2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared pursuant to the Rules of the Securities and Exchange Commission for quarterly reports on Form 10-Q and, accordingly, these footnotes condense or omit information and disclosures which substantially duplicate information provided in our latest audited financial statements. These unaudited financial statements should be read in conjunction with the financial statements and notes included in our Annual Report on Form 10-K for the year ended July 31, 2011. In the opinion of management, these unaudited consolidated financial statements reflect all adjustments, including normal recurring accruals, necessary for a fair presentation of the results for the interim periods presented. The operating results for the three months ended October 31, 2011 are not necessarily indicative of future trends or the Company's results of operations for the entire fiscal year ending July 31, 2012.

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant inter-company transactions and balances have been eliminated in consolidation.

Foreign Currency Remeasurement

The financial statements of the Company's foreign subsidiaries are remeasured in accordance with Financial Accounting Standards Board Accounting Standards Codification (FASB ASC) Topic 830, Foreign Currency Matters. The subsidiaries' functional currency is the U.S. dollar. Accordingly, the Company's foreign subsidiaries remeasure monetary assets and liabilities at month-end exchange rates while long-term non-monetary items are remeasured at historical rates. Income and expense accounts are remeasured at the average rates in effect during the month. Net gains or losses resulting from foreign currency remeasurement and transaction gains or losses are included in the consolidated results of operations as a component of Other income, net, and were not significant for the three months ended October 31, 2011 or 2010.

Derivatives

The Company conducts business in a number of foreign countries, with certain transactions denominated in local currencies. The purpose of the Company's foreign currency management is to minimize the effect of exchange rate fluctuations on certain foreign denominated net monetary assets. The Company does not use derivative financial instruments for trading or speculative purposes.

During the twelve months ended July 31, 2011, the Company entered into a derivative in the form of a foreign currency forward contract to minimize the effect of exchange rate fluctuations associated with the remeasurement of net monetary assets denominated in foreign currencies. This transaction did not qualify for hedge accounting under FASB ASC Topic 815, Derivatives and Hedging. The change in fair value of this derivative is recorded directly in the Company's statement of operations and offsets the change in fair value of the net monetary assets denominated in foreign currencies. The Company recorded $0.2 million of income in Other income, net for the three months ended October 31, 2011. There was no activity recorded for the same period in 2010. During the three months ended October 31, 2011, the Company's foreign currency forward contract expired. The notional amount of the foreign currency forward contract was $4.6 million and $4.8 million, respectively, at July 31, 2011. The following table summarizes the fair value of the derivative instrument as of October 31, 2011 and July 31, 2011:

Derivatives not designated as hedging instruments:

Balance Sheet Location

October 31,
2011

July 31,
2011

(in thousands)

Foreign exchange contract

Other accrued expenses

—

187

Revenue Recognition

The Company recognizes revenue based on guidance provided in FASB ASC Topic 605, Revenue Recognition ("ASC 605"). The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller's price is fixed or determinable and collectability is reasonably assured.

Revenue related to equipment sales is recognized when: (a) the Company has a written sales agreement; (b) delivery has occurred; (c) the price is fixed or determinable; (d) collectability is reasonably assured; (e) the product delivered is standard product with historically demonstrated acceptance; and (f) there is no unique customer acceptance provision or payment tied to acceptance or an undelivered element significant to the functionality of the system. Generally, payment terms are time based after product shipment. When sales to a customer involve multiple elements, revenue is recognized on the delivered element provided that (1) the undelivered element is a proven technology, (2) there is a history of acceptance on the product with the customer, (3) the undelivered element is not essential to the customer's application, (4) the delivered item(s) has value to the customer on a stand-alone basis, and (5) if the arrangement included a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the Company. The arrangement consideration, or the amount of revenue to be recognized on each separate unit of accounting, is allocated at the inception of the arrangement to all deliverables on the basis of their relative selling price based on the provisions of Accounting Standards Update ("ASU") 2009-13.

Revenue related to spare parts is recognized on shipment.

Revenue related to maintenance and service contracts is recognized ratably over the duration of the contracts.

Engineering and Product Development Costs

The Company expenses all engineering, research and development costs as incurred. Expenses subject to capitalization in accordance with the FASB ASC Topic 985, Software, relating to certain software development costs, were insignificant for the three months ended October 31, 2011 and 2010, respectively.

Shipping and Handling Costs

Shipping and handling costs are included in cost of sales in the consolidated statements of operations. These costs, when included in the sales price charged for products, are recognized in net sales. Shipping and handling costs were insignificant for the three months ended October 31, 2011 and 2010, respectively.

Income Taxes

Income tax expense relates principally to operating results of foreign entities in jurisdictions primarily in Asia and Europe.

As of October 31, 2011 and July 31, 2011, the total liability for unrecognized income tax benefits was $10.5 million and $9.1 million, respectively, (of which $5.3 million, if recognized, would impact the Company's income tax rate and therefore are recorded in other long-term liabilities on the Company's consolidated balance sheet). The Company recognizes interest and penalties related to uncertain tax positions as a component of income tax expense. As of October 31, 2011 and July 31, 2011, the Company had accrued approximately $1.4 million and $1.3 million, respectively, for potential payment of accrued interest and penalties.

The Company conducts business globally and, as a result, the Company and its subsidiaries or branches file income tax returns in the U.S. federal jurisdiction and various U.S. state, and foreign jurisdictions. In the normal course of business the Company is subject to examination by taxing authorities throughout the world, including such major jurisdictions as the United States, Singapore, France and Germany. With few exceptions, the Company is no longer subject to U.S. federal, state and local or non-U.S. income tax examinations for years before 2000.

As a result of completion of the merger with Credence Systems Corporation ("Credence") on August 29, 2008, a greater than 50% cumulative ownership change in both entities triggered a significant limitation in net operating loss carryforward utilization. The Company's ability to use operating and acquired net operating loss and credit carryforwards is subject to annual limitation as defined in sections 382 and 383 of the Internal Revenue Code. The Company currently estimates that the annual limitation on its use of net operating losses generated through August 29, 2008 will be approximately $10.1 million which, based on currently enacted federal carryforward periods, limits the amount of net operating losses able to be used to approximately $202.0 million. The Company will continue to assess the realizability of these carryforwards in subsequent periods.

Accounting for Stock-Based Compensation

The Company has various stock-based compensation plans, including the Company's 2010 Stock Plan, as amended on November 26, 2010 ("2010 Plan"), the LTX Corporation 2004 Stock Plan, the Company's 2001 Stock Plan, the Company's 1999 Stock Plan, and the Company's 1993 Stock Plan. In addition, the Company assumed the StepTech, Inc. Stock Option Plan as part of its acquisition of StepTech, Inc. ("StepTech") and the Credence 2005 Stock Incentive Plan with its acquisition of Credence. The Company can only grant awards from the 2010 Plan.

The Company granted 737,100 and 692,700 restricted stock unit based awards during the three months ended October 31, 2011 and 2010, respectively, all of which are service-based and have four year vesting terms.

The Company recognizes stock-based compensation expense on its equity awards in accordance with the provisions of FASB ASC Topic 718, Compensation – Stock Compensation ("ASC 718"). Under ASC 718, the Company is required to recognize as expense the estimated fair value of all share-based payments to employees. In accordance with this standard, the Company has elected to recognize the compensation cost of all service based awards on a straight-line basis over the vesting period of the award.

Product Warranty Costs

The Company's products are sold with warranty provisions that require it to remedy deficiencies in quality or performance of products over a specified period of time at no cost to its customers. The Company generally offers a warranty for all of its products, the standard terms and conditions of which are based on the product sold and the customer. For all testers sold, the Company accrues a liability for the estimated cost of standard warranty at the time of tester shipment and defers the portion of product revenue attributed to the estimated selling price of non-standard warranty. Costs for non-standard warranties are expensed as incurred. Factors that impact the expected product warranty liability include the number of installed testers, historical and anticipated product failure rates, material usage and service labor costs. The Company periodically assesses the adequacy of its recorded product warranty liability and adjusts it as necessary.

The following table shows the change in the product warranty liability, as required by FASB ASC Topic 460, Guarantees, for the three months ended October 31, 2011 and 2010:


	Three Months Ended October 31,
Product Warranty Activity	2011			2010
	(in thousands)
Balance at beginning of period	$	2,281		$	4,398
Warranty expenditures for current period		(1,069	)		(2,643	)
Changes in liability related to pre-existing warranties		20			(25	)
Provision for warranty costs in the period		501			2,539

Balance at end of period	$	1,733		$	4,269

Comprehensive income (loss)

Comprehensive income (loss) is composed of two components: net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) consists of unrealized gains and losses on the Company's marketable securities.

Net income (loss) per share

Basic net income (loss) per share is computed by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted net income (loss) per share reflects the maximum dilution that would have resulted from the assumed exercise and share repurchase related to dilutive stock options and restricted stock units and is computed by dividing net income (loss) by the weighted average number of common shares and the dilutive effect of all securities outstanding.

Reconciliation between basic and diluted earnings per share is as follows:


	Three Months Ended October 31,
	2011			2010
	(in thousands, except per share data)
Net income (loss)	$	(4,909	)	$	19,675
Basic EPS
Weighted average shares outstanding		49,487			49,161
Basic EPS	$	(0.10	)	$	0.40
Diluted EPS
Weighted average shares outstanding		49,487			49,161
Plus: impact of stock options and unvested restricted stock units		—			727

Weighted average common and common equivalents shares outstanding		49,487			49,888
Diluted EPS	$	(0.10	)	$	0.39

For the three months ended October 31, 2011 and 2010, options to purchase approximately 1,401,690 shares and 1,953,327 shares, respectively, of common stock were not included in the calculation of diluted net loss per share because their inclusion would have been anti-dilutive. These options could be dilutive in the future. The calculation of diluted net loss per share also excludes 1,869,976 and 1,731,453 RSUs for the period ended October 31, 2011 and, 2010, respectively, in accordance with the contingently issuable shares guidance of FASB ASC Topic 260, Earnings Per Share. The calculation of diluted net income (loss) per share for the three months ended October 31, 2010 also excludes the impact of conversion features of the Company's Convertible Senior Subordinated Notes due 2011 as to include them would have been anti-dilutive.

Cash and Cash Equivalents and Marketable Securities

The Company considers all highly liquid investments that are readily convertible to cash and that have original maturity dates of three months or less to be cash equivalents. Cash and cash equivalents consist primarily of operating cash and money market accounts. Marketable securities consist primarily of debt securities that are classified as available-for-sale and held-to-maturity, in accordance with FASB ASC Topic 320, Investments – Debt and Equity Securities. The Company also holds certain investments in commercial paper that it considers to be held to maturity, based on their maturity dates. Securities available for sale include corporate and governmental obligations with various contractual maturity dates some of which are greater than one year. The Company considers the securities to be liquid and convertible to cash within 30 days. The Company has the ability and intent to liquidate any security that the Company holds to fund operations over the next twelve months if necessary and as such has classified these securities as short-term. Governmental obligations include U.S. Government, State, Municipal and Federal Agency securities. The Company has an overnight sweep investment arrangement with its bank for certain accounts to allow the Company to enter into diversified overnight investments via a money market mutual fund which generally provides a higher investment yield than a regular operating account.

Gross unrealized gains and losses for the three months ended October 31, 2011 and 2010 were not significant. Realized gains, losses and interest are included in investment income in the Statements of Operations. Unrealized gains and losses are reflected as a separate component of comprehensive income and are included in Stockholders' Equity. The Company analyzes its securities portfolio for impairment on a quarterly basis or upon occurrence of a significant change in circumstances. There were no other than temporary impairment losses recorded in the three months ended October 31, 2011 or 2010.

Inventories

Inventories are stated at the lower of cost or market, determined on the first-in, first-out ("FIFO") method, and include materials, labor and manufacturing overhead. The components of inventories are as follows:


	October 31, 2011		July 31, 2011
	(in thousands)
Purchased components and parts	$	12,762	$	11,313
Units-in-progress		4,730		2,080
Finished units		10,528		7,752

Total inventories	$	28,020	$	21,145

The Company establishes inventory reserves when conditions exist that indicate inventory may be in excess of anticipated demand or is obsolete based upon assumptions about future demand for the Company's products or market conditions. The Company regularly evaluates the ability to realize the value of inventory based on a combination of factors including the following: forecasted sales or usage, estimated product end of life dates, estimated current and future market value and new product introductions.

Purchasing and usage alternatives are also explored to mitigate inventory exposure. When recorded, reserves are intended to reduce the carrying value of inventory to its net realizable value. As of October 31, 2011 and July 31, 2011, inventory is stated net of inventory reserves of $42.7 million and $43.0 million, respectively. If actual demand for products deteriorates or market conditions are less favorable than projected, additional inventory reserves may be required. Such reserves are not reversed until the related inventory is sold or otherwise disposed of. The Company had sales of $4.2 million of previously reserved inventory for the three months ended October 31, 2011, which represents the gross cash received from the customer. The Company released reserves of $0.9 million for the three months ended October 31, 2011, related to these sales. The Company had sales of $2.5 million of previously reserved inventory for the three months ended October 31, 2010, which represents the gross cash received from the customer. The Company released reserves of $0.3 million for the three months ended October 31, 2010, related to these sales.

Property and Equipment

Property and equipment acquired is recorded at cost. Property and equipment related to the Credence merger was recorded at fair value on the date of acquisition. The Company provides for depreciation and amortization on the straight-line method. Charges are made to operating expenses in amounts that are sufficient to amortize the cost of the assets over their estimated useful lives. Equipment spares used for service and internally manufactured test systems used for testing components and engineering projects are recorded at cost and depreciated over 3 to 7 years. Repair and maintenance costs that do not extend the lives of property and equipment are expensed as incurred. Property and equipment are summarized as follows:


	(in thousands)						(in years)
	October 31, 2011			July 31, 2011			Estimated Useful Lives
Equipment spares	$	59,624		$	65,078		5 or 7
Machinery, equipment and internally manufactured systems		42,260			41,476		3-7
Office furniture and equipment		4,617			4,892		3-7
Purchased software		2,862			2,805		3
Land		2,524			2,524		—
Leasehold improvements		6,163			6,134		Term of lease or useful life, not to exceed 10 years

Property and equipment, gross		118,050			122,909
Less: accumulated depreciation and amortization		(97,930	)		(102,082	)

Property and equipment, net	$	20,120		$	20,827

Impairment of Long-Lived Assets Other Than Goodwill

On an on-going basis, management reviews the value and period of amortization or depreciation of long-lived assets. In accordance with FASB ASC Topic 360, Property, Plant and Equipment , the Company reviews whether impairment losses exist on long-lived assets when indicators of impairment are present. During this review, the Company re-evaluates the significant assumptions used in determining the original cost of long-lived assets. Although the assumptions may vary, they generally include revenue growth, operating results, cash flows and other indicators of value. Management then determines whether there has been a permanent impairment of the value of long-lived assets based upon events or circumstances that have occurred since acquisition. The extent of the impairment amount recognized is based upon a determination of the impaired asset's fair value. As of October 31, 2011 and July 31, 2011 there were no indicators that required the Company to conduct a recoverability test at that date.

Goodwill and Other Intangibles

In accordance with FASB ASC Topic 350, Intangibles – Goodwill and Other, ("ASC 350"), the Company is required to review goodwill by reporting unit for impairment at least annually or more often if there are indicators of impairment present. The Company has determined its entire business represents one reporting unit. Historically, the Company has performed its annual impairment analysis during the fourth quarter of each year. The provisions of ASC 350 require that a two-step impairment test be performed for goodwill. In the first step, the Company compares the implied fair value of each reporting unit to which goodwill has been allocated to its carrying value. If the implied fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is considered not impaired and the Company is not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the implied fair value of the reporting unit, then the Company must perform the second step of the impairment test in order to determine the implied fair value of the reporting unit's goodwill. If the carrying value of a reporting unit's goodwill exceeds its implied fair value, then the Company would record an impairment loss equal to the difference. As of October 31, 2011 and July 31, 2011, the implied fair value of the goodwill of the Company's reporting unit exceeds the Company's carrying value of its net assets and therefore no impairment exists as of those dates.

Determining the fair value of a reporting unit requires the Company to make judgments and involves the use of significant estimates and assumptions. These estimates and assumptions include revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates, future economic and market conditions and determination of appropriate market comparables. The Company bases its fair value estimates on assumptions it believes to be reasonable but that are unpredictable and inherently uncertain. Actual future results may differ from those estimates.

The Company's Goodwill consists of the following:


Goodwill	October 31, 2011		July 31, 2011
	(in thousands)
Credence (August 29, 2008)	$	28,662	$	28,662
Step Tech (June 10, 2003)		14,368		14,368

Total goodwill	$	43,030	$	43,030

There was no change in the goodwill balance for the three months ended October 31, 2011 or 2010.

Intangible assets, all of which relate to the Credence merger, consist of the following:


			As of October 31, 2011
Description	Estimated Useful Life		Gross Carrying Amount		Accumulated Amortization		Net Amount
	(in years)		(in thousands)		(in thousands)		(in thousands)

Trade names		2.0	$	300	$	300	$	—

Distributor relationships		2.0		2,800		2,800		—
Key customer relationships		3.0		8,500		8,500		—
Developed technology—ASL		6.0		16,000		13,450		2,550
Developed technology—Diamond		9.0		9,400		7,713		1,687
Maintenance agreements		7.0		1,900		611		1,289

Total intangible assets			$	38,900	$	33,374	$	5,526


			As of July 31, 2011
Description	Estimated Useful Life		Gross Carrying Amount		Accumulated Amortization		Net Amount
	(in years)		(in thousands)		(in thousands)		(in thousands)
Trade names		2.0	$	300	$	300	$	—
Distributor relationships		2.0		2,800		2,800		—
Key customer relationships		3.0		8,500		8,500		—
Developed technology—ASL		6.0		16,000		12,945		3,055
Developed technology—Diamond		9.0		9,400		7,495		1,905
Maintenance agreements		7.0		1,900		543		1,357

Total intangible assets			$	38,900	$	32,583	$	6,317

Intangible assets are amortized based upon the pattern of estimated economic use over their estimated useful lives. The weighted average estimated remaining useful life over which these intangible assets will be amortized is 2.7 years.

The Company expects amortization for these intangible assets to be:


For the fiscal year ending July 31,	Amount
	(in thousands)
Remainder of 2012	$	2,372
2013		1,583
2014		769
2015		396
Thereafter		406

Total	$	5,526