%				(26)		%
Japan			2,198						15%												2,396						14%												1,519						10%						(8)		%				58		%
Southeast Asia			548						4%												797						5%												625						4%						(31)		%				28		%
Asia Pacific			11,917						81%												14,283						85%												12,358						84%						(17)		%				16		%
United States			1,871						13%												1,413						9%												1,512						10%						32		%				(7)		%
Europe			820						6%												1,009						6%												828						6%						(19)		%				22		%
Total			$	14,608					100%												$	16,705					100%												$	14,698					100%						(13)		%				14		%

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.

The changes in net sales in all regions other than Korea for fiscal 2018 compared to fiscal 2017 primarily reflected changes in semiconductor equipment spending, including product and customer mix, and increased spending in semiconductor spares and services. The increase in net sales to customers in China also reflected increased investments in display manufacturing equipment. The decrease in net sales to customers in Korea primarily reflected decreased investments in display manufacturing equipment.

Gross Margin

Gross margins for the periods indicated were as follows:

																					Change
			2019						2018						2017						2019 over 2018						2018 over 2017
Gross margin			43.7		%				45.0		%				45.0		%				(1.3) points						— points

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 in fiscal 2018 remained flat compared to fiscal 2017.

Gross margin during fiscal 2019, 2018 and 2017 included $89 million, $87 million and $69 million, respectively, of share-based compensation expense.

Research, Development and Engineering

Research, Development and Engineering (RD&E) expenses for the periods indicated were as follows:

																					Change
			2019						2018						2017						2019 over 2018						2018 over 2017
			(In millions)
Research, development and engineering			$	2,054					$	2,022					$	1,781					$	32					$	241

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, inspection, patterning and other technologies to improve chip performance, power, area and cost. In Display and Adjacent Markets, RD&E investments were focused on expanding the company’s market opportunity with new display technologies.

RD&E expenses increased slightly in fiscal 2019 compared to the prior year and increased in fiscal 2018 compared to fiscal 2017, 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 2019, 2018 and 2017 included $99 million, $96 million and $83 million, respectively, of share-based compensation expense.

Marketing and Selling

Marketing and selling expenses for the periods indicated were as follows:

																					Change
			2019						2018						2017						2019 over 2018						2018 over 2017
			(In millions)
Marketing and selling			$	521					$	521					$	457					$	—					$	64

Marketing and selling expenses remained flat in fiscal 2019 compared to fiscal 2018. Marketing and selling expenses increased in fiscal 2018 compared to fiscal 2017 primarily due to additional headcount.

Marketing and selling expenses for fiscal years 2019, 2018 and 2017 included $31 million, $31 million and $28 million, respectively, of share-based compensation expense.

General and Administrative

General and administrative (G&A) expenses for the periods indicated were as follows:

																					Change
			2019						2018						2017						2019 over 2018						2018 over 2017
			(In millions)
General and administrative			$	461					$	483					$	438					$	(22)					$	45

General and administrative expenses in fiscal 2019 decreased slightly compared to fiscal 2018 primarily due to lower variable compensation expenses. General and administrative expenses in fiscal 2018 increased compared to fiscal 2017 primarily due to additional headcount and unfavorable impact from foreign exchange fluctuation, partially offset by lower variable compensation expense.

G&A expenses during fiscal 2019, 2018 and 2017 included $44 million, $44 million and $40 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
			2019						2018						2017						2019 over 2018						2018 over 2017
			(In millions)
Interest expense			$	237					$	234					$	198					$	3					$	36
Interest and other income, net			$	156					$	139					$	78					$	17					$	61

Interest expenses incurred were primarily associated with the senior unsecured notes. Interest expense in fiscal 2019 remained relatively flat compared to the prior year. Interest expense increased slightly in fiscal 2018 compared to fiscal 2017 due to the issuance of senior unsecured notes in March 2017.

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 2019 increased compared to fiscal 2018 primarily driven by unrealized gains on equity investment securities. Interest and other income, net in fiscal 2018 increased compared to fiscal 2017 primarily driven by realized gains on sales of securities and higher interest income from investments.

Income Taxes

Provision for income taxes and effective tax rates for the periods indicated were as follows:

																					Change
			2019						2018						2017						2019 over 2018						2018 over 2017
			(In millions, except percentages)
Provision for income taxes			$	563					$	1,358					$	297					$	(795)					$	1,061
Effective income tax rate			17.2		%				30.9		%				7.8		%				(13.7)		points				23.1		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 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 payable over eight years. U.S. deferred tax assets and liabilities were subject to remeasurement due to the reduction of the U.S. federal corporate tax rate. The U.S. Securities and Exchange Commission issued Staff Accounting Bulletin No. 118, which provided guidance on accounting for the income tax effects of the Tax Act and a measurement period for companies to complete this accounting. Applied completed the accounting for the Tax Act during the measurement period, which ended one year after the enactment date of the Tax Act. Accounting for the remeasurement of deferred tax assets was completed in the fourth quarter of fiscal 2018, and the accounting for the transition tax was completed in the first quarter of fiscal 2019.

The Tax Act also includes provisions that impact Applied starting in fiscal 2019, including a provision designed to tax global intangible low-taxed income (GILTI). On June 14, 2019, the U.S. government released regulations that significantly affect how the GILTI provision of the 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.

Applied’s 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.

The effective tax rate for fiscal 2018 was higher than fiscal 2017 primarily due to tax expense of $1.1 billion for the transition tax and remeasurement of deferred tax assets as a result of the Tax Act, partially offset by changes in the geographical composition of income, tax benefits from the lower U.S. federal corporate tax rate, adoption of authoritative guidance for share-based compensation, and the resolution of tax liabilities for uncertain tax positions. In addition, fiscal 2017 included tax benefits from the recognition of previously unrecognized foreign tax credits.

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 16 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 devices, 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.

Customer investments in semiconductor manufacturing equipment continued to be the primary contributor of Applied’s revenue during fiscal 2019. Semiconductor equipment customers continued to make strategic investments in new technology transitions. Spending by memory customers, compared to fiscal 2018, was lower as they delayed new capacity additions and lowered their fab utilization rates in response to excess industry supply and inventory levels. Foundry and logic spending increased year-over-year led by customer investments in both advanced and mature foundry-logic nodes. Overall semiconductor systems revenue for fiscal 2019 decreased as compared to the prior year.

Certain significant measures for the periods indicated were as follows:

																					Change
			2019						2018						2017						2019 over 2018																		2018 over 2017
			(In millions, except percentages and ratios)
Net sales			$	9,027					$	10,577					$	9,544					$	(1,550)					(15)		%				$	1,033					11		%
Operating income			$	2,464					$	3,441					$	3,177					$	(977)					(28)		%				$	264					8		%
Operating margin			27.3		%				32.5		%				33.3		%										(5.2) points												(0.8) points

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

			2019						2018						2017
Foundry, logic and other			52		%				36		%				51		%
Dynamic random-access memory (DRAM)			22		%				27		%				15		%
Flash memory			26		%				37		%				34		%
			100		%				100		%				100		%

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. Five customers each accounted for at least 10 percent of this segment’s net sales, and together they accounted for approximately 65 percent of this segment’s net sales for fiscal 2019.

Net sales for fiscal 2018 increased compared to fiscal 2017 primarily due to higher spending from memory customers, partially offset by lower spending from foundry, logic and other customers. Although operating margin remained flat, operating income for fiscal 2018 increased compared to fiscal 2017 primarily due to favorable changes in product mix and higher net sales, partially offset by higher RD&E expenses.

The following region accounted for at least 30 percent of total net sales for the Semiconductor Systems segment for one or more of past three fiscal years:

																														Change
			2019												2018												2017												2019 over 2018																		2018 over 2017
			(In millions, except percentages)
Korea			$	1,435		16		%				$	2,883		27		%				$	2,955		31		%				$	(1,448)					(50)		%				$	(72)					(2)		%

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
			2019						2018						2017						2019 over 2018																		2018 over 2017
			(In millions, except percentages and ratios)
Net sales			$	3,854					$	3,754					$	3,014					$	100					3		%				$	740					25		%
Operating income			$	1,101					$	1,102					$	817					$	(1)					—		%				$	285					35		%
Operating margin			28.6		%				29.4		%				27.1		%										(0.8) points												2.3 points

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. Net sales increased in fiscal 2018 compared to fiscal 2017 primarily due to higher customer spending for spares and services. In fiscal 2019, two customers each accounted for at least 10 percent of this segment’s net sales.

Operating income for fiscal 2019 remained flat compared to the prior year primarily due to higher net sales, partially 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. Operating income and operating margin for fiscal 2018 increased compared to the fiscal 2017, reflecting higher net sales partially offset by increased headcount to support business 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.

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.

The market environment for Applied's Display and Adjacent Markets segment in fiscal 2019 was characterized by weak demand for display manufacturing equipment for mobile products and TVs, compared to fiscal 2018. In addition, uneven demand patterns 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
			2019						2018						2017						2019 over 2018																		2018 over 2017
			(In millions, except percentages and ratios)
Net sales			$	1,651					$	2,298					$	2,042					$	(647)					(28)		%				$	256					13		%
Operating income			$	294					$	574					$	585					$	(280)					(49)		%				$	(11)					(2)		%
Operating margin			17.8		%				25.0		%				28.6		%										(7.2) points												(3.6) points

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. Four customers each accounted for at least 10 percent of this segment’s net sales, and together they accounted for approximately 68 percent of net sales for this segment in fiscal 2019.

Net sales for fiscal 2018 increased compared to fiscal 2017 primarily due to higher customer investments in TV display manufacturing equipment. Operating income and operating margin for fiscal 2018 decreased slightly compared fiscal 2017, primarily due to higher RD&E spending and unfavorable product mix, offset by higher net sales.

The following regions 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
			2019												2018												2017												2019 over 2018																		2018 over 2017
			(In millions, except percentages)
China			$	1,469		89		%				$	1,957		85		%				$	978		48		%				$	(488)					(25)		%				$	979					100		%
Korea			$	55		3		%				$	151		7		%				$	791		39		%				$	(96)					(64)		%				$	(640)					(81)		%

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.

Financial Condition, Liquidity and Capital Resources

Applied’s cash, cash equivalents and investments consist of the following:

			October 27, 2019						October 28, 2018
			(In millions)
Cash and cash equivalents			$	3,129					$	3,440
Short-term investments			489						590
Long-term investments			1,703						1,568
Total cash, cash-equivalents and investments			$	5,321					$	5,598

Sources and Uses of Cash

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

			2019						2018						2017
			(In millions)
Cash provided by operating activities			$	3,247					$	3,787					$	3,789
Cash provided by (used in) investing activities			$	(443)					$	571					$	(2,526)
Cash provided by (used in) financing activities			$	(3,115)					$	(5,928)					$	341

In March 2016, the Financial Accounting Standards Board issued authoritative guidance that simplifies several aspects of the accounting for share-based payment transactions, including forfeitures, income tax, and classification on the statement of cash flows. Applied adopted this guidance in the first quarter of fiscal 2018. Upon adoption, Applied elected to apply the presentation requirements for cash flows related to excess tax benefits and employee taxes paid for withheld shares retrospectively. Adopting this guidance increased cash provided by operating activities by $180 million with corresponding net decreases in cash provided by financing activities for fiscal 2017.

Operating Activities

Cash from operating activities for fiscal 2019 was $3.2 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 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. Cash provided from operating activities remained flat from fiscal 2017 to fiscal 2018 due to the increase in income taxes payable, offset by lower deferred revenue and higher increase in accounts receivable.

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 $1.5 billion, $1.6 billion and $746 million of accounts receivable during fiscal 2019, 2018 and 2017, respectively. Applied discounted letters of credit issued by customers of $48 million and $37 million in fiscal 2019 and 2018, respectively. There was no discounting of promissory notes in each of fiscal 2019 and 2018. Applied did not discount letters of credit issued by customers or discount promissory notes during fiscal 2017.

Applied’s working capital was $5.8 billion at October 27, 2019 and $6.7 billion at October 28, 2018.

Days sales outstanding at the end of fiscal 2019, 2018 and 2017 was 61 days, 58 days, and 54 days, respectively. Days sales outstanding varies due to the timing of shipments and payment terms. 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. The increase in days sales outstanding at the end of fiscal 2018 compared to the end of fiscal 2017 was primarily due to less favorable revenue linearity in fiscal 2018.

Investing Activities

Applied used $443 million and $2.5 billion of cash in investing activities in fiscal 2019 and 2017, respectively. Applied generated $571 million in cash from investing activities in fiscal 2018. Capital expenditures in fiscal 2019, 2018 and 2017 were $441 million, $622 million and $345 million, respectively. 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. Capital expenditures in fiscal 2017 were primarily for demonstration and test equipment and laboratory tools in North America. Proceeds from sales and maturities of investments, net of purchase of investments were $26 million and $1.2 billion for fiscal 2019 and 2018, respectively. Purchases of investments, net of proceeds from sales and maturities of investments was $2.1 billion for fiscal 2017. 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 $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.

Applied generated $341 million of cash from financing activities in fiscal 2017, consisting primarily of net proceeds received from the issuance of senior unsecured notes of $2.2 billion, proceeds from common stock issuance of $97 million, partially offset by cash used for repurchases of common stock of $1.2 billion, cash dividends to stockholders of $430 million and debt repayments of $205 million.

In September 2017, Applied’s Board of Directors approved a common stock repurchase program authorizing up to $3.0 billion in repurchases. In February 2018, the Board of Directors approved a new common stock repurchase program authorizing up to an additional $6.0 billion in repurchases. At October 27, 2019, $1.9 billion remained available for future stock repurchases under this repurchase program.

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 of $0.20 per share. During fiscal 2017, Applied’s Board of Directors declared four quarterly cash dividends in the amount of $0.10 per share. 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 with a group of banks that is scheduled to expire in September 2021. This agreement provides for borrowings in United States dollars at interest rates keyed to one of two rates selected by Applied for each advance and includes financial and other covenants with which Applied was in compliance at October 27, 2019. Remaining credit facilities in the amount of approximately $74 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 (SPA) are not consummated on or before June 30, 2020, which date may be extended by three months on two separate occasions if, on the applicable date, the only remaining conditions to closing relate to required regulatory approvals. 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 27, 2019 and October 28, 2018, and Applied has not utilized these credit facilities.

In fiscal 2011, Applied established a short-term commercial paper program of up to $1.5 billion. At October 27, 2019 and October 28, 2018, Applied did not have any commercial paper outstanding, but may issue commercial paper notes under this program from time to time in the future.

In March 2017, Applied issued senior unsecured notes in the aggregate principal amount of $2.2 billion. Applied had senior unsecured notes in the aggregate principal amount of $5.4 billion outstanding as of October 27, 2019. The indentures governing these notes include covenants with which Applied was in compliance at October 27, 2019. In May 2017, Applied completed the redemption of the entire outstanding $200 million in principal amount of senior notes due in October 2017. See Note 11 of Notes to Consolidated 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. 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 27, 2019, Applied has $938 million of total payments remaining, payable in installments in the next seven 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 and other agreements with banks, see Off-Balance Sheet Arrangements below.

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. As of October 27, 2019, the maximum potential amount of future payments that Applied could be required to make under these guarantee agreements was approximately $76 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 27, 2019, Applied has provided parent guarantees to banks for approximately $151 million to cover these arrangements.

Applied also has operating leases for various facilities. Total rent expense for fiscal 2019, 2018 and 2017 was $51 million, $50 million and $34 million, respectively.

Contractual Obligations

The following table summarizes Applied’s contractual obligations as of October 27, 2019:

			Payments Due by Period
Contractual Obligations			Total						Less Than 1 Year						1-3 Years						3-5 Years						More Than 5 Years
			(In millions)
Debt obligations			$	5,350					$	600					$	750					$	—					$	4,000
Interest expense associated with debt obligations			2,918						219						374						342						1,983
Operating lease obligations			171						45						58						38						30
Income tax from change in U.S. tax laws1			938						82						163						234						459
Purchase obligations2			2,020						1,888						117						15						—
Other long-term liabilities3,4			20						—						2						2						16
Total			$	11,417					$	2,834					$	1,464					$	631					$	6,488

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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, post-retirement 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 post-retirement 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, post-retirement benefit and deferred compensation plans is presented in Note 13, 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 27, 2019, the gross liability for unrecognized tax benefits that was not expected to result in payment of cash within one year was $489 million. Interest and penalties related to uncertain tax positions that were not expected to result in payment of cash within one year of October 27, 2019 was $50 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.

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.

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 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.

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.

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; impairments of assets, or investments; gain or loss on sale of strategic investments; certain income tax items and other discrete adjustments. Additionally, fiscal 2019 and 2018 non-GAAP results exclude estimated discrete income tax expense items associated with recent 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.

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)																								2019						2018						2017
Non-GAAP Adjusted Gross Profit
Reported gross profit - GAAP basis																								$	6,386					$	7,517					$	6,612
Certain items associated with acquisitions1																								37						179						172
Non-GAAP adjusted gross profit																								$	6,423					$	7,696					$	6,784
Non-GAAP adjusted gross margin																								44.0		%				46.1		%				46.2		%
Non-GAAP Adjusted Operating Income
Reported operating income - GAAP basis																								$	3,350					$	4,491					$	3,936
Certain items associated with acquisitions1																								55						197						191
Acquisition integration and deal costs																								22						5						3
Other gains, losses or charges, net																								—						—						(12)
Non-GAAP adjusted operating income																								$	3,427					$	4,693					$	4,118
Non-GAAP adjusted operating margin																								23.5		%				28.1		%				28.0		%
Non-GAAP Adjusted Net Income
Reported net income - GAAP basis2																								$	2,706					$	3,038					$	3,519
Certain items associated with acquisitions1																								55						197						191
Acquisition integration and deal costs																								22						5						3
Impairment (gain on sale) of strategic investments, net																								(6)						(25)						(3)
Loss (gain) on strategic investments, net																								(30)						—						—
Loss on early extinguishment of debt																								—						—						5
Other gains, losses or charges, net																								—						—						(12)
Income tax effect of changes in applicable U.S. tax laws3																								(24)						1,112						—
Income tax effects related to amortization of intra-entity intangible asset transfers																								62						—						—
Resolution of prior years’ income tax filings and other tax items																								95						(26)						(79)
Income tax effect of non-GAAP adjustments4																								(5)						(7)						(14)
Non-GAAP adjusted net income																								$	2,875					$	4,294					$	3,610

1			These items are incremental charges attributable to completed acquisitions, consisting of amortization of purchased intangible assets.
2			Amounts for fiscal 2017 included the recognition of the previously unrecognized foreign tax credits.
3			Charges to income tax provision related to a one-time transition tax and a decrease in U.S. deferred tax assets as a result of the recent U.S. tax legislation.
4			Adjustment to provision for income taxes related to non-GAAP adjustments reflected in income before income taxes.

APPLIED MATERIALS, INC.

UNAUDITED RECONCILIATION OF GAAP TO NON-GAAP ADJUSTED RESULTS

(In millions, except per share amounts)																								2019						2018						2017
Non-GAAP Adjusted Earnings Per Diluted Share
Reported earnings per diluted share - GAAP basis																								$	2.86					$	2.96					$	3.25
Certain items associated with acquisitions																								0.05						0.18						0.16
Acquisition integration and deal costs																								0.02						—						—
Impairment (gain on sale) of strategic investments, net																								—						(0.02)						—
Loss (gain) on strategic investments, net																								(0.03)						—						—
Income tax effect of change in applicable U.S. tax laws																								(0.03)						1.08						—
Income tax effects related to amortization of intra-entity intangible asset transfers																								0.07						—						—
Other gains, losses or charges, net																								—						—						(0.01)
Resolution of prior years’ income tax filings and other tax items																								0.10						(0.02)						(0.07)
Non-GAAP adjusted earnings per diluted share																								$	3.04					$	4.18					$	3.33
Weighted average number of diluted shares																								945						1,026						1,084

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)																								2019						2018						2017
Semiconductor Systems Non-GAAP Adjusted Operating Income
Reported operating income - GAAP basis																								$	2,464					$	3,441					$	3,177
Certain items associated with acquisitions1																								43						183						184
Non-GAAP adjusted operating income																								$	2,507					$	3,624					$	3,361
Non-GAAP adjusted operating margin																								27.8		%				34.3		%				35.2		%
AGS Non-GAAP Adjusted Operating Income
Reported operating income - GAAP basis																								$	1,101					$	1,102					$	817
Certain items associated with acquisitions1																								—						—						1
Acquisition integration costs																								—						2						3
Non-GAAP adjusted operating income																								$	1,101					$	1,104					$	821
Non-GAAP adjusted operating margin																								28.6		%				29.4		%				27.2		%
Display and Adjacent Markets Non-GAAP Adjusted Operating Income
Reported operating income - GAAP basis																								$	294					$	574					$	585
Certain items associated with acquisitions1																								12						14						5
Acquisition integration costs																								1						1						—
Non-GAAP adjusted operating income																								$	307					$	589					$	590
Non-GAAP adjusted operating margin																								18.6		%				25.6		%				28.9		%

1			These items are incremental charges attributable to completed acquisitions, consisting of amortization of purchased intangible assets.

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.