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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number 0-6920

Applied Materials, Inc.

Registrant’s telephone number, including area code

Securities registered pursuant to Section 12(b) of the Act:

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes þ          No o

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes þ          No o

     Aggregate market value of the voting stock held by non-affiliates of the registrant as of April 27, 2003, based upon the closing sale price reported by the Nasdaq National Market on that date: $23,089,903,123. Aggregate market value of the voting stock held by non-affiliates of the registrant as of December 26, 2003, based upon the closing sale price reported by the Nasdaq National Market on that date: $37,501,091,957.

     Number of shares outstanding of the issuer’s Common Stock, $.01 par value, as of December 26, 2003: 1,681,469,908

     Portions of the definitive Proxy Statement for Applied Materials, Inc.’s Annual Meeting of Stockholders to be held on March 24, 2004 are incorporated by reference into Part III of this Form 10-K.

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      This Annual Report on Form 10-K of Applied Materials, Inc. and its subsidiaries (Applied or the Company) contains forward-looking statements. All statements other than statements of historical fact may be forward-looking statements. These include statements regarding Applied’s future financial results, operating results, business strategies, projected costs and capital expenditures, products, competitive positions, and plans and objectives of management for future operations. Forward-looking statements may be identified by use of words such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “intend” and “continue,” or the negative of these terms, and include the assumptions that underlie such statements. Applied’s actual results could differ materially from those expressed or implied in these forward-looking statements as a result of various risks and uncertainties, including those set forth in the section entitled “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations — Trends, Risks and Uncertainties.” All forward-looking statements in this report are based on information available to Applied as of the date hereof and Applied assumes no obligation to update any such statements.

      The following information should be read in conjunction with the Consolidated Financial Statements and notes thereto included in this Annual Report. All references to fiscal year apply to Applied’s fiscal year which ends on the last Sunday in October.

      Organized in 1967, Applied, a Delaware corporation, develops, manufactures, markets and services integrated circuit fabrication equipment for the worldwide semiconductor industry. Customers for these products include semiconductor wafer manufacturers and semiconductor integrated circuit (or chip) manufacturers, who either use the semiconductors they manufacture in their own products or sell them to other companies for use in advanced electronic components.

      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). As the density of the circuit components is increased to enable greater computing power in the same or smaller area, the complexity of building the chip also increases, necessitating the formation of smaller structures and more intricate wiring schemes. 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 remove selected film layers. Similar processes are then used to build the layers of wiring structures on the wafer. A typical, simplified process sequence for building the wiring portion of copper-based chips involves initially depositing a dielectric film layer onto the base layer of circuit components using a chemical vapor deposition (CVD) system. An etch system is then used to create openings and patterns in the dielectric layer. To form the metal wiring, these openings and patterns are subsequently filled with conducting material using physical vapor deposition (PVD) and/or electrochemical plating (ECP) technologies. A chemical mechanical polishing (CMP) step then polishes the wafer to maintain a flat surface. Additional deposition, etch and CMP steps are then performed to build up the layers of wiring needed to complete the interconnection of the circuit elements to form the chip. Advanced chip designs require about 500 steps involving these and other processes to complete the manufacturing cycle.

      Applied operates in a single industry segment for the manufacture, marketing and servicing of integrated circuit fabrication equipment. Applied currently manufactures systems that perform most of the primary steps in the chip fabrication process, including: atomic layer deposition (ALD), CVD, PVD, ECP, etch, ion implantation, rapid thermal processing (RTP), CMP, metrology and wafer inspection. Applied’s subsidiary, AKT, Inc. (AKT), manufactures CVD systems and array testers for making flat panel displays (FPDs) used in notebook computers, desktop monitors, televisions and other applications. Applied’s subsidiary, Etec Systems, Inc. (Etec), is a manufacturer of systems that generate, etch, measure and inspect circuit patterns on masks used in the photolithography process. Applied also provides products and services to enhance manufacturing yields.

      Most of Applied’s products are single-wafer systems with multiple process chambers attached to a base platform. The simultaneous processing of several wafers enables high manufacturing productivity and precise control of the process. Applied sells most of its single-wafer, multi-chamber systems on four basic mainframes: the Centura®, the Endura®, the Producer® and the Vantage^TM platforms. These platforms currently support ALD, CVD, PVD, etch and RTP technologies.

      Throughout its history, the semiconductor industry has migrated to increasingly larger wafers to build its chips. The predominant wafer size used for volume production today is 200mm, or eight-inch, wafers, but

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      A majority of process steps used in chipmaking are performed to build the interconnect, a complex matrix of microscopic wires that carry electrical signals to connect the transistor and capacitor components of a chip. Customers are transitioning from using aluminum as the main conducting material for the interconnect to copper, which has lower resistance than aluminum and can carry more current in a smaller area. Applied is a leading supplier of systems for manufacturing copper-based chips, ranging from the systems to deposit tantalum nitride barrier and copper materials to CMP products, for smoothing these layers for optimized planarity.

      Complementing the transition to copper to improve chip speed is the use of highly efficient low dielectric constant (low k) films to replace silicon dioxide as the insulator between the copper wiring structures. Applied leads the industry in providing a low k dielectric process that is being used in volume production by a number of semiconductor manufacturers.

      The transistor portion of the chip is another area in which semiconductor manufacturers are advancing their device designs to improve speed. Applied introduced several new products this year for these new applications, particularly in the areas of epitaxy, nitride and tungsten deposition to enable these enhanced designs.

Products

      The following summarizes Applied’s portfolio of products and process technologies.

      Deposition is a fundamental step in fabricating a semiconductor. During deposition, a layer of either dielectric (material used as insulation between conductors) or electrically conductive (typically metal materials used to carry current) film is deposited or grown on a wafer. Applied currently provides equipment to perform the four main types of deposition: atomic layer deposition, chemical vapor deposition, physical vapor deposition and electrochemical plating. Applied also offers certain types of dielectric deposition processes using its rapid thermal processing systems.

      ALD is an emerging technology in which single layers of atoms are used to build chip structures. This technology enables customers to deposit a very thin layer of either conducting or insulating material with uniform coverage in very small areas. Applied offers ALD processes for depositing tungsten and tantalum nitride films. The Applied Endura iCuB/S^TM product is the industry’s first system to integrate ALD and PVD chambers on a single platform for depositing the critical barrier and seed layers in copper interconnects. The Applied Centura iSprint Tungsten system combines an ALD chamber to deposit a tungsten nucleation film with a CVD tungsten bulk fill process on one system. The iSprint is used to form contact structures that connect the transistors to the wiring areas of the chip.

      CVD is used by customers 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, silicon nitride, dielectric anti-reflective coatings, low k dielectric (highly efficient insulating materials), high k dielectric (electrical charge-storing materials), aluminum, titanium, titanium nitride, polysilicon, tungsten, refractory metals or silicides. Applied offers the following CVD products and technologies:

      The Applied Producer CVD system — This high-throughput platform features Twin-Chamber^TM 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 maximum simultaneous processing capacity of six wafers. Many of Applied’s dielectric CVD processes can be performed on this platform. The Applied Producer Advanced Patterning Film^TM process is an innovative CVD hardmask film that enables customers to fabricate sub-50 nanometer (nm) transistor gates and contact structures using standard lithography. In fiscal 2003, the Company introduced the Applied Producer DARC 193 process, a dielectric anti-reflective coating that provides the precise dimensional control and compatibility needed for fabricating interconnects and transistors using advanced lithography methods.

      The Applied Centura Ultima HDP-CVD® system — High-density plasma CVD (HDP-CVD) is used to fill very small, deep spaces with dielectric film. One of the processes offered on the system is fluorinated

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      Low k Dielectric Films — Many semiconductor manufacturers are now incorporating new low k dielectric materials in their new copper-based chip designs to improve interconnect speed. The Applied Producer Black Diamond^TM CVD low k process is being used by customers in volume production to produce some of the industry’s most advanced devices. Using conventional CVD equipment, the Black Diamond process has provided customers with a cost-effective way to transition to this new and challenging material. A complementary low k dielectric film, called the Applied Producer BLOk^TM (Barrier Low k) enables the complete, multi-layer dielectric structure to benefit from low k technology.

      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 semiconductor 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. Launched in fiscal 2003, the Applied Centura RP Epi system offers selective epi processes for transistor-level applications. In addition to silicon applications, the Company offers the Applied Centura Epi system for silicon-germanium epi process technology, which can reduce power usage and increase speed in certain types of advanced chips.

      Polysilicon Deposition — Polysilicon is a type of silicon used to form portions of the transistor structure within the semiconductor device. The Applied Centura Polygen^TM LPCVD (low pressure chemical vapor deposition) system is a single-wafer, multi-chamber product that deposits thin polysilicon films at high temperatures with high productivity and process control. A variant of the system, the Applied Centura Polycide LPCVD product, combines chambers for polysilicon and tungsten silicide deposition on the Centura platform in an integrated process to create transistor gate structures in memory chips. To address the challenging requirements of 130nm and below devices, the Applied Centura DPN (decoupled plasma nitridation) system integrates chambers for DPN and RTP anneal on one platform to enable superior film quality, material properties and process control.

      Silicon Nitride Deposition — The Applied Centura SiNgen^TM LPCVD system is a single-wafer, high-temperature system that deposits silicon nitride films in transistor-area applications. This system minimizes the amount of time the wafer is exposed to high temperatures and reduces particles while improving operating cost and productivity in critical transistor nitride layers for 130nm and below devices. The system also features the DPN chamber which uses a plasma process to incorporate a high concentration of nitrogen into the gate oxide to prevent leakage in devices with 90nm and below designs.

      Tungsten Deposition — Tungsten material 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. The Company has two products for depositing tungsten: the Applied Centura Sprint^TM Tungsten CVD system for 130nm and 90nm devices and the advanced Applied Centura iSprint ALD/CVD system. The latter product combines ALD technology and CVD chambers on the same platform for 65nm and below applications.

      PVD, also called sputtering, is a physical process in which atoms of a gas, such as argon, are accelerated at 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 deposition processes, including aluminum, aluminum alloys, cobalt, titanium/ titanium nitride, tantalum/ tantalum nitride, tungsten/ tungsten nitride, nickel vanadium and copper (Cu). The Applied Endura CuB/S (copper barrier/seed) PVD system, launched in fiscal 1998, is widely used by customers for fabricating copper-based chips. Using PVD technology, the system deposits the critical layers that prevent copper material from entering other areas of the device and primes the structure for the subsequent deposition of bulk copper material by electrochemical plating.

      The Endura’s highly flexible, multi-chamber architecture allows the integration of multiple PVD processes or combinations of metal CVD and PVD technologies on the same system. In addition to the integrated Applied Endura iCuB/S ALD/PVD system (discussed in the Atomic Layer Deposition section), the Applied Endura iLB PVD/CVD system combines a PVD chamber for depositing titanium with a CVD chamber for titanium nitride deposition to form the critical lining layers of interconnect structures. These structures are subsequently filled with tungsten, aluminum, copper or other materials.

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      Electrochemical plating 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 and improve the adhesion of the copper film.

      The Applied SlimCell ECP (electrochemical plating) system introduced in fiscal 2003, offers a new small-volume cell design that allows independent bath chemistry for multi-step processing. The system enables a reduction in defect levels compared to conventional large bath systems while reducing chemical consumption.

      Etching is used many times throughout the semiconductor 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 full range of systems for etching dielectric, metal and silicon films to meet the requirements of sub-100nm processing.

      For dielectric applications, the Applied Centura eMax^TM system etches a broad range of films in the contact and interconnect regions of the chip. The recently introduced high-throughput Applied Producer Etch system targets cost-driven etch applications with 90nm and below design geometries. To address advanced low k etch applications, the Company introduced its Applied Centura Enabler^TM Etch system in fiscal 2003 that performs etch, strip and clean steps in a single chamber. The Enabler’s all-in-one capability streamlines the process flow for 65nm and below chip designs and significantly reduces operating costs.

      The Applied Centura DPS Etch systems are used to etch conducting films, such as metal and silicon materials, and offer customers the technology, productivity and reliability required for 100nm and below processing. The Applied Centura Transforma^TM Etch patterning system combines silicon etch technology with integrated metrology capability to enable customers to improve process control, device yield and overall fab cycle time for building advanced transistor gate structures.

      During ion implantation, silicon wafers are bombarded by a beam of ions, called dopants, that penetrate (or implant) the film surface to a desired depth. The implantation step is used during transistor fabrication to change the properties of a material and achieve a particular electrical performance.

      Low-energy, high current implant technology is key to enabling the fabrication of smaller structures, which contributes to faster transistor performance. The Applied Quantum^TM II system provides customers with the capability to create thin, advanced transistor structures for sub-100nm applications.

      RTP subjects a wafer 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. RTP is used mainly for modifying the properties of deposited films. The Applied Centura XE+ and Radiance® RTP systems offer advances in temperature and ramp rate control as well as other features aimed at providing leading-edge capability for sub-130nm generations. These single-wafer systems are also used for growing high quality oxide and oxynitride films, deposition steps that traditional batch furnaces can no longer achieve with the necessary precision and control. The Company also offers the Applied Vantage Radiance RTP system, a streamlined platform designed for high-volume 300mm manufacturing.

      CMP removes material from a wafer to create a flat (planarized) surface. This allows subsequent photolithography patterning steps to take place with greater accuracy and enables film layers to build up with minimal height variations. Applied entered the CMP market in 1995 with its Mirra® system and has since added several important features to this product, including integrated cleaning, film measurement and process control capabilities. In fiscal 2003, Applied introduced a new system on its 300mm Applied Reflexion® CMP platform, the Applied Reflexion LK system, for polishing the delicate copper/low k interconnects using low downforce, high-throughput technology. The Reflexion LK is the only CMP system in the industry to

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      Applied offers several types of products that are used to inspect the wafer during various stages of the fabrication process in the following categories:

      Scanning electron microscopes (SEMs) use an electron beam to form images of microscopic features of a semiconductor wafer at extremely high magnification. Applied provides customers with full automation, along with the high accuracy and sensitivity needed for measuring advanced-generation feature sizes. The Applied NanoSEM^TM 3D Metrology system extends CD-SEM technology beyond the measurement of critical dimensions to enable the three-dimensional imaging of chip structures to more precisely control the lithography and etching processes.

      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^TM G2 Defect Analysis system enables customers to use this technology as an integral part of their production lines to analyze defects as small as 50nm with high productivity.

      In fiscal 2003, Applied acquired Boxer Cross, Inc. and added the Applied BX-10 Implant/ Anneal Metrology system to its product line. The BX-10 system measures critical process parameters that directly affect transistor performance and provides users with monitoring capability for multiple future device generations.

      Using laser-based technology, defects can be detected on patterned wafers (wafers with circuit images printed on them) as they move between processing steps. Defects may include particles, open circuit lines, shorts between lines or other problems. The Applied ComPlus-EV Inspection system, introduced in fiscal 2003, detects defects in devices with design rules of 90nm and below. Incorporating key advances in imaging technology, the system captures up to 50 percent more defects than the previous system with the high speed required for customers’ volume production lines.

      The most advanced flat panel displays (FPDs) are manufactured using technologies similar to those for making semiconductors. One difference is the vastly larger area of the substrate (panel). Compared to today’s largest wafers (300mm diameter), the panels can be up to 35 times larger in area. New generation FPD fabs are being built primarily for manufacturing large-area flat panel liquid crystal display (LCD) television screens, which is experiencing strong demand and is projected to continue growing at significant rates as consumers move to larger home entertainment systems.

      Applied supplies plasma-enhanced CVD (PECVD) systems and electron beam array testers to FPD manufacturers. Applied offers a range of systems that can process different substrate sizes to meet the industry’s requirements for ever larger substrates. In response to the growing market for larger LCD screens, Applied introduced its latest PECVD system in fiscal 2003, the sixth-generation AKT-25K PECVD, which addresses FPD fab requirements for substrates larger than one square meter.

      Masks are used by photolithography systems to transfer microscopic circuit designs onto wafers. Since any imperfection will be replicated on the wafer, the mask must be defect-free with precise imaging. Applied provides systems for the writing, etching, measurement and inspection of masks.

Customer Service and Support

      Applied Global Services plays a critical role in the Company’s ability to continuously satisfy its customers’ production requirements. Approximately 3,000 trained customer engineers and process support engineers are deployed in more than a dozen countries. These engineers are usually located at or near the customers’ fab sites and service over 16,000 installed Applied systems.

      Applied’s line of service products offers an innovative approach to maintaining and servicing Applied equipment in customers’ fabs. With the Applied Total Parts Management® (TPM) program, the Company

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Backlog

      Applied’s backlog decreased from $3.2 billion at October 27, 2002 to $2.5 billion at October 26, 2003. Applied manufactures its systems based on order backlog and customer commitments. Backlog includes only orders for which written authorizations have been accepted, shipment dates within 12 months have been assigned and revenue has not been recognized. In addition, backlog includes service revenue and maintenance fees to be earned within the next 12 months. However, customers may delay delivery of products or cancel orders suddenly prior to shipment, subject to possible cancellation penalties. Backlog adjustments for fiscal 2003 totaled $553 million, which consisted of cancellations, currency and other adjustments. Due to possible customer changes in delivery schedules and cancellations of orders, Applied’s backlog at any particular date is not necessarily indicative of actual sales for any succeeding period. Delays in delivery schedules and/or a reduction of backlog during any particular period could have a material adverse effect on Applied’s business and results of operations.

Manufacturing, Raw Materials and Supplies

      Applied’s manufacturing activities consist primarily of assembling various commercial and proprietary components into finished systems in Austin, Texas. Applied also has manufacturing operations in Santa Clara, California; Hillsboro, Oregon; Horsham, England; and Rehovot, Israel. Production requires some raw materials, including a wide variety of mechanical and electrical components, to be manufactured to Applied’s specifications. Applied uses numerous vendors to supply parts, components and subassemblies (parts) for the manufacture and support of its products. Although Applied makes reasonable efforts to assure that parts are available from multiple qualified suppliers, this is not always possible; accordingly, some key parts may be obtained only from a single supplier or a limited group of suppliers. Applied has sought, and will continue to seek, to minimize the risk of production and service interruptions and/or shortages of key parts by: 1) selecting and qualifying alternative suppliers for key parts; 2) monitoring the financial condition of key suppliers; 3) maintaining appropriate inventories of key parts; and 4) qualifying parts on a timely basis.

Research, Development and Engineering

      Applied’s long-term growth strategy requires continued development of new manufacturing products. Applied’s significant investment in research, development and engineering (RD&E) has generally enabled it to deliver new products and technologies before the emergence of strong demand, thus allowing customers to incorporate these products into their manufacturing plans at an early stage in the technology selection cycle. Applied works closely with its global customers to design systems and processes that meet their planned technical and production requirements. Product development and engineering organizations are primarily located in the United States, as well as in the United Kingdom and Israel, with process support and customer demonstration laboratories in the United States, the United Kingdom and Israel.

      Applied invested $1.2 billion (16 percent of net sales) for fiscal 2001, $1.1 billion (21 percent of net sales) for fiscal 2002 and $921 million (21 percent of net sales) for fiscal 2003, in RD&E for product development and engineering programs to create new product lines and improve existing technologies. Applied has spent an average of 16 percent of net sales on RD&E over the last five years. In addition to RD&E for specific product technologies, Applied maintains ongoing programs in software, automation control systems, materials research and environmental control that have applications to its products. In fiscal 2003, Applied focused on developing systems for customers’ new chip designs, including systems to enable faster and denser transistor and interconnect structures with 65nm and below linewidths.

Marketing and Sales

      Because of the highly technical nature of its products, Applied markets and sells its products worldwide through a direct sales force. For fiscal 2003, net sales to customers in each region as a percentage of Applied’s total net sales were: North America (primarily the United States) 26 percent, Japan 18 percent, Europe

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      During fiscal 2003, more than 70 percent of Applied’s net sales were to regions outside the United States of America. Managing Applied’s global operations presents challenges and involves uncertainties that may affect Applied’s business, financial condition and results of operations. For further discussion, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Trends, Risks and Uncertainties — Applied is Exposed to the Risks of Operating a Global Business.”

      Information on net sales to unaffiliated customers and long-lived assets attributable to Applied’s geographic regions is included in Note 10 of Notes to Consolidated Financial Statements. Net sales to Intel Corporation represented 12 percent of Applied’s fiscal 2001 net sales, and 10 percent of Applied’s fiscal 2002 net sales. During fiscal 2003, two customers individually accounted for greater than 10 percent of net sales: net sales to Intel Corporation represented 13 percent of Applied’s net sales, and net sales to Samsung America, Inc. represented 12 percent of Applied’s net sales.

Competition

      The global semiconductor equipment industry is highly competitive and is characterized by increasingly rapid technological advancements and demanding worldwide service requirements. Applied’s ability to compete depends on its ability to commercialize its technology and continually improve its products, processes and services, as well as its ability to develop new products that meet constantly evolving customer requirements. Significant competitive factors for succeeding in the semiconductor manufacturing equipment market include the equipment’s technical capability, productivity and cost-effectiveness, and level of technical service and support provided by the vendor. The importance of each of these factors varies depending on the specific customer’s needs and criteria, including considerations such as the customer’s process application, product requirements, timing of the purchase and particular circumstances of the purchasing decision. The pace of technological change is rapid, with customers continually moving to smaller critical dimensions and larger wafer sizes and adopting new materials for fabricating the chip. Existing technology can be adapted to the new requirements; however, these requirements sometimes create the need for an entirely different technical approach. The rapid pace of technological change continually creates opportunities for existing competitors and startups, and can quickly diminish the value of existing technologies.

      Substantial competition exists for each of Applied’s products. Competitors range from small companies that compete with a single product and/or in a single region to global companies with multiple lines of semiconductor processing products. Competitors in a given technology tend to have different degrees of market presence in the various regional markets. Management believes that Applied is a strong competitor and that its competitive position is based on the ability of its products and services to continue to address customer requirements. Success for Applied will require a continued high level of investment in RD&E and in sales, marketing and customer support activities.

Patents and Licenses

      Management believes that Applied’s competitive position is significantly dependent upon skills in engineering, manufacturing and marketing, and not just on its patent position. However, protection of Applied’s technological assets by obtaining and enforcing patents is important. Therefore, Applied has a practice to file patent applications in the U.S. and other countries for inventions that Applied considers significant. Applied has a number of patents in the U.S. and other countries, and additional applications are pending for new developments in its equipment and processes. Applied does not consider its business materially dependent upon any one patent, although taken as a whole, the rights of Applied and the products made and sold under its patents are a significant element of Applied’s business. In addition to patents, Applied also possesses other proprietary intellectual property, including trademarks, knowhow, trade secrets and copyrights.

      Applied enters into patent and technology licensing agreements with other companies when management determines that it is in its best interest to do so. Applied pays royalties under existing patent license agreements for the use, in several of its products, of certain patented technologies that are licensed to Applied for the life of the patents. Applied also receives royalties from licenses granted to third parties. Royalties received from and paid to third parties have not been and are not expected to be material.

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      In the normal course of business, Applied periodically receives and makes inquiries regarding possible patent infringement. In dealing with such inquiries, it may become necessary or useful for Applied to obtain or grant licenses or other rights. However, there can be no assurance that such licenses or rights will be available to Applied on commercially reasonable terms. If Applied is not able to resolve a claim, negotiate a settlement of the matter, obtain necessary licenses on commercially reasonable terms and/or successfully prosecute or defend its position, Applied’s business, financial condition and results of operations could be materially and adversely affected.

Environmental Matters

      Two of Applied’s locations have been designated as environmental cleanup sites. In 1987, the United States Environmental Protection Agency designated one of the locations, in Santa Clara, California, as a Superfund site and named Applied as a “Responsible Party.” Cleanup activities at this site began in 1984 and were substantially completed in February 2002. The California Regional Water Quality Control Board has designated Applied as a “Discharger” with respect to the other site in Sunnyvale, California. Applied was named a Discharger at the Sunnyvale site in 1997 as it currently owns the site in question; however, prior owners and operators are responsible for performing cleanup and monitoring activities. Applied maintains a number of environmental, health and safety programs that are primarily preventive in nature. Neither compliance with federal, state and local provisions regulating discharge of materials into the environment, nor remedial agreements or other actions relating to the environment, has had, or is expected to have, a material effect on Applied’s capital expenditures, competitive position, financial condition or results of operations. The most recent report on Applied’s environmental, health and safety activities can be found on the Company’s web site at http://www.appliedmaterials.com/about/ environment.html. This report will be updated in the future. This website address is intended to be an inactive textual reference only; none of the information contained on Applied’s website is part of this report or is incorporated by reference herein.

Employees

      None of Applied’s employees are represented by a trade union, and management considers its relations with employees to be good. In the high-technology industry, competition for highly-skilled employees is intense. Applied believes that its future success is highly dependent upon its continued ability to attract and retain qualified employees. There can be no assurance that Applied will be able to attract, hire, assimilate and retain a sufficient number of qualified people. At October 26, 2003, Applied employed 12,050 regular employees.

Available Information

      Applied’s website is http://www.appliedmaterials.com. Applied makes available free of charge, on or through its website, its annual, quarterly and current reports, and any amendments to those reports, as soon as reasonably practicable after electronically filing such reports with the Securities and Exchange Commission (SEC). This website address is intended to be an inactive textual reference only; none of the information contained on Applied’s website is part of this report or is incorporated by reference herein.

      Information concerning Applied’s principal properties at October 26, 2003 is set forth below:

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(1)	Includes approximately 220,000 square feet that were being subleased.
(2)	Subject to loans of $19 million, collateralized by property and equipment with a net book value of $46 million at October 26, 2003.
(3)	Approximately 1.4 million square feet were available for sublease.

      In addition to the above properties, Applied leases office space for sales and customer support offices in 86 locations throughout the world: 26 in North America (principally the United States), four in Taiwan, 21 in Japan, 20 in Europe, seven in Korea and eight in Asia-Pacific (including China).

      In addition, Applied owns: 1) 96 acres of buildable land in Texas that can accommodate approximately 1,464,000 square feet of additional building space; 2) 26 acres in Oregon that can accommodate approximately 396,000 square feet of additional building space; 3) 43 acres in California that can accommodate approximately 1,247,000 square feet of additional building space; and 4) nine acres in Japan that can accommodate approximately 766,000 square feet of additional building space. Applied also leases: 1) 13 acres in Taiwan that can accommodate approximately 271,000 square feet of additional building space; and 2) 10 acres in Israel that can accommodate approximately 111,000 square feet of additional building space. This additional building space is anticipated to satisfy Applied’s future needs.

      Applied is productively utilizing substantially all of the owned facilities, and considers the above facilities suitable and adequate to meet its requirements.

Novellus

      On June 13, 1997, after Varian Associates, Inc. (Varian) failed to respond to requests by Applied to discuss certain patent issues, Applied filed a lawsuit against Varian captioned Applied Materials, Inc. v. Varian Associates, Inc. (case no. C-97-20523-RMW) in the United States District Court for the Northern District of California, alleging infringement of several of Applied’s patents concerning PVD technology. On July 7, 1997, Applied amended that action to allege infringement of those same Applied PVD patents against Novellus Systems, Inc. (Novellus) and to add Novellus as a defendant, as a result of Novellus’ acquisition of Varian’s thin film systems PVD business. On June 23, 1997, Novellus filed a separate lawsuit against Applied captioned Novellus Systems, Inc. v. Applied Materials, Inc. (case no. C-97-20551-EAI) in the United States District Court for the Northern District of California, alleging infringement by Applied of several PVD technology patents that were formerly owned by Varian. Novellus seeks damages for past infringement, a permanent injunction, treble damages for willful infringement, pre-judgment interest and attorneys’ fees. In September 2000, Applied and Varian settled their disputes and Applied released all claims with respect to the Inova system as it was made and sold as of May 7, 1997. On October 3, 2000, Applied’s claims against Varian and Varian’s claims and counterclaims against Applied were dismissed with prejudice. The litigation with Novellus continues. Discovery has closed in the actions. The court has rescheduled the previously set trial date from January 20, 2004 to May 24, 2004. Applied believes the May trial will involve only infringement and validity issues regarding Novellus’ patent claims against Applied and Applied’s declaratory judgment claims against Novellus’ patents. Applied believes it has meritorious claims and defenses and intends to pursue them vigorously.

Axcelis Technologies

      On January 8, 2001, Axcelis Technologies, Inc. (Axcelis), formerly a subsidiary of Eaton Corporation, filed a lawsuit against Applied in the United States District Court for the District of Massachusetts, captioned Axcelis Technologies, Inc. v. Applied Materials, Inc. (case no. 01-10029 DPW). The lawsuit alleges that

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Linear Technology

      On March 2, 2001, Linear Technology Corp. (LTC) filed a third party complaint against Applied in the United States District Court for the Eastern District of Texas, captioned Texas Instruments, Inc. v. Linear Technology Corp. v. Applied Materials, Inc. (case no. 2-01-CV4 (DF)). The complaint against Applied alleged that Applied is obligated to indemnify LTC and defend LTC for certain claims in the underlying patent infringement lawsuit brought by Texas Instruments, Inc. (TI) against LTC. The complaint also alleged claims for breach of contract, breach of warranty, and various unfair business practices. In the complaint, LTC alleged that, before LTC purchased certain equipment from Applied, Applied failed to disclose to LTC that TI previously had won a jury verdict against Hyundai Electronics Industries Co., Ltd. (Hyundai) for patent infringement based on Hyundai’s use of certain semiconductor equipment including some Applied tools. LTC’s Texas lawsuit against Applied sought indemnification and damages from Applied and an order requiring Applied to defend LTC in the underlying lawsuit with TI. On January 15, 2002, the court granted TI’s motion to sever Applied and the other third party defendants from the action and dismissed LTC’s action against Applied and the other third party defendants without prejudice. On March 12, 2002, LTC filed a complaint against Applied in the Superior Court for the County of Santa Clara, captioned Linear Technology Corp. v. Applied Materials, Inc., Novellus Systems, Inc. and Tokyo Electron Ltd., (case no. CV806004) alleging claims for breach of contract, fraud and deceit, negligent misrepresentation, suppression of fact, unfair competition, breach of warranty, express contractual indemnity, implied equitable indemnity and declaratory relief. On November 12, 2002, LTC filed an amended complaint in the Santa Clara action asserting essentially the same claims as in the original complaint but adding an additional assertion that LTC and TI have settled their litigation. In the amended complaint, LTC seeks compensatory damages, punitive damages, injunctive relief and restitution. LTC also seeks costs and attorneys’ fees including costs and attorneys’ fees for the TI litigation. Applied’s motion to dismiss the amended complaint was granted in part. LTC filed a Second Amended Complaint and Applied’s motion to dismiss the Second Amended Complaint was also granted. LTC has filed a Third Amended Complaint alleging claims for fraud and deceit by suppression of material fact and violation of Cal. Bus. and Prof. Code 17200. Applied has filed a motion to dismiss that complaint. Applied believes that it has meritorious defenses and intends to pursue them vigorously.

Semitool

      On June 11, 2001, Semitool, Inc. (Semitool) filed a lawsuit against Applied in the United States District Court for the Northern District of California, captioned Semitool, Inc. v. Applied Materials, Inc. (case no. CV-01-2277 CRB). The lawsuit alleged that Applied infringed a patent concerning seed repair and electroplating owned by Semitool. Semitool sought a preliminary and permanent injunction, damages, costs and attorneys’ fees. On July 12, 2001, before Applied had answered the complaint, Semitool voluntarily dismissed its action against Applied in the Northern District of California. On the same day, Semitool filed a substantially identical action against Applied in the United States District Court for the District of Oregon captioned Semitool, Inc. v. Applied Materials, Inc. (case no. CV’01-1066 AS). On July 13, 2001, Applied filed a declaratory judgment action against Semitool in the Northern District of California captioned Applied Materials, Inc. v. Semitool, Inc. (case no. CV-01-2673 BZ). In that action, Applied sought a declaration that Applied had not infringed the Semitool patent and that Semitool’s patent is invalid and unenforceable. Applied also sought costs and attorneys’ fees. The California Court has transferred Applied’s action against Semitool to the District of Oregon. The actions are proceeding together in Oregon. Semitool has also asserted similar claims against certain other semiconductor equipment manufacturers. The Oregon Court has issued an order interpreting the patent claims and has scheduled a trial date of February 3, 2004. Applied believes it has meritorious claims and defenses and intends to pursue them vigorously.

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David Scharf

      On July 31, 2001, David Scharf, an individual, filed a lawsuit against Applied in the United States District Court for the Central District of California, captioned David Scharf v. Applied Materials, Inc. (case no. 01-06580 AHM). The lawsuit alleges that Applied has infringed, has induced others to infringe and has contributed to others’ infringement of a patent concerning color synthesizing scanning electron microscope technology. Mr. Scharf seeks a preliminary and permanent injunction, damages and costs. Applied has answered the complaint and counterclaimed for declaratory judgment of non-infringement and invalidity. On May 10, 2002, Mr. Scharf filed a request for re-examination of his patent with the Patent and Trademark Office. On June 26, 2002, the case was removed from the Court’s active docket after the parties stipulated to stay the case pending the results of that re-examination. On July 11, 2002, Applied filed its own request for re-examination of Mr. Scharf’s patent with the Patent and Trademark Office. Applied’s request for re-examination was granted on September 19, 2002. Applied believes it has meritorious defenses and counterclaims and intends to pursue them vigorously.

ASMI

      On August 27, 2002, ASM America, Inc. and ASM International, N.V. (collectively ASMI) filed a lawsuit against Applied in the United States District Court for the District of Arizona, captioned ASM America, Inc. and ASM International, N.V. v. Applied Materials, Inc. (case no. Civ’02 1660 PHX SMM). The lawsuit sought a judicial declaration that ASMI does not infringe six patents belonging to Applied that relate to remote cleaning of CVD chambers and to deposition of silicon nitride. The suit also sought a judicial declaration that two of the six patents are invalid. Applied moved for a more definitive statement with respect to two of ASMI’s causes of action. On September 29, 2003, the court granted Applied’s motion for a more definitive statement. ASMI filed an amended complaint on October 31, 2003. The amended lawsuit seeks a judicial declaration that ASMI does not infringe the six patents and that the six patents are invalid. On December 15, 2003, Applied answered the amended complaint by denying the allegations and counterclaiming for infringement of the six patents. Applied seeks damages, a preliminary and permanent injunction, costs and attorney’s fees. No trial date has been set. Applied believes it has meritorious defenses and counterclaims and intends to pursue them vigorously.

      On October 3, 2003, ASMI filed a lawsuit against Applied in the United States District Court for the Eastern District of Texas, captioned ASM America, Inc. and ASM International, N.V. v. Applied Materials, Inc. (case no. 2 03CV 348 TJW). The lawsuit alleges infringement of six ASMI patents and seeks damages for past infringement, enhanced damages, attorneys’ fees, and injunctive relief. Applied responded to the complaint by denying the allegations and counterclaiming for a declaratory judgment of invalidity, unenforceability and non-infringement of the patents. Applied also has asserted that ASMI is infringing seven Applied patents, including the six patents at issue in the Arizona action plus an additional patent. Applied seeks injunctive relief, compensatory and enhanced damages, costs and attorneys’ fees. Applied has filed a motion to transfer the case from the Eastern District of Texas to the District of Arizona. Applied believes it has meritorious defenses and counterclaims and intends to pursue them vigorously.

Varian Semiconductor Equipment Associates, Inc.

      On September 13, 2002, Varian Semiconductor Equipment Associates, Inc. filed a demand for arbitration with the American Arbitration Association asserting that Applied has breached a patent license agreement between Varian and Applied dated January 1, 1992. Varian seeks to recover royalties, interest and attorneys’ fees. The arbitration hearing on whether the products are covered by the license agreement has concluded. On May 2, 2003, the arbitration panel issued an interim decision finding that some, but not all, of the products at issue were subject to the agreement. The arbitration panel next will consider whether the asserted claims of the patents under which those products were found to be covered are valid. Applied believes that it has meritorious defenses and intends to pursue them vigorously.

Robert Bosch GmbH

      On October 10, 2002, Robert Bosch GmbH (Bosch), a German company, filed a lawsuit against Applied in the United States District Court for the District of Delaware, captioned Robert Bosch GmbH v. Applied Materials, Inc. (civil action no. 02-1523). The lawsuit alleged that Applied infringed two patents owned by Bosch related to anisotropic etching. Bosch sought a preliminary and permanent injunction, damages, costs and attorneys’ fees. Applied answered the complaint and counterclaimed for declaratory judgment of non-

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      From time to time, Applied receives notification from customers claiming that such customers are entitled to indemnification or other obligations from Applied related to infringement claims made against the customers by third parties. In addition, Applied is subject to various other legal proceedings and claims, either asserted or unasserted, that arise in the ordinary course of business. Although the outcome of these claims cannot be predicted with certainty, Applied does not believe that any of these other existing legal matters will have a material adverse effect on its financial condition or results of operations.

      None.

EXECUTIVE OFFICERS OF THE REGISTRANT

      The following table and notes set forth information about Applied’s four executive officers:

(1)	Mr. Morgan, age 65, has been Chairman of the Board of Directors since 1987. Mr. Morgan served as Chief Executive Officer from 1977 to April 2003. Mr. Morgan also served as President from 1976 to 1987.
(2)	Mr. Splinter, age 53, was appointed President and Chief Executive Officer and a member of the Board of Directors of Applied Materials on April 30, 2003. Prior to joining Applied Materials, Mr. Splinter worked for nearly 20 years at Intel Corporation. Most recently he was Executive Vice President and Director of the Sales and Marketing Group at Intel Corporation, responsible for sales and operations worldwide. Mr. Splinter previously held various executive positions at Intel Corporation, including Executive Vice President and General Manager of the Technology and Manufacturing Group.
(3)	Mr. Bronson, age 55, was appointed Executive Vice President in December 2000 and has been Chief Financial Officer since January 1998. Mr. Bronson also served in the Office of the President from January 1998 to October 2002, as Senior Vice President and Chief Administrative Officer from 1998 to 2000 and Group Vice President from 1994 to 1998. Prior to that, Mr. Bronson had been Vice President since November 1990. Mr. Bronson joined Applied in 1984.
(4)	Mr. Janker, age 54, has been Senior Vice President of Sales and Marketing since May 2003. Prior to that, he was appointed to Senior Vice President of Global Operations and Corporate Marketing in December of 2002. From December 1998 to 2002, he was Group Vice President of Corporate Marketing and Business Management. From 1982 to 1998, Mr. Janker served in a variety of sales and marketing management positions in the United States and in Europe.

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PART II

      The following table sets forth the high and low closing sale prices as reported on the Nasdaq National Market, as adjusted to reflect a two-for-one stock split in the form of a 100 percent stock dividend, effective April 16, 2002.

      Applied’s common stock is traded on the Nasdaq National Stock Market under the symbol AMAT. As of December 26, 2003, there were approximately 6,995 directly registered holders of stock.

      To date, Applied has not declared or paid cash dividends to its stockholders. Applied has no plans to declare and pay cash dividends.

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(1)	Each fiscal year ended on the last Sunday in October.
(2)	Effective the first fiscal quarter of 2001, Applied implemented the Securities and Exchange Commission’s Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements.” For periods prior to fiscal 2001, data was not available to provide pro forma information as if the change in accounting principle were applied retroactively. For further details, see Note 1 of Notes to Consolidated Financial Statements.
(3)	Amounts prior to fiscal 2002 have been restated to reflect a two-for-one stock split in the form of a 100 percent stock dividend, effective April 16, 2002.
(4)	Discontinued operations in 1999 consisted of a reversal of provision for discontinuance of joint venture subsequently retained.

Results of Operations

      Applied develops, manufactures, markets and services integrated circuit fabrication equipment for the worldwide semiconductor industry. Demand for Applied’s products can change significantly from period to period as a result of numerous factors, including, but not limited to, changes in: 1) global economic conditions; 2) advanced technology and/or capacity requirements of semiconductor manufacturers; 3) the profitability of semiconductor manufacturers; 4) supply and demand for semiconductors; and 5) relative competitiveness of Applied’s products and services. For this and other reasons, Applied’s results of operations for fiscal 2001, 2002 and 2003 may not necessarily be indicative of future operating results.

      Effective the first fiscal quarter of 2001, Applied implemented the SEC’s Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements.” For periods prior to fiscal 2001, data was not available to provide pro forma information as if the change in accounting principle were applied retroactively. For further details, see Note 1 of Notes to Consolidated Financial Statements.

      Applied’s business was subject to cyclical industry conditions in fiscal 2001, 2002 and 2003. As a result of these conditions, there were significant fluctuations in Applied’s quarterly new orders and net sales, both

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      Quarterly and full fiscal year financial information follows:

(1)	Net income/(loss) included an after-tax expense of $267 million from a cumulative effect of change in accounting principle for the first fiscal quarter of 2001.

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

	*	Primarily the United States.

**	Includes China.

      During the first fiscal quarter of 2001, slowing worldwide demand for semiconductors resulted in a rapid decline in demand for semiconductor manufacturing equipment. Inventory buildups in telecommunication products, slower than expected personal computer sales and slower global economic growth caused semiconductor companies to reduce their capital spending and reschedule or cancel existing orders. This decline in demand deepened sequentially throughout fiscal 2001 into a severe industry downturn due to continued weakness in the macro-economic climate and consumption of electronic goods, which resulted in further capital spending cutbacks by Applied’s customers. Included in fiscal 2001 net sales were $642 million of revenue recognized as part of the cumulative effect of implementing the SEC’s Staff Accounting Bulletin No. 101 (SAB 101), “Revenue Recognition in Financial Statements.”

      Net sales declined 31 percent from $7.3 billion for fiscal 2001 to $5.1 billion for fiscal 2002. The decline in demand for Applied’s products continued into the first fiscal quarter of 2002. In the second fiscal quarter of 2002, customers ordered equipment for 200mm advanced capacity to satisfy demand driven by consumer-related and wireless devices. Customers ordered 200mm capacity for this demand increase as their transition to 300mm equipment was not yet complete. Customers also continued to place technology orders to invest in 300mm wafer processing, copper and smaller line-width technologies. However, second quarter demand levels proved to be unsustainable as the global economic environment weakened through the middle of the year, and customers reduced their level of capacity spending accordingly while maintaining advanced technology spending. Net sales peaked in the third fiscal quarter of 2002 and flattened in the fourth fiscal quarter of 2002. Included in fiscal 2002 net sales was the remaining $9 million of revenue that was recognized as part of the cumulative effect of implementing SAB 101.

      Net sales declined 12 percent from $5.1 billion for fiscal 2002 to $4.5 billion for fiscal 2003. Orders declined from $1.6 billion for the fourth fiscal quarter of 2002 to $1.0 billion for the first and second fiscal quarters of 2003, reflecting the continued and prolonged downturn in the semiconductor industry. However, orders increased to $1.1 billion for the third fiscal quarter and $1.3 billion for the fourth fiscal quarter of 2003, reflecting customers’ continued investments in memory and logic and their transition to 300mm, along with the increased capacity utilization in both advanced and established technologies. Following the new order trends, net sales decreased to approximately $1.1 billion for each of the first three fiscal quarters of 2003, reflecting the impact of the prolonged industry downturns and increased to $1.2 billion for the fourth fiscal quarter of 2003, indicating the beginning of an industry recovery.

      In response to the continuing difficult business conditions, Applied implemented a series of activities to better align Applied’s cost structure with prevailing economic conditions during early fiscal 2003. Realignment activities consisted of consolidation of facilities, reductions in workforce, and refocused product efforts, such as the electron-beam mask pattern product line and implementation of the global spare parts distribution system (which included a closure of a central warehouse). As a result of the realignment activities, Applied vacated approximately two million square feet and reduced approximately 3,800 positions. Realignment activities resulted in charges across multiple categories, as incurred, including cost of products sold, research, development and engineering expenses, and restructuring and asset impairment charges, as discussed below.

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      Gross margin as a percentage of net sales decreased from 44.3 percent for fiscal 2001 to 40.6 percent for fiscal 2002, and to 35.8 percent for fiscal 2003. In fiscal 2000, Applied experienced unprecedented new order and revenue growth. Accordingly, Applied expanded its manufacturing facilities to accommodate anticipated growth. The decreased business volume in fiscal 2001, 2002 and 2003, due to the industry downturn, was insufficient to fully absorb the overhead costs of these facilities, resulting in lower gross margins for all respective periods. The continued decline in gross margin for fiscal 2003 was principally attributable to under absorption of manufacturing and field service costs as a result of prolonged lower business volumes, and inventory writeoffs and charges associated with refocused product efforts, including an electron-beam mask pattern product and implementation of the global spare parts distribution system.

      Applied’s future operating results depend, to a considerable extent, on its ability to maintain a competitive advantage in the products and services it provides. Applied believes that it is critical to continue to make substantial investments in research, development and engineering (RD&E) to assure the availability of innovative technology that meets the current and projected requirements of its customers’ most advanced semiconductor designs. Applied has historically maintained its commitment to investing in RD&E in order to continue to offer new products and technologies. As a result, RD&E expenses were $1.2 billion (16 percent of net sales) for fiscal 2001, $1.1 billion (21 percent of net sales) for fiscal 2002, and $921 million (21 percent of net sales) for fiscal 2003. Development cycles range from 12 to 36 months depending on whether the product is an enhancement of existing technology or a new product. Most of Applied’s existing product lines are the result of internal product development activities. In certain instances, Applied acquires technologies either in existing areas of development or through new product opportunities to complement its existing technology capabilities and to reduce time to market for market entry and penetration. Throughout the periods covered by this report, Applied has developed products designed to enable our customers to fabricate chips with 65nm and below feature sizes and new materials such as copper and low k dielectrics.

      During fiscal 2001, Applied continued its development of technologies for copper and low k-based chips and 300mm wafers, as well as focused efforts on the core technologies that would be required for customers to begin development of 100nm and below generation devices. Areas of increased investment included maskmaking technology, metrology and inspection, ion implantation, and products for depositing and etching new materials.

      In fiscal 2002, Applied invested in critical development activities to meet its customers’ rapid move to sub-100nm dimensions in their most advanced designs, which were anticipated to begin entering production in fiscal 2003. This difficult and challenging dimensional shift was compounded by the need to provide much of the technology for both 200mm and 300mm wafers, requiring additional process and hardware development. For the sub-100nm chip generations, inspection and metrology tools became more important to assure enhanced device performance as well as adequate manufacturing yields. Accordingly, Applied focused its RD&E resources on these technologies. In addition, development of innovations such as advanced wafer wet cleaning and atomic layer deposition, which deposits materials in increasingly smaller structures, addressed new market opportunities for Applied. Within virtually all of the technology areas, including fab and yield management, Applied invested in more advanced software capabilities.

      In fiscal 2003, Applied refocused product efforts and made investments in strategic products. Applied focused on the development of several important processing technologies to enable the production of new chips using copper and low k dielectric materials, as well as to meet the challenges of smaller, 65nm and below, feature sizes. In addition to interconnect solutions, Applied continued to invest resources in the development of systems for advanced transistor designs with smaller gate structures that enable faster signal propagation and reduced power. Applied also continued the development of its process diagnostic and control capabilities with systems to inspect and measure smaller dimensions and defects.

      Marketing, selling, general and administrative expenses decreased from $902 million (12 percent of net sales) for fiscal 2001 to $709 million (14 percent of net sales) for fiscal 2002, and to $626 million (14 percent of net sales) for fiscal 2003. The decreases from fiscal 2001 to 2002 and 2003 were due primarily to headcount reductions and cost reduction activities, limiting discretionary expenditures to align costs to a lower business volume.

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      The restructuring actions taken in fiscal 2001, 2002 and 2003 were intended to better align Applied’s cost structure with prevailing market conditions due to the prolonged industry downturn. These actions, which were necessary as a result of reduced business volume, reduced Applied’s global workforce and consolidated global facilities.

      Restructuring, asset impairments and other charges for fiscal 2001 totaled $221 million, consisting of a charge of $10 million for acquired in-process research and development and restructuring and asset impairment charges of $211 million. The restructuring and asset impairment charges of $211 million consisted of $105 million for headcount reductions, $45 million for consolidation of facilities and $61 million for other costs, primarily fixed asset writeoffs due to facility consolidation. As of October 26, 2003, the majority of the fiscal 2001 restructuring actions have been completed.

      Restructuring, asset impairments and other charges for fiscal 2002 totaled $85 million, consisting of a charge of $8 million for acquired in-process research and development and restructuring and asset impairment charges of $77 million. The restructuring and asset impairment charges consisted of $39 million for headcount reductions, $16 million for consolidation of facilities and $22 million for other costs, primarily fixed asset writeoffs due to facility consolidation. As of October 26, 2003, the majority of the fiscal 2002 restructuring actions have been completed.

      Restructuring, asset impairments and other charges for fiscal 2003 totaled $372 million, consisting of $186 million for headcount reductions, $86 million for consolidation of facilities and $100 million for other costs, primarily fixed asset writeoffs due to facility consolidation. The fiscal 2003 restructuring activities are expected to be completed during early 2004, which will result in additional costs.

      For further details, see Note 6 of Notes to Consolidated Financial Statements.

      Net interest income was $174 million for fiscal 2001, $131 million for fiscal 2002 and $102 million for fiscal 2003. The decrease in net interest income in fiscal 2002 and 2003 was due primarily to lower average interest rates.

      Applied’s effective income tax provision/(benefit) rate was 29.8 percent for fiscal 2001, 21.0 percent for fiscal 2002 and (29.5) percent for fiscal 2003. The actual effective rate for fiscal 2001 of 29.8 percent differed from the anticipated effective rate of 29.5 percent due to the non-tax deductible nature of $10 million of acquired in-process research and development expense and a shift in the geographic composition of Applied’s pre-tax income. Applied’s actual effective rate of 21.0 percent for fiscal 2002 differed from the anticipated effective rate of 29.5 percent primarily due to significant Foreign Sales Corporation and extraterritorial income tax benefits, which resulted from an increase in Foreign Sales Corporation and extraterritorial qualified income. Without these additional benefits, earnings per share would have been reduced by $0.02 for fiscal 2002. Applied expected and experienced an actual effective benefit rate of 29.5 percent for fiscal 2003. Applied’s future effective income tax rate depends on various factors, such as tax legislation, the geographic composition of Applied’s pre-tax income and non-tax deductible expenses incurred in connection with acquisitions.

      On April 18, 2003, Applied acquired Boxer Cross, Inc., a producer of in-line monitoring systems that provide customers with critical electrical measurement data for controlling semiconductor processes, for $14 million in cash. On April 8, 2002, Applied acquired Electron Vision Corporation, a designer, manufacturer and seller of e-beam stabilization and curing tools for the semiconductor, thin film head and micro-fabrication industries, for $26 million in cash. On December 3, 2001, Applied acquired Global Knowledge Services, Inc., a provider of advanced data mining services to improve semiconductor manufacturing yield and efficiency, for $16 million in cash. On November 20, 2001, Applied acquired the assets of Schlumberger’s electron-beam wafer inspection business for $66 million in cash. On June 27, 2001, Applied acquired Oramir, a supplier of advanced laser cleaning technology for semiconductor wafer, for $21 million in cash.

      For further details, see Note 12 of Notes to Consolidated Financial Statements.

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Recent Accounting Pronouncement

      In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51.” FIN 46 provides guidance on: 1) the identification of entities for which control is achieved through means other than through voting rights, known as “variable interest entities” (VIEs); and 2) which business enterprise is the primary beneficiary and when it should consolidate a VIE. This new requirement for consolidation applies to entities: 1) where the equity investors (if any) do not have a controlling financial interest; or 2) whose equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. In addition, FIN 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. FIN 46 is effective for all new VIEs created or acquired after January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period ending after December 15, 2003. Certain disclosures are effective immediately. Applied holds an interest in a venture fund, Applied Materials Ventures I, L.P. (Ventures I). Applied will implement FIN 46 during the first fiscal quarter of 2004 and will consolidate Ventures I as a VIE. Applied does not expect the implementation to have a material effect on the financial condition or results of operations. For additional discussion of this recent accounting pronouncement and Ventures I, see Note 1 and Note 3 of the Notes to the Consolidated Financial Statements.

Financial Condition, Liquidity and Capital Resources

      Applied increased its cash, cash equivalents and short-term investments from $4.9 billion at October 27, 2002 to $5.5 billion at October 26, 2003. Applied has not undertaken any significant external financing activities for several years.

      Applied generated cash from operating activities of $1.6 billion for fiscal 2001, $492 million for fiscal 2002 and $802 million for fiscal 2003. The primary sources of cash from operating activities have been net income, as adjusted to exclude the effect of non-cash charges, and changes in working capital levels, including accounts receivable and inventories. Applied utilized programs to sell accounts receivable of $1.2 billion for fiscal 2001, $689 million for fiscal 2002 and $556 million for fiscal 2003. These accounts receivable sales had the effect of increasing cash and reducing accounts receivable and days sales outstanding. Days sales outstanding was 68 days at the end of fiscal 2003, compared to 66 days at the end of fiscal 2002 and 56 days at the end of fiscal 2001. A portion of these sold accounts receivable is subject to certain limited recourse provisions. However, Applied has not experienced any losses under these programs. For further details regarding accounts receivable sales, see Note 11 of Notes to Consolidated Financial Statements. Inventories were reduced by $323 million in fiscal 2003 due to ongoing inventory reduction and management programs.

      Applied used $1.6 billion of cash for investing activities for fiscal 2001, $693 million for fiscal 2002 and $731 million for fiscal 2003. Capital expenditures, net of retirements, were $711 million for fiscal 2001, $417 million for fiscal 2002 and $212 million for fiscal 2003, totaling $1.3 billion for the past three years. Application laboratories, equipment and related facilities comprised most of the capital spending. The largest capital expenditure for the last three years was $153 million for additional construction and fit-up of the Maydan Process Module Technology Center in Sunnyvale, California where Applied’s demonstration laboratories for new technology applications are located. Fiscal 2002 capital expenditures also included $65 million for the purchase of properties in Santa Clara, California that were previously held under a synthetic lease. Fiscal 2003 capital expenditures also included $52 million for the purchase of facilities in Hillsboro, Oregon that were previously held under a synthetic lease. Investing activities also included purchases and sales of short-term investments and acquisitions of technology or of other companies to allow Applied to access new market opportunities or emerging technologies.

      Applied used $261 million of cash from financing activities for fiscal 2001, and generated $131 million for fiscal 2002 and $8 million for fiscal 2003. During fiscal 2001, net common stock activity used $169 million of cash as stock repurchases increased and stock sales to employees decreased. During fiscal 2002 and 2003, net common stock activity generated $75 million and $73 million of cash as proceeds received from stock sales to employees exceeded the amount used for stock repurchases. Since March 1996, Applied has systematically repurchased shares of its common stock in the open market to partially fund its stock-based employee benefit and incentive plans. Financing activities also included borrowings and repayments of debt. Net changes in debt used $92 million of cash for fiscal 2001, generated $56 million of cash for fiscal 2002 and used $64 million of cash for fiscal 2003.

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      On March 21, 2002, Applied’s Board of Directors approved a two-for-one stock split of Applied’s common stock, which was distributed in the form of a 100 percent stock dividend on or about April 16, 2002 to stockholders of record as of April 1, 2002.

      Although cash requirements will fluctuate based on the timing and extent of these factors, 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 for each of the three years in the period ended October 26, 2003, see the Consolidated Statements of Cash Flows in this Annual Report on Form 10-K.

Off-Balance Sheet Arrangements

      During the ordinary course of business, Applied provides standby letters of credit or other guarantee instruments to certain parties as required for certain transactions initiated by either Applied or its subsidiaries. As of October 26, 2003, the maximum potential amount of future payments that Applied could be required to make under these guarantee agreements was approximately $56 million. Applied has not recorded any liability in connection with these guarantee arrangements beyond that required to appropriately account for the underlying transaction being guaranteed. Applied does not believe, based on historical experience and information currently available, that it is probable that any amounts will be required to be paid under these guarantee arrangements.

      Applied also has additional guarantee arrangements on behalf of certain subsidiaries. As of October 26, 2003, Applied has not recorded any liability related to guarantees of subsidiary obligations. Applied does not expect, based on historical experience and information currently available, that it is probable any amounts will be required to be paid under these arrangements. Subsidiary guarantees as of October 26, 2003 were associated with the following types of arrangements: short-term borrowings, term loans, overdrafts and leases. While certain subsidiaries have short-term borrowing, term loans and overdraft facilities available totaling approximately $169 million as of October 26, 2003, no amounts were outstanding as October 26, 2003. In the event of use and subsequent default of these facilities by Applied’s subsidiaries, such arrangements would be guaranteed by Applied. In addition, certain subsidiaries have lease arrangements guaranteed by Applied. These leases will expire between 2009 and 2014. In the event that the subsidiaries do not make the required payments, Applied could be required to pay the leases on behalf of the subsidiaries. As of October 26, 2003, annual lease obligations under these arrangements approximated $12 million.

      Ventures I invests in privately-held, early-stage companies engaged in developing systems, components and devices based on nanotechnology for specific applications and products. Ventures I is a limited partnership with Applied as the sole limited partner and an independent party as the general partner. Applied has committed to fund $50 million in capital contributions, but has reserved the option to discontinue capital contributions at $25 million. Applied’s capital contributions to Ventures I totaled approximately $9 million through October 27, 2002 and $16 million through October 26, 2003. See Note 3 of Notes to Consolidated Financial Statements for further details on Ventures I.

      Applied also has operating leases for various facilities. Total rental expense for operating leases was $153 million for fiscal 2001, $140 million for fiscal 2002 and $134 million for fiscal 2003.

      The following table summarizes the effect on Applied’s liquidity and cash flows from contractual obligations of debt arrangements and non-cancelable operating leases as of October 26, 2003:

Critical Accounting Policies

      The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make judgments, assumptions and estimates that affect the amounts reported. Note 1 of Notes to Consolidated Financial Statements describes the significant accounting policies used in the preparation of the consolidated financial statements. Certain of these significant accounting policies are considered to be critical accounting policies, as defined below.

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      A critical accounting policy is defined as one that is both material to the presentation of Applied’s financial statements and requires management to make difficult, subjective or complex judgments that could have a material effect on Applied’s financial condition and results of operations. Specifically, critical accounting estimates 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 are discussed in the section below entitled “Trends, Risks and Uncertainties.” 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:

      Applied provides for the estimated cost of warranty when revenue is recognized. Estimated warranty costs are determined by analyzing specific product and historical configuration statistics and regional warranty support costs. Applied’s warranty obligation is affected by product 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.

      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 inventory adjustments for excess or obsolete inventory might be required, which could have a material adverse effect on Applied’s business, financial condition and results of operations.

      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 reviews goodwill annually in accordance with Statement of Financial Accounting Standards (SFAS) No. 142 (SFAS 142), “Goodwill and Other Intangible Assets.” 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 judgment 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 write down the asset to its realizable value. The fair value of a reporting unit is estimated using the market multiples approach, and is dependent on market values for companies in a similar industry. A severe decline in market value 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.

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      Applied accounts for income taxes in accordance with SFAS No. 109, (SFAS 109) “Accounting for Income Taxes,” which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. SFAS 109 also requires that deferred tax assets be 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 its future taxable income will be sufficient to realize its deferred tax assets.

      Applied provides for income taxes based upon an annual estimated effective income tax rate. 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 on a timely basis. 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 is subject to various legal proceedings and claims, either asserted or unasserted, that arise in the ordinary course of business. Applied evaluates, among other factors, the degree of probability of an unfavorable outcome and reasonably estimates the amount of the loss. Significant judgment is required in both the determination of the probability and as to whether an exposure can be reasonably estimated. When Applied determines that it is probable that a loss has been incurred, the effect is recorded promptly in the consolidated financial statements. Although the outcome of these claims cannot be predicted with certainty, Applied does not believe that any of the existing legal matters will have a material adverse effect on its financial condition or results of operations. However, significant changes in legal proceedings and claims or the factors considered in the evaluation of those matters could have a material adverse effect on Applied’s business, financial condition and results of operations.

Trends, Risks and Uncertainties

      As a supplier to the global semiconductor industry, Applied is subject to the industry’s business cycles, the timing, length and volatility of which are difficult to predict. The semiconductor industry has historically been cyclical because of sudden changes in demand for semiconductors and manufacturing capacity, including capacity utilizing the latest technology. The rate of changes in demand, including end demand, is accelerating, and the effect of these changes on Applied is occurring sooner, exacerbating the volatility of these cycles. These changes have affected the timing and amounts of customers’ capital equipment purchases and investments in new technology, and continue to affect Applied’s net sales, gross margin and results of operations. In addition to affecting Applied’s customers and suppliers, these business cycles also challenge key management, engineering and other employees of Applied.

      During periods of increasing demand for semiconductor manufacturing equipment, Applied must have sufficient manufacturing capacity and inventory to meet customer demand, and must be able to attract, hire, assimilate and retain a sufficient number of qualified individuals. The semiconductor industry appears to be in the early stages of an upturn. However, management cannot predict the sustainability of a recovery, if any, and/or the industry’s rate of growth in such a recovery, both of which will be affected by many factors, including the global uncertainties discussed below. If Applied is unable to effectively manage its resources and production capacity during an industry upturn, there could be a material adverse effect on its business, financial condition and results of operations. Conversely, in downturns, Applied must be able to appropriately align its cost structure with prevailing market conditions and effectively motivate and retain key employees. In response to the downturn that began in fiscal 2001, Applied continues the implementation of realignment activities in order to align its cost structure with business conditions and to enable Applied to focus resources on core research and development programs. If Applied is unable to implement these realignment activities according to the timetable and to the extent anticipated, if implementation negatively affects Applied’s operations, net sales or profitability, or if Applied does not maintain effective cost controls, Applied’s business, financial condition, or results of operations may be negatively affected.

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      Because it operates in a highly competitive environment, Applied’s future success is heavily dependent upon effective development, commercialization and customer acceptance of its new products and services over those of its competitors. Specifically, these risks may include, but are not limited to, Applied’s ability to timely and cost-effectively: 1) develop new products, services and technologies, including those utilizing new materials, such as copper and low-k materials; 2) improve existing products, services and technologies; 3) develop new markets in the semiconductor industry for Applied’s products and services; 4) introduce new products and services to the marketplace; 5) achieve market acceptance and accurately forecast demand for its products and services; 6) transition from 200mm systems to 300mm systems; 7) qualify new or improved products for volume manufacturing with its customers; 8) commence and adjust production to meet customer demands; 9) price products and services appropriately; and 10) lower customers’ cost of ownership. The development, introduction and support of an increasingly broad set of new or improved products, services and technologies, including those enabling the transition to smaller device feature sizes, new materials and 300mm wafers, grow increasingly complex and expensive over time. Such new or improved products and services may involve higher costs and reduced efficiencies compared to Applied’s more established products and services and could adversely affect Applied’s gross margins. If Applied does not develop and introduce new or improved products, services and technologies in a timely and cost-effective manner in response to changing market conditions or customer requirements, its competitive position, financial condition and results of operations could be materially and adversely affected.

      The semiconductor industry is characterized by rapid ongoing changes, including: 1) more complex technology requirements, 2) the changing information technology cost structure and the importance of driving down cost of ownership, 3) the increasing significance of consumer electronics as a driver for chip demand and the related focus on lower prices, 4) the growing type and variety of integrated circuits and applications, 5) an increasing number of applications across multiple substrate sizes in the semiconductor industry, resulting in divergent interests among semiconductor manufacturers, 6) a rising percentage of business from customers in Asia and emergence of customers and competitors in new geographical regions, 7) customer demands for increasingly shorter lead times for the manufacture and installation of semiconductor manufacturing equipment and 8) higher capital requirements for new semiconductor fabrication plants. These factors are increasing the need for customer partnering, use of foundries, collective research and development efforts and process integration support. These trends also heighten the importance of spare parts and services as a competitive advantage for semiconductor equipment manufacturers. In addition, key integrated circuit manufacturers have become influential in technology decisions made by their global partners. If Applied does not successfully manage the risks resulting from the ongoing changes occurring in the semiconductor industry, its business, financial condition and results of operation could be materially and adversely affected.

      Applied’s customer base is and has been highly concentrated. Orders from a relatively limited number of manufacturers of integrated circuits have accounted for, and likely will continue to account for, a substantial portion of Applied’s net sales, which may lead customers to demand pricing and other terms less favorable to Applied. In addition, sales to any single customer may vary significantly from quarter to quarter. If current customers delay, cancel or do not place orders, Applied may not be able to replace these orders with new orders. As Applied’s products are configured to customer specifications, changing, rescheduling or canceling orders may result in significant and often non-recoverable costs. The resulting fluctuations in the amount of and terms of orders could have a material adverse effect on Applied’s business, financial condition and results of operations.

      During fiscal 2003, more than 70 percent of Applied’s net sales were to regions outside the United States. Certain manufacturing facilities and suppliers of Applied are also located outside the United States. Managing Applied’s global operations presents challenges, including those arising from periodic regional economic downturns, trade balance issues, varying business conditions and demands, variations in enforcement of intellectual property and contract rights in different jurisdictions, differences in the ability to develop relationships with suppliers and other local businesses, changes in U.S. and international laws and regulations including U.S. export restrictions, fluctuations in interest and currency exchange rates, the need to provide

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      Applied’s success depends in large part on its ability to attract, retain and motivate key employees, including those in managerial, technical, marketing and support roles. Achieving this objective may be difficult due to changes in the global economy, the industry, Applied’s workforce actions and realignment activities, and its changes in management. If Applied does not successfully attract, retain and motivate key employees, the Company’s operating results and ability to capitalize on its opportunities may be materially and adversely affected.

      Applied’s business depends on its ability to supply products that meet the rapidly changing demands of its customers, which depends in part on the timely delivery of parts, components, and subassemblies (parts) from suppliers. Some key parts may be obtained only from a single supplier or a limited group of suppliers. In addition, Applied outsources certain manufacturing activities. Significant interruptions of manufacturing operations as a result of the failure or inability of suppliers to timely deliver quality parts, outsourcing difficulties, natural disasters (such as earthquakes or tornadoes), or other causes (such as information technology or infrastructure failures, regional economic downturns, political instability, terrorism, acts of war, or epidemics) could result in delayed product deliveries or manufacturing inefficiencies. Any or all of these factors could materially and adversely affect Applied’s business, financial condition and results of operations.

      Applied has made, and may in the future make, acquisitions of, or significant investments in, businesses with complementary products, services and/or technologies. Acquisitions involve numerous risks, including but not limited to: 1) diversion of management’s attention from other operational matters; 2) the inability to realize expected synergies resulting from the acquisition; 3) failure to commercialize purchased technology; 4) impairment of acquired intangible assets as a result of technological advancements or worse-than-expected performance of the acquired company; 5) integration and retention of key employees; and 6) integration of operations. Mergers and acquisitions are inherently subject to significant risks, and the inability to effectively manage these risks could materially and adversely affect Applied’s business, financial condition and results of operations.

      Applied is subject to environmental and safety regulations in connection with its business operations, including but not limited to regulations related to the development, manufacture and use of its products. Failure or inability to comply with existing or future environmental and safety regulations could result in significant remediation liabilities, the imposition of fines and/or the suspension or termination of development, manufacture or use of certain of its products, each of which could have a material adverse effect on Applied’s business, financial condition and results of operations.

      Applied is subject to various risks related to: 1) new, different, inconsistent or even conflicting laws, rules and regulations that may be enacted by legislative bodies and/or regulatory agencies in the regions in which Applied operates and with which Applied must comply; and 2) disagreements or disputes between national or regional regulatory agencies related to international trade.

      For example, the World Trade Organization (WTO) has determined that the U.S. Foreign Sales Corporation (FSC) and Extraterritorial Income (ETI) exclusion constitute prohibited export subsidies warranting the possible imposition of trade sanctions on certain goods. Applied has benefited from FSC and ETI tax provisions, and the elimination of these tax benefits could materially and adversely affect Applied’s financial condition and results of operations.

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      During fiscal 2002, Applied filed an application with the SEC for an exemptive order confirming that it is not subject to the Investment Company Act of 1940 (the Act), which requires companies primarily engaged in the business of investing in securities to comply with additional rules and regulations. Largely due to the industry downturn, Applied’s ratios of investments to total assets and of interest income to net income have increased, resulting in the risk that Applied could be deemed to be covered by the Act. If the SEC does not grant the exemption, Applied may have to take other actions that could adversely affect its results of operations in order not to be subject to the Act.

      Applied from time to time is, and in the future may be, involved in legal proceedings or claims regarding patent infringement, intellectual property rights, antitrust, environmental regulations, securities, contracts, product performance, product liability, employment and other matters. In addition, Applied on occasion receives notification from customers who believe that Applied owes them indemnification or other obligations related to infringement claims made against the customers by third parties. These legal proceedings and claims, whether with or without merit, are time-consuming and expensive to prosecute or defend and divert management’s attention and resources. There can be no assurance regarding the outcome of current or future legal proceedings or claims. In addition, Applied’s intellectual property rights may not provide significant competitive advantages if they are circumvented, invalidated or rendered obsolete by the rapid pace of technological change. Furthermore, the laws of other countries permit the protection of Applied’s proprietary rights to varying extents, compared to U.S. laws. Applied’s success is dependent in part upon the protection of its intellectual property rights. Infringement of Applied’s rights by a third party could result in uncompensated lost market and revenue opportunities for Applied. If Applied is not able to resolve a claim, negotiate a settlement of the matter, obtain necessary licenses on commercially reasonable terms, and/or successfully prosecute or defend its position, Applied’s business, financial condition and results of operations could be materially and adversely affected.

Interest Rate Risk

      At October 26, 2003, Applied’s investment portfolio included fixed-income securities with a fair value of approximately $5.0 billion. These securities are subject to interest rate risk and will decline in value if interest rates increase. Due to the short duration of Applied’s investment portfolio, an immediate 10 percent change in interest rates is not expected to have a material effect on Applied’s near-term financial condition or results of operations.

      Applied’s long-term debt bears interest primarily at fixed rates; therefore, Applied’s results of operations would be affected by interest rate changes only to the extent that variable rate short-term notes payable are outstanding. Due to the short-term nature and relatively insignificant amount of Applied’s short-term notes payable, an immediate 10 percent change in interest rates is not expected to have a material effect on Applied’s near-term financial condition or results of operations.

Foreign Currency Exchange Rate Risk

      Certain operations of Applied are conducted in foreign currencies, such as Japanese yen, the euro, Israeli shekel and British pound. Applied enters into forward exchange and currency option contracts to hedge a portion of, but not all, existing and anticipated foreign currency denominated transactions expected to occur within 12 months. Gains and losses on these contracts are generally recognized in the Consolidated Statements of Operations at the time that the related transactions being hedged are recognized. Because the effect of movements in currency exchange rates on forward exchange and currency option contracts generally offsets the related effect on the underlying items being hedged, these financial instruments are not expected to subject Applied to risks that would otherwise result from changes in currency exchange rates. Applied does not use derivative financial instruments for trading or speculative purposes. Net foreign currency gains and losses did not have a material effect on Applied’s results of operations for fiscal 2001, 2002 or 2003.

      Forward exchange contracts are denominated in the same currency as the underlying transactions (primarily Japanese yen, the euro, Israeli shekel and British pound), and the terms of the forward exchange contracts generally match the terms of the underlying transactions. Applied’s outstanding forward exchange contracts are marked-to-market (see Note 2 of Notes to Consolidated Financial Statements), as are the majority of the related underlying transactions being hedged; therefore, the effect of exchange rate changes on forward exchange contracts is expected to be substantially offset by the effect of these changes on the

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      The consolidated financial statements required by this Item are set forth on the pages indicated at Item 15(a).

      None.

      As required by Rule 13a-15(b), Applied management, including the Chief Executive Officer and Chief Financial Officer, conducted an evaluation as of the end of the period covered by this report, of the effectiveness of Applied’s disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that Applied’s disclosure controls and procedures were effective as of the end of the period covered by this report. As required by Rule 13a-15(d), Applied management, including the Chief Executive Officer and Chief Financial Officer, also conducted an evaluation of Applied’s internal control over financial reporting to determine whether any changes occurred during the fourth fiscal quarter that have materially affected, or are reasonably likely to materially affect, Applied’s internal control over financial reporting. Based on that evaluation, there has been no such change during the fourth fiscal quarter.

      It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system will be met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events.

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PART III

      Pursuant to Paragraph G(3) of the General Instructions to Form 10-K, portions of the information required by Part III of Form 10-K are incorporated by reference from Applied’s Proxy Statement to be filed with the SEC in connection with the 2004 Annual Meeting of Stockholders (“the Proxy Statement”).

      (1) Information concerning directors, including Applied’s audit committee financial expert, appears in Applied’s Proxy Statement, under “Election of Directors.” This portion of the Proxy Statement is incorporated herein by reference.

      (2) For information with respect to Executive Officers, see Part I of this Annual Report on Form 10-K, under “Executive Officers of the Registrant.”

      (3) Information concerning Section 16(a) beneficial ownership reporting compliance appears in Applied’s Proxy Statement, under “Section 16(a) Beneficial Ownership Reporting Compliance.” This portion of the Proxy Statement is incorporated herein by reference.

      Applied has adopted the Standards of Business Conduct, a code of ethics with which every person who works for Applied is expected to comply. The Standards of Business Conduct are publicly available on Applied’s website under the Investors Section (at http://www.appliedmaterials.com/ investors/cg standards.html#1). This website address is intended to be an inactive, textual reference only; none of the material on this website is part of this report. If any substantive amendments are made to the Standards of Business Conduct or grant any waiver, including any implicit waiver, from a provision of the code to Applied’s Chief Executive Officer, Chief Financial Officer or Corporate Controller, Applied will disclose the nature of such amendment or waiver on that website or in a report on Form 8-K.

      Information concerning executive compensation appears in Applied’s Proxy Statement, under “Executive Compensation and Related Information.” This portion of the Proxy Statement is incorporated herein by reference.

      Information concerning the security ownership of certain beneficial owners and management appears in Applied’s Proxy Statement, under “Principal Stockholders.” This portion of the Proxy Statement is incorporated herein by reference.

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      The following table summarizes information with respect to options under Applied’s equity compensation plans at October 26, 2003:

(1)	Includes only options outstanding under Applied’s stock option plans, as no stock warrants or rights were outstanding as of October 26, 2003.
(2)	Includes 17,633 shares of common stock reserved for future issuance under the Applied Materials, Inc. Employees’ Stock Purchase Plan.
(3)	Includes options to purchase 1,994 shares of Applied’s common stock assumed through various mergers and acquisitions, after giving effect to the applicable exchange ratios. These assumed options had a weighted average exercise price of $14.26 per share. No further shares are available for issuance under these assumed plans.
(4)	Includes 7,295 shares of common stock reserved for future issuance under the Applied Materials, Inc. Employees’ Stock Purchase Plan for Offshore Employees.

      The information appearing in Applied’s fiscal 2003 Proxy Statement under the heading “Certain Relationships and Related Transactions” is incorporated herein by reference.

      Information concerning principal accountant fees and services and the audit committee’s preapproval policies and procedures appear in Applied’s Proxy Statement under the heading “Fees Paid to PricewaterhouseCoopers LLP” and is incorporated herein by reference.

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PART IV

      (a) The following documents are filed as part of this Annual Report on Form 10-K:

      (b) On August 12, 2003, Applied furnished under Item 12 of Form 8-K the press release announcing Applied’s financial results for the fiscal quarter ended July 27, 2003, Applied’s consolidated condensed balance sheets as of October 27, 2002 and July 27, 2003, and Applied’s consolidated condensed statements of operations for the three months and the nine months ended July 28, 2002 and July 27, 2003.

      All other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.

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APPLIED MATERIALS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying Notes to Consolidated Financial Statements.

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APPLIED MATERIALS, INC.

CONSOLIDATED BALANCE SHEETS