filings.toolsItem 16. Form 10-K Summary
218K characters. Original on sec.gov · Markdown
Item 16. Form 10-K Summary
None.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors
Applied Materials, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Applied Materials, Inc. and subsidiaries (the Company) as of October 25, 2020 and October 27, 2019, the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended October 25, 2020, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of October 25, 2020 and October 27, 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended October 25, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of October 25, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated December 11, 2020 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
Changes in Accounting Principles
As discussed in note 1 to the consolidated financial statements, the Company changed its method of accounting for leases as of October 28, 2019 due to the adoption of Accounting Standards Codification Topic 842, Leases. As discussed in note 15 to the consolidated financial statements, the Company changed its method of accounting for intra-entity transfers of assets other than inventory as of October 29, 2018 due to the adoption of Accounting Standards Update No. 2016-16, Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Evaluation of net realizable value adjustments to inventories for excess or obsolescence
As discussed in notes 1 and 8 to the consolidated financial statements, the Company has inventories with a carrying value of $3,904 million as of October 25, 2020. The Company adjusts inventory carrying value for estimated excess or obsolescence equal to the difference between cost of inventory and the estimated net realizable value based upon assumptions about future demand and market conditions. If actual demand were to be substantially lower than estimated, there could be a significant adverse impact on the carrying value of inventories and results of operations.
We identified the evaluation of net realizable value adjustments to inventories for excess or obsolescence as a critical audit matter. Evaluation of the Company’s estimates regarding forecasted sales and inventory consumption involved a high degree of auditor judgment.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design and tested the operating effectiveness of certain internal controls over the Company’s process for determining net realizable value adjustments for inventory excess or obsolescence, including controls related to estimating forecasted sales and inventory consumption. We evaluated certain inventories for excess or obsolescence by comparing the Company’s sales and inventory consumption forecast to historical sales, historical inventory usage, known customer orders, and industry outlook reports. In addition, for certain inventories, we compared the Company’s historical estimates of net realizable value adjustments for excess and obsolescence to the actual physical inventory disposals to evaluate the Company’s ability to accurately estimate the net realizable value adjustments.
| /S/ KPMG LLP | ||
| KPMG LLP |
We have served as the Company’s auditor since 2004.
Santa Clara, California
December 11, 2020
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors
Applied Materials, Inc.:
Opinion on Internal Control Over Financial Reporting
We have audited Applied Materials, Inc. and subsidiaries’ (the Company) internal control over financial reporting as of October 25, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of October 25, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of October 25, 2020 and October 27, 2019, the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended October 25, 2020, and the related notes (collectively, the consolidated financial statements), and our report dated December 11, 2020 expressed an unqualified opinion on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
| /s/ KPMG LLP | ||
| KPMG LLP |
Santa Clara, California
December 11, 2020
APPLIED MATERIALS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share amounts)
| Fiscal Year | 2020 | 2019 | 2018 | ||||||||||||||
| Net sales | $ | 17,202 | $ | 14,608 | $ | 16,705 | |||||||||||
| Cost of products sold | 9,510 | 8,222 | 9,188 | ||||||||||||||
| Gross profit | 7,692 | 6,386 | 7,517 | ||||||||||||||
| Operating expenses: | |||||||||||||||||
| Research, development and engineering | 2,234 | 2,054 | 2,022 | ||||||||||||||
| Marketing and selling | 526 | 521 | 521 | ||||||||||||||
| General and administrative | 567 | 461 | 483 | ||||||||||||||
| Total operating expenses | 3,327 | 3,036 | 3,026 | ||||||||||||||
| Income from operations | 4,365 | 3,350 | 4,491 | ||||||||||||||
| Interest expense | 240 | 237 | 234 | ||||||||||||||
| Interest and other income, net | 41 | 156 | 139 | ||||||||||||||
| Income before income taxes | 4,166 | 3,269 | 4,396 | ||||||||||||||
| Provision for income taxes | 547 | 563 | 1,358 | ||||||||||||||
| Net income | $ | 3,619 | $ | 2,706 | $ | 3,038 | |||||||||||
| Earnings per share: | |||||||||||||||||
| Basic | $ | 3.95 | $ | 2.89 | $ | 3.00 | |||||||||||
| Diluted | $ | 3.92 | $ | 2.86 | $ | 2.96 | |||||||||||
| Weighted average number of shares: | |||||||||||||||||
| Basic | 916 | 937 | 1,013 | ||||||||||||||
| Diluted | 923 | 945 | 1,026 |
See accompanying Notes to Consolidated Financial Statements.
APPLIED MATERIALS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In millions)
| Fiscal Year | 2020 | 2019 | 2018 | ||||||||||||||
| Net income | $ | 3,619 | $ | 2,706 | $ | 3,038 | |||||||||||
| Other comprehensive income (loss), net of tax: | |||||||||||||||||
| Change in unrealized gain (loss) on available-for-sale investments | 9 | 21 | (51) | ||||||||||||||
| Change in unrealized net loss on derivative instruments | (117) | (7) | 4 | ||||||||||||||
| Change in defined and postretirement benefit plans | (11) | (51) | (17) | ||||||||||||||
| Change in cumulative translation adjustments | — | (1) | — | ||||||||||||||
| Other comprehensive loss, net of tax | (119) | (38) | (64) | ||||||||||||||
| Comprehensive income | $ | 3,500 | $ | 2,668 | $ | 2,974 |
See accompanying Notes to Consolidated Financial Statements.
APPLIED MATERIALS, INC.
CONSOLIDATED BALANCE SHEETS
(In millions, except per share amounts)
| October 25, 2020 | October 27, 2019 | ||||||||||
| ASSETS | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | 5,351 | $ | 3,129 | |||||||
| Short-term investments | 387 | 489 | |||||||||
| Accounts receivable, net | 2,963 | 2,533 | |||||||||
| Inventories | 3,904 | 3,474 | |||||||||
| Other current assets | 764 | 581 | |||||||||
| Total current assets | 13,369 | 10,206 | |||||||||
| Long-term investments | 1,538 | 1,703 | |||||||||
| Property, plant and equipment, net | 1,604 | 1,529 | |||||||||
| Goodwill | 3,466 | 3,399 | |||||||||
| Purchased technology and other intangible assets, net | 153 | 156 | |||||||||
| Deferred income taxes and other assets | 2,223 | 2,031 | |||||||||
| Total assets | $ | 22,353 | $ | 19,024 | |||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||||
| Current liabilities: | |||||||||||
| Current portion of long-term debt | $ | — | $ | 600 | |||||||
| Accounts payable and accrued expenses | 3,138 | 2,511 | |||||||||
| Contract liabilities | 1,321 | 1,336 | |||||||||
| Total current liabilities | 4,459 | 4,447 | |||||||||
| Long-term debt, net of current portion | 5,448 | 4,713 | |||||||||
| Income taxes payable | 1,206 | 1,275 | |||||||||
| Other liabilities | 662 | 375 | |||||||||
| Total liabilities | 11,775 | 10,810 | |||||||||
| Commitments and contingencies (Note 16) | |||||||||||
| Stockholders’ equity: | |||||||||||
| Preferred stock: $0.01 par value per share; 1 shares authorized; no shares issued | — | — | |||||||||
| Common stock: $0.01 par value per share; 2,500 shares authorized; 914 and 916 shares outstanding at 2020 and 2019, respectively | 9 | 9 | |||||||||
| Additional paid-in capital | 7,904 | 7,595 | |||||||||
| Retained earnings | 27,209 | 24,386 | |||||||||
| Treasury stock: 1,091 and 1,079 shares at 2020 and 2019, respectively | (24,245) | (23,596) | |||||||||
| Accumulated other comprehensive loss | (299) | (180) | |||||||||
| Total stockholders’ equity | 10,578 | 8,214 | |||||||||
| Total liabilities and stockholders’ equity | $ | 22,353 | $ | 19,024 |
See accompanying Notes to Consolidated Financial Statements.
APPLIED MATERIALS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In millions)
| Common Stock | Additional Paid-In Capital | Retained Earnings (b) | Treasury Stock | Accumulated Other Comprehensive Income (Loss) | Total | ||||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||||||||||||||||||||
| Balance at October 29, 2017 | 1,060 | $ | 11 | $ | 7,056 | $ | 18,539 | 917 | $ | (15,912) | $ | (64) | $ | 9,630 | |||||||||||||||||||||||||||||||||
| Adoption of new accounting standards (a) | — | — | — | (3) | — | — | 3 | — | |||||||||||||||||||||||||||||||||||||||
| Net income | — | — | — | 3,038 | — | — | — | 3,038 | |||||||||||||||||||||||||||||||||||||||
| Other comprehensive loss, net of tax | — | — | — | — | — | — | (64) | (64) | |||||||||||||||||||||||||||||||||||||||
| Dividends declared ($0.70 per common share) | — | — | — | (694) | — | — | — | (694) | |||||||||||||||||||||||||||||||||||||||
| Share-based compensation | — | — | 258 | — | — | — | — | 258 | |||||||||||||||||||||||||||||||||||||||
| Issuance under stock plans | 9 | — | (40) | — | — | — | — | (40) | |||||||||||||||||||||||||||||||||||||||
| Common stock repurchases | (102) | (1) | — | — | 102 | (5,282) | — | (5,283) | |||||||||||||||||||||||||||||||||||||||
| Balance at October 28, 2018 | 967 | $ | 10 | $ | 7,274 | $ | 20,880 | 1,019 | $ | (21,194) | $ | (125) | $ | 6,845 | |||||||||||||||||||||||||||||||||
| Adoption of new accounting standards (c) | — | — | — | 1,570 | — | — | (17) | 1,553 | |||||||||||||||||||||||||||||||||||||||
| Net income | — | — | — | 2,706 | — | — | — | 2,706 | |||||||||||||||||||||||||||||||||||||||
| Other comprehensive loss, net of tax | — | — | — | — | — | — | (38) | (38) | |||||||||||||||||||||||||||||||||||||||
| Dividends declared ($0.83 per common share) | — | — | — | (770) | — | — | — | (770) | |||||||||||||||||||||||||||||||||||||||
| Share-based compensation | — | — | 263 | — | — | — | — | 263 | |||||||||||||||||||||||||||||||||||||||
| Issuance under stock plans | 9 | — | 58 | — | — | — | — | 58 | |||||||||||||||||||||||||||||||||||||||
| Common stock repurchases | (60) | (1) | — | — | 60 | (2,402) | — | (2,403) | |||||||||||||||||||||||||||||||||||||||
| Balance at October 27, 2019 | 916 | $ | 9 | $ | 7,595 | $ | 24,386 | 1,079 | $ | (23,596) | $ | (180) | $ | 8,214 | |||||||||||||||||||||||||||||||||
| Net income | — | — | — | 3,619 | — | — | — | 3,619 | |||||||||||||||||||||||||||||||||||||||
| Other comprehensive loss, net of tax | — | — | — | — | — | — | (119) | (119) | |||||||||||||||||||||||||||||||||||||||
| Dividends declared ($0.87 per common share) | — | — | — | (796) | — | — | — | (796) | |||||||||||||||||||||||||||||||||||||||
| Share-based compensation | — | — | 307 | — | — | — | — | 307 | |||||||||||||||||||||||||||||||||||||||
| Issuance under stock plans | 10 | — | 2 | — | — | — | — | 2 | |||||||||||||||||||||||||||||||||||||||
| Common stock repurchases | (12) | — | — | — | 12 | (649) | — | (649) | |||||||||||||||||||||||||||||||||||||||
| Balance at October 25, 2020 | 914 | $ | 9 | $ | 7,904 | $ | 27,209 | 1,091 | $ | (24,245) | $ | (299) | $ | 10,578 |
(a) - Represents the reclassification adjustment related to the early adoption of Accounting Standards Update (ASU) 2018-02 Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.
(b) - Retained earnings balance as of October 29, 2017 and October 28, 2018 included increases of $281 million and $6 million, respectively, related to the adoption of the standard related to revenue recognition.
(c) - Represents the adjustment related to the adoption of Accounting Standard Update (ASU) 2016-01 Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities and ASU 2016-16 Income Tax (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory.
See accompanying Notes to Consolidated Financial Statements.
APPLIED MATERIALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
| Fiscal Year | 2020 | 2019 | 2018 | ||||||||||||||
| Cash flows from operating activities: | |||||||||||||||||
| Net income | $ | 3,619 | $ | 2,706 | $ | 3,038 | |||||||||||
| Adjustments required to reconcile net income to cash provided by operating activities: | |||||||||||||||||
| Depreciation and amortization | 376 | 363 | 457 | ||||||||||||||
| Deferred income taxes | 80 | 49 | 71 | ||||||||||||||
| Other | 60 | (19) | 4 | ||||||||||||||
| Share-based compensation | 307 | 263 | 258 | ||||||||||||||
| Changes in operating assets and liabilities, net of amounts acquired: | |||||||||||||||||
| Accounts receivable | (427) | (207) | 16 | ||||||||||||||
| Inventories | (421) | 248 | (1,014) | ||||||||||||||
| Other current and non-current assets | (161) | (86) | (199) | ||||||||||||||
| Accounts payable and accrued expenses | 327 | (247) | 170 | ||||||||||||||
| Contract liabilities | (16) | 135 | 75 | ||||||||||||||
| Income taxes payable | (10) | 44 | 886 | ||||||||||||||
| Other liabilities | 70 | (2) | 25 | ||||||||||||||
| Cash provided by operating activities | 3,804 | 3,247 | 3,787 | ||||||||||||||
| Cash flows from investing activities: | |||||||||||||||||
| Capital expenditures | (422) | (441) | (622) | ||||||||||||||
| Cash paid for acquisitions, net of cash acquired | (107) | (28) | (6) | ||||||||||||||
| Proceeds from sales and maturities of investments | 1,754 | 1,940 | 3,276 | ||||||||||||||
| Purchases of investments | (1,355) | (1,914) | (2,077) | ||||||||||||||
| Cash provided by (used in) investing activities | (130) | (443) | 571 | ||||||||||||||
| Cash flows from financing activities: | |||||||||||||||||
| Debt borrowings, net of issuance costs | 2,979 | — | — | ||||||||||||||
| Debt repayments | (2,882) | — | — | ||||||||||||||
| Proceeds from common stock issuances | 174 | 145 | 124 | ||||||||||||||
| Common stock repurchases | (649) | (2,403) | (5,283) | ||||||||||||||
| Tax withholding payments for vested equity awards | (172) | (86) | (164) | ||||||||||||||
| Payments of dividends to stockholders | (787) | (771) | (605) | ||||||||||||||
| Cash used in financing activities | (1,337) | (3,115) | (5,928) | ||||||||||||||
| Increase (decrease) in cash, cash equivalents and restricted cash equivalents | 2,337 | (311) | (1,570) | ||||||||||||||
| Cash, cash equivalents and restricted cash equivalents — beginning of period | 3,129 | 3,440 | 5,010 | ||||||||||||||
| Cash, cash equivalents and restricted cash equivalents — end of period | $ | 5,466 | $ | 3,129 | $ | 3,440 | |||||||||||
| Reconciliation of cash, cash equivalents, and restricted cash equivalents | |||||||||||||||||
| Cash and cash equivalents | 5,351 | 3,129 | 3,440 | ||||||||||||||
| Restricted cash equivalents included in deferred income taxes and other assets | 115 | — | — | ||||||||||||||
| Total cash, cash equivalents, and restricted cash equivalents | $ | 5,466 | $ | 3,129 | $ | 3,440 | |||||||||||
| Supplemental cash flow information: | |||||||||||||||||
| Cash payments for income taxes | $ | 542 | $ | 522 | $ | 300 | |||||||||||
| Cash refunds from income taxes | $ | 68 | $ | 22 | $ | 63 | |||||||||||
| Cash payments for interest | $ | 219 | $ | 219 | $ | 219 |
See accompanying Notes to Consolidated Financial Statements.
Note 1 Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of Applied Materials, Inc. and its subsidiaries (Applied or the Company) after elimination of intercompany balances and transactions. All references to a fiscal year apply to Applied’s fiscal year which ends on the last Sunday in October. Fiscal 2020, 2019 and 2018 contained 52 weeks each. Each fiscal quarter of 2020, 2019 and 2018 contained 13 weeks.
Certain prior year amounts have been reclassified to conform to current year presentation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ materially from those estimates. On an ongoing basis, Applied evaluates its estimates, including those related to standalone selling price (SSP) related to revenue recognition, accounts receivable and sales allowances, fair values of financial instruments, inventories, intangible assets and goodwill, useful lives of intangible assets and property and equipment, fair values of share-based awards, and income taxes, among others. Applied bases its estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.
As of October 25, 2020, the COVID-19 pandemic and worldwide response remains fluid. As a result, many of Applied’s estimates and assumptions are subject to increased judgment and volatility. These estimates may differ materially in future periods as the pandemic continues to evolve and additional information becomes available.
Cash Equivalents
All highly-liquid investments with a remaining maturity of three months or less at the time of purchase are considered to be cash equivalents. Cash equivalents consist primarily of investments in institutional money market funds.
Investments
All of Applied’s investments, except equity investments held in privately-held companies, are classified as available-for-sale at the respective balance sheet dates. Investments classified as available-for-sale are measured and recorded at fair value with changes in fair value recorded in the accompanying Consolidated Statements of Operations. Interest earned on cash and investments, as well as realized gains and losses on sale of securities, are included in interest and other income, net in the Consolidated Statements of Operations.
Equity investments without readily determinable fair value are measured at cost, less impairment, adjusted by observable price changes. Adjustments resulting from impairments and observable prices changes will be recorded in the Consolidated Statements 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. Bad debt expense and any reversals are recorded in marketing and selling expenses in the Consolidated Statement of Operations.
Inventories
Inventories are stated at the lower of cost or net realizable value, with cost determined on a first-in, first-out (FIFO) basis. Applied adjusts inventory carrying value for estimated obsolescence equal to the difference between the cost of inventory and the estimated net realizable value based upon assumptions about future demand and market conditions. Applied fully writes down inventories and noncancelable purchase orders for inventory deemed obsolete. Applied performs periodic reviews of inventory items to identify excess inventories on hand by comparing on-hand balances to anticipated usage using recent historical activity as well as anticipated or forecasted demand. If estimates of customer demand diminish further or market conditions become less favorable than those projected by Applied, additional inventory adjustments may be required.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Property, Plant and Equipment
Property, plant and equipment is stated at cost. Depreciation is provided over the estimated useful lives of the assets using the straight-line method. Estimated useful lives for financial reporting purposes are as follows: buildings and improvements, 3 to 30 years; demonstration and manufacturing equipment, 3 to 5 years; software, 3 to 5 years; and furniture, fixtures and other equipment, 3 to 5 years. Land improvements are amortized over the shorter of 15 years or the estimated useful life. Leasehold improvements are amortized over the shorter of five years or the lease term.
Intangible Assets
Goodwill and indefinite-lived assets are not amortized, but are reviewed for impairment annually during the fourth quarter of each fiscal year and whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. Purchased technology and other intangible assets are presented at cost, net of accumulated amortization, and are amortized over their estimated useful lives of 1 to 15 years using the straight-line method.
Long-Lived Assets
Applied reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets or asset group may not be recoverable. Applied assesses these assets for impairment based on estimated future cash flows from these assets.
Revenue Recognition from Contracts with Customers
Applied recognizes revenue when promised goods or services 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 determines revenue recognition through the following five steps; (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.
Identifying the contract(s) with customers. Applied sells manufacturing equipment, services, and spare parts directly to its customers in the semiconductor, display, and related industries. The Company generally considers written documentation including, but not limited to, signed purchase orders, master agreements, and sales orders as contracts provided that collection is probable. Collectability is assessed based on the customer’s creditworthiness determined by reviewing the customer’s published credit and financial information, historical payment experience, as well as other relevant factors.
Identifying the performance obligations. Applied’s performance obligations include delivery of manufacturing equipment, service agreements, spare parts, installation, extended warranty and training. Applied’s service agreements are considered one performance obligation and may include multiple goods and services that Applied provides to the customer to deliver against a performance metric. Judgment is used to determine whether multiple promised goods or services in a contract should be accounted for separately or as a group.
Determine the transaction price. The transaction price for Applied’s contracts with customers may include fixed and variable consideration. Applied includes variable consideration in the transaction price to the extent that it is probable that a significant reversal of revenue will not occur when the uncertainty associated with the variable consideration is subsequently resolved.
Allocate the transaction price to the performance obligations. A contract’s transaction price is allocated to each distinct performance obligation identified within the contract. Applied generally estimates the standalone selling price of a distinct performance obligation based on historical cost plus an appropriate margin. For contracts with multiple performance obligations, Applied allocates the contract’s transaction price to each performance obligation using the relative standalone selling price of each distinct good or service in the contract.
Recognizing the revenue as performance obligations are satisfied. Applied recognizes revenue from equipment and spares parts at a point in time when Applied has satisfied its performance obligation by transferring control of the goods to the customer which typically occurs at shipment or delivery. Revenue from service agreements is recognized over time, typically within 12 months, as customers receive the benefits of services.
The incremental costs to obtain a contract are not material.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Payment Terms. Payment terms vary by contract. Generally, the majority of payments are due within a certain number of days from shipment of goods or performance of service. The remainder is typically due upon customer technical acceptance. Applied typically receives deposits on future deliverables from customers in the Display and Adjacent Markets segment and, in certain instances, may also receive deposits from customers in the Applied Global Services segment. Applied’s payment terms do not generally contain a significant financing component.
Shipping and Handling Costs
Applied accounts for shipping and handling activities related to contracts with customers as costs to fulfill our promise to transfer the associated products. Accordingly, amounts billed for shipping and handling costs are recorded as a component of net sales and costs as a component of cost of products sold.
Warranty
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. If actual warranty costs differ substantially from Applied’s estimates, revisions to the estimated warranty liability would be required.
Applied also sells extended warranty contracts to its customers which provide an extension of the standard warranty coverage period of up to 2 years. Applied receives payment at the inception of the contract and recognizes revenue ratably over the extended warranty coverage period, as the customer simultaneously receives and consumes the benefits of the extended warranty.
Sales and Value Added Taxes
Taxes collected from customers and remitted to governmental authorities are presented on a net basis in the Consolidated Statements of Operations.
Research, Development and Engineering Costs
Research, development and engineering costs are expensed as incurred.
Income Taxes
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 carryovers. 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.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Derivative Financial Instruments
Applied uses financial instruments, such as forward exchange and currency option contracts, to hedge a portion of, but not all, existing and anticipated foreign currency denominated transactions typically expected to occur within 24 months. The purpose of Applied’s foreign currency management is to mitigate the effect of exchange rate fluctuations on certain foreign currency denominated revenues, costs and eventual cash flows. In certain cases, Applied also uses interest rate swap or lock agreements to hedge against the variability of cash flows due to changes in the benchmark interest rate of fixed rate debt. The terms of derivative financial instruments used for hedging purposes are generally consistent with the timing of the transactions being hedged. All of Applied’s derivative financial instruments are recorded at fair value based upon quoted market prices for comparable instruments. For derivative instruments designated and qualifying as cash flow hedges, the effective portion of the gain or loss on these hedges is reported as a component of accumulated other comprehensive income (loss) in stockholders’ equity, and is reclassified into earnings when the hedged transaction affects earnings. If the transaction being hedged fails to occur, or if a portion of any derivative is ineffective, the gain or loss on the associated financial instrument is recorded promptly in earnings. For derivative instruments used to hedge existing foreign currency denominated assets or liabilities, the gain or loss on these hedges is recorded promptly in earnings to offset the changes in the fair value of the assets or liabilities being hedged. Applied does not use derivative financial instruments for trading or speculative purposes.
Foreign Currencies
As of October 25, 2020, all of Applied’s subsidiaries use the United States dollar as their functional currency. Accordingly, assets and liabilities of these subsidiaries are remeasured using exchange rates in effect at the end of the period, except for non-monetary assets, such as inventories and property, plant and equipment, which are remeasured using historical exchange rates. Foreign currency-denominated revenues and costs are remeasured using average exchange rates for the period, except for costs related to those balance sheet items that are remeasured using historical exchange rates. The resulting remeasurement gains and losses are included in interest and other income, net in the Consolidated Statements of Operations as incurred.
Concentrations of Credit Risk
Financial instruments that potentially subject Applied to significant concentrations of credit risk consist principally of cash equivalents, investments, trade accounts receivable and derivative financial instruments used in hedging activities. Applied invests in a variety of financial instruments, such as, but not limited to, commercial paper, corporate and municipal bonds, United States Treasury and agency securities, and asset-backed and mortgage-backed securities, and, by policy, limits the amount of credit exposure with any one financial institution or commercial issuer. Applied is exposed to credit-related losses in the event of nonperformance by counterparties to derivative financial instruments, but does not expect any counterparties to fail to meet their obligations. Applied performs ongoing credit evaluations of its customers’ financial condition and generally requires no collateral to secure accounts receivable. Applied maintains an allowance reserve for potentially uncollectible accounts receivable based on its assessment of the collectability of accounts receivable. Applied regularly reviews the allowance by considering factors such as historical experience, credit quality, age of the accounts receivable balances, and current economic conditions that may affect a customer’s ability to pay. In addition, Applied utilizes deposits and/or letters of credit to mitigate credit risk when considered appropriate.
Recent Accounting Pronouncements
Accounting Standards Adopted
Leases. In February 2016, the Financial Accounting Standard Board (FASB) issued authoritative guidance for lease accounting, which requires lessees to recognize lease assets and liabilities on the balance sheet for certain lease arrangements that are classified as operating leases under the previous standard, and to provide for enhanced disclosures. Applied adopted this guidance in the first quarter of fiscal 2020 using the modified retrospective transition method which required applying the new standard as of the beginning of the period of adoption with no adjustment to comparative prior periods. Applied elected the package of practical expedients permitted under the transition guidance, which allow Applied not to reassess whether a contract contains a lease, initial direct costs and lease classification for leases existing prior to adoption. Applied also elected to combine the lease and non-lease components as a single lease component and not to use hindsight in determining the lease term. Upon adoption, Applied recognized right-of-use assets of $160 million, net of deferred rent of $4 million and lease liabilities of $164 million.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Derivatives and Hedging. In August 2017, the FASB issued authoritative guidance that modifies the recognition and presentation of hedge accounting to better align an entity’s risk management strategies and financial reporting for hedging relationships. The authoritative guidance expands the application of hedge accounting for non-financial and financial risk components and eases certain hedge effectiveness assessment requirements. Applied adopted this guidance in the first quarter of fiscal 2020 under the modified retrospective approach. The cumulative effect adjustment for the elimination of the ineffectiveness was not material to Applied’s consolidated financial statements. The presentation and disclosure have been amended on a prospective basis, as required by this update.
Receivables: Nonrefundable Fees and Other Costs. In March 2017, the FASB issued authoritative guidance that will shorten the amortization period for certain callable debt securities held at a premium to the earliest call date to more closely align with expectations incorporated in market pricing. Applied adopted this guidance in the first quarter of fiscal 2020 on a modified retrospective basis. The adoption of this guidance did not have a significant impact on Applied’s consolidated financial statements.
Accounting Standards Not Yet Adopted
Simplifying the Accounting for Income Taxes: In December 2019, the FASB issued an accounting standard update to simplify the accounting for income taxes (Topic 740). This amendment removes certain exceptions and improves consistent application of accounting principles for certain areas in Topic 740. This authoritative guidance will be effective for Applied in the first quarter of fiscal 2022, with early adoption permitted. Applied is currently evaluating the effect of this new guidance on Applied’s consolidated financial statements.
Retirement Benefits: Changes to the Disclosure Requirements for Defined Benefit and other Postretirement Plans. In August 2018, the FASB issued authoritative guidance that adds, removes, and clarifies disclosure requirements for defined benefit and other postretirement plans. This authoritative guidance will be effective for Applied in fiscal 2021 on a retrospective basis, with early adoption permitted. The adoption of this guidance is not expected to have a significant impact on Applied's defined benefit and other postretirement disclosures.
Goodwill Impairment. In January 2017, the FASB issued authoritative guidance that simplifies the process required to test goodwill for impairment. The authoritative guidance will be effective for Applied in the first quarter of fiscal 2021. The adoption of this guidance is not expected to have a significant impact on Applied’s consolidated financial statements.
Financial Instruments: Credit Losses. In June 2016, the FASB issued authoritative guidance that modifies the impairment model for certain financial assets by requiring use of an expected loss methodology, which will result in more timely recognition of credit losses. The authoritative guidance will be effective for Applied in the first quarter of fiscal 2021. The adoption of this guidance will not have a significant impact on Applied’s consolidated financial statements.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 2 Earnings Per Share
Basic earnings per share is determined using the weighted average number of common shares outstanding during the period. Diluted earnings per share is determined using the weighted average number of common shares and potential common shares (representing the dilutive effect of stock options, restricted stock units, and employee stock purchase plan shares) outstanding during the period. Applied’s net income has not been adjusted for any period presented for purposes of computing basic or diluted earnings per share due to the Company’s non-complex capital structure.
| Fiscal Year | 2020 | 2019 | 2018 | ||||||||||||||
| (In millions, except per share amounts) | |||||||||||||||||
| Numerator: | |||||||||||||||||
| Net income | $ | 3,619 | $ | 2,706 | $ | 3,038 | |||||||||||
| Denominator: | |||||||||||||||||
| Weighted average common shares outstanding | 916 | 937 | 1,013 | ||||||||||||||
| Effect of dilutive stock options, restricted stock units and employee stock purchase plan shares | 7 | 8 | 13 | ||||||||||||||
| Denominator for diluted earnings per share | 923 | 945 | 1,026 | ||||||||||||||
| Basic earnings per share | $ | 3.95 | $ | 2.89 | $ | 3.00 | |||||||||||
| Diluted earnings per share | $ | 3.92 | $ | 2.86 | $ | 2.96 | |||||||||||
| Potentially dilutive securities | — | 3 | — |
Potentially dilutive securities attributable to outstanding stock options and restricted stock units are excluded from the calculation of diluted earnings per share where the combined exercise price and average unamortized fair value are greater than the average market price of Applied common stock, and therefore their inclusion would be anti-dilutive.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 3 Cash, Cash Equivalents and Investments
Summary of Cash, Cash Equivalents and Investments
The following tables summarize Applied’s cash, cash equivalents and investments by security type:
| October 25, 2020 | Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | |||||||||||||||||||
| (In millions) | |||||||||||||||||||||||
| Cash | $ | 1,136 | $ | — | $ | — | $ | 1,136 | |||||||||||||||
| Cash equivalents: | |||||||||||||||||||||||
| Money market funds | 4,209 | — | — | 4,209 | |||||||||||||||||||
| Municipal securities | 6 | — | — | 6 | |||||||||||||||||||
| Total Cash equivalents | 4,215 | — | — | 4,215 | |||||||||||||||||||
| Total Cash and Cash equivalents | $ | 5,351 | $ | — | $ | — | $ | 5,351 | |||||||||||||||
| Short-term and long-term investments: | |||||||||||||||||||||||
| U.S. Treasury and agency securities | $ | 394 | $ | 4 | $ | — | $ | 398 | |||||||||||||||
| Municipal securities | 359 | 6 | — | 365 | |||||||||||||||||||
| Commercial paper, corporate bonds and medium-term notes | 492 | 8 | 1 | 499 | |||||||||||||||||||
| Asset-backed and mortgage-backed securities | 470 | 9 | — | 479 | |||||||||||||||||||
| Total fixed income securities | 1,715 | 27 | 1 | 1,741 | |||||||||||||||||||
| Publicly traded equity securities | 11 | 36 | 2 | 45 | |||||||||||||||||||
| Equity investments in privately-held companies | 121 | 25 | 7 | 139 | |||||||||||||||||||
| Total equity investments | 132 | 61 | 9 | 184 | |||||||||||||||||||
| Total short-term and long-term investments | $ | 1,847 | $ | 88 | $ | 10 | $ | 1,925 | |||||||||||||||
| Total Cash, Cash equivalents and Investments | $ | 7,198 | $ | 88 | $ | 10 | $ | 7,276 |
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| October 27, 2019 | Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | |||||||||||||||||||
| (In millions) | |||||||||||||||||||||||
| Cash | $ | 1,071 | $ | — | $ | — | $ | 1,071 | |||||||||||||||
| Cash equivalents: | |||||||||||||||||||||||
| Money market funds | 1,677 | — | — | 1,677 | |||||||||||||||||||
| U.S. Treasury and agency securities | 4 | — | — | 4 | |||||||||||||||||||
| Commercial paper, corporate bonds and medium-term notes | 377 | — | — | 377 | |||||||||||||||||||
| Total Cash equivalents | 2,058 | — | — | 2,058 | |||||||||||||||||||
| Total Cash and Cash equivalents | $ | 3,129 | $ | — | $ | — | $ | 3,129 | |||||||||||||||
| Short-term and long-term investments: | |||||||||||||||||||||||
| U.S. Treasury and agency securities | $ | 336 | $ | 1 | $ | — | $ | 337 | |||||||||||||||
| Non-U.S. government securities* | 10 | — | — | 10 | |||||||||||||||||||
| Municipal securities | 402 | 4 | — | 406 | |||||||||||||||||||
| Commercial paper, corporate bonds and medium-term notes | 642 | 5 | — | 647 | |||||||||||||||||||
| Asset-backed and mortgage-backed securities | 631 | 4 | — | 635 | |||||||||||||||||||
| Total fixed income securities | 2,021 | 14 | — | 2,035 | |||||||||||||||||||
| Publicly traded equity securities | 8 | 40 | 3 | 45 | |||||||||||||||||||
| Equity investments in privately-held companies | 105 | 10 | 3 | 112 | |||||||||||||||||||
| Total equity investments | 113 | 50 | 6 | 157 | |||||||||||||||||||
| Total short-term and long-term investments | $ | 2,134 | $ | 64 | $ | 6 | $ | 2,192 | |||||||||||||||
| Total Cash, Cash equivalents and Investments | $ | 5,263 | $ | 64 | $ | 6 | $ | 5,321 |
- Includes agency debt securities guaranteed by Canada.
Maturities of Investments
The following table summarizes the contractual maturities of Applied’s investments at October 25, 2020:
| Cost | Estimated Fair Value | ||||||||||
| (In millions) | |||||||||||
| Due in one year or less | $ | 367 | $ | 369 | |||||||
| Due after one through five years | 878 | 893 | |||||||||
| Due after five years | — | — | |||||||||
| No single maturity date** | 602 | 663 | |||||||||
| Total | $ | 1,847 | $ | 1,925 |
** Securities with no single maturity date include publicly-traded and privately-held equity securities, and asset-backed and mortgage-backed securities.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Gains and Losses on Investments
Gross realized gains and losses on sales of investments for each fiscal year were as follows:
| 2020 | 2019 | 2018 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Gross realized gains | $ | 19 | $ | 10 | $ | 29 | |||||||||||
| Gross realized losses | $ | 2 | $ | 2 | $ | 3 |
At October 25, 2020, gross unrealized losses related to Applied’s debt investment portfolio were not material. Applied regularly reviews its debt investment portfolio to identify and evaluate investments that have indications of possible impairment. Factors considered in determining whether an unrealized loss is considered to be temporary, or other-than-temporary and therefore impaired, include: the length of time and extent to which fair value has been lower than the cost basis; the financial condition, credit quality and near-term prospects of the investee; and whether it is more likely than not that Applied will be required to sell the security prior to recovery.
Applied determined that the gross unrealized losses on its marketable fixed-income securities at October 25, 2020, October 27, 2019 and October 28, 2018 were temporary in nature and therefore it did not recognize any impairment of its marketable fixed-income securities for fiscal 2020, 2019 or 2018. During fiscal 2020, 2019 and 2018, impairment charge on equity investments in privately-held companies were not material. These impairment charges are included in interest and other income, net in the Consolidated Statement of Operations.
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.
The components of gain (loss) on equity investments for each fiscal year were as follows:
| 2020 | 2019 | ||||||||||||||||
| (In millions) | |||||||||||||||||
| Publicly traded equity securities | |||||||||||||||||
| Unrealized gain | $ | 14 | $ | 28 | |||||||||||||
| Unrealized loss | (17) | (5) | |||||||||||||||
| Realized gain on sales | 1 | 2 | |||||||||||||||
| Equity investments in privately-held companies | |||||||||||||||||
| Unrealized gain | 18 | 13 | |||||||||||||||
| Unrealized loss | (7) | (6) | |||||||||||||||
| Realized gain on sales | 8 | 5 | |||||||||||||||
| Realized loss on sales or impairment | (8) | (1) | |||||||||||||||
| Total gain (loss) on equity investments, net | $ | 9 | $ | 36 |
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 4 Fair Value Measurements
Applied’s financial assets are measured and recorded at fair value on a recurring basis, except for equity investments in privately-held companies. These equity investments are generally accounted for under the measurement alternative, defined as cost, less impairments, adjusted for subsequent observable price changes and are periodically assessed for impairment when events or circumstances indicate that a decline in value may have occurred. Applied’s nonfinancial assets, such as goodwill, intangible assets, and property, plant and equipment, are recorded at cost and are assessed for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable.
Fair Value Hierarchy
Applied uses the following fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:
-
Level 1 — Quoted prices in active markets for identical assets or liabilities;
-
Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
-
Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Applied’s investments consist primarily of debt securities that are classified as available-for-sale and recorded at their fair values. In determining the fair value of investments, Applied uses pricing information from pricing services that value securities based on quoted market prices and models that utilize observable market inputs. In the event a fair value estimate is unavailable from a pricing service, Applied generally obtains non-binding price quotes from brokers. Applied then reviews the information provided by the pricing services or brokers to determine the fair value of its short-term and long-term investments. In addition, to validate pricing information obtained from pricing services, Applied periodically performs supplemental analysis on a sample of securities. Applied reviews any significant unanticipated differences identified through this analysis to determine the appropriate fair value. As of October 25, 2020, substantially all of Applied’s available-for-sale, short-term and long-term investments were recognized at fair value that was determined based upon observable inputs.
Applied’s equity investments with readily determinable values consist of publicly traded equity securities. These investments are measured at fair value using quoted prices for identical assets in an active market and the changes in fair value of these equity investments are recognized in the consolidated statements of operations.
Investments with remaining effective maturities of 12 months or less from the balance sheet date are classified as short-term investments. Investments with remaining effective maturities of more than 12 months from the balance sheet date are classified as long-term investments.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Assets Measured at Fair Value on a Recurring Basis
Financial assets (excluding cash balances) measured at fair value on a recurring basis are summarized below:
| October 25, 2020 | October 27, 2019 | ||||||||||||||||||||||||||||||||||||||||||||||
| Level 1 | Level 2 | Total | Level 1 | Level 2 | Total | ||||||||||||||||||||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||||||||||||||||||||
| Assets: | |||||||||||||||||||||||||||||||||||||||||||||||
| Available-for-sale debt security investments | |||||||||||||||||||||||||||||||||||||||||||||||
| Money market funds* | $ | 4,324 | $ | — | $ | 4,324 | $ | 1,677 | $ | — | $ | 1,677 | |||||||||||||||||||||||||||||||||||
| U.S. Treasury and agency securities | 375 | 23 | 398 | 323 | 18 | 341 | |||||||||||||||||||||||||||||||||||||||||
| Non-U.S. government securities | — | — | — | — | 10 | 10 | |||||||||||||||||||||||||||||||||||||||||
| Municipal securities | — | 371 | 371 | — | 406 | 406 | |||||||||||||||||||||||||||||||||||||||||
| Commercial paper, corporate bonds and medium-term notes | — | 499 | 499 | — | 1,024 | 1,024 | |||||||||||||||||||||||||||||||||||||||||
| Asset-backed and mortgage-backed securities | — | 479 | 479 | — | 635 | 635 | |||||||||||||||||||||||||||||||||||||||||
| Total available-for-sale debt security investments | $ | 4,699 | $ | 1,372 | $ | 6,071 | $ | 2,000 | $ | 2,093 | $ | 4,093 | |||||||||||||||||||||||||||||||||||
| Equity investments with readily determinable values | |||||||||||||||||||||||||||||||||||||||||||||||
| Publicly traded equity securities | $ | 45 | $ | — | $ | 45 | $ | 45 | $ | — | $ | 45 | |||||||||||||||||||||||||||||||||||
| Total equity investments with readily determinable values | $ | 45 | $ | — | $ | 45 | $ | 45 | $ | — | $ | 45 | |||||||||||||||||||||||||||||||||||
| Total | $ | 4,744 | $ | 1,372 | $ | 6,116 | $ | 2,045 | $ | 2,093 | $ | 4,138 | |||||||||||||||||||||||||||||||||||
- Amount as of October 25, 2020 includes $115 million invested in money market funds related to deferred compensation plans. Due to restrictions on the distribution of these funds, they are classified as restricted cash equivalents and are included in deferred income taxes and other assets in the Consolidated Condensed Balance Sheets.
Applied did not have any financial assets measured at fair value on a recurring basis within Level 3 fair value measurements as of October 25, 2020 or October 27, 2019.
Assets and Liabilities Measured at Fair Value on a Non-recurring Basis
Applied’s equity investments without readily determinable values consist of equity investments in privately-held companies. Applied elected the measurement alternative, defined as cost, less impairments, adjusted for subsequent observable price changes on a prospective basis for certain equity investments without readily determinable fair values and is required to account for any subsequent observable changes in fair value within the statements of operations. These investments are periodically assessed for impairment when an event or circumstance indicates that a decline in value may have occurred.
During fiscal 2020, 2019 and 2018, impairment charges on equity investments in privately-held companies were not material.
Other
The carrying amounts of Applied’s financial instruments, including cash and cash equivalents, restricted cash equivalents, accounts receivable, notes payable - short term, and accounts payable and accrued expenses, approximate fair value due to their short maturities. At October 25, 2020, the aggregate principal amount of long-term senior unsecured notes was $5.5 billion, and estimated fair value was $6.6 billion. At October 27, 2019, the aggregate principal and estimated fair value amounts of long-term senior unsecured notes were both $4.8 billion and estimated fair value was $5.5 billion. The estimated fair value of long-term senior unsecured notes is determined by Level 2 inputs and is based primarily on quoted market prices for the same or similar issues. See Note 11 of the Notes to the Consolidated Financial Statements for further detail of existing debt.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 5 Derivative Instruments and Hedging Activities
Derivative Financial Instruments
Applied conducts business in a number of foreign countries, with certain transactions denominated in local currencies, such as the Japanese yen, euro, Israeli shekel and Taiwanese dollar. Applied uses derivative financial instruments, such as forward exchange contracts and currency option contracts, to hedge certain forecasted foreign currency denominated transactions expected to occur typically within the next 24 months. The purpose of Applied’s foreign currency management is to mitigate the effect of exchange rate fluctuations on certain foreign currency denominated revenues, costs and eventual cash flows. The terms of currency instruments used for hedging purposes are generally consistent with the timing of the transactions being hedged.
Applied does not use derivative financial instruments for trading or speculative purposes. Derivative instruments and hedging activities, including foreign currency exchange and interest rate contracts, are recognized on the balance sheet at fair value. Changes in the fair value of derivatives that do not qualify for hedge treatment, as well as the ineffective portion of any hedges, are recognized currently in earnings. All of Applied’s derivative financial instruments are recorded at their fair value in other current assets or in accounts payable and accrued expenses.
Hedges related to anticipated transactions are designated and documented at the inception of the hedge as cash flow hedges and foreign exchange derivatives are typically entered into once per month. Cash flow hedges are evaluated for effectiveness quarterly. The effective portion of the gain or loss on these hedges is reported as a component of AOCI in stockholders’ equity and is reclassified into earnings when the hedged transaction affects earnings. The majority of the after-tax net income or loss related to foreign exchange derivative instruments included in AOCI at October 25, 2020 is expected to be reclassified into earnings within 12 months. Prior to adopting the new accounting guidance for hedge accounting, changes in the fair value of currency forward exchange and option contracts due to changes in time value were excluded from the assessment of effectiveness. Subsequent to the adoption of the new accounting guidance, only changes in the fair value of option contracts due to changes in time value were excluded from the assessment of effectiveness. The initial value of this excluded component is amortized on a straight-line basis over the life of the hedging instrument and recognized in the financial statement line item to which the hedge relates. Both ineffective hedge amounts and hedge components excluded from the assessment of effectiveness are recognized in earnings. If the transaction being hedged is no longer probable to occur, or if a portion of any derivative is deemed to be ineffective, Applied promptly recognizes the gain or loss on the associated financial instrument in the statement of operations. The amount recognized due to discontinuance of cash flow hedges that were probable not to occur by the end of the originally specified time period were not significant for fiscal years 2020, 2019 or 2018.
Additionally, forward exchange contracts are generally used to hedge certain foreign currency denominated assets or liabilities. These derivatives are typically entered into once per month and are not designated for hedge accounting treatment. Accordingly, changes in the fair value of these hedges are recorded in earnings to offset the changes in the fair value of the assets or liabilities being hedged.
The fair values of foreign exchange derivative instruments at October 25, 2020 and October 27, 2019 were not material.
Applied is also exposed to interest rate risk associated with its potential future borrowings. During fiscal 2020, Applied entered into a series of interest rate contracts to hedge against the variability of cash flows due to changes in the benchmark interest rate of fixed rate debt. These instruments were designated as cash flow hedges at inception and were settled in conjunction with the issuance of debt in May 2020.
The gain (loss) on derivatives in cash flow hedging relationships recognized in AOCI for derivatives designated as hedging instruments for the indicated periods were as follows:
| Derivatives in Cash Flow Hedging Relationships | |||||||||||||||||
| 2020 | 2019 | 2018 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Foreign exchange contracts | $ | 3 | $ | (14) | $ | 3 | |||||||||||
| Interest rate contracts | (151) | — | — | ||||||||||||||
| Total | $ | (148) | $ | (14) | $ | 3 |
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The effects of derivative instruments and hedging activities on the Consolidated Statements of Operations were as follows:
| Derivatives in Cash Flow Hedging Relationships | |||||||||||||||||
| Total Amount Presented in the Consolidated Statement of Operations in which the Effects of Cash Flow Hedges are Recorded | Amount of Gain or (Loss) Reclassified from AOCI into Consolidated Statement of Operations | Amounts of Gain (Loss) Excluded from Effectiveness Testing Recognized in Consolidated Statement of Operations | |||||||||||||||
| (In millions) | |||||||||||||||||
| 2020 | |||||||||||||||||
| Foreign Exchange Contracts: | |||||||||||||||||
| Net Sales | $ | 17,202 | $ | (2) | $ | 4 | |||||||||||
| Cost of products sold | $ | 9,510 | 6 | (3) | |||||||||||||
| Research, development and engineering | $ | 2,234 | 4 | — | |||||||||||||
| General and administrative | $ | 567 | 1 | — | |||||||||||||
| Interest Rate Contracts: | |||||||||||||||||
| Interest expense | $ | 240 | (7) | — | |||||||||||||
| $ | 2 | $ | 1 | ||||||||||||||
| 2019 | |||||||||||||||||
| Foreign Exchange Contracts: | |||||||||||||||||
| Cost of products sold | $ | 8,222 | $ | 2 | $ | 15 | |||||||||||
| General and administrative | $ | 461 | (3) | (6) | |||||||||||||
| Interest Rate Contracts: | |||||||||||||||||
| Interest expense | $ | 237 | (3) | — | |||||||||||||
| $ | (4) | $ | 9 | ||||||||||||||
| 2018 | |||||||||||||||||
| Foreign Exchange Contracts: | |||||||||||||||||
| Cost of products sold | $ | 9,188 | $ | 4 | $ | 19 | |||||||||||
| General and administrative | $ | 483 | (3) | (7) | |||||||||||||
| Interest Rate Contracts: | |||||||||||||||||
| Interest expense | $ | 234 | (3) | — | |||||||||||||
| $ | (2) | $ | 12 |
| Amount of Gain or (Loss) Recognized in Consolidated Statement of Operations | |||||||||||||||||||||||
| Location of Gain or (Loss) Recognized in Consolidated Statement of Operations | 2020 | 2019 | 2018 | ||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||
| Derivatives Not Designated as Hedging Instruments | |||||||||||||||||||||||
| Foreign exchange contracts | General and administrative | $ | — | $ | (8) | $ | (5) | ||||||||||||||||
| Foreign exchange contracts | Interest and other income, net | (10) | — | — | |||||||||||||||||||
| Total return swaps - deferred compensation | Cost of products sold | 1 | — | — | |||||||||||||||||||
| Total return swaps - deferred compensation | Operating expenses | 6 | — | — | |||||||||||||||||||
| Total return swaps - deferred compensation | Interest and other income, net | (1) | — | — | |||||||||||||||||||
| Total | $ | (4) | $ | (8) | $ | (5) | |||||||||||||||||
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Credit Risk Contingent Features
If Applied’s credit rating were to fall below investment grade, it would be in violation of credit risk contingent provisions of the derivative instruments discussed above, and certain counterparties to the derivative instruments could request immediate payment on derivative instruments in net liability positions. The aggregate fair value of all derivative instruments with credit-risk related contingent features that were in a net liability position was immaterial as of October 25, 2020 and October 27, 2019.
Entering into derivative contracts with banks exposes Applied to credit-related losses in the event of the banks’ nonperformance. However, Applied’s exposure is not considered significant.
Note 6 Accounts Receivable, Net
Applied has agreements with various financial institutions to sell accounts receivable and discount promissory notes from selected customers. Applied 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. Financing charges on the sale of receivables and discounting of letters of credit are included in interest expense in the accompanying Consolidated Statements of Operations and were not material for all years presented.
Accounts receivable are presented net of allowance for doubtful accounts of $30 million at October 25, 2020 and October 27, 2019. Changes in allowance for doubtful accounts in each fiscal year were as follows:
| 2020 | 2019 | 2018 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Beginning balance | $ | 30 | $ | 33 | $ | 34 | |||||||||||
| Provision | — | — | — | ||||||||||||||
| Deductions1 | — | (3) | (1) | ||||||||||||||
| Ending balance | $ | 30 | $ | 30 | $ | 33 |
1 Deductions primarily represent releases of allowance for doubtful accounts credited to expense as a result of an overall lower risk profile of Applied’s customers and cash collections.
Applied sells its products principally to manufacturers within the semiconductor and display industries. While Applied believes that its allowance for doubtful accounts is adequate and represents its best estimate as of October 25, 2020, it continues to closely monitor customer liquidity and industry and economic conditions, which may result in changes to Applied’s estimates.
Note 7 Contract Balances
Contract assets primarily result from receivables for goods transferred to customers where payment is conditional upon technical sign off and not just the passage of time. Contract liabilities consist of unsatisfied performance obligations related to advance payments received and billings in excess of revenue recognized. Applied’s contract assets and liabilities are reported in a net position on a contract-by-contract basis at the end of each reporting period.
Contract assets are generally classified as current and included in Other Current Assets in the Consolidated Balance Sheets. Contract liabilities are classified as current or non-current based on the timing of when performance obligations will be satisfied and associated revenue is expected to be recognized.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Contract balances at the end of each reporting period were as follows:
| October 25, 2020 | October 27, 2019 | ||||||||||
| (In millions) | |||||||||||
| Contract assets | $ | 148 | $ | 108 | |||||||
| Contract liabilities | $ | 1,321 | $ | 1,336 |
The increase in contract assets during fiscal 2020, was primarily due to goods transferred to customers where payment was conditional upon technical sign off, offset by the reclassification of contract assets to net accounts receivable upon meeting conditions to the right to payment.
During fiscal 2020, Applied recognized revenue of approximately $1.1 billion related to contract liabilities at October 27, 2019. This reduction in contract liabilities was offset by new billings for products and services for which there were unsatisfied performance obligations to customers and revenue had not yet been recognized as of October 25, 2020.
There were no impairment losses recognized on Applied’s accounts receivables and contract assets during fiscal 2020 and 2019.
As of October 25, 2020, the amount of remaining unsatisfied performance obligations on contracts with an original estimated duration of one year or more was approximately $1.1 billion, of which approximately 70% is expected to be recognized within 12 months and the remainder is expected to be recognized within the following 24 months thereafter. Applied has elected the available practical expedient to exclude the value of unsatisfied performance obligations for contracts with an original expected duration of one year or less.
Note 8 Balance Sheet Detail
| October 25, 2020 | October 27, 2019 | ||||||||||
| (In millions) | |||||||||||
| Inventories | |||||||||||
| Customer service spares | $ | 1,270 | $ | 1,245 | |||||||
| Raw materials | 870 | 802 | |||||||||
| Work-in-process | 624 | 575 | |||||||||
| Finished goods | 1,140 | 852 | |||||||||
| $ | 3,904 | $ | 3,474 |
Included in finished goods inventory is $16 million at October 25, 2020 and $13 million at October 27, 2019, of newly-introduced systems at customer locations where the sales transaction did not meet Applied’s revenue recognition criteria as set forth in Note 1. Finished goods inventory includes $416 million and $318 million of evaluation inventory at October 25, 2020 and October 27, 2019, respectively.
| October 25, 2020 | October 27, 2019 | ||||||||||
| (In millions) | |||||||||||
| Other Current Assets | |||||||||||
| Prepaid income taxes and income taxes receivable | $ | 162 | $ | 96 | |||||||
| Prepaid expenses and other | 602 | 485 | |||||||||
| $ | 764 | $ | 581 |
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| Useful Life | October 25, 2020 | October 27, 2019 | |||||||||||||||
| (In years) | (In millions) | ||||||||||||||||
| Property, Plant and Equipment, Net | |||||||||||||||||
| Land and improvements | $ | 256 | $ | 254 | |||||||||||||
| Buildings and improvements | 3-30 | 1,655 | 1,590 | ||||||||||||||
| Demonstration and manufacturing equipment | 3-5 | 1,586 | 1,505 | ||||||||||||||
| Furniture, fixtures and other equipment | 3-5 | 646 | 602 | ||||||||||||||
| Construction in progress | 237 | 120 | |||||||||||||||
| Gross property, plant and equipment | 4,380 | 4,071 | |||||||||||||||
| Accumulated depreciation | (2,776) | (2,542) | |||||||||||||||
| $ | 1,604 | $ | 1,529 |
Depreciation expense was $320 million, $306 million and $258 million for fiscal 2020, 2019 and 2018 respectively.
| October 25, 2020 | October 27, 2019 | ||||||||||
| (In millions) | |||||||||||
| Deferred Income Taxes and Other Assets | |||||||||||
| Non-current deferred income taxes | $ | 1,711 | $ | 1,766 | |||||||
| Operating lease right-of-use assets | 252 | — | |||||||||
| Income tax receivables and other assets | 260 | 265 | |||||||||
| $ | 2,223 | $ | 2,031 |
| October 25, 2020 | October 27, 2019 | ||||||||||
| (In millions) | |||||||||||
| Accounts Payable and Accrued Expenses | |||||||||||
| Accounts payable | $ | 1,124 | $ | 958 | |||||||
| Compensation and employee benefits | 800 | 559 | |||||||||
| Warranty | 201 | 196 | |||||||||
| Dividends payable | 201 | 192 | |||||||||
| Income taxes payable | 222 | 160 | |||||||||
| Other accrued taxes | 33 | 55 | |||||||||
| Interest payable | 36 | 38 | |||||||||
| Operating lease liabilities, current | 64 | — | |||||||||
| Other | 457 | 353 | |||||||||
| $ | 3,138 | $ | 2,511 |
| October 25, 2020 | October 27, 2019 | ||||||||||
| (In millions) | |||||||||||
| Other Liabilities | |||||||||||
| Defined and postretirement benefit plans | $ | 241 | $ | 212 | |||||||
| Operating lease liabilities, non-current | 195 | — | |||||||||
| Other | 226 | 163 | |||||||||
| $ | 662 | $ | 375 |
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 9 Business Combinations
Kokusai Electric Corporation
On June 30, 2019, Applied entered into a Share Purchase Agreement (SPA) to acquire all outstanding shares of Kokusai Electric Corporation (Kokusai Electric) for $2.2 billion in cash, subject to certain post-closing adjustments. Kokusai Electric is a leading company in providing high-productivity batch processing systems and services for memory, foundry and logic customers. These systems complement Applied’s portfolio of single-wafer processing systems. Following the close of the transaction, Kokusai Electric will operate as a business unit of Applied’s Semiconductor Systems segment and continue to be based in Tokyo, with technology and manufacturing centers in Toyama, Japan and Cheonan, Korea. The transaction is subject to regulatory approvals and other customary closing conditions. The SPA contains certain termination rights, including if the transactions contemplated by the SPA are not consummated on or before June 30, 2020 (Outside Date), which date may be extended by three months on two separate occasions if, on the applicable date, the only conditions to closing relate to required regulatory approvals. Pursuant to the terms of the SPA, the parties mutually extended the Outside Date to September 30, 2020, and on September 30, 2020 mutually further extended the Outside Date to December 30, 2020.
Note 10 Goodwill, Purchased Technology and Other Intangible Assets
Goodwill and Purchased Intangible Assets
Applied’s methodology for allocating the purchase price relating to purchase acquisitions is determined through established and generally accepted valuation techniques. Goodwill is measured as the excess of the purchase price over the sum of the amounts assigned to tangible and identifiable intangible assets acquired less liabilities assumed. Applied assigns assets acquired (including goodwill) and liabilities assumed to one or more reporting units as of the date of acquisition. Typically, acquisitions relate to a single reporting unit and thus do not require the allocation of goodwill to multiple reporting units. If the products obtained in an acquisition are assigned to multiple reporting units, the goodwill is distributed to the respective reporting units as part of the purchase price allocation process.
Goodwill and purchased intangible assets with indefinite useful lives are not amortized, but are reviewed for impairment annually during the fourth quarter of each fiscal year and whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The process of evaluating the potential impairment of goodwill and intangible assets requires significant judgment, especially in emerging markets. Applied regularly monitors current business conditions and considers other factors including, but not limited to, adverse industry or economic trends, restructuring actions and lower projections of profitability that may impact future operating results.
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. Applied determines the fair value of each of its reporting units based on a weighting of income and market approaches. If the carrying value of a reporting unit exceeds its 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.
As of October 25, 2020, Applied’s reporting units include Semiconductor Products Group and Imaging and Process Control Group, which combine to form the Semiconductor Systems reporting segment, Applied Global Services, Display and Adjacent Markets and other reporting units recorded under Corporate and Other.
In the fourth quarter of fiscal 2020, Applied performed a qualitative assessment to test goodwill for all of its reporting units for impairment. Applied determined that it was more likely than not that each of its reporting units’ fair values exceeded their respective carrying values and that it was not necessary to perform the two-step goodwill impairment test for any of its reporting units.
The evaluation of goodwill and intangible assets for impairment requires the exercise of significant judgment. In the event of future changes in business conditions, Applied will be required to reassess and update its forecasts and estimates used in future impairment analyses. If the results of these future analyses are lower than current estimates, a material impairment charge may result at that time.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Details of goodwill were as follows:
| October 25, 2020 | October 27, 2019 | ||||||||||||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||||||||
| Semiconductor Systems | $ | 2,208 | $ | 2,182 | |||||||||||||||||||||||||||||||
| Applied Global Services | 1,018 | 1,018 | |||||||||||||||||||||||||||||||||
| Display and Adjacent Markets | 199 | 199 | |||||||||||||||||||||||||||||||||
| Corporate and Other | 41 | — | |||||||||||||||||||||||||||||||||
| Carrying amount | $ | 3,466 | $ | 3,399 |
During fiscal 2020, the increase in goodwill was primarily due to the preliminary purchase accounting for acquisitions completed in fiscal 2020, which were not material to Applied’s results of operations.
A summary of Applied’s purchased technology and intangible assets is set forth below:
| October 25, 2020 | October 27, 2019 | ||||||||||
| (In millions) | |||||||||||
| Purchased technology, net | $ | 75 | $ | 71 | |||||||
| Intangible assets - finite-lived, net | 78 | 85 | |||||||||
| $ | 153 | $ | 156 |
Finite-Lived Purchased Intangible Assets
Applied amortizes purchased intangible assets with finite lives using the straight-line method over the estimated economic lives of the assets, ranging from 1 to 15 years.
Applied evaluates long-lived assets for impairment whenever events or changes in circumstances indicate the carrying value of an asset group may not be recoverable. Applied assesses the fair value of the assets based on the amount of the undiscounted future cash flow that the assets are expected to generate and recognizes an impairment loss when estimated undiscounted future cash flow expected to result from the use of the asset, plus net proceeds expected from disposition of the asset, if any, are less than the carrying value of the asset. When Applied identifies an impairment, Applied reduces the carrying value of the group of assets to comparable market values, when available and appropriate, or to its estimated fair value based on a discounted cash flow approach.
Intangible assets, such as purchased technology, are generally recorded in connection with a business acquisition. The value assigned to intangible assets is usually based on estimates and judgments regarding expectations for the success and life cycle of products and technology acquired. Applied evaluates the useful lives of its intangible assets each reporting period to determine whether events and circumstances require revising the remaining period of amortization. In addition, Applied reviews intangible assets for impairment when events or changes in circumstances indicate their carrying value may not be recoverable. Management considers such indicators as significant differences in actual product acceptance from the estimates, changes in the competitive and economic environments, technological advances, and changes in cost structure.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Details of finite-lived intangible assets were as follows:
| October 25, 2020 | October 27, 2019 | ||||||||||||||||||||||||||||||||||
| Purchased Technology | Other Intangible Assets | Total | Purchased Technology | Other Intangible Assets | Total | ||||||||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||||||||
| Gross carrying amount: | |||||||||||||||||||||||||||||||||||
| Semiconductor Systems | $ | 1,476 | $ | 256 | $ | 1,732 | $ | 1,449 | $ | 252 | $ | 1,701 | |||||||||||||||||||||||
| Applied Global Services | 35 | 44 | 79 | 33 | 44 | 77 | |||||||||||||||||||||||||||||
| Display and Adjacent Markets | 163 | 38 | 201 | 163 | 38 | 201 | |||||||||||||||||||||||||||||
| Corporate and Other | 13 | 16 | 29 | — | 9 | 9 | |||||||||||||||||||||||||||||
| Gross carrying amount | $ | 1,687 | $ | 354 | $ | 2,041 | $ | 1,645 | $ | 343 | $ | 1,988 | |||||||||||||||||||||||
| Accumulated amortization: | |||||||||||||||||||||||||||||||||||
| Semiconductor Systems | $ | (1,423) | $ | (185) | $ | (1,608) | $ | (1,400) | $ | (168) | $ | (1,568) | |||||||||||||||||||||||
| Applied Global Services | (31) | (44) | (75) | (30) | (44) | (74) | |||||||||||||||||||||||||||||
| Display and Adjacent Markets | (157) | (37) | (194) | (144) | (37) | (181) | |||||||||||||||||||||||||||||
| Corporate and Other | (1) | (10) | (11) | — | (9) | (9) | |||||||||||||||||||||||||||||
| Accumulated amortization | $ | (1,612) | $ | (276) | $ | (1,888) | $ | (1,574) | $ | (258) | $ | (1,832) | |||||||||||||||||||||||
| Carrying amount | $ | 75 | $ | 78 | $ | 153 | $ | 71 | $ | 85 | $ | 156 |
Details of amortization expense for each fiscal year by segment were as follows:
| 2020 | 2019 | 2018 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Semiconductor Systems | $ | 40 | $ | 43 | $ | 184 | |||||||||||
| Applied Global Services | 1 | 1 | 1 | ||||||||||||||
| Display and Adjacent Markets | 13 | 13 | 14 | ||||||||||||||
| Corporate and Other | 2 | — | — | ||||||||||||||
| Total | $ | 56 | $ | 57 | $ | 199 |
Amortization expense for each fiscal year was charged to the following categories:
| 2020 | 2019 | 2018 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Cost of products sold | $ | 37 | $ | 38 | $ | 180 | |||||||||||
| Research, development and engineering | 1 | 1 | 1 | ||||||||||||||
| Marketing and selling | 18 | 18 | 18 | ||||||||||||||
| Total | $ | 56 | $ | 57 | $ | 199 |
As of October 25, 2020, future estimated amortization expense is expected to be as follows:
| Amortization Expense | |||||
| (In millions) | |||||
| 2021 | $ | 49 | |||
| 2022 | 33 | ||||
| 2023 | 20 | ||||
| 2024 | 17 | ||||
| 2025 | 15 | ||||
| Thereafter | 19 | ||||
| Total | $ | 153 |
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 11 Borrowing Facilities and Debt
Revolving Credit Facilities
In February 2020, Applied entered into a five-year $1.5 billion committed unsecured revolving credit agreement (Revolving Credit Agreement) with a group of banks. 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 replaced Applied’s prior $1.5 billion credit agreement that was scheduled to expire in September 2021. The Revolving Credit Agreement provides for borrowings 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.
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.
No amounts were outstanding under the Revolving Credit Agreement as of October 25, 2020 and October 27, 2019.
In addition, Applied has revolving credit facilities with Japanese banks pursuant to which it may borrow up to approximately $76 million in aggregate at any time. 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. As of October 25, 2020 and October 27, 2019, no amounts were outstanding under these revolving credit facilities.
Term Loan and Short-term Commercial Paper
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 this term loan credit agreement 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 of $1.5 billion. At October 25, 2020 and October 27, 2019, Applied did not have any commercial paper outstanding.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Senior Unsecured Notes
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.
Debt outstanding as of October 25, 2020 and October 27, 2019 was as follows:
| Principal Amount | |||||||||||||||||||||||
| October 25, 2020 | October 27, 2019 | Effective Interest Rate | Interest Pay Dates | ||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||
| Current portion of long-term debt: | |||||||||||||||||||||||
| 2.625% Senior Notes Due 2020 | $ | — | $ | 600 | 2.640% | April 1, October 1 | |||||||||||||||||
| Total current portion of long-term debt | — | 600 | |||||||||||||||||||||
| Long-term debt, net of current portion: | |||||||||||||||||||||||
| 4.300% Senior Notes Due 2021 | — | 750 | 4.326% | June 15, December 15 | |||||||||||||||||||
| 3.900% Senior Notes Due 2025 | 700 | 700 | 3.944% | April 1, October 1 | |||||||||||||||||||
| 3.300% Senior Notes Due 2027 | 1,200 | 1,200 | 3.342% | April 1, October 1 | |||||||||||||||||||
| 1.750% Senior Notes Due 2030 | 750 | — | 1.792% | June 1, December 1 | |||||||||||||||||||
| 5.100% Senior Notes Due 2035 | 500 | 500 | 5.127% | April 1, October 1 | |||||||||||||||||||
| 5.850% Senior Notes Due 2041 | 600 | 600 | 5.879% | June 15, December 15 | |||||||||||||||||||
| 4.350% Senior Notes Due 2047 | 1,000 | 1,000 | 4.361% | April 1, October 1 | |||||||||||||||||||
| 2.750% Senior Notes Due 2050 | 750 | — | 2.773% | June 1, December 1 | |||||||||||||||||||
| 5,500 | 4,750 | ||||||||||||||||||||||
| Total unamortized discount | (15) | (10) | |||||||||||||||||||||
| Total unamortized debt issuance costs | (37) | (27) | |||||||||||||||||||||
| Total long-term debt, net of current portion | 5,448 | 4,713 | |||||||||||||||||||||
| Total debt | $ | 5,448 | $ | 5,313 |
Note 12 Leases
A contract contains a lease when Applied has the right to control the use of an identified asset for a period of time in exchange for consideration. Applied leases certain facilities, vehicles and equipment under non-cancelable operating leases, many of which include options to renew. Options that are reasonably certain to be exercised are included in the calculation of the right-of-use asset and lease liability. Applied’s leases do not contain residual value guarantees or significant restrictions that impact the accounting for leases. As implicit rates are not available for the leases, Applied uses the incremental borrowing rate as of the lease commencement date in order to measure the right-of-use asset and liability. Operating lease expense is generally recognized on a straight-line basis over the lease term.
Applied elected the practical expedient to account for lease and non-lease components as a single lease component for all leases. For leases with a term of one year or less, Applied elected not to record a right-of-use asset or lease liability and to account for the associated lease payments as they become due.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The components of lease expense and supplemental information were as follows:
| 2020 | |||||||||||
| (In millions, except percentage) | |||||||||||
| Operating lease cost | $ | 69 | |||||||||
| Weighted-average remaining lease term (in years) | 5.2 | ||||||||||
| Weighted-average discount rate | 1.8 | % |
Total rent expense for fiscal 2019 and 2018, was $51 million and $50 million, respectively.
Supplemental cash flow information related to leases are as follows:
| 2020 | |||||||||||
| (In millions) | |||||||||||
| Operating cash flows paid for operating leases | $ | 70 | |||||||||
| Right-of-use assets obtained in exchange for operating lease liabilities | $ | 156 |
As of October 25, 2020, the maturities of lease liabilities are as follows:
| Operating Leases | |||||
| Fiscal | (In millions) | ||||
| 2021 | $ | 68 | |||
| 2022 | 55 | ||||
| 2023 | 48 | ||||
| 2024 | 42 | ||||
| 2025 | 33 | ||||
| Thereafter | 25 | ||||
| Total lease payments | $ | 271 | |||
| Less imputed interest | (12) | ||||
| Total | $ | 259 |
Prior to the adoption of the new lease standard, future minimum lease payments as of October 27, 2019, as defined under the previous lease accounting guidance, were as follows:
| Lease Payments | |||||
| Fiscal | (In millions) | ||||
| 2020 | $ | 45 | |||
| 2021 | 34 | ||||
| 2022 | 24 | ||||
| 2023 | 21 | ||||
| 2024 | 17 | ||||
| Thereafter | 30 | ||||
| Total | $ | 171 |
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 13 Stockholders’ Equity, Comprehensive Income and Share-Based Compensation
Accumulated Other Comprehensive Income (Loss)
Changes in the components of accumulated other comprehensive income (AOCI), net of tax, were as follows:
| Unrealized Gain (Loss) on Investments, Net | Unrealized Gain (Loss) on Derivative Instruments Qualifying as Cash Flow Hedges | Defined and Postretirement Benefit Plans | Cumulative Translation Adjustments | Total | |||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||
| Balance at October 29, 2017 | $ | 53 | $ | (11) | $ | (120) | $ | 14 | (64) | ||||||||||||||||||||
| Adoption of new accounting standards (a) | 5 | (2) | — | — | 3 | ||||||||||||||||||||||||
| Other comprehensive income (loss) before reclassifications | (66) | 5 | (23) | — | (84) | ||||||||||||||||||||||||
| Amounts reclassified out of AOCI | 15 | (1) | 6 | — | 20 | ||||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | (51) | 4 | (17) | — | (64) | ||||||||||||||||||||||||
| Balance at October 28, 2018 | $ | 7 | $ | (9) | $ | (137) | $ | 14 | $ | (125) | |||||||||||||||||||
| Adoption of new accounting standards (b) | (17) | — | — | — | (17) | ||||||||||||||||||||||||
| Other comprehensive income (loss) before reclassifications | 22 | (10) | (57) | (1) | (46) | ||||||||||||||||||||||||
| Amounts reclassified out of AOCI | (1) | 3 | 6 | — | 8 | ||||||||||||||||||||||||
| Other comprehensive income, net of tax | 21 | (7) | (51) | (1) | (38) | ||||||||||||||||||||||||
| Balance at October 27, 2019 | $ | 11 | $ | (16) | $ | (188) | $ | 13 | $ | (180) | |||||||||||||||||||
| Other comprehensive income (loss) before reclassifications | 16 | (115) | (21) | — | (120) | ||||||||||||||||||||||||
| Amounts reclassified out of AOCI | (7) | (2) | 10 | — | 1 | ||||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | 9 | (117) | (11) | — | (119) | ||||||||||||||||||||||||
| Balance at October 25, 2020 | $ | 20 | $ | (133) | $ | (199) | $ | 13 | $ | (299) |
(a) - Represents the reclassification adjustment related to the early adoption of Accounting Standards Update (ASU) 2018-02 Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.
(b) - Represents the reclassification adjustment related to the adoption of Accounting Standard Update (ASU) 2016-01 Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.
The tax effects on the unrealized loss on derivative instruments qualifying as cash flow hedges for fiscal 2020 was $33 million. The tax effects on net income of amounts reclassified from AOCI for the fiscal years 2020, 2019 and 2018 were not material.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Stock Repurchase Programs
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.
The following table summarizes Applied’s stock repurchases for each fiscal year:
| 2020 | 2019 | 2018 | |||||||||||||||
| (In millions, except per share amounts) | |||||||||||||||||
| Shares of common stock repurchased | 12 | 60 | 102 | ||||||||||||||
| Cost of stock repurchased | $ | 649 | $ | 2,403 | $ | 5,283 | |||||||||||
| Average price paid per share | $ | 56.32 | $ | 39.86 | $ | 51.55 |
Applied records treasury stock purchases under the cost method using the first-in, first-out (FIFO) method. Upon reissuance of treasury stock, amounts in excess of the acquisition cost are credited to additional paid in capital. If Applied reissues treasury stock at an amount below its acquisition cost and additional paid in capital associated with prior treasury stock transactions is insufficient to cover the difference between the acquisition cost and the reissue price, this difference is recorded against retained earnings.
Dividends
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.
Share-Based Compensation
Applied has a stockholder-approved equity plan, the Employee Stock Incentive Plan, which permits grants to employees of share-based awards, including stock options, restricted stock, restricted stock units, performance shares and performance units. In addition, the plan provides for the automatic grant of restricted stock units to non-employee directors and permits the grant of share-based awards to non-employee directors and consultants. Share-based awards made under the plan may be subject to accelerated vesting under certain circumstances in the event of a change in control of Applied. Applied also has two Employee Stock Purchase Plans, one generally for United States employees and a second for employees of international subsidiaries (collectively, ESPP), which enable eligible employees to purchase Applied common stock.
Applied recognized share-based compensation expense related to equity awards and ESPP shares. The effect of share-based compensation on the results of operations and the related tax benefits for each fiscal year were as follows:
| 2020 | 2019 | 2018 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Cost of products sold | $ | 103 | $ | 89 | $ | 87 | |||||||||||
| Research, development, and engineering | 116 | 99 | 96 | ||||||||||||||
| Marketing and selling | 36 | 31 | 31 | ||||||||||||||
| General and administrative | 52 | 44 | 44 | ||||||||||||||
| Total share-based compensation | $ | 307 | $ | 263 | $ | 258 | |||||||||||
| Income tax benefits recognized | $ | 39 | $ | 37 | $ | 45 |
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Share-based expense in fiscal 2020 increased compared to the prior years primarily due to expense related to awards with provisions that became effective in the first quarter of fiscal 2020 that allow partial accelerated vesting in the event of a qualifying retirement.
The cost associated with share-based awards that are subject solely to time-based vesting requirements, less expected forfeitures, is recognized over the awards’ service period for the entire award on a straight-line basis. Share-based awards granted to certain executive officers allow partial accelerated vesting in the event of a qualifying retirement based on age and years of service. The cost associated with performance-based equity awards, which include both performance and market goals, is recognized for each tranche over the service period. The cost of equity awards related to performance goals is based on an assessment of the likelihood that the applicable performance goals will be achieved. For the equity awards based on market goals, the cost is recognized based upon the assumption of 100% achievement of the goal.
At October 25, 2020, Applied had $425 million in total unrecognized compensation expense, net of estimated forfeitures, related to grants of share-based awards and shares issued under Applied’s ESPP, which will be recognized over a weighted average period of 2.4 years. At October 25, 2020, there were 56 million shares available for grants of share-based awards under the Employee Stock Incentive Plan, and an additional 10 million shares available for issuance under the ESPP.
Stock Options
Stock options are rights to purchase, at future dates, shares of Applied common stock. The exercise price of each stock option equals the fair market value of Applied common stock on the date of grant. Options typically vest over three to four years, subject to the grantee’s continued service with Applied through the scheduled vesting date, and expire no later than seven years from the grant date. There were no stock options granted during fiscal 2020, 2019 and 2018. There were no outstanding stock options at the end of fiscal 2020.
Restricted Stock Units, Restricted Stock, Performance Shares and Performance Units
Restricted stock units are converted into shares of Applied common stock upon vesting on a one-for-one basis. Restricted stock has the same rights as other issued and outstanding shares of Applied common stock except these shares generally have no right to dividends and are held in escrow until the award vests. Performance shares and performance units are awards that result in a payment to a grantee, generally in shares of Applied common stock on a one-for-one basis, if performance goals and/or other vesting criteria established by the Human Resources and Compensation Committee of Applied’s Board of Directors are achieved or the awards otherwise vest. Restricted stock units, restricted stock, performance shares and performance units typically vest over three to four years and vesting is usually subject to the grantee’s continued service with Applied and, in some cases, achievement of specified performance goals. The compensation expense related to the service-based awards is determined using the fair market value of Applied common stock on the date of the grant, and the compensation expense is recognized over the vesting period.
During fiscal 2020, 2019 and 2018, certain executive officers were granted awards that are subject to the achievement of specified performance goals (performance-based awards).
Performance-based awards granted in fiscal 2018
Certain awards require the achievement of positive adjusted operating profit and vest ratably over three years. Other awards require the achievement of targeted levels of adjusted operating profit margin and wafer fabrication equipment market share, and the number of shares that may vest in full after three years ranges from 0% to 200% of the target amount.
The fair value of these awards is estimated on the date of grant. If the performance goals are achieved as of the end of the performance period, the awards will vest, provided that the grantee remains employed by Applied through each applicable vesting date. If the performance goals are not achieved, no compensation expense is recognized and any previously recognized compensation expense is reversed. The expected cost is based on the awards that are probable to vest and is reflected over the service period and reduced for estimated forfeitures.
Performance-based awards granted in fiscal 2019 and 2020
Certain awards are subject to the achievement of targeted levels of adjusted operating margin and total shareholder return (TSR) relative to a peer group, comprised of companies in the Standard & Poor's 500 Index. Each metric will be weighted 50% and will be measured over a three-year period. The number of shares that may vest in full after three years ranges from 0% to 200% of the target amount. The awards become eligible to vest only if performance goals are achieved and will vest only if the grantee remains employed by Applied through each applicable vesting date, subject to a qualifying retirement based on age and years of service. The awards provide for a partial payout based on actual performance at the conclusion of the three-year performance period in the event of a qualifying retirement.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The fair value of the portion of the awards subject to targeted levels of adjusted operating margin is estimated on the date of grant. If the performance goals are not achieved as of the end of the performance period, no compensation expense is recognized and any previously recognized compensation expense is reversed. The expected cost is based on the awards that are probable to vest and is reflected over the service period and reduced for estimated forfeitures.
The fair value of the portion of the awards subject to targeted levels of TSR is estimated on the date of grant using a Monte Carlo simulation model. Compensation expense is recognized based upon the assumption of 100% achievement of the TSR goal and will not be reversed even if the threshold level of TSR is never achieved, and is reflected over the service period and reduced for estimated forfeitures.
A summary of the changes in restricted stock units, restricted stock, performance shares and performance units outstanding under Applied’s equity compensation plans is presented below:
| Shares | Weighted Average Grant Date Fair Value | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value | ||||||||||||||||||||
| (In millions, except per share amounts) | |||||||||||||||||||||||
| Non-vested restricted stock units, restricted stock, performance shares and performance units at October 29, 2017 | 22 | $ | 23.96 | 2.2 years | $ | 1,239 | |||||||||||||||||
| Granted | 6 | $ | 50.62 | ||||||||||||||||||||
| Vested | (9) | $ | 22.15 | ||||||||||||||||||||
| Canceled | (1) | $ | 30.19 | ||||||||||||||||||||
| Non-vested restricted stock units, restricted stock, performance shares and performance units at October 28, 2018 | 18 | $ | 32.64 | 2.0 years | $ | 600 | |||||||||||||||||
| Granted | 8 | $ | 36.00 | ||||||||||||||||||||
| Vested | (7) | $ | 28.41 | ||||||||||||||||||||
| Canceled | (1) | $ | 34.59 | ||||||||||||||||||||
| Non-vested restricted stock units, restricted stock, performance shares and performance units at October 27, 2019 | 18 | $ | 35.78 | 2.1 years | $ | 985 | |||||||||||||||||
| Granted | 6 | $ | 53.89 | ||||||||||||||||||||
| Vested | (8) | $ | 31.25 | ||||||||||||||||||||
| Canceled | (1) | $ | 42.61 | ||||||||||||||||||||
| Non-vested restricted stock units, restricted stock, performance shares and performance units at October 25, 2020 | 15 | $ | 45.36 | 2.2 years | $ | 914 | |||||||||||||||||
| Non-vested restricted stock units, restricted stock, performance shares and performance units expected to vest | 14 | $ | 45.51 | 2.1 years | $ | 871 |
At October 25, 2020, 1.2 million additional performance-based awards could be earned based upon achievement of certain levels of specified performance goals.
Employee Stock Purchase Plans
Under the ESPP, substantially all employees may purchase Applied common stock through payroll deductions at a price equal to 85 percent of the lower of the fair market value of Applied common stock at the beginning or end of each 6-month purchase period, subject to certain limits. Applied issued 3 million shares in each of fiscal 2020, 4 million shares in fiscal 2019 and 3 million shares in fiscal 2018, under the ESPP. Compensation expense is calculated using the fair value of the employees’ purchase rights under the Black-Scholes model. Underlying assumptions used in the model are outlined in the following table:
| 2020 | 2019 | 2018 | |||||||||||||||
| ESPP: | |||||||||||||||||
| Dividend yield | 1.41 | % | 1.99 | % | 1.68 | % | |||||||||||
| Expected volatility | 48.2 | % | 35.5 | % | 34.4 | % | |||||||||||
| Risk-free interest rate | 0.58 | % | 2.21 | % | 2.09 | % | |||||||||||
| Expected life (in years) | 0.5 | 0.5 | 0.5 | ||||||||||||||
| Weighted average estimated fair value | $17.30 | $10.61 | $12.02 |
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 14 Employee Benefit Plans
Employee Bonus Plans
Applied has various employee bonus plans. A discretionary bonus plan provides for the distribution of a percentage of pre-tax income to Applied employees who are not participants in other performance-based incentive plans, up to a maximum percentage of eligible compensation. Other plans provide for bonuses to Applied’s executives and other key contributors based on the achievement of profitability and/or other specified performance criteria. Charges under these plans for fiscal 2020, 2019 and 2018 were $471 million, $292 million and $382 million, respectively.
Employee Savings and Retirement Plan
Applied’s Employee Savings and Retirement Plan (the 401(k) Plan) is qualified under Sections 401(a) and (k) of the Internal Revenue Code (the Code). Eligible employees may make salary deferral and catch-up contributions under the 401(k) Plan on a pre-tax basis and on a Roth basis, subject to an annual dollar limit established by the Code. Applied matches 100% of participant salary and/or Roth deferral contributions up to the first 3% of eligible contribution and then 50% of every dollar between 4% and 6% of eligible contribution. Applied does not make matching contributions on any catch-up contributions made by participants. Plan participants who were employed by Applied or any of its affiliates became 100% vested in their Applied matching contribution account balances. Applied’s matching contributions under the 401(k) Plan were approximately $52 million for fiscal 2020, $49 million for fiscal 2019 and $45 million for fiscal 2018.
Defined Benefit Pension Plans of Foreign Subsidiaries and Other Postretirement Benefits
Several of Applied’s foreign subsidiaries have defined benefit pension plans covering substantially all of their eligible employees. Benefits under these plans are typically based on years of service and final average compensation levels. The plans are managed in accordance with applicable local statutes and practices. Applied deposits funds for certain of these plans with insurance companies, pension trustees, government-managed accounts, and/or accrues the expense for the unfunded portion of the benefit obligation on its Consolidated Financial Statements. Applied’s practice is to fund the various pension plans in amounts sufficient to meet the minimum requirements as established by applicable local governmental oversight and taxing authorities. Depending on the design of the plan, local custom and market circumstances, the liabilities of a plan may exceed the qualified plan assets. The differences between the aggregate projected benefit obligations and aggregate plan assets of these plans have been recorded as liabilities by Applied and are included in other liabilities and accrued expenses in the Consolidated Balance Sheets.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
A summary of the changes in benefit obligations and plan assets, which includes post-retirement benefits, for each fiscal year is presented below:
| 2020 | 2019 | 2018 | |||||||||||||||
| (In millions, except percentages) | |||||||||||||||||
| Change in projected benefit obligation | |||||||||||||||||
| Beginning projected benefit obligation | $ | 617 | $ | 524 | $ | 506 | |||||||||||
| Service cost | 13 | 11 | 12 | ||||||||||||||
| Interest cost | 8 | 10 | 11 | ||||||||||||||
| Plan participants’ contributions | 1 | 1 | 1 | ||||||||||||||
| Actuarial loss | 6 | 84 | 24 | ||||||||||||||
| Settlements | — | (1) | (1) | ||||||||||||||
| Foreign currency exchange rate changes | 33 | (5) | (16) | ||||||||||||||
| Benefits paid | (10) | (8) | (12) | ||||||||||||||
| Plan amendments and other adjustments | 6 | 1 | (1) | ||||||||||||||
| Ending projected benefit obligation | $ | 674 | $ | 617 | $ | 524 | |||||||||||
| Ending accumulated benefit obligation | $ | 627 | $ | 578 | $ | 490 | |||||||||||
| Range of assumptions to determine benefit obligations | |||||||||||||||||
| Discount rate | 0.4% - 6.5% | 0.5% - 3.1% | 0.6% - 3.1% | ||||||||||||||
| Rate of compensation increase | 2.3% - 10.0% | 2.3% - 3.6% | 2.4% - 3.5% | ||||||||||||||
| Change in plan assets | |||||||||||||||||
| Beginning fair value of plan assets | $ | 409 | $ | 365 | $ | 361 | |||||||||||
| Return on plan assets | — | 30 | 17 | ||||||||||||||
| Employer contributions | 12 | 27 | 11 | ||||||||||||||
| Plan participants’ contributions | 1 | 1 | 1 | ||||||||||||||
| Foreign currency exchange rate changes | 19 | (5) | (12) | ||||||||||||||
| Settlements | — | (1) | (1) | ||||||||||||||
| Benefits paid | (10) | (8) | (12) | ||||||||||||||
| Ending fair value of plan assets | $ | 431 | $ | 409 | $ | 365 | |||||||||||
| Funded status | $ | (243) | $ | (208) | $ | (159) | |||||||||||
| Amounts recognized in the consolidated balance sheets | |||||||||||||||||
| Noncurrent asset | $ | — | $ | 5 | $ | 19 | |||||||||||
| Current liability | (2) | (1) | (1) | ||||||||||||||
| Noncurrent liability | (241) | (212) | (177) | ||||||||||||||
| Total | $ | (243) | $ | (208) | $ | (159) | |||||||||||
| Estimated amortization from accumulated other comprehensive loss into net periodic benefit cost over the next fiscal period | |||||||||||||||||
| Actuarial loss | $ | 14 | $ | 12 | $ | 8 | |||||||||||
| Prior service credit | — | — | (1) | ||||||||||||||
| Total | $ | 14 | $ | 12 | $ | 7 | |||||||||||
| Amounts recognized in accumulated other comprehensive loss | |||||||||||||||||
| Net actuarial loss | $ | 242 | $ | 226 | $ | 161 | |||||||||||
| Prior service credit | — | — | (2) | ||||||||||||||
| Total | $ | 242 | $ | 226 | $ | 159 | |||||||||||
| Plans with projected benefit obligations in excess of plan assets | |||||||||||||||||
| Projected benefit obligation | $ | 674 | $ | 424 | $ | 365 | |||||||||||
| Fair value of plan assets | $ | 431 | $ | 211 | $ | 186 | |||||||||||
| Plans with accumulated benefit obligations in excess of plan assets | |||||||||||||||||
| Accumulated benefit obligation | $ | 627 | $ | 385 | $ | 331 | |||||||||||
| Fair value of plan assets | $ | 431 | $ | 211 | $ | 186 |
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
| 2020 | 2019 | ||||||||||||||||
| Plan assets — allocation | |||||||||||||||||
| Equity securities | 38 | % | 36 | % | |||||||||||||
| Debt securities | 43 | % | 45 | % | |||||||||||||
| Insurance contracts | 9 | % | 9 | % | |||||||||||||
| Other investments | 10 | % | 10 | % | |||||||||||||
The following table presents a summary of the ending fair value of the plan assets:
| October 25, 2020 | October 27, 2019 | ||||||||||||||||||||||||||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||||||||||||||||||||
| Equity securities | $ | 103 | $ | — | $ | — | $ | 103 | $ | 90 | $ | — | $ | — | $ | 90 | |||||||||||||||||||||||||||||||
| Debt securities | 72 | — | — | 72 | 70 | — | — | 70 | |||||||||||||||||||||||||||||||||||||||
| Insurance contracts | — | — | 39 | 39 | — | — | 36 | 36 | |||||||||||||||||||||||||||||||||||||||
| Other investments | — | 16 | — | 16 | — | 14 | — | 14 | |||||||||||||||||||||||||||||||||||||||
| Cash | 2 | — | — | 2 | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Total assets at fair value | $ | 177 | $ | 16 | $ | 39 | 232 | $ | 160 | $ | 14 | $ | 36 | 210 | |||||||||||||||||||||||||||||||||
| Assets measured at net asset value | 199 | 199 | |||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 431 | $ | 409 |
The following table presents the activity in Level 3 instruments for each fiscal year:
| 2020 | 2019 | ||||||||||||||||
| (In millions) | |||||||||||||||||
| Balance, beginning of year | $ | 36 | $ | 36 | |||||||||||||
| Actual return on plan assets: | |||||||||||||||||
| Relating to assets still held at reporting date | — | (3) | |||||||||||||||
| Purchases, sales, settlements, net | 1 | 4 | |||||||||||||||
| Currency impact | 2 | (1) | |||||||||||||||
| Balance, end of year | $ | 39 | $ | 36 |
Applied’s investment strategy for its defined benefit plans is to invest plan assets in a prudent manner, maintaining well-diversified portfolios with the long-term objective of meeting the obligations of the plans as they come due. Asset allocation decisions are typically made by plan fiduciaries with input from Applied’s international pension committee. Applied’s asset allocation strategy incorporates a sufficient equity exposure in order for the plans to benefit from the expected better long-term performance of equities relative to the plans’ liabilities. Applied retains investment managers, where appropriate, to manage the assets of the plans. Performance of investment managers is monitored by plan fiduciaries with the assistance of local investment consultants. The investment managers make investment decisions within the guidelines set forth by plan fiduciaries. Risk management practices include diversification across asset classes and investment styles, and periodic rebalancing toward target asset allocation ranges. Investment managers may use derivative instruments for efficient portfolio management purposes.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
A summary of the components of net periodic benefit costs and the weighted average assumptions used for net periodic benefit cost calculations for each fiscal year is presented below:
| 2020 | 2019 | 2018 | |||||||||||||||
| (In millions, except percentages) | |||||||||||||||||
| Components of net periodic benefit cost | |||||||||||||||||
| Service cost | $ | 13 | $ | 11 | $ | 12 | |||||||||||
| Interest cost | 8 | 10 | 11 | ||||||||||||||
| Expected return on plan assets | (22) | (20) | (20) | ||||||||||||||
| Amortization of actuarial loss and prior service credit | 12 | 7 | 3 | ||||||||||||||
| Net periodic benefit cost | $ | 11 | $ | 8 | $ | 6 | |||||||||||
| Weighted average assumptions | |||||||||||||||||
| Discount rate | 1.23 | % | 1.98 | % | 2.16 | % | |||||||||||
| Expected long-term return on assets | 5.10 | % | 5.40 | % | 5.41 | % | |||||||||||
| Rate of compensation increase | 2.69 | % | 2.74 | % | 2.66 | % |
Asset return assumptions are derived based on actuarial and statistical methodologies, from analysis of long-term historical data relevant to the country in which each plan is in effect and the investments applicable to the corresponding plan. The discount rate for each plan was derived by reference to appropriate benchmark yields on high quality corporate bonds, allowing for the approximate duration of both plan obligations and the relevant benchmark yields.
Future expected benefit payments for the pension plans and the postretirement plan over the next ten fiscal years are as follows:
| Benefit Payments | |||||
| (In millions) | |||||
| 2021 | $ | 14 | |||
| 2022 | 13 | ||||
| 2023 | 14 | ||||
| 2024 | 14 | ||||
| 2025 | 14 | ||||
| 2026-2030 | 94 | ||||
| $ | 163 |
Company contributions to these plans for fiscal 2021 are expected to be approximately $6 million.
Executive Deferred Compensation Plans
Applied sponsors two unfunded deferred compensation plans, the Executive Deferred Compensation Plan (Predecessor EDCP) and the 2016 Deferred Compensation Plan (2016 DCP) (formerly known as the 2005 Executive Deferred Compensation Plan), under which certain employees may elect to defer a portion of their following year’s eligible earnings. The Predecessor EDCP was frozen as of December 31, 2004 such that no new deferrals could be made under the plan after that date and the plan would qualify for “grandfather” relief under Section 409A of the Code. The Predecessor EDCP participant accounts continue to be maintained under the plan and credited with deemed interest. The 2016 DCP was originally implemented by Applied effective as of January 1, 2005, and amended and restated as of October 12, 2015, and is intended to comply with the requirements of Section 409A of the Code. In addition, Applied also sponsors a non-qualified deferred compensation plan as a result of the acquisition of Varian. Amounts payable for all plans, including accrued deemed interest, totaled $151 million and $123 million at October 25, 2020 and October 27, 2019, respectively, which were included in other liabilities in the Consolidated Balance Sheets.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 15 Income Taxes
The components of income before income taxes for each fiscal year were as follows:
| 2020 | 2019 | 2018 | |||||||||||||||
| (In millions) | |||||||||||||||||
| U.S. | $ | 92 | $ | 363 | $ | 389 | |||||||||||
| Foreign | 4,074 | 2,906 | 4,007 | ||||||||||||||
| $ | 4,166 | $ | 3,269 | $ | 4,396 |
The components of the provision for income taxes for each fiscal year were as follows:
| 2020 | 2019 | 2018 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Current: | |||||||||||||||||
| U.S. | $ | 196 | $ | 240 | $ | 1,021 | |||||||||||
| Foreign | 263 | 260 | 117 | ||||||||||||||
| State | 20 | 12 | 22 | ||||||||||||||
| 479 | 512 | 1,160 | |||||||||||||||
| Deferred: | |||||||||||||||||
| U.S. | (3) | 8 | 151 | ||||||||||||||
| Foreign | 76 | 46 | 57 | ||||||||||||||
| State | (5) | (3) | (10) | ||||||||||||||
| 68 | 51 | 198 | |||||||||||||||
| $ | 547 | $ | 563 | $ | 1,358 |
A reconciliation between the statutory U.S. federal income tax rate and Applied’s actual effective income tax rate for each fiscal year is presented below:
| 2020 | 2019 | 2018 | |||||||||||||||
| Tax provision at U.S. statutory rate | 21.0 | % | 21.0 | % | 23.4 | % | |||||||||||
| Changes in U.S. tax law | — | — | 25.3 | ||||||||||||||
| Effect of foreign operations taxed at various rates | (5.9) | (5.9) | (15.6) | ||||||||||||||
| Changes in prior years’ unrecognized tax benefits | 0.5 | 2.6 | (0.9) | ||||||||||||||
| Resolutions of prior years’ income tax filings | (1.0) | (0.1) | 0.2 | ||||||||||||||
| Research and other tax credits | (1.3) | (1.1) | (0.8) | ||||||||||||||
| Other | (0.2) | 0.7 | (0.7) | ||||||||||||||
| 13.1 | % | 17.2 | % | 30.9 | % |
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.
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.
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 MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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 provisions 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.
In the reconciliation between the statutory U.S. federal income tax rate and the effective income tax rate, the effect of foreign operations taxed at various rates represents the difference between an income tax provision at the U.S. federal statutory income tax rate and the recorded income tax provision, with the difference expressed as a percentage of worldwide income before income taxes. This effect is substantially related to the tax effect of pre-tax income in jurisdictions with lower statutory tax rates. The foreign operations with the most significant effective tax rate impact are in Singapore. The statutory tax rate for fiscal 2018 for Singapore is 17%. Applied has been granted conditional reduced tax rates that expire in fiscal 2025, excluding potential renewal and subject to certain conditions with which Applied expects to comply. The tax benefit arising from these tax rates was $215 million for fiscal 2020 or $0.23 per diluted share.
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 carryovers. 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. The components of deferred income tax assets and liabilities were as follows:
| October 25, 2020 | October 27, 2019 | ||||||||||
| (In millions) | |||||||||||
| Deferred tax assets: | |||||||||||
| Allowance for doubtful accounts | $ | 4 | $ | 8 | |||||||
| Inventory reserves and basis difference | 119 | 117 | |||||||||
| Installation and warranty reserves | 14 | 11 | |||||||||
| Intangible assets | 1,355 | 1,472 | |||||||||
| Accrued liabilities | 24 | 15 | |||||||||
| Deferred revenue | 32 | 36 | |||||||||
| Tax credits | 326 | 264 | |||||||||
| Deferred compensation | 130 | 98 | |||||||||
| Share-based compensation | 30 | 36 | |||||||||
| Lease liability | 55 | — | |||||||||
| Other | 96 | 58 | |||||||||
| Gross deferred tax assets | 2,185 | 2,115 | |||||||||
| Valuation allowance | (314) | (257) | |||||||||
| Total deferred tax assets | 1,871 | 1,858 | |||||||||
| Deferred tax liabilities: | |||||||||||
| Fixed assets | (76) | (65) | |||||||||
| Right of use assets | (54) | — | |||||||||
| Undistributed foreign earnings | (39) | (38) | |||||||||
| Total deferred tax liabilities | (169) | (103) | |||||||||
| Net deferred tax assets | $ | 1,702 | $ | 1,755 |
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
A valuation allowance is recorded to reflect the estimated amount of net deferred tax assets that may not be realized. Changes in the valuation allowance in each fiscal year were as follows:
| 2020 | 2019 | 2018 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Beginning balance | $ | 257 | $ | 230 | $ | 227 | |||||||||||
| Increases | 57 | 27 | 8 | ||||||||||||||
| Decreases | — | — | (5) | ||||||||||||||
| Ending balance | $ | 314 | $ | 257 | $ | 230 |
At October 25, 2020, Applied has state research and development tax credit carryforwards of $327 million, including $309 million of credits that are carried over until exhausted and $15 million that are carried over for 15 years and begin to expire in fiscal 2031. It is more likely than not that all tax credit carryforwards, net of valuation allowance, will be utilized.
Applied maintains liabilities for uncertain tax positions. These liabilities involve considerable judgment and estimation and are continuously monitored based on the best information available. Gross unrecognized tax benefits are classified as non-current income taxes payable or as a reduction in deferred tax assets. A reconciliation of the beginning and ending balances of gross unrecognized tax benefits in each fiscal year is as follows:
| 2020 | 2019 | 2018 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Beginning balance of gross unrecognized tax benefits | $ | 845 | $ | 374 | $ | 391 | |||||||||||
| Settlements with tax authorities | (446) | (1) | (152) | ||||||||||||||
| Lapses of statutes of limitation | (3) | (2) | (37) | ||||||||||||||
| Increases in tax positions for current year | 44 | 33 | 91 | ||||||||||||||
| Increases in tax positions for prior years | 91 | 441 | 83 | ||||||||||||||
| Decreases in tax positions for prior years | (35) | — | (2) | ||||||||||||||
| Ending balance of gross unrecognized tax benefits | $ | 496 | $ | 845 | $ | 374 |
The increases in tax positions for prior years of $441 million for fiscal 2019 include the effect of adoption of Accounting Standard Update 2016-16 Income Tax (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. Tax expense for interest and penalties on unrecognized tax benefits for fiscal 2020, 2019 and 2018 was $24 million, $24 million and $12 million, respectively. The income tax liability for interest and penalties for fiscal 2020, 2019 and 2018 was $74 million, $50 million and $26 million, respectively, and was classified as non-current income taxes payable.
Included in the balance of unrecognized tax benefits for fiscal 2020, 2019 and 2018 are $410 million, $758 million, and $294 million, respectively, of tax benefits that, if recognized, would affect the effective tax rate.
In fiscal 2020, Applied settled tax audits in Singapore related to fiscal 2012 through fiscal 2019 for additional tax payments of $72 million and a reduction of future tax deductions of $374 million. The tax expense impact of these settlements was $26 million. In fiscal 2019, Applied paid an immaterial amount as a result of settlements with tax authorities. In fiscal 2018, Applied paid $158 million, including interest and penalties, as a result of a settlement in Israel for fiscal 2011 through fiscal 2015 resulting in the recognition of a tax expense of $6 million.
Applied’s tax returns remain subject to examination by taxing authorities. These include U.S. returns for fiscal 2015 and later years, and foreign tax returns for fiscal 2010 and later years.
The timing of the resolution of income tax examinations, as well as the amounts and timing of various tax payments that may be part of the settlement process, is highly uncertain. This could cause fluctuations in Applied’s financial condition and results of operations. Applied continues to have ongoing negotiations with various taxing authorities throughout the year.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 16 Warranty, Guarantees, Commitments and Contingencies
Warranty
Changes in the warranty reserves during each fiscal year were as follows:
| 2020 | 2019 | 2018 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Beginning balance | $ | 196 | $ | 208 | $ | 206 | |||||||||||
| Provisions for warranty | 165 | 148 | 175 | ||||||||||||||
| Changes in reserves related to preexisting warranty | 2 | 7 | 3 | ||||||||||||||
| Consumption of reserves | (162) | (167) | (176) | ||||||||||||||
| Ending balance | $ | 201 | $ | 196 | $ | 208 |
Applied products are generally sold with a warranty for a 12-month period following installation. The provision for the estimated cost of warranty is recorded when revenue is recognized. Parts and labor are covered under the terms of the warranty agreement. The warranty provision is based on historical experience by product, configuration and geographic region. Quarterly warranty consumption is generally associated with sales that occurred during the preceding four quarters, and quarterly warranty provisions are generally related to the current quarter’s sales.
Guarantees
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 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.
Legal Matters
From time to time, Applied receives notification from third parties, including customers and suppliers, seeking indemnification, litigation support, payment of money or other actions by Applied in connection with claims made against them. In addition, from time to time, Applied receives notification from third parties claiming that Applied may be or is infringing or misusing their intellectual property or other rights. Applied also is subject to various other legal proceedings and claims, both asserted and unasserted, that arise in the ordinary course of business.
Although the outcome of the above-described matters, claims and proceedings cannot be predicted with certainty, Applied does not believe that any will have a material effect on its consolidated financial condition or results of operations.
Note 17 Industry Segment Operations
Applied’s three reportable segments are: Semiconductor Systems, Applied Global Services, and Display and Adjacent Markets. As defined under the accounting literature, Applied’s chief operating decision-maker has been identified as the President and Chief Executive Officer, who reviews operating results to make decisions about allocating resources and assessing performance for the entire Company. Segment information is presented based upon Applied’s management organization structure as of October 25, 2020 and the distinctive nature of each segment. Future changes to this internal financial structure may result in changes to Applied’s reportable segments.
The Semiconductor Systems reportable segment includes semiconductor capital equipment for etch, rapid thermal processing, deposition, chemical mechanical planarization, metrology and inspection, wafer packaging, and ion implantation.
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 other products.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The Display and Adjacent Markets segment includes products for manufacturing liquid crystal displays (LCDs), organic light-emitting diodes (OLEDs), equipment upgrades and flexible coating systems and other display technologies for TVs, monitors, laptops, personal computers, smart phones, and other consumer-oriented devices.
Each operating segment is separately managed and has separate financial results that are reviewed by Applied’s chief operating decision-maker. Each reportable segment contains closely related products that are unique to the particular segment. Segment operating income is determined based upon internal performance measures used by Applied’s chief operating decision-maker. The chief operating decision-maker does not evaluate operating segments using total asset information.
Applied derives the segment results directly from its internal management reporting system. The accounting policies Applied uses to derive reportable segment results are substantially the same as those used for external reporting purposes. Management measures the performance of each reportable segment based upon several metrics including orders, net sales and operating income. Management uses these results to evaluate the performance of, and to assign resources to, each of the reportable segments.
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 related to share-based compensation; certain management, finance, legal, human resources, and research, development and engineering 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. Segment operating income also excludes interest income/expense and other financial charges and income taxes. Management does not consider the unallocated costs in measuring the performance of the reportable segments.
Information for each reportable segment for and as of the end of each fiscal year were as follows:
| Net Sales | Operating Income (Loss) | Depreciation/ Amortization | Capital Expenditures | Accounts Receivable | Inventories | ||||||||||||||||||||||||||||||||||||||||||
| (In millions) | |||||||||||||||||||||||||||||||||||||||||||||||
| 2020: | |||||||||||||||||||||||||||||||||||||||||||||||
| Semiconductor Systems | $ | 11,367 | $ | 3,714 | $ | 219 | $ | 226 | $ | 2,061 | $ | 2,139 | |||||||||||||||||||||||||||||||||||
| Applied Global Services | 4,155 | 1,127 | 34 | 30 | 764 | 1,545 | |||||||||||||||||||||||||||||||||||||||||
| Display and Adjacent Markets | 1,607 | 291 | 31 | 29 | 179 | 195 | |||||||||||||||||||||||||||||||||||||||||
| Corporate and Other | 73 | (767) | 92 | 137 | (41) | 25 | |||||||||||||||||||||||||||||||||||||||||
| Total | $ | 17,202 | $ | 4,365 | $ | 376 | $ | 422 | $ | 2,963 | $ | 3,904 | |||||||||||||||||||||||||||||||||||
| 2019: | |||||||||||||||||||||||||||||||||||||||||||||||
| Semiconductor Systems | $ | 9,027 | $ | 2,464 | $ | 202 | $ | 168 | $ | 1,543 | $ | 1,703 | |||||||||||||||||||||||||||||||||||
| Applied Global Services | 3,854 | 1,101 | 25 | 47 | 790 | 1,535 | |||||||||||||||||||||||||||||||||||||||||
| Display and Adjacent Markets | 1,651 | 294 | 22 | 43 | 246 | 214 | |||||||||||||||||||||||||||||||||||||||||
| Corporate and Other | 76 | (509) | 114 | 183 | (46) | 22 | |||||||||||||||||||||||||||||||||||||||||
| Total | $ | 14,608 | $ | 3,350 | $ | 363 | $ | 441 | $ | 2,533 | $ | 3,474 | |||||||||||||||||||||||||||||||||||
| 2018: | |||||||||||||||||||||||||||||||||||||||||||||||
| Semiconductor Systems | $ | 10,577 | $ | 3,441 | $ | 303 | $ | 168 | $ | 1,597 | $ | 2,215 | |||||||||||||||||||||||||||||||||||
| Applied Global Services | 3,754 | 1,102 | 21 | 33 | 630 | 1,243 | |||||||||||||||||||||||||||||||||||||||||
| Display and Adjacent Markets | 2,298 | 574 | 20 | 39 | 142 | 246 | |||||||||||||||||||||||||||||||||||||||||
| Corporate and Other | 76 | (626) | 113 | 382 | (46) | 17 | |||||||||||||||||||||||||||||||||||||||||
| Total | $ | 16,705 | $ | 4,491 | $ | 457 | $ | 622 | $ | 2,323 | $ | 3,721 |
Semiconductor Systems and Display and Adjacent Markets revenues are recognized at a point in time. Applied Global Services revenue is recognized at a point in time for tangible goods such as spare parts and equipment, and over time for service agreements. The majority of revenue recognized over time is recognized within 12 months of the contract inception.
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
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 | % |
The reconciling items included in Corporate and Other were as follows:
| 2020 | 2019 | 2018 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Unallocated net sales | $ | 73 | $ | 76 | $ | 76 | |||||||||||
| Unallocated cost of products sold and expenses | (533) | (322) | (444) | ||||||||||||||
| Share-based compensation | (307) | (263) | (258) | ||||||||||||||
| Total | $ | (767) | $ | (509) | $ | (626) |
For geographical reporting, revenue by geographic location is determined by the location of customers’ facilities to which products were shipped. Long-lived assets consist primarily of property, plant and equipment and are attributed to the geographic location in which they are located. Net sales and long-lived assets by geographic region for and as of each fiscal year were as follows:
| 2020 | 2019 | 2018 | |||||||||||||||
| (In millions) | |||||||||||||||||
| Net sales: | |||||||||||||||||
| United States | $ | 1,619 | $ | 1,871 | $ | 1,413 | |||||||||||
| China | 5,456 | 4,277 | 5,047 | ||||||||||||||
| Korea | 3,031 | 1,929 | 3,539 | ||||||||||||||
| Taiwan | 3,953 | 2,965 | 2,504 | ||||||||||||||
| Japan | 1,996 | 2,198 | 2,396 | ||||||||||||||
| Europe | 736 | 820 | 1,009 | ||||||||||||||
| Southeast Asia | 411 | 548 | 797 | ||||||||||||||
| Total outside United States | 15,583 | 12,737 | 15,292 | ||||||||||||||
| Consolidated total | $ | 17,202 | $ | 14,608 | $ | 16,705 |
| October 25, 2020 | October 27, 2019 | ||||||||||||||||
| (In millions) | |||||||||||||||||
| Long-lived assets: | |||||||||||||||||
| United States | $ | 1,628 | $ | 1,539 | |||||||||||||
| China | 14 | 20 | |||||||||||||||
| Korea | 21 | 24 | |||||||||||||||
| Taiwan | 59 | 56 | |||||||||||||||
| Japan | 16 | 16 | |||||||||||||||
| Europe | 21 | 28 | |||||||||||||||
| Southeast Asia | 18 | 23 | |||||||||||||||
| Total outside United States | 149 | 167 | |||||||||||||||
| Consolidated total | $ | 1,777 | $ | 1,706 |
APPLIED MATERIALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following customers accounted for at least 10 percent of Applied’s net sales in each fiscal year, which were for products and services in multiple reportable segments:
| 2020 | 2019 | 2018 | |||||||||||||||
| Samsung Electronics Co., Ltd. | 18 | % | * | 13 | % | ||||||||||||
| Taiwan Semiconductor Manufacturing Company Limited | 18 | % | 14 | % | * | ||||||||||||
| Intel Corporation | * | 12 | % | 11 | % | ||||||||||||
- Less than 10%
Note 18 Unaudited Quarterly Consolidated Financial Data
| Fiscal Quarter | |||||||||||||||||||||||||||||
| First | Second | Third | Fourth | Fiscal Year | |||||||||||||||||||||||||
| (In millions, except per share amounts) | |||||||||||||||||||||||||||||
| 2020: | |||||||||||||||||||||||||||||
| Net sales | $ | 4,162 | $ | 3,957 | $ | 4,395 | $ | 4,688 | $ | 17,202 | |||||||||||||||||||
| Gross profit | $ | 1,858 | $ | 1,749 | $ | 1,955 | $ | 2,130 | $ | 7,692 | |||||||||||||||||||
| Net income | $ | 892 | $ | 755 | $ | 841 | $ | 1,131 | $ | 3,619 | |||||||||||||||||||
| Earnings per diluted share | $ | 0.96 | $ | 0.82 | $ | 0.91 | $ | 1.23 | $ | 3.92 | |||||||||||||||||||
| 2019: | |||||||||||||||||||||||||||||
| Net sales | $ | 3,753 | $ | 3,539 | $ | 3,562 | $ | 3,754 | $ | 14,608 | |||||||||||||||||||
| Gross profit | $ | 1,665 | $ | 1,530 | $ | 1,557 | $ | 1,634 | $ | 6,386 | |||||||||||||||||||
| Net income | $ | 771 | $ | 666 | $ | 571 | $ | 698 | $ | 2,706 | |||||||||||||||||||
| Earnings per diluted share | $ | 0.80 | $ | 0.70 | $ | 0.61 | $ | 0.75 | $ | 2.86 |
INDEX TO EXHIBITS
These Exhibits are numbered in accordance with the Exhibit Table of Item 601 of Regulation S-K:
| Incorporated by Reference | |||||||||||||||||
| Exhibit No. | Description | Form | File No. | Exhibit No. | Filing Date | ||||||||||||
| 31.2 | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002† | ||||||||||||||||
| 32.1 | Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002‡ | ||||||||||||||||
| 32.2 | Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002‡ | ||||||||||||||||
| 101.INS | XBRL Instance Document‡ | ||||||||||||||||
| 101.SCH | XBRL Taxonomy Extension Schema Document‡ | ||||||||||||||||
| 101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document‡ | ||||||||||||||||
| 101.DEF | XBRL Taxonomy Extension Definition Linkbase Document‡ | ||||||||||||||||
| 101.LAB | XBRL Taxonomy Extension Label Linkbase Document‡ | ||||||||||||||||
| 101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document‡ | ||||||||||||||||
| 104 | Cover Page Interactive Data File (formatted as inline XBRL) |
| * | Indicates a management contract or compensatory plan or arrangement, as required by Item 15(a)(3). | ||||
| † | Filed herewith. | ||||
| ‡ | Furnished herewith. |
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| APPLIED MATERIALS, INC. | |||||
| By: | /S/ GARY E. DICKERSON | ||||
| Gary E. Dickerson | |||||
| President, Chief Executive Officer |
Dated: December 11, 2020
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Gary E. Dickerson, Daniel J. Durn and Teri Little, jointly and severally, his or her attorneys-in-fact, each with the power of substitution, for him or her in any and all capacities, to sign any amendments to this Annual Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| Title | Date | |||||||
| /S/ GARY E. DICKERSON | President, Chief Executive Officer and Director (Principal Executive Officer) | December 11, 2020 | ||||||
| Gary E. Dickerson | ||||||||
| /S/ DANIEL J. DURN | Senior Vice President, Chief Financial Officer (Principal Financial Officer) | December 11, 2020 | ||||||
| Daniel J. Durn | ||||||||
| /S/ CHARLES W. READ | Corporate Vice President, Corporate Controller and Chief Accounting Officer (Principal Accounting Officer) | December 11, 2020 | ||||||
| Charles W. Read | ||||||||
| /S/ THOMAS J. IANNOTTI | ||||||||
| Thomas J. Iannotti | Chairman of the Board | December 11, 2020 | ||||||
| /S/ JUDY BRUNER | ||||||||
| Judy Bruner | Director | December 11, 2020 | ||||||
| /S/ XUN CHEN | ||||||||
| Xun Chen | Director | December 11, 2020 | ||||||
| /S/ AART J. DE GEUS | ||||||||
| Aart J. de Geus | Director | December 11, 2020 | ||||||
| /S/ STEPHEN R. FORREST | ||||||||
| Stephen R. Forrest | Director | December 11, 2020 | ||||||
| /S/ ALEXANDER A. KARSNER | ||||||||
| Alexander A. Karsner | Director | December 11, 2020 | ||||||
| /S/ ADRIANNA C. MA | ||||||||
| Adrianna C. Ma | Director | December 11, 2020 | ||||||
| /s/ YVONNE MCGILL | ||||||||
| Yvonne McGill | Director | December 11, 2020 | ||||||
| /s/ SCOTT A. MCGREGOR | ||||||||
| Scott A. McGregor | Director | December 11, 2020 |
Previous: Item 15. Exhibits, Financial Statement Schedules