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 2018 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 2018 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 Part II, Item 8 of this 2018 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.

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Lam Research Corporation 2018 10-K 32

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 is a global supplier of innovative wafer fabrication equipment and services to the semiconductor industry. We have built a strong global presence with core competencies in areas like nanoscale applications enablement, chemistry, plasma and fluidics, advanced systems engineering and a broad range of operational disciplines. Our products and services are designed to help our customers build smaller, faster, and better performing devices that are used in a variety of electronic products, including mobile phones, personal computers, servers, wearables, automotive devices, storage devices, and networking equipment. Our vision is to realize full value from natural technology extensions of our company.

Our customer base includes leading semiconductor memory, foundry, and integrated device manufacturers that make products such as NVM, DRAM memory, and logic devices. We aim to increase our strategic relevance with our customers by contributing more to their continued success. Our core technical competency is integrating hardware, process, materials, software, and process control enabling results on the wafer.

Semiconductor manufacturing, our customers’ business, involves the complete fabrication of multiple dies or integrated circuits on a wafer. This involves the repetition of a set of core processes and can require hundreds of individual steps. Fabricating these devices requires highly sophisticated process technologies to integrate an increasing array of new materials with precise control at the atomic scale. Along with meeting technical requirements, wafer processing equipment must deliver high productivity and be cost-effective.

Demand from the Cloud, IoT, and other markets is driving the need for increasingly powerful and cost-efficient semiconductors. At the same time, there are growing technical challenges with traditional scaling. These trends are driving significant inflections in semiconductor manufacturing, such as the increasing importance of vertical 3D scaling strategies as well as multiple patterning to enable shrinks.

We believe we are in a strong position with our leadership and competency in deposition, etch, and clean to facilitate some of the most significant innovations in semiconductor device manufacturing. Several factors create opportunity for sustainable differentiation for us: (i) our focus on research and development, with several on-going programs relating to sustaining engineering, product and process development, and concept and feasibility; (ii) our ability to effectively leverage cycles of learning from our broad installed base; (iii) our collaborative focus with ecosystem partners; and (iv) focus on delivering our multi-product solutions with a goal to enhance the value of Lam’s solutions to our customers.

During the most recent fiscal year, demand for our products improved as semiconductor device manufacturers made technology and capacity investments. Over the longer term, we believe that our technology inflections in our industry, including 3D device scaling, multiple patterning process flow, and advanced packaging/chip integration will lead to an increase in our served addressable market for our products and services in deposition, etch, and clean. While there could be variability in the near-term, we believe that demand for our products and services will increase faster than overall spending on wafer fabrication equipment, as the proportion of customers’ capital expenditures rises in these technology inflection areas, and we target to gain market share.

We acquired the outstanding shares of Coventor, Inc. (“Coventor”), a privately-held company, on August 28, 2017, as further discussed in Note 19 of our Consolidated Financial Statements contained in Part II, Item 8 of this 2018 Form 10-K. The results of the acquired business are included in our Consolidated Financial Statements.

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

	Year Ended												Change
June 24, 2018				June 25, 2017				June 26, 2016				FY18 vs. FY17							FY17 vs. FY16
	(in thousands, except per share data and percentages)
Revenue	$	11,076,998			$	8,013,620			$	5,885,893			$	3,063,378			38.2	%		$	2,127,727			36.1	%
Gross margin	$	5,165,032			$	3,603,359			$	2,618,922			$	1,561,673			43.3	%		$	984,437			37.6	%
Gross margin as a percent of total revenue	46.6		%		45.0		%		44.5		%		1.6%							0.5%
Total operating expenses	$	1,951,733			$	1,701,227			$	1,544,666			$	250,506			14.7	%		$	156,561			10.1	%
Net income	$	2,380,681			$	1,697,763			$	914,049			$	682,918			40.2	%		$	783,714			85.7	%
Net income per diluted share	$	13.17			$	9.24			$	5.22			$	3.93			42.5	%		$	4.02			77.0	%

Revenues in fiscal year 2018 increased 38% compared to fiscal year 2017, and revenues in fiscal year 2017 increased 36% compared to fiscal year 2016, reflecting an increase in technology and capacity investments by our customers.

The increase in gross margin as a percentage of revenue for fiscal year 2018 compared to fiscal year 2017 was primarily due to favorable margin mix and higher revenue.

Fiscal year 2017 gross margin as a percentage of revenue compared to fiscal year 2016 improved primarily due to higher revenue and improved factory utilization resulting from higher production volume.

Operating expenses in fiscal year 2018 increased as compared to fiscal years 2017 and 2016 primarily as a result of higher employee headcount and increased investment in research and development.

Our cash and cash equivalents, investments, and restricted cash and investments balances totaled approximately $5.2 billion as of June 24, 2018, compared to $6.3 billion as of June 25, 2017. Cash flow provided from operating activities was $2.7 billion for fiscal year 2018 compared to $2.0 billion for fiscal year 2017. Cash flow provided from operating activities in fiscal 2018 was primarily used for $2.7 billion in treasury stock purchases, $396 million in net principal payments on debt, $308 million in dividends paid to our stockholders, and $273 million of capital expenditures and are partially offset by $85 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 2018 were approximately $11.2 billion, an increase of 30% compared to fiscal year 2017. Shipments for fiscal year 2017 were approximately $8.6 billion, an increase of 46% compared to fiscal year 2016. The increase in shipments during the fiscal year 2018 as compared to the last two fiscal years is related to stronger customer demand.

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	Year Ended
June 24, 2018				June 25, 2017				June 26, 2016
Shipments (in millions)	$	11,176			$	8,586			$	5,901
Korea	33		%		32		%		17		%
Japan	19		%		15		%		16		%
China	16		%		13		%		20		%
Taiwan	13		%		24		%		25		%
United States	7		%		8		%		8		%
Southeast Asia	7		%		4		%		11		%
Europe	5		%		4		%		3		%

The percentage of total Lam semiconductor processing system shipments to each of the markets we serve were as follows for fiscal years 2018, 2017, and 2016.

	Year Ended
June 24, 2018			June 25, 2017			June 26, 2016
Memory	78	%		67	%		68	%
Foundry	14	%		27	%		23	%
Logic/integrated device manufacturing	8	%		6	%		9	%

Our shipments to memory customers during the fiscal year 2018 increased primarily due to higher levels of investments from our DRAM and NAND customers. Our shipments to foundry customers decreased during the fiscal year 2018 primarily due to decreased investments in leading and trailing edge technology applications from our foundry customers.

Unshipped orders in backlog as of June 24, 2018, were approximately $2.0 billion, a slight decrease from approximately $2.1 billion as of June 25, 2017. Our unshipped orders backlog includes orders for systems, spares, and services. Please refer to “Backlog” in Part I, Item 1, “Business” of this 2018 Form 10-K for a description of our policies for adding to and adjusting backlog.

Revenue

	Year Ended
June 24, 2018				June 25, 2017				June 26, 2016
Revenue (in millions)	$	11,077			$	8,014			$	5,886
Korea	35		%		31		%		18		%
Japan	17		%		13		%		17		%
China	16		%		13		%		18		%
Taiwan	13		%		26		%		25		%
United States	7		%		8		%		8		%
Southeast Asia	7		%		5		%		10		%
Europe	5		%		4		%		4		%

The revenue increases in fiscal year 2018 compared to the last two fiscal years and in fiscal year 2017 compared to fiscal year 2016, reflect 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 timelines. The overall Asia region continued to account for a majority of our revenues as a substantial amount of the worldwide capacity additions for semiconductor manufacturing continued to occur in this region.

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Our deferred revenue balance was $994 million as of June 24, 2018, compared to $966 million as of June 25, 2017. As noted in Note 3 to our Consolidated Financial Statements in Part II, Item 8 of this 2018 Form 10-K, the adoption of accounting standard update 2014-09 is expected to result in a net decrease, estimated between $100 million and $200 million, to our total current liabilities balance, affecting our deferred revenue, deferred costs and resulting deferred profit recognition. 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 $607 million as of June 24, 2018, compared to $397 million as of June 25, 2017.

Gross Margin

	Year Ended												Change
June 24, 2018				June 25, 2017				June 26, 2016			FY18 vs. FY17							FY17 vs. FY16
	(in thousands, except percentages)
Gross margin	$	5,165,032			$	3,603,359			$	2,618,922			$	1,561,673			43.3	%		$	984,437			37.6	%
Percent of revenue	46.6		%		45.0		%		44.5		%		1.6%							0.5%

The increase in gross margin as a percentage of revenue for fiscal year 2018 compared to fiscal year 2017 was primarily due to favorable margin mix and higher revenue.

The increase in gross margin as a percentage of revenue for fiscal year 2017 compared to fiscal year 2016 was primarily due to higher revenue and improved factory utilization resulting from higher production volume.

Research and Development

	Year Ended												Change
June 24, 2018				June 25, 2017				June 26, 2016			FY18 vs. FY17							FY17 vs. FY16
	(in thousands, except percentages)
Research & development	$	1,189,514			$	1,033,742			$	913,712			$	155,772			15.1	%		$	120,030			13.1	%
Percent of revenue	10.7		%		12.9		%		15.5		%		(2.2)%							(2.6)%

We continued to make significant R&D investments focused on leading-edge deposition, etch, clean, and other semiconductor manufacturing requirements. The increase in R&D expense during fiscal year 2018 compared to fiscal year 2017 was primarily due to an $88 million increase in employee compensation and benefits related to increased headcount, a $24 million increase in supplies, and a $23 million increase in outside services and miscellaneous expenses.

The increase in R&D expense during fiscal year 2017 compared to fiscal year 2016 was primarily due to an $80 million increase in employee compensation and benefits related to increased headcount, a $20 million increase in depreciation and lab maintenance, a $9 million increase in outside services, and a $7 million increase in supplies.

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Selling, General, and Administrative

	Year Ended												Change
June 24, 2018				June 25, 2017				June 26, 2016			FY18 vs. FY17							FY17 vs. FY16
	(in thousands, except percentages)
Selling, general, and administrative	$	762,219			$	667,485			$	630,954			$	94,734			14.2	%		$	36,531			5.8	%
Percent of revenue	6.9		%		8.3		%		10.7		%		(1.4)%							(2.4)%

The increase in selling, general, and administrative (“SG&A”) expense during fiscal year 2018 compared to fiscal year 2017 was primarily due to a $44 million increase in employee compensation and benefits from increased headcount, a $28 million increase in outside services, and a $15 million increase in rent, utilities and repairs.

The increase in SG&A expense during fiscal year 2017 compared to fiscal year 2016 was primarily due to a $36 million increase in employee compensation and benefits from increased headcount, a $15 million gain from sale of assets in fiscal year 2016, and a $14 million increase in outside services, offset by a $41 million decrease in acquisition-related costs associated with the terminated agreement with KLA-Tencor.

Other Expense, Net

Other expense, net, consisted of the following:

	Year Ended												Change
June 24, 2018				June 25, 2017				June 26, 2016			FY18 vs. FY17							FY17 vs. FY16
	(in thousands)
Interest income	$	85,813			$	57,858			$	29,512			$	27,955			48.3	%		$	28,346			96.0	%
Interest expense	(97,387		)		(117,734		)		(134,773		)		$	20,347			(17.3	)%		$	17,039			(12.7	)%
Gains (losses) on deferred compensation plan related assets, net	14,692				17,880				(3,995		)		$	(3,188	)		(17.8	)%		$	21,875			(547.6	)%
Loss on impairment of investments	(42,456		)		—				—				$	(42,456	)		100.0	%		$	—			—	%
Gains (losses) on extinguishment of debt, net	542				(36,252		)		—				$	36,794			(101.5	)%		$	(36,252	)		(100.0	)%
Foreign exchange (losses) gains, net	(3,382		)		(569		)		308				$	(2,813	)		494.4	%		$	(877	)		(284.7	)%
Other, net	(19,332		)		(11,642		)		(5,191		)		$	(7,690	)		66.1	%		$	(6,451	)		125.7	%
	$	(61,510	)		$	(90,459	)		$	(114,139	)		$	28,949			(32.0	)%		$	23,680			(20.7	)%

Interest income increased in fiscal year 2018 compared to fiscal years 2017 and 2016 primarily as a result of higher yield.

The decrease in interest expense during fiscal year 2018 compared to fiscal year 2017 was primarily due to the conversions of 2018 and 2041 Convertible Notes as well as the retirement of the 2018 Convertible Notes in May 2018. The decrease in interest expense during fiscal year 2017 compared to fiscal year 2016 was primarily due to the retirement of the 2016 Convertible Notes.

The gain on deferred compensation plan related assets, in fiscal years 2018 and 2017, compared to a loss in fiscal year 2016 was driven by an improvement in the fair market value of the underlying funds.

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The loss on impairment of investments during fiscal year 2018 is the result of a decision to sell selected investments held in foreign jurisdictions in connection with our cash repatriation strategy following the December 2017 U.S. tax reform.

Loss on extinguishment of debt during fiscal year 2017 related to the special mandatory redemption of certain senior notes issued, as well as the termination of the Amended and Restated Term Loan Agreement following the termination of the Agreement and Plan of Merger and Reorganization with KLA-Tencor.

Income Tax Expense

As discussed in Note 6, “Income Taxes,” to our Consolidated Financial Statements in Part II, Item 8 of this 2018 Form 10-K, the “Tax Cuts & Jobs Act” (hereafter referred to as “U.S. tax reform”) was signed into law on December 22, 2017 and was effective starting in our quarter ended December 24, 2017. U.S. tax reform reduces the U.S. federal statutory tax rate from 35% to 21%, mandates payment of a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred, and creates new taxes on certain foreign sourced earnings. The impact on income taxes due to a change in legislation is required under the authoritative guidance of Accounting Standards Codification (“ASC”) 740, Income Taxes, to be recognized in the period in which the law is enacted. In conjunction, the SEC issued Staff Accounting Bulletin (“SAB”) 118, which allows for the recording of provisional amounts related to U.S. tax reform and subsequent adjustments related to U.S. tax reform during an up to one-year measurement period that is similar to the measurement period used when accounting for business combinations. As such, there is significant activity in the fiscal year ended June 24, 2018, which reflects the change in legislation. Most of that activity has provisionally been recorded in our Consolidated Financial Statements in the period ended June 24, 2018, as we have not yet completed all of the accounting for the tax effects of enactment. We recorded what we believe to be a reasonable estimate and the provisional activity is subject to further adjustments under SAB 118, with the exception of revaluation of our deferred tax balances to reflect the new U.S. federal statutory tax rate, which is considered final and complete under SAB 118. In addition, for significant items for which we could not make a reasonable estimate, no provisional activity was recorded. We will continue to refine the provisional balances and adjustments may be made under SAB 118 during the measurement period as a result of future changes in interpretation, information available, assumptions made by the Company and/or issuance of additional guidance; these adjustments could be material.

The below discussion around the provision for income taxes and effective tax rate are significantly impacted by U.S. tax reform.

Our provision for income taxes and effective tax rate for the periods indicated were as follows:

	Year Ended												Change
June 24, 2018				June 25, 2017				June 26, 2016			FY18 vs. FY17							FY17 vs. FY16
	(in thousands, except percentages)
Income tax expense	$	771,108			$	113,910			$	46,068			$	657,198			576.9	%		$	67,842			147.3	%
Effective tax rate	24.5		%		6.3		%		4.8		%		18.2%							1.5%

The increase in the effective tax rate in fiscal year 2018 as compared to fiscal year 2017 was primarily due to the impact of U.S. tax reform and its mandated one-time transition tax on accumulated unrepatriated foreign earnings.

The increase in the effective tax rate in fiscal year 2017 as compared to fiscal year 2016 was primarily due to the change in the mix of income offset by the recognition of previously unrecognized tax benefits.

In July 2015, the U.S. Tax Court issued an opinion favorable to Altera Corporation (“Altera”) with respect to Altera’s litigation with the Internal Revenue Service (“IRS”). The litigation related to the treatment of stock-based compensation expense in an intercompany cost-sharing arrangement with Altera’s foreign subsidiary. In its opinion, the U.S. Tax Court accepted Altera’s position of excluding stock-based compensation from its intercompany cost-sharing arrangement. In July 2018, the U.S. Court of Appeals for the Ninth Circuit reversed the 2015 decision of the U.S. Tax Court. In August 2018, the opinion made by the U.S. Court of Appeals for the Ninth Circuit was withdrawn to allow time for a reconstituted panel to confer on the appeal. We are currently

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evaluating the impact, if any, of these subsequent events on our fiscal year 2019 Consolidated Financial Statements. We are unable to estimate the impact at this time.

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. Additionally, the impact of U.S. tax reform is being evaluated for how it will affect future years’ tax expense due to tax reform provisions that we will be subject to beginning in fiscal year 2019. Tax reform provisions being evaluated impacting future years include “Global Intangible Low-Taxed Income” (“GILTI”) and other provisions. Please refer to Note 6 of our Consolidated Financial Statements in Part II, Item 8 of this 2018 Form 10-K.

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 $437 million and $546 million at the end of fiscal years 2018 and 2017, respectively. These gross deferred tax assets were offset by gross deferred tax liabilities of $169 million and $585 million at the end of fiscal years 2018 and 2017, respectively, and a valuation allowance of $200 million and $114 million at the end of fiscal years 2018 and 2017, respectively. The change in the gross deferred tax assets, gross deferred tax liabilities, and valuation allowance between fiscal year 2018 and 2017 is primarily due to deferred revaluation to reflect the new U.S. statutory tax rate and decreases related to allowances and reserves, prepaid cost sharing, and unremitted earnings of foreign subsidiaries.

As of our fiscal year ended June 24, 2018, 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. The valuation allowances were $200 million and $114 million at the end of fiscal years 2018 and 2017, 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, effectively settled issues under audit, and new audit activity. Any 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 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

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•	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 in Part II, Item 8 of this 2018 Form 10-K 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 net realizable 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.

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 general or unspecified reserves; all warranty reserves are related to specific systems.

Equity-based Compensation: 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 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

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realization could be negatively impacted by market conditions and other variables not known or anticipated at this time. In the event that we determined that we will not be able to realize all or part of our net deferred tax assets, an adjustment will be charged to earnings in the period such determination was made. Likewise, if we later determined that it is more likely than not that the deferred tax assets will 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 will 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 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 lifecycle 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.

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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 Part II, Item 8 of this 2018 Form 10-K.

Liquidity and Capital Resources

Total gross cash, cash equivalents, investments, and restricted cash and investments balances were $5.2 billion at the end of fiscal year 2018 compared to $6.3 billion at the end of fiscal year 2017. This decrease was primarily due to Common Stock repurchases in connection with our stock repurchase program. Approximately $4.1 billion and $4.8 billion of our total cash and investments as of June 24, 2018, and June 25, 2017, respectively, was held outside the United States in our foreign subsidiaries, the majority of which was held in U.S. dollars. U.S. taxes have already been provided for due to U.S. tax reform as discussed in Note 6 of our Consolidated Financial Statements, included in Part II, Item 8 of this 2018 Form 10-K.

Cash Flow from Operating Activities

Net cash provided by operating activities of $2.7 billion during fiscal year 2018 consisted of (in millions):

Net income	$	2,381
Non-cash charges:
Depreciation and amortization	326
Equity-based compensation expense	172
Deferred income taxes	3
Impairment of investments	42
Amortization of note discounts and issuance costs	14
Changes in operating asset and liability accounts	(317		)
Other	35
	$	2,656

Significant changes in operating asset and liability accounts, net of foreign exchange impact, included the following uses of cash: increases in inventories of $701 million, accounts receivable of $502 million, and prepaid expenses and other assets of $14 million, partially offset by the following sources of cash: increases in accrued expenses and other liabilities of $752 million, deferred profit of $112 million, and accounts payable of $36 million.

Cash Flow from Investing Activities

Net cash provided by investing activities during fiscal year 2018 was $2.7 billion, primarily consisting of net sale and maturities of available-for-sale securities of $3.2 billion, partially offset by capital expenditures of $273 million and business acquisitions of $116 million.

Cash Flow from Financing Activities

Net cash used by financing activities during fiscal year 2018 was $3.3 billion, primarily consisting of $2.7 billion in Common Stock repurchases, $756 million of cash paid for debt extinguishment, and $308 million of dividends paid, partially offset by $360 million of net proceeds from issuance of commercial paper, and $85 million of stock issuance and treasury stock reissuances associated with our employee stock-based compensation plans.

Liquidity

Given that the semiconductor industry is highly competitive and has historically experienced rapid changes in demand, we believe that maintaining sufficient liquidity reserves is important to support sustaining levels of investment in R&D and capital infrastructure. Anticipated cash flows from operations based on our current business outlook, combined with our current levels of cash, cash equivalents, and short-term investments as of June 24, 2018, are expected to be sufficient to support our anticipated levels of operations, investments, debt service requirements, capital expenditures, capital redistributions, and dividends through at least the next twelve months. However, uncertainty in the global economy and the semiconductor industry, as well as disruptions in

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credit markets, have in the past, and could in the future, impact customer demand for our products, as well as our ability to manage normal commercial relationships with our customers, suppliers, and creditors.

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, 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 assurance that such funding will be available in needed quantities or on terms favorable to us.

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 24, 2018, 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 $280 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 in Part II, Item 8 of this 2018 Form 10-K for further discussion. The amounts in the table below also exclude $14 million associated with funding commitments related to non-marketable equity investments as we are unable to make a reasonable estimate regarding the timing of capital calls.

	Total				Less than 1 Year				1-3 Years				3-5 Years				More than 5 Years
	(in thousands)
Operating leases	$	74,343			$	22,117			$	32,635			$	8,556			$	11,035
Capital leases	64,116				3,948				9,345				13,116				37,707
Purchase obligations	372,226				353,295				12,317				6,452				162
Long-term debt and interest expense (1)	2,513,556				61,736				1,404,664				51,173				995,983
One-time transition tax on accumulated unrepatriated foreign earnings (2)	882,995				70,640				141,279				141,279				529,797
Other long-term liabilities (3)	90,629				5,280				12,898				6,104				66,347
Total	$	3,997,865			$	517,016			$	1,613,138			$	226,680			$	1,641,031

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(1)

The conversion period for the 2.625% Convertible Senior Notes due May 2041 (the “2041 Notes”) was open as of June 24, 2018, and as such the net carrying value of the 2041 Notes is included within current liabilities on our Consolidated Balance Sheet. The principal balances of the 2041 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 in Part II, Item 8 of this 2018 Form 10-K for additional information concerning the 2041 Notes and associated conversion features.

(2)	Value represented is provisional in nature and subject to future measurement period adjustments under SAB 118. We may choose to apply existing tax credits, thereby reducing the actual cash payment.

(3)	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

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Fremont and Livermore, California; Tualatin, Oregon; 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 $250 million. See Note 15 to our Consolidated Financial Statements in Part II, Item 8 of this 2018 Form 10-K 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 24, 2018, 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 the minimum cancellation fee. Actual expenditures will vary based on the volume of transactions and length of contractual service provided.

Income Taxes

During the December 2017 quarter, a one-time transition tax on accumulated unrepatriated foreign earnings, estimated at $991 million, was recognized associated with the December 2017 U.S. tax reform. This value is identified as provisional in our Consolidated Financial Statements for the period ended June 24, 2018, and is subject to future measurement period adjustments under SAB 118. Such an adjustment was made during the June 2018 quarter, incorporating new information into the estimate; we may make further adjustments as new information is made available. The revised estimate is now $883 million. The one-time transition tax may be elected to be paid over a period of eight years. The Company intends to make this election, and anticipates 8% of the transition tax to be paid each September 15 for years 2018 through 2022, and 15%, 20%, and 25%, respectively, to be paid each September 15 for years 2023 through 2025.

Long-Term Debt

In May 2011, we issued and sold $450 million in aggregate principal amount of 1.25% Convertible Senior Notes due May 2018 (the “2018 Notes”) at par. The 2018 Notes matured in May 2018. Concurrent with the issuance of the 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 2018 Notes.

During the twelve months ended June 24, 2018 we paid approximately $448 million in settlement of the 2018 Notes. We did not issue any shares of our Common Stock in respect of the 2018 Notes on a net basis as a result of our exercise of the convertible note hedge we purchased concurrently with the issuance of the 2018 Notes. The maturity of the 2018 Notes did not affect the warrants sold concurrent with the issuance of the 2018 Notes and those warrants remain outstanding, with contractual expirations ranging from August 15 to October 24, 2018.

In June 2012, with the acquisition of Novellus, we assumed $700 million in aggregate principal amount of 2.625% Convertible Senior Notes due May 2041. 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.

During the quarter-ended June 24, 2018, the market value of our Common Stock was greater than or equal to 130% of the 2041 Notes conversion prices for 20 or more trading days of the 30 consecutive trading days preceding the quarter end. As a result, 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 2018.

On March 12, 2015, we completed a public offering of $500 million aggregate principal amount of Senior Notes due March 15, 2020 (the “2020 Notes”) and $500 million aggregate principal amount of Senior Notes due

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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”), together with the 2020 Notes, and 2021 Notes, the “Senior Notes”, and collectively with the Convertible Notes, the “Notes”). We pay interest at an annual rate of 2.80% on the 2021 Notes on a semi-annual basis on June 15 and December 15 of each year.

We may redeem the 2021 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 respective indenture, and accrued and unpaid interest before May 15, 2021. We may redeem the 2021 Notes at par, plus accrued and unpaid interest at any time on or after May 15, 2021. 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, at a price equal to 101% of the principal amount of the respective note, plus accrued and unpaid interest.

During fiscal year 2018, 2017, and 2016, we made $753 million, $1.7 billion, and $451 million, respectively, in principal payments on long-term debt and capital leases.

Revolving Credit Arrangements

On October 13, 2017, we entered into Amendment No. 2 to Amended and Restated Credit Agreement (the “2nd Amendment”), among the Company, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent, which amends the Company’s Amended and Restated Credit Agreement dated as of November 10, 2015, by and among the Company, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent, Amendment No. 1 to Amended and Restated Credit Agreement, dated as of April 26, 2016, among the Company, the lenders party thereto and JPMorgan Chase Bank, N.A., as administrative agent (as further amended by the 2nd Amendment, the “Amended Credit Agreement”).

Among other things, the Amended Credit Agreement provides for a $500 million increase to the Company’s revolving credit facility, from $750 million under the Credit Agreement to $1.25 billion under the Amended Credit Agreement. The Amended Credit Agreement also modifies the date of maturity of the revolving credit facility from November 10, 2020 to October 13, 2022. The Amended Credit Agreement provides an expansion option, that will allow the Company, subject to certain requirements, to request an increase in the facility of up to an additional $600 million, for a potential total commitment of $1.85 billion. Other than as disclosed in this paragraph, the material terms of the Amended Credit Agreement are substantially the same as the Credit Agreement.

Interest on amounts borrowed under the credit facility is, at our option, based on (1) a base rate, defined as the greatest of (a) prime rate, (b) Federal Funds rate plus 0.5%, or (c) one-month London Interbank Offered Rate (“LIBOR”) plus 1.0%, plus a spread of 0.0% to 0.5%, or (2) 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 Credit Agreement contains affirmative covenants, negative covenants, financial covenants, and events of default. As of June 24, 2018, we had no borrowings outstanding under the Amended Credit Agreement and were in compliance with all financial covenants.

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Commercial Paper Program

On November 13, 2017, we established a commercial paper program (“the CP Program”) under which we may issue unsecured commercial paper notes on a private placement basis up to a maximum aggregate amount outstanding at any time of $1.25 billion. Individual maturities may vary, but cannot not exceed 397 days from the date of issue. The net proceeds from the CP Program will be used for general corporate purposes, including repurchases of our Common Stock from time to time and under our stock repurchase program. If at any time, funds are not available under favorable terms under the CP Program, we may utilize the Amended Credit Agreement for funding. Amounts available under the CP Program may be re-borrowed. The CP Program is backstopped by our Revolving Credit Arrangement.

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 24, 2018, 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 24, 2018, the maximum potential amount of future payments that we could be required to make under these arrangements and letters of credit was $22 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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