LAM RESEARCH CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS With the exception of historical facts, the statements contained in this discussion are forward-looking statements, which are subject to the safe harbor provisions created by the Private Securities Litigation Reform Act of 1995.

Certain, but not all, of the forward-looking statements in this report are specifically identified as forward-looking, by use of phrases and words such as "we believe," "we anticipate," "we expect," "may," "should," "could" and other future-oriented terms. The identification of certain statements as "forward-looking" is not intended to mean that other statements not specifically identified are not forward-looking. Forward-looking statements include, but are not limited to, statements that relate to: trends in the global economic environment and the semiconductor industry; the anticipated levels of, and rates of change in, future shipments, margins, market share, capital expenditures, revenue and operating expenses generally; volatility in our quarterly results; customer requirements and our ability to satisfy those requirements; customer capital spending and their demand for our products; our ability to defend our market share and to gain new market share; anticipated growth in the industry and the total market for wafer-fabrication equipment and our growth relative to such growth; levels of research and development ("R&D") expenditures; the estimates we make, and the accruals we record, in order to implement our critical accounting policies (including but not limited to the adequacy of prior tax payments, future tax liabilities and the adequacy of our accruals relating to them); our access to capital markets; our ability to manage and grow our cash position; and the sufficiency of our financial resources to support future business activities (including but not limited to operations, investments, debt service requirements and capital expenditures). Such statements are based on current expectations and are subject to risks, uncertainties, and changes in condition, significance, value, and effect, including without limitation those discussed below under the heading "Risk Factors" within Part II Item 1A and elsewhere in this report and other documents we file from time to time with the Securities and Exchange Commission ("SEC"), such as our annual report on Form 10-K for the year ended June 24, 2012 (our "2012 Form 10-K"), our quarterly report on Form 10-Q for the quarter ended September 23, 2012, and our current reports on Form 8-K. Such risks, uncertainties and changes in condition, significance, value, and effect could cause our actual results to differ materially from those expressed in this report and in ways not readily foreseeable. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof and are based on information currently and reasonably known to us. We undertake no obligation to release the results of any revisions to these forward-looking statements, which may be made to reflect events or circumstances that occur after the date hereof or to reflect the occurrence or effect of anticipated or unanticipated events.

Documents To Review In Connection With Management's Discussion and Analysis Of Financial Condition and Results Of Operations For a full understanding of our financial position and results of operations for the three months ended December 23, 2012, and the related Management's Discussion and Analysis of Financial Condition and Results of Operations below, you should also read the Condensed Consolidated Financial Statements and notes presented in this Form 10-Q and the financial statements and notes in our 2012 Form 10-K.

Overview Management's Discussion and Analysis of Financial Condition and Results of Operations consists of the following sections: Executive Summary provides an overview of the Company's operations and a summary of certain highlights of our results of operations Results of Operations provides an analysis of operating results Critical Accounting Policies and Estimates discusses accounting policies that reflect the more significant judgments and estimates we use to prepare our Condensed Consolidated Financial Statements Liquidity and Capital Resources provides an analysis of cash flows and financial position.

EXECUTIVE SUMMARY We design, manufacture, market, refurbish, and service semiconductor processing equipment used in the fabrication of integrated circuits and are recognized as a major provider of such equipment to the worldwide semiconductor industry. Our customers include semiconductor manufacturers that make DRAM, flash memory, microprocessors, and other logic integrated circuits for a wide range of consumer and industrial electronics. Semiconductor wafers are subjected to a complex series of process and preparation steps that result in the simultaneous creation of many individual integrated circuits. We leverage our expertise in semiconductor processing to develop technology and productivity solutions that typically benefit our customers through lower defect rates, enhanced yields, faster processing time, and reduced cost as well as by facilitating their ability to meet more stringent performance and design standards.

28-------------------------------------------------------------------------------- Table of Contents The semiconductor capital equipment industry is cyclical in nature and has historically experienced periodic and pronounced changes in customer demand resulting in industry downturns and upturns. Today's leading indicators of change in customer investment patterns, such as electronics demand, memory pricing, and foundry utilization rates, may not be any more reliable than in prior years. Demand for our equipment can vary significantly from period to period as a result of various factors, including, but not limited to, economic conditions (both general and in the semiconductor and electronics industries), industry supply and demand, prices for semiconductors, customer capacity requirements, and our ability to develop, acquire, and market competitive products. For these and other reasons, our results of operations during any particular fiscal period are not necessarily indicative of future operating results.

Demand for our products declined during the second half of calendar year 2012 as certain semiconductor device manufacturers, particularly NAND memory manufacturers, reduced their investment levels. We believe demand for mobile products, which require semiconductor devices such as NAND memory, will continue to grow in calendar year 2013, eventually requiring additional investment in capital equipment. As a result, we believe capital equipment spending has the potential to increase in calendar year 2013, and currently believe that the second half of the year has greater potential than the first half of 2013.

Further, we believe that, over the long term, demand for our products will increase as customers' capital expenditures rise to address the increasing complexity of semiconductor device manufacturing and meet growing demand for semiconductor devices, particularly in the mobility space.

The following table summarizes certain key financial information for the periods indicated below (in thousands, except percentage and per share data): Three Months Ended December 23, September 23, December 25, 2012 2012 2011 Revenue $ 860,886 $ 906,888 $ 583,981 Gross margin $ 315,414 $ 333,886 $ 234,826 Gross margin as a percent of revenue 36.6 % 36.8 % 40.2 % Total operating expenses $ 311,372 $ 317,174 $ 187,280 Net income $ 6,408 $ 2,768 $ 33,212 Diluted net income per share $ 0.04 $ 0.02 $ 0.27 In the quarter ended December 23, 2012, revenue decreased as compared to the quarter ended September 23, 2012 due to the decline in demand for semiconductor capital equipment. Gross margin as a percent of revenues decreased as compared to the September 2012 quarter due primarily to increased costs related to rationalization of certain product configurations, unfavorable factory utilization, as well as product mix changes, offset by a decrease in costs associated with Novellus acquisition-related inventory fair value adjustments.

Operating expenses in the December 2012 quarter decreased as compared to the quarter ended September 2012, as a result of reductions in field and support group spending, lower integration costs, and lower variable compensation associated with the decline in operating income.

Our cash and cash equivalents, short-term investments, and restricted cash and investments balances totaled approximately $2.7 billion as of December 23, 2012 compared to $2.9 billion as of September 23, 2012. Cash generated by operations was approximately $193 million during the December 2012 quarter. We used cash during the December 2012 quarter to repurchase $355 million of our shares and purchase $39 million of property and equipment. As of December 23, 2012, employee headcount remained flat to the September quarter at approximately 6,600 people.

RESULTS OF OPERATIONS Shipments Three Months Ended December 23, September 23, December 25, 2012 2012 2011 Shipments (in millions) $ 803 $ 935 $ 563 North America 29 % 18 % 19 % Taiwan 22 % 29 % 18 % Asia Pacific 14 % 22 % 8 % Japan 14 % 8 % 10 % Korea 12 % 16 % 37 % Europe 9 % 7 % 8 % 29 -------------------------------------------------------------------------------- Table of Contents Shipments for the December 2012 quarter decreased 14% compared to the September 2012 quarter and increased 43% year over year. The year over year increase reflects operations post-acquisition of Novellus, which occurred on June 4, 2012. During the December 2012 quarter, applications below the 40 nanometer technology node were 78% of total systems shipments. The system shipments in the memory, foundry, and logic/integrated device manufacturing markets were approximately 20%, 51% and 29%, respectively. During the September 2012 quarter, applications below the 40 nanometer technology node were 81% of total systems shipments. The system shipments in the memory, foundry, and logic/integrated device manufacturing markets were approximately 42%, 48% and 10%, respectively.

Revenue Three Months Ended Six Months Ended December 23, September 23, December 25, December 23, December 25, 2012 2012 2011 2012 2011 Revenue (in millions) $ 861 $ 907 $ 584 $ 1,768 $ 1,264 Taiwan 26 % 28 % 17 % 27 % 15 % North America 24 % 18 % 18 % 21 % 19 % Korea 12 % 24 % 34 % 18 % 29 % Asia Pacific 20 % 15 % 8 % 17 % 11 % Japan 10 % 8 % 14 % 9 % 16 % Europe 8 % 7 % 9 % 8 % 10 % Revenue for the December 2012 quarter decreased 5% compared to the September 2012 quarter due to the decline in demand for semiconductor capital equipment.

Revenue for the three and six months ended December 23, 2012 increased 47% and 40%, respectively, as compared to the same periods last year, reflecting operations post-acquisition of Novellus. Our deferred revenue balance decreased to $282 million as of December 23, 2012 compared to $364 million as of September 23, 2012. Our deferred revenue balance does not include shipments to Japanese customers, to whom title does not transfer until customer acceptance.

Shipments to Japanese customers are classified as inventory at cost until the time of acceptance. The anticipated future revenue value from shipments to Japanese customers was approximately $46 million as of December 23, 2012 compared to $21 million as of September 23, 2012.

Gross Margin Three Months Ended Six Months Ended December 23, September 23, December 25, December 23, December 25, 2012 2012 2011 2012 2011 (in thousands, except percentages) Gross margin $ 315,414 $ 333,886 $ 234,826 $ 649,300 $ 518,709 Percent of revenue 36.6 % 36.8 % 40.2 % 36.7 % 41.0 % The decrease in gross margin as a percentage of revenue during the December 2012 quarter as compared to the September 2012 quarter is primarily due to costs incurred related to rationalization of certain product configurations, which increased from $3 million to $17 million, unfavorable factory utilization, as well as product mix changes. These declines were partially offset by costs associated with Novellus acquisition-related inventory fair value adjustments, which decreased from approximately $44 million to $27 million.

The decrease in gross margin as a percentage of revenue during the December 2012 quarter as compared to the December 2011 quarter is primarily due to $27 million in costs associated with Novellus acquisition-related inventory fair value adjustments, $21 million of amortization of acquired Novellus intangible assets, and $17 million of costs incurred related to rationalization of certain product configurations.

The decrease in gross margin as a percentage of revenue during the six months ended December 23, 2012 quarter as compared to the same period in the prior year is primarily due to acquisition-related inventory fair value adjustments of approximately $71 million and amortization of acquired intangible assets of approximately $41 million, which did not occur in the six months ended December, 25 2011.

30 -------------------------------------------------------------------------------- Table of Contents Research and Development Three Months Ended Six Months Ended December 23, September 23, December 25, December 23, December 25, 2012 2012 2011 2012 2011 (in thousands, except percentages) Research and development ("R&D") $ 165,951 $ 163,311 $ 104,024 $ 329,262 $ 206,583 Percent of revenue 19.3 % 18.0 % 17.8 % 18.6 % 16.3 % We continue to make significant R&D investments focused on leading-edge plasma etch, single-wafer clean, deposition, and other semiconductor manufacturing requirements. The increase in R&D expenses during the December 2012 quarter compared to the September 2012 quarter was primarily due to an increase in supplies and outside services costs offset by a reduction in variable compensation due to lower operating income levels.

While December 2011 reflects Lam standalone results, December 2012 reflects combined operations with Novellus. The increase in R&D expenses during the December 2012 quarter compared to the same period in the prior year was primarily due to a $27 million increase in employee compensation and benefits, mainly as a result of higher headcount, a $16 million increase in supplies and facilities costs, a $7 million increase in depreciation and amortization, and a $5 million increase in outside services.

While the six months ended December 25, 2011 reflect Lam standalone results, the six months ended December 23, 2012 reflect combined operations with Novellus.

The increase in R&D expenses during the six months ended December 23, 2012 compared to the same period in the prior year was primarily due to a $57 million increase in employee compensation and benefits, mainly as a result of higher headcount, a $24 million increase in supplies and facilities costs, a $14 million increase in depreciation and amortization, and a $10 million increase in outside services.

Selling, General and Administrative Three Months Ended Six Months Ended December 23, September 23, December 25, December 23, December 25, 2012 2012 2011 2012 2011 (in thousands, except percentages) Selling, general and administrative ("SG&A") $ 144,400 $ 153,863 $ 83,256 $ 298,263 $ 163,456 Percent of revenue 16.8 % 17.0 % 14.3 % 16.9 % 12.9 % The decrease in SG&A expenses during the December 2012 quarter compared to the September 2012 quarter was primarily due to an $8 million decline in salaries and benefits as a result of reduction in variable compensation on lower operating income and $5 million lower integration costs.

The increase in SG&A expenses during the December 2012 quarter compared to the same period in the prior year was primarily due to the impact of combined operations with Novellus. Increased expenses included $29 million in employee compensation and benefits, $19 million in intangible asset amortization, and $10 million in supplies and facilities costs.

The increase in SG&A expenses in the six months ended December 23, 2012 compared to the same period in the prior year was primarily due to the impact of combined operations with Novellus. Increased expenses included $63 million in employee compensation and benefits, $39 million in intangible asset amortization, $14 million in integration and acquisition-related expenses, and $18 million in supplies and facilities costs.

Restructuring and Asset Impairments During the three and six months ended December 23, 2012 we incurred net restructuring charges of $1.0 million primarily related to changes in sublease assumptions for previously restructured buildings. During the six months ended December 25, 2011, the Company incurred asset impairment charges of $1.7 million related to a decline in the market value of certain facilities.

31-------------------------------------------------------------------------------- Table of Contents Other Expense, Net Other expense, net consisted of the following: Three Months Ended Six Months Ended December 23, September 23, December 25, December 23, December 25, 2012 2012 2011 2012 2011 (in thousands) Interest income $ 4,376 $ 3,800 $ 2,472 $ 8,176 $ 5,061 Interest expense (14,975 ) (15,144 ) (9,346 ) (30,119 ) (18,606 ) Gains (losses) on deferred compensation plan related assets 1,234 2,741 (348 ) 3,975 (2,213 ) Foreign exchange losses (3,274 ) (368 ) (142 ) (3,642 ) (1,232 ) Other, net (751 ) (967 ) (421 ) (1,718 ) (2,868 ) $ (13,390 ) $ (9,938 ) $ (7,785 ) $ (23,328 ) $ (19,858 ) Interest expense increased in the three and six months ended December 23, 2012 as compared to the same periods in the prior year due to the 2041 Notes assumed in June 2012 in connection with the Novellus acquisition.

Foreign exchange losses in December 2012 were related to un-hedged portions of the balance sheet exposures, primarily in the Taiwan dollar and Korean Won.

In the three and six months ended December 23, 2012, we recognized gains on assets which are related to obligations under our deferred compensation plan, whereas during the same periods in the prior year we recognized losses on assets due to changes in the market value of securities in this portfolio.

Income Tax Expense Our tax benefits for the three and six months ended December 23, 2012 were $(15.8) million and $(11.8) million, respectively, which yielded effective income tax rates of 168.6% and 456.4%, respectively. Our tax expenses for the three and six months ended December 25, 2011 were $6.5 million and $22.0 million, respectively, which yielded effective income tax rates of 16.5% and 17.3%, respectively. The increase in the effective tax rate for the three and six months ended December 23, 2012 compared to the three and six months ended December 25, 2011 was primarily due to the recognition of previously unrecognized tax benefits due to lapse of statute of limitations and the successful resolution of certain tax matters, the reduced level of income, an increase in the percentage of profits in jurisdictions with lower tax rates combined with a projected pre-tax loss in higher tax jurisdictions, and the treatment of integration and impairment expenses as a discrete event in determining the annual effective tax rate, offset by an increase in the non-deductible stock based compensation. In addition, the U.S. federal research and development (R&D) tax credit has expired as of December 31, 2011 and no tax benefit has been included in the calculation of the provision for income taxes for the three and six months ended December 23, 2012. On January 2, 2013 the "American Taxpayer Relief Act of 2012" was signed into law, which includes retroactive extension of the U.S. federal R&D tax credit through December 31, 2013. The Company is currently evaluating the impact of this R&D credit extension on the provision for income taxes for the remainder of fiscal year 2013.

The effective tax rate of 168.6% and 456.4% for the three and six months ended December 23, 2012 includes the tax impact of the following discrete items which are recorded in the period in which they occur: (1) a tax benefit of $30.5 million and $30.9 million for the three months and six months, respectively, due to the recognition of previously unrecognized tax benefits due to lapse of statute of limitations and successful resolution of certain tax matters, and (2) the effective tax rate impact of integration and impairment expenses of $28.3 million and $45.3 million for the three months and six months, respectively, for which little tax benefit is derived. The effective tax rate of 16.5% and 17.3% for the three and six months ended December 25, 2011 includes the tax impact of the following discrete items which are recorded in the period in which they occur: (1) a tax expense of $2.2 million and $3.8 million, respectively, related to the filing of prior year foreign tax returns, which resulted in provision to return true-ups, (2) a tax expense of $0.8 million and $1.7 million, respectively, of interest related to uncertain tax positions, (3) a tax benefit of $2.5 million and $3.7 million, respectively, related to the acquisition, restructuring and asset impairment related expenses, and (4) a tax benefit of $6.9 million and $7.1 million, respectively, related to the recognition of previously unrecognized tax benefits and the reversal of the related interest accruals due to finalization of certain foreign uncertain tax positions.

Deferred Income Taxes We had gross deferred tax assets, related primarily to reserves and accruals that are not currently deductible and tax credit carryforwards, of $345.6 million and $253.7 million as of December 23, 2012 and June 24, 2012, respectively. The gross deferred tax assets were offset by deferred tax liabilities of $357.7 million and a valuation allowance of $55.2 million as of December 23, 2012. The gross deferred tax assets were offset by deferred tax liabilities of $285.6 million and a valuation allowance of $55.2 million as of June 24, 2012.

32 -------------------------------------------------------------------------------- Table of Contents We record a valuation allowance to reduce our deferred tax assets to the amount that is more-likely-than-not to be realized. Realization of our net deferred tax assets is dependent on future taxable income. We believe it is more likely than not that such assets will be realized; however, ultimate realization could be negatively impacted by market conditions and other variables not known or anticipated at this time. In the event that we determine that we would not be able to realize all or part of our net deferred tax assets, an adjustment would be charged to earnings in the period such determination is made. Likewise, if we later determine that it is more-likely-than-not that the deferred tax assets would be realized, then the previously provided valuation allowance would be reversed.

We evaluate the realizability of the deferred tax assets quarterly and will continue to assess the need for changes in valuation allowances, if any.

Uncertain Tax Positions We reevaluate uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit, and new audit activity. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES A critical accounting policy is defined as one that has both a material impact on our financial condition and results of operations and requires us to make difficult, complex and/or subjective judgments, often as a result of the need to make estimates about matters that are inherently uncertain. The preparation of financial statements in conformity with U.S. Generally Accepted Accounting Principles ("GAAP") requires management to make certain judgments, estimates and assumptions that could affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We based our estimates and assumptions on historical experience and on various other assumptions we believed to be applicable and evaluate them on an ongoing basis to ensure they remain reasonable under current conditions. Actual results could differ significantly from those estimates, which could have a material impact on our business, results of operations, and financial condition.

We believe that the following critical accounting policies reflect the more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition: We recognize all revenue when persuasive evidence of an arrangement exists, delivery has occurred and title has passed or services have been rendered, the selling price is fixed or determinable, collection of the receivable is reasonably assured, and we have received customer acceptance, completed our system installation obligations, or are otherwise released from our installation or customer acceptance obligations. If terms of the sale provide for a lapsing customer acceptance period, we recognize revenue upon the expiration of the lapsing acceptance period or customer acceptance, whichever occurs first. If the practices of a customer do not provide for a written acceptance or the terms of sale do not include a lapsing acceptance provision, we recognize revenue when it can be reliably demonstrated that the delivered system meets all of the agreed-to customer specifications. In situations with multiple deliverables, we recognize revenue upon the delivery of the separate elements to the customer and when we receive customer acceptance or are otherwise released from our customer acceptance obligations. We allocate revenue from multiple-element arrangements among the separate elements based on their relative selling prices, provided the elements have value on a stand-alone basis. Our sales arrangements do not include a general right of return. The maximum revenue we recognize on a delivered element is limited to the amount that is not contingent upon the delivery of additional items. We generally recognize revenue related to sales of spare parts and system upgrade kits upon shipment. We generally recognize revenue related to services upon completion of the services requested by a customer order. We recognize revenue for extended maintenance service contracts with a fixed payment amount on a straight-line basis over the term of the contract. When goods or services have been delivered to the customer but all conditions for revenue recognition have not been met, we record deferred revenue and/or deferred costs of sales in deferred profit on our Consolidated Balance Sheet.

Inventory Valuation: Inventories are stated at the lower of cost or market using standard costs that generally approximate actual costs on a first-in, first-out basis. We maintain a perpetual inventory system and continuously record the quantity on-hand and standard cost for each product, including purchased components, subassemblies, and finished goods. We maintain the integrity of perpetual inventory records through periodic physical counts of quantities on hand. Finished goods are reported as inventories until the point of title transfer to the customer. Generally, title transfer is documented in the terms of sale. Unless specified in the terms of sale, title generally transfers when we complete physical transfer of the products to the freight carrier. Transfer of title for shipments to Japanese customers generally occurs at the time of customer acceptance. We eliminate all intercompany profits related to the sales and purchases of inventory between our legal entities from our Consolidated Financial Statements.

Management evaluates the need to record adjustments for impairment of inventory at least quarterly. Our policy is to assess the valuation of all inventories including manufacturing raw materials, work-in-process, finished goods, and spare parts in each reporting period. Obsolete inventory or inventory in excess of management's estimated usage requirements over the next 12 to 36 months is written down to its estimated market value if less than cost. Estimates of market value include, but are not limited to, management's forecasts related to our future manufacturing schedules, customer demand, technological and/or market obsolescence, general semiconductor market conditions, and possible alternative uses. If future customer demand or market conditions are less favorable than our projections, additional inventory write-downs may be required and would be reflected in cost of goods sold in the period in which we make the revision.

33 -------------------------------------------------------------------------------- Table of Contents Warranty: Typically, the sale of semiconductor capital equipment includes providing parts and service warranty to customers as part of the overall price of the system. We provide standard warranties for our systems. When appropriate, we record a provision for estimated warranty expenses to cost of sales for each system when we recognize revenue. We do not maintain general or unspecified reserves; all warranty reserves are related to specific systems. The amount recorded is based on an analysis of historical activity that uses factors such as type of system, customer, geographic region, and any known factors such as tool reliability trends. All actual or estimated parts and labor costs incurred in subsequent periods are charged to those established reserves on a system-by-system basis.

Actual warranty expenses are accounted for on a system-by-system basis and may differ from our original estimates. While we periodically monitor the performance and cost of warranty activities, if actual costs incurred are different than our estimates, we may recognize adjustments to provisions in the period in which those differences arise or are identified. In addition to the provision of standard warranties, we offer customer-paid extended warranty services. Revenues for extended maintenance and warranty services with a fixed payment amount are recognized on a straight-line basis over the term of the contract. Related costs are recorded as incurred.

Equity-based Compensation - Employee Stock Purchase Plan ("ESPP") and Employee Stock Plans: GAAP requires us to recognize the fair value of equity-based compensation in net income. We determine the fair value of our restricted stock units ("RSUs") based upon the fair market value of Company stock at the date of grant. We estimate the fair value of our stock options and ESPP awards using the Black-Scholes option valuation model. This model requires us to input highly subjective assumptions, including expected stock price volatility and the estimated life of each award. We amortize the fair value of equity-based awards over the vesting periods of the awards, and we have elected to use the straight-line method of amortization.

We make quarterly assessments of the adequacy of our tax credit pool related to equity-based compensation to determine if there are any deficiencies that we are required to recognize in our Consolidated Statements of Operations. We will only recognize a benefit from stock-based compensation in paid-in-capital if we realize an incremental tax benefit after all other tax attributes currently available to us have been utilized. In addition, we have elected to account for the indirect benefits of stock-based compensation on the research tax credit through the income statement (continuing operations) rather than through paid-in-capital. We have also elected to net deferred tax assets and the associated valuation allowance related to net operating loss and tax credit carryforwards for the accumulated stock award tax benefits for income tax footnote disclosure purposes. We will track these stock award attributes separately and will only recognize these attributes through paid-in-capital.

Income Taxes : Deferred income taxes reflect the net tax effect of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, as well as the tax effect of carryforwards. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized.

Realization of our net deferred tax assets is dependent on future taxable income. We believe it is more-likely-than-not that such assets will be realized; however, ultimate realization could be negatively impacted by market conditions and other variables not known or anticipated at the time. In the event that we determine that we would not be able to realize all or part of our net deferred tax assets, an adjustment would be charged to earnings in the period such determination is made. Likewise, if we later determine that it is more-likely-than-not that the deferred tax assets would be realized, then the previously provided valuation allowance would be reversed.

We calculate our current and deferred tax provision based on estimates and assumptions that can differ from the actual results reflected in income tax returns filed during the subsequent year. Adjustments based on filed returns are recorded when identified.

We recognize the benefit from a tax position only if it is more-likely-than-not that the position would be sustained upon audit based solely on the technical merits of the tax position. Our policy is to include interest and penalties related to unrecognized tax benefits as a component of income tax expense.

Please refer to Note 10 of the Notes to the Consolidated Financial Statements for additional information.

In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for uncertain tax positions based on the two-step process prescribed within FASB ASC 740-10. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more-likely-than-not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step requires us to estimate and measure the tax benefit as the largest amount that is more than 50% likely to be realized upon ultimate settlement. It is inherently difficult and subjective to estimate such amounts, as this requires us to determine the probability of various possible outcomes. We reevaluate these uncertain tax positions on a quarterly basis. This evaluation is based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit, and new audit activity. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision in the period such determination is made.

Goodwill and Intangible Assets: Goodwill represents the amount by which the purchase price in each business combination exceeds the fair value of the net tangible and identifiable intangible assets acquired. We allocate the carrying value of goodwill to our reporting units. We test goodwill and identifiable intangible assets with indefinite useful lives for impairment at least annually.

We amortize intangible assets with estimable useful lives over their respective estimated useful lives, and we review for impairment whenever events or changes in circumstances indicate that the carrying amount of the intangible asset may not be recoverable and the carrying amount exceeds its fair value.

34-------------------------------------------------------------------------------- Table of Contents We review goodwill at least annually for impairment. If certain events or indicators of impairment occur between annual impairment tests, we would perform an impairment test of goodwill at that date. In testing for a potential impairment of goodwill, we: (1) allocate goodwill to our reporting units to which the acquired goodwill relates; (2) estimate the fair value of our reporting units; and (3) determine the carrying value (book value) of those reporting units, as some of the assets and liabilities related to those reporting units are not held by those reporting units but by a corporate function. Prior to this allocation of the assets to the reporting units, we are required to assess long-lived assets for impairment. Furthermore, if the estimated fair value of a reporting unit is less than the carrying value, we must estimate the fair value of all identifiable assets and liabilities of that reporting unit, in a manner similar to a purchase price allocation for an acquired business. This can require independent valuations of certain internally generated and unrecognized intangible assets such as in-process R&D and developed technology. Only after this process is completed can the amount of goodwill impairment, if any, be determined. Beginning with our fiscal year 2012 goodwill impairment analysis, we adopted new accounting guidance that allowed us to first assess qualitative factors to determine whether it was necessary to perform a quantitative analysis. Under the revised guidance, an entity is no longer required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more-likely-than-not that its fair value is less than its carrying amount.

The process of evaluating the potential impairment of goodwill is subjective and requires significant judgment at many points during the analysis. We determine the fair value of our reporting units by using a weighted combination of both a market and an income approach, as this combination is deemed to be the most indicative of fair value in an orderly transaction between market participants.

Under the market approach, we use information regarding the reporting unit as well as publicly available industry information to determine various financial multiples to value our reporting units. Under the income approach, we determine fair value based on estimated future cash flows of each reporting unit, discounted by an estimated weighted-average cost of capital, which reflects the overall level of inherent risk of a reporting unit and the rate of return an outside investor would expect to earn.

In estimating the fair value of a reporting unit for the purposes of our annual or periodic analyses, we make estimates and judgments about the future cash flows of our reporting units, including estimated growth rates and assumptions about the economic environment. Although our cash flow forecasts are based on assumptions that are consistent with the plans and estimates we are using to manage the underlying businesses, there is significant judgment involved in determining the cash flows attributable to a reporting unit. In addition, we make certain judgments about allocating shared assets to the estimated balance sheets of our reporting units. We also consider our market capitalization and that of our competitors on the date we perform the analysis. Changes in judgment on these assumptions and estimates could result in a goodwill impairment charge.

As a result, several factors could result in impairment of a material amount of our goodwill balance in future periods, including, but not limited to: (1) weakening of the global economy, weakness in the semiconductor equipment industry, or our failure to reach our internal forecasts, which could impact our ability to achieve our forecasted levels of cash flows and reduce the estimated discounted cash flow value of our reporting units; and (2) a decline in our stock price and resulting market capitalization, if we determine that the decline is sustained and indicates a reduction in the fair value of our reporting units below their carrying value. In addition, the value we assign to intangible assets, other than goodwill, is based on our estimates and judgments regarding expectations such as the success and life cycle of products and technology acquired. If actual product acceptance differs significantly from our estimates, we may be required to record an impairment charge to write down the asset to its realizable value.

Recent Accounting Pronouncements In June 2011, the Financial Accounting Standards Board ("FASB") issued new authoritative guidance that increases the prominence of items reported in other comprehensive income ("OCI") by eliminating the option to present components of OCI as part of the statement of changes in stockholders' equity. The amendments in this standard require that all non-owner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. We adopted this guidance in the September 2012 quarter. The implementation of this authoritative guidance did not have an impact on our financial position or results of operations, but did change the presentation of our financial statements.

35-------------------------------------------------------------------------------- Table of Contents LIQUIDITY AND CAPITAL RESOURCES As of December 23, 2012, we had $2.7 billion in cash and cash equivalents, short-term investments, and restricted cash and investments (total cash and investments) compared to $3.0 billion as of June 24, 2012.

Cash Flows from Operating Activities Net cash provided by operating activities of $442.5 million during the six months ended December 23, 2012 consisted of (in millions): Net income $ 9.2 Non-cash charges: Depreciation and amortization 153.2 Equity-based compensation 48.4 Amortization of convertible note discount 15.6 Restructuring charges 1.0 Deferred income taxes (19.3 ) Changes in operating asset and liability accounts 209.7 Other 24.7 $ 442.5 Changes in operating asset and liability accounts, net of foreign exchange impact, included the following sources of cash: decreases in accounts receivable of $171.3 million, inventories of $105.3 million, and prepaid and other assets of $37.9 million and increases in deferred profit of $4.2 million, partially offset by a use of cash resulting from decreases in trade accounts payable of $102.1 million and accrued liabilities of $6.9 million.

Cash Flows from Investing Activities Net cash used for investing activities during the six months ended December 23, 2012 was $130.7 million, primarily consisting of capital expenditures of $82.9 million, net purchases of available-for-sale securities of $40.0 million, and cash paid for a business acquisition of $8.7 million.

Cash Flows from Financing Activities Net cash used for financing activities during the six months ended December 23, 2012 was $693.4 million, primarily consisting of $710.0 million in treasury stock repurchases partially offset by net proceeds from issuance of common stock related to employee equity-based plans of $17.5 million.

Liquidity Given the cyclical nature of the semiconductor equipment industry, we believe that maintaining sufficient liquidity reserves is important to support sustaining levels of investment in R&D and capital infrastructure. Based upon our current business outlook, we expect that our levels of cash, cash equivalents, and short-term investments at December 23, 2012 will be sufficient to support our anticipated levels of operations, investments, debt service requirements, and capital expenditures, through at least the next 12 months.

In the longer term, liquidity will depend to a great extent on our future revenues and our ability to appropriately manage our costs based on demand for our products and services. While we have substantial cash balances in the United States and offshore, we may require additional funding and need to raise the required funds through borrowings or public or private sales of debt or equity securities. We believe that, if necessary, we will be able to access the capital markets on terms and in amounts adequate to meet our objectives. However, given the possibility of changes in market conditions or other occurrences, there can be no certainty that such funding will be available in needed quantities or on terms favorable to us.

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