Basis of Presentation

In the opinion of management, the unaudited interim consolidated condensed financial statements of Applied Materials, Inc. and its subsidiaries (Applied or the Company) included herein have been prepared on a basis consistent with the October 28, 2018 audited consolidated financial statements and include all material adjustments, consisting of normal recurring adjustments, necessary to fairly present the information set forth therein. These unaudited interim consolidated condensed financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in Applied’s Annual Report on Form 10-K for the fiscal year ended October 28, 2018 (2018 Form 10-K). Applied’s results of operations for the three months ended January 27, 2019 are not necessarily indicative of future operating results. Applied’s fiscal year ends on the last Sunday in October of each year. Fiscal 2019 and 2018 each contain 52 weeks, and the first three months of fiscal 2019 and 2018 each contained 13 weeks.

At the beginning of the first quarter of fiscal 2019, Applied adopted the new revenue recognition standard using the full retrospective method. All financial statements and disclosures have been recast to comply with this new guidance. See "Recent Accounting Pronouncements - Accounting Standards Adopted" section below for further information.

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.

Changes to Significant Accounting Policies

Applied adopted various amended guidance during the first quarter of fiscal 2019. The following accounting policies have been updated as part of the adoption of the new standards.

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 Condensed Statement of Operations.

Sales and Value Added Taxes

Taxes collected from customers and remitted to governmental authorities are presented on a net basis in the accompanying Consolidated Condensed Statements of Operations.

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.

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 we provide 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 as customers receive the benefits of services.

The incremental costs to obtain a contract are not material.

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.

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 accompanying Consolidated Condensed 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 accompanying Consolidated Condensed Statements of Operations.

Recent Accounting Pronouncements

Accounting Standards Adopted

Retirement Benefits. In March 2017, the FASB issued authoritative guidance which requires companies to present the service cost component of net benefit cost in the same line items in which they report compensation cost. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. Applied adopted this guidance in the first quarter of fiscal 2019 on a retrospective basis. The adoption of this guidance resulted in reclassification of other components of net benefit costs outside of income from operations and did not have a significant impact on Applied’s consolidated financial statements.

Business Combinations. In January 2017, the FASB issued authoritative guidance that clarifies the definition of a business to help companies evaluate whether acquisition or disposal transactions should be accounted for as asset groups or as businesses. Applied adopted this guidance in the first quarter of fiscal 2019 on a prospective basis. The impact of the adoption depends on the facts and circumstances of future acquisition or disposal transactions.

Income Taxes: Intra-Entity Asset Transfers. In October 2016, the FASB issued authoritative guidance that changed the tax accounting for intra-entity transfers of assets other than inventory. After adoption, the income tax effect of intra-entity transfers is realized at the time of the transfer instead of over the life of the asset. Applied adopted this guidance in the first quarter of fiscal 2019 using a modified retrospective approach, resulting in a cumulative effect adjustment to retained earnings. Upon adoption, deferred tax assets increased by $1.6 billion related to the estimated income tax effects of future amortization of intra-entity intangible asset transfers, with an offset to retained earnings.

Classification of Certain Cash Receipts and Cash Payments. In August 2016, the FASB issued authoritative guidance which addresses classification of certain cash receipts and cash payments related to the statement of cash flows. Effective in the first quarter of fiscal 2019, Applied adopted the authoritative guidance retrospectively. The adoption of this guidance did not have a significant impact and only impacts disclosures in Applied' s consolidated condensed statements of cash flow.

Financial Instruments: Classification and Measurement. In January 2016, the FASB issued authoritative guidance that requires equity investments that do not result in consolidation, and are not accounted for under the equity method, to be measured at fair value, and requires recognition of any changes in fair value in net income unless the investments qualify for a new measurement alternative. For financial liabilities measured at fair value, the change in fair value caused by a change in instrument-specific credit risk will be required to be presented separately in other comprehensive income. Applied adopted this standard in the first quarter of fiscal year 2019. Upon adoption, Applied elected to apply the measurement alternative for equity investments without readily determinable fair value. Under the alternative, Applied measures investments without readily determinable fair value at cost, less impairment, adjusted by observable price changes prospectively to all equity investments that exist as of adoption and will reassess at each reporting period whether an investment qualifies for the alternative. Adopting this standard required Applied to record a cumulative net increase to retained earnings of approximately $21 million with the corresponding $17 million decrease in accumulated other comprehensive income, net of tax, for the unrealized gains and losses associated with equity investments with readily determinable fair values, as the authoritative guidance is required to be adopted prospectively. Going forward, the impact of this new standard could result in volatility in Applied's consolidated statement of operations.

Revenue Recognition. In May 2014, the FASB issued authoritative guidance that requires revenue recognition to depict the transfer of promised goods or services to a customer in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services and requires certain additional disclosures. Applied adopted this authoritative guidance in the first quarter of fiscal 2019 using the full retrospective method, which required restating each prior reporting period presented. Refer to the Impacts to Previously Reported Results section below for the impact of the adoption of the standard to Applied’s consolidated financial statements.

For all periods prior to the date of initial adoption of this standard, Applied elected to use the practical expedient pursuant to which Applied excluded disclosures of both transaction prices allocated to remaining performance obligations and when these performance obligations are expected to be recognized as revenue.

The most significant impact from the adoption of this standard is fewer constraints on revenue recognition upon shipment of manufacturing equipment.

Impacts to Previously Reported Results

Adoption of the standards related to revenue recognition and retirement benefits impacted Applied’s Consolidated Condensed Statement of Operations for the first quarter of fiscal 2018 as follows:



	Three Months Ended
	January 28, 2018
	As Previously Reported		Revenue Recognition Adjustment			Retirement Benefit Adjustment			As Adjusted
	(In millions, except per share amounts)

Net sales	$	4,204	$	1		$	—		$	4,205
Cost of products sold	$	2,284	$	(20	)	$	1		$	2,265
Gross profit	$	1,920	$	21		$	(1	)	$	1,940
Research, development and engineering	$	488	$	—		$	1		$	489
Interest and other income, net	$	25	$	—		$	2		$	27
Income before income taxes	$	1,162	$	21		$	(2	)	$	1,183
Provision for income taxes	$	1,027	$	(9	)	$	—		$	1,018
Net income	$	135	$	30		$	—		$	165
Earnings per share: basic	$	0.13	$	0.03		$	—		$	0.16
Earnings per share: diluted	$	0.13	$	0.02		$	—		$	0.15

Adoption of the retirement benefits standard did not have any impact on Applied’s Consolidated Balance Sheet or Consolidated Condensed Statement of Cash Flows.

Adoption of the standard related to revenue recognition impacted Applied’s Consolidated Balance Sheet at October 28, 2018 as follows:



	October 28, 2018
	As Previously Reported		Adjustment			As Adjusted
	(In millions)

Accounts receivable, net	$	2,565	$	(242	)	$	2,323
Inventories	$	3,722	$	(1	)	$	3,721
Other current assets	$	430	$	100		$	530
Deferred income taxes and other assets	$	470	$	3		$	473
Customer deposits and deferred revenue	$	1,347	$	(1,347	)	$	—
Contract liabilities	$	—	$	1,201		$	1,201
Retained earnings	$	20,874	$	6		$	20,880

Adoption of the revenue recognition standard did not impact cash provided by or used in investing or financing activities in Applied’s consolidated Condensed Statement of Cash Flows for the first quarter of fiscal 2018. The adoption did not impact total cash provided by operating activities, however it impacted individual components of cash provided by operating activities for the first quarter of fiscal 2018 as follows:



	Three Months Ended
	January 28, 2018
	As Previously Reported			Adjustment			As Adjusted
	(In millions)

Cash flows from operating activities:
Net income	$	135		$	30		$	165
Adjustments required to reconcile net income to cash provided by operating activities:
Deferred income taxes	$	41		$	(9	)	$	32
Changes in operating assets and liabilities:
Inventories	$	(195	)	$	(16	)	$	(211	)
Accounts payable and accrued expenses	$	(125	)	$	(2	)	$	(127	)
Contract liabilities	$	353		$	(3	)	$	350

Accounting Standards Not Yet Adopted

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. Applied is currently evaluating the effect of this new guidance on Applied’s consolidated financial statements.

Fair Value Measurement: Changes to the Disclosure Requirements for Fair Value Measurement. In August 2018, the FASB issued authoritative guidance that eliminates, amends, and adds disclosure requirements for fair value measurements. While the amended and new disclosure requirements primarily relate to Level 3 fair value measurements, the authoritative guidance also eliminates disclosure requirements related to the amount and reasons for transfer between Level 1 and Level 2 of fair value hierarchy, policy for timing of transfer between levels, and the valuation processes for Level 3 fair value measurements. The authoritative guidance will be effective for Applied in the first quarter of fiscal 2020. Early adoption is permitted only for the removal and amendment of certain disclosures, while the new disclosures requirements are to be applied prospectively. Applied is currently evaluating the effect of this new guidance on Applied’s consolidated financial statements.

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. The authoritative guidance will be effective for Applied in the first quarter of fiscal 2020, with early adoption permitted. Applied is currently evaluating the effect of this new guidance on Applied’s consolidated financial statements.

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. This authoritative guidance will be effective for Applied in the first quarter of fiscal 2020 on a modified retrospective basis, with early adoption permitted. Applied is currently evaluating the impact of adopting this new accounting guidance on Applied’s consolidated financial statements.

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. Early adoption is permitted. 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. Early adoption is permitted beginning in the first quarter of fiscal 2020. Applied is currently evaluating the effect of this new guidance on Applied’s consolidated financial statements.

Leases. In February 2016, the 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. The authoritative guidance will be effective for Applied in the first quarter of fiscal 2020 and should be applied using a modified retrospective approach. Early adoption is permitted. Applied is currently evaluating the effect of this new guidance on Applied’s consolidated financial statements.