Description
Applied Materials, Inc. Director GERHARD H PARKER bought 50,000 shares on 8-30-2012 at $ 11.53
BUSINESS OVERVIEW
Incorporated in 1967, Applied, a Delaware corporation, provides manufacturing equipment, services and software to the global semiconductor, flat panel display, solar photovoltaic (PV) and related industries. Applied’s customers include manufacturers of semiconductor wafers and chips, flat panel liquid crystal displays (LCDs), solar PV cells and modules, and other electronic devices. These customers may use what they manufacture in their own end products or sell the items to other companies for use in advanced electronic components. The Company’s fiscal year ends on the last Sunday in October.
Applied is the world’s largest semiconductor fabrication equipment supplier based on revenue, with the capability to provide global deployment and support services. Applied also is the leading supplier of LCD fabrication equipment to the flat panel display industry, and the leading supplier of solar PV manufacturing systems to the solar industry, based on revenue.
Applied operates in four reportable segments: Silicon Systems Group, Applied Global Services, Display, and Energy and Environmental Solutions. Applied manages its business based upon these segments. A summary of financial information for each reportable segment is found in Note 16 of Notes to Consolidated Financial Statements. A discussion of factors that could affect Applied’s operations is set forth under “Risk Factors” in Item 1A, which is incorporated herein by reference.
Silicon Systems Group Segment
Applied’s Silicon Systems Group segment develops, manufactures and sells a wide range of manufacturing equipment used to fabricate semiconductor chips, also referred to as integrated circuits (ICs). Most chips are built on a silicon wafer base and include a variety of circuit components, such as transistors and other devices, that are connected by multiple layers of wiring (interconnects). Applied offers systems that perform most of the primary processes used in chip fabrication, including atomic layer deposition (ALD), chemical vapor deposition (CVD), physical vapor deposition (PVD), electrochemical deposition (ECD), rapid thermal processing (RTP), chemical mechanical planarization (CMP), wet cleaning, and wafer metrology and inspection, as well as systems that etch or inspect circuit patterns on masks used in the photolithography process. Applied’s semiconductor manufacturing systems are used by integrated device manufacturers and foundries to build and package memory, logic and other types of chips.
Most chips currently are fabricated using 45 nanometer (nm) and larger linewidth dimensions, although Applied is also working with customers on leading-edge technology for advanced nodes using 32nm, 22nm and smaller dimensions. To build a chip, the transistors, capacitors and other circuit components are first created on the surface of the wafer by performing a series of processes to deposit and selectively remove portions of successive film layers. Similar processes are then used to build the layers of wiring structures on the wafer. As the density of the circuit components increases to enable greater computing capability in the same or smaller physical area, the complexity of building the chip also increases, necessitating more process steps to form smaller structures and more intricate wiring schemes. A typical, simplified process sequence for building the wiring or interconnect portion of a chip involves initially depositing a dielectric film layer onto the base layer of circuit components using a CVD system. An etch system is then used to create openings and patterns in the dielectric layer. To form the metal interconnects, these openings and patterns are filled with conducting material using PVD and ECD technologies. A CMP step then polishes the wafer to achieve a flat surface. Additional deposition, etch and CMP steps are then performed to build up the layers needed to complete the interconnection of the circuit elements. Advanced chip designs require more than 500 steps involving these and other processes to complete the manufacturing cycle.
While some device manufacturers are still using aluminum as the main conducting material for building interconnect structures, most have transitioned to copper. Copper has lower resistance than aluminum and can carry more current in a smaller area. Applied is the leading supplier of systems for manufacturing copper-based chips, including equipment for depositing, etching and planarizing copper interconnect layers. Complementing the transition to copper to improve chip speed is the use of low dielectric constant (low k) films to replace silicon dioxide material as the insulator between the copper wiring structures. Applied also leads the industry in providing systems for depositing low k dielectric films.
The transistor is another key area of the chip where semiconductor manufacturers are improving their device designs to enhance performance. Applied has the industry’s largest portfolio of technically advanced products for building smaller and faster transistors. One method of enhancing chip performance is strain engineering, a technique that stretches or compresses the space between atoms, allowing electrical current to flow more quickly. Multiple strain films are typically used in advanced devices since they have an additive effect on increasing transistor speed. Applied has a comprehensive portfolio of systems to enable these applications using CVD and epitaxial deposition technologies.
Major chipmakers are integrating new high dielectric constant (high-k) and metal materials and processes in their transistor gate structures to increase chip performance and reduce power consumption. Applied has a comprehensive portfolio of fully characterized processes for building these high-k/metal gates. These solutions include an integrated dielectric gate stack tool that combines four critical processes in a single system, a portfolio of metallization technologies using ALD and PVD, and an innovative high temperature etch system.
A new type of chip packaging is also emerging, known as three-dimensional (3D) ICs, as new consumer products demand higher performance in a smaller space. Providing greater functionality in a smaller footprint, 3D-ICs stack multiple chips together and electrically connect them using deep holes, called through-silicon via (TSV) structures. Applied has the industry’s most comprehensive line of production-proven systems and processes required for the majority of advanced packaging manufacturing steps, including etch, CVD, PVD, ECD, wafer cleaning and CMP systems. To facilitate the adoption of packaging technology, Applied is working with consortiums and other equipment suppliers to lower customers’ implementation costs.
Some chip manufacturers have announced that they will be employing the new 3D manufacturing methods to enhance chip performance. One method is based on new 3D transistor designs that replace the traditional two-dimensional gate with a thin 3D gate. This new structure, targeted for the 22nm technology node and below, improves the performance and energy efficiency of the chip. In 2011, the Company introduced the Applied Centura Conforma ™ system, which uses conformal plasma doping technology to modify the electrical properties of 3D and planar transistor structures.
Most of Applied’s semiconductor equipment products are single-wafer systems with multiple process chambers attached to a base platform. This enables each wafer to be processed separately in its own environment, allowing precise process control, while the system’s multiple chambers enable simultaneous, high productivity manufacturing. Applied sells most of its single-wafer, multi-chamber systems on five basic platforms: the Centura ® , Endura ® , Producer ® , Raider ® and Vantage ® platforms. These platforms support ALD, CVD, PVD, ECD, etch and RTP technologies.
Over time, the semiconductor industry has migrated to increasingly larger wafers to build chips. The predominant or common wafer size used today for volume production of advanced chips is 300 millimeter (mm), or 12-inch, wafers. Applied offers a comprehensive range of 300mm systems through its Silicon Systems Group segment. Applied also offers earlier-generation 200mm systems, as well as products and services to support all of its systems, which are reported under its Applied Global Services segment.
The following summarizes Applied’s portfolio of products and their associated process technology areas reported under its Silicon Systems Group segment.
Deposition
Deposition is a fundamental step in fabricating a chip. During deposition, layers of dielectric (an insulator), barrier, or electrically conductive (typically metal) films are deposited or grown on a wafer. Applied currently provides equipment to perform four types of deposition: ALD, CVD, ECD and PVD. In addition, Applied’s RTP systems can be used to perform certain types of dielectric deposition.
Atomic Layer Deposition
ALD is an advanced technology in which atoms are deposited one layer at a time to build chip structures. This technology enables customers to fabricate thin films of either conducting or insulating material with uniform coverage in nanometer-sized structures. One of the most critical areas of the transistor is its gate, which is built by depositing layers of dielectric films. At the 22nm node and below, these film layers are so thin that they must be atomically engineered. To meet this challenge, in 2011, Applied introduced its Applied Centura Integrated Gate Stack system with advanced ALD technology. The system builds ultrathin high-k film layers less than 2nm in thickness — about one hundred thousandth the width of a human hair.
Chemical Vapor Deposition
CVD is used to deposit dielectric and metal films on a wafer. During the CVD process, gases that contain atoms of the material to be deposited react on the wafer surface, forming a thin film of solid material. Films deposited by CVD may be silicon oxide, single-crystal epitaxial silicon, amorphous silicon, silicon nitride, dielectric anti-reflective coatings, low k dielectric (for highly efficient insulating materials), aluminum, titanium, titanium nitride, polysilicon, tungsten, refractory metals or silicides. Applied offers the following CVD products and technologies:
The Applied Producer CVD platform — This high-throughput platform features Twin-Chamber ® modules that have two single-wafer process chambers per unit. Up to three Twin-Chamber modules can be mounted on each Producer platform, giving it a simultaneous processing capacity of six wafers. Many dielectric CVD processes can be performed on this platform. The highest productivity model of this system is the Applied Producer GT, which has achieved rapid customer acceptance due to its fast wafer handling performance and compact design.
Low k Dielectric Films — Low k dielectric materials are used in copper-based chip designs to further improve interconnect speed. Using conventional CVD equipment, the Applied Producer Black Diamond ® family of low k systems provides customers with a proven, cost-effective way to integrate a variety of low k films into advanced interconnect structures. In 2011, the Company introduced its third-generation low k technologies, the Applied Producer Black Diamond 3 system and Applied Producer Nanocure 3 system. Together, these products are designed to enable smaller, higher performance and more power-efficient devices at 22nm and below.
Lithography-Enabling Solutions — Applied offers several technologies on the Producer system to help chipmakers extend their current 193nm lithography tools, including a line of Applied APF ® (advanced patterning film) films and Applied DARC ® (dielectric anti-reflective coating) films. Together, they provide a film stack with the precise dimensional control and compatibility needed to cost-effectively pattern nano-scale features without additional integration complexity.
Gap Fill Films — There are many steps during the chipmaking process in which very small and deep, or high aspect ratio (HAR), structures must be filled void-free with a dielectric film. Many of these applications include the deposition of silicon oxides in substrate isolation structures, contacts and interconnects. In addition to its Applied Centura Ultima HDP-CVD ® (high-density plasma CVD) and Applied Producer HARP ™ (high aspect ratio process) systems, the Company offers its breakthrough Applied Producer Eterna ™ FCVD system. Targeted for 20nm and below chips, the Eterna system delivers a liquid-like film that flows freely into virtually any structure to provide void-free dielectric fill.
Strain Engineering Solutions — The Applied Producer HARP system also plays a key role in enhancing transistor performance, enabling chipmakers to boost chip speed by depositing strain-inducing dielectric films. Offering the industry’s first integrated stress nitride deposition and ultraviolet (UV) cure solution, the Applied Producer Celera CVD delivers benchmark levels of high-stress tensile silicon nitride films. The Company also offers the Applied Centura SiNgenPlus low pressure CVD system for low temperature silicon nitride films. Used together, and in conjunction with silicon germanium (SiGe) films using Applied’s epitaxial deposition technologies, these systems can provide additive strain engineering benefits.
Through-Silicon Via Films — The Company has a comprehensive portfolio of products for TSV fabrication, including the Applied Producer InVia ™ system. This product uses a unique process to deposit the critical oxide liner film layer in HAR TSV structures, enabling robust electrical isolation of the TSV, which is vital for reliable device performance. For applications where higher temperatures can damage the manufacturing process, the Applied Producer Avila ™ CVD system allows high quality dielectric film deposition at stable substrate temperatures at a low cost of ownership.
Epitaxial Deposition — Epitaxial silicon (epitaxy or epi) is a layer of pure silicon grown in a uniform crystalline structure on the wafer to form a high quality base for the device circuitry. Epi technology is used in an increasing number of integrated circuit devices in both the wafer substrate and transistor areas of a chip to enhance speed. The Applied Centura Epi system integrates pre- and post-epi processes on the same system to improve film quality and reduce production costs. This system is also used for SiGe epi technology, which reduces power usage and increases speed in certain types of advanced chips. For emerging transistor designs, the Applied Centura RP Epi system offers selective epi processes to enable faster transistor switching through strain engineering techniques.
Polysilicon Deposition — Polysilicon is a type of silicon used to form portions of the transistor structure within the integrated circuit device. The Applied Centura Polygen ™ LPCVD system is a single-wafer, multi-chamber product that deposits thin polysilicon films at high temperatures to create transistor gate structures. To address the challenging requirements of shrinking gate dimensions, the Applied Centura DPN Gate Stack system integrates chambers for decoupled plasma nitridation (DPN), RTP anneal and polysilicon deposition on one platform to enable superior film quality and material properties.
Tungsten Deposition — Tungsten is used in the contact area of a chip that connects the transistors to the wiring circuitry. In aluminum-based devices, tungsten is also used in the structures that connect the multiple layers of aluminum wiring. Applied has two products for depositing tungsten: the Applied Centura Sprint ® Tungsten CVD system for 90nm and below devices and the Applied Centura iSprint ALD/CVD system for more advanced applications. The latter product combines ALD technology and CVD chambers on the same platform.
Electrochemical Deposition
Electrochemical deposition is a process by which metal atoms from a chemical fluid (an electrolyte) are deposited on the surface of an immersed object. Its main application in the semiconductor industry is to deposit copper in interconnect wiring structures. This process step follows the deposition of barrier and seed layers which prevent the copper from contaminating other areas of the device, improve the adhesion of the copper film and enable electrodeposition to occur. Applied offers two ECD systems: the Applied Raider GT ECD for electroplating advanced chip interconnect structures, and the Applied Raider S ECD for advanced TSV packaging applications.
Physical Vapor Deposition
PVD is a physical process in which atoms of a gas, such as argon, are accelerated toward a metal target. The metal atoms chip off, or sputter away, and are then deposited on the wafer. The Applied Endura PVD system offers a broad range of advanced metal deposition processes, including aluminum, aluminum alloys, cobalt, titanium/titanium nitride, tantalum/tantalum nitride, tungsten/tungsten nitride, nickel, vanadium and copper. In 2010, Applied celebrated the 20 th year of its Applied Endura platform, the most successful metal deposition system in the history of the semiconductor industry.
The Applied Endura CuBS (copper barrier/seed) PVD system is widely used by customers for fabricating copper-based chips. Using PVD technology, the system deposits a tantalum-based barrier film that prevents copper material from entering other areas of the device and then a copper seed layer that primes the structure for the subsequent deposition of bulk copper. The Applied Endura CuBS RFX PVD system extends cost-effective CuBS technology to the 22nm node. The Applied Endura Avenir ™ RF PVD system sequentially deposits the multiple metal film layers that form the heart of the industry’s new, faster, metal gate transistors. The Applied Endura iLB PVD/ALD system advances the state-of-the-art in ALD technology, enabling customers to shrink their speed-critical contact structures for 20nm and below devices.
Applied’s Endura system has also been used for many years in back-end applications to deposit metal layers before final bump or wire bonding packaging steps are performed. The Applied Charger ™ UBM PVD system, which is specifically designed for under-bump metallization (UBM) and other back-end processes, features linear architecture for reliable performance and very high productivity at a low cost per wafer.
Etch
Etching is used many times throughout the integrated circuit manufacturing process to selectively remove material from the surface of a wafer. Before etching begins, the wafer is coated with a light-sensitive film, called photoresist. A photolithography process then projects the circuit pattern onto the wafer. Etching removes material only from areas dictated by the photoresist pattern. Applied offers a wide range of systems for etching dielectric, metal and silicon films to meet the requirements of advanced processing.
Applied’s Producer Etch system utilizes the Twin-Chamber Producer platform to target cost-sensitive dielectric etch applications. To address advanced dielectric etch applications, the Applied Centura Enabler ® E5 Etch system enables customers to create the 40:1 HAR contact features that are critical to the yield and performance of 32nm and below DRAM and Flash memory chips. The Applied Centura Carina ™ system uses innovative, high-temperature technology to deliver the etch capability essential for scaling logic and memory devices with high-k/metal gates at 45nm and below.
In 2011, the Company introduced its Applied Centris AdvantEdge ™ Mesa ™ silicon etch, which features an unprecedented eight process chambers for high wafer output and proprietary system intelligence software to assure every process on every chamber precisely matches. The system also saves on power, water and gas consumption, helping customers to lower operating costs and support their sustainable manufacturing initiatives. The Applied Centura Mariana ™ Trench Etch system provides customers with the capability to scale DRAM capacitors by enabling the etching of 80:1 aspect ratio structures. The Applied Centura Silvia ™ system is specifically designed for etching small, deep holes for TSV applications in 3D-ICs. For etching metals, the Applied Opus ™ AdvantEdge Metal Etch uses an optimized 5-chamber platform configuration that enables customers to extend aluminum interconnect technology and productivity for flash and DRAM memory applications.
Rapid Thermal Processing
RTP is a process in which a wafer is subjected to rapid bursts of intense heat that can take the wafer from room temperature to more than 1,000 degrees Celsius in less than 10 seconds. A rapid thermal process is used mainly for annealing, which modifies the properties of deposited films. The Applied Centura Radiance ® Plus and Applied Vantage RadOx ™ RTP systems feature advanced RTP technology with differing platform designs. While the multi-chamber Centura platform offers exceptional process flexibility, the streamlined two-chamber Vantage platform is designed for dedicated high-volume manufacturing. These single-wafer RTP systems are also used for growing high quality oxide and oxynitride films, deposition steps that traditional large batch furnaces can no longer achieve with the necessary precision and control.
Applied’s latest RTP systems address the critical need for controlling wafer temperature to increase chip performance and yield. The laser-based Applied Vantage Astra ™ millisecond anneal system abruptly raises the surface temperature of the wafer locally to modify material properties at the atomic level. In 2011, the Company introduced the Applied Vantage Vulcan system, the first RTP system to heat the wafer entirely from the backside. This system brings a new level of precision and control to the anneal process, allowing chipmakers to produce more high performance devices per wafer.
Chemical Mechanical Planarization
The CMP process removes material from a wafer to create a flat (planarized) surface. This process allows subsequent photolithography patterning steps to occur with greater accuracy and enables film layers to build with minimal height variations. Applied has led the industry with its 300mm Applied Reflexion ® LK system, with features such as integrated cleaning, film measurement and process control capabilities. Applied’s latest CMP product, the Applied Reflexion GT system, has an innovative dual-wafer design that increases performance while lowering system cost of ownership in fabricating copper interconnects and tungsten contacts.
Surface Preparation
Cleaning the surface of the wafer is critical to the adhesion and quality of films that are subsequently deposited in the chip fabrication process. Applied offers several surface preparation systems. The Applied Raider SP can incorporate several types of cleaning methods, including spray, vapor, immersion, megasonics and anneal technologies with automated single or dual-side wafer processing for high volume manufacturing.
Metrology and Wafer Inspection
Applied offers several products for measuring features and inspecting defects on the wafer during various stages of the fabrication process. These systems enable customers to characterize and control critical dimension (CD) and defect issues, especially at advanced generation technology nodes.
Critical Dimension and Defect Review Scanning Electron Microscopes (CD-SEMs and DR-SEMs)
Scanning electron microscopes (SEMs) use an electron beam to form images of microscopic features of a patterned wafer at extremely high magnification. Applied’s SEM products provide customers with full automation, along with the high accuracy and sensitivity needed for measuring very small CDs. The Applied VeritySEM ® 4i metrology system uses proprietary SEM imaging technology to enable precise control of the lithography and etching processes, measuring CDs at a precision of less than 0.3nm. Applied’s OPC Check ™ software for the VeritySEM system performs automated qualification of OPC-based (optical proximity correction) chip designs, significantly reducing mask (see Mask Making section below) verification time over conventional manual methods.
DR-SEMs review defects on the wafer (such as particles, scratches or residues) that are first located by a defect detection system and then classify the defects to identify their source. The high-throughput, fully automatic Applied SEMVision ™ Defect Analysis products enable customers to use this technology as an integral part of their production lines to analyze defects as small as 30nm with industry-leading throughput.
Wafer Inspection
Using deep ultraviolet (DUV) laser-based technology, defects can be detected on patterned wafers (wafers with printed circuit images) as they move between processing steps. Defects include particles, open circuit lines, and shorts between lines. The Applied UVision ® 4 wafer inspection system detects yield-limiting defects in the critical patterning layers of 22nm and below logic and memory devices. In 2011, the Company introduced the Applied DFinder system, the first darkfield wafer inspection system to use DUV laser scanning to detect particles as small as 40nm in interconnect layers.
Mask Making
Masks are used by photolithography systems to transfer microscopic circuit designs onto wafers. Since an imperfection in a mask may be replicated on the wafer, the mask must be virtually defect-free. Applied provides systems for etching and inspecting masks.
The Applied Centura Tetra ™ X Advanced Reticle Etch system is an advanced etch tool for fabricating leading-edge masks at 22nm and below. Applied’s Tetra line of systems has been used by mask makers worldwide to etch the majority of high-end masks over the last five years. The Company also addresses the challenges of detecting defects on 22nm masks with its Applied Aera3 ™ Mask inspection system. Using sophisticated aerial imaging technology, the Aera3 allows users to immediately see how the pattern on the mask will appear on the wafer, revealing only the defects most likely to print and significantly reducing inspection time. These systems also address the challenge of fabricating emerging extreme ultraviolet (EUV) lithography masks.
CEO BACKGROUND
Michael R. Splinter has been President and Chief Executive Officer of Applied since April 2003 and Chairman of the Board of Directors since March 2009. Prior to joining Applied, Mr. Splinter was at Intel Corporation, a manufacturer of chips and computer, networking and communications products, for 20 years. While at Intel, he held a number of executive positions, including Executive Vice President and Director of Sales and Marketing and Executive Vice President and General Manager of the Technology and Manufacturing Group. Mr. Splinter is a director of The NASDAQ OMX Group, Inc.
With over 35 years of experience in the technology/information sector, Mr. Splinter brings his leadership and extensive global business, operating, marketing and industry experience to the Board. As Applied’s Chief Executive Officer, he also brings to the Board his strategic vision for the Company, proven management experience and in-depth understanding of complex industry and global challenges and opportunities, creating a vital link that enables the Board to perform its oversight function with the benefit of management’s key perspectives. Mr. Splinter’s service on the board of The NASDAQ OMX Group provides him with a solid understanding of the importance of good corporate governance and broad exposure to a wide range of issues facing companies in diverse industries.
Aart J. de Geus is a co-founder of Synopsys, Inc., a provider of electronic design automation (EDA) software and related services for semiconductor design companies, and currently serves as Chairman of its Board of Directors and Chief Executive Officer. Since 1986, Dr. de Geus has served as a director of and held various positions at Synopsys, including President, Senior Vice President of Engineering and Senior Vice President of Marketing. From 1982 to 1986, Dr. de Geus was employed by the General Electric Company, a global infrastructure, finance and media company, where he was the Manager of the Advanced Computer-Aided Engineering Group.
Dr. de Geus has experience growing Synopsys, which he co-founded in 1986, from a start-up to a well-established publicly-traded company. His over-25 years of executive and technological leadership provide the Board with important perspectives on navigating a company through various stages of growth, as well as innovation, management development, and global challenges and opportunities.
Stephen R. Forrest has served as Vice President for Research at the University of Michigan since January 2006, where he also holds faculty appointments as Professor of Electrical Engineering and Computer Science in the College of Engineering, and as Professor of Physics in the College of Literature, Science and the Arts. Dr. Forrest leads the University’s Optoelectronics Components and Materials Group. From 1992 to 2005, Dr. Forrest served in a number of positions at Princeton University, including as Chair of the Electrical Engineering Department, Director of the Center for Photonics and Optoelectronic Materials, and as director of the National Center for Integrated Photonic Technology. Prior to Princeton, Dr. Forrest was a faculty member of the Electrical Engineering and Materials Science Departments at the University of Southern California.
As a distinguished academic leader, Dr. Forrest brings to the Board his extensive knowledge of semiconductor and alternative energy technologies and experience with research and development portfolio management, government policy, technology licensing, and product commercialization. He also has unique insights from his experience with cross-functional endeavors on how to achieve economic transformation through technology. Dr. Forrest has worked closely with industry, government, entrepreneurs, and community leaders to develop businesses focused on alternative energy and other technologies to diversify a state’s economy and increase global competitiveness.
Thomas J. Iannotti served as Senior Vice President and General Manager, Enterprise Services, for Hewlett-Packard Company, a technology solutions provider to consumers, businesses and institutions globally, from February 2009 until his retirement in October 2011. From 2002 to January 2009, Mr. Iannotti held various executive positions at Hewlett-Packard, including most recently as Senior Vice President and Managing Director, Enterprise Business Group, Americas. From 1978 to 2002, Mr. Iannotti worked at Digital Equipment Corporation, a vendor of computer systems and software, and at Compaq Computer Corporation, a supplier of personal computing systems, after its acquisition of Digital Equipment Corporation.
Mr. Iannotti has broad and deep industry and technology knowledge, leadership skills and broad-based expertise from his various executive positions at several publicly-traded technology companies for over 30 years, including in his recent senior management role at Hewlett-Packard. Mr. Iannotti’s experience with service management on a global, regional, and country level, including in Asia and Europe, provides a valuable perspective to the Board.
Susan M. James served as a partner at Ernst & Young LLP, a global leader in assurance, tax, transaction and advisory services, from 1987 to 2006. Ms. James joined Ernst & Young in 1975 and, following her retirement in 2006, served as a consultant to the firm until December 2009. She also served on the Ernst & Young Americas Executive Board of Directors from January 2002 to June 2006. Ms. James is a certified public accountant (inactive) and member of the American Institute of Certified Public Accountants. Ms. James currently serves as a member of the boards of directors of Coherent, Inc. and Yahoo! Inc.
Ms. James brings to the Board her extensive financial and accounting expertise, demonstrated leadership capability and broad experience with global technology companies from her 35-year career at Ernst & Young. Ms. James’ experience as an independent auditor has provided her with a deep understanding of accounting principles, financial reporting rules and regulations, and knowledge of audit procedures. In addition, as the current Chair of the audit committees of Coherent and Yahoo!, Ms. James brings leadership experience and a valuable perspective to her service as a member of Applied’s Audit Committee.
Alexander A. Karsner has served as Chief Executive Officer of Manifest Energy LLC, a clean energy infrastructure development and finance company, since July 2009. From March 2006 to August 2008, he served as Assistant Secretary for Energy Efficiency and Renewable Energy at the U.S. Department of Energy. From April 2002 to March 2006, Mr. Karsner was Managing Director of Enercorp LLC, a private company involved in international project development, management and financing of renewable energy infrastructure. Mr. Karsner has also worked with Tondu Energy Systems of Texas, Wartsila Power Development of Finland and other multi-national energy firms and developers. Mr. Karsner currently serves as a member of the board of directors of Codexis, Inc.
Mr. Karsner brings to the Board experience in, and knowledge of, the energy industry and related public policies. Specifically, Mr. Karsner’s leadership in renewable energy policy, technologies and commercialization, and his expertise in domestic and international energy markets, have enhanced the Board’s perspectives on innovation, strategy, and market diversification. His service on the board of directors of Codexis has further increased Mr. Karsner’s understanding of issues related to clean energy and alternative technologies.
Gerhard H. Parker served as Executive Vice President, New Business Group, of Intel Corporation from 1998 until his retirement in May 2001. From 1988 to 1998, Dr. Parker was Senior Vice President of Intel’s Technology and Manufacturing Group. Dr. Parker currently serves as a member of the boards of directors of FEI Company and Lattice Semiconductor Corporation.
Dr. Parker brings to the Board extensive manufacturing, engineering, operational, and strategic experience. In addition, Dr. Parker’s long experience as a senior executive who managed new businesses, worldwide manufacturing, and technology development at Intel contributes to the Board’s ability to oversee these areas at Applied. Dr. Parker’s service on the boards of FEI and Lattice Semiconductor, including his position as Chairman of the Board of FEI, brings to the Board additional expertise on strategy, global challenges and opportunities, and board leadership.
Dennis D. Powell served as an Executive Advisor at Cisco Systems, Inc., a provider of networking products and services, from February 2008 to September 2010. He served as Cisco’s Chief Financial Officer from May 2003 to February 2008, and in addition, served as an Executive Vice President from 2007 to 2008 and a Senior Vice President from 2003 to 2007. Since joining Cisco in 1997, Mr. Powell also served as Senior Vice President, Corporate Finance and Vice President, Corporate Controller. Before joining Cisco, Mr. Powell was employed by Coopers & Lybrand LLP, an accounting firm, for 26 years, where he was last a senior partner. Mr. Powell currently serves as a member of the board of directors of Intuit, Inc. and VMware, Inc.
Mr. Powell brings to the Board substantial financial and accounting expertise and executive management experience acquired in the course of managing financial strategy and operations as the Chief Financial Officer of Cisco, and working as an independent auditor at Coopers & Lybrand for 26 years. Mr. Powell’s current service as a director and member of the audit committees of Intuit and VMware broadens his insights on corporate governance and enhances his perspective as Chair of Applied’s Audit Committee.
Willem P. Roelandts served as Chairman of the Board of Directors of Xilinx, Inc., a supplier of programmable logic solutions, from July 2003 to February 2009, and as a director from January 1996 to August 2009. Mr. Roelandts served as President and Chief Executive Officer of Xilinx from January 1996 to January 2008. Prior to joining Xilinx, Mr. Roelandts held various executive positions during a 29-year career at Hewlett-Packard Company, where he last served as Senior Vice President and General Manager of Computer Systems Organizations. Mr. Roelandts currently serves as a director of Aruba Networks, Inc. He is also a member of the Advisory Board of the Center for Science, Technology and Society at Santa Clara University.
Mr. Roelandts has significant expertise with strategic and line management, engineering innovation, market diversification, and executive development, having been the President, Chief Executive Officer and a director of Xilinx for 13 years, and serving in various executive positions at Hewlett-Packard for almost 30 years. This extensive executive management and operational experience on a global basis has given him a deep understanding of what produces success at companies that are driven by innovation, research, and development, which provides a valuable perspective to our Board. His current service as a director and member of the compensation committee of Aruba Networks further enhances his perspective.
James E. Rogers has served as Chairman since 2007, and President, Chief Executive Officer and a member of the Board of Directors since 2006, of Duke Energy Corporation, an electric power company that supplies and delivers electricity and natural gas service. Mr. Rogers was Chairman and Chief Executive Officer of Cinergy Corp., a provider of electric and gas service, from 1994 until its merger with Duke Energy in 2006. He was Chairman, President and Chief Executive Officer of PSI Energy, Inc., a provider of electric and gas service, from 1988 until 1994. Mr. Rogers served as a director of Fifth Third Bancorp from 1995 to 2009 and currently serves as a director of CIGNA Corporation.
Mr. Rogers brings to the Board his substantial global and leadership experience, as well as broad knowledge and experience in the energy field, from his more than 20 years as the chief executive officer of utility companies, including as the current Chairman, President and Chief Executive Officer of Duke Energy, which operates in the highly-regulated energy industry. In addition, Mr. Rogers’ current service as Chair of the compensation committee of CIGNA, as well as his past service on other companies’ compensation committees, contributes to his role as a member of Applied’s Human Resources and Compensation Committee.
Robert H. Swan has served as Senior Vice President, Finance and Chief Financial Officer of eBay Inc., a provider of online marketplaces and payment services, since March 2006. From 2003 to March 2006, Mr. Swan was Chief Financial Officer and Executive Vice President of Electronic Data Systems Corporation, a technology services company. Mr. Swan also served as Executive Vice President and Chief Financial Officer of TRW, Inc., a global manufacturing and service company, from 2001 to 2002 and held various executive positions at Webvan Group, Inc., an online grocery delivery service, from 1999 to 2001. Mr. Swan spent the first 15 years of his career at the General Electric Company in various roles.
Mr. Swan has significant financial expertise and global financial management experience from his many years of managing finance organizations as the current Chief Financial Officer of eBay and in his prior positions at large, global public companies. In addition, Mr. Swan has substantial management and leadership skills in his role at eBay, where he is responsible for all aspects of eBay’s finance function, including controllership, financial planning and analysis, tax, treasury, audit, mergers and acquisitions, and investor relations. His financial expertise and management and leadership skills are valuable to the Board and to the Audit Committee, of which he is a member.
MANAGEMENT DISCUSSION FROM LATEST 10K
Overview
Applied provides manufacturing equipment, services and software to the global semiconductor, flat panel display, solar photovoltaic (PV) and related industries. Applied’s customers include manufacturers of semiconductor wafers and chips, flat panel liquid crystal displays (LCDs), solar PV cells and modules, and other electronic devices. These customers may use what they manufacture in their own end products or sell the items to other companies for use in advanced electronic components. Applied operates in four reportable segments: Silicon Systems Group, Applied Global Services, Display, and Energy and Environmental Solutions. A summary of financial information for each reportable segment is found in Note 16 of Notes to Consolidated Financial Statements. A discussion of factors that could affect Applied’s operations is set forth under “Risk Factors” in Item 1A, which is incorporated herein by reference. Product development and manufacturing activities occur primarily in North America, Europe, Israel and Asia. Applied’s broad range of equipment and service products are highly technical and are sold primarily through a direct sales force.
Applied’s results historically have been driven primarily by worldwide demand for semiconductors, which in turn depends on end-user demand for electronic products. Each of Applied’s businesses is subject to highly cyclical industry conditions, as demand for manufacturing equipment and services can change depending on supply and demand for chips, LCDs, solar PVs and other electronic devices, as well as other factors, such as global economic and market conditions, and technological advances in fabrication processes.
Fiscal 2011 and 2009 contained 52 weeks each, while fiscal 2010 contained 53 weeks.
Financial results for fiscal 2011 over fiscal 2010 reflected a decrease in total new orders, while net sales increased to a record level and net income also increased. The decline in new orders reflected softening demand for semiconductor, LCD and solar equipment in the second half of the year. The semiconductor industry was negatively impacted by uncertainty in the macroeconomic environment whereas the LCD and solar equipment industries were negatively impacted by overcapacity. In the fourth quarter of fiscal 2011, new orders were $1.6 billion, down 33 percent from the prior quarter. For fiscal 2011, net sales increased year-over-year primarily due to increased industry investment in crystalline-silicon (c-Si) solar equipment and higher sales of spares and refurbished semiconductor equipment. Operating income for fiscal 2011 included favorable adjustments to restructuring reserves of $60 million, offset in part by asset impairment charges of $30 million, and a net gain on sale of facilities of $27 million. In fiscal 2010, Applied incurred charges totaling $486 million that included a plan to restructure its Energy and Environmental Solutions segment.
Financial results for fiscal 2010 over fiscal 2009 reflected significantly increased demand for manufacturing equipment and services due to more favorable global economic and industry conditions. The increase in total orders from fiscal 2009 was primarily due to increased demand for semiconductor, display and c-Si solar PV products, partially offset by decreased demand for SunFab ™ thin film solar lines. Net sales increased during fiscal 2010 compared to fiscal 2009, due primarily to higher sales of semiconductor and display equipment. In fiscal 2010, Applied incurred charges totaling $486 million that included a plan to restructure its Energy and Environmental Solutions segment, consisting of inventory-related charges of $330 million related to SunFab thin film solar equipment, asset impairment charges of $108 million, employee severance charges of $45 million, and other costs of $3 million. This action was in response to adverse market conditions for thin film solar, including delays in utility-scale solar adoption, solar panel manufacturers’ challenges in obtaining affordable capital, changes and uncertainty in government renewable energy policies, and competitive pressure from c-Si solar technologies. As part of the restructuring, Applied discontinued sales to new customers of its fully-integrated SunFab lines but continued to offer individual tools for thin film solar manufacturing. Applied is supporting existing SunFab customers with services, upgrades and capacity increases through its Applied Global Services segment and is continuing RD&E efforts to improve thin film panel efficiency and high-productivity deposition. Also in fiscal 2010, Applied incurred charges totaling $84 million associated with a restructuring program to reduce its global workforce as of October 25, 2009 by approximately 1,000 positions over a period of 18 months.
Fiscal 2009 financial results reflected significantly reduced demand for manufacturing equipment and services due to extremely unfavorable global economic and industry conditions, particularly in the first half of fiscal 2009. Negative trends in consumer spending and pervasive economic uncertainty led some customers to dramatically reduce factory operations and to reduce their spending. In the second half of fiscal 2009, demand for semiconductor and display equipment increased, but was still down significantly from fiscal 2008 levels. Fiscal 2009 financial results included charges associated with restructuring programs.
In November 2011, Applied completed its acquisition of Varian Semiconductor Equipment Associates, Inc. (Varian) for an aggregate purchase price of approximately $4.2 billion, net of cash acquired. The acquisition enhances Applied’s product portfolio with market-leading ion implantation technology and is expected to enable Applied to become the semiconductor industry leader in transistor technologies.
Applied’s future operating results depend to a considerable extent on its ability to maintain a competitive advantage in the equipment and service products it provides. Applied believes that it is critical to continue to make substantial investments in RD&E to assure the availability of innovative technology that meets the current and projected requirements of its customers’ most advanced designs. Applied historically has maintained its commitment to investing in RD&E in order to continue to offer new products and technologies. RD&E expenses were $1.1 billion (11 percent of net sales) in fiscal 2011, $1.1 billion (12 percent of net sales) in fiscal 2010, and $934 million (19 percent of net sales) in fiscal 2009. RD&E expense during fiscal 2011, 2010 and 2009 included $46 million, $43 million and $50 million, respectively, of share-based compensation expense. Development cycles range from 12 to 36 months depending on whether the product is an enhancement of an existing product, which typically has a shorter development cycle, or a new product, which typically has a longer development cycle. Most of Applied’s existing products resulted from internal development activities and innovations involving new technologies, materials and processes. In certain instances, Applied acquires technologies, either in existing or new product areas, to complement its existing technology capabilities and to reduce time to market.
In fiscal 2011, Applied developed logic and memory chip technologies to meet the requirements of manufacturing below the 22nm node. These systems were designed to help semiconductor customers continue their drive to pack more transistors in the same space using high-k/metal gate technologies and double patterning processes. These technologies include low k dielectrics and curing for interconnect structures and high-k dielectric materials and ALD processes for fabricating transistor gates. Applied also focused on processes to help customers build new three-dimensional (3D) gate structures. In addition, Applied continued to focus on optimizing the cost-effectiveness of through-silicon via (TSV) technologies to enable their widespread implementation. TSV technologies permit interconnecting 3D chip stacks to enable better device performance, lower power consumption and the integration of heterogeneous devices. Applied is also investing in other new product development areas such as 450mm wafer systems. In the Display sector, Applied developed deposition systems to enable larger OLED, LCD and touch-enabled displays. In solar, Applied focused on screen printing technology to keep pace with cell manufacturers’ new higher-efficiency cell designs. Another key development area was “smart” capability, which brings a new level of precision and control to the PV production process.
In fiscal 2010, Applied developed new technology to enable next-generation 22nm and below chip designs. Applied also developed technology for TSVs. In the solar PV area, Applied continued the development of its precision wafering and cell manufacturing products for lowering the cost of producing solar-generated electricity through advanced c-Si technology. RD&E also included activities to develop products that enable lower-cost production of solar energy, production of LED devices for display backlighting and general lighting, and other products to enable energy conservation.
In fiscal 2009, Applied focused on developing systems for semiconductor customers’ new chip designs with 32nm and below geometries, including systems to enable faster transistors using strain engineering and high-k/metal gate technologies, as well as double patterning processes that enable customers to extend their existing 193nm lithography tools through additional technology generations. Applied also focused on developing technology for manufacturing next-generation displays. RD&E also included activities to develop products that enable lower-cost production of solar energy and other products to enable energy conservation.
Fiscal 2011 financial results reflected decreased demand for semiconductor manufacturing equipment compared to fiscal 2010, particularly in the second half of fiscal 2011, due primarily to uncertain global economic conditions. In the fourth quarter of fiscal 2011, new orders were $925 million, a decrease of 25 percent compared to the prior quarter. For fiscal 2011, new orders decreased by $270 million to $5.5 billion compared to fiscal 2010. The decrease in new orders was primarily due to reduced demand from memory customers. Net sales increased by $111 million to $5.4 billion for fiscal 2011 compared to fiscal 2010. The increase in net sales was primarily due to increased investment by logic customers. Three customers accounted for 52 percent of net sales in this segment in fiscal 2011. Approximately 45 percent of net sales in the fourth quarter of fiscal 2011 were for orders received and shipped within the quarter, down from 49 percent in the third quarter of fiscal 2011. The book to bill ratio (new orders divided by net sales) decreased to 1.0 for fiscal 2011, reflecting decreased demand, compared to 1.1 for fiscal 2010. Operating income in fiscal 2011 was $1.8 billion, a decrease of $128 million from the prior year. The decrease was due in part to a settlement agreement between Applied and Samsung Electronics Co., Ltd (Samsung) that provided for volume-based rebates and other incentives to Samsung. The decrease was also due to operating expenses incurred as a result of headcount increases during fiscal 2011. In 2011, Applied introduced the Applied Centura Conforma system which uses conformal plasma doping technology to modify the electrical properties of 3D and planar transistor structures.
Fiscal 2010 financial results reflected increased demand for manufacturing equipment over fiscal 2009 due to improved global economic and industry conditions. New orders increased by $4.1 billion to $5.8 billion for fiscal 2010 compared to fiscal 2009. The significant increase in new orders was primarily from memory and foundry customers and to a lesser extent logic customers, which reflected the general recovery in the semiconductor equipment industry. The majority of fiscal 2010 new orders were for customers’ capacity expansions, while fiscal 2009 orders were primarily for customers’ new technology investments. Net sales increased by $3.3 billion to $5.3 billion in fiscal 2010 compared to fiscal 2009. The increase in net sales was primarily due to increased investment by memory and foundry customers. Four customers accounted for 51 percent of net sales in this segment in fiscal 2010. Approximately 61 percent of net sales in the fourth quarter of fiscal 2010 were for orders received and shipped within the quarter. The book to bill ratio (new orders divided by net sales) increased to 1.1 for fiscal 2010, reflecting increased demand, compared to 0.9 for fiscal 2009. Operating income increased by $1.7 billion to $1.9 billion for fiscal 2010 compared to fiscal 2009. The increase in operating income for fiscal 2010 was due to considerably higher revenue from semiconductor equipment sales and reflected the general recovery in the semiconductor equipment industry during fiscal 2010. Results for fiscal 2010 included Semitool, which was acquired by Applied during the first quarter of fiscal 2010. In 2010, Applied introduced its Applied Reflexion GT CMP system, for fabricating copper interconnects and its Applied Centura AdvantEdge Mesa silicon etch system for fabricating nano-scale circuit features with angstrom-level precision.
The Company also introduced the Applied Producer EternaFCVD system, which is targeted for 20nm and below chips and delivers a liquid-like film that flows freely into virtually any structure to provide void-free dielectric fill.
Fiscal 2009 financial results reflected significantly reduced demand for manufacturing equipment due to extremely unfavorable global economic and industry conditions. Silicon Systems Group new orders decreased by $2.4 billion to $1.7 billion in fiscal 2009 compared to fiscal 2008. The decrease in new orders reflected significantly lower demand, primarily from memory and logic customers. Net sales decreased by $2.0 billion to $2.0 billion in fiscal 2009 compared to fiscal 2008. The decrease in net sales was due to decreased capital investments, primarily by memory customers. The book to bill ratio decreased to 0.9 for fiscal 2009, reflecting significantly decreased demand, compared to 1.0 for fiscal 2008. Operating income decreased by $1.0 billion to $201 million in fiscal 2009 compared to fiscal 2008. The decrease in operating income was due to significantly lower sales resulting in lower factory absorption, partially offset by lower operating expenses from cost control initiatives. Operating income for fiscal 2009 also reflected an increase in bad debt expense. After an operating loss in the first half of fiscal 2009, the Silicon Systems Group returned to operating profitability during the second half of the year, which was primarily driven by sales to foundry customers. During the year, the Company introduced a new platform specifically designed for under-bump metallization (UBM) and other back-end processes, the Applied Charger UBM PVD system.
Applied Global Services Segment
The Applied Global Services segment encompasses technically differentiated products, including spares, services, certain earlier generation equipment products, and remanufactured equipment, to improve operating efficiency, reduce operating costs, and lessen the environmental impact of semiconductor, display and solar customers’ factories. Customer demand for products and services is fulfilled through a global distribution system with trained service engineers located in close proximity to customer sites.
In fiscal 2010, as part of the restructuring of the Energy and Environmental Solutions segment, Applied discontinued sales to new customers of its fully-integrated SunFab thin film solar production lines but continued to offer individual tools for thin film solar manufacturing. Applied is supporting existing SunFab customers with services, upgrades and capacity increases through its Applied Global Services segment as these products are considered to have reached a particular stage in the product lifecycle and, effective in the first quarter of fiscal 2011, Applied accounts for these products under its Applied Global Services segment.
Fiscal 2011 operating financial results reflected a cyclical downturn in demand for equipment to manufacture LCD products that resulted in an extremely low level of orders in the fourth quarter of fiscal 2011. In the fourth quarter of fiscal 2011, new orders were $20 million, a decrease of 91 percent compared to the prior quarter. For fiscal 2011, new orders decreased by $163 million to $636 million compared to fiscal 2010. The decrease in new orders reflected customers’ decisions to delay investment in new LCD TV capacity, which was partially offset by increased demand for LTPS and touch panel systems, although this demand also softened in the fourth quarter of fiscal 2011 as an initial build-out of manufacturing capacity was absorbed. Net sales decreased by $200 million to $699 million for fiscal 2011 compared to fiscal 2010. The decrease in net sales reflected a decline in spending for LCD TV products, as customers delayed their investments, including plans for manufacturing in China, partially offset by increased demand for equipment to manufacture new mobile devices like smart phones and tablets. The book to bill ratio remained flat at 0.9 for fiscal 2011. Operating income decreased by $120 million to $147 million for fiscal 2011 compared to fiscal 2010. The decrease in operating income for fiscal 2011 reflected an unfavorable product mix. Three customers accounted for 54 percent of net sales for the Display segment in fiscal 2011. The decrease in operating margin in fiscal 2011 compared to fiscal 2010 was due to changes in product mix. In 2011, the Company introduced the Applied AKT-20K PX PECVD system for manufacturing high-performance OLED and LCD displays and the Applied AKT-AristoTwin system for manufacturing touch-enabled displays.
Fiscal 2010 operating financial results reflected increased demand for LCD equipment over fiscal 2009 due to improved global economic and industry conditions. New orders increased by $512 million to $799 million for fiscal 2010 compared to fiscal 2009. The increase in new orders reflected the general recovery in the LCD market, as customers increased production levels in response to strong end-demand for flat panel TVs and notebook computers. Net sales increased by $397 million to $899 million for fiscal 2010 compared to fiscal 2009. The increase in net sales reflected strong market demand for LCD products. Five customers accounted for 71 percent of net sales for the Display segment in fiscal 2010. The book to bill ratio increased to 0.9 for fiscal 2010, reflecting increased demand, compared to 0.6 for fiscal 2009. Operating income increased by $216 million to $267 million for fiscal 2010 compared to fiscal 2009. The increase in operating income was due to a significant increase in net sales and improved gross margin driven by an increase in volume.
Fiscal 2009 financial results reflected significantly reduced demand for LCD equipment due to extremely unfavorable global economic and industry conditions. New orders decreased significantly to $287 million in fiscal 2009 compared to $1.5 billion in fiscal 2008, which reflected the slowdown in the display industry from fiscal 2008 when display manufacturers added capacity. Net sales decreased by $474 million to $502 million in fiscal 2009 compared to fiscal 2008 as a result of significantly lower orders. Operating income decreased to $51 million in fiscal 2009 from $301 million in fiscal 2008. Operating income decreased due to significantly lower revenue, partially offset by lower operating expenses due to cost control initiatives. The book to bill ratio decreased to 0.6 for fiscal 2009, reflecting significantly decreased demand, compared to 1.5 for fiscal 2008.
Energy and Environmental Solutions Segment
The Energy and Environmental Solutions segment includes products for fabricating c–Si solar PVs, high throughput roll-to-roll coating systems for flexible electronics, and web products. This business is focused on delivering solutions to generate and conserve energy, with an emphasis on lowering the cost to produce solar power by providing equipment to enhance manufacturing scale and efficiency. Until the first quarter of fiscal 2011, the Energy and Environmental Solutions segment included the fully-integrated SunFab production line for manufacturing thin film solar panels. During the third quarter of fiscal 2010, Applied announced a plan to restructure its Energy and Environmental Solutions segment in response to adverse market conditions for thin film solar and as a result, Applied discontinued sales of SunFab lines to new customers, but is offering individual tools for thin film solar manufacturing. Applied is supporting existing SunFab line customers with services, upgrades and capacity increases through its Applied Global Services segment, and effective in the first quarter of fiscal 2011, Applied accounts for these products under its Applied Global Services segment.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Overview
Applied provides manufacturing equipment, services and software to the global semiconductor, flat panel display, and solar industries. Applied’s customers include manufacturers of semiconductor wafers and chips, flat panel liquid crystal displays (LCDs), crystalline silicon (c-Si) solar photovoltaic cells and modules (PVs), and other electronic devices. These customers may use what they manufacture in their own end products or sell the items to other companies for use in advanced electronic components. Applied operates in four reportable segments: Silicon Systems Group, Applied Global Services, Display, and Energy and Environmental Solutions. A summary of financial information for each reportable segment is found in Note 16 of Notes to Consolidated Condensed Financial Statements. A discussion of factors that could affect Applied’s operations is set forth under “Risk Factors” in Item 1A of Part II of this report, which is incorporated herein by reference. Product development and manufacturing activities occur primarily in North America, Europe, Israel and Asia. Applied’s broad range of equipment and service products are highly technical and are sold primarily through a direct sales force.
Applied’s results historically have been driven primarily by worldwide demand for semiconductors, which in turn depends on end-user demand for electronic products. Each of Applied’s businesses is subject to highly cyclical industry conditions, as demand for manufacturing equipment and services can change depending on supply and demand for chips, LCDs, solar PVs and other electronic devices, as well as other factors, such as global economic and market conditions, and technological advances in fabrication processes. In light of this cyclicality, Applied’s results can vary significantly year over year, as well as quarter over quarter.
The first half of fiscal 2012 was characterized by strong demand for semiconductor equipment led by foundry customers while weakness continued in the display and solar industries. In the third quarter of fiscal 2012, demand for semiconductor equipment from foundry and logic customers softened as a result of a slowdown in the semiconductor industry and uncertain global economic conditions, while demand for display and solar equipment remained weak. Applied expects semiconductor equipment investments across all categories of customers to decline further in the fourth quarter of fiscal 2012, as fluctuations in consumer buying patterns and global macroeconomic uncertainties cause chipmakers to significantly delay their capital equipment spending until they see signs of stronger consumer demand. Applied also expects the low investment levels for display and solar equipment to continue in the fourth quarter of fiscal 2012 as conditions in those industries remain challenging.
Financial results for the third quarter and first nine months of fiscal 2012 compared to the prior year reflected decreased demand for display and solar equipment, partially offset by the addition of sales attributable to Varian Semiconductor Equipment Associates, Inc. (Varian) and foundry customers.
Financial results for the third quarter of fiscal 2012 compared to the second quarter of fiscal 2012 reflected a decrease in both new orders and net sales, primarily from foundry and logic customers.
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 July 29, 2012 , Applied Materials, Inc. has provided parent guarantees to banks for approximately $181 million to cover these services.
Applied’s investment portfolio consists principally of investment grade money market mutual funds, U.S. Treasury and agency securities, municipal bonds, corporate bonds and mortgage-backed and asset-backed securities, as well as equity securities. Applied regularly monitors the credit risk in its investment portfolio and takes appropriate measures, which may include the sale of certain securities, to manage such risks prudently in accordance with its investment policies.
For the nine months ended July 29, 2012 , Applied did not recognize any impairment on its marketable securities. At July 29, 2012 , Applied had a gross unrealized loss in its investment portfolio of $1 million due to a decrease in the fair value of certain fixed income securities.
During the nine months ended July 29, 2012 , Applied recorded a bad debt provision of $9 million as a result of certain customers’ financial condition. Applied did not record a bad debt provision during the nine months ended July 31, 2011. While Applied believes that its allowance for doubtful accounts at July 29, 2012 is adequate, it will continue to closely monitor customer liquidity and economic conditions.
At July 29, 2012 , approximately $950 million of cash, cash equivalents and marketable securities held by foreign subsidiaries may be subject to U.S. taxes if repatriated for U.S. operations. Of this amount, Applied intends to permanently reinvest approximately $400 million outside of the U.S. and does not plan to repatriate these funds. For the remaining cash, cash equivalents and marketable securities held by foreign subsidiaries, U.S. taxes have been provided in the financial statements.
Although cash requirements will fluctuate based on the timing and extent of factors such as those discussed above, Applied’s management believes that cash generated from operations, together with the liquidity provided by existing cash balances and borrowing capability, will be sufficient to satisfy Applied’s liquidity requirements for the next 12 months. For further details regarding Applied’s operating, investing and financing activities, see the Consolidated Condensed Statements of Cash Flows in this report.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates that affect the amounts reported. Note 1 of Notes to Consolidated Financial Statements in our Annual Report on Form 10-K and Note 1 to Notes to Consolidated Condensed Financial Statements in this report describe the significant accounting policies used in the preparation of the consolidated financial statements. Certain of these significant accounting policies are considered to be critical accounting policies.
A critical accounting policy is defined as one that is both material to the presentation of Applied’s consolidated financial statements and that requires management to make difficult, subjective or complex judgments that could have a material effect on Applied’s financial condition or results of operations. Specifically, these policies have the following attributes: (1) Applied is required to make assumptions about matters that are highly uncertain at the time of the estimate; and (2) different estimates Applied could reasonably have used, or changes in the estimate that are reasonably likely to occur, would have a material effect on Applied’s financial condition or results of operations.
Estimates and assumptions about future events and their effects cannot be determined with certainty. Applied bases its estimates on historical experience and on various other assumptions believed to be applicable and reasonable under the circumstances. These estimates may change as new events occur, as additional information is obtained and as Applied’s operating environment changes. These changes have historically been minor and have been included in the consolidated financial statements as soon as they became known. In addition, management is periodically faced with uncertainties, the outcomes of which are not within its control and will not be known for prolonged periods of time. These uncertainties include those discussed in Part II, Item 1A, “Risk Factors.” Based on a critical assessment of its accounting policies and the underlying judgments and uncertainties affecting the application of those policies, management believes that Applied’s consolidated financial statements are fairly stated in accordance with accounting principles generally accepted in the United States of America, and provide a meaningful presentation of Applied’s financial condition and results of operations.
Management believes that the following are critical accounting policies:
Revenue Recognition
Applied recognizes revenue when all four revenue recognition criteria have been met: persuasive evidence of an arrangement exists; delivery has occurred or services have been rendered; seller’s price to buyer is fixed or determinable; and collectability is probable. Each sale arrangement may contain commercial terms that differ from other arrangements. In addition, Applied frequently enters into contracts that contain multiple deliverables. Judgment is required to properly identify the accounting units of the multiple deliverable transactions and to determine the manner in which revenue should be allocated among the accounting units. Moreover, judgment is used in interpreting the commercial terms and determining when all criteria of revenue recognition have been met in order for revenue recognition to occur in the appropriate accounting period. While changes in the allocation of the estimated sales price between the units of accounting will not affect the amount of total revenue recognized for a particular sales arrangement, any material changes in these allocations could impact the timing of revenue recognition, which could have a material effect on Applied’s financial condition and results of operations.
Warranty Costs
Applied provides for the estimated cost of warranty when revenue is recognized. Estimated warranty costs are determined by analyzing specific product data, current and historical configuration statistics and regional warranty support costs. Applied’s warranty obligation is affected by product and component failure rates, material usage and labor costs incurred in correcting product failures during the warranty period. As Applied’s customer engineers and process support engineers are highly trained and deployed globally, labor availability is a significant factor in determining labor costs. The quantity and availability of critical replacement parts is another significant factor in estimating warranty costs. Unforeseen component failures or exceptional component performance can also result in changes to warranty costs. If actual warranty costs differ substantially from Applied’s estimates, revisions to the estimated warranty liability would be required, which could have a material adverse effect on Applied’s business, financial condition and results of operations.
Allowance for Doubtful Accounts
Applied maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. This allowance is based on historical experience, credit evaluations, specific customer collection history and any customer-specific issues Applied has identified. Changes in circumstances, such as an unexpected material adverse change in a major customer’s ability to meet its financial obligation to Applied or its payment trends, may require Applied to further adjust its estimates of the recoverability of amounts due to Applied, which could have a material adverse effect on Applied’s business, financial condition and results of operations.
Inventory Valuation
Inventories are generally stated at the lower of cost or market, with cost determined on a first-in, first-out basis. The carrying value of inventory is reduced for estimated obsolescence by the difference between its cost and the estimated market value based upon assumptions about future demand. Applied evaluates the inventory carrying value for potential excess and obsolete inventory exposures by analyzing historical and anticipated demand. In addition, inventories are evaluated for potential obsolescence due to the effect of known and anticipated engineering change orders and new products. If actual demand were to be substantially lower than estimated, additional adjustments for excess or obsolete inventory may be required, which could have a material adverse effect on Applied’s business, financial condition and results of operations.
Goodwill and Intangible Assets
Applied reviews goodwill and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable, and also annually reviews goodwill and intangibles with indefinite lives for impairment. Intangible assets, such as purchased technology, are generally recorded in connection with a business acquisition. The value assigned to intangible assets is usually based on estimates and judgments regarding expectations for the success and life cycle of products and technology acquired. If actual product acceptance differs significantly from the estimates, Applied may be required to record an impairment charge to reduce the carrying value of the reporting unit to its realizable value. The fair value of a reporting unit is estimated using both the income approach and the market approach taking into account such factors as future anticipated operating results and estimated cost of capital. Management uses significant judgment when assessing goodwill for potential impairment, especially in emerging markets. If Applied were to encounter challenging economic conditions, such as a decline in operating results, an unfavorable industry or macroeconomic environment, or any other adverse change in market conditions, Applied may be required to perform the two-step quantitative goodwill impairment analysis. If such conditions have the effect of changing one of the critical assumptions or estimates used in the quantitative goodwill impairment analysis, it could result in an unexpected impairment charge for impaired goodwill, which could have a material adverse effect on Applied’s business, financial condition and results of operations.
Income Taxes
The effective tax rate is highly dependent upon the geographic composition of worldwide earnings, tax regulations governing each region, non-tax deductible expenses incurred in connection with acquisitions and availability of tax credits. Management carefully monitors the changes in many factors and adjusts the effective income tax rate as required. If actual results differ from these estimates, Applied could be required to record a valuation allowance on deferred tax assets or adjust its effective income tax rate, which could have a material adverse effect on Applied’s business, financial condition and results of operations.
Applied accounts for income taxes by recognizing deferred tax assets and liabilities using statutory tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities, net operating losses and tax credit carryforwards. Deferred tax assets are also reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized. Management has determined that it is more likely than not that Applied’s future taxable income will be sufficient to realize its deferred tax assets.
The calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent with Applied’s expectations could have a material impact on Applied’s results of operations and financial condition.
Non-GAAP Results
Management uses non-GAAP results to evaluate the Company’s operating and financial performance in light of business objectives and for planning purposes. Applied believes these measures enhance investors’ ability to review the Company’s business from the same perspective as the Company’s management and facilitate comparisons of this period’s results with prior periods. The non-GAAP results presented below and elsewhere in this report exclude the impact of the following, where applicable: restructuring and asset impairment charges and any associated adjustment related to restructuring actions, certain discrete tax items, certain acquisition-related costs, investment impairments, and gain or loss on sale of facilities. These non-GAAP measures are not in accordance with GAAP and may differ from non-GAAP methods of accounting and reporting used by other companies. The presentation of this additional information should not be considered a substitute for results prepared in accordance with GAAP.
CONF CALL
Michael Sullivan - Vice President of Investor Relations
Okay and good afternoon. Joining me today are Mike Splinter, our Chairman and CEO; George Davis, our Chief Financial Officer; and Joe Sweeney, our General Counsel and Corporate Secretary.
Today we'll discuss the results for our third quarter, which ended on July 29. Our earnings release was issued just after 1 p.m. Pacific Time and you could find a copy on our website, appliedmaterials.com. Also on the website is our quarterly financial highlights presentation, which provides additional details.
Mike Splinter will lead off today's call with comments about the industry environment as well as our performance and strategies. George will then discuss our financial performance for the quarter, along with our business outlook.
And so with that introduction, I'd now like to turn the call over to Mike Splinter.
Michael R. Splinter - Chairman and Chief executive Officer
Thanks, Mike, and good afternoon everyone on the call today. I'm pleased to report that Applied Materials delivered solid financial performance in line with our outlook despite challenging industry conditions in semiconductor, display and solar. Thanks to strong execution demonstrated by our teams around the world, we posted $2.3 billion of revenue, with earnings near the midpoint of our target range. Strong cash flow performance enabled us to return $615 million to shareholders while maintaining our cash balance.
Over the past 3 months, we have made excellent progress with the Varian integration. We are accelerating our compliance to combine the 2 companies, and we are on track to exceed our targeted synergy savings.
In June, we announced the appointment of Gary Dickerson as Applied Materials President. I've asked Gary to focus his attention on the company's product strategy and development engine, with a view to improving the effectiveness and efficiency of our R&D investments. Gary is fully immersed in this endeavor, and will provide an update at our next call in November.
As we outlined at SEMICON West, demand for wafer fabrication equipment has softened dramatically since the first half of the year, with sharp declines in foundry and NAND investment. As we look to our fiscal Q4, we see a combination of macroeconomic and industry dynamics contributing to a very weak business environment. We believe this pullback in demand is seasonal, and we expect it to be short-lived, with orders and revenue recovering in our first fiscal quarter.
During this period, we will diligently manage discretionary spending, while focusing our investments on critical programs that support our strategic priorities to grow share in wafer fab equipment and expand our total available market.
From European austerity to slowing growth in China and the U.S., economic uncertainty is weighing on top of a seasonal pullback to produce weaker near-term demand. And our customers are choosing to delay their investments until they see stronger demand signals. China is now the largest market for TVs, PCs and smartphones, and the Chinese economy will play a pivotal role in determining how quickly industry investment levels recover.
While mobility remains the most significant driver of growth in the semiconductor industry, this is also causing changes in market dynamics. For the second year in a row, we are feeling the effects of more pronounced seasonal buying, as consumers wait for new smartphone and tablet models to be released.
With foundries representing about 45% of wafer fab equipment spending in 2012, the investment patterns of these customers are the single most important factor impacting our business today. In addition, lower-than-expected PC sales have held back DRAM bit growth to the 30% range and consequently, investments in new capacity remain at extremely at low levels.
The adoption of solid-state drives is not ramping as quickly as forecast and with only modest increase in the bits per box for mobile devices, we now see NAND bit growth in the range of 60% to 65%. As a result, customers have announced they will cut production by roughly 150,000 wafer starts per month on top of reduction in their capital spending.
Looking at the industry as a whole, we are maintaining the 2012 wafer fab equipment forecast that we shared at SEMICON. We believe spending will be in the range of $30 billion to $33 billion for the year, and there is a firm foundation for the multiyear capital investment cycle to continue.
As the mobility trend gathers pace, we believe foundries will need between 100,000 and 150,000 wafer starts per month of additional 28-nanometer capacity next year. In addition, ultrabooks and Windows 8 have the potential to spur PC growth and drive resurgence in demand for both DRAM and flash memory.
Within this investment cycle, the spending mix favors Applied's leadership areas as customers introduce increasingly complex transistors schemes. We expect 2012 to be a record year for our Epi business, driven by an increasing number of selected Epi applications. Our metal deposition group also delivered another strong quarter, benefiting from broader adoption of metal gate transistors.
With the 450-millimeter road map becoming clearer and timing of major milestones more predictable, we continue to ramp our development program to be in the right position at the right time to serve our customers through this transition.
In Display, mobility-related markets represented 100% of our orders this quarter. We expect investment in these markets to remain at healthy levels as customers shift production of displays and touch panels for both smartphones and tablets to larger substrate sizes and more advanced technologies.
In contrast, TV sales for the first half of the year were around 90 million units, which is below the level needed to stimulate capacity additions.
In the near term, TV-related investment will be limited to development tools for new technology, focused on metal oxide transistors and organic LEDs.
As macroeconomic conditions improve, we believe that TV supply and demand can rebalance quickly, and this will provide a catalyst for customers to resume their plans to populate new factories in China. We expect to see the first orders for these factories before the end of the calendar year.
In solar, end-market demand is still robust and we maintain our view that global installations will be in the range of 27 to 35 gigawatts for the year. The industry is relentlessly driving down manufacturing costs and making conversion efficiency improvements. As a result, TV-generated electricity is reaching parity with retail electricity rates in many areas of the world.
At the same time, overcapacity within the supply chain has created an exceptionally challenging environment for wafer, cell and module manufacturers. Our EES results reflect an environment of extremely cautious investment by our customers as they focus on conserving cash.
Industry consolidation is occurring, albeit slower than anticipated, and this rationalization of capacity will be a critical factor in determining when the supply and demand come back into balance.
We remain focused on lowering our cost structure in EES, and have made significant progress shifting our manufacturing footprint to Asia while exiting LED.
In summary, we are currently navigating a period of turbulence in our markets and managing a rapidly changing demand profile in our semiconductor equipment business. We delivered solid results for the third quarter, and we're operating the company efficiently with disciplined spending, aligned to the contours of this business environment.
Although we see a weak near-term outlook, we firmly believe that the fundamental trends in mobility and solar energy adoption provide a strong platform for Applied Materials to generate long-term value and attractive returns for our shareholders.
Now let me hand the call over to George for additional comments on our performance and outlook. George?
George S. Davis - Chief Financial Officer and Executive Vice President
Thank you, Mike. And let me add my welcome to everyone on the call today. In our third fiscal quarter, Applied generated strong operating cash flow and ramped the return of cash to shareholders, buying back 3.6% of shares outstanding in the quarter. In a difficult environment, we are controlling spending while ensuring we prioritize investment in key areas to support future growth.
Let me start by comparing our third quarter results to the prior quarter. Orders declined 35% to $1.8 billion, reflecting push-outs in semiconductor equipment, lower AGS orders due to the absence of a finFET thin-film solar order and continuing weak demand in our non-semiconductor business.
Net sales decreased 8% to $2.3 billion due to lower semiconductor equipment sales. Non-GAAP gross margin was down slightly to 41.6%, primarily due to the impact of lower volumes. Total non-GAAP operating expenses were $543 million, 6% below our Q2 levels and 4% below our outlook of $565 million plus or minus $10 million. Adjusting for onetime beneficial items, our run rate was approximately $560 million.
For the fourth quarter, we expect to lower our target run rate to $545 million plus or minus $10 million, as we continue to tightly manage discretionary spending while selectively increasing our investment for critical programs in SSG.
Our non-GAAP effective tax rate was 27% and for the fiscal year, the rate expectation remains at 26% to 27%. The modest uptick in the rate reflected the impact of lower revenue on our global tax structure.
Cash and investments ended the quarter approximately flat at $3.2 billion, as our operating cash flow offset total cash return to shareholders and CapEx. Our strong cash flow performance was due to effective working capital management, with improved inventory and receivable balances offsetting the impact of lower revenues.
Our capital allocation priorities for cash continue to be investing in attractive opportunities in our businesses, increasing the dividend in line with the growth of the business and utilizing share repurchases as the preferred means of returning excess cash.
We increased share buybacks to $500 million in the quarter, repurchasing 46.7 million shares at an average price of $10.71 per share. We also paid $115 million in dividends, reflecting the 13% increase that we announced in March.
Over the past 4 quarters, we have repurchased approximately 97 million shares or more than 7% of shares outstanding at an average price of $11.08. We expect to continue to be an active buyer of our stock in this environment.
Next I will comment on our segment results as compared to the prior quarter. SSG orders were down 41% to $1.2 billion, led by foundry customers. For our fiscal year, we expect SSG orders will be weighted 60% to 65% in the first half, with nearly 70% of foundry orders in the first half of our fiscal year.
Net sales decreased 13% to $1.5 billion, consistent with our outlook at the SEMICON West briefing. The largest sequential declines were from foundry and NAND at 17% and 18%, respectively. SSG's non-GAAP operating margin was 31.2%, in line with model performance.
In AGS, orders were $531 million. Excluding a thin-film solar line booked in fiscal Q2, orders declined 4% sequentially. AGS net sales were up 5% to $579 million, as strengths in spares and services offset weakness in 200-millimeter equipment demand. AGS achieved model performance, with non-GAAP operating margin increasing to 23.3%.
In Display, orders decreased to $67 million, as LCD equipment spending continue to push out. This is the fourth consecutive quarter with orders below $100 million, reflecting exceptionally low demand for television manufacturing equipment. Net sales for Display were up 6% to $142 million, with mobility investments for touch panel and high-resolution screens accounting for the majority of revenue. Non-GAAP operating margin for the quarter was 8.5%.
In EES, orders decreased to $35 million, reflecting low solar equipment demand as capacity continues to be absorbed. Net sales were approximately flat at $77 million, with solar sales largely reflecting deferred revenue. EES had a non-GAAP operating loss of $64 million, which included an inventory charge of $26 million.
Next I will talk about our expectations for the fourth quarter. As Mike indicated, we are seeing strong seasonal effects in our wafer fab equipment business, along with macroeconomic uncertainties that are leading our customers to reduce spending until they see signs of stronger consumer demand over the next few months. Accordingly, absent further weakening in the global economy, we expect the company's orders and revenues to bottom in our fiscal Q4.
Turning to our business segments, we expect SSG net sales to be down 45% to 55% in Q4, marking the low point of our business for the year. We are seeing a strong pullback across all categories of semiconductor equipment customers, and this is the primary factor in the near-term reduction in earnings for the company.
In AGS, we expect net sales to be up 5% to 15%, including more than $75 million in revenue from a thin-film solar line.
In Display, we believe net sales will be down 25% to 40%, as the TV capacity ramp in China is pushed out for at least an additional quarter. Despite the low level of revenue, we expect Display to remain profitable in the quarter.
In EES, we expect net sales to be down 10% to 30%, as the timing of the solar equipment recovery remains uncertain.
We expect our overall net sales to be down 25% to 40%, and our non-GAAP earnings to be between $0 and $0.06 per share.
Now, Mike, let's open the call for questions.
Michael Sullivan - Vice President of Investor Relations
Thanks, George. [Operator Instructions] Jay, let's begin.
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