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 consolidated financial statements should be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2013. 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, 2013 are not necessarily indicative of future trends or the Company’s results of operations for the entire fiscal year ending July 31, 2014.

These unaudited 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.

Revenue Recognition

The Company recognizes revenue based on guidance provided in Topic 605, Revenue Recognition, to the Financial Accounting Standards Board Codification (“FASB ASC”) and Accounting Standards Update 2009-13, Multiple-Deliverable Revenue Arrangements. 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 or service has been rendered; (c) the price is fixed or determinable; (d) collectability is reasonably assured; (e) the product delivered is a 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.

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.

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, 2013		July 31, 2013
	(in thousands)
Material and purchased components	$	16,265	$	15,379
Work-in-process		1,851		2,887
Finished testers, including inventory consigned to customers		11,122		10,873

Total inventories	$	29,238	$	29,139

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 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, 2013 and July 31, 2013, inventory is stated net of inventory reserves of $42.8 million and $41.8 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.

As of October 31, 2013 and July 31, 2013, the Company’s inventory of $29.2 million and $29.1 million, respectively, was stated net of inventory reserves of $42.8 million and $41.8 million, respectively, and primarily consisted of X-Series, ASL, ASL_x, Diamond, and Diamond_x products.

Goodwill and Other Intangibles

In accordance with Topic 350, Intangibles—Goodwill and Other, to the FASB ASC, 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 Company evaluated the implied fair value based on the Company’s market capitalization of its one reporting unit as compared to the carrying value of the net assets assigned to its reporting unit as of July 31, 2013. As of that date, the fair value of the reporting unit exceeded the carrying value of its net assets and therefore no impairment existed.

The Company’s intangible assets as of October 31, 2013 and July 31, 2013, all of which relate to the Credence merger, consisted of the following:


			As of October 31, 2013
Description	Estimated Useful Life		Gross Carrying Amount		Accumulated Amortization		Net Amount
	(in years)		(in thousands)		(in thousands)		(in thousands)
Developed technology—ASL		6.0		16,000		15,803		197
Developed technology—Diamond		9.0		9,400		8,965		435
Maintenance agreements		7.0		1,900		1,154		746

Total intangible assets			$	27,300	$	25,922	$	1,378


			As of July 31, 2013
Description	Estimated Useful Life		Gross Carrying Amount		Accumulated Amortization		Net Amount
	(in years)		(in thousands)		(in thousands)		(in thousands)
Developed technology—ASL		6.0		16,000		15,737		263
Developed technology—Diamond		9.0		9,400		8,906		494
Maintenance agreements		7.0		1,900		1,086		814

Total intangible assets			$	27,300	$	25,729	$	1,571

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 1.3 years.

The Company expects amortization for these intangible assets to be:


Year ending July 31,	Amount (in thousands)
Remainder of 2014	$	576
2015		396
2016		321
2017		85
Thereafter		—

Total	$	1,378

Impairment of Long-Lived Assets Other Than Goodwill

On an ongoing basis, management reviews the value of and period of amortization or depreciation of the Company’s long-lived assets. In accordance with Topic 360, Property, Plant and Equipment, to the FASB ASC, the Company reviews whether impairment losses exist on its long-lived assets other than goodwill when indicators of impairment are present. If this review is needed, the Company assesses future cash flows and re-evaluates the significant assumptions used in determining the original cost of long-lived assets other than goodwill. 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 compared to its carrying value. As of October 31, 2013 and July 31, 2013 there were no indicators that required the Company to conduct a recoverability test as of those dates.

Foreign Currency Remeasurement

The financial statements of the Company’s foreign subsidiaries are remeasured in accordance with Topic 830, Foreign Currency Matters, to the FASB ASC. The Company’s 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 expense, net, and were not significant for the three months ended October 31, 2013 and 2012.

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 tester products sold, the Company accrues a liability for the estimated cost of standard warranty at the time of tester shipment. 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 Company’s product warranty liability, as required by Topic 460, Guarantees, to the FASB ASC for the three months ended October 31, 2013 and 2012:


	Three Months Ended October 31,
Product Warranty Activity	2013			2012
	(in thousands)
Balance at beginning of period	$	1,217		$	1,672
Warranty expenditures for current period		(705	)		(966	)
Changes in liability related to pre-existing warranties		2			—
Provision for warranty costs in the period		781			1,011

Balance at end of period	$	1,295		$	1,717

Engineering and Product Development Expenses

The Company expenses all engineering, research and development expenses as incurred. Expenses subject to capitalization in accordance with Topic 985, Software, to the FASB ASC relating to certain software development costs, were insignificant for the three months ended October 31, 2013 and 2012.

Shipping and Handling Costs

Shipping and handling costs are included in cost of sales in the consolidated statements of operations. Shipping and handling costs were insignificant for the three months ended October 31, 2013 and 2012.

Income Taxes

Provision for income taxes relates principally to operating results of foreign entities in jurisdictions primarily in Asia and Europe.

As of October 31, 2013 and July 31, 2013, the Company’s total liability for unrecognized income tax benefits was $6.9 million and $6.8 million, respectively (of which $3.3 million and $3.2 million, if recognized, would impact the Company’s income tax rate). The Company recognizes interest and penalties related to uncertain tax positions as a component of provision for income taxes. As of October 31, 2013 and July 31, 2013, the Company had accrued approximately $0.9 million 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 the years prior to 1998.

As a result of completion of the Company’s 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 equity awards outstanding under various stock-based compensation plans, including the Company’s 2010 Stock Plan, as amended on November 26, 2010 (“2010 Plan”), the Company’s 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 and has made awards that remain outstanding under the StepTech, Inc. Stock Option Plan as part of its acquisition of StepTech, Inc. (“StepTech”) in 2003 and the Credence 2005 Stock Incentive Plan in connection with its acquisition of Credence. The Company can only grant new awards under the 2010 Plan.

The Company recognizes stock-based compensation expense for its equity awards in accordance with the provisions of Topic 718, Compensation—Stock Compensation to the FASB ASC (“Topic 718”). Under Topic 718, the Company is required to recognize as expense the estimated fair value as of the grant date of all share-based payments to employees. In accordance with this standard, the Company has elected to recognize the compensation cost of each service based award on a straight-line basis over the vesting period of such award. The Company recorded stock-based compensation expense of approximately $1.1 million for each of the three months ended October 31, 2013 and 2012, respectively, in connection with its share-based payments.

There were no restricted stock unit awards granted during the three months ended October 31, 2013.

The Company granted 793,900 restricted stock unit awards during the three months ended October 31, 2012, all of which are service-based and vest 25% in each of the four years following the grant date.

Net (loss) income per share

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

Reconciliation between the Company’s basic and diluted net (loss) income per share for the three month periods ended October 31, 2013 and October 31, 2012 were as follows:


	Three Months Ended October 31,
	2013			2012
	(in thousands, except per share data)
Net (loss) income	$	(6,900	)	$	549
Basic (loss) earnings per share
Weighted average shares outstanding- basic		47,900			48,303
Basic (loss) earnings per share	$	(0.14	)	$	0.01
Diluted (loss) earnings per share
Weighted average shares outstanding- basic		47,900			48,303
Plus: impact of stock options and unvested restricted stock units		—			408

Weighted average common and common equivalent shares outstanding- diluted		47,900			48,711
Diluted (loss) earnings per share	$	(0.14	)	$	0.01

For the three months ended October 31, 2013 and 2012, options to purchase approximately 0.7 million shares and 0.9 million shares, respectively, of common stock were not included in the calculation of diluted net (loss) income per share because their inclusion would have been anti-dilutive. These options could be dilutive in the future. The calculation of diluted net (loss) income per share also excludes 1.3 million restricted stock units for the three months ended October 31, 2013, in accordance with the contingently issuable shares guidance of Topic 260, Earnings Per Share, to the FASB ASC.

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. Marketable securities consist primarily of debt securities that are classified as available-for-sale and held-to-maturity, in accordance with Topic 320, Investments—Debt and Equity Securities, to the FASB ASC. The Company also holds certain investments in commercial paper or certificates of deposit that it considers to be held-to-maturity, based on their maturity dates. Securities available-for-sale includes corporate, asset-backed, mortgage-backed, 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 on investments held by the Company for the three months ended October 31, 2013 and 2012 were not significant. Unrealized gains and losses on investments held by the Company are reflected as a separate component of comprehensive income (loss) and are included in Stockholders’ Equity. Realized gains, losses and interest on investments held by the Company are included in interest income in the Consolidated Statements of Operations and Comprehensive Income (Loss). The Company analyzes its investments for impairment on a quarterly basis or upon occurrence of indicators of possible impairment. There were no other temporary impairment losses in the three months ended October 31, 2013 or 2012.

Property and Equipment

Property and equipment acquired is recorded at cost. 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 three to seven years. Repair and maintenance costs that do not extend the lives of property and equipment are expensed as incurred. The Company’s property and equipment as of October 31, 2013 and July 31, 2013 are summarized as follows:


	October 31, 2013			July 31, 2013			Estimated Useful Lives
	(in thousands)						(in years)
Equipment spares	$	58,110		$	58,461		5 or 7
Machinery, equipment and internally manufactured systems		36,068			34,587		3-7
Office furniture and equipment		2,063			2,014		3-7
Purchased software		488			488		3
Land		2,524			2,524		—
Leasehold improvements		6,952			6,983		Term of lease or useful life, not to exceed 10 years

Property and equipment, gross		106,205			105,057
Less: accumulated depreciation and amortization		(89,227	)		(88,410	)

Property and equipment, net	$	16,978		$	16,647