Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations contains forward-looking statements, which are subject to risks, uncertainties and changes in condition, significance, value and effect. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of certain factors, including but not limited to those discussed in “Risk Factors” and elsewhere in this 2016 Form 10-K and other documents we file from time to time with the Securities and Exchange Commission. (See “Cautionary Statement Regarding Forward-Looking Statements” in Part I of this 2016 Form 10-K).

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) provides a description of our results of operations and should be read in conjunction with our Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements included in this 2016 Form 10-K. MD&A consists of the following sections:

Executive Summary provides a summary of the key highlights of our results of operations and our management’s assessment of material trends and uncertainties relevant to our business.

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 used in the preparation of our Consolidated Financial Statements.

Liquidity and Capital Resources provides an analysis of cash flows, contractual obligations and financial position.

Executive Summary

Lam Research has been an innovative supplier of wafer fabrication equipment and services to the semiconductor industry for more than 35 years. Our customers include semiconductor manufacturers that make memory, microprocessors, and other logic integrated circuits for a wide range of electronics; including mobile phones, computers, tablets, wearables, automotive features, storage devices, and networking equipment.

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Our market-leading products are designed to help our customers build the smaller, faster, and more powerful devices that are necessary to power the capabilities required by end users. The process of integrated circuits fabrication consists of a complex series of process and preparation steps, and our product offerings in deposition, etch, and clean address a number of the most critical steps in the fabrication process. We leverage our expertise in semiconductor processing to develop technology and/or 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.

The semiconductor capital equipment industry has been highly competitive and characterized by rapid changes in demand. This cyclicality has been mitigated in recent years by market demands and consolidation among our customers. With a reduced number of customers, variability in their business plans lead to changes in demand for Lam’s equipment and services. The variability in our customers’ investments during any particular period is dependent on several factors including but not limited to electronics demand, economic conditions (both general and in the semiconductor and electronics industries), industry supply and demand, prices for semiconductors, and our customers’ ability to develop and manufacture increasingly complex and costly semiconductor devices.

During the most recent fiscal year, demand for our products improved as semiconductor device manufacturers, particularly non volatile memory customers, made capacity and technology investments. Technology inflections in our industry, including 3DNAND, multiple patterning, FINFET and advanced packaging have led to an increase in our served addressable market for our deposition and etch products. We believe that, over the longer term, demand for our products should increase as the proportion of customers’ capital expenditures rises in these technology inflection areas, and we continue to gain market share.

In October 2015, as further described in Note 19 to our Consolidated Financial Statements, we announced that we had entered into an agreement to acquire KLA-Tencor Corporation.

The following summarizes certain key financial information for the periods indicated below:

	Year Ended
June 26, 2016				June 28, 2015				June 29, 2014				FY16 vs. FY15							FY15 vs. FY14
	(in thousands, except per share data and percentages)
Revenue	$	5,885,893			$	5,259,312			$	4,607,309			$	626,581			11.9	%		$	652,003			14.2	%
Gross margin	$	2,618,922			$	2,284,336			$	2,007,481			$	334,586			14.6	%		$	276,855			13.8	%
Gross margin as a percent of total revenue	44.5		%		43.4		%		43.6		%		1.1		%					(0.2		)%
Total operating expenses	$	1,544,666			$	1,496,297			$	1,329,812			$	48,369			3.2	%		$	166,485			12.5	%
Net income	$	914,049			$	655,577			$	632,289			$	258,472			39.4	%		$	23,288			3.7	%
Net income per diluted share	$	5.22			$	3.70			$	3.62			$	1.52			41.1	%		$	0.08			2.2	%

Fiscal year 2016 revenues increased 12% compared to fiscal year 2015, reflecting an increase in technology and capacity investments by our customers. Gross margin as a percentage of revenue improved 1.1%, which was primarily due to a more favorable customer and product mix.

Fiscal year 2015 revenues increased 14% compared to fiscal year 2014, reflecting the steady increase in spending on technology inflections. The small decrease in gross margin as a percentage of revenue for the fiscal year 2015 compared to fiscal year 2014 was due primarily to less favorable product mix partially offset by improved factory utilization due to higher production volumes.

Operating expenses in fiscal year 2016 increased as compared to fiscal year 2015 primarily as a result of continued investments in research and development and increased employee headcount. Fiscal year 2016 also included KLA-Tencor acquisition related costs.

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Operating expenses in fiscal year 2015 increased as compared to fiscal year 2014 primarily as a result of continued investments in the next-generation research and development. In fiscal year 2015, we also recorded a goodwill impairment of approximately $79 million related to our single-wafer clean reporting unit.

Our cash and cash equivalents, investments, and restricted cash and investments balances totaled approximately $7.1 billion as of June 26, 2016 compared to $4.2 billion as of June 28, 2015. This increase was primarily the result of approximately $2.4 billion proceeds from June 2016 senior notes issuance, net of related issuance costs combined with cash flow provided from operating activities. Cash flow provided from operating activities was $1.4 billion for fiscal year 2016 compared to $786 million for fiscal year 2015. Cash flow provided from operating activities in fiscal 2016 was primarily used for $451.5 million of principal payments on debt instruments, $158.4 million in treasury stock purchases, $190.4 million in dividends paid to our stockholders, and $175.3 million of capital expenditures, and are partially offset by $59.4 million of treasury stock reissuance and common stock issuance resulting from our employee equity-based compensation programs.

Results of Operations

Shipments and Backlog

Shipments for fiscal year 2016 were approximately $5.9 billion, an increase of 8% compared to fiscal year 2015. Shipments for fiscal year 2015 were approximately $5.5 billion, an increase of 20% compared to fiscal year 2014. The increase in shipments during the fiscal year 2016 as compared to the last two fiscal years is related to continued strengthening of customer demand for semiconductor equipment.

	Year Ended
June 26, 2016				June 28, 2015				June 29, 2014
Shipments (in millions)	$	5,901			$	5,472			$	4,551
Taiwan	25		%		22		%		21		%
Korea	17		%		26		%		24		%
China	20		%		12		%		15		%
Japan	16		%		14		%		13		%
Southeast Asia	11		%		5		%		5		%
United States	8		%		15		%		15		%
Europe	3		%		6		%		7		%

The percentage of total semiconductor processing system shipments to each of the markets we serve were as follows for fiscal years 2016, 2015, and 2014.

	Year Ended
June 26, 2016			June 28, 2015			June 29, 2014
Memory	68	%		58	%		60	%
Foundry	23	%		30	%		30	%
Logic/integrated device manufacturing	9	%		12	%		10	%

Our shipments to memory customers increased during fiscal year 2016 primarily due to higher demand from mobile, enterprise and client solid state drives. Foundry and logic spending decreased due to relatively lower spending levels at leading edge process nodes.

Unshipped orders in backlog as of June 26, 2016 were approximately $1,371 million, an increase from approximately $880 million as of June 28, 2015. Our unshipped orders backlog includes orders for systems, spares, and services. Please refer to “Backlog” in Part I Item 1, “Business” of this report for a description of our policies for adding to and adjusting backlog.

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Revenue

	Year Ended
June 26, 2016				June 28, 2015				June 29, 2014
Revenue (in millions)	$	5,886			$	5,259			$	4,607
Taiwan	25		%		21		%		23		%
Korea	18		%		27		%		24		%
China	18		%		12		%		14		%
Japan	17		%		12		%		14		%
Southeast Asia	10		%		5		%		5		%
United States	8		%		17		%		13		%
Europe	4		%		6		%		7		%

The revenue increase in fiscal year 2016 as compared to the last two fiscal years reflects an increase in technology and capacity investments by our customers. Our revenue levels are generally correlated to the amount of shipments and our installation and acceptance time lines. The overall Asia region continues to account for a majority of our revenues as a substantial amount of the worldwide capacity additions for semiconductor manufacturing continues to occur in this region. Our deferred revenue balance was $566 million as of June 26, 2016 compared to $518 million as of June 28, 2015. 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 customer acceptance. The anticipated future revenue value from shipments to Japanese customers was approximately $132 million as of June 26, 2016 compared to $164 million as of June 28, 2015.

Gross Margin

	Year Ended
June 26, 2016				June 28, 2015				June 29, 2014			FY16 vs. FY15							FY15 vs. FY14
	(in thousands, except percentages)
Gross margin	$	2,618,922			$	2,284,336			$	2,007,481			$	334,586			14.6	%		$	276,855			13.8	%
Percent of total revenue	44.5		%		43.4		%		43.6		%		1.1		%					(0.2		)%

The increase in gross margin as a percentage of revenue for fiscal year 2016 compared to fiscal year 2015 was due to a more favorable customer mix and product mix. Additionally, there was a $10 million impairment charge of a long lived asset in fiscal year 2015.

The decrease in gross margin as a percentage of revenue for fiscal year 2015 compared to fiscal year 2014 was due primarily to a less favorable product mix partially offset by improved factory utilization due to higher production volumes.

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Research and Development

	Year Ended
June 26, 2016				June 28, 2015				June 29, 2014			FY16 vs. FY15							FY15 vs. FY14
	(in thousands, except percentages)
Research & development (“R&D”)	$	913,712			$	825,242			$	716,471			$	88,470			10.7	%		$	108,771			15.2	%
Percent of total revenue	15.5		%		15.7		%		15.6		%		(0.2		)%					0.1		%

We continued to make significant R&D investments focused on leading-edge deposition, plasma etch, single-wafer clean and other semiconductor manufacturing requirements. The increase in R&D expense during fiscal year 2016 compared to fiscal year 2015 was primarily due to a $36 million increase in employee compensation and benefits related to increased headcount, a $14 million increase in facility and information technology related spending, a $14 million increase in supplies, a $12 million increase in depreciation and lab maintenance, and an $8 million increase in costs associated with campus consolidation.

The increase in R&D expense during fiscal year 2015 compared to fiscal year 2014 was primarily due to a $71 million increase in salaries and benefits related to increased headcount and higher incentive and equity compensation, a $12 million increase in supplies, a $5 million increase in depreciation and lab maintenance, and a $6 million increase in outside services.

Selling, General and Administrative

	Year Ended
June 26, 2016				June 28, 2015				June 29, 2014			FY16 vs. FY15							FY15 vs. FY14
	(in thousands, except percentages)
Selling, general & administrative (“SG&A”)	$	630,954			$	591,611			$	613,341			$	39,343			6.7	%		$	(21,730	)		(3.5	)%
Percent of total revenue	10.7		%		11.2		%		13.3		%		(0.5		)%					(2.1		)%

The increase in SG&A expense during fiscal year 2016 compared to fiscal year 2015 was primarily due to $51 million of KLA-Tencor acquisition related costs and a $3 million increase in restructuring charges. This increase was offset by a $15 million gain on sale of assets net of associated exit costs.

The decrease in SG&A expense during fiscal year 2015 compared to fiscal year 2014 was due primarily to a decrease of $11 million in integration costs, a $9 million decrease in costs associated with rationalization of product configurations, and an $8 million decrease related to impairment of long lived assets. This decrease was offset by an $8 million increase in compensation and benefits expense.

Goodwill Impairment

Our annual goodwill impairment analysis for fiscal year 2015 resulted in a non-cash impairment charge upon our single-wafer clean reporting unit of $79 million, extinguishing the goodwill ascribed to the reporting unit. Uncertainty surrounding future revenue growth in certain products resulted in the estimated discounted cash flow falling below the carrying value of the goodwill balance. There were no impairment charges in fiscal year 2016 or 2014.

Gain on Sale of Real Estate

During fiscal year 2014, we sold our interest in nonessential property in Palo Alto, California, resulting in $135 million in net proceeds and a realized gain of $83 million from the transaction.

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Other Expense, Net

Other expense, net, consisted of the following:

	Year Ended
June 26, 2016				June 28, 2015				June 29, 2014
	(in thousands)
Interest income	$	29,512			$	19,268			$	12,540
Interest expense	(134,773		)		(73,682		)		(61,692		)
(Losses) gains on deferred compensation plan related assets, net	(3,995		)		9,071				9,559
Foreign exchange gains (losses), net	308				2,331				1,529
Other, net	(5,191		)		(4,177		)		668
	$	(114,139	)		$	(47,189	)		$	(37,396	)

Interest income increased in fiscal year 2016 as compared to fiscal years 2015 and 2014, primarily as a result of higher cash and investment balances, as well as improvement to yield. The increase in interest expense during fiscal year 2016 as compared to fiscal year 2015 and 2014 was primarily due to the $1 billion Senior Note issuance in March 2015, combined with the note issuance cost amortization related to our KLA-Tencor acquisition bridge financing facility. The increase in interest expense during fiscal year 2015 as compared with fiscal years 2014 was primarily due to the $1 billion Senior Note issuance in the March 2015 quarter.

Foreign exchange gains in fiscal years 2016, 2015 and 2014 were related to un-hedged portions of the balance sheet exposures.

The loss on deferred compensation plan related assets, net in fiscal year 2016, as compared to similar gains in fiscal years 2015 and 2014, was driven by decline in the fair market value of the underlying funds at year end.

Other, net expense realized during fiscal year 2016 was primarily due to commitment fees related to our revolving loan and term loan commitments. Other, net expense realized during fiscal year 2015 was primarily due to a settlement of matters relating to certain investment transactions. Other, net income realized during fiscal year 2014 was primarily due to a gain on the disposition of a private equity investment.

Income Tax Expense (benefit)

	Year Ended
June 26, 2016				June 28, 2015				June 29, 2014
	(in thousands, except percentages)
Income tax expense	$	46,068			$	85,273			$	91,074
Effective tax rate	4.8		%		11.5		%		12.6		%

The decrease in the effective tax rate in fiscal year 2016 as compared to fiscal year 2015 was primarily due to the tax benefit of the Altera court ruling (discussed in more detail below), higher income in lower tax jurisdictions, and an increased federal tax benefit due to a retroactive and permanent extension of federal research and development tax credit in fiscal year 2016.

The decrease in the effective tax rate in fiscal year 2015 as compared to fiscal year 2014 was primarily due to geographic mix of income between higher and lower tax jurisdictions, and an increased federal tax benefit in fiscal year 2015 due to a retroactive reinstatement of the second half of fiscal year 2014 federal research and development tax credit in fiscal year 2015.

In July 2015, the United States Tax Court (the “Court”) issued an opinion favorable to Altera Corporation (“Altera”) with respect to Altera’s litigation with the Internal Revenue Service (“IRS”). The litigation relates to the

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treatment of stock-based compensation expense in an inter-company cost-sharing arrangement with Altera’s foreign subsidiary. In its opinion, the Court accepted Altera’s position of excluding stock-based compensation from its inter-company cost-sharing arrangement. However, the U.S. Department of the Treasury has not withdrawn the requirement to include stock-based compensation from its regulations. We have evaluated the opinion and have recorded a tax benefit of $87.7 million related to reimbursement of cost share payments for the previously shared stock-based compensation costs. We have also recorded a tax benefit of $11.2 million related to stock-based compensation expense. In addition, we have recorded a tax liability of $73.6 million for the U.S. tax cost of potential repatriation of the associated contingent foreign earnings because at this time we cannot reasonably conclude that we have the ability and the intent to indefinitely reinvest these contingent earnings. We will continue to monitor this matter and related potential impacts to our consolidated financial statements.

International revenues account for a significant portion of our total revenues, such that a material portion of our pre-tax income is earned and taxed outside the United States at rates that are generally lower than in the United States. Please refer to Note 6 of our Consolidated Financial Statements.

Deferred Income Taxes

Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, as well as the tax effect of carryforwards. Our gross deferred tax assets were $465 million and $311 million at the end of fiscal years 2016 and 2015, respectively. These gross deferred tax assets were offset by deferred tax liabilities of $429 million and $318 million at the end of fiscal years 2016 and 2015, respectively, and a valuation allowance of $102 million and $86 million at the end of fiscal years 2016 and 2015, respectively. The change in the gross deferred tax assets, deferred tax liabilities, and valuation allowance between fiscal year 2016 and 2015 is primarily due to an increase related to tax credit carryforwards, recognition of a prepaid cost sharing deferred tax benefit related to the Altera case ruling and a decrease in deferred tax liabilities related to amortization of intangible assets offset by an increase in deferred tax liabilities related to depreciation of tangible assets, convertible debt accretion and an accrual for future tax liabilities due to the expected repatriation of foreign earnings of certain foreign subsidiaries for 2016.

As of our fiscal year end of June 26, 2016 we continue to record a valuation allowance to offset the entire California deferred tax asset balance due to the single sales factor apportionment election resulting in lower taxable income in California. We also recorded a valuation allowance on certain state tax credits and continue to record valuation allowances on certain foreign entities’ net operating losses. The valuation allowances were $102 million and $86 million at the end of fiscal years 2016 and 2015, respectively.

We evaluate if the deferred tax assets are realizable on a quarterly basis and will continue to assess the need for changes in valuation allowances, if any.

Uncertain Tax Positions

We re-evaluate 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, and effectively settled issues under audit. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision.

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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 base our estimates and assumptions on historical experience and on various other assumptions we believe 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. Our critical accounting estimates include:

•	the recognition and valuation of revenue from multiple-element arrangements, which impacts revenue;

•	the valuation of inventory, which impacts gross margin;

•	the valuation of warranty reserves, which impacts gross margin;

•	the valuation of equity based compensation expense, including forfeiture estimates, which impacts both gross margin and operating expenses;

•	the recognition and measurement of current and deferred income taxes, including the measurement of uncertain tax positions, which impact our provision for income tax expenses; and

•	the valuation and recoverability of long-lived assets, which impacts gross margin and operating expenses when we record asset impairments or accelerate their depreciation or amortization.

We believe that the following critical accounting policies reflect the more significant judgments and estimates used in the preparation of our consolidated financial statements regarding the critical accounting estimates indicated above. See Note 2, "Summary of Significant Accounting Policies," of our Consolidated Financial Statements for additional information regarding our accounting policies.

Revenue Recognition: We recognize 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 or are otherwise released from our 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 using their relative selling prices, based on our best estimate of selling price. Our sales arrangements do not include a general right of return. The maximum revenue recognized 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, deferred revenue and deferred costs are recorded in deferred profit on our Consolidated Balance Sheet.

Inventory Valuation: 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 requirement 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.

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Warranty: We record a provision for estimated warranty expenses to cost of sales for each system when we recognize revenue. 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. We do not maintain a general or unspecified reserves; all warranty reserves are related to specific systems.

Equity-based Compensation: Employee Stock Purchase Plan (“ESPP”) and Employee Stock Plans: We determine the fair value of our restricted stock units (“RSUs”), excluding market-based performance RSUs, based upon the fair market value of our common stock at the date of grant, discounted for dividends. We estimate the fair value of our market-based performance RSUs using a Monte Carlo simulation model at the date of the grant. We estimate the fair value of our stock options and ESPP awards using a Black-Scholes option valuation model. This model requires the input of 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 award and we have elected to use the straight-line method of amortization. We estimate expected equity award forfeitures based on historical forfeiture rate activity and expected future employee turnover. We recognize the effect of adjustments made to the forfeiture rate, if any in the period that we change the forfeiture estimate.

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 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.

Long-lived assets: We review goodwill at least annually for impairment. If certain events or indicators of impairment occur between annual impairment tests, we will perform an impairment test at that date. In testing for a potential impairment of goodwill, we: (1) allocate goodwill to the 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. Prior to this allocation of the assets to the reporting units, we 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. In our goodwill impairment process we first assess qualitative factors to determine whether it is necessary to perform a quantitative analysis. We do not calculate the fair value of a reporting unit unless we determine, based on a qualitative assessment, that it is more likely than not that the reporting unit’s 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 an income approach. 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, 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

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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. Changes in judgment on these assumptions and estimates could result in a goodwill impairment charge.

As a result, several factors could result in an 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 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 common stock price and resulting market capitalization, to the extent we determine that the decline is sustained and indicates a reduction in the fair value of our reporting units below their carrying value. Further, the value assigned to intangible assets, other than goodwill, is based on estimates and judgments regarding expectations such as the success and life cycle of products and technology acquired. If actual product acceptance differs significantly from the estimates, we may be required to record an impairment charge to write down the asset to its realizable value.

For other long-lived assets, we routinely consider whether indicators of impairment are present. If such indicators are present, we determine whether the sum of the estimated undiscounted cash flows attributable to the assets is less than their carrying value. If the sum is less, we recognize an impairment loss based on the excess of the carrying amount of the assets over their respective fair values. Fair value is determined by discounted future cash flows, appraisals or other methods. We recognize an impairment charge to the extent the present value of anticipated net cash flows attributable to the asset are less than the asset’s carrying value. The fair value of the asset then becomes the asset’s new carrying value, which we depreciate over the remaining estimated useful life of the asset. Assets to be disposed of are reported at the lower of the carrying amount or fair value.

Recent Accounting Pronouncements

For a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements, see Note 3, “Recent Accounting Pronouncements,” of our Consolidated Financial Statements, included in item 8 of this report.

Liquidity and Capital Resources

Total gross cash, cash equivalents, investments, and restricted cash and investments balances were $7.1 billion at the end of fiscal year 2016 compared to $4.2 billion at the end of fiscal year 2015. This increase was primarily the result of approximately $2.4 billion net proceeds from the June 2016 debt issuances. Approximately $3.1 billion and $2.2 billion of our total cash and investments as June 26, 2016 and June 28, 2015, respectively, was held outside the United States in our foreign subsidiaries, the majority of which is held in U.S. dollars and, substantially all of which would be subject to tax at U.S. rates if it were to be repatriated. Refer to Note 6 of our Consolidated Financial Statements, included in Item 8 of this report, for information concerning the potential tax impact of repatriating earnings for certain non-U.S. subsidiaries that are permanently reinvested outside the United States.

Cash Flow from Operating Activities

Net cash provided by operating activities of $1.4 billion during fiscal year 2016 consisted of (in millions):

Net income	$	914.0
Non-cash charges:
Depreciation and amortization	291.0
Equity-based compensation expense	142.3
Deferred income taxes	(49.0		)
Amortization of note discounts and issuance costs	70.5
Changes in operating asset and liability accounts	(52.2		)
Gain on sale of assets	(15.2		)
Other	48.9
	$	1,350.3

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Significant changes in operating asset and liability accounts, net of foreign exchange impact, included the following uses of cash: increases in accounts receivable of $169.0 million, inventories of $66.4 million, and prepaid expenses and other assets of $46.7 million, partially offset by the following sources of cash: increases in accounts payable of $41.6 million, deferred profit of $27.1 million, and accrued expenses and other liabilities of $161.1 million.

Cash Flow from Investing Activities

Net cash provided by investing activities during fiscal year 2016 was $592.5 million, which was primarily due to net sales and maturities of available-for-sale securities of $798.8 million, and proceeds on sale of assets of $79.7 million, off-set by net transfers to restricted cash and investments of $112.4 million and capital expenditures of $175.3 million.

Cash Flow from Financing Activities

Net cash provided by financing activities during fiscal year 2016 was $1,595.7 million, which was primarily due to $2,338.1 million in proceeds from the issuance of long-term debt, partially offset by $451.5 million of principal payments related primarily to the maturity of $450.0 million of convertible notes in the June quarter, $158.4 million in treasury stock repurchases and $190.4 million of dividends paid to stockholders.

Liquidity

Given the historical 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 investments at June 26, 2016 will be sufficient to support our presently 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 or choose 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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Off-Balance Sheet Arrangements and Contractual Obligations

We have certain obligations to make future payments under various contracts, some of which are recorded on our balance sheet and some of which are not. Obligations that are recorded on our balance sheet in accordance with GAAP include our long-term debt which is outlined in the following table. Our off-balance sheet arrangements are presented as operating leases and purchase obligations in the table. Our contractual obligations and commitments as of June 26, 2016, relating to these agreements and our guarantees are included in the following table based on their contractual maturity date. The amounts in the table below exclude $231.5 million of liabilities related to uncertain tax benefits as we are unable to reasonably estimate the ultimate amount or time of settlement. See Note 6 of our Consolidated Financial Statements for further discussion.

	Total				Less than 1 year				1-3 years				3-5 years				More than 5 years				Sublease Income
	(in thousands)
Operating Leases	$	62,417			$	20,393			$	19,902			$	13,570			$	8,758			$	(206	)
Capital Leases	7,425				7,208				160				57				—				—
Purchase Obligations	231,586				221,312				4,358				4,205				1,711				—
Long-term Debt and Interest Expense (1)	5,891,509				138,847				721,363				1,547,636				3,483,663				—
Other long-term liabilities (2)	134,562				1,050				589				8,373				124,550				—
Total	$	6,327,499			$	388,810			$	746,372			$	1,573,841			$	3,618,682			$	(206	)

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(1)

The conversion period for the Convertible Notes was open as of June 28, 2015 and as such the net carrying value of the Convertible Notes is included within current liabilities on our Consolidated Balance Sheet. The principal balances of the Convertible Notes are reflected in the payment period in the table above based on the contractual maturity assuming no conversion. See Note 13 of our Consolidated Financial Statements for additional information concerning the Convertible Notes and associated conversion features.

(2)	Certain tax-related liabilities and post retirement benefits classified as other non-current liabilities on the consolidated balance sheet are included in the more than 5 years category due to the uncertainty in the timing and amount of future payments. Additionally the balance excludes contractual obligations recorded in our consolidated balance sheet as current liabilities.

Operating Leases

We lease most of our administrative, R&D and manufacturing facilities, regional sales/service offices and certain equipment under non-cancelable operating leases. Certain of our facility leases for buildings located in Fremont and Livermore, California, and certain other facility leases provide us with an option to extend the leases for additional periods or to purchase the facilities. Certain of our facility leases provide for periodic rent increases based on the general rate of inflation. In addition to amounts included in the table above, we have guaranteed residual values for certain of our Fremont and Livermore facility leases of up to $249.9 million. See Note 15 to our Consolidated Financial Statements for further discussion.

Capital Leases

Capital leases reflect building and office equipment lease obligations. The amounts in the table above include the interest portion of payment obligations.

Purchase Obligations

Purchase obligations consist of significant contractual obligations either on an annual basis or over multi-year periods related to our outsourcing activities or other material commitments, including vendor-consigned inventories. The contractual cash obligations and commitments table presented above contains our minimum obligations at June 26, 2016 under these arrangements and others. For obligations with cancellation provisions, the amounts included in the preceding table were limited to the non-cancelable portion of the agreement terms or

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the minimum cancellation fee. Actual expenditures will vary based on the volume of transactions and length of contractual service provided.

Long-Term Debt

In May 2011, we issued and sold $450.0 million in aggregate principal amount of 0.50% Convertible Senior Notes due May 2016 (the “2016 Notes”) at par. At the same time, we issued and sold $450.0 million in aggregate principal amount of 1.25% Convertible Senior Notes due May 2018 (the “2018 Notes”) at par. We pay cash interest on the 2018 Notes at an annual rate of 1.25%, on a semi-annual basis. The 2016 Notes matured in May 2016. Until their maturity in May 2016, we paid cash interest on the 2016 Notes at an annual rate of 0.5% on a semi-annual basis. Concurrently with the issuance of the 2016 Notes and 2018 Notes, we purchased convertible note hedges and sold warrants, which were structured to reduce the potential future economic dilution associated with the conversion of the 2016 Notes and the 2018 Notes.

In connection with the maturity of the 2016 Notes, we paid approximately $451.6 million in settlement of the 2016 Notes. We did not issue any shares of our Common Stock in respect of the 2016 Notes on a net basis as a result of our exercise of the convertible note hedge we purchased concurrently with the issuance of the 2016 Notes. The maturity of the 2016 Notes did not affect the warrants sold concurrently with the issuance of the 2016 Notes and those warrants remain outstanding in accordance with their terms.

The 2018 Notes may be converted into our Common Stock, under certain circumstances, based on a conversion rate of 16.3354 shares of our Common Stock per $1,000 principal amount of Notes, which is equal to a conversion price of approximately $61.22 per share of our Common Stock. The conversion price will be subject to adjustment for certain corporate events, including dividends on our Common Stock. Concurrently with the issuance of the Notes, we purchased convertible note hedges and sold warrants, which were structured to reduce the potential future economic dilution associated with the conversion of the 2018 the Notes.

In June 2012, with the acquisition of Novellus, we assumed $700.0 million in aggregate principal amount of 2.625% Convertible Senior Notes due May 2041 (the "2041 Notes"). We pay cash interest on the 2041 Notes at an annual rate of 2.625%, on a semi-annual basis. The 2041 Notes may be converted, under certain circumstances, into our Common Stock based on a conversion rate of 29.3158 shares of Common Stock per $1,000 principal amount of notes, which represents a conversion price of approximately $34.11 per share of Common Stock. The conversion price will be subject to adjustment for certain events, including dividends on our Common Stock.

During the quarter-ended June 26, 2016, the market value of our Common Stock was greater than or equal to 130% of the 2018 Notes and 2041 Notes conversion prices for 20 or more trading days of the 30 consecutive trading days preceding the quarter end. As a result, the 2018 Notes and the 2041 Notes are convertible at the option of the holder and are classified as current liabilities in our Consolidated Balance Sheets for fiscal year 2016.

On March 12, 2015, we completed a public offering of $500.0 million aggregate principal amount of Senior Notes due March 15, 2020 (the “2020 Notes”) and $500.0 million aggregate principal amount of Senior Notes due March 15, 2025 (the “2025 Notes”). We pay interest at an annual rate of 2.75% and 3.80%, respectively, on the 2020 Notes and 2025 Notes, on a semi-annual basis on March 15 and September 15 of each year.

We may redeem the 2020 Notes and 2025 Notes at a redemption price equal to 100% of the principal amount of such series (“par”), plus a “make whole” premium as described in the indenture in respect to the 2020 Notes and 2025 Notes and accrued and unpaid interest before February 15, 2020, for the 2020 Notes and before December 15, 2024, for the 2025 Notes. We may redeem the 2020 Notes and 2025 Notes at par, plus accrued and unpaid interest at any time on or after February 15, 2020 for the 2020 Notes and on or after December 24, 2024 for the 2025 Notes. In addition, upon the occurrence of certain events, as described in the indenture, we will be required to make an offer to repurchase the 2020 Notes and 2025 Notes at a price equal to 101% of the principal amount of the respective note, plus accrued and unpaid interest.

On June 7, 2016, we completed a public offering of $800.0 million aggregate principal amount of Senior Notes due June 15, 2021 (the "2021 Notes"), $600.0 million aggregate principal amount of Senior Notes due June 15, 2023 (the "2023 Notes") and $1 billion aggregate principal amount of Senior Notes due June 15, 2026 (the "2026 Notes" together with the 2020 Notes, 2021 Notes, 2023 Notes, and 2025 Notes, the “Senior Notes”, and

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collectively with the Convertible Notes, the “Notes”). We will pay interest at an annual rate of 2.80%, 3.45% and 3.90%, respectively, on the 2021 Notes, 2023 Notes and 2026 Notes, on a semi-annual basis on June 15 and December 15 of each year, beginning December 15, 2016.

We may redeem the 2021 Notes, 2023 Notes, and 2026 Notes at a redemption price equal to 100% of the principal amount of such series (“par”), plus a “make whole” premium as described in the indenture in respect to the 2021 Notes, 2023 Notes, and 2026 Notes and accrued and unpaid interest before May 15, 2021, for the 2021 Notes, before April 15, 2023 for the 2023 Notes, and before March 15, 2026 for the 2026 Notes. We may redeem the 2021 Notes, 2023 Notes, and 2026 Notes at par, plus accrued and unpaid interest at any time on or after May 15, 2021 for the 2021 Notes, on or after April 15, 2023 for the 2023 Notes, and on or after March 15, 2026 for the 2026 Notes. In addition, upon the occurrence of certain events, as described in the indenture, we will be required to make an offer to repurchase the 2021 Notes, 2023 Notes and 2026 Notes at a price equal to 101% of the principal amount of the respective note, plus accrued and unpaid interest.

In the event (i) the proposed merger with KLA-Tencor is not completed on or prior to December 30, 2016 or (ii) the Agreement and Plan of Merger and Reorganization, dated as of October 20, 2015, by and among us, KLA-Tencor, Topeka Merger Sub 1, Inc., and Topeka Merger Sub 3, Inc. (as assignee of Topeka Merger Sub 2, Inc.), is terminated on or at any time prior to such date (each such event referred to as a “Special Mandatory Redemption Event”), we will be required to redeem all of the 2023 Notes and the 2026 Notes then outstanding, at a special mandatory redemption price equal to 101% of the aggregate principal amount of such notes, plus accrued and unpaid interest from the date of initial issuance, or the most recent interest payment date on which interest was paid, whichever is later, to, but not including, the Special Mandatory Redemption Date (as defined below). The 2021 Notes are not subject to this special mandatory redemption. The “Special Mandatory Redemption Date” means the date specified in the notice of special mandatory redemption to be delivered to the holders of the notes no later than five business days following the Special Mandatory Redemption Event, which Special Mandatory Redemption Date shall be three business days after such notice is mailed.

During fiscal year 2016, 2015, and 2014, we made $451.5 million, $1.5 million, and $1.7 million, respectively, in principal payments on long-term debt and capital leases.

Term Loan Agreement

On May 13, 2016, we entered into an Amended and Restated Term Loan Agreement (the “Amended and Restated Term Loan Agreement”), which amends and restates the Term Loan Agreement we entered into on November 10, 2015 with a syndicate of lenders. The Amended and Restated Term Loan Agreement provides for a $1,530 million senior unsecured term loan facility composed of two tranches; (i) a $1,005 million tranche of 3-year senior unsecured loans (the "3-Year Tranche") maturing on the 3-year anniversary of the closing date of the acquisition of KLA-Tencor subject to several conditions; and (ii) a $525.0 million tranche of 5-year senior unsecured loans (the "5-Year Tranche") maturing on the 5-year anniversary of the closing date of the acquisition of KLA-Tencor subject to several conditions. The Amended and Restated Term Loan will terminate on October 20, 2016 if the merger has not been consummated by such date.

Interest on amounts borrowed under the Amended and Restated Term Loan Agreement is, at our option, based on (i) a base rate, defined as the greatest of (a) prime rate, (b) Federal Funds rate plus 0.50%, or (c) one-month LIBOR plus 1.00%, plus a spread of 0.00% to 0.75% for the 3-Year Tranche or 0.125% to 1.000% for the 5-Year Tranche or (ii) LIBOR multiplied by the statutory reserve rate plus a spread of 1.000% to 1.750% for the 3-Year Tranche or 1.125% to 2.000% for the 5-Year Tranche, in each case as the applicable spread is determined based on the rating of the our non-credit enhanced, senior unsecured long-term debt.

Principal and accrued and unpaid interest is due and payable in equal quarterly amounts as set forth in the Amended and Restated Term Loan Agreement, with any remaining balance due and accrued and unpaid interest due at maturity. Additionally, we will pay the lenders a quarterly commitment fee that varies based on our rating described above. The Amended and Restated Term Loan Agreement also contains financial covenants that require us to maintain (i) a consolidated debt to capitalization ratio of no more than 0.50 to 1.00 (the “Capitalization Covenant”), provided that, until and including the earlier of (x) the end of the first two consecutive full fiscal quarters following the Amended and Restated Term Loan Agreement's closing date that we are in compliance with the Capitalization Covenant and (y) December 31, 2017, if we are not in compliance with the Capitalization Covenant, we will be deemed not to have violated the Capitalization Covenant so long as our

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consolidated debt to adjusted EBITDA ratio is less than or equal to 4.50 to 1.00 for the period of four fiscal quarters then ended, and (ii) liquidity of no less than $1.0 billion, in each case determined in accordance with the Amended and Restated Term Loan Agreement. The funding of the loans under the Amended and Restated Term Loan Agreement will be on the closing date of the acquisition of KLA-Tencor subject to several conditions.

Revolving Credit Arrangements

On November 10, 2015, we entered into an Amendment and Restatement Agreement (as amended on April 26, 2016, by Amendment No.1 to Amended and Restated Credit Agreement, and as further amended, restated, amended and restated, supplemented or otherwise modified from time to time, the “Amended and Restated Credit Agreement”), which amends and restates our prior unsecured Credit Agreement, dated March 12, 2014 (as amended by Amendment No. 1, dated March 5, 2015). The Amended and Restated Credit Agreement provides for an increase to our revolving unsecured credit facility, from $300.0 million to $750.0 million with a syndicate of lenders. It includes an expansion option, subject to certain requirements, for us to request an increase in the facility of up to an additional $250.0 million, for a potential total commitment of $1.0 billion. Proceeds from the credit facility can be used for general corporate purposes. The facility matures on November 10, 2020.

Interest on amounts borrowed under the credit facility is, at our option, based on (i) a base rate, defined as the greatest of (a) prime rate, (b) Federal Funds rate plus 0.5%, or (c) one-month LIBOR plus 1.0%, plus a spread of 0.0% to 0.5%, or (ii) LIBOR multiplied by the statutory reserve rate, plus a spread of 0.9% to 1.5%, in each case as the applicable spread is determined based on the rating of our non-credit enhanced, senior unsecured long-term debt. Principal and any accrued and unpaid interest is due and payable upon maturity. Additionally, we will pay the lenders a quarterly commitment fee that varies based on our credit rating. The Amended and Restated Credit Agreement contains affirmative covenants, negative covenants, financial covenants and events of default that are substantially similar to those in the Amended and Restated Term Loan Agreement. As of June 26, 2016, we had no borrowings outstanding under the credit facility and were in compliance with all financial covenants.

Debt Commitment

On October 20, 2015, we obtained a commitment for $4.2 billion of bridge financing from Goldman Sachs Bank USA and Goldman Sachs Lending Partners LLC (“the Commitment Parties”) to finance, in part, the acquisition of KLA-Tencor. The Commitment Parties' commitment to provide financing (the “Bridge Facility”) was subject to certain conditions, including consummation of the merger with KLA-Tencor. On November 10, 2015, we entered into the Term Loan Agreement for $0.9 billion and the Bridge Facility was reduced to $3.3 billion, correspondingly, both with a syndicate of lenders. Following the execution of our June 2016 debt offering and other available credit modifications (see Note 13 to our Consolidated Financial Statements), this commitment was terminated during the three months ended June 26, 2016.

Other Guarantees

We have issued certain indemnifications to our lessors for taxes and general liability under some of our agreements. We have entered into certain insurance contracts that may limit our exposure to such indemnifications. As of June 26, 2016, we had not recorded any liability on our Consolidated Financial Statements in connection with these indemnifications, as we do not believe, based on information available, that it is probable that we will pay any amounts under these guarantees.

Generally, we indemnify, under pre-determined conditions and limitations, our customers for infringement of third-party intellectual property rights by our products or services. We seek to limit our liability for such indemnity to an amount not to exceed the sales price of the products or services subject to our indemnification obligations. We do not believe, based on information available, that it is probable that we will pay any material amounts under these guarantees.

We provide guarantees and standby letters of credit to certain parties as required for certain transactions initiated during the ordinary course of business. As of June 26, 2016, the maximum potential amount of future payments that we could be required to make under these arrangements and letters of credit was $12.1 million. We do not believe, based on historical experience and information currently available, that it is probable that any amounts will be required to be paid.

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