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

• Overview: a summary of Applied's business and measurements

• Results of Operations: a discussion of operating results

• Segment Information: a discussion of segment operating results

• Business Combinations: a summary or overview of acquired businesses

• Recent Accounting Pronouncements: a discussion of new accounting pronouncements and its impact to Applied's consolidated financial statements

• Financial Condition, Liquidity and Capital Resources: an analysis of cash flows, sources and uses of cash, contractual obligations and financial position

• Off-Balance Sheet Arrangements and Contractual Obligations

• Critical Accounting Policies: a discussion of critical accounting policies that require the exercise of judgments and estimates

• Non-GAAP Results: a presentation of results reconciling GAAP to non-GAAP measures

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 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 following table presents certain significant measurements for the past three fiscal years:

                                                                                      Change
Fiscal Year                    2012           2011           2010        2012 over 2011     2011 over 2010

                                       (In millions, except per share amounts and percentages)
New orders                 $    8,037     $   10,142     $   10,249     $       (2,105 )   $        (107 )
Net sales                  $    8,719     $   10,517     $    9,549     $       (1,798 )   $         968
Gross margin               $    3,313     $    4,360     $    3,715     $       (1,047 )   $         645
Gross margin percent             38.0 %         41.5 %         38.9 %     (3.5) points        2.6 points
Operating income           $      411     $    2,398     $    1,384     $       (1,987 )   $       1,014
Operating margin percent          4.7 %         22.8 %         14.5 %    (18.1) points        8.3 points
Net income                 $      109     $    1,926     $      938     $       (1,817 )   $         988
Earnings per diluted share $     0.09     $     1.45     $     0.70     $        (1.36 )   $        0.75
Non-GAAP Results
Gross margin               $    3,566     $    4,397     $    3,788     $         (831 )   $         609
Gross margin percent             40.9 %         41.8 %         39.7 %     (0.9) points        2.1 points
Operating income           $    1,379     $    2,411     $    1,731     $       (1,032 )   $         680
Operating margin percent         15.8 %         22.9 %         18.1 %     (7.1) points        4.8 points
Net income                 $      960     $    1,723     $    1,181     $         (763 )   $         542
Earnings per diluted share $     0.75     $     1.30     $     0.88     $        (0.55 )   $        0.42

Reconciliations of non-GAAP measures are presented under "Non-GAAP Results" below. Fiscal 2012 and 2011 each contained 52 weeks each, while fiscal 2010 contained 53 weeks.
Fiscal 2012 was a year characterized by significant fluctuations in demand for semiconductor equipment, which is Applied's largest business, coupled with an extremely weak market environment for display and solar equipment. Mobility, connectivity and cloud computing trends drove the semiconductor industry spending, with mobility as the biggest influence. Applied also completed its acquisition of Varian in the first quarter of fiscal 2012. Consumer buying patterns for electronic products, combined with growing semiconductor customer concentration, contributed to a seasonality effect, with relatively strong demand for semiconductor equipment led by foundry customers during the first half of fiscal 2012, followed by softening of demand from foundry and logic customers in the third quarter of fiscal 2012 and further declines across all categories of wafer fab equipment customers in the fourth quarter of fiscal 2012. Low investment levels for display equipment continued in fiscal 2012, characterized by decreased capacity requirements for larger flat panel televisions as conditions in this industry remained challenging. As with the semiconductor industry, demand for mobility products, such as smartphones and tablets, significantly influenced equipment spending in the display industry. In the solar industry, fiscal 2012 was characterized by continued excess manufacturing capacity, which led to significantly reduced demand for c-Si equipment, as well as weaker operating performance and outlook by the fourth quarter of fiscal 2012.
The first nine months of fiscal 2011 reflected increased demand across all segments except Display due to more favorable global economic and industry conditions than in fiscal 2010, although demand softened for semiconductor, LCD and solar equipment in the last quarter of fiscal 2011. Towards the end of fiscal 2011, the semiconductor, LCD and solar industries were negatively impacted by uncertainty in the macroeconomic environment and the LCD and solar equipment industries were also negatively impacted by overcapacity. Applied's strategic priorities for 2013 include expanding market share in wafer fab equipment and growing its technical capabilities, extending its technology leadership in solar and display equipment and enhancing its organization in key product areas. In semiconductor equipment, Applied intends to increase investment in 300mm and 450mm research and development and enhance the technical field team. In addition, Applied plans to make selective investments in developing enabling technologies for display and solar products.

Results of Operations
The following table presents certain quarterly and full fiscal year financial information:

                                                  Fiscal Quarter                     Fiscal
                                      First        Second     Third      Fourth       Year

                                            (In millions, except per share amounts)
2012:
New orders                        $   2,008       $ 2,765    $ 1,799    $ 1,465     $  8,037
Net sales                         $   2,189       $ 2,541    $ 2,343    $ 1,646     $  8,719
Gross margin                      $     786       $ 1,011    $   930    $   586     $  3,313
Operating income (loss)           $     179       $   409    $   322    $  (499 )   $    411
Net income (loss)                 $     117       $   289    $   218    $  (515 )   $    109
Earnings (loss) per diluted share $    0.09       $  0.22    $  0.17    $ (0.42 )   $   0.09
2011:
New orders                        $   2,971       $ 3,185    $ 2,390    $ 1,596     $ 10,142
Net sales                         $   2,686       $ 2,862    $ 2,787    $ 2,182     $ 10,517
Gross margin                      $   1,136       $ 1,189    $ 1,184    $   852     $  4,360
Operating income                  $     674       $   677    $   687    $   361     $  2,398
Net income                        $     506       $   489    $   476    $   456     $  1,926
Earnings per diluted share        $    0.38       $  0.37    $  0.36    $  0.34     $   1.45
2010:
New orders                        $   1,965       $ 2,533    $ 2,725    $ 3,026     $ 10,249
Net sales                         $   1,849       $ 2,296    $ 2,518    $ 2,886     $  9,549
Gross margin                      $     711       $   927    $   860    $ 1,217     $  3,715
Operating income                  $     116       $   386    $   183    $   699     $  1,384
Net income                        $      83       $   264    $   123    $   468     $    938
Earnings per diluted share        $    0.06       $  0.20    $  0.09    $  0.35     $   0.70

Orders and sales for manufacturing equipment historically has been volatile across all segments as a result of sudden changes in demand and other factors, including global economic and market conditions and rapid technological advances in fabrication processes. Applied's business was subject to cyclical industry conditions in fiscal 2012, 2011 and 2010. As a result of these conditions and the changing global economic environment, there were significant fluctuations in Applied's quarterly new orders and net sales, both within and across the three fiscal years. As of the end of fiscal 2012 and 2011, the semiconductor, display and solar equipment industries were each in a capacity-driven downturn. The nature and timing of a recovery in capital equipment investment are expected to depend largely on the macroeconomic environment.

New Orders
New orders by geographic region, determined by the product shipment destination
specified by the customer, were as follows:

                                         Change                                  Change
                      2012           2012 over 2011           2011           2011 over 2010           2010

                                                (In millions, except percentages)
Taiwan         $ 2,155        27 %        (4)%        $  2,235        22 %       (19)%        $  2,760        27 %
China              403         5 %       (80)%           2,066        20 %        (4)%           2,155        21 %
Korea            1,784        22 %        39%            1,286        13 %       (24)%           1,703        17 %
Japan              600         7 %       (40)%           1,001        10 %        35%              741         7 %
Southeast Asia     283         4 %       (39)%             463         5 %       (31)%             675         7 %
Asia Pacific     5,225        65 %       (26)%           7,051        70 %       (12)%           8,034        79 %
United States    1,995        25 %        (4)%           2,069        20 %        53%            1,348        13 %
Europe             817        10 %       (20)%           1,022        10 %        18%              867         8 %
Total          $ 8,037       100 %       (21)%        $ 10,142       100 %        (1)%        $ 10,249       100 %

New orders for fiscal 2012 decreased from fiscal 2011, reflecting a steep decline in demand for c-Si solar equipment, combined with reduced demand for LCD TV and semiconductor equipment, partially offset by new orders of $1.0 billion attributable to Varian. The reduction in new orders from customers in China primarily reflected the decreased investments in the solar industry due to overcapacity. Customers in Taiwan, United States and Korea together represented 74 percent of total new orders for fiscal 2012. In the fourth quarter of fiscal 2012, new orders were $1.5 billion, down 19 percent from the prior quarter, reflecting lower semiconductor equipment demand, partially offset by modest order increases in other segments.
New orders for fiscal 2011 were slightly down from fiscal 2010, primarily attributable to decreased demand for semiconductor equipment from memory customers and decreased demand for LCD TV equipment, partially offset by increased demand for touch panel tools from display customers and increased demand for c-Si equipment from solar manufacturers. Customers in Taiwan, United States and China together represented 62 percent of total new orders for fiscal 2011. In the fourth quarter of fiscal 2011, new orders were $1.6 billion, down 33 percent from the third quarter of fiscal 2011.
New orders by reportable segment for the past three fiscal years were as follows:

                                         Change                                  Change
                      2012           2012 over 2011           2011           2011 over 2010           2010

                                                (In millions, except percentages)
Silicon
Systems Group  $ 5,294        66 %        (4)%        $  5,489        54 %        (5)%        $  5,759        56 %
Applied Global
Services         2,274        28 %        (3)%           2,333        23 %         7%            2,183        21 %
Display            274         4 %       (57)%             636         6 %       (20)%             799         8 %
Energy and
Environmental
Solutions          195         2 %       (88)%           1,684        17 %        12%            1,508        15 %
Total          $ 8,037       100 %       (21)%        $ 10,142       100 %        (1)%        $ 10,249       100 %

New orders for fiscal 2012 decreased for all segments compared to the same periods in the prior year, mostly due to the excess manufacturing capacity in the solar industry and the continued down cycle in the display industry, partially offset by the addition of orders attributable to Varian of $1.0 billion. The Silicon Systems Group's and Applied Global Services' relative share of total new orders increased compared to the prior year as a result of the addition of Varian and the sharp decrease in orders in Display and Energy and Environmental Solutions.
For fiscal 2011 as compared to fiscal 2010, new orders by segment as well as the relative share of total new orders for the Silicon Systems Group and Display decreased, while new orders by segment as well as the relative share of new orders in Applied Global Services and Energy and Environmental Solutions increased.

Changes in backlog during fiscal 2012 and 2011 were as follows:

                    2012         2011
                      (In millions)
Beginning balance $ 2,392     $  3,244
New orders          8,037       10,142
Net sales          (8,719 )    (10,517 )
Net adjustments      (104 )       (477 )
Ending balance    $ 1,606     $  2,392

Backlog consists of: (1) orders for which written authorizations have been accepted and assigned shipment dates are within the next 12 months, or shipment has occurred but revenue has not been recognized; and (2) contractual service revenue and maintenance fees to be earned within the next 12 months. Applied's backlog at any particular time is not necessarily indicative of actual sales for any future periods, due to the potential for customer changes in delivery schedules or cancellation of orders. Approximately 75 percent of the backlog as of the end of fiscal 2012 is anticipated to be shipped within the first two quarters of fiscal 2013.
Applied's backlog was $1.6 billion at October 28, 2012 as compared to $2.4 billion at October 30, 2011. Backlog adjustments were negative for fiscal 2012 and totaled $104 million, primarily consisting of customer cancellations. Backlog by reportable segment as of October 28, 2012 and October 30, 2011 was as follows:

                                                          Change
                                         2012         2012 over 2011         2011

                                            (In millions, except percentages)
Silicon Systems Group              $   705     44 %       (23)%        $   913     38 %
Applied Global Services                580     36 %       (12)%            662     28 %
Display                                206     13 %       (39)%            337     14 %
Energy and Environmental Solutions     115      7 %       (76)%            480     20 %
Total                              $ 1,606    100 %       (33)%        $ 2,392    100 %

Backlog decreased in fiscal 2012 from fiscal 2011 across all segments reflecting decreased demand for semiconductor, LCD and solar equipment. In the fourth quarter of fiscal 2012, approximately 53 percent of net sales in the Silicon Systems Group, Applied's largest business segment, were for orders received and shipped within the quarter, up from 45 percent in the fourth quarter of fiscal 2011.
Net Sales
Net sales by geographic region, determined by the location of customers' facilities to which products were shipped, were as follows:

                                         Change                                  Change
                      2012           2012 over 2011           2011           2011 over 2010          2010

                                               (In millions, except percentages)
Taiwan           2,411        28 %        15%            2,093        20 %       (24)%          2,750        29 %
China              783         9 %       (70)%           2,574        24 %        65%           1,557        16 %
Korea            1,897        22 %        50%            1,263        12 %       (29)%          1,768        19 %
Japan              704         8 %       (23)%             912         9 %        19%             768         8 %
Southeast Asia     312         3 %       (47)%             592         5 %         2%             578         6 %
Asia Pacific     6,107        70 %       (18)%           7,434        70 %         -%           7,421        78 %
United States    1,749        20 %       (11)%           1,963        19 %        71%           1,147        12 %
Europe             863        10 %       (23)%           1,120        11 %        14%             981        10 %
Total          $ 8,719       100 %       (17)%        $ 10,517       100 %        10%         $ 9,549       100 %

Net sales for fiscal 2012 decreased from the prior year, primarily due to decreased industry investment in c-Si solar products and LCD TV equipment, partially offset by sales attributable to Varian. Net sales attributable to Varian were $1.0 billion for fiscal 2012. The reduction in net sales from customers in China primarily reflected the decreased investments in the solar and display industries due to overcapacity. Customers in Taiwan, Korea and United States combined represented 70 percent of total net sales in fiscal 2012. In the fourth quarter of fiscal 2012, net sales were $1.6 billion, down 30 percent from the prior quarter, led by a reduction in semiconductor equipment sales.
Net sales for fiscal 2011 increased from fiscal 2010, primarily due to increased industry investment in c-Si solar equipment and higher sales of spares and refurbished semiconductor equipment. Customers in China, Taiwan and United States combined represented 63 percent of total net sales in fiscal 2011. Net sales by reportable segment for the past three fiscal years were as follows:

                                         Change                                  Change
                      2012           2012 over 2011           2011           2011 over 2010          2010

                                               (In millions, except percentages)
Silicon
Systems Group  $ 5,536        64 %         2%         $  5,415        51 %         2%         $ 5,304        56 %
Applied Global
Services         2,285        26 %        (5)%           2,413        23 %        29%           1,865        20 %
Display            473         5 %       (32)%             699         7 %       (22)%            899         9 %
Energy and
Environmental
Solutions          425         5 %       (79)%           1,990        19 %        34%           1,481        15 %
Total          $ 8,719       100 %       (17)%        $ 10,517       100 %        10%         $ 9,549       100 %

For fiscal 2012 as compared to fiscal 2011, net sales in the Silicon Systems Group increased slightly while net sales across all other segments decreased. The decrease reflected lower investments in c-Si solar and LCD TV equipment, partially offset by sales attributable to Varian. The Silicon Systems Group's relative share of total net sales increased compared to the prior year and remains the largest contributor of net sales.
For fiscal 2011 as compared to fiscal 2010, net sales in the Silicon Systems Group remained essentially flat while net sales in Energy and Environment Solutions and Applied Global Services increased due to increased demand for c-Si equipment, and spare parts and refurbished equipment, respectively. Net sales in Display decreased during fiscal 2011 as compared to fiscal 2010 due to a weaker LCD TV market. For fiscal 2011 as compared to fiscal 2010, the relative share of total net sales in the Silicon Systems Group decreased, while the relative share of total net sales in Energy and Environmental Solutions increased. The increase in Energy and Environmental Solutions' relative share of total net sales was due to increased demand for c-Si equipment.
Gross Margin
Gross margins for the past three fiscal years were as follows:

                                                                                    Change
                            2012           2011           2010        2012 over 2011      2011 over 2010

                                                (In millions, except percentages)
Gross margin            $    3,313     $    4,360     $    3,715     $       (1,047 )   $            645
Gross margin (% of net
sales)                        38.0 %         41.5 %         38.9 %     (3.5) points         2.6 points
Non-GAAP Results
Gross margin            $    3,566     $    4,397     $    3,788     $         (831 )   $            609
Gross margin (% of net
sales)                        40.9 %         41.8 %         39.7 %     (0.9) points         2.1 points

Reconciliations of non-GAAP measures are presented under "Non-GAAP Results" below.
Gross margin decreased in fiscal 2012 from fiscal 2011 due primarily to changes in segment and customer mix, inventory fair value adjustments and intangible asset amortization associated with purchase accounting, additional inventory reserves and lower net sales, partially offset by sales for a single thin film solar production line, for which inventory was fully reserved prior to fiscal 2012. Inventory fair value adjustments and intangible asset amortization, mostly associated with the acquisition of Varian, were $253 million in fiscal 2012. Inventory charges of approximately $290 million were recorded in fiscal 2012 as a result of the softening of demand for semiconductor-related businesses and continued weakness in the solar industry. Of the total inventory charges during fiscal 2012, $13 million were recorded in connection with the restructuring of the Energy and Environmental Solutions segment. The increase in gross margin and non-GAAP gross margin in fiscal 2011 from fiscal 2010 was principally

attributable to the inventory-related charges of $330 million incurred in fiscal 2010 associated with SunFab thin film solar equipment, which lowered gross margin for fiscal 2010 by approximately 3 percentage points. Gross margin during fiscal 2012, 2011 and 2010 included $54 million, $48 million and $32 million, respectively, of share-based compensation expense. Research, Development and Engineering
Research, Development and Engineering (RD&E) expenses for the past three fiscal years were as follows:

                                                                                     Change
                            2012           2011           2010         2012 over 2011       2011 over 2010

                                                           (In millions)
Research, development
and engineering         $    1,237     $    1,118     $    1,143     $            119     $          (25 )

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. The increase in RD&E for fiscal 2012 compared to the prior year was primarily due to the RD&E expenses related to Varian of approximately $180 million and continued investment in the development of smaller linewidths and 450mm wafer equipment, partially offset by lower investments in solar R&D projects and the cessation of LED equipment development. 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. RD&E expense during fiscal 2012, 2011 and 2010 included $54 million, $46 million and $43 million, respectively, of share-based compensation expense.
In fiscal 2012, Applied developed transistor and interconnect technologies for . . .